When Worlds Collide

Lately, I’ve been feeling a bit guilty about posting my business associations Limericks on a contracts blog.  But now Emory Law School’s Professor Frederick Tung (pictured below the supernova) has solved my problems with an article posted on SSRN and entitled: The New Death of Contract: Creeping Corporate Fiduciary Duties for Creditors.  I am indebted to Professor Tung for showing how business associations law often relates to fundamental contracts issues and for showing the consequences of the collision involving these two realms of legal doctrine.
 
The abstract from SSRN is posted below:

The article identifies a worrisome trendin corporate law and scholarship. Across seemingly unrelated issueareas, courts and scholars have lost faith in private corporatebargains. They invite judicial intervention into private contract,proposing to expand fiduciary duties beyond their traditionalshareholder centered focus to protect non-shareholder claimants frommanagerial opportunism. When conflict between claimant classes becomesacute, managers pursuing shareholder value may make inefficientinvestments that benefit shareholders but harm other claimants and thefirm generally. I argue that claimants’ private contracts with the firmare superior to expanded duty for constraining this opportunism.

 Ifocus on one specific conflict – the conflict between shareholders andcreditors. Existing doctrine already works a shift in fiduciary dutiesto creditors when this conflict becomes acute – when a firm becomesinsolvent. Scholars propose to expand on current doctrine to includemore creditors more of the time. I argue that both existing doctrineand its proposed expansions suffer fatal theoretical infirmities. Thechief failing is that the accepted hypothetical bargain analysis fromwhich corporate fiduciary duty derives cannot justify current doctrineor expansion proposals. Expanded duty to creditors is also costlycompared to private contract.
 
I propose an approach I callcontract primacy. Shareholder primacy should remain the default rule.Private contracting should be effective to curb manager opportunism.Additional legal constraints are costly and unnecessary. Sophisticatedcreditors typically negotiate elaborate covenant protections by thetime a firm is in distress, often to the benefit of other creditors,who implicitly delegate monitoring responsibilities to the low costmonitor. A creditor may even negotiate for control of the firm,displacing shareholder primacy. Against the current doctrine andconventional wisdom, courts should vindicate these contracts forcreditor primacy without insisting on the firm’s insolvency. Thedoctrine should be abandoned, and proposals for further expansion offiduciary duty for creditors should be rejected.

[Jeremy Telman]