At first glance, corporate law’s waste doctrine makes little sense. The classic definition of waste—a transaction “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” of corporate assets—suggests that waste should never arise, for what corporation would ever enter into a transaction so absurd, absent self-dealing or gross negligence? Yet waste claims are regularly made. The conventional wisdom is that waste claims never succeed; but empirical studies show that’s wrong, and some of the most significant corporate law cases of the last two decades have dealt with waste. Respected judges have called for the doctrine’s abolition, referring to it as a “vestige” and memorably deriding it as the mythical “Loch Ness Monster” of corporate law; still, waste survives. It is a remnant of ultra vires, a doctrine proclaimed dead for over a hundred years—but waste is not dead. It confounds our model of managerial responsibility; after decades in which discussion of directors’ and officers’ duties have focused on the fiduciary duties of care and loyalty, waste still sits largely outside that framework, for waste isn’t a fiduciary duty at all. And, after almost a century of life, waste may now be fading as an independent doctrine in corporate law.
My article is the first modern study thoroughly canvassing waste—its origins, growth, present role, and future prospects. It begins by tracking the prehistory of waste back to the nineteenth century and the ultra vires doctrine, the now largely discarded set of rules that barred corporations from acting for purposes not spelled out in their corporate charters, focusing particularly on ultra vires’s prohibition on gifts by corporations. The article then moves to show how this ban on gifts was, starting in the 1930s, reworked by courts into the modern doctrine of corporate waste in a series of cases chiefly targeting executive compensation.
Waste appeared at a moment, the early 1930s, when larger social and political developments led courts to seek new tools to interrogate and criticize corporate management. Older doctrines limiting corporate activity, such as ultra vires, had eroded or disappeared, and newer mechanisms to rein in corporate managers, such as mandatory disclosure, were still in their infancy. Waste, then, would be the first of a series of what Robert Thompson has dubbed “fail-safe devices,” doctrines empowering courts to scrutinize corporate transactions that did not clearly violate fiduciary duties, but also did 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 offered both litigants and courts some procedural advantages. A waste claim could be tough to get rid of—ratification by a majority of disinterested shareholders, for instance, could not extinguish a waste claim, and defendants’ attempts to have waste dismissed at the pleading stage were occasionally denied with the observation that waste claims were fact-specific and there existed a “strong disfavor” to summary judgment for such claims.
Yet the broad use of waste could create its own problems. By its terms waste applied not only to transactions in which a corporation received no consideration, but also to deals in which a corporation received so little consideration that the transaction could be seen as a “gift in part.” This seemed however to open the door for courts to scrutinize any transaction in which, it was alleged, the corporation received significantly less than it gave. If widely deployed, waste claims would have required courts frequently to second-guess business decisions, contravening the hands-off approach embodied in the Business Judgment Rule. As the article follows waste across the rest of the twentieth century, then, we repeatedly see oscillations in its career. Courts would look with favor on waste claims in moments of crisis when its application could prove useful, but take a more skeptical approach to such claims when the moment passed—until a new crisis would appear and waste again became useful. In the 1990s, for instance, waste claims were so disfavored that several Delaware Chancellors called for the doctrine’s abolition; yet with the corporate and financial crises of the following decade, waste was invoked more favorably in the high-profile Disney and Citigroup cases—only to fall into desuetude when those crises passed.
The article closes by moving toward the present day, and identifying a trend in which Delaware courts are increasingly treating waste as merely a signal of, or even another term for, violations of the fiduciary duty of good faith. Although waste and good faith are conceptually quite 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. Waste has been a useful tool to interrogate corporate mismanagement for over eighty years, and courts should think twice before abandoning it.
The full article is available for download here.
This post originally appeared in the Harvard Law School Forum on Corporate Governance and Financial Regulation on January 2, 2017. The original post can be found here.