Family Law and Entrepreneurial Action

In response to Benjamin Means, The Contractual Foundation of Family-Business Law, 75 Ohio St. L.J. 675 (2014)

The Critical Resource Theory of Fiduciary Duty

This Article proposes a new theory to unify the law of fiduciary duty. The prevailing view holds that fiduciary law is atomistic, arising for varied reasons in established categories of cases (such as trustee-beneficiary and director-shareholder) and ad hoc in relationships where one person trusts another and becomes vulnerable to harm as a result. By contrast, the critical resource theory of fiduciary duty holds that every relationship properly designated as fiduciary conforms to the following pattern: one party (the fiduciary) acts on behalf of another party (the beneficiary) while exercising discretion with respect to a critical resource belonging to the beneficiary. Relying on insights from the property rights theory of the firm, this critical resource theory holds that the primary purpose of the law of fiduciary duty is to combat opportunism within relationships that fit this pattern. The beneficiary initially protects against opportunism through self-help denying or threatening to deny the fiduciary access to the critical resource that is an essential platform for opportunistic behavior in these settings. Fiduciary law supplements self-help by depriving the fiduciary of the benefits from opportunism. By requiring the existence of a critical resource at the core of all fiduciary relationships, the critical resource theory assists courts in differentiating fiduciary relationships from relationships in which harm is caused merely by misplaced trust. The critical resource theory also justifies the varying intensity of fiduciary duties across fiduciary relationships: Where self-help is effective, fiduciary constraints are relatively weak, and where self-help is weak, fiduciary constraints are relatively intense. Three additional implications of the critical resource theory of fiduciary duty are also developed: (1) The critical resource theory implies that fiduciary duty and the contractual obligation of good faith and fair dealing are close cousins, both imposing loyalty obligations of varying intensity to combat opportunism; (2) the critical resource theory affirms the capacity of parties in a fiduciary relationship to contract out of fiduciary duties; and (3) the critical resource theory explains why restitution is the usual remedy for a breach of fiduciary duty

The Shareholder Primacy Norm

Corporate directors have a fiduciary duty to make decisions in the best interests of the shareholders. This aspect of fiduciary duty is often called the shareholder primacy norm. Legal scholars generally assume that the shareholder primacy norm is a major factor considered by boards of directors of publicly traded corporations in making ordinary business decisions and that changing the shareholder primacy norm would have an effect on the substance of those decisions. This Article challenges this view and argues that the shareholder primacy norm was never equipped to mediate conflicts between shareholders and nonshareholder constituencies of a corporation. The origins and development of the shareholder primacy norm suggest that it was introduced into corporate law to perform a much different and somewhat surprising function: the shareholder primacy norm was first used by courts to resolve disputes among majority and minority shareholders, and over time this use of the shareholder primacy norm evolved into the modern doctrine of minority oppression. This application of the shareholder primacy norm seems incongruous today because minority oppression cases involve conflicts among shareholders, not conflicts between shareholders and nonshareholders. Nevertheless, when early courts employed rules requiring directors to act in the interests of all shareholders (not just the majority shareholders), they were creating the shareholder primacy norm. Once used to resolve minority oppression cases, the shareholder primacy norm easily found its way into cases involving publicly traded corporations because courts did not routinely distinguish closely held corporations from publicly traded corporations until the middle of this century. But the application of the shareholder primacy norm to the ordinary business decisions of publicly traded corporations is muted by the business judgment rule. As a result, even though the shareholder primacy norm is closely associated with debates about the social responsibility of publicly traded corporations, it\u27s impact on the ordinary business decisions of such corporations is extremely limited

Independent Legal Significance, Good Faith, and the Interpretation of Venture Capital Contracts

Venture capital contracts are inherently incomplete. When interpreting such contracts, courts could deal with the expectations of parties formally by inquiring only about the plain meaning of the contract or qualitatively by enforcing the presumed expectations of the parties, regardless of whether those expectations are expressed in the contract. The Delaware courts have opted for a formal approach. In doing so, they appear to be engaged in an effort to force contracting parties toward completeness. While the duty of good faith appears to respond to the inevitable incompleteness of contracts, the courts largely ignore this duty in preferred stock cases. This omission, coupled with the doctrine of independent legal significance - which treats charter amendments via merger separately from charter amendments via board and stockholder approval - virtually ensures that preferred stockholders will be subject to opportunistic behavior by common stockholders. Whether courts should respond to claims of injustice in this context depends on comparative institutional analysis. Just because market contracting produces incomplete contracts does not mean that courts should be obligated to fill such contracts. On the other hand, this Article suggests that the application of the duty of good faith in this context might provide valuable incentives to renegotiate when unexpected circumstances arise

Team Production in Venture Capital Investing

Entrepreneurs and venture capitalists engage in team production. Inherent in team production is an incentive problem: team members have an incentive to shirk. The incentive to shirk derives from the inability to monitor team members perfectly and compensate them based on productivity. Economic models of team production teach that solutions to shirking must involve (1) a principal (2) with authority to break the budget by realigning the claims of team members through use of a penalty or a bonding arrangement (3) based only on observations of team output, not on monitoring of individual inputs. This paper analyzes the team production problem in venture capital investing using the rich set of facts provided by the book Startup: A Silicon Valley Adventure, which recounts how entrepreneur Jerry Kaplan and his venture capitalists at Kleiner Perkins Caufield & Byers, the most prominent venture capital firm in Silicon Valley, formed and operated GO Corporation. The paper argues that entrepreneurs and venture capitalists address the team production problem through staged financing, the practice of investing only enough money to allow the entrepreneur to progress to the next milestone in its business plan. Under the traditional view, the possibility of abandonment by the venture capitalist is the key virtue of staged financing. This insight is important but incomplete because it fails to accord full credit to the power of staged financing to provide incentives to both the entrepreneur and the venture capitalist. From the entrepreneur\u27s perspective, the prospect of abandonment is not the only danger in staged financing, and it may not even be the most important. Another danger is that successive rounds of financing may substantially dilute the entrepreneur\u27s interest in the company. This threat of dilution provides the entrepreneur with incentives to be diligent, thus effectively addressing the team production problem. Unlike the entrepreneur, the venture capitalist is not susceptible to dilution because the venture capitalist has a fixed claim, enforced by the right of first refusal in all additional financings. Nevertheless, the venture capitalist has incentives to maximize valuation at each stage of the financing process. Those incentives derive primarily from the reputational effects of high valuations

The Dystopian Potential of Corporate Law

The community of corporate law scholars in the United States is fragmented. One group, heavily influenced by economic analysis of corporations, is exploring the merits of increasing shareholder power vis-a-vis directors. Another group, animated by concern for social justice, is challenging the traditional, shareholder-centric view of corporate law, arguing instead for a model of stakeholder governance. The current disagreement within corporate law is as fundamental as in any area of law, and the debate is more heated than at any time since the New Deal. This paper is part of a debate on the audacious question, Can Corporate Law Save the World? In the first part of the debate, Professor Kent Greenfield builds on his book, THE FAILURE OF CORPORATE LAW: FUNDAMENTAL FLAWS AND PROGRESSIVE POSSIBILITIES, offering a provocative critique of the status quo and arguing that corporate law matters to issues like the environment, human rights, and the labor question. In response, Professor Smith contends that corporate law does not matter in the way Professor Greenfield claims. Corporate law is the set of rules that defines the decision making structure of corporations, and reformers like Professor Greenfield have only two options for changing corporate decision making: changing the decision maker or changing the decision rule. More specifically, he focuses on board composition and shareholder primacy. Professor Smith argues that changes in corporate law cannot eradicate poverty or materially change existing distributions of wealth, except by impairing the creation of wealth. Changes in corporate law will not clean the environment. And changes in corporate law will not solve the labor question. Indeed, the only changes in corporate law that will have a substantial effect on such issues are changes that make the world worse, not better

Venture Capital Contracting in the Information Age

Most venture capitalists provide services to their portfolio companies beyond capital investment. Although these services form an important part of the bargain between the venture capitalists and the entrepreneur, they are rarely specified or even capable of specification in venture capital contracts. This article examines the moral hazard and adverse selection problems facing entrepreneurs who hire venture capitalists to provide value-added services and describes the role of the market for venture capitalist reputation in addressing those problems. Further, the Article speculates about whether advances in information technology - specifically, the World Wide Web - are likely to improve the efficiency of the market for venture capitalist reputation

The Dystopian Potential of Corporate Law

The community of corporate law scholars in the United States is fragmented. One group, heavily influenced by economic analysis of corporations, is exploring the merits of increasing shareholder power vis-a-vis directors. Another group, animated by concern for social justice, is challenging the traditional, shareholder-centric view of corporate law, arguing instead for a model of stakeholder governance. The current disagreement within corporate law is as fundamental as in any area of law, and the debate is more heated than at any time since the New Deal. This paper is part of a debate on the audacious question, Can Corporate Law Save the World? In the first part of the debate, Professor Kent Greenfield builds on his book, THE FAILURE OF CORPORATE LAW: FUNDAMENTAL FLAWS AND PROGRESSIVE POSSIBILITIES, offering a provocative critique of the status quo and arguing that corporate law matters to issues like the environment, human rights, and the labor question. In response, Professor Smith contends that corporate law does not matter in the way Professor Greenfield claims. Corporate law is the set of rules that defines the decision making structure of corporations, and reformers like Professor Greenfield have only two options for changing corporate decision making: changing the decision maker or changing the decision rule. More specifically, he focuses on board composition and shareholder primacy. Professor Smith argues that changes in corporate law cannot eradicate poverty or materially change existing distributions of wealth, except by impairing the creation of wealth. Changes in corporate law will not clean the environment. And changes in corporate law will not solve the labor question. Indeed, the only changes in corporate law that will have a substantial effect on such issues are changes that make the world worse, not better

Family Law and Entrepreneurial Action

In The Contractual Foundation of Family-Business Law, Benjamin Means aspires to lay the groundwork for a law of family businesses. In this brief response essay, I suggest that a workable family-business law along the lines suggested by Means is consistent with an overarching policy in the United States of promoting entrepreneurial action, and I evaluate the proposal against this policy goal, with particular attention to Means’s arguments in favor of “family-business defaults” and his concern over the potentially disruptive role of fiduciary law