Managers’ Fiduciary Duties in Financially Distressed Corporations: Chaos in Delaware (and Elsewhere)

The inherent conflict between creditors and shareholders has long occupied courts and commentators interested in corporate governance. Creditors holding fixed claims to the corporation\u27s assets generally prefer corporate decision making that minimizes the risk of firm failure. Shareholders, in contrast, have a greater appetite for risk, because, as residual owners, they reap the rewards of firm success while sharing the risk of loss with creditors. Traditionally, this conflict is mediated by a governance structure that imposes a fiduciary duty on the corporation\u27s managers-its officers and directors-to maximize the value of the shareholders\u27 interests in the firm. In this traditional view, officers, and directors serve as agents of the shareholders and thus are charged with a fiduciary duty to maximize the value of the principals\u27 ownership interests. Under this model of corporate governance, managers are not agents for the company\u27s creditors and thus owe no fiduciary duty to act in the best interests of creditors. For the most part, this traditional model of corporate governance has dominated corporate law. Over recent years, however, a number of courts have suggested or held that these normal fiduciary duties of corporate managers may change when firms move into and through periods of deepening financial distress. The purpose of this Article is twofold. First, we offer a positive analysis of the fiduciary duties of managers, as corporations move along the time spectrum from solvency to Chapter 11 reorganization. While, certainly, we are unable to clarify entirely the mess that courts have created, we believe that we are able to offer guidance regarding the present state of the law and how the law is likely to evolve on these important matters. In the second part of the Article, we offer our prescription for corporate managers’ fiduciary duties, as corporations move along the time spectrum from solvency to bankruptcy. Our view is that the fiduciary obligation of corporate managers should be uniform across the pre-bankruptcy period, changing only at the point the company enters into Chapter 11. Our prescription is informed by simple economic concepts. Our view is that clear and efficient default rules are of the utmost importance, since such rules will protect the expectations of the parties, respect their pricing, and thus facilitate an efficient allocation of the risk of loss in financial transactions