Privately Ordered Fiduciaries

Category: Print Issues

Megan Wischmeier Shaner

Volume 28

, Issue 1

28 GEO. MASON L. REV. 345 (2020)

Introduction

In corporate law there exists a disconnect between the outsized role officers play in managing the corporation and the scant attention officers receive in corporate doctrine. Corporate officers, particularly at public corporations, occupy a central role in the economy and in our society more broadly. Executive officers have control over “vast aggregations of wealth, of which they may own very little.”¹ Moreover, they are afforded great deference in how they manage corporate assets. As the well-documented succession of corporate mismanagement and fraud that has occurred over the past three decades revealed, the decision-making of members of the C-Suite has profound consequences not only for the individual firm for which they work but also for the economy and markets worldwide.²

The modern corporate officer’s power and influence extends beyond the economic. Undisputedly, senior executive officers, like the chief executive officer (“CEO”), wield enormous power, occupying “recognized positions of immense economic and social influence” and drawing “widespread attention in the larger cultural arena.”³ Prominent CEOs Warren Buffett, Mark Benioff, Jeff Bezos, Marissa Mayer, Elon Musk, and Tim Cook, for example, are household names, dominating the news cycle and social media platforms. Using their corporate power and status, these individuals are often viewed as leaders on political and social issues like climate change, minimum wage, healthcare, and education. Today’s executive officers play a leading role in setting the economic, social, and moral agendas of corporations, markets, and society more broadly.⁴

Given the central role that officers play in the economy and society, accountability is vital to instilling confidence in the corporation as an institution. Imposing fiduciary duties on management has been cited as a central way to hold managers accountable.⁵ Historically, however, corporate doctrine has devoted limited attention to prescribing the role and legal principles governing officers. As the officer rose to prominence in the twentieth century, corporate law largely remained silent.⁶ Even today, following notable scandals largely attributable to the actions of executive officers,⁷ these individuals remain the most undertheorized participant in the corporate endeavor.

Over the past two decades, legal and practical hurdles to developing doctrine addressing the corporate officer have been cleared away. In 2004, the Delaware Code was amended to provide for personal jurisdiction over nonresident officers of Delaware corporations.⁸ “Around this same time there was a dramatic shift underway in corporate governance norms that had been buttressed by federal regulation to create greater board independence from officers.”⁹ With fewer board seats occupied by company executives, officer conduct was no longer reliably regulated by bootstrapping obligations to an officer’s concurrent director status,¹⁰ underscoring the need for specific rules addressing officer obligations.

The separation of director and officer status in public corporations led to a heightened focus on officers as distinct legal actors in the corporation and on the accompanying legal standards that would govern them. The Delaware Supreme Court’s 2009 decision in Gantler v. Stephens¹¹ clarified, in part, the fiduciary obligations and accountability of corporate officers.¹² In Gantler, the court held that “officers of Delaware corporations, like directors, owe fiduciary duties of care and loyalty, and that the fiduciary duties of officers are the same as those of directors.”¹³ These developments in corporate law, individually and collectively, cleared a path for the exploration and development of the legal contours of officer duties.¹⁴ The courts, stockholders, and their counsel, however, have declined the invitation to tackle officer accountability and responsibility.¹⁵ And somewhat ironically, when faced with the few officer challenges that have been brought before them, the Delaware courts have applied a director-centric lens in evaluating officer issues, narrowing the potential avenues for legal challenges, closing the door on future doctrinal development, and limiting the guidance available to market actors.¹⁶

The absence of officer doctrine has not gone unnoticed. Academics, jurists, corporate managers, and their counsel have all commented on the ambiguity that exists with respect to the legal rules governing officer decision-making and liability.¹⁷ In fall 2018, the Officer Liability Task Force (the “Task Force”) of the American Bar Association (“ABA”) met for the first time to discuss: (1) the uncertainty in the law surrounding the nature and scope of the fiduciary duties of, and applicability of the business judgment rule to, corporate officers; and (2) potential ways to address that uncertainty, including whether any potential products, such as annotated model employment agreements, would assist in providing additional clarity.¹⁸ The Task Force’s objectives are, however, relatively narrow:

This Task Force is focused on a specific objective: to evaluate the development of tools that may be used to bring greater certainty to corporations, boards and officers about officers’ duties and relationship to the board and corporation overall . . . the Task Force will attempt to develop means by which corporations may address these issues within the confines of current positive law.¹⁹

Accordingly, the Task Force is exploring the viability of private ordering solutions (i.e., structuring officer obligations and liabilities through firm-specific contractual agreements).²⁰

In setting out its objectives and agenda, the Task Force cautions that it “will not wade into the debate regarding the precise nature of officers’ fiduciary duties, nor the wisdom of applying the business judgment rule to officers.”²¹ Private ordering in the corporate space is, however, inextricably intertwined with these (and other) broader normative questions. While framed as a modest proposal, the Task Force would extend private ordering of corporate governance in a radical new direction, taking aim at bedrock principles of corporate law—fiduciary duties and the business judgment rule.²² Prior case law has endorsed the idea that stockholders’ rights may be contractually structured.²³ The Task Force’s project extends this view, raising the issue of whether stockholder protections (i.e., fiduciary duties) may also be subject to contract.

This Article tackles the broader issues raised by the Task Force’s work, taking a deep dive into the issue of private ordering of corporate officer fiduciary obligations and liability. Specifically, this Article addresses questions like: Should officer duties be a product of contract or common law? What is the foundational basis for officer fiduciary obligations? What are (or should be) the bounds, if any, for private ordering of this nature? How does officer private ordering fit within the broader scheme of privately ordered fiduciaries across business organizations? What are possible ways to structure the private ordering of officer duties, in particular the business judgment rule?

This Article’s goal is twofold: to examine the issues surrounding privately ordered officer duties, first from a pragmatic angle and then from a normative angle. Part I reviews the emergence of private ordering in the corporate sphere, highlighting the aims and efforts of the ABA Task Force. Then, Part II examines limits to the effectiveness and enforceability of private ordering of corporate officers. Part III follows by evaluating the legal viability and contractual considerations of private ordering of: (1) officer fiduciary duties; and (2) business judgment rule application. Part III also discusses drafting considerations that are likely to arise as corporate actors and their counsel undertake private ordering of officer obligations. Finally, Part IV discusses the broader normative implications for corporate law if officer fiduciary duties and liabilities become dominated by private ordering. Notably, this Article concludes that private ordering, though seemingly an attractive way to more clearly define corporate officer obligations, ultimately may weaken stockholder rights, complicate the courts’ role in enforcement, and marginalize market norms in ways that muddle the very subject—the duties and liabilities of corporate officers—that it seeks to clarify.

I. The Call for Private Ordering Solutions

Private ordering is not a novel phenomenon in corporate law. Classic examples of privately ordered corporate measures include poison pills, staggered board provisions, majority voting bylaws, and advance notice bylaws.²⁴ More recently, corporate contracting has taken the form of forum selection bylaws, fee shifting provisions, minimum stake requirements, appraisal waivers, limitations on books and records inspection rights, and arbitration provisions.²⁵ The few judicial decisions and statutory amendments limiting the bounds of corporate contracting have not slowed the private ordering movement. Attempts at using contracts to shape key aspects of corporate governance and to shift the distribution of rights and power in the corporation continue apace,²⁶ including the recent efforts of the ABA Task Force.

To date, the Delaware courts have largely supported and endorsed corporations’ power to arrange their affairs through private ordering in organizational documents.²⁷ The enabling nature of the Delaware General Corporation Law (“DGCL”) contemplates a large amount of leeway in crafting corporate charters and bylaws.²⁸ Indeed, the contract metaphor that pervades corporate law is frequently cited as the basis for allowing private ordering in these organizational documents.²⁹ As the Delaware courts reiterate and reinforce the idea that charters and bylaws are contracts, corporate actors become more confident that private ordering amendments will be upheld, triggering further developments and proposals to include corporate governance features in organizational documents.³⁰

Outside of a corporation’s organizational documents, private ordering through other devices, like stockholder agreements, has been on the rise.³¹ Though often viewed through a different legal lens than private ordering set forth in organizational documents, attempts to restructure the rights and balance of power within a corporation using stockholder agreements have similarly been upheld by the courts.³² Although receiving less judicial attention than charter and bylaw amendments, stockholder agreements are poised to play a central role in private ordering’s future.³³

Embracing the private ordering movement, the ABA Task Force seeks to use contractual means to bring certainty to a long-neglected area of the law—the nature and scope of officer fiduciary duties and the applicability of the business judgment rule to officer actions. For over eight decades the Delaware courts have refrained from expounding on corporate officers’ fiduciary obligations.³⁴ In the absence of judicial guidance, corporations and their counsel have been pushed to seek private means of providing greater certainty.³⁵ With no indication of forthcoming clarity from the courts or legislature, the Task Force’s objective is to evaluate the possibilities for private ordering in this space.³⁶ In particular, the Task Force is focused on developing potential products such as model employment agreements, bylaw provisions, or charter provisions to address some of the outstanding legal issues surrounding corporate officers.³⁷

The Task Force’s project differs from the private ordering movement to date in several respects. First, the ABA, and not a private actor, is the proponent of private ordering for corporate officers.³⁸ Second, and relatedly, the impetus for the Task Force’s corporate contracting effort can be characterized as addressing a void in the law rather than as an effort to engage in firm-specific restructuring of corporate governance mechanisms. Thus, concerns raised about boards’ and stockholders’ use (or abuse) of private ordering in an attempt to skew the balance of corporate power are not as salient for the Task Force’s recommendations as they have been for the development of prior ex ante governance measures.³⁹

Third, the Task Force’s proposal extends private ordering from procedure-oriented matters to substantive corporate law. Recent private ordering efforts have focused on limiting or channeling stockholders’ right to sue through creating different “procedural preconditions on shareholders’ ability to bring litigation.”⁴⁰ In contrast, fiduciary obligations and the business judgment rule, which are the focus of the Task Force, are considered “bedrock principles” of corporate jurisprudence.⁴¹ The Task Force’s proposal signals a shift in corporate contracting from procedural aspects of instituting and maintaining litigation to shaping the substantive rights and duties underlying the legal dispute.⁴² Stated another way, prior private ordering focused on stockholders’ exercise (or waiver) of their rights, whereas the Task Force’s project addresses doctrinal stockholder protections. The Task Force’s proposal thus moves private ordering to a domain of substantive law that has largely been untouched. As a result, the Task Force’s work raises important questions regarding the permissible scope of private ordering in the corporation. In considering how such contracting would be structured, the Task Force’s project also exposes the complexities and uncertainties that underlie officer fiduciary doctrine.

II. The Limits of Private Ordering

The rise in private ordering raises the question: Should there be a limit to a corporation’s ability to structure itself through contracts? And if so, what is that limit? This Part addresses those questions by examining the judicial, statutory, and intrinsic limits on private ordering of corporations, ultimately underscoring the importance of the unique nature of corporations and the integrity of the relationship between corporate parties in defining those limits.

Scholars have put forth a variety of proposals for limiting a corporation’s power to arrange its affairs through contract. Such proposals typically focus on applying more exacting judicial scrutiny or requiring more robust stockholder consent.⁴³ Absent specific statutory prohibition, however, courts have largely upheld and endorsed private ordering.⁴⁴ As the Delaware Supreme Court pointed out in Salzberg v. Sciabacucchi,⁴⁵ “our DGCL was intended to provide directors and stockholders with flexibility and wide discretion for private ordering and adaptation to new situations.”⁴⁶ Despite such sweeping judicial rhetoric endorsing the practice, corporate private ordering is not without limitation. There are several features of private ordering efforts that may bear on the adjudication of their validity, namely: (1) the type of business entity involved; (2) where the private ordering is set forth; and (3) the right or actor involved.⁴⁷ How each of these features impacts the validity of private ordering mechanisms, as a general matter, is discussed in turn.

A. The Type of Business Entity

The ability to privately order is not identical for all business entities. Unincorporated business entities like limited liability companies (“LLCs”) and limited partnerships (“LPs”) unequivocally embrace freedom of contract as a foundational characteristic. Delaware’s statutory framework for these entities is explicit: “[i]t is the policy of [the LLC Act and LP Act] to give maximum effect to the principle of freedom of contract and to the enforceability of [limited liability company agreements and partnership agreements].”⁴⁸

In contrast, the ability to privately order in the corporate context finds its basis implicitly through a combination of an enabling corporate statute, the prevalence of contract theory in corporate law, and the judicial opinions that continue to endorse the contractual model of the corporation.⁴⁹ The lack of an explicit statutory declaration that the freedom of contract underpins the corporate form means, however, that the ability to privately order in corporations has limits not present in LLCs or LPs, as described below.⁵⁰

B. Where Private Ordering Takes Place

Where corporate private ordering efforts take place—in the certificate of incorporation, the bylaws, or a private contract—is also a key factor for courts and scholars to consider when evaluating those efforts’ validity. By statute, the contents of Delaware certificates of incorporation are limited only to the extent a provision therein cannot be “contrary to the laws of this State.”⁵¹ Similarly, bylaws of Delaware corporations “may contain any provision . . . relating to the business of the corporation, the conduct of its affairs, and . . . the rights or powers of [the corporation,] its stockholders, directors, officers or employees” so long as such provision is “not inconsistent with law or with the certificate of incorporation.”⁵² Accordingly, courts have understood this language to provide broad authorization for private ordering in corporate governing documents so long as they do not run afoul of the mandatory terms of corporate law.⁵³

In addition, the differing process and consent requirements to amend the governing documents may play a role in the validity of private ordering. Given the ability of stockholders and the board to each unilaterally amend its provisions, a corporation’s bylaws is the predominant venue for corporate contracting.⁵⁴ Courts have largely upheld bylaw amendments under theories of implied consent and reliance on the contract metaphor.⁵⁵ Some scholars, however, have objected to the courts’ approval of private ordering in bylaws, questioning the validity of the implied consent theory⁵⁶ and raising concerns regarding the unequal power of boards and stockholders to amend bylaws.⁵⁷

In contrast to changes in the bylaws, charter amendments require both board and stockholder approval to be effective. Private ordering in the charter thus raises fewer concerns regarding consent and unequal power than unilateral bylaw amendments.⁵⁸ As a result, “stockholder-approved charter amendments are given great respect under [the] law.”⁵⁹ Unless such a provision violates express statutory language or settled rules of public policy, private ordering in the charter will be respected and upheld by the court.⁶⁰

The dual approval requirement, however, makes private ordering in public company charters difficult and, as a practical matter, unlikely given that many private ordering efforts are motivated by competitions for power between stockholders and the board. See supra note 39 and accompanying discussion (discussing private ordering as a means for each of the board and stockholders to try to shift the balance of power in corporate governance). The exception to this would be pre-IPO amendments. See Salzberg, 227 A.3d at 109 & n.1 (describing the pre-IPO forum selection provisions adopted by Blue Apron Holdings, Inc., Roku, Inc., and Stitch Fix, Inc.); Winship, supra note 26, at 496 (“As there are no shareholders yet to give approval . . . pre-IPO charter provisions are unilaterally adopted.”).

Outside of corporate organizational documents, contractual corporate governance has also occurred in stockholder agreements, debt instruments, and commercial and consumer contracts.⁶¹ These other fora for private ordering have, by comparison, received little attention from courts and commentators. The rise in the use of stockholder agreements to contractually structure corporate governance, in particular at large corporations, has, however, begun to draw the attention of courts and scholars.⁶² In particular, recent Delaware decisions evaluating stockholder agreements have upheld their provisions using a contract law analysis.⁶³ As Professor Jill Fisch points out, these recent decisions “demonstrate the potentially expansive private ordering available through shareholder agreements” and “the growing trend of using shareholder agreements to engage in aggressive private ordering.”⁶⁴ She argues, however, that this trend is concerning and that private ordering should be limited to a corporation’s organizational documents.⁶⁵

C. The Right or Actor Affected

A third facet of private ordering that plays a critical role in enforceability is the agreement’s impact on the relationships and rights within the corporate form. As Professor George Geis observed,

[c]learly many corporate contracts are real—including those with suppliers, vendors, employees, creditors, and so on. But it is one thing to say that a corporation can make contracts and another thing to assert that a corporation is a contract. The latter implies that contract doctrine might regulate the governance relationship between shareholders and the firm (or among shareholders).⁶⁶

In the context of preferred stockholders and bondholders, the courts have made clear that such senior claimants’ rights are contractual in nature, even when those rights are embodied in the charter.⁶⁷ The contractual approach for senior claimants is “easily understood to flow from the nature of the bondholder or preferred shareholder’s relationship to the corporation, which at its core is not simply that of being a provider of capital but doing so with no greater expectation than that the relationship is adversarial.”⁶⁸

Outside of the senior claimant context, there are certain internal corporate affairs matters that are “essentially contractual in nature” such that the courts analyze them from a contractual approach.⁶⁹ These matters include dividends, indemnification, and advancement.⁷⁰ But not all internal corporate affairs matters can be modified and arranged through private ordering. Efforts, especially unilateral board actions, that impede fundamental corporate rights—like stockholders’ rights to vote or sell their shares—will likely attract significant judicial scrutiny and criticism.⁷¹ Further, the courts have made clear that private ordering efforts that would “transgress a statutory enactment or a public policy settled by the common law or implicit in the General Corporation Law itself” will be unenforceable.⁷²

Under Delaware law, for example, a corporation is required to have an annual meeting for the election of directors; is required to have shareholder approval for amendments to the certificate of incorporation; must have appropriate shareholder concurrence in the authorization of a merger; and is required to have shareholder approval in order to dissolve. Generally, these mandatory provisions may not be varied by terms of the certificate of incorporation or otherwise.⁷³

Whether officer fiduciary duties and the application of the business judgment rule would similarly be considered mandatory features of corporate law, and thus immune from private ordering, is discussed in the next Part.

III. Privately Ordering Officer Duties

The ability of corporations to contract some, but not all, internal matters raises the question: How far can private ordering go in changing the procedural and substantive relationships between and among the corporate governance participants—directors, officers, stockholders?⁷⁴ Given the ABA Task Force’s focus on the substantive relationship of officers with the other participants, the remainder of this Article takes up that question. This Part first reviews the complementary fiduciary concepts of standards of conduct and standards of review in corporate law, then examines the extent to which those standards, as applied to corporate officers, may be privately ordered.

A. Standards of Conduct and Standards of Review

Corporate law makes a distinction in fiduciary doctrine between standards of conduct and standards of review.⁷⁵ Standards of conduct are the duties a fiduciary is expected to discharge in the course of performing her role within the corporate enterprise. Fiduciary duties, as standards of conduct, are outward facing: they define expectations of corporate actors, informing them how they should serve the corporation.⁷⁶ These expectations include the dual fiduciary duties of care and loyalty, as well as the “specific subsidiary fiduciary rules that elaborate on the application of [those broader primary duties]” like the duties of good faith, oversight, and disclosure.⁷⁷

Standards of review, on the other hand, are the rules a court will apply in evaluating a fiduciary’s conduct to determine whether she breached her duties.⁷⁸ The default standard of judicial review is the business judgment rule.⁷⁹ The business judgment rule “is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.”⁸⁰

As is often discussed in corporate scholarship, the standards of review and standards of conduct do not identically coincide.⁸¹ Rather, there is a significant gap between the ex ante fiduciary obligations espoused by the courts and the lower ex post standard of review under which an actor’s conduct must past judicial muster.⁸² Moreover, standards of review and conduct have not developed—and do not operate—in silos. For example, the business judgment rule was a corporate law construct long before the duty of care was embraced as a corporate norm; thus, the articulation of the standard of conduct for care was rooted in the business judgment rule standard of review.⁸³

In corporate jurisprudence, fiduciary doctrine is largely a creature of common law. Fiduciary duties, arising from the traditional powers of equity and enforceable by courts, serve as a check on the statutory authority of managers.⁸⁴ As applied to directors, the applicable standards of review and standards of conduct are relatively well-established, having been carefully crafted in thousands of court opinions.⁸⁵ As described by Professor Edward Rock, notwithstanding “the fact-specific, narrative quality of Delaware opinions, over time [those decisions] yield reasonably determinative guidelines” for the role and duties of directors.⁸⁶

As applied to officers, however, the courts have been relatively silent, leaving scholars to speculate as to the exact contours of both the applicable standard of conduct and standard of review.⁸⁷ The ABA Task Force’s project recommends private ordering as a way to clarify: (1) officer fiduciary duties; and (2) the applicability of the business judgment rule to officer actions. The following sections analyze these two aspects of corporate fiduciary doctrine, addressing the viability of private ordering for each aspect and discussing possible contractual drafting considerations.

B. Standards of Conduct: Fiduciary Duties

1. Viability of Private Ordering

The ability of corporations to privately order officer fiduciary duties is subject to both statutory and equitable limitations. These two limitations are discussed in turn.

a. Statutory Limitations

In business associations more broadly, the laws governing contractual specification of fiduciary obligations fall along a spectrum. At one end of the spectrum are corporate statutes: the DGCL does not allow modification of director fiduciary duties.⁸⁸

For examples of commentators arguing that director fiduciary duties are a mandatory aspect of corporate law, see Lucian Arye Bebchuk & Assaf Hamdani, Optimal Defaults for Corporate Law Evolution, 96 Nw. U. L. Rev. 489, 496 & n.16 (2002) (citing “the duty of loyalty of corporate directors” as a mandatory aspect of corporate law); Black, supra note 53, at 551–53 (1990); Melvin Aron Eisenberg, The Structure of Corporation Law, 89 Colum. L. Rev. 1461, 1486 (1989) (self-dealing rules are “largely mandatory, at least for publicly held corporations”); Marcel Kahan, The Qualified Case Against Mandatory Terms in Bonds, 89 Nw. U. L. Rev. 565, 607 n.164 (1995); Randall S. Thomas, What Is Corporate Law’s Place in Promoting Societal Welfare?: An Essay in Honor of Professor William Klein, 2 Berkeley Bus. L.J. 135, 139 (2005). But see Gabriel Rauterberg & Eric Talley, Contracting Out of the Fiduciary Duty of Loyalty: An Empirical Analysis of Corporate Opportunity Waivers, 117 Colum. L. Rev. 1075, 1077–78 (2017) (arguing that the ability to waive corporate opportunity claims means the duty of loyalty is no longer mandatory). And the Delaware courts have made clear that, for directors, fiduciary duties trump freedom of contract.⁸⁹ At the opposite end of the spectrum are Delaware’s alternative entity statutes—the LLC Act and LP Act—which allow modification, or even elimination, of fiduciary obligations of managers, members, or partners.⁹⁰ Falling in the middle of the spectrum, though trending more towards alternative entities, are agency and partnership law, which allow limitation, but not elimination, of fiduciary duties.⁹¹ On which part of this spectrum corporate officers fall is unclear.

Officers awkwardly straddle an agent-director fiduciary dichotomy. On the one hand, some courts, statutes, and treatises describe officers as agents of the corporation.⁹² On the other hand, however, Gantler and its progeny appear to situate officers in their own special director-like fiduciary role within the corporation.⁹³ Adding to the confusion, the Delaware Court of Chancery recently described corporate officers as both agents and director-like fiduciaries of the corporation.⁹⁴ Given the consequences vis-à-vis the ability to contractually arrange fiduciary obligations, how officers are classified is a critical threshold issue that must be resolved.⁹⁵

For a discussion of the ambiguity surrounding the definition and classification of “officer” in corporate law, as well as a proposal for reform, see generally id.

State corporate codes provide little guidance on how to resolve issues involving officers or whether private ordering efforts to specify officer fiduciary duties are viable. Delaware, the decided leader in corporate law,⁹⁶ says very little in its corporate statutes about officers, even failing to define the term “officer.”⁹⁷ Section 142 of the DGCL, the principal provision addressing the role of the officer,⁹⁸ provides only that: “Every corporation organized under this chapter shall have such officers with such titles and duties as shall be stated in the bylaws or in a resolution of the board of directors which is not inconsistent with the bylaws . . . .”⁹⁹

While one can argue that this language allows modification of officer fiduciary—as opposed to more general—duties, courts are highly unlikely to adopt that interpretation. In contrast to the DGCL, the statutory language in the Delaware LLC and LP provisions specifically allow modification of member, manager, or partner fiduciary duties.¹⁰⁰ Given the central role that fiduciary duties play in checking managerial power in corporations, absent express statutory language like that provided for LLCs and LPs, the courts will be resistant to reading such expansive contractual freedoms into section 142.¹⁰¹

Another DGCL provision that bears on the ability to contractually structure officer duties is section 122. Section 122(17) allows a corporation to renounce any interest in specific business opportunities in its certificate of incorporation or by action of its board of directors.¹⁰² Such a charter provision or board action thus allows directors and officers to take advantage of certain types of business opportunities without running afoul of their duty of loyalty.¹⁰³

While one could argue that section 122(17) supports the ability to contractually limit officer duties—in the charter or by the board through separate agreement—that argument is unpersuasive for several reasons. First, the Delaware courts have explained that a renunciation of corporate opportunities under section 122(17) operates as a waiver of, not a limitation on, a director’s or officer’s duty of loyalty.¹⁰⁴

Section 102(b)(7) of the DGCL further supports this conclusion. Section 102(b)(7) allows a corporation to exculpate directors for breaching their duty of care by including a provision in its charter. Del. Code Ann. tit. 8, § 102(b)(7). While sometimes described as a limitation on directors’ fiduciary duty of care, an exculpatory provision does not limit the content of the duty of care, but rather limits the extent of the remedy for a breach of such duty. Balotti & Finkelstein, supra note 103, § 4.19[A] n.1097 (“Note also that Section 102(b)(7) allows the certificate of incorporation of a Delaware corporation to limit or eliminate the financial liability of directors for breach of the duty of care . . . Such a limitation of liability does not, however, limit or eliminate the requirement that directors act with due care . . . .”); William E. Knepper & Dan A. Bailey, Liability of Corporate Officers and Directors § 7.04, at 217 (4^th ed. 1988) (“The commentators agree that the new section [102(b)(7)] does not eliminate or alter a director’s fiduciary duty of care.”). That exculpation does not eliminate a director’s duty of care is demonstrated by the fact that exculpation only applies to money damages resulting from a breach, not to equitable damages such as an injunction. See also 5 Del. Laws 544 (1986) (commentary to section 102(b)(7)) (“This provision would have no effect on the availability of equitable remedies, such as injunction or rescission, for breach of fiduciary duty.”). This is an important distinction: a waiver does not alter the content of an officer’s fiduciary duties, but merely signals the corporation’s relinquishment of its legal right to enforce a particular duty in a particular context.¹⁰⁵ Second, even if read as a narrow fiduciary limitation, the legislature’s use of specific statutory language in section 122(17) to authorize the limitation of directors’ and officers’ duty of loyalty indicates that the corporation’s authority to modify “duties” under section 142 does not extend to those duties that are fiduciary in nature.¹⁰⁶ Indeed, under the canon of construction “expressio unius est exclusio alterius,” reading section 122(17) to limit an officer’s duty of loyalty further supports the premise that any limitation or elimination of officer fiduciary duties requires specific statutory language similar to that of section 122.¹⁰⁷

Outside of Delaware, however, one can make a stronger argument in favor of the validity of private ordering of officer fiduciary duties. Ohio’s corporate statute, for example, more directly addresses officer standards of conduct and standards of review and the ability to alter them contractually.¹⁰⁸ In pertinent part, section 1701.641 of the Ohio code provides that:

(A) Unless the articles, the regulations, or a written agreement with an officer establishes additional fiduciary duties, the only fiduciary duties of an officer are the duties to the corporation set forth in division (B) of this section.

(B) An officer shall perform the officer’s duties to the corporation in good faith, in a manner the officer reasonably believes to be in or not opposed to the best interests of the corporation, and with the care that an ordinarily prudent person in a like position would use under similar circumstances . . . .

(D) An officer shall be liable in damages for a violation of the officer’s duties under division (B) of this section only if it is proved by clear and convincing evidence in a court of competent jurisdiction that the officer’s action or failure to act involved an act or omission undertaken with deliberate intent to cause injury to the corporation or undertaken with reckless disregard for the best interests of the corporation. This division does not apply if, and only to the extent that, at the time of an officer’s act or omission that is the subject of the complaint, either of the following is true:

(1) The articles or the regulations of the corporation state by specific reference to division (D) of this section that the provisions of this division do not apply to the corporation.

(2) A written agreement between the officer and the corporation states by specific reference to division (D) of this section that the provisions of this division do not apply to the officer.¹⁰⁹

The default fiduciary duties that section 1701.641(A) and (B) imposes on officers are essentially the same duties that the Ohio code imposes on directors.¹¹⁰ Under section 1701.641(A), a corporation can, however, impose additional fiduciary duties on an officer via its charter, corporate regulations, or a written agreement with the officer.¹¹¹ By stating only that a corporation can add fiduciary duties, the Ohio statute implies, though, that default fiduciary duties cannot be eliminated. Moreover, the standard of liability articulated in section 1701.641(D) establishes default liability standards for officers that are, again, akin to those of directors.¹¹² Subsection (D) does allow modification of those standards, however, by permitting a corporation to opt out of the subsection’s liability standard by including a provision in its charter, bylaws, or in a written agreement.¹¹³

In sum, when compared to the DGCL, the Ohio code provides greater clarity with respect to the default fiduciary duties and standards of review for officers, while also recognizing limited means for contractually arranging such duties and standards. While Ohio’s statute does not permit broad discretion to privately order officers’ duties, it does indicate that, at least in some jurisdictions, corporations are permitted to engage in some degree of private ordering of officer fiduciary duties.¹¹⁴

b. Equitable Limitations

In corporate law, it is not enough that corporate contracting may be legally taken, such action must also be equitable to be valid.¹¹⁵ As the Delaware Supreme Court explained in ATP Tour, Inc. v. Deutscher Tennis Bund¹¹⁶91 A.3d 554 (Del. 2014) (en banc). in relation to fee-shifting bylaws, whether a specific facially valid bylaw would be enforced “depends on the manner in which it was adopted and the circumstances under which it was invoked.”¹¹⁷ Thus even assuming, arguendo, that case law and statutes permit corporations to modify or eliminate officer fiduciary duties, equitable considerations may still limit the validity of such efforts.

To ensure that directors do not misuse their broad managerial authority, they “are charged with an unyielding fiduciary duty to protect the interests of the corporation and to act in the best interests of its shareholders.”¹¹⁸ In making decisions, directors must comply with their fundamental fiduciary duties of loyalty and care.¹¹⁹ Professor Lyman Johnson accurately summarized the fiduciary predicament that directors face in attempting to privately order officer duties:

[G]iven that officers cannot be exculpated from personal liability for breaching their duties under Delaware law, and given the Supreme Court’s description of fiduciary duties as “immutable,” it is doubtful that boards of directors—themselves fiduciaries—could reduce (or eliminate) ex ante the fiduciary standards applicable to officers, or act to lessen the consequences of fiduciary duty breaches, whether by means of employment contracts or through bylaw amendments.¹²⁰

In other words, directors would be hard pressed to successfully defend the decision to grant executive officers broad corporate authority and deference in exercising such authority, while at the same time limiting, or eliminating, any protection from abuse of such power. Surrendering a central tool for reducing managerial agency costs seems to run contrary to the board’s own fiduciary responsibility of oversight.¹²¹

2. Contracting Considerations

Assuming that officer fiduciary duties can be contractually structured, what issues will arise as corporations, boards, officers, and their counsel draft these provisions? This Section discusses some of the drafting considerations that are implicated regardless of whether the private ordering is situated in the charter, the bylaws, or a private agreement.

First, private ordering of officer fiduciary duties will be the product of human effort and thus is subject to error and ambiguity. Behavioral bias and limitations—like bounded rationality, framing and endowment effects, self-interestedness, and status quo bias, among others—can impact the drafting of a provision. Legal scholars, for example, have observed patterns in charters suggesting the influence of these types of behavioral phenomena on their drafting.¹²²

Moreover, scholars across all disciplines agree that structuring a relationship and accurately reducing parties’ expectations to words is a difficult, if not impossible, task. And the probability for error is even higher when, as is the case organizational documents, language is intended to project into the future and govern a long-term relationship.¹²³

As scholars, judges, and practitioners agree, fiduciary duties, as a general matter, are relatively undefined and highly contextual in nature, making prediction difficult.¹²⁴ While “the normal accretive process of common law development has ameliorated this problem by producing a rich body of interpretive authority on fiduciary matters,”¹²⁵ attempting to reduce decades of fiduciary cases to finite contractual language is a challenging, perhaps impossible task. As two prominent Delaware jurists have observed in the LLC context—where parties already engage in this type of contracting—“the free-writing in delineating or eliminating fiduciary duties that commonly occurs within the operating agreement is a poor substitute for what can be accomplished within the corporate context.”¹²⁶ Thus, fiduciary duty provisions will often be flawed, necessitating judicial involvement.¹²⁷

In addition, the underlying problem—the uncertainty surrounding officer fiduciary duties—that private ordering solutions are intended to remedy complicates parties’ ability to effectively contract in this space. The ability to contractually shape a fiduciary relationship with an officer assumes that the parties can start from statutory or common law default principles of law.¹²⁸ Where, as is currently the case, parties lack a common understanding of the relevant default legal fiduciary duty principles, any negotiation and private ordering will inherently be ambiguous and litigious. Indeed, the lack of established default principles has been one of the critiques of private ordering efforts in the LLC and LP context.¹²⁹ In the absence of a set of standard defaults, parties will incur material transaction costs in the drafting process. Unable to rely on their mutual understandings of default principles of law, parties will be forced to “evaluate entity-specific provisions, ostensibly bargained for on an investment-by-investment basis to protect their interests.”¹³⁰ Moreover, to the extent boards are negotiating fiduciary duties with each individual officer, such officer-specific tailoring will merely compound already high transaction costs.¹³¹

The risks and transaction costs described above will vary depending on jurisdiction. Delaware, on the one hand, has no statutory guidance and little common law guidance regarding officer fiduciary duties.¹³² Thus, transaction costs for private ordering officers in Delaware corporations will be high. On the other hand, states that have adopted versions of the Model Business Corporation Act (“MBCA”) provide some statutory guidance regarding officer conduct.¹³³ The MBCA’s language regarding officer duties, however, only ameliorates the transaction costs attendant to private ordering to a limited degree. There are still many unresolved issues surrounding officers in MBCA jurisdictions, including the lack of definitional clarity (i.e., who is an “officer”?) and the exact contours of the subsidiary fiduciary duties that are derived from the broader primary duties of care and loyalty.¹³⁴ Indeed, the MBCA recognizes the important role of common law development of the duties in supplementing the baseline principles its provisions offer officers.¹³⁵ Thus, even under the MBCA, or similarly drafted statutes, the transaction costs of privately ordering officer fiduciary duties will still remain fairly high.

In sum, regardless of the jurisdiction, the uncertainty surrounding officer duties means that private ordering solutions will carry material transaction costs in the ex ante negotiating and drafting process and the ex post enforcement process.¹³⁶

C. Standards of Review: The Business Judgment Rule

1. Viability of Private Ordering

The business judgment rule is a “cornerstone concept in corporate law.”¹³⁷ Corporate directors clearly enjoy the protections of the business judgment rule—the “presumption that that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.”¹³⁸ Whether officers enjoy similar judicial deference is uncertain. Commentary and case law on the issue are sparse and seem to point in both directions.¹³⁹ Delaware—the leading corporate law jurisdiction—has acknowledged the uncertainty, but to date has yet to provide any conceptual or positive law on the matter.¹⁴⁰ In light of the uncertainty, can parties contractually structure the degree of deference a court should apply in reviewing officer conduct?¹⁴¹

The ability to contractually provide for application of the business judgment rule to officers will depend on the jurisdiction. While Delaware refrains from articulating either standards of conduct or standards of review in its statutes, leaving them as common law principles,¹⁴² other corporate codes do. For example, the MBCA recognizes the business judgment rule’s applicability to officers’ decisions so long as they are acting within their discretionary authority.¹⁴³ In its commentary, however, the MBCA drafters make clear that

[t]he elements of the business judgment rule and the circumstances for its application continue to be developed and refined by courts. Accordingly, it would not be desirable to freeze the concept in a statute. Thus, [the MBCA] does not codify the business judgment rule as a whole, although certain of its principal elements, relating to personal liability issues, are reflected in [it].¹⁴⁴

The American Law Institute’s Principles of Corporate Governance are more affirmative than the MBCA in addressing the business judgment rule’s application to officers, providing that an officer’s duty of care “is subject to the provisions of . . . (the business judgment rule) where applicable.”¹⁴⁵ The different formulations of the business judgment rule by Delaware, the ALI, and the MBCA can be described as follows: “[Delaware’s] model is a presumption, while the [ALI formulation] is a safe harbor.”¹⁴⁶ And the MBCA’s language “recognizes the business judgment rule and provides guidance as to its application” but explicitly refrains from serving as a codification of the rule.¹⁴⁷

An analysis of specific jurisdictions illustrates the varying viability of contractually structuring the business judgment rule. In jurisdictions, like Ohio and Nevada, where the business judgment rule is codified in statute,¹⁴⁸ the ability to privately order the rule is unlikely absent express statutory authority. The inability to contract the rule in these jurisdictions may, however, be a nonissue as the codification of the rule leaves no uncertainty in the standard of review applicable to officers necessitating private ordering.¹⁴⁹

On the other end of the spectrum, in jurisdictions like Delaware that apply a presumption and, to some degree, in jurisdictions that adopt the MBCA’s language, the ability to contractually provide for the business judgment rule is more nuanced.¹⁵⁰ There, the business judgment rule exists as a common law standard of judicial review and thus there is no statutory authority on which to rely in determining the viability of private ordering. In the absence of express statutory language, the Delaware courts have made clear that the only other limit on private ordering is if a provision runs contrary to settled rules of public policy.¹⁵¹ Along those lines, the pertinent inquiry is: Does an officer business judgment rule violate public policy? Unfortunately, the answer to this depends upon first resolving underlying questions as to whether (and why) the business judgment rule applies, or does not apply, to officers under default legal principles.¹⁵²

As a standard of review, the business judgment rule and fiduciary duties are, however, intertwined. Indeed, where a standard of review is calibrated essentially sets the bar for compliance with the fiduciary standard of conduct.¹⁵³ The duty of care and the business judgment rule, for example, illustrate this interdependency. As explained by Professor Johnson: “[T]he business judgment rule preceded a clear articulation of the duty of care and the standard of conduct (care) thus became embedded in the standard of review (the business judgement rule).”¹⁵⁴

The discussion regarding the viability of fiduciary duty contracting is thus instructive when considering the viability of privately ordering application of the business judgment rule. To the extent that courts would be hesitant to allow parties to privately arrange officer fiduciary duties, such concerns would also be present with respect to the business judgment rule. This would be especially true if courts held that parties were unable to privately order fiduciary duties: contractual business judgment rules could be viewed as a backdoor means of limiting those duties.

Finally, as discussed above in the context of fiduciary standards of conduct, the board’s own fiduciary duties would be implicated in (and perhaps would limit) any effort to contractually structure business judgment rule presumptions for officers.¹⁵⁵

2. Contracting Considerations

As discussed above, whether the business judgment rule, as a matter of law, applies to officers is an open question. While the courts have largely remained silent on this issue, a lively debate exists among academics and experts in the field.¹⁵⁶ Assuming, arguendo, that courts will enforce contractually provided business judgment rule protections for corporate officers, this Section proposes a framework for privately ordering business judgment rule deference that strikes a balance between the competing arguments—those in favor of managerial deference versus those concerned about managerial accountability—raised in the literature.

Proponents of business judgement rule protection point out that officers are empowered to exercise discretion and judgment with respect to both executive and administrative functions.¹⁵⁷ This director-like authority (indeed, for executive officers it is a direct delegation of directors’ statutory authority) implicates the policy rationales that underlie the business judgment rule,¹⁵⁸ thus supporting its application to officers as well as directors.

On the other hand, objections to extending business judgement rule deference to corporate officers typically focus on the different roles, rights, and responsibilities that officers have as compared to directors. These fundamental differences, critics point out, undermine much of the reasoning behind the business judgment rule’s protections.¹⁵⁹

For example, one rationale for extending business judgment rule deference to directors is that they are generally less involved in the daily operations of the corporation and must rely on the information and reports made to them by officers.¹⁶⁰ Executive officers, by contrast, are intimately involved in the day-to-day management of the business. “[W]ith greater access to the books and records of the corporation and a more intimate knowledge of the business and affairs of the corporation, one of the primary functions of officers is to be fully informed with respect to the corporate enterprise and to report to the board.”¹⁶¹ Given their high-ranking status and “access to considerably more and better information than directors,” officers should be held to a more exacting judicial standard of review than directors.¹⁶² Accordingly, officers’ managerial role, as well as their more lucrative compensation, differentiates these individual from directors such that the conventional rationales for applying the business judgment rule do not support the rule’s application to officers.¹⁶³

The opposing positions raised by the two camps can be summarized as managerial deference versus managerial accountability. A limited application of the business judgment rule based on corporate hierarchy assuages the concerns on both sides of the debate. State laws generally treat “officers” as a monolith, failing to provide any gradation within this class of corporate actor.¹⁶⁴ Yet not all officers are the same. Senior executive officers, often referred to as the C-Suite, occupy positions of immense power and authority within the corporation, most often having their power delegated directly from the board.¹⁶⁵ At the other end of the spectrum, a corporation may have numerous vice presidents, executive vice presidents, senior vice presidents, assistant treasurers, and the like, most of whom are officers in name only and have responsibilities akin to rank-and-file employees.¹⁶⁶ A business judgement rule structured to take into account the variation in types of officers would be well-suited to further the business judgment rule’s policy rationales while avoiding overbroad application.¹⁶⁷

Federal securities laws and the ALI’s Principles of Corporate Governance (“ALI Principles”) are instructive in this regard. Both federal securities law and the ALI Principles recognize in their provisions that there are different ranks of officers within the corporate enterprise and that legal obligations should be tailored accordingly.¹⁶⁸ For example, rules promulgated under the Securities and Exchange Acts of 1933 and 1934 define “officer” broadly, but then further define a subset of officers—“executive officers”—that have heightened responsibilities and liabilities.¹⁶⁹ The ALI Principles similarly identify different tiers of officers in its definitional provisions—“officers,” “senior executives,” and “principal senior executives”—which then implicate different legal rights and obligations.¹⁷⁰ The differentiation in legal obligations stems from the recognition that not all officers are alike: some individuals are officers in title only, while others are vested with director-like management authority; each should be held accountable according to his or her role.¹⁷¹

Tailoring the application of the business judgment rule to the type of officer in a fashion similar to that employed by the ALI or in securities laws—whether through private ordering, state statutes, or case law—strikes a balance between the competing concerns raised in the literature. Differentiating officers’ roles and responsibilities allows identification of those corporate actors whose risk-taking and business decision-making are in line with the policies animating the business judgment rule and thus deserve judicial deference. Applying the business judgment rule only to senior executives would then align more closely with the expectations of the parties—boards, officers, and stockholders—because deference would be limited to those individuals who are truly exercising director-like authority. Moreover, fashioning the business judgment rule in this manner would be consistent with efforts in other areas of corporate law to distinguish the roles and responsibilities of officers from those of directors.¹⁷²

Lastly, as is the case with contractually structuring fiduciary duties, reducing the business judgment rule to words will be an arduous task. Indeed, the ABA Corporate Laws Committee, charged with drafting the MBCA and comprised of some of the top lawyers, judges, and academics in corporate law, has been unable to articulate the rule in statute.¹⁷³ Using private ordering means to clarify an area of that law that is described as one “of the great puzzles” of American corporate law¹⁷⁴ and “one of the least understood concepts in the entire corporate field”¹⁷⁵ may, in the end, create only more uncertainty and litigation, not less. Private ordering’s utility may, in reality, be greatly outweighed by the ex ante transaction costs and ex post litigation costs.¹⁷⁶

IV. A Normative Evaluation of Private Ordering

Setting aside the issue of whether contractually arranging officer duties and liabilities within the confines of current positive law is viable, the normative question remains: Should corporations be able to individually select the rules that will govern their officers’ conduct? In many respects the Task Force’s proposal serves merely as the latest iteration of a debate that has long-plagued corporate law discourse—Are the corporation and the rules and regulations that govern it purely creatures of contract or are they something broader?¹⁷⁷ This Part addresses these questions by examining the dual private-public nature of the corporation and the role of fiduciary duties in incentivizing desirable corporate behavior. It then follows by considering the implications of privately ordering officer duties on the governance of corporate behavior, focusing on the effect of private ordering on: (1) the role of stockholders in holding officers accountable; (2) the role of the courts in policing officer behavior; and (3) the role of markets and norms on influencing officer conduct.

A. The Private-Public Nature of the Corporation and the Importance of Fiduciary Duties

Proponents of the nexus of contracts theory view the corporation as a collection of contractual relationships;¹⁷⁸ they view the duties imposed on corporate actors, including fiduciary duties, as “simply a species of contract,”¹⁷⁹ in effect, a creature of private law. Traditional corporate scholars, on the other hand, view fiduciary duties as mandatory constraints emanating from the trust-like relationship that exists between stockholders and management.¹⁸⁰ This entity conception of the corporation situates the corporation’s role in the broader context of social and political values, and thus corporate law is public, not private, law.¹⁸¹ Allowing the private ordering of officers—central figures in corporate governance—would reinforce the nexus of contracts theory of the firm in corporate doctrine while weakening an entity conception of the corporation and corporate relations in a way that could undermine beneficial societal conventions.

In their exercise of power, managers—whether they are directors, officers, or certain controlling stockholders—are held to certain fiduciary standards. These fiduciary obligations do not arise as a matter of contract,¹⁸² but out of public policy. Serving as a way to protect investors who entrust vast amounts of capital to centralized management, fiduciary duties find their legal roots in broader social welfare and relational considerations not present in contract law.¹⁸³ As explained by former Delaware Supreme Court Chief Justice Myron Steele, “[w]e, as a society, encourage corporate investment, which is ‘socially desirable, but vulnerable,’ by designing a liability framework that (1) incentivizes fiduciary conduct on terms with which investors can relate and (2) proves itself an effective protector of investor interests.”¹⁸⁴ And “[w]ithout the ability to create their own remedies or protective devices, shareholders must depend on courts to enforce fiduciary duties to make directors and officers, entrusted with shareholder property, walk the proverbial ‘straight and narrow.’”¹⁸⁵

Even staunch proponents of the contractual theory of the firm recognize that the role of fiduciary duties within the corporate enterprise may be different than their contractually based counterparts in unincorporated business entities.¹⁸⁶ Certain mandatory rules, such as fiduciary duties, exist because of the unique relationships created in the corporate structure. Corporate law’s enshrinement of the relationship between managers and stockholders as fiduciary in character requires actors to conduct themselves in an “‘other-regarding way’ consistent with duties of care and loyalty.”¹⁸⁷ Indeed, the courts point to the imposition of fiduciary duties as a key factor that distinguishes business entities from long-term relational contracting.¹⁸⁸ Fiduciary duties serve as a critical mechanism for policing opportunistic and inept conduct by management and protecting the interests of stockholders and the corporate enterprise.¹⁸⁹ In this way, fiduciary duties legitimize the corporate endeavor and its separation of ownership from control. By permitting private agreements between corporations and officers, private ordering may undermine the social welfare and protection policies that underlie public policy motivations giving rise to managerial fiduciary duties.

Corporate law plays a pivotal role in our economic system.¹⁹⁰ In addition to stockholders, large corporations (both private and publicly traded) have a significant impact on constituencies including employees, creditors, customers, and local communities.¹⁹¹ Even in a monitoring age of corporate governance, CEOs and senior executive officers, not boards of directors, run these corporations.¹⁹² Accepting the reality of corporate managerialism has profound consequences for private ordering in this space. As Professor Lawrence Mitchell writes: “Absolute power corrupts absolutely. It would probably be a bad idea, and completely inconsistent with the structures legitimating the modern corporation, to permit CEOs to run corporations unchecked.”¹⁹³ Fiduciary duties combat both traditional agency problems such as opportunism and shirking, as well as, albeit to a lesser degree, managerial behaviors such as overconfidence and bias.¹⁹⁴ In an age where other checks on managerial power, like market pressures, stockholder election and removal, and stockholder litigation, are absent or severely restricted, there is added pressure on fiduciary duties to maintain officer accountability.¹⁹⁵

In addition, fiduciary duties have the potential to be more impactful in incentivizing optimal corporate decision-making at the officer, rather than board, level. Professor Mitchell stated:

[W]hen the board fails, it fails as an institution and not as individuals. The board itself may be held accountable, but the individuals who comprise it are relatively immune . . . The CEO presents a different story. The CEO is an identifiable, known individual . . . [I]dentifying the CEO as the figure to bear the brunt of corporate accountability will instill in the CEO the kind of sense of responsibility that will help to ensure the best kind of corporate decisionmaking . . . .¹⁹⁶

The dangers in allowing officers to limit or eliminate the fiduciary obligations corporate law imposes are great. Professor Kent Greenfield cautions that corporate scholars, judges, and legislators should also keep in mind the corporation’s position within society at large when crafting corporate governance rules: “while the corporation is a hugely important and successful engine of wealth creation, it can also be an amoral behemoth that fouls the environment, worsens political inequalities, and takes advantage of horrible injustices for its own financial gain.”¹⁹⁷

In the modern American corporation, it is the executive officers who are at the helm of these behemoths. The impact of their decision-making is not limited to a corporation’s financial returns but reaches its workforce, consumer base, community, the environment, and markets worldwide. Officer misconduct was identified as a contributing—if not leading—factor in all of the following disasters: the Gulf of Mexico oil spill,¹⁹⁸ the widespread financial fraud in the early 2000s,¹⁹⁹ the global financial crisis in 2008,²⁰⁰ and Massey Energy’s Big Branch mine explosion.²⁰¹ More recently, the near implosion of WeWork, a unicorn startup valued at nearly $50 billion, was attributed to its former CEO and founder’s conduct and the company’s poor corporate governance structure.²⁰² The fallout from this single officer’s erratic, self-interested, and sometimes illegal, behavior and management left WeWork valued at a mere fraction of its original valuation and resulted in a layoff of a large portion of its workforce.²⁰³ As these examples illustrate, there are significant externalities that flow from officer misconduct and poor governance structures. Ensuring officer fidelity to principles of good faith, loyalty, and care, is thus critical. To the extent that private ordering allows corporations and officers to contract around these basic principles, it may weaken options for strong corporate oversight that can prevent these types of disasters.

In sum, because of the potentially significant, widespread consequences, allowing officers’ fiduciary obligations to be mutable should not be taken lightly. Indeed, in the officer-dominated corporate structure, one could argue that fiduciary duties should be beyond private ordering except pursuant to explicit statutory authority.²⁰⁴ Alternatively, to the extent that the courts continue to endorse private ordering and allow corporations to tailor officer duties via contract, such provisions should be subject to the type of heightened judicial scrutiny based on the Unocal Corp. v. Mesa Petroleum Co.²⁰⁵ decision, as proposed by Professor Fisch.²⁰⁶

B. The Impact of Private Ordering on the Governance of Corporate Behavior

Private ordering of officer duties and liabilities has implications, not only for corporate conventions, but also for the ability of corporate and societal actors to enforce and ensure responsible corporate behavior. The remainder of this Section assumes the enforceability of privately ordered officer duties and discusses the impact of private ordering on the role of stockholders, courts, and markets in corporate governance.

1. The Role of Stockholders

Under current corporate doctrine—without the overlay of private ordering—stockholders are significantly constrained in their ability to reduce agency costs and hold officers accountable. The courts have made clear that stockholders lack the power to remove officers.²⁰⁷ And while bylaws often provide for officer appointments and processes for filling vacancies, stockholders’ power to amend the bylaws with the aim of impacting the corporation’s governance is limited, making bylaw amendments an unlikely avenue for stockholders to regulate officer conduct.²⁰⁸ At best, then, stockholders can indirectly influence the oversight and accountability of officers via their rights to elect and remove directors and sell their shares (i.e., voting with their feet). These are, however, theoretical checks on management. Scholars have repeatedly found that, in practice, these tactics have very little impact on the board and its decision-making.²⁰⁹

In light of the foregoing, litigation rights are the only viable option for stockholders to ensure managerial accountability.²¹⁰ Privately ordering officer fiduciary duties could, however, severely limit stockholders’ ability to sue. To the extent that officer duties are modified via private contract, stockholders would generally lack standing to enforce those contractual duties.²¹¹ Furthermore, if stockholders sought to hold the board accountable for binding the corporation to unfavorable fiduciary modifications (be it in a contract or the bylaws) or for failing to enforce an officer’s contractual fiduciary duties, the board would be protected by the deferential business judgment rule, making successful litigation challenging.²¹² In sum, with private ordering, all of stockholders’ traditional governance powers—vote, sell, and sue—could be relatively useless with respect to the ability to influence officers.

The result of private ordering is that officers would be insulated from any meaningful accountability by stockholders.²¹³ Given the capture phenomenon documented between the board and senior executive officers,²¹⁴ further reductions in stockholders’ ability to hold officers accountable is problematic and runs counter to the governance system traditionally envisioned for the corporate form.²¹⁵ Moreover, contractarian scholars’ characterization of fiduciary duties as a contractual “hypothetical bargain,” such that parties may “substitute other constraints on the fiduciary’s conduct, including compensation, exit, and control rules” in place of fiduciary duties, assumes actual negotiation over such terms between the board and potential or current officers.²¹⁶ As revealed in the context of executive compensation packages, such arm’s length negotiation does not always occur.²¹⁷ The power imbalance that exists between the board and officers makes preserving stockholder oversight and accountability that much more critical.

2. The Role of the Courts

Corporate law places great weight on the concept of fiduciary duties, vesting power in the courts, as the keepers of those duties, to set, maintain, and enforce the standards of conduct expected of managers.²¹⁸ To the extent that officer fiduciary duties become the subject of private ordering, their nature would shift from mandatory to enabling, which results in a key tradeoff:

[T]o the extent that American courts have permitted greater contractual freedom in corporate law, their relative tolerance has been coupled with greater judicial activism in reading implied terms into the corporate contract and in monitoring for opportunism. Thus, the issue of contractual freedom is inextricably entangled with the issue of institutional competence. Do we rely on prophylactic rules allowing little or no departure from the statutory baseline? Or do we counterbalance contractual freedom with ex post judicial review?²¹⁹

In an era of private ordering, pressure may be placed on the courts to evaluate fiduciary modifications, limitations, or eliminations ex post for fairness. Courts will have to figure out the proper interpretative framework and standard of review for evaluating such corporate contracting—contract law, corporate law, or both.²²⁰ Resolving the threshold question of what legal principles govern will have important implications for tough questions like: Who is the “contract” between, and thus who has enforcement rights—the corporation, stockholders, board, or officers? What third party beneficiary rights, if any, arise from private ordering? How should individuals who occupy dual director-officer status within the corporation be analyzed?

Relatedly, courts will have to tackle the complicated scenarios where standards of conduct are privately ordered but standards of review are not (and vice versa)—a challenge that has yet to be fully resolved in the unincorporated entity context.²²¹ As former Vice Chancellor of the Delaware Court of Chancery Jack Jacobs explained, confronting the challenges of resolving conflicts in private contractual ordering in alternative entity forms required the court “to develop a new legal epistemology—a way of thinking, if you will—about how to approach . . . fundamental issues that in the conventional corporate law world had long been settled.”²²² Similarly, private ordering officer duties may necessitate the court to decide fiduciary duty issues afresh through a hybrid lens of contract and corporate law.

In some cases, however, private ordering may take the courts entirely out of the officer fiduciary equation. Boards of directors may choose to discipline disloyal officers internally or include alternative dispute resolution mechanisms in corporate contracts to avoid messy, public litigation. The efficiencies of private adjudication, however, come at a cost. As Professor Fisch explains, judicial resolution of private ordering (especially in organizational documents) has important benefits by “facilitat[ing] the transparency of governance innovation, lead[ing] to clarification of the law and permit[ing] the spread of provisions that have the potential to enhance corporate value or facilitate their operations.”²²³ As boards increasingly handle contractual fiduciary matters privately, courts may have fewer opportunities to weigh in on officer duties and the questions raised above. Moreover, in contrast to public litigation, private adjudication of fiduciary disputes will decrease the legal and reputational deterrent effects of liability for fiduciary breaches at the individual firm level, and potentially across corporate America, as well.

3. The Role of Markets and Norms

Generally, fiduciary duty issues are, by their very nature, complicated legal controversies that are highly dependent on factual context. Allowing fiduciary duties to be privately ordered will layer complex contract interpretation questions on top of the already highly contextual nature of fiduciary duty analysis. Such a result is bound to further muddy fiduciary doctrine. Questions surrounding privately ordered fiduciary duties are likely to result in courts drawing fine-grained distinctions between fiduciary duty variants that stem from creative lawyering, further complicating this area of law. Officer fiduciary duty cases will hinge on the specific tailoring of such duties in organizational documents or other contractual provisions, thereby stratifying officer fiduciary doctrine in a way that undermines the broader expressive and deterrent functions of corporate law.²²⁴ The result is that officer fiduciary duties will not be fungible across corporate America (or even within a corporation) in the same way that directorial fiduciary duties are.²²⁵ “Corporate manag[ers], investors, regulators, banks, capital markets, and other groups are sensitive to corporate governance practices and the courts’ enforcement [of], interpretation [of], and general commentary on those practices.”²²⁶ To the extent that fiduciary duties have systemic importance to capital markets and corporate governance expectations, that importance will be undermined by private ordering in this space.

Moreover, while corporate law describes fiduciary duties as running from officers to the corporation and its stockholders,²²⁷ it would be narrow—indeed naïve and unrealistic—to think that the benefits that flow from these legal obligations are so limited. Fiduciary duty jurisprudence supports and interacts with social norms to reinforce proper managerial behavior.²²⁸

The norms that flow from litigation’s enforcing fiduciary standards strengthen sensible management of firms and thus contribute to increased economic activity. The norms themselves shape best practices and in that way reduce agency costs as well as uncertainty. Each in turn yields a public benefit. Fiduciary duties, therefore, are hardly private, as they yield important externalities—their enforcement not only compensates those injured by misconduct, but also promotes investment by establishing investor-friendly norms to which managers must conform.²²⁹

In a private ordering world, however, questions of fiduciary duties will shift in an important way from majoritarian to tailored legal analyses. Discussions about community expectations and ideals of proper managerial behavior and fidelity to fiduciary principles will be replaced with inquiries focused on the actual intentions of the specific parties at hand and the specific language used. This will occur without regard to the broader moral ideas underlying fiduciary relationships that have historically separated business entities from contractual relationships, and which have had such a foundational effect on the formation of corporate law.²³⁰

Conclusion

In the wake of decades of judicial and legislative silence on the issue, an ABA Task Force has sought to remedy the uncertainty regarding fiduciary duties that plagues corporate officers. The principal tool at their disposal is private ordering, whether in private contracts or through bylaw or charter provisions. The Task Force’s proposal moves private ordering to a domain that has largely been untouched—substantive corporate law principles. As a result, it raises important questions regarding the scope of private ordering in the corporation and the normative consequences of allowing officer fiduciary duties and liability to become a creature of contract.

Considering how such contracting would be structured exposes the complexities and uncertainties regarding fiduciary doctrine in the corporate governance structure. Contractual efforts in this area of the law will merely mask the underlying officer doctrine problem and perhaps even exacerbate the problem as decisions in this area will be case specific, interpreting tailored provisions that provide no predictability for future cases. This is a stark departure from the more traditional common law development of fiduciary doctrine that, over time, yields reasonably determinative guidelines for fiduciaries’ roles and duties. A closer look at the viability and drafting of contractual fiduciary obligations and the business judgment rule reveal that while the Task Force’s private ordering solution is characterized as remedying the uncertainty surrounding officers, it may well have the opposite effect.

Allowing private ordering with respect to officers—central figures in corporate governance—has important economic, societal, and normative consequences. In an officer-dominated environment, as presently exists in many organizations, there are significant externalities that flow from officer misconduct, harming not just capital markets, but labor markets, customers, and the environment. Expanding private ordering into the realm of officer fiduciary duties raises important issues regarding accountability, deterrence, and responsibility. Moreover, how officer duties are addressed by courts, commentators, and legislators will have important consequences if other corporate fiduciaries, like controlling stockholders, seek to privately order their legal duties.

In sum, while private ordering may address some of the uncertainties in the undertheorized area of corporate officer fiduciary duties, it raises many new concerns, and may not, ultimately, provide the clarity the ABA Task Force seeks. Corporations—their boards, officers, and stockholders—would be wise to move slowly to ensure that their private ordering efforts do not create more problems than they resolve.

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Privately Ordered Fiduciaries

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