Academic journal article Fordham Journal of Corporate & Financial Law

In Search of a Higher Standard: Rethinking Fiduciary Duties of Directors of Wholly-Owned Subsidiaries

Academic journal article Fordham Journal of Corporate & Financial Law

In Search of a Higher Standard: Rethinking Fiduciary Duties of Directors of Wholly-Owned Subsidiaries

Article excerpt

[T]o say that a man is a fiduciary only begins analysis; it gives direction to further inquiry. To whom is he a fiduciary? What obligations does he owe as a fiduciary? In what respects has he failed to discharge these obligations? And what are the consequences of his deviation from duty?

Justice Frankfurter1

[O]ur corporate law is not static. It must grow and develop in response to, indeed in anticipation of, evolving concepts and needs.

Unocal Corp. v. Mesa Petroleum Co.2

I. INTRODUCTION

Recent corporate scandals have made us aware of the abuses that can occur when corporate officers and directors succumb to greed in pursuit of the ever-increasing share price.3 Due to the power dynamics inherent in the parent/wholly-owned subsidiary context, the whollyowned subsidiary is particularly vulnerable to manipulation.4 Imagine, for example, that you are a director of a wholly-owned subsidiary. You suspect that the parent company wants to loot the subsidiary or have the subsidiary engage in various sweetheart deals with the parent in order to improve the parent's bottom line.5 What should you do? You certainly have a fiduciary duty to the parent.6 But you also have a duty to the wholly-owned subsidiary as an entity.7 In addition, you may (depending on the circumstances) have duties to the subsidiary's creditors,8 as well as certain government regulators.9 Finally, the interests of other constituencies may need to be considered.10

You are faced with a dilemma." You can either: serve the parent and risk being sued by creditors, regulators and/or other constituencies;12 serve the subsidiary and risk being sued and/or fired by the parent; or, you can quit.13 Where shall you look for guidance? This is obviously an important area of the law,14 but due in large part to the fact that, generally speaking, only the parent has standing to sue the board of its wholly-owned subsidiary (and it is much easier to just replace the directors), it is an area of the law that is far from well-developed.15 The Delaware Supreme Court has said that "in a parent and wholly owned subsidiary context, the directors of the subsidiary are obligated only to manage the affairs of the subsidiary in the best interests of the parent and its shareholders."16 Meanwhile, the United States District Court for the District of Columbia has said that "the directors of a wholly-owned subsidiary owe the corporation fiduciary duties, just as they would any other corporation."17 As for legal commentators, one has argued that a fundamental rights analysis should be applied to differentiate "legitimate" from "illegitimate" shareholder demands in the whollyowned subsidiary context.18 Another commentator has suggested that due to the uniquely insulated nature of the relationship between a parent company and its wholly-owned subsidiary, directors of wholly-owned subsidiaries should be held to a lesser standard than other directorsperhaps all we should expect of them is to act as mere agents of the parent.19 In this article, however, I will argue that precisely because the relationship between a parent company and its wholly-owned subsidiary is so insulated, directors of wholly-owned subsidiaries should be held to higher fiduciary standards than other directors. In the alternative, I argue that a derivative right to enforce the wholly-owned subsidiary director's duty to the corporation should be granted to stakeholders.

Following this Introduction, Part II of this article will examine the historical background and theories of the corporation generally. This examination of the historical background of the corporation will serve to remind us that the state's interest in bestowing limited liability upon shareholders and immortality upon the corporate entity is not merely to make shareholders wealthy, but rather to utilize shareholder wealth aggrandizement as a means to foster economic growth generally.20 We shall see how both the so-called "race to the bottom" and the takeover boom of the 1980s laid the groundwork for the modern stakeholder empowerment movement in corporate law. …

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