COVID-19’s Impact on Directors’ Fiduciary Duties to Distressed Companies
Date: June 29, 2020
The COVID-19 pandemic sweeping across the United States has triggered unprecedented disruption of corporate America, resulting in many otherwise healthy companies facing financial distress and potentially teetering on insolvency. These companies’ directors understandably may have questions about how this sudden change in financial health impacts the fiduciary duties they owe to the company.
As state and local governments allow businesses to reopen and resume operations, directors of distressed companies must make a number of important decisions that impact the company’s finances, the health and safety of employees and customers, and the potential liabilities the company may face from opening its doors.
As they make these determinations, directors may question what role COVID-19 should play in their decision-making process. While COVID-19 most certainly has thrown the corporate world into chaos, the legal principles governing directors’ obligations have not changed.
Continue to Serve the Company
Directors are obligated to make decisions that best serve the company’s interests and those of its shareholders. The fiduciary duties of directors who serve healthy, solvent companies are clear: fulfill their duty of care and fulfill their duty of loyalty.
Directors of unhealthy, insolvent companies should be aware of the following:
- Directors’ fiduciary duties do not change when a company enters the zone of insolvency.
- Directors do not have a duty to shut down the insolvent corporation to marshal assets for creditors.
- Directors of insolvent companies do not owe fiduciary duties to creditors.
- Creditors may not bring direct claims against directors for breach of fiduciary duty.
- Directors owe fiduciary duties to the corporation and must make decisions that benefit the corporation, which in turn will benefit all residual interest holders—both creditors and shareholders.
Practical Implications During the COVID-19 Crisis
Despite the chaos caused by COVID-19 possibly having driven otherwise healthy companies into financial distress or even insolvency, nothing really has changed regarding directors’ responsibility to discharge their fiduciary duties. While creditors may have become residual interest holders, directors do not directly owe them fiduciary duties. Creditors do not have standing to bring direct claims against directors, and the directors’ fiduciary obligations to the company do not change whether the company is in the zone of insolvency or has become insolvent. Directors should continue to fulfill their duties of care and loyalty owed to the corporation, which will benefit creditors and shareholders alike.
The disruption created by COVID-19 does, however, alter the information directors must consider in fulfilling their duties of care and loyalty. To make decisions that they reasonably believe are in the company’s best interests, they must be well-informed and knowledgeable about facts and circumstances surrounding the company, which necessarily requires an understanding and consideration of the impact COVID-19 could have on the company’s operations.
This includes weighing the benefits of opening for business, which mainly would be revenue generation, against the potential costs of resuming operations, such as costs of operating at less than full capacity and possible liability resulting from employees or customers who may become infected on the company’s premises. Directors should be well-informed about the company’s potential need for additional financing and assess COVID-19’s conceivable impact on the company’s business and its ability to generate adequate revenue to service the debt. They also should evaluate the stimulus packages provided by the federal government and their possible benefits for the company’s finances. There are numerous other issues related to COVID-19 that will affect different companies in different ways that directors should also consider. The obvious point here is that COVID-19 has had and will continue to have an undeniable impact on how companies operate, and that impact must inform the decision-making process.
Directors are not fortune tellers, and they legally cannot in hindsight be faulted for making the wrong decisions. They will be protected under the business judgment rule so long as they act using their knowledge of critical facts affecting the company. They must carefully deliberate and make decisions based on the facts in front of them, which now includes COVID-19’s impact on the company and its operations. The decision process has not changed; all that has changed is that COVID-19 must now be part of the discussion.
FOR MORE INFORMATION
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