“To the extent Pfeiffer v. Toll conflicts with our current interpretation of [Brophy], Pfeiffer cannot be Delaware law.”

Based upon the recent Delaware Supreme Court decision, Kahn v. Kohlberg Kravis Roberts & Co. LLP, C.A. No. 1808 (Del. June 20, 2011), profits earned at the expense of a company may be subject to disgorgement even without an actual showing of harm to the company.  This important decision clarifies what many practitioners thought was the law under Brophy, discussed below.

For a brief discussion of the decision, click here.  In Kahn, which was entered on June 20, 2011, the Delaware Supreme Court overturned a Delaware Court of Chancery decision, reviving the claims of minority shareholders of an entity named Primedia Inc.  In so doing, the Court ruled that no showing of harm is required for the granting of disgorgement of profits based on a “Brophy” claim, thus overturning the recent Court of Chancery decision of Pfeiffer v. Toll, 989 A.2d 683 (Del. Ch. 2010).

In Kahn, the appellant shareholders alleged that the controlling shareholder of Primedia, Kohlberg Kravis Roberts & Co. LLP (“KKR”), and certain directors and officers, breached their duty of loyalty to Primedia by purchasing hundreds of millions of dollars of preferred stock n Primedia on the open market when the price was low, later causing Primedia to redeem the shares at full value. Plaintiffs also asserted a Brophy claim stating that the KKR defendants breached their fiduciary duties to Primedia by purchasing the preferred stock at a time when they possessed material nonpublic information.  Essentially, according to the Plaintiffs, KKR knew that the value of Primedia’s earnings would exceed previous forecasts, and that Primedia planned to redeem its outstanding preferred stock, and therefore KKR enriched itself at Primedia’s expense.

Relying upon Pfeiffer v. Toll, 989 A.2d 683 (Del. Ch. 2010), the Court of Chancery granted Primedia’s Special Litigation Committee’s dismissal motion, holding that because Primedia suffered no harm, disgorgement was not an available remedy for the minority shareholders’ Brophy claims.

On appeal, the Delaware Supreme Court disagreed with the Court of Chancery’s interpretation of Brophy v. Cities Serv. Co., 70 A.2d 5 (Del. Ch. 1949), stating that “actual harm to the corporation is not required for a plaintiff to state a claim under Brophy.”  According to the Delaware Supreme Court, the Brophy court relied upon principles of equity and restitution for the proposition that a fiduciary cannot use confidential corporate information for one’s own benefit.  “Even if the corporation did not suffer actual harm, equity requires disgorgement of that profit.” The Delaware Supreme Court further stated that the requirement set forth in Pfeiffer that a plaintiff must show that the corporation suffered actual harm in order to bring a Brophy claim—“is not a correct statement of our law. To the extent Pfeiffer v. Toll conflicts with our current interpretation of [Brophy], Pfeiffer cannot be Delaware law.”