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 To those who taught me: the late S. Samuel Arsht and Andrew B. Kirkpatrick of the Delaware
bar; Martin Lipton of the New York bar; Hon. Walter K. Stapleton of the Third Circuit Court of
Appeals; and especially to those I teach daily, Joshua, Benjamin and William W. Allen who
came late in my life, but in time! Bless you all.
— William T. Allen

To those who have made this casebook possible: especially Victor Brudney, whose generous
assistance with materials rescued me during my first year of teaching corporate law, and whose
advice and criticism have been invaluable ever since; and especially to my former students
whose insights from practice have enriched my own understanding of business organization.
— Reinier Kraakman
SUMMARY OF CONTENTS
Contents
Preface
Acknowledgments
Introduction

1. ACTING THROUGH OTHERS: THE LAW OF AGENCY

2. JOINT OWNERSHIP OF A BUSINESS: THE LAW OF PARTNERSHIPS AND
LIMITED LIABILITY COMPANIES
3. THE CORPORATE FORM
4. THE PROTECTION OF CREDITORS
5. DEBT, EQUITY, AND ECONOMIC VALUE
6. NORMAL GOVERNANCE: THE VOTING SYSTEM
7. NORMAL GOVERNANCE: THE DUTY OF CARE
8. THE DUTY OF LOYALTY: CONFLICT TRANSACTIONS
9. EXECUTIVE COMPENSATION
10. SHAREHOLDER LAWSUITS
11. TRANSACTIONS IN CONTROL
12. FUNDAMENTAL TRANSACTIONS: MERGERS AND ACQUISITIONS
13. PUBLIC CONTESTS FOR CORPORATE CONTROL
14. TRADING IN THE CORPORATION’S SECURITIES

Table of Cases
Index
CONTENTS

Preface
Acknowledgments

INTRODUCTION

ACTING THROUGH OTHERS: THE LAW

OF AGENCY

1.1 INTRODUCTION TO AGENCY

1.2 AGENCY FORMATION, AGENCY TERMINATION, AND PRINCIPAL’S
LIABILITY
1.2.1 Formation
1.2.2 Termination
1.2.3 Parties’ Conception Does Not Control
Jenson Farms Co. v. Cargill, Inc.
1.2.4 Liability in Contract
1.2.4.1 Actual and Apparent Authority
White v. Thomas
1.2.4.2 Inherent Authority
Gallant Ins. Co. v. Isaac
1.2.5 Liability in Tort
Humble Oil & Refining Co. v. Martin
Hoover v. Sun Oil Co.
1.2.6 Liability in Tort Under the Apparent Authority Doctrine
1.3 THE GOVERNANCE OF AGENCY (THE AGENT’S DUTIES)
1.3.1 The Nature of the Agent’s Fiduciary Relationship
1.3.2 The Agent’s Duty of Loyalty to the Principal
Tarnowski v. Resop
1.3.3 The Trustee’s Duty to Trust Beneficiaries
In re Gleeson
JOINT OWNERSHIP OF A BUSINESS:
THE LAW OF PARTNERSHIPS AND LIMITED
LIABILITY COMPANIES

2.1 INTRODUCTION TO PARTNERSHIP: WHY JOINT OWNERSHIP?

William Klein & John C. Coffee, The Need
To Assemble At-Risk Capital
2.2 PARTNERSHIP FORMATION
Vohland v. Sweet
2.3 RELATIONS WITH THIRD PARTIES
2.3.1 Partnership Creditors’ Claims Against Departing Partners
2.3.2 Third-Party Claims Against Partnership Property
2.3.3 Claims of Partnership Creditors to Partner’s Individual
Property
2.4 PARTNERSHIP GOVERNANCE AND ISSUES OF AUTHORITY
National Biscuit Co. v. Stroud
2.5 TERMINATION (DISSOLUTION AND DISSOCIATION)
2.5.1 Accounting for Partnership’s Financial Status and Performance
Sample Partnership Balance Sheet
Sample Partnership Income Statement
Accounting for Partners’ Capital
Adams v. Jarvis
2.5.2 Statutory Dissolution of a Partnership at Will
2.5.3 Opportunistic Dissolution and the Partner’s Duty of Loyalty
Page v. Page
2.6 AGENCY CONFLICTS AMONG CO-OWNERS: FIDUCIARY DUTIES
Meinhard v. Salmon
2.7 LIMITED LIABILITY SUCCESSORS OF THE GENERAL PARTNERSHIP
2.7.1 The Limited Partnership
2.7.2 The Limited Liability Partnership
2.7.3 The Limited Liability Company
2.7.3.1 Taxation of LLCs
2.7.3.2 Contractual Flexibility
Pappas et al. v. Tzolis
THE CORPORATE FORM

3.1 INTRODUCTION TO THE CORPORATE FORM

3.2 CREATION OF A FICTIONAL LEGAL ENTITY
3.2.1 A Note on the History of Corporate Formation
3.2.2 The Process of Incorporating Today
3.2.3 The Articles of Incorporation, or “Charter”
3.2.4 The Corporate Bylaws
3.2.5 Shareholders’ Agreements
3.3 LIMITED LIABILITY
Frank Easterbrook & Daniel Fischel,
Limited Liability and the Corporation
3.4 TRANSFERABLE SHARES
3.5 CENTRALIZED MANAGEMENT
3.5.1 Legal Construction of the Board
3.5.1.1 The Holder of Primary Management Power
Automatic Self-Cleansing Filter Syndicate Co.,
Ltd. v. Cunninghame
3.5.1.2 Structure and Function of the Board
3.5.1.3 Formality in Board Operation
3.5.1.4 A Critique of Boards
3.5.2 Corporate Officers: Agents of the Corporation
Jennings v. Pittsburgh Mercantile Co.

THE PROTECTION OF CREDITORS

4.1 MANDATORY DISCLOSURE

4.2 CAPITAL REGULATION
4.2.1 Financial Statements
4.2.2 Distribution Constraints
4.2.3 Minimum Capital and Capital Maintenance Requirements
4.3 STANDARD-BASED DUTIES
4.3.1 Director Liability
4.3.2 Creditor Protection: Fraudulent Transfers
4.3.3 Shareholder Liability
 4.3.3.1 Equitable Subordination
Costello v. Fazio
4.3.3.2 Piercing the Corporate Veil
Sea-Land Services, Inc. v. The Pepper Source
Kinney Shoe Corp. v. Polan
4.4 VEIL PIERCING ON BEHALF OF INVOLUNTARY CREDITORS
Walkovszky v. Carlton

DEBT, EQUITY, AND ECONOMIC VALUE

5.1 CAPITAL STRUCTURE

5.1.1 Legal Character of Debt
5.1.2 Legal Character of Equity
5.2 BASIC CONCEPTS OF VALUATION
5.2.1 The Time Value of Money
5.2.2 Risk and Return
5.2.3 Diversification and Systematic Risk
5.3 VALUING ASSETS
5.3.1 The Discount Cash Flow (DCF) Approach
5.3.2 The Relevance of Prices in the Securities Market
In re Emerging Communications Inc.,
Shareholder Litigation

NORMAL GOVERNANCE: THE VOTING SYSTEM

6.1 INTRODUCTION: SHAREHOLDER VOTING IN THE NEW

CORPORATE GOVERNANCE
6.2 ELECTING AND REMOVING DIRECTORS
6.2.1 Electing Directors
6.2.2 Removing Directors
6.3 SHAREHOLDER MEETINGS AND ALTERNATIVES
6.4 PROXY VOTING AND ITS COSTS
Rosenfeld v. Fairchild Engine & Airplane Corp.
6.5 CLASS VOTING
6.6 SHAREHOLDER INFORMATION RIGHTS
6.7 TECHNIQUES FOR SEPARATING CONTROL FROM CASH FLOW RIGHTS
6.7.1 Circular Control Structures
Speiser v. Baker
6.7.2 Vote Buying
Frank Easterbrook & Daniel Fischel, Voting in
Corporate Law
Schreiber v. Carney
6.7.3 Controlling Minority Structures
Lucian A. Bebchuk, Reinier Kraakman &
George G. Triantis, Stock Pyramids,
Cross-Ownership, and Dual Class Equity
6.8 MITIGATING A COLLECTIVE PROBLEM TODAY: ACTIVIST INVESTORS
Marcel Kahan & Edward B. Rock, Hedge
Funds in Corporate Governance and
Corporate Control
6.9 THE FEDERAL PROXY RULES
6.9.1 Rules 14a-1 Through 14a-7: Disclosure and Shareholder
Communication
6.9.2 Activist Investors and the Short Slate Proxy Contest
6.9.3 Access to the Company’s Proxy Statement: Rule 14a-8:
Shareholder Proposals
6.9.4 Rule 14a-9: The Antifraud Rule
Virginia Bankshares, Inc. v. Sandberg
6.10 FIDUCIARY SUPERINTENDENCE OF SHAREHOLDER VOTING
Schnell v. Chris-Craft Industries, Inc.

NORMAL GOVERNANCE: THE DUTY OF CARE

7.1 INTRODUCTION TO THE DUTY OF CARE

7.2 THE DUTY OF CARE AND THE NEED TO MITIGATE DIRECTOR RISK
AVERSION
Gagliardi v. TriFoods International, Inc.
7.3 STATUTORY TECHNIQUES FOR LIMITING DIRECTOR AND OFFICER RISK
EXPOSURE
7.3.1 Indemnification
 Waltuch v. Conticommodity Services, Inc.
7.3.2 Directors and Officers Insurance
7.4 JUDICIAL PROTECTION: THE BUSINESS JUDGMENT RULE
Kamin v. American Express Co.
7.4.1 Understanding the Business Judgment Rule
7.4.2 The Duty of Care in Takeover Cases: A Note
on Smith v. Van Gorkom 244
7.4.3 Additional Statutory Protection: Authorization for Charter
Provisions Waiving Liability for Due Care Violations
7.5 THE BOARD’S DUTY TO MONITOR: LOSSES “CAUSED” BY BOARD
PASSIVITY
Francis v. United Jersey Bank
Graham v. Allis-Chalmers Manufacturing Co.
In the Matter of Michael Marchese
In re Caremark International Inc. Derivative
Litigation
In re Citigroup Inc. Shareholder Derivative
Litigation
7.6 “KNOWING” VIOLATIONS OF LAW
Miller v. AT&T

THE DUTY OF LOYALTY: CONFLICT TRANSACTIONS

8.1 DUTY TO WHOM?

8.1.1 The Shareholder Primacy Norm
A.P. Smith Manufacturing Co. v. Barlow
8.1.2 Constituency Statutes
8.1.3 Defining Corporate Purpose in the Charter: Benefit
Corporations
8.2 SELF-DEALING TRANSACTIONS
8.2.1 The Disclosure Requirement
State ex rel. Hayes Oyster Co. v. Keypoint
Oyster Co.
Melvin Eisenberg, Self-Interested Transactions
in Corporate Law
8.3 THE EFFECT OF APPROVAL BY A DISINTERESTED PARTY
8.3.1 Early Regulation of Fiduciary Self-Dealing
8.3.2 Judicial Review of Self-Dealing Today: The Limited Role
of Safe Harbor Statutes
Cookies Food Products v. Lakes Warehouse
8.3.3 Judicial Review When Transaction Has Been Approved by a
Disinterested Majority of the Board
Melvin Eisenberg, Self-Interested Transactions in
Corporate Law
Cooke v. Oolie
8.3.4 Approval by a Minority of Directors: Special Board
Committees
8.3.5 Shareholder Ratification of Conflict Transactions
Lewis v. Vogelstein
8.4 CORPORATE DIRECTORS AND THE DUTY OF GOOD FAITH
8.5 CONTROLLING SHAREHOLDERS AND THE FAIRNESS STANDARD
8.5.1 Different Treatment for Controlling Shareholders?
Sinclair Oil Corp. v. Levien
Weinberger v. UOP, Inc.
8.5.2 Approval by a Board Minority of “Independent” Directors:
Special Committees
8.6 CORPORATE OPPORTUNITY DOCTRINE
8.6.1 Determining Which Opportunities “Belong” to the
Corporation
8.6.2 When May a Fiduciary Take a Corporate Opportunity?
8.7 THE DUTY OF LOYALTY IN CLOSE CORPORATIONS
Donahue v. Rodd Electrotype Co.
Frank Easterbrook & Daniel Fischel, Close
Corporations and Agency Costs
Smith v. Atlantic Properties, Inc.

EXECUTIVE COMPENSATION

9.1 INTRODUCTION
9.2 THE CHALLENGE OF EXECUTIVE PAY
 9.2.1 Creating Incentives That Align Managers With Investors
9.2.2 Political and Regulatory Responses to Executive Pay
9.3 ARE U.S. CEOs PAID TOO MUCH?
Lucian Bebchuk & Jesse Fried, Pay Without
Performance: Overview of the Issues
Bengt Holmstrom, Pay Without Performance
and the Managerial Power Hypothesis:
A Comment
9.4 JUDICIAL REVIEW OF COMPENSATION
9.4.1 The Law of Executive Officer Compensation
In re The Goldman Sachs Group, Inc.
Shareholder Litigation
9.5 JUDICIAL REVIEW OF DIRECTOR COMPENSATION
Calma v. Templeton

SHAREHOLDER LAWSUITS

10.1 DISTINGUISHING BETWEEN DIRECT AND DERIVATIVE CLAIMS

10.2 SOLVING A COLLECTIVE ACTION PROBLEM: ATTORNEYS’ FEES AND THE
INCENTIVE TO SUE
Fletcher v. A.J. Industries, Inc.
10.3 STANDING REQUIREMENTS
10.4 BALANCING THE RIGHTS OF BOARDS TO MANAGE THE CORPORATION
AND SHAREHOLDERS’ RIGHTS TO OBTAIN JUDICIAL REVIEW
10.4.1 The Demand Requirement of Rule 23
Levine v. Smith
Rales v. Blasband
10.4.2 Special Litigation Committees
Zapata Corp. v. Maldonado
In re Oracle Corp. Derivative Litigation
Joy v. North
10.5 DEALING WITH AN ABUNDANCE OF SHAREHOLDER SUITS: EXCLUSIVE
FORUM BYLAWS
10.6 SETTLEMENT AND INDEMNIFICATION
10.6.1 Settlement by Class Representatives
 10.6.2 Settlement by Special Committee
Carlton Investments v. TLC Beatrice
International Holdings, Inc.
10.7 WHEN ARE DERIVATIVE SUITS IN SHAREHOLDERS’ INTERESTS?

TRANSACTIONS IN CONTROL

11.1 SALES OF CONTROL BLOCKS: THE SELLER’S DUTIES

11.1.1 The Regulation of Control Premia
Zetlin v. Hanson Holdings, Inc.
Perlman v. Feldmann
11.1.2 A Defense of the Market Rule in Sales of Control
Frank H. Easterbrook & Daniel R. Fischel,
Corporate Control Transactions
In re Delphi Financial Group Shareholder
Litigation
11.2 SALE OF CORPORATE OFFICE
11.3 LOOTING
11.4 TENDER OFFERS: THE BUYER’S DUTIES
Brascan Ltd. v. Edper Equities Ltd.
11.5 THE HART-SCOTT-RODINO ACT WAITING PERIOD

FUNDAMENTAL TRANSACTIONS:
MERGERS AND ACQUISITIONS

12.1 INTRODUCTION
12.2 ECONOMIC MOTIVES FOR MERGERS
12.2.1 Integration as a Source of Value
12.2.2 Other Sources of Value in Acquisitions: Tax, Agency Costs,
and Diversification
12.2.3 Suspect Motives for Mergers
12.2.4 Do Mergers Create Value?
12.3 THE EVOLUTION OF THE U.S. CORPORATE LAW OF MERGERS
12.3.1 When Mergers Were Rare
12.3.2 The Modern Era
12.4 THE ALLOCATION OF POWER IN FUNDAMENTAL TRANSACTIONS
12.5 OVERVIEW OF TRANSACTIONAL FORM
12.5.1 Asset Acquisition
Katz v. Bregman
12.5.2 Stock Acquisition
12.5.3 Mergers
12.5.4 Triangular Mergers
12.6 STRUCTURING THE M&A TRANSACTION
12.6.1 Timing
12.6.2 Regulatory Approvals, Consents, and Title Transfers
12.6.3 Planning Around Voting and Appraisal Rights
12.6.4 Due Diligence, Representations and Warranties, Covenants,
and Indemnification
12.6.5 Deal Protections and Termination Fees
12.6.6 Accounting Treatment
12.6.7 A Case Study: Excerpt from Timberjack Agreement and
Plan of Merger
12.7 THE APPRAISAL REMEDY
12.7.1 History and Theory
12.7.2 The Appraisal Alternative in Interested Mergers
12.7.3 The Market-Out Rule
12.7.4 The Nature of “Fair Value”
12.7.5 Discounted Cash Flow Analysis
12.7.6 Current Developments in Appraisal
12.8 THE DE FACTO MERGER DOCTRINE
Hariton v. Arco Electronics, Inc.
12.9 THE DUTY OF LOYALTY IN CONTROLLED MERGERS
12.9.1 Cash Mergers or Freeze-Outs
Kahn v. Lynch Communications Systems, Inc.
Kahn v. M&F Worldwide Corp et al.
11.9.2 Do Controlling Shareholders Have a Duty to Offer Only a
Fair Price on the First, Tender Offer Step of a Two Step
Freeze-Out? 520
In re CNX Gas Corporation Shareholders
Litigation
PUBLIC CONTESTS FOR CORPORATE CONTROL

13.1 INTRODUCTION
13.2 DEFENDING AGAINST HOSTILE TENDER OFFERS
Unocal Corp. v. Mesa Petroleum Co.
13.3 PRIVATE LAW INNOVATION: THE POISON PILL
13.4 CHOOSING A MERGER OR BUYOUT PARTNER: REVLON, ITS SEQUELS,
AND ITS PREQUELS
Smith v. Van Gorkom
Revlon, Inc. v. MacAndrews and Forbes
Holdings, Inc.
13.5 PULLING TOGETHER UNOCAL AND REVLON
Paramount Communications, Inc. v. Time, Inc.
Paramount Communications, Inc. v. QVC
Network, Inc.
13.6 REGULATION OF TAKEOVERS IN OTHER LEGAL SYSTEMS
13.7 BRINGING TAKEOVERS LAW DOWN TO DATE
Lyondell Chemical Co. v. Ryan
C&J Energy Services, Inc. v. City of Miami
General Employees and Sanitation
Employees Retirement Trust
13.8 PROTECTING THE DEAL
13.8.1 “No Shops/No Talks” and “Fiduciary Outs”
13.8.2 Shareholder Lock-ups
Omnicare, Inc. v. NCS Healthcare, Inc.
13.9 STATE ANTITAKEOVER STATUTES
13.9.1 First- and Second-Generation Antitakeover Statutes
(1968-1987)
13.9.2 Third-Generation Antitakeover Statutes
13.10 PROXY CONTESTS FOR CORPORATE CONTROL
Blasius Industries, Inc. v. Atlas Corp.

TRADING IN THE CORPORATION’S SECURITIES

14.1 COMMON LAW OF DIRECTORS’ DUTIES WHEN TRADING IN THE
CORPORATION’S STOCK
Goodwin v. Agassiz
14.2 THE CORPORATE LAW OF INSIDER TRADING POST-GOODWIN
Freeman v. Decio
14.3 §16(b) AND RULE 16-b UNDER THE 1934 ACT
14.4 EXCHANGE ACT §10(b) AND RULE 10b-5
14.4.1 Evolution of Private Right of Action Under §10
14.4.2 Elements of a 10b-5 Claim
14.4.3 Early Rule 10b-5 Insider Trading Liability: The Equal
Access Theory
SEC v. Texas Gulf Sulphur Co.
Santa Fe Industries, Inc. v. Green
14.4.4 The Equal Access Theory of Rule 10b-5 Liability
14.4.5 Elements of 10b-5 Liability: The Fiduciary Duty Theory
Chiarella v. United States
14.4.6 The Problem of Tippees after Chiarella
Dirks v. SEC
United States v. Newman
14.4.7 Note on Regulation FD
14.4.8 The Introduction of the Misappropriation Theory
United States v. O’Hagan
14.4.9 Civil Liability, Civil Fines, and Criminal Penalties for
Security Fraud Violations
Elkind v. Liggett & Myers, Inc.
14.5 THE OTHER SIDE OF 10B-5: FRAUD-ON-THE-MARKET CLASS ACTIONS
14.5.1 Materiality and Reliance in FOM Class Actions
Basic Inc. v. Levinson
14.5.2 Loss Causation in 10b-5 Class Actions
14.5.3 The Role of Class Certification in Recent Challenges to
FOM Actions
14.6 INSIDER TRADING AND FOM CLASS ACTIONS: THE ACADEMIC POLICY
DEBATES
14.6.1 The Insider-Trading Debate
14.6.2 The Academic Policy Debate over FOM Class Actions
Table of Cases
Index
PREFACE TO THE FIFTH EDITION

This book represents our effort to assist students and non-specialist

lawyers to achieve an understanding of the basic principles of law that
undergird the legal structures within which business is conducted in the
United States. Our approach in this effort is premised upon a functional
perspective of law. Thus, we attempt to ask how these legal structures
function to produce desired benefits to parties who enter into agreements
and relationships, or how legal structures (or rules) add costs and can
impede sensible business organization. In this second aspect, the
analytical or critical perspective, our point of view is informed through
our understanding of basic principles of economics. The book, however,
requires of its readers no formal training or understanding of economics.
The concepts are for the most part quite intuitive and easily grasped.
We have organized the book into two segments. The first (and shorter)
of these segments — the Introduction and Chapters 1-3 — deals with the
fundamentals of organizational law in a business setting. Chapter 1
focuses on agency law, which is no less a predicate for modern enterprises
functioning in a market economy than contract or property law. Chapter 2
addresses the partnership form and its modern variants: the limited
partnership, limited liability company, and limited liability partnership.
Chapter 3 introduces the corporate form, explicitly contrasted against the
partnership and its variants, such as the LLC.
The larger segment of the book, Chapters 4-14, addresses the legal
regulation of a variety of actions, decisions, and transactions that involve
or concern the modern public corporation. Chapter 4 explores
relationships among shareholders, corporations, and corporate creditors.
Chapters 5 provides a basic primer on applicable finance concepts useful
in understanding issues respecting estimating costs of funding a business
and estimating asset values. Chapters 6 and 7 explore what we term
“normal governance” — that is, the legal framework that regulates the
vast majority of the corporation’s ordinary business activities. Chapter 6
addresses the routine functioning of the voting system, including the proxy
rules and some current issues in corporate governance. Chapter 7 explores
the duty of care, together with the multiple legal devices that insulate
corporate officers and directors from shareholder liability, including, most
notably, the business judgment rule.
Chapters 8 and 13 are devoted to particular classes of corporate actions
and related shareholder transactions that are subject to more specialized
regulation by corporate law. Chapter 8 addresses self-dealing and other
potential duty of loyalty issues arising from the conduct of corporate
officers, directors, and controlling shareholders. Chapter 9 focuses on the
particular challenges of executive compensation. Chapter 10 reviews the
law and practice of shareholder derivative suits. Chapter 11 examines
transactions in corporate control, including sales of control blocks of
shares and tender offers. Chapter 12 addresses the specialized legal
treatment of so-called fundamental corporate actions, with special
attention to merger and acquisition transactions. Chapter 13 turns to the
dramatic topic of conflicts for corporate control, including hostile tender
offers and proxy contexts. And finally, Chapter 14 examines the regulation
of transactions in shares on the public markets, including such topics as
insider trading and fraud on the market.
Throughout, the fifth edition contains substantial updating from the
fourth edition, especially respecting the topics of corporate finance,
corporate governance, mergers & acquisitions and securities regulations.
The basic structure and insights of the book remain unchanged, however.
These materials continue to be structured in a way that conforms to the
simple insight that much of corporate law can be divided into general
governance, on the one hand, and discrete areas of specialized governance
on the other. We expect some teachers will present the materials in a
different sequence. We have taken care to facilitate alternative approaches
by recapping in later chapters points more exhaustively made in earlier
ones and by supplying cross-references for further review.
The book contains a number of notes that are perhaps a bit longer and
more openly explanatory than other authors prefer. In this we have been
motivated by our experience as teachers to want to provide a rather full
textual basis for a general understanding of each subject. Our aim is to
provide for those happy occasions when class gets deeply involved in an
interesting discussion. In this event we are comforted by the knowledge
that we can move on to the next class knowing that all of the basic
information and insights have been made available to the class in the
reading assignment.
 In the end, what makes this branch of law so interesting (and
frustrating) to students, practitioners, and scholars alike is the vital role
played in it by the open-textured concept of fiduciary duty. From the early
study of agency, to its conclusion with corporate mergers and acquisitions,
the field and these materials offer myriad puzzles arising from the
admixture of morality and efficiency that is often encountered when courts
are required to fill in the specifics of a fiduciary’s obligations. In
approaching this subject, the book places primary emphasis on the
Delaware statute and decisions, as that law grows in its dominant
importance for publicly financed corporations in the United States.
Opinions by the Delaware Court of Chancery and the Delaware Supreme
Court tend to outnumber cases from other jurisdictions.
We must offer very real thanks and appreciation to colleagues and
friends who have taught from these materials for some years and who have
been generous in their comments, contributions, and suggestions. First
among these is Guhan Subramanian, our talented coauthor on several prior
editions of this Book. Needless to say, we are grateful for his numerous
contributions in the past and, like loyal continuing partners, we are fully
prepared to hold him intellectually harmless for the novel content of the
5th Edition. Next among those to whom we owe deep gratitude are Victor
Brudney, whose teaching materials provided the starting point for this
book, and Henry Hansmann, who has commented so richly and so long
that it would be difficult to exaggerate our gratitude. Other colleagues
have made useful comments and supplied detailed guidance. Among these
are Jennifer Arlen, Ryan Bubb, Lucian Bebchuk, Bernard Black, John
Coates, Rob Daines, Jill Fisch, Jesse Fried, Jon Hanson, Hon. Jack B.
Jacobs, Marcel Kahan, Ehud Kamar, Vic Khanna, Stephen J. Lubben, Mark
Roe, and Hon. Leo Strine. We acknowledge gladly our debt to them. In
addition, numerous anonymous reviewers made very helpful comments,
and we hope that they will find the book improved because of their efforts.
Finally, we each owe a debt of gratitude to student researchers and
secretarial associates. Among students, some especially stand out for their
glad assistance: Alison Gooley, NYU, 1999, of the Bar of New South
Wales; Ronnie Deutch, NYU, 2002, of the New York bar; Melissa
Anderson, HLS, 2009; Jeffrey Young, HLS, 2010; Maria Parra-Orlandoni,
HLS, 2015 and Divya Suwasin, NYU 2016. Susannah Atkins, Carol
Bateson, Cara R. Conlin, Linell Hanover, Annie Hard, Barbara Karasinski,
Kimberly Peterson, and Paula Prather offered cheerful and highly
competent assistance. Our gratitude extends to them all.

William T. Allen
Reinier Kraakman
February 2016
ACKNOWLEDGMENTS

We thank the authors and copyright holders of the following works for
permitting their inclusion in this book:

Bebchuk and Fried, Pay Without Performance: Overview of the Issues,

30 J. Corp. L. 647 (2005).
Bebchuk, Kraakman, and Triantis, Stock Pyramids, Cross-Ownership,
and Dual Class Equity, 295ff. in Randall K. Morck, ed., Concentrated
Corporate Ownership (2000).
Easterbrook and Fischel, Close Corporations and Agency Costs, 38
Stan. L. Rev. 271 (1986). Stanford Law Review by School of Law, Stanford
University, Copyright © 1986. Reproduced with permission of Stanford
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INTRODUCTION

Like much of civil law, the law of business enterprises is concerned with
facilitating voluntary economic relationships. Property law and contract
law are the legal bedrock of market economies, but other bodies of law are
also important. Among these are the laws of security interests, money and
credit, bankruptcy, intellectual property, agency, and enterprise
organization. This book deals primarily with the last, but hardly the least,
of these fields: the law of enterprise organization. In particular, we address
the laws of agency, partnership (and related limited liability entities), and
corporations.
Because cooperative economic relationships frequently raise the same
recurring problems, the law provides a useful menu of standard forms to
address these problems. Thus, the laws of agency, partnership,
noncorporate limited liability entities, and corporations can be seen as
offering parties a set of standard legal forms from which to choose the
form most suited to their needs. The choice of a standard form is
implicitly a contractual choice. Moreover, these forms themselves are
more or less contractual insofar as they may be customized or fine-tuned
by the parties by express agreement — and, of course, with the assistance
of expert lawyering. As we shall also see, the laws of agency, partnership,
and corporations are not entirely malleable because fiduciary duties
grounded in equity — a principal focus of this course — limit the
opportunistic use of contractual and even statutory rights. Finally, agency
law as well as the law of all business entities have a “property” dimension
in addition to a contractual dimension, insofar as they may alter the legal
rights of third parties as well as the rights of the parties who enter into
these enterprise relationships.
We begin by examining the law of agency. The agency relationship can
be imagined as the simplest form of business organization. Alternatively it
may be seen as the legal glue that contours the boundaries of a legal
enterprise: Which persons have the power to bind the entity contractually
and in tort or criminal law, and which persons act outside the entity?
Agency law also prefigures many of the most basic and difficult problems
of corporation law, most particularly those arising from the so-called
fiduciary duty of loyalty. From agency, we move to the general partnership
— which we may think of as the simplest form of a jointly owned business
firm. (For our purposes, a “firm” is a form of business relation that has a
temporal dimension, a social identity, and a separate pool of dedicated
business assets.) And from partnership and
other noncorporate forms, we move to our principal subject — the
corporate form — which is the most stable, complex, and socially
important form in the menu of business forms that the law provides.
Before beginning, we will address here two very general themes that
run throughout this book. The first is a policy theme: How does one
evaluate and critique enterprise law, and what are the goals of enterprise
law? The second theme concerns the role that the morally charged
language of enterprise law (it is law, after all) plays in its legitimation and
enforcement.
We begin with the policy theme. It goes without saying that the
fundamental objective of enterprise law — indeed of all law — is to
increase social welfare. Yet, this abstract formulation tells us little about
how enterprise law should contribute to social welfare or how it might be
tweaked to do a better job. Like many other modern commentators on
enterprise law, we sometimes assert that good law is “efficient” law,
meaning that it maximizes the size of the economic pie (even if the pie’s
pieces are allocated quite differently according to whether one is, say, an
investor or an employee).1 At other times we assert that the goal of the
business corporation is to maximize long-term shareholder wealth.
Needless to say, there is a gap of some distance between innocuously
stating that enterprise law should increase social welfare and asserting that
this means furthering the interests of shareholders or other investors of
risk capital.
Some commentators argue that large enterprises such as public
corporations should not privilege shareholder interests over those of other
constituencies such as creditors, employees, suppliers, customers, or even
the interests of society as a whole. We explore these alternative goals in
Chapter 4 (The Protection of Creditors), Chapter 7 (Conflict Transactions:
The Duty of Loyalty), and Chapter 12 (Public Contests for Corporate
Control). Elsewhere, we take the primacy of shareholder interests for
granted. This is not because we believe that shareholder ownership of
corporations is an indisputable and sacred property right, or that it is an
obvious principle of natural law. Rather, it is partly because we believe
that shareholder/investor welfare is a workable if imperfect proxy for
social welfare in most situations, and partly because the primacy of
shareholder/investor welfare dominates American enterprise law as a
matter of pure empirics. The objective of maximizing shareholder welfare
runs so deeply through the relevant statutory and case law that it is rarely
questioned or even stated, except when the conflict between the interests
of shareholders and those of other corporate constituencies grows too
acute to ignore.
Once shareholder/investor welfare is identified as the principal
objective of enterprise law, it follows easily that economic efficiency is
the logical criterion for evaluating enterprise law. Shareholders/investors
are the “equity
holders” or “residual claimants” of business entities — a fancy way of
saying that they don’t get paid until everyone else is paid first, including
business creditors, employees, and suppliers. Any factor that increases
residual value of the enterprise to its shareholders (or other equity
investors) is “efficient” by this criterion — at least if it does not impose
uncompensated costs on third parties such as tort victims. And any factor
that reduces the costs of capital, labor, supplies, and the like adds to the
residual value of the enterprise. Put differently, efficient law adds to the
value of the firm just as any other factor might do, by reducing the costs of
the firm’s inputs and increasing the value of its outputs.
There are at least three specific ways in which enterprise law can
enhance the efficiency of enterprises. The first is by providing standard
platforms for business entities as well as agency contracts and creditor
protections. Where negotiating parties are involved, these platforms are
often an integrated set of default terms open to contractual modification.
Where third-party rights are at stake, the analogous standard terms are
often mandatory. In both cases, however, standard platforms save time and
effort by allowing parties to do business in shorthand, without reinventing
the legal wheel. Second, enterprise law adds value by permitting business
actors to modify third-party property rights in circumstances when
contract alone cannot do the job. We address this function in Chapters 2
and 3, where we demonstrate how legal entities permit investors to divide
their assets among different buckets that serve as collateral for different
groups of creditors. This power to assign specific assets to support
business creditors is enormously useful and yet, as we will argue, cannot
be achieved by contract alone.
Finally, enterprise law provides a variety of rules and standards —
collectively termed “fiduciary duties” — that are intended to either
prevent or remedy self-interested opportunism by parties within
enterprises. The simplest example is that of an agent who agrees to act
loyally on behalf of his principal, but is economically motivated to act
against his principal’s interests in numerous ways, from colluding with
third parties in negotiating contracts on the principal’s behalf to
expropriating the principal’s property or private information for his own
benefit. This genre of opportunism is a chronic problem in every sort of
enterprise, from simple agency relationships to publicly traded
corporations. In the academic literature, it is referred to generically as the
“agency problem” and the costs that inevitably arise from the fact that
agents rather than owners themselves are at work in the enterprise are
referred to as “agency costs.” This problem and the costs that it produces
are not specific to the law of agency at all. Indeed, these are not legal
terms of art. But addressing them lies at the core of the understanding and
critical analysis of much of enterprise law.
As the problem of mitigating agency costs implies, evaluating the
efficiency of a particular legal rule or a particular reform in enterprise law
requires a good deal of knowledge about institutional context and
enforcement. Research in the social sciences can be helpful here. But at
the very least, clarity is essential about one’s empirical assumptions about
the institutional context as well as the weights assigned to particular costs
and benefits. In the end, and over time, the balance of costs and benefits
generally determines the survivorability of legal doctrine here, as in so
many other areas of the law.
However, policy-oriented analysis is certainly not the only aim of the
study of organization law by lawyers. If it were, enterprise law would be
nothing but a pastiche of applied social sciences — mostly economics and
finance perhaps, but with a dash of psychology and organization theory
tossed in. The meaning of this imaginary law would be wholly captured in
phrases such as “efficiency,” “transaction costs,” “collective action
problems,” and the “prisoner’s dilemma.” Its rules and standards would be
understood as more or less well-supported hypotheses. Individual
plaintiffs and defendants would occupy roughly the same status as
laboratory animals behaving in accordance with the vector of their self-
interest and the law’s calibration of incentives. Judges would be the
investigators-in-chief.
Needless to say, this Orwellian account of enterprise law is not the real
thing by a long shot, even if traces of applied social science occur in the
case law and large deposits of it may be found in the academic literature.
The principal statutes of enterprise law, including the statute that will play
the most important role in this book — the Delaware General Corporation
Law (DGCL) — read like an integrated set of self-contained rules that
erect a legal entity, and describe its governance mechanisms. In the
aggregate, they seem to rest on social science no more than the blueprints
for large buildings do. Similarly, if one reads an opinion handed down by
the Delaware Court of Chancery or the Delaware Supreme Court
concerning an issue in corporate law, the number of references to
“efficiency” or “transaction costs” is vanishingly small in comparison to
that of legal terms of art such as “entire fairness” and the “business
judgment rule.” Moreover, the language of these opinions is often morally
charged and didactic. The authorities cited are statutory provisions and
prior case law. This is, in short, law as we know it. The attention to policy
concerns is often here, but it resides in the melody rather than in the
words. The only remotely “scientific” piece of the typical opinion is the
careful attention paid to the facts and institutional context at the outset of
the decision. And this resembles anthropology or history more than
economics.
Phrased more directly, judges and lawyers occupy a different role than
social scientists do. Judges and lawyers are understood to be believers in
the language of law. Indeed, they are the high priests and the deacons of
the faith. For them, the articulated reason for some judicial act is not
simply a concurrence with good policy, but a legally derived cause in
itself. In this faith, law is all about the meaning of legal doctrines:
statutes, court rules, administrative procedures, judicial precedents, and
the rich body of professional learning that allows experienced lawyers to
perform their professional functions. These meanings may be unclear at
times, but the internal processes of law — canons of construction, rules of
authority and judicial processes of discovery, trial and appeal, and even
much scholarship — are about clarifying legal meanings as well as their
application. This is the “interior” perspective on law.
 How, then, can faith and science freely coexist in the study of
enterprise law — and perhaps even in its creation?2 Our long answer to
this question lies in the discussion of the materials in this book. The short
answer comes in several pieces.
The most obvious piece is that the interior perspective on enterprise
law comes first in time. The law’s basic entity forms, its morally charged
categories, and even the forerunners of today’s business statutes long
predate the normative claims made by modern economics. Indeed, some
fundamental concepts in organizational economics were inspired by
enterprise law. Examples include entire subfields of microeconomics such
as “the principal-agent problem,” the idea of “transaction costs,” and the
distinction between production by a principal’s agents within a legal entity
as distinct from acquiring goods or services from independent contractors
in the market.
A second aspect of the coexistence of “faith-based” legal analysis and
economically oriented policy derives from the policy-making role of the
judiciary. Even a judge who is a strict constructionist finds that policy-
making choices are inescapably thrust upon her. Linguistic ambiguity
alone often requires a judge to make choices. To be sure, in such situations
— and they arise frequently in the law of enterprise organization — courts
avoid using concepts like “efficiency” to justify their choices, even if
these concepts are central to evaluating the wisdom of the outcome
reached. However, this may change over the years as more lawyers trained
in economic analysis enter the profession. Even today, one should not
underestimate how many lawyers and judges — especially those who are
frequently involved in business-related cases — are, if not fully bilingual,
able to discourse in the language of economics as well as that of
traditional enterprise law. In business law, the lawyer who fails to
understand the economics of a problem usually fails to find a satisfactory
solution to the problem.
Finally, we hasten to add our prediction that today’s coexistence will
never result in policy analysis supplanting enterprise law as we know it.
There are two reasons. The first is that the vice of microeconomic theory
cannot completely close on the complex institutional structures and
transactions encountered in enterprise law. Markets and contracts are
incomplete, and information is noisy in the real world. Judgments based
on the situational insights of sophisticated lawyers and judges, as
expressed in the language of the law, will ordinarily dominate judgments
mechanically derived from an abstract policy framework. Second and even
more important, business actors are not two-dimensional puppets entirely
controlled by economic concerns. They are moral individuals (albeit more
or less imperfect ones) whose actions often reflect ethical notions as well.
In many cases, the soft prodding of conscience or reputation may elicit
more legal compliance than will the threat of monetary sanctions. The
morally charged language of business law takes aim directly at conscience
and reputation. For most of us, it is one thing to be scolded by a court for
acting inefficiently and quite another to be charged with acting disloyally
or in bad faith. Arguably, in fact, some obligations imposed by enterprise
law are enforced exclusively by these soft sanctions. And arguably, this is
the way it should be.

1. Those familiar with the literature addressing various definitions of efficiency will recognize
that by “efficiency” we mean “Kaldor-Hicks efficiency.” This form of efficiency looks to
increasing the size of the value pie. In principal, a larger pie is divisible in a way that makes all
participants in an enterprise better off. Yet efficient law increases Kaldor-Hicks efficiency by
increasing the size of the pie, regardless of how the increased pie is divided. Kaldor-Hicks
efficiency is to be contrasted with “Pareto efficiency,” under which a change is efficient only if
the pie increases and every constituent’s piece of pie is also increased. The latter criterion is too
demanding to serve as a useful norm in enterprise law.
2. We ask the reader to excuse this phrasing, which borrows from another, more venerable
discussion.
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