Smith v. Van Gorkom: Managerial Liability and Exculpatory Clauses ...
Smith v. Van Gorkom: Managerial Liability and Exculpatory Clauses ...
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<strong>Smith</strong> v. <strong>Van</strong> <strong>Gorkom</strong>: <strong>Managerial</strong> <strong>Liability</strong> <strong>and</strong><br />
<strong>Exculpatory</strong> <strong>Clauses</strong>—A Proposal to Fill the Gap<br />
of the Missing Officer Protection<br />
Dennis R. Honabach*<br />
I. INTRODUCTION<br />
Twenty years ago, the Delaware Supreme Court delivered its<br />
startling opinion in <strong>Smith</strong> v. <strong>Van</strong> <strong>Gorkom</strong>. 1 There, to the surprise of<br />
virtually everyone, the court elected to hold directors personally liable<br />
for damages in a shareholder action alleging mere negligence. Until<br />
then, the legal community had assumed that directors were essentially<br />
immune from personal liability for breaches of the fiduciary duty of<br />
care. Directors—st<strong>and</strong>ard canon went—had to fear personal liability<br />
only in cases in which plaintiffs alleged the directors had breached<br />
their duty of loyalty.<br />
For a short time, <strong>Van</strong> <strong>Gorkom</strong> appeared to change that—but only<br />
for a very short time! Reacting to the alarms set off by the opinion,<br />
the Delaware legislature quickly enacted section 102(b)(7) of the Delaware<br />
General Corporation Law. 2 Section 102(b)(7) permits shareholders<br />
to adopt a charter provision granting directors immunity from<br />
personal liability for breaches of their duty of care. In the following<br />
years all but one jurisdiction, the District of Columbia, enacted some<br />
kind of m<strong>and</strong>atory or optional provision permitting shareholders of<br />
corporations incorporated in their jurisdiction to provide similar protection<br />
to their directors. 3<br />
What is surprising, however, is that only seven states have elected<br />
to make similar protection available to corporate officers. Arguably,<br />
the same reasoning that supports protecting directors also applies to<br />
officers; yet, there has been little movement to provide such protection.<br />
This article explores that curious phenomenon. I contend that<br />
the explanation for the exclusion of officers is more an accident of<br />
history than a product of tight legal analysis. Although the absence of<br />
such protection for corporate officers has been generally unimportant<br />
until now, I posit that corporations, in a post-Enron world, should be<br />
* Dean <strong>and</strong> Professor of Law, Washburn University School of Law. I wish to acknowledge<br />
the helpful comments of Professor Lawrence A. Hamermesh, Professor Lyman P.Q. Johnson,<br />
<strong>and</strong> my colleague at Washburn University School of Law, Professor Robert Rhee. I also<br />
wish to thank Andrew Parmenter, my research assistant, for his able help. Needless to say, any<br />
remaining errors are mine alone.<br />
1. 488 A.2d 858 (Del. 1985).<br />
2. DEL. CODE ANN. tit. 8, § 102(b)(7) (2001).<br />
3. See MARK A. SARGENT & DENNIS R. HONABACH, D & O LIABILITY HANDBOOK:<br />
LAW—SAMPLE DOCUMENTS—FORMS (Thompson West ed., 2006) (discussing various state<br />
provisions).<br />
307
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308 Washburn Law Journal [Vol. 45<br />
able to correct that oversight by adopting a provision that would extend<br />
similar protection to officers as well. Finally, I conclude by advocating<br />
for the adoption of statutory provisions permitting corporations<br />
to shield their officers from personal liability for breaches of the duty<br />
of care. While the proposed provisions track the language of the dominant<br />
patterns for exculpatory provisions, they also reflect the adoption<br />
procedures of the officer exculpatory provision proposed more<br />
than a decade ago by the American Law Institute.<br />
II. BACKGROUND<br />
The tale of <strong>Van</strong> <strong>Gorkom</strong> is widely known. As with all tales, the<br />
true facts may or may not actually be as commonly portrayed, but that<br />
point is a nicety to be ignored in the retelling of the story. 4 By all<br />
accounts, the case was factually complex; indeed, some have argued,<br />
too complex for most law students to underst<strong>and</strong>. 5<br />
For our purposes, however, a shorth<strong>and</strong> version of the facts will<br />
suffice. Trans Union Corporation’s board of directors approved a<br />
cash-out merger of the company in a fashion that most would now<br />
view as hastily approved <strong>and</strong> poorly documented. 6 At the time, the<br />
board of directors consisted of ten members—five outside directors<br />
<strong>and</strong> five officer-directors. 7 Jerome <strong>Van</strong> <strong>Gorkom</strong>, the CEO <strong>and</strong> chairman<br />
of the board of directors, anxious to sell the corporation, personally<br />
negotiated the deal with Jay Pritzker. 8 <strong>Van</strong> <strong>Gorkom</strong> apparently<br />
based the offering price of $55 per share on a calculation that he had<br />
had Carl Peterson, the corporation’s controller, do to determine<br />
whether a leveraged buy-out at $55 was feasible. 9 <strong>Van</strong> <strong>Gorkom</strong> first<br />
gave notice of the deal to the board in an oral presentation that lasted<br />
less than two hours. 10 The remaining directors—including Bruce<br />
Chelberg, the corporation’s president, <strong>and</strong> William Browder, the vice<br />
president <strong>and</strong> former chief legal officer, docilely followed <strong>Van</strong><br />
<strong>Gorkom</strong>’s lead. 11 The board members approved the deal even though<br />
4. For a thorough retelling of the story, see WILLIAM M. OWEN, AUTOPSY OF A MERGER<br />
(1986).<br />
5. See Lawrence A. Hamermesh, Why I Do Not Teach <strong>Van</strong> <strong>Gorkom</strong>, 34 GA. L. REV. 477,<br />
480-81 (2000).<br />
6. It is fair to note that although most commentators today view the process employed by<br />
the Trans Union directors as woefully inadequate, the court split sharply on the issue in a 3-2<br />
vote. Adding the vote of the chancellor who granted judgment for the defendants, the split<br />
among jurists was 3-3. For defendant <strong>Van</strong> <strong>Gorkom</strong>’s view of the case, see J. W. <strong>Van</strong> <strong>Gorkom</strong>,<br />
The ‘Big Bang’ for Director <strong>Liability</strong>: The Chairman’s Report, 12 DIRECTORS & BOARDS 17<br />
(1987) (arguing that “it was not the law” but the Delaware Supreme Court’s “distorted reasoning”<br />
that led to an incorrect decision).<br />
7. <strong>Smith</strong> v. <strong>Van</strong> <strong>Gorkom</strong>, 488 A.2d 858, 868 (Del. 1985).<br />
8. Id. at 866.<br />
9. Id.<br />
10. Id. at 869.<br />
11. Id. at 868-69.
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they had not had an opportunity to review the documents at the meeting<br />
because the documents arrived too late. 12<br />
At no time did <strong>Van</strong> <strong>Gorkom</strong>, Chelberg, or Peterson inform the<br />
board that senior managers had reacted completely negatively to the<br />
proposed deal at a management meeting held just before the board<br />
meeting. 13 At the board meeting, Donald Romans, the company’s<br />
chief financial officer, did disclose that he had not been involved in<br />
the deal negotiations <strong>and</strong> that he knew nothing about the deal until<br />
the morning of the meeting. 14 As to the price, he told the board that<br />
$55 was in the range of a fair price but at the low end of the range. 15<br />
Neither he nor anyone else told the board that at the earlier seniormanagement<br />
meeting, he had objected to the proposed deal because<br />
he thought the price was too low. 16<br />
<strong>Van</strong> <strong>Gorkom</strong> told the board that the deal effectively put Trans<br />
Union on the auction block because the corporation remained free to<br />
accept any offer that beat the $55 price. 17 (The court would later determine<br />
that the terms of the buy-out as initially presented to the<br />
board, <strong>and</strong> as later revised, effectively locked Trans Union into the<br />
deal such that no serious counter-bid could be made). 18 <strong>Van</strong> <strong>Gorkom</strong><br />
executed the final agreement later that day while at the opera; neither<br />
he nor any other director read the agreement prior to delivering it to<br />
Pritzker. 19<br />
The plaintiffs brought a class action initially seeking to enjoin the<br />
transaction on the theory that the price paid by Pritzker was woefully<br />
inadequate. Denied injunctive relief, plaintiffs recast the action as<br />
seeking damages from the directors. Plaintiffs did not name any of<br />
the non-officer directors as defendants. 20<br />
Everyone knew—or at least thought they knew—the futility of<br />
the suit. Courts never held directors personally liable. The proverbial<br />
shearing of the pig <strong>and</strong> all of that! 21 Plaintiffs were simply getting<br />
desperate. Or so everyone believed!<br />
12. See id. at 874.<br />
13. Id. at 867.<br />
14. Id. at 868-69.<br />
15. Id. at 869.<br />
16. Id. at 867 n.6.<br />
17. Id. at 868.<br />
18. Id. at 878.<br />
19. Id. at 869.<br />
20. At the time, Delaware procedural rules would not have afforded the Delaware courts<br />
jurisdiction over the non-director officers. Those rules have recently been changed. See infra<br />
notes 119-21 <strong>and</strong> accompanying text.<br />
21. In a classic aphorism, Professor Bishop described actions to impose personal liability for<br />
failure to exercise due care as much “like the proverbial shearing of the pig—much squealing,<br />
little wool!” Joseph W. Bishop, Jr., Sitting Ducks <strong>and</strong> Decoy Ducks: New Trends in the Indemnification<br />
of Corporate Directors <strong>and</strong> Officers, 77 YALE L.J. 1078, 1095 (1968).
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310 Washburn Law Journal [Vol. 45<br />
III. THE DECISION<br />
Wrong! The Delaware Supreme Court, to the surprise of virtually<br />
everyone 22 <strong>and</strong> the dismay of many, 23 held the individual defendants—both<br />
inside directors <strong>and</strong> outside directors—personally liable. 24<br />
The court rem<strong>and</strong>ed the case for a determination of damages. Facing<br />
potential damages of nearly $80 million, the defendants settled the<br />
fiduciary claim as well as a companion federal securities action against<br />
the directors <strong>and</strong> Pritzker for $23.5 million. 25 Of that amount, the corporation’s<br />
D&O carrier paid $10 million. 26 The defendant directors<br />
paid $1.5 million; Pritzker paid the rest. 27<br />
<strong>Van</strong> <strong>Gorkom</strong> can be <strong>and</strong> has been characterized in many ways: as<br />
a loyalty case; 28 as a last-period case; 29 as a disclosure case; 30 as an<br />
early change of control case; 31 <strong>and</strong> as a deal protection case. 32 In this<br />
article, I treat <strong>Van</strong> <strong>Gorkom</strong> as it is perhaps most commonly viewed—a<br />
case involving the corporate managers’ duty of care. The decision is<br />
most often cited for the court’s declaration that “the directors of Trans<br />
Union breached their fiduciary duty to their stockholders . . . by their<br />
failure to inform themselves of all information reasonably available to<br />
22. Jonathan R. Macey & Geoffrey P. Miller, Trans Union Reconsidered, 98 YALE L.J. 127,<br />
131 (1988) (“The outcome of the case was exactly opposite to what virtually every observer of<br />
Delaware law would have predicted.”).<br />
23. Daniel R. Fischel, The Business Judgment Rule <strong>and</strong> the Trans Union Case, 40 BUS. LAW.<br />
1437, 1455 (1985) (describing the decision as “one of the worst . . . in the history of corporate<br />
law”). The view of some commentators has not softened over time. E.g., Fred S. McChesney, A<br />
Bird in the H<strong>and</strong> <strong>and</strong> <strong>Liability</strong> in the Bush: Why <strong>Van</strong> <strong>Gorkom</strong> Still Rankles, Probably, 96 NW. U.<br />
L. REV. 631 (2002) (“Time has not dimmed the initial luster of the <strong>Van</strong> <strong>Gorkom</strong> decision. Considered<br />
a legal disaster in 1985, it is judged no less disastrous today.”).<br />
24. Despite questioning from the court, the defendants continued to contend they should be<br />
treated as a group. <strong>Van</strong> <strong>Gorkom</strong>, 488 A.2d at 899 (Christie, J., dissenting). Later, on a motion<br />
for reargument, O’Boyle, one of the outside directors, argued he should be treated separately<br />
because he had been ill <strong>and</strong> had not participated in the September meeting. The court rejected<br />
his motion as being untimely. Id. at 898-99. Some have suggested that the defendants’ decision<br />
to defend as a group was a serious tactical error. See, e.g., Steven A. Ramirez, The Chaos of<br />
<strong>Smith</strong>, 45 WASHBURN L.J. 343, 349-52 (2006).<br />
25. As a result, shareholders received less than $2 per share in the settlement. See McChesney,<br />
supra note 23, at 643 (calculating the recovery per shareholder from the settlement to be<br />
$1.85 by dividing the amount of the settlement by the 12,734,404 shares represented by the plaintiff<br />
class).<br />
26. See OWEN, supra note 4, at 261.<br />
27. Id.<br />
28. Carey Kirk, Duty of Care <strong>and</strong> Duty of Loyalty in the Aftermath of Trans Union, 5 T.M.<br />
COOLEY L. REV. 1, 3-4 (1988); Alan R. Palmiter, Reshaping the Corporate Fiduciary Model: A<br />
Director’s Duty of Independence, 67 TEX. L. REV. 1351, 1355 (1989).<br />
29. Sean J. Griffith, Deal Protection Provisions in the Last Period of Play, 71 FORDHAM L.<br />
REV. 1899, 1953 (2003); Jonathan R. Macey, <strong>Smith</strong> v. <strong>Van</strong> <strong>Gorkom</strong>: Insights About C.E.O.s,<br />
Corporate Law Rules, <strong>and</strong> the Jurisdictional Competition for Corporate Charters, 96 NW. U. L.<br />
REV. 607, 609-14 (2002).<br />
30. Lawrence A. Hamermesh, A Kinder, Gentler Critique of <strong>Van</strong> <strong>Gorkom</strong> <strong>and</strong> Its Less Celebrated<br />
Legacies, 96 NW. U. L. REV. 595, 597-99 (2002); see Ramirez, supra note 24, at 348-49 &<br />
n.46.<br />
31. Andrew G.T. Moore II, The 1980s—Did We Save the Stockholders While the Corporation<br />
Burned?, 70 WASH. U. L.Q. 277, 281 (1992).<br />
32. See, e.g., R. Franklin Balotti & Gilchrist Sparks III, Deal-Protection Measures <strong>and</strong> the<br />
Merger Recommendation, 96 NW. U. L. REV. 467 (2002).
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them <strong>and</strong> relevant to their decision to recommend the Pritzker merger<br />
. . . .” 33 With its emphasis on the decision-making process employed<br />
by the directors, the opinion thus became widely accepted as the wellspring<br />
of the procedural duty of due care doctrine. 34<br />
The court’s decision in <strong>Van</strong> <strong>Gorkom</strong> is important for other reasons.<br />
In its opinion, the court reaffirmed the gross negligence st<strong>and</strong>ard<br />
for assessing directorial conduct that it had announced only a few<br />
months earlier in Aronson v. Lewis. 35 The court also recognized a<br />
duty of c<strong>and</strong>or, which it found that the Trans Union directors had violated<br />
by failing to disclose to the corporation’s shareholders all information<br />
they had or should have had when they sought shareholder<br />
approval of the transaction. 36<br />
IV. THE LEGACY<br />
The decision was startling, but any joy in plaintiffs’ offices—<strong>and</strong><br />
fear in corporate offices—following the announcement of the decision<br />
quickly dissipated. Immediately following the Delaware Supreme<br />
Court’s decision in <strong>Van</strong> <strong>Gorkom</strong>, the state legislatures took three legislative<br />
steps to reaffirm the protected role of corporate directors. 37<br />
First, some legislatures increased the availability of corporate indemnification<br />
for directors <strong>and</strong> officers. 38 Second, the Delaware legislature<br />
increased the availability of D&O liability insurance by loosening<br />
the non-exclusivity of the indemnification provisions. 39 Finally, <strong>and</strong><br />
perhaps most importantly, the Delaware legislature enacted section<br />
102(b)(7), 40 permitting Delaware corporations to limit or eliminate<br />
33. <strong>Smith</strong> v. <strong>Van</strong> <strong>Gorkom</strong>, 488 A.2d 858, 893 (Del. 1985).<br />
34. The court had already foreshadowed the creation of the procedural duty of care in its<br />
decision in Aronson v. Lewis, 473 A.2d 805 (Del. 1984), a decision by a panel of Justices Moore,<br />
Christie, <strong>and</strong> McNeilly. Ironically Justices Christie <strong>and</strong> McNeilly would later dissent from the<br />
application of the procedural st<strong>and</strong>ard in <strong>Van</strong> <strong>Gorkom</strong>. <strong>Van</strong> <strong>Gorkom</strong>, 488 A.2d at 897<br />
(McNeilly, J., dissenting); id. at 898 (Christie, J., dissenting).<br />
35. 473 A.2d 805 (Del. 1984).<br />
36. <strong>Van</strong> <strong>Gorkom</strong>, 488 A.2d at 893. As Professor Hamermesh has noted, this was the first<br />
time the court held that directors of Delaware corporations were subject to a duty of complete<br />
c<strong>and</strong>or in a case not involving self-dealing or a case in which the directors were using inside<br />
information to sell or buy the corporation’s shares. Hamermesh, supra note 30, at 597-98.<br />
37. See E. Norman Veasey, Jesse A. Finkelstein & C. Stephen Bigler, Delaware Supports<br />
Directors with a Three-Legged Stool of Limited <strong>Liability</strong>, Indemnification, <strong>and</strong> Insurance, 42 BUS.<br />
LAW. 399 (1987).<br />
38. See James J. Hanks, Jr., Evaluating Recent State Legislation on Director <strong>and</strong> Officer<br />
<strong>Liability</strong> Limitation <strong>and</strong> Indemnification, 43 BUS. LAW. 1207, 1221-24 (1988) (discussing the expansion<br />
of indemnification in derivative suits).<br />
39. Id. at 1224-27 (discussing the expansion of the non-exclusivity provisions governing director<br />
<strong>and</strong> officer indemnification).<br />
40. DEL. CODE ANN. tit. 8, § 102(b)(7) (2001). Section 102(b)(7) provides:<br />
§ 102 Contents of certificate of incorporation.<br />
. . . .<br />
(b) In addition to the matters required to be set forth in the certificate of incorporation<br />
by subsection (a) of this section, the certificate of incorporation may also contain<br />
any or all of the following matters:<br />
. . . .
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312 Washburn Law Journal [Vol. 45<br />
the personal liability of their corporate directors. 41 Many believe this<br />
last step, the adoption of the exculpation provision, effectively overruled<br />
<strong>Van</strong> <strong>Gorkom</strong>. 42 Some also believe that both the enactment of<br />
section 102(b)(7) <strong>and</strong> the individual corporate decisions to add an exculpatory<br />
provision to corporate charters resulted in a loss of shareholder<br />
value. 43<br />
Section 102(b)(7) permits corporations to amend their corporate<br />
charters to shelter directors from personal liability to the corporation<br />
or its shareholders so long as their actions do not fall within one of<br />
four exceptions: unlawful dividends; acts or omissions that constitute a<br />
“breach of the director’s duty of loyalty”; “acts or omissions not made<br />
in good faith or which involve intentional misconduct or a knowing<br />
violation of law”; <strong>and</strong> “any transaction from which the director derives<br />
an improper personal benefit.” 44 Section 102(b)(7) allows corporations<br />
to negate the application of <strong>Van</strong> <strong>Gorkom</strong> to their directors<br />
even when directors engage in grossly negligent conduct, including<br />
conduct involving significant procedural shortcomings. Not surprisingly,<br />
section 102(b)(7) proved popular with corporate management.<br />
(7) A provision eliminating or limiting the personal liability of a director to the<br />
corporation or its stockholders for monetary damages for breach of fiduciary duty as a<br />
director, provided that such provision shall not eliminate or limit the liability of a director:<br />
(i) For any breach of the director’s duty of loyalty to the corporation or its stockholders;<br />
(ii) for acts or omissions not in good faith or which involve intentional<br />
misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv) for any<br />
transaction from which the director derived an improper personal benefit. No such<br />
provision shall eliminate or limit the liability of a director for any act or omission occurring<br />
prior to the date when such provision becomes effective. All references in this<br />
paragraph to a director shall also be deemed to refer (x) to a member of the governing<br />
body of a corporation which is not authorized to issue capital stock, <strong>and</strong> (y) to such<br />
other person or persons, if any, who, pursuant to a provision of the certificate of incorporation<br />
in accordance with § 141(a) of this title, exercise or perform any of the powers<br />
or duties otherwise conferred or imposed upon the board of directors by this title.<br />
41. See generally Hanks, supra note 38 (discussing the various state legislative responses to<br />
the <strong>Van</strong> <strong>Gorkom</strong> decision); see SARGENT & HONABACH, supra note 3 (updating the evaluation<br />
of state D&O legislation).<br />
42. E.g., Marc I. Steinberg, The Evisceration of the Duty of Care, 42 SW. L.J. 919, 920<br />
(1988).<br />
43. E.g., Ramirez, supra note 24, at 352-53. The claim that the exculpatory regime created<br />
by section 102(b)(7) resulted in a loss of shareholder wealth is based on an event study done by<br />
Michael Bradley <strong>and</strong> Cindy Schipani. Michael Bradley & Cindy A. Schipani, The Relevance of<br />
the Duty of Care St<strong>and</strong>ard in Corporate Governance, 75 IOWA L. REV. 1 (1989). Professors<br />
Bradley <strong>and</strong> Schipani reported that Delaware corporations suffered a significant loss in share<br />
value as a consequence of the enactment of section 102(b)(7), <strong>and</strong> Delaware corporations that<br />
adopted section 102(b)(7) provisions suffered additional significant losses in share value. Id. at<br />
60-68. The validity of Bradley <strong>and</strong> Schipani’s study has been challenged by others. For example,<br />
Professors Sanjai Bhagat <strong>and</strong> Roberta Romano argue that Bradley <strong>and</strong> Schipani’s use of the<br />
statute’s effective date is troubling because the effective date of the statute is not a meaningful<br />
event date. They note that the statute’s enactment was well publicized <strong>and</strong> any effect it would<br />
have should have been impounded in share price well before the effective date. See Sanjai Bhagat<br />
& Roberta Romano, Event Studies <strong>and</strong> the Law: Part II: Empirical Studies of Corporate Law,<br />
4 AM. L. ECON. REV. 380, 391-92 (2002). The conduct of shareholders seems to bear out Bhagat<br />
<strong>and</strong> Romano’s critique. If the inclusion of an exculpatory provision in a corporation’s charter<br />
imposes a significant loss on shareholder value, one would expect institutional shareholders to<br />
call for its repeal. None has.<br />
44. DEL. CODE ANN. tit. 8, § 102(b)(7).
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Following the section’s effective date, virtually every publicly traded<br />
corporation incorporated in Delaware adopted a section 102(b)(7)<br />
provision. 45<br />
Many other states—spurred on by a heated “race to the bottom”<br />
46 or “race to the top” 47 —quickly followed suit. Six states struck<br />
new ground, imposing m<strong>and</strong>atory provisions limiting director liability.<br />
48 Most, however, enacted their own charter-option provisions;<br />
forty-four states now have some form of charter-option statute. 49 In<br />
an abundance of caution, two states—Louisiana <strong>and</strong> Utah—have both<br />
a self-executing liability limitation 50 <strong>and</strong> a charter-option provision. 51<br />
Only one jurisdiction—the District of Columbia—has not adopted<br />
any additional protection for corporate managers.<br />
The individual state provisions differ in several ways. Many of<br />
the differences involve minor wording changes of little consequence.<br />
45. Hamermesh, supra note 5, at 490.<br />
46. See William Cary, Federalism <strong>and</strong> Corporate Law: Reflections upon Delaware, 83 YALE<br />
L.J. 663 (1974); Daniel J.H. Greenwood, Democracy <strong>and</strong> Delaware: The Mysterious Race to the<br />
Bottom/Top, 23 YALE L. & POL’Y REV. 381 (2005) (arguing that the race to the top/bottom<br />
theories obscure the political theories we have made in corporate law); see also Macey, supra<br />
note 29, at 622-24.<br />
47. See Ralph K. Winter, Jr., State Law, Shareholder Protection, <strong>and</strong> the Theory of the Corporation,<br />
6 J. LEGAL STUD. 251 (1977). In a companion article in this issue, Professor Henry<br />
Butler employs the race to the top approach, contending that in announcing the decision in <strong>Van</strong><br />
<strong>Gorkom</strong>, the Delaware Supreme Court almost cost Delaware its position as the dominant state<br />
for incorporation. Henry N. Butler, <strong>Smith</strong> v. <strong>Van</strong> <strong>Gorkom</strong>, Jurisdictional Competition, <strong>and</strong> the<br />
Role of R<strong>and</strong>om Mutations in the Evolution of Corporate Law, 45 WASHBURN L.J. 267, 272<br />
(2006); see also Macey, supra note 29, at 624-25.<br />
48. FLA. STAT. ANN. § 607.0831 (West 2001); IND. CODE ANN. § 23-1-35-1(e) (West 2005);<br />
NEV. REV. STAT. § 78.138 (2003); OHIO REV. CODE ANN. § 1701.59(D) (West 1994 & Supp.<br />
2003); VA. CODE ANN. § 13.1-692.1 (1999); WIS. STAT. ANN. § 180.0828 (West 2002).<br />
49. ALA. CODE § 10-2B-2.02(b)(3) (LexisNexis 1999); ALASKA STAT. § 10.06.210(1)(n)<br />
(2004); ARIZ. REV. STAT. ANN. § 10-202(B)(1) (2004); ARK. CODE ANN. § 4-27-202(B)(3)<br />
(2001); CAL. CORP. CODE § 204(a)(10) (West 1990); COLO. REV. STAT. § 7-108-402(1) (1999);<br />
CONN. GEN. STAT. § 33-636(b)(4) (2005); DEL. CODE ANN. tit. 8, § 102(b)(7) (2001); GA. CODE<br />
ANN. § 14-2-202(b)(4) (2003); HAW. REV. STAT. §§ 414-32(b), 414-222 (2004); IDAHO CODE<br />
ANN. § 30-1-202(2)(d) (Supp. 1999); 805 ILL. COMP. STAT. ANN. 5/2.10(b)(3) (West 2004); IOWA<br />
CODE ANN. § 490.202(2)(d) (West 1999); KAN. STAT. ANN. § 17-6002(b)(8) (1993); KY. REV.<br />
STAT. ANN. § 271B.2-020(2)(d) (LexisNexis 2003); ME. REV. STAT. ANN. tit. 13-C, § 202(2)(D)<br />
(2005); MD. CODE ANN., CORPS. & ASS’NS §§ 2-104(b)(8), 2-405.2 (LexisNexis 1999); MASS.<br />
ANN. LAWS ch. 156B, § 13(b)(1 1/2) (LexisNexis 2005); MICH. COMP. LAWS SERV.<br />
§ 450.1209(1)(c) (LexisNexis 2001); MINN. STAT. ANN. §§ 302A.111 (4)(u), 302A.251(4) (West<br />
2004); MISS. CODE ANN. § 79-4-2.02(b)(4)-(5) (2001); MO. ANN. REV. STAT. § 351.355(2) (West<br />
2001); MONT. CODE ANN. § 35-1-216(2)(d) (2005); NEB. REV. STAT. § 21-2018(2)(d)-(e) (1997);<br />
NEV. REV. STAT. § 78.037 (2003); N.H. REV. STAT. ANN. § 293-A:2.02(b)(4) (LexisNexis 1999);<br />
N.J. STAT. ANN. § 14A:2-7(3) (West 2003); N.M. STAT. ANN. § 53-12-2(E) (LexisNexis Supp.<br />
2005); N.Y. BUS. CORP. LAW § 402(b) (McKinney 2003); N.C. GEN. STAT. § 55-2-02(b)(3) (2005);<br />
N.D. CENT. CODE § 10-19.1-10(5)(u) (2001); OKLA. STAT. ANN. tit. 18, § 1006(B)(7) (West<br />
1999); OR. REV. STAT. § 60.047(2)(d) (2003); 15 PA. CONS. STAT. ANN. § 1713(a)-(b) (West<br />
1995); R.I. GEN. LAWS § 7-1.1-48(a)(6) (1999); S.C. CODE ANN. § 33-2-102(e) (1990); S.D. CODI-<br />
FIED LAWS § 47-1A-202.1(4) (Supp. 2005); TENN. CODE ANN. § 48-12-102(b)(3) (2002); TEX.<br />
REV. CIV. STAT. ANN. art. 1302, § 7.06(B) (Vernon 2003); VT. STAT. ANN. tit. 11A, § 2.02(b)(4)<br />
(1997); WASH. REV. CODE ANN. §§ 23B.02.020(5)(j), 23B.08.320 (West 1994 & Supp. 2006); W.<br />
VA. CODE ANN. § 31D-2-202(b)(4) (LexisNexis 2003); WYO. STAT. ANN. § 17-16-202(b)(iii)-(v)<br />
(2003).<br />
50. LA. REV. STAT. ANN. § 12:91(A)-(E) (Supp. 2006); UTAH CODE ANN. § 16-10a-840(4)<br />
(2001).<br />
51. LA. REV. STAT. ANN. § 12:24(C)(4) (1994 & Supp. 2006); UTAH CODE ANN. § 16-10a-<br />
841.
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Some, however, are quite significant. One important difference is the<br />
extent to which these exculpatory exclusionary provisions limit the<br />
ability of shareholders to reduce or eliminate the risk of personal liability<br />
for violations involving forms of managerial misconduct far<br />
more egregious than mere mismanagement.<br />
Two general patterns of provisions ultimately developed. One is<br />
based on Delaware’s section 102(b)(7). 52 As noted above, section<br />
102(b)(7) prohibits directorial exculpation for acts or omissions not<br />
made in good faith, for acts that constitute intentional misconduct,<br />
<strong>and</strong> for acts or omissions that constitute a breach of the duty of loyalty.<br />
Section 102(b)(7) likewise does not shelter illegal acts or unlawful<br />
dividends. 53 Both the duty-of-loyalty exception <strong>and</strong> the good-faith<br />
exception are particularly troubling because neither is well defined.<br />
The Delaware corporate code does not employ the term “loyalty”<br />
anywhere other than in section 102(b)(7); hence its parameters are<br />
difficult to ascertain. Likewise, “good faith” is an open-ended term<br />
that has lately become quite controversial.<br />
The second pattern, which evolved later, is provided by section<br />
2.02(b)(4) of the Model Business Corporation Act (MBCA). 54 Section<br />
2.02(b)(4) omits Delaware’s broad exclusions for liabilities arising<br />
from breaches of a director’s duty of loyalty <strong>and</strong> for directors’ acts not<br />
taken in good faith. Instead, it excludes from coverage only liabilities<br />
“for (A) the amount of a financial benefit received by a director to<br />
which he is not entitled; (B) an intentional infliction of harm on the<br />
corporation or the shareholders; (C) a violation of section 8.33; or (D)<br />
an intentional violation of criminal law.” 55<br />
A few states that quickly enacted clones of Delaware’s section<br />
102(b)(7) subsequently replaced their original provisions with ones<br />
that tracked MBCA section 2.02(b)(4), apparently because section<br />
2.02(b)(4) allows more liability limitation <strong>and</strong> eliminates the definitional<br />
ambiguity surrounding the duty-of-loyalty exclusion. 56 The<br />
Delaware model remains dominant, however, as only twelve states<br />
52. DEL. CODE ANN. tit. 8, § 102(b)(7)(i).<br />
53. Id. Other early statutes omitted such a broad duty-of-loyalty exception <strong>and</strong> only excluded<br />
narrowly defined types of misconduct. The Maryl<strong>and</strong> statute, for example, excluded from<br />
the coverage of its provision only the actual receipt of “an improper benefit or profit in money,<br />
property, or services” <strong>and</strong> “active <strong>and</strong> deliberate dishonesty.” MD. CODE ANN. CTS. & JUD.<br />
PROC. § 5-419 (LexisNexis 2002).<br />
54. MODEL BUS. CORP. ACT § 2.02(b)(4) (2002). For a general discussion of the development<br />
of the Model Act’s director-protection provisions, in particular section 2.02(b)(4), see<br />
James J. Hanks, Jr. & Larry P. Scriggins, Protecting Directors <strong>and</strong> Officers from <strong>Liability</strong>—The<br />
Influence of the Model Business Corporation Act, 56 BUS. LAW. 3, 25-27 (2000).<br />
55. MODEL BUS. CORP. ACT § 2.02(b)(4). A violation of section 8.33 occurs with an authorization<br />
of an illegal distribution. Id. § 8.33(a).<br />
56. See, e.g., ARIZ. REV. STAT. ANN. § 10-202(B)(1) (2004) (tracking MODEL BUS. CORP.<br />
ACT § 2.02(b)(4), replacing ARIZ. REV. STAT. ANN. § 10-054(A), which tracked Delaware’s<br />
§ 102(b)(7)).
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follow the MBCA pattern. 57 Twenty-four states continue to follow the<br />
basic Delaware pattern. 58 Seven states have idiosyncratic charter-option<br />
provisions. 59 Eight states have either m<strong>and</strong>atory exculpatory provisions<br />
or have adopted reformulations of the duty of care that<br />
dramatically limit the possibility of liability, including two that also<br />
have a charter option. 60<br />
The practical distinction between Delaware’s exceptions, particularly<br />
its broad duty-of-loyalty exclusion <strong>and</strong> “good faith” exception<br />
<strong>and</strong> the MBCA’s more narrowly circumscribed exclusions had, until<br />
recently, not proven to be significant, even though Delaware’s pattern<br />
theoretically requires the courts to explore the murky boundary between<br />
the duties of care, good faith, <strong>and</strong> loyalty. Recent developments,<br />
however, have made the distinction quite important.<br />
V. THE DISNEY LITIGATION<br />
The decision in In re Walt Disney Co. Derivative Litigation 61 has<br />
raised important questions about the meaning of the “good faith” exclusion<br />
in section 102(b)(7) <strong>and</strong>, more fundamentally, the existence or<br />
nonexistence of a separate duty of good faith. The Disney litigation<br />
revolved around the hiring <strong>and</strong> relatively rapid termination of Michael<br />
Ovitz. The underlying facts read like a daytime soap opera. 62 At the<br />
urging of Michael Eisner, Disney’s CEO <strong>and</strong> chairman of the board,<br />
Disney hired Ovitz in 1995. Fourteen months later, Disney termi-<br />
57. ARIZ. REV. STAT. ANN. § 10-202(B)(1); GA. CODE ANN. § 14-2-202(b)(4) (2003); HAW.<br />
REV. STAT. §§ 414-32(b), 414-222 (2004); IDAHO CODE ANN. § 30-1-202(2)(d) (Supp. 1999);<br />
IOWA CODE ANN. § 490.202(2)(d) (West 1999); MICH. COMP. LAWS SERV. § 450.1209(1)(c) (LexisNexis<br />
2001); MISS. CODE ANN. § 79-4-2.02(b)(4)-(5) (2001); MONT. CODE ANN. § 35-1-<br />
216(2)(d) (2005); NEB. REV. STAT. § 21-2018(2)(d)-(e) (1997); N.H. REV. STAT. ANN. § 293-<br />
A:2.02(b)(4) (LexisNexis 1999); S.D. CODIFIED LAWS § 47-1A-202.1 (Supp. 2005); VT. STAT.<br />
ANN. tit. 11A, § 2.02(b)(4) (1997).<br />
58. ALASKA STAT. § 10.06.210(1)(n) (2004); ARK. CODE ANN. § 4-27-202(B)(3) (2001);<br />
CAL. CORP. CODE § 204(a)(10) (West 1990); COLO. REV. STAT. § 7-108-402(1) (1999); CONN.<br />
GEN. STAT. § 33-636(b)(4) (2005); DEL. CODE ANN. tit. 8, § 102(b)(7) (2001); 805 ILL. COMP.<br />
STAT. ANN. 5/2.10(b)(3) (West 2004); KAN. STAT. ANN. § 17-6002(b)(8) (1993); KY. REV. STAT.<br />
ANN. § 271B.2-020(2)(d) (LexisNexis 2003); LA. REV. STAT. ANN. § 12:24(C)(4) (1994 & Supp.<br />
2006); MASS. ANN. LAWS ch. 156B, § 13(b)(1 1/2) (LexisNexis 2005); MINN. STAT. ANN.<br />
§§ 302A.111(4)(u), 302A.251(4) (West 2004); MO. ANN. STAT. § 351.355(2) (West 2001); N.J.<br />
STAT. ANN. § 14A:2-7(3) (West 2003); N.Y. BUS. CORP. LAW § 402(b) (McKinney 2003); N.D.<br />
CENT. CODE § 10-19.1-10(5)(u) (2001); OKLA. STAT. ANN. tit. 18, § 1006(B)(7) (West 1999); OR.<br />
REV. STAT. § 60.047(2)(d) (2003); 15 PA. CONS. STAT. ANN. § 1713(a)-(b) (West 1995); R.I. GEN.<br />
LAWS § 7-1.1-48(a)(6) (1999); S.C. CODE ANN. § 33-2-102(e) (1990); TENN. CODE ANN. § 48-12-<br />
102(b)(3) (2002); TEX. REV. CIV. STAT. ANN. art. 1302, § 7.06(B) (Vernon 2003); WASH. REV.<br />
CODE ANN. §§ 23B.02.020(5)(j), 23B.08.320 (Supp. 2006).<br />
59. ALA. CODE § 10-2B-2.02(b)(3) (LexisNexis 1999); MD. CODE ANN., CORPS. & ASS’NS<br />
§§ 2-104(b)(8), 2-405.2 (LexisNexis 1999); NEV. REV. STAT. § 78.037 (2003); N.M. STAT. ANN.<br />
§ 53-12-2(E) (LexisNexis Supp. 2005); N.C. GEN. STAT. § 55-2-02(b)(3) (2005); W. VA. CODE<br />
ANN. § 31D-2-202(b)(4) (LexisNexis 2003); WYO. STAT. ANN. § 17-16-202(b)(iii)-(v) (2003).<br />
60. See supra notes 48 <strong>and</strong> 50.<br />
61. 825 A.2d 275 (Del. 2003).<br />
62. For a colorful, entertaining, <strong>and</strong> at some times shocking retelling of the facts, see James<br />
B. Stewart, Partners, THE NEW YORKER, Jan. 10, 2005, at 46.
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316 Washburn Law Journal [Vol. 45<br />
nated Ovitz’s employment. 63 The board, however, did not elect to<br />
treat his termination as one for cause. As a result, Ovitz became entitled<br />
to a severance payment of roughly $39 million in cash <strong>and</strong> vested<br />
options potentially yielding another $101 million. 64<br />
Not surprisingly, some disgruntled Disney shareholders brought a<br />
derivative suit against Eisner, Ovitz, the directors who approved the<br />
employment contract, <strong>and</strong> the directors who approved the no-fault<br />
termination. The Delaware Court of Chancery initially dismissed the<br />
plaintiffs’ complaint on the grounds that plaintiffs had failed to state a<br />
claim <strong>and</strong> that plaintiffs had failed to make the requisite dem<strong>and</strong> on<br />
the directors. 65<br />
On appeal, the Delaware Supreme Court, troubled by the facts of<br />
the case, described the termination payment to Ovitz as “exceedingly<br />
lucrative, if not luxurious.” 66 It characterized the decision-making<br />
process that the Disney board allegedly employed both in hiring <strong>and</strong><br />
in discharging Ovitz as “casual, if not sloppy <strong>and</strong> perfunctory.” 67 At<br />
the same time, the court was highly critical of the plaintiffs’ complaint,<br />
describing it as a “pastiche of prolix invective.” 68 The court held that<br />
the plaintiffs’ complaint was subject to dismissal because it lacked sufficient<br />
particularized allegations, but the court concluded that in the<br />
interests of justice it would permit the plaintiffs to replead that portion<br />
of their complaint, alleging breach of fiduciary duty <strong>and</strong> waste. 69<br />
On rem<strong>and</strong>, the plaintiffs—after obtaining additional information<br />
pursuant to Delaware’s inspection statute 70 —pled facts that Chancellor<br />
William B. Ch<strong>and</strong>ler III found to raise a “cognizable question of<br />
whether the defendant directors of the Walt Disney Company should<br />
be held personally liable to the corporation for a knowing or intentional<br />
lack of due care in the directors’ decision-making process regarding<br />
Ovitz’s employment <strong>and</strong> termination.” 71 The defendants<br />
argued that the plaintiffs’ new complaint alleged, at most, a breach of<br />
the directors’ duty of care <strong>and</strong> that directors were thus protected from<br />
liability by the section 102(b)(7) exculpatory provision in Disney’s<br />
charter. 72 The chancellor rejected both arguments. He noted that the<br />
complaint alleged failure of the directors to exercise any business<br />
63. Disney hired Ovitz effective October 1, 1995, <strong>and</strong> terminated him on December 11,<br />
1996. See Brehm v. Eisner, 746 A.2d 244, 249-52 (Del. 2000).<br />
64. Id. at 253.<br />
65. In re Walt Disney Co. Derivative Litig., 731 A.2d 342, 380 (Del. 1998).<br />
66. Brehm, 746 A.2d at 249.<br />
67. Id.<br />
68. Id.<br />
69. Id. at 248, 267.<br />
70. DEL. CODE ANN. tit. 8, § 220 (2001).<br />
71. In re Walt Disney Co. Derivative Litig., 825 A.2d 275, 278 (Del. 2003).<br />
72. Id. at 286. The defendants also argued that the revised complaint failed to allege actions<br />
that were not protected under the business judgment rule. Id.
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judgment. 73 He also determined that the protection of the exculpatory<br />
clause was not available to the defendants, stating:<br />
Where a director consciously ignores his or her duties to the corporation,<br />
thereby causing economic injury to its stockholders, the director’s<br />
actions are either “not in good faith” or “involve intentional<br />
misconduct.” Thus, plaintiffs’ allegations support claims that fall<br />
outside the liability waiver provided under Disney’s certificate of<br />
incorporation. 74<br />
As a result of the Court of Chancery’s decision, the case proceeded to<br />
trial.<br />
Following a full, revealing, <strong>and</strong> oft-times embarrassing trial,<br />
Chancellor Ch<strong>and</strong>ler concluded that, while the defendants had not exercised<br />
model corporate governance, they had not breached their fiduciary<br />
duties. 75 Chancellor Ch<strong>and</strong>ler reaffirmed his belief that a<br />
section 102(b)(7) provision created an affirmative defense with the<br />
burden of proof on the defendant directors to demonstrate they were<br />
entitled to that protection. 76 He attempted, but failed to satisfactorily<br />
define “good faith,” 77 leaving its meaning murky. 78<br />
In addition to the troublesome interpretive problems, the exculpatory<br />
provisions raise the issue of which party has the burden of<br />
proving, or disproving, the applicability of the provision. To be consistent<br />
with the apparent intent of the drafters, one might well suspect<br />
that defendants should be required to demonstrate that a validly<br />
adopted exculpatory provision exists. One might expect the burden to<br />
then shift back to the plaintiffs to prove that the defendants’ conduct<br />
was not protected by the provision. In Emerald Partners v. Berlin, 79<br />
however, the Delaware Supreme Court concluded that a section<br />
102(b)(7) provision provides defendants with an affirmative defense<br />
requiring the defendants to prove their conduct falls within the pa-<br />
73. Id. at 278.<br />
74. Id. at 290.<br />
75. In re Walt Disney Co. Derivative Litig., No. 15452, slip op. at 139 (Del. Ch. Aug. 9,<br />
2005), available at http://courts.delaware.gov/opinions/(anhs4mjxxwbgr345smau20vm)/down<br />
load.aspx?ID=64510.<br />
76. Id. at 124.<br />
77. For an excellent discussion of the issue of the relationship between “good faith” <strong>and</strong><br />
section 102(b)(7), see John L. Reed & Matt Neiderman, “Good Faith” <strong>and</strong> the Ability of Directors<br />
to Assert § 102(b)(7) of the Delaware General Corporation Law as a Defense to Claims Alleging<br />
Abdication, Lack of Oversight, <strong>and</strong> Similar Breaches of Fiduciary Duty, 29 DEL. J. CORP.<br />
L. 111 (2004).<br />
78. As this article goes to print, the Delaware Court of Chancery’s decision is on appeal to<br />
the Delaware Supreme Court. Delaware Supreme Court Oral Arguments (Jan. 25, 2006), available<br />
at http://courts.Delaware.gov/Courts/Supreme%20Court/?audioargs.htm; R<strong>and</strong>all Chase,<br />
Judge Erred, Attorney Says in Disney Appeal, DELAWARE ONLINE, Jan. 26, 2006, http://www.<br />
delawareonline.com/apps/pbcs.dll/article?AID=/20060126/BUSINESS/601260327/1003.<br />
79. 787 A.2d 85 (Del. 2001); see also Malpiede v. Townson, 780 A.2d 1075 (Del. 2001);<br />
Stephen A. Radin, Director Protection Statutes After Malpiede <strong>and</strong> Emerald Partners, INSIGHTS,<br />
Feb. 2002, at 10, 10.
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318 Washburn Law Journal [Vol. 45<br />
rameters of the provision, except when the plaintiffs allege only<br />
breaches of the directors’ duty of care. 80<br />
It is critical to note that the charter-option statutes have no effect<br />
on plaintiffs’ ability to seek non-monetary equitable remedies, such as<br />
an injunction or rescission, for any breach of fiduciary duty. Furthermore,<br />
the statutes generally provide no protection from suits brought<br />
by creditors or other third parties. 81<br />
For the purposes of the article, the most important difference in<br />
the various state exculpatory provisions is the degree to which the<br />
statutes provide any protection to corporate officers. Most states follow<br />
the Delaware <strong>and</strong> MBCA patterns in extending the coverage of<br />
their exculpatory provisions only to directors. Seven states, however,<br />
do provide protection for officers. 82 The rationale for the remaining<br />
states not extending protection to officers is not clear. A plausible<br />
explanation for the omission is that the “crisis” created by <strong>Van</strong><br />
<strong>Gorkom</strong> involved directors, <strong>and</strong> thus, directors—particularly outside<br />
directors—clamored for relief. As most corporate officers at the time<br />
were also serving as directors, there seemed to be little need for extending<br />
protection to officers qua officers.<br />
To appreciate the impact of the exculpatory provisions on corporate<br />
law, one needs to recall the corporate environment at the time<br />
<strong>Van</strong> <strong>Gorkom</strong> was decided. The era of hostile takeovers had just begun<br />
to heat up. The popular press, legal journals, <strong>and</strong> soon corporate<br />
decisions were filled with the rhetoric of poison pills, white knights,<br />
green mail, <strong>and</strong> the like. The corporate governance system was under<br />
serious attack as managers, jurists, <strong>and</strong> corporate theorists debated<br />
the appropriateness of various responses to the emerging hostile takeover<br />
market.<br />
Yet, in 1985, corporate theory was largely still a product of the<br />
pioneering work of Adolph Berle <strong>and</strong> Gardener Means. In their classic<br />
work, The Modern Corporation <strong>and</strong> Private Property, Berle <strong>and</strong><br />
Means posited that ownership of publicly held corporations was so<br />
widely dispersed that managers effectively controlled corporate activ-<br />
80. Emerald Partners, 787 A.2d at 91; see Prod. Res. Group, L.L.C. v. NCT Group, Inc., 863<br />
A.2d 772, 793-95 (Del. Ch. 2004).<br />
81. The North Carolina provision, however, is drafted broadly enough to shield directors<br />
from third-party claims. See N.C. GEN. STAT. § 55-2-02(b)(3) (2005) (permitting the articles of<br />
incorporation to provide an exculpatory provision eliminating personal liability “arising out of<br />
an action whether by or in the right of the corporation or otherwise . . . .” (emphasis added)).<br />
The apparent open-ended statutory language was intended to cover shareholder class actions<br />
such as in <strong>Van</strong> <strong>Gorkom</strong>, but the language is broader. The validity of the North Carolina statute<br />
as it applies to claims brought by third parties has not been tested.<br />
82. LA. REV. STAT. ANN. § 12:24(c)(4) (1994 & Supp. 2006); MD. CODE ANN., CORPS. &<br />
ASS’NS §§ 2-104(b)(8), 2-405.2 (LexisNexis 1999), MD. CODE ANN., CTS. & JUD. PROC. § 5-418<br />
(LexisNexis 2002); NEV. REV. STAT. § 78.138(7) (2003); N.H. REV. STAT. ANN. § 293-A:2.02(b)<br />
(4) (LexisNexis 1999); N.J. STAT. ANN. § 14A:2-7(3) (West 2003); UTAH CODE ANN. § 16-10a-<br />
840(4) (2001); VA. CODE ANN. § 13.1-692.1 (1999).
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ity. 83 Individual shareholders, they argued, simply held too small a<br />
stake in their corporations to be expected to exercise any effective<br />
oversight over managerial behavior. 84 Instead, corporate managers<br />
controlled the corporation.<br />
Building on the Berle-Means hypothesis, Professor William Cary<br />
argued that states, hungry for corporate franchise fees, were locked<br />
“in a race to the bottom.” 85 The goal of each state, he maintained,<br />
was to attract corporations <strong>and</strong> corporate taxes <strong>and</strong> fees by offering<br />
managers the most managerial-favorable corporate statute. Consequently,<br />
shareholders could not rely on either state legislatures or<br />
state courts for any meaningful protection.<br />
Many commentators, viewing the enactment of the exculpatory<br />
provisions through the Berle-Means lens, condemned the provisions—<br />
regardless of their form—as just another example of classic managerialism.<br />
They contend that the adoption of an exculpatory provision<br />
resulted in a decline in shareholder value. 86 They saw the passage of<br />
the exculpatory provisions as nothing more than another instance in<br />
which corporate managers—suddenly threatened by the possibility of<br />
being held accountable for their actions—were able to call successfully<br />
on state legislators to gain further insulation from shareholder<br />
control.<br />
For many reasons that explanation did not go unchallenged.<br />
Most importantly, the emerging Contract Model of the corporation<br />
placed corporate relations in a whole new light. 87 In contrast to the<br />
Berle-Means managerial theory of the corporation, the Contract<br />
Model of the corporation views the corporation as a nexus of explicit<br />
<strong>and</strong> implicit contracts entered into by shareholders <strong>and</strong> other investors.<br />
88 As two of the leading Contract Model theorists explain:<br />
The contractual theory of the corporation states that the corporation<br />
is a set of contracts among the participants in the business, including<br />
shareholders, managers, creditors, employees <strong>and</strong> others.<br />
The terms of the agency contract include the provisions of state law,<br />
which are regarded as a st<strong>and</strong>ard form that can be accepted by the<br />
parties or rejected either by drafting around the provision or by incorporating<br />
in another state. The corporate contract also specifies<br />
the extent to which the parties rely on the competitive pressures<br />
from capital, product, <strong>and</strong> managerial labor markets as well as inter-<br />
83. ADOLF A. BERLE, JR. & GARDINER C. MEANS, THE MODERN CORPORATION AND PRI-<br />
VATE PROPERTY 7 (1932).<br />
84. Id. at 69.<br />
85. Cary, supra note 46, at 663-68. Cary’s hypothesis has been soundly challenged. See,<br />
e.g., Winter, supra note 47.<br />
86. See discussion supra note 43.<br />
87. See Henry N. Butler, The Contractual Theory of the Corporation, 11 GEO. MASON L.<br />
REV. 99, 100 (1989).<br />
88. The use of the phrase “nexus of contracts” can be traced back to Michael C. Jensen <strong>and</strong><br />
William H. Meckling’s path-breaking article, Theory of the Firm: <strong>Managerial</strong> Behavior, Agency<br />
Costs <strong>and</strong> Ownership Structure, 3 J. FIN. ECON. 305, 310 (1976).
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320 Washburn Law Journal [Vol. 45<br />
nal incentive structures such as corporate hierarchy, boards of directors<br />
<strong>and</strong> managerial compensation contracts, to force agents to act<br />
in their shareholders’ best interests. 89<br />
While it may be accurate to describe shareholders as sometimes stuck<br />
with their deal, Contract Model theorists deem those shareholders no<br />
more powerless than visitors to an amusement park who might want<br />
to stop the rollercoaster ride just as the last car begins to plunge down<br />
the steep, initial descent. Ex ante, shareholders—<strong>and</strong> rollercoaster<br />
riders—are free to bargain for the price <strong>and</strong> protections they desire.<br />
Consequently, rather than viewing the appropriate role of corporate<br />
law to be to fashion the “correct” rules for corporate governance, the<br />
Contractarians believe the proper role of the state to be to provide an<br />
appropriate set of default governance rules. 90 Corporate law, Contractarians<br />
contend, should permit shareholders <strong>and</strong> other corporate<br />
participants to vary those default rules—including fiduciary rules—as<br />
they desire. 91 Optional governance rules, such as those provided by<br />
section 102(b)(7), nestle comfortably in the fabric of the Contract<br />
Model.<br />
At least two arguments can be advanced in opposition to the<br />
Contract Model. First, because of the power imbalance within the<br />
corporation, the “contracts” that the Contract Model champions are<br />
really nothing more than expressions of the dominant power of corporate<br />
managers. Second, developments in the field of behavioral economics<br />
undercut the fundamental premise of the theory, namely, the<br />
assumption that shareholders can rationally determine the best basket<br />
of corporate governance rules. Even some of the early supporters of<br />
the model have cast doubt on its continuing vitality, arguing that legislation<br />
that has undercut the market for corporate control has allowed<br />
managers to engage in more self-serving behavior. 92<br />
In the late 1980s, however, the Contract Model provided considerable<br />
theoretical support for the passage of section 102(b)(7) <strong>and</strong> its<br />
clones. Shareholders who applauded the decision in <strong>Van</strong> <strong>Gorkom</strong><br />
need do nothing. Shareholders who preferred the pre-<strong>Van</strong> <strong>Gorkom</strong><br />
rules were free to return to them. That large numbers of corporations<br />
elected to do so was thus justified, not as a managerial power grab, but<br />
rather as an appropriate exercise of shareholder governance.<br />
89. Henry N. Butler & Larry E. Ribstein, Opting Out of Fiduciary Duties: A Response to<br />
Anti-Contractarians, 65 WASH. L. REV. 1, 7 (1990).<br />
90. STEPHEN M. BAINBRIDGE, CORPORATION LAW AND ECONOMICS 28-31 (2002); FRANK<br />
H. EASTERBROOK & DANIEL R. FISCHEL, THE ECONOMIC STRUCTURE OF CORPORATE LAW 34-<br />
36 (1991).<br />
91. Butler & Ribstein, supra note 89, at 28-32.<br />
92. Henry G. Manne, Editorial, The Follies of Regulation, WALL ST. J., Sept. 27, 2005, at<br />
A19.
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As a result of the widespread elections to insert exculpatory provisions<br />
in corporate charters, many commentators believe the passage<br />
of section 102(b)(7) <strong>and</strong> its progeny effectively overruled <strong>Van</strong><br />
<strong>Gorkom</strong>. 93 Not surprisingly, it has become commonplace to assume<br />
that the enactment of section 102(b)(7) had—<strong>and</strong> continues to have—<br />
a profound impact on corporate governance <strong>and</strong> the potential exposure<br />
of corporate directors to personal liability. The validity of that<br />
assumption, however, is shaky. It depends largely on the belief that<br />
directors truly faced an increased risk of personal liability in the post-<br />
<strong>Van</strong> <strong>Gorkom</strong>, pre-section 102(b)(7) world. But did they?<br />
It is true that before <strong>Van</strong> <strong>Gorkom</strong>, no one thought directors faced<br />
any real threat of liability for breaching their duty of care. And it is<br />
true that in holding the Trans Union directors personally liable, <strong>Van</strong><br />
<strong>Gorkom</strong> did make clear that directors were at risk. But <strong>Van</strong> <strong>Gorkom</strong><br />
threatened liability only if directors failed miserably in following an<br />
appropriate decision-making procedure like that outlined in the decision.<br />
94 A well-advised board had little to fear.<br />
Indeed, the <strong>Van</strong> <strong>Gorkom</strong> opinion actually resolved troubling issues<br />
about the potential liability of directors in ways that should have<br />
done much to allay the fears of most directors. In its opinion, the<br />
court reiterated its holding in Aronson v. Lewis95 that gross negligence,<br />
<strong>and</strong> not the simple negligence st<strong>and</strong>ard implied by the duty-ofcare<br />
rhetoric, 96 was the appropriate st<strong>and</strong>ard for determining director<br />
liability. 97 The court also affirmed that the business judgment rule<br />
created a presumption that the directors acted in good faith <strong>and</strong> stated<br />
that the gross negligence st<strong>and</strong>ard applied to plaintiffs’ attempts to<br />
overcome the business judgment rule. 98 Finally, the court laid the<br />
groundwork for the developing distinction between substantive due<br />
care (did the board make the correct decision?) <strong>and</strong> procedural due<br />
care (did the board employ a reasonable process in making its deci-<br />
93. See, e.g., Edward Rock & Michael Wachter, Dangerous Liaisons: Corporate Law, Trust<br />
Law <strong>and</strong> Interdoctrinal Legal Transplants, 96 NW. U. L. REV. 651, 651-52 (2002) (“People were<br />
shocked by <strong>Smith</strong> v. <strong>Van</strong> <strong>Gorkom</strong>. Teeth were gnashed. The Delaware General Corporate Law<br />
. . . was amended. The world went on. . . . The story has a happy ending. Shareholders, managers,<br />
<strong>and</strong> the Delaware legislature rode to the rescue, enacted section 102(b)(7) <strong>and</strong> largely restored<br />
the status quo ante. But it is a cautionary tale nonetheless. Transplanting legal concepts,<br />
without attention to the underlying context, can cause great mischief.”).<br />
94. Bayless Manning, Reflections <strong>and</strong> Practical Tips on Life in the Boardroom After <strong>Van</strong><br />
<strong>Gorkom</strong>, 41 BUS. LAW. 1 (1985).<br />
95. 473 A.2d 805, 812 (Del. 1984).<br />
96. At the time, the typical statement of the directors’ obligation was that they should use<br />
that “amount of care which ordinarily careful <strong>and</strong> prudent men would use in similar circumstances.”<br />
Graham v. Allis-Chalmers Mfg. Co., 188 A.2d 125, 130 (Del. 1963); see also Stephen<br />
A. Radin, The Director’s Duty of Care Three Years After <strong>Smith</strong> v. <strong>Van</strong> <strong>Gorkom</strong>, 39 HASTINGS<br />
L.J. 707, 711 (1988).<br />
97. <strong>Smith</strong> v. <strong>Van</strong> <strong>Gorkom</strong>, 488 A.2d 858, 873 (Del. 1985).<br />
98. Id.
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322 Washburn Law Journal [Vol. 45<br />
sion?). 99 As a result of the decision, directors generally are shielded<br />
from liability exposure in most instances so long as they employ an<br />
appropriate decision-making process. 100<br />
In short, despite the hysteria of the moment, directors were no<br />
more at risk after <strong>Van</strong> <strong>Gorkom</strong> than they ever were before. As one<br />
commentator stated, “the [<strong>Van</strong> <strong>Gorkom</strong>] opinion is not a sc<strong>and</strong>alous<br />
harbinger of increased exposure. Quite to the contrary, the decision<br />
arguably lowered the st<strong>and</strong>ard of conduct by defining breaches of the<br />
duty of care in terms of ‘gross’ rather than ‘ordinary’ negligence.” 101<br />
In light of the considerable protection provided directors by the<br />
court’s analysis in <strong>Van</strong> <strong>Gorkom</strong>, one might draw a rather startling conclusion:<br />
Despite the controversy surrounding the enactment of the exculpatory<br />
provisions, section 102(b)(7) <strong>and</strong> its progeny elsewhere<br />
provided directors with little real additional protection. Simply put,<br />
the effect of the statute was psychological, not legal. While the new<br />
provisions appeared to calm the troubled seas, anyone who had<br />
stepped back <strong>and</strong> surveyed the l<strong>and</strong>scape would have concluded that<br />
the waters were already quite placid.<br />
The claim that the exculpatory provisions did not play a key role<br />
in protecting directors from actual litigation gains some support by the<br />
results of the paucity of suits holding directors liable in those jurisdictions<br />
that were slow to provide any protection for corporate directors.<br />
Section 204(a)(10) of the California Code still provides no protection<br />
99. Id. at 893 (“To summarize: we hold that the director defendants of Trans Union<br />
breached their fiduciary duty to their stockholders . . . by their failure to inform themselves of all<br />
information reasonably available to themselves <strong>and</strong> relevant to their decision to recommend the<br />
Pritzker merger . . . .”).<br />
100. Note that I do not claim that <strong>Van</strong> <strong>Gorkom</strong> had no effect on corporate decision-making.<br />
Indeed, it has had a substantial effect. Whether the overall effect was beneficial or detrimental<br />
continues to be a matter of debate. Some commentators believe that <strong>Van</strong> <strong>Gorkom</strong> had injurious<br />
effects in that it encouraged directors to “over process” their decision-making. The claim is that<br />
directors engage in choreographed meetings <strong>and</strong> employ outside experts, such as investment<br />
bankers, to secure fairness opinions in most corporate control transactions. Charles M. Elson &<br />
Robert B. Thompson, <strong>Van</strong> <strong>Gorkom</strong>’s Legacy: The Limits of Judicially Enforced Constraints <strong>and</strong><br />
the Promise of Proprietary Incentives, 96 NW. U. L. REV. 579, 586 (2002). But see, Helen M.<br />
Bowers, Fairness Opinions <strong>and</strong> the Business Judgment Rule: An Empirical Investigation of Target<br />
Firms’ Use of Fairness Opinions, 96 NW. U. L. REV. 567 (2002) (finding that the frequency of<br />
target firms’ use of fairness reports in the post-<strong>Van</strong> <strong>Gorkom</strong> years was not materially different<br />
from their use in the five years prior to the decision). On the other h<strong>and</strong>, some commentators,<br />
including me, believe that the process culture created by <strong>Van</strong> <strong>Gorkom</strong> has indeed led to improved,<br />
more thoughtful collective decision-making. See Lynn A. Stout, In Praise of Procedure:<br />
An Economic <strong>and</strong> Behavioral Defense of <strong>Smith</strong> v. <strong>Van</strong> <strong>Gorkom</strong> <strong>and</strong> the Business Judgment Rule,<br />
96 NW. U. L. REV. 675 (2002). At the same time, I must acknowledge that the tendency to<br />
advocate a process-based approach to a problem is an occupational hazard of those legally<br />
trained. Grant Gilmore’s classic aphorism provides the most notable admonishment against<br />
over reliance on process: “The better the society, the less law there will be. In Heaven there will<br />
be no law, <strong>and</strong> the lion will lie down with the lamb . . . . In Hell there will be nothing but law, <strong>and</strong><br />
due process will be meticulously observed.” GRANT GILMORE, THE AGES OF AMERICAN LAW<br />
111 (1977).<br />
101. Roberta Romano, What Went Wrong with Directors’ <strong>and</strong> Officers’ <strong>Liability</strong> Insurance?,<br />
14 DEL. J. CORP. L. 1, 24 (1989).
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for directors against <strong>Van</strong> <strong>Gorkom</strong>-like claims. 102 An idiosyncratic<br />
charter-option provision, California’s provision is applicable only to<br />
actions brought by or on behalf of the corporation. It does not apply<br />
to shareholder class actions such as the one brought by the plaintiffs in<br />
<strong>Van</strong> <strong>Gorkom</strong>. Yet there are no reported cases holding any director of<br />
a California corporation personally liable for damages for a breach of<br />
her duty of care.<br />
Likewise, there are no reported cases holding directors liable in<br />
states that were slow to adopt any director-protection provision. For<br />
example, no directors of an Illinois corporation were held personally<br />
liable for a breach of their duty of care even though the Illinois legislature<br />
did not provide them with a charter-option provision until 1993,<br />
eight years after the <strong>Van</strong> <strong>Gorkom</strong> decision. 103<br />
Moreover, even when states did adopt charter-option provisions,<br />
they did not permit corporations to shelter directors from liabilities<br />
arising from acts that occurred prior to the effective date of the revised<br />
statute. One would have thought that had <strong>Van</strong> <strong>Gorkom</strong> really<br />
opened the liability floodgates, the plaintiffs’ bar would have eagerly<br />
sought to impose liability for those unsheltered acts. Yet there are no<br />
reported cases imposing liability on directors for acts that occurred<br />
prior to the effective dates of any of those statutes.<br />
If the threat of personal liability was so minimal following <strong>Van</strong><br />
<strong>Gorkom</strong>, why then did charter-option provisions <strong>and</strong> other liabilitylimiting<br />
legislation become so popular in the years immediately following<br />
the decision? The answer is complex. In part, there was genu-<br />
102. CAL. CORP. CODE § 204(a)(10) (West 1990). Section 204(a)(10) provides:<br />
The articles of incorporation may set forth:<br />
(a) Any or all of the following provisions, which shall not be effective unless expressly<br />
provided in the articles: . . . (10) Provisions eliminating or limiting the personal liability<br />
of a director for monetary damages in an action brought by or in the right of the corporation<br />
for breach of a director’s duties to the corporation <strong>and</strong> its shareholders, as set<br />
forth in [s]ection 309, provided, however, that (A) such a provision may not eliminate<br />
or limit the liability of directors (i) for acts or omissions that involve intentional misconduct<br />
or a knowing <strong>and</strong> culpable violation of law, (ii) for acts or omissions that a<br />
director believes to be contrary to the best interests of the corporation or its shareholders<br />
or that involve the absence of good faith on the part of the director, (iii) for any<br />
transaction from which a director derived an improper personal benefit, (iv) for acts or<br />
omissions that show a reckless disregard for the director’s duty to the corporation or its<br />
shareholders in circumstances in which the director was aware, or should have been<br />
aware, in the ordinary course of performing a director’s duties, of a risk of serious<br />
injury to the corporation or its shareholders, (v) for acts or omissions that constitute an<br />
unexcused pattern of inattention that amounts to an abdication of the director’s duty to<br />
the corporation or its shareholders, (vi) under [s]ection 310, or (vii) under [s]ection 316,<br />
(B) no such provision shall eliminate or limit the liability of a director for any act or<br />
omission occurring prior to the date when the provision becomes effective, <strong>and</strong> (C) no<br />
such provision shall eliminate or limit the liability of an officer for any act or omission<br />
as an officer, notwithst<strong>and</strong>ing that the officer is also a director or that his or her actions,<br />
if negligent or improper, have been ratified by the directors.<br />
Id. (emphasis added).<br />
103. 805 ILL. COMP. STAT. ANN. 5/2.10(b)(3) (West 2004) (added in 1993 by Public Act 88-43,<br />
S. 448, 88th Gen. Assem. (Ill. 1993)).
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324 Washburn Law Journal [Vol. 45<br />
ine fear <strong>and</strong> shock that the rules had in some way changed. Even<br />
though <strong>Van</strong> <strong>Gorkom</strong> itself was not the anti-managerial disaster many<br />
proclaimed it to be, no one could be sure that another shoe was not<br />
about to drop. The concern resulting from that uncertainty was magnified<br />
by the hard times precipitated by the economic decline of the<br />
late 1980s. Perhaps more importantly, the dramatic increase in hostile<br />
takeover activity that occurred during the decade placed directors in<br />
the uncomfortable position of having to make major financial decisions<br />
under incredible time pressure. Many directors naturally feared<br />
that plaintiffs’ counsel, armed with hindsight, might persuade a court<br />
to “<strong>Van</strong> <strong>Gorkom</strong>”-ize an unprofitable decision on the theory that the<br />
directors had acted too hastily.<br />
To make matters worse, for reasons only tangentially related to<br />
<strong>Van</strong> <strong>Gorkom</strong>, D&O insurance rates began to soar. 104 The causes for<br />
the increased rates were multifold, but it became a popular, yet misguided,<br />
sport to point to the <strong>Van</strong> <strong>Gorkom</strong> decision as a major contributing<br />
cause. 105 For these <strong>and</strong> other reasons, the pressure to undo <strong>Van</strong><br />
<strong>Gorkom</strong> legislatively—or to head it off with legislation in states in<br />
which the courts had not rendered a <strong>Van</strong> <strong>Gorkom</strong>-like decision—<br />
proved irresistible to most state legislatures.<br />
Eventually, D&O rates returned to normal levels, <strong>and</strong> outside directors<br />
breathed a sigh of relief. Some no doubt attributed the eventual<br />
calming of the liability crisis to the enactment of the exculpatory<br />
provisions. Those provisions, however, were likely little more than<br />
placebos that helped steady the spirits of many would-be directors<br />
while they waited for the return of normalcy.<br />
VI. THE CASE FOR EXPANDING THE SCOPE OF EXCULPATORY<br />
PROVISIONS TO INCLUDE OFFICERS<br />
If the effect of the exculpatory provisions has been largely symbolic,<br />
one might think it perplexing that I nevertheless now argue that<br />
states should follow the lead of those seven states—Louisiana, 106 Ma-<br />
104. E. Norman Veasey, Jesse A. Finkelstein & C. Stephen Bigler, Responses to the D&O<br />
Insurance Crisis, 19 REV. SEC. & COMM. REG. 263 (1986).<br />
105. For a thorough discussion of the D&O liability insurance crisis in the late 1980s, see<br />
Romano, supra note 101; see also Roberta Romano, Corporate Governance in the Aftermath of<br />
the Insurance Crisis, 39 EMORY L.J. 1155, 1157-60 (1990).<br />
106. LA. REV. STAT. ANN. § 12:24(c)(4) (1994 & Supp. 2006).
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ryl<strong>and</strong>, 107 Nevada, 108 New Hampshire, 109 New Jersey, 110 Utah, 111 <strong>and</strong><br />
Virginia 112 —that have extended the protection of their exculpatory<br />
provisions to corporate officers. Indeed, given the paucity of reported<br />
actions seeking to impose liability on corporate officers, one might<br />
argue that such protection is unnecessary; I believe otherwise. In today’s<br />
post-Enron business-legal environment, corporate officers face a<br />
substantial risk of liability litigation, including claims of negligent conduct.<br />
While the latter type of litigation may ultimately be unsuccessful,<br />
its specter likely will have undesirable consequences on officer<br />
behavior <strong>and</strong>, in turn, on corporate performance. Providing officers<br />
an exculpatory shield will prevent the harm of threatened litigation.<br />
Increased liability exposure for corporate officers seems inevitable.<br />
Because many of the Enron-era corporate fiascos can be traced<br />
to misbehavior by corporate officers, there have been, <strong>and</strong> will continue<br />
to be, calls for holding corporate officers accountable for corporate<br />
failings. 113 Indeed, there already have been changes at the<br />
federal level. A number of the provisions of the Sarbanes-Oxley Act<br />
of 2002 114 focus on the potential criminal <strong>and</strong> civil liability of corporate<br />
officers. 115 The fallout from Enron <strong>and</strong> similar corporate sc<strong>and</strong>als,<br />
however, has affected more than just federal law. The ongoing<br />
debate about the desirability of federalizing corporate law seems certain<br />
to pressure states, particularly Delaware, to demonstrate concern<br />
about the apparent deviant behavior of corporate officers. 116<br />
The decision by the Delaware legislature to amend its procedural<br />
code to exp<strong>and</strong> the courts’ jurisdiction over officers of Delaware corporations<br />
is probably a response to such pressure. Prior to 2004, Delaware<br />
courts were unable to exercise personal jurisdiction over<br />
107. MD. CODE ANN., CORPS. & ASS’NS §§ 2-104(b)(8), 2-405.2 (LexisNexis 1999); MD.<br />
CODE ANN, CTS. & JUD. PROC. § 5-418 (LexisNexis 2002). For discussions of the Maryl<strong>and</strong><br />
provisions, see James J. Hanks, Jr. & Larry P. Scriggins, Let Stockholders Decide: The Origins of<br />
the Maryl<strong>and</strong> Director <strong>and</strong> Officer <strong>Liability</strong> Statute of 1988, 18 U. BALT. L. REV. 235 (1989);<br />
Dennis R. Honabach, Consent, Exit, <strong>and</strong> the Contract Model of the Corporation—A Commentary<br />
on Maryl<strong>and</strong>’s New Director <strong>and</strong> Officer <strong>Liability</strong> Limiting <strong>and</strong> Indemnification Legislation Statute,<br />
18 U. BALT. L. REV. 310 (1989); <strong>and</strong> Mark Sargent, Two Cheers for the Maryl<strong>and</strong> Director<br />
<strong>and</strong> Officer <strong>Liability</strong> Statute, 18 U. BALT. L. REV. 278 (1989).<br />
108. NEV. REV. STAT. § 78.138(7) (2003).<br />
109. N.H. REV. STAT. ANN. § 293-A:2.02(b)(4) (LexisNexis 1999).<br />
110. N.J. STAT. ANN. § 14A:2-7(3) (West 2003).<br />
111. UTAH CODE ANN. § 16-10a-840(4) (2001).<br />
112. VA. CODE ANN. § 13.1-692.1 (1999). For a discussion of Virginia’s provision, see Dennis<br />
R. Honabach, All that Glitters: A Critique of the Revised Virginia Stock Corporation Act, 12 J.<br />
CORP. L. 433, 472 (1987).<br />
113. Troy A. Paredes, Corporate Decisionmaking: Too Much Pay, Too Much Deference: Behavioral<br />
Corporate Finance, CEOs, <strong>and</strong> Corporate Governance, 32 FLA. ST. U. L. REV. 673, 749<br />
(2005).<br />
114. Pub. L. No. 107-204, 116 Stat. 745 (codified as amended in scattered sections of titles 11,<br />
15, 18, 28, <strong>and</strong> 29 U.S.C.).<br />
115. E.g., Sarbanes-Oxley Act of 2002 §§ 302, 305(b), 906(a).<br />
116. See, e.g., Robert B. Thompson, Delaware, the Feds, <strong>and</strong> the Stock Exchange: Challenges<br />
to the First State as First in Corporate Law, 29 DEL. J. CORP. L. 779, 790-92 (2004).
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officers under the rule of Shaffer v. Heitner. 117 Some commentators<br />
have pointed to that lack of jurisdiction as the probable cause for the<br />
dearth of any significant officer liability litigation. 118 Perhaps fearing<br />
federalization of corporate law, the Delaware legislature amended<br />
section 3114(a) of title 10 of its code to provide for implied jurisdiction<br />
over corporate officers, even if those officers do not serve as corporate<br />
directors. 119 The official explanation for the change was that<br />
[w]hile such officers are currently subject to personal jurisdiction in<br />
Delaware if they also serve as directors, the 2003 amendments establish<br />
personal jurisdiction over the most senior corporate officers<br />
identified in the statute <strong>and</strong> highly compensated executive officers<br />
identified in SEC filings regardless of whether they also serve as<br />
directors. Because of enhanced requirements for independent director<br />
representation on public company boards of directors, it is<br />
likely that fewer senior officers will also serve as directors. Therefore,<br />
had [s]ection 3114 not been amended, the ability to obtain personal<br />
jurisdiction in Delaware over some of the most significant<br />
participants in corporate governance would have been impaired. 120<br />
If the revision of section 3114 has the effect desired by some reformers,<br />
officers should expect to face increased exposure to litigation.<br />
The impact of that increased litigation depends ultimately on the<br />
law applicable in care cases brought against corporate officers. The<br />
traditional articulation of an officer’s duty of care is that the officer<br />
should act in good faith in what she reasonably believes to be in the<br />
best interest of the corporation using the care that a person in like<br />
circumstances would reasonably exercise under similar circumstances.<br />
121 That formulation tracks closely the st<strong>and</strong>ard generally applicable<br />
to directors. It implies, just as it did when originally applied<br />
to directors, that an officer who acts negligently will be held personally<br />
liable for the loss she causes. In applying the reasonable director<br />
st<strong>and</strong>ard, the courts have required plaintiffs to prove gross negligence<br />
as a precondition to director liability. The courts have further insulated<br />
directors from liability by applying the business judgment rule to<br />
117. 433 U.S. 186 (1977).<br />
118. E.g., Hillary A. Sale, Delaware’s Good Faith, 89 CORNELL L. REV. 456, 459 (2004);<br />
William B. Ch<strong>and</strong>ler III & Leo. E. Strine, Jr., The New Federalism of the American Corporate<br />
Governance System: Preliminary Reflections of Two Residents of One Small State, 152 U. PA. L.<br />
REV. 953, 1003 (2003).<br />
119. See DEL. CODE ANN. tit. 10, § 3114 (1999 & Supp. 2004). Chancellors William B. Ch<strong>and</strong>ler<br />
III <strong>and</strong> Leo E. Strine Jr. indeed offered that explanation for the revision of section 3114.<br />
They contended that the change was appropriate given the increase in the number of independent,<br />
non-officer directors resulting from the changes in corporate governance patterns. They<br />
noted that, in the past, most officers also served as directors <strong>and</strong> thus were subject to directorbased<br />
jurisprudence rules. See Ch<strong>and</strong>ler & Strine, supra note 118.<br />
120. State of Delaware, http://www.state.de.us/corp/2003amends.shtml (last visited Jan. 24,<br />
2006).<br />
121. MODEL BUS. CORP. ACT § 8.42 (2002).
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shelter from review many directorial actions not involving self-dealing<br />
or changes in control. 122<br />
Is simple negligence or gross negligence the st<strong>and</strong>ard for finding<br />
liability in cases against officers? Does the business judgment rule apply<br />
to officers? A few states have answered these questions statutorily.<br />
Louisiana 123 <strong>and</strong> Utah 124 required plaintiffs to prove that an<br />
officer’s conduct constituted gross negligence. Nevada provides officers<br />
with even more protection; it conditions a finding of liability<br />
upon plaintiffs’ ability to prove that an officer’s conduct constituted<br />
intentional wrongdoing, fraud, or misconduct. 125<br />
Most states’ legislatures, however, have not addressed either<br />
question, leaving their resolution to the courts. Surprisingly, few<br />
courts have answered either question. As a result, the existing case<br />
law is both sparse <strong>and</strong> conflicting. A few courts have spoken loosely<br />
of holding corporate officers to a simple negligence st<strong>and</strong>ard. Most,<br />
however, have tended to speak of officers <strong>and</strong> directors interchangeably,<br />
implying that the same rules are applicable to both. 126<br />
In the aftermath of Enron, several commentators have attempted<br />
to analyze both the existing law <strong>and</strong> its desirability. In an important<br />
article, Professors Lyman P.Q. Johnson <strong>and</strong> David Millon, two of the<br />
premier corporate law theorists of the day, have argued that officers<br />
are <strong>and</strong> should be subject to more scrutiny <strong>and</strong> to a stricter st<strong>and</strong>ard<br />
of liability than corporate directors. 127 They argue that the failure of<br />
the courts to distinguish between the st<strong>and</strong>ard to be employed to evaluate<br />
directors <strong>and</strong> the st<strong>and</strong>ard to be employed to evaluate corporate<br />
officers is the consequence of the failure of legal theorists to explain<br />
why corporate officers are fiduciaries. 128 Professors Johnson <strong>and</strong> Millon<br />
note that while directors are not corporate agents (<strong>and</strong> thus may<br />
be properly held only to a gross negligence st<strong>and</strong>ard) 129 corporate officers<br />
are agents <strong>and</strong> should be treated as such. The law of agency,<br />
they emphasize, has developed over time a rich body of fiduciary law,<br />
one tenet of which is that absent an agreement otherwise, agents are<br />
122. For a thorough discussion of the business judgment rule, see DENNIS J. BLOCK, NANCY<br />
E. BARTON & STEPHEN A. RADIN, THE BUSINESS JUDGMENT RULE: FIDUCIARY DUTIES OF<br />
CORPORATE DIRECTORS (5th ed. 1998).<br />
123. LA. REV. STAT. ANN. § 12.91(A)-(E) (Supp. 2006).<br />
124. UTAH CODE ANN. § 16-10(a)-840(4) (2001).<br />
125. NEV. REV. STAT. § 78.138 (2003).<br />
126. See generally A. Gilchrist Sparks III & Lawrence A. Hamermesh, Common Law Duties<br />
of Non-Director Corporate Officers, 48 BUS. LAW. 215 (1992) (discussing the sparse case law<br />
addressing the issue of the fiduciary duties of corporate officers).<br />
127. Lyman P.Q. Johnson & David Millon, Recalling Why Corporate Officers Are Fiduciaries,<br />
46 WM. & MARY L. REV. 1597 (2005); see also Lyman P.Q. Johnson, Corporate Officers <strong>and</strong><br />
the Business Judgment Rule, 60 BUS. LAW. 439 (2005); Lyman P.Q. Johnson & Mark Sides, The<br />
Sarbanes-Oxley Act <strong>and</strong> Fiduciary Duties, 30 WM. MITCHELL L. REV. 1149, 1223-24 (2004).<br />
128. Johnson & Millon, supra note 127, at 1623-27.<br />
129. Id. at 1639.
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328 Washburn Law Journal [Vol. 45<br />
held to a st<strong>and</strong>ard of simple negligence. 130 Finding no such agreement,<br />
Professors Johnson <strong>and</strong> Millon argue that officers should be<br />
held to the “highly context-specific” st<strong>and</strong>ard applied in tort law to<br />
other agents to ensure that officers exercise appropriate<br />
stewardship. 131<br />
Professors Johnson <strong>and</strong> Millon note that while most states permit<br />
corporations to reduce or eliminate director liability for failure to satisfy<br />
their duty of care, only a few permit corporations to similarly<br />
shield officers from monetary liability. They imply that this state of<br />
affairs is a result of a tacit recognition that corporate officers should<br />
be held to a higher st<strong>and</strong>ard. 132 They never address the obvious possibility<br />
that the reason most exculpatory provisions apply only to a director<br />
might well be explained more easily as a historical artifact, a<br />
response to <strong>Van</strong> <strong>Gorkom</strong>.<br />
Elsewhere, Professor Johnson has argued that corporate officers<br />
are unable, <strong>and</strong> should not be permitted, to avail themselves of the<br />
protections provided by the business judgment rule. 133 To support his<br />
position, he advances several arguments in support of his contention<br />
that there is an important distinction between applying the business<br />
judgment rule to officers’ conduct <strong>and</strong> the application of a st<strong>and</strong>ard of<br />
reasonable care, rather than gross negligence. 134 Professor Johnson<br />
begins his analysis by categorizing the rationales for applying the business<br />
judgment rule to corporate directors into three policies. He identifies<br />
these policies as: “encouraging directors to serve <strong>and</strong> take risks;<br />
avoiding judicial encroachment into business decisions; <strong>and</strong> preserving<br />
the board’s central decision making role in corporate governance.” 135<br />
Professor Johnson then argues that the first <strong>and</strong> third policies<br />
simply do not apply to corporate officers. He contends that officers<br />
do not need additional protection to take on appropriate risks because<br />
they, unlike directors, receive substantial compensation. 136 He also<br />
contends that officers should bear greater risks because they work full<br />
time <strong>and</strong> have specialized knowledge that is unavailable to directors.<br />
137 Preserving the board’s governance role, he contends, requires<br />
130. RESTATEMENT (SECOND) OF AGENCY § 379 (1958).<br />
131. Johnson & Millon, supra note 127, at 1637. Elsewhere, Professor Johnson has teamed<br />
up with Mark A. Sides to again argue that, as agents, corporate officers should be held to the<br />
st<strong>and</strong>ard of ordinary care. Unfortunately, Johnson <strong>and</strong> Sides likewise fail to explain why the<br />
st<strong>and</strong>ard of care for corporate officers should be greater than one of gross negligence. They too<br />
seem to assume that the officer’s status as agent is self-explanatory. Johnson & Sides, supra note<br />
127.<br />
132. Johnson & Millon, supra note 127, at 1639.<br />
133. Johnson, supra note 127.<br />
134. Id. at 455-66.<br />
135. Id. at 455.<br />
136. Id. at 458-59.<br />
137. Id. at 460.
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that the board decide whether to pursue a claim against an officer. 138<br />
The courts, Professor Johnson maintains, should not automatically<br />
shield officer action from review.<br />
Professor Johnson does admit that the second rationale, “avoiding<br />
judicial encroachment into business judgment,” might have some<br />
application to officers. 139 He contends, however, that the rationale<br />
would only prevent assessment of the substantive soundness of the<br />
decision. He argues that the rationale does not support barring courts<br />
from assessing the process by which the officers made that decision. 140<br />
In other words, he would have courts apply <strong>Van</strong> <strong>Gorkom</strong>’s processoriented<br />
assessment whenever plaintiffs challenge an officer’s action.<br />
To conclude his arguments, Professor Johnson notes that if one<br />
accepts the popular neo-classical economic proposition that existing<br />
rules reflect shareholder preferences, one could infer from the status<br />
quo that shareholders prefer, or at least are willing to tolerate, the<br />
existing st<strong>and</strong>ard of simple reasonable care applied in determining officer<br />
liability. 141 Moreover, Professor Johnson adds that if shareholders<br />
truly prefer to hold officers to a lesser st<strong>and</strong>ard, they can simply<br />
contract for such a st<strong>and</strong>ard. 142 He also notes that states could provide<br />
officers with more protection but most do not. Finally, he notes,<br />
corporations can easily shield officers from personal liability by<br />
purchasing D&O liability coverage. Directors could then sue officers<br />
<strong>and</strong> obtain recovery from the insurance carrier rather than the officer<br />
himself. 143 Professor Johnson recognizes that the availability of D&O<br />
proceeds would undercut the deterrent effect of the liability he seeks.<br />
He suggests, though, that diminution in deterrence might be offset<br />
somewhat by requiring officers to remain liable for a portion of any<br />
judgment. 144<br />
138. Id. at 464-65.<br />
139. Id. at 455.<br />
140. Id. at 463.<br />
141. Id. at 466. It seems unlikely that Professor Johnson truly believes this point. Rather, it<br />
appears he is simply tweaking the arguments of those who espouse the oft-overstated neoclassical<br />
law <strong>and</strong> economics position that, whatever the rule, it must be the rule shareholders desire.<br />
The correctness of his proposition is entirely dependent on description of the current rule, which<br />
is murky at best. He admits that point is not clear. He adds, however, that “it is hard to believe<br />
most investors wish to hold officers to a st<strong>and</strong>ard of care below what they expect from all other<br />
people (except directors) who act on their behalf, such as doctors, lawyers, . . . etc.” Id. He<br />
offers no support for this normative assertion.<br />
142. Id. at 466-67. The validity of Professor Johnson’s assertion that officers could simply<br />
modify their fiduciary duties by contract in the absence of any statutory authorization is unclear.<br />
Certainly Contractarians would support that proposal, but traditionalists are likely to argue<br />
against permitting that form of private ordering.<br />
143. On this point, Professor Johnson errs in that he overlooks the “insured against insured”<br />
exclusion in D&O policies, which renders the policy inapplicable to suits brought by the corporation<br />
itself, other than derivative suits. JOSEPH WARREN BISHOP, JR., THE LAW OF CORPORATE<br />
OFFICERS AND DIRECTORS INDEMNIFICATION AND INSURANCE § 8:16 (Jennifer L. Berger Revision<br />
2004); see also CORPORATE GOVERNANCE: LAW AND PRACTICE § 5.04(4)(d) (2005).<br />
144. Johnson, supra note 127, at 468.
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330 Washburn Law Journal [Vol. 45<br />
Professor Johnson’s analysis has not gone unchallenged. In an<br />
article responding to Professor Johnson’s most recent piece, Professor<br />
Lawrence A. Hamermesh <strong>and</strong> A. Gilchrist Sparks III review Professor<br />
Johnson’s analysis <strong>and</strong> find it unpersuasive. 145 They argue that the<br />
rationales for applying the business judgment rule to corporate directors<br />
apply equally well to corporate officers. They note that a shield<br />
from liability is necessary to encourage corporate officers to make the<br />
types of risky business decisions that shareholders desire of their corporate<br />
officers. They point out that contrary to Professor Johnson’s<br />
suggestion, D&O policy protection will be unavailable to officers in an<br />
action brought by the corporation. 146 While they agree with Professor<br />
Johnson’s recognition that courts should not second-guess the substance<br />
of an officer’s decision, Hamermesh <strong>and</strong> Sparks strongly disagree<br />
with his assertion that the courts should evaluate the decisionmaking<br />
process employed by corporate officers. 147 Finally, they disagree<br />
with Professor Johnson’s assertion that imposing a higher st<strong>and</strong>ard<br />
of care on corporate officers would serve to preserve the board’s<br />
governance role. They argue instead that such a rule would actually<br />
encourage officers to pass on risky decisions to the board, a result that<br />
would infringe upon the board’s ability to delegate appropriate authority<br />
<strong>and</strong> decision-making to officers. The result, they contend,<br />
would be top-heavy management. 148<br />
Despite the spirited discourse between the commentators, the<br />
current state of the law remains uncertain. Given that uncertainty <strong>and</strong><br />
given the widespread calls for holding officers accountable for corporate<br />
misfortunes, officers can expect to find themselves more frequently<br />
named defendants in actions alleging they breached their duty<br />
of care. Eventually the courts will resolve the uncertainty surrounding<br />
the applicable liability rule in such cases, but that resolution will be a<br />
long time coming. That delay itself will be unsettling to corporate officers.<br />
Moreover, the risk that courts might decide to hold officers to<br />
a st<strong>and</strong>ard of ordinary negligence <strong>and</strong> deny them the protection of the<br />
business judgment rule will loom large over officers as they go about<br />
their work. The imposition of liability, or even the threat of liability,<br />
will have a chilling effect on the risk-taking conduct of corporate officers.<br />
Indeed, in all likelihood, the current debate over the applica-<br />
145. Lawrence A. Hamermesh & A. Gilchrist Sparks III, Corporate Officers <strong>and</strong> the Business<br />
Judgment Rule: A Reply to Professor Johnson, 60 BUS. LAW. 865 (2005) [hereinafter Reply to<br />
Professor Johnson]. In an earlier article, Hamermesh <strong>and</strong> Sparks concluded that “[t]he business<br />
judgment rule is almost universally applied to officers.” See Sparks & Hamermesh, supra note<br />
126, at 237.<br />
146. Reply to Professor Johnson, supra note 145, at 871.<br />
147. Id. at 873-74.<br />
148. Id. at 874-75.
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bility of the business judgment rule to officer conduct has already had<br />
a chilling effect.<br />
One way to eliminate the uncertainty over how courts will resolve<br />
the officer liability issues would be to amend the exculpatory provisions<br />
to provide officers statutory protection from personal liability.<br />
Exp<strong>and</strong>ing the coverage of the exculpatory provisions to include officers<br />
would not undercut the deterrent value of other statutes, such as<br />
the Sarbanes-Oxley Act, being implemented to combat officer misconduct<br />
of the type that occurred in Enron <strong>and</strong> subsequent corporate<br />
sc<strong>and</strong>als. The actions of Bernie Ebbers, 149 Andrew Fastow, 150 Dennis<br />
Kozlowski, 151 Joseph Nacchio, 152 John Rigas, 153 Jeff Skilling, 154 <strong>and</strong><br />
other corporate officers who have been indicted <strong>and</strong> convicted for<br />
their actions in the recent wave of corporate sc<strong>and</strong>als did not involve<br />
negligent conduct. Those officers would find no solace in an exculpatory<br />
provision, even if existing charter-option provisions, or<br />
m<strong>and</strong>atory provisions, were exp<strong>and</strong>ed to include corporate officers.<br />
Nor would the expansion of the exculpatory provisions affect the market,<br />
ethical, <strong>and</strong> moral forces that compel most officers to perform<br />
satisfactorily without regard to the possibility of liability.<br />
149. Bernie Ebbers is the former chief executive officer <strong>and</strong> one of the founders of<br />
WorldCom. Ebbers was found guilty of securities fraud, conspiracy, <strong>and</strong> filing false documents<br />
with regulators in connection with a fraud that over-reported WorldCom’s earnings from somewhere<br />
between five <strong>and</strong> eleven billion dollars. For a brief article, see Dan Ackman, Bernie<br />
Ebbers Guilty, FORBES.COM, Mar. 15, 2005, http://www.forbes.com/home/management/2005/03/<br />
15/cx_da_0315ebbersguilty.html.<br />
150. Andrew Fastow is the former chief financial officer of Enron. He pled guilty to two<br />
counts of wire <strong>and</strong> securities fraud, agreeing to serve a ten-year sentence <strong>and</strong> cooperate in the<br />
prosecution of other Enron executives. Fastow was an important figure in Enron’s use of “offbalance<br />
sheet special purpose entities” to hide the company’s massive losses. For a brief article,<br />
see Wikipedia, Andrew Fastow, http://en.wikipedia.org/wiki/Andrew_Fastow (last visited Jan. 24,<br />
2006).<br />
151. Leo Dennis Kozlowski is the former chief executive officer of Tyco International. Kozlowski<br />
was convicted on twenty-two counts of gr<strong>and</strong> larceny relating to $150 million in unauthorized<br />
bonuses. He was also convicted of fraud against the company’s stockholders in an amount<br />
over $400 million. For a brief article, see Wikipedia, Dennis Kozlowski, http://en.wikipedia.org/<br />
wiki/Dennis_Kozlowski (last visited Jan. 25, 2006).<br />
152. Joseph Nacchio is the former chief executive officer of Qwest Communications.<br />
Nacchio is currently facing civil suits brought by both the SEC <strong>and</strong> private shareholders. He has<br />
also been indicted on forty-two counts of insider trading relating to the allegedly illegal sale of<br />
$101 million in Qwest stock. The civil suits deal with a massive fraud between 1999 <strong>and</strong> 2002 in<br />
which Qwest falsely reported one-time sales or trades as recurring revenues in order to improperly<br />
book almost $3 billion in revenue which eased its merger with US West Inc. For a brief<br />
article, see Judith Kohler, Former Qwest CEO Joseph Nacchio Indicted, YAHOO FIN., Dec. 21,<br />
2005, http://biz.yahoo.com/ap/051221/qwest_nacchio.html?.v=2.<br />
153. John Rigas is the former chief executive officer <strong>and</strong> one of the founders of Adelphia<br />
Communications. He was forced to resign in 2002 after being indicted for wire, bank, <strong>and</strong> securities<br />
fraud. Rigas, his sons, <strong>and</strong> others were accused of concealing over $2.3 billion in liabilities<br />
from corporate investors <strong>and</strong> of misappropriating corporate funds. For a brief article, see<br />
Wikipedia, John Rigas, http://en.wikipedia.org/wiki/John_Rigas (last visited Jan. 25, 2006).<br />
154. Jeff Skilling was chief executive officer of Enron from February to August in 2001.<br />
Skilling was indicted on thirty-five counts, including fraud <strong>and</strong> insider trading relating to the<br />
collapse of Enron. For a brief article, see Wikipedia, Jeffrey Skilling, http://en.wikipedia.org/<br />
wiki/Jeffrey_Skilling (last visited Jan. 25, 2006).
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Moreover, there is good reason to believe shareholders would<br />
want to prevent liability litigation aimed at corporate officers for<br />
breaches of their duty of care. Corporate litigation is frightfully<br />
costly. The danger of strike suits is widely recognized. 155 In some instances<br />
the board itself may use the threat of litigation inappropriately<br />
to gain leverage in negotiating with corporate officers who have fallen<br />
out of favor. Even when shareholders sincerely believe that corporate<br />
officers have performed poorly, their use of litigation as a corrective<br />
tool will burden the corporation <strong>and</strong> their fellow shareholders with<br />
considerable expense both in terms of out-of-pocket costs as well as<br />
the opportunity costs incurred when management is compelled to defend<br />
itself in court rather than manage the corporation. Consequently,<br />
as is true with all civil litigation, litigation to enforce an<br />
officer’s duty of care can be justified only if it satisfies one of the following<br />
three goals: deterrence, compensation, or punishment. It is unlikely<br />
that such litigation would meet any of those goals.<br />
Most shareholders are unlikely to find much solace in viewing the<br />
imposition of personal liability as a form of punishment. They will<br />
likely view this as a cost the state should incur. On the other h<strong>and</strong>, the<br />
deterrence <strong>and</strong> compensation rationales, at least at first glance, appear<br />
to have some validity. The specter of liability will shape officer behavior.<br />
Likewise, recovery of a personal judgment against a wayward officer<br />
would provide some measure of recovery to the shareholders.<br />
But do either the deterrence or compensation justifications really support<br />
the argument for imposing personal liability on officers? Are the<br />
costs of such a liability scheme worth the benefits?<br />
There are reasons to believe they are not. The claim for imposing<br />
personal liability on an officer to deter misconduct seems weak. As<br />
many others have noted, officers already are subject to a number of<br />
incentives to act in an appropriate fashion, including the loss of reputation,<br />
the loss of employment, the desire to conform to cultural<br />
norms, <strong>and</strong> the desire to comply with ethical st<strong>and</strong>ards. While some<br />
commentators point to the recent sc<strong>and</strong>als as evidence that the deterrent<br />
effect of these restraints is insufficient, 156 no one doubts that<br />
these restraints exist <strong>and</strong> that they provide some deterrence against<br />
155. One might contend that strike suits are much less of a problem in litigation brought<br />
against corporate officers because the board of directors would control the decision of whether<br />
or not to proceed. That argument assumes, however, that the plaintiff would be unable to join<br />
the members of the board of directors as defendants for failing to have properly supervised the<br />
defendant officers.<br />
156. E.g., Lisa M. Fairfax, Spare the Rod, Spoil the Director? Revitalizing Directors’ Fiduciary<br />
Duty Through Legal <strong>Liability</strong>, 42 HOUS. L. REV. 393, 433-38 (2005). Such arguments appear to<br />
be a product of the Nirvana Fallacy, which compares the results of imperfect market forces<br />
against the results of idealized perfect government regulation.
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sloppy decision-making. And, most relevant for our purposes, these<br />
incentives are free <strong>and</strong> already exist.<br />
Nevertheless, one might contend that extending the coverage of<br />
the exculpatory provisions to officers is unwise because the prospect<br />
of facing a possible lawsuit for negligent conduct is worthwhile as it<br />
adds one more disincentive to sloppy decision-making. It is not<br />
enough, however, to note that the possibility of liability adds additional<br />
deterrence. The hard question is whether the benefit of the incremental<br />
addition to existing incentives exceeds its cost.<br />
That question is far easier to pose than to answer. The costs <strong>and</strong><br />
benefits of deterrence rules are devilishly difficult to measure. Moreover,<br />
little available empirical work exists to prove or disprove that<br />
claim. Indeed, we know little about how officers make decisions or<br />
about which processes work best in arriving at particular decisions. 157<br />
But whatever the merits of encouraging boards of directors to adopt a<br />
formal decision-making process in dealing with the types of questions<br />
that come before them, it seems unlikely that we should encourage<br />
corporate officers to take the same process-laden approach in every<br />
decision they make. 158 Indeed, there is reason to believe that rather<br />
than improving the quality of officer decision-making, the specter of<br />
liability might encourage officers to adopt inferior decision-making<br />
processes <strong>and</strong> to refrain from taking appropriate risks. 159<br />
The compensation claim for supporting litigation to enforce an<br />
officer’s duty of care likewise seems weak. The losses to a particular<br />
company resulting from poor decision-making can be astonishingly<br />
large. Even if some officers, mainly CEOs, have amassed the fortunes<br />
many believe they possess, it is not clear that many officers could actually<br />
be expected to pay a significant portion of the judgment that<br />
would result from breach-of-care litigation. Note that the $20 million<br />
that the <strong>Van</strong> <strong>Gorkom</strong> plaintiffs recovered in 1985 would now be worth<br />
157. Indeed, author Malcolm Gladwell argues that in some instances decision-making unencumbered<br />
by elaborate processes may produce superior results. MALCOLM GLADWELL, BLINK:<br />
THE POWER OF THINKING WITHOUT THINKING (2005). A similar point has been made by Samuel<br />
Fraidin. Samuel N. Fraidin, Duty of Care Jurisprudence: Comparing Judicial Intuition <strong>and</strong><br />
Social Psychology Research, 38 U.C. DAVIS L. REV. 1 (2004) (arguing that the duty of care<br />
jurisprudence as applied to directors “is incoherent, arbitrary, <strong>and</strong> inefficient” because it is not<br />
based on a robust theory of group decision-making).<br />
158. Unlike directors who act only at regular <strong>and</strong> special meetings, officers are called upon<br />
to make numerous types of decisions, including major decisions that result in recommendations<br />
to the boards, such as the hiring <strong>and</strong> discharging of employees, selection of teams to work on<br />
projects, <strong>and</strong> the determination of how closely to monitor an employee. Sometimes a decision<br />
that seems minor, such as which flights to take to a business meeting, will take on vital importance<br />
later. To suggest that all such decisions must be subjected to an exhaustive decision-making<br />
process, lest they be evaluated later by a jury functioning under the haze of the hindsight<br />
bias, seems quite undesirable.<br />
159. Hamermesh <strong>and</strong> Sparks make this point. See Reply to Professor Johnson, supra note<br />
145, at 875.
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334 Washburn Law Journal [Vol. 45<br />
more than $35 million. 160 The aggregate compensation 161 for the<br />
heads of the top 500 largest U.S. corporations in 2004 was $3.3 billion,<br />
only an average of $6.6 million each. While $6.6 million may seem<br />
like a massive amount, only a portion of it would be available to pay<br />
off a liability judgment, as most of it would have been spent. Even if<br />
some officers are incredibly wealthy, much of their wealth is likely to<br />
be shielded from execution on any judgment. It is also unlikely that<br />
shareholders can expect to gain much more from the officers as a<br />
group. CEOs as a group appear to be the only officers to have cashed<br />
in on the princely compensation available to corporate leaders.<br />
Compare the situation that arises in a care case with that which<br />
occurs in a loyalty case. In the former, recovery has traditionally been<br />
unlikely. In the latter, recovery is far more common. In a loyalty<br />
case, the amount at stake is likely to be lower, <strong>and</strong> some rough convergence<br />
is likely between the amount lost by the company <strong>and</strong> the<br />
amount improperly gained by the officer, <strong>and</strong> that officer’s total<br />
worth. In short, the benefit of litigation is not the size of the judgment<br />
received but the amount of the judgment collected. In care cases<br />
brought against corporate officers, any amount collected is likely to be<br />
relatively small compared to the combined out-of-pocket <strong>and</strong> opportunity<br />
costs of pursuing such litigation.<br />
At the system level, the issue is whether the marginal gains—<strong>and</strong><br />
it is important to recognize that shifting of dollars from one individual’s<br />
pocket to another’s is not a gain 162 —from improved managerial<br />
decisions exceed the costs of litigation. Is the marginal benefit of improved<br />
decision-making greater than the sum of the cost of increased<br />
caution in decision-making <strong>and</strong> the cost of the actual litigation necessary<br />
to make the threat of litigation credible? At best, a net gain<br />
seems an unlikely result.<br />
A second argument further undercuts the compensation rationale.<br />
Compensation is only relevant to the extent the shareholder suffers<br />
actual loss. What portion of the loss suffered by a corporation is<br />
really a loss to its shareholders? At first that question might seem<br />
odd. After all, if a corporate officer were to make a faulty decision<br />
that resulted in a corporate loss of $1 million, shareholder losses<br />
would seem to axiomatically total $1 million. That calculation, however,<br />
becomes less certain when one considers how shareholders invest<br />
their resources. The rational shareholder is likely to have<br />
160. This calculation is made using the 2004 Consumer Price Index.<br />
161. Special Report CEO Compensation, FORBES.COM, Apr. 23, 2004, http://www.forbes.com/<br />
2004/04/21/04ceol<strong>and</strong>.html. Total compensation is defined “as salary <strong>and</strong> bonus; plus ‘other’<br />
compensation, which includes vested restricted stock grants, <strong>and</strong> ‘stock gains,’ the value realized<br />
from exercising stock options during the just-concluded fiscal year.” Id.<br />
162. Indeed the litigation costs incurred in bringing about the shift are a deadweight loss!
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diversified her portfolio of investments in order to “wash out” the<br />
non-systemic risks in her investment portfolio. 163 As a result, the<br />
losses in share value resulting from careless judgments in one company<br />
are offset to some degree by gains in the value of the securities<br />
of other companies in her portfolio that benefit from the negligence of<br />
the first company. Put differently, some of the loss she suffers from<br />
her “bet” on the negligently managed company is likely to be offset by<br />
her unexpected “winnings” from companies that experience abnormal<br />
gains as a result of the negligent decision of the first company.<br />
The situation is much like that discussed in the classic vineyard<br />
hypothetical used in many law school corporation courses. 164 There<br />
the students advise a hypothetical investor who is about to invest in<br />
the operation of one or more vineyards. The investor is faced with a<br />
number of possibilities that would affect the value of her investment<br />
in vineyards, including the possibility of a worldwide decline in dem<strong>and</strong><br />
for grapes <strong>and</strong> a change in consumer preferences for types of<br />
grapes. She can do little about these risks. 165 She also faces the possibility<br />
that the return on her investment could be affected by risks associated<br />
with a particular vineyard. Such risks include possible<br />
unfavorable local weather conditions, localized pests, <strong>and</strong> fire. In this<br />
category, one should include the residual levels of poor management<br />
of any particular vineyard that cannot be eliminated by efficient<br />
monitoring.<br />
What action would a rational investor take? She could invest all<br />
of her wealth in a single vineyard. She then could win big, but she<br />
could also lose big. Unless she is risk-neutral or risk-preferring, she is<br />
unlikely to take that gamble. Instead, by investing in vineyards in different<br />
locations, growing different types of grapes, managed by different<br />
individuals, she can essentially wash out the idiosyncratic risks<br />
associated with any single vineyard. Were she able to spread her investment<br />
about at no additional cost, i.e. if complete diversification<br />
were possible <strong>and</strong> costless, she would suffer no loss from any of the<br />
idiosyncratic risks associated with a particular vineyard <strong>and</strong> a particular<br />
management team. In that situation, the loss in production she<br />
suffered from any particular vineyard, whatever its cause, would be<br />
163. Richard A. Booth, Stockholders, Stakeholders, <strong>and</strong> Bagholders (or How Investor Diversification<br />
Affects Fiduciary Duty), 53 BUS. LAW. 429, 468 (1998). Some shareholders do not<br />
diversify their holdings. Should the law be structured to protect the diversified (savvy) shareholder<br />
or the undiversified shareholder? Booth quips that generally such shareholders might be<br />
deemed contributorily negligent. Id.<br />
164. This hypothetical can be found at JEFFREY D. BAUMAN, ELLIOT J. WEISS & ALAN R.<br />
PALMITER, CORPORATIONS LAW AND POLICY MATERIALS AND PROBLEMS 14 (5th ed. 2003).<br />
165. For now, I focus only on downside risks—that is, losses. Risk, of course, is not a negative<br />
factor. Upside risk—wins—are real as well. The value of vineyards, for example, would<br />
increase if scientists discovered a positive correlation between grape consumption <strong>and</strong> increased<br />
longevity.
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336 Washburn Law Journal [Vol. 45<br />
offset by an increased production in another vineyard, perhaps because<br />
of superior management, or, assuming no change in dem<strong>and</strong><br />
curves, an increase in the price of grapes. Thus, even if mismanagement<br />
occurred at one of her vineyards, she would have no claim for,<br />
<strong>and</strong> presumably no need for, compensation. 166 Under these conditions,<br />
she would be unwilling to bear any of the deadweight costs associated<br />
with suing any of her managers for a breach of her duty of care.<br />
The same analysis applies whenever an individual elects to<br />
purchase corporate shares. Should she purchase only General Motors<br />
shares or the shares of a basket of automobile manufacturers? Should<br />
she invest only in the auto manufacturing sectors or should she spread<br />
her investment across other industries? The answer is evident; she<br />
should diversify.<br />
Diversification, however, is neither a costless nor a perfect solution.<br />
Even when feasible, diversification can offset losses only when<br />
the action of the officers results in a net positive return. If an officer’s<br />
act has a net negative return, diversification can only dilute the effect<br />
of the loss. 167 Some forms of mismanagement—such as failing to adequately<br />
protect corporate property from fire—have a net negative<br />
return.<br />
Moreover, not all investors will diversify their portfolios. In some<br />
instances they will fail to do so because diversification may not be<br />
possible. Consider, for example, the situation of an investor who finds<br />
her wealth locked in a minority interest in a closely held corporation<br />
168 or in some other illiquid investment. 169 In such a situation, she<br />
can do nothing to diversify her investment portfolio. In other instances,<br />
investors may not appreciate the importance of diversification<br />
or may attempt to diversify but will fail to do so.<br />
One might argue that, because not all shareholders can or do diversify,<br />
liability rules should be fashioned to protect these undiversified<br />
shareholders. It would be an error, however, to do so. Not only<br />
would such rules often compensate diversified shareholders for losses<br />
they did not actually incur, they would also force all diversified shareholders<br />
to bear the costs of protecting those shareholders who are unable<br />
to or choose not to diversify. 170<br />
166. For a similar analysis, see Booth, supra note 163, at 460-61.<br />
167. FRANKLIN A. GEVURTZ, CORPORATION LAW § 4.1(b), at 293 n.54 (2000).<br />
168. This fact explains the willingness courts have exhibited to police opportunistic behavior<br />
in closely held corporations.<br />
169. A classic instance of a non-diversifiable investment is one’s own body, a fact which may<br />
explain the courts’ traditional willingness to evaluate physician conduct even though medical<br />
care is as difficult for judges to comprehend as management decision-making. Peter V. Letsou,<br />
Implications of Shareholder Diversification on Corporate Law <strong>and</strong> Organization: The Case of the<br />
Business Judgment Rule, 77 CHI.-KENT L. REV. 179, 207-09 (2001).<br />
170. See Booth, supra note 163. But see Letsou, supra note 169, at 202 (noting that firms may<br />
still benefit from liability rules that deter negligent conduct in some instances).
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The benefit of diversification, however, need not be complete dissipation<br />
of the loss for it to matter in determining whether to extend<br />
the protections of exculpatory provisions to corporate officers. It is<br />
sufficient to recognize that, except in unique circumstances, diversification<br />
may eliminate much of the loss a shareholder would otherwise<br />
experience as a result of a faulty decision by a corporate officer. In<br />
other circumstances, diversification may so dilute the costs of mismanagement<br />
to the point that costs of litigation are not worthwhile.<br />
When the benefits <strong>and</strong> costs of diversification <strong>and</strong> the benefits<br />
<strong>and</strong> costs of judicial oversight of managerial conduct are compared, it<br />
becomes clear that diversification weakens the argument for close judicial<br />
scrutiny of management for negligent mismanagement. The<br />
general lack of successful litigation against corporate officers <strong>and</strong> the<br />
near universal acceptance of the current “judicial h<strong>and</strong>s-off” rules, including<br />
the business judgment rule, which courts apply to refrain from<br />
exercising active oversight of corporate officers for negligent conduct,<br />
would seem to support that conclusion. 171 That conclusion, however,<br />
is at best an informed guesstimate. Indeed, some shareholders might<br />
actually prefer close judicial oversight of managerial conduct even in<br />
duty-of-care cases. 172<br />
The existence of uncertainty about the efficacy of non-liability restraints<br />
on officer negligent conduct <strong>and</strong> the efficacy of diversification<br />
to offset investor losses caused by officer conduct is relevant in fashioning<br />
the terms of the exculpatory language. When costs <strong>and</strong> benefits<br />
are uncertain, it is desirable to permit affected individuals to<br />
fashion governance rules applicable to their situation.<br />
Therefore, although some jurisdictions, such as Louisiana, 173<br />
Virginia, 174 <strong>and</strong> Nevada, 175 have imposed a non-waivable cap on the<br />
liability of officers (<strong>and</strong> directors), it is more desirable to allow shareholders<br />
to decide whether to cap or eliminate officer liability. Legislatures<br />
that want to do so can easily achieve their goal. One approach,<br />
171. Contrary to my argument, Lyman P.Q. Johnson argues that officers are now subject to a<br />
st<strong>and</strong>ard of ordinary care. See Johnson, supra note 127, at 466. As explained in her article in this<br />
issue, Professor Cheryl Wade has a similar view of existing law. She admits, however, that the<br />
majority likely does not share her view. Cheryl Wade, What Independent Directors Should Expect<br />
from Inside Directors: <strong>Smith</strong> v. <strong>Van</strong> <strong>Gorkom</strong> as a Guide to Intra-firm Governance, 45 WASH-<br />
BURN L.J. 367, 381 (2006). If, however, Professors Johnson <strong>and</strong> Wade are correct in their<br />
position, the proposal I make to exp<strong>and</strong> the applicability of the exculpatory provisions to include<br />
officers only becomes timelier.<br />
172. I do not address here the troubling issue of whether shareholders should be entitled to<br />
impose managerial supervision costs on the public. To the extent that the courts provide an ex<br />
post settling up mechanism for resolving intra-corporate disputes, the legal system effectively<br />
subsidizes the decision of individuals to do business as a corporation. Of course, all forms of<br />
judicial supervision have a similar effect.<br />
173. LA. REV. STAT. ANN. § 12:24(C)(4) (Supp. 2006).<br />
174. VA. CODE ANN. § 13.1-692.1 (Michie 1999).<br />
175. NEV. REV. STAT. § 78.037 (2003).
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338 Washburn Law Journal [Vol. 45<br />
followed by Maryl<strong>and</strong>, 176 New Hampshire, 177 <strong>and</strong> New Jersey, 178 is<br />
simply to modify their charter-option provision by inserting “or officer”<br />
into the coverage. In those states, the decision to shield officers<br />
is left to the shareholders in exactly the same manner as the decision<br />
to shield directors.<br />
Simple as that solution might be, it overlooks three important issues.<br />
The first is whether corporate directors should have any voice in<br />
the adoption of an officer-exculpation provision. Directors, especially<br />
outside directors, are compelled by necessity to rely on corporate officers<br />
for the information they need to perform their directorial<br />
duties. 179 Thus, it certainly is in the directors’ best interests to incentivize<br />
officers to act reasonably. Consequently, directors should have<br />
the power to veto any attempt to shield officers from personal liability<br />
for shoddy decision-making.<br />
The second issue is whether shareholders who also serve as officers<br />
should be able to vote in favor of shielding corporate officers<br />
from liability. This question is similar to that which arises under current<br />
exculpation statutes permitting shareholder-directors to vote in<br />
favor of having their corporation adopt a charter exculpatory provision.<br />
The conflicts of interest are obvious, though neither section<br />
102(b)(7) nor any of its progeny prevent interested shareholders/directors<br />
from voting in favor of proposals to cause their corporation to<br />
opt out of the director-liability regime.<br />
Finally, one might question whether shareholders should be permitted<br />
some escape route from an officer exculpatory provision if at a<br />
later date they come to believe that the exculpatory provision is systematically<br />
leading officers to fail to perform as diligently as shareholders<br />
might wish. 180 In theory, shareholders could call upon their<br />
board of directors to propose an amendment to the corporation’s articles<br />
to eliminate the liability protection. There are some concerns,<br />
however, that the board of directors might not be as responsive as it<br />
ought to be, either because the directors also serve as officers or because<br />
of the presence of a dominating corporate officer.<br />
The American Law Institute (ALI) recognized some of these issues<br />
when it proposed section 7.19 of the Principles of Corporate<br />
Governance. 181 Section 7.19, Limitation on Damages for Certain Violations<br />
of the Duty of Care, was unique in that it would permit share-<br />
176. MD. CODE ANN., CORPS. & ASS’NS § 2-104(b)(8) (LexisNexis 1999).<br />
177. N.H. REV. STAT. ANN. § 293-A:2.02(b)(4) (LexisNexis 1999).<br />
178. N.J. STAT. ANN. § 14A:2-7(3) (West 2003).<br />
179. Wade, supra note 171, at 382.<br />
180. The board of directors, or in some instances the shareholders, can always remove an<br />
individual officer for failure to meet performance expectations.<br />
181. AM. LAW INST., PRINCIPLES OF CORPORATE GOVERNANCE: ANALYSIS AND RECOMMEN-<br />
DATIONS § 7.19 (1994).
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holders to cap officer liability for breaches of their duty of care to an<br />
amount not less than the officer’s annual salary. It conditioned the<br />
validity of a liability cap, however, on approval by a vote of disinterested<br />
shareholders after full disclosure. It also required that any officer-liability<br />
cap provision be subject to repeal by shareholders at any<br />
annual meeting without prior action by the board of directors. By<br />
disqualifying the votes of interested shareholder-officers, the ALI’s<br />
adoption procedures would allay some lingering fears that officers<br />
would use their power to compel shareholders to adopt an exculpatory<br />
provision without regard to the desirability of such a provision.<br />
To accommodate the concerns of shareholders, officers, <strong>and</strong> directors,<br />
legislators in states following the Delaware pattern could<br />
adopt the following provision:<br />
§ 102 Contents of certificate of incorporation.<br />
(b) In addition to the matters required to be set forth in the certificate<br />
of incorporation by subsection (a) of this section, the certificate<br />
of incorporation may also contain any or all of the following<br />
matters:<br />
. . . .<br />
(X) A provision eliminating or limiting the personal liability of<br />
an officer to the corporation or its stockholders for monetary damages<br />
for breach of fiduciary duty as an officer, provided that such<br />
provision shall not eliminate or limit the liability of an officer: (i) for<br />
any breach of the officer’s duty of loyalty to the corporation or its<br />
stockholders; (ii) for acts or omissions not in good faith or which<br />
involve intentional misconduct or a knowing violation of law; or (iii)<br />
for any transaction from which the officer derived an improper personal<br />
benefit. Such provision shall be valid only if adopted by a<br />
majority of the independent <strong>and</strong> disinterested directors <strong>and</strong> by a<br />
majority of the disinterested shareholders <strong>and</strong> only if the provision<br />
can be repealed by shareholders at an annual meeting without the<br />
action of the board of directors. No such provision shall eliminate<br />
or limit the liability of an officer for any act or omission occurring<br />
prior to the date when such provision becomes effective. All references<br />
in this paragraph to an officer shall also be deemed to refer to<br />
any person or persons who exercises or performs any of the powers<br />
or duties of a corporate officer regardless of title.<br />
Legislators in states following the Model Act pattern could adopt the<br />
following provision:<br />
(b) The articles of incorporation may set forth:<br />
. . . .<br />
(X) A provision eliminating or limiting the liability of an officer<br />
to the corporation or its shareholders for money damages for any<br />
action taken, or any failure to take any action, as a director, except<br />
liability for (A) the amount of a financial benefit received by a director<br />
to which he or she is not entitled; (B) an intentional infliction<br />
of harm on the corporation or the shareholders; (C) an intentional<br />
violation of criminal law; or (D) intentional failure to follow the<br />
instructions or policies of the board of directors. Such provision<br />
shall be valid only if adopted by a majority of the independent <strong>and</strong>
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340 Washburn Law Journal [Vol. 45<br />
disinterested directors <strong>and</strong> by a majority of the disinterested shareholders<br />
<strong>and</strong> only if the provision can be repealed by shareholders at<br />
an annual meeting without the action of the board of directors. No<br />
such provision shall eliminate or limit the liability of an officer for<br />
any act or omission occurring prior to the date when such provision<br />
becomes effective. All references in this paragraph to an officer<br />
shall also be deemed to refer to any person or persons who exercises<br />
or performs any of the powers or duties of a corporate officer<br />
regardless of title.<br />
In building on the existing patterns of the director-focused exculpatory<br />
provisions, neither of the proposals would cure the interpretive<br />
problems inherent in the existing statutes. They, however, should not<br />
introduce any new problems either.<br />
The adoption of either of these proposed provisions would surely<br />
reignite the debate over the propriety of allowing corporations to<br />
shelter directors or officers from liability for breaches of their fiduciary<br />
duties. Ever since the passage of section 102(b)(7), commentators<br />
have objected to optional provisions such as those proposed above.<br />
They contend that, while these charter-option provisions appear to<br />
maximize shareholder power, they really only perpetuate the illusion<br />
of shareholder choice. These critics, building on the Berle-Means<br />
managerial control hypotheses, contend that corporate managers continue<br />
to control the shareholder proxy voting process <strong>and</strong> thus are<br />
able to cause the corporation to opt into the exculpatory provision. 182<br />
182. One could also argue that however desirable such a provision might be, it is unfair to<br />
give some shareholders the power to impose a no-liability regime on their fellow shareholders.<br />
That argument, however, is not persuasive. Certainly those shareholders who vote for the adoption<br />
of the provision have no unfairness claim. Likewise, shareholders who purchased their<br />
shares after the corporate code provided for the adoption of the exculpatory provision would<br />
seem to have no grounds to object. They should be deemed to have taken the risk that the<br />
majority of shares might determine it desirable to opt into the regime limiting monetary recourse<br />
against officers.<br />
Dissenting shareholders who purchased their shares before the legislature approved provisions<br />
allowing corporations to shield officers for liability for breaches of their duty of care would<br />
seem to have a better claim of unfairness. One could argue that they have no complaint, because<br />
in buying their shares, they implicitly consent to any lawful change to either the governing corporate<br />
statute or to the governance documents of their corporation, or to both. The price they<br />
paid presumably reflected the existing rights provided by the corporate code <strong>and</strong> by the corporate<br />
governance documents, as well as all permissible changes that might be made to those<br />
rights. In effect, one could maintain, they purchased shares with a wild card attached, which<br />
provided that “anything goes.”<br />
That argument, however, is overbroad. No pricing mechanism can take into account any<br />
<strong>and</strong> all possible changes in a contract. Indeed modern contract law permits parties to avoid<br />
performance of a contract that has failed in its fundamental purpose. Some changes are acceptable<br />
because they are not so radical as to rise to the level of “frustration.” In this argument, one<br />
may view the role of appraisal rights as allowing shareholders who find their corporate “contract”<br />
frustrated to opt out.<br />
Whether any particular change would be acceptable, <strong>and</strong> hence impounded in the shareholders’<br />
purchase price, would depend on how foreseeable the change was at the time the shareholder<br />
purchased her shares. Foreseeability, in turn, would depend on how much the change<br />
departed from existing law <strong>and</strong> how unusual that change was in the corporate world. For example,<br />
one could argue that, in light of near universality of exculpatory provisions in the world of<br />
corporate governance, shareholders of a corporation incorporated in the District of Columbia,<br />
the only jurisdiction that does not permit or m<strong>and</strong>ate the limitation of director liability for negli-
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However salient that argument might have been at one time, the<br />
recent results of shareholder voting at annual meetings make clear<br />
that managers no longer have absolute control over the outcome of<br />
shareholder votes. Recent results in proxy voting demonstrate the<br />
power of shareholders, especially institutional shareholders, to override<br />
management’s desires on matters of corporate governance. During<br />
the 2004 proxy season, 144 shareholder proposals calling for<br />
corporate governance reforms received the affirmative vote of a majority<br />
of shares represented voting at the meeting; fifty received the<br />
vote of at least a majority of all outst<strong>and</strong>ing shares. 183 These results<br />
make it difficult to argue that by enacting an optional exculpatory provision<br />
protecting officers from personal liability for a breach of their<br />
duty of care, a state would effectively impose a m<strong>and</strong>atory limitation<br />
on officer liability similar to the Virginia provision. 184 While one<br />
might expect managers to propose that the corporation opt out of personal<br />
liability for officers, shareholders simply will not rubber stamp<br />
those requests. If shareholders do approve such a proposal, their action<br />
should be seen as a rational response to the problems presented<br />
by making judicial oversight of officers’ actions available to any shareholder<br />
who believes officers have acted carelessly.<br />
gence, should be deemed to have consented, upon purchasing their shares, to a statutory <strong>and</strong><br />
governance-document change limiting director liability.<br />
Viewing the proposal in that light, implying assent to the validity of the provision exp<strong>and</strong>ing<br />
the statutory exculpatory provisions to permit corporations to shelter corporate officers, as well<br />
as directors, seems reasonable. Given the remote possibility of holding officers liable for<br />
breaches of their duty of care under the current law, permitting a corporation to shield its officers<br />
from personal liability for such breaches would seem little more than a formality. One<br />
would expect such a change to have little effect on share price.<br />
183. GEORGESON SHAREHOLDER, ANNUAL CORPORATE GOVERNANCE REVIEW 2004 16-22,<br />
available at http://www.georgesonshareholder.com/pdf/2004_corpgov.pdf.<br />
184. Section 13.1-692.1, Virginia’s exculpatory provision, adopted in 1987, provides:<br />
A. In any proceeding brought by or in the right of a corporation or brought by or on<br />
behalf of shareholders of the corporation, the damages assessed against an officer or<br />
director arising out of a single transaction, occurrence or course of conduct shall not<br />
exceed the lesser of:<br />
1. The monetary amount, including the elimination of liability, specified in the articles<br />
of incorporation or, if approved by the shareholders, in the bylaws as a limitation on or<br />
elimination of the liability of the officer or director; or<br />
2. The greater of (i) $100,000 or (ii) the amount of cash compensation received by the<br />
officer or director from the corporation during the twelve months immediately preceding<br />
the act or omission for which liability was imposed.<br />
B. The liability of an officer or director shall not be limited as provided in this section if<br />
the officer or director engaged in willful misconduct or a knowing violation of the criminal<br />
law or of any federal or state securities law, including, without limitation, any claim<br />
of unlawful insider trading or manipulation of the market for any security.<br />
C. No limitation on or elimination of liability adopted pursuant to this section may be<br />
affected by any amendment of the articles of incorporation or bylaws with respect to<br />
any act or omission occurring before such amendment.<br />
VA. CODE ANN. § 13.1-692.1 (1999). For a full discussion of the Virginia provision, see<br />
Honabach, supra note 112, at 471-75.
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342 Washburn Law Journal [Vol. 45<br />
VII. CONCLUSION<br />
The story of <strong>Van</strong> <strong>Gorkom</strong> is one replete with ironies. Roundly<br />
criticized as opening the floodgates for breach of the duty-of-care suits<br />
aimed at corporate directors, it actually provided much safety for directors<br />
by affirming the gross negligence st<strong>and</strong>ard <strong>and</strong> by establishing<br />
a relatively easily negotiated procedural safe harbor. Hailed by critics<br />
who had previously criticized courts for their traditional h<strong>and</strong>s-off approach<br />
to allegations of managerial failure to exercise due care, <strong>Van</strong><br />
<strong>Gorkom</strong> motivated state legislatures to adopt exculpatory provisions<br />
such as section 102(b)(7) that were intended to provide directors even<br />
more protection, though they actually provided precious little additional<br />
protection. Finally, by igniting a firestorm about the appropriateness<br />
of adopting such charter-option provisions, it provided critics<br />
of the Berle-Means model of the corporation fertile ground for cultivating<br />
the Contract Model of the corporation.<br />
In this article, I call for the creation of yet another irony. Even<br />
though the effect of section 102(b)(7) <strong>and</strong> its progeny was largely psychological,<br />
I argue for the expansion of the coverage of those exculpatory<br />
provisions to include corporate officers. At present, the status of<br />
the liability rules applicable to corporate officers is unclear. It may be<br />
that the courts will eventually decide to hold officers to a simple negligence<br />
st<strong>and</strong>ard of care <strong>and</strong> deny them the benefit of the business judgment<br />
rule. Were they to do so, the expansion of the exculpatory<br />
provisions would be desperately needed. On the other h<strong>and</strong>, the<br />
courts may eventually conclude that the appropriate liability st<strong>and</strong>ard<br />
is gross negligence <strong>and</strong> that the business judgment rule applies equally<br />
to officers. Were they to so decide, such expansion would prove to<br />
have been unnecessary, just as the adoption of the original round of<br />
exculpatory provisions was unnecessary. Even in that situation, corporate<br />
stakeholders would be compelled to endure uncertainty <strong>and</strong><br />
confusion while the courts fashion clear rules.<br />
Therefore, I believe that state legislatures should enact legislation<br />
making the protection of their exculpatory provisions available to corporate<br />
officers. Otherwise, we will face multiple rounds of litigation<br />
seeking to impose liabilities on corporate officers for breaches of their<br />
duty of care. That litigation, however, will be a poor way to resolve<br />
the issue. It will produce uncertainty <strong>and</strong> anxiety, neither of which is<br />
desirable, especially in the marketplace. By enacting legislation exp<strong>and</strong>ing<br />
the coverage of the exculpatory provisions, legislators can<br />
halt that litigation at the outset <strong>and</strong> in so doing save corporations <strong>and</strong><br />
their shareholders needless costs.