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Markkula Center for Applied Ethics

Insolvency, Bankruptcy, and the Board

Risk, Rules, and Realities

Timothy J. Harris

Background and Overview

A presentation by Timothy J. Harris of Morrison & Foerster LLP to the Silicon Valley Chapter of the National Association of Corporate Directors on October 15, 2009.

Before a struggling company reaches insolvency, decides to seek bankruptcy protection, or decides to make a general assignment for the benefit of creditors, its board of directors must address a number of issues that, if ignored or inappropriate addressed, may result in litigation or personal liability.

This presentation provides practical suggestions and tips in observing fiduciary duties; entering the "zone of insolvency"; avoiding pitfalls in recapitalizations, pay-to-play financings, and down rounds; and advice on the wisdom and timing of resigning from the board of directors.

Ethical Issues and Challenges

When a company is struggling, the organizational environment is fraught with ethical pitfalls and traps. The first step is to recognize the ethical issues. Inevitably, someone or some group(s) will be damaged by whatever decisions are made. Often decision makers will have to make a choice between two or more bad alternatives.

Decision makers will be pressured by various parties, all of whom will have real or perceived conflicts of interest. Stakeholders will be looking for a speedy resolution of the problem, and short cuts will be hard to resist, even when decision makers have every intension to act ethically.

One of the challenges will be to identify all of the individuals and groups that have an important stake in the outcome. Judging that some concerns are of more importance than others will be an important next step.

Once the options are identified, prioritizing them according to which do the most good or the least harm will take discipline and energy. Grappling with the fairness and "proportionality" of the options is also a critical step.

After a tentative decision is reached, it should be tested and communicated to the stakeholders, an important step to maintain transparency in the process. Testing the decision with a third party who is both knowledgeable and disinterested could provide value to the process.

Finally, thought should be given to how the decision is to be implemented; will the implementation reflect care and attention to the significant consequences for the primary stakeholders? Although it takes both institutional and personal courage, performing a post mortem would also be valuable to those involved in the process.

Oct 15, 2009