Delaware corporate law differs from other areas where fiduciary obligations apply – such as agency, LLCs, partnerships, and trusts.  Three distinct actors owe fiduciary duties – executive officers, directors, and controlling shareholders – and numerous aspects of their duties greatly differ.  But Delaware corporate law is not unique in the way many believe.  Conventional wisdom holds that, uniquely, corporate law’s standards of conduct (fiduciary duties) diverge from judicial standards of review, the latter being more deferential.  Yet, the two sets of standards often converge and are identical.  The supposed distinction is not uniformly accurate, and unenforceable standards of conduct may not be “law” at all where standards do diverge.

Three Fiduciaries

Unlike other fiduciary areas, Delaware corporate law does not have a singular duty of care and loyalty, but multiple variations of those duties owed by three governance actors.  The beneficiary of the duties, reasons for the duties, and demands of the duties all differ for officers, directors, and controlling shareholders.

1. Officers

One would think numerous decisions would address the fiduciary demands on and failings of these central actors.  Yet, from a corporate governance standpoint, director primacy prevails.  Most decisional law thus addresses the fiduciary duties of corporate directors; the law of officers remains sparse. [1]

The Delaware Court of Chancery repeatedly notes that the applicability of the business judgment rule to officers is unsettled.  Whether an officer’s standard of care is the agency standard of ordinary care (negligence) or the deferential director standard of gross negligence is unresolved.  Director dependence on officers for providing full, timely, and accurate information, and the director’s statutory right to rely on officers, suggests a stricter standard of care for officers than the director gross negligence standard.  Unlike directors, officers cannot be exculpated for duty of care breaches.  Delaware has not fully articulated the contours of officer oversight duties; the scope of an officer’s duty of disclosure; whether officers may consider noninvestor stakeholders; and whether officers, who are not subject to control by shareholders (and aren’t their agents), owe duties to shareholders that are rightly pursuable via direct litigation.

The fiduciary duty analysis of officers can, as Gantler suggests, remain uncomplicated by a separate judicial standard of review such as the business judgment rule.  As in agency law, a court can examine officer wrongdoing by focusing on two elements:  Did a fiduciary duty exist, and did a defendant breach that duty?  The point is that Delaware does not treat officers like directors.  One cannot say that officers owe the same duties as directors, that courts will review their conduct similarly, or that the consequences of a breach are identical.  Delaware’s law of officers is not the law of directors.

2. Controlling Shareholders

The duty of care of controlling shareholders is limited.  It arises where the controller, without adequately investigating, sells corporate control under circumstances suggesting the buyer may loot the company.  The duty is breached only by grossly negligent conduct.  No divergent standard of review is used in analyzing such conduct.  The duty of care is not the same for controlling shareholders as it is for officers, being narrower in scope and more lax in its demands, again dispelling the notion that there is a single duty of care in corporate law.

As to a controller’s duty of loyalty in the self-dealing context,[2] Delaware long ago abandoned the traditional fiduciary approach of requiring disinterested prior approval.   Delaware instead adopted an entire fairness test under which controller self-dealing is permitted if, ex post, the fiduciary can prove entire fairness.

In 2014, the Delaware Supreme Court partially restored loyalty to the traditional duty of loyalty by providing for prior approvals[3] – i.e., by careful, independent directors and informed, uncoerced, disinterested shareholders.  By obtaining ex ante consents, the entire fairness standard of review can be sidestepped in favor of a business judgment review standard.  Adding the business judgment rule – designed for directors (not shareholders) acting for the corporation – to the requirement that a controlling shareholder obtain two sets of approval contributed nothing.

If, from the outset, the controller conditions the proposed transaction on dual approvals, the controller fulfills its duty of loyalty, subject only to ex post allegations of wrongdoing by independent directors or tainted approval by minority shareholders.  The duty of loyalty, unaided by any separate judicial standard of review, can directly achieve the desired policy outcome of transactional certainty.  MFW created a novel, redundant, and unnecessary divergence.

Still, the manner in which Delaware courts evaluate controller self-dealing differs from how they evaluate officer or director self-dealing.  We see again that these three actors are not treated the same with respect to their duty of loyalty.

3. Directors

Directors, like officers, owe a duty of care pervasively, unlike controlling shareholders.  Directors, unlike officers, are not agents, and they do not owe duties for that reason.  Directors are held to a loose standard of gross negligence, whereas the standard of care for officers is unclear, though likely stricter.  Directors, unlike officers, can be exculpated from liability for a care breach.

Concerning loyalty, directors cannot directly compete with the corporation, unlike shareholders, but the proscription appears narrower than for officers.  Doctrinally, the beneficiaries of director duties, outside the Revlon context, are both the corporation and its shareholders, whereas controlling shareholders, outside limited contexts, can act in their own self-interest, and officers, as agents of the corporation (not shareholders), are to advance the best interests of the company.

Normatively, the proper beneficiary of director duties is the most contentious subject in modern corporate law.  Many advocate for a broader “stakeholder” focus, rather than a shareholder wealth focus.  The point is that the recurrent debate about corporate purpose centers on director duties.  Scant debate addresses the proper normative focus of controlling shareholder or officer duties.  This again reveals how discourse about Delaware corporate law treats these three actors differently.

Do Standards of Conduct-Standards of Review Diverge?

When Delaware courts evaluate alleged fiduciary misconduct – typically by directors – they do not simply determine whether a duty existed and whether it was breached.  Courts use  different, more prolix constructs – standards of review – to examine alleged wrongdoing.  Standards of review purportedly diverge from fiduciary duties.  Much of Delaware’s corporate “law” for directors concerns standards of review, not fiduciary duties.  This ostensible divergence is supposedly unique to corporate law, setting it apart not only from other areas of fiduciary law but other areas of law generally.

The divergence theory was first advanced by Professor Melvin Eisenberg in 1993.[4]  Certain Delaware judges seized on it in academic writings and judicial opinions.  As David Kershaw notes, “there is no support at all for this distinction in any jurisdiction prior to very recent Delaware case law.”  The Delaware Supreme Court made only seven references to “standard of conduct” in corporate fiduciary decisions before Professor Eisenberg’s article, one in each of 1939, 1975, and 1985, and two in 1981 and 1991.  Only three Supreme Court cases used both of the phrases “standard of conduct” and “standard of review” before 1993.  The Supreme Court did not use the phrase “standard of conduct” for the next seven years.  In many years the phrase is not used at all, and in no year since 1998 does it appear more than once.  One Supreme Court case since 1993 contains both the “standard of conduct” and “standard of review” phrases.

The Delaware Supreme Court used the phrase “standard of review” by itself only 11 times in corporate fiduciary cases before 1993.  Since 1993, that phrase has not been used in seven of the ensuing years, and very infrequently in all other years.  The Delaware Chancery Court uses both phrases more than the Supreme Court, but uses “standard of conduct” far less than “standard of review.”

There is little divergence and much convergence in Delaware.  Concerning director loyalty, there appears to be no bifurcated standard of conduct-standard of review for wrongfully usurping a corporate opportunity, appropriating confidential information, or directly competing with the corporation.  For self-dealing, the standard of review for a transaction not pre-approved is entire fairness.  Professor Eisenberg, however, stated that the standard of conduct also was fairness, thus aligning the two.  And where informed independent directors and uncoerced,  disinterested shareholders approve a transaction, the duty of loyalty is fulfilled.  Thus, the divergence of standards for directors seems narrowly to be that the standard of review for self-dealing transactions lacking pre-approval is entire fairness rather than the outright prohibition of such dealings seen elsewhere.

Concerning care, if a director complies with the duty of care, the business judgment rule standard of review obtains.  If a director breaches her duty of care, the business judgment rule standard does not apply.  The standard of review for the duty of care thus requires that the standard of conduct be fulfilled.  The former is not more forgiving, it is equivalent in its demands, again pointing toward convergence, not divergence.

Professor Eisenberg and others insist that standards of conduct are “law.”  Unenforceable standards are not “law” simply because judges pronounce them; judges pronounce nonbinding dicta as well.  The conduct/review dichotomy fails the congruence feature argued by the legal philosopher and Harvard Law professor Lon Fuller to be a necessary characteristic for a rule to be a “legal” rule recognizable as law.  Congruence demands that a rule as announced must be the rule as applied.  It fails as well under an imperative theory of law described by Israeli philosopher and former University of Oxford professor Joseph Raz as an obligation backed by a sanction because, supposedly, violating a standard of conduct may not result in a sanction.  Even expressive theories of law, according to which laws embody and convey community norms, would seem to demand that a potential sanction accompany the expression of norms, not that shared norms alone constitute law.

Simply because standards of conduct may not constitute “law” under one or more jurisprudential theories where they diverge from standards of review may not be grounds to abandon them.  It would be very disquieting if there were no legal duties of loyalty and care for Delaware directors.  The better move is the opposite – to employ fiduciary duties more explicitly, emphatically, and frequently.  Delaware courts should acknowledge that there is less divergence than commonly believed and downplay standards of review in favor of directly assessing whether directors fulfilled or breached a particular duty.  This will renew the generative force of fiduciary duties in Delaware and, possibly, bolster a commitment to enforcing them.

ENDNOTES

[1]  In 2009 the Delaware Supreme Court finally held that officers owe fiduciary duties of care and loyalty.  Gantler v. Stephens, 965 A.2d 695, 708-09 (Del. 2009).

[2]  Space constraints limit me to the controller’s duty in the self-dealing setting.

[3]  Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014).

[4]  Melvin A. Eisenberg,  The Divergence of Standards of Conduct and Standards of Review in Corporate Law,  62 Fordham L. Rev. 437 (1993).

This post comes to us from Professor Lyman Johnson at the Washington & Lee University School of Law and the University of St. Thomas (Minneapolis) School of Law. It is based on his recent book chapter, “The Three Fiduciaries of Delaware Corporate Law – and Eisenberg’s Error,” available here.