Out-of-court Workouts and Corporate Authority
Historically, counsel for the debtor only needed board authority for the commencement of a case under the Bankruptcy Code, and then relied on the Code's comprehensive framework to effectuate a reorganization or sale of substantially all of the debtor's assets. Obtaining the necessary corporate authority to effect a successful out-of-court workout or liquidation, however, is a tricky affair at best. This article contains some suggestions for both borrower's and lender's counsel in dealing with these situations and some recommendations to our colleagues who prepare loan and shareholder agreements in the first place.
Enough has been written, both in this column1 and elsewhere,2 regarding the duties of directors and officers of insolvent companies and the apparent shift, in many jurisdictions, in the identity of the beneficiaries of those duties away from shareholders toward unsecured creditors and other stakeholders. Usually, it appears to be an after-the-fact effort to put creditors' hands in someone's deep pockets. For purposes of this article, just assume that those ladies and gentlemen owe a duty (to someone) to avoid self-dealing and to maximize the values (reorganization or liquidation) of the subject company's assets.
As counsel for an insolvent Indiana corporation that conducted a recent out-of-court self-liquidation, we encountered a series of issues that we hope will prove interesting and helpful to you: (1) you can't use unanimous consent resolutions when even one shareholder or director is absent or uncooperative, (2) it's easier to obtain the corporate authority for a bankruptcy filing than it is to effect out-of-court sales, and (3) if you are borrower's counsel, you'd better get the corporate authority issues right the first time, because some buyer is going to demand your formal opinion that your client in fact has the authority to enter into that asset or stock purchase agreement.
One of our biggest challenges in this regard came in dealing with a second-tier Malaysian subsidiary, the parent of which was 83 percent owned by the liquidating Indiana corporation and 17 percent by Malaysian investors. The minority shareholders were entitled to appoint three of the seven directors and, by means of a shareholders agreement with super-majority requirements, effectively held a blocking position on matters not to their liking. All of the shares of stock of the Malaysian subsidiary were owned by the first-tier subsidiary, which was also a co-obligor on the loan from the U.S. bank. So, the entire proceeds from the sale would have to go to pay the bank. Needless to say, the minority shareholders were not pleased at this outcome.
While the U.S. assets were being liquidated in a piecemeal fashion, the company and its lender had concluded that the only way to obtain any real value for the Asian subsidiary was to sell that company as a going concern, and, for a variety of reasons (mostly relating to the default under the Malaysian lender's line of credit and the priority afforded to the employee's severance claims under that nation's laws), the only real option to accomplish that was a sale of all of the stock of the Malaysian subsidiary. Of course, under most state's laws, the sale of all or substantially all of a corporation's assets requires shareholder approval.3
After negotiating a letter of intent with a competitor, the parties then began the task of trying to close the transaction by the end of the year, when certain tax holidays expired. Among the many complications, however, were that one of the Malaysian shareholders was in receivership, and several of the directors were very difficult to reach and not especially interested in helping. So, trying to obtain "unanimous" consent resolutions—director or shareholder—was pointless.
Relying on the Indiana statute4 and the first-tier subsidiary's (seller's) bylaws, we concluded that, while the best practice would be to have at least two days' notice before a board of directors meeting, followed by another 10 days' notice preceding a shareholders' meeting, we could run those two periods concurrently, and we needed to do so in order to beat the year-end deadline. Since there was some possibility of confusion regarding exactly who the directors were, we also addressed that issue in the context of the overall meeting. Further, since the president of the parent company was in Malaysia trying to hold the situation together, and neither the statute nor the bylaws precluded such meetings from occurring overseas, the special meetings of directors and officers would take place in Malaysia, with U.S. counsel participating by conference call.
In a manner that only lawyers could appreciate, late one night, U.S. time, there commenced a directors meeting to confirm the bylaws and identify the remaining directors; after adjourning that meeting, shareholders owning 91 percent of the outstanding shares met to elect and confirm the board of directors; thereafter, the board of directors meeting reconvened and, after an extended discussion, the board approved the transaction and recommended that the shareholders vote to approve it; finally, the shareholders meeting was reconvened for purposes of voting on the sale of the subsidiary, and the motion carried, with 83 percent of the shares voting in favor and the remainder abstaining. The board of directors vote was similar, with the parent corporation's slate of four directors voting to approve the deal and the minority shareholders' representatives abstaining. Detailed minutes were taken by the corporate secretary and U.S. counsel and circulated for review immediately thereafter.
The issue of potential liability for the directors came up early and often during the formal board meeting itself and the many discussions and letters that preceded it. While we are not aware of any case law that would impose the above-described limited fiduciary duties toward creditors on shareholders per se, nevertheless, in a close corporation, it is those same shareholders (or their nominees) that serve as the directors. Can we conclude that the shareholders of a close corporation, who are also directors, have a duty as shareholders to vote to approve a sale of substantially all assets as recommended by the board? Probably not, but forward-thinking counsel might be able to craft some remedies in the initial loan documents that could prevent this from becoming a problem. (If the shareholders/directors are also guarantors of the bank debt, the lender for whose benefit the workout or liquidation is taking place presumably would have more leverage than in our case.)
Even though this example had some unusual facts, it is not difficult to imagine similar problems of a more generic variety. For example, one or more of the shareholders in the close corporation could be in bankruptcy/receivership, mentally incompetent or physically unavailable; or the shares could be part of a probate estate. In our case, the shareholders had executed a very limited waiver in conjunction with the loan agreement, but some additional, broader language in the loan documentation would have been helpful. For example, practitioners should consider the following:
- Have both directors' and shareholders' resolutions authorizing the company to enter into the loan agreement be broad enough to authorize the directors and officers to effect any necessary restructurings, in the event of default. Certainly, though, as the time between execution of those resolutions and the date of default grows longer, their efficacy would be more suspect.
- If there is an existing shareholder agreement, or if one is executed after the date of the loan agreement, it should be specifically subordinated to the terms of the loan agreement; further, consider whether the shareholder agreement ought to terminate upon the event of, and failure to cure, a material default under the loan agreement. Once the corporation becomes insolvent, the shareholders arguably have no economic stake in the outcome. But, see In re Central Ice Cream, 836 F.2d 1068 (7th Cir. 1987) (shareholders have some residual claim if claims in litigation turn out to be a proverbial gold mine).
- Any such shareholder agreement should also contain provisions that abrogate any super-majority voting requirement, or other impediments to a workout, once the board of directors concludes that the corporation is insolvent or in the "vicinity of insolvency," whatever that means. Credit Lyonnais Bank Nederland N.V. v. Pathe Communications Corp., 1991 WL 27613 (Del. Ch. Dec. 30, 1991).
In a chapter 11 case, we rarely encounter the same difficulties. Authorization to file a bankruptcy petition usually requires a simple majority vote of the directors. Then, Bankruptcy Code §363 and Bankruptcy Rules 2002 and 6004 in effect substitute notice to all interested parties for the requirement of shareholder approval. Indeed, the bankruptcy judge has been called the "board of directors in black robes." For any number of reasons, it may be preferable to effect an out-of-court solution rather than file a chapter 11 case. It would be a shame if the only reason for commencing the bankruptcy case is because the debtor cannot obtain the requisite authority to sell its assets.
2 Markell, Bruce A., "The Folly of Representing Insolvent Corporations: Examining Lawyer Liability and Ethical Issues Involved in Extending Fiduciary Duties to Creditors," 6 J. Bankr. Law and P., p. 403 (and cases cited at p. 405, n.3-5). Return to article