Six Considerations for Directors Navigating Distressed M&A

When a company faces financial distress or insolvency, its board of directors faces heightened scrutiny. Actions taken during this critical period are more likely to be second-guessed in hindsight by creditors, shareholders, and courts. Observing proper fiduciary duties and following appropriate governance processes are particularly important in distressed M&A transactions.

The following considerations can help directors balance stakeholder interests while minimizing legal exposure and maximizing enterprise value in distressed transactions.

1. Understand Fiduciary Duties and Maximize Enterprise Value

Directors of insolvent companies or those operating in the “zone of insolvency” remain subject to the same fundamental fiduciary duties as directors of solvent corporations: care, loyalty, and good faith. However, directors of an insolvent company must also consider creditors’ interests because creditors become the residual beneficiaries and may gain standing to bring fiduciary breach claims.

The primary focus should be maximizing the value of the enterprise for the benefit of all stakeholders. This often requires balancing competing interests while maintaining a clear focus on overall value preservation and enhancement.

2. Prioritize Disclosure, Transparency, and Conflict Management

Full disclosure of potential conflicts is essential. Boards should consider appointing experienced, independent directors to ensure that conflicts do not compromise the process and leave board decisions open to second-guessing in the future. In some cases, it may be necessary to establish and empower a special committee of independent directors for this purpose.

Document all deliberations thoroughly. Courts frequently review board minutes and supporting materials when evaluating whether directors fulfilled their fiduciary obligations. A well-documented record demonstrating thoughtful consideration of alternatives can provide crucial protection against future challenges.

3. Consider All Alternatives and Test the Market

Obtain all material information, and explore all alternatives thoroughly. Consider conducting a market test to ensure that the company is getting the best possible deal under the circumstances. This step is particularly important when the proposed transaction involves insiders or parties with relationships to directors or major stakeholders. Courts often look more favorably on boards that have conducted robust market checks and can demonstrate that they explored multiple options before selecting a course of action.

4. Realistically Stress-Test Liquidity and Timing

Timing is critical in distressed situations. The board should carefully assess the company’s runway to consummate a transaction, particularly if market conditions are suboptimal. Developing realistic projections for available liquidity and understanding how long the company can continue operations are essential for making informed decisions.

5. Focus on Valuation and Distribution Compliance

To maximize value, engage valuation experts and transaction advisers experienced with distressed M&A. When considering distributions, carefully evaluate lien priority, claim priority, contract counterparty rights, and statutory requirements. Analyze and implement compliance with governance documents and applicable law to mitigate potential clawback challenges. Even seemingly routine distributions can become the subject of litigation in bankruptcy scenarios if proper procedures are not followed.

6. Engage the Right Experts

Retain qualified financial advisers, legal counsel with restructuring experience, and other specialists as needed to help assess options, define processes, and guide implementation. The right advisers can help boards understand complex restructuring alternatives, negotiate with creditors, and execute transactions that maximize value while minimizing legal exposure.

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee a similar outcome.