In North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, the Delaware Supreme Court, in a case of first impression, addressed the ability of creditors to assert claims for breach of fiduciary duty against directors of a Delaware corporation that is insolvent or operating within the zone of insolvency. The Court unequivocally held that, as a matter of law, a creditor cannot assert a direct claim in either situation and that, when a corporation is insolvent, a creditor can only assert a derivative claim for breach of fiduciary duty against the corporation’s directors. See Gheewalla, 2007 Del. LEXIS 227, 24-25, 31-32 (Del. May 18, 2007).
One of the questions that remains unanswered in the Court’s opinion is whether a creditor can assert derivative claims for breach of fiduciary duty against directors when the corporation is operating within the zone of insolvency. While the Court did not specifically address this issue, the Court strongly suggested that creditors are precluded from asserting derivative claims in such situation. First, the Court observed that, in questioning whether it was necessary for creditors to have a right to assert claims for breach of fiduciary duty against directors of a corporation operating within the zone of insolvency, the Delaware Court of Chancery in several cases noted that creditors already have specific legal protections through “their negotiated agreements, their security instruments, the implied covenant of good faith and fair dealing, fraudulent conveyance law, and bankruptcy law.” Id., at 23 (citing North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 2006 WL 2588971, at *13 (Del. Ch. Sept. 1, 2006); Production Resources Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772, 790 (Del. Ch. 2004); Big Lots Stores, Inc. v. Bain Capital Fund VVI, LLC, 2006 WL 846121, at *8 (Del. Ch. Mar. 28, 2006)). Second, the Court pointedly noted that directors of a Delaware corporation owe their fiduciary duties to the corporation’s shareholders and that such duties do not change when a corporation begins to operate within the zone of insolvency. The Court stressed that “[w]hen a solvent corporation is navigating 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.” Id. at 25 (emphasis added). Finally, the Court stressed that insolvency, and not the zone of insolvency, is the dividing line when derivative claims of breach of fiduciary duty shift from the stockholders of a corporation to its creditors.
“When a corporation is solvent, [directors’] fiduciary duties may be enforced by its shareholders, who have standing to bring derivative actions on behalf of the corporation because they are the ultimate beneficiaries of the corporation’s growth and increased value. When a corporation is insolvent, however, its creditors take the place of the shareholders as the residual beneficiaries of any increase in value.” Id., at 26 (emphasis in original).
As a result, the Court’s highlighting of the existing legal protections available to creditors, the Court’s strong focus on the fiduciary duties owed by directors to the corporation’s shareholders, and the Court’s emphasis on creditors’ ability to enforce derivate claims only after a corporation’s insolvency all strongly suggest that the Court views creditors as having no right to bring derivative claims for breach of fiduciary claims against directors of a corporation that is operating within the zone of insolvency.
The Court’s opinion in Gheewalla provides definitive guidance to boards of Delaware corporations that are insolvent or operating within the zone of insolvency, including those considering a sale or comparable transaction involving a change of control of the corporation. While a Delaware corporation is operating within the zone of insolvency, directors owe fiduciary duties to the corporation’s stockholders and must exercise their business judgment in the best interests of the corporation and its stockholders. After a Delaware corporation becomes insolvent, directors continue to owe the same fiduciary duties, but the corporation’s creditors replace its stockholders as the primary constituency affected by any breach of such duties. As a result, as long as directors of an insolvent corporation continue to make business judgments that are in the best interests of the corporation and its constituencies, creditors of the corporation will have difficulty successfully asserting any claim of breach of fiduciary duty.