19 Jan 2016 Email to ENR Cheifs of Staff - How Could Fiduciary Duty Conflict With the Public and...

7/26/2019 19 Jan 2016 Email to ENR Cheifs of Staff - How Could Fiduciary Duty Conflict With the Public and National Interest

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From: Douglas Grandt [email protected]: How could fiduciary duty conflict with the Public and National Interest [Corrected]

Date: January 19, 2016 at 8:55 AMTo: Edward Hild (Sen. Murkowski) [email protected], David Cleary (Sen. Alexander)

[email protected], Dan Kunsman (Sen. Barrasso) [email protected],Joel Brubaker (Sen. Capito) [email protected], James Quinn (Sen. Cassidy) [email protected],Jason Thielman (Sen. Daines) [email protected], Chandler Morse (Sen. Flake)[email protected], Chris Hansen (Sen. Gardner) [email protected],Ryan Bernstein (Sen. Hoeven) [email protected], Boyd Matheson (Sen. Lee) [email protected], Mark Isakowitz (Sen. Portman) [email protected], John Sandy (Sen. Risch) [email protected],Travis Lumpkin (Sen. Cantwell) [email protected], Jeff Lomonaco (Sen. Franken)[email protected], Joe Britton (Sen. Heinrich) [email protected], Betsy Lin (Sen. Hirono)[email protected], Patrick Hayes (Sen. Manchin) [email protected],Bill Sweeney (Sen. Stabenow) [email protected], Mindy Myers (Sen. Warren)[email protected], Jeff Michels (Sen. Wyden) [email protected],Michaeleen Crowell (Sen. Sanders) [email protected], Kay Rand (Sen. King) [email protected], Joe Hack (Sen. Fischer) [email protected], Derrick Morgan (Sen. Sasse) [email protected],Karen Billups (Senate ENR Ctee) [email protected], Colin Hayes (Senate ENR Ctee)[email protected], Angela Becker-Dippmann (Senate ENR Ctee) [email protected]

Cc: Jordan Cox (Sen. Fischer) [email protected], Ginger Willson (Sen. Sasse) [email protected],Ali Aafedt (Sen. Hoeven) [email protected]

Dear Chiefs of Staff of the Senate Energy & Natural Resources Committee (ENR) and the Nebraska Senate Deleg ation,

On January 15, I emailed Senators Fischer's and Sasses Chiefs of Staff Jordan Cox and Ginger Willson, asking again for theirintervention with ENR Chairman Murkowski:

Please request Senator Murkowski to call for testimony and assurances that CEOs will act in the Public and NationalInterest when there is a conflict with their fiduciary duty. As part of an energy policy, ENR should compel them to act in

our best interest.

For your convenience I will restate my rationale for petroleum CEOs testifying before ENR:

I fear that sustained low oil prices will cause production companies to go belly up precipitously, reducing refineries'feedstock, leaving America with less diesel, gasoline, kerosene, fuel oil, and other liquid fuels. The bottom line as I seeit, is a collapse of petroleum equities, a general downward market panic, and devastating declines in the economic healthof the nation, individual retirement funds, pensions and superannuationsin short, mayhem in America.

In my January 15 email to you, the Chiefs of Staff of the ENR member Senators, I bemoaned the fact that you have notresponded to my dozens of emails (and dozens of letters to the Senators). Yesterday, it occurred to me that perhaps you do notunderstand fiduciary duty and why CEOs and Boards of Directors exercising fiduciary duty in the face of insolvency will likely bein direct conflict with Congress requirement that they act in the Public and National Interest.

Therefore, I direct you to American Bar Association document that hopefully will elucidate the basis for my fears:

INSOLVENCY AND FIDUCIARY DUTIES: ADVISING DIRECTORS AND OFFICERS WHEN THE COMPANY CANNOT PAY ITSBILLSdated August 6, 2010[CORRECTION] (Bit.ly/ABA6Aug10)

Sincerely yours,

Doug Grandt
http://www.americanbar.org/content/dam/aba/publications/blt/2010/09/inside-buslaw-insolvency-201009.authcheckdam.pdfhttp://www.americanbar.org/content/dam/aba/publications/blt/2010/09/inside-buslaw-insolvency-201009.authcheckdam.pdfhttp://bit.ly/ABA6Aug10http://www.americanbar.org/content/dam/aba/publications/blt/2010/09/inside-buslaw-insolvency-201009.authcheckdam.pdfhttp://www.americanbar.org/content/dam/aba/publications/blt/2010/09/inside-buslaw-insolvency-201009.authcheckdam.pdfhttp://www.americanbar.org/content/dam/aba/publications/blt/2010/09/inside-buslaw-insolvency-201009.authcheckdam.pdfhttp://www.americanbar.org/content/dam/aba/publications/blt/2010/09/inside-buslaw-insolvency-201009.authcheckdam.pdfhttp://bit.ly/ABA6Aug10http://www.americanbar.org/content/dam/aba/publications/blt/2010/09/inside-buslaw-insolvency-201009.authcheckdam.pdfmailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]


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MIUtiC N BAA A SOCIATION

Business

law

Section

Annual Meeting

San Francisco C

August

6,

2 1

2:3

p.m.

PST

INSOLVENCY AND FIDUCIARY DUTIES:

ADVISING DIRECTORS AND OFFICERS

WHEN THE COMPANY CANNOT PAY

ITS

BILLS

Program

Chair Moderator:

Lewis H Lazarus, Esq.

Morr is James

LLP

Program Speakers:

The Honorable Elizabeth S Stong

United States Bankruptcy Judge, E D of New York

Ted

S

Waksman, Esq

Weil, Gotshal Manges LLP

Kristen

K

McGuffey, Esq.

Executive Vice President, General Counsel and Secretary

Simmons Bedding Company

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William reekmuir

Executive Vice President,

hief

Financial

Officer

and Treasurer

Simmons Bedding Company

Craig

D

Hansen,

Esq

Squire, Sanders Dempsey L L P

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TABLE OF CONTENTS

Page

I

DIRECTORS

AND

OFFICERS

FIDUCIARY DUTIES ....................................... 1

A. The Duty

of

Loyalty ............................ ................................ .......... 1

B The Duty of Care ................................ ................................... ...... 2

C The Business

Judgment

Rule .. ............................................. ......... 2

II. HOW DO THESE

DUTIES

CHANGE WHEN A CORPORATION

APPROACHES INSOLVENCY? ................................................................... 3

A.

Introduction

................................................................................ 3

B Zone or Vicinity of Insolvency .......................... ............................ 3

C

To Whom

Are Fiduciary Duties Owed? ..... ..................................... 4

D A Word on Deepening Insolvency ...................................... ......... 4

III. SPECIFIC CHAPTER

11

CONSiDERATIONS ...... ...... ..... ..... ...... ..... ..... ...... .... 5

A. Duties During

Chapter 11

Proceedings ......................................... 5

B Revlon Duties and Their Application To A Chapter 11 ................... 6

IV. COMMON CHAPTER 11 TRANSACTION STRUCTURES THAT

IMPLICATE FIDUCIARY DUTIES ......................................... ....................... 7

A. Introduction ................................................................................ 7

B The 6 Sale ........................................ ................................. ....... 7

C

The StandAlone Plan ..................... ....................................... ........ 8

D The Plan Sponsor .................................. ................................... .... 9

V RESTRUCTURING

TRANSACTIONS INVOLVING RELATED PARTIES ............. 9

A.

Introduction

.................................. ..................................... ......... 9

B The Use Of Special Committees In A Chapter

11

......................... 10

VI.

SOME

CAUTIONARY WORDS REGARDING D&O INSURANCE .... .... .... .... .... 12

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10 2


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Exhibits

T BLE

OF CONTENTS

continued)

Page

Bankruptcy Bulletin - Delaware Supreme Court Clarifies Fiduciary

Duties When A Corporation Is Insolvent

or

In the Zone of Insolvency

- Weil, Gotshal Manges LLP

2 orth American Catholic Educational

Programming

Foundation

Inc. v Cheewa//a 93 A.2d 92 (Del. 2007)

3 Sample Memorandum to Board of Directors of Distressed

Companies Regarding Scope

of

Fiduciary Duties - Squire, Sanders

Dempsey L L P

4 Fiduciary Duties for Directors

of

Troubled Companies - Weil,

Gotshal Manges LLP

5

Rev/on

Duties Under Delaware Law - Morris James LLP

PHO

ENIXJS2

85I 02

11


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I DIRECTORS AND OFFICERS FIDUCIARY DUTIES

Generally, directors and officers fiduciary duties comprise the

duty

of

loyalty and the duty of care. Under Delaware law, corporate officers and

directors have identical

fiduciary

duties.

See

Cant/er

v

Stephens

965 A.2d

695, 708-09 (Del. 2009).

So

long

as

the directors and officers

comply with

these duties,

they

are entitled to the

protections of

the business judgment rule.

When the business judgment rule applies, a court

will

not

typically

substitute its

own view for those

of

directors and officers

or

second-guess the outcome

of

business decisions by holding a director or officer personally liable for a

mistake in

judgment.

Each of these duties is discussed more fully below.

A

The

uty

o Loyalty

1. In deal ings

with

and on

behalf of

the corporation, directors

owe a

fiduciary

duty of loyalty to the

corporation,

which demands that there

be

no

conflict

between the

corporation's

interest and the

director's

interest.

Directors

must

avoid

self-dealing,

observe

confidentiality

obligations, and

not

abuse corporate

opportunities

for

personal gain.

A

disqualifying

interest can

exist

because a

director

is

dominated or

controlled by a party interested in a

corporate transaction.

Challenges to conflicts of interests can be cured by a

showing that

an

action was approved by a

majority of

disinterested directors

who

were

informed of

the conflict.

2. The

duty of

loyalty includes the

obligation to

act in good

faith

with

a

true

faithfulness and devotion to the interests of the corporation

and its shareholders.

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A failure to act in good

faith

could be shown where a director

intentionally acts with a purpose other than that of advancing

the best interests of the

corporation,

acts with the intent to

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violate applicable law, or intentionally fails to act in the face

of a known duty

to

act.

A

director who

deliberately avoids acting in the best interests

of

the

corporation

cannot evade

liability

by showing

that

he/she

technically met the requirements

of

their fiduciary

duties.

3 The

duty of

loyalty also includes the

obligation

to disclose

any conflicts of

interest

with respect to any corporate matter being decided.

In

matters before the board, a

director must inform fellow

directors of any conflict of interest.

When seeking shareholder action on a

matter

involving a

conflict

of

interest,

an

interested director

must

disclose

to

all

shareholders such

conflict

of interest.

B The uty o are

Directors are required to exercise a requisite degree

of

care and

prudence in the process

of

making decisions and in carrying out directorial

responsibilities.

PHOENIXl52 85 10 2

Directors must inform themselves

of

all material

information

reasonably available to them before making a business

decision.

The General Corporation Law of Delaware allows directors to

rely on

information

provided

by

the

corporation s

officers,

employees, and

other

advisors, as long

as

the directors

reasonably believe the information provided is within the

scope

of

the provider s professional

or expert

competence,

and the person

so

relied upon has been selected

with

care.

The duty

of

care still requires that directors evaluate advice

and

information

critically and investigate further

if

there are

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facts or circumstances signaling a need for additional

information.

C he

Business Judgment Rule

Under the business

judgment

rule, there is a

presumption

that

in

making

a business decision the director

of

a corporation acted on an

informed

basis, in good

faith

and in the honest

belief

that the action taken was in the

best interests of

the company.

Standard

of judicial

review used by courts

to

determine when

close scrutiny of a transaction is warranted. When directors

have

fulfilled

their duties

of

care and loyalty in good faith,

courts presume,

under

the business

judgment

rule,

that

their

decisions are valid.

Protects

directors ability to

exercise their discretion when

making decisions on behalf of the corporation without fear of

a

court questioning

the

wisdom

of their decision in

hindsight.

A plaintiff can overcome the

presumption of

the business

judgment rule by showing

that

a director has failed to act

with

due care

or

loyalty,

or

lacked good

faith

in carrying out

these duties, in which case, the

court will

scrutinize the

challenged transaction substantively.

II. HOW DO

THESE

DUTIES CHANGE WHEN A CORPORATION PPRO CHES

INSOLVENCY?

A Introduction

What does

it

mean

to

be in the zone

or

vicinity

of

insolvency?

To

whom

are

directors fiduciary

duties owed when a corporation

is

in the zone of insolvency or is insolvent?

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Do creditors have claims for breaches

of fiduciary

duties against

directors

of

a corporation that is in the zone

of

insolvency

or is

insolvent?

B Zone

or

Vicinity o nsolvency

1. There

is

no exact

definition of

the zone

or

vicinity

of

insolvency, but generally, a corporation is considered in the zone or vicinity

of insolvency when it

is

near or approaches the point where:

the sum of such entity's debts

is

greater than all of such

entity's

property,

with

no reasonable prospect that the

business can

be

successfully continued

or

The corporation

is

unable

to

pay its debts

as

they fall due in

the usual course

of

business.

2. This rather subjective concept can be

difficult

to apply in

practice,

but it

may

be telling that

the

question is

being asked. The board

should act diligently in determining whether the

corporation is

in the zone or

vicinity

of

insolvency and may consider, among

other

factors, advice

of

its

financial advisors in reaching its conclusion.

3. A company may

be

operating

in the zone

of

insolvency

when it

is

not yet technically insolvent under either the

bankruptcy

test or

the equitable insolvency test,

but

nevertheless

is

experiencing financial

difficulties.

4.

s

the risk that creditors

will

not be paid increases, the

likelihood that a company is in the zone of insolvency increases.

C To Whom

re

Fiduciary Duties Owed?

In

the case

of North

merican

Catholic Educational

Programming

Foundation Inc. v Cheewa/la 930

A.2d 92 (Del. 2007), the Delaware Supreme

Court clarified the law on fiduciary duties for directors of distressed

corporations when it held as follows:

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Solvent Corporations: directors owe

fiduciary

duties to the

corporation

and its shareholders.

Zone

of

Insolvency: directors continue

to

owe

fiduciary

duties

to the corporation and its shareholders, and ot to creditors,

when a

corporation

becomes distressed or

is

at risk of

insolvency.

Insolvency: when a corporation is insolvent, directors owe

fiduciary

duties to the corporation as an enterprise, and the

creditors are permitted to bring derivative suits on behalf of

the corporation, but not direct causes of action.

D A Word

o

Deepening Insolvency

Historically, a theory that has been advanced in a number of cases

against, among others, officers and directors,

is

a claim for damages based on

the concept

of

deepening insolvency. The

theory of

liability for damages for

deepening insolvency was never

well-defined nor

was

it

universally embraced

by all courts, and there are few written judicial decisions concerning the topic.

Accordingly, creativity in the use

of

the

theory

abounds. Simply stated, the

concept

of

damages

for

deepening insolvency

is

that there are times when a

defendant s

conduct,

either fraudulently or

negligently, prolongs the life a

corporation,

thereby increasing the corporation s debt and exposure to

creditors. Under the deepening insolvency theory, those

with

fiduciary

obligations may be liable for damages suffered by creditors for deepening the

insolvency of a corporation.

n the past, there were arguably three classes of possible

defendants against

whom this

legal

theory has

been directed. Officers and

directors may

be

held personally liable concerning actions taken

that

could

be

construed

to

prolong the life

of

a corporation

to

the

detriment

of

creditors,

thereby

deepening the insolvency

of

the corporation. Essentially, the theory

of

deepening insolvency as against officers and directors has been used as a way

to assert liability for mismanagement using a hindsight test. The

theory

has

also been used against certain lenders

as

well

as

the company's professionals.

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The

crux of

the deepening insolvency issue for the officers and

directors of

a corporation was

whether

actions that are being taken,

or not

taken, essentially created a worsening situation for the corporation s creditors.

Recently, however, the deepening insolvency

theory

of liability has been

rejected by courts,

including

the Delaware courts. See e.g. Trenwick America

Litigation Trust v. Ernst Young L.L.P. 906 A.2d 168, 205 (Del. Ch. 2006)

(rejecting independent cause of action for deepening insolvency); Fehribach v.

Ernst

&

Young L.L.P. 493 F.3d 905,

909

(7th Cir. 2007) (applying citing

Trenwick for the

proposition that

the deepening insolvency

theory

makes no

sense ); see generally Cheewalla 930 A.2d 92. Accordingly, officers and

directors

owe a Delaware

corporation

the general duties of care and loyalty. In

this

regard, if a board acts

with

due diligence and in good faith, but the chosen

strategy results in a deepening insolvency, the directors are protected by the

business judgment rule. To conclude otherwise

would fundamentally

transform

Delaware law. Trenwick 906 A.2d

at

205.

The deepening insolvency

theory of

liability, again, was never a

clearly defined cause of action, and the cause of action is no longer viable with

respect

to

Delaware corporations.

Notwithstanding, it

is something that the

Board

as

well

as

the officers

of

the Company should

be

aware of.

III.

SPECIFIC CHAPTER

CONSIDERATIONS

A. Duties

During

Chapter

Proceedings.

In the case of Trenwick Am. Litigation Trust v. Ernst & Young

L.L.P. 906 A.2d 168 (Del. Ch. 2006), aff d Trenwick Am. Litigation Trust v.

Billet

93

A.2d

438

(Del. 2007), the Delaware courts clarified

that

the

operation of

the business

judgment

rule does

not

change depending on the

level

of

solvency

of

a corporation.

The duties of a corporate chapter debtor-in-possession or

DIP , are essentially

two

fold: First, those prescribed by state corporate law

(i.e., the

duty

of care and duty of loyalty described above); and second, those

duties

imposed on a DIP

under

federal

bankruptcy

law. If there is a conflict, the

duties under

federal

bankruptcy

law

will

prevail.

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A

DIP

owes a fiduciary

duty to

all interested parties, creditors and

shareholders alike. Although there are two sources of fiduciary duties for a DIP

the federal bankruptcy law duties are, for all practical purposes, derived from

the state law

duties of

care and loyalty. Specifically, under the

bankruptcy

laws,

a

DIP

is held

to

a standard

of

care, skill and diligence

that

an

ordinary

person

will exercise under similar circumstances. See In re Rigden 795 F.2d 727,730

(9th Cir. 1986); In re Happy Time Fashions Inc. 7 B.R. 665, 670 (Bankr.

S.D.N.Y. 1980).

Simply stated, the

DIP

has a duty

of

loyalty to

maximize

the value

of the estate , refrain

from

self-dealing, and treat all parties

fairly

in addressing

and resolving the conflicting tensions

that

necessarily arise between the various

stakeholders and parties in interest in a

chapter

11 proceeding. See

Commodity

Futures Trading Comm n

v

Weintraub 471 U.S. 343, 353 (1985); In

re Integrated Resources Inc. 147

B.R.

650, 658 (S.D.N.Y. 1992). From a

practical perspective, unlike the decision-making process outside of a chapter

11 proceeding, many of the decisions

of officers

and directors made in the

context of a

chapter

11 are subject

to

disclosure to, and approval by, the

bankruptcy

court. Under the

bankruptcy

laws, transactions that fall outside of

the

debtor's ordinary course of business require prior bankruptcy court

approval. The approval by a bankruptcy court of a particular transaction (e.g.,

sale, selection

of

a plan sponsor, stalking horse

bidder,

to

name a few) provides

an additional layer

of protection

for a director and officer

of

a DIP.

Finally, it is

common

practice

to

include, as

part

of a chapter 11

plan

of

reorganization (the Plan ) and related

confirmation order

and

findings

of fact and conclusions of law, that the DIP's officers and directors acted in

good

faith and fully discharged their fiduciary

duties

in the context of the

restructuring - related decisions. These

findings

and conclusions are typically

supported by an injunction contained in the Plan

prohibiting

creditors and other

parties in

interest

from

initiating actions against the directors and officers,

unless their

conduct

rose to the level

of

gross negligence or willful misconduct.

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,

B

Revlon

Duties and

Their

Application To

A

Chapter

11.

In a non-bankruptcy

context,

courts have held that when it

becomes obvious that the sale of a company (or presumably its assets) is

inevitable, a heightened level

of

scrutiny

is applied

to

evaluate the decision

of

a

target's

Board

granting prohibitive

buyer protection devices to a potential

purchaser which will chill competitive bidding. In

other

words, once the

company is in play, the Board has an affirmative

duty

to get the highest price -

no playing favorites . In a non-bankruptcy context, the seminal case in

defining

the heightened

scrutiny of

buyer protections which would have the

impact of chilling bidding is Revlon v MacAndrews Forbes Holdings Inc. 506

A.2d 173 (Del. 1986). In essence, the legal duty of a board

of

directors once a

decision has been made to sell the company or its assets is

to maximize

the

value and not to grant such advantage to one or more potential bidders that

has the effect of stacking the deck and chilling the bidding.

As stated above, a Chapter 11 DIP owes a fiduciary

duty

to all of

the creditors and other interest holders

of

its

bankruptcy

estate to

maximize

value. See

In

re Bidermann Industr. U.S.A. Inc. 203

B.R.

547, 551 (Bankr.

S.D.

N.Y. 1997). The filing of a bankruptcy proceeding has the practical effect of

putting the company in play whether the company likes

it or

not. Since the

ultimate fiduciary duty

of

an insolvent company is

to maximize

the return

to

the

various constituencies, the company needs to understand

that

a reorganization

plan that maximizes value, even

if

it is a plan that is not necessarily proposed

by the company, needs to be seriously evaluated much like a

tender

offer

outside of a bankruptcy proceeding. As such, there is a duty to shop and that

involves keeping an open mind

to

proposals even

if they

are not generated by

the company.

All restrictions on the debtor's ability to market its assets will

be

subject

to

the strictest scrutiny provided by a Bankruptcy Court. See

TCI

Holdings

LLe 428

B.R.

117, 144 (Bankr. N.J. 2010),' see e.g. Bidermann Indust. U.S.A.

Inc. 203

B.R.

at

551

(holding window-shop clause improper); In re Big Rivers

Iec. Co. 233 B.R. 726, 734-735

W.D

. Ky. 1998) (voiding

no-shop

clause

because

it

forced debtor to violate its fiduciary duty). Compare Revlon 506

A.2d at 184

(finding

improper

lock-up

and no-shop agreement ending

PHOENIXI528510.2

8


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negotiations

with other known bidders) and Paramount Communications Inc. v

QVC Network Inc. 637 A.2d 34,49 (Del.

1994)

(holding no-shop provision

impermissibly

interfered

with directors ability to

negotiate

with other

known

bidders).

The

Court will

analyze the transaction

under

provisions

of

the Bankruptcy

Code, such as section 363 (discussed below) and section

1129

(Confirmation

of

a Plan), and will look to

how

the transaction was tailored when determining

whether to

impose an enhanced level of scrutiny.

See

In re PWS

Holding

Corp.

228

F.3d 224,

247

(3d Cir. 2000). The sale or the

confirmability of

the

debtor s

plan may be defeated i f a breach of fiduciary

duty

by officers

or

directors is

demonstrated.

See e.g. In re Coram Healthcare Corp.

271

B.R.

228

(Bankr. D.

Del.

2001) (debtor s

plan

of

reorganization rejected on good faith grounds

where the

debtor s chief

executive

officer

and president had been receiving

almost 1

million per year

under

employment agreements with a large

creditor

of

the debtor without

debtor s

knowledge).

IV. COMMON CHAPTER 11 TRANSACTION STRUCTURES THAT IMPLICATE

FIDUCIARY DUTIES.

A.

Introduction

While each chapter 11 is unique, there are

common

transaction

structures

that

are used

as

a means

to maximize

the recovery

to

the various

constituencies. Each of these

common

transaction structures implicates the

fiduciary

duties

of

the DIP's directors and officers. Most

of

these transaction

structures are implemented

as

part

of

the plan but,

as

described

immediately

below, a sale

of

all or a substantial

portion of

a DIP's assets may occur pursuant

to a proceeding

under

11 U.S.c. 363

of

the Bankruptcy Code (a 363 Sale ).

B The 363 Sale.

Under the

bankruptcy

laws, a DIP may sell assets free and clear

of

liens, claims and encumbrances outside the

ordinary

course

of

business,

provided that prior

bankruptcy

court

approval is obtained. Typically, in a 363

Sale, the DIP will

formulate

a sale process by which prospective purchasers may

PHOENIXl5285I 0 2

9


15/87

obtain material

non-public information

necessary

to submit

a bid, the process

by which bids must be submitted the evaluation of the bids and the ultimate

auction that may occur to select the highest

or

best bid. The DIP's directors

and officers, together with their restructuring professionals,

must

design a sale

process

that

does

not

create unnecessary barriers

to

prospective purchasers

or

otherwise chill

competitive

bidding. While it is beyond the scope of these

materials, the

implementation

as part

of

the sale process

that

is developed, of

typical buyer protective devices , such as break-up fees, topping fees,

no-

shop, window-shop and go-shop provisions will

be

scrutinized by not only the

bankruptcy

court but by other creditors and parties in interest, including

prospective bidders. In the context

of

formulating and

implementing

a 363

Sale, the DIP's directors and officers need

to

be

cognizant

of, and particularly

sensitive to, the

following:

PHOENIXI528510 2

Does the prospective 363

Sale potentially

involve a related

party,

including

participation

of

controlling shareholders,

interested directors

or

executive management

of

the DIP

with

one or more potential bidders?

If

so, it may be necessary to

form a special committee

of

the board

of

directors to

conduct

the sale process (see discussion below regarding

Use of Special Committees ).

Is

the 363

Sale

the

most

likely vehicle

to maximize

the value

of the assets and the recoveries to the various constituencies

when compared to

other

potential alternative restructuring

scenarios (i.e., a StandAlone Plan or a Plan Sponsor

structu

re ?

Are there substantial

or

good business reasons

for

the 363

Sale?

Are the bid procedures

to

be

implemented appropriate

to

ensure that there are no unnecessary barriers to a

competitive bidding process?

1


16/87

Are there factors, beyond the mere purchase price, th t

should

be

evaluated in determining the highest

or

best offer?

Such factors may include,

for

example, ntitrust

or

other

regulatory concerns, financing and due diligence

contingencies and potential significant delays in closing the

sale transaction.

Are the DIP's

restructuring

professionals (lawyers, financial

advisors and

investment

bankers) actively involved

not only

in the formul tion

of

the sale process but also the evaluation

and negotiation

of

bids?

There are considerable protections afforded to the directors and

officers

of

a

DIP

in connection

with

a 363 Sale. As mentioned above,

most

363

Sale

transactions involve the sale

of

assets outside the

ordin ry

course

of

business and require b nkruptcy court approval. Hence, the sale process

developed and implemented

as

well

as

the selection

of

the highest

or

best bid

is

ultim tely

subject

to

approval by the

b nkruptcy court following

extensive

notice and disclosure to creditors and parties in interest and, in most

circumstances, an auction.

C

The Stand lone Plan

The

proper

discharge of the directors and officers

fiduci ry

duties

requires th t numerous potential restructuring alternatives be evaluated to

determine

the particular vehicle th t maximizes the value

of

the company

for

the benefit of the various stakeholders. Typically, a 363 Sale may render a

recovery to stakeholders th t is

signific ntly

less than the

long

term value

associated with a Standalone Plan , and the associated debt and

equity

securities th t may

be

issued

pursu nt to

such a plan. Under a Standalone Plan,

the debtor

will

likely restructure its existing debt and equity securities without

the

benefit of

additional third party capital (except

for

normal exit financing

for

working capital purposes). Depending upon valuation considerations,

p rticul r

stakeholders (particularly those parties

with

a loan

to

own objective)

may view a new debt

or equity

security issued by the reorganized

debtor as

creating greater long

term

value than the cash distribution th t may be received

PHOENIXI528510 2


17/87

as part

of

a 363

Sale.

In general, in determining whether to pursue a

Standalone Plan, the directors should consider mUltiple factors, including the

following:

An assessment

of

the potential recoveries

to

stakeholders

under

a

liquidation

363

Sale

and a Plan Sponsor (discussed

below) scenario.

The views

of

stakeholders regarding the

restructuring

scenario to be selected.

The

long-term feasibility of

the DIP reorganizing on a

standalone basis.

The opinions of the DIP's restructuring professionals of the

Standalone

Plan

from a financial and

implementation point of

view.

D The Plan Sponsor

Typically, a DIP may determine that its ability to reorganize and

maximize

recoveries to all stakeholders

is greatly

enhanced

through

the active

participation in the Plan by a third party investor or Plan Sponsor who is

willing to

provide fresh capital

into

the DIP. Again, like a 363

Sale

the directors

and officers

of

the DIP should develop and

implement

a competitive process to

select a

particular Plan

Sponsor. The process

to

select the

Plan

Sponsor may

resemble the auction process discussed above to select the highest or best

offer in connection

with

a 363

Sale.

V.

RESTRUCTURING TRANSACTIONS INVOLVING RELATED

PARTIES.

A Introduction

Many

restructuring

transactions involve the participation of related

parties to the

DIP.

These types

of

transactions are subject

to

careful scrutiny by

bankruptcy

courts. It is worth noting that these types

of

transactions

not

only

involve directors

of

distressed companies

who

may have a personal interest in

the outcome

of

the restructuring because

of

ownership

of existing debt or

PHOENIXJ528510 2

2


18/87

equity

securities,

but

also executive management that may

be

critically

important to a prospective purchaser of the assets

or

to a Plan Sponsor.

The United States Supreme Court, in

Bank

of

America National

Trust

and

Savings Assoc.

v 2 3 N

LaSalle Street Partnership

526

U S

434

(1999), specifically addressed the parameters governing the ability

of

existing

equity to

reacquire the

equity

in the reorganized debtor where creditors were

not

being paid in full, or

did not

otherwise consent. Specifically, in

2 3 North

LaSalle the Supreme Court held that a plan was

unconfirmable

unless it

provided for a specific mechanism

to permit

the

solicitation

and negotiation

of

competing

bids

for

the

equity

in the reorganized

debtor,

or otherwise allow

the market to

test whether

the holders

of

old equity were paying the highest

value for the new equity.

In responding to the

implication of 2 3

North LaSalle the directors

of

the DIP may

want to

consider the

following:

If existing equity

is represented on the board

of

directors, the

formation of

a Special Committee

(described below) may very well be warranted.

Develop a process

to

ensure

that

the reinvestment

opportunity

is

sufficiently

exposed

to

the market

to

ensure that the highest and best price is obtained.

While the Supreme Court gives

little

guidance on the

mechanism to ensure that the highest

or

best price is

obtained, directors

of DIPs

have either:

(i) formulated

processes by which

third party

investors could

submit

competing

bids for the equity in the reorganized

debtor;

or ij) agreed

to terminate

the exclusive period

to

file a plan

so that competing

plans could

be

filed.

B The

Use OfSpecial Committees In A Chapter

I I

In circumstances where the

DIP

may

be

pursuing a restructuring

or

sale transaction involving a related party, DIPs are increasingly turning to the

formation of

a special

committee of

the board of

directors

(the Special

PHOENIXl528510.2

3


19/87

Committee ) comprised

of

independent and disinterested directors

to

evaluate

and consider such related-party transact ions. While there is no absolute

requirement under

Delaware law or

bankruptcy

law that the

DIP

form a Special

Committee

in these circumstances, the absence

of

a Special Committee (or at

least a

group

of

the

existing

board

who

are both disinterested and

independent)

to

evaluate sale and

restructuring

transactions involving a related

party

may evidence the transactions

fundamental

unfairness.

Bankruptcy courts, creditors and

other

stakeholders of the DIP

together with

the Office

of

the United States Trustee, are particularly attuned to

related-party transactions. Hence, the DIP should consider the formation of the

Special Committee comprising

independent

and disinterested directors

that

are

fully-informed, well-represented

and active in the negotiation process

to

select

a

particular restructuring

transaction involving a related party.

A

director

is interested where the

director

may receive a material

benefit as a result of the potential

restructuring

transaction. Directors may be

interested even

though

they do not receive a

direct

benefit that relates

to

the

restructuring

transaction. For example, a

director

may

be

interested if the

benefit received by the contemplated

restructuring

transaction provides further

business or

other

deals

with

the related party.

In addition

to satisfying the disinterested requirement, the director

should also

be

independent.

In this

regard, courts often

look

to

whether

the

director is

controlled by,

or

beholden to,

another

person or entity, or

whether

outside influences affect the

proper

exercise

of

the

director s

business

judgment.

In

forming a Special Committee to evaluate

restructuring

alternatives (i.e., 363

Sale

StandAlone Plan, Plan Sponsor, etc.), certain

other

important considerations should

be

taken

into

account:

PHOENIXl528510 2

The Special

Committee

should

be informed as to

the process

(i.e., auction process, buyer protective devices, etc.) and all

of

the material

terms

of the various proposals.

4


20/87

The Special Committee should be active in the negotiation

process

culminating

in the selection

of

a particular

restructuring

alternative.

The Special Committee should have real bargaining power,

including the authority to approve or disapprove a particular

restructuring

transaction involving a related party, as

opposed

to

simply making a recommendation

to

the full

board regarding a transaction.

The Special Committee should have access to competent and

independent legal and financial advisors as well as to senior

management. It is not uncommon for the DIP's restructuring

counsel

to

advise the Special Committee

under

circumstances

where such counsel is independent, although

it is

increasingly common for the Special Committee in the

context

of

a chapter 11 to employ separate counsel.

Typically, the DIP's senior management is critical to a particular

potential

bidder or

bidders. While prospective bidders (and the Special

Committee itself) must have access to senior or executive management, the

Special Committee should determine senior management's involvement in the

actual

bidding

process and the selection

of

the

ultimate

transaction to be

implemented

as

part

of

the chapter 11

to

avoid perceived

or

actual conflicts

of

interest.

VI.

SOME

CAUTIONARY WORDS REGARDING D O

INSURANCE

A Chapter

11

may have

wide-ranging implications

for the

debtor s

D O

policies and the coverages available

under

them. Some bankruptcy courts have

held that the D O policy is actually an asset of the

bankruptcy

estate and

should

be

available to pay the claims

of

creditors against the debtor.

As an

asset of the bankruptcy estate, some courts have held

that

the directors and

officers should not be able

to

deplete the

policy

by having access

during

the

chapter

11

for the advance

of

defense costs. As a result of these lines of cases,

PHOENIXJ5 85

10 2 15


21/87

may insurance carriers require prior

b nkruptcy

court approval for the advance

of defense costs.

Directors and officers of companies in financial distress should review the

terms

of

the D O policy

with competent

legal advisors

to

assess the availability

of

the policies in the

context of

a form l Chapter 11.

PHOENIXJ528510 2 6


22/87

Exhibit 1

Bankruptcy Bulletin - Delaware Supreme

Court

Clarifies Fiduciary Duties

When A Corporation s

Insolvent

or

In the Zone

of

Insolvency

Weil, Gotshal Manges

LLP

Exhibit 2

North

merican

Catholic Educational Programming Foundation Inc. v

Cheewalla

930

A.2d

92 (Del.

2007

Exhibit 3

Sample

Memorandum to

Board

of

Directors

of

Distressed Companies

Regarding Scope of Fiduciary Duties

PHOENIXl5 85I 0 2

Squire, Sanders Dempsey L.L.P.

Exhibit 4

Fiduciary Duties for

Directors of

Troubled Companies

Weil, Gotshal Manges

LLP

Exhibit 5

Revlon

Duties under Delaware Law

Morris

James LLP


23/87

EXHI IT


24/87

nkrup t cy

"

Bulletin

June 2007'

Delaware Supreme Court Clarifies Fiduciary Duties When a Corporation

s

Insolvent or

in

the Zone

of

Insolvency

The

Delaware Supreme

Court

recently

considered whether, under Delaware

law, a creditor of a

corporation

in

the

zone

of

insolvency

or

an

insolvent

corporation can bring

a direct action

Whether and to what extent a

creditor of an insolvent corpo-

ration or a corporation in the

zone of insolvency may bring

a direct claim for a breach of

a fiduciary duty

was

unclear

prior to the instant case.

against the

corporation s

directors

for a breach of fiduciary duty.

The

court, in

North American Catholic

Educational Programming Foundation

lnc. v. Gheewalla

held

that creditors

of a

corporation

that s

insolvent,

or

in the zone

of insolvency, have

no

right

to

assert direct claims

against

corporate

directors for breach of

Jiduciary duty.

The

decision resolves

uncertainty

created by previous

opinions that discussed but did not

rule

on

the fiduciary duties owed

to

creditors by directors of corporations

in the

zone

of insolvency.

Directors Fiduciary Duties

Directors of

solvent corporations

owe

fiduciary duties,

such

as

the duty

of care and

the

duty of loyalty, to

shareholders,

but not to

creditors.

The

duty

of care generally requires

directors

to

exercise

that

degree

of care

that

an ordinarily

prudent

person would exercise

under the

same or similar circumstances.

The duty

of loyalty, alternatively,

prohibits

self-dealing

and the

usur-

pation

of corporate opportunities. In

evaluating these duties, courts have

adhered to the

business

judgment

rule,

which

is a

presumption

that

directors

who made

a business

decision acted on

an

informed basis,

in

good

faith

and

in the honest belief

that the action taken

was in

the best

interests of

the

solvent corporation.

Creditors

of an

insolvent corporation

may bring derivative claims against

directors on behalf of the corporation

for breaches of fiduciary duties.

Whether and

to

what

extent a creditor

of an insolvent corporation or a

corporation in the zone of insolvency

may

bring a direct c laim for a breach

of a fiduciary

duty

was unclear prior

to the instant case. Previous case law

indicated that directors of a corpo-

ration that is insolvent or in

the

zone

of insolvency owe duties

to

the firm's

creditors since

those creditors may

own the

firm's residual value.

While the Delaware S upreme Court

has ne ver addressed directors' fidu-

ciary duties

when

a corporation s in

the

zone of insolvency,

other

courts

in Delaware have addressed

the

issue.

In

Credit Lyonnais Bank Nederland

N. V v. Pathe Communicatio ns Corp.

the

seminal case regarding

the

duties

of a

board

of directors in

the

zone of

insolvency, the Delaware Court of

Chancery found

that "where a cor-

poration

s operating in

the

vicinity

of insolvency, a board of directors s

not merely

the agent

of

the

residue

risk-bearers,

but

owes its

duty to

the

corporate enterprise."

The Delaware Court of Chancer y stated

that

directors have "an obligation

to the community

of interest

that

sustain[s) the corporation, to exercise

judgment

in

an

informed, good faith

effort to maximize the corporation's

long-term wea lth creating capacity."

This case has been cited by courts and

commentators for the proposition

that

a director's fiduciary duty, while

in

the

zone of inSOlvency, reqUires

the

director to take creditors' interests

into

account along wi th the interests of all

constituencies of the corporation.

In Production Resources Group L.L.C.

v

N T

Group Inc.

the

Delaware Court

of Chancery, in

dicta

explained that

the

Credit Lyonllais

decision did not

create a new body of creditors' rights

law exposing directors

to

a new set of

fiduciary duties

to

creditors

when the

company

is in

the

zone of insolvency.

Rather,

the

Credit Lyonnais decision

was meant to highlight the fact that

directors

have

discretion to

temper

the risks they take on behalf of the

equity

holders

when the company

s

in

the zone

of insolvency.

The

court

in

Production

ResOllrces stated that

under

Credit Lyonnais directors are

protected by

the

business

judgment

rule, if they, in good faith, pursued

a less risky strategy because of fear

that

a

more

risky

one

might render a

company unable

to meet its obliga-

tions. Creditors have

other

sources

of

protection

such as the ability

to bargain for liens on assets

and

negotiated

covenants

in agreements.

Fraudulent conveyance

laws

and

prinCiples

of

implied

covenants

of

good faith

and

fair dealing also serve

to protect creditors. The court in

Production Resources

concluded that

the

business

judgment

rule remains

significant in

the

zone of insolvency

and

provides directors with

the

Wei . Gotsh al Manges LlP 2


25/87

Bankrupt cy Bulletin

-

ability to make a range of good faith,

prudent

judgments about the risks

they should undertake on behalf of

troubled

corporations.

Factual

ackground

In

North American Catholic,

the

plaintiff,


Educational Programming Foun-

dation,

Inc. ("NACEPF

U

,

brought

direct (not derivative) claims against

directors of Clearwire Holdings, Inc.

("Clearwire") for breaches of fiduciary

duties while Clearwire was

insolvent

or in the zone of inSOlvency. NACf.PF

and Clearwire entered into an

agreement whereby

NACf.PF

would

sell certain radio wave spectrum

licenses to Clearwire. Subsequently,

the market for wireless

spectrum

collapsed, and Clearwire

attempted

to end its

obligations

to

NACEPF

among

others

and,

effectively,

went

out of business.

NACEPF alleged that Clearwire was

either insolvent or in the zone of

insolvency at all relevant times

and the defendant directors of the

Clearwire

board

owed fiduciary

duties

to

NACEPF as a

creditor

of

Clearwire. NACEPF further alleged

that

the

directors

failed to exercise

their

fiduciary

duties

on

behalf

of

NACf.PF

by

failing to preserve Clear-

wire's assets for the benefit of its

creditors and for continuing to hold

NACEPF's

licences when

Clearwire

was not going to use

them.

The

Delaware

Supreme Court

affirmed the decision of the Court

of Chancery, which dismissed the

case.

The Court

of

Chancery

held

that

creditors

have

no direct claim

against a corporation in the zone

of insolvency

and

concluded that,

in this case, NACEPF's complaint

failed to

state

a cause of

action

for a

direct claim

against

a director of an

insolvent corporation.

The Delaware Supreme Court's

Decision

Corporations n the Zone of Insolvency

NACEPF

argued

that the court

should

recognize a creditor's right

to

bring

a direct claim against dirc(.tors for

breaches of fiduciary duties. The

court found that

the

need

to

provide

directors with guidance when car-

rying out their duties compels the

conclusion

that

creditors of a corpo-

ration in the

zone

of insolvency

may

not

bring a direct claim for breach

of a fiduciary duty. The court noted

that directors of corporations in the

zone of insolvency must continue

to

discharge their fiduciary duties

to the

corporation and its shareholders by

exercising their business

judgment

in

the best interests of

the

corporation for

the benefit of its shareholder owners."

Insolvent Corporations

The Court of Chancery had deter-

mined that NACf.PF's complaint failed

to satisfy pleading reqUirements

and,

thus, did

not

state a direct creditor

claim, even assuming a direct claim for

breach of fIduciary duty to a creditor

were legally cognizable in the context

of an insolvent corporation. The

Delaware Supreme court held

that

individual

creditors of an illsolvent

corporation have flO right to assert

direct claims for breach of fiduciary

duty against corpor ate directors." The

court explained that recognizing a

new right for creditors to bring direct

fiduciary daims against direttors of

insolvent corporations would create a

conflict between the directors' duty to

maximizc value for the benefit of all

interested parties

and

a direct fidu-

ciary

duty

to individual creditors. The

court further stated that directors

of

insolvent corporations should be able

to

participate in "good faith negotia-

tions with individual creditors for the

benefit of

the

corporation." While the

court noted that NACEPF did not bring

a derivative claim against the directors

June 2007

and only asserted a direct claim against

the directors, the court advised cred-

itors

that

they may bring derivative

claims to protcct their interests.

Conclusion

The


decision

has provided Significant guidance for

directors faced with difficult decisions

for

stmggling corporations: First, the

holding clarifies that the fiduciary

duties of directors and officcrs of

insolvent corporations pertain to the

corporation itself

not creditors. Sccond, by removing the

possibili ty of direct suits by creditors

against directors, the decision removes

significant negotiat ing leverage from

creditors. Creditors still have a remedy

in derivative suits,

but

they must clear

certain procedural hurdles to bring

them. When these suits are successful,

recoveries enure to the benefit of the

corporation. Third, the holding implies

that the tmst fund doctrine, by which

directors of insolvent corporations

were required to manage corporate

assets as

though

they were held in trust

for creditors, cannot support the cre-

ation of special fiduciary duties owed

to creditors by directors of insolvent

corporations

under

Delaware

law.

By

mling

that directors of financially

struggling corporations owe fiduciary

duties to shareholders and the corpo-

ration itself,

the

Delaware Supreme

Court has made it much easier for

directors to exercise their business

judgment, and be protected by the

business judgment mle,

without

exposure to direct liability suits

brought

by disgruntled creditors.

N. Am Catholi c Educ. Found. Inc v

Ghel Wullu,

No. 52\,

2006,

2oo7 WL

1453705

(Del.

May 18, 2oo7).

Crt'llit Lyollnais Bank Nl dnland, N V v Pallre

Commc l/S Corp.,

No. Civ. A.

12150, 1991

WL

277613

(Del.

Ch

.

Dec.

30, 1991).

( rod. ReI. Group,

LL.C.

v

eT Group, Inc. 86

A.2d 772

(Del. Ch

. 2004).

Wei , Gotshal Manges

LLI'

3


26/87

EXHI IT


27/87

IN THE SUPREME COURT OF THE STATE OF DELAWARE

NORTH AMERICAN CATHOLIC

EDUCATIONAL PROGRAMMING

FOUNDATION, INC., No. 521, 2006

Plaintiff Below, Court BelowCourt of Chancery

Appellant, of the State of Delaware,

in and for New Castle County

v. C.A. No. 1456-N

ROB GHEEWALLA, GERRY

CARDINALE and JACK DALY,

Defendants Below, Appellees.

Submitted: February 12, 2007

Decided: May 18, 2007

Before STEELE, Chief Justice, HOLLAND, BERGER, RIDGELY,

Justices, and ABLEMAN, Judge.1

Upon appeal from the Court of Chancery. AFFIRMED.

Edward M. McNally, Esquire (argued) and Raj Srivatsan, Esquire,

Morris, James, Hitchens & Williams, Wilmington, Delaware, for appellant.

Samuel A. Nolen, Esquire, Richards, Layton & Finger, Wilmington,

Delaware, for appellees.

HOLLAND, Justice:

1Sitting by designation pursuant to Del. Const. art. IV, 12 and Supr. Ct. R. 2 and 4.


28/87

2

This is the appeal of the plaintiff-appellant, North American Catholic

Educational Programming Foundation, Inc. (NACEPF) from a final

judgment of the Court of Chancery that dismissed NACEPFs Complaint for

failure to state a claim.2 NACEPF holds certain radio wave spectrum

licenses regulated by the Federal Communications Commission (FCC). In

March 2001, NACEPF, together with other similar spectrum license-holders,

entered into the Master Use and Royalty Agreement (the Master

Agreement) with Clearwire Holdings, Inc. (Clearwire), a Delaware

corporation. Under the Master Agreement, Clearwire could obtain rights to

those licenses as then-existing leases expired and the then-current lessees

failed to exercise rights of first refusal.

The defendant-appellees are Rob Gheewalla, Gerry Cardinale, and

Jack Daly (collectively, the Defendants), who served as directors of

Clearwire at the behest of Goldman Sachs & Co. (Goldman Sachs).

NACEPFs Complaint alleges that the Defendants, even though they

comprised less than a majority of the board, were able to control Clearwire

because its only source of funding was Goldman Sachs. According to

NACEPF, they used that power to favor Goldman Sachs agenda in

derogation of their fiduciary duties as directors of Clearwire. In addition to

2North American Catholic Educational Programming Foundation, Inc. v. Gheewalla,

2006 WL 2588971 (Del. Ch. Sept. 1, 2006) (Opinion).


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bringing fiduciary duty claims, NACEPFs Complaint also asserts that the

Defendants fraudulently induced it to enter into the Master Agreement with

Clearwire and that the Defendants tortiously interfered with NACEPFs

business opportunities.3

NACEPF is not a shareholder of Clearwire. Instead, NACEPF filed

its Complaint in the Court of Chancery as a putative creditorof Clearwire.

The Complaint alleges direct, not derivative, fiduciary duty claims against

the Defendants, who served as directors of Clearwire while it was either

insolvent or in the zone of insolvency.

Personal jurisdiction over the Defendants was premised exclusively

upon 10Del.C. 3114, which subjects directors of Delaware corporations to

personal jurisdiction in the Court of Chancery over claims for violation of a

duty in [their] capacity [as directors of the corporation]. No other basis for

personal jurisdiction over the Defendants was asserted. Accordingly,

NACEPFs efforts to bring its other claims in the Court of Chancery fail on

jurisdictional grounds unless those other claims are adequately alleged to be

sufficiently related to a viable fiduciary duty claim against the Defendants.

3 This action was initially filed in the Superior Court; it was dismissed without prejudice

for lack of subject matter jurisdiction. Transfer to the Court of Chancery was permitted

under 10Del. C. 1902.


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For the reasons set forth in its Opinion, the Court of Chancery

concluded: (1) that creditors of a Delaware corporation in the zone of

insolvency may not assert direct claims for breach of fiduciary duty against

the corporations directors; (2) that the Complaint failed to state a claim for

the narrow, if extant, cause of action for direct claims involving breach of

fiduciary duty brought by creditors against directors of insolvent Delaware

corporations; and (3) that, with dismissal of its fiduciary duty claims,

NACEPF had not provided any basis for exercising personal jurisdiction

over the Defendants with respect to NACEPFs other claims. Therefore, the

Defendants Motion to Dismiss the Complaint was granted.

In this opinion, we hold that the creditors of a Delaware corporation

that is either insolvent or in the zone of insolvency have no right, as a matter

of law, to assert direct claims for breach of fiduciary duty against the

corporations directors. Accordingly, we have concluded that the judgments

of the Court of Chancery must be affirmed.

Facts4

NACEPF is an independent lay organization incorporated under the

laws of Rhode Island. In 2000, NACEPF joined with Hispanic Information

and Telecommunications Network, Inc. (HITN), Instructional

4 The relevant facts are primarily selected excerpts from the opening brief filed by

NACEPF in this appeal.


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Telecommunications Foundation, Inc. (ITF), and various affiliates of ITF

to form the ITFS Spectrum Development Alliance, Inc. (the Alliance).

Collectively, the Alliance owned a significant percentage of FCC-approved

licenses for microwave signal transmissions (spectrum) used for

educational programs that were known as Instruction Television Fixed

Service spectrum (ITFS) licenses.

The Defendants were directors of Clearwire. The Defendants were

also all employed by Goldman Sachs and served on the Clearwire Board of

Directors at the behest of Goldman Sachs. NACEPF alleges that the

Defendants effectively controlled Clearwire through the financial and other

influence that Goldman Sachs had over Clearwire.

According to the Complaint, the Defendants represented to NACEPF

and the other Alliance members that Clearwires stated business purpose

was to create a national system of wireless connections to the internet.

Between 2000 and March 2001, Clearwire negotiated a Master Agreement

with the Alliance, which Clearwire and the Alliance members entered into in

March 2001. NACEPF asserts that it negotiated the terms of the Master

Agreement with several individuals, including the Defendants. NACEPF

submits that all of the Defendants purported to be acting on the behalf of

Goldman Sachs and the entity that became Clearwire.


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Under the terms of the Master Agreement, Clearwire was to acquire

the Alliance members ITFS spectrum licenses when those licenses became

available. To do so, Clearwire was obligated to pay NACEPF and other

Alliance members more than $24.3 million. The Complaint alleges that the

Defendants knew but did not tell NACEPF that Goldman Sachs did not

intend to carry out the business plan that was the stated rationale for asking

NACEPF to enter into the Master Agreement, i.e., by funding Clearwire.

In June 2002, the market for wireless spectrum collapsed when

WorldCom announced its accounting problems. It appeared that there was

or soon would be a surplus of spectrum available from WorldCom.

Thereafter, Clearwire began negotiations with the members of the Alliance

to end Clearwires obligations to the members. Eventually, Clearwire paid

over $2 million to HITN and ITF to settle their claims and; according to

NACEPF, was only able to limit its payments to that amount by otherwise

threatening to file for bankruptcy protection. These settlements left the

NACEPF as the sole remaining member of the Alliance. The Complaint

alleges that, by October 2003, Clearwire had been unable to obtain any

further financing and effectively went out of business.5

5Complaint at 36 (Except for money advanced to it as a stopgap measure by Goldman

Sachs in late 2001, Clearwire was never able to raise any significant money.).


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NACEPFs Complaint

In its Complaint, NACEPF asserts three claims against the

Defendants. In Count I of the Complaint, NACEPF alleges that the

Defendants fraudulently induced it to enter into the Master Agreement and,

thereafter, to continue with the Master Agreement to preserv[e] its

spectrum licenses for acquisition by Clearwire.6 In Count II, NACEPF

alleges that because, at all relevant times, Clearwire was either insolvent or

in the zone of insolvency, the Defendants owed fiduciary duties to

NACEPF as a substantial creditor of Clearwire, and that the Defendants

breached those duties by:

(1) not preserving the assets of Clearwire for its benefit and that

of its creditors when it became apparent that Clearwire would

not be able to continue as a going concern and would need to be

liquidated and (2) holding on to NACEPFs ITFS license rights

when Clearwire would not use them, solely to keep Goldman

Sachss investment in play.7

In Count III, NACEPF claims that the Defendants tortiously interfered with

a prospective business opportunity belonging to NACEPF in that they

caused Clearwire wrongfully to assert the right to acquire NACEPF

6Id. at 40.

7Id. at 45.


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wireless spectrum, which resulted in NACEPF losing the opportunity to

convey its licenses for spectrum to other buyers.8

Motions to Dismiss

The Defendants moved to dismiss the Complaint on two grounds:

first, for lack of personal jurisdiction under Court of Chancery Rule

12(b)(2); and, second, for NACEPFs failure to state a claim upon which

relief can be granted under Court of Chancery Rule 12(b)(6). With respect

to their first basis for dismissal, the Defendants noted that NACEPFs sole

ground for asserting personal jurisdiction over them is 10Del.C. 3114.

The Defendants argued that personal jurisdiction under 3114 requires, at

least, sufficient allegations of a breach of fiduciary duty owed by director-

defendants. With respect to their second basis for dismissal, the Defendants

contended that, even assuming that personal jurisdiction was sufficiently

alleged, NACEPFs Complaint failed to set forth allegations which

adequately supported any of its claims for relief, as a matter of law.

Court of Chancery Rule 12(b)(2)

The Court of Chancery initially addressed the Defendants motion

under Rule 12(b)(2).9 It began by examining the exercise of personal

8Id. at 50.

9See Branson v. Exide Elecs. Corp., 625 A.2d 267 (Del. 1993).


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jurisdiction over nonresident directors of Delaware corporations under 10

Del.C. 3114:10

[T]he Delaware courts have consistently held that Section

3114 is applicable only in connection with suits brought against

a nonresident for acts performed in his . . . capacity as a director

. . . of a Delaware corporation. Further narrowing the scope of

Section 3114, Delaware cases have consistently interpreted

[early cases construing the section] as establishing that [it] . . .

appl[ies] only in connection with suits involving the statutory

and nonstatutory fiduciary duties of nonresident directors.11

10

The basis for personal jurisdiction relied upon by NACEPF, provides:

Every nonresident of this State who after September 1, 1977,accepts election or appointment as a director, trustee or member of the

governing body of a corporation organized under the laws of this State or

who after June 30, 1978, serves in such capacity, and every resident of thisState who so accepts election or appointment or serves in such capacity

and thereafter removes residence from this State shall, by such acceptance

or by such service, be deemed thereby to have consented to theappointment of the registered agent of such corporation (or, if there is

none, the Secretary of State) as an agent upon whom service of process

may be made in all civil actions or proceedings brought in this State, by or

on behalf of, or against such corporation, in which such director, trustee ormember is a necessary or proper party, or in any action or proceeding

against such director, trustee or member for violation of a duty in suchcapacity, whether or not the person continues to serve as such director,trustee or member at the time suit is commenced. Such acceptance or

service as such director, trustee or member shall be a signification of the

consent of such director, trustee or member that any process when soserved shall be of the same legal force and validity as if served upon such

director, trustee or member within this State and such appointment of the

registered agent (or, if there is none, the Secretary of State) shall beirrevocable.

10Del. C. 3114(a) (emphasis added).11

Donald J. Wolfe, Jr. & Michael A. Pittenger, Corporate and Commercial Practice inthe Delaware Court of Chancery 3-5[a] (2005).


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The Court of Chancery limited its Rule 12(b)(2) analysis to whether personal

jurisdiction existed over the Defendants with respect to Count II of the

Complaint.

Count II alleged that the Defendants breached their fiduciary duties

while they served as directors of Clearwire and while Clearwire was either

insolvent or in the zone of insolvency. The Court of Chancery concluded

that the facts alleged in the Complaint, as supported by the affidavit

submitted by NACEPF, constituted a prima facia showing of a breach of

fiduciary duty by the Defendants in their capacity as directors of a Delaware

corporation. Accordingly, the Court of Chancery held that a statutory basis

for the exercise of personal jurisdiction had been established by NACEPF

for purposes of litigating Count II of the Complaint.

NACEPF expressly premised its Rule 12(b)(2) arguments for personal

jurisdiction over the Defendants regarding Counts I and III (i.e., the non-

fiduciary duty claims) on the Court of Chancerys first determining that

Count II (i.e., the fiduciary duty claim) survives the Defendants Rule

12(b)(6) motion to dismiss. Accordingly, the Court of Chancery proceeded

on the basis that if it found that Count II must be dismissed under Rule

12(b)(6), then it would be without personal jurisdiction over the Defendants

for purposes of moving forward with the merits of Counts I and III.


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Therefore, to resolve the issue of personal jurisdiction, the Court of

Chancery was required to decide whether, as a matter of law, Count II of the

NACEPF Complaint properly stated a breach of fiduciary duty claim upon

which relief could be granted.

Court of Chancery Rule 12(b)(6)

The standards governing motions to dismiss under Court of Chancery

Rule 12(b)(6) are well settled:

(i) all well-pleaded factual allegations are accepted as true; (ii)even vague allegations are well-pleaded if they give the

opposing party notice of the claim; (iii) the Court must draw all

reasonable inferences in favor of the non-moving party; and (iv)

dismissal is inappropriate unless the plaintiff would not be

entitled to recover under any reasonably conceivable set of

circumstances susceptible of proof.12

In the Court of Chancery and in this appeal, NACEPF waived any

basis it may have had for pursuit of its claim derivatively. Instead, NACEPF

seeks to assert only a direct claim for breach of fiduciary duties. It contends

that such direct claims by creditors should be recognized in the context of

both insolvency and the zone of insolvency. Accordingly, in ruling on the

12(b)(6) motion to dismiss Count II of the Complaint, the Court of Chancery

was confronted with two legal questions: whether, as a matter of law, a

corporations creditorsmay assert directclaims against directors for breach

12In re General Motors (Hughes) Sholder Litig., 897 A.2d 162, 168 (Del. 2006)

(quoting Savor, Inc. v. FMR Corp., 812 A.2d 894, 896-97 (Del. 2002)).


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of fiduciary duties when the corporation is either: first, insolvent or second,

in the zone of insolvency.

Allegations of Insolvency and Zone of Insolvency

In support of its claim that Clearwire was either insolvent or in the

zone of insolvency during the relevant periods, NACEPF alleged that

Clearwire needed substantially more financial support than it had obtained

in March 2001.13 The Complaint alleges Goldman Sachs had invested $47

million in Clearwire, which represent[ed] 84% of the total sums invested in

Clearwire in March 2001, when Clearwire was otherwise virtually out of

funds.14

After March 2001, Clearwire had financial obligations relatedto its agreement with NACEPF and others that potentiallyexceeded $134 million, did not have the ability to raisesufficient cash from operations to pay its debts as they becamedue and was dependent on Goldman Sachs to make additionalinvestments to fund Clearwires operations for the foreseeablefuture.15

The Complaint also alleges:

For example, upon the closing of the Master Agreement,Clearwire had approximately $29.2 million in cash and of that$24.3 million would be needed for future payments for

spectrum to the Alliance members. Clearwires burn rate was

13Complaint at 30.

14Id. at 7(a).

15Id. at 7(b) (emphasis added). NACEPF also asserts that Clearwire was unable to

borrow money or obtain any other significant financing after March 2001, except fromGoldman Sachs.Id. at 7(c).


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$2.1 million per month and it had then no significant revenues.The process of acquiring spectrum upon expiration of existinglicenses was both time consuming and expensive, particularly ifexisting licenseholders contested the validity of any Clearwireoffer that those license holders were required to match undertheir rights of first refusal.16

Additionally, in the Complaint, NACEPF alleges that, [b]y October 2003,

Clearwire had been unable to obtain any further financing and effectively

went out of business. Except for money advanced to it as a stopgap measure

by Goldman Sachs in late 2001, Clearwire was never able to raise any

significant money.17

The Court of Chancery opined that insolvency may be demonstrated

by either showing (1) a deficiency of assets below liabilities with no

reasonable prospect that the business can be successfully continued in the

face thereof,18or (2) an inability to meet maturing obligations as they fall

due in the ordinary course of business.19 Applying the standards applicable

to review under Rule 12(b)(6), the Court of Chancery concluded that

16Id. at 30.

17Id. at 36.

18For that proposition, the Court of Chancery relied upon Production Res. Group v. NCTGroup, Inc., 863 A.2d 772, 782 (Del. Ch. 2004) (quoting Siple v. S & K Plumbing &Heating, Inc., 1982 WL 8789, at *2 (Del. Ch. Apr. 13, 1982)); Geyer v. Ingersoll PublnsCo., 621 A.2d 784, 789 (Del. Ch. 1992) (explaining that corporation is insolvent if it hasliabilities in excess of a reasonable market value of assets held); and McDonald v.Williams, 174 U.S. 397, 403 (1899) (defining insolvent corporation as an entity withassets valued at less than its debts).19For that proposition, the Court of Chancery also relied upon Production Res. Group v.NCT Group, Inc., 863 A.2d at 782 (quoting Siple v. S & K Plumbing & Heating, Inc.,1982 WL 8789, at *2).

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