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Fiduciary Duties For A Corporate Director In The "Zone of Insolvency" And Beyond

12/01/2008

This is the third in a series of brief articles that Moye White is sending to its clients and friends to provide practical advice about the opportunities and challenges presented by today's economy.

FIDUCIARY DUTIES FOR A CORPORATE DIRECTOR IN THE “ZONE OF INSOLVENCY” AND BEYOND

By Elizabeth H. Getches and Scott Bauer

During these challenging economic times, many companies are facing cash-flow problems and even the prospect of closing their doors. The following are important considerations for individuals serving as directors of these companies as they near and reach insolvency.

Carefully Draft and Revise Your Incorporation Documents. A carefully drafted exculpation clause in your company’s articles of incorporation, or other formation documents, can circumscribe a director’s personal liability for claims brought by creditors of the corporation. These clauses can limit or eliminate a directors’ personal liability to the corporation or its stockholders for monetary damages for breach of fiduciary duty.

Make Informed and Well-Documented Board Decisions. The “business judgment rule” applies to insulate decisions made by boards of directors. This rule, which presumes that a director has acted in the best interests of the company’s shareholders, may insulate board-approved decisions even when a risky strategy might later prove harmful to creditors. Thus, all significant decisions – to the extent possible – should be made, or ratified, by the board. Your board should be fully and adequately informed before discussing and approving decisions and every decision should be fully documented in the board books and minutes.

Upon Insolvency, Know The Limits Of A Creditor’s Claims. Prior to insolvency, directors owe duties of loyalty and care to the company’s shareholders and not to creditors. As a company reaches insolvency, the board begins to owe certain duties to creditors, and creditors may bring claims against the board of directors if it has not acted in the interests of all of the creditors. As a director of an insolvent corporation, it is imperative not to favor your own interest over the creditors’ claims.

Get The Right Expert. There are a number of different tests for determining insolvency. For example, balance sheet insolvency defines insolvency at the moment when your company’s liabilities are greater than its assets. The cash flow test, by contrast, looks into the future to determine whether your company’s capital will remain adequate over time instead of focusing on whether the corporation has been paying bills on a timely basis. The proper valuation of your company’s goodwill can also impact the insolvency determination. An expert can help the board determine the best methodology for calculating insolvency. Once a method is selected, the board should apply this methodology consistently to its consideration of insolvency.

For more information contact: Elizabeth H. Getches or Scott R. Bauer at (303) 292-2900

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Moye White LLP has prepared this bulletin to provide general information, however this bulletin does not provide legal advice and does not create an attorney-client relationship between the reader and Moye White. No legal or business decision should be based solely on the content of this bulletin.

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