Debunking the corporate fiduciary myth.

• Author: Alces, Kelli A.

1. INTRODUCTION II. CORPORATE FIDUCIARY DUTIES A. What are Fiduciary Duties? B. To Whom Are Fiduciary Duties Owed? C. Duty of Loyalty 249 D. "Duty" of Care 250 E. Good Faith? 252 F. Summary 256 III. APPLYING THEORIES OF FIDUCIARY DUTIES AND FIDUCIARY RELATIONSHIPS A. Evolving Away from Corporate Fiduciary Duties B. Reliance Theory 259 C. Agency Costs 262 1. Acceptance of Position of Trust and Power 2. Abuse of Power a. Theft b. Insider Trading 3. Open-Ended Control a. Looking over Their Shoulders b. Don't Be Conflicted Without Permission 4. Summary D. Fiduciary Relationships v. Contracts IV. REPLACING FIDUCIARY DUTIES WITH CONTRACT TERMS A. Why are We Still So Preoccupied with Fiduciary Duties? B. All Investors Created Equal Bargain for Different Rights and Roles C. Equity Trustee 278 D. Enforcing Corporate Contracts V. CONCLUSION I. INTRODUCTION

   The doctrine of corporate fiduciary obligation-which holds that corporate officers and directors are fiduciaries of the corporation and its shareholders and are disciplined primarily through the enforcement of fiduciary duties-has been the core basis of all corporate law. However, today that doctrine is little more than a fiction. The emperor wears no clothes. The common law has developed in such a way that the relationship among corporate officers, directors, and the firm should no longer be characterized as a fiduciary one. Corporate managers (1) are not entrusted with "open-ended" control, (2) and corporate practice has gone beyond the expectation that managers will put the shareholders' or corporation's best interests before their own. It is now customary to assume that managers will hold their own personal interests paramount and to exploit that self interest by using incentive compensation as a way to direct managerial behavior and decision-making. Such employment incentives and market forces do far more to monitor corporate decision makers than any supposed sense of loyalty or fiduciary obligation. When market forces can or do adequately constrain agency costs, the relationship in question is no longer properly regarded as fiduciary' (3)

   At first blush, applying fiduciary principles to corporate governance seems like a natural fit. The officers and directors of a corporation do not own the corporation or its assets. Instead, they manage them for the benefit of the corporation's investors. A fiduciary relationship often exists when one person or entity is entrusted with acting for the benefit of another and so is called upon to eschew self interest in favor of the best interests of the beneficiary. (4) When one person or entity is entrusted with a power over the well being of another, the potential for abuse of that power can define the relationship as fiduciary' (5) Fiduciary relationships are, therefore, defined by the relative vulnerability of the beneficiary. The efficacy of the fiduciary obligation is not in providing every particular of faithful fiduciary behavior; rather, it is the opposite-trusting the fiduciary's judgment and having the flexibility to check the fiduciary's behavior any time it deviates from serving the beneficiary faithfully. Such flexibility has long made fiduciary duties an effective way to monitor those who have been granted open-ended control over the assets or well being of others. Beneficiaries want to rely on someone else's expertise and think it is in their best interests to trust, rather than directly control, the fiduciary. This focus on trust rather than direct monitoring or control is the hallmark of fiduciary law.

   This Article does not suggest that the concept of fiduciary obligation is not important to corporate law. (6) However, instead of serving as a guiding principle for corporate doctrine, fiduciary principles are the obstacles around which much of the law of corporate governance must maneuver. It is in spite of, rather than because of, corporate fiduciary duties that corporate law has developed. Because managerial independence is so important and shareholder interference in business decisions is potentially harmful, the fiduciary obligation has been weakened and very narrowly defined. (7) One important attribute of fiduciary duties is their flexibility and ability to address unpredictable problems. That sort of amorphous standard does not suit corporate governance. The poor fit means that we deny corporate governance duties the kind of enforcement that would make them truly fiduciary. Narrowing the scope of fiduciary obligation and applying it to only very few and very specific situations undermines the benefits of using fiduciary obligation in the first place. The conventional wisdom has cast too wide a net in defining corporate fiduciary duties and so has failed to realize that their limited purposes could be better served through contractually enforced rules and standards of managerial behavior.

   Scholars have grappled with how best to characterize corporate fiduciary duties and to what object those duties should be enforced. (8) One view rests its understanding of fiduciary duties on moral grounds: directors are in a position of trust and confidence and so should be held to a high, legally enforceable standard of trustworthiness. (9) Somewhat related to that first view is another that focuses on the role of fiduciary duties in reducing agency costs associated with the separation of ownership and control inherent in the corporate form. (10) This view argues that fiduciary duties exist as a means to hold directors and officers more accountable, or to offer another layer of protection against the opportunity they have to abuse their position by using the assets under their control for personal, rather than corporate, gain. (11) A third group focuses its analysis on the economic, contractarian view of corporate law. (12) It argues that fiduciary duties are useful gap fillers in the contracts that make up the corporation and exist because parties to a contract could never provide for every contingency in advance. (13) Fiduciary duties fill inevitable gaps in contracts and should be interpreted in light of what the parties would have agreed to had they explicitly negotiated terms providing for the situation before the court. (14) When we hold the application of corporate fiduciaries up to any of these theories of fiduciary obligation, we see that the current enforcement of corporate fiduciary duties does not fit into any of the available molds. Despite the understandable assumptions to the contrary, it appears that fiduciary obligation is not really the preferred means to the stated ends of corporate governance law and policy. Importing traditional fiduciary principles into the law of corporate governance brings far more baggage than fits. This realization has led some scholars to conclude that corporate fiduciary duties should be eliminated, (15) but those commentators fail to realize that the fiduciary character of the corporate governance relationships is already gone.

   The use of the term "fiduciary" in corporate governance is a misnomer. It is dangerous and costly to assume that fiduciary duties function well in the corporate context. The assumption may give shareholders a false sense of security or a belief that they are able to discipline management effectively when in fact, because of the very limited nature of corporate governance duties, they are not. Also, the assumption may leave a gap in monitoring and accountability that could otherwise be filled. The misdeeds that currently constitute breaches of fiduciary duty could be punished, prevented, and redressed in much more effective and economically efficient ways. If we accept that the corporation is a nexus of contracts, then all investors should be equally free to negotiate the terms of their investment and their attendant control over management, just as creditors do. (16) This gives us the freedom to toss aside the traditional view of corporate organization and ask: What would happen if shareholders were just the most junior creditors? What if shareholders could negotiate with management about the rights they would have over corporate governance? To that end, an "equity trustee," much like an indenture trustee representing widely dispersed bondholders, can represent shareholders to management and remain informed on their behalf. (17) Through the enforcement of agreements reached on the shareholders' behalf by an equity trustee and agreements providing for the rights of other investors, corporate constituents can monitor and discipline corporate officers and directors more efficiently and effectively in a post-fiduciary world than they have been able to thus far. When all investors can negotiate contracts with the corporation that monitor and discipline corporate managers to the extent allowed under corporate law, the enforcement of those investment contracts will replace fiduciary duties as the dominant corporate governance mechanism.

   This Article proceeds in three parts. Part II considers the state of corporate fiduciary duties now. It considers to whom those duties are currently owed and then reviews in turn each of the "fiduciary" duties defined by Delaware corporate law. It concludes that the conventional wisdom assumes that corporate fiduciary duties do more than they actually can do. Part III then applies the prevailing theories about the meaning and purposes of fiduciary relationships to the relationship between corporate managers and the firm as it is currently construed. It concludes that regardless of the theory of fiduciary relationships applied, corporate fiduciary duties fall short and that the corporate governance relationships are not, in fact, fiduciary in nature. Use of the term "fiduciary" to describe the duties owed to the firm by corporate management implies broader duties than actually exist without specific contract terms requiring them and does more harm than good. Part IV describes new corporate governance mechanisms...