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In Pennsylvania, the ALI Principles of Corporate Governance Have Been, "At Best, Unhelpful."

Regular readers know that I have been a long-time critic of the American law Institute's Principles of Corporate Governance and, more recently, a critic of the ALI's effort to again tackle a restatement of the Law of Corporate Governance.

My blog posts on the topic are collected here. And then there are my law review articles:

Bainbridge, Stephen Mark, Do We Need a Restatement of the Law of Corporate Governance? (July 7, 2022). UCLA School of Law, Law-Econ Research Paper No. 22-06, Available at SSRN: https://ssrn.com/abstract=4156924

Bainbridge, Stephen Mark, A Critique of the American Law Institute’s Draft Restatement of the Corporate Objective (August 4, 2022). UCLA School of Law, Law-Econ Research Paper No. 07, 2022, Available at SSRN: https://ssrn.com/abstract=4181921

So naturally I was interested in a blog post from Edward Robson-a Pennsylvania practitioner-on the impact of the ALI Principles on Pennsylvania law:

I have never had particularly strong feelings about the ALI Principles themselves, but their application in Pennsylvania to cases dealing with closely-held companies has been, at best, unhelpful.

Although our Supreme Court gave them a hearty endorsement shortly after their creation, most Pennsylvania courts (including that same Supreme Court) since then have found them to be inconsistent with Pennsylvania law.

...

The result is the legal equivalent of scrapple (for those not from Pennsylvania, this will help you digest the metaphor: https://en.wikipedia.org/wiki/Scrapple)—likely to lead to procedural wrangling and litigation sideshows that make it frustrating for counsel plotting a course though business divorce litigation.

Go read the whole thing.

 

The Restatement Reporters Reply

A recent post criticized the Restatement of the Law of Corporate Governance's approach to the law of controlling shareholders. The Reporters have sent along this response:

In your blog post, you take issue with two elements of Section 5.10, which was approved by the ALI at its May 2022 annual meeting.

The first element relates to the types of transaction in which a controller is considered to be interested. Your blog post suggests that the restatement is taking an approach that is “entirely different” from the Delaware Supreme Court’s approach in Sinclair Oil. v. Levien, 280 A.2d (Del. 1971). Yet, the restatement is completely consistent with Sinclair Oil. Under section 1.23, which defines “interested” and is referenced in section 5.10, a controller is interested if the controller “receives a benefit … when the benefit … is not shared with shareholders pro rata …”. The issue in Sinclair Oil was whether a parent was conflicted as to a dividend paid by its non-wholly owned subsidiary.  The dividend was paid pro rata to the parent and the subsidiary’s minority shareholders.  The Delaware Supreme Court held that there was no conflict—a sound decision and one with which the restatement fully accords, both in its black letter and in comment 3.  Sinclair Oil also deals with another issue: whether the parent usurped a corporate opportunity belonging to the subsidiary. But corporate opportunities involving controllers are addressed neither by section 5.10 nor by section 1.23 (they will be addressed by a different provision yet to be drafted) and these sections can thus hardly take a different approach to that issue than did Sinclair Oil.

The second, and more important, element you take issue with relates to the standard of review that applies when a controller is interested in a transaction involving a controlled entity.  Absent a cleansing act, there is broad consensus that a fairness standard applies.  But what if there was a cleansing act?  Under Kahn v. Lynch, a 1994 decision by the Delaware Supreme Court that has been followed by other jurisdictions that have addressed that issue, a single proper cleansing act has the effect of shifting the burden of proof on fairness, rather than of reinstating the business judgment rule. And under MFW, a 2014 decision by the Delaware Supreme Court that has been followed by New York but has been rejected by Oklahoma, two proper cleansing acts have the effect of reinstating the business judgement rule. 

Both Lynch and MFW involved freeze-out mergers. But Kahn v. Tremont, 694 A.2d 422 (Del. 1997) involved a regular self-dealing transaction between a Valhi (an entity owned Simmons) and Tremont (an entity controlled by Simmons). In Tremont, the Delaware Supreme Court noted:

Ordinarily, in a challenged transaction involving self‑dealing by a controlling shareholder the substantive legal standard is that of entire fairness, with the burden of persuasion resting upon the defendants. Weinberger v. UOP, Inc., Del. Supr., 457 A.2d 701, 710 (1983). The burden, however, may be shifted from the defendants to the plaintiff through the use of a well-functioning committee of independent directors. Kahn v. Lynch Communication Sys., Del. Supr., 638 A.2d 1110, 1117 (1994).

Id. at 428.

Subsequent to Tremont, a plethora of Chancery court cases have applied the Lynch framework in settings other than freeze-out mergers. The notes to section 5.10 list over 10 such opinions by the Chancery court, of which about half are reported.

To be sure, the blog is correct in noting that several of these opinions pre-date MFW. But the relevance of this point escapes me. MFW does not speak to the issue of which transactions are subject to Lynch to start with. Moreover, I do not think that there is anyone who has argued that, under Delaware law, a transaction that is subject to the Lynch rule, meaning that a single cleansing merely shifts the burden under a fairness test, is not also subject to the MFW gloss on Lynch, meaning that two proper cleansing acts reinstate the business judgment rule. The relevant date for whether a Delaware court decision elucidates the scope of Lynch is thus the date when the Lynch rule was announced, not the date when it was clarified by MFW.  And all the cited cases post-date Lynch.

Several leading commentators, including two highly respected former Delaware judges, have criticized these Chancery court decisions.  There are certainly cogent arguments for limiting the scope of transactions subject to the Lynch rule, as there are cogent arguments in the other direction. But when the weight of judicial authority is overwhelmingly in one direction—and for these purposes, law review articles by former members of the judiciary do not constitute judicial authority—the role of the restatement is not to evaluate these policy arguments, or to predict rulings by the Delaware Supreme Court in a yet-to-be-filed case, but to restate the law as it stands today.  And that is what Section 5.10 has done.

The Restatement of the Law of Corporate Governance's Flawed Approach to Controlling Shareholder Transactions

Tentative Draft No. 1 of the Restatement of the Law of Corporate Governance purports to restate the law governing transactions involving a controlling shareholder.

Section 5.10 states that:

If the corporation enters into a transaction in which a controller [§ 1.10] is interested [§ 1.23], the controller fulfills its duty of loyalty to the corporation and its shareholders with respect to the transaction if:

(1) the transaction is fair to the corporation at the time it is entered into; or

(2) the transaction is conditioned on it being approved in advance, and is so approved, by both disinterested directors [§ 1.15], acting in good faith and on reasonable inquiry with the power to retain their own professional advisers and to negotiate the terms of the transaction, and disinterested shareholders [§ 1.16], in each case following disclosure concerning the conflict of interest [§ 1.14(a)] and the transaction [§ 1.14(b)] to the disinterested directors and disinterested shareholders, respectively.

I have a number of problems with this provision, as drafted. First, by incorporating the definition set forth in section 1.23(b), the drafters have swept far too large a swath of transactions into the operative provisions. They define an interest as:

A shareholder of a corporation is “interested” in a transaction involving the corporation or in conduct by the corporation for purposes of § 1.16 if:

(1) the shareholder is a director, officer, or controller of the corporation, or an affiliate of a director, officer, or controller of the corporation, that is interested in the transaction or conduct or that is not independent of a person that is interested in the transaction or conduct; or

(2) both the corporation and the shareholder are parties to the transaction or conduct; or

(3) the shareholder receives a benefit (or suffers a detriment) in the transaction or conduct which is not generally shared with (or suffered by) the other shareholders of the corporation, and that benefit (or detriment) is of such significance to that particular shareholder that it would reasonably be expected to affect the shareholder’s judgment with respect to the transaction or conduct.

Subsections (a) and (b) basically replicate Delaware General Corporation Law section 144’s definition of when a director or officer has an interest in the transaction. So what, you ask? The Delaware legislature could have adopted a 144-style provision applicable to controlling shareholders. But it has not done so. Neither has the Model Business Corporation Act.

Instead, Delaware law took an entirely different approach in Sinclair Oil. v. Levien, 280 A.2d (Del. 1971). Under Sinclair Oil, the initial question is whether the controlling shareholder “has received a benefit to the exclusion and at the expense of the subsidiary.” (To be sure, Sinclair Oil involved a parent-subsidiary relationship, but the parent by definition is a controlling shareholder and the principles are the same.)

The fact that the controlling shareholder is a party to the transaction is not enough. The controlling shareholder must have gotten a benefit that is both at the expense of and to the exclusion of the minority shareholders.

This is made clear by the court’s treatment of the minority’s objection to the subsidiary’s dividend policy. Sinven (the subsidiary) had adopted at Sinclair Oil’s behest a policy of paying out the maximum lawful dividend. This benefited Sinclair Oil but did not constitute self-dealing by Sinclair Oil because Sinclair received nothing from Sinven to the exclusion of its minority stockholders.” Id. at 772.

Unlike Restatement subsection (3), moreover, it is not enough that the controlling shareholder get a benefit or even that the benefit is not shared. The controlling shareholder must get a benefit not only that excludes the minority but comes at their expense. This is made clear by the court’s treatment of the minority’s complaint that Sinclair Oil had denied Sinven opportunities to develop oil properties outside of Venezuela. “From 1960 to 1966 Sinclair purchased or developed oil fields in Alaska, Canada, Paraguay, and other places around the world. The plaintiff contends that these were all opportunities which could have been taken by Sinven.” Id. But the court rejected that claim: “Sinclair usurped no business opportunity belonging to Sinven. Since Sinclair received nothing from Sinven to the exclusion of and detriment to Sinven's minority stockholders, there was no self-dealing.” Id. Again, you must have both exclusion AND detriment.

Sinclair Oil also suggests that the Restatement gets the substantive law wrong. Section 5.10 seems to assume that any “interested” transaction involving a controller is subject to intrinsic fairness analysis (unless cleansed as per below). But that is not the law, at least in Delaware. Under Sinclair Oil, there are two standards of review. If the plaintiff can carry the burden of proof of showing that the controlling shareholder benefited itself at the expense and exclusion of the minority, then entire fairness is the standard. But if the plaintiff cannot, the business judgment rule is the standard of review.

The rule is not: Controlling shareholder > controlling shareholder connected to transaction > fairness.

The rule is: Controlling shareholder > controlling shareholder benefited at the expense of and to the exclusion of minority shareholders > if yes, fairness; if no, business judgment rule.

In addition, you will note that the drafters have basically grafted the MFW standard for freezeout mergers by a controlling shareholder onto to all cases involving a controlling shareholder. It is debatable whether the MFW rule ought to extend beyond the freezeout merger context. The potential conflict of interest is especially pronounced in this context. After all, “a merger in which it is bought out is the most important event that can occur in a small corporation's life, to wit, its death . . ..” SEC v. Geon Industries, Inc., 531 F.2d 39, 47 (1976). In a freezeout merger, the transaction takes on even greater significance because the controlling shareholder is buying the company and thus has a strong incentive to minimize the prize at the expense of the minority. Freezeout mergers thus have long been the subject of especially close review.

Yet, as been ably said by a court otherwise quite protective of minority shareholder rights, “The majority . . . have certain rights to what has been termed ‘selfish ownership’ in the corporation which should be balanced against the concept of their fiduciary obligation to the minority.” Wilkes v. Springside Nursing Home, Inc., 353 N.E.2d 657, 663 (Mass. 1976). This seems to be the principle animating Sinclair Oil, which allows some controlling shareholder transactions the protection of the business judgment rule even without the sort of cleansing envisioned by MFW. The Restatement seems to have abandoned that principle by conditioning the business judgment rule on cleansing.

As support for extending MFW beyond the freezeout merger context the Reporters’ Note cites a number of Delaware Chancery Court decisions. Many of those decisions are unpublished and several pre-date MFW. Those decisions, moreover, have been criticized for blurring the distinction between going private transactions and transactions involving a going concern:

The Supreme Court decision does not create a universally-applicable safe harbor procedure for all manner of controlling stockholder transactions. Two main arguments form the basis of this contention.

The dual tenets of doctrinal clarity and cohesion underpin the first argument. A careful reading of the MFW decision fails to detect any mention of competing precedent or a general proclamation regarding its applicability to other types of controlling stockholder transactions. MFW is clearly situated on a path of doctrinal evolution of judicial inspection of going private transactions with controlling stockholders. Canons of judicial interpretation counsel against an indirect reversal or modification of established precedent.

Additionally, the theoretical justifications for the MFW decision hold significantly less weight in the going concern context. MFW's doctrinal shift is grounded on the twin pillars representing the competency of independent directors and non-affiliated stockholders. Whatever the validity of these mechanisms in the freeze out context, the legal and financial scholarship does not validate an extension to going concern transactions. Serious flaws hamper the ability of independent directors and non-affiliated stockholders to pass meaningful judgment on going concern transactions. In the final tally, MFW does not produce an all-encompassing framework for all controlling stockholder transactions.

Itai Fiegenbaum, The Geography of MFW-Land, 41 Del. J. Corp. L. 763, 767–68 (2017).

Three leading Delaware commentators, including former Chief Justice Leo Strine and former Justice Jack Jacobs likewise have argued that:

We . . . would not apply MFW to all transactions with controlling stockholders: the MFW solution was tailored specifically to the problem created by the Lynch line of cases, namely that those cases created poor incentives in the going private merger context for transactional planners and encouraged wasteful litigation yielding no benefit for investors or society. The solution MFW embraced credits procedures that, if implemented with fidelity, give minority stockholders in a squeeze-out merger the key protections they would receive in a merger with a third-party acquiror: (i) fiduciaries actively negotiating for their benefit and (ii) the right to determine for themselves as stockholders whether the transaction is in their best interests. This solution addressed concerns unique to the controller going private context: the requirement that the controller concede that the special committee of independent directors could say no responded directly to the concern that the controller could bypass that committee decision by presenting a tender offer directly to the minority stockholders.

The MFW solution was never designed to apply to all transactions between controlling stockholders and companies. MFW repeatedly emphasized that it was addressing only the context of going private mergers: it defined the question presented as “what should be the correct standard of review for mergers between a controlling stockholder and its subsidiary,” and recited that “[o]utside the controlling stockholder merger context, it has long been the law that even when a transaction is an interested one but not requiring a stockholder vote, Delaware law has invoked the protections of the business judgment rule when the transaction was approved by disinterested directors acting with due care.” Thus, the idea that MFW meant, without saying so, to define the treatment of all transactions with controlling stockholders is at odds with MFW's own text.

Lawrence A. Hamermesh et. al., Optimizing the World's Leading Corporate Law: A Twenty-Year Retrospective and Look Ahead, 77 Bus. Law. 321, 339 (2022). But the drafters ignored that guidance.

You may say that the Restatement is not intended to restate Delaware law. That is true. As I have quipped before, we already have an excellent restatement of Delaware corporate law.

As I have argued in my article, Do We Need a Restatement of the Law of Corporate Governance?, the Restatement is unlikely to have much influence. Instead, like its predecessor—the Principles of Corporate Governance—it likely will be mostly ignored.

I have argued that one reason the Principles were so controversial and were ultimately mostly ignored is that the Principles’ drafters consistently tried to expand the scope of liability for directors and officers:

Early drafts focused on the need for management accountability and relied on judicial review as the primary mechanism for accomplishing that goal. The early drafts therefore increased the likelihood of a corporate decision undergoing judicial review and the concomitant risk of liability for directors and officers.

Stephen M. Bainbridge, Independent Directors and the Ali Corporate Governance Project, 61 Geo. Wash. L. Rev. 1034, 1041 (1993).

The more I see of the Restatement, the more concerned I am that the drafters are heading in a similar direction. It seems as though whenever the reporters are unable to locate statutory or case law constraining fiduciary conduct, they opt to adopt the most prescriptive available precedent, even if it is from unpublished trial court opinions not tested on appeal.

As I explained, the Principles' drafters ultimately backed off. The drafters of the Restatement ought to do likewise.

The Restatement of the Law of Corporate Governance: A Grammatical Quibble

Tentative Draft Number 1 uses the terms "decisionmaking" and "decisionmaker." This is error.

"Decision making" is a noun + a gerund. When used in the noun form it is open and unhyphenated. When it is used as a compound adjective preceding a noun it is to be hyphenated. See Chicago Manual of Style (17th ed.) at 449. Hence, for example:

• Decision making is hard.
• The corporation's decision-making process is flawed.

Decision maker is a compound noun with a single function; i.e., the first noun modifies the second noun. According to Chicago (17th ed.) at 450, such a noun is open and unhyphenated. Hence, for example:

• The Chief Reporter is an excellent decision maker.

Some commentators might use compound nouns, such as decision maker, as compound adjectives and give them a hyphen. See, for example:

• The Chief Reporter uses a Magic 8-ball as a decision-maker tool.

I find that usage awkward and probably inadmissible. I prefer:

• The Chief Reporter uses a Magic 8-ball as a decision-making tool.

The Restatement of the Business Judgment Rule: The Question of Rationality

Regular readers know I am working on a couple of projects dealing with the forthcoming Restatement of the Law of Corporate Governance. Not everything I think about the restatement will make it into a law review article, but they will make great blog fodder.

To with, the drafters have restated the business judgment rule in section 4.02 as follows (in pertinent part):

A director or officer who makes a business judgment is not liable to the corporation or its shareholders if the director or officer: ... (4) rationally believes that the business judgment is in the best interests of the corporation.

Reporter's Note 1 to that section explains that:

Delaware incorporates the fourth component of the black letter by explaining: “where the business judgment presumptions are applicable, the board’s decision will be upheld unless it cannot be attributed to any rational purpose.” . . . A line of cases decided under Delaware law support the test that under the business judgment rule, a corporate decision will be upheld unless it cannot be attributed to any rational business purpose.

I agree with everything the drafters say. But I would like to add a friendly amendment, which I hope they will consider incorporating into the text. I take the following from Stephen M. Bainbridge, Corporation Law and Economics (2002), at 274-75:

In Sinclair Oil Corp. v. Levien, the Delaware supreme court held that so long as the board’s decision could be attributed to any rational business purpose the business judgment rule precluded the court from substituting its judgment as to the merits of the decision for those of the board.[1] Similarly, in Brehm v. Eisner, the court held that the business judgment rule does not apply when the board has “act[ed] in a manner that cannot be attributed to a rational business purpose.”[2]

The reference to a “rational business purpose,” properly understood, does not contemplate substantive review of the decision’s merits. As Professor Michael Dooley observes, “Sinclair’s use of [the word] rational is to be equated with conceivable or imaginable and means only that the court will not even look at the board’s judgment if there is any possibility that it was actuated by a legitimate business reason. It clearly does not mean, and cannot legitimately be cited for the proposition, that individual directors must have, and be prepared to put forth, proof of rational reasons for their decisions.”[3] Consequently, as Chancellor Allen has stated:

[W]hether a judge or jury considering the matter after the fact, believes a decision substantively wrong, or degrees of wrong extending through “stupid” to “egregious” or “irrational”, provides no ground for director liability, so long as the court determines that the process employed was either rational or employed in a good faith effort to advance corporate interests. To employ a different rule—one that permitted an “objective” evaluation of the decision—would expose directors to substantive second guessing by ill-equipped judges or juries, which would, in the long-run, be injurious to investor interests.[4]

Instead, as Chancellor Allen observed elsewhere, “such limited substantive review as the rule contemplates (i.e., is the judgment under review ‘egregious’ or ‘irrational’ or ‘so beyond reason,’ etc.) really is a way of inferring bad faith.”[5]

Put another way, inquiry into the rationality of a decision is a proxy for an inquiry into whether the decision was tainted by self-interest. In Parnes v. Bally Entertainment Corp., for example, the Delaware supreme court stated that: “The presumptive validity of a business judgment is rebutted in those rare cases where the decision under attack is ‘so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.’”[6]In that case, Bally’s CEO allegedly demanded bribes from prospective takeover bidders and, moreover, allegedly received such a bribe from the successful bidder. In holding that the plaintiff shareholder had stated a cause of action, the court observed that “it is inexplicable that independent directors, acting in good faith, could approve the deal” when it was so tainted.

Litwin v. Allen is often cited as an exception to the foregoing proposition.[7] Put another way, Litwin supposedly creates an “incredible stupidity” exception to the business judgment rule. Under this reading of the opinion, it stands as an example of a board decision so irrational as to not deserve the protection of the business judgment rule. One problem with this analysis is that Litwin involved the directors of a bank, who are typically held to a higher standard of accountability than directors of other corporations. Another is that Litwin is a sport—a case that falls well outside the norm. It is cited so often, because it stands alone as plausible precedential support for the irrationality exception to the business judgment rule. Finally, consistent with our hypothesis that courts use rationality as a code word for self-dealing, the Litwin court found the transaction in question to be “so improvident, so risky, so unusual, and unnecessary as to be contrary to fundamental conceptions of prudent banking practice.” Although the court expressly declined to find a violation of the duty of loyalty, it seems fair to ask whether “we have reason to disbelieve the protestations of good faith by directors who reach ‘irrational’ conclusions?”[8]

In sum, it may be that there are some board decisions that are so dumb that the business judgment rule will not insulate them from judicial review.[9] Even if the set of such decisions is not an empty one, however, the tail ought not wag the dog. Because a prerequisite of rationality easily can erode into a prerequisite of reasonableness, courts must tread warily here. If they want to persist in requiring that there be a rational business purpose, at least they can ensure that that requirement lacks teeth.

The Restatement of The Geography of Revlon-Land

As regular readers know, I am working on several projects relating to the tentative draft of the restatement of the Law of Corporate Governance. As I've plowed through the draft, I noticed that the drafters touch in passing on the geography of Revlon-land.

Reporter’s Note 3 to Section 2.01 comments in passing on the issue of when Revlon duties trigger, suggesting that “when a corporation is sold for cash” and “all of the shareholders will be cashed out” “the board may not balance the interests of shareholders against the interests of other stakeholders. This is the clear holding of Delaware’s Revlon case and a long line of other cases.” It is true that Revlon clearly held that when Revlon duties have triggered, there can be no consideration of interests other than those of the shareholders.

The implicit suggestion that Revlon is always triggered by a sale for cash, however, is controversial. True, dictum in some Delaware Chancery Court decisions suggest that that all cash and some mixed consideration sales trigger Revlon.[1]I have elsewhere argued that those decisions are inconsistent with controlling Delaware Supreme Court precedent.[2] In my view, the relevant Supreme Court precedents clearly indicate “that an acquisition by a publicly held corporation with no controlling shareholder that results in the combined corporate entity being owned by dispersed shareholders in the proverbial “large, fluid, changeable and changing market” does not trigger Revlon whether the deal is structured as all stock, all cash, or somewhere in the middle. The form of consideration is simply irrelevant.”[3]

I have also argued that the Chancery Court dicta is inconsistent with the policy concerns that motivated Revlon.[4]The Chancery Court dicta is premised on the notion that Revlon is concerned with “whether there will be a tomorrow for the shareholders,” but Revlon was mainly concerned with whether the structure of the transaction allows the market to redress any conflicts of interest on the part of the target directors.[5] As long as the acquirer is publicly held, the conflict of interest concerns are muted and “diversified shareholders will be indifferent as to the allocations of gains between the parties. In turn, those shareholders also will be indifferent as to the form of consideration.”[6] It is that approach to Revlonduties that the drafters should restate.

Scalia on Restatements of the Law

I am working away at a couple of law review articles about the tentative draft of the Restatement of the Law of Corporate Governance. In doing so, a friend pointed me to a great quote from Justice Scalia:

[M]odern Restatements . . . are of questionable value, and must be used with caution. The object of the original Restatements was “to present an orderly statement of the general common law.” Over time, the Restatements' authors have abandoned the mission of describing the law, and have chosen instead to set forth their aspirations for what the law ought to be. . . . Restatement sections such as that should be given no weight whatever as to the current state of the law, and no more weight regarding what the law ought to be than the recommendations of any respected lawyer or scholar. And it cannot safely be assumed, without further inquiry, that a Restatement provision describes rather than revises current law.

Kansas v. Nebraska, 574 U.S. 445, 475–76 (2015) (Scalia, J., concurring in part) (citations omitted). I concur.

Do we need a Restatement of the Law of Corporate Governance? (No.)

In 1978, the American Law Institute authorized a project originally intended to result in a restatement of corporate law.[1] As the decade long process of reaching consensus on the corporate governance project dragged on, it became what is still one of the most controversial projects the ALI ever attempted.[2] Indeed, one highly respected commentator went so far as to describe the project as “the most controversial event in the history of American corporate law.”[3] Perhaps because of the controversy surrounding the project, it has had little influence on judicial development of corporate law.[4]

Despite this dubious precedent the ALI has returned to the corporate governance field with a proposed Restatement of the Law of Corporate Governance (Restatement).[5] At the ALI’s 2022 annual meeting, the membership considered Tentative Draft No. 1, which contained provisions defining various terms, discussing the duties of care and loyalty, and the social purpose of the corporation.[6] Except for one of the duty of loyalty provisions, the membership approved the draft.[7]

It is probably too late to stop the Restatement project from going forward. The ALI membership voted to approve the idea of a Restatement and subsequently voted to approve most of the first tentative draft. The project has three reporters, all well respected corporate law academics.[8] There are dozens of very prominent and very influential attorneys, judges, and academics acting as advisers to the project.[9] There are 170 ALI members serving as a consultative group.[10] So the project has a lot of inertia and a lot of powerful individuals with a stake in seeing the project come to fruition. Granted, the time and effort expended to date are sunk costs that logically should be ignored in deciding whether to continue the project, but people are not very good at ignoring sunk costs.[11] The train has left the station and is unlikely to be derailed.

Nonetheless, to borrow a phrase from William F. Buckley, it is sometimes necessary to stand “athwart history, yelling Stop,’ especially “when no one is inclined to do so, or to have much patience with those who so urge it.”[12]

Courts are the main audience for Restatements and, as such, their content is “generally common law.”[13] The purpose of a restatement is to clarify “the underlying principles of the common law” that have “become obscured by the ever-growing mass of decisions in the many different jurisdictions, state and federal, within the United States.”[14]

It is here that we come to the crux of the matter. Unlike most common law topics, corporate law is not troubled by the potential for confusion that arises when many competing jurisdictions are all contributing to the development of the law with more or less equal claims to authority.[15] The law of corporate governance, especially that applicable to public corporations, is dominated by a single Leviathan.

Delaware is home to more than half of the public corporations listed for trading on U.S. stock exchanges.[16]Delaware’s share of large public corporations is even higher, with almost two-thirds of Fortune 500 corporations.[17] As far as the larger universe of business entities is concerned, Delaware is home to over 1 million, which consistently places it in the top 5 states of organization.[18] Most business entities form under the laws of their home state, of course, but Delaware is the leading choice of businesses that opt to incorporate outside their home state.[19] Because of the generally accepted choice of law principle known as the internal affair doctrine Delaware law will govern corporate governance disputes regardless of which U.S. jurisdiction in which the dispute is litigated.[20]

Delaware’s dominance of the corporate law field is further enhanced because many state courts follow Delaware law when their own state law does not provide an answer to the question at bar.[21] They presumably do so because of Delaware’s widely acknowledged mass of high-quality corporate law.[22] Even federal courts may look to Delaware law for assistance in interpreting federal law, as the Third Circuit observed in a case interpreting Bankruptcy Code § 328’s requirement that indemnification provisions in employment agreements be reasonable:

We look to Delaware corporate law as a guide primarily because it offers time-tested insights on how courts should best evaluate an issue similar to the one before us. Additionally, Delaware's law often cues the market.[23]

Accordingly, a Restatement of the Law of Corporate Governance is unnecessary. Courts and lawyers will look to the well spring of corporate law for guidance, rather than the product of an unelected think tank whose drafters lack the powerful incentives to get it right to which the Delaware legislature and courts are subject.[24]

Accordingly, I quipped on Twitter that:

We don't need a Restatement of Corporate Governance. We already have one. Folk on the Delaware General Corporation Law: Fundamentals, 2021 Edition . . ..[25]

Either the Restatement of Corporate Governance will restate Delaware law (in which case who needs it) or it will not restate the law but rather propose changes (in which case it will be ignored).[26]

 

Another Comment on Eric Orts' Comment on the ALI's Restatement of Corporate Purpose: Do Constituency Statutes Allow Consideration of Environmental Factors?

A few days ago, I directed your attention to a short article by Professor Eric Orts at the CLS Blue Sky Law Blog, in which he criticized the corporate objective provision of the forthcoming Restatement of the Law of Corporate Governance. (Go read Orts' article and come back.) As I noted, the article is thoughtful, as is typical of Professor Orts' work, for which I have considerable respect, but I disagreed with a couple of points (as is often the case because we have rather different normative priors).

I've decided to do an article on the Restatement provision and in working on it today, I realized I had a couple of other thoughts about Professor Orts' article. In a prior post, I addressed his criticism of the framing of the Restatement's approach whether directors may depart from shareholder value maximization norm. In this post, I address his criticism of the Restatement drafters' treatment of so-called constituency statutes.

The Restatement expressly splits out what it calls “stakeholder jurisdictions” from what it calls “common-law jurisdictions.”[1] Since Pennsylvania adopted the first constituency statute in 1983,[2] thirty states have adopted constituency statutes (a.k.a. non-shareholder constituency statutes or stakeholder statutes).[3] Although the details vary somewhat, the statutes generally authorize directors to consider various factors other than shareholder value maximization when making corporate decisions.[4] Massachusetts’ statute is typical:

(a) A director shall discharge his duties as a director, including his duties as a member of a committee: . . . (3) in a manner the director reasonably believes to be in the best interests of the corporation. In determining what the director reasonably believes to be in the best interests of the corporation, a director may consider the interests of the corporation’s employees, suppliers, creditors and customers, the economy of the state, the region and the nation, community and societal considerations, and the long-term and short-term interests of the corporation and its shareholders, including the possibility that these interests may be best served by the continued independence of the corporation.[5]

The Principles’ drafters did not address these statutes, instead relegating them to the comments, where the drafters opined that “it is clear that such statutes can be interpreted so as to be consistent with § 2.01.”[6]

In the Restatement, constituency statutes are promoted to the black letter law. Oddly, however, the black letter text of § 2.01(a)(2) suggests that in states with a constituency statute it is only licit for directors to consider the interests of various constituencies.[7] As even a cursory reading of the Massachusetts statute suggests, however, the name constituency statutes is somewhat of a misnomer. Massachusetts allows directors to consider such factors as the economy of the state or nation and “societal considerations,” for example, neither of which fit within a conventional definition of constituency.[8] Thirteen other states contain similar provisions.[9]

In contrast, § 2.01(a)(1) explicitly contemplates that directors of corporations in common law jurisdictions may go beyond the interests of the corporation’s constituencies to consider environmental and ethical concerns.[10] This difference led Professor Orts to complain that Restatement § 2.01 “misinterprets the legal import of corporate constituency statutes in a manner that unduly narrows the discretion of corporate directors and managers.”[11]

For example, “the environment” and “ethical considerations” are explicitly included as allowable decision-making factors in common-law jurisdictions but omitted in stakeholder jurisdictions (§ 2.01(a)).  Surely corporate decisionmakers in stakeholder jurisdictions may also take account of environmental and ethical considerations even if they are not specified as stakeholder interests.[12]

I respectfully disagree with Professor Orts’ reading of the constituency statutes. The factors most commonly authorized for director consideration by the statutes are the long-term interests of the corporation, firm profitability, growth prospects, employees, customers, supplies, creditors, and communities.[13] No state explicitly lists the environment as a factor directors are authorized to continue.[14] Only 10 states authorize directors to consider “any other appropriate factors,”[15] which may implicitly authorize consideration of environmental concerns. In this regard, the Restatement drafters got the law right.

Another Comment on Eric Orts' Comment on the ALI's Restatement of Corporate Purpose: Can Directors Act Ethically Without Regard to Profit?

A few days ago, I directed your attention to a short article by Professor Eric Orts at the CLS Blue Sky Law Blog, in which he criticized the corporate objective provision of the forthcoming Restatement of the Law of Corporate Governance. (Go read Orts' article and come back.) As I noted, the article is thoughtful, as is typical of Professor Orts' work, for which I have considerable respect, but I disagreed with a couple of points (as is often the case because we have rather different normative priors).

I've decided to do an article on the Restatement provision and in working on it today, I realized I had a couple of other thoughts about Professor Orts' article. In this post, I address his criticism of the framing of the Restatement's approach whether directors may depart from shareholder value maximization norm.

The ALI's 1994 Principles of Corporate Governance  § 2.01(b) obliged the corporation to obey the law, allowed it to consider appropriate ethical concerns, and allowed to engage in philanthropic activities, in all cases even if doing do did not promote shareholder value or corporate profit. In contrast, in Restatement § 2.01, engaging in philanthropic activities is the only action expressly permitted “whether or not doing so enhances the economic value of the corporation.”[1] The framing by the Restatement’s drafters led Professor Orts to object that:

Allowing only an “economic objective” forces out any ethical or environmental consideration that does not technically qualify as a long-term economic rationalization.  The Restatement’s § 2.01 departs from the recognition in the Principles that ethical considerations may conflict with the economic objective, and that directors and officers may nevertheless follow their consciences in these situations.  (Principles, § 2.01 & cmt. h.)  Even Milton Friedman, a famous (or infamous) champion of the economic objective in business corporations, conceded that profit-seeking must “conform[] to the basic rules of the society, both those embodied in law and those embodied in ethical custom.”  To employ an updated example, doing the right thing with respect to the climate emergency may require a particular firm (such as a big oil company) to sacrifice some profits even as calculated over the long term. The Restatement’s § 2.01 seems instead to require big oil companies to maximize their long-term profits even it means burning our planet beyond all recognition.  It seems also to require a corporation adopting an anti-racist personnel policy to justify it with an economic or “business case” rationale rather than an appeal to an ethics of mutual respect and equal treatment.[2]

It seems unlikely, however, that the drafters intended thereby to effect any substantive change vis-à-vis the Principles. Comment e to § 2.01, for example, states without limitation to specific jurisdictional types that “corporations may take into account their effects on the environment, as well as the social impact of their operations.”[3] Comment e also states that “the economic objective does not imply that the corporation must extract the last penny of profit out of every transaction in which it is involved.” Illustration 6 states that in all jurisdictions it would be licit for a corporation to adopt a mission statement committing the company “to creating a sustainable, low-carbon future, advancing equality and diversity, and fostering employee success.”[4] Illustrations 27 and 28 both involve hypothetical oil companies that voluntarily reduce oil production claiming that doing so will both save the planet and be profitable in the long term.[5] In both, the drafters conclude that § 2.01 is not violated.[6] Given that the business judgment rule almost certainly would protect an informed decision by the board that the reduction would produce sustainable, long-term profits,[7] Professor Orts’ concern seems misplaced.

 

A Comment on Eric Orts' Comment on the ALI's Restatement of Corporate Purpose

The American Law Institute has just published the first tentative draft of its new Restatement of the Law of Corporate Governance. Tentative Draft Number 1 is incomplete, but includes a foundational statement on corporate purpose. Section 2.01 is entitled "The Objective of a Corporation" and states that:

(a) The objective of a corporation is to enhance the economic value of the corporation, within the boundaries of the law;

(1) in common-law jurisdictions: for the benefit of the corporation’s shareholders. In doing so, a corporation may consider:

(a) the interests of the corporation’s employees;

(b) the desirability of fostering the corporation’s business relationships with suppliers, customers, and others;

(c) the impact of the corporation’s operations on the community and the environment; and

(d) ethical considerations related to the responsible conduct of business;

(2) in stakeholder jurisdictions: for the benefit of the corporation’s shareholders and/or, to the extent permitted by state law, for the benefit of employees, suppliers, customers, communities, or any other constituencies.

(b) A corporation, in the conduct of its business, may devote a reasonable amount of resources to public-welfare, humanitarian, educational, and philanthropic purposes, whether or not doing so enhances the economic value of the corporation.

As regular readers know, I have been working a lot on corporate purpose over the last two years, so I will have much more to say about the ALI draft as we go forward. Today, I want to direct your attention to a short article by Professor Eric Orts at the CLS Blue Sky Law Blog. (Go read it and come back.) The article is thoughtful, as is typical of Professor Orts' work, for which I have considerable respect, but I disagree with at least a couple of points (as is often the case because we have rather different normative priors).

First, I am far less certain than he that it is possible for corporations to opt out of the shareholder value maximization principle via the articles of incorporation. In fact, that question has been the subject of considerable debate. See, e.g., Joan MacLeod Heminway, Shareholder Wealth Maximization As A Function of Statutes, Decisional Law, and Organic Documents, 74 Wash. & Lee L. Rev. 939, 957 (2017) (arguing that “a charter provision that is inconsistent with the shareholder wealth maximization norm should be valid”); Stefan J. Padfield, The Role of Corporate Personality Theory in Opting Out of Shareholder Wealth Maximization, 19 Transactions: Tenn. J. Bus. L. 415, 439 (2017) (suggesting that “Chancellor Chandler’s comments in the eBay decision suggest that” efforts to opt out of shareholder value maximization may be unavailing). My own view at one time was that “state law arguably does not permit corporate organic documents to redefine the directors’ fiduciary duties.” Stephen M. Bainbridge, Interpreting Nonshareholder Constituency Statutes, 19 Pepp. L. Rev. 971, 985 (1992). Today, however, my view is that it is a question that has been essentially mooted by the availability of the public benefit corporation (PBC) option.

The benefit corporation point leads to my second disagreement. As I read Professor Orts’ analysis, he suggests that we should understand the widespread adoption of PBC statutes as being pertinent to understanding the duties of directors and officers of business corporations incorporated under a state’s general business corporation law. If so, I disagree.

Although it has not done so to date, the widespread availability of PBCs as an alternative to the traditional business corporation could alleviate the growing pressure on the latter to pursue ESG, since they provide an alternative by which social justice activists can pursue their ESG goals while still making a profit. In any case, the widespread adoption of PBC statutes confirms that shareholder value maximization—i.e., Dodge v. Ford Motor Co.—is corporate law’s general rule. After all, if Dodge were not the law, PBCs would be unnecessary. Boards of business corporations would be free to pursue public benefits without violating their fiduciary duties. The perceived need for PBC statutes suggests that boards are not free to do so absent the statute.

The drafters of the California PBC statute presumably had such an argument in mind when they including the following qualification in the statute: “The existence of a provision of this part shall not of itself create any implication that a contrary or different rule of law is or would be applicable to a business corporation that is not a benefit corporation.” Cal. Corp. Code § 14600 (b).

Some more skeptical thoughts about the American Law Institute's planned Restatement of Corporate Law

A while back I noted that the American Law Institute is going to try writing a Restatement of the Law of Corporate Governance. I was skeptical.

Some thoughts: First, a restatement that applies to both closely held corporations and public corporations is unlikely to be successful. I refer you to my mentor Michael Dooley who argued that:

. . . the participants in a firm must have some governance structure to determine three basic questions. First, what are the general sorts of adaptive decisions that will need to be made over time? Second, what general normative principle guides decision making—that is, for whose benefit are decisions to be made? And, third, who, within the firm, shall make the adaptive decisions?

The answer to the second question is the same for all capitalist firms: decisions are to be made to benefit the interests of the residual claimants because maximizing their wealth necessarily maximizes the wealth of the coalition. The first and third questions are closely related, but their answers differ depending on salient characteristics of the type of firm in question.

In most general partnerships and closely held corporations, there is no functional distinction between management and residual claimants because the same persons perform both functions. Thus, all adaptive decisions, whether routine or extraordinary, are made by the residual claimants. In publicly held corporations, however, management and residual claimants have sharply differentiated functions. This distinction is codified in all corporations statutes by provisions similar to section 8.01(b) of the Revised Model Business Corporation Act: “All corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation managed under the direction of, its board of directors, subject to any limitation set forth in the articles of incorporation.”

The different decision-making structures prescribed for partnerships and closely held corporations, on the one hand, and publicly held corporations, on the other, result only partially from the number of putative decision makers involved in the respective types of firms. The characteristics that primarily dictate the choice of decision-making structure are the similarities in information and interests of the decision makers. Thus, if all partners actively participate in the management of the business, each partner should have (or, at least, be exposed to) the same facts necessary to make adaptive decisions. And since all partners are residual claimants, each has the same interest, namely, increasing the size of the residual interest. Under these conditions, an elaborate decision-making structure is unnecessary because the partners will tend to reach agreement informally and largely by consensus. Not only is this aspect of partnership governance the one that is most frequently observed,¹⁹ it is also the one predicted by Kenneth Arrow's theories of organizational decision making. According to Arrow, where an organization's decision makers have identical information and interests, decisions will be reached by “Consensus” because each participant, voting in his or her own self-interest, will naturally select the course of action preferred by the others.²¹

Where information and interests differ, however, it is obviously infeasible to involve all participants in the decision-making process. Given the normative goal of increasing the size of the residual interest, it makes sense to confer decisive authority on the residual claimants in a partnership, but only because the partners are also the active managers of the firm. Where the residual claimants are not expected to run the firm and especially when they are many in number (thus increasing disparities in information and interests), their function becomes specialized to risk-bearing, thereby creating both the opportunity and necessity for managerial specialists. Again as Arrow predicts, where information and interests differ, the residuals will no longer either be able or inclined to reach decisions that are in the best interests of their group. Instead, it will become “cheaper and more efficient to transmit all the pieces of information once to a central place” and to have the central place “make the collective decision and transmit it rather than retransmit all the information on which the decision is based.”

Arrow calls this latter decisional structure “Authority” . . ..

 ^{______________}

¹⁹ It is significant that the default governance rule for partnerships provides for equal participation in management by the partners. See Unif. Partnership Act § 18(e) (1914). Many state corporations statutes permit close corporation shareholders to adopt a partnership-like governance structure by dispensing with the board of directors and assuming direct shareholder control of the business. See, e.g., Del.Code Ann. tit. 8, § 351 (1991). The Revised Model Business Corporation Act has recently been amended to provide even greater flexibility by authorizing the use of unanimous shareholder agreements to tailor the corporation's governance structure to the shareholders' particular needs. See Rev. Model Business Corp. Act § 7.32. This procedure gives close corporation shareholders the same amount of self-determination regarding governance as is available under the Uniform Partnership Act. See generally Committee on Corporate Laws, Changes in the Revised Model Business Corporation Act—Amendments Pertaining to Closely Held Corporations, 46 Bus.Law. 297 (1990).

²¹ See generally Kenneth J. Arrow, The Limits of Organization (1974).

Michael P. Dooley, Two Models of Corporate Governance, 47 Bus. Law. 461, 466–67 (1992). A Restatement of Public Corporate Law must grapple with the value of authority. In turn, that means you have to grapple with the tradeoff between authority and accountability that drives my work on director primacy:

The director primacy account of corporate governance begins with the observation that the size and complexity of the public corporation ensures that stakeholders face significant collective action problems in making decisions, suffer from intractable information asymmetries, and have differing interests. Under such conditions, consensus-based decision-making structures are likely to fail. Instead, it is cheaper and more convenient to assign the decision-making function to a central decision maker wielding the power to rewrite intra-corporate contracts by fiat.

Stephen M. Bainbridge, Why the North Dakota Publicly Traded Corporations Act Will Fail, 84 N.D.L. Rev. 1043, 1046 (2008).

Second, if the Restatement does track Delaware law, there is a serious irony here. Dooley was active in leading the opposition to the first effort. Mike was the Reporter for the Model Business Corporation Act and helped lead  the ABA Business Law Section’s Ad Hoc Committee on the ALI Corporate Governance Project (known as “CORPRO”). One of CORPO’s main goals was to move the Project TOWARDS Delaware law. See, e.g., Michael P. Dooley & E. Norman Veasey, The Role of the Board in Derivative Litigation: Delaware Law and the Current Ali Proposals Compared, 44 Bus. Law. 503 (1989). For example, “the procedures governing derivative suits gradually moved toward the Delaware position, as did the substantive provisions governing interested-director transactions.” Stephen M. Bainbridge, Independent Directors and the Ali Corporate Governance Project, 61 Geo. Wash. L. Rev. 1034, 1043 (1993).

Third, one of the core problems with the first effort was that it did not restate Delaware law. If you’re going to restate public corporation law, you have to restate Delaware law. But the first effort was managed by Mel Eisenberg—one of the giants of the corporate law academy in the latter part of the 20^th Century, for whom I had great admiration—and who bought into the race to the bottom thesis that Delaware law is pure evil. As a result, “Unlike previous restatements prepared by the American Law Institute, the Corporate Governance Project undertook not only to restate the laws governing the internal affairs of corporation, but also to make recommendations on what corporate law should provide and what would be considered good corporate practice.” Elliott Goldstein, Future Articulation of Corporation Law, 39 Bus. Law. 1541 (1984). That approach drove much of the opposition which eventually led the reporters to admit that they were not restating the law, which resulted in the change of name from restatement to Principles. See Dooley, supra, at 493 (noting that the draft document “no longer purports to restate the law”). If you’re going to restate Delaware law, why bother? We have several very fine treatises on Delaware law. In addition, whose word are you going to take on the content of Delaware law: the members of the Delaware judiciary or a bunch of academics and lawyers?

Which brings me to my main concern about the current project. A number of the members of the committee are well known critics of Delaware law and, in some cases, known proponents of federalizing corporate law. Indeed, a number of folks on the committee are among the academics Leo Strine famously accused of pretending that they knew the law of Delaware (re corporate purpose) better than the Delaware judiciary. See Honorable Leo E. Strine, Jr., The Dangers of Denial: The Need for A Clear-Eyed Understanding of the Power and Accountability Structure Established by the Delaware General Corporation Law, 50 Wake Forest L. Rev. 761, 788 (2015) (“Rather than pretend that the law is already what they wish it to be, advocates of change should take on the harder work involved in real reform.”). All honorable folks, but not who I would want to undertake a restatement of Delaware law rather than a running critique thereof.

The American Law Institute is going to try writing a Restatement of Corporate Governance. Again. Oh joy.

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.