Director of a troubled company? Stay alert! As a director of a troubled company, decisions you make can trigger huge potential liabilities--unless you take steps to limit or avoid your exposure.

• Author: Williams, Greg T.
• Position: Corporate Governance

If you are a member of a corporate board of directors, you already know that you owe fiduciary duties to the company and its shareholders. These fiduciary duties arise under state corporate statutes and case law. What you may not know is that should the corporation approach insolvency, these responsibilities may flip -- or gradually shift -- to the company's creditors under certain circumstances. If this happens, the decisions you make will most likely change completely. Today's challenging economic conditions make this an excellent time to review this topic.

The board-level issues related to a company approaching insolvency are highly complex, and raise many questions. For example, for a cash-burning company with only enough cash in the bank to pay off company creditors: Is it the appropriate time to pay off those creditors and wind down the company? This would guarantee no return to the equity holders, but at least the creditors would be made whole. What if the assets can be sold and turned into cash as part of winding down the company? Does this give the company a longer lifeline? Do you know for sure that the company's assets can be sold? What price will they bring? What about the responsibility the company and its management have to the company's employees?

Added to the questions are management's optimistic statements that a big customer order is on the horizon and that the order will be made if only the company can hang on. Should the company spend additional funds chasing the order? These and similar issues and questions must be carefully addressed to avoid legal exposure.

Under ordinary circumstances, the rights of company creditors are specified by contracts entered into with those creditors (loan agreements, leases, etc.). However, in many states, including California and Delaware, directors may become subject to claims by creditors for breach of fiduciary duty if they take or fail to take certain actions when a corporation is in the vicinity of insolvency.

For example, in a leading Delaware case (Geyer v. Ingersoll Publications Co., 621 A.2d784 (Del. 1992)), a creditor of a corporation sued the corporation's chairman/controlling stockholder when the corporation defaulted on the creditor's promissory note.

The creditor alleged that the company chairman engaged in transactions that resulted in an improper shift of assets to the stockholder, thereby rendering the corporation unable to repay the creditor. The court ruled that because...