Managing the Distressed Enterprise: the Turf of Personal Liability
| Publication year | 1996 |
| Pages | 1 |
| Citation | Vol. 25 No. 4 Pg. 1 |
1996, April, Pg. 1. Managing the Distressed Enterprise: The Turf of Personal Liability
Attorneys are frequently called on to advise the managers of limited liability ventures with respect to their individual exposure. Most directors and officers of corporations, managers and members of limited liability companies (known as "LLCs"), partners in limited liability partnerships (known as "LLPs") and trustees of business trusts profess keen interest in avoiding personal liability. Predictably, however, the attention devoted to management accountability soars only as the fortunes of the business decay.
This article focuses on the liability of directors and officers in the proximity of corporate insolvency. It offers perspective for those called on to counsel the managers of a deteriorating corporate enterprise. In particular, the fiduciary duties of directors and officers of corporations approaching insolvency are explored in detail. The more sagacious practitioners, however, will appreciate that many of the principles surveyed here are more broadly applicable to the managers of other juridical forms of limited liability.
State law has long provided that directors and officers are fiduciaries for their corporation and its stockholders.(fn1) Their duties extend to each of the various classes of equity,(fn2) as well as to minority shareholders.(fn3) Accordingly, corporate managers may not manipulate the affairs of the company so as to secure control for one faction of shareholders or to exclude another.(fn4) In particular, the fiduciary obligations typically owed by directors and officers are those of obedience, care and loyalty.(fn5)
However, even more may be required of some. Most state corporate statutes permit delegation of authority by the board to one or more committees comprised of individual directors.(fn6) Of particular significance is the view expressed by one prominent court that the existence of an audit committee implies a "structured investigation and analysis of a company's fiscal welfare" and "create[s] at least the impression of great care and precision through detailed review and oversight."(fn7) This sentiment suggests that certain committees of directors will be held to even loftier fiduciary standards based on the special knowledge that these persons have or are expected to have.(fn8)
In contradistinction to the responsibilities owed to equity interest holders, directors and officers of a solvent firm owe no fiduciary duty to corporate creditors.(fn9) Nonetheless, these corporate managers risk personal liability on company contracts and instruments if they fail to provide notice that they have executed the contract or instrument on behalf of a corporate principal, or if they fail to identify the corporation on whose behalf they have penned.(fn10) Directors and officers also may be held individually accountable to third persons for: (1) unjustifiably interfering with corporate contracts;(fn11) (2) authorizing, directing or participating in torts committed by their corporation;(fn12) (3) aiding and abetting breach of the corporation's fiduciary duties;(fn13) and (4) being negligent in the supervision of subordinates.(fn14)
Increasingly, directors and officers also are held responsible for authorizing, directing, participating in or failing to abate corporate violations of statutes and regulations that do not expressly provide for management liability. The reported decisions embrace personal liability predicated on patent infringement,(fn15) and transgressions under the Fair Labor Standards Act,(fn16) Lanham Act(fn17) and Farm Labor Contractor Registration Act,(fn18) as well as state consumer protection and antitrust legislation.(fn19) Of perhaps even greater significance than these cases, however, are those that hold corporate managers individually responsible for remediation costs under formidable environmental legislation.(fn20)
As the business begins to falter, the managers of the firm frequently escalate their efforts to foster trade and husband resources. Although understandable, an aggressive approach can be perilous. For example, wholly independent of any management fiduciary duties, persons who materially misrepresent the organization's financial condition to third parties expose themselves for such loss as may ensue.(fn21) In addition, personal liability may result if a director or officer causes a corporate
Most corporate managers with access to the firm's financial resources appreciate that they can incur liability to the Internal Revenue Service ("IRS") as a "responsible person" for willfully failing to collect and pay over to the IRS trust fund taxes.(fn23) Less appreciated, however, is a statute affording the federal government payment priority---regardless of the source or nature of its claim---against insolvent obligors in defined circumstances.(fn24) Those who cause payments to be made in derogation of the federal priority are personally liable to the extent of any unpaid federal claim.(fn25) On the state level, a few jurisdictions have enacted legislation providing that directors and officers can be held individually accountable for the failure of the corporation to pay state taxes(fn26) and for unpaid employee compensation owed by the firm.(fn27)
As the corporation approaches insolvency, management's scrupulous and unqualified performance of fiduciary duties becomes all the more imperative. The particular powers controlled by the board of directors can have a profound impact on a troubled enterprise.(fn28) Moreover, those whose claims remain unsatisfied after company assets are exhausted frequently look to the directors and officers of the failed business as another potential source of recovery.
Once a corporation is insolvent, it is well-established that the firm's creditors supplant its equity interest holders as the beneficiaries of management's fiduciary obligations.(fn29) Unfortunately, judging the fulfillment of fiduciary duties as the enterprise approaches "insolvency" can be difficult. Some corporate codes define insolvency as the inability of the enterprise to discharge its obligations as they mature, i.e., "equitable...
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