I am blogging from the Annual ABA Meeting in Chicago. This post includes a few highlights from a panel presentation entitled “The Expanding Role of Fiduciary Duties in Challenging Times”, and addresses a topic of great interest to readers of this blog: The duties of directors and officers in the context of a failing business, or one in the “zone of insolvency”.
Delaware Supreme Court Justice Henry duPont Ridgely and Kurt Heyman, an experienced Delaware corporate litigator, were on the panel that discussed recent Delaware opinions that describe fiduciaries duties in general as well as in the context of a failing business.
Kurt discussed the recent Delaware Supreme Court decision in Gantler v. Stephens, 695 A.2d 695, 708-09 & n.37 (Del. 2009), as summarized here on this blog. The Gantler case held that officers have the same fiduciary duties as directors, but also noted that the protections of DGCL Section 102(b)(7) do not protect officers.
Kurt explained that the Gantler decision raises three (3) fundamental questions:
(1) what is an officer?
(2) what does it mean for officers to have “identical” fiduciary duties to directors”
(3) what are the consequences of the foregoing?
(1) What is an officer? We should start by focusing on “non-director officers”. The DGCL does not define “officer”, but Section 142(a) does allow for a corporation to have such officers as are provided for in the bylaws. Moreover, in the long-arm statute, the Delaware Code imposes personal jurisdiction over officers who hold such titles as President, CFO, etc., or one who is identified as such in SEC filings.
(2) What does it mean? We refer to the much more abundant descriptions of the fiduciary duties of directors. Gantler identifies two fiduciary duties of directors: care and loyalty. For care Kurt cited to the 2006 Chancery decision in Disney and for loyalty the 1987 Supreme Court decision in Ivanhoe. He observed that the duty of good faith is part of the duty of loyalty (see Stone v. Ritter), and that the duty of disclosure is part of both the duty of care and of loyalty. So too, the duty of candor is part of the duty of loyalty. Kurt observed that the Revlon duty is a subset of both care and loyalty. He pointed out to those assembled that: “aiding and abetting” claims can be asserted against officers who are not involved in the actual decision-making, such as in a Revlon situation, but who help the directors in their breach.
(3) What are the consequences of fiduciary duties being imposed on officers? The exculpation protection of DGCL Section 102(b)(7) does not apply to officers. That section allows protection for directors for claims against them for monetary liability for breaches of the duty of care (but does not cover breaches of the duty or loyalty or suits for injunctive relief). Also, DGCL Section 141(e) only protects directors from liability for “good faith reliance" on reports of managers….” However, 10 Del. C. Section 3114 (b) imposes personal jurisdiction on both directors and (since 2004) officers of Delaware corporations via implied consent.
One possible legislative change in response to Gantler is to include officers within the protection of both Sections 102(b)(7) and 141(e), although at least one school of thought argues that such a change is not necessary. [Kurt Heyman graciously agreed to allow me to post his PowerPoint presentation on this blog, here. Thanks, Kurt.]
FIDUCIARY DUTIES IN THE CONTEXT OF FAILING COMPANIES
Justice Ridgely discussed the “insolvency exception” in this context and whether it is more related to “standing” or duties, or both. He said that when a company becomes insolvent, creditors can bring a derivative action on behalf of the corporation. (N.B. This is not a transcript and any references to what judges on the panel said is merely my paraphrasing and is not to be read as a verbatim recitation.)
Justice Ridgely addressed the issue of when a company is deemed insolvent. This is a factual issue that often is disputed, but at least four standards are used to make the determination: (i) the balance sheet test (liabilities exceed assets); (ii) the cash flow test (can bills be paid as they become due); (iii) the bankruptcy code test at 11 U.S.C. Section 101(32), et seq.; and (iv) the unreasonably small amount of capital analysis.
Bankruptcy Judge Eugene Wedoff, also a panel member, remarked that in bankruptcy proceedings insolvency is used most often in connection with issues of fraudulent conveyance claims.
Justice Ridgely observed that the "trust fund doctrine", holding that the directors must preserve the assets of an insolvent company, originated in the context of the procedure for a corporate dissolution. His Honor also noted that the Business Judgment Rule would apply to protect directors who have made a good faith, informed decision to either try to revive a dying company or put it into bankruptcy. See generally Nelson v. Emerson, 2008 WL 1961150 (Del. Ch., May 6, 2008), summarized here. He referred to the 2004 Chancery Court decision in Production Resources which clarified Chancellor Allen’s decision in Credit Lyonnais as standing for the position that the Business Judgment Rule is a shield against creditors’ claims.
Justice Ridgely also discussed the Delaware Supreme Court’s 2006 decision in North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, summarized on this blog here. He described the opinion as supporting the view that directors must have discretion to act in the best interests of the corporation. His Honor explained the decision as including the following key points:
- recognizing, after a company is insolvent, the standing of creditors to make claims derivatively againt directors
- however, no such standing is granted to creditors in the amorphous "zone of insolvency"
- the opinion should be read to focus on the issue of standing for directors only when a company is insolvent and not for the principle that directors owe duties to creditors at that point in time when a company is insolvent
- creditors do not have direct claims against directors either during insolvency or in the so-called "zone of insolvency" (a "location" which the Delaware Supreme Court has never tried to define).
During a discussion of the Business Judgement Rule’s protection of decisions of directors in connection with deciding whether or not to file for bankruptcy, the use of a Motion to Dismiss related claims under Rule 12(b)(6) was discussed. Vice Chancellor Donald Parsons, of the Delaware Chancery Court, who was attending the panel discussion, rose to remind all in attendance that the Delaware courts have often reiterated that in the context of a Rule 12(b)(6) motion to dismiss, the court will not accept mere "conclusory allegations" nor will unreasonable inferences be accepted. Kurt Heyman added that in the Rule 12(b)(6) context, the court will take judicial notice of a Section 102(b)(7) provision in the corporation’s charter to the effect that the directors are protected from claims for a breach of the duty of care.
Judith Elkin, who together with Kendyl Hanks, also prepared materials for the presentation today, noted that in a bankruptcy context, the creditors are deemed owners of the corporation, and not the shareholders. It was also observed that if a trustee in bankruptcy recovers money on behalf of the corporation, the money would be received for the benefit of creditors. She also noted that it is becoming increasingly common to see claims of "aiding and abetting" asserted against lenders of companies who received loans shortly before they entered bankruptcy and used those loans, for example, to the detriment of other creditors. See generally, In Re Fedders North America, Inc., 405 B.R. 527, 542 (Bankr. D.Del. 2009).
UPDATE: Professor Stephen Bainbridge, a nationally recognized expert on corporate law, comments here about the above posting that refers to judicial notice of Section 102(b)(7) exculpation provisions and how that relates to prior decisions of the Delaware courts. The good professor has a second post here that comments on the sections of the above post regarding the Gantler decision.
SUPPLEMENT: In reply to the above post, a well-known corporate law scholar, Professor Lyman Johnson sent us a recent article that he co-authored on the topic of officers’ fiduciary duties. Here is the article. Thanks, Professor.