Musings on the dynamics of corporate governance issues, director liability concerns, corporate control transactions, ethics, and federalism.

• Author: Veasey, E. Norman
• Position: Symposium: Corporate Control Transactions

INTRODUCTION

When I was a first-year student at this Law School nearly fifty years ago, one or more of the professors who reorganized our brains asked us in several policy contexts what Moses would do. We were asked to step back in the context of the Socratic discussion of a particular case or principle of law and visualize the answer to big policy questions.

Moses, of course, was a humble man and tended to understate his own importance. Having seen the burning bush and having received Divine guidance and powers, he strove to carry out God's mission. I do not have the talent or the Divine guidance and powers that Moses received. Thus, I cannot be the instrument to part the waters or to take us to the Promised Land by solving and mediating the conflicting philosophies and interpretations of our jurisprudence as analyzed by the brilliant scholars at this Symposium.

This Symposium is devoted to in-depth treatment of the law and economics issues inherent in control transactions. There are a dozen scholarly papers presented to this Symposium. These papers and the commentary that followed shine the kleig lights on many important aspects of this large and complex area. An after-dinner speech is not the right vehicle to try to rationalize all these issues. Even if I had the talent to do that--which I do not--it would not be ethical for me to do so. So I will take some refuge in my judicial position and say absolutely nothing of any depth or importance.

With that mission in mind, I will try to speak more broadly--but briefly--about the corporation law. In the course of these somewhat superficial ridge-running remarks, I will touch on the dynamics of corporate governance issues, director liability concerns, corporate control transactions, ethics, and federalism.

1. CORPORATE GOVERNANCE

   In the 1990s, while the economy and the securities markets were on the ascendancy, there was a huge paradox developing. The transactions and corporate behavior that led to the demise of Enron, Worldcom, and others were festering like an undetected carcinoma. At the same time, in other venues, there was a strong movement toward best practices in corporate governance. That movement was internally generated in several corporations and was encouraged by judges, counselors, the American Bar Association (ABA), academics, institutional investors, and organizations.

   Simultaneously and perhaps relatedly, there was in part a reform movement evolving in the realm of lawyer ethics. The American Law Institute was working on its Restatement of the Law Governing Lawyers (1) and the ABA had initiated its Evaluation of the Model Rules of Professional Conduct, known as Ethics 2000. (2) As it turns out, the Sarbanes-Oxley Act of 2002 (3) involved a bit of a convergence of corporate governance and professional responsibility. More about that later.

   First, I want to touch on the dynamics of corporate governance in the context of the standards of conduct of corporate directors. I use the term "standards of conduct" deliberately because I think we will agree that it is helpful to separate standards of conduct from standards of liability of directors. Courts expect directors to act independently, with due care and in good faith not only in making business decisions, but also in their oversight responsibilities. Liability may or may not follow a failure to live up to these aspirational standards.

   Structural changes such as the movements toward a preponderance of independent directors, executive sessions of independent directors, and other best practices are good developments in enhancing the expectations of standards of conduct. Although state law generally governs internal affairs of corporations, Delaware law is enabling and does not spell out issues like the details of independence. And rightly so, but now some of these corporate governance reforms are being governed, as to some corporations and influenced as to others, by the Sarbanes-Oxley Act, the SEC Rules, and the proposed listing requirements of the New York Stock Exchange and NASDAQ. Yet, most aspects of corporate internal affairs and lawyer ethics continue to be governed by state law, and that mostly means judicially created and enforced fiduciary duty law.

   The keystone of state-based corporation law is the business judgment rule. Investors expect loyal directors to take prudent, carefully considered, good faith business risks for the economic gain of the enterprise. Courts are ill-equipped to second-guess business decisions, so courts focus on loyalty, independence, good faith, and process.

   Although the business judgment rule is not strictly applicable to the directors' oversight responsibilities, the fiduciary duties of good faith, loyalty, and due care are. From Chancellor Allen's Caremark (4) decision in 1996 we see that the courts will measure the directors' standard of conduct and standard of liability by evolving yardsticks depending on modern developments. In that case we see an emphasis on the good faith standard.

   There is some debate about whether good faith really is one of the fiduciary duties or whether it is subsumed in the duty of loyalty. Although the duty of good faith may be subsumed in the duty of loyalty, the opposite may not be true. Thus, I think it may be accurate to consider the duty of good faith as an additional duty beyond the duty of loyalty, at least for some purposes. Certainly, a director who sublimates the corporate interest to the director's own personal interest is probably acting disloyally and is probably not acting in good faith. But perhaps not all failures to act in good faith will necessarily implicate disloyal concepts of self-interest or self-dealing.

   In my opinion, good faith requires an honesty of purpose and eschews a disingenuous mindset of seeming on the surface to act for the corporate good, but not caring for the well-being of the constituents of the fiduciary. Although the concept of good faith is not fully developed in the case law, an argument could be made that reckless, irresponsible, or irrational conduct but not necessarily self-dealing or larcenous conduct could implicate concepts of good faith. Moreover, in the new, post-Enron era of corporate responsibility requiring new standards mandated by Congress, rules of self regulatory organizations (SROs), or voluntary best practices, good faith may emerge as a central issue of the directors' standard of conduct. It may or may not emerge as a standard of liability, however.

   Irrationality is the outer limit of the business judgment rule and may be the functional equivalent of the waste test or it may show that a decision is not made in good faith. If the board's decision or conduct is irrational or so beyond reason that no reasonable director would credit the decision or conduct, lack of good faith may, in some circumstances, be inferred.

   It is important to corporate America that we have directorial candidates who are willing to serve, and that they be provided with adequate pay, indemnification, and insurance. Sarbanes-Oxley may have shrunk the universe of those candidates, but that is another issue for another day. Directors should not be seen as guarantors of good results or preventors of the malfeasance, misfeasance, or nonfeasance of others. They should be entitled to rely in good faith on corporate documents, committees, and experts to a significant degree in making their business judgments. And they should not be held personally liable for negligence. In this connection, the Delaware statutory law may come to aid the director.

   Section 141(e) of the Delaware General Corporation Law provides that directors shall be "fully protected" in relying in good faith upon corporate records, reports of officers or committees of the board, or experts that the director "reasonably believes" to be opining within that person's expertise and who has "been selected with reasonable care by or on...