More Bad News for James Hardie and Its Asbestos Compensation Fund

Thu, 02 Sep 2010 14:26:33 GMT

Managing legacy liabilities is never easy. For some, it can be a nightmare. Thus, James Hardie and its asbestos compensation fund took yet another hit yesterday through the loss of a tax appeal. The loss is described here in mass media in Australia. The mass media is focused on the fund's long term survival prospects in light of the adverse ruling and the continuing slumps in the building sector that buys product from James Hardie entities.

The company issued a statement yesterday (go here to investor relations page), but did not include a link to the opinion. According to the statement. the loss will result in a charge of about $ 330 million (US) unless there is a successful further appeal. The company also says it will not violate loan covenants by taking the charge.

Is The United States Bankrupt? The Dellutri Law Group Offers A Free Consultation.

Thu, 02 Sep 2010 12:49:51 GMT

Is the United States Bankrupt? Yea probably, but it doesn't seem to know it just yet. We are running deficits every year with no end in sight, and the national debt continues to escalate.

Normal people would have pulled their hair out by now. Normal people would have said enough is enough. Normal people would have changed their spending habits when the money was gone. However, this small cash flow issue does not seem to bother our Government, as they continue to spend, spend, spend. Who was the last person or corporation that spent themselves into prosperity? Go ahead think about it.

It is at this time that I must re-iterate my offer to the United States Government. As a responsible citizen, business owner and bankruptcy attorney, I will gladly provide a free consultation to the United States Government, just like I do to all of my consumer clients. I am extending this offer because I think this Great Country is bleeding cash, and we need to stop the wasting of resources in this Country.

I am willing to sit down with the President, Tim Geithner and anyone else. I will even provide a beer for the president, as he may need it when I tell him that Air Force One will probably be sold at a Bankruptcy Trustee's auction.

At this free consultation we can discuss the Government's debt problems and how a bankruptcy can lead the way to a fresh financial start.

I could go on and on, but I think you get the point.

August Bankruptcy Filings Down 8% From July But Still On Record Pace

Thu, 02 Sep 2010 11:56:41 GMT

Historically, August bankruptcy filings are usually less than July. This July we saw an 8% drop in consumer bankruptcy filings across the nation. This statistic does not mean that we are in a recovery, and please don't assume anything than it is just a number.

Overall, across the United States, consumer bankruptcy filings are still high and are near the 2005 mark. In 2005, Congress overhauled the bankruptcy laws to protect consumers. Yea, thanks guys, after seeing what a job they did on the bankruptcy code, I can't wait to see how the health care system works. I mean you guys run Social Security, Medicare, Fannie Mae, Freddie Mac, the Post Office and most recently took on Wall Street. I'm convinced that we have nothing to fear.

Mark Brunnell Answers Questions About His Bankruptcy

Thu, 02 Sep 2010 11:24:59 GMT

Mark Brunnell is a debtor in a Chapter 11 bankruptcy. I don't mean that in a derogatory way. I mean that he is in the process of using the bankruptcy laws and rules to reorganize his sizeable debts. He made a name for himself as a professional football player. Now, as a sign that no-one is immune from this economy, he is trying to reorganize his debts and move on with his life. Mr. Brunnell is currently trying to make the roster of the New York Jets. Good Luck to him.

As a debtor in bankrutpcy, Mr. Brunnell must answer questions about his assets and liabilities. He must also prepare a chapter 11 plan of reorganization and a disclosure statement which will detail how he intends to deal with his creditors.

Vacation Induced Optimism?

Tue, 31 Aug 2010 23:37:27 GMT

It seems that I use most of my time in this space to rail against an unthoughtful regulatory architecture that will certainly surprise and may ultimately do unintended and substantial harm to our nascent and uncertain recovery. While, from where I sit, it’s still fair to say this market continues to show little real conviction that it’s safe to get back in the water (hardly an irrational mindset) there is, periodically, some good news. So let’s make time for a bit of good news. Ta-da: It was reported recently that average consumer credit card borrowings have dropped below $5,000 per person for the first time since 2002.

This is terrific news. Perhaps not the stuff of rational giddiness, but combine that with the fact that corporate earnings are up, private cash savings rates are at recent highs, the de-leveraging is going great guns (everywhere, that is, outside of our government), house prices seem to be stabilizing in most markets even if sales continue to lag, interest rates are at ridiculously low levels and the reality of the re-set of the valuations of both the commercial and residential property stock has been internalized. A bit of optimism is not wildly inappropriate.

All that sets the table for a sustained recovery, albeit a slow one. Yes, there are real risks to this modest good news scenario including, notably, the levels of governmental debt, the exhaustion of the strategy of pushing growth with cheap money, the likelihood of higher taxes and ham-handed regulatory action and continued governmental-bred uncertainly. So prospects for low sustained growth could yet be transmogrified into stagflation.

So, what can be done to support the growth scenario? In large measure, we need to continue to engage in the political and regulatory process to try to mitigate any further potential damage from regulatory misfires or overreach. We cannot make up aggregate demand, rehire away all the unemployment (please hire where possible) or reverse the psychology of the bad news cycle, but we can still play an important role as FinReg and its philosophic regulatory and legislative siblings get implemented.

Beyond that, I plan to fully embrace a strategy of hope. As Labor Day looms and the can kicking of summer comes to an end, we see some data from our admittedly somewhat myopic perch as a capital markets law firm sustained by transactional activity that is consistent with the upbeat scenario. That’s enough to make me mildly optimistic. Could this be vacation induced bonhomie? Maybe. But for the moment, I’m sticking with it. There’s always time to embrace despair later.

By Rick Jones.

K&L Gates Webinar: HUD Interpretive Rule - Are Marketing Agreements Under Siege?

Tue, 31 Aug 2010 17:17:50 GMT

K&L Gates Webinar: HUD Interpretive Rule – Are Marketing Agreements Under Siege?

Date/Time: Tuesday, September 14, 2010 at 2:00 p.m. EDT

Location: Attend via Webinar. Login directions will be distributed via email the day before the event.

RSVP: Click here to register online. Registration closes at 5:00 p.m. EDT on September 10.

As Section 8 of the Real Estate Settlement Procedures Act ("RESPA") provides an exemption for payments made by one person to another person for actual, necessary, and distinct services, mortgage lenders, homebuilders, real estate brokers, title insurance companies, and other settlement service providers have maintained marketing agreements for decades without much guidance from the U.S. Department of Housing and Urban Development ("HUD"). That all changed on June 25, 2010 when HUD issued a RESPA interpretive rule regarding the permissibility of marketing agreements between home warranty companies and real estate brokers and agents. Although the interpretive rule provided RESPA guidance in the limited circumstance of per-transaction home warranty marketing agreements, HUD's interpretation has caused settlement service providers generally to question the RESPA compliance of flat fee marketing and service agreements, as well as the permissible types of marketing services performed under these agreements.

Join us on Tuesday, September 14, 2010 from 2:00 p.m. until 3:15 p.m. Eastern Daylight Time for a webinar to learn more about HUD's interpretive rule and the effects this interpretation could have on your existing marketing agreements. Time for questions and answers will follow the webinar presentation.

Speakers Include:

Phillip L. Schulman, Partner, Washington, D.C.
Holly Spencer Bunting, Associate, Washington, D.C.

The Cost Of Bankruptcy Keeps Increasing

Tue, 31 Aug 2010 12:12:15 GMT

As a consumer bankruptcy attorney, I see first hand how the bankruptcy code and bankruptcy rules play out in the courtroom and creditor's meetings on a daily basis. It seems to me that a great deal of unnecessary costs (administrative and non-administrative) are being placed upon individuals filing for bankruptcy protection.

According to one study from the American Bankruptcy Institute Law Review, the costs of bankruptcy of increased since the bankruptcy law changed in 2005. The article found that consumer debtors filing for Chapter 7 and Chapter 13 protection in the years after 2005’s Bankruptcy Code overhaul (BAPCPA) face costs up to 55% higher than those who filed in 2003 and 2004.

K&L Gates Webinar: The Politics of Dodd-Frank Rule Making - Comment Letters Are Not Enough

Mon, 30 Aug 2010 14:16:57 GMT

K&L Gates Webinar: The Politics of Dodd-Frank Rule Making – Comment Letters Are Not Enough

Date/Time:
Thursday, September 16, 2010 at 2:00 p.m. EDT

Location:
Attend via Webinar. Login directions will be distributed via email the day before the event.

RSVP:
Click here to register online. Registration closes at 5:00 p.m. EDT on September 14.

K&L Gates is pleased to invite you to our complimentary Webinar on the politics of rule making under the Dodd-Frank Act conducted by members of our Public Policy Practice Group in consultation with our Financial Services Practice Area.

The recently enacted Dodd-Frank Act is the most comprehensive regulatory reform in the financial services industry affecting nearly every part of the financial services industry. The new law is over 2000 pages long with 315 required rule makings, 145 required studies and reports, and dozens of ambiguities and internal contradictions. Many significant issues and thousands of details have been left to the regulators – who must proceed (and are proceeding) immediately and with unusual speed to fill in much of the substance – including issues such as:

To what extent will investment companies or their managers be considered companies "predominately engaged in financial activities" falling within the scope of Financial Stability Oversight Council (FORC) regulations that are to be designed to "identify risks to the financial stability of the U.S.," "promote market discipline" and "respond to emerging threats to the stability of the U.S. financial system"
What investor protection regulations will be considered by the new Investor Advisory Committee to be established within the SEC to advise and consult on investor protection, the effectiveness of disclosure and related issues?
What will be the prohibitions on sponsoring or investing in private funds under the Volcker Rule?
What is a "major swap participant" or a "major security-based swap participant," what constitutes a "substantial position" in swaps that could have systemic implications, and what positions will be deemed to constitute hedging or mitigating of "commercial risk," which will be excluded from computation of a substantial position?
What is a qualified residential mortgage loan under the risk retention rules?
How will the Bureau of Consumer Financial Protection define "unfair"?

But this is not simply a dry, technical process dependent on the filing of substantive comments in response to the notice of proposed rule making. Certainly that will be necessary. But those impacted by the new law just file comments at their peril.

This policy making process will be political from the start, with the regulators responsive to Congressional informal oversight and direction (which could change dramatically with the fall elections). One House Subcommittee Chairman held an oversight hearing with the SEC before the bill was even signed! Moreover, Congressional leaders already have recognized the need for additional legislation to make "technical corrections" and possibly substantive modifications as well. Companies and their trade associations will be seeking to use this process to minimize burdens and to advantage themselves competitively. What will you do? Some companies make things happen – others just say "what happened?" This Webinar will discuss how getting involved early and adopting a comprehensive approach to regulatory implementing activity can provide significant benefits.

To learn more, please join us for a one-hour complimentary Webinar on Thursday, September 16.

We’ll leave time at the end of the Webinar for questions.

For more information please visit the Financial Services Reform Webpage.

Speakers Include:

Bruce J. Heiman, Partner, Washington, D.C.
Daniel F. C. Crowley, Partner, Washington, D.C.
William A. Kirk, Partner, Washington, D.C.
Karishma Shah Page, Associate, Washington, D.C.

"Tells" for Executive Lies During Investor Calls ?

Sat, 28 Aug 2010 14:01:32 GMT

This story from The Economist explains an academic effort to formally look for "tells" on when executives were lying during investor conference calls. Key "tells" are said to be use of extreme adjectives, a lack of ums and ahs, and swearing. Some might think the same principles also could be applied to testimony of persons involved in the litigation industry.

Covered Bonds Anyone?

Fri, 27 Aug 2010 17:27:31 GMT

Covered bond legislation is once again a hot topic on Capitol Hill. Representative Scott Garrett (R-NJ) co-sponsored the latest iteration of his proposed legislation (United States Covered Bond Act of 2010 or H.R. 5823 (pdf)) along with Representatives Kanjorski (D-NJ) and Bachus (R-AL). The House Financial Services Committee recently voted in favor of reporting H.R. 5823 to the full House of Representatives for consideration, which hopefully will be taken up for a vote this fall shortly after the August recess.

You might recall that Representative Garrett almost succeeded in getting covered bond legislation into the Fin Reg package that passed last month . Lacking one vote (pdf), and facing scrutiny from the FDIC, the language found itself on the cutting room floor when Fin Reg ingloriously exited the reconciliation process. Notwithstanding these setbacks, Garrett’s latest attempt to push this legislation through appears to have some momentum in the Senate as well—Senator Bob Corker (R. Tenn.) has asked for the Senate Banking Committee to hold hearings on the topic. In addition, H.R. 5823 has drawn the strong support of industry groups such as the Commercial Real Estate Finance Counsel, SIMFA and the American Securitization Forum.

Covered bonds function as a cross between an unsecured corporate bond and an asset-backed security, representing both a direct-recourse obligation of the financial institution that issued the bond, and an obligation secured by a specified pool of assets that remain on the financial institution's balance sheet. They are old (like, centuries old) and safe (well, they are supposed to be). Under H.R. 5823, eligible issuers (including FDIC insured depository institutions, bank holding companies and other approved non-bank financial companies) would be permitted to issue covered bonds secured by a pre-defined set of eligible assets (such as commercial or residential mortgage loans) pursuant to an approved covered bond program.

Although H.R. 5823 (again, which is likely to continue to morph as it works its way through the House and Senate and into the Oval Office) is similar in many respects to the previously introduced versions, there is one key pragmatic difference worth highlighting—a difference that will certainly delay the establishment of a covered bond market in the United States. Representative Melissa Bean (D-Ill.) introduced an amendment in the committee process requiring multiple Federal agencies (instead of the Comptroller of the Currency as originally proposed in H.R. 5823) to jointly establish a covered bond regulatory oversight scheme. Workable? Hardly … it’s a bad idea. Given what Fin Reg has already saddled the agencies with, when will they get around to a jointly produced workable oversight scheme? I am not overly optimistic.

Aside from what H.R. 5823 provides in its current form, the more interesting debate is whether any covered bond legislation will create a robust new alternative source of capital for banks and other eligible financial institutions. With deals getting done in 2009, and several more in the pipeline before year end, it’s not at all clear that issuers will jump on the bandwagon. Although there appears to be investor appetite for covered bonds in the United States, and the structure of covered bonds accomplishes Congress’ desire for skin in the game, it’s just not clear eligible issuers will want to keep all of their skin in this game, or whether a covered bond market will provide a cheaper (or even a cost competitive) source of capital. Only time will tell, assuming H.R. 5823 ultimately becomes law. For our part, we welcome the opportunity to do new types of deals.

The good news for proponents of covered bond legislation is that both the House and the Senate seem interested, at least for now, in passing some form of covered bond legislation. We will continue to monitor this proposed legislation as it works its way through the House and the Senate.

Stay tuned…

By Stewart McQueen.

FSA Consults on Amendments to the Remuneration Code and Extension of its Scope

Fri, 27 Aug 2010 16:02:11 GMT

By: Ian Fraser, Philip J. Morgan, Victoria Green

The FSA has published a consultation paper proposing significant changes to its Remuneration Code, including a major increase in scope from the approximately 27 largest banks, building societies and broker-dealers operating in the UK that are currently covered to over 2,500 FSA-authorised banks, building societies, asset managers, UCITS investment firms and some firms engaged in corporate finance, venture capital, the provision of financial advice and stockbrokers. The asset managers within the scope of the proposed rules are those to which the Markets in Financial Instruments Directive rules apply, other than so-called exempt CAD firms which do not exercise investment discretion.

To view the complete alert online, click here.

Sovereign Debt and Securities Fraud - A Wave Ahead ?

Fri, 27 Aug 2010 12:07:19 GMT

The Conglomerate includes this recent post picking up from from the SEC accusing New Jersey of securities fraud. Among other things, the post ask whether the US may soon see a wave of securities suits against sovereigns regarding their statements when selling debt.

Made for TV Movie Ahead Regarding Bernie Banton's Mesothelioma Death, and the Asbestos-Related Corporate Blunders of James Hardie

Thu, 26 Aug 2010 12:32:18 GMT

Perhaps some day Australia's James Hardie company will end in textbooks as an example of poor handling of risks. For now, James Hardie's investor relations group has a new challenge . The company and its officers and directors already have been through major problems, including convictions for misleading investors. Then it was the subject of a book: Killler Company.

Now, Australia's Daily Telegraph reports that a made for TV movie may be created regarding the mesothelioma death of Bernie Banton, and the related "James Hardie asbestos saga." The article is here. It states:

A tribute to Banton

FREMANTLEMEDIA Australia is developing the James Hardie asbestos saga for a new TV drama, expected to be delivered to the ABC.

An ABC spokeswoman last week confirmed the venture, reiterating it was "in development at this stage and is yet to be commissioned".

The story of James Hardie - specifically the manufacturing company's multimillion-dollar liability payout to former employees as a result of its use of asbestos products - captivated the country the last decade, with stoic campaigner Bernie Banton (who died in 2007) becoming the public face of the David v Goliath battle.

401K Withdrawal or Bankruptcy? Which One Is Better?

Thu, 26 Aug 2010 11:57:02 GMT

As a Consumer and Bankruptcy Attorney, I meet with people everyday to discuss Bankruptcy and other available Consumer remedies. I always tell people not to touch their retirement savings because a 401K and IRA are protected 99.99% of the time when a consumer files for bankruptcy.

Recently, Fidelity released its report on the status of the 401(k) programs that it manages. Some of the highlights, or perhaps better described as lowlights, “(1) participants who borrowed or initiated an application to borrow from their plans reached a 10 year record high and (2) nearly 45% of borrowers who received a hardship withdrawal in the past year took another one this year.”

Texas Rangers Chapter 11 Saga - Lessons Learned?

Wed, 25 Aug 2010 15:11:27 GMT

The Texas Rangers Chapter 11 case is finally winding down, following several weeks of nearly non-stop legal wrangling and high stakes drama. Rangers Baseball Express, LLC (“RBE”), a group fronted by legendary pitcher Nolan Ryan, emerged as the winner following a lengthy and raucous auction.

There are numerous lessons which can be drawn from this fascinating case (particularly regarding professional major league sports franchise bankruptcies). However, one truism especially stands out:

· Chapter 11 provides a highly effective mechanism for expeditiously resolving complex legal and financial logjams when consensus exists among the major parties.

· Chapter 11 also offers an effective forum and provisions that can be used to “cram down” dissenting parties in the absence of such consensus.

· Chapter 11 does NOT, however, readily lead to case resolutions that are both fast AND non-consensual.

To recap quickly: Texas Rangers Baseball Partners (“TRB Partners”), the partnership entity that held the Rangers’ franchise rights from Major League Baseball and all team assets, and Major League Baseball (“MLB”), favored a sale of the team to RBE. The bank lenders owed $525 million by entities (the “HSG Group Entities”) controlled by Tom Hicks, the Rangers’ indirect owner, refused to consent to the sale to RBE because they believed that a higher sale price for the team could be obtained. Because TRB Partners had guaranteed only $75 million of such debt, TRB Partners, MLB and RBE (the “Plan Proponents”) took an aggressive gamble and sought to use a Chapter 11 filing to effect a quick sale of the team without the consent of the lenders. The case was filed together with a plan of reorganization in an effort to avoid a competitive bidding process, on the theory that because all creditors, including the lenders, would be paid in full the amounts directly owed by TRB Partners, the lenders would be deemed to be “unimpaired” under the Plan and thus presumed to accept it.

At first, the aggressive strategy appeared to succeed when Judge Michael Lynn ruled that the plan, with some modifications, could proceed towards confirmation. However, the lenders took steps to force certain of the HSG Group Entities which directly owned TRB Partners (“Rangers Equity”) into bankruptcy as well. Judge Lynn ruled that the Rangers Equity entities would be impaired by the plan, and appointed William Snyder as an independent chief restructuring officer. Snyder was authorized to make the determination as to whether such entities could vote to approve the plan consistent with whatever fiduciary obligations they might owe to the lenders. When he indicated a strong preference for a competitive bid process, the Plan Proponents’ aggressive strategy began to unravel.

The Plan Proponents’ legal strategy was certainly solid, and it is possible that in a non-fast tracked case the plan could have been confirmed over the lenders’ objections. However, the Plan Proponents were looking for as short a journey through Chapter 11 as possible, as they were facing both the intense public scrutiny under which all major league sports teams operate, and the imperatives of the Major League Baseball schedule, including trading deadlines. Accordingly, there was no margin for error in the Plan Proponents’ strategy. Unfortunately, they were opposed by deep pocketed, well-advised and motivated adversaries who had sufficient legal arguments at their disposal to be able to block a quick confirmation. The Plan Proponents wound up with no choice but to accede to an auction as the only viable means for an expeditious exit.

Bankruptcy courts are forums that exist fundamentally to maximize the value of assets. In the absence of truly exigent circumstances, it would essentially fly in the face of one of the primary underlying principles of the Bankruptcy Code to allow a sale to take place over creditor objections where strong evidence existed to show that a competitive bidding process would result in higher and better value. The lenders stated it succinctly in one of their many pleadings:

This extraordinary schedule is not justified by the facts of this case. While this case continues to receive outsized publicity given the Debtor’s industry, it is not Lehman Brothers, Chrysler, GM, or any of the other cases where the debtor’s very existence, or the United States’ economy, hung in the balance. . . The Debtor is fundamentally sound and there is absolutely no need for unreasonable speed to ensure its continued existence – there is no proverbial melting ice cube here.

Ironically, it appears that in the end nearly every party got what it wanted. RBE succeeded in purchasing the team. MLB got its preferred buyer. The lenders that forcefully challenged the process wound up realizing the benefits from a competitive bidding process that maximized the value of the team assets.

Perhaps even more ironically, the amount realized by the lenders in the end appears close to an amount that, by one account, was on the table in the months of negotiations that preceded the case, but that was pulled when the Chapter 11 case was filed and the parties went to war.

Tobacco Wars Continue: California Secretary of State Certifies Ballot Initiative to Raise Tobacco Tax by $ 1 per pack, with Funds to Benefit Cancer Research

Wed, 25 Aug 2010 12:41:06 GMT

Tobacco sales continue today thanks to "big tobacco" long ago obtaining federal law preemption against most product liability claims. The industry strategy was both brilliant and deadly. Then, when litigation risks were closing in from cost recovery lawsuits by the states, the tobacco settlement kept the industry moving ahead as it locked states into enjoying the tax revenue being used to fund state budgets.

So, industry won a couple of times, and therefore people keep smoking and dying. In that light, it's good to see some potential offset ahead from a California ballot initiative to raise tobacco taxes by $ 1 per pack, with proceeds to fund cancer research. The initiative’s website is here.

The initiative was officially certified on August 24, 2010 by the California Secretary of State, as described here. The net result is that the initiative will be on the ballot for the 2012 national election.

The organizers of the initiative would love financial support for the battle ahead to get the initiative passed. Set out below are key excerpts from the Secretary of State’s website:

The Attorney General’s official title and summary of the initiative is as follows:

IMPOSES ADDITIONAL TAX ON CIGARETTES FOR CANCER RESEARCH. INITIATIVE STATUTE. Imposes additional five cent tax on each cigarette distributed ($1.00 per pack), and an equivalent tax increase on other tobacco products, to fund cancer research and other specified purposes. Requires tax revenues be deposited into a special fund to finance research and research facilities focused on detecting, preventing, treating, and curing cancer, heart disease, emphysema, and other tobacco-related diseases, and to finance prevention programs. Creates nine-member committee charged with administering the fund. Summary of estimate by Legislative Analyst and Director of Finance of fiscal impact on state and local government: Increase in new cigarette tax revenues of about $855 million annually by 2011-12, declining slightly annually thereafter, for various health research and tobacco-related programs. Increase of about $45 million annually to existing health, natural resources, and research programs funded by existing tobacco taxes. Increase in state and local sales taxes of about $32 million annually. (09-0097.)

Dead Zone? Direct Claims by Creditors of a California Corporation May Not Lie Against Management Based on Management's Allegedly Shifting Duties When Corporation Is in the Zone of Insolvency or Even Insolvent

updates@antitrustlawblog.com (Sheppard Mullin) — Wed, 25 Aug 2010 12:38:22 GMT

The California Court of Appeal recently rejected the argument that directors and officers owe fiduciary duties to the company's creditors when the company is in the so-called "zone of insolvency," or is even clearly insolvent. In Berg & Berg Enterprises, LLC v. John Boyle, et al., 100 Cal. Rptr. 3d 875 (Cal. Ct. App. 6th Dist. Oct. 29, 2009), the California court expounded that "there is no broad, paramount fiduciary duty of due care or loyalty that directors of an insolvent corporation owe the corporation's creditors solely because of a state of insolvency." Id. at 893-94. The court was even much less inclined to find that directors owed such duties when the corporation is not clearly insolvent but on the brink of insolvency, and held that "there is no fiduciary duty prescribed under California law that is owed to creditors by directors of a corporation solely by virtue of its operating in the 'zone' or 'vicinity' of insolvency." Id. at 893.

It is well settled that directors and officers of a solvent company owe fiduciary duties to act with honesty, loyalty and good faith to the company's shareholders, since the shareholders are the owners of the company and its residual risk bearers. So long as the company remains solvent, the company's obligations to its creditors are governed simply by their contractual arrangement.

When the company becomes insolvent, some courts outside of California have held that management's duties shift to the company's creditors. See, e.g., Geyer v. Ingersoll Publ’ns Comp., 621 A.2d 784, 787 (Del. Ch. 1992) ("When the insolvency exception does arise, it creates fiduciary duties for directors for the benefit of creditors."). The rationale for this shift in the fiduciary duties is that when a company is insolvent, creditors' contract claims are affected by management's decisions in a way they are not outside of insolvency. At the same time, shareholders' interests become essentially worthless. While there are no California cases specifically recognizing this shift, some courts have found it to be an application of the "trust fund doctrine" recognized by the California courts. Under that doctrine, which is typically limited to situations where officers or directors divert, dissipate, or unduly risk corporate assets, an insolvent company's assets are said to be managed as though held in trust for the benefit of its creditors.

Beginning in the 1990's, courts outside of California began to suggest that management's fiduciary duties are owed to creditors not only when insolvency ensues, but also when the company is still technically solvent but within what has been termed as the "zone" or "vicinity" of insolvency. The catalyst for this trend was Chancellor Allen's statement in an unpublished decision in Delaware in 1991. See Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., No. 12150, 1991 Del. Ch. LEXIS 215, *108 (Del. Ch. Dec. 30, 1991) ("At least where a corporation is operating in the vicinity of insolvency, a board of directors is not merely the agent of the residue risk bearers, but owes its duty to the corporate enterprise."). Chancellor Allen expanded on this statement in his now-famous footnote 55, outlining a hypothetical situation in which a board of directors' best course of action would be one that neither stockholders, creditors nor any particular group would prefer, but rather one that would best serve the "community of interests" represented by the corporation. Id. at *108 n.55. Chancellor Allen noted that "the possibility of insolvency can do curious things to incentives, exposing creditors to risks of opportunistic behavior and creating complexities for directors." Id. The proponents of expanding the zone-of-insolvency theory have relied on this footnote to argue that, once the company teeters on the brink of insolvency, the pool of those to whom directors owe their fiduciary duties expands to include the company's creditors.

This concept of a "zone of insolvency" has caused no small amount of consternation among practitioners, judges and commentators alike. For example, how does a company know when it is in the dreaded "zone"? See Prod. Res. Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772, 790 (Del. Ch. 2004) ("[I]t is not always easy to determine whether a company even meets the test for solvency.").

In 2007, the Delaware Supreme Court brought much-needed clarity to this issue, and significantly limited creditors' ability to bring zone-of-insolvency-type claims against the management of Delaware companies, when it announced that "no direct claim for breach of fiduciary duties may be asserted by the creditors of a solvent corporation that is operating in the zone of insolvency." North American Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 101 (Del. 2007).

In California, until the decision in Berg, no published opinion had addressed the issue of whether California law recognizes claims for breach of management's fiduciary duties to creditors either when the company is insolvent or in the zone of insolvency. In Berg, the California Court of Appeal made it clear that such claims cannot lie against the management of a California company.

The Berg Decision

Berg, the largest creditor of a California corporation based in Cupertino, Pluris, Inc. (“Pluris”), sued the directors of Pluris after Pluris had experienced financial difficulties and entered into an assignment for the benefit of its creditors ("ABC") under sections 493.010 and 1802 of the California Code of Civil Procedure.

Berg alleged that prior to the ABC, Pluris and a Berg-related entity were involved in a litigation regarding a lease repudiated by Pluris. The litigation was later settled when Pluris, which was experiencing financial distress, informed Berg that it was in the process of securing outside financing to continue operations and that such financing was conditioned on the settlement of its dispute with Berg. Pluris and the Berg-related entity agreed to a settlement of the litigation that assigned the claim of the Berg-related entity to Berg, making him Pluris' largest creditor. Berg allegedly informed Pluris at the time that, in case Pluris was unable to obtain the financing, Berg had a plan to derive value from Pluris’ net operating losses by reorganizing under the Bankruptcy Code or exploring other alternatives.

Eventually, Pluris could not secure sufficient outside financing, and its directors entered into the ABC instead of pursuing Berg’s plan.

The Trial Court

After several amendments to his complaint, the essence of Berg's claim was that the Pluris directors owed their fiduciary duty to Berg and the other creditors because the company was either insolvent or operating in the "zone of insolvency" at the time the ABC was accomplished. Berg alleged that Pluris' directors breached this duty when they approved the ABC transaction and did not pursue Berg's plan or alternative options that may have preserved the value of Pluris' $50 million net operating loss.

The directors demurred, and the trial court ultimately sustained the demurrer without leave to amend. In its dismissal of Berg's complaint, the trial court relied on a decision by the United States District Court for the Northern District of California interpreting California law. CarrAmerica Realty Corp. v. nVIDIA Corp., Case No. 05-00428, 2006 U.S. Dist. LEXIS 75399 (N.D. Cal. September 29, 2006). The CarrAmerica court had concluded that the trust fund doctrine governs the duties of management of an insolvent corporation in California. The court stated that the scope of this doctrine is limited to cases where directors or officers have "diverted, dissipated, or unduly risked the insolvent corporation's assets" necessary to satisfy' creditors' claims. Such conduct involves self-dealing or prohibited preferential treatment of certain creditors. As such, since Berg failed to point to such misconduct by Pluris' directors, Berg's allegations failed to state a cognizable claim under California law.

On Appeal

The Court of Appeal affirmed the trial court's decision and approved the lower court's reliance on CarrAmerica. In effect, according to the Berg court, under California law, the company's insolvency does not create new duties on part of the directors who continue to be bound by their obligation to refrain from engaging in misconduct, self-dealing or preferential transfers to creditors.

According to the court, there was no misconduct on the part of Pluris' directors when they approved the ABC, which the court described as "a recognized statutory alternative to liquidation through bankruptcy," instead of "investigating, exploring or pursuing a bankruptcy reorganization." Such other alternatives described by Berg were "inherently speculative," the costs and risks of which "would not have been eliminated by discussions with Carl Berg or anyone else."

Further, the court held that even assuming that Berg's complaint pled a cognizable claim, the Pluris' directors would not be liable on alternative grounds. The Court found that the directors would be insulated from liability pursuant to the business judgment rule that immunizes directors when they acted in good faith in what they believed to be the company's best interest and without the presence of conflict of interest. According to the court, Berg made merely conclusory allegations that, without more, failed to rebut the presumption afforded by the business judgment rule.

Closing Thoughts

While the Berg decision is very favorable to directors of California corporations, the Supreme Court of California is yet to opine on the issue, and other appellate courts may hold differently in the future. In addition, a different set of circumstances facing directors charting the troubled waters of insolvency may yield a different result. Lastly, while there have been no California cases holding that directors owed their fiduciary duties to the company's creditors, directors of California companies have been found liable for breaches of fiduciary duties owed to the corporation and its shareholders when their decision to file bankruptcy harmed the value of the company's shares and when they did not consider other alternatives to bankruptcy. See, e.g., Davis v. Yageo Corporation, 481 F.3d 661 (9th Cir. 2007) (directors liable as the bankruptcy filing was a breach of fiduciary duty designed to enable the majority shareholder to acquire the corporation’s assets at less than fair value). Therefore, it remains important for California directors to continue to exercise diligence in weighing the options available to them when their company is insolvent and in considering the impact of these alternatives on all the company's constituencies, including its shareholders and creditors.

Authored By:

Robert Sahyan
(415) 774-3146
rsahyan@sheppardmullin.com

Dead Zone? Direct Claims by Creditors of a California Corporation May Not Lie Against Management Based on Management's Allegedly Shifting Duties When Corporation Is in the Zone of Insolvency or Even Insolvent

updates@antitrustlawblog.com (Sheppard Mullin) — Wed, 25 Aug 2010 12:38:22 GMT

Dead Zone? Direct Claims by Creditors of a California Corporation May Not Lie Against Management Based on Management's Allegedly Shifting Duties When Corporation Is in the Zone of Insolvency or Even Insolvent

updates@antitrustlawblog.com (Sheppard Mullin) — Wed, 25 Aug 2010 12:38:22 GMT

Dead Zone? Direct Claims by Creditors of a California Corporation May Not Lie Against Management Based on Management's Allegedly Shifting Duties When Corporation Is in the Zone of Insolvency or Even Insolvent

updates@antitrustlawblog.com (Sheppard Mullin) — Wed, 25 Aug 2010 12:38:22 GMT

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Dead Zone? Direct Claims by Creditors of a California Corporation May Not Lie Against Management Based on Management's Allegedly Shifting Duties When Corporation Is in the Zone of Insolvency or Even Insolvent

Dead Zone? Direct Claims by Creditors of a California Corporation May Not Lie Against Management Based on Management's Allegedly Shifting Duties When Corporation Is in the Zone of Insolvency or Even Insolvent

Dead Zone? Direct Claims by Creditors of a California Corporation May Not Lie Against Management Based on Management's Allegedly Shifting Duties When Corporation Is in the Zone of Insolvency or Even Insolvent

Dead Zone? Direct Claims by Creditors of a California Corporation May Not Lie Against Management Based on Management's Allegedly Shifting Duties When Corporation Is in the Zone of Insolvency or Even Insolvent