Directors of the financially troubled company: guidance for a thankless job.

• Author: Davis, Gardner
• Position: Florida

Directors of the financially troubled corporation face a difficult and thankless job. As leaders of a failing enterprise, directors must deal with unhappy creditors and disappointed shareholders, make the most of diminishing resources, and determine the course of the company's future. As an additional complication, once the corporation enters what is referred to as the "vicinity of insolvency," directors' obligations and the standards by which they are measured change. This article discusses the fiduciary duties applicable to directors of corporations in the "vicinity of insolvency" under Florida law and provides practical guidance for counsel to advise directors of these general legal principles, many of which remain unsettled, as they contemplate the available alternatives.

Fiduciary Duties of Directors Generally

Under Florida law directors oversee the management of the business and affairs of the corporation, (1) and their actions are governed by a mixture of statutory and common law principles. (2) The corporate director's fiduciary duties are generally expressed in terms of the "duty of care" and the "duty of loyalty" which have been codified in F.S. [section] 607.0830 (2001):

(1) A director shall discharge his or her duties as a director, including his or her duties as a member of a committee:

(a) In good faith;

(b) With the care an ordinarily prudent person in a like position would exercise under similar circumstances; and

(c) In a manner he or she reasonably believes to be in the best interests of the corporation. (3)

To satisfy the duty of care, directors must follow a reasonable and informed deliberative process. The directors should attend the meetings, ask questions, review written materials, and otherwise inform themselves of relevant information reasonably available to them. (4) In performing their duties, directors should seek the input of experts, such as investment bankers, attorneys, and accountants, (5) and should, if possible, consider and discuss important issues at more than one meeting. (6)

The duty of loyalty requires directors to act in good faith in the best interests of the corporation and its shareholders and to refrain from engaging in activities which would permit them to receive an improper personal benefit from their relationship with the corporation. The duty of loyalty prohibits misappropriation of corporate opportunities, bad faith, and self-dealing. (7)

Except in extraordinary circumstances, the "business judgment rule" acts as a judicial presumption that directors have fulfilled these duties, unless a challenger can affirmatively demonstrate a breach. The business judgment rule gives directors "wide discretion in the exercise of business judgment in the performance of their duties" and when it applies, courts will not "pass upon questions of mere business expediency or the mere exercise of business judgment, which is vested by law in the governing body of the corporation." (8)

Fiduciary Duties in the "Vicinity of Insolvency"

* To Whom is the Duty Owed--to Shareholders and Creditors or to Creditors Exclusively?

Directors of solvent Florida corporations owe fiduciary duties exclusively to the corporation's shareholders and not to its creditors. (9) It is well-settled law that once a company has entered statutory insolvency proceedings, fiduciary duties are owed to creditors. (10) However, in the landmark case of Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., 1991 WL 277613 (Del. Ch. 1991), the Delaware Chancery Court held that this duty to creditors begins earlier, at the point the corporation enters "the vicinity of insolvency."

The reasoning of Credit Lyonnais was explained in In re Ben Franklin Retail Stores, Inc., 225 B.R. 646 (Bankr. N.D. Ill. 1998) (aff'd 1999 WL 982964 (N.D. Ill. 1999); 2000 WL 28266 (N.D. Ill. 2000): When a corporation is solvent, satisfaction of creditors' claims requires only compliance with the contracts that create them. However, once the corporation enters financial distress, "the value of the creditors' contract claims against an insolvent corporation may be affected by the business decisions of managers" and "at the same time, the claims of the shareholders are (at least temporarily) worthless." (11) In this...