By Professor Robert W. Miller (University of South Dakota, Knudson School of Law)
The proliferation of bankruptcy directors represents a controversial shift in the corporate governance landscape. Delegating corporate decision-making to bankruptcy directors insulates conflicted transactions and claims from the traditional protections provided by derivative standing and entire fairness. Critics, however, have questioned their independence and cleansing effect. Are bankruptcy directors really independent when their role includes negotiation with and/or investigation into the same parties who appoint them? Should their decisions be given deference when their appointments are associated with lower recoveries for creditors? Bankruptcy directors’ salience is best illustrated by the numerous proposals made for evaluating their cleansing effect, including Professors Ellias, Kamar, and Kastiel’s ground-breaking study. None of these suggestions, however, reflect the history of bankruptcy case control, the development of safeguards covering conflicted corporate governance in bankruptcy, and the realities of bankruptcy case administration.
This article applies historical and practical lessons to explain why bankruptcy courts should apply the entire fairness standard to evaluate whether bankruptcy directors have cleansing effect. The proposal operationalizes the fair process and fair selection required by entire fairness through (i) a standardized protocol promoting the disclosure of connections between bankruptcy directors and insiders who appoint them (ii) a heightened burden for approval reflecting the structural bias endemic to bankruptcy directors’ relationship with the insiders.
This article’s main contribution is to examine the debate over bankruptcy directors through the lens of bankruptcy law’s historic struggles with conflicted corporate governance, informed by two recent cases that emphasize the need for a formal practice and show how this article’s proposal could be applied. This article’s framework for analyzing bankruptcy directors is rooted in the fact that while bankruptcy directors are new, the policy stakes here are not. By tracing the history of case control and the treatment of conflicted transactions, the lessons gleaned from past practice can be operationalized within the current statutory framework while accounting for the impact of contemporary capital structures.
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