Fiduciary Duties and Creditors?

Difficult economic times frequently generate unanticipated questions and challenges for a corporation and its creditors.  One unanticipated question may include if or when fiduciary duties should be extended to a corporation’s creditors.

While it is well-recognized that officers and directors owe fiduciary duties to shareholders and the corporation, whether those fiduciary duties extend to a corporation’s creditors is less certain.  Generally, the law extends fiduciary duties to creditors when a corporation becomes insolvent—commonly meaning the corporation cannot pay its debts as they become due.  What if, however, the corporation is not yet insolvent but heading towards insolvency, also known as operating in the “zone of insolvency?”

Currently, the law regarding whether fiduciary duties are owed to creditors when a corporation is operating in the “zone of insolvency” is less settled.  A large concern held by creditors and generated by the “zone of insolvency” is that shareholders and directors who are about to wind up with nothing because they know the corporation is heading towards insolvency may take unreasonable gambles with corporate assets that otherwise would have gone to the creditors upon dissolution of the corporation.  If fiduciary duties are owed to creditors while a corporation is operating in the “zone of insolvency,” the theory is that a corporation will be less likely to gamble big.  While many courts have hinted that fiduciary duties exist when a corporation enters the “zone of insolvency,” the issue remains largely undecided.

Creditors can take steps to protect themselves from the risks presented when a corporation operates in the “zone of insolvency.”  For example, creditors can negotiate and implement safeguards by placing limitations on corporate behavior, such as restricting the types of projects in which the firm may invest or conditioning when it may invest.  Similarly, a creditor could negotiate for a share of the up-side that may be realized in various projects, such as through convertible debt securities.  In addition, corporate governance restrictions could be applied, such as limits on certain expenditures.

Just as creditors can take steps to protect themselves, corporations also can initiate steps to protect themselves.  For example, a corporation can document in minutes and memoranda the corporation’s good faith exercise of its business judgment in all actions designed to prolong the life of the corporation, increase its debt, or extend terms.  Likewise, before decisions are made, officers and directors can and should become thoroughly educated on the corporation’s financial condition.


Innovative Litigation, L.L.C., as owner and host of this site, and Matthew McKinney as the author (acting on behalf of and through Innovative Litigation, L.L.C.) cannot and does not warrant the accuracy or reliability of the information presented on or through this site.  The law can and does change over time and the information contained herein may not reflect the most recent laws – whether statutory law, administrative law, case law, constitutional law, or otherwise.  The information on this website does not constitute legal advice and readers should not rely on it to solve problems or other matters.  Further, you should seek licensed counsel in the appropriate legal jurisdiction before taking any action.  Any information provided on this site is presented “As Is” for your personal curiosity and enjoyment.  It is not meant to be relied upon for legal advice, counsel, or for any other purposes.  Such information does not take the place of a lawyer.  Rules and laws differ by jurisdiction and the information contained within this website may not apply in your jurisdiction.  The appearance of articles, listings, or ads, by or for professionals, on this site, does not constitute an endorsement.  In all cases, you are responsible for determining the quality of services, information, and/or advice provided by professionals through, or as a consequence of, your use of this site.  Neither liability nor responsibility shall arise to any person or entity with respect to loss or damage caused (or alleged to be caused), directly or indirectly, by information posted on this website, or by reason of contact with a professional listed on, or posting information to, this site.  No attorney-client relationship is formed by viewing this website and practice is limited to jurisdiction where lawyers are admitted.  The information furnished on the website is only general and not a substitute for personalized legal advice.   Legal advice cannot be given without full consideration of all relevant information relating to the individual(s) situation.  Laws can change daily and new laws may, and likely will, affect the accuracy of the information herein.  The information herein may be outdated and replaced by new law.

If you are seeking representation, please read the following notice before sending an e-mail:

Sending an e-mail will not make you a client.  Until an agreement regarding representation is reached with you, anything you send will not be confidential or privileged.  Before representation can occur, a lawyer will first take you through the conflict of interest procedure and see that you are put in touch with the lawyer best suited to handle your matter.

If you proceed with an e-mail, you confirm that you have read and understood this notice.


About Matthew McKinney

Attorney focused on civil and commercial litigation.
This entry was posted in Business Owner, Director, Litigation, Shareholder and tagged , , , , , , , . Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s