Be Fair But Beware: The Spectre of Self-Dealing & In/Solvency

In some cases that I’ve worked, the officers or owners are working against me – and their creditors – by self-dealing.

What is Self-Dealing?

For the record, self-dealing is not necessarily stealing but it is fraudulent. For example, self-dealing can be when an officer of a company tries to gain an unfair tactical advantage on the creditors or bank, so that he can do something like buy the assets at a reduced cost or own the company some other way.

When trying to understand self-dealing, it is important to know that when a company is in “the zone” of insolvency the fiduciary responsibilities of the officers and directors of that company shift from a duty to the shareholders to a duty to the creditors. Though “the zone” of insolvency can be  difficult to prove, presumably when I’m brought in to a company, insolvency is already roosting or on the horizon. Thus, if any officer is creating value for himself or the shareholders instead of the creditors, he is automatically self-dealing even though it might not have been considered thus had the company been solvent at the time of his actions.

I could devise a strategy for a client because I believe he is in the “zone of” insolvency, but he could say that his definition of insolvency is different and that he is going to continue acting in the interest of himself and his shareholders. Obviously, there are a lot of interpretations of insolvency which makes this legal concept very difficult to understand or litigate.

Self-Dealing or Not

In one huge turnaround case, I was blind-sided by an officer of the company who was trying to buy the assets of the business through a shell company. He obviously wasn’t acting in the best interests of the creditors because he was trying to drive down the price of assets to purchase them himself.

With proper disclosure to the creditors and without other credible purchasers in the game, self-dealing could possibly be approved by the creditors, but it’s a very fine line that requires a lot of honesty. By creating a process that inserts a turnaround person in the company, self-dealing will not occur.

Though I’d had an early gut-feeling that someone was self-dealing, I wasn’t able to uncover what was happening before I had to speak with the creditors. Therefore, despite my promising the creditors that there was no self-dealing, as I’ve already said, this officer was doing exactly that.

This undermined my credibility with the creditors and created a conflict between me and the officer, which delayed the resolution of the case. Though I regained my credibility, these actions behind my back created unnecessary hurdles for the company and case.

Trust Your Gut

When I have to give expert testimony, like in this case, I have to know the truth, and I pride myself on my ability to find the truth when I’m working a case.

I had a valuable lesson emphasized for me during this case: trust my gut.

If you don’t trust someone, keep an eye on him. Ask lots of questions. Don’t feel bad about mistrust; if that person does nothing wrong then you will find nothing wrong and be pleasantly surprised.

Have you ever seen a case of self-dealing? Tell us about it.

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