A defense of the corporate law duty of care.

• Author: Velasco, Julian

1. INTRODUCTION II. ARGUMENTS AGAINST A. Unenforced 1. Empirical Response 2. Business Judgment Rule 3. Exculpation B. Undesirable 1. Judicial Incompetence 2. Litigation Costs 3. Risk Aversion C. Unnecessary 1. Other Law 2. Market Forces D. Not Fiduciary 1. Contractual Duty 2. Tort Duty 3. Distinctiveness a. Distinctively Fiduciary? b. Inherently Fiduciary c. Conflation III. ARGUMENTS IN FAVOR A. Pedigree B. Deterrence C. The Duty of Loyalty Is Weak D. The Duty of Loyalty Is Not Enough E. The Expressive Value of Law IV. WHY IT MATTERS A. Fiduciary Principles Are Inherently Broad B. Oversimplification C. Doomed to Failure V. CONCLUSION I. INTRODUCTION

   The fiduciary duty of care does not seem to get very much respect. Most people would acknowledge the importance of the duty of loyalty, (1) but the same is not true of the duty of care. Historically, the corporate law duty of care has been underenforced at best, and arguably unenforced entirely. When it seemed that the courts might finally breathe life into the duty, legislatures responded quickly to prevent that from happening. Some scholars do not consider the duty of care to be a fiduciary duty at all, and there are those who would do away with it entirely. It seems that the duty of care does not have many defenders these days. (2)

   In this Article, I intend to provide a comprehensive defense of the fiduciary duty of care in corporate law. I hope to show that the duty of care is not simply an ill-fitting appendage to the duty of loyalty, but rather an essential aspect of the singular fiduciary concept that also encompasses the duty of loyalty. Simply put, a fiduciary has the duty to act in the interests of the beneficiary in all relevant respects. once the breadth of this singular fiduciary concept is properly understood, it is revealed to be much more than any of the individual duties that it comprises. Far from being streamlined or focused, fiduciary law would be impoverished if it were limited to the duty of loyalty. Thus, the duty of care should not be eliminated from the ranks of fiduciary duties.

   However, I do not intend to argue for a more robust duty of care. Rather, I will defend the duty of care, as it currently exists in corporate law (more or less) (3)--deliberately and advisedly underenforced, but not entirely unenforced. (4) There are many benefits that flow from the duty of care, but also many costs. A policy of reduced enforcement can significantly mitigate many of those costs, while retaining most of the benefits. In other words, the duty of care works in the corporate context precisely because caution is built into the enforcement equation.

   This Article will proceed as follows. Part II will consider various arguments against the duty of care. These arguments can be grouped into several categories: that there really is no such duty because it is unenforced; that the duty is undesirable for practical reasons; that the duty is unnecessary because of other forces; and that the duty of care is not a fiduciary duty. The arguments have varying degrees of merit, and each will be considered in turn. One theme will recur: whatever merit the argument may have when considered against a robust duty of care is severely diminished when considered against the existing, underenforced duty. In other words, most arguments against the duty of care are logically only arguments for reduced enforcement of the duty of care. They do not establish that non-enforcement or elimination of the duty of care would be ideal.

   Part III will consider various arguments in favor of the duty of care. I start by showing that the duty of care is a well-established fiduciary duty and then address its deterrence value. Next, I argue that the duty of care is necessary because of the duty of loyalty's shortcomings: first, that it is also underenforced and therefore unable to police fiduciary relationships on its own, and second, that the concept of loyalty is inadequate to capture the essence of the fiduciary principle. Finally, I discuss the expressive value of law: the duty of care is necessary to let fiduciaries know that they have a legal duty to pursue the beneficiaries' interests with skill and diligence (i.e., carefully), and not merely to avoid conflicts of interest (i.e., loyally).

   I close with a discussion of why the issue matters. I explain that the fiduciary principle is necessarily broad and expansive and cannot be boiled down to a few simple rules. I then argue that the urge to simplify the law of fiduciary duties by eliminating the duty of care from its ranks is misguided. Finally, I suggest that, in the long run, the courts will tend to resist the reductionist impulse to simplify at the expense of equity. Thus, it is better to accept the duty of care and deal with it directly than to attempt to eliminate it and invite judicial innovation.

2. ARGUMENTS AGAINST

   This part will consider the case against the duty of care. The main arguments fall into four categories, and each will be considered in turn. Section A will consider the argument that there really is no duty of care because it is unenforced. Section B will consider the argument that the duty of care is undesirable for practical reasons. Section C will consider the argument that the duty of care is unnecessary because of other forces that lead to adequate care. Section D will consider the argument that, whatever it may be, the duty of care is not a fiduciary duty.

   1. Unenforced

      Perhaps the most obvious argument against the duty of care, at least in corporate law, is that effectively there is no such duty. Empirically, there are very few cases where liability has been premised on a breach of the duty of care. Doctrinally, the business judgment rule shields directors from liability in all but the most extreme cases. Moreover, corporations have the option to shield directors from liability for breaches of the duty of care by including exculpation provisions in their charters. It would seem that there is very little, if any, bite left in the duty of care. If that is the case, then perhaps the duty of care should be explicitly retired once and for all. (5) These arguments are not without merit, but careful consideration can reveal their limits.

      1. Empirical Response

         The most straightforward argument against the duty of care is that it is meaningless because it is virtually unenforced: there are very few cases in which directors have been held personally liable for monetary damages in cases involving solely a duty of care claim. (6) As Professor Joseph Bishop once put it, "[t]he search for cases in which directors of industrial corporations have been held liable in derivative suits for negligence uncomplicated by self-dealing is a search for a very small number of needles in a very large haystack." (7) The dearth of cases resulting in liability for breach of the duty of care is undeniably relevant, but may not be as damning as it seems. There are circumstances that put the raw numbers into perspective.

         Although the cases are few and far between, they are not non-existent. By comparison, cases leading to director liability based solely on the quality of substantive business decisions are truly rare. Although courts often reserve the right to find liability based upon irrational decisions, (8) they rarely do so in fact. Because of this, waste might be fairly described as more theoretical than real. (9) The same is not quite true of procedural care. A leading treatise identifies about a dozen cases that led to director liability for breach of the duty of care. (10) Admittedly, this is not a very large number, but it is not zero. Moreover, the number must be considered in the context of the corporate legal landscape.

         The lack of cases can readily be explained by the divergence between standards of conduct and standards of review in corporate law. (11) Standards of conduct are rules addressed to actors, specifying expectations regarding their behavior, while standards of review are rules addressed to courts, specifying how actions are to be judged. In most areas of law, standards of conduct and review converge. For example, in tort law, the standard of conduct is ordinary care, and the standard of review is negligence. The same is not true in corporate law, where standards of conduct and standards of review diverge. This divergence is most evident in the business judgment rule.

         Delaware defines the business judgment rule as "a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." (12) Alternatively, the business judgment rule can be described as a deferential standard of review for duty of care cases. (13) Thus, although the standard of conduct for the duty of care is something like ordinary care, the standard of review is gross negligence rather than mere negligence. (14) Some would characterize the business judgment rule as a policy of nonreview, (15) although this characterization seems more appropriate with respect to the substance of business decisions than to the decision-making process. (16)

         The next section considers the justification for the business judgment rule. For present purposes, it is sufficient to note that the business judgment rule explains why there are so few cases leading to director liability. Because the standard of review is so deferential, the burden on the plaintiff is quite high. The natural consequence of such deference is that few cases result in liability. Additionally, if it is difficult to recover against directors for breach of the duty of care, then it may not be worthwhile to file many such lawsuits in the first place. Furthermore, any meritorious cases are likely to settle early. (17) Thus, one should not expect to find many cases leading to director liability based on the duty of care.

         In fact, the legal landscape is even more...