Corporate Governance Issues for the Financially Troubled Company

01/01/2003

INTRODUCTION

Bankruptcy in the United States is a matter of federal law.  Corporate governance matters, however, generally are controlled by state law.  Although federal laws preempt conflicting state laws, in most cases federal and state laws are interpreted and applied to eliminate conflicts so that no preemption occurs.

Bankruptcy is an excellent example of federal and state coordination.  The federal bankruptcy statute governs the bankruptcy process with respect to debtors and creditors in the federal bankruptcy courts.  The applicable state corporation statute governs the bankrupt corporation’s internal corporate affairs.  The discussion that follows reviews certain basic principles of corporate governance, including the duties owed by directors and officers to the creditors of financially troubled and bankrupt corporations, with particular attention on transactions involving a change of corporate control.  This outline generally does not differentiate between the duties and liabilities of officers and directors, but rather considers them as a group for purposes of corporate governance issues.  Because of the popularity of Delaware as a state of incorporation, with the result that a large percentage of both public and private corporations are incorporated in Delaware, and because Delaware has the most well-developed case law concerning corporations, Delaware corporation law is used as the primary state law reference.

The following discussion also concerns issues that may arise in connection with the insolvency of limited liability companies and limited liability partnerships.  In addition, it addresses certain ethical issues that may confront attorneys advising insolvent and bankrupt entities.  Finally, it focuses on the Sarbanes-Oxley Act of 2002, which has given rise to interpretive questions and issues relevant to corporate and bankruptcy practitioners.

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