In normal circumstances, a director’s primary duty (owed to the company, not the company’s shareholders or the corporate group) is to promote the success of the company for the benefit of its shareholders as a whole. When a company enters a period of financial distress (the so-called “zone of insolvency”) there is a shift of emphasis in the duties of the directors: directors must consider the interests of the company’s creditors and, depending on the extent of the financial distress, may need to prioritise such interests over those of its members.

When a company enters a period of financial distress, directors must consider the interests of the company’s creditors and, depending on the extent of the financial distress, may need to prioritise such interests over those of its members. In such distressed situations, the key current heads of liability directors may face (for which they may potentially incur personal liabilities) include wrongful trading, fraudulent trading, misfeasance and breach of duty.

On April 23, 2019, Ropes & Gray, representing a large group of shareholder defendants, won a decision in the U.S. District Court for the Southern District of New York that provides potential fraudulent transfer protection for payments made to shareholders in leveraged buyouts, stock redemptions and other securities transactions.

Constructive Fraudulent Transfer Claims and the Securities Safe Harbor

On February 27, 2018, the U.S. Supreme Court issued a ruling that will make it easier for bankruptcy trustees, creditors’ committees, and other bankruptcy estate representatives to claw back payments made to shareholders in leveraged buyouts and dividend recapitalizations.

Constructive Fraudulent Transfer Claims and the Securities Safe Harbor

On August 26, 2014, in the case In re MPM Silicones, LLC, Case No. 14-22503 (Bankr. S.D.N.Y.) (“Momentive”), the United States Bankruptcy Court for the Southern District of New York held that secured creditors could be “crammed down” in a chapter 11 plan with replacement notes bearing interest at substantially below market rates.

In an important decision for private equity sponsors and other insiders who advance loans to their businesses, on April 30, 2013, the Ninth Circuit Court of Appeals in In re Fitness Holdings International confirmed that bankruptcy courts may recharacterize debt as equity, but held that recharacterization is determined by state law. In its ruling, the Ninth Circuit joins the U.S. Court of Appeals for the Fifth Circuit in deferring to state law on this issue and explicitly rejects the various federal law based tests that have been adopted by a majority of U.S.