1. 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

2. 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 ?

3. 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?

4. 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

5. 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.

6. 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?

7. 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

8. 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

9. 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.

10. 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

11. 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?

12. 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?

13. 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?

14. 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