In Quadrant Structured Products Company, Ltd. v. Vertin, 115 A.3d 535 (Del. Ch. May 4, 2015), the Delaware Court of Chancery denied defendants’ motion for summary judgment, held that Delaware law imposes neither a continuous insolvency nor an irretrievable insolvency requirement, and found sufficient evidence in the record to support a reasonable inference that the debtor corporation was insolvent on the date the complaint was filed. In so holding, the Court provided an in-depth analysis of creditor derivative standing following the Delaware Supreme Court’s decision in N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007).
The individual defendants are members of the board of directors of the corporate debtor, Athilon Capital Corp. Athilon’s equity is wholly owned by defendant Merced Capital LP. Plaintiff Quadrant Structured Products Company, Ltd. is an owner of debt securities issued by Athilon. In this action, Quadrant alleged that following Merced’s acquisition of Athilon, the board took numerous actions to benefit Merced at the expense of Athilon’s other stakeholders. In February 2015, the defendants moved for summary judgment on the theory that Athilon had returned to solvency and Quadrant therefore had lost standing to pursue any derivative claims.
The Court first analyzed in depth Delaware law on creditor breach of fiduciary duty claims, both before and after Gheewalla. The Court concluded that Gheewalla and the cases following it implemented a new regime in evaluating such claims. The current regime holds that there is no longer any zone of insolvency, no cause of action for deepening insolvency, and no fiduciary duties owed directly to creditors. Therefore, after Gheewalla, there is no need under Delaware law for derivative standing hurdles that may be “unnecessary and counterproductive impediments to the effective use of the derivative action as a meaningful tool for oversight.” Directors of Delaware corporations are already sufficiently protected by other aspects of Delaware law.
In addressing defendants’ argument that Delaware law should recognize a continuous insolvency requirement, the Court also looked to the purposes of a derivative action. Derivative suits are intended to remedy wrongdoing by directors and allow equitable owners to increase the company’s value. Creditors share each of those incentives when a company is insolvent, and continue to have such incentives as long as they remain a creditor of the company. Thus, the Court concluded that the proper analogy in the creditor derivative context is a continuous creditor requirement, not a continuous insolvency requirement. In addition, the Court found that depriving creditors of standing to pursue derivative claims on behalf of a company that goes back and forth over the insolvency line while the equity is owned entirely by one stockholder would lead to a “failure of justice” because conflicted fiduciaries could prevent the corporation or its stockholders from pursuing valid claims.
For these reasons, among others, the Court held that “to maintain a derivative claim, the creditor-plaintiff must plead and later prove that the corporation was insolvent at the time suit was filed. The creditor-plaintiff need not, however, plead and prove that the corporation was insolvent continuously from the time of suit through the date of judgment.” Finally, the Court also held that the proper test to assess creditor derivative standing at the time the litigation is filed is to determine whether the company “has liabilities in excess of a reasonable market value of its assets.” While this test potentially conflicts with certain passages quoted in Gheewalla, which were originally written in the receivership context, the Court drew a distinction between claims in the receivership setting and fiduciary duty claims of creditors. Using this test, Quadrant’s showing that Athilon’s GAAP balance sheet showed a $300 million negative equity value was sufficient to create an issue of material fact as to Athilon’s solvency at the time suit was filed.