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If your company faces possible insolvency, what does that mean for you as a director? That was a question on the minds of many on October 15, 2009, as the Silicon Valley Chapter of the National Association of Corporate Directors met at Wilson Sonsini Goodrich & Rosati, 950 Page Mill Road, Palo Alto. I'd been through that experience myself about 20 years ago when I was on the board of Associated Cooperatives Inc., once a wholesale in Richmond, California, for member retail co-ops. The program was well attended and from the many questions, it was easy to tell that at least a few of those attending weren't there out of idle curiosity.

The panel was moderated by Priya Cherian Huskins, a partner at Woodruff-Sawyer & Co., a full-service insurance brokerage and risk management consulting. Selected in 2007 by Business Insurance as one of the industry’s “Women to Watch,” Ms. Huskins is a recognized expert in directors and officers (D&O) liability risk and its mitigation. In addition to consulting on D&O insurance matters, she counsels clients on how to reduce their exposure to shareholder lawsuits and regulatory investigations as well as other corporate governance matters. She is a frequent speaker nationally and internationally on D&O issues, and has authored numerous articles for various well-respected industry publications. Ms. Huskins did an excellent job of not only restating questions, so that everyone could hear, but focusing them and guiding panelists to get the most information practical to attendees in the relatively short time available.

Timothy Harris of Morrison and Forester represents public and private companies and venture capital firms in corporate and securities matters. In his private company practice, Mr. Harris specializes in advising start-up and emerging growth technology enterprises from incorporation through acquisition or initial public offering in matters including venture capital financing, debt financing, equity incentive compensation and technology development (including licensing, joint development, distribution and other technology transfer matters).

Mr. Harris led off the discussion with a general description of legal issues with his advice to remain engaged and informed if your company is approaching insolvency. Remember you have a duty of care to insist on current information, ask tough questions (risks, consequences), monitor financial condition, and memorialize deliberations. Your duty of loyalty requires that you put the company's interests first. Scrutinize your action from the perspective of a potential plaintiff.

When entering the "zone of insolvency," follow your gut instincts and err on the side of assuming you are farther along the continuum than the picture management presents. You must increasingly take into account the company's community of interest, especially creditors. Maximizing the enterprise value of the company is more art than science. How to allocate remaining funds is key. Your decisions will be second guessed. Paying your lawyer may come as a high priority (chuckle).

• Recapitalization tips: model the pro forma capitalization, beware of conflicts between early investors and later investors.
• Pay-to-play: model the pro forma capitalization, beware of conflicts between participants and non-participants
• Down rounds: focus on process as much as the result.
• Resignation tip: think of serving as a director of a troubled company like parenting a troubled teenager. Your resignation doesn't protect you for your service preresignation. On the other hand, resigning can inflame the process and your reputation. Remaining on the board gives you amn opportunity to help resolve the issues. Yes, it requires a much more significant time commitment and is likely to be very stressful but bailing represents an additional risk of harm.
• There was some interesting discussion about entering into contracts with employees, so they get paid before shareholders.

Bruce MacIntyre, of Perkins Coie, followed next on the panel. Mr. MacIntyre is a partner with his firm's Business practice and has more than 20 years experience with focus in the areas of insolvency and bankruptcy, debtor and creditor issues, creditor rights, out-of-court workouts and debt restructuring, as well as a background in complex and commercial litigation and as a business owner himself. Mr. MacIntyre reviewed the fundamentals of bankruptcy, which provide:

• Breathing room through an automatic stay
• A fresh start, discharge/plan of reorganization. The plan becomes a contract, legally enforceable between the corporation and creditors.
• Fair treatment of creditors - the "absolute priority rule." Secured creditors, priority unsecured, general unsecured, equity. Nothing can flow down unless senior paid first, unless there is agreement. Trust funds (precollected taxes, etc.) get high priority, since they aren't actually "company" funds.

Bankruptcy works because the process is transparent. It becomes "life in a fishbowl," requiring full disclosure.

D&O insurance is like any other asset of the corporation. Trustees will look at any cause of action... should they be bringing it, rather than the board? What's best for the estate, not for the directors. Buy your D&O policy early and be careful about what it covers. It must benefit the company, not the directors.

Discussed chapter 7 (liquidation) or 11 (reorganization where management stays in control - court approval is required for transactions outside the normal course). He's seen many more chapter 7s in the last year. Also discussed federal vs state law alternatives. Bankruptcy is federal and uniform. In state alternatives, such as receivership, where can you file is an important consideration. Know who your creditors are. The more complicated and diverse, the more likely bankruptcy is your best alternative. At least that's what I thought I heard.

Michael Maidy, wrapped up the panel discussion with alternatives to bankruptcy. Mr. Maidy is one of the co-founders of Sherwood Partners, LLC, and comes from a highly successful accounting background. He is a respected authority on innovative financial services and crisis management, with more than 36 years of experience in all facets of credit, lending, and finance. Mr. Maidy is one of the leading authorities regarding corporate restructuring, finance and Assignments for the Benefit of Creditors (ABCs).

First, he broadly outlined alternative procedures, which primarily involved either restructuring (out of court workout, M&A, Chapter 11 reorganization) or liquidation (friendly foreclosure, self-managed process, chap 7 or liquidating chapter 11, receivership or Assignments for the Benefit of Creditors... which he then went on to describe in greater detail).

In an ABC process the debtor company selects and transfers all assets to an assignee. The assignee is a fiduciary for the benefit of all creditors. Their duties are to maximize net proceeds from the assets, distribute the proceeds to the creditors, and generally wind down the business.

The company and assignee generally execute standard agreements. The assignee identifies a subset of employees to retain and assist with the process. They also indentify potential buyers and markets the business assets to them. It is critical to cast a wide net when looking for targets. The goal is to get multiple offers and/or an auction. From my understanding, they company board typically resigns upon asset assignment. A special purpose entity is set up for assets, while the shell company retains liabilities. Benefits include:

• The third party assignee is selected by the company, not the court, and takes on fiduciary risks, allowing the board and management to move on with their lives.
• An experiencexd third party can maximize the value of assets and ability to move with speed.
• ABC avoids the cost, risk and noise of a public bankruptcy.
• Process can be cost effective in distributing the maximum amount to creditors.
• Provides for follow-up and wind-down with taxing authorities and tactical issues.

While the ABC process works well for restarts where a friendly closure and retaining critical employees is key, the process doesn't work well where the company is incorporated or doing business in an unfavorable state, when it is difficult to obtain creditor consents to the process, and when funding is inadequate.

After the forum, I went "behind the scenes" with Ms. Huskins, Mr. MacIntyre and SVNACD's Webmaster, Thomas Wohlmut to watch Mr. Wohlmut tape a podcast summarizing a few key points:

• Seek professional advice early in the process, examine all your options and document your decisions.
• Resignation isn't usually a good option. Your liability remains (including reputation) but your ability to steer the outcome is gone.
• Yes, there are upsides to bankruptcy. Since there is so much to learn, it broadens your experience and is great resume fodder.

On that last point, I'll just note that as with any of my reports from SVNACD meetings, the issues are complex. Even though I've been a director with a company that went through bankruptcy, much of the material covered was new to me. My brief notes are simply meant to give you a flavor of the meeting and to entice you to attend future events. SVNACD meetings are great networking opportunities that allow ample time to cover dozens of questions from an audience that is often facing the same issues you are.

See the PowerPoint slides from the program and a brief podcast on the SVNACD site. Next Event: Directors and Due Care in the Technological Age, 11/19/09.

with the Corporate Governance NETwork