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Original Creator: Holger Spamann Current Version: Holger Spamann Show/Hide

We have seen that U.S. corporate law focuses on protecting only shareholders, rather than all stakeholders — with some very limited protections for creditors.  In fact, U.S. corporate law, at least the Delaware variety, contains few rules, period.  Further, even those few rules can mostly be abrogated or circumvented in a corporation’s charter. This lack of strict rules is why this course mainly focuses on fiduciary duties and the occasional shareholder approval requirement.

In sum, Delaware corporate law does little more than enable charter contracting by supplying default terms, gap-filling (?) fiduciary duties, and, importantly, an able judiciary to enforce these terms and duties. By contrast, corporate law outside the U.S. tends to be much more rule based. We have seen one example in UK takeover law. This raises questions: Why is U.S. corporate law as liberal as it is? Is this liberality a good thing?

U.S. corporate law’s liberality and lack of concern for non-shareholder constituencies are intimately related to the rise of Delaware as the foremost state of incorporation. Delaware attracts so many corporate charters mainly because “foreign corporations” — corporations with few or even no operations in Delaware — can opt to be governed by Delaware law as long as they incorporate in Delaware. That is, Delaware’s prominence is predicated on a choice of law rule. Under the “internal affairs doctrine” the applicable corporate law is the law of the state of incorporation. This doctrine undergirds Delaware’s business of “competing for corporate charters.”  Such competition would not be possible if the applicable corporate law were, for example, the law of the state of the corporation’s headquarters, as it is in many non-U.S. jurisdictions.

Charter competition treats corporate law as a product. That is, corporate law appears not as regulation, but as a service to contracting parties organizing a business. The “contract” consists of the charter terms and the applicable corporate law. The contracting parties, in a narrow sense, are those involved in drafting the charter. In a broader sense, the contracting parties include all those who voluntarily interact with the corporation, such as shareholders. To be sure, their agreement to the charter terms is not literally required. But they have the option not to interact, to charge higher prices, to invest less money, and so on, if the charter terms displease them. In anticipation of these options, the drafters of the charter have strong incentives to take these other parties’ concerns into account. Or so the argument goes.

Such reliance on private contracting has indeed been the hallmark of U.S. state corporate law (but not federal securities law) for many decades. It complements the internal affairs doctrine in two ways. First, confidence in private contracting provides a normative underpinning for free choice of corporate law. Second, any restrictions on private contracting imposed by an individual state could be easily circumvented by (re-)incorporating in another state. Do you think this deference to private contracting is appropriate?

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  1. 1 Show/Hide More Choice of Law: The Internal Affairs Doctrine
    Original Creator: Holger Spamann Current Version: Holger Spamann

    The “internal affairs doctrine” is a choice of law rule that applies the law of the state of incorporation to the corporation’s “internal affairs.”

    While many in the U.S. treat the internal affairs doctrine as self-evident, other countries frequently insist on applying their corporate law to all corporations that have their headquarters in that country, or some other substantial connection to that country. Such insistence on a substantial connection is no stranger to U.S. choice of law. In fact, for most contracts, U.S. courts generally refuse to apply “[t]he law of the state chosen by the parties to govern their contractual rights and duties” if “the chosen state has no substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties choice,” see Restatement of the Law (2nd) Conflict of Laws § 187(2)(a). U.S. courts will, however, enforce any chosen state's corporate law under the internal affairs doctrine.

    The internal affairs doctrine allowed corporations to migrate away from states that imposed restrictions. Again, “migration” is a mere figure of speech — no people or assets need to move out of state to avoid that state's corporate law. Mere reincorporation in another state is sufficient.

    Nowadays this issue is mostly discussed in connection with shareholder rights. In recent decades, commentators have been intensely debating whether Delaware’s enabling approach to shareholder rights is the result of a “race to the top” or a “race to the bottom” from the perspective of the shareholder/manager relationship. But Delaware actually became a major corporate domicile only because other states tried to protect non-shareholder constituencies through corporate law. In particular, in an attempt to combat “trusts,” a/k/a cartels, New York in the later 19th and early 20th century prohibited holding companies — it prohibited its corporations from owning stock in other corporations. In response, corporations migrated to New Jersey. When New Jersey’s governor Woodrow Wilson ran for the presidency in 1912, he advocated amendments that limited holding companies in New Jersey as well. Thus, the corporations moved on to Delaware and they have stayed there ever since. The issue of “trusts” was left to federal antitrust law.

    In general, regulatory competition may work for the contracting parties writ large. As previously indicated, this group includes all those who voluntarily interact with the corporation. But regulatory competition clearly does not address the concerns of third parties, such as tort creditors or the general public. To the extent that these groups are affected by corporate law, regulatory competition is apt to generate negative externalities. Such externalities would then require federal intervention, such as the federal antitrust and securities laws. 

    Are negative externalities a real problem in corporate law, or a negligible quibble? The answer depends on two related issues: First, the scope of the internal affairs doctrine. The fewer rules the doctrine covers, the less potential for externalities. As its name implies, the internal affairs doctrine covers internal organizational rules, but the details can be tricky, as Lidow illustrates.

    Second, do third parties really need the protection of rules covered by the internal affairs doctrine? After all, tort victims are already protected by tort law, the environment is protected by environmental statutes and so on.  Nevertheless, additional protection through organizational law may be required. The reason is that this other law is imperfect, owing to the limits of both the political process and of law’s capacity to regulate human affairs. Hence societies must rely on non-legal norms to regulate most human interaction. However, the corporate context may interfere with the operation of non-legal norms, be it by diffusing responsibility, by suppressing internalized norms, or by some other mechanism. Do we need to insist on some mandatory internal corporate structure to avoid “sociopathic” corporate behavior? Or to take a more positive view, does organizational law provide opportunities for “mandatory betterment” that would be infeasible or unethical for individuals? For example, should we impose co-determination or affirmative action for boards? The U.S. has neither, but many European countries do.

    If one concludes that externalities from corporate law are a real problem, then one should wonder why states accept the internal affairs doctrine. It is often said, especially in Delaware, that the U.S. Constitution enshrines the internal affairs doctrine; CTS is usually cited as support. See, e.g., VantagePoint below. Read CTS and judge for yourself.

    1. 1.1 Show/Hide More CTS v. Dynamics (U.S. 1987)
      Original Creator: Holger Spamann Current Version: Holger Spamann

      This decision upheld Indiana’s version of DGCL 203 against constitutional challenge. In the 1980s, most states passed some form of an anti-takeover statute. They were hotly politically contested, as you might infer from the heated debate between the Justices and the various amici.

      In Edgar v. MITE (1982), a plurality of the Supreme Court struck down an Illinois law that purported to apply to any tender offer for shares of  “corporation or other issuer of securities of which shareholders located in Illinois own 10% of the class of equity securities subject to the offer, or for which any two of the following three conditions are met: the corporation (1) has its principal executive office in Illinois, (2) is organized under the laws of Illinois, or (3) has at least 10% of its stated capital and paid-in surplus represented within the State,” 457 U.S. 624, 627 (1982).

      The Indiana statute at issue here in CTS is different as it applies only to corporations chartered in Indiana. Does this fact or anything else in the decision imply that the internal affairs doctrine is enshrined in the U.S. Constitution?

    2. 1.2 Show/Hide More VantagePoint v. Examen Inc. (Del. 2005)
      Original Creator: Holger Spamann Current Version: Holger Spamann

      This Delaware case deals with the only sustained challenge to the internal affairs doctrine in the U.S.: section 2115 of the California Corporations Code.

      1. By its own terms, does section 2115 apply in this case?
      2. Why does the Delaware Supreme Court not apply section 2115?
      3. Does the Delaware Supreme Court hold that the internal affairs doctrine is embodied in the U.S. constitution?
      4. What is better for Delaware’s business – section 2115 or strict adherence to the internal affairs doctrine?
      5. As a policy matter, did the party arguing for application of section 2115, VantagePoint, deserve its protection in this case?



    3. 1.3 Show/Hide More Lidow v. Superior Court (Cal. 2012)
      Original Creator: Holger Spamann Current Version: Holger Spamann

      This California decision accepts the internal affairs doctrine in principle. Nevertheless, in this case it applies California law to a dispute between a Delaware corporation and its officer.

      1. How does the Court of Appeals of California determine the scope of the internal affairs doctrine?
      2. Looking beyond this particular case, what scope of the internal affairs doctrine increases the application of California law – a narrow scope or a broad scope?
      3. What can corporations—or rather those who control them—do to escape application of California law under section 2115 or under Lidow, and are they likely to do that? What can corporations do to escape application of Delaware law under the internal affairs doctrine, and are they likely to do that?



  2. 2 Show/Hide More What is the right normative lens for corporate law?
    Original Creator: Holger Spamann Current Version: Holger Spamann

    We are now ready to tackle the ultimate question: What is the point of corporate law? Is it merely to facilitate contracting?  If so, what is the best way to do it? If not, what other goals should corporate law aim to advance?

    In this context, commentators like to contrast the so-called contractarian and entity views of the corporation. As its name suggests, the contractarian view emphasizes the contractual aspects of the corporation, from drafting the initial charter to executive compensation contracts to customer relationships. By contrast, the entity view emphasizes the importance of the (large) corporation on the life of its constituents and beyond. Commentators tend to associate the contractarian view with an argument for contractual freedom, and the entity view with an argument for more mandatory rules.

    In truth, this is a false dichotomy. The views are two sides of the same coin. A corporation is both one or more contracts (the charter above all) and an entity. Contracts can be regulated, and often are — for example, in the criminalization of cartels. And the mere fact that the corporate entity is important for people does not necessarily mean that we think the state should regulate how people organize it.

    What the two views do, however, is illustrate the different rationales for corporate law-making. One rationale is to remedy contracting imperfections even between the contracting parties. Another rationale is to prevent externalities on non-contracting parties. U.S. corporate law tends to downplay the latter, perhaps because its perspective has been narrowed by the internal affairs doctrine and the doctrine’s limiting effects on regulation through corporate law. Implicitly, however, U.S. law also seems to fear externalities arising specifically from incorporation. If not, why would a law firm not be allowed to organize as a corporation? Or perhaps it should be allowed? We will approach such questions through Citizens United.

    The corporation as a contract

    As we have seen, U.S. corporate law grants very extensive contractual freedom. Choose your state. Choose your corporate charter (cf. DGCL 102(b)(1) – read!). Even choose your entity type. For example, anyone not satisfied with DGCL 102(b)(7)’s restrictions on eliminating corporate fiduciary duties can choose a Delaware Limited Liability Company instead, where “[fiduciary] duties may be . . . eliminated by provisions in the LLC agreement; provided, that the LLC agreement may not eliminate the implied contractual covenant of good faith and fair dealing.” Del. LLC Act § 1101©. If that is still not enough, the Delaware statutory trust may help. Cf. Del. Code title 12, ch. 38.

    Indeed, why limit permissible charter provisions at all? Once we rely on contracting to get the right result, why stop at particular provisions? In fact, if law is a “product” why not allow private providers to supply it? That is, why require election of any state law for incorporation? Private providers might be better at generating and maintaining private contract forms, registries, and arbitration — instead of, for example, the Delaware General Corporation Law, Secretary of State, and Chancery Court respectively. If the contractual model holds, people’s self-interest will ensure that they choose the most suitable package. The more options, the better.

    Perhaps having so many options would make contracting too complex and confusing? That can hardly be a good argument because the existing options allow for plenty of confusion — for example the offer of non-voting shares and complicated voting structures. Many financial contracts are extremely complex, much more complex than we could reasonably expect charters to be — at present, public corporation charters are generally short, overwhelmingly boilerplate, and show very little variation. And the difficulty of evaluating a charter term pales in comparison to that of valuing a business.

    Of course, human fallibility can undermine the contractual model (careful, though — it undermines faith in regulation as well). For example, if gullible investors do not price charter provisions correctly, savvy founders will produce bad charters. This might warrant prohibiting certain charter terms. But why stop there? Why not stop investors from investing in bad businesses? In other words, should some agency review the “investment worthiness” of securities before they can be issued to the public? Such review did exist in many states for a long time.

    Perhaps the best argument for why charter freedom may not produce optimal results even if people generally contract well is charters’ long life. Drafters cannot foresee everything, and corporations can be around for a very long time. Then again, drafters know this, so they could build whatever flexibility they desire into their charter.

    The corporation as a social entity

    Of course, the contractarian view of the corporation is not the only possible view. In fact, for most of the 20th century, a different view prevailed in the U.S. and elsewhere. This was the view of the corporation as a social entity. This view saw a much larger role for mandatory law in structuring the entity and in regulating the entity’s interaction with the world. For example, the most famous account of large U.S. corporations in the 20th century, Adolf Berle & Gardiner Means’ “The Modern Corporation & Private Property” (1932; 1968) reviewed the dispersion of (family) ownership and the rise of professional management to conclude (pp. 310-313):

    “Observable throughout the world . . . is this insistence that power in economic organization shall be subjected to the same tests of public benefit which have been applied in their turn to power otherwise located.  . . .

    “By tradition, a corporation ‘belongs’ to its shareholders . . . and theirs is the only interest to be recognized as the object of corporate activity. Following this tradition, and without regard for the changed character of ownership, it would be possible to apply in the interests of the passive property owner [i.e., shareholders] the doctrine of strict property rights . . . . Were this course followed, the bulk of American industry might soon be operated by trustees for the sole benefit of inactive and irresponsible security owners.  . . .

    “[Another] possibility exists, however. On the one hand, the owners of passive property, by surrendering control and responsibility over the active property, have surrendered the right that the corporation should be operated in their sole interest . . . At the same time, the controlling groups [i.e., managers], by means of the extension of corporate powers, have in their own interest broken the bars of tradition which require that the corporation be operated solely for the benefit of the owners of passive property.  . . . The control groups have . . . cleared the way for the claims of a group far wider than either the owners or the control. They have placed the community in a position to demand that the modern corporation serve not alone the owners or the control but all society.  . . .

    “In still larger view, the modern corporation may be regarded not simply as one form of social organization but potentially (if not yet actually) as the dominant institution of the modern world.  . . .

    “The rise of the modern corporation has brought a concentration of economic power which can compete on equal terms with the modern state — economic power versus political power, each strong in its own field. The state seeks in some aspects to regulate the corporation, while the corporation, steadily becoming more powerful, makes every effort to avoid such regulation.  . . .  The future may see the economic organism, now typified by the corporation, not only on an equal plane with the state, but possibly even superseding it as the dominant form of social organization. The law of corporations, accordingly, might well be considered as a potential constitutional law for the new economic state.  . . . "

    1. 2.2 Show/Hide More Citizens United v. Federal Election Com'n (US 2010)
      Original Creator: Holger Spamann Current Version: Holger Spamann

      In this very controversial decision, the Supreme Court’s conservative majority held that a prohibition of corporate expenditures on certain types of speech violates the First Amendment. The decision implicates important legal issues of free speech, stare decisis, and judicial restraint. For our purposes, however, I have edited the case down to the passages dealing directly with the constitutionality of, and rationale for, distinguishing corporate from non-corporate speech. Please focus on this distinction.


      The First Amendment reads, in relevant part:

      “Congress shall make no law … abridging the freedom of speech, or of the press.”


      As a preliminary matter, consider the following questions:

      1. Does a literal reading of the First Amendment protect corporate expenditures?
      2. Does an originalist reading of the First Amendment, adopted in 1791, protect corporate expenditures? You may recall that incorporation required a special act of the legislature well into the 19th century. Cf. Justice Scalia’s concurrence and Justice Stevens’ dissent.


      In answering the latter question, you may want to distinguish between different types of corporations. In particular, many of the arguments and precedents that the Justices discuss relate to news, media, and political organizations, and the petitioner in the case is a non-profit advocacy organization funded mostly by donations from individuals. In this class, we are primarily interested in business corporations.


      The main questions to consider are:

      3. Do the Justices treat the corporation as an abstraction—a convenient way of summarizing legal relationships between individual human beings? Or as a “concentration of economic power which can compete on equal terms with the modern state” (Berle and Means)? Or as something different altogether?
      4. Do the “the procedures of shareholder democracy” protect dissenting shareholders when they disagree with speech approved by (a) boards and managers or (b) majority shareholders? Should they? What would be the contractarian answer?
      5. What other arguments for distinguishing corporate and individual speech do the Justices consider?
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December 07, 2017

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