Directors’ and Officers’ Fiduciary Duties When Corporation Insolvent
When a company becomes insolvent, there are changes in the duties owed by the company’s officers and directors. Specifically, insolvency can trigger a fiduciary duty from the company to its creditors. This is called the Trust Fund Doctrine, and corporate officers and directors should be aware of its implications.
What are Fiduciary Duties?
Officers and directors of a corporation owe fiduciary duties to the corporation including a duty of care, and a duty of loyalty. The duty of care requires fiduciaries to act in an informed manner. It requires fiduciaries to review all relevant information reasonably available to them before making company decisions. The duty of loyalty requires fiduciaries to act in a disinterested manner, in good faith, and to avoid self-dealing or actions that would benefit themselves at the corporation’s expense.
The Business Judgment Rule
Decisions of corporate fiduciaries are examined under what is known as the Business Judgment Rule. The Business Judgment Rule gives corporate officers and directors broad discretion in making decisions. Courts will not review or second guess an officer or director’s decisions or hold them liable for such decisions so long as they are: (1) disinterested and independent; (2) acting in good faith; and (3) reasonably diligent in learning the facts.
The Trust Fund Doctrine
When a corporation becomes insolvent, the traditional fiduciary duties and business judgement rule still apply. However, insolvency can trigger additional duties from the corporation to its creditors.
Under the Trust Fund Doctrine, once a corporation becomes insolvent, all of its assets immediately become a trust fund for all of its creditors. Under that doctrine, an officer or director can breach a fiduciary duty owed to creditors of the corporation when they divert corporate assets for the benefit of insiders or preferred creditors. The scope of the trust fund doctrine is limited to cases where directors or officers have diverted, dissipated, or unduly risked an insolvent corporations assets.
When is a Corporation Insolvent?
When a corporation is insolvent, or in the “zone of insolvency” is a fuzzy concept in California. One area that provides some guidance is California’s Corporations Code. California Corporations Code section 501 identifies that a corporation is insolvent when it would “likely be unable to meet its liabilities as they mature.”
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