Introduction
Professor Bainbridge has cast doubt on the American Law Institute’s new project, The Restatement of the Law of Corporate Governance (the “Restatement”). As the Reporter for the project, I welcome the challenge and am grateful to Professor Bainbridge for raising such useful and interesting questions. As I will explain in more detail below, I disagree with Professor Bainbridge because I think there is great importance in the American Law Institute (ALI) convening a conversation on foundational questions of corporate law and governance. I hope and expect that the results will be valuable to judges, corporate lawyers, legislators, and the general legal community.
But, even more fundamentally, Professor Bainbridge misconstrues our target audience: this Restatement is primarily aimed at non-Delaware judges deciding corporate cases. As such, it includes both Delaware and non-Delaware law, with Delaware law often but not always leading the way. At the same time, as it synthesizes the law, it aims for a “user-friendly” version that captures the essential core of the doctrine, without necessarily including every “jot or tittle.” In doing so, we adhere to the four guiding principles of ALI restatements: ascertaining “the nature of the majority rule”; ascertaining “trends in the law”; determining “what specific rule fits best with the broader body of law and therefore leads to more coherence in the law”; and ascertaining “the relative desirability of competing rules.”
Why a Restatement?
Professor Bainbridge argues that corporate law is unsuited to a restatement, that there is a “mismatch” because, he says, “corporate law is largely statutory,” and restatements are unnecessary and inappropriate for statutory fields in general and corporate law in particular because, especially in Model Business Corporation Act (MBCA) states, the “common law functions, at most, interstitially.” But Professor Bainbridge exaggerates across both dimensions. First, corporate law—in particular, the areas of corporate law that the Restatement, like the Principles of Corporate Governance (the “PCG”) before it, will concentrate on—is not all that statutory. Second, even largely statutory fields can benefit from restatements especially when, as here, the scope for judicial discretion is broad.
There are two ways in which a restatement can be valuable in interpreting a statutory provision enacted against the backdrop of a long common law tradition. First, a restatement will clarify the substantive terms of a statute that codifies a common law rule. Second, when a statute leaves scope for interpretation, a restatement will restate subsequent judicial developments.
For example, in corporate governance, there is no topic as important as the fiduciary duties of directors and officers (the subject of Chapters 4 and 5 of the Restatement). Yet fiduciary duty law in all jurisdictions is almost entirely common law. The Delaware General Corporate Law (DGCL) does not even attempt to define the duty of care or loyalty, and only mentions them in a subsidiary way as in the context of exculpation under DGCL section 102(b)(7). In this context, the statutory provision relies upon the common law development of the duties of care and loyalty and the scope for judicial discretion is broad.
Even the MBCA, which strives for broader coverage, leaves much to judicial development. As a model statute, it covers many topics largely beyond the scope of the Restatement, including filing requirements and the powers of the secretary of state; incorporation; purposes and powers; the corporate name; the registered office and agent; shares and distributions; domestication and conversion; amendment of the articles of incorporation; disposition of assets; dissolution; and foreign corporations.
In the areas where there is the most overlap—shareholders and directors and officers—the MBCA approach differs from the Restatement approach. As a model statute, the MBCA, like the DGCL, provides the ground rules for the election of directors, director terms, director resignation and removal, meetings and actions of the board, and indemnification. Only a small (but important) portion addresses directors’ fiduciary duties. In these areas, the MBCA seeks to provide safe harbors without a comprehensive definition or analysis of the content of those duties. MBCA section 8.30(a) and (b) (Standards of Conduct for Directors) provides a general statement of director duties that “are analogous to those generally articulated by courts in evaluating director conduct, often referred to as the duties of care and loyalty”:
- (a) Each member of the board of directors, when discharging the duties of a director, shall act: (i) in good faith, and (ii) in a manner the director reasonably believes to be in the best interests of the corporation.
- (b) The members of the board of directors or a board committee, when becoming informed in connection with their decision-making function or devoting attention to their oversight function, shall discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances.
But these general descriptions leave huge areas to common law development. Under section 8.30(a), the MBCA’s version of the duty of loyalty, what constitutes “good faith”? When may a fiduciary compete with the corporation? When may a fiduciary use corporate property or corporate information? When may a fiduciary take a business opportunity that the fiduciary learns about in the course of the fiduciary’s corporate role or outside the corporate role?
Under section 8.30(b), the MBCA’s version of the duty of care, what does it mean to “discharge . . . duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances”? What are directors’ duties in selling a company? How does section 8.30(b) apply to oversight? Similarly, the comments to section 8.31, which sets out elements of the business judgment rule, explicitly state that the section does not codify the business judgment rule but leaves it open for judicial development: “The elements of the business judgment rule and the circumstances for its application continue to be developed and refined by courts. Accordingly, it would not be desirable to freeze the concept in a statute. Thus, section 8.31 does not codify the business judgment rule as a whole, although certain of its principal elements, relating to personal liability issues, are reflected in section 8.31(a)(2).” In all of these contexts, the MBCA leaves scope for judicial interpretation and, thus, room for a restatement.
By contrast, the Restatement will devote two full chapters to directors’ and officers’ fiduciary duties, and it will probe much more deeply, avoiding those topics where statutes provide the full answer and there is no scope for judicial discretion.
The difference is apparent, for example, with regard to director conflict-of-interest transactions. We follow the MBCA safe harbor where it applies, but we will address a wider range of situations as well. Unlike the MBCA, we consider a range of duty-of-loyalty issues that go beyond interested transactions, and we do not categorically exclude judicial review of transactions that may not fit the definition of a “transaction in which a director or officer is interested.” Moreover, we will also address a range of non-transactional conflicts, such as competition with the corporation and use of corporate property, areas that the MBCA comments recognize as appropriate for common law adjudication.
Even more importantly, as the MBCA recognizes, its treatment of director conflict-of-interest transactions does not address interested transactions involving controlling shareholders. The Restatement, by contrast, works through the complicated issues relating to controller transactions.
Even in the areas of corporate governance law that are more statutory, such as the composition of the board of directors, is a restatement really unnecessary? This is a long-standing issue at the ALI, going back to its founding. Roswell Perkins, president of the ALI in 1982 when the PCG project was launched, provided a fascinating historical summary of the ALI’s consideration of a restatement in the area of corporate law. It turns out that the questions that Professor Bainbridge raises are hardly new:
William Draper Lewis, the first Director of the ALI, was extremely interested in corporation law. In 1923 there was a great debate within the Council of the Institute as to whether corporation law should be an early subject for an ALI Restatement. General Wickersham took the view that it was impossible to write a Restatement for a subject that was so largely statutory. Judge Learned Hand said that, on the contrary, there were principles to statutes as well as to decisions and that such a project was entirely possible.
The debate continued. As Learned Hand stated at the ALI Council’s May 1933 meeting in response to Colonel Wickersham’s argument:
I take the other view. I think it is a mistake to suppose that because so much of the law of Corporations is in statutory form it is not subject to Restatement. That is rather an inheritance from the time when statutes were regarded as they were by common law lawyers as something extraneous and alien and an interference with the course of the law. There is not any more divergence in statute than there is in decision. What has now become part of our jurisprudence and in which there has been a great deal of work done is, if I may use the phrase, the common law of the statutes. It is quite possible to state statutory law in a matter of that sort. . . . My own work is concerned far more with statutes than it is with judicial decisions. I am not aware of any great difference in procedure when I am dealing with the statutes and when I am dealing with the common law. The habits of an English-speaking lawyer do not change when he goes from one to the other.
While I agree with Learned Hand, the proof will ultimately be in the pudding. The Restatement will primarily focus on corporate common law and, even when statutes impinge, will focus on issues open to judicial interpretation. To the extent that statutes arise, as in the case of exculpation, I expect critics like Professor Bainbridge to look closely to see whether we have added value.
Why Now?
Professor Bainbridge recounts the stormy history of the Principles of Corporate Governance, a history that I remember vividly from when I was Bob Mundheim’s student at the University of Pennsylvania Law School and a young lawyer working with Allen Black at Fine, Kaplan, and Black. Both were actively engaged in the project. Professor Bainbridge takes this “dubious precedent” as a compelling argument against returning to the corporate governance field. But is it?
When the ALI launched the Principles of Corporate Governance project in 1978, it had both good timing and bad timing because corporate law, after a period of relative quiescence, was about to explode. In its origin, the project was a response to high-profile corporate scandals of the 1970s, including the shocking failure of Penn Central, illegal corporate campaign contributions, and overseas bribery by leading U.S. corporations. But, starting in 1980, it collided with an unparalleled period of economic and legal change. With the appointment of William Baxter as head of the Antitrust Division of the U.S. Department of Justice, merger policy was transformed with the immediate reversal of a nearly per se prohibition of horizontal and vertical mergers, a regulatory barrier that channeled M&A activity during the 1960s and 1970s into conglomerate acquisitions. Around the same time, Michael Milken and Drexel Burnham Lambert pioneered the issuance of public debt by below investment grade firms.
This combination of factors led to a huge upsurge in merger and restructuring activity. Inefficient conglomerates—formed when horizontal and vertical mergers were limited by regulation—were dismantled. Hostile takeovers, spurred by leverage newly available from Milken’s “junk bond” machine, became common. Leveraged buyouts, likewise funded by debt, proved enormously profitable. Firms restructured in two ways: converting equity to debt through leveraged recapitalizations; selling off or spinning off units as conglomerate businesses increased their focus on a few core areas. With shareholders predictably tendering into premium offers, management fought back against hostile bids and pioneered a variety of “defensive” techniques.
As these battles reached the courts, it became clear just how little law there was on the key issues that the new era raised. When boards resisted hostile bids, what was the standard of review? When companies were sold for cash, what was the board expected to do? When companies were taken private, either in a management buyout or a controlling shareholder freezeout, what were the basic ground rules? There was very little law in any jurisdiction on the core issues raised by these major transformations of the capital markets.
The modern law of M&A began, inter alia, with Weinberger (1983), continued with Van Gorkom (1985), Unocal (1985), Moran (1985), Revlon (1986), and then closed out the decade with Paramount v. Time (1989). These and many other cases laid the groundwork for modern corporate law. As the dates of these seminal cases show, the PCG were drafted and debated at precisely the same time as the law was rapidly developing.
As a result, the PCG project became a forum for debating the most important issues in corporate governance. With everything up for grabs, the stakes seemed high. With the law in a state of flux, whatever the ALI did would be controversial. The PCG was a “principles” project and thus far less constrained than a restatement. Rooted in existing law, the PCG was caught between the challenge of “restating” and “reforming” quickly changing law at the same time as the participants had deeply held substantive views on what the law should be.
In the intervening years, corporate law has settled down. Many of the biggest questions were resolved in the 1980s, refined in the 1990s, and continue to develop until today. There is now wide consensus over what the law is, at least in its overall structure, even as there is constant debate over the details. This, as we will see, makes corporate law a perfect area for a restatement.
But even if there is now enough corporate law to restate, why return to it now? Because, in addition to the relevant law settling down, much has changed. The first transformational change is the ever-increasing concentration of equity ownership in the hands of institutional investors and, with it, the evolving role of shareholders. When one looks at the PCG, shareholders, other than controlling shareholders, are entirely absent. This was appropriate at the time because shareholders did not play an important role in corporate governance. In the years since the PCG were approved in 1992, that has changed: shareholders are now vitally important to corporate governance. In 1950, institutions held $8.7 billion in equities (6.1 percent of total); in 1980, institutions held $436.2 billion in equity (18 percent of total); in 2009, they held $10.239 trillion (40.4 percent of total). Between 1987 and 2009, the institutional ownership in the top 1000 U.S. corporations grew from 46.6 percent to 73 percent. In 2009, the twenty-five largest corporations by market value had an average institutional ownership of over 60 percent. In the years since 2009, the trend has accelerated. Today, the “Big Three” institutional investors (BlackRock, Vanguard, and State Street) collectively manage around 20 percent of the shares in most public companies.
Along with this concentration of shares in institutional hands has come the emergence of activist hedge funds that search for underperforming companies whose stock price can be increased through a targeted intervention. Hundreds of billions of dollars are now invested in such strategies and a new practice area—“activism defense”—has emerged in which bankers and lawyers counsel firms on how to anticipate or respond to activist hedge funds. But it is not just activist hedge funds that drive the debate. Actively managed mutual funds and public pension funds have also taken prominent roles.
With the change in the shareholder base has come a change in the legal role of shareholders. Not only are votes by shareholders more meaningful because the largest shareholders now take voting seriously, but the legal effect of a shareholder vote has changed dramatically.
With the change in shareholders has come a change in directors. Independent directors are far more independent today than they were in the 1970s and 1980s. With that, the effect of disinterested director approval on the standard of review has become more significant, especially when paired with disinterested shareholder approval.
A second major change is in how people think about the business corporation’s role in society. Courts have long had to consider the limits on board discretion in devoting corporate resources to worthy goals and the extent to which such decisions must be justified as conducive to long-term shareholder value. Two new developments have brought these considerations into the mainstream of corporate governance. First, proponents of ESG have re-conceptualized their concerns as part of ordinary risk management. For example, they now argue that the non-trivial risk that Europe will adopt a carbon tax means that multinational corporations should pay attention to their carbon footprint as a matter of ordinary risk management. Second, the largest institutional investors now make ESG considerations part of their stewardship guidelines. BlackRock, for example, now expects portfolio companies to have at least two women and one director who identifies as a member of an underrepresented group on the board. These public debates over corporations’ social role pose the question of how these considerations fit within the law’s corporate governance framework. As will be discussed in connection with section 2.01 (the Objective of a Corporation), the flexibility of the traditional framework accommodates current concerns.
A third major change is the role of the board of directors in compliance and risk management. The federal Organizational Sentencing Guidelines first became effective in 1991. Caremark was decided in 1996. Since then, compliance and risk management have become key board functions, with resulting and evolving liability risk.
Have these changes in the world changed the fundamental principles of corporate law? Is the traditional framework still appropriate? A Restatement of the Law of Corporate Governance is an opportunity to address these questions. Perhaps even more importantly, it is an opportunity for the corporate law community and the larger legal community to think together about the answers. The reporters are being assisted by an incredibly distinguished group of advisers and ALI members drawn from every corner of the corporate law ecosystem: current and retired members of the Delaware Chancery and Supreme Court; leading federal judges; distinguished litigators who represent both plaintiffs and defendants; transactional lawyers who play central roles in the largest M&A transactions; board advisers and general counsel of major companies; leading figures from the world of ESG; and a sprinkling of academics.
Who Is Our Audience?
Professor Bainbridge tells us that, with the concentration of expertise in the Delaware bench and bar, and with many comprehensive and specialized treatises, surely the Delaware bench and bar do not need a Restatement of the Law of Corporate Governance.
In thinking of our task and our audience, it is worth returning to the core mission of the ALI, as memorialized in its certificate of incorporation:
The particular business and objects of the society are educational, and are to promote the clarification and simplification of the law and its better adaptation to social needs, to secure the better administration of justice, and to encourage and carry on scholarly and scientific legal work.
We take the goal of “the clarification and simplification of the law” to be our polestar.
As Professor Bainbridge points out, Delaware is the center of U.S. corporate law, with superb judges and lawyers who dedicate their professional lives to the field. Delaware law has become the subject of excellent treatises, memoranda, and law review commentary. Yet, despite this intense attention—or perhaps because of it—it turns out that disagreements over particular issues constantly arise, and can benefit from “clarification and simplification.” Indeed, Delaware itself has a tradition of critically evaluating the development of its law.
But Delaware, however crucial to the project, is not our primary audience, and treatises devoted to explaining Delaware corporate law to Delaware lawyers do not preempt us. There is a huge potential audience of people who deal with corporate law but who are not steeped in Delaware corporate law. We aim at the judges dealing with corporate law cases in the forty-nine states that are not Delaware. We aim at lawyers outside of Delaware who represent Delaware and non-Delaware corporations, whether in litigation, transactions, or as board counselors. We aim at legislators around the country who are considering what to codify and why.
Finally, we aim at the general legal community concerned with the issues raised by corporate law. Corporate law is not simply a specialization but is a critical area of law for any market economy. For whom is the corporation managed? What is the role of non-shareholder stakeholders in corporate governance? To what extent may a firm take environmental impact into account in setting firm strategy? To what extent must it? Where better to debate these issues than the ALI?
What Law Are We Restating?
Professor Bainbridge argues that there is no need for a Restatement of the Delaware Law of Corporate Governance because the Delaware corporate law community looks to Delaware cases and treatises for guidance on Delaware corporate law. But our Restatement is not defined to be a restatement of the Delaware Law of Corporate Governance. This is intentional. As with other restatements, with fifty different jurisdictions, the goal is to identify the best legal approach to a given issue, especially when there are a variety of approaches.
As an example, consider section 2.01 (the objective of a corporation), approved by the membership at the May 2022 meeting and the subject of a companion article by Professor Bainbridge. There are few topics timlier than the question “for whom is the corporation managed?” Over the last five years, it has been the focus of intense discussion by CEOs of giant asset managers like BlackRock’s Larry Fink, by the leading organization of public company chief executive officers—the Business Roundtable, by political leaders, and by law and business academics. What can a restatement say that will be useful and relevant when there are such active debates in law, finance, management, and politics, debates in which the descriptive and normative are intertwined?
First, the Restatement seeks to describe the default characteristics of the enterprise form we call the “corporation.” Second, the Restatement seeks to make clear in the comments and illustrations how current debates over ESG fit in, and to elaborate on the flexibility that the enterprise form provides for taking ESG factors into account.
We thus draw a distinction between the characteristics of the legal form (the “objective”) and the “purpose” that a particular business might pursue. This distinction allows a lawyer to begin to determine, for a particular business venture, the most appropriate enterprise form from the menu of options (corporations, LLCs, LPs, general partnerships, etc.). In focusing on the characteristics of the corporate form, we necessarily set other issues aside such as the circumstances under which a director will be liable for breaching his or her fiduciary duty. These issues are handled elsewhere.
It turns out that even this task is highly complex. During the meeting of the advisers and members consultative group, Leo Strine (former chief justice of the Delaware Supreme Court and former chancellor of the Delaware Court of Chancery) challenged an earlier “shareholder primacy” draft as ignoring the actual variation provided by the states that adopted stakeholder statutes in the 1980s. Given our desire to describe the core characteristics of the corporate enterprise form as one of a menu of options, Strine was correct to point out that these legislative reforms introduced substantial heterogeneity around the question of corporate objective. Pennsylvania’s statute, for example, explicitly rejected shareholder primacy: “The board of directors, committees of the board, and individual directors shall not be required, in considering the best interests of the corporation or the effects of any action, to regard any corporate interest or the interests of any particular group affected by such action as a dominant or controlling interest or factor.”
In response, we expanded section 2.01 to restate the “objective” in both traditional and stakeholder jurisdictions, and we identified in the black letter, comments, and illustrations some potential differences in the treatment of particular issues. This expansion allowed us to capture more accurately the menu of options. For Delaware and jurisdictions that follow a similar approach, we adopted language based on Chancellor Chandler’s discussion in the eBay case: “The objective of a corporation is to enhance the economic value of the corporation, within the boundaries of the law . . . for the benefit of the corporation’s shareholders.” The Restatement then clarifies that, in doing so, a corporation may (but need not) consider the interests of employees, customers, suppliers, as well as the impact on communities, the environment, etc. As we then make clear in the comments, this “may” is not a “must” or a “shall” but still provides great discretion to boards of directors to consider the full range of interests and values so long as there is some “rational relationship” to shareholder benefit. As our discussion makes clear, many of the concerns raised under the banner of ESG fit comfortably within the traditional approach.
With regard to stakeholder jurisdictions, the restating process is more complex as there is substantial heterogeneity in how courts have interpreted stakeholder statutes. In some states, stakeholder statutes are interpreted through a shareholder-primacy lens; in others, there is an embrace of the statutory language permitting tradeoffs. As we indicate in the comments and illustrations to section 2.01, the history of the stakeholder statutes make clear that they were intended to reject the Delaware Supreme Court’s “shareholder primacy” approach as illustrated by the Revlon line of M&A cases. Beyond the Revlon context, there is insufficient judicial authority regarding the scope of the expanded discretion provided.
Finally, the new “benefit corporation” form provides an option for a mandatory obligation to consider the interests of all stakeholders. We discuss benefit corporations in the comments but not in the black letter because, to date, there is minimal judicial commentary on the statutory provisions.
As is traditional for restatements, the meaning of the black letter provisions is developed through the comments and illustrations. Here, again, the focus is on restating current law. Thus, for example, the Restatement takes a strong position that corporations are obliged to act within the boundaries set by law even if doing so reduces profits and shareholder value, a position that Professor Bainbridge views as perpetuating bad policy.
But the black letter “within the boundaries of the law” also provides an example of the extent to which a restatement is a collective project of limited ambition. In the preliminary and council drafts of section 2.01, we had a variety of illustrations that sought to introduce greater nuance into the discussion including a double-parking illustration quite similar to Professor Bainbridge’s example. My own analysis paralleled Professor Bainbridge’s, but there was no consensus around the illustration and, more importantly, too little law to resolve it. Accordingly, we limited ourselves to one clear illustration on which all agreed, namely, that a corporation that pays a bribe to secure a contract because the risk of detection is small involves a departure from section 2.01. We left the other, extremely interesting illustrations out of the Restatement despite the fact—or indeed because of the fact—that the issues raised are so interesting and controversial given the current state of the law. Where the law does not resolve an issue, a restatement should generally be silent.
Section 5.10 provides an example of the simplification strategy. Transactions in which a controller is interested are among the most important and most complicated areas of fiduciary duty law because a controller may have powerful conflicts of interest. The MBCA, for example, does not even address such transactions. Controller transactions have been the subject of intense judicial scrutiny for decades. Beginning with the seminal opinion in Weinberger v. UOP, Inc. (1983), which involved a controlling shareholder acquiring the shares held by the non-controlling shareholders, a long line of Delaware cases has addressed the judicial standards of review of controller transactions, ultimately arriving at Kahn v. M & F Worldwide Corp. In M & F Worldwide (often referred to as “MFW” after the name of the Chancery Court opinion), the Delaware Supreme Court identified the conditions under which a controller could avoid the “entire fairness” review that would otherwise apply:
To summarize our holding, in controller buyouts, the business judgment standard of review will be applied if and only if: (i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.
Since 2014, there have been numerous cases providing further development of each of these elements.
We have approached restating this important strand of fiduciary duty doctrine by capturing the essence of the Delaware approach without restating each jot and tittle. Our hope, in doing so, is to make the general approach useful to judges outside of Delaware who have to adjudicate cases in which the controller is interested in the transaction.
Thus, Restatement section 5.10 currently reads, in the main operative section, as follows:
§ 5.10. Interested Transactions Involving a Controller
- (a) If the corporation enters into a transaction in which a controller [§ 1.10] is interested [§ 1.23], the controller fulfills its duty of loyalty to the corporation and its shareholders with respect to the transaction if:
- (1) the transaction is fair to the corporation at the time it is entered into; or
- (2) the transaction is conditioned on it being approved in advance, and is so approved, by (A) disinterested directors [§ 1.15], acting in good faith and on reasonable inquiry with the power to retain their own professional advisers and to negotiate the terms of the transaction, and (B) disinterested shareholders [§ 1.16], in each case following disclosure concerning the conflict of interest [§ 1.14(a)] and the transaction [§ 1.14(b)] to the disinterested directors and disinterested shareholders, respectively.
This tracks the MFW Worldwide standard but is simpler. In our view, section 5.10 captures the essence of MFW: a controller can avoid the “fairness” inquiry only if there is proper approval by disinterested directors and disinterested shareholders. But, in our view, this formulation will be easier for judges and lawyers outside of Delaware to apply.
Note also that this follows the MBCA’s “safe harbor” strategy. Approval by disinterested directors and shareholders is not required for controller transactions, but securing that approval results in the controller fulfilling its duty of loyalty.
Note, further, that we follow the MBCA in stating explicitly that satisfaction of the requirements of section 5.10(a)(2) results in the controller satisfying its duty of loyalty, rather than Delaware’s somewhat oblique formulation that says that, when the MFW preconditions are satisfied, the “business judgment rule” will apply. Those steeped in Delaware law understand that, in the MFW context, our Restatement amounts to much the same thing. Indeed, in subsequent opinions, Delaware courts have said that, in this context, there is an “irrebuttable business judgment rule.” But, for judges and lawyers outside of Delaware, Delaware’s “business judgment rule” formulation is unnecessarily confusing because it suggests that there is an additional inquiry that must be completed, namely, whether the controller has satisfied the business judgment rule. Little would be gained in preserving the current Delaware distinction between the “rebuttable” and the “irrebuttable” business judgment rule.
Section 5.10 also illustrates another feature of the ALI drafting process: this is a “tentative draft.” While our draft is consistent with current Delaware law, as reflected for example in numerous cases from the Delaware Chancery Court, there is currently a debate in Delaware over whether the Delaware Chancery approach correctly construes the scope of MFW: is satisfying the MFW requirements the only way to avoid entire fairness review of any interested transaction involving a controller? As the Delaware Supreme Court has not addressed this question for over twenty-five years, we view the tentative draft as tentative. If, in the coming years, the Delaware Supreme Court provides other ways to avoid entire fairness review in a subset of controlling shareholder transactions, then we will revisit section 5.10 in light of those developments.
Finally, consider our section 5.11, which was presented to the advisers and members consultative group in February 2022. Section 5.10 addresses transactions with the corporation involving a controller, including controller freezeouts of non-controlling shareholders. But, as corporate lawyers know, there is more than one way to achieve the same end. What about a controller who, instead of merging with the corporation, goes directly to the shareholders through a tender offer followed by a “short-form” merger (i.e., without a transaction with the corporation)? Will that be treated the same way as a controller freezeout merger that involves a transaction with the corporation? And, if so, what about a controller tender offer that does not result in a freezeout?
This is a very interesting and tricky area of Delaware corporate law and one that, to our knowledge, no other state has addressed. On the one hand, a controller freezeout merger is substantively close to a controller freezeout tender offer. After some cases that suggested that the standards of review might vary depending on transactional structure, Delaware today largely applies the same “unified standard” to both structures. Our Restatement will help non-Delaware lawyers and judges cut through the variety of opinions from which this standard emerged. But the case law is less clear on how to view controller tender offers outside of the freezeout context. Although there are some who argue that all controller tender offers not followed by a merger at the same price are necessarily coercive, courts have not gone so far.
As a result, we limit section 5.11 to controller tender offers that are part of a freezeout transaction, restating the “unified standard.” At the same time, as we will make clear in the comments, we do not currently take a position on the law governing controller tender offers outside of the freezeout context except to highlight the potential concerns with such tender offers:
The section does not address tender offers by a controller (or a self-tender offer by a controlled corporation) that do not involve a stated desire to acquire all of the company’s shares and to take the company private. As with other situations when a controller’s power over the company might give rise to fiduciary concerns, tender offers by a controller that do not involve a stated desire to acquire all of the company’s shares and to take the company private and self-tender offers might also pose dangers that the duty of loyalty exists to police. These situations are diverse. Some can involve tenders that offer other stockholders valuable liquidity and that do not eliminate a robust, active market in the trading of the company’s minority shares. Current case law does not allow the formulation of a comprehensive approach to these transactions. At a minimum, however, a controlling shareholder tender offer may not improperly coerce shareholders and must be free of disclosure violations. Case law has yet to address whether, and if so in what circumstances, additional requirements—such as a duty to offer a fair price unless the offers has been approved in some form by disinterested directors or shareholders—extend to such offers.
This comment will be included because judges, in and out of Delaware, may have occasion to adjudicate claims of controller coercion outside of the freezeout context. We expect that the Restatement’s treatment will be helpful when such issues arise.
What Counts as Influence?
Professor Bainbridge argues at length that the PCG were not influential in the development of corporate governance. As the Reporter for the Restatement, my brief is not to defend the PCG. The Restatement is a very different project than the PCG and should be judged on its own merits. While the PCG sought to shape a rapidly evolving area of the law, the Restatement is committed to restating the results of that evolution with all the benefits of hindsight. Professor Bratton’s historical account of the PCG provides an insightful analysis of the doctrinal and political context within which the PCG evolved, as well as some of its principal contributions.
At the same time, it is worth considering how some of the PCG’s doctrinal innovations have become positive law. Consider Part III of the PCG, “Corporate Structure: Functions and Powers of Directors and Officers; Audit Committee in Large Publicly Held Corporations.” One of the most enduring legal legacies of the PCG generation of academics was the re-imagination of the corporate board from a “management board” to a “monitoring board.” As Mel Eisenberg observed in his seminal law review articles (ultimately collected into the book, The Structure of the Corporation), the core provision of the Delaware statute—section 141(a)’s statement that “[t]he business and affairs of a corporation shall be managed by or under the direction of a board of directors”—seems to imagine that the board of a corporation will manage the firm. Yet, as Eisenberg argued persuasively, this cannot be the case in large publicly held firms. A board that meets six to eight times per year does not have the time to manage a major firm (constraints of time) and does not have access to the information necessary to do so (constraints of information). Finally, directors who then served on boards largely did not have the independence from management to take a leading role (constraints of composition, selection, and tenure).
What was to be done? One reaction was to try to give the board the tools it needed to manage the corporation such as a full-time staff. But the more interesting and important response was to give the board a new job that it could do, and then to modify the law to support that new role. That new role? To act as the monitor of management.
In a series of articles and programs, academics promoted the idea of the “monitoring” board and worked out how it was to work. The constraint of time? Monitoring is something that can be done with six to eight meetings a year. Constraints of information? Require an independent audit committee to whom the outside auditors would report. Constraints of composition? Require an independent nominating committee to appoint independent directors who would staff the other committees as well. How to monitor the chief executive officer? Require an independent compensation committee.
Starting in the 1970s, practices in the largest publicly held corporations began to evolve, as did stock exchange listing requirements. With Mel Eisenberg as Chief Reporter of the PCG, it is not surprising that Part III is a fully worked out implementation of the monitoring board.
Now, of course, the monitoring board has been written into law and stock exchange listing requirements directly. Audit committees must be independent. Compensation committees must be independent. Nomination committees must be independent. Finally, a majority of the board of directors must be independent. Today, in most public companies, all the directors are independent with the exception of the sole insider, the chief executive officer.
Have the PCG’s provisions on the structure of boards of directors of public companies been influential? Very. As of 2022, Part III of the PCG, originally offered as a set of “recommendations,” is now very close to a restatement.
Conclusion
The ALI is a private, non-profit organization with no law making power, except in the Northern Mariana Island (but no longer in the U.S. Virgin Islands). It is only as influential as it is persuasive. The fact that it has been so persuasive over so many years is a testament to the quality of its output.
What makes restatements persuasive is the quality of the people involved in the project. The Restatement of the Law of Corporate Governance is an ideal opportunity for the general corporate law community collectively to think through foundational issues in our field, whether in meetings of the advisers and members consultative group, in Council deliberations, in discussions at the annual meetings, or in conferences and law review articles examining and critiquing drafts. Last time around, the criticisms of the PCG drafts were important, influential, and were themselves substantial contributions to corporate law.
To return to the earlier “pudding” metaphor, the proof of whether we have made a valuable contribution to the corporate law community will be in the eating. Like anything that is not bland, our product is not likely to satisfy all palates, but it might just stimulate most of them and inspire a lively engagement between them on why some savored the dish and others found it off-putting.
We welcome Professor Bainbridge to this great adventure!
