The Fiduciary Duties in the “Zone of Insolvency”

Directors of healthcare organizations normally owe fiduciary duties to their shareholders or, in the case of nonprofits, to the charitable mission of the organization. As an organization descends to bankruptcy, however, the board’s duties may shift. At some point, the board may be imposed with different and often conflicting obligations to the corporate enterprise as a whole, with a primary criterion being the interests of creditors. In this article, the authors analyze the murky areas of the Zone and give guidance as to when the board’s duty may shift-and as to how directors should proceed both in determining their duties and in working to fulfill them.

The “Zone of Insolvency” (the Zone) is not the title of a B-grade science-fiction film; rather, it refers to an important but little-known concept of corporate law that may have a dramatic impact upon the manner in which healthcare corporate directors exercise their fiduciary obligations in situations of corporate financial distress.  During the time period a corporation is in the Zone, the duties and obligations of the corporation’s directors undergo a fundamental shift designed to benefit the corporate enterprise as a whole, and particularly to benefit the creditors.  This generally is referred to as the “Insolvency Exception” to the general duty-of-care standards applicable to individual board member conduct.

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