Other People's Money
48 Pages Posted: 27 Sep 2007 Last revised: 13 Oct 2008
There is no more sacred tenet of corporate law than the one stating that corporate directors owe a fiduciary duty to shareholders. We argue that while this rule has not yet generated seriously wrongheaded outcomes, it is an "almost right" principle that should be abandoned before it does. As a threshold matter, we show the notion of special duties owed to shareholders is plainly inconsistent with everyday business decisions and corporate law. Firms can take and do take actions that are inconsistent with those of a fiduciary and that favor creditors at the expense of shareholders, despite supposedly trumping fiduciary duties owed to the latter. A bankruptcy filing is the most obvious of these.
The recent cases in Delaware over fiduciary duties in the "zone of insolvency" demonstrate how the attempt to delineate clearly what duties are owed to different investors in a firm is doomed to fail. Using Credit Lyonnais and its predecessor Central Ice Cream, we show how courts are attuned to the problem of conflicting interests among different investors, but are not likely to create efficient rules by using labels like "fiduciary duties" and applying them to shareholders sometimes and creditors other times.
We offer two potential replacements for the shareholder fiduciary duty doctrine. The most familiar for corporate scholars and practitioners is the idea of fiduciary duties being owed to the firm as a whole, coupled with a strong business judgment rule. Although we think this is superior to the existing rule, we show how this principle itself may be wanting in some important cases. In venture capital transactions, for one, the ex ante bargain appears to give certain investors the right to take actions in bad states of the world that may destroy firm value in order to create incentives for managers to avoid those bad states. Courts disrupting these deals in the name of fiduciary duties may be upsetting well struck bargains.
We therefore set out an alternative paradigm, one in which no fiduciary duties exist at all, and directors face liability for their decisions (other than for neglect or surreptitious self-dealing) only if they violate a contractual obligation owed a shareholder, creditor, or other investor. We conclude by showing how separating corporate law from conceptions of duty brings needed clarity to the often-litigated issue of disclosure duties. The problem, we suggest, is largely contractual, and in setting the default rules the focus should be on the ability of parties to opt outor opt in.
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By Harvey Gelb