The fiduciary duties of Bear Stearns directors

Gordon Smith analyzes Bear Stearns' directors' decision to sell to JP Morgan for $2/share in the light of directors' duties in the zone of insolvency. He notes that CEO Alan Schwartz justified the move to avoid bankruptcy as "the best outcome for all of our constituencies based upon the current circumstances."

As Gordon says, the possibility that bankruptcy would have been better for the shareholders than the fire sale doesn't necessarily invalidate a board decision made in good faith. Indeed, Kelli Alces and I argue in Directors' Duties in Failing Firms, the business judgment rule continues to apply in the zone of insolvency.

Certainly this fact scenario will test the limits of this approach. Consider that the company was saying last week that it was worth near its $84 market value at the end of the last fiscal year, and that John Carney estimates that $2/share suggests Morgan is buying either Bear's building or its business for a negative $400 million.

Note, too, that the shareholders, many of whom are Bear employees, will have the last word – they get to vote on the deal. A Bear shareholder who got in on last night's conference call said he'll vote against. He's probably not alone, particularly if things calm down and Bear's value increases before the vote.

Another possible issue here is the the extent of the Bear directors' obligation to shop the company and the nature of any deal protection provisions. Morgan says it's not worried about any other buyers coming in at this dire stage. But, again, things can change fast.

Does this mean that Bear might end up getting its cake (Morgan stops the run on the bank) and eating it too (no fire sale to Morgan)?

Comments

[Matt Bodie]

Regarding said cake, are there any deal protection provisions for Morgan?

[Larry Ribstein]

Yes, but on quick perusal I didn't see anything striking -- no-shop, option on the building. The shareholders can get out of this one.