Part I: The Fiduciary Duties of Officers and Directors of Insolvent Corporations

(April 23, 2010):  Many health care providers are in a fight for financial survival.  Ever-decreasing reimbursement costs, coupled with increasing costs and expanding contractor audits of Medicare billings have put many providers out of business.  As a Firm, we do what we can to defend health care providers who are being subjected to subjective audits, many times years after the services were rendered.  Unfortunately, sometimes we are called in too late to assist.  We were recently contacted by a company on the verge of insolvency.  David P. Parker, a corporate attorney here, was asked to address the fidcuciary duties of Officers and Directors.  Over the next few days, Mr. Parker will be posting several articles examing the  fiduciary duties of Officers and Directors of insolvent corporations and corporations operating in the so called “Zone of Insolvency.”

Part I:  The Fiduciary Duties of Officers and Directors of Insolvent Corporations

In the United States, corporations are creatures of state law, and the fiduciary duties of a corporation’s directors are defined by its state of incorporation. Many U.S. corporations are incorporated in the state of Delaware, which has a strong tradition of well-developed corporate jurisprudence.   There may, however, be differences between Delaware law and the laws of other states within the United States.  In general, Directors of solvent corporations have two basic “fiduciary” duties, the duty of care and the duty of loyalty, owed to the corporation itself and the shareholders. Directors must act in good faith, with the care of a prudent person, and in the best interest of the corporation. Directors must also refrain from self-dealing, usurping corporate opportunities and receiving improper personal benefits.  Decisions made by a Director on an informed basis, in good faith and in the honest belief that the action was taken in the best interest of the corporation will be protected by the “business judgment rule.”  Generally, officers owe the same fiduciary duties as directors.

 It has long been settled that under ordinary (i.e., solvent) circumstances, shareholders typically have only a derivative (and not direct) right to sue for breach of the fiduciary duties of directors. If they do bring suit against directors, they must do so on behalf of the corporation, and any proceeds of those suits are for the benefit of the corporation.

 The Delaware Supreme Court in Catholic Educ. Programming Found., Inc. v. Gheewalla opined that upon insolvency, creditors (who have, after all, taken the place of shareholders as the de facto owners) may likewise bring only derivative – and not direct – suits on behalf of the corporation against directors