Delaware Court Holds that Creditors Have No Direct Cause of Action Against Directors of Company Operating in the Zone of Insolvency for Breach of Fiduciary Duty
On May 18, 2007, the Supreme Court for the State of Delaware (the "Court") held that a creditor of a corporation that is operating within the zone of insolvency may not bring a direct action against the corporation's directors for a breach of fiduciary duty under Delaware law. The Court agreed with the lower court that (i) the creditors' existing protections, including negotiated agreements, security instruments, implied covenant of good faith and fair dealing, fraudulent conveyance law and bankruptcy law make an additional layer of protection in the form of a direct cause of action for breach of fiduciary duty unnecessary and (ii) allowing creditors a direct cause of action against the directors may undermine the corporation's ability to vigorously negotiate with its creditors at a time when the corporation may most need that ability.
Accordingly, the Court held that while in the zone of insolvency, "directors must continue to discharge their fiduciary duties to the corporation and its shareholders by exercising their business judgment in the best interests of the corporation for the benefit of its shareholder owners." Noting that a corporation's insolvency "makes the creditors the principal constituency injured by any fiduciary breaches that diminish the firm's value", the Court did, however, note that creditors have standing to bring derivative claims against directors on behalf of the corporation for breaches of fiduciary duty. See North American Catholic Educ. Programming Found., Inc. v. Gheewall, et al., No. 521, 2006 (Decided May 18, 2007).
By: Mary Johnson
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