A proposal to eliminate director standards from the model business corporation act

University of Cincinnati Law Review

Volumn 67, Issue 4, 1999, Pages 1201-1228

  Smith, D Gordon ^a  

^a NONE

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EID: 0033464440     PISSN: 00096881     EISSN: None     Source Type: Journal    
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References (116)

1. See COMMITTEE ON CORPORATE LAWS, Report of Committee on Corporate Laws: Changes in the Model Business Corporation Act, 30 BUS. LAW. 501, 501 (1975) (noting that the Committee approved the final wording in a meeting on September 21, 1974) [hereinafter Report]. The Committee did not use the term "fiduciary," reasoning that: [T]hose responsibilities of directors which are fiduciary in nature would be sufficiently comprehended in the affirmative standard adopted so as to make unnecessary the use of a term which presents the possibility of importing into the area of corporation law more than is appropriate of the attributes and obligations of a fiduciary as firmly established in the law of trusts. Id. at 506.
2. The ABA's Committee on Business Corporations published a "Model for State Business Corporation Acts" in 1946. The MBCA was first published in The Business Lawyer in 1950. A.B.A. Committee on Business Corporations, Model Business Corporation Act, 6 BUS. LAW. 1 (1950).
3. The ABA's Committee on Business Corporations published a "Model for State Business Corporation Acts" in 1946. The MBCA was first published in The Business Lawyer in 1950. A.B.A. Committee on Business Corporations, Model Business Corporation Act, 6 BUS. LAW. 1 (1950).
4. For a discussion of the early history of the MBCA, see Melvin Aron Eisenberg, The Model Business Corporation Act and the Model Business Corporation Act Annotated, 29 BUS. LAW. 1407 (1974).
5. A significant number of states had adopted statutes defining the standard of care owed by a director to the corporation well before the Committee began work on the MBCA provision. Albert Victor Wray, Note, Corporations - Directors and Officers - Standard of Care - Liability for Negligence, 45 N.C. L. REV. 748, 751 (1967) ("Since the late 1920s, eleven states have adopted statutes defining the relation of the director to the corporation and the standard of care required of the director."). Prior to the publication of the MBCA, several states adopted or were influenced by another "Model Business Corporation Act," this one finalized by the National Conference of Commissioners on Uniform State Laws (NCCUSL) in 1928. 9 U.L.A. 115 (1957) (listing four states as adopting substantial portions of the Act). That Act included a provision entitled "Relation of Directors and Officers to Corporation," which read as follows: Officers and directors shall be deemed to stand in a fiduciary relation to the corporation, and shall discharge the duties of their respective positions in good faith, and with that diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions. Id. at 186. NCCUSL withdrew the Act from active promulgation in 1957, shortly after publication of the MBCA 9 U.L.A. 61 (1967 Supp.).
6. A significant number of states had adopted statutes defining the standard of care owed by a director to the corporation well before the Committee began work on the MBCA provision. Albert Victor Wray, Note, Corporations - Directors and Officers - Standard of Care - Liability for Negligence, 45 N.C. L. REV. 748, 751 (1967) ("Since the late 1920s, eleven states have adopted statutes defining the relation of the director to the corporation and the standard of care required of the director."). Prior to the publication of the MBCA, several states adopted or were influenced by another "Model Business Corporation Act," this one finalized by the National Conference of Commissioners on Uniform State Laws (NCCUSL) in 1928. 9 U.L.A. 115 (1957) (listing four states as adopting substantial portions of the Act). That Act included a provision entitled "Relation of Directors and Officers to Corporation," which read as follows: Officers and directors shall be deemed to stand in a fiduciary relation to the corporation, and shall discharge the duties of their respective positions in good faith, and with that diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions. Id. at 186. NCCUSL withdrew the Act from active promulgation in 1957, shortly after publication of the MBCA 9 U.L.A. 61 (1967 Supp.).
7. A significant number of states had adopted statutes defining the standard of care owed by a director to the corporation well before the Committee began work on the MBCA provision. Albert Victor Wray, Note, Corporations - Directors and Officers - Standard of Care - Liability for Negligence, 45 N.C. L. REV. 748, 751 (1967) ("Since the late 1920s, eleven states have adopted statutes defining the relation of the director to the corporation and the standard of care required of the director."). Prior to the publication of the MBCA, several states adopted or were influenced by another "Model Business Corporation Act," this one finalized by the National Conference of Commissioners on Uniform State Laws (NCCUSL) in 1928. 9 U.L.A. 115 (1957) (listing four states as adopting substantial portions of the Act). That Act included a provision entitled "Relation of Directors and Officers to Corporation," which read as follows: Officers and directors shall be deemed to stand in a fiduciary relation to the corporation, and shall discharge the duties of their respective positions in good faith, and with that diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions. Id. at 186. NCCUSL withdrew the Act from active promulgation in 1957, shortly after publication of the MBCA 9 U.L.A. 61 (1967 Supp.).
8. Report, supra note 1, at 504.
9. Elliott Goldstein & Robert W. Hamilton, The Revised Model Business Corporation Act, 38 BUS. LAW. 1019, 1022 (1983).
10. COMMITTEE ON CORPORATE LAWS, 1983 Revised Model Business Corporation Act: Exposure Draft 8-46 (American Bar Foundation, 1983) ("A director shall discharge his duties as a director . . . when exercising his business judgment, with the belief, premised on a rational basis, that his decision is in the best interests of the corporation.").
11. Robert W. Hamilton, Reflections of a Reporter, 63 TEX. L. REV. 1455, 1463 (1985).
12. See COMMITTEE ON CORPORATE LAWS, Changes in the Model Business Corporation Act Pertaining to the Standards of Conduct and Standards of Liability for Directors - Final Adoption, 53 BUS. LAW. 813 (1998) [hereinafterFinal Adoption].
13. See ed. at 813-14 (discussing revisions of MBCA §§ 8.30-8.31). For discussion of the amendments, see COMMITTEE ON CORPORATE LAWS, Changes in the Model Business Corporation Act - Amendments Pertaining to Electronic Filings/Standards of Conduct and Standards of Liability for Directors, 53 BUS. LAW. 157 (1997) [hereinafter Amendments].
14. See Melvin Aron Eisenberg, The Divergence of Standards of Conduct and Standards of Review in Corporate Law, 62 FORDHAM L. REV. 437 (1993).
15. See Amendments, supra note 9, at 176 (citing Eisenberg's article "for a detailed analysis of how and why standards of conduct and standards of liability diverge in corporate law").
16. Jeremy Bentham captured the distinction artfully: A law confining itself to the creation of an offence, and a law commanding a punishment to be administered in case of the commission of such an offence, are two distinct laws; not parts (as they seem to have been generally accounted hitherto) of one and the same law. The acts they command are altogether different; the persons they are addressed to are altogether different. Instance, Let no man steal; and, Let the judge cause whoever is convicted of stealing to be hanged. JEREMY BENTHAM, A FRAGMENT ON GOVERNMENT AND AN INTRODUCTION TO THE PRINCIPLES OF MORALS AND LEGISLATION 430 (W. Harrison ed., 1948).
17. Meir Dan-Cohen, Decision Rules and Conduct Rules: On Acoustic Separation in Criminal Law, 97 HARV. L. REV. 625 (1984).
18. Id. at 630.
19. Eisenberg calls the elements of the duty of care "fairly demanding." Eisenberg, supra note 10, at 440. Although the phrase "ordinarily prudent person" might suggest that "ordinary" negligence is the relevant standard, some states subject to that statutory language have cases with seemingly conflicting results. See, e.g., Thomas M. McEachin, Theriot v. Bourg: The Demise of the Business Judgment Rule in Louisiana?, 59 LA. L. REV. 375, 379-81 (1998); M. Saylor Sims, Level of Conduct Actionable Under the South Carolina Business Judgment Rule, 48 S.C. L. REV. 45 (1996). Sadly, Delaware has fared no better on this issue. See Henry Ridgely Horsey, The Duty of Care Component of the Delaware Business Judgment Rule, 19 DEL. J. CORP. L. 971, 981-97 (1993) (describing the development of the duty of care and business judgment rule in Delaware).
20. Eisenberg calls the elements of the duty of care "fairly demanding." Eisenberg, supra note 10, at 440. Although the phrase "ordinarily prudent person" might suggest that "ordinary" negligence is the relevant standard, some states subject to that statutory language have cases with seemingly conflicting results. See, e.g., Thomas M. McEachin, Theriot v. Bourg: The Demise of the Business Judgment Rule in Louisiana?, 59 LA. L. REV. 375, 379-81 (1998); M. Saylor Sims, Level of Conduct Actionable Under the South Carolina Business Judgment Rule, 48 S.C. L. REV. 45 (1996). Sadly, Delaware has fared no better on this issue. See Henry Ridgely Horsey, The Duty of Care Component of the Delaware Business Judgment Rule, 19 DEL. J. CORP. L. 971, 981-97 (1993) (describing the development of the duty of care and business judgment rule in Delaware).
21. Eisenberg calls the elements of the duty of care "fairly demanding." Eisenberg, supra note 10, at 440. Although the phrase "ordinarily prudent person" might suggest that "ordinary" negligence is the relevant standard, some states subject to that statutory language have cases with seemingly conflicting results. See, e.g., Thomas M. McEachin, Theriot v. Bourg: The Demise of the Business Judgment Rule in Louisiana?, 59 LA. L. REV. 375, 379-81 (1998); M. Saylor Sims, Level of Conduct Actionable Under the South Carolina Business Judgment Rule, 48 S.C. L. REV. 45 (1996). Sadly, Delaware has fared no better on this issue. See Henry Ridgely Horsey, The Duty of Care Component of the Delaware Business Judgment Rule, 19 DEL. J. CORP. L. 971, 981-97 (1993) (describing the development of the duty of care and business judgment rule in Delaware).
22. Eisenberg justifies the business judgment rule on two grounds: (1) the strict application of the duty of care "could result in the unfair imposition of liability"; and (2) "the shareholders' own best interests may be served by conducting only a very limited review of the quality of directors' and officers' decisions." Id. at 443-44. Others have argued that the primary benefit of the business judgment rule is that it preserves the centralized decision making of the board of directors, an argument that is closely related to Eisenberg's second justification. See 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, 522 (1989); D. Gordon Smith, Corporate Governance and Managerial Incompetence: Lessons From Kmart, 74 N.C. L. REV. 1037, 1119-22 (1996). In a provocative article, Kent Greenfield and John Nilsson recently proposed a "new explanation" for the business judgment rule emanating from the "paradox posed by the coexistence of directors' rigid fiduciary duty to maximize profits and the apparent leniency of the business judgment rule." Kent Greenfield & John E. Nilsson, Gradgrind's Education: Using Dickens and Aristotle to Understand (And Replace?) the Business Judgment Rule, 63 BROOK. L. REV. 799, 834 (1997). Under their view, the business judgment rule avoids the strict utilitarianism inherent in the duty of care. Recognizing that this solution is less than ideal in that it leaves the strict duty of care in force rather than crafting a duty that allows for more expansive director action, the authors argue: Under a legal regime governed by the BJR . . . what the directors do appears to be less important than what they say they do. In effect, directors are forced to reaffirm the fiduciary duty to maximize profits rhetorically, even if they are acting against that duty in actuality. The business judgment rule props up the fiduciary duty to maximize profits - turning it into a shibboleth of sorts - even as it ameliorates its harshness. Id. at 837. Although they do not address the duty of care and business judgment rule as standards of conduct and liability, respectively, the authors seem to recognize the descriptive accuracy of the dichotomy, even as they oppose its normative desirability.
23. Eisenberg justifies the business judgment rule on two grounds: (1) the strict application of the duty of care "could result in the unfair imposition of liability"; and (2) "the shareholders' own best interests may be served by conducting only a very limited review of the quality of directors' and officers' decisions." Id. at 443-44. Others have argued that the primary benefit of the business judgment rule is that it preserves the centralized decision making of the board of directors, an argument that is closely related to Eisenberg's second justification. See 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, 522 (1989); D. Gordon Smith, Corporate Governance and Managerial Incompetence: Lessons From Kmart, 74 N.C. L. REV. 1037, 1119-22 (1996). In a provocative article, Kent Greenfield and John Nilsson recently proposed a "new explanation" for the business judgment rule emanating from the "paradox posed by the coexistence of directors' rigid fiduciary duty to maximize profits and the apparent leniency of the business judgment rule." Kent Greenfield & John E. Nilsson, Gradgrind's Education: Using Dickens and Aristotle to Understand (And Replace?) the Business Judgment Rule, 63 BROOK. L. REV. 799, 834 (1997). Under their view, the business judgment rule avoids the strict utilitarianism inherent in the duty of care. Recognizing that this solution is less than ideal in that it leaves the strict duty of care in force rather than crafting a duty that allows for more expansive director action, the authors argue: Under a legal regime governed by the BJR . . . what the directors do appears to be less important than what they say they do. In effect, directors are forced to reaffirm the fiduciary duty to maximize profits rhetorically, even if they are acting against that duty in actuality. The business judgment rule props up the fiduciary duty to maximize profits - turning it into a shibboleth of sorts - even as it ameliorates its harshness. Id. at 837. Although they do not address the duty of care and business judgment rule as standards of conduct and liability, respectively, the authors seem to recognize the descriptive accuracy of the dichotomy, even as they oppose its normative desirability.
24. Eisenberg justifies the business judgment rule on two grounds: (1) the strict application of the duty of care "could result in the unfair imposition of liability"; and (2) "the shareholders' own best interests may be served by conducting only a very limited review of the quality of directors' and officers' decisions." Id. at 443-44. Others have argued that the primary benefit of the business judgment rule is that it preserves the centralized decision making of the board of directors, an argument that is closely related to Eisenberg's second justification. See 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, 522 (1989); D. Gordon Smith, Corporate Governance and Managerial Incompetence: Lessons From Kmart, 74 N.C. L. REV. 1037, 1119-22 (1996). In a provocative article, Kent Greenfield and John Nilsson recently proposed a "new explanation" for the business judgment rule emanating from the "paradox posed by the coexistence of directors' rigid fiduciary duty to maximize profits and the apparent leniency of the business judgment rule." Kent Greenfield & John E. Nilsson, Gradgrind's Education: Using Dickens and Aristotle to Understand (And Replace?) the Business Judgment Rule, 63 BROOK. L. REV. 799, 834 (1997). Under their view, the business judgment rule avoids the strict utilitarianism inherent in the duty of care. Recognizing that this solution is less than ideal in that it leaves the strict duty of care in force rather than crafting a duty that allows for more expansive director action, the authors argue: Under a legal regime governed by the BJR . . . what the directors do appears to be less important than what they say they do. In effect, directors are forced to reaffirm the fiduciary duty to maximize profits rhetorically, even if they are acting against that duty in actuality. The business judgment rule props up the fiduciary duty to maximize profits - turning it into a shibboleth of sorts - even as it ameliorates its harshness. Id. at 837. Although they do not address the duty of care and business judgment rule as standards of conduct and liability, respectively, the authors seem to recognize the descriptive accuracy of the dichotomy, even as they oppose its normative desirability.
25. Eisenberg, supra note 10, at 447.
26. See Amendments, supra note 9, at 162: In earlier versions of the Model Act the duty of care element . . . suggesting caution or circumspection vis-a-vis danger or risk, has long been problematic given the fact that risk-taking decisions are central to the directors' role. . . . In order to facilitate its understanding and analysis, independent of the other general standards of conduct for directors, the duty of care element has been set forth as a separate standard of conduct in subsection (b). Id.
27. Dan-Cohen, supra note 13, at 633.
28. Id. at 633-34. Dan-Cohen describes the behavioral side effects more fully as follows: [I]n the real world . . . [judges] are aware of the system's conduct rules and may take them into account in making decisions. By the same token, because individuals are familiar with the decision rules, they may well consider those rules in shaping their own conduct. We may say, therefore, that reality differs from the imagined world in that real-world decision rules are likely to have conduct side effects, just as real-world conduct rules are likely to have decisional side effects. Id. at 632.
29. The messages sent to directors and courts often are altered by agreement. Most importantly, modern incorporation statutes typically allow a corporation to eliminate or limit the personal liability of directors for breaches of the duty of care through a charter provision. See MODEL BUS. CORP. ACT § 2.02(b)(4) (1984) (amended 1998); 8 DEL. CODE ANN. tit. 8, § 102(b)(7) (1998 Supp.). Corporations routinely adopt such provisions. See Roberta Romano, Corporate Governance in the Aftermath of the Insurance Crisis, 39 EMORY L.J. 1155 (1990) (finding that "over 90% of a random sample of 180 Delaware firms adopted a limited liability provision within one year of the statute's enactment").
30. The message of "care" sent by legislatures to directors under provisions like MBCA § 8.30 may be compromised by these liability shields, but the statutes usually allow exculpation only with respect to money damages, not injunctive relief. As a result, directors still have some incentive to maintain the standard of conduct. For a useful discussion of the MBCA provision, see COMMITTEE ON CORPORATE LAWS, Changes in the Revised Model Business Corporation Act - Amendment Pertaining to the Liability of Directors, 45 BUS. LAW. 695 (1990).
31. See Dan-Cohen, supra note 13, at 639 (calling vagueness with respect to the defenses of duress and necessity in criminal law a "virtue").
32. Id.
33. See id. at 640. Dan-Cohen also suggests that even if a body of case law arises around a decision rule, the case law, "because of its sheer volume and complexity, would probably elude the legally untutored citizen." Id. In reviewing the cases applying fiduciary duties to corporate directors - who typically are well tutored by lawyers - this caution should not be so limited.
34. William T. Allen, Ambiguity in Corporation Law, 22 DEL. J. CORP. L. 894, 895 (1997).
35. Id. at 898.
36. Id.
37. For a recent examination of the role of ambiguity in the competition for corporate charters, see Ehud Kamar, A Regulatory Competition Theory of Indeterminacy in Corporate Law, 98 COLUM. L. REV. 1908 (1998). Another benefit of ambiguity is not directly related to selective transmission, but rather to the possibility of tailoring remedies to circumstances. In an interesting study of banking cases, Patricia McCoy has shown that the business judgment rule is roughly calibrated by judges to respond to changes in market constraints on directors. See Patricia A. McCoy, A Political Economy of the Business Judgment Rule in Banking: Implications for Corporate Law, 47 CASE W. RES. L. REV. 1, 22-55 (1996).
38. For a recent examination of the role of ambiguity in the competition for corporate charters, see Ehud Kamar, A Regulatory Competition Theory of Indeterminacy in Corporate Law, 98 COLUM. L. REV. 1908 (1998). Another benefit of ambiguity is not directly related to selective transmission, but rather to the possibility of tailoring remedies to circumstances. In an interesting study of banking cases, Patricia McCoy has shown that the business judgment rule is roughly calibrated by judges to respond to changes in market constraints on directors. See Patricia A. McCoy, A Political Economy of the Business Judgment Rule in Banking: Implications for Corporate Law, 47 CASE W. RES. L. REV. 1, 22-55 (1996).
39. Dan-Cohen, supra note 13 at 652.
40. Eisenberg, supra note 10, at 466.
41. The elements of the duty of care are drawn from the American Law Institute's Principles of Corporate Governance, for which Eisenberg was the Reporter. See generally AMERICAN LAW INSTITUTE, PRINCIPLES OF CORPORATE GOVERNANCE: ANALYSIS AND RECOMMENDATIONS (1994).
42. Eisenberg, supra note 10, at 441.
43. Edward B. Rock, Saints and Sinners: How Does Delaware Corporate Law Work?, 44 UCLA L. REV. 1009, 1016 (1997).
44. Rock argues that Delaware law is not "unpredictable and indefinite," but "over time [yields] reasonably determinate guidelines." Id. at 1017. This claim seems difficult to sustain. Rock's own comparison of Paramount Communications, Inc. v. Time Inc., 571 A.2d 1140 (Del. 1990), and Paramount Communications, Inc. v. QVC Network Inc., 637 A.2d 34 (Del. 1994), illustrates the difficulty in predicting the course of Delaware fiduciary duty law. See id. at 1072-88. Although Rock uses these cases to argue that lawyers looking for "rules" have missed the point of Delaware law, the guidance he derives from the cases is that directors should behave "in good faith and with due care." Id. at 1086. This is always good advice and may lead to specific actions by the directors, but it is a stretch to consider these standards "reasonably determinate guidelines."
45. Eisenberg suggests that bifurcated standards still may be effective if directors hear both messages, but he provides no explanation for why directors would elect to meet the stricter standard if given a clear choice. Eisenberg, supra note 10, at 465 (describing a "two-part message" containing the duty of care and the business judgment rule).
46. Arguably, selective transmission is, at least in some cases, illegitimate. It seems to violate norms of notice prior to punishment that run deep in the law. If the law had a decision rule that were harsher than the conduct rule, therefore, an actor might be penalized without notice and this would rightfully be considered unfair. With respect to the duty of care and the business judgment rule, however, the decision rule is more lenient than the conduct rule. Directors are given notice, therefore, of the expected standard of conduct and cannot complain if liability follows from deviation from that standard.
47. See, e.g., Arthur T. von Mehren, Some Reflections on Codification and Case Law in the Twenty-First Century, 31 U.C. DAVIS L. REV. 659, 667 (1998) (noting that a "quest for greater coherency, comprehensibility, and administrability caused the [United States] to take on qualities traditionally associated with codified systems").
48. Amendments, supra note 9, at 179.
49. Id. at 180.
50. Id. at 162. The last two sentences of this excerpt were revised in the final adoption of the new provisions to limit its application to the oversight function of directors. See Final Adoption, supra note 8, at 813-14.
51. Eisenberg, supra note 10, at 464.
52. Amendments, supra note 9, at 162.
53. Eisenberg, supra note 10, at 439. One of the earliest cases to use the term "business judgment rule" contains the following analysis: The question is frequently asked, how does the operation of the so-called "business judgment rule" tie in with the concept of negligence? There is no conflict between the two. When courts say that they will not interfere in matters of business judgment, it is presupposed that judgment - reasonable diligence - has in fact been exercised. Casey v. Woodruff, 49 N.Y.S.2d 625, 643 (Sup. Ct. 1944).
54. Although the intention of the Committee is made clear in the Comments, the grammatically awkward phrasing of the statutory provision - admonishing directors to discharge their duties with the care that a person would use - leads to uncertainty.
55. Amendments, supra note 9, at 161 (emphasis added).
56. Eisenberg, supra note 10, at 464.
57. Franklin Gevurtz, in analyzing the formulation of the business judgment rule as a presumption that directors did not violate their fiduciary duties when they made their decision, interprets that "presumption" simply as a device for allocating the burden of proof. If that were the only effect of the presumption, it would be meaningless, as observed by Gevurtz: This "presumption" entails nothing more than saying that the plaintiff who challenges a decision of the board has the burden of proving that the directors breached one of their duties. Yet, the proposition that the plaintiff, in any context, has the burden of proving his or her prima facie case is a rule with which every first-year law student should be familiar. Franklin A. Gevurtz, "The Business Judgment Rule: Meaningless Verbiage or Misguided Notion?, 67 S. CAL. L. REV. 287, 292 (1994). The important question, also addressed by Gevurtz, is whether the business judgment rule actually affects the quantum of proof. Gevurtz concludes that, "For many courts and writers the answer is really no." Id. In accordance with the excerpt accompanying the following footnote, I disagree.
58. R. Franklin Balotti & James J. Hanks, Jr., Rejudging the Business Judgment Rule, 48 BUS. LAW. 1337, 1348 (1993).
59. A court could impose a heavier-than-normal burden of proof on plaintiffs, as Balotti and Hanks indicate may be common when courts apply the business judgment rule, but nothing in the wording of the new provisions requires this result. If statutory bifurcation of standards of conduct and liability is to be meaningful, differences in the standards should be apparent from the language of the statute and should not be left to subsequent judicial explication.
60. Section 8.31 recognizes that directors will not be held liable if (1) the corporation's charter contains a liability shield and the director's conduct falls within the scope of the shield, or (2) the action at issue is a director's conflicting interest transaction and the director has properly followed a procedural safe harbor. Acknowledging these limitations on director liability is perhaps convenient for the person reading the statute, but they are not relevant to the safe-harbor discussion. The liability shield is a contractual exception from liability and thus displaces both the standard of conduct and the standard of liability for those corporations that have adopted them. The conflicting interest transactions simply do not raise issues of care, but of loyalty. Section 8.31 also requires the plaintiff to show that the director's actions caused damage to the corporation or its shareholders. Again, this requirement does not make the standards of liability less demanding than the standards of conduct. Causation is implicit in the duty of care itself.
61. Eisenberg, supra note 10, at 464.
62. See Report, supra note 1, at 504.
63. See SEC Release No. 33-5466 (March 8, 1974).
64. SEE GEORGE C. GREANIAS & DUANE WINDSOR, THE FOREIGN CORRUPT PRACTICES ACT: ANATOMY OF A STATUTE 17-31 (1982).
65. See William L. Cary, Federalism and Corporate Law: Reflections Upon Delaware, 83 YALE L.J. 663 (1974).
66. See 31 BUS. LAW. 861 (1975).
67. See RALPH NADER ET AL., TAMING THE GIANT CORPORATION (1976).
68. The changes in corporate governance wrought during this period were extraordinary. Most importantly, most corporate boards are now comprised of majority outside directors. Robert Hamilton described the changes as follows: The practice of having outside unaffiliated directors serve on boards of directors is not new; indeed, many publicly held corporations voluntarily placed outside persons on their boards of directors as far back as the 1920's, if not earlier. At that time, however, these directors generally were dismissed as mere tokens, since the overwhelming majority of boards of directors were composed of directors who were officers or employees of the corporation. Indeed, many very large corporations had no outside directors on their boards until well after World War II. In the 1970's and 1980's, the corporate world has implemented, on a de facto basis, without legal compulsion or a great deal of fanfare, a program in which much greater reliance is placed on "independent" or "outside" directors in corporate governance than ever before. Today, outside independent directors comprise the majority of most boards of directors of publicly held corporations. Robert W. Hamilton, Reliance and Liability Standards for Outside Directors, 24 WAKE FOREST L. REV. 5, 6 (1989).
69. On the other hand, the committees drafting incorporation statutes traditionally have been very friendly to corporate managers. For contemporaneous accounts, see Ernest L. Folk III, State Statutes: Their Roles in Prescribing Norms of Responsible Management Conduct, 31 BUS. LAW. 1031, 1056 (1976) (observing with respect to corporation law revision committees that "pro-management interests invariably predominate, directly or indirectly"); Eisenberg, supra note 2, at 1410 (noting with respect to the MBCA that "[d]uring the whole term of its existence the Committee seems to have had no shareholders'-lawyer members").
70. In the Official Comment to § 8.30(b), the Committee wrote: The phrase "ordinarily prudent person" constitutes a basic frame of reference grounded in the field of tort law and provides a primary benchmark for determining negligence. For this reason, its use in the standard of care for directors, suggesting that negligence is the proper determinant for measuring deficient (and thus actionable) conduct, has caused confusion and misunderstanding. Amendments, supra note 9, at 165.
71. See Seafirst Corp. v. Jenkins, 644 F. Supp. 1160 (W.D. Wash. 1986); Gaillard v. Natomas Co., 208 Cal. App. 3d 1250, 1264 (1989); Lindner Fund, Inc. v. Waldbaum, Inc., 624 N.E.2d 160, 161 (1993).
72. In Seafirst, the court denied summary judgment to the defendants, who claimed that, "as long as they acted in good faith, they are immune from liability under the business judgment rule." 644 F. Supp. at 1159.
73. The court correctly held that "proof of good faith alone is not sufficient to satisfy the business judgment rule." Id. In Gaillard, the court consistently referred to the statutory provision (based on § 8.30) as the "business judgment rule." See, e.g., 208 Cal. App. 3d at 1264. Nevertheless, after a detailed examination of the facts available, the court concluded that summary judgment was not justified on most of the claims presented. With respect to the approval of "golden parachutes" for officers of the corporation by members of the compensation committee of the board of directors, the court reasoned: A trier of fact could reasonably find that the circumstances warranted a thorough review of the golden parachute agreements by the members of the compensation committee to determine whether they served the best interests of the corporation. Thus, although a trier of fact might conclude that the compensation committee's reliance upon Flom with no further inquiry was reasonable, it could also reasonably find that the members of the compensation committee should have, at the very least, independently reviewed the terms of the golden parachutes to consider whether they served a valid use of corporate funds or constituted executive overreaching. Id. at 1271. The court in Lindner Fund committed the same error as the previous cases in referring to the statute as the business judgment rule. In this case, however, the court found that the actions of the directors did not violate a fiduciary duty. 624 N.E.2d at 162.
74. The court correctly held that "proof of good faith alone is not sufficient to satisfy the business judgment rule." Id. In Gaillard, the court consistently referred to the statutory provision (based on § 8.30) as the "business judgment rule." See, e.g., 208 Cal. App. 3d at 1264. Nevertheless, after a detailed examination of the facts available, the court concluded that summary judgment was not justified on most of the claims presented. With respect to the approval of "golden parachutes" for officers of the corporation by members of the compensation committee of the board of directors, the court reasoned: A trier of fact could reasonably find that the circumstances warranted a thorough review of the golden parachute agreements by the members of the compensation committee to determine whether they served the best interests of the corporation. Thus, although a trier of fact might conclude that the compensation committee's reliance upon Flom with no further inquiry was reasonable, it could also reasonably find that the members of the compensation committee should have, at the very least, independently reviewed the terms of the golden parachutes to consider whether they served a valid use of corporate funds or constituted executive overreaching. Id. at 1271. The court in Lindner Fund committed the same error as the previous cases in referring to the statute as the business judgment rule. In this case, however, the court found that the actions of the directors did not violate a fiduciary duty. 624 N.E.2d at 162.
75. As noted by the Committee, Washington courts later corrected Seafirst. See Shinn v. Thrust IV, Inc., 786 P.2d 285, 290 n.1 (Wash. App. 1990). Lindner Fund has passed into obscurity in New York, having been cited only once and that in a federal opinion where the court implicitly corrected the error by quoting part of the case that properly described the business judgment rule. See Dynamics Corp. of America v. WHX Corp., 967 F. Supp. 59, 65 (1997). Even courts in California, which still occasionally cite Gaillard in referring to the statute as the business judgment rule, acknowledge common law limitations on the statutory standards. See, e.g., Briano v. Rubio, 54 Cal. Rptr. 2d 408, 414 (1996) (reasoning that the statute "combines the notion of a director's immunity from liability for an honest mistake of business judgment with the concept of a director's obligation to use reasonable diligence in performing his or her duties.").
76. See Charles Hansen, Revised § 8.30 of the Model Business Corporation Act: A Major Improvement Long Overdue, 69 CORPORATION 1, 2-3 (1998) (hereinafter Hansen, Revised § 8.30) ("even though a large number of states have statutory language which adopts the 'ordinarily prudent person' language of § 8.30(a), it has generally been ignored by well instructed courts . . . However, there are enough instances of courts giving the language operative effect to warrant serious concern."); Charles Hansen, The Duty of Care, the Business Judgment Rule, and the American Law Institute Corporate Governance Project, 48 BUS. LAW. 1355, 1374 (1993) ("It now is generally accepted that in a corporate context, the reasonably prudent person formulation is not only incorrect, but dangerously misleading. More than one court has followed this language literally to reach unintended and damaging results.").
77. See Charles Hansen, Revised § 8.30 of the Model Business Corporation Act: A Major Improvement Long Overdue, 69 CORPORATION 1, 2-3 (1998) (hereinafter Hansen, Revised § 8.30) ("even though a large number of states have statutory language which adopts the 'ordinarily prudent person' language of § 8.30(a), it has generally been ignored by well instructed courts . . . However, there are enough instances of courts giving the language operative effect to warrant serious concern."); Charles Hansen, The Duty of Care, the Business Judgment Rule, and the American Law Institute Corporate Governance Project, 48 BUS. LAW. 1355, 1374 (1993) ("It now is generally accepted that in a corporate context, the reasonably prudent person formulation is not only incorrect, but dangerously misleading. More than one court has followed this language literally to reach unintended and damaging results.").
78. 644 F. Supp. at 1160.
79. See Theriot v. Bourg, 691 So. 2d 213 (1st Cir. 1997)); Lussier v. Mau-Van Dev., Inc., 667 P.2d 804 (Haw. Ct. App. 1983); Shinn v. Thrust IV, Inc., 786 P.2d 285 (Wash. App. 1990); FDIC v. Stanley, 770 F. Supp. 1281 (N.D. Ind. 1991).
80. 691 So. 2d at 213.
81. Hansen, Revised § 8.30, supra note 64, at 3.
82. See Theriot, 691 So. 2d at 219.
83. See id.
84. See id. at 219-222.
85. Id. at 220.
86. Id. at 222.
87. Id. at 223.
88. The appellate court summarized the evidence relating to the duty of care claim as follows: The testimony of the majority directors showed that, when they entered into this project, they had no clear idea of the cost of the project or the point at which they would break even or earn profits. This was reflected in the testimony of several of the defendants wherein they gave substantially differing figures when asked what they anticipated the project would cost. Additionally, they entered this endeavor without a business plan or other vehicle by which they could assess the feasibility of the project. Rather they chose to shift that responsibility to others. Unfortunately, those they placed in the role of determining the feasibility of the initial project and the course the business would take over its brief existence were not equipped to provide sound, thorough advice. Id. at 225. This view of the evidence certainly contravenes Hansen's view of Theriot as "contrary to well established legal principles dealing with a director's duty of care in the decision making context." Hansen, Revised § 8.30, supra note 64, at 3.
89. 667 P.2d 804 (Haw. Ct. App. 1983).
90. See id. at 815-18.
91. Id. at 818.
92. 786 P.2d 285 (Wash. App. 1990).
93. The court prefaced the relevant paragraph of its decision by saying, "even if the rule is applicable to partnerships, it could not apply here because Thrust's conduct violated the due care standard requisite to application of the rule." Id. at 290.
94. See id. at 289.
95. See id. at 290 n.1.
96. 770 F. Supp. 1281 (N.D. Ind. 1991).
97. Id. at 1312.
98. Patricia A. McCoy, The National Business Judgment Rule in Banking, 44 CATH. U.L. REV. 1031, 1033 (1996).
99. Amendments, supra note 9, at 161.
100. The Committee noted in its Official Comment to § 8.30 that courts addressing a duty of care claim typically deal with the conduct of the entire board, rather an individual director. As a result, the failure of one director to meet the standards of care will not necessarily result in liability: Deficient performance of section 8.30 duties on the part of a particular director may be overcome, absent unusual circumstances, by acceptable conduct . . . on the part of other directors sufficient in number to perform the function or discharge the duty in question. While not thereby remedied, the deficient performance becomes irrelevant in any evaluation of the action taken. Id. at 161.
101. 448 A.2d 858 (Del. 1985).
102. See Eisenberg, supra note 10, at 448 ("The concept of gross negligence . . . is notoriously ambiguous, and in practice it is common to find that courts that purport to apply that standard actually apply a standard that is either more or less demanding."); Gevurtz, supra note 47, at 299-300 ("[R]egardless of who is right or wrong as to the result in Van Gorkom, [it is] evident that the gross rather than ordinary negligence label had little impact upon the result.").
103. Amendments, supra note 9, at 173-74.
104. Percy v. Millaudon, 8 Mart. (n.s.) 68, 74 (La. 1829).
105. See, e.g., Spring's Appeal, 71 Pa. 11, 21 (1872): I do not mean to say by any means that their responsibility is limited . . . and that there might not exist such a case of negligence . . . as would make perfectly honest directors personally liable. But it is evident that gentlemen elected by the stockholders from their own body ought not to be judged by the same strict standard as the agent or trustee of a private estate. Id.; Hun v. Cary, 82 N.Y. 65, 71 (1880): It is impossible to give the measure of culpable negligence for all cases, as the degree of care required depends upon the subjects to which it is to be applied. What would be slight neglect in the care of a quantity of iron might be gross neglect in the care of a jewel. What would be slight neglect in the care exercised in the affairs of a turnpike corporation, or even of a manufacturing corporation, might be gross neglect in the care exercised in the management of a savings bank intrusted with the savings of a multitude of poor people, depending for its life upon credit and liable to be wrecked by the breath of suspicion. Id.
106. Arthur von Mehren refers to the American Law Institute's Restatements of the Law as "an unofficial form of codification." von Mehren, supra note 37, at 669.
107. See George P. Fletcher, Truth in Codification, 31 U.C. DAVIS L. REV. 745, 750 (1998).
108. Id.
109. OLIVER WENDELL HOLMES, THE COMMON LAW 89 (Little, Brown 1963).
110. See Stanley A. Kaplan, Fiduciary Responsibility into Management of the Corporation, 31 BUS. LAW. 883, 887 (1976) The concept of a "fiduciary" may serve as a useful legal fiction to stimulate the development of new or expanding obligations by analogy to the seminal concept of the trustee. On the other hand, clarity of description and precision in defining duties might at this stage be better achieved through abandonment of so amorphous a term in favor of developing a more precise set of notions of duty and responsibility in connection with each of the separate capacities now lumped within the broad and nebulous term "fiduciary." Id.
111. Perhaps the best of these attempts was made by Samuel Arscht, a distinguished Delaware lawyer. See S. Samuel Arsht, The Business Judgment Rule Revisited, 8 HOFSTRA L. REV. 93 (1979). For a more recent attempt, in treatise form, see DENNIS J. BLOCK ET AL., THE BUSINESS JUDGMENT RULE: FIDUCIARY DUTIES OF CORPORATE DIRECTORS (4th ed. 1993).
112. Perhaps the best of these attempts was made by Samuel Arscht, a distinguished Delaware lawyer. See S. Samuel Arsht, The Business Judgment Rule Revisited, 8 HOFSTRA L. REV. 93 (1979). For a more recent attempt, in treatise form, see DENNIS J. BLOCK ET AL., THE BUSINESS JUDGMENT RULE: FIDUCIARY DUTIES OF CORPORATE DIRECTORS (4th ed. 1993).
113. See generally Eric Talley, Intra-Firm Monitoring and the Content of Fiduciary Duties (1999) (unpublished manuscript, on file with author).
114. Shortly after the Committee first adopted director standards, several Delaware lawyers (including Norman Veasey, now Chief Justice of the Delaware Supreme Court) debated the merits of codification in the pages of The Business Lawyer. See E. Norman Veasey & William E. Manning, Codified Standard - Safe Harbor or Uncharted Reef? An Analysis of the Model Act Standard of Care Compared with Delaware Law, 35 BUS. LAW. 919 (1980); cf. S. Samuel Arsht & Joseph Hinsey IV, Codified Standard - Same Harbor But Charted Channel: A Response, 35 BUS. LAW. 947 (1980). Veasey and Manning expressed some concern over the MBCA's use of the words "reasonably believes to be in the best interests of the corporation," but otherwise found that "the duties and rights of directors under [the statute] are substantively similar to those imposed by Delaware law, although the verbal formulations differ." Veasey & Manning, supra, at 945. With respect to the contested phrase, Arsht and Hinsey argued that subsequent cases would interpret the words to accord with Delaware law, see Arsht & Hinsey, supra, at 959-61, and their prediction has largely been fulfilled.
115. Shortly after the Committee first adopted director standards, several Delaware lawyers (including Norman Veasey, now Chief Justice of the Delaware Supreme Court) debated the merits of codification in the pages of The Business Lawyer. See E. Norman Veasey & William E. Manning, Codified Standard - Safe Harbor or Uncharted Reef? An Analysis of the Model Act Standard of Care Compared with Delaware Law, 35 BUS. LAW. 919 (1980); cf. S. Samuel Arsht & Joseph Hinsey IV, Codified Standard - Same Harbor But Charted Channel: A Response, 35 BUS. LAW. 947 (1980). Veasey and Manning expressed some concern over the MBCA's use of the words "reasonably believes to be in the best interests of the corporation," but otherwise found that "the duties and rights of directors under [the statute] are substantively similar to those imposed by Delaware law, although the verbal formulations differ." Veasey & Manning, supra, at 945. With respect to the contested phrase, Arsht and Hinsey argued that subsequent cases would interpret the words to accord with Delaware law, see Arsht & Hinsey, supra, at 959-61, and their prediction has largely been fulfilled.
116. Eisenberg, supra note 2, at 1414.