Enforcing Corporate Fiduciary Duties in Bankruptcy
63 Pages Posted: 8 Mar 2007 Last revised: 15 Sep 2011
Date Written: 2007
Because of a gaping hole in the law of corporate governance, rogue officers and directors can escape liability for severely disloyal, bad faith management by causing the company they operate to enter bankruptcy. The disappearance of the derivative suits that enforce state law fiduciary duties once a corporation files bankruptcy threatens to significantly undermine their deterrent effect outside of bankruptcy. Bankruptcy need not serve as a safe haven for faithless corporate managers. In fact, the Bankruptcy Code provides a solution to this problem, the appointment of a chapter 11 trustee to replace, monitor, or help troubled corporate managers, but bankruptcy courts and debtors' shareholders and creditors have been too intimidated by the traditionally extreme nature of that remedy to use it effectively. As a consequence, parties wishing to hold irresponsible managers accountable for the harm they have caused the now bankrupt corporation continue to try to use state law enforcement mechanisms that are not effective within a bankruptcy case. The common belief that a chapter 11 trustee must completely replace a debtor's management makes that remedy far too expensive to use in all but the most egregious of circumstances. The resulting loophole allows culpable officers and directors to escape the consequences of their malfeasance.
This article argues that bankruptcy courts and litigants should abandon the conventional wisdom regarding the extreme nature of the appointment of a chapter 11 trustee when faced with severe problems with a debtor's management. Instead, bankruptcy courts should embrace the discretion the Bankruptcy Code gives them to define the scope of a trustee's duties in a way that mitigates the harm such managers may inflict upon the debtor without causing the reorganizing company to endure the unnecessary costs or disruptions that would accompany the complete ouster of the debtor's current management. The chapter 11 trustee is, in situations of severe mismanagement of the debtor, a mandatory remedy that has fallen into disuse. Because a trustee is the only means provided by the Bankruptcy Code to address breaches of fiduciary duty by a debtor's managers, bankruptcy courts should require interested parties to use the corporate governance rules and mechanisms enumerated in the Bankruptcy Code before trying to force causes of action against management under state or other nonbankruptcy law to fit into a bankruptcy case. More specifically, courts should require litigants to bring a motion for the appointment of a trustee before requesting leave to pursue derivative suits against the debtor's managers if there is a significant problem with the debtor in possession's operation of the firm.
Keywords: corporations, chapter 11 trustees, bankruptcy, bankruptcy trustees, derivative suits, fiduciary duties
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