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When a startup faces financial distress Delaware state law imposes specific obligations on company officers. These officers have fiduciary duties of care and loyalty, requiring them to make well-informed decisions that prioritize the company’s interests over their own.
For solvent companies, these duties extend to both the corporation and its shareholders. However, when a company becomes insolvent and cannot meet its creditor obligations, officers continue to owe these duties to the company and creditors gain the ability to file derivative lawsuits if those duties are breached.
In insolvency, the focus shifts to maximizing the company’s value, which can take various forms. In some cases this might involve continuing operations to secure a lucrative sale, while in others, it could mean a swift shutdown to preserve cash. Given the complexity of these situations it’s essential to seek tailored legal guidance.
If the decision is made to close the company, several paths are available, each with distinct implications: informal wind-down, corporate dissolution, assignment for the benefit of creditors (ABC), Chapter 7 bankruptcy, or Chapter 11 bankruptcy. The presence of debts to banks or creditors, particularly their ability to foreclose on assets, can significantly influence the choice.
1. Informal Wind-Down: This involves selling off the company’s assets, laying off employees, and ceasing operations without formally dissolving the corporation. It’s a less structured approach that avoids formalities but may leave the company’s legal status unresolved.
2. Corporate Dissolution: A formal process where a company officer oversees the liquidation of assets and the termination of the company’s legal existence. This option suits companies that don’t require bankruptcy protection but seek an orderly, legal closure.
3. Assignment for the Benefit of Creditors (ABC): Recognized in states like California and Delaware, this formal process involves transferring the company’s assets and liabilities to a professional fiduciary, known as the Assignee, without court involvement. The Assignee liquidates assets to benefit creditors who are notified to submit claims. If a buyer is lined up an asset sale can occur shortly after the ABC is initiated.
4. Chapter 7 Bankruptcy: This public filing with the U.S. Bankruptcy Court places a trustee in control of the company’s assets. The trustee liquidates all assets, terminates remaining employees, and may pursue litigation to recover preferential transfers. An automatic stay halts creditor actions, such as foreclosures or lawsuits.
5. Chapter 11 Bankruptcy: Also a public filing, Chapter 11 allows the company’s board to retain control of assets while operations often continue. This process, which is costlier, typically requires debtor-in-possession (DIP) financing or use of a lender’s cash collateral. A key feature is the ability to sell assets “free and clear” of liens through a court-approved process under Section 363 of the Bankruptcy Code.
Choosing the right path depends on the company’s specific circumstances, including its financial position, creditor obligations, and operational goals. Consulting with experienced corporate counsel like Louis Lehot is critical to ensure compliance with fiduciary duties and to select the most appropriate course of action.