Baird & Henderson on "Other People's Money"
In corporate law classes at Chicago and other law schools this fall, students are studying the rules that govern the conduct of corporate directors and officers. Collectively known as "fiduciary duties", these include the "duty of care" and the "duty of loyalty". Nearly the entirety of corporate law is premised on these duties being owed to shareholders. In a new paper (see the abstract below), Professors Baird & Henderson argue that fiduciary duties as currently conceived are more harmful than helpful, and that they should be replaced with a new, contract-based approach. The full paper is available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1017615.
"Other People's Money"
is no more sacred tenet of corporate law than the one stating that corporate
directors owe a fiduciary duty to shareholders. We argue that while this rule
has not yet generated seriously wrongheaded outcomes, it is an “almost right”
principle that should be abandoned before it does. As a threshold matter, we
show the notion of special duties owed to shareholders is plainly inconsistent
with everyday business decisions and corporate law. Firms can take and do take
actions that are inconsistent with those of a fiduciary and that favor
creditors at the expense of shareholders, despite supposedly trumping fiduciary
duties owed to the latter. A bankruptcy filing is the most obvious of these.
The recent cases in Delaware over fiduciary duties in the “zone of insolvency” demonstrate how the attempt to delineate clearly what duties are owed to different investors in a firm is doomed to fail. Using Credit Lyonnais and its predecessor Central Ice Cream, we show how courts are attuned to the problem of conflicting interests among different investors, but are not likely to create efficient rules by using labels like “fiduciary duties” and applying them to shareholders sometimes and creditors other times.
We offer two potential replacements for the shareholder fiduciary duty doctrine. The most familiar for corporate scholars and practitioners is the idea of fiduciary duties being owed to the firm as a whole, coupled with a strong business judgment rule. Although we think this is superior to the existing rule, we show how this principle itself may be wanting in some important cases. In venture capital transactions, for one, the ex ante bargain appears to give certain investors the right to take actions in bad states of the world that may destroy firm value in order to create incentives for managers to avoid those bad states. Courts disrupting these deals in the name of fiduciary duties may be upsetting well struck bargains.
We therefore set out an alternative paradigm, one in which no fiduciary duties exist at all, and directors face liability for their decisions (other than for neglect or surreptitious self-dealing) only if they violate a contractual obligation owed a shareholder, creditor, or other investor. We conclude by showing how separating corporate law from conceptions of duty brings needed clarity to the often-litigated issue of disclosure duties. The problem, we suggest, is largely contractual, and in setting the default rules the focus should be on the ability of parties to opt out—or opt in.