Title: Directors' Negligence Liability to Creditors: A Comparative and Critical View
Abstract: I. INTRODUCTION The imposition of liability on corporate directors is one of the primary solutions offered by company law to the problem. This problem ensues from the separation between ownership and control, one of the main characteristics of the modern corporation. In large corporations, shareholders do not actually manage the business of the corporation. Directors and officers, who are not necessarily equity holders of the corporation, oversee the day-to-day business of a corporation. Even when corporate directors and officers are also shareholders, the percentage of their holdings is relatively low compared to the total equity of the corporation, and the agency problem applies to them as well. The imposition of liability on corporate directors is therefore intended to serve two main purposes: (1) deter directors from making improper use of the powers conferred upon them, and (2) compensate the corporation for damage caused by a breach of the directors' duties. Even in small corporations controlled by few people simultaneously holding shares and acting as directors, these two purposes are relevant. Directors, even when they are shareholders in the corporation, are capable of acting upon whim, on occasion preferring their own interests to those of the creditors of the corporation. They may also refrain from taking precautions when conducting the business of the corporation. The basic principles of the separate legal personality of the corporation and the limited liability of its shareholders may place the creditors of the corporation in an impossible situation. Out of concern for the creditors, it is also appropriate to impose liability upon directors in such small, private corporations. The imposition of liability on corporate directors in a closely held corporation serves the two purposes mentioned above: deterring improper conduct and compensating the corporation for damage caused to it. Compensating the corporation may place the creditors in the position they would have been in had there been no breach of duty. There are those who believe that while there is need for a normative determination of liability for breach of fiduciary duties, no such need exists regarding breach of the duty of care.1 According to this view, market forces will ensure that the duty of care is met in the most efficient way. Where the director controls the capital of the corporation, he has a direct personal interest in the economic success of the enterprise. In the other cases, there are a number of market forces that can provide an incentive to the directors to uphold the proper duty of care: the corporate control market, the labor market, and directors' benefits. A. Corporate Control Market Directors who cause losses to the corporation as a result of their negligence are likely to lose their posts. Their negligence may cause disgruntled shareholders to replace them or make the corporation an easy target for a take-over. The end result in both scenarios is the same: the corporate control market will force out negligent directors. B. Labor Market The success of the director is measured by the profitability of the corporation. Negligent management impairing the profits of the corporation also damages the reputation of the corporate director. Consequently, his chances of obtaining office in the future, as well as his salary level, will be damaged by his negligence. C. Directors' Benefits In many cases, corporate directors are remunerated in accordance with the profitability of the corporation. This remuneration can be expressed by setting the salary, even if only partially, in accordance with the profits of the corporation, and by the award of options to directors. The directors therefore have a strong incentive to act carefully to increase the profitability of the corporation. According to this market-driven approach, these market forces suffice to achieve the goal of deterrence, and are less costly than the institution of a legal claim. …
Publication Year: 2001
Publication Date: 2001-01-01
Language: en
Type: article
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Cited By Count: 7
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