Comments

GHEEWALLA AND INSOLVENCY: CREATINGGREATER CERTAINTY FOR DIRECTORS OFDISTRESSED COMPANIES

Bryan Anderson*

The topic of directors' fiduciary duties in Delaware corporations has,in recent years, been a source of increasing debate. From recent corporatescandals to controversies surrounding corporate takeovers, the duties ofdirectors have been the constant subject of corporate governance reformproposals.' On one level, the debate has focused on the traditional duties ofcare and loyalty and the circumstances under which each is breached. Onanother level, the debate has focused on the constituency groups to whomthese duties are owed.

This Comment focuses on the latter, addressing the difficulty indetermining fiduciary duty constituents in a financially distressedcorporation because of the ambiguities surrounding insolvency. Part I ofthis Comment looks at the dilemma faced by directors as the corporationapproaches insolvency-the so called "zone of insolvency." Part IIanalyzes the impact of the recent decision by the Delaware Supreme Courtin North American Catholic Education Programming Foundation, Inc. v.Gheewalla (hereafter "Gheewalla") to preclude creditors from bringingfiduciary claims in the zone of insolvency.!

While academics have given much attention to the zone of insolvencydebate,3 very few have touched even tangentially upon the newly relevant

* University of Pennsylvania Journal of Business Law Editor-in-Chief, J.D. 20091. See generally, William T. Allen, Jack B. Jacobs, & Leo E. Strine, Jr., The Great

Takeover Debate: A Mediation on Bridging the Conceptual Divide, 69 U. CHI. L. REv. 1067(2002). (discussing the appropriate role of directors in the context of competing theories onthe appropriate purpose of the corporation).

2. N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92 (Del.2007).

3. See, e.g., Rutheford B. Campbell, Jr. & Christopher W. Frost, Managers' FiduciaryDuties in Financially Distressed Corporations: Chaos in Delaware (and Elsewhere), 32 J.

1031

U. OF PENNSYLVANIA JOURNAL OF BUSINESS LAW [Vol. 11:4

definition of insolvency in this area.4 Because directors' duties shift fromshareholders to creditors once the corporation is insolvent, it is vital fordirectors to know when the corporation has reached this transition point sothat they may properly execute their duties. Part III of this Commentargues that Gheewalla fails to meet its purported goal of clarifyingdirectors' duties by leaving the concept of insolvency ambiguous. Finally,Part IV explores several possible solutions to provide directors with greaterclarity, including a bright line rule defining insolvency as the point ofstatutory filing for bankruptcy.

I. SHAREHOLDERS' AND CREDITORS' DIVERGENT INTERESTS

The corporation divides ownership and management, giving votingrights to shareholders on significant corporate decisions and givingdirectors the authority to manage the affairs of the corporation.' In theirmanagement of the corporation, directors owe fiduciary duties of care andloyalty to the corporation and to its shareholders.6 Delaware law isgenerally deferential to the business decisions of directors so long as theirdecisions are made in an informed and good faith manner and so long asthey abstain from placing personal interests above those of thecorporation The Delaware General Corporate Law ("DGCL") fortifiesthis deference by enabling corporations to amend their corporate charters toexculpate directors for breaches of their duty of care.' Shareholders aregiven both the right to vote in board elections and to sue for breaches of

CORP. L. 491 (2007) (discussing the competing pressures on corporate managers whenoperating in the zone of insolvency); Richard M. Cieri & Michael J. Riela, ProtectingDirectors and Officers of Corporations That Are Insolvent or in the Zone or Vicinity ofInsolvency: Important Considerations, Practical Solutions, 2 DEPAUL Bus. & COM. L.J.295 (2004); Laura Lin, Shift of Fiduciary Duty Upon Corporate Insolvency: Proper ScopeofDirectors'Duty to Creditors, 46 VAND. L. REv. 1485, 1487 (1993).

4. Geyer v. Ingersoll Publications Co., 621 A.2d 784, 789 (Del. Ch. 1992) (grapplingwith the issue of defining insolvency); Campbell, supra note 3, at 491; Cieri, supra note 3,at 291.

5. See Levine v. Smith, 591 A.2d 194, 207 (Del. 1991) (presuming directors to bedisinterested and independent).

6. See, e.g., Ivanhoe Partners v. Newmont Min. Corp., 535 A.2d 1334, 1341 (Del.1987) (holding that the board has a responsibility to manage the business and affairs of acorporations with the fiduciary obligations of care and loyalty); see also Revlon, Inc. v.MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 179 (Del. 1985); Unocal Corp. v.Mesa Petroleum Co., 493 A.2d 946 (Del. 1985); Aronson v. Lewis, 473 A.2d 805, 812 (Del.1984).

7. Aronson, 473 A.2d at 812 (holding that the business judgment rule is "apresumption that in making a business decision the directors of a corporation acted on aninformed basis, in good faith and in the honest belief that the action taken was in the bestinterests of the company.").

8. DEL. CODE ANN. tit. 8, § 102 (1983).

1032

GHEEWALLA AND INSOLVENCY

fiduciary duties to police the execution of directors' duties.9

Creditors too have a financial stake in the corporation. However,unlike shareholders, creditors are given neither the right to vote nor theability to bring fiduciary claims against directors of solvent corporations.' °

Rather, creditors' rights are protected by contracts and various commonlaw and statutory remedies. Creditors may provide for variouscontingencies in their contracts and may seek contractual damages orrescission if the corporation breaches its contract." Additionally, creditorsmay rely on fraudulent conveyances law, illegal dividends law, impliedcovenants of good faith and fair dealing, and bankruptcy law. 12 Finally,creditors protect themselves by pricing the risk of default into their interestrates.

While these two corporate constituencies share in the benefits of afinancially prosperous company, in times of financial trouble their interestscan vary dramatically, creating a dilemma for directors. 3 Shareholdersgenerally seek profits and growth and have a greater appetite for risk, whilecreditors are risk averse and generally seek a return on their principalinvestment.1

4

Despite the many protections afforded creditors, Delaware corporatelaw has nonetheless provided creditors with the additional protection offiduciary claims in certain situations. This protection is rooted in aprevailing fear of agency costs expressed through wealth-transfer fromcreditors to shareholders.' The wealth-transfer theory 6 suggests that when

9. See, e.g., Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031, 1036 (Del.2004) (noting that the derivative suit enables a stockholder to bring suit on behalf of thecorporation for harm done to the corporation).

10. See Geyer, 621 A.2d at 787 (noting that as a general rule, directors do not owecorporate creditors any extra-contractual duties, absent special circumstances such ascorporate insolvency, fraud, or violation of a statute).

11. See Simons v. Cogan, 549 A.2d 300, 304 (Del. 1988) (noting that directors do notowe a duty to creditors beyond the relevant contractual terms); Big Lots Stores, Inc. v. BainCapital Fund VII LLC, 922 A.2d 1169, 1181 (Del. Ch. 2006); Production Resources Groupv. NCT Group, Inc., 863 A.2d 772, 790 (Del. Ch. 2004); Geyer, 621 A.2d at 787.

12. Gheewalla, 930 A.2d at 99.13. Production Resources Group, 863 A.2d at 790 n.57 (noting that when a firm is

insolvent or near insolvency, the interests of shareholders and creditors can drasticallydiverge); see also Lin, supra note 3, at 1523.

14. Ramesh K.S. Rao, et. al., Fiduciary Duty a la Lyonnais: An Economic Perspectiveon Corporate Governance in a Financially-Distressed Firm, 22 J. CoRP. L. 53, 78 (1996).

15. See id. at 75.16. See id. at 77 (illustrating the wealth-transfer problem).

Assume that an airline company, operating on the border of insolvency, faces two options:liquidate its assets and pay off its creditors, or continue operations. The firm has $200million in assets, which is exactly sufficient to meet its debt obligations. If it continuesoperations, the airline will either increase its overall value to $450 million or loseeverything. Each of these outcomes has a 50% chance of occurring. Assume a discount rateof 10%. The expected payoffs for the firm are presented in Table Al.

2009] 1033

U. OF PENNSYLVANIA JOURNAL OF BUSINESS LAW [Vol. 11:4

firms are insolvent, shareholders, who have lost their equity interests, willencourage directors to take risky measures to save the corporation andrestore value.' 7 Creditors, by contrast, who never stand to gain more thanthe level of debt owed to them, resist such measures, standing to lose thereturn of their principal. Therefore, in the insolvent corporation, creditorsbear little of the upside potential and all of the downside risk fromdirectors' risky efforts.' 8 The wealth-transfer theory suggests that ifdirectors are not restrained by fiduciary duties to creditors, they will betempted to transfer remaining corporate value to shareholders through risky

Table Al: Risk Payoffs to the FirmRisk Total ExpectedLevel Return Return

(ER)

Liquidate 0% $200 $200million million

Continue 50% $450 $225million millionor $0

PV ofER

200million$204.55million

By continuing operations, the airline has increased total firm value by almost $5 million.From this perspective, the economic efficiency considerations justify a continuance ofoperations. An examination of the effects on debt and equity reveal that this increase infirm value is not shared equally by the constituents. Consider the following two tables:

Table A2: Risk Payoffs to DebtRiskLevel

Total Return ExpectedReturn(ER)

PV of ER

Liquidate 0% $200 million $200 million $200 millionContinue 50% $200 million $100 million $90.91

or $0 million

Table A3: Risk Payoffs to EquityRisk Total E:Level Return R

(f

xpectedetumER)

Liquidate 0% $0 $0 $0million million million

Continue 50% $250 $125 $113.64million million millionor $0

17. Stephen R. McDonnell, Geyer v. Ingersoll Publications Co.: Insolvency ShiftsDirectors'Burden from Shareholders to Creditors, 19 DEL. J. CORP. L. 177, 189-90 (1994).

18. Id.; Lin, supra note 3, at 1492 ("creditors [of insolvent corporations] do not enjoythe entire gain of making good decisions, but bear the entire risk loss of making bad ones.").

1034

GHEEWALLA AND INSOLVENCY

strategies.' 9 This theory is based on at least two notable assumptions, thatin the absence of a fiduciary duty to creditors, directors of nearly insolventcorporations will 1) do what shareholders want them to do and 2) beuninhibited in adopting financially risky strategies. We will later see thatboth case law and empirical evidence challenge the validity of theseassumptions.

Delaware courts have dealt with the wealth-transfer problem byshifting the primary focus of fiduciary duties from shareholders to creditorsat the point of insolvency.2 ° Cases such as Production Resources Groupand Geyer drew the transition point for the expansion of fiduciary duties atthe point of insolvency, reasoning that shareholders are the residualclaimants of the corporations during periods of solvency and that creditorsstep into their shoes upon insolvency. 2 Thus, while the corporation issolvent, fiduciary duties run to shareholders, and when the corporationbecomes insolvent, these duties run primarily to creditors.22 Yet, courtshave been divided on their views of fiduciary duties as the corporation

approaches the so called "zone of insolvency., 23 Until Gheewalla, twoambiguities remained unaddressed by Delaware courts: 1) to whomdirectors owed fiduciary duties while in the "zone of insolvency;" and 2)the types of fiduciary claims that could be brought by creditors in the zoneof insolvency.24

The case law leading up to Gheewalla left open the possibility thatcreditors could bring claims for breaches of fiduciary duties againstdirectors in the zone of insolvency. In Credit Lyonnais, PathCommunications Co. ("PCC") defaulted on financing provided by CreditLyonnais for a leveraged buyout ("LBO").25 Credit Lyonnais soughtdeclaratory and injunctive relief regarding a Corporate Governance

19. Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., C.A. No.12150 1991 WL 277613 at *34, n.55 (Del. Ch. Dec. 30, 1991); Rao, et. al., supra note 15, at75.

20. Credit Lyonnais, 1991 WL 277613 at *34 ; Production Resources Group, 863 A.2dat 791; Geyer, 621 A.2d at 787.

21. Production Resources Group, 863 A.2d at 791 ("the directors continue to have thetask of attempting to maximize the value of the firm. That much of their job does notchange. But the fact of insolvency does necessarily affect the constituency on whose behalfthe directors are pursuing that end."); Geyer, 621 A.2d at 787 (noting that as a general rule,directors do not owe corporate creditors any extra-contractual duties, absent specialcircumstances such as corporate insolvency, fraud, or violation of a statute).

22. Production Resources Group, 863 A.2d at 791; Geyer, 621 A.2d at 787.23. Credit Lyonnais, 1991 WL 277613 at *34 (stating that the debtor owed fiduciary

duties to the "community of interests" in the zone of insolvency); Production ResourcesGroup, 863 A.2d at 791 (noting that only in special circumstances do duties extend beyondshareholders in the zone of insolvency).

24. Rutheford, supra note 3, at 500-06.25. Credit Lyonnais, 1991 WL 277613 at *1.

20091 1035

U. OF PENNSYLVANIA JOURNAL OF BUSINESS LAW [Vol. 11:4

Agreement that allegedly gave Credit Lyonnais governance control over26MGM, the LBO target. PCC, a 98% stockholder of MGM,

counterclaimed that Credit Lyonnais breached its fiduciary duty by refusingto act in the best interest of shareholders by impeding a sale of assets.27 Inan expansive interpretation of fiduciary duties, Vice Chancellor Allennoted that in the zone of insolvency, fiduciary duties are owed to the"community of interests" in the corporation rather than solely toshareholders or creditors. 2

' This holding suggested that directors were topreserve the economic value of the corporation during this period ratherthan focus their efforts toward one particular constituency.29

Although Credit Lyonnais articulated a standard for fiduciary dutiesduring the zone of insolvency, it provided no solace to directors, leavingthem without a clear definition of either the zone of insolvency or the socalled "community of interests."3 ° The "community of interests" languageleft directors of financially troubled corporations to worry about claimsfrom shareholders, creditors, and perhaps even other constituencies.Central to Allen's view was the fear that if directors owed a duty toshareholders alone, they would be subject to shareholders' opportunisticwhims.3

The next Delaware case to address the "zone" problem wasProduction Resources Group v. NCT Group, Inc.32 The breach of dutyclaim arose when the creditor, Production Resources Group, L.L.C.("PRG"), alleged that NCT Group, Inc. ("NCT"), had engaged in bad-faithconduct to systematically advantage the controlling stockholder to thedetriment of the creditors.33 PRG had standing to bring a fiduciary breachclaim for wrongful conduct by virtue of NCT's actual insolvency.34

Although not dispositive to the case, Vice Chancellor Strine noted that thezone of insolvency concept was "an admittedly confusing one," escapingeasy definition.3" Also notable was Strine's suggestion that plaintiff-

26. Id.27. Id. at *33.28. Id. at *34.29. See id. (noting that the directors' duty is to the corporate entity as a whole, not to

maximizing the financial well-being of the controlling stockholder).30. See id. at *34 n.55 (describing how the directors' decision-making will be

influenced based upon the relevant constituencies considered).31. See Credit Lyonnais, 1991 WL 277613 at *34 n.55 (noting that stockholders' and

creditors' interests are occasionally non-aligned).32. 863 A.2d 772 (Del. Ch. 2004).33. Id. at 776 ("The facts as pled suggest that PRG and its de facto controlling

stockholder Salkind are engaging in bad faith conduct designed to advantage Salkind to thedetriment of PRG and other NCT creditors.").

34. Id. at 784 ("NCT has no reasonable prospect for overcoming its balance sheetinsolvency.").

35. Id. at 789.

1036

GHEEWALLA AND INSOLVENCY

friendly pleading standards, coupled with the hard-to-define zone ofinsolvency, would likely increase the amount of unnecessary litigation.36

Unfortunately, rather than clarify the duty to the "community of interests,"Strine construed the Credit Lyonnais holding narrowly. He interpretedCredit Lyonnais to mean that directors' duties did not change in the zone ofinsolvency but, rather, that directors had expanded discretion to considercreditors' interests in decision making. 37 Thus, Production Resources mayhave given directors of a solvent company slightly more protection bybacking away from a broad duty to the "community of interests."Nevertheless, it left substantial ambiguity by leaving both this and the zoneof insolvency largely undefined. It was not until Gheewalla, infra, thatthese issues were finally clarified.

The case law leading up to Gheewalla was also unclear about thetypes of fiduciary breach claims a creditor could bring-beyond the "zoneof insolvency"-in actual insolvency. Once the corporation reached thepoint of actual insolvency, Delaware law was clear that fiduciary dutieswere owed to creditors. 8 However, the question about how to enforcethose claims remained unanswered. The controversy centered on whethercreditors could bring both derivative and direct claims for breaches offiduciary duties. This issue had important implications for Delawarecorporate law. Direct claims by individual creditors would give individualcreditors the same fiduciary claim standing as shareholders in addition tothe protections already afforded by contract, statute, and common law.Dicta in both Production Resources and Big Lots left open the possibilityof direct claims by creditors against directors for breaches of fiduciaryduties.39 In Production Resources, Strine noted that in circumstancesshowing a "marked degree of animus toward a particular creditor" directorsmay "expose themselves to a direct fiduciary duty claim by that creditor., 40

Similarly, in Big Lots, Vice Chancellor Lamb echoed the dicta inProduction Resources noting that cases of invidious conduct toward aparticular creditor may give rise to direct claims by the creditor against the

36. Id. (noting the "possibility of derivative suits by two sets of plaintiffs with starklydifferent conceptions of what is best for the firm.").

37. Id. at 788 ("Credit Lyonnais provided a shield to directors from stockholders whoclaimed that the directors had a duty to undertake extreme risk").

38. Production Resources Group, 863 A.2d at 790-91 ("When a firm has reached thepoint of insolvency, it is settled that under Delaware law, the firm's directors are said to owefiduciary duties to the company's creditors."); Geyer, 621 A.2d at 787 ("[T]he general ruleis that directors do not owe creditors duties beyond the relevant contractual terms absent'special circumstances... e.g., fraud, insolvency .... ').

39. See generally Big Lots Stores, Inc. v. Bain Capital Fund VII LLC, 922 A.2d 1169(Del. Ch. 2006); Production Resources, 863 A.2d at 798.

40. Production Resources, 863 A.2d at 798.

2009] 1037

U. OF PENNSYLVANIA JOURNAL OF BUSINESS LAW [Vol. 11:4

directors of the insolvent corporation.4' However, Lamb also noted that thecontractual, statutory, and common law remedies available to creditors maymake the direct claims by creditors unnecessary-an argument often citedin Delaware case law for limiting the expansion of creditors' rights.42

The policy rationale supporting these varied decisions was a desireto protect the rights of both constituent groups while providing directorswith clear guidelines for executing their duties.43 However, the case lawwas full of ambiguities in this area due to loosely defined terms and to theabsence of a clear ruling on whether creditors had the same fiduciary claimthat was available to shareholders.

II. GHEEWALLA BRINGS MUCH NEEDED CLARITY

Gheewalla finally brought much needed clarity to these issues. InGheewalla, North American Catholic Educational ProgrammingFoundation, Inc. ("NACEPF"), an owner of radio wave spectrum andcreditor of Clearwire Holding, Inc., ("Clearwire") brought a direct claimfor breach of fiduciary duties against directors of Clearwire. NACEPFalleged that in the zone of insolvency, Clearwire had preferred the agendaof another creditor, Goldman Sachs, in derogation of their duties asdirectors of Clearwire. 4 After being rebuffed by the Delaware Court ofChancery for lack of standing to bring a direct claim, NACEPF appealed tothe Delaware Supreme Court.45 In its first impression treatment of zone ofinsolvency claims, the Court held that creditors were not entitled to anyfiduciary breach claim, either direct or derivative, in the "zone ofinsolvency" and, furthermore, upon insolvency, could only bring derivativeclaims for such breaches.46 The Court grounded its holding in several

41. Big Lots, 922 A.2d at 1184 ("[D]uty to disclose is not a general duty to discloseeverything the director knows about transactions in which the corporation is involved.Rather, the director disclosure cases decided in Delaware courts have implicatedcircumstances in which the director is personally engaged in transactions harmful to thecorporation, but beneficial to the director.").

42. See, e.g., Big Lots, 922 A.2d at 1180 ("[C]reditors are usually better able to protectthemselves than dispersed shareholders"); Simons v. Cogan, 549 A.2d 304 (noting thatdirectors do not owe a duty to creditors beyond the relevant contractual terms); ProductionResources, 863 A.2d at 790 (pointing out various protections already enjoyed by creditors);Geyer v. Ingersoll Publications Co., 621 A.2d at 787 (reiterating the general rule limitingprotections for creditors to those within the contract).

43. See Gheewalla 930 A.2d at 101 (seeking to provide directors with clearly delineatedfiduciary guidelines); Credit Lyonnais Bank Nederland, 1991 WL 277613 at *34, n. 55(noting different incentive structures when considering the community of interests.).

44. See Gheewalla, 930 A.2d at 93 (alleging that Clearwire "favorfed] Goldman Sachs'agenda in derogation of their fiduciary duties . ").

45. Id.46. Id. at 100 (holding against NACEPF and limiting the claims that creditors can bring

for breach of fiduciary duty); see also, Trenwick America Litigation Trust v. Ernst &

1038

GHEEWALLA AND INSOLVENCY

arguments affirming a general trend in Delaware law to limit the expansionof creditors' rights.

The Court adopted the reasoning set forth in Production Resourcesregarding creditor protections noting that, unlike shareholders, creditors areoften protected by "strong covenants, liens on assets, and other negotiatedcontractual protections.'47 As in Production Resources, the Court noted:"with these protections, when creditors are unable to prove that acorporation or its directors breached any of the specific duties owed tothem, one would think that the conceptual room for concluding that thecreditors were somehow, nevertheless, injured by inequitable conductwould be extremely small if extant. 's

Gheewalla also affirmed the "well established" reluctance ofDelaware courts to expand creditors rights holding that: "[w]hileshareholders rely on directors acting as fiduciaries to protect their interest,creditors are afforded protection through contractual agreements, fraud andfraudulent conveyance law, implied covenants of good faith and fairdealing, bankruptcy law, general commercial law and other sources ofcreditor rights. 49

The Court affirmed the Chancery Court's reasoning by recognizingthe extensive protections available to creditors and the reluctance to expandthese protections. It also expressed the importance of providing certaintyfor corporate directors to efficiently execute their duties.50 Further, theopinion affirmed the Chancery Court's reasoning that "any benefit to bederived by the additional protection of direct claims appeared minimal, atbest, and significantly outweighed by the costs to economic efficiency.""

As a policy matter, the court stated that it had sought to providedirectors with "clear signal beacons," "brightly lined channel markers" andclearly marked "safe harbors" for executing their fiduciary duties on behalfof shareholders.52 And, indeed, while the clear signal beacons were lost fora time in the uncertainty following the Credit Lyonnais and ProductionResources cases, Gheewalla did much to restore their visibility. There islittle doubt that precluding direct fiduciary duty claims is an important steptoward greater certainty for directors. Their preclusion gives directors of

Young, L.L.P., 906 A.2d 168 (Del. Ch. 2006) (squarely rejecting the "deepeninginsolvency" cause of action that had been accepted in a minority of states and is based on asimilar premises as the fiduciary duty claims).

47. See Production Resources Group, 863 A.2d at 790.48. Id.49. Gheewalla, 930 A.2d at 99.50. Gheewalla, 930 A.2d at 101 ("[Directors have] the legal responsibility to manage

the business of a corporation for the benefit of its shareholders owners." (citing Malone v.Brincat, 722 A.2d 5 (1998)).

51. Gheewalla, 930 A.2d at 100.52. Id. at 101 (citing Malone, 722 A.2d at 10).

2009] 1039

U. OF PENNSYLVANIA JOURNAL OF BUSINESS LAW [Vol. 11:4

financially distressed corporations the important freedom to negotiate ingood faith with various creditors without fearing direct claims for fiduciarybreaches. 3 However, the Court did little to explain why maintainingderivative claims for creditors of insolvent corporations is nonethelessefficient or necessary. The Court reasoned that because creditors are theresidual beneficiaries of an insolvent corporation, they have standing tobring derivative claims on behalf of the corporation for breaches offiduciary duties. 4 However, the Court did not explain why the sameprotections that made direct claims unnecessary in the zone of insolvencydid not also make derivative claims unnecessary upon actual insolvency.

After Gheewalla, directors of solvent corporations can, at leasttheoretically, ignore the complications of the "zone of insolvency" doctrineand the so called "community of interests," focusing their attentionsexclusively on maximizing corporate value for the benefit of itsshareholders." Additionally, directors are free to negotiate with creditorswithout fear of direct claims for breaches of fiduciary duties. 6 Thesedevelopments provide directors with much needed additional clarity. Butthe true test of the effectiveness of the Gheewalla holding is not in thehypotheticals advanced in the courtroom, but rather in how its holdingplays out in practical corporate governance. For instance, notably absentfrom Gheewalla's holding is any discussion of the difficulties surroundingmanagement's measurement of insolvency.

III. POST-GHEEWALLA UNCERTAINTY

Despite precluding creditors' fiduciary claims during corporatesolvency, the Gheewalla decision stops short of its purported objective ofcreating fiduciary clarity. The Court argues that the ambiguous concept ofthe "zone of insolvency" runs counter to the Courts attempt to establish"clear signal beacons" for directors' duties.57 Yet, Gheewalla does notprovide directors or creditors with a clear method for determining whenactual insolvency occurs. Directors are thus left with the worry that, at anygiven moment during the firm's financial distress, the directors might find

53. Gheewalla, 930 A.2d at 100-01 ("[T]he ability to negotiate in good faith ... wouldlikely be significantly undermined .... ).

54. Id. at 101 (explaining that creditors take the place of shareholders in the case ofinsolvency).

55. See id. (precluding creditors from asserting fiduciary duty claims against directorsof insolvent corporations).

56. Id. at 100 (precluding such claims).57. Id. at 101 (noting that they are compelled by "the need to provide directors with

definitive guidance" to hold that creditors may not bring a direct claim for breach offiduciary duty in the zone of insolvency); Production Resources Group, 863 A.2d at 789,n.56 ("[T]he 'zone' issue is an admittedly confusing one.").

1040

GHEEWALLA AND INSOLVENCY

themselves unwittingly beholden to creditors because of the difficulty indetermining the timing of corporate insolvency. Thus, the problem ofuncertainty persists. Gheewalla attempted to create greater certainty andcorporate efficiency, but due to the practical difficulties in definingcorporate insolvency, the holding in Gheewalla merely swaps oneambiguous definition for another-namely "zone of insolvency" for"insolvency." If the Court had given a bright-line definition for insolvency,it could have created the certainty it purported to provide.

For now directors are left to grapple with the difficulty ofdetermining when insolvency occurs. Delaware courts have adopted twopossible definitions for insolvency: (1) balance-sheet insolvency and (2)bankruptcy insolvency. The former occurs when liabilities exceed assets.58

In contrast, bankruptcy insolvency occurs when a company is unable tomeet its debts as they come due in the ordinary course of business.59 Acompany can be found insolvent under either test.

How courts define insolvency has important timing implications.For instance, balance-sheet insolvency can occur earlier than bankruptcyinsolvency since one can have an insolvent balance sheet before debtsactually become due.60 Alternatively, bankruptcy insolvency may occurbefore balance-sheet insolvency because a corporation's debtors may paylate.

61

Perhaps as a result of these complicated timing issues, the Delawarecourts have held that events satisfying either definition are sufficient totrigger insolvency.62 In Production Resources, the debtor, NCT, wasdeemed bankrupt under both tests.63 Under the balance-sheet test the courtfound that NCT's liabilities exceeded its assets by nearly five times. 64

Additionally, the court noted that there was no reasonable prospect tocontinue business because NCT did not have the credit necessary to borrowat commercially reasonable rates to meet obligations going forward. 65 The

58. Production Resources, 863 A.2d at 783-784 ("NCT's liabilities are nearly fivetimes its assets.").

59. Id. ("NTC does not have the credit necessary to borrow at commercially reasonablerates that will enable it to meet its obligations going forward.").

60. 16 AM. JUR. 31 Proof of Facts 583, § 9 (2007) ("A corporation may be insolventunder this method before being 'bankruptcy insolvent'....").

61. Id. ([B]ankruptcy insolvency may occur earlier than balance-sheet insolvency...

62. See Geyer v. Ingersoll Publications Co., 621 A.2d 784, 789 (Del. Ch. 1992) ("Anentity is insolvent when it is unable to pay its debts as they fall due in the usual course ofbusiness .... that is, an entity is insolvent when it has liabilities in excess of a reasonablemarket value of assets held.").

63. See Production Resources Group v. NCT Group, Inc., 863 A.2d 772, 783-84 (Del.Ch. 2004).

64. Id. at 783.65. See Production Resources, 863 A.2d at 784 ("[T]he complaint creates a rational

2009] 1041

U. OF PENNSYLVANIA JOURNAL OF BUSINESS LAW [Vol. 11:4

court found that the company also met the bankruptcy test for insolvencybecause it was unable to meet its debts as they came due for at least twosignificant debtors.66 The company only operated through an unusualarrangement with one creditor and avoided its obligations with theplaintiff-creditor. 67 This was a clear case of corporate insolvency under anex post analysis because the corporation was deeply insolvent. However,many cases are not as clear, and, what may be clear from the court's expostanalysis does not provide a clear ex ante guide for directors regarding whenactual insolvency occurs. Not only may either definition arise at a differentpoint in time, but both depend on determining the current financial status ofthe corporation-at best an "inexact science" and, at times, difficult orimpossible to ascertain.6 s

For instance, a firm's assets may be valued at either the fair marketprice they would bring if sold separately in liquidation or the fair marketvalue of the assets sold together as a "going concern., 69 This valuationuncertainty makes it difficult for directors to know when liabilities exceedassets.

The difficulty in ascertaining the point of insolvency gives rise tonumerous problems. First, a firm's historical balance sheet may show thefirm to be solvent prior to filing for bankruptcy. However, once the firmfiles for bankruptcy, it may restate its balance sheet retroactively throughwrite-offs. 0 While this restatement is beneficial to the firm vis-A-vis theclaims of creditors, it potentially exposes corporate directors to liability.7'Additionally, once a firm files for bankruptcy, its directors may argue thatit has been insolvent for a period of time prior to filing in order to recoverassets on the Bankruptcy Code avoiding powers.7 2 However, this

inference that funding NCT's business through borrowing or credit is unsustainable.").66. Id. ("The reality is that it is not meeting its obligations to creditors .....67. Id. (noting that the complaint is supported by findings to this effect).68. See Ramesh K.S. Rao, et. al., Fiduciary Duty a la Lyonnais: An Economic

Perspective on Corporate Governance in a Financially-Distressed Firm, 22 J. CoRP. L. 53,62 (1996) ("Unfortunately, the exact financial condition of any given firm is not easy todetermine; it depends on the measure used to ascertain the firm's financial well-being.");Stephen R. McDonnell, Geyer v. Ingersoll Publications Co.: Insolvency Shifts Directors'Burden From Shareholders To Creditors, 19 DEL. J. CORP. L. 177, 195-96 (1994) ("Prior tothe commencement of such statutory proceedings, determining when a corporation becomesinsolvent is, 'at best, an inexact science' and at worst, unduly burdensome or impossible,due to the difficulty in valuing a corporation's assets.")

69. See Steven R. Gross et al., Shifting Duties: Directors Face Risks in Workout, NAT'LL.J., Apr. 15, 1991, at 19.

70. See Rao, supra note 68, at 63-64 (explaining how a balance sheet may be restated toshow insolvency of the company before filing for bankruptcy).

71. Id. (noting the expansion of fiduciary duty to creditors during insolvency).72. A debtor may have the option to reject executory contracts or unexpired leases. 11

U.S.C. § 365(a) (1994). A debtor may also avoid any transfer made to or for a creditor onaccount of antecedent debt within 90 days before filing for bankruptcy if such payment

1042

GHEEWALLA AND INSOLVENCY

argument, while maximizing the value of the firm, exposes directors tocreditors' claims, thus creating a conflict of interest.73 Under the currentdoctrine, directors may be held liable to creditors for "retroactiveinsolvency. '74 In other words, the balance-sheet may have reflectedsolvency prior to filing for bankruptcy, but the directors may retroactivelyfind they were serving the wrong constituency. This creates conflicts ofinterest and further complicates the Gheewalla court's purported policy ofcertainty.

Secondly, uncertainty regarding the precise point of insolvency mayhave a chilling effect on directors who fear being held personally liable foracting on behalf of the wrong constituency. 75 There is evidence to suggestthat directors become overly-conservative when they are in the vicinity ofinsolvency out of fear of liability.7 6 This uncertainty exists despitefiduciary duties running solely to shareholders prior to actual insolvencyand may therefore limit directors' activity to increase shareholder value.77

This "chilling effect" may also have repercussions beyond fiduciary duties.Qualified directors may be reluctant to serve on Delaware boards for fearof personal liability for decisions made during a period of corporatefinancial distress. 78 Further, directors may file for bankruptcy prematurelyto escape uncertainty leading to a lost corporate value (self-protection at theexpense of failing to maximize corporation value).7 9 Thus, the currentdefinitions of insolvency in the fiduciary duties context create confusionregarding the constituency served and also raise personal conflicts ofinterest for the individual directors.8s

Finally, ambiguous grounds for claims lead to increased litigation.In Production Resources, Vice Chancellor Strine suggested that plaintiff-friendly pleading standards coupled with the "hard-to-define vicinity ofinsolvency" would require the court to give creditors standing when they

would result in a greater payment than under a Chapter 7 liquidation. 11 U.S.C. § 365(1994).

73. See Rao, supra note 68, at 67 (explaining how creditor claims survive duringperiods of insolvency prior to filing for bankruptcy)

74. Id.75. Id. at 66 ("This phenomenon significantly increases the likelihood of personal

liability.").76. See Rao, supra note 68, at 66 (noting that directors "may feel constrained to make

overly-conservative decisions when they are unsure whether their corporation is in thevicinity of insolvency").

77. See McDonnell, supra note 68, at 206 (noting that directors of financially troubledDelaware corporations are burdened with the enormous practical problem of attempting todetermine the company's current financial status).

78. Id. at 209-210 (fearing an exclusion of qualified board members).79. Id. ("[T]he application of strict fiduciary principles may force directors of nearly

insolvent corporations to... prematurely file for bankruptcy.").80. See Rao, supra note 68, at 67 (discussing various definitions of insolvency).

2009] 1043

U. OF PENNSYLVANIA JOURNAL OF BUSINESS LAW [Vol. 11:4

pled facts suggesting that the company was in the "zone of insolvency."'"This same logic applies to the hard-to-measure actual insolvency. Acreditor pleading facts that, if true, would suggest that the company isinsolvent would allow the creditor to proceed with discovery even insituations where it is ultimately determined that the corporation is solvent.82

The ambiguous definition thus exposes the firm to costly and timeconsuming litigation at a financially fragile time.

IV. TOWARD GREATER CLARITY

Post-Gheewalla, a clear method for bringing together theory andpractice remains unarticulated. In theory, Delaware courts believe directorsshould have "clear signal beacons" for navigating the challenging waters ofcorporate governance.83 However, due to the ambiguity surroundinginsolvency, this theory proves difficult to apply.84

A workable and efficient solution should provide the claritydirectors need, limit disputes over hard-to-define concepts, and maintainadequate protection for the rights of the constituents. There are at leastthree solutions that would provide some practical relief to this problem: 1)shifting the burden to creditors to prove that directors had knowledge of thefirm's insolvency; 2) abolishing the fiduciary claim by creditors altogether(even upon actual insolvency); 3) defining insolvency, for fiduciary dutypurposes, as arising only upon the statutory filing for bankruptcy.

Stephen McDonnell has suggested that, in light of the difficulty ofascertaining the financial conditions of a corporation, courts should modifythe fiduciary duty standard for insolvent directors by requiring knowledgeof insolvency-a burden of proof to be carried by creditors.8 Thisstandard would likely lessen litigation by discouraging creditors frombringing less certain cases. Additionally, this solution would give directorsgreater certainty regarding their exposure to claims. However, it would notprovide creditors with a bright-line for bringing fiduciary claims but would

81. Production Resources, 863 A.2d at 790.82. Id. at 790, n.56 ("[Once a firm becomes insolvent, there is little doubt that creditors

can press derivative claims .... ).83. See Gheewalla, 930 A.2d at 101 ("This Court has endeavored to provide the

directors with clear signal beacons and brightly lined channel markers as they navigate withdue care, good faith, and loyalty on behalf a Delaware corporation and its shareholders."(quoting Malone v. Brincatt, 722 A.2d 5, 10 (1998))).

84. See McDonnell, supra note 68, at 195-196 ("[D]etermining when a corporationbecomes insolvent is, 'at best, an inexact science' and at worst, unduly burdensome orimpossible, due to the difficulty in valuing a corporation's assets.").

85. See McDonnell, supra note 68, at 208-209 ("[T]he burden should be placed uponthe creditor to demonstrate that the director either knew or should have known of thecorporation's precarious financial condition ....").

1044

GHEEWALLA AND INSOLVENCY

simply move the litigation battle from the occurrence of insolvency to thedirectors' knowledge of the insolvency. Thus, the unresolved ambiguity ofinsolvency would continue to create costly litigation. The second possiblesolution is to abolish fiduciary claims by creditors altogether. AfterGheewalla, the value of the fiduciary claim has been narrowed to such asmall subset of circumstances that its utility is questionable. First,corporate charter exculpations for breaches of duty of care under DGCL102(b)(7) survive insolvency.86 Thus, creditors, like shareholders, mayonly bring breach of loyalty or lack of good faith claims when seekingdamages. Second, unlike shareholders who may bring both direct andderivative claims, creditors are limited by Gheewalla to bring onlyderivative suits.8 7 These suits are subject to heightened proceduralrequirements including demand and pleading-with-particularityrequirements.88 Finally, as the Delaware courts have noted, it is hard toimagine a scenario involving self-dealing by a director of an insolventcorporation that would not either violate creditor contractual provisions orfraudulent conveyance laws.8 9 Thus, the cost of wading through arduousdiscovery for the small subset of cases falling within this narrow definitionmay well outweigh the benefits of the protection it allegedly affords.

A third solution, short of discarding fiduciary duty claims by creditorsaltogether, is to clarify the concept of insolvency. The myriad of problemscreated by the ambiguity of insolvency can be resolved by drawing the lineat the point of statutory filing for bankruptcy. 90 A party offered thissolution to the Court of Chancery in the court's most recent grappling withthe definition of insolvency. In Geyer v. Ingersoll Publications Co., thecreditor brought a fiduciary duty claim against the sole director of thecorporation after the corporation defaulted on promissory note payments tothe creditor.9 The creditor alleged that after defaulting on payments, thedirector, for his personal benefit, caused the corporation to surrender major

86. See Production Resources, 863 A.2d at 777 (holding that the provision in corporatecharters protecting directors from liability for a breach of duty of care applies to claimsmade by shareholders and creditors).

87. See Gheewalla, 930 A.2d at 103 ("[I]ndividual creditors of an insolvent corporationhave no right to assert direct claims for breach of fiduciary duty against corporatedirectors.").

88. See generally Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) (noting that thedemand requirement is meant to act as a hurdle to litigation).

89. See Production Resources, 863 A.2d at 790 (noting that with the protectionsafforded creditors, the conceptual room for finding that "creditors were somehow,nevertheless, injured by inequitable conduct would be extremely small, if extant").

90. See McDonnell, supra note 17, 195-196 ("A corporation is clearly insolvent whenstatutory proceedings under state law or Chapter 7 or 11 bankruptcy proceedings under theUnited States Code have commenced.").

91. Geyer, 621 A.2dat 786.

2009] 1045

1046 U. OF PENNSYLVANIA JOURNAL OF BUSINESS LAW [Vol. 11:4

assets to third parties at the expense of the corporation. 92 Specifically, thedirector allegedly cancelled an agreement worth $50 million with anothercorporation, in exchange for the benefit of personally acquiring a newbusiness entity. 93 The defendant-director, Mr. Ingersoll, argued that thecreditor lacked personal jurisdiction over him for the breach of fiduciaryduty claims because, he argued, insolvency should be defined as the time ofstatutory filing.94 The Geyer court acknowledged that insolvency, definedas a statutory filing for bankruptcy, would "give directors a clear andobjective indication as to when their duties to creditors arise. .9'

However, Mr. Ingersoll's argument was ultimately rebuffed by the court,on the grounds that there were "other policy concerns" to be considered bythe Court.96 Specifically, the Court argued that, under Credit Lyonnais,directors owed a duty to the "entire corporate enterprise" upon actualinsolvency and not to shareholders alone.97 The Court also argued that itsinterpretation of insolvency was supported by Delaware case law and theordinary meaning of insolvency.98

Had the Geyer court adopted the recent rationale advanced in

Gheewalla, Mr. Ingersoll's argument would likely have prevailed. TheGeyer court admitted that the defendant's definition of insolvency wouldprovide greater clarity and objectivity for directors in determining whentheir duties to creditors arose.99 This notion of clarity for directors isconsistent with Gheewalla's policy of providing "clear signal beacons andbrightly lined channel markers" for directors.' ° The Geyer court'srationale for its definition of insolvency as insolvency-in-fact is also basedon a notion of "community interests," a concept rejected by Gheewalla.''The Gheewalla court reasoned that in all times of solvency, including thezone of insolvency, the directors must continue to execute their fiduciaryduties for the benefit of the shareholders.°

0 2

Curiously, after basing its definition of insolvency chiefly on theneed to protect the various constituents of the "corporate enterprise," theGeyer Court proceeded to find the same actions equally colorable under afraudulent conveyances claim. 103 The Court held that the Mr. Ingersoll's

92. Id.93. Id.94. Id.95. Id. at 789.96. Geyer, 621 A.2d at 789.97. Id.98. Id. at 790.99. Id. at 789.

100. Gheewalla, 930 A.2d at 101.101. Geyer, 621 A.2d at 789.102. Gheewalla, 930 A.2d at 101.103. Geyer, 621 A.2d at 791.

GHEEWALLA AND INSOLVENCY

cancellation of the agreement worth $50 million fell within the term"conveyance" as defined by 6 Del. C. § 1301( 2)(19 74).1°4 The Courtspecifically noted that the agreements "released" were assets that thecorporation could have used to pay its creditors.' °5 Thus, this case wouldhave accomplished two things by adopting the Mr. Ingersoll's definition ofinsolvency. First, it would have provided clarity to directors regardingwhen their duty to creditors arose. Secondly, it would have demonstratedthe ability or creditors to obtain relief for wrongful director conductthrough non-fiduciary claims.

Gheewalla, at both the Court of Chancery level and again at theDelaware Supreme Court level, demonstrates a shift away from theambiguous "community interest" rationale of Credit Lyonnais and Geyer,toward a clear standard for directors.10 6 The next logical step in this trendis for the Delaware courts to either abolish creditor fiduciary claimsaltogether, or to adopt a bright-lined definition for insolvency in thefiduciary duty context. Mr. Ingersoll's definition 7 seems the most logical.

But does a further restriction on creditor fiduciary claims leavecreditors vulnerable to the wealth-transfer problem? The answer dependslargely on whether the theory's primary assumptions hold. The firstassumption is that directors of financially distressed public corporations arewilling to do what shareholders desire of them. The second assumption isthat directors of financially distressed public corporations are uninhibited inadopting financially risky strategies. Neither of these assumptions are verypersuasive in light of other constraints on director behavior.

Directors are granted deference to make business decision underDelaware's business judgment rule.'0 8 This means that courts will notsecond-guess directors' business decisions in the absence of evidence ofgross negligence in the decision making process.109 This gives directors thefreedom to differ with shareholders about the best strategy for thecorporation. Directors also experience additional pressures which inhibitthem from taking overly risky strategies. Various scholars and

104. Under the Fraudulent Conveyances Act, the term conveyance "includes everypayment of money, assignment, release, transfer, lease, mortgage or pledge of tangible orintangible property, and also the creation of any lien or encumbrance." Id.

105. Id.106. See Gheewalla, 930 A.2d at 101 (precluding creditors from bringing fiduciary

claims prior to insolvency and reiterating that directors are responsible to manage thecorporation for the benefit of the shareholders).

107. See Geyer, 621 A.2d at 789 (noting that Mr. Ingersoll advocates for the insolvencyexception to arise upon the institution of statutory proceedings).

108. See, e.g. Aronson, 473 A.2d at 812 (outlining the deferential business judgmentrule).

109. See id. (noting that the burden is on the party alleging misconduct to demonstratethat the directors abused their discretion).

2009] 1047

U. OF PENNSYLVANIA JOURNAL OF BUSINESS LAW [Vol. 11:4

practitioners doubt that the wealth-transfer problem occurs in practice dueto other moderating economic and legal pressures.10° For instance, thecomposition of corporate boards includes more pro-creditor representativesas corporations become financially distressed.'' Insolvent boards ofteninclude large block holding creditors." 2 Job security fears also play animportant role in moderating directors' actions.' 3 Less than 46% ofdirectors sitting on a board prior to insolvency remain with the firmemerging from insolvency. 14 The directors who resign or are forced outare, on average, unable to find work with other public companies forapproximately three years and often suffer significant reputational andemotional damage." 5 These significant employment repercussions suggestthat job security plays an important role in keeping directors from "bettingthe farm." 116 Additionally, directors may be encouraged to avoidbankruptcy and negotiate "workouts" with creditors to avoid litigationarising after statutory filing." 7 Finally, directors are legally constrained byfraudulent conveyance laws from conveying property with intent to defraudcreditors and from selling for less than a fair or reasonable price at a timewhen the debtor is insolvent or expecting to incur future debts beyond itsability to pay."'

110. See Rao, supra note 14, at 75 (noting that the wealth-transfer may in fact be fromshareholders to creditors due to the shareholders' diminished capacities for intervention and,among other pressures, job security concerns on the part of directors); Viral V. Acharya,Yakov Amihud & Lubomir Litov, Creditor Rights and Corporate Risk-Taking, 28 (U. ofPenn. Inst. for Law and Econ. Working Paper, 2008), available athttp://ssm.com/abstract-=1085195 (observing that stronger creditor rights lead to lesscorporate risk-taking and may thereby lead to sub-optimal corporate decision making); LynnM. LoPucki & William C. Whitford, Corporate Governance in the BankruptcyReorganization of Large, Publicly Held Companies, 141 U. PA. L. REv. 669, 685 (1993)("Management often has a career interest in preserving the company. If the company is soldoff, either in small parts or as a unit, the managers are likely to lose their jobs.").

111. See Rao, supra note 14, at 74 ("[Flinancial distress is associated with a statisticallysignificant increase in the proportion of outside board seats held by major block holders,investment bankers, and representatives of the firm's creditors.").

112. Id.113. See Rao, supra note 15, at 75 (noting that directors are incentived to adhere to

creditors' interests in order to protect their employment status); Stuart C. Gilson,Management Turnover and Financial Distress, 25 J. FIN. ECON. 241, 247 (1989) (findingthat financially distressed firms are almost three times as likely to experience turnovercompared to non-finincially-distressed firms).

114. See Rao, supra note 14, at 75.115. See Gilson, supra note 113, at 242, 252.116. See Rao, supra note 14, at 67.117. Note that the directors are liable to shareholders but protected by the business

judgment rule from taking reasonable measures to preserve the corporation. Thus, by takingmeasure to avoid bankruptcy, they can take steps to satisfy creditors, avoid lawsuits thatmay arise upon bankruptcy, and begin to restore value to shareholders.

118. See RESTATEMENT (SECOND) OF CONTRACT LAW § 205 (1981) (imposing "uponeach party [to a contract] a duty of good faith and fair dealing in [the contract's]

1048

GHEEWALLA AND INSOLVENCY

At the heart of the wealth-transfer theory is the concern thatcreditors will bear the full extent of the agency costs created by directorrisk-taking. 19 However, directors of financially distressed companies aregiven discretion to choose prudent rather than overly risky strategies. Andevidence suggests that reputational and employment concerns are likely toconstrain a director from "betting the farm." These constraints coupledwith the various protections afforded creditors, further weaken the rationalfor providing creditors with fiduciary claims. 120

In sum, it is doubtful that the fiduciary duty claim, in its very limitedpost-Gheewalla state, provides any additional or necessary protection forcreditors. Evidence suggests that the wealth-transfer problem does notoccur, in practice, because directors of financially distressed publiccompanies are face other important constraints including greater creditorinfluence and job security concerns. 1 2' Even if directors were to engage inimproper transfers of wealth, creditors are protected by, among otherthings, fraudulent conveyance laws. Thus, the premise on which fiduciaryclaims are granted to creditors is weak, at best.

But, assuming that creditors retain the right to bring these claims, abright-line definition of insolvency is needed to provide directors with thecertainty that Gheewalla purported to provide. This bright line should bethe date of statutory filing, when the directors and all constituencies will beon notice of the shift in fiduciary concerns. As Vice Chancellor Strinenoted in Production Resources, many insolvent firms operate for yearsunder the protection of Chapter 11.122 This phase of a firm's life is whenthe creditor is clearly the residual claimant on the firm. It is here, ifanywhere, that the creditor is the proper party to police the fiduciary dutiesof the directors and not at an earlier ambiguous date.

Gheewalla is consistent with a trend to provide Delaware corporatedirectors with greater certainty in executing their fiduciary duties and notsubjecting them to fiduciary breach claims by various constituencies.123

performance and its enforcement"); DEL. CODE ANN. tit. 6, § 1301(2) (1974); see Rao, supranote 15, at 73; see also, 11 U.S.C. § 548(a) (1988); see McDonnell, supra note 17, at 181(noting that creditors rights are generally governed by contract law and that the fiduciaryduties owed to creditors upon insolvency are thus ambiguous).

119. See generally Rao, supra note 14 (noting that creditors are concerned that directors'interests will not be aligned with their interests).

120. See RESTATEMENT (SECOND) OF CONTRACT LAW § 205 (1981) (imposing "uponeach party [to a contract] a duty of good faith and fair dealing in [the contract's]performance and its enforcement"); McDonnell, supra note 17, at 181 (noting that creditorsrights are generally governed by contract law and that the fiduciary duties owed to creditorsupon insolvency are thus ambiguous).

121. See Rao, supra note 14, at 75 (noting that directors are incentived to adhere tocreditors' interests in order to protect their employment status).

122. NCT, 863 A.2d at 792.123. Gheewalla, 930 A.2d at 101; Trenwick, 906 A.2d 168 (squarely rejecting the

2009] 1049

U. OF PENNSYLVANIA JOURNAL OF BUSINESS LAW [Vol. 11:4

Nonetheless, Gheewalla stopped short of providing bright-line clarity byneither revoking the fiduciary cause of action completely nor by defininginsolvency as the date upon which the firm files for statutory bankruptcy.Directors, consequently, are needlessly exposed to creditor fiduciary claimsand increased litigation at a time when all alternatives and energies shouldbe directed toward the managing the corporation.2 4

"deepening insolvency" cause of action that had been accepted in a minority of states and isbased on similar premises to the fiduciary duty claims).

124. See Gheewalla, 930 A.2d at 100-01 (arguing that directors should be concernedwith maximizing the value of the insolvent corporation as opposed to direct duties toindividual creditors).

1050