When a business struggles, its officers and directors often look for ways to slow the company’s cash outflows. This may result in businesses paying vendors outside of the terms of their contracts or not paying vendors at all for the goods and services rendered. Yet, to keep a business running, these same officers and directors may continue to order new products from existing vendors or enter into new contracts with new vendors without alerting them to the financial difficulties that their company is facing.

This scenario is not all that unusual, but it raises ethical and legal questions particularly when the business enters the arena of financial insolvency. For instance, an executive may be tempted to pay one vendor instead of another. The executive may also decide to enter into a new purchase agreement for goods or services even though the executive knows, or should know, that the company will not be able to pay, or at the least, pay under the terms of the agreement.

This conduct could be problematic because in many jurisdictions, when a company becomes insolvent, the fiduciary duty owed by the corporate officers and directors may expand to include the company’s creditors. See In re Total Containment, Inc., 335 B.R. 589, 603 (Bankr. E.D. Pa. 2005) ("Where a company becomes insolvent, the fiduciary duty owed by corporate officers and directors shifts to the company's creditors."); see also In re Lemington Home for Aged, 659 F.3d 282, 290 (3d Cir. 2011), as amended (Oct. 20, 2011) (explaining that, under Pennsylvania law, the fiduciary duties of directors and officers "are owed not only to the corporation and its shareholders, but also to the creditors of an insolvent entity"); In re Transcolor Corp., 296 B.R. 343, 373 (Bankr. D. Md. 2003) ("As the director of an insolvent corporation, [director] ignored his fiduciary duty to the company's creditors."). It is important to consider the applicable states’ laws because only certain jurisdictions permit these types of claims. Compare Tatung Co., Ltd. v. Shu Tze Hsu, 217 F. Supp. 3d 1138, 1192 (C.D. Cal. 2016) ("[I]n California, directors owe a fiduciary duty to an insolvent corporation's creditors to avoid actions that divert, dissipate, or unduly risk corporate assets that might otherwise be used to pay creditors claims." (citation omitted)) with N. Am. Cath. Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 103 (Del. 2007) (“[I]ndividual creditors of an insolvent corporation have no right to assert direct claims for breach of fiduciary duty against corporate directors.” (emphasis in original)).

Significantly, this fiduciary duty may require that all creditors within the same creditor class be treated equally, and thus constrain the officer’s ability to pick and choose between vendors to pay and those to ignore. See Nw. Nat. Ins. Co. v. Goldstein, 368 A.2d 1095, 1097 (Md. App. Ct. 1977) ("We believe the State policy on insolvency to be to treat all creditors within the same class equally.").For example, in Keener Lumber Co., the court explained:

[O]nce a director’s fiduciary duty to creditors arises, a director is generally prohibited from taking advantage of his intimate knowledge of the corporate affairs and his position of trust for his own benefit and to the detriment of the creditors to whom he owes the duty. The jury should also be instructed that, once the fiduciary duty arises, a director must treat all creditors of the same class equally by making any payments to such creditors on a pro rata basis. We further suggest that the jury be instructed that, under the particular facts of this case, if a fiduciary duty arose at some point in time, the acts that may have amounted to a breach of this fiduciary duty include, but are not necessarily limited to: (1) continuing to purchase lumber from plaintiff without disclosing the status of Perry Builders; and (2) failing to pay all creditors of the same class on a pro rata basis.

Keener Lumber Co. v. Perry, 560 S.E.2d 817, 826–27 (N.C. Ct. App. 2002); see also Associated Hardwoods, Inc. v. Lail, No. 18 CVS 329, 2018 WL 3747439, at *4 (N.C. Super. Aug. 6, 2018) ("[T]he director is generally prohibited from taking advantage of his intimate knowledge of the corporate affairs and his position of trust for his own benefit and to the detriment of the creditors to whom he owes the duty and must treat all creditors of the same class equally by making any payments to such creditors on a pro rata basis."). 

Officers and directors should be aware that continuing to contract or entering into a contract when the officer or director knows or should know that the company will not pay, may breach their fiduciary duties and place them at risk of claims for fraud and potential personal liability. By way of example, under Pennsylvania law, an officer or director commits the tort of intentional misrepresentation when: (1) a representation is made; (2) which is material to the transaction at hand; (3) the representation is made falsely, with knowledge of its falsity or recklessness as to whether it is true or false; (4) with the intent of misleading another into relying on it; (5) the party justifiably relied on the misrepresentation; and (6) the reliance on the misrepresentation proximately caused the injury. Gibbs v. Ernst, 647 A.2d 882, 889 (Pa. 1994). Additionally, Pennsylvania law makes fraudulent transfers voidable if the debtor made the transfer or incurred the obligation “with actual intent to hinder, delay or defraud any creditor of the debtor.” See 12 Pa. C.S. § 5104(a)(1). Thus, an officer or director representing—via contract—that payment will be made in a certain time frame when they know that to be false would seemingly meet the elements of intentional misrepresentation or a fraudulent transfer claim. In re Swarthmore Grp., Inc., 667 B.R. 258 (Bankr. E.D. Pa. 2025) (denying motion to dismiss fraudulent transfer claim because the complaint adequately pled “badges of fraud” to establish corporation’s insolvency before share-purchase agreement).

Personal liability for this conduct comes into play because certain jurisdictions like Pennsylvania and New York recognize the participation theory of liability. Under that theory, a corporate officer may be liable in tort for their own wrongful conduct on behalf of the corporation, even though the corporation is not a sham and there is no other basis for piercing the corporate veil. Wicks v. Milzoco Builders, Inc., 470 A.2d 86, 89–90 (Pa. 1983); Francis J. Bernhardt, III, P.C. v. Needleman, 705 A.2d 875, 878 (Pa. Super. Ct. 1997); Bank of Landisburg v. Burruss, 524 A.2d 896, 901 (Pa. Super. Ct. 1987). This basis of individual liability is predicated on the corporate officer’s own actions and participation in the corporation’s wrongful conduct, rather than the corporation’s status and his relationship to the corporation. See North Shore Architectural Stone, Inc. v. American Artisan Constr., Inc., 153 A.D.3d 1420 (N.Y. 2d App. Div. 2017). Under the participation theory, officers and directors who breach their fiduciary duties by failing to treat vendors equally or by pursuing contracts with vendors for which they know the vendor won’t be paid may find themselves personally liable. Other jurisdictions recognize similar theories, although they may refer to it differently. See Gore v. Scotland Golf, Inc., 136 S.W.3d 26, 32 (Tex. App. 2003) ("The law is well-settled that a corporate agent can be held individually liable for fraudulent statements or knowing misrepresentations even when they are made in the capacity of a representative of the corporation.”); E & A Produce Corp. v. Olmo, 864 So. 2d 447, 448 (Fla. Dist. Ct. App. 2003) (“[I]ndividual officers and agents of a corporation may be held personally liable for their tortious acts, even if such acts were committed within the scope of their employment or as corporate officers.”) 

Against this backdrop, officers and directors of insolvent companies should be mindful to treat their creditors equally and refrain from making any misrepresentations when purchasing product or entering into contracts with current and new vendors. Acting otherwise could make a bad situation worse by expanding what would ordinarily be pure corporate liability into personal liability. By the same token, vendors and creditors who have been misled by a financially distressed buyer may have a powerful, alternative tool for recovery given the expansion of fiduciary duties when a company is insolvent and the personal liability that may attach under the participation theory.