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Editor: Brian JM Quinn
Boston College Law School

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Monday, May 21, 2007

Delaware Issues Important Decision Clarifying Directors' Fiduciary Duties to Creditors

On Friday, the Delaware Supreme Court issued a landmark decision on the scope of directors' fiduciary duties to creditors once a Delaware company enters the zone of insolvency or becomes insolvent.  The case is North American Catholic Educational Programming Foundation, Inc. v. Gheewalla.  In Gheewalla, the Court held that creditors do not have a direct claim against directors for a breach of fiduciary duty once the company enters the zone of insolvency or becomes insolvent.  However, with respect to a claim when the company is insolvent, the Court stated that "[c]reditors may nonetheless protect their interest by bringing derivative claims on behalf of the insolvent corporation on any other direct nonfiduciary claim.”

Previously, although it was uncertain, it was generally thought that that directors of a Delaware corporation had some measure of fiduciary duty to creditors once a corporation entered the zone of insolvency.  However, the Court here rejected this belief, stating that in the zone of insolvency directors' fiduciary duties run only to the corporation and its shareholders (apparently the Court agrees with Stephen Bainbridge).  The Court's holding is likely to have wide-spread implications for bankruptcy and restructuring deals, and I will have more analysis once I have had the opportunity to furhter review the decision. For a bit more of an in-depth analysis of the decision at this time, I refer you to this memo prepared by the well-known, crack Delaware law firm of Richards, Layton & Finger.   

http://lawprofessors.typepad.com/mergers/2007/05/delaware_issues.html

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