financial articulation of a fiduciary duty to bondholders

THE FINANCIAL ARTICULATION OF AFIDUCIARY DUTY TO BONDHOLDERS

WITH FIDUCIARY DUTIES TOSTOCKHOLDERS OF THE

CORPORATIONt

ALBERT H. BARKEYtt

I. INTRODUCTION ....................................... 48

II. THE CORPORATE-FINANCE FRAMEWORK ........ 49A. CORPORATE CURRENT-MARKET-VALUE

MAXIMIZATION ...................................... 49B. THE BLACK-SCHOLES CONCEPTION OF THE

CORPORATION ....................................... 51C. UNANTICIPATED WEALTH EXPROPRIATIONS ......... 52D. EFFICIENT MARKET PORTFOLIOS .................... 55

III. STOCKHOLDER WEALTH EXPROPRIATIONSFROM BONDHOLDERS ............................... 56A. THE EXPROPRIATION TENDENCY .................... 56B. THE BONDHOLDER-WEINBERGER HYPOTHETICAL ..... 58

1. Factual Aspects of Weinberger .................. 582. Dicta Aspects of Weinberger .................... 603. The Bondholder-Weinberger Hypothetical:

Facts ............................................. 61

IV. A FIDUCIARY LAW SOLUTION ...................... 64A. THE BONDHOLDER-WEINBERGER HYPOTHETICAL:

A RGUMENTS ......................................... 641. Debtor Speaks ................................ 642. Appraisal Creditors Speak ................... 673. Contractual Creditors Speak ................. 67

B. W HAT IS FAIR? ...................................... 72V. THE NEW FIDUCIARY ARTICULATION ............. 74

A. GLOBAL WEALTH MAXIMIZATION .................... 74B. PROCEDURAL FAIRNESS .............................. 78

1. Additional Factual Aspects of Weinberger... 78

t Copyright 1986 by Albert H. Barkey.tt Member, New York bar; private practice, Bronx, N.Y.; B.A., 1970, New York

University; M.B.A., 1972, New York University; M.P.A., 1979, Mt. Sinai School ofMedicine, Baruch College; J.D., 1980, New York Law School; A.P.C., 1981, New YorkUniversity; Diploma, 1983, United States Army Command and General Staff OfficerCourse; LL.M., 1984, New York University.

CREIGHTON LAW REVIEW

2. Additional Dicta Aspects of Weinberger ..... 803. The Procedural-Fairness Structure ........... 81

VI. CONCLUSION .......................................... 83

I. INTRODUCTION

The premise of this Article is that there should be coherence be-tween the theoretical structures of corporate finance and corporatefiduciary law.' Because corporate finance is grounded in science, andbecause corporate fiduciary law is grounded in public policy, this Ar-ticle views corporate fiduciary law as a corrective of corporate-finan-cial anomalies. Under this view, the identification of a corporate-financial anomaly points to the superimposition of corporate fiduci-ary law on that anomaly.

A central dogma of corporate practice views the for-profit corpo-ration as properly seeking to maximize the value of its stock withoutdirect regard for the value of other classes of its securities.2 Thisdogma operates through three assumptions: (1) that a managerial fi-duciary duty to stockholders does not also imply corresponding dutiesto the corporation's other classes of securityholders, 3 (2) that equita-ble ownership of the corporation's assets by stockholders does notalso imply corresponding ownerships by the corporation's otherclasses of securityholders, 4 and (3) that maximizing the value of thecorporation's stock is equivalent to maximizing the value of the cor-poration's assets.5

This Article challenges this central dogma and its operational as-sumptions on grounds of incongruity with and derivative unfairnessunder the established theoretical structure of corporate finance.

1. This Article develops the corporate law implications of the Black-Scholes op-tion-pricing framework. See generally A. Barkey, The Black-Scholes RedistributionArgument in the Statutory-Fiduciary Context of Weinberger v. UOP, Inc. (Dec. 21,1983) (limited distribution manuscript) (available from the New York UniversitySchool of Law).

2. See Brudney, Equal Treatment of Shareholders in Corporate Distributionsand Reorganizations, 71 CALIF. L. REV. 1072, 1089 n.42 (1983); Easterbrook & Fischel,The Proper Role of a Target's Management in Responding to a Tender Offer, 94 HARV.L. REV. 1161, 1191 (1981); Prokesch, Merger Wave: How Stock and Bonds Fare, N.Y.Times, Jan. 7, 1986, at 1, col. 1; Norris, Not the Preferred Treatment, BARRON'S, June17, 1985, at 45, col. 1.

3. See Broad v. Rockwell Int'l Corp., 642 F.2d 929, 958-59 (5th Cir.), cert. denied,454 U.S. 965 (1981); Norte & Co. v. Manor Healthcare Corp., Nos. 6827, 6831, at 6-7(Del. Ch. Nov. 21, 1985) (available on LEXIS, States library, Del file).

4. See Norte & Co., at 6. Gibson & Campbell, Fundamental Law for Takeovers,39 Bus. LAW. 1551, 1551 (1984).

5. See Easterbrook & Fischel, supra note 2, at 1190-91; Fischel, The BusinessJudgment Rule and the Trans Union Case, 40 Bus. LAW. 1437, 1442-43 (1985); Warden,The Boardroom as a War Room: The Real World Applications of the Duty of Care andthe Duty of Loyalty, 40 BUs. LAW. 1431, 1431 (1985).

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1986] FIDUCIARY DUTY TO BONDHOLDERS

Also, this Article sketches a new line of development for corporatelaw based upon a new fiduciary articulation which reconciles the cor-porate conflict of interest between "bondholders" and stockholders.Because of the national influence of Delaware's law of corporations 7

and because of the elegance of the generalized fact pattern in Wein-berger v. UOP, Inc. ,8 this Article employs aspects of Weinberger in anillustrative discussion of the new fiduciary articulation.

II. THE CORPORATE-FINANCE FRAMEWORK

A. CORPORATE CURRENT-MARKET-VALUE MAXIMIZATION

An operating decision "efficiently" uses corporate assets when itmaximizes their present value;9 an operating decision "wastes" corpo-rate assets when it reduces their present value.' 0 Corporate "financ-ing decisions" are decisions regarding methods of providing capital tothe corporation." Corporate debt is "risky" when there is a chancethat the corporation might not be able to make full payments on allits debt promises.12 A "side payment" is a transfer of wealth be-tween classes of the corporation's securityholders.13

A central problem for the corporation is that there is, in general,no way of directly constructing managerial objectives from the di-verse preferences of the corporation's securityholders. 14 This

6. The term "bond" is used herein for all debt securities. See AM. BAR FOUND.,COMMENTARIES ON INDENTURES 7 n.3, 8 (1971). For a discussion of the "investmentcontract" definition of a security, see Schneider, The Elusive Definition of a Security,14 REV. SEC. REG. 981 (1981) (discussing the definition of security under the federalsecurities laws). For a discussion of investor interest in bonds, see Ehrlich, The Smor-gasbord of Bonds: Something For Almost Every Palate, Bus. WK., -, 122 (Dec. 30,1985). The distinction between debt and equity is irrelevant to the conflict of classes ofsecurityholders having nested claims on the corporation's assets and cash flow. Theterm "stocks" is used herein as a parallel to the term "bonds," and means "shares ofstock" or "stock."

7. See Black, Jr., A National Law of Takeovers Evolves in Delaware, LegalTimes, Nov. 25, 1985, at 6, col. 1.

8. 457 A.2d 701, 704-08 (Del. 1983).9. In other words, the decision selects the use with the largest present value of

its expected value. See E. FAMA & M. MILLER, THE THEORY OF FINANCE 180 (1972).The expected (mean) value is the sum over all outcomes of each outcome times thechance of that outcome occurring. See id.

10. In other words, the decision selects a use with a present value of its expectedvalue which is less than the present value of the assets. See Stiglitz, Some Aspects ofthe Pure Theory of Corporate Finance: Bankruptcies and Take-Overs, 3 BELL J. ECON.& MGMT. SCI. 458, 460-62 (1972).

11. See E. FAMA & M. MILLER, supra note 9, at 109, 150-57.12. Id. at 152 n.5, 179.13. See id. at 179-80. A "side payment" is a payment made on the side.14. Id. at 67-68 (discussing Arrow's proposition stated in K. ARROW, SOCIAL

CHOICE AND INDIVIDUAL VALUES 48-59 (2d ed. 1963)). See generally J. KELLY, ARROWIMPOSSIBILITY THEOREMS (1978).


problem is solved, in general, by a rule of corporate current-market-value maximization15 which states that "given perfect capital mar-kets, optimal operating decisions for a firm at any point in time in-volve maximizing the market value of those securities outstandingbefore the operating decision is made.' 6 If the corporation complieswith this rule and efficiently uses corporate assets, then all of thecorporation's securityholders agree on the corporation's operating de-cisions and are indifferent about the corporation's financing deci-sions.17 Therefore, this rule is a ground for independent professionaldecision-making by corporate officers and directors. 18

An anomaly in this rule occurs when there exists risky debtwithout side payments because of the possibility that an operatingdecision which efficiently uses corporate assets to maximize the cur-rent market value of the corporation might not also maximize theseparate current market values of the corporation's bonds andstocks.19 The significance of this anomaly depends on the facts ofeach case. 20 The manifestation of this anomaly through a corporatepolicy of inefficient use of corporate assets is rectified by the capitalmarket: capital market anticipation of such a policy is reflected inthe market values of the corporation's securities, and such a policymakes a corporate takeover profitable under a takeover policy of effi-cient use of corporate assets.2 1

When maximizing the current market value of the corporationdoes not also maximize the current market value of its stocks, thenthe current market value of the corporation's stocks can be maxi-mized by: (1) inefficiently using corporate assets, or (2) efficientlyusing corporate assets with a bondholder-to-stockholder side pay-ment.22 If there is a significant chance of corporate bankruptcy, thenthese means respectively transform into: (1) wasting corporate as-sets, or (2) preserving corporate assets with a bondholder-to-stock-holder side payment.23

15. E. FAMA & M. MILLER, supra note 9, at 69-73. For a discussion of unanimitytheorems, see De Angelo, Competition and Unanimity, 71 AM. ECON. REV. 18, -

(1981).16. E. FAMA & M. MILLER, supra note 9, at 176. For a discussion of perfect capital

markets, see id. at 3-41, 176-78.17. Id. at 69, 145, 176.18. See id. at 69, 74-75.19. Id. at 71, n.4, 178-80.20. Jensen & Meckling, Theory of the Firm: Managerial Behavior, Agency Costs,

and Ownership Structure, 3 J. FIN. ECON. 305, 337 n.43 (1976). See W. KLEIN, BUSINESSORGANIZATION AND FINANCE 190 (1980).

21. Fama, The Effects of a Firm's Investment and Financing Decisions on theWelfare of its Security Holders, 68 AM. ECON. REV. 272, 282-84 (1978).

22. See E. FAMA & M. MILLER, supra note 9, at 180.23. See Stiglitz, supra note 10, at 460-62.

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FIDUCIARY DUTY TO BONDHOLDERS

B. THE BLACK-SCHOLES CONCEPTION OF THE CORPORATION

An "option" is "[a] contract giving its holder the right to buy orsell... [something] at a predetermined price and predetermined timeperiod. ' 2 4 A "call option" is an option to buy.25 A "compound op-

tion" is "an option on an option. ' 2 6 "Synergy" means that the total

effect of a combination is greater than the sum of the individual ef-

fects of the components of that combination before that combinationoccurred. A "nonsynergistic merger" is a merger without corporatemarket value synergy: the market value of the combined corporationequals the sum of the premerger market values of the corporationsmerging. 27 An "efficient capital market" is a capital market in which"any new information reaching the market concerning asset values is

immediately impounded into security prices.128 The "debt capacity"of a corporation is the profile of the maximum market value of bonds

that the corporation can have outstanding in the capital market for arange of interest rates.

2 9

Aristotle said that "the house is there that men may live in it,

but it is also there because the builders have laid one stone upon an-other. ' 30 The Black-Scholes option-pricing framework is an example

of such a duality because it scientifically describes both option prices

and the bondholder-stockholder corporate-financial mechanism. 31

This framework is based on postulates regarding the capital

24. Dow JONES & CO., INC., THE ABC's OF OPTION TRADING 30 (1981).25. Id. at 29.26. K. Shastri, Valuing Corporate Securities: Some Effects of Mergers by Ex-

change Offers 10 (University of Pittsburgh WP-517 Jan. 1982).27. See Galai & Masulis, The Option Pricing Model and the Risk Factor of Stock, 3

J. FIN. ECON. 53, 66 & n.38, 68 (1976).28. Id. at 72. See generally E. FAMA, FOUNDATIONS OF FINANCE 133-68 (1976) (dis-

cussing four models of efficient capital market equilibrium).29. See Stapleton, Mergers, Debt Capacity, and the Valuation of Corporate Loans,

in MERGERS AND ACQUISITIONS 9, 9-10, 14 (1982) (discussing the Black-Scholes optionpricing framework).

30. D. THOMPSON, ON GROWTH AND FORM 6 (1942) (providing a statement of theparable).

31. See Smith, Jr., Option Pricing: A Review, 3 J. FIN. ECON. 3, 4 (1976). TheBlack-Scholes option pricing model is the limiting case of the binomial option pricingformula. Cox, Ross & Rubinstein, Option Pricing: A Simplified Approach, 7 J. FIN.ECON. 229, 250-54 (1979). The model "seeks to price the securities whose values arecontingent upon the value of the underlying asset." Hsia, Coherence of the ModernTheories of Finance, 1981 FIN. REV. 27, 36. The model values a call option when itsunderlying asset does not make asset distributions before the call's maturity. Smith,Jr., supra, at 4-5, 25 (discussing European and nondividend-paying American calls). Acombination model values a call option when its underlying asset makes known futureasset distributions before the call's maturity. Roll, An Analytic Valuation Formulafor Unprotected American Call Options on Stocks with Known Dividends, 5 J. FIN.ECON. 251, - (1977). A compound model values a call option on a call option. SeeGeske, The Valuation of Corporate Liabilities as Compound Options, 12 J. FIN. &QUAN. ANAL. 541, - (1977).

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market,32 and its usefulness cannot be evaluated independently ofthe capital market efficiency on which it is grounded.33

In the Black-Scholes scientific conception of the corporation, thestockholders own a call option, with operational control, on the bond-holders' ownership of the corporate assets and cash flow. 34 Underthis view, there is a dynamic mathematical "distribution of ownershipbetween the stockholders and bondholders. '35 The corporation'sstock is a compound option when the corporation issues finite-matur-ity risky coupon bonds;3 6 the stock of the combined corporation in anonsynergistic merger is a compound option.37 Also, in general, cor-porate debt capacity is synergistic in nonsynergistic mergers.38

C. UNANTICIPATED WEALTH EXPROPRIATIONS

In general: "Bond protective contractual provisions" seek to fixexisting corporate conditions (under which original bond purchaseprices and bond interest rates are fixed) in order to restrict possiblecorporate acts which might adversely affect the value of their bonds,and they seek to force a preferred remedy (such as bond buyback,bond renegotiation, or corporate bankruptcy)when the value of theirbonds significantly deteriorates. 39 The contract (termed on "inden-ture") containing these provisions (termed "covenants") is negotiatedbetween the corporation representing the stockholders who control itand a separate corporation (termed a "trustee") representing thebondholders. 40 "Bond pricing" is the coordinate determination

32. Galai & Masulis, supra note 27, at 54-55. "Subsequent modification of the ba-sic Black-Scholes model ... shows that the analysis is quite robust with respect to re-laxation of the basic assumptions under which the model is derived. No singleassumption seems crucial to the analysis." Smith, Jr., supra note 31, at 4.

33. See Bhattacharya, Empirical Properties of the Black-Scholes Formula UnderIdeal Conditions, 15 J. FIN. & QUAN. ANAL. 1081, 1081, 1095 (1980).

34. Black & Scholes, The Pricing of Options and Corporate Liabilities, 81 J. POL.ECON. 637, 649-52 (1973); Stapleton, supra note 29, at 9.

35. Smith, Jr., supra note 31, at 43.36. Geske, supra note 31, at 542 (stating: "At every coupon date, until the final

payments, the stockholders have the option of buying the next coupon or forfeiting thefirm to the bondholders.").

37. K. Shastri, supra note 26, at 10. "The valuation equations ... collapse to theBlack-Scholes equation in three special cases." Id. at 14.

38. In other words, the debt capacity of the combined corporation in a nonsyner-gistic merger is generally greater than the sum of the premerger debt capacities of thecorporations merging. Stapleton, supra note 29, at 15, 18, 24-25.

39. See Black & Cox, Valuing Corporate Securities: Some Effects of Bond Inden-ture Provisions, 31 J. FIN. 351, 355-57 (1976); Brody, Controversial Issue, BARRON's,Sept. 19, 1983, at 15, 19, col. 1; Jensen & Meckling, supra note 20, at 337-38; Smith, Jr.& Warner, On Financial Contracting: An Analysis of Bond Covenants, 7 J. FIN. ECON.117, 119, 153 (1979).

40. See AMER. BAR FOUND., supra note 6; AM. BAR ASS'N COMM. ON DEV. IN BUSI-NESS FINANCING, SECTION OF CORP., BANKING AND Bus. L., Model Simplified Inden-

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regarding a bond's purchase, interest, and redemption payments."States of nature" are eventualities or possible future outcomes. "Va-riance" is a measure of dispersion around the expected (mean) valueof outcomes.

41

The anomaly in the rule of corporate current-market-value max-imization-generalized to conditions wherein the current marketvalue of the corporation increases, remains the same, or decreases-isthe basis of the bondholder-stockholder corporate conflict of inter-est.42 Bond protective contractual provisions are a signal (indicator)to the capital market that the stockholder-controlled corporation willconform to the rule of corporate current-market-value maximizationand efficiently use corporate assets. In general, this signal is re-flected in the market values of the corporation's securities.43

When the original bondholders lend money to a firm, theytake cognizance not only of the returns in the differentstates of nature of the firm under its present managementbut also of the chance of a take-over bid, a new managementwhich would make an alternative set of decisions. Theymust take into account all the possible take-over bids, andthe resulting dispersion in the possible returns from the firmmay be very large indeed.4 4

Thus, ex ante contractual specificities in bond pricing might be expost imperfect-even if they are ex ante perfect-because of unantic-ipated changes in facts, possibilities, and probabilities affecting thevalue of the bonds.45 Bondholder-stockholder side payments whichare caused by such contractually unanticipated changes are

ture, 38 Bus. LAW. 741, 751, 758-62 (1983); Smith, Case & Morison, The Trust IndentureAct of 1939 Needs No Conflict of Interest Revision, 35 Bus. LAW. 161, 163-66 (1979);Stark, The Trust Indenture Act of 1939 in the Proposed Federal Securities Code, 32VAND. L. REV. 527, 530, 537 (1979); Note, The Trust Indenture Act of 1939: The Corpo-rate Trustee As Creditor, 24 UCLA L. REV. 131, 131 & n.3 (1976).

41. M. SPIEGEL, PROBABILITY AND STATISTIcs 78 (1975).42. See E. FAMA & M. MILLER, supra note 9, at 152 n.5, 179-80; Galai & Masulis,

supra note 27, at 62-71; Stiglitz, supra note 10, at 460-62.43. Scott, Jr., On The Theory Of Conglomerate Mergers, 32 J. FIN. 1235, 1241

(1977). See Fama, supra note 21, at 283-84; Gilson & Kraakman, The Mechanisms ofMarket Efficiency, 70 VA. L. REV. 549, 613-14 (1984). Cf. Stiglitz, supra note 10, at 461n.l1 (stating that "a firm which must have continual recourse to the capital marketmust continue to worry about returns in all states [of nature]").

44. Stiglitz, supra note 10, at 473.45. See id.; Farrell, Takeovers and Buyouts Clobber Blue-Chip Bondholders, Bus.

WK. 113, 114 (Nov. 11, 1985) (statement of Mr. Harold H. Goldberg, Senior Vice-Presi-dent, Moody's Investors Service, Inc.) (stating: "There's no way to anticipate a [bond-rating] downgrade from a possible future [corporate] restructuring while remainingfair to a company's current prospects."); (paraphrase of statement of Mr. Frederick H.Joseph, Vice-chairman and Chief Executive Officer, Drexel Burnham Lambert, Inc.)(stating that "there's no protective covenant that a good lawyer can't get around.").For a discussion of bond ratings, see O'Neill & Weinberger, Corporate Restructuringsand Bond Ratings, 17 MERG. & AcQ. 36, - (1982) (discussing the approach of Standard

1986]


"unanticipated wealth expropriations" because they are a conse-quence of the failure of contractual ordering to provide perfect pro-tection for bondholders' and/or stockholders' wealth. 46

Because the variables in the Black-Scholes option-pricing frame-work admit of changes which are not contractually anticipated bybond pricing in the capital market, "unanticipated changes in any ofthese variables can affect the market value of the stockholders' andbondholders' claims" evaluated under this framework.47 For exam-ple, the Black-Scholes option-pricing framework has shown that in anonsynergistic merger

between two firms containing only pure coupon bonds andequity in their capital structure, the possible wealth transfereffects are:

(i) from stockholders to short and long-termdebtholders

(ii) from stockholders and long-term debtholders toshort-term debtholders

(iii) from stockholders and short-term debtholders tolong-term debtholders

and (iv) from long-term debtholders to stockholders andshort-term debtholders.

The above wealth-expropriation effects . . . carrythrough even when the bonds receive coupon payments andwhen the variance of returns on the merged firm changes af-ter retirement of short-term debt.48

Bondholder-stockholder unanticipated wealth expropriations mightalso occur in corporate divestitures, issuances and retirements ofbonds and stocks, spin-offs, etc.49

Unanticipated wealth expropriations can be neutralized by sidepayments among the classes of securityholders involved in the expro-priations.5 0 Investors are economically unaffected by an unantici-pated wealth expropriation when they own equal proportions of theclasses of securities affected by that expropriation. 5 '

& Poor's Corp.); Willoughby, Uncertain Umpires, FORBES, -, 131 (June 16, 1986) (dis-cussing shaky bond ratings based on payment insurance).

46. See Galai & Masulis, supra note 27, at 55 n.5, 61-62, 68 n.43.47. Smith, Jr., supra note 31, at 45.48. K. Shastri, supra note 26, at 3.

49. Galai & Masulis, supra note 27, at 62-66, 69-71.50. Id. at 55 n.5, 62, 70; K. Shastri, supra note 26, at 55-56. See E. FAMA & M.

MILLER, supra note 9, at 71-72 n.4, 155 n.10, 179. These side payments include new un-anticipated wealth expropriations. See Galai & Masulis, supra note 27, at 69, 70, 78-79.

51. Galai & Masulis, supra note 27, at 62 & nn.27-28.

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D. EFFICIENT MARKET PORTFOLIOS

Risk (variance) has two components: diversifiable risk (which isrisk that can be eliminated by investment diversification) and covari-ance risk (which is the nondiversifiable residual risk).5 2 A "risk-averse" investor eschews specified risk (the variance of outcomes in

an investment) in favor of its economically equivalent certainty (the

expected value of the investment), whereas a "risk-liking" investor

seeks such risk as against such certainty. A "risk-neutral" investor isindifferent to such risk or to such certainty.53

The intertemporal capital-asset-pricing model54 can be developedfrom the addition of three postulates to those of the Black-Scholesoption-pricing framework:55 (1) all investors are risk-averse,5 6 (2) allinvestors have restricted mathematical forms of risk aversion and/or

all investments have restricted mathematical forms of returns5 7 and

(3) all investors simultaneously possess identical investment facts and

beliefs.5 8 In the intertemporal capital-asset-pricing model, all inves-tors agree on the price of instantaneous covariance risk5 9 and all in-

vestors own (in varying quantities) equal proportions of each

corporation's securities invested in. 6 0

"[O]ptimum portfolios for all investors" are combinations of a

52. See generally H. MARKOWITZ, PORTFOLIO SELECTION - (1959). "Covariancerisk" is the marginal change in portfolio risk caused by an asset.

53. E. FAMA & M. MILLER, supra note 9, at 200-03; Posner, The Rights of Creditorsof AJffiliated Corporations, 43 U. CHI. L. REv. 499, 502 nn.8-9 (1976). For a discussionregarding risk-oriented states of mind, see K. ARROW, ESSAYS IN THE THEORY OF RISK-BEARING 90-119 (1970); H. MARKOWITZ, supra note 52, at 205-73; Friedman & Savage,The Utility Analysis of Choices Involving Risk, 56 J. POL. ECON. 279, - (1948) (ex-pected utility maximization with a concave-convex von Neumann-Morgenstern utilityfunction); and Pratt, Risk Aversion in the Small and in the Large, 32 ECONOMETRICA122, - (1964).

54. The intertemporal capital-asset-pricing model is a special case of the arbitragetheory of capital asset pricing. See Ross, The Arbitrage Theory of Capital Asset Pric-ing, 13 J. ECON. THEORY 341, - (1976). Its usefulness cannot be evaluated indepen-dently of the capital market efficiency on which it is grounded. See Roll, A Critique ofthe Asset Pricing Theory's Tests, 4 J. FIN. ECON. 129, - (1977). See generally Merton,An Intertemporal Capital Asset Pricing Model, 41 ECONOMETRICA 867, - (1973).

55. See Galai & Masulis, supra note 27, at 54-55 & nn.4-6. See generally Hsia,supra note 31, at - (integrating the option-pricing model with the capital-asset-pricingmodel, the time-state preference model, and the Modigliani-Miller propositions).

56. Galai & Masulis, supra note 27, at 54.57. See Cass & Stiglitz, The Structure of Investor Preferences and Asset Returns,

and Separability in Portfolio Allocation: A Contribution to the Pure Theory of MutualFunds, 2 J. ECON. THEORY 122 (1970); Ross, Mutual Fund Separation in Financial The-ory - The Separating Distributions, 17 J. ECON. THEORY 254, (1978).

58. Galai & Masulis, supra note 27, at 54. See generally Stiglitz, supra note 10, at464 (stating: "It is the latter assumption that we find most objectionable.").

59. See Jensen, Capital Markets: Theory and Evidence, 3 BELL J. ECON. & MGMT.Sci. 357, 362-63, 394-95 (1972).

60. E. FAMA & M. MILLER, supra note 9, at 289.


riskless asset with an efficient market portfolio which "consists of allassets in the market, each entering the portfolio with weight equal tothe ratio of its total market value to the total market value of all as-sets."61 These combinations of a riskless asset and the efficient mar-ket portfolio vary in accordance with each investor's degree of riskaversion.62 Investors are indifferent to all wealth expropriationswithin the efficient market portfolio because all investors own equalproportions of all assets within the efficient market portfolio. 63

III. STOCKHOLDER WEALTH EXPROPRIATIONS FROMBONDHOLDERS

A. THE EXPROPRIATION TENDENCY

In the Black-Scholes conception of the corporation, the exerciseprice on the stockholders' call option regarding corporate assets andcash flow is the payment due the bondholders. 64 Assume that corpo-rate assets (including cash flow) have equal chances for values whichare equally greater than and less than their expected value.

In the case of two classes of corporate securities such as bondsand stocks, the Black-Scholes conception of the corporation might bethought of as stockholders owning the corporate form (call option onthe corporate substance) and bondholders owning the corporate sub-stance (assets and cash flow). The mechanism of this form-substancedistinction-and more generally of the nesting of ownerships of cor-porate assets and cash flow by classes of the corporation's securi-tyholders-involves an inherent corporate tendency for unanticipatedwealth expropriations from bondholders which the classical concep-tion of stockholder equitable ownership of the corporate substancefails to discern.65

61. Id.62. Id. If investors also own nonmarketable assets, then investors own combina-

tions of a riskless asset with both marketable and nonmarketable assets. Jensen,supra note 59, at 380-82 (discussing Mayers' model). A portfolio having zero covariancewith the market portfolio can be substituted for the riskless asset. Black, Capital Mar-ket Equilibrium with Restricted Borrowing, 45 J. Bus. 444, - (1972).

63. Galai & Masulis, supra note 27, at 62 & n.27, 71 n.50. Investor indifference tosuch wealth expropriation exists only when all investors own efficient market portfo-lios or when all investors in the classes of securities involved in the expropriations ownequal proportions of those securities. Id. at 62 & nn.27-28.

64. See supra notes 34-37 and accompanying text. The appropriate time whenvalue adjustment would be made is upon comparing debt payments with corporatereturns.

65. The classical conception's objection that it cannot be explained why corporateevents such as takeovers might be deleterious to bondholders, see Easterbrook & Fis-chel, supra note 2, at 1190, is overcome by the explanation of the generalized anomalyin the rule of corporate current-market-value maximization intensified through theexpropriation tendency by risk-averse stockholders.

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A risk-averse stockholder equitable owner of such corporate as-sets would not seek unanticipated increases in their instantaneous va-riance because increased variance equally increases the chances fordecreased values along with increased values. 66 However, a risk-averse stockholder equitable owner of a call option on such assetswould seek, ceteris paribus,67 unanticipated increases in their instan-taneous variance when the call option's exercise price is (1) greaterthan the expected value of such assets, because increased variance in-creases the chances for exercising the call option,68 and (2) less thanthe expected value of such assets while the corporation's asset instan-taneous covariance risk and capital-structure-unaffected marketvalue69 are constant, 70 because increased variance decreases the in-stantaneous covariance risk of the corporation's stocks and increasestheir market value. 71 Situation (1) admits of unanticipated wealthexpropriations from bondholders through waste of corporate assetsbecause there is a significant chance of corporate bankruptcy whenthe call option's exercise price is greater than the expected value ofthe corporation's assets.72 Situation (2) admits of unanticipatedwealth expropriations from bondholders through: (a) wealth redistri-butions because an increase in the stocks' market value correspond-ingly decreases the bonds' market value, 73 and (b) inefficient use ofcorporate assets because of the chance "that a more profitable

66. A risk-averse (decreasing positive marginal utility of wealth with increasingwealth) individual would not desire to participate in an investment having an equalchance of equal gain or loss because the increase in utility from such gain is less thanthe decrease in utility from such loss: the net utility from such chances is less than theutility of not taking such chances. See supra note 53.

67. "Ceteris paribus" means "if all other relevant things (as factors or elements)correspond or remain unaltered." WEBSTER'S THIRD NEW INTERNATIONAL DICTIONARY368 (1976).

68. Increased variance (dispersion) increases the portion (tail) of the profile (dis-tribution) of chances of asset values above the call option's exercise price.

69. "Capital-structure-unaffected market value" means that the corporation'smarket value is the sum of the market values of its bonds and stocks unaffected by themarket value ratio of its bonds to stocks. See Smith, Jr., supra note 31, at 45. See gen-erally Modigliani & Miller, The Cost of Capital, Corporation Finance and the Theory ofInvestment, 48 AM. ECON. REV. 261, 268 (1958) (stating that "the market value of anyfirm is independent of its capital structure"); Stiglitz, A Re-Examination of the Modi-gliani-Mioller Theorem, 59 AM. ECON. REV. 784, 788-89 (1969).

70. Galai & Masulis, supra note 27, at 56 & n.10, 58-60, 62-64, 71 & n.52 (discussingthe conjoint use of the Black-Scholes option-pricing model and the intertemporal capi-tal-asset-pricing model).

71. Id. at 59-60, 63-64, 71 & n.53. For examples that the concept of decreasingstockholders' covariance risk by increasing the risk of corporate bankruptcy is appar-ently foreign to our commentators, see Easterbrook & Fischel, supra note 5, at 1442;McDaniel, Bondholders and Corporate Governance, 41 Bus. LAW. 413, 433-34 (1986).Diversifiable risk becomes economically irrelevant to risk-averse stockholders throughtheir investment diversification in the efficient capital market.

72. See supra notes 10, 23 and accompanying text.73. Galai & Masulis, supra note 27, at 58-60, 63-64, 71 & n.53.


investment project will be rejected in favor of a project with a highervariance of... returns. '74

B. THE BONDHOLDER-WENBERGER HYPOTHETICAL

1. Factual Aspects of Weinberger

A "first-step acquisition" is the establishment of a less than com-plete stock-ownership position in a corporation which becomes thebasis for a subsequent attempt to increase that stock-ownership posi-tion; a "two-step acquisition" is the establishment of complete stockownership of a corporation by the integration through the secondstep of two individually less than complete stock-ownership positions.A "cash-out merger" is a merger in which the nonacquiring stock-holders of the stock-acquired corporation receive money as the soleconsideration for their stock and their elimination as stockholders.The "share price" is the amount of money for which a share of stockis able to be bought or sold or is otherwise valued. The "premiumover the market price" is the amount of money above the marketprice of a security that a buyer is willing to pay, or a seller is willingto accept, in exchange for that security. "Majority stockholder" sta-tus results when one corporation acquires more than fifty percent ofanother corporation's stock: the stock-acquiring corporation becomesthe "parent corporation" and the (partially or wholly) stock-acquiredcorporation becomes the "subsidiary corporation." A "dual parent-subsidiary director" is an individual who is simultaneously a memberof the board of directors of both the parent corporation and its sub-sidiary corporation.

Weinberger represents the generalized fact pattern of a two-stepacquisition in which the first-step acquisition and the second-stepcash-out merger have equal share prices with approximately equalpremiums over their market prices and in which majority stock-holder and dual parent-subsidiary director statuses result from thefirst-step acquisition.

7 5

The merger seems to have been nonsynergistic because both cor-porations were conglomerates (economically diversified) 76 and pureconglomerate mergers have no market value synergy.77 At the timewhen the market price of the subsidiary's stock was $14.50 per

74. Id. at 71. In other words, there is a chance that stockholders could "benefitfrom projects whose net effect ... [is] to reduce the total value of the firm." Jensen &Meckling, supra note 20, at 337 n.43.

75. Weinberger v. UOP, Inc., 457 A.2d 701, 704-08 (1983).76. Id. at 704.77. Galai & Masulis, supra note 27, at 66 & n.38, 68.

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share, 78 dual parent-subsidiary directors had inside information "thatit would be a good investment for [the parent] to acquire the remain-ing 49.5% of [the subsidiary's] shares of any price up to $24 each." 79

Because efficient market "theory is concerned with how the marketreacts to disclosed information and is silent as to the optimumamount of information required or whether that optimum should beachieved on a mandatory or voluntary basis,"8 0 this ($14.50 v. $24)share price discrepancy is consistent with the existence of an efficientcapital market. The merger seems to have occurred in an efficientcapital market because the stocks of both corporations were publiclytraded on the New York Stock Exchange,8 1 and this exchange ismore or less an efficient capital market.8 2

The parent corporation did not contemplate merging with thesubsidiary corporation until almost three years after their stockpurchase bargaining in the first-step acquisition.8 3 "No functionalbright line can be drawn to offer an easy operational distinction be-tween a merger contemplated as a second step at the time controlwas acquired and a merger which was not so contemplated but isstimulated by events after the acquisition of control."'8 4 The position-ing of unanticipated wealth expropriations might be a distinguishingfinancial feature between anticipated and unanticipated mergers.8 5

Unless the parent sells its stocks in the subsidiary to the extent thatits status as the majority stockholder is extinguished, the parent ar-guably is the only realistic purchaser for the aggregate of the subsidi-ary's minority stocks. Second-step acquisition unanticipated wealthexpropriations might occur because, at the time of the purchase ofthe parent's or subsidiary's securities, the capital market: (1) per-ceives the parent as not completely acquiring the subsidiary's stocks,(2) ambiguously perceives the parent as completely and not com-pletely acquiring the subsidiary's stocks, or (3) overreacts to the per-ception of the parent as completely acquiring the subsidiary'sstocks.8 6 The approximate equality between the subsidiary's stock

78. Weinberger, 457 A.2d at 706.79. Id. at 705.80. SEC. AND EXCH. COMM'N, REPORT OF THE ADVISORY COMM. ON CORP. DISCLO-

SURE TO THE SEC. AND EXCH. COMM'N D-6 (1977).81. Weinberger, 457 A.2d at 704.82. Fama & Blume, Filter Rules and Stock-Market Trading, 39 J. Bus. 226 (1966).83. Weinberger, 457 A.2d at 704-05.84. Brudney, supra note 2, at 1119 n.144.85. A. Barkey, supra note 1, at 16. Schedule 13D filings under section 13(d)(1) of

the Securities Exchange Act, 15 U.S.C. § 78m(d)(1) (1982) might not unambiguouslysignal information because of their boilerplate disclosure. Tobin & Maiwurm, Beach-head Acquisitions: Creating Waves in the Marketplace and Uncertainty in the Regula-tor Framework, 38 Bus. LAW. 419, 434-36 (1983) (discussing waffling disclosure).

86. See Galai & Masulis, supra note 27, at 70.

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market price of "a fraction under $14 per share" before the $21 pershare first-step acquisition8 7 and its stock market price of $14.50 pershare before the $21 per share cash-out merger8 8 is consistent withthe view that the capital market perceived the parent as not in-tending to completely acquire the subsidiary's stocks because other-wise the share price before the $21 per share cash-out mergerarguably would have been around $21 instead of $14.50. This appar-ent capital market perception is consistent with the fact that the par-ent did not contemplate merging with the subsidiary until almostthree years after their stock purchase bargaining in the first-stepacquisition.

89

Thus, Weinberger represents the generalized fact pattern of asurprise nonsynergistic parent-subsidiary cash-out merger occurringin an efficient capital market.90

2. Dicta Aspects of Weinberger

Weinberger involves a class action in equity, on behalf ofmerger-objecting subsidiary stockholders who were eliminated asstockholders by operation of the merger statute,91 challenging thefairness of the parent-subsidiary cash-out merger.92 Although Wein-berger's holding is irrelevant to the bondholder-stockholder focus ofthis Article,93 aspects of Weinberger's views are relevant.94

Weinberger states that "a more liberal approach [to securitiesvaluation] must include proof of value by any techniques or methodswhich are generally considered acceptable in the financial commu-nity and otherwise admissible in court.195 Weinberger thereby opensthe door to issues, detected by the Black-Scholes option-pricingframework, concerning unanticipated wealth expropriations amongclasses of corporate securities. 96 Weinberger: (1) affirms a fiduciaryduty of loyalty (with "good management") on corporate officers anddirectors to the corporation, 97 (2) affirms a fiduciary duty of loyalty(with "complete candor") on corporate officers and directors to the

87. Weinberger, 457 A.2d at 704.88. Id. at 706.89. Id. at 704-05.90. See supra text accompanying notes 75-89.91. DEL. CODE ANN. tit. 8, § 251 (1974).92. Weinberger, 457 A.2d at 703.93. For a statement of the narrow definition to be given to court determinations,

see H. BLACK, HANDBOOK ON THE LAW OF JUDICIAL PRECEDENTS 37 (1912) and K.LLEWELLYN, THE BRAMBLE BUSH 42 (1960).

94. For a statement of the persuasive authority of dicta, see K. LLEWELLYN, supranote 93, at 42.

95. Weinberger, 457 A.2d at 713.96. A. Barkey, supra note 1, at 6, 10.97. Weinberger, 457 A.2d at 710.

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corporation's stockholders,9 8 (3) states that statutory appraisal "shallgovern the financial remedy available to minority shareholders in acash-out merger," 99 (4) finds that "there is a legislative intent to fullycompensate shareholders for whatever their loss may be, subject onlyto the narrow limitation that one can not take speculative effects ofthe merger into account, °1 00 (5) states that "elements of future value,including the nature of the enterprise, which are known or suscepti-ble of proof as of the date of the merger and not the product of spec-ulation, may be considered" in the statutory appraisal,1 01 (6) statesthat in the statutory appraisal proceedings, "[w]hen the trial courtdeems it appropriate, fair value also includes any damages, resultingfrom the taking, which the stockholders sustain as a class,"' 0 2

(7) states that if the statutory appraisal remedy is inadequate, thenthe courts may "fashion any form of equitable and monetary relief asmay be appropriate, including rescissory damages. '10 3

3. The Bondholder-Weinberger Hypothetical: Facts

"Nonsubordinated bonds" are bonds having a corporate paymentpriority equal to that of other bonds while contractually establishedpayment priorities operate among the corporation's bonds.'0 4 Thecovariance between two returns equals the product of the positivesquare root of each return's variance times the "correlation coeffi-cient."' 0 5 The correlation coefficient can vary from +1 to 1: +1means perfect correlation, 0 means no correlation, and -1 meansperfect inverse correlation.10 6

Imagine two for-profit Delaware corporations--each having one

98. Id. (quoting Lynch v. Vickers Energy Corp., 383 A.2d 278, 281 (Del. 1977)(quoting Lynch v. Vickers Energy Corp., 351 A.2d 570, 573 (Del. Ch. 1976))).

99. Id. at 715 (construing DEL. CODE ANN. tit. 8, § 262(h) (1974)). See generallySeligman, Reappraising the Appraisal Remedy, 52 GEo. WASH. L. REV. 829, 831-37(1984); Thompson, Squeeze-Out Mergers and the "New" Appraisal Remedy, 62 WASH.U.L.Q. 415, 416-23 (1984).

100. Weinberger, 457 A.2d at 714.101. Id. at 713.102. Id. "Weinberger does not say when it would be appropriate to include this pri-

vate eminent domain element of damages in the value determination.... Other thanrescissory damages, it is difficult to imagine any damages that the court could havebeen contemplating." Berger & Allingham II, A New Light on Cash-Out Mergers:Weinberger Eclipses Singer, 39 Bus. LAW. 1, 18-19 (1983).

103. Weinberger, 457 A.2d at 714 (stating that courts may fashion such a remedy"particularly where fraud, misrepresentation, self-dealing, deliberate waste of corpo-rate assets, or gross and palpable overreaching are involved").

104. See generally Everett, Subordinated Debt - Nature, Objectives and Enforce-ment, 44 B.U.L. REV. 487, 489-96 (1964). For a theoretical discussion of debt subordina-tion agreements, see Carlson, A Theory of Contractual Debt Subordination and LienPriority, 38 VAND. L. REV. 975, 982-83 (1985).

105. M. SPIEGEL, supra note 41, at 82.106. Id.

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class of publicly-traded stocks and one class of risky publicly-tradedpure-discount bonds with conjointly equal bond maturities-identicalin every respect but for less than perfect correlation of returns be-tween them. 0 7 The bond purchase prices and the bond protectivecontractual provisions do not anticipate a cash-out merger, the issu-ance of nonsubordinated bonds and the retirement of stocks.10 8 Thecapital market conforms to the Black-Scholes option-pricing frame-work and more or less to the intertemporal capital-asset pricingmodel. For each corporation, and for the combined corporation re-sulting from their merger, the corporate asset instantaneous covari-ance risk and capital-structure-unaffected market value areconstant. 109

One corporation obtains both dual parent-subsidiary director and(50.5%) majority stockholder control of the other corporation.1 10 Thecapital market perceives that these corporations will not undergo acash-out merger with the issuance of nonsubordinated bonds and theretirement of stocks.1 ' These corporations undergo a surprise non-synergistic cash-out merger three years later.1 1 2 The cash-out shareprice equals the market price of the shares before the capital marketwas aware of the surprise cash-out merger proposal.' 1 3 Several daysafter the date of the merger,1 1 4 the combined corporation makes thepublicly announced decision 1 5 to issue a specified amount of non-subordinated bonds, which will conjointly mature with the originalbonds, and to use their proceeds for the merger cash-out, other speci-fied stock retirements, and maintaining a constant market value forthe combined corporation."i 6 Also, the combined corporationpublicly announces that it is instituting, through such bond issuanceand stock retirements and through other means, a "prospectivecontingency plan" 117 of defense against corporate takeover so as "to

107. See Galai & Masulis, supra note 27, at 62.108. See Forsyth, Bad Grades, BARRON'S, Feb. 24, 1986, at 24, col. 1.109. See supra note 70 and accompanying text.110. See supra text accompanying note 75.111. See supra text accompanying notes 87-89.112. See supra text accompanying notes 76-77, 89-90.113. See Galai & Masulis, supra note 27, at 68.114. See supra text accompanying note 101.115. This emphasizes that the bond pricing of the new bonds will fully reflect (fair-

market-value impound) the new risks associated with the new facts. See E. FAMA &M. MILLER, supra note 9, at 78-79 n.31; Galai & Masulis, supra note 27, at 79 n.66. Cf.Prokesch, supra note 2, at D4, col. 6 (statement of Mr. Kingman D. Penniman, Vice-president, McCarthy, Crisanti & Maffei) (stating, regarding Phillips Petroleum's re-structuring: "Those holding the debt issued to finance the recapitalization have faredfairly because the interest paid reflects the new market risks.").

116. See Galai & Masulis, supra note 27, at 63-69.117. Moran v. Household Int'l, Inc., 490 A.2d 1059, 1075 (Del. Ch.), affd, 500 A.2d

1346 (Del. 1985).

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protect the corporation from a perceived threat to corporate policyand effectiveness.' ' 1 8 The combined corporation fully complies withall contractual obligations under all bond protective contractualprovisions.

119

Some of the subsidiary's stockholders dissent from the cash-outmerger agreement and perfect their appraisal rights.120 These stock-holders and some of the original bondholders are risk-neutral andrisk-liking investors' 2 ' (during the time span of these events)122 whopossess unique investment facts and beliefs. 123 Arbitrarily, the net fi-nancial effect before the date of appraisal is, ceteris paribus, thatstockholders gain wealth 124 and original bondholders lose corre-sponding wealth 25 because of unanticipated wealth expropriations inwhich: (1) stockholders lose wealth and original bondholders gaincorresponding wealth due to the merger per se,126 and (2) stockhold-ers gain wealth and original bondholders lose corresponding wealthdue to the cash-outs per se.' 2 7

A dispute over these gains and losses arises from the Delawareappraisal proceedings. Assume, representation by the original bond-holders (Contractual Creditors), the dissenting stockholders (Ap-

118. Id. at 1076.119. See DEL. CODE ANN. tit. 8, § 259 (1974).120. See supra text accompanying note 99.121. This locally neutralizes a postulate of the intertemporal capital-asset-pricing

model. See supra notes 56-57 and accompanying text.122. This emphasizes the problem that if rules of law were to distinguish between

risk-averse and non-risk-averse investors in favor of the latter, see Easterbrook & Fis-chel, Corporate Control Transactions, 91 YALE L.J. 698, 711-14 (1982), then a risk-averse investor - whose risk averseness is determined in court by testing that investor- can always allege, perhaps truthfully, that at a relevant past time the investor wasrisk-neutral or risk-liking. The fact of past inadequate risk diversification supportssuch an allegation even though the investor's true state of mind at that time is un-known. Furthermore, an investor might be inherently risk-averse, risk-neutral, andrisk-liking because "[a] utility function need not be everywhere concave or everywhereconvex." H. MARKOWITZ, supra note 52, at 218. E. FAMA & M. MILLER, supra note 9,at 203; Friedman & Savage, supra note 53.

123. This locally neutralizes a postulate of the intertemporal capital-asset-pricingmodel. See supra note 58 and accompanying text.

124. This mimics a synergistic merger with respect to stockholders. See Brudney& Chirelstein, Fair Shares in Corporate Mergers and Takeovers, 88 HARV. L. REV. 297,308-09, 313-25 (1974).

125. See Farrell, supra note 45, at 113 (stating that "for every stock owner whobenefits from a stock buyback, acquisition, or leveraged buyout, there is a lucklessholder of debt"); Weberman, Redmail, FORBES 173, 173 (Oct. 7, 1985) (stating: "In a lotof these big takeovers the acquired stockholders make a killing, but holders of the ex-isting bonds take a hosing.").

126. See Galai & Masulis, supra note 27, at 66, 68. This mimics a "negative"-syner-gistic merger with respect to stockholders. See Lorne, A Reappraisal of Fair Shares inControlled Mergers, 126 U. PA. L. REV. 956, 976 (1978).

127. See Galai & Masulis, supra note 27, at 69.

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CREIGHTON LAW REVIEW [Vol. 20

praisal Creditors), and the combined corporation (Debtor).128

Contractual Creditors seek compensation regarding the cash-outs perse loss. Appraisal Creditors seek compensation regarding the mergerper se loss and the cash-outs per se gain. Debtor seeks not to com-pensate Contractual Creditors and Appraisal Creditors. The follow-ing selective arguments might be made:

IV. A FIDUCIARY LAW SOLUTION

A. THE BONDHOLDER-WEINBERGER HYPOTHETICAL: ARGUMENTS

1. Debtor Speaks Regarding Contractual Creditors

Our law is clear:12 9 Bondholders (Contractual Creditors) haveno standing to maintain a claim for breach of fiduciary duty becausebondholders are not equitable owners of the corporation's assets andbecause corporate officers and directors owe a fiduciary duty only tothose who are such equitable owners.' 30 "The stockholders of a cor-poration are the equitable owners of its assets .... ,,131

"There is a generally accepted picture of corporate debt relation-ships under which the entire responsibility for governance falls tothe contract drafter."'13 2 Thus, if a "fiduciary duty of good faith andfair dealing" to bondholders were to be imposed on the parent-suc-

128. Because bondholder wealth is affected, the bondholders might be permitted tospeak either directly or indirectly or by parallel litigation. Bonds are deemed "sharesof stock" when the bonds can vote, etc., and such voting bondholders of the subsidiarymight dissent from the cash-out merger agreement and seek appraisal. See DEL. CODEANN. tit. 8, § 221 (1974). "Once a stockholder perfects his appraisal rights, he loses hisstatus as a stockholder and becomes a creditor of the corporation." Berger & Al-lingham II, supra note 102, at 21 (citing Braasch v. Goldschmidt, 41 Del. Ch. 519, -,

199 A.2d 760, 766 (1964)).129. This case does not involve a claim of fraud, see Harff v. Kerkorian, 347 A.2d

133, 133-34 (Del. 1975) (involving allegations of intentional looting of the corporation),or a claim of misconduct regarding bondholder equity conversion rights, see PittsburghTerminal Corp. v. Baltimore & Oh. R.R., 680 F.2d 933, 935 (3d Cir.), cert. denied, 459U.S. 1056 (1982); Van Gemert v. Boeing Co., 520 F.2d 1373, 1374-79 (2d Cir.), cert. de-nied, 423 U.S. 947 (1975); Green v. Hamilton Int'l Corp., 437 F. Supp. 723, 725-29(S.D.N.Y. 1977), or a corporation in bankruptcy, see Pepper v. Litton, 308 U.S. 295, 296-302 (1939). The view that "if expropriation is the game, fraud is its name," McDaniel,supra note 71, at 445, seems to be in error because it is too broad, for example, "in anaction at law for deceit or fraudulent misrepresentation an intent to defraud must beestablished." Harman v. Masoneilan Int'l, Inc., 442 A.2d 487, 499 (Del. 1982).

130. Norte & Co. v. Manor Healthcare Corp., Nos. 6827, 6831, at 7-8 (Del. Ch. Nov.21, 1985) (available on LEXIS, States Library, Del file).

131. State ex rel. Miller v. Loft, Inc., 156 A. 170, 172 (Del. Super. Ct. 1931). Cf. Rev-lon, Inc. v. MacAndrews & Forkes Holdings, Inc., 506 A.2d 173, 176 (Del. 1986) (statingthat "while concern for various corporate constituencies is proper when addressing atakeover threat, that principle is limited by the requirement that there be some ration-ally related benefit accruing to the stockholders").

132. Bratton, Jr., The Interpretation of Contracts Governing Corporate Debt Rela-tionships, 5 CARDOZO L. REV. 371, 371 (1984) (discussing judicial intervention tensionbetween liberal and strict contract interpretation).


cessor corporation in a parent-subsidiary cash-out merger because ofits control over both corporations agreeing to merge, then this fiduci-ary duty would be "discharged as a matter of law" when there is fullcorporate compliance with all obligations under all bond protectivecontractual provisions.133 Because Debtor has fully complied with allits obligations under all bond protective contractual provisions,1 34

such a fiduciary duty would be discharged if it were imposed.135

Also, postmerger cash-outs (stock retirements) which are outside ofthe merger agreement are not subject to such a fiduciary duty be-cause they are outside of parent-successor control over both corpora-tions agreeing to merge. 136 Because bondholders could have avoidedadverse economic effects resulting from the cash-outs by investing inefficient market portfolios or in equal proportions of the corpora-tion's bonds and stocks,137 they assumed the risks of their bonds bychoosing not to so invest.-3 8

133. Broad v. Rockwell Int'l Corp., 642 F.2d 929, 958 (5th Cir.), cert. denied, 454U.S. 965 (1981). Cf Gardner & Florence Call Cowles Found. v. Empire, Inc., 589 F.Supp. 669, 673 (S.D.N.Y. 1984) (stating: "Fiduciary duties in a debenture contract...do not exist in the abstract, but are derived from the Indenture itself."), vacated, 754F.2d 478 (2d Cir. 1985).

134. See supra text accompanying note 119.135. See Broad v. Rockwell Int'l Corp., 642 F.2d 929, 958-59 (5th Cir.), cert. denied,

454 U.S. 965 (1981).136. See id.137. See supra notes 51, 63 and accompanying text. Whether all investors can own

either efficient market portfolios or equal proportions of the corporation's affectedclasses of securities are questions of fact regarding the capital market. Compare Brud-ney, supra note 2, at 1099-1102 (stating that sufficient stock diversification is factuallyunlikely, etc.) with E. FAMA, supra note 28, at 253-54 (comparing substantial diversifi-cation benefits with randomly selected New York Stock Exchange portfolio containingunder sixteen different stocks).

138. This is a coercive risk-diversification policy: diversify in a special way or elsesuffer expropriations by the corporation(s) invested in. For portfolio arguments re-garding equal treatment for investors, compare Easterbrook & Fischel, supra note 122,at 711-14 (presenting a stock diversification argument for "allowing the gains from cor-porate control transactions to be apportioned unequally" because "risk averse investorscan reduce the risk of losses without extinguishing profitable-but-risky transactions")with DeMott, Current Issues in Tender Offer Regulation: Lessons From the British, 58N.Y.U.L. REV. 945, 983 n.191 (1983) (presenting a stock diversification argument that a"fund that mimics the composition of the market as a whole" might "not gain as oftenas it loses when corporate control is sold on terms that treat shareholders unequally")and McDaniel, supra note 71, at 436 (stating that "wealth transfers from bondholdersto stockholders" involve risk that "cannot be eliminated by [bond] diversification") andid. (stating that "a mutual fund [of bonds and stocks] is not a perfect substitute for adiversified portfolio"). For a review of the Easterbrook & Fischel gain-keeping stock-diversification argument, see Bebchuk, Toward Undistorted Choice and Equal Treat-ment in Corporate Takeovers, 98 HARV. L. REV. 1693, 1784 (1985); Coffee, Jr., Regulat-ing the Market for Corporate Control: A Critical Assessment of the Tender Offer's Rolein Corporate Governance, 84 COLUM. L. REV. 1145, 1216-21 (1984). Another form of theassumption-of-risk view focuses on the partial anticipation of corporate events throughthe bond protective contractual provisions: bondholders are deemed to assume the en-tire risk of an uncertain future event when they show awareness of its possibility of


Regarding Appraisal Creditors

Weinberger states that in the statutory appraisal proceedings,"[w]hen the trial court deems it appropriate, fair value also includesany damages, resulting from the taking, which the stockholders sus-tain as a class."' 39 Because both Debtor's and Appraisal Creditors'equity underwent a simultaneous merger per se loss of wealth,140Debtor did not "take" this wealth from Appraisal Creditors. 141 Be-cause Contractual Creditors gained Appraisal Creditors' wealth fromthe merger per se loss, 142 Appraisal Creditors should look to Contrac-tual Creditors for such merger per se loss compensation and not toDebtor.

Weinberger states that "elements of future value, including thenature of the enterprise, which are known or susceptible of proof asof the date of the merger and not the product of speculation, may beconsidered" in the statutory appraisal. 143 Because the cash-outs perse gain resulted from a financing decision made several days after thedate of the merger 4 4 and therefore was not "known or susceptible ofproof as of the date of the merger,"'1 45 it should not be considered inthe statutory appraisal. Weinberger states that if the statutory ap-praisal remedy is inadequate, then the courts may "fashion any formof equitable and monetary relief as may be appropriate, including re-scissory damages."'1 46 Because the cash-outs per se gain results fromconditions under which the corporation has not gained wealth 147 andbecause Appraisal Creditors bear no investment risk 148 resultingfrom stock ownership under the increased corporate debt which isintertwined with such gain,149 Appraisal Creditors should not share

occurrence. See Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 182(Del. 1986) (stating: "The Notes covenants specifically contemplated a waiver to per-mit sale of the company at a fair price. The Notes were accepted by the holders onthat basis, including the risk of an adverse market effect stemming from a waiver.").Should "fair price," or fair value, include unanticipated wealth expropriations?

139. Weinberger, 457 A.2d at 713.140. See supra note 126 and accompanying text.141. Cf. United States v. Willow River Power Co., 324 U.S. 499, 511 (1945) (holding

that a mean-variance change in height of river was not a "taking" of property); Fama,Agency Problems and the Theory of the Firm, 88 J. POL. ECON. 288, 290 (1980) (discuss-ing the "nexus of contracts perspective" in which "ownership of the firm is an irrele-vant concept").

142. See supra text accompanying note 126.143. Weinberger, 457 A.2d at 713.144. See supra text accompanying notes 114-16, 127.145. Weinberger, 457 A.2d at 713.146. Id. at 714.147. See supra text accompanying note 116.148. Cf. Lorne, supra note 126, at 987 (providing an argument against synergistic

merger gain sharing).149. See supra text accompanying notes 116, 127.

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in this net cash-outs per se gain.

2. Appraisal Creditors Speak Regarding Contractual Creditors

Debtor's argument regarding Contractual Creditors is incorpo-rated by reference herein.15 0

Regarding Debtor

Weinberger finds that "there is legislative intent to fully com-pensate shareholders for whatever their loss may be, subject only tothe narrow limitation that one cannot take speculative effects of themerger into account." 151 Because of this legislative intent, Debtorshould fully compensate appraisal Creditors, within or without theappraisal statute, for their nonspeculative merger per se loss.1 5 2

Weinberger states that "elements of future value, including thenature of the enterprise, which are known or susceptible of proof asof the date of the merger and not the product of speculation, may beconsidered" in the statutory appraisal. 15 3 Although the cash-outs perse gain154 is not "known or susceptible of proof as of the date of themerger,"'' 55 this gain is nonspeculative and known as of the date ofappraisal.1 5 6 Weinberger states that if the statutory appraisal rem-edy is inadequate, then the courts may "fashion any form of equitableand monetary relief as may be appropriate, including rescissory dam-ages.'1 5 7 Because statutory appraisal does not adequately compensateAppraisal Creditors for the loss of their pro rata share of the presentvalue as of the date of the merger of the nonspeculative gross cash-outs per se gain which proceeds from the (synergistic) corporate debtcapacity as of the instant of the merger, 58 Appraisal Creditors seeksuch compensation outside of statutory appraisal.

3. Contractual Creditors Speak

It is basic that "our corporate law is not static. It must grow anddevelop in response to, indeed in anticipation of, evolving conceptsand needs.' 5 9 Because the established theoretical structure of corpo-

150. Incorporating supra notes 129-38 and accompanying text.151. Weinberger, 457 A.2d at 714.152. For a statement of the merger per se loss, see supra text accompanying note

126.153. Weinberger, 457 A.2d at 713.154. For a statement of the cash-outs per se gain, see supra text accompanying

note 127.155. Weinberger, 457 A.2d at 713.156. See supra text accompanying notes 124, 127.157. Weinberger, 457 A.2d at 714.158. See supra notes 38, 153-56 and accompanying text.159. Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 957 (Del. 1985).

1986]


rate finance is grounded in science, our corporate law should bebrought into congruity with it by adoption into our law of the impli-cations of the rule of corporate current-market-value maximizationand the Black-Scholes scientific conception of the corporation.

A generic managerial fiduciary duty to bondholders proceedsfrom the rule of corporate current-market-value maximization:Weinberger affirms a fiduciary duty of loyalty (with "good manage-ment") on corporate officers and directors to the corporation; 160 inequivalent economic language, there is a generic managerial fiduciaryduty to efficiently use corporate assets and maximize the currentmarket value of the corporation. 161 Weinberger affirms a fiduciaryduty of loyalty on corporate officers and directors to the corporation'sstockholders; 162 in equivalent economic language, there is a genericmanagerial fiduciary duty to maximize the current market value ofthe corporation's stocks.163 These generic managerial fiduciary dutieslogically proceed from the rule of corporate current-market-valuemaximization: "optimal operating decisions for a firm at any point intime involve maximizing the market value of those securities out-standing before the operating decision is made."'1 64 Because bond-holders and stockholders are equal (interchangeable) securityholdersunder this rule,'6 5 the generic managerial fiduciary duty to maximizethe current market value of the corporation's stocks implies thatthere is a corresponding generic managerial fiduciary duty to maxi-mize the current market value of the corporation's bonds. When theanomaly in the rule of corporate current-market-value maximizationoccurs and the generic managerial fiduciary duties to the corporationand its stockholders conflict,166 then this generic managerial fiduci-ary duty to bondholders logically exists as the means to reconcile theconflict and restore the rule by an implied bondholder-to-stockholderside payment. 167

Translating the Black-Scholes conception of the corporation intothe language of our corporate law, equitable ownership of the corpo-ration's assets and cash flow corresponds to the seniority (priority) ofclaims by classes of the corporation's securityholders on those assetsand cash flow. 68 Because, in general, bondholders and stockholders

160. Weinberger, 457 A.2d at 710. "A corporation has an interest of its own in be-ing well managed." Gordon v. Elliman, 306 N.Y. 456, 466, 119 N.E.2d 331, 338 (1954).

161. See supra notes 9, 17-18 and accompanying text.162. Weinberger, 457 A.2d at 710.163. See supra notes 9, 17-18 and accompanying text.164. E. FAMA & M. MILLER, supra note 9, at 176 (emphasis added).165. See supra notes 14-18 and accompanying text.166. See supra note 19 and accompanying text.167. See supra note 22 and accompanying text.168. See supra notes 31-37.

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have first and residual claims respectively on the corporation's assetsand cash flow, 169 they are correspondingly the first and residual equi-table owners of the corporation's assets and cash flow. Because cor-porate officers and directors owe fiduciary duties to the equitableowners of the corporation's assets 1 70 and because, in general, bond-holders are the first equitable owners of the corporation's assetsunder the Black-Scholes conception of the corporation, 171 corporateofficers and directors owe fiduciary duties to bondholders which cor-respond to those owed to stockholders. Given the foundation of abondholder-management fiduciary relation which proceeds from therule of corporate current-market-value maximization and the Black-Scholes conception of the corporation, the "fiduciary formula" per-mits compensation to bondholders (Contractual Creditors) for theircash-outs per se loss: 172

Fiduciary law creates causes of action for the entrustoragainst the fiduciary, even if the parties did not contract.The courts can provide protection to the entrustor by impos-ing on the fiduciary obligations that the parties would haveagreed upon if the costs of contracting or the nature of therelation had not precluded them from doing so. 173

But for the nature of the bondholder-management fiduciary relationin which perfect ex ante foresight with perfectly specified bond pric-ing is not possible,174 the bondholders and management would haveagreed upon bond pricing which would obligate the corporation tocompensate the bondholders for wealth which otherwise and now isunanticipatedly expropriated from the bondholders because the effi-cient capital market would have impounded this expropriation intosuch bond pricing.175

169. V. BRUDNEY & M. CHIRELSTEIN, CASES AND MATERIALS ON CORPORATE FI-NANCE 79-81 (2d ed. 1979). "The claims of the various investment securities upon theearnings and assets of the enterprise are defined in the portion of the investment con-tract which sets forth the amount of such claims and prescribes their priority vis-a-visother claimants." Id. at 79.

170. See Norte & Co. v. Manor Healthcare Corp., Nos. 6827, 6831, at - (Del. Ch.Nov. 21, 1985) (available on LEXIS, States library, Del file).

171. See supra notes 168-69 and accompanying text.172. For a statement of the cash-outs per se loss, see supra text accompanying note

127.173. Frankel, Fiduciary Law, 71 CALIF. L. REV. 795, 825 (1983). The term "entrus-

tor" means "the party to whom the fiduciary owes fiduciary duties." Id. at 800 n.17.174. See supra notes 44-46 and accompanying text.175. See supra notes 28, 43 and accompanying text. Also, but for the nature of the

bondholder-management fiduciary relation in which bondholders have unequal bar-gaining power with management, see Brody, supra note 39, at 19, col. 1, and Farrell,supra note 45, at 114, the bondholders and management would have agreed upon ex-propriation countermeasures (e.g., bond buyback, bond renegotiation, bond substitu-tion) which would obligate the corporation to compensate the bondholders for wealthwhich otherwise and now is unanticipatedly expropriated from the bondholders be-

1986]


Such compensation to bondholders is the logical counterpart ofour corporate law's policy of permissive managerial resistance totakeovers 176 because it offsets the loss of the unrestricted capitalmarket takeover mechanisms which rectifies the policy manifestationof the anomaly in the rule of corporate current-market-Value max-imization. 177 Furthermore, such compensation is consistent with apublic policy of competitive business maneuver: 178 if the bondhold-ers and the corporation were to continuously recontract, then the al-ternatives would be for the bondholders to receive such netcompensation through bond pricing in the efficient capital market 179

or for bond protective contractual provisions which would "severelyrestrict the actions of the firm.' 8 0 The view that "[tjhe most obviousand important characteristic of long-term debt financing is that theholder ordinarily has not bargained for and does not expect anysubstantial gain in the value of the security to compensate for therisk of loss"''1 becomes irrelevant in this context because: (1) thecomponents of bond pricing are functionally equivalent and impoundthe publicly known information regarding expected gain and risk

cause management does so act or contract when the bondholders have more or lessequal bargaining power with management. See Brody, supra note 39, at 19, col. 1; Far-rell, supra note 45, at 114.

176. For a statement of the policy of permissive managerial resistance to takeovers,see Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 955 n.10 (Del. 1985); Moran v.Household Int'l, Inc., 500 A.2d 1346, 1350 (Del. 1985). See generally Veasey, BusinessJudgment Rule: The New Incarnation, Legal Times, March 10, 1986, at 25, col. 1.Debtor has instituted takeover defenses which restrict a possible takeover by the bond-holders or others. See supra text accompanying notes 117-18.

177. See supra notes 21, 43-44 and accompanying text.178. In general, for-profit corporations compete with other for-profit corporations

for business. The public policy supporting such competition is manifested in the fed-eral antitrust laws.

179. See supra notes 28, 43-44 and accompanying text.180. Galai & Masulis, supra note 27, at 55 n.5. See Jensen & Meckling, supra note

20, at 338 (stating: "To completely protect the bondholders ... these [bond protectivecontractual] provisions would have to be incredibly detailed and cover most operatingaspects of the enterprise including limitations on the riskiness of the projects under-taken."). Such restrictive contractual provisions are analogous to the imposition ofcommon law or statutory law rules." "[A]lthough the legal rules can protect againstfraud and particularly blatant forms of self-dealing by management, they cannot domuch more without denying the company the benefits of management's expertise inmaking major corporate decisions." DeMott, supra note 138, at 1012 (summarizing theview of professional managerial prerogatives regarding mergers and tender offersstated in Lipton, Takeover Bids in the Target's Boardroom, 35 Bus. LAW. 101, 116-20(1979)). "[T]he design of specific legal rules governing the terms of mergers ... affect-ing managerial interests appears very costly if not impossible. In such areas, regula-tion cannot feasibly go beyond very general rules, such as the requirement of 'fairness,'without creating severe obstacles to efficient managerial decision-making." Anderson,Conflicts of Interest: Ffficiency, Fairness and Corporate Structure, 25 UCLA L. REV.738, 790 (1978) (discussing statutory rules).

181. AM. BAR FOUND., supra note 6, at 1.


through investor bargaining in the efficient capital market,18 2 and(2) investors in all investment vehicles expect appropriate gains fromtheir investments-

8 3

Should risk-neutral and risk-liking investors (such as AppraisalCreditors and Contractual Creditors),1 8 4 with or without their posses-sion of unique investment facts and beliefs, be penalized by permis-sive (judicially tolerated) wealth expropriations because of "theexistence of diversification-not its employment"?18 5 The questioncan be recast as follows: should investors' risk-neutral and risk-lik-ing states of mind be penalized? (The penalization of states of mindis the domain of the theory of criminal law.)18 6 To penalize such in-vestors would be to punish mental nonconformity with procrusteanidealized mathematical conditions regarding risk averseness andefficient market portfolios in an otherwise completely noncriminalcontext.187 Such penalization is perverse and unfair because these in-vestors are the victims and not the perpetrators of such wealth ex-propriations.'88 Risk diversification does not rationally "exist" forrisk-neutral and risk-liking investors. Moreover, such penalization iscontrary to a reasonable fiduciary "constraint that no investor bemade worse off by the transaction.' 8 9 "The requirement thateveryone receive at least the value of his investment under existingconditions serves much the same function as the rule against

182. See supra notes 28, 43-44, 59-60 and accompanying text.183. Risk-averse investors seeks gains which are related to investment covariance

risks, whereas risk-neutral investors seek the greatest expected gains and risk-likinginvestors seek the greatest possible gains. Risk-averse investors dominate the market-clearing prices for securities in the efficient capital market; bond economic gains andlosses are determined from such market-clearing prices.

184. See supra text accompanying notes 121-22.185. Easterbrook & Fischel, supra note 122, at 713.186. American civil law is directed toward damages, whereas American criminal

law is directed toward states of mind. In general, an objective truth finder regardingan individual's state of mind would obviate the requirement for an "act" or "harm"under the theory of our criminal laws - pure thought crimes would exist - becausethe "act" and "harm" are not relevant per se but only as indicators of the individual'sforbidden state of mind. If the "act" were central to our criminal laws, then the "act"would be penalized without the requirement for a concurrent forbidden state of mind.If "harm" were central to our criminal laws, then "insanity" would not be a defensebecause it does not undo the "harm"; and the crimes of "attempt," "conspiracy," and"solicitation" would not exist because there is no "harm" per se in these crimes. For adefinition of these quoted terms and for a discussion of criminal law theory, see J.HALL, LAW, SOCIAL SCIENCE AND CRIMINAL THEORY (1982), and J. HALL, GENERALPRINCIPLES OF CRIMINAL LAW (2d ed. 1960).

187. See supra notes 54-58 and accompanying text.188. There exists a corporate financing policy under which unanticipated wealth

expropriations either do not occur or are neutralized. Galai & Masulis, supra note 27,at 66 & n.37, 68-69; K. Shastri, supra note 26, at 55-57.

189. Easterbrook & Fischel, supra note 122, at 715.


theft."190

On these grounds and because "inequitable action does not be-come permissible simply because it is legally possible,"1 91 ContractualCreditors seek such compensation under a new fiduciary articula-tion which requires the corporation and its officers and directors to:(1) maximize the present value of the returns, evaluated with respect

to all eventualities, on corporate assets, and (2) make corporate sidepayments so all classes of the corporation's securityholders receive

more or less as much wealth as such classes would otherwise attain

through alternative nonexpropriating corporate decisions.192

B. WHAT IS FAIR?

Appraisal Creditors' argument applies Weinberger's general lan-guage to Debtor and Debtor's argument applies Weinberger's specificlanguage to Appraisal Creditors. Appraisal Creditors' and Debtor'sargument applies existing law and a coercive risk-diversification pol-icy to Contractual Creditors. Contractual Creditors' argument ap-plies financial and fiduciary theory to Appraisal Creditors andDebtor.

What is fair? An advocate's answer to this question might be"Who is my client?" A scientist's answer to this question might be"What is the problem?"1 93 Because fairness within a system arguablymeans congruence with the postulates of that system and because

190. Id.191. Schnell v. Chris-Craft Indus., 285 A.2d 437, 439 (Del. 1971).192. "As long as the total market value of the firm has increased... those who are

better off receive more than enough to compensate in turn those who are worse offand so induce the latter to go along with the decision." E. FAMA & M. MILLER, supranote 9, at 71-72 n.4. Cf Myers, Determinants of Corporate Borrowing, 5 J. FIN. ECON.147, 158 (1977) (discussing renegotiation of the bond contracts). Part (1) forbids thecorporate policies of inefficient use of corporate assets and waste of corporate assets;part (2) compels rectification of unanticipated wealth expropriations resulting fromcorporate decision making. Because a corporate policy of waste of corporate assets isgrossly impermissible on public policy grounds, side payments would not be madeunder the alternative policy of preserving corporate assets. See generally supra notes22-23 and accompanying text. (An alternative corporate decision includes remainingwith the status quo.) The new fiduciary articulation is operationally consistent withthe duty of the board of directors to seek "the maximization of the company's value ata sale for the stockholders' benefit," Revlon, Inc. v. MacAndrews & Forbes Holdings,Inc., 506 A.2d 173, 182 (Del. 1986) (stating that directors' duties of loyalty and care tostockholders were violated by asset-option lock-up and no-shop agreements which hadas their principal object the protection of bondholders through interfering "with get-ting the best price for the stockholders at a sale of the company"), because it requiresdirectors to maximize the value of corporate assets and to make corporate side pay-ments so stockholders receive as much wealth as they would otherwise attain throughalternative nonexpropriating corporate decisions.

193. See T. KUHN, THE STRUCTURE OF SCIENTIFIC REVOLUTIONS 109-10, 148 (2d ed.1970) (stating the proposition that different paradigms perceive and solve differentproblems regarding common underlying facts).


only Contractual Creditors' argument is logically congruent with theapplicable theoretical structure of corporate finance, ContractualCreditors state the fair position from the viewpoint of corporate fi-nance. The new fiduciary articulation is fair to all classes of the cor-poration's securityholders because it compels efficient use ofcorporate assets with side payments so as to maximize gains and min-imize losses for all such classes.

The "transactions-costs view"194 that a managerial fiduciary dutyto bondholders should be created on the ground of the costs involvedin contracting for bond protective contractual provisions and withoutthe foundation of a bondholder-management fiduciary relation' 95

seems to be in error because: (1) the transactions costs aspect of thefiduciary formula cannot impose duties (obligations) without thefoundation of a fiduciary relation,196 and (2) such transactions costsand their bond protective contractual provisions become irrelevantthrough bond pricing in the efficient capital market fully reflectingthe extent to which bond protective contractual provisions are lessthan perfect or do not exist.197 Furthermore, the transactions-costview cannot solve the problem of the transformation of perfect exante contractual specificities in bond pricing into imperfect ex postcontractual specificities' 98 because: (1) a fully protected contract (in

194. The transactions-costs view should not be confused with the costly-contractinghypothesis. The bond-pricing issue of inherent ex post unanticipated wealth expropri-ations, see supra text accompanying note 45; Smith, Jr. & Warner, supra note 39, at119 n.5, is separable from views "about whether the total value of the firm is influ-enced by the way in which the bondholder-stockholder conflict is controlled." Id. at119. The "costly contracting hypothesis" states "that control of the bondholder-stock-holder conflict through financial contracting can increase the value of the firm," id at121, whereas the "irrelevance hypothesis" states that control of "the bondholder-stock-holder conflict does not change the value of the firm." Id. at 120. The evidence sup-ports the costly-contracting hypothesis. Id at 153. This means that economic factors"are insufficient to induce the stockholders to maximize the value of the firm ratherthan maximizing the value of the equity." Id at 121. The factual dominance of thecostly-contracting hypothesis is to be expected because the unrestricted capital markettakeover mechanism, supra note 21 and accompanying text, supporting the irrelevancehypothesis when corporate investment policy is not fixed, see Smith, Jr. & Warner,supra note 39, at 120, is neutralized by our corporate law's policy of permissive mana-gerial resistance to takeovers. See supra text accompanying notes 176-77.

195. See McDaniel, supra note 71, at 447, 456.196. See supra note 173 and accompanying text. See also SEC v. Chenery Corp.,

318 U.S. 80, 85-86 (1943) (stating that fiduciary status precedes content definitionwithin that status). Thus, notions about "efficient" or "optimal" fiduciary duties, Mc-Daniel, supra note 71, at 447 & nn.176-78, seem to have no meaning in the absence of afiduciary relation which is the foundation for such fiduciary duties.

197. See supra notes 28, 43-44 and accompanying text. Cf AM. BAR FOUND., supranote 6, at 13 (stating: "Of great importance, of course, is the relationship between thestrength of the covenants and the other negotiated terms, including the interestrate.").

198. See supra text accompanying note 45.


which the extent of protection is determined by and correspondinglyallocated to the specific risks anticipated) 199 is not a continuous pro-cess of recontracting, and (2) the transactions costs aspect of the fidu-ciary formula cannot admit of a continuous recontracting notionwhen the parties agree, or seek to agree, on fixed bond pricing.200

In the transactions-costs view, the fiduciary duty to bondholdersis coterminous with the contractual obligation to bondholders20 1 be-cause a fiduciary duty created on the ground of the costs of con-tracting is logically subsumed into the fact of such contracting. Incontrast, the new fiduciary articulation is not limited in its applica-tion by bond contractual obligations.

V. THE NEW FIDUCIARY ARTICULATION

A. GLOBAL WEALTH MAXIMIZATION

The generalized anomaly in the rule of corporate current-mar-ket-value maximization defines the new fiduciary articulation be-cause it specifies what is to be rectified. Because this generalizedanomaly applies generally to the corporation, 20 2 its new fiduciary ar-ticulation counterpart correspondingly applies generally to our corpo-rate law. This new fiduciary articulation requires the corporationand its officers and directors to: (1) maximize the present value ofthe returns, evaluated with respect to all eventualities, on corporateassets, and (2) make corporate side payments so all classes of the cor-poration's securityholders receive more or less as much wealth assuch classes would otherwise attain through alternative nonex-propriating corporate decisions. 20 3 By its terms, the new fiduciary ar-ticulation solves by external imposition the following problem:20 4

199. Cf. Posner, supra note 53, at 508 (1976) (indicating that overprotection of cred-itors is possible).

200. See supra note 173 and accompanying text.201. See McDaniel, supra note 71, at 443, 447. Cf. Broad v. Rockwell Int'l Corp.,

642 F.2d 929, 958-59 (5th Cir.), cert. denied, 454 U.S. 965 (1981). For a discussion of theview that Broad did not give due consideration to an unanticipated change in Iowa law(removing the prohibition on cash-out mergers) which affected the contractual rightsand conversion value of the convertible subordinated debentures held by the originalpurchasers, see Recent Decisions, Trustee Under an Indenture, Issuing Corporation,and Successor Corporation Did Not Breach Indenture or Fiduciary Duties to Holdersof Convertible Subordinated Debentures by Eliminating Bondholders' ConversionRights Pursuant to A Merger-Broad v. Rockwell International Corp., 30 EMORY L.J.1167, 1168 n.3, 1200-02, 1205-09 (1981). Thus, Broad partially illustrates the unantici-pated wealth expropriation problem discussed supra in the text accompanying notes43-46.

202. See supra note 42 and accompanying text.203. For the limitation on corporate side payments while there is a significant

chance of corporate bankruptcy, see supra note 192.204. The classical conception's, see supra text accompanying note 65, objection that

it is necessary to maintain "the idea that agents (managers) are accountable to their

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Stockholder use (or misuse) of production/investmentpolicy frequently involves not some action, but the failure totake a certain action (e.g., failure to accept a positive netpresent value project). Because of this, investment policycan be very expensive to monitor, since ascertaining that thefirm's production/investment policy does not maximise thefirm's market value depends on magnitudes which are costlyto observe. Solutions to this problem are not obvious. Forexample, if the indenture were to require the bondholders(rather than the stockholders) to establish the firm's invest-ment policy, the problem would not be solved; the bondhold-ers, acting in their self interest, would choose an investmentpolicy which maximized the value of the bonds, not thevalue of the firm.20 5

The new fiduciary articulation formalizes the evolutionary sepa-ration of corporate management from rank-and-file stockholder con-trol.20 6 It benefits employees, communities, and national economicorganization because it implicitly forbids corporate decisions whichincrease the risk of corporate bankruptcy without correspondinglymaximizing the present value of the corporation's assets. 20 7 Ingeneral, it inherently overrides bond protective contractual provi-sions because such provisions restrict the corporation's freedom to

principals (shareholders)," Easterbrook & Fischel, supra note 2, at 1191, concededlydoes not apply to bondholders because managers are also their agents, see id. at 1195;and is otherwise overcome by: (a) the rule of corporate current-market-value max-imization in which bondholders and stockholders are interchangeable with respect tomanagement, and (b) the Black-Scholes conception of the corporation in which bond-holders are, in general, the first equitable owners of the corporation's assets and cashflow. The objection regarding "prejudice (to] shareholders by decreasing the incentiveof management to act in their best interest," id. at 1192, is overcome by the expressrequirements of the new fiduciary articulation. Additional objections regarding un-knowable future decisions by possible takeover successors, how to balance possiblegains and losses, etc., see id. at 1190-91, are likewise overcome by the express require-ments of the new fiduciary articulation.

205. Smith, Jr. & Warner, supra note 39, at 130 (footnote omitted). Accord W.KLEIN, supra note 20, at 190 (stating, with respect to bondholder-stockholder, commonstockholder - preferred stockholder and option/warrantholder - stockholder corpo-rate conflicts of interest: "There appears to be no fully satisfactory solution to theproblem that may be created by this kind of prospective conflict .... [I]t appears tohave received little analytic attention.").

206. See A.A. BARLE & G.C. MEANS, THE MODERN CORPORATION AND PRIVATEPROPERTY 119-125, 356-57 (1932); Fama, supra note 141, at 290; Jensen & Meckling,supra note 20, at 343-51, 353. For a review of schools-of-thought (models) regardingcorporate governance, see Mangrum, In Search of a Paradigm of Corporate Social Re-sponsibility, 17 CREIGHTON L. REV. 21, 26-49 (1983). The "public interest" model's con-cern about the separation of corporate ownership and control, see id. at 33 istheoretically overcome by a "scientific" model (the new fiduciary articulation) whichintegrates financial theory with the "contract" and "rights" models of corporategovernance.

207. See supra notes 71, 73-74 & 192 and accompanying text.


maximize returns on corporate assets208 in competitive business ma-neuver:209 the continuing managerial fiduciary duties under the newfiduciary articulation cannot be contracted away by the parties be-cause they are superimposed on public policy grounds.210 The new fi-duciary articulation requires immunization (e.g., by book-entrychanges in bond redemption value) of the corporation's securitiesfrom unanticipated wealth expropriations resulting from corporatedecisions, but it does not require immunization from all unantici-pated changes in risk or value because it speaks solely to corporatedecision making.

The new fiduciary articulation is the economic functionalequivalent of the bundle (vector) of possible corporate fiduciary du-ties because the essential concern for all investors in the for-profitcorporation is wealth maximization. Conflicting ideals create elabo-rate systems of learning which disappear when these conflicts are re-solved:21' "[T]he rules that govern the managers' duty of care havebeen distinguished from the rules governing the duty of loyalty....The duty of loyalty and the duty of care ... are treated differently,with the business judgment rule covering only the latter. '212 Withrespect to the integrated managerial activity of decision making,21 3 itis a conflict of ideals to: (1) have a judicial hands-off policy of sup-porting managerial prerogatives through an operationally advisory fi-duciary duty (duty of care with the business judgment rule),214

(2) have a judicial hands-on policy of supporting rectification of inves-tor grievances through an operationally compulsory fiduciary duty(duty of loyalty with the entire-fairness careful-scrutiny rule),215

208. See supra note 180 and accompanying text.209. See supra note 178 and accompanying text.210. Bond contractual provisions regarding corporate payment priorities do not re-

strict corporate operations and thus would not be overridden by the new fiduciaryarticulation.

211. T. ARNOLD, THE FOLKLORE OF CAPITALISM 364-65 (1937).212. Easterbrook & Fischel, supra note 2, at 1197. For a statement of the Dela-

ware business judgment rule, see Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984). Fora discussion of duty of care and duty of loyalty issues, see Hinsey, Business Judgmentand the American Law Institute's Corporate Governance Project: The Rule, the Doc-trine, and the Reality, 52 GEO. WASH. L. REV. 609 (1984); Manning, The Business Judg-ment Rule and the Director's Duty of Attention: Time for Reality, 39 BUS. LAW. 1477,1492-97 (1984); Ruder, Duty of Loyalty - A Law Professor's Status Report, 40 BuS.LAW. 1383 (1985); Veasey, Further Reflections on Court Review of Judgments of Direc-tors: Is the Judicial Process Under Control?, 40 Bus. LAW. 1373 (1985). See also RE-STATEMENT (SECOND) OF AGENCY §§ 379, 387 (1957); RESTATEMENT (SECOND) OFTRUSTS §§ 170, 174 (1957).

213. See C. BARNARD, THE FUNCTIONS OF THE EXECUTIVE 185-211 (13th ed. 1968).214. See Johnson v. Trueblood, 629 F.2d 287, 292 (3d Cir. 1980). See generally Uno-

cal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 954 (Del. 1985).215. See Weinberger, 457 A.2d at 710. For a statement of the entire-fairness care-

ful-scrutiny rule, see infra text accompanying note 240.

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(3) allocate the burden of proof under the operationally compulsoryfiduciary duty so as to reconstitute the operationally advisory fiduci-ary duty,2 16 and (4) sometimes allocate the burden of proof under theoperationally advisory fiduciary duty in a manner which resemblessuch allocation under the operationally compulsory fiduciary duty.217

An underlying theoretical reason for the conjointment of such con-flicting ideals seems to be that our adversarial procedural structure- in which issue resolution occurs through dialectical alternationunder a neutral (nondirected or passive) adjudicator - is partially in-appropriate for the adjudication of problems in which there is an in-tertwining of issues.2 18

By its terms, the new fiduciary articulation points to:(a) derivative claims for its part (1) breach because the corporation isthe legal owner of its assets, and (b) individual claims for its part(2) breach because side payments are an inherent incident of corpo-rate security ownership under it.219 Because there cannot be a basisfor a derivative claim without a corresponding individual claim forside payment by some securityholder and because there can be a

216. See infra text accompanying notes 247-49.217. See Unocal Corp., 493 A.2d at 954-58 (discussing and enhanced duty of care

with the business judgment rule based, in part, on duty of loyalty consideration, statedin Guth v. Loft, Inc., 5 A.2d 503, 510 (Del. 1939)). "While the business judgment rulemay be applicable to the actions of corporate directors responding to takeover threats,the principles upon which it is founded - care, loyalty and independence - must firstbe satisfied." Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 180(Del. 1986) (footnote omitted).

218. See Fuller, Adjudication and the Rule of Law, 1960 PROC. AM. SOC'Y INT'L L.1, 3-5 (discussing polycentric problems). For other considerations, compare Moran v.Household Int'l, Inc., 490 A.2d 1059, 1074 (Del. Ch.) (stating that "[b]ecause the role ofa fiduciary ordinarily does not admit of any conflicting interests or conduct the busi-ness judgment rule seeks to accommodate that status to the realities of the businessworld."), affd, 500 A.2d 1346 (Del. 1985) with Easterbrook & Fischel, supra note 2, at1199 (stating that the rationales underlying the business judgment rule are "the inabil-ity of courts to make better business decisions than managers" and "the inefficiencythat would result were managers encouraged to disregard the costs of gathering infor-mation and making decisions"). Given our adversarial procedural structure, the di-chotomy between monocentric (justiciable) and polycentric (nonjusticiable) problemsis a ground under the new fiduciary articulation for the use of a generic business judg-ment rule and of a generic entire-fairness careful-scrutiny rule: in general, businessproblems essentially are polycentric (this would be the presumption of a business judg-ment rule) except for possible conflicts between fiduciary duties, etc., which essentiallyare monocentric (this would be the presumption of an entire-fairness careful-scrutinyrule).

219. Cf. Abelow v. Symonds, 38 Del. Ch. 572, 578, 156 A.2d 416, 420 (1959) (statingthat individual claims are "designed to enforce common rights running against plain-tiffs' own corporation or those dominating it, while" derivative claims are designed"for the purpose of remedying wrongs to the corporation itself"). For a discussion ofthe characterization of stockholder claims as derivative or individual, see Welch,Shareholder Individual and Derivative Actions: Underlying Rationales and theClosely Held Corporation, 9 J. CORP. L. 147, 148 & nn.1-3, 149-69 (1984).


basis for an individual claim for side payment without a correspond-ing derivative claim by some securityholder, 220 the individual claimoverrides the derivative claim.22 1 For example, there cannot be a de-rivative claim regarding a nonsynergistic merger per se because thecorporation's assets (market value) are not damaged, but there can bean individual claim for side payment regarding an unanticipatedwealth expropriation in such a merger.222 What do such individualclaims mean for corporate governance? The answer to this questionis to be found in the logical extension of Weinberger's views.

B. PROCEDURAL FAIRNESS

1. Additional Factual Aspects of Weinberger

Four dual parent-subsidiary directors - in differing internalcombinations - requested, performed, and discussed a feasibilitystudy on the parent's acquiring the subsidiary's remaining publiclyheld shares.223 This feasibility study used the subsidiary's "informa-tion for the exclusive benefit of" the parent224 and concluded "that itwould be a good investment for [the parent] to acquire the remaining49.5% of [the subsidiary's] shares at any price up to $24 each."225 Thesubsidiary's president, a dual parent-subsidiary director who partici-pated in the parent's executive committee meeting which

220. Also, a securityholder might recast a derivative claim into an individual claimfor side payment if there is a procedural advantage (e.g., application of an entire-fair-ness careful-scrutiny rule instead of a business judgment rule) in doing so.

221. See generally Bratton, Jr., The Economics and Jurisprudence of ConvertibleBonds, 1984 WIs. L. REV. 667, 733-39; Clark, The Duties of the Corporate Debtor to itsCreditors, 90 HARV. L. REV. 505 (1977); Coffee, Jr. & Schwartz, The Survival of the De-rivative Suit: An Evaluation and a Proposal for Legislative Reform, 81 COLUM. L.REV. 261, 262 (1981); Levmore, Monitors and Freeriders in Commercial and CorporateSettings, 92 YALE L.J. 49, 80-82 (1982); Note, Creditors' Derivative Suits on Behalf ofSolvent Corporations, 88 YALE L.J. 1299 (1979); Note, Public Creditors of Financial In-stitutions: The Case for a Derivative Right of Action, 86 YALE L.J. 1422, 1446-47 (1977).The argument that the economic case for bondholder derivative suits is compelling be-cause their misconduct-deterrence effect leads to a reduction in the cost of debt capital,McDaniel, supra note 71, at 452 & nn.214-16, seems to be irrelevant from the viewpointof the corporation's bondholders because the corporation's securityholders are indiffer-ent about its financing decisions within the rule of corporate current-market-valuemaximization. See supra note 17 and accompanying text. In general, the separabilityof corporate financing and operating decisions occurs when there is no optimal capitalstructure for the corporation, see Miller, Debt and Taxes, 32 J. FIN. 261, - (1977), orwhen an optimal capital structure is not changed by the corporation, see DeAngelo &Masulis, Optimal Capital Structure Under Corporate and Personal Taxation, 8 J. FIN.ECON. 3 (1980).

222. See supra note 48 and accompanying text.223. Weinberger, 457 A.2d at 705. There were seven parent designee directors (six

dual parent-subsidiary directors) on the subsidiary's thirteen member board of direc-tors. Id. at 704-05.

224. Id. at 709.225. Id. at 705.


responsively authorized its management to arrange for a subsidiarycash-out merger within the price range of $20 to $21 per share and topresent a merger proposal to the parent's board of directors fourbusiness days later,226 retained an investment banking firm to pro-vide a fairness opinion on the prospective cash-out merger offer.2 27

He did not at any time seek a cash-out share price higher than $21per subsidiary share;228 there was no parent-subsidiary bargainingover the cash-out share price.2 29

The parent and subsidiary boards of directors met - separately,but with telephone contact maintained between the meetings - toconsider the cash-out merger proposal.230 The parent formally pro-posed to the subsidiary a $21 per share cash-out merger agreementrequiring that the minimum number of the subsidiary's majority ofthe minority shares voting for the merger equal about two-thirds ofall the subsidiary's minority shares.231 The subsidiary's investmentbanking opinion letter, which was hurriedly prepared during the fourbusiness day span, found the $21 share price to be fair.232 Althoughthe parent's feasibility study with its $24 subsidiary share price valua-tion "was made available to" dual parent-subsidiary directors,233 itwas not discussed at the subsidiary's board meeting 234 nor sharedwith the subsidiary's nonparent designee directors.235 The subsidi-ary's board of directors, with the active nonvoting participation andsupport of its parent designee directors, adopted a resolution to ac-cept the parent's $21 per share cash-out merger offer.236

The cash-out merger agreement was approved by a majority voteof the subsidiary's minority shares at the subsidiary's annual meetingfifty-nine business days later.237 The subsidiary's proxy statement re-garding this cash-out merger agreement vote did not disclose:(1) "the circumstances surrounding the rather cursory preparation ofthe [investment banking] fairness opinion" while "the impression wasgiven [the subsidiary's] minority that a careful study had beenmade, '23 8 and (2) "the critical information that [the parent]

226. Id. at 705-06.227. Id. at 706.228. Id. at 706, 711.229. Id. at 711.230. Id. at 707.231. Id.232. Id.233. Id at 709.234. Id. at 707.235. Id. at 708.236. Id. at 707.237. Id. at 708 (stating the percentage as "51.9% of the total minority").238. Id. at 712.

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considered a price of $24 to be a good investment. '239

2. Additional Dicta Aspects of Weinberger

Weinberger states that "where one stands on both sides of atransaction, he has the burden of establishing its entire fairness, suf-ficient to pass the test of careful scrutiny by the courts. '240 Wein-berger views procedural-fairness standards as testing for arm's-lengthbargaining in an otherwise self-dealing transaction:24 1 Proceduralfairness at the subsidiary's negotiating level includes the dual parent-subsidiary directors' absolute noninvolvement in the transaction oran independent negotiating committee of outside directors bargainingwith the parent at arm's length.242 Procedural fairness at the subsid-iary's stockholder level includes neutralized voting, whereby a major-ity of the subsidiary's minority shares can approve or disapprove themerger,243 based on complete disclosure of "all material facts rele-vant to the transaction" by "those relying on the vote. '244 Becausean informed vote of the majority of the subsidiary's minority sharesapproving the merger will shift the burden of proof back to thestockholder "plaintiff attacking the merger, '245 and because an in-dependent negotiating committee of the subsidiary's outside directorsis "strong evidence" of fairness,2 46 these independent means of proce-dural fairness are strongly mutually reinforcing.

The entire-fairness careful-scrutiny rule logically (by its terms)does not apply while adequate procedural fairness exists becausethere is no possible conflict of fiduciary duties.247 Hence, "an acquisi-tion with these procedural protections would be reviewed by thecourts under a standard resembling the 'business judgment' rule ap-plicable to an acquisition by an unrelated third party. '248 In otherwords, the allocation of the burden of proof under an entire-fairnesscareful-scrutiny standard of judicial review reconstitutes a business

239. Id.240. Id. at 710. "There is no 'safe harbor' for such divided loyalties in Delaware."

Id. For Weinberger's definition of "entire fairness" in the cash-out merger context,see id. at 711. Cf. Revlon, Inc., 506 A.2d 173, 182 (stating that "the... board could notmake the requisite showing of good faith by preferrint the noteholders and ignoring itsduty of loyalty to the shareholders").

241. See Weinberger, 457 A.2d at 703, 709-11.242. Id. at 710-11.243. Id. at 703, 707.244. Id. at 703.245. Id.246. Id. at 709-10 n.7.247. See supra text accompanying note 240.248. Chazen, Fairness from a Financial Point of View in Acquisitions of Public

Companies: Is "Third-Party Sale Value" the Appropriate Standard?, 36 Bus. LAW.1439, 1441 (1981) (footnote omitted).

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judgment rule through procedural fairness standards.249

Thus, Weinberger represents the generalized view that a corpo-rate decision requires an entire-fairness careful-scrutiny standard ofjudicial review, which reconstitutes a business judgment rule throughprocedural-fairness standards, when there is a possible conflict of fi-duciary duties on the corporate decision maker regarding thatdecision.

250

3. The Procedural-Fairness Structure

The foundation of a securityholder-management fiduciary rela-tion proceeds from the rule of corporate current-market-value max-imization and the Black-Scholes conception of the corporation. 25 1

The possible conflict of fiduciary duties on management to the classesof the corporation's securityholders proceeds from the generalizedanomaly in the rule of corporate current-market-value maximiza-tion.252 This possible conflict is reconciled and the rule of corporatecurrent-market-value maximization is restored by the new fiduciaryarticulation which neutralizes such generalized anomaly.25 3 An indi-vidual claim for side payment ipso facto alleges management's breachof the new fiduciary articulation and the operation of such genera-lized anomaly with its consequent possible conflict of fiduciary duties.Because of this possible conflict of fiduciary duties, an entire-fairnesscareful-scrutiny rule with its procedural-fairness reconstituted busi-ness judgment rule logically applies to judicial review of individualclaims for side payments.254

Thus, an entire-fairness careful-scrutiny rule overrides a busi-ness judgment rule in judicial review of individual claims. If thereexists only one de facto class of the corporation's securityholders, 255

249. See supra text accompanying notes 245-48.250. See supra text accompanying notes 240-01, 245-49.251. See supra notes 160-71 and accompanying text.252. See supra note 42 and accompanying text.253. See supra notes 19, 22-23, 42, & 192 and accompanying text.254. See supra notes 218, 250 and accompanying text. In other words, an entire-

fairness care-scrutiny rule applies because management stands on both fiduciary sidesof a decision involving a possible bondholder-stockholder corporate conflict of interest.An otherwise essentially polycentric (nonjusticiable) management decision is trans-formed into an essentially monocentric (justiciable) decision between conflicting fidu-ciary duties which conforms to the monocentric organization of our adjudicatorysystem. In the Black-Scholes conception of the corporation, each class of securi-tyholders has a call option on the equitable corporate ownership by the immediatelysenior (prior) class of securityholders. Thus, fiduciary conflicts regarding classes of thecorporation's securityholders involve a nesting of monocentric conflicts and not apolycentric conflict.

255. The existence of only one de facto class of the corporation's securityholderswould occur, for example, when all investors own either efficient market portfolios orequal proportions of the classes of the corporation's securities.

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then the part (2) requirement of the new fiduciary articulation sim-plifies into a requirement for unilateral side payments. A businessjudgment rule logically applies to judicial review of individual claimsfor unilateral side payments because there is no possible conflict offiduciary duties regarding such claims.256

In an individual claim for side payment, the securityholderwould need to allege management's objective failure to meet the sidepayment requirement of the new fiduciary articulation. This wouldinvoke entire-fairness careful-scrutiny with the burden of proof onmanagement to show its compliance with the new fiduciary articula-tion. If management can show requisite "procedural fairness," thenthe burden of proof would shift to the securityholder to show man-agement's noncompliance with the new fiduciary articulation: a re-constituted business judgment rule would apply.

"Entire fairness" in this context logically means compliance withthe requirements of the new fiduciary articulation. "Procedural fair-ness" in this context might include a "fiduciary compliance group" inwhich: (1) an independent (e.g., tenured for a fixed term) profes-sional management committee makes the corporation's side-paymentdecisions - this might be "strong evidence" of fairness, 25 7 and(2) there is representation and veto power (under the new fiduciaryarticulation) by each class of the corporation's securityholders, withcomplete disclosure by management of all material facts, regardingsuch side-payment decisions - this might shift the burden of proofback to the securityholder plaintiff challenging such decisions.258

In other words, some form of participation by the classes of thecorporation's securityholders in the ongoing managerial decision-making process seems to be necessary in order to ensure protectionof their economic interests.25 9 In this context, a reconstituted

256. See supra note 218 and accompanying text. An otherwise essentiallymonocentric (justiciable) management decision between conflicting fiduciary duties istransformed into an essentially polycentric (nonjusticiable) decision which does notconform to the monocentric organization of our adjudicatory system. Although thenew fiduciary articulation's part (2) requirement for side payments might be consid-ered as extinguished when there is only one de facto class of the corporation's securi-tyholders, its function of compelling appropriate corporate class payments continues toapply under such facts. For example, a claim for unilateral side payment seems to beappropriate when there is a wrongful denial of a dividend to the sole de facto class ofthe corporation's securityholders.

257. Cf Weinberger, 457 A.2d at 709-10 n.7, 711.258. Cf id. at 703, 707.259. See Jensen & Meckling, supra note 20, at 338; Smith, Jr. & Warner, supra

note 39, at 130. Whereas bondholder participation on the board of directors mightmake such bondholders "control persons under the federal securities laws," McDaniel,supra note 71, at 441, and "'insiders' under the federal bankruptcy law," id., bond-holder participation in the procedural-fairness structure would not do that because thisstructure is exclusively directed toward the expropriation consequences of corporate

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business judgment rule prevents unjustified paralysis of the corpora-tion. Thus, the objection that a "manager responsible to two conflict-ing interests is in fact answerable to neither" 260 is overcome by thenew fiduciary articulation (securityholders' unanimity) with its pro-cedural fairness structure.

VI. CONCLUSION

Our corporate fiduciary law is incongruous with the corporate-fi-nancial structure in which it is operationally embedded. Given theestablishment of coherence between the theoretical structures of cor-porate finance and corporate fiduciary law, adjustment of our corpo-rate fiduciary law to the less-than-ideal conditions of particular casesfollows as a matter of course.

Economic conflicts among the classes of the corporation's securi-tyholders proceed from the generalized anomaly in the rule of corpo-rate current-market-value maximization, and such conflicts areintensified through the expropriation tendency by risk-averse stock-holders. In particular, bondholder-stockholder unanticipated wealthexpropriations are a consequence of the failure of contractual order-ing to provide perfect protection for bondholders' and/or stockhold-ers' wealth.

An equal generic managerial fiduciary duty to all the corpora-tion's securityholders arises out of the rule of corporate current-mar-ket-value maximization, and managerial fiduciary duties to theclasses of the corporation's securityholders arise out of equitableownerships of the corporation's assets and cash flow by such classesunder the Black-Scholes conception of the corporation. Fiduciarylaw permits compensation and the imposition of a fiduciary obliga-tion regarding bondholder-stockholder unanticipated wealth expro-priations resulting from corporate decision-making. This fiduciaryobligation is the neutralizing counterpart to the generalized anomalyin the rule of corporate current-market-value maximization. Formal-ized as "the new fiduciary articulation," it requires the corporationand its officers and directors to: (1) maximize the present value ofthe returns, evaluated with respect to all eventualities, on corporateassets, and (2) make corporate side payments so all classes of the cor-poration's securityholders receive more or less as much wealth as

decisions which are made by others. (Although side payments through this structurewould not be made while there is a significant chance of corporate bankruptcy, seesupra note 192, this structure's monitoring function continues to apply under suchfacts.)

260. Easterbrook & Fischel, supra note 2, at 1192.

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such classes would otherwise attain through alternative nonex-propriating corporate decisions.

The new fiduciary articulation subsumes existing corporate fidu-ciary duties and overrides bond protective contractual provisionswhich violate its requirements. It implicitly forbids corporate deci-sions which increase the risk of corporate bankruptcy without corre-spondingly maximizing the present value of the corporation's assets.Under it, in general, individual claims for side payments override de-rivative claims; and on entire-fairness careful-scrutiny rule overridesa business judgment rule and reconstitutes a business judgment rulethrough procedural-fairness standards.

financial articulation of a fiduciary duty to bondholders

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