Navigating the Zone of Insolvency in the Credit Crisis

1. Navigating the Zone of Insolvencyin the Credit Crisis What the Board Should Know

2. Overview of Issues for Board in Times of Financial Distress • Fiduciary Duties • General • Issues for Solvent versus Insolvent Corporations • Disclosure Liabilities • 1933 Act and1934 Act Liabilities • Limitations on Liability, Indemnification, and D&O Insurance • Recent Developments – Schoon v. Troy and other cases

3. Fiduciary Duties of the Directors • A director shall perform his or her duties (including on committees) • in good faith • in a manner such director believes to be in the best interests of the corporation and its shareholders • with such due care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances including consideration of reasonable alternatives • A director should perform his or her duties on an informed basis • A director may rely on information, opinions, reports or statements, including financial statements and other financial data, in each case prepared or presented by any of the following: • One or more officers or employees of the corporation whom the director believes to be reliable and competent in the matters presented • Counsel, independent accountants, or other persons as to matters which the director believes to be within such person’s professional or expert competence • When a Board exercises its fiduciary responsibilities, a court generally will not substitute its judgment if decisions are made in good faith to advance the corporation's interests and a rational decision making process is used

4. “Zone of Insolvency” • Not clearly defined Financial Conditions • Insolvency (general test) The corporation cannot pay its debts as they come due, in the ordinary course of its business OR The value of the corporation’s debts/liabilities (including contingent liabilities) exceeds the reasonable market value of its assets

5. Fiduciary Duties – The Effects of Financial Conditions • The same fiduciary duties continue to govern the conduct & obligations of directors of a solvent or insolvent corporation • At all times, the directors have a responsibility to maximize the corporation’s economic value • However, depending on the corporation’s financial condition, the Board’s constituency shifts, that is, the beneficiaries of the directors’ fiduciary duties change • A solvent corporation • Principal constituents are the corporation’s shareholders • The Board’s responsibility to shareholders is to maximize the corporation’s economic value • A corporation in the “Zone of Insolvency” • The Board must balance interests of creditors & shareholders • Competing responsibilities of wealth creation & capital preservation • creditors’ interests do not necessarily supersede shareholders’ interests • directors must still seek to maximize long-term wealth • however, directors cannot take excessive risks that compromise the corporation’s ability to pay debts • An insolvent corporation • Principal constituents are the corporation’s creditors • Strong emphasis on capital preservation and preserving the corporation’s ability to pay its obligations

6. Practical Considerations • Work closely with management to analyze and understand the corporation’s level of financial exposure • Capital structure, major obligations, cash flow needs • Corporation’s forecasted performance, in light of current business environment • Cash flows • Debts that cannot be paid as they come due • Debt covenants • Contingent liabilities that may need to be booked as a reserve • Potential uncollectible receivables/write-offs • Guarantees; letters of credit • Review, test, redo and revise management’s analysis as needed and particularly look at actual compared to projected performance and question assumptions (e. g., the availability of future financing, purchasing assumptions by key customers) • Be sensitive to management’s potential psychological barriers and resistance to the need for assistance

7. Practical Considerations (cont’d) • Review accounting policies and financial statements • Work with accountants to determine the impact that accounting principles and practices, such as “marking to market” and revenue recognition, may have on company’s balance sheet and financial statements • Take into account (i) any accounting principles or practices that may have a disparate impact on the corporation itself or the corporation’s industry sector; and (ii) the anticipated effect of the current credit crisis on the magnitude of the corporation’s short-term and long-term liabilities • Identify corporation’s creditors and major stockholders • Understand motivations • Near and long-term strategy and objectives

8. Practical Considerations (cont’d) • Plan for specific liquidity issues • Exercise and demonstrate closer board oversight • Consult frequently with management, experts/advisors • Contingency planning • Establish flexible board process • Review bylaws, advancement and indemnification commitments, insurance • Be aware of WARN Act issues • Be alert to fraudulent conveyance risk • Dividends • Affiliate guaranties • Asset transfers between affiliates • Assets sold in private sales by owners under financial distress • Executive compensation • Continue to utilize “best corporate practices”

9. Ali M.M. Mojdehi Chair, NA Financial Restructuring, Creditors’ Rights and Bankruptcy Group Baker & McKenzie LLP 12544 High Bluff Drive, Third Floor San Diego, CA 92130 Tel: +1 858 523 6280 Fax: +1 858 250 8290 ali.m.m.mojdehi@bakernet.com