Corporate

Creditor’s Fiduciary Duty Claims Proceed Based on Traditional Insolvency Test

 Quadrant Structured Products Company, Ltd. v. Vertin, C.A. No. 6990-VCL (Del. Ch. May 4, 2015) [an enhanced version of this opinion is available to lexis.com subscribers].

This Court of Chancery opinion is destined to be cited as a seminal ruling for its historical and doctrinal analysis of important principles of Delaware corporate law, including the following:

  • • The reasons why creditors can pursue derivative claims on behalf of insolvent corporations against corporate officers and directors.
  • • The reasons why the traditional balance sheet test is the proper standard for determining when a creditor has standing to bring a derivative claim and why insolvency is only determined at the time of filing as opposed to the irretrievable insolvency test used for the appointment of a receiver under DGCL § 291.
  • • Basic principles: reviewing the two fundamental fiduciary duties owed by directors of loyalty and care.  In addition to describing the component of loyalty that includes the requirement to act in good faith, which is a condition of the duty of loyalty, the Court also explains what must be shown in order to establish a claim that a director breached the duty of loyalty and failed to act in good faith: for instance, where the fiduciary intentionally acts with a purpose other than that of advancing the best interest of the corporation. See footnotes 21-23.

This pithy opinion, which is of average length by Chancery standards at 45-pages, is in many ways akin to a condensed law review article or a mini-treatise on first principles of Delaware corporate law.  There are many gems in this opinion that make it worth reading in full.  Among them is a reference to the scholarship of Professor Bainbridge that was quoted in a prior Chancery opinion regarding the question of what impact insolvency should have on the ability of directors to rely on the business judgment rule. That is: none.  Seefootnote 19. This decision also features the helpful summary of the duties of directors in the context of insolvency and the rights of creditors in connection with an insolvent corporation.  For example:

  • • Creditors can never bring direct claims for breach of fiduciary duty.
  • • Delaware does not recognize the theory of either deepening insolvency or the zone of insolvency.
  • • For purposes of analyzing fiduciary duty claims, the only transition point that affects fiduciary duty analysis is insolvency itself.
  • • Directors of an insolvent firm do not owe any particular duty to creditors. Rather, they continue to owe fiduciary duties to the corporation for the benefit of all its residual claimants (the category which includes creditors after the point of insolvency).  Nor do they need to shut down an insolvent firm and marshal its assets for distribution to creditors although they may do so in the exercise of their business judgment if that is the best route to maximize the value of the firm.

SupplementProfessor Bainbridge kindly links to this post and provides a quote and a citation to his scholarship referred to in this opinion.

 Read more Delaware business litigation case summaries and commentary on Delaware Corporate and Commercial Litigation Blog, a blog hosted by Francis G.X. Pileggi, of Eckert Seamans.

For more information about LexisNexis products and solutions, please connect with us through our corporate site.