"Let Them Eat Cake!": Whither Fiduciary Duties to Creditors?
Marie-Antoinette lives again. The last great queen of France, guillotined in 1793, threatens to make us all lose our heads in 2006. She may rival, or even eclipse, her close contemporary and fellow Austrian, Mozart, as "historical personality" of the year. Mich�le Lorin, the president of the Marie-Antoinette Association in France, confidently predicts that we are about to plunge into a warm bath of "Marie-Antoinette mania".
Professor Larry Ribstein's reference on his Ideoblog to this working paper he co-authored with Gardner Carton's Kelli Alces entitled "Directors' Duties in Failing Firms" brought to mind a statement most commonly -- though wrongly -- ascribed to Marie Antoinette: "Let them eat cake!"
In their paper, Professor Ribstein and Ms. Alces conclude that "corporate directors of failing firms do not have special duties to creditors" and that "creditors are not owed general fiduciary protection even if they are subject to a special risk of abuse in failing firms." In other words, "Let the [creditors] eat cake!" They write:
[W]hile the [Production Resources] court acknowledged the slight possibility that an individual creditor might have a fiduciary duty claim that was outside the bounds of specific creditor remedies, the scope of any such relief would be narrow. If the creditor of a corporation in or near insolvency can recover, it would most likely be under a traditional fraud or other theory whose application is shaped by the circumstances, including the corporation's insolvency.
These conclusions, however sound and noteworthy they may be, are not exactly the conclusions one would expect to obtain from a random sampling of bankruptcy professionals and judges being questioned about fiduciary duties owed to creditors upon the debtor's insolvency or entry into the "zone of insolvency." In Miller v. Dutil (In re Total Containment, Inc.), 335 B.R. 589, 603 (Bankr. E.D. Pa., 12/18/2005), for example, the bankruptcy court stated categorically, "Where a company becomes insolvent, the fiduciary duty owed by corporate officers and directors shifts to the company's creditors." Similarly, in FDIC v. Sea Pines Co., 692 F.2d 973, 976-77 (4th Cir. 1982), cert denied, 461 U.S. 928 (1983), the Fourth Circuit stated:
[W]hen the corporation becomes insolvent, the fiduciary duty of the directors shifts from the stockholders to the creditors. The law by the great weight of authority seems to be settled that when a corporation becomes insolvent, or in a failing condition, the officers and directors no longer represent the stockholders, but by the fact of insolvency, become trustees for the creditors, and that they cannot by transfer of its property or payment of cash, prefer themselves or other creditors.
Finally, in Rafool v. Goldfarb (In re Fleming Packaging Corp.), 2005 WL 2205703 (Bankr. C.D. Ill., 8/26/2005), the bankruptcy court concurred with the trustee that fiduciary duties to creditors arise upon the debtor's insolvency, stating:
Relying on the recent case of Production Resources Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772 (Del. Ch., Nov. 17, 2004), the Trustee asserts that upon insolvency, the existing duties owed by the directors to the corporation are not destroyed, but rather that additional duties, owed to the corporation's creditors, arise. The Trustee maintains that he may properly bring this action directly on behalf of the Debtor. In addition, because those duties which arise upon insolvency are owed to the creditors as a class and because any recovery for a breach of those duties would inure to the corporation, the Trustee contends that he has standing to bring those claims derivatively. This Court agrees.
The law may someday mirror the logically compelling conclusions reached by Professor Ribstein and Ms. Alces, but it doesn't appear that courts are there quite yet. Until then, expect that litigation by trustees and committees will continue to allege breaches of fiduciary duties by directors to creditors (and related claims of "deepening insolvency" -- whether arising as an injury from an independent wrong, as a measure of damages, or as an independent tort in its own right) in an attempt to pressure director defendants (and their D&O carriers) to pony up their allocable share of creditor losses (or at least a good chunk of the available D&O policy limits).
© Steve Jakubowski 2006
See also Clarkson Co. v. Shaheen, 660 F.2d 506, 512 (2nd Cir.), where Judge Lumbard, applying New York law, held that directors owed a fiduciary duty to creditors once the corporation became insolvent, rejecting the defendants' claim that such duties did not arise until the corporation was on the point of dissolution.