Wasting Away

The corporate waste doctrine often baffles students, and occasionally teachers, of corporate law. On its face the doctrine is straightforward; a wasteful transaction occurs when a corporation has entered into an exchange “for consideration so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade,” an act equivalent to gift or “spoliation.” But wait—when would a corporation ever enter into such a transaction, without there being self-dealing or gross negligence? And what court would ever entertain such a claim? Yet for almost a century waste has been a recognized doctrine in corporation law. Even in the face of judicial hostility—respected judges have called it a “vestige” and mocked it as the “Loch Ness Monster” of corporate law—waste has survived.

My article The Life (and Death?) of Corporate Waste is the first modern study thoroughly canvassing waste, from its origins in the nineteenth century’s ultra vires doctrine to the present day. It argues that waste has existed apart from the fiduciary duties, and has survived because it serves as a “fail-safe” device empowering courts to scrutinize corporate transactions that do not clearly violate fiduciary duties, but also do not appear to be the products of careful business judgment or disinterested decision-making. As one Delaware Chancellor put it in a 2007 case, “[w]hen pled facts support an inference of waste, judicial nostrils smell something fishy and full discovery into the background of the transaction is permitted.” Waste also offers some procedural advantages; growing out of ultra vires and not the fiduciary duties, it retained the old ultra vires rule that unanimous shareholder ratification was required to extinguish a waste claim. That said, waste seemed at odds with other elements of corporate law, particularly the Business Judgment Rule—for wasn’t a waste claim in part a request for a court to evaluate the reasonableness of a corporate transaction, something the rule suggested courts would decline to do?

We may now be in the twilight of waste as an independent doctrine, for courts are increasingly treating waste as merely a signal of, or even another term for, violations of the duty of good faith, an aspect of the fiduciary duty of loyalty. Although waste and good faith are conceptually distinct, conflating them is understandable, for good faith like waste has been used, as one court recently put it, as a “‘fiduciary out’ from the business judgment rule, for situations where, even though there is no indication of conflicted interest or lack of independence on the part of directors, the nature of their action can in no way be understood as in the corporate interest.” Treating waste as equivalent to bad faith also helps simplify corporate managers’ duties, changing waste from a somewhat obscure freestanding doctrine into an aspect of the familiar duty of loyalty within the well-established fiduciary duty framework. Yet I end by cautioning against this trend. For most of a century, waste has been a useful tool to interrogate corporate mismanagement, and courts should think twice before abandoning it.

Harwell Wells, is an I. Herman Stern Professor of Law at Temple University Beasley School of Law. Professor Wells’ interests focus on corporations and legal history, and he regularly teaches business organizations, professional responsibility, and property.

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