Delaware Law Requires Directors to Manage the Corporation for the Benefit of its Stockholders and the Absurdity of Denying It

In a new article posted on SSRN and forthcoming in the Journal of Corporation Law, I address what I take to be a minor intellectual scandal. To wit, for decades, eminent law professors have been publishing scholarly articles claiming that Delaware law permits directors to promote the interests of non-stockholder constituencies even if doing so harms stockholders in the long term (or, at least, that Delaware law is unclear on whether directors may do this). But as all competent Delaware lawyers know, and as numerous scholars have pointed out, this is clearly wrong. In Delaware, the standard of conduct requires that, in making a business decision, directors act for the purpose of promoting the value of the corporation for the benefit of the stockholders in the long term and for no other purpose. The Delaware Supreme Court and the Delaware Court of Chancery have said this so often, so consistently and so clearly (and leading treatises on Delaware law so plainly confirm the point) that any lawyer who advised a client otherwise would undoubtedly be committing legal malpractice.

But these scholars’ misreading of the law is even more egregious than this suggests. It involves no ordinary sort of malpractice, for the cases these scholars are misreading include the most famous cases in the history of corporate law: Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), and Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). Both cases clearly and expressly hold that directors are required to manage the corporation for the benefit of the stockholders, but, astonishingly, these scholars claim that the cases say exactly the opposite. Indeed, they routinely say that Unocal held that directors may consider the interests of other corporate constituencies, even to the long-term detriment of the stockholders, and that Revlon limited this holding only by prohibiting the consideration of non-stockholder constituencies in change-of-control contexts. Both of these propositions, it must be said, are preposterous.

In truth, the Delaware Supreme Court stated in Unocal that it begins its analysis from “the basic principle that corporate directors have a fiduciary duty to act in the best interests of the corporation’s stockholders.” 493 A.2d at 955. The court did go on to say that, in responding to a takeover proposal, directors may consider “the impact on ‘constituencies’ other than shareholders (i.e., creditors, customers, employees, and perhaps even the community generally),” but, given what the court had just said about directors having a fiduciary duty to act in the best interests of the stockholders, this language could never reasonably have been interpreted to mean anything other than the traditional rule that directors may consider the interests of non-stockholder constituencies instrumentally in relation to the end of benefiting stockholders in the long term—i.e., that directors may direct value to non-stockholder constituencies for the purpose of capturing net benefits to stockholders in the long term. In fact, we know for sure that this is what the language in Unocal means because, just six months after deciding Unocal, the Delaware Supreme Court took the Revlon case in part because it wanted to “address for the first time the extent to which a corporation may consider the impact of a takeover threat on constituencies other than shareholders.” 506 A.2d at 176. When it reached that issue, the court said,

The Revlon board argued that … Unocal permits consideration of other corporate constituencies. Although such considerations may be permissible, there are fundamental limitations upon that prerogative. A board may have regard for various constituencies in discharging its responsibilities, provided there are rationally related benefits accruing to the stockholders. Unocal, 493 A.2d at 955.

506 A.2d at 182. This is the general rule, and it goes back to the very dawn of modern corporate law in the nineteenth century. Revlon, of course, articulated an exception to the rule applicable in change-of-control contexts. Thus, the court continued,

However, such concern for non-stockholder interests is inappropriate when an auction among active bidders is in progress, and the object no longer is to protect or maintain the corporate enterprise but to sell it to the highest bidder.

Id. Consequently, Revlon absolutely excludes a stakeholder interpretation of Unocal, a fact that was publicly acknowledged by Revlon’s counsel after the case was decided and that was widely discussed by scholars and practitioners at the time. Furthermore, in subsequent cases, such as Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1282 n.29 (Del. 1989), the Delaware Supreme Court has been careful to quote the language from Unocal about other constituencies only in connection with the interpretation of that language from Revlon. Thus, any lawyer who reads Unocal as permitting directors to consider the interests of non-stockholder constituencies except as definitively interpreted in Revlon (i.e., instrumentally towards to end of benefiting stockholders) misreads the law in a grossly incompetent fashion. It is a misreading that would be inexcusable for a law student, that ought to get a first-year associate fired, and that would again amount to clear legal malpractice.

Moreover, these principles were not new in Delaware law when the Delaware Supreme Court decided Unocal and Revlon. On the contrary, the Court of Chancery had already stated them in Kelly v. Bell, 254 A.2d 62, 64 (Del. Ch. 1969), aff’d 266 A.2d 878 (Del. 1970), and in Theodora Holding Corp. v. Henderson, 257 A.2d 398 (Del. Ch. 1969). After Unocal and Revlon, the Delaware Supreme Court repeated and reaffirmed them in Mills Acquisition, as noted above, and in Malone v. Brincat, 722 A.2d 5 (Del. 1998), and N. Am. Cath. Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007). The Court of Chancery has done likewise in Katz v. Oak Indus., Inc., 508 A.2d 873 (Del. Ch. 1986), TW Servs., Inc. v. SWT Acquisition Corp., No. 10427, 1989 WL 20290 (Del. Ch. Mar. 2, 1989), In re Toys “R” Us, Inc. S’holder Litig., 877 A.2d 975 (Del. Ch. 2005), eBay Domestic Holdings, Inc. v. Newmark, 16 A.3d 1 (Del. Ch. 2010), In re Trados Inc. S’holder Litig., 73 A.3d 17 (Del. Ch. 2013), In re Rural Metro Corp. S’holders Litig., 88 A.3d 54 (Del. Ch. 2014), Frederick Hsu Living Tr. v. ODN Holding Corp., No. 12108, 2017 WL 1437308 (Del. Ch. Apr. 25, 2017), and other cases. The Delaware judges who have expressly affirmed these principles in their opinions include Chancellor Duffy, Chancellor Marvel, Justice Moore, Chancellor Allen, Justice Holland, Chief Justice Strine, Chancellor Chandler, Vice Chancellor Laster, Vice Chancellor Slights, and Vice Chancellor Zurn.

Even more, these principles are fundamental principles of equity that have animated corporate law since its very beginnings in the early nineteenth century when courts of equity, in both America and England, first asserted jurisdiction over corporate directors. Indeed, the very reason that courts of equity asserted such jurisdiction was that equity has always recognized that, when some persons entrust their property to the management of others, those entrusted with the property are, in managing the property entrusted to them, required by equity to pursue no ends other than benefiting those who entrusted them with the property in the first place. Thus, whether corporate directors were analogized to trustees or to agents, courts of equity imposed on directors a fiduciary duty to manage the corporation for the benefit of the stockholders. Courts have been explicit about this principle of equity for as long as there has been such a thing as corporate law. Hence, in Dodge v. Woolsey, 59 U.S. 331 (1855), the U.S. Supreme Court expressly held that directors must manage the corporation to benefit the stockholders, and in Taunton v. Royal Ins. Co., (1864) 71 Eng. Rep. 413, and Hampson v. Price’s Patent Candle Co., [1876] 34 LT 711,  English courts held that directors may consider the interests of non-stockholder constituencies such as customers or employees, but they may consider these interests only instrumentally as a means to the end of benefiting stockholders. Most remarkably, in Hutton v. W. Cork Ry. Co. [1883] 23 Ch D 654, another English court held that, while such instrumental consideration of other constituencies is permissible when the business is a going concern, it becomes impermissible when the company ceases to be a going concern and is winding up its business, thus fully anticipating the Delaware Supreme Court’s holding in Revlon more than a hundred years later. Early corporate law treatises cite these and similar cases and explain the law in accordance with their holdings. Long before Dodge v. Ford Motor Co., 170 N.W. 668 (Mich. 1919), therefore, the rule that directors must manage the corporation for the benefit of its stockholders was blackletter law. Unsurprisingly, Delaware judges were aware of these cases, and Chancellor Duffy even cited Hutton in Kelly v. Bell.

Given all this, how is it that so many eminent law professors fail to recognize what are probably the most fundamental principles not only of Delaware law but of corporate law generally? The answer, I suggest, is that while these legal principles have long been settled beyond any reasonable dispute, they also play a part in a much wider and decidedly unsettled controversy about the proper role of corporations in society. This wider controversy concerns not what the law is but what it ought to be. It is a normative controversy in political economy—and very often a political controversy as well. Nowadays, it is common to think of the contending sides in this debate as being those who favor the shareholder model of corporate governance (i.e., the view that corporations should be run for the benefit of their shareholders) and those who favor the stakeholder model of corporate governance (i.e., the view that corporations should be run for the benefit of all corporate constituencies, even when this sometimes works to the ultimate detriment of shareholders), but in various forms the debate has been going on for a very long time. Much older than the Berle-Dodd exchange in the Harvard Law Review for 1932, the controversy goes back at least as far as Adam Smith and The Wealth of Nations in 1776.

This brings us to the key point: it is extremely inconvenient for anyone who favors the stakeholder model that implementing that model is illegal in the corporate law jurisdiction that matters most (many would say, the only jurisdiction that matters at all). The honest way of dealing with this problem, of course, is to admit that Delaware law prohibits the stakeholder model and then argue that Delaware law should be changed. Such a course is surely possible, for, as everyone involved in corporate governance knows, most states have passed statutes that, in some form or other, license the stakeholder model. Still, human nature being what it is, there is another way of dealing with inconvenient realities, a way that, cynics would say, is the more common way when, as here, the question tends to become political and could affect the allocation of power and money in society. In controversies of this kind, individuals may succumb to the temptations of motivated reasoning, and standards of argumentation tend to collapse. Indeed, as Princess Ida says, although narrow-minded pedants believe that two and two make four, she can prove that “two and two make five—or three—or seven . . . if the case demands.” The absurdity of saying that Delaware law does not require directors to maximize value for shareholders is not as great as that of saying two and two make five or three or seven, but it is close, and just as Princess Ida could rewrite the laws of arithmetic to obtain the result she desired, so too might a motivated advocate rewrite the laws of Delaware for a similar reason.

But is this really why so many eminent law professors so badly misread Delaware law? The explanation verges on suggesting these scholars are being dishonest, and I utterly reject such an odious explanation. I refuse to believe any scholar would engage in such tactics, and, in this case, the abilities and integrity of individuals involved conclusively rule out any such possibility. Having no other explanation to offer, however, I conclude that the matter is a mystery and cannot be explained, and what cannot be explained must be passed over in silence.

The complete article is available here on SSRN.