The California Court of Appeal recently rejected the argument that directors and officers owe fiduciary duties to the company’s creditors when the company is in the so-called “zone of insolvency,” or is even clearly insolvent. In Berg & Berg Enterprises, LLC v. John Boyle, et al., 100 Cal. Rptr. 3d 875 (Cal. Ct. App. 6th Dist. Oct. 29, 2009), the California court expounded that “there is no broad, paramount fiduciary duty of due care or loyalty that directors of an insolvent corporation owe the corporation’s creditors solely because of a state of insolvency.” Id. at 893-94. The court was even much less inclined to find that directors owed such duties when the corporation is not clearly insolvent but on the brink of insolvency, and held that “there is no fiduciary duty prescribed under California law that is owed to creditors by directors of a corporation solely by virtue of its operating in the ‘zone’ or ‘vicinity’ of insolvency.” Id. at 893.
It is well settled that directors and officers of a solvent company owe fiduciary duties to act with honesty, loyalty and good faith to the company’s shareholders, since the shareholders are the owners of the company and its residual risk bearers. So long as the company remains solvent, the company’s obligations to its creditors are governed simply by their contractual arrangement.
When the company becomes insolvent, some courts outside of California have held that management’s duties shift to the company’s creditors. See, e.g., Geyer v. Ingersoll Publ’ns Comp., 621 A.2d 784, 787 (Del. Ch. 1992) (“When the insolvency exception does arise, it creates fiduciary duties for directors for the benefit of creditors.”). The rationale for this shift in the fiduciary duties is that when a company is insolvent, creditors’ contract claims are affected by management’s decisions in a way they are not outside of insolvency. At the same time, shareholders’ interests become essentially worthless. While there are no California cases specifically recognizing this shift, some courts have found it to be an application of the “trust fund doctrine” recognized by the California courts. Under that doctrine, which is typically limited to situations where officers or directors divert, dissipate, or unduly risk corporate assets, an insolvent company’s assets are said to be managed as though held in trust for the benefit of its creditors.
Beginning in the 1990’s, courts outside of California began to suggest that management’s fiduciary duties are owed to creditors not only when insolvency ensues, but also when the company is still technically solvent but within what has been termed as the “zone” or “vicinity” of insolvency. The catalyst for this trend was Chancellor Allen’s statement in an unpublished decision in Delaware in 1991. See Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., No. 12150, 1991 Del. Ch. LEXIS 215, *108 (Del. Ch. Dec. 30, 1991) (“At least where a corporation is operating in the vicinity of insolvency, a board of directors is not merely the agent of the residue risk bearers, but owes its duty to the corporate...
