should consider and seek advice from
professionals regarding whether private
transactions should be subject to a
market check in which other parties
have an opportunity to participate.
Understanding Insolvency. It is critical
that parties truly understand whether
a company is solvent at the time a
restructuring is consummated, as
solvency may implicate both director
duties and the practical ability to close
the deal. A company must generally pass
three tests to be considered solvent:
1 Does the fair value of the corporation’s assets exceed its
debts (balance sheet test)?
2 Can the corporation pay its debts as they become due in the
ordinary course of business (cash
3 Does the corporation have adequate capital for the business
that it operates (capital adequacy test)?
Companies must pass all three tests,
and parties should be careful to avoid
alternative rationales, such as equating
solvency with a lack of a “going concern”
qualification in a borrower’s financials.
Avoiding Mistaken Identity of Interest.
As discussed earlier, to follow correct
board process and create a record that
will demonstrate, even in hindsight,
that directors acted appropriately,
the transaction must be considered
on an entity-by-entity basis. When a
parent corporation and its subsidiary
are solvent, there is generally an
identity of interest because actions that
benefit the subsidiary also benefit the
parent through improved enterprise
value. However, if the subsidiary
becomes insolvent, this identity of
interest disappears. The directors and
officers of the insolvent subsidiary
owe their primary fiduciary duties
to the creditors of that subsidiary. By
contrast, the directors and officers of
the solvent parent corporation owe
their primary fiduciary duties to the
shareholders of the parent, not to the
subsidiary or the subsidiary’s creditors.
As evidenced by Caesars, the interest
of these different constituencies
may not always be aligned.
Avoiding Overreliance on Fairness
Opinions. Boards should obtain
professional advice when analyzing
restructuring transactions, including
consideration of the fairness of the deal,
viable alternatives, potential risks, and the
It is critical that parties truly understand
whether a company is solvent at the time a
restructuring is consummated, as solvency
may implicate both director duties and
the practical ability to close the deal.
continued on page 24
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