Court Appoints Receiver for Insolvent Closely Held Corporation

Badii v. Metropolitan Hospice Inc., C.A. No. 6192-VCP (March 12, 2012)  involves a post-trial decision on an action under 8 Del. C. § 291 for the appointment of a receiver for an insolvent, closely held corporation, Metropolitan Hospice, Inc. (“MHI”) which owed, among other things, approximately $2 million to the IRS for back taxes, penalties, and interest.  MHI’s board of directors and the holders of its common stock having voting rights agreed on a plan (which the IRS also agreed with) to resolve this federal tax liability for a relatively small amount of money.  Under the plan, MHI would transfer all of its assets and liabilities to a newly formed corporation, “NewCo,” in exchange for 100% of NewCo’s stock.  Then, NewCo would pay off the federal tax liability for the appraised value of MHI’s tangible assets, approximately $54,000, and MHI will dissolve, distributing its sole asset – i.e., the NewCo stock – to its shareholders pro rata.  While MHI’s board and holders of voting common stock agreed with the plan, a major holder of non-voting stock disagreed with the plan. 

By way of background, MHI’s largest shareholder and its cofounder, Sousan Badii (owning 52% of the outstanding stock), died in 2010.  Pursuant to a shareholders’ agreement, the voting rights attached to a shareholder’s common stock terminate upon the shareholder’s death.  After Badii died, her stock became nonvoting and MHI’s second largest shareholder, who owned 30% of the company’s common stock, became the majority stock owner controlling over 60% of its voting stock.  A dispute arose as to what effect, if any, the reorganization should have on the shareholder’s voting rights.  Badii’s estate argued that either it should have voting rights in NewCo or MHI should auction its NewCo stock with the cash proceeds being distributed to MHI’s creditors upon dissolution.  The board and voting shareholders argued that the reorganization maintained the status quo, including the relative voting rights of the Company’s shareholders.  With this deadlock, Badii’s estate filed  an action under 8 Del. C. § 291 seeking the appointment of a receiver to auction MHI’s assets.

Under 8 Del. C. § 291, the Court is given the discretion to appoint a receiver for an insolvent corporation “to take charge of its assets, estate, effects, business and affairs, and . . . to do all other acts which might be done by the corporation and which may be necessary or proper.”  In addition,  the court noted that “[t]he appointment of a receiver is appropriate only if the company is insolvent and there exists ‘special [exigent] circumstances’ where some real beneficial purpose will be served.”  The Court then focused on the issue of whether Badii’s estate had demonstrated that appointment of a receiver was necessary to protect MHI’s creditors or shareholders by showing “some benefit that such an appointment would produce or some harm it could avoid.”

Since it was undisputed that MHI was insolvent, the Court turned to whether there existed exigent circumstances which would warrant the appointment of a receiver.  In finding that exigent circumstances existed, the Court highlighted the “time is of the essence” component with respect to IRS tax issue in that “the Company has received a finite grace period from the IRS to reorganize the business and discharge a significant debt for a relatively small amount of money. These circumstances demand decisive and deliberate action from the Board.”  Because there were competing plans as to what course MHI should pursue, the Court stated:

Where a company is insolvent, as MHI is, and the board believes that pursuing a certain course of action will result in an increase in the value of the firm, the creditors are the residual beneficiaries of that increase.  Here, the Board must act to exploit a time-sensitive opportunity in the form of the IRS settlement.  The Board has attempted to do so by adopting the Duncan Plan.  The Court is not convinced, however, that that Plan evenhandedly addresses the interests of the creditors, such as the Estate, and all of the shareholders. In these circumstances – indisputable insolvency, a time-sensitive opportunity, and the Board’s insistence on a dubious transaction – there is sufficient exigency to warrant appointment of a neutral receiver charged with ensuring that the Company fairly attempts to take advantage of the possibly short-lived IRS offer.

The Court then determined that while the appointment of a receiver could have both beneficial and detrimental effects by causing and avoiding delay and added expense, in the end the Court found that “[a]voiding such [incidental] delay and expense and increasing the likelihood of a full and fair evaluation of the Company’s options for taking advantage of the IRS offer provide[s] a sufficiently beneficial purpose to justify appointment of a receiver under the circumstances of this case.”