Corporate law – and fiduciary law in general – has struggled with how to handle loyalty duties that are harmful to society.  For example, a director’s act of loyalty to shareholders that harms the environment, or a director’s effort to benefit her corporation by breaking the law.  Not all of these cases are easily resolved by refinements to the law.  In some cases, though, the courts have indicated that the conduct at issue is not merely unacceptable, but also inconsistent with the fiduciary’s own obligation to be loyal.  A notable instance is when directors intentionally violate the law to benefit their corporation or its shareholders.  The Delaware courts have indicated that such conduct is legally barred and that it constitutes a kind of disloyalty to the corporation.  See, e.g., Desimone v. Barrows, 924 A.2d 908, 934 (Del.Ch. 2007).  In a new paper, I examine such constraints on loyalty.

The starting point of the paper’s argument is to recognize that there are different types of constraint on loyal conduct.  Some limits are external, coming from outside a loyalty obligation’s ambit, such as the duty to comply with the terms of a contract.  Likewise, if a fiduciary has to obey positive law simply because it is positive law, the limit is external.  Other limits are internal.  A proper understanding of a given loyalty duty might  limit how a fiduciary  pursues the interests of her beneficiary.  What makes such a constraint internal is that its origin is the loyalty obligation itself; it is built into this loyalty.  My paper focuses on the attorney-client relation as a fiduciary relationship that can, potentially, also be understood as an internal constraint.  But several of the leading examples are from corporate law, and indeed the paper’s arguments should extend to a range of fiduciary settings.

As noted, under Delaware law corporate directors violate the fiduciary duty of loyalty if they intentionally violate the law.  Moreover, such behavior can count as disloyal even if it is pursued with the goal of acting in the corporation’s best interests.  How are we to make sense of that, as an internal constraint?  One way is to see the breaking of commitments as a kind of disloyalty.  If you owe loyalty to someone, note that it can be disloyal to break an agreement you make with them even if the breach is in their best interests.  Moreover, intentional violations of law can also be a violation of a commitment directors have made to their corporation.  The corporate charter can amount to such a commitment.

Still, it is natural to wonder if the idea of an internal loyalty constraint matches common understandings of loyalty.  Do loyalties really work this way, or is this just an esoteric legal variant on the way people think outside of the law?  In fact, there are some extra-legal analogies available to us.  A good example is in the work of the philosopher T.M. Scanlon.  Scanlon’s analysis of what friends owe each other suggests that a true friend would not engage in certain immoral conduct even if done on their friend’s behalf.  See T.M. Scanlon, What We Owe to Each Other (1998) 164.  I think Scanlon is right, and if so, that suggests there are internal constraints on the loyalty of friends.  They may not owe a legal loyalty obligation, but the moral constraints contained within their loyalties are still a recognizable part of their daily lives.

That said, if our concern is legal policy, why choose internal over external constraints?  This is a hard question to answer in the abstract, but I suggest a few possibilities.  Compliance effects are one potential reason.  Fiduciaries may more readily comply with constraints on their loyalty obligations if they understand this is part of what it means for them to be loyal in the first place.  Another possibility is that an internal approach shifts the path of legal reasoning; judges may reason differently if they see a constraint as a component of fiduciary loyalty rather than an external imposition on that loyalty’s scope.  That could matter if a loyalty-based framework changes legal outcomes.  But it could even matter in cases where courts would reach identical outcomes, whether loyalty constraints are internal or external.  That is because the process of legal reasoning has its own costs: If the internal constraints approach cuts down on complexity for courts, that is valuable.  Likewise, the process of figuring out the law matters for fiduciaries and their beneficiaries.  Internal constraints may be more accessible to regulated parties.

These are a few of the topics raised by thinking about internal and external limits on fiduciary loyalty, and the paper offers others.  Internal or external, the law is filled with constraints on fiduciary loyalty, and there is much more that could be said.  I am hopeful, however, that thinking in terms of this distinction will help advance this part of fiduciary law, and corporate law, further.  Fiduciary loyalty takes many forms, and one of its most interesting features is the way that it can limit its own excesses.

This post comes to us from Professor Andrew Gold at Brooklyn Law School. It is based on his recent paper, “The Internal Limits on Fiduciary Loyalty,” available here.