Chapter 11 is designed to enable a company in financial distress to preserve its business as a going concern and maximize the distributable value to creditors. This may be accomplished through the debtor's rehabilitation of its business and restructuring of its balance sheet through a stand-alone plan of reorganization or through the sale of its assets or businesses pursuant to section 363 of the Bankruptcy Code (or a Chapter 11 plan). The best course of action to preserve the debtor as a going concern and maximize value is dependent on the facts and circumstances of the Chapter 11 case and the interests of the relevant stakeholders.
During a Chapter 11 case, the interests of the debtor's main constituencies -- eg, secured lenders, unsecured creditors, management and employees -- often conflict. For example, the secured lenders may want a prompt sale of the business to assure that its value is maintained and they are repaid (partially or in full) as soon as practicable. On the other hand, the debtor's unsecured creditors and management team may be desirous of a longer Chapter 11 case. This desire in fueled by the hope that, as time goes on, the value of the business will increase (which would maximize distributions to unsecured creditors) and the Chapter 11 case may be effectuated through a stand-alone restructuring (which would increase the likelihood that the management team keeps its job).A debtor's board of directors is responsible for making the major decisions in a Chapter 11 case. These decisions, which must be consistent with the goal of preserving the debtor as a going concern (if possible) and maximizing value of the debtor's estates, are subject to bankruptcy court approval. A board's adherence to non-bankruptcy corporate governance standards will insulate its decisions from being second-guessed by the bankruptcy court.
It is widely known that members of a board of directors have fiduciary duties. Specifically, directors have a duty of care and a duty of loyalty. The duty of care requires that directors 1) take informed actions after considering all reasonably available material information and 2) exercise the care that a reasonably prudent person would exercise under similar circumstances. The duty of loyalty requires that directors act in good faith and in the reasonable belief that the action taken is in the best interests of the corporation and on the basis of independent and disinterested judgment. If these duties are fulfilled, decisions made by directors generally will be protected by the "business judgment rule" -- a judicially created presumption that in making a business decision, a director of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company -- and , therefore, approved by the bankruptcy court.
In a Chapter 11 case, directors must fulfill their duties in the midst of a multi-party negotiation (or litigation) to determine the redistribution of value among creditors (and sometimes shareholders) of the distressed company. The Chapter 11 process is fast-paced and fluid, and parties in Chapter 11 cases are not shy about expressing their self-interested views or threatening litigation. As a result, the task faced by directors of deciding on the best course of action is daunting. Directors require guidelines for establishing a process that will enable them to make reasonable and defensible decisions. A recent decision in In re Global Crossing Ltd., a Chapter 11 case pending in the United States Bankruptcy Court for the Southern District of New York, provides a guide for directors faced with the task of determining the appropriate course of action for a Chapter 11 debtor.
In re Global Crossing Ltd.
On Jan. 28, 2002, Global Crossing Ltd. Commenced voluntary Chapter 11 cases in the United States Bankruptcy Court for the Southern District of New York. In re Global Crossing Ltd., Case No. 02-40188 (REG). On August 9 of that year, the Bankruptcy Court approved a purchase agreement (the Purchase Agreement) among Global Crossing Ltd., Global Crossing Holdings Ltd. (collectively, Global Crossing), joint provisional liquidators, Hutchison Telecommunications Limited (Hutchison) and Singapore Technologies Telemedia Pte Ltd. (STT), which provided for the sale of 61.5% of the equity of reorganized Global Crossing to Hutchison and STT for $250 million. The Purchase Agreement provided the foundation for Global Crossing's plan of reorganization, which was confirmed by the Bankruptcy Court on Dec. 26, 2002.
The Purchase Agreement was contingent on obtaining various regulatory approvals by April 30, 2003; however, the required approvals were not forthcoming. As a result, Hutchison exercised its contractual rights and withdrew as an investor. STT exercised its contractual right to make the entire investment itself; nonetheless, it was not bound to close because the regulatory approvals had not been granted prior to the April 30, 2003 deadline set forth in the Purchase Agreement. Meanwhile, a third-party expressed an interest in purchasing Global Crossing. These actions required Global Crossing to determine the best way to proceed. Its three principal options included:
- terminating the Purchasing Agreement and reopening the auction process;
- continuing the process with STT, although STT would not be bound to close, or
- entering into an amendment of the Purchase Agreement, binding both Global Crossing and STT to close (subject to a fiduciary out for Global Crossing's board of directors).
The board of directors decided that entering into the amendment was the best course of action based on the following.
Consultation. The board of directors consulted with, among others, 1) its financial advisors and attorneys, 2) its holders of bank debt and unsecured creditor constituencies, and 3) its management team.
Understanding. The board of directors discussed in detail and had a proper understanding of its fiduciary duties, particularly, its duty to maximize the value of the estates, while taking into account the interests of its creditor constituencies.
Consideration. The board of directors considered its options at length. In doing so, it considered the views of the management team and its creditor constituencies (understanding that such views may not be entirely objective).
Specifically, the board considered the following:
the value of "locking down" STT's commitment (i.e., "a bird in the hand is worth two in the bush");
- the cost and risk of a new auction;
- its reluctance to turn away from the confirmed plan of reorganization and related settlements of inter-creditor disputes;
- the costs and delays of focusing on a new plan of reorganization and the attendant actions related thereto;
- Global Crossing's liquidity issues;
- that entering into the amendment would not preclude Global Crossing from entering into a better deal;
- the relative regulatory risks of a deal with STT or a third party; and
- the support of the creditors' committee.
The Bankruptcy Court determined that the factors that the board of directors considered were reasonable and were considered in a rational manner. The holders of bank debt and the potential purchaser disagreed and objected to Global Crossing's decision to enter into the amendment, stating that, "given the risks involved," the decision was not reasonable. The Bankruptcy Court explained that Global Crossing's decision was subject to the "business judgment rule." The business judgment rule "is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. This presumption protects boards of directors from "judicial second-guessing when the following elements are present: i) a business decision, ii) disinterestedness, iii) due care, iv) good faith and v) no abuse of discretion or waste of corporate assets." In that regard, "courts are loathe to interfere with corporate decisions absent a showing of bad faith, self-interest, or gross negligence."
The Bankruptcy Court also eloquently articulated that:
"[T]he issue, as the court sees it, is whether in making the decision it did, the [b]oard [of directors] acted with the requisite care, disinterestedness and good faith in the effort to maximize value -- rather than whether this or any other court would necessarily make the same business decision, on the one hand, or seek to maximize value in a different way, on the other. . . In the absence of failures to comply with the key duties -- the requisite care,, disinterestedness and good faith -- [case law does] not authorize bankruptcy courts to dictate the means to achieve that objective, nor, in particular, [does it] provide authority for a court to substitute its business judgment as the appropriate means for that of a board. Efforts to maximize value not infrequently require choosing one of a number of options, more than one of which may be reasonable."
In applying the business judgment rule to the board of directors' decision to enter into the amendment, the Bankruptcy Court began by noting the Global Crossing established an extensive process for making the decision. Notably, the Bankruptcy Court stated that "[f]aced with uncertainties no matter which option the [b]oard might choose, [Global Crossing] employed a process that maximized their ability to make a sound decision." The Bankruptcy Court explained that the directors were "mindful of their duties, employed the right standard, solicited the input of their professional advisors. . . ; deliberated; and made their decision based on a lengthy consideration of the relevant facts and options." The Bankruptcy Court also found that the board of directors was "appropriately disinterested." In authorizing Global Crossing to enter into the amendment, the Bankruptcy Court provided:
"[T]his ruling is simply that [Global Crossing] exercised perfectly reasonable judgment, fully in compliance with the requirements of applicable law, in locking in their deal with STT -- even though continuing with STT is not without risk -- and in choosing not to abandon the attractive deal they had for one that might or might not be more attractive, if it could be secured at all."
The Global Crossing decision clearly elucidates lessons for directors faced with the task of making decisions that will affect the future of a debtor's business operations and the value to be distributed to creditors. These lessons will help directors, together with their advisors, to devise a roadmap for making these decisions. The major lessons are as follows:
Be mindful of your duties and employ the right standard
The fiduciary duties of a board of directors of a Chapter 11 debtor are the duties of care and loyalty. These duties run to both creditors and shareholders. The overall duty of the board of directors is to act with care, disinterestedness and in good faith in an effort to preserve the debtor's business as a going concern and maximize the value of the debtor's estates. To the extent the board does this, its decisions should be protected by the business judgment rule and should not be "second-guessed" by a bankruptcy court.
Solicit input from your professionals
Companies in Chapter 11 retain professionals to advise them on all aspects of their cases. The board of directors should work closely with these professionals, soliciting input on the board's duties, the facts and circumstances surrounding the relevant decision to be made, the various options the board should consider and the impact of such decisions on the debtor's business operations and the value of the debtor's estates. This solicitation will provide the board of directors with all pertinent information and allow the board of directors to consider all options, risks and benefits when making a decision.
Consult with major constituencies, but maintain an independent role
The decisions made by the board of directors will impact the debtor's various constituencies. As such, they should be consulted (most often this occurs through communications between professionals, which are then relayed to the board of directors) to determine their views and desires. Although the major constituencies (eg, secured lenders, creditors' committee and management) should be consulted, the board of directors should be mindful that each constituency has its own agenda and actions should not be taken solely because one constituency demands it. Rather, the board of directors should make independent decisions based on all relevant facts and circumstances, including the views of all major constituencies.
Engage in extensive deliberations
The major decisions to be made by a debtor's board of directors are important and complex, and will be carefully observed by the debtor's major constituencies. In addition, the options to consider may be plentiful and more than one may be reasonable. As a result, the board of directors should engage in extensive deliberations, considering all pertinent facts and options, before making a decision. Adequate minutes and other records memorializing those deliberations are also essential. Once the board of directors has sufficiently deliberated, in consultation with the debtor's advisors, it should make a decisions that it believes will establish the means for preserving the debtor as a going concern and maximizing the value of the debtor's estate.
The Global Crossing decision teaches that if the board of directors adheres to the foregoing lessons and establishes a process that will enable it to make reasoned, independent and well-supported decisions, it should not be second-guessed by a bankruptcy court.
REPRINTED WITH PERMISSION FROM THE DECEMBER 2003 EDITION OF THE BANKRUPTCY STRATEGIST c 2003ALM PROPERTIES, INC. ALL RIGHTS RESERVED. FURTHER DUPLICATION WITHOUT PERMISSION IS PROHIBITED.