Managers' Fiduciary Duty Upon the Firm's Insolvency: Accounting for Performance Creditors

Corporate managers generally owe a fiduciary duty exclusively to shareholders --a duty interpreted as requiring the managers to maximize shareholder value. When the firm is solvent, the duty to maximize shareholder value tends to give managers an incentive to act efficiently that is, in a way that increases total value. But when the firm is insolvent, this duty might give managers an incentive to run the firm in a way that reduces the value of debt more than it increases the value of equity and, therefore, is inefficient. The leading view among corporate law scholars is that an insolvent firm's managers should therefore maximize the sum of the values of all financial claims both those held by shareholders and those held by creditors against the firm. This Article points out a previously unrecognized problem with this "financial value maximization" ("FVM") approach. What FVM proponents have overlooked is that an insolvent firm is likely to have two types of creditors: (1) "'payment creditors" parties owed cash, who hold financial claims against the firm; and (2) "performance creditors" parties owed contractual performance, who hold claims for performance against the firm. The FVM approach requires managers to take into account the effect of their actions on one type of creditor payment creditors but not on the other performance creditors. We show that FVM's failure to account for performance creditors might cause an insolvent firm's managers to act in a way that harms performance creditors more than it benefits those with financial claims against the firm and, therefore, is inefficient. Our analysis indicates that an insolvent firm's managers should be obligated to maximize the sum of the values of all claims against the firm, both claims for cash and claims for performance. This approach, we show, would eliminate the distortions associated with the FVM approach and actually make shareholders better off ex ante.