Hypothetical Company Inc. (HCI) is in desperate need of cash, and its board of directors decides to raise capital by selling some of the company’s underutilized assets. HCI conducts an expedited search for a buyer, but because of the distressed economic environment, cannot find one offering a reasonable price. Nonetheless, the board ultimately decides to accept the only offer received. All of HCI’s equity holders support the proposed transaction, since their equity, in all likelihood, would be wiped out if HCI files bankruptcy, and the cash generated by the asset sale allows HCI to survive a little longer. HCI’s largest creditor, however, vehemently opposes the transaction, claiming the price is insufficient and the assets should be sold in a lengthier process, even if that means filing bankruptcy. Despite the creditor’s opposition, HCI’s counsel concludes that the board faces very little exposure, since all of HCI’s equity holders support the transaction. Is HCI’s counsel correct or misguided?
HCI’s counsel very likely provided incorrect advice or at least did not consider the board’s potential liability broadly enough. As all lawyers know, corporate officers and directors owe fiduciary duties to their corporations. Hence, the right to bring a cause of action against officers and directors for breaches of fiduciary duties belongs to the corporation. In general, only equity holders may derivatively pursue breach of fiduciary duty claims. Creditors, on the other hand, typically lack standing to assert derivative claims, a fact that makes sense given the contractual relationship between the company and its creditors. Unlike equity holders, creditors have the ability to protect themselves through the negotiation process and ultimately by requiring protective provisions in their agreement with the company.
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