Directors' Duties to Creditors: Power Imbalance and the Financially Distressed Corporation

Abstract

This Article questions the widely held view that the fiduciary duties that corporate directors ordinarily owe to or for the benefit of shareholders should "shift" to creditors when the corporation is in financial distress. This view suffers from two important flaws. First, it mistakenly assumes a strong connection between duty and priority in right of payment. Thus, the thinking goes, as the corporation approaches insolvency, creditors should displace shareholders as the residual claimants, to whom duties should run. While this may make sense when a corporation liquidates, it ignores the fact that priority is a distributional doctrine, and therefore functions very differently than does duty. Moreover, priority is often an unstable and opaque doctrine, and thus a poor trigger of duty. The second, and more important, mistake is that linking priority and duty causes us to ignore the deeper normative concerns that should animate duty in the corporate context. These normative concerns usually respond to power imbalances expressed as disparities of volition (voluntariness), cognition (information), and exit (access to secondary markets). On this view, it is apparent that not all creditors of the distressed corporation are equal. Creditors who lack volition, cognition, and exit-and thus should benefit from directorial duties-might include tort creditors, terminated at-will employees, taxing authorities and certain trade creditors. Other creditors-chiefly banks and bondholders-neither need nor deserve directorial duties. They typically benefit from high levels of volition, cognition, and exit, as expressed in both the heavily negotiated contracts that govern their relationships with the corporate debtor and their access to well-established secondary markets. This Article contains a proposal for adjusting directors' duties accordingly.