June 1, 2008

Hard Times Make for Hard Decisions


By Douglas Cushing

Summer 2008

The current economic and credit environment presents tough challenges for the officers and directors of private companies and for those running public corporations. For both groups, the rules are largely the same with public disclosure requirements for public companies making the biggest difference. How does the current climate affect the risks and liability in the private domain for corporate officers and for board members, often also majority shareholders?

Oregon courts have not been a haven for shareholder claims, often finding either that the officers' and directors' actions were protected by the business judgment rule or that the shareholders themselves did not have proper standing to bring a claim. But the courts have held that majority shareholders/directors can be held responsible for oppressive conduct that breaches their duty of loyalty to the corporation and minority shareholders if they run the corporation for their personal benefit and not for that of all shareholders. Similarly, if individual directors take advantage of what is otherwise a corporate opportunity, the minority shareholders or the corporation can assert a viable claim that the company has been damaged.

A recent Delaware bankruptcy court decision may portend future elevated concerns about a board's behavior as it faces hard decisions. Oregon companies should be concerned too because Delaware decisions often set the standard for corporate behavior throughout the country. In re Bridgeport Holdings, Inc. 2008 WL 2235330, the liquidating trust of Micro Warehouse, Inc., on behalf of the unsecured creditors of the corporation, brought an action against the former officers and directors and the turnaround professional engaged to address the company's financial structure. While this case now stands only at the point of the court's denial of a motion to dismiss, its factual setting should cause directors to pay close attention. The case is not one involving the "zone of deepening insolvency," a theory in which Delaware decisions have seemingly offered solace to corporate directors. This case may more accurately be seen as directors seemingly giving up too early.

Micro Warehouse, the company involved, was a computer products retailer owned by a group of individuals who had acquired it in a leveraged buyout in early 2000. The buyout occurred just before the dot com bubble burst. After the downturn, the company experienced significant difficulties but continued in operation, notwithstanding the financial problems. Despite growing pressure from lenders, the struggling company's board did not try aggressively to maximize its value over 2001 to mid-2003. When the board finally decided to act by seeking a potential buyer, the board limited its view to a single company, with which a key board member had a prior relationship. After hiring a turnaround company in mid-August 2003, the board proceeded to strike a deal with that company, which completed its due diligence in a short two weeks, negotiated the agreement, and closed the sale during the first week of September. That deal was done notwithstanding other competitors' inquiries about the financial status of Micro Warehouse and attempts to engage in sale discussions. The board obtained a sale price of $28 million, paid in cash. While not an insignificant amount, independent experts ultimately concluded that the company value was at least four times that amount. After years of litigation, the purchaser in fact paid an additional $25 million to settle claims against it.

Yet, there was no claim that Micro Warehouse's directors had a self-interest over and above their shareholdings in the company, or that there was any advantage or benefit provided to any of them in the particular transaction. Such a finding was also made in similar Oregon cases, in which the duty of the director to the corporation was upheld without regard to a claim of individual benefit by the board members.

Does this mean that a board is a guarantor of the corporate value? The answer is a clear no. But directors must examine all opportunities and alternatives, consult with professionals (not just their lawyer but also outside accounting firms, investment bankers, and lenders), and be sure their decisions are in the best interest of the corporation and all shareholders. The directors should also document the steps taken and the opinions and analyses collected. There is no absolute guarantor liability to shareholders or creditors, but as Judge Walsh noted in the Bridgeport decision, a fiduciary can be responsible when "he takes or fails to take any action which demonstrates a faithlessness or lack of true devotion to the interests of the corporation and its shareholders." It may be as simple as, pay attention and do your homework — and do not be afraid to ask for help from professional advisers.

Back to Top