Ann Lipton has a long blog post about Judge Rakoff’s decision in In re Nine West LBO Securities Litigation, 2020 WL 7090277 (S.D.N.Y. Dec. 4, 2020). She explains:
The short version is that Nine West was taken private in a leveraged buyout by Sycamore; as part of the deal, allegedly the Sycamore buyers caused the company to sell the profitable subsidiaries to its own affiliates for less than they were worth, and the whole thing ended in Nine West’s bankruptcy. In the wake of all of this, the debtholders (many of whom held debt that predated the sale), via the litigation trustee, sued Nine West’s former directors – the ones who had approved the sale – for violating their fiduciary duties by negotiating a deal that would result in the company’s bankruptcy. Last year, Judge Rakoff refused to dismiss the claims, in a decision that spawned a thousand law firm updates about directors’ duties when selling the company.
Professor Lipton then observes that "what I find interesting is how little anyone – including Judge Rakoff – seems to have interrogated the legal question of to whom the directors’ fiduciary duties were owed." She then launches into a very thoughtful and insightful analysis of that question. It's a highly recommended read.
I also wrote about that issue in my article Much Ado about Little? Directors' Fiduciary Duties in the Vicinity of Insolvency, 1 J. Bus. & Tech. L. 335 (2006-2007), available at: https://digitalcommons.law.umaryland.edu/jbtl/vol1/iss2/7, in which I argued that:
The insistence that the firm is a real entity is a form of reification—i.e., treating an abstraction as if it has material existence. Reification is often useful, or even necessary, because it permits us to utilize a form of shorthand—it is easier to say General Motors did so and so than to attempt in conversation to describe the complex process that actually may have taken place. Indeed, it is very difficult to think about large firms without reifying them. Reification, however, can be dangerous. It becomes easy to lose sight of the fact that firms do not do things, people do things.
In other words, the corporation is not a thing to which duties to can be owed, except as a useful legal fiction. The distinction between direct and derivative shareholder litigation is one area in which that fiction long has been thought useful. This article is not the appropriate forum for determining whether distinguishing between direct and derivative litigation continues to make sense. Having said that, however, it nevertheless seems useful to note the implications of contractarian theory for Credit Lyonnais’ notion that the duties of directors of companies in the vicinity of insolvency run to the entity.
At the outset, we must acknowledge that while the contractarian approach of treating the corporation as a nexus of contracts is an improvement on entity-based conceptions, it too is somewhat misleading. After all, to say that the firm is a nexus is to imply the existence of a core or kernel capable of contracting. But kernels do not contract—people do. In other words, it does us no good to avoid reifying the firm by reifying the nexus at the center of the firm. Hence, it is perhaps best to understand the corporation as having a nexus of contracts.
If the corporation has a nexus, where is it located? The Delaware code, like the corporate law of every other state, gives us a clear answer: the corporation’s “business and affairs . . . shall be managed by or under the direction of the board of directors.” Put simply, the board of directors is the nexus of a set of contracts with various constituencies that the law collectively treats as a legal fiction called the corporation. [I developed this argument at length in The Board of Directors as Nexus of Contracts, 88 Iowa L. Rev. 1 (2002).]
As such, it simply makes no sense to think of the board of directors as owing fiduciary duties to the corporate entity. Indeed, since the legal fiction we call the corporate entity is really just a vehicle by which the board of directors hires factors of production, it is akin to saying that the board owes duties to itself.
Professor Lipton went on to observe that "Nine West is, then, a real-world example of the “two masters” problem that is frequently used to justify shareholder primacy."
My Zone of Insolvency article discussed the two masters problem, as Professor Andrew Gold has explained:
When you are dealing with insolvency, with a zone of insolvency, you have what Professor Bainbridge has called a two-master problem.' If boards are supposed to look out for shareholders and also supposed to look out for creditors, they are in a very awkward spot because, whichever side they choose, they may end up, if they favor one side, being sued by the other side. And so, as you go into this area of insolvency and as you end up with potentially conflicting fiduciary duties, the business judgment rule becomes especially important.
