This week, Congress
will hold hearings on the big losses being racked up by the Big
Three automakers. The automakers, particularly General Motors, want
federal dollars to keep out of bankruptcy and, in order to secure
it, have been working overtime to scare lawmakers that the
consequences of denying them a bailout would be severe. As part of
that effort, Big Three representatives have stated repeatedly that
they have no other options and that bankruptcy, in particular, is
off the table. Some have implied that, if there is a bankruptcy, it
will be a Chapter 7 liquidation that results in the implosion of
much of the industry.
It may be, however,
that in trying to twist Congress's arm, the automakers have turned
their backs on their fiduciary duties under corporate law. Congress
should ask automaker executives who testify point-blank about their
legal duties, the state of their preparations for bankruptcy, and
what they plan to do if they are ultimately forced to file for
bankruptcy. These topics, more than any other line of inquiry, will
inform Congress and the public about a bailout's prospects to turn
the Big Three around, whether the automakers can be trusted with
the investment of taxpayer dollars, and whether bankruptcy-instead
of a bailout-would be a better option.
Duty to Creditors
A corporation's board
of directors, as well as its executives, owes a fiduciary duty to
the corporation's owners. This duty includes the duty of
loyalty-that is, to manage the corporation in the owners' interest
rather than their own. It is the duty of loyalty that prevents a
CEO from usurping a hot business prospect from his corporation for
his own profit and from looting a corporation outright.
Usually the owners of
a corporation are its shareholders, but not always. As a
corporation approaches insolvency-when its debts exceed its
assets-equity positions in it become diminished and then are wiped
out. In other words, shareholders have lost their bet on the
company, to borrow a phrase from scholar Frederick Tung. All that
is left are the creditors, whose interests will be directly
affected by any subsequent corporate actions. And when an insolvent
corporation goes through reorganization in bankruptcy, these
creditors usually become the new shareholders. At some point, then,
the corporation's leaders' fiduciary duties transfer from
shareholders to creditors.
being a part of corporate law, do vary by state, but the law in
Delaware, the corporate home of both General Motors and Ford, is
perfectly clear that once the corporation becomes insolvent,
directors owe a fiduciary duty to creditors even before the formal
commencement of bankruptcy proceedings. This has been reaffirmed in
case after case, putting corporate directors and executives on
notice of their obligations to creditors.
Bankruptcy "Not an Option"?
From their balance
sheets and market capitalizations, it is apparent that GM
(especially) and Ford are, at present, either insolvent or
careening inevitably toward that state. Their board and executives,
then, have or may soon have a legal duty to act in creditors'
This duty requires
that the corporations' leaders take reasonable steps to plan for
contingencies that may affect creditors' interests. The chief among
them is a bankruptcy filing. The bankruptcy process, after all,
exists to protect creditors' interests when a firm's debts exceed
its ability to pay all of them. And when a business has a high
"going-concern value"-that is, when it is worth more kept together
than broken up and liquidated-creditors are best served by a
reorganization under Chapter 11 of the Bankruptcy Code. There is
good reason to believe that GM and Ford are in this territory.
Turning around such
massive corporations, however, is complicated and time-consuming.
Under Chapter 11, the bankrupt business has just 18 months to put
together and win approval for a reorganization plan before the
gates are flung open and any party to the proceeding may put
forward a plan. If that
happens, bankruptcy could drag on for years, which is in no one's
interest except for the bankruptcy lawyers. This is why
most big corporations are already hard at work on a reorganization
plan well before they file for bankruptcy-18 months is just not
enough time to get it done and then accepted.
Yet leaders and
spokesmen of all of the Big Three have made it abundantly clear
that bankruptcy is "not an option that [they are] considering" for their
companies-as if they had that choice. Really, they
are trying to play a game of chicken with Congress, and raising the
stakes might make a taxpayer-funded bailout-which stands a good
chance of keeping automaker leaders safe and comfortable in their
executive suites-more likely. But if they delay on preparing for
bankruptcy, creditors' interests are placed at enormous risk-a
possible violation of directors' and executives' fiduciary
Questions for Congress
This week, Members of
Congress should ask those auto industry executives who testify
whether their corporations are currently preparing bankruptcy
filings and reorganization plans. If the corporations are not,
lawmakers should inquire into why this is so and seek to determine
whether this failure constitutes a breach of the duties owed to
creditors. After all, Congress could not possibly entrust billions
in taxpayer dollars with executives who are simply ignoring their
duties to those who have lent them money in the past.
And if the automakers
are preparing filings, they should apologize for misleading the
public and Congress in recent weeks, and Congress should inquire
into the contents of their plans. Specifically, if the automakers
are really planning Chapter 7 liquidation (as their representatives
are rumored to have threatened to congressional leaders), the
public should be made aware of the fact that even the automakers'
executives, with their deep insider knowledge, have determined that
their businesses are worth more broken up than kept together, a
conclusion that should call into question the likelihood that a
bailout would have any positive effect. Chapter 7 would be an
admission by the automakers, then, that a taxpayer bailout would
merely prolong economically unsound businesses.
However, it is more
likely, despite the threats and bluster, that the automakers are
actually contemplating Chapter 11 reorganization at this moment,
and on this point, Congress ought to call their bluff. Since the
automakers are seeking federal dollars, their reorganization plans,
in whatever stage of development they are in, as well as any
supporting documents, should be shared with the public-much as a
corporation might share its plans with a potential
debtor-in-possession financer prior to actually filing bankruptcy.
Just as with such private funding, if public money is going to be
invested in the auto industry, the public deserves to know what the
automakers believe is the best way to spend that money.
No less important
would be how the plans resolve the automakers' high cost of labor,
top-heavy bureaucracies, excess of nameplates, and unwieldy
dealership networks. In all likelihood, any reorganization would
rely upon the special powers under bankruptcy law to escape from
untenable contracts and reshape their labor and dealer
relationships. A bailout that does not include powers that would be
exercised in a reorganization plan, however, would be insufficient
to meet the challenges facing the industry and thus unlikely to
succeed. Passing a bailout without at least this kind of
information would be the height of irresponsibility.
More Details Required
Corporations do not
exist for the aggrandizement and enrichment of their leaders but
for the benefit of their owners. This basic premise of corporate
law provides a yardstick against which to measure certain major
corporate decisions and to determine whether corporate leaders are
acting in the corporation's interest, as they are required to do,
or in their own.
Under this fiduciary
duty, the executives of insolvent corporations may be required to
explore bankruptcy as an option and to begin the long, difficult
task of putting together a filing and reorganization plan. This
process, more so than any press release or statement by an
executive, reveals facts essential to the decision to invest in
that corporation, which is why private investors demand access to
the details of a bankruptcy before lending their money to an
insolvent business. For Congress to be a wise steward of the public
purse and responsibly evaluate the need for a bailout, it requires
an unvarnished account of these corporations' prospects. Only
direct questioning of executives about their bankruptcy planning is
likely to yield the sort of information that Congress needs to make
the right decision.
M. Grossman is Senior Legal Policy Analyst in the Center for
Legal and Judicial Studies at The Heritage Foundation.