Fiduciary Duties in Distressed Corporations: Second-Generation Issues

This paper examines variations in corporate fiduciary duties arising from financial distress. This paper argues whether there is an affirmatively enforceable duty under the principles of Credit Lyonnais is not moot, because, inter alia, the availability of aiding and abetting liability for breach of fiduciary duty will give rise to a greater set of potentially liable defendants (aiding and abetting a fraudulent transfer typically not separately giving rise to liability), allowing a court to reverse some outcomes that would otherwise obtain under the in pari delicto doctrine and the Wagoner rule, and will expand the remedies available. This paper argues application of the business judgment rule to directors\u27 operation of a distressed firm should be, if anything, stronger than the corresponding provision applied to a solvent firm. The rationale is that a contrary right would create an anomalous option for creditors having expressly negotiated approval rights - one that would be difficult to value and that would create greater costs of investigation in order to avoid being a winner in a contest presenting a winner\u27s curse. This paper also examines the interplay of distress with approval of conflict of interest and final period transactions. It concludes that during distress short of insolvency, fiduciary duties to maximize firm value on a sale should continue to be owed to stockholders, and that approval of conflict-of-interest transactions by disinterested stockholders should continue to shift the burden of proof as to transaction fairness. Lastly, this paper argues for an increase in the duty of candor, following Malone v. Brincat, during distress appertaining to communications to creditors. Financial creditors will consider information a debtor provides in deciding whether to exercise contractually negotiated control rights. Creditors should be entitled to rely on truthfulness even if the debtor is unaware of a particular action the creditor may take in reliance. As proposed, a creditor would not need to prove a distressed debtor made a statement for purposes of influencing the creditor\u27s conduct because financial creditors may be presumed to be deciding whether to exercise remedies on an ongoing basis. Other elements of a cause of action, e.g., whether a defendant failed to exercise the appropriate care in assuring the accuracy of the statement, would remain unchanged. This paper was presented on November 4, 2005, at the conference Twilight in the Zone of Insolvency: Fiduciary Duty and Creditors of Troubled Companies hosted by the University of Maryland School of Law