The nonprofit sector is an enormous contributor to the American economy, providing 5.5 percent of the nation’s GDP and employing 13.7 million people. Just like for-profit corporations, nonprofits can be susceptible to financial problems and insolvency, and may ultimately seek protection under the Bankruptcy Code (although, unlike for-profit corporations, nonprofits cannot be forced into bankruptcy involuntarily). While there is ample guidance for nonprofit directors regarding their fiduciary duties generally, very little has been written about the duties of directors of insolvent nonprofit corporations.
It is well settled that the duties of officers and directors emanate from state law. Directors are stewards charged with balancing risk and furthering the purpose of the enterprise. The purpose of a for-profit corporation is to enhance the value of the enterprise for the benefit of residual interest-holders, ordinarily the owners of the enterprise. The purpose of a nonprofit corporation is to further the stated mission of the enterprise, rather than to generate wealth for stakeholders.
Some nonprofits have members (nonprofit membership organizations) and some do not (non-member not-for-profit organizations). While in some respects the members of a nonprofit membership organization are like shareholders of a for-profit corporation, in that they elect a board of directors, membership interests in a nonprofit, unlike shares in a for-profit corporation, represent a controlling rather than an economic stake in the enterprise. They cannot be transferred for value like shares of for-profit corporations, and often do not even entitle members to a share of the residual value of the enterprise upon dissolution.
The members of a nonprofit membership organization periodically elect a board of directors, which is ultimately responsible for the operation of the enterprise and the fulfillment of its mission. The boards of non-member not-for-profit corporations are self-selecting and self-perpetuating. The mission of a nonprofit membership organization may either be to advance a charitable or public purpose—as in the case of a nonprofit hospital system, a nonprofit theater, National Public Radio (NPR) or Public Broadcasting Services (PBS)—or to benefit the members of the nonprofit—as in the case of a rural electrical cooperative, a local food cooperative, a university club, a country club, or a professional sports association, such as the National Football League (NFL), Major League Baseball (MLB), and the Professional Golfers’ Association (PGA). The mission of a non-member not-for-profit will be to advance a particular charitable or public purpose.
When a for-profit corporation becomes insolvent, the directors continue to be obligated to preserve (and, if possible, enhance) the value of the enterprise, although the beneficiaries of this obligation shift from the owners to the creditors of the company. Similarly, when a nonprofit corporation becomes insolvent, the directors remain obligated to fulfill their fiduciary obligations as delineated under state law (i.e., to advance the stated mission of the enterprise). While in either case, state law, rather than federal bankruptcy law, will continue to govern a director’s fiduciary duties in a bankruptcy proceeding, a bankruptcy filing will require a board to navigate an entirely new statutory framework while discharging its fiduciary obligations.
In some respects, a bankruptcy filing will shift the landscape to provide greater power to creditors. For example, in a bankruptcy case a debtor will be required to provide a greater level of transparency regarding its financial condition and operations than is ordinarily required. Soon after the filing of a chapter 11 case, a representative of the Office of the United States Trustee (a branch of the Department of Justice) will solicit indications of interest from unsecured creditors in forming an official committee. If a sufficient level of interest is shown, a committee will be formed, which may retain legal and financial professionals at the debtor’s expense and will act as the creditors’ watchdog in the chapter 11 process. During bankruptcy, a debtor will be required to seek court approval, after providing creditors with notice and the opportunity to object, before taking any action that is not in the debtor’s ordinary course of business. Bankruptcy will also provide creditors with remedies for addressing director malfeasance that are not ordinarily available, such as replacing the debtor-in-possession with a trustee or examiner, subordinating a director’s claim under section 510(c), converting the case to chapter 7 (if the debtor is not a farmer or a nonprofit), and objecting to plan confirmation on the basis of improper enrichment of directors.
In other respects, a bankruptcy filing shifts the landscape to provide directors with greater power to deal with recalcitrant creditors. For example, bankruptcy can be used to force a restructuring over a group of holdouts, and a debtor may even strip a creditor of its right to vote on a proposed plan as a consequence of the creditor’s conduct during the chapter 11 case by “designating” or disqualifying that creditor’s vote.
Fiduciary Duties of For-Profit Corporate Boards
The goal of the board of a for-profit corporation is to maximize the value of the enterprise (without subjecting the enterprise to unreasonable risk). Under state law, directors of a corporation generally owe a fiduciary duty to the corporation, including, among other things, to maximize its value. 
As set forth in Torch Liquidating Trust ex rel. Bridge Associates L.L.C. v. Stockstill, 561 F.3d 377 (5th Cir. 2009), when a corporation is solvent, the shareholders are the beneficiaries of the corporation’s growth and increased value and have standing to bring actions against directors on the company’s behalf asserting a claim for breach of the directors’ duties to the corporation. When the corporation is insolvent, however, the creditors take the place of the shareholders as the holders of the residual interest in the enterprise, and thus acquire standing to bring derivative actions on behalf of the company. The derivative suit is a powerful weapon for enforcing directors’ fiduciary duties under state law and challenging corporate mismanagement.
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