There are two ways to dissolve a Delaware corporation: through “elective” or “default” dissolution procedures. First, through elective dissolution, also referred to as “judicial” dissolution, a Delaware corporation must petition the Court of Chancery for approval of the security set aside, and provide notice of dissolution to potential claimants.1 Alternatively, through default dissolution, also referred to as “extrajudicial” dissolution, a Delaware corporation does not petition the court for review of its plan and security. Instead, Section 281(b) of the Delaware General Corporation Law provides a default procedure whereby the corporation must adopt a plan of distribution through which, among other things, the corporation “shall make such provision as will be reasonably likely to be sufficient to provide compensation” for pending and future claims.2
Under either the default or elective dissolution, there is a potential risk of director liability if procedures are not complied with.3 One way to limit potential director liability is to follow the elective, as opposed to default, procedures. Directors choosing to follow the elective procedure will receive the court’s stamp of approval through its determination of adequate security, thereby insulating directors from some future claims. Directors who have chosen the default dissolution procedure will remain subject to potential future claims, such as claims they have not adequately complied with Section 281(b)’s requirement of “reasonableness.” Accordingly, following the default rules for dissolution of a Delaware corporation is more risky, regardless of corporate directors’ good faith and due care.4
The Court of Chancery recently discussed dissolution procedures under Delaware law in In re Swisher Hygiene, Inc., 2020 WL 3125415 (Del. Ch. June 12, 2020). The petitioner, Swisher Hygiene, Inc. (Swisher), sold all of its assets and filed a certificate of dissolution, notified its potential creditors of the dissolution, and then filed a petition with the Court of Chancery under the judicial dissolution procedures set forth in 8 Del. C. Section 280.5 As a part of the petition to the court, Swisher sought a determination of an amount constituting sufficient security to cover wind-down costs, pending litigation, prospective claims, as well as any unknown or unripe claims.6
Swisher then filed a motion for distribution and a motion seeking approval of a process to resolve or set a reserve for the remaining unsettled claims, including five creditor claims and a litigation matter with Honeycrest Holdings, Ltd. (Honeycrest).7 Swisher sought to distribute $10 million to its stockholders, leaving a remaining reserve of $6.279 million, in addition to $1.667 million set aside for the Honeycrest litigation.8 Honeycrest, opposed the motion for distribution on the grounds that any “distribution would reduce the value of its potential judgment [against Swisher] in [the lawsuit in] New York.”9
The court explained that, under 8 Del. C. Section 280(c)(1), a corporation that has provided notice to potential claimants “shall petition the Court of Chancery to determine the amount and form of security that will be reasonably likely to be sufficient to provide compensation for any claim against the corporation which is the subject of a pending action, suit or proceeding to which the corporation is a party.”10 Thereafter, if such a reserve is adequate, an interim distribution to stockholders may be proper.11
The court held Swisher followed proper procedures for a judicial dissolution and its reserve was adequate to justify an interim distribution.12 Indeed, the court explained it was not required to guarantee availability of the full amount of any judgment a creditor could achieve against Swisher; rather, the court was only required to determine an amount “reasonably likely to provide compensation for any claim against the corporation which is the subject of a pending action, suit or proceeding.”13 Specifically, the court explained that, even with the proposed distribution to the stockholders, a total reserve of $6.9 million would be reasonably, and, in fact amply, likely to satisfy any judgment Honeycrest obtained in the future against Swisher.14
Key takeaways
- There are two ways to dissolve a Delaware corporation: (i) elective (or judicial) dissolution and (ii) default (or extrajudicial) dissolution.
- Risk of director liability exists in both types of dissolution proceedings.
- Elective dissolution requires the Court of Chancery’s involvement, which reduces (but does not eliminate) the likelihood of future liability for inadequate reserves. Therefore, in the event a Delaware corporation seeks to dissolve, risk of director liability is less where the corporation gets the Court of Chancery’s stamp of approval.
- Default dissolution does not involve the Court of Chancery and, therefore, exposes a corporation’s directors to more risk and a greater likelihood of liability for improperly following dissolution procedures, including setting aside inadequate reserves.
- A corporation in judicial dissolution under 8 Del. C. Section 280 is not required to hold all of its cash in reserve to cover potential claims; rather, the corporation must only set aside as security an amount reasonably likely to provide compensation for any claim against the corporation which is the subject of a pending action, suit or proceeding.
- See 8 Del. C. Sections 280, 281(a).
- Id. Section 281(b).
- See 8 Del. C. Section 281(c) (providing that directors of a dissolved corporation will not be personally liable to the claimants of the dissolved corporation only if the corporation has complied with either the elective or default procedure).
- See In re RegO Co., 623 A.2d 92, 97 (Del. Ch. 1992) (“[R]eliance upon the mechanism of Section 281(b) may present a risky situation for corporate directors regardless of their good faith and due care.”).
- See Swisher, 2020 WL 3125415, at *1.
- Id.
- Id.
- Id.
- Id. at *3.
- Id. at *2.
- Id.; see also In re Sobieski Bancorp, Inc., 2006 WL 4782384, at *1 (Del. Ch. Aug. 14, 2006) (holding an interim distribution to stockholders was proper under 8 Del. C. Section 281(a) because there were significant assets available for the satisfaction of pending and future claims).
- See Swisher, 2020 WL 3125415, at *4.
- Id.
- Id.
Client Alert 2020-405c
