The role of aspiration in corporate fiduciary duties.
Corporate law is characterized by a pervasive divergence between standards of conduct and standards of review. Courts often opine on the relatively demanding standard of conduct, but their judgments must be based on the more forgiving standard of review. Commentators defend this state of affairs by insisting that it provides guidance to directors without imposing ruinous liability. However, the dichotomy can lead many, especially those who focus on the bottom line, to call into question the meaningfulness of standards of conduct. Of particular concern is the increasing popularity, in legal and scholarly circles, of the notion that fiduciary duty standards of conduct are aspirational and unenforceable. This theory, which I will call the "aspirational view," is misguided. The use of the term "aspirational" is especially problematic. Whatever else "aspirational" may mean, it does not mean obligatory or mandatory. Whether by design or only by effect, the aspirational view has the potential to undermine fiduciary duties significantly. In this Article, I will argue that fiduciary duty standards of conduct are in fact duties--fully binding on actors even when they are not enforced. I will also argue that the unenforced duty is a meaningful concept because people obey the law for many different reasons, and not simply out of fear of punishment.
TABLE OF CONTENTS INTRODUCTION I. THE ASPIRATIONAL VIEW A. Legal Scholarship B. The Disney Case C. Judges Writing Extrajudicially II. WHY THE DIVERGENCE? A. Acoustic Separation B. Room for Error III. BIFURCATION OR TRIPARTITION? A. Bifurcation B. Tripartition IV. STANDARDS OF CONDUCT ARE NOT MERELY ASPIRATIONAL A. Are Standards of Conduct Aspirational? B. The Viability of the Unenforced Requirement C. Is There Enforcement After All? CONCLUSION
A peculiar characteristic of corporate law is the divergence of standards of conduct and standards of review. (1) Standards of conduct are rules of behavior that tell actors what is expected of them. Standards of review, on the other hand, are rules of decision that tell judges how to adjudicate cases. In many areas of law, the two types of standards coincide. For example, in tort law, the standard of conduct is ordinary care, and the standard of review is negligence, which is generally defined as the lack of ordinary care. Intuitively, it makes sense for actors to be judged by the standards with which they are expected to comply. However, the two types of standards need not align. In corporate law, they do not.
Corporate law is characterized by a pervasive divergence between standards of conduct and standards of review. For example, with respect to the duty of care, directors are expected to act with ordinary care, but judges will review their actions not for negligence, but for gross negligence. (2) Likewise, with respect to the duty of loyalty, directors are expected to act without conflicts of interests, but judges will review their actions for fairness, and only if there is a financial conflict of interest that rises to the level of self-dealing. (3) It is similar for the duty of good faith: directors are expected to honestly pursue the interests of the corporation and its shareholders, but judges will review their actions for intentional misconduct. (4) The wisdom of this divergence may be debatable, but its existence is not.
Courts often will speak of fiduciary duties in lofty terms but generally do not follow up with enforcement action. Ultimately, claims of breach of fiduciary duty rarely lead to liability for directors. This is a predictable consequence of the divergence. Courts often opine on the relatively demanding standard of conduct, but their judgments must be based on the more forgiving standard of review. Commentators defend this state of affairs by insisting that it provides guidance to directors without imposing ruinous liability. (5) However, the dichotomy can lead many, especially those who focus on the bottom line, to call into question the meaningfulness of standards of conduct.
Of particular concern is the increasing popularity, in legal and scholarly circles, of the notion that fiduciary duty standards of conduct are aspirational and unenforceable. This theory, which I will call the "aspirational view," is misguided. The use of the term "aspirational" is especially problematic. "Aspiration" is generally defined as "[a] strong desire for high achievement" (6) or "[a] fervent hope, wish, or goal"; (7) synonyms include "ambition," "hope," "dream," and "ideal." (8) Perhaps the term is intended to elevate fiduciary duties by appealing to grand moral ideals. Its actual effect, however, is to debase fiduciary duties by rendering them optional and perhaps even unachievable. After all, whatever else "aspirational" may mean, it does not mean obligatory or mandatory. That standards of conduct are sometimes described not only as unenforced but unenforceable only reinforces this impression. I believe that the growing popularity of the aspirational view presents a dangerous development that ought to be arrested. Whether by design or only by effect, it has the potential to undermine fiduciary duties. To the extent that fiduciary duties are not enforced by courts, they depend upon voluntary compliance. Presumably, greater compliance can be expected for mandatory rules than for optional ones. (9) Thus, moving fiduciary duties from the former category into the latter likely would have negative consequences: if directors come to believe that standards of conduct are aspirational rather than mandatory, and therefore optional, they can be expected to reduce compliance over time.
In this Article, I will argue that the aspirational view is misguided and that fiduciary duty standards of conduct are duties--fully binding on actors even when they are not enforced. My argument will proceed as follows. In Part I, I will provide examples of the aspirational view in both judicial opinions and corporate law scholarship. In Part II, I will explore the justification for the divergence between standards of conduct and standards of review in corporate law. I will explore two theories: the acoustic separation theory, and what I call the room-for-error theory. Although the acoustic separation theory might support the aspirational view, it is deeply problematic and has not been adopted by the courts. The room-for-error theory is a more solid justification for the divergence and is the theory on which the courts and most scholars rely. This theory provides greater support for the mandatory view of fiduciary duties.
In Part III, I will argue that this divergence does not result in a bifurcation of fiduciary duties, as is commonly believed, but rather a tripartite division. First, standards of review create a minimum threshold for liability: conduct that is sufficiently egregious will lead to liability whereas less offensive conduct will not. Second, standards of conduct create a separate threshold: they distinguish between conduct that is required by law and conduct that is not. In other words, standards of conduct include behavior that is required by law but not legally enforced. Third, beyond standards of conduct, there is behavior that is praiseworthy and ought to be encouraged, but which the law does not specifically require. This, I will argue, is the realm of aspiration. Best practices are a possible example: generally, fiduciaries ought to consider following best practices, but they are not necessarily required to do so. Thus, fiduciary duties are not bifurcated between standards that are enforced and those that are merely aspirational. Rather, there is a third category, which is often overlooked, that comprises standards that are required but not enforced.
In Part IV, I will defend this tripartite division and the mandatory view of fiduciary duties. First, I will argue that fiduciary duty standards of conduct are not inherently aspirational and unenforceable. Although courts, at times, describe fiduciary duties in lofty terms, they generally articulate standards of conduct that are quite mundane and perfectly enforceable. Second, I will defend the concept of the unenforced duty--which is, essentially, the heart of the standard of conduct. I will argue that it is a meaningful concept because people obey the law for many different reasons, and not simply out of fear of punishment. Finally, I will propose the view that fiduciary duties are not unenforced after all, but only imperfectly enforced--a fate shared by all laws.
As I hope to demonstrate, the fundamental flaw of the aspirational view is that it conflates unenforced duties with aspirational ideals. According to the aspirational view, a fiduciary's duty of care is merely to avoid gross negligence; to avoid negligence is merely aspirational. This is much too little to expect and demand of directors. Fiduciaries are supposed to be held to a higher standard because of their position of trust, but under this view, they are actually held to a much lower standard than the average person. Strangers generally owe each other a duty to avoid negligence, yet such conduct is considered aspirational for directors. This cannot be correct. For good reasons, we may not hold directors accountable for failure to meet the standard of conduct. However, we cannot pretend that the standard of review satisfies the role of the standard of conduct and that the standard of conduct is merely aspirational.
I. THE ASPIRATIONAL VIEW
The divergence between standards of conduct and standards of review in corporate law raises an important question: what are we to make of standards of conduct? Standards of review are fairly straightforward: they are the law as enforced. But standards of conduct are not enforced. This can lead one to question what they represent.
There are two obvious, competing theories. The first I shall call the "mandatory view." It maintains that standards of conduct are mandatory rules of law that are binding upon fiduciaries even if they are not legally enforced. A prominent proponent is Professor Melvin Eisenberg, whose work highlighted the divergence in corporate law. Despite the lack of enforcement, Eisenberg insists that "[s]tandards of conduct in corporation law are neither meaningless nor merely aspirational. Rather, they are legal rules intended to control behavior." (10) This is my position as well. I shall call the alternative theory the "aspirational view." It does not consider standards of conduct to be law in the strict sense because they are not subject to legal enforcement. Standards of conduct are not seen as mandatory rules but rather as aspirational and unenforceable. As between the two theories, the mandatory view is the more traditional one. Corporate law has developed under the implicit assumption that standards of conduct are, in fact, law. The aspirational view is becoming increasingly popular, however, and it deserves attention.
In this Part, I will illustrate the aspirational view by reference to legal scholarship and judicial opinions. Unfortunately, the aspirational view remains somewhat inchoate, and no straightforward manifesto exists to illustrate it perfectly. Many of the authors may not be focused on the precise issue that is the subject of this Article. Moreover, much of the terminology at issue is inherently ambiguous. For example, even the key term, "standards of conduct," is not limited to its meaning in the context of fiduciary duties; any norm can be considered a standard of conduct. Thus, we must review the writings of others with care. What follows is intended to be more illuminating than probative. Nevertheless, to varying degrees even if not always intentionally--the writings discussed in this Part create the impression that compliance with fiduciary duty standards of conduct is not mandatory.
A. Legal Scholarship
The aspirational view has its origins in academic legal scholarship and can best be illustrated by reference to it. The works of scholarship considered below are varied in nature. Some focus on the issue in depth, whereas others deal with it in passing. Likewise, some emphasize the aspirational nature of standards of conduct, and some emphasize their unenforceability. Although there is no single, clear statement of the aspirational view, it comes across to varying degrees in each of the following works.
An example in which the issue is dealt with more or less in passing can be found in an article written by Professor John Coffee. (11) In the article, Coffee confronts a perceived overuse of the criminal law and addresses the criminalization of fiduciary duty law through wire and mail fraud statutes. (12) In the course of the discussion, he describes the language of fiduciary duties as "soft-edged and aspirational." (13) He goes on to say that standards of conduct "can never be fully realized nor even defined with specificity in advance." (14) Although they may seem plausible enough in context, these claims are actually unsupported assertions. Moreover, they strongly suggest that standards of conduct are not only nonmandatory but also inappropriate for enforcement and possibly even unachievable ideals. Such casual statements are dangerous because they can be readily accepted, easily repeated, and even emphasized by others. (15)
A more thorough exploration of the issue can be found in the work of Professor Edward Rock. Rock has argued that corporate governance operates largely through informal and/or nonlegal sanctions. (16) He notes that corporate law decisions "sometimes impose legal sanctions but surprisingly often do not." (17) Ultimately, "the principal sanction is not directly financial but reputational." (18) He also believes that judicial opinions on corporate law matters "can best be thought of as 'corporate law sermons," (19) and suggests that it would be better to "think of judges more as preachers than as policemen." (20) Although Rock does not use the word " aspirational" to describe fiduciary duties, it is clearly the import of his theories. After all, the terms "sermons" and "preachers" sound much less mandatory than do "legal decisions" and "policemen."
In another work, coauthored by Professor Michael Wachter, Rock has developed the argument further. (21) Rock and Wachter claim that "the raison d'etre of firms is to replace legal governance of relations with nonlegally enforceable governance mechanisms (what are sometimes called 'norms')." (22) Under this view, "corporate law emerges as a remarkably sophisticated mechanism for facilitating self-governance by NLERS"--that is, "nonlegally enforceable rules and standards." (23) "In other words, in this model, the boundary of the firm is a jurisdictional boundary chosen by the participants." (24) Thus, according to Rock and Wachter, fiduciary duties truly are, and ought to be, largely unenforceable. (25)
In a recent article, Professors Claire Hill and Brett McDonnell have argued that "extra-legal forces, particularly non-binding pronouncements of the Delaware judiciary, are a critical adjunct to corporate law." (26) According to them, "[l]aw, in its traditional sense, is ... not fully able to do what the corporation and its shareholders need it to do: make agents live up to their fiduciary duty to act with undivided loyalty to their principals." (27) It is therefore necessary to "invoke extra-legal forces such as reputation." (28) This is done by means of what they call the "penumbra of Delaware corporate law," (29) which they define as "extra-legal forces ... that extend Delaware corporate law significantly beyond law on the books as enforced." (30) Included in the penumbra are "non-binding pronouncements of the Delaware judiciary" (31)--that is, standards of conduct.
Although they do not use the term, aspiration plays an important role in Hill and McDonnell's theory. According to them, "what is 'required' or indeed routinely done on account of what is in the penumbra, is not the same as what is required and routinely done under law." (32) Although they believe that the penumbra operates as "an important influence on corporate director behavior" (33) through "reputational and norm-following mechanisms," (34) they are not legally enforceable. Indeed, standards of conduct are explicitly labeled as "non-binding" (35) and are not considered "[l]aw, in its traditional sense." (36) Thus, for Hill and McDonnell, compliance with standards of conduct seems much more aspirational than mandatory.
Finally, Professors Margaret Blair and Lynn Stout have done some important work on the issue of trust in corporate law. (37) Although they do not explicitly refer to fiduciary duties as aspirational, their work takes on this tenor. After a thorough exploration of the concept of trust and a review of the experimental evidence, the authors turn their attention to "three enduring puzzles in corporate scholarship." (38) First, on the "nature and meaning of the concept of fiduciary duty," they conclude that "the essence of a fiduciary relationship is the legal expectation that the fiduciary will adopt the other-regarding preference function that is the hallmark of trustworthy behavior." (39) Second, they explain the divergence between standards of conduct and standards of review (40) as follows: "By articulating a social expectation that directors will exercise due care, judicial opinions on the duty of care may influence directors' behavior not so much by changing their external incentives as by changing their internal preferences." (41) Third, with respect to the role of trust and cooperation in corporate law, they conclude that "using legal rules, including contract, to discourage opportunistic behavior can, in some situations, be not only unnecessary but counterproductive, increasing the likelihood of the very sort of misbehavior against which it was intended to protect." (42)
Evident throughout the work is a shift in emphasis from the enforceable legal requirement to the internalized moral duty. In fact, they define trust as "internalized trust," which does not include "calculative behavior motivated by external rewards or sanctions" of any kind, whether legal, market, or social in nature. (43) For them, internalized trust is "a taste or preference for behaving trustworthily" (44)--essentially, a moral virtue. To the extent that Blair and Stout emphasize trust, they deemphasize law. (45) This is at least consistent with the aspirational view of fiduciary duties and probably also an argument against the mandatory view.
B. The Disney Case
The aspirational view of fiduciary duties has not yet worked its way into the law, but evidence of it can be found in some judicial opinions. The most important case in which this has happened is the Disney case. This case has led to many judicial opinions, three of which are especially relevant to the current discussion. The first, Brehm v. Eisner, is the first Delaware Supreme Court opinion in the case; (46) the second, In re Walt Disney Co. Derivative Litigation, is the chancery court's opinion after the trial; (47) the third, also titled In re Walt Disney Co. Derivative Litigation, is the Delaware Supreme Court's opinion upholding the trial court's decision. (48)
The facts of the Disney case are well known and described at length in the various judicial opinions, so only a brief summary will be presented here. Michael Eisner was the CEO of Disney. (49) The company was looking for an eventual successor for Eisner, and he chose his friend, David Ovitz. (50) Ovitz's employment agreement provided that, if he were terminated without cause, he would receive essentially the full benefits of his employment contract. (51) His employment with Disney did not work out very well, and, after only fourteen months, he was terminated without cause. (52) As a result, he received a termination payment in excess of $130 million. (53) Shareholders sued in a derivative action but were ultimately unsuccessful. (54)
Throughout its first opinion in the case, the Delaware Supreme Court made various statements that reflect the aspirational view. Perhaps the most noteworthy passage is the following:
This is a case about whether there should be personal liability of the directors of a Delaware corporation to the corporation for lack of due care in the decision-making process and for waste of corporate assets. This case is not about the failure of the directors to establish and carry out ideal corporate governance practices. All good corporate governance practices include compliance with statutory law and case law establishing fiduciary duties. But the law of corporate fiduciary duties and remedies for violation of those duties are distinct from the aspirational goals of ideal corporate governance practices. Aspirational ideals of good corporate governance practices for boards of directors that go beyond the minimal legal requirements of the corporation law are highly desirable, often tend to benefit stockholders, sometimes reduce litigation and can usually help directors avoid liability. But they are not required by the corporation law and do not define standards of liability. (55)
On its surface, this passage may seem unobjectionable. The court appears to be saying only that "[a]spirational ideals of good corporate governance practices ... are not required by the corporation law." (56) This is obviously correct: the law cannot and should not mandate aspirational ideals. However, closer examination reveals that the court was doing more than merely stating the obvious.
For example, the court described the "legal requirements of the corporation law" as "minimal." (57) Clearly, it must have been referring to the standard of review rather than the more expansive standard of conduct. Indeed, the court went on to state quite clearly that anything that goes beyond the "standards of liability" may be "highly desirable," "benefi[cial]," and "help[ful]," but it is "not required by the corporation law." (58) In other words, it is merely aspirational.
The significance of these statements is highlighted by the factual context of the case. The court dismissed the case on the pleadings even though it elsewhere admitted that this was "potentially a very troubling case on the merits," and that, "both as to the processes ... and the waste test, this [wa]s a close case." (59) For the facts to represent a "close case" with respect to the standard of review, they must have represented an easy case with respect to the standard of conduct. The directors' conduct, as alleged, was fairly egregious. (60) Nevertheless, the court characterized it as a mere failure to comply with "[a] spirational ideals of good corporate governance practices." (61) Although the court never explicitly stated that fiduciary duty standards of conduct are merely aspirational, it was obviously of that opinion.
The plaintiffs in the Disney case were given leave to amend the pleadings (62) and eventually were able to obtain a trial on the merits. (63) Ultimately, the court found in favor of the defendants. (64) In its opinion after the trial, the chancery court also opined on the role of aspiration in the law of fiduciary duties. Again, the most noteworthy passage is the following:
Unlike ideals of corporate governance, a fiduciary's duties do not change over time. How we understand those duties may evolve and become refined, but the duties themselves have not changed, except to the extent that fulfilling a fiduciary duty requires obedience to other positive law. This Court strongly encourages directors and officers to employ best practices, as those practices are understood at the time a corporate decision is taken. But Delaware law does not--indeed, the common law cannot--hold fiduciaries liable for a failure to comply with the aspirational ideal of best practices, any more than a commonlaw court deciding a medical malpractice dispute can impose a standard of liability based on ideal--rather than competent or standard--medical treatment practices, lest the average medical practitioner be found inevitably derelict. Fiduciaries are held by the common law to a high standard in fulfilling their stewardship over the assets of others, a standard that (depending on the circumstances) may not be the same as that contemplated by ideal corporate governance. Yet therein lies perhaps the greatest strength of Delaware's corporation law. Fiduciaries who act faithfully and honestly on behalf of those whose interests they represent are indeed granted wide latitude in their efforts to maximize shareholders' investment. Times may change, but fiduciary duties do not. Indeed, other institutions may develop, pronounce and urge adherence to ideals of corporate best practices. But the development of aspirational ideals, however worthy as goals for human behavior, should not work to distort the legal requirements by which human behavior is actually measured. (65)
This language is very different than that of the Delaware Supreme Court. There is no talk of "minimal legal requirements." (66) To the contrary, the court acknowledged that fiduciary duties impose a "high standard," which "(depending on the circumstances) may not be the same [standard] as that contemplated by ideal corporate governance." (67)
The aspirational view of fiduciary duties is nevertheless evident in the court's opinion. When the court spoke of "the legal requirements by which human behavior is actually measured," (68) it was referring to standards of review. Everything else, including standards of conduct, is lumped together as "aspirational ideal[s] of best practices." (69) Although the court "strongly encourage[d] directors and officers to employ best practices, as those practices are understood at the time a corporate decision is taken," it could not "hold fiduciaries liable for a failure to comply with the aspirational ideal of best practices." (70) Again, this is true even though the court specifically acknowledged that "there [were] many aspects of [the] defendants' conduct that fell significantly short of the best practices of ideal corporate governance." (71) The court clearly believed that standards of conduct are merely aspirational. When the court asserted that directors would "be found inevitably derelict" (72) if they were held liable for aspirational ideals, it was suggesting that standards of conduct are not only unenforceable, but even unachievable.
Moreover, the court made the unnecessary and questionable assertion that fiduciary duties "do not change over time." (73) Because the court also said that "the development of aspirational ideals ... should not work to distort the legal requirements by which human behavior is actually measured," (74) it seems the court believed that standards of review do not change over time. If this assertion were true, it would limit the reach of fiduciary duties considerably. The context of the assertion is also particularly significant. The court elsewhere explicitly acknowledged that societal expectations were changing as a result of the then-recent financial scandals at companies such as Enron and WorldCom. (75) Yet rather than point out that the conduct in Disney occurred before those scandals and therefore should not be judged by subsequent standards, the court insisted that fiduciary duties are unchanging. According to the court, the ever-increasing societal expectations of directors have no legal significance. In other words, standards of conduct remain aspirational forever.
On the final appeal, the Delaware Supreme Court upheld the trial court's decision. (76) Its opinion is fundamentally in line with the others. A particularly noteworthy passage is the following:
In our view, a helpful approach is to compare what actually happened here to what would have occurred had the committee followed a "best practices" (or "best case") scenario, from a process standpoint.... Had that scenario been followed, there would be no dispute (and no basis for litigation) over what information was furnished to the committee members or when it was furnished. Regrettably, the committee's informational and decisionmaking process used here was not so tidy. That is one reason why the Chancellor found that although the committee's process did not fall below the level required for a proper exercise of due care, it did fall short of what best practices would have counseled. (77)
Although the court's opinion never used the term "aspirational" and did not explicitly discuss standards of conduct and standards of review together, the aspirational view is evident throughout. When the court stated that "the committee's process did not fall below the level required for a proper exercise of due care," it was clearly referring to the standard of review. When the court said that "the committee's process ... f[e]ll short of what best practices would have counseled" and, elsewhere, that it "fell far short," (78) we can conclude that it did not satisfy the standard of conduct. The court, unfortunately, went on to say that the directors "breached no duty of care" (79) and had performed "adequately." (80) With respect to Eisner's conduct, the court used similar language: "Even though the Chancellor found much to criticize in Eisner's 'imperial CEO' style of governance, ... in the end, Eisner's conduct satisfied the standards required of him as a fiduciary." (81) Obviously, the court believes that standards of conduct are not mandatory; they are aspirational.
C. Judges Writing Extrajudicially
It is not uncommon for Delaware judges to engage in extrajudicial scholarship. The extent to which such scholarship should be used as an interpretive tool to help understand opinions written by such judges is an interesting question. There is no doubt, though, that judges writing off the bench can have a significant influence. In this Section, I will consider the writings of two important judges: the Honorable Norman Veasey, the former Chief Justice of the Delaware Supreme Court, and the Honorable William Allen, one of the most highly respected Chancellors in the history of the Delaware Chancery Court. (82)
Not surprisingly, Veasey's extrajudicial writings echo the opinion he authored for Brehm v. Eisner. For example, he insists that "the law of corporate fiduciary duties and remedies for violation of those duties are distinct from the aspirational goals of ideal corporate governance practices." (83) Throughout his writings, he is able to go into greater detail on the matter. On various occasions, he has written about the divergence between standards of conduct and standards of review, which he acknowledges "is implied in Delaware jurisprudence ... but is not well developed in the cases." (84)
For Veasey, standards of review are "the standards applied by courts to determine whether directors will be held liable for wrongdoing," (85) and standards of conduct are "the normative means, or best practices, by which directors should fulfill their functions." (86) Because standards of conduct do not necessarily lead to liability, (87) he often refers to them as aspirational. (88) Unlike the trial court in Disney, however, Veasey acknowledges that there can be some interaction between standards of conduct and standards of review:
[C]orporate law does, I believe, inform good corporate practices.... The same may be true in reverse. That is, modern trends in good corporate governance may become such well-established norms that the failure to follow the trends could conceivably result in liability in an egregious case. So good corporate practice may inform corporate law. (89)
Ultimately, Veasey believes that fiduciary duties are "dynamic, not static." (90) According to him, "The legal determination whether directors have acted in accordance with these fiduciary principles may change as extralegal expectations for directorial conduct change." (91) Veasey generally believes that "[c]odes of best practices ...--not judicial fiat--are the appropriate intracorporate vehicle" for reform. (92) Nevertheless, he also believes that "judges can and should perform a service by speaking out to encourage best corporate practices that could have a prophylactic benefit in minimizing the exposure of directors to liability." (93) He has offered a list of seven suggestions for good corporate practice, but has been explicit in stating that they are "offered as an aspirational matter only." (94)
Chancellor Allen has also expressed opinions consistent with the aspirational view of fiduciary duties. According to him, the law of fiduciary duties can be seen "as an expression of community ideals designed to inspire solidarity around certain values." (95) He suggests that "the duty of care [is] essentially aspirational: informing well-intentioned persons of what they should be doing in a most general way." (96) For Allen, this does not render fiduciary duties meaningless. This is because, Oliver Wendell Holmes's "bad man" philosophy notwithstanding, (97) people generally "obey law for reasons not fully accounted for by ... utilitarian calculus." (98) According to Allen, "there is some virtue to the judicial articulation of nonenforceable standards of conduct" because "most human beings place value on thinking of themselves as moral actors who live up to societal expectations." (99) He concludes that aspirational fiduciary duties can affect director behavior without an explicit enforcement mechanism.
In two works coauthored with Vice Chancellors Jack B. Jacobs--later made a Delaware Supreme Court Justice and Leo E. Strine, Jr., Allen has also suggested that standards of conduct are aspirational. In two separate articles, when discussing differences between standards of conduct and standards of review, the authors refer to standards of conduct, in passing, as "aspirational." (100) The lack of discussion suggests that they believe the characterization to be obvious and noncontroversial. At the very least, it can lead the reader to that conclusion.
II. WHY THE DIVERGENCE?
At the heart of the aspirational view of fiduciary duties--that is, the theory that standards of conduct are aspirational and unenforceable-is the divergence between standards of conduct and standards of review in corporate law. In order to determine whether the aspirational view is a sensible interpretation of this divergence, we must understand why the divergence exists in the first place. In this Part, I will consider the two main theories that may explain the divergence. First, I will consider the "acoustic separation" theory, proposed by Professor Meir Dan-Cohen, which posits that the law may wish to say different things to different audiences. (101) Next, I will consider what I call the "room-for-error" theory, which provides the justification for the business judgment rule. I will argue that, whereas the acoustic separation theory may provide more support for the aspirational view, the room-for-error theory is more compatible with the mandatory view. Because corporate law has coalesced around the room-for-error theory, the mandatory view seems a more appropriate interpretation of the divergence than the aspirational view.
Before turning to these theories, however, it is worth noting, if only briefly, the types of reasons that are not given for the divergence. The divergence is not said to exist because of the relative unimportance of standards of conduct. Neither scholars nor courts argue that fiduciary duties are relatively unimportant and unworthy of additional enforcement. Nor do they argue that compliance with standards of conduct is unimportant, or that compliance at the level of standards of review is all that is necessary. To the contrary, in a world of never-ending financial crises and scandals, the importance of good behavior is appreciated all too well. What they believe is that there are better ways to balance compliance with other goals than through greater legal enforcement. Of course, if fiduciary duties were considered relatively insignificant, then the aspirational view would make perfect sense. The fact that they are considered terribly important adds to the credibility of the mandatory view. (102)
A. Acoustic Separation
One possible explanation for the divergence was proposed by Meir Dan-Cohen. (103) Although his particular focus was on criminal law rather than corporate law, the relevant principles could apply to any area of law. Dan-Cohen recognizes a distinction between what he calls "conduct rules" and "decision rules" (104)--which correspond to standards of conduct and standards of review, respectively, in corporate law. He argues that, although these types of rules generally correspond, they need not do so and could diverge. (105) The reason they might diverge, he suggests, is so that the law can say different things to different audiences. In particular, the law may wish to say one thing to the general population about the criminal law, and something different to the courts. (106)
One example that Dan-Cohen relies upon is the duress defense. (107) He suggests that, when the law is speaking to the general population, it should emphasize the importance of compliance with the law; however, when the law is speaking to the courts, it may wish to make allowances for cases involving duress. (108) According to Dan-Cohen, perhaps the general public should not be informed about this defense because it might lead to suboptimal resistance to coercion or to excessive claims of duress. (109) Thus, the divergence between conduct rules and decision rules could lead to maximum compliance with the law while simultaneously providing for humane exceptions. (110)
The theory of acoustic separation could provide some support for the aspirational view. It is consistent with the notion that conduct rules--that is, standards of conduct--are not meant to be enforced and thus are arguably aspirational. If this were the basis for the divergence in corporate law, then perhaps the aspirational view would be on solid ground. However, the theory is deeply problematic.
There are two types of objections to the acoustic separation theory: one descriptive and one normative. As a descriptive matter, this theory depends upon an acoustic separation that simply may not exist. By "acoustic separation," Dan-Cohen means that the law would be able to speak to different audiences without each hearing what the law says to the others. (111) Clearly these conditions do not obtain in reality. Dan-Cohen understands the problem, but argues that it is plausible to believe that a partial separation exists and that therefore this justification might retain some validity. (112)
Personally, I am skeptical that any meaningful acoustic separation can exist over the long run. In a democratic society, the law cannot be hidden. The relevant audience eventually will come to understand the applicable law, at least generally. However, even if a partial acoustic separation may exist with respect to the general population and criminal law, it is especially unlikely to obtain with respect to directors and corporate law. Directors are sophisticated parties with access to legal counsel. For major transactions and other situations that are most likely to lead to litigation, directors generally have the advice of expert counsel. These attorneys are paid very well to ensure that directors are well informed of their options under the law. That directors could somehow be uninformed about standards of review is implausible. (113)
Dan-Cohen argues that standards of conduct, which are directed at the general population, are simpler to understand than standards of review, which are directed at legal experts. (114) However, lawyers flatter themselves if they believe that only they can understand the concepts involved. Corporate directors are not simpletons. Standards of review, moreover, generally are quite simple in corporate law. (115) For example, one of the most basic principles of corporate law is the business judgment rule--a decision rule which provides directors with an extraordinary degree of protection from liability. (116) Fairness (117) and intentional misconduct (118) are not especially complex, either. Similarly, directors are fully aware of exculpation charter provisions, which create decision rules that further limit their exposure to liability. (119) It seems likely that directors often may know more about the standards of review than about the standards of conduct. (120) As a result, it is difficult to believe that there is any meaningful acoustic separation in corporate law.
The more significant objections to the acoustic separation theory are normative. Professor Richard Singer has dealt with these issues extensively. (121) For present purposes, I wish to highlight two general considerations. First, although acoustic separation--and the selective transmission that makes it possible (122)--may be interesting as a theoretical construct, it is not desirable for a democratic society. (123) As Dan-Cohen himself admits, "[T]he sight of law tainted with duplicity and concealment is not pretty." (124) Nevertheless, he insists that acoustic separation does not necessarily depend upon "deliberate, purposeful human action," or "a conspiracy view of lawmaking in which legislators, judges, and other decisionmakers plot strategies for segregating their normative communications more effectively." (125) His efforts on this front, though, are halfhearted and not very convincing. The fact remains that acoustic separation is normatively very problematic.
Second, acoustic separation is unfair from the perspective of the actor. According to Dan-Cohen, "When decision rules are more lenient than relevant conduct rules, as in our duress example, no one is likely to complain about the frustration of an expectation of punishment." (126) This assertion is simply wrong. A person who refuses to succumb to coercion can be expected to complain in frustration when he learns that he could have relied on the secret defense of duress. (127) Dan-Cohen claims that "[a]n individual who would not have committed an offense but for his knowledge of the existence of such a defense" essentially "admits to being the Holmesian 'bad man,' who acts out of fear of legal sanctions rather than out of deference to his duties," and suggests that his concerns do not deserve respect. (128) However, this is an oversimplified assessment. People who resist coercion or duress often do so at great personal cost. Why should they make such sacrifices if society does not truly expect it of them? The same fairness concerns that motivate the availability of the defense in the first place suggest that those to whom it should apply ought to be made aware of its existence--and this is true even though others who become aware of the defense may falsely claim it. Hiding relevant considerations from actors seems inappropriate. Dan-Cohen suggests that any calculus as to the costs and benefits of compliance with law is inappropriate, but does not provide a convincing account of why that is so.
Regardless of whether one finds the acoustic separation theory convincing, the fact remains that the theory has not gained much traction in corporate law. Although it may be discussed, and occasionally approved, by corporate law scholars, it is not relied on very heavily. More importantly, it has not gained acceptance in the courts. The next Section considers the justification upon which the courts and most scholars rely.
Although the acoustic separation theory has not gained any significant traction, a related theory might seem more respectable. It is often said that the law of corporate fiduciary duties is ambiguous. (129) One could argue that this ambiguity has a positive effect on compliance: because fiduciaries cannot be sure whether their conduct will lead to liability, they will be more cautious than they would in the face of a clear rule. (130)
This claim must be assessed on both a descriptive and normative level. Descriptively, we must first ask whether the law of corporate fiduciary duties can meaningfully be described as ambiguous. There is widespread agreement that the law is ambiguous, and legal scholars generally view this situation very negatively. (131) However, I am skeptical of such claims. (132) On the one hand, it seems difficult to imagine how the law of fiduciary duties could be more precise. After all, fiduciary duties are essentially matters of equity rather than law. (132) On the other hand, if one is looking for a safe harbor of sorts, (134) then it is difficult to imagine a safer harbor than the one provided by the business judgment rule. (135) A cynic might insist that the law is clear: directors always win. The cynic would be wrong, of course, but not necessarily far off the mark. The fact is that directors generally know exactly how to escape liability; but rather than play it safe, they often want to push the limits. It is only at the boundaries that the law is indeterminate and that, of course, is unavoidable. Take, for example, the duty of loyalty: if directors avoid self-dealing, they will not be subject to the entire fairness test. (136) It is only when they insist upon self-dealing that they are subject to the indeterminacy of having to prove the fairness of their conduct. (137) Hostile takeover situations may be more complicated because directors cannot avoid the inherent conflict. (138) Directors could avoid any risk of liability, however, by not resisting the wishes of the shareholders. (139) It is unfair to describe the law as indeterminate under such circumstances. Finally, litigation generally will be about the gray areas of the law, because few will bother to litigate a matter that is settled. Looking at the case law in almost any area will suggest a significant amount of indeterminacy. Perhaps, then, all law is indeterminate. Accordingly, as a descriptive matter, it is not fair or meaningful to make the claim about the law of corporate fiduciary duties in particular.
As a normative matter, we must ask whether ambiguity or indeterminacy is a good thing. To the extent that the ambiguity is inescapable, it does not much matter. All that can be done is to note the good and bad side effects and try to manage them. To the extent that the ambiguity is intentional, however, the normative issue becomes more important. In that case, ambiguity becomes almost indistinguishable from acoustic separation: to keep the law ambiguous in order to foster the desired behavior is akin to hiding the law so that people will act out of ignorance. The same factors that make acoustic separation distasteful also make ambiguity distasteful; the difference is simply one of degree. To the extent that corporate law is ambiguous, it may lead to greater "compliance"--if it may be called that--but this is not necessarily a good thing.
B. Room for Error
In corporate law, as opposed to legal scholarship, the divergence between standards of conduct and standards of review is not exactly a separate doctrine. (140) First and foremost, the divergence is the product of the business judgment rule. The business judgment rule is one of the most fundamental principles of corporate law. (141) According to the Delaware courts, "It is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." (142) This "powerful presumption" (143) shields directors' decisions from review in all but the most extreme cases. (144) In duty of care cases, evidence of negligence is insufficient to rebut the presumption; plaintiffs must establish gross negligence. (145) In duty of loyalty cases, evidence of a conflict of interest is insufficient; plaintiffs must establish a financial or familial conflict that rises to the level of self-dealing. (146) In duty of good faith cases, evidence of lack of good faith is insufficient; plaintiffs must establish intentional misconduct. (147) The business judgment rule is most powerful in cases challenging the substance of business decisions. In such cases, evidence of a very bad decision is insufficient; plaintiffs must establish that the decision was utterly irrational and amounted to waste. (148) Protection of the business judgment rule is what gives rise to the divergence between standards of conduct and standards of review.
The judicial defense of the business judgment rule begins with the language of the corporation statutes, (149) which provide that "[t]he business and affairs of every corporation ... shall be managed by or under the direction of a board of directors," (150) rather than by the shareholders who would challenge their decisions or the courts that would evaluate them. (151) It is often noted that business decisions are inherently risky and should not be subject to second-guessing after the fact. (152) Courts in particular are said to be ill equipped to make or review business decisions. (153) Shareholders, on the other hand, can be said to have assumed the risk by investing in equity securities. (154) Therefore, they should not complain when things do not turn out as hoped. (155)
Legal enforcement of fiduciary duties exposes directors to the risk of liability. This can discourage people from serving on boards because the potential liability would far exceed the compensation received. (156) Exculpation statutes, which helped eliminate liability for breach of the duty of care, were adopted for this very reason. (157) Perhaps even more important, however, is the effect that excessive liability would have on directors' business judgment. Because risk and return are related, shareholders want directors to take appropriate business risks. However, if directors face potential liability when things go wrong, they might well become excessively risk averse. (158) This would have the effect of reducing the rate of return that shareholders could expect on their investments. (159) Thus, it is in the interests of both directors and shareholders to reduce the directors' exposure to liability.
One important way to do this is to lower the standards of review. (160) Low standards of review give the directors room to make honest mistakes. With liability reserved for the worst offenders, directors are free to concentrate on business matters. (161) They can rest assured that, even if they happen to fall short of the standard of conduct, they likely would remain in compliance with the corresponding standard of review--and free from liability. (162) The divergence is a powerful tool that allows directors to pursue the interests of the corporation and its shareholders aggressively.
The business judgment rule can be characterized as allowing room for error on the part of honest directors, but it can also be characterized as allowing room for error on the part of the courts, or at least compensating therefor. (163) If the legal system were perfect, honest directors would not have to fear liability. Only directors who were actually negligent or irrational, or engaged in unfair self-dealing or intentional misconduct, would face liability. Such directors should be held liable. Because litigation is imperfect, however, an honest and faithful director might erroneously be considered negligent or irrational, or to have engaged in unfair self-dealing or intentional misconduct. The divergence between standards of conduct and standards of review can help. Corporate law recognizes that if fiduciary duties were enforced at the level of standards of conduct, then imperfect litigation likely would lead to overenforcement of fiduciary duties. (164) This would stifle entrepreneurialism and wealth generation. Underenforcement of fiduciary duties by means of lowered standards of review solves this problem. Moreover, compensating for the limits of litigation does not simply trade overenforcement for underenforcement. Because imperfect litigation likely would lead to overenforcement of the standard of review, the result may not be so far from the appropriate level of enforcement for the standard of conduct.
Assuring directors that they will only be found to have breached the duty of care if they are grossly negligent provides great comfort. Of course, mistakes are still possible: directors may wrongly be found to have acted with gross negligence. That is likely only when directors were actually negligent, however. It seems highly unlikely that a director who acted with due care will be found to have been grossly negligent. (165) Directors can feel confident that, as long as they try to act with due care, they will not be found liable for breach of the duty of care. The same can be said with respect to the other fiduciary duties as well. With respect to the duty of loyalty, a court might wrongly conclude that a director acted unfairly, but only when there was a conflict of interest. Directors can be confident that, as long as they avoid conflicts of interest, they will not be held liable for a breach of the duty of loyalty. With respect to the duty of good faith, a court might wrongly conclude that a director engaged in intentional misconduct. However, this seems extremely unlikely if directors try to conduct themselves above reproach; it seems to be a risk only when directors decide to engage in questionable dealings. And, of course, courts might wrongly conclude that a decision was irrational and amounted to waste. However, the rarity of such holdings suggests that there is very little to fear on this front. (166) A decision would have to be quite bad indeed to be considered irrational. (167)
This, then, is the fundamental justification for the business judgment rule generally, and for the divergence between standards of conduct and standards of review specifically: they protect directors from honest mistakes on their part as well as from inevitable mistakes on the part of the legal system. This empowers directors to pursue the interests of the corporation and its shareholders to the best of their abilities, without excessive fear of liability.
At the heart of the room-for-error theory is a cost-benefit analysis. Society must weigh the competing values of directorial authority and accountability. (168) In this analysis, the limits of litigation loom large. Society has concluded that the costs of enforcement often outweigh the benefits. As Eisenberg put it,
If directors or officers who violate the standards of reasonableness and fairness sometimes escape liability because of a less demanding standard of review, it is not because they have acted properly, but because utilizing standards of review that were fully congruent with the relevant standards of conduct would impose greater costs than the costs of letting some persons who violated their standards of conduct escape liability. (169)
However, the cost-benefit analysis could change over time as different factors shift. If litigation became less imperfect, or if directors became more malfeasant, the current balance achieved by the business judgment rule may become obsolete. The enforcement of standards of conduct could be appropriate in the future.
The room-for-error theory is more compatible with the mandatory view than the aspirational view. Although the views are all consistent in terms of the end result--reduced enforcement of fiduciary duties--they do not share a common philosophy. Under the aspirational view, standards of conduct are inherently aspirational and ought not to be enforced. By contrast, the mandatory view would prefer to enforce standards of conduct and only reluctantly yields on the issue because of competing values. The room-for-error theory provides for reduced enforcement because of a cost-benefit analysis. This seems more compatible with the mandatory view than the aspirational view. But for the associated costs, standards of conduct would be enforced.
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|Title Annotation:||Introduction through II. Why the Divergence? p. 519-553|
|Publication:||William and Mary Law Review|
|Date:||Nov 1, 2012|
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