As a company approaches insolvency, the question of whose interests the board must serve becomes acute.
The prevailing view. Directors of an insolvent company continue to owe duties to the corporation, and creditors may enforce those duties derivatively because they become the residual claimants. There is generally no direct duty owed to individual creditors.
Deepening insolvency as an independent cause of action has been rejected in most jurisdictions, though the underlying conduct may support fiduciary or fraudulent transfer claims.
Business judgment protection continues. Directors may pursue a reasonable strategy to save the company, and taking risk is not a breach.
What gets examined. Continued trading while unable to pay; payments to insiders and affiliates; grants of new security for old debt; transfers of opportunities to a related entity; and compensation increases.
Practical steps. Increase board meeting frequency; obtain independent advice; document the alternatives considered and the basis for the choice; consider a restructuring committee of disinterested directors; monitor the solvency analysis with real numbers rather than assumptions; and confirm directors and officers insurance including run-off.
Personal exposure for unpaid payroll taxes and, in many states, unpaid wages, which is not discharged by the entity’s insolvency.