A directors duty to a corporation’s creditors

A directors duty to a corporations creditors Disclaimer: This work has been submitted by a student. This is not an example of the work produced by our Law Essay Writing Service . You can view samples of our professional work here . A directors duty to a corporation’s creditors Introduction In this chapter we will look at two related issues; how the somewhat nebulous duties discussed in the previous chapter operate to protect creditors interests and drawing on theoretical writing on corporate governance analyse the extent to which there is potential for conceptual and actual conflicts of interest. The issues that this dissertation attempts to answer are pertinent to the core of corporate governance and therefore I will initially attempt to outline a conceptual background to the debate within this chapter. Theories of Corporate Governance The legal framework within which the Corporation as a social entity operates is informed by a vast and at sometimes incomprehensible corpus of economic theory. An understanding of the role of the corporation will give us an understanding of the objective norm by which we are assessing our current legal rules that regulate the relationships of three of the major corpo rate constituents: Creditors, Shareholders and Directors. Boatright outlines in his introduction the importance of the modern conception of the corporation to corporate law: ‘ The modern theory of the firm, which is central to finance and corporate law, views the corporation as a nexus of contracts between the various corporate constituencies. Upon this foundation finance theory and corporate law postulate shareholder wealth as the objective of the firm ’ [1] A problematic issue for Corporate Law is that situations of Insolvency challenge the primacy of shareholder wealth maximisation in favour of creditor protection. It causes many scholars in the legal profession to go back to the roots of why ought corporations be shareholder wealth maximising? And furthermore why does it hold such ideological weight? Undoubtedly shareholders are one of the most important parties in the contractual nexus of a corporation; they provide ready capital, hold a claim on resi dual assets and bear the residual risk of corporate failure. However their integral role per se doesn’t justify their primacy in corporate law and theory. Boatright summarises the main argument for shareholder primacy: Only those who bear the residual risk are appropriate for making discretionary decisions as to wealth-maximisation. If employees, bondholders and perhaps creditors had control they would tend to favour decisions that maximise their fixed-claim, this could mean that less-profitable decisions would be taken. Even managers and directors will have separate agendas and avoid profitable ventures if it was likely to increase risk to them or reduce their power. Only shareholders that bear flexible and varying costs and benefits are in the position to make purely profit-maximising decisions. In a legal sense this special interest of the shareholders is protected through the operation of fiduciary duties to shareholders, such theories argue that no other part y in the corporate contractual nexus would benefit from the arrangement as much and therefore shareholders are more willing to pay for the privilege of having their interests protected whereas creditors and other parties would rather not have their interests tied as closely to the corporations performance as closely. A good example of the distinctive nature of shareholder and director relations can be viewed when we consider the contract of employment. An employee of a firm does not benefit from a fiduciary duty to maximise profits in various ways as such a duty could prejudice them in many ways such as reducing their pay and lengthening their hours. They would prefer a more fixed contractual relationship. The welfare of society is maximised through this corporate arrangement because it is viewed as the most efficient arrangement but by no means the only arrangement other examples can be employee-owned corporations and most pertinent to this dissertation the role of creditors intere sts. This work is looking at one aspect of the contractual nexus and whether the balance between shareholder and creditor interests is both ethical and practical. Interrelated into this task are other conceptual questions that we are forced to confront.