CONTENTS INTRODUCTION I. EARLY (MORE MANDATORY) CORPORATE LAW AND THE PRIVATE ORDERING WAVE OF THE NINETEENTH CENTURY II. THE DRAMATIC SHIFT TO MORE CONTRACTING OUT IN CONTEMPORARY CORPORATE LAW A. Closely Held Firms B. Publicly Held Firms 1. Contracting Out of Fiduciary Duty a. Duty of Care b. Contracting Out of Business Opportunity 2. Contracting Out of Voting and Other Statutory Governance Provisions a. Dual-Class Voting b. Appraisal C. Startups Transitioning to Publicly Held Status III. MAPPING THE MODERN SPACE FOR PRIVATE ORDERING AND CONTRACTING OUT IN CORPORATIONS A. Macro Influences on the Shift in the Societal View to More Private Ordering and Contracting Out B. Factors Affecting Contracting Out in Modern Corporate Cases 1. Customization of Governance Rules to the Needs of a Specific Business 2. Risk of Externalization 3. Limits on the Parties' Capacity in Publicly Held Companies to Sufficiently Address Agency Costs 4. Technology and Market Innovations that Change the Relative Capacity of Key Governance Players C. The Mandatory Rules that Can Be Expected to Remain 1. Core Fiduciary Duties Negating a "Purely Contractual" Law 2. Greater Oversight of Cleansing 3. Limitations on Contracting Arising from Contractual Interpretation CONCLUSION
INTRODUCTION
Private ordering and contracting out seem to be in the midst of a golden age in American entity law. Among closely held entities, Limited Liability Companies (LLCs) have swept the space. LLC statutes and case law proclaim the central policy "to give the maximum effect to ... freedom of contract." (1) Close corporation law in most states goes as far, with late twentieth-century statutory authorizations that permit contracts to provide almost any governance rule the parties desire. (2) For publicly held corporations, the exculpation for director statutes enacted after Smith v. Van Gorkom (3) have been broadened to permit governing provisions that exculpate officers as well. (4) Other recent statutes provide authorization for contracting to relax rules on taking a corporate opportunity and to waive appraisal. (5) A third recent growth area for contracting around traditional rules has appeared in the space for startup entities, where firms, often funded by venture capital, have pushed the envelope for contracting to change rules about voting and control when the firms are private but carry these contracted rules forward in a way that further rearranges the publicly held space. (6)
Does this mean the end of mandatory law or the end of the law's limits on contracting out? Not exactly. Even with these three areas of clearly visible changes, mandatory rules remain a key part of corporate law. Common law claims based on fiduciary duties and the statutory claim for oppression, for example, remain available for closely held entities. (7) The efforts to contract around fiduciary duties in public corporations remain bounded and courts remain vigilant in policing questionable contracting. (8) The extent to which startups are able to take their contracting rules into public markets is still developing. (9) Yet, these changes necessitate updating our template as to the reach of private ordering in our business entities and the limits that remain in the various contexts.
This Article proceeds as follows: Part I provides a brief historical examination of the origins of mandatory corporate law and an initial dramatic move away from that paradigm at the end of the nineteenth century. Part II examines modern changes in private ordering and contracting out in the three areas--closely held entities, publicly held corporations, and startups backed by venture capital with contracting terms that carry forward with the entity when it goes public. Part III probes in more detail the reasons that have propelled greater acceptance of contracting away from mandatory legal rules, such as fiduciary duties or centralized control, and examines the limits that continue to be applied in each space.
The justifications for mandatory rules vary in the different contexts with distrust of contract in these settings for a variety of reasons. For example, participants in closely held entities regularly can't or don't protect themselves against legal rules of centralized control or majority rule that may open them up to harm by co-venturers who control the business. It may be too costly to bargain, or they feel unable to bargain effectively without breaking the trust necessary for the business to survive, or they may lack sufficient knowledge about what could happen. Shareholders in publicly held entities may own too small a stake or be unable to effectively coordinate against managers or controlling shareholders. Markets or intermediary funds that hold most shares in American public companies (usually for beneficiaries in company-sponsored and tax-favored retirement plans) may not be attuned to particular issues. Startups may include some sophisticated investors, but the business may move too fast such that the bargaining failed to address various important issues that can become relevant when the company's shares become more widely held.
I. EARLY (MORE MANDATORY) CORPORATE LAW AND THE PRIVATE ORDERING WAVE OF THE NINETEENTH CENTURY
The central reason for forming corporations has always been to gain legal recognition of the entity as separate from the individuals behind it in order to use one or many of the characteristics that follow from separateness. Initially, separateness could achieve something as simple as cross-generational conveyancing and contracting as to property. (10) Early illustrations can be found in religious uses of corporations so that property remained for the charitable use of monasteries or bishoprics beyond the lives of the original actors and was not transferred to the heirs of a particular person. (11) Other early uses of separate entities provided autonomy for groups to determine rules within a profession (e.g., guilds) (12) or a geographic space (e.g., several of the American colonies were established and governed by chartered entities). (13)
The sovereign's right to create (or not create) corporations established a set of mandatory rules and boundaries that limited the space for private action and contracting. (14) A corporation's duration and its purpose were typically defined by the charter that was granted. (15) Whatever autonomy there was came from the sovereign and then from the American states that succeeded to the monarch's sovereignty after the American Revolution. (16) Early American governments "significantly restricted associations' access to the benefits that came from being legal entities or legal persons," preferring politically neutral entities and disadvantaging organizations viewed as "socially or politically disruptive." (17)
Across the nineteenth century and in the wake of the Industrial Revolution, the American states repeatedly modified their laws to endow their corporations with new characteristics helpful to owning a business--e.g., limited liability, (18) a governance hierarchy establishing centralized control (in a board of directors) and majority rule, (19) perpetual duration, (20) and a lock-in of investor funds. (21) In what, in retrospect, can be identified as a major shift to private ordering and contracting out in American corporate law, the states moved to "general incorporation statutes" that essentially removed state power over the incorporation choice, putting it in the hands of private actors. (22) This was most starkly visible in a series of state enactments of enabling statues in the 1890s and thereafter, first by New Jersey and followed by the other states, with Delaware soon becoming the recognized pacesetter, a role it continues to hold today. (23)
Even with the broad flexibility given to private parties under these enabling statutes, this first contracting-out movement to some extent simply masked a shift of the regulatory impulses from the state to the federal government. There were a host of new federal statutes regulating significant corporate behavior in, for example, antitrust, (24) safety and employee protection statutes, (25) and prohibition of corporate political contributions. (26) Further, state corporate law itself retained significant spaces of mandatory rules for which contracting out did not seem possible, for example, fiduciary duty and limits on mergers and other fundamental changes. (27)
Even for areas like voting and control, in corporation statutes, there was what was sometimes referred to as a "statutory norm"--specifying centralized control in the board and actions by majorities that could not be changed. (28) The corporation statutes did provide that the certificate could limit or restrict the power of the board or majorities via clauses added to the certificate, a method which insured this flexibility and, in the words of a leading twentieth-century Delaware-law commentator S. Samuel Arsht, "aided those promoters who were determined to assure to management the dominant position in the corporation." (29) Thus, the corporate form of the early twentieth century was perceived as imposing a statutory norm of immutability of governance by directors that led to courts' blocking shareholder agreements naming officers and their compensation or requiring the unanimous vote of shareholders for certain corporate acts normally done by directors. In McQuade v. Stoneham, (30) for example, the New York high court ruled that stockholders could not contract to place limits on "the power of directors ... to manage the business ... by the selection of defined agents at defined salaries." (31)
II. THE DRAMATIC SHIFT TO MORE CONTRACTING OUT IN CONTEMPORARY CORPORATE LAW
A reprise of this shift to private ordering and what can be termed as the modern law of contracting out illustrates parallel contemporary movements in three different forms of business associations described below. All three had...
