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fiduciary duties in the vicinity of insolvency - Turnaround ...

FIDUCIARY DUTIES IN

THE VICINITY OF

INSOLVENCY

Joseph U. Schorer

Kirkland & Ellis

Presentation to

TURNAROUND MANAGEMENT ASSOCIATION

November 8, 2002

(c) 2002. Joseph U.

Schorer. All rights

reserved.

1


OVERVIEW

• Fiduciary duties of directors and

officers from the perspective of the

company’s counsel

(c) 2002. Joseph U.

Schorer. All rights

reserved.

2


TOPICS TO BE

COVERED

• Fiduciary duty issues

• Other liability issues for Ds & Os

• Director’s duty and/or right to

resign

(c) 2002. Joseph U.

Schorer. All rights

reserved.

3


FIDUCIARY DUTIES

• Duties of Ds and Os when the

corporation is solvent

• Fiduciary duties when insolvency

concerns arise

(c) 2002. Joseph U.

Schorer. All rights

reserved.

4


FIDUCIARY DUTIES

GENERALLY--DUTIES

• Duty of care

u Directors must be reasonably

informed

• Duty of loyalty

u Good faith

u Disinterestedness

• Business judgment rule

u Presumes the foregoing

u Gross negligence standard

(c) 2002. Joseph U.

Schorer. All rights

reserved.

5


FIDUCIARY DUTIES

GENERALLY--

BENEFICIARIES

• No fiduciary duties to creditors

• Contracts and statutory rules are

strict measure of company

obligations

(c) 2002. Joseph U.

Schorer. All rights

reserved.

6


TRIGGERING DUTIES

TO CREDITORS

• When is the duty to creditors

triggered?

u “Insolvency in fact”

u Transactions that render the

company insolvent or nearly

insolvent

u “Vicinity of insolvency”

(c) 2002. Joseph U.

Schorer. All rights

reserved.

7


TRIGGERING DUTIES

TO CREDITORS

• “Insolvency in fact” test

u Balance sheet—liabilities exceed

reasonable market value of assets

u Equity insolvency —when the

corporation is unable to pay its

debts as they become due in the

ordinary course

u Geyer v. Ingersoll Publications Co.,

621 A.2d 784, 787-90 (Del. Ch.

1992)

(c) 2002. Joseph U.

Schorer. All rights

reserved.

8


TRIGGERING DUTY TO

CREDITORS

• Transactions that will render the

company insolvent or nearly

insolvent

u In re Buckhead America Corp., 178

B. R. 956, 968-69 (D. Del. 1994)

(directors approved $175 million of

long term debt)

(c) 2002. Joseph U.

Schorer. All rights

reserved.

9


“VICINITY OF

INSOLVENCY”

• Credit Lyonnais Bank Nederland,

N.V. v Pathe Communications

Corp. (1991 WL 277613, 34) (Del.

Ch. 1991)

u In dicta, a few other courts have

referred favorably to this opinion

(c) 2002. Joseph U.

Schorer. All rights

reserved.

10


CREDIT LYONNAIS

• “At least where a corporation is

operating in the vicinity of

insolvency, a board of directors is

not merely the agent of the residue

[sic] risk bearers, but owes its duty

to the corporate enterprise.”

(c) 2002. Joseph U.

Schorer. All rights

reserved.

11


CREDIT LYONNAIS

• “The MGM board or its executive

committee had an obligation to the

community of interests that

sustained the corporation, to

exercise judgment in an informed,

good faith effort to maximize the

corporation’s long-term wealth

creating capacity.”

(c) 2002. Joseph U.

Schorer. All rights

reserved.

12


CREDIT LYONNAIS—VICINITY OF

INSOLVENCY

• Court’s discussion of “vicinity of insolvency” was

dicta

• The case did not define “vicinity of insolvency,”

nor have subsequent decisions

• Most commentators analogize to a continuum—

as the company approaches “insolvency in fact,”

directors must increasingly consider “community

of interests”

(c) 2002. Joseph U.

Schorer. All rights

reserved.

13


VICINITY OF INSOLVENCY—

PRACTICAL CONSIDERATIONS

• Process

u Clear record of director care

u Use of outside professionals

u How current is information?

• Is it a bet-the-company decision?

• Is it a bet-the-company business?

• Margin of error

(c) 2002. Joseph U.

Schorer. All rights

reserved.

14


SCOPE OF FIDUCIARY DUTIES

UPON INSOLVENCY

• Continuing duties to shareholders?

• Dealing with divided duties after insolvency

u Focus on the “entire corporate enterprise”--Geyer

u Issues for the interested directors

• Note that in majority of cases granting relief, the

alleged misconduct involved diversion of assets

to insiders or preferred creditors

(c) 2002. Joseph U.

Schorer. All rights

reserved.

15


FIDUCIARY DUTIES AFTER

BANKRUPTCY COMMENCES

• Primary duty to creditors

• Court supervision

(c) 2002. Joseph U.

Schorer. All rights

reserved.

16


OTHER LIABILITY ISSUES FOR

DIRECTORS AND OFFICERS

• Statutory liabilities—trust fund

taxes, PACA, wages (some states

create liability for officers), etc.

• Contractual “trust fund” status;

conversion

• Bad checks

• Sarbanes Oxley

(c) 2002. Joseph U.

Schorer. All rights

reserved.

17


DIRECTOR’S RIGHT TO RESIGN

• General rule: prerogative to resign

• Exceptions to the general rule

u If resignation will cause immediate harm

u If resignation will leave assets unprotected

• Practical considerations

u No release from pre-resignation defaults

u Time commitments, stress, reputation, loyalty

u Control

u Chapter 11 plan release/injunction/exculpation

(c) 2002. Joseph U.

Schorer. All rights

reserved.

18


SUMMARY

• Duties don’t change as insolvency

approaches, but the beneficiaries

do

• Ambiguous legal standards make

decision-making very much in-themoment

(c) 2002. Joseph U.

Schorer. All rights

reserved.

19

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