Shifting Duties: The Impact of Insolvency on the Fiduciary Duties of Directors

Abstract:     
It is generally well understood that directors of a solvent corporation stand as fiduciaries to the corporation and its equity holders. In sharp contrast, directors do not owe fiduciary duties to debt holders. However, when a corporation becomes insolvent-or even approaches the vicinity of insolvency-the directors' fiduciary duties change under constructive trust principles; they shift to encompass a duty to debt holders. This shift can occur prior to bankruptcy filing, and the actual time at which it occurs can be elusive. Moreover, the nature of the directors' additional obligations is neither broadly recognized in board rooms nor well defined in statutory or case law, exacerbating the already complex and daunting problems directors of troubled companies face.

JEL Classification: G33, G34

working papers series