Last week, Judge Kevin Gross of the U.S. Bankruptcy Court for the District of Delaware further interred the concept that directors of Delaware corporations can be held liable for good faith decisions that ultimately worsened the condition of the enterprise and resulted in bankruptcy or insolvency. In dismissing causes of action against the directors of Midway Games, Inc., Judge Gross followed a strong line of recent Delaware state (Trenwick Am. Litigation Trust v. Ernst & Young, LLP, 906 A.2d 168 (Del. Ch. 2006), aff’d, 931 A.2d 438 (Del. 2007); North America Catholic Programming Foundation, Inc., v. Gheewalla, 930 A.2d 92 (Del. 2007)) and federal (In re Radnor Holdings Corp., 353 B.R. 820 (Bankr. D. Del. 2006); In re Fedders North America, Inc., 405 B.R. 527 Bankr. D. Del. 2009)) cases that for all intents and purposes have eliminated the idea of liability for "deepening insolvency".
The suit against the Midway Games directors alleged breaches of their duty of care and duty of loyalty arising from their approval of certain loan transactions between Midway Games and its controlling shareholder in the months prior to Midway Games’ bankruptcy filing. Judge Gross noted, however, that the plaintiff Creditors’ Committee did not allege either that the transactions themselves were unfair or that they profited the board members in any way. The gravamen of the complaint, therefore, was that Midway Games should have sought bankruptcy protection sooner than it did instead of obtaining the loans. "The Court finds that the duty of care claims are in reality claims of deepening insolvency and are not sustainable." To Judge Gross, the clear import of the state and federal precedents make clear, even when a corporation is insolvent, both that "the business judgment rule protects good faith, disinterested business decisions", and that directors of Delaware corporations "do not have a duty to protect creditors of an insolvent corporation at the expense of the corporation and its shareholders."
The opinion granting the directors’ motion to dismiss includes an interesting coda, in which Judge Gross disclaimed any view regarding the wisdom of the extensive protections provided to directors of Delaware corporations. "The decision [to dismiss] is not an endorsement of any of the Defendants’ actions. The Defendants oversaw the ruin of a once highly successful company, only to hide behind the protective skirt of Delaware law, which the Court is bound to apply."