In this article, the authors consider the nature of corporate managers’ fiduciary duties in periods when the company is in financial distress. This matter is important not only to corporate managers, who need clear rules regarding their duties, but also to equity and debt investors, who must understand the nature of corporate fiduciary duties in order to price the capital that they contribute to the enterprise and allocate the financial risks of loss to the most efficient risk bearer from among the investors.
Unfortunately, courts – especially the important Delaware courts – have made a mess of all of this.
In the positive portion of the article, the authors describe and offer some clarification of corporate managers’ shifting fiduciary duties, as the corporation’s financial distress deepens. They conclude that corporate managers are obligated in periods when the corporation is solvent to act in the best interests of shareholders. When, however, the corporation moves into the “vicinity of insolvency”, corporate managers are obliged to act in the best interests of some undefined conglomerate of corporate stakeholders. In actual insolvency managers’ duties shift to a duty to act in the best interests of creditors. Finally, in bankruptcy, corporate managers must act in the best interests of shareholders and creditors as a whole.
The authors find these poorly articulated and constantly shifting standards to be pernicious, both with regard to the ability of corporate managers to make legally proper decisions and with regard to investors’ ability to price their investments and predictably and efficiently allocate their risks of loss.
In the normative portion of the article, the authors argue for an abandonment of this confusing and inefficient regime of corporate fiduciary duties. Their view is that in all periods prior to bankruptcy, the fiduciary duties of corporate managers should be consistently defined by reference to the best interests of shareholders. Once a company is in bankruptcy, they believe that the obligation of managers should shift to an obligation to act in the best interests of shareholders and creditors as a whole. This approach will, in their view, lead in most (but not necessarily all) cases to pleasing and efficient outcomes. It will provide intelligible criteria to guide the actions of managers and will enable investors to price their capital and allocate risks of loss in efficient manners
