Do We Need a Restatement of the Law of Corporate Governance?

In 1978, the American Law Institute (ALI) authorized a project originally intended to result in a Restatement of corporate law.[1] The drafters intended their project to be a departure from traditional restatements.[2] As they visualized it, the project was to offer “a combination of classic Restatement, forward looking guidelines, and perhaps also model provisions.”[3] Their efforts, however, met with immediate resistance. When Tentative Draft No. 1 was published in 1982, it was widely criticized for failing to restate the law but rather proposing major and dramatic changes in the law.[4]

As the decade-long drafting process continued, the project was downgraded from the status of a Restatement to that of Principles of Corporate Governance (the Principles). Even so, it remained what is still one of the most controversial projects the ALI ever attempted.[5] Indeed, one respected commentator went so far as to describe the project as “the most controversial event in the history of American corporate law.”[6]

Despite this dubious precedent the ALI has returned to the corporate governance field with a proposed Restatement of the Law of Corporate Governance (Restatement).[7] At the ALI’s 2022 annual meeting, the membership approved most of Tentative Draft No. 1, which contained provisions defining various terms, discussing the duties of care and loyalty, and the social purpose of the corporation.[8]

Given that vote, it doubtless would be difficult for the ALI to reverse course and stop the Restatement project from going forward. The project has three prominent reporters, moreover, all well respected corporate law academics.[9] There are dozens of very influential attorneys, judges, and academics acting as advisers to the project.[10] There are 170 ALI members serving as a consultative group.[11] So the project has a lot of momentum and a lot of powerful individuals with a stake in seeing the project come to fruition.

Having said that, however, the time and effort expended to date are sunk costs.[12] Granted, many people are not very good at ignoring sunk costs.[13] Ignoring sunk costs, however, is precisely what rational decision makers – including the ALI – ought to do.[14]

The basic problem with the proposed Restatement of the Law of Corporate Governance is that corporate law is not a suitable subject for being restated. Courts are the main audience for restatements and, as such, a restatement’s content is “generally common law.”[15] The purpose of a restatement is to clarify “the underlying principles of the common law” that have “become obscured by the ever-growing mass of decisions in the many different jurisdictions, state and federal, within the United States.”[16] Historically, the ALI thus avoided statutory subject areas.[17]

In most states, however, corporate law is largely statutory. The Model Business Corporation Act (MBCA), which is an ongoing project of the American Bar Association’s Corporate Laws Committee, is in force in 32 states and the District of Columbia.[18] Many other states have adopted the MBCA in parts.[19] Unlike a restatement, which can go decades without being updated, the MBCA’s drafters produce a near constant stream of updates and innovations. Because the MBCA provides detailed up-to-date guidance, the role of the common law in MBCA states is principally gap filling. To the extent MBCA states need common law guidance, moreover, they are likely to look to corporate law’s Leviathan rather than to a restatement.

It is difficult to think of a body of law as thoroughly dominated by a single state as corporate law is dominated by Delaware, especially the law governing public corporations. Indeed, Delaware law is so dominant that, in many respects, it functions as a de facto national corporate law.[20]

The relevance of Delaware’s dominance is demonstrated by an observation made by Melvin Eisenberg, chief reporter of the Principles. In defending the ALI’s decision to go forward with the Principles, Eisenberg posed the rhetorical question, “how could the ALI fail to undertake a project in the area of law governing those institutions on which our entire system of production of goods and services depends?”[21] The answer, of course, is that most of those institutions are public corporations and most public corporations are incorporated in Delaware. With respect to those key institutions, there thus is little risk that the common law will be obscured by conflicting rules coming from many competing jurisdictions.

In light of Delaware’s dominance, the proposed Restatement faces three distinct but related obstacles. First, Delaware law provides a well-developed body of high-quality law. Delaware courts thus are unlikely to look to the Restatement rather than their own precedents. As precedent for that prediction consider that Delaware courts cited the Principles only 19 times in the 26 years from 1996 to 2022.[22]

Second, because Delaware law provides such a large body of highly respected case law, non-Delaware jurisdictions looking for guidance will look to Delaware instead of a Restatement. In fact, many state courts already explicitly follow Delaware law when their own state law does not provide an answer to the question at bar.[23] Even foreign countries look to Delaware corporate law for guidance.[24] There is no reason to think they would cease doing so even if a Restatement were available.

Finally, perhaps even more so than the MBCA, Delaware law evolves rapidly in response to changing conditions. For some “eighty-five to ninety years, there has been a constant stream of corporate litigation, mostly in the Court of Chancery . . ..”[25] The steady flow of new cases posing novel questions gives Delaware courts more than ample opportunity to keep the law up to date in response to changing conditions.

In contrast, if the Restatement goes forward, it will be a static document.[26] When the project is completed, the drafters will disband and thus will be unable to “exercise oversight over” the Restatement’s continuing fitness for purpose.[27] As for the larger ALI, “it is ill-equipped to evaluate the possible consequences of law reform proposals and not equipped at all to evaluate the actual consequences of those proposals once adopted.”[28] The single moment of a Restatement, even if done beautifully, thus cannot keep up with the constantly evolving business and legal environment. Accordingly, many of the Restatement’s provisions inevitably will become obsolescent, which will enhance the incentives for courts and lawyers to look elsewhere for guidance.

In sum, a Restatement of the Law of Corporate Governance is unnecessary. Courts and lawyers not only in Delaware but across the country and around the globe will look to Delaware law for guidance, even when it is not directly applicable.

ENDNOTES

[1] See Principles of Corporate Governance and Structure: Restatement and Recommendations viii (Am. L. Inst., Tent. Draft No. 1 1982) [hereinafter Draft No. 1].

[2] See Melvin Aron Eisenberg, New Modes of Discourse in the Corporate Law Literature, 52 Geo. Wash. L. Rev. 582, 608 (1984) (stating that the project explicitly did “not take ‘traditional Restatement form’”).

[3] Draft No. 1, supra note 1, at ix.

[4] See Shyamkrishna Balganesh & Peter S. Menell, Restatements of Statutory Law: The Curious Case of the Restatement of Copyright, 44 Colum. J.L. & Arts 285, 314 (2021) (“While the project began as a Restatement initiative, it soon attracted criticism for being overtly reformative, a premise that it did not hide.”); Joel Seligman, A Sheep in Wolf’s Clothing: The American Law Institute Principles of Corporate Governance Project, 55 Geo. Wash. L. Rev. 325, 351 (1987) (“The Business Roundtable virulently objected . . . to calling the Corporate Governance project a Restatement . . ..”); Robert B. Thompson, Preemption and Federalism in Corporate Governance: Protecting Shareholder Rights to Vote, Sell, and Sue, 62 L. & Contemp. Probs. 215, 223 (Summer 1999) (noting that the project was “vigorously criticized as making overregulatory suggestions for state corporate law”).

[5] See Balganesh & Menell, supra note 4, at 314 (“The Principles project was an innovation that the ALI introduced in 1984 when one of its very controversial efforts, the Corporate Governance Project, was met with significant resistance during its early days.”); Douglas M. Branson, Too Many Bells? Too Many Whistles? Corporate Governance in the Post-Enron, Post-Worldcom Era, 58 S.C. L. Rev. 65, 113 (2006) (noting that the project “proved very controversial”).

[6] William J. Carney, The ALI’s Corporate Governance Project: The Death of Property Rights?, 61 Geo. Wash. L. Rev. 898, 898 (1993).

[7] Restatement of the Law, Corporate Governance, Am. L. Instit., https://www.ali.org/projects/show/corporate-governance/ (last visited June 7, 2022).

[8] Restatement of the Law of Corporate Governance (Am. L. Inst., Tent. Draft No. 1) [hereinafter cited as Restatement].

[9] Restatement at iv (listing the reporters).

[10] See id. at v-vi (listing advisers).

[11] See id. at vii-viii (listing members).

[12] “‘Sunk costs’ . . . are costs that have already been incurred and do not vary with one’s subsequent actions.” Russell B. Korobkin & Thomas S. Ulen, Law and Behavioral Science: Removing the Rationality Assumption from Law and Economics, 88 Cal. L. Rev. 1051, 1144 (2000).)

[13] See Shmuel I. Becher, Behavioral Science and Consumer Standard Form Contracts, 68 La. L. Rev. 117, 128 (2007) (noting that “overcoming the sunk cost effect is likely to be an extremely challenging task”).

[14] See Reid Hastie & Robyn M. Dawes, Rational Choice in an Uncertain World: The Psychology of Judgement and Decision Making 37 (2001) (discussing sunk costs).

[15] Restatement at x.

[16] Id.

[17] Balganesh & Menell, supra note 4, at 301 (noting the “mismatch between the Restatements and statutes”).

[18] Corp. L. Comm., Model Business Corporation Act v (rev. ed. 2016).

[19] Id.

[20] Ronald J. Gilson, Globalizing Corporate Governance: Convergence of Form or Function, 49 Am. J. Compar. L. 329, 331 (2001). Mike Dooley thus observed that, in the corporate law field, “the terms ‘prevailing,’ ‘weight’ and ‘majority’ are all understood to mean ‘Delaware.’” Michael P. Dooley, Two Models of Corporate Governance, 47 Bus. Law. 461, 463 (1992). Arguably, Congress is the only real competition to Delaware’s status as regulator-in-chief of corporate governance. See Mark J. Roe, Delaware’s Competition, 117 Harv. L. Rev. 588 (2003) (discussing competition between Wilmington and Washington).

[21] Eisenberg, supra note 2, at 495.

[22] Those numbers were derived by searching Westlaw’s Delaware State Cases database on June 20, 2022, for citations to “Principles #of Corporate Governance: Analysis #and Recommendations.”

[23] See, e.g., Dynamics Corp. of Am. v. CTS Corp., 794 F.2d 250, 253 (7th Cir. 1986), rev’d on other grounds, 481 U.S. 69 (1987) (“Indiana takes its cues in matters of corporation law from the Delaware courts, which are more experienced in such matters . . ..”); Weinberger v. Am. Composting, Inc., 4:11CV00848 JLH, 2012 WL 1190970, at *5 (E.D. Ark. Apr. 9, 2012) (observing that “state courts often rely heavily upon Delaware law” when interpreting derivative suit statutes); Casey v. Brennan, 780 A.2d 553, 567 (N.J. Super. App. Div. 2001), aff’d, 801 A.2d 245 (N.J. 2002) (“When considering issues of first impression in New Jersey regarding corporate law, we frequently look to Delaware for guidance or assistance.”).

[24] See Omari Scott Simmons, Delaware’s Global Threat, 41 J. Corp. L. 217, 246 (2015) (“Delaware, in the merger and acquisitions context, has influenced developments in Japanese takeover law, as well as statutory and other legal innovations in the United Kingdom, Canada, Australia, China, and India.”).

[25] E. Norman Veasey, Musings from the Center of the Corporate Universe, 7 Del. L. Rev. 163, 167 (2004).

[26] As Allan Vestal observed, Restatements offer “static statements,” Allan D. Vestal, The Restatement (Second) of Judgments: A Modest Dissent, 66 Cornell L. Rev. 464, 465 (1981), but “the law is a growing, dynamic force.” Id. at 508.

[27] Alan Schwartz & Robert E. Scott, Obsolescence: The Intractable Production Problem in Contract Law, 121 Colum. L. Rev. 1659, 1663 (2021).

[28] Id. at 1708.

This post comes to us from Stephen M. Bainbridge, the William D. Warren Distinguished Professor of Law at UCLA School of Law. It is based on his recent article, “Do We Need a Restatement of the Law of Corporate Governance?” available here.

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