Trenwalla: A Call for Rationalizing Fiduciary Duties to Creditors in Delaware

Abstract:     
In 2007, the Delaware Supreme Court considers two cases: North American Catholic Educational Programming Foundation, Inc. v. Gheewalla and Trenwick America Litigation Trust v. Ernst and Young, et al., both involving fiduciary duties to creditors. Not since Bovay v. H.M. Byllesby & Co., a 1944 corporate insolvency case decided upon the historical trust fund doctrine, has the Delaware Supreme Court had the opportunity to reexamine the state of Delaware case law on directorial duties to creditors at insolvency or the "vicinity of insolvency." On May 18, 2007, the Court held that "individual creditors of an insolvent corporation have no right to assert [direct] claims for breach of fiduciary duty against corporate directors." Given that these issues are equally applicable to direct or derivative fiduciary duties to creditors, will the Delaware Supreme Court will take the opportunity presented in Trenwick to eliminate the troublesome fiduciary derivative duty to creditors in favor of more rational, creditor-particular remedies.

The Delaware Supreme Court stands at a divide and thus should adopt a rational approach to the law of creditor rights by eliminating all derivative fiduciary duties in whatever context. This rational approach is dictated by: 1) the need for corporate management to be able to "engage in vigorous and good faith" negotiations with creditors in or near insolvency; 2) creditors' inability to meet the exacting legal standards required to bring a derivative suit; 3) the unfair exposure that advisors to corporate directors suffer under the Delaware regime after Gheewalla; and 4) the lack of rationality of the present day "duty to creditors" to its historical underpinnings (the trust fund doctrine) which required unjust enrichment of corporate management at the expense of the corporate enterprise.

Keywords: insolvency, duty of directors, fiduciary duties, derivative actions

JEL Classifications: G33, K22, L21

Working Paper Series