Future Articulation of Corporation Law

Author(s): Elliott Goldstein

Source: The Business Lawyer, Vol. 39, No. 4 (August 1984), pp. 1541-1549
Published by: American Bar Association
Stable URL: https://www.jstor.org/stable/40686584
Accessed: 17-01-2019 00:58 UTC

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide
range of content in a trusted digital archive. We use information technology and tools to increase productivity and
facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.

Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at
https://about.jstor.org/terms

American Bar Association is collaborating with JSTOR to digitize, preserve and extend access
to The Business Lawyer

This content downloaded from 49.150.10.249 on Thu, 17 Jan 2019 00:58:43 UTC
All use subject to https://about.jstor.org/terms
 Future Articulation of Corporation Law

By Elliott Goldstein*

To address the future of corporation law, we must look first to the past.
Changes in corporation law are inevitably debated based upon two competing
ideologies, advocating either more or less control of corporate governance, with
each view having prevailed at some point or another in history. This ebb and
flow of popular conceptions is reflected in legal writings and forms the center of
the controversy surrounding the American Law Institute's proposed Principles
of Corporate Governance: Restatement and Recommendations? now entitled
"Principles of Corporate Governance: Analysis and Recommendations" (the
Corporate Governance Project). Unlike previous restatements prepared by the
American Law Institute, the Corporate Governance Project undertook not only
to restate the laws governing the internal affairs of corporation, but also to make
recommendations on what corporate law should provide and what would be
considered good corporate practice. In making recommendations for future
legislation, judicial decisions, and changes in the internal organization of corpo-
rations, reliance on precedents from which a "better rule" might be extrapolated
was not always possible. Since they could not rely on precedent, reporters for
the Corporate Governance Project seem to have relied, consciously or uncon-
sciously, on a basic or underlying philosophy which would harmonize their
proposals for reform.
In preparing for the Project, great care was taken to test current opinion at
symposia held at various locations in the United States. Discussion among
participating lawyers, academics, and businessmen led to the conclusion that the
American Law Institute should undertake a study of corporation law as it
relates to corporate governance. Some proponents of the Project felt it would be
an alternative to federal intervention in corporate governance. Others felt that it
was an important addition to corporate law and that a codification or restate-
ment of the law of corporations should be attempted.2 The first draft, though
defended by many sources, drew criticism from many others. The vehemence of

*Mr. Goldstein is a member of the Georgia and District of Columbia bars and practices law with
Powell, Goldstein, Frazer & Murphy in Atlanta, Georgia, and Washington, D.C.
1. Principles of Corporate Governance and Structure: Restatement and Recommendations,
(Tent. Draft No. 1 1982).
2. Commentaries on Corporate Structure and Governance (D. E. Schwartz ed. 1979).

1541

This content downloaded from 49.150.10.249 on Thu, 17 Jan 2019 00:58:43 UTC
All use subject to https://about.jstor.org/terms
1542 The Business Lawyer; Vol. 39, August 1984

the criticism startled some proponents of the Project, who considered the first
draft to be an excellent start.
That there should have been so wide a divergence of thought and opinion
should not have been surprising. In fact, the question of corporate governance or
corporate control is one upon which the United States has always been of two
minds. The history of corporations in America is well documented. For more
than 100 years, the corporation has been a controversial issue in the political life
of the United States. At an early stage, the corporation became the focus of
animosity or antagonism because of the problems encountered by the individual
in a market system. Farmers felt that low prices for their commodities and
higher prices for manufactured products were caused by machinations of the
"trusts." Small businessmen and laborers expressed opposition to the growth of
"soulless corporations." As corporations grew in size and influence, the idea was
accepted that there should be some government regulations in selected areas.
First, because of the dependence of the entire community on public utility
services and the disappearance of competition among public utilities as monop-
oly was achieved, some form of governmental regulation of public utilities was
accepted as necessary. With the passage of the Sherman Act, the public accepted
the concept of some government intervention in the affairs of large private
corporations and trust busting became a symbol of the power of the common
man to control large corporations. The hyperbole of trust busting became a part
of the accepted wisdom that large corporations were evil and could only be held
in check by government action. During this period, monetary policy was
another continuing political issue. The agrarian revolts against a restrictive
monetary policy based on the gold standard focused popular hostility against
corporate institutions. At this comparatively early date it was proposed that
there be direct control of corporations through federal chartering.
The New Deal was a direct descendant of the agrarian and populist move-
ments of the nineteenth century. Roosevelt's legislative policy represented an
acceptance by the federal government of the populist and agrarian programs of
the previous forty years. Because of the severity of the 1933 depression, federal
intervention in economics and business matters was accepted as the only
alternative to complete economic chaos. As economic activity increased, how-
ever, the program turned to reform. Commencing with the Securities Act of
1933 and the Securities Exchange Act of 1934, Congress created numerous
administrative agencies which dealt with some portion of the operations of
corporations. Among the early rejected proposals was another proposal for
federal chartering of corporations.
Interest in controlling corporations escalated again after the Watergate inves-
tigations. The disclosure that cash campaign contributions had been made from
funds not identified in corporation accounts led to an investigation of corporate
accounting. This was followed by the disclosure that a number of large corpora-
tions had paid bribes to foreign government officials. In the wake of these

This content downloaded from 49.150.10.249 on Thu, 17 Jan 2019 00:58:43 UTC
All use subject to https://about.jstor.org/terms
 Dynamics of Corporate Control: Future Law 1543

disclosures, the Foreign Corrupt Practices Act3 was passed by Congress without
substantial opposition. This act for the first time imposed direct federal controls
on the accounting practices of publicly held corporations. And proposals for
federal chartering of corporations reappeared. Finally, during this period, the
enforcement division of the SEC used consent decrees to require the introduc-
tion of outside directors approved by the enforcement division onto the boards of
a number of publicly held corporations, in effect using the federal courts to
control some activities of publicly owned corporations.4
Predating this history of congressional approval and public acceptance of
federal intervention in corporate governance, market forces were permitted to
shape the growth of the United States and the development of corporations
without government intervention. Deeply inbedded in American traditions is the
concept of the pioneer who rejected government interference. Many proposals
for federal regulation of corporations were defeated in Congress because of the
historic distrust of federal intervention. A part of this history was the dramatic
growth of industry during the period commencing with the Civil War and
ending with World War I. During that period entrepreneurs dominated the
public imagination and were seen to be creating great wealth by their individual
efforts. The wealth accumulated by those captains of industry often funded
projects which benefited the general public. The period from the end of World
War I until the beginning of the Great Depression in 1929 was marked by
consolidation of corporations under professional managers, a tremendous
growth in the economy, and a disinclination for state or federal regulations.
Today, market theory as an efficient regulator of economic institutions is now
more widely and generally accepted than in the years before the New Deal.
Helping to shape public opinion were such popular economics lessons as those
provided by Milton Friedman in his book Free to Choose? and the PBS
television series based on that work. Opinion surveys indicated that public
distrust of government exceeded its distrust of large corporations. Government
itself began to question its own efficiency, and, as a part of the regulatory reform
movement, economic values were applied to regulation, requiring a cost-benefit
analysis for new regulations.
Just as political thought has followed two conflicting ideologies, so has legal
thought paralleled these ideologies. An influential body of legal thought accepts
the concept that there must be some form of governmental regulation of large
corporations. Their conclusions can, in part, be traced to one work, Berle and
Means' The Modern Corporation and Private Property* From their conclusions
that shareholders had little or no influence on the management which controlled
the operations of corporations, it was argued that corporate management must

3. 15 U.S.C. §§ 78a, 78m, 78dd-l, 78dd-2, 78ff (1982).

4. Matthews, Recent Trends in SEC Requested Ancillary Relief in SEC Level Injunctive
Actions, 31 Bus. Law. 1323 (1976).
5. M. Friedman, Free to Choose (1980).
6. Berle & Means, The Modern Corporation and Private Property (1932 & rev. ed. 1968).

This content downloaded from 49.150.10.249 on Thu, 17 Jan 2019 00:58:43 UTC
All use subject to https://about.jstor.org/terms
1544 The Business Lawyer; Vol. 39, August 1984

be held accountable, and therefore some system to control management must be

created.
Various theories describing how corporations might be controlled by govern-
ment have been advanced. One method of federal control involves federal
chartering of corporations with control to be effected by a board of directors
composed of professional directors nominated by the shareholders who would
serve as internal auditors of the corporation.7 Another method of control would
require a federal minimum standards statute setting federal standards for state
corporation laws.8 An alternative method envisions control through use of the
courts in stockholder derivative actions. Advocates of the derivative suits propose
to confine the power of the board of directors to terminate a derivative action to
those cases which do not involve material self-dealing; to require the defendant
to contribute at least the amount of plaintiffs expenses to any settlement and to
give the plaintiff an incentive to contest indemnification; to impose a ceiling on
liability after litigation for due-care violations; and to place a floor on the
expected financial contributions required of defendants settling after litigation
for the purpose of making the punishment, "fair and certain - reduced in its
severity, but increased in its probability."9
Another approach to controlling corporations is through controls voluntarily
imposed by the structure and composition of the board of directors, the so-called
monitoring model. The primary objective of the board would be to select,
monitor, and remove the members of the chief executive office rather than to set
policy.10 An SEC proposal suggested that corporations be controlled through
administrative action and, in general, recommended increased participation of
shareholders in corporate governance through shareholder nomination of direc-
tors, increased availability of shareholder proposals, and increased opportunities
for shareholder voting.11
As a counterbalance to the literature on corporate control, a number of
writers have advocated that there be no government attempt at regulation. From
their viewpoint, all phases of corporate activity are adequately and properly
controlled by market forces, and neither direct nor indirect regulation is needed.
They argue that shareholders desire to maximize their wealth and directors
desire leisure. The market is the strongest force which prompts executives to
manage properly and permits shareholders to profit through ownership of

7. Nader, Green & Seligman, Taming the Giant Corporation (1976); D. E. Schwartz, Consti-
tutionalizing the Corporation: A Case For Federal Chartering of Corporations, 31 Bus. Law. 1125
(1976).
8. Cary, A Proposed Federal Corporate Minimum Standards Act, 29 Bus. Law. 1101, 1115
(1974).
9. Coffee & Schwartz, The Survival of the Derivative Suit: An Evaluation and a Proposal for
Legislative Reform, 81 Colum. L. Rev. 261, 327 (1981).
10. Eisenberg, Legal Models of Management Structure in the Modern Corporation: Officers,
Directors, and Accountants, 63 Calif. L. Rev. 375 (1975).
11. Securities and Exchange Commission Staff, Report on Corporate Accountability, 96th
Cong., 2d Sess. (Comm. Print 1980).

This content downloaded from 49.150.10.249 on Thu, 17 Jan 2019 00:58:43 UTC
All use subject to https://about.jstor.org/terms
 Dynamics of Corporate Control: Future Law 1545

stock.12 The limited governance role assigned to shareholders, it is asserted, is in

fact the genius of the corporate form. It provides the most important incentive to
invest in large enterprises because it allows one to invest in, and profit from, an
undertaking without incurring the enormous costs that would be necessary to
manage the undertaking completely.13
One writer suggests that the SEC not only should retreat from its interven-
tion into corporate governance but should also reexamine its method of opera-
tion to do away with its "enforcement mentality approach" to dealing with
corporate problems.14 Another has argued that "there really is no right general
answer to the question, 'what would constitute a model board?' "15 The compo-
sition which fits one company may be entirely unsuitable for another.
That the Corporate Governance Project would generate controversy was
presaged by the experience of the Committee on Corporate Laws of the Section
of Corporation, Banking and Business Law. This committee is charged with the
responsibility for the drafting and updating of the Model Business Corporation
Act. In 1974 it adopted an amendment to section 3516 of the Model Business
Corporation Act (MBCA) to formalize a standard for director conduct and to
define the authority of the board. Controversy was generated by the revision of
this section of the MBCA. The revision included a change of the first paragraph
of section 35 of the MBCA to provide that "the business and affairs of a
corporation shall be managed under the direction of a board of directors. . ."
instead of by the board of directors.11 The second paragraph of section 35 was
revised to follow the phraseology of section 5 of the MBCA dealing with
indemnification of directors, and states the duty of a director as:

A director shall perform his duties as a director, including his duties as a

member of any committee of the board upon which he may serve, in good
faith, in a manner he reasonably believes to be in the best interests of the
corporation, and with such care as an ordinarily prudent person in a like
position would use under similar circumstances.18

The use of the language "reasonably believes to be in the best interests of the
corporations" precipitated a controversy over whether the requirement of rea-
sonable belief weakened the safe harbor offered by the good faith exercise of the
business judgment rule. On the one hand, two commentators argued:

[I]n the business judgment area both [the Delaware statute and Section
35, MBCA] require, at a minimum, that directors act in good faith with a

12. Fischel, The Corporate Governance Movement, 35 Vand. L. Rev. 1259 (1982).
13. Dooley, Controlling Giant Corporations, The Question of Legitimatizing, Corporate Gover-
nance, Past & Future, at 38 (Manne ed. 1982).
14. Kripke, The SEC and Corporate Disclosure: Regulation in Search of a Purpose (1979).
15. Letts, Corporate Governing, A Different Slant, 35 Bus. Law. 1505, 1516 (1980).
16. Report of Committee on Corporate Laws: Changes in the Model Business Corporation Act,
30 Bus. Law. 501, 502-03 (1975).
17. Id. at 502.
18. Id.

This content downloaded from 49.150.10.249 on Thu, 17 Jan 2019 00:58:43 UTC
All use subject to https://about.jstor.org/terms
1546 The Business Lawyer; Vol. 39, August 1984

rational business purpose. Indeed, action lacking rational business purpose

is unlikely to be found to have been taken in good faith. However, Section
35 MBCA pushes beyond these substantive standards and requires the
courts to glance backward at the director's belief that his action was in the
best interests of the corporation.19

Two other members of the Committee on Corporate Laws who were heavily
involved in the drafting of section 35 countered that:

[B]ut rather than a hidden reef, the "reasonable belief test is merely a
sensible limitation of the business judgment rule; the perimeter of good
faith business judgment is drawn with a very long but not an endless
radius. Section 35 accurately charts the channel for directors in dealing
with their decision making responsibilities. In the process, it provides
important guidance for the performance of directorial duties that many
have found to be useful and desirable as a matter of public policy.20

Controversy also was generated when the Committee on Corporate Laws

prepared The Corporate Director's Guidebook.21 The Guidebook, which at-
tempts to acquaint directors with their legal responsibilities, has been generally
accepted and widely distributed as a useful text for members of the board of
directors and corporate officers concerned with the structure and operation of
boards. However, the exposure draft of The Corporate Directors Guidebook
received severe criticism from corporate counsel and corporate secretaries,22 the
major criticism being addressed to the Guidebook's advancement of the idea of a
preferred model for the board of directors, the implication in some of its
terminology that an outside director must be an adversary, and the possibility of
judicial acceptance of the Guidebook as a model approved or endorsed by either
the American Bar Association or business in general.
The same controversies have surfaced in the wake of the Committee's revision
of the MBCA. In 1980, the Committee commenced a reorganization and
revision of the MBCA in connection with its revision and republication of the
Model Business Corporation Act Annotated. In some respects, its work paral-
leled the work of the reporters for the Corporate Governance Project. Its
original plan was to revise only those provisions of the MBCA which required
changes in style or format to make them consistent throughout the Act and to
make only those changes necessary to include the simplifications and innova-
tions which had been developed in various states. However, when the work of
the Corporate Governance Project commenced, it was decided that an attempt at
revision of sections 35, 41, and 47 to make them consistent with the text of the

19. Veasey & Manning, Codified Standard - Safe Harbor or Unchartered Reef? An Analysis of
the Model Act Standard of Care Compared with Delaware Law, 35 Bus. Law 919, 945 (1980).
20. Hinsey & Arsht, Codified Standard - Same Harbor But Chartered Channel, A Response, 35
Bus. Law IX, XXV (1980).
21. Corporate Director's Guidebook, 33 Bus. Law 1595 (1978).
22. Corporate Director's Guidebook: Comments Submitted by the American Society of Corporate
Secretaries, 33 Bus. Law 321, 334 (1977).

This content downloaded from 49.150.10.249 on Thu, 17 Jan 2019 00:58:43 UTC
All use subject to https://about.jstor.org/terms
 Dynamics of Corporate Control: Future Law 1547

Corporate Governance Project should be made. In revising section 35, which

became section 8.30,23 an attempt was made to codify the business judgment
rule. The revision of section 41, which became section 8.31,24 permitted the
validity of a transaction between a corporation and an officer or director to be
attacked on the grounds of lack of fairness even though all material facts of the
transaction were disclosed or known and the board of directors, a committee of
the board, or the shareholders had ratified the transaction. Section 47, which
became section 8.32,25 generally received little criticism.
The revised Model Business Corporation Act was published for comment in
1983. 26 The criticism of sections 8.30 and 8.31 was so persuasive, the difficulty
of attempting to codify the business judgment rule so great, and the text of
section 8.31 seemingly so clearly erroneous, that the committee now plans to
adopt, as its final revision, substantially the same language as was found in
sections 35 and 41 of the MBCA.

In presenting its first draft, the Corporate Governance Project attempted to

formulate a model structure for the corporation, state the business judgment
rule, treat the officers' and directors' duty of care, and discuss shareholder
remedies, including proposed rules for the bringing of, conduct of, and termina-
tion of stockholder's derivative actions. The draft, Tentative Draft No. I,27 drew
a number of criticisms which could have been expected. In drafting, the
reporters assumed that the structure and membership of the board should be
governed by law, at least in large publicly held corporations; that board
decisions with respect to termination of self-dealing controversies or other
transactions with interested parties should be subject to almost a de novo judicial
review; that there should be a restatement of the business judgment rule and the
scope of review of directors' decisions; and, that changes should be made in the
law governing stockholders' derivative actions to make them a more useful tool
in reviewing decisions by the directors. Tentative Draft No. 1 was severely
criticized by two committee of the Section of Corporation, Banking and Business
Law (the Committee on Corporate Law Departments and the Committee on
Corporate Laws), by the Section of Litigation of the American Bar Association,
and by the Business Round Table. The criticisms shared by all those who
commented were that the proposed rules would freeze corporate governance into
a rigid mandatory rule rather than operate as flexible guidelines permitting
healthy evolution; the treatment of the business judgment rule would seriously
erode the protection it historically afforded corporate management and boards of
directors; and the treatment of remedies unnecessarily complicated the resolu-
tion of derivative claims and increased the risk of financial loss to boards of
directors. Other criticisms included the failure to consider business school and

23. 1983 Revised Model Business Corp. Act § 8.30 (Exposure Draft 1983).
24. Id. §8.31.
25. Id. § 8.32.
26. 1983 Revised Model Business Corp. Act (Exposure Draft 1983).
27. Principles of Corporate Governance and Structure: Restatement and Recommendations,
supra note 1.

This content downloaded from 49.150.10.249 on Thu, 17 Jan 2019 00:58:43 UTC
All use subject to https://about.jstor.org/terms
1548 The Business Lawyer; Vol. 39, August 1984

economic studies of corporate management and a seeming bias for governance

by litigation.
The Corporate Governance Project has now been renamed Principles of
Corporate Governance: Analysis and Recommendations. The Project has been
substantially modified, and the language changed in many respects.
As to what the future holds, it is probable that the Corporate Governance
Project, under its new title and substantially revised, will be approved by the
membership of the American Law Institute. It is probable also that legislation
affecting corporations will be introduced into Congress from time to time, with
the content and probability of passage dependent on the current political mood
of the country. For example, H. R. 3561, 28 which would modify the application
of the Clayton Act to certain large acquisitions, would make difficult any
acquisition that would result in an entity with assets of $5 billion and with
employees of the acquirer and its controlled corporations totaling in excess of
25,000, unless the acquirer divests itself of ownership or control or assets equal
in value to those to be acquired. This bill has been the subject of hearings before
the House Committee on the Judiciary.
With respect to the Model Business Corporation Act, since certain areas of
corporation law are in the process of developing, the following sections of the
Model Business Corporation Act will be reexamined and presumably revised by
the Committee on Corporate Laws:

1. section 8.30 dealing with the duty of the care and the business judgment
rule;
2. section 7.40 dealing with procedures in derivative actions, since the
section as presently written does not address the role of an independent
committee of the board of directors in dismissing a derivative action;
3. section 8.31 dealing with the duty of loyalty as it applies to transactions
between a corporation and its officers and directors;
4. other sections, as a part of the committee's duty to revise the Act from
time to time in order to keep it current.

The Committee on Corporate Laws will prepare guidebooks or articles on "The

Duties of Directors of Corporations, the Majority of Whose Stock is Closely
Held" and "The Duties of Directors of a Corporation Which is a Target of a
Hostile Tender Offer."

There will be some changes in corporate practice if some of the provisions of

the Model Business Corporation Act are adopted as a part of state corporation
laws. For instance, the Close Corporation Supplement will make it possible to
eliminate the board of directors of wholly owned subsidiaries. Because of the
provisions eliminating par value and stated value, new questions will arise as to
the propriety of the payment of dividends.
We may expect new answers to new questions which are being presented to
boards of directors today. These questions include the duties of directors in

28. H. R. 3561, 98th Cong., 1st Sess. (1984).

This content downloaded from 49.150.10.249 on Thu, 17 Jan 2019 00:58:43 UTC
All use subject to https://about.jstor.org/terms
 Dynamics of Corporate Control: Future Law 1549

connection with the divestiture of a division or subsidiary, the duties of directors

of a parent corporation with respect to the business and affairs of a subsidiary
which is an integral part of the parent, and the possibility of resolving disputes
by methods other than litigation. And, as we look to the future, we may expect
further tensions, as those who advocate more control of publicly held corpora-
tions debate those who advocate reliance on the market to control publicly held
corporations.

This content downloaded from 49.150.10.249 on Thu, 17 Jan 2019 00:58:43 UTC
All use subject to https://about.jstor.org/terms