Directors’ Duties in Failing Firms

Cite this Article
Keith Sharfman, Directors’ Duties in Failing Firms, Truth on the Market (February 07, 2006),

Larry Ribstein over at Ideoblog has written (together with coauthor Kelli Alces) an important new paper concerning the fiduciary duties of directors of failing firms. Conventional wisdom (as often stated in law review articles and judicial dicta) is that director fiduciary duties, though generally owed to shareholders, shift from shareholders to creditors when the firm nears or enters insolvency. Ribstein and Alces, however, argue persuasively against this view. They contend that the directors’ duties run to the firm itself rather than to any particular class of stakeholders such as shareholders or creditors. Thus, no special set of fiduciary duties to creditors arises on account of insolvency; the ordinary business judgment rule remains in effect.

Conceiving of fiduciary duties as extending to the firm rather than to individual stakeholders is a major breakthrough of both practical and theoretical importance. If Ribstein and Alces are correct, the capacity of creditors to sue derivatively on behalf of insolvent firms is weaker than many people think, and creditors will have to look elsewhere for remedies in cases where it is alleged that the directors improvidently gambled with the firm’s assets for the shareholders’ benefit but at the creditors’ expense.