In re Zenith Electronics Corporation

The recent decision of the Bankruptcy Court confirming a plan of reorganization over the objections of shareholders in In re Zenith Electronics Corporation, 241 B.R. 92 (Bankr. D. Del. 1999), raises interesting issues of director fiduciary duty law. The plan had been negotiated pre-petition with creditors and called for the principal shareholder of the debtor, who was also a large secured and unsecured creditor, to acquire the debtor on confirmation through a new equity investment. The solicitation of votes on the plan had occurred pre-petition by means of SEC approved disclosure materials. No auction process had been employed to value the debtor, nor had minority shareholders been offered the opportunity to co-invest with the majority shareholder, who, in effect, was taking the debtor private. The decision to eliminate the interests of shareholders was based entirely on investment banking valuation testimony, although the Board obtained no actual fairness opinion. The plan also provided for the debtor and all creditors who received distributions to release the majority shareholder, directors and all other significant players in the development of the plan.

In addressing the Section 1129(a)(3) requirement that a plan be proposed in good faith and not by any means forbidden by law, the Bankruptcy Court determined without citation to authority that the plan also had to pass muster under the Delaware corporate doctrine of "entire fairness" because it involved a transaction between a corporation and its controlling shareholder. This doctrine requires that both the price and the process be fair. The fact that the Zenith plan was a pre-pack negotiated and approved by the Board pre-bankruptcy makes this an easy conclusion to reach. But there appears to be no reason why it would not apply with equal force to every case in which controlling shareholders are funding a plan that excludes minority shareholders. This, in turn, adds a whole new dimension to the Board process that must be followed in approving such a plan.

Addressing the substance of this test, the Bankruptcy Court had no difficulty finding entire fairness on the facts of the case. First, the use of bankruptcy cram-down procedure was held to be entirely proper and not to taint the process. Second, the Bankruptcy Court found that the involvement of creditors in the plan negotiations eliminated any undue influence the controlling shareholder may have had, although the court found no evidence of influence in any event. Finally, the Bankruptcy Court found extensive evidence of management efforts to pursue alternative investors and no evidence of any actual alternative to the proposed plan. The fairness of the price was supported by credible valuation testimony and by the evidence of efforts to find alternative buyers. The Bankruptcy Court found that an auction process was not necessary and that CEO to CEO contacts were an acceptable marketing strategy within the Board's discretion. The absence of a fairness opinion was not deemed significant in light of the Bankruptcy Court's supervisory role in the confirmation process.