Court Denies Application for Appointment of Receiver for Insolvent Corporation Based on Lack of Exigent Circumstances

In yet another example of the role that the Delaware Court of Chancery plays as an international arbiter of disputes, on December 15, 2010, the Court of Chancery in Pope Investments LLC v. Benda Pharmaceutical Inc. et al., C.A. No. 5171-VCP, denied, without prejudice, an application for the appointment of a receiver on the grounds that while the plaintiff demonstrated that the defendant Benda Pharmaceutical Inc. was insolvent, the plaintiff failed to show that "special circumstances existed which would warrant the appointment of a receiver." Read opinion here.

This summary was prepared by Kevin F. Brady and Zhun Lu of Connolly Bove Lodge & Hutz LLP.  In keeping with an international theme, it is interesting to note that the defendant Benda is a publicly-traded Delaware corporation with its principal office in Wuhan, China, and one of the co-authors of this summary, Zhun Lu, who was born and raised in Wuhan, China, is now a member of the Delaware Bar.

Background

In 2006, Pope, an investment fund, made an equity investment in Benda, a holding company whose assets are in China.  Benda is engaged in research, discovery, and development of pharmaceuticals.  It owns or controls various Chinese subsidiaries or joint ventures (Hubei Tongi Benda Ebei Pharmaceutical Co., Ltd., Shenzhen SiBiono GeneYech Co., Ltd., Yidu Benda Chemical Co., Ltd. and Jiangling Benda).  Pope initially purchased $4.15 million of Benda common stock in 2006. In 2007, Pope loaned Benda $5.52 million in the form of a convertible note to Benda which gave Benda the option to purchase additional shares upon the loan's maturity.  In an unrelated agreement, Pope received warrants to acquire almost 10 million additional shares.  Thus, while Pope only owned a 21% stake in Benda, its beneficial interest was much higher. 

Benda suffered financial losses and was not able to repay the note.  In 2009, Pope obtained a judgment in a New York court on the over-due note.  It then filed an action in the Court of Chancery against Benda and its directors, directly and derivatively, for breaches of fiduciary duty seeking, among other things, the appointment of a receiver to allow Pope to recover the amount of its judgment.  While Pope holds an equity interest in Benda, it only asserted a claim for a receiver in its capacity as a creditor.

Parties' Positions

In supporting the appointment of a receiver, Pope argued that, among other things, (1) Benda was insolvent; and (2) Banda's director defendants made improper loans to insiders for the purpose of gaining preferred creditor status and failed to repay loans.  Thus, Pope argued that Benda's liquidation would be disorderly and inefficient without a receiver to assume management of Benda's business affairs.

In opposing the appointment of a receiver, the defendants argued that (1) Benda merely has illiquid assets but was not insolvent, (2) Benda has an ongoing viable business, (3) the parties' dispute was mainly over the proper course of management (which is not sufficient for a court to appoint a receiver), and (4) there were less drastic remedies than the appointment of receiver available (for example, Pope could use its substantial ownership of the company to change its management or to enforce the judgment in China.)

Section 291 Requirements for Appointing a Receiver

As the Court noted, a receiver is appointed for the protection of the rights of stockholders and creditors when a company has become insolvent.  Under 8 Del. C. § 291, the appointment of a receiver is within the sole discretion of the court, upon the application by any creditor or stockholder.  However, the appointment is proper "only if the company is insolvent and there exist 'special circumstances' where 'some real beneficial purpose will be served."  In other words, "the court will appoint a receiver only if the company is insolvent and exigent circumstances warrant such relief."  The Court also noted that a company is insolvent (i) if the entity's liabilities exceed its assets and (ii) if the entity is unable to pay its obligations as they come due in the ordinary course of business.  Insolvency is a jurisdictional fact so the proof of insolvency must be clear, convincing, and free from any doubt.

Read the entire article at the Delaware Corporate and Commercial Litigation Blog