DGCL § 174: Director Liability for Unlawful Dividends and Buybacks

Under Section 174 of the Delaware General Corporation Law, directors who approve an unlawful dividend or an unlawful stock repurchase are personally liable, jointly and severally, for the full amount of the distribution plus interest. A creditor or the corporation can pursue any single participating director for the entire payout, and the claim can be brought any time within six years of the payment.¹ The standard of conduct is willful or negligent, not fraudulent, which means an inattentive yes vote is enough.

What Makes a Dividend or Buyback Unlawful

Section 174 does not define the underlying violation. It borrows from two other provisions of the DGCL, and knowing where those lines sit is the starting point for knowing when personal exposure begins.

Stock Repurchases: Section 160

A Delaware corporation cannot repurchase or redeem its own shares when capital is already impaired or when the buyback itself would impair capital. Capital has a specific meaning here. Surplus equals net assets (total assets minus total liabilities) minus stated capital, and if no surplus remains after the repurchase, capital is impaired.² A narrow exception allows repurchase of preferred shares carrying a liquidation preference where the shares are retired with a corresponding capital reduction. Outside that carve-out, any buyback that leaves capital impaired puts the approving directors within reach of Section 174.

Dividends: Sections 170 and 173

Section 173 requires dividends to comply with the DGCL. The substantive rule sits in Section 170, which restricts dividends to two sources. The first is surplus. The second, sometimes called a nimble dividend, allows a corporation without surplus to pay from net profits earned in the current or immediately preceding fiscal year. A separate guardrail applies when losses or depreciation have reduced capital below the aggregate amount represented by any class of preferred stock with a liquidation preference: no nimble dividends on any shares until that deficiency is cured.³ Anything paid outside those boundaries is unlawful.

Who Is on the Hook, and for What Kind of Conduct

Section 174(a) reaches the directors “under whose administration” the unlawful distribution occurred, and it does so on a willful or negligent standard.¹ Bad intent is not required. If a director failed to exercise reasonable care in confirming that surplus or net profits supported the distribution, that alone can carry the day for a plaintiff.

Liability is joint and several. The plaintiff does not have to sue everyone who voted yes; it can go after a single director for the entire distribution. That is a hard fact for outside directors who sit on multiple boards. One inadequately scrutinized vote can create exposure equal to the full payout.

The claim runs to the corporation and, if the corporation dissolves or becomes insolvent, to its creditors.¹ The Delaware Supreme Court held in Gheewalla that creditors of an insolvent corporation have standing to bring derivative claims for breaches that diminish the company’s value.⁴ Practically, a bankruptcy trustee or an unpaid creditor can revive a Section 174 claim well after the directors thought the file was closed.

How Long the Exposure Lasts

Claims can be brought within six years after the unlawful dividend was paid or the unlawful repurchase was completed.¹ The clock runs from the payment date, not the date of the board vote. A director who leaves the board in year one still carries the exposure through year six. Keep the records that show what you saw and asked before you voted.

What a Liable Director Owes

The liable director owes the full amount of the unlawful distribution. A $10 million dividend paid without adequate surplus means the participating directors are on the hook for $10 million, with the aim of restoring the corporation to the position it would have been in had the payment never happened.¹

Interest runs on top of the principal from the time liability accrued.¹ Section 174 does not fix a rate. Where no contract rate applies, Delaware’s general legal rate is 5% above the Federal Reserve discount rate in effect when the interest begins to accrue.⁵ Because that rate floats, the interest component can grow meaningfully over multi-year litigation.

Two Defenses That Actually Work

Getting Your Dissent Into the Minutes

A director who votes against the distribution, or who was absent when it was approved, can avoid liability, but the statute is specific about how. The dissent must be entered in the corporate minutes at the meeting or immediately after receiving notice of the action.¹ A verbal objection that never reaches the minutes does not count. A director who was present and silent is presumed to have concurred. If you disagree, make sure the corporate secretary writes it down before you leave the room.

Good-Faith Reliance Under Section 172

Section 172 shields a director who relies in good faith on the corporation’s records, or on reports and opinions from officers, employees, board committees, or outside experts, when making judgments about asset value, liabilities, net profits, surplus, or other facts bearing on whether a distribution is lawful. Directors who meet that standard are “fully protected.”⁶

The protection is real, but it has conditions. The expert must have been selected with reasonable care, the director must reasonably believe the person is competent on the subject, and the reliance must be in good faith rather than willfully blind.⁷ A director who asked the CFO or an independent appraiser to calculate surplus, and who reasonably relied on the answer, has a strong defense if the numbers later prove wrong. A director who rubber-stamped the distribution without looking at anything has a much harder time.

If You Pay, Who You Can Chase

Contribution From Fellow Directors

Section 174(b) lets a director who pays a judgment seek contribution from every other director who voted for or concurred in the unlawful distribution.¹ The right is proportional. If five directors approved the payment and one pays the whole judgment, that director can pursue the other four for their shares. Collection can be a different story: co-directors may lack the assets, or may successfully invoke Section 172. The legal right and the practical recovery are not the same thing.

Subrogation Against Knowing Stockholders

Section 174(c) opens a second path. A director who pays the corporation for an unlawful distribution steps into the corporation’s shoes and can pursue stockholders who received the funds, but only those who had “knowledge of facts indicating” the distribution was unlawful. Recovery is proportional to what each stockholder received.¹

The knowledge requirement is the bottleneck. A public company shareholder who deposits a dividend check has almost certainly never seen the surplus calculations. Subrogation claims are more workable in closely held corporations, where major stockholders often sit on the board or have direct access to the financial information that would show the distribution exceeded legal limits. Board attendance records, internal financial memos, and communications discussing surplus can establish the necessary knowledge. Without that evidence, the paying director remains the ultimate source of repayment, regardless of who actually received the money.

1
Justia. Delaware Code 8-174 – Liability of Directors for Unlawful Payment of Dividend or Unlawful Stock Purchase or Redemption
2
Delaware Code Online. Delaware Code Title 8 Chapter 1 Subchapter V – Section 154
3
Delaware Code Online. Delaware Code Title 8 Chapter 1 Subchapter V – Section 170
4
Justia. North American Catholic v Gheewalla – 2007
5
Justia. Delaware Code 6-2301 – Legal Rate and Loans
6
Justia. Delaware Code 8-172 – Liability of Directors and Committee Members as to Matters Involving Certain Corporate Actions
7
Delaware Code Online. Delaware Code Title 8 Chapter 1 Subchapter IV – Section 141(e)