By Michael W. Peregrine and Miles W. Hughes, McDermott Will & Emery LLP, Chicago, IL
[Full article available here]
A series of recent creditors-rights decisions suggest that healthcare directors may have greater flexibility when responding to organizational financial distress.
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In Production Resources Group, L.L.C. v. NCT Group, Inc., the Chancery Court emphasized that neither the nature of the fiduciary duties owed by directors and officers nor the standard of scrutiny applied to their decisions changes as the corporation approaches insolvency. Rather, the existence of financial distress simply causes the class of persons to whom fiduciary duties are owed to expand to the corporation's creditors.16 The court also held that "the business judgment rule remains important and provides directors with the ability to make a range of good faith, prudent judgments about the risks they should undertake on behalf of troubled firms."17 Central to the court's decision was the notion that the directors and officers of an insolvent or nearly-insolvent corporation should have the flexibility to pursue riskier turn-around strategies without being exposed to liability for breach of fiduciary duty if the chosen course of action fails.
In Trenwick America Litigation Trust v. Ernst & Young LLP, the Chancery Court reaffirmed its commitment to the business judgment rule by holding that Delaware law does not recognize an independent cause of action for deepening insolvency.18 In doing so, the court stated that "[i]f the board of an insolvent corporation, acting with due diligence and good faith, pursues a business strategy that it believes will increase the corporation's value, but that also involves the incurrence of additional debt, it does not become the guarantor of that strategy's success."19 Thus, "[e]ven when the company is insolvent, the board may pursue, in good faith, strategies to maximize the value of the firm."20 An appeal of the decision is now pending before the Delaware Supreme Court, oral argument having been heard on March 14, 2007. Given the deference accorded by courts throughout the country to business law decisions by Delaware's highest court, the importance of the pending appeal of the Chancery Court's decision in Trenwick cannot be overstated.
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