In a detailed May 4, 2015 opinion, the Delaware Chancery Court extensively reviewed the rights of an insolvent company’s creditors to pursue derivative claims against the company’s directors
In the opinion, Vice Chancellor Laster said that “to bring a derivative action, a creditor-plaintiff must plead and later prove that the corporation was insolvent at the time the suit was filed.” Because he found that Quadrant had introduced sufficient material to support a reasonable inference that Athilon was insolvent at the time Quadrant filed suit, and therefore he denied the defendants’ motion for summary judgment.
In making these determinations, Laster broadly surveyed the legal principles underpinning derivative litigation in Delaware, including the rights of creditors to assert derivative claims under some circumstances. He reduced the various principles pertaining to these issues to a succinct bullet point list:
- There is no legally recognized “zone of insolvency” with implications for fiduciary duty claims. The only transition point that affects fiduciary duty analysis is insolvency itself.
- Regardless of whether a corporation is solvent or insolvent, creditors cannot bring direct claims for breach of fiduciary duty.
- After a corporation becomes insolvent, creditors gain standing to assert claims derivatively for breach of fiduciary duty.
- The directors of an insolvent firm do not owe any particular duties to creditors. They continue to owe fiduciary duties to the corporation for the benefit of all of its residual claimants, a category which now includes creditors. They do not have a duty to shut down the insolvent firm and marshal its assets for distribution to creditors, although they may make a business judgment that this is indeed the best route to maximize the firm’s value.
- Directors can, as a matter of business judgment, favor certain non-insider creditors over others of similar priority without breaching their fiduciary duties.
- Delaware does not recognize the theory of “deepening insolvency.” Directors cannot be held liable for continuing to operate an insolvent entity in the good faith belief that they may achieve profitability, even if their decisions ultimately lead to greater losses for creditors.
- When directors of an insolvent corporation make decisions that increase or decrease the value of the firm as a whole and affect providers of capital differently only due to their relative priority in the capital stack, directors do not face a conflict of interest simply because they own common stock or owe duties to large common stockholders. Just as in a solvent corporation, common stock ownership standing alone does not give rise to a conflict of interest.
- The business judgment rule protects decisions that affect participants in the capital structure in accordance with the priority of their claims.
In summarizing his ruling on the issues raised in the defendants’ summary judgment motion, Laster said “in my view … to maintain standing to sue derivatively, a creditor must establish that the corporation was insolvent at the time the creditor filed suit. The creditor need not demonstrate that the corporation continued to be insolvent until the date of judgment.”