Advice for the Financially Distressed

The Harvard Corporate Governance Blog features a post urging directors at financially depressed companies to protect themselves by anticipating certain obstacles.

The United States Bankruptcy Court for the District of Delaware recently issued a memorandum opinion which refused to dismiss breach of fiduciary duty claims against corporate directors who approved the sale of a financially distressed company's assets on the brink of bankruptcy.

According to John F. Olson, partner at Gibson, Dunn & Crutcher LLP, in Bridgeport, a bankruptcy liquidating trust, filed a complaint against the officers and directors of the debtor, alleging that they did not perform their duties to the company, its shareholders, and its creditors when selling the company's assets.

To limit such claims, Olson suggests directors and officers of financially distressed companies should:

• assume all actions will be scrutinized and second guessed

• avoid actions that could cause loss of protection of business judgment rule (e.g., conflicts of interest or conflicting loyalties; insider issues; preferential treatment of certain stakeholders, failing to keep informed)

• act with care after obtaining all necessary information (directors, members and managers can rely in good faith on reports prepared by officers or outside experts)

• obtain adequate professional and expert advice on a timely basis

• in consultation with the company’s advisers, establish and follow a deliberate decision-making process

• document the decision-making process

• disclose all material facts

• in connection with potential transactions, hire investment bankers, obtain fairness opinions and/or seek offers from potential purchasers

• do not freeze up–no decision is a decision and will likely lead to an argument that duties were abdicated

The court decided that "directors have a duty to inform themselves, prior to making a business decision, of all material information reasonably available to them." The directors lost the protection of the business judgement rule.

Going forward, this ruling is sure to influence directors so that they ensure that they have any facts to support their decision-making actions.