December 20, 2005
Is Time Warner's Board About to Breach a Fiduciary Duty?
Posted by Gordon Smith

AoltwIn his letter to the Time Warner board of directors released yesterday, Carl Icahn objects to Time Warner's exclusive negotiations with Google over AOL. Icahn argues that Google is the wrong strategic partner, and that a deal with Microsoft or Yahoo or eBay might unlock more value for Time Warner shareholders. Then he writes this:

On the eve of a proxy contest, I believe it would be a blatant breach of fiduciary duty to enter into an agreement with Google that would either foreclose the possibility of entering into a transaction that would be more beneficial for Time Warner shareholders or make such a transaction more difficult to achieve. (emphasis added)

Hmm. Icahn points to no conflicts of interest in this transaction. He simply claims that a Google transaction would be a bad idea. Here is some Fiduciary Duty 101: bad business decisions, even egregiously bad business decisions, are not actionable breaches of fiduciary duty. The business judgment rule would protect Time Warner's board of directors in this instance, even if they entered into a transaction that many people believed was substantively horrible.

Another aspect of Icahn's statement that I find interesting is that business people seem to have a more expansive notion of fiduciary duty than lawyers. If I am right about that, then fiduciary law may be working pretty well. Let me briefly explain why.

In this short symposium paper, I borrow from the work of Meir Dan-Cohen, Mel Eisenberg, and others to discuss the difference between "standards of conduct" [edited: see comments] and "standards of liability." The basic idea is that we want directors to hear this message: be diligent and make wise decisions. This is the standard of conduct. But we don't want to hold directors liable merely for a failure of diligence or wisdom. (Why? Two reasons: because we want directors to be bold and because we want to preserve the value of centralized decision making.) Before imposing liability, we want some evidence of wrongdoing, such as a conflict of interest. This is the standard of liability.

My sense is that many business people think about the standard of conduct when they contemplate fiduciary duties, even though they know about the standard of liability. Consider Icahn's concluding paragraph to the Time Warner board:

Once again, I am not opposed to the board using its business judgment to enter into a transaction with Google or another suitor so long as the transaction does not destroy or impede Time Warner's flexibility to unlock shareholder value in the near and long term. However, I want this letter to serve as notice to Time Warner's directors that if they enter into a transaction that has that effect, shareholders will seek to hold directors responsible. (emphasis added)

The reference to "business judgment" seems clear enough: he recognizes the board's legal authority to act in that sphere. So how will shareholders "hold directors responsible"? At the ballot box.

And this is as it should be.

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