Smith v. Van Gorkom: Managerial Liability and Exculpatory Clauses ...

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Smith v. Van Gorkom: Managerial Liability and 

Exculpatory Clauses—A Proposal to Fill the Gap 

of the Missing Officer Protection 

Dennis R. Honabach* 

I. INTRODUCTION 

Twenty years ago, the Delaware Supreme Court delivered its 

startling opinion in Smith v. Van Gorkom. 1 There, to the surprise of 

virtually everyone, the court elected to hold directors personally liable 

for damages in a shareholder action alleging mere negligence. Until 

then, the legal community had assumed that directors were essentially 

immune from personal liability for breaches of the fiduciary duty of 

care. Directors—standard canon went—had to fear personal liability 

only in cases in which plaintiffs alleged the directors had breached 

their duty of loyalty. 

For a short time, Van Gorkom appeared to change that—but only 

for a very short time! Reacting to the alarms set off by the opinion, 

the Delaware legislature quickly enacted section 102(b)(7) of the Delaware 

General Corporation Law. 2 Section 102(b)(7) permits shareholders 

to adopt a charter provision granting directors immunity from 

personal liability for breaches of their duty of care. In the following 

years all but one jurisdiction, the District of Columbia, enacted some 

kind of mandatory or optional provision permitting shareholders of 

corporations incorporated in their jurisdiction to provide similar protection 

to their directors. 3 

What is surprising, however, is that only seven states have elected 

to make similar protection available to corporate officers. Arguably, 

the same reasoning that supports protecting directors also applies to 

officers; yet, there has been little movement to provide such protection. 

This article explores that curious phenomenon. I contend that 

the explanation for the exclusion of officers is more an accident of 

history than a product of tight legal analysis. Although the absence of 

such protection for corporate officers has been generally unimportant 

until now, I posit that corporations, in a post-Enron world, should be 

* Dean and Professor of Law, Washburn University School of Law. I wish to acknowledge 

the helpful comments of Professor Lawrence A. Hamermesh, Professor Lyman P.Q. Johnson, 

and my colleague at Washburn University School of Law, Professor Robert Rhee. I also 

wish to thank Andrew Parmenter, my research assistant, for his able help. Needless to say, any 

remaining errors are mine alone. 

1. 488 A.2d 858 (Del. 1985). 

2. DEL. CODE ANN. tit. 8, § 102(b)(7) (2001). 

3. See MARK A. SARGENT & DENNIS R. HONABACH, D & O LIABILITY HANDBOOK: 

LAW—SAMPLE DOCUMENTS—FORMS (Thompson West ed., 2006) (discussing various state 

provisions). 

307


308 Washburn Law Journal [Vol. 45 

able to correct that oversight by adopting a provision that would extend 

similar protection to officers as well. Finally, I conclude by advocating 

for the adoption of statutory provisions permitting corporations 

to shield their officers from personal liability for breaches of the duty 

of care. While the proposed provisions track the language of the dominant 

patterns for exculpatory provisions, they also reflect the adoption 

procedures of the officer exculpatory provision proposed more 

than a decade ago by the American Law Institute. 

II. BACKGROUND 

The tale of Van Gorkom is widely known. As with all tales, the 

true facts may or may not actually be as commonly portrayed, but that 

point is a nicety to be ignored in the retelling of the story. 4 By all 

accounts, the case was factually complex; indeed, some have argued, 

too complex for most law students to understand. 5 

For our purposes, however, a shorthand version of the facts will 

suffice. Trans Union Corporation’s board of directors approved a 

cash-out merger of the company in a fashion that most would now 

view as hastily approved and poorly documented. 6 At the time, the 

board of directors consisted of ten members—five outside directors 

and five officer-directors. 7 Jerome Van Gorkom, the CEO and chairman 

of the board of directors, anxious to sell the corporation, personally 

negotiated the deal with Jay Pritzker. 8 Van Gorkom apparently 

based the offering price of $55 per share on a calculation that he had 

had Carl Peterson, the corporation’s controller, do to determine 

whether a leveraged buy-out at $55 was feasible. 9 Van Gorkom first 

gave notice of the deal to the board in an oral presentation that lasted 

less than two hours. 10 The remaining directors—including Bruce 

Chelberg, the corporation’s president, and William Browder, the vice 

president and former chief legal officer, docilely followed Van 

Gorkom’s lead. 11 The board members approved the deal even though 

4. For a thorough retelling of the story, see WILLIAM M. OWEN, AUTOPSY OF A MERGER 

(1986). 

5. See Lawrence A. Hamermesh, Why I Do Not Teach Van Gorkom, 34 GA. L. REV. 477, 

480-81 (2000). 

6. It is fair to note that although most commentators today view the process employed by 

the Trans Union directors as woefully inadequate, the court split sharply on the issue in a 3-2 

vote. Adding the vote of the chancellor who granted judgment for the defendants, the split 

among jurists was 3-3. For defendant Van Gorkom’s view of the case, see J. W. Van Gorkom, 

The ‘Big Bang’ for Director Liability: The Chairman’s Report, 12 DIRECTORS & BOARDS 17 

(1987) (arguing that “it was not the law” but the Delaware Supreme Court’s “distorted reasoning” 

that led to an incorrect decision). 

7. Smith v. Van Gorkom, 488 A.2d 858, 868 (Del. 1985). 

8. Id. at 866. 

9. Id. 

10. Id. at 869. 

11. Id. at 868-69.


2006] Managerial Liability and Exculpatory Clauses 309 

they had not had an opportunity to review the documents at the meeting 

because the documents arrived too late. 12 

At no time did Van Gorkom, Chelberg, or Peterson inform the 

board that senior managers had reacted completely negatively to the 

proposed deal at a management meeting held just before the board 

meeting. 13 At the board meeting, Donald Romans, the company’s 

chief financial officer, did disclose that he had not been involved in 

the deal negotiations and that he knew nothing about the deal until 

the morning of the meeting. 14 As to the price, he told the board that 

$55 was in the range of a fair price but at the low end of the range. 15 

Neither he nor anyone else told the board that at the earlier seniormanagement 

meeting, he had objected to the proposed deal because 

he thought the price was too low. 16 

Van Gorkom told the board that the deal effectively put Trans 

Union on the auction block because the corporation remained free to 

accept any offer that beat the $55 price. 17 (The court would later determine 

that the terms of the buy-out as initially presented to the 

board, and as later revised, effectively locked Trans Union into the 

deal such that no serious counter-bid could be made). 18 Van Gorkom 

executed the final agreement later that day while at the opera; neither 

he nor any other director read the agreement prior to delivering it to 

Pritzker. 19 

The plaintiffs brought a class action initially seeking to enjoin the 

transaction on the theory that the price paid by Pritzker was woefully 

inadequate. Denied injunctive relief, plaintiffs recast the action as 

seeking damages from the directors. Plaintiffs did not name any of 

the non-officer directors as defendants. 20 

Everyone knew—or at least thought they knew—the futility of 

the suit. Courts never held directors personally liable. The proverbial 

shearing of the pig and all of that! 21 Plaintiffs were simply getting 

desperate. Or so everyone believed! 

12. See id. at 874. 

13. Id. at 867. 

14. Id. at 868-69. 

15. Id. at 869. 

16. Id. at 867 n.6. 

17. Id. at 868. 

18. Id. at 878. 

19. Id. at 869. 

20. At the time, Delaware procedural rules would not have afforded the Delaware courts 

jurisdiction over the non-director officers. Those rules have recently been changed. See infra 

notes 119-21 and accompanying text. 

21. In a classic aphorism, Professor Bishop described actions to impose personal liability for 

failure to exercise due care as much “like the proverbial shearing of the pig—much squealing, 

little wool!” Joseph W. Bishop, Jr., Sitting Ducks and Decoy Ducks: New Trends in the Indemnification 

of Corporate Directors and Officers, 77 YALE L.J. 1078, 1095 (1968).



III. THE DECISION 

Wrong! The Delaware Supreme Court, to the surprise of virtually 

everyone 22 and the dismay of many, 23 held the individual defendants—both 

inside directors and outside directors—personally liable. 24 

The court remanded the case for a determination of damages. Facing 

potential damages of nearly $80 million, the defendants settled the 

fiduciary claim as well as a companion federal securities action against 

the directors and Pritzker for $23.5 million. 25 Of that amount, the corporation’s 

D&O carrier paid $10 million. 26 The defendant directors 

paid $1.5 million; Pritzker paid the rest. 27 

Van Gorkom can be and has been characterized in many ways: as 

a loyalty case; 28 as a last-period case; 29 as a disclosure case; 30 as an 

early change of control case; 31 and as a deal protection case. 32 In this 

article, I treat Van Gorkom as it is perhaps most commonly viewed—a 

case involving the corporate managers’ duty of care. The decision is 

most often cited for the court’s declaration that “the directors of Trans 

Union breached their fiduciary duty to their stockholders . . . by their 

failure to inform themselves of all information reasonably available to 

22. Jonathan R. Macey & Geoffrey P. Miller, Trans Union Reconsidered, 98 YALE L.J. 127, 

131 (1988) (“The outcome of the case was exactly opposite to what virtually every observer of 

Delaware law would have predicted.”). 

23. Daniel R. Fischel, The Business Judgment Rule and the Trans Union Case, 40 BUS. LAW. 

1437, 1455 (1985) (describing the decision as “one of the worst . . . in the history of corporate 

law”). The view of some commentators has not softened over time. E.g., Fred S. McChesney, A 

Bird in the Hand and Liability in the Bush: Why Van Gorkom Still Rankles, Probably, 96 NW. U. 

L. REV. 631 (2002) (“Time has not dimmed the initial luster of the Van Gorkom decision. Considered 

a legal disaster in 1985, it is judged no less disastrous today.”). 

24. Despite questioning from the court, the defendants continued to contend they should be 

treated as a group. Van Gorkom, 488 A.2d at 899 (Christie, J., dissenting). Later, on a motion 

for reargument, O’Boyle, one of the outside directors, argued he should be treated separately 

because he had been ill and had not participated in the September meeting. The court rejected 

his motion as being untimely. Id. at 898-99. Some have suggested that the defendants’ decision 

to defend as a group was a serious tactical error. See, e.g., Steven A. Ramirez, The Chaos of 

Smith, 45 WASHBURN L.J. 343, 349-52 (2006). 

25. As a result, shareholders received less than $2 per share in the settlement. See McChesney, 

supra note 23, at 643 (calculating the recovery per shareholder from the settlement to be 

$1.85 by dividing the amount of the settlement by the 12,734,404 shares represented by the plaintiff 

class). 

26. See OWEN, supra note 4, at 261. 

27. Id. 

28. Carey Kirk, Duty of Care and Duty of Loyalty in the Aftermath of Trans Union, 5 T.M. 

COOLEY L. REV. 1, 3-4 (1988); Alan R. Palmiter, Reshaping the Corporate Fiduciary Model: A 

Director’s Duty of Independence, 67 TEX. L. REV. 1351, 1355 (1989). 

29. Sean J. Griffith, Deal Protection Provisions in the Last Period of Play, 71 FORDHAM L. 

REV. 1899, 1953 (2003); Jonathan R. Macey, Smith v. Van Gorkom: Insights About C.E.O.s, 

Corporate Law Rules, and the Jurisdictional Competition for Corporate Charters, 96 NW. U. L. 

REV. 607, 609-14 (2002). 

30. Lawrence A. Hamermesh, A Kinder, Gentler Critique of Van Gorkom and Its Less Celebrated 

Legacies, 96 NW. U. L. REV. 595, 597-99 (2002); see Ramirez, supra note 24, at 348-49 & 

n.46. 

31. Andrew G.T. Moore II, The 1980s—Did We Save the Stockholders While the Corporation 

Burned?, 70 WASH. U. L.Q. 277, 281 (1992). 

32. See, e.g., R. Franklin Balotti & Gilchrist Sparks III, Deal-Protection Measures and the 

Merger Recommendation, 96 NW. U. L. REV. 467 (2002).



them and relevant to their decision to recommend the Pritzker merger 

. . . .” 33 With its emphasis on the decision-making process employed 

by the directors, the opinion thus became widely accepted as the wellspring 

of the procedural duty of due care doctrine. 34 

The court’s decision in Van Gorkom is important for other reasons. 

In its opinion, the court reaffirmed the gross negligence standard 

for assessing directorial conduct that it had announced only a few 

months earlier in Aronson v. Lewis. 35 The court also recognized a 

duty of candor, which it found that the Trans Union directors had violated 

by failing to disclose to the corporation’s shareholders all information 

they had or should have had when they sought shareholder 

approval of the transaction. 36 

IV. THE LEGACY 

The decision was startling, but any joy in plaintiffs’ offices—and 

fear in corporate offices—following the announcement of the decision 

quickly dissipated. Immediately following the Delaware Supreme 

Court’s decision in Van Gorkom, the state legislatures took three legislative 

steps to reaffirm the protected role of corporate directors. 37 

First, some legislatures increased the availability of corporate indemnification 

for directors and officers. 38 Second, the Delaware legislature 

increased the availability of D&O liability insurance by loosening 

the non-exclusivity of the indemnification provisions. 39 Finally, and 

perhaps most importantly, the Delaware legislature enacted section 

102(b)(7), 40 permitting Delaware corporations to limit or eliminate 


34. The court had already foreshadowed the creation of the procedural duty of care in its 

decision in Aronson v. Lewis, 473 A.2d 805 (Del. 1984), a decision by a panel of Justices Moore, 

Christie, and McNeilly. Ironically Justices Christie and McNeilly would later dissent from the 

application of the procedural standard in Van Gorkom. Van Gorkom, 488 A.2d at 897 

(McNeilly, J., dissenting); id. at 898 (Christie, J., dissenting). 

35. 473 A.2d 805 (Del. 1984). 

36. Van Gorkom, 488 A.2d at 893. As Professor Hamermesh has noted, this was the first 

time the court held that directors of Delaware corporations were subject to a duty of complete 

candor in a case not involving self-dealing or a case in which the directors were using inside 

information to sell or buy the corporation’s shares. Hamermesh, supra note 30, at 597-98. 

37. See E. Norman Veasey, Jesse A. Finkelstein & C. Stephen Bigler, Delaware Supports 

Directors with a Three-Legged Stool of Limited Liability, Indemnification, and Insurance, 42 BUS. 

LAW. 399 (1987). 

38. See James J. Hanks, Jr., Evaluating Recent State Legislation on Director and Officer 

Liability Limitation and Indemnification, 43 BUS. LAW. 1207, 1221-24 (1988) (discussing the expansion 

of indemnification in derivative suits). 

39. Id. at 1224-27 (discussing the expansion of the non-exclusivity provisions governing director 

and officer indemnification). 

40. DEL. CODE ANN. tit. 8, § 102(b)(7) (2001). Section 102(b)(7) provides: 

§ 102 Contents of certificate of incorporation. 

. . . . 

(b) In addition to the matters required to be set forth in the certificate of incorporation 

by subsection (a) of this section, the certificate of incorporation may also contain 

any or all of the following matters: 

. . . .



the personal liability of their corporate directors. 41 Many believe this 

last step, the adoption of the exculpation provision, effectively overruled 

Van Gorkom. 42 Some also believe that both the enactment of 

section 102(b)(7) and the individual corporate decisions to add an exculpatory 

provision to corporate charters resulted in a loss of shareholder 

value. 43 

Section 102(b)(7) permits corporations to amend their corporate 

charters to shelter directors from personal liability to the corporation 

or its shareholders so long as their actions do not fall within one of 

four exceptions: unlawful dividends; acts or omissions that constitute a 

“breach of the director’s duty of loyalty”; “acts or omissions not made 

in good faith or which involve intentional misconduct or a knowing 

violation of law”; and “any transaction from which the director derives 

an improper personal benefit.” 44 Section 102(b)(7) allows corporations 

to negate the application of Van Gorkom to their directors 

even when directors engage in grossly negligent conduct, including 

conduct involving significant procedural shortcomings. Not surprisingly, 

section 102(b)(7) proved popular with corporate management. 

(7) A provision eliminating or limiting the personal liability of a director to the 

corporation or its stockholders for monetary damages for breach of fiduciary duty as a 

director, provided that such provision shall not eliminate or limit the liability of a director: 

(i) For any breach of the director’s duty of loyalty to the corporation or its stockholders; 

(ii) for acts or omissions not in good faith or which involve intentional 

misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv) for any 

transaction from which the director derived an improper personal benefit. No such 

provision shall eliminate or limit the liability of a director for any act or omission occurring 

prior to the date when such provision becomes effective. All references in this 

paragraph to a director shall also be deemed to refer (x) to a member of the governing 

body of a corporation which is not authorized to issue capital stock, and (y) to such 

other person or persons, if any, who, pursuant to a provision of the certificate of incorporation 

in accordance with § 141(a) of this title, exercise or perform any of the powers 

or duties otherwise conferred or imposed upon the board of directors by this title. 

41. See generally Hanks, supra note 38 (discussing the various state legislative responses to 

the Van Gorkom decision); see SARGENT & HONABACH, supra note 3 (updating the evaluation 

of state D&O legislation). 

42. E.g., Marc I. Steinberg, The Evisceration of the Duty of Care, 42 SW. L.J. 919, 920 

(1988). 

43. E.g., Ramirez, supra note 24, at 352-53. The claim that the exculpatory regime created 

by section 102(b)(7) resulted in a loss of shareholder wealth is based on an event study done by 

Michael Bradley and Cindy Schipani. Michael Bradley & Cindy A. Schipani, The Relevance of 

the Duty of Care Standard in Corporate Governance, 75 IOWA L. REV. 1 (1989). Professors 

Bradley and Schipani reported that Delaware corporations suffered a significant loss in share 

value as a consequence of the enactment of section 102(b)(7), and Delaware corporations that 

adopted section 102(b)(7) provisions suffered additional significant losses in share value. Id. at 

60-68. The validity of Bradley and Schipani’s study has been challenged by others. For example, 

Professors Sanjai Bhagat and Roberta Romano argue that Bradley and Schipani’s use of the 

statute’s effective date is troubling because the effective date of the statute is not a meaningful 

event date. They note that the statute’s enactment was well publicized and any effect it would 

have should have been impounded in share price well before the effective date. See Sanjai Bhagat 

& Roberta Romano, Event Studies and the Law: Part II: Empirical Studies of Corporate Law, 

4 AM. L. ECON. REV. 380, 391-92 (2002). The conduct of shareholders seems to bear out Bhagat 

and Romano’s critique. If the inclusion of an exculpatory provision in a corporation’s charter 

imposes a significant loss on shareholder value, one would expect institutional shareholders to 

call for its repeal. None has. 

44. DEL. CODE ANN. tit. 8, § 102(b)(7).



Following the section’s effective date, virtually every publicly traded 

corporation incorporated in Delaware adopted a section 102(b)(7) 

provision. 45 

Many other states—spurred on by a heated “race to the bottom” 

46 or “race to the top” 47 —quickly followed suit. Six states struck 

new ground, imposing mandatory provisions limiting director liability. 

48 Most, however, enacted their own charter-option provisions; 

forty-four states now have some form of charter-option statute. 49 In 

an abundance of caution, two states—Louisiana and Utah—have both 

a self-executing liability limitation 50 and a charter-option provision. 51 

Only one jurisdiction—the District of Columbia—has not adopted 

any additional protection for corporate managers. 

The individual state provisions differ in several ways. Many of 

the differences involve minor wording changes of little consequence. 

45. Hamermesh, supra note 5, at 490. 

46. See William Cary, Federalism and Corporate Law: Reflections upon Delaware, 83 YALE 

L.J. 663 (1974); Daniel J.H. Greenwood, Democracy and Delaware: The Mysterious Race to the 

Bottom/Top, 23 YALE L. & POL’Y REV. 381 (2005) (arguing that the race to the top/bottom 

theories obscure the political theories we have made in corporate law); see also Macey, supra 

note 29, at 622-24. 

47. See Ralph K. Winter, Jr., State Law, Shareholder Protection, and the Theory of the Corporation, 

6 J. LEGAL STUD. 251 (1977). In a companion article in this issue, Professor Henry 

Butler employs the race to the top approach, contending that in announcing the decision in Van 

Gorkom, the Delaware Supreme Court almost cost Delaware its position as the dominant state 

for incorporation. Henry N. Butler, Smith v. Van Gorkom, Jurisdictional Competition, and the 

Role of Random Mutations in the Evolution of Corporate Law, 45 WASHBURN L.J. 267, 272 

(2006); see also Macey, supra note 29, at 624-25. 

48. FLA. STAT. ANN. § 607.0831 (West 2001); IND. CODE ANN. § 23-1-35-1(e) (West 2005); 

NEV. REV. STAT. § 78.138 (2003); OHIO REV. CODE ANN. § 1701.59(D) (West 1994 & Supp. 

2003); VA. CODE ANN. § 13.1-692.1 (1999); WIS. STAT. ANN. § 180.0828 (West 2002). 

49. ALA. CODE § 10-2B-2.02(b)(3) (LexisNexis 1999); ALASKA STAT. § 10.06.210(1)(n) 

(2004); ARIZ. REV. STAT. ANN. § 10-202(B)(1) (2004); ARK. CODE ANN. § 4-27-202(B)(3) 

(2001); CAL. CORP. CODE § 204(a)(10) (West 1990); COLO. REV. STAT. § 7-108-402(1) (1999); 

CONN. GEN. STAT. § 33-636(b)(4) (2005); DEL. CODE ANN. tit. 8, § 102(b)(7) (2001); GA. CODE 

ANN. § 14-2-202(b)(4) (2003); HAW. REV. STAT. §§ 414-32(b), 414-222 (2004); IDAHO CODE 

ANN. § 30-1-202(2)(d) (Supp. 1999); 805 ILL. COMP. STAT. ANN. 5/2.10(b)(3) (West 2004); IOWA 

CODE ANN. § 490.202(2)(d) (West 1999); KAN. STAT. ANN. § 17-6002(b)(8) (1993); KY. REV. 

STAT. ANN. § 271B.2-020(2)(d) (LexisNexis 2003); ME. REV. STAT. ANN. tit. 13-C, § 202(2)(D) 

(2005); MD. CODE ANN., CORPS. & ASS’NS §§ 2-104(b)(8), 2-405.2 (LexisNexis 1999); MASS. 

ANN. LAWS ch. 156B, § 13(b)(1 1/2) (LexisNexis 2005); MICH. COMP. LAWS SERV. 

§ 450.1209(1)(c) (LexisNexis 2001); MINN. STAT. ANN. §§ 302A.111 (4)(u), 302A.251(4) (West 

2004); MISS. CODE ANN. § 79-4-2.02(b)(4)-(5) (2001); MO. ANN. REV. STAT. § 351.355(2) (West 

2001); MONT. CODE ANN. § 35-1-216(2)(d) (2005); NEB. REV. STAT. § 21-2018(2)(d)-(e) (1997); 

NEV. REV. STAT. § 78.037 (2003); N.H. REV. STAT. ANN. § 293-A:2.02(b)(4) (LexisNexis 1999); 

N.J. STAT. ANN. § 14A:2-7(3) (West 2003); N.M. STAT. ANN. § 53-12-2(E) (LexisNexis Supp. 

2005); N.Y. BUS. CORP. LAW § 402(b) (McKinney 2003); N.C. GEN. STAT. § 55-2-02(b)(3) (2005); 

N.D. CENT. CODE § 10-19.1-10(5)(u) (2001); OKLA. STAT. ANN. tit. 18, § 1006(B)(7) (West 

1999); OR. REV. STAT. § 60.047(2)(d) (2003); 15 PA. CONS. STAT. ANN. § 1713(a)-(b) (West 

1995); R.I. GEN. LAWS § 7-1.1-48(a)(6) (1999); S.C. CODE ANN. § 33-2-102(e) (1990); S.D. CODI- 

FIED LAWS § 47-1A-202.1(4) (Supp. 2005); TENN. CODE ANN. § 48-12-102(b)(3) (2002); TEX. 

REV. CIV. STAT. ANN. art. 1302, § 7.06(B) (Vernon 2003); VT. STAT. ANN. tit. 11A, § 2.02(b)(4) 

(1997); WASH. REV. CODE ANN. §§ 23B.02.020(5)(j), 23B.08.320 (West 1994 & Supp. 2006); W. 

VA. CODE ANN. § 31D-2-202(b)(4) (LexisNexis 2003); WYO. STAT. ANN. § 17-16-202(b)(iii)-(v) 

(2003). 

50. LA. REV. STAT. ANN. § 12:91(A)-(E) (Supp. 2006); UTAH CODE ANN. § 16-10a-840(4) 

(2001). 

51. LA. REV. STAT. ANN. § 12:24(C)(4) (1994 & Supp. 2006); UTAH CODE ANN. § 16-10a- 

841.



Some, however, are quite significant. One important difference is the 

extent to which these exculpatory exclusionary provisions limit the 

ability of shareholders to reduce or eliminate the risk of personal liability 

for violations involving forms of managerial misconduct far 

more egregious than mere mismanagement. 

Two general patterns of provisions ultimately developed. One is 

based on Delaware’s section 102(b)(7). 52 As noted above, section 

102(b)(7) prohibits directorial exculpation for acts or omissions not 

made in good faith, for acts that constitute intentional misconduct, 

and for acts or omissions that constitute a breach of the duty of loyalty. 

Section 102(b)(7) likewise does not shelter illegal acts or unlawful 

dividends. 53 Both the duty-of-loyalty exception and the good-faith 

exception are particularly troubling because neither is well defined. 

The Delaware corporate code does not employ the term “loyalty” 

anywhere other than in section 102(b)(7); hence its parameters are 

difficult to ascertain. Likewise, “good faith” is an open-ended term 

that has lately become quite controversial. 

The second pattern, which evolved later, is provided by section 

2.02(b)(4) of the Model Business Corporation Act (MBCA). 54 Section 

2.02(b)(4) omits Delaware’s broad exclusions for liabilities arising 

from breaches of a director’s duty of loyalty and for directors’ acts not 

taken in good faith. Instead, it excludes from coverage only liabilities 

“for (A) the amount of a financial benefit received by a director to 

which he is not entitled; (B) an intentional infliction of harm on the 

corporation or the shareholders; (C) a violation of section 8.33; or (D) 

an intentional violation of criminal law.” 55 

A few states that quickly enacted clones of Delaware’s section 

102(b)(7) subsequently replaced their original provisions with ones 

that tracked MBCA section 2.02(b)(4), apparently because section 

2.02(b)(4) allows more liability limitation and eliminates the definitional 

ambiguity surrounding the duty-of-loyalty exclusion. 56 The 

Delaware model remains dominant, however, as only twelve states 

52. DEL. CODE ANN. tit. 8, § 102(b)(7)(i). 

53. Id. Other early statutes omitted such a broad duty-of-loyalty exception and only excluded 

narrowly defined types of misconduct. The Maryland statute, for example, excluded from 

the coverage of its provision only the actual receipt of “an improper benefit or profit in money, 

property, or services” and “active and deliberate dishonesty.” MD. CODE ANN. CTS. & JUD. 

PROC. § 5-419 (LexisNexis 2002). 

54. MODEL BUS. CORP. ACT § 2.02(b)(4) (2002). For a general discussion of the development 

of the Model Act’s director-protection provisions, in particular section 2.02(b)(4), see 

James J. Hanks, Jr. & Larry P. Scriggins, Protecting Directors and Officers from Liability—The 

Influence of the Model Business Corporation Act, 56 BUS. LAW. 3, 25-27 (2000). 

55. MODEL BUS. CORP. ACT § 2.02(b)(4). A violation of section 8.33 occurs with an authorization 

of an illegal distribution. Id. § 8.33(a). 

56. See, e.g., ARIZ. REV. STAT. ANN. § 10-202(B)(1) (2004) (tracking MODEL BUS. CORP. 

ACT § 2.02(b)(4), replacing ARIZ. REV. STAT. ANN. § 10-054(A), which tracked Delaware’s 

§ 102(b)(7)).



follow the MBCA pattern. 57 Twenty-four states continue to follow the 

basic Delaware pattern. 58 Seven states have idiosyncratic charter-option 

provisions. 59 Eight states have either mandatory exculpatory provisions 

or have adopted reformulations of the duty of care that 

dramatically limit the possibility of liability, including two that also 

have a charter option. 60 

The practical distinction between Delaware’s exceptions, particularly 

its broad duty-of-loyalty exclusion and “good faith” exception 

and the MBCA’s more narrowly circumscribed exclusions had, until 

recently, not proven to be significant, even though Delaware’s pattern 

theoretically requires the courts to explore the murky boundary between 

the duties of care, good faith, and loyalty. Recent developments, 

however, have made the distinction quite important. 

V. THE DISNEY LITIGATION 

The decision in In re Walt Disney Co. Derivative Litigation 61 has 

raised important questions about the meaning of the “good faith” exclusion 

in section 102(b)(7) and, more fundamentally, the existence or 

nonexistence of a separate duty of good faith. The Disney litigation 

revolved around the hiring and relatively rapid termination of Michael 

Ovitz. The underlying facts read like a daytime soap opera. 62 At the 

urging of Michael Eisner, Disney’s CEO and chairman of the board, 

Disney hired Ovitz in 1995. Fourteen months later, Disney termi- 

57. ARIZ. REV. STAT. ANN. § 10-202(B)(1); GA. CODE ANN. § 14-2-202(b)(4) (2003); HAW. 

REV. STAT. §§ 414-32(b), 414-222 (2004); IDAHO CODE ANN. § 30-1-202(2)(d) (Supp. 1999); 

IOWA CODE ANN. § 490.202(2)(d) (West 1999); MICH. COMP. LAWS SERV. § 450.1209(1)(c) (LexisNexis 

2001); MISS. CODE ANN. § 79-4-2.02(b)(4)-(5) (2001); MONT. CODE ANN. § 35-1- 

216(2)(d) (2005); NEB. REV. STAT. § 21-2018(2)(d)-(e) (1997); N.H. REV. STAT. ANN. § 293- 

A:2.02(b)(4) (LexisNexis 1999); S.D. CODIFIED LAWS § 47-1A-202.1 (Supp. 2005); VT. STAT. 

ANN. tit. 11A, § 2.02(b)(4) (1997). 

58. ALASKA STAT. § 10.06.210(1)(n) (2004); ARK. CODE ANN. § 4-27-202(B)(3) (2001); 

CAL. CORP. CODE § 204(a)(10) (West 1990); COLO. REV. STAT. § 7-108-402(1) (1999); CONN. 

GEN. STAT. § 33-636(b)(4) (2005); DEL. CODE ANN. tit. 8, § 102(b)(7) (2001); 805 ILL. COMP. 

STAT. ANN. 5/2.10(b)(3) (West 2004); KAN. STAT. ANN. § 17-6002(b)(8) (1993); KY. REV. STAT. 

ANN. § 271B.2-020(2)(d) (LexisNexis 2003); LA. REV. STAT. ANN. § 12:24(C)(4) (1994 & Supp. 

2006); MASS. ANN. LAWS ch. 156B, § 13(b)(1 1/2) (LexisNexis 2005); MINN. STAT. ANN. 

§§ 302A.111(4)(u), 302A.251(4) (West 2004); MO. ANN. STAT. § 351.355(2) (West 2001); N.J. 

STAT. ANN. § 14A:2-7(3) (West 2003); N.Y. BUS. CORP. LAW § 402(b) (McKinney 2003); N.D. 

CENT. CODE § 10-19.1-10(5)(u) (2001); OKLA. STAT. ANN. tit. 18, § 1006(B)(7) (West 1999); OR. 

REV. STAT. § 60.047(2)(d) (2003); 15 PA. CONS. STAT. ANN. § 1713(a)-(b) (West 1995); R.I. GEN. 

LAWS § 7-1.1-48(a)(6) (1999); S.C. CODE ANN. § 33-2-102(e) (1990); TENN. CODE ANN. § 48-12- 

102(b)(3) (2002); TEX. REV. CIV. STAT. ANN. art. 1302, § 7.06(B) (Vernon 2003); WASH. REV. 

CODE ANN. §§ 23B.02.020(5)(j), 23B.08.320 (Supp. 2006). 

59. ALA. CODE § 10-2B-2.02(b)(3) (LexisNexis 1999); MD. CODE ANN., CORPS. & ASS’NS 

§§ 2-104(b)(8), 2-405.2 (LexisNexis 1999); NEV. REV. STAT. § 78.037 (2003); N.M. STAT. ANN. 

§ 53-12-2(E) (LexisNexis Supp. 2005); N.C. GEN. STAT. § 55-2-02(b)(3) (2005); W. VA. CODE 

ANN. § 31D-2-202(b)(4) (LexisNexis 2003); WYO. STAT. ANN. § 17-16-202(b)(iii)-(v) (2003). 

60. See supra notes 48 and 50. 

61. 825 A.2d 275 (Del. 2003). 

62. For a colorful, entertaining, and at some times shocking retelling of the facts, see James 

B. Stewart, Partners, THE NEW YORKER, Jan. 10, 2005, at 46.



nated Ovitz’s employment. 63 The board, however, did not elect to 

treat his termination as one for cause. As a result, Ovitz became entitled 

to a severance payment of roughly $39 million in cash and vested 

options potentially yielding another $101 million. 64 

Not surprisingly, some disgruntled Disney shareholders brought a 

derivative suit against Eisner, Ovitz, the directors who approved the 

employment contract, and the directors who approved the no-fault 

termination. The Delaware Court of Chancery initially dismissed the 

plaintiffs’ complaint on the grounds that plaintiffs had failed to state a 

claim and that plaintiffs had failed to make the requisite demand on 

the directors. 65 

On appeal, the Delaware Supreme Court, troubled by the facts of 

the case, described the termination payment to Ovitz as “exceedingly 

lucrative, if not luxurious.” 66 It characterized the decision-making 

process that the Disney board allegedly employed both in hiring and 

in discharging Ovitz as “casual, if not sloppy and perfunctory.” 67 At 

the same time, the court was highly critical of the plaintiffs’ complaint, 

describing it as a “pastiche of prolix invective.” 68 The court held that 

the plaintiffs’ complaint was subject to dismissal because it lacked sufficient 

particularized allegations, but the court concluded that in the 

interests of justice it would permit the plaintiffs to replead that portion 

of their complaint, alleging breach of fiduciary duty and waste. 69 

On remand, the plaintiffs—after obtaining additional information 

pursuant to Delaware’s inspection statute 70 —pled facts that Chancellor 

William B. Chandler III found to raise a “cognizable question of 

whether the defendant directors of the Walt Disney Company should 

be held personally liable to the corporation for a knowing or intentional 

lack of due care in the directors’ decision-making process regarding 

Ovitz’s employment and termination.” 71 The defendants 

argued that the plaintiffs’ new complaint alleged, at most, a breach of 

the directors’ duty of care and that directors were thus protected from 

liability by the section 102(b)(7) exculpatory provision in Disney’s 

charter. 72 The chancellor rejected both arguments. He noted that the 

complaint alleged failure of the directors to exercise any business 

63. Disney hired Ovitz effective October 1, 1995, and terminated him on December 11, 

1996. See Brehm v. Eisner, 746 A.2d 244, 249-52 (Del. 2000). 

64. Id. at 253. 

65. In re Walt Disney Co. Derivative Litig., 731 A.2d 342, 380 (Del. 1998). 

66. Brehm, 746 A.2d at 249. 

67. Id. 

68. Id. 

69. Id. at 248, 267. 

70. DEL. CODE ANN. tit. 8, § 220 (2001). 

71. In re Walt Disney Co. Derivative Litig., 825 A.2d 275, 278 (Del. 2003). 

72. Id. at 286. The defendants also argued that the revised complaint failed to allege actions 

that were not protected under the business judgment rule. Id.



judgment. 73 He also determined that the protection of the exculpatory 

clause was not available to the defendants, stating: 

Where a director consciously ignores his or her duties to the corporation, 

thereby causing economic injury to its stockholders, the director’s 

actions are either “not in good faith” or “involve intentional 

misconduct.” Thus, plaintiffs’ allegations support claims that fall 

outside the liability waiver provided under Disney’s certificate of 

incorporation. 74 

As a result of the Court of Chancery’s decision, the case proceeded to 

trial. 

Following a full, revealing, and oft-times embarrassing trial, 

Chancellor Chandler concluded that, while the defendants had not exercised 

model corporate governance, they had not breached their fiduciary 

duties. 75 Chancellor Chandler reaffirmed his belief that a 

section 102(b)(7) provision created an affirmative defense with the 

burden of proof on the defendant directors to demonstrate they were 

entitled to that protection. 76 He attempted, but failed to satisfactorily 

define “good faith,” 77 leaving its meaning murky. 78 

In addition to the troublesome interpretive problems, the exculpatory 

provisions raise the issue of which party has the burden of 

proving, or disproving, the applicability of the provision. To be consistent 

with the apparent intent of the drafters, one might well suspect 

that defendants should be required to demonstrate that a validly 

adopted exculpatory provision exists. One might expect the burden to 

then shift back to the plaintiffs to prove that the defendants’ conduct 

was not protected by the provision. In Emerald Partners v. Berlin, 79 

however, the Delaware Supreme Court concluded that a section 

102(b)(7) provision provides defendants with an affirmative defense 

requiring the defendants to prove their conduct falls within the pa- 

73. Id. at 278. 

74. Id. at 290. 

75. In re Walt Disney Co. Derivative Litig., No. 15452, slip op. at 139 (Del. Ch. Aug. 9, 

2005), available at http://courts.delaware.gov/opinions/(anhs4mjxxwbgr345smau20vm)/down 

load.aspx?ID=64510. 

76. Id. at 124. 

77. For an excellent discussion of the issue of the relationship between “good faith” and 

section 102(b)(7), see John L. Reed & Matt Neiderman, “Good Faith” and the Ability of Directors 

to Assert § 102(b)(7) of the Delaware General Corporation Law as a Defense to Claims Alleging 

Abdication, Lack of Oversight, and Similar Breaches of Fiduciary Duty, 29 DEL. J. CORP. 

L. 111 (2004). 

78. As this article goes to print, the Delaware Court of Chancery’s decision is on appeal to 

the Delaware Supreme Court. Delaware Supreme Court Oral Arguments (Jan. 25, 2006), available 

at http://courts.Delaware.gov/Courts/Supreme%20Court/?audioargs.htm; Randall Chase, 

Judge Erred, Attorney Says in Disney Appeal, DELAWARE ONLINE, Jan. 26, 2006, http://www. 

delawareonline.com/apps/pbcs.dll/article?AID=/20060126/BUSINESS/601260327/1003. 

79. 787 A.2d 85 (Del. 2001); see also Malpiede v. Townson, 780 A.2d 1075 (Del. 2001); 

Stephen A. Radin, Director Protection Statutes After Malpiede and Emerald Partners, INSIGHTS, 

Feb. 2002, at 10, 10.



rameters of the provision, except when the plaintiffs allege only 

breaches of the directors’ duty of care. 80 

It is critical to note that the charter-option statutes have no effect 

on plaintiffs’ ability to seek non-monetary equitable remedies, such as 

an injunction or rescission, for any breach of fiduciary duty. Furthermore, 

the statutes generally provide no protection from suits brought 

by creditors or other third parties. 81 

For the purposes of the article, the most important difference in 

the various state exculpatory provisions is the degree to which the 

statutes provide any protection to corporate officers. Most states follow 

the Delaware and MBCA patterns in extending the coverage of 

their exculpatory provisions only to directors. Seven states, however, 

do provide protection for officers. 82 The rationale for the remaining 

states not extending protection to officers is not clear. A plausible 

explanation for the omission is that the “crisis” created by Van 

Gorkom involved directors, and thus, directors—particularly outside 

directors—clamored for relief. As most corporate officers at the time 

were also serving as directors, there seemed to be little need for extending 

protection to officers qua officers. 

To appreciate the impact of the exculpatory provisions on corporate 

law, one needs to recall the corporate environment at the time 

Van Gorkom was decided. The era of hostile takeovers had just begun 

to heat up. The popular press, legal journals, and soon corporate 

decisions were filled with the rhetoric of poison pills, white knights, 

green mail, and the like. The corporate governance system was under 

serious attack as managers, jurists, and corporate theorists debated 

the appropriateness of various responses to the emerging hostile takeover 

market. 

Yet, in 1985, corporate theory was largely still a product of the 

pioneering work of Adolph Berle and Gardener Means. In their classic 

work, The Modern Corporation and Private Property, Berle and 

Means posited that ownership of publicly held corporations was so 

widely dispersed that managers effectively controlled corporate activ- 

80. Emerald Partners, 787 A.2d at 91; see Prod. Res. Group, L.L.C. v. NCT Group, Inc., 863 

A.2d 772, 793-95 (Del. Ch. 2004). 

81. The North Carolina provision, however, is drafted broadly enough to shield directors 

from third-party claims. See N.C. GEN. STAT. § 55-2-02(b)(3) (2005) (permitting the articles of 

incorporation to provide an exculpatory provision eliminating personal liability “arising out of 

an action whether by or in the right of the corporation or otherwise . . . .” (emphasis added)). 

The apparent open-ended statutory language was intended to cover shareholder class actions 

such as in Van Gorkom, but the language is broader. The validity of the North Carolina statute 

as it applies to claims brought by third parties has not been tested. 

82. LA. REV. STAT. ANN. § 12:24(c)(4) (1994 & Supp. 2006); MD. CODE ANN., CORPS. & 

ASS’NS §§ 2-104(b)(8), 2-405.2 (LexisNexis 1999), MD. CODE ANN., CTS. & JUD. PROC. § 5-418 

(LexisNexis 2002); NEV. REV. STAT. § 78.138(7) (2003); N.H. REV. STAT. ANN. § 293-A:2.02(b) 

(4) (LexisNexis 1999); N.J. STAT. ANN. § 14A:2-7(3) (West 2003); UTAH CODE ANN. § 16-10a- 

840(4) (2001); VA. CODE ANN. § 13.1-692.1 (1999).



ity. 83 Individual shareholders, they argued, simply held too small a 

stake in their corporations to be expected to exercise any effective 

oversight over managerial behavior. 84 Instead, corporate managers 

controlled the corporation. 

Building on the Berle-Means hypothesis, Professor William Cary 

argued that states, hungry for corporate franchise fees, were locked 

“in a race to the bottom.” 85 The goal of each state, he maintained, 

was to attract corporations and corporate taxes and fees by offering 

managers the most managerial-favorable corporate statute. Consequently, 

shareholders could not rely on either state legislatures or 

state courts for any meaningful protection. 

Many commentators, viewing the enactment of the exculpatory 

provisions through the Berle-Means lens, condemned the provisions— 

regardless of their form—as just another example of classic managerialism. 

They contend that the adoption of an exculpatory provision 

resulted in a decline in shareholder value. 86 They saw the passage of 

the exculpatory provisions as nothing more than another instance in 

which corporate managers—suddenly threatened by the possibility of 

being held accountable for their actions—were able to call successfully 

on state legislators to gain further insulation from shareholder 

control. 

For many reasons that explanation did not go unchallenged. 

Most importantly, the emerging Contract Model of the corporation 

placed corporate relations in a whole new light. 87 In contrast to the 

Berle-Means managerial theory of the corporation, the Contract 

Model of the corporation views the corporation as a nexus of explicit 

and implicit contracts entered into by shareholders and other investors. 

88 As two of the leading Contract Model theorists explain: 

The contractual theory of the corporation states that the corporation 

is a set of contracts among the participants in the business, including 

shareholders, managers, creditors, employees and others. 

The terms of the agency contract include the provisions of state law, 

which are regarded as a standard form that can be accepted by the 

parties or rejected either by drafting around the provision or by incorporating 

in another state. The corporate contract also specifies 

the extent to which the parties rely on the competitive pressures 

from capital, product, and managerial labor markets as well as inter- 

83. ADOLF A. BERLE, JR. & GARDINER C. MEANS, THE MODERN CORPORATION AND PRI- 

VATE PROPERTY 7 (1932). 

84. Id. at 69. 

85. Cary, supra note 46, at 663-68. Cary’s hypothesis has been soundly challenged. See, 

e.g., Winter, supra note 47. 

86. See discussion supra note 43. 

87. See Henry N. Butler, The Contractual Theory of the Corporation, 11 GEO. MASON L. 

REV. 99, 100 (1989). 

88. The use of the phrase “nexus of contracts” can be traced back to Michael C. Jensen and 

William H. Meckling’s path-breaking article, Theory of the Firm: Managerial Behavior, Agency 

Costs and Ownership Structure, 3 J. FIN. ECON. 305, 310 (1976).



nal incentive structures such as corporate hierarchy, boards of directors 

and managerial compensation contracts, to force agents to act 

in their shareholders’ best interests. 89 

While it may be accurate to describe shareholders as sometimes stuck 

with their deal, Contract Model theorists deem those shareholders no 

more powerless than visitors to an amusement park who might want 

to stop the rollercoaster ride just as the last car begins to plunge down 

the steep, initial descent. Ex ante, shareholders—and rollercoaster 

riders—are free to bargain for the price and protections they desire. 

Consequently, rather than viewing the appropriate role of corporate 

law to be to fashion the “correct” rules for corporate governance, the 

Contractarians believe the proper role of the state to be to provide an 

appropriate set of default governance rules. 90 Corporate law, Contractarians 

contend, should permit shareholders and other corporate 

participants to vary those default rules—including fiduciary rules—as 

they desire. 91 Optional governance rules, such as those provided by 

section 102(b)(7), nestle comfortably in the fabric of the Contract 

Model. 

At least two arguments can be advanced in opposition to the 

Contract Model. First, because of the power imbalance within the 

corporation, the “contracts” that the Contract Model champions are 

really nothing more than expressions of the dominant power of corporate 

managers. Second, developments in the field of behavioral economics 

undercut the fundamental premise of the theory, namely, the 

assumption that shareholders can rationally determine the best basket 

of corporate governance rules. Even some of the early supporters of 

the model have cast doubt on its continuing vitality, arguing that legislation 

that has undercut the market for corporate control has allowed 

managers to engage in more self-serving behavior. 92 

In the late 1980s, however, the Contract Model provided considerable 

theoretical support for the passage of section 102(b)(7) and its 

clones. Shareholders who applauded the decision in Van Gorkom 

need do nothing. Shareholders who preferred the pre-Van Gorkom 

rules were free to return to them. That large numbers of corporations 

elected to do so was thus justified, not as a managerial power grab, but 

rather as an appropriate exercise of shareholder governance. 

89. Henry N. Butler & Larry E. Ribstein, Opting Out of Fiduciary Duties: A Response to 

Anti-Contractarians, 65 WASH. L. REV. 1, 7 (1990). 

90. STEPHEN M. BAINBRIDGE, CORPORATION LAW AND ECONOMICS 28-31 (2002); FRANK 

H. EASTERBROOK & DANIEL R. FISCHEL, THE ECONOMIC STRUCTURE OF CORPORATE LAW 34- 

36 (1991). 

91. Butler & Ribstein, supra note 89, at 28-32. 

92. Henry G. Manne, Editorial, The Follies of Regulation, WALL ST. J., Sept. 27, 2005, at 

A19.



As a result of the widespread elections to insert exculpatory provisions 

in corporate charters, many commentators believe the passage 

of section 102(b)(7) and its progeny effectively overruled Van 

Gorkom. 93 Not surprisingly, it has become commonplace to assume 

that the enactment of section 102(b)(7) had—and continues to have— 

a profound impact on corporate governance and the potential exposure 

of corporate directors to personal liability. The validity of that 

assumption, however, is shaky. It depends largely on the belief that 

directors truly faced an increased risk of personal liability in the post- 

Van Gorkom, pre-section 102(b)(7) world. But did they? 

It is true that before Van Gorkom, no one thought directors faced 

any real threat of liability for breaching their duty of care. And it is 

true that in holding the Trans Union directors personally liable, Van 

Gorkom did make clear that directors were at risk. But Van Gorkom 

threatened liability only if directors failed miserably in following an 

appropriate decision-making procedure like that outlined in the decision. 

94 A well-advised board had little to fear. 

Indeed, the Van Gorkom opinion actually resolved troubling issues 

about the potential liability of directors in ways that should have 

done much to allay the fears of most directors. In its opinion, the 

court reiterated its holding in Aronson v. Lewis95 that gross negligence, 

and not the simple negligence standard implied by the duty-ofcare 

rhetoric, 96 was the appropriate standard for determining director 

liability. 97 The court also affirmed that the business judgment rule 

created a presumption that the directors acted in good faith and stated 

that the gross negligence standard applied to plaintiffs’ attempts to 

overcome the business judgment rule. 98 Finally, the court laid the 

groundwork for the developing distinction between substantive due 

care (did the board make the correct decision?) and procedural due 

care (did the board employ a reasonable process in making its deci- 

93. See, e.g., Edward Rock & Michael Wachter, Dangerous Liaisons: Corporate Law, Trust 

Law and Interdoctrinal Legal Transplants, 96 NW. U. L. REV. 651, 651-52 (2002) (“People were 

shocked by Smith v. Van Gorkom. Teeth were gnashed. The Delaware General Corporate Law 

. . . was amended. The world went on. . . . The story has a happy ending. Shareholders, managers, 

and the Delaware legislature rode to the rescue, enacted section 102(b)(7) and largely restored 

the status quo ante. But it is a cautionary tale nonetheless. Transplanting legal concepts, 

without attention to the underlying context, can cause great mischief.”). 

94. Bayless Manning, Reflections and Practical Tips on Life in the Boardroom After Van 

Gorkom, 41 BUS. LAW. 1 (1985). 

95. 473 A.2d 805, 812 (Del. 1984). 

96. At the time, the typical statement of the directors’ obligation was that they should use 

that “amount of care which ordinarily careful and prudent men would use in similar circumstances.” 

Graham v. Allis-Chalmers Mfg. Co., 188 A.2d 125, 130 (Del. 1963); see also Stephen 

A. Radin, The Director’s Duty of Care Three Years After Smith v. Van Gorkom, 39 HASTINGS 

L.J. 707, 711 (1988). 


98. Id.



sion?). 99 As a result of the decision, directors generally are shielded 

from liability exposure in most instances so long as they employ an 

appropriate decision-making process. 100 

In short, despite the hysteria of the moment, directors were no 

more at risk after Van Gorkom than they ever were before. As one 

commentator stated, “the [Van Gorkom] opinion is not a scandalous 

harbinger of increased exposure. Quite to the contrary, the decision 

arguably lowered the standard of conduct by defining breaches of the 

duty of care in terms of ‘gross’ rather than ‘ordinary’ negligence.” 101 

In light of the considerable protection provided directors by the 

court’s analysis in Van Gorkom, one might draw a rather startling conclusion: 

Despite the controversy surrounding the enactment of the exculpatory 

provisions, section 102(b)(7) and its progeny elsewhere 

provided directors with little real additional protection. Simply put, 

the effect of the statute was psychological, not legal. While the new 

provisions appeared to calm the troubled seas, anyone who had 

stepped back and surveyed the landscape would have concluded that 

the waters were already quite placid. 

The claim that the exculpatory provisions did not play a key role 

in protecting directors from actual litigation gains some support by the 

results of the paucity of suits holding directors liable in those jurisdictions 

that were slow to provide any protection for corporate directors. 

Section 204(a)(10) of the California Code still provides no protection 

99. Id. at 893 (“To summarize: we hold that the director defendants of Trans Union 

breached their fiduciary duty to their stockholders . . . by their failure to inform themselves of all 

information reasonably available to themselves and relevant to their decision to recommend the 

Pritzker merger . . . .”). 

100. Note that I do not claim that Van Gorkom had no effect on corporate decision-making. 

Indeed, it has had a substantial effect. Whether the overall effect was beneficial or detrimental 

continues to be a matter of debate. Some commentators believe that Van Gorkom had injurious 

effects in that it encouraged directors to “over process” their decision-making. The claim is that 

directors engage in choreographed meetings and employ outside experts, such as investment 

bankers, to secure fairness opinions in most corporate control transactions. Charles M. Elson & 

Robert B. Thompson, Van Gorkom’s Legacy: The Limits of Judicially Enforced Constraints and 

the Promise of Proprietary Incentives, 96 NW. U. L. REV. 579, 586 (2002). But see, Helen M. 

Bowers, Fairness Opinions and the Business Judgment Rule: An Empirical Investigation of Target 

Firms’ Use of Fairness Opinions, 96 NW. U. L. REV. 567 (2002) (finding that the frequency of 

target firms’ use of fairness reports in the post-Van Gorkom years was not materially different 

from their use in the five years prior to the decision). On the other hand, some commentators, 

including me, believe that the process culture created by Van Gorkom has indeed led to improved, 

more thoughtful collective decision-making. See Lynn A. Stout, In Praise of Procedure: 

An Economic and Behavioral Defense of Smith v. Van Gorkom and the Business Judgment Rule, 

96 NW. U. L. REV. 675 (2002). At the same time, I must acknowledge that the tendency to 

advocate a process-based approach to a problem is an occupational hazard of those legally 

trained. Grant Gilmore’s classic aphorism provides the most notable admonishment against 

over reliance on process: “The better the society, the less law there will be. In Heaven there will 

be no law, and the lion will lie down with the lamb . . . . In Hell there will be nothing but law, and 

due process will be meticulously observed.” GRANT GILMORE, THE AGES OF AMERICAN LAW 

111 (1977). 

101. Roberta Romano, What Went Wrong with Directors’ and Officers’ Liability Insurance?, 

14 DEL. J. CORP. L. 1, 24 (1989).



for directors against Van Gorkom-like claims. 102 An idiosyncratic 

charter-option provision, California’s provision is applicable only to 

actions brought by or on behalf of the corporation. It does not apply 

to shareholder class actions such as the one brought by the plaintiffs in 

Van Gorkom. Yet there are no reported cases holding any director of 

a California corporation personally liable for damages for a breach of 

her duty of care. 

Likewise, there are no reported cases holding directors liable in 

states that were slow to adopt any director-protection provision. For 

example, no directors of an Illinois corporation were held personally 

liable for a breach of their duty of care even though the Illinois legislature 

did not provide them with a charter-option provision until 1993, 

eight years after the Van Gorkom decision. 103 

Moreover, even when states did adopt charter-option provisions, 

they did not permit corporations to shelter directors from liabilities 

arising from acts that occurred prior to the effective date of the revised 

statute. One would have thought that had Van Gorkom really 

opened the liability floodgates, the plaintiffs’ bar would have eagerly 

sought to impose liability for those unsheltered acts. Yet there are no 

reported cases imposing liability on directors for acts that occurred 

prior to the effective dates of any of those statutes. 

If the threat of personal liability was so minimal following Van 

Gorkom, why then did charter-option provisions and other liabilitylimiting 

legislation become so popular in the years immediately following 

the decision? The answer is complex. In part, there was genu- 

102. CAL. CORP. CODE § 204(a)(10) (West 1990). Section 204(a)(10) provides: 

The articles of incorporation may set forth: 

(a) Any or all of the following provisions, which shall not be effective unless expressly 

provided in the articles: . . . (10) Provisions eliminating or limiting the personal liability 

of a director for monetary damages in an action brought by or in the right of the corporation 

for breach of a director’s duties to the corporation and its shareholders, as set 

forth in [s]ection 309, provided, however, that (A) such a provision may not eliminate 

or limit the liability of directors (i) for acts or omissions that involve intentional misconduct 

or a knowing and culpable violation of law, (ii) for acts or omissions that a 

director believes to be contrary to the best interests of the corporation or its shareholders 

or that involve the absence of good faith on the part of the director, (iii) for any 

transaction from which a director derived an improper personal benefit, (iv) for acts or 

omissions that show a reckless disregard for the director’s duty to the corporation or its 

shareholders in circumstances in which the director was aware, or should have been 

aware, in the ordinary course of performing a director’s duties, of a risk of serious 

injury to the corporation or its shareholders, (v) for acts or omissions that constitute an 

unexcused pattern of inattention that amounts to an abdication of the director’s duty to 

the corporation or its shareholders, (vi) under [s]ection 310, or (vii) under [s]ection 316, 

(B) no such provision shall eliminate or limit the liability of a director for any act or 

omission occurring prior to the date when the provision becomes effective, and (C) no 

such provision shall eliminate or limit the liability of an officer for any act or omission 

as an officer, notwithstanding that the officer is also a director or that his or her actions, 

if negligent or improper, have been ratified by the directors. 

Id. (emphasis added). 

103. 805 ILL. COMP. STAT. ANN. 5/2.10(b)(3) (West 2004) (added in 1993 by Public Act 88-43, 

S. 448, 88th Gen. Assem. (Ill. 1993)).



ine fear and shock that the rules had in some way changed. Even 

though Van Gorkom itself was not the anti-managerial disaster many 

proclaimed it to be, no one could be sure that another shoe was not 

about to drop. The concern resulting from that uncertainty was magnified 

by the hard times precipitated by the economic decline of the 

late 1980s. Perhaps more importantly, the dramatic increase in hostile 

takeover activity that occurred during the decade placed directors in 

the uncomfortable position of having to make major financial decisions 

under incredible time pressure. Many directors naturally feared 

that plaintiffs’ counsel, armed with hindsight, might persuade a court 

to “Van Gorkom”-ize an unprofitable decision on the theory that the 

directors had acted too hastily. 

To make matters worse, for reasons only tangentially related to 

Van Gorkom, D&O insurance rates began to soar. 104 The causes for 

the increased rates were multifold, but it became a popular, yet misguided, 

sport to point to the Van Gorkom decision as a major contributing 

cause. 105 For these and other reasons, the pressure to undo Van 

Gorkom legislatively—or to head it off with legislation in states in 

which the courts had not rendered a Van Gorkom-like decision— 

proved irresistible to most state legislatures. 

Eventually, D&O rates returned to normal levels, and outside directors 

breathed a sigh of relief. Some no doubt attributed the eventual 

calming of the liability crisis to the enactment of the exculpatory 

provisions. Those provisions, however, were likely little more than 

placebos that helped steady the spirits of many would-be directors 

while they waited for the return of normalcy. 

VI. THE CASE FOR EXPANDING THE SCOPE OF EXCULPATORY 

PROVISIONS TO INCLUDE OFFICERS 

If the effect of the exculpatory provisions has been largely symbolic, 

one might think it perplexing that I nevertheless now argue that 

states should follow the lead of those seven states—Louisiana, 106 Ma- 

104. E. Norman Veasey, Jesse A. Finkelstein & C. Stephen Bigler, Responses to the D&O 

Insurance Crisis, 19 REV. SEC. & COMM. REG. 263 (1986). 

105. For a thorough discussion of the D&O liability insurance crisis in the late 1980s, see 

Romano, supra note 101; see also Roberta Romano, Corporate Governance in the Aftermath of 

the Insurance Crisis, 39 EMORY L.J. 1155, 1157-60 (1990). 

106. LA. REV. STAT. ANN. § 12:24(c)(4) (1994 & Supp. 2006).



ryland, 107 Nevada, 108 New Hampshire, 109 New Jersey, 110 Utah, 111 and 

Virginia 112 —that have extended the protection of their exculpatory 

provisions to corporate officers. Indeed, given the paucity of reported 

actions seeking to impose liability on corporate officers, one might 

argue that such protection is unnecessary; I believe otherwise. In today’s 

post-Enron business-legal environment, corporate officers face a 

substantial risk of liability litigation, including claims of negligent conduct. 

While the latter type of litigation may ultimately be unsuccessful, 

its specter likely will have undesirable consequences on officer 

behavior and, in turn, on corporate performance. Providing officers 

an exculpatory shield will prevent the harm of threatened litigation. 

Increased liability exposure for corporate officers seems inevitable. 

Because many of the Enron-era corporate fiascos can be traced 

to misbehavior by corporate officers, there have been, and will continue 

to be, calls for holding corporate officers accountable for corporate 

failings. 113 Indeed, there already have been changes at the 

federal level. A number of the provisions of the Sarbanes-Oxley Act 

of 2002 114 focus on the potential criminal and civil liability of corporate 

officers. 115 The fallout from Enron and similar corporate scandals, 

however, has affected more than just federal law. The ongoing 

debate about the desirability of federalizing corporate law seems certain 

to pressure states, particularly Delaware, to demonstrate concern 

about the apparent deviant behavior of corporate officers. 116 

The decision by the Delaware legislature to amend its procedural 

code to expand the courts’ jurisdiction over officers of Delaware corporations 

is probably a response to such pressure. Prior to 2004, Delaware 

courts were unable to exercise personal jurisdiction over 

107. MD. CODE ANN., CORPS. & ASS’NS §§ 2-104(b)(8), 2-405.2 (LexisNexis 1999); MD. 

CODE ANN, CTS. & JUD. PROC. § 5-418 (LexisNexis 2002). For discussions of the Maryland 

provisions, see James J. Hanks, Jr. & Larry P. Scriggins, Let Stockholders Decide: The Origins of 

the Maryland Director and Officer Liability Statute of 1988, 18 U. BALT. L. REV. 235 (1989); 

Dennis R. Honabach, Consent, Exit, and the Contract Model of the Corporation—A Commentary 

on Maryland’s New Director and Officer Liability Limiting and Indemnification Legislation Statute, 

18 U. BALT. L. REV. 310 (1989); and Mark Sargent, Two Cheers for the Maryland Director 

and Officer Liability Statute, 18 U. BALT. L. REV. 278 (1989). 

108. NEV. REV. STAT. § 78.138(7) (2003). 

109. N.H. REV. STAT. ANN. § 293-A:2.02(b)(4) (LexisNexis 1999). 

110. N.J. STAT. ANN. § 14A:2-7(3) (West 2003). 

111. UTAH CODE ANN. § 16-10a-840(4) (2001). 

112. VA. CODE ANN. § 13.1-692.1 (1999). For a discussion of Virginia’s provision, see Dennis 

R. Honabach, All that Glitters: A Critique of the Revised Virginia Stock Corporation Act, 12 J. 

CORP. L. 433, 472 (1987). 

113. Troy A. Paredes, Corporate Decisionmaking: Too Much Pay, Too Much Deference: Behavioral 

Corporate Finance, CEOs, and Corporate Governance, 32 FLA. ST. U. L. REV. 673, 749 

(2005). 

114. Pub. L. No. 107-204, 116 Stat. 745 (codified as amended in scattered sections of titles 11, 

15, 18, 28, and 29 U.S.C.). 

115. E.g., Sarbanes-Oxley Act of 2002 §§ 302, 305(b), 906(a). 

116. See, e.g., Robert B. Thompson, Delaware, the Feds, and the Stock Exchange: Challenges 

to the First State as First in Corporate Law, 29 DEL. J. CORP. L. 779, 790-92 (2004).



officers under the rule of Shaffer v. Heitner. 117 Some commentators 

have pointed to that lack of jurisdiction as the probable cause for the 

dearth of any significant officer liability litigation. 118 Perhaps fearing 

federalization of corporate law, the Delaware legislature amended 

section 3114(a) of title 10 of its code to provide for implied jurisdiction 

over corporate officers, even if those officers do not serve as corporate 

directors. 119 The official explanation for the change was that 

[w]hile such officers are currently subject to personal jurisdiction in 

Delaware if they also serve as directors, the 2003 amendments establish 

personal jurisdiction over the most senior corporate officers 

identified in the statute and highly compensated executive officers 

identified in SEC filings regardless of whether they also serve as 

directors. Because of enhanced requirements for independent director 

representation on public company boards of directors, it is 

likely that fewer senior officers will also serve as directors. Therefore, 

had [s]ection 3114 not been amended, the ability to obtain personal 

jurisdiction in Delaware over some of the most significant 

participants in corporate governance would have been impaired. 120 

If the revision of section 3114 has the effect desired by some reformers, 

officers should expect to face increased exposure to litigation. 

The impact of that increased litigation depends ultimately on the 

law applicable in care cases brought against corporate officers. The 

traditional articulation of an officer’s duty of care is that the officer 

should act in good faith in what she reasonably believes to be in the 

best interest of the corporation using the care that a person in like 

circumstances would reasonably exercise under similar circumstances. 

121 That formulation tracks closely the standard generally applicable 

to directors. It implies, just as it did when originally applied 

to directors, that an officer who acts negligently will be held personally 

liable for the loss she causes. In applying the reasonable director 

standard, the courts have required plaintiffs to prove gross negligence 

as a precondition to director liability. The courts have further insulated 

directors from liability by applying the business judgment rule to 

117. 433 U.S. 186 (1977). 

118. E.g., Hillary A. Sale, Delaware’s Good Faith, 89 CORNELL L. REV. 456, 459 (2004); 

William B. Chandler III & Leo. E. Strine, Jr., The New Federalism of the American Corporate 

Governance System: Preliminary Reflections of Two Residents of One Small State, 152 U. PA. L. 

REV. 953, 1003 (2003). 

119. See DEL. CODE ANN. tit. 10, § 3114 (1999 & Supp. 2004). Chancellors William B. Chandler 

III and Leo E. Strine Jr. indeed offered that explanation for the revision of section 3114. 

They contended that the change was appropriate given the increase in the number of independent, 

non-officer directors resulting from the changes in corporate governance patterns. They 

noted that, in the past, most officers also served as directors and thus were subject to directorbased 

jurisprudence rules. See Chandler & Strine, supra note 118. 

120. State of Delaware, http://www.state.de.us/corp/2003amends.shtml (last visited Jan. 24, 

2006). 

121. MODEL BUS. CORP. ACT § 8.42 (2002).



shelter from review many directorial actions not involving self-dealing 

or changes in control. 122 

Is simple negligence or gross negligence the standard for finding 

liability in cases against officers? Does the business judgment rule apply 

to officers? A few states have answered these questions statutorily. 

Louisiana 123 and Utah 124 required plaintiffs to prove that an 

officer’s conduct constituted gross negligence. Nevada provides officers 

with even more protection; it conditions a finding of liability 

upon plaintiffs’ ability to prove that an officer’s conduct constituted 

intentional wrongdoing, fraud, or misconduct. 125 

Most states’ legislatures, however, have not addressed either 

question, leaving their resolution to the courts. Surprisingly, few 

courts have answered either question. As a result, the existing case 

law is both sparse and conflicting. A few courts have spoken loosely 

of holding corporate officers to a simple negligence standard. Most, 

however, have tended to speak of officers and directors interchangeably, 

implying that the same rules are applicable to both. 126 

In the aftermath of Enron, several commentators have attempted 

to analyze both the existing law and its desirability. In an important 

article, Professors Lyman P.Q. Johnson and David Millon, two of the 

premier corporate law theorists of the day, have argued that officers 

are and should be subject to more scrutiny and to a stricter standard 

of liability than corporate directors. 127 They argue that the failure of 

the courts to distinguish between the standard to be employed to evaluate 

directors and the standard to be employed to evaluate corporate 

officers is the consequence of the failure of legal theorists to explain 

why corporate officers are fiduciaries. 128 Professors Johnson and Millon 

note that while directors are not corporate agents (and thus may 

be properly held only to a gross negligence standard) 129 corporate officers 

are agents and should be treated as such. The law of agency, 

they emphasize, has developed over time a rich body of fiduciary law, 

one tenet of which is that absent an agreement otherwise, agents are 

122. For a thorough discussion of the business judgment rule, see DENNIS J. BLOCK, NANCY 

E. BARTON & STEPHEN A. RADIN, THE BUSINESS JUDGMENT RULE: FIDUCIARY DUTIES OF 

CORPORATE DIRECTORS (5th ed. 1998). 

123. LA. REV. STAT. ANN. § 12.91(A)-(E) (Supp. 2006). 

124. UTAH CODE ANN. § 16-10(a)-840(4) (2001). 

125. NEV. REV. STAT. § 78.138 (2003). 

126. See generally A. Gilchrist Sparks III & Lawrence A. Hamermesh, Common Law Duties 

of Non-Director Corporate Officers, 48 BUS. LAW. 215 (1992) (discussing the sparse case law 

addressing the issue of the fiduciary duties of corporate officers). 

127. Lyman P.Q. Johnson & David Millon, Recalling Why Corporate Officers Are Fiduciaries, 

46 WM. & MARY L. REV. 1597 (2005); see also Lyman P.Q. Johnson, Corporate Officers and 

the Business Judgment Rule, 60 BUS. LAW. 439 (2005); Lyman P.Q. Johnson & Mark Sides, The 

Sarbanes-Oxley Act and Fiduciary Duties, 30 WM. MITCHELL L. REV. 1149, 1223-24 (2004). 

128. Johnson & Millon, supra note 127, at 1623-27. 

129. Id. at 1639.



held to a standard of simple negligence. 130 Finding no such agreement, 

Professors Johnson and Millon argue that officers should be 

held to the “highly context-specific” standard applied in tort law to 

other agents to ensure that officers exercise appropriate 

stewardship. 131 

Professors Johnson and Millon note that while most states permit 

corporations to reduce or eliminate director liability for failure to satisfy 

their duty of care, only a few permit corporations to similarly 

shield officers from monetary liability. They imply that this state of 

affairs is a result of a tacit recognition that corporate officers should 

be held to a higher standard. 132 They never address the obvious possibility 

that the reason most exculpatory provisions apply only to a director 

might well be explained more easily as a historical artifact, a 

response to Van Gorkom. 

Elsewhere, Professor Johnson has argued that corporate officers 

are unable, and should not be permitted, to avail themselves of the 

protections provided by the business judgment rule. 133 To support his 

position, he advances several arguments in support of his contention 

that there is an important distinction between applying the business 

judgment rule to officers’ conduct and the application of a standard of 

reasonable care, rather than gross negligence. 134 Professor Johnson 

begins his analysis by categorizing the rationales for applying the business 

judgment rule to corporate directors into three policies. He identifies 

these policies as: “encouraging directors to serve and take risks; 

avoiding judicial encroachment into business decisions; and preserving 

the board’s central decision making role in corporate governance.” 135 

Professor Johnson then argues that the first and third policies 

simply do not apply to corporate officers. He contends that officers 

do not need additional protection to take on appropriate risks because 

they, unlike directors, receive substantial compensation. 136 He also 

contends that officers should bear greater risks because they work full 

time and have specialized knowledge that is unavailable to directors. 

137 Preserving the board’s governance role, he contends, requires 

130. RESTATEMENT (SECOND) OF AGENCY § 379 (1958). 

131. Johnson & Millon, supra note 127, at 1637. Elsewhere, Professor Johnson has teamed 

up with Mark A. Sides to again argue that, as agents, corporate officers should be held to the 

standard of ordinary care. Unfortunately, Johnson and Sides likewise fail to explain why the 

standard of care for corporate officers should be greater than one of gross negligence. They too 

seem to assume that the officer’s status as agent is self-explanatory. Johnson & Sides, supra note 

127. 

132. Johnson & Millon, supra note 127, at 1639. 

133. Johnson, supra note 127. 

134. Id. at 455-66. 

135. Id. at 455. 

136. Id. at 458-59. 

137. Id. at 460.



that the board decide whether to pursue a claim against an officer. 138 

The courts, Professor Johnson maintains, should not automatically 

shield officer action from review. 

Professor Johnson does admit that the second rationale, “avoiding 

judicial encroachment into business judgment,” might have some 

application to officers. 139 He contends, however, that the rationale 

would only prevent assessment of the substantive soundness of the 

decision. He argues that the rationale does not support barring courts 

from assessing the process by which the officers made that decision. 140 

In other words, he would have courts apply Van Gorkom’s processoriented 

assessment whenever plaintiffs challenge an officer’s action. 

To conclude his arguments, Professor Johnson notes that if one 

accepts the popular neo-classical economic proposition that existing 

rules reflect shareholder preferences, one could infer from the status 

quo that shareholders prefer, or at least are willing to tolerate, the 

existing standard of simple reasonable care applied in determining officer 

liability. 141 Moreover, Professor Johnson adds that if shareholders 

truly prefer to hold officers to a lesser standard, they can simply 

contract for such a standard. 142 He also notes that states could provide 

officers with more protection but most do not. Finally, he notes, 

corporations can easily shield officers from personal liability by 

purchasing D&O liability coverage. Directors could then sue officers 

and obtain recovery from the insurance carrier rather than the officer 

himself. 143 Professor Johnson recognizes that the availability of D&O 

proceeds would undercut the deterrent effect of the liability he seeks. 

He suggests, though, that diminution in deterrence might be offset 

somewhat by requiring officers to remain liable for a portion of any 

judgment. 144 

138. Id. at 464-65. 

139. Id. at 455. 

140. Id. at 463. 

141. Id. at 466. It seems unlikely that Professor Johnson truly believes this point. Rather, it 

appears he is simply tweaking the arguments of those who espouse the oft-overstated neoclassical 

law and economics position that, whatever the rule, it must be the rule shareholders desire. 

The correctness of his proposition is entirely dependent on description of the current rule, which 

is murky at best. He admits that point is not clear. He adds, however, that “it is hard to believe 

most investors wish to hold officers to a standard of care below what they expect from all other 

people (except directors) who act on their behalf, such as doctors, lawyers, . . . etc.” Id. He 

offers no support for this normative assertion. 

142. Id. at 466-67. The validity of Professor Johnson’s assertion that officers could simply 

modify their fiduciary duties by contract in the absence of any statutory authorization is unclear. 

Certainly Contractarians would support that proposal, but traditionalists are likely to argue 

against permitting that form of private ordering. 

143. On this point, Professor Johnson errs in that he overlooks the “insured against insured” 

exclusion in D&O policies, which renders the policy inapplicable to suits brought by the corporation 

itself, other than derivative suits. JOSEPH WARREN BISHOP, JR., THE LAW OF CORPORATE 

OFFICERS AND DIRECTORS INDEMNIFICATION AND INSURANCE § 8:16 (Jennifer L. Berger Revision 

2004); see also CORPORATE GOVERNANCE: LAW AND PRACTICE § 5.04(4)(d) (2005). 

144. Johnson, supra note 127, at 468.



Professor Johnson’s analysis has not gone unchallenged. In an 

article responding to Professor Johnson’s most recent piece, Professor 

Lawrence A. Hamermesh and A. Gilchrist Sparks III review Professor 

Johnson’s analysis and find it unpersuasive. 145 They argue that the 

rationales for applying the business judgment rule to corporate directors 

apply equally well to corporate officers. They note that a shield 

from liability is necessary to encourage corporate officers to make the 

types of risky business decisions that shareholders desire of their corporate 

officers. They point out that contrary to Professor Johnson’s 

suggestion, D&O policy protection will be unavailable to officers in an 

action brought by the corporation. 146 While they agree with Professor 

Johnson’s recognition that courts should not second-guess the substance 

of an officer’s decision, Hamermesh and Sparks strongly disagree 

with his assertion that the courts should evaluate the decisionmaking 

process employed by corporate officers. 147 Finally, they disagree 

with Professor Johnson’s assertion that imposing a higher standard 

of care on corporate officers would serve to preserve the board’s 

governance role. They argue instead that such a rule would actually 

encourage officers to pass on risky decisions to the board, a result that 

would infringe upon the board’s ability to delegate appropriate authority 

and decision-making to officers. The result, they contend, 

would be top-heavy management. 148 

Despite the spirited discourse between the commentators, the 

current state of the law remains uncertain. Given that uncertainty and 

given the widespread calls for holding officers accountable for corporate 

misfortunes, officers can expect to find themselves more frequently 

named defendants in actions alleging they breached their duty 

of care. Eventually the courts will resolve the uncertainty surrounding 

the applicable liability rule in such cases, but that resolution will be a 

long time coming. That delay itself will be unsettling to corporate officers. 

Moreover, the risk that courts might decide to hold officers to 

a standard of ordinary negligence and deny them the protection of the 

business judgment rule will loom large over officers as they go about 

their work. The imposition of liability, or even the threat of liability, 

will have a chilling effect on the risk-taking conduct of corporate officers. 

Indeed, in all likelihood, the current debate over the applica- 

145. Lawrence A. Hamermesh & A. Gilchrist Sparks III, Corporate Officers and the Business 

Judgment Rule: A Reply to Professor Johnson, 60 BUS. LAW. 865 (2005) [hereinafter Reply to 

Professor Johnson]. In an earlier article, Hamermesh and Sparks concluded that “[t]he business 

judgment rule is almost universally applied to officers.” See Sparks & Hamermesh, supra note 

126, at 237. 

146. Reply to Professor Johnson, supra note 145, at 871. 

147. Id. at 873-74. 

148. Id. at 874-75.



bility of the business judgment rule to officer conduct has already had 

a chilling effect. 

One way to eliminate the uncertainty over how courts will resolve 

the officer liability issues would be to amend the exculpatory provisions 

to provide officers statutory protection from personal liability. 

Expanding the coverage of the exculpatory provisions to include officers 

would not undercut the deterrent value of other statutes, such as 

the Sarbanes-Oxley Act, being implemented to combat officer misconduct 

of the type that occurred in Enron and subsequent corporate 

scandals. The actions of Bernie Ebbers, 149 Andrew Fastow, 150 Dennis 

Kozlowski, 151 Joseph Nacchio, 152 John Rigas, 153 Jeff Skilling, 154 and 

other corporate officers who have been indicted and convicted for 

their actions in the recent wave of corporate scandals did not involve 

negligent conduct. Those officers would find no solace in an exculpatory 

provision, even if existing charter-option provisions, or 

mandatory provisions, were expanded to include corporate officers. 

Nor would the expansion of the exculpatory provisions affect the market, 

ethical, and moral forces that compel most officers to perform 

satisfactorily without regard to the possibility of liability. 

149. Bernie Ebbers is the former chief executive officer and one of the founders of 

WorldCom. Ebbers was found guilty of securities fraud, conspiracy, and filing false documents 

with regulators in connection with a fraud that over-reported WorldCom’s earnings from somewhere 

between five and eleven billion dollars. For a brief article, see Dan Ackman, Bernie 

Ebbers Guilty, FORBES.COM, Mar. 15, 2005, http://www.forbes.com/home/management/2005/03/ 

15/cx_da_0315ebbersguilty.html. 

150. Andrew Fastow is the former chief financial officer of Enron. He pled guilty to two 

counts of wire and securities fraud, agreeing to serve a ten-year sentence and cooperate in the 

prosecution of other Enron executives. Fastow was an important figure in Enron’s use of “offbalance 

sheet special purpose entities” to hide the company’s massive losses. For a brief article, 

see Wikipedia, Andrew Fastow, http://en.wikipedia.org/wiki/Andrew_Fastow (last visited Jan. 24, 

2006). 

151. Leo Dennis Kozlowski is the former chief executive officer of Tyco International. Kozlowski 

was convicted on twenty-two counts of grand larceny relating to $150 million in unauthorized 

bonuses. He was also convicted of fraud against the company’s stockholders in an amount 

over $400 million. For a brief article, see Wikipedia, Dennis Kozlowski, http://en.wikipedia.org/ 

wiki/Dennis_Kozlowski (last visited Jan. 25, 2006). 

152. Joseph Nacchio is the former chief executive officer of Qwest Communications. 

Nacchio is currently facing civil suits brought by both the SEC and private shareholders. He has 

also been indicted on forty-two counts of insider trading relating to the allegedly illegal sale of 

$101 million in Qwest stock. The civil suits deal with a massive fraud between 1999 and 2002 in 

which Qwest falsely reported one-time sales or trades as recurring revenues in order to improperly 

book almost $3 billion in revenue which eased its merger with US West Inc. For a brief 

article, see Judith Kohler, Former Qwest CEO Joseph Nacchio Indicted, YAHOO FIN., Dec. 21, 

2005, http://biz.yahoo.com/ap/051221/qwest_nacchio.html?.v=2. 

153. John Rigas is the former chief executive officer and one of the founders of Adelphia 

Communications. He was forced to resign in 2002 after being indicted for wire, bank, and securities 

fraud. Rigas, his sons, and others were accused of concealing over $2.3 billion in liabilities 

from corporate investors and of misappropriating corporate funds. For a brief article, see 

Wikipedia, John Rigas, http://en.wikipedia.org/wiki/John_Rigas (last visited Jan. 25, 2006). 

154. Jeff Skilling was chief executive officer of Enron from February to August in 2001. 

Skilling was indicted on thirty-five counts, including fraud and insider trading relating to the 

collapse of Enron. For a brief article, see Wikipedia, Jeffrey Skilling, http://en.wikipedia.org/ 

wiki/Jeffrey_Skilling (last visited Jan. 25, 2006).



Moreover, there is good reason to believe shareholders would 

want to prevent liability litigation aimed at corporate officers for 

breaches of their duty of care. Corporate litigation is frightfully 

costly. The danger of strike suits is widely recognized. 155 In some instances 

the board itself may use the threat of litigation inappropriately 

to gain leverage in negotiating with corporate officers who have fallen 

out of favor. Even when shareholders sincerely believe that corporate 

officers have performed poorly, their use of litigation as a corrective 

tool will burden the corporation and their fellow shareholders with 

considerable expense both in terms of out-of-pocket costs as well as 

the opportunity costs incurred when management is compelled to defend 

itself in court rather than manage the corporation. Consequently, 

as is true with all civil litigation, litigation to enforce an 

officer’s duty of care can be justified only if it satisfies one of the following 

three goals: deterrence, compensation, or punishment. It is unlikely 

that such litigation would meet any of those goals. 

Most shareholders are unlikely to find much solace in viewing the 

imposition of personal liability as a form of punishment. They will 

likely view this as a cost the state should incur. On the other hand, the 

deterrence and compensation rationales, at least at first glance, appear 

to have some validity. The specter of liability will shape officer behavior. 

Likewise, recovery of a personal judgment against a wayward officer 

would provide some measure of recovery to the shareholders. 

But do either the deterrence or compensation justifications really support 

the argument for imposing personal liability on officers? Are the 

costs of such a liability scheme worth the benefits? 

There are reasons to believe they are not. The claim for imposing 

personal liability on an officer to deter misconduct seems weak. As 

many others have noted, officers already are subject to a number of 

incentives to act in an appropriate fashion, including the loss of reputation, 

the loss of employment, the desire to conform to cultural 

norms, and the desire to comply with ethical standards. While some 

commentators point to the recent scandals as evidence that the deterrent 

effect of these restraints is insufficient, 156 no one doubts that 

these restraints exist and that they provide some deterrence against 

155. One might contend that strike suits are much less of a problem in litigation brought 

against corporate officers because the board of directors would control the decision of whether 

or not to proceed. That argument assumes, however, that the plaintiff would be unable to join 

the members of the board of directors as defendants for failing to have properly supervised the 

defendant officers. 

156. E.g., Lisa M. Fairfax, Spare the Rod, Spoil the Director? Revitalizing Directors’ Fiduciary 

Duty Through Legal Liability, 42 HOUS. L. REV. 393, 433-38 (2005). Such arguments appear to 

be a product of the Nirvana Fallacy, which compares the results of imperfect market forces 

against the results of idealized perfect government regulation.



sloppy decision-making. And, most relevant for our purposes, these 

incentives are free and already exist. 

Nevertheless, one might contend that extending the coverage of 

the exculpatory provisions to officers is unwise because the prospect 

of facing a possible lawsuit for negligent conduct is worthwhile as it 

adds one more disincentive to sloppy decision-making. It is not 

enough, however, to note that the possibility of liability adds additional 

deterrence. The hard question is whether the benefit of the incremental 

addition to existing incentives exceeds its cost. 

That question is far easier to pose than to answer. The costs and 

benefits of deterrence rules are devilishly difficult to measure. Moreover, 

little available empirical work exists to prove or disprove that 

claim. Indeed, we know little about how officers make decisions or 

about which processes work best in arriving at particular decisions. 157 

But whatever the merits of encouraging boards of directors to adopt a 

formal decision-making process in dealing with the types of questions 

that come before them, it seems unlikely that we should encourage 

corporate officers to take the same process-laden approach in every 

decision they make. 158 Indeed, there is reason to believe that rather 

than improving the quality of officer decision-making, the specter of 

liability might encourage officers to adopt inferior decision-making 

processes and to refrain from taking appropriate risks. 159 

The compensation claim for supporting litigation to enforce an 

officer’s duty of care likewise seems weak. The losses to a particular 

company resulting from poor decision-making can be astonishingly 

large. Even if some officers, mainly CEOs, have amassed the fortunes 

many believe they possess, it is not clear that many officers could actually 

be expected to pay a significant portion of the judgment that 

would result from breach-of-care litigation. Note that the $20 million 

that the Van Gorkom plaintiffs recovered in 1985 would now be worth 

157. Indeed, author Malcolm Gladwell argues that in some instances decision-making unencumbered 

by elaborate processes may produce superior results. MALCOLM GLADWELL, BLINK: 

THE POWER OF THINKING WITHOUT THINKING (2005). A similar point has been made by Samuel 

Fraidin. Samuel N. Fraidin, Duty of Care Jurisprudence: Comparing Judicial Intuition and 

Social Psychology Research, 38 U.C. DAVIS L. REV. 1 (2004) (arguing that the duty of care 

jurisprudence as applied to directors “is incoherent, arbitrary, and inefficient” because it is not 

based on a robust theory of group decision-making). 

158. Unlike directors who act only at regular and special meetings, officers are called upon 

to make numerous types of decisions, including major decisions that result in recommendations 

to the boards, such as the hiring and discharging of employees, selection of teams to work on 

projects, and the determination of how closely to monitor an employee. Sometimes a decision 

that seems minor, such as which flights to take to a business meeting, will take on vital importance 

later. To suggest that all such decisions must be subjected to an exhaustive decision-making 

process, lest they be evaluated later by a jury functioning under the haze of the hindsight 

bias, seems quite undesirable. 

159. Hamermesh and Sparks make this point. See Reply to Professor Johnson, supra note 

145, at 875.



more than $35 million. 160 The aggregate compensation 161 for the 

heads of the top 500 largest U.S. corporations in 2004 was $3.3 billion, 

only an average of $6.6 million each. While $6.6 million may seem 

like a massive amount, only a portion of it would be available to pay 

off a liability judgment, as most of it would have been spent. Even if 

some officers are incredibly wealthy, much of their wealth is likely to 

be shielded from execution on any judgment. It is also unlikely that 

shareholders can expect to gain much more from the officers as a 

group. CEOs as a group appear to be the only officers to have cashed 

in on the princely compensation available to corporate leaders. 

Compare the situation that arises in a care case with that which 

occurs in a loyalty case. In the former, recovery has traditionally been 

unlikely. In the latter, recovery is far more common. In a loyalty 

case, the amount at stake is likely to be lower, and some rough convergence 

is likely between the amount lost by the company and the 

amount improperly gained by the officer, and that officer’s total 

worth. In short, the benefit of litigation is not the size of the judgment 

received but the amount of the judgment collected. In care cases 

brought against corporate officers, any amount collected is likely to be 

relatively small compared to the combined out-of-pocket and opportunity 

costs of pursuing such litigation. 

At the system level, the issue is whether the marginal gains—and 

it is important to recognize that shifting of dollars from one individual’s 

pocket to another’s is not a gain 162 —from improved managerial 

decisions exceed the costs of litigation. Is the marginal benefit of improved 

decision-making greater than the sum of the cost of increased 

caution in decision-making and the cost of the actual litigation necessary 

to make the threat of litigation credible? At best, a net gain 

seems an unlikely result. 

A second argument further undercuts the compensation rationale. 

Compensation is only relevant to the extent the shareholder suffers 

actual loss. What portion of the loss suffered by a corporation is 

really a loss to its shareholders? At first that question might seem 

odd. After all, if a corporate officer were to make a faulty decision 

that resulted in a corporate loss of $1 million, shareholder losses 

would seem to axiomatically total $1 million. That calculation, however, 

becomes less certain when one considers how shareholders invest 

their resources. The rational shareholder is likely to have 

160. This calculation is made using the 2004 Consumer Price Index. 

161. Special Report CEO Compensation, FORBES.COM, Apr. 23, 2004, http://www.forbes.com/ 

2004/04/21/04ceoland.html. Total compensation is defined “as salary and bonus; plus ‘other’ 

compensation, which includes vested restricted stock grants, and ‘stock gains,’ the value realized 

from exercising stock options during the just-concluded fiscal year.” Id. 

162. Indeed the litigation costs incurred in bringing about the shift are a deadweight loss!



diversified her portfolio of investments in order to “wash out” the 

non-systemic risks in her investment portfolio. 163 As a result, the 

losses in share value resulting from careless judgments in one company 

are offset to some degree by gains in the value of the securities 

of other companies in her portfolio that benefit from the negligence of 

the first company. Put differently, some of the loss she suffers from 

her “bet” on the negligently managed company is likely to be offset by 

her unexpected “winnings” from companies that experience abnormal 

gains as a result of the negligent decision of the first company. 

The situation is much like that discussed in the classic vineyard 

hypothetical used in many law school corporation courses. 164 There 

the students advise a hypothetical investor who is about to invest in 

the operation of one or more vineyards. The investor is faced with a 

number of possibilities that would affect the value of her investment 

in vineyards, including the possibility of a worldwide decline in demand 

for grapes and a change in consumer preferences for types of 

grapes. She can do little about these risks. 165 She also faces the possibility 

that the return on her investment could be affected by risks associated 

with a particular vineyard. Such risks include possible 

unfavorable local weather conditions, localized pests, and fire. In this 

category, one should include the residual levels of poor management 

of any particular vineyard that cannot be eliminated by efficient 

monitoring. 

What action would a rational investor take? She could invest all 

of her wealth in a single vineyard. She then could win big, but she 

could also lose big. Unless she is risk-neutral or risk-preferring, she is 

unlikely to take that gamble. Instead, by investing in vineyards in different 

locations, growing different types of grapes, managed by different 

individuals, she can essentially wash out the idiosyncratic risks 

associated with any single vineyard. Were she able to spread her investment 

about at no additional cost, i.e. if complete diversification 

were possible and costless, she would suffer no loss from any of the 

idiosyncratic risks associated with a particular vineyard and a particular 

management team. In that situation, the loss in production she 

suffered from any particular vineyard, whatever its cause, would be 

163. Richard A. Booth, Stockholders, Stakeholders, and Bagholders (or How Investor Diversification 

Affects Fiduciary Duty), 53 BUS. LAW. 429, 468 (1998). Some shareholders do not 

diversify their holdings. Should the law be structured to protect the diversified (savvy) shareholder 

or the undiversified shareholder? Booth quips that generally such shareholders might be 

deemed contributorily negligent. Id. 

164. This hypothetical can be found at JEFFREY D. BAUMAN, ELLIOT J. WEISS & ALAN R. 

PALMITER, CORPORATIONS LAW AND POLICY MATERIALS AND PROBLEMS 14 (5th ed. 2003). 

165. For now, I focus only on downside risks—that is, losses. Risk, of course, is not a negative 

factor. Upside risk—wins—are real as well. The value of vineyards, for example, would 

increase if scientists discovered a positive correlation between grape consumption and increased 

longevity.



offset by an increased production in another vineyard, perhaps because 

of superior management, or, assuming no change in demand 

curves, an increase in the price of grapes. Thus, even if mismanagement 

occurred at one of her vineyards, she would have no claim for, 

and presumably no need for, compensation. 166 Under these conditions, 

she would be unwilling to bear any of the deadweight costs associated 

with suing any of her managers for a breach of her duty of care. 

The same analysis applies whenever an individual elects to 

purchase corporate shares. Should she purchase only General Motors 

shares or the shares of a basket of automobile manufacturers? Should 

she invest only in the auto manufacturing sectors or should she spread 

her investment across other industries? The answer is evident; she 

should diversify. 

Diversification, however, is neither a costless nor a perfect solution. 

Even when feasible, diversification can offset losses only when 

the action of the officers results in a net positive return. If an officer’s 

act has a net negative return, diversification can only dilute the effect 

of the loss. 167 Some forms of mismanagement—such as failing to adequately 

protect corporate property from fire—have a net negative 

return. 

Moreover, not all investors will diversify their portfolios. In some 

instances they will fail to do so because diversification may not be 

possible. Consider, for example, the situation of an investor who finds 

her wealth locked in a minority interest in a closely held corporation 

168 or in some other illiquid investment. 169 In such a situation, she 

can do nothing to diversify her investment portfolio. In other instances, 

investors may not appreciate the importance of diversification 

or may attempt to diversify but will fail to do so. 

One might argue that, because not all shareholders can or do diversify, 

liability rules should be fashioned to protect these undiversified 

shareholders. It would be an error, however, to do so. Not only 

would such rules often compensate diversified shareholders for losses 

they did not actually incur, they would also force all diversified shareholders 

to bear the costs of protecting those shareholders who are unable 

to or choose not to diversify. 170 

166. For a similar analysis, see Booth, supra note 163, at 460-61. 

167. FRANKLIN A. GEVURTZ, CORPORATION LAW § 4.1(b), at 293 n.54 (2000). 

168. This fact explains the willingness courts have exhibited to police opportunistic behavior 

in closely held corporations. 

169. A classic instance of a non-diversifiable investment is one’s own body, a fact which may 

explain the courts’ traditional willingness to evaluate physician conduct even though medical 

care is as difficult for judges to comprehend as management decision-making. Peter V. Letsou, 

Implications of Shareholder Diversification on Corporate Law and Organization: The Case of the 

Business Judgment Rule, 77 CHI.-KENT L. REV. 179, 207-09 (2001). 

170. See Booth, supra note 163. But see Letsou, supra note 169, at 202 (noting that firms may 

still benefit from liability rules that deter negligent conduct in some instances).



The benefit of diversification, however, need not be complete dissipation 

of the loss for it to matter in determining whether to extend 

the protections of exculpatory provisions to corporate officers. It is 

sufficient to recognize that, except in unique circumstances, diversification 

may eliminate much of the loss a shareholder would otherwise 

experience as a result of a faulty decision by a corporate officer. In 

other circumstances, diversification may so dilute the costs of mismanagement 

to the point that costs of litigation are not worthwhile. 

When the benefits and costs of diversification and the benefits 

and costs of judicial oversight of managerial conduct are compared, it 

becomes clear that diversification weakens the argument for close judicial 

scrutiny of management for negligent mismanagement. The 

general lack of successful litigation against corporate officers and the 

near universal acceptance of the current “judicial hands-off” rules, including 

the business judgment rule, which courts apply to refrain from 

exercising active oversight of corporate officers for negligent conduct, 

would seem to support that conclusion. 171 That conclusion, however, 

is at best an informed guesstimate. Indeed, some shareholders might 

actually prefer close judicial oversight of managerial conduct even in 

duty-of-care cases. 172 

The existence of uncertainty about the efficacy of non-liability restraints 

on officer negligent conduct and the efficacy of diversification 

to offset investor losses caused by officer conduct is relevant in fashioning 

the terms of the exculpatory language. When costs and benefits 

are uncertain, it is desirable to permit affected individuals to 

fashion governance rules applicable to their situation. 

Therefore, although some jurisdictions, such as Louisiana, 173 

Virginia, 174 and Nevada, 175 have imposed a non-waivable cap on the 

liability of officers (and directors), it is more desirable to allow shareholders 

to decide whether to cap or eliminate officer liability. Legislatures 

that want to do so can easily achieve their goal. One approach, 

171. Contrary to my argument, Lyman P.Q. Johnson argues that officers are now subject to a 

standard of ordinary care. See Johnson, supra note 127, at 466. As explained in her article in this 

issue, Professor Cheryl Wade has a similar view of existing law. She admits, however, that the 

majority likely does not share her view. Cheryl Wade, What Independent Directors Should Expect 

from Inside Directors: Smith v. Van Gorkom as a Guide to Intra-firm Governance, 45 WASH- 

BURN L.J. 367, 381 (2006). If, however, Professors Johnson and Wade are correct in their 

position, the proposal I make to expand the applicability of the exculpatory provisions to include 

officers only becomes timelier. 

172. I do not address here the troubling issue of whether shareholders should be entitled to 

impose managerial supervision costs on the public. To the extent that the courts provide an ex 

post settling up mechanism for resolving intra-corporate disputes, the legal system effectively 

subsidizes the decision of individuals to do business as a corporation. Of course, all forms of 

judicial supervision have a similar effect. 

173. LA. REV. STAT. ANN. § 12:24(C)(4) (Supp. 2006). 

174. VA. CODE ANN. § 13.1-692.1 (Michie 1999). 

175. NEV. REV. STAT. § 78.037 (2003).



followed by Maryland, 176 New Hampshire, 177 and New Jersey, 178 is 

simply to modify their charter-option provision by inserting “or officer” 

into the coverage. In those states, the decision to shield officers 

is left to the shareholders in exactly the same manner as the decision 

to shield directors. 

Simple as that solution might be, it overlooks three important issues. 

The first is whether corporate directors should have any voice in 

the adoption of an officer-exculpation provision. Directors, especially 

outside directors, are compelled by necessity to rely on corporate officers 

for the information they need to perform their directorial 

duties. 179 Thus, it certainly is in the directors’ best interests to incentivize 

officers to act reasonably. Consequently, directors should have 

the power to veto any attempt to shield officers from personal liability 

for shoddy decision-making. 

The second issue is whether shareholders who also serve as officers 

should be able to vote in favor of shielding corporate officers 

from liability. This question is similar to that which arises under current 

exculpation statutes permitting shareholder-directors to vote in 

favor of having their corporation adopt a charter exculpatory provision. 

The conflicts of interest are obvious, though neither section 

102(b)(7) nor any of its progeny prevent interested shareholders/directors 

from voting in favor of proposals to cause their corporation to 

opt out of the director-liability regime. 

Finally, one might question whether shareholders should be permitted 

some escape route from an officer exculpatory provision if at a 

later date they come to believe that the exculpatory provision is systematically 

leading officers to fail to perform as diligently as shareholders 

might wish. 180 In theory, shareholders could call upon their 

board of directors to propose an amendment to the corporation’s articles 

to eliminate the liability protection. There are some concerns, 

however, that the board of directors might not be as responsive as it 

ought to be, either because the directors also serve as officers or because 

of the presence of a dominating corporate officer. 

The American Law Institute (ALI) recognized some of these issues 

when it proposed section 7.19 of the Principles of Corporate 

Governance. 181 Section 7.19, Limitation on Damages for Certain Violations 

of the Duty of Care, was unique in that it would permit share- 

176. MD. CODE ANN., CORPS. & ASS’NS § 2-104(b)(8) (LexisNexis 1999). 

177. N.H. REV. STAT. ANN. § 293-A:2.02(b)(4) (LexisNexis 1999). 

178. N.J. STAT. ANN. § 14A:2-7(3) (West 2003). 

179. Wade, supra note 171, at 382. 

180. The board of directors, or in some instances the shareholders, can always remove an 

individual officer for failure to meet performance expectations. 

181. AM. LAW INST., PRINCIPLES OF CORPORATE GOVERNANCE: ANALYSIS AND RECOMMEN- 

DATIONS § 7.19 (1994).



holders to cap officer liability for breaches of their duty of care to an 

amount not less than the officer’s annual salary. It conditioned the 

validity of a liability cap, however, on approval by a vote of disinterested 

shareholders after full disclosure. It also required that any officer-liability 

cap provision be subject to repeal by shareholders at any 

annual meeting without prior action by the board of directors. By 

disqualifying the votes of interested shareholder-officers, the ALI’s 

adoption procedures would allay some lingering fears that officers 

would use their power to compel shareholders to adopt an exculpatory 

provision without regard to the desirability of such a provision. 

To accommodate the concerns of shareholders, officers, and directors, 

legislators in states following the Delaware pattern could 

adopt the following provision: 

§ 102 Contents of certificate of incorporation. 

(b) In addition to the matters required to be set forth in the certificate 

of incorporation by subsection (a) of this section, the certificate 

of incorporation may also contain any or all of the following 

matters: 

. . . . 

(X) A provision eliminating or limiting the personal liability of 

an officer to the corporation or its stockholders for monetary damages 

for breach of fiduciary duty as an officer, provided that such 

provision shall not eliminate or limit the liability of an officer: (i) for 

any breach of the officer’s duty of loyalty to the corporation or its 

stockholders; (ii) for acts or omissions not in good faith or which 

involve intentional misconduct or a knowing violation of law; or (iii) 

for any transaction from which the officer derived an improper personal 

benefit. Such provision shall be valid only if adopted by a 

majority of the independent and disinterested directors and by a 

majority of the disinterested shareholders and only if the provision 

can be repealed by shareholders at an annual meeting without the 

action of the board of directors. No such provision shall eliminate 

or limit the liability of an officer for any act or omission occurring 

prior to the date when such provision becomes effective. All references 

in this paragraph to an officer shall also be deemed to refer to 

any person or persons who exercises or performs any of the powers 

or duties of a corporate officer regardless of title. 

Legislators in states following the Model Act pattern could adopt the 

following provision: 

(b) The articles of incorporation may set forth: 

. . . . 

(X) A provision eliminating or limiting the liability of an officer 

to the corporation or its shareholders for money damages for any 

action taken, or any failure to take any action, as a director, except 

liability for (A) the amount of a financial benefit received by a director 

to which he or she is not entitled; (B) an intentional infliction 

of harm on the corporation or the shareholders; (C) an intentional 

violation of criminal law; or (D) intentional failure to follow the 

instructions or policies of the board of directors. Such provision 

shall be valid only if adopted by a majority of the independent and



disinterested directors and by a majority of the disinterested shareholders 

and only if the provision can be repealed by shareholders at 

an annual meeting without the action of the board of directors. No 

such provision shall eliminate or limit the liability of an officer for 

any act or omission occurring prior to the date when such provision 

becomes effective. All references in this paragraph to an officer 

shall also be deemed to refer to any person or persons who exercises 

or performs any of the powers or duties of a corporate officer 

regardless of title. 

In building on the existing patterns of the director-focused exculpatory 

provisions, neither of the proposals would cure the interpretive 

problems inherent in the existing statutes. They, however, should not 

introduce any new problems either. 

The adoption of either of these proposed provisions would surely 

reignite the debate over the propriety of allowing corporations to 

shelter directors or officers from liability for breaches of their fiduciary 

duties. Ever since the passage of section 102(b)(7), commentators 

have objected to optional provisions such as those proposed above. 

They contend that, while these charter-option provisions appear to 

maximize shareholder power, they really only perpetuate the illusion 

of shareholder choice. These critics, building on the Berle-Means 

managerial control hypotheses, contend that corporate managers continue 

to control the shareholder proxy voting process and thus are 

able to cause the corporation to opt into the exculpatory provision. 182 

182. One could also argue that however desirable such a provision might be, it is unfair to 

give some shareholders the power to impose a no-liability regime on their fellow shareholders. 

That argument, however, is not persuasive. Certainly those shareholders who vote for the adoption 

of the provision have no unfairness claim. Likewise, shareholders who purchased their 

shares after the corporate code provided for the adoption of the exculpatory provision would 

seem to have no grounds to object. They should be deemed to have taken the risk that the 

majority of shares might determine it desirable to opt into the regime limiting monetary recourse 

against officers. 

Dissenting shareholders who purchased their shares before the legislature approved provisions 

allowing corporations to shield officers for liability for breaches of their duty of care would 

seem to have a better claim of unfairness. One could argue that they have no complaint, because 

in buying their shares, they implicitly consent to any lawful change to either the governing corporate 

statute or to the governance documents of their corporation, or to both. The price they 

paid presumably reflected the existing rights provided by the corporate code and by the corporate 

governance documents, as well as all permissible changes that might be made to those 

rights. In effect, one could maintain, they purchased shares with a wild card attached, which 

provided that “anything goes.” 

That argument, however, is overbroad. No pricing mechanism can take into account any 

and all possible changes in a contract. Indeed modern contract law permits parties to avoid 

performance of a contract that has failed in its fundamental purpose. Some changes are acceptable 

because they are not so radical as to rise to the level of “frustration.” In this argument, one 

may view the role of appraisal rights as allowing shareholders who find their corporate “contract” 

frustrated to opt out. 

Whether any particular change would be acceptable, and hence impounded in the shareholders’ 

purchase price, would depend on how foreseeable the change was at the time the shareholder 

purchased her shares. Foreseeability, in turn, would depend on how much the change 

departed from existing law and how unusual that change was in the corporate world. For example, 

one could argue that, in light of near universality of exculpatory provisions in the world of 

corporate governance, shareholders of a corporation incorporated in the District of Columbia, 

the only jurisdiction that does not permit or mandate the limitation of director liability for negli-



However salient that argument might have been at one time, the 

recent results of shareholder voting at annual meetings make clear 

that managers no longer have absolute control over the outcome of 

shareholder votes. Recent results in proxy voting demonstrate the 

power of shareholders, especially institutional shareholders, to override 

management’s desires on matters of corporate governance. During 

the 2004 proxy season, 144 shareholder proposals calling for 

corporate governance reforms received the affirmative vote of a majority 

of shares represented voting at the meeting; fifty received the 

vote of at least a majority of all outstanding shares. 183 These results 

make it difficult to argue that by enacting an optional exculpatory provision 

protecting officers from personal liability for a breach of their 

duty of care, a state would effectively impose a mandatory limitation 

on officer liability similar to the Virginia provision. 184 While one 

might expect managers to propose that the corporation opt out of personal 

liability for officers, shareholders simply will not rubber stamp 

those requests. If shareholders do approve such a proposal, their action 

should be seen as a rational response to the problems presented 

by making judicial oversight of officers’ actions available to any shareholder 

who believes officers have acted carelessly. 

gence, should be deemed to have consented, upon purchasing their shares, to a statutory and 

governance-document change limiting director liability. 

Viewing the proposal in that light, implying assent to the validity of the provision expanding 

the statutory exculpatory provisions to permit corporations to shelter corporate officers, as well 

as directors, seems reasonable. Given the remote possibility of holding officers liable for 

breaches of their duty of care under the current law, permitting a corporation to shield its officers 

from personal liability for such breaches would seem little more than a formality. One 

would expect such a change to have little effect on share price. 

183. GEORGESON SHAREHOLDER, ANNUAL CORPORATE GOVERNANCE REVIEW 2004 16-22, 

available at http://www.georgesonshareholder.com/pdf/2004_corpgov.pdf. 

184. Section 13.1-692.1, Virginia’s exculpatory provision, adopted in 1987, provides: 

A. In any proceeding brought by or in the right of a corporation or brought by or on 

behalf of shareholders of the corporation, the damages assessed against an officer or 

director arising out of a single transaction, occurrence or course of conduct shall not 

exceed the lesser of: 

1. The monetary amount, including the elimination of liability, specified in the articles 

of incorporation or, if approved by the shareholders, in the bylaws as a limitation on or 

elimination of the liability of the officer or director; or 

2. The greater of (i) $100,000 or (ii) the amount of cash compensation received by the 

officer or director from the corporation during the twelve months immediately preceding 

the act or omission for which liability was imposed. 

B. The liability of an officer or director shall not be limited as provided in this section if 

the officer or director engaged in willful misconduct or a knowing violation of the criminal 

law or of any federal or state securities law, including, without limitation, any claim 

of unlawful insider trading or manipulation of the market for any security. 

C. No limitation on or elimination of liability adopted pursuant to this section may be 

affected by any amendment of the articles of incorporation or bylaws with respect to 

any act or omission occurring before such amendment. 

VA. CODE ANN. § 13.1-692.1 (1999). For a full discussion of the Virginia provision, see 

Honabach, supra note 112, at 471-75.



VII. CONCLUSION 

The story of Van Gorkom is one replete with ironies. Roundly 

criticized as opening the floodgates for breach of the duty-of-care suits 

aimed at corporate directors, it actually provided much safety for directors 

by affirming the gross negligence standard and by establishing 

a relatively easily negotiated procedural safe harbor. Hailed by critics 

who had previously criticized courts for their traditional hands-off approach 

to allegations of managerial failure to exercise due care, Van 

Gorkom motivated state legislatures to adopt exculpatory provisions 

such as section 102(b)(7) that were intended to provide directors even 

more protection, though they actually provided precious little additional 

protection. Finally, by igniting a firestorm about the appropriateness 

of adopting such charter-option provisions, it provided critics 

of the Berle-Means model of the corporation fertile ground for cultivating 

the Contract Model of the corporation. 

In this article, I call for the creation of yet another irony. Even 

though the effect of section 102(b)(7) and its progeny was largely psychological, 

I argue for the expansion of the coverage of those exculpatory 

provisions to include corporate officers. At present, the status of 

the liability rules applicable to corporate officers is unclear. It may be 

that the courts will eventually decide to hold officers to a simple negligence 

standard of care and deny them the benefit of the business judgment 

rule. Were they to do so, the expansion of the exculpatory 

provisions would be desperately needed. On the other hand, the 

courts may eventually conclude that the appropriate liability standard 

is gross negligence and that the business judgment rule applies equally 

to officers. Were they to so decide, such expansion would prove to 

have been unnecessary, just as the adoption of the original round of 

exculpatory provisions was unnecessary. Even in that situation, corporate 

stakeholders would be compelled to endure uncertainty and 

confusion while the courts fashion clear rules. 

Therefore, I believe that state legislatures should enact legislation 

making the protection of their exculpatory provisions available to corporate 

officers. Otherwise, we will face multiple rounds of litigation 

seeking to impose liabilities on corporate officers for breaches of their 

duty of care. That litigation, however, will be a poor way to resolve 

the issue. It will produce uncertainty and anxiety, neither of which is 

desirable, especially in the marketplace. By enacting legislation expanding 

the coverage of the exculpatory provisions, legislators can 

halt that litigation at the outset and in so doing save corporations and 

their shareholders needless costs.

Smith v. Van Gorkom: Managerial Liability and Exculpatory Clauses ...

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