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Rethinking Corporate Opportunities: Part II

In the preceding post, we discussed the Delaware law governing corporate opportunities. In this post, I propose an alternative approach to these issues.

If the corporation is best described as the nexus of a set of relational contracts between various corporate constituencies, our analysis of corporate law appropriately is informed by the contract law principles applicable to relational contracts. In a classic article on such contracts, Professors Robert Scott and Charles Goetz argued that relational contracts should be interpreted using a “joint maximization model.” Their model requires an agent to use best efforts on behalf of the principal. Best efforts does not require the agent to advance the principal’s interests at the agent’s expense (contra Cardozo). Instead, the agent must seek to maximize the joint interests of the agent and the principal. Using this insight, one can propose a four-step test for how corporate opportunity cases should be analyzed:

1. Was this venture an “opportunity”? Delaware law does not clearly bifurcate definitional issues from conduct issues. Bifurcating the two, however, would lead to greater clarity. A bright-line definition would enable the officer or director to more readily determine whether the venture is legally problematic. At the same time, however, a director or officer would not be liable merely for taking a venture that falls within the definition of a corporate opportunity. Instead, liability results only if the director usurped—wrongfully took—the opportunity.


2. Did the officer or director disclose the opportunity to the corporation? (a) If not, the director is liable for his failure to do so, with liability being measured by the traditional common law constructive trust rules. (b) If disclosure was made, go on to step 3.


3. Did the corporation accept or reject the offered opportunity? (a) If the corporation chose to accept the opportunity, the director may not personally exploit it. If he does so, a constructive trust can be imposed on his ill-gotten gains. (b) If the corporation rejected the opportunity, the director is free to personally exploit it, subject to the requirements of Step 4.


4. Does the manner in which the director or officer exploited the opportunity work to the detriment or to the benefit of the corporation? (a) If the opportunity works to the firm’s detriment, then the director or officer may be liable for damages for breach of the agency law duty not to compete with the firm. (b) If the opportunity benefits the corporation, no liability.

This disclosure and consent rule has a number of advantages. First, it encourages competition and discourages costly opportunism within the firm. If directors were able to freely compete with the firm their would be a strong incentive to pursue their self-interest at the expense of the firm—perhaps even to sabotage the firm as Guth did. In other words, this proposal treats the problem as one of allocating property rights to information generated by agents of a corporation. Corporate agents generate lots of information. It is hard sometimes to figure out whether the information belongs to the corporation. Consequently, a prophylactic rule of disclosure seems appropriate. It removes the incentive for agents to divert potential opportunities to their own use.

Second, disclosure may encourage joint maximization. Presumably, firms will consent to the director or officer exploiting the opportunity when it is in both parties interest. To be sure, the rule arguably requires too much disclosure, especially if we embrace a broad definition of corporate opportunity. One might, for example, require an officer or director to disclose all outside profit-making ventures in which the officer or director has an interest, including indirect interests such as being an officer, director or large shareholder of an entity exploiting the opportunity. On balance, however, the benefits of a disclosure based approach likely outweigh the costs of repetitive disclosure.

Arguably the disclosure and consent test does a better job than do the courts’ stated rationales at explaining and justifying results in Guth and Broz. What really bothered the court in Guth, probably, was the fact that Guth did not offer Loft a right of first refusal to buy Pepsi, but instead went behind Loft’s back to purchase Pepsi for himself. In contrast, in Broz the director fully disclosing the opportunity to the firm and gave it a fair opportunity to compete.

© Stephen M. Bainbridge, William D. Warren Professor of Law, UCLA School of Law, 2007