A lot of corporate law is being made in bankruptcy court these days. Take for example In re Midway Games Inc., 428 B.R. 303 (Bankr. Ct. Delaware 2010). A committee of unsecured creditors challenged the actions of the board of directors of Midway for obtaining additional financing for the company instead of filing for bankruptcy. The company was insolvent at the time and presumably an earlier bankruptcy would have benefited the unsecured creditors while the additional financing provided the company with some needed cash but only prolonged the company’s agony. Along the way the majority shareholders also sold their 87% interest in the company and $70 million in debt to an individual for a mere $100,000.
The bankruptcy court reaffirmed the Delaware courts’ objection to the “deepening insolvency” theory (essentially that a board of directors must look to help the creditors over the interests of the company once a company becomes insolvent and stop the bleeding.) Delaware law is clear that directors are not liable for taking actions to make a corporation viable once it is insolvent. A board “does not have a duty to protect creditors of an insolvent corporation at the expense of the corporation and its shareholders." Thus, the court found no breach of the duty of care by the board.
Next, the court looked at the duty of loyalty that directors owe to a corporation. Although it held in the directors favor, this case does serve as a reminder to directors that they cannot become complacent about their role because they have an affirmative duty of oversight encapsulated in the duty of loyalty they owe to the corporation. If directors fail to act in the face of a known duty to act and they demonstrate “a conscious disregard for their responsibilities" as directors, then they have breached the duty of loyalty. I have noted in earlier posts that this breach of the duty of loyalty looks an awful lot like the duty of care and may have been constructed to get around the exculpatory clauses found in many articles of incorporation that prohibit monetary damages being assessed against directors for the breach of the duty of care, but so far no one else has taken up that banner.
So what about the sale of the 87% interest and $70 million in unsecured notes for $100,000? The court found nothing wrong there either because the shareholders/noteholders “had the unfettered right to dispose of their Midway interests as they saw fit. The board was not involved in the transaction and could not prevent it. The stockholders qua stockholders owed no duty to the corporation.