Dangerous Liaisons: Corporate Law, Trust Law, and Interdoctrinal Legal Transplants

By Rock, Edward; Wachter, Michael | Northwestern University Law Review, Winter 2002 | Go to article overview

Dangerous Liaisons: Corporate Law, Trust Law, and Interdoctrinal Legal Transplants


Rock, Edward, Wachter, Michael, Northwestern University Law Review


People were shocked by Smith v. Van Gorkom.1 Teeth were gnashed. The Delaware General Corporate Law ("GCL") was amended. The world went on.

But why were people so surprised and so upset? As we all know, corporate law emerged out of the law of trusts and agency. It had long been said that directors, like trustees and agents, have a duty of care. The trustee's duty of care had classically been elaborated in negligence terms, as a duty "to exercise such care and skill as a man of ordinary prudence would exercise in dealing with his own property."2 When trustees act negligently, they are liable for the damages that they cause. Agents, too, are liable for negligence in the performance of their duties.3 And, here, in Smith v. Van Gorkom, we had a case in which, at least in the eyes of the Delaware Supreme Court, directors acted with gross negligence. So liability was imposed. Why such a big deal?

One answer is that it had never happened before. Never before had Delaware directors been held liable for a breach of the duty of care absent a breach of the duty of loyalty, at least outside the context of financial institutions. But, as an explanation, that answer is incomplete. First, it does not explain why it had not happened before. Moreover, it does not explain whether finally having such a case, which brought with it the prospect of additional such cases, was good or bad for shareholders. Finally, it does not explain why this negligence-based fiduciary duty of care was and is a fixture of trust and agency law while it proves so troublesome in corporate law.

So what is going on? How is it that corporate law is drawn to talking about a director's duty of care as "the care that an ordinarily prudent person would exercise under similar circumstances,"4 yet, when courts finally take that talk seriously, the corporate world rebels? Why is corporate law's flirtation with negligence talk such a dangerous liaison? That is the question we address in this Article.

What is required is both an analysis and a diagnosis. We provide both. The duty of care is a "legal transplant": it is a fixture of the classical law of trusts and agency that was transplanted into corporate law along with the duty of loyalty. As is often the case with legal transplants, whether interdoctrinal or cross border, transplants can cause mischief.5 When a legal concept is taken from one context and incorporated into a fundamentally different setting, it may carry with it implications and characteristics that do not serve anyone's interests. The logic of legal concepts has a momentum of its own.

The peculiar problems with corporate law's duty of care derive from the transplanting of a concept from the market context into the firm context. Difficulties arise if one fails to recognize the market-firm boundary as critical. That boundary represents a choice of governance structure, a choice between third-party judicial enforcement of market transactions and nonlegal self-governance within firms.

In moving unselfconsciously across this boundary, the seeds of mischief were sown. It is, indeed, evidence of corporate law's sensitivity to the underlying economic logic of firms that, through the device of the business judgment rule, it was able to keep the mischief at bay for so long. Eventually, however, the logic of legal concepts won out, and the court imposed liability for negligent director conduct.

The story has a happy ending. Shareholders, managers, and the Delaware legislature rode to the rescue, enacted section 102(b)(7), and largely restored the status quo ante. But it is a cautionary tale nonetheless. Transplanting legal concepts, without attention to the underlying context, can cause great mischief.

I. THE MESS

An "ordinary prudence" or "reasonable person" duty of care, if taken seriously, creates an impossible mess for corporate law. To demonstrate this difficulty, this Part will first review the duties of loyalty and care that apply to trustees and agents and will then trace the problems created in the attempts to incorporate these duties into Delaware corporate law and the Model Business Corporation Act. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Note: primary sources have slightly different requirements for citation. Please see these guidelines for more information.

Cited article

Dangerous Liaisons: Corporate Law, Trust Law, and Interdoctrinal Legal Transplants
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen
Items saved from this article
  • Highlights & Notes
  • Citations
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Search by... Author
    Show... All Results Primary Sources Peer-reviewed

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.