Part III: Analysis and Conclusion

(April 26, 2010): Part III:  Analysis and Conclusion

In the midst of an economic downturn, headlines are filled with accounts of failed corporations and bankruptcies as well as notorious government bailouts.  There are many threatened lawsuits directed at officers and Directors of corporations for breaches of their fiduciary duties or seeking judicial declarations that corporations are insolvent or in the so called “zone of insolvency.” Gheewalla provides important guidance to  Directors, creditors and their professionals. It establishes that, irrespective of whether a Delaware corporation is within the zone of insolvency or insolvent, individual creditors cannot assert direct claims for breach of fiduciary duty against Directors. In the case of an insolvent corporation, however, creditors can assert derivative claims on behalf of the corporation against Directors. It should be noted that the ruling is limited to breach of fiduciary duty claims: it does not restrict other kinds of claims or rights that may be asserted by creditors directly against a corporation under a contract, agreement or applicable law. Also, the ruling may engender increased litigation over when a corporation becomes “insolvent” and which parties should have the right to prosecute derivative claims.

Should you have any questions regarding these issues, don’t hesitate to contact us.  For a complementary consultation, you may call Robert W. Liles or one of our other attorneys at 1 (800) 475-1906.

Part II: The “Zone of Insolvency” — the Delaware Example

(April 26, 2010): This is the second installment of a three part article by David P. Parker examining the fiduciary duties of officers and directors of insolvent corporations and corporations operating in the so called “Zone of Insolvency.”

In Gheewalla, a significant Delaware law decision regarding creditors’ ability to sue corporate fiduciaries, the Delaware Supreme Court addressed the issue of whether a corporate director owes fiduciary duties to the creditors of a company that is insolvent or in the “zone of insolvency.”  The Court ruled that directors of a solvent Delaware corporation that is operating in the zone of insolvency owe their fiduciary duties to the corporation and its shareholders, and not to its creditors. The Court also ruled that the fiduciary duties of directors of an insolvent corporation continue to be owed to the corporation.   However, with respect to an insolvent corporation, you must have standing in order to pursue derivative claims for directors’ breaches of their fiduciary duty to the corporation.

The Supreme Court of Delaware examined the issue as to whether Delaware law recognizes a creditor’s right to bring direct fiduciary-duty claims against the directors of a corporation operating in the zone of insolvency. In holding that Delaware law does not recognize such a right, the Court explained:

When a solvent corporation enters the zone of insolvency the focus for Delaware directors does not change: Directors must continue to discharge their fiduciary duties to the corporation and its shareholders by exercising their business judgment in the best interests of the corporation for the benefit of its shareholder owners.

The Court also stated that creditors, unlike shareholders, already have several protections available to them, including contractual agreements, security instruments, the implied covenant of good faith and fair dealing, and fraudulent conveyance laws that “render the imposition of an additional, unique layer of protection through direct claims for breach of fiduciary duty unnecessary.” The Court also agreed with the Chancery Court’s reasoning that:

[A]n otherwise solvent corporation operating in the zone of insolvency is one in most need of effective and proactive leadership — as well as the ability to negotiate in good faith with its creditors — goals which would likely be significantly undermined by the prospect of individual liability arising from the pursuit of direct claims by creditors.

The Court also closed the door on a creditor’s right to bring a direct breach of fiduciary duty claim against directors of an insolvent corporation, reasoning that such a right would create uncertainty for directors who have a fiduciary duty to exercise their business judgment in the best interests of an insolvent corporation. According to the Court, a direct right of action would create a conflict between the duty of the directors to “maximize the value of the insolvent corporation for the benefit of all of those having an interest in it, and the newly recognized direct fiduciary duty to individual creditors.” The Court explained that it is important to allow a director to “engage in vigorous, good faith negotiations with individual creditors for the benefit of the corporation.” The Court did not, however, leave creditors without recourse for a breach of fiduciary duty by a director. It made clear that creditors of an insolvent corporation have standing to maintain derivative claims against directors on behalf of the corporation for a breach of fiduciary duty.

The ability of a creditor to sue a fiduciary can vary, depending on the specific facts at issue.  David Parker has extensive experience in this care of the law and can represent your interests.  For a complementary consultation, you may call Mr. Parker or one of our other attorneys at:  1 (800) 475-1906.

Part I: The Fiduciary Duties of Officers and Directors of Insolvent Corporations

(April 23, 2010): This is the first installment of a three part article by David Parker examining the Fiduciary Duties of Officers and Directors of Insolvent Corporations and Corporations operating in the so called “Zone of Insolvency.”

Part I:  The Fiduciary Duties of Officers and Directors of Insolvent Corporations

Over the next few days, David P. Parker will be posting several articles examing the  fiduciary duties of Officers and Directors of insolvent corporations and corporations operating in the so called “Zone of Insolvency.”

In the United States, corporations are creatures of state law, and the fiduciary duties of a corporation’s directors are defined by its state of incorporation. Many U.S. corporations are incorporated in the state of Delaware, which has a strong tradition of well-developed corporate jurisprudence.   There may, however, be differences between Delaware law and the laws of other states within the United States.  In general, Directors of solvent corporations have two basic “fiduciary” duties, the duty of care and the duty of loyalty, owed to the corporation itself and the shareholders. Directors must act in good faith, with the care of a prudent person, and in the best interest of the corporation. Directors must also refrain from self-dealing, usurping corporate opportunities and receiving improper personal benefits.  Decisions made by a Director on an informed basis, in good faith and in the honest belief that the action was taken in the best interest of the corporation will be protected by the “business judgment rule.”  Generally, officers owe the same fiduciary duties as directors.

It has long been settled that under ordinary (i.e., solvent) circumstances, shareholders typically have only a derivative (and not direct) right to sue for breach of the fiduciary duties of directors. If they do bring suit against directors, they must do so on behalf of the corporation, and any proceeds of those suits are for the benefit of the corporation.

The Delaware Supreme Court in Catholic Educ. Programming Found., Inc. v. Gheewalla opined that upon insolvency, creditors (who have, after all, taken the place of shareholders as the de facto owners) may likewise bring only derivative – and not direct – suits on behalf of the corporation against directors

 David Parker has extensive experience representing the interests of Corporate Officers and Directors.  Should you have questions regarding the responsibilities of these individuals to insolvent corporations, give us a call.  Mr. Parker can be reached at: 1 (800) 475-1906.