This Article diagnoses the failure of D&O insurance as a form of pernicious relational contracting. Insurers ignore even the worst corporate governance because they can recoup losses in the years to come. This recognition unlocks a potential solution: mandatory rotation. If insurers had only a few years to recoup any losses, they would seek to limit those losses by serving as an active gatekeeper.

Introduction

In a typical year, managers of corporations representing about 10% of America’s big public corporations are sued by their investors.¹ 1.Securities Class Action Filings: 2019 Year in Review, Cornerstone Research 13, https​://securities.stanford.edu/research-reports/1996-2019/Cornerstone-Research-Securities-Class​-Action-Filings-2019-YIR.pdf [https://perma.cc/PD8P-YL84] (reporting 10% of S&P 500 by market cap was sued for securities violations in 2019). Last year brought slightly fewer. Securities Class Action Filings: 2021 Year in Review, Cornerstone Research 15, https://www.cornerstone.com/wp-content/uploads/2022/02/Securities-Class-Action-Filings-2​021-Year-in-Review.pdf. [https://perma.cc/4JGL-35SH]. This 10% figure plainly understates the scope of litigation, since many investors’ suits are derivative actions with no securities violation component, but comprehensive data for derivative suits are not available.In this Article, I use the word “manager” to refer to both officers and directors.Show More These suits cost billions of dollars to litigate and settle.² 2.Alice Uribe & Leslie Scism, Companies Are Paying a Lot More to Insure Their Directors and Officers, Wall St. J. (June 21, 2020, 5:30 AM), https://www.wsj.com/articles/companies-are-paying-a-lot-more-to-insure-their-directors-and-officers-11592731801?mod=hp_listc_po​s2 [https://perma.cc/93HE-LMK9] (reporting that D&O litigation expenses are approaching $1 billion annually, not including jury verdicts or settlements).Show More Proponents of shareholder litigation argue that America’s corporate directors and officers are prone to gross negligence, bad faith, and self-dealing.³ 3.E.g., Eugene V. Rostow, To Whom and For What End is Corporate Management Responsible?, in The Corporation In Modern Society 48 (Edward S. Mason ed., 1959) (characterizing derivative suits as “the most important procedure the law has yet developed to police the internal affairs of corporations”); Robert B. Thompson & Randall S. Thomas, The Public and Private Faces of Derivative Lawsuits, 57 Vand. L. Rev. 1747, 1786–87 (2004) (finding data that derivative suits play a valuable monitoring role in duty of loyalty cases and that the tool combats unscrupulous directors); see also Jill E. Fisch, Teaching Corporate Governance Through Shareholder Litigation, 34 Ga. L. Rev. 745, 746 (2000) (explaining how the rules of shareholder litigation can “deter[] corporate misconduct”).Show More Critics argue that these are attorney-driven “strike suits.”⁴ 4.See Rostow, supranote 3; Stephen M. Bainbridge, Fee-Shifting: Delaware’s Self-Inflicted Wound, 40 Del. J. Corp. L. 851, 852–53 (2016); Roberta Romano, The Shareholder Suit: Litigation without Foundation?, 7 J.L. Econ. & Org. 55, 84 (1991); Sean J. Griffith, Correcting Corporate Benefit: How to Fix Shareholder Litigation by Shifting the Doctrine on Fees, 56 B.C. L. Rev. 1, 2 (2015).Show More

Nearly everyone agrees that directors’ and officers’ insurance (“D&O insurance”) is part of the problem.⁵ 5.Dain C. Donelson, Justin J. Hopkins & Christopher G. Yust, The Role of Directors’ and Officers’ Insurance in Securities Fraud Class Action Settlements, 58 J.L. & Econ. 747, 748 (2015); see Sean J. Griffith, Uncovering A Gatekeeper: Why the SEC Should Mandate Disclosure of Details Concerning Directors’ and Officers’ Liability Insurance Policies, 154 U. Pa. L. Rev. 1147, 1189 (2006).Show More

Essentially all public companies buy insurance to protect their managers from the cost of shareholder litigation, and it is easy to see how widespread insurance can cause problems.⁶ 6.Griffith, supra note 5, at 1168.Show More Insured officers and directors are protected against the legal consequences of their mismanagement and recklessness.⁷ 7.Id. at 1163.Show More They can behave badly without ever seeing the bill. The insurance company pays the bill. Indeed, managers may ask insurers to pay lucrative settlements, even in meritless cases, just to minimize the hassle and cost of litigation.⁸ 8.Tom Baker & Sean J. Griffith, How the Merits Matter: Directors’ and Officers’ Insurance and Securities Settlements, 157 U. Pa. L. Rev. 755, 797–98 (2009).Show More And it is insurers’ reputation as honeypots that draws plaintiffs’ lawyers to concoct meritless suits.⁹ 9.See Richard M. Phillips & Gilbert C. Miller, The Private Securities Litigation Reform Act of 1995: Rebalancing Litigation Risks and Rewards for Class Action Plaintiffs, Defendants and Lawyers, 51 Bus. Law. 1009, 1014–15 (1996).Show More Thus, D&O insurance serves to clog up dockets with stories of misbehavior, both encouraged and imagined.

This critique is strange because it is at odds with a plausible theory of gatekeeper behavior.¹⁰ 10.The “gatekeeper” idea is that trusted professionals near the corporation can be used as external checks on fraud and mismanagement. See John C. Coffee, Jr., The Acquiescent Gatekeeper: Reputational Intermediaries, Auditor Independence and Governance of Accounting 11–13 (Colum. L. Sch., Ctr. For L. & Econ. Stud., Working Paper No. 191, 2001), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=270944 [https://perma.cc/LM3D-3T6H].Show More Why would insurers sign up to be punching bags?¹¹ 11.See Joseph A. Grundfest, Punctuated Equilibria in the Evolution of United States Securities Regulation, 8 Stan. J.L. Bus. & Fin. 1, 7–8 (2002) (“D&O insurers could today easily make the retention of insurer-approved auditors a condition of coverage. They could today also require an element of control over the audit process. Yet they don’t. Why?”).Show More Insurers have strong incentives to watch for warning signs and drop customers before the hammer drops, or at least to increase insurance premiums vividly when clients stand on the precipice of trouble.¹² 12.Such responses were once common. Roberta Romano, What Went Wrong With Directors’ and Officers’ Liability Insurance?, 14 Del. J. Corp. L. 1, 12 (1989). Professor Romano’s article diagnosed insurer responses to a sudden increase in liability exposure, so it is unsurprising that insurers reacted in this way. Id. at 13. There is no indication that this tendency to withdraw is still commonplace.Show More They have strong incentives to monitor their insureds for dangerous risk. They have strong incentives to retain control of individual suits to fight meritless ones. All of these risk-controlling practices are commonplace when insurers offer nearly any other kind of multi-million-dollar coverage. ¹³ 13.Richard V. Eicson & Aaron Doyle, Uncertain Business: Risk, Insurance and the Limits of Knowledge 94–211 (2004) (reporting research from a variety of contexts including building construction and disability management); Steven Shavell, On Liability and Insurance, 13 Bell J. Econ. 120, 121–22 (1982) (modeling the relationship between liability and insurance and concluding that, “[a]lthough the purchase of liability insurance changes the incentives created by liability rules, the terms of the insurance policies sold in a competitive setting would be such as to provide an appropriate substitute (but not necessarily equivalent) set of incentives to reduce accident risks”).Show More Critics of D&O insurance tacitly assume that these insurers are uniquely negligent in protecting themselves from moral hazard, adverse selection, and predation.¹⁴ 14.Moral hazard is the tendency of insured parties to engage in riskier conduct. Kenneth J. Arrow, Uncertainty and the Welfare Economics of Medical Care, 53 Am. Econ. Rev. 941, 961 (1963); Daniel Schwarcz, Reevaluating Standardized Insurance Policies, 78 U. Chi. L. Rev. 1263, 1283 (2011). With respect to health insurance, smoking has been described as the “classic moral hazard.” Thomas R. McLean, International Law, Telemedicine & Health Insurance: China as a Case Study, 32 Am. J.L. & Med. 7, 25 (2006). Adverse selection is the tendency of the costliest clients to seek out coverage offered at a given price. Cf. George A. Akerlof, The Market for “Lemons”: Quality Uncertainty and the Market Mechanism, 84 Q.J. Econ. 488, 488 (1970) (setting out a canonical adverse selection model in a non-insurance commercial setting); Peter Siegelman, Adverse Selection in Insurance Markets: An Exaggerated Threat, 113 Yale L.J. 1223, 1223 (2004) (explaining that adverse selection is a process where “insureds utilize private knowledge of their own riskiness when deciding to buy or forgo insurance”).Show More

For now, it appears the critics are right and theory is wrong. D&O insurers do not drop their clients regularly; instead, renewal rates approach 100%.¹⁵ 15.Aon, Quarterly D&O Pricing Index: Fourth Quarter and Full Year 2018, at 9 (2018), https://www.aon.com/getmedia/20bfac85-dce6-4902-91cb-c61265abcd7e/2018-Q4-DO-Pric​ing-Index.aspx [https://perma.cc/PR58-CPUT] (95.7% annual retention); Aon, Quarterly D&O Pricing Index: Fourth Quarter and Full Year 2017, at 9 (2017), https://ww​w.aon.com/attachments/risk-services/d-o_pricing_index/2017_Q4_DO_Pricing_Index.pdf [h​ttps://perma.cc/V33R-ZY9U] (93.2% annual retention); Aon, Quarterly D&O Pricing Index: Fourth Quarter and Full Year 2016, at 8 (2016), https://www.aon.com/attachme​nts/risk-services/d-o_pricing_index/2016_Q4_DO_Pricing_I​ndex.pdf [https://perma.cc/HRY​4-4HTA] (95.3% annual retention); Aon, Quarterly D&O Pricing Index: Fourth Quarter and Full Year 2015, at 8 (2015), https://www.aon.com/attachments/risk-services/d-o_pricing_index​/2015_Q4_DO_Pricing_Index.pdf [https://perma.cc/J5WG-K6QQ] (95% annual retention); Aon, Quarterly D&O Pricing Index: Fourth Quarter and Full Year 2014, at 8 (2014), https://www.aon.com/attachments/risk-services/d-o_pricing_index/201​4_Q4_DO_Pricing_I​ndex.pdf [https://perma.cc/8CDA-MSYG] (93.7% annual retention); Aon, Quarterly D&O Pricing Index: Fourth Quarter and Full Year 2013, at 3 (2013), https://www.aon​.com/attachments/risk-services/d-o_pricing_index/2013_Q4_DO_P​ricing-Index.pdf [https://​perma.cc/22DW-YDPB] (94.9% annual retention) Aon, Quarterly D&O Pricing Index: Fourth Quarter and Full Year 2012, at 3 (2012), https://www.aon.com/attachments/risk-services/d-o_pricing_index/2012_4Q_DandOPricingI​ndex.pdf [https://perma.cc/4GJU-4PKG] (94% retention for Q4).Show More D&O insurers do not penalize risky clients with much higher premiums; instead, premium increases are almost lockstep.¹⁶ 16.Alicia Davis Evans, The Investor Compensation Fund, 33 J. Corp. L. 223, 261 (2007) (“Currently, competitive pressures appear to make it impossible for D&O insurer premium prices to reflect governance risk fully.”).Show More D&O insurers do not monitor clients’ quality of governance and risk-exposure; instead, insurers devote essentially zero effort to monitoring existing clients.¹⁷ 17.Infra Section II.C.Show More Insurers do not fight weak claims; instead, they cede control over litigation to the client and agree to settle essentially every well-pleaded complaint.¹⁸ 18.Baker & Griffith, supra note 8, at 797–804.Show More Far from gatekeepers, insurers have become cheerful doormen for those who would cart the insurer’s wealth, and that of the corporate client, out the door.¹⁹ 19.Cf. Grundfest, supra note 11, at 7 (noting that “the current structure of D&O insurance and auditor liability has failed to give rise to incentives” to address fraud risks even though “D&O insurers could today easily make the retention of insurer-approved auditors a condition of coverage”).Show More

Why? And what can be done to fix it? This Article explains the failure of the D&O insurance market and a solution. The analysis is moderate in that it accepts the good and bad of D&O insurance and tries to tilt the balance,²⁰ 20.See Shauhin A. Talesh, Insurance Companies as Corporate Regulators: The Good, The Bad, and the Ugly, 66 DePaul L. Rev. 463, 467 (2017) (“The debate going forward is not whether insurers are good risk regulators as prior scholars theorize, but more precisely, examining under what conditions can insurers make positive regulatory interventions into corporate behavior and nudge corporations toward a governance structure in line with societal values of fairness, equality, transparency, and safety.”); Chen Lin, Micah S. Officer, Thomas Schmid & Hong Zou, Is Skin in the Game a Game Changer? Evidence from Mandatory Changes of D&O Insurance Policies, 68 J. Acct. & Econ. 1–2 (2019) (arguing that the structure of insurance policies matters).Show More rather than, say, banning D&O insurance altogether.²¹ 21.See, e.g., Merritt B. Fox, Civil Liability and Mandatory Disclosure, 109 Colum. L. Rev. 237, 288–89 (2009) (calling for an end to D&O insurance for certain securities violations).Show More This Article’s argument contains four premises.

First, insurance (D&O and otherwise) can be operated in an “active” or “passive” fashion.²² 22.Most insurers do not embrace a purely active or passive strategy, and it can be difficult to distinguish them in many cases. An insured who makes a costly claim may see her future premium rise from either an active or passive insurer, but for very different reasons. The active insurer raises the rate insofar as the claim signals information about the client’s type and future riskiness. The passive insurer raises the rate simply because that is the deal: the insurer pays now and recoups later, even if the claim was a fluke and signals nothing about the insured’s risk.Show More An active insurer seeks to address clients’ risks by discovering current risk level, setting premiums that reflect it, and discouraging excessively risky behavior.²³ 23.Daniel Schwarcz, Coverage Information in Insurance Law, 101 Minn. L. Rev. 1457, 1487 (2017) (“[T]he risk of moral hazard only exists when the insurer does not observe policyholder levels of activity or care after purchase . . . .”).Show More By contrast, a passive insurer does little vetting, risk-pricing, or monitoring. Instead, the passive insurer just seeks to recoup losses on a costly client by charging that client more in the future.²⁴ 24.Infra Section III.A.Show More

Second, active insurance is socially preferable at the margin. Active insurers encourage least-cost avoiders to avoid risks. They force their customers to internalize their expected costs.²⁵ 25.Omri Ben-Shahar & Kyle D. Logue, Outsourcing Regulation: How Insurance Reduces Moral Hazard, 111 Mich. L. Rev. 197, 228 n.102 (2012).Show More And they generate information about the magnitude of risks.²⁶ 26.See Tom Baker & Sean J. Griffith, Predicting Corporate Governance Risk: Evidence from the Directors’ and Officers’ Liability Insurance Market, 74 U. Chi. L. Rev. 487, 489–90 (2007) (arguing that insurance premiums can publicize problematic governance).Show More At a minimum, the board may ask the chief executive officer (“CEO”) for an explanation if insurance costs treble. Conversely, passive insurers are more problematic. They protect bad managers from the cost of their bad conduct, and muddy the signal litigation might otherwise send, by spreading the cost of managerial malfeasance into distant future periods. For that reason, society will tend to be better served by relatively more active insurance and managers will tend to prefer relatively more passive insurance.

Third, the passive method is viable only if the market for insurance is rather uncompetitive and illiquid, because it requires customers to submit themselves to years of premiums that exceed the actuarially fair rate.²⁷ 27.Infra Sections III.B. & C.Show More If the insureds often switched under those circumstances, the passive insurance model would collapse. Passive insurance requires enduring relationships between insured and insurer, but it can thrive under those conditions.

Fourth, the existing insurance market is consistent with an excessive degree of passive insurance, owing to agency costs and transaction costs.²⁸ 28.Infra Sections II.C. & III.D.Show More Insurance relationships are long-lasting; switching insurers is rare. For a firm to switch from its longstanding passive insurer to a lower-priced active insurer, directors and officers must approve the change. But directors and officers would be exposed to greater pressure and transparency from an active insurer. At the same time, contracting conventions and market structure impose frictions on competition. Managers can cite these frictions as a reason to retain the passive insurer they like best.

These premises lead to the descriptive conclusion that insufficient client turnover has led D&O insurance to insufficiently address client risk. The normative conclusion is that we should impose mandatory D&O insurance rotation.

Insurers should be permitted no more than five years with a given client, at which time they must take their underwriting elsewhere. Mandatory rotation renders the passive insurance model impractical. Insurers can never hope to insure passively and then recoup their losses down the line. Every insurer will have to actively vet insureds for risks pending over the next few years, to monitor for abrupt changes during that period, and to take steps to limit a corporation’s slide toward increased risk; the result is that corporations and their managers will be more likely to internalize the expected cost of their harmful behaviors and, thus, take those harms more seriously.

Mandatory rotation has been used in other areas of law to destabilize corrupt relationships that compromise gatekeepers and fiduciaries. Auditing partners must rotate every five years.²⁹ 29.Infra Subsection IV.B.1.Show More The theory is that genuine auditing can jeopardize a long relationship, but auditors who know they will soon lose their client anyway are freer to audit honestly. Similar intuitions drive term limits for elected officials.³⁰ 30.Infra Subsection IV.B.2.Show More The temptation to buckle to special interests is greater if it secures reelection. If reelection is impossible, the politician is freer to act according to her best judgment of the public interest. Likewise, career diplomats with the foreign service are permitted only three years in a given foreign country.³¹ 31.Infra Subsection IV.B.3.Show More While these changes may diminish some country-specific expertise, the alternative of long-service may tempt foreign service officers to strike implicit bargains with their host country that undermine America’s interests.

The deep economic intuition behind mandatory insurance rotation is that passive D&O insurance is a relational contract.³² 32.See Jay M. Feinman, The Insurance Relationship as Relational Contract and the “Fairly Debatable” Rule for First-Party Bad Faith, 46 San Diego. L. Rev. 553, 556–57 (2009) (“The insurance contract is a relational contract par excellence. The relation created by the contract extends over time; although a typical policy term is a year, the rate of renewal is very high, often in the order of ninety percent, so a typical relation extends over years or even decades.”). Note that Feinman was not addressing D&O insurance.Show More Relational contracts are agreements that motivate cooperation without recourse to legal enforcement, but are instead embedded in a relationship.³³ 33.See Robert E. Scott, Conflict and Cooperation in Long-Term Contracts, 75 Calif. L. Rev. 2005, 2007–08 (1987); Morten Hviid, Long-Term Contracts and Relational Contracts, in 5The Encyclopedia of Law and Economics 54 (Boudewijn Bouckaert & Gerrit De Geest eds., 1999) (“Relational contract theory can be seen as an attempt to generate a model able to explain when transacting parties do not resort to contracts and by what means they ensure that each party fulfils their obligations. The theory focuses on the relationship between the ‘contracting’ parties and posits that this leads to cooperation and to implicit obligations being self-enforcing.”); Benjamin E. Hermalin, Avery W. Katz & Richard Craswell, Contract Law, in 1 Handbook of Law and Economics 123 (A. Mitchell Polinsky & Steven Shavell eds., 2007) (“Within the literature, self-enforcing contracts are often known as relational contracts.” (emphasis omitted)).Show More For example, a long-term supply agreement may include an unwritten term that the seller may sometimes deliver goods late or mark up prices to reflect rising costs, and the buyer may happily honor that agreement even if no court would enforce it, because the buyer wants to preserve an ongoing profitable relationship.³⁴ 34.For examples of this kind, see, e.g., Stewart Macaulay, Non-Contractual Relations in Business: A Preliminary Study, 28 Am. Socio. Rev. 55, 61–67 (1963); Ian R. MacNeil, The Many Futures of Contracts, 47 S. Cal. L. Rev. 691, 721, 732 (1974); H. Beale & T. Dugdale, Contracts Between Businessmen: Planning and the Use of Contractual Remedies, 2 Brit. J.L. and Soc’y 45, 45–46, 51, 53 (1975).Show More Relational contracts are widespread, but they only succeed when certain fragile conditions are met.³⁵ 35.E.g., Hviid, supra note 33, at 55 (“Repeated interaction may enable cooperation, because of the potential for a current deviation to be punished in the future. For this to work, four conditions must be met.”).Show More Importantly, relational contracts require some mechanism for overcoming the “last period problem.”³⁶ 36.Sean J. Griffith, Afterward and Comment: Towards an Ethical Duty to Market Investors, 35 Conn. L. Rev. 1223, 1239 (2003) (“The last period problem is a concept drawn from game theory and experimental economics to explain individual defections from cooperative enterprises in the last period of a repeated situation.”).Show More

In relational contracts, enforceable contract rights underdetermine the parties’ relationship.³⁷ 37.Charles J. Goetz & Robert E. Scott, Principles of Relational Contracts, 67 Va. L. Rev. 1089, 1091 (1981) (“A contract is relational to the extent that the parties are incapable of reducing important terms of the arrangement to well-defined obligations.”).Show More Cooperation is possible nevertheless because one party can detect and subsequently penalize defection by the other.³⁸ 38.Hviid, supra note 33, at 55 (“Any deviation must be observable and it must be punishable. This punishment must be credible so that it is clear that when required the punishment will be carried out, and the parties must be patient in the sense that the future matters to them.”).Show More Fear of reprisal keeps both parties cooperative. However, defection again becomes rational in the last period of a long game because reprisal becomes impossible.³⁹ 39.Christine Jolls, Contracts as Bilateral Commitments: A New Perspective on Contract Modification, 26 J. Legal Stud. 203, 231–32 (1997).Show More Passive insurance is a relational contract in which the managers agree (on behalf of the entity) to pay a higher-than-competitive rate in the future, and the insurer agrees to cover claims without any effort to expose or reduce governance problems. If both parties knew that the relationship was going to end soon, the insurer would have reason to breach the informal agreement by reducing its costs through monitoring and increasing its premiums now. And since they know they won’t get the cozy treatment that they want anyway, managers will no longer cheerlead an overpriced premium.

Part of what is interesting about this project is exploring the dark side of relational contracts. Most often, scholars of relational contracts adopt a laudatory tone: Is it not amazing that parties can accomplish their goals without much law?⁴⁰ 40.See, e.g., Robert C. Ellickson, Order Without Law: How Neighbors Settle Disputes 1, 1 (1991); Lisa Bernstein, Beyond Relational Contracts: Social Capital and Network Governance in Procurement Contracts, 7 J. Legal Analysis 561, 561–62 (2015) (discussing how master supply agreements, a type of relational contract between business firms, are designed to “keep the law . . . largely out of their relationship” and can “create a space in which private order can flourish.”).Show More But parties’ ability to informally secure a result is only laudatory if we would have been happy to honor their agreement had they made it formal. And not all contracts are of this sort. Business cartels use relational contracts to tacitly enforce restraints of trade that we would never countenance as formal contracts.⁴¹ 41.Hermalin et al., supra note 33, at 122 (“It has long been understood from the repeated games literature that some agreements are self enforcing in the context of an ongoing relationship. The most prominent example of such ‘agreements’ is tacit collusion among competing firms.”).Show More Mob bosses use relational contracts to reward and govern their lieutenants.⁴² 42.Curtis J. Milhaupt & Mark D. West, The Dark Side of Private Ordering: An Institutional and Empirical Analysis of Organized Crime, 67 U. Chi. L. Rev. 41, 43, 66 (2000).Show More And D&O insurers promise to help paper over managers’ mistakes and abuses in return for wastefully large insurance premiums. Relational contracts can allow parties to coordinate in ways we would never tolerate from formal contracts.

The structure of this Article is as follows. Part I introduces the practice and industrial organization of D&O insurance. Part II discusses the link between insurance and risk: while insurance can reduce riskiness, D&O insurers actually appear to exacerbate client risks, doing almost no monitoring or vetting. Part III provides a stylized introduction to two ways that D&O insurance business can operate—actively and passively. That Part shows that the market likely operates to generate excessive levels of passive insurance, and it explains that manager opportunism is central to the problem. Accordingly, Part IV presents a solution intended to increase the proportion of active D&O insurance: mandatory rotation of D&O insurers. It also explains analogies to other domains of law and addresses objections.

1. Securities Class Action Filings: 2019 Year in Review, Cornerstone Research 13, https​://securities.stanford.edu/research-reports/1996-2019/Cornerstone-Research-Securities-Class​-Action-Filings-2019-YIR.pdf [https://perma.cc/PD8P-YL84] (reporting 10% of S&P 500 by market cap was sued for securities violations in 2019). Last year brought slightly fewer. Securities Class Action Filings: 2021 Year in Review, Cornerstone Research 15, https://www.cornerstone.com/wp-content/uploads/2022/02/Securities-Class-Action-Filings-2​021-Year-in-Review.pdf. [https://perma.cc/4JGL-35SH]. This 10% figure plainly understates the scope of litigation, since many investors’ suits are derivative actions with no securities violation component, but comprehensive data for derivative suits are not available.In this Article, I use the word “manager” to refer to both officers and directors. ↑
2. Alice Uribe & Leslie Scism, Companies Are Paying a Lot More to Insure Their Directors and Officers, Wall St. J. (June 21, 2020, 5:30 AM), https://www.wsj.com/articles/companies-are-paying-a-lot-more-to-insure-their-directors-and-officers-11592731801?mod=hp_listc_po​s2 [https://perma.cc/93HE-LMK9] (reporting that D&O litigation expenses are approaching $1 billion annually, not including jury verdicts or settlements). ↑
3. E.g., Eugene V. Rostow, To Whom and For What End is Corporate Management Responsible?, in The Corporation In Modern Society 48 (Edward S. Mason ed., 1959) (characterizing derivative suits as “the most important procedure the law has yet developed to police the internal affairs of corporations”); Robert B. Thompson & Randall S. Thomas, The Public and Private Faces of Derivative Lawsuits, 57 Vand. L. Rev. 1747, 1786–87 (2004) (finding data that derivative suits play a valuable monitoring role in duty of loyalty cases and that the tool combats unscrupulous directors); see also Jill E. Fisch, Teaching Corporate Governance Through Shareholder Litigation, 34 Ga. L. Rev. 745, 746 (2000) (explaining how the rules of shareholder litigation can “deter[] corporate misconduct”). ↑
4. See Rostow, supra note 3; Stephen M. Bainbridge, Fee-Shifting: Delaware’s Self-Inflicted Wound, 40 Del. J. Corp. L. 851, 852–53 (2016); Roberta Romano, The Shareholder Suit: Litigation without Foundation?, 7 J.L. Econ. & Org. 55, 84 (1991); Sean J. Griffith, Correcting Corporate Benefit: How to Fix Shareholder Litigation by Shifting the Doctrine on Fees, 56 B.C. L. Rev. 1, 2 (2015). ↑
5. Dain C. Donelson, Justin J. Hopkins & Christopher G. Yust, The Role of Directors’ and Officers’ Insurance in Securities Fraud Class Action Settlements, 58 J.L. & Econ. 747, 748 (2015); see Sean J. Griffith, Uncovering A Gatekeeper: Why the SEC Should Mandate Disclosure of Details Concerning Directors’ and Officers’ Liability Insurance Policies, 154 U. Pa. L. Rev. 1147, 1189 (2006). ↑
6. Griffith, supra note 5, at 1168. ↑
7. Id. at 1163. ↑
8. Tom Baker & Sean J. Griffith, How the Merits Matter: Directors’ and Officers’ Insurance and Securities Settlements, 157 U. Pa. L. Rev. 755, 797–98 (2009). ↑
9. See Richard M. Phillips & Gilbert C. Miller, The Private Securities Litigation Reform Act of 1995: Rebalancing Litigation Risks and Rewards for Class Action Plaintiffs, Defendants and Lawyers, 51 Bus. Law. 1009, 1014–15 (1996). ↑
10. The “gatekeeper” idea is that trusted professionals near the corporation can be used as external checks on fraud and mismanagement. See John C. Coffee, Jr., The Acquiescent Gatekeeper: Reputational Intermediaries, Auditor Independence and Governance of Accounting 11–13 (Colum. L. Sch., Ctr. For L. & Econ. Stud., Working Paper No. 191, 2001), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=270944 [https://perma.cc/LM3D-3T6H]. ↑
11. See Joseph A. Grundfest, Punctuated Equilibria in the Evolution of United States Securities Regulation, 8 Stan. J.L. Bus. & Fin. 1, 7–8 (2002) (“D&O insurers could today easily make the retention of insurer-approved auditors a condition of coverage. They could today also require an element of control over the audit process. Yet they don’t. Why?”). ↑
12. Such responses were once common. Roberta Romano, What Went Wrong With Directors’ and Officers’ Liability Insurance?, 14 Del. J. Corp. L. 1, 12 (1989). Professor Romano’s article diagnosed insurer responses to a sudden increase in liability exposure, so it is unsurprising that insurers reacted in this way. Id. at 13. There is no indication that this tendency to withdraw is still commonplace. ↑
13. Richard V. Eicson & Aaron Doyle, Uncertain Business: Risk, Insurance and the Limits of Knowledge 94–211 (2004) (reporting research from a variety of contexts including building construction and disability management); Steven Shavell, On Liability and Insurance, 13 Bell J. Econ. 120, 121–22 (1982) (modeling the relationship between liability and insurance and concluding that, “[a]lthough the purchase of liability insurance changes the incentives created by liability rules, the terms of the insurance policies sold in a competitive setting would be such as to provide an appropriate substitute (but not necessarily equivalent) set of incentives to reduce accident risks”). ↑
14. Moral hazard is the tendency of insured parties to engage in riskier conduct. Kenneth J. Arrow, Uncertainty and the Welfare Economics of Medical Care, 53 Am. Econ. Rev. 941, 961 (1963); Daniel Schwarcz, Reevaluating Standardized Insurance Policies, 78 U. Chi. L. Rev. 1263, 1283 (2011). With respect to health insurance, smoking has been described as the “classic moral hazard.” Thomas R. McLean, International Law, Telemedicine & Health Insurance: China as a Case Study, 32 Am. J.L. & Med. 7, 25 (2006). Adverse selection is the tendency of the costliest clients to seek out coverage offered at a given price. Cf. George A. Akerlof, The Market for “Lemons”: Quality Uncertainty and the Market Mechanism, 84 Q.J. Econ. 488, 488 (1970) (setting out a canonical adverse selection model in a non-insurance commercial setting); Peter Siegelman, Adverse Selection in Insurance Markets: An Exaggerated Threat, 113 Yale L.J. 1223, 1223 (2004) (explaining that adverse selection is a process where “insureds utilize private knowledge of their own riskiness when deciding to buy or forgo insurance”). ↑
15. Aon, Quarterly D&O Pricing Index: Fourth Quarter and Full Year 2018, at 9 (2018), https://www.aon.com/getmedia/20bfac85-dce6-4902-91cb-c61265abcd7e/2018-Q4-DO-Pric​ing-Index.aspx [https://perma.cc/PR58-CPUT] (95.7% annual retention); Aon, Quarterly D&O Pricing Index: Fourth Quarter and Full Year 2017, at 9 (2017), https://ww​w.aon.com/attachments/risk-services/d-o_pricing_index/2017_Q4_DO_Pricing_Index.pdf [h​ttps://perma.cc/V33R-ZY9U] (93.2% annual retention); Aon, Quarterly D&O Pricing Index: Fourth Quarter and Full Year 2016, at 8 (2016), https://www.aon.com/attachme​nts/risk-services/d-o_pricing_index/2016_Q4_DO_Pricing_I​ndex.pdf [https://perma.cc/HRY​4-4HTA] (95.3% annual retention); Aon, Quarterly D&O Pricing Index: Fourth Quarter and Full Year 2015, at 8 (2015), https://www.aon.com/attachments/risk-services/d-o_pricing_index​/2015_Q4_DO_Pricing_Index.pdf [https://perma.cc/J5WG-K6QQ] (95% annual retention); Aon, Quarterly D&O Pricing Index: Fourth Quarter and Full Year 2014, at 8 (2014), https://www.aon.com/attachments/risk-services/d-o_pricing_index/201​4_Q4_DO_Pricing_I​ndex.pdf [https://perma.cc/8CDA-MSYG] (93.7% annual retention); Aon, Quarterly D&O Pricing Index: Fourth Quarter and Full Year 2013, at 3 (2013), https://www.aon​.com/attachments/risk-services/d-o_pricing_index/2013_Q4_DO_P​ricing-Index.pdf [https://​perma.cc/22DW-YDPB] (94.9% annual retention) Aon, Quarterly D&O Pricing Index: Fourth Quarter and Full Year 2012, at 3 (2012), https://www.aon.com/attachments/risk-services/d-o_pricing_index/2012_4Q_DandOPricingI​ndex.pdf [https://perma.cc/4GJU-4PKG] (94% retention for Q4). ↑
16. Alicia Davis Evans, The Investor Compensation Fund, 33 J. Corp. L. 223, 261 (2007) (“Currently, competitive pressures appear to make it impossible for D&O insurer premium prices to reflect governance risk fully.”). ↑
17. Infra Section II.C. ↑
18. Baker & Griffith, supra note 8, at 797–804. ↑
19. Cf. Grundfest, supra note 11, at 7 (noting that “the current structure of D&O insurance and auditor liability has failed to give rise to incentives” to address fraud risks even though “D&O insurers could today easily make the retention of insurer-approved auditors a condition of coverage”). ↑
20. See Shauhin A. Talesh, Insurance Companies as Corporate Regulators: The Good, The Bad, and the Ugly, 66 DePaul L. Rev. 463, 467 (2017) (“The debate going forward is not whether insurers are good risk regulators as prior scholars theorize, but more precisely, examining under what conditions can insurers make positive regulatory interventions into corporate behavior and nudge corporations toward a governance structure in line with societal values of fairness, equality, transparency, and safety.”); Chen Lin, Micah S. Officer, Thomas Schmid & Hong Zou, Is Skin in the Game a Game Changer? Evidence from Mandatory Changes of D&O Insurance Policies, 68 J. Acct. & Econ. 1–2 (2019) (arguing that the structure of insurance policies matters). ↑
21. See, e.g., Merritt B. Fox, Civil Liability and Mandatory Disclosure, 109 Colum. L. Rev. 237, 288–89 (2009) (calling for an end to D&O insurance for certain securities violations). ↑
22. Most insurers do not embrace a purely active or passive strategy, and it can be difficult to distinguish them in many cases. An insured who makes a costly claim may see her future premium rise from either an active or passive insurer, but for very different reasons. The active insurer raises the rate insofar as the claim signals information about the client’s type and future riskiness. The passive insurer raises the rate simply because that is the deal: the insurer pays now and recoups later, even if the claim was a fluke and signals nothing about the insured’s risk. ↑
23. Daniel Schwarcz, Coverage Information in Insurance Law, 101 Minn. L. Rev. 1457, 1487 (2017) (“[T]he risk of moral hazard only exists when the insurer does not observe policyholder levels of activity or care after purchase . . . .”). ↑
24. Infra Section III.A. ↑
25. Omri Ben-Shahar & Kyle D. Logue, Outsourcing Regulation: How Insurance Reduces Moral Hazard, 111 Mich. L. Rev. 197, 228 n.102 (2012). ↑
26. See Tom Baker & Sean J. Griffith, Predicting Corporate Governance Risk: Evidence from the Directors’ and Officers’ Liability Insurance Market, 74 U. Chi. L. Rev. 487, 489–90 (2007) (arguing that insurance premiums can publicize problematic governance). ↑
27. Infra Sections III.B. & C. ↑
28. Infra Sections II.C. & III.D. ↑
29. Infra Subsection IV.B.1. ↑
30. Infra Subsection IV.B.2. ↑
31. Infra Subsection IV.B.3. ↑
32. See Jay M. Feinman, The Insurance Relationship as Relational Contract and the “Fairly Debatable” Rule for First-Party Bad Faith, 46 San Diego. L. Rev. 553, 556–57 (2009) (“The insurance contract is a relational contract par excellence. The relation created by the contract extends over time; although a typical policy term is a year, the rate of renewal is very high, often in the order of ninety percent, so a typical relation extends over years or even decades.”). Note that Feinman was not addressing D&O insurance. ↑
33. See Robert E. Scott, Conflict and Cooperation in Long-Term Contracts, 75 Calif. L. Rev. 2005, 2007–08 (1987); Morten Hviid, Long-Term Contracts and Relational Contracts, in 5 The Encyclopedia of Law and Economics 54 (Boudewijn Bouckaert & Gerrit De Geest eds., 1999) (“Relational contract theory can be seen as an attempt to generate a model able to explain when transacting parties do not resort to contracts and by what means they ensure that each party fulfils their obligations. The theory focuses on the relationship between the ‘contracting’ parties and posits that this leads to cooperation and to implicit obligations being self-enforcing.”); Benjamin E. Hermalin, Avery W. Katz & Richard Craswell, Contract Law, in 1 Handbook of Law and Economics 123 (A. Mitchell Polinsky & Steven Shavell eds., 2007) (“Within the literature, self-enforcing contracts are often known as relational contracts.” (emphasis omitted)). ↑
34. For examples of this kind, see, e.g., Stewart Macaulay, Non-Contractual Relations in Business: A Preliminary Study, 28 Am. Socio. Rev. 55, 61–67 (1963); Ian R. MacNeil, The Many Futures of Contracts, 47 S. Cal. L. Rev. 691, 721, 732 (1974); H. Beale & T. Dugdale, Contracts Between Businessmen: Planning and the Use of Contractual Remedies, 2 Brit. J.L. and Soc’y 45, 45–46, 51, 53 (1975). ↑
35. E.g., Hviid, supra note 33, at 55 (“Repeated interaction may enable cooperation, because of the potential for a current deviation to be punished in the future. For this to work, four conditions must be met.”). ↑
36. Sean J. Griffith, Afterward and Comment: Towards an Ethical Duty to Market Investors, 35 Conn. L. Rev. 1223, 1239 (2003) (“The last period problem is a concept drawn from game theory and experimental economics to explain individual defections from cooperative enterprises in the last period of a repeated situation.”). ↑
37.  Charles J. Goetz & Robert E. Scott, Principles of Relational Contracts, 67 Va. L. Rev. 1089, 1091 (1981) (“A contract is relational to the extent that the parties are incapable of reducing important terms of the arrangement to well-defined obligations.”). ↑
38. Hviid, supra note 33, at 55 (“Any deviation must be observable and it must be punishable. This punishment must be credible so that it is clear that when required the punishment will be carried out, and the parties must be patient in the sense that the future matters to them.”). ↑
39. Christine Jolls, Contracts as Bilateral Commitments: A New Perspective on Contract Modification, 26 J. Legal Stud. 203, 231–32 (1997). ↑
40. See, e.g., Robert C. Ellickson, Order Without Law: How Neighbors Settle Disputes 1, 1 (1991); Lisa Bernstein, Beyond Relational Contracts: Social Capital and Network Governance in Procurement Contracts, 7 J. Legal Analysis 561, 561–62 (2015) (discussing how master supply agreements, a type of relational contract between business firms, are designed to “keep the law . . . largely out of their relationship” and can “create a space in which private order can flourish.”). ↑
41. Hermalin et al., supra note 33, at 122 (“It has long been understood from the repeated games literature that some agreements are self enforcing in the context of an ongoing relationship. The most prominent example of such ‘agreements’ is tacit collusion among competing firms.”). ↑

42. Curtis J. Milhaupt & Mark D. West, The Dark Side of Private Ordering: An Institutional and Empirical Analysis of Organized Crime, 67 U. Chi. L. Rev. 41, 43, 66 (2000). ↑

The post Changing Guards: Improving Corporate Governance with D&O Insurer Rotations first appeared on Virginia Law Review.

This Article makes three contributions to the literature. First, using original interviews with in-house dealmakers, it provides the literature’s first account of how deals are made within companies. Both economists and legal scholars have tackled the puzzle of incomplete contracting, but leading explanations overlook the critical influence of companies’ internal deal-building process. Unlike individuals who enter into contracts, sophisticated business parties do not have monolithic intent. Instead, even before taking a seat at the negotiation table, business parties engage in a complex, internal bargaining process that requires many intra-corporate constituencies to weigh in and sign off on the deal. The result is that sophisticated business parties bring multiple agendas to the negotiation table, and those agendas are reflected in the contract. Second, collaboration complicates intent, especially for sophisticated parties. Rather than being the result of rational, considered contract design, contractual gaps may be mere byproducts of the contract-shepherding process within the firm. Finally, this Article offers practical guidance to courts and contract designers about the overlooked and rampant intra-corporate bargaining and pork-barreling process. It helps them account for collaborative intent in ex ante contract design and ex post contract enforcement.

Introduction

Four weeks before Halloween in 2018, a Delaware Chancery Court decision spooked the corporate world. In an unprecedented move, the court released German pharmaceutical giant Fresenius from its $4.75 billion contract to buy U.S. generic drug manufacturer Akorn based on a contract term called the material adverse change clause.¹ 1.Akorn, Inc. v. Fresenius Kabi AG, No. CV 2018-0300, 2018 WL 4719347 (Del. Ch. Oct. 1, 2018), aff’d, 198 A.3d 724 (Del. 2018).Show More The decision in Akorn, Inc. v. Fresenius Kabi AG was the first time Delaware courts had found that a company triggered a material adverse change clause, and it sparked a storm of anxiety and commentary.² 2.Many major firms issued client alerts, immediately digesting the landmark case for their clients. See, e.g., David Leinwand, James E. Langston & Mark E. McDonald, Akorn v. Fresenius: A MAC in Delaware, Cleary Gottlieb Steen & Hamilton LLP (Oct. 11, 2018), https://www.clearymawatch.com/2018/10/akorn-v-fresenius-mac-delaware [https://perma.cc​/43KW-C54E]; Chris Gorman & Lisa Richards, Akorn v. Fresenius: Important Practical Lessons from First-Ever Material Adverse Effect, Fenwick & West LLP (Oct. 24, 2018), https://www.fenwick.com/publications/pages/akorn-v-fresenius-important-practical-lessons-from-first-ever-material-adverse-effect.aspx [https://perma.cc/9KPX-75MZ]; Peter A. Atkins & Edward B. Micheletti, ‘Reasonable Efforts’ Clauses in Delaware: One Size Fits All, Unless . . ., Skadden, Arps, Slate, Meagher & Flom LLP (Nov. 1, 2018), https://www.​skadden.com/insights/publications/2018/10/reasonable-efforts-clauses-in-delaware [https://p​erma.cc/JR7Z-FYAP]; Grant J. Esposito, David J. Fioccola & Robert W. May, Delaware Court of Chancery Finds a Material Adverse Event and Excuses Buyer from Obligation to Close in Akorn v. Fresenius Kabi AG, Morrison & Foerster LLP (Oct. 9, 2018), https://www.mofo.com/resources/insights/181009-delaware-material-adverse-event.html [htt​ps://perma.cc/FE72-NR7Q].Show More

In every merger and acquisition (“M&A”) deal, there is a material adverse change provision: a long-winded, heavily negotiated provision choked with exceptions and caveats. Material adverse change provisions almost always say the same thing: that if something huge and unexpected happens between the contract’s signing and the deal’s closing, one or both parties can back out of the deal.³ 3.Albert Choi & George Triantis, Strategic Vagueness in Contract Design: The Case of Corporate Acquisitions, 119 Yale L.J. 848, 854 (2010) [hereinafter Choi & Triantis, Strategic Vagueness](defining a material adverse change clause in a contract as one that “permit[s] the buyer to avoid the closing of a deal if a material change has occurred in the financial condition, assets, liabilities, business, or operations of the target firm”).Show More And, perhaps most surprisingly, despite the long negotiations and dense legalese, material adverse change provisions are vague.⁴ 4.Id. at 853 (noting that material adverse change clauses are vague, but “among the most heavily negotiated nonprice terms”).Show More

Vague provisions like these are common but surprising. In M&A contracts, for example, parties routinely haggle over whether they will use “best efforts,” “commercially reasonable best efforts,” or “reasonable best efforts” to accomplish certain tasks—and each of these standards will be left unspecified and unquantified.⁵ 5.See Scot Baker & Albert Choi, Contract’s Role in Relational Contract, 101 Va. L. Rev. 559, 565 (2015) (describing the common “best efforts” provisions as “a fault-based and open-ended standard”); Anthony J. Casey & Anthony Niblett, Self-Driving Contracts, 43 J. Corp. L. 1, 8 (2017) (“[Parties can choose to] use a vague standard that also requires a court to fill in the details after the fact. This could be a clause that requires something like ‘reasonable efforts,’ ‘best efforts,’ or ‘commercially reasonable efforts.’”); Victor P. Goldberg, In Search of Best Efforts: Reinterpreting Bloor v. Falstaff, 44 St. Louis L. Rev. 1465, 1465 (2000) (“When contracting parties cannot quite define their obligations, they often resort to placeholder language, like ‘best efforts.’”); Robert E. Scott, Contract Design and the Shading Problem, 99 Marq. L. Rev. 1, 20 (2015) (“[I]n the past fifty years, parties have increasingly inserted vague terms such as ‘best efforts,’ reasonable best efforts,’ or ‘commercially reasonable best efforts’ as modifiers that are combined with specific of precise performance obligations under the contract.”). The contracts law case Bloor v. Falstaff, 601 F.2d 609 (2d Cir. 1979), is another famous case about best efforts clauses.Show More In debt contracts, borrowers promise to let lenders conduct “routine” inspections, without specifying what is routine.⁶ 6.In A. Gay Jenson Farms Co. v. Cargill, 309 N.W.2d 285 (Minn. 1981), the well-known agency law case, for example, large international conglomerate Cargill lent money to a small Minnesota grain elevator operator, in part on the condition that Cargill could conduct routine inspections of the grain elevator. The intrusive nature of the inspections became one of the reasons that the grain elevator operator’s other creditors later sued Cargill, arguing that the grain elevator operator was an agent of Cargill and that Cargill should be liable for the operator’s debts. Id. at 290–91.Show More In just about any corporate contract, parties promise “material” compliance or compliance that does not rise to a “material adverse effect,” again without specifying what those thresholds might mean.⁷ 7.Robert Malionek & Jon Weichselbaum, Five Keys to Analyzing a Material Adverse Effect, N.Y.L.J. (Mar. 6, 2019), https://www.lw.com/thoughtLeadership/five-keys-analyzing-materia​l-adverse-effect-ny-law-journal [https://perma.cc/TM95-FQKH] (noting that “[m]ateriality is both qualitative and quantitative” and that in M&A contracts, representations can be made “that reasonably would be expected to result in [a material adverse change]”).Show More In each of these circumstances, sophisticated parties, who have both the technical sophistication and financial means to draft specific, complete provisions, choose instead to embrace vague, incomplete ones.

The persistence of vague provisions, incomplete contracts, and other such contractual oddities has long plagued both legal scholars and economists—and neither literature has a shortage of explanations. Economist and Nobel Prize laureate Oliver Hart famously notes that contracts are necessarily incomplete: there are no parties, no circumstances, where every contingency can be thought of and thought out ex ante.⁸ 8.See Oliver Hart, The Nobel Prize, https://www.nobelprize.org/prizes/economic-sciences/​2016/hart/facts/ [https://perma.cc/E6MG-HZY4] (last visited Nov. 10, 2021) (“In the mid-1980s, [Hart] contributed to the theory of incomplete contracts. . . . These analyses have been significant for, among other things, governance of companies and the design of laws and institutions.”); Oliver Hart & John Moore, Foundations of Incomplete Contracts, 66 Rev. Econ. Stud. 115 (1999) [hereinafter Hart & Moore, Foundations of Incomplete Contracts](developing a model for the idea that contracts are incomplete); Oliver D. Hart, Incomplete Contracts and the Theory of the Firm, 4 J.L. Econ. & Org. 119 (1988); Oliver Hart, Dep’t of Econ., Harvard Univ., Incomplete Contracts and Control, Nobel Prize Lecture 372–73 (Dec. 8. 2016), https://www.nobelprize.org/uploads/2018/06/hart-lecture.pdf [https://perma.cc/7TK​E-49TD] [hereinafter Hart, Incomplete Contracts & Control](noting that, although economists spent many decades working on questions involving complete contracts, “[a]ctual contracts are not like this, as lawyers have recognized for some time. They are poorly worded, ambiguous, and leave out important things. They are incomplete.”).Show More Many scholars have argued convincingly that vagueness in contracts—especially in contracts between sophisticated business parties—is intentional and rational: provisions that are rarely litigated but expensive to negotiate, such as material adverse effect provisions, are particularly well-suited to vagueness.⁹ 9.Choi & Triantis, Strategic Vagueness, supra note 3, at 852–53, 855 (arguing that parties can use vague contract provisions efficiently—for example, material adverse change clauses in acquisition agreements may remain vague because they are rarely litigated); Robert E. Scott & George G. Triantis, Anticipating Litigation in Contract Design, 115 Yale L.J. 814, 818–22 (2006) [hereinafter Scott & Triantis, Anticipating Litigation] (examining the efficiency of investment in the design and enforcement phases of the contracting process and arguing that parties can lower overall contracting costs by using vague contract terms ex ante and shifting investment to the ex post enforcement phase); Robert E. Scott & George G. Triantis, Incomplete Contracts and the Theory of Contract Design, 56 Case W. Res. L. Rev. 187, 195–96 (2005) (considering the role of litigation in motivating contract design).Show More Still others have argued that contracts do not need to be complete or specific. Community and industry norms can and do fill the gap where contracts are vague—and sometimes even when contracts do not even exist.¹⁰ 10.See Ronald J. Gilson, Charles Sabel & Robert E. Scott, Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine, 110 Colum. L. Rev. 1377, 1398–99 (2010) [hereinafter Gilson et al., Braiding] (discussing the “rivalry” between formal and informal enforcement for contracts and noting that the two can substitute for each other or complement each other); see also Lisa Bernstein, Opting Out of the Legal System: Extralegal Contractual Relations in the Diamond Industry, 21 J. Legal Stud. 115, 121–24 (1992) [hereinafter Bernstein, Opting Out] (describing trade association enforcement of contractual breaches); Lisa Bernstein, Private Commercial Law in the Cotton Industry: Creating Cooperation Through Rules, Norms, and Institutions, 99 Mich. L. Rev. 1724, 1725 (2001) (describing the cotton industry’s alternative system of enforcement to the typical legal system).Show More And, in those cases, it is the threat of informal sanctions, such as loss of reputation, that curbs bad behavior, even without a legally binding contract.¹¹ 11.Informal sanctions are particularly effective in small, tight-knit communities where parties have many points of contact. A robust literature has documented the role of norms and informal sanctions in a variety of interesting settings. See Robert C. Ellickson, Of Coase and Cattle: Dispute Resolution Among Neighbors in Shasta County, 38 Stan. L. Rev. 623, 628, 677 (1986) [hereinafter Ellickson, Of Coase and Cattle] (describing how rural cattle ranchers in Shasta County, California, abide by norms rather than rules and how animal trespass disputes are settled by self-help rather than formal legal enforcement mechanisms); Robert C. Ellickson, A Hypothesis of Wealth-Maximizing Norms: Evidence from the Whaling Industry, 5 J.L. Econ. & Org. 83, 84–85 (1989) (presenting evidence of informal enforcement—norms—overtaking formal enforcement in the whaling industry); Peter T. Leeson, An-arrgh-chy: The Law and Economics of Pirate Organization, 115 J. Pol. Econ. 1049, 1051 (2007) (describing the extralegal systems that pirates developed to provide checks on captain predation and to “create piratical law and order”); Bernstein, Opting Out, supra note 10, at 124 (describing how a diamond-merchant trade association in New York City helps to enforce contracts); Gillian K. Hadfield & Iva Bozovic, Scaffolding: Using Formal Contracts to Support Informal Relations in Support of Innovation, 2016 Wis. L. Rev. 981, 987, 1017 (describing the way in which commercial contracting parties across a variety of industries use a mix of formal and informal contracts to support their business relationships); Lisa Bernstein, Beyond Relational Contracts: Social Capital and Network Governance in Procurement Contracts, 7 J. Legal Analysis 561, 562 (2015) (describing how original equipment manufacturers in the Midwest have used a mix of formal contracts, relational contracts, and other tools to build and support their business relationships); Jonathan M. Barnett, Hollywood Deals: Soft Contracts for Hard Markets, 64 Duke L.J. 605, 607 (2015) (discussing the use of non-binding agreements—or “soft contracts”—in modern Hollywood filmmaking).Show More

In many contexts, these explanations are convincing. Consider a simple apartment lease signed between one landlord and one tenant. Rather than spending a lot of time up-front discussing the specific condition in which the tenant needs to leave the apartment at move-out, the parties might simply decide to agree to the vague provision that the tenant needs to leave the apartment “clean.” The law and economics view explains this decision well: in most cases, the tenant leaves the place clean enough, and the parties will never have to haggle over the details upon move-out. Relational contracting theory also explains the vagueness well: the landlord doesn’t need to be too specific about cleanliness because the tenant relies on the landlord to give her a good reference for her next apartment rental.

But while existing explanations work well for simple, two-party contracts, and do some work in explaining sophisticated-party contracting, they fall short.¹² 12.In previous work, for example, I explored the puzzle of term sheets in M&A contracting. Term sheets—short, nonbinding precursors to a full-fledged M&A contract—are not contracts and are not legally binding or enforceable. Parties to term sheets do not operate in the tight-knit communities where informal sanctions are known to work. Nonetheless, once parties sign them, they behave as though bonded. Why do nonbinding term sheets have binding power? See Cathy Hwang, Deal Momentum, 65 UCLA L. Rev. 376, 380 (2018) (describing how deal lawyers use preliminary agreements in M&A deals); Cathy Hwang, Faux Contracts, 105 Va. L. Rev. 1025, 1056 (2019) [hereinafter, Hwang, Faux Contracts] (describing how M&A deals create small relational ecosystems in which both the contracting parties and their agents are incentivized to engage in consummate, rather than perfunctory, performance).Show More Certainly cost-benefit analysis and informal sanctions account for some contractual oddities—but not all. This Article offers a friendly addendum to those pathbreaking explanations: collaborative intent.

At its core, collaborative intent relies on a simple idea: businesses are not monoliths. They contain many divisions, departments, operational groups, and other constituencies. This idea is well-understood in the literature—even Ronald Coase’s seminal work on the boundary of the firm assumed that companies would contain multiple different groups within it.¹³ 13.Ronald H. Coase, The Nature of the Firm, 16 Economica 386, 390 (1937) (posing and discussing the “boundaries of the firm” question: When should individuals be expected to form firms, and when should they be expected to cooperate through contract?).Show More Collaborative intent takes this idea a step further: it explicitly recognizes that each module within a company has its own purpose and, correspondingly, its own incentives, goals, limitations, and preferences. Internal constituencies often have a chance to veto—or at least weigh in on—both the substance and form of a proposed deal. By the time a company brings its intent to the negotiating table, that intent reflects the result of a consensus-building process within the company—in other words, the company brings what this Article calls its collaborative intent.

That collaborative intent in turn helps to account for many contractual oddities. Contracts that result from this kind of institutional collaboration are not necessarily rational, intentional, or carefully considered. Instead, they are amalgamations of many preferences within each deal party and result from the consensus-building process of getting the deal through a bureaucracy.

This Article provides a layered account of collaborative intent and its impact on deals and contracts, and proceeds as follows. Part I sets the stage. It shows how current contract theory does not account for the dealmaking process within firms. Part II presents the theory and evidence of collaborative intent. It uses two dozen original interviews with in-house dealmakers to show how the process of building consensus for a deal within the firm impacts contractual form and structure. Interview participants brought experience from a variety of industries, ranging from technology to hospitality to gaming, and uniformly reported that dealmaking within the firm is a collaborative exercise: it requires vote-whipping, pork-barreling, and balancing the needs of various constituencies into a coherent but multifaceted “intent.” Part III turns to implications. Existing literature overlooks the institutional details that impact contract design. Collaborative intent injects important and overlooked nuance and helps to build out a nuanced account of dealmaking that can help shape contract theory, enforcement, and design.

1. Akorn, Inc. v. Fresenius Kabi AG, No. CV 2018-0300, 2018 WL 4719347 (Del. Ch. Oct. 1, 2018), aff’d, 198 A.3d 724 (Del. 2018). ↑
2. Many major firms issued client alerts, immediately digesting the landmark case for their clients. See, e.g., David Leinwand, James E. Langston & Mark E. McDonald, Akorn v. Fresenius: A MAC in Delaware, Cleary Gottlieb Steen & Hamilton LLP (Oct. 11, 2018), https://www.clearymawatch.com/2018/10/akorn-v-fresenius-mac-delaware [https://perma.cc​/43KW-C54E]; Chris Gorman & Lisa Richards, Akorn v. Fresenius: Important Practical Lessons from First-Ever Material Adverse Effect, Fenwick & West LLP (Oct. 24, 2018), https://www.fenwick.com/publications/pages/akorn-v-fresenius-important-practical-lessons-from-first-ever-material-adverse-effect.aspx [https://perma.cc/9KPX-75MZ]; Peter A. Atkins & Edward B. Micheletti, ‘Reasonable Efforts’ Clauses in Delaware: One Size Fits All, Unless . . ., Skadden, Arps, Slate, Meagher & Flom LLP (Nov. 1, 2018), https://www.​skadden.com/insights/publications/2018/10/reasonable-efforts-clauses-in-delaware [https://p​erma.cc/JR7Z-FYAP]; Grant J. Esposito, David J. Fioccola & Robert W. May, Delaware Court of Chancery Finds a Material Adverse Event and Excuses Buyer from Obligation to Close in Akorn v. Fresenius Kabi AG, Morrison & Foerster LLP (Oct. 9, 2018), https://www.mofo.com/resources/insights/181009-delaware-material-adverse-event.html [htt​ps://perma.cc/FE72-NR7Q]. ↑
3. Albert Choi & George Triantis, Strategic Vagueness in Contract Design: The Case of Corporate Acquisitions, 119 Yale L.J. 848, 854 (2010) [hereinafter Choi & Triantis, Strategic Vagueness] (defining a material adverse change clause in a contract as one that “permit[s] the buyer to avoid the closing of a deal if a material change has occurred in the financial condition, assets, liabilities, business, or operations of the target firm”). ↑
4. Id. at 853 (noting that material adverse change clauses are vague, but “among the most heavily negotiated nonprice terms”). ↑
5. See Scot Baker & Albert Choi, Contract’s Role in Relational Contract, 101 Va. L. Rev. 559, 565 (2015) (describing the common “best efforts” provisions as “a fault-based and open-ended standard”); Anthony J. Casey & Anthony Niblett, Self-Driving Contracts, 43 J. Corp. L. 1, 8 (2017) (“[Parties can choose to] use a vague standard that also requires a court to fill in the details after the fact. This could be a clause that requires something like ‘reasonable efforts,’ ‘best efforts,’ or ‘commercially reasonable efforts.’”); Victor P. Goldberg, In Search of Best Efforts: Reinterpreting Bloor v. Falstaff, 44 St. Louis L. Rev. 1465, 1465 (2000) (“When contracting parties cannot quite define their obligations, they often resort to placeholder language, like ‘best efforts.’”); Robert E. Scott, Contract Design and the Shading Problem, 99 Marq. L. Rev. 1, 20 (2015) (“[I]n the past fifty years, parties have increasingly inserted vague terms such as ‘best efforts,’ reasonable best efforts,’ or ‘commercially reasonable best efforts’ as modifiers that are combined with specific of precise performance obligations under the contract.”). The contracts law case Bloor v. Falstaff, 601 F.2d 609 (2d Cir. 1979), is another famous case about best efforts clauses. ↑
6. In A. Gay Jenson Farms Co. v. Cargill, 309 N.W.2d 285 (Minn. 1981), the well-known agency law case, for example, large international conglomerate Cargill lent money to a small Minnesota grain elevator operator, in part on the condition that Cargill could conduct routine inspections of the grain elevator. The intrusive nature of the inspections became one of the reasons that the grain elevator operator’s other creditors later sued Cargill, arguing that the grain elevator operator was an agent of Cargill and that Cargill should be liable for the operator’s debts. Id. at 290–91. ↑
7. Robert Malionek & Jon Weichselbaum, Five Keys to Analyzing a Material Adverse Effect, N.Y.L.J. (Mar. 6, 2019), https://www.lw.com/thoughtLeadership/five-keys-analyzing-materia​l-adverse-effect-ny-law-journal [https://perma.cc/TM95-FQKH] (noting that “[m]ateriality is both qualitative and quantitative” and that in M&A contracts, representations can be made “that reasonably would be expected to result in [a material adverse change]”). ↑
8. See Oliver Hart, The Nobel Prize, https://www.nobelprize.org/prizes/economic-sciences/​2016/hart/facts/ [https://perma.cc/E6MG-HZY4] (last visited Nov. 10, 2021) (“In the mid-1980s, [Hart] contributed to the theory of incomplete contracts. . . . These analyses have been significant for, among other things, governance of companies and the design of laws and institutions.”); Oliver Hart & John Moore, Foundations of Incomplete Contracts, 66 Rev. Econ. Stud. 115 (1999) [hereinafter Hart & Moore, Foundations of Incomplete Contracts] (developing a model for the idea that contracts are incomplete); Oliver D. Hart, Incomplete Contracts and the Theory of the Firm, 4 J.L. Econ. & Org. 119 (1988); Oliver Hart, Dep’t of Econ., Harvard Univ., Incomplete Contracts and Control, Nobel Prize Lecture 372–73 (Dec. 8. 2016), https://www.nobelprize.org/uploads/2018/06/hart-lecture.pdf [https://perma.cc/7TK​E-49TD] [hereinafter Hart, Incomplete Contracts & Control] (noting that, although economists spent many decades working on questions involving complete contracts, “[a]ctual contracts are not like this, as lawyers have recognized for some time. They are poorly worded, ambiguous, and leave out important things. They are incomplete.”). ↑
9. Choi & Triantis, Strategic Vagueness, supra note 3, at 852–53, 855 (arguing that parties can use vague contract provisions efficiently—for example, material adverse change clauses in acquisition agreements may remain vague because they are rarely litigated); Robert E. Scott & George G. Triantis, Anticipating Litigation in Contract Design, 115 Yale L.J. 814, 818–22 (2006) [hereinafter Scott & Triantis, Anticipating Litigation] (examining the efficiency of investment in the design and enforcement phases of the contracting process and arguing that parties can lower overall contracting costs by using vague contract terms ex ante and shifting investment to the ex post enforcement phase); Robert E. Scott & George G. Triantis, Incomplete Contracts and the Theory of Contract Design, 56 Case W. Res. L. Rev. 187, 195–96 (2005) (considering the role of litigation in motivating contract design). ↑
10. See Ronald J. Gilson, Charles Sabel & Robert E. Scott, Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine, 110 Colum. L. Rev. 1377, 1398–99 (2010) [hereinafter Gilson et al., Braiding] (discussing the “rivalry” between formal and informal enforcement for contracts and noting that the two can substitute for each other or complement each other); see also Lisa Bernstein, Opting Out of the Legal System: Extralegal Contractual Relations in the Diamond Industry, 21 J. Legal Stud. 115, 121–24 (1992) [hereinafter Bernstein, Opting Out] (describing trade association enforcement of contractual breaches); Lisa Bernstein, Private Commercial Law in the Cotton Industry: Creating Cooperation Through Rules, Norms, and Institutions, 99 Mich. L. Rev. 1724, 1725 (2001) (describing the cotton industry’s alternative system of enforcement to the typical legal system). ↑
11. Informal sanctions are particularly effective in small, tight-knit communities where parties have many points of contact. A robust literature has documented the role of norms and informal sanctions in a variety of interesting settings. See Robert C. Ellickson, Of Coase and Cattle: Dispute Resolution Among Neighbors in Shasta County, 38 Stan. L. Rev. 623, 628, 677 (1986) [hereinafter Ellickson, Of Coase and Cattle] (describing how rural cattle ranchers in Shasta County, California, abide by norms rather than rules and how animal trespass disputes are settled by self-help rather than formal legal enforcement mechanisms); Robert C. Ellickson, A Hypothesis of Wealth-Maximizing Norms: Evidence from the Whaling Industry, 5 J.L. Econ. & Org. 83, 84–85 (1989) (presenting evidence of informal enforcement—norms—overtaking formal enforcement in the whaling industry); Peter T. Leeson, An-arrgh-chy: The Law and Economics of Pirate Organization, 115 J. Pol. Econ. 1049, 1051 (2007) (describing the extralegal systems that pirates developed to provide checks on captain predation and to “create piratical law and order”); Bernstein, Opting Out, supra note 10, at 124 (describing how a diamond-merchant trade association in New York City helps to enforce contracts); Gillian K. Hadfield & Iva Bozovic, Scaffolding: Using Formal Contracts to Support Informal Relations in Support of Innovation, 2016 Wis. L. Rev. 981, 987, 1017 (describing the way in which commercial contracting parties across a variety of industries use a mix of formal and informal contracts to support their business relationships); Lisa Bernstein, Beyond Relational Contracts: Social Capital and Network Governance in Procurement Contracts, 7 J. Legal Analysis 561, 562 (2015) (describing how original equipment manufacturers in the Midwest have used a mix of formal contracts, relational contracts, and other tools to build and support their business relationships); Jonathan M. Barnett, Hollywood Deals: Soft Contracts for Hard Markets, 64 Duke L.J. 605, 607 (2015) (discussing the use of non-binding agreements—or “soft contracts”—in modern Hollywood filmmaking). ↑
12. In previous work, for example, I explored the puzzle of term sheets in M&A contracting. Term sheets—short, nonbinding precursors to a full-fledged M&A contract—are not contracts and are not legally binding or enforceable. Parties to term sheets do not operate in the tight-knit communities where informal sanctions are known to work. Nonetheless, once parties sign them, they behave as though bonded. Why do nonbinding term sheets have binding power? See Cathy Hwang, Deal Momentum, 65 UCLA L. Rev. 376, 380 (2018) (describing how deal lawyers use preliminary agreements in M&A deals); Cathy Hwang, Faux Contracts, 105 Va. L. Rev. 1025, 1056 (2019) [hereinafter, Hwang, Faux Contracts] (describing how M&A deals create small relational ecosystems in which both the contracting parties and their agents are incentivized to engage in consummate, rather than perfunctory, performance). ↑

13. Ronald H. Coase, The Nature of the Firm, 16 Economica 386, 390 (1937) (posing and discussing the “boundaries of the firm” question: When should individuals be expected to form firms, and when should they be expected to cooperate through contract?). ↑

The post Collaborative Intent first appeared on Virginia Law Review.

This Article reveals that central to the argument in favor of corporate constitutional personhood was a direct analogy between corporate shareholders and racial minorities. This Article thus highlights the intersection of corporate personhood and race, a connection that has rarely, if ever, been explored. Corporate lawyers’ expansive interpretation of equal protection ultimately triumphed in the Supreme Court with the twin cases of Yick Wo v. Hopkins, a bedrock of modern civil rights doctrine, and Santa Clara v. Southern Pacific Railroad, a case credited with extending equal protection rights to corporations. This is the first Article to juxtapose these two seminal cases and to expose the deep and long-standing connections between them. In so doing, this Article uncovers a neglected history of the link between corporations and race, as well as a lost history of the Fourteenth Amendment.

Introduction

“Like Frankenstein’s baby, there was no end to its growing, and no limit to its voracity. And, like that wonderful child, it started in to devour its author.”

– Records of the California Constitutional Convention (1878)

“The Fourteenth Amendment . . . stands in the constitution as a perpetual shield against all unequal and partial legislation by the states, and the injustice which follows from it, whether directed against the most humble or the most powerful; against the despised laborer from China, or the envied master of millions.”

– The Railroad Tax Cases (9th Cir. 1882)

Since the controversial cases of Citizens United v. Federal Election Commission¹ 1.558 U.S. 310 (2010).Show More and Burwell v. Hobby Lobby,² 2.573 U.S. 682 (2014).Show More which recognized the political speech and religious freedom rights of corporations,³ 3.In Citizens United, the Supreme Court struck down a federal law, 2 U.S.C. § 441b (2006), that banned direct corporate spending on political campaigns. 558 U.S. at 372. Citizens United was part of a long line of cases in which the Court had recognized the First Amendment rights of corporations, including: NAACP v. Alabama ex rel. Patterson, 357 U.S. 449, 459 (1958) (freedom of association); NAACP v. Button, 371 U.S. 415, 428–29 (1963) (freedom of expression and association); New York Times Co. v. Sullivan, 376 U.S. 254, 264 (1964) (freedom of speech and the press); and First National Bank of Boston v. Bellotti, 435 U.S. 765, 784 (1978) (campaign expenditures as political speech). Hobby Lobby concluded that corporations were “persons” under the Religious Freedom Restoration Act, 42 U.S.C. §§ 2000bb–1, and held that Health and Human Services regulations requiring employers to provide insurance that covered contraceptives unconstitutionally burdened closely held corporations’ exercise of religion. 573 U.S. at 736.Show More respectively, activist groups have been lobbying for a constitutional amendment to eliminate corporate constitutional personhood.⁴ 4.See Move to Amend, https://www.movetoamend.org/ [https://perma.cc/RH9L-2FZT] (last visited Aug. 19, 2020); United for the People, http://united4thepeople.org/ [https://perma.cc/XS9X-LZNR] (last visited Aug. 19, 2020).Show More Granting corporations constitutional rights, they argue, gives powerful mega-corporations even greater means to avoid regulation and manipulate elections, thus threatening “the democratic promise of America.”⁵ 5.United for the People, supra note 4; Move to Amend, supra note 4. See Joanna M. Meyer, The Real Error in Citizens United, 69 Wash. & Lee L. Rev. 2171, 2198 (2012).Show More In 2019, Rep. Pramila Jayapal (D-WA) introduced a bill to provide that “the rights extended by the Constitution are the rights of natural persons only” and that corporations “shall have no rights under this Constitution.”⁶ 6.H.R.J. Res. 48, 116th Cong. (2019) (proposing an amendment to the Constitution of the United States providing that the rights extended by the Constitution are the rights of natural persons only). Other bills introduced in both the House and the Senate have targeted specific constitutional rights, such as one “waiving the application of the first article of amendment to the political speech of corporations.” H.R.J. Res. 39, 116th Cong. (2019). See United for the People, http://united4thepeople.org/amendments/ (last visited Oct. 31, 2021) [https://perma.cc/QGU7-883U], for an up-to-date list of proposed amendments relating to corporate constitutional rights.Show More Supporters of this amendment showcase buttons and bumper stickers that proclaim: “Corporations are not People!”⁷ 7.See Move to Amend, https://move-to-amend.myshopify.com/collections/frontpage [https://perma.cc/8JVP-CYAD] (last visited Dec. 28, 2021).Show More

Corporate constitutional rights have been debated since the early years of the American Republic.⁸ 8.For early cases debating the constitutional rights of corporations, see Bank of United States v. Deveaux, 9 U.S. (5 Cranch) 61, 63–64 (1809); Hope Insurance Co. of Providence v. Boardman, 9 U.S. (5 Cranch) 57, 58 (1809); Terrett v. Taylor, 13 U.S. (9 Cranch) 43, 46–47 (1815); Trustees of Dartmouth College v. Woodward, 17 U.S. (4 Wheaton) 518, 556 (1819); Proprietors of Charles River Bridge v. Proprietors of Warren Bridge, 36 U.S. (11 Peters) 420, 421 (1837); and Louisville, Cincinnati & Charleston Railroad Co. v. Letson, 43 U.S. (2 Howard) 497, 499 (1844). See also Adam Winkler, We the Corporations: How American Businesses Won Their Civil Rights, at xxi (2018) (describing how the country’s most powerful corporations have persistently tried to use the Constitution to evade unwanted government regulations); Margaret M. Blair & Elizabeth Pollman, The Derivative Nature of Corporate Constitutional Rights, 56 Wm. & Mary L. Rev. 1673, 1680 (2015) (explaining how the Supreme Court was tasked with determining the applicability of constitutional provisions to corporations in an 1809 case involving the first Bank of the United States).Show More Missing from histories of corporate personhood, however, is the central role that race played in the development of corporate constitutional rights.⁹ 9.Legal historians of corporate personhood have discussed corporate Fourteenth Amendment cases in some detail but have neglected the role that race played in the development of these cases. For representative writings on corporate personhood and constitutional rights, see Morton J. Horwitz, Santa Clara Revisited: The Development of Corporate Theory, 88 W. Va. L. Rev. 173, 174 (1985); Blair & Pollman, supra note 8, at 1677; Reuven S. Avi-Yonah, Citizens United and the Corporate Form, 2010 Wis. L. Rev. 999, 1033–34; Gregory A. Mark, The Personification of the Business Corporation in American Law, 54 U. Chi. L. Rev. 1441, 1443 (1987); Herbert Hovenkamp, The Classical Corporation in American Legal Thought, 76 Geo. L.J. 1593, 1640–41 (1988); David K. Millon, Theories of the Corporation, 1990 Duke L.J. 201, 205–07; Elizabeth Pollman, Reconceiving Corporate Personhood, 2011 Utah L. Rev. 1629, 1630; Margaret M. Blair, Corporate Personhood and the Corporate Persona, 2013 U. Ill. L. Rev. 785, 796–97; Kent Greenfield, In Defense of Corporate Persons, 30 Const. Comment. 309, 310–12 (2015); Tamara R. Piety, Why Personhood Matters, 30 Const. Comment. 361, 362–63 (2015); Turkuler Isiksel, Corporations as Rights-Bearers, J. Pol. (forthcoming) (manuscript at 1–2) (on file with the author).Show More This Article uncovers this link by highlighting the strategy of a group of corporate lawyers and Ninth Circuit¹⁰ 10.At the time, the Circuit Court for the District of California, where the cases discussed in this Article arose, was located in the federal circuit encompassing California and Oregon. This court exercised both original and appellate jurisdiction and was staffed by one Supreme Court Justice (Stephen Field), one circuit court judge (Lorenzo Sawyer), and one district court judge (Ogden Hoffman), any two of which could hear a case. Christian G. Fritz, Federal Justice in California: The Court of Ogden Hoffman, 1851–1891, at 29–30 (1991). To avoid confusion, this Article follows contemporary scholarship that refers to these cases as occurring in the Ninth Circuit. Id. at 29; Howard J. Graham, Everyman’s Constitution: Historical Essays on the Fourteenth Amendment, the “Conspiracy Theory,” and American Constitutionalism 573 (1968); Winkler, supra note 8, at 153–54. However, this should not be confused with the modern-day U.S. Court of Appeals for the Ninth Circuit, which was not created until the federal appellate system was redesigned in 1891. Joshua Glick, On the Road: The Supreme Court and the History of Circuit Riding, 24 Cardozo L. Rev. 1753, 1826 (2003).Show More judges to expand the Fourteenth Amendment using cases involving both corporations and race. As this Article reveals, modern ideas about corporate personhood are predicated on a historical analogy between corporate shareholders and racial minorities.¹¹ 11.A growing area of scholarship explores the connections between corporations and race. See, e.g., Cheryl L. Wade, Attempting to Discuss Race in Business and Corporate Law Courses and Seminars, 77 St. John’s L. Rev. 901 (2003); Alfred Dennis Mathewson, Race in Ordinary Course: Utilizing the Racial Background in Antitrust and Corporate Law Courses, 23 St. John’s J. Legal Comment. 667, 685 (2008); Cheryl L. Wade, Introduction to Symposium on People of Color, Women, and the Public Corporation: The Sophistication of Discrimination, 79 St. John’s L. Rev. 887, 890 (2005); Thomas W. Joo, Corporate Hierarchy and Racial Justice, 79 St. John’s L. Rev. 955 (2005); Thomas W. Joo, Race, Corporate Law, and Shareholder Value, 54 J. Legal Ed. 351 (2004); Juliet E.K. Walker, White Corporate America: The New Arbiter of Race? in Constructing Corporate America: History, Politics, Culture, 246, 253, 260 (Kenneth Lipartito & David B. Sicilia eds., 2007).Show More Yet racial analogies not only helped corporations gain constitutional rights; corporations themselves created constitutional guarantees that ultimately protected racial minorities. This neglected history shows that corporations have been crucial players in shaping rights guarantees—particularly an expansive interpretation of equal protection under the Fourteenth Amendment—that apply to individuals as well. In revealing these complex interconnections, this Article exposes the multifaceted legacy of litigation over corporate personhood in the development of modern equal protection jurisprudence.

This Article juxtaposes two seminal cases, decided on the same day in 1886 and brought by the same lawyers: Santa Clara County v. Southern Pacific Railroad,¹² 12.118 U.S. 394 (1886).Show More credited with establishing corporate Fourteenth Amendment rights,¹³ 13.See Horwitz, supra note 9, at 173; Blair & Pollman, supra note 8, at 1694–95; Avi-Yonah, supra note 9, at 1033–34.Show More and Yick Wo v. Hopkins,¹⁴ 14.118 U.S. 356 (1886).Show More a touchstone of modern civil rights jurisprudence.¹⁵ 15.See 2 Encyclopedia of American Civil Rights and Liberties 482, 1055 (Kara E. Stooksbury, John M. Scheb, II & Otis H Stephens, Jr. eds., rev. and expanded ed. 2017); Peter Irons, Jim Crow’s Children: The Broken Promise of the Brown Decision 53 (2004); see also infra notes 327–35 (noting early civil rights cases citing Yick Wo).Show More This Article uncovers the conjoined history of these two Fourteenth Amendment cases, one involving a corporation and the other a Chinese immigrant, and their antecedents.¹⁶ 16.Scholars have studied the connection between Fourteenth Amendment claims of Chinese immigrants and the Supreme Court’s desire to protect economic rights. See Thomas Wuil Joo, New “Conspiracy Theory” of the Fourteenth Amendment: Nineteenth Century Chinese Civil Rights Cases and the Development of Substantive Due Process Jurisprudence, 29 U.S.F. L. Rev. 353, 354–55 (1995); Thomas W. Joo, Yick Wo Re-Revisited: Nonblack Nonwhites and Fourteenth Amendment History, 2008 U. Ill. L. Rev. 1427, 1428; Charles McClain, Jr., In Search of Equality: The Chinese Struggle Against Discrimination in Nineteenth-Century America 83 (1994); Graham, supra note 10, at 15; Daniel W. Levy, Classical Lawyers and the Southern Pacific Railroad, 9 W. Legal Hist. 177, 211, 216 (1996); Paul Kens, Justice Stephen Field: Shaping Liberty from the Gold Rush to the Gilded Age 209 (1997); Winkler, supra note 8, at 153. However, no prior scholarship has specifically examined the intersection of Fourteenth Amendment claims by corporations and by Chinese immigrants.Show More Drawing on little-known archival sources, it traces how the same coterie of corporate lawyers simultaneously brought Fourteenth Amendment cases involving Chinese and corporate litigants before the sympathetic Ninth Circuit in order to strategically craft a broad interpretation of the Equal Protection Clause that applied to all “persons,” natural and artificial alike.¹⁷ 17.See In re Ah Fong, 1 F. Cas. 213, 213 (C.C.D. Cal. 1874) (No. 102); Ho Ah Kow v. Nunan, 12 F. Cas. 252, 252 (C.C.D. Cal. 1879) (No. 6,546); In re Ah Chong, 2 F. 733, 737 (C.C.D. Cal. 1880); In re Tiburcio Parrott, 1 F. 481, 482 (C.C.D. Cal. 1880); The Railroad Tax Cases, 13 F. 722, 727 (C.C.D. Cal. 1882); In re Quong Woo, 13 F. 229, 233 (C.C.D. Cal. 1882); County of Santa Clara v. S. Pac. R.R. Co., 18 F. 385, 386, 397 (C.C.D. Cal. 1883), aff’d, 118 U.S. 394 (1886); In re Yick Wo, 9 P. 139, 139 (Cal. 1885), rev’d sub nom. Yick Wo v. Hopkins, 118 U.S. 356 (1886); In re Wo Lee, 26 F. 471, 475 (C.C.D. Cal. 1886).Show More Although in the Slaughter-House Cases the Supreme Court had suggested that it would read the Fourteenth Amendment narrowly,¹⁸ 18.Slaughter-House Cases, 83 U.S. (16 Wall.) 36, 80–81 (1873).Show More in Yick Wo and Santa Clara the Court changed course and adopted the Ninth Circuit’s expansive interpretation of equal protection, a doctrinal shift with lasting effects today.

This is not a story of unintended consequences. By expanding the scope of the Equal Protection Clause to include Chinese immigrants, corporate lawyers were able to use the Chinese cases to draw a through-line from African Americans—the original beneficiaries of the Fourteenth Amendment—to Chinese immigrants, to corporate shareholders.¹⁹ 19.The social and political connections of Chinese “coolies” with railroad and mining corporations in the context of Greater Reconstruction debates over the meaning of “free labor” and “equality” are explored in Evelyn Atkinson, Slaves, Coolies, and Shareholders: Corporations Claim the Fourteenth Amendment, 10 J. Civ. War Era 54 (2020).Show More This comparison was made possible because corporate lawyers and federal judges intentionally portrayed the corporation as simply an aggregate of rights-bearing shareholders who did not forsake their constitutional rights when they joined the corporation. In this framing, shareholders were members of a persecuted group, the same as racial minorities.

This view of the corporation as solely an aggregate of rights-bearing shareholders was at odds with an older common law vision of the corporation as both an aggregate of individuals and a separate legal person with special rights and duties distinct from those of “natural” persons.²⁰ 20.See John Dewey, The Historic Background of Corporate Legal Personality, 35 Yale L.J. 655, 656 (1926); 3 The Collected Papers of Frederic William Maitland 307 (H. A. L. Fisher ed., 1911).Show More In Part I below, this Article exposes a contour of common law corporate personhood that has not previously been noted: incorporation was a status in which corporate legal persons existed in a hierarchical relationship with the public, akin to master-servant or parent-child.²¹ 21.See discussion infra Part I.Show More The common law view of the corporation as a “child” or “servant” of the public justified more stringent state regulation of corporations than of individuals: the state was the benevolent parent, overseeing its corporate child to ensure the corporation acted in the public interest.²² 22.William Novak discusses the extensive power of state legislatures to regulate in the “public interest” in William J. Novak, The People’s Welfare: Law and Regulation in Nineteenth-Century America 19–20 (1996).Show More

Yet as Part II discusses, throughout the nineteenth century, corporate lawyers challenged this view, arguing that corporations were not “children” who owed a special duty of obedience to the parental state but private, profit-making entities whose interests were unrelated or even potentially opposed to those of the public. In this view, the corporation was a naturally arising market phenomenon, akin to any other private market actor, with no special obligation to the public welfare.²³ 23.This has been called the “natural” or “real entity” theory of the corporation, that corporations are naturally emerging market entities controlled by their managers. See Avi-Yonah, supra note 9, at 1000–01; Blair, supra note 9, at 805; Pollman, supra note 9, at 1642; Arthur W. Machen, Jr., Corporate Personality, 24 Harv. L. Rev 253, 262 (1911).Show More In support of this argument, corporate lawyers reframed the corporation not as a group of individuals authorized to act as one “artificial,” “legal person” for certain purposes, but as solely an aggregation of constitutional-rights-bearing shareholders.²⁴ 24.This is called the “aggregate” or “associational” theory. See Horwitz, supra note 9, at 182; Mark, supra note 9, at 1462; Hovenkamp, supra note 9, at 1597–98; Pollman, supra note 9, at 1662. Morton Horwitz argues that the aggregate theory was short-lived because of the increasing separation of management and control and that the “entity” theory replaced the aggregate theory in the early twentieth century. Horwitz, supra note 9, at 182. However, Citizens United, Hobby Lobby, and other recent cases have invoked an aggregate view of the corporation to justify extending freedom of speech and religion to corporations. See Citizens United v. FEC, 558 U.S. 310, 356 (2010) (“Yet certain disfavored associations of citizens—those that have taken on the corporate form—are penalized for engaging in the same political speech.”); Burwell v. Hobby Lobby Stores, Inc., 573 U.S. 682, 720 (2014) (attributing the religious beliefs of the shareholders of a closely held corporation to the corporate entity itself). But see Avi-Yonah, supra note 9, at 1040 (arguing that “both the majority and the dissent [of Citizens United] adopted the real entity view of the corporation”). Actually, the Court tacked back and forth between different conceptions of corporate personality.Show More By framing the corporation simply as a collection of private, rights-bearing individuals, corporate lawyers were able to argue that the rights and duties of corporations were simply the rights and duties of the natural persons who composed them, and no more.²⁵ 25.See infra Part I.Show More

This debate over whether the corporation was a state creation granted legal personhood in certain contexts for the purpose of furthering the public interest, or simply a group of private, rights-bearing individuals pursuing their own economic gain, was central to the cases involving corporate Fourteenth Amendment rights. While Morton Horwitz, Gregory Mark, and others have shown that key to the Ninth Circuit’s reasoning in Santa Clara was a view of the corporation as an aggregate of shareholders,²⁶ 26.Horwitz, supra note 9, at 223; Mark, supra note 9, at 1464.Show More they have not examined the equally viable, alternative vision of the corporation as a “child of the state” presented by opposing counsel and reflected in public opinion. More importantly, they have overlooked the racial analogy underlying the precedents to Santa Clara on which the doctrine of corporate constitutional personhood was built.²⁷ 27.Mark and Horwitz have explained the reliance on the aggregate theory of corporate personhood as primarily rooted in property protection. Mark, supra note 9, at 1464; Horwitz, supra note 9, at 177.Show More This Article reveals the background and reasoning behind this significant judicial reframing of corporate personhood: the aggregate theory of the corporation allowed corporate lawyers and judges to analogize shareholders to racial minorities as similarly persecuted groups targeted by discriminatory legislation.

This analogy, of course, disregarded the immense power discrepancy between corporate shareholders and persecuted racial groups. By holding that the Equal Protection Clause applied to “the despised laborer from China” as much as the “envied master of millions,”²⁸ 28.The Railroad Tax Cases, 13 F. 722, 741 (C.C.D. Cal. 1882).Show More the Ninth Circuit endorsed an interpretation of the Amendment as treating all persons alike, regardless of their social and economic power. This reasoning bolstered a “formal equality” interpretation of the Fourteenth Amendment, in contrast to claims that the Amendment embodied a commitment to “substantive equality” or anti-subordination—part of a trend towards limiting the Amendment’s ability to address long-standing inequalities that continues today.²⁹ 29.“Substantive equality,” or “anti-subordination,” consists not only in eliminating discrimination but also in “alter[ing] the circumstances that are identified as giving rise to equality questions in the first place.” Catharine A. MacKinnon, Substantive Equality: A Perspective, 96 Minn. L. Rev. 1, 11 (2011) [hereinafter MacKinnon, Substantive Equality]; see also Ruth Colker, Reflections on Race: The Limits of Formal Equality, 69 Ohio St. L.J. 1089, 1090 (2008) (contrasting a “formal equality” with an “anti-subordination” perspective); Kimberlé Williams Crenshaw, Race, Reform, and Retrenchment: Transformation and Legitimation in Antidiscrimination Law, 101 Harv. L. Rev. 1331, 1336 (1988) (contrasting “equality as a process” with “equality as a result”). For an extensive analysis of “formal” versus “substantive” concepts of equality, see generally Catharine A. MacKinnon, Sex Equality (2007) [hereinafter MacKinnon, Sex Equality].Show More

This is not a case of manipulation by corporate lawyers of disempowered minority litigants. Chinese litigants were willing partners in the strategy to join forces with corporations to expand the Fourteenth Amendment. As this Article reveals, the economic and social connections between industrial corporate magnates and the elite Chinese mercantile and political community were long-standing. Both relied financially on the continued immigration of Chinese laborers, and both had long been represented by the same corporate lawyers. They were also both the target of discriminatory regulations that aimed to simultaneously curb corporate power and stem Chinese immigration. The Fourteenth Amendment provided a valuable tool for corporate lawyers to advocate on behalf of both sets of clients. By eliding the difference between Chinese immigrants and shareholders in these interrelated lines of cases, corporate lawyers cemented an interpretation of equal protection that culminated in the success of the twin cases of Santa Clara and Yick Wo.

For years, scholars have pondered Chief Justice Morrison Waite’s famously blithe comment at the outset of oral argument in Santa Clara that the Justices did not wish to hear argument on whether the Fourteenth Amendment applied to corporations, as they were “all of [the] opinion that it does.”³⁰ 30.Santa Clara County v. S. Pac. R.R. Co., 118 U.S. 394, 396 (1886); see, e.g., Howard Jay Graham, The Waite Court and the Fourteenth Amendment, 17 Vand. L. Rev. 525, 530 (1964) (“Nowhere in the United States Reports are there to be found words more momentous or more baffling than these.”); Horwitz, supra note 9, at 173 (“[The decision] has always been puzzling and controversial”); Pollman, supra note 9, at 1644 n.92 (“[T]he unusual circumstances of this case have evoked skepticism and debate.”).Show More Gregory Mark has pointed out that Waite expressly avoided addressing the constitutional question and argued that his statement indicated that the Court merely intended to accept the argument that the corporate property in this case was protected as property of the shareholders.³¹ 31.Mark, supra note 9, at 1464.Show More Elizabeth Pollman has also explained Waite’s statement as concerned with protecting the shareholders’ property interests.³² 32.Pollman, supra note 9, at 1644–45.Show More Howard Graham, dismissing the claim as “dictum,” went so far as to contend that “the recording of this statement was a fluke––the Court reporter’s after-thought!”³³ 33.Graham, supra note 30, at 530.Show More Adam Winkler has likewise claimed that Waite never intended his quote to become part of the opinion, but that it was intentionally misrepresented in the case report by a perfidious court reporter.³⁴ 34.Winkler, supra note 8, at 153.Show More

J. Willard Hurst even posited that, given late nineteenth-century law’s general embrace of economic activity, extending the Fourteenth Amendment to corporations “provoked no significant contemporary controversy.”³⁵ 35.James Willard Hurst, The Legitimacy of the Business Corporation in the Law of the United States 1780–1970, at 68 (1970).Show More

This Article offers a novel interpretation of this puzzle. By reading Santa Clara in light of Yick Wo and the preceding line of corporate and Chinese Fourteenth Amendment cases, this Article illuminates the context of equal protection jurisprudence surrounding Waite’s enigmatic statement—specifically, the interplay between corporate personhood and race. As this Article reveals, the definition of equal protection that the Court adopted in Yick Wo had been developed in Ninth Circuit corporate and Chinese Fourteenth Amendment cases throughout the preceding decade and was central to the arguments of counsel in both Yick Wo and Santa Clara. By the time the Waite Court heard Santa Clara, the link between racial minorities and corporate shareholders had become well established in equal protection jurisprudence.³⁶ 36.Elizabeth Pollman notes the precedential effect of the Ninth Circuit’s equal protection jurisprudence but does not explore the explicit connections to race. Pollman, supra note 9, at 1644.Show More Although the Court announced its expanded interpretation of equal protection in Yick Wo rather than Santa Clara, its reasoning had long been applied equally to corporate litigants. This Article suggests that one reason why the Court declined to hear arguments on whether the Fourteenth Amendment protected corporations was because the combined precedent of Chinese and corporate cases had already established that it did.

The success of corporations at claiming constitutional rights has produced a forked legacy. Critics of Citizens United and Hobby Lobby have contended that corporate personhood has been used to trump the rights of individuals³⁷ 37.As Justice Ruth Bader Ginsburg argued in Hobby Lobby, the majority prioritized religious rights of employers over the reproductive rights of female employees. Burwell v. Hobby Lobby Stores, Inc., 573 U.S. 682, 740 (2014) (Ginsburg, J., dissenting); see also Jessica L. Waters & Leandra N. Carrasco, Untangling the Reproductive Rights and Religious Liberty Knot, 26 Yale J.L. & Feminism 217 (2014).Show More and to subvert the democratic process.³⁸ 38.One outcome of Citizens United has arguably been to permit dark-money groups to sway elections. See Heather K. Gerken, The Real Problem with Citizens United: Campaign Finance, Dark Money, and Shadow Parties, 97 Marq. L. Rev. 903, 905 (2014); Danny Emmer, Shedding Light on “Dark Money”: The Heightened Risk of Foreign Influence Post-Citizens United, 20 Sw. J. Int’l L. 381, 382 (2014).Show More In contrast, supporters of the decisions have argued that corporations are collections of shareholders who do not lose their fundamental rights simply because they do business as a corporation.³⁹ 39.Citizens United v. FEC, 558 U.S. 310, 339–40 (2010); Hobby Lobby, 573 U.S. at 706–07; see, e.g., Richard A. Epstein, The Defeat of the Contraceptive Mandate in Hobby Lobby: Right Results, Wrong Reasons, 2014 Cato Sup. Ct. Rev. 35, 45; Paul Horwitz, The Hobby Lobby Moment, 128 Harv. L. Rev. 154, 162–63 (2014).Show More Yet even those who oppose corporate constitutional personhood must acknowledge the discomfiting reality that corporate rights litigation has been, and continues to be, an important means of expanding rights protections for natural persons. Today, corporations play an important role in protecting civil rights in other contexts, such as by bringing claims for racial discrimination on behalf of their members under the 1866 Civil Rights Act.⁴⁰ 40.42 U.S.C. § 1981(a). Because corporations are typically the contracting party in these cases, not the natural persons against which the actual discrimination is directed, under common law principles of contract law the corporation is the only “person” that has standing to sue. See infra note 342.Corporate litigation has also laid the groundwork for individual claims regarding religious freedom. Hobby Lobby has been invoked by smaller corporations, nonprofits, individuals, and partnerships claiming freedom of religion rights in similar contexts. See, e.g., Brief for Petitioners at 38 n.6, Masterpiece Cakeshop, Ltd. v. Colo. C.R. Comm’n, 138 S. Ct. 1719 (2018) (No. 16-111); Reply Brief for Petitioners in Nos. 14-1418, 14-1453 & 14-1505, at 7–8, Zubik v. Burwell, 578 U.S. 403 (2016) (Nos. 14-1418, 14-1453, 14-1505, 15-35, 15-105, 15-119 & 15-191); Brief for Petitioners in Nos. 15-35, 15-105, 15-119 & 15-191, at 2, Zubik, 578 U.S. 403 (Nos. 14-1418, 14-1453, 14-1505, 15-35, 15-105, 15-119 & 15-191). The wealth and institutional knowledge of large corporations like Hobby Lobby and their lawyers make them ideally suited to pursue impact litigation that establishes precedent for non-corporate claims of religious freedom violations.Show More This does not mean we should rehabilitate constitutional-rights-bearing corporate persons; but we must admit that a blanket condemnation of corporate personhood ignores the important historical legacy of corporate rights litigation and the continued interconnection—even interdependency—of corporations and racial minorities.

The Article proceeds in three Parts. Part I addresses the common law vision of the corporation as both an aggregate of individuals and a “child of the state” with rights and duties different from those of natural persons and traces the continued viability of this vision throughout the period in which Santa Clara was decided. Part II concerns corporate challenges to this traditional view in Fourteenth Amendment litigation, examining the strategy of corporate lawyers’ and Ninth Circuit judges’ reliance on the aggregate theory of corporate personhood to analogize Chinese immigrants to corporate shareholders in order to support a broad reading of the Equal Protection Clause. Part III examines the background of Santa Clara and reveals how the meaning of equal protection established by the Chinese and corporate Fourteenth Amendment cases informed the Court’s ultimate rulings in Santa Clara and Yick Wo, laying the groundwork for modern equal protection doctrine today.

1. * Postdoctoral Teaching Fellow, University of Chicago. Ph.D, University of Chicago; J.D., Harvard Law School. Many thanks to Amy Dru Stanley, Laura Weinrib, Alison LaCroix, Jonathan Levy, Ajay Mehrotra, Christopher Schmidt, Naomi Lamoreaux, Gregory Mark, Adam Winkler, Paul Kens, Nikolas Bowie, Naama Maor, Lael Weinberger, and the American Bar Foundation Doctoral Fellows Workshop (2018–2020) for their comments and insights. Thank you also to the editors of the Virginia Law Review for their deep engagement with this text, as well as their technical prowess. ↑
2. 558 U.S. 310 (2010). ↑
3. 573 U.S. 682 (2014). ↑
4. In Citizens United, the Supreme Court struck down a federal law, 2 U.S.C. § 441b (2006), that banned direct corporate spending on political campaigns. 558 U.S. at 372. Citizens United was part of a long line of cases in which the Court had recognized the First Amendment rights of corporations, including: NAACP v. Alabama ex rel. Patterson, 357 U.S. 449, 459 (1958) (freedom of association); NAACP v. Button, 371 U.S. 415, 428–29 (1963) (freedom of expression and association); New York Times Co. v. Sullivan, 376 U.S. 254, 264 (1964) (freedom of speech and the press); and First National Bank of Boston v. Bellotti, 435 U.S. 765, 784 (1978) (campaign expenditures as political speech). Hobby Lobby concluded that corporations were “persons” under the Religious Freedom Restoration Act, 42 U.S.C. §§ 2000bb–1, and held that Health and Human Services regulations requiring employers to provide insurance that covered contraceptives unconstitutionally burdened closely held corporations’ exercise of religion. 573 U.S. at 736. ↑
5. See Move to Amend, https://www.movetoamend.org/ [https://perma.cc/RH9L-2FZT] (last visited Aug. 19, 2020); United for the People, http://united4thepeople.org/ [https://perma.cc/XS9X-LZNR] (last visited Aug. 19, 2020). ↑
6. United for the People, supra note 4; Move to Amend, supra note 4. See Joanna M. Meyer, The Real Error in Citizens United, 69 Wash. & Lee L. Rev. 2171, 2198 (2012). ↑
7. H.R.J. Res. 48, 116th Cong. (2019) (proposing an amendment to the Constitution of the United States providing that the rights extended by the Constitution are the rights of natural persons only). Other bills introduced in both the House and the Senate have targeted specific constitutional rights, such as one “waiving the application of the first article of amendment to the political speech of corporations.” H.R.J. Res. 39, 116th Cong. (2019). See United for the People, http://united4thepeople.org/amendments/ (last visited Oct. 31, 2021) [https://perma.cc/QGU7-883U], for an up-to-date list of proposed amendments relating to corporate constitutional rights. ↑
8.  See Move to Amend, https://move-to-amend.myshopify.com/collections/frontpage [https://perma.cc/8JVP-CYAD] (last visited Dec. 28, 2021). ↑
9. For early cases debating the constitutional rights of corporations, see Bank of United States v. Deveaux, 9 U.S. (5 Cranch) 61, 63–64 (1809); Hope Insurance Co. of Providence v. Boardman, 9 U.S. (5 Cranch) 57, 58 (1809); Terrett v. Taylor, 13 U.S. (9 Cranch) 43, 46–47 (1815); Trustees of Dartmouth College v. Woodward, 17 U.S. (4 Wheaton) 518, 556 (1819); Proprietors of Charles River Bridge v. Proprietors of Warren Bridge, 36 U.S. (11 Peters) 420, 421 (1837); and Louisville, Cincinnati & Charleston Railroad Co. v. Letson, 43 U.S. (2 Howard) 497, 499 (1844). See also Adam Winkler, We the Corporations: How American Businesses Won Their Civil Rights, at xxi (2018) (describing how the country’s most powerful corporations have persistently tried to use the Constitution to evade unwanted government regulations); Margaret M. Blair & Elizabeth Pollman, The Derivative Nature of Corporate Constitutional Rights, 56 Wm. & Mary L. Rev. 1673, 1680 (2015) (explaining how the Supreme Court was tasked with determining the applicability of constitutional provisions to corporations in an 1809 case involving the first Bank of the United States). ↑
10.  Legal historians of corporate personhood have discussed corporate Fourteenth Amendment cases in some detail but have neglected the role that race played in the development of these cases. For representative writings on corporate personhood and constitutional rights, see Morton J. Horwitz, Santa Clara Revisited: The Development of Corporate Theory, 88 W. Va. L. Rev. 173, 174 (1985); Blair & Pollman, supra note 8, at 1677; Reuven S. Avi-Yonah, Citizens United and the Corporate Form, 2010 Wis. L. Rev. 999, 1033–34; Gregory A. Mark, The Personification of the Business Corporation in American Law, 54 U. Chi. L. Rev. 1441, 1443 (1987); Herbert Hovenkamp, The Classical Corporation in American Legal Thought, 76 Geo. L.J. 1593, 1640–41 (1988); David K. Millon, Theories of the Corporation, 1990 Duke L.J. 201, 205–07; Elizabeth Pollman, Reconceiving Corporate Personhood, 2011 Utah L. Rev. 1629, 1630; Margaret M. Blair, Corporate Personhood and the Corporate Persona, 2013 U. Ill. L. Rev. 785, 796–97; Kent Greenfield, In Defense of Corporate Persons, 30 Const. Comment. 309, 310–12 (2015); Tamara R. Piety, Why Personhood Matters, 30 Const. Comment. 361, 362–63 (2015); Turkuler Isiksel, Corporations as Rights-Bearers, J. Pol. (forthcoming) (manuscript at 1–2) (on file with the author). ↑
11. At the time, the Circuit Court for the District of California, where the cases discussed in this Article arose, was located in the federal circuit encompassing California and Oregon. This court exercised both original and appellate jurisdiction and was staffed by one Supreme Court Justice (Stephen Field), one circuit court judge (Lorenzo Sawyer), and one district court judge (Ogden Hoffman), any two of which could hear a case. Christian G. Fritz, Federal Justice in California: The Court of Ogden Hoffman, 1851–1891, at 29–30 (1991). To avoid confusion, this Article follows contemporary scholarship that refers to these cases as occurring in the Ninth Circuit. Id. at 29; Howard J. Graham, Everyman’s Constitution: Historical Essays on the Fourteenth Amendment, the “Conspiracy Theory,” and American Constitutionalism 573 (1968); Winkler, supra note 8, at 153–54. However, this should not be confused with the modern-day U.S. Court of Appeals for the Ninth Circuit, which was not created until the federal appellate system was redesigned in 1891. Joshua Glick, On the Road: The Supreme Court and the History of Circuit Riding, 24 Cardozo L. Rev. 1753, 1826 (2003). ↑
12. A growing area of scholarship explores the connections between corporations and race. See, e.g., Cheryl L. Wade, Attempting to Discuss Race in Business and Corporate Law Courses and Seminars, 77 St. John’s L. Rev. 901 (2003); Alfred Dennis Mathewson, Race in Ordinary Course: Utilizing the Racial Background in Antitrust and Corporate Law Courses, 23 St. John’s J. Legal Comment. 667, 685 (2008); Cheryl L. Wade, Introduction to Symposium on People of Color, Women, and the Public Corporation: The Sophistication of Discrimination, 79 St. John’s L. Rev. 887, 890 (2005); Thomas W. Joo, Corporate Hierarchy and Racial Justice, 79 St. John’s L. Rev. 955 (2005); Thomas W. Joo, Race, Corporate Law, and Shareholder Value, 54 J. Legal Ed. 351 (2004); Juliet E.K. Walker, White Corporate America: The New Arbiter of Race? in Constructing Corporate America: History, Politics, Culture, 246, 253, 260 (Kenneth Lipartito & David B. Sicilia eds., 2007). ↑
13. 118 U.S. 394 (1886). ↑
14. See Horwitz, supra note 9, at 173; Blair & Pollman, supra note 8, at 1694–95; Avi-Yonah, supra note 9, at 1033–34. ↑
15. 118 U.S. 356 (1886). ↑
16.  See 2 Encyclopedia of American Civil Rights and Liberties 482, 1055 (Kara E. Stooksbury, John M. Scheb, II & Otis H Stephens, Jr. eds., rev. and expanded ed. 2017); Peter Irons, Jim Crow’s Children: The Broken Promise of the Brown Decision 53 (2004); see also infra notes 327–35 (noting early civil rights cases citing Yick Wo). ↑
17. Scholars have studied the connection between Fourteenth Amendment claims of Chinese immigrants and the Supreme Court’s desire to protect economic rights. See Thomas Wuil Joo, New “Conspiracy Theory” of the Fourteenth Amendment: Nineteenth Century Chinese Civil Rights Cases and the Development of Substantive Due Process Jurisprudence, 29 U.S.F. L. Rev. 353, 354–55 (1995); Thomas W. Joo, Yick Wo Re-Revisited: Nonblack Nonwhites and Fourteenth Amendment History, 2008 U. Ill. L. Rev. 1427, 1428; Charles McClain, Jr., In Search of Equality: The Chinese Struggle Against Discrimination in Nineteenth-Century America 83 (1994); Graham, supra note 10, at 15; Daniel W. Levy, Classical Lawyers and the Southern Pacific Railroad, 9 W. Legal Hist. 177, 211, 216 (1996); Paul Kens, Justice Stephen Field: Shaping Liberty from the Gold Rush to the Gilded Age 209 (1997); Winkler, supra note 8, at 153. However, no prior scholarship has specifically examined the intersection of Fourteenth Amendment claims by corporations and by Chinese immigrants. ↑
18. See In re Ah Fong, 1 F. Cas. 213, 213 (C.C.D. Cal. 1874) (No. 102); Ho Ah Kow v. Nunan, 12 F. Cas. 252, 252 (C.C.D. Cal. 1879) (No. 6,546); In re Ah Chong, 2 F. 733, 737 (C.C.D. Cal. 1880); In re Tiburcio Parrott, 1 F. 481, 482 (C.C.D. Cal. 1880); The Railroad Tax Cases, 13 F. 722, 727 (C.C.D. Cal. 1882); In re Quong Woo, 13 F. 229, 233 (C.C.D. Cal. 1882); County of Santa Clara v. S. Pac. R.R. Co., 18 F. 385, 386, 397 (C.C.D. Cal. 1883), aff’d, 118 U.S. 394 (1886); In re Yick Wo, 9 P. 139, 139 (Cal. 1885), rev’d sub nom. Yick Wo v. Hopkins, 118 U.S. 356 (1886); In re Wo Lee, 26 F. 471, 475 (C.C.D. Cal. 1886). ↑
19. Slaughter-House Cases, 83 U.S. (16 Wall.) 36, 80–81 (1873). ↑
20. The social and political connections of Chinese “coolies” with railroad and mining corporations in the context of Greater Reconstruction debates over the meaning of “free labor” and “equality” are explored in Evelyn Atkinson, Slaves, Coolies, and Shareholders: Corporations Claim the Fourteenth Amendment, 10 J. Civ. War Era 54 (2020). ↑
21. See John Dewey, The Historic Background of Corporate Legal Personality, 35 Yale L.J. 655, 656 (1926); 3 The Collected Papers of Frederic William Maitland 307 (H. A. L. Fisher ed., 1911). ↑
22. See discussion infra Part I. ↑
23. William Novak discusses the extensive power of state legislatures to regulate in the “public interest” in William J. Novak, The People’s Welfare: Law and Regulation in Nineteenth-Century America 19–20 (1996). ↑
24. This has been called the “natural” or “real entity” theory of the corporation, that corporations are naturally emerging market entities controlled by their managers. See Avi-Yonah, supra note 9, at 1000–01; Blair, supra note 9, at 805; Pollman, supra note 9, at 1642; Arthur W. Machen, Jr., Corporate Personality, 24 Harv. L. Rev 253, 262 (1911). ↑
25. This is called the “aggregate” or “associational” theory. See Horwitz, supra note 9, at 182; Mark, supra note 9, at 1462; Hovenkamp, supra note 9, at 1597–98; Pollman, supra note 9, at 1662. Morton Horwitz argues that the aggregate theory was short-lived because of the increasing separation of management and control and that the “entity” theory replaced the aggregate theory in the early twentieth century. Horwitz, supra note 9, at 182. However, Citizens United, Hobby Lobby, and other recent cases have invoked an aggregate view of the corporation to justify extending freedom of speech and religion to corporations. See Citizens United v. FEC, 558 U.S. 310, 356 (2010) (“Yet certain disfavored associations of citizens—those that have taken on the corporate form—are penalized for engaging in the same political speech.”); Burwell v. Hobby Lobby Stores, Inc., 573 U.S. 682, 720 (2014) (attributing the religious beliefs of the shareholders of a closely held corporation to the corporate entity itself). But see Avi-Yonah, supra note 9, at 1040 (arguing that “both the majority and the dissent [of Citizens United] adopted the real entity view of the corporation”). Actually, the Court tacked back and forth between different conceptions of corporate personality. ↑
26. See infra Part I. ↑
27. Horwitz, supra note 9, at 223; Mark, supra note 9, at 1464. ↑
28. Mark and Horwitz have explained the reliance on the aggregate theory of corporate personhood as primarily rooted in property protection. Mark, supra note 9, at 1464; Horwitz, supra note 9, at 177. ↑
29. The Railroad Tax Cases, 13 F. 722, 741 (C.C.D. Cal. 1882). ↑
30.  “Substantive equality,” or “anti-subordination,” consists not only in eliminating discrimination but also in “alter[ing] the circumstances that are identified as giving rise to equality questions in the first place.” Catharine A. MacKinnon, Substantive Equality: A Perspective, 96 Minn. L. Rev. 1, 11 (2011) [hereinafter MacKinnon, Substantive Equality]; see also Ruth Colker, Reflections on Race: The Limits of Formal Equality, 69 Ohio St. L.J. 1089, 1090 (2008) (contrasting a “formal equality” with an “anti-subordination” perspective); Kimberlé Williams Crenshaw, Race, Reform, and Retrenchment: Transformation and Legitimation in Antidiscrimination Law, 101 Harv. L. Rev. 1331, 1336 (1988) (contrasting “equality as a process” with “equality as a result”). For an extensive analysis of “formal” versus “substantive” concepts of equality, see generally Catharine A. MacKinnon, Sex Equality (2007) [hereinafter MacKinnon, Sex Equality]. ↑
31. Santa Clara County v. S. Pac. R.R. Co., 118 U.S. 394, 396 (1886); see, e.g., Howard Jay Graham, The Waite Court and the Fourteenth Amendment, 17 Vand. L. Rev. 525, 530 (1964) (“Nowhere in the United States Reports are there to be found words more momentous or more baffling than these.”); Horwitz, supra note 9, at 173 (“[The decision] has always been puzzling and controversial”); Pollman, supra note 9, at 1644 n.92 (“[T]he unusual circumstances of this case have evoked skepticism and debate.”). ↑
32. Mark, supra note 9, at 1464. ↑
33. Pollman, supra note 9, at 1644–45. ↑
34. Graham, supra note 30, at 530. ↑
35. Winkler, supra note 8, at 153. ↑
36. James Willard Hurst, The Legitimacy of the Business Corporation in the Law of the United States 1780–1970, at 68 (1970). ↑
37. Elizabeth Pollman notes the precedential effect of the Ninth Circuit’s equal protection jurisprudence but does not explore the explicit connections to race. Pollman, supra note 9, at 1644. ↑
38. As Justice Ruth Bader Ginsburg argued in Hobby Lobby, the majority prioritized religious rights of employers over the reproductive rights of female employees. Burwell v. Hobby Lobby Stores, Inc., 573 U.S. 682, 740 (2014) (Ginsburg, J., dissenting); see also Jessica L. Waters & Leandra N. Carrasco, Untangling the Reproductive Rights and Religious Liberty Knot, 26 Yale J.L. & Feminism 217 (2014). ↑
39. One outcome of Citizens United has arguably been to permit dark-money groups to sway elections. See Heather K. Gerken, The Real Problem with Citizens United: Campaign Finance, Dark Money, and Shadow Parties, 97 Marq. L. Rev. 903, 905 (2014); Danny Emmer, Shedding Light on “Dark Money”: The Heightened Risk of Foreign Influence Post-Citizens United, 20 Sw. J. Int’l L. 381, 382 (2014). ↑
40. Citizens United v. FEC, 558 U.S. 310, 339–40 (2010); Hobby Lobby, 573 U.S. at 706–07; see, e.g., Richard A. Epstein, The Defeat of the Contraceptive Mandate in Hobby Lobby: Right Results, Wrong Reasons, 2014 Cato Sup. Ct. Rev. 35, 45; Paul Horwitz, The Hobby Lobby Moment, 128 Harv. L. Rev. 154, 162–63 (2014). ↑

41. 42 U.S.C. § 1981(a). Because corporations are typically the contracting party in these cases, not the natural persons against which the actual discrimination is directed, under common law principles of contract law the corporation is the only “person” that has standing to sue. See infra note 342.

    Corporate litigation has also laid the groundwork for individual claims regarding religious freedom. Hobby Lobby has been invoked by smaller corporations, nonprofits, individuals, and partnerships claiming freedom of religion rights in similar contexts. See, e.g., Brief for Petitioners at 38 n.6, Masterpiece Cakeshop, Ltd. v. Colo. C.R. Comm’n, 138 S. Ct. 1719 (2018) (No. 16-111); Reply Brief for Petitioners in Nos. 14-1418, 14-1453 & 14-1505, at 7–8, Zubik v. Burwell, 578 U.S. 403 (2016) (Nos. 14-1418, 14-1453, 14-1505, 15-35, 15-105, 15-119 & 15-191); Brief for Petitioners in Nos. 15-35, 15-105, 15-119 & 15-191, at 2, Zubik, 578 U.S. 403 (Nos. 14-1418, 14-1453, 14-1505, 15-35, 15-105, 15-119 & 15-191). The wealth and institutional knowledge of large corporations like Hobby Lobby and their lawyers make them ideally suited to pursue impact litigation that establishes precedent for non-corporate claims of religious freedom violations. ↑

The post Frankenstein’s Baby: The Forgotten History of Corporations, Race, and Equal Protection first appeared on Virginia Law Review.

This Note proposes two changes to existing conceptions of merger deal prices in appraisal cases. First, the appraisal statute should be understood to exclude the value of reduced agency costs from appraisal awards. Second, when material non-public information is disclosed to the buyer but withheld from the market, both the appraisal statute and basic notions of market efficiency demand that courts take cognizance of it. The best way to operationalize these conceptual modifications is to presume that the target’s unaffected stock price equals fair value unless the petitioner establishes that material information was withheld from the market.

This approach adds needed clarity to the Delaware Supreme Court’s salutary recent embrace of the efficient capital markets hypothesis in the appraisal context. Adopting it would increase stockholder value, encourage efficient change-of-control transactions, and simplify appraisal proceedings. It preserves appraisal’s foundational role as a safeguard against the exploitation of minority stockholders by compensating them when the deal price omits suppressed material information.

I. Introduction

Section 262 of the Delaware General Corporation Law (“DGCL”) provides that a dissenting target stockholder in a merger or consolidation transaction may petition the Court of Chancery for an award of the fair value of her shares.¹ 1.Del. Code Ann. tit. 8, § 262 (2020). The appraisal remedy is limited to two types of transactions: “squeeze-outs” effected under §§ 253 and 267, and other mergers or consolidation transactions involving some cash consideration. See id.Show More Appraisal is a critical safety net for minority stockholders, and appraisal petitions increased dramatically during the past decade as Delaware courts have constrained other methods for challenging change-of-control transactions.² 2.See infra notes 20–22 and accompanying text.Show More Disagreement persists about whether and when the market price, the deal price, or some other metric is the best indicator of fair value. Each of these approaches is rooted in an incomplete conception of the determinants of merger prices. This Note presents a revised model of merger deal prices that resolves many of the theoretical and practical impediments to articulating a properly functional appraisal remedy. It then suggests a method for operationalizing the revised model.

In two 2017 decisions, the Delaware Supreme Court (“Supreme Court”) relied on the Efficient Capital Markets Hypothesis (“ECMH”) to reverse the Court of Chancery and endorse the deal price as the best evidence of fair value. The decisions and the Supreme Court’s treatment of the ECMH sparked widespread debate about the proper role of the ECMH in appraisal law and the broader purposes of the appraisal statute. Unresolved questions about the proper role of the ECMH and its broader purposes remain pending before the Supreme Court as of the time of this writing. Although Delaware’s recent emphasis on the ECMH is a welcome development, its failure to account for the role of reduced agency costs and the value of non-public information threatens to undermine the benefits of adopting the ECMH. A more complete theory of appraisal law must acknowledge two critical facts. First, agency cost reductions—the value created by replacing existing managers with more effective ones—are a key motivation for pursuing mergers, and they should belong to the acquirer. To incentivize efficient change-of-control transactions, courts should exclude the value of reduced agency costs from appraisal awards. Second, the value of non-public information about the target company is often a key element of merger prices. By relying on the ECMH without explicitly incorporating the value of non-public information into appraisal fair value, courts subvert the theory’s ability to provide reliable estimates of fair value. The best formulation of the appraisal remedy—and the one most consistent with the ECMH, the appraisal statute, and the purposes of Delaware corporate law—presumes market prices are fair in the absence of evidence that material non-public information was withheld from the market.

To define the “fair value” of an appraisal petitioner’s shares, it is first necessary to re-examine the composition of merger deal prices. If the target company’s stock trades in an efficient market, then its stock price “reflects all publicly available information as a consensus, per-share valuation.”³ 3.Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd. (Dell), 177 A.3d 1, 16 (Del. 2017).Show More The existing stock price sets the presumptive baseline for merger fair value because no rational stockholder would tender her shares to an acquirer at a lower price than she would receive on the open market.⁴ 4.It is assumed that the Supreme Court has endorsed the ECMH inclusive of that theory’s conventional assumption that market participants are rational. See Steven M. Sheffrin, Rational Expectations 99 (2d ed. 1996). This assumption is uncontroversial in the present context—i.e., it is beyond doubt that no reasonable shareholder would tender her shares at a lower price than she could readily receive elsewhere—but it has been contested in others. See, e.g., Franco Modigliani & Richard A. Cohn, Inflation, Rational Valuation and the Market, 35 Fin. Analysts J. 24, 24 (1979) (arguing that persistent inflation distorts market prices of securities, a finding inconsistent with some forms of the ECMH); Lawrence H. Summers, Does the Stock Market Rationally Reflect Fundamental Values?, 41 J. Fin. 591 (1986) (arguing that empirical evidence does not conclusively confirm the ECMH and that market prices do not always rationally reflect the fundamental values of securities). This Note does not aspire to contribute to scholarly commentary on the ECMH; like the Supreme Court, it adopts the hypothesis as a tool for deciding appraisal cases. See Dell, 177 A.3d at 24; see also Are Markets Efficient?, Chi. Booth Rev. (June 30, 2016), https://review.chicagobooth.edu/­economics/2016/video/are-markets-efficient [https://perma.cc/7HBU-C4ZL] (interview with Eugene Fama and Richard Thaler) (“The point is not that markets are efficient. . . . It’s just a model.”).Show More The second component of merger prices is the value of merger “synergies,” the value created by combining formerly separate business units. Agency cost reductions are a third source of value, created when an acquirer replaces existing management with superior business administrators. Finally, material non-public information (MNPI) is an often-overlooked fourth component of merger value. Prospective buyers receive MNPI during the diligence phase of merger transactions.⁵ 5.See infra Section III.B.Show More MNPI is by definition relevant to company value; it is information which “would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information available” about the company.⁶ 6.Klang v. Smith’s Food & Drug Ctrs., Inc., 702 A.2d 150, 156 (Del. 1997) (quoting Rosenblatt v. Getty Oil Co., 493 A.2d 929, 944 (Del. 1985)). Note, too, that MNPI may be value-positive or value-negative. See infra Section III.D.Show More

The appraisal statute excludes from appraisal awards “any element of value arising from the accomplishment or expectation of the merger,”⁷ 7.Del. Code Ann. tit. 8, § 262(h) (2020).Show More and synergies are consequently not included in appraisal awards. This Note will argue that the statute should also bar appraisal petitioners from recovering the value of agency cost reductions because they, too, are created by the transaction itself. This observation has important policy implications for capital formation; most importantly, excluding reduced agency costs is essential to incentivizing efficient change-of-control transactions.

Courts and academics analyzing appraisal have neglected to account for the value of non-public information as a determinant of merger prices. MNPI is definitionally value-laden, but in a world governed by the ECMH, it is not incorporated into market prices.⁸ 8.This Note adopts the “semi-strong” form of the ECMH embraced by the Supreme Court, which holds that market prices incorporate all publicly available information about asset prices. See Verition Partners Master Fund Ltd. v. Aruba Networks, Inc. (Aruba III), 210 A.3d 128, 137–38, 138 n.53 (Del. 2019).Show More When MNPI disseminated to the buyer is withheld from the market (e.g., if the board fails to disclose a conflict when it recommends stockholders vote in favor of a merger), the risk of minority stockholder exploitation is high. Appraisal analysis should therefore explicitly acknowledge that suppressed MNPI is relevant to company value. However, MNPI will often be prohibitively difficult for courts to value. For example, suppose that an appraisal petitioner establishes at trial that the merger buyer induced the target’s CEO to support an unfairly low deal price by secretly offering her employment at the merged firm. It will likely be very difficult to determine with precision how this undisclosed conflict affected the ultimate sale price; the petitioner certainly should have received a better price for her shares, but it is not clear how much. This presents a dilemma for implementing the proposed merger deal price model in appraisal cases.

The solution is to define market prices as the baseline for appraisal fair value, presuming that the target’s unaffected stock price is the best evidence of the company’s value. This automatically excises synergies and agency cost reductions from appraisal awards. The presumption can be surmounted by evidence of MNPI suppression. Where this threshold is met, the court should exercise its discretion to determine the appraisal award, as it currently does, bearing in mind that buyers are entitled to the value they create through synergies and reduced agency costs. This approach will meaningfully simplify appraisal proceedings and refocus the remedy on the policy goals it serves—facilitating capital formation and encouraging efficient, non-exploitative mergers.

Part II situates the appraisal remedy within its doctrinal context. It introduces appraisal as an important safeguard against minority stockholder exploitation in change-of-control transactions, one that operates outside of the traditional breach of fiduciary duty merger litigation arena. It details several cases that collectively embody the recent controversy over the ECMH’s role in appraisal proceedings and concludes with an economic analysis of appraisal’s role in the broader corporate contract. Part III presents the revised merger deal price framework. Starting with the assumption that Delaware corporate law exists to facilitate investment and maximize long-term stockholder value, it argues that courts should exclude agency cost reductions and include the value of MNPI. It then develops the foregoing analysis into a method for adjudicating appraisal petitions that relies on a rebuttable presumption that market prices are fair.

Part IV analyzes the proposed framework’s likely consequences. It applies the framework to three noteworthy recent appraisal cases, reaching divergent results from the Delaware courts in each. It then argues that, if adopted, the adjudicatory model would bring much-needed clarity and rigor to the Supreme Court’s embrace of the ECMH, enabling courts to more fully utilize the ECMH’s analytical advantages. It would reduce some of the complexity associated with judicial determinations of company value, decrease the volume of appraisal petitions, and discourage speculative appraisal petitions—an outcome consistent with recent trends in Delaware deal jurisprudence. Next, it considers the likely effects on capital formation and the broader merger and acquisition (“M&A”) market. Excluding agency cost reductions would allow M&A buyers to retain the value they create when they replace inefficient management, increasing their incentives to pursue efficient corporate control transactions. It would also further the goal of maximizing stockholder value by eliminating appraisal premia. And, by incorporating MNPI into the fair value calculation, the suggested framework would discourage collusion between targets and buyers during the deal process, thereby preserving appraisal’s traditional function as a check on process adequacy. Part IV closes by describing appraisal’s continuing importance under the revised framework. Many firms’ shares do not trade in efficient markets, and this Note makes no attempt to supplant appraisal’s established role in such cases. Furthermore, appraisal will remain an effective judicial tool for policing process adequacy, particularly in conflict transactions. A brief conclusion follows in Part V.

1. * J.D. & M.B.A., University of Virginia, 2020. I am very grateful to Professor Quinn Curtis, who introduced me to corporate law and advised me on this Note. For helpful comments and suggestions, I thank Wade Houston, Will Walsh, George Geis, Joe Fore, Nick Carey, Rebecca Lamb, F.D. Carroll, Matt Hoffer-Hawlik, and Matt Levine. I thank Charlotte K. Newell for educating me about the history of Delaware’s appraisal statute, and the staff of the Virginia Law Review for their input and editorial work on this Note—especially Matt West. ↑
2. Del. Code Ann. tit. 8, § 262 (2020). The appraisal remedy is limited to two types of transactions: “squeeze-outs” effected under §§ 253 and 267, and other mergers or consolidation transactions involving some cash consideration. See id. ↑
3. See infra notes 20–22 and accompanying text. ↑
4. Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd. (Dell), 177 A.3d 1, 16 (Del. 2017). ↑
5. It is assumed that the Supreme Court has endorsed the ECMH inclusive of that theory’s conventional assumption that market participants are rational. See Steven M. Sheffrin, Rational Expectations 99 (2d ed. 1996). This assumption is uncontroversial in the present context—i.e., it is beyond doubt that no reasonable shareholder would tender her shares at a lower price than she could readily receive elsewhere—but it has been contested in others. See, e.g., Franco Modigliani & Richard A. Cohn, Inflation, Rational Valuation and the Market, 35 Fin. Analysts J. 24, 24 (1979) (arguing that persistent inflation distorts market prices of securities, a finding inconsistent with some forms of the ECMH); Lawrence H. Summers, Does the Stock Market Rationally Reflect Fundamental Values?, 41 J. Fin. 591 (1986) (arguing that empirical evidence does not conclusively confirm the ECMH and that market prices do not always rationally reflect the fundamental values of securities). This Note does not aspire to contribute to scholarly commentary on the ECMH; like the Supreme Court, it adopts the hypothesis as a tool for deciding appraisal cases. See Dell, 177 A.3d at 24; see also Are Markets Efficient?, Chi. Booth Rev. (June 30, 2016), https://review.chicagobooth.edu/­economics/2016/video/are-markets-efficient [https://perma.cc/7HBU-C4ZL] (interview with Eugene Fama and Richard Thaler) (“The point is not that markets are efficient. . . . It’s just a model.”). ↑
6. See infra Section III.B. ↑
7. Klang v. Smith’s Food & Drug Ctrs., Inc., 702 A.2d 150, 156 (Del. 1997) (quoting Rosenblatt v. Getty Oil Co., 493 A.2d 929, 944 (Del. 1985)). Note, too, that MNPI may be value-positive or value-negative. See infra Section III.D. ↑
8. Del. Code Ann. tit. 8, § 262(h) (2020). ↑
9. This Note adopts the “semi-strong” form of the ECMH embraced by the Supreme Court, which holds that market prices incorporate all publicly available information about asset prices. See Verition Partners Master Fund Ltd. v. Aruba Networks, Inc. (Aruba III), 210 A.3d 128, 137–38, 138 n.53 (Del. 2019). ↑

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While firms with such a commitment may be created using a variety of control and contractual mechanisms, the related transaction costs tend to be very high. This Article develops a social enterprise legal form that draws on the legal regime for community development financial institutions (CDFIs) and European legal forms for work-integration social enterprises (WISEs). This form would certify to investors, consumers, and governments that designated firms have a commitment as social enterprises. By obviating the need for costly social impact measurement, this form would facilitate the provision of subsidy-donations to social enterprises from multiple groups, particularly investors (through below-market investment) and consumers (via premiums over market prices). Thus, this social enterprise form would be to altruistic investors and consumers what the nonprofit form is to donors.

Moreover, the proposal could facilitate the flow of investments by foundations in social enterprises (known as program-related investments, “PRIs”) because it would help foundations verify the social impact of their investees. In addition, by giving subsidy-providers greater assurance that social enterprises pursue social missions effectively, the proposed legal form could facilitate public markets for social enterprises.

Introduction

In recent years, there have been efforts to encourage firms to pursue social goals. In a striking statement to public corporations, Larry Fink, Blackrock’s CEO, wrote: “Society is demanding that companies, both public and private, serve a social purpose. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.”¹ 1.Letter from Larry Fink, Chairman & Chief Exec. Officer, Blackrock, to CEOs (2018), https://www.blackrock.com/corporate/investor-relations/2018-larry-fink-ceo-letter [https://­perma.cc/7QRQ-9DG6]. For a similar statement by Martin Lipton, the renowned legal advisor for public corporations, see Martin Lipton et al., The New Paradigm: A Roadmap for an Implicit Corporate Governance Partnership Between Corporations and Investors To Achieve Sustainable Long-Term Investment and Growth, Harv. L. Sch. F. on Corp. Governance (Jan. 11, 2017), https://corpgov.law.harvard.edu/2017/01/11/corporate-governance-the-new-para­digm/ [https://perma.cc/B5AJ-EWNW].Show More The imperative that firms pursue social goals, however, is very vague. What range of permissible non-pecuniary goals should companies be encouraged to pursue?² 2.See generally Oliver Hart & Luigi Zingales, Companies Should Maximize Shareholder Welfare Not Market Value, 2 J.L. Fin. & Acct. 247 (2017) (arguing that company and asset managers should pursue policies consistent with the non-pecuniary preferences of their investors).Show More This question reflects a much re-hashed debate regarding the role and purpose of corporations. Many studies view this topic as a matter of corporate governance. That is, the key question is whether policies that seek to create social impact—often referred to as “CSR” (for corporate social responsibility)—maximize shareholder value in the long term. If the answer is yes, then it is a win-win situation for all because such policies are assumed to benefit society.

This Article takes a different approach by arguing that the pressing question should be: Does the pursuit of social missions by for-profit organizations actually benefit the intended beneficiaries? While the literature is not conclusive,³ 3.Compare Ronald W. Masulis & Syed Walid Reza, Agency Problems of Corporate Philanthropy, 28 Rev. Fin. Stud. 592, 619–21 (2015) (claiming that corporate donations advance CEO interests and reduce firm value), with Allen Ferrell, Hao Liang & Luc Renneboog, Socially Responsible Firms, 122 J. Fin. Econ. 585, 585–91, 596–605 (2016) (arguing that well-governed firms are more engaged in CSR, and there is a positive association between CSR and shareholder value).Show More it is easy to see how a reputation for being socially responsible can help companies sell more products, attract investments, or even get more lenient treatment from regulators. However, just having a good reputation does not mean that CSR policies achieve their putative purpose of helping stakeholders and society at large. Without a mechanism for ensuring that CSR actually benefits the stakeholders, companies can easily use it as a means of “greenwashing.”⁴ 4.“Greenwashing occurs when a corporation increases its sales or boosts its brand image through environmental rhetoric or advertising, but in reality does not make good on these environmental claims.” Miriam A. Cherry, The Law and Economics of Corporate Social Responsibility and Greenwashing, 14 U.C. Davis Bus. L.J. 281, 282 (2013).Show More Greenwashing may be particularly conducive to shareholder value because it promotes a strong reputation and higher sales without actually doing anything substantial for society.⁵ 5.This arguably explains why well-governed firms that are more accountable to their shareholders tend to engage in value-enhancing CSR. See generallyFerrell, Liang & Renneboog, supra note 3. For a similar argument in the context of regulation, see Steven L. Schwarcz, Misalignment: Corporate Risk-Taking and Public Duty, 92 Notre Dame L. Rev. 1, 3–4 (2016) (arguing that regulation designed to align managers’ and investors’ interests does not necessarily help address negative externalities).Show More But—while false signals of doing good may increase shareholder value—those who support companies for their good deeds would presumably be disappointed were the truth to come to light.

The problem is that it is extremely difficult to verify companies’ social impact. Existing measures of social impact tend to be vague, include metrics that are difficult to quantify, and even mix shareholder protection metrics with environmental or societal ones.⁶ 6.This is most obviously manifested in the ESG metrics because they include both (i) governance metrics, which are supposed to increase accountability to shareholders and (ii) social and environmental metrics, which are supposed to measure firms’ contributions to social and environmental objectives.Show More But if measurement is rarely available, how do we know that firms are pursuing social goals effectively?

The legal approach to addressing these questions has been to introduce legal hybrid forms—in particular, the benefit corporation.⁷ 7.See infra Part II.Show More These forms are supposed to communicate to investors, consumers, workers, and society at large that firms’ activities benefit society. To date, as many as thirty-six states, including Delaware, have adopted one or more such legal forms.⁸ 8.B Lab, State by State Status of Legislation, Benefit Corp., http://benefitcorp.net/policy­makers/state-by-state-status? [https://perma.cc/X524-35UE] (last visited Mar. 18, 2020).Show More However, existing legal forms fail to clarify the actual impact of companies’ social goals.⁹ 9.See, e.g., John E. Tyler III, Evan Absher, Kathleen Garman & Anthony Luppino, Purposes, Priorities and Accountability Under Social Business Structures: Resolving Ambiguities and Enhancing Adoption, 19 Advances Entrepreneurship Firm Emergence & Growth 39, 39 (2017) (arguing that “social business models do not meaningfully prioritize or impose accountability to ‘social good’ over other purposes”).Show More Just like CSR, these forms could portray a misleading picture of companies’ social contributions. Many of the companies that adopt these legal forms have little or no discernible social impact.¹⁰ 10.See Ofer Eldar, The Role of Social Enterprise and Hybrid Organizations, 2017 Colum. Bus. L. Rev. 92, 99 (discussing Laureate University, a for-profit network of universities incorporated as a benefit corporation but that uses aggressive promotional tactics and has low graduation and loan repayment rates); see also Michael B. Dorff, James Hicks & Steven Davidoff Solomon, The Future or Fancy? An Empirical Study of Public Benefit Corporations 46 (Eur. Corp. Governance Inst., Working Paper No. 495, 2020), https://papers.ssrn.com­/sol3/papers.cfm?abstract_id=3433772 [https://perma.cc/D9R8-VZWC]. Dorff et al. list standard firms, such as Ripple Foods, as having incorporated as benefit corporations, even though these firms do not have any clear social impact other than producing goods (such as dairy-free milk) that appeal to certain consumers.Show More And companies that appear to be highly successful in pursuing social missions already had such impact before they adopted the legal forms.¹¹ 11.Two such examples include the Greyston Bakery and Patagonia. See Eldar, supra note 10, at 189 n.270.Show More

Why have these forms seemingly failed to generate greater social impact? In this Article, I claim that they suffer from the same underlying problem as CSR policies. These forms are simply not structured in a way that makes companies more likely to pursue social goals effectively. Therefore, the legal forms cannot serve as useful signals to investors or consumers that the firms benefit society in the ways they purport to.

An effective legal form must meet two conditions. First, the form must give firms incentives to pursue social missions effectively. At the very least, the goal of maximizing shareholders’ profits should not interfere with the firm’s social mission. Ideally, the firm should have a financial stake in the accomplishment of the social mission. Second, the firm should have the competence to pursue such missions. Competence is particularly important because social goals, such as unemployment or access to capital, tend to be complex. Accomplishing complex social goals requires the firm to tailor its social programs to the specific attributes and needs of the beneficiaries.

The issues of incentives and competence are very similar to standard issues in corporate governance. Broadly stated, the main goal of corporate governance policy is to ensure that managers have both (i) the incentives to maximize shareholder value and (ii) the competence to make decisions on behalf of the corporation.¹² 12.See Zohar Goshen & Richard Squire, Principal Costs: A New Theory for Corporate Law and Governance, 117 Colum. L. Rev. 767, 784 (2017) (identifying conflict costs and competence costs as the two main sources of costs that corporate governance is designed to address).Show More What complicates things when it comes to social responsibility is that a firm that purports to pursue CSR not only makes profits on behalf of the investors, but it also serves as a conduit for a subsidy or a donation. As I explain elsewhere, these subsidies or donations need not be direct transfers from the government or donors. In fact, they are usually latent in the sense that they reflect premium prices paid by consumers or below-market returns from investors.¹³ 13.Eldar, supra note 10, at 104–05.Show More

For policy makers, the main design issue is how to assure those who provide subsidy-donations that they will be used effectively. Thus, the principal goal of this Article is to develop a legal form with key structural elements that give managers the incentives and competence to accomplish this. This form can signal to stakeholders that firms professing to promote social impact actually do what they claim.

The policy I propose is modeled on the structural elements found in social enterprises that transact with their beneficiaries (e.g., as consumers or workers), which I have addressed in previous work.¹⁴ 14.See id.; see also Ofer Eldar, The Organization of Social Enterprises: Transacting Versus Giving 10–15 (July 27, 2018) (unpublished paper), https://papers.ssrn.com/sol3/papers.­cfm?abstract_id=3217663 [https://perma.cc/S36D-3LWP].Show More The transactional relationship with its beneficiaries gives the firm a stake in helping them develop, and also enables the firm to observe beneficiaries’ abilities and needs. Thus, such firms have both the incentives and competence to serve certain social goals. The proposal builds on the regulatory regime for community development financial institutions (CDFIs), which certifies financial institutions as firms that serve low-income populations,¹⁵ 15.The CDFI regime is currently limited to low-income borrowers, but it could be extended to a wider class of beneficiaries, and extended beyond the U.S.Show More and combines this regime with certain elements found in benefit corporations.¹⁶ 16.Specifically, as in benefit corporations, a qualified majority voting is required to change the mission of the firm. See infra text accompanying note 111.Show More

In essence, the proposal is to introduce a new social enterprise (SE) legal form. Firms organized under the SE legal form would be required to obtain a government certification as a “Social Enterprise” if they commit, in their charters, to transacting with one or more carefully defined classes of beneficiaries. These beneficiaries may include, among others, workers, borrowers, and consumers. Beneficiaries will be divided into different classes in accordance with certain criteria of need (e.g., level of income). To maintain the certification, firms must commit to having a minimum percentage of their business associated with beneficiary transactions. Whereas current benefit corporation laws permit companies to choose a third-party standard that measures their social purpose,¹⁷ 17.The MBCL provides criteria for third-party standards, but companies have discretion to select how their performance will be measured. See infra Part II.Show More my proposed reform would require companies to adhere to one federal standard defined by a single federal certifier.

The main goal of this proposed policy is to facilitate the flow of subsidized capital and income to social enterprises. This legal form is necessary to attract subsidies from dispersed subsidy-providers, such as investors and consumers. Currently, investors and consumers mainly rely on costly contractual and ownership mechanisms to ensure that relevant firms transact with their beneficiaries. Under the proposed system, investors and consumers would have notice that the firm transacts with beneficiaries before they purchase shares or products. In this respect, the proposed law would be to altruistic investors and consumers essentially what the nonprofit form is to donors.¹⁸ 18.The nonprofit form assures donors that the managers of donative organizations have limited incentives to expropriate the subsidy-donations; hence, they are more likely to distribute donations to the intended beneficiaries. Henry B. Hansmann, The Role of Nonprofit Enterprise, 89 Yale L.J. 835, 838–39 (1980). Similarly, the proposed legal form would assure investors and consumers that the firm has incentives to use subsidies effectively.Show More Thus, the proposal is likely to unlock much-needed capital to scale social enterprises and increase social impact.

The ability of the SE legal form to source subsidies from a wider range of subsidy-providers could serve two additional complementary objectives. First, it could help facilitate the process for allocating subsidized investments (known as program-related investments or “PRIs”) from foundations. While most policy initiatives seek to attract institutional shareholder investment to channel capital for social goals, the best candidates for investing in social impact are foundations. The reason is that they have vast amounts of capital that they are supposed to employ to further philanthropic goals.¹⁹ 19.See, e.g., Matt Onek, Philanthropic Pioneers: Foundations and the Rise of Impact Investing, Stan. Soc. Innovation Rev. (Jan. 17, 2017) https://ssir.org/articles/entry/­philanthropic_pioneers_foundations_and_the_rise_of_impact_investing# [https://perma.cc/­MJ7A-52Q8].Show More Paradoxically, foundations often resist making PRIs in for-profit social enterprises because such investments could expose them to tax penalties if they cannot verify the social mission of their investees. Currently, such verification is cumbersome and subject to legal uncertainty. Thus, making certified firms eligible for PRIs would facilitate the process for allocating such investments.

Second, more ambitiously, the proposal has the potential to meet a long-awaited goal of social entrepreneurs: facilitating their access to capital markets. The inability of social enterprises to tap into capital markets substantially burdens their ability to grow and increase their social impact. Attempts to establish social exchanges for firms that combine profit and missions have largely been futile, primarily due to the difficulties of measuring social impact. A new legal form could help by providing adequate assurance to the investors who are expected to subsidize such impact.

One objection to this proposal might be that a legal hybrid form based solely on firms’ transactional relationships with their beneficiaries is overly reductive or too narrow. Should a legal hybrid form not capture the universe of social missions, such as the protection of the environment, diversity, and human rights? These objectives are indeed laudable, but it does not follow that legal forms can adequately address them. In the absence of credible certification mechanisms and clear metrics of social impact, legal forms for organizations with broad social purposes are not likely to signal that these firms pursue social missions effectively. Furthermore, the class of organizations that transact with disadvantaged persons is large and highly consequential.²⁰ 20.For example, they range from microfinance institutions to firms that provide eyeglasses in developing countries.Show More Concentrating on these firms could transform legal hybrid forms from a marginal phenomenon to a remarkable vehicle for promoting development.

This Article proceeds as follows: Part I describes how legal hybrid forms are supposed to serve as a commitment device to potential subsidy providers and explains why a new form is necessary to facilitate the formation of social enterprises. Part II critically evaluates the principal existing legal forms for companies with a social purpose and explains why they fail to serve as adequate commitment devices. Part III discusses the key elements of the CDFI regime and why other certification mechanisms do not work as well. Part IV proposes a design for a new legal form for social enterprises and discusses its principal elements in detail. Part V discusses the design of possible government subsidies for the proposed legal hybrid form.

1. * Duke University School of Law; Duke Innovation and Entrepreneurship Initiative. I thank Richard Brooks, Jamie Boyle, John Coyle, Elisabeth De Fontenay, Brian Galle, Henry Hansmann, Yair Listokin, Richard Schmalbeck, Steven Schwarcz, Michael Simkovic, Emily Strauss, Rory Van Loo, Andrew Verstein, and participants in seminars at Duke University School of Law and Boston University School of Law for helpful comments and suggestions. I am also grateful to Heather Cron, Zach Lankford, Renuka Medury, Kelsey Moore, Catherine Prater, and Hadar Tanne for excellent research assistance. Email: eldar@law.duke.edu. ↑
2. Letter from Larry Fink, Chairman & Chief Exec. Officer, Blackrock, to CEOs (2018), https://www.blackrock.com/corporate/investor-relations/2018-larry-fink-ceo-letter [https://­perma.cc/7QRQ-9DG6]. For a similar statement by Martin Lipton, the renowned legal advisor for public corporations, see Martin Lipton et al., The New Paradigm: A Roadmap for an Implicit Corporate Governance Partnership Between Corporations and Investors To Achieve Sustainable Long-Term Investment and Growth, Harv. L. Sch. F. on Corp. Governance (Jan. 11, 2017), https://corpgov.law.harvard.edu/2017/01/11/corporate-governance-the-new-para­digm/ [https://perma.cc/B5AJ-EWNW]. ↑
3. See generally Oliver Hart & Luigi Zingales, Companies Should Maximize Shareholder Welfare Not Market Value, 2 J.L. Fin. & Acct. 247 (2017) (arguing that company and asset managers should pursue policies consistent with the non-pecuniary preferences of their investors). ↑
4. Compare Ronald W. Masulis & Syed Walid Reza, Agency Problems of Corporate Philanthropy, 28 Rev. Fin. Stud. 592, 619–21 (2015) (claiming that corporate donations advance CEO interests and reduce firm value), with Allen Ferrell, Hao Liang & Luc Renneboog, Socially Responsible Firms, 122 J. Fin. Econ. 585, 585–91, 596–605 (2016) (arguing that well-governed firms are more engaged in CSR, and there is a positive association between CSR and shareholder value). ↑
5. “Greenwashing occurs when a corporation increases its sales or boosts its brand image through environmental rhetoric or advertising, but in reality does not make good on these environmental claims.” Miriam A. Cherry, The Law and Economics of Corporate Social Responsibility and Greenwashing, 14 U.C. Davis Bus. L.J. 281, 282 (2013). ↑
6. This arguably explains why well-governed firms that are more accountable to their shareholders tend to engage in value-enhancing CSR. See generally Ferrell, Liang & Renneboog, supra note 3. For a similar argument in the context of regulation, see Steven L. Schwarcz, Misalignment: Corporate Risk-Taking and Public Duty, 92 Notre Dame L. Rev. 1, 3–4 (2016) (arguing that regulation designed to align managers’ and investors’ interests does not necessarily help address negative externalities). ↑
7. This is most obviously manifested in the ESG metrics because they include both (i) governance metrics, which are supposed to increase accountability to shareholders and (ii) social and environmental metrics, which are supposed to measure firms’ contributions to social and environmental objectives. ↑
8. See infra Part II. ↑
9. B Lab, State by State Status of Legislation, Benefit Corp., http://benefitcorp.net/policy­makers/state-by-state-status? [https://perma.cc/X524-35UE] (last visited Mar. 18, 2020). ↑
10. See, e.g., John E. Tyler III, Evan Absher, Kathleen Garman & Anthony Luppino, Purposes, Priorities and Accountability Under Social Business Structures: Resolving Ambiguities and Enhancing Adoption, 19 Advances Entrepreneurship Firm Emergence & Growth 39, 39 (2017) (arguing that “social business models do not meaningfully prioritize or impose accountability to ‘social good’ over other purposes”). ↑
11. See Ofer Eldar, The Role of Social Enterprise and Hybrid Organizations, 2017 Colum. Bus. L. Rev. 92, 99 (discussing Laureate University, a for-profit network of universities incorporated as a benefit corporation but that uses aggressive promotional tactics and has low graduation and loan repayment rates); see also Michael B. Dorff, James Hicks & Steven Davidoff Solomon, The Future or Fancy? An Empirical Study of Public Benefit Corporations 46 (Eur. Corp. Governance Inst., Working Paper No. 495, 2020), https://papers.ssrn.com­/sol3/papers.cfm?abstract_id=3433772 [https://perma.cc/D9R8-VZWC]. Dorff et al. list standard firms, such as Ripple Foods, as having incorporated as benefit corporations, even though these firms do not have any clear social impact other than producing goods (such as dairy-free milk) that appeal to certain consumers. ↑
12. Two such examples include the Greyston Bakery and Patagonia. See Eldar, supra note 10, at 189 n.270. ↑
13. See Zohar Goshen & Richard Squire, Principal Costs: A New Theory for Corporate Law and Governance, 117 Colum. L. Rev. 767, 784 (2017) (identifying conflict costs and competence costs as the two main sources of costs that corporate governance is designed to address). ↑
14. Eldar, supra note 10, at 104–05. ↑
15. See id.; see also Ofer Eldar, The Organization of Social Enterprises: Transacting Versus Giving 10–15 (July 27, 2018) (unpublished paper), https://papers.ssrn.com/sol3/papers.­cfm?abstract_id=3217663 [https://perma.cc/S36D-3LWP]. ↑
16. The CDFI regime is currently limited to low-income borrowers, but it could be extended to a wider class of beneficiaries, and extended beyond the U.S. ↑
17. Specifically, as in benefit corporations, a qualified majority voting is required to change the mission of the firm. See infra text accompanying note 111. ↑
18. The MBCL provides criteria for third-party standards, but companies have discretion to select how their performance will be measured. See infra Part II. ↑
19. The nonprofit form assures donors that the managers of donative organizations have limited incentives to expropriate the subsidy-donations; hence, they are more likely to distribute donations to the intended beneficiaries. Henry B. Hansmann, The Role of Nonprofit Enterprise, 89 Yale L.J. 835, 838–39 (1980). Similarly, the proposed legal form would assure investors and consumers that the firm has incentives to use subsidies effectively. ↑
20. See, e.g., Matt Onek, Philanthropic Pioneers: Foundations and the Rise of Impact Investing, Stan. Soc. Innovation Rev. (Jan. 17, 2017) https://ssir.org/articles/entry/­philanthropic_pioneers_foundations_and_the_rise_of_impact_investing# [https://perma.cc/­MJ7A-52Q8]. ↑
21. For example, they range from microfinance institutions to firms that provide eyeglasses in developing countries. ↑

The post Designing Business Forms to Pursue Social Goals first appeared on Virginia Law Review.

Introduction

Behavioral law and economics has had significant influence on the regulation of consumer credit.¹ 1.See, e.g., Ryan Bubb & Richard H. Pildes, How Behavioral Economics Trims Its Sails and Why, 127 Harv. L. Rev. 1593, 1644–47 (2014).Show More This is both important and justified. It is important because consumer finance is central to the functioning of a modern economy; it is what President Obama called the “lifeblood” during the height of the financial crisis in 2009.² 2.Address Before a Joint Session of the Congress, 1 Pub. Papers 145, 147 (Feb. 24, 2009).Show More At the level of individual households, consumer credit is important because the timing of income and expenses are rarely contemporaneous. And yet, credit transactions are fraught. Credit both reflects and perpetuates wide differences in individuals’ economic opportunities and their vulnerability to financial adversity. Credit is more expensive for the poor, and this fact creates a patina of exploitation and abuse over debt transactions that has resulted in extensive state and federal regulation.

The influence of behavioral economics on consumer credit regulation is justified because two features of consumer credit raise doubts about consumers’ ability to make borrowing choices that are in their best interests. The first feature is complexity. Consumer debt often has a complex fee structure, opaque repayment terms, and default consequences that are hard to evaluate.³ 3.For a discussion of the importance of complexity and faulty borrower comprehension in consumer credit markets, see Lauren E. Willis, Decisionmaking and the Limits of Disclosure: The Problem of Predatory Lending: Price, 65 Md. L. Rev. 707, 766–98 (2006) [hereinafter Willis, Decisionmaking and the Limits of Disclosure]. Unfortunately, interventions to increase consumer financial literacy do not appear to help remedy these problems. Lauren E. Willis, Against Financial-Literacy Education, 94 Iowa L. Rev. 197, 201 (2008); Lauren E. Willis, The Financial Education Fallacy, 101 Am. Econ.Rev. 429, 429 (2011). Because financial education and disclosure have proven to be largely ineffective, Professor Willis has provocatively argued for an alternative known as “performance-based consumer law.” Lauren E. Willis, Performance-Based Consumer Law, 82 U. Chi. L. Rev. 1309, 1311 (2015).Show More The second feature is the tradeoff between current and future purchasing power that is at the heart of every credit transaction. It is the essence of debt that the borrower exchanges her promise to pay amounts in the future for the ability to consume more now. This intertemporal tradeoff is one that individuals often struggle to make properly, and the challenge is especially great for individuals who focus excessively on the short term and who are therefore inclined to borrow impulsively and on terms that they subsequently regret.⁴ 4.See Ian M. McDonald, The Global Financial Crisis and Behavioural Economics, 28 Econ. Papers 249, 251 (2009).Show More Both complexity and intertemporal choice are areas where behavioral law and economics scholarship is able to traffic in deep intuitions and draw on strong empirical evidence to make recommendations about how to regulate imperfectly rational consumers.⁵ 5.I am unaware of any data about the intuitive appeal of complexity and impatience as explanations for why people struggle to evaluate credit contracts. Nevertheless, I trust that most readers, particularly those with home mortgages, will be inclined to agree that understanding all the terms of a secured loan, even when one is trained in law or economics, demands a great deal of time and effort. It is unsurprising then that some do not even make the effort. Judge Posner famously declined to read the “boilerplate” on his own home mortgage. David Lat, Do Lawyers Actually Read Boilerplate Contracts?, Above the Law (June 22, 2010, 2:42 PM), http://abovethelaw.com/2010/06/do-lawyers-actaully-read-boilerplate-contracts-judge-richard-posner-doesnt-do-you/ [https://perma.cc/R574-VCQS]. I also expect that most of us identify with the present-biased individual, who procrastinates when it comes to unpleasant tasks and acts impulsively when it comes to food or leisure. For a review of the literature, see Lee Anne Fennell, Willpower and Legal Policy, 5 Ann. Rev. L. & Soc. Sci. 91 (2009).Show More

In this Article, I focus on arguments about consumer finance regulation that draw on research about “present bias,” which is a sort of myopia that causes people to focus on the present and neglect the future. I argue that consumer law scholarship that draws on these insights has itself been myopic. People borrow money in order to buy things, and scholarship has generally neglected to consider what borrowed funds are used for.⁶ 6.Some researchers do think it is broadly relevant what consumers do with the loan proceeds, but none evaluate the bundled loan and purchase together from the perspective of a biased consumer. See, e.g., Shmuel I. Beecher, Yuval Feldman & Orly Lobel, Poor Consumer(s) Law: The Case of High-Cost Credit and Payday Loans, in Legal Applications of Marketing Theory (Jacob Gersen & Joel Steckel eds.) (forthcoming 2020) (manuscript at 10), http://ssrn.com/abstract = 3235810 [https://perma.cc/2ZRB-QQ44].Show More I show that focusing on the terms of a loan, isolated from the good or service that is purchased with the proceeds, leads to misleading conclusions about the benefits to the borrower. Integrating the costs and benefits of the underlying purchase with the terms of the credit transaction can upend standard conclusions about the effects of present bias and relocate efforts to improve consumer welfare from the regulation of financial products to the circumstances that create demand for high-cost credit in the first place. I demonstrate the significance of this theoretical claim by reporting results from a study of tax refund anticipation loans (RALs), which shows how RALs increase the use of paid tax preparers and the take-up of the earned income tax credit (EITC) by low-income households. Because of the size of the EITC, these loans may make present-biased taxpayers better off, even if the loans are designed to exploit their bias.

When considering the benefits of credit transactions for present-biased consumers, why do the motivating purchases matter? The answer is that many goods and services are characterized by significant upfront costs but benefits that are only realized in the future. As I show in Part I, present-biased consumers tend to undervalue products with this temporal pattern of costs and benefits.⁷ 7.See discussion infra Section I.A.Show More Durable goods, such as homes, cars, and appliances, are like this. Purchasing durable goods involves a significant cash outlay at the time of purchase in exchange for a stream of consumption benefits that are realized over time. In fact, all sorts of choices present this same temporal pattern of immediate costs and future benefits. For example, the benefits of education are mostly realized long after the classroom experience. Applying for social welfare benefits can require an upfront investment of time and effort in exchange for benefits that are received in the future. The EITC, which is the largest federal cash transfer to low-income households,⁸ 8.Chris Edwards & Veronique de Rugy, Earned Income Tax Credit: Small Benefits, Large Costs, Cato Inst. (Oct. 14, 2015), https://www.cato.org/publications/tax-budget-bulletin/earned-income-tax-credit-small-benefits-large-costs [https://perma.cc/5L9L-RHX9].Show More is only available to individuals who file a tax return and complete the burdensome earned income credit (EIC) schedule.⁹ 9.On the difficulties of filing for the EITC, see Michelle Lyon Drumbl, Beyond Polemics: Poverty, Taxes, and Noncompliance, 14 eJournal Tax Res. 253, 275–77 (2016); Francine J. Lipman, The Working Poor Are Paying for Government Benefits: Fixing the Hole in the Anti-Poverty Purse, 2003 Wis. L. Rev. 461, 464; George K. Yin et al., Improving the Delivery of Benefits to the Working Poor: Proposals to Reform the Earned Income Tax Credit Program, 11 Am. J. Tax Pol’y 225, 254–56 (1994). In her latest annual report to Congress, however, the National Taxpayer Advocate noted that the IRS has been working to improve EITC outreach and education. Internal Revenue Serv., Nat’l Taxpayer Advoc.,Ann. Rep. to Congress 144 (2017).Show More The key point is that when the deferred costs and immediate benefits of certain exploitative credit products are added to the immediate costs and deferred benefits of durable goods and services, the bundled transaction may be one that is appealing to a present-biased individual and makes them better off. The exploitative loan tempts the present-biased individual to do something that is in her interest but that she would not otherwise do.¹⁰ 10.I say that a loan is exploitative if only biased borrowers want to borrow on its terms. This definition does not imply anything about the profitability of these loans to the lender or about the division of the gains from trade. For a philosophical treatment of exploitation, see Alan Wertheimer, Exploitation 7–8(1996).Show More

The results from this analysis sound a note of caution about decontextualizing the choices that consumers make. At the most general level, this Article shows that if consumer law is to help imperfectly rational consumers, it is not enough to show that certain goods or services would only be purchased by consumers acting on a bias that operates against their own interests. It must also consider what other choices these consumers are likely to make that depend on that product and how the exploitative product fits into the overall way that they have arranged their lives. The personal affairs of present-biased individuals are likely to be characterized by a variety of biased decisions that may be interconnected in important ways. Although the entire constellation of choices made by present-biased individuals will leave them worse off than if they made the same choices rationally, this does not imply that compelling them to make any one of these choices rationally will leave them better off.¹¹ 11.Law and economics scholars will recognize this as an application of the general theory of the second best to intra-personal choice. R.G. Lipsey & R.K. Lancaster, TheGeneral Theory of Second Best, 24 Rev. Econ. Stud. 11, 11–12 (1956).Show More

The second contribution of this Article is to consumer finance regulation specifically. Regulating the substantive terms of consumer credit requires distinguishing between different kinds of loan products and the uses to which the loan proceeds are put. Specifically, secured debt that must be used to purchase goods and services with deferred benefits has different effects on present-biased consumers than general unsecured debt that can be used to change the timing of consumption generally.¹² 12.Seediscussion infra Section I.A.Show More When we integrate the loan’s terms with the pattern of costs and benefits from the purchase that necessitated the loan, we see that the bundled transaction may in fact be beneficial for present-biased consumers.¹³ 13.Seediscussion infra Section I.A.Show More If the bundled transaction is beneficial, then prohibiting credit terms that are designed to tempt present-biased individuals might hurt those that the ban is meant to help.

Third, and at the level of most direct application, the results of my empirical study have very specific implications for the regulation of RALs and refund anticipation checks (RACs). The results sound a warning to regulators about the effects of eliminating these products. RALs disappeared almost entirely following a regulatory change in 2011,¹⁴ 14.See discussion infra Section II.D.Show More a change that was celebrated by consumer advocates.¹⁵ 15.Chi Chi Wu & Jean Ann Fox, Nat’l Consumer Law Ctr. & Consumer Fed’n of Am., The Party’s Over for Quickie Tax Loans: But Traps Remain for Unwary Taxpayers 2 (2012), https://www.nclc.org/images/pdf/pr-reports/report-ral-2012.pdf [https://perma.cc/J9QX-QM­XK] (“While an occasional fringe lender may make a tax-time loan, the sale of RALs as a widespread industry-wide practice is over. RALs will no longer drain the tax refunds of millions of mostly low-income taxpayers.”).Show More The near elimination of RALs reduced the use of paid tax preparers, lowered take-up of the EITC, and increased demand for RACs.¹⁶ 16.See discussion infra Part II.Show More RACs are popular, and RALs have begun to make a comeback, but both credit products are the focus of opposition from advocates and concern by regulators.¹⁷ 17.Tax RALs are resurgent, albeit in smaller amounts than before. For a sense of the magnitude of this resurgence, there were 35,000 refund loans made in 2014 and approximately one million loans made in 2016. Kevin Wack, Tax Refund Loans Get a Second Life, Am. Banker (June 15, 2016, 2:49 PM), https://www.americanbanker.com/news/tax-refund-loans-get-a-second-life [https://perma.cc/ZG58-WG4M].Show More Thus, understanding the role they play in affecting tax compliance and the take-up of valuable social benefits is important and timely.

To be clear, present bias is not the only reason to be suspicious of credit transactions, and the purpose of my analysis is not to provide an all-things-considered appraisal of high-cost credit products. Complexity, unrealistic optimism about repayment prospects, and other psychological biases may cause people to choose financial products that are not in their best interests.¹⁸ 18.Overly optimistic borrowers may borrow too much or too little. See Richard M. Hynes, Overoptimism and Overborrowing, 2004 BYU L. Rev. 127, 131.Show More I agree with scholars who emphasize the problem of complexity and the potential role for regulation in this area.¹⁹ 19.See, e.g., Saurabh Bhargava & George Loewenstein, Behavioral Economics and Public Policy 102: Beyond Nudging, 105 Am. Econ. Rev. 396, 396 (2015) (arguing that behavioral economics should leverage gaps in the traditional economic approach that assume fully rational and informed individuals to deliver policy solutions).Show More But when regulation is motivated by concerns about borrowers’ psychological biases, it must consider not just how those biases generate demand for the product being regulated but also how that product is likely to fit into the life of someone who exhibits that bias more generally.

Part I explains the present bias framework for thinking about credit transactions and describes how present bias has been used to explain demand for three economically important, high-cost credit products. I show how integrating the underlying purchase transaction into the analysis of these credit products can change our conclusions about whether these products are beneficial. In Parts II–V, I report and discuss the results of an original study of the effects of regulating RALs. The results illustrate the theoretical effects I describe in Part I, provide evidence that is relevant for regulating this financial product, and raise hard questions about the intermediating role of the private sector between individuals and the U.S. Treasury. In Part VI, I describe a framework for thinking about the regulation of consumer credit products, paying special attention to RALs.

1. * Class of 1948 Professor of Scholarly Research in Law, University of Virginia School of Law. Thanks to Jennifer Arlen, Oren Bar-Gill, Gustavo Bobonis, Tom Brennan, Ryan Bubb, Mihir Desai, Brian Galle, Yehonatan Givati, Jacob Goldin, Daniel Hemel, Louis Kaplow, Lewis Kornhauser, Kory Kroft, Day Manoli, Ruth Mason, Patricia McCoy, Alex Raskolnikov, Kyle Rozema, Emily Satterthwaite, David Schizer, Kathryn Spier, Rory Van Loo, David Walker, George Yin, workshop participants at the American Law and Economics Association Annual Meeting, the Columbia Law School-Hebrew University Tax Conference, the University of Toronto, Boston University, Cardozo Law School, New York University, and Harvard Law School. Thanks to the Brookings Institution and AggData LLC for providing data. I am especially indebted to Kent Olson of the UVA Law Library for exceptional research assistance. ↑
2. See, e.g., Ryan Bubb & Richard H. Pildes, How Behavioral Economics Trims Its Sails and Why, 127 Harv. L. Rev. 1593, 1644–47 (2014). ↑
3. Address Before a Joint Session of the Congress, 1 Pub. Papers 145, 147 (Feb. 24, 2009). ↑
4. For a discussion of the importance of complexity and faulty borrower comprehension in consumer credit markets, see Lauren E. Willis, Decisionmaking and the Limits of Disclosure: The Problem of Predatory Lending: Price, 65 Md. L. Rev. 707, 766–98 (2006) [hereinafter Willis, Decisionmaking and the Limits of Disclosure]. Unfortunately, interventions to increase consumer financial literacy do not appear to help remedy these problems. Lauren E. Willis, Against Financial-Literacy Education, 94 Iowa L. Rev. 197, 201 (2008); Lauren E. Willis, The Financial Education Fallacy, 101 Am. Econ.
   

   Rev. 429, 429 (2011). Because financial education and disclosure have proven to be largely ineffective, Professor Willis has provocatively argued for an alternative known as “performance-based consumer law.” Lauren E. Willis, Performance-Based Consumer Law, 82 U. Chi. L. Rev. 1309, 1311 (2015). ↑

5. See Ian M. McDonald, The Global Financial Crisis and Behavioural Economics, 28 Econ. Papers 249, 251 (2009). ↑
6. I am unaware of any data about the intuitive appeal of complexity and impatience as explanations for why people struggle to evaluate credit contracts. Nevertheless, I trust that most readers, particularly those with home mortgages, will be inclined to agree that understanding all the terms of a secured loan, even when one is trained in law or economics, demands a great deal of time and effort. It is unsurprising then that some do not even make the effort. Judge Posner famously declined to read the “boilerplate” on his own home mortgage. David Lat, Do Lawyers Actually Read Boilerplate Contracts?, Above the Law (June 22, 2010, 2:42 PM), http://abovethelaw.com/2010/06/do-lawyers-actaully-read-boilerplate-contracts-judge-richard-posner-doesnt-do-you/ [https://perma.cc/R574-VCQS]. I also expect that most of us identify with the present-biased individual, who procrastinates when it comes to unpleasant tasks and acts impulsively when it comes to food or leisure. For a review of the literature, see Lee Anne Fennell, Willpower and Legal Policy, 5 Ann. Rev. L. & Soc. Sci. 91 (2009). ↑
7. Some researchers do think it is broadly relevant what consumers do with the loan proceeds, but none evaluate the bundled loan and purchase together from the perspective of a biased consumer. See, e.g., Shmuel I. Beecher, Yuval Feldman & Orly Lobel, Poor Consumer(s) Law: The Case of High-Cost Credit and Payday Loans, in Legal Applications of Marketing Theory (Jacob Gersen & Joel Steckel eds.) (forthcoming 2020) (manuscript at 10), http://ssrn.com/abstract = 3235810 [https://perma.cc/2ZRB-QQ44]. ↑
8. See discussion infra Section I.A. ↑
9. Chris Edwards & Veronique de Rugy, Earned Income Tax Credit: Small Benefits, Large Costs, Cato Inst. (Oct. 14, 2015), https://www.cato.org/publications/tax-budget-bulletin/earned-income-tax-credit-small-benefits-large-costs [https://perma.cc/5L9L-RHX9]. ↑
10. On the difficulties of filing for the EITC, see Michelle Lyon Drumbl, Beyond Polemics: Poverty, Taxes, and Noncompliance, 14 eJournal Tax Res. 253, 275–77 (2016); Francine J. Lipman, The Working Poor Are Paying for Government Benefits: Fixing the Hole in the Anti-Poverty Purse, 2003 Wis. L. Rev. 461, 464; George K. Yin et al., Improving the Delivery of Benefits to the Working Poor: Proposals to Reform the Earned Income Tax Credit Program, 11 Am. J. Tax Pol’y 225, 254–56 (1994). In her latest annual report to Congress, however, the National Taxpayer Advocate noted that the IRS has been working to improve EITC outreach and education. Internal Revenue Serv., Nat’l Taxpayer Advoc.,
    

    Ann. Rep. to Congress 144 (2017). ↑

11. I say that a loan is exploitative if only biased borrowers want to borrow on its terms. This definition does not imply anything about the profitability of these loans to the lender or about the division of the gains from trade. For a philosophical treatment of exploitation, see Alan Wertheimer, Exploitation 7–8
    

    (1996). ↑

12. Law and economics scholars will recognize this as an application of the general theory of the second best to intra-personal choice. R.G. Lipsey & R.K. Lancaster, The General Theory of Second Best, 24 Rev. Econ. Stud. 11, 11–12 (1956). ↑
13. See discussion infra Section I.A. ↑
14. See discussion infra Section I.A. ↑
15. See discussion infra Section II.D. ↑
16. Chi Chi Wu & Jean Ann Fox, Nat’l Consumer Law Ctr. & Consumer Fed’n of Am., The Party’s Over for Quickie Tax Loans: But Traps Remain for Unwary Taxpayers 2 (2012), https://www.nclc.org/images/pdf/pr-reports/report-ral-2012.pdf [https://perma.cc/J9QX-QM­XK] (“While an occasional fringe lender may make a tax-time loan, the sale of RALs as a widespread industry-wide practice is over. RALs will no longer drain the tax refunds of millions of mostly low-income taxpayers.”). ↑
17. See discussion infra Part II. ↑
18. Tax RALs are resurgent, albeit in smaller amounts than before. For a sense of the magnitude of this resurgence, there were 35,000 refund loans made in 2014 and approximately one million loans made in 2016. Kevin Wack, Tax Refund Loans Get a Second Life, Am. Banker (June 15, 2016, 2:49 PM), https://www.americanbanker.com/news/tax-refund-loans-get-a-second-life [https://perma.cc/ZG58-WG4M]. ↑
19. Overly optimistic borrowers may borrow too much or too little. See Richard M. Hynes, Overoptimism and Overborrowing, 2004 BYU L. Rev. 127, 131. ↑
20. See, e.g., Saurabh Bhargava & George Loewenstein, Behavioral Economics and Public Policy 102: Beyond Nudging, 105 Am. Econ. Rev. 396, 396 (2015) (arguing that behavioral economics should leverage gaps in the traditional economic approach that assume fully rational and informed individuals to deliver policy solutions). ↑

The post Myopic Consumer Law first appeared on Virginia Law Review.

Introduction

In 2018, Facebook Chairman and CEO Mark Zuckerberg faced senators on national television regarding conduct that prompted the Federal Trade Commission (FTC) to seek its largest ever fine.¹ 1.Cecilia Kang, A Facebook Settlement with the F.T.C. Could Run into the Billions, N.Y. Times, Feb. 15, 2019, at B6.Show More The main issue was not what Facebook did directly to its users. Instead, the hearing focused on the social network’s failure to restrain third parties. Most notably, the political consulting firm Cambridge Analytica had accessed millions of users’ accounts in an effort to support election candidates.² 2.Katy Steinmetz, Mark Zuckerberg Survived Congress. Now Facebook Has to Survive the FTC, Time (Apr. 13, 2018, 12:42 PM), https://time.com/5237900/facebook-ftc-privacy-data-cambridge-analytica/ [https://perma.cc/4SJJ-YHP9].Show More Before Zuckerberg’s Senate testimony, the FTC had already sued Google and Amazon to force them to monitor third parties for privacy violations and in-app video game purchases by children that sometimes reached in the thousands of dollars.³ 3.See FTC v. Amazon.com, Inc., No. C14-1038-JCC, 2016 WL 10654030, at *8 (W.D. Wash. July 22, 2016) (finding Amazon accountable for in-app charges); Agreement Containing Consent Order at 5, Google Inc., No. 102-3136, (F.T.C. Mar. 30, 2011), https://www.ftc.gov/sites/default/files/documents/cases/2011/03/110330googlebuzzagreeorder.pdf [https://perma.cc/7R6W-5VNP] (ordering Google to require “service providers by contract to implement and maintain appropriate privacy protections”).Show More In other words, the FTC is requiring large technology companies to act in ways traditionally associated with public regulators—by policing other businesses for legal violations.

Over time, policy makers have enlisted a large array of private actors in their quest for optimal regulatory design.⁴ 4.See, e.g., Kenneth A. Bamberger, Regulation as Delegation: Private Firms, Decisionmaking, and Accountability in the Administrative State, 56 Duke L.J. 377, 453 (2006) (conceiving of regulators’ decisions to let regulated entities fill in vague mandates as delegation); Cary Coglianese & David Lazer, Management-Based Regulation: Prescribing Private Management to Achieve Public Goals, 37 Law & Soc’y Rev. 691, 691, 726 (2003) (describing the “intertwining of the public and private sectors”); Jody Freeman, The Private Role in Public Governance, 75 N.Y.U. L. Rev. 543, 549–56 (2000) (surveying the great diversity of private governance actors); Gillian E. Metzger, Privatization as Delegation, 103 Colum. L. Rev. 1367, 1369 (2003) (conceiving of privatization of health care, welfare provision, prisons, and public education as delegation); Martha Minow, Public and Private Partnerships: Accounting for the New Religion, 116 Harv. L. Rev. 1229, 1237–42 (2003) (exploring implications of privatization for public values).Show More Scholarship on the private role in public governance has focused on third-party enforcers whose main function is to provide a support service. Those enforcers include self-regulatory organizations formed by industry and independent auditors mandated by regulators.⁵ 5.See Bamberger, supra note 4, at 452–58; Freeman, supra note 4, at 635, 644. As another example, in policing stock exchanges, the Securities and Exchange Commission (SEC) relies heavily on self-regulatory organizations to monitor wrongdoing and propose rules. Jennifer M. Pacella, If the Shoe of the SEC Doesn’t Fit: Self-Regulatory Organizations and Absolute Immunity, 58 Wayne L. Rev. 201, 202 (2012). Courts also order third-party monitors. See Veronica Root, The Monitor-“Client” Relationship, 100 Va. L. Rev. 523, 531–33 (2014).Show More The corporate law strand of this enforcement literature emphasizes a network of “gatekeepers,” such as lawyers, accountants, and certifiers who guard against compliance and governance failures.⁶ 6.See John C. Coffee, Jr., Gatekeepers: The Professions and Corporate Governance 2–3 (2006) (chronicling the evolution of auditors, attorneys, securities analysts, and credit-rating agencies in guarding against corporate governance failures); Assaf Hamdani, Gatekeeper Liability, 77 S. Cal. L. Rev. 53, 117–18 (2003) (discussing the need to expand gatekeeper liability in the wake of the Enron fraud scandal); Reinier H. Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J.L. Econ. & Org. 53, 54 (1986) (contrasting whistleblowers with gatekeepers, who are third parties that can “prevent misconduct by withholding support”).Show More For instance, before releasing annual reports, a publicly traded company must obtain the signoff of a certified accountant.⁷ 7.15 U.S.C. § 78m(a) (2018) (“Every issuer of a security . . . shall file with the Commission . . . such annual reports (and such copies thereof), certified if required by the rules and regulations of the Commission by independent public accountants . . . .”).Show More In these more familiar private enforcement contexts, the private “cops on the beat”⁸ 8.Kraakman, supra note 6, at 53 n.1 (attributing to Jeremy Bentham the “cop-on-the-beat” metaphor and using it to describe gatekeepers).Show More are ancillary actors rather than core market participants.⁹ 9.The literature has also extensively analyzed self-regulation as part of a broader new governance that arose in recent decades. Administrative agencies now pursue collaborative and responsive models of public governance designed to encourage the business sector to self-regulate. See, e.g., Ian Ayres & John Braithwaite, Responsive Regulation: Transcending the Deregulation Debate 3 (1992); Jody Freeman, Collaborative Governance in the Administrative State, 45 UCLA L. Rev. 1, 6–7 (1997). Additionally, large businesses have dramatically grown their compliance departments to police the firm from within. See, e.g., Sean J. Griffith, Corporate Governance in an Era of Compliance, 57 Wm. & Mary L. Rev. 2075, 2077 (2016); Kimberly D. Krawiec, Organizational Misconduct: Beyond the Principal-Agent Model, 32 Fla. St. U. L. Rev. 571, 572 (2005); Veronica Root, Coordinating Compliance Incentives, 102 Cornell L. Rev. 1003, 1004 (2017). This important and nascent literature on corporate compliance has remained focused on the firm’s role in overseeing internal operations, or on traditional gatekeepers doing so.Show More

This Article demonstrates how policymakers have enlisted a new class of more powerful third-party enforcers: the businesses at the heart of the economy. The ten largest American companies by valuation operate in information technology, finance, oil, and pharmaceuticals.¹⁰ 10.Fortune 500 List, Fortune (last visited Oct. 18, 2019), http://fortune.com/fortune­500/list/filtered?sortBy=mktval (identifying the ten most valuable American companies as Apple, Alphabet, Microsoft, Amazon, Berkshire Hathaway, Facebook, JPMorgan Chase, Johnson & Johnson, Exxon Mobil, and Bank of America). One of these companies, Berkshire Hathaway, is a conglomerate operating in diverse industries, including finance, while Johnson & Johnson sells pharmaceuticals in addition to consumer goods. Berkshire Hathaway, Fortune (updated Mar. 29, 2018), https://fortune.com/fortune500/2018/berkshire-hathaway/; Johnson & Johnson, Fortune (updated Mar. 29, 2018), https://fortune.com/fortune500/2018/johnson-johnson/.Show More A regulator has put leading firms in each of these industries on notice about their responsibilities for third-party oversight.¹¹ 11.See infra Part II.Show More In addition to the FTC, the Environmental Protection Agency (EPA)—along with the Department of Justice (DOJ)—requires BP Oil and other energy companies to audit offshore oil platform operators for environmental compliance.¹² 12.Consent Decree Among Defendant BP Exploration & Production Inc., the United States of America, and the States of Alabama, Florida, Louisiana, Mississippi, and Texas at 32–33, In re Oil Spill by the Oil Rig “Deepwater Horizon” in the Gulf of Mex., on Apr. 20, 2010, No. 10-MDL-2179 (E.D. La. Oct. 5, 2015), ECF No. 15436-1 [hereinafter BP Consent Decree].Show More The Food and Drug Administration (FDA) expects Pfizer and other drug companies to ensure suppliers and third-party labs follow the agency’s health and safety guidelines.¹³ 13.21 C.F.R. § 211.22(a) (2018) (explaining best practices for quality control of contractors); FDA Warning Letter from Cheryl A. Bigham, Dist. Dir., Kan. City Dist., Office of Regulatory Affairs, to Thomas Handel, President & Gen. Manager, Meridian Med. Techs., Inc., a Pfizer Co. (Sept. 5, 2017), https://www.fda.gov/iceci/enforcementactions/warningletters/2017/ucm­574981.htm [https://perma.cc/JMX9-V7VL].Show More The Consumer Financial Protection Bureau (CFPB) orders financial institutions, such as American Express, to monitor independent debt collectors and call centers for deceptive practices.¹⁴ 14.Am. Express Centurion Bank, CFPB No. 2012-CFPB-0002 (Oct. 1, 2012) (joint consent order).Show More

The widespread conscription of businesses as enforcers—also called “enforcer-firms” below—shares characteristics with, but differs meaningfully from, prior iterations of third-party regulation. For instance, the FTC’s original administrative order required Facebook to hire a third-party auditor—an example of the old gatekeeper model—to certify Facebook’s compliance.¹⁵ 15.Facebook, Inc., FTC File No. 0923184, No. C-4365, at 3–4 (F.T.C. July 27, 2012) (decision and order).Show More In that arrangement, refusing to sign off on Facebook’s biennial reports to the FTC constituted the auditor’s main sanction.¹⁶ 16.See id. at 6.Show More Facebook could, however, respond to that sanction by bringing its business elsewhere.¹⁷ 17.The consent order does not prevent such a response. See id.Show More That ability to retaliate weakens traditional gatekeepers’ power and independence.¹⁸ 18.See Joel S. Demski, Corporate Conflicts of Interest, 17 J. Econ. Persp. 51, 57 (2003).Show More

In contrast, the enforcer-firm is usually the client—or at least a crucial business partner—of the third parties it regulates. Its main sanction is to cease doing business with those third parties, which can prove devastating.¹⁹ 19.See infra Section IV.A.Show More The client relationship that weakens traditional gatekeepers thus strengthens the enforcer-firm. In short, policymakers have begun relying on third-party enforcement by the real gatekeepers of the economy: the firms who control access to core product markets.²⁰ 20.A diversified firm may play both a new and traditional gatekeeper role. For instance, by allowing a company to serve as both a commercial bank and investment bank, the law enables large financial institutions to operate as both traditional gatekeepers—overseeing their clients by underwriting securities, prompted by liability avoidance under the Securities Act of 1933—and as new gatekeepers, being the clients who hire third-party businesses. See infraSection II.A; Kraakman, supranote 6, at 82–83.Show More

In highlighting an overlooked enforcement model, this Article builds on the literature scrutinizing the increasingly narrow divide between private businesses and the administrative state.²¹ 21.See supra note 4 and accompanying text.Show More Although that scholarship has yet to examine the enforcer-firm in any sustained manner,²² 22.To the extent scholars have discussed mandated third-party governance it has been in passing or in narrower contexts such as in criminal or international law. See, e.g., Larry Catá Backer, Surveillance and Control: Privatizing and Nationalizing Corporate Monitoring After Sarbanes-Oxley, 2004 Mich. St. L. Rev. 327, 433–34 (2004) (referencing how the Bank Secrecy Act causes a larger number of businesses to become “part of the network of the state’s eyes and ears”); John Braithwaite, Responsive Regulation and Developing Economies, 34 World Dev. 884, 889–90 (2006) (exploring how domestic firms can serve as a means of reaching foreign actors); Stavros Gadinis & Colby Mangels, Collaborative Gatekeepers, 73 Wash. & Lee L. Rev. 797, 910–11 (2016) (focusing on money laundering); Itai Grinberg, The Battle over Taxing Offshore Accounts, 60 UCLA L. Rev. 304, 304 (2012) (referencing a “growing consensus that financial institutions should act as cross-border tax intermediaries”). For other ways that scholars have recognized that businesses regulate other firms, see infra Part I.Show More mandated third-party governance raises some similar accountability issues as previous generations of third-party enforcement. In particular, as a new area of quasi-regulatory activity unlikely to be overturned by judicial review, conscripted enforcement lacks transparency and traditional measures of public involvement, such as notice and comment rulemaking.²³ 23.See, e.g., Rachel E. Barkow, Overseeing Agency Enforcement, 84 Geo. Wash. L. Rev. 1129, 1130 (2016) (“Most aspects of agency enforcement policy generally escape judicial review.”); Freeman, supra note 4, at 647 (“Most self-regulatory programs lack the transparency and public involvement that characterize legislative rulemaking.”); Lesley K. McAllister, Regulation by Third-Party Verification, 53 B.C. L. Rev. 1, 3–4 (2012) (identifying accountability challenges with third-party enforcement models).Show More

However, if designed well, the enforcer-firm offers some hope for improving upon prior regulatory models’ accountability. Because enforcer-firms often sell directly to consumers, they may prove more responsive to public concerns when compared to traditional gatekeepers, which interact most closely with regulated entities.²⁴ 24.See, e.g., Coffee, supra note 6, at 15–18 (describing gatekeeper shortcomings).Show More And because the enforcer-firm is itself a prime target of public regulation, it would be easier for an administrative agency to oversee it than to add a whole new category of firms as required for oversight of traditional gatekeepers.²⁵ 25.See infra Section IV.B.Show More The conscription of businesses proved crucial in other administrative contexts, including the implementation of a personal income tax.²⁶ 26.Ajay K. Mehrotra, Making the Modern American Fiscal State: Law, Politics, and the Rise of Progressive Taxation, 1877–1929, at 282–83 (2013).Show More The enforcer-firm could, by analogy, enable the regulatory state to bring dispersed business actors into compliance.

None of this should be taken as an endorsement of the enforcer-firm, which is too new and understudied to yield strong normative conclusions. However, an openness to the upsides of the enforcer-firm responds to the critique that administrative law scholars have too often portrayed private actors as an intrusion into legitimacy, which prevents “imagining the means by which private actors might contribute to accountability.”²⁷ 27.Freeman, supra note 4, at 675. Numerous scholars have taken up this call in other contexts. See, e.g., Sarah E. Light, The Law of the Corporation as Environmental Law, 71 Stan. L. Rev. 137, 139–41 (2019) (calling for a holistic view of corporations’ role in promoting environmental goals).Show More

Mandated third-party governance also speaks to vibrant corporate law inquiries. Scholars have paid considerable attention to the duties of directors and officers, personal liability for corporate wrongdoing, and organizational structure.²⁸ 28.See generally Nicolai J. Foss et al., The Theory of the Firm, in 3 Encyclopedia of Law and Economics 631 (Boudewijn Bouckaert & Gerrit De Geest eds., 2000); infra Part III.Show More Conscripted enforcement shapes each of these areas and pushes against depictions of the firm emphasizing its private nature. Those depictions are rooted in the influential metaphor—sometimes described as the most dominant theory of the firm—that the firm is a “nexus of contracts” among owners, managers, laborers, suppliers, and customers.²⁹ 29.See, e.g., Melvin A. Eisenberg, The Conception That the Corporation Is a Nexus of Contracts, and the Dual Nature of the Firm, 24 J. Corp. L. 819, 820 (1999); Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. Fin. Econ. 305, 310 (1976); Steven L. Schwarcz, Misalignment: Corporate Risk-Taking and Public Duty, 92 Notre Dame L. Rev. 1, 26 (2016).Show More The firm remains exceedingly private. But by directing businesses to write enforcement-oriented contract clauses and monitor external relationships for legal violations, as a descriptive matter the state is pushing the firm toward a larger public role.³⁰ 30.See infra Section III.A.Show More

That insight is relevant beyond theory and institutional design. In the highest legislative circles and corporate boardrooms, debates are unfolding about what duties corporations owe to society, with some taking particular aim at the idea that shareholders should come above all other stakeholders.³¹ 31.See Elizabeth Warren, Companies Shouldn’t Be Accountable Only to Shareholders, Wall St. J., Aug. 15, 2018, at A17; Larry Fink, Larry Fink’s 2018 Letter to CEOs: A Sense of Purpose, BlackRock, https://www.blackrock.com/corporate/investor-relations/2018-larry-fin­k-ceo-letter [https://perma.cc/P9X6-HN85] (last visited Jan. 13, 2020); Martin Lipton et al., It’s Time to Adopt the New Paradigm, Harv. L. Sch. F. Corp. Governance, https://corpgov.­law.harvard.edu/2019/02/11/its-time-to-adopt-the-new-paradigm [https://perma.cc/3XH9-SSRS] (last visited Jan. 13, 2020); Business Roundtable Redefines the Purpose of a Corporation to Promote ‘An Economy That Serves All Americans,’ Business Roundtable (Aug. 19, 2019), [https://perma.cc/9K2F-2HLG]. On shareholder primacy, see infra note 189 and accompanying text.Show More Conscripted enforcement marks a significant uptick in federal regulatory involvement in the firm by imposing more of an affirmative public duty to act.³² 32.See infra Section III.D.Show More Cast against the backdrop of the firm as public enforcer, calls for business leaders to do more for society appear less disconnected from reality than would be the case under a largely private conception of the firm.³³ 33.There is arguably a gap between rhetoric and reality. See Marcel Kahan & Edward Rock, Symbolic Corporate Governance Politics, 94 B.U. L. Rev. 1997, 2042 (2014).Show More

The Article is structured as follows. Part I provides an overview of the well-studied ways that private entities serve as enforcers. Part II offers four case studies of how regulators have implemented mandated enforcement of third parties in some of the largest U.S. industries: the FTC and technology, the CFPB and banking, the EPA and oil, and the FDA and pharmaceuticals. Part III examines how mandated enforcement alters the firm’s contracts, relationships, and governance. It also explores shifts in liability at the personal and entity level, which could influence organizational structure. Part IV concludes by considering implications for the effectiveness and accountability of the administrative state.

1. * Associate Professor of Law, Boston University; Affiliated Fellow, Yale Law School Information Society Project. For extremely valuable input, I am grateful to Hilary Allen, William Eskridge, George Geis, Anna Gelpern, Jonathan Lipson, Nicholas Parrillo, Carla Reyes, Kevin Schwartz, Andrew Tuch, Michael Vandenbergh, David Walker, and Jay Wexler, and to workshop participants at Boston University, the University of Pennsylvania, the University of Virginia, and Yale ISP. Special thanks to Eric Talley for unusually formative early comments. Jacob Axelrod, Sam Burgess, Omeed Firoozgan, Christopher Hamilton, Allison Mcsorley, Tyler Stites, Kelsey Sullivan, and Gavin Tullis provided excellent research assistance. The Virginia Law Review editors, and particularly Mark Russell, were tremendously thorough and helpful throughout. ↑
2. Cecilia Kang, A Facebook Settlement with the F.T.C. Could Run into the Billions, N.Y. Times, Feb. 15, 2019, at B6. ↑
3. Katy Steinmetz, Mark Zuckerberg Survived Congress. Now Facebook Has to Survive the FTC, Time (Apr. 13, 2018, 12:42 PM), https://time.com/5237900/facebook-ftc-privacy-data-cambridge-analytica/ [https://perma.cc/4SJJ-YHP9]. ↑
4. See FTC v. Amazon.com, Inc., No. C14-1038-JCC, 2016 WL 10654030, at *8 (W.D. Wash. July 22, 2016) (finding Amazon accountable for in-app charges); Agreement Containing Consent Order at 5, Google Inc., No. 102-3136, (F.T.C. Mar. 30, 2011), https://www.ftc.gov/sites/default/files/documents/cases/2011/03/110330googlebuzzagreeorder.pdf [https://perma.cc/7R6W-5VNP] (ordering Google to require “service providers by contract to implement and maintain appropriate privacy protections”). ↑
5. See, e.g., Kenneth A. Bamberger, Regulation as Delegation: Private Firms, Decisionmaking, and Accountability in the Administrative State, 56 Duke L.J. 377, 453 (2006) (conceiving of regulators’ decisions to let regulated entities fill in vague mandates as delegation); Cary Coglianese & David Lazer, Management-Based Regulation: Prescribing Private Management to Achieve Public Goals, 37 Law & Soc’y Rev. 691, 691, 726 (2003) (describing the “intertwining of the public and private sectors”); Jody Freeman, The Private Role in Public Governance, 75 N.Y.U. L. Rev. 543, 549–56 (2000) (surveying the great diversity of private governance actors); Gillian E. Metzger, Privatization as Delegation, 103 Colum. L. Rev. 1367, 1369 (2003) (conceiving of privatization of health care, welfare provision, prisons, and public education as delegation); Martha Minow, Public and Private Partnerships: Accounting for the New Religion, 116 Harv. L. Rev. 1229, 1237–42 (2003) (exploring implications of privatization for public values). ↑
6. See Bamberger, supra note 4, at 452–58; Freeman, supra note 4, at 635, 644. As another example, in policing stock exchanges, the Securities and Exchange Commission (SEC) relies heavily on self-regulatory organizations to monitor wrongdoing and propose rules. Jennifer M. Pacella, If the Shoe of the SEC Doesn’t Fit: Self-Regulatory Organizations and Absolute Immunity, 58 Wayne L. Rev. 201, 202 (2012). Courts also order third-party monitors. See Veronica Root, The Monitor-“Client” Relationship, 100 Va. L. Rev. 523, 531–33 (2014). ↑
7. See John C. Coffee, Jr., Gatekeepers: The Professions and Corporate Governance 2–3 (2006) (chronicling the evolution of auditors, attorneys, securities analysts, and credit-rating agencies in guarding against corporate governance failures); Assaf Hamdani, Gatekeeper Liability, 77 S. Cal. L. Rev. 53, 117–18 (2003) (discussing the need to expand gatekeeper liability in the wake of the Enron fraud scandal); Reinier H. Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J.L. Econ. & Org. 53, 54 (1986) (contrasting whistleblowers with gatekeepers, who are third parties that can “prevent misconduct by withholding support”). ↑
8. 15 U.S.C. § 78m(a) (2018) (“Every issuer of a security . . . shall file with the Commission . . . such annual reports (and such copies thereof), certified if required by the rules and regulations of the Commission by independent public accountants . . . .”). ↑
9. Kraakman, supra note 6, at 53 n.1 (attributing to Jeremy Bentham the “cop-on-the-beat” metaphor and using it to describe gatekeepers). ↑
10. The literature has also extensively analyzed self-regulation as part of a broader new governance that arose in recent decades. Administrative agencies now pursue collaborative and responsive models of public governance designed to encourage the business sector to self-regulate. See, e.g., Ian Ayres & John Braithwaite, Responsive Regulation: Transcending the Deregulation Debate 3 (1992); Jody Freeman, Collaborative Governance in the Administrative State, 45 UCLA L. Rev. 1, 6–7 (1997). Additionally, large businesses have dramatically grown their compliance departments to police the firm from within. See, e.g., Sean J. Griffith, Corporate Governance in an Era of Compliance, 57 Wm. & Mary L. Rev. 2075, 2077 (2016); Kimberly D. Krawiec, Organizational Misconduct: Beyond the Principal-Agent Model, 32 Fla. St. U. L. Rev. 571, 572 (2005); Veronica Root, Coordinating Compliance Incentives, 102 Cornell L. Rev. 1003, 1004 (2017). This important and nascent literature on corporate compliance has remained focused on the firm’s role in overseeing internal operations, or on traditional gatekeepers doing so. ↑
11. Fortune 500 List, Fortune (last visited Oct. 18, 2019), http://fortune.com/fortune­500/list/filtered?sortBy=mktval (identifying the ten most valuable American companies as Apple, Alphabet, Microsoft, Amazon, Berkshire Hathaway, Facebook, JPMorgan Chase, Johnson & Johnson, Exxon Mobil, and Bank of America). One of these companies, Berkshire Hathaway, is a conglomerate operating in diverse industries, including finance, while Johnson & Johnson sells pharmaceuticals in addition to consumer goods. Berkshire Hathaway, Fortune (updated Mar. 29, 2018), https://fortune.com/fortune500/2018/berkshire-hathaway/; Johnson & Johnson, Fortune (updated Mar. 29, 2018), https://fortune.com/fortune500/2018/johnson-johnson/. ↑
12. See infra Part II. ↑
13. Consent Decree Among Defendant BP Exploration & Production Inc., the United States of America, and the States of Alabama, Florida, Louisiana, Mississippi, and Texas at 32–33, In re Oil Spill by the Oil Rig “Deepwater Horizon” in the Gulf of Mex., on Apr. 20, 2010, No. 10-MDL-2179 (E.D. La. Oct. 5, 2015), ECF No. 15436-1 [hereinafter BP Consent Decree]. ↑
14. 21 C.F.R. § 211.22(a) (2018) (explaining best practices for quality control of contractors); FDA Warning Letter from Cheryl A. Bigham, Dist. Dir., Kan. City Dist., Office of Regulatory Affairs, to Thomas Handel, President & Gen. Manager, Meridian Med. Techs., Inc., a Pfizer Co. (Sept. 5, 2017), https://www.fda.gov/iceci/enforcementactions/warningletters/2017/ucm­574981.htm [https://perma.cc/JMX9-V7VL]. ↑
15. Am. Express Centurion Bank, CFPB No. 2012-CFPB-0002 (Oct. 1, 2012) (joint consent order). ↑
16. Facebook, Inc., FTC File No. 0923184, No. C-4365, at 3–4 (F.T.C. July 27, 2012) (decision and order). ↑
17. See id. at 6. ↑
18. The consent order does not prevent such a response. See id. ↑
19. See Joel S. Demski, Corporate Conflicts of Interest, 17 J. Econ. Persp. 51, 57 (2003). ↑
20. See infra Section IV.A. ↑
21. A diversified firm may play both a new and traditional gatekeeper role. For instance, by allowing a company to serve as both a commercial bank and investment bank, the law enables large financial institutions to operate as both traditional gatekeepers—overseeing their clients by underwriting securities, prompted by liability avoidance under the Securities Act of 1933—and as new gatekeepers, being the clients who hire third-party businesses. See infra Section II.A; Kraakman, supra note 6, at 82–83. ↑
22. See supra note 4 and accompanying text. ↑
23. To the extent scholars have discussed mandated third-party governance it has been in passing or in narrower contexts such as in criminal or international law. See, e.g., Larry Catá Backer, Surveillance and Control: Privatizing and Nationalizing Corporate Monitoring After Sarbanes-Oxley, 2004 Mich. St. L. Rev. 327, 433–34 (2004) (referencing how the Bank Secrecy Act causes a larger number of businesses to become “part of the network of the state’s eyes and ears”); John Braithwaite, Responsive Regulation and Developing Economies, 34 World Dev. 884, 889–90 (2006) (exploring how domestic firms can serve as a means of reaching foreign actors); Stavros Gadinis & Colby Mangels, Collaborative Gatekeepers, 73 Wash. & Lee L. Rev. 797, 910–11 (2016) (focusing on money laundering); Itai Grinberg, The Battle over Taxing Offshore Accounts, 60 UCLA L. Rev. 304, 304 (2012) (referencing a “growing consensus that financial institutions should act as cross-border tax intermediaries”). For other ways that scholars have recognized that businesses regulate other firms, see infra Part I. ↑
24. See, e.g., Rachel E. Barkow, Overseeing Agency Enforcement, 84 Geo. Wash. L. Rev. 1129, 1130 (2016) (“Most aspects of agency enforcement policy generally escape judicial review.”); Freeman, supra note 4, at 647 (“Most self-regulatory programs lack the transparency and public involvement that characterize legislative rulemaking.”); Lesley K. McAllister, Regulation by Third-Party Verification, 53 B.C. L. Rev. 1, 3–4 (2012) (identifying accountability challenges with third-party enforcement models). ↑
25. See, e.g., Coffee, supra note 6, at 15–18 (describing gatekeeper shortcomings). ↑
26. See infra Section IV.B. ↑
27. Ajay K. Mehrotra, Making the Modern American Fiscal State: Law, Politics, and the Rise of Progressive Taxation, 1877–1929, at 282–83 (2013). ↑
28. Freeman, supra note 4, at 675. Numerous scholars have taken up this call in other contexts. See, e.g., Sarah E. Light, The Law of the Corporation as Environmental Law, 71 Stan. L. Rev. 137, 139–41 (2019) (calling for a holistic view of corporations’ role in promoting environmental goals). ↑
29. See generally Nicolai J. Foss et al., The Theory of the Firm, in 3 Encyclopedia of Law and Economics 631 (Boudewijn Bouckaert & Gerrit De Geest eds., 2000); infra Part III. ↑
30. See, e.g., Melvin A. Eisenberg, The Conception That the Corporation Is a Nexus of Contracts, and the Dual Nature of the Firm, 24 J. Corp. L. 819, 820 (1999); Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. Fin. Econ. 305, 310 (1976); Steven L. Schwarcz, Misalignment: Corporate Risk-Taking and Public Duty, 92 Notre Dame L. Rev. 1, 26 (2016). ↑
31. See infra Section III.A. ↑
32. See Elizabeth Warren, Companies Shouldn’t Be Accountable Only to Shareholders, Wall St. J., Aug. 15, 2018, at A17; Larry Fink, Larry Fink’s 2018 Letter to CEOs: A Sense of Purpose, BlackRock, https://www.blackrock.com/corporate/investor-relations/2018-larry-fin­k-ceo-letter [https://perma.cc/P9X6-HN85] (last visited Jan. 13, 2020); Martin Lipton et al., It’s Time to Adopt the New Paradigm, Harv. L. Sch. F. Corp. Governance, https://corpgov.­law.harvard.edu/2019/02/11/its-time-to-adopt-the-new-paradigm [https://perma.cc/3XH9-SSRS] (last visited Jan. 13, 2020); Business Roundtable Redefines the Purpose of a Corporation to Promote ‘An Economy That Serves All Americans,’ Business Roundtable (Aug. 19, 2019), [https://perma.cc/9K2F-2HLG]. On shareholder primacy, see infra note 189 and accompanying text. ↑
33. See infra Section III.D. ↑
34. There is arguably a gap between rhetoric and reality. See Marcel Kahan & Edward Rock, Symbolic Corporate Governance Politics, 94 B.U. L. Rev. 1997, 2042 (2014). ↑

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