INTRODUCTION 550 I. THE PROBLEMS WITH MODERN CHAPTER 11 554 II. DIP FIDUCIARY DUTIES 557 A. Corporate Fiduciary Duties 558 B. Fiduciary Duties in Bankruptcy 563 III. AN APPLIED ACCOUNT OF DIP FIDUCIARY DUTIES 569 A. Reject the RSA 570 B. Renegotiate the DIP Loan 571 C. Resist the Loan-to-Own 573 D. Other Considerations 574 CONCLUSION 575
INTRODUCTION
Fiduciary duties are the bedrock of corporate law. It is axiomatic that a corporation's directors are fiduciaries, owing duties of loyalty and care to the corporation's shareholders. (1) Such fiduciary duties have substantial bite and play the central role in ensuring that companies are managed in shareholders' interests. (2)
When a company files for bankruptcy, however, the situation is different. In theory, the corporate directors continue owing fiduciary duties (albeit to creditors as well as shareholders), and the corporate debtor itself owes the duties of a trustee, (3) but in practice fiduciary duties have little purchase in bankruptcy. This Article argues that the lack of meaningful fiduciary duties for directors in bankruptcy is responsible for a range of deleterious effects on the modern corporate bankruptcy system. In short, without fiduciary duties, corporate bankruptcy is broken.
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Most large American corporations file bankruptcy under chapter 11, the reorganization provision of the Bankruptcy Code, under which debtors remain "in possession" of their bankruptcy estate. (4) That is, no trustee is ever appointed. (5) Chapter 11 debtors in possession (DIPs) (6) owe fiduciary duties to the bankruptcy estate, just like trustees. (7) Plain statements of this principle are legion. (8)
The duty is frequently stated, yet rarely applied. Indeed, it is hard to find many examples of DIP fiduciary duties in action. Who can enforce the duty to the estate, and what form might that enforcement take? (9) What does the duty comprise, when is it simply instructive or hopeful, and when does it have "teeth?" (10) How do these bankruptcy-triggered duties relate to the duties of management under state corporate law? (11) And most plainly, what does the duty require of the DIP's board? (12) None of these fundamental points have been satisfactorily established.
That is, the DIP's chapter 11 fiduciary duties loom wraith-like around corporate restructuring--noted but rarely seen. This stands in contrast to corporate law, where the board's fiduciary duties are highly specified.
At the same time, modern chapter 11 is increasingly seen as "problematic." (13) Aggressive forum shopping, (14) extreme deference to insider deals, (15) and excessive speed have moved chapter 11 into a realm where powerful insiders always win. (16) Ellias and Stark call it "hardball." (17) LoPucki calls it "lawless." (18) Dick summarizes the development of modern, ultra-aggressive restructuring "as a normative failure in the... capital markets that will likely continue and grow worse over time." (19)
The proponents of these deals pick and choose which parts of chapter 11 they want to follow, using what is useful and ignoring those pieces that might lead to more balance or transparency. (20) As one noted commentator recently summarized, "proponents of bankruptcy a la carte (including financial institutions, hedge funds, private-equity funds, and their restructuring professionals) misappropriate value meant for a more diffuse group of stakeholders and capture it for themselves." (21)
This Article argues that these two issues are closely related: the underdevelopment of the DIP's fiduciary duties enables the abuses seen in modern chapter 11. I thus use this Article to frame those bankruptcy-specific fiduciary duties and then identify several common instances in which the DIP's board must act to meet those duties. The first Part synthesizes the prior literature, which the second Part uses as a springboard for a novel argument that directly links more active DIP boards to the current abuses that plague chapter 11. (22) That is, rather than abstractly stating that a DIP's board must follow the duties of care and loyalty, I identify specific steps that the board should contemplate to meet its duties.
This Article argues, for example, that the DIP's board should approach a takeover--whether by a pre-bankruptcy lender or by a group of funds that has acquired a majority position in the "fulcrum security"--just as it would outside of bankruptcy. Just as a "normal" corporation sometimes has an obligation to slow down a hostile bid to maximize value for shareholders, a DIP's board should consider objecting to credit bids, (23) or rejecting overly aggressive milestones, (24) or quick sales, even in situations where the debtor's management agreed to these pre-bankruptcy. That is, the DIP's board may often have a duty to reconsider what it did as a state-law board.
Of course, once it became clear that boards are adopting such a proactive approach to chapter 11, it would have knock-on effects on pre-bankruptcy negotiations. I argue that is a good thing to the extent it reduces the pressure on boards to agree to onerous deals on the eve of filing. And in bankruptcy, the expectation that boards will actively attempt to maximize the value of the estate--for all stakeholders--will move chapter 11 back toward a point of balance, which has been missing for at least a decade. (25)
This Article is thus the first to analyze the DIP's fiduciary duties from a perspective that integrates the literature on DIP corporate governance and broader corporate bankruptcy policy considerations. While the articles identifying problems with modern chapter 11 are legion, those offering solutions are rare.
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Part I sets forth a brief review of the current state of chapter 11. Restructuring support agreements, prepacks that are in and out of bankruptcy in less than 24 hours, and aggressive venue (and judge) shopping are all features of modern chapter 11. Restructuring support agreements (or RSAs) are particularly troublesome, inasmuch as they often seem to allow parties to "waive" key parts of the Bankruptcy Code. For example, some recent RSAs seem to be designed to evade the rule that all creditors within a class receive equal treatment. (26)
Part II of this Article then frames the DIP's fiduciary duties by reference to the comparable duties under Delaware corporate law. I argue that the DIP's duties are at least as wide-ranging as those, and the Delaware duties offer the advantage of extensive judicial explication. But the application of those duties is also an issue in chapter 11--and too often the issues of how the duties are applied, who can enforce them, and how the duties relate to the bankruptcy-specific remedial provisions of chapter 11 are neglected. For example, because Delaware law routinely immunizes directors from liability for breaching the duty of care, should chapter 11 do the same? These application issues are just as important as the framing of the fiduciary duties themselves.
Once the duties of a DIP's board are established, Part III of the Article then looks to how these duties could address the tribulations of modern chapter 11. As noted at the outset, the core of the DIP's fiduciary duties is the simple requirement that the board actively work to maximize the value of the estate. That means that the board may not negotiate a deal to sell the debtor-firm to the senior lenders simply because such a deal is "easy," and likewise it means that maximizing the returns to bondholders or those senior lenders is inconsistent with maximizing estate value as a whole. In short, the board must actively consider and reconsider all possible options in chapter 11.
And indeed, I ultimately conclude that if we take a DIP's fiduciary duties seriously, it could open a new, more dynamic role for boards in chapter 11 cases. In doing so, chapter 11 might well heal itself and preserve its continued utility in the American economy.
I. THE PROBLEMS WITH MODERN CHAPTER 11
Large corporations in theory can file for bankruptcy under either chapter 7 or chapter 11, but most file under chapter 11. (27) In chapter 7, the debtor's assets are all placed under the control of an independent, court-appointed trustee who liquidates the company and distributes the liquidation proceeds according to a fixed statutory order of distribution. (28) Chapter 11 is different. As two leading commentators have summarized:
In Chapter 11, the corporation's management operates its business under court supervision, filing various reports and appearing regularly in court. The procedure's goal is the adoption of a reorganization plan by a vote of the creditors organized by classes to reflect differing legal and economic interests. Creditors and other stakeholders get notice of important issues, legal and economic, and have an opportunity to object to whatever has been proposed. Shareholders are recognized as stakeholders in bankruptcy reorganization and fairly often emerge from the reorganization with an interest in the corporation, although frequently one of small value. The company's business is managed by existing management, which exercises the powers of the Debtor in Possession (DIP).... The supervising court is a specialized bankruptcy court within the structure of the federal district courts and exercises an exclusive federal jurisdiction over bankruptcy matters. Most cases are handled by members of a highly specialized bar. (29)
Following its enactment in 1978, and for at least the following decade, chapter 11 was both widely used and heavily criticized. According to critics, chapter 11 was too debtor-friendly and too slow:
Chapter 11 seemed to give too much control to the debtor's managers enabling them to stiff-arm creditors and drag out the bankruptcy cases for inordinate periods of time. Managers were playing with creditors' money, and large cases often lasted several years or more The worst offender was Eastern Airlines.... Although it was clear to...
