Direct Creditor Claims for Breach of Fiduciary Duty: TWILIGHT IN THE ZONE OF INSOLVENCY: Fiduciary Duty and Creditors of Troubled Companies University of Maryland School of Law Journal of Business & Technology Law Direct Creditor Claims for Breach of Fiduciary Duty: Is They Is, Or Is They Ain’t? Roger A. Lane, Esq. November 4, 2005

Section 102(b)(7) Charter Provision Solvent “Zone” of Insolvency Insolvent In Fact Common Preferred Mezz Secured Unsecured Board of Directors Section 102(b)(7) Charter Provision ?

The Big Picture Continuum of financial conditions Can any line be drawn that is not arbitrary? Continuum of stakeholders Does debt really negotiate its terms more than equity? Does equity really need “gap-filler” rules when it controls the board? Is the distinction “really” common vs. everything else? Unsecured vs. all else?

The Big Picture, cont’d What passes through 102(b)(7)? Claims for Injunctive Relief Limited Claims for Damages Duty of Loyalty/Improper Personal Benefit Bad Faith/Intentional Misconduct Unlawful Dividend, Stock Purchase or Redemption

The Shareholder Scenario Full range of possible claims and remedies Direct and derivative claims for damages, plus statutory remedies Appraisal Direct and derivative claims for injunctive relief, plus statutory remedies Books and records, annual meetings, election contests, etc.

What Might A Creditor Do? Quasi-derivative standing to pursue derivative claims for damages Most active area for actual creditor assertion of fiduciary duty claims today Standing often granted to creditors in bankruptcy; query whether demand requirements apply, esp. outside bankruptcy No fundamental change in substantive duties of directors or in pre-dispute advice to directors So where are the really novel issues?

Direct Creditor Claims for Breach of Fiduciary Duty What does/could this even mean? Undeveloped area, even as to “insolvent in fact” corporations Four areas stand out initially: Shareholder favoritism Inter-creditor favoritism with self-dealing Inter-creditor favoritism without self-dealing Voting rights and related doctrines

Direct Creditor Claims for Breach of Fiduciary Duty, cont’d Shareholder favoritism: Delaware 160, 173 & 174 provide direct creditor action for unlawful dividends, stock purchases or repurchases Delaware statutory remedy already exists for direct distribution of cash/property to shareholders that leaves creditors unpaid Query whether statutory remedies evince a broader policy…and which way it cuts

Direct Creditor Claims for Breach of Fiduciary Duty, cont’d Inter-creditor favoritism with self-dealing: Actionable if motivated by self-interest; that is, if there is an accompanying duty of loyalty issue Example: favoritism toward a creditor who is also a director, or affiliated with a director Asmussen; Penn. Co. v. S. Broad St.

Direct Creditor Claims for Breach of Fiduciary Duty, cont’d Inter-creditor favoritism without self-dealing: “there might, possibly exist circumstances in which the directors display such a marked degree of animus towards a particular creditor with a proven entitlement to payment that they expose themselves to a direct fiduciary duty claim by that creditor” -- PRG v. NCT, 2004

Direct Creditor Claims for Breach of Fiduciary Duty, cont’d How to understand this difficult issue? “as the case proceeds, …the opportunity will arise to revisit some of these questions….” “it may well be…that…existing principles of tort or contract law are sufficient when applied with the understanding that directors bear a fiduciary relation to creditors when a firm is insolvent….” is there a D&O policy in the neighborhood?

Direct Creditor Claims for Breach of Fiduciary Duty, cont’d Voting rights and related doctrines: direct claims for injunctive relief Secured lender with stock pledge/proxy rights What if a charter amendment is adopted to bar action by stockholder written consent?

Direct Creditor Claims for Breach of Fiduciary Duty, cont’d Revlon/QVC and Unocal/Unitrin Might a creditor have a claim? Against entrenchment? For a sale of the company?

Concluding Remark "Flying saucers come so near, they leave us mortals filled with fear. So tell me Major, ere I faint, is they is or is they ain't?“ Estelle Dumbrava, in a 1964 letter to Maj. Maston Jacks, USAF Project Bluebook