In a troubled economy where businesses are struggling to survive, it is no surprise that many organizations find themselves insolvent or nearly insolvent. Directors of insolvent or nearly insolvent organizations are facing the question of to whom they owe their duty of loyalty, and whose best interest must they consider when making decisions. When in the zone of insolvency, directors still owe a duty to stakeholders to act in their best interests. Judicial decisions in some jurisdictions, however, have suggested that when an organization is insolvent or in the “zone of insolvency,” the directors’ fiduciary duties extend to the organization’s creditors as well.
Ohio courts have not decided whether directors of an insolvent or nearly insolvent corporation owe a fiduciary duty to the corporation’s creditors. Federal courts applying Ohio law, however, have held that directors owe no such duty to creditors. The cases, discussed below, rely on Ohio Rev. Code § 1701.59 to reach their conclusions. Rev. Code § 1701.59(B) imposes a duty on a director to act in good faith and in a manner that he believes is in or not opposed to the best interests of the corporation. Section 1701.59(E) explains the factors a director may take into consideration when performing his duty:
(E) For purposes of this section, a director, in determining what the director reasonably believes to be in the best interests of the corporation, shall consider the interests of the corporation’s shareholders and, in the director’s discretion, may consider any of the following:
(1) The interests of the corporation’s employees, suppliers, creditors, and customers . . . .
Ohio Rev. Code § 1701.59(E) (emphasis added). The most significant language is the distinction between the mandatory consideration (the interests of the shareholders) and the permissive considerations (which include the interests of the corporation’s creditors).
In Official Committee of Unsecured Creditors of PHD, Inc. v. Bank One, the District Court for the Northern District of Ohio granted a director’s motion to dismiss and found that the director of an insolvent corporation owed no fiduciary duty to the corporation’s creditors. The Committee argued that upon PHD’s insolvency, the director owed a duty of care to PHD’s unsecured creditors. The Committee further argued that he breached this duty by failing to fulfill his responsibilities as a director, failing to prevent others from making misrepresentations to PHD’s creditors, and failing to mitigate the effect of others’ misrepresentations to the creditors.
The court disagreed. It focused on the word “may” § 1701.59(E) and determined that there was no indication that the legislature intended that consideration of creditors’ interests was anything other than permissive. The court denied the motion for reconsideration as to the dismissal of the Committee’s claims for breach of fiduciary duty owed to the creditors. The court explained, “because Ohio statutory law explicitly defines the duties of directors of a corporation, and because that explicit definition does not require directors to consider the interests of creditors, there is no fiduciary duty owed by directors to creditors, regardless of the financial state of the corporation.”
The court granted the motion for reconsideration as to dismissal of the Committee’s claims that the directors breached their fiduciary duties to the corporation because none of the parties had moved to dismiss those claims, so the court’s dismissal of those claims was clear error. This distinction clarifies the court’s belief that under Ohio law, even during insolvency, directors do not owe fiduciary duties to a corporation’s creditors. However, the creditors of an insolvent corporation may bring a claim for breach of fiduciary duty to the corporation itself.
In In re Amcast Industrial Corp., the bankruptcy court took a similar approach and reached the same conclusion, that officers and directors do not owe a fiduciary duty to a corporation’s creditors even if the corporation is insolvent or in the zone of insolvency. There, the court concluded:
The plain language of Ohio Rev. Code § 1701.59(E) clarifies that a director has discretion to consider many constituencies of the corporate enterprise, including creditors, when making corporate decisions. However, a director has no distinct legal obligation directly to creditors, separate from the corporate entity as a whole, even when a corporation has reached the point of insolvency.
Thus, the court found that Ohio law does not impose a fiduciary duty on directors to a corporation’s creditors when the corporation is insolvent or nearly insolvent.
While not controlling on Ohio courts, Bank One and Amcast may be influential on the issue because they reflect reasonable applications of Rev. Code § 1701.59(E).
Ohio state courts have not determined the issue, but the Supreme Court of Delaware recently analyzed it in detail in National American Catholic Educational Programming Foundation, Inc. v. Gheewalla. Because Ohio case law is silent on the subject, an Ohio court might consider a Delaware business law case as persuasive authority. In Gheewalla, the plaintiff was a creditor of Clearwire Holdings, Inc. The defendants were directors of Clearwire while it was either insolvent or in the zone of insolvency. The plaintiff alleged that the defendants breached the fiduciary duties they owed to the plaintiff as a creditor.
The Supreme Court affirmed the Chancery Court’s decision to dismiss the complaint. It first held, “no direct claim for breach of fiduciary duties may be asserted by the creditors of a solvent corporation that is operating in the zone of insolvency.” The court reasoned that creditors, unlike shareholders, have contractual agreements, fraud and fraudulent conveyance law, implied covenants of good faith and fair dealing, bankruptcy law, commercial law, and other sources of creditor rights to protect them. It concluded that a corporation in the zone of insolvency is most in need of effective and proactive leadership and the ability to negotiate with creditors; a direct fiduciary duty cause of action for creditors likely would undermine these goals. Finally, when in the zone of insolvency, the court stated that the focus for directors does not change; they must continue to exercise their business judgment in the best interests of the corporation for the benefit of the shareholders. For all of these reasons, the court refused to allow creditors to bring direct claims for breach of fiduciary duty.
Second, the Supreme Court held, “individual creditors of an insolvent corporation have no right to assert direct claims for breach of fiduciary duty against corporate directors.” (emphasis by court). The court noted that when a corporation is insolvent, creditors take the place of shareholders as beneficiaries of an increase in value, so creditors of an insolvent corporation have standing to maintain derivative claims on behalf of the corporation for breaches of fiduciary duties. However, to find that directors owe fiduciary duties directly to creditors “would create uncertainty for directors who have a fiduciary duty to exercise their business judgment in the best interest of the insolvent corporation.” It also would conflict with the directors’ duty to maximize the value of the insolvent corporation for the benefit of all those with an interest in it. Therefore, while creditors of an insolvent corporation may bring a derivative action against the directors for breach of fiduciary duty, they cannot bring a direct action because the directors owe no fiduciary duty to the creditors.
Given the vast experience of Delaware courts with business and corporate law matters, Ohio state courts may well see Gheewalla as persuasive on the issue. Furthermore, as the federal courts explained in Amcast and Bank One, the plain language of Rev. Code § 1701.59(E) supports a finding that directors do not owe a fiduciary duty to the corporation’s creditors regardless of the corporation’s financial state. This is especially true given that the statute expressly makes the consideration of shareholders’ interests mandatory but makes consideration of creditors’ interests permissive. Thus, we can say that Ohio law probably does not impose on corporate directors a fiduciary duty to the corporation’s creditors when the corporation is insolvent or nearly insolvent. Still, with no Ohio case on point, it is impossible to conclude with certainty.