Freedom of Contract and the Publicly Traded Uncorporation

Abstract

Over the past decade, individual investors have poured hundreds of billions of dollars into publicly traded companies that have opted-out of traditional fiduciary duties. These publicly traded “uncorporations” are organized as limited partnerships or limited liability companies, and many are governed by operating agreements that eliminate the fiduciary duties of managers and controlling equityholders. Advocates for the contractarian approach to fiduciary duties argue that parties should have the freedom opt-out of fiduciary duties and, instead, deploy contractual mechanisms for reducing agency costs. In 2004, Delaware fully integrated this contractarian approach to fiduciary duties into its alternative entity statutes, paving the way for today’s growing population of fiduciary-free public companies. Many other states followed. Yet, just over after a decade later, Delaware judges and commentators have begun to call for reintroduction of a mandatory fiduciary duty of loyalty. Although advocates for a mandatory duty of loyalty acknowledge the contractarian paradigm of contracting for substitutions, they argue that it is inapplicable in the context of publicly-traded companies, where robust contractual freedom leaves investors vulnerable to self-dealing and other misconduct. Advocates for reintroducing a mandatory duty of loyalty also argue that contractual freedom has led to sub-optimal levels of standardization with regard to the terms that govern these entities.

As argued in this Article, the forces that shape state business lawmaking (in particular Delaware’s) make legislative adoption of a mandatory fiduciary duty of loyalty unlikely. Neither jurisdictional competition nor internal interest group dynamics will encourage the legislature to take this step and, in fact, make maintenance of the status quo more likely.

This Article offers an alternative approach that reflects a new model for business lawmaking in the era of contractual freedom. With information available about commonly adopted governance structures and terms, their coherence in light of the circumstances under which these entities operate, and the ways that investors are routinely left vulnerable, it is possible to design a set of standardized terms that capture the benefits of contractability while also providing investors with additional protection where needed. Importantly, achieving widespread adoption of standardized terms would not require state lawmakers to negate their commitments to contractual freedom. Recent empirical and theoretical work on the role of statutory menus indicates that widespread adoption can be achieved even if the standardized terms are not mandatory.

Keywords: alternative entities, contractual freedom, private ordering, limited partnership, limited liability company, master limited partnership