Contractarian Theory and Unilateral Bylaw Amendments

38 Pages Posted: 29 Aug 2017 Last revised: 2 Jul 2018

Albert H. Choi

University of Virginia School of Law

Geeyoung Min

Columbia Law School

Date Written: June 29, 2018

Abstract

Corporate directors have been utilizing a potent mechanism in dealing with shareholder activism and shareholder litigation: the right to unilaterally amend corporate bylaws. Directors have exercised this right, for instance, to impose various requirements on who can nominate a director or call a special shareholder meeting, or to designate an exclusive forum where the shareholders can bring suit. Based on the theory that corporate charters and bylaws constitute a “contract” between the shareholders and the corporation, courts have blessed many of the bylaws that directors have unilaterally adopted. This Article examines the contractarian theory by drawing a parallel between amending charters and bylaws on the one hand, and amending contracts on the other; and by comparing the right to unilaterally amend corporate bylaws with the right to unilaterally modify contracts. The Article shows how contract law imposes various limitations on the modifying party’s discretion. The Article also compares the standard contractual relationship with that of the shareholders and the corporation more generally and uncovers several important differences that could make shareholders (particularly, minority shareholders) more vulnerable to counterparty (directors’ and controlling shareholder’s) opportunism. For example, unlike contracting parties who have the right to terminate the contractual relationship or opt out of undesirable modifications, shareholders lack the right of termination or opt-out. As a possible solution, the Article considers various mechanisms, including giving the shareholders the right of optional redemption, more robust disclosure, the right to vote (including the right to elect or replace directors), and subjecting bylaw amendments to more active judicial oversight. The Article suggests that active judicial oversight, through the vigorous application of the proper and equitable purpose test or imposition of good faith and fair dealing obligations, would be better in retaining the desired flexibility and policing directors’ and controlling shareholder’s opportunism.

Suggested Citation

Choi, Albert H. and Min, Geeyoung, Contractarian Theory and Unilateral Bylaw Amendments (June 29, 2018). Iowa Law Review, Vol. 104, 2018, Forthcoming; U of Penn, Inst for Law & Econ Research Paper No. 17-37. Available at SSRN: https://ssrn.com/abstract=3024873

Albert H. Choi (Contact Author)

University of Virginia School of Law ( email )

580 Massie Road
Charlottesville, VA 22903
United States

Geeyoung Min

Columbia Law School ( email )

435 West 116th Street
New York, NY 10027
United States

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