The Attorney’s Role in Advising Business Debtors on Alternatives to Bankruptcy
For more information, see §6.2 of Mazyar M. Hedayat, Ch. 6, Advising Business Debtors: Alternatives to Bankruptcy, BUSINESS BANKRUPTCY PRACTICE (IICLE®, 2026)
The role of legal counsel in guiding a financially distressed business through nonbankruptcy alternatives is both critical and complex. Business clients often arrive at this juncture under immense pressure — from creditors, lenders, stakeholders, and even family members — to resolve urgent financial crises. Emotions can run high, and decisions must often be made under duress, increasing the risk of missteps.
In such scenarios, counsel must carefully delineate their responsibilities. It is not the attorney’s role to make operational decisions — such as which divisions to shut down, which projects to abandon, or how to revise the company’s marketing or pricing strategies. These are fundamentally business judgments. However, the attorney plays a vital role in helping the client identify and evaluate the legal strategies and restructuring options available to support and achieve the client’s broader business objectives.
To do this effectively, the attorney must first identify who the client is — a critical step when the business is closely held or when ownership and management are not the same. Counsel must then assess how the client’s interests align with, or diverge from, those of other key constituencies, including creditors, shareholders, suppliers, and employees.
Credibility and competence are essential. The attorney must gain the trust of ownership and management in order to ask the difficult but necessary questions that test the client’s assumptions, challenge unrealistic expectations, and provide a sober assessment of legal risk. Counsel must not be afraid to probe deeply or to disrupt internal narratives that may be clouded by wishful thinking or denial.
In the case of closely held businesses, owners are often reluctant to acknowledge the severity of the situation. They may be emotionally and financially invested, and resistant to ceding control or admitting failure. While it is not the attorney’s job to force existential decisions, effective representation requires ensuring that ownership or management seriously confront the following threshold questions when considering reorganization or other nonbankruptcy paths:
a. Have all of the underlying problems giving rise to the financial difficulty been identified?
b. Can the company’s problems be fixed?
c. Does ownership or management have the will to fix the problems and complete the process?
d. What will it cost to complete the process?
e. Does the company have the resources to solve the problems in terms of capital and personnel?
f. Does the company have the time necessary to fix its problems?
g. Is ownership willing to invest capital to salvage the company and on what terms?
h. Will key suppliers and customers cooperate in the process?
i. Will key employees stay the course or jump ship?
j. Will major lenders and other creditors cooperate in the process?
k. Do current economic conditions and trends make a reorganization feasible?
These questions cannot be asked or answered in a vacuum. Rather, they must be considered in the context of many factors, including the following:
a. the nature and severity of the company’s financial difficulties;
b. the length of time that the company has been experiencing financial problems;
c. the company’s current relationship with its creditors, suppliers, lenders, and employees;
d. the nature and seasonality of the client’s business;
e. current and projected general economic conditions;
f. the company’s capital structure;
g. the number of creditors and the amount of various types of debt the company has;
h. what, if any, tax benefits can be preserved or obtained (e.g., the retention and use of loss carrybacks and carryforwards);
i. current ownership’s willingness and ability to inject capital;
j. the availability of outside investors to inject capital;
k. the apparent willingness, if any, of major individual creditors or general creditor classes either to compromise their claims or to extend payment terms on a consensual basis; and
l. ownership’s or management’s mental toughness and willingness to go through the reorganization process, which can be adversarial, expensive, uncertain of outcome, and frustrating.
The answers to these hard questions may be strongly influenced by the alternative strategies that the attorney presents for the client’s consideration and the cost, benefits, and risks each strategy entails.
It should be clear that a client’s initial response to everyday financial distress may have a significant impact on its future viability. For example, in response to cash shortages, the client may decide to slow down payments to vendors in an attempt to catch up, essentially using trade creditors to finance the company’s short-term operations. While these tactics may succeed at getting the distressed company back on track, these quick fixes often have a snowball effect on the business. Vendors who are not being promptly paid may shorten terms on future sales or switch to cash-on-delivery payments, thereby further stressing operations. Collection calls may intensify, credit may be cut off, and lawsuits may be filed. As a result, cash becomes tighter, and what was the company’s minor problem is now much more significant.
An attorney should also advise a company’s directors about how their typical fiduciary duties may shift upon a company’s insolvency. Specifically, directors’ fiduciary duties may extend to creditors as a group rather than individual creditors. This principle is supported by the Delaware Supreme Court’s decision in North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007), which held that creditors of an insolvent corporation have standing to bring derivative claims on behalf of the corporation but cannot pursue direct claims for breach of fiduciary duties against directors. See also Caulfield v. Packer Group, Inc., 2016 IL App (1st) 151558, 56 N.E.3d 509, 404 Ill.Dec. 525.
Illinois courts have similarly recognized that directors and officers owe fiduciary duties to creditors upon insolvency. For instance, in Technic Engineering, Ltd. v. Basic Envirotech, Inc., 53 F.Supp.2d 1007 (N.D.Ill. 1999), the court noted that once a corporation becomes insolvent, its assets are deemed to be held in trust for the benefit of creditors, and directors occupy a fiduciary relationship toward them. Additionally, Prime Leasing v. Kendig, 332 Ill.App.3d 300, 773 N.E.2d 84, 265 Ill.Dec. 722 (1st Dist. 2002), clarified that fiduciary duties in insolvency run to creditors as a group and not to individual creditors, aligning with the derivative nature of such claims.
The Bankruptcy Court for the Northern District of Illinois explicitly adopted the reasoning in Gheewalla, supra, concluding that the Illinois Supreme Court would likely agree that individual creditors cannot directly sue directors for breach of fiduciary duty. The court emphasized that allowing such direct claims could create conflicts of interest and undermine directors’ ability to negotiate effectively during insolvency. See Soverino v. Netzel (In re Netzel), 442 B.R. 896 (Bankr. N.D.Ill. 2011).
Similarly, in RMB Fasteners, Ltd. v. Heads & Threads International, No. 11 CV 02071, 2012 WL 401490 (N.D.Ill. Feb. 7, 2012), the court noted that the Illinois Supreme Court has not directly addressed this issue but predicted, based on Gheewalla and related Illinois precedent, that individual creditors lack standing to bring direct fiduciary-duty claims. The court highlighted that Illinois courts often look to Delaware law for guidance on corporate law issues, further reinforcing the applicability of Gheewalla’s principles in Illinois.
Additionally, Illinois appellate courts have aligned with this reasoning. In Caulfield, supra, the court reiterated that creditors of insolvent corporations could bring derivative claims but not direct claims for breach of fiduciary duty, citing Gheewalla as persuasive authority. The court emphasized that fiduciary duties owed by directors extend to creditors only in the context of derivative claims, not direct actions.
If the insolvent client is a limited liability company (LLC), however, even derivative claims by creditors may be barred. In CML V, LLC v. Bax, 28 A.3d 1037 (Del. 2011), the creditor of an LLC brought several derivative claims against the LLC’s present and former managers for breaching the duties of care and loyalty and acting in bad faith. The vice chancellor dismissed the claims for lack of standing, and the Supreme Court of Delaware affirmed. The court based its ruling on the definition of “proper plaintiff” in the Delaware Limited Liability Company Act, which provides that “a proper derivative action plaintiff ‘must be a member or an assignee of a limited liability company interest.’ ” [Emphasis omitted.] 28 A.3d at 1041, quoting Del. Code Ann. tit. 6, §18-1002. Because the statute was unambiguous, “[o]nly LLC members or assignees of LLC interests have derivative standing to sue on behalf of an LLC — creditors do not.” 28 A.3d at 1043.
Although Bax plainly bars derivative claims by creditors against Delaware LLCs, it is less clear whether the holding applies to Illinois LLCs. The definition of “proper plaintiff” in the Illinois Limited Liability Company Act (LLCA), 805 ILCS 180/1-1, et seq., is slightly different than its Delaware counterpart:
No action shall be brought in the right of a limited liability company by a member or transferee who is a substituted member, unless (i) the plaintiff was a member or is a transferee who was a substituted member at the time of the transaction of which the person complains or (ii) the person’s status as a member or a transferee who is a substituted member had devolved upon him or her by operation of law or under the terms of the operating agreement from a person who was a member or a transferee who was a substituted member at the time of the transaction. 805 ILCS 180/40-5.
Thus, the LLCA imposes certain conditions on the ability of members or “transferees” to bring derivative claims. Unlike the Delaware statute, however, the LLCA’s definition of “proper plaintiff” never states that a derivative action plaintiff “must” be a member or transferee. Thus, it seems plausible that a court could distinguish Bax and hold that a creditor of an Illinois LLC has standing to bring a derivative, insolvency-based breach-of-fiduciary-duty claim against the LLC’s management. There are no reported Illinois authorities on this issue.