A Delaware bankruptcy judge recently ruled that information concerning the compensation and performance of “hand-picked” directors of a private equity firm’s portfolio company was discoverable in an action for breach of fiduciary duty against the private equity firm.

In an adversary proceeding in the chapter 11 bankruptcy of car hauler Allied Systems Holdings, Inc., the creditors’ committee asserted claims against Allied’s directors for breach of fiduciary duty and against Allied’s private equity owner, Yucaipa Companies, for aiding and abetting such breach. See In re Allied Systems Holdings, Inc., 2015 Bankr. LEXIS 3839 (Bankr. D. Del. Nov. 9, 2015). Specifically, the creditors’ committee alleged that the Allied directors—purportedly hand-picked and controlled by Yucaipa—breached their fiduciary duties to Allied by acting in the interests of Yucaipa to the detriment of Allied. Id. at *24-26.

In related discovery, the committee requested that Yucaipa produce information relating to the directors’ compensation and their employee performance reviews. Id. at *22. The committee also requested that Yucaipa produce the personnel files for any employee Yucaipa reasonably expected to be a witness in the case. Id. at *23. The committee contended that the requested documents could show that the directors received financial incentives and positive performance reviews in exchange for taking actions in Yucaipa’s interest, in breach of their fiduciary duties to Allied.

Yucaipa objected to the committee’s requests for information relating to director compensation on the grounds that such requests were “only intended to annoy, harass and embarrass” the Allied directors and Yucaipa. Id. at *27. Yucaipa contended that the only documentation responsive to such requests reflected the total compensation received by the directors and maintained that “those figures, standing alone, could [not] possibly support [the committee’s] allegations concerning the Directors’ purported conflicting loyalties, misplaced incentives, or anything else.”Id. at *28-29. Yucaipa further asserted that because it “did not perform formal, regular employment reviews” that no such documentation existed that was responsive to the committee’s requests for performance reviews or personnel files. Id. at *28.

In general, “[p]ersonnel files are discoverable; although such discovery may be limited given that such files contain confidential information.” Id.at *31. Moreover, a request for such files must be “reasonably calculated to reveal evidence pertaining to the allegations in the complaint.” Id. at *32.

The bankruptcy court overruled Yucaipa’s objections and held that the committee’s requests for the personnel files and documentation relating to director compensation and performance were reasonably calculated to reveal evidence that was “clearly related to the Committee’s allegations of conflicting loyalties and misplaced incentives.” Id. at *34. The court reasoned that “[a]lthough a total dollar figure may not be probative into conflicting loyalties, misplaced incentives, or other Committee allegations, the Committee should be able to explore the compensation amounts and compensation structures of the Yucaipa Directors.” Id. at *33.

Acknowledging that “Yucaipa cannot produce documents that do not exist” in the absence of “formal, regular employment reviews,” the bankruptcy court further ordered Yucaipa to produce all “informal assessment[s] or evaluations of the [directors’] performance,” such as an “e-mail stating ‘nice job during the meeting’” or “nice!” in response to a specific board decision, because such “[f]eedback related to the [directors’] performance is relevant to the allegations made by the Committee” that the directors received praise from Yucaipa for taking actions that were in Yucaipa’s interest, rather than Allied’s. Id. at *34.

Takeaway

The decision highlights the fact that personnel records may not be as confidential as generally understood and that private equity firms may want to be circumspect with respect to their dealings and communications with their portfolio companies’ directors and others who might be targeted as “hand-picked” by them.