Estate of Badii ex rel. Badii v. Metropolitan Hospice, Inc., C.A. No. 6192-VCP (Del. Ch. Mar. 12, 2012) (Parsons, V.C.)

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In this memorandum opinion, the Court of Chancery appointed a receiver for an insolvent corporation deadlocked over how to discharge a tax lien.

Defendant Metropolitan Hospice, Inc. (“MHI”), a closely held corporation, operated a hospice facility in Atlanta.  Sousan Badii (“Badii”) owned 52% of MHI, Dr. Errol Duncan (“Duncan”) owned 30%, and two other shareholders owned the remaining 18%.  When Badii died in 2010, her estate (the “Estate”) became the majority owner of MHI, and the executor of the Estate became a member of MHI’s Board.  Pursuant to a shareholders agreement terminating the voting rights of shares upon the death of their holder, the Estate received no voting rights in the corporation despite its majority ownership.

By the time of Badii’s death, MHI had experienced financial difficulties that led to missed payments to creditors and employees, and perfection by the IRS of a tax lien for over $1.7 million.  To address the federal tax liability, the corporation hired an advisor that recommended a five-step reorganization process (the “Duncan Plan”).  Under the Duncan Plan, (1) MHI would transfer all of its assets and liabilities to a newly-formed corporation (“NewCo”); (2) NewCo would transfer 100% of its stock to MHI and pay $54,000 to the IRS to remove the tax lien; (3) the IRS would extinguish the tax liability; (4) MHI would dissolve and distribute its NewCo stock to current MHI shareholders; and (5) MHI would file a certificate of dissolution.  As an alternative to the Duncan Plan, the executor of the Estate proposed an open auction of the corporation.  Although the executor (who had replaced Badii as a director of MHI) voted in opposition to the Duncan Plan, the Board ultimately approved the reorganization plan.  The shareholders agreement, however, provided that any “major decision” that was not approved unanimously—including a decision, such as the Duncan Plan, to sell all or substantially all of MHI’s assets or to dissolve or liquidate MHI—needed to be approved by the “Majority Interest Holders.”  Consequently, the parties disputed whether the Estate (as the owner of a majority of MHI’s equity) or Duncan (as the holder of a majority of voting power in MHI) should be considered the Majority Interest Holder with the power to break the deadlock.

The Estate brought this action pursuant to 8 Del. C. § 291 seeking the appointment of a receiver for MHI.  The Estate argued, among other matters, that it was the Majority Interest Holder and therefore entitled to approve (or not approve) the Duncan Plan.  The Estate also argued that the Duncan Plan constituted an unfair, self-interested transaction in breach of the Board’s fiduciary duty of loyalty.  In particular, Duncan, a controlling shareholder and director of MHI, would gain majority voting power in NewCo, while the Estate would have no voting rights despite owning a majority of its equity.  Lastly, the Estate asserted that it was a creditor of MHI because Badii was due unpaid wages.  Defendant MHI denied that the Estate was the Majority Interest Holder, and it argued that there was no need to appoint a receiver because the Board was dealing evenhandedly with all stakeholders during the reorganization process.

Vice Chancellor Parsons noted that the decision whether to appoint a receiver for a corporation lies within the sole discretion of the Court.  Accordingly, the Court will do so only if the corporation is insolvent, which was not in dispute.  In addition, the Court held that exigent circumstances must exist, and a receiver must produce some benefit or avoid some harm. 

First, the Court held that the limited grace period provided by the IRS to reorganize the corporation and discharge the tax lien indicated that exigent circumstances existed.  The Court also cited the possibility that the Board would pursue a “dubious transaction” as further support for its finding.  The Court explained that when a corporation is insolvent, creditors take the place of shareholders as the beneficiaries of any increase in the corporation’s value.  Accordingly, the Court expressed concern as to whether the Board had treated creditors and shareholders evenhandedly when the Board considered reorganization proposals.  The Court found that the Board improperly ignored the alternatives proposed by the Estate, which was a significant creditor and shareholder of MHI.  In particular, the Board did not provide any rationale for rejecting another reorganization proposal that, unlike the Duncan Plan, would have granted the Estate voting rights in the newly formed corporation in addition to discharging the tax lien.  The Court reasoned that, even though the Duncan Plan would benefit all of MHI’s creditors and shareholders, the Board’s refusal to pursue any deal that would not maintain Duncan’s majority voting power constituted a self-dealing transaction.  Second, the Court held that the appointment of a receiver would serve a beneficial purpose.  The Court reasoned that a receiver could implement the first three steps of the Duncan Plan, which would allow MHI to discharge the tax lien, and then independently and disinterestedly decide what subsequent actions were in the best interests of MHI’s stakeholders.  In addition, by giving the receiver the power to choose the reorganization plan, the receiver’s status as an officer of the Court eliminated a potential entire fairness challenge by the Estate. 

Concluding that the benefits of appointing a receiver outweighed any potential delays or costs associated with a receiver’s reevaluation of the Duncan Plan, the Court granted the Estate’s application and appointed a receiver for MHI.  The Court charged the receiver with the task of discharging the tax lien before then attempting to resolve outstanding creditor and shareholder claims.  As a result, the Court found it unnecessary to decide which individual was the “Majority Interest Holder” under the shareholders agreement.

The full opinion is available here.

 

Published In: Bankruptcy Updates, Business Organization Updates, Civil Procedure Updates, Tax Updates, Wills, Trusts, & Estate Planning Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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