Creditors and Other Non-Shareholder Constituencies | Holger Spamann | August 17, 2013


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Creditors and Other Non-Shareholder Constituencies

by Holger Spamann Show/Hide

So far, we have been discussing the relationships between boards (managers) and shareholders, and between majority (controlling) shareholders and minority shareholders. We now broaden our horizon and consider other constituencies, such as creditors, workers, and consumers.

The Corporation as a Nexus of Contracts

You might think that non-shareholder constituencies are fundamentally different because they are “outsiders” to the corporation, while shareholders (and boards) are “insiders.” But this is misleading, at least in large publicly held corporations. Most investors in these corporations are “outsiders” no matter how they invest, be it through debt or equity. In fact, from most investors’ and the controller’s (founder’s) point of view, debt and equity are largely interchangeable as investment vehicles, and the choice between them hinges on details of cash flow and control rights, rather than on any notion of inside/outside.

One frequently hears that shareholders are the corporation’s “owners,” while other constituencies are “merely” contracting partners. This may contain some truth for small businesses, but it is clearly not true for large businesses. In the technical legal sense of the term, shareholders only own their shares, not the corporation. In the functional sense, shareholders lack the control rights that one generally associates with ownership. Obviously, individual shareholders cannot deal with corporate property as they please. And at least in Delaware, shareholders cannot even make decisions about corporate property collectively, since business decisions are the prerogative of the board (cf. DGCL 141(a)). As to replacing the board, this is difficult for dispersed shareholders in practice, as we have seen. In fact, shareholders may not even have the legal right to replace the board, or any other meaningful control rights. For example, the dual class share structure in Google and Facebook gives the founders full control of their corporations even though they have sold off most of the equity.

The better, modern view is that the corporation is simply a nexus of contracts (and other obligations). In this view, many different constituents transact with one another through the corporate form. In addition to managers and shareholders, these constituents include creditors, workers, customers, suppliers, and others. Corporate law’s goal is to facilitate their transactions, not to defend ostensible ownership rights. In this view, shareholders are not special — at least in principle.

Shareholder Primacy?

This is not to say that the law should not, or does not, treat shareholders differently for pragmatic reasons. In fact, as you have probably already guessed and we will now confirm, corporate law is almost exclusively concerned with the relationships between shareholders and boards, and between shareholders themselves.

Corporate Law vs. The Laws Governing Corporations

To be sure, for the most part, this is mere nomenclature. Many legal rules govern relationships between corporations and other constituencies. It’s just that we group these rules under different headings: “labor and employment law,” “consumer law,” “antitrust,” “contract law,” etc. In this perspective, corporate law is merely the name we give to those legal rules that specifically deal with “internal governance” — the misleading term (see above) for relationships between shareholders and boards, and between shareholders themselves. By definition then, this “area of law” does not deal with other constituencies. But this is without substantive content.

Fiduciary Duties

The substantive question is the content of corporate fiduciary duties. Corporate directors and officers obviously have to comply with all the laws protecting other constituencies (cf. DGCL 102(b)(7)(ii))). In exercising their remaining discretion, however, can or must they take into account the interests of all affected? Or must they act solely for shareholders’ benefit?

Delaware law: fiduciary duties to whom?

As we have already glimpsed in Revlon and will now see very clearly in Gheewalla and eBay, directors and officers of Delaware corporations owe fiduciary duties only to common stockholders. To be sure, Delaware courts continue to assert that corporate fiduciaries owe their duties “to the corporation and its shareholders.” But when the rubber hits the road, recent Delaware decisions have opted for shareholders. This is often dubbed “shareholder primacy” — the idea that, within the boundaries of contracts and regulations, corporations are to be run for the benefit of shareholders alone.

The competing “stakeholder model” suggests that boards should and do manage corporations for the benefit of all their stakeholders. As a matter of positive law, proponents interpret the words “to the corporation and its shareholders” (emphasis added) as shorthand for their broader view of fiduciary duties. This interpretation sounds sensible, for what else would the words “to the corporation” mean? Then again, the Delaware courts don’t see it that way (see previous paragraph).

In 2013, the Delaware General Assembly dealt a further blow to the stakeholder model by amending the DGCL to add a new “Subchapter XV. Public Benefit Corporations.” The new DGCL 362(a) explicitly provides:

“A ‘public benefit corporation’ is a for-profit corporation organized under and subject to the requirements of this chapter that is intended to produce a public benefit or public benefits and to operate in a responsible and sustainable manner. To that end, a public benefit corporation shall be managed in a manner that balances the stockholders' pecuniary interests, the best interests of those materially affected by the corporation's conduct, and the public benefit or public benefits identified in its certificate of incorporation. In the certificate of incorporation, a public benefit corporation shall … [s]tate within its heading that it is a public benefit corporation.”

Thus, corporations organized for a public benefit are clearly distinct from standard Delaware corporations under the DGCL. This strongly suggests that standard Delaware corporations are not to be managed for the public benefit.

Practical relevance?

In normal times, these debates are almost entirely irrelevant from a purely legal point of view. The reason is the lenient standard of review for normal board decisions (i.e., the duty of care). As you already know, the business judgment rule gives boards almost unfettered discretion. Consequently, for a very long time, there was only one reported case where “shareholder primacy” mattered, and of course, everyone cited this one case.

The case is Dodge v. Ford Motor Co. (Mich. 1919). Henry Ford took the stand and argued that the Ford Motor Company did not pay dividends because it needed the money to benefit its workers and customers. In truth, Ford probably just wanted to avoid paying out money to his minority stockholders the Dodge brothers, who had by then become his competitors. In any event, the court held against Ford, on the grounds that “A business corporation is organized and carried on primarily for the profit of the stockholders.” But Ford almost certainly would have won if he had argued that the company needed the cash for future investment or some other business purpose.

There are, however, two ways in which the debate does matter. First, the legal rule probably matters directly in the sale of the company. This is because in this “end game” situation, conflicts between constituencies become very visible. The board can no longer hide behind “long-term shareholder interest” to justify some action that directly benefits a non-shareholder constituency. Cf. the passage on non-shareholder constituencies in Revlon, and watch out for the kind of very nasty things corporate managers are allowed to do to creditors in MetLife v. RJR Nabisco.

Second, the legal rule may matter inasmuch as it guides the behavior of honest, faithful fiduciaries — to the extent it influences “board room culture,” if you will. A director may genuinely care about whether she is legally bound to benefit only shareholders or stakeholders as a whole. Thus, she may vote differently depending on what her legal advisors tell her about the content of fiduciary duties. That these fiduciary duties are not enforceable in court may be irrelevant.

Normative considerations
The right goal vs. an achievable goal

To the extent that the content of fiduciary duties does matter and works literally as intended, it is clearly bad. By definition, maximizing the interests of one group only (common shareholders) generates less social welfare than maximizing the interests of all groups combined. Ex ante, this harms even the favored group, because it will have to make concessions on other points to obtain the collaboration of the other constituencies. Since the pie is smaller (because the law doesn’t maximize it), there will be less for everyone to share.

For example, taken at face value, In re Trados Inc. Shareholder Litigation (Del. Ch. 2013) would force boards of insolvent corporations to bet the corporation’s last cash at the casino (or embark on some similarly risky, negative net present value project). For without the gamble, common stockholders get nothing. With the gamble, there is a chance that the board will win and shareholders get something. To be sure, the gamble is bad for all stakeholders combined, i.e., once creditors and preferred stockholders are included: on average, casino gamblers lose. But Trados claims that boards should work only for common stockholders. Ex ante, this rule is bad even for the common stockholders: to obtain investments from creditors etc., they will have to make other promises that compensate creditors for their anticipated losses from gambling.

Shareholder primacy advocates do not deny the conceptual validity of the preceding argument. They merely question its practical relevance on two complementary grounds. Firstly, they point out that various legal rules and in particular contracts restrict the ability of boards to favor shareholders at the expense of other constituencies. Secondly, they question if there could be any legal oversight over boards if boards were charged with maximizing the interests of all stakeholders. What are those “interests,” and what actions maximize them? It’s hard enough to figure out, e.g., what action maximizes the share price (under Revlon’s deceptively simple maxim of getting the highest price). Shareholder primacy advocates fear that stakeholder interests are so diffuse that they will always provide a pretext for managers to favor themselves. In this view, being accountable to everyone in theory means being accountable to no one in practice.

Framing corporate law: two perspectives

Importantly, no serious commentator argues that shareholders are the only people who matter in the grand scheme of things, workers etc. be damned. Rather, the disagreement is about the method of getting the best collective outcome. The debate between shareholder primacy and stakeholder models is thus closely related to the framing of the main conflict surrounding corporations. Which is the worse problem: (1) unfaithful managers wasting (mostly) shareholders’ money, or (2) shareholders and their faithful managers exploiting other constituencies?

In favor of shareholder primacy, commentators argue that shareholders have no legal means beyond fiduciary duties to get any of their money back. They have no right to dividends, or to withdraw their principal investment. By contrast, creditors (including, e.g., workers as wage claimants) have contractually specified payment rights, and the corporation must file for bankruptcy if it does not fulfill these obligations. Moreover, many other constituencies can withdraw or withhold their contribution if the corporation does not keep to its bargain: workers can move to a different job, customers can buy from different providers, etc. By contrast, shareholders part with their equity investment up front and do not get it back unless the board in its discretion decides to make a distribution. Importantly, this feature is arguably essential to equity as the most flexible form of financing.

Against this, proponents of the stakeholder model argue that shareholders in fact already have strong protection, namely their right to elect the board. No board would completely disregard shareholder wishes, or else it would be fired. There is, therefore, a tendency for boards to favor shareholders at the expense of everybody else, or so the argument goes, and fiduciary duties should at least not exacerbate this tendency. Moreover, the argument that laws other than corporate law sufficiently protect other constituencies is circular and defective to the extent that corporations in fact shape those other laws through lobbying. (To this latter argument, shareholder primacy proponents reply that this is a much broader problem of deficient rules on political spending and lobbying. You should keep this connection in mind when reading Citizens United later in the course.)

The big (comparative) picture

In this connection, it is worth pointing out that some countries push the stakeholder model considerably further in large corporations. They mandate that workers elect part of the board (so-called co-determination in Germany and many other Northern and Central European countries), or that the board be self-perpetuating (Netherlands). In this comparative perspective, U.S. corporate law heavily leans towards shareholder primacy, both normatively and factually, because only common shareholders elect the board in U.S. corporations.

To be sure, shareholder governance is merely the U.S. default. The charter may give board seats to other constituencies. (For example, preferred stockholders nominated the majority of the board of Trados Inc. in the aforementioned Trados case.) That so few large corporations adopt such alternative arrangements may provide some clues about their desirability. But this is an even deeper question that we must postpone until we have encountered some more concrete scenarios.


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  1. 1 Show/Hide More Creditors
    Original Creator: Holger Spamann

    We begin with creditors because (1) creditors are the only constituency that still has some remnants of protections in corporate law, and (2) most other claims ultimately resolve into damages or other financial claims, transforming all constituencies into creditors at the end of the day.

    Gheewalla sets forth the principle that creditors cannot invoke the protections of fiduciary duties against corporate directors (although they may occasionally have standing to enforce a derivative claim on behalf of the corporation). MetLife v. RJR Nabisco declines to protect the plaintiff-creditor under a contractual implied duty of good faith and fair dealing. The bottom line is that creditors have to rely on contractual protections. The MetLife decision reviews many customary protective clauses.

    Do you find the courts' reasonings convincing?

    1. 1.1 Show/Hide More NACEPF v. Gheewalla (Del. 2007)
      Original Creator: Holger Spamann

      The decision addresses, and you should look out for, two related but separate questions:

      1. Who has standing to assert a fiduciary duty claim?
      2. Whom is the fiduciary duty owed to, i.e., whose interests does it protect?

      How might the answer to the second question have made a difference in this case? Whose interests were conflicting, and how, if at all, could the courts have adjudicated this conflict?

    2. 1.2 Show/Hide More Metropolitan Life Ins. Co. v. RJR Nabisco Inc. (SDNY 1989)
      Original Creator: Holger Spamann

      MetLife, a very sophisticated creditor of RJR, claimed that the leveraged buyout of RJR by KKR was an entirely unanticipated event that violated RJR's implied duty of good faith and fair dealing towards its creditors. The court doesn't buy it. Do you?

      Regardless, notice the striking contrast between the treatment of creditors and shareholders in this and other 1980s takeover cases. In MetLife, the court blesses a takeover that clearly reduced creditor value by billions of dollars without the deal-specific approval of creditors. At about the same time, Delaware cases empowered and even required boards to defeat takeovers in the name of “inadequate value” to shareholders even when the latter would have approved the deal. Does this make sense?

      NB: The book Barbarians at the Gate tells the tale of the “bidding war” referred to in Judge Walker's introduction — it is a fun read.

  2. 2 Show/Hide More eBay v. Newmark (Del. Ch. 2010)
    Original Creator: Holger Spamann

    This case pits eBay against Craig Newmark and Jim Buckmaster in a battle for control of craigslist. Craig and Jim are craigslist’s founder and CEO, respectively.

    craigslist is a close corporation — a corporation with only few shareholders and no public market for its shares. craigslist’s only shareholders at the time were Craig, Jim, and eBay. Close corporations tend to generate two problems not seen in public corporations. First, personal relationships loom much larger. By the time close corporations show up in court, these relationships have generally soured. Second, exit for a shareholder is difficult in the absence of a public market for the shares. This is related to the first point, as it makes it harder to dissolve sour relationships. Moreover, it means that shareholders cannot obtain liquidity (i.e., cash in some, or all, of their stake) by selling, which leads to disputes over payout policy when some shareholders need liquidity and others don’t (or they do but they are in control and pay themselves generous salaries). In fact, controlling shareholders may abuse a minority’s liquidity need to force the minority to sell out at a low price. When no individual shareholder has control, disputes can easily lead to deadlock. Court intervention may be necessary to resolve the deadlock. Cf. DGCL 226 (read!; also skim DGCL 341, 342, and 350-353).

    Both of these problems are at play in the present case, but with a twist. The twist is that the shareholders do not just disagree about payouts. They disagree about the more basic question of whether the corporation should be generating profits in the first place. eBay thinks so, but Craig and Jim do not. This is our main focus here. What is the purpose of a Delaware corporation, according to the court? Can shareholders enforce that purpose in court? Hint: Beyond the confines of this particular lawsuit, what did eBay ultimately want, and do you think eBay could have successfully sued for it (eBay never did)?

    I assign the full opinion because (1) the context is crucial to understand the outcome, as always, and (2) the opinion is an excellent review of almost everything we have done so far: fiduciary duties, shareholder voting, shareholder litigation, and takeover defenses.

  3. 3 Show/Hide More Enforcement of Regulations against Corporations
    Original Creator: Holger Spamann

    As previously mentioned, corporations are subject to extensive regulations protecting non-shareholder constituencies. Regulatory enforcement is a major practice area, and virtually all corporations now employ dedicated regulatory compliance departments. Examples of such regulations include antitrust, banking regulation, and environmental protection law. While these laws all have their specialized courses, their enforcement presents some common issues that deserve mention even in an introductory corporate law course.

    Civil Enforcement

    Civil enforcement against corporations is easy, at least conceptually speaking, because it is similar to any other civil litigation. (In practice, corporate civil litigation employs armies of lawyers.) By and large, in civil proceedings, it does not matter whether the defendant is an individual or a corporation. In particular, under the law of agency, acts of individual employees are imputed to the corporation as they would be to an individual employer. Thus, the only question particular to corporate suits is whether the same corporate agent or group of agents — for example, the CEO or the board — had all relevant knowledge or intent where such is required, or whether “collective knowledge” is sufficient. On this question, courts have given divergent answers.

    Criminal Enforcement

    Unlike civil enforcement, criminal enforcement raises a host of issues particular to corporate defendants. This is because first, a corporation does not have a mind and hence cannot have a “guilty mind” —mens rea—, and second, it does not have a body and hence cannot be incarcerated.


    At common law, corporations could not be criminally liable. In the 19th century, however, criminal statutes regulating economic behavior through fines proliferated. Some of those statutes explicitly extended criminal liability to corporations. In 1909, the Supreme Court assessed the constitutionality of one such statute in New York Central & Hudson River Railroad Co. v. U.S., holding  that

    “Applying the principle [of respondeat superior] governing civil liability, we go only a step farther in holding that the act of the agent, while exercising the authority delegated to him …, may be controlled, in the interest of public policy, by imputing his act to his employer and imposing penalties upon the corporation for which he is acting ….

    “It is true that there are some crimes, which in their nature cannot be committed by corporations. But there is a large class of offenses … wherein the crime consists in purposely doing the things prohibited by statute. In that class of crimes we see no good reason why corporations may not be held responsible for and charged with the knowledge and purposes of their agents, acting within the authority conferred upon them. … If it were not so, many offenses might go unpunished and acts be committed in violation of law, where, as in the present case, the statute requires all persons, corporate or private, to refrain from certain practices forbidden in the interest of public policy.”

    212 U.S. 481, 494–95 (1909).

    Nowadays, federal criminal statutes targeting a “person” — almost all statutes — presumptively apply to corporations (cf. 1 U.S.C. §1), as long as the agent acted within the scope of her employment and sought, at least in part, to benefit the corporation.


    Is this extension of criminal liability a good idea? Or is civil liability sufficient?

    Basics: Deterrence and Incapacitation

    Leaving aside moral blame and retribution, there are two main arguments for why civil liability is insufficient for individuals: deterrence and incapacitation. Do these two arguments also support criminal liability for corporations?

    For individuals, the threat of (criminal) imprisonment can improve deterrence beyond (civil) monetary liability, which is limited by an individual’s wealth. Corporations, however, cannot be imprisoned. They can only pay monetary fines. Thus, as far as penalties go, criminal liability does not improve deterrence for corporations beyond what civil liability could do. But criminal law does offer procedural enhancements that matter for corporate deterrence. First, certain aggressive enforcement tools, such as wiretaps, are only available in criminal prosecutions. These tools increase deterrence by increasing the probability that a violation will be discovered. Second, in criminal proceedings the government can act as a central enforcer on behalf of a dispersed class of injured parties, none of whom might have individual incentives to pursue a civil claim (but note that class actions would achieve the same purpose). For example, these two procedural enhancements are crucial for the government's enforcement of insider trading rules (but note that the majority of insider trading enforcement actions are brought by the S.E.C. in civil or administrative proceedings) and of antitrust rules against price fixing.

    The second argument for individual criminal liability is incapacitation. Some individuals cannot be deterred, and society may be better off keeping them in prison. Similarly, if an organization is prone to illegal behavior despite the threat of civil liability, society may be better off shutting down that organization or at least excluding it from certain activities or businesses. In particular, some corporations may have more “aggressive” corporate cultures — the ingrained norms of behavior inside the organization — than others.


    Some commentators worry that corporations can offend with impunity because their well-financed legal defense teams overwhelm prosecutors' resources and resolve.

    However, other commentators have the opposite concern — corporate criminal liability may overdeter. The optimal amount of certain crimes, such as the bribing of foreign officials, may well be zero. But shareholders, or even boards, do not have direct control over such crimes, which may be committed by lower-level employees. Therefore, shareholders and boards can prevent such crimes only through costly compliance programs. In other words, what is an intentional crime at the level of the acting individual (and, in the eyes of the law, for the corporation as a whole) is essentially a negligent tort at the level of the overseeing board and shareholders.

    If the criminal penalty equals the societal harm caused by the crime, then corporations will be incentivized to spend only the socially optimal amount on compliance programs. However, if the penalty is higher than the social harm, then compliance spending may be socially excessive. A similar problem arises when it is unclear what constitutes lawful behavior, which is frequent in heavily regulated areas. For example, a bank might violate anti-money-laundering rules by not disclosing some transactions to its regulator, and violate privacy rules by disclosing too much. The net social benefit of disclosure is likely to vary little as the bank discloses a little bit more or less. But the bank itself is affected drastically if there is any small variation which leads to illegal disclosure or non-disclosure, since such violations can carry heavy sanctions. Again, the bank would be incentivized to spend more than the socially optimal amount on ensuring compliance.

    1. 3.1 Show/Hide More Federal Sentencing Guidelines: Introductory Commentary to Chapter 8 - Sentencing of Organizations

      How do the Federal Sentencing Guidelines address the concerns described in my introductory note on enforcement? Do they profess to aim at optimal deterrence or optimal incapacitation? Do they achieve either? If not, what else do they aim to do, and does that make sense?

      The complete Guidelines for organizations are available here.

    2. 3.3 Show/Hide More U.S. Attorney S.D.N.Y.: Deferred Prosecution Agreement with General Motors (2015)
      Original Creator: Holger Spamann

      The complaint below memorializes the outcome of the federal government's investigation into General Motor's ignition switch scandal. Judge Nathan of the S.D.N.Y. entered the forfeiture order sought in December 2015.

      What exactly did the government prosecute General Motors for? Was GM's prosecution necessary for deterrence? For incapacitation?


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