Academic journal article SAM Advanced Management Journal

Resuscitating the Comatose Firm: Changing Management Responsibilities under Chapter 11

Academic journal article SAM Advanced Management Journal

Resuscitating the Comatose Firm: Changing Management Responsibilities under Chapter 11

Article excerpt

Several articles on management under bankruptcy have appeared in the management literature concerned with issues of "image"|1~ and the characteristics of firms most likely to go bankrupt.|2,3,4~ This paper contributes to that literature by specifying some of the operational and strategic implications of operating under bankruptcy, particularly under Chapter 11, which allows protection from creditors of the firm.

A corporation that files for Chapter 11 is usually laden with debt and starved for cash. Under Chapter 11, creditors are barred from pursuing the debtor pending a bankruptcy court's approval of a plan for restructuring the corporation's debts.|5~ Restructuring means determining the order in which creditors will be paid, how much each creditor will be paid, and the time period over which each creditor will be paid.

A corporation's attempt to reorganize by filing for Chapter 11 bankruptcy creates an instantaneous change in the obligations of management. The duty of management to make decisions in the best interests of its shareholders is overruled. Instead, bankruptcy law requires management to give paramount importance to the interests of the corporation's unsecured creditors, followed in importance by the other creditors. Management is required, in essence, to disregard the shareholders' interests.|6~

This change in management's obligations springs from an iron-clad rule: In return for the protection of Chapter 11, the corporation must sever its attachment to its shareholders and devote itself to its creditors.

This rule is implemented in several ways. One method is the imposition of a new standard of conduct for officers and directors. Another is the requirement that many "normal" corporate business decisions be pre-approved by the bankruptcy court, which protects the interests of unsecured creditors.

A third method of implementing the rule is a severe restriction on the power of a reorganizing Chapter 11 corporation to give its shareholders anything of value for their shares until it completely pays the claims of unsecured creditors.|7~ This means that shareholders (whose shares in the bankrupt corporation are usually canceled) can expect to lose most or all of their investment.

The first two methods of implementing the rule favoring creditors have the greatest impact on the day-to-day work of officers and directors. These two methods (a new rule of conduct for officers and directors and court supervision of business decisions) are discussed here in more detail, followed by a look at the impact on officers and directors.

New Rule of Conduct for Officers and Directors

The new rule of conduct takes effect at the corporation's bankruptcy filing and is as follows: All management decisions must be made for the benefit of the corporation's creditors and meet the "fiduciary duty" standard of conduct. This standard of conduct exceeds the ethical standard by which officers and directors are normally judged.

The normal ethical standard of conduct for officers and directors outside bankruptcy is the "business judgment" standard. This means that an officer or director cannot enrich himself personally at the corporation's expense. For example, he cannot obtain a loan from the corporation which he has no intention of repaying, cause the corporation to trade with a profit-making company he owns at non-market prices, or steal a business opportunity from the corporation for personal profit. However, the officer or director is normally free to make wrong business decisions in good faith without fear of liability. During a Chapter 11 bankruptcy, however, the "business judgment" rule for officers and directors is replaced by the stricter "fiduciary" rule.|8~ The fiduciary rule implies a high degree of good faith and competence by the officers and directors, who are said to hold a great trust. The fiduciary standard is exemplified, in another arena, by the high ethics and competence required from a bank serving as trustee for a half-million dollar trust. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.