Journal of Corporate Renewal

October 2016

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 flow test)?

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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