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Court of Chancery Limits Creditor Fiduciary Duty Claims

North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, C.A. No. 1456-N (Del. Ch. September 1, 2006). This is another in a series of Court of Chancery decisions that limit the claims that creditors may make based on the theory the directors owe the creditors a duty when their corporation is insolvent or in the vicinity of insolvency. Ever since the famous footnote in Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., 1991 WL 277613 (Del. Ch. Dec. 30, 1991), creditors have argued that directors should owe them a fiduciary duty to take their interests into account when the creditors are the residual interest holders in a corporation that is insolvent or nearly so. A series of recent decisions have limited those creditor arguments. See e.g. Production Resources Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772 (Del. Ch. 2004) [holding most creditor claims must be brought as derivative claims]. This new decision further limits creditor claims by holding that creditors may not bring a direct claim for breach of fiduciary duty based on the theory the entity is in the vicinity of insolvency. Further, the decision holds that for clearly insolvent companies, only creditors whose claims are beyond fair dispute may claim the directors owe them a duty. This and similar decisions signal that the Court of Chancery does not favor creditor claims against directors. See also Big Lots Stores, Inc. v. Bain Capital Fund VII, LLC, 2006 WL 846121 (Del. Ch. March 28, 2006). After all, creditors may protect themselves through their loan covenants and there are significant difficulties in sorting out the competing interests of stockholders, creditors and others when directors are faced with the particularly difficult problems of insolvency. Note, however, that none of these cases has yet made it to the Delaware Supreme Court. Hence, the final word on creditor rights has not yet been written. Share
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