Abolition of the corporate duty to creditors

Columbia Law Review

Volumn 107, Issue 6, 2007, Pages 1321-1403

  Hu, Henry T C ^a   Westbrook, Jay Lawrence ^b  

^a UNIVERSITY OF TEXAS AT AUSTIN   (United States)

^b UNIVERSITY OF TEXAS   (United States)

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EID: 36549090576     PISSN: 00101958     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (564)

1. For succinctness, we discuss primarily the most important duty shifting doctrine, although much of our discussion also applies to other doctrines. Specifically, we focus on the doctrine associated with the traditional "trust fund" analysis and its modern extensions. We do not discuss, for instance, "deepening insolvency," wherein recovery is sought from officers, directors, and others for prolonging the life of an insolvent corporation. See, e.g., Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340, 349 (3d Cir. 2001) (stating that "'deepening insolvency' may give rise to a cognizable injury" under Pennsylvania law). The deepening insolvency doctrine appears to be falling of its own weight. In a characteristically thoughtful and witty decision, Vice Chancellor Leo Strine held in August 2006 that "Delaware law does not recognize [deepening insolvency] as a cause of action, because catchy though the term may be, it does not express a coherent concept."
2. Trenwick Am. Litig. Trust v. Ernst & Young, L.L.P., 906 A.2d 168, 174 (Del. Ch. 2006). Other judges are skeptical as well.
3. See, e.g., Seitz v. Detweiler, Hershey & Assocs. (In re CitX Corp.), 448 F.3d 672, 678 (3d Cir. 2006) (holding that deepening insolvency is not an independent cause of action) ;
4. Official Comm. of Unsecured Creditors v. Rural Tel. Fin. Coop. (In re VarTec Telecom, Inc.), 335 B.R. 631, 646 (Bankr. N.D. Tex. 2005) (holding that Texas does not recognize tort of "deepening insolvency").
5. As to related doctrines (and statutes) in other common law jurisdictions, see generally Caron Bélanger Ernst & Young Inc. v. Wise (In re Peoples Dep't Stores Inc.), [2004] 3 S.C.R. 461, 481-86 (Can.) (discussing "best interests of the corporation" under Canadian law);
6. Andrew Keay & Michael Murray, Making Company Directors Liable: A Comparative Analysis of Wrongful Trading in the United Kingdom and Insolvent Trading in Australia, 14 Int'l Insolvency Rev. 27 (2005) (comparing United Kingdom's wrongful trading statute to Australia's insolvent trading statute);
7. Mark Cheng Wai Yuen, Corporate Director's Common Law Duty to Creditors? - A Revelation of the Present State of the Law, 22 Sing. L. Rev. 104 (2002) (comparing corporate duty doctrines adopted by courts in Australia, New Zealand, and United Kingdom to Singapore approach). For a pertinent nineteen-country survey,
8. see INSOL Int'l, Directors in the Twilight Zone II (2005) (comparing countries' approaches to powers and duties of directors of financially troubled corporations).
9. See infra Part I.B.3.
10. No. 521, 2006, slip op. at 15-16 (Del. May 18, 2007) (stating that court had "never directly addressed the zone of insolvency issue involving directors' purported fiduciary duties to creditors").
11. We thus exclude discussion of fraudulent behavior, inter alia. Cf. id. at 24 (distinguishing fiduciary duty claims from claims rooted in contract or tort).
12. We keep an open mind regarding one prebankruptcy duty directors might have to creditors: the duty to file for bankruptcy. Often directors may best serve shareholders as well as creditors by an early filing, but we do not attempt to find die answer here. Indeed, we suggest that, in our framework, the key item on the research agenda is to determine when such filings should be mandated. See infra Part V.
13. For one pessimistic view, see Steven Rattner, The Coming Credit Meltdown, Wall St. J., June 18, 2007, at A17 (stating that "money is available today in quantities, at prices and on terms never before seen in the 100-plus years since U.S. financial markets reached full flower"). Similar deterioration in corporate creditworthiness may be occurring in Europe.
14. See Floyd Norris, Are High Credit Ratings Just a Thing of the Past?, N.Y. Times, Nov. 11, 2006, at C3 (asserting that European credit ratings are trending downward, but that trend is less advanced than in United States). In August 2007, the Federal Reserve Board and European Central Bank felt compelled to intervene in ways not seen since 9/11 to stem near panic in world financial markets.
15. See, e.g., David Smith et al., Panic on Wall Street Spreads Fears of Contagion Around the World, Australian, Aug. 13, 2007, at 29 (noting how European Central Bank had injected more liquidity in just two days in August 2007 than it had provided in wake of September 11);
16. Ben Steverman, Markets: Keeping the Bears at Bay, Bus. Wk. Online, Aug. 13, 2007, at http://www.businessweek.com/investor/content/aug2007/ pi20070810_184123.htm (on file with the Columbia Law Review) (noting reasons for Federal Reserve's injections of liquidity in August 2007 and immediately after September 11 terrorist attacks).
17. For analysis of these changes, which have been driven in part by the growth of hedge funds (and hedge fund "decoupling" of shareholder voting rights from the accompanying economic interest), see Henry T. C. Hu & Bernard Black, The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership, 79 S. Cal. L. Rev. 811, 815 (2006) [hereinafter Hu & Black, The New Vote Buying] (analyzing decoupling of economic ownership from voting power and corporate governance implications, including role of hedge fund activism) ;
18. David A. Katz & Laura A McIntosh, Corporate Governance: Advice on Coping with Hedge Fund Activism, N.Y.L.J., May 25, 2006, at 5 (stating that "[e]very decade needs a villain" and that in 2000s, "it appears to be activist hedge funds");
19. Kara Scannell, Outside Influence: How Borrowed Shares Swing Company Votes, Wall St. J., Jan. 26, 2007, at Al (discussing decoupling via share lending and foregoing analysis);
20. Ben White, Thesis on Hedge Fund Tactics Gives Investors a Shock, Fin. Times, Oct. 6, 2006, at 29 (discussing institutional investors and the New Vote Buying-based speech). Similar changes appear to be occurring worldwide.
21. See, e.g., Andrew Morse, Hostile Bid Breaks Japanese Mold, Wall St. J., July 25, 2006, at C4 (discussing unprecedented takeover attempt in Japan) ;
22. David Reilly, Deutsche Boerse's New Tune on Mergers Gives Investors Hope a New Deal Will Come, Wall St. J., Oct. 26, 2005, at Cl (describing implications for German shareholders of developments involving Deutsche Boerse);
23. Laura Santini, A Firm Activist, Lichtenstein Wins Big in South Korea, Wall St. J., Aug. 10, 2006, at C1 (describing implications of hedge fund's purchase of shares of underperforming South Korean corporation); Julia Werdigier, At More Companies, Shareholders are Challenging the Boss, and Winning, Int'l Herald Trib., May 24, 2007, at 14 (discussing fight over ABN AMRO and other shareholder-related developments in Europe).
24. We are aware of only one other article that has called for a bankruptcy filing to trigger managerial duties to creditors, just published by Professors Rutherford Campbell and Christopher Frost. See Rutherford B. Campbell, Jr. & Christopher W. Frost, Managers' Fiduciary Duties in Financially Distressed Corporations: Chaos in Delaware (and Elsewhere), 32 J. Corp. L. 491, 522-25 (2007). It offers a helpful analysis and deploys some of the same points we make in this article. Campbell and Frost, however, ground their prescription largely on arguments rooted in the concept that "clear and efficient default rules are of the utmost importance."
25. Id. at 494. Our analysis instead centers on the structure of shareholder ownership rights and of governance systems. Campbell and Frost do not consider the structure of shareholder ownership rights, do not address key congruence issues (such as the imposition of conflict resolution responsibilities on the corporate governance system), and do not consider the research necessitated by abolition of duty shifting.
26. Elizabeth Warren & Jay Lawrence Westbrook, Financial Characteristics of Businesses in Bankruptcy, 73 Am. Bankr. L.J. 499, 523 (1999).
27. The interests of shareholders and those of other constituencies do not always conflict, of course. Thus, from an instrumental standpoint, a corporation may further the interests of shareholders by making large (and visible) charitable donations to host communities. In this Article, we are focusing on harder cases, where decisions do turn on which constituency matters. In addition, when we talk of the "corporate objective," we generally mean the core (i.e., primary) objective of the corporation. For a corporation to have as its core objective the furtherance of its shareholders' welfare is not necessarily inconsistent with a corporation adopting as some lesser objective the promotion of the interests of nonshareholder constituencies. This Article does not expressly analyze the general desirability of a "multiple constituency" philosophy or other corporate "social responsibility" matters. See infra note 16 (discussing how views we express in this Article are largely independent of multiple constituency issue). We believe this is appropriate for three reasons. First, the sole exception to the core duty to shareholders recognized in Delaware and most other states is that flowing from duty shifting. Irrespective of how one stands on corporate "social responsibility" generally, this exception exists as a matter of law and must be addressed. Second, Delaware and most other states have long rejected the "multiple constituency" approach and, if anything, have become more focused on the interests of shareholders in the past few years. Third, and perhaps most important, it is the rare public corporation that takes seriously the concept of a core duty to multiple constituencies; this is especially unlikely in today's environment of hedge funds, private equity funds, and shareholder activism. Professor Robert Charles Clark recently noted that it does not appear that directors and officers ever consider a "multiple constituency" approach and, instead, "simply assume or state that the main effort is to maximize shareholder value."
28. Robert C. Clark, Major Changes Lead Us Back to Basics (A Response to the Symposium on My Treatise), 31 J. Corp. L. 591, 596 (2006).
29. For a classic critique of a "multiple constituency" philosophy, see Comm. on Corporate Laws, Other Constituencies Statutes: Potential for Confusion, 45 Bus. Law. 2253 (1990);
30. see also David A. Skeel, Jr., Icarus and American Corporate Regulation, 61 Bus. Law. 155, 175-76 (2005) (opposing multiple constituency approach to corporate law).
31. But see Margaret M. Blair & Lynn A. Stout, A Team Production Theory of Corporate Law, 85 Va. L. Rev. 247, 248-57 (1999) (advocating "team production" approach to understanding public corporations);
32. see also Janis Sana, Creditor Rights and the Public Interest: Restructuring Insolvent Corporations 101-02 (2003) (stating that, in Canada, directors act for all stakeholders).
33. At least as a starting point, in most cases, management concerned about shareholders need not consider the individual risk and time preferences of its shareholders. See Henry T. C. Hu, Risk, Time, and Fiduciary Principles in Corporate Investment, 38 UCLA L. Rev. 277, 287-95 (1990) [hereinafter Hu, Risk & Time] (arguing that using conventional capital budgeting technique generally leads to investment decisions that benefit all shareholders regardless of individual time and risk preferences) ;
34. infra Parts H.B.1-2 (discussing corporate governance system and largely unitary interests of shareholders). In this Article, we focus primarily on the usual publicly held corporation. The special considerations associated with closely held corporations (such as those flowing from ill-diversified shareholders) are beyond the scope of this Article. We also assume, among other things, only one class of equity holders, all of whom are fully diversified and are concerned solely with their own material well-being.
35. See infra Part II.B.2 (discussing stylized fact pattern involving only one class of equityholders). For a discussion of limitations to the unitary nature of the interests of shareholders,
36. see infra note 155 and accompanying text.
37. In this Article, we leave aside attempts by one group of shareholders (e.g., controlling shareholders) to deprive another group of shareholders (e.g., minority shareholders) of their formal or informal ownership rights.
38. For more details about the core nature of investment decisions and a discussion of the difficulties they pose, see Hu, Risk & Time, supra note 12, at 279-80, 287-306.
39. See Micheline Maynard, Ford Posts Loss of $5.8 Billion, Worst Since 1992, N.Y. Times, Oct. 24, 2006, at Al (reporting Ford CEO Alan Mulally's description of two choices);
40. cf. Standard & Poor's, Stock Report: Ford Motor Co. (Oct. 14, 2006) (analyzing Ford creditworthiness as of Sept. 11, 2006);
41. Antony Currie & Jonathan Ford, For Ford, It Doesn't Add Up: Investors' Valuation of Stock Is off When Considering Firm's Liabilities, Assets, Wall St. J., Feb. 12, 2007, at C12 (claiming that intrinsic value of Ford shares is zero);
42. Shikha Dalmia, The UAW's Health-Care Dreams, Wall St. J., July 27, 2007, at A13 (claiming that Ford, among others, was "teetering on the brink of bankruptcy," notwithstanding second quarter profit in 2007).
43. Maynard, supra note 14.
44. We do not argue that the existing bundle of rights allocated to shareholders is the only possible one, but rather that the longstanding foundational structure of shareholder ownership rights should not be abandoned without compelling reasons. We also suggest that whatever rights are in the bundle at a given time should not be abrogated without transparency and due process. See infra Part III.C. We should also make it clear that we are not addressing larger questions of the social responsibility of corporations. Such questions involve social and political policies outside the scope of this Article. Comments from readers and our conversations with each other confirm to us that one does not have to be politically liberal or conservative to adopt the views we express in this Article.
45. See also supra note 11 (discussing interests of multiple constituencies).
46. See Henry T. C. Hu, Shareholder and Creditor Decoupling: Separating "Embedded Rights" and Contractual Rights from Economic Interests 4 (contribution to 10th Singapore Conference on International Business Law, Aug. 22-23, 2007, and associated conference volume) (draft of Aug. 17, 2007, on file with the Columbia Law Review) [hereinafter Hu, Shareholder and Creditor Decoupling] (introducing concept of "embedded rights," of which voting rights, inspection rights, and rights to sue directors for violations of fiduciary duty are examples).
47. The "maximization right"-the right to require that management run the corporation in a way intended to maximize benefits to shareholders-is probably the most important of these embedded rights. This "maximization right" concept was introduced in Henry T. C. Hu, New Financial Products, the Modern Process of Financial Innovation, and the Puzzle of Shareholder Welfare, 69 Tex. L. Rev. 1273, 1288-1300 (1991) [hereinafter Hu, Shareholder Welfare]. However, to avoid the possibility of infinite regress, this Article's ownership-based analysis is not dependent on the existence of this particular embedded right. It is sufficient for our purposes to rely instead on other, more structural rights, such as voting rights.
48. The above static versus dynamic economic rights assertion does not depend in any way on "contingent claims analysis" (CCA - a branch of finance theory made possible by option pricing models), on any of the related finance theoretic scholarship, or on the validity of any related finance scholarship. Some finance theorists have used CCA analysis to analyze certain creditor-shareholder conflicts and, in doing so, viewed shareholders as call holders of some sort. See, e.g., Marc Chesney & Rajna Gibson-Asner, Reducing Asset Substitution with Warrant and Convertible Debt Issues, J. Derivatives, Fall 2001, at 39, 51 (stating that, under posited capital structure, equity "can be priced as a combination of down-and-out European calls that is similar to a vertical call spread"). For an introduction to call options and option pricing models,
49. see Henry T. C. Hu, Misunderstood Derivatives: The Causes of Informational Failure and the Promise of Regulatory Incrementalism, 102 Yale L.J. 1457, 1464-76 (1993) [hereinafter Hu, Misunderstood Derivatives].
50. As to the matter of options always having value, see infra note 221 and accompanying text.
51. See, e.g., Hu & Black, The New Vote Buying, supra note 8, at 814-19 (discussing recent emergence of this phenomenon and independent significance of shareholder voting and economic rights). This Article does not purport to address all of the implications of such decoupling.
52. See infra Part V.
53. See infra Part II.B; cf. supra note 11 (noting distinction between "core" and secondary corporate objectives and discussing multiple constituency issue).
54. See infra Part I.C.
55. Civ. A. No. 12150, 1991 WL 277613, at *34 (Del. Ch. Dec. 30, 1991).
56. N. Am. Catholic Educ. Programming Found, v. Gheewalla, No. 521, 2006, slip op. at 19, 22 (Del. May 18, 2007).
57. See infra Part I.C.
58. 30 F. Cas. 435 (C.C.D. Me. 1824) (No. 17, 994).
59. 1 E. Merrick Dodd, Jr. & Ralph J. Baker, Cases on Business Associations-Corporations 895 (1940);
60. Lawrence M. Friedman, A History of American Law 199 (2d ed. 1985).
61. Wood, 30 F. Cas. at 436.
62. See, e.g., Joseph Jude Norton, Relationship of Shareholders to Corporate Creditors upon Dissolution: Nature and Implications of the "Trust Fund" Doctrine of Corporate Assets, 30 Bus. Law. 1061, 1064 (1975). Note that the United States is like many other countries in excluding banks from the operation of the ordinary bankruptcy laws.
63. See 11 U.S.C. § 109(b)(2) (2000). More broadly, governments tend to subject banks and other financial institutions to special regulation, including limiting the risk taking they may engage in.
64. See, e.g., Robert Charles Clark, The Soundness of Financial Intermediaries, 86 Yale L.J. 1, 3 (1976). As with the state law duty shifting doctrines, bank regulatory regimes seek to limit shareholder-optimal risk taking.
65. Henry T. C. Hu, Swaps, the Modern Process of Financial Innovation and the Vulnerability of a Regulatory Paradigm, 138 U. Pa. L. Rev. 333, 366-70 (1989). But, in contrast to those doctrines' failure to consider mechanisms to guide managerial behavior, bank regulatory regimes rely on a wide variety of finely-tuned legal, administrative, and market mechanisms to do so.
66. See infra Parts II.C.2-II.D.
67. See Joseph W. Bishop, Jr., Sitting Ducks and Decoy Ducks: New Trends in the Indemnification of Corporate Directors and Officers, 77 Yale L.J. 1078, 1099 (1968) (discussing uniqueness of bank director exposure).
68. Writing in 1940, Professors Merrick Dodd and Ralph Baker belitded the significance of the "trust fund doctrine"; all that Story meant "was that corporate property must be first appropriated to the payment of the debts of the company before there can be any distribution of it among stockholders - a proposition that is sound upon the plainest principles of common honesty." Dodd & Baker, supra note 26, at 895.
69. The Bankruptcy Act of 1800 was repealed in 1803, and the next federal bankruptcy statute would not be adopted until 1841. It was 1898 before the United States began to have a continuous federal bankruptcy system. Theodore Eisenberg, Bankruptcy and Debtor-Creditor Law 216 (3d ed. 2004);
70. Elizabeth Warren & Jay Lawrence Westbrook, The Law of Debtors and Creditors 108 (5th ed. 2005) [hereinafter Warren & Westbrook, Text, Cases & Problems]. Not coincidentally, Justice Story, in the years after Wood, was a leading advocate of adoption of a federal bankruptcy law. According to his son, he actually drafted the bill that became the 1841 Act. 2 Life and Letters of Joseph Story 407 (William W. Story ed., 1851).
71. This response was also understandable as a way of reaching the right result in the face of poorly drafted pleadings. See Bayless Manning & James J. Hanks, Jr., Legal Capital 31 (3d ed. 1990) (deeming Justice Story's Wood opinion "simple, clear and wholly adequate for the particular problem with which he was confronted");
72. Norton, supra note 28, at 1062-63 (describing bill in equity as "poorly written").
73. For an amusing discussion of this historical context, see Manning & Hanks, supra note 31, at 20-43.
74. Arthur Stone Dewing, The Financial Policy of Corporations 21 (3d rev. ed. 1934).
75. One of the leading English cases was Trevor v. Whitworth, (1887) 12 App. Cas. 409, 411 (H.L.) (appeal taken from CA.) ("[N]o reduction of capital otherwise than as allowed by statute is legitimate.").
76. See Dewing, supra note 33, at 25-26 (arguing that aggregate par value representations are suspect).
77. Act of Apr. 15, 1912, eh. 351, 1912 N.Y. Laws 687 (codified at N.Y. Stock Corp. Law §19);
78. see Dewing, supra note 33, at 23 (noting first statute permitting no-par stock); Dodd & Baker, supra note 26, at 1001 (discussing New York statute and comparing with those of other states). It may not be entirely coincidental that these developments followed shortly after the adoption of our first viable bankruptcy law in 1898. In England, a leading case left directors largely free to ignore creditor interests.
79. See Salomon v. Salomon & Co., [1897] A.C. 22, 27 (H.L.) (appeal taken from C.A.) (holding that director need not indemnify company against creditors' claims).
80. Dewing, supra note 33, at 23.
81. 2 James D. Cox, Thomas Lee Hazen & F. Hodge O'Neal, Corporations § 16.15 n.2 (1995).
82. Hollins v. Brierfield Coal & Iron Co., 150 U.S. 371, 382 (1893).
83. Am. Nat'l Bank of Austin v. MortgageAmerica Corp. (In re MortgageAmerica Corp.), 714 F.2d 1266, 1269 (5th Cir. 1983)
84. (quoting 15A William Meade Fletcher et al., Fletcher Cyclopedia of the Law of Private Corporations § 7369, at 42 (perm, ed., rev. vol. 1981)).
85. For excellent discussions of the trust fund cases, see Decker v. Mitchell (In re JTS Corp.), 305 B.R. 529, 535-36 (Bankr. N.D. Cal. 2003);
86. Gregory V. Varallo & Jesse A. Finkelstein, Fiduciary Obligations of Directors of the Financially Troubled Company, 48 Bus. Law. 239, 245-48 (1992).
87. 38 A.2d 808, 809 (Del. 1944).
88. Id. at 811-12, 814.
89. Id. at 813 (citations omitted).
90. Id.
91. Today this common law doctrine has been displaced with respect to the termination of corporations by state statutory law relating to the "winding up" of corporations and by federal bankruptcy law. If shareholders wish to terminate a corporation outside of bankruptcy, the directors must follow specific statutory rules about notifying creditors, paying creditors, and distributing remaining property to shareholders. See, e.g., Rev. Model Bus. Corp. Act §§ 14.02, 14.06, 14.09(a) (2005);
92. cf. Pac. Scene, Inc. v. Penasquitos, Inc., 758 P.2d 1182, 1183 (Cal. 1988) (stating that "Legislature has generally occupied the field with respect to the remedies available against the former shareholders of dissolved corporations, thus preempting antecedent common law causes of action") ;
93. Rev. Model Bus. Corp. Act §14.05 official cmt. (stating that winding up process under Revised Model Business Corporations Act "does not have any of the characteristics of common law dissolution"). However, because of the ubiquity of bankruptcy law in the United States in the last century, use of winding up for insolvent corporations has been less important. In the United Kingdom, where business bankruptcy law is treated as part of corporate law, winding up is the customary "bankruptcy" process for insolvent corporations.
94. See Roy M. Goode, Principles of Corporate Insolvency Law 19 (3d ed. 2005) (noting that usual method of insolvency proceedings in United Kingdom is winding up); Harry Rajak, Company Liquidations, at vii (1988) (remarking that winding up is usual course for insolvent corporations in United Kingdom).
95. 324 A.2d 215 (Del. Ch. 1974), rev'd on other grounds, 347 A.2d 133 (Del. 1975). The single corporate act challenged was the declaration of a dividend of $1.75 a share by Metro-Goldwyn-Mayer the previous year. The plaintiffs, holders of convertible subordinate debt, did not allege fraud or that the dividends violated either the governing indenture or any Delaware statute. Instead, the plaintiffs argued that defendants breached their fiduciary duty to the plaintiffs since defendants were the controlling stockholders and such dividends on the common stock hurt the market value of their debentures and the conversion feature.
96. Id. at 221. Without citing Bovay, the trust fund doctrine, or offering much by way of analysis, the court suggested the possibility of debenture holders having extracontractual rights when there were "special circumstances" such as "fraud, insolvency, or a violation of a statute."
97. Id. at 221-22. Nowhere did the Harff court suggest that these extracontractual rights involved a fiduciary duty to creditors.
98. See, e.g., Simons v. Cogans, 542 A.2d 785, 788 (Del. Ch. 1987) (quoting with approval 1987 chancery court opinion that "'(i) a debenture holder has no independent right to maintain a claim for breach of fiduciary duty and (ii) in the absence of fraud, insolvency or a statutory violation, a debenture holder's rights are defined by the terms of the indenture'"
99. (quoting Cont'l Ill. Nat'l Bank & Trust Co. v. Hunt Int'l Res. Corp., No. 7888, 1987 WL 55826, at *4 (Del. Ch. Feb. 27, 1987))), aff'd, 549 A.2d 300 (Del. 1988). The Delaware Supreme Court expressly predicated the existence of any fiduciary duty owed by management on an "existing property right or equitable interest supporting such a duty"; until a debenture is converted into stock, the holder has no equitable interest and remains a creditor "whose interests are protected by the contractual terms of the indenture." 549 A.2d at 304. The court also noted that "an equitable interest in the issuing corporation [is] necessary for the imposition of a trust relationship with concomitant fiduciary duties."
100. Id. at 303.
101. With perhaps one major exception, all of the decisions in which courts have allowed recovery on such grounds involved directors of an insolvent corporation diverting corporate assets for the benefit of insiders or preferred creditors. Professor Laura Lin groups the cases as follows: (1) withdrawing assets from the insolvent corporation as alleged payment of claims that the directors had against the corporation, such as loans to the company or unpaid commissions; (2) using corporate funds to pay off the company's loans that the directors had personally guaranteed; (3) engaging in transactions, usually without fair consideration to the company, for the benefit of its parent corporation or related entities; (4) pocketing the proceeds of a sale of all corporate assets to a third party or otherwise transferring property to a related entity, leaving the former corporation insolvent; and (5) other forms of self-dealing in which die directors use assets of the insolvent firm for their own benefit, such as pledging stock owned by the corporation as collateral to finance the directors' personal stock purchases. Laura Lin, Shift of Fiduciary Duty upon Corporate Insolvency: Proper Scope of Directors' Duty to Creditors, 46 Vand. L. Rev. 1485, 1513-14 (1993) (citations omitted).
102. The exception is N.Y. Credit Men's Adjustment Bureau v. Weiss, 110 N.E.2d 397 (N.Y. 1953). For a discussion of this case,
103. see Jonathan C. Lipson, Directors' Duties to Creditors: Power Imbalance and die Financially Distressed Corporation, 50 UCLA L. Rev. 1189, 1205-06 (2003);
104. Varallo & Finkelstein, supra note 41, at 247-48.
105. It is nonetheless noteworthy that the example used in Credit Lyonnais assumes a "dead" corporation, just like the carcasses in Wood and Bovay.
106. For a discussion of corporate "investment decisions" and their importance, see Hu, Risk & Time, supra note 12, at 279-81.
107. In fact, Credit Lyonnais not only intervenes as to investment decisions, but also as to the other major class of managerial decisions - financing decisions. For the distinction between investment decisions and financing decisions, see, for example, Hu, Risk & Time, supra note 12, at 279 & n.1 (characterizing investment decisions as "any use of current resources to achieve a future return" and financing decisions as, roughly speaking, "how the corporation obtains the money").
108. For a discussion of this control versus economic rights theme in both the corporate governance system (i.e., voting rights versus economic rights) and the bankruptcy governance system (i.e., control versus priority), see infra Parts II.C-D, III.B. We have also independentiy considered this theme previously in our respective fields. In the context of die bankruptcy governance system,
109. see Jay Lawrence Westbrook, The Control of Wealth in Bankruptcy, 82 Tex. L. Rev. 795, 797 nn.3-4 (2004) [hereinafter Westbrook, Control] ;
110. see also Goode, supra note 46, ¶¶2-02 to -08. In the context of the corporate governance system,
111. see Henry T. C. Hu & Bernard Black, Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms, 61 Bus. Law. 1011, 1013-14 (2006) [hereinafter Hu & Black, Taxonomy];
112. Henry T. C. Hu & Bernard Black, Hedge Funds, Insiders, and the Decoupling of Economic and Voting Ownership: Empty Voting and Hidden (Morphable) Ownership, 13 J. Corp. Fin. 343, 353-55 (2007) [hereinafter Hu & Black, Decoupling].
113. Credit Lyonnais Bank Nederland, N.V. v. Pathe Commc'ns Corp., Civ. A. No. 12150, 1991 WL 277613, at *33-*34 (Del. Ch. Dec. 30, 1991).
114. Id. at *34.
115. Id. It seemed clear that Credit Lyonnais created a shield for directors, not a sword to be used against them. Indeed, several years after Credit Lyonnais, shortly before resigning from the bench, Chancellor Allen offered dicta that appeared to exclude duty shifting as a sword in the hands of creditors. See Equity-Linked Investors, L.P. v. Adams, 705 A.2d 1040, 1041 (Del. Ch. 1997). This is not the law in Delaware today.
116. See infra Part IV.
117. The famous footnote follows: The possibility of insolvency can do curious things to incentives, exposing creditors to risks of opportunistic behavior and creating complexities for directors. Consider, for example, a solvent corporation having a single asset, a judgment for $51 million against a solvent debtor. The judgment is on appeal and thus subject to modification or reversal. Assume that the only liabilities of the company are to bondholders in the amount of $12 million. Assume that the array of probable outcomes of the appeal is as follows: Expected Value 25% chance of affirmance ($51mm) $12.75 70% chance of modification ($4mm) 2.8 5% chance of reversal ($0) 0 Expected Value of Judgment on Appeal Thus, the best evaluation is that the current value of the equity is $3.55 million. ($15.55 million expected value of judgment on appeal - $12 million liability to bondholders). Now assume an offer to settle at $12.5 million (also consider one at $17.5 million). By what standard do the directors of the company evaluate the fairness of these offers? The creditors of this solvent company would be in favor of accepting either a $12.5 million offer or a $17.5 million offer. In either event they will avoid the 75% risk of insolvency and default. The stockholders, however, will plainly be opposed to acceptance of a $12.5 million setdement (under which they get practically nothing). More importantly, they very well may be opposed to acceptance of the $17.5 million offer under which the residual value of the corporation would increase from $3.5 to $5.5 million. This is so because the litigation alternative, with its 25% probability of a $39 million outcome to them ($51 milIon - $12 million = $39 million) has an expected value to the residual risk bearer of $9.75 million ($39 million × 25% chance of affirmance), substantially greater than the $5.5 million available to them in the settlement. While in fact the stockholders' preference would reflect their appetite for risk, it is possible (and with diversified shareholders likely) that shareholders would prefer rejection of both settlement offers. But if we consider the community of interests that the corporation represents it seems apparent that one should in this hypothetical accept die best settlement offer available providing it is greater than $15.55 million, and one below that amount should be rejected. But that result will not be reached by a director who thinks he owes duties directly to shareholders only. It will be reached by directors who are capable of conceiving of the corporation as a legal and economic entity. Such directors will recognize that in managing the business affairs of a solvent corporation in the vicinity of insolvency, circumstances may arise when the right (both the efficient and the fair) course to follow for the corporation may diverge from the choice that the stockholders (or the creditors, or the employees, or any single group interested in the corporation) would make if given the opportunity to act. Credit Lyonnais, 1991 WL 277613, at *34 n.55.
118. Although Chancellor Allen's litigation example implicitly weighs conflicting interests, there is no reason to believe that those weights were meant to (or even can) be used in nonlitigation contexts. See infra Part II.C.2.
119. 863 A.2d 772, 790-91 (Del. Ch. 2004). In this case, Production Resources had obtained a judgment against NCT Group, Inc., but had been unsuccessful in collecting the judgment Production Resources claimed NCT was insolvent and sought to protect its interests by the appointment of a receiver for NCT under Delaware law. Production Resources also alleged that NCT's board and one of its officers had breached their fiduciary duties. Credit Lyonnais and the trust fund doctrine came up in a procedural context: NCT claimed that this fiduciary breach count raised derivative claims that Production Resources had not properly pled. If die nature of the claim was direct, rather than derivative, the count would not be barred.
120. See also U.S. Bank Nat'l Ass'n v. U.S. Timberlands Klamath Falls, L.L.C., 864 A.2d 930, 947-48 (Del. Ch. 2004) (" [Directors' or managers' fiduciary duties may extend to the interests of the company's creditors when the company is in the 'zone of insolvency.'"), vacated, 875 A.2d 632 (Del. 2005);
121. Odyssey Partners, L.P. v. Fleming Cos., 735 A.2d 386, 417 (Del. Ch. 1999) ("[W]hile directors normally do not owe creditors fiduciary duties, an exception exists in the case of insolvency _"
122. (citing Geyer v. Ingersoll Publ'ns, 621 A.2d 784, 787 (Del. Ch. 1992)));
123. Equity-Linked Investors, L.P. v. Adams, 705 A.2d 1040, 1042 (Del. Ch. 1997) (discussing interests of common stockholders relative to those of preferred stockholders);
124. Haft v. Haft, 671 A.2d 413, 422 (Del. Ch. 1995) (discussing inefficiencies of proxy voting);
125. Geyer, 621 A.2d at 787 ("[N] either party seriously disputes that when the insolvency exception does arise, it creates fiduciary duties for the benefit of creditors.").
126. N. Am. Catholic Educ. Programming Found, v. Gheewalla, No. 521, 2006, slip op. at 17-24 (Del. May 18, 2007) (discussing court of chancery's opinion in Production Resources).
127. Prod. Res. Group, 863 A.2d at 790 n.57. Vice Chancellor Strine said, elegantly and accurately, that he did not need to "explore the metaphysical boundaries of the zone of insolvency" because the company was insolvent.
128. Id. at 790.
129. Id. at 790-91.
130. Brandt v. Hicks, Muse & Co. (In re Healthco Int'l, Inc.), 208 B.R. 288, 302 (Bankr. D. Mass. 1997) (involving suit brought by trustee in bankruptcy on behalf of corporation but in interest of creditors).
131. See infra Part II.E (warning that worthwhile "bet the company" risk taking may be precluded if Healthco is followed). It is worth noting that the corporation in Chancellor Allen's example in Credit Lyonnais was solvent, albeit comatose and with no business to operate.
132. This is based on a search of the "U.S. Law Reviews and Journals, Combined" database on Lexis on August 4, 2006. Using the phrase "credit lyonnais /10 pathe" generated 160 items.
133. Mark J. Roe, Bankruptcy and Debt: A New Model for Corporate Reorganizations, 83 Colum. L. Rev. 527, 583 (1983).
134. Stephen M. Bainbridge, Corporation Law and Economics 431 (2002);
135. see also Sabin Willed, The Shallows of Deepening Insolvency, 60 Bus. Law. 549, 561 (2005) (viewing insolvent company as "dea[d]" and its owners as having no real interest in it);
136. cf. Janis Sarra, Taking the Corporation past the 'Plimsoll Line'-Director and Officer Liability When the Corporation Founders, 10 Int'l Insolvency Rev. 229, 233-34 (2001) (asserting residual claimant justification for duty shifting in context of Canadian doctrine). The statements set out in the text represent the classic conflating of insolvency, an economic state, and bankruptcy, a legal proceeding. In a recent essay, Professor Bainbridge appears to have modified his views on duty shifting somewhat, but continues to subscribe to duty shifting's vision that shareholders are nothing more than as-if liquidation residual claimants.
137. See Stephen M. Bainbridge, Much Ado About Little? Directors' Fiduciary Duties in the Vicinity of Insolvency, 1 J. Bus. & Tech. L. 335 passim (2007).
138. See, e.g., Alon Chaver & Jesse M. Fried, Managers' Fiduciary Duty upon the Firm's Insolvency: Accounting for Performance Creditors, 55 Vand. L. Rev. 1813, 1815-16 (2002) (discussing rationales for duty shifting with respect to performance creditors);
139. Andrew Keay, Directors' Duties to Creditors: Contractarian Concerns Relating to Efficiency and Over-Protection of Creditors, 66 Mod. L. Rev. 665, 693-98 (2003) (discussing rationales for duty shifting with respect to employees, customers, involuntary creditors, and many trade creditors);
140. Lipson, supra note 49, at 1245-48 (discussing rationales for duty shifting with respect to tort and wage claimants).
141. We are sympathetic to the special needs of constituencies such as involuntary creditors but feel that any accommodation for those needs must be based on approaches far more finely tuned than duty shifting. See infra note 268 (elaborating on this and discussing pertinent bankruptcy statute provisions).
142. See, e.g., Lipson, supra note 49, at 1211 (stating that "chief criticism" of Credit Lyonnais is that it "creates uncertainty");
143. Frederick Tung, Gap Filling in the Zone of Insolvency, 1 J. Bus. & Tech. L. 1201, 1204 (2007) (arguing that fiduciary duties to creditors "are unnecessary and may be counterproductive").
144. For a recent essay criticizing duty shifting resting in large part on the desirability of general directorial insulation from challenge, see Richard A. Booth, The Duty to Creditors Reconsidered-Filling a Much Needed Gap in Corporation Law, 1 J. Bus. & Tech. L. 415, 425 (2007).
145. For very thoughtful discussions of the effect of these doctrines on the capacity of the corporation's legal advisors to advise management, see Royce de Rohan Barondes, Fiduciary Duties in Distressed Corporations: Second Generation Issues, 1 J. Bus. & Tech. L. 371, 378-87 (2007);
146. Bruce A. Markell, The Folly of Representing Insolvent Corporations: Examining Lawyer Liability and Ethical Issues Involved in Extending Fiduciary Duties to Creditors, 6 J. Bankr. L. & Prac 403, 413-27 (1997).
147. For a discussion of Campbell and Frost's helpful article, see supra note 9.
148. One recent article claims that a corporation's use of net present value in deciding on investments would "[serve] the interests of all corporate constituencies." See Remus D. Valsan & Moin A. Yahya, Shareholders, Creditors, and Directors' Fiduciary Duties: A Law and Finance Approach, 2 Va. L. & Bus. Rev. 1, 4 (2007). As to their critical claim that "maximizing the value of the firm is functionally equivalent with maximizing shareholder value," Valsan and Yahya note that one of the authors of this Article has "a different opinion" and outlines that opinion.
149. Id. at 40 & n.108
150. (referring to Hu, Risk & Time, supra note 12). On there being a difference in opinion, we agree. Valsan and Yahya fail to address a number of crucial matters, including differences between diversifiable and nondiversifiable risk, die impact of shareholder diversification on how net present value calculations should be adjusted for risk, and corporate decisions that are not translatable into net present value terms. The closest Valsan and Yahya come to addressing the issue of diversifiable versus nondiversifable risk appears at the end of footnote 157, wherein they appear to assume away conflicts between diversified shareholders and creditors on the ground that shareholders in a corporation would also hold bonds in the corporation-and in just the right amounts.
151. Id. at 49 n.157.
152. Indeed, its 2003 opinion in Omnicare, Inc. v. NCS Healthcare, Inc. could be read to reject duty shifting, although it did not cite Credit Lyonnais. In Omnicare, the majority noted: Notwithstanding the corporation's insolvent condition, the NCS board had no authority to execute a merger agreement that subsequendy prevented it from effectively discharging its ongoing fiduciary responsibilities. The stockholders of a Delaware corporation are entitled to rely upon the board to discharge its fiduciary duties at all times. The fiduciary duties of a director are unremitting and must be effectively discharged in the specific context of the actions that are required with regard to the corporation or its stockholders as circumstances change. 818 A.2d. 914, 938 (Del. 2003) (citations omitted).
153. For example, a June 2006 bankruptcy opinion indicates that, notwithstanding the critical nature of the issue, none of the parties even tried to dispute that Delaware law imposed fiduciary duties to creditors once a corporation was operating in the "vicinity of insolvency." Official Comm. of Unsecured Creditors of Verestar, Inc. v. Am. Tower Corp. (In re Verestar, Inc.), 343 B.R. 444, 471 (Bankr. S.D.N.Y. 2006). In a July 2005 opinion, the chief judge of the District of Delaware's Bankruptcy Court adopted the Credit Lyonnais insolvency or "vicinity of insolvency" as the trigger for duty shifting; she neither referenced Omnicare on this issue nor gave any indication that any litigant disputed her characterization.
154. Liquidation Trust of Hechinger Inv. Co. of Del. v. Fleet Retail Fin. Group (In re Hechinger Inv. Co. of Del.), 327 B.R. 537, 548 (Bankr. D. Del. 2005).
155. N. Am. Catholic Educ. Programming Found, v. Gheewalla, No. 521, 2006, slip op. at 20 (Del. May 18, 2007) ("When a corporation is insolvent, however, its creditors take the place of the shareholders as the residual beneficiaries of any increase in value.").
156. Id. at 3. Importantly, the lower court held it did not have to determine if Clearwire was insolvent or in the vicinity of insolvency, so the holding in the case must stand independent of that factual question. See N. Am. Catholic Educ. Programming Found, v. Gheewalla, No. Civ. A. 1456-N, 2006 WL 2588971, at *6 n.65 (Del. Ch. Sept. 1, 2006).
157. North American, No. 521, 2006, slip op. at 24.
158. Id. at 17-19.
159. Id. at 19 (referring to "need for providing directors with definitive guidance"). We believe, however, that in actual litigation, the distinction between whether a corporation is "insolvent" or merely in the "zone of insolvency" can also be far from clear. Even in the Delaware duty shifting cases themselves, there is no agreement as to what "insolvency" means. Compare Prod. Res. Group, L.L.C. v. NCT Group, Inc., 863 A2d 772, 782 (Del. Ch. 2004) (holding that insolvency means either (1) an asset shortfall in face of which no reasonable prospect of successful continuation exists, or (2) "'an inability to meet maturing obligations as they fall due'"
160. (quoting Siple v. S & K Plumbing & Heating, Inc., No. 6731, 1982 WL 8769, at *2 (Del. Ch. Apr. 13, 1982))),
161. with Geyer v. Ingersoll Publ'ns Co., 621 A.2d 784, 787-90 (defining insolvency as when value of assets is less than amount of debts).
162. A 2005 Delaware bankruptcy court, purporting to apply Delaware duty shifting doctrines, looked at neither Production Resources nor Geyer for guidance as to the meaning of "insolvency," but instead at the Bankruptcy Code. In re Hechinger Inv. Co., 327 B.R. at 548.
163. See North American, No. 521, 2006, slip op. at 20-21.
164. Id.
165. (quoting Prod. Res. Group, 863 A.2d at 792).
166. See infra Part IV.
167. U.S. Const, art. I, § 8, c1.4.
168. Bankruptcy Act of 1898, ch. 541, 30 Stat. 544, repealed by Bankruptcy Reform Act of 1978, Pub. L. No. 95-598, 92 Stat. 2549, 2682.
169. Warren & Westbrook, Text, Cases & Problems, supra note 31, at 107-08;
170. see also David A. Skeel, Jr., Debt's Dominion: A History of Bankruptcy Law in America 24-28 (2001) [hereinafter Skeel, Debt's Dominion] (describing various bankruptcy laws enacted during nineteenth century);
171. Charles Warren, Bankruptcy in United States History 3-141 (1935) (describing attempts at bankrupcty legislation in United States up to 1898).
172. Bankruptcy Act of 1867, ch. 176, 14 Stat. 517 (repealed 1878). In the 1898 Bankruptcy Act, corporations were not permitted to use die composition provisions that were that Act's closest approach to reorganization.
173. See Stephen J. Lubben, Railroad Receiverships and Modern Bankruptcy Theory, 89 Cornell L. Rev. 1420, 1440 (2004) (noting that "the [1898] Bankruptcy Act did not permit the reorganization of large corporations and expressly excepted railroads from its scope").
174. Novica Petrovski, The Bankruptcy Code, Section 1121: Exclusivity Reloaded, 11 Am. Bankr. Inst. L. Rev. 451, 455 n.12 (2003).
175. The same thing was true of insolvency statutes around the world. Most of them, like the United States law, contained a "composition" provision, but those provisions were notoriously ill-designed and nearly useless. See generally 1 J.H. Dalhuisen, Dalhuisen on International Insolvency and Bankruptcy, pt. I, § 2.01 (1986) (describing development of corporate reorganization law and composition provisions in United States and western Europe).
176. See Lubben, supra note 82, at 1426-52 (discussing history of railroad industry receiverships in late nineteenth and early twentieth centuries);
177. id. at 1425, 1444, 1469-70, 1471-72 (noting contemporary critics' concerns that receivership arrangements were often characterized by collusion and self-dealing).
178. See generally Skeel, Debt's Dominion, supra note 81, at 48-70 (discussing railroad receiverships in general).
179. Act of June 22, 1938, Pub. L. No. 75-696, 52 Stat. 840 (repealed 1978);
180. Harvey R. Miller & Shai Y. Waisman, Does Chapter 11 Reorganization Remain a Viable Option for Distressed Businesses for the Twenty-First Century?, 78 Am. Bankr. L.J. 153, 167 (2004) ("The so-called 'Great Depression' of the 1930s was the catalyst for the codification of principles that had evolved in the Railroad Equity Receiverships.");
181. Charles J. Tabb, The Future of Chapter 11, 44 S.C. L. Rev. 791, 806 (1993) ("Chapter 11 is the product of experience. Equity receiverships were used because voluntary deals could not be made. Section 77B and then Chapters X and XI, which were designed to replace equity receiverships, were enacted for the same reason. So too with Chapter 11 in 1978.").
182. Bankruptcy Reform Act of 1978, Pub. L. No. 95-598, 92 Stat. 2549 (codified as amended at 11 U.S.C. §§ 101-1300 (2000)).
183. See, e.g., Miller & Waisman, supra note 87, at 199-200 (noting that European countries are "mov[ing] towards a reorganization model similar to . . . chapter 11").
184. 11 U.S.C. § 701 (a) (1) ("Promptly after the order for relief under this chapter, the United States trustee shall appoint one disinterested person ... to serve as interim trustee in the case."); § 702(b) ("At the meeting of creditors held under section 341 of this title, creditors may elect one person to serve as trustee in the case . . . .").
185. § 704 (requiring trustee to "collect and reduce to money the property of the estate for which such trustee serves, and close such estate as expeditiously as is compatible with the best interests of parties in interest").
186. § 704(a) (listing trustee's duties in administering Chapter 7 estate);
187. U.S.C.A. § 1106(a) (West 2004 & Supp. 2007) (giving Chapter 11 trustee most of duties of Chapter 7 trustee);
188. U.S.C. § 1107(a) (giving Debtor in Possession most of powers and duties of Chapter 11 trustee); § 1108 (giving Chapter 11 trustee power to operate debtor's business).
189. § 1109(b) ("A party in interest... may raise and may appear and be heard on any issue in a case under this chapter."). In large cases, there is often a creditors' committee that acts for creditors generally. § 1102 ("[T] he United States trustee shall appoint a committee of creditors holding unsecured claims and may appoint additional committees of creditors or of equity security holders ....").
190. See, e.g., Lynn M. LoPucki & William C. Whitford, Patterns in the Reorganization of Large, Publicly Held Companies, 78 Cornell L. Rev. 597, 610-11 (1993) (discussing changes in share ownership in Chapter 11 reorganizations).
191. 11 U.S.C. § 105(c);
192. U.S.C.A. § 157(b) (West 2006); 2 Collier on Bankruptcy 1 105.07 (rev. 15th ed. 2007).
193. Lynn M. LoPucki, The Demographics of Bankruptcy Practice, 63 Am. Bankr. L.J. 289, 311 (1989) ("Bankruptcy is probably among the most highly specialized areas of practice.").
194. Elizabeth Warren & Jay Lawrence Westbrook, The Promise of Chapter 11: Measuring Success 8 (unpublished manuscript, on file with the Columbia Law Review) [hereinafter Warren & Westbrook, Outcomes] (noting that large companies choose to file for Chapter 11 "even when liquidation is an almost-certain prospect").
195. See infra Part II.D.2.
196. See infra Part II.A.
197. See infra Part II.B.1.
198. See infra Part II.B.2.
199. See infra Part II.C.
200. See infra Part II.C.1.
201. See infra Part II.C.2.
202. See infra Part II.D.
203. See infra Part II.E.
204. Hu, Risk & Time, supra note 12, at 279.
205. Id.
206. These interconstituency and intraconstituency conflicts are discussed in greater detail in, for example, Henry T. C. Hu, Behind the Corporate Hedge: Information and the Limits of "Shareholder Wealth Maximization," J. Applied Corp. Fin., Fall 1996, at 39, 40-43 [hereinafter Hu, Behind the Corporate Hedge];
207. Henry T. C. Hu, Buffett, Corporate Objectives, and the Nature of Sheep, 19 Cardozo L. Rev. 379, 392-95, 397-406 (1997)
208. [hereinafter Hu, Nature of Sheep]; Hu, Shareholder Welfare, supra note 17, at 1286-1309;
209. Hu, Risk & Time, supra note 12, at 295-306, 318-66;
210. Hu & Black, Taxonomy, supra note 53, at 1019 n.23.
211. As to how modern financial science has helped us understand the divergence of interests, see, for example, Hu, Behind the Corporate Hedge, supra note 109, at 43-48;
212. Hu, Risk & Time, supra note 12, at 295-306, 318-47.
213. Cf. Robert Charles Clark, Corporate Law 33-34 (1986) (stating that "major problem dealt with by corporate law" is how to keep managers accountable while allowing them great discretionary power).
214. Adolph A. Berle, Jr. & Gardiner C. Means, The Modern Corporation and Private Property 5 (1932).
215. See Henry T. C. Hu, Hedging Expectations: "Derivative Reality" and the Law and Finance of the Corporate Objective, 73 Tex. L. Rev. 985, 1016-17 (1995)
216. [hereinafter Hu, Derivative Reality]; Hu, Risk & Time, supra note 12, at 318-32.
217. For discussions of when managers may want to take more risk than would be optimal for diversified shareholders, see Hu, Misunderstood Derivatives, supra note 18, at 1492-95;
218. Hu, Risk & Time, supra note 12, at 325-26, 328-32.
219. See Brian J. Hall, The Challenge of Turning Managers into Owners, NBER Rep., Summer 2004, at 9, 10-11 (finding that insufficient diversification is important part of establishing strong ownership incentives);
220. Brian J. Hall & Kevin J. Murphy, Stock Options for Undiversified Executives, 33 J. Acct. & Econ. 3, 8-21 (2002) (showing that stock options result in high costs to companies and lower values for managers).
221. For new evidence on how options holdings can sometimes substantially decrease executives' willingness to take risk, see Katharina Lewellen, Financing Decisions When Managers Are Risk Averse, 82 J. Fin. Econ. 551, 556-69 (2006).
222. See infra Part II.B.
223. For a helpful survey and analysis of the literature on bank and bond covenants, see William W. Bratton, Bond Covenants and Creditor Protection: Economics and Law, Theory and Practice, Substance and Process, 7 Eur. Bus. Org. L. Rev. 39 (2006).
224. Different legal systems around the world have made quite different decisions about legal priorities among creditors and other stakeholders, including employees. See generally Ulrik Rammeskow Bang-Pedersen, Asset Distribution in Transnational Insolvency: Combining Predictability and Protection of Local Interests, 73 Am. Bankr. L.J. 385 (1999) (discussing possible distribution rules for transnational bankruptcies); Jay Lawrence Westbrook, Universal Participation in Transnational Bankruptcies, in Making Commercial Law: Essays in Honour of Roy Goode 419 (Ross Cranston ed., 1997) (discussing priorities for distribution in transnational bankruptcies under European Union system);
225. Jay Lawrence Westbrook, Universal Priorities, 33 Tex. Int'l L.J. 27, 30-31, 34 (1998) (discussing transnational insolvency problems raised by existence of different priority systems in different countries and policy reasons underlying United States priority system).
226. For a finance theory-oriented analysis, see Cheol Park, Monitoring and Structure of Debt Contracts, 55 J. Fin. 2157, 2172-85 (2000).
227. There are intercreditor agreements but they are almost always within alliances of lenders or other homogeneous subsets of creditors. See, e.g., Mark N. Berman &Jo Ann J. Brighton, Second-Lien Financings: Enforcement of Intercreditor Agreements in Bankruptcy, Am. Bankr. Inst. J., Feb. 2006, at 38, 39 (listing "issues that might be presented to bankruptcy courts about the enforceability of provisions commonly found in intercreditor agreements used in second-lien financing transactions");
228. C. Edward Dobbs, Negotiating Points in Second Lien Financing Transactions, 4 DePaul Bus. & Com. L.J. 189, 189-92 (2006) (discussing negotiation of intercreditor agreements between providers of first- and second-lien loans);
229. James C. Schulwolf, Controlling Your Destiny: Key Issues in Subordination and Intercreditor Agreements, Secured Lender, Nov.-Dec. 1995, at 22, 22 (discussing motivations for intercreditor agreements and common negotiation issues).
230. As to the concept of shareholders holding "maximization rights," see supra note 17.
231. See Warren & Westbrook, Text, Cases & Problems, supra note 31, at 223-27 (outlining difference between secured and unsecured claims);
232. Michael J. Herbert & Domenic E. Pacitti, Down and Out in Richmond, Virginia: The Distribution of Assets in Chapter 7 Bankruptcy Proceedings Closed During 1984-1987, 22 U. Rich. L. Rev. 303, 310-11 (1988) (noting that, during period of study, over 95% of Chapter 7 cases did not pay distributions);
233. Lynn M. LoPucki, Contract Bankruptcy: A Reply to Alan Schwartz, 109 Yale L.J. 317, 328 (1999) (noting that junior creditors prefer reorganization because it results in larger recovery than liquidation);
234. Stephen J. Lubben, Some Realism About Reorganization: Explaining the Failure of Chapter 11 Theory, 106 Dick. L. Rev. 267, 278 (2001) (discussing "conflicting creditor preferences between liquidation and reorganization");
235. cf. John D. Ayer, Debt Abides: A Prolegomena for Any Future Chapter 11, 78 Am. Bankr. L.J. 427, 447-48 (2004) (illustrating differences in potential payoffs from equity and debt standpoints).
236. John Plender, Markets Versus the Conventional Wisdom in 2007, Fin. Times, Jan. 2, 2007, at 16. A credit derivative has been defined as a "derivative whose payoff depends on die creditworthiness of one or more companies or countries."
237. John C. Hull, Options, Futures, and Other Derivatives 746 (6th ed. 2006). As to some questions for duty shifting posed by credit derivatives, see infra Part V
238. Henry Sender, Debt Buyers vs. The Indebted, Wall St. J., Oct. 17, 2006, at C1.
239. Henry Sender, A Company's Road to Restructuring May Teem with Hedge-Fund Potholes, Wall St. J., Mar. 30, 2006, at Cl.
240. See generally, Lucian Ayre Bebchuk & Jesse M. Fried, The Uneasy Case for the Priority of Secured Claims in Bankruptcy, 105 Yale L.J. 857 (1996) (discussing secured creditors versus unsecured creditors, especially those unable to adjust their terms to varying bankruptcy provisions);
241. Elizabeth Warren &Jay Lawrence Westbrook, Contracting Out of Bankruptcy: An Empirical Intervention, 118 Harv. L. Rev. 1197, 1237 (2005) (providing empirical data showing substantial number of maladjusting creditors).
242. See infra Parts II.C, II.E.
243. Of course, the identity of the owners may change.
244. See supra note 57 and accompanying text (analyzing Credit Lyonnais's famous footnote 55).
245. The discussion in this Part draws on an evolving framework set out in Hu, Behind the Corporate Hedge, supra note 109, at 40-50 (addressing corporate hedgingrelated distinctions between "shareholder wealth maximization" and "shareholder welfare maximization" from finance perspective);
246. Hu, Nature of Sheep, supra note 109, at 392-95, 397-407 (analyzing one prominent corporation essentially run on hybrid of "actual" and "blissful" shareholder wealth maximization);
247. Hu, Derivative Reality, supra note 113, at 996-1040 (discussing incompleteness of "shareholder wealth maximization"); Hu, Shareholder Welfare, supra note 17, at 1278-1309 (discussing financial innovation and the corporate objective, including new types of corporate securities and certain "short-termism" issues);
248. Hu, Risk & Time, supra note 12, at 295-366 (discussing three basic conceptions of shareholder fidelity);
249. Hu & Black, Taxonomy, supra note 53, at 1019 n.23 (discussing hedge fund activism and "short-termism");
250. Hu & Black, The New Vote Buying, supra note 8, at 814-63 (discussing shareholder ownership rights, shareholders that are "empty voters," and how decoupling of economic ownership and voting ownership undermines existing legal and economic dieories of corporate governance).
251. See, e.g., Richard A. Brealey & Stewart C. Myers, Principles of Corporate Finance 23-24 (7th ed. 2003) (arguing that managers should maximize market value of each stockholder's share).
252. I Am. Law Inst., Principles of Corporate Governance § 2.01 (1994).
253. Id. § 2.01 reporter's note 1 (quoting Dodge v. Ford Motor Co., 170 N.W. 668, 684 (Mich. 1919)).
254. Rev. Model Bus. Corp. Act § 8.30(a) (2005).
255. Id. § 8.30(a) official cmt. 2.
256. Paramount Commc'ns Inc. v. QVC Network Inc., 637 A.2d 34, 43 (Del. 1994)
257. (quoting Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1280 (Del. 1989)).
258. N. Am. Catholic Educ. Programming Found, v. Gheewalla, No. 521, 2006, slip op. at 20 (Del. May 18, 2007) (emphasis added).
259. Id. at 15, 19 (emphasis added);
260. see infra Part II.E.
261. See infra Part II.B.2.
262. For discussions on the transition to actual shareholder wealth maximization, see Hu, Derivative Reality, supra note 113, at 1000-07;
263. Hu, Shareholder Welfare, supra note 17, at 1279-83;
264. Hu, Risk & Time, supra note 12, at 295-306, 355-66;
265. cf. Jeffrey N. Gordon, The Rise of Independent Directors in the United States, 1950-2005: Of Shareholder Value and Stock Market Prices, 59 Stan. L. Rev. 1465, 1527-35 (2007) (discussing independent board and shareholder value).
266. Hu, Shareholder Welfare, supra note 17, at 1282-83 (stating that "[m]ost academics now believe that shareholder wealth maximization is the basic pecuniary objective of the modern publicly held corporations");
267. see also supra Parts I.B.2, I.B.4 (discussing Credit Lyonnais, North American, and whether there exists duty to maximize shareholder wealth); infra Part IV (discussing North American and whether there exists duty to maximize shareholder wealth).
268. Paramount Commc'ns Inc. v. QVC Network Inc., 637 A.2d 34, 44 (Del. 1994).
269. Id. at 48;
270. see also Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 182-83 (Del. 1986) (detailing duty of board after authorization of management to negotiate sale of company).
271. See Paramount Commc'ns, Inc. v. Time, Inc., 571 A.2d 1140, 1154 (Del. 1990) (stating that "fiduciary duty to manage a corporate enterprise includes the selection of a time frame for achievement of corporate goals");
272. Geller v. Tabas, 462 A.2d 1078, 1082 (Del. 1983) (relying on business judgment rule to strike plaintiff shareholders' claims of breach of fiduciary duty from company making speculative investments in silver and United States Treasury bond futures contracts);
273. Penn v. Pemberton & Penn, 53 S.E.2d 823, 829 (Va. 1949) ("They simply decided to do business in a very conservative way until there were reasonably good prospects of making substantial profits.");
274. Hu, Risk & Time, supra note 12, at 301-02 (discussing effect of business judgment rule and other cases).
275. This was introduced in Hu, Risk & Time, supra note 12, at 357-62, and developed further in subsequent literature.
276. See, e.g., Hu, Behind the Corporate Hedge, supra note 109, at 46-51 (examining how such shareholder wealth maximization concepts need to incorporate shareholder expectations in order to properly guide decisions on whether to hedge);
277. Hu, Nature of Sheep, supra note 109, at 398-408 (illustrating blissful versus actual shareholder weidth maximization with selected case studies);
278. Hu, Derivative Reality, supra note 113, at 1007-09 (comparing blissful shareholder wealth maximization with actual shareholder wealth maximization);
279. Hu, Shareholder Welfare, supra note 17, at 1285-86 (exploring how blissful shareholder wealth maximization might influence corporate investment decisions).
280. "Blissful" shareholder value maximization effectively assumes that information costs, agency costs, and other factors can cause stock prices to deviate from their "intrinsic" or "fair value"; and, in such cases, managers' task is to maximize not the actual stock price, but the intrinsic value of the shares thus defined. Hu, Risk & Time, supra note 12, at 357-62.
281. See Hu, Behind the Corporate Hedge, supra note 109, at 42-43; Hu, Nature of Sheep, supra note 109, at 397-406.
282. For ways in which Buffett and Munger's "intrinsic value" maximization differs from "blissful shareholder wealth maximization," see Hu, Nature of Sheep, supra note 109, at 402. In the wake of the Enron, WorldCom, and other recent debacles, Michael Jensen, the former President of the American Finance Association, called for adoption of a notion of shareholder wealth maximization very similar to blissful shareholder wealth maximization.
283. See Joseph Fuller & Michael C. Jensen, Dare to Keep Your Stock Price Low, Wall St. J., Dec. 31, 2001, at A8.
284. For detailed discussions of the balance between corporate welfare and shareholder welfare, see Hu, Derivative Reality, supra note 113, at 1004-05, 1010-30;
285. Hu, Risk & Time, supra note 12, at 299-300, 318-32.
286. For an introduction to the capital asset pricing model, see William F. Sharpe, Gordon J. Alexander & Jeffery V. Bailey, Investments 261-92 (5th ed. 1995).
287. Factually, the substantial majority of shares are now held by institutional investors; for instance, at year-end 2004, institutional investors owned 69.4% of the shares of the largest 1,000 companies in the United States. Institutional Equity Ownership up in 2003, Pensions & Investments, Oct. 17, 2005, at 32. Moreover, the individual investors who hold such minority stakes tend to be more sophisticated and well-off than, say, individual investors who only own mutual funds. Thus, one recent survey indicated that "59 percent of equity investors with household financial assets of $500,000 or more own both stock mutual funds and individual stock, compared with 20 percent of those with household assets below $50,000. Seventy percent of equity investors in this low-asset category solely own stock mutual funds." Inv. Co. Inst & Sec. Indus. Ass'n, Equity Ownership in America, 2005, at 14 (2005). In addition, most individual equity investors hold a broader range of investments, such as bond funds, money market funds, annuities, and investment real estate. Id. at 24. Normatively, it is not reasonable to manage a company for a small minority of shareholders who-by choice or ignorance-are not diversified, when the result is to prevent maximization of shareholder wealth using modern portfolio theory. For discussions of the general viability of running a corporation with well-diversified shareholder diversification in mind and some exceptions, see Hu, Nature of Sheep, supra note 109, at 392-94 (discussing Berkshire Hathaway); Hu, Shareholder Welfare, supra note 17, at 1306-09 (discussing why diversified shareholders do not benefit from corporate reduction of unsystematic risk);
288. Hu, Risk & Time, supra note 12, at 361-66 (discussing wealth maximization problems associated with closely held corporations and inadequately diversified shareholders);
289. cf. Joy v. North, 692 F.2d 880, 886 (2d Cir. 1982) ("[C]ourts need not bend over backwards to give special protection to shareholders who refuse to reduce the volatility of risk by not diversifying.").
290. For a more precise and detailed exposition of the ideas in this paragraph, see Hu, Risk & Time, supra note 12, at 287-95, 355-66.
291. For contrary examples where the particular risk preferences of shareholders do matter, see Hu, Behind the Corporate Hedge, supra note 109, at 48-50;
292. Hu, Derivative Reality, supra note 113, at 1031-40.
293. m is the rate of return applicable to that beta.
294. See infra Part III A
295. Brealey & Myers, supra note 131, at 21.
296. For examples of this counterintuitive situation and the associated distinctions between shareholder wealth maximization and shareholder welfare maximization, see Hu, Behind the Corporate Hedge, supra note 109, at 48-50;
297. Hu, Derivative Reality, supra note 113, at 1033-36.
298. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (codified as amended in scattered sections of 11, 15, 18, 28, 29 U.S.C).
299. This theme, the need for an entity's objective to correspond to the mechanisms of the host governance system, has been previously raised in the context of the governance of stock exchanges. See Means and Ends: NYSE Regulation, NYSE Group, and the Matter of Togetherness: Hearing on a Review of Self-Regulatory Organizations in the Securities Markets Before the S. Comm. on Banking, Housing, and Urban Affairs, 109th Cong, passim (2006) (statement of Henry T. C. Hu, Allan Shivers Chair in the Law of Banking and Finance, University of Texas School of Law).
300. As to the core nature of shareholder exclusivity in voting power, see Hu & Black, Taxonomy, supra note 53, at 1013-14;
301. Hu & Black, Decoupling, supra note 53, at 344, 353-55;
302. Hu & Black, The New Vote Buying, supra note 8, at 814-15;
303. supra Part ILB;
304. infra Part II.D.1.
305. See, e.g., William A. Klein & John C. Coffee, Jr., Business Organization and Finance: Legal and Economic Principles 124 (10th ed. 2007) (stating that, by statute, shareholders have right to vote in director elections and "fundamental matters" such as certain mergers, amendments of articles, and liquidation).
306. As to shareholder inspection rights and shareholder rights to sue for fiduciary breaches, see, for example, Melvin A. Eisenberg, Corporations and Other Business Organizations: Cases and Materials 258-75, 912-1039 (9th ed. unabr. 2005).
307. See, e.g., Sanford Grossman & Oliver Hart, One Share-One Vote and the Market for Corporate Control, 20 J. Fin. Econ. 175, 175-80 (1988) (arguing that one share-one vote rule encourages selection of best management team);
308. Milton Harris & Artur Raviv, Corporate Governance: Voting Rights and Majority Rules, 20 J. Fin. Econ. 203, 226-28 (1988) (concluding that one share-one vote rule in conjunction with simple majority rule results in election of best management);
309. Hu & Black, Decoupling, supra note 53, at 353-57 (discussing theoretical and empirical support for idea that linking voting rights to shares results in efficient market for corporate control) ;
310. Hu & Black, The New Vote Buying, supra note 8, at 850-57 (same).
311. The creditor remedy of involuntary bankruptcy is often not terribly useful. See Susan Block-Lieb, Why Creditors File So Few Involuntary Petitions and Why the Number Is Not Too Small, 57 Brook. L. Rev. 803, 835-52 (1991) (explaining why creditors often disfavor involuntary bankruptcy). One question for further research is whether it should be easier for creditors to initiate a bankruptcy proceeding under some circumstances.
312. Credit Lyonnais Bank Nederland, N.V. v. Pathe Commc'ns Corp., Civ. A. No. 12150, 1991 WL 277613, at *34 n.55 (Del. Ch. Dec 30, 1991);
313. see supra note 57 and accompanying text.
314. Credit Lyonnais, 1991 WL 277613, at *34 n.55.
315. See infra Parts III.A-B.1.
316. By contrast, business bankruptcy law, under the rubric "insolvency," is largely embedded in corporate law in the United Kingdom and most other common law countries. See Am. Law Inst., Principles of Cooperation Among the NAFTA Countries 1 n.2 (2003).
317. Some commentators have suggested that bankruptcy law must be limited to procedure, with all substantive policies to be found in other law. See Douglas G. Baird & Thomas H. Jackson, Corporate Reorganizations and the Treatment of Diverse Ownership Interests: A Comment on Adequate Protection of Secured Creditors in Bankruptcy, 51 U. Chi. L. Rev. 97, 100-01 (1984) (arguing that bankruptcy law should only include substantive rules that preserve assets for collective good of investors as group) ;
318. James W. Bowers, Whither What Hits the Fan?: Murphy's Law, Bankruptcy Theory, and the Elementary Economics of Loss Distribution, 26 Ga. L. Rev. 27, 76-80 (1991) (arguing that efficient bankruptcy law would look like "just another specialized form of civil procedure"). There is no compelling reason for this dichotomy, given that the circumstance of general default may well create reasons for the application of different policies than would be appropriate in other contexts.
319. Jay Lawrence Westbrook, Bankruptcy Control of the Recovery Process, 12 Am. Bankr. Inst. L. Rev. 245, 252 & n.40, 254 n.51 (2004) [hereinafter Westbrook, Process];
320. Westbrook, Control, supra note 53, at 855-56. Indeed, one of the key themes that we emphasize in this Article is the presence of two alternative governance systems; the principal-agent problems in the bankruptcy governance system are no less worthy of consideration than those that arise in the corporate governance system. The principal-agent problems associated with the two systems are different, stemming in part from differences in the "principal" and differences in the homogeneity of stakeholder interests. Finally, because of the somewhat diminished role of market discipline when a corporation is in bankruptcy, the need for legal mechanisms to address agency issues becomes manifest.
321. See generally Warren & Westbrook, Text, Cases & Problems, supra note 31, at 395-99 (discussing history and mechanisms of reorganization under Chapter 11).
322. 11 U.S.C. § 1107(a) (2000).
323. §§ 1126(c), 1129(a)(7)(A)(i).
324. Cf. In re Channel Master Holdings, Inc., 309 B.R. 855, 860-61 (Bankr. D. Del. 2004) (noting that court is free to allocate secured party collateral to fund creditor committee professionals).
325. Concerning corporate control, see generally Hu & Black, Taxonomy, supra note 53, at 1013-14 (discussing how voting power is central to concept of share ownership);
326. Hu & Black, Decoupling, supra note 53, at 344, 353-55 (discussing roles of shareholder vote and one share-one vote paradigm in theory of corporate governance and capital structure);
327. Hu & Black, The New Vote Buying, supra note 8, at 814-15 (discussing vote as "core source of shareholder power" that serves instrumental and legitimizing purposes).
328. As to control of bankruptcy proceedings, see Westbrook, Process, supra note 167, at 253 (noting that bankruptcy regimes universally give control of debtor's assets to publicly designated official or entity).
329. As explained below, the public control may fall into the hands of private interests, but in principle it is always public.
330. The ends sought through application of bankruptcy laws vary gready in theory and in practice around the world. Among the objectives might be the lowest possible cost for debt capital, a solution to the "collective action" problem faced by creditors, and the achievement of pari passu distributional fairness, among others.
331. Westbrook, Process, supra note 167, at 247. Central to the necessary control is a stay or moratorium on creditor actions. Virtually all bankruptcy systems provide for such a stay. In the United States, the stay is very broad and automatic, while in many jurisdictions the stay is granted only after a request to a court and may be limited in scope.
332. See id. at 253. The breadth of the stay determines the breadth of bankruptcy court control and therefore the extent to which the policies of the legislature can be served.
333. See, e.g., 11 U.S.C. § 362(a) (2000);
334. Insolvency Act, 1986, c. 45, § 8, sched. B1, para. 44 (Eng.)
335. (as amended by Enterprise Act, 2002, c. 40, § 248, sched. 16 (Eng.)). Japan is one of the countries in which a stay must be sought in each case.
336. See Shinichiro Abe, Recent Developments of Insolvency Laws and Cross-Border Practices in the United States and Japan, 10 Am. Bankr. Inst L. Rev. 47, 53 (2002) (noting that Japanese law provides no automatic stay and discussing alternative temporary legal restraints on creditors);
337. Kent Anderson, The Cross Border Insolvency Paradigm: A Defense of the Modified Universal Approach Considering the Japanese Experience, 21 U. Pa. J. Int'l Econ. L. 679, 705 (2000) ("Notably though, unlike the United States, no automatic stay is issued at commencement. Instead, debtor's assets are only protected upon application for and granting of a 'preservation measure' (hozen shobun)" (quoting Hasan Ho [Bankruptcy Act], Law No. 71 of 1922, art. 155));
338. Shoichi Tagashira, Intraterritorial Effects of Foreign Insolvency Proceedings: An Analysis of "Ancillary" Proceedings in the United States and Japan, 29 Tex. Int'l L.J. 1, 12-13 (1994) ('Yet Japan has never accepted the notion of such a comprehensive automatic stay."). Germany is an example of a country in which the stay is limited in scope;
339. it cannot reach secured creditors. Klaus Kamlah, The New German Insolvency Act: Insolvenzordnung, 70 Am. Bankr. L.J. 417, 425-28 (1996) ("The Insolvenzordnung does not impose an automatic stay on secured creditors' enforcement of their rights against property of the estate. Here, German law takes a more complex approach.").
340. See Westbrook, Control, supra note 53, at 857-60.
341. Warren & Westbrook, Outcomes, supra note 97, at 3 (stating that forty percent of unsuccessful cases are dismissed or converted within six months and three-quarters gone within year of filing).
342. Every creditor is a "party in interest" entitled to participate actively in the bankruptcy proceeding. See, e.g., 11 U.S.C. §§ 102, 105, 1124(2);
343. Collier on Bankruptcy, supra note 95, ¶ 1109.01.
344. The DIP system was adopted in large part on the argument that existing management, for all of its faults, would manage the company better than some trustee in bankruptcy having no prior knowledge of the company and often little expertise in the industry. 3 Collier on Bankruptcy, supra note 95, 1 365.06(1)(d).
345. 7 Collier on Bankruptcy, supra note 95, 1 1122.01.
346. See 11 U.S.C. § 1126(a) ("The holder of a claim or interest . . . may accept or reject a plan.");
347. § 1141(d)(1)(B) (stating that confirmation of plan "terminates all rights and interests of equity security holders and general partners provided for by the plan").
348. Elizabeth Warren, Bankruptcy Policymaking in an Imperfect World, 92 Mich. L. Rev. 336, 355-57 (1993).
349. Indeed, most jurisdictions with developed insolvency laws recognize that default by certain kinds of debtors-like utilities, nursing homes, and insurance companies-require a primary focus on protection of customers going forward. Banks, insurance companies, and railroads are excluded from Chapter 7 liquidation in the United States. 11 U.S.C. § 109(b).
350. Railroads must use separate provisions of Chapter 11 designed exclusively for them. Warren & Westbrook, Text, Cases & Problems, supra note 31, at 875.
351. Warren & Westbrook, Outcomes, supra note 97, at 3.
352. "Asset recapitalization" comprises the financial restructuring of a company or a sale of the company's business to a third party as a going concern. Jay Lawrence Westbrook, The Globalisation of Bankruptcy Reform, 1999 N.Z. L. Rev. 401, 410-11.
353. 11 U.S.C. § 365(a).
354. For example, a creditor who has his contract assumed as part of a confirmed plan of reorganization will be promised full payment, §§ 502(b), 1129(a), whereas a creditor who has his contract rejected will be promised only a pro-rata payment as an unsecured creditor. § 502(g). "Critical vendors" are those whom the debtor seeks to pay immediately after filing bankruptcy because they are so "critical" to the debtor's business that the debtor will fail without them. The Seventh Circuit has held that bankruptcy courts do not have the authority to grant critical vendor relief. In re Kmart Corp., 359 F.3d 866, 874 (7th Cir. 2004);
355. see StevenJ. Lubben, The "New and Improved" Chapter 11, 93 Ky. L.J. 839, 854 (2005).
356. Other courts have expressed caution and hesitance toward "critical vendors" and at least one court has outlined a three-part test that must be satisfied in order for a creditor to attain such an elevated status over other general unsecured creditors, but many such orders have been approved. See, e.g., In re CoServ, L.L.C., 273 B.R. 487, 498 (Bankr. N.D. Tex. 2002).
357. See, e.g., David A. Skeel, Jr., The Past, Present and Future of Debtor-InPossession Financing, 25 Cardozo L. Rev. 1905, 1920-29 (2004) [hereinafter Skeel, Past, Present & Future] (describing how debtor's decision to accept DIP financing can transfer control of debtor to lender);
358. Mary Jo Wiggins, Finance and Factionalism: The Uneasy Present (and Future) of Special Interest Committees in Corporate Reorganization Law, 41 San Diego L. Rev. 1373, 1384 (2004) ("The use of debtor-in-possession financing and the willingness of some bankruptcy courts to approve so-called 'first-day orders' potentially leaves many unsecured creditors without adequate notice or protection or both.").
359. See, e.g., In re Office Prod, of Am., Inc., 136 B.R. 983, 984-88 (Bankr. W.D. Tex. 1992).
360. See generally Martin J. Bienenstock, Conflicts Between Management and the Debtor in Possession's Fiduciary Duties, 61 U. Cin. L. Rev. 543 (1992) (discussing whether Bankruptcy Code facilitates enforcement of management's fiduciary duties);
361. John T. Roache, Note, The Fiduciary Obligations of a Debtor in Possession, 1993 U. 111. L. Rev. 133 (discussing which fiduciary standard should be applied to debtor in possession in Chapter 11 reorganization).
362. 11 U.S.C. § 1103(c)(2)-(3).
363. A notable recent instance was the Chapter 11 proceeding filed by a huge power company, Mirant In re Mirant Corp., 334 B.R. 800 (Bankr. N.D. Tex. 2005). There was a crucial dispute between shareholders and management as to the value of the company and therefore the amount of value, if any, that should be available to shareholders in a reorganization plan. Id. at 806. The court appointed a shareholder committee to represent the interests of that group and held hearings to resolve the dispute. Id. Following the court's preliminary ruling, the parties settled on a plan. Id. at 811;
364. see also Rebecca Smith, Court Orders Mirant to Revamp Calculation of Value of Company, Wall St. J. Online, June 30, 2005 (on file with the Columbia Law Review).
365. 11 U.S.C. § 1129(a)(5). Another example is the appointment of special committees to represent particular constituencies upon a showing of need.
366. See, e.g., In re Loral Space & Commc'ns, Ltd., No. 04 Civ. 8645(RPP), 2004 U.S. Dist LEXIS 25681, at *12-*16 (Bankr. S.D.N.Y. Dec. 23, 2004) (appointing shareholder committee).
367. 11 U.S.C. § 1129(a)(8), (b).
368. A creditor is en tided to sell another person its claim against a bankrupt debtor if disclosure of the sale is made. Fed. R. Bankr. P. 3001(e)(2). In large public Chapter 11 cases there may be a substantial market in claims.
369. For an explanation of the practice, see Paul M. Goldschmid, More Phoenix Than Vulture: The Case for Distressed Investor Presence in the Bankruptcy Reorganization Process, 2005 Colum. Bus. L. Rev. 191, 206-09.
370. Claims trading is increasingly important given the emerging role of hedge funds in Chapter 11 proceedings and the roaring controversy over their disclosure obligations under Federal Rule of Bankruptcy Procedure 2019. See, e.g., In re Northwest Airlines, 363 B.R. 701, 704 (Bankr. S.D.N.Y. 2007).
371. Even this bankruptcy system, designed for negotiation and conflict resolution, has been strained by the development of credit derivatives. There is emerging concern that, as a result, creditors sometimes may not have the normal economic incentives to maximize value and save a business because they have bargained away risk. See INSOL Int'l, Credit Derivatives in Restructurings 15-16 (2006);
372. Frank Partnoy & David A. Skeel, Jr., The Promise and Perils of Credit Derivatives, 75 U. Cin. L. Rev. 1019, 1035 (2007) (providing example). For a related point, applicable in both the corporate governance context and the bankruptcy context, see infra Part V (referring to analytical framework conceiving "decoupling" of creditor contractual rights and creditor economic interests).
373. The 7-Eleven case illustrates the difference between saving the company and saving the business. The old company lost everything, but the business-slimmed down but intact-was sold as a going concern. See Larry Light, Suzanne Woolley & Stephanie Anderson Forest, Quickie Bankruptcies: Speed Isn't Everything, Bus. Wk., Apr. 29, 1991, at 72, 72-73;
374. Doug Bandow, Shooting the Economic Wounded, Cato Institute, May 17, 2003, available at http://www.cato.org/dailys/05-17-03.html (on file with the Columbia Law Review).
375. More recendy, Kmart successfully emerged from bankruptcy at $15 per share and rose to $109 per share before merging with Sears. Joel Groover, A Site Better: Big-name Retailers Sought-for Their Real Estate, Shopping Centers Today, Feb. 2005, at http:// www.icsc.org/srch/sct/sct0205/ (on file with the Columbia Law Review).
376. Stephen J. Lubben, The Direct Costs of Corporate Reorganization: An Empirical Examination of Professional Fees in Large Chapter 11 Cases, 74 Am. Bankr. L.J. 509, 550 (2000).
377. Warren & Westbrook, Outcomes, supra note 97, at 25-26.
378. This is not to say, of course, that in individual cases the costs associated with lawyers or managers may not be excessive.
379. See, e.g., Stuart C. Gilson, Management Turnover and Financial Distress, 25 J. Fin. Econ. 241, 261 (1989) (concluding that management turnover is much more likely to occur in distressed companies);
380. RonaldJ. Gilson, Reflections in a Distant Mirror: Japanese Corporate Governance Through American Eyes, 1998 Colum. Bus. L. Rev. 203, 214 (discussing study of management changes in poorly performing companies);
381. Lynn M. LoPucki & William C. Whitford, Corporate Governance in the Bankruptcy Reorganization of Large, Publicly Held Companies, 141 U. Pa. L. Rev. 669, 723-37 (1993) (finding that nearly all distressed companies change CEOs at least once before or after confirmation);
382. Elizabeth Warren, The Untenable Case for Repeal of Chapter 11, 102 Yale L.J. 437, 449-52 (1992) (reviewing "gloomy prospect for managers of distressed companies").
383. See Barry E. Adler, Vedran Capkun & Lawrence A. Weiss, Destruction of Value in the New Era of Chapter 11, at 12, 29 (Oct 24, 2006) (unpublished manuscript, on file with the Columbia Law Review), available at http://ssrn.com/abstract=795987 (discussing incentives for managers to delay bankruptcy filing).
384. Hu, Nature of Sheep, supra note 109, at 407
385. (quoting letter from Charles T. Munger to Henry T. C. Hu (Jan. 14, 1991)).
386. For a discussion of the notion that the corporation's assets now represent the creditor's money-that is, the idea of the primacy of the residual claimant-see supra note 16 and accompanying text; infra Parts III.A., III.C.2, IV.
387. Dwyer v. Jones (In re Tri-State Paving, Inc.), 32 B.R. 2, 3 (Bankr. W.D. Pa. 1982), discussed in Elizabeth Warren & Jay Lawrence Westbrook, The Law of Debtors and Creditors 632 (3d ed. 1996). The directors claimed the money was owed to them, but the court did not agree and the opinion gives the definite impression that tile directors literally "bet the company."
388. See also Prod. Res. Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772, 790 n.57 (Del. Ch. 2004) ("[I]t is easy to posit extreme hypothetical involving directors putting cash in slot machines....").
389. Dean Foust, No Overnight Success, Bus. Wk., Sept. 20, 2004, at 18, 18.
390. See supra Part II.A.2.
391. One exception might be where options that are well out of the money (as may be the case with troubled corporations) tempt managers to engage in "bet the company" behavior-the increase in volatility alone would, under standard option pricing models, increase the value of their options. See, e.g., Hu, Risk & Time, supra note 12, at 328-29 (discussing incentive effects of stock options on managerial risk taking).
392. See Adler et al., supra note 200, at 8-9 (stating that "debtors now frequently enter bankruptcy with little or no liquid assets and require an immediate debtor-inpossession ... loan to continue in business, with the pre-bankruptcy secured lender... in a unique position to provide such a loan").
393. Henry Hansmann & Reinier Kraakman, The Essential Role of Organizational Law, 110 Yale L.J. 387, 399-401 (2000) (describing use of corporate subsidiaries as "asset partitioning" devices).
394. See Skeel, Past, Present & Future, supra note 187, at 1920-21 (describing scenarios in which control has shifted through additional credit).
395. See, e.g., Vanessa Finch, The Recasting of Insolvency Law, 68 Mod. L. Rev. 713, 735 (2005) (noting that, in era of secured creditor influence, courts must guard against creditors "insisting on excessively low risk strategies when more enterprising behavior would . . . benefit unsecured creditors").
396. For an empirical exploration of the potential alliance of caution between management and bondholders, from the perspective of the bondholders, see Mark S. Klock, Sattar A. Mansi & William F. Maxwell, Does Corporate Governance Matter to Bondholders?, 40 J. Fin. & Quantitative Analysis 693 (2005).
397. See, e.g., Richard M. Cieri & Michael J. Riela, Protecting Directors and Officers of Corporations That Are Insolvent or in the Zone or Vicinity of Insolvency: Important Considerations, Practical Solutions, 2 DePaul Bus. & Com. L.J. 295, 303-06 (2004) (noting lack of clarity about whether business judgment or entire fairness rule applies to duties to creditors).
398. Under Delaware's current formulation, the business judgment rule is "a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984). On similar grounds, some lawyers have urged that directors may have a duty to cause their corporations to hedge against currency, commodity, and other market fluctuations. This reflects, among other things, a failure to distinguish between the welfare of the corporation and the welfare of diversified shareholders.
399. See, e.g., Hu, Behind the Corporate Hedge, supra note 109, at 49-50 (discussing corporate hedging and varying approaches of gold mining companies);
400. supra Parts II.B.1.a, II.B.2 (discussing conflicts between entity-optimal and shareholder-optimal risk behavior).
401. It is increasingly recognized, by gold mining companies and others, that such advice is often contrary to the interests of shareholders. As one example, Barrick, the leading gold miner that had hedged aggressively against drops in the gold price, has recently moved significantly away from hedging as a policy matter. Canadian Press, Barrick Gold Corp. Goes Unhedged, Now Able to Sell Production at Spot Prices, May 2, 2007, available at Westlaw, Canadian Press Wire (on file with the Columbia Law Review) (noting how Barrick's status as unhedged gold producer "marks the end of an era").
402. N. Am. Catholic Educ. Programming Found, v. Gheewalla, No. 521, 2006, slip op. at 20 (Del. May 18, 2007).
403. As to the role of risk taking in economic growth, see, for example, Douglas J. Cumming, The Determinants of Venture Capital Portfolio Size: Empirical Evidence, 79 J. Bus. 1083, 1114 (2006) (noting importance of venture capital and entrepreneurial investing for economic growth);
404. Greg Ip & Mark Whitehouse, Why Economists Track Firms' R&D, Wall St. J., Sept. 29, 2006, at A2 (discussing research showing domestic economic growth from investment in R&D).
405. See, e.g., Jim Collins, The Wizard, King, and Hobbit of Business, Fast Company, Apr. 2004, at 93, 95 (discussing IBM 360 project);
406. The Selling of the 707, Fortune, Oct. 1957, at 129, 129 (stating that prior to first 707, Boeing had invested $185 million - $36 million more than Boeing's net worth in previous year);
407. Jerry Useem, 20 That Made History, Fortune, June 27, 2005, at 58, 60 (implying that 707 was negative net present value project);
408. cf. Leslie Wayne, Boeing Bets the House - A Return to No. 1 Rests on Its New Dreamliner, N.Y. Times, May 7, 2006, § 3, at 1 (noting how Boeing is today resting its hopes on 787, its first new commercial airplane in a decade).
409. See, e.g., Louis R. Dienes, United States: Insolvent Companies Create Boardroom Risks for Venture Capital Firms, Mondaq, Nov. 28, 2006, at http://www. mondaq.com/article.asp?articleid=44466 (on file with the Columbia Law Review) (advising that venture capital representatives on boards may owe fiduciary duties to creditors).
410. For introductions to venture capital risks and returns, see generally John H. Cochrane, The Risk and Return of Venture Capital, 75 J. Fin. Econ. 3 (2005) (measuring statistically expected return on venture capital investments);
411. Cumming, supra note 215 (investigating efficient size of venture capital funds) ;
412. Steven N. Kaplan & Per Strõmberg, Characteristics, Contracts, and Actions: Evidence from Venture Capitalist Analyses, 59 J. Fin. 2177 (2004) (testing predictions of financial contracting theories using investments by venture capitalists).
413. See supra note 63 and accompanying text (discussing In re Healthco Int'l, Inc., 208 B.R. 288 (Bankr. D. Mass. 1997)).
414. Cf. United States v. Sec. Indus. Bank, 459 U.S. 70, 78-80 (1982) (establishing limits on Congress's power to adjust property rights retroactively).
415. See supra note 18 and accompanying text (discussing this analysis and its relationship to "contingent claims analysis" approach in finance theory). That is, their economic ownership rights, as a legal matter, include a call option in the economic sense. A call option is a form of contract that gives the owner of the contract the right, but not the obligation, to buy an asset at a specified price. This contract has value to the owner that varies with, among other things, the exercise price under the contract, the current price of the asset, and the time remaining until expiration.
416. See, e.g., Hu, Misunderstood Derivatives, supra note 18, at 1466-67, 1473-76 (discussing ability of contracts to insulate exogenous risk and describing independent variables influencing value of option).
417. This is because an option only gives rights and does not impose any obligations on the options holder: In other words, the obligation is one-sided. Consideration of options pricing models also confirms this. See Hu, Misunderstood Derivatives, supra note 18, at 1466-67, 1474-76 (discussing nature of obligations as to options and Black-Scholes option pricing model).
418. N. Am. Catholic Educ. Programming Found, v. Gheewalla, No. 521, 2006, slip op. at 20 (Del. May 18, 2007).
419. See supra note 57 and accompanying text.
420. See Lipson, supra note 49, at 1231-32 ("[A]t the moment it matters most-the 'vicinity of insolvency'-it will usually be difficult, if not impossible, to know whether the corporation will be able to reorganize, or whether it will have to liquidate.").
421. See supra Part I.B.2.
422. It is instructive to note that even in England the "wrongful trading" provision penalizing directors for carrying on an insolvent business requires that they know the business has no reasonable prospect apart from liquidation. Insolvency Act, 1986, c. 45, § 214(3) (Eng.).
423. As to the core nature of shareholder exclusivity in voting power, see Hu & Black, Taxonomy, supra note 53, at 1013-14;
424. Hu & Black, Decoupling, supra note 53, at 344, 353-55;
425. Hu & Black, The New Vote Buying, supra note 8, at 814-15;
426. see also supra Parts II.B, II.C.I, II.D.I.
427. Indeed, as discussed in Part IV infra, shareholders have the exclusive right to sue directiy for breaches of fiduciary duty.
428. N. Am. Catholic Educ. Programming Found, v. Gheewalla, No. 521, 2006, slip op. at 20 (Del. May 18, 2007) (stating that, upon insolvency, creditors become "'the principal constituency injured by any fiduciary breaches that diminish the firm's value'" because shareholders are no longer effectively the residual claimants
429. (quoting Prod. Res. Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772, 794 n.67 (Del. Ch. 2004))).
430. 564 A.2d 651, 659 (Del. Ch. 1988);
431. see also MM Cos. v. Liquid Audio, Inc., 813 A.2d 1118, 1126, 1129 (Del. 2003) (adopting Chancellor Allen's formulation).
432. See supra Part I.B.2. Other mechanisms of the corporate governance system, however, continue to operate in favor of shareholder interests. The market for corporate control is animated in large part by share prices: a low share price flowing from "bad" management that would attract bidders and a subsequent higher share price after a spell of "good" management. Incentives force corporate managers to focus on maximizing shareholder wealth. (Indeed, if corporate managers instead managed the company in the interests of creditors as directed by duty shifting, an unwelcome hostile takeover would be all the more likely.)
433. Another factor aligning managers with shareholders is that managers typically have large securities holdings, including shares and stock options, in their companies. Even when companies are troubled, those securities holdings continue to incentivize managers to focus on the share price. As noted above, these factors may or may not outweigh the influence over management that creditors often enjoy during periods of financial distress. See supra notes 202-211 and accompanying text.
434. See supra note 8.
435. See, e.g., Hu & Black, Taxonomy, supra note 53, at 1014 ("Sometimes [hedge funds] hold more votes than shares - a pattern we call 'empty voting' because the votes have been emptied of an accompanying economic interest") ;
436. Hu & Black, Decoupling, supra note 53, at 348 (describing practice of "empty voting" by hedge funds) ;
437. Hu & Black, The New Vote Buying, supra note 8, at 815 (analyzing decoupling of economic ownership from voting power and corporate governance implications);
438. Scannell, supra note 8 (recounting instances of "empty voting" by hedge funds);
439. White, supra note 8 ("The concern centres on the increasing ability of hedge funds and other sophisticated investors to accumulate large voting positions while having little, or even negative, economic interest in a company.");
440. see also infra Part V (discussing implications of decoupling for our analysis).
441. Hu & Black, The New Vote Buying, supra note 8, at 817, 834.
442. Those who view this change positively refer to a "new corporate governance paradigm" while those who look askance speak darkly about opening the "floodgates to contested elections." See, e.g., Brooke A. Masters, Shareholders Flex Muscles, Wash. Post, June 17, 2006, at DOl (quoting Patrick McGurn of Institutional Shareholder Services as saying that "new corporate governance paradigm [is] emerging" with respect to shareholder power);
443. Memorandum from David A. Katz & Laura A. McIntosh, Wachtell, Lipton, Rosen & Katz, to Clients, Corporate Governance: A Seismic Shift in the Mechanics of Electing Directors (July 27, 2006) (on file with the Columbia Law Review) (stating that "[t]his is a dynamic moment in the history of public company shareholder voting" and that certain changes in voting mechanics "threaten to open the floodgates to contested elections").
444. See, e.g., infra note 246 and accompanying text (discussing impact majority vote system would have had on reelection of Disney chairman Michael Eisner).
445. Masters, supra note 235.
446. Id.
447. See Claudia H. Allen, Study of Majority Voting in Director Elections i-v (Feb. 5, 2007), available at http://www.ngelaw.com/files/upload/ majority_callen_020707.pdf (on file with the Columbia Law Review);
448. Companies Switch to Tougher Majority Voting for Board Directors, Says Survey, 21 Andrews Corp. Officers and Directors Liability Litig. Rep. 13 (2006);
449. Masters, supra note 235. In June 2006, at the end of the proxy season, Wachtell Lipton, a firm long oriented to director primacy, admitted that the majority voting standard "will become universal." Memorandum from Martin Lipton, Gregory E. Osding & David M. Adlerstein, Wachtell, Lipton, Rosen & Katz, to Clients, Majority Voting - A Look Back at the 2006 Proxy Season (June 12, 2006) (on file with the Columbia Law Review).
450. On August 1, 2006, amendments to the Delaware General Corporation Law became effective, having the effect of encouraging the adoption of majority voting bylaws. Memorandum from Martin Lipton et al., Wachtell, Lipton, Rosen & Katz, to Clients, Delaware Adopts Majority Voting Amendments (July 7, 2006) (on file with the Columbia Law Review).
451. Masters, supra note 235 (citing Institutional Investor Services statistics).
452. Memorandum from David A. Katz & Laura A. McIntosh, Wachtell, Lipton, Rosen & Katz, to Clients, Corporate Governance Update: Poison Pills-Maintain Flexibility in Takeover Defense (Jan. 26, 2006) (on file with the Columbia Law Review). Under shareholder pressure, companies have increasingly eliminated takeover defenses or submitted them to a shareholder vote. In 2004 and 2005, shareholders voted on nearly seventy-five precatory shareholder proposals to rescind poison pills. Each received an average of fifty-seven percent of the votes cast. Lawyers advise corporations that the consequences of ignoring such majority votes "can be severe" and that they "should take care to avoid that situation if possible."
453. Id. at 3.
454. Internet Availability of Proxy Materials, Exchange Act Release No. 52,926, 70 Fed. Reg. 74,598, 74,598-99 (proposed Dec. 15, 2005). By allowing this switch to electronic delivery, the cost to dissident shareholders of launching proxy fights-historically, a major barrier-is lowered dramatically.
455. See Shareholder Proposals, Exchange Act Release No. 56,160, 72 Fed. Reg. 43,466, 43,469-72 (proposed Aug. 3, 2007) (to be codified at 17 C.F.R. pt 240);
456. Shareholder Proposals Relating to the Election of Directors, Exchange Act Release No. 56,161, 72 Fed. Reg. 43,488, 43,493 (proposed Aug. 3, 2007) (to be codified at 17 C.F.R. pt. 240) ;
457. Kara Scannell, SECs Solomon? Cox Splits Vote on Proxy Access, Wall St. J., July 26, 2007, at Cl.
458. Big Board Moves to Change Rule on Proxy Votes, N.Y. Times, Oct. 25, 2006, at C12.
459. Report and Recommendations of the Proxy Working Group to the New York Stock Exchange 21 (June 5, 2006), at http://www.nyse.com/pdfs/PWG_REPORT.pdf (on file with the Columbia Law Review).
460. About seventy to eighty percent of all publicly held companies' shares are held in "street name," meaning that the record owner is a broker, bank, or other depository. Id. at 10.
461. Under NYSE's existing Rule 452, brokers who hold shares for their clients and do not receive specific voting instructions prior to the meeting date may use the brokers' own discretion in voting on any matters considered "routine." Id. at 8.
462. One of the items considered "routine" was the uncontested election of directors. Id. at 1.
463. Historically, brokers have cast uninstructed shares " overwhelmingly" in support of the board's recommendations, meaning that the incumbent board has a significant advantage in director elections and other matters. Id. at 14.
464. Eisner was reelected with fifty-five percent of the votes cast. Had broker votes not counted, Eisner would have received only forty-five percent of the votes. Id. at 9.
465. See Masters, supra note 235.
466. A 2006 Council of Institutional Investors study found that sixty-one of the ninety-seven companies whose shareholder proposals received a majority vote in 2005 had taken action similar to that requested-more than double the percentage of the previous year. Id.
467. See, e.g., John Maggs, CEOs Under Fire, Nat'l J., June 16, 2007, at 42, 45 (discussing saga of man in chicken suit).
468. See Unisuper Ltd. v. News Corp., No. 1699-N, 2005 Del. Ch. LEXIS 205, at *32 (Del. Ch. Dec. 20, 2005).
469. Id.
470. Unisuper Ltd. v. News Corp., No. 1699-N, 2006 Del. Ch. LEXIS 11, at *11 (Del. Ch. Jan. 19, 2006). For reactions to these opinions, see David Marcus, News Agents, Daily Deal, Feb. 27, 2006 (arguing that Unisuper cases suggest shareholder primacy is gaining ground in Delaware);
471. Memorandum from Theodore N. Mirvis, Paul K. Rowe & William Savitt, Wachtell, Lipton, Rosen & Katz, to Clients, Delaware Supreme Court Is Likely to Hear Quick Appeal from Controversial News Corp. Decision (Jan. 20, 2006) (on file with the Columbia Law Review) (predicting that Delaware Supreme Court affirmance would allow shareholders to impose binding mandates on directors).
472. See, e.g., Credit Bureau of Broken Bow v. Moninger, 284 N.W.2d 855, 856 (Neb. 1979);
473. Gerdes v. Kennamer, 155 S.W.3d 541, 544 (Tex. App. 2004);
474. Judge Approves Sale of Simpson Assets to Help Pay Judgment, CNN, at http://www.cnn.com/US/9811/03/ simpson.estate/index.html (last visited Sept. 7, 2007) (on file with the Columbia Law Review) (describing seizure of O.J. Simpson's assets, including Heisman trophy, to pay judgments).
475. Insolvency Act, 1986, c. 45, §§ 238, 423(3) (Eng.);
476. Hamish Anderson, Insolvency Focus, L. Soc'y Gazette, Feb. 19, 1992, at 26.
477. In United States law the concept correlative to "transactions at an undervalue" is the constructive fraudulent conveyance. 11 U.S.C. § 548(a) (2000).
478. "Each permits the undoing of a transaction without a showing of actual intent to defraud." 11 U.S.C. §548(a) (1) (B) ;
479. Unif. Fraudulent Transfer Act §§ 4(a) (2), 5, 7A U.L.A. pt. 2, at 58, 129 (2006);
480. see 5 Collier on Bankruptcy, supra note 95, ¶ 548.01[1]-[2].
481. Unif. Fraudulent Transfer Act § 7. The Act does permit injunctive relief and receivership remedies against the debtor, but not monetary liability.
482. 11 U.S.C. § 523(a)(6);
483. Charles Jordan Tabb, The Scope of the Fresh Start in Bankruptcy: Collateral Conversions and the Dischargeability Debate, 59 Geo. Wash. L. Rev. 56, 59 (1990).
484. An example of criminal penalties for secreting or carrying off collateral is Hindering Secured Creditors, Tex. Penal Code Ann. § 32.33 (Vernon 2006).
485. By an "individual" debtor, we refer throughout to a debtor who is a natural person rather than a legal entity.
486. As with personal property, there is an action for conversion or waste if the debtor puts the collateral beyond a secured party's reach, but that remains a property-based remedy, not an independent duty owed to the creditor qua creditor. It is also an ordinary, tort-like duty, not a fiduciary obligation.
487. Even after default, debtors do not owe their creditors fiduciary or other special duties. Instead, creditors are expected to include in their contracts such restraints on debtor behavior as they diink necessary and appropriate. Both individual and corporate debtors are subject to receivership remedies in cases of fraud or similar conduct. Warren & Westbrook, Text, Cases & Problems, supra note 31, at 154-55. However, these remedies are conservatory, protecting the value of the debtor's property for the benefit of creditors, rather than imposing a liability duty on the debtor.
488. Sometimes these contractual duties are supported by the restraints imposed by property law with regard to collateral given as security, but those restraints are themselves quite narrow. There is a rich literature concerning the costs and benefits of expanding contract liability, but most of it in recent years has been focused on tort liability along the lines of tortious inducement of breach of contract. See, e.g., Mark P. Gergen, Tortious Interference: How It Is Engulfing Commercial Law, Why This is not Entirely Bad, and a Prudential Response, 38 Ariz. L. Rev. 1175, 1182-83 (1996) (exploring different prayers of damage under tortious interference that can create "an enormous potential scope in contract");
489. Harvey S. Perlman, Interference with Contract and Other Economic Expectancies: A Clash of Tort and Contract Doctrine, 49 U. Chi. L. Rev. 61, 70-72 (1982) (assessing costs of economic loss with respect to determining proper limits of liability for tortious act);
490. James B. Sales, The Tort of Interference with Contract: An Argument for Requiring a "Valid Existing Contract" to Restrain the Use of Tort Law in Circumventing Contract Remedies, 22 Tex. Tech. L. Rev. 123, 127 (1991) ("Generally, contract remedies promote efficiency and predictability, whereas the intervention of tortious interference with contract introduces inefficiency and unpredictability.").
491. For a list of critiques of tortious interference's ambiguities, see Gary Myers, The Differing Treatment of Efficiency and Competition in Antitrust and Tortious Interference Law, 77 Minn. L. Rev. 1097, 1109-10 (1993).
492. Interestingly enough, that sentiment is expressed in a recent Delaware case discussing the duty shifting doctrines. See Trenwick Am. Litig. Trust v. Ernst & Young, L.L.P., 906 A.2d 168, 173, 199 (Del. Ch. 2006) (noting that Delaware law leaves protection of creditors largely to contracts they negotiate).
493. The court makes a similar statement in North American, despite its adoption of duty shifting. N. Am. Catholic Educ. Programming Found, v. Gheewalla, No. 521, 2006, slip op. at 15 (Del. May 18, 2007).
494. Apparendy, lenders and other creditors do not often bargain for directors' duties to protect creditor interests. One reason may be that they are not regarded as important or efficacious for creditors. Another possible reason is the risk of liability to a creditor found to have been in control of a corporation. See, e.g., Bergquist v. First Nat'l Bank of St. Paul (In re Am. Lumber Co.), 5 B.R. 470, 477-78 (Bankr. D. Minn. 1980). In addition, depending on the nature of the agreement, there may be questions as to its enforceability under Delaware law.
495. See, e.g., Richard Posner, Economic Analysis of Law 119 (6th ed. 2003).
496. Professors Hertig and Kanda assert that limited liability is a good reason for imposing on corporations an additional duty to creditors, but provide little concrete justification. Gerard Hertig & Hideki Kanda, Creditor Protection, in The Anatomy of Corporate Law: A Comparative and Functional Approach 71, 71-73 (2004).
497. See, e.g., Edward J. Balleisen, Navigating Failure 12 (2001) (comparing stringent mid-nineteenth century European bankruptcy law to more lenient American law);
498. Joseph McKnight, Protection of the Family Home from Seizure by Creditors: The Sources and Evolution of a Legal Principle, 86 Sw. Hist. Q. 369, 388-90 (1983) (comparing provisions of 1829 act of Mexican state of Coahuila y Texas, which followed Spanish tradition of protecting debtor's land, with eighteenth century English law allowing debtors to protect certain movables but subjected all land and slaves to enforcement of debt).
499. Imprisonment for debt retreated, but unevenly. Balleisen, supra note 263, at 12 ("From the 1820s onward, a growing number of states dramatically curtailed the use of imprisonment for debt, essentially restricting the institution to instances in which a debtor was guilty of gross fraud.");
500. Bruce H. Mann, Republic of Debtors 106 (2002) (commenting that argument against imprisoning debtors-that old insolvency laws were based on fiction that debtors were criminal-resulted in New York abolishing imprisonment for most debt in 1831, while Pennsylvania waited eleven more years to abolish imprisonment for most debt).
501. Balleisen, supra note 263, passim (discussing bankruptcy discharge of personal liability for business debts).
502. See Trevor v. Whitworth, (1887) 12 App. Cas. 409, 411 (H.L.) (appeal taken from C.A.) ("The surrender of shares . . . may be lawfully made without reducing the real capital, but no reduction of capital otherwise than as allowed by statute is legitimate ....");
503. Craig A. Peterson & Norman W. Hawker, Does Corporate Law Matter? Legal Capital Restrictions on Stock Distributions, 31 Akron L. Rev. 175, 180-83 (1997) (discussing historical move away from par value legal capital doctrine);
504. supra notes 32-38 and accompanying text. For a description of the view from Europe, where some of the same sorts of rules are now being reviewed, see Bratton, supra note 117, at 41-44.
505. See, e.g., Lynn M. LoPucki, The Death of Liability, 106 Yale L.J. 1, 6 (1996) ("[T] his Article concludes that currendy effective judgment-proofing strategies are fully capable of defeating the liability system.").
506. Of course, those rules are critically important with regard to tort victims and other involuntary creditors. We do not address the problems presented by involuntary creditors of financially distressed debtors in this Article, beyond noting that its solution should probably be sought in bankruptcy law and policy. We note, however, that until now no special priority has been given to most of these creditors under most state laws or the Bankruptcy Code. Indeed, until 1978 tort creditors generally could not present their claims in bankruptcy, but had to be content with an undischarged claim that often had little postbankruptcy value. 2 Collier on Bankruptcy, supra note 95, ¶ 101.05.
507. Cf. Marshall v. McCaffrey (In re McCaffrey), 216 B.R. 196, 202 (Bankr. E.D. Mich. 1997) (dismissing plaintiff's arguments against dischargeability of debt on grounds of breach of fiduciary duty, conversion, and failure to keep adequate records when portion of corporate loan was used for gambling).
508. See supra Part II.E.
509. See infra Part III.C.2.
510. Prod. Res. Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772, 790-91 (Del. Ch. 2004) ;
511. see supra note 62 and accompanying text.
512. See Regulation S-K, 17 C.F.R. §§ 229.303, 229.402 (2007). Other, more specific, SEC disclosure requirements, such as those relating to limitations on the payment of dividends, may apply in certain narrow circumstances.
513. On a related point, Professor Lipson has made an effective attack on Credit Lyonnais by recognizing that the duty shifting doctrines rest upon a confusion between priority and duty. See Lipson, supra note 49, at 1192.
514. See 2 Michael T. Madison et al., The Law of Real Estate Financing § 12:34 (rev. ed. 2007) (describing typical steps required for judicial foreclosure).
515. See Restatement (Third) of Prop.: Mortgages § 4.1 (1997) ("A mortgage creates only a security interest in real estate and confers no right to possession of that real estate on the mortgagee.") ;
516. id. § 4.6 (outlining elements of waste and remedies for breach of duty by mortgagor).
517. See, e.g., Nissan Motor Acceptance Corp. v. Baker, 239 B.R. 484, 488-89 (N.D. Tex. 1999) (mem.) (holding creditor in violation of bankruptcy stay for failure to return car that was lawfully seized before bankruptcy but was not sold before bankruptcy was filed).
518. The stay does not have effect if the foreclosure is complete before filing. See generally, 2 Collier on Bankruptcy, supra note 95, ¶ 105.02 (discussing procedures for applying for bankruptcy stays);
519. id. ¶ 362.05 (discussing exceptions to bankruptcy stays).
520. Cf. JP Morgan Chase Bank v. Altos Hornos de Mex., S.A. de C.V., 412 F.3d 418, 426-27 (2d Cir. 2005) (finding that funds deposited in collection account from which creditor could withdraw for purposes of debt repayment were not property of creditor).
521. As to personal property, the rights to seizure, sale, and payment from proceeds are found in U.C.C. §§ 9-601 to 9-607 (2004).
522. Some courts have tried to expand the rights of secured parties after default, but recent cases have insisted on the traditional bundle. See, e.g., In re Mitchell v. Bankillinois, 316 B.R. 891, 897 (S.D. Tex. 2004) (highlighting differences between lienholder and owner).
523. 11 U.S.C. § 1104 (2000).
524. Cf. N. Pac Ry. Co. v. Boyd, 228 U.S. 482, 505-06 (1913) (emphasizing that foreclosure proceedings take into account interests of botfi shareholders and creditors, even if creditors have "prior rights");
525. Louisville Trust Co. v. Louisville, New Albany & Chi. Ry. Co., 174 U.S. 674, 688 (1899) (discussing need to protect unsecured creditors from collusion between bondholders and stockholders);
526. Bezanson v. Fleet Bank-NH, 29 F.3d 16, 20 (1st Cir. 1994) (holding that creditor for "loan in default cannot walk away with the collateral if it is worth more than the debt").
527. See supra Parts II.B, II.C, III.B.
528. MM Cos. v. Liquid Audio, Inc., 813 A.2d 1118, 1126 (Del. 2003).
529. See, e.g., In re KDI Holdings, Inc., 277 B.R. 493, 515-16 (Bankr. S.D.N.Y. 1999) (listing elements to establish lender liability);
530. see also Bratton, supra note 117, at 50-51 (noting that managing creditor can be held liable to stockholders).
531. See, e.g., Bergquist v. First Nat'l Bank of St. Paul (In re Am. Lumber Co.), 5 B.R. 470, 476 (Bankr. D. Minn. 1980).
532. See generally Hernando de Soto, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else 61-62 (2000) (describing closely tracked Western property system).
533. N. Am. Catholic Educ. Programming Found, v. Gheewalla, No. 521, 2006, slip op. (Del. May 18, 2007);
534. see also discussion supra Part I.B.4.
535. North American, No. 521, 2006, slip op. at 23-24.
536. Id. at 19.
537. The Canadian Supreme Court has adopted a somewhat similar approach, through the "oppression" remedy. See Janis Sarra, Canada's Supreme Court Rules No Fiduciary Obligation Towards Creditors on Insolvency-People's Department Stores v. Wise, 15 Int'l. Insolvency Rev. 1 passim (2006) (discussing oppression remedy). That court also imposed a duty of care owed to creditors. Id. at 9.
538. North American, No. 521, 2006, slip op. at 20 (emphasis in original)
539. (quoting Prod. Res. Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772, 794 n.67 (Del. Ch. 2004)).
540. Id. at 15, 20, 23 (emphasis added).
541. Id. at 23 (emphasis added).
542. See supra Parts II.A.1, II.B.
543. See supra Parts II.A.1, II.B.
544. As to the need to consider the timing issue, see Legal Dep't, Int'l Monetary Fund, Orderly & Effective Insolvency Procedural Principles: Key Issues 53-55 (1999);
545. cf. Hertig & Kanda, supra note 262, at 73 (stating that "all jurisdictions have devised ways to induce insolvent firms to file for bankruptcy with reasonable promptness"). In the United States, a key question for future research is determining whether the corporate governance system or the bankruptcy system should be the locus of the transition decision.
546. See Legal Dep't, Int'l Monetary Fund, supra note 296, at 59;
547. Warren & Westbrook, Text, Cases & Problems, supra note 31, at 397.
548. Westbrook, Control, supra note 53, at 859-60.
549. Professors Hertig and Kanda say that most countries require directors to file an insolvency proceeding upon insolvency, but they seem to be focused primarily upon European countries. Hertig & Kanda, supra note 262, at 73.
550. One example is Germany, where a failure to file for insolvency once a corporation is insolvent may subject directors to both criminal penalties and civil liability. Sandy Shandro, Germany: Failed to File? Go Directly to Jail!, Am. Bankr. Inst. J., Jan. 24, 2006, at 18 (including survey of European rules of this type).
551. Such a filing by the directors of a German subsidiary of the Singer Group precipitated its worldwide bankruptcy in over one hundred countries. See Evan D. Flaschen, AnthonyJ. Smits & Leo Plank, Foreign Representatives in U.S. Chapter 11 Cases: Filling the Void in the Law of Multinational Insolvencies, 17 Conn. J. Int'l L. 3, 20 (2001).
552. Other common law countries have penalties for "wrongful trading," which means roughly continuing the business after it has become insolvent. See, e.g., Keay & Murray, supra note 2, at 34.
553. See Block-Lieb, supra note 162, at 805 (noting that "a surprisingly small number of involuntary petitions are filed each year").
554. But see In re Liberate Techs., 314 B.R. 206, 218 (Bankr. N.D. Cal. 2004) (finding debtor's bankruptcy petition premature because "[d]ebtor is very solvent, very liquid, and can sell its assets as a going concern outside of bankruptcy").
555. See supra Part III.A.
556. The corporation's attorney-client privilege can be waived by a trustee in bankruptcy. Commodity Futures Trading Comm'n v. Weintraub, 471 U.S. 343, 358 (1985).
557. See supra note 12.
558. See, e.g., Hu, Shareholder Welfare, supra note 17, at 1292-1317 (discussing impact of financial innovation on capital structure and related matters).
559. See supra note 150 (discussing exceptions to presumption of well-diversified shareholders).
560. See, e.g., Hu & Black, The New Vote Buying, supra note 8, at 814-23, 844-47.
561. Id. at 814-27 (coining term "empty voting" and setting forth analytical framework for decoupling, in shareholder context, of voting rights and economic interest). The term "empty voter" does not refer only to those without any economic interest in a company. This term involves looking at the extent of voting power relative to the economic interest, not the absolute level of economic interest.
562. Id. at 825.
563. See, e.g., Hu & Black, Decoupling, supra note 53, at 346-53 (discussing evidence regarding extent of decoupling).
564. This discussion of extending this shareholder decoupling analytical framework to decoupling in the creditor context is based on Hu, Shareholder and Creditor Decoupling, supra note 17, at 20-21 (coining terms "empty creditor" and "empty covenant-holder," relating functional elements of creditor decoupling to those of shareholder decoupling, and discussing parallel policy concerns).