The American Law Institute (ALI) is currently working on a Restatement of the Law of Corporate Governance (“Restatement”). As with all restatements, the purpose of the proposed restatement is to clarify “underlying common law principles” that have “become obscured by the ever-growing mass of decisions in the many different jurisdictions, state and federal, in the United States.” United. .” As I argued in my article, Do We Need a Reformulation of Corporate Governance Law?, corporate law is virtually unique in that it is dominated by the law of a single jurisdiction. ; namely, Delaware. Given the importance of Delaware legislation in this area, the proposed restatement is unlikely to have any influence.
In my new article, A Critique of the American Law Institute‘s Draft Restatement of the Corporate Objective, I turn to an assessment of a key provision of the proposed restatement; namely, § 2.01, which seeks to reaffirm the company’s purpose. Section 2.01 distinguishes between what the drafters refer to as common law jurisdictions and stakeholder jurisdictions. The latter are states that have adopted constituency status (ie, non-shareholder constituency status).
The provisional draft of § 2.01 was approved by the members of the ALI during the annual meeting of the Institute. My article is intentionally agnostic on the underlying normative question of whether corporations should focus exclusively on shareholder interests or should consider stakeholder interests as well. Instead, it offers a critique of § 2.01 and offers suggestions to clarify important open issues and better align § 2.01 with applicable law.
The drafters state that, in common law jurisdictions, the purpose of business is “to increase the economic value of the business, within the limits of the law.” . . for the benefit of the shareholders of the company. . ..” In doing so, the company is allowed to take into account the impact of its actions on the various stakeholders, provided that it benefits the shareholders.
In stakeholder jurisdictions, the company’s objective is “to increase the economic value of the company, within the limits of the law . . . for the benefit of the shareholders of the company and/or, to the extent permitted by state law, for the benefit of employees, suppliers, customers, communities or any other constituency.
In both sets of jurisdictions, the drafters say the company “may devote a reasonable amount of resources to public welfare, humanitarian, educational, and philanthropic purposes, whether or not doing so enhances the economic value of the company.”
In my view, § 2.01 is fundamentally flawed. It makes no sense from a theoretical or practical point of view to speak of a business objective. Edward, 1st Baron Thurlow, is said to have asked, “Have you ever expected a society to have a conscience, when it has no soul to die for and no body to kick?” To say that a company has a purpose is therefore a form of the commodification fallacy. Reification is omnipresent because it simplifies the discourse, but it is nonetheless a mistake. As Mitu Gulati, Eric Zolt and William Klein have observed: “It may be conceptually useful, for example, to describe corporations as paying taxes, but we are fooling ourselves and risk being deceived if we do not understand that the burden taxes are borne by individuals. .”
Looking at people rather than entities is also more theoretically correct. As Jeremy Telman explained, those who take “a contractual view of business” “avoid the commodification of business by viewing it as a bond of contracts”. In other words, contractors view society as a legal fiction representing a set of explicit and implicit contracts. From this point of view, even if an entity can be considered to have a purpose, in the context of the company, there is simply no entity that can have a purpose.
All of this may sound pedantic and/or scholastic, but it is important. By reifying society, the Principles and the Restatement ignore the fundamental point that society can achieve its goals only by acting through agents. In turn, § 2.01 – both old and new – ignores the fundamental fact that these officers may have a conflict of interest. It may be the rare case that managers use this discretion to benefit themselves financially at the expense of shareholders and/or stakeholders, but it seems likely that managers often use their discretion to generate psychic benefits by directing company resources to pet charities and other personal resources. preferences. As such, it is inaccurate and unnecessary to frame the matter as a matter of corporate purpose rather than a matter of fiduciary duty. The principles set out in § 2.01 should therefore be incorporated into the provisions of the Restatement relating to the fiduciary duties of directors and officers.
Whether § 2.01 remains in place or is incorporated into Chapters 5 and 6 of the Restatement, there are a number of changes that drafters should incorporate to modify and clarify its various provisions. These include: What is the purpose of the business? Are exchanges allowed? Is the opt-out allowed? Should § 2.01 mandate obedience to the law? Does § 2.01 include Caremark? How does § 2.01 apply to redemptions? What rules govern corporate charitable activities? Why did the editors ignore the particular problems of multinationals?
It would be particularly useful to specify whether the opt-out is authorized. Whether corporate law consists primarily of mandatory or default rules is a long-standing debate. The law governing the corporate purpose is no exception. Some commentators argue that a corporation can opt out of the principle of maximizing shareholder value in the articles of incorporation. Others argue that the principle of maximizing shareholder value is an imperative rule from which a company cannot escape.
The black letter text of the Restatement is silent on this issue. Comments and illustrations tend to suggest that the opt-out is allowed. In the reporters’ note, however, the editors are of the view that § 2.01 ducks the issue on the grounds that there is no law to rewrite. Accordingly, the editors merely observe that it is unclear under current law “whether a company can opt out of shareholder primacy by a provision of the original charter or by an amendment to the charter “, which is true but useless.
The main unanswered question, however, is whether the authorization of § 2.01 for the company to consider the interests of stakeholders allows the company to make compromises between the interests of shareholders and stakeholders. In other words, after considering the interests of the stakeholders, could the directors make a decision that increases the value of the company, whatever that means, by transferring wealth from shareholders to stakeholders? Alternatively, could the directors make a decision that provides modest benefits to shareholders while providing substantially greater benefits to stakeholders?
The relevant comment in § 2.01 is somewhat ambiguous:
When decisions involve trade-offs between stakeholders, differences between models become more significant and can affect results. Whereas under the traditional approach consideration of the interests of non-shareholders must be “rationally linked” to shareholder benefits, in a “may” or “shall” jurisdiction, consideration of the interests of non-shareholders shareholders will sometimes not only be permitted without regard to shareholder benefits, but may be mandatory.
Neither statement is entirely accurate.
It is true that Delaware law—outside Revlon-land – allows a board to take into account the interests of “different constituencies in discharging its responsibilities, provided there are rationally connected benefits for shareholders”. Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 182 (Del. 1986). But Delaware law is also clear that directors can make compromises that benefit stakeholders at the expense of shareholders. In In re Trados, Inc. Shareholder Litigation, 73 A.3d 17, 40–41 (Del. Ch. 2013), for example, Vice Chancellor Travis Laster stated that “the standard of conduct for trustees requires that they endeavor in good faith and with full knowledge to maximize the value of the company for the benefit of its residual successors, the ultimate beneficiaries of the value of the company, and not for the benefit of its contractual successors. Trados can presumably be read as also suggesting that shareholders should be the primary beneficiary of corporate decisions.
With respect to stakeholder jurisdictions, although constituency bylaws allow directors to consider the interests of non-shareholder constituencies, the bylaws do not expressly authorize directors to harm shareholder interests for the benefit of stakeholders. Thus, constituency statutes can be understood as a narrow rejection of RevlonThe rule that shareholder value is the only lawful measure for directors’ decision-making once a process of sale of control has begun, which was intended as an adjustment rather than a fundamental change in corporate law. Accordingly, constituency statutes could plausibly be interpreted as preserving a requirement that director actions taken after considering stakeholder interests must always be rationally related to shareholder interests. As Jonathan Macey explained, the bylaws “are mere tie-breakers, allowing managers to consider the interests of non-shareholder constituencies when it does not demonstrably harm shareholders”.
Drafters should clarify and confirm that, in both common law and stakeholder jurisdictions, directors cannot in any way benefit stakeholders at the expense of shareholders. This is obviously the law in the first and most plausible understanding of constituency statutes.
The full document is available for download here.