DELAWARE'S FIDUCIARY IMAGINATION: GOING-PRIVATES AND LORD ELDON'S REPRISE.

• Author: Kershaw, David

TABLE OF CONTENTS INTRODUCTION I. HISTORICAL CONCEPTIONS OF THE FIDUCIARY RELATION A. Power and Undertaking 1. The Source of Fiduciary Obligation 2. The Structure of Fiduciary Duties 3. To Whom is the Duty Owed: Stockholders "Convening" the Corporation B. Influence and Superiority: The Fiduciary as "Economic Agent". 1. The Doctrines of Undue Influence and Fair Dealing 2. Influence and Fiduciary Relations 3. The Infiltration of Fiduciary Influence II. CONTROLLING SHAREHOLDERS AS FIDUCIARIES A. Regulating Going-Privates Lord Eldon Style B. Controllers' Fiduciary Power in the Supreme Court C. Fiduciary Conceptions in Delaware's Going-Private Law 1. Power/undertaking in Delaware's going-privates 2. The Infusion of Fiduciary Influence in Going-Private Mergers 3. Fiduciary Influence Interference in Going-Private Tender Offers III. THE COLONIZING EFFECT OF FIDUCIARY INFLUENCE: FIDUCIARY DUTIES TO CREDITORS CONCLUSION INTRODUCTION

What does it mean to be a fiduciary and does it really matter whether the law labels a person a fiduciary or not? Until the late twentieth century Delaware corporate law could have given a singular, coherent answer to these questions. Today, to its detriment, it is no longer able to do so.

In Delaware's original understanding of fiduciary relations, a fiduciary was merely a legal label applied to a person who is subject to legal obligations arising from her undertaking to perform a representative position or role and her empowerment to perform that role. This conception is referred to in this article as the "power/undertaking conception" of fiduciary relations. In this conception, the fiduciary duties she owes are not the product of her being designated "a fiduciary," rather they arise from or are implied in the undertaking and empowerment. Victor Morawetz, one of New York's leading late-nineteenth century corporate lawyers, referred to these obligations as the "implied condition[s]" (1) of delegated discretion. Earlier, and more foundationally, as Lord Holt put it in the 1703 case of Coggs v. Barnard: "[the] undertaking obliges the undertaker to a diligent management." (2) Accordingly, in this power/undertaking conception of fiduciary relations, the duty of good faith (which evolved into the business judgment rule) (3) and the duty of care are inherent in the agreement to perform and to be empowered to perform the representational role. Similarly, the duty to avoid a conflict of duty and personal interest, which evolved in the United States to provide for fairness review of self-dealing transactions, (4) is a corollary of the agreement to act in good faith to further the purpose for which the power was delegated--it ensures that the exercise of the delegated discretion is not infected with personal financial interest. (5) As Lord Eldon, the father of modern fiduciary law, put it in 1802, a fiduciary cannot "manage for the benefit and advantage of himself." (6)

These obligations orbit the fiduciary's exercise of delegated power. In the corporate context, as those powers are the corporation's powers and as the corporation appoints those who exercise those powers, necessarily these fiduciary duties are owed to and enforced by the corporation. Likewise, anyone who usurps corporate power, such as a majority shareholder who controls and directs the exercise of board power, owes the consequential duties to the corporation.

This power/undertaking conception of fiduciary relations was the conception of fiduciary relations in U.S. corporate law in the nineteenth and most of the twentieth century. It is a conception upon which most of the fiduciary law taught in a JD corporations course today was structured and built. However, commencing in the mid-twentieth century, and in the late twentieth century in Delaware corporate law, a different conception of the fiduciary was born; a conception also rooted in Lord Eldon's equity jurisprudence and the concern about the ability of one party to take advantage of and exercise undue influence over another in the context of transactions such as contracts and gifts. When applicable this undue influence doctrine required proof that the transaction was the product of a fair process, and in some instances, evidence that the agreed upon price was also fair. This doctrine, therefore, provided a separate legal pathway to entire fairness review.

Although this undue influence doctrine has nothing to do with traditional fiduciary obligation it was often applicable to power/undertaking fiduciaries who, in relation to certain transactions, were able to take advantage of their charge and exercise influence. (7) It was, however, equally applicable to persons in such a superior position, even where they were not power/undertaking fiduciaries. But although such relations of potential advantage and influence were never "fiduciary" relations, courts in several U.S. states (including Delaware) in the early- to mid-20th century began to designate such relations of superiority and inferiority as fiduciary. This article explores the foundations and infusion of this "influence conception" of fiduciary relations, with particular regard to its central and recent role in Delaware corporate law on going-private transactions. (8)

As a result of this influence infusion, Delaware courts began to deploy the designation of fiduciary and the idea of fiduciary duties in relation to two wholly separate legal ideas, generating within Delaware law two independent structures of "fiduciary" obligation. In one, the traditional power/undertaking conception, the existence of fiduciary duties is dependent on the transfer of power and the duties are the discrete, endogenous product of the undertaking to act and the empowerment to act. The term fiduciary in this conception merely labels someone who is subject to such obligation--it is a product not a source of obligation. In the other, the influence conception, duty is sourced in an abstract and broad loyalty obligation which is the product of being designated a fiduciary. And in this conception, there is no power limitation on who can be a fiduciary; the designation is a function of the extent of the superiority and domination, and a judicially imposed threshold for such extent. These two conceptions, therefore, offer profoundly different ideas about the nature and source of duty and obligation and provide for very different judicial roles in delineating fiduciary obligation.

Delaware corporate law, however, has no sight of how the conception of the fiduciary has been transformed in the past half century; it pays little attention to what is under the bonnet of the concepts of the fiduciary and fiduciary duty, and its standard bearers such as entire fairness. It has therefore no sight of how the influence conception has affected the way it thinks about fiduciary obligation. Today Delaware law is peppered with questions and problems which are the product of the structural changes that the introduction of the fiduciary influence conception has wrought. This article focuses only on the fiduciary duties of controlling shareholders and on the question of whether directors owe direct duties of care to creditors, but there are other problems--for example, Delaware's difficulty in distinguishing between direct and derivative actions. In several instances, these questions and problems would have made no sense and would have been given short shrift in the absence of this conceptual and structural change.

Moreover, policy debate and empirical inquiry evolve from these new questions, but often with no sense of why they became questions at all. Without close attention to the evolution and source of these legal ideas, concepts, and structures, our policy debates are flying blind. This is not to say, of course, that the legal questions and answers which are the product of these new structures, and the changes to the judicial role which they bring about, do not offer superior tools and methods for addressing corporate activity and relations; they may. But as a prerequisite to their effective evaluation, we should know where these questions come from. Attention to the conceptual evolution of the idea of the fiduciary set forth in this article allows us to see where they come from.

The article is structured as follows. Part I explores the different conceptions of fiduciary relations. It first explores the power/undertaking conception of fiduciary relations in relation to directors and majority shareholders and shows how statements in U.S. corporate law that appear inconsistent with it--because they suggest duties are owed outside of the corporation, such as directorial duties to stockholders or majority shareholder duties to minority shareholders--are often on closer inspection not inconsistent at all. Part I then turns to the nature and "fiduciarization" of the undue influence doctrine, its importation into Delaware law, and its implications for the nature and structure of fiduciary obligation. Part II of the Article considers the application of these fiduciary conceptions to controlling shareholders, first highlighting the initial dominance in U.S. law generally, and Delaware law in particular, of the power/undertaking conception, and second, documenting the rise and impact of the influence conception in Delaware going-private law. Part III provides another example of the effects of the infusion of the fiduciary influence conception in the context of whether director's fiduciary duties are owed directly to creditors. The Conclusion concludes.

1. HISTORICAL CONCEPTIONS OF THE FIDUCIARY RELATION

   Much digital ink has been spilt over the nature and categorization of fiduciary relationships and obligations. (9) For example, for Professors De Mott and (now Mr. Justice) Finn, central to the determination of whether a person is a fiduciary is whether the relationship generates a legitimate or reasonable expectation of loyalty on the part of the beneficiary; (10)...