It somehow escaped my attention that the American Law Institute is going to try writing a Restatement of the Law of Corporate Governance. Because they did such a good job the first time?
My article Independent Directors and the ALI Corporate Governance Project, 61 Geo. Wash. L. Rev. 1034 (1992), explored the hash the ALI made of the project the first time they tried.
The first attempt foundered. It was ultimately downgraded from a Restatement to a set of Principles, which have proven almost completely irrelevant to the development of corporate law in the intervening decades. Put bluntly, it has been almost entirely without influence.
The Project floundered because of the competing interests of the various voting blocks within the ALI. The ALI prides itself on being, in the words of its then-President, “analytical and impartial.” In fact, however, the process by which the project took shape most closely resembled the rough-and-tumble politics of a state legislature.
Two voting groups within the ALI—academics within the law and economics school and corporate practitioners—strongly resisted much of the Project. Law and economics scholars tended to oppose mandatory rules, be skeptical of the utility of independent directors, and resist attempts to expand the scope of judicial review of management actions. Between the steady barrage of critical academic commentary they directed at the Project and their growing strength within the ALI, their influence gradually began to be felt. For example, Tentative Draft No. 2 strongly rejected the notion that market forces alone will result in the creation of effective monitoring systems. In contrast, the Final Draft significantly softened and scaled back the discussion of market forces.
While resistance from the law and economics community undoubtedly played an important part in shaping the Project’s final form, the critical opposition ultimately came from corporate practitioners. Many corporate practitioners undoubtedly perceived legitimate policy objections to the Project, but there was another force at work: self-interest. In the long run, a lawyer’s self-interest points towards expansive judicial review. Rational members of the plaintiff’s bar prefer rules throwing open the courthouse doors. So too should rational litigators within the corporate bar, given that defending lawsuits is almost as profitable as bringing them in the first instance. Even transactional lawyers have a strong interest in frequent judicial review of their client’s conduct, given that it is the threat of litigation that makes transactional lawyers necessary to those clients. Because most observers believed that the Project would significantly increase the amount of corporate litigation, long-run self-interest thus should have led practitioners to support the Project.
Short-run self-interest, however, cut the other way. Many senior corporate executives strongly opposed the Project. Nor did they fail to make the corporate bar aware of their views. Indeed, it was alleged “that corporations were hiring members of the ALI to represent their interests in that body’s deliberations and that they were removing their legal business from law firms with partners who were sympathetic to the ALI’s pro-litigation outlook.” If so, short-run self-interest argued for keeping one’s clients happy by voting as those clients wished.
The ALI’s leadership apparently believed that much of the opposition to the Project within the Institute arose from this source. Prior to the 1992 annual meeting, for example, President Perkins wrote that it was “critical that our final deliberations not be subject to the charge of a skewed representation, weighted toward any particular interest group.” That he felt it necessary to further warn the membership not to vote unless they had “the stomach for voting in a way that an important client might not like” strongly suggests that at least some members did not leave their clients’ interests at the door.
To understand the practicing bar’s opposition to the Project we thus must first understand the business community’s opposition. Again, much of the opposition undoubtedly proceeded from legitimate policy concerns. Many executives were concerned that the derivative suit rules, for example, would increase the number of strike suits, resulting in greater costs. Others thought the ALI should be restating existing law, rather than making new law. Some objected to the lack of flexibility in the Project’s various provisions. Still others thought the Project’s drafters misunderstood the corporate enterprise. In view of the ALI’s prestige and the widespread acceptance earlier restatements had received from courts, the business community undoubtedly feared that what it saw as policy missteps would quickly become law.
Here too, however, self-interest no doubt also played a part. Unlike most ALI projects, the corporate governance project directly affected the prerogatives and pocketbooks of senior corporate managers. Despite all the denials and qualifications offered by the Project’s proponents, increasing management accountability—and thus management’s liability exposure—was the Project’s central goal
Not surprisingly, much of the business community’s opposition centered on the Project’s liability provisions. Early drafts of the Project’s substantive provisions would have significantly increased the likelihood of personal liability on the part of an officer or director. Given the significantly greater risk of personal liability if those drafts had been adopted, self-interest is the most plausible explanation for the vehemence of the business community’s opposition. In turn, their opposition was reflected in the positions taken by many within the ALI.
In the face of this opposition, the Project’s drafters steadily backed down. The compromises ultimately reached generally reduced the likelihood of director and officer liability. In particular, the procedures governing derivative suits gradually moved towards the Delaware position. The substantive provisions, including those governing interested director transactions, were likewise modified. Perhaps as a mere incidental by-product these changes also generally introduced a greater degree of judicial deference to decisions made by independent directors.
Maybe the new Project will go more smoothly.
Maybe.
I have a sneaking feeling, however, that the new project will be the gift that keeps on giving law review article topics and that I’m going to spend much of the final years of my career takings shots at the drafts to come.
