Many startups funded by venture capitalists may face the harsh reality of running out of money. While some of the lucky ones will lock in another round of financing, others, to put it bluntly, will not. Fortunately, in Delaware, there are many options for those startups who lose out on investor funding.
First of all, company officers have inchoate fiduciary duties relating to Delaware corporations struggling financially. In fact, according to Delaware state law, officers owe fiduciary duties of due care and loyalty to make informed decisions in the very best interests of the company - not their own personal interests.
When a company is solvent, officers owe these fiduciary duties to the corporation and its stockholders. However, if a company is insolvent and unable to pay its creditors, the officers still owe their fiduciary duties to the company. Additionally, when insolvent, the creditors even have the right to bring derivative claims for breach of fiduciary duty against officers.
Discharging fiduciary duties when a company is insolvent makes you focus on maximizing value, which can mean many things. Sometimes, maximizing value might translate to continuing operations for the company to complete a valuable sale. While in other cases, it may mean shutting down quickly to conserve cash.
Because of these unique scenarios, it is critical to seek legal advice specific to the situation. When the final decision is made that the company needs to wind down, options include an informal approach to a bankruptcy filing or an assignment for the benefit of creditors, or ABC. Keep in mind that if the company owes money to a bank or creditor, the lender's right to foreclose on the company's assets could become a pivotal factor to consider. There are several avenues to consider, including Informal wind down; corporate dissolution; ABC; Chapter 7 bankruptcy, and; Chapter 11 bankruptcy.
First, in an informal wind down, the company typically tries to find a buyer for its assets, eventually lays off its employees, and shuts down unsold business operations, but does not complete a formal end to the corporate existence.
Second, a corporate dissolution is a formal process typically managed by a company officer, which involves winding up the corporation's affairs, liquidating assets, and ending the company's legal existence. When a company doesn't need bankruptcy protection but wants a formal, legal winddown, a company may choose to do a corporate dissolution.
Third, many states in the U.S., like California and Delaware, recognize a formal process where a company can hire a professional fiduciary and make a general assignment of the company's assets and liabilities to that fiduciary, known as the Assignee, without a court filing. The Assignee is then charged with liquidating the company's assets for the benefit of creditors, who are notified of the ABC process and instructed to submit claims to the Assignee. If a buyer has been identified, an Assignee may close an asset sale soon after the ABC is made.
Fourth, a Chapter 7 bankruptcy is a public filing with the U.S. Bankruptcy Court, where a bankruptcy trustee is appointed to take control of all of the company's assets. This approach tends to terminate any remaining employees and liquidates all assets of the company. The filing triggers the automatic bankruptcy stay, which prevents secured creditors from foreclosing on the company's assets and from pursuing lawsuits. In this approach, the trustee can bring litigation claims on behalf of the corporation to recover preferential transfers.
And lastly, a Chapter 11 bankruptcy is a public filing with the U.S. Bankruptcy Court that triggers the automatic bankruptcy stay. Unlike a Chapter 7 bankruptcy, in Chapter 11, the board stays in control of the company's assets. And operations often continue, and the higher cost of the Chapter 11 process requires DIP financing or the use of a lender's cash collateral. Selling assets "free and clear" of liens, claims, and interests through a Bankruptcy Court-approved sale process under Section 363 of the Bankruptcy Code is the primary use of Chapter 11.
Determining which of these paths is best for a particular company depends on several factors.
So, be sure to get reliable legal advice from corporate counsel before making your decision.
Originally published by The Thrive Global on the 28th of January, 2021.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.