Three British scholars recently tackled the nexus of contracts a.k.a. contractarian theory of the corporation. I'm using it as a excuse to revisit some of my own work on contractarianism.
Gibbs, David and Gindis, David and Whayman, Derek, Not by Contract Alone: The Contractarian Theory of the Corporation and the Paradox of Implied Terms (January 22, 2021). European Business Organization Law Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3771451 or http://dx.doi.org/10.2139/ssrn.3771451
Specifically, we show that this role does not sit comfortably with the ‘strong form contractarian’ position, which demands a literal interpretation of the claim that the corporation is a nexus of contracts.
In contrast, I have argued that:
In a more important sense, ... the corporation has a nexus. After all, to say that the firm is a nexus is to imply the existence of a core or kernel capable of contracting. But kernels do not contract--people do. In other words, it does us no good to avoid reifying the firm by reifying the nexus at the center of the firm.
Stephen M. Bainbridge, The Board of Directors As Nexus of Contracts, 88 Iowa L. Rev. 1, 17 (2002). As I argue therein, "If the corporation has a nexus, however, where is it located? The Delaware code, like the corporate law of every other state, gives us a clear answer: the corporation's 'business and affairs . . . shall be managed by or under the direction of a board of directors.' Put simply, the board is the nexus." Id. at 25.
In any case, back to Gibbs et al.:
Strong-form contractarians (to whom we shall refer to simply as ‘contractarians’ in what follows) reject the suggestion that their use of the term ‘contract’ is too loose to correspond to the legal understanding of an actual, legally enforceable reciprocal promise or agreement, and claim that the contracts involved in corporate ventures are ‘real contracts’6 consisting of express or implied terms struck by real parties. When courts are called upon to imply missing contractual terms, contractarians argue, they do so with a wealth-maximization objective in mind. We show that a considerable extension of standard contract doctrine is necessary for this account to work and contend that courts will refuse to extend it as contractarians require, with the consequence that many gaps either cannot be filled or can only be filled by non-contractual doctrines.
Gibbs et al. thus assert that contractarians claim "that features of ‘corporateness’ have been, and therefore can be, ‘created by contract, supplemented perhaps by other common law devices such as trusts or agency.’"
In contrast, I have staked out what I suppose might be called a weak nexus of contracts theory:
Many commentators have criticized the contractarian model on the ground, inter alia, that it is an incomplete theory of how people relate to one another within a firm. If contractarianism claimed to be a valid description of economic reality, this argument might have some traction. In my view, however, contractarianism claims only to offer a richer metaphor than do traditional entity-based theories and, therefore, a more useful heuristic for understanding corporations. Put another way, I tell my classes that the nexus of contracts model is properly viewed as a metaphor rather than as a positive account of economic reality. I analogize contractarianism to Newtonian physics, which no longer credibly claims to be true, but still provides a simple model that adequately explains a large and important set of physical phenomena.
Contractarianism in the Business Associations Classroom: Kovacik v. Reed and the Allocation of Capital Losses in Service Partnerships, 34 Ga. L. Rev. 631, 644 (2000). As a result, I am dubious of strong claims that you could create a corporation purely by contract. To the contrary, I agree with Vice Chancellor Travis Laster, who observed that "that notwithstanding scholarly approaches such as the widely embraced view of the corporation as a nexus of contracts ..., the DGCL rests on a concept of the corporation that is grounded in a sovereign exercise of state authority: the chartering of a 'body corporate' that comes into existence on the date on which a certificate of incorporation becomes effective." Juul Labs, Inc. v. Grove, 238 A.3d 904, 914 n.7 (Del. Ch. 2020). Strikingly, however, VC Laster observes that he that he nevertheless regards the nexus of contracts model "as a helpful metaphor." Id. As, of course, do I.
Gibbs et al. further argue that:
The problem can be roughly stated as follows. Given that contracts are incomplete, whenever courts adjudicate contractual disputes, they attempt to fill the gaps using the doctrine of implied terms in order to enforce mutually agreed obligations. But giving effect to obligations by implication comes with the risk that the implied term may not have been truly consented to. This undermines the very basis of contractual liability, namely consent, and conflicts with the courts’ practical imperatives to maintain legal certainty and deter excessive litigation. Courts, as a result, will more often than not refrain from implying terms, even when this runs the risk of not holding parties to their bargains. While the imperative to hold parties to their bargains is rooted in consent, so is the imperative to refuse to imply terms. We call this antinomy the ‘paradox of implied terms’.
As the number of parties increases, the effects of this paradox multiply, inherently limiting contract law’s reach beyond two parties. This constraint limits the courts’ ability to build a nexus by implying third-party obligations by inferring, for example, a contract between its existing members and a putative new member. It follows that the vehicle of contract cannot create the complex set of multi-party obligations which constitute the corporate form. Conversely, in a true corporation, parties can be added to (or removed from) the nexus without the express or implied consent of all other parties in the nexus, and without affecting their liabilities. This is only possible because non-contractual doctrines, that is, doctrines that are not rooted in consent, are involved. This poses a significant challenge to contractarianism.
First, I don't find the issue of consent all that troubling, as explained in my Georgia article:
In the nexus of contracts model, partnership statutes and decisions can be thought of as a standard form contract voluntarily adopted—perhaps with modifications—by the partners. The point of a standard form contract, of course, is to reduce bargaining costs. Parties for whom the default rules are a good fit can take the default rules off the rack, without having to bargain over them. Parties for whom the default rules are inappropriate, in contrast, are free to bargain out of the default rules. I illustrate this point by telling my class the following parable: A while back I flew into LAX and schlepped out to a car rental lot. There was a huge line growing at least as fast as it was being served, so there were many impatient travelers behind me by the time I got to the front. The agent handed me a long and detailed standard form agreement. Did I bargain over the agreement’s terms? No, of course not. Did I even read the agreement? No, of course not. In this context, relying on a standard form contract significantly reduced the transaction costs that would have been associated with bargaining. 34 Geo. L. Rev. at 646.
And, as I have observed elsewhere:
Is a standard form contract any less of a contract just because it is offered on a take-it-or-leave-it basis, however? If the market is competitive, a party making a take-it-or-leave-it offer will set price and other terms that will lead to sales despite the absence of particularized negotiations.
Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 Nw. U.L. Rev. 547, 589 (2003).
Second, I take issue with Gibbs et al.'s explication of hypothetical bargaining and gap filling. I don't think courts use the hypothetical bargain to supply party-specific rules to fill a specific gap in a specific corporation. Instead, I think they use it to come up with default rules applicable to all corporations. See, e.g., id. at 577 (arguing that "a shareholder wealth maximization norm [would] emerge from the bargain as the majoritarian default?").
Third, I note that in the US (by which, of course, I mean in Delaware) courts at least claim they're engaged in facilitating private ordering:
- "The DGCL is intentionally designed to provide directors and stockholders with flexible authority, permitting great discretion for private ordering and adaptation." Hollinger Intern., Inc. v. Black, 844 A.2d 1022, 1078 (Del. Ch. 2004), judgment entered, (Del. Ch. 2004), and aff'd, 872 A.2d 559 (Del. 2005).
- The DGCL is “an enabling statute that provides great flexibility for creating the capital structure of a Delaware corporation.” Shintom Co. v. Audiovox Corp., 888 A.2d 225, 227 (Del.2005)
- The DGCL is “a broadly enabling statute." In re Topps Co. S'holders Litig., 924 A.2d 951, 958 (Del. Ch.2007)
- The DGCL is “is widely regarded as the most flexible in the nation because it leaves the parties to the corporate contract (managers and stockholders) with great leeway to structure their relations, subject to relatively loose statutory constraints.” Jones Apparel Gp., Inc. v. Maxwell Shoe Co., 883 A.2d 837, 845 (Del.Ch.2004)
- “Unlike the corporation law of the nineteenth century, modern corporation law contains few mandatory terms; it is largely enabling in character.” Matter of Appraisal of Ford Hldgs., Inc. Preferred Stock, 698 A.2d 973, 976 (Del. Ch.1997).
Finally, I note with interest that the earliest reference to "nexus of contracts" I could find in Westlaw's law review database was Ronald J. Gilson, A Structural Approach to Corporations: The Case Against Defensive Tactics in Tender Offers, 33 Stan. L. Rev. 819 (1981). It says something about the merits of contractarian theory that we're still arguing about it 40 years later.
