d'attorre

home / Archivio / Fascicolo / Duty of obedience: the forgotten duty of U.S. Corporate Law

indietro stampa articolo indice fascicolo leggi articolo leggi fascicolo


Duty of obedience: the forgotten duty of U.S. Corporate Law

Alan R. Palmiter

PAROLE CHIAVE: USA - diritto societario - societÓ

Sommario:

- I. Duty of obedience in the u.s. for-profit corporation - A. Original Duty of Obedience (Corollary to Ultra Vires Doctrine) - B. Abandonment of the Duty of Obedience (Along with Ultra Vires Doctrine) - C. Revival of the Implicit Duty of Obedience (and Ultra Vires Doctrine) - II. Duty of obedience in the U.S. non-profit corporation - A. Scope of Non-Profit Duty of Obedience - B. Survival of Obedience Duty in an Age of Non-Profit Adaptability - III. Revival of explicit duty of obedience in the U.S. for-profit corporation - A. Obedience to Internal Corporate Norms - B. Obedience to Non-Corporate Legal Norms - C. Effect of Disobedience (Fashioning Internal Corporate Remedies) - IV. Conclusion - NOTE


Directors and officers of for-profit corporations in the United States are said to owe two duties to the corporation: care and loyalty. But not so long ago, they also owed the corporation a “duty of obedience”. This third duty, now largely forgotten, compelled corporate fiduciaries to abide by legal norms – both those of the corporation and of external law. In this essay, I assert that U.S. corporate law would do well to revive a “duty of obedience” – and may actually be in the process of doing so. Explicit recognition of such a duty would extend the corporate purpose beyond maximizing shareholder wealth and thus advance the legitimacy of the corporation in society. Moreover, such a duty would recognize that the duties of care and loyalty are incomplete. Corporate actions that violate legal norms, even when those actions are approved by diligent and selfless directors, are inconsistent with fundamental expectations of corporate conduct 1. Recognition and development of an obedience duty would resolve much of the confusion engendered by the “duty of good faith” – a confusion that has engendered much attention 2. Introducing an obedience duty into the corporate fiduciary lexicon would offer a clearer vocabulary for those who counsel corporate fiduciaries about their duties to abide by legal norms. It would provide a principled basis for the judicial review of internal corporate controls and corporate [continua ..]

» Per l'intero contenuto effettuare il login inizio


I. Duty of obedience in the u.s. for-profit corporation

A duty of obedience once occupied an established place in the U.S. for-profit corporation. In his magisterial treatise on corporate law, Ballantine declared in 1946 that even before owing duties of care and loyalty to the corporation: “Directors owe a threefold duty to the corporation. First they must be obedient” 11. More recently, looking back at the fundamental aspects of U.S. corporate law, a federal court described the fiduciary duty triumvirate as follows: The duty of obedience requires a director to avoid committing ultra vires acts, i.e., acts beyond the scope of the authority of the corporation as defined by its articles of incorporation or the laws of the state of incorporation .... The duty of loyalty dictates that a director must act in good faith and must not allow his personal interests to prevail over the interests of the corporation .... The duty of due care requires that a director must handle his corporate duties with such care as an ordinarily prudent man would use under similar circumstances 12. The duty of obedience served mostly as a natural corollary to the ultra vires doctrine. Just as the corporation was prevented from acting beyond its powers, corporate actors were obligated not to perpetrate such actions – and could be held liable if they did 13. Although instances of personal liability appear to have been few, the threat was real. Corporations, from the beginning and still today, are to engage only in [continua ..]

» Per l'intero contenuto effettuare il login inizio


A. Original Duty of Obedience (Corollary to Ultra Vires Doctrine)

Corporate law in the United States began as the regulation of corporate powers. Most early corporate law cases turned on whether the corporation was exercising its powers according to the governing statute and its corporate charter. Most early corporate law treatises devote themselves extensively to questions of ultra vires. In its heyday at the turn of the last century, the ultra vires doctrine provided umbrage for shareholders who sought protection from management excess – whether for acts beyond the power given to the corporation, acts that were illegal, or acts that exceeded the authority conferred by shareholders 21. For example, corporate waste – corporate expenditures lacking business justification – was treated as exceeded power, not failed duty 22. Importantly, the ultra vires doctrine supplied a tool for ensuring corporate compliance with non-corporate norms. Arguing for the revival of the ultra vires doctrine, Professor Greenfield has pointed out: During the height of the ultra vires doctrine, a corporation’s illegal activities were considered a subset of the larger category of ultra vires activities. In no sense were corporations considered as having the authority to perform illegal activities, even when performed to advance the interest of the firm 23. A commonly cited example of the application of the ultra vires doctrine – and its corollary duty to obey non-corporate norms – is the 1909 case of Roth [continua ..]

» Per l'intero contenuto effettuare il login inizio


B. Abandonment of the Duty of Obedience (Along with Ultra Vires Doctrine)

But then a subtle shift began in corporate law. Instead of talking about directors being personally liable for their unauthorized actions, treatise authors began to talk about the liability of directors for failures to act responsibly – a switch from power to duty. For example, a turn-of-the-century treatise declared that if directors “attempt to act beyond their powers, they may be liable to the corporation for mismanagement” 27. Another leading treatise marked the evolution away from power, observing in 1894, “no one can state with confidence what the law on the subject of the ultra vires doctrine is at the present time, still less predict what it will be in the near future” 28. In 1927, the same treatise would conclude that the liability of directors for ultra vires acts is grounded on “violation of authority, or neglect of duty” 29. In 1946, Ballantine concluded that the duty of obedience was losing its force, explaining that, although directors and officers were liable for exceeding charter limitations on their authority, “the better view” is that they are not liable for damages if their excess was “in good faith, without negligence on their part, or if they acted with the consent of the shareholders” 30. The language of power had been supplanted by that of duty 31. Knepper’s treatise of 1974, while continuing to echo the existence of a triumvirate of corporate fiduciary [continua ..]

» Per l'intero contenuto effettuare il login inizio


C. Revival of the Implicit Duty of Obedience (and Ultra Vires Doctrine)

The privatization of the corporation failed. The corporate law command that corporate actors must ensure corporate compliance with internal and external legal norms is again well-established 45. Not only have courts returned to the ultra vires doctrine to invalidate management power grabs – such as dead-hand poison pills and backdated options – they have made that clear corporate actors are bound to ensure compliance with non-corporate legal norms. Corporate statutes also make clear that corporate illegality finds no comfort under corporate law. For example, exculpation provisions in Delaware corporations cannot absolve directors from personal liability for “a knowing violation of law” 46. A revival of the ultra vires doctrine – and implicitly the duty of obedience – has come as corporate actors have tested the outer limits of managerial power. Recent cases limiting the power of the board to disenfranchise shareholders have used the language of management power, as well as that of fiduciary duty 47. Likewise, courts looking at backdated options have chastised directors for both breaching their duties of loyalty and disregarding stated plan limits 48. Implicit in both lines of cases is the notion that corporate actors are bound to follow internal corporate norms. Respect for internal corporate norms also undergirds the “reasonable expectations” doctrine in the close corporation 49. The [continua ..]

» Per l'intero contenuto effettuare il login inizio


II. Duty of obedience in the U.S. non-profit corporation

The duty of obedience has a clearer and more-established pedigree in the U.S. non-­profit corporation. It is regularly mentioned as a fundamental aspect of non-profit trusteeship, along with the duties of care and loyalty. The legal non-profit literature devotes a good deal of attention to its contours and its place in non-profit law 57. Court cases apply the obedience duty to require non-profit actors ensure compliance with the non-profit’s mission, donative restrictions and tax requirements 58. This is not surprising. The U.S. non-profit corporation exists to serve social purposes, as embodied in both internal and external norms 59. Compliance with these norms is not only central to the legitimacy of the non-profit corporation, but frames the duties imposed on its actors. The non-profit vocabulary of “mission” and “trusteeship” suggests the degree of obedience that non-profit fiduciaries owe to the organization and the space it occupies 60.

» Per l'intero contenuto effettuare il login inizio


A. Scope of Non-Profit Duty of Obedience

The leading textbook on non-profit law explains that non-profit trustees have a duty “to carry out the purposes of the organization as expressed in the articles or certificate of incorporation” 61. The duty has been summarized as mandating that the board refrain from transactions and activities that are ultra vires, that is, beyond the corporation’s powers and purposes as expressed in its certificate of incorporation …. Thus, the director must follow the purposes and powers expressed in the governing legal documents 62. The obedience duty therefore tracks and reinforces the non-profit’s mission – “to act with fidelity, within the bounds of the law generally, to the organization’s ‘mission” 63. Commentators have also pointed out that, beyond complying with internal norms, non-profit fiduciaries also must ensure the non-profit complies with external legal regimes “ranging from federal and state tax laws, civil rights statutes, and antitrust laws which affect all organizations” 64. The consequences of non-compliance by non-profit directors may be even more onerous than for their for-profit brethren: A non-profit fiduciary can be held responsible if an organization violates the law. For example, a director or officer is liable for a corporation’s failure to pay taxes if she meets the Internal Revenue Code’s definition of “responsible person” and the failure to [continua ..]

» Per l'intero contenuto effettuare il login inizio


B. Survival of Obedience Duty in an Age of Non-Profit Adaptability

The privatization movement has also seeped into the non-profit corporate world. Just as the for-profit corporation is seen as a private adaptation to the business, financial, and legal landscapes in which it operates, the non-profit corporation has come under pressure to get with the times. Old missions must be updated, dead hands must be buried, and non-profit fiduciaries must focus on the bottom line. As a recent treatise author has explained: To the extent the duty of obedience does not carry with it a duty to assure that the trust is meeting contemporaneous needs, it does not set forth an appropriate standard 71. Thus, the duty of obedience has come under attack for limiting non-profit adaptability. The Revised Model Nonprofit Corporation Act (RMNCA), for example, does not recognize the duty of obedience in the non-profit corporation, apparently to create symmetry with its for-profit cousin 72. But rather than deny the existence of a duty to comply with legal norms – the tack taken by the ALI Principles for for-profit corporations – the RMNCA assumes the duty of obedience is subsumed in the duties of care and loyalty 73. This conflation has both rhetorical and normative significance. By conflating obedience with care and loyalty, non-profit fiduciaries are told that diligence and personal fidelity are all that is expected of them 74. Removing obedience from the named triumvirate makes compliance with internal and external norms easier [continua ..]

» Per l'intero contenuto effettuare il login inizio


III. Revival of explicit duty of obedience in the U.S. for-profit corporation

Does a duty of obedience in the U.S. for-profit corporation make sense? At one level, the question is beside the point given that corporate law already recognizes an implicit duty of corporate actors to comply with internal and external legal norms. More relevant are two other questions: first, should corporate law formally recognize such a duty and, second, how should its contours be defined? To begin this inquiry, it is useful to cast the duty of obedience in clearer relief. The following diagram identifies the triumvirate of fiduciary duties and their overlapping coverage, using a handful of canonical U.S. corporate law cases to illustrate their operation.   (IMMAGINE)   Cases involving violations of corporate fiduciary duties: Care only:Smith v. Van Gorkom (Del. 1985) – violation of duty of due care (gross negligence) by directors for failing to become informed about company’s value in a cash-out merger 81. Care/loyalty:Litwin v. Allen (Sup. Ct. N.Y. County 1940) – violation of duty of care (taking on too much risk) by bank directors for approving financial transaction with corporation having conflicting ties to bank’s parent 82. Loyalty only:Globe Woolen Co. v. Utica Gas & Elec. Co. (NY 1918) – violation of duty of loyalty by director who failed to inform fellow directors of risk to the corporation in entering into self-dealing transaction with director 83. Care/obedience:McCall v. [continua ..]

» Per l'intero contenuto effettuare il login inizio


A. Obedience to Internal Corporate Norms

As the ultra vires doctrine has been rediscovered, in a more subtle and textured form, so too its implicit duty of obedience. Courts speak about the limits on the power of directors to adopt takeover defenses that undercut shareholder rights – such as dead-hand poison pills and supermajority voting requirements 89. And, hand in hand, directors bear a duty not to adopt such defenses. Likewise, as corporate governance has shifted from conduct-based to disclosure-based regulation, corporate disclosures define new templates of corporate power. Courts again speak about the limits of management power when norms implicit in disclosure documents are violated – such as backdated options and other option grants 90. And directors bear a duty not to permit such power excesses. Although the line between limits imposed by power boundaries and those imposed by fiduciary duties is sometimes blurred, recent cases make clear that the ultra vires doctrine is still alive as an admonition to follow corporate statutes and corporate-specific guidelines 91. And where directors stray from the template for corporate powers, there is reason (and a long tradition) for corporate law to address not only the corporation, but also its actors. Although not yet openly tested, the duty of obedience to comply with internal corporate norms waits in the wings not only to mandate a corporate outcome (through declaratory or injunctive action), but also to impose personal liability on [continua ..]

» Per l'intero contenuto effettuare il login inizio


B. Obedience to Non-Corporate Legal Norms

Here, the duty of obedience is called on to do yeoman’s work. The ultra vires doctrine and its duty of obedience were primarily seen as means to limit the corporation to those activities envisioned first by the legislature and later by shareholders – an internal function. Although the classic doctrine makes passing references to compliance with non-corporate legal norms, this was not the original function of the duty of obedience. Perhaps, as some have argued, extending the obedience duty to non-corporate legal norms goes too far 93. The duty of obedience perhaps should be understood only to reach compliance with internal corporate norms, such as statutory restrictions or limits in the articles of incorporation. There are many problems with this argument. For one, times have changed. Modern corporate law has moved ineluctably beyond an internal ultra vires doctrine to one that also covers the corporation’s obligation to comply with law – that is, one that addresses corporate externalities. As the ultra vires doctrine has lost its central role in controlling internal conflicts, recognition of the corporation’s moral obligation to comply with law has become firmly established. That is, while the doctrine has lost its preeminence, the obedience duty has grown into a powerful (if unstated) premise of the modern corporation. The obedience duty as fashioned by Delaware courts (and confirmed in Sarbanes-Oxley) reaches well beyond internal [continua ..]

» Per l'intero contenuto effettuare il login inizio


C. Effect of Disobedience (Fashioning Internal Corporate Remedies)

Corporations invariably violate the law. Should corporate actors be personally liable for allowing the corporation to violate internal and external norms? The answer, thus far, has been almost uniformly no. Although judicial rhetoric that directors are obligated to ensure corporate compliance is common, personal liability is the great exception – if not wholly absent. It is a big step from saying that corporate actors are bound to ensure corporate compliance to saying they should face personal liability for failing to remain watchful and rein in corporate illegality. For this reason, perhaps, Delaware has avoided mention of an obedience duty out of a concern of explicitly making corporate actors responsible for compliance with non-corporate norms. After all, it’s a delicate balancing job to ensure the legitimacy of the Delaware corporation, while limiting the responsibility of Delaware corporate actors. A duty of obedience even in the context of non-corporate legal norms, however, need not imply personal liability for organizational illegality. As the Delaware courts have made clear, personal liability can attach only when (even selfless) corporate actors “consciously disregard” their duties, including their duty to monitor corporate illegality 102. This would seem an acceptable compromise. So like the duty of care, the duty of obedience may best be seen as largely aspirational. Just as corporate law calls on directors to be informed [continua ..]

» Per l'intero contenuto effettuare il login inizio


IV. Conclusion

The duty of obedience, once a recognized element of the for-profit corporate landscape, continues to have aspirational and normative meaning. Whether in cases applying the ultra vires doctrine to board decisions that stray beyond internal corporate norms, statutory mandates of internal controls, or articles that exculpate directors except for knowing violations of law, the duty of corporate actors to ensure legal compliance by the for-profit corporation is imbedded in corporate law. Compliance with internal corporate norms and external legal requirements is central to the legitimacy of the corporation. So why has the duty of obedience, as such, vanished from the corporate lexicon? One explanation is that its original and principal function as a liability corollary to the ultra vires doctrine disappeared with the demise of the full-blown ultra vires doctrine. As the corporation has come to be accepted as an open-ended enterprise and questions of corporate power have been displaced by questions of fiduciary duty, the need for obedience-based liability dissolved. Another explanation for the disappearance of obedience may come from the (temporary) rise of the theory of the corporation as a “private contract” between investors and managers. As such, corporate actors should owe no duties (beyond those specifically imposed upon them by law) to ensure corporate compliance with legal norms. But over the past two decades, a host of criminal sentencing guidelines, [continua ..]

» Per l'intero contenuto effettuare il login inizio


NOTE

» Per l'intero contenuto effettuare il login inizio