Meaning
Fiduciary obligations shift from shareholders to the general body of creditors when a corporation faces financial distress. This insolvency duty requires directors to prioritize the interests of those to whom the company owes money. It arises before a formal bankruptcy filing occurs, typically when insolvency is probable.
The duty prevents the board from taking excessive risks with assets that now effectively belong to the creditors.
Priority Transition
Management must stop acting solely for the benefit of equity holders. The transition of insolvency duty marks a change in the legal standard for every business decision. Actions that might have been acceptable during profitable times become breaches of law in a distressed context.
Conduct Assessment
Liquidators review past transactions to see if the interests of the creditors were ignored. Assessment of insolvency duty involves checking for unfair preferences or the sale of assets at an undervalue. Directors who fail this test face personal liability for the resulting losses.
Legal Liability
Courts can order individuals to pay damages if they breached their obligations during the decline. This liability for insolvency duty is a powerful tool for recovering funds in a liquidation. It ensures that those in control of the company remain accountable for their stewardship during the final months of operation.
