The Importance of the Business Judgment Rule

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University of Maryland Francis King Carey School of Law DigitalCommons@UM Carey Law

Faculty Scholarship Francis King Carey School of Law Faculty

2017

The Importance of the Business Judgment Rule

Bernard S. Sharfman University of Maryland Francis King Carey School of Law

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Digital Commons Citation Sharfman, Bernard S., "The Importance of the Business Judgment Rule" (2017). Faculty Scholarship. 1586. https://digitalcommons.law.umaryland.edu/fac_pubs/1586

This Article is brought to you for free and open access by the Francis King Carey School of Law Faculty at DigitalCommons@UM Carey Law. It has been accepted for inclusion in Faculty Scholarship by an authorized administrator of DigitalCommons@UM Carey Law. For more information, please contact [email protected]. 39748-nyb_14-1 Sheet No. 17 Side A 12/08/2017 14:30:42 1 1 UMBER * HARFMAN 27 S. S ERNARD JUDGMENT RULE B NEW YORK UNIVERSITY THE IMPORTANCE OF THE BUSINESS 14 FALL 2017 N First, without the Rule, the raw power of equity could conceivably re- Anyone who has had the opportunity to teach corporate law under- “A page of history is worth a volume of logic.” JOURNAL OF LAW & BUSINESS application of the Rule under Delaware law: the Chancery Court and preme Su- Court opinions in Bodell v. General Gas & Electric. By taking this approach, the following insights into the Rule—which are apparent when not the starting as point readily is Aronson—are discovered. quire all challenged board of directors (“Board”) decisions entire to fairness undergo review. The an Rule is the tool used by a court to restrain itself from persistently implementing such a review. This is function the of the Rule. Second, most as a result of important the need to restrain equity, there stands how difficult it is to provide a business compelling judgment explanation rule of why (the the “Rule”) is so explanation important. of why this To is so, this provide Article takes the a approach that the Aron- better son formulation of the Rule is not the proper starting Article place. begins Instead, by this starting with a close read of two cases that initiated the * Bernard S. Sharfman is an associate fellow of the R Street Institute, a 1. A quote from a Supreme Court opinion delivered by Justice Oliver OLUME V \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 1 8-DEC-17 7:20 for helping to get this paper Sharfman started would and also for like his to helpful Chandler thank comments. Myron Mr. III, Steele, Troy Joan Paredes, Hamdani, Amitai Aviram, William Eric C. Chaffee, Heminway, Kurt Heyman, Matthew Edwards, Robert Justinas Rhee, Jarusevicius, and Andrew Mark Ramseyer Schwartz, for helpful comments. Mr. Sharfman is their dedicating this article to positive Assaf his wife, Susan feedback and Thea David, and his daughter, Amy David Sharfman. Wendell Holmes. N.Y. Tr. Co. v. Eisner, 256 U.S. 345, 349 (1921). Visiting Assistant Professor of Law at the University of Maryland Law, a member of the Journal of Corporation Law’s editorial advisory board, School of and a former Visiting Assistant Professor of University School of Law. Mr. Sharfman would like to thank George Mocsary Law at Case Western Reserve 39748-nyb_14-1 Sheet No. 17 Side A 12/08/2017 14:30:42 12/08/2017 A 17 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 17 Side B 12/08/2017 14:30:42 R R R R R R R R R R R R R R R R R R R R . . . 60 [Vol. 14:27 . . . . 43 ) ...... 47 a ...... 53 HAREHOLDER § 141( ...... 67 S ...... 58 ...... 63 ...... 58 ...... 50 ...... 57 ULE AND R ...... 56 ...... 33 BJECTIVE OF O NTRODUCTION QUITY I UDGMENT E J ...... 68 ...... 55 ...... 42 ...... 34 37 ...... 39 AXIMIZATION NYU JOURNAL OF LAW & BUSINESS M ...... 28 Principal–Agent Model Nexus of Contracts Model ULE AND THE USINESS OWER OF ...... 69 B R P The Continued Denial of SWM Summary The Business Judgment Rule Formulation Rebutting the Presumption The Rule as Abstention Doctrine? Summary Shareholder Wealth Maximization as the Objective of Corporate Governance A Stakeholder Model of Corporate Governance For the Benefit of Stockholders Bodell I Bodell II Fairness (Entire Fairness) as a Standard of Review Summary 1. 2. EALTH HE HE HE D. E. A. B. C. D. W A. B. C. A. B. C. D. The business judgment rule (the “Rule”) is an equitable I. T to abstain from an entire fairness review if there is no evidence of a breach in fiduciary duties or taint surrounding a Board decision. Moreover, stockholder wealth maximization (“SWM”) is the legal obligation of the and Board the Rule serves to support that purpose. The SWM requirement enters into corporate law through a Board’s fiduciary duties as applied under the Rule, not through statutory law. In essence, SWM is an equitable concept. is no room for fairness in the Rule’s duties must be formulation; mutually exclusive. fairness Third, there are and three policy drivers fiduciary that underlie the use of the Rule: (1) protecting the Board’s statutory authority to run the company without the fear of its members being held liable for honest mistakes in judgment; (2) respect for the private ordering of corporate governance arrangements, which almost always grant extensive authority to the Board to make decisions on behalf of the corporation; recognition and that (3) the they courts’ are not business experts, making authority deference a necessity. to Additionally, Board the Rule is an abstention doctrine just not in terms of precluding duty of care claims, but also by requiring courts II. T III. T ONCLUSION NTRODUCTION doctrine that is the most prominent and important standard of standard important and prominent most the is that doctrine C I 28 \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 2 8-DEC-17 7:20 39748-nyb_14-1 Sheet No. 17 Side B 12/08/2017 14:30:42 12/08/2017 B 17 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 18 Side A 12/08/2017 14:30:42 29 formula- —that was Lyman P.Q. 5 See Bodell v. General v. Bodell Aronson formulation is like formulation, this Arti- Aronson Aronson 405, 423–31 (2013). Johnson would prefer . L. formulation is a common starting point ORP However, anyone who has had the opportu- the had has who anyone However, 2 is not the proper starting place for its expla- . J. C 4 EL Aronson D , Part II. , 38 THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE Unsettledness in Delaware Corporate Law: Business Judgment Rule, Corpo- at 425. See infra For want of a better simile, trying to explain its impor- Id. Instead of starting with the To provide a better understanding of the Rule’s impor- 3 5. Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) (citations omitted). 4. 2. Cede & Co. v. Technicolor, Inc., 634 3.A.2d 345, 361 (Del. 1993). One corporate law scholar, Lyman Johnson, even suggests that it is that the courts focus simply on whether a fiduciary duty has been breached, with the Rule being reduced to a “not policy [to] weigh in on statement the substantive soundness of that director decisions” when directs the courts reviewing a corporate Board decision for a breach care. in the Board’s duty of because it includes an aspect of the duty of care—the need for a Board to make a decision “on an informed basis” 2017] judicial review under corporate law. The Rule protects a decision of a corporate board of directors (“Board”) from ness a fair- review (“entire fairness” under well-pleaded Delaware complaint law) provides unless sufficient a evidence that Board the has breached its fiduciary duties or making that process is tainted, such as with interestedness or a the lack decision- independence. of \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 3 8-DEC-17 7:20 tance is like throwing darts at a filling dart up board every with spot the on goal the of board. One and eventually becomes satisfied gets with the tired spots that were hit, but understands that the center of the bull’s-eye has been missed. the that approach the takes Article this tance, time to get rid of the Rule as a judicial standard of Johnson, review. rate Purpose nation. The preme Court. Yet, starting with the starting in the middle of a story, with understanding. much to be lost in its tant. not found in prior formulations used by the Delaware Su- nity to teach corporate law understands the difficulty in viding pro- a compelling explanation of why the Rule is so impor- tion of the Rule cle takes the novel approach of explaining the Rule by starting with a close reading of two cases which initiated tion the applica- of the Rule under (“DGCL”): Delaware the General Chancery Corporation Court Law (the in opinions “Court”) “Chancery”) (the Court Supreme ware and Dela- 39748-nyb_14-1 Sheet No. 18 Side A 12/08/2017 14:30:42 12/08/2017 A 18 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 18 Side B 12/08/2017 14:30:42 [Vol. 14:27 ), 140 A. 264 (Del. By taking this ap- 6 ), 132 A. 442 (Del. Ch. ”). Bodell II Bodell I Bodell II ” and “ , could conceivably require all challenged Bodell I NYU JOURNAL OF LAW & BUSINESS (“ formulation. Bodell I , Bodell v. Gen. Gas & Elec. Corp. ( aff’d Second, given the need to restrain equity, there is no First, without the Rule, the raw power of equity, as made Aronson 6. Bodell v. Gen. Gas & Elec. Corp. ( 1926), 30 Gas & Electric \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 4 8-DEC-17 7:20 to happen) could lead the court to ignore the implications of applying its equitable powers without restraint, potentially allowing the balance to move too far in the direction of equity and resulting in far too many decisions coming under a fair- 1927). ary duties must be mutually exclusive. An entire fairness review fairness entire An exclusive. mutually be must duties ary is not allowed unless there is evidence that a fiduciary duty has been breached or taint surrounds the cess. If a decision-making court finds pro- no breach or taint, then review is halted and the decision stands, thus upholding the Board’s statutory authority to manage the corporation. The Rule serves as a result fulcrum balancing the lever between the is man- that the agerial discretion of the board of directors, as provided by statutory corporate law, on one end, and equity, with its focus on fiduciary duties and the potential for an entire dard fairness of review on the other end. The Rule stan- and its formulation ensures that equity and statutory corporate moving the Rule as a standard of judicial review (if it ever were law co-exist. Re- the Board’s statutory authority to run the company without the without company the run to authority statutory Board’s the fear of constantly facing potential liability for honest mistakes in judgment. Protecting against this potential original policy driver underlying the Rule. This requires equity liability is the to be restrained so as not to create an imbalance. To do this, Courts use the Rule as a tool to distinguish situations in which a Board decision should stand without further review from situations in which an entire fairness review is required and the full force of equity is to be applied. This is the most important function of the Rule. room in the Rule formulation for fairness; fairness and fiduci- clear in Board decisions to undergo an entire fairness review. face of this power, In the issue for courts is to the determine how the interests of stockholders are to be balanced against protecting proach, the following insights into the Rule were discovered, which may not have been so readily apparent by starting with the 39748-nyb_14-1 Sheet No. 18 Side B 12/08/2017 14:30:42 12/08/2017 B 18 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 19 Side A 12/08/2017 14:30:42 31 Revlon of corpo- ) even though two 8 private ordering dealt with Section 4a of the old The Business Judgment Rule as Abstention II formulation of the Rule. The SWM but also in a more fundamental way, and 9 83 (2004). . tit. 8, § 141(a) (2016). tit. 8, § 152 (2015). Aronson EV . . Bodell I NN NN ( A A 7 . L. R ODE ODE AND V . C . C Stephen M. Bainbridge, THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE EL EL , 57 See D D The discussion that follows is specifically focused on those Fifth, the Rule serves to support the default legal obliga- Third, the role played by the Rule does not change under Fourth, the Rule is an abstention doctrine not just in 7. 8. 9. Doctrine those less common business decisions that come under corporate law’s intermediate standards of judicial review, the (“SWM”), an approach to corporate governance that encour- ages a Board to implement all major decisions with economic interests of stockholders only in mind. This is not readily the apparent from the requirement enters into corporate law through a Board’s fiduciary duties as applied under the Rule, not through statutory law. In essence, SWM is an equitable concept. The implementation of SWM is indirect as all three of the major policy drivers that influence the Rule also guide courts to stay away from a direct focus on SWM unless the Rule has been rebutted. Board decisions which are permitted to be reviewed under the Rule. This means that the Article minimizes the discussion of by requiring courts to abstain from an entire fairness review if there is no evidence of a breach surrounding in a Board fiduciary decision. duties or taint tion of the Board known as stockholder wealth maximization 2017] ness review. In essence, the Rule is a on self-imposed a constraint court’s equitable powers. DGCL 141(a), \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 5 8-DEC-17 7:20 DGCL, currently embodied in DGCL § 152 tensive authority to the Board to make decisions on behalf of the corporation, and (2) the recognition by courts are not that business experts, making deference to Board authority they a necessity. terms of precluding duty of care claims, as persuasively argued by Stephen Bainbridge, additional policy drivers are identified which reinforce the use of the Rule versus an automatic entire fairness review. These policy drivers are: (1) respect for the rate governance arrangements, which almost always grant ex- 39748-nyb_14-1 Sheet No. 19 Side A 12/08/2017 14:30:42 12/08/2017 A 19 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 19 Side B 12/08/2017 14:30:42 see Id. 1, 1 [Vol. 14:27 ELAWARE , http://corp test, to review D GENCY Unocal A HOOSE 12 C BOUT A , Corwin v. KKR Fin. Holdings duty to maximize stockholder See ORPORATIONS ELAWARE Revlon C D both of which are meant to pro- HY 11 ., W R TATE OF test, S , J LACK NYU JOURNAL OF LAW & BUSINESS Unocal S. B EWIS L and its corporate law often serves as the authority that and the See 13 Also, the discussion that follows—when it references state 10 Paramount Communications Inc. v. QVC Network Inc., 637 A.2d 34 12. Kahn v. M&F Worldwide Corp., 88 A.3d 635, 642 (Del. 2014) (ac- 10. Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 11. Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985) (cre- 13. of Delaware corporate law. Delaware is the state where the vast majority of the largest United States companies are rated, incorpo- corporate law—has been pragmatically framed in the context standard of review, as long as they are satisfied that a majority of stockholders informed have approved the decision. ating a two-pronged test, commonly referred to as the defensive measures taken by a board of outside directors investor or to group of repel investors attempts to gain by control of an the corporation). cording to the Delaware Supreme Court, “[w]here a self-dealing transaction by involving a controlling stockholder is challenged, the applicable standard of judicial review is ‘entire fairness,’ burden with of the persuasion”). However, defendants the having Rule may the still apply in a where the transaction controlling stockholder offers to buy out the minority stockholders (freeze-out) if the Board appoints a special independent committee negotiate to the transaction on behalf of stockholders. minority of majority informed an by approved is transaction the minority stockholders and the at 645. In addition to Kahn’s freeze-out merger scenario, it noted that courts have recently taken other action to increase the number of should also be Board decisions that come under the Rule, and not under an entire fairness 182 (Del. 1986) (establishing wealth when the the break-up, sale, or merger of a also company is inevitable); (Del. 1994). (2007), http://corp.delaware.gov/whycorporations_web.pdf (stating Delaware is the “favored state of incorporation for U.S. businesses”). Accord- that ing to the State of Delaware website, Delaware is the legal home to “[m]ore than 66% of all publicly-traded companies in 66% the of the United Fortune 500.” States including 32 duty \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 6 8-DEC-17 7:20 other states look to when developing their own statutory and LLC, 125 A.3d 304 (Del. 2015). tect decisions from an automatic fairness plied with review a heightened even level if of judicial ap- scrutiny. The Article also minimizes the discussions of those Board must decisions initially that come under the entire fairness view, standard of such re- as when a transaction corporation with a controlling enters stockholder. into a self-dealing .delaware.gov/aboutagency.shtml (last visited Oct. 10, 2017). 39748-nyb_14-1 Sheet No. 19 Side B 12/08/2017 14:30:42 12/08/2017 B 19 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 20 Side A 12/08/2017 14:30:42 33 393, . L. . IN . & F & . ORP J. C ORDHAM QUITY F E , 12 , I. Part III discusses SWM as a legal 15 OWER OF Director Compliance with Elusive Fiduciary Duties 16 P HE tit. 8, § 141(a) (2016). T . NN Therefore, the primary examples are from Del- A 14 ODE . C Nadelle Grossman, THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE EL D See direct and superintend the affairs of the corporation. In this respect they may be guilty of acts of commis- sion or omission, of Now mal-feasance where acts or are executed within nonfeasance. their authority, be will it consequences, bad with attended though . . . very difficult to determine that these are breaches of trust. For it is by no means just in a judge, after bad consequences have arisen from such their executions power, to say that they of foresaw at the time what must necessarily happen; and therefore, were guilty of a breach of trust. This judicial policy of protecting board members from lia- As early as 1742, equity recognized that corporate boards [Directors] are most properly agents employ them to in this trust, and who empower them to those who This Article proceeds as follows: Part I discusses the ori- 16. Charitable Corp. v. Sutton [1742] 26 Eng. Rep. 642 (citations omit- 14. 15. has been consistently identified as a major policy objective of bility when their honest mistakes in judgment turn out badly should not be held liable for honest mistakes in judgment. Ac- cording to the Lord Chancellor of England: ted). 2017] law. common \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 7 8-DEC-17 7:20 obligation of Board decision-making and how the Rule is both consistent with and supportive of SWM. in a Climate of Corporate Governance Reform Governance Corporate of Climate a in 397 (2007). law which provides the Board with almost unlimited authority to manage the corporation. aware, but the thinking is meant to be global. gins of the Rule as a tool used by judges to restrain themselves from using their authority under equity to review Board decisions for (entire) fairness. Judges recognized that necessity in this order to protect directors was from liability for honest a how describes II Part badly. out turn that judgment in mistakes the Rule has been applied under DGCL § 141(a), the statutory 39748-nyb_14-1 Sheet No. 20 Side A 12/08/2017 14:30:42 12/08/2017 A 20 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 20 Side B 12/08/2017 14:30:42 , 53 ARTON UTIES OF [Vol. 14:27 E. B E. D ANCY , N IDUCIARY : F LOCK However, the Board ULE ), 15 Del. Ch. 119, 132 A. J. B J. 22 R ENNIS Bodell I D UDGMENT In response, the Chancery had J Bodell I of the Rule versus the alternative 21 Instead, it is a policy driver cited 19 use A. USINESS B Delaware Directors’ Fiduciary Duties: The Focus on Loy- Our Two Corporation Systems: Law and Economics HE 675, 680 (citing 1 1 (citing 680 675, 9 (5th ed. 1998 & Supp. 2002). , T Moreover, the statute which allowed for the . L. NYU JOURNAL OF LAW & BUSINESS 20 23 18 US , the plaintiffs alleged that the Board violated its is discussed, but first the discussion needs to fo- ADIN , 15 Del. Ch. 420, 140 A. 264 (1927). at 123, 132 A. at 444. IRECTORS . J. B aff’d . at 122–23, 132 A. at 444. A Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106, 139 (Del. 139 106, A.2d 964 Litig., Derivative S’holder Inc. Citigroup D 259, 271 (1967). A. R . More recently, courts and commentators have be- Bodell I. Bodell I EV 17 U. P Bodell II In re See id See id. See id. Protecting board members from liability when their hon- In the long term by taking risks without the debilitating com- the if liable personally held be will they that fear pany experiences losses. This doctrine however, that when the company suffers losses, share- also means, holders may not be able to hold the directors personally liable. Ultimately, the discretion granted directors and managers allows them to maximize shareholder value in TEPHEN , 11 20. Bodell v. Gen. Gas & Elec. Corp. ( 18. 17. Henry G. Manne, 21. 22. 23. 19. Randy J. Holland, . L. R ORPORATE A est mistakes in judgment turn out badly is not the Rule, as it is commonly mistaken to be. fiduciary duties by initiating a plan to sell no-par for value below stock its fair sales value. & S C V 34 the Rule. Fifty years ago, Henry Manne “preclude[s] the stated courts from any consideration of honest if in- that the Rule the of purpose the be to seems that and decisions, business ept Rule.” \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 8 8-DEC-17 7:20 come aware that protecting directors from such liability allows for also optimal risk-taking in corporate decision-making: granted a temporary restraining order. 442 (1926), by courts in justifying the clear become will This review. fairness (entire) automatic an of when cus on itself was not accused of self-dealing or of personally profiting from the sales. Ch. 2009). alty 39748-nyb_14-1 Sheet No. 20 Side B 12/08/2017 14:30:42 12/08/2017 B 20 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 21 Side A 12/08/2017 14:30:42 35 ELA- pro- D 24 to cir- 25 TATE OF S Lyman Johnson, see proper cases AWS OF THE 701, 709–13 (2011). . L 27 EV B.U. L. R ORPORATION 819, 821–22 (1993). For an excellent dis- C A Short History of the Delaware Court of Chancery . L. , 91 ORP ENERAL as authority for reviewing the Board’s ac- . J. C , G 26 EL D 28 No-par common stock was approved in 1917 to be followed ENSON , 15 Del. Ch. at 128, 132 A. at 446. , 18 THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE at 129, 132 A. at 446 (emphasis added). . A. R. B Id Bodell I Id. If this was not clear enough, the Chancery also stated, However, even in the face of this “absolute power,” the and answered in the affirmative. So far as the literal language of cerned, the directors the may from time to section time issue no is con- par stock for any consideration they may see fit, even though the price they fix is far below its actual value . . . . What I am now pointing out is simply this - that the statute does not impose any restraint apparent unbridled upon power of the the directors. Whether equity will, in accordance with the principles which prompt it to restrain an abuse of powers granted in absolute terms, lay its restraining hand upon the directors in case of an abuse of this absolute power, is another question which will be presently considered 19 (1921). 24. 25. 26.equity Delaware of secret “[t]he Hanrahan, and Quillen to According 27. 28. – 1792–1992 cumscribe it.” “But notwithstanding the absolute character of the language in which the power to direct the directors is expressed, it cannot be that a court of equity is powerless in Chancery had no problem with identifying the countervailing power of equity of fairness based on conscience. Second, equity is the recognition the is Equity case. special the to applied justly that be always cannot rule universal the flexible application of broad moral principles (maxims) to fact specific situations for the sake of justice. Delaware has preserved the essence.” William T. Quillen & Michael Hanrahan, by no-par value preferred stock in 1925. sense moral a is equity First, origin. in English both concepts, old two in rests 2017] issuance of no-par value stock, Section 4a of the DGCL, \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 9 8-DEC-17 7:20 WARE cussion of how equity is applied under corporate law, tions: vided the Board with unrestrained authority to determine the adequacy of the consideration to be received in exchange for the no-par value stock as long as the Board had authority to do so under the company’s certificate of incorporation. Delaware’s Non-Waivable Duties 39748-nyb_14-1 Sheet No. 21 Side A 12/08/2017 14:30:42 12/08/2017 A 21 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 21 Side B 12/08/2017 14:30:42 , 33 This This is . 31 See infra IDUCIARY in favor F [Vol. 14:27 56 (John W. USINESS OSTS VERSUS B 32 presumption C GENCY , A This presumption is an ac- TRUCTURE OF 30 S LARK HE : T C. C GENTS OBERT . While they are not trustees in the strict R A 29 See NYU JOURNAL OF LAW & BUSINESS , the Chancery begins its legal analysis by noting fiduciaries , 15 Del. Ch. at 129, 132 A. at 446 (emphasis added) at 122–23, 132 A. at 444. at 123, 132 A. at 444. RINCIPALS AND P (emphasis added). Directors are fiduciaries of both the corpora- at 132, 132 A. at 448. Bodell I IN Id. Bodell I Id. See id. See id. , The application of the Chancery’s fairness review focused As authority for using its equitable powers in the face of In Nevertheless, in identifying the balance between Board 29. 30. 31. 32. 33. UTIES sense of the term, yet for convenience they described have as often such.” been primarily on the substantive nature of the stock sales regarding sales stock the of nature substantive the on primarily their overall benefits to stockholders, but also appears to have taken into consideration director conduct and motivations by noting that the Board was not interested in the transaction statutory law that suggests “There is no rule better settled in the law of corporations than otherwise, the Chancery that directors noted, in their conduct of the corporation stand in the situation of and by concluding that “[a] complete absence of selfish tive mo- and of personal profit on their part forcefully argues that D 36 \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 10 8-DEC-17 7:20 sion that they serve two masters. In Part III, reconciles this it unusual situation by taking the is position that the fiduciary du- described how the Court ties owed to the corporation are for the benefit of the stockholders. Part III. Pratt & Richard J. Zeckhauser eds., 1985). This gives the misleading impres- knowledgment of Board authority as derived through statutory law. authority and equity where a statute provides amount of the managerial discretion, the maximum Chancery applied a balance that was strongly oriented toward equity, Board requiring the to demonstrate fairness in their decision-making. there “accords to the acts of the directors a directors the of acts the to “accords there of their propriety and fairness.” that when statutory law provides the Board with authority, was the result of the factual finding that the sale of equity was to occur at a price below fair market value. tion and stockholders. perhaps the source for the famous Rule presumption formulation. language in the current 39748-nyb_14-1 Sheet No. 21 Side B 12/08/2017 14:30:42 12/08/2017 B 21 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 22 Side A 12/08/2017 14:30:42 35 37 did not Lofland v. Cahall, Bodell I . see also Bodell II However, what Bodell II 38 B. A court of equity always has the right to 37 , the Chancery made an emphatic declaration , 15 Del. Ch. at 129, 132 A. at 446; THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE at 134–37, 132 A. at 449–50. at 135, 132 A. at 449. at 139, 132 A. at 451. Bodell I 34 Id. Id. Id. Bodell I However, was a fairness review really required? This was The Chancery found that the shares were not sold below In 36 34. 35. 36. 37. Sample v. Morgan, 914 A.2d 647, 675 n.54 (Del Ch. 2007) (“That the 38. the fair sales value, thus absolving the Board of any liability. 2017] judgment was formed in absolute faith.” honesty and entire good The Chancery also vacated der. the outstanding restraining or- \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 11 8-DEC-17 7:20 circumscribe Board authority when the court perceives that a wrong has been committed. the issue taken up by the Court in quire this? If not, what kind of decision-making tool or would the filter court use to make the determination that a fairness answer is whether a challenged Board decision would come always under a fairness review, placing the Board in tion the of constantly posi- facing significant potential liability for honest mistakes in judgment that turn out badly. Does equity re- where their individual interests are concerned.”); Adams v. Clearance Corp., 121 A. 2d 302, 306 (Del. 1956) (“When the directors, or the majority stockholders, exercise a power that the them, it is competent for anyone who conceives himself aggrieved thereby to general corporation law confers upon invoke the processes of a court of equity for protection against its oppressive exercise. Notwithstanding therefore the absolute terms in which the power of the directors is expressed, equity will afford protection against its wrong- ful use.” (citations and quotes omitted)); Schnell v. Chris-Craft Indus., Inc., 285 A.2d 437, 439 (Del. 1971) (“[I]nequitable action does not become per- missible simply because it is legally possible.”). 118 A. 1, 3 (Del. 1922) (“Directors of a corporation are trustees for the stock- the for trustees are corporation a of (“Directors 1922) (Del. 3 1, A. 118 holders, and their acts are governed by the Rules applicable to such a rela- tion, which exact of them the utmost good faith and fair dealing, especially that the power of equity can never be denied, even in the face of a statutory law that provides the Board with absolute authority in a specific area of corporate decision-making and where there is no evidence of director self-interest. This declaration is not in dispute. operation of Delaware corporate law depends importantly on the subjection of action in conformity with legal rules to equitable principles has long been understood.”). 39748-nyb_14-1 Sheet No. 22 Side A 12/08/2017 14:30:42 12/08/2017 A 22 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 22 Side B 12/08/2017 14:30:42 41 [Vol. 14:27 ), 15 Del. Ch. 420, 426, 140 Bodell II to affirm the Chancery’s deci- Bodell II 21 Del. Laws 273 (1899). See NYU JOURNAL OF LAW & BUSINESS , the Court was not reticent in taking issue with Continuing with this line of thinking, the Court 40 Bodell II Id. 39 This is a direct repudiation of the approach applied by In The Legislature, in enacting the clothe the directors statute, of a corporation meant with exception- to ally large powers in the sale of its no par value stock. If in the particular case there is nothing to show that the directors did not what exercise they believed to be their the best interest discretion of the cor- for poration, certainly an honest judgment should not be mistake reviewable by the Court. of business 41. 39. This was perhaps the first case where the Delaware courts applied the 40. Bodell v. Gen. Gas & Elec. Corp. ( A. 264, 267 (Del. 1927). the Chancery and perhaps the first case fairness cannot be part of the Rule formulation. It makes that clear explained why that protecting director decision-making when it only involves honest mistakes of business judgment (most critical when director liability is involved) cannot coexist with a fairness standard of review. A fairness review is only concerned with an objective analysis into whether the results were fair to the plaintiffs; it does not take into consideration whether the decision was an honest mistake of business judgment. Either fairness or the policy of protecting honest mistakes of business judgment can be a component of the Rule, but not both. They are mutu- in latter the chose Court Supreme Delaware The exclusive. ally formulating its Rule, an approach which still stands today: Rule under the DGCL, a statutory set of laws general incorporation. created in 1899 to allow for 38 review was or was not required? That tool turns out to be the Rule, the standard of judicial preme review Court used that in the Delaware Su- \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 12 8-DEC-17 7:20 also said: sion. corporation, should be liberally directors.” construed in favor of the both the Chancery’s apparent lack of respect for the managerial discretion provided by statutory law and its fairness dard stan- of review. According to the Court, “the broad and eral language of the statute, gen- embodied in the Certificate of In- 39748-nyb_14-1 Sheet No. 22 Side B 12/08/2017 14:30:42 12/08/2017 B 22 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 23 Side A 12/08/2017 14:30:42 39 Most 43 ) that has 44 This precedent holds 45 tit. 8, § 141(a) (2016). tit. 8, § 152 (2015). tit. 8, § 141(a) (2016). . . . NN NN NN Therefore, the fairness review as required by A A A 47 42 , 15 Del. Ch. 420, 426, 140 A. 264, 267 (the directors were not ODE ODE ODE Fairness (Entire Fairness) as a Standard of Review . C . C . C THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE at 268. EL EL EL was not required. D D D Bodell II Id. Id. The Court concurred with the lower court and found C. Before moving to a discussion of the Rule under DGCL By using the language, “discretion of a board of directors” It may be impossible to lay down a this subject, general but we think the discretion rule of a board of on directors in the sale of its no par value stock should not be interfered with, except constructive, for such fraud, actual as or improper motive gain or arbitrary action or or conscious disregard of the personal stock- its of rights the and corporation the of interests holders. In affirming the Chancery Court’s decision, the Court 46 44. 45. 46. 47. 42. 43. § 141(a), it is important to understand what is meant by a fair- this Rule formulation acknowledges the managerial authority of the Board as provided by statutory corporate law. going to financially benefit from the transaction). Bodell I 2017] \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 13 8-DEC-17 7:20 that the directors had utilized their best judgment and acted in good faith. importantly, however, the formulation reduces the demands of equity by requiring only the absence of certain types of improper Board conduct, namely actual or constructive fraud, in order to allow the decision to stand. Moreover, in formulating its Rule without the inclusion of fairness as a substantive component, the Court established a critical precedent under Sec- tion 4a of the old DGCL (currently DGCL § 152 been since applied to DGCL § 141(a). thority to make corporate decisions. found no evidence that the Board was not acting in interest of the corporation and the the fact that the Board was not best interested in the transaction served as significant evidence of this. that there are significant limits to the reach of equity at least where statutory law grants the board seemingly absolute au- 39748-nyb_14-1 Sheet No. 23 Side A 12/08/2017 14:30:42 12/08/2017 A 23 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 23 Side B 12/08/2017 14:30:42 , L. UKE see also D [Vol. 14:27 Law, 43 and the one that a Entire fairness is a is the forerunner of 49 48 Bodell I When this standard of review 52 Moreover, “[n]ot even an honest 53 Fairness and Trust in Corporate required a rigorous review of the stock , 787 A.2d at 97. NYU JOURNAL OF LAW & BUSINESS Bodell I , 747 A.2d at 1112. found it inappropriate to use such a review unless Entire fairness requires a review of the result for 50 According to Ezra (a.k.a. Lawrence) Mitchell, an “[en- Solomon Emerald Partners 51 The fairness review found in Bodell II 49. Reis v. Hazelett Strip-Casting Corp., 28 50. A.3d 442, Emerald Partners 459 v. Berlin, 787 (Del. A.2d 85, 51. 93 Ch. (Del. 2001). 52. Lawrence E. Mitchell, 48. Cinerama, Inc. v. Technicolor, Inc., 663 A. 2d 1156, 1162 (Del. 1995) 53. 425, 427 (1993). J. the Court more closely focuses on the details sion-making of the process transaction in and an deci- effort to assess the substantive terms.”). fairness of the transaction’s 2011). Solomon v. Armstrong, 747 A.2d 1098, 1112 (Del. Ch. 1999) (“[T]he board’s (“[T]he 1999) Ch. (Del. 1112 1098, A.2d 747 Armstrong, v. Solomon decision is reviewed through the lens of entire fairness, pursuant the to directors which lose the presumption of good business judgment, and where transaction’s circumstances.” tire] fairness [review] contemplates a range of values and fiduciary conduct that properly is analyzed within the totality of a (“If the [R]ule is rebutted, the burden shifts to the defendant directors, the proponents of the challenged transaction, to prove to the ‘entire trier of fairness’ fact of the the transaction to the shareholder plaintiff.”); 40 ness review. sales, focusing on both the substantive and procedural nature of the sales and on the conduct and motivations of the directors. Such a fairness review would have created a heavy burden mistake honest an time every up conjured were it if Board a on in judgment turned out badly. This is essentially why the Court in its Rule had been overcome. \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 14 8-DEC-17 7:20 “substantive fairness,” with the burden of proof on the defendants. applies, courts must “consider carefully how the board of each to regard with duties fiduciary its of all discharged rectors di- aspect of the non-bifurcated components fair of dealing and fair price.” entire fairness: court’s most onerous standard of review the review currently used by Delaware courts when the Rule is overcome (now called “entire fairness). Board would most like to avoid, thus encouraging a Board to conduct its decision-making process within the confines of the Rule. However, while starting afresh under entire fairness does put a heavy burden on a Board, liability.” it “is not an implication of 39748-nyb_14-1 Sheet No. 23 Side B 12/08/2017 14:30:42 12/08/2017 B 23 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 24 Side A 12/08/2017 14:30:42 , 41 , disclosed For exam- see also Encite 54 58 that the pricing negotiated possible In addition, “[p]art of fair 55 , No. 2476-VCG, 2011 Del. Ch. LEXIS t transactions, price may be the 57 “relates to the economic and financial con- non-fraudulen “embraces questions of when the transaction price dealing see also Encite LLC v. Soni fair, independent of the board’s beliefs.” THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE Fair ; at 748 (emphasis added). In the uncommon fact pattern where a stock price, sale price, stock a where pattern fact uncommon the In 56 Id. Id. , even if the “board used an unfair process to authorize the bonuses” 59 Id. While in theory the review for entire fairness is a non-bi- Fair 54. Gesoff v. IIC Indus., Inc., 902 A.2d 1130, 1145 (Del. Ch. 2006) (em- 55. Weinberger v. UOP, Inc., 457 A.2d 701, 711 (Del. 1983) (emphasis 56. 57. 59. Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983); 58. Valeant Pharm. Int’l v. Jerney, 921 A. 2d 732 (Del. Ch. 2007) (focus- siderations of the proposed [transaction], including all vant rele- factors: assets, market value, earnings, future and prospects, any other elements that affect the value of intrinsic a company’s or stock.” inherent furcated process, in practice courts have great discretion in focusing more on one component than the other. was timed, how it was initiated, structured, to the directors, and how the approvals of the the stockholders were directors obtained.” and price of real estate, or level of compensation, etc. is not at is- phasis added). added). 2017] belief that the transaction was entirely fair will be sufficient to establish entire fairness. Rather, the transaction itself must be objectively \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 15 8-DEC-17 7:20 terms were so fair as to render where the the transaction pricing entirely terms fair. of Nevertheless, a transaction process that cannot be is justified by the reference product to reliable of markets or an by son unfair compari- to substantial and dependable precedent persuading transactions, the court the of the fairness burden of the of terms will be exceptionally difficult.” tained, what ultimately matters most is that the price was a fair one.” ple, “at least in preponderant consideration. That is, although evidence of fair dealing may help demonstrate the fairness of the price ob- by use of corporate information privy.” to which the latter is not dealing is the obvious duty of candor . . . . Moreover, one pos- sessing superior knowledge may not mislead any stockholder Valeant it “does not end the court’s inquiry because it is 2011 Del. Ch. LEXIS 177 at *24. 177 at *75 (Del. Ch. 2011). Memorandum opinion. ing on fair dealing in a Board decision to pay large cash selves bonuses and to to them- certain non-Board employees). In the cash bonus context of 39748-nyb_14-1 Sheet No. 24 Side A 12/08/2017 14:30:42 12/08/2017 A 24 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 24 Side B 12/08/2017 14:30:42 Bodell II [Vol. 14:27 62 61 ), 15 Del. Ch. 119, 129, 132 Bodell I Summary D. NYU JOURNAL OF LAW & BUSINESS and the entire fairness review, at least in terms ), only fair dealing may apply. ’s Rule formulation guides a court in how it 60 stands for the raw power of equity and how it can in favor of their propriety and fairness.” Bodell I at 1376. Id. Bodell I The heavy burden found in both the fairness review ap- Bodell II 60. Nixon v. Blackwell, 626 A. 2d 1366 61. (Del 1993). 62. Bodell v. Gen. Gas & Elec. Corp. ( out badly for shareholders. This makes the Rule a necessity. plied in of the volume and duration of litigation, requires some way to avoid an automatic fairness review of Board decisions that turn 42 sue (e.g., where the Board of a non-statutory, closely-held corporation provided themselves with advantageous ways to liqui- date their illiquid company stock holdings through company repurchases without providing such means for non-employee stockholders \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 16 8-DEC-17 7:20 A. 442, 446 (1926). understanding the essence of the Rule. stands for the need to truly respect statutory authority, requiring the courts to restrain the power of equity in the face of this authority. This required restraint provides the foundation for potentially trump statutory law, even where statutory law provides the Board with unlimited decision-making authority. Ac- cording to the court, this was true even though the court knowledged ac- that there “accords to the acts of the directors a presumption must understand about the Rule, this is it. should apply this restraint in its review of a Board decision. It first brings to the fore the requirement that a court spect must re- managerial discretion. This means that fairness approach gentler a Instead, cannot review. court’s a in stop first the be must be taken, an approach that involves fiduciary duties, not fairness. There is no room in the ness; fairness Rule and fiduciary formulation duties must be for mutually exclusive. fair- A fairness review is not decision the surrounding taint some is there or breached been allowed unless a fiduciary duty such has as director’ interestedness. This is the sence of fundamental the es- Rule and if there is one thing that law students 39748-nyb_14-1 Sheet No. 24 Side B 12/08/2017 14:30:42 12/08/2017 B 24 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 25 Side A 12/08/2017 14:30:42 43 ) a 63 That is, “ob- 66 § 141( , provided the stat- , “At its core, the Dela- ULE AND generates outcomes that are R II. private ordering at best Williams v Geier UDGMENT J Private ordering of authority is consid- tit. 8, § 141(a) (2016). tit. 8, § 152 (2015). 65 . . NN NN USINESS ). Unlike Section 4a and its successor DGCL A A B ODE ODE HE . C . C T THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE DGCL 141(a) is an opt-out or “default” rule, not an EL EL 64 D D On its face, this statutory law can be interpreted as provid- The significance of the Rule peaks when the Rule is ap- Most importantly, both are examples of the private order- welfare-enhancing, while law mixed (and tend strongly towards the welfare-reducing), informal norms should come with a strong presumption of legitimacy. For- mal legal rules are likely to be inefficient at best and amorally redis- tributive at worst. Thus, under a wide range of circumstances, such as when society is interested in maximizing tions, and when society is utilitarian interested in resolving standard legal considera- dis- putes within groups, lawmakers are unlikely to improve upon the customary rules the group develops through voluntary, private in- teraction. [B]ecause informal norms generate outcomes that are generally 64. 65. Williams v. Geier, 671 A.2d 1368, 1381 66.(1996). According to Professor Jonathan Macey: 63. of a board of directors, except as may be otherwise provided in provided otherwise be may as except directors, of board a of this chapter or in its certificate of incorporation.” ing the Board with unlimited managerial authority, similar to the authority provided by DGCL Section 4a Bodell (as discussed I in and II § 152, plied under the critically important that provides the Board statutory with authority to manage the corpora- corporate law tion. In Delaware, this law “The is DGCL business § and 141(a), under this chapter which shall be managed by or under the direction affairs states, of every corporation organized ered efficient because it allows for the implementation of market-driven corporate governance arrangements. 2017] \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 17 8-DEC-17 7:20 cording to the Court in ware General Corporation Law is a broad enabling act which leaves latitude for substantial utory parameters and judicially imposed principles of fiduciary duty are honored.” opt-in rule. As a default rule, the delegation of unlimited authority to the Board is not expected to be substantively altered through a charter amendment. In practice, this has certainly been the case, especially in the context of public companies. ing or enabling approach found in statutory corporate law. Ac- 39748-nyb_14-1 Sheet No. 25 Side A 12/08/2017 14:30:42 12/08/2017 A 25 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 25 Side B 12/08/2017 14:30:42 Courts [Vol. 14:27 67 note 26, at 705. supra (forthcoming 2017). . EV Such respect is not (2016). 68 1123, 1140–41 (1997). . Johnson, . L. R EV See courts have shown great def- OLUM L. R 251, 253 69 C , OLICY ORNELL The Tension Between Hedge Fund Activism and The Market Reaction to Corporate Governance Reg- C . & P tit. 8, § 122(17) (2000); Gabriel V. Rauterberg & , 82 . 431, 431 (2011). . CON tit. 8, § 102(b)(7) (2015). Section 102(b)(7) bars . NN NN CON A Public and Private Ordering and the Production of Legitimate NYU JOURNAL OF LAW & BUSINESS A J. L. E . E ODE IN Contracting Out of the Fiduciary Duty of Loyalty: An Empirical Anal- Empirical An Loyalty: of Duty Fiduciary the of Out Contracting ODE . C , 12 J. F EL . C D In essence, the Board and stockholders have agreed to agreed have stockholders and Board the essence, In EL D 70 , 101 See Why stockholders permit the Board unrestrained author- 68. Bernard S. Sharfman, 67. David F. Larcker et al., 69. 70. Malpiede v. Townson, 780 A.2d 1075 (Del. 2001). Delaware courts Jonathan R. Macey, and Illegitimate Legal Rules Corporate Law 44 served governance choices are the result of value-maximizing contracts between stockholders and management.” \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 18 8-DEC-17 7:20 the recognition that the Board, with superior information, including confidential information, is in make the the most important best corporate decisions. The position parties to to the corporate contract recognize that a centralized, hierarchi- contract away the Board’s fiduciary duty of care. Thus, private ordering provides another policy rationale for why the courts should restrain themselves when applying equitable principles to Board decision-making, adding weight to the lever on side the where statutory law rests and away from equity under the Rule. ity under both DGCL § 152 and DGCL § 141(a) is based on ulation However, as Lyman Johnson has pointed out, an exculpation clause does not does clause exculpation an out, pointed has Johnson Lyman as However, eliminate the duty of care, only the consequences financial liability of the Board is the focus. of its breach when the erence for the authority ment. provided by this type of amend- have also demonstrated respect for the statutory either right a charter amendment or simply a Board of resolution, to contract out of corporations, by the fiduciary duty of loyalty when applying the corporate opportunities doctrine. Talley, L. Eric ysis of Corporate Opportunity Waivers any claim for money damages against the director defendants based on solely the board’s alleged breach of its duty of care. understand that this private under ordering the sanction has of been statutory compelled corporate agreed to respect law the to and wishes of will those parties feel Board to have manage the the company with cluding minimal interference interference, from in- the courts. from duty of care granted by DGCL liability § as 102(b)(7), allowed under the authority speculative. For example, when a corporation amends its charter to provide for an exculpation clause to protect directors 39748-nyb_14-1 Sheet No. 25 Side B 12/08/2017 14:30:42 12/08/2017 B 25 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 26 Side A 12/08/2017 14:30:42 45 71 73 RGANIZATION O IMITS OF L 801–16 (1986) (arguing HE AW , T L Production, Information Costs, and 777, 788 (1972). . RROW EV . R J. A ORPORATE , C CON . E ENNETH M LARK K A C , 62 HARLES C a point which, if seriously taken, will help make sure THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE 72 OBERT R Such deference to Board authority is shared by the courts The “business judgment” rule is a that judicial creation presumes stances, propriety, in a board’s decision. under Viewed defensively, it does not certain create authority. In this sense the “business circum- judgment” rule is not relevant in corporate decision- making until after a decision is made. It is generally used as a defense soundness. The to board’s managerial decision-making an attack power, on however, the comes from decision’s § 141(a). creation and legislative The grant are related judicial because the “business judgment” rule evolved to give recognition and deference to directors’ business expertise when exercising their managerial power under § 141(a). holders. More effective control of corporate activity is achieved for most purposes by group, whose main function transferring is to negotiate with and manage (rene- decision authority gotiate to with) the other inputs a of the team. smaller If every stock owner participated in each decision in a corporation, not only would large bureaucratic would shirk the task costs of becoming well informed be on the issue to be incurred, but decided, many since the losses associated with sions will be borne in large part by the many other corporate unexpectedly stock- bad deci- 71. 72. Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) (citing Zapata Corp. 73. Zapata Corp. v. Maldonado, 430 A.2d 779, 782 (Del. 1981). Economic Organization that “facilitation of cooperation” tasks). According allows to Kenneth Arrow, information for scattered over a efficiently large organization completing must be both large filtered and transmitted to a centralized authority in order for a large organization to make informed decisions and minimize error in decision-making. in its application of the Rule. The Delaware has described the Rule as “an acknowledgment of the Supreme manage- Court rial prerogatives 141(a),” of Delaware directors under Section the balance does not tip too far towards equity: Armen A. Alchian & Harold Demsetz, 68–70centralized a that argued Demsetz Harold and Alchian Arman (1974). authority was necessary to eliminate the problems associated with having a large number of stockholders: 2017] cal authority is necessary for the successful management of a corporation, especially as it grows to any significant size. \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 19 8-DEC-17 7:20 v. Maldonado, 430 A.2d 779, 782 (Del. 1981)). 39748-nyb_14-1 Sheet No. 26 Side A 12/08/2017 14:30:42 12/08/2017 A 26 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 26 Side B 12/08/2017 14:30:42 [Vol. 14:27 “[J]udges are not 78 , 389, 406–09 (2014). . EV Embellishing this important 74 . L. R LA F Judges recognize that they lack in- 76 Shareholder Wealth Maximization and Its Imple- , 66 Therefore, as long as the courts do not note 77, at 409–11. 79 NYU JOURNAL OF LAW & BUSINESS (i.e., directors should not be blamed for hon- 80 Dodge v. Ford Motor Co. supra Bodell II As stated by the Michigan Supreme Court in the fa- Id. Id. 77 75 In part, the humility expressed by courts with respect to Judges need to respect Board decision-making for the Unlike the defensive nature of the policy rationale uti- 74. 75. Corwin v. KKR Financial Holdings LLC, 125 A.3d 304, 313–14 (Del. 76. Brehm v. Eisner, 746 A.2d 244, 263 (Del. 2000) (quoting 77. Lewis v. Bernard S. Sharfman, 78. Dodge v. Ford Motor Co., 170 N.W. 79. 668, 684 (Mich. 1919). 80. Sharfman, their own decision-making abilities is reflective of their understanding that making a business decision can be the result of a that expertise requiring process thought complicated and long courts do not have. The following statement, in the context of a Board trying to make a wealth maximizing decision half on of be- stockholders, makes that point: simple reason that they are inferior to the Board in determining terms what is the of best corporate decision and therefore should not take on the role of reviewing the substantive decisions of the Board, including determining degrees of business the risk.” “appropriate lized in est mistakes of business judgment), cuses this on how corporate policy decision-making is enhanced because rationale fo- of a Board’s business expertise. 2015). Vogelstein, 699 A. 2d 327, 336 (Del Ch. 1997)). mentation Under Corporate Law formation, decision-making skills, expertise, and vested interest (i.e., stake in the company) relative to corporate management. 46 \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 20 8-DEC-17 7:20 mous case of makers with more . information . . .” (in the case of directors) point, the Court has also stated that “the core rationale of the Rule is that judges are poorly positioned to evaluate dom the of wis- business decisions and there is little utility them to second-guess having the determination of impartial decision- find a breach in a Board’s fiduciary duties, not want to they get involved typically in any do type of substantive review of a Board decision. business experts.” 39748-nyb_14-1 Sheet No. 26 Side B 12/08/2017 14:30:42 12/08/2017 B 26 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 27 Side A 12/08/2017 14:30:42 47 , the of cor- Aronson Bodell II This approach is 82 private ordering 81 note 9, at 109. supra The Business Judgment Rule Formulation A. THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE at 408. Id. thority for making this decision. In sum, what courts desire in terms of corporate authority estimating the coefficients of those variables. This requires many sources of knowledge and expertise that chancellors and judges lack, including experience in the particular business that the company may be in, product and skills, financial company skills, creative and analytical thinking knowledge, pertinent to a company’s business, confidential infor- management mation, and so on. For example, who has the knowledge and expertise to decide whether corporate a culture enhances distinctive or detracts from holder value? The clear stock- answer is that the board and its executive management are the proper locus of au- [D]etermining whether a business decision is stockholder wealth-maximizing is not just about plugging in a formula and calculating computer the or result, calculator which can any do. Rather, the it specific formula refers that will to be utilized by management to determine if a particular decision maximizes stockholder wealth. One can think of this in terms of a mathematical formula where the decision maker is given the responsibility of choosing the variables and In contrast to the Rule formulation found in 81. 82. Bainbridge, current formulation of the Rule under § 141(a) (the can be summarized in the following Stephen Bainbridge: the statement “[p]reservation of managerial discre- by Professor tion should always be the null hypothesis.” 2017] \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 21 8-DEC-17 7:20 supported not only by the desire to refrain from punishing the Board for honest mistakes in judgment but also by two tional policy addi- drivers: (1) respect for the porate governance arrangements, which almost always the bulk of place authority for decision-making with the Board, and; (2) courts’ recognized lack of business expertise. All three policy drivers encourage a court to use the Rule and discourage it from going directly to an entire fairness review. 39748-nyb_14-1 Sheet No. 27 Side A 12/08/2017 14:30:42 12/08/2017 A 27 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 27 Side B 12/08/2017 14:30:42 , Van [Vol. 14:27 at 807. TRUCTURE OF Id. S , 473 A.2d at 812). CONOMIC E HE Aronson , T , this liability occurred de- where the Court made abso- ISCHEL 84 , R. F The Enduring Legacy of Smith v. Van Gorkom , to establish that a Board has made an ANIEL Van Gorkom 83 & D & In 85 NYU JOURNAL OF LAW & BUSINESS , 488 A.2d at 872 (quoting 86 107–08 (1991). Van Gorkom Smith v Van Gorkom AW ASTERBROOK Gross negligence is the standard used to determine L , the Court addressed the issue of “when is a stockholder’s de- Bernard S. Sharfman, 87 See Van Gorkom to be entirely justified: H. E H. For many, this additional requirement was a mistake, lead- mistake, a was requirement additional this many, For Under challenging the decision to establish facts rebutting the presumption. It is a presumption that in making a business decision business a making in that presumption a is It 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. Absent an abuse of discretion, that judgment will be respected by the courts. The burden is on the party that the business judgment rule is designed to avoid. Information is necessary for corporate managers to firm. maximize But the there value is of a the before making limit a decision. to how much managers should know It is not hard to see why the case produced such a swift and sweep- ing reaction. Judicial inquiry into the amount of information managers should acquire before deciding creates the precise difficulties Aronson 83. Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) (citations omitted). 84. Smith v. Van Gorkom, 488 A.2d 858, 85.873 (Del. 1985). Frank Easterbrook and Daniel Fischel found the criticism of 86. 87. ORPORATE RANK ing to the heavily criticized decision in the famous corporate law case of In mand upon a board of directors, to redress an alleged wrong to the corporation, excused as futile prior to the filing of a derivative suit?” Gorkom F C spite the fact that the Board had agreed to sell for the company a forty-eight percent premium closing above price. the previous day’s 48 formulation) includes an aspect of the duty of care, the need for a Board to make a decision on an informed basis: \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 22 8-DEC-17 7:20 lutely clear that an uninformed come Board a court’s deference to decision Board authority and could could create over- director liability. rectors have informed themselves ‘prior to making a business decision, of all material information reasonably them.’” available to informed decision, a court must determine “whether the di- 33 Del. J. Corp. L. 287, 291 (2008). 39748-nyb_14-1 Sheet No. 27 Side B 12/08/2017 14:30:42 12/08/2017 B 27 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 28 Side A 12/08/2017 14:30:42 49 In es- a statu- 90 89 According , “Courts do 91 Walt Disney Co. Deriva- decision if they found In re Brehm v Eisner Van Gorkom , the Delaware General Assembly, 88 . tit. 8, § 102(b)(7) (2015). Under § 102(b)(7), stock- NN Van Gorkom A ODE . C THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE Interestingly, a valid waste claim may still exist even if the plaintiff at 873. In sum, meeting the requirements of procedural due EL D Id. Id. Id. 92 Soon after However, consistent with the underlying policies of not A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of breach a of director: (i) the For director’s any duty of stockholders; loyalty (ii) to for acts the or omissions corporation not in or good faith its or which involve intentional misconduct or a knowing violation of law; . . . ; or (iv) for any transaction from which the director derived an improper personal benefit. To recover on a claim of corporate waste, the plaintiffs must shoul- der the burden of proving that the exchange was so one sided that 88. 90. 91. Brehm v. Eisner, 746 A.2d 244, 264 92. (Del. 2000). 89. holders are allowed to incorporate into their certificate of incorporation: Id. 2017] if there has been a breach becoming of informed. the directors’ duty of care in \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 23 8-DEC-17 7:20 responding to concerns that directors faced too much in the way of personal liability, enacted DGCL 102(b)(7), only.” to the Delaware Supreme Court in not measure, weigh or quantify directors’ judgments. We not do even decide if they are care reasonable in in this context. the Due decision-making context is process due care tory provision that protects directors from monetary for liability any actions arising from a breach of their corporations duty of opt-in care if through a charter amendment. the opportunity to veto the sence, Delaware lawmakers have given Delaware corporations cannot overcome the presumption of the Rule. tive Litig., 906 A.2d 27, 73–74 (Del. 2006). In essence, waste is a standard of review that stands outside the Rule and is applicable when irrationality is not found to be associated with a lack of good faith: it was not in their best interests. punishing the Board’s honest mistakes in judgment and defer- ring to Board decision-making authority as provided by private ordering and the court’s recognition of its lack of business expertise, the “informed” element of care.” due “substantive not care,” due “procedural the Rule refers only to 39748-nyb_14-1 Sheet No. 28 Side A 12/08/2017 14:30:42 12/08/2017 A 28 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 28 Side B 12/08/2017 14:30:42 [Vol. 14:27 overruled on . L. 447, 466 93 ORP , 33 J. C due care, good 95 at 430, quoting Aronson v. Lewis, 473 A.2d Rebutting the Presumption Id. , 906 A.2d at 74). The Fetishization of Independence , courts have created a fuller picture of what , 746 A.2d at 254). B. NYU JOURNAL OF LAW & BUSINESS Disney and independence, 94 Bodell II , 746 A.2d at 264 n.66. Directors must not only be independent, but must act inde- A party alleging domination and control of a company’s board Brehm Since The business judgment rule, as a general matter, protects directors from liability long for as their there decisions exist “a so tedness business decision, disinteres- sion will be upheld unless it cannot be attributed purpose. to any rational no business person of ordinary, sound judgment would conclude that the corporation has received adequate consideration. A claim of waste will arise only in the rare, unconscionable case where rectors irrationally di- squander or give away corporate assets. This on- where that proposition the of corollary a is waste for standard erous business judgment presumptions are applicable, the board’s deci- bility to the performance of one’s duties . . . that generally touches on independence.” pendently. Kahn v. Tremont Corp., 694 A.2d 422, 429 (Del. 1997). As this Court has previously stated in dence: “[i]t defining is the director care, attention and indepen- sense of individual responsi- 805, 816 (Del. 1984). Where only one director has an interest in a transaction, however, a plaintiff seeking to rebut the presumption of the business judgment rule under the duty of loyalty must show that “the interested director controls or dominates the board as a whole.” Cinerama, Inc. v. Technicolor, Inc., 663 A.2d (Del. 1156, 1995). 1168 of directors bears the burden of proving such control by showing a 93. 94. Under Delaware law, “[a] director is interested in a given transaction 95. Under Delaware law: Freedman v. Adams, 58 A.3d 414, 417 (Del. 2013) (quotations and citations omitted) (citing if she stands to gain monetarily from it in a way that other stockholders do not.” Usha Rodrigues, 50 care under the Rule means that a Board has not reached their failure the includes that process negligent grossly a by decision to consider all material facts reasonably available.” \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 24 8-DEC-17 7:20 rational business purpose), are required in order for a Board decision to receive the protections of the Rule: kinds of conduct (fiduciary duties) and lack of taint surrounding the decisions (e.g., disinterestedness, independence and (2008) (citing Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984), other grounds by Brehm 39748-nyb_14-1 Sheet No. 28 Side B 12/08/2017 14:30:42 12/08/2017 B 28 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 29 Side A 12/08/2017 14:30:42 : 51 Eshleman v. Keenan Moskowitz v. Bantrell, and a challenged (in discussing when a court 97 See also Eshleman Id. , the Delaware Supreme Court stated that failing to and no abuse of discretion 96 THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE Lyondell v. Ryan , 906 A.2d at 67). faith decision does not constitute vires fraud, conduct or waste.” There illegality, is a presumption that ultra directors have acted in accordance with each of these elements, and this presumption cannot be overcome unless the complaint pleads specific facts demonstrating otherwise. Put another way, under the business lack of independence on the part of Odyssey Partners, L.P v. Fleming a Cos., Inc., 735 A.2d 386, 407 (Del. majority of the directors. Ch. 1999). Theoretically, a director can be “controlled” by another, for purposes of determining whether the director lacked the independence necessary to consider the challenged transaction objectively. A controlled director is one who party, is whether dominated through by close another personal or familial through force of will. relationship Orman v. Cullman, 794 A.2d 5, 25 n. 50 (Del. or Ch. 2002). A director may also be deemed “controlled” if he or she is beholden to the allegedly controlling entity, as when the has entity the direct or indirect unilateral power to decide director whether continues the to receive a benefit upon which the director is so dependent or is of such subjective material importance that its threatened loss might create a reason to question whether the director is able to consider the corporate merits transaction objectively. of the challenged declaration of the dividend as a matter of prudent agement business man- and that the withholding of it is theory explicable of an only oppressive or on fraudulent the abuse of discretion. That courts have the power in proper cases to compel the directors to declare a dividend, is sustained by respectable that authorities. they should But do so on a mere showing that an asset exists from which a dividend may be declared, has never, I dare say, serted anywhere. In been such a case a court acts as- only after a demonstra- tion that the corporation’s affairs are in a condition justifying the 96. In 97.refuses Board the when discretion of abuse an be may it example, For 2017] \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 25 8-DEC-17 7:20 22 Del. Ch. 82, 87–88, 194 A. 40, 43 (1937). 190 A.2d 749, 750 (Del. 1963) (citing may direct a Board to declare a dividend, the court said: “[t]he principle of law applicable to the relief sought is well settled. Before a court will interfere with the judgment of discretion must the be shown.”). Board of Directors, fraud or gross abuse of Telxon Corp. v. Meyerson, 802 A.2d 257, 264 (Del. 2002). act in good faith means that a Board has intentionally failed face “to act of in the a known duty to act, duties.” Lyondell Chem. Co. v. Ryan, 970 A.2d 235, 243 (Del. 2009) (quoting demonstrating a conscious disregard for his Disney to pay out a dividend even though the amount of earnings. company As stated has by the Chancery accumulated Court in a large 39748-nyb_14-1 Sheet No. 29 Side A 12/08/2017 14:30:42 12/08/2017 A 29 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 29 Side B 12/08/2017 14:30:42 U- D [Vol. 14:27 , this for- IDUCIARY : F ULE Bodell II R Instead, it must first 100 UDGMENT J USINESS B HE 110 (6th ed. 2009)). ., T As a result, even though the decision Gulfport Energy Corp. v. Liddell, No. 3128-VCN, 99 IRECTORS ex rel. 102 D NYU JOURNAL OF LAW & BUSINESS ADIN ET AL A. R 98 ORPORATE at 91. at 93. , the balance provided by the Rule has shifted toward C Such a finding “will be the basis for a finding of sub- Id. Id. Id. TEPHEN Therefore, while director conduct and lack of taint re- Under this Rule formulation, relative to the Rule found in found Rule the to relative formulation, Rule this Under judgment rule, the Court will not invalidate a Board’s decision or question its reasonableness, so long as its decision can be attributed to a rational business purpose. If the presumption has been overcome, “the burden then 101 1 S 98. Robotti & Co. 99. 100. 101. 102. Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1165 (Del. 1995). 2010 WL 157474, at *11 (Del. Ch. Jan. 14, 2010) (footnotes omitted) (quoting standing the prevalence of exculpation clauses that mute the effect of a finding that the Board was made the not challenged informed decision. when it quirements under this Rule formulation may seem more tensive and ex- demanding than those found in mulation’s purpose is exactly the same: to serve as a tool that courts can use to determine whether a Board decision should stand or be subject to a fairness review, i.e., an entire fairness review. These additional requirements can be understood as simply technical corrections when put in the context of main- defense of line important most and first the as Rule the taining against an entire fairness review. In that vein, the presumption Bodell II equity through the explicit requirements of independence, a rational business purpose and most importantly, the relatively new requirement that the Board be informed. These are additional ways for a court to move category a of Board Board decision decisions out of that the the courts scrutinizing are and barred into from the realm of a fairness review, notwith- shifts to the director defendants to demonstrate that the challenged act or transaction was entirely fair to the and corporation its stockholders.” stantive liability.” TIES FOR 52 \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 26 8-DEC-17 7:20 make a determination that the fair. transaction was not entirely may have lost the protections of the Rule, the court cannot go directly to a determination of damages. 39748-nyb_14-1 Sheet No. 29 Side B 12/08/2017 14:30:42 12/08/2017 B 29 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 30 Side A 12/08/2017 14:30:42 53 105 Even though re- 104 As such, “the business judgment 103 note 9. of a Board’s decisions, or for breaches in The Rule as Abstention Doctrine? supra quality C. THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE at 101. at 109. That courts define the duty of care in such narrow Id. Id. 106 Duty of care claims that go beyond the judicially defined Stephen Bainbridge, one of the most important corporate uations. Given the significant virtues however, one must not of lightly interfere with manage- discretion, ment or the board’s decision-making authority in the name of accountability. Preservation of discretion managerial should always be the null hypothesis. Establishing the proper mix countability of thus emerges deference as the and central problem in ac- applying the business judgment Rule to particular sit- As recently reaffirmed by the Delaware Supreme erning Court, pleading the standard gov- in Delaware to survive a miss motion is reasonable to conceivability. That dis- is, when considering such a motion, a court must: accept all well-pleaded factual allegations in the Complaint as true, accept even vague allegations in the plaint Com- as “well-pleaded” if they provide the defendant notice of the 104. 103. Bainbridge, 105. 106. According to the Chancery Court: carve-out will quickly be under the lenient standard dismissed of “reasonable conceivability,” the without discovery determining in use courts Delaware the that review of standard even whether a complaint will survive a defendant’s motion to dismiss. 2017] language can be understood to mean that the court must pre- sume that a board decision does not review come so long under as a a Board’s fiduciary fairness duties have been met. law scholars of the past twenty years, has argued that the Rule is an abstention doctrine. \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 27 8-DEC-17 7:20 rule’s function is to preclude courts the from directors deciding violated whether their duty of care.” quired to focus on procedural due care, cluded, courts are under still the pre- Rule, from reviewing care, i.e., for the substantive due the duty of care that arise from ordinary negligence in becoming informed. According to Bainbridge, courts are willing abstain to from the review of most duty of they find this the best care way to protect Board authority claims from un- because warranted court interference: 39748-nyb_14-1 Sheet No. 30 Side A 12/08/2017 14:30:42 12/08/2017 A 30 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 30 Side B 12/08/2017 14:30:42 , 88 , in II [Vol. 14:27 and 110 135, 147 (2006). . AW Bodell I . L Finally, in 1971, the US B 109 , 62 It was not until 1963 that the Dela- Being Informed Does Matter: Fine Tuning Gross 108 1139, 1193 (2013). . NYU JOURNAL OF LAW & BUSINESS EV The Tort Foundation of Duty of Care and Business Judgment Given this carve-out for most duty of care claims, L. R 107 (citing Graham v. Allis-Chalmers Manufacturing Co., 188 A.2d at 148 (citing Kaplan v. Centex Corp., 284 A.2d 119, 124 (Del. Ch. AME directors did, in fact, make a business judgment authorizing the Id. Id. D But the Rule as a means of precluding duty of care claims The business judgment rule cannot be an abnegation of power because its very existence arises from the exercise of judicial lawmak- ing. The court’s power court’s power to to take it. . . . give Rather, the systematic outcomes of deference no must liability are achieved also because the business judgment rule mean reflects a the reasoned judgment of courts on the nature of a wrong; they evince the exercise of judicial power, and not the relinquishment of it. claim, draw all reasonable inferences in favor of the plaintiff, and deny the motion unless the plaintiff could not recover under any reasonably conceivable set of circumstances susceptible of This proof. reasonable “conceivability” standard asks whether there “possibility” is of recovery. a If the well-pled factual allegations of complaint the would entitle the plaintiff to relief under conceivable a set reasonably of circumstances, the court must deny the motion to dismiss. 107. As pointed out by Robert Rhee, the concept of the Rule as abstention 108. Bernard S. Sharfman, 109. 110. OTRE Dent v. Ramtron Int’l Corp., Central C.A. Mortg. Co. No. v. 7950-VCP Morgan Stanley (Del Mortg. Capital Ch. Hldgs. 531, LLC, 2014) 536 27 (Del. 2011)). A.3d (citing doctrine does not imply judicial abnegation: Robert J. Rhee, N 54 terms means that the claims simply do not describe a violation of the law. \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 28 8-DEC-17 7:20 the Rule can indeed be understood as an abstention doctrine. could not have been the Rule’s original intent, at least under Delaware corporation law. At the time of Negligence Twenty Plus Years After Van Gorkom was not even in the context of the Rule, but rather in regard to regard in rather but Rule, the of context the in even not was the Board’s oversight of the company. ware courts recognized the duty of care as a Board duty and it Delaware Chancery Court established that being informed was part of a Board’s fiduciary duties under the Rule. 1926 and 1927 respectively, a Board’s fiduciary duties did not include a duty of care. 125, 130 (Del. 1963) (“It appears that directors of a corporation in managing the corporate affairs are bound to use that amount of care which ordina- rily careful and prudent men would use in similar circumstances.”). 1971)) (“Application of the Rule of necessity depends upon a showing that informed transaction under review.”) (emphasis added). 39748-nyb_14-1 Sheet No. 30 Side B 12/08/2017 14:30:42 12/08/2017 B 30 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 31 Side A 12/08/2017 14:30:42 55 TE- Bo- 1 S UTIES FOR D IDUCIARY : F of corporate govern- ULE R UDGMENT J Summary private ordering D. USINESS Gulfport Energy Corp. v. Liddell, No. 3128-VCN, B Therefore, in a very global and funda- tit. 8, § 141(a) (2016). HE . 111 110 (6th ed. 2009)). ex rel. However, two additional policy drivers are ., T NN A 112 ODE IRECTORS D . C THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE ADIN ET AL EL D . As already discussed, as a result of the application of the The observation that the duty of care was a late arrival as The role played by the Rule does not change under A. R 111. Robotti & Co. 112. ORPORATE been tainted with fraud, interest, lack of good faith, abuse of discretion, lack of independence, gross negligence in becoming informed, etc. part of a Board’s fiduciary duties is not meant to imply that the that imply to meant not is duties fiduciary Board’s a of part Rule was not originally meant to be That an is, it abstention is not doctrine. necessary to focus only on the duty of preclusion care claims of to come to the conclusion that the Rule is and has always been an abstention doctrine, at least since dell II Rule formulation, courts must abstain from a fairness when review the plaintiff fails to show that the Board decision has 2010 WL 157474, at *11 (Del. Ch. 2010) (footnotes omitted) (quoting C 2017] \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 29 8-DEC-17 7:20 ness review if there is no breach surrounding a in Board fiduciary decision. duties or taint PHEN restrain the courts from reviewing a Board ness. decision First, respect for for the fair- ance arrangements, which grant Second, corporation. the of behalf on decisions make to Board extensive authority to the the recognition by the courts that they perts, meaning that are they must not typically defer to business the judgment ex- decision Board a whether of determination the in Board the of is wealth maximizing. Additionally, taints surrounding a business decision now include lack of independence or a rational business purpose. Moreover, the Rule is trine not an just abstention in doc- terms of precluding persuasively argued by Stephen Bainbridge, but duty also in a more of care claims, as fundamental way, by requiring courts to abstain from a fair- mental way, the Rule can be understood as an abstention doctrine, requiring the court to abstain from a fairness review unless some sort of director misconduct or taint surrounding the decision is found. DGCL 141(a). identified which reinforce the use of the Rule as a means to 39748-nyb_14-1 Sheet No. 31 Side A 12/08/2017 14:30:42 12/08/2017 A 31 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 31 Side B 12/08/2017 14:30:42 , [Vol. 14:27 https://papers.ssrn ), HAREHOLDER S Oct. 29, 2016 ( AXIMIZATION III. BJECTIVE OF M O NSTITUTE I AW EALTH The Modern Corporation Statement on Company Law L W formulation does not expand on what it NYU JOURNAL OF LAW & BUSINESS USINESS ULE AND THE 114 B R Aronson HE This opens the door for some to argue that the objec- LARKE T 113 Does the Rule really serve as evidence that corporate law The term stockholder value. Where directors pursue the latter goal, it is usually a product not of legal obligation, but of the pressures imposed on them by financial markets, activist stockholders, the threat of a hos- tile takeover schemes. and/or stock-based compensation Contrary to widespread belief, generally corporate are not directors under a legal obligation mize profits to for maxi- their stockholders. This is reflected in the acceptance in nearly all jurisdictions of some version of the business judgment rule, under which disinterested and informed directors have the discretion to act in what they believe to be in the best long term interests of the company as even if this does not entail seeking to maximise short- a separate entity, G. C 113. Aronson v. Lewis, 473 A.2d 805, 812. 114. Lynn Stout et al., ACK J .com/sol3/papers.cfm?abstract_id=2848833 (this document was signed promi- some including also but scholars, law corporate mainly signatories, 55 by nent practitioners such as Martin poison Lipton, pill). the purported inventor of the does not require the Board to maximize This shareholder Part value? makes the argument that “no.” the answer is a decisive 56 \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 30 8-DEC-17 7:20 act with the corporation. This point is very timely as a number of academics recently signed a statement arguing in part that the Rule serves as evidence that the Board is obligation under to maximize no the legal wealth of stockholders: tive of Board decision-making is not SWM, but rather the balancing of the interests of the multiple stakeholders that inter- means for directors to act “in the best interests of the corporation.” 39748-nyb_14-1 Sheet No. 31 Side B 12/08/2017 14:30:42 12/08/2017 B 31 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 32 Side A 12/08/2017 14:30:42 57 BYU L. 106, 119 NTERPRISE E What’s Wrong—and What’s RIVATE 8 (2001). . IN J. P . F note 85, at 36. note 85, at 38. ORP , 22 . C supra supra , , PPL J. A Value Maximization, Stakeholder Theory, and the Cor- ISCHEL ISCHEL of Corporate Governance , 14 119 & F & F note 115, at 11. Third, according to Easterbrook and Fischel, 117 supra Second, by serving only one master—sharehold- Shareholder Wealth Maximization as the Objective According to Jensen, if a stakeholder approach is Fourth, according to John Boatwright, “corporate 115 THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE ASTERBROOK ASTERBROOK 116 118 A. E E There are several different reasons and explanations for Why SWM is preferable as the corporate objective can also can objective corporate the as preferable is SWM Why 1319, 1390 (2016) (citing John R. Boatright, . 115. Michael C. Jensen, 116. 117. Jensen, 118. 119. See George A. Mocsary, Freedom of Corporate Purpose, 2016 EV R interests of multiple stakeholders without maximizing the in- objective an of maximization the for allows SWM any, of terests function. why it is optimal to have SWM as governance and why the corporate law objective should support of that objec- corporate tive by imposing legal obligations on the Board. First, unlike a stakeholder approach (to the balancing of task unenviable the given is directors of board be discussed below) where the be explained through two models of the corporation, the principal-agent model and the nexus of contracts model. ers—a Board can be held more accountable for its decisions. According to Frank Easterbrook and Daniel Fischel, “a is and both of freed been has . . . masters two serve to told manager answerable to neither. Faced group, with the a manager demand other.” can from either appeal to the interests of the decision-making is more efficient and effective when management has a single, clearly defined objective and wealth shareholder maximization provides not only guide but a one that, if pursued, increases workable the total wealth crea- decision tion of the firm.” Right—with Stakeholder Management because it is firms.” “the operational assumption of successful taken, then “[t]he result will be confusion and lack of purpose that will [fundamentally] handicap the firm in its competition for survival.” one can think of SWM as the default rule under corporate law 2017] \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 31 8-DEC-17 7:20 porate Objective Function (2006)). 39748-nyb_14-1 Sheet No. 32 Side A 12/08/2017 14:30:42 12/08/2017 A 32 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 32 Side B 12/08/2017 14:30:42 122 305, 310 . [Vol. 14:27 CON . E IN J. F Theory of the Firm: Manage- , 3 (2003). This is a result of the hypo- 123 1629, 1631 (2002). . . 547, 547–48 124 EV Director Primacy: The Means and Ends of Corpo- EV Under a nexus of contracts or “con- L. R That is, they are the parties to the cor- 121 ARY 125 The Team Production Theory of Corporate Law: A Critical . U. L. R W NYU JOURNAL OF LAW & BUSINESS N However, the typical separation within the cor- . & M . M 120 , 97 W at 547–48. at 547–48, 579. at 548 , 43 Id. See id. See id. Michael Jensen and William Meckling would describe an In a principal-agent model of the corporation, sharehold- In this hypothetical bargain, shareholders, the sole claim- Nexus of Contracts Model Principal–Agent Model 121. Michael C. Jensen & William H. Meckling, 120. Alan J. Meese, 123. 124. 125. 122. Stephen M. Bainbridge, organization that takes the corporate form as that a serves legal “as fiction a nexus for a among set individuals.” of contracting relationships ers are viewed as owners their of agents. the corporation and Boards as ants to the residual cash flows generated by argue that since they are the least the contractually protected rela- firm, would their in filler gap the as SWM deserve they parties, other to tive corporate contract. holder profit. Therefore, directors should be legally bound to minimize agency costs with the objective of maximizing shareholder profits. 2. poration of ownership from control creates great potential for managerial self-dealing and shirking. If are realized, increased agency costs, including the Board decisions that are results not focused on SWM. Agency costs are a detriment to share- maximize shareholders’ wealth. Nevertheless, the board of directors still has fiduciary duties to 58 1. \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 32 8-DEC-17 7:20 rial Behavior, Agency Costs and Ownership Structure Assessment tractarian” model of the corporation, perceived shareholders to own are the not corporation but only one of many parties that contract with the corporation. are considered to be (1976). rate Governance thetical bargain struck between shareholders parties and in the the corporation. other porate contract that have the greatest risk of ending up nothing with as a result of their dealings with the corporation. the In context of public companies, shareholders enforce their 39748-nyb_14-1 Sheet No. 32 Side B 12/08/2017 14:30:42 12/08/2017 B 32 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 33 Side A 12/08/2017 14:30:42 . , 59 OL . L. US and J. P J. . B 129 , 73 , . 791, 804–07 OLUM C EV A Theory of Share- . L. R , 2015 ENN T , 82 127 Activist Hedge Funds in a World of Board Bernard S. Sharfman, See supra note 85, at 38 (“[M]aximizing profits , Mergers and the Market for Corporate Control Corporate for Market the and Mergers ISCHEL & F Cash Tender Offers for Shares – A Reply to Chairman Cohen 231, 236 (1967) (citations omitted). Bernard S. Sharfman, As stated by Henry Manne, SWM as the corporate L.J. THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE 128 ASTERBROOK see also and hedge fund activism. UKE E 110 (1965). Manne provides the following description of how the One reason why other stakeholders would support a Like the principal-agent model of the corporation, a D . cient managers, the stage is set for the critical functioning market of for the corporate control. Outsiders . the in necessarily (not gains capital substantial make to opportunity . . will respond to the tax sense) by buying control, managing and the then company perhaps disposing efficiently, of the shares. It is not they necessary remain permanently that to manage the business. Briefly, the market for corporate control in our system operates in the following manner: if traded an shares is existing poorly managed, corporation holders of with spond those by shares selling. publicly This will will re- drive the price down to the cated point by indi- the quality of management which the ceiving. corporation As the is price of re- securities of any corporation is thought to be low relative to the price that would be generated by more effi- 126 . 813 (2016). 128. 127. An activist hedge fund works in a similar manner to the potential 126.Manne, G. Henry 129. E-mail from Henry G. Manne, Professor Emeritus of Law, Geo. Ma- EV CON 2015); ( E R 1967 Board and executive management targeting SWM is because all other parties that have must contracted be with the paid corporation off residual. prior to the shareholders receiving any the market for corporate control. holder Activism and Its Place in Corporate Law acquirer. The difference is that the activist hedge fund attempts to inefficiencies correct through its influence, not its control quires a significant of but not controlling share in a company at a relatively low the company. It ac- price with the expectation that existing inefficiencies will eventually be cor- rected through its efforts and the price will rise efficiencies. to In reflect essence, these hedge fund enhanced activism provides a corrective function similar to, but with less investment and more advocacy than, what is found in 2017] preference for SWM through the market for trol corporate con- \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 33 8-DEC-17 7:20 Henry G. Manne, market for corporate control operates: for equity investors assists the other ‘constituencies’ automatically.”). son Univ., to Bernard S. Sharfman (Dec. 29, 2012) (on file with author). objective is an example of “pure positive economics” Independence: Creators or Destroyers of Long-Term Value? nexus of contracts model tells us to expect the corporate ob- should be accepted as such. 39748-nyb_14-1 Sheet No. 33 Side A 12/08/2017 14:30:42 12/08/2017 A 33 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 33 Side B 12/08/2017 14:30:42 . ECH . & T [Vol. 14:27 US J. B , 1 this would mean that all stakeholders Gap Filling in the Zone of Insolvency 130 NYU JOURNAL OF LAW & BUSINESS ; (2) deference to private ordering as author- 131 A Stakeholder Model of Corporate Governance Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106, 139 (Del. 139 106, A.2d 964 Litig., Derivative S’holder Inc. Citigroup B. In re Those who signed off on the statement rejecting SWM as If one is to think of the corporation as a nexus of con- 607 (2007). 131. 130. Frederick Tung, L. Ch. 2009). the legal objective of Board decision-making most likely be- of corporate governance arrangements and is assumed to be value-maximizing for all stakeholders, including shareholders. Again, the balance of authority is almost always tilted heavily toward the Board. courts the by played role the include also must one then tracts, create courts The enforced. are contracts those sure making in fiduciary duties which serve “as gap-filling devices for incom- plete contracts between shareholders Moreover, if fiduciary duties and are crafted carefully to maximize firm managers.” shareholder value, 60 jective to be SWM. However, unlike the principal-agent model, it does not suggest agency that costs is the an only way to exclusive achieve that focus objective. From nexus a of contracts approach, on that determination should be up minimizing to the organizers of the corporation with input from all stakeholders. For example, the critical question of what should be the balance of power between needs to be resolved prior the to commencing operations as a cor- Board and shareholders poration. This, of course, is referred to as the private ordering \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 34 8-DEC-17 7:20 icy drivers already discussed—(1) protecting the Board from liability for honest mistakes in judgment, which also serves the purpose of allowing the Board “to maximize shareholder value in the long term by taking risks without the that debilitating they fear will be held personally liable if the company experiences losses” ized by statutory law, and; Board, and not (3) the courts, is in the courts’ best position to make cor- recognition that porate the decisions—severely restrain judicial desire to active take role an in arbitrating disputes. These drivers courage strongly courts, en- as a means of maximizing shareholder value, to defer to the judgment of the Board. would benefit from their application. However, the three pol- 39748-nyb_14-1 Sheet No. 33 Side B 12/08/2017 14:30:42 12/08/2017 B 33 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 34 Side A 12/08/2017 14:30:42 61 The 132 of a public com- public a of 138 The End of History for Corporate for History of End The A Team Production Theory of Corpo- In this model, “two or more 135 This is in contrast to another type 134 at 252–53. . Id. 247 (1999). . They use their model, a fiduciary model, to EV 137 439, 447–48 (2001). . L. R A . L.J. V THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE EO In this model, “the board of directors functions as a at 249 (“In this Article we take issue with . . . the stockholder at 287–319. At the time of their article’s publication, this was a . and that this conclusion is already recognized by G 140 , 85 . Id. Id Id. Id. Id. Id. 133 Id 139 Perhaps the best-known stakeholder model in corporate 136 From a normative perspective, a stakeholder model would , 89 132. Kraakman, Reinier & Hansmann Henry 135. 136. 137. Margaret M. Blair & Lynn A. Stout, 133. 134. 138. 140. 139. Blair & Stout focus exclusively on the corporation as a public com- rate Law SWM as the objective of this conduct. law literature is the team production model of Margaret Blair and Lynn Stout. allow, without legal ramifications, a Board to consider multiple consider to Board a ramifications, legal without allow, stakeholders, not just stockholders, This would require in the Rule to protect its the interests of decision-making. multiple stakeholders, not just stockholders. As conduct, a as result, director embodied in fiduciary duties, would not have tive’ model of the corporation.” 2017] lieve in a stakeholder model model, of there the is corporation. no In one such stakeholder residual claimant. According to a holding Henry Hansmann and Reinier the position of Kraakman, there are two types of stakeholder models. of stakeholder model which they describe as a “‘representa- \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 35 8-DEC-17 7:20 argue that SWM is not the correct objective courts. neutral coordinator of the contributions stakeholders in the firm.” and returns of all Law stakeholder constituencies appoint board of directors, representatives which then elaborates policies to that mize maxi- the joint the welfare of all stakeholders, subject gaining to leverage that the each group bar- brings to the boardroom ta- ble.” pany first model is called tion.” a “‘fiduciary’ model of the corpora- wealth maximization goal . . . .”). pany. relatively new argument 39748-nyb_14-1 Sheet No. 34 Side A 12/08/2017 14:30:42 12/08/2017 A 34 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 34 Side B 12/08/2017 14:30:42 147 [Vol. 14:27 142 The result is 146 143 Like equity investors, 145 of the Rule, since it omits 148 Team members are primarily 144 In this role, board members are 141 formulation NYU JOURNAL OF LAW & BUSINESS Aronson at 271–76. at 281. at 272. at 277. at 288. at 274–76. at 300. Id. Id. Id. Id. Id. Id. Id. In their model, Blair and Stout suggest that “the business Blair and Stout model the public company as a team of Any person or entity that makes a specialized investment 141. 142. 143. 144. 145. 146. 147. 148. Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) (citations omitted). judgment rule may help prevent coalition members (and especially stockholders) from using lawsuits as strategic devices to works Rule the because is This coalition. the from rents extract to ensure that directors can only be found liable for breach of the duty of care in circumstances where a finding serves of liability the collective interests of all the firm’s members.” that has little or no value outside the joint enterprise (a “firm- specific” investment) is a member of the team. members who make firm-specific investments in the corporation with the goal of producing goods and services as a (“team team production”), with the board of directors serving as a “mediating hierarchy.” Moreover, Blair and Stout find support for their understanding in the 62 \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 36 8-DEC-17 7:20 because they trust the board of directors to do its best sure to the en- stakeholders recoup their investments. made up of executives, rank-and-file employees, and equity investors, but can also include researchers, creditors, the community, local marketers, and vendors who provide specialized products and services to these the stakeholders firm. have made firm-specific therefore investments must and be considered residual interest tected holders, pro- only by long-term, implicit agreements tual and therefore not legally enforceable) that they enter into (non-contrac- “that no one team member is a ‘principal’ who enjoys a right of control over the team.” express language stating that directors who act in “the best in- “mediating hierarchs whose job is to balance team members’ competing interests in a fashion that enough keeps that the productive everyone coalition stays happy together.” 39748-nyb_14-1 Sheet No. 34 Side B 12/08/2017 14:30:42 12/08/2017 B 34 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 35 Side A 12/08/2017 14:30:42 63 L. ORNELL C , 84 , This silence re- 150 formulation was applied in a do so solely for the benefit of share- Aronson 149 Fiduciary Duties as Residual Claims: Obligations to note 137, at 300. For the Benefit of Stockholders tit. 8, § 101(b) (1998). . supra NN C. A ODE have a legal obligation to maximize stockholder . C THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE EL does D So, where does the idea of SWM as a legal requirement While the stakeholder approach of Blair and Stout has statutory that noting by begins argument this Surprisingly, 1266, 1269 (1999) (“Indeed, the very justification for having different . 151 149. Blair & Stout, 150. 151. Jonathan R Macey, EV R come from? In yet another courts twist, applying the principals idea of is equity Board has derived when breached its from determining fiduciary duties if as applied a under Rule. In essence, SWM is the a creation of equity, and not of statutory law. Non-shareholder Constituencies from a Theory of the Firm Perspective Firm the of Theory a from Constituencies Non-shareholder types of business organizations is to other permit participants in investors, the entrepreneurs, corporate and enterprise to select the tional design basic they organiza- prefer from a menu of standard form contracts.”). 2017] terests of the company” \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 37 8-DEC-17 7:20 garding the objective of the corporation has always been the approach of statutory corporate law. As a result, statutory corporate law must be understood as being concerned only with the “basic organizational design” of the corporation: its attrib- utes as a legal entity (such as limited liability for stockholders), and how its default rules distribute ity. decision-making author- much appeal, a much stronger argument can be made that the that made be can argument stronger much a appeal, much Board value and that the Rule, as applied, this legal facilitates requirement. fulfillment of corporate law is silent regarding this objective. Instead, DGCL simply states that corporations can be formed “to conduct or promote any lawful business or purposes.” holders. While it is not known why the Court what did not “best clarify interests” means should be noted in that the the context of the Rule, it fend a legal challenge to a Board decision. derivative suit where shareholders were suing on behalf of the corporation. In that case, the Court may simply have felt there was no need to clarify what “best interests” means. Neverthe- less, Blair and Stout argue that the Rule works to support team all members, not just stockholders, when it is used to de- 39748-nyb_14-1 Sheet No. 35 Side A 12/08/2017 14:30:42 12/08/2017 A 35 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 35 Side B 12/08/2017 14:30:42 Aron- [Vol. 14:27 a case which an- 152 , due care in the Gheewalla procedural v. stockholders hold residual claims to only NACEPF NYU JOURNAL OF LAW & BUSINESS begins by explaining why only stockholders are 153 at 101. Id. the business of a corporation for stockholder the benefit owners.’ of its Accordingly, fiduciary duties The Court then goes on to explain that the separation of Delaware corporate law provides for a separation of control and ownership. The directors corporations have ‘the legal responsibility of to manage Delaware In opposition to a stakeholder model of the corporation Under the Rule, fiduciary duties are a means to an end. ciaries of the corporation’s value. growth and increased Gheewalla It is well settled that directors owe fiduciary duties to the corporation. When a corporation is solvent, those duties may be enforced by its stockholders, who have standing to bring derivative actions on behalf of the corporation because they are the ultimate benefi- formulation. But most importantly, this conduct requires 152. N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 153. the cash flows of the corporation. ownership and control as provided by the default rules of statutory corporate law is the reason fiduciary duties must be applied by the courts for the benefit of stockholders: such as the team production model, this statement reflects the understanding that Supreme Court in They embody the type of conduct that the directors in courts order to avoid having their decisions fall require under an of entire fairness review. The courts have significant latitude defining in what that conduct should be. For example, as noted above, the duty of care is only son the Board to act in the best interests of stockholders. This was clearly spelled out in a series of statements by the Delaware A.2d 92 (Del. 2007). 64 \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 38 8-DEC-17 7:20 swered the critical question of whether the fiduciary duties solely to its stockholders when the Board corporation still owed entered the “zone of insolvency,” i.e., when it is financially dis- tressed and may become insolvent. given the right to bring derivative suits: 39748-nyb_14-1 Sheet No. 35 Side B 12/08/2017 14:30:42 12/08/2017 B 35 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 36 Side A 12/08/2017 14:30:42 65 154 In re Trados Inc. Shareholder Liti- 157 155 . Trados Inc. S’holder Litig., 73 A.3d 17 (Del. Ch. 2013). encapsulates this thinking in the following quote: THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE at 36–37. 156 Id. Id. In re Id. , their fiduciary duties to the corporation and its stockholders by exercising their business judgment in the best interests of the corporation for the holder benefit owners of its stock- Here, we have the Court telling us exactly what the phrase Vice Chancellor Laster, in are imposed upon the directors to regulate their conduct when they perform that function. Moreover, the Court stated that even when a corporation When a solvent corporation is navigating in the zone of insolvency, the focus for Delaware directors does not change: directors must continue to discharge constituencies may be considered only instrumentally to advance that end. rently. They may do so, however, because such activi- ties are rationalized as producing greater profits over the long-term. Decisions of this corporation nature as benefit a whole, the and by increasing the of share value the increase directors the corporation, the of value available for the opinions therefore residual often refer claimants. to directors Judicial owing fiduciary duties to the corporation and its shareholders. This formulation captures the foundational rela- corpora- the to duties owe directors which in tionship tion for the ultimate benefit of the entity’s claimants. residual Nevertheless, stockholders’ best must interest always, within legal limits, be the end. Other It is, of course, accepted that a corporation may take steps, such as giving charitable contributions or pay- ing higher wages, that do not maximize profits cur- 154. 155. 156. 157. “best interests of the corporation” should mean in the context of a Rule review: the protections of the Rule will apply if Board decisions are made for “the benefit of its stockholder owners.” is in the zone of insolvency, a Board still owes fiduciary duties to stockholders and not to creditors: 2017] \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 39 8-DEC-17 7:20 gation 39748-nyb_14-1 Sheet No. 36 Side A 12/08/2017 14:30:42 12/08/2017 A 36 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 36 Side B 12/08/2017 14:30:42 ., Dodge 162 [Vol. 14:27 the Court Dodge v. Ford Speaking in 161 160 , the Court found that the 158 Dodge In 159 NYU JOURNAL OF LAW & BUSINESS note 119, at 1344. supra The Frederick Hsu Living Trust v. ODN Holding Corp ., noted above. at 684–85. at 684. (“There should be no confusion . . . of the duties which George Mocsary notes that this was not something that the Id. Id. Id. This legal obligation was a result of the court applying its If that was not clear enough, Vice Chancellor Laster These statements are explicit endorsements of SWM and primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in choice the of means to attain that end and does not ex- tend to a change in the end itself, to the reduction of profits or the nondistribution of profits among stock- purposes. other to them devote to order in holders A business corporation is organized and carried on Mocsary, 159. Dodge v. Ford Motor Co., 170 N.W. 160. 668, 682 (1919). 161. 158. Frederick Hsu Living Tr. v. ODN Holding Corp., No. 12108-VCL, 162. power of equity, as opposed to implementing statutory corpo- be to Rule the of objective the requires equity sum, In law. rate stakeholder model of the corporation. Almost 100 years this ago same understanding was espoused by preme Court in the famous corporate the law case of Michigan Su- Motor, Co stated in “Delaware case law is clear that the board of directors of a for- profit corporation . . . must, within the limits of its legal discretion, treat stockholder welfare as the other only interests only end, to considering the extent that related to doing stockholder welfare.” so is rationally a direct repudiation of the idea that corporate law espouses a 2017 Del. Ch. LEXIS 67, at *45 (Ch. Apr. 14, 2017) (citations omitted). 66 \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 40 8-DEC-17 7:20 stated that the Board had a legal obligation to maximize profits the of the corporation for the benefit of stockholders: Board abused its discretion in withholding a special dividend payment because its decision to do so was a result of intentionally disregarding the interests of stockholders. terms of the duties that the Board and minority Henry Ford owed shareholders to under corporate law, Mr. Ford conceives that he and the stockholders owe to the general public and the duties which in law he and his codirectors owe to protesting, minority stockholders.”) court came up with out of the blue, but an affirmation of Michigan case law. See 39748-nyb_14-1 Sheet No. 36 Side B 12/08/2017 14:30:42 12/08/2017 B 36 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 37 Side A 12/08/2017 14:30:42 67 Unocal Aronson The Continued Denial of SWM D. 163 THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE , where the Court found that the Board had abused its However, this does not mean that the courts are not fo- When a court reviews a Board decision under the Rule, a Even in the face of clear statements by the courts that Dodge 163. This is consistent with what then Chancellor William Chandler said making such a determination. Underlying this approach are cused on SWM as the objective of a per se; it Board’s simply means that fiduciary courts must restrain themselves duties in in the context of a rights plan (poison test: pill) “Directors as of reviewed a for-profit under Delaware the corporation cannot deploy a rights plan to defend a business strategy that openly maximization—at eschews stockholder least wealth not consistently with the directors’ fiduciary under Delaware duties law.” eBay Domestic Holdings, Inc. v. Newmark, 16 A.3d 1, 35 (Del. Ch. 2010). rect way to maximize shareholder quires value. further explanation. This last point re- decision will rarely lose the protections cause of the the decision was Rule sub-optimal just in be- terms of context, SWM. the In protections this will be lost only if it is clear decision that was the made without stockholder interests in mind, e.g. in discretion when it withheld the annual payment of its special dividend. already mentioned, statutory corporate law is silent on SWM. This opens the door for those who model of the believe corporation to argue in that corporate law a does in- stakeholder who those Second, practice. in approach an such support deed believe in a stakeholder model are not willing to accept SWM as being the objective of equitable principles, no matter how many times courts state this to be haps this is just inconsistent with their long-held views their on what understanding. Per- equity means and therefore cannot be accepted as what true. could Yet, be fairer to shareholders and who other contract with stakeholders the corporation than to require that Board decision-making be targeted to SWM if all parties benefit from such an objective? Third, the courts utilize the Rule in an indi- 2017] SWM and only SWM. Unfortunately, starting with the formulation of the Rule may cause this to be overlooked. SWM is a legal obligation of all Board decision-making under corporate law, continued resistance to SWM should still be expected. I expect this for the following three reasons. First, as \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 41 8-DEC-17 7:20 39748-nyb_14-1 Sheet No. 37 Side A 12/08/2017 14:30:42 12/08/2017 A 37 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 37 Side B 12/08/2017 14:30:42 [Vol. 14:27 165 However, this lack of direct fo- Summary 164 tit. 8, § 365(a) (2013). E. . NN Case law clearly states that the Board is A note 77, at 399–412. 166 ODE NYU JOURNAL OF LAW & BUSINESS supra . C EL D at 400. (“Preserving managerial discretion necessarily means that Id. While one can argue that corporate law encompasses a 164. Sharfman, 165. 166. While beyond the scope of this Article, a stakeholder model, such as stakeholder model and that the Rule serves as evidence of this, a better argument is that the legal obligation of the Board SWM is and that the Rule serves to only that support purpose. that purpose and 68 the three policy drivers that have already been discussed; drivers which direct a court under the to Rule. forego Instead, courts a focus on direct the directors focus and conduct evidence of taint of surrounding on the the decision-mak- SWM ing process: fraud, self-dealing, lack of independence, etc. In essence, protecting the ability of way best the is courts and shareholders by interference without Boards to make decisions to ensure that SWM occurs. \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 42 8-DEC-17 7:20 fiduciary duties, not through statutory law. In essence, SWM is an equitable concept. The implementation of SWM is indirect, as all three of the major policy drivers that influence the Rule guide courts away from a focus on SWM unless the been rebutted, either by Rule a breach in a has Board’s fiduciary duties or because the court has identified a taint surrounding the decision-making process. under a legal obligation to maximize shareholder wealth. The requirement of SWM enters corporate law through a Board’s interpret this approach as a court’s lack of thereby interest helping make in their case SWM, that the court is endorsing a stakeholder approach to corporate law over SWM. cus on SWM provides the opportunity for those so willing to mining whether a decision maximizes shareholder wealth. The problem that is this approach is counterintuitive and therefore subject to being misun- derstood, especially by those who have been trained in the law and that believe accountability should always be the default rule.”). team production, may be appropriate in the special case of a public benefit corporation (PBC). Newly enacted DGCL 365(a) allows the Board to manage the PBC in a manner that those stakeholders balances who have made a the significant non-stock investment in interests the of stockholders and corporation. fiduciary duties will be weak and that courts will primarily refrain from deter- from refrain primarily will courts that and weak be will duties fiduciary 39748-nyb_14-1 Sheet No. 37 Side B 12/08/2017 14:30:42 12/08/2017 B 37 Side No. Sheet 39748-nyb_14-1 39748-nyb_14-1 Sheet No. 38 Side A 12/08/2017 14:30:42 69 Smith v. Van , the Court, by took a more sophis- , one is immediately Bodell II In Bodell II Bodell I 170 . ONCLUSION ), with a fairness review of a Board C Bodell II 167 tit. 8, § 152 (2015). The Court in . 168 NN A ODE where the Court made absolutely clear that director . C THE IMPORTANCE OF THE BUSINESS JUDGMENT RULE 169 EL , D It should now be easy to see that the defining moment in In the court’s decision in 167. 168. Bodell v. Gen. Gas & Elec. Corp., 169.132 A. 442, 444 (1926). Smith v. Van Gorkom, 488 A.2d 858, 170.873 (Del. 1985). Bodell v. Gen. Gas & Elec. Corp., 140 A. 264, 267 (1927). some sort of taint had surrounded estedness). To serve as this tool of restraint is precisely why the the decision (i.e., inter- Rule must be retained in its present lose this form. ability to restrain themselves from imposing a fairness If courts were to review, then Board decision-making and shareholder would wealth doubtless suffer as a result. the history of the Rule was not the famous case of Gorkom about the separation of ownership from control and how the interests of stockholders must be in balance with the Board’s statutory authority. The policy driver behind this approach is that the Board should be allowed to run the company without the fear of constantly facing potential liability for honest mis- restrained. be must equity occur, to this For judgment. in takes In order to implement such restraint, the Court employed the Rule: the tool used review fairness a when and review further without stand should to determine when is required a and the full force of Board equity is to be applied. decision Here, the Court made clear that under board decision the could not Rule, include the fairness unless review a court of had made a a finding that a fiduciary duty had been breached or ticated approach, understanding that corporate law is all rounded the decision, established the Rule as doctrine an in the abstention most fundamental way. precluding a fairness review of a Board decision unless a fiduciary duty had been breached or some sort of taint had sur- 2017] \\jciprod01\productn\N\NYB\14-1\NYB102.txt unknown Seq: 43 8-DEC-17 7:20 liability could result from an uninformed Board decision, but the much older case of struck by the power of equity and how the court felt so easily justified in challenging statutory law, Section 4a of the DGCL (currently DGCL § 152 decision even when the Board had statutory authority without restraint. to act 39748-nyb_14-1 Sheet No. 38 Side A 12/08/2017 14:30:42 12/08/2017 A 38 Side No. Sheet 39748-nyb_14-1