The Duty to Creditors Reconsidered - Filling a Much Needed Gap in Corporation Law

Abstract

The most fundamental question of corporation law is to whom does the board of directors of a corporation owe its fiduciary duty. Recently, the question has tended to be whether and under what circumstances the board of directors has the duty to maximize stockholder wealth. But if a corporation is insolvent (or close to it), business decisions designed to maximize stockholder wealth may result in a reduction of creditor wealth. Although the conventional wisdom is that creditors must protect themselves by contractual means, there is a substantial body of case law that says that creditors can assert claims sounding in fiduciary duty. Until recently, most such decisions have come from the bankruptcy courts. The state courts, who have primary jurisdiction with regard to the interpretation of corporation law, have had few opportunities to say otherwise. But in Credit Lyonnais Bank Nederland v. Pathe Communications (1991) and Production Resources Group v. NCT Corporation (2004), the Delaware Court of Chancery confirmed that the protections of fiduciary duty extend to creditors (in addition to stockholders) - at least when a corporation is in fact insolvent and possibly when it may be rendered so by the business decision in question - on the theory that the board of directors ultimately has the duty to maximize the value of the firm as a whole. These unfortunate decisions have led creditors and commentators to argue for a wholly new body of creditor rights and have encouraged further loose talk from the bankruptcy courts who must apply state law in this difficult setting. The fallacy inherent in extending the protections of fiduciary duty to creditors is that stockholders themselves enjoy no remedy except in situations in which the corporation is for sale - a situation in which there is little danger of harm to creditors. The board of directors is otherwise under no enforceable duty to maximize stockholder wealth. And the CEO typically has a strong incentive to ensure the survival of the firm. In situations in which the board of directors has failed to maximize stockholder wealth, the stockholders are protected by the market for corporate control rather than a legal remedy. Under the business judgment rule, the stockholders cannot challenge such decisions in court. Neither should the creditors be able to do so. Thus, even though creditors might favor a rule that favors them when the board of directors is tempted to bet the farm on a risky business strategy, they have no need for a remedy. Fortunately, the cases in which creditors have prevailed up to now are cases in which they should have prevailed anyway under fraudulent transfer law. But the law would be better served if the courts made it clear once and for all that fiduciary duty is about the stockholders and no one else.