It is well-known that equity is a central part of corporate law, and courts do not hesitate to remind litigants of that fact. Yet, a fuller appreciation of what equity means for corporate law is still lacking. In a recent article, we offer a new account of corporate law’s equity, showing that it is a kind of meta-law – or law about law – which operates ex post to address polycentric problems, conflicting rights, and opportunism.
Polycentric problems involve genuine complexity, where a change in one area of a system causes unforeseen changes elsewhere. A classic example from Professor Lon Fuller is a spider web, which, if pulled in one location, can produce unpredictable tensions elsewhere in the web. Whether we are talking about larger scale economic systems or about the corporation – corporations can themselves be complex systems – much of corporate law deals with polycentricity. Corporate law also regularly deals with conflicting presumptive rights, frequently between directors and shareholders. And opportunism risks run rampant in corporate contexts.
Some cases implicate all three challenges. Consider a Delaware corporate opportunity case like Broz v. Cellular Information Systems, Inc. There, the court’s eight factor test tracks a range of potentially relevant features, including: the corporation’s financial ability to take the opportunity; the corporation’s line of business; how the opportunity was presented to the director or officer; whether the corporation has an interest or expectancy in the opportunity; and other related considerations. Notice that the relevance of some of these factors could also depend on the conduct of the parties, which might be affected by the parties’ awareness of the Broz test itself. Notice also that factors like a corporation’s line of business can be hard to define and can also evolve (as was at issue in Broz). Combined with a large and dynamic variation in fact patterns, corporate opportunity cases pose polycentric problems.
If we focus on the director’s or officer’s presumptive right to pursue outside business interests where they don’t harm the corporation, and if we recognize the countervailing importance of the corporation’s right to fiduciary loyalty, we have a conflicting rights challenge. And, as is also true with nuisance law cases, the precise boundaries between such presumptive rights may be best specified ex post. If we instead focus on opportunism concerns, the need for equitable interventions to address director or officer conduct that takes advantage of corporate expectations – and corporate law doctrine itself – should be evident. Corporate opportunity cases thus implicate a range of reasons for equity’s role: polycentricity, conflicting rights, and opportunism.
Loyalty itself may also call for equity. Not only is fiduciary loyalty fine-grained in many of its applications (including corporate opportunity cases), it must also address new and sophisticated transactions, evolving relationships between the parties, information asymmetries that shift over time, complex fact patterns, and a set of obligations that are somewhat vague both within the law and within social norms. The tools that corporate law has selected for governing standards of conduct invite ex post interventions and adjustments.
The corporate opportunity doctrine, however, is by no means unique. The Schnell doctrine is also a perfect fit for a system of meta-law. As announced in Schnell vs. Chris-Craft Industries, Inc., “inequitable action does not become permissible simply because it is legally possible.” That doctrine sets up a limited but vital equitable overlay to address uses of corporate powers that are opportunistic in hard to foresee ways. Like the corporate opportunity doctrine, it also addresses concerns with polycentricity and conflicting rights. The structured approach in Schnell indicates something else as well; it indicates the importance of balancing law and equity with care.
What polycentricity, conflicting rights, and opportunism have in common is the great difficulty in addressing them ex ante while avoiding overly complex first-order law. This is the challenge Aristotle recognized as calling for equity, and that challenge is still with us today. Equitable interventions can produce their own problems, however, including opportunism with respect to equitable remedies. Moreover, rule of law concerns like predictability and stability in the law emerge if equity is not cabined properly. While these considerations matter wherever equity is used, they are particularly prominent for corporations, given the development of new transaction types, changes in market conditions, and party sophistication. The borderline between law and equity is thus vital to the success of equity within corporate law.
As we argue, much of the structure of corporate law – its architecture – is explained by the need for a robust equity that can intervene where needed, while also avoiding the dangers of unconstrained judicial discretion. Corporate law maintains a careful balance, one that constantly updates, to avoid both pitfalls. Efforts to strike that balance explain various features of corporate law, including: fiduciary duties, the business judgment rule, derivative litigation, the doctrine of independent legal significance, different standards of review, and even the way corporate law has changed. As we show in the article, this account also offers something importantly different from conventional theories of corporate law, such as the nexus of contracts approach. Focusing on the equity in corporate law gives us a distinctive picture of both corporate law and its evolution.
This post comes to us from professors Andrew S. Gold at the University of California, Irvine School of Law and Henry E. Smith at Harvard Law School. It is based on their recent article, “The Equity in Corporate Law,” forthcoming in the Notre Dame Law Review and available here.