Under the balance sheet insolvency definition, insolvency occurs when liabilities exceed the reasonable market value of assets held. 1994), rehearing overruled (July 12, 1994), writ denied (Dec. Under the equity insolvency definition, a corporation is insolvent when it is unable to pay its debts as they become due in the ordinary course of business. In other contexts, courts have historically utilized two definitions of insolvency: the so-called equity definition and the balance sheet definition. Despite the serious implication of expanding the scope of the fiduciary duties to creditors into the pre-insolvency status of a corporation, courts have given surprisingly little guidance on defining the "zone" of insolvency. For the past 10 years, directors and officers have wondered whether their corporation has actually entered the "vicinity" or "zone" of insolvency. The Credit Lyonnais decision - which clearly departed from the prior bright-line insolvency test for imposing a shift of fiduciary duties - created instant uncertainty for directors and officers in distressed situations. In other words, the duties to creditors may arise even where the corporation is actually solvent but is approaching insolvency. would make if given the opportunity to act." Id. irectors recognize that in managing the business affairs of a solvent corporation in the vicinity of insolvency, circumstances may arise when the right (both the efficient and fair) course to follow for the corporation may diverge from the choice that the stockholder. The court gave the following explanation for the shift in duties: "here a corporation is operating in the vicinity of insolvency, a board of directors is not merely the agent of the residue risk bearers, but owes its duty to the corporation enterprise. The genesis of the doctrine is the Delaware Chancery Court's seminal decision in Credit Lyonnais Bank Nederland, N.V. The doctrine of expanding the fiduciary duties of directors and officers in the pre-insolvency period is relatively young, but has been widely accepted. As many courts have stated, to impose obligations on the directors and officers to the corporation's creditors only when insolvency is undisputed may be too late, given the critical operational and financial decisions made just prior to being declared officially insolvent. The theory behind expanding the scope of fiduciary duties to include creditors at the pre-insolvency stage is that creditors may no longer be adequately protected by the agreements they negotiated with the corporation and so they need additional extra-contractual protections. While it is undisputed that these fiduciary duties to creditors vest when a corporation is insolvent or initiates an insolvency proceeding, many courts have expanded the time when directors and officers owe fiduciary duties to creditors to include the period when the corporation is in the vicinity of insolvency or the "zone" of insolvency. When a corporation becomes financially troubled, a shift occurs in the fiduciary role of its officers and directors, who must more actively and consciously consider the interests of the corporation's creditors when making decisions. Officers and directors continue to have fiduciary responsibilities, but they are no longer limited to the corporate entity and its shareholders. The obvious question for corporate officials and those who advise them is: At what point prior to insolvency do the fiduciary obligations of officers and directors shift to include creditors? This article summarizes the circumstances that may give rise to a shift of fiduciary duties to creditors, and describes the duties that may be owed when a corporation is in the vicinity of insolvency.Shifting Fiduciary Duties In the 'Zone' of InsolvencyThe rules regarding fiduciary duties applicable to solvent corporations become more complicated when a corporation is financially troubled. Under a relatively recent but widely accepted theory, courts have held that the fiduciary duties of directors and officers have been expanded to include the corporation's creditors when the corporation is in a financially troubled situation and approaching insolvency. It is well established that when a corporation is insolvent, its officers and directors owe fiduciary duties not only to the corporation and its shareholders, but to the corporation's creditors as well.
0 Comments
Leave a Reply. |
AuthorWrite something about yourself. No need to be fancy, just an overview. ArchivesCategories |