issues facing officers and directors in financially troubled companies

8/14/2019 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


20/21

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

issues facing officers and directors in financially troubled companies

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