October 25, 2007
Why Do We Trust Directors?
Posted by Julian Velasco

This is a question that has been bothering me, and I was wondering what others thought: why do courts trust directors so much?  I'm not asking why we have a business judgment rule.  A great deal has been written on that topic, including by me.  I understand the reasons for that and agree whole-heartedly.  But we also have an entire fairness test for a reason.

My concern is that courts are too ready to apply the business judgment rule rather than the entire fairness test or some intermediate standard of review (and that intermediate standards of review eventually are watered down to the point where they do little more than the business judgment rule).  There are many conflicts of interests that courts simply will not recognize as affecting director independence.  Among the most important are those that stem from so-called "structural bias".

In my article, Structural Bias and the Need for Substantive Review, 82 Wash. U. L.Q. 821 (2004), I note that there are at least three different ways of understanding structural bias: as an implicit conspiracy among directors to pursue their group interests; as relationship, and a preference directors may show for colleagues and friends; and as a psychological phenomenon known as "ingroup bias".  I argue that such conflicts undermine confidence in the applicability of a standard of review as deferential as the business judgment rule.  (I also argue that situations involving structural bias also do not warrant the application of a standard as severe as the entire fairness test, and so an effective intermediate standard of review is necessary; but that is beside the point.)

Refusing to recognize entire categories of conflicts and sticking with the deference of the business judgment rule implies a great deal of trust in directors.  Whence this trust?

I assume that this trust in directors does not stem from the fact that we believe they are more virtuous than others.  (Neither, of course, would I be willing to say that they are less virtuous than others.)

Maybe it's just a general trust in people, such that we wouldn't accept structural bias-like claims in any situation.  But I'm not sure that explains it, because directors get a lot more deference than just about anyone else.

Maybe it's a mistaken belief that structural bias assumes directors are corrupt.  But, as I explain in my article, that is simply not true.  Structural bias, in each of the forms I discuss, can occur on either a conscious or unconscious level.  It should be treated like self-dealing: we don't apply a heightened standard of review because we've concluded that directors actually are misbehaving; we do so because the situation makes the extreme deference of the business judgment rule inappropriate.

I also don't think the traditional justifications for the business judgment rule rationale can really explain why we take it so far.  As others have explained before me, most of those justifications could fairly be said to apply in other contexts as well.

Does it boil down to judicial economy -- are Courts simply concluding that these are not the sorts of things that they want to get involved with?  (That doesn't seem very plausible with respect to the Delaware courts, at least.)  Is it just a strongly pro-business mentality -- or an anti-litigation mentality?  ("You can sue, but only if you can really prove your case.")  Is it politics and the race to the bottom?

I'd appreciate any thoughts people might be willing to share: not on why we have a business judgment rule, but on why courts trust directors so much that they're willing to ignore all but the most egregious conflicts of interest.

| Bookmark

TrackBacks (1)

TrackBack URL for this entry:

Links to weblogs that reference Why Do We Trust Directors?:

ยป Why do We Trust Directors? from Law Business ...
"Julian Velasco poses the titular question in a post that asks: My concern is that courts are too rea ..." [more] (Tracked on October 26, 2007 @ 13:05)
Recent Comments
Popular Threads
Search The Glom
The Glom on Twitter
Archives by Topic
Archives by Date
January 2019
Sun Mon Tue Wed Thu Fri Sat
    1 2 3 4 5
6 7 8 9 10 11 12
13 14 15 16 17 18 19
20 21 22 23 24 25 26
27 28 29 30 31    
Miscellaneous Links