Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Sunday, January 27, 2008

Brown & Gopalan on Del. 102(b)(7) Waiver of Liability Provisions

Opting Only in: Contractarians, Waiver of Liability Provisions, and the Race to the Bottom, by J. ROBERT BROWN Jr., University of Denver Sturm College of Law, and SANDEEP GOPALAN, Arizona State University - College of Law, was recently posted on SSRN.  Here is the abstract:

Corporate law scholarship is replete with those who favor an enabling approach to regulation, with companies having the right to opt in to particular requirements or regimes. Opting in (or out) permits private ordering and allows for efficient relationships that are a product of bargaining between owners and managers.

This paper tests the core claim of scholars in the nexus of contracts tradition - that private ordering as a process of bargaining creates optimal rules. We do this by analyzing empirical evidence in the context of waiver of liability provisions. The article examines the history of these provisions, emphasizing that they arose in Delaware not from an effort to overturn Van Gorkom but from a decision to intervene in the market for D&O insurance. In other words, their genesis was owed to a desire to interfere with market forces with respect to insurance.

The Delaware model allowed companies to opt in to a regime that eliminated monetary damages for breach of the duty of care through amendments to the articles of incorporation. The contractarian approach would suggest that shareholders and management would use this authority to negotiate agreements that are in their mutual best interests. If a process of bargaining is at work as they claim, the opt-in process ought to result in a variety of practices, with some companies adopting waiver of liability provisions, others not, while still others modify the provisions to only waive liability in particular circumstances. These provisions, therefore, represent a laboratory for determining whether, and the degree to which, bargaining to achieve more efficient private arrangements actually occurs.

Our analysis reveals that the diversity predicted by a private ordering model is not borne out by the evidence. Instead, the evidence shows that one categorical rule (liability for breach of the duty of care) was merely replaced by another (no liability for a breach of the duty of care), with no evidence that the change increased efficiency. The article demonstrates that bargaining does not take place as the contractarian thesis would predict and that the so called private ordering does not necessarily result in greater efficiency

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