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Court of Chancery Rejects Deepening Insolvency Theory

Trenwick America Litigation Trust v. Ernst & Young LLP, C.A. No. 1571-N, 2006 WL 2333201 (Del. Ch. Aug. 10, 2006). The Delaware courts have struggled for the last fifteen years over the scope of the duties of directors to creditors when their company is in the vicinity of insolvency. In two landmark decisions, the first in 2004, and just recently, the Court of Chancery sought to define the limits of that duty. Indeed, in this decision the Court rejected the very idea that there is a duty to avoid taking risks that may have the effect of deepening the insolvency of a Delaware corporation, at least in most circumstances. In Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., 1991 WL 277613 (Del. Ch. Dec. 30, 1991), the Court of Chancery suggested that when a corporation approached insolvency the board of directors might have a duty to preserve its assets for the benefit of its creditors and not take business risks that would benefit the equity holders. When that would actually occur has been the subject of endless debate. In Production Resources Group L.L.C. v. NCT Group. Inc., 863 A.2d 772 (Del. Ch. 2004), Vice Chancellor Strine began the process of refining the dicta in Credit Lyonnais. He has now continued that process in an exhaustive discussion of the theory behind holding directors responsible for decisions that may risk the capital of corporations when the company already cannot pay its debts. The Trenwick decision reflects the wisdom of not restricting the business judgment of directors even when their company has financial problems. The Court has ruled that such decisions taken in good faith are entitled to the same respect under the business judgment rule. Thus, at least in cases where the board has no conflict of interest, it will continue to be the very rare case where a director is held personally responsible for his or her business decisions. The Trenwick decision is also important for its conclusion that the directors of a wholly owned subsidiary are not liable for following the directions of the parent entity, at least when those instructions are not blatantly improper, because their duty is to the parent, the stockholder of their corporation. Share

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