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Authors

Chanel Van Dyke

Abstract

This Note addresses the relatively recent phenomenon of springing guaranties, albeit only in the context of their effect on bankruptcy’s traditional reorganization process. As such, this Note targets springing guaranties triggered by bankruptcy-related events. Unfortunately, the threat of liability posed by such springing guaranties creates perverse incentives for the guarantor. This is problematic because lenders only employ springing guaranties if the guarantor is an insider of the borrower who has the capacity to wield significant decision-making authority. Although directors of a solvent corporation only owe fiduciary duties to shareholders, this obligation broadens to encompass creditors, as well as shareholders, as the corporate entity approaches insolvency. It is incumbent upon the directors to take a more holistic approach in making decisions so as to consider the welfare of the corporate entity as a whole, as opposed to merely the individual stakeholders. Once in bankruptcy, the debtor in possession (“DIP”) owes these duties to the estate, thus coming full circle in favor of the holistic approach. In contrast, the springing guaranty device encourages the insider-guarantor to make decisions based on an inverted approach. As the company approaches insolvency and all the signals indicating that it is time to authorize a bankruptcy align, the existence of the springing guaranty discourages the guarantor from adopting the holistic approach. Instead of paying heed to the signals and accordingly adopting the approach most likely to maximize the value of the corporate entity, the springing guaranty incentivizes the guarantor to adopt an individualistic approach that favors the guarantor’s own interests at the expense of the corporate entity’s interests. This manifests itself in the guarantor’s delayed authorization of a bankruptcy filing despite the fact that all objective indicators suggest that the guarantor should have timely authorized the filing. Eventually, the guarantor is left with no choice but to authorize the filing. However, at that point, the delay has taken its toll on the corporate debtor, so its prospects of undergoing a successful reorganization are substantially diminished. The springing guaranty device is the culprit behind the guarantor’s skewed decision-making process and the subsequently diminished viability of the borrower upon entering bankruptcy. For that reason, this Note takes the position that in appropriate cases, bankruptcy courts should invoke their equitable powers to enjoin the enforcement of detrimental springing guaranties.

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