I am what is known in corporate law jurisprudence circles as a contractarian. As I explain in my essay, Community and Statism: A Conservative Contractarian Critique of Progressive Corporate Law Scholarship, “contractarians” model the firm not as an entity, but as an aggregate of various inputs acting together to produce goods or services. Employees provide labor. Creditors provide debt capital. Shareholders initially provide equity capital and subsequently bear the risk of losses and monitor the performance of management. Management monitors the performance of employees and coordinates the activities of all the firm’s inputs. The firm is simply a legal fiction representing the complex set of contractual relationships between these inputs. In other words, the firm is not a thing, but rather a nexus or web of explicit and implicit contracts establishing rights and obligations among the various inputs making up the firm.
The nexus of contracts model has important implications for a range of corporate law topics, the most obvious of which is the debate over the proper role of mandatory legal rules. As a positive matter, contractarians contend that corporate law in fact is generally comprised of default rules, from which shareholders are free to depart, rather than mandatory rules. As a normative matter, contractarians argue that this is just as it should be.
As a contractarian, I was very interested by a proposal in the CLS Blue Sky Blog from Professor Eric Talley that adopts a contractarian approach to the issues currently roiling Delaware corporate law. For the benefit of those who are coming in late, Delaware's proposed Senate Bill 21 (SB21) aims to restructure fiduciary duty analysis for controlling stockholders, officers, and directors in Delaware corporations. Proponents argue SB21 is necessary to prevent corporations from leaving Delaware for states like Nevada or Texas—a phenomenon dubbed "DExit." Critics counter that the bill would undermine Delaware's competitive advantage of predictable case law interpreted by skilled judges.
Professor Eric Talley identifies a crucial oversight in the debate: Delaware's historical strength lies not only in its judiciary but also in its flexible, contractarian approach to corporate law. Talley proposes a modest alteration to SB21—adding an "opt-in" feature—that would preserve Delaware's contractarian principles while addressing concerns from both sides.
This solution would create a new section (144A) offering relaxed safe harbor for transactions involving interested parties, but only for corporations whose charters expressly adopt it. A complementary provision, Section 102(b)(8), would authorize corporations to adopt this safe harbor through charter amendments. This approach draws inspiration from Delaware's successful Section 102(b)(7), which allows corporations to waive monetary liability for breaches of duty of care.
Talley argues this contractarian solution would preserve Delaware's flexibility while addressing concerns from both perspectives. Companies could choose their preferred governance framework rather than being subjected to a universal rule. This approach would also remedy SB21's most significant drawback—its mandatory nature—by making the proposed safe harbor optional, thus reaffirming Delaware's commitment to the flexible, enabling approach that has kept it at the forefront of corporate law.
In a forthcoming post at the CLS Blue Sky Blog, Professor Jeffrey Gordon offers what he calls "an additional framing and a minor modification to Talley’s proposal, a friendly amendment." Gordon's argument begins with the dual nature of controlling shareholders in corporate governance. While controllers help solve managerial agency costs through close monitoring, they also present their own agency costs through potential extraction of "private benefits of control" via diversionary transactions.
Gordon explains that the difference between U.S. law (which allows controllers to retain control premiums) and other jurisdictions (which require premium sharing through "mandatory bid" rules) stems from trust in Delaware courts to maintain effective fiduciary litigation that prevents excessive private benefit extraction by new controllers.
This judicial control is particularly crucial for dual-class stock structures, where the wedge between cash flow rights and control rights creates ongoing temptation for controllers to divert resources. Gordon provides examples showing how controllers with decreasing cash flow rights have increasing incentives to divert corporate resources.
Gordon articulates a key insight: incorporating in Delaware represents a commitment strategy by controllers to assure investors they won't extract improper private benefits. This commitment subjects controllers to Delaware's rigorous fiduciary duty regime.
Building on Professor Eric Talley's opt-in proposal, Gordon supports preserving a demanding fiduciary duty regime while allowing some controllers to opt out, with pricing consequences in capital markets. Gordon adds refinements for approval processes: for dual-class companies, requiring majority approval from each class; for single-class companies, requiring majority approval from disinterested shareholders. Without these approvals, opt-outs would be evaluated under the TripAdvisor standard.
Finally, Gordon suggests controllers should be able to lower the threshold for "facts and circumstances" control determination (e.g., from 33% to 20%) when opting into the new regime, and he proposes specific language for a new Section 102(b)(8) to implement these recommendations.
I find their general approach attractive, even if I might quibble with a few details. Delaware corporate law is generally enabling, meaning it provides corporations with broad flexibility to structure their governance and operations as they see fit, rather than imposing rigid mandatory rules. This approach allows companies to tailor their bylaws, board structures, and fiduciary obligations within the framework of statutory and common law principles. As a contractarian, I think that is as it should be.
Both Talley and Gordon propose an"opt-in" approach under which companies would have to choose to switch from current law into their proposed safe harbor, with voting structures that are designed to protect minority shareholders. I concur that an "opt-in" approach is superior here to an "opt-out approach."
First, an opt-in approach preserves Delaware's current fiduciary duty regime as the default, maintaining the predictability and established precedent that many corporations value. This avoids disrupting the existing legal framework that has been developed through decades of case law and judicial expertise.
Second, an opt-in model aligns with Delaware's contractarian tradition by allowing corporations to affirmatively choose the governance structure that best suits their needs, rather than forcing all corporations to take action to maintain the status quo. This respects corporate autonomy and the ability of firms to make deliberate governance choices.
Third, an opt-in approach better protects minority shareholders by requiring explicit action (and in Gordon's refinement, specific approval processes) to adopt the more relaxed fiduciary standards. This ensures greater transparency about the change and provides clearer notice to investors.
Finally, an opt-in structure serves as a market test for the new fiduciary regime. If the new safe harbor truly adds value and reduces unnecessary litigation without harming minority shareholders, corporations will voluntarily adopt it. If it doesn't, the market will signal this through limited adoption.
Note that neither Talley nor Gordon address the provisions of SB21 amending the shareholder inspection rights under DGCL section 220. The logic of allowing companies to opt-into those provisions seems equally compelling.
