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A Third Circuit Analysis of Fiduciary Duties in the Face of Bankruptcy

In re Ultimate Escapes Holdings, LLC, 682 Fed. Appx. 125 (2017)

In re Ultimate Escapes Holdings, LLC, No. 12-50849 (BLS), 2015 WL 1590132 (Bankr. D. Del. Feb. 5, 2015)

In affirming the decisions of the courts below, the Third Circuit in its Opinion of In re Ultimate Escapes Holdings, LLC not only provides a refresher on Delaware’s entire fairness and business judgment standards; it also sends a comforting signal to officers and directors faced with difficult decisions when a company is in financial distress and on the verge of bankruptcy.

As the merger negotiations continued, UE’s financial situation deteriorated.  An influx of personal money from two directors, Mr. Tousignant and Mr. Keith (together, the “Defendants”), and a financing agreement with a third party proved insufficient to ease the situation.  UE’s financial situation further deteriorated and it was unable to meet upcoming payroll and certain vendor obligations.  Mr. Tousignant approached CapSource, the Debtors’ principal lender, for help; however, CapSource refused to provide further financing.  Subsequently, Mr. Tousignant approached CH to find a solution.  The two companies entered into a non-traditional financing agreement (the “Agreement”), the subject of this dispute.  UE agreed to transfer certain properties as well as 30 of its members to CH in return for the needed $115,000.  The Agreement further contained a “membership-transfer paragraph” that included a waiver of the non-solicitation prohibition.  Eventually the merger negotiations came to a halt and CH initiated a mass solicitation of UE’s members.  Shortly thereafter, UE filed for chapter 11 bankruptcy protection.

Pursuant to the confirmed plan, a liquidating trust was created and a trustee (the “Trustee”) was appointed.  The Debtors transferred all of their remaining assets, including potential litigation claims, to the trust.  Thereafter, the Trustee brought suit against the Defendants alleging claims for breach of fiduciary duty and corporate waste in connection with the negotiation and execution of the Agreement.  The Trustee argued that the Defendants were grossly negligent and that they acted with self interest in entering into the Agreement that “essentially transferred Ultimate Escapes’ member list, a multi-million dollar asset and the putative ‘crown jewel’ of the company, to Club Holdings for a mere $115,000.”  The Trustee argued that a heightened level of scrutiny, as opposed to the business judgment standard, should be applied.

After a three-day bench trial and having found that the Agreement “was negotiated over the course of a few intense, frantic days for Ultimate Escapes,” the Delaware Bankruptcy Court submitted its Proposed Findings of Fact and Conclusions of Law to the Delaware District Court recommending that a judgment be entered in favor of the Defendants.  The Bankruptcy Court found, among other things, that the Agreement “only intended for the transfer of member information for the limited purpose of converting approximately thirty (30) Ultimate Escapes’ members to Club Holdings.”  Indeed, the Bankruptcy Court found that the purpose of the Agreement was “to provide Ultimate Escapes with a necessary cash infusion at a critical juncture.”  With respect to the waiver of the non-solicitation provision, the Bankruptcy Court noted that “it is understandable that the parties would need to modify confidentiality restrictions to allow for the transfer of members to support the cost of the transferred leased properties.”  The Trustee objected to the Proposed Findings, but the District Court overruled the objections.  The Trustee then appealed.

In agreeing with the courts below, the Third Circuit started its analysis with a reminder that “[r]egardless of the outcome, we judge a fiduciary’s actions based on what he reasonably knew at the time he acted.”  Opinion at 129 (citing Chen v. Howard-Anderson, 87 A.3d 648, 665 (Del. Ch. 2014) (“Fiduciary decisions are not judged by hindsight.  The defendants’ actions must stand or fall based on what they knew and did at the time.”)).  The Court found, among other things, that the Defendants were not materially interested as “they gained no personal benefit from the transfer of the 30 membership interests nor from the provision on which Club Holdings eventually relied to justify mass solicitation of Ultimate Escapes’ clients.”  Opinion at 130.  The Court also rejected the Trustee’s arguments that the Defendants acted with gross negligence, finding that they “worked diligently on a constrained deadline to cover the cash shortfall.”  Opinion at 131.  In concluding that the business judgment standard is the proper standard, the court noted that all that needed to be shown is that the transaction had a rational business purpose.  Id.  The Court found that “infus[ing] Ultimate Escapes with necessary cash to keep it afloat” satisfied this requirement.  Id.  Lastly, the Court rejected the Trustee’s corporate waste argument.  Acknowledging that while UE “could have found a better source of funding,” the record did not support that the execution of the Agreement amounted to corporate waste.  Id.