Issues Facing Officers and Directors in Financially Troubled Companies
Transcript of Issues Facing Officers and Directors in Financially Troubled Companies
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ISSUES FACING OFFICERS AND
DIRECTORS IN FINANCIALY
TROUBLED COMPANIES
January 29, 2009
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OUTLINE
Zone of Insolvency
Defined
Causes of Action
Claimants
Derivative Claims
Deepening Insolvency
Defenses
Directors and Officers Insurance
Mechanics
Coverage Waterfall
Priority of Payment Endorsement
Indemnification
Endorsements
Property of the Bankruptcy Estate
Select Issues
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ZONE OF INSOLVENCY
Definition: Where a corporation is operating in the
vicinity of insolvency, a board of directors is notmerely the agent of the risk bearers, but owes its dutyto the corporate enterprise. Credit Lyonnais Bank
Nederland N.V. v. Pathe Communications Corp., No.
12150, 1991 Del. Ch. LEXIS 215, at 108 (Del. Ch. Dec.30, 1991).
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SOLVENCY TESTS
Balance Sheet
Fair Value of Assets Minus Fair Value of Liabilities
Cash Flow
Failure to Pay Debts as They Become Due
Capital Adequacy
Capital Level is Not Adequate to Meet Current and/or
Future Obligations
If you have to ask, or if your lender asks for an opinionletter, youre in the zone.
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CAUSES OF ACTION
Breach of Fiduciary Duty
Breach of Duty of Loyalty/Care
Breach of Duty to Disclose
Unlawful Dividend
Fraudulent Conveyance
Breach of Contract
Breach of Implied Covenant of Good Faith and Fair
Dealing
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CLAIMANTS
Trade Creditors
Unsecured Banks
Mezzanine and Second Lien Lenders Chapter 11 or Chapter 7 Trustees
Creditors Committees
Assignee For the Benefit of Creditors Debtor-in-Possession
Post Confirmation Trusts
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DERIVATIVE CLAIMS
Creditors, as Quasi Equity Investors, Only Hold DerivativeClaims Against the Corporation, and Its Officers and Directors.
The general rule is that [officers and] directors do not owe duties beyondthe relevant contractual terms. No direct claim for breach of fiduciaryduties may be asserted by creditors of a solvent corporation that isoperating in the zone of insolvency. When a corporation is insolvent,however, its creditors take the place of shareholders as the residual
beneficiaries of any increase in value. Consequently, the creditors of aninsolvent corporation have standing to maintain derivative claims on
behalf of the corporation for breach of fiduciary duties. NationalAmerican Catholic Educational Programming Foundation, inc. v.Gheewalla, 930 A.2d 92 (Del. 2007).
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DEEPENING INSOLVENCY
The Board of Directors, Officers, Restructuring Advisors,
Lenders, Investment Bankers, Accountants and Attorneys
Who Prolong the Operating Life of a Financially Distressed
Company, and Thus Deplete Its Assets and Increase
Creditors Exposure May Be Liable to the Company.
Recognized as a cause of action in Florida, Louisiana,
Massachusetts, New Jersey, North Carolina and Tennessee.
Not recognized in Georgia and Texas.
Recognized as a damages theory.
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DEEPENING INSOLVENCY
Must prove wrongful conduct, such as fraud, as opposed tomere negligence
Incurrence of additional debt in an uncertain business isnot, in itself, a breach of a fiduciary duty. In re GlobalServ. Group LLC, 316 B.R. 451 (Bankr. S.D.N.Y. 2004).
Delaware imposes no absolute obligation on a board of a
company that can not pay its bills to cease operations andliquidate. Trenwick Am. Litig. Trust v. Ernst & Young,LLP, 906 A.2d 168, 174 (Del. Ch. 2006).
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DEFENSES
Business Judgment Rule
Exculpatory Charter Provision
8 Del. C. 102(b)(7)
Does Not Cover Officers
Does Not Cover Breach of Duty of Loyalty, IntentionalMisconduct, Knowing Violation of the Law and Personal Benefit
In Pari Delecto
Plaintiff That Participated in Wrongdoing May Not RecoverDamages Arising From Such Wrongdoing
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D&O INSURANCE
Mechanics
Notice of Claim Filed with Carrier
Claims Made Policy
Notice of Coverage (or Denial) with Reservation of Rights
Engage Counsel
Joint Defense Agreement
Diminishing Coverage
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COVERAGE WATERFALL
Side A Direct Coverage of Officers and
Directors
Side B Reimbursement Coverage for the Corporation,
Based on Funds Paid to Indemnify Officers
and Directors
Side C Coverage of the Corporation for Claims
Against It
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ADDITIONAL COVERAGE
Tail Policy Coverage for Post Policy Claims
Add Ons Employee Practices, Employee Dishonesty,
Representation and Warranties
Personal Coverage for Post Resignation Claims
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PRIORITY OF PAYMENTS
ENDORSEMENT
Express Subordination of Payments: First Side A, NextSide B, and Finally Side C
Sample Language: In the event of a Loss from one ormore covered Claims the Insurer in all events shall (i) first
pay all Loss for coverage under Side A, (ii) then, onlyafter payments of all Loss covered by Side A, pay all Lossunder Side B, and (iii) then, only after payments of allLoss covered by Side A and Side B, pay all Loss underSide C.
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PRIORITY OF PAYMENTS
ENDORSEMENT
Advance Waiver of the Automatic Stay
Exclude All Requirements That Payments Must Be
Approved by Officers, Directors or the Company
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INDEMINFICATION
Delaware and Massachusetts Law
A Corporation May Indemnify Officers and Directors for DefenseExpenses. Del. Code Ann. tit. 8, 145(a); Mass. Gen. Laws ch. 156D,8.51(directors), 8.56 (officers). Indemnification of Expenses is
Mandatory When the Officer/Directors Defense is Successful. Del.Code Ann. tit. 145(c); Mass. Gen. Laws ch. 156D, 8.52 (directors),8.56 (officers).
Indemnification in Bankruptcy
Seek an Order Authorizing Continuing Indemnification
File a Proof of Claim
Carrier May Require Insured to Exhaust All IndemnificationClaims Before Coverage Kicks In
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ENDORSEMENTS
Insured v. Insured
Example: Company (covered under Side C) Sues a Director
(covered under Side A)
Sample Language: The Insurer shall not be liable for any Loss
in connection with any Claim brought by, or on behalf of
Insured, except and to the extent that such claim is by, or on
behalf of a debtor-in-possession, any bankruptcy trustee, litigation
trustee, examiner, creditors committee, equity committee,administrator or liquidator, or any comparable authority (or any
assignee of the foregoing parties).
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ENDORSEMENTS
Indemnification Coverage During Bankruptcy
Final Adjudication for Personal Conduct Exclusions
Pollution and Nuclear Exclusions
Securities Claims and Claims by Public Debt Holders
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ENDORSEMENTS
Government and Regulatory Investigations
Other Insurance Policy Claims
Lengthy Trigger for Notice Provisions
Severability for Innocent Officers and Directors
Relation Back Start Date
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PROPERTY OF THE
BANKRUPTCY ESTATE
Is D&O Insurance Property of the Estate
The Policy -- Yes
The Proceeds -- It Depends
If Side A exists, the proceeds are not property of theEstate.
If Side A does not exist, you must seek an order authorizinguse of proceeds to cover legal fees and costs. Any
settlement of the litigation must be approved by the Court. Useof any proceeds to pay a judgment or settlementmust have the creditors consent.
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SELECT ISSUES
In an Assignment for the Benefit of Creditors the
Assignee Holds All Derivative Claims
Derivative Claims Can Be Discharged Under a Plan of
Reorganization
A D&O Policy Will be Rescinded for Application Fraud