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A Breach of Trust

Posted By Conn Carroll On November 18, 2008 @ 9:50 am In Economics | Comments Disabled

This week the executives of the Big Three auto makers are expected to testify on Capitol Hill. As Heritage Senior Legal Analyst Andrew Grossman points out [1], these industry titans may have breached their fiduciary duties by relying solely on Congress to bail them out:

A corporation’s board of directors, as well as its executives, owes a fiduciary duty to the corporation’s owners. This duty includes the duty of loyalty—that is, to manage the corporation in the owners’ interest rather than their own. … Usually the owners of a corporation are its shareholders, but not always. As a corporation approaches insolvency—when its debts exceed its assets—equity positions in it become diminished and then are wiped out. All that is left are the creditors, whose interests will be directly affected by any subsequent corporate actions. And when an insolvent corporation goes through reorganization in bankruptcy, these creditors usually become the new shareholders. At some point, then, the corporation’s leaders’ fiduciary duties transfer from shareholders to creditors.

Fiduciary duties, being a part of corporate law, do vary by state, but the law in Delaware, the corporate home of both General Motors and Ford, is perfectly clear that once the corporation becomes insolvent, directors owe a fiduciary duty to creditors even before the formal commencement of bankruptcy proceedings.

This duty requires that the corporations’ leaders take reasonable steps to plan for contingencies that may affect creditors’ interests. The chief among them is a bankruptcy filing. The bankruptcy process, after all, exists to protect creditors’ interests when a firm’s debts exceed its ability to pay all of them. And when a business has a high “going-concern value”—that is, when it is worth more kept together than broken up and liquidated—creditors are best served by a reorganization under Chapter 11 of the Bankruptcy Code. There is good reason to believe that GM and Ford are in this territory.

Turning around such massive corporations, however, is complicated and time-consuming. … This is why most big corporations are already hard at work on a reorganization plan well before they file for bankruptcy—18 months is just not enough time to get it done and then accepted.

Yet leaders and spokesmen of all of the Big Three have made it abundantly clear that bankruptcy is “not an option that [they are] considering [2]” for their companies—as if they had that choice. Really, they are trying to play a game of chicken with Congress, and raising the stakes might make a taxpayer-funded bailout—which stands a good chance of keeping automaker leaders safe and comfortable in their executive suites—more likely. But if they delay on preparing for bankruptcy, creditors’ interests are placed at enormous risk—a possible violation of directors’ and executives’ fiduciary duties.

This week, Members of Congress should ask those auto industry executives who testify whether their corporations are currently preparing bankruptcy filings and reorganization plans. If the corporations are not, lawmakers should inquire into why this is so and seek to determine whether this failure constitutes a breach of the duties owed to creditors. After all, Congress could not possibly entrust billions in taxpayer dollars with executives who are simply ignoring their duties to those who have lent them money in the past.


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URL to article: http://blog.heritage.org/2008/11/18/a-breach-of-trust/

URLs in this post:

[1] points out: http://www.heritage.org/Research/Economy/wm2134.cfm

[2] not an option that [they are] considering: http://www.reuters.com/article/businessNews/idUSTRE49953V20081010

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