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E-MailJens Frankenreiter is an Associate Professor of Law at Washington University in St. Louis, and Eric Talley is Isidor and Seville Sulzbacher Professor of Law at Columbia Law School. This post is based on their working paper.
In corporate law circles, contractarianism is all the rage. Yet again. This now-familiar account of corporate law traces back at least as far back as the 1980s, casting its lot with the idea that “the firm” is best understood as nexus of interconnected contracts. Under this accounting, corporate law’s essential remit is to act as an enabling platform, providing a series default governance rules that countenance (and even invite) additional tailoring by participants. Beyond a few “off-limits” exceptions, parties to the corporate contract have tremendous freedom to allocate cash flow and control rights in ways that will (theoretically) maximize the surplus available.
The contractarian account of corporate law has always had its critics, many of whom argue that corporate structures are sufficiently complex and rife with externalities that a strong commitment to contractarianism is destined to collapse on itself, possibly sowing the seeds of wealth and income inequality in the process. Yet wherever one lands on the merits of contractarianism as legal policy, it has proven to be an exceedingly powerful academic rallying cry. If deviations from corporate law’s default rules are adequately disclosed and executed in the appropriate document, the argument goes, sophisticated investors can adjust their willingness to pay accordingly, and a self-interested corporate designer will have the incentives to design rules that attract (or at least don’t scare away) investment capital. Contractarianism’s allure, moreover, is not simply confined to academic audiences. Legislators and judges have embraced it as well (if somewhat more belatedly), and arguments like those described above have impelled an expansion of corporate contractarianism, toppling in the process several heretofore “off limits” shibboleths that the law has traditionally safeguarded.
Accordingly, a significant amount of corporate law innovation in the last quarter century has pivoted on the opening of intra-corporate rights and obligations to the domain of contracting. Such movements are by now unexceptional: they include (among other things) now-widespread waivers of directors’ fiduciary duties of care, of the corporate opportunity doctrine, of appraisal rights, or even of fraud liability; the embrace of dual class stock; the permissibility of tenured and volume-diluted voting schemes; and the use of inter-shareholder contracts to outflank supposedly immutable duties in corporate law.
In our new research study, we consider the most recent example where contractarianism has jostled the traditional boundaries of corporate law: the 2022 Delaware reform that expanded corporations’ power to waive certain fiduciary duties for officers (and not just directors) of firms incorporated in the state. The famous antecedent to this reform is by now a familiar tale to students of Delaware corporate law: In 1986, Delaware amended its statutes to permit corporate charters to waive monetary exposure for directors found to have breached their fiduciary duties of care. That reform—codified in § 102(b)(7) of the Delaware General Corporate Law—came on the heels of a landmark opinion holding that board members could be held liable for gross negligence in the process by which directors became informed before reaching a decision to sell the company. Significantly, § 102(b)(7) left several facets of fiduciary duties off limits, including the duty of loyalty, bad faith conduct, claims seeking injunctive relief, and actions alleging a breached duty as predicate offence in an aiding-and-abetting claim brought against a third party (such as a financial or legal advisor).
An equally curious omission from the 1986 statute was any provision for waiving the duty of care for corporate officers. Only directors could benefit from a 102(b)(7) waiver, and then only if the waiver was explicitly enshrined in the corporate charter. In the years following the 1986 reform, Delaware corporations quickly flocked to adopt charter provisions that embraced this new protection, typically deploying language that parroted back the express terms of the statute verbatim. By 2020, in fact, over nine in ten of Delaware incorporated public companies had adopted such a provision. Yet plaintiffs attempting to recover from officers still could allege care violations with some chances of success (particularly through direct actions, which are not subject to demand-futility rules).
Three and a half decades after § 102(b)(7)’s genesis, the Delaware legislature revisited the section once again in 2022, allowing—for the first time—a corporate charter to waive monetary exposure for officers found to have breached their duty of care. Although the 2022 amendment placed additional limitations on officer-facing waivers (most significantly an explicit exclusion for derivative lawsuits), the change brought about what many commentators perceived to be a significant expansion of the enabling landscape in Delaware. Dozens of client alerts advised clients not to walk, but to run to amend their charters in order to take advantage of this new contractarian wiggle room. Newly public companies, too, were advised to make maximal use of duty-of-care waivers. Not everyone was impressed, however: At least some commentators pointed to the reform’s limited scope and questioned whether officer-facing waivers would see widespread adoption.
We are now more than a year into Delaware’s experiment expanding the permissible space of care waivers to officers—a significant milestone because it guarantees that all Delaware companies will have had at least one opportunity to seek a charter amendment as part of their annual meeting calendar. The timing affords us a propitious opportunity to assess how (or whether) Delaware corporations have responded to this newest exculpation experiment. In a new working paper, we investigate the reaction to a much-heralded 2022 legal reform in Delaware that permitted a corporation’s charter to exculpate its officers from monetary exposure for breaching their fiduciary duties of care.
To isolate reactions to this statutory reform, we make extensive use of generative AI tools to identify and interpret charter amendments that introduce officer-facing waivers. We find a surprisingly tepid rate of uptake among Delaware corporations through the end of the first post-reform year, notwithstanding widespread predictions that corporate entities would quickly storm the exculpation exits once permitted to do so.
Our study makes two contributions to the empirical study of law—one methodological and the other substantive. Methodologically, we develop a novel and powerful use case for deploying large language models such as ChatGPT as a tool for distilling and extracting technical provisions from legal texts (in this case corporate charters), allowing us to accelerate and streamline an endeavor that would have consumed substantial time and resources using traditional human-labeling protocols. Notably, and in a significant departure from previous machine learning tools, ChatGPT accomplishes this set of tasks without the need for training data specifically tailored for this purpose. Perhaps most impressive is the accuracy with which ChatGPT can operate: we perform several validation exercises, which generally indicate that our proposed method yields highly accurate results.
Substantively, we demonstrate that Delaware’s statutory invitation attracted few takers in its first year of effectiveness: specifically, we show that only a modest minority of eligible corporations amended their charters to include officer-facing waivers. This tepid rate of uptake, moreover, persists even in corporations that went public after the reform’s effective date, suggesting that transaction costs are unlikely to be the culprit for the listless response. Furthermore, we show that stock market investors also exhibited a muted response to the reform, raising doubts about whether firms feared amendments would trigger an adverse market reception. Our results seem more consistent with alternative explanations, ranging from the plausible irrelevance of Delaware’s reform, to a risk-averse reticence among corporate managers who rationally adopt a “wait and see” approach to gauge how such waivers are received by both courts and corporate stakeholders while keeping their options open.
Ultimately, of course, it could take several more years for us to fully gauge how much officer-facing will come to move the needle of corporate contractarianism. (Stay tuned for future AI-driven updates of this paper!) Indeed, as one of us has previously documented, corporate opportunity waivers under DGCL § 122(17) took years to become widely embraced by Delaware corporations. For now, however, we can only conclude that Delaware’s most recent entry in the contractarian horse rase has been slow out of the gate.
