Abolition of the Corporate Duty to Creditors

85 Pages Posted: 3 Apr 2007 Last revised: 3 Dec 2007

See all articles by Henry T. C. Hu

Henry T. C. Hu

University of Texas at Austin - School of Law

Jay Lawrence Westbrook

University of Texas at Austin - School of Law


The corporation's core objective is to further the interests of shareholders. But one judicially crafted exception has long existed. In many jurisdictions around the world, financial distress mandates a shift to a duty to creditors. In May 2007, the Delaware Supreme Court announced a modern law of duty shifting.

This Article's prescription and reasoning break with existing law and critiques. We urge abolition of the doctrines. The result would be a duty to creditors arising upon a formal bankruptcy filing. This legal step, not "insolvency" or another financial metric, would be determinative.

Our reasoning is structural. First, the doctrines conflict with the corporate governance structure, one consisting of two alternative systems: the corporate governance system rooted in state law and the bankruptcy corporate governance system rooted in federal law. The mechanisms of the normal system promote the largely unitary interests of shareholders while those of the bankruptcy system primarily protect the disparate interests of creditors. By imposing creditor-oriented goals on corporations subject to the shareholder-oriented governance system, duty shifting mismatches ends and means.

Second, the doctrines misconceive the structure of shareholder ownership rights. Using a myopic residual claimant analysis, they ignore call option-like economic rights as well as voting and other "embedded rights" inherent in the concept of shareholder. Moreover, duty shifting imposes a unique duty on corporate debtors, depriving shareholders of property without justification, disclosure, or legal process.

Following the abolition of duty shifting, the task at hand will be to determine the optimal transition between the two governance systems.

Keywords: bankruptcy & reorganization, corporate governance, corporate investment, corporate objective, Credit Lyonnais, creditor rights, diversification, fiduciary duty, financial distress, hedging, ownership, risk-taking, shareholder rights, shareholder wealth maximization, troubled companies, voting rights

JEL Classification: D21,D23,G31,G32,G33,G34,G38,K20,K22,K29,L21,O38

Suggested Citation

Hu, Henry T. C. and Westbrook, Jay L., Abolition of the Corporate Duty to Creditors. Columbia Law Review, Vol. 107, pp. 1321-1403, October 2007, Available at SSRN: https://ssrn.com/abstract=977582

Henry T. C. Hu (Contact Author)

University of Texas at Austin - School of Law ( email )

727 East Dean Keeton Street
Austin, TX 78705
United States
512-232-1373 (Phone)
512-471-6988 (Fax)

Jay L. Westbrook

University of Texas at Austin - School of Law ( email )

727 East Dean Keeton Street
Austin, TX 78705
United States
(512) 232-1303 (Phone)

HOME PAGE: http://www.law.utexas.edu/webra/faculty/jwestbrook

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