LexisNexis® CLE On-Demand features premium content from partners like American Law Institute Continuing Legal Education and Pozner & Dodd. Choose from a broad listing of topics suited for law firms, corporate legal departments, and government entities. Individual courses and subscriptions available.
In a detailed May 4, 2015 opinion (here), Vice Chancellor Travis Laster of the Delaware Chancery Court extensively reviewed the rights of an insolvent company’s creditors to pursue derivative claims against the company’s directors [an enhanced version of this opinion is available to lexis.com subscribers]. As Francis Pileggi put it in a May 6, 2015 post on his Delaware Corporate and Commercial Litigation blog (here), Laster’s opinion in Quadrant Structured Products Company, Ltd. v. Vincent Vertin et al. is “destined to be cited as a seminal ruling for its historical and doctrinal analysis of important principles of Delaware corporate law.”
Prior to the credit crisis, Athilon Capital Corp. guaranteed credit default swaps that one of its subsidiaries wrote on senior tranches of collateralized debt obligations. To fund its operations, Athilon raised debt financing by issuing various notes. Athilon suffered significant losses during the financial crisis. In the wake of these events, one of Athilon’s debt holders (EBF) acquired all of Athilon’s outstanding equity securities. As the company’s sole stockholder, EBF reconstituted the board, after which it made a number of moves to address Athilon’s financial situation.
In October 2011, Quadrant Structured Products Company, another of Athilon’s noteholders, filed a derivative lawsuit in Delaware Chancery Court against Athilon’s board. Quadrant contended that the directors’ actions, which Quadrant alleged were made to benefit EBF and to the detriment of the company, breached their fiduciary duties. Quadrant argued that under Delaware law, it had the right as a creditor to assert a derivative claim against the Athilon directors because the company was insolvent. In an earlier post (here), I discussed Vice Chancellor Laster’s October 2014 ruling in the Quadrant lawsuit, in which Laster denied in part the defendants’ motion to dismiss.
Following the motion to dismiss denial, Athilon made a number of additional financial moves that the defendants contend returned the company to solvency. The defendants then moved for summary judgment. The defendants argued that for a creditor to have standing to maintain a derivative action, the corporation on whose behalf the creditor sues must be insolvent at the time of the suit and continuously thereafter. The defendants argued that whether or not Athilon was insolvent at the time Quadrant filed suit, Athilon’s current balance sheet shows that it is now solvent, and therefore that Quadrant no longer had standing to pursue the derivative lawsuit.
The May 4 Ruling
In his May 4, 2015 opinion, Vice Chancellor Laster denied the defendants’ motion for summary judgment. He said that the question of whether or not Delaware imposes a continuous insolvency requirement in order for creditors to have standing to assert a derivative claim is a “question of first impression.” In his ruling, he rejected “the defendants’ attempt to impose a continuous insolvency requirement for creditor derivative claims.”
He 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:
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.” Laster then added a note of modesty, with his observation that “to state the obvious, this is the opinion of one trial judge. The Delaware Supreme Court may well disagree.”
By contrast to Delaware law, courts applying Pennsylvania law have applied the “deepening insolvency” theory to hold that directors of a company in the zone of insolvency have duties for which the company’s creditors may seek to hold them liable. For a recent post discussing a decision in which the Third Circuit applied these principles in holding the directors of nonprofit entity liable, refer here.
Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
For more information about LexisNexis products and solutions, please connect with us through our corporate site.