Prepared by the Business Law Section Executive Committee
The unique financial problems occasioned by COVID-19, and the lockdown responses of federal, state and municipal governments, draw into sharp focus the fiduciary duties of directors and officers when addressing economic distress for their entities. These fiduciary duties vary according to the jurisdiction in which the entity is organized. For example, under Delaware law directors owe fiduciary duties of loyalty and care. The duty of loyalty obligates directors to act in good faith, in the best interests of the corporation, and to avoid self-dealing or other acts that would confer an improper personal benefit from a director's relationship with the corporation. The duty of care requires that directors inform themselves of material and relevant information that is reasonably available to them and to act with requisite care. In the discharge of these fiduciary duties, Delaware directors generally are subject to — and protected by — the so-called “business-judgment rule”, whereby the directors are presumed to have acted on an informed basis, in good faith and in the honest belief that the action was in the best interests of the entity.
When an entity is solvent, Delaware directors and officers owe these fiduciary duties to the entity and its interest holders. When an entity is insolvent (under Delaware law it is determined under one of two tests, namely the “equitable insolvency test” (the entity is unable to pay its debts as they become due in the ordinary course of business), or the “balance sheet test” (its liabilities exceed the reasonable market value of its assets)), Delaware directors and officers continue to owe their fiduciary duties to the entity and its interest holders, but creditors now may have standing to bring derivative claims for breach of fiduciary duty against directors and officers, although creditors do not have standing to bring direct claims for breach of fiduciary duty.
When faced with insolvency, directors’ and officers’ next steps depends upon a very fact-sensitive analysis, and directors and officers would be well-advised to seek legal advice for their entity’s particular situation. That said, the focus should be on taking steps that appear rationally designed to increase the value of the firm as a whole, even if these steps entail some risk, thereby benefitting creditors and (hopefully) the entity’s other interest holders; decisions that confer direct or specific benefits to one group should be avoided. In an appropriate case, such steps may include considering restructuring and wind-down plans, including seeking relief in bankruptcy for the entity.
To learn more, check out the Business Law Section's recent program, Fiduciary Duties: More Than Just The Golden Rule. See more details and view the program now here!
If you would like to submit content or write an article for the Business Law Section, please email Kara Sikorski at firstname.lastname@example.org.
Subscribe to Business Law Section news here!