Trey Drury has written a thoughtful piece on Delaware’s 102b7 and its drawbacks.  As he notes, his article and 102b7 essentially seek to find a balance between corporate authority and accountability.  His article suggests that the statute in its current form undermines accountability in a number of important ways.  In an effort to correct this shortcoming, he offers a solution—legislative action that would require periodic reauthorization of the 102b7 by shareholders.  The solution is an interesting compromise because it appears to preserve the benefits of 102b7 while allowing shareholders genuine ability to opt out of those benefits if they choose (or at least to reevaluate them).  Yet I must admit that I am not sure if his solution will create real change or it will amount to mere rubber-stamping of the status quo.

Trey’s article starts with a nice examination of the events leading up to the passage of 102b7—namely Van Gorkom and the potential for too much personal liability for directors as well as the perceived crisis in the D&O insurance market created by Van Gorkom.  Here Trey does a good job of capturing the concerns generated by Van Gorkom and reminding the reader that not all agreed with the severity of those concerns.

First, Trey notes that the statute appears to create incentives for directors to engage in sub-optimal behavior.  Here Trey discusses the notion that, because directors can avoid personal liability for breaches of duty of care, directors are less likely to be diligent in carrying out their duty.  While agreeing with that concept, I think the article would benefit from a more an in-depth discussion regarding the impact of liability regimes on director behavior, especially in light of those who insist that such regimes have no little to no impact on corporate behavior.  Trey also notes a subtler manner in which 102b7 impacts issues of corporate governance.  Here Trey maintains that 102b7 allows directors to avoid 10B-5 liability.  This is because10b-5 requires scienter, yet because 102b-7 incentivizes directors to be inattentive, the statute makes it difficult to prove scienter because the statute makes it less likely that directors will have the knowledge necessary for such proof.  I found this discussion intriguing because I think there is a connection between the way in which directors’ carry out their duty of care and the ability to bring securities fraud actions.  However, I am not sure if the article made that connection in a convincing fashion.  Indeed, the article focused on the notion that 102b7 creates incentives for directors to be less attentive and less informed regarding corporate affairs.  Yet the article did not really discuss the impact of SOX and other new federal rules regulating corporate conduct.  Indeed, the studies I have read suggest that since SOX, directors and officers have been paying more attention to their obligations, spending more time on governance mattes and becoming more entwined in corporate operations.  How do such studies impact the article’s analysis regarding scienter?  Moreover, it seems like demonstrating scienter in the corporate context is a difficult proposition in and of itself.  Is it really the case that 102b7 significantly enhances that difficulty?  Put another way, is there any evidence—empirical or anecdotal—that there is a link between demonstrating scienter and the adoption of 102b7?  I think this portion of the article would benefit from a more detailed discussion of these issues.

The next section of the article notes that the problems that 102b7 were designed to resolve may in fact be resolved.  Thus, the article points out that the issues associated with the D&O market may have been exaggerated.  Then the article notes that courts appear to have addressed many of the concerns associated with Van Gorkom regarding issues of uncertainty and the potential for too much personal liability.  Here I think Trey’s argument has a lot of merit, and that the argument would be enhanced by pinpointing some of the language and commentary regarding cases such as Disney, which suggest that while courts are willing to articulate a seemingly higher standard of care for directors and officers, they are not willing to impose liability for defects in the exercise of that care.

The article then points out that 102b7 has caused courts to rely on good faith as a way to get around the prohibitions in 102b7 and enable shareholders their day in court.  Trey makes a good point what while the focus on good faith may seem to vindicate shareholders by allowing them their day in court, it comes at a cost—namely greater uncertainty, given the ill-defined nature of the good faith doctrine. The article also focuses on the limits of the contractarian theory.

Finally, the article proposes a solution that in many ways is consistent with the contractarian theory because it allows shareholder true choice in the exercise their contract rights—that is, it allows shareholder to re-authorize 102b-7.   Trey notes two possibilities for reauthorization—through shareholder proposals or through legislation.  He maintains that collective action and rational apathy problems makes the shareholder proposal route less attractive than legislation where corporations would be required to put reauthorization on the ballot.  However, I am not sure that legislation really overcomes the problems of collective action and rational apathy.  To be sure, the measure will be on ballot.  But it seems that it would suffer the same fate as other issues shareholders vote upon—that is, shareholders, because of collective action problems and rational apathy, will follow the advice of management. Indeed, the article does not discuss why we should expect shareholders to be more attentive in the context of the reauthorization vote that they are in other contexts.  Of course it is possible that the new wave of shareholder activism will mean that any shareholder vote on reauthorization will be meaningful because that activism suggest that shareholders will play a greater role in governance matters. But such a possibility needs to be addressed.

In the end, I found the piece thoughtful and insightful.  I certainly welcome articles that seek to explore how we can revitalize the threat of personal liability in order to strike a better balance between corporate accountability and authority.

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