Delaware’s Fiduciary Imagination: Going-Privates and Lord Eldon’s Reprise

What is the source of the duties that a fiduciary owes, and what are those fiduciary duties designed to do? In a recent article, Delaware’s Fiduciary Imagination: Lord Eldon’s Reprise, I argue that Delaware law is deeply conflicted about the answers to these questions, conflict that is having a deleterious effect on the quality of Delaware law.

The article argues that Delaware corporate law deploys the concept of the fiduciary and fiduciary duties to reflect two separate and wholly distinct legal ideas. The ideas have separate sources in early English and U.S. common law and equity, have structurally distinct understandings of the nature and content of fiduciary duties, and have profoundly different constituencies that may benefit from, and are able to enforce, such duties.

More precisely, prior to 1970, Delaware law consistently used the idea of the fiduciary in its “traditional sense,” in a way consistent with Lord Eldon’s foundational fiduciary jurisprudence in the early 19th century. In this conception of fiduciary relations, a fiduciary obligation arises when one person­ – a director. agent, or trustee – is “clothed with power” to act on behalf of or for another – a corporation, principal, or beneficiary – and when that person agrees (undertakes) to use that power for purposes for which the power is transferred. In this power/undertaking understanding of fiduciary relations, a person does not owe fiduciary duties because she is a fiduciary; rather the terms fiduciary and fiduciary duty merely categorize and label persons who agree and are empowered to perform a particular role, and who are thereby subject to the legal obligations that flow from such agreement and empowerment. Through the lens of this traditional approach, a director’s fiduciary duties – including the duty to exercise powers in good faith (which is the foundational idea underpinning the business judgment rule),[1] the duty to avoid conflicts of duty and interest (the foundational idea underpinning one pathway to self-dealing fairness review),[2] and the duty of care – can all be understood as endogenous to the agreement and empowerment to perform the role of a director.  These fiduciary obligations are not derived from an overarching duty of loyalty that applies to individuals who are deemed to be fiduciaries. Instead, the undertaking and empowerment imply a set of discrete second-order obligations designed to ensure the performance of the first order obligation, the undertaking. Moreover, in this traditional conception of fiduciary relations, the recipient of the obligations is clear: The duties are owed to the person who the fiduciary agrees to act for or on behalf of. In the case of a corporation, in this conception, directorial fiduciary duties are owed only to the corporation and can only be enforced by or on behalf of the corporation.

This power/undertaking conception of fiduciary relations formed the bedrock of Delaware corporate fiduciary law until the early 1970s. Through the lens of controlling shareholder fiduciary duties and going private transactions, my article shows how, consistent with this conception, until the 70s controlling shareholder fiduciary status was dependent on the usurpation of board power. However, starting in the early 20th century, a different idea of the fiduciary was formed. This separate and distinct idea is rooted in early 19th century English and American jurisprudence on undue influence in contractual relations and testamentary dispositions. Pursuant to this undue influence doctrine, where a pre-existing relationship of superiority or dominance between two contracting parties had the potential to affect and influence the formation of the intention and the volition of one of the contracting parties, courts of equity would require evidence of fair dealing connected primarily to process but also to price. For the doctrine to apply, courts would look for evidence of “superiority,” significant influence or domination of one party over another, or as one New York Court of Appeals’ case famously put it, the courts looked for “overmastering influence.”

In its original incarnation, this undue influence doctrine was not a fiduciary doctrine; it did not render a person who, because of her dominant or superior position was capable of influencing or unconsciously coercing another, “a fiduciary.” Rather the doctrine merely regulated the legal relations between those parties arising from a contract between them or a gift or testamentary disposition from one party to another. To apply the label and idea of a fiduciary to a person simply because she is in a position of superiority and dominance in relation to another when she has neither been empowered nor undertaken to act for or on behalf of that other person, deploys the idea of the fiduciary in a completely distinct way to how it is used in the context of power/undertaking relations. And to do so offers a completely different structure of fiduciary obligation.

In this “fiduciary influence”-structure, obligations relating to transactional fair process and fair price are owed to the recipient of the duties because the superior party is deemed to be an influence fiduciary, not simply because that person is in a position to affect the volition of the counterparty in the context of a transaction. This structure in turn readily makes available the idea that once categorized as this type of influence fiduciary a set of other-regarding/loyalty obligations are owed by this fiduciary, of which the fair dealing rules are merely one component. And because these other-regarding duties are not grounded in the agreement to act for or on behalf of another and the empowerment to do so, the obligations are naturally deemed to be sourced in a “duty of loyalty,” which such a fiduciary owes by reason of her fiduciary status. In contrast to the power/understanding conception, such a fiduciary duty becomes a first-order obligation, providing a deep well of unexplored obligation. Moreover, as this fiduciary status and its duty of loyalty is not dependent on any transfer of power or the undertaking to act for or on behalf of another, influence fiduciary duties can, in theory, be owed by any superior or dominant party to any person or constituency deemed inferior or dominated.

There is of course no legal essence of the term “fiduciary;” the law can use it as it chooses. But if it is used unknowingly to label and understand two very separate ideas then legal trouble beckons. This is precisely what Delaware law has done, and trouble has arrived. Following the lead of fiduciary law in other U.S. jurisdictions, most notably New York, Delaware now unknowingly uses the influence conception of fiduciary relations alongside the traditional conception. Foundationally, in Peyton v Peyton, in the context of a dispute over a testamentary disposition between husband and wife, the Delaware Supreme Court first clearly adopted the influence conception, holding that “every fiduciary relation implies a condition of superiority of one of the parties over the other,” a position that was alien to Delaware corporate law prior to the 1970s but was then, as the article shows, infused into Delaware law.

Through the lens of Delaware going-private case law, the article shows how Delaware’s myopia in relation to both the historical roots of fiduciary law, as well as the comingling of these separate and distinct fiduciary conceptions, has had three notable and detrimental effects. The first is that the modern story of the evolution of Delaware’s going-private fiduciary law has no sense that the legal outcomes it has generated are precisely the same as those offered over 200 years ago by courts of equity when fashioning, separately, fiduciary law and the law of undue influence. Every fairness-review-turn and “innovation” celebrated in the last 40 years of going-private case law can be located in the path dependent trench dug by Lord Eldon and his contemporaries. The reason for this outcome-continuity is that both the power/undertaking and influence conceptions offer separate pathways to fairness review of transactions, although with the former only in relation to fair price, and with the latter in relation to both fair process and price. Nevertheless, outcome convergence should not be mistaken for legal and conceptual convergence. On the contrary, the comingling of these two legal ideas under the banner of “fiduciary relations” renders it very difficult to parse what are the legal drivers of these outcomes, and it prevents courts from having clear sight of whether different cases, dealing with different going private scenarios, are consistent or contradictory. These problems, my article argues, are best exemplified in the leading case of Pure Resources. Finally, the article argues that the structural indeterminacy generated by the co-existence of these conceptions of fiduciary obligation is becoming increasingly observable in several modern legal arguments that prior to the 1970s (and the infusion of the influence conception) would have been nonsensical. These arguments threaten a significant extension in the reach of director obligations, as well as a significant enhancement of judicial power to create and extend those obligations. As an example, the article discusses duties owed by directors to creditors. Another example, not discussed in the article, would include the law on direct and derivative actions.

It may be that policy arguments made for such enhanced fiduciary obligation for directors are compelling, and it may be that we want to empower “judicial carpenters” to craft them, but at a minimum we need to understand the structural legal drivers of such arguments and to understand why they have become legally sensical when not long ago they were not. At present, Delaware law has no sight of these drivers.

ENDNOTES

[1] David Kershaw, The Foundations of Anglo-American Corporate Fiduciary Law (2018), 68-92.

[2] David Kershaw, The Foundations of Anglo-American Corporate Fiduciary Law (2018), 309-368.

This post comes to us from David Kershaw, dean and professor of law at the London School of Economics Law School. It is based on his recent article, “Delaware’s Fiduciary Imagination: Going-Privates and Lord Eldon’s Reprise,” published in the Washington University Law Review and available here.

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