Abstract: A storm is brewing on the corporate law horizon. Several recent judicial developments, which this Article ties together for the first time, present the most refined opportunity yet for mandatory arbitration—today prevalent in consumer and employment contracts—to enter the corporate law sphere, shutting the courthouse doors before corporate entities and shareholders precisely where legal remedy is most needed. Yet, for this scenario to unfold, the Supreme Court would have to declare that corporate charters and bylaws are “contracts.” Otherwise, restrictions on arbitration (including those recently enacted by Delaware) cannot be preempted by the Federal Arbitration Act.
As this Article innovatively explains, scholars have long resorted to inaccurate metaphors, such as “nexus of contracts,” in the corporate context. If, however, we move away from legal realist conventions, embrace the idea that corporate law is a self-standing category within private law, and examine its distinctive properties—most importantly, its principled reliance on ex post judicial supervision over open-ended factual scenarios—we find that corporate law is nearly the structural opposite of contract law. This legal distinction also generates a set of powerful economic benefits. Existing scholarship has focused on procedural and doctrinal aspects, such as directors’ power to amend corporate documents without shareholders’ consent. This Article ties the arguments into an overarching theoretical framework, originally bringing together the literature on private law theory, law and economics, and corporate litigation.
Similar to the 1980s takeover wave, and recent debates surrounding corporations’ constitutional rights and corporate purpose, the specter of mandatory arbitration offers an opportunity to take a fresh look at corporate law’s theoretical foundations. The economic benefits and non-contractual, equity-based structure of corporate law are two sides of the same coin. To avoid both inefficiency and injustice, courts and scholars must recognize the implications of corporate law’s distinct nature.
Corporate law is not contract law, and corporate charters and bylaws are not contracts. Influenced by American legal realism,1See, e.g., Edward B. Rock, Corporate Law Doctrine and the Legacy of American Legal Realism, 163 U. Pa. L. Rev. 2019 (2015). with its skepticism of legal concepts and categories,2See, e.g., Felix S. Cohen, Transcendental Nonsense and the Functional Approach, 35 Colum. L. Rev. 809, 820 (1935) (“[A legal] proposition . . . would be scientifically useful if [the legal concepts it uses] were defined in non-legal terms.”). scholars over the last several decades have been loosely employing a contract-centric terminology when discussing issues in corporate law.3See, e.g., Bernard S. Black, Is Corporate Law Trivial?: A Political and Economic Analysis, 84 Nw. U. L. Rev. 542, 555–60 (1990) (discussing much of corporate law as consisting of “avoidable rules” and “changeable rules”); Frank H. Easterbrook & Daniel R. Fischel, Contract and Fiduciary Duty, 36 J.L. & Econ. 425 (1993) (describing agency and corporate duties as the result of contractual processes); Eugene F. Fama & Michael C. Jensen, Separation of Ownership and Control, 26 J.L. & Econ. 301, 302 (1983) (“An organization is the nexus of contracts, written and unwritten, among owners of factors of production and customers.”). As this Article demonstrates, those references have been, at most, a metaphor. In practice, both law and economics scholars,4For a detailed analysis of the link between legal realism and modern law and economics, along with a suggestion as to how to better construe both, see Henry E. Smith, Complexity and the Cathedral: Making Law and Economics More Calabresian, 48 Eur. J.L. & Econ. 43 (2019). and the Delaware courts, are taking corporate law for what it actually is: a distinct legal framework, having its own defining structure, and residing on the same level as contract, property, or tort in the hierarchy of private law.5Importantly, these other frameworks (contract, property, and tort law) have already moved away from the more extreme form of legal realism. Today, much of the scholarship is devoted to the legal concepts that govern these fields (in a manner that also responds to economic and other extra-legal concerns). This change is largely taking place as part of the new private law movement. See infra notes 275–81 and accompanying text. This Article introduces the new private law approach into corporate law, where it has not been widely applied before. Corporate law’s unique characteristics, in turn, allow our economy, society, and technology to flourish, in a way no other legal framework can (or is meant to) achieve.6See infra Section II.B (explaining how corporate law facilitates innovation and entrepreneurship, by creating legal entities with human-like freedom of action, subject to very few contractual or legal constraints ex ante, and subject to broad judicial supervision ex post).
As this Article explains for the first time, the “contract” metaphor—so far tamed by this more nuanced understanding—is now set on a course that might lead it to fundamentally reshape American corporate law as we know it. Two recent developments—one, the Salzberg v. Sciabacucchi7227 A.3d 102 (Del. 2020). decision from the Supreme Court of Delaware; the other, Doris Behr 2012 Irrevocable Trust v. Johnson & Johnson,8No. 3:19‑cv‑8828 (D.N.J. filed Mar. 21, 2019). a case currently pending in federal court—might operate in conjunction to bring about a dramatic development: sending corporate law into the “black hole”9Cynthia Estlund, The Black Hole of Mandatory Arbitration, 96 N.C. L. Rev. 679, 682 (2018). of mandatory arbitration.
Provisions of this kind, today commonly found in consumer and employment contracts, shut the courthouse doors precisely in those situations where civil justice is most needed, and impose severe human and economic costs on our society and rule of law.10See, e.g., Margaret Jane Radin, Boilerplate: The Fine Print, Vanishing Rights, and the Rule of Law (2013). Corporate law, which relies on litigation even more heavily than other legal frameworks,11See infra Sections II.B, II.C. would functionally become a dead letter under a mandatory arbitration regime.12See, e.g., Ann M. Lipton, Manufactured Consent: The Problem of Arbitration Clauses in Corporate Charters and Bylaws, 104 Geo. L.J. 583, 626–40 (2016). Yet, according to both the Federal Arbitration Act (“FAA”)139 U.S.C. §§ 1–16. and the United States Supreme Court, this scenario can only transpire if the federal courts find corporate charters and bylaws to be “contracts.”14See infra note 21 and accompanying text. Ironically, the realist-inspired imprecision that has given rise to such phrases as “nexus of contracts”15E.g. Fama & Jensen, supra note 3, at 302. The phrase “nexus of contracts” appears in over 1,700 works of legal literature. See Lexis+, https://perma.cc/U8Y6-PEQR (search for the term “nexus of contracts” within the category “Secondary Materials”; at the time of writing, the search generated 1,707 results). As this Article explains, that usage does not support a judicial finding that corporate charters and bylaws are contracts. See infra Section II.C. might put the brakes on the highly influential “corporate governance movement,”16E.g. Mariana Pargendler, The Corporate Governance Obsession, 42 J. Corp. L. 359 passim (2016). advocated by the very same law and economics scholars who are using these phrases.
This Article makes two original contributions to the literature: first, in Part I, it describes the current doctrinal situation—what Salzberg and Johnson & Johnson say, how they relate to one another, and how arbitration proponents might utilize these cases to try and introduce mandatory arbitration, first into federal securities law, then state corporate law. No previous academic work has discussed Johnson & Johnson in detail. While Salzberg did attract much scholarly fanfare,17See Dhruv Aggarwal, Albert H. Choi & Ofer Eldar, Federal Forum Provisions and the Internal Affairs Doctrine, 10 Harv. Bus. L. Rev. 383 (2020) (empirically reviewing the effect of the Chancery Court’s Salzberg decision on the share prices of corporations that have adopted federal forum provisions, and calling for the decision’s reversal on these grounds and others); Joseph A. Grundfest, The Limits of Delaware Corporate Law: Internal Affairs, Federal Forum Provisions, and Sciabacucchi, 75 Bus. Law. 1319 (2019) (criticizing the Chancery Court’s Salzberg decision and calling for its reversal, based primarily on arguments in the state-vs.-federal law, or internal affairs, dimension); Michael Klausner, Jason Hegland, Carin LeVine & Jessica Shin, State Section 11 Litigation in the Post-Cyan Environment (Despite Sciabacucchi), 75 Bus. Law. 1769 (2020) (positively reviewing the Delaware Supreme Court’s Salzberg decision, while arguing that litigation under the Securities Act of 1933 might continue in state courts despite the decision); Daniel B. Listwa & Bradley J. Polivka, First Principles for Forum Provisions, 2019 Cardozo L. Rev. De-Novo 106 (arguing that the Chancery Court’s Salzberg decision erred in its construction of the internal affairs doctrine, due to applying a principle of territoriality rather than comity); Mark J. Loewenstein, Pushing the Envelope: Salzberg v. Sciabacucchi and Delaware’s Evolving View of the Internal Affairs Doctrine, 48 Sec. Regul. L.J. 182 (2020) (discussing the Delaware Supreme Court’s Salzberg decision in the context of the internal affairs doctrine); Mohsen Manesh, The Contested Edges of Internal Affairs, 87 Tenn. L. Rev. 251 (2020) (discussing the Salzberg case and other recent developments with the potential to fundamentally expand or restrict the influence of state corporate law, particularly that of Delaware). those works focused on a different dimension—the boundary between corporate and securities law, and the practice of forum selection provisions (which send cases to one court, rather than another)—as opposed to this Article’s emphasis on the more troubling prospect of mandatory arbitration, which aims to stifle all litigation on behalf of the affected corporations.18See, e.g., Aggarwal et al., supra note 17, at 414–16; Grundfest, supra note 17, at 1341 (“Standard objections to arbitration, which include a lack of transparency and the loss of rights that are common in federal or state court, are meaningless when assessing [a federal forum provision] that directs federal claims to an open federal court where the Federal Rules of Civil Procedure and Federal Rules of Evidence apply.” (footnote omitted)).
This Article’s second contribution is even more distinctive. So far, scholarship about corporate litigation has been carried out mostly apart from the literature on corporate theory (or “corporate anatomy”19See, e.g., Reinier Kraakman, John Armour, Paul Davies, Luca Enriques, Henry Hansmann, Gerard Hertig, Klaus Hopt, Hideki Kanda, Mariana Pargendler, Wolf-Georg Ringe & Edward Rock, The Anatomy of Corporate Law: A Comparative and Functional Approach (3d ed. 2017).). The former mainly discusses doctrinal and practical developments in the way corporate law is enforced, while the latter seeks to discern the legal and economic principles that make corporate law what it is. This Article, in Part II, ties the two areas together.
Achieving this synthesis is crucial, because the highly practical, litigation-vs.-arbitration controversy actually hinges on a theoretical question: is corporate law a branch of contract law, and by extension,20This is a critical point: if corporate law is not contract law, then by definition, it is impossible for corporate charters and bylaws to be contracts. The reason is that “contract,” just like “corporate charter,” is a legal concept. Neither instrument can “pull itself up by the bootstraps” and modify its own pre-existing nature. That nature is initially defined by law. See, e.g., James D. Cox, Corporate Law and the Limits of Private Ordering, 93 Wash. U. L. Rev. 257, 279 n.91 (2015); Felipe Jiménez, The Grounds of Arbitral Authority, 96 Tul. L. Rev. (forthcoming 2022) (manuscript at 14–17), https://perma.cc/VGD9-VFX9. To determine if something is a contract or not, we must turn to the organic legal framework that gives rise to that instrument. In U.S. private law, that framework is mostly state common law; this is also what federal courts will have to rely on when considering the questions covered in this Article. See infra notes 132–33 and accompanying text. Specifically, for charters and bylaws, that framework is corporate law, which—due to the reasons described in this Article—gives rise to something very different than “contracts,” as they are defined by contract law. Since corporate law mandates that every corporation must have at least a charter, see, e.g., Del. Code Ann. tit. 8, § 101(a) (2021), it is logically impossible for these documents to be “contracts,” seemingly placing all corporations under the rule of contract law, which is precisely what corporate law differs from. People can still make contracts in regard to corporations (such as a share transfer agreement), just as they can make contracts for the sale of property, for the waiver of a right in tort, or for giving up their share under a will. This fact does not turn the original device—the corporate charter, deed of property, act of tort, or will—into a contract. If no contract was made, which is the default case, we are left with the non-contractual rights and duties, governed by corporate, property, tort, and inheritance law, respectively. are corporate charters and bylaws contracts? According to both the FAA and the U.S. Supreme Court, the FAA strictly applies to contractual, consent-based relationships, as opposed to those grounded in other legal frameworks.21See 9 U.S.C. § 2 (“A written provision in any . . . contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction . . . shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.”). Similarly, the Supreme Court has repeatedly invoked the “fundamental principle that arbitration is a matter of contract.” AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 339 (2011) (quoting Rent-A-Center, W., Inc. v. Jackson, 561 U.S. 63, 67 (2010)). If corporate law lies outside of contract law, then arbitration proponents’ efforts should fail,22See Zachary D. Clopton & Verity Winship, A Cooperative Federalism Approach to Shareholder Arbitration, 128 Yale L.J. F. 169, 177 (2018) (“Under the FAA, arbitration agreements are presumptively valid, irrevocable, and enforceable. This presumption is triggered, however, only if corporate governing documents count as ‘contracts’ under the FAA.”). and corporate law may remain vital and enforceable.
If, however, we take the “contract” metaphor at face value, presumably not much would be left23This Article takes seriously the Supreme Court’s distinction between contracts and non-contracts for purposes of the FAA. At this point, one might again suggest a supposedly more “realist” theory: some judges, who believe civil litigation should be minimized, may have found mandatory arbitration to be a convenient way to dispose of it. For a similar argument, see Pamela K. Bookman, The Arbitration-Litigation Paradox, 72 Vand. L. Rev. 1119 (2019). Presumably, judges in FAA cases might define as “contract” anything they do not want people to be able to vindicate in court. To the extent it occurs, this problem can be addressed separately: primarily, we ought to do away with the idea that supporting private litigation, or opposing it, is a “liberal” or “conservative” matter. The enforceability of private law, through litigation, is—and can become more of—a bipartisan cause. See, e.g., Brian T. Fitzpatrick, The Conservative Case for Class Actions (2019). Moreover, a functioning, enforceable private law is a condition for the existence of free markets and, indeed, free society. See infra notes 270–74 and accompanying text. In any event, this Article provides a core part of the argument that should be made to the Court, when the issue of mandatory arbitration in corporate law comes before it. to stop the Supreme Court from giving fiduciaries the green light to self-exculpate through mandatory arbitration clauses24See infra Section I.C.—which is likely to occur in precisely those corporations that would most need the assistance of courts.25See infra note 218 and accompanying text. Considering that the total value of publicly-listed shares at U.S. stock exchanges is close to $50 trillion,26See Total Market Value of U.S. Stock Market, Siblis Rsch., https://perma.cc/AT9H-DKSJ (stating that “[t]he total market capitalization of the U.S. stock market is . . . [approximately $47 trillion] [as of June 30, 2021]”). This amount should be considered in addition to the value of shares issued by private, or not-publicly-listed, corporations. The latter are an increasingly important phenomenon. See, e.g., Elizabeth Pollman, Startup Governance, 168 U. Pa. L. Rev. 155, 157 (2019) (“Over three hundred ‘unicorn’ startups have reached private valuations described as one billion dollars or more. . . . Our economy and society are increasingly dominated by companies that start in the proverbial garage or dorm room and, for a critical period, operate [as private companies].”). Both private and public corporations feature the same basic structure discussed in this Article, see infra Part II. That structure requires, among other things, ex post supervision by courts, and is incompatible with mandatory arbitration. it is hard to overstate what is hanging in the balance.
As this Article originally explains, the confusion between corporate and contract law—now on the verge of causing its greatest harm ever—is the result of a broader “low-visibility problem” that has been plaguing corporate law discourse for many decades. That problem exists on at least three levels. First, scholars often fail to treat corporate law as law,27Bill Bratton, Corporate Law as Law, Jotwell (Nov. 15, 2019) (reviewing David Kershaw, The Foundations of Anglo-American Corporate Fiduciary Law (2018)), https://perma.cc/G2ZH-C656 (treating the possibility of “corporate law as law” with an air of surprise, as well as stating that, while “Kershaw is affirmatively . . . anti-realist,” “I cannot join him in that”). that is, a jural discipline having its own internal structure, rules, and principles.28See Shyamkrishna Balganesh & Gideon Parchomovsky, Structure and Value in the Common Law, 163 U. Pa. L. Rev. 1241, 1244 (2015). Instead, corporate law is often studied as a predominantly economic29See, e.g., Robert Bartlett & Frank Partnoy, The Misuse of Tobin’s q, 73 Vand. L. Rev. 353 (2020) (surveying a wide range of recent works in that vein); see also Frank H. Easterbrook & Daniel R. Fischel, The Economic Structure of Corporate Law (1991). or political30See, e.g., Marcel Kahan & Ehud Kamar, Price Discrimination in the Market for Corporate Law, 86 Cornell L. Rev. 1205, 1248–50 (2001) (suggesting that the prevalence of corporate litigation is a matter of political economy, through which Delaware preserves its status as the premier venue for incorporation). In contrast, this Article embraces a position much closer to Kershaw, supra note 27: corporate law has its own substance, and practices such as corporate litigation are meant to protect the independent rights and expectations of real people, predating concepts such as “race to the bottom” or “race to the top.” Corporate law’s reliance on litigation is not a bug, but a feature. matter.31Corporate law is the only framework experiencing this problem at such magnitude. Other disciplines in private law, including property, tort, and contract itself, have long moved toward greater emphasis on legal concepts and unifying principles. See infra notes 275–81 and accompanying text. In fact, this move is also occurring in other areas of business law itself. See, e.g., John Morley, The Separation of Funds and Managers: A Theory of Investment Fund Structure and Regulation, 123 Yale L.J. 1228, 1231–32 (2014) (“I offer a broad perspective by suggesting . . . that the essence of investment funds and their regulation lies . . . in the nature of their organization. An investment fund . . . is an enterprise that holds investments in a particular way. . . . This pattern . . . has never been [previously] identified as a common feature of the various types of investment funds.”). This Article brings a similarly broad perspective to corporate law.
Second, even when scholars do think in legal terms, corporate law is often assumed to be merely part of some other discipline—mainly contract law (this Article’s focus), but also agency32See, e.g., J.B. Heaton, Corporate Governance and the Cult of Agency, 64 Vill. L. Rev. 201, 207–14 & passim (2019) (surveying in detail the development of “agency” as a central term of art in corporate academic literature, as well as strongly criticizing that usage). or property law,33See, e.g., Robert Anderson IV, A Property Theory of Corporate Law, 2020 Colum. Bus. L. Rev. 1; Henry Hansmann & Reinier Kraakman, The Essential Role of Organizational Law, 110 Yale L.J. 387, 440 (2000) (“At its essential core, organizational law is property law, not contract law.”). among others.34Some scholars, mainly on the stakeholderist (or “corporate social responsibility”) side, often overlook the line separating corporate law from public law, or general regulation. See, e.g., Sarah E. Light, The Law of the Corporation as Environmental Law, 71 Stan. L. Rev. 137 (2019).
Third, although they sometimes accept that corporate law is a self-standing legal category, most scholars tend to overlook at least one of the defining building blocks that, together, make corporate law what it is: the corporation’s purpose, separate personhood, duty to obey positive law, equitable obligations to residual claimants, and fiduciary duties owed to the entity.35See Asaf Raz, A Purpose-Based Theory of Corporate Law, 65 Vill. L. Rev. 523 (2020). These foundational elements are supplied by law, not contract;36For example, regarding separate personhood, see Kraakman et al., supra note 19, at 31 (“[L]egal personality  clearly requires special rules of law.”). and, as this Article describes, they give rise to unique economic and social benefits, not achievable through any other legal framework.37See infra Section II.B. On the flipside, these properties of corporate law also require constant, ex post monitoring by courts of equity, through litigation—precisely what mandatory arbitration makes impossible.
To be certain, although the link between corporate litigation and corporate theory scholarship can be made stronger, this Article joins a body of literature that has started making it. In a groundbreaking 2016 article,38Lipton, supra note 12. Professor Ann Lipton dissected the problem of mandatory arbitration in corporate law, criticizing it from both descriptive39See id. at 600–26 (arguing that corporations are not contracts, so the FAA cannot apply to them). and normative40See id. at 626–40 (arguing that mandatory arbitration would make corporate law largely unenforceable, leading to an unjustified impairment of shareholders’ rights). aspects. Professors James Cox and Jill Fisch have recently made similar arguments,41See Cox, supra note 20; Jill E. Fisch, Governance by Contract: The Implications for Corporate Bylaws, 106 Calif. L. Rev. 373 (2018). in the somewhat more benign42See supra note 18 and accompanying text. context of forum selection provisions. As the citations throughout this Article demonstrate, a number of other authors have turned their attention to this scholarly space.
While this Article builds upon these essential works, it also importantly adds to them. First, in the doctrinal dimension, this Article is the first to discuss and analyze several very recent developments—namely, the Salzberg and Johnson & Johnson cases43See supra notes 7–8 and accompanying text.—which, if left unchecked, might soon turn mandatory arbitration in corporate law into a reality. Second, in the theoretical dimension, this Article offers an innovative account of corporate law’s distinctive, and non-contractual, nature. Existing works44See, e.g., sources cited supra notes 12, 41. mainly discuss the topic through various examples, correctly illustrating how consent is lacking from the day-to-day workings of corporate law. These examples, however, are not tied to an overarching theory; they demonstrate that corporate law is not contract law, but they do not explain why that is so—what advantages we derive from corporate law’s unique structure. They also do not fully discuss why corporate law cannot become more cognate with contract law, if courts or other lawmakers considered making it so. This Article provides that explanation in detail.45Relatedly, this Article fills another important gap in existing literature: even when writing about the mandatory structure of corporate law, scholars often invoke the language of contract. See, e.g., Lucian Arye Bebchuk, Limiting Contractual Freedom in Corporate Law: The Desirable Constraints on Charter Amendments, 102 Harv. L. Rev. 1820, 1822 (1989) (“[Even] the contractual view of the corporation offers strong reasons for placing significant limits on the freedom to opt out.”). This usage can become highly problematic, because in the arbitration context, the Supreme Court makes an almost binary distinction between contracts and non-contracts; under the textualist approach, anything that is a “contract” might, presumably, fall within the scope of the FAA. See, e.g., Lipton, supra note 12, at 636 n.301. This Article takes a step back, proving that corporate law is not contract law, and charters and bylaws are not contracts—full stop.
Third, previous works have concentrated on various power and information asymmetries between shareholders and managers, which make “shareholder consent” to such litigation-limiting provisions an empty construct.46See, e.g., Cox, supra note 20, at 258–59, 262–72, 283–90; Fisch, supra note 41, at 382–99; Lipton, supra note 12, at 600–26. This Article expands the argument much further: the problem of mandatory arbitration in corporate law is not merely one of consent.47This point is becoming increasingly important, due to the rise of highly powerful institutional investors. See Zohar Goshen & Sharon Hannes, The Death of Corporate Law, 94 N.Y.U. L. Rev. 263 (2019) (arguing that the empowerment of institutional investors can make corporate law unnecessary). In fact, corporate law is very much alive. See Raz, supra note 35, at 528, 531. Even to the extent private actors have greater power vis-à-vis directors and officers, and so might presumably “consent” to mandatory arbitration, that “consent” should not, as a rule, be enforced, for the reasons explained here. See infra Sections II.B, II.C. Rather, it is a problem of enforcement and power to act. Even the most well-informed group of shareholders cannot absolve all present and future fiduciaries of a corporation from legal liability to the entity, over inherently unpredictable, long-term, open-ended scenarios (precisely what corporate law is designed to facilitate). The ideas of equity and ex post supervision are woven into the fabric of corporate law, just as much as the business judgment rule or asset partitioning.
This Article proceeds as follows: Part I provides a doctrinal and practical overview of the current and future state of affairs in corporate mandatory arbitration. Section I.A offers an introduction to both mandatory arbitration and corporate litigation, as they currently stand. Section I.B discusses the Johnson & Johnson case in detail, also explaining how it relates to the recent Salzberg decision. Section I.C describes the route through which Johnson & Johnson or a similar case, combined with Salzberg, might turn mandatory arbitration into a reality, first in the securities arena, then in state corporate law.
Part II turns to the theoretical argument. Because any inquiry into mandatory arbitration hinges on the question of whether corporate law is “contractual” in nature, that Part provides the answer: an unambiguous “no.” Section II.A discusses the root problem—many scholars’ and policymakers’ ongoing refusal to recognize corporate law as a self-standing legal framework and to study its unique nature. Section II.B then goes to the heart of the argument: if not contract, what is corporate law, and what economic and other benefits do we derive from its distinctive legal structure? Section II.C addresses the way in which the phrase “contract” is used in both Delaware case law and corporate academic literature; it explains why looking at that word in isolation ignores a broader, more nuanced idea of corporate law, which both of these bodies of text are conveying.
Similar to the 1980s takeover wave,48See, e.g., William T. Allen, Our Schizophrenic Conception of the Business Corporation, 14 Cardozo L. Rev. 261, 263 (1992) (“The 1980s were turbulent years for corporation law. . . . [In 1977,] [n]o one realized . . . that . . . the secure ground upon which the accepted suppositions of corporation law had been premised would [soon] break apart . . . .”). the discussion surrounding corporations’ constitutional rights over the last decade,49See Elizabeth Pollman, Wrong Turns with Corporate Rights, 98 B.U. L. Rev. Online 44, 44 n.1 (2018) (citing a wide range of recent scholarly works on the topic). and the recent reinvigoration of the corporate purpose debate50See, e.g., Jill E. Fisch & Steven Davidoff Solomon, Should Corporations Have a Purpose?, 99 Tex. L. Rev. 1309 (2021); Jeffrey M. Lipshaw, The False Dichotomy of Corporate Governance Platitudes, 46 J. Corp. L. 345 (2021) (surveying and responding to the recent flux of literature on the topic); Raz, supra note 35.—each bringing corporate theory and corporate practice together in unforeseen ways—this Article turns the specter of mandatory arbitration from a threat to a scholarly opportunity. It is time to consider what corporate law does, and how it does it.51Cf. Henry E. Smith, The Persistence of System in Property Law, 163 U. Pa. L. Rev. 2055, 2065 (2015) (“It is time to consider what property does, and how it does it.”). Pulling corporate law away from the more extreme form of legal realism would preserve its very existence, preventing it from being overrun by mandatory arbitration. As importantly, it would bring corporate literature in line with broader private law scholarship, and provide an answer to what is perhaps the most fundamental question in the field: why do we have corporate law in the first place—and why should we defend its continued presence, separate from any other framework, most pressingly, contract.
I. The New Road to Mandatory Arbitration in Corporate Law
A. The Present Landscape of Mandatory Arbitration and Corporate Litigation
[T]here can be no injury, but there must be a remedy in all or some of them; and therefore I will never determine that frauds of this kind are out of the reach of courts of law or equity, for an intolerable grievance would follow from such a determination.52Charitable Corp. v. Sutton (1742) 26 Eng. Rep. 642, 645; 2 Atk. 400, 406 (Eng.).
Before this Article delves into the issue of mandatory arbitration in corporate law, the current Section asks more generally: what are the pathologies of mandatory arbitration in the United States, and what is corporate litigation—which has so far remained outside of the mandatory arbitration sphere—doing in the meantime for our economy and civil justice system?
To start with, there is not much wrong with arbitration per se.53As the discussion in this Section shows, the U.S. mandatory arbitration system bears little relation to other forms of arbitration, geared toward good faith dispute resolution and the provision of justice to deserving parties. That is generally the case, for example, in the field of international investment arbitration, as well as arbitration between power-symmetrical parties (the FAA’s original subject matter), both of which are outside the scope of this Article. For a nuanced discussion of ways in which the U.S. mandatory arbitration system crosses the line from a dispute resolution device to a justice-impeding one, see Stephen J. Ware, The Centrist Case Against Current (Conservative) Arbitration Law, 68 Fla. L. Rev. 1227 (2016). In current U.S. practice, however, “arbitration clauses” cover a wide range of provisions, often having nothing to do with arbitration as a method of dispute resolution, and everything to do with dispute elimination and obfuscation. These clauses are usually formulated by the party enjoying superior power and information, and are inserted, on a “take it or leave it” basis, into contracts of adhesion—mainly consumer and employment agreements, ranging from mobile phone contracts54See AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 336 (2011). to those governing the hiring of law firm associates and partners.55See, e.g., infra note 65. The problem with the U.S. version of mandatory arbitration, then, is rooted not in the concept of arbitration, but in the extremely simplistic way the Supreme Court requires that arbitration agreements be enforced “according to their terms.”56CompuCredit Corp. v. Greenwood, 565 U.S. 95, 98 (2012).
Although a plain reading of the FAA579 U.S.C. §§ 1–16. instructs us that arbitration provisions “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract,”58Id. § 2 (emphasis added). in practice, the Court is currently not acknowledging almost any “such grounds.”59See Judith Resnik, Diffusing Disputes: The Public in the Private of Arbitration, the Private in Courts, and the Erasure of Rights, 124 Yale L.J. 2804, 2860–74 (2015) (detailing the Supreme Court’s gradual move from an earlier jurisprudence, which did recognize various exceptions to arbitration, grounded in other legal fields, to its current arbitration jurisprudence). Instead, it has aggressively expanded the FAA’s reach, even in cases where contract law or equity do require the non-enforcement of an arbitration provision,60See, e.g., AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 351–52 (2011) (nullifying state contract law rule against certain unconscionable arbitration provisions). and even where the contents of the arbitration clause negate any possibility of an “effective vindication”61Am. Express Co. v. Italian Colors Rest., 570 U.S. 228 passim (2013). of the legal rights at issue.
Such clauses might state, for example, that the weaker party “waives” all rights to bring any class action, although arbitration is fully compatible with class proceedings,62See Am. Arb. Ass’n, Supplementary Rules for Class Arbitrations (Oct. 8, 2003), https://perma.cc/F98Z-LRX2. and despite the fact that it is entirely impossible to “arbitrate” certain claims on a non-class basis.63See, e.g., Concepcion, 563 U.S. at 365 (Breyer, J., dissenting) (“[A]greements that forbid the consolidation of claims can lead small-dollar claimants to abandon their claims rather than to litigate. . . . What rational lawyer would have signed on to represent the Concepcions in litigation for the possibility of fees stemming from a $30.22 claim?”). An arbitration clause can purport to cover an unlimited range of future disputes in which the stronger party might be involved, even if they have nothing to do with, and could not be contemplated at the time of, the original contract where the arbitration mandate appears.64See David Horton, Infinite Arbitration Clauses, 168 U. Pa. L. Rev. 633, 678–83 (2020). Even more extremely, an arbitration provision might declare that the arbitrator must defer to the very action being challenged in arbitration—thus creating what is known as “the firm always wins” clause.65See Respondent’s Brief in Opposition at 7, Winston & Strawn LLP v. Ramos, 140 S. Ct. 108 (2019) (No. 18‑1437), https://perma.cc/ER5E-86H4 (quoting the contents of a “firm always wins” arbitration clause from a law firm partnership agreement, which stated that “[t]he panel of arbitrators shall have no . . . authority to substitute its judgment for, or otherwise override the determinations of, the Partnership, or the Executive Committee or officers authorized to act in its behalf, with respect to any determination made or action committed to by such parties”). The law firm’s petition for certiorari has been denied, after the parties’ briefs and many amicus briefs were filed. See Docket for 18-1437, U.S. Sup. Ct., https://perma.cc/NSG9-3FQT. Yet, the very existence of such provisions (which remain, at least plausibly, valid in states where no judicial precedent has been reached to the contrary) highlights the pathologies of the U.S. mandatory arbitration system.
Some of the most basic tenets of law—namely, the principle that no one may be a judge in one’s own case66See, e.g., John V. Orth, Due Process of Law: A Brief History 15–32 (2003).—are thus being subverted by the U.S. system of mandatory arbitration. Unsurprisingly, this results in less people seeking to enforce their rights in the first place,67See, e.g., Estlund, supra note 9; Samuel Issacharoff & Florencia Marotta-Wurgler, The Hollowed Out Common Law, 67 UCLA L. Rev. 600, 632–35 (2020); Resnik, supra note 59, at 2812 (“Despite the heralding of arbitration as a speedy and effective alternative to courts, the mass production of arbitration clauses has not resulted in ‘mass arbitrations.’ Instead, the number of documented consumer arbitrations is startlingly small.” (footnote omitted)). and deformation of justice in many of the cases that are filed.68See, e.g., Radin, supra note 10. In economic terms, the more justice-impeding the arbitration clause it can draft, the more wealth a party can unilaterally shift to itself. The gross inequities generated by mandatory arbitration’s overreach have been studied extensively by scholars of civil procedure, constitutional law, and contract law.69See, e.g., Michelle L. Caton, Form over Fairness: How the Supreme Court’s Misreading of the Federal Arbitration Act Has Left Consumers in a Lurch, 21 Geo. Mason L. Rev. 497 (2014); Estlund, supra note 9; Arthur R. Miller, Simplified Pleading, Meaningful Days in Court, and Trials on the Merits: Reflections on the Deformation of Federal Procedure, 88 N.Y.U. L. Rev. 286, 322–31 (2013); Resnik, supra note 59. This is far from purely a matter of legal doctrine: in a well-regarded 2013 book, Professor Margaret Jane Radin documented the human costs of mandatory arbitration clauses in the U.S., along with other, similarly self-exculpatory terms in standard-form contracts.70Radin, supra note 10.
To make things even worse, courts and legislatures (particularly at the state level) cannot do much about this. Once an arbitration provision is placed in a contract, extremely little room is left for equitable, ex post review (possibly reshaping, limiting, or revoking arbitration in a specific case) to preserve any degree of fairness. That is because, in a line of cases, epitomized by such decisions as AT&T Mobility LLC v. Concepcion,71563 U.S. 333 (2011). the Supreme Court has held that almost no state law may interfere with any arbitration clause. Indeed, state laws that do so are pre-empted by the FAA.72See, e.g., id. at 352 (“Because it ‘stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress,’ California’s Discover Bank rule [(prohibiting class action waivers in certain contracts)] is pre-empted by the FAA.” (citation omitted) (quoting Hines v. Davidowitz, 312 U.S. 52, 67 (1941))).
As a result, if corporate charters and bylaws are found to come under the FAA’s ambit, then presumably neither Delaware,73Delaware law does prohibit the inclusion of mandatory arbitration clauses in corporate charters and bylaws. See Del. Code Ann. tit. 8, § 115 (2021). As the Delaware legislature explained, “Section 115 . . . invalidates . . . a provision selecting the courts in a different State, or an arbitral forum, if it would preclude litigating [internal corporate] claims in the Delaware courts.” S.B. 75, 148th Gen. Assemb., Synopsis § 5 (Del. 2015) (enacted), https://perma.cc/Y9CW-W5J7. nor any other state of incorporation, can regulate what corporate directors and officers put into those documents, so long as they frame these provisions as “arbitration clauses.” Contrary to the (justified) wishes of some scholars, the structure of U.S. arbitration law currently makes it impossible to ensure that cases will be heard by a “credible arbitral institution,”74Andrew K. Jennings, Firm Value and Intracorporate Arbitration, 38 Rev. Litig. 1 passim (2018). or that a process of “interpretation”75Megan Wischmeier Shaner, Interpreting Organizational “Contracts” and the Private Ordering of Public Company Governance, 60 Wm. & Mary L. Rev. 985 passim (2019). by courts, limiting arbitration to “reasonable and equitable”76Id. at 996. The exceptionally broad reach of federal arbitration law, and its interference with state law, present a uniquely problematic form of “ex ante corporate governance,” not encountered in previous debates (such as those over poison pills, staggered boards, forum selection clauses, and so on). The Supreme Court’s arbitration jurisprudence makes it much more difficult to remedy wrongs through ex post, equitable intervention. That form of remedy is the traditional province of the courts—and a solution often invoked by judges and scholars to address the various problems of private ordering in the corporate context. See, e.g., George S. Geis, Ex-Ante Corporate Governance, 41 J. Corp. L. 609, 643–44 (2016); infra notes 191, 358–61. provisions, will take place.
Despite all this, two borders have not been crossed. First, even while expanding the reach of anything bearing the title “arbitration clause,” the Supreme Court continues to impose one overarching limitation: that arbitration clause must be part of a contract, not some other legal document.77See, e.g., Concepcion, 563 U.S. at 339. Second (and closely related), mandatory arbitration has not become part of the corporate law landscape. In fact, no Supreme Court case has held corporate charters and bylaws to be “contracts” under the FAA. As this Article proves, these documents truly are not, cannot, and have never been contracts, under any form of doctrinal, historical, linguistic, or economic analysis.78See infra Part II.
Accordingly, corporate law remains one of the more well-functioning areas of U.S. law.79See, e.g., Jill E. Fisch, Leave It to Delaware: Why Congress Should Stay Out of Corporate Governance, 37 Del. J. Corp. L. 731 (2013). Directors, officers, and other actors bound by the norms of corporate law continue to be subject to the jurisdiction of regular courts, most importantly, those in Delaware.80For a detailed discussion of recent cases where corporate law actors were held accountable in the Delaware courts, see Joel Edan Friedlander, Vindicating the Duty of Loyalty: Using Data Points of Successful Stockholder Litigation as a Tool for Reform, 72 Bus. Law. 623 (2017). “[T]he Delaware courts determine questions of liability in the most significant corporate law cases, [and] provide instruction on best practices for the directors of publicly held corporations.”81David Skeel, The Bylaw Puzzle in Delaware Corporate Law, 72 Bus. Law. 1, 23–24 (2016). This dual function—the corporate law court as a provider of both remedy and guidance—is recognized even by those scholars who most strongly advocate a wide breadth for the business judgment rule, and stress the significance of “norms,” as opposed to “law,” in shaping the day-to-day behavior of corporate actors.82See Edward B. Rock & Michael L. Wachter, Islands of Conscious Power: Law, Norms, and the Self-Governing Corporation, 149 U. Pa. L. Rev. 1619, 1661–63, 1686–89 (2001) (discussing situations where, despite the article’s general thesis, corporate litigation remains necessary and beneficial); see also Lawrence A. Hamermesh, A Babe in the Woods: An Essay on Kirby Lumber and the Evolution of Corporate Law, 45 Del. J. Corp. L. 125, 138 (2020) (“Skepticism about the limits of shareholder litigation . . . is not the same as implacable opposition to such litigation. In Delaware’s system of corporate law, representative stockholder plaintiffs, and their lawyers, are a bulwark against misappropriation and electoral manipulation by self-interested directors, officers, and controlling stockholders, and are therefore a critical promoter of efficient, wealth-creating corporate governance.”). The rise of powerful activist shareholders—pulling us away from the “Berle and Means” era,83See Adolf A. Berle, Jr. & Gardiner C. Means, The Modern Corporation and Private Property (1932). characterized by strong separation of ownership and control—does not detract from the need for effective corporate litigation; instead, it relies on it.84See, e.g., Fisch, supra note 79, at 780 (“Today’s corporation bears little resemblance to [the Berle and Means] model. . . . [I]nstitutional intermediaries own an ever-increasing majority of publicly traded equities and exercise the traditional shareholder powers such as the right to vote and the right to sue.” (emphasis added)). This point is further illustrated infra note 89: if shareholders could not sue to repeal the inequitable poison pill, it is not clear how they could meaningfully exercise their voting rights. Without well-functioning courts of equity, there could be no effective shareholder activism to begin with.
For example, in one derivative action case, Americas Mining Corporation v. Theriault,8551 A.3d 1213 (Del. 2012). the Delaware courts successfully remedied a fiduciary breach by a controlling shareholder, in the amount of $2.031 billion.86See id. at 1218. Americas Mining was a particularly fruitful exercise in corporate law enforcement, but the Delaware courts also routinely grant remedies, and approve settlements, in the tens or hundreds of millions of dollars.87See, e.g., Friedlander, supra note 80. Delaware judges do not shy away from denying motions to dismiss, even in cases that involve well-known, well-connected entities and businesspeople.88See, e.g., In re Dell Techs. Inc. Class V Stockholders Litig., Consol. C.A. No. 2018‑0816‑JTL, 2020 Del. Ch. LEXIS 211 (Del. Ch. June 11, 2020) (denying motion to dismiss a complaint against Michael Dell and other defendants, following alleged non-compliance with the requirements set forth in Delaware law, in the course of a $40.5 billion share conversion transaction).
As Section II.B below explains, the open-endedness of corporate existence, where almost no legal constraints are imposed on the corporation ex ante, inevitably leads to a wide range of ever-changing factual scenarios. The Delaware courts—as opposed to “private ordering,” or any other mechanism—are the ones who approve or reject, on an equitable, case-by-case basis, the numerous legal devices that corporations, their fiduciaries, and their legal counsel come up with.89A perfect example is the poison pill. In 1985, the Delaware Supreme Court has accepted the original form of the poison pill as an anti-hostile-takeover device. See Moran v. Household Int’l, 500 A.2d 1346, 1357 (Del. 1985). Yet, this ex ante grant of power does not mean that any use of a poison pill, even inequitably or contrary to the principles of corporate law, is permissible ex post. In 1998, the same court struck down a recent innovation—the “no-hand” poison pill, designed to be so irredeemable that not even a whole new board of directors could repeal it. See Quickturn Design Sys. v. Shapiro, 721 A.2d 1281, 1283, 1292 (Del. 1998).
While corporate litigation is not perfect, of course, it is better than no litigation (that is, making corporate law unenforceable). Occasionally, non-meritorious litigation practices emerge from the plaintiff side, but the Delaware courts are well-versed in weeding them out.90See, e.g., In re Trulia, Inc. Stockholder Litig., 129 A.3d 884, 887 (Del. Ch. 2016) (responding to the practice of “disclosure settlements”—ones leading to the payment of attorneys’ fees while providing little additional value to the represented class of shareholders—by establishing a rule that requires the court not to approve a settlement, unless it clearly provides such value). Accordingly, leading corporate litigation scholars agree that litigation is an important, beneficial mechanism to enforce the substantive norms of corporate law.91See, e.g., David H. Webber, Shareholder Litigation Without Class Actions, 57 Ariz. L. Rev. 201, 266–67 (2015) (“[T]here is substantial evidence that at least a subset of existing class actions are meritorious and value enhancing, [and] that top firms and institutional lead plaintiffs, particularly public-pension funds, correlate with better outcomes for shareholders.”). While both meritorious and non-meritorious claims exist,92In corporate law, the way in which meritorious claims are identified might be different, and in some respects more deferential toward defendants, compared to most other fields of law. This is due to concepts such as the business judgment rule, which is unique to corporate law, and results from its open-endedness principle. See infra Section II.B. To an extent, this seems to be the thrust behind such well-known works as Rock & Wachter, supra note 82, and Zohar Goshen & Richard Squire, Principal Costs: A New Theory for Corporate Law and Governance, 117 Colum L. Rev. 767 (2017). While a robust understanding of the business judgment rule is fully justified, it does not change the fact that the rule imposes some conditions (including loyal and informed fiduciary action), comporting with the rest of corporate law’s structure. Sometimes, those requirements are not met, and litigation becomes necessary. This is the “surgical field” in which corporate litigation operates. It is not a valid argument to simply mention that corporate law endows fiduciaries with broad management powers, or that such powers are mostly executed properly, while overlooking the fact that corporate litigation is meant to deal precisely with the other category of cases—those where the power has been improperly utilized. as in any other field of law, no scholar seriously suggests eliminating all corporate litigation.93See, e.g., Jill E. Fisch, Sean J. Griffith & Steven Davidoff Solomon, Confronting the Peppercorn Settlement in Merger Litigation: An Empirical Analysis and a Proposal for Reform, 93 Tex. L. Rev. 557 (2015) (characterizing a specific troubling practice—settlements for supplemental disclosure and attorneys’ fees, see supra note 90—while not implicating other, more meritorious litigation practices); Sean J. Griffith & Dorothy S. Lund, A Mission Statement for Mutual Funds in Shareholder Litigation, 87 U. Chi. L. Rev. 1149 (2020) (discussing many benefits generated by shareholder litigation, and the manner in which mutual fund managers can be encouraged to bring more meritorious cases); Webber, supra note 91, at 267 (“An optimal reform to shareholder litigation would offer flexibility and nuance, allowing preservation of meritorious, value-enhancing actions . . . .”); Holger Spamann, Indirect Investor Protection: The Investment Ecosystem and Its Legal Underpinnings 19–20 (Eur. Corp. Governance Inst., Working Paper No. 594, 2021), https://perma.cc/PVE7-6KQL (“While some shareholder litigation is controversial, some is very likely essential, in particular corporate fiduciary duty litigation against self-dealing by corporate insiders . . . .”).
Recently, however, even this final fortress—corporate law, enforceable in court—has come under clear and present danger, as Sections I.B and I.C below explain in detail.
B. The Johnson & Johnson and Salzberg Cases: A New Roadmap for Mandatory Arbitration in Corporate Law
On March 21, 2019, a relatively little-noticed case94This Article is the first scholarly work to analyze the Johnson & Johnson case. The case received some coverage in other circles. See, e.g., Cydney Posner, Mandatory Arbitration Shareholder Proposal Goes to Court—as Chair Clayton Suggested, Cooley PubCo (Mar. 25, 2019), https://perma.cc/A6EQ-NZJR. In early 2019, twenty-six law professors have signed a white paper discussing the Johnson & Johnson shareholder proposal, predating the court case (and focusing on the internal affairs, corporate-vs.-securities dimension, which became less salient following the 2020 Salzberg decision). See Jacob Hale Russell, Mandatory Securities Arbitration’s Impermissibility Under State Corporate Law: An Analysis of the Johnson & Johnson Shareholder Proposal (Rock Ctr. for Corp. Governance Working Paper Series No. 237, 2019), https://perma.cc/2QC6-VKH9. was filed in the United States District Court for the District of New Jersey. That case, Doris Behr 2012 Irrevocable Trust v. Johnson & Johnson,95No. 3:19‑cv‑8828 (D.N.J. filed Mar. 21, 2019). The complaint in this case has been amended three times, following the Delaware Supreme Court’s Salzberg decision and other developments, discussed in this Section. Third Amended Complaint, Doris Behr 2012 Irrevocable Tr. v. Johnson & Johnson, No. 3:19‑cv‑8828 (D.N.J. July 13, 2021), https://perma.cc/A2SA-2UFQ [hereinafter Johnson & Johnson Complaint]. involves a unique procedural situation: a shareholder proposing the adoption of a mandatory arbitration clause in a corporation’s bylaws.96See infra note 107 and accompanying text. This fact makes the success of the arbitration proposal less likely in this specific case,97See infra text accompanying notes 165–76. but that is not the most pertinent issue. More importantly, the arguments raised in Johnson & Johnson illustrate how, when corporate directors start making such proposals, they will enjoy the most potent chance yet for mandatory arbitration to expand into the corporate law realm.
The Johnson & Johnson case has two features that are likely to be replicated by directors aiming to impose mandatory arbitration on their corporations (and to secure the judicial precedents that will enable them to do so). First, the case directly deals with limits on the litigation of federal securities claims, rather than internal affairs, or state law corporate claims.98See infra notes 116–18 and accompanying text. Arbitration proponents are likely to try ushering mandatory arbitration through securities law first, relying on the Delaware Supreme Court’s recent Salzberg decision,99Salzberg v. Sciabacucchi, 227 A.3d 102 (Del. 2020). discussed shortly below. While mandatory arbitration in securities law is bad enough, it might easily spread from there to state corporate law as well.100See infra Section I.C.
Second, the arbitration proponent in Johnson & Johnson has adopted a tactic, also likely to be followed by pro-arbitration directors, which ignores or attempts to sneak through the backdoor101See Johnson & Johnson Complaint, supra note 95, at 5, 7, 12, 13 (referring five times to corporate bylaws using the word “agreement,” or its inflections, without any substantive discussion or attempt to support that claim). the more important question in this debate: are corporate charters and bylaws “contracts,” at least for purposes of the FAA?102See supra note 21 (discussing the requirement that a “contract” exist for the FAA to apply). If the federal courts correctly find (as they have before)103See Kirleis v. Dickie, McCamey & Chilcote, P.C., 560 F.3d 156, 158, 162–63, 166 (3d Cir. 2009) (denying a corporate defendant’s motion to compel arbitration, on the grounds that the plaintiff-shareholder never consented, in the contract law sense, to an arbitration clause in the corporation’s bylaws). that these documents are not contracts, federal arbitration law cannot apply to them. If the courts fail to do so, however, the floodgates are likely to open for mandatory arbitration in both securities and corporate law.104See infra Section I.C.
Under the combined effect of legal realism’s disdain for categories,105See, e.g., supra note 2 and accompanying text. and a misreading of some cases and scholarly works,106See infra Section II.C. arbitration proponents would like this issue to either “slip under the radar,” or be incorrectly answered. This Article puts the question squarely on the table, and cogently answers it. While Johnson & Johnson and Salzberg provide a boilerplate for arbitration proponents’ future arguments, they also provide the roadmap for rejecting them.
Johnson & Johnson was filed by Hal Scott, professor emeritus at Harvard Law School,107See Hal S. Scott—Biography, Harv. L. Sch., https://perma.cc/2QC5-943Q. The Johnson & Johnson complaint was filed by Scott both in his personal name, and as trustee of the Doris Behr 2012 Irrevocable Trust, a Massachusetts common law trust, in which capacity he owns 1,050 shares of Johnson & Johnson. See Johnson & Johnson Complaint, supra note 95, at 2, 6. who is engaged in an academic and public campaign against the practice of securities litigation.108See, e.g., Hal S. Scott & Leslie N. Silverman, Stockholder Adoption of Mandatory Individual Arbitration for Stockholder Disputes, 36 Harv. J.L. & Pub. Pol’y 1187 (2013); Hal S. Scott, The SEC’s Misguided Attack on Shareholder Arbitration, Wall St. J. (Feb. 21, 2019), https://perma.cc/7GTS-4JJ6. In November 2018, somewhat ironically, Scott adopted a strategy most often employed by shareholders’ rights activists:109Scott is operating as a “corporate gadfly”—an individual shareholder, owning a relatively small number of shares, but potentially wielding large influence on corporate affairs by making various shareholder proposals. See Kobi Kastiel & Yaron Nili, The Giant Shadow of Corporate Gadflies, 94 S. Cal. L. Rev. 569 (2021). he made a shareholder proposal, and sought to have it voted on at the 2019 annual shareholder meeting of Johnson & Johnson.110See Johnson & Johnson Complaint, supra note 95, at 2, 4. Shareholders are entitled to do so under the SEC’s Rule 14a‑8,11117 C.F.R. § 240.14a‑8 (2021). but a corporation may refuse to include a proposal in its proxy materials, if any one of a “few specific circumstances”112Id. are met. Among those circumstances, the proposal may be excluded when it would, “if implemented, cause the company to violate any state, federal, or foreign law to which it is subject.”113Id. § 240.14a‑8(i)(2).
Scott’s proxy submission was framed as a precatory proposal,114A precatory shareholder proposal is “advice” to the corporation or its directors, rather than a binding requirement. See, e.g., Lucian Arye Bebchuk, The Case for Increasing Shareholder Power, 118 Harv. L. Rev. 833, 846 (2005) (“[Precatory] resolutions are not binding: under state corporate law, directors have discretion whether to follow precatory proposals . . . , and directors’ freedom to disregard such resolutions is protected under the business judgment rule.”). stating: “The shareholders of Johnson & Johnson request the Board of Directors take all practicable steps to adopt a mandatory arbitration bylaw [providing as follows].”115Johnson & Johnson Complaint, supra note 95, at 4. In Scott’s proposal, the bylaw would require “disputes between a stockholder and the Corporation and/or its directors, officers or controlling persons relating to claims under federal securities laws in connection with the purchase or sale of any securities issued by the Corporation to be exclusively and finally settled by arbitration.”116Id. If adopted, Scott’s proposed bylaw would mandate “that any disputes subject to arbitration may not be brought as a class and may not be consolidated or joined.”117Id. at 5.
Scott’s proposal also included a “supporting statement,” where things get even more intriguing. Among other contentions, that statement raises a patently false assertion: that “[t]he United States is the only developed country in which stockholders of public companies can form a class and sue their own company for violations of securities laws.”118Id. In reality, many developed countries have securities class actions; over the last few years, numerous European countries even saw an increase in certain kinds of collective shareholder litigation.119See Laying Down the Law: Europe Is Seeing More Collective Lawsuits from Shareholders, Economist (Dec. 7, 2017), https://perma.cc/947C-BWY5. Recoveries for the class in such actions went as high as $1.5 billion.120See Institutional S’holder Servs., The Top 25 Non-North American Settlements 2, 4 (2020), https://perma.cc/2Y85-AYJX (providing information on the 2018 Netherlands case of Ageas SA/NV (formerly known as Fortis S.A./N.V. & Fortis N.V.), which settled for said amount, as well as providing information on high-recovery cases from several other countries).
Shortly thereafter, Johnson & Johnson rejected Scott’s demand to include his proposal in the corporation’s 2019 proxy materials, and sought a no-action letter from the SEC, meant to affirm the legality of this decision.121See Johnson & Johnson Complaint, supra note 95, at 6. In the correspondence between the parties, leading to the issuance of the no-action letter, Johnson & Johnson reasoned that a mandatory arbitration clause would, among other things, “violate New Jersey state [corporate] law.”122Id. at 8 (emphasis omitted). The corporation based this argument on the Delaware Chancery Court’s Salzberg decision,123Sciabacucchi v. Salzberg, C.A. No. 2017‑0931‑JTL, 2018 Del. Ch. LEXIS 578 (Del. Ch. Dec. 19, 2018). For discussion of the case, see infra text accompanying notes 141–54. Note that “Delaware law is significant here because . . . New Jersey courts frequently look for guidance [from Delaware] on corporate law issues absent controlling New Jersey authority.” Memorandum of Law of Amicus Curiae Attorney General of the State of New Jersey at 7, Doris Behr 2012 Irrevocable Tr. v. Johnson & Johnson, No. 3:19‑cv‑8828 (D.N.J. Aug. 27, 2019), https://perma.cc/GEA3-2B6Y. but also on other, directly arbitration-related authorities, such as Kirleis v. Dickie, McCamey & Chilcote, P.C.124560 F.3d 156, 158, 162–63, 166 (3d Cir. 2009) (denying a corporate defendant’s motion to compel arbitration, on the grounds that the plaintiff-shareholder never consented, in the contract law sense, to an arbitration clause in the corporation’s bylaws). In his responsive correspondence (and later, in the complaint countering the corporation’s and SEC’s positions), Scott raised several arguments centered on the Supreme Court’s interpretation of the FAA.125See Johnson & Johnson Complaint, supra note 95, at 7. The main FAA cases relied upon by Scott, in response to Johnson & Johnson’s and the SEC’s letters, are Shearson/American Express Inc. v. McMahon, 482 U.S. 220 (1987), and Epic Systems Corporation v. Lewis, 138 S. Ct. 1612 (2018).
On February 11, 2019, the SEC issued the no-action letter requested by Johnson & Johnson,126Letter from Jacqueline Kaufman, Att’y-Adviser, Sec. & Exch. Comm’n Off. of Chief Couns., Div. of Corp. Fin., to Johnson & Johnson Att’y Marc S. Gerber (Feb. 11, 2019), https://perma.cc/Z6M7-MY37. thus blocking the arbitration proposal’s way into the 2019 annual meeting. In response, Scott filed his action in the federal New Jersey District Court.127See supra note 95. The Johnson & Johnson Complaint, supra note 95, is the third amended complaint filed by Scott, but his substantive arguments have remained nearly identical throughout his various complaints, except to the extent discussed in this Section, mainly following the Delaware Supreme Court’s Salzberg decision. The complaint consists of a single count of action, for “violation of federal securities law,”128Johnson & Johnson Complaint, supra note 95, at 12. arguing that the proposed bylaw is not illegal under New Jersey corporate law, and, even if it were, that state law is pre-empted by the FAA.129See id. at 8–9, 13. Thus, under Scott’s theory, Johnson & Johnson acted unlawfully when it excluded Scott’s proposal under Rule 14a‑8(i)(2), since implementing the proposal would not cause the corporation “to violate any state, federal, or foreign law.”13017 C.F.R. § 240.14a‑8(i)(2) (2021).
The questions facing the court, therefore, are: (1) whether inserting a securities law mandatory arbitration clause into a corporation’s bylaws conforms with New Jersey corporate law, and by extension,131See supra note 123. Delaware corporate law; and, (2) if such a clause were enacted, whether the bylaws constitute a “contract” to which the FAA, and the U.S. Supreme Court’s arbitration precedents, apply. These are questions of state law, and thus, under the Erie132Erie R.R. Co. v. Tompkins, 304 U.S. 64 (1938). doctrine, federal courts adjudicating this issue—in Johnson & Johnson, or future cases about mandatory arbitration in securities and corporate law—are required to apply state corporate law to resolve it.133The federal courts are facing this issue under their “federal question” jurisdiction, since both the Securities Acts and the Federal Arbitration Act are federal statutes. Yet, even within its federal question jurisdiction, the Erie doctrine requires a federal court to apply state law when faced with a state law question (such as the question “are corporate charters and bylaws ‘contracts’?”). See, e.g., Abbe R. Gluck, Intersystemic Statutory Interpretation: Methodology as “Law” and the Erie Doctrine, 120 Yale L.J. 1898, 1926 (2011) (“[T]he Erie doctrine applies in federal-question and federal constitutional cases, just as it does in diversity cases, provided that an analytically separate question of state law is presented.”).
Recognizing what might be at stake in Johnson & Johnson, institutional investors and members of the bar were quick to respond. In addition to the original defendant’s motion to dismiss the complaint,134Memorandum of Law in Support of Defendant Johnson & Johnson’s Motion to Dismiss, Doris Behr 2012 Irrevocable Tr. v. Johnson & Johnson, No. 3:19‑cv‑8828 (D.N.J. May 31, 2019), https://perma.cc/MFE6-LBD3 [hereinafter Johnson & Johnson Defendant’s Original Motion to Dismiss]. a similar motion was filed by two large institutional shareholders, the California Public Employees’ Retirement System (CalPERS) and the Colorado Public Employees’ Retirement Association, who joined the case as intervenors,135Memorandum in Support of Motion to Dismiss of Proposed Intervenors California Public Employees’ Retirement System & Colorado Public Employees’ Retirement Ass’n, Doris Behr 2012 Irrevocable Tr. v. Johnson & Johnson, No. 3:19‑cv‑8828 (D.N.J. May 31, 2019), https://perma.cc/5YQE-DVJX [hereinafter Johnson & Johnson Intervenors’ Motion to Dismiss]. represented by renowned plaintiffs’ attorney Deepak Gupta.136See id. at 30. In addition to other arbitration-related cases, Gupta represented the appellees before the Supreme Court in AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011). See id. at 335. Curiously, Johnson & Johnson presents the rare case where if the motion to dismiss is granted, that would be a plaintiff-friendly move.
In their original motions to dismiss, both Johnson & Johnson and the institutional intervenors relied on two lines of argument. The first runs along the internal affairs, corporate law-vs.-securities law axis,137See Johnson & Johnson Defendant’s Original Motion to Dismiss, supra note 134, at 14–28; Johnson & Johnson Intervenors’ Motion to Dismiss, supra note 135, at 9–14. primarily based on the Delaware Chancery Court’s Salzberg decision.138Sciabacucchi v. Salzberg, C.A. No. 2017‑0931‑JTL, 2018 Del. Ch. LEXIS 578 (Del. Ch. Dec. 19, 2018). The second argument concerns the distinction between corporate law and contract law.139See infra note 163 and accompanying text. At this point, it is worthwhile to pause and discuss Salzberg, a case which has received extensive scholarly attention.140See supra note 17. Existing literature, however, does not primarily focus on the case’s possible influence in the more critical arbitration context, which this Article now covers.
At issue in Salzberg was one primary question: can the charters and bylaws of a Delaware corporation regulate the rights and duties arising outside of state corporate law (that is, beyond the realm of “internal affairs”141“The internal affairs doctrine . . . holds that the chartering state alone should govern a corporation’s ‘internal affairs’—what the Restatement (Second) of Conflict of Laws defines as ‘the relations inter se of the corporation, its shareholders, directors, officers or agents.’ In contrast, the rights and obligations of ‘third persons,’ namely those other than ‘the directors, officers or stockholders of the corporation,’ are subject to ordinary conflicts analysis.” Vincent S.J. Buccola, Opportunism and Internal Affairs, 93 Tul. L. Rev. 339, 340 (2018) (footnotes omitted) (quoting Restatement (Second) of Conflict of Laws § 302 cmt. a (Am. L. Inst. 1971)).)? This question arose after three Delaware corporations, prior to the initial public offering (IPO) of their shares, adopted so-called “federal forum provisions,”142E.g. Salzberg, 2018 Del. Ch. LEXIS 578, at *2. mandating that plaintiffs must litigate their federal securities law claims against the corporation only in federal court, despite the 1933 Securities Act’s allowance for filing securities claims in state court.143See 15 U.S.C. § 77v(a) (stating that, in respect to “class actions, [and] all suits in equity and actions at law brought to enforce any liability or duty created by this subchapter,” the federal courts’ jurisdiction is “concurrent with State and Territorial courts”); Cyan, Inc. v. Beaver Cnty. Emps. Ret. Fund, 138 S. Ct. 1061, 1078 (2018) (“[The Securities Litigation Uniform Standards Act of 1998 (“SLUSA”)] did nothing to strip state courts of their longstanding jurisdiction to adjudicate class actions alleging only 1933 Act violations. Neither did SLUSA authorize removing such suits from state to federal court.”). While forum selection provisions in regard to state corporate law claims have been allowed since the 2013 Boilermakers decision144Boilermakers Loc. 154 Ret. Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013). and the 2015 amendment to the Delaware General Corporation Law,145Del. Code Ann. tit. 8, § 115 (2021) (“The certificate of incorporation or the bylaws may require . . . that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts in this State . . . .”). Salzberg added the internal affairs question into the mix.
In December 2018, the trial court—Delaware’s Chancery Court—decided Salzberg in favor of the plaintiff, by finding that the federal forum provisions violate the internal affairs boundary.146See Salzberg, 2018 Del. Ch. LEXIS 578, at *3–4, *33–49. The court (1) observed that “a 1933 Act claim resembles a tort or contract claim brought by a plaintiff who happens also to be a stockholder, but under circumstances where stockholder status is incidental to the claim,”147Id. at *40. and (2) defined “purchasers of securities” as “parties external to the corporation.”148Id. Therefore, the federal forum provisions were found to be “ineffective and invalid.”149Id. at *8, *49.
Since the Johnson & Johnson original complaint was filed shortly after this decision (and prior to its reversal), the defendant and intervenors broadly relied on it in their original motions to dismiss, pointing out that it foreclosed the ability to impose other limits on securities litigation (including mandatory arbitration) by placing that limit in a corporation’s charter or bylaws.150See Johnson & Johnson Defendant’s Original Motion to Dismiss, supra note 134, at 14–28; Johnson & Johnson Intervenors’ Support of Motion to Dismiss, supra note 135, at 9–14.
On March 18, 2020, however, the Delaware Supreme Court reversed.151Salzberg v. Sciabacucchi, 227 A.3d 102, 109 (Del. 2020). In its Salzberg opinion, the state’s high court devised an entirely new doctrine: the “outer band”152Id. at 131. theory, according to which certain matters—such as the securities laws—lie outside the “internal affairs” sphere, but still within the scope of the Delaware General Corporation Law.153See, e.g., id. (“‘[I]ntra-corporate’ matters . . . are not necessarily limited to ‘internal affairs’ . . . .”). The court reasoned that “[a federal forum provision is] also . . . a provision ‘defining, limiting and regulating the powers of the corporation, the directors and the stockholders,’ since FFPs prescribe where current and former stockholders can bring [1933 Act] claims against the corporation and its directors and officers.”154Id. at 115. In other words, the fact that the same people are involved in both securities and corporate relationships, at least in most cases, was dispositive in the eyes of the court.
The Delaware Supreme Court’s Salzberg decision thus eliminated one ground for opposing Scott’s proposal in the Johnson & Johnson case: it is now possible to use a corporation’s charter or bylaws to control some aspects of federal securities litigation. The former case, however, dealt with a far less troubling practice (forum selection, directing plaintiffs to one court, rather than another) compared to the latter (mandatory arbitration, entirely shutting the courthouse doors before any and all plaintiffs).155See supra note 18 and accompanying text. Salzberg also did not implicate the FAA, and did not hinge on the question of whether or not corporate charters and bylaws are “contracts,”156In several parts of its opinion, the Salzberg court discusses the issue, in a manner consistent with this Article’s thesis: charters and bylaws are unique creatures of corporate law, governed by equity principles, rather than by contract law. See infra notes 358–60 and accompanying text. which is the more fundamental inquiry with regard to arbitration.
Moreover, the Salzberg court explicitly rejected the application of Salzberg in the mandatory arbitration context, saying that “[s]uch provisions, at least from our state law perspective, would violate [Delaware General Corporation Law] Section 115.”157Salzberg, 227 A.3d at 137 n.169. Similarly, Professor Joseph Grundfest has argued that the outcome in Salzberg serves to preclude, not promote, mandatory arbitration.158See Grundfest, supra note 17, at 1384–86. In an amicus brief filed in a California state court, a group of high-ranking Delaware jurists, among them two former Chief Justices of Delaware, have also noted the difference between forum selection and mandatory arbitration.159See Amicus Brief of Former Delaware Justices, Chancellors, & Vice Chancellors & Professor Joseph A. Grundfest in Support of Motion to Dismiss for Forum Non Conveniens at 5–6, In re Dropbox, Inc. Secs. Litig., No. 19‑CIV‑05089 (Cal. Super. Ct. July 10, 2020), https://perma.cc/EMS5-G6DW (implying that, “[i]n contrast” to federal forum provisions, mandatory arbitration clauses are “objectionable”).
Nonetheless, this did not prevent Scott from stating, in his amended complaint filed after the Delaware Supreme Court’s Salzberg decision, that “[the decision] eliminates any possible basis for Johnson & Johnson’s argument that [Scott’s] shareholder-arbitration proposal violates Delaware law.”160Johnson & Johnson Complaint, supra note 95, at 13. Similarly, see id. at 5, 7, 12 (instances in which the plaintiff refers to corporate bylaws using the word “agreement,” or its inflections, without any substantive discussion or attempt to support that claim). This claim is incorrect. The Johnson & Johnson defendants—just like corporations, shareholders, and directors who will oppose mandatory arbitration in future cases—still have their second line of argument (also the focus of this Article): the fact that corporate law is distinct from contract law, and therefore,161See supra note 20 and accompanying text. corporate charters and bylaws are not contracts subject to the FAA or the U.S. Supreme Court’s arbitration precedents.162See supra note 21.
Indeed, both original motions to dismiss in Johnson & Johnson have correctly addressed this fundamental issue.163See Johnson & Johnson Defendant’s Original Motion to Dismiss, supra note 134, at 30; Johnson & Johnson Intervenors’ Motion to Dismiss, supra note 135, at 19–26. Salzberg detracts nothing from this argument, and even supports it.164See infra notes 358–60 and accompanying text. Part II below develops this reasoning in depth. Prior to that, however, Section I.C explains how ignoring this distinction (perhaps due to the same excessive focus on Salzberg’s internal affairs angle, as advanced by Hal Scott) can dramatically alter the landscape of both securities and corporate law enforcement.
As it turns out, by the time Johnson & Johnson filed its new motion to dismiss165Memorandum of Law in Support of Defendant Johnson & Johnson’s Motion to Dismiss, Doris Behr 2012 Irrevocable Tr. v. Johnson & Johnson, No. 3:19‑cv‑8828 (D.N.J. Nov. 20, 2020), https://perma.cc/U7WJ-QAET [hereinafter Johnson & Johnson Motion to Dismiss]. This is the third motion to dismiss filed by Johnson & Johnson in the case; in addition to the original motion to dismiss, Johnson & Johnson Defendant’s Original Motion to Dismiss, supra note 134, there was a second motion to dismiss, filed in response to Scott’s first amended complaint (his second complaint out of four overall). There is no substantial difference between the first and second amended complaints, or the second and third motions to dismiss, for purposes of the discussion here. (responding to Scott’s second amended complaint, filed post-Salzberg166Second Amended Complaint, Doris Behr 2012 Irrevocable Tr. v. Johnson & Johnson, No. 3:19‑cv‑8828 (D.N.J. Oct. 20, 2020), https://perma.cc/WK7Y-R4KY.), in which the institutional intervenors joined,167Notice of Joinder of Intervenor-Defendants California Public Employees’ Retirement System & Colorado Public Employees’ Retirement Ass’n, Doris Behr 2012 Irrevocable Tr. v. Johnson & Johnson, No. 3:19‑cv‑8828 (D.N.J. Nov. 20, 2020), https://perma.cc/E89D-JLKL. a few facts had shifted in the case. Most importantly, Johnson & Johnson had agreed to let Scott include his arbitration proposal in the 2021 annual meeting168See Johnson & Johnson Motion to Dismiss, supra note 165, at 3, 12, 21–22.—likely, in large part, because it had recognized there is little chance Scott’s proposal would win a shareholder majority.169Approximately eight months after Johnson & Johnson filed its original motion to dismiss, another arbitration proposal made by Hal Scott, similar to the one in Johnson & Johnson, was rejected by 97.6% of Intuit Inc.’s voting shareholders. See Intuit Inc., U.S. Secs. & Exch. Comm’n Form 8-K, EDGAR (Jan. 27, 2020), https://perma.cc/LFU2-S5AK. In this case, the corporation’s directors recommended to shareholders that the proposal be rejected. See Inuit Inc., Notice of 2020 Annual Meeting of Stockholders and Proxy Statement 78 (Nov. 27, 2019), https://perma.cc/3J9Z-B83D. This extremely strong opposition to mandatory arbitration only highlights the danger of such provisions being adopted via the bylaw route, where shareholders will not even have a say on the matter, or in other circumstances where directors have the decisive power, see infra notes 189–94 and accompanying text. This is especially true for corporations where—unlike Intuit and Johnson & Johnson—directors are less attuned to the corporation’s or shareholders’ interests (to put it mildly). Accordingly, the new motion to dismiss mainly revolved around procedural arguments such as mootness and ripeness,170See Johnson & Johnson Motion to Dismiss, supra note 165, at 17–26. stating that the court cannot issue an “advisory opinion.”171Id. at 4. On June 30, 2021, the district court agreed with Johnson & Johnson, dismissing the second amended complaint on these grounds.172Doris Behr 2012 Irrevocable Tr. v. Johnson & Johnson, No. 3:19‑cv‑8828, 2021 U.S. Dist. LEXIS 122928 (D.N.J. June 30, 2021). The court, however, also granted Scott “one final opportunity to file an amended complaint,”173Id. at *13–14. which Scott promptly did.174Johnson & Johnson Complaint, supra note 95. Expectedly, Johnson & Johnson (again joined by the institutional intervenors)175Notice of Joinder of Intervenor-Defendants California Public Employees’ Retirement System & Colorado Public Employees’ Retirement Ass’n, Doris Behr 2012 Irrevocable Tr. v. Johnson & Johnson, No. 3:19‑cv‑8828 (D.N.J. Aug. 12, 2021), https://perma.cc/CM2W-VGA5. moved to dismiss this complaint as well, relying on similarly procedural arguments.176Memorandum of Law in Support of Defendant Johnson & Johnson’s Motion to Dismiss, Doris Behr 2012 Irrevocable Tr. v. Johnson & Johnson, No. 3:19‑cv‑8828 (D.N.J. Aug. 10, 2021), https://perma.cc/TPL5-PHG2. At the time this Article is being written, the motion is pending.
Whether or not the Johnson & Johnson case is ultimately dismissed (and whether or not that decision goes on appeal), it has provided the template for how mandatory arbitration proponents are likely to try introducing it into this new field of law. The unique circumstances that procedurally impeded Scott’s arbitration proposal are not expected to repeat in the next round, when corporate directors will be the ones making the proposal (or simply inserting an arbitration clause into their corporation’s bylaws, without any proposal to shareholders, or anyone else).177See infra notes 189–91 and accompanying text. The same types of substantive arguments raised by both sides in Johnson & Johnson will be litigated again—except this time, shareholders will be the plaintiffs (perhaps also derivatively, on behalf of the corporation), opposing the mandatory arbitration provision. Their success, or lack thereof, will shape a large swath of U.S. law for a long time to come. Section I.C below describes how this scenario might unfold in detail.
C. The Next Round: Toward Federal Imposition of Mandatory Arbitration in Corporate Law?
As Section I.A above explains, litigation in courts (particularly the Delaware courts) remains an important, beneficial mechanism for the enforcement of corporate law in the United States. Section I.B has described how proponents of mandatory arbitration have initiated a campaign—now taking its first steps through the federal courts, in the Johnson & Johnson litigation—aimed at making private enforcement of the securities laws substantially more difficult, if not impossible.
This Section merges these two lanes: it explains how the current legal situation might evolve in the long run—specifically, how mandatory arbitration might inject itself first into federal securities law, and from there, expand to state corporate law. This Section also shows that the strongest barrier against this troubling development lies in recognizing that corporate law is separate from contract law, and therefore, the federal courts cannot apply the FAA to corporate charters and bylaws. This, in turn, leads to Part II below, where the distinction between corporate and contract law is developed in depth.
1. The Path Toward Mandatory Arbitration in Corporate Law
It makes sense to start where we left off: the Johnson & Johnson case, discussed in Section I.B. Johnson & Johnson implicates the following question: can a Delaware corporation lawfully channel securities law claims into mandatory arbitration, by adding to its bylaws an arbitration clause that would be governed by the FAA?178See supra text accompanying notes 121–33. This question, in turn, splits into two branches, each being dispositive if answered “no.” First, can corporate charters and bylaws regulate the rights and duties arising under an external field of law (in this case, securities law)? Second, are corporate charters and bylaws “contracts” subject to the FAA?
The first branch has been affirmatively answered by the Delaware Supreme Court’s Salzberg decision, which found that corporate charters and bylaws may regulate various aspects of securities holders’ rights under federal securities law.179See supra text accompanying notes 151–54. Yet, this does not affect the second, corporate-vs.-contract distinction. If the courts adjudicating that question correctly find that charters and bylaws are not contracts,180See infra Part II. this should end the case, just as much as if Salzberg was differently decided.181See, e.g., Clopton & Winship, supra note 22, at 177 (“Under the FAA, arbitration agreements are presumptively valid, irrevocable, and enforceable. This presumption is triggered, however, only if corporate governing documents count as ‘contracts’ under the FAA.”). Since the FAA does not apply to corporate charters and bylaws, attempts to enact mandatory arbitration provisions may be subject to review or revocation, either ex ante, through statute (such as Delaware’s Section 115),182See Del. Code Ann. tit. 8, § 115 (2021); S.B. 75, 148th Gen. Assemb., Synopsis § 5 (Del. 2015) (enacted), https://perma.cc/Y9CW-W5J7. or ex post, through equitable adjudication in state or federal court.183If the arbitration clause deals with the litigation of securities claims, it might not be covered by Delaware’s Section 115, which pertains to “internal corporate claims.” Tit. 8, § 115. Even so, the arbitration clause would also not be covered by the FAA (and the Supreme Court’s arbitration precedents), because it is not part of a “contract.” See supra note 21. Arbitration can exist outside the scope of the FAA, governed only by state law and non-FAA federal law. As a result, securities plaintiffs will have a space to challenge arbitration clauses, whether relying on ex post equitable grounds, or the securities laws’ anti-waiver provision, see 15 U.S.C. §§ 77n, 78cc, or an ex ante measure such as SEC rulemaking. If the arbitration clause deals with the litigation of internal affairs claims, it is subject to both Section 115 and the full plethora of state law equitable powers, see infra Section II.B.
Yet, a certain risk arises in the current circumstances of the Johnson & Johnson litigation, and future cases in its vein. Given all the “brouhaha”184Cf. Joseph A. Grundfest & Kristen A. Savelle, The Brouhaha Over Intra-Corporate Forum Selection Provisions: A Legal, Economic, and Political Analysis, 68 Bus. Law. 325 (2013). over the first dimension—the internal affairs, corporate-vs.-securities issue decided in Salzberg, and covered at length by scholars185See supra note 17.—the federal courts might be led to treat it as dispositive. As discussed above, Scott argues that the Salzberg decision “eliminates any possible basis”186Johnson & Johnson Complaint, supra note 95, at 13. for finding his proposal contrary to law. In fact, the corporate-vs.-contract distinction—which Scott ignores or minimizes187See supra note 160 and accompanying text. (and future arbitration proponents are likely to, as well)—is equally dispositive in this case, and more important as a general matter. It must not slip under the federal courts’ radar. Part II below explains in detail how the courts should resolve this question.
Assume, however, that—even if the issue is fully addressed by the federal courts, including the Supreme Court—corporate charters and bylaws are found to be “contracts” under the FAA, so that the FAA, and the Supreme Court’s expansive arbitration jurisprudence,188See supra Section I.A. apply to them. What would come next? The first and most obvious effect would be the adoption of arbitration provisions in regard to securities law claims. A corporation’s directors, in their sole discretion, could simply amend the corporation’s bylaws to include an arbitration clause,189See, e.g., Del. Code Ann. tit. 8, § 109(a) (2021) (“[A]ny corporation may, in its certificate of incorporation, confer the power to adopt, amend or repeal bylaws upon the directors . . . .”). The vast majority of U.S. public corporations indeed have such a director-empowering clause in their certificates of incorporation. See, e.g., Fisch, supra note 41, at 379–80 (citing Lipton, supra note 12, at 589 n.25). perhaps with language similar to that in Scott’s proposal to Johnson & Johnson.190See Johnson & Johnson Complaint, supra note 95, at 4–5. Again, so much for the “contract” metaphor.191The unilateral amendment of corporate constitutional documents, by the corporation’s fiduciaries, is different than the (seemingly) unilateral modification of an agreement under contract law. See Albert H. Choi & Geeyoung Min, Contractarian Theory and Unilateral Bylaw Amendments, 104 Iowa L. Rev. 1, 29–32 (2018). The best solution Professors Choi and Min find, for the various problems that arise in the corporate context, is the granting of “equitable relief” through “stronger judicial oversight,” which is characterized by “speed and low cost.” Id. at 41. This is precisely the solution that mandatory arbitration makes impossible.
Alternatively, directors could use their exclusive power to propose charter amendments,192See tit. 8, § 242(b)(1). and submit such an arbitration provision to shareholders’ vote in the next annual meeting. In fact, this is the only route where shareholders would be asked, in any form, whether they wish to “arbitrate”193The quotation marks are necessary. See Resnik, supra note 59, at 2812 (“Despite the heralding of arbitration as a speedy and effective alternative to courts, the mass production of arbitration clauses has not resulted in ‘mass arbitrations.’ Instead, the number of documented consumer arbitrations is startlingly small.” (footnote omitted)). their claims. Even for those corporations that proceed through the charter (rather than bylaws) avenue, acceptance rates for directors’ arbitration proposal might be considerable, resulting from shareholders’ entrenched collective action problems and directors’ vast informational and procedural advantage.194See, e.g., Geeyoung Min, Shareholder Voice in Corporate Charter Amendments, 43 J. Corp. L. 289, 296–99 (2018) (discussing the “Failure of [the] Shareholder Right to Veto Charter Amendments” and noting that “[g]iven these structural impediments, it is uncertain whether a shareholder approval requirement in the charter amendment process could effectively prevent directors’ opportunistic amendment attempts”). Still, to the extent shareholders (specifically, large institutional shareholders such as Vanguard and BlackRock) have the opportunity to prevent the adoption of an arbitration clause in a certain corporation,195See, e.g., supra note 169. they ought to do so (and are, in fact, obliged to, as fiduciaries for their investors, and in some cases, for the corporations in which they invest).196For a discussion of activist shareholders as fiduciaries for the target corporation, see Raz, supra note 35, at 567–70.
So far, this Section has discussed the course of mandatory arbitration in the securities law realm. Indeed, that is the issue directly addressed in the Johnson & Johnson case.197See supra Section I.B. If mandatory arbitration sweeps across the U.S. securities law landscape, we might see a large swath of the securities acts become practically unenforceable, specifically through class actions—a mechanism which the Supreme Court has called “essential.”198Tellabs, Inc. v. Makor Issues & Rts., Ltd., 551 U.S. 308, 313 (2007). Yet, the U.S. securities arena would not experience a complete return to the Hobbesian state of nature, since there is some alternative—albeit far less efficient199See, e.g., Roy Shapira, Mandatory Arbitration and the Market for Reputation, 99 B.U. L. Rev. 873, 901–04 (2019) (discussing ways in which SEC enforcement falls short of private litigation, in terms of information production and in other respects).—enforcement mechanism: civil and criminal actions, brought against securities law violators by the SEC and the Department of Justice.200See, e.g., Tellabs, 551 U.S. at 313 (discussing the “criminal prosecutions and civil enforcement actions brought, respectively, by the Department of Justice and the [SEC]”). Even this final outlet, however, would not be available when mandatory arbitration spreads to its next target: state corporate law claims dealing with the corporation’s internal affairs.201There is no state corporate law equivalent to the SEC, and the enforcement of internal affairs law is dependent on private actors. One seeming exception is actions brought by the state Attorney General, see Del. Code Ann. tit. 8, §§ 124(3), 284(a), 323, 384 (2021), but these only relate to few, delineated subject matters, and play a small role in the landscape of corporate law enforcement. It is possible to try expanding the enforcement of private law by state actors, and some scholars have suggested doing so in the face of the spread of mandatory arbitration. See, e.g., Sarath Sanga, A New Strategy for Regulating Arbitration, 113 Nw. U. L. Rev. 1121, 1153–60 (2019). While state enforcement of private law is better than no enforcement at all, it is still inferior to enforcement by private actors. See, e.g., Shapira, supra note 199, at 901–04. Since Delaware, like all other states, has practically no mechanisms in place for the public enforcement of corporate law, the costs of creating this institutional framework are also likely to be exceptional.
At this point, we should return to Delaware’s Section 115.202Tit. 8, § 115. One might correctly observe that mandatory arbitration of corporate law matters is legally impossible, given the Delaware legislature’s express prohibition of that practice.203See id.; S.B. 75, 148th Gen. Assemb., Synopsis § 5 (Del. 2015) (enacted), https://perma.cc/Y9CW-W5J7 (“Section 115 . . . invalidates . . . a provision selecting the courts in a different State, or an arbitral forum, if it would preclude litigating [internal corporate] claims in the Delaware courts.”). Indeed, this appears to be the argument made by the Delaware Supreme Court in the final part of the Salzberg decision.204See Salzberg v. Sciabacucchi, 227 A.3d 102, 137 n.169 (Del. 2020) (“Much of the opposition to FFPs seems to be based upon a concern that if upheld, the ‘next move’ might be forum provisions that require arbitration of internal corporate claims. Such provisions, at least from our state law perspective, would violate Section 115 . . . .”). In addition, even if Section 115 did not exist, mandatory arbitration would remain contrary to corporate law principles, and should be equitably regulated ex post. See infra Sections II.B, II.C. The Delaware court, however, neglected to mention one obvious risk: that the U.S. Supreme Court would find corporate charters and bylaws to be “contracts” under the FAA. In such a case, the Court would be set on a road culminating in a declaration that Section 115 is pre-empted by the FAA, and is therefore invalid for arbitration-related purposes.
How would that road unfold? Again, remember that we are (hypothetically) past the point in which a Johnson & Johnson-like case has led the U.S. Supreme Court to find that corporate charters and bylaws are “contracts” subject to the FAA. Assume the directors of some Delaware corporation—possibly one whose fiduciaries are especially eager, for whatever reason, to shield themselves from the reach of law205See infra note 218 and accompanying text.—now insert an arbitration clause into their corporation’s bylaws. Instead of dealing only with the “federal securities laws,” as in Scott’s Johnson & Johnson proposal,206See Johnson & Johnson Complaint, supra note 95, at 4–5. the internal affairs arbitration clause might mirror the language of Section 115, covering “any or all internal corporate claims,”207Tit. 8, § 115. or claims “based upon a violation of a duty by a current or former director or officer or stockholder in such capacity.”208Id.
The linguistic possibilities are endless, as are the various ways to defeat the meaningful enforcement of corporate law: for example, through a “waiver” of the right to file any derivative action (rather than only class actions),209This would eliminate any practical way for the corporate entity to sue its fiduciaries for any breach whatsoever, since they will not sue themselves (on behalf of the corporation). Therefore, a waiver of the right to file a derivative action (or derivative arbitration) is precisely equivalent to waiving the right to sue (or arbitrate), full stop. Derivative and class actions are fundamentally different, as the former is filed on behalf of a single person (the corporation), while the latter is filed on behalf of a non-precisely-delineated group of people. See, e.g., Ams. Mining Corp. v. Theriault, 51 A.3d 1213, 1265 (Del. 2012) (“[T]he corporation was harmed and the total recovery is awarded to the corporation . . .—not ‘nominally’ but actually. . . . Delaware law does not analyze the ‘benefit achieved’ for the corporation in a derivative action . . . as if it were a class action recovery . . . .”). However, in the U.S., a serious error has occurred with respect to Rule 23.1 of the Federal Rules of Civil Procedure: the Rule requires that derivative plaintiffs “fairly and adequately represent the interests of shareholders or members who are similarly situated in enforcing the right of the corporation or association.” Fed. R. Civ. P. 23.1(a) (emphasis added). In fact, shareholders are simply not party to a derivative action, which is between the corporate entity—through a representative—and the defendant. The improper phrasing of Rule 23.1 might encourage courts to erroneously view derivative actions as akin to class actions, and to similarly uphold “derivative action waivers” in arbitration clauses. or through a “firm always wins” clause210See supra note 65.—which, in the corporate context, would translate to “the firm always loses,” as the corporate entity would be deprived of its ability to hold its fiduciaries accountable for any violation.
Next, one or more shareholders of the Delaware corporation at issue would likely file an action in the Delaware Chancery Court, seeking a declaratory judgment that the arbitration provision is ineffective and invalid, mainly given the clear language of Section 115.211See tit. 8, § 115 (prohibiting the inclusion of mandatory arbitration clauses in corporate charters and bylaws). The Chancery Court would have a much easier job in that case, compared to Salzberg,212See supra text accompanying notes 146–49. since the arbitration clause squarely comes within the scope of the corporation’s internal affairs. After the unlawful provision has been struck down, the director-defendants would likely appeal to the Delaware Supreme Court. If that court takes its own language in the final part of Salzberg seriously,213See Salzberg v. Sciabacucchi, 227 A.3d 102, 137 n.169 (Del. 2020). it would affirm the Chancery Court’s ruling.
The stage would then be set for what might become “Delaware’s fall”214Lynn M. LoPucki, Delaware’s Fall: The Arbitration Bylaws Scenario, in Can Delaware Be Dethroned?: Evaluating Delaware’s Dominance of Corporate Law 35 (Stephen M. Bainbridge, Iman Anabtawi, Sung Hui Kim & James Park eds., 2018). For more on this point, see Skeel, supra note 81, at 19–20 (“Delaware needs cases; corporate law litigation is the fuel that powers the mighty Delaware corporate law engine. . . . What sets Delaware apart is its sophisticated corporate law judiciary and its rich supply of precedents . . . .”).—and that of American corporations’ and shareholders’ rights more generally. The director-defendants could seek certiorari from the U.S. Supreme Court. If that writ is granted, then the Court, having already found corporate charters and bylaws to be “contracts” under the FAA (within this hypothetical scenario), might proceed to declare that Delaware’s Section 115 is pre-empted by the FAA, in similar fashion to the Concepcion decision215AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 352 (2011) (“Because it ‘stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress,’ California’s Discover Bank rule [(prohibiting class action waivers in certain contracts)] is pre-empted by the FAA.” (citation omitted) (quoting Hines v. Davidowitz, 312 U.S. 52, 67 (1941))). To be certain, Delaware’s Section 115 does not counter any Congressional objective; in fact, Congress hardly ever says anything about the internal affairs of corporate law, which is the province of the states. In the scenario described here, the federal courts might miss this point. and others in its vein. The Court would then overturn the Delaware Supreme Court’s ruling, reinstating the internal affairs arbitration clause in the corporation’s bylaws, and opening the floodgates for widespread adoption of such clauses among corporations chartered in Delaware and elsewhere in the U.S.
2. The Harms of Mandatory Arbitration in Corporate Law
Clearly, not all American corporations will get mandatory arbitration clauses inserted into their charters or bylaws, in regard to either securities or internal affairs claims. The rise of institutional investor stewardship and proxy advisor oversight,216See, e.g., Fisch, supra note 79, at 780 (“Commentators claim that proxy advisory firms exercise excessive influence over shareholder voting outcomes because of the tendency of institutional investors to defer to the advisors’ recommendations.”). combined with the simple fact that many fiduciaries seek to lawfully meet their duties, while guarding the corporation’s and investors’ long-term interests, make it plausible that mandatory arbitration is less likely to materialize in corporations with higher levels of corporate governance. Indeed, this phenomenon is partly demonstrated by the Johnson & Johnson and Intuit directors’ refusal to cooperate with Hal Scott’s arbitration proposals.217See supra note 169.
The problem is more nuanced, however. As can be analogized from Professor Michal Barzuza’s research on fiduciary duty waivers,218See Michal Barzuza, Inefficient Tailoring: The Private Ordering Paradox in Corporate Law, 8 Harv. Bus. L. Rev. 131 (2018); Michal Barzuza & David C. Smith, What Happens in Nevada? Self-Selecting into Lax Law, 27 Rev. Fin. Stud. 3593 (2014); Michal Barzuza, Market Segmentation: The Rise of Nevada as a Liability-Free Jurisdiction, 98 Va. L. Rev. 935 (2012). the corporations most likely to get arbitration provisions, in their charters or bylaws, are those that are more likely to violate the law in the first place (or see their fiduciaries commit such violations). Whether or not mandatory arbitration clauses become quantitatively as prevalent as, say, 102(b)(7) provisions,219Del. Code Ann. tit. 8, § 102(b)(7) (2021) (allowing for the waiver of monetary remedies for duty of care breaches by directors of a Delaware corporation, if a provision to that effect is placed in the corporation’s charter). On the prevalence of 102(b)(7) provisions, see Matteo Gatti, Did Delaware Really Kill Corporate Law? Shareholder Protection in a Post-Corwin World, 16 N.Y.U. J.L. & Bus. 345, 366 (2020) (“[V]irtually all firms incorporated (or reincorporated) in Delaware after July 1, 1986 (when Section 102(b)(7) became effective), and more than 90% of the pre-existing corporations, . . . have managed to pass the charter amendment.” (footnote omitted)). as a qualitative matter, the effect of mandatory arbitration will be significant. Those fiduciaries and entities who most require “law” to be disciplined, as opposed to “norms,”220See Rock & Wachter, supra note 82, at 1621–22. are the ones who will be able, and incentivized, to place themselves beyond enforceable law. Lawsuits will become impossible precisely where lawsuits are needed.
Moreover, the concept of litigation plays a primordial role in corporate law; without courts of equity, fiduciaries can easily undermine the non-judicial mechanisms meant to supervise them, such as shareholder voting, upon which most activism and stewardship are built.221See, e.g., supra notes 84, 89 and accompanying text. Mandatory arbitration in corporate law is thus likely to generate an unpredictable, systemically complex, and unprecedentedly troubling set of effects.
This Article mainly aims to demonstrate why corporate law and mandatory arbitration are structurally incompatible; it does not seek to describe all the practical consequences of mandatory arbitration in corporate law—many of which have been analyzed in excellent detail by Professor Lipton.222See Lipton, supra note 12, at 626–40. The remainder of this Section, however, discusses a few of those implications, both to stress the magnitude of the issue, and to keep the literature on this point updated in light of recent scholarship.
Just as in consumer and employment law, the root problem with mandatory arbitration in corporate law is that it does not channel cases to alternative dispute resolution, but the opposite: it practically eliminates them, leading to an impairment of justice, accompanied by a unilateral shift of wealth to the party managing to shut the courthouse doors before the other.223See supra Section I.A. Yet, mandatory arbitration in corporate law also presents its own distinctive set of issues. Two examples were mentioned shortly above: the derivative action waiver and the “firm always loses” clause.224See supra notes 209–10 and accompanying text. More generally, if arbitration clauses truly are to be enforced “according to their terms,”225CompuCredit Corp. v. Greenwood, 565 U.S. 95, 98 (2012). what would prevent the corporation’s fiduciaries—who will almost always be the ones drafting the arbitration provision226See supra notes 189–94 and accompanying text.—from requiring the posting of a $10 million bond as a prerequisite for filing any arbitration claim, or automatically staying any claim for three years while the board can “deliberate” on whether or not to start a proceeding itself, or any similar justice-obstructing device?
Furthermore, as Professor Lipton notes, corporate law relies on a set of representative enforcement mechanisms, which make individualized “arbitration” entirely meaningless.227See Lipton, supra note 12, at 632–36. By definition, there is no such thing as an “individual” derivative action,228See supra note 209. nor a “particularized” harm to shareholders, who all hold units of identical economic magnitude,229See Asaf Raz, Share Law: Toward a New Understanding of Corporate Law, 40 U. Pa. J. Int’l L. 255, 268, 313 (2018). and respectively share in the effects of corporate and managerial decisions (such as merging the corporation for too low a price,230See, e.g., Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). or infringing upon shareholders’ voting rights231See, e.g., Blasius Indus., Inc. v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988).). Arbitration clause drafters might also attempt to waive corporate law’s important set of information-revealing tools, such as the Section 220 demand for corporate books and records, without which many lawsuits cannot be initiated or pursued.232See Del. Code Ann. tit. 8, § 220(c) (2021) (providing for a judicial procedure to compel inspection of corporate books and records by shareholders). On the recent rise in the importance of such procedures, see, for example, George S. Geis, Information Litigation in Corporate Law, 71 Ala. L. Rev. 407 (2019); Roy Shapira, Corporate Law, Retooled: How Books and Records Revamped Judicial Oversight, 42 Cardozo L. Rev. 1949 (2021).
Even if every public corporation had just a handful of large institutional investors (which is hardly the case),233See Jill E. Fisch, Standing Voting Instructions: Empowering the Excluded Retail Investor, 102 Minn. L. Rev. 11 (2017) (discussing the important role of individual, non-institutional shareholders in the U.S., and the need for a better policy response to their interests). there would still be no economic justification, nor any practical way, to run an identical arbitration five or ten times, for each shareholder anew. As Professor David Webber found, even in a litigation environment dominated by institutional investors, “loss of the class action would eliminate . . . any remedy for substantial investor losses. . . . [C]ertain types of remedies would cease to be pursued without class action litigation. Specifically even positive-value claimants would no longer pursue remedies such as corporate governance reform.”234Webber, supra note 91, at 265.
Nor would it be even remotely feasible to submit the exact same breach of law to millions of individual arbitrations, considering retail shareholder ownership.235See Fisch, supra note 233. Yet, unless all of these proceedings are pursued, the same, single violation can never be fully remedied (or deterred). How does this square with the Supreme Court’s praise for “reducing the cost and increasing the speed of dispute resolution”?236AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 345 (2011).
These facts hint at an important observation, closely related to this Article’s broader thesis. In the corporate context, the Supreme Court cannot repeat the claim that “[b]y agreeing to arbitrate . . . , a party does not forgo the substantive rights . . . ; it only submits to their resolution in an arbitral, rather than a judicial, forum.”237Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 628 (1985). Instead, the party—a shareholder, or the corporation itself—is deprived of substantive rights when corporate law’s special enforcement mechanisms disappear. Those substantive rights are the product of a distinct legal framework, relying on its own methods of enforcement to address unique, corporate-specific situations.238See infra Section II.B. Elimination of corporate litigation means elimination of corporate law as an enforceable legal field, period. Even the most meritorious cases could never be brought,239For detailed discussion of such recent cases, see Friedlander, supra note 80, at 624–26, 646–48. Consider, for example, Americas Mining Corporation v. Theriault, 51 A.3d 1213 (Del. 2012). In that case, the corporation’s fiduciaries were penalized in the amount of $2.031 billion for engaging in a self-interested transaction. See id. at 1218. Under a mandatory arbitration regime, the fiduciaries could have simply amended the corporation’s bylaws prior to the transaction, adding an arbitration clause with various justice-impairing devices. The case could then have not been brought, or, if brought, not be decided correctly. The fiduciaries would have gone away with a multi-billion-dollar free lunch. and those who choose to violate the norms of corporate law would get “free lunch,” in respect to any decision, however harmful or irrational.
Accordingly, the insertion of a mandatory arbitration clause into a corporation’s charter or bylaws, including standard justice-impairing provisions, is functionally equivalent to a waiver of equitable and fiduciary duties, which Delaware law has long prohibited, even outside the arbitration context.240See, e.g., Sample v. Morgan, 914 A.2d 647, 664 (Del. Ch. 2007) (“An essential aspect of our form of corporate law is the balance between law . . . and equity (in the form of concepts of fiduciary duty). Stockholders can entrust directors with broad legal authority precisely because they know that that authority must be exercised consistently with equitable principles of fiduciary duty.” (emphasis added)); sources cited infra notes 358–61. Importantly, the FAA and the Supreme Court do allow courts to override arbitration clauses, as long as this is done “upon such grounds as exist at law or in equity for the revocation of any contract,”2419 U.S.C. § 2 (emphasis added). such that “arbitration agreements [are placed] on equal footing with all other contracts.”242Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440, 443 (2006). In another case, the Supreme Court has warned that the FAA is intended “to make arbitration agreements as enforceable as other contracts, but not more so.” Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 404 n.12 (1967). Delaware’s Section 115, prohibiting mandatory arbitration of corporate law disputes,243See Del. Code Ann. tit. 8, § 115 (2021); S.B. 75, 148th Gen. Assemb., Synopsis § 5 (Del. 2015) (enacted), https://perma.cc/Y9CW-W5J7. does indeed place arbitration on equal footing with other “contracts” (or, more correctly, corporate and directorial actions): in every case, a waiver of equitable and fiduciary obligations is legally impossible. This fact, too, must guide the federal courts adjudicating the issue.
Finally, it is unlikely that, over the long term, corporations and shareholders will submit to a regime where their rights are unenforceable. Large institutional investors—from the U.S., and just as importantly, from overseas—can simply shift more money into securities issued by non-U.S. corporations. Similarly, more new incorporations of international businesses might take place in jurisdictions where the nation’s highest court did not decide to make corporate law mostly unenforceable. Although fewer cases of misconduct will become publicly known, when future Enron-style scandals (or more recent ones—pick your favorite) do get uncovered, outsiders to the U.S. corporate governance system will have a hard time understanding why no civil recourse exists. Just like incorporation, litigation might also shift abroad whenever possible.244For discussion of corporate and securities litigation outside of the U.S., see, for example, sources cited supra notes 119–20. These developments would harm both the U.S.’s image and its economy.
Is the scenario described in this Section actually going to unfold? As discussed above, the federal courts’ approval of mandatory arbitration clauses in corporate charters and bylaws is contingent upon one preliminary finding: that these documents are “contracts.”245See supra note 21. Part II explains why such a finding cannot be made consistent with law.
II. What Defines Corporate Law—and Makes It Non-Contractual
A. Corporate Law’s Boundary Question: So Far, Unresolved
Hohfeld’s project . . . seems to promise . . . [that] [t]axonomic activity will be happening. There will be classification. And jurisprudence by subdivision. Oh, joy.246Pierre Schlag, How to Do Things with Hohfeld, 78 L. & Contemp. Probs. 185, 186 (2015) (formatting altered) (discussing Wesley Newcomb Hohfeld, Some Fundamental Legal Conceptions as Applied in Judicial Reasoning, 23 Yale L.J. 16 (1913)).
Part I above has discussed the new doctrinal landscape, arising from a pair of recent cases (Johnson & Johnson and Salzberg), which might lead the federal courts to introduce the practice of mandatory arbitration into the corporate law sphere. This troubling economic and social development hinges on a question of legal classification: under state law,247See supra notes 132–33 and accompanying text. is corporate law part of contract law—and by extension,248See supra note 20. are corporate charters and bylaws “contracts”? Only if they are, can the FAA, and the Supreme Court’s expansive arbitration precedents,249See supra Section I.A. enter the corporate law playing field.250See supra note 21.
This Part turns to a more theoretical approach, connecting with broader scholarship in corporate theory, contract theory, and law and economics, to prove that the answer to that question is squarely “no.”
To start with, why do we even have to ask this question now? After all, no one thinks to conflate most other areas of private law with contract. No judge, practitioner, or scholar would seriously believe that an act of tort is an act of contract-making. Nor do we consider property law to be a branch of contract law. As this Section illustrates, today’s cutting-edge scholarship devotes itself to discerning the unifying principles and legal structures that delineate each of these fields, and many others.
Corporate law, however, has remained different. Despite the huge amount of high-quality corporate scholarship, these taxonomic questions have yet to be clearly answered. At its root, this state of affairs might be grounded in the American tradition of legal realism,251For a discussion of legal realism’s influence on U.S. corporate law, see Rock, supra note 1. which distances itself from legal concepts, classifications, and doctrines. As Professor Felix Cohen famously wrote in 1935, “[a legal] proposition . . . would be scientifically useful if [the legal concepts it uses] were defined in non-legal terms.”252Cohen, supra note 2, at 820.
Over the last several decades (and in corporate law more than any other area), legal realism has largely morphed into the law and economics movement.253On the link between these two movements, see Hanoch Dagan & Benjamin C. Zipursky, Introduction: The Distinction Between Private Law and Public Law, in Research Handbook on Private Law Theory 1, 7–9 (Hanoch Dagan & Benjamin C. Zipursky eds., 2020); Smith, supra note 4, at 46–48. Similar to Professor Cohen, many law and economics scholars more readily discuss non-legal concepts—say, “externalities” or “Tobin’s q”254See, e.g., Bartlett & Partnoy, supra note 29.—than they do “corporate charters,” “equity,” or “corporate purpose.” When reviewing the work of non-realist scholars, some authors seem to regard the possibility of “corporate law as law”255Bratton, supra note 27 (emphasis added). with an air of surprise.
As a result, we see a comparatively little amount of scholarship devoted to theoretical, structural questions—such as what defines corporate law, and why we have it in the first place—and a much broader literature dedicated to important, yet more dynamic issues, such as dual-class shares,256Compare, e.g., Lucian A. Bebchuk & Kobi Kastiel, The Untenable Case for Perpetual Dual-Class Stock, 103 Va. L. Rev. 585 (2017) (advocating the adoption of “sunsets,” terms in corporate constitutional documents that mandate the cancellation of the more senior class of shares a certain period of time after its issuance), with, e.g., Jill Fisch & Steven Davidoff Solomon, The Problem of Sunsets, 99 B.U. L. Rev. 1057 (2019) (criticizing such terms). staggered boards,257See, e.g., Yakov Amihud, Markus Schmid & Steven Davidoff Solomon, Settling the Staggered Board Debate, 166 U. Pa. L. Rev. 1475 (2018) (analyzing empirical and theoretical issues surrounding the staggered board). executive compensation,258See, e.g., Lucian Bebchuk & Jesse Fried, Pay Without Performance: The Unfulfilled Promise of Executive Compensation (2004) (discussing the sharp increase in executive compensation over time and describing compensation as a topic of heated debate). and so on.259For a discussion of the difference between structural and dynamic legal concepts, see Balganesh & Parchomovsky, supra note 28; Raz, supra note 35, at 525–26, 531–32. Corporate-specific legal concepts, such as corporate personhood, which in fact play a significant role in the daily operation and economics of business organizations,260For a discussion of the economic and practical importance of corporate personhood—which is often not called that, but instead referred to using terms such as “entity” or “firm”—see, for example, Raz, supra note 35, at 539–48. are often left by the scholarly wayside.261See, e.g., Ann M. Lipton, Beyond Internal and External: A Taxonomy of Mechanisms for Regulating Corporate Conduct, 2020 Wis. L. Rev. 657, 661 (“Companies do not act; individuals within them do.”). If we choose, from the outset, to treat one of corporate law’s building blocks—personhood—as transparent, all corporate affairs would pass off merely as direct relationships between stakeholders, fiduciaries, and shareholders. In practice, however, most of the frameworks discussed in Professor Lipton’s article as constraining “directors”—for example, employment and environmental law—actually bind the corporation itself. As a rule, neither directors, nor shareholders, can be sued for breach of these non-corporate legal norms. For further discussion of the significance of the corporation’s entity status, see infra Section II.B.
Among other effects, this has resulted in the rise of the “contract” and “private ordering” metaphors in corporate legal academia.262See supra note 3. After all, if we do not have to deal with definitions and categories, why not assume that corporate law has very little structure of its own, and is just part of something more intuitive like contract law? When corporate law scholars depart from the “contract” metaphor, many tend to replace it with another, such as “property”263See supra note 33. or “agency.”264See, e.g., Heaton, supra note 32, at 207–14 (surveying in detail the development of “agency costs” as a central concept in corporate academic literature). In non-legal usage, the word “agency” might broadly refer to situations where one person affects the interests of another. In legal terms, however, corporate law is not and cannot be a branch of agency law. First, agency is defined as “the fiduciary relationship that arises when one person (a ‘principal’) manifests assent to another person (an ‘agent’) that the agent shall act on the principal’s behalf and subject to the principal’s control.” Restatement (Third) of Agency § 1.01 (Am. L. Inst. 2006) (emphasis added). In corporate law, the corporation does not control its fiduciaries’ actions; the near-opposite is true: the corporation’s actions are mostly directed by its directors or other fiduciaries. Second, agency is not limited to corporations. See, e.g., Jonathan R. Macey, Agency Costs, Corporate Governance, and the American Labor Union, 38 Yale J. on Regul. 311, 326 (2021) (discussing, for example, “[a]gency problems between clients and lawyers”). Thus, the concept of agency cannot serve to distinguish corporate law from other legal frameworks; a different principle is required, as is offered in this Article. Quite simply, “[w]hat all of these scholars have failed to consider is one possibility: corporate law is corporate law.”265Raz, supra note 35, at 581. To be certain, several works do discuss corporate law’s boundary question—what distinguishes corporate law from other legal frameworks, and why do we need it at all?—in various contexts. See, e.g., William W. Bratton & Michael L. Wachter, A Theory of Preferred Stock, 161 U. Pa. L. Rev. 1815, 1819 (2013) (“The theoretical interest concerns the problem of defining the corporation’s boundaries, asking the ‘who’s in and who’s out’ question regarding the line dividing fiduciary beneficiaries from contract counterparties.”); Ofer Eldar & Andrew Verstein, The Enduring Distinction Between Business Entities and Security Interests, 92 S. Cal. L. Rev. 213 (2019) (comparing corporate law and the law of security interests in property); John Morley, The Common Law Corporation: The Power of the Trust in Anglo-American Business History, 116 Colum. L. Rev. 2145 (2016) (arguing that trust law is capable of producing many of corporate law’s benefits); Edward Rock & Michael Wachter, Dangerous Liaisons: Corporate Law, Trust Law, and Interdoctrinal Legal Transplants, 96 Nw. U. L. Rev. 651, 652 (2002) (arguing that, from a Coasean viewpoint, corporate law and trust law are fundamentally different, since the former lies in the “firm context” and the latter in the “market context”); Andrew Verstein, Enterprise Without Entities, 116 Mich. L. Rev. 247 (2017) (arguing that contract law, particularly as applied in reciprocal insurance exchanges, is capable of producing many of corporate law’s benefits). Yet, some of these works reject the view that corporate law is substantively distinct from other areas; and, while they all compare corporate law with other frameworks, these works do not provide an underlying principle for corporate law itself. Even when, finally, discussing corporate law as such, authors often overlook at least one of its defining properties, leading to highly fragmented discourse.266See Raz, supra note 35, at 525–26, 533.
At the bottom line, corporate law suffers from a multi-faceted low-visibility problem.267See supra text accompanying notes 27–37. With the specter of mandatory arbitration (leaning on the confusion between corporate and contract law), this problem now threatens the very existence of corporate law as an enforceable framework.268See supra Part I.
This predicament is not shared by other areas of private law, which have largely re-embraced legal inquiry. In 2000, renowned legal philosopher Jeremy Waldron wrote that “any steps we have taken down th[e] road [offered in Cohen’s 1935 article269Cohen, supra note 2.] have been taken without giving up the conceptual terminology of traditional legal analysis.”270Jeremy Waldron, “Transcendental Nonsense” and System in the Law, 100 Colum. L. Rev. 16, 17 (2000). As Professor Ronald Coase, one of the greatest law and economics scholars in history, said in his 1991 Nobel Prize lecture, “the legal system [has] a profound effect on the working of the economic system and may in certain respects be said to control it.”271Ronald H. Coase, The Institutional Structure of Production, Lecture to the Memory of Alfred Nobel, Nobel Prize (Dec. 9, 1991), https://perma.cc/8XGZ-KPT8.
Recently, Professor Hanoch Dagan and co-authors have argued that “markets arise out of and operate through law—not just through public regulation but also through private law regimes . . . that create entitlements, enforce market exchanges, and limit expropriation.”272Hanoch Dagan, Avihay Dorfman, Roy Kreitner & Daniel Markovits, The Law of the Market, 83 L. & Contemp. Probs. i, i (2020). Even in the context of blockchain—which has been initially perceived as an almost polar alternative to legal ordering, where “anything goes” if only you can code it—legal norms and concepts, including contract principles and litigation in courts, strongly persist.273See Shaanan Cohney & David A. Hoffman, Transactional Scripts in Contract Stacks, 105 Minn. L. Rev. 319 (2020). Put simply, law came before the market, and it is a predicate for private ordering, not the other way around.274This statement has no collectivist overtones, but rather the opposite. To have free markets, it is imperative to have a functioning, credible legal system, where rights are actually enforced (as opposed to, say, the current U.S. system of consumer and employment law, dominated by mandatory arbitration). Legal frameworks such as corporate law distinctively contribute to entrepreneurship and economic productivity, thanks to their legally-generated structure. See infra Section II.B.
Accordingly, structural theory enjoys a respectable role in the fields of property, tort, and of course, contract. In each of these areas, scholars make a nuanced effort to locate the underlying, unifying principles of the particular legal framework. For example, Professor Randy Barnett concludes that the foundation of contract law is “consent.”275Randy E. Barnett, A Consent Theory of Contract, 86 Colum. L. Rev. 269 (1986). Professors Thomas Merrill and Henry Smith discuss the reduction of information costs through the numerus clausus principle in property law.276Thomas W. Merrill & Henry E. Smith, Optimal Standardization in the Law of Property: The Numerus Clausus Principle, 110 Yale L.J. 1 (2000). Professors John Goldberg and Benjamin Zipursky have recently formulated a new theoretical justification for tort law.277John C.P. Goldberg & Benjamin C. Zipursky, Recognizing Wrongs (2020). Indeed, high-level theory remains especially prevalent in the field of tort law, as it has been for many decades. See, e.g., Ernest J. Weinrib, The Idea of Private Law (1995) (discussing the fundamental nature of private law, mainly using tort law examples and doctrines). These works, which today are increasingly associated with the new private law movement,278See, e.g., The Oxford Handbook of the New Private Law (Andrew S. Gold, John C.P. Goldberg, Daniel B. Kelly, Emily Sherwin & Henry E. Smith eds., 2021) [hereinafter The Oxford Handbook of the New Private Law]; Paul B. Miller, The New Formalism in Private Law, 66 Am. J. Juris. (forthcoming 2021) (manuscript at 2), https://perma.cc/JDY8-9Q8K (“Private law is resurgent in the United States. A growing group of scholars . . . are providing new theoretical perspectives on tort, property, contract, fiduciary law and other subjects under the banner of the New Private Law.”); New Priv. L., https://perma.cc/2MW4-EVVQ. sharply contrast with legal realism’s neglect of legal concepts and categories.279See, e.g., Andrew S. Gold, John C.P. Goldberg, Daniel B. Kelly, Emily Sherwin & Henry E. Smith, Introduction, in The Oxford Handbook of the New Private Law, supra note 278, at xv, xvi (“NPL takes private law concepts and categories seriously. . . . NPL scholarship . . . starts from the premise that distinctions among established private law categories . . . are intelligible and pragmatically warranted. There is accordingly great value in scholarship that aims to identify their respective domains, and the ways in which they interact.”). At the same time, they respond to Professor Cohen’s criticism280Cohen, supra note 2. in that they are neither formalistic, nor divorced from economic and social realities.281A clear example is Professors Merrill and Smith’s justification of a legal concept—the numerus clausus principle of property law—in both doctrinal and economic terms (the reduction of information costs). See Merrill & Smith, supra note 276.
Why should corporate law be any different?282Professor Paul Miller has recently written about corporate law within the framework of new private law. See Paul B. Miller, Corporations, in The Oxford Handbook of the New Private Law, supra note 278, at 341. This Article continues and deepens this scholarship. After all, even under its expansive arbitration jurisprudence,283See supra Section I.A. the Supreme Court would not apply the FAA to an arbitration clause in a deed of property, because it is not a contract,284In some cases, a document that serves as a deed of property might also be a contract, if the requirements for contract formation have been met. By itself, a deed of property is not a contract, and has no “parties” in the contractual sense, as it is binding on all the people in the world (in rem). It derives its normative power not from the consent of each of these people, but from property law as law. See supra note 20. and there was no “consent” by external parties to be bound by it. Likewise, if a heavy object fell on a person from the third floor of a nearby building, the Court would place the case in the correct category—tort law—and would rightly ignore a presumed “arbitration clause” that was, say, affixed to the side of the building, in such a manner that the victim could neither read it prior to being hit, nor agree to it. Similarly, it is time to take corporate law at face value: a distinct legal field, having its own structure and practices, meant to deal with a unique set of real-world situations, and separate from contract law (or any other framework).
The following Section does precisely that. Specifically, it demonstrates that, like other branches of private law, corporate law has a unifying principle: the open-endedness of the corporation’s activities and relationships. This legally-generated principle, and its economic and social implications, have no equivalent in other fields of law. As the discussion below indicates, they make corporate law not merely different, but in some respects the opposite of contract law.
B. Corporate Law’s Defining Property: The Open-Endedness Principle
In a recent article, Professors Zohar Goshen and Doron Levit point to an intriguing fact:
Almost every aspect of corporate governance that was studied in the last forty years yielded conflicting empirical findings, for instance: dual-class shares; anti-takeover defenses, such as poison pills, staggered boards, and protective state legislations; and the strength of corporate governance as measured by several indices.285Zohar Goshen & Doron Levit, Irrelevance of Governance Structure 2–3 (Eur. Corp. Governance Inst., Working Paper No. 606, 2019), https://perma.cc/M3MC-ZWHZ (citation and footnotes omitted).
How can this be? As this Section explains—for the first time in corporate law scholarship—the lack of persistent findings is due to no fault of empirical researchers. Rather, it is one effect of corporate law’s legal structure (as opposed to economic or political structure),286See supra notes 29–30 and accompanying text. which involves the concepts of purpose, personhood, equity, and fiduciary duty.287See Raz, supra note 35, at 530, 533–66. These concepts are found together only in corporate law, and they manifest through a number of well-studied phenomena, discussed below, including the business judgment rule,288See, e.g., Cox, supra note 20, at 264 (“Flexibility within the corporation occurs through a centralized board that operates under an unconstrained corporate charter whose decisions are insulated by overwhelming deference provided by the business judgment rule.”). capital lock-in,289See, e.g., Margaret M. Blair, Locking in Capital: What Corporate Law Achieved for Business Organizers in the Nineteenth Century, 51 UCLA L. Rev. 387 (2003). asset partitioning,290See, e.g., Hansmann & Kraakman, supra note 33, at 390 (“[O]rganizational law . . . provide[s] for the creation of . . . ‘asset partitioning’ that could not practicably be established [without organizational law].”). and perpetual existence.291See, e.g., Andrew A. Schwartz, The Perpetual Corporation, 80 Geo. Wash. L. Rev. 764 (2012).
This legal structure, in turn, is tied to a unifying principle: open-endedness. Corporate law is meant to facilitate a wide range of eventualities that neither involved parties, nor legislators, nor judges, nor scholars can predict, plan, or regulate before-the-fact (ex ante). Corporate law is an ex post framework. It is about making very little information available to anyone in advance. Instead, it lets the corporate entity pursue open-ended adventures, and disciplines it (or its human representatives) after-the-fact, in courts of equity, through inquiry into what is right and just at the present moment. What corporate law does mandate ex ante is this regime of ex post supervision. That is the “bargain” entities and shareholders “agree” to when they step into the domain of corporate law. As this Section originally explains, this structure also generates a powerful set of economic and social benefits, only achievable through corporate law.
Importantly, this open-endedness principle also makes corporate law very different—in fact, almost the opposite—from another legal framework: contract law. In a way that is more familiar to economic scholars,292See Saul Levmore, The Ex-Middle Problem for Law-and-Economics, 22 Am. L. & Econ. Rev. 1, 2 (2020) (“Law-and-economics is driven by an ex ante perspective.”). contract law is built around a principle of ex ante consent.293See, e.g., Barnett, supra note 275. It is about making promises before-the-fact, and enforcing them in the manner they were made. Although “parties to a contract are free to be as whimsical or fanciful as they like in describing the promise to be performed,”294Merrill & Smith, supra note 276, at 3. from the moment a contract comes into being, it limits the parties’ autonomy and freedom of action, under pain of legal sanction. As the Restatement (Second) of Contracts says, “[a] contract is a promise or a set of promises for the breach of which the law gives a remedy, or the performance of which the law in some way recognizes as a duty.”295Restatement (Second) of Contracts § 1 (Am. L. Inst. 1981). Contract law hinges on consent,296See, e.g., Barnett, supra note 275. and that consent, in turn, has to be to something.297See, e.g., Cox, supra note 20, at 279 n.91 (“[T]he requirement of definiteness is not a matter that the parties can waive if they are to have a contract. Indeed, it is tautological to argue that the parties can agree to an indefinite level of performance, since there cannot be an agreement if parties do not know to what they have agreed.”).
Contract law permits for some ex post wiggle room, partly stemming from the fact that contracts are inherently incomplete.298See, e.g., Scott Baker & Kimberly D. Krawiec, Incomplete Contracts in a Complete Contract World, 33 Fla. St. U. L. Rev. 725, 725 (2006) (“Contracts are never fully complete, because some contractual incompleteness is inevitable, given the costs of thinking about, bargaining over, and drafting for future contingencies.”). Yet, even such intervention is shaped by whatever subject matter the parties have agreed to before-the-fact. The Delaware Chancery Court has expanded on this point:
The temporal focus is critical. Under a fiduciary duty . . . analysis, a court examines the parties as situated at the time of the wrong. . . . [L]iability depends on the parties’ relationship when the alleged breach occurred, not on the relationship as it existed in the past. [A contract law] claim, by contrast, looks to the past. . . . [It asks] what the parties would have agreed to . . . at the time of contracting.299ASB Allegiance Real Est. Fund v. Scion Breckenridge Managing Member, LLC, 50 A.3d 434, 440 (Del. Ch. 2012) (emphases added; formatting altered). For detailed analysis of this temporal distinction, see Daniel Markovits, Sharing Ex Ante and Sharing Ex Post: The Non-Contractual Basis of Fiduciary Relations, in Philosophical Foundations of Fiduciary Law 209 (Andrew S. Gold & Paul B. Miller eds., 2014). Specifically, with regard to the open-endedness principle discussed here, see id. at 214 (“Contract partners do not engage each other concretely, through their peculiar interests and for the particular persons that they are or develop into.” (emphasis added)).
Corporate law stands firmly on the ex post side. To begin with, every corporation is a legal person.300For discussions of corporate personhood as a defining building block of corporate law, and its many practical implications, see, for example, Kraakman et al., supra note 19, at 5–8 (discussing “[l]egal personality” as a “core structural characteristic of the . . . corporation”); Eric W. Orts, Business Persons: A Legal Theory of the Firm (2013); John C. Coates IV, State Takeover Statutes and Corporate Theory: The Revival of an Old Debate, 64 N.Y.U. L. Rev. 806, 818–35 (1989) (discussing the corporation’s entity nature in detail); Raz, supra note 35, at 539–48. Two well-known concepts—asset partitioning and capital lock-in—can be viewed as different aspects of corporate personhood. Because the corporate person owns its own assets (and owes its own obligations), entirely separate from its shareholders (who, in turn, have their own assets and obligations), corporate law generates a distinct economic pool that cannot be touched by shareholders’ creditors.301See Hansmann & Kraakman, supra note 33. Nor, just as importantly, can it be touched by shareholders themselves: capital lock-in mandates that “individual shareholders [cannot] remov[e] productive business assets at will.”302Elisabeth de Fontenay, Individual Autonomy in Corporate Law, 8 Harv. Bus. L. Rev. 183, 201 (2018). These achievements can only be unlocked by corporate law, as law;303See Kraakman et al., supra note 19, at 31; Hansmann & Kraakman, supra note 33, at 390. no other private law framework enables us to create a new, non-human legal person, with its own set of rights and duties.
Next, the corporation is endowed with extremely broad capacity to operate in the world. Some corporate statutes declare that “a business corporation shall have the legal capacity of natural persons to act,”30415 Pa. Cons. Stat. § 1501 (2021). The Model Business Corporation Act similarly provides that “every corporation . . . has the same powers as an individual to do all things necessary or convenient to carry out its business and affairs.” Model Bus. Corp. Act § 3.02 (Am. Bar Ass’n 2016). while others provide it with a very extensive list of “[s]pecific powers,”305Del. Code Ann. tit. 8, § 122 (2021). practically equaling those of a human being. The corporation can use these human-like powers “to engage in any lawful act or activity.”306Id. § 102(a) (“The certificate of incorporation shall set forth: . . . The nature of the business or purposes to be conducted or promoted. It shall be sufficient to state . . . that the purpose of the corporation is to engage in any lawful act or activity for which corporations may be organized under [Delaware law] . . . .”). Note that the “any lawful act” language has its origins in the idea of general incorporation, which replaced the early nineteenth century model of incorporation by special legislation and for pre-specified goals. See, e.g., Herbert Hovenkamp, The Classical Corporation in American Legal Thought, 76 Geo. L.J. 1593, 1634–40 (1988). On exceptional occasions, some corporations might replace the “any lawful act” language with a narrower goal, or otherwise modify certain default characteristics of the corporation—for example, by specifying pre-determined dividend distributions, or setting a limited lifetime for the corporation, after which it has to liquidate and distribute its residual value. Yet, this is simply a matter of (inherently imprecise) cost-benefit analysis with regard to a particular corporation: it means that the corporation would be more constrained in its actions, and would not be capable of producing the same unpredictable range of eventualities—often extremely positive ones—that is, by default, the hallmark of corporations. Both the “any” and the “lawful” are highly consequential. Like any other person, the corporation is required to obey the law.307See, e.g., Raz, supra note 35, at 549 n.135. For example, when a corporation makes a contract, it has to be fulfilled—but that is because the corporation is a person, subject to general law, not because of any ex ante command (relating specifically to that contract) within corporate law itself.
To the contrary, corporate law nowhere tells corporations which acts or activities to engage in. Just as a human’s life is open-ended, in the sense that no law tells the person which contracts or voluntary relationships to participate in, so too is a corporation’s. Many adventures,308See, e.g., Jatan Mehta, How SpaceX’s Falcon Heavy Could Enable Fantastic Science in the Outer Solar System, Medium (Mar. 28, 2018), https://perma.cc/C7BG-CUVS. or misadventures,309See, e.g., David Skeel, Icarus in the Boardroom: The Fundamental Flaws in Corporate America and Where They Came From 143–74 & passim (2005) (discussing many corporate misdeeds, including the Enron scandal, as related to corporations’ partly legitimate risk-taking behavior). can transpire. When we add the corporation’s perpetual existence into the mix,310See tit. 8, § 102(b)(5) (stating that, unless the certificate of incorporation specifies otherwise, “the corporation shall have perpetual existence”); Schwartz, supra note 291. the range of potential endeavors grows even further, well beyond that of a human. The open-endedness principle is perhaps most famously facilitated by the business judgment rule (again, a concept limited to corporate law),311See, e.g., In re Viacom Inc. Stockholders Litig., Consol. C.A. No. 2019‑0948‑JRS, 2020 Del. Ch. LEXIS 373, at *3 (Del. Ch. Dec. 29, 2020) (noting, while discussing judicial deference to corporate directors, that “the conduct of corporate fiduciaries is given less judicial scrutiny than the conduct of trust fiduciaries”); Rock & Wachter, supra note 265, at 661, 668 (discussing the lack of a business judgment rule in trust law); Robert H. Sitkoff, Fiduciary Principles in Trust Law, in The Oxford Handbook of Fiduciary Law 41, 41 (Evan J. Criddle, Paul B. Miller & Robert H. Sitkoff eds., 2019) (“[T]he trust law duty of care . . . is not softened by a business judgment rule.”); Julian Velasco, Fiduciary Judgment Rules, 62 Wm. & Mary L. Rev. 1397, 1414–15 (2021) (“Perhaps the most obvious way in which corporate law differs from other applications of fiduciary law is in the business judgment rule. . . . [T]he business judgment rule actually serves the purposes of fiduciary law in corporate law’s special circumstances.” (emphasis added)). Contract law, as well, does not have any concept that is analogous to the business judgment rule. mandating that “in the absence of facts showing self-dealing or improper motive, a corporate officer or director is not legally responsible to the corporation for losses that may be suffered as a result of a decision that an officer made or that directors authorized in good faith”312Gagliardi v. Trifoods Int’l, Inc., 683 A.2d 1049, 1051 (Del. Ch. 1996). For more on this point and its relation to the open-endedness principle, see Leo E. Strine, Jr., Delaware’s Corporate-Law System: Is Corporate America Buying an Exquisite Jewel or a Diamond in the Rough? A Response to Kahan & Kamar’s Price Discrimination in the Market for Corporate Law, 86 Cornell L. Rev. 1257, 1275 (2001) (“The Delaware Model . . . provides corporate managers with the flexibility to do practically any lawful act, subject to judicial review focused on whether the managers were properly motivated and not irrational.”).—no matter what the decision actually is.313See, e.g., E. Norman Veasey with Christine T. Di Guglielmo, What Happened in Delaware Corporate Law and Governance from 1992–2004? A Retrospective on Some Key Developments, 153 U. Pa. L. Rev. 1399, 1405 (2005) (“Courts should not second-guess the business decisions of directors, and the Delaware courts have not done so.”). Contract law, with its ex ante nature, cannot (and is not meant to) achieve anything similar.
Consider, for example, a corporation like Google. Would it be possible for anyone to write an ex ante contract that dictates—even in broad strokes—the details of all the corporation’s future activities? Such a task is impossible, at any point in time (both at the corporation’s founding, and any “midstream” moment of its existence). The reason is that people can (and sometimes should) predict or plan the future only to a limited extent.314See, e.g., Baker & Krawiec, supra note 298, at 725. Although the impossibility of fully knowing the future is also an issue in contract law (the subject of Baker and Krawiec’s article), a different layer of complexity arises in corporate law. The presence of a separate entity, combined with the other open-endedness devices discussed in this Section, creates an additional “degree of freedom.” From the moment a contract comes into existence, contract law operates to narrow the range of possible future events; the parties must act consistent with the contract, and not any other way. Accordingly, even ex post judicial intervention is grounded in the original contract and the parties’ intentions. See supra note 299 and accompanying text. In contrast, as discussed in this Section, from the moment a corporation comes into existence, corporate law operates to expand the range of possible future events. Naturally, and at however high an investment of money and effort, no one could (or can today) even imagine most of the activities Google would engage in within a long-enough period of time.315See Raz, supra note 35, at 547–48. What began as purely a search engine developer turned into a corporation dealing with such projects as YouTube and autonomous cars. If Google’s existence was based on “contract,” as opposed to corporate law, none of these feats could be achieved, or they would require an infinite cost at the contract drafting stage. Indeed, they would require omniscience. Corporate entities both change the world, and adapt to it, in numerous, entirely unforeseeable ways. Through this, corporate law encourages innovation and entrepreneurship, in a manner that is impossible to attain by any other legal device.
As a result, both contractarians (arguing that corporate law merely provides “default rules” in a contract between shareholders and managers),316See supra note 3. and property theorists (arguing that corporate law simply draws lines between distinct pools of property, in turn reducing contracting costs with stakeholders),317See Hansmann & Kraakman, supra note 33, at 401–03. are missing the bigger picture. Corporate law does something more profound: through its open-endedness principle, it creates a whole new actor, free from the shackles of pre-existing obligations, and sends it off to pursue unlimited adventures. The infinite cost of planning all future activities through contract is reduced to less than one hundred dollars—the filing fee for establishing a new corporation.318See Division of Corporations Fee Schedule, Del. Dep’t of State 1 (Aug. 1, 2020), https://perma.cc/KBW4-AP4K (indicating that the filing fee for establishing a new Delaware corporation is $89). Of course, corporate law is not the single driver of economic activity and wealth formation in any society, but it is an important one. See, e.g., William T. Allen, Jack B. Jacobs & Leo E. Strine, Jr., Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law, 56 Bus. Law. 1287, 1287 (2001) (“[E]lementary variables such as technology, education, availability of capital, and even social values such as diligence and self-restraint, are vital ingredients as well. But . . . it [is] clear . . . that the law of enterprise organization plays an important role in facilitating economic welfare.”). That is, to say the least, anything but trivial.319Contra Black, supra note 3.
The discussion so far has focused on the benefits generated by corporate law’s open-endedness principle—namely, efficiency and innovation, facilitated by corporate personhood, the “any lawful act or activity” statutory language, perpetual existence, and the business judgment rule. Although the trajectory of the corporation’s life is open-ended, the same is not true of corporate law itself. Corporate law does not only confer power; it also imposes duties. Unlike in a contract, however, those duties are not delineated before-the-fact. Instead, they are based on concepts of purpose, equity and fiduciary duty, calling for a judicial inquiry that examines “the parties’ relationship as it existed at the time of the wrong”320ASB Allegiance Real Est. Fund v. Scion Breckenridge Managing Member, LLC, 50 A.3d 434, 440 (Del. Ch. 2012).—meaning ex post.
As a general matter, if it does not violate the norms of corporate law, the corporation can fail—going bankrupt, or dissolving with zero net worth—with its residual claimants receiving no compensation at all.321See, e.g., Raz, supra note 229, at 275–76 (“[T]he residual interests . . . [are] those left after all corporate obligations, of any kind, to all non-residual claimants are satisfied, in practice or in capacity.”). Accordingly, if the corporation does not meet its other obligations, residual claimants are not legally entitled to any value. This fact is implicit in the very concept of a residual claim, which again, is a unique aspect of corporate law.322See id. at 272–78. This is the opposite of contract law, where by definition, a failure to accomplish the subject matter generates a right for remedy, or performance is otherwise seen as a duty.323See, e.g., supra note 295 and accompanying text. The corporation is neither a contractual counterparty to shareholders, nor their fiduciary.324See, e.g., In re Stillwater Cap. Partners Inc. Litig., 851 F. Supp. 2d 556, 573 (S.D.N.Y. 2012) (“A corporation does not owe a fiduciary duty to its shareholders . . . .”); Alessi v. Beracha, 849 A.2d 939, 950 (Del. Ch. 2004) (“[The defendant corporation] owes no fiduciary duty to [the plaintiff shareholder].”).. This does not mean, however, that shareholders have no claims at all. Corporate share law, or the law of residual claims, is a core part of the corporate legal framework.325See Raz, supra note 229, at 272, 275–76. Shareholders’ rights are shaped within corporate law itself, subject to its open-endedness principle, and using tools of equity and ex post review.
For example, even if we could somehow tell the corporation’s fortunes in advance (which we cannot), shareholders would still be exposed to a wide variety of unpredictable scenarios. One category of such events is share dilution: at any given moment, the corporation might increase its outstanding share capital, by allocating additional shares to new owners, thus decreasing each current shareholder’s relative stake in the corporation’s residual value (along with other rights, such as voting). The corporation can do this—nothing says otherwise, ex ante—but it must do it in an equitable manner. Delaware law has dealt with intricate sets of circumstances in this context.326See, e.g., Feldman v. Cutaia, 956 A.2d 644, 655 (Del. Ch. 2007) (“A claim for wrongful equity dilution is premised on the notion that the corporation, by issuing additional equity for insufficient consideration, made the complaining stockholder’s stake less valuable.”); Mira Ganor, The Power to Issue Stock, 46 Wake Forest L. Rev. 701 (2011) (discussing the law and theory of share dilution). More generally, the range of situations that might occur in the corporation-shareholder relationship extends beyond any example we may be aware of at the present moment. Corporate law generates and responds to unexpected, perhaps even odd, events, of which neither the substance, nor the parties being affected, can be known before-the-fact.327See, e.g., Verified Complaint at 29, Shekhawat v. Kumar, No. 2019‑0079‑AGB (Del. Ch. Feb. 6, 2019) (asking for remedy following an allegedly inequitable reverse share split, at a ratio of “1-for-2,185,000,” designed to strip the plaintiff of his shares, specifically in order to forestall another shareholder litigation case filed by the plaintiff); Verified Petition for Equitable Relief at 1, In re Heat Biologics, Inc., No. 2019‑0741‑JTL (Del. Ch. Sept. 13, 2019) (asking for remedy ex parte, such “that the Court deem the Company to have received approval from the holders of a majority of the outstanding shares” for a proposal necessary to maintain NASDAQ listing, since the corporation could not actually receive such approval, as a large fraction of its public shareholders happen to reside in Germany, where proxy materials cannot be adequately distributed to shareholders and received from them). For an ever-replenishing source of similarly unpredictable corporate law stories, see Columns by Matt Levine, Bloomberg, https://perma.cc/K3WW-4SWP.
The same holds true for the law of corporate purpose: that the corporation can “engage in any lawful act or activity”328Del. Code Ann. tit. 8, § 102(a)(3) (2021). does not mean that a for-profit corporation, for example, may start acting like a charitable or nonprofit corporation. In a series of cases, including 1989’s Paramount Communications, Inc. v. Time, Inc.329571 A.2d 1140 (Del. 1989). and 2010’s eBay Domestic Holdings, Inc. v. Newmark,33016 A.3d 1 (Del. Ch. 2010). the Delaware courts have held that the for-profit corporation’s purpose is the lawful pursuit of profit.331See Raz, supra note 35, at 536–39. Directors and officers, by unilateral action (either charter or bylaw amendment, or the ongoing management of the enterprise), cannot abuse the fact that the law of corporate purpose is not clearly delineated in statute or contract. Once again, the courts are required to divine the equitable substance of corporate law, ex post.
Although this Article is the first to propose the open-endedness principle as a unifying theory for corporate law, the concept relates to many well-recognized strands of legal and economic scholarship. Consider three examples: Judge Frank Easterbrook and Professor Daniel Fischel’s work on contract and fiduciary duty;332Easterbrook & Fischel, supra note 3. Professor Amir Licht’s work on information asymmetries in fiduciary law;333Amir N. Licht, Motivation, Information, Negotiation: Why Fiduciary Accountability Cannot Be Negotiable, in Research Handbook on Fiduciary Law 159 (D. Gordon Smith & Andrew S. Gold eds., 2018). and Professor Henry Smith’s work on equity as meta-law.334Henry E. Smith, Equity as Meta-Law, 130 Yale L.J. 1050 (2021).
In their 1993 article, Judge Easterbrook and Professor Fischel famously argued that fiduciary duty is but a default term in a contract—presumably, if we could somehow eliminate the unusually high information costs associated with the corporate form, there would be no need for fiduciary duties:
[A] “fiduciary” relation is a contractual one characterized by unusually high costs of specification and monitoring. The duty of loyalty replaces detailed contractual terms, and courts flesh out the duty of loyalty by prescribing the actions the parties themselves would have preferred if bargaining were cheap and all promises fully enforced.335Easterbrook & Fischel, supra note 3, at 427.
What is missing from this argument, however, is why the costs of monitoring are so high to begin with—and whether they can ever be lowered to a level that would allow for waiving the duty of loyalty. At least in the corporate context, the answer is “no.” Corporate law is precisely about keeping the future unknown (and, as a result, making information costs exceptionally high). Lowering specification and monitoring costs would require telling the future of a human-like entity with open-ended freedom of action, which is impossible for any price.336Easterbrook and Fischel emphasize the concept of pricing as a catch-all remedy, stating, for example, that “[e]ven if one party has the power to overawe the other, it can collect the value of the position in the price.” Id. at 432. They also argue that “the price reflects the value of the entire contractual package.” Id. at 436. In reality, however, it is impossible—through markets, private ordering, or any other non-fiduciary mechanism—to find the price for which a corporation ought to surrender the loyalty it is owed. That is because the unknowable future actions of fiduciaries—practically subject, in the first place, only to the requirement of loyalty—are what shapes the corporation’s value, on an ongoing basis. When information about some phenomenon can only become knowable ex post, its elimination cannot be “priced” ex ante. Most people would indeed prefer that “all promises [be] fully enforced,”337Id. at 427. but in itself, that is an empty, circular statement. Without the duty of loyalty, there would be no “promise” to enforce. Ex ante, corporate law does not tell fiduciaries much, besides to loyally promote the corporation’s purpose, through whatever lawful acts they choose. To find out whether the fiduciary has actually done so, corporate law’s ex post devices are constantly required, by definition.
In his 2018 article, Professor Licht sounds a similar theme, arguing that “asymmetries due to unobservable and unverifiable information . . . provide a compelling justification for a strict, full-disclosure-based [fiduciary] accountability regime.”338Licht, supra note 333, at 179. Where do these problems of unobservability and unverifiability come from? In other fiduciary contexts, such as trust or agency law, they might simply be the result of the trustee or agent not revealing all the cards to their beneficiary. This may be termed “interpersonal” information asymmetry. In corporate law, however, an additional problem emerges: aside from such interpersonal imbalances, there is also a unique temporal information asymmetry. Put simply, neither the beneficiary, nor the fiduciary, know (or can know) what the corporation will do, or what will happen to it, within a given time frame. It is the future itself that is unobservable and unverifiable. Yet, because the fiduciary holds the capacity to shape the corporation’s fate, by directing its actions—and has superior information about the state of the corporation, when it does become knowable—fiduciary duties must arise.
In his 2021 article, Professor Smith presents a theory of equity as “meta-law,”339Smith, supra note 334. geared toward the fact that “because regular law seeks generality and ex ante certainty, it cannot handle situations in which intense interactions can lead to unforeseen and undesired results.”340Id. at 1056. Corporate law facilitates what is perhaps the signature example of such “intense interactions”: not only does every corporation involve an intricate web of actors (the entity, its residual claimants, and its fiduciaries) and duties (equitable and fiduciary, in addition to the corporation’s general duty of legal obedience), corporate law does this while actively minimizing the amount of ex ante certainty available to anyone. Professor Smith mentions equity’s vital role in dealing with the “problem of opportunism,”341Id. at 1056, 1095. but corporate law requires equity to go further: even when no one intends to act opportunistically, the open-endedness of corporate existence inevitably generates a potential for misunderstandings, mistreatment, and misappropriation of rights. Equity therefore serves an unwaivable function within the corporate framework.
Finally, it is true that “[a]fter Legal Realism . . . seeing law, especially private law, as having a structure goes against the grain,”342Id. at 1142. but as the discussion here demonstrates, the legally-generated, non-contractual concepts of purpose, personhood, legal obedience, equity, and fiduciary duty constitute the structure of corporate law, and at the same time, create an important, unique set of benefits for our economy and society at large.
As this Section has shown, corporate law has none of contract law’s building blocks: neither consent, nor ex ante promises, nor sanction for their breach. Corporate law has different components: purpose, entity status, and ex post equitable supervision accompanied by fiduciary duties. While contract law has its unifying principle of consent, corporate law rests on a principle of open-endedness. Corporate law confers power upon entities and their fiduciaries to embark on unpredictable adventures, nowhere prescribed ex ante, but it also disciplines the use of that power ex post. When we move away from the more extreme form of legal realism, and examine corporate law as law, we also find that it distinctively facilitates innovation, entrepreneurship, and other desirable economic and social values.
If we accept that what the law says matters, the difference between corporate and contract law—specifically under the most important jurisdiction in this area, Delaware—cannot be ignored. Any attempt to treat corporations in an ex ante manner, as if they were contracts, leaves no choice but either to eliminate the economically beneficial freedom of action provided by corporate law, or abandon its ex post remedial mechanisms, basically handing a gift to wrongdoing actors. When deciding the question of mandatory arbitration in corporate law,343See supra Part I. the federal courts, relying on state law,344See supra notes 132–33 and accompanying text. have no ground for conflating these two, very distinct legal frameworks.
C. How We Use the Word “Contract” in Corporate Law: Either Metaphor or Error
A contract means something. It’s the law, and it’s enforceable. Deal with it.345Kelly Connolly, Better Call Saul’s Kim Wexler Is the Best Character on TV, TV Guide (Mar. 25, 2020), https://perma.cc/L2CR-XJPF (quoting Better Call Saul (AMC Networks Mar. 2, 2020)).
Given this Article’s bright-line argument—corporate law is not contract law, but an independent legal category, with its own principles, structure, and economic and social implications—one might justifiably wonder: how does this square with the common use of the word “contract” in both corporate law cases and corporate academic literature? Although corporate charters and bylaws are never described as “contracts” in the Delaware General Corporation Law,346Del. Code Ann. tit. 8 (2021). the Delaware courts do seem to be calling them that.347See, e.g., Airgas, Inc. v. Air Prods. & Chems., Inc., 8 A.3d 1182, 1188 (Del. 2010) (“Corporate charters and bylaws are contracts . . . .”); Morris v. Am. Pub. Utils. Co., 122 A. 696, 700 (Del. Ch. 1923) (“That a corporate charter is a contract has been long settled.”). Similarly, the term “contract” is a mainstay of corporate law scholarship, especially in the law and economics community.348See supra note 3.
This Section proves that both of these corpuses of text are using the word in one of two ways: either as a metaphor,349See, e.g., Thomas W. Joo, Contract, Property, and the Role of Metaphor in Corporations Law, 35 U.C. Davis L. Rev. 779 (2002). intended to broadly allude to some similarities—but certainly not an identity—between charters and contracts; or as a simple error, ignoring what corporate law actually says and does. The use of “contract” in corporate law is thus similar to its use in phrases such as “the social contract.”350Jean-Jacques Rousseau, The Social Contract (G. D. H. Cole trans., Prometheus Books 1988) (1762). It is also akin to how the term “fiduciary” is employed in constitutional and administrative law: a useful comparison, informing and enriching our understanding of the legal device,351See, e.g., Andrew Kent, Ethan J. Leib & Jed Handelsman Shugerman, Faithful Execution and Article II, 132 Harv. L. Rev. 2111 (2019). but not one that can be used to invoke the entire structure, doctrines, and rules of contract (or fiduciary) law, in a manner that can be directly applied to corporations (or the U.S. government).352See Samuel L. Bray & Paul B. Miller, Against Fiduciary Constitutionalism, 106 Va. L. Rev. 1479, 1481 (2020) (arguing against fiduciary constitutionalism, while calling it “bad fiduciary law and bad constitutional law”).
In Delaware cases, the word “contract” is occasionally invoked in connection with corporate charters and bylaws.353See supra note 347. Opponents of private law enforcement are likely to try and take advantage of this terminology in the upcoming mandatory arbitration debate.354See supra Section I.C. In reality, however, the Delaware courts are using that term in a highly qualified manner—making it so different from actual contract, as defined by contract law,355See supra Section II.B; supra note 20 (explaining that contract is a creature of law, so in order to find whether something is a contract, we must turn to the legal framework that gives rise to that instrument). that it can only be construed as a metaphor. The word “contract” is subordinated to the inherently non-contractual concepts356For a discussion of the fundamental nature of contract law as grounded in the ex ante dimension (and being incompatible with ex post judicial supervision of the kind prevalent in corporate law), see supra note 299 and accompanying text. of equity’s primacy, broad judicial oversight, and ex post intervention.
To see this, one need only examine several decisions cited in Salzberg,357Salzberg v. Sciabacucchi, 227 A.3d 102 (Del. 2020). For discussion of the case, see supra text accompanying notes 141–54. the most recent Delaware Supreme Court case on the nature of corporate charters and bylaws. The Salzberg court quotes a decision stating that “[a]t its core, the [Delaware General Corporation Law] is a broad enabling act which leaves latitude for substantial private ordering, provided the statutory parameters and judicially imposed principles of fiduciary duty are honored.”358Salzberg, 227 A.3d at 116 (emphasis added) (quoting Williams v. Geier, 671 A.2d 1368, 1381 (Del. 1996)). Another decision is cited as saying that “Delaware’s corporate statute . . . leaves the parties . . . with great leeway to structure their relations, subject to . . . the policing of director misconduct through equitable review.”359Id. (emphasis added) (quoting Jones Apparel Grp., Inc. v. Maxwell Shoe Co., Inc., 883 A.2d 837, 845 (Del. Ch. 2004)). Once again: “forum selection clauses . . . [should be] den[ied] enforcement . . . to the limited extent necessary to avoid some fundamentally inequitable result.”360Id. at 132 (emphasis added) (quoting Boilermakers Loc. 154 Ret. Fund v. Chevron Corp., 73 A.3d 934, 949 (Del. Ch. 2013)). Highlighting the primacy of equity over contract, the Boilermakers court even describes ex post judicial supervision as “the main point” pertaining to the operation of corporate bylaws. Boilermakers, 73 A.3d at 963. Other cases emphasize the same.361See, e.g., Lacey v. Velasco, C.A. No. 2019‑0312‑SG, 2021 Del. Ch. LEXIS 25, at *3–18 (Del. Ch. Feb. 11, 2021) (“[T]he entity and its directors are not contractually bound to one another by the charter—they are not counter-parties—and the legal compulsion for directors to comply with the charter arises as part of their fiduciary duties, and not in contract. . . . The relationship between directors and their corporation is typically fiduciary, rather than contractual, and if any claim is created on behalf of the corporation by a failure on the part of directors to comply with the entity’s formative documents, it is a claim for breach of fiduciary duty.” (footnote omitted)); Sample v. Morgan, 914 A.2d 647, 664 (Del. Ch. 2007) (“An essential aspect of our form of corporate law is the balance between law . . . and equity . . . . Stockholders can entrust directors with broad legal authority precisely because they know that that authority must be exercised consistently with equitable principles . . . .”).
This regime of ex post judicial modification is not “contract,” and by definition, it cannot be.362See supra Section II.B; supra note 299 and accompanying text. Instead, what the Delaware courts are talking about is the structure of corporate law, as a self-standing legal category. They are essentially saying this: when a given act—by directors, officers, or any other person subject to the norms of corporate law—comports with the building blocks of corporate law (among them equity and fiduciary duty),363See Raz, supra note 35, at 545–46, 557–66. we are likely to approve that act after-the-fact. While doing so, we will sometimes also mention that an “event of volition” on the part of some shareholders, or the corporate entity (for example, a vote to amend the corporate charter), took place, if it did (which is not always the case). This is where we use the word “contract,” mainly for lack of more nuanced terminology—perhaps a long-term effect of legal realism’s disdain for legal concepts.364See supra note 2 and accompanying text. This is the space in which the “ex ante corporate governance movement”365Shaner, supra note 75, at 1040. has been operating, and should continue to operate.
Even when these scattered instances of volition occur, however, they do not rise to the level of “consent,” and do not turn corporate law into contract law. If the act at issue does not align with our equitable principles—and, given the open-ended power which corporate law uniquely confers upon the entity and its fiduciaries,366See supra Section II.B. some acts will inevitably end up in that basket—we shall deem the act inequitable, and thus impermissible.367See Schnell v. Chris-Craft Indus., Inc., 285 A.2d 437, 439 (Del. 1971) (“[I]nequitable action does not become permissible simply because it is legally possible.”). Any purported ex ante “consent” will not change this result.
Therefore, contrary to some commentators’ well-motivated concerns,368See, e.g., Lipton, supra note 12, at 641 (“By justifying fee-shifting bylaws and forum selection clauses as contractual, Delaware may have triggered an unintended consequence in opening the door to mandatory arbitration . . . .”). a close reading of Delaware case law does not lend support to a “contractarian” view of the corporation. The exact opposite is true: at every turn, corporate law actors rely on ex post adjudication to remedy violations, deter misconduct, and reduce power and information asymmetries. When faced with the question of mandatory arbitration in corporate law, the federal courts will have to carefully examine these cases—the original Archimedean point (along with concepts of equity and structure) from which corporate law emanates (particularly on account of the Erie doctrine).369See supra notes 132–33 and accompanying text. Even if, occasionally, a case uses the word “contract” without following it with a discussion of equity and ex post review,370See, e.g., sources cited supra note 347. this does not detract from the many cases that do.371See, e.g., sources cited supra notes 358–61. Corporate law should be treated as a whole. A judge (and certainly a textualist judge) is not at liberty to read one part of the sentence—“contract”—and skip the discussion of non-contractual, ex post supervision, grounded in equity and in the structure of corporate law.
When we turn to the story of “contract” in corporate law scholarship, things get even more interesting. Since the 1970s, and particularly following Professors Michael Jensen and William Meckling’s description of the corporation as “a nexus for contracting relationships,”372Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. Fin. Econ. 305, 311 (1976) (emphasis omitted). corporate law academics—especially within the dominant law and economics movement—have been keen on using a language of “contract” when discussing innumerable, ever-changing topics in corporate law.373See, e.g., William W. Bratton, Jr., The “Nexus of Contracts” Corporation: A Critical Appraisal, 74 Cornell L. Rev. 407 (1989) (surveying the early development of the language of contract in corporate law).
Yet, there is an apparent irony here: more often than not, these law and economics scholars belong to the shareholderist camp, advocating both shareholder wealth maximization (as the end) and shareholder empowerment (as the means) in corporate law.374See, e.g., Raz, supra note 35, at 527–28, 567 (discussing shareholderism and some of the scholarly works advocating it). The highly influential corporate governance movement,375See, e.g., Pargendler, supra note 16. which has expanded to global proportions,376See, e.g., Mariana Pargendler, The Rise of International Corporate Law, 98 Wash. U. L. Rev. 1765 (2021). largely rests on these premises. The legal concept of contract, however, is strongly antithetical to advancing shareholders’ rights.
After all, if the corporate “contract” is the corporation’s charter and bylaws; if contract law is an ex ante regime, where contracts are to be enforced according to their existing terms;377See supra Section II.B. and if directors and officers (shareholders’ arch-rivals under the “agency costs” theory that dominates corporate economic scholarship)378See, e.g., Heaton, supra note 32. can both dictate the terms of charters and bylaws,379See supra notes 189–94 and accompanying text. and run nearly every other aspect of the corporation380See, e.g., Del. Code Ann. tit. 8, § 141(a) (2021) (“The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors . . . .”).—then “contract” as such cannot possibly be beneficial for shareholders. Mandatory arbitration, of course, provides the clearest example.381See supra Section I.C. To protect shareholder interests, there must be some framework other than contract at play, and indeed there is: corporate law. In practice, the leading economic works debate the merits of various non-contractual, corporate-specific legal devices, grounded in equity, fiduciary duties, and legislative and judicial lawmaking to protect asymmetrically-positioned parties.382See, e.g., sources cited supra notes 256–58.
How, then, can the widespread use of the phrase “contract” in corporate scholarly circles be explained? There are at least two plausible answers. First, it is likely that some law and economics scholars, deeply influenced by the tradition of legal realism,383See supra note 253. do not pay sufficient attention to legal concepts and categories—especially when it comes to corporate law, which suffers from a “low-visibility problem” at the outset.384See supra text accompanying notes 27–37. While the substance of these authors’ scholarship deals with corporate law as corporate law, the language they employ turns to “contract.” In any case, the mere use of a word cannot override the legal norms and structures that define what is required to form a contract (ex ante consent to specific promises), and what corporate law is about (ex post supervision over open-ended adventures), making the two areas inherently differ from one another.385See supra Section II.B.
The second explanation involves an intriguing bit of history. It comes from new research by Professor David Gindis.386David Gindis, On the Origins, Meaning and Influence of Jensen and Meckling’s Definition of the Firm, 72 Oxford Econ. Papers 966 (2020). As Gindis reveals, Professors Jensen and Meckling chose to highlight the term “contract” in their 1976 article387Jensen & Meckling, supra note 372. as a response to a broader social and political controversy going on at the time.388See Gindis, supra note 386, at 973–76. That debate concerned the proper role of corporations in society: should they only serve shareholder interests, or should they operate in the benefit of other stakeholders, including employees and consumers.389See id. This is the same topic that has resurfaced over the last couple of years.390See supra note 50. In the vocabulary of the 1970s, Jensen and Meckling believed that stressing a “contractual” view of the firm, as opposed to it being a creature of the state, would support the shareholder-focused argument.391See Gindis, supra note 386, at 980–81 (“[Jensen and Meckling’s] definition makes sense once the socio-political context within which [their 1976 article] was written is taken into account. . . . [W]hen Jensen and Meckling got immersed in the public debate about corporate responsibility and regulation in the late 1970s and early 1980s, their message that private corporations were unlikely to survive additional regulatory burdens followed from their definition of the firm.”).
Today, however, we know that this particular dispute—between the lawful pursuit of wealth and stakeholder orientation—lies on a separate axis from the debate concerning the rights and duties of the corporate entity, its shareholders, and its fiduciaries vis-à-vis one another. Put simply, there is no need to invoke the word “contract” to defend a lawful profit-seeking view of the corporation.392While corporate law has a legally prescribed structure, and strongly diverges from contract law, it also mandates that the purpose of for-profit corporations is the lawful pursuit of profit. See Raz, supra note 35. More accurately, Jensen and Meckling (just like present-day law and economics scholars) could have said that the corporation is a creature of private law—which includes, in addition to contract, the fields of property, tort, and corporate law, among others.393See, e.g., The Oxford Handbook of the New Private Law, supra note 278 (including chapters on each of these fields and many others). In each of these, the actors are private. The state serves in a legislative and adjudicative capacity, but is not itself a party (a right-and-duty bearer) within the private law relationship.394See, e.g., John C.P. Goldberg, Introduction: Pragmatism and Private Law, 125 Harv. L. Rev. 1640, 1640 (2012) (“Private law is law, so government is involved, albeit in a particular way. Typically, it makes available institutions and procedures that enable individuals and entities to define their relationships and to assert and demand the resolution of claims against others.” (emphasis added)); Raz, supra note 35, at 576 nn.284–85. Indeed, commentators who view the corporation as a “creature of the state,” often relying on cases such as Trustees of Dartmouth College v. Woodward, 17 U.S. (4 Wheat.) 518, 636 (1819), and echoing the “concession theory” of corporate law, are equally as mistaken as the contractarians. The former tend to underappreciate the effect of general incorporation, see supra note 306. That reform has modified the state’s role in corporate law, from a right-and-duty bearing actor to a law-making and law-enforcing one—just as it is in other areas of private law. The content of each private law framework (contract, property, corporate, and so on) is different, but the state’s role is similar. To meaningfully create and enforce certain rights—including those of the shareholders Jensen and Meckling sought to defend—the legal (and economic) framework must differ from contract.395See supra Section II.B.
Given that Jensen and Meckling came from a background of economic, not legal, scholarship (combined with the influence of legal realism, discussed above), there was scant chance they would take this simple, but profound, step. They settled for “contract,” intending to address a completely different problem from the present one, in which pro-arbitration advocates will seek to leverage a misconstrued “contract” terminology to collapse corporate law’s enforceability, allowing disloyal actors to place themselves beyond the reach of legal remedy.396See supra Section I.C. This is a far cry from what law-and-economists, from Jensen and Meckling to the present day, have been aiming for.
When the question of mandatory arbitration in corporate law reaches the federal courts in full force, in addition to the substantive and functional inquiry offered in Section II.B, the courts should remain mindful of this Section’s linguistic analysis—demonstrating the exceptionally qualified, metaphorical, and historically circumscribed way in which both state courts, and members of the scholarly community, have used the word “contract” in the corporate law context.
A storm is brewing on the corporate law horizon. A series of recent events, which this Article ties together for the first time—namely, the Johnson & Johnson case pending in federal court, and the Delaware Supreme Court’s recent Salzberg decision—raise the possibility that, in the future, large swaths of U.S. corporate law will become practically unenforceable, placed beyond the reach of any court or other remedial mechanism.
This would happen if the federal courts—as high as the Supreme Court—choose to authorize the enforcement of mandatory arbitration clauses in corporate charters and bylaws. Such provisions could then be unilaterally imposed by corporate directors and officers—the very same people whom litigation in open court is meant to supervise. Due to the Supreme Court’s expansive arbitration jurisprudence, this situation would eliminate any chance for corporations and shareholders to challenge both the arbitration clause itself, and any act of misconduct by directors, officers, and other corporate law actors, however egregious or harmful.
Although it is likely that not all corporations will become subject to mandatory arbitration, the corporations most likely to suffer from such justice-impeding provisions are the ones where wrongdoing is more likely to occur in the first place. In practice, such arbitration terms are equivalent to a waiver of all fiduciary and equitable duties within the corporate relationship—a waiver which Delaware law has long prohibited, even outside of the arbitration context. Part I describes in detail this new trajectory U.S. corporate law might soon embark on.
Will mandatory arbitration in corporate law actually happen? According to the Federal Arbitration Act, and ample precedent from the Supreme Court, this troubling move hinges upon one preliminary finding: that corporate charters and bylaws are “contracts.” As this Article explains in Part II, such a determination cannot be made consistent with law. Under the influence of legal realism, scholars have long been reluctant to discuss the legal structure of corporate law, and the boundary separating it from other frameworks, most importantly, contract law. As this Article originally demonstrates, if we bring corporate law in line with the newest private law scholarship, while taking a moment to consider corporate law as law, we find that corporate law is not merely different, but in some respects the opposite of contract law.
Just like other areas of private law, including contract and property, have an underlying theme, corporate law has its open-endedness principle: it is about what happens after-the-fact. Corporate law generates extremely little information ex ante, and vests the corporate entity with the power to go on unpredictable adventures (think Google or SpaceX), premised on the concepts of corporate personhood, the “any lawful act or activity” statutory language, perpetual existence, and the business judgment rule. All of these are unique creatures of corporate law, not encountered in any other framework, least of all contract.
While contract law is about promises made before-the-fact, and enforceable according to their pre-defined terms, corporate law disciplines its actors through ex post devices: the law of corporate purpose, equitable remedies, and fiduciary duties. Corporate law’s non-contractual nature thus encourages innovation, entrepreneurship, and risk-taking, while keeping corporations and their fiduciaries within enforceable legal constraints. The majority of corporate law cases are variations on this basic theme: freedom of action, combined with ex post enforcement to remedy and deter wrongdoing. What corporations can do is open-ended and permissive; corporate law itself is not. If there is anything remotely approaching an act of “consent” by corporations and shareholders, it is to enter the structure of corporate law, where they are protected by these non-contractual devices.
This Article has shown that the legal realist-inspired “contract” metaphor cannot substitute for a serious, methodical analysis of what corporate law is, what makes it distinct from other legal frameworks, and how its unique building blocks support economic progress and innovation in modern society. Facing the specter of mandatory arbitration, even economically-minded scholars should pay attention to the legal taxonomies upon which the future of corporate governance hinges. Following the developments examined in this Article, federal courts may soon be asked to decide whether to allow corporate law actors to place themselves beyond the reach of enforceable law, through the use of mandatory arbitration clauses. According to the Federal Arbitration Act and the Supreme Court’s precedents—combined with the diverging, almost polar, concepts of corporation and contract under state law—there is no basis for doing so. If we accept that it is possible for some legal concepts to not be contracts (which even the most market-oriented lawmakers and scholars would admit), then corporate law, and the instruments it gives rise to—corporate charters and bylaws—top that list.