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Citation: 3 Cardozo L. Rev. 627 1981 - 1982

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The literature on corporate governance' has gone through several
phases of development. The first phase began with the seminal work
of Berle and Means 2 which espoused the view that control of the
corporation 3 rests with the directors and officers. After conducting an
empirical investigation of the two hundred largest nonfinancial corpo-
rations in America in 1929, they concluded that control is divorced
from ownership when corporate wealth is widely dispersed, 4 thereby

This Note will be limited to a discussion of the rules and remedies designed to improve
corporate governance of publicly held corporations. A corporation is publicly held if its securities
are traded on an exchange or are quoted over the counter. See generally W. CARY & M.
EISENBERG, CASES AND MATERIALS ON CORPORATIONS 15-18 (5th ed. 1980) (listing the major
economic and legal characteristics of a publicly held corportion). Corporate governance of
closely held corporations poses different questions which are beyond the scope of this Note. See
generally Hetherington, The Minority's Duty of Loyalty in Close Corporations, 1972 DUKE L.J.
921 (examination of special fiduciary responsibilities in the setting of the closely held corpora-
tion); Hetherington, Special Characteristics, Problems, and Needs of the Close Corporation,
1969 U. ILL. L.F. 1 (detailed analysis of the problems facing a closed corporation and the needs
for appropriate legislative reform); Hornstein, A Remedy for CorporateAbuse-JudicialPower
to Wind Up a Corporationat the Suit of a Minority Shareholder,40 COLUM. L. REV. 220 (1940)
(comment upon the need and availability of dissolution to remedy wrongdoing in the closely held
corporation); O'Neal, Close CorporationLegislation: A Survey and an Evaluation, 1972 DUKE
L.J. 867 (outline of the inadequacies in legislation which fails to address the specialized concerns
of the closely held corporation); O'Neal, Oppugnancy and Oppression in Close Corporations:
Remedies in America and in Britain, 1 B.C. INDUS. & COM. L. REV. 1 (1959) (discussion of the
heavy impact of dissension in a closely held corporation and the remedies available to sharehold-
ers in that type of business organization). The courts have dealt differently with closely held
corporations than they have with publicly held corporations, especially with regard to the
shareholders' derivative action and the award of remedies. See Bradley, A Comparative Evalua-
tion of the Delaware and Maryland Close Corporation Statutes, 1968 DuE L.J. 525, 543-52
(dissolution by judicial decree initiated by shareholders of closely held corporations compared
with statutes authorizing dissolution by shareholder vote); see also DEL. CODE ANN. tit. 8, §§
341-356 (1974 & Supp. 1980) (special rules regulating the statutory closed corporation); Commit-
tee on Corporate Laws, Proposed Statutory Close CorporationSupplement to the Model Business
CorporationAct, 37 Bus. LAW. 269 (1981) (proposal for same).
3 "Control" of the corporate enterprise was defined as possession of the power to select the
board of directors or dictate to management. Id. at 69-70.
1 Berle and Means found that in 65 of the 200 largest nonfinancial corporations in 1929, no
one shareholder or compact group owned as much as 5% of the company's stock and that in 16
more cases the largest block of shares was in the 5% to 20% range. More specifically, their
survey indicated that 65% of these 200 corporations were controlled by management or legal
device, 23% by minority blocks of shares (defined as about 20% of all shares) and in only 12%
was corporate control in the hands of a majority of shareholders, private owners, or a receiver.
Id. at 94-118.

628 CARDOZO LAW REVIEW [Vol. 3:627

permitting the directors and officers to manage the corporation with-
out significant shareholder participation.
The second phase of analysis centered on where, within the
management levels of the corporation, actual power and control is
located. The commentators who conducted this analysis directly chal-
lenged the accuracy of the legal model of corporate governance,
which asserts that the corporate entity is managed by a board of
directors 5 elected by the shareholders, 6 and concluded that the board
of directors does not, in fact, manage the corporation. 7 In other

The separation of ownership from control of the corporation noted by Berle and Means still
exists 40 to 50 years later. See Larner, Ownership & Control in the 200 Largest Nonfinancial
Corporations, 1929 and 1963, 56 AM. ECON. REV. 777, 783 (1966) (160 cases in which the
corporation was controlled by management); see also W. CARY & M. EISENBERG, supra note 1, at
212 ("Further dispersion . . . has undoubtedly taken place since 1963."); Jones, Corporate
Governance: Who Controls the Large Corporation?,30 HASTINGS L.J. 1261 (1979) (statistics
show that, expect in rare cases, management is firmly in control of the corporate enterprise).
Even in the quasi-publicly traded corporation, i.e., corporations with between 11 and 499
shareholders, the "public shareholders ... are not involved in active management." Knauss,
CorporateGovernance-A Moving Target, 79 MICH. L. REv. 478, 481 (1981). See generally M.
statistics relevant to concentration of shareholdings in relation to the expectations of shareholder
participation in corporate affairs).
Cary and Eisenberg, however, warn that although this type of data "is impressive and
important," W. CARY & M. EISENBERG, supra note 1, at 211, control of the corporation by
management should be distinguished from shareholder participation in certain corporate activi-
ties. Id. at 211-12. See infra note 38 and accompanying text. In any event, there is a virtual
consensus that shareholder democracy is a myth. See infra note 40 and accompanying text.
5 See, e.g., DEL. CODE ANN. tit. 8, § 141(a) (Supp. 1980) ("The business and affairs of every
corporation organized under this chapter shall be managed by or under the direction of a board
of directors .... ); N.Y. Bus. CORP. LAW § 701 (McKinney Supp. 1981-1982) ("Subject to any
provision in the certificate of incorporation . . . the business of a corporation shall be managed
under the direction of its board of directors .... ); OHIO REV. CODE ANN. § 1701.59 (Page
Supp. 1981) ("[E]xcept where the law, the articles, or the regulations require action to be
authorized or taken by shareholders, all of the authority of a corporation shall be exercised by or
under the direction of its directors."); MODEL BUSINESS CORP. ACT ANN. § 35, para. 1 (2d ed.
Supp. 1977) ("All corporate powers shall be exercised by or under authority of, and the business
and affairs of a corporation shall be managed under the direction of, a board of directors except
as may be otherwise provided in this Act or the articles of incorporation."). For the significance
of the words "under the direction of" in many corporation codes, see infra note 18.
6. See, e.g., DEL. CODE ANN. tit. 8, § 211(b) (1974) ("An annual meeting of stockholders
shall be held for the election of directors .... "). See also Dubin v. Muchnick, 108 Misc. 2d
1042, 1046, 438 N.Y.S.2d 920, 923 (Sup. Ct. 1981) (a shareholder agreement guaranteeing a
minority shareholder's continued tenure as director will not protect against his discharge for
cause. Such an agreement "is illegal as against public policy . . . [and] must be construed as an
obligation to retain him only so long as he keeps the agreement on his part faithfully to act as a
trustee for the shockholders.") (quoting Fells v. Katz, 256 N.Y. 67, 72, 175 N.E. 516, 517
(1931)); State ex rel. Ross v. Anderson, 31 Ind. App. 34, 67 N.E. 207 (1903) (charter provision
for permanent directors is invalid).
I Commentators have long asserted that the officers exert more power over corporate affairs
than the directors. See, e.g., Dwight, Liability of CorporateDirectors, 17 YALE L.J. 33 (1907)
(identifying nonworking directors as a factor resulting in management domination of corpora-


words, this analysis suggests that not only are shareholders effectively
denied their franchise, as Berle and Means concluded, but directors
also lack a participatory role in governing corporate affairs. In place
of the legal model, a working model" which vests the management
function in the corporate executives rather than the board of directors
was suggested." The working model of corporate governance has
achieved universal theoretical acceptance.10 A variety of suggestions
have been advanced in an attempt to restructure or regulate the
corporation in order to avoid the perceived inadequacies of the legal
model. I These suggestions include: politicization of the corporation,

tions). Not until recent years, however, has sophisticated methodological research been brought
to bear on the question. See, e.g., J. BAKER, DIREcroas AND THEIR FUNCTiONs-A PRELIMINARY
STUDY (1945). For more detailed and updated findings of the composition and nature of the
modern directorship, see infra notes 55-61 and accompanying text.
8 W. CARY & M. EISENBERG, supra note 1, at 215, defines the working model of corporate
governance as "the model which embodies actual corporate practice [in which] most of the
powers supposedly vested in the board are actually vested in the executives."
9 This, of course, is an oversimplification of the actual organizational structure of most
publicly held corporations since the executives must delegate a significant amount of managerial
responsibility to subordinates. For sources detailing the organization and behavior of corporate
management, see studies cited in Coffee, Beyond the Shut-Eyed Sentry: Toward a Theoretical
View of CorporateMisconduct and an Effective Legal Response, 63 VA. L. REV. 1099, 1101 n.1
(because of the increasing complexity of the business enterprise, the burden of operational
decisionmaking has been reallocated from senior to middle-level management by decentraliza-
tion) with J. K. GALBRAITH, THE NEW INDUSTRIAL STATE (1967) (decisionmaking is exercised by
those people who comprise the corporate technocracy and who have access to information
regardless of their corporate titles). .
'0 W. CARY & M. EISENBERC, supra note 1, at 215 ("[A]ll serious students of corporate affairs
recognize that . . . in the typical large publicly held corporation the board does not 'manage' the
corporation's business in the ordinary meaning of that term."). The failure of the legal model
underlies all the major commentaries dealing with corporate governance. See, e.g., J. BACON,
CorporateGovernance, the Monitoring Board, and the Director'sDuty of Care, 61 B.U.L. REv.
623 (1981).
II Most of the suggested measures for remedying the malady of the legal model urge strength-
ening the board of directors and making it more independent from management. Mr. Harold
Williams, former chairman of the Securities and Exchange Commission, accurately summarized
the present discontent with the legal model when he observed that" '[t]he board, in effect, often
insulates management, rather than holding it accountable.' " Hubbard, Company
Boards Don't Need Uncle Sam, N.Y. Times, June 24, 1979, at F14, col. 3. In addition, Mr.
emphasized the need for corporations to restore public trust in their activities by
making changes in the way they are governed.
.. . Boards should redefine their own responsibilities, and take measures to
accommodate the changed role of the board of directors and the altered environment
in which corporations function ....


federal control over the chartering process, 3 and enhanced share-
holder power.14
The third phase of commentary offers a different suggestion: the
monitoring model of corporate governance.' 5 Recognizing that the
board is unable to manage effectively the publicly held corporation,",

"The core question," he added, "is whether we can improve the existing process
and make it work better, or whether we should take steps to modify or replace it."
*2 See, e.g., C. STONE, supra note 10, at 152-83 (urging the use of public directors appointed
by and responsible to the public).

(presenting the case for federal chartering of American corporations); Cary, Federalism and
Corporate Law: Reflections Upon Delaware, 83 YALE L.J. 663 (1974) (federal minimum stand-
ards); Henning, Federal Corporate Chartering for Big Business: An Idea Whose Time Has
Come?, 21 DEPAUL L. REv. 915 (1972) (federal chartering).
Statutory proposals for the federal incorporation of the American corporation have met
with little success. See Cary, supra, at 700 (The case for federal incorporation is "politically
unrealistic. It has been raised many times in Congress and in the literature but has no public
appeal. American business would unanimously reject such a convenient vehicle for government
control of the major industries of this country."); Dent, supra note 10, at 638-44. For a criticism
of the federal minimum standards proposal, see Winter, State Law, ShareholderProtection, and
the Theory of the Corporation, 6 J. LEGAL STUD. 251 (1977). It is becoming clear that the
political climate in America is no more receptive to this proposal than to the federal chartering
suggestion. Professor Stone's remark that "legislatures are not inclined to come down hard on
their corporate constituents," C. STONE, supra note 10, at 50, applies equally to the United States
" See, e.g., Douglas, Directors Who Do Not Direct, 47 HARv. L. REV. 1305, 1330 (1934)
(proposing organization of corporation to give "scattered and disorganized investors group
strength and power so that they can gain admittance to the councils of business and make their
influence felt around the negotiation table or in the courts."); Eisenberg, Access to the Corporate
Proxy Machinery, 83 HARV. L. REv. 1489 (1970); Note, A Proposalfor the Designation of
ShareholderNominees for Director in the CorporateProxy Statement, 74 COLUM. L. REV. 1139
Some of these proposals are influenced more by the authors' prejudices than by a careful
understanding of corporate organization and its influence on corporate behavior. For example,
although in principle the Nader proposal has appeal, R. NADER, M. GREEN & J. SELIGMAN, supra
note 13, it is questionable whether the public interest director could really be expected to exert
much influence within the corporate organization which is, in fact, structured in ways that
seriously limit such a director's potential effectiveness. See infra notes 66-77 and accompanying
text. Unlike the proposals listed above, the monitoring model is an attempt to define the duties of
the board with a realistic view of corporate organization and management. The model is
intended to restructure the board's oversight responsibilities in order to overcome organizational
obstacles that impede effective board participation in the corporation.
BERG, supra note 4, at 164-77, 198-211; Coffee, supra note 9, at 1147-56; Leech & Mundheim,
The Outside Director of the Publicly Held Corporation, 31 Bus. LAW. 1799, 1804-06 (1976);
Soderquist, Toward a More Effective CorporateBoard: Reexamining Roles of Outside Directors,
52 N.Y.U. L. REV. 1341, 1358-63 (1977).
16 See J. BAKER, supra note 7, at 12; M. EISENBERG, supra note 4, at 139-48; R. GORDON,
BUSINESS LEADERSHIP IN THE LARGE CORPORATION 116-46 (2d ed. 1961); Coffee, supra note 9, at
1136 ("Boards do not set policy, do not veto management, seldom intervene short of a major
crisis, and do not even select their own successors or the next chief executive officer."); Dent,
supra note 10, at 625-29.

In addition. In performing the monitoring duty. 10 Relegating the board to a monitoring function might appear inconsistent with the board's statutory duty to manage the corporation. See infra notes 63.g. See C.' 8 Monitoring responsibilities require initial selec- tion of officers. however. STONE. See supra note 5. CYCLOPEDIA OF THE LAW OF PRIVATE CORPORATIONS § 437 (rev. supra note 10. supra note 10. the board of directors is relieved of its duty to manage and is instead charged with the duty of monitoring or overseeing the execu- tives' performance. 188. 8. 190-94 and accompanying text. Each officer shall hold his office until his successor is elected and qualified or until his earlier resignation or removal. § 142(b) ("Officers shall be chosen . CODE ANN.1982] MONITORING MODEL 631 the monitoring model requires the board of directors to perforin the superego function of the corporate personality. and shall hold their offices for such terms as are prescribed by the bylaws or determined by the board of directors or other governing body. Under the monitoring model. and possibly reviewing long range goals and major projects. at 626 ("The directors' failure to manage springs not from personal negligence but from a basic structural defect in the traditional model of corporate govern- ance . Both models operate on the theory that in spite of managerial duties imposed on directors by statute and corporate charter. The managing duty contained in corporation codes. . id. reviewing transactions between the corporation and insiders. The size and complexity of the publicly held corporation contribute to the board's inability to manage. . and replace- ment of them when necessary. at 632 & n. id.' 9 Implementation of the monitoring model also necessitates establishing a structural network which will enable the board to monitor and effectively critique the corporation's business operations. under the monitoring model it would not do so. at 630-31. 21 See supra notes 10-11. at 633 & nn. DEL. the monitoring model reverses the traditional corporate hier- archy of control and places the primary duty to manage the business operations of the company with the corporate executives. overseeing management's compliance with the law. id. supra note 10. FLETCHER. id. § 141(c) (1974) (board designation of committees). periodic evaluation of their performance. and oversight committees which would include some members of the board. perm. e. § 496. tit. the board would also rely more heavily on independent outside directors. beyond the bare- bone and vague requirements of the corporation codes.48. See 2 W. supra note 10.. ed. selecting accounting procedures. . the executives actually manage and control the corporation. the monitoring functions would include fixing management's compensa- tion. Although the board may not delegate all of its authority. exactly. 20Dent.. however. STONE. These board functions are certainly within the board's statutory grasp. and the addition of the words "or under the direction of" in many codes is sufficiently broad to sanction. the directors are supposed to be doing. 1982). ). 9 More specifically. the monitoring role of the board of directors."). is nowhere defined with any degree of specificity. counter-organiza- 11See C.2 1 In addition. at 141 ("One of the most incredible features of the present-day board system is that. there is almost no authoritative guide as to what. at 161-73. The underlying premise of the monitoring model is that the 20 board could not manage the corporation even if it wanted to do So. See Dent..")..1 7 As with the working model. if only implicitly. the board may delegate much of its authority to committees and corporate officers. See.50-55.

L. 88-92 (author rejects the "pocketbook" strategy of corporate control. 330-36 (1981). 28 Shareholders are largely inactive. and tenure further restrict the board's ability to manage the publicly held corporation. see Block & Prussin. Dent. REV. they do not prevent effective monitoring of the executives. at 633. supra note 10. however. See infra note 40 and accompanying text. Only if this occurs will the monitoring model achieve its ultimate purpose. The prospects for more extensive reform are not encouraging. at 141-49. various constraints of time. CARY & M. in the final analysis. at 36-39. punish even the slightest deviation from maximum efficiency. to "pro- vide some meaningful check on self-serving behavior. A Procedural Treatment of Derivative Suit Dismissals by Minority Directors. reforming behavior by enforcing or increasing monetary penalties for violations of the law. The board must be able to implement policy despite bureaucratic inertia. 25 Although these factors prevent the board from effectively managing the day-to-day operations of the corporation. L. at 641-44. supra note 10. composition. Coffee & Schwartz. incompetence. 26 Neither market forces27 nor shareholders28 compel adoption of the monitoring model. or ever. Brudney.. or have selected stock investments precisely so that they do not need to be involved in monitoring corporate activity.. namely. supra note 10. and recognizes the inability of shareholders and consumers to pressure for corporate reform through the marketplace). reform is now being sought in the legal forum. As a result. 27.e. see also C. 261. EISENBERG. at 634-38. The board's ability to monitor. Note. 3:627 tional forces have overtaken the corporation: the chief executive offi- cer often controls the board.2 4 Finally. 29 Certain aspects of the monitoring model are being adopted on the federal 22 See infra notes 51-62 and accompanying text.. 885 (1981). REV. i. however salutary the model might be. 70-75 (1981). supra note 4. or complacency on the part of management . M. L. at 214-16. EISENBERG. 24 See infra notes 70-77 and accompanying text. The Independent Director-Heavenly City or Potemkin Village?. . and information must pass through the corporate hierarchy to the board undistorted by employee self-interest.632 CARDOZO LAW REVIEW [Vol. voice their disapproval by selling their shares. STONE. is contingent on its ability to overcome these obstacles. 26 Dent. 69 CALIF. (2) market forces operating through outside directors are not likely to be sufficient. and (3) the market for corporate control is not so efficient that a takeover will immediately. 95 HARv. The Business Judgment Rule and Shareholder Derivative Actions: Viva Zapata?. 217One commentator has offered several reasons why the market does not provide an efficient impetus for the implementation of the monitoring model: (1) the market forces which may punish corporations that fail to implement the monitoring model will. 22 operation dominates policy. 2 For recent recommendations of proposed legal reforms. 2' W. See Dent. LAW. REV. 81 COLUM.. exact punishment not on management but on the shareholders. 658 (1982) ("There is little doubt that the market is inadequate to foster responsible corporate behavior in many areas."). selection. supra note 1. supra note 10. 37 Bus. 597.2 3 and in- formation blockage is the rule rather than the exception.. The Survival of the Derivative Suit: An Evaluation and a Proposalfor Legislative Reform. 23 See infra notes 65-69 and accompanying text.

(1975) (federal corporation law inappropriately preempts state corporation law and should not be expanded absent congressional consideration and consent thereto). GUIDE (CCH) 2495H (March 9. 1779 (1976) (illustration of how ancillary remedies further the purposes and goals of the Securities Acts).").57 & 59. 1146 (1965) (description of the expanding impact of federal regulation on corporate law). 31 Bus. 3 but have been unable to delineate the specific contours or requirements of the model. 84 (1975) ("Corporations are creatures of state law.J. 570-72 (1975) (possible consequences of an SEC investigation). 1977). Far-Reaching EquitableRemedies Under the Securities Acts and the Growth of Federal CorporateLaw.") and Malley.14(a)-101.. The six primary statutes governing SEC operations each contain a provision preserving the jurisdiction of state securities commissions. The New York Stock Exchange now requires corporations to maintain an audit committee as a condition to listing on the Exchange. See id. 33 [M]any commentators challenged the proposition chat the Lproposed] "customary" committee functions are accepted and stated that a definition of functions customar- . 1331-52 (1976) (providing extensive catalogue of cases involving ancillary decrees). 31 See Cort v. LAW. L. see Freeman. except where federal law expressly requires certain responsibilities of directors with respect to stockholders. 17 C. 66. L. This Note discusses how the equitable remedies available to courts in shareholders' derivative suits can be fashioned to implement the monitoring model. LAW. 1323. Ancillary Remedies In SEC Civil Enforcement Suits. In some instances.J. 30 but a comparable phenomenon is not occurring 31 on the state level where the bulk of corporate activity is regulated. 34 Bus. Ash. and investors commit their funds to corporate directors on the understanding that. corporations consented to the reform measures in an attempt to avoid jeopardizing the corporation's line of credit and wasting time and resources during litigation. See id.S. 2 N. 567. REV. 64 GEo. Comment.R. The commentators who have examined the model have urged its adoption on a wholesale basis.F.E.1982] MONITORING MODEL 633 level. LAW. at 748 nn.3 30 See. The Overview Committees of the Board of Directors. See also infra text accompanying note 202 (American Law Institute proposal urging adoption of the monitoring model).g. 78 HAv. For criticisms of the Commission's jurisdiction to use disclosure as a means de- signed less to protect investors than to achieve substantive reform of corporate conduct. See Mathews. Recent Trends in SEC Requested Ancillary Relief in SEC Level Injunctive Actions. 31 Bus. state law will govern the internal affairs of the corporation. especially the demands by the Commission for ancillary relief. 89 HMAv. L. e.S. 422 U. 24 EMORY L. In addition. An SEC proposal which would have required companies under the jurisdiction of the Commission to maintain auditing committees was not adopted. the SEC has creatively used consent decrees to impose corporate governance reforms on mismanaged companies. See generally Farrand. 1295. "Federal Corporation Law": An Assessment. REV. § 240. 32 See Report by the Committee on Corporate Laws. & MARY L. 737 (1976) (ancillary relief is an essential supplement to statutory remedies as a means of enforcing the federal securities law). Effective Defense of SEC Investi- gations: Laying the Foundationfor Successful Disposition of Subsequent Civil. 1295 (1976) (SEC's management fraud program has "gone beyond what is granted to [the Commis- sion] by law. Fleischer. Mathews. Administrative and Criminal Proceedings. Federal corporation law refers to that body of law arising from the Security and Exchange Acts of 1933 and 1934.Y. REV. 17 WM. Court- Appointed Directors: Ancillary Relief in Federal Securities Law Enforcement Actions. Item 6(d) (1981) (proxy statements must include a description of the functions of an audit committee). The Legality of the SEC's Management Fraud Program. See id. at 1324. 1837 (1979) [hereinafter cited as Report].

CARDOZO LAW REVIEW [Vol. they are enabling statutes which permit the board to operate with minimal interference from the shareholders or the state. .. The detailed implementation of the model would be developed after a careful examination of the wrongdoing alleged and a creative search for remedies best designed to prevent misconduct given the specifics of corporate organizational structure. LAW. thus assuring meaningful participation by the monitoring board of directors in 37 increasing corporate responsibility and accountability. 3' See infra notes 50-77 and accompanying text. While affording plaintiff-shareholders relief.. the SEC has left the matter to the "evolving nature of corporate committee systems and the varying characteristics and needs of different issuers . 1229. Rather. would not allow for needed flexibility. at 357. Similarly. Part IV will illustrate how creative and permissible modification of judicial remedial techniques can encourage the growth of the corporate superego. 356-57 (Dec. namely. 3' See infra notes 38-49 and accompanying text. .3 8 Although the legal model of corporate governance embodies ily performed ... encourage director self-implementation of the monitoring model. And finally. THE CORPORATE SHAREHOLDER AND THE DEluVATIvE ACTION State corporation codes are not designed to regulate corporate behavior. 6. 3' Compare Cary. thus tending to deter the evolution of committee functions and limit experimentation. some were concerned that a "laundry list" approach would set a ceiling or lowest common denominator and discourage committees from performing different functions. 3 4 After briefly surveying the conclusions of corporate organization theory in Part 11. See Greene & Falk. 31 See infra notes 78-123 and accompanying text. if prop- erly understood and applied. Part I of this Note will examine the theoretical underpinnings of the derivative action which make it a suitable tool for implementing the monitoring model. 16 SEC Docket 348. I. 3 Part III will demonstrate that the rules of liability need not preclude judicial intervention. 1978). Id. 1235-46 (1979). The Audit Committee-A Measured Contribution to Corporate Governance: A Realistic Appraisalof Its Objectives and Functions. Rather than attempt to define the committees' functions. incremental adoption of the monitoring model in a shareholders' de- rivative action. 34 Bus. but can. 3:627 The Note suggests a more modest method of implementation. the derivative action could also be em- ployed to remedy the structural inadequacies of corporate governance that give rise to misconduct. 37 See infra notes 124-201 and accompanying text.35 Part III will apply those conclusions to a critical evaluation of the legal principles of liability that have tempered the judiciary's attitude toward corporate director- ships and misconduct. supra note 13 (spirited attack upon the growing trend toward corporate permissiveness among the states and appeal for increased regulation of corporate activity) and .

599 (1965) (same) with Arsht. § 275 (1974) (voluntary dissolution). "Practically. See generally Hessen."). supra note 10. 1113 (1976) (passionate defense of government noninterference) and Winter. Reply to Professor Cary. 276 S. The corporation is therefore usually considered an indispensible party to the action. at 337-38. if dissatisfied with management. App. the power of the board is limited to a small degree by the requirement of many corporation codes that certain corporate transactions require shareholder approval. 30 HASTINGS L. Ct. 1327 (1979) (al- though shareholders do not participate in corporate affairs to any significant degree. Id. 1980) (merger proposals).1982] MONITORING MODEL 635 the notion that shareholders maintain a check on the board's control of the corporation through the power of the ballot. They are attracted to corporate shares precisely because they will not be required to participate in managerial decision mak- ing. the shareholders are nonparticipants in the governance of the polymyriad corporations. 1488 (1958) (reviewing J.2d 621. 79 n. 1970). PA.. 93 Va. Book Review. § 251(c) (Supp. partly because of the difficulty of organizing so many fellow investors. EISENBERG. notions of a free democratic society have also been used to justify additional government regulation of the publicly held corporation. CONARD. 347. sell. 614 S. 346. REv. Atlas Constr. supra note 13 (same). at 24 (proliferation of corporations properly attributed to American democratic ideals). See. § 109 (1974 & Supp. and 41 protection against. W.J. namely." Id. 115 U.. in PUBLIC POLICY AND THE MODERN CORPORATION 3.W. Origins of the American Business Corporation. 67 YALE L. See Handlin & Handlin. 25 S. 69. . 330 (Mo. L. Latty.g. 8. corporate and director misconduct. " See supra note 6 and accompanying text. 1980) (amendment of by-laws. See E. 31 Bus.51 (1980) (Inactivity is "a deliberate decision for most shareholders. at 213 (remedy not always available "since holdings may be so large that [shareholders] are locked in"). the only protection afforded dissatisfied shareholders is the so- called "Wall Street Rule".2d 300.. CODE ANN. But see id. the derivative action does provide shareholders with a remedy for. 669 (1967) (roundtable discussion of the sale of large investments). LAW. 10 CAP. KEFAUVER. But cf."). Manning. 19 (D. Why Are Business CorporationLaws Largely "Enabling?'. Bass ed.. 40 In contrast. and partly because of the ease of selling out instead of struggling . Jones. In any event. Corporate Officer and Director Liability: Is CorporateBehavior Beyond the Control of Our Legal System?. CORPORATIONS IN PERSPECTIVE §§ 203-204.J. 622 (1981). U. nonpartici- pation parallels shareholder expectations). Since the suit is brought for the benefit of the corporation. Ward v. id. H. IN A FEW HANDS: MONOPOLY POWER IN AMERICA 238-39 (1965). Grunewald & H. In the majority of cases. supra note 1. belongs to the corporation. e. A New Concept of Corporations: A Contractualand Private Property Model. recovery. id. Co. 1477. DEL. at 47-48. Ironically. 3 it is generally agreed that shareholder democracy is a myth. at 340). HENN. 1966). 427. Radford Trust Co. Noninterference by the state is widely believed to have led to the growth of corporations in America. 1981). at 337-40 (1976) ("[S]harehold- ers are impotent. if any.. HANDBOOK OF THE LAW OF CORPORATIONS AND OTHER BUSINESS ENTER- PRIsEs § 360 (2d ed. C. 41 The shareholders' derivative action is a suit brought by the shareholder on behalf of the corporation. Mount v. Professor Stone has argued that the stock of the American corporation is divided among so many people that shareholders are incapable of concerted action to oust management even when clear wrongdoing has taken place. Inasmuch as the primary right to seek redress belongs to the corporation itself. Mutual Funds as Investors of Large Pools of Money.Q. Cf. THE AMERICAN STOCKHOLDER (1958) ("The modern proxy contest has become a grotesque travesty of an orderly machinery for corporate decision-making. Moore.E. 278 S.L. STONE.. 244 (1896). the shareholder is made the nominal plaintiff and the corporation is the real party in interest. CARY & M.C. 50 CORNELL L. 40 See A. Broski v. LIVINGSTON. unless charter provides otherwise). REv. tit.E.

Y.. 337 U. but cannot be proved so before trial. including attorneys' fees. Although these requirements are intended to discourage frivolous suits. because of the threat of extensive discovery and disruption of normal business activities which may accompany a lawsuit which is groundless in any event. 12 Diamond v. Both statutes and judge-made law treat as dubious.L. or worse. Ureamuno. 75 (1967) (derivative actions "serve a basic and increasing need in the contemporary economy"). 13 W. To Whom and for What Ends Is CorporateManagement Responsible?. 294 (1973) (author suggests that a public interest derivative suit is essential to the proper enforcement of corporation laws). and shareholders.. The following requirements have been imposed either by courts or by legislatures to deter this type of action: [O]wnership of stock at the commencement and during the pendency of the suit. provision by plaintiff of security for ex- penses. 393 N. 1959) ("Procedural obstacles bristle. ed. and reimbursement of defendants' expenses. '2 has long been used to police corporate misconduct. 85 (1969). the most recent and perhaps the most detrimental threat to legitimate derivative actions comes from the judiciary. In this regard. Manor Drug Stores. CYCLOPEDIA OF THE LAW OF PRIVATE CORPORATIONS § 5941. 24 CASE W. RES.S. The Power of Directorsto TerminateShareholderLitigation: The Death of the Derivative Suit?. at 742-43 (expressing strong interest in curbing nuisance actions) with Dent. 915. fair representa- tion of the shareholders by the plaintiff. Loan Corp. at 48 (labeling shareholders' derivative action "the most important procedure the law has yet developed to police the internal affairs of corporations"). See also Friedman.2d 920 (1979).2d 619. 301 N. perm. 3:627 The derivative action.. Compare the position of Justice Rehnquiat in Blue Chip. See Blue Chip Stamps v. Bennett. See generally Note. The Public Interest Derivative Suit: A ProposalforEnforcing CorporateResponsibility. U. bringing of suit within the period of a short statute of limitations for certain actions against directors. 169. in THE CORPORATION IN MODERN SocIETY 49 (E. at 97 ("Many of these obstacles seem designed more to thwart all derivative suits. 421 U. 248 N.").636 CARDOZO LAW REVIEW [Vol. 541. Beneficial Indus. indemnification of corporate personnel for litigation expenses.Y.2d 910. Cohen v. supra. 383 U. demands on the board and the shareholders to take action with respect to the alleged wrong or a showing that such demands would be futile.2d 78. Mason ed. the law seeks to bar "strike" suits brought merely with the expectation that the corporation will buy out plaintiff's private pecuniary interest in order to avoid the nuisance of the litigation.. L. Special Litigation Committees-An Expanding and Potent Threat to Shareholder Derivative Suits.E. including those that are meritorious. 74. ownership of stock at the time of the alleged wrong. the court held that the business judgment rule may permit dismissal of a shareholder derivative action if a committee of noninterested directors decides that the suit would not be in the best interests of the corporation. 548 (1949) (derivative action is "the chief regulator of corporate management"). and are relentlessly enforced . 421 U. 723. PA. 1980) ("Stockholders' suits are especially important as a remedy for minority stockholders to call directors and controlling stockholders to account for mismanagement and fraudulent manipula- tion. Dent..S. see Surowitz v. the professional stockhold- ers' suit against those who misuse other peoples' money.S. than to prevent alleged abuses.. 2 CARDOzo L. . wherein shareholders act as private attor- neys general. 24 N. 232 (1980) (an expansion of this doctrine will lead to "loss of confidence in the courts and in corporations").S. In Auerbach v. 363. 116 U.Y. 75 Nw. REV.2d 994. 503. 371 (1966). L."). The Revival of the Derivative Suit.5 (1980). 43 It Since the derivative action is intended to benefit the corporation.E.S. supra note 41. 47 N.Y. REV.1. Hilton Hotels Corp. Dykstra. REv. it is possible that they will discourage legitimate suits as well. of the corporation.2d 494. . 742-43 (1975) ("[I]n this type of litigation . 419 N. officers. FLETCHER. 97 n. 96. . 43 Rostow. REv.."). the mere existence of an unresolved lawsuit has settlement value to the plaintiff . at 362 (rev. known as the contemporaneous ownership requirement.S.") and Rostow. allegation with particularity of the facts constituting the corporate cause of action. often interpreted to require the plaintiff in effect to plead evidence.

ANN. 1980). See.1-43. Many states which do not have statutory provisions for the derivative action provide for it in their rules of civil procedure. LAWS § 7- 1. 13 W. STAT. The suit would thereby present the court with the opportunity to examine how the corporation has been managed or. 1981). CODE ANN. W. § 1516 (Purdon 1967 & Supp. 44 The theory of the stockholder derivative suit has been explained as follows: [I]t is a suit having a double aspect. ANN. Supp. Amalgamated Copper Co.. DEL. ANN.28(b) (1951). more often. 396 U. CODE ANN. FLETCHER. Inc. LAW § 626 (McKinney 1963). TEX. Bus. e. ANN. Co- op. Merrill Lynch Asset Management. 23. Civ. GA. § 327 (1974). 8. GEN.08. CODE ANN.1982] MONITORING MODEL is well-suited as a vehicle for implementing the protections afforded by the monitoring model for several reasons. § 7-4-121 (1973 & Supp..N. § 48-718 (1979). REV. tit. 14A:3-6 (West 1969 & Supp. CENT. 999 (S. 244 U. §§ 22-614 to -615 (1977 & Supp. LAWS ch.405 (West 1957). STAT. N.1 (derivative actions and accompanying rules). 261.1491-1493 (1973).I. tit. ANN. at 363. § 271A. § 55-55 (1975). §§ 450. § 627 (1964). REv. 13-A. supra note 43. More importantly. Wis.S. By definition.J. FLErcHER. v. TENN. § 1. ANN. The derivative action is considered an extraordinary device since it reverses the corporate norm: the shareholder is entitled to make the decision to bring the action even though it is the board of directors that supposedly manages the corpora- tion. The suit is thus an action for specific enforcement of an obligation owed by the corporation to the stockholders to assert its rights of action when the corporation has been put in default by the wrongful refusal of the directors or management to make suitable measures for its protection. Second. N. ANN. MONT.. § 46 (Michie/Law. STAT. 18. GEN.45a (Supp. STAT. N. Bernhard. CODE § 800 (West 1977). § 157. § 21-2047 (1977). it is an action by a shareholder who alleges that the board of directors has failed to exercise its right to pursue wrongs done to the corporation 44 either by third parties or. 45 The remedies available to a court of equity are inherently flexible and can be The derivative action is now recognized in almost every jurisdiction. ME. § 23A. See Aiuz. 1982).147 (West 1977 & Supp. Miss. STAT. § 35-1-514 (1981). the derivative action addresses problems directly related to corporate governance.D. FLA. Gartenberg v. ILL. 32.245 (Bobbs-Merrill 1981). MAss. mismanged. "5 See Ross v. § 15-6-23.S. CODE ANN. S. R.g. Although a derivative action may be brought directly against the corporate officers.D. § 496A. § 5990. CORP. IowA CODE ANN.1 (Supp. PA. R. CODE ANN. REV. See United Copper Sec. LAWS ANN. CAL. the derivative suit is an action in equity. STAT. 15. The stockholders have a right in equity to compel the assertion of a corporate right of action against the directors or other wrongdoers when the corporation wrongfully refuses to sue.1 (1969). 531. First. supra note 43. LAWS ANN. Co. REv. CODE § 10-19-48 (1976). VA. § 10-049 (1976). §§ 64-223 to -224 (1980).460 (1969). Bus. STAT. 1982-1983).Y. STAT. REV. COMP. tit. CorP. the derivative action can al- lege that some mechanism in the corporation failed in permitting the wrong to occur in the first instance. 5.43 (1962). see also FErn. WASH. more accurately. CODE ANN. 1982-1983). CODE § 31-1-103 (1982). The board may at times decline to bring the action since it can hardly be expected to sue itself. COMP. STAT. CORP. P. 156B.Y. ANN. STAT: ch. OKLA. Ky. ARK. ACT art. 487 F. STAT.14 (Vernon 1980). REV. this Note focuses primarily on suits brought against directors for having failed to protect the shareholders from company misconduct. 1982-1983). NEB. tit. 1979). 13 W. REv. 1982). 1982). 263-64 (1917). MICH.C. 538-39 (1970). N. STAT.D. § 607. by the insiders themselves. § 79-3-93 (1972). ANN. § 180. . CoLo. STAT.

198 N.. 298 U. in some cases shareholder-plaintiffs have been restricted precisely because the derivative action is one in equity. 536 (1925)).. Although the equitable nature of derivative suits will facilitate implementation of the moni- toring model. "[t]here is a good deal to be said [concerning framing of remedies but the general rule is] all within the realm of reason. ."). obliga- tions. "'[p]revention of impending injury by unlawful action is a well recognized function of courts of equity.W. of unjust enrichment. by ." Id. Further.Y.S. Finally. Moreover. 510. none can be given in equity." H. See D.S. MCCLINTOCK. Oreamuno. Clover Meadow Creamery Co.4 In this See generally. 417 U."). 301 fashion a remedy to effectuate structural reform . damages cannot be ascertained.000). 238. 46 Flexibility and creativity in framing remedies are critical in implementing the moni- toring model because the causes of corporate wrongdoing vary enor- mously. 361. See. 288 (1936) (In the context of a shareholder action. depending on the facts.Y. 329 (1944) ("The essence of equity jurisdiction has been the power of the Chancellor to do equity and to mould [the remedy] to the necessities of the particular case. This is a result of the origins of equity jurisprudence. but it was nevertheless factual in the sense that it made particular charges or allegations that might vary from case to case. 53 (1934) (suit barred by laches where plaintiff acquiesced in defendant's alleged wrong during a two-year period). Wells Co. . inter alia. Milk Ass'n v. . Bangor Punta Operations. 980 (1957) (noting the importance of the equitable origin of the derivative action as a means toward understanding its development and growth). at 77-78. a court of equity will devise a remedy to meet the situation. Bowles. REv.. 217 Minn. at 54-55 (emphasis added). 321 U. . Prunty. Erickson-Hellekson-Vye Co.2d 910.2d 162 (1944) ("clean hands" doctrine). Relief may be unavailable because the court is unable to grant the appropriate remedy.. even though former defendants-directors' misconduct allegedly damaged the corporation in excess of $7. It is true that the complaint before us does not contain any allegation of damages to the corporation but this has never been considered to be an essential requirement for a cause of action founded on a breach of fiduiciary duty .2d 78 (1969).. 50 Ohio App. 3:627 tailored to fit the peculiar circumstances of a case. is not merely to compensate the plaintiff for wrongs committed by the defendant but . Bangor & Aroostook R.E. HANDBOOK ON THE PRINCIPLES OF EQuITy 49 (2d ed. v. and are intended to award relief that is unavailable at law. CARDOZO LAW REVIEW [Vol. 24 N. Ohio Farmers' Co-op.g.S. at 77. 268 U. "[w]henever a situation exists which is contrary to the principles of equity and which can be redressed within the scope of judicial action. Inc. v. v.S. though no similarrelief has been given before. supra.2d 494. . . the derivative suit allows the court . as an action in equity.This is because the function of such an action . equity is never a panacea for complaining shareholders since "[e]quity does not undertake to redress wrongs which are violations of moral. 15 N. at 77. . at 76 (emphasis added). e. A procedure that enables directors to monitor managerial activities in one corporation may be wholly inappropriate for another corporation. 16 See Hecht Co. McCLINTOCK. In any event. The Shareholders'DerivativeSuit: Notes On Its Derivation. L. the organizational structure of the corporation will dictate or at least influence the selection from available remedies. Equitable remedies are given as a matter of discretion rather than as a matter of right. Often.Y. "to prevent them. DOBBS. 1948).' ") (quoting Pierce v... Id.. Id. .Where a statute has expressly denied the remedy. 47 See. H. or the legal remedies themselves are inappropriate.000. 32 N. 321. HAND- BOOK ON THE LAW OF REMEDIES 31 (1973) ("The petition to the chancellor for equity was formal in the sense that it contained repeated elements . A.S.E.U.R.g. 248 N. ." Id. 261. . Society of Sisters. e. as distinguished from legal. Carter v. 703 (1974) (suit dismissed on grounds. see also Diamond v. Carter Coal Co.

. 1968) (Friendly. 714-17 (1974) (equity will not permit a windfall for the defendant notwithstanding that such recovery may deter future wrongdoing). 895..1Imposition of monetary damages as a "remedy" for director misconduct has not been an effective form of relief in the derivative action. 301 N. 224 A. See generally Annot.L.J. Manganese Corp. 1972 DuKE L. Schultz. "[ilf observers of the corporate scene became convinced [that by virtue of adoption of the monitoring model] executives are subject to effective and independent supervision. action for tortious conduct).. 312.. 248 N.S. He also recommends that a structural change in the model of corporate governance. See. requiring them to perform these duties with reasonable care would not deter qualified persons from serving. 359 (Iowa 1972) (award of exemplary damages). see also Bangor Punta Operations v. For a reasoned defense of the Diamond court and the need to view the derivative action as a deterrent mechanism. at 498.2d 348.g. 157 Ga. 741-47 (Fla. Construction Mach. 401 F. Charles v.Y. 200 A. DOBBS.") (emphasis omitted). 1005 (1971). at 211. 319 (1873)). A Behavioral Analysis of Directors'Liability for Negligence. 417 U. e. at 135-36 (damages are substitutionary relief intended to compensate plaintiffs loss). 64. were similarly applicable in the business . 404 U. Texas Gulf Sulphur Co. however. 202 N. ."). 52 N. or to which their agency or trust relates. 618-19 (1965) (same)." Id. 401 (1964) ("If the test of negligence which is applicable in the field of torts . 261. Professor Conard suggests limiting the penalty in a derivative suit to one-year's salary of the defendant-director.. see Coffee & Schwartz. supra note 46. 81 COLUM. Bangor & Aroostook R. see also SEC v.field. See also Dent.S. 333.W. Wiliner. 563. 66. at 918." Id.'. Holden v. L. 703. supra note 10. such damages generally are not awarded in equitable proceedings on the ground that plaintiffs would be unjustly enriched. 48 See D.R.E.Chasen.2d 634. .1982] MONITORING MODEL important respect.R. But see Pelletier v. REV. . 1975) (rejecting the Diamond argument and analysis of the purpose of a derivative action). Punitive damages may be awarded to deter future misconduct. as suggested in this Note. would be far more worthy of attention since. 313 So. 423 Pa. . In fact. 866 (2d Cir. however.2d 833.. Selheimer v.2d 398. Id. they might willingly accept a diminution or even an abandonment of the clumsy threat of liability for damages. Smith v.S. Brown-Borhek Co. it would realistically be very difficult if not almost impossible to secure the services of able and experienced corporate directors.2d 118. of America. 578. J. One obvious solution to allay the fears of the courts which argue that imposing monetary damages might very well deter competent people from assuming positions as corporate directors is to limit the amount of the damage award for which a director might be held liable.2d at 912. removing from agents and'trustees all inducement to attempt dealing for their own benefit in matters which they have undertaken for others.E. the derivative action differs from a claim seeking only monetary damages and a return to the status quo ante.2d 605. . Conard. 2d 739.. the prospect of "fining" a director has been offered as one reason for the judicial reluctance to find directors liable for wrongdoing.W. 643 (1966) (a strict standard of due care may "render unattractive positions as directors of business corpora- tions"). 276 S. App. 431-32. cert.3d 350 (1975) (analysis of decisions concerning the allowance of punitive damages in derivative actions). 325. concurring) ("The consequences of holding that negligence in the drafting of a press release . denied. 137 N. at 649 ("If directors were assigned tasks they reasonably could perform. 302-09 (1981). 258 Iowa 409..2d at 81 (emphasis in original) (quoting Dutton v. 120 (1981) (award of punitive damages in derivative. Co. 414 Pa.Y. . The Survival of the Derivative Suit: An Evaluation and a Proposalfor Legislative Reform.. Epperson & Co. 48 The prospective focus of the derivative suit on preventing wrongdoing enables the court to impose monitoring responsibilities which will 49 then modify corporate behavior.may impose civil liability on the corporation are frightening. But see Schein v.") (footnote omitted). 67 A.

at 1108-13. but would only be implementing the measure of reform needed to remedy the wrongdo- ing which injured the corporation. CODE ANN. 77 YALE L.. LAW § 727 (McKinney Supp. . and opportunities for change). Once the derivative action is recognized as a tool for implementing necessary corporate reforms..J. Finally. the transition from scholarly proposals to adequate shareholder pro- tection will have been effected. except that no indemnification shall be made [if] such person shall have been adjudged to be liable for negligence or misconduct . . A corporation may also protect its directors through liability insurance whether or not the corporation would have the power to indemnify the directors. N. A second reason for preferring equitable remedies is that the impact damage awards might be expected to have on director conduct is diminished by the availability of indemnification. it is necessary to recognize and understand the board's dependence on the corporation's executives. .g. II. fines and amounts paid in settlement . § 145(a) (1974) ("A corporation may indemnify .Y. See generally W.. . [so permits]. 8..50 In particular. .Y.J. 1981-1982). . 3:627 The shareholders' derivative action can provide the means needed for implementing the monitoring model.. See.640 CARDOZO LAW REVIEW [Vol. Sitting Ducks and Decoy Ducks: New Trends in the Indemnification of CorporateDirectors and Officers. EISENBERG. . 8. . . a director [or] officer . supra note 9. 1981-1982). . See. . 89 YALE L. supra note 1. 50 For purposes of remedying misconduct. DEL.. . Judicial Intervention and OrganizationTheory: ChangingBureaucraticBehavior and Policy. Bus. or to prevent the misconduct which threatens the corporate assets. CORP. ). STONE." C. tit. In so doing the courts would not be overstepping their judicial mandate. a director [or] officer . CODE ANN. see also Bishop. LAW §§ 722-723 (McKinney Supp. 513. particularly the chief executive officer (CEO). unless . judgments. CARY & M. 1078. it is a virtual sine qua non to affording adequate remedies in any derivative action. see also Note. 513 (1980) (effective judicial remedies require understanding the nature of organization. the importance of the organization of the corpora- tion cannot be overestimated. . . DEL.. § 145(g) (1974). See Coffee.g. against expenses (including attorneys' fees). CORP. monetary threats are not likely to be effective when dealing with the corporate personality for the very reason that corporations do not view threats to their profits in the same way that a good bookkeeper would be expected to recognize that wrongdoing which results in liability is a "bad bargain. at 970. N. . Id. at 952-70. e. tit. . supra note 10. e. if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation . CORPORATE ORGANIZATION AND BEHAVIOR Insight into the organization of publicly held corporations is crucial to an understanding of the misconduct that occurs and how to prevent it. Bus. against expenses incurred by him in connection with the defense or settlement of [a derivative] action . the court . limits of institu- tional capacity. as well as counter-organizational forces which have overtaken and impeded corporate accountability and efficiency. § 145(b) ("A corporation may indemnify . . id. at 35-57."). 1093 (1968) ("the existence of insurance against such liability is likely to encourage the conduct on which the liability is grounded"). It is common for the corporation to pay the director's entire premium for liability insurance.

DEL. Brudney. Executive Dominance Although the legal model of corporate governance dictates that the shareholders elect directors. § 142(a) (Supp. tit. 51 See Klein. CODE ANN. CARY & M. In a complex organization concerned with complex choices. R.. 60 [T]he board normally has no staff of its own to evaluate the information it does receive or to gather information directly. CORP. Bus. at 94-96. REV.1982] MONITORING MODEL 641 A. select the officers. 31 Bus. supra note 13. INC. N.] a substantial number of seats [on the board] are held by executives themselves. Directors:Myth and Reality ." who. at 94-102. 3 (1973)]. DiREC- TOR DATA: CHARACTERISTICS OF OUTSIDE DIRECrORS (1978) (61 % of outside directors are chosen as a result of previous contact with management).8-10 57 M. 0 and therefore depend 5' See supra note 6 and accompanying text. the CEO. at 215 ("[F]ew boards spend more than 36 hours a year in meeting time and about half spend only 18 hours or less. LAW. REv. When the director acts contrary to the interests of management. e."). BACON. 293. EISENBERG. see also HFIDRICK & STRUGGLES. supra note 1. it must rely on the executives to perform those functions either directly or through the executives' own staff. usually the CEO. Interlocking DirectoratesAmong the "Fortune500.5 2 the process in reality is reversed. at 610 n.Ten Years Later. because of his control over the proxy machinery. 5 [In fact. 8. 49-50]. supra note 1. Shareholders do not participate effec- tively in the election process. supra note 27. 51 KORN/FERRY INTERNATIONAL.9 percent of the 1970 Fortune500 [Smith. See HEIDRICK & STRUGGLES. 52 See. in exchange for a board position. NADER. But see infra note 191. 59 lack an adequate staff. select 54 or recommend 5 the directors.39 (question- ing the assumption that the existence of a nominating committee necessarily diminishes the dominance of the chief executive officer)." ANTITRUST L. 1980). policy cannot be developed on a part-time ba- sis. EISENBERG. Mace. PROFILE OF THE BOARD OF DIRECTORS (1971) (37% of chief executive officers have removed directors). Instead. & ECON. at 47. 1355.. 58 This depen- dence becomes all the more exaggerated and problematic since the directors generally spend a limited amount of time dealing with the corporation's affairs. 49. M. Summer 1970. LAW § 715 (McKinney 1963 & Supp. GREEN J. It need . Conduct of DirectorsWhen Litigation is Commenced Against Management. at 88. 57 Selection of board members by the CEO also gives rise to psychological and economic dependence on the CEO.8 percent of the industrials in the Heidrick & Struggles sample [PROFILE OF THE BOARD OF DIRECTORS 5 (1971)]. 32 RUTGERS L. in turn. EISENBERG. M. 53 and the officers. '4 See M.g. '3 See supra note 40 and accompanying text. 1359 (1976). at 145. MACE... and 55. CORPORATE DIRECTORSHIP PRACTICES: MEMBERSHIP AND COMMITTEES OF THE BOARD 2. SELIGMAN. Employee-directors held half or more of the board's seats in 29 percent of the approximately 500 manufacturing corporations included in a 1973 Confer- ence Board Survey [J. 1981). MACE. the CEO will often expect director fidelity and loy- alty. INC.Y. BOARD OF DIRECTORS: SIXTH ANNUAL STUDY 22 (1979) (75% of the boards of 390 New York Stock Exchange companies select outside directors on the basis of the recommendation of the chief executive officer). supra note 4. 307 (1979). supra note 10. CARY & M. at 216 & nn. 56 Moreover. often has the power to remove the director. "I See W. W. supra note 10.

Implementation of successful monitoring procedures in most cases. " See supra note 16 and accompanying text. Mar. supra note 58. supra note 10. Note. at D23. the competitive strains. N. at 1837. nonmanagerial personnel to serve as directors. BROWN. The past decade has seen an increase in the number of corporations with boards composed of a majority of nonmanagement directors. supra note 4. or the real financial status of the host company. B.g. only two of the four outside directors would be considered independent.6 3 Although other commentators are somewhat skeptical about the ability of outside directors to improve corporate governance. Restructuring the Corporate Board of Directors: Fond Hope-FaintPromise?. Times. VANCE. "I See HEIDRICK & STRUGGLES. e. at 31-32. 1979) ("The average nominating committee of the Billion dollar respondents consists of one inside director and four outside directors. '3 See. The Evolving Role of the Director in Corporate Governance. REV."). will require more than the appointment or election of outside directors. at 127 ("[I]f there is any hope of getting from the board some of the special functions we are after. Goldberg. 3:627 on executive officers for all their information. 1353. it is not at all surprising that the board does not function as an effective. with outside directors of some sort. 65 CORNELL L. THE CORPORATE DIRECTOR: A CRITICAL EVALUATION 4 (1968) ("[I]n only the rarest of instances do outside directors have even the faintest idea of the technical processes. Oct. See Small. 1356 (1979). Rise is Reported in Outside Directors. supra note 27. 2 (SEC report indicates a decline in the numbers of corporate directors "who are either employed by or affiliated with the companies they serve"). In fact. C. The Business Judgment Rule in DerivativeSuits Against Directors.Y. at 216 (footnote omitted) (emphasis added).3% sent marketing data. supra note 32. Report. Id. C. Debate on Outside Directors. 600. at 598 n. REv.7% sent an agenda. 1982. 64 See Brudney. Organization Theory The second important consideration for improving corporate governance concerns a variety of counter-organizational forces. Officer hardly be added that this kind of power over informationflow is virtually equivalent to power over decision. 29.J. some input over and above that which management alone can provide."). at 144 (quality and quantity of information received by directors is "almost wholly within the control of the corporation's executives"). EISENBERG. an important first step would be made toward improving corporate governance.2% sent directors manufacturing data prior to the meeting. Korur/FEaaY INTERNATIONAL. . see also S. N. See generally M. 10. § 3 (Business). at 5 (of 474 industrials surveyed. 3. CARDOZO LAW REVIEW [Vol.Y. However. only 21. Brudney. supra note 15. 76 MICH. One solution to the problem of dependence might be to appoint outside.. many commentators have suggested that implementation of significant cor- porate reforms requires as much. col. BOARD OF DIRCTORS STUDY OF BILLION DOLLAR INDUSTIALS 4 (Supp. however. at 1."). L. only 17. Solomon. Times.. But cf. supra note 27. 618-22 (1980). it lies.6 4 if outside directors could maintain a posture independent and critical of the insiders. STONE.3 (data compiled after 1977 suggests that the trend has recently leveled off and that some statistical representations have been criticized for employing a too imprecise definition of "independent" director). under the SEC's previously proposed definition of an 'independent' director. 1 Consequently. 2 independent managerial unit. INC. 581 (1978). 30 HASTINGS L. and 11% sent no information at all). obviously. 1972. only 5. col.

710 (1974) ("Frankensteinian creations of eco- nomic necessity. at 47-52 (1970)). the corporation's personnel become creatures of the corporation itself and perform in ways that they would not outside the corporate framework. 67 Coffee. what is. Corporationsand Social Responsibility: In Search of the Corporate Soul. One additional counter-organizational force affects the ability of the directors to manage the corporation. 70 Coffee. Id. 42 CEO. Another phenomenon that inhibits the board's ability to reform corporate behavior is "sub-goal pursuit. operations often domi- 6 8 nate policy rather than vice versa." According to this theory. WILLIAMSON. the board's actions might nevertheless be frustrated by a phenomenon called "persistent behav- ior. Professor Coffee concludes that "proposals for new systems of corporate accountability that have been designed primarily to combat traditional conflicts of interest may not be well adapted to deal with [the] newer species of corporate misconduct. social. This overzealousness may in turn result in misconduct. '6 7 In other words.1982] MONITORING MODEL 643 and employee 5 loyalty to the corporation manifests itself in aggressive acquisition of corporate profits. 6I Id. see also Stevenson. supra note 9. REv."69 Put most simply. In addition. WASH. 70 "Information 65 The bulk of corporate misconduct occurs in the middle-level echelons of the corporate hierarchy. L. good for a corporation may not be good for a manager of the corporation's subdivision. when a complex bureaucracy lacks an effective monitoring system. albeit wrongdoing committed for the benefit of the corporation. 709. and (4) management must take defensive maneuvers in order to divert take-overs. 30-69. Managerial zealousness is primarily due to the short-term interests of manage- ment which include the perception that (1) management's performance is likely to be judged over the short term. (3) management personnel are likely to engage in risk taking in order to advance their careers. "given an opportunity to exercise discretion. at 1105. supra note 9. See Coffee. supra note 9.' ")." Id." This term refers to "the inertial force that seems to exist within some organizations leading a subunit within the organization to con- tinue in a pattern of behavior because of the 'sunk costs' involved. and political characteristics which in human personalities we call the 'soul. only in the most unusual circumstances will the board be aware of misconduct or be in a position to affect it. STONE. supra note 9. managers at lower levels within a firm will tend to act not to maximize the firm's welfare. long after the conduct in question has become counterproductive to the enterprise as a whole. but rather the interests and autonomy of their own unit or division. at 1135 (citing 0. whose hallmark is managerial overzeal- ousness. absent some mechanism for ensuring compliance with corporate directives. 1112-13. According to organization theory. Id. at 1106. (2) salary incentives depend on performance over the short-term. at 1132-56. at 1129-36. Id." Even if the board were to pursue aggressively a policy designed to end such misconduct. . at 1105 n. corporate 'persons' are deficient in that concatenation of spiritual. See C.ll. at 3-7. supra note 10. at 1105 & n.13. at 1125.

1982. Id. the weaker its control over the actions exercised by those at the top of the organizational hierarchy. from a purely pragmatic perspective. Perhaps more significant. Mar. 3:627 blockage." but rather by the corporate mentality. the size and complexity of the corporation undoubtedly inhibit the information flow. INSIDE Bu- REAucRAcy 143 (1966). loyalty of the corporate 11According to the "Law of Diminishing Control. STONE. 1961. the board will often be unable to deal effectively with misconduct even when it suspects that such misconduct is occurring. at 1. 19.").. inhibits the flow of adverse information from the lower echelons of the corporation up to the board and vice versa. Thus. 73 In fact." since such a coricept is "entirely inadequate to capture the nuances of misleading corporate communications. It is important to note that this situation is not caused simply by "lies. DRUCKER. . there is no in- centive to notify the directors of wrongdoing." formulated by A. 12 As a result of this inability to receive information. the corporate organization impedes effective remedial action.. DOWNS." as the phenomenon is called. July-Aug. 5 ("A survey of 606 boards by Korn/Ferry. REV. information re- garding misconduct will rarely be communicated through the corpo- 72 rate hierarchy to the board. says 18% consider ethics one of their top four priorities.. The sheer size and complexity of the modern publicly held corporation is not conducive to efficient communication. at 61 ("[E]veryone in the organization simply knows that the executives above a certain level 'don't want to hear about' the fact that tests on a promising new drug are producing cataracts in laboratory animals. the board of directors has often been "the last group to hear of trouble in the great business catastrophes of the century. at 6. Professor Stone argues that those who operate the corporation believe that the board is only interested in hard facts: capital costs and financial ratios. Policies or directives trans- mitted from the board intended for lower level managers may become distorted or diluted as they pass through several managerial tiers. As a result. is the relative infrequency with which adverse information is transmitted upward through the corporate hierarchy. 1972). Information blockage may be caused by several factors. .. . 7 Moreover. J. down from 35% in 1980. Bus. HAv. even when the directors suspect misconduct. 7' And in most instances. or that a brake is burning out in trial runs . CARDOZO LAW REVIEW [Vol. Indeed. the larger an organization becomes. however." P. at 150. corporate personnel often operate on the assumption that the board does not want to know about illegalities which everyone does any- 4 way. a survey conducted in 1961 by the Harvard Business Review of its subscribing executives found that four out of seven respondents expressed agreement with the statement that businessmen would violate a code of ethics whenever they thought they could avoid detection. How Ethical Are Businessmen?. U' See id. 73 See C. THE CONCEPT OF THE CORPORATION 628 (2d ed. col. 9. "). Again. see also Wall St. Baumhart. supra note 10..

A NEED FOR REEVALUATION OF THE JUDICIAL VIEW OF DIRECTORS' LIABILITY Misconduct is in part a result of defects in the corporate struc- ture. Even assuming a willingness of corporate employees to blow the whistle. corporations engage in "Kafkaesque" ploys involving the use of middlemen and "linear structure of authority" which effectively structure information blockage into the corporate system. Having identified the problem. an assumption of doubtful validity.76 the board would still not necessarily receive the information that it needs to prevent misconduct. 4. namely. III. col. "[s]ome of the enemies of business now encourage an employee to be disloyal to the enterprise. nothing more repugnant to the corporate mentality than a whistle blower. by recognizing that such factors exist. Wall St.. Apr. STONE. little can be done to offset the adverse effect on communi- cation exerted by such factors as size or complexity of the corporation.19821 MONITORING MODEL 645 personnel lies where the power is. of course. Coffee. Admittedly. at 85. In fact. with the officers and not with the board of directors. whistle blowing or professional responsibility-it is another tactic for spreading disunity and creating conflict." The Whistle Blowers. 17. 1972. 76 See Coffee. It is toward this end that the follow- ing discussion is directed. supra note 9. at 1129-30 (noting that in the cases of questionable payments. 1980. TIME. Although commentators have offered impressive sup- port for these assertions. Directors tend to play passive or nonexistent oversight roles and counter-organizational behavior by employees is largely undetected by the board. at 5. supra note 10. . 77 See C. judicial remedies must be designed in light of corporate organizational forces. a court will be better able to tailor the monitoring remedy to fit the specific corporate organization. supra note 9. the judiciary continues to cling to the belief that corporate wrongdoing is predominantly the result of individual 75 There is. Professor Coffee notes that in attempts to isolate senior officials from wrongdoing. at 1133. In order to confront and stem corporate misconduct. J. Apr. corporate higher-ups are deliberately and systematically shielded from knowl- 77 edge of wrongdoing. few corporations had submitted written guidelines to personnel in an effort to stop illegal conduct). at 58-69. They want to create suspicion and disharmony. A former chairman of General Motors noted. a court will be more likely to pinpoint the precise reasons for a given board's inability to uncover or control misconduct. See also Crock. SEC Isn't Likely to Force Firms'Lawyersto Tell Boards of Employee Wrongdoing. 2 (an SEC proposal which would require corporate attorneys to report significant occurrences of misconduct to the board of directors received "an avalanche of criticism" from corporate management).7 5 and that these employees are in- formed as to what constitutes intolerable wrongdoing. However this is labeled-industrial espionage. Nevertheless.

. 188 A. see also Bates v. When the rules governing liability are reexamined and properly applied.' The Delaware court found for the defendants and held that. What action should he have taken. 251 U. 3 DEL. 3:627 aberrant behavior which the directors are unable to foresee or deter. at 80. Andrews. 91 N. 79 On its face. ? He would scarcely have helped to a solution by adding another cook to the broth. .S. courts will have no opportunity to impose equitable remedies designed to implement the monitoring model. Barnes v. 244. and thus have no duty to monitor corporate affairs. The adjustments are justified not only because they will facilitate the development of monitoring responsibilities. Dresser. 80 See Ward. implementation of the monitoring model will require adjust- ments in the judiciary's attitude regarding the scope of directors' liability. this decision.g. but also be- cause courts have expanded the protections afforded directors to near- total immunity. 188 A. courts rarely impose liability on directors in connec- tion with the wrongdoing of others. inactive members of the board.E."). 78 For this reason.Y. 614. Chofin. Ch. 298 F. Conse- quently. Fiduciary Standards Applicable to Officers and Directors and the Business Judgment Rule Under Delaware Law.80 would surely impede the imposition of monitoring duties by a court in a derivative action. 325 Mass. Courts undoubtedly either hesitate or refuse entirely to impose monitoring responsibilities on directors when they do not believe that the directors should be held liable for failure to monitor in the first place. and how can I say that it would have stopped the losses. The plaintiffs attempted to prove that the defendant-directors were liable as a matter of law by reason of their failure to take action to prevent the illegal activity. is the celebrated case of Graham v. e. L. if fol- lowed. Unless directors can be held liable. 78. 1924) ("Suppose I charge [the director] with a complete knowledge of [corporate affairs]. Corn. Allied Freight Ways v. 529-30 (1920) (directors held not liable for misconduct of others since wrongdoing was not foreseeable). active directors.2d 125 (1963). That is... 246 (1978) (suggesting that the results attained in Allis-Chalmers should be reached by many courts today). courts will not be able to effectively cure the disease if they are unwilling to examine its symp- toms. Ch. J. 524.2d 765 (1950). 81 41 Del. 70 41 Del. but will not shield the negligent..D. they will continue to protect the diligent. absent actual 78 See. Implementation of the monitoring model is inconsistent with the current judicial reluctance to impose liability on directors. a shareholder brought a derivative action against the corporation's directors to recover criminal penalties paid by the corporation as a result of federal antitrust violations committed by various company employees. CARDOZO LAW REVIEW [Vol. 617 (S. In Allis-Chalmers. The leading case holding that directors are not liable for the misconduct of others that they did not foresee.2d at 127. Allis- Chalmers Manufacturing Co. 630. .N.

on the other hand. at 81-82.8" and sub-goal pursuit. 88 See supra note 70 and accompanying text. the holding in Briggs was expressly limited to the facts of the case. at 683-84. was a manufacturing company which employ[ed] in excess of 31. Clearly these factual distinctions are relevant to a determination as to the right of a director to rely on the honesty and actions of others. Cary. supra note 40. 619 (1963) (remedies designed to implement control system as an alternative to damages might have permitted Allis-Chalmers court to consider more seriouslv imposing liability). and it is really . Id. Indeed. REV. 81Id. See generally. 1975). Allis-Chalmers should be rejected. at 80-84. COLO. Briggs itself has been severely criticized. 141 U. some commentators have concluded that given the specific facts in Allis-Chalmers. CYCLO- PEDIA OF THE LAW OF PRIVATE COR'OaATIONS § 1085 (rev. supra note 7 at 38-39. Allis-Chalmers. [with a] sales volume . . Extent of Duty to Install Control System to Prevent Anti-trust Violations by Subordinates.87 issuing guidelines will not be an effective means of preventing misconduct unless supported by a monitoring system. 35 U. 84 Id.S. Ch. ed. 88 See supra note 66 and accompanying text. [The Company was so complex] that it was not practicable for the Board to consider in detail specific problems of the various divisions. Moore. 5000 dealers and distributors.2d at 130-31. Courts 82 The plaintiffs unsuccessfully attempted to prove that the directors had actual notice of the violations. 132 (1891) (5-4 decision). and only when notice rebuts the presumption of honesty is reliance unjustified and institu- tion of an effective watchdog system required. 188 A. supra note 13. The decision in Allis-Chalmers is also assailable on the ground that the court placed excessive reliance on the near-century-old Supreme Court decision in Briggs v. but rather overzealous loyalty to the corporation. [had] a total of 24 plants. Briggs involved manage- ment of an 1880's banking institution which was capable of being managed by a single officer. 87 See supra note 69 and accompanying text.2d at 130. 0 For these reasons. 3 W. at 85. a duty to monitor should have been triggered. 88 the board will not receive notice of wrongdoing unless information block- ages are overcome 8" and disincentives of whistle-blowing elimi- nated. 41 Del. .000. L. . 90 See supra notes 75-77 and accotnpanying text. 188 A.8 3 the directors had no duty to install a system designed to detect a course of misconduct which leads to corporate losses.1982] MONITORING MODEL notice 82 or actual knowledge of facts that should have put them on notice of wrongdoing. perm. in excess of $500. 89 See supra notes 71-74 and accompanying text. Moreover. Even the most superficial analysis distinguishes the two cases.000 annually.000 people. 145 sales offices.2d at 128. . 85 The court's unsupported assumptions about corporate organiza- tion and bureaucracy are sharply at odds with the well researched findings of modern organization theory: wrongdoing is not due to dishonesty. The Court held that "in this case we do not think these defendants fairly liable for not preventing loss by putting the bank into liquidation within ninety days after they became directors. 85 Id. Comment. at 83-86. 188 A. Dwight. . Spaulding. FLETCHER. 84 The court's ratio decidendi suggested that a director is per- mitted to rely upon the honesty of employees.

illegal. B. Supp.2d 721.W. 533. See cases cited in W. Feldman v. 212 F. under the facts of a particular case.. but will not insu- late directors who do not.S. and. will continue to protect the diligent director who actively participates in corporate decisionmak- ing by monitoring the activities of the corporation.2d 300. the rule has become a virtual shield of immunity for corporate directors. Extensive deference by the courts to directors' business judgment might hinder implementation of the monitoring model which requires affirmative judicial action that arguably interferes with director autonomy. A proper application of the rule. courts will not interfere with the judgment of a corporate director).. or where their business judgment is exercised unfairly or in a dishonest manner). Ct. CARDOZO LAW REVIEW [Vol. v. 301 F. 1969). the failure of the board to monitor justifies imposing liability on directors for the misconduct of others.Y. Marshall Field & Co. v.2d 389. Even assuming a readiness of the courts to find directors liable for the misconduct of others.g. Pennroad Corp.. 712 (N. 19 N. denied.S. denied.E. gross overreaching. Panter v. 1954). 396 (6th Cir..2d 271. 1981) (court will not interfere with the board's actions unless the matter is ultra vires. Broski v. Goodrich Co. e. 775-76 (3d Cir. Grace v. 3:627 should accept the findings of organization theorists and hold directors liable for corporate wrongdoing when they have failed to institute monitoring systems. EISENBERG. III.D. at 523-24 (note on liability of directors of banks and other financial institutions).S. App. supra note 1. Seagrave Corp. although Briggs has not been overruled. Originally intended as a judicial endorsement of a common sense appreciation of the director's role and limitations within a publicly held corporation. 155 F. cert.2d 531. Jones. at 166 (emphasis added). 1092 (1981). however. Northwest Indus. bad faith. 614 S. . 226 N. Only by examining closely the peculiar organiza- tional characteristics of a corporation is it possible to gain an apprecia- tion of why and how corporate misconduct flourishes. Grace Inst. 706. 454 U. Mount. only then is it possible to determine whether. 9 ' That is.F. CARY & M.2d 773. implementation of monitoring responsibili- ties in a derivative action will be impeded by judicial reluctance to interfere with director autonomy and discretion. 313. 329 U..). 725 (1967) (policy of the New York courts to avoid interference with the internal management of corporations). The business judgment rule provides that a court will not inter- fere with informed business decisions that are carried out in good faith to that the case becomes reduced at last. fraudulent. the no- tion that a director might be held liable for failure to monitor will remain a rule in potentia unless courts are prepared to intrude when necessary upon the directors' prerogatives in "managing" the corpora- tion. 279 N. The judicial policy of nonintervention is seen most clearly in applications of the business judgment rule. cert.) (in absence of fraud. 304 (Mo. 808 (1946). Finally.Y. 293. it has been severely limited in subsequent court decisions." 141 U.2d 307. 296 (7th Cir.S. "I See. 646 F. or abuse of discretion.

2d 878. 582 F. unforeseeable events. 8 HoFsTRA L. or dishonesty). 275 (3d is not the function of the court to say that it would have acted differently and to charge the directors for any loss or expenditures incurred. 879 (Del. 1974).S. 81. Pacific E. 1978) ("[W]here the shareholder contends that the directors' judgment is so unwise or unreasonable as to fall outside the permissible bounds of the directors' sound discretion. Woodruff.1982] MONITORING MODEL 649 and in the best interests of the corporation.")."). or other personal interest of. One rationale for the rule is that it protects directors from liability for corporate losses caused by fluctuating markets.g. 49 N. or (2) the directors voted to authorize the transaction even though they did not reasonably believe or could not have reasonably believed the transaction to be for the best interest of the corporation. CARY & M. directors must be given wide latitude in their handling of corporate affairs. American Fin. 619. See Cramer v. or other forces beyond the directors' control. Signal Cos. & Elecs. Bell. 611 (1935) ("If [mere mistake warranted judicial intereference].D. See. or (3) in some other way the directors' authorization of the transaction was not in good faith. 21 Del. bar inquiry into acts not carried out in good faith or decisions which are unreasonable. 627 (S. 316 A. Corp. aff'd. 111-12 (1979).").S.. 582 F.Y.2d 619 (Del. 93. General Tel. and uninfluenced by any consideration other than what they honestly believe to be for the best interests of the [corporation].. v. we think... W. Another rationale is that the rule promotes judicial economy. See. Kelly & Wyndham.2d 599.Y. & Elecs. e. 604. cert.. be able to conduct its own analysis of the reasonableness of that business judgment. Gimbel v. 316 A. 652 F. 274 (3d Cir. 1129 (1979). a court should. Ella M. REv. where the court stated: The business judgment rule originated as a means of limiting the liability of corpo- rate directors and officers for mistakes made while performing their duties . Ch... 180 A. 1129 (1979). courts would be clogged with the pure business problems of corporations concern- ing which individual stockholders were in disagreement with the officers and directors chosen by . 1981). the directors who authorized the transaction will not be enjoined or set aside for the directors' failure to satisfy the standards that govern a director's performance of his or her duties. Karasik v. 487 F. e. Corp..2d 625 (Sup.S. at 1510 ("a long line of Delaware cases has held that even an arm's-length combination is subject to judicial review for fairness"). If in the course of management they arrive at a decision for which there is a reasonable basis. as the result of their independent judgment. however. The rule does not. Corp. 1978).) ("There are limits on the business judgment rule which fall short of intentional or inferred fraudulent misconduct and which are based simply on gross inadequacy of price [for sale of the corporation's wholly owned subsidiary].g.2d 259. Id. The rule has been stated as follows: A corporate transaction that involves no self-dealing by. Casey v. 1980) ("The 'business judgment' doctrine bars judicial inquiry into actions of directors taken in good faith and in honest pursuit of the legitimate purpose of the corporation. denied. 97. Supp.2d 259. EISENBERG.. 439 U. The directors are entrusted with the management of the affairs of the [corporation]. supra note 1. at 642-43 (emphasis added). Cf. Inc. 610 (Del. The rationale for the rule is that in order for the corporation to be managed properly and efficiently. The Business Judgment Rule Revisited. 266 A. General Tel. Cramer v.2d 53 (2d Cir. 439 U. unless: (1) the directors did not exercise due care to ascertain the relevant and available facts before voting to authorize the transaction. 1944). Ch. 92 The board is entitled to HSee Elfenbein v. cert. bad faith. aff'd per curiam. 1970) (payment of voluntary taxes falls within the scope of business judgment rule absent personal gain. denied. and directors who authorized the transaction will not be held person- ally liable for resultant damages. Ct. Arsht.. and they act in good faith.

' Costello v. 184 N. 2d 29. it is presupposed that judgment-reasonable diligence-has in fact been exercised. 197. 123 N. 49 N.E. 113. Dole & Clark Bldg. Saint Joseph Lead Co. " Polikoff v.96 Likewise.S. 25 N. 27 Bus. 103 N. 91 See Arsht. conservation of judicial time should not take precedence. at 112. 143 Ill. 148. 564-65 (1967). again. Woodruff. 104. the rule assumes that informed deci- 97 sionmaking has in fact occurred. 278. a case arises which calls for judicial correction.. 283. 209 N. See also Cary & Harris.. the courts will not substitute their judg- ment 3 by holding the board liable as a guarantor of corporate suc- cess. ("Of course if the error in judgment is contaminated by fraud.Y. 1972) (before applying the rule courts should require that directors have adequate information). 35 GEo. Casey v.Y.E. where the court stated: When courts say that they will not interfere in matters of business judgment. 35-36. However. 1914) (substitution of someone else's business judgment for that of directors' "'is no business for any court to follow' ") (quoting Gamble v. App. 643 (Sup.E.g. '3Holmes v. is a standard no man should be judged by. collusion or other vitiating circumstance. Casey v. Significantly. CARDOZO LAW REVIEW [Vol. 3:627 considerable discretion.9 4 The business judgment rule is therefore an attempt to strike the proper balance between the need to protect shareholders from uninformed and reckless decisions of their agents 5 and the need to protect directors from the unpredictability of the market and corpo- rate business. 49 N. See generally Note. 262. 795 (1962) (" '[C]ourts of equity will not undertake to control the policy or business methods of a corporation. and having it and its consequences as a source. 100 N. .E. L. 643 (Sup. supra note 92. Pollitz v. Issue Feb. 'Wisdom developed after an event. 202 (1890)). "' See infra note 121.. and the business more successful if other methods were pursued. Wabash R. 37 I11.E. when a board fails to supervise or monitor the corporation due to inatten- tiveness.2d 625. 61.2d 792."). and if hindsight proves that the "wrong" business decision was made.Y. 420.2d 625.Y. the rule simply is irrelevant in assessing liability for indeci- sion.. 147 N. 208. the majority to think and decide for the corporate creature.R.."). Woodruff. the rule was not intended to grant immunity from liability when uninformed directors have simply rubberstamped the decisions of the officers. 201. Present Day Statutes and the Model Act. 70 (Special Supp. 07 See. 91. 252... 207 N. Pullman Iron & Steel Co. Costello. 107 (Sup. Ct. A director cannot close his eyes to what is going on about him in the conduct of the business of the corporation and have it said that he is exercising business judgment. e. 84 Misc. 724 (1912) ("the exercise of [directors' power to make business decisions] for the common and general interests of the corporation may not be questioned although the results show that what they did was unwise or inexpedient"). REv.Y. 1944) ("The law recognizes that no director is infallible and that he will make mistakes .S. 721. Ct. 124. Standardsof Conduct Under Common Law.. 423 (1892)). Corp. 1944).S. when the corporation is unfairly prejudiced by the actions of its directors. The Continuing Viability of the Business Judgment Rule as a Guide for Judicial Restraint."). 152 [1913]. The rule is meant to apply only when decisions are in fact made.' ") (quoting Wheeler v. WASH. 99. Ct. Queens County Water Co. although it may be seen that a wiser policy might be adopted. application of the rule presupposes director in- volvement in the corporation's business affairs and organization. LAW..Y. See id. 562. 32 N.

Cary. Arsht argues that many cases can be resolved by articulating a special rule for cases involving parent-subsidiary relationships. at 94. 316 A.50 ("However the business judgment rule is formu- lated.' 'gross abuse of discretion. " See Brudney. The rule occasionally has been so inconsistently 8 and erroneously 99 applied to insulate directors from liability that the rule itself now exemplifies the judiciary's near refusal to examine whether the directors actually engaged in informed deci- sionmaking. afJ'd per curiam. 1975) ("[T]he rules [which interpret the business judgment rule] are laid down [in] . the plaintiff sought an injunction on the ground that the board failed to act on such an important matter with informed deliberation. Dent. courts have erroneously extended the business judgment rule to protect blind ratification of corporate management decisions and director noninvolvement. 1974). but practicing lawyers and commentators give credence to dicta [even if it represents a judicial penchant for colorful phrases]. .such glittering generalities that the case[s] could be decided either way thereunder without violating the rules. supra note 10.100 In Gimbel.Only six directors . its teaching imports virtually no liability for a director not visibly afflicted with a conflict of interest or egregiously inattentive to his duties. supra note 10. Id. Alterna- tively.). where he explains: Perhaps [Arsht is correct]. . supra note 27. . He reconciles the cases by determining that an apparently overly lenient standard used in some cases represents a "[j]udicial penchant for colorful phrases such as 'gross negligence.' and 'palpable overreaching' [which] simply fuels the fire [of confusion]. these instances may exist side by side or even appear in the same case with summary dismissals of ordinary negligence complaints. the transaction had been submitted to the board "on approximately two days' notice . at 679-83 (criticizing the business judgment rule in cases involving parent-subsidiary relations). at 104-10. at 12 (rev. When the board ratified the sale. Id.").2d 619 (Del. 136-37 (criticizing judicial applications of the business judgment rule that fail to make any reference to a director's duty of care). supra note 92.. and probably had agreed to it prior to the board meeting. . 3A W. Signal Cos. But cf. judicial state- ments appearing to adopt lenient standards of care no doubt discourage the bringing of suits and influence the bases on which suits are settled even if lawyers have misinterpreted those statements. . One such example of how the rule has been misapplied is Gimbel v. Many instances can be found in which courts hold decisionmakers liable without proof of fraud. . at 614 n. supra note 93. a shareholder sued to enjoin the sale of a wholly owned subsidiary to an unaffiliated buyer for an allegedly inadequate price. ed.[of the fourteen] knew of the purpose of the meeting in advance." 10' Nevertheless. Arsht has attempted to find consistency among the various and often apparently conflicting standards of care used in the application of the business judgment rule."). the court concluded that these facts "do not in themselves justify the conclusion that the 'directors acted so far without information that they can be 91See Note. Dent. FLETCHER. ."). The facts showed that although the officers had considered the transaction' for some time. supra note 13. at 614. 10.1982] MONITORING MODEL Unfortunately. 100316 A.2d 599 (Del." Arsht. Ch. at 646. at 563 ("[The rule yields in]consistent result[s]. CYCLOPEDIA OF THE LAW OF PRIVATE CORI'ORATIONS § 1029. at 646-47 & nn. perm.

the rule served to insulate from judicial inquiry the directors' decision to approve the transaction but not the reasonableness of the transaction itself. In Syracuse. a shareholder should not be barred from challenging the approval of a transaction when it evidences uninformed decisionmaking by directors who owe a fiduciary duty of loyalty and due care. The business judgment rule need not inhibit courts from impos- ing significant monitoring responsibilities on the board inasmuch as the rule itself implies a degree of care and awareness of corporate affairs. This interpretation. however. A Syracuse shareholder suspected waste of corporate funds and misconduct in areas under the jurisdiction of the executive committee and reported his suspicions to the board. Id. 3:627 said to have passed an unintelligent and unadvised judgment.Y. 167 A. 51 Misc. Ct. Channel 9.2d at 26. Syracuse. does not comport with the general principle that the business judgment rule only protects decisions made in good faith and in the best interests of the corporation. they will probably be unwilling to impose monitoring procedures designed to modify the board's deci- sionmaking process. 273 N. the directors argued. which elevates the rule to an almost irrebuttable presump- tion in favor of directors' decisions. The rule is intended to protect only informed decisions made in good faith and in the best interests of the corporation. Even if they do find liability. According to one commentator. 326. is inconsistent with the original purpose of the rule and should be rejected. The business judgment rule as applied in cases such as Gimbel can impede implementation of the monitoring model. That is. 2d 188. Arsht. 833 (1933)). the board members refused to consider the shareholder's allegations. See supra notes 92-94 and accompanying text. 103 One illuminating example of a proper application of the rule in a situation where the directors ignored monitoring responsibilities is Syracuse Television. 19 Del.S. at 615 (quoting Mitchell v. the rule balances the directors' right to substantial discretion to act without fear of liability with the shareholders' right to responsible decisionmaking.. this formulation of the business judgment rule would insulate nearly every board decision from judi- cial scrutiny.2d 16 (Sup.Y. however. When properly applied. Inc. 273 N.S. at 124-25. The rule does not insulate bad faith or ill-considered decisions that fortuitously do not reach the standard of "unreasonableness. 0 3 Since the rule does not protect uninformed deci- 102 Id. 329-30. at 195. Highland-Western Class Co." Simply because a transaction does not reach the point of unreasonableness from a business perspective. 831. v.. Inc. inter alia.' "102 Given the circumstances of the case. the application of the business judgment rule in Gimbel was correct since the directors' decision ultimately was not insulated from judicial scrutiny. Courts that are unwilling to scrutinize the directors' decisionmaking process will most likely not find liability for ill-considered or uninformed decisions. The Gimbel approach. As a defense to the subsequent derivative action. Ch. an executive committee was appointed 'which had a variety of oversight functions. supra note 92. that their "absence of action was .652 CARDOZO LAW REVIEW [Vol. For more than a year. 1966). The court eventually issued a preliminary injunction on the ground that the price was so unreasonable as to raise a question of whether the directors had acted outside the bounds of reason in approving'the sale.

Syracuse. the court held the directors liable for their inaction.N. 273 N.1982] MONITORING MODEL 653 sionmaking.e. supra note 10. .Y.2d at 26. corporate reform will be encouraged once the courts provide the impetus. it will provide a basis for judicial imposition of equitable reme- dies designed to encourage the directors to monitor corporate affairs. The court summarily rejected this defense on the ground that "[i]t can hardly be argued that the board members exercised their sound business judgment by refusing to even consider the [shareholder's] motion. supra note 33. the business judgment rule will continue to protect informed decisions. See Lanza v. a prudent businessperson in like position with the accompanying duties of good faith and loyalty. their decisions prove to have been incorrect.. from a retrospective business vantage point. 273 N. but will be compelled to be on its guard for corporate misconduct. when the business judgment rule is properly applied. 273 N.S. Leasco Data Processing Equip. Supp. the rule need not be abandoned or weakened to accommodate the monitoring model.D.S. In so doing. An examination of the directors' right to rely provides one exam- ple of how the rules of lihbility themselves can serve as long-term the exercise of sound business judgment . i. 1306 n. it should not prevent a court from taking steps to ensure that future decisions are both responsible and informed.." Id. 332 F. however. 544.2d at 27. Once corporate directors are aware that a failure to assume oversight responsibilities will give rise to liability if misconduct occurs. Greene & Falk. 51 Misc. the board will not be able to hide behind a shield of immunity. . The only difference is that the standard of due care will be defined in terms of the committees upon which the directors serve and the knowledge the board members could or should be expected to acquire. After determining that the relevant standard of care for the committee members was defined by their membership on the executive committee. 104 This is especially true since the standards utilized in business judgment cases. 1973). the courts will encourage reform rather than litigation. First.. at 195. Once those steps are taken. Second. 577-78 (E.. 2d at 196-97. at 191.. Self-implemen- tation of the monitoring model will then take place outside the deriva- tive action. Feit v. at 1247 (discussing "differential liability" for board members who sit on oversight committees). See also Dent.. they will be encouraged to implement monitoring reforms on their own rather than face the threat of a derivative action. Directors will still be able to rely on the rule when. proper application of the liability rules will encourage direc- tors to adopt monitoring procedures on their own before a derivative suit is filed.Id. 1971).. As this case illustrates. In sum. 479 F.S.2d at 22.Y. Proper application of the liability rules will provide two benefits. at 646- 47 and cases cited therein (emphasizing the importance of defining the business judgment rule in terms of a director's duty of care).Y. Before liability can take this form. consistent results in derivative actions are necessary with more imme- diate and effective remedies afforded to shareholder-plaintiffs.2d 1277. or the making of no decision at all. 104 it need only be properly and consistently ap- plied.98 (2d Cir. Drexel & Co.Y. would still apply once the monitoring model is implemented.

§ 495. supra note 10. para. simple enough: courts must impose sanctions on them for failing to assume monitoring responsibility when that failure causes shareholder injury. is concerned"). Brady Consultants.D. 108 The solution to the reluctance of outside directors to monitor effectively is. at 1362-63 (footnotes omitted). 3 (1981) (consideration of the opportunity of corporate counsel to inform directors of wrongdoing inasmuch as the counsel's advice is relied upon by corporate clients). Handler & Christy. at 649 (although it would be "absurd" to allow the directors to rely exclusively on the opinions of officers as to how they should vote at board meetings..2d 849.W. Acr ANN. however. § 35. Reliance on Advice of Counsel as a Defense in Corporate and Securities Cases. at 498 ("A policy of broad managerial delegation adopted by the board of directors of a large corporation has been upheld by the courts under the business judgment rule. 1981) (although corporate directors and officers are chargeable with knowledge of any matter that it is their duty to know. § 35. The Role of Inside Counsel in CorporateAccountability Process.] and should be clarified. DEL. or in relying in good faith upon other records of the corporation. MODEL BuSINESs CORP. 10 8 For 105The right to rely is widely recognized in corporation codes. "a limiting principle is hard to find"). Supp. directors. 62 VA. 2. L. 3:627 remedies for improving corporate governance. Bus. it is hoped that this clarification of the statutory premise [of the director's right to rely. See also Dent. . at 314. Hawes & Sherrard. Soderquist. they may not be charged with the knowledge of all the affairs of the corporation). see also MODEL BUSINESS CORP. The lack of clarity which now exists regarding the limits of a director's right to rely is a direct result of the courts' uncertainty as to the duties a director is realistically capable of performing. Supp. MODEL BUSINESS CORP. § 35. at 259 (2d ed. 2. TECH. Supp. L. at 255 (2d ed.g. supra note 105. See generally Ferrara & Steinberg. shall. 1977): Since the growth of the law in [the] dynamic corporate area [of the director's duty of care and right to rely] will continue to come through judicial interpretation. 8 TEX. CODE ANN. Texas CorporateDirectors'Standardof Care and Right to Rely: A ProposedModification." have shown an increased awareness of their exposure to liability. Supp. 1977) ("[T]o the extent [that the duty of the director to manage the corporation] might be interpreted to require active involvement by the board in day-to-day affairs of the corporation. supra note 18. . 305 N. supra note 15. 1980) ("A member of the board of directors . . L.Y. 291 (1976) (statutory expansion of right to rely accords with needs of complex organizational structure of the corporation)."). See. 1977) ("[active] involvement is clearly neither practical nor feasible insofar as today's complex corporation . 06 Yet the right to rely is not absolute and will not protect directors who "close their eyes" to corpo- rate operations. para. 105 The directors' right to delegate authority and to rely on the work product and advice of others is a matter of corporate necessity. N. 2 W. 2 (2d ed. para."). 8. See Dent. 851 (S. see infra note 111] will assist the courts in recognizing more clearly the practicalities of accountability in the corporate model and thus permit the law to develop princi- . 1981) (same). § 141(e) (Supp. tit. REV. Handler & Christy. e. . 1977).654 CARDOZO LAW REVIEW [Vol."). para. at 255 (2d ed. 2. Acr ANN. CORP. § 35. § 717 (McKinney Supp. supra note 15. it does not accord with the realities of today's corporation[. in the performance of his duties. Acr ANN. faced with a "rising tide of lawsuits by disgruntled shareholders. . at 648-49. FtrcHE. supra note 10. LAW. REV. 107 See supra notes 96-97 and accompanying text. 4 CORP. 1 (1976) (suggesting the proper limits of the defense of reliance on legal advice). be fully protected in relying in good faith upon the books of account or reports made to the corporation . jo See MODEL BUSINESS CORP. particu- larly the large diversified enterprise. REv. In the last few years. . 0 7 A clear definition limiting the right to rely will have the salient effect of alerting board members to the extent of their duty to involve themselves in supervising the corporation. at 1361. see also Nichols v. Soderquist. ACr ANN.

reports or statements . Supp.. MODEL BUSINESS CORN. 1924) ("The measure of a director's duties [to keep advised of the conduct of the corporate affairs] is uncertain. if directors in a series of derivative actions are held liable for theft of corporate funds by reason of their failure to be informed as to the selection process and veracity of the corporation's accounting reports." Id. Id. N. .The amendment consequently makes the right of reliance available to directors with respect to all mattersfor which the board of directors is responsible.Y.D. The Model Business Act also provides that when the director relies upon corporate officers and employees. in which directors will have available to them. a director shall be entitled to rely on information. at 254-55 (emphasis added).Y. 109For suggestions as to the oversight committees which the board can establish in performing its monitoring duties. Several courts have gone beyond the exclusory language of the Model Business Corporation Act" 3 and have interpreted the director's pies of responsibility and liability which more accurately recognize the proper role of the corporate director. When reliance is upon legal counsel or public accountants." Id. the matter relied upon must be "within [their] professional or expert competence. "but he shall not be considered to be acting in good faith unless he has knowledge concerning the matter in question that would cause such reliance to be warranted. such as that a director must give reasonable attention to the corporate business. Acr ANN. Barnes v. Bus. § 717 (McKinney Supp. CoRn. opinions. § 35. 298 F. 2. .. when a director relies upon a board committee in which the director is not a member. then corporate board members will be put on notice that part of their duty as directors entails monitoring the corporate audit proc- ess. the right to rely on others and (ii) the range of materials on which directors will have the right to rely ." Id. Andrews. § 35(a). 110E. .109 The limitations on justified reliance that currently exist in state corporate codes" 0 mirror those of the Model Business Corporation Act: "In performing his duties. by force of statute.1982] MONITORING MODEL 655 example. § 35(c).N." This alternative would directly impose a duty to be informed which the monitoring model requires. DEL. I" See Handler & Christy. . LAW. 2. 1977) (emphasis added). 1. such reliance must be upon persons whom the director believes to be "reliable and competent in the matters presented. 8.""' This standard. 615 (S. perhaps by establishing an audit committee. § 141(e) (1974). the courts contenting themselves with vague declarations. does not provide any specific guidelines for determining when the director's reliance is in fact rea- 2 sonable. § 35. . supra note 105. 1981).. para. . 614. tit.. however. "I The alternative text of the statute might have read. And finally. . 11 It merely states the limits in reference to a vague standard of good faith. see infra notes 190-94 and accompanying text.").but he shall not be considered to be acting in good faith if he has knowledge concerning the matter in question that would cause such reliance to be unwar- ranted. at 304-11 (critiquing this section of the Model Business Act). The Model Business Act modified its earlier rule to broaden both (i) the range of situations . CODE ANN. the committee must be such that "the director reasonably believes to merit confidence. at 270-71 (2d ed.g.§ 35(b). para.

1964). 390 (Sup. 364 N. 270 N. denied sub nom.rely would be wholly consistent with the presump- tions of the monitoring model and would require that the director have access to all relevant data before endorsing management proposals. 857 (1973): [T]hese are times when corporations are exceeding in size and impact even the giantism of the past. 822 (1967). 213 S. Drexel & Co. v. Inc.E.656 CARDOZO LAW REVIEW [Vol. 2d 234.E.1 5 In Doyle v. Union Insurance Co. '"' See..2d 37 (9th Cir. v. the court's reasoning is equally applicable to publicly held corporations. But cf. 36 N. 329 N. 599. Ray.. Johnson v.S. 467 (7th Cir.S. Ct. the presumption would be that the board would have denied the officer the right to act as he did)..J. 368 N..2d 134.E. 51 Misc.S. concurring). .2d 16 (Sup. supra note 105. Syracuse Inc. an outside director does not have an affirmative duty to solicit information but he must consider any adverse information which comes to his attention).). Co. e. Channel 9. and when the importance of directorate oversight of the manage- ment technocracy is greater than ever. Ct.2d 629 (1965). Kutik v. C.2d 369 (1st Cir.. Burgin. The director's right to rely would therefore be readily assimilated into the monitoring model of corporate governance provided that the director has sufficient information concerning the reliability and veracity of reports and dependable accounts of employee integrity and competence. Barr v.) (Coffin.Y.2d 692 (1948) (reliance on report of corporate audit in an action alleging payment of illegal dividends is not available as a defense if the corporate directors make no effort to inform themselves about the situation). 1306 (2d Cir. . 2d 188. 23 A.2d 387.. Stein's. 188. afJ'd. when new layers and dimensions of corporate obligation are being recognized. denied.. 994 (1971).S.S. Baker v." 6 for example. 841. see also In re Kauffman Mut. Syracuse Television. at 268.. 258 N.2d 257 (1st Cir. cert. the law holds them accountable for that which they reasona- bly should have known or discovered in the discharge of their duties . Union Insurance Co.2d 180. 479 F. Inc. DePinto v.Y.2d 497. 13 CrEIGHTON L. 42 Misc. 2d 839. 17 N. Alternatively. 50 S. 389 U. and scrutiny may fairly be expected on the part of directors today than in a simpler era. Fund Actions. 116 202 Neb.. see Moses v.2d 36 (1979)..2d 1. Mutual Loan & Inv. 1281.2d 463. 374 F. Lanza v.g. Co. 381. 445 F." 4 the degree of knowledge being relative to the circumstances of the case.D. 277 N. 404 U. Taylor. Life Ins. 6 (Sup. 383 (1979). Such an interpretation of the right to . nevertheless. Outside Directors'Liability for Breach of Fiduciary Duty to Investigate-Doyle v. at 309-11 & nn. 507 (1975) (reiterating "the long-standing rule that [a nonaffiliated director] does not exempt himself from liability by failing to do more than passively rubber-stamp the decisions of the active managers").g.. the violation of which requires intent or reckless- ness. 217 N. . Platt Corp. See generally Handler & Christy. Moses. 2d 640. 1980). Wackman.2d 408 (1966). See generally Comment.S. v.Y.W. sensitiv- ity. 1973) (under the Securities Acts. Id.Y.S.Y.) (implying that when an officer fails to disclose fully in a conflict situation. the right to rely would require that a director actively solicit such information through his own information network if unbiased information is unavailable.S. e. Provident See. denied. 3:627 right to rely to require an affirmative duty of active involvement by the director which necessarily contemplates acquisition of knowledge that would justify the director's reliance. A higher degree of professionalism. the Nebraska Supreme Court held various outside directors liable for selling assets of the company for less 14 See. 649 F. While corporate directors are not liable for errors of judgment.Y.2d 1277. 80 Misc. 479 F. Platt. 1966). where the court stated: It is the obvious duty of directors to know what is transpiring in the business affairs of their corporation. . 249 N.Y.C.2d 371. rev'd on other grounds. cert. 273 N. 1975). Blumenthal. 558. cert. 643.2d 823.Y.74-89 (citing circumstances courts have considered as relevant when determining whether reliance was justi- fied).S.. Ct. 414 U. Although Doyle involved a closely held corporation.

875.C.S.. 1979). and hold them to a strict account of any breach of the trust relation. supra note 4. Care Corp.D. e. see Knauss. 165.W. 215. Thus. 1977). at 610.2d 237.2d 66 (1952). at 608.Y. 123.") (quoting Bosworth v.Y. 165 (1901)). CorporationStatutes: 1959-1966." 8 the court held the directors liable for failing to inform themselves of the under- lying fairness of the transaction and the representations set forth in the company's proxy statement. 281. 56 N. 241 P. at 613. 278 S.2d 191.N. considered somewhat as agents for the corporation. that of a fiduciaries). Blaustein v. 263 A.2d 738. Remillard-Dandini Co..Y. 163. 293 N. Although corporate directors are not literally agents of the shareholders.S. 52 N.g.) ("[The] fiduciary duty requires that the directors act in good faith and in the best interests of the corporation in carrying out its business. afftd.S.2d 969.2d 212. 308 U. 428. 254 F. Loy v. 653 (S. 608-09.W.. Supp. App. 1981).D. 277 N. Lorm Corp. supra note 41.2d at 43. 975 (Del. 278 N.").W. 277 N.1982] MONITORING MODEL 657 than a fair price. but includes the dedication of his uncorrupted business judgment for the sole benefit of the corporation. Singer v. courts of equity treat them as trustees. 349 U. The primary importance of the fiduciary duties of a corporate directorate therefore is to establish that the corporate entity and purpose must be the sole foci of the directors' responsibilities. ignorance because of neglect of duty on the part of a director creates the same liability as actual knowledge and failure to act on that knowledge.N.E. See generally H.E. 613. Folk.Y. the court held that "[w]here the duty of knowing exists. . 277 N. 1966) the law of agency is generally held to apply to directors by analogy. 157.Y. 44. Linge v. 293 N. 121Id.W.2d 705 (1944). see. 277 N. 168 N.Y.Y. 109 Cal. cert.S. the breach of a director's fiduciary duty has been recognized as an independent cause of action distinct from allegations of actual fraud. but in their relation to the property of the corporation their relations are. modified. Even though the directors claimed that they were relying on an audit by a reputable accounting firm and the approval of the State Director of Insurance. Feldmann. Reverse Producers Corp. and the cases holding directors to the high standards of a fiduciary are legion. Litton. comment (1958). Pepper v. Pan Am. 176 (2d Cir.. 31 N.2d at 41.J.W. 2d 405. Ltd. 119 Id. 219 F.W. (1967). v. and that the directors' conduct will be judged by a standard higher than customary market notions of acceptability. 11 Id. 380 A. 194-95 (Iowa 1980). at 488.. Elfenbein v.2d at 38.N. RESTATEMENT (SECOND) OF AGENCY § 14C.' ' 17 202 Neb.E. 899-900.D.2d 173. Treadway Cos. 61 N.Petroleum & Transp. 97. v. 268 N.2d at 42-44. Supp. Ralston Purina Co. Magnavox Co.. in equity. 619. and for relying wholly on the insiders' recommendations. at 611.2d at 42.1 19 More specifically. For all practical purposes they are trustees when called upon in equity to account for their official conduct. e. Corp.2d 934. 277 N.2d 589.D."' 20 The policyholders were thus 2 denied the benefit of their agents as fiduciaries. 487 F. 240 (1966) (directors in their dealings with third parties are.. §§ 235-242. aff'd.2d 897 (1981).").. Allen. 1980). Lewis.2d 53 (2d Cir. at 601.D. 652 F. in law. 224 N.Y. 25 A. American Fin. Remillard Brick Co. 41-42. Co. 960 (1941) ("While courts of law generally treat the directors as agents. Supp. 502 (S.Y. App. 295 (1939). 1966 DuKE L. Fiduciary duties of directors play a significant role in defining the scope of a director's duty.. Perlman v.) ("[T]he responsibility of the [director-] fiduciary is not limited to a proper regard for the tangible balance sheet assets of the corporation. Vogel v. See.'1 7 The facts demonstrated that the only involve- ment of the outside directors was voting to investigate the transaction and eventually authorizing the actual sale.2d 357 (2d Cir.2d 236. v. 638 F. see Hermusic. and even compliance with a statute has been held an insufficient defense in an action alleging a breach of the director's fiduciary duty. 120 Id. 952 (1955). 490 F. HENN.. aff'd.g.S. denied.E. 627 (S. 19 N.

a possibility that fiduciary ideology inherently ignores. Some problems [of corporate misconduct] seem to require structural reform. at 498. EMPLOYING REMEDIES TO IMPLEMENT CORPORATE GOVERNANCE REFORM Because the board of directors is incapable of managing the corporation. it gives direction to further inquiry. cert. J. 458. Acceptance by other courts of the Doyle decision would put directors on notice of their duty to act independently and intelligently. denied. would provide a framework which would enable the board to exercise fiduciary duties more effectively. it probably does not by itself compel acceptance of the monitoring model as a touchstone for determining liability.. 464. ') (emphasis added).") and Perlman v. are forbidden to those bound by fiduciary ties.658 CARDOZO LAW REVIEW [Vol. are consistent with the board's monitoring role inasmuch as the fiduciary duties establish director loyalty to the corporation. 546 (1928)(Cardozo. Organization theory highlights those aspects of corporate behav- ior that permit misconduct to remain undeterred. Feldmann. 545.E.Y. 952 (1955) with SEC v. 219 F. the courts could encour- age monitoring functions by imposing liability in accordance with organization theory. a court remedying a breach of fiduciary duties should frame its order to encourage the adoption of the monitoring model. by negative reinforcement. To whom is he a fiduciary? In what respects has he failed to aischarge these obligations? And what are-the consequences of his deviation from duty?") and Coffee. 164 N. 349 U. [T]he punctilio of an honor the most sensitive.' 2 3 Even with- out adopting such a broad duty to monitor. at 1111 ("[N]ot all problems reduce themselves neatly to questions of honorable conduct or are resolvable simply by exercising other admirable virtues. see supra note 121. While the fiduciary duty of a corporate director does play an important role in defining the limits of the director's behavior.S.. 249 N. 176 (2d Cir. but will also serve a long term goal of more specifically defining. Fiduciary duties. is then the standard of behavior. supra note 9. IV. in essence. 80. 318 U. such as diligence and foresight. 123 Knauss. as discussed supra note 121.. 3:627 Doyle. Imposition of liability will not only permit im- plementation of remedial judicial orders to meet the specific allega- tions in the derivative suit. however. at 657 & n. supra note 4. .S. Salmon. 184. Compare Meinhard v. the traditional legal model of corporate governance is 121 Dent..2d 173. to the publicly held corporation).) (applying the Cardozo language originally stated with reference to the joint venture. Chenery Corp.)("But to say that a man is a fiduciary only begins [the] analysis. 85-86 (1943) (Frankfurter. A trustee is held to something stricter than the morals of the marketplace . the duties of corpo- rate directors. supra note 10. held the directors liable for failure to correct those defects which organization theory has identified as the cause of corporate irresponsibility and misconduct: board dependence on the CEO and lack of adequate and independent information networks. Some commenta- tors have opined that the findings of corporate organization theory are so compelling that a failure to monitor would involve a breach of a director's duty of care1 22 or fiduciary responsibilities. Recognizing this. C.) ("Many forms of conduct permissible in a workaday world for those acting at arm's length.J. Implementation of the monitoring model. and would hopefully encourage internal monitoring reforms.

the appoint- 124 Dent. Id.E. In any event. 389. 56 Cal. a receiver may be appointed for the corporation itself-to collect and distribute the judgment.12 4 If the monitoring model is successfully implemented. 314. however.1 (3d ed. 125 See supra notes 43-44. § 7665. A. R. moreover. "there are few functions of a receiver that cannot be evolved by innovative use of the inherent powers of the equity court. 121 See Sinclair v.1982] MONITORING MODEL 659 structurally inaccurate. In order to preserve the board of directors as protectors of the corporation and its shareholders. In recognizing this inability to manage. § 7666. The derivative suit historically has been used to police corporate management. A TREATISE ON THE LAW AND PRACTICE OF RECEIVERS §§ 711-732.2d 854. ed. 132 P. Alternatively. Moore Cent. Once courts recognize that the board's duty to "'manage" should encompass various monitoring responsibilities. Koshaba. courts should use the derivative action to devise remedies that will create an environment in which the directors will be encouraged to perform the monitoring function.. 12o 16 W. supra note 10. FLETCHER. perm. crea- tive remedies will be more readily available in a derivative suit. 45 S.2d 555 (1947) (power of court to appoint a receiver is not limited by statutory authority. §§ 7665-7666. the fruits of which will be a clearer definition of the duties of board members. . cJ. 1959).' 25 Its effectiveness has been undermined by judicial reluctance to interfere with the board's statutory duty to manage the corporation. or to restore the corporation to economic health. manifested by a ready.C. On the other hand. A variety of flexible remedies has already been ordered in deriva- tive actions despite the courts' general adherence to the board's statu- tory managing role. the board of directors can revitalize the corporate decisionmaking process and in- crease corporate accountability. A receiver may be referred to as "passive" when his only function is to act as a custodian of specific property and to insure its preservation during the pendency of the claim. since it is one of the inherent powers of the courts of equity). to overhaul corporate manage- ment. Id. App. 861-62 .. CLARK. Koshaba v. 1979).. Id. 2d 302. There are various ways of categorizing receivers. Receivership Appointment of a receiver for a corporation is a traditional equi- table remedy1 26 employed by courts pursuant to their equitable powers' 2 7 or express statutory authority. This recognition.' 28 Normally. will help to create a dialogue between direc- tors and the courts. at 13. at times indiscriminate. See generally 3 R. one commentator has suggested that the only alternative to adopting the monitoring model is the abolition of the board of directors. a receiver may be termed "temporary" when he is instructed to act until either a permanent receiver is appointed or the prayer for a permanent receiver is dismissed. 228 N. adher- ence to the business judgment rule. at 681. R. CYCLOPEDIA OF THE LAW OF PRIVATE CORPORATIONS § 7664 (rev.

409 A. an end or object which must be within the jurisdiction of the court. has suspended ordinary business for lack of funds or is being conducted at a great loss or in a manner greatly prejudicial to the interests of creditors or shareholders). N. 44 Md. 408. 1964) (reversing appointment of receiver on grounds that receivership is an ancillary remedy and the substantive relief sought would not justify its use). 8.S. Corp..' 3 ' The receivership remedy is designed to protect the immediate interests of the corporation. See generally Grant v. 1980) (distinguishing equity receiver from receivership authorized by statute). EQUITY JuRIsPRuDENCE § 1330 (5th ed."). that a federal court may appoint a receiver only as ancillary to or in aid of the main object of the suit. receivership is directly relevant to formulating monitor- ing remedies because it illustrates the considerable power available to courts. 3:627 ment of a receiver wrests control of the corporation from management and vests it in the receiver who. App. CODE ANN. its creditors.E. cert. FtcrcHER.. Dolman. § 322 (failure of corporation to obey court order). supra note 126. It provides authority for imposing less onerous equitable reme- dies which leave the principal managerial responsibilities with exist- ing corporate management.. LAW § 1202 (McKinney 1963)." Pioche Mines Consol. Sinclair . 380 U.. as an agent of the court. 413. HENN. S & P Nat'l Corp.2d 938. §§ 7668. 333 F. id. § 7666 & nn. tit. Transit Inv. § 14A:14-2(2) (West 1969) (receiver may be appointed when corporation is insolvent. Allied Developers. Bus.J. 360 F.2d 741. denied.2d 257. ANN.Y. Inc. 414 (1944). PoMEaoY. Orth v. "I See SEC v. and sharehold- 32 ers. § 1804. 12 The receiver's principal responsibility is either to protect corporate assets from dissipation during the pendency of litigation 13 0 or to operate the corporation until it is either revived or liquidated.2d 1123 (Ct. Albre v. where the court stated: It is fundamental. 616 (1919) (sale of corporate property to prejudice of creditors required dismissal of receiver). 945 (3d Cir. v. 131 See generally H. 130 16 W.. cf. § 226(a)(1)-(3) (1974) (court appointment of receiver custodian for deadlock or failure to take steps to dissolve when corporate business had been abandoned). Prudential Ins. 272 (9th Cir. & Lane v. N. S. Gay Co. barring the existence of a statute which authorizes a contrary course. CORP. 289 Ill. Co. 'ascertain the true state of affairs * * * and report thereon' to the court and public shareholders and preserve the corporate assets. supra note 126. however. 124 N. 1966) ("[T]he primary purpose of the appointment [of the receiver] was promptly to install a responsible officer of the court who could bring the companies into compliance with the law. 7673. Blanchard Bros.660 CARDOZO LAW REVIEW [Vol. and imposes oversight duties on the board of directors. A receiver is an officer of the court who stands as a neutral among adverse parties. operates the corporation. 4 J. DEL. FLErCHER. 750-51 (2d Cir. G. or where. Inc. 560. 322 U. Receivership per se is not a remedy that would be helpful in implementing the monitoring model since it does not comtemplate a continuing oversight function on the part of the board of directors. Receivership is generally an interim measure. 16 W. 1942). CODE § 1803 ( West 1977) (court appointment of receiver to protect corpora- tion pending dissolution proceeding on the merits). 956 (1965). 128 CAL. v.S. id. App. 132 F. ' See Crites. § 375. Nevertheless. supra note 41. Spec. 1 (1942) ("[I]t is well settled that a court of equity has inherent power to appoint a receiver at the request of a stockholder on the grounds of fraud or mismanagement. STAT. because of dissensions on the board."). 1941). CoRP.16-17. it cannot properly function. and has been construed as a "means to an end.

and must not 'dilute' that loyalty. of 'undivided loy- alty. but. 134 See generally 16W. where the court stated: The court.. Gettinger v. 190 A. CoR'. 136United States v. 163.2d 405 (1979) (only when dissension. the court should move "with great caution in conferring such authority and exposing the property to the hazards of business. at 952 (listing statutes that provide courts with less drastic alternative remedies). and nature of receiver)... eligibility. 150 A. Philadelphia Transp. may permit a receiver to continue the conduct of a business temporarily. Prudential Ins. Middle States Oil Corp... v. § 275 (1974). Johnson.E.. 189 N. LAW § 203(a)(3) (McKinney 1963) (ultra vires activities may be asserted in an action to annul or dissolve the corporation).. 35 and only when no other remedy would be adequate. FLErCHEM. e. in such a way as to benefit himself or his associates. Bus. the receiver is obligated to observe the highest standards of undivided loyalty in protecting the interests of all parties.' ") (quoting Crites. §§ 7734-7740 (selection. App. Bus. 1946) (derivative action) (A receiver "owes a duty of strict impartiality. 195 (1930). 613.. a receiver of a solvent corporation should be appointed only when the rights of creditors and shareholders would not be substantially prejudiced). Co. See generally 16 W. He is 'bound to act fairly and openly with respect to every aspect of the proceedings before the court. N. Wylde. Prudential Ins. FLETCHER.").2d 563 (1963) (receiver appointed to protect interests of creditors). 466 (8th Cir. 68 Ill. § 1104-a(a) (McKinney Supp. § 7811. or mismanagement renders impossible continuation of corporation or preservation of corporate assets is appointment justified). control of the corporation is taken from management and placed in the hands of the receiver. DEL. Some states authorize voluntary dissolution by a vote of a specified percentage of the corporation's shareholders. Conse- quently. inter alia. 133See Crites. 991 (2d Cir. Inc. See. 8. e.2d 316 (1963) (receivership order reversed on grounds that. Co. 36 Courts recognize that the appointment of a receiver Constr. 1938). LAW § 1104 (McKinney 1963). See generally 16A W. v. fraud.S. when the interests of the parties seem to require it. 414 (1944) (A receiver is "not free to deal with the property under his control. 13' See Poulakidas v. at 414). ANN. 408. supra note 126.. duties. in its discretion. Co. 410 Pa. supra note 126. §§ 8034-8035 (dissolution as an equitable remedy may be granted only in cases clearly warranting such relief).S. v. The appointment of a receiver is a drastic measure to be exercised only with great caution.Y. Co. 490. Any profits that might have resulted from a breach of these high standards . A statutorily forced dissolution may also be authorized despite the absence of a two-thirds or majority shareholder approval when serious corporate misconduct is alleged.. Charalidis. 98 F..1982] MONITORING MODEL 661 When a receiver is appointed. Folk. Eq. 127 So. 220 Ala. 345 Mass. Heaney. 1977) . Supp.. and qualifications of receiver). §§ 7810-7839 (powers. wasted..E. See. 712. 154 F.g. 347 (1930). See also MODEL BUSINESS CoRP.Y. 322 U. or diverted for noncorporate purposes by those in control of the corporation). § 97 (2d ed.g. dispute. FLETCHEa. Perhaps the most drastic remedy available to the plaintiff-shareholder in a derivative suit is dissolution which contemplates the end of the corporation's life and the distribution of its assets to creditors and shareholders. 106 N. Elevator Supplies Co. 386 N. Phelan v.J. supra note 121. Tate v. would have to be disgorged and applied to the estate. tit.' 33 and is 34 responsible for applying his business expertise toward the end. 322 U.' to all persons interested in the receivership estate.2d 462. 3d 610. Inc. AcT. CODE ANN. rights. supra note 126.2d 978. id. N. CoRP. 1981-1982) (holders of 20% of outstanding shares of certain corporations may petition for dis- solution on the grounds that directors have been guilty of fraud or oppressive conduct or that the corporate assets are being looted." and such action is justified only when clearly necessary for the preservation of the rights of the parties.

13 N.2d 914. 294 Pa. 1966) (dissolution compelled when board was hopelessly deadlocked).2d 288 (1960). Nicholas. 196 N.. Fisher v. see also Gidwitz v. v.. 768 (Ct. The court may then retain jurisdiction and threaten management with dissolu- tion of the corporation if the schedule is not met. 163 A.E. In determining whether to grant a request for dissolution... Bernstein v. 320 N. When dissolution is requested because of serious corporate misconduct.Y. e.E. especially when less onerous remedies are available.J. Div. Thwing v. 385. Thus. the power of the court to dissolve the corporation is discretionary. Hall v. and Commercial Morality. 37 Ill. 2d 208. and an order of affirmative relief such as the declaration of a dividend or an award of damages). See. See 16A W. Fougeray.2d 540. 50 N. they have applied the remedy to some publicly held corporations as well. L.. 264 Or. v. Polikoff v. Corp. Since dissolution does not seek to modify corporate behavior. it is not a remedy that will directly aid implementation of the monitoring model.2d 313. whether dissolution would be oppressive to the shareholders. 20 Ill. Bowler. See Kaybill Corp. closely held corpo- rations. Clapp. Co.. 170 N.2d 190. 184 N. Hall v.2d 792 (1962).W.. 886. Bus. 427 F. Super. 155 So. RExv. supra note 1. at 232 (advocating use of threat of dissolution to deter wrongful conduct). 756.2d 975 (1948) (dissolution only in case of no dissension among shareholders and only when no other remedy is available). since it serves as a powerful deterrent to future misconduct. 39 Del. 26 A. 200 Okla. Dole & Clark Bldg. 315. cJ. App. Ch. 918 (Ch. Inc.. including exercise of its practice of retaining jurisdiction for supervisory purposes and reserving the more severe measures as a final weapon against recalcitrance. Dole & Clark Bldg.").g. CARDOZO LAW REVIEW [Vol. New Jersey Bankers' See. 614. 410. For example. Divorce Corporate Style: Dissension. Leibert v. see RKO Theaters. see also Laurel Springs Land Co. 3 N. 2d 29..2d 131 (1960) (dissolution ordered when acts of directors were oppressive and board was deadlocked). 2d 29. 233. 156 A.Hornstein.2d 310 (Me..E. 1981-1982) (dissolution at court's discretion). 158 N. N.g. 127. 184 N. 216 A.2d 598 (1974) (corporation permitted to pay delinquent debts in lieu of and in threat of dissolution). In re Collins-Doan Co. 109 N. e. 820 (1916) (less drastic form of relief awarded with warning that if it were not effective.J. 185.W. 3d 309. Lanzit Corrugated Box Co. and is rarely exercised.2d 848. John S. 279 S.. 229 Ala.J.. v. Commercial Body Builders.E. supra note 126. 143 A.. Pachman. Eq. City Park Brewing Co.2d 159 (1949). Although courts generally have limited the dissolution remedy to small. 382. an order deducting exces- sive salaries and bonuses. Polikoff v.J. Oppression. & App. 887 (1893) (retention of jurisdiction to ensure payment of dividends). by a combination of lesser remedies. a court may impose certain conditions on management to be met within a specified period. Corp. 3:627 may seriously jeopardize the economic well-being of a corporation 137 (describing factual situations that justify dissolution). 134 Minn. Isaacs & Sons Farms. Trenton-New Brunswick Theaters Co.Y. 330-32 & nn. 857 (1955) ("[E]quity may. accomplish much toward avoiding recurrent mismanagement . 507 P. Co. Inc. 398. 760. "I See SEC v. & L. § 8036. 1970) ("[The appointment of a receiver] carries connotations which may be ruinous in an industry where ready access to borrowed funds . 395-96 (1973) (listing several alternatives to dissolution including an injunction against the oppressive conduct. however. in a derivative suit. 538 (1934). Pulliam. see. App. Manchester Drive-In. 244. 582 (1928). Cherne. Eq.. 631-33. 37 Ill. the corporation would be dissolved). courts consider the probability of resolving the deadlock. dissolution may be useful simply as a tool to insure compliance with other remedies ordered in a shareholders' derivative suit. Inc. 247 N.Y. See Baker v. 74 A. FL~rcHER. 10 SEroN HALL L. Presumably. Laskey v. App. Guaranty Laundry Co. Err. Bankers' Fire & Marine Ins. Dissolution is not wholly useless in this regard. 1931).S. 148. 401. 1950). v. and whether dissolution would best serve the public interest. CoRP. few corporate directors or executives would have difficulty choosing between dissolution and the implementation of monitoring procedures.2d 102 (1963).2d 792 (1962). 24 I11..104-12 (1979) (explaining reasons for judicial reluctance to order dissolution). 196 (4th Cir.. whether the corporation is solvent.2d 387. 154 Tex. McDonald.E. 191 P. 9 N. 70 A.LAW § 1111(a) (McKinney 1963 & Supp. Inc. See Patton v. 173.

29 Bus. they may impose less onerous remedies designed to curb corporate manage- ment's errant ways. 142 For example. 42 Receivership thus illustrates both the broad power available to a court in derivative suits as well as the flexibility with which that power can be exercised. Pa. apparently. at 148-49.D. 380 N. 39 Generally.S. Id. 137 (E. SEC. thus impairing the corporation's financial stability.2d 1210 (3d Cir. the threat of receivership is available to a court as a means for persuading management to adopt monitoring or other is a condition precedent to profitable operation and where prompt payment of receivables is essential. 121. Pa. denied. 408 N.2d 969. . 636 F. 919 (1961). cert. Inc. MONITORING MODEL 663 since the investment community and the public often react adversely to news of receivership. The court was able to structure its remedy to create the optimum protection while at the same time minimizing the liabilities inherent in the receivership.. the attendant lack of faith among the corporation's creditors may outlast the receiv- er's tenure.Y. Because CGS was obligated on a note under which it would be in default if a receiver were appointed for 60 consecutive days. 98 F. Fur- thermore. SEC Developments in Litigation and the Molding of Remedies. and at the same time to preserve its assets.) (receiver denied on grounds that personal service company would be greatly injured if "the fact of its being placed in receivership became public knowledge clientele may well be deterred. United States. the receiver is an officer of the court and may only act within the court's order. CGS Scientific Corp.' Since courts have the power to order receivership. 521 (E.S. Issue Mar.2d 462. Ras Enters. Supp. 511.2d 160. if a receiver is appointed to improve a corporation's financial standing. 1971). courts have modified the remedy when necessary to avoid some of the harsh consequences that normally attend receivership. Rumbaugh v. LAW. Daro Indus. 143 See supra note 136. 44 N. 466 (8th Cir.. depends on a constant inflow of new business. 307 F. in Adelman v. Similar to the remedy of dissolution. Johnson. 1938). Id. the receiver is appointed to preserve the status quo. v. v."). Nonetheless.2d 162. 123 (Special Supp.1982]. 141 See Northwest Marine Works v.. Los Angeles Trust Deed & Mortgage Exch. 1962). 285 F. 182 (9th Cir. the opposite result may occur. 38 Thus.E. 140 See supra note 130. Supp. 43 receivership does not provide for continuing managerial role for existing executives and directors. 491 F. 1960) ("It is appreciated that the conservator type of receivership which we have insisted upon is not well adapted to a business the very essence of which is promotion and.2d 329 (1978). Likewise. In fact. 366 U."). 1980). the court modified its original order so that the custodian's tenure would last only 59 days. 1974). 40 which results in effective suspension of the business and the inability of the company to participate in speculative investment activities so essential to corporate growth.Y.2d 537 (9th Cir. 139 See United States v. 13 See Sporkin. 332 F. at 152 (Motion for Amendment). afj'd. if a receiver is appointed to take temporary custody of the corporation's assets in order to prevent their dissipation.").D. the plaintiff-shareholder brought an action for rescission of an allegedly fraudulent sale of one corporation to another. Beck. The court was convinced that a custodian was needed pending the suit on its merits in order to avoid irreparable harm to CGS and its shareholders.

217 N. 1960). 141 42 N. remedy in implementing the monitoring model. af'd sub nom. v.147 the trial court in a derivative suit appointed a special fiscal agent in lieu of a receiver. however. but presumably considered such action to be consistent with the broad equitable power. See Holi-Rest." Id.2d at 46-47. 144 If directors and execu- tives can be convinced that the threat of receivership is real.W. A TREATISE ON EQUITY JURISPRUDENCE. receivership is an important. Treloar. that "[ilt is well recognized that a court of equity has inherent power in a proper case to appoint a receiver [and that] such drastic action is avoided where possible. 126 A. while the fiscal agent serves as an agent of the court who is responsible for monitoring the activities of the corporate managers. 1956). PoMERoY. 148 The court had 144 Id. 1961). subject. CARDOZO LAW REVIEW [Vol. v. discussed infra note 157. 1941)).Y. Inc. Ferguson v.W. to the watchful eye and approval of the fiscal agent.J." Id. Supp. The court emphasized the flexibility of equitable remedies. B. 506 (S. Courts have based their authority to appoint fiscal agents either on their equitable powers which permit tailoring remedies to meet specific situations although similar relief has never before been granted. Super. Inc. they undoubtedly will make a serious effort to guard against further wrongdoing. The court did state. 42 N.2d 517. 1956).N. Div. Tabah. 126 A. albeit indirect. 527 (Iowa 1974). 146 Ferguson v. 126 A. 243. Roach v. Margulies.2d at 526 (sua sponte order appointing fiscal agent where plaintiff requested "any and all other relief found to be equitable"). The special fiscal agent differs from the receiver in that a receiver replaces corporate management. . the appointment of a special fiscal agent is considererd a less onerous course because the corporate managers are allowed to retain control over the corporation. Div. The court did not address the issue of the trial court's power to act sua sponte. and noted that a "court of equity has the power of devising its remedy and shaping it so as to fit the changing circumstances of every case and the complex relations of all the parties. however.2d 45 (App. Treloar. 46 In the latter case. In this way. 141 Holi-Rest. 148 The court did not explicitly state that the facts of the case justified appointment of a receiver. In Roach v. at 244-45.D. Margulies. 145 or on the power to appoint a receiver. Appointment of a special fiscal agent is an equitable remedy which contemplates the monitoring of corporate management and is available to courts as the first step toward implementation of the full monitoring model.2d at 47 (quoting 1 J. Special Fiscal Agents Several courts have avoided the harshness that often accompanies the appointment of a receiver by appointing instead a special fiscal agent for mismanaged corporations.2d 665 (2d Cir. Birrell. 3:627 procedures designed to control misconduct. 126 A. 288 F. § 109 (5th ed.2d 45 (App. 190 F. 217 N. Super. 243.J. at 245.

the defendant directors had not yet been held liable for any misconduct other than ignoring the trial court's order to allow the investigation of the company's books. In Ferguson v. 150 Appointment of the fiscal agent. was "an ingeniously equitable pendente lite device un- doubtedly hopefully contrived to avoid more stringent measures.public and its large number of subscribers.Y. 126 A. explaining that the trial court had attempted to balance the interests of the corporation's business operations with the sharehold- ers' need for protection. 126 A. at 245. Abrams v.D. since the opinion was issued pursuant to an interlocutory appeal."). and is listed as one of the reasons for requiring a demand upon the directors before a derivative action may be brought." Although Margulies involved a closely held corporation.D.149 When the corporation's directors refused to cooperate with the investigation subsequently conducted by plaintiff's accountants." ' 5' The evidence showed that the company lacked adequate ac- counting practices and that those who were disobeying the court- ordered investigation were involved in self-dealing at the corpora- tion's expense. the chances that the defendant would obey the injunc- tion were at best speculative. First.J. Presumably the court rejected the injunction for two rea- sons.2d at 47. 361. and therefore an injunction was an inadequate mechanism for preventing dissipation of the corporation's assets. Tabah. 288 F.. 369 (N. Ferguson v. Appointment of a receiver would have "injur[ed] the business in its relations with the. Birrell. 1974) ("[T]he Corporation. 110The court did not consider the more traditional course of action of simply enjoining the defendant from future wrongdoing.2d 665 (2d Cir. Supp. Cf. the court had not yet determined whether the requirements for issuing a preliminary injunction had been met. Inc. the plaintiff moved for appointment of a receiver. The court thus retained jurisdiction over the case. Therefore. fiscal agents have also been appointed in derivative actions involving pub- licly held corporations. in view of the alleged contempt.R. 1960). . 153190 F.'53 a bankruptcy trustee-shareholder instituted a derivative action on behalf of a large publicly held corporation alleging that over one million shares of stock had been fraudulently issued as part of a conspiracy to enable the 149 Access to corporate records is crucial to the successful litigation of a derivative suit. the court concluded." Id. Sec- ondly. . Super.1982] MONITORING MODEL 665 previously granted the plaintiff the right to inspect the financial rec- ords of the company. I11. The special fiscal agent was thus vested "with full power and authority to check the propriety of all disbursements to be 52 made or proposed to be made by the corporation. 15142 N.N. 506 (S. The order denying the receiver was made without prejudice. Mayflower Investors. The appellate court sustained the appointment of the fiscal agent. at 244. It also empowered the fiscal agent to report any questionable disbursements to the parties who then would be able to "apply to the court for relief with respect thereto if deemed advisable. . 62 F. 151Id.D.ought to be given the opportunity to sue [because] the corporate officers and directors will undoubtedly be in possession of more information that is necessary to frame the complaint properly and to pursue the action more efficiently. affd sub nom.2d at 46. 1961)." Id.

. the court ordered the agent to immediately "assume exclusive control and operation of the . at 511.666 CARDOZO LAW REVIEW [Vol."' 5 5 Recognizing the need to protect against further diversion of the corporation's as- sets. The agent was appointed with full power and authority to check the propriety of all proposed or actual disbursements. In Holi-Rest. In considering the plaintiff's request for the appointment of a receiver. v. . be sufficient to properly protect the corporation's assets. '17 See also Holi-Rest.2d at 670. 288 F. The agent was also responsible for collecting and distributing the judgment rendered in the suit.l. at 527. remarking that it was reasonable to suspect that a watchdog over corporate expenditures would not. Cow'. The court order also provided that if more drastic measures were needed. Upon request of the plaintiff.' 151 The chairman of the board had by this time left his position at the corporation in favor of life as a fugitive in Brazil. the plaintiff or the agent could seek amplifica- tion of the agent's powers or the plaintiff could renew his request for the appointment of a receiver. Supp. some of which never occurred. . 1"6190 F. L. The court of appeals affirmed the order. Inc.'" The court thereby indicated a willingness to employ the special fiscal 57agent remedy flexibly to meet new circumstances as they developed. mismanaging company books. a receiver was appointed to replace the fiscal agent and to take over active operation of the corporation.W. 128-29 (1975) (noting similarity between functions of fiscal agent in Holi-Rest and duties of receiver appointed pursuant to Iowa statute). 155 190 F.2d at 667 n. the fiscal agent essentially replaced management. the court opted for a less stringent course and appointed a special fiscal agent. Treloar: Egregious Impropriety Elicits ExtraordinaryRemedy. The broad powers granted the fiscal agent were deemed necessary in light of the defendant's misconduct. 121.' The suit also charged that management had breached its fiduciary duties by participating in and contenancing numerous fraudulent transac- tions which resulted in the misappropriation of millions of dollars. Id. Once challenged. in light of the developing circumstances and involvement of the corporation's management in dishonesty. Thus. 217 N. management could take the proposed action only with the written approval of the agent or the court." Id. Supp. 3:627 chairman of the board to maintain control of the company. which included barring the plaintiff-shareholder from participating in the opera- tion of the business. keeping false minutes of meetings. 288 F. its corporate books and records and its financial affairs. Five days after the district court declined to grant the request for a receiver. 1 J. the court acknowledged "the drastic nature of [the] remedy and its possible adverse effect on corporate business. draining the corporation of capital. and drawing an excessive salary. See Note. in which the court appointed a fiscal agent and retained jurisdiction over the parties and subject matter of the litigation in the event that additional measures were needed. Treloar. Id. at 511. all of the corporation's principal officers and directors were arrested by federal officers and charged with violations of the securities laws. at 674. Holi-Rest v. His financial dealings left the corporation in chaos and spawned numerous lawsuits.2d 517 (Iowa 1974). corporation. as well as conducting a full audit of corporate transactions in order to ascertain the actual condition of the business. Any corporate expenditure challenged by the agent was to be reported to the officer or director responsible.

When this 158 See supra note 126.1982] MONITORING MODEL To date. Removal and Replacement of Directors In some cases. the courts that have employed the special fiscal agent remedy have demonstrated in general terms the flexibility of equitable reme- dies and have laid the groundwork for other courts to fashion similar remedies designed to encourage adoption of the monitoring model. some of the directors may themselves be either involved in the alleged wrongdoing or exceptionally loyal to the corporation's officers such that it would be unrealistic to expect the directors to assume significant monitoring responsibilities. 159 The equitable agent could effectively protect the corporation while ensuring that the mandated reforms were being implemented. courts could appoint an equitable agent authorized to scrutinize the success of the corporation's reorganization without divesting the directors of the authority to control the process of reorganization. however. but also because it would avoid the possibly harmful financial effects caused by receivership. presumably courts could also order an equitable agent to per- form a receiver's multifarious functions. in terms of direct interfer- ence. Still. management of the corporation. 5 8 For example. Furthermore. courts have not been particularly receptive to the idea of appointing special fiscal agents. instead of appointing a receiver pending reorganization of a corporation. The equitable agent could serve as a temporary overseer and hopefully would en- courage the internalization of reforms needed to improve corporate governance. the appointment of a special fiscal agent to oversee management arguably is more intrusive than the appointment of a receiver which simply replaces existing managers or directors. . That is. it is likely that directors would prefer this remedy to a receiver not only because they would retain their posi- tions within the company. 15' See supra notes 137-41 and accompanying text. it seems that courts are more comfortable replacing management entirely than attempting to directly supervise corporate activities and decisions. In fact. the presence of a special fiscal agent or an equita- ble agent may provide a sufficient impetus to force a previously inactive board of directors to perform a meaningful monitoring func- tion. C. Since courts possess the authority to keep the directors in office while subjecting the board to the oversight functions of the fiscal agent. In other cases. The reluctance may simply be symp- tomatic of the broader traditional reticence to interfere with the.

See infra note 171.668 CARDOZO LAW REVIEW [Vol.. exercise this right.g.g. the directors themselves have engaged in conduct damag- ing to the corporation. 593 (1954) (holding that when corporate by-laws provide that president shall call shareholders meeting upon request of shareholders. as the conductors of corporate affairs. CoRn. Shareholders generally have such power to remove. certain jurisdictions permit the removal of directors for 63 cause prior to the expiration of the director's tenure. 116 A. the appointment of new directors stands a better chance of achieving permanent governance reform. and any reform implemented by the board is likely to be more effective and permanent than reform ordered by a court. however. N. N. tit. e. and when it appears that the board will be either unwilling or unable to monitor responsibly in the future. Bus. CODE ANN.E.160 Before discussing the mechanics of removal and replacement. to call said meeting). But cf. 62 Al- ternatively. Nat'l Guar. tit. 432. See. LAW § 706 (a)-(b) (McKinney 1963) (majority vote for removal . § 122(2) (1974). 306 N. In contrast. it should not be frustrated simply because the directors were not directly engaged in the alleged wrongdoing. Bruch v. Removal and replacement is intended simply to eliminate a specific problem. Fiscal agents acting at the direction of the appointing court have limited authority which generally does not extend to restructuring decisionmaking procedures. the directors themselves may remove other directors. in comparison to remedies such as the appointment of a special fiscal agent. directors may sue one another derivatively for damages.Y. However. and only a failure by the directors to monitor. § 141(k) (Supp. 180. a director who has breached his duties of care and loyalty may be removed by the shareholders at annual shareholders' meetings. removal and replacement should be considered as a possible remedy.. 427. see supra note 5.Y. e. 163 See. Personal ties between executives and directors as well as established decisionmaking procedures that include only a minimal board role may make it impossible to implement the monitoring model without appointing new directors. 3:627 occurs. tit. CoRP. CODE ANN. Moreover. proferring charges against four directors is a proper purpose for shareholder action and president may be compelled. Bus. Credit Corp. N. 8.g. removal may not be justified. 118 N. DEL. e. LAW § 706(a) (McKinney 1963) (directors may remove each other for cause if the charter or by-law so provides).Y.. 1980) (removal with or without cause by majority vote). CODE ANN.Y. §211(d) (1974) (special shareholders' meeting may be called only by directors and such persons author- ized in charter or by-law). Ch. DEL. The right of the corporate entity "to sue and be sued" is one of the legal endowments of incorporation. only the directors are empow- ered to call a special meeting of the shareholders. 8. DEL. N. courts have the power either to remove or replace directors. in a writ of mandamus. e. LAW § 202 (McKinney 1963).Y. and the directors.' 6' For example. new directors do have such authority.2d 590. 186-90. If removal by fellow directors is not permitted or justified under the circumstances. Auer v. Moreover. See. implementation of the monitoring model will require the removal and replacement of directors.g. Shareholders may request that a special meeting be held for the limited purpose of electing new directors. But cf. Bus. there is a preliminary question of whether in the context 'of a deriva- tive suit... LAW § 602(c) (McKinney 1963 & Supp. 8. in 10o In most cases involving removal. 13 Del. Dressel. 1"I Under some circumstances. Implementation of the monitoring model in some cases surely will require an infusion of new blood into the board of directors. 102 See supra note 6. 1981-1982) (same). In some jurisdictions. 741-42 (1922) (directors may not exercise power of removal). CoRP. at least under the traditional standards for removal. When derivative actions allege misconduct by the officers or executives. CoRn. Bus. 738. when it is clear that the wrongdoing alleged in a derivative suit occurred because of the board's failure to monitor. When removal is necessary to implement the model.

128 N. See generally Brudney.. some courts have held 4 that the right of removal is implied. 432.1 Although available in theory. supra note 1. REP. 60 When removal for cause is sanctioned by statute or implied as a matter of right. Rav. Removal of a director through the electoral process is generally difficult to achieve due to the board's control of the proxy machinery. See Campbell v. "[T]he cost of reproducing a list [of shareholders alone] . 165 In addition to control of the proxy machinery.. REv. stockholders' opportu- nities to choose management. the shareholders' right of removal is usually qualified by various procedural safeguards afforded for cause and removal without cause if so provided in charter). Auer v. 306 N. 118 N. Inc.2d 291. Loew's. 310 (1956) (after noting that proxy machinery is a practical necessity. at 353-65 (proxy contests and expenses). 50 S.. 427. The Costs of Free Speech in Proxy Contests for Corporate Control. these avenues of relief may not in fact be particularly useful to discontented shareholders. e. See generally W. Rav. EINHORN. 30-31 (proxy contests for the election of directors took place in approximately . of dollars . 864 (1957). 10 "The cost of a proxy contest in a widely held corporation can run into the hundreds of thousands. 134 A.E. it is highly unlikely that shareholders who do not have an enormous financial interest in the corporation would initiate a proxy fight for the removal of a corporate director. Campbell v. 563. 36 Del. . 173. 572. 259. 65 MICH. 858 (1975) (right of removal is implied.'6 and the high cost of a proxy fight. EIsraBEG. Removal of the Corporate Director During His Term of Office. 134 A. 1277-78 (1977).2d 852.CAL. See generally Travers. "otherwise a director who is guilty of the worst sort of violation of his duty could nevertheless remain on the board. The shareholders' right of removal exists regardless of whether or not the certificate of incorporation speaks to the question. Protecting the Shareholder's Right to Inspect the Share Register in Corporate Proxy Contests for the Election of Directors. 593 (1954) ("it seems to be settled law that the stockholders who are empowered to elect directors have the inherent power to remove them for cause").S. incumbents prevailed in only two of the 23 reported proxy fights in 1972). 20 WAYNE L. Ch. 563. Fiduciary Ideology in Transactions Affecting Corporate Control.E. Dressel. . W. 53 IowA L. the board enjoys the psychological prestige of incumbency and will generally be reimbursed out of the corporate treasury for reasonable expenses incurred during the proxy contest.1982] MONITORING MODEL 669 the absence of statutory authority for removal. EISBsERc." Schulman. Garrett. Rv.. if not millions. For this reason.2d 590.Y. and make it doubtful that many challenges would successfully occur in reasonably well-run companies even if managements were restricted to 'informing' shareholders.2d 852.5 % of meetings involving filings of proxy votes. Inc. Rv. Ch. L. See E. Rosenfeld v.. It is hardly to be believed that a director who is disclosing the corporation's trade secrets to a competitor would be immune from removal by the stockholders"). These factors "place insurgents at a relative disadvantage.. at 142-43. the author suggests several ways to reform the proxy system in order to facilitate corporate democ- racy). U. to say the least. Attitudes on Corporate Democracy-A Critical Analy- sis."). at 1292 n. See 1972 U. 15 (1973). 293 (1955). L. 309 N.116.. 1." Id. CARY & M. CARY & M.400. L.range[s] from $900 to $2. 282 (1966) (use of corporate funds to finance proxy contests "effectively curtails. ANN. 1968) (listing examples of costs in proxy contests). 164 See. 36 Del. rather than enlarges. 51 Nw. Fairchild Engine & Airplane Corp.g. ARANOW & H. Note. PROXY CONTESTS FOR CORPORATE CONTROL 543-44 (2d ed.Y.. 581. 1273. supra note 1. 389 (1967) (analysis and criticism of various interests allegedly protected when shareholders lack the power of removal and survey of different grounds for which removal has been permitted). 168. In addition. Loew's. SEc. a director may be removed only by a majority shareholder vote.

901 (I956) (relusal to entertain derivative action for removal of director since court would be accomplishing what a majority of the shareholders failed to do on their own) with Brown v. Whyte v. Cody. Hinkley v. 175 N. see. supra note 163. aff'd..Y.Y. 236 S. 808 (1946). 234 (1924). 516 (1931). 154 N.Y. McClayton v. they can exercise their inherent equitable powers to remove a director in a derivative action. diverted corporate funds to another corporation in which he has a financial interest. 361. 178 N. 168W. 134 A. Freeman v. 329 U. 544. Ct. App. 69 Some judges apparently believe that they should not supplant the shareholders as the deter- miners of whether cause for removal exists. Rptr.E.. 546 (1931) (a valid removal by the shareholders is contingent upon service of specific charges. 444. the standard for removal seems to be whether the director's actions have caused damage to the corporation. supra note 1. 2d 227. See also Travers.2d 852. Campbell v.2d 898. Dev. 7 Cal.2d 862. to the extent that the board is no longer able to function.") and Edward Sidebotham & Son v. Katz. Cause for removal has been found where a corporate director has misappropriated corporate funds. 865. impedes the very purpose of the board's existence. Sagemiller. 901-02 (1956). 210 N.g. 571 (1963) ("Since directors hold a position of trust. 82 N. 563. denied. Supp. Fells v. 552. 1 N. EISENBERG.. . adequate notice. such as fraudulent behavior or breach of fiduciary duties. 1130 (1907). 545. Del.S. 30 Cal. 127 A. the derivative action should be recognized as a ready alternative.2d 570. Chandler. bringing improper pressure upon the board by stirring up employees. supra note 18. D. 865. 119 A. 716 (D. 189 N. In re Burkin. 216 (1960). 3:627 corporate directors. 114 S. 183 Cal.E. 136 N. Feldman v. 36 Del. In re Koch. judicial power to remove them exists independent of statute. 395 (Sup. Many cases that held that a director may not be removed in an equitable proceeding. Supp.g. 104 N. 171 In general. 191 Wis. Cassell Co. 155 F. Rptr.Y. FLrCHER. Pennroad Corp. Chandler.S.. CARY & M. 170 Yet when it is clear that a director is guilty of more than a mere indiscretion. 216 Cal. King Pontiac Co.Y. §363 (remedies available to director removed or threatened with removal). See also infra notes 177-80 and accompanying text (discussion of whether court appointment of directors impermissibly interferes with shareholders' right to elect new direc- tors). 859 (1957) (director may bring an action to challenge the shareholders' removal). 1 7 Although ostensibly intended to protect direc- tors from arbitrary or capricious attacks.. 570. e. 154 N. 1 N.Y.2d 862.16 Given these practical difficulties of removing directors by traditional means. Rptr. 568.C. e. 136 N.).2d 898. Loew's.E. 1930). Co. 2d 823.2d 570. Fox v. 281 Pa. Edward Sidebotham & Son v. 230. e. Courts are split as to whether. and suppliers. customers. at 143.Y. 512.' 7 1 the shareholders 167 See. 839 (1926). 66 F. 2 W. 573-74. 252 N. the safeguards are consid- ered so cumbersome that the removal procedure is rarely used in publicly held corporations. Ch. 60 F. 257 N. North Venture Rd. have been partially overruled by statute. 322. W. 2d 823. See infra note 173. 67. § 360 (regularity and legality of removal proceedings). CARDOZO LAW REVIEW [Vol.S.E... Lyon. 1945). cert. 319 (removal of executive officer who held a position similar to a corporate director). App. 573. afJ'd.B.E. 183 Cal. acting without authority.. "0 See. 335. People v.E.S. 318. Impairment of the board's ability to operate may also constitute cause for removal. App.W. or has otherwise acted with fraudulent intent. 7 Cal. 109 Compare In re Burkin.Y. 216 (1960) (court's equitable powers permit removal of directors).S. and full opportunity for the director to rebut the accusations). Inc. Examples of impairment include director insubordination.g. 141 Misc. at 415-18 (attacking these "safeguards" as judicial paternalism). Faust.Y.2d 478 (1960). since a violation of the cooperative conduct of the board. in the absence of majority share- holder support. 256 N.2d 733 (3d Cir.

CoRP. In other words. if courts recognized director removal as a rem- edy in derivative suits. 173 See. Bus.. See Travers. however. the courts should be able to remove a director from office since "[d]irectors have no per- sonal interest in their office but may be compared with trustees. CODE § 304 (West 1977) (courts empowered to remove directors in suit brought by holders of at least 10 % of shares "in case of fraudulent or dishonest acts or gross abuse of authority or discretion with reference to the corporation. incapable or unsuited to the perform- ance of their duties."). Ch. when cause for removal is established. supra note 163. ensure that shareholder impotence and apathy would no longer serve as an impediment to protecting the corporation from director misconduct. but merely facilitating the exercise of an existing right. ConP. 134 A.. . Many directors will sometimes prefer to resign rather than enter into litigation or face a block of shareholders who seek their removal. .1982] MONITORING MODEL have the theoretical right to remove the wrongdoer. supra note 18. implementation of the monitoring model would not increase the risk of removal. § 358. 1946). they would not be creating a new shareholder right. According to one eminent commentator.173 In jurisdic- tions that do not. at 397 & nn. e. Inc. Campbell v. Thus. See Bishop. Md. Loew's. supra note 64. 563. at 1099 (directors of industrial corporations run little risk of liability for ordinary negligence). and a court that removed a director would merely be acting on the shareholders' be- half. Consequently.17 Consequently.2d 852 (1957). It is doubtful whether mere negligence or nonfeasance. CAL.57-58. standing alone. courts should be sensitive to the difficulties faced by shareholders who seek to remove an errant director and.. Professor Fletcher has found it "surprising"' that many courts have declared "that there is no remedy in equity courts to remove legally elected directors even if they are shown to be dishonest. it is unlikely that a court would accede to shareholders' demands to remove for directors guilty only of failing to monitor the corporation's managers. It is anomalous to state on the one hand that directors are the duly elected representatives and fiduciaries of the shareholders.. and overall harassment of the board of directors. FLErcHER. permit removal as a remedy in a derivative suit. 172 2 W. Recog- nition of the right of removal in a derivative action would neither eliminate the requirement of proving cause for removal nor prevent directors from rebutting allegations of wrongdoing. 36 Del. surprising that some jurisdictions now give statutory recognition to the shareholders' right of removal in a derivative action. unless of course the duty to monitor were considered a part of the directors' general fiduciary duties or duty of care. at 173. LAW § 706(d) (McKinney 1963) (director can be removed in a derivative action by the holders of 10 % of the company's outstanding shares). 165 (D. N. and then insist that a shareholder is powerless to seek the removal of a director who is clearly acting contrary to the best interests of the corporation.g. is a sufficient ground for removal. Recognition of the right of shareholder removal in a deriva- tive action will often force a director to heed the wishes of a substantial block of shareholders. Recognition would." Id.Y. who are subject to removal by the courts . it is not ".

5 SEC Docket 241 (D. as well as the nature and extent of the director's involvement. Mgmt.C. See SEC v.D. 123 U. 3 SEC Docket 30 (S. five of whom shall be appointed by the court after consultation with the Commis- sion and two of whom shall be nominated by the majority shareholder after notice to the Commission and approval by the court). Given the power to take such drastic measures. the most likely candidates will be directors with close affiliations and long-held loyalties to executives guilty of wrongdoing since these directors in all probability could not be relied on to perform effective monitoring duties.'" leaving control of the corporation in the hands of corpo- rate personnel. a court may. Westgate- California Corp. See generally Farrand. Thus. and reorganization of the board of directors to contain a majority of outside independent directors. court approval of directors who must meet certain criteria satisfactory to the Commission.D. at 143 ("[O]ther forms of relief may accomplish the same purpose [as director removal]. for cause. 5 SEC Docket 584 (C. SEC v. Inc. 1973) (board of directors to be reconstituted to seven persons. The authority to appoint new directors derives from courts' authority to appoint receiv- ers or special fiscal agents. Mattel. Comment. L. at 123-24. 1188 (1975). To date. enjoin the entire board of directors from managing the corporation and vest management in a court-appointed receiver or a custodian... Whether a particular director or directors should be removed clearly will depend on the peculiar characteristics of the corporation and the type of misconduct at issue. see also W. Mattel. 1974) (appointment of six independent. one professor of law. 4 SEC Docket 620 (S.Y. The appointment of a receiver or fiscal agent transfers control of corporate affairs or oversight responsibilities from the directors and officers to a court-appointed caretaker.D.. Equitable Remedies in SEC Enforcement Actions.D. Directors who appear un- suited to the task. Cal. supra note 31. The replacement of directors may be accomplished either by direct court appointment or by shareholder election. 1974) (board of directors is to consist of at least 40% of outside independent directors who meet the Commission's criteria)."). Inc. Sporkin. The . When removal is intended principally to facilitate implementation of the monitoring model. however. A director who was actively involved in the wrongdoing obviously would be a prime candidate for removal simply by virtue of his wrongdoing. -SEC v. Canadian Javelin. M'The SEC has proffered the identical argument in requesting the appointment of directors.D. Charter Sees. should be removed. CARY & M. a majority of whose members should be unaffiliated with Mattel. 3:627 If removal is available. In deciding which directors should be removed. Corp. for whatever reason. SEC v. 5 SEC Docket 241 (D. supra note 1. SEC v. interim directors: two attorneys. supra note 138. EISENBERG. courts presumably have the power to take the less drastic step of appointing a new director or directors. the next question involves how many directors should be removed and how they should be replaced. 1974) (Mattel to appoint and maintain a board of directors. Rzv. PA.. one professor of finance and two businessmen). Cal.N. courts should be guided by the goal of forming a board of directors that will take seriously its monitoring responsibilities.672 CARDOZO LAW REVIEW [Vol. the SEC has succeeded in obtaining consent decrees imposing court-appointed directors. satisfactory to the Commission and approved by the court).C. 1974).

179 Depending on the circumstances. court appointment of directors constitutes an intoler- able usurpation of the shareholders' right to elect directors. court appointment of directors would not completely disenfranchise shareholders since they would still be entitled to vote for or against changes in the corporation that 76 require shareholder approval. See Comment. see also Manning. state courts have not followed the example set by the SEC cases. and.17 9 Unilat- eral appointments of directors should be limited to situations in which management's control of the proxy machinery would be likely to frustrate any attempt at reform. If the shareholders were satisfied with the performance of the appoint- ees.. .1982] MONITORING MODEL 673 Arguably.2d 341. courts might be able to adopt a middle position by making temporary appointments and allowing the shareholders to elect permanent directors at the next annual meeting.) (explaining import of "ancillary relief"). The reluctance of courts to appoint new directors is perhaps a reflection of the traditional judicial hands-off policy which leaves control of corporations in the hands of the elected directors. CODE § 308(a)-(b) (West 1982). Corn'. are not limited as to authority and purpose of the securities laws. State courts. CORP. Although this objection has merit. should not prevent a court in a deriva- tive action from appointing new directors. 390-91 (2d Cir. cert.S. courts should make every effort to respect that right. some states spe- cifically empower the court to appoint provisional directors. 8. Still. pursuant to their general equity powers. in appropriate circumstances. 177See. 1981-1982). 223. those directors could then be elected to permanent positions. 176See supra note 38. do any more than rubber-stamp the nominees selected by the incumbent board and the executive officers. possess similar authority to frame appropriate remedies. supra note 30 (criticizing SEC for improperly using enforcement powers to influence and mold corporate behavior). v. Chris-Craft Indus. First.178 Thus.nonuse"). 72 YALE L. supra note 40 and accompanying text. when shareholders clearly have the right to elect new direc- tors. it is questionable whether shareholders. See generally Freeman. shareholders have already been partially disen- franchised to the extent that state law allows the board of directors to appoint successors for board vacancies. 414 U. 177 Moreover. 1 Furthermore.Y. N. 75 Second. denied.J. CODE ANN. See supra note 91. it should not be grounds for courts to refuse under any and all circumstances to appoint new directors. at 750 ("[s]tockholder electoral rights have fallen into a state of . Courts should defer to established election procedures unless it appears that those procedures offer no authority to appoint or control the selection of corporate directors in actions brought by the SEC for violation of the Securities Acts derives from various forms of "ancillary relief" employed to enforce the purposes and policies of the securities laws. LAW § 705 (McKinney Supp. supra note 31. 910 (1973). 175 See Comment. supra note 31. . 261 (1962). at 737-44. the shareholders' right to elect directors isby no means absolute. DEL. in contrast to the SEC.g. Nevertheless. tit. cf. and. in electing directors. . 17 See CAL. 480 F. e. Bus. Piper Aircraft Corp. The Shareholder's AppraisalRemedy: An Essay for Frank Coker. § 223 (1974)..

D.L.. Starr & Steinberg.. Corp. 1945) (order for new election after proxy violation). See Wyatt v.g. supervise these elections in order that competent and disinterested boards of directors may be obtained for the corporations. SEC v. 1974) (corporation must grant proxy to a holder approved by the Commission and enjoined from voting shares for 14 months). 3:627 real chance for improvement.."). e. a court should not preclude shareholders from the full exercise of this right. SEC v.S. 597 F. Transit Inv. Savoy Indus.. judicial supervision of the elections may be warranted to ensure the election of competent. The court reasoned that the rule did not apply in the action sub judice and that [e]xperienced management is a valuable corporate asset . Where experienced directors are court-appointed. Shinn.2d 129 (2d Cir. it offers no assur- ance of improved corporate governance. See SEC v. REv. disinterested direc- tors. Deferral to established procedures.2d 938.674 CARDOZO LAW REVIEW [Vol. Id. Reelection of a court-appointed director by the shareholders might also be accomplished by informing the shareholders of the court's prior appointment and actions as well as the qualifica- tions of the directors seeking office. For this reason. courts could facilitate the election of competent directors by requiring nominees to detail their own qualifications and disclose any relevant prior misconduct in the proxy material.C. 7 SEC Docket 492 (D. 1973) (future voting of stock must be approved by Commission). 555 (1981) (information bearing on management's business expertise and reputation is highly material to shareholder decisionmak- ing). Malhas v. 1942) (ordering trial court to "permit the stockholders of the corporate defendants as promptly as possible to elect boards of directors from among competent and disinterested nominees and shall if necessary.. In Vesco. 186 Misc. Orth v.2d 28 (2d Cir.D. new directors will face the same difficulties that led to the demise of 180 See. S. notwithstanding a state statute which might be interpreted to require receipt of a majority of votes. Disclosure of Information Bearing on Management Integrity and Competency. Ct. does not mean that courts should abstain from all involve- ment. See generally Ferrara. In some circumstances. . in a subsequent derivative action challenging the election of the directors by the shareholders. Cal. however. the court should decide on the facts of the particular case whether a sound reason exists for denying them elected office. the same court held that in order to return the corporation to private control a district court may provide that a candidate for directorship need only obtain the highest number of votes. In the absence of a compelling reason. The opportunity for improving corporate governance might prove short-lived if newly elected or court-appointed directors are not subsequently reelected by the shareholders. . courts should attempt to structure the remedy of replacement to encourage the re- election of the reformers. Armstrong. 571 F. See SEC v. Moreover. U.2d 502 (Sup. 216. Vesco. 5 SEC Docket 765 (D. 1978). 1979). At a minimum. Alternatively. 947 (3d Cir. 76 Nw. the court upheld a special master's plan permitting court-appointed directors to stand for reelection by the shareholders after the expiration of the directors' tenure under a court-supervised reorganization of the corporation.1975) (defendants to put shares in a voting trust).D. Failure to comply with the court's order would also be grounds for voiding the election. 132 F.. Once elected or appointed. The SEC has successfully employed similar measures. . Westgate-California Corp. 59 N. 0 Although removal and replacement will be an effective remedy when directors themselves are guilty of misconduct.Y. at 130. The court so held despite the general rule that trustees in reorganization are usually barred from acting as directors or officials of the reorganized company.C. the court might provide the court-appointed or outside directors with control of the proxy machinery. 3 SEC Docket 30 (S. OSEC Petroleum. .A.

See. 1267 (4th Cir. The chances for developing a monitoring system can be improved.1 (rev."). 576 (5th Cir. 1977) (applying Wyoming law) (action to preliminarily enjoin sale of majority interest in corporation denied in lieu of damages which may adequately c6mpensate corporation and minority shareholder). 442 F. 1978) ("The focus always must be on prevention of injury by a proper order. model which is to 181 See supra notes 47-49 and accompanying text. 329 (1944) ("The essence of equity jurisdiction has been the power of the Chancellor to do equity and to mould [injunctive relief] to the necessities of the particular case.E. FLErCHER.S. Western Nuclear. 98 Ill. Supp. 1258 (1981) (breach of employment contract addressed through legal damages rather than the equitable remedy of specific performance). the contours of the injuction issued must be tailored to restrain no more than that which is reasonably required to accomplish its ends. Va. Further. Disabled Miners of S. Consolidation Coal Co. A real threat of future misconduct leading to irreparable harm must also be shown. e. the issuance of an in- junction arguably is less intrusive on the management of a corporation than the appointment of a director or an equitable agent. Inc. injunctive relief attempts to mod- ify.S. Mandatory Injunctions and Oversight Committees The most promising remedy available in a derivative suit to encourage implementation of the monitoring model is the mandatory injunction. 321 U. ed. Kaplan v. Carret v. 573 F. injunctive relief will likely be more palat- able not only to courts but also to directors and executives.. App. W. perm. Cheker Oil Co.g. 143. See Hecht Co.. Stenberg v.2d 1261. In addition.. e. 321. Kaplan. D. Among the rules for determining the propriety of injunctive relief are the requirements that there must not be an adequate remedy at law. however. Procedures selected by the board will be more likely to become a permanent part of the corporate structure than procedures selected and implemented by a court appointed agent whose tenure is limited. denied.. cert. 436 F. Callaway.181 This is precisely the goal of the monitoring model. the parties' future behavior. 404 U. Bowles. v. ("In order to obtain equitable relief. In addition. e. 3d 136. 952 (S. v.D. id. creative uses of the injunction may stand a better chance of implementing permanent governance reform than other remedies."). 911 (1971). See. 1974)). substantial injury which is not speculative or contingent upon uncertainties.2d 1253. or at least define.). These rules are subject to the exigencies of each case. see. 1978). 489 F. one must be able to show an actual. v. The injunc- tion would define the duties of the board but leave the actual design and implementation of corporate governance reform to the existing directors.. 925 (6th Cir.2d 567. 423 N.N. For this reason. CYCLOPEDIA OF THE LAW OF PfIVATE CORPORATIONS §§ 4856-4875. Unlike remedies at law. See generally 10 W.Y.g. ." (quoting Canal Auth.19821 MONITORING MODEL their predecessors. Design and implementation of monitoring procedures by the board is also consistent with the policy of the monitoring. if the new directors are required to oper- ate in accordance with specific judicial guidelines issued in the form of a mandatory injunction.2d 921..g.

South Chester Tube Co. Other remedies such as equitable agents presumably would impose monitoring procedures to be fol- lowed by the board with the hope that self-regulation would follow. Wood. 383 A. 379 (1966). e. Atlas Coal Co. Supp. CARY & M. 61 N. FLErCHER.2d 783 (1972).D.2d 374.S... Blakesley v.676 CARDOZO LAW REVIEW [Vol. tit. 337 N. injunctions can also be fashioned to remedy structural mis- conduct. at 302-03 & nn.. e. eludes detection by the board of directors. 763 (S. § 4860. Rosenthal. 245 Iowa 506. 154 Conn.. but in terms of implementing monitoring procedures."' 18 3 In derivative suits.1-9 and cases cited therein.2d 218 (Del. 18' See. Beresth.")).. Twin City Barge & Towing Co. 609 (1968).2d 492 (Sup. CODE ANN.2d 852 (10th Cir. v. 84 preventing wrongful diversion of corporate funds..g.2d . 220 A. see also DEL. Lawrence. 12. Fliegler v. Banner Indus. Vickers Energy Corp. 1949). 40 A. 87 Any attempt to delineate specifically how courts could fash- 182 10 W. Mandatory injunctions are traditional remedies available to a court of equity. 97 N. restraining ultra vires activities. W. 274 Minn.Y. Evans. Weil v. 495. 143 N. LAW § 203(a)(1) (McKinney 1963) (same).W. at 296.Y. Abrams v. 608 P. 38. 185 See. § 124(1) (1974) (shareholder suit for injunction). EISENBERG. See. supra note 181. Jones..S. 227 Kan. 758. 1966) (quoting with approval 2 L.2d 278 (Del. N. § 4860. Loss."). Lynch v. 82 injunctive relief is ap- propriate and should be afforded when necessary "to protect the property of the corporation and the rights of stockholders where the corporate powers are being illegally or unconscientiously exe- cuted.Y.g. 8 5 and setting aside transactions that involve interested directors.S. 361 A. 21-23. 1976) (corporate opportu- nity).. 181Id. 1961) ("[t]he only [effective] sanctions for enforcing compliance with section 16(a) . 8 6 Nev- ertheless.W. 8.are criminal prosecutions and mandatory injunctions. 606. that is..N. . and have been issued in attempts to resolve a variety of corporate problems. Walker & Co.2d 911.g. Textile Realty Corp. Allowing the board to design its own procedures essentially initiates monitoring through self-regulation. v. 187 Courts also could issue injunctions to prevent future conduct. Inc. Bus. v. it is more likely that mandatory injunctions directing the board to take certain actions would be used.2d 663 (1953). R & J Bottling Co. see Stern v. be- cause of the structure of the corporation. there is substantial authority for permitting equitable relief.' Ct.D. 461 F. 114Aiple v.Y. misconduct of corporate management which. 390 U. Mandatory injunctions can be used in an attempt to remedy a virtually limitless array of problems brought to light in derivative suits.. e. 1972) (mandatory injunction ordered when plaintiffs were denied access to shareholders' list). supra note 1. CORP. Johnson. 45-46. SECURITIES REuLATIONS 1040 (2d ed. Although use of an injunction in a derivative suit will be tem- pered by judicial reluctance to interfere with the board's authority and the business affairs of the corporation. 3:627 develop corporate self-regulation. 285 F. Robbins v. 1977) (tender offer and disclosure requirement). at 42 ("Although there are cases holding that quo warranto is the sole remedy available to the state for an injunction and that an equity suit by the state will not lie. injunctive relief generally has been limited to unraveling specific corporate transactions.2d 908 (1980) (nondisclosure of offer to buy shares by third party is breach of fiduciary duty by those with such knowledge).

however.. 83 H~Av. 400. 210 N. Eisenberg. cert. 1947) ("Stockholders are entitled to employ watchmen to eye the guardians of their enterprise. 163 F. 588 (1933) (a statute which empowers the shareholders to amend or repeal the by-laws is considered a plenary grant of authority). 330...W. 189 Shareholders may request that an oversight committee be established. Inc. Premier Mfg. Ry. Access to the CorporateProxy Machinery. Supp. the appointment of oversight committees at the request of the shareholders. "s' See generally Report.. 517 (3d Cir. For purposes of implementing the monitoring model. Union Pac. perhaps in the form of a proposed amendment to the by-laws. Transamerica Corp. 839 (1928). 1964) (mandatory injunction for disbanding of shareholders' committee denied in lieu of court enjoining shareholder meeting and court regulation of proxy contest).). Crocker v. one spec- ific use of the mandatory injunction merits discussion: the corporate oversight committee.2d 577. supra note 181. denied. 431 F. .1982] MONITORING MODEL ion injunctive relief to meet all of the problems of corporate govern- ance surely would be futile.. 188 The purpose of oversight committees is to ensure that the board receives adequate and current information about the corporation and is able to evaluate critically management's operation of the corpora- tion's business affairs. 226 F. Cal. See Gamble v. The feasibility of injunctive remedies and how those remedies can best be utilized in a given situation will depend entirely on the corporation and the misconduct at issue. FtE'rCHER. cert. § 4853.S. R.D. Farmers & Merchants Bank.D. 335-36 (S. 29 F.").2d 283 (1961) (shareholder's right to examine corporate records enforceable by mandatory injunction). v. 297 Minn. supra note 32 (discussion of various oversight committees and their respective functions). 332 U. indefinite. a court may hold the directors liable for failure to appoint such a committee if the duty to do so was stated in the corporation's by-laws or charter. Hagy v. Supp. 1037. and ambiguous to be enforced and that such injunction will be granted only in cases of grave injustices and irreparable injury). Chalfen v. 89 Oversight committees are the mainstay of 456. 154 Tex. 1977) ("A court of equity is less favorably disposed to grant mandatory rather than prohibitory equitable relief.2d 366. L. and a corporation will be required to entertain a shareholder proposal to appoint an oversight committee. the directors. Arden-Mayfair. Medical Inv. they are not always receptive to pleas for this type of relief.R.S. 385. Kass v.2d 216 (1973) (in light of substantial harm to plaintiff. mandatory injunction requiring corporate director to resign from the board). Chicago & N. Merin. 279 S.").S. Brown. In addition. 371-75 (4th Cir. 172 A.. Hill. 1041 (C. 293 So.2d 511. Patton v. 2d 438 (Miss. Neuwirth v.W. Corp. Inc. 460-61 (1966) (injunction ordering specific enforcement of shareholders' agreement and. would probably not be construed as impermissibly abridging the exclusive duty of the board to "manage" the corporation. I11. 582. bad faith.N. Corp. 1974) (mandatory injunction specifically enforcing shareholders' voting agreement dissolved on grounds that agreement was too vague.D. While courts have issued mandatory injunctions with respect to areas normally within the exclusive control of the board of directors. 414 (N.. 174. 333.. 847 (1948). see 10 W.2d 848 (1955) (mandatory injunction ordering payment of dividends). 580 (Me. denied. See. Supp. breach of fiduciary duty or abuse of discretion). See SEC v. 1967) (plaintiff denied mandatory enforcement of right to shareholder list since a federal court will not entertain mandatory injunction where procedural remedy sought is only relief prayed for).g. W. Finally. 1975) (judicial interference with management of corpora- tion through mandatory injunction will not be permitted when decision not to declare dividend does not amount to fraud. Nicholas. Gay's Super Mkts. if warranted by subsequent events. 279 U. 289 U. 343 A. temporary mandatory injunction granted ordering defendant corporation to register notes in plaintiff's name). See Rogers v.Y. 267 F. Gay v. e. 404 Pa.

. supra note 33. see supra note 30. courts appear reluctant to require corporations to establish oversight committees. NEW REPUBLIC. REV. and management performance committees. See C. the number with nominating committees grew between 1975 and 1978 from 111 to 297). Report. Likewise. Nov. Rather. if it occurs at all. National Farmers Org. [1974-1975 Transfer Binder] FED. Hawes. Greene & Falk. 191 State courts seem more reluctant to grant this type of relief than federal courts. providing an ethical review. For present requirements of the New York Stock Exchange and the SEC concerning the audit committee. e. an area that could be addressed by a compensation committee). 3:627 the monitoring model. supra note 32. a nonsystematic review of corporate policies and procedures even by an independent board fails to assure an effective mechanism for monitoring the corporation. at 1236-46. col. supra note 15. Richer Than All The Tribe. 7 SEC Docket 603 (S.19 5 The reluctance does not stem from doubts as to the authority to issue mandatory injunctions requiring committees since the equitable power to order receivership or a special fiscal agent most certainly encompasses the power to order the estab- lishment of oversight committees. without them. L. however. at 666-67. 7. 1980... supra note 32.9 2 legal audit committees. 191See generally Report. 963 of 993 responding companies had audit committees. SEC v. Executive monitoring of its own activities necessarily falls short of bona fide supervision and oversight. Bus. at 1841. the reluctance is again a REv. Report. at 1. implementation will require a combination of rem- edies that includes some kind of oversight committee.. 6 & 13. HARV. Feb.g. L. at 20. BROWN. Tenn.D.D. 1982. 1489 (1970). Bus. REv. "' See generally Greene & Falk. Most boards do not presently evaluate management performance in any depth. The duties of the audit would include supervising independent and internal auditors. 93 mittees. Although the remedies discussed previously undoubtedly can contribute to the implementa- tion of monitoring procedures. Designing a Plan for the Ideal Board.678 CARDOZO LAW REVIEW [Vol. June 17. SEC v. see also Green. SEC.003 (W. 190 See Lear.. either falls by default upon executives or is accom- plished by the board on an ad hoc basis. Wall St.-Dec.-Dec. REx'. 1979. . 19 ' financial audit committees. supra note 10. none of them alone is likely to be sufficient. 24-26 (noting that compensation paid to officers of industrial corporations often is unrelated to company performance. Rather. supra note 32. at 18 (anticipated developments in outside director compensation). Nov. 9 4 As with other reme- dies. REv.. Jan. monitoring of the corporation. supplying interim financial information. A survey has shown that in 1978. 1 (1974). 74 COLUM. See. 1975) (mandatory imposition of internal compliance procedures). HAuv. Union Planters Corp. J. supra note 33. 19' See Mace. at 26. and hiring advisers. (CCH) 95. 03 See Dent. 19 0 nominating com. Stockholder Appointment of Independent Auditors: A Proposal. Compensation for Outside Directors.. at 1863 (of 993 responding companies. 1976. at 1863. at 21. Commentators have suggested a variety of committees to cure assorted corporate ills: compensation committees. Inc. Iowa 1975) (appointment of independent accounting firm to establish adequate audit procedures in lieu of appointing receiver). 5 (nominating committees originally developed to help select new directors are also starting to screen top management candidates).

. and so a mandatory injunction should not be granted when its enforcement will require too great an amount of supervision by the court. 1003 (D. ordering that committees be established is less intrusive on corporate management's autonomy than instructing a receiver or special fiscal agent to take control of corporate affairs. the judiciary's concerns about its own competence are merely illusory.19 8 particu- larly when shareholders' derivative suits reveal a board of directors failing to oversee the operations of the corporations. The court held the directors liable for negligent mismanagement and require[d] by injunction that the appropriate committees and officers of the Hospi- tal present to the full Board a written policy statement governing investments and the use of idle cash in the Hospital's bank accounts and other funds.D." Id. at 648 ("Courts are not asked to make business policy or to decide whether the directors' decisions were the wisest that could have been made. possibly modify. See Dent. Lucy Webb Hayes Nat'l Training School for Deaconesses and Missionaries. Id. The evidence showed that the management of the corporation was handled almost exclusively by two trustees whose actions received only cursory supervision by the full board.. The court required that the board review. This question is no more difficult than many others routinely decided. 199 The duty to develop guide- ""See supra text accompanying notes 124-25. plaintiffs brought a class action alleging that the directors of a corporation had breached their fiduciary duties of care and loyalty. a task for which it may not be well-suited. at 1018. but only to decide whether the directors acted with reasonable prudence. As noted earlier."). 925 (6th Cir. 573 F. the court advised the defendants "to restrict membership on its Board to the representatives of financial institutions which have no substantial business relationship with the Hospital. Use of oversight committees would eliminate the need for continued surveillance once the oversight committee was installed. FLETCHER. Of all the remedies suggested to improve corporate governance. § 4853." 8 Third. '91 For a discussion of the proper limits of judicial "interference" in the internal management of a corporation. First. ordering the estab- lishment of committees would obviate the need for the court to articu- late the precise procedures and jurisdiction of the committees. at 1019. see Stenberg v. Supp. Second. 198 One example of an enlightened attitude toward court-ordered oversight committees is Stern v. In Lucy Webb. this passivity is unwarranted. however. supra note 181. 199 In some cases. courts are often reluctant to employ remedies which require continued judicial surveillance of their own orders. 381 F.2d 921. and . Cheker Oil Co.C. In addition. Courts should reexamine their posture of noninterference in general and specifically 19 7 with regard to oversight committees..1982] MONITORING MODEL symptom of judicial passivity regarding the internal workings of cor- porations."). 1974). see also 10 W. 1978). it would require constant oversight in respect to the acts enjoined. It is also possible for the court to appoint "special counsel" to investigate the nature of the corporation and possible undisclosed wrongdoing. oversight committees should be the most appealing to courts settling derivative suits. and then adopt the investment committee guidelines which governed the utilization and investment of the Hospital's liquid assets. at 275-76 ("An injunction will not be granted where. supra note 10. and establish a procedure for the periodic reexamination of existing investments and other financial arrangements to insure compliance with Board policies.

378 N. See generally C. costly new legislation that would inevitably add expenses and limit flexibility in solving new problems. 91st Cong. 340 P. e. Hendrixson. 2d Sess. After listing examples of reforms adopted by vari- ous corporations in restructuring the composition and functions of their boards of directors. subject to court approval since the directors are the most familiar with the corporation's organization and existing oversight procedures. at F14. Finally. 2. supra note 10. R.. leaving the details of implementing monitoring procedures to the directors encourages self-regulation and enhances the prospects of continued internal re- 200 form-the policy of the monitoring model.S.g. 517.W. Hubbard. Times. 9 Utah 2d 152. at cols. executives believe that further improvements [in corporate governance] can and will be achieved and that they will be brought about more effectively by corporations acting on their own rather than under cumbersome.. a corporation will be required to entertain a shareholder proposal to appoint an oversight committee. REP. Mr. Co. 279 U. at 516-17 (cataloging different tools which can be used to aid judicial fact finding). 1973). . cert.. 517 (3d Cir. hold directors liable for failure to appoint such a committee if such a duty was stated in the corporation's by-laws or charter.. The courts should provide relief which seeks to place the directors as monitors of the corporation so that their reform will be truly efficacious in remedying and pre- 20 venting corporate misconduct. FOURTH REPORT BY THE SELECT COMMITrEE ON CRIME. June 24. supra. Transamerica Corp.2d 416 (1959). 29 F. N. 1807. 3 SEC Docket 30 (S. if any. See. supra note 50. at 111-18. 37 (1971) ("No amount of Government regulation can be as effective as private enterprise carefully monitoring its own [corporate activities]. 201 See. 946 (Ind. A court may. 163 F.) cert. In addition. See SEC v. Hubbard. Brown. See Cressy v. rather than judicially coerced or imposed. The variations of relief are as many as the forms of corporate misconduct and organization. col. e. SEC v. 754 (1914). 371 (4th Cir. ' CONCLUSION The commentators and critics who have long advocated signifi- cant reform of the manner in which corporations are governed should take comfort in a recent proposal of the American Law Institute (ALI). Company Boards Don't Need Uncle Sam. Westgate-California Corp. 200 A court probably could not order a board of directors to amend the corporation's charter or by-laws to require appointment of oversight committees. AMPHETAMINES. Note. See Gamble v. 3:627 lines could be left with the directors.. CARDOZO LAW REVIEW [Vol. not to say most. Veterans v. 149 N. H.E. Kalt-Zimmers Mfg. STONE. the chairman of a consulting firm.2d 941. Shannon Continental Corp. 847 (1948). 839 (1928). denied. 159 Wis. See also Hub- bard. injunctive relief should be framed so that corporate reform is internal and self-regulating."). suggested that corporate executives favor voluntary reform rather than mandatory regulation. In the final analysis.S. Many.g. 2-3.. Cal. Disabled Am. The ALI has now urged adoption of the monitoring model for report to the court with its findings.").Y.. No. however. denied. 332 U. Casper v. 1947). 1979.2d 511.D.2d 366. 1978) ("[U]nless the legislature has made a specific grant of power to courts allowing [judicial] amendments [to a corporation's charter] that power has been denied.

' 204 The corporate community has accused the drafters of the proposal of "appalling arrogance [in] think[ing that] they can vote on how America is managed" 2 5 and labeled the Restatement proposal " 'a ludicrous imposition of an unworkable method by a bunch of people who don't know anything about it.. A Business Roundtable letter to the Institute asking it to reconsider its view stated that the "proposal was ill conceived.' ". In its Principles of Corporate Gov- ernance and Structure: Restatement and Structure.1982] MONITORING MODEL large publicly held corporations. however. To the extent that the broad approach of codifying a model of corporate behavior inhibits the board's need for flexibility. might prove to be premature.206 In light of the out- pouring of criticism from various corporate quarters.' " Id. however."' Id. June 10. 204Id. a former head of the Securities and Exchange Commissions thought it was " 'presumptuous for the legal community to tell the business community what the methods of corporate governance should be. 5. for the purposes of this Note entry into the thicket of this aspect of the dispute is unnecessary. Line 246) (1909). 205 Id. col. it might be noted that "[tihe lady doth protest too much. How-. As the ALI reporters noted." W. SHAKESPEARE. at D6. (statement of John Stichnoth. 207 Id. at DI. the ALI set forth a set of rules clarifying the duties of the members of the board and outlined an organizational structure for corporate governance. it remains to be seen whether the ALI will formally adopt the proposal. Roderick Hills. 3. less risk-taking and fewer candidates willing to serve on boards of direc- tors.2 02 A declaration of victory for corporate reformers.20 7 one might sympathize with the concerns of the ALI's detractors. But the Business Roundtable initiated a lobbying campaign against adoption of the Restatement and the vote was postponed. Se. at D1. 208With respect to the remonstrances of the corporate community. methinks. 4 (statement of Andrew Sigler. 3. general counsel of the Union Carbide Corporation). 1982. wholesale implementation of the monitoring model through the stroke of the brush does not seem any more likely now than it was at the beginning of the last decade when the reform was first suggested. N. Hamlet.Y. undesirable and 'based on false premises in areas where the [Institute] reporters have little or no expertise. "the legal system has 202 Lewin. at D6. The Corporate-Reform Furor. in 5 THE WORKS OF WILtIAM SHAKESPEARE 103 (Act III. 20e Id. col. 203The draft of the ALl proposal was to have been voted on at the Institute's annual meeting in May.20 3 Corporate executives have reacted with a torrent of criticism alleging that the reform would "lead to more lawsuits. 208 Implementation of the monitoring model in the context of the shareholders' derivative action limits the scope of reform to those situations where structural inadequacies of the corporate organization manifest themselves in wrongdoing capa- ble of redress. In any event. 1982. Id. Times. col. president and chairman of the board of Champion International Corporation and head of the Business Roundtable's Corporate Respon- sibility Task Force). 4. col. at D6. col. ever. . ii.

at D6. if presently lying dormant. especially when the misconduct alleged is due to a failure of the board to serve a meaningful and supervisory function within the publicly held corporation. supra note 202. The logic of corporate theorists and the expansive reach of equity compel the exercise of this authority in a derivative action. 3:627 always been the final arbiter of the responsibilities and liabilities of 2 00 directors.682 CARDOZO LAW REVIEW [Vol. The authority of the courts to implement monitoring reforms specifically tailored to meet the needs of the problem before the court is certainly extant. The reach of the court order effect- ing the necessary reforms to prevent further misconduct is limited only by the vision of the court." Structural defects in corporate governance will often result in corporate wrongdoing to the prejudice of the corporation and its shareholders. col. Equity has always sought to provide a remedy where none exists at law. 5. Bruce Dickstein 109 Lewin. Resort to the legal forum in the shareholders' derivative action can serve as one means to reform the governance structure of a corporation beset by misconduct. .