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7/26/2019 19 Jan 2016 Email to ENR Cheifs of Staff - How Could Fiduciary Duty Conflict With the Public and National Interest
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From: Douglas Grandt [email protected]: How could fiduciary duty conflict with the Public and National Interest [Corrected]
Date: January 19, 2016 at 8:55 AMTo: Edward Hild (Sen. Murkowski) [email protected], David Cleary (Sen. Alexander)
[email protected], Dan Kunsman (Sen. Barrasso) [email protected],Joel Brubaker (Sen. Capito) [email protected], James Quinn (Sen. Cassidy) [email protected],Jason Thielman (Sen. Daines) [email protected], Chandler Morse (Sen. Flake)[email protected], Chris Hansen (Sen. Gardner) [email protected],Ryan Bernstein (Sen. Hoeven) [email protected], Boyd Matheson (Sen. Lee) [email protected], Mark Isakowitz (Sen. Portman) [email protected], John Sandy (Sen. Risch) [email protected],Travis Lumpkin (Sen. Cantwell) [email protected], Jeff Lomonaco (Sen. Franken)[email protected], Joe Britton (Sen. Heinrich) [email protected], Betsy Lin (Sen. Hirono)[email protected], Patrick Hayes (Sen. Manchin) [email protected],Bill Sweeney (Sen. Stabenow) [email protected], Mindy Myers (Sen. Warren)[email protected], Jeff Michels (Sen. Wyden) [email protected],Michaeleen Crowell (Sen. Sanders) [email protected], Kay Rand (Sen. King) [email protected], Joe Hack (Sen. Fischer) [email protected], Derrick Morgan (Sen. Sasse) [email protected],Karen Billups (Senate ENR Ctee) [email protected], Colin Hayes (Senate ENR Ctee)[email protected], Angela Becker-Dippmann (Senate ENR Ctee) [email protected]
Cc: Jordan Cox (Sen. Fischer) [email protected], Ginger Willson (Sen. Sasse) [email protected],Ali Aafedt (Sen. Hoeven) [email protected]
Dear Chiefs of Staff of the Senate Energy & Natural Resources Committee (ENR) and the Nebraska Senate Deleg ation,
On January 15, I emailed Senators Fischer's and Sasses Chiefs of Staff Jordan Cox and Ginger Willson, asking again for theirintervention with ENR Chairman Murkowski:
Please request Senator Murkowski to call for testimony and assurances that CEOs will act in the Public and NationalInterest when there is a conflict with their fiduciary duty. As part of an energy policy, ENR should compel them to act in
our best interest.
For your convenience I will restate my rationale for petroleum CEOs testifying before ENR:
I fear that sustained low oil prices will cause production companies to go belly up precipitously, reducing refineries'feedstock, leaving America with less diesel, gasoline, kerosene, fuel oil, and other liquid fuels. The bottom line as I seeit, is a collapse of petroleum equities, a general downward market panic, and devastating declines in the economic healthof the nation, individual retirement funds, pensions and superannuationsin short, mayhem in America.
In my January 15 email to you, the Chiefs of Staff of the ENR member Senators, I bemoaned the fact that you have notresponded to my dozens of emails (and dozens of letters to the Senators). Yesterday, it occurred to me that perhaps you do notunderstand fiduciary duty and why CEOs and Boards of Directors exercising fiduciary duty in the face of insolvency will likely bein direct conflict with Congress requirement that they act in the Public and National Interest.
Therefore, I direct you to American Bar Association document that hopefully will elucidate the basis for my fears:
INSOLVENCY AND FIDUCIARY DUTIES: ADVISING DIRECTORS AND OFFICERS WHEN THE COMPANY CANNOT PAY ITSBILLSdated August 6, 2010[CORRECTION] (Bit.ly/ABA6Aug10)
Sincerely yours,
Doug Grandt
http://www.americanbar.org/content/dam/aba/publications/blt/2010/09/inside-buslaw-insolvency-201009.authcheckdam.pdfhttp://www.americanbar.org/content/dam/aba/publications/blt/2010/09/inside-buslaw-insolvency-201009.authcheckdam.pdfhttp://bit.ly/ABA6Aug10http://www.americanbar.org/content/dam/aba/publications/blt/2010/09/inside-buslaw-insolvency-201009.authcheckdam.pdfhttp://www.americanbar.org/content/dam/aba/publications/blt/2010/09/inside-buslaw-insolvency-201009.authcheckdam.pdfhttp://www.americanbar.org/content/dam/aba/publications/blt/2010/09/inside-buslaw-insolvency-201009.authcheckdam.pdfhttp://www.americanbar.org/content/dam/aba/publications/blt/2010/09/inside-buslaw-insolvency-201009.authcheckdam.pdfhttp://bit.ly/ABA6Aug10http://www.americanbar.org/content/dam/aba/publications/blt/2010/09/inside-buslaw-insolvency-201009.authcheckdam.pdfmailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]7/26/2019 19 Jan 2016 Email to ENR Cheifs of Staff - How Could Fiduciary Duty Conflict With the Public and National Interest
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MIUtiC N BAA A SOCIATION
Business
law
Section
Annual Meeting
San Francisco C
August
6,
2 1
2:3
p.m.
PST
INSOLVENCY AND FIDUCIARY DUTIES:
ADVISING DIRECTORS AND OFFICERS
WHEN THE COMPANY CANNOT PAY
ITS
BILLS
Program
Chair Moderator:
Lewis H Lazarus, Esq.
Morr is James
LLP
Program Speakers:
The Honorable Elizabeth S Stong
United States Bankruptcy Judge, E D of New York
Ted
S
Waksman, Esq
Weil, Gotshal Manges LLP
Kristen
K
McGuffey, Esq.
Executive Vice President, General Counsel and Secretary
Simmons Bedding Company
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William reekmuir
Executive Vice President,
hief
Financial
Officer
and Treasurer
Simmons Bedding Company
Craig
D
Hansen,
Esq
Squire, Sanders Dempsey L L P
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TABLE OF CONTENTS
Page
I
DIRECTORS
AND
OFFICERS
FIDUCIARY DUTIES ....................................... 1
A. The Duty
of
Loyalty ............................ ................................ .......... 1
B The Duty of Care ................................ ................................... ...... 2
C The Business
Judgment
Rule .. ............................................. ......... 2
II. HOW DO THESE
DUTIES
CHANGE WHEN A CORPORATION
APPROACHES INSOLVENCY? ................................................................... 3
A.
Introduction
................................................................................ 3
B Zone or Vicinity of Insolvency .......................... ............................ 3
C
To Whom
Are Fiduciary Duties Owed? ..... ..................................... 4
D A Word on Deepening Insolvency ...................................... ......... 4
III. SPECIFIC CHAPTER
11
CONSiDERATIONS ...... ...... ..... ..... ...... ..... ..... ...... .... 5
A. Duties During
Chapter 11
Proceedings ......................................... 5
B Revlon Duties and Their Application To A Chapter 11 ................... 6
IV. COMMON CHAPTER 11 TRANSACTION STRUCTURES THAT
IMPLICATE FIDUCIARY DUTIES ......................................... ....................... 7
A. Introduction ................................................................................ 7
B The 6 Sale ........................................ ................................. ....... 7
C
The StandAlone Plan ..................... ....................................... ........ 8
D The Plan Sponsor .................................. ................................... .... 9
V RESTRUCTURING
TRANSACTIONS INVOLVING RELATED PARTIES ............. 9
A.
Introduction
.................................. ..................................... ......... 9
B The Use Of Special Committees In A Chapter
11
......................... 10
VI.
SOME
CAUTIONARY WORDS REGARDING D&O INSURANCE .... .... .... .... .... 12
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Exhibits
T BLE
OF CONTENTS
continued)
Page
Bankruptcy Bulletin - Delaware Supreme Court Clarifies Fiduciary
Duties When A Corporation Is Insolvent
or
In the Zone of Insolvency
- Weil, Gotshal Manges LLP
2 orth American Catholic Educational
Programming
Foundation
Inc. v Cheewa//a 93 A.2d 92 (Del. 2007)
3 Sample Memorandum to Board of Directors of Distressed
Companies Regarding Scope
of
Fiduciary Duties - Squire, Sanders
Dempsey L L P
4 Fiduciary Duties for Directors
of
Troubled Companies - Weil,
Gotshal Manges LLP
5
Rev/on
Duties Under Delaware Law - Morris James LLP
PHO
ENIXJS2
85I 02
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I DIRECTORS AND OFFICERS FIDUCIARY DUTIES
Generally, directors and officers fiduciary duties comprise the
duty
of
loyalty and the duty of care. Under Delaware law, corporate officers and
directors have identical
fiduciary
duties.
See
Cant/er
v
Stephens
965 A.2d
695, 708-09 (Del. 2009).
So
long
as
the directors and officers
comply with
these duties,
they
are entitled to the
protections of
the business judgment rule.
When the business judgment rule applies, a court
will
not
typically
substitute its
own view for those
of
directors and officers
or
second-guess the outcome
of
business decisions by holding a director or officer personally liable for a
mistake in
judgment.
Each of these duties is discussed more fully below.
A
The
uty
o Loyalty
1. In deal ings
with
and on
behalf of
the corporation, directors
owe a
fiduciary
duty of loyalty to the
corporation,
which demands that there
be
no
conflict
between the
corporation's
interest and the
director's
interest.
Directors
must
avoid
self-dealing,
observe
confidentiality
obligations, and
not
abuse corporate
opportunities
for
personal gain.
A
disqualifying
interest can
exist
because a
director
is
dominated or
controlled by a party interested in a
corporate transaction.
Challenges to conflicts of interests can be cured by a
showing that
an
action was approved by a
majority of
disinterested directors
who
were
informed of
the conflict.
2. The
duty of
loyalty includes the
obligation to
act in good
faith
with
a
true
faithfulness and devotion to the interests of the corporation
and its shareholders.
PHOENIXl528510 2
A failure to act in good
faith
could be shown where a director
intentionally acts with a purpose other than that of advancing
the best interests of the
corporation,
acts with the intent to
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violate applicable law, or intentionally fails to act in the face
of a known duty
to
act.
A
director who
deliberately avoids acting in the best interests
of
the
corporation
cannot evade
liability
by showing
that
he/she
technically met the requirements
of
their fiduciary
duties.
3 The
duty of
loyalty also includes the
obligation
to disclose
any conflicts of
interest
with respect to any corporate matter being decided.
In
matters before the board, a
director must inform fellow
directors of any conflict of interest.
When seeking shareholder action on a
matter
involving a
conflict
of
interest,
an
interested director
must
disclose
to
all
shareholders such
conflict
of interest.
B The uty o are
Directors are required to exercise a requisite degree
of
care and
prudence in the process
of
making decisions and in carrying out directorial
responsibilities.
PHOENIXl52 85 10 2
Directors must inform themselves
of
all material
information
reasonably available to them before making a business
decision.
The General Corporation Law of Delaware allows directors to
rely on
information
provided
by
the
corporation s
officers,
employees, and
other
advisors, as long
as
the directors
reasonably believe the information provided is within the
scope
of
the provider s professional
or expert
competence,
and the person
so
relied upon has been selected
with
care.
The duty
of
care still requires that directors evaluate advice
and
information
critically and investigate further
if
there are
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facts or circumstances signaling a need for additional
information.
C he
Business Judgment Rule
Under the business
judgment
rule, there is a
presumption
that
in
making
a business decision the director
of
a corporation acted on an
informed
basis, in good
faith
and in the honest
belief
that the action taken was in the
best interests of
the company.
Standard
of judicial
review used by courts
to
determine when
close scrutiny of a transaction is warranted. When directors
have
fulfilled
their duties
of
care and loyalty in good faith,
courts presume,
under
the business
judgment
rule,
that
their
decisions are valid.
Protects
directors ability to
exercise their discretion when
making decisions on behalf of the corporation without fear of
a
court questioning
the
wisdom
of their decision in
hindsight.
A plaintiff can overcome the
presumption of
the business
judgment rule by showing
that
a director has failed to act
with
due care
or
loyalty,
or
lacked good
faith
in carrying out
these duties, in which case, the
court will
scrutinize the
challenged transaction substantively.
II. HOW DO
THESE
DUTIES CHANGE WHEN A CORPORATION PPRO CHES
INSOLVENCY?
A Introduction
What does
it
mean
to
be in the zone
or
vicinity
of
insolvency?
To
whom
are
directors fiduciary
duties owed when a corporation
is
in the zone of insolvency or is insolvent?
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Do creditors have claims for breaches
of fiduciary
duties against
directors
of
a corporation that is in the zone
of
insolvency
or is
insolvent?
B Zone
or
Vicinity o nsolvency
1. There
is
no exact
definition of
the zone
or
vicinity
of
insolvency, but generally, a corporation is considered in the zone or vicinity
of insolvency when it
is
near or approaches the point where:
the sum of such entity's debts
is
greater than all of such
entity's
property,
with
no reasonable prospect that the
business can
be
successfully continued
or
The corporation
is
unable
to
pay its debts
as
they fall due in
the usual course
of
business.
2. This rather subjective concept can be
difficult
to apply in
practice,
but it
may
be telling that
the
question is
being asked. The board
should act diligently in determining whether the
corporation is
in the zone or
vicinity
of
insolvency and may consider, among
other
factors, advice
of
its
financial advisors in reaching its conclusion.
3. A company may
be
operating
in the zone
of
insolvency
when it
is
not yet technically insolvent under either the
bankruptcy
test or
the equitable insolvency test,
but
nevertheless
is
experiencing financial
difficulties.
4.
s
the risk that creditors
will
not be paid increases, the
likelihood that a company is in the zone of insolvency increases.
C To Whom
re
Fiduciary Duties Owed?
In
the case
of North
merican
Catholic Educational
Programming
Foundation Inc. v Cheewa/la 930
A.2d 92 (Del. 2007), the Delaware Supreme
Court clarified the law on fiduciary duties for directors of distressed
corporations when it held as follows:
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Solvent Corporations: directors owe
fiduciary
duties to the
corporation
and its shareholders.
Zone
of
Insolvency: directors continue
to
owe
fiduciary
duties
to the corporation and its shareholders, and ot to creditors,
when a
corporation
becomes distressed or
is
at risk of
insolvency.
Insolvency: when a corporation is insolvent, directors owe
fiduciary
duties to the corporation as an enterprise, and the
creditors are permitted to bring derivative suits on behalf of
the corporation, but not direct causes of action.
D A Word
o
Deepening Insolvency
Historically, a theory that has been advanced in a number of cases
against, among others, officers and directors,
is
a claim for damages based on
the concept
of
deepening insolvency. The
theory of
liability for damages for
deepening insolvency was never
well-defined nor
was
it
universally embraced
by all courts, and there are few written judicial decisions concerning the topic.
Accordingly, creativity in the use
of
the
theory
abounds. Simply stated, the
concept
of
damages
for
deepening insolvency
is
that there are times when a
defendant s
conduct,
either fraudulently or
negligently, prolongs the life a
corporation,
thereby increasing the corporation s debt and exposure to
creditors. Under the deepening insolvency theory, those
with
fiduciary
obligations may be liable for damages suffered by creditors for deepening the
insolvency of a corporation.
n the past, there were arguably three classes of possible
defendants against
whom this
legal
theory has
been directed. Officers and
directors may
be
held personally liable concerning actions taken
that
could
be
construed
to
prolong the life
of
a corporation
to
the
detriment
of
creditors,
thereby
deepening the insolvency
of
the corporation. Essentially, the theory
of
deepening insolvency as against officers and directors has been used as a way
to assert liability for mismanagement using a hindsight test. The
theory
has
also been used against certain lenders
as
well
as
the company's professionals.
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The
crux of
the deepening insolvency issue for the officers and
directors of
a corporation was
whether
actions that are being taken,
or not
taken, essentially created a worsening situation for the corporation s creditors.
Recently, however, the deepening insolvency
theory
of liability has been
rejected by courts,
including
the Delaware courts. See e.g. Trenwick America
Litigation Trust v. Ernst Young L.L.P. 906 A.2d 168, 205 (Del. Ch. 2006)
(rejecting independent cause of action for deepening insolvency); Fehribach v.
Ernst
&
Young L.L.P. 493 F.3d 905,
909
(7th Cir. 2007) (applying citing
Trenwick for the
proposition that
the deepening insolvency
theory
makes no
sense ); see generally Cheewalla 930 A.2d 92. Accordingly, officers and
directors
owe a Delaware
corporation
the general duties of care and loyalty. In
this
regard, if a board acts
with
due diligence and in good faith, but the chosen
strategy results in a deepening insolvency, the directors are protected by the
business judgment rule. To conclude otherwise
would fundamentally
transform
Delaware law. Trenwick 906 A.2d
at
205.
The deepening insolvency
theory of
liability, again, was never a
clearly defined cause of action, and the cause of action is no longer viable with
respect
to
Delaware corporations.
Notwithstanding, it
is something that the
Board
as
well
as
the officers
of
the Company should
be
aware of.
III.
SPECIFIC CHAPTER
CONSIDERATIONS
A. Duties
During
Chapter
Proceedings.
In the case of Trenwick Am. Litigation Trust v. Ernst & Young
L.L.P. 906 A.2d 168 (Del. Ch. 2006), aff d Trenwick Am. Litigation Trust v.
Billet
93
A.2d
438
(Del. 2007), the Delaware courts clarified
that
the
operation of
the business
judgment
rule does
not
change depending on the
level
of
solvency
of
a corporation.
The duties of a corporate chapter debtor-in-possession or
DIP , are essentially
two
fold: First, those prescribed by state corporate law
(i.e., the
duty
of care and duty of loyalty described above); and second, those
duties
imposed on a DIP
under
federal
bankruptcy
law. If there is a conflict, the
duties under
federal
bankruptcy
law
will
prevail.
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A
DIP
owes a fiduciary
duty to
all interested parties, creditors and
shareholders alike. Although there are two sources of fiduciary duties for a DIP
the federal bankruptcy law duties are, for all practical purposes, derived from
the state law
duties of
care and loyalty. Specifically, under the
bankruptcy
laws,
a
DIP
is held
to
a standard
of
care, skill and diligence
that
an
ordinary
person
will exercise under similar circumstances. See In re Rigden 795 F.2d 727,730
(9th Cir. 1986); In re Happy Time Fashions Inc. 7 B.R. 665, 670 (Bankr.
S.D.N.Y. 1980).
Simply stated, the
DIP
has a duty
of
loyalty to
maximize
the value
of the estate , refrain
from
self-dealing, and treat all parties
fairly
in addressing
and resolving the conflicting tensions
that
necessarily arise between the various
stakeholders and parties in interest in a
chapter
11 proceeding. See
Commodity
Futures Trading Comm n
v
Weintraub 471 U.S. 343, 353 (1985); In
re Integrated Resources Inc. 147
B.R.
650, 658 (S.D.N.Y. 1992). From a
practical perspective, unlike the decision-making process outside of a chapter
11 proceeding, many of the decisions
of officers
and directors made in the
context of a
chapter
11 are subject
to
disclosure to, and approval by, the
bankruptcy
court. Under the
bankruptcy
laws, transactions that fall outside of
the
debtor's ordinary course of business require prior bankruptcy court
approval. The approval by a bankruptcy court of a particular transaction (e.g.,
sale, selection
of
a plan sponsor, stalking horse
bidder,
to
name a few) provides
an additional layer
of protection
for a director and officer
of
a DIP.
Finally, it is
common
practice
to
include, as
part
of a chapter 11
plan
of
reorganization (the Plan ) and related
confirmation order
and
findings
of fact and conclusions of law, that the DIP's officers and directors acted in
good
faith and fully discharged their fiduciary
duties
in the context of the
restructuring - related decisions. These
findings
and conclusions are typically
supported by an injunction contained in the Plan
prohibiting
creditors and other
parties in
interest
from
initiating actions against the directors and officers,
unless their
conduct
rose to the level
of
gross negligence or willful misconduct.
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,
B
Revlon
Duties and
Their
Application To
A
Chapter
11.
In a non-bankruptcy
context,
courts have held that when it
becomes obvious that the sale of a company (or presumably its assets) is
inevitable, a heightened level
of
scrutiny
is applied
to
evaluate the decision
of
a
target's
Board
granting prohibitive
buyer protection devices to a potential
purchaser which will chill competitive bidding. In
other
words, once the
company is in play, the Board has an affirmative
duty
to get the highest price -
no playing favorites . In a non-bankruptcy context, the seminal case in
defining
the heightened
scrutiny of
buyer protections which would have the
impact of chilling bidding is Revlon v MacAndrews Forbes Holdings Inc. 506
A.2d 173 (Del. 1986). In essence, the legal duty of a board
of
directors once a
decision has been made to sell the company or its assets is
to maximize
the
value and not to grant such advantage to one or more potential bidders that
has the effect of stacking the deck and chilling the bidding.
As stated above, a Chapter 11 DIP owes a fiduciary
duty
to all of
the creditors and other interest holders
of
its
bankruptcy
estate to
maximize
value. See
In
re Bidermann Industr. U.S.A. Inc. 203
B.R.
547, 551 (Bankr.
S.D.
N.Y. 1997). The filing of a bankruptcy proceeding has the practical effect of
putting the company in play whether the company likes
it or
not. Since the
ultimate fiduciary duty
of
an insolvent company is
to maximize
the return
to
the
various constituencies, the company needs to understand
that
a reorganization
plan that maximizes value, even
if
it is a plan that is not necessarily proposed
by the company, needs to be seriously evaluated much like a
tender
offer
outside of a bankruptcy proceeding. As such, there is a duty to shop and that
involves keeping an open mind
to
proposals even
if they
are not generated by
the company.
All restrictions on the debtor's ability to market its assets will
be
subject
to
the strictest scrutiny provided by a Bankruptcy Court. See
TCI
Holdings
LLe 428
B.R.
117, 144 (Bankr. N.J. 2010),' see e.g. Bidermann Indust. U.S.A.
Inc. 203
B.R.
at
551
(holding window-shop clause improper); In re Big Rivers
Iec. Co. 233 B.R. 726, 734-735
W.D
. Ky. 1998) (voiding
no-shop
clause
because
it
forced debtor to violate its fiduciary duty). Compare Revlon 506
A.2d at 184
(finding
improper
lock-up
and no-shop agreement ending
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negotiations
with other known bidders) and Paramount Communications Inc. v
QVC Network Inc. 637 A.2d 34,49 (Del.
1994)
(holding no-shop provision
impermissibly
interfered
with directors ability to
negotiate
with other
known
bidders).
The
Court will
analyze the transaction
under
provisions
of
the Bankruptcy
Code, such as section 363 (discussed below) and section
1129
(Confirmation
of
a Plan), and will look to
how
the transaction was tailored when determining
whether to
impose an enhanced level of scrutiny.
See
In re PWS
Holding
Corp.
228
F.3d 224,
247
(3d Cir. 2000). The sale or the
confirmability of
the
debtor s
plan may be defeated i f a breach of fiduciary
duty
by officers
or
directors is
demonstrated.
See e.g. In re Coram Healthcare Corp.
271
B.R.
228
(Bankr. D.
Del.
2001) (debtor s
plan
of
reorganization rejected on good faith grounds
where the
debtor s chief
executive
officer
and president had been receiving
almost 1
million per year
under
employment agreements with a large
creditor
of
the debtor without
debtor s
knowledge).
IV. COMMON CHAPTER 11 TRANSACTION STRUCTURES THAT IMPLICATE
FIDUCIARY DUTIES.
A.
Introduction
While each chapter 11 is unique, there are
common
transaction
structures
that
are used
as
a means
to maximize
the recovery
to
the various
constituencies. Each of these
common
transaction structures implicates the
fiduciary
duties
of
the DIP's directors and officers. Most
of
these transaction
structures are implemented
as
part
of
the plan but,
as
described
immediately
below, a sale
of
all or a substantial
portion of
a DIP's assets may occur pursuant
to a proceeding
under
11 U.S.c. 363
of
the Bankruptcy Code (a 363 Sale ).
B The 363 Sale.
Under the
bankruptcy
laws, a DIP may sell assets free and clear
of
liens, claims and encumbrances outside the
ordinary
course
of
business,
provided that prior
bankruptcy
court
approval is obtained. Typically, in a 363
Sale, the DIP will
formulate
a sale process by which prospective purchasers may
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obtain material
non-public information
necessary
to submit
a bid, the process
by which bids must be submitted the evaluation of the bids and the ultimate
auction that may occur to select the highest
or
best bid. The DIP's directors
and officers, together with their restructuring professionals,
must
design a sale
process
that
does
not
create unnecessary barriers
to
prospective purchasers
or
otherwise chill
competitive
bidding. While it is beyond the scope of these
materials, the
implementation
as part
of
the sale process
that
is developed, of
typical buyer protective devices , such as break-up fees, topping fees,
no-
shop, window-shop and go-shop provisions will
be
scrutinized by not only the
bankruptcy
court but by other creditors and parties in interest, including
prospective bidders. In the context
of
formulating and
implementing
a 363
Sale, the DIP's directors and officers need
to
be
cognizant
of, and particularly
sensitive to, the
following:
PHOENIXI528510 2
Does the prospective 363
Sale potentially
involve a related
party,
including
participation
of
controlling shareholders,
interested directors
or
executive management
of
the DIP
with
one or more potential bidders?
If
so, it may be necessary to
form a special committee
of
the board
of
directors to
conduct
the sale process (see discussion below regarding
Use of Special Committees ).
Is
the 363
Sale
the
most
likely vehicle
to maximize
the value
of the assets and the recoveries to the various constituencies
when compared to
other
potential alternative restructuring
scenarios (i.e., a StandAlone Plan or a Plan Sponsor
structu
re ?
Are there substantial
or
good business reasons
for
the 363
Sale?
Are the bid procedures
to
be
implemented appropriate
to
ensure that there are no unnecessary barriers to a
competitive bidding process?
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Are there factors, beyond the mere purchase price, th t
should
be
evaluated in determining the highest
or
best offer?
Such factors may include,
for
example, ntitrust
or
other
regulatory concerns, financing and due diligence
contingencies and potential significant delays in closing the
sale transaction.
Are the DIP's
restructuring
professionals (lawyers, financial
advisors and
investment
bankers) actively involved
not only
in the formul tion
of
the sale process but also the evaluation
and negotiation
of
bids?
There are considerable protections afforded to the directors and
officers
of
a
DIP
in connection
with
a 363 Sale. As mentioned above,
most
363
Sale
transactions involve the sale
of
assets outside the
ordin ry
course
of
business and require b nkruptcy court approval. Hence, the sale process
developed and implemented
as
well
as
the selection
of
the highest
or
best bid
is
ultim tely
subject
to
approval by the
b nkruptcy court following
extensive
notice and disclosure to creditors and parties in interest and, in most
circumstances, an auction.
C
The Stand lone Plan
The
proper
discharge of the directors and officers
fiduci ry
duties
requires th t numerous potential restructuring alternatives be evaluated to
determine
the particular vehicle th t maximizes the value
of
the company
for
the benefit of the various stakeholders. Typically, a 363 Sale may render a
recovery to stakeholders th t is
signific ntly
less than the
long
term value
associated with a Standalone Plan , and the associated debt and
equity
securities th t may
be
issued
pursu nt to
such a plan. Under a Standalone Plan,
the debtor
will
likely restructure its existing debt and equity securities without
the
benefit of
additional third party capital (except
for
normal exit financing
for
working capital purposes). Depending upon valuation considerations,
p rticul r
stakeholders (particularly those parties
with
a loan
to
own objective)
may view a new debt
or equity
security issued by the reorganized
debtor as
creating greater long
term
value than the cash distribution th t may be received
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as part
of
a 363
Sale.
In general, in determining whether to pursue a
Standalone Plan, the directors should consider mUltiple factors, including the
following:
An assessment
of
the potential recoveries
to
stakeholders
under
a
liquidation
363
Sale
and a Plan Sponsor (discussed
below) scenario.
The views
of
stakeholders regarding the
restructuring
scenario to be selected.
The
long-term feasibility of
the DIP reorganizing on a
standalone basis.
The opinions of the DIP's restructuring professionals of the
Standalone
Plan
from a financial and
implementation point of
view.
D The Plan Sponsor
Typically, a DIP may determine that its ability to reorganize and
maximize
recoveries to all stakeholders
is greatly
enhanced
through
the active
participation in the Plan by a third party investor or Plan Sponsor who is
willing to
provide fresh capital
into
the DIP. Again, like a 363
Sale
the directors
and officers
of
the DIP should develop and
implement
a competitive process to
select a
particular Plan
Sponsor. The process
to
select the
Plan
Sponsor may
resemble the auction process discussed above to select the highest or best
offer in connection
with
a 363
Sale.
V.
RESTRUCTURING TRANSACTIONS INVOLVING RELATED
PARTIES.
A Introduction
Many
restructuring
transactions involve the participation of related
parties to the
DIP.
These types
of
transactions are subject
to
careful scrutiny by
bankruptcy
courts. It is worth noting that these types
of
transactions
not
only
involve directors
of
distressed companies
who
may have a personal interest in
the outcome
of
the restructuring because
of
ownership
of existing debt or
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equity
securities,
but
also executive management that may
be
critically
important to a prospective purchaser of the assets
or
to a Plan Sponsor.
The United States Supreme Court, in
Bank
of
America National
Trust
and
Savings Assoc.
v 2 3 N
LaSalle Street Partnership
526
U S
434
(1999), specifically addressed the parameters governing the ability
of
existing
equity to
reacquire the
equity
in the reorganized debtor where creditors were
not
being paid in full, or
did not
otherwise consent. Specifically, in
2 3 North
LaSalle the Supreme Court held that a plan was
unconfirmable
unless it
provided for a specific mechanism
to permit
the
solicitation
and negotiation
of
competing
bids
for
the
equity
in the reorganized
debtor,
or otherwise allow
the market to
test whether
the holders
of
old equity were paying the highest
value for the new equity.
In responding to the
implication of 2 3
North LaSalle the directors
of
the DIP may
want to
consider the
following:
If existing equity
is represented on the board
of
directors, the
formation of
a Special Committee
(described below) may very well be warranted.
Develop a process
to
ensure
that
the reinvestment
opportunity
is
sufficiently
exposed
to
the market
to
ensure that the highest and best price is obtained.
While the Supreme Court gives
little
guidance on the
mechanism to ensure that the highest
or
best price is
obtained, directors
of DIPs
have either:
(i) formulated
processes by which
third party
investors could
submit
competing
bids for the equity in the reorganized
debtor;
or ij) agreed
to terminate
the exclusive period
to
file a plan
so that competing
plans could
be
filed.
B The
Use OfSpecial Committees In A Chapter
I I
In circumstances where the
DIP
may
be
pursuing a restructuring
or
sale transaction involving a related party, DIPs are increasingly turning to the
formation of
a special
committee of
the board of
directors
(the Special
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Committee ) comprised
of
independent and disinterested directors
to
evaluate
and consider such related-party transact ions. While there is no absolute
requirement under
Delaware law or
bankruptcy
law that the
DIP
form a Special
Committee
in these circumstances, the absence
of
a Special Committee (or at
least a
group
of
the
existing
board
who
are both disinterested and
independent)
to
evaluate sale and
restructuring
transactions involving a related
party
may evidence the transactions
fundamental
unfairness.
Bankruptcy courts, creditors and
other
stakeholders of the DIP
together with
the Office
of
the United States Trustee, are particularly attuned to
related-party transactions. Hence, the DIP should consider the formation of the
Special Committee comprising
independent
and disinterested directors
that
are
fully-informed, well-represented
and active in the negotiation process
to
select
a
particular restructuring
transaction involving a related party.
A
director
is interested where the
director
may receive a material
benefit as a result of the potential
restructuring
transaction. Directors may be
interested even
though
they do not receive a
direct
benefit that relates
to
the
restructuring
transaction. For example, a
director
may
be
interested if the
benefit received by the contemplated
restructuring
transaction provides further
business or
other
deals
with
the related party.
In addition
to satisfying the disinterested requirement, the director
should also
be
independent.
In this
regard, courts often
look
to
whether
the
director is
controlled by,
or
beholden to,
another
person or entity, or
whether
outside influences affect the
proper
exercise
of
the
director s
business
judgment.
In
forming a Special Committee to evaluate
restructuring
alternatives (i.e., 363
Sale
StandAlone Plan, Plan Sponsor, etc.), certain
other
important considerations should
be
taken
into
account:
PHOENIXl528510 2
The Special
Committee
should
be informed as to
the process
(i.e., auction process, buyer protective devices, etc.) and all
of
the material
terms
of the various proposals.
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The Special Committee should be active in the negotiation
process
culminating
in the selection
of
a particular
restructuring
alternative.
The Special Committee should have real bargaining power,
including the authority to approve or disapprove a particular
restructuring
transaction involving a related party, as
opposed
to
simply making a recommendation
to
the full
board regarding a transaction.
The Special Committee should have access to competent and
independent legal and financial advisors as well as to senior
management. It is not uncommon for the DIP's restructuring
counsel
to
advise the Special Committee
under
circumstances
where such counsel is independent, although
it is
increasingly common for the Special Committee in the
context
of
a chapter 11 to employ separate counsel.
Typically, the DIP's senior management is critical to a particular
potential
bidder or
bidders. While prospective bidders (and the Special
Committee itself) must have access to senior or executive management, the
Special Committee should determine senior management's involvement in the
actual
bidding
process and the selection
of
the
ultimate
transaction to be
implemented
as
part
of
the chapter 11
to
avoid perceived
or
actual conflicts
of
interest.
VI.
SOME
CAUTIONARY WORDS REGARDING D O
INSURANCE
A Chapter
11
may have
wide-ranging implications
for the
debtor s
D O
policies and the coverages available
under
them. Some bankruptcy courts have
held that the D O policy is actually an asset of the
bankruptcy
estate and
should
be
available to pay the claims
of
creditors against the debtor.
As an
asset of the bankruptcy estate, some courts have held
that
the directors and
officers should not be able
to
deplete the
policy
by having access
during
the
chapter
11
for the advance
of
defense costs. As a result of these lines of cases,
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may insurance carriers require prior
b nkruptcy
court approval for the advance
of defense costs.
Directors and officers of companies in financial distress should review the
terms
of
the D O policy
with competent
legal advisors
to
assess the availability
of
the policies in the
context of
a form l Chapter 11.
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Exhibit 1
Bankruptcy Bulletin - Delaware Supreme
Court
Clarifies Fiduciary Duties
When A Corporation s
Insolvent
or
In the Zone
of
Insolvency
Weil, Gotshal Manges
LLP
Exhibit 2
North
merican
Catholic Educational Programming Foundation Inc. v
Cheewalla
930
A.2d
92 (Del.
2007
Exhibit 3
Sample
Memorandum to
Board
of
Directors
of
Distressed Companies
Regarding Scope of Fiduciary Duties
PHOENIXl5 85I 0 2
Squire, Sanders Dempsey L.L.P.
Exhibit 4
Fiduciary Duties for
Directors of
Troubled Companies
Weil, Gotshal Manges
LLP
Exhibit 5
Revlon
Duties under Delaware Law
Morris
James LLP
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EXHI IT
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nkrup t cy
"
Bulletin
June 2007'
Delaware Supreme Court Clarifies Fiduciary Duties When a Corporation
s
Insolvent or
in
the Zone
of
Insolvency
The
Delaware Supreme
Court
recently
considered whether, under Delaware
law, a creditor of a
corporation
in
the
zone
of
insolvency
or
an
insolvent
corporation can bring
a direct action
Whether and to what extent a
creditor of an insolvent corpo-
ration or a corporation in the
zone of insolvency may bring
a direct claim for a breach of
a fiduciary duty
was
unclear
prior to the instant case.
against the
corporation s
directors
for a breach of fiduciary duty.
The
court, in
North American Catholic
Educational Programming Foundation
lnc. v. Gheewalla
held
that creditors
of a
corporation
that s
insolvent,
or
in the zone
of insolvency, have
no
right
to
assert direct claims
against
corporate
directors for breach of
Jiduciary duty.
The
decision resolves
uncertainty
created by previous
opinions that discussed but did not
rule
on
the fiduciary duties owed
to
creditors by directors of corporations
in the
zone
of insolvency.
Directors Fiduciary Duties
Directors of
solvent corporations
owe
fiduciary duties,
such
as
the duty
of care and
the
duty of loyalty, to
shareholders,
but not to
creditors.
The
duty
of care generally requires
directors
to
exercise
that
degree
of care
that
an ordinarily
prudent
person would exercise
under the
same or similar circumstances.
The duty
of loyalty, alternatively,
prohibits
self-dealing
and the
usur-
pation
of corporate opportunities. In
evaluating these duties, courts have
adhered to the
business
judgment
rule,
which
is a
presumption
that
directors
who made
a business
decision acted on
an
informed basis,
in
good
faith
and
in the honest belief
that the action taken
was in
the best
interests of
the
solvent corporation.
Creditors
of an
insolvent corporation
may bring derivative claims against
directors on behalf of the corporation
for breaches of fiduciary duties.
Whether and
to
what
extent a creditor
of an insolvent corporation or a
corporation in the zone of insolvency
may
bring a direct c laim for a breach
of a fiduciary
duty
was unclear prior
to the instant case. Previous case law
indicated that directors of a corpo-
ration that is insolvent or in
the
zone
of insolvency owe duties
to
the firm's
creditors since
those creditors may
own the
firm's residual value.
While the Delaware S upreme Court
has ne ver addressed directors' fidu-
ciary duties
when
a corporation s in
the
zone of insolvency,
other
courts
in Delaware have addressed
the
issue.
In
Credit Lyonnais Bank Nederland
N. V v. Pathe Communicatio ns Corp.
the
seminal case regarding
the
duties
of a
board
of directors in
the
zone of
insolvency, the Delaware Court of
Chancery found
that "where a cor-
poration
s operating in
the
vicinity
of insolvency, a board of directors s
not merely
the agent
of
the
residue
risk-bearers,
but
owes its
duty to
the
corporate enterprise."
The Delaware Court of Chancer y stated
that
directors have "an obligation
to the community
of interest
that
sustain[s) the corporation, to exercise
judgment
in
an
informed, good faith
effort to maximize the corporation's
long-term wea lth creating capacity."
This case has been cited by courts and
commentators for the proposition
that
a director's fiduciary duty, while
in
the
zone of inSOlvency, reqUires
the
director to take creditors' interests
into
account along wi th the interests of all
constituencies of the corporation.
In Production Resources Group L.L.C.
v
N T
Group Inc.
the
Delaware Court
of Chancery, in
dicta
explained that
the
Credit Lyonllais
decision did not
create a new body of creditors' rights
law exposing directors
to
a new set of
fiduciary duties
to
creditors
when the
company
is in
the
zone of insolvency.
Rather,
the
Credit Lyonnais decision
was meant to highlight the fact that
directors
have
discretion to
temper
the risks they take on behalf of the
equity
holders
when the company
s
in
the zone
of insolvency.
The
court
in
Production
ResOllrces stated that
under
Credit Lyonnais directors are
protected by
the
business
judgment
rule, if they, in good faith, pursued
a less risky strategy because of fear
that
a
more
risky
one
might render a
company unable
to meet its obliga-
tions. Creditors have
other
sources
of
protection
such as the ability
to bargain for liens on assets
and
negotiated
covenants
in agreements.
Fraudulent conveyance
laws
and
prinCiples
of
implied
covenants
of
good faith
and
fair dealing also serve
to protect creditors. The court in
Production Resources
concluded that
the
business
judgment
rule remains
significant in
the
zone of insolvency
and
provides directors with
the
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Bankrupt cy Bulletin
-
ability to make a range of good faith,
prudent
judgments about the risks
they should undertake on behalf of
troubled
corporations.
Factual
ackground
In
North American Catholic,
the
plaintiff,
North American Catholic
Educational Programming Foun-
dation,
Inc. ("NACEPF
U
,
brought
direct (not derivative) claims against
directors of Clearwire Holdings, Inc.
("Clearwire") for breaches of fiduciary
duties while Clearwire was
insolvent
or in the zone of inSOlvency. NACf.PF
and Clearwire entered into an
agreement whereby
NACf.PF
would
sell certain radio wave spectrum
licenses to Clearwire. Subsequently,
the market for wireless
spectrum
collapsed, and Clearwire
attempted
to end its
obligations
to
NACEPF
among
others
and,
effectively,
went
out of business.
NACEPF alleged that Clearwire was
either insolvent or in the zone of
insolvency at all relevant times
and the defendant directors of the
Clearwire
board
owed fiduciary
duties
to
NACEPF as a
creditor
of
Clearwire. NACEPF further alleged
that
the
directors
failed to exercise
their
fiduciary
duties
on
behalf
of
NACf.PF
by
failing to preserve Clear-
wire's assets for the benefit of its
creditors and for continuing to hold
NACEPF's
licences when
Clearwire
was not going to use
them.
The
Delaware
Supreme Court
affirmed the decision of the Court
of Chancery, which dismissed the
case.
The Court
of
Chancery
held
that
creditors
have
no direct claim
against a corporation in the zone
of insolvency
and
concluded that,
in this case, NACEPF's complaint
failed to
state
a cause of
action
for a
direct claim
against
a director of an
insolvent corporation.
The Delaware Supreme Court's
Decision
Corporations n the Zone of Insolvency
NACEPF
argued
that the court
should
recognize a creditor's right
to
bring
a direct claim against dirc(.tors for
breaches of fiduciary duties. The
court found that
the
need
to
provide
directors with guidance when car-
rying out their duties compels the
conclusion
that
creditors of a corpo-
ration in the
zone
of insolvency
may
not
bring a direct claim for breach
of a fiduciary duty. The court noted
that directors of corporations in the
zone of insolvency 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."
Insolvent Corporations
The Court of Chancery had deter-
mined that NACf.PF's complaint failed
to satisfy pleading reqUirements
and,
thus, did
not
state a direct creditor
claim, even assuming a direct claim for
breach of fIduciary duty to a creditor
were legally cognizable in the context
of an insolvent corporation. The
Delaware Supreme court held
that
individual
creditors of an illsolvent
corporation have flO right to assert
direct claims for breach of fiduciary
duty against corpor ate directors." The
court explained that recognizing a
new right for creditors to bring direct
fiduciary daims against direttors of
insolvent corporations would create a
conflict between the directors' duty to
maximizc value for the benefit of all
interested parties
and
a direct fidu-
ciary
duty
to individual creditors. The
court further stated that directors
of
insolvent corporations should be able
to
participate in "good faith negotia-
tions with individual creditors for the
benefit of
the
corporation." While the
court noted that NACEPF did not bring
a derivative claim against the directors
June 2007
and only asserted a direct claim against
the directors, the court advised cred-
itors
that
they may bring derivative
claims to protcct their interests.
Conclusion
The
North American Catholic
decision
has provided Significant guidance for
directors faced with difficult decisions
for
stmggling corporations: First, the
holding clarifies that the fiduciary
duties of directors and officcrs of
insolvent corporations pertain to the
corporation itself
not creditors. Sccond, by removing the
possibili ty of direct suits by creditors
against directors, the decision removes
significant negotiat ing leverage from
creditors. Creditors still have a remedy
in derivative suits,
but
they must clear
certain procedural hurdles to bring
them. When these suits are successful,
recoveries enure to the benefit of the
corporation. Third, the holding implies
that the tmst fund doctrine, by which
directors of insolvent corporations
were required to manage corporate
assets as
though
they were held in trust
for creditors, cannot support the cre-
ation of special fiduciary duties owed
to creditors by directors of insolvent
corporations
under
Delaware
law.
By
mling
that directors of financially
struggling corporations owe fiduciary
duties to shareholders and the corpo-
ration itself,
the
Delaware Supreme
Court has made it much easier for
directors to exercise their business
judgment, and be protected by the
business judgment mle,
without
exposure to direct liability suits
brought
by disgruntled creditors.
N. Am Catholi c Educ. Found. Inc v
Ghel Wullu,
No. 52\,
2006,
2oo7 WL
1453705
(Del.
May 18, 2oo7).
Crt'llit Lyollnais Bank Nl dnland, N V v Pallre
Commc l/S Corp.,
No. Civ. A.
12150, 1991
WL
277613
(Del.
Ch
.
Dec.
30, 1991).
( rod. ReI. Group,
LL.C.
v
eT Group, Inc. 86
A.2d 772
(Del. Ch
. 2004).
Wei , Gotshal Manges
LLI'
3
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EXHI IT
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IN THE SUPREME COURT OF THE STATE OF DELAWARE
NORTH AMERICAN CATHOLIC
EDUCATIONAL PROGRAMMING
FOUNDATION, INC., No. 521, 2006
Plaintiff Below, Court BelowCourt of Chancery
Appellant, of the State of Delaware,
in and for New Castle County
v. C.A. No. 1456-N
ROB GHEEWALLA, GERRY
CARDINALE and JACK DALY,
Defendants Below, Appellees.
Submitted: February 12, 2007
Decided: May 18, 2007
Before STEELE, Chief Justice, HOLLAND, BERGER, RIDGELY,
Justices, and ABLEMAN, Judge.1
Upon appeal from the Court of Chancery. AFFIRMED.
Edward M. McNally, Esquire (argued) and Raj Srivatsan, Esquire,
Morris, James, Hitchens & Williams, Wilmington, Delaware, for appellant.
Samuel A. Nolen, Esquire, Richards, Layton & Finger, Wilmington,
Delaware, for appellees.
HOLLAND, Justice:
1Sitting by designation pursuant to Del. Const. art. IV, 12 and Supr. Ct. R. 2 and 4.
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2
This is the appeal of the plaintiff-appellant, North American Catholic
Educational Programming Foundation, Inc. (NACEPF) from a final
judgment of the Court of Chancery that dismissed NACEPFs Complaint for
failure to state a claim.2 NACEPF holds certain radio wave spectrum
licenses regulated by the Federal Communications Commission (FCC). In
March 2001, NACEPF, together with other similar spectrum license-holders,
entered into the Master Use and Royalty Agreement (the Master
Agreement) with Clearwire Holdings, Inc. (Clearwire), a Delaware
corporation. Under the Master Agreement, Clearwire could obtain rights to
those licenses as then-existing leases expired and the then-current lessees
failed to exercise rights of first refusal.
The defendant-appellees are Rob Gheewalla, Gerry Cardinale, and
Jack Daly (collectively, the Defendants), who served as directors of
Clearwire at the behest of Goldman Sachs & Co. (Goldman Sachs).
NACEPFs Complaint alleges that the Defendants, even though they
comprised less than a majority of the board, were able to control Clearwire
because its only source of funding was Goldman Sachs. According to
NACEPF, they used that power to favor Goldman Sachs agenda in
derogation of their fiduciary duties as directors of Clearwire. In addition to
2North American Catholic Educational Programming Foundation, Inc. v. Gheewalla,
2006 WL 2588971 (Del. Ch. Sept. 1, 2006) (Opinion).
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3
bringing fiduciary duty claims, NACEPFs Complaint also asserts that the
Defendants fraudulently induced it to enter into the Master Agreement with
Clearwire and that the Defendants tortiously interfered with NACEPFs
business opportunities.3
NACEPF is not a shareholder of Clearwire. Instead, NACEPF filed
its Complaint in the Court of Chancery as a putative creditorof Clearwire.
The Complaint alleges direct, not derivative, fiduciary duty claims against
the Defendants, who served as directors of Clearwire while it was either
insolvent or in the zone of insolvency.
Personal jurisdiction over the Defendants was premised exclusively
upon 10Del.C. 3114, which subjects directors of Delaware corporations to
personal jurisdiction in the Court of Chancery over claims for violation of a
duty in [their] capacity [as directors of the corporation]. No other basis for
personal jurisdiction over the Defendants was asserted. Accordingly,
NACEPFs efforts to bring its other claims in the Court of Chancery fail on
jurisdictional grounds unless those other claims are adequately alleged to be
sufficiently related to a viable fiduciary duty claim against the Defendants.
3 This action was initially filed in the Superior Court; it was dismissed without prejudice
for lack of subject matter jurisdiction. Transfer to the Court of Chancery was permitted
under 10Del. C. 1902.
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4
For the reasons set forth in its Opinion, the Court of Chancery
concluded: (1) that creditors of a Delaware corporation in the zone of
insolvency may not assert direct claims for breach of fiduciary duty against
the corporations directors; (2) that the Complaint failed to state a claim for
the narrow, if extant, cause of action for direct claims involving breach of
fiduciary duty brought by creditors against directors of insolvent Delaware
corporations; and (3) that, with dismissal of its fiduciary duty claims,
NACEPF had not provided any basis for exercising personal jurisdiction
over the Defendants with respect to NACEPFs other claims. Therefore, the
Defendants Motion to Dismiss the Complaint was granted.
In this opinion, we hold that the creditors of a Delaware corporation
that is either insolvent or in the zone of insolvency have no right, as a matter
of law, to assert direct claims for breach of fiduciary duty against the
corporations directors. Accordingly, we have concluded that the judgments
of the Court of Chancery must be affirmed.
Facts4
NACEPF is an independent lay organization incorporated under the
laws of Rhode Island. In 2000, NACEPF joined with Hispanic Information
and Telecommunications Network, Inc. (HITN), Instructional
4 The relevant facts are primarily selected excerpts from the opening brief filed by
NACEPF in this appeal.
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5
Telecommunications Foundation, Inc. (ITF), and various affiliates of ITF
to form the ITFS Spectrum Development Alliance, Inc. (the Alliance).
Collectively, the Alliance owned a significant percentage of FCC-approved
licenses for microwave signal transmissions (spectrum) used for
educational programs that were known as Instruction Television Fixed
Service spectrum (ITFS) licenses.
The Defendants were directors of Clearwire. The Defendants were
also all employed by Goldman Sachs and served on the Clearwire Board of
Directors at the behest of Goldman Sachs. NACEPF alleges that the
Defendants effectively controlled Clearwire through the financial and other
influence that Goldman Sachs had over Clearwire.
According to the Complaint, the Defendants represented to NACEPF
and the other Alliance members that Clearwires stated business purpose
was to create a national system of wireless connections to the internet.
Between 2000 and March 2001, Clearwire negotiated a Master Agreement
with the Alliance, which Clearwire and the Alliance members entered into in
March 2001. NACEPF asserts that it negotiated the terms of the Master
Agreement with several individuals, including the Defendants. NACEPF
submits that all of the Defendants purported to be acting on the behalf of
Goldman Sachs and the entity that became Clearwire.
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6
Under the terms of the Master Agreement, Clearwire was to acquire
the Alliance members ITFS spectrum licenses when those licenses became
available. To do so, Clearwire was obligated to pay NACEPF and other
Alliance members more than $24.3 million. The Complaint alleges that the
Defendants knew but did not tell NACEPF that Goldman Sachs did not
intend to carry out the business plan that was the stated rationale for asking
NACEPF to enter into the Master Agreement, i.e., by funding Clearwire.
In June 2002, the market for wireless spectrum collapsed when
WorldCom announced its accounting problems. It appeared that there was
or soon would be a surplus of spectrum available from WorldCom.
Thereafter, Clearwire began negotiations with the members of the Alliance
to end Clearwires obligations to the members. Eventually, Clearwire paid
over $2 million to HITN and ITF to settle their claims and; according to
NACEPF, was only able to limit its payments to that amount by otherwise
threatening to file for bankruptcy protection. These settlements left the
NACEPF as the sole remaining member of the Alliance. The Complaint
alleges that, by October 2003, Clearwire had been unable to obtain any
further financing and effectively went out of business.5
5Complaint at 36 (Except for money advanced to it as a stopgap measure by Goldman
Sachs in late 2001, Clearwire was never able to raise any significant money.).
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7
NACEPFs Complaint
In its Complaint, NACEPF asserts three claims against the
Defendants. In Count I of the Complaint, NACEPF alleges that the
Defendants fraudulently induced it to enter into the Master Agreement and,
thereafter, to continue with the Master Agreement to preserv[e] its
spectrum licenses for acquisition by Clearwire.6 In Count II, NACEPF
alleges that because, at all relevant times, Clearwire was either insolvent or
in the zone of insolvency, the Defendants owed fiduciary duties to
NACEPF as a substantial creditor of Clearwire, and that the Defendants
breached those duties by:
(1) not preserving the assets of Clearwire for its benefit and that
of its creditors when it became apparent that Clearwire would
not be able to continue as a going concern and would need to be
liquidated and (2) holding on to NACEPFs ITFS license rights
when Clearwire would not use them, solely to keep Goldman
Sachss investment in play.7
In Count III, NACEPF claims that the Defendants tortiously interfered with
a prospective business opportunity belonging to NACEPF in that they
caused Clearwire wrongfully to assert the right to acquire NACEPF
6Id. at 40.
7Id. at 45.
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8
wireless spectrum, which resulted in NACEPF losing the opportunity to
convey its licenses for spectrum to other buyers.8
Motions to Dismiss
The Defendants moved to dismiss the Complaint on two grounds:
first, for lack of personal jurisdiction under Court of Chancery Rule
12(b)(2); and, second, for NACEPFs failure to state a claim upon which
relief can be granted under Court of Chancery Rule 12(b)(6). With respect
to their first basis for dismissal, the Defendants noted that NACEPFs sole
ground for asserting personal jurisdiction over them is 10Del.C. 3114.
The Defendants argued that personal jurisdiction under 3114 requires, at
least, sufficient allegations of a breach of fiduciary duty owed by director-
defendants. With respect to their second basis for dismissal, the Defendants
contended that, even assuming that personal jurisdiction was sufficiently
alleged, NACEPFs Complaint failed to set forth allegations which
adequately supported any of its claims for relief, as a matter of law.
Court of Chancery Rule 12(b)(2)
The Court of Chancery initially addressed the Defendants motion
under Rule 12(b)(2).9 It began by examining the exercise of personal
8Id. at 50.
9See Branson v. Exide Elecs. Corp., 625 A.2d 267 (Del. 1993).
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9
jurisdiction over nonresident directors of Delaware corporations under 10
Del.C. 3114:10
[T]he Delaware courts have consistently held that Section
3114 is applicable only in connection with suits brought against
a nonresident for acts performed in his . . . capacity as a director
. . . of a Delaware corporation. Further narrowing the scope of
Section 3114, Delaware cases have consistently interpreted
[early cases construing the section] as establishing that [it] . . .
appl[ies] only in connection with suits involving the statutory
and nonstatutory fiduciary duties of nonresident directors.11
10
The basis for personal jurisdiction relied upon by NACEPF, provides:
Every nonresident of this State who after September 1, 1977,accepts election or appointment as a director, trustee or member of the
governing body of a corporation organized under the laws of this State or
who after June 30, 1978, serves in such capacity, and every resident of thisState who so accepts election or appointment or serves in such capacity
and thereafter removes residence from this State shall, by such acceptance
or by such service, be deemed thereby to have consented to theappointment of the registered agent of such corporation (or, if there is
none, the Secretary of State) as an agent upon whom service of process
may be made in all civil actions or proceedings brought in this State, by or
on behalf of, or against such corporation, in which such director, trustee ormember is a necessary or proper party, or in any action or proceeding
against such director, trustee or member for violation of a duty in suchcapacity, whether or not the person continues to serve as such director,trustee or member at the time suit is commenced. Such acceptance or
service as such director, trustee or member shall be a signification of the
consent of such director, trustee or member that any process when soserved shall be of the same legal force and validity as if served upon such
director, trustee or member within this State and such appointment of the
registered agent (or, if there is none, the Secretary of State) shall beirrevocable.
10Del. C. 3114(a) (emphasis added).11
Donald J. Wolfe, Jr. & Michael A. Pittenger, Corporate and Commercial Practice inthe Delaware Court of Chancery 3-5[a] (2005).
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10
The Court of Chancery limited its Rule 12(b)(2) analysis to whether personal
jurisdiction existed over the Defendants with respect to Count II of the
Complaint.
Count II alleged that the Defendants breached their fiduciary duties
while they served as directors of Clearwire and while Clearwire was either
insolvent or in the zone of insolvency. The Court of Chancery concluded
that the facts alleged in the Complaint, as supported by the affidavit
submitted by NACEPF, constituted a prima facia showing of a breach of
fiduciary duty by the Defendants in their capacity as directors of a Delaware
corporation. Accordingly, the Court of Chancery held that a statutory basis
for the exercise of personal jurisdiction had been established by NACEPF
for purposes of litigating Count II of the Complaint.
NACEPF expressly premised its Rule 12(b)(2) arguments for personal
jurisdiction over the Defendants regarding Counts I and III (i.e., the non-
fiduciary duty claims) on the Court of Chancerys first determining that
Count II (i.e., the fiduciary duty claim) survives the Defendants Rule
12(b)(6) motion to dismiss. Accordingly, the Court of Chancery proceeded
on the basis that if it found that Count II must be dismissed under Rule
12(b)(6), then it would be without personal jurisdiction over the Defendants
for purposes of moving forward with the merits of Counts I and III.
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11
Therefore, to resolve the issue of personal jurisdiction, the Court of
Chancery was required to decide whether, as a matter of law, Count II of the
NACEPF Complaint properly stated a breach of fiduciary duty claim upon
which relief could be granted.
Court of Chancery Rule 12(b)(6)
The standards governing motions to dismiss under Court of Chancery
Rule 12(b)(6) are well settled:
(i) all well-pleaded factual allegations are accepted as true; (ii)even vague allegations are well-pleaded if they give the
opposing party notice of the claim; (iii) the Court must draw all
reasonable inferences in favor of the non-moving party; and (iv)
dismissal is inappropriate unless the plaintiff would not be
entitled to recover under any reasonably conceivable set of
circumstances susceptible of proof.12
In the Court of Chancery and in this appeal, NACEPF waived any
basis it may have had for pursuit of its claim derivatively. Instead, NACEPF
seeks to assert only a direct claim for breach of fiduciary duties. It contends
that such direct claims by creditors should be recognized in the context of
both insolvency and the zone of insolvency. Accordingly, in ruling on the
12(b)(6) motion to dismiss Count II of the Complaint, the Court of Chancery
was confronted with two legal questions: whether, as a matter of law, a
corporations creditorsmay assert directclaims against directors for breach
12In re General Motors (Hughes) Sholder Litig., 897 A.2d 162, 168 (Del. 2006)
(quoting Savor, Inc. v. FMR Corp., 812 A.2d 894, 896-97 (Del. 2002)).
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12
of fiduciary duties when the corporation is either: first, insolvent or second,
in the zone of insolvency.
Allegations of Insolvency and Zone of Insolvency
In support of its claim that Clearwire was either insolvent or in the
zone of insolvency during the relevant periods, NACEPF alleged that
Clearwire needed substantially more financial support than it had obtained
in March 2001.13 The Complaint alleges Goldman Sachs had invested $47
million in Clearwire, which represent[ed] 84% of the total sums invested in
Clearwire in March 2001, when Clearwire was otherwise virtually out of
funds.14
After March 2001, Clearwire had financial obligations relatedto its agreement with NACEPF and others that potentiallyexceeded $134 million, did not have the ability to raisesufficient cash from operations to pay its debts as they becamedue and was dependent on Goldman Sachs to make additionalinvestments to fund Clearwires operations for the foreseeablefuture.15
The Complaint also alleges:
For example, upon the closing of the Master Agreement,Clearwire had approximately $29.2 million in cash and of that$24.3 million would be needed for future payments for
spectrum to the Alliance members. Clearwires burn rate was
13Complaint at 30.
14Id. at 7(a).
15Id. at 7(b) (emphasis added). NACEPF also asserts that Clearwire was unable to
borrow money or obtain any other significant financing after March 2001, except fromGoldman Sachs.Id. at 7(c).
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13
$2.1 million per month and it had then no significant revenues.The process of acquiring spectrum upon expiration of existinglicenses was both time consuming and expensive, particularly ifexisting licenseholders contested the validity of any Clearwireoffer that those license holders were required to match undertheir rights of first refusal.16
Additionally, in the Complaint, NACEPF alleges that, [b]y October 2003,
Clearwire had been unable to obtain any further financing and effectively
went out of business. Except for money advanced to it as a stopgap measure
by Goldman Sachs in late 2001, Clearwire was never able to raise any
significant money.17
The Court of Chancery opined that insolvency may be demonstrated
by either showing (1) a deficiency of assets below liabilities with no
reasonable prospect that the business can be successfully continued in the
face thereof,18or (2) an inability to meet maturing obligations as they fall
due in the ordinary course of business.19 Applying the standards applicable
to review under Rule 12(b)(6), the Court of Chancery concluded that
16Id. at 30.
17Id. at 36.
18For that proposition, the Court of Chancery relied upon Production Res. Group v. NCTGroup, Inc., 863 A.2d 772, 782 (Del. Ch. 2004) (quoting Siple v. S & K Plumbing &Heating, Inc., 1982 WL 8789, at *2 (Del. Ch. Apr. 13, 1982)); Geyer v. Ingersoll PublnsCo., 621 A.2d 784, 789 (Del. Ch. 1992) (explaining that corporation is insolvent if it hasliabilities in excess of a reasonable market value of assets held); and McDonald v.Williams, 174 U.S. 397, 403 (1899) (defining insolvent corporation as an entity withassets valued at less than its debts).19For that proposition, the Court of Chancery also relied upon Production Res. Group v.NCT Group, Inc., 863 A.2d at 782 (quoting Siple v. S & K Plumbing & Heating, Inc.,1982 WL 8789, at *2).
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