By: James Yoder, Michael Onufrak and Siobhan Cole
On Feb. 5, 2015, the United States Bankruptcy Court for the District of Delaware, per Judge Brendan L. Shannon, entered proposed findings of fact and conclusions of law in favor of the former president and CEO of Ultimate Escapes Inc., James M. Tousignant, and its chairman, Richard Keith, after determining that Tousignant’s actions in negotiating and executing a controversial asset purchase agreement were protected by the business judgment rule, despite the demise of the company a short time later. The failure of a business strategy, in and of itself, does not create liability on the part of the former directors and officers of a bankrupt company.
Ultimate Escapes was a luxury destination club that provided its members with access to high-end vacation residences around the world. Unfortunately, Ultimate Escapes’ business suffered greatly from the economic downturn that began in 2008, and on Sept. 20, 2010, Ultimate Escapes filed voluntary petitions for relief pursuant to Chapter 11 of the Bankruptcy Code.
Prior to that time, Ultimate Escapes and a major competitor, Club Holdings LLC, were engaged in merger negotiations. As part of their negotiations, the parties agreed to exchange confidential business information, including their respective membership lists, for the exclusive purpose of a premerger due diligence evaluation. Tousignant was expressly authorized by Ultimate Escapes’ board to proceed to finalize and execute a merger agreement with the signatures to be held in attorney escrow pending consummation.
While merger discussions continued over the course of several months, Ultimate Escapes experienced a severe liquidity crisis. In late July 2010, despite prior secured loans from commercial lenders and personal capital contributions from Tousignant and Keith, Ultimate Escapes had insufficient cash to meet payroll and vendor obligations due by Aug. 6, 2010. To alleviate the situation, Ultimate Escapes agreed to sell to Club Holdings a premier vacation property located at 1600 Broadway in New York City.
Nevertheless, by Aug. 5, it became apparent that there was still a $115,000 shortfall between the NYC property sale proceeds and Ultimate Escapes’ immediate financial needs. Therefore, Tousignant negotiated the disputed “August 6th agreement” with the president of Club Holdings whereby, in exchange for the needed $115,000, Ultimate Escapes would (among other obligations) use best efforts to transfer 30 of its members (900 member nights) to Club Holdings.
The Aug. 6 agreement also provided that Ultimate Escapes would not hold Club Holdings liable if the promised efforts ultimately resulted in the transfer of more than 30 members. This latter provision was in the contract because, to successfully recruit 30 members willing to transfer their memberships, it was necessary to solicit substantially more than that number. On Sept. 16, 2010, as prospects for completing the merger diminished, Club Holdings solicited the entire membership of Ultimate Escapes contending that, pursuant to the terms of the Aug. 6 agreement, Tousignant waived confidentiality as to Ultimate Escapes’ membership list.
The trustee of the Ultimate Escapes Bankruptcy Estate, Edward T. Gavin, filed suit against Tousignant and Keith alleging they breached their respective fiduciary duties of care, loyalty and good faith by selling Ultimate Escapes’ member list, a $40 million asset and the putative "crown jewel" of the company, to Club Holdings for $115,000. The trustee asserted that the value of the Ultimate Escapes membership list virtually was eliminated by Club Holdings’ unrestricted solicitation.
Standard of Judicial Review
The trustee argued that Tousignant, and Keith were (1) grossly negligent in entering into the Aug. 6 agreement, (2) were motivated by their own self-interests rather than the best interests of Ultimate Escapes, and (3) the contract was an irrational waste of corporate assets. The trustee contended these facts rebutted the presumption that the business judgment rule applied to the challenged transaction. The trustee argued for the imposition of either of the two more stringent standards of judicial review — entire fairness or enhanced scrutiny.
In order to rebut the presumption that the business judgment rule applied, the trustee was required “to point to sufficient facts to support a reasonable inference that the decision to enter into the “August 6th Agreement was a breach of Tousignant’s duty of loyalty or duty of care.”
Duty of Loyalty
In an effort to do so, the trustee first argued that Tousignant breached the duty of loyalty by putting his own self-interest before the interest of the corporation and its shareholders. In support of that argument, the trustee alleged that Tousignant acted out of self-interest to protect his equity in the company.
Judge Shannon rejected the trustee’s argument, however, and found that Tousignant had “every incentive and every right to endeavor to protect his equity in the company.” Delaware law presumes that investors act to maximize the value of their own investments. When directors or their affiliates own material amounts of common stock, it aligns their interests with other stakeholders.
The trustee’s second argument was that in addition to his desire to protect his own equity in the company, Tousignant also sought to avoid Ultimate Escapes’ default and possible bankruptcy because he had concerns regarding: (1) liability for his personal guarantees on certain real estate assets, (2) loss of a $50,000 personal advance of an interest payment to a secured lender, (3) liability for an $89 million personal indemnity guarantee triggered by bankruptcy of the company, (4) a potential loss of employment compensation as CEO and (5) fear of potential personal criminal liability for missing payroll.
In rejecting these arguments, the court found that Tousignant did not receive any personal benefits from the transaction that were not equally shared by the stockholders when he entered into the Aug. 6 agreement. On the contrary, Ultimate Escapes' outside directors and general counsel believed that consummation of the Club Holdings merger would be the best result for all stakeholders and multiple witnesses denied that Tousignant personally profited from the Aug. 6 agreement.
Tousignant's decision to enter into the Aug. 6 agreement was simply an act in furtherance of the merger, which was seen at that moment as the best possible outcome for the company. Furthermore, the evidence did not clearly establish that Tousignant would have avoided liability under his personal guarantee if the companies merged and there was virtually no evidence that Tousignant's actions were driven by fear of criminal liability. Instead, the court found that Tousignant legitimately was concerned about keeping the company afloat and avoiding public disclosure of the missed payroll in the company's filings with the U.S. Securities and Exchange Commission. In sum, the court found no evidence that Tousignant's decision to enter into the Aug. 6 agreement was based on "extraneous considerations or influences."
Duty of Care
Likewise, the court found that the evidence failed to support a finding that Tousignant violated his duty of care. Judge Shannon rejected the trustee’s contentions that Tousignant was (1) grossly negligent, (2) failed to adequately inform himself of the agreement's provisions, (3) failed to seek the advice or approval of the board of directors or other outside advisers prior to entering into the agreement, and (4) failed to prudently manage the debtors' business operations.
First, Tousignant had authority to operate the business generally and had either apparent or actual authority to enter into the Aug. 6 agreement. Second, Tousignant diligently pursued alternative sources of financing prior to entering into the Aug. 6 agreement, including: (a) personally making an interest payment on behalf of the company, (b) arranging for the sale of the NYC property to Club Holdings, and (c) lobbying the company’s primary secured lender for additional financing.
Third, upon receipt of the Aug. 6 agreement, Tousignant promptly shared it with the company’s chief financial officer and general counsel. Fourth, the trustee’s argument that Tousignant did not adequately inform himself of the substance of the Aug. 6 agreement was contradicted by statements in an Aug. 6, 2010, email from Club Holdings’ president, which was consistent with Tousignant’s interpretation of the limited scope of the member solicitation.
Business Judgment Rule
Following a three-day bench trial, the bankruptcy court held entirely in favor of Tousignant and Keith. The court declined to apply the more rigorous entire fairness and enhanced scrutiny standards (1) because the evidence failed to show that Tousignant put any potential personal benefits ahead of the corporate merits of the challenged transaction and (2) because the Aug. 6 agreement was not a transaction related to a sale wherein a fundamental change of control occurred or was contemplated.
Judge Shannon found that the intent of the Aug. 6 agreement was to transfer member information for the limited purpose of converting approximately 30 Ultimate Escapes members to Club Holdings. The intent of the Aug. 6 agreement was not to give Club Holdings unrestricted access to Ultimate Escapes’ confidential and proprietary membership list in exchange for $115,000.
Therefore, the court held that Tousignant’s actions in negotiating and executing the agreement were protected by the business judgment rule. Judge Shannon explained that the business judgment rule “is not only a rule, but a presumption that the directors of a corporation acted independently, with due care, in good faith, and in the honest belief that their actions were in the stockholders’ best interests.”
In applying the business judgment rule, the court held that Tousignant properly was focused on bridging a critical liquidity gap when he entered into the Aug. 6 agreement and as such, his decision was attributable to a rational business purpose. If the Aug. 6 agreement had not forestalled the liquidity gap, the resultant bankruptcy filing would have killed the Club Holdings merger and wiped out all shareholder equity.
Although Tousignant and others diligently worked to keep their company afloat, they were ultimately unsuccessful. Judge Shannon pointed out however, as then-Chancellor Leo Strine once stated, "[i]t is no doubt regrettable" that a company may file bankruptcy, but "the mere fact of a business failure does not mean that plaintiff can state claims against the directors, officers, and advisors on the scene just by pointing out that their business strategy did not pan out."
The bankruptcy case is In re Ultimate Escapes Holdings LLC et al., Case No. 10-12915 (BLS) in the U.S. Bankruptcy Court for the District of Delaware. The adversary proceeding is Edward T. Gavin, Trustee of the UE Liquidating Trust, on behalf of the Estates of Ultimate Escapes Holdings LLC et al. v. James M. Tousignant et al., Adv. Proc. No. 12-50849 (BLS).
For further information regarding the Court’s decision or for advice regarding application of the business judgment rule, please contact Michael Onufrak (215.864.7174 | firstname.lastname@example.org); James Yoder (302.467.4524 | email@example.com) or Siobhan Cole (215.864.6891 | firstname.lastname@example.org).
DISCLOSURE: Defendant James M. Tousignant is represented by White and Williams LLP.
 Opinion, p. 18, quoting In re Autobacs Strauss Inc., 473 B.R. 525, 562 (Bankr. D. Del 2012).
 Id., quoting Chen v. Howard-Anderson, 87 A.3d 648, 670-71 (Del. Ch. 2014).
 Opinion, p. 21, Rales v. Blashand, 634 A.2d 927, 933 (Del. 1993).
 Opinion, p. 22, Guft v. Loft Inc., 5 A.2d 503, 510 (Del. 1939).
 Id., quoting Beam v. Stewart, 845 A.2d 1040, 1049 (Del. 2004).
 Opinion p. 20, Beam v. Stewart, 845 A.2d 1040, 1049 (Del. 2004),
 Id., Paramount Commc'ns Inc. v. QVC Network Inc., 637 A.2d 34, 46 (Del. 1994) (internal quotations omitted).
 Opinion, p. 16, quoting Williams v. Geier, 671 A.2d 1368, 1376 (Del. 1996).
 Opinion, p. 31, quoting Trenwick America Litig. Trust v. Ernst & Young, 906 A.2d 168, 193 (Del. Ch. 2006).