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As anyone who has been involved in an effort to sell a troubled company can tell you, it’s an extremely stressful process, particularly for members of the board who know that every decision they make is likely to be second-guessed by creditors and shareholders and closely scrutinized by a court. This brief Goodwin memo highlights some of the things that boards should keep in mind as they manage the sale process for a distressed company.  This excerpt discusses fiduciary duty issues and the need for transparency, disclosure and conflicts management:

– Understand Fiduciary Duties and Maximize Enterprise Value.  Directors of insolvent companies or those operating in the “zone of insolvency” remain subject to the same fundamental fiduciary duties as directors of solvent corporations: care, loyalty, and good faith. However, directors of an insolvent company must also consider creditors’ interests because creditors become the residual beneficiaries and may gain standing to bring fiduciary breach claims.

The primary focus should be maximizing the value of the enterprise for the benefit of all stakeholders. This often requires balancing competing interests while maintaining a clear focus on overall value preservation and enhancement.

– Prioritize Disclosure, Transparency, and Conflict Management. Full disclosure of potential conflicts is essential. Boards should consider appointing experienced, independent directors to ensure that conflicts do not compromise the process and leave board decisions open to second-guessing in the future. In some cases, it may be necessary to establish and empower a special committee of independent directors for this purpose.

Document all deliberations thoroughly. Courts frequently review board minutes and supporting materials when evaluating whether directors fulfilled their fiduciary obligations. A well-documented record demonstrating thoughtful consideration of alternatives can provide crucial protection against future challenges

Other topics addressed in the memo include the need to consider all alternatives and test the market, the importance of realistically stress-testing liquidity and its impact on deal timing, and the requirement for the board to focus on valuation and compliance with contractual and other obligations when it comes to distributions of the sale proceeds.

– John Jenkins