When Chapter 11 Hits, D&O Claims Can Take the Unsecured Director Down

Following Chapter 11 Bankruptcy and expedited bulk-asset sales, unsecured creditors often face the challenge of recovering funds, leading them to explore legal avenues such as pursuing claims against directors and officers (D&O claims). In this context, directors with a history of questionable judgment or failure to address emerging issues find themselves vulnerable. The article explores the dynamics of unsecured creditors seeking recovery through D&O claims and outlines protective measures for directors and officers.

Corporate Bankruptcy Landscape:

The success rate of Chapter 11 bankruptcy cases is notably low, primarily due to secured lenders' impatience with time-consuming reorganizations, culminating in expedited bulk-asset sales that leave minimal assets for unsecured creditors. In such scenarios, unsecured creditors' committees often turn to D&O claims as an alternative source of recovery.

Evaluation of D&O Claims:

Unsecured creditors' committees scrutinize various factors when evaluating the viability of D&O claims. The article emphasizes the importance of the business judgment rule, which serves as the primary legal protection for directors. It explores how the board's role in Chapter 11, especially in the face of insolvency, influences potential liability. Written presentations, board minutes, and interviews are examined to determine if decisions were reasonably informed.

Components of a Properly Functioning Board:

The article highlights the significance of an independent board, free from undue influence by management. It delves into factors such as familial or friendship ties among board members and CEOs, potential conflicts of interest, and the need for a diverse and qualified board to enhance shareholder value. Dysfunction within the board, lack of independence, or domination by a single individual are flagged as red flags for unsecured creditors' committees.

Addressing Financial Distress:

Recognizing signs of financial distress becomes critical for directors and officers. The article stresses the importance of timely reactions to changing market conditions and product obsolescence. Fiduciary duties extend to creditors as a corporation approaches insolvency, necessitating a broadened focus. Directors are encouraged to monitor actions and negotiations to resolve financial distress, demonstrating their commitment to addressing challenges.

Minimizing Liability:

Directors and officers are advised to remain engaged and seek solutions rather than resigning from the board when faced with financial distress. The article underscores that resignation may not absolve past actions from scrutiny, and active participation in finding solutions can be instrumental in minimizing potential liability.

In the aftermath of Chapter 11 bulk-asset sales, unsecured creditors explore avenues like D&O claims to recover funds. Directors and officers must navigate these challenges by adhering to fiduciary duties, ensuring a properly functioning board, and actively addressing financial distress. The article provides insights into the dynamics surrounding D&O claims, empowering directors and officers to protect themselves in the complex landscape of corporate restructuring.