A question that frequently recurs is whether or not directors of insolvent companies have fiduciary duties to creditors. Creditors often attempt to argue that as companies move into the “zone of insolvency,” directors’ duties move from the company’s shareholders to the company’s creditors. While courts have discredited this theory, creditors nevertheless seek to raise this issue.
In a November 3, 2014 post on his M&A Law Prof Blog entitled “Director Fiduciary Duties and the Insolvent Corporation” (here), Boston College Law Professor Brian J.M. Quinn reviews a recent Delaware Chancery Court decision that addressed these issues. (Hat Tip to UCLA Law Professor Stephen Bainbridge for his December 3, 2014 post on his blog linking to Quinn’s post.)
Professor Quinn’s blog post discusses the October 1, 2014 opinion in Quadrant Structured Products Ltd. v. Vertin (here) in which Vice Chancellor Travis Laster clarified the duties of directors of insolvent companies, particularly with respect to creditors.
In the Quadrant case, the directors of an insolvent company authorized the company’s participation in a transaction that, if it had succeeded, would have been very beneficial for the company’s controlling shareholder. If it were unsuccessful, it would have left the company as an empty shell. The company’s creditors sought to hold the directors liable for making risky decisions that would have benefited the controlling shareholder at their expense.
Vice Chancellor Laster said that “I do not believe it is accurate any longer to say that the directors of an insolvent corporation owe fiduciary duties to creditors.” He added that while it remains true that insolvency “marks a shift in Delaware law,” that shift “does not refer to an actual shift of duties to creditors (duties do not shift to creditors).” Instead, the shift refers primarily to creditors’ standing to bring derivative actions for breach of fiduciary duty, something they may not do if the corporation is solvent, even if it is in the zone of insolvency.
Laster concludes by saying that “the fiduciary duties that creditors gain standing to enforce are not special duties to creditors, but rather the fiduciary duties that directors owe to the corporation to maximize its value for the benefit of all residual claimants.”
Laster’s language stresses the directors’ obligations to maximize the value of the corporation for the benefit of all residual claimants. As Professor Quinn notes, “even in insolvency, stockholders remain residual claimants,” adding that “at no point do we see some sort of magical shifting of duties from the corporation to the creditors.”
What happens is that “once a corporation is insolvent, creditors may gain standing, but the duties of the board do not change.” That means that “boards of insolvent corporations are under no fiduciary duties to preserve capital and resources for the benefit of creditors.”
Apropos of Nothing: Beatles marionettes perform to the song “Help.” I recommend watching Ringo in particular.