Financial Articulation of a Fiduciary Duty to Bondholders with ...

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CREIGHTON LAW REVIEW [Vol. 20 Such compensation to bondholders is the logical counterpart of our corporate law's policy of permissive managerial resistance to takeovers 176 because it offsets the loss of the unrestricted capital market takeover mechanisms which rectifies the policy manifestation of the anomaly in the rule of corporate current-market-Value maximization. 177 Furthermore, such compensation is consistent with a public policy of competitive business maneuver: 178 if the bondholders and the corporation were to continuously recontract, then the alternatives would be for the bondholders to receive such net compensation through bond pricing in the efficient capital market 179 or for bond protective contractual provisions which would "severely restrict the actions of the firm.' 8 0 The view that "[tjhe most obvious and important characteristic of long-term debt financing is that the holder ordinarily has not bargained for and does not expect any substantial gain in the value of the security to compensate for the risk of loss"'' 1 becomes irrelevant in this context because: (1) the components of bond pricing are functionally equivalent and impound the publicly known information regarding expected gain and risk cause management does so act or contract when the bondholders have more or less equal bargaining power with management. See Brody, supra note 39, at 19, col. 1; Farrell, supra note 45, at 114. 176. For a statement of the policy of permissive managerial resistance to takeovers, see Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 955 n.10 (Del. 1985); Moran v. Household Int'l, Inc., 500 A.2d 1346, 1350 (Del. 1985). See generally Veasey, Business Judgment Rule: The New Incarnation, Legal Times, March 10, 1986, at 25, col. 1. Debtor has instituted takeover defenses which restrict a possible takeover by the bondholders or others. See supra text accompanying notes 117-18. 177. See supra notes 21, 43-44 and accompanying text. 178. In general, for-profit corporations compete with other for-profit corporations for business. The public policy supporting such competition is manifested in the federal antitrust laws. 179. See supra notes 28, 43-44 and accompanying text. 180. Galai & Masulis, supra note 27, at 55 n.5. See Jensen & Meckling, supra note 20, at 338 (stating: "To completely protect the bondholders ... these [bond protective contractual] provisions would have to be incredibly detailed and cover most operating aspects of the enterprise including limitations on the riskiness of the projects undertaken."). Such restrictive contractual provisions are analogous to the imposition of common law or statutory law rules." "[A]lthough the legal rules can protect against fraud and particularly blatant forms of self-dealing by management, they cannot do much more without denying the company the benefits of management's expertise in making major corporate decisions." DeMott, supra note 138, at 1012 (summarizing the view of professional managerial prerogatives regarding mergers and tender offers stated in Lipton, Takeover Bids in the Target's Boardroom, 35 Bus. LAW. 101, 116-20 (1979)). "[T]he design of specific legal rules governing the terms of mergers ... affecting managerial interests appears very costly if not impossible. In such areas, regulation cannot feasibly go beyond very general rules, such as the requirement of 'fairness,' without creating severe obstacles to efficient managerial decision-making." Anderson, Conflicts of Interest: Ffficiency, Fairness and Corporate Structure, 25 UCLA L. REV. 738, 790 (1978) (discussing statutory rules). 181. AM. BAR FOUND., supra note 6, at 1.
1986] FIDUCIARY DUTY TO BONDHOLDERS through investor bargaining in the efficient capital market, 18 2 and (2) investors in all investment vehicles expect appropriate gains from 8 3 their investments- Should risk-neutral and risk-liking investors (such as Appraisal Creditors and Contractual Creditors), 1 8 4 with or without their possession of unique investment facts and beliefs, be penalized by permissive (judicially tolerated) wealth expropriations because of "the existence of diversification-not its employment"? 18 5 The question can be recast as follows: should investors' risk-neutral and risk-liking states of mind be penalized? (The penalization of states of mind is the domain of the theory of criminal law.) 18 6 To penalize such investors would be to punish mental nonconformity with procrustean idealized mathematical conditions regarding risk averseness and efficient market portfolios in an otherwise completely noncriminal context.187 Such penalization is perverse and unfair because these investors are the victims and not the perpetrators of such wealth expropriations.' 88 Risk diversification does not rationally "exist" for risk-neutral and risk-liking investors. Moreover, such penalization is contrary to a reasonable fiduciary "constraint that no investor be made worse off by the transaction.' 8 9 "The requirement that everyone receive at least the value of his investment under existing conditions serves much the same function as the rule against 182. See supra notes 28, 43-44, 59-60 and accompanying text. 183. Risk-averse investors seeks gains which are related to investment covariance risks, whereas risk-neutral investors seek the greatest expected gains and risk-liking investors seek the greatest possible gains. Risk-averse investors dominate the marketclearing prices for securities in the efficient capital market; bond economic gains and losses are determined from such market-clearing prices. 184. See supra text accompanying notes 121-22. 185. Easterbrook & Fischel, supra note 122, at 713. 186. American civil law is directed toward damages, whereas American criminal law is directed toward states of mind. In general, an objective truth finder regarding an individual's state of mind would obviate the requirement for an "act" or "harm" under the theory of our criminal laws - pure thought crimes would exist - because the "act" and "harm" are not relevant per se but only as indicators of the individual's forbidden state of mind. If the "act" were central to our criminal laws, then the "act" would be penalized without the requirement for a concurrent forbidden state of mind. If "harm" were central to our criminal laws, then "insanity" would not be a defense because it does not undo the "harm"; and the crimes of "attempt," "conspiracy," and "solicitation" would not exist because there is no "harm" per se in these crimes. For a definition of these quoted terms and for a discussion of criminal law theory, see J. HALL, LAW, SOCIAL SCIENCE AND CRIMINAL THEORY (1982), and J. HALL, GENERAL PRINCIPLES OF CRIMINAL LAW (2d ed. 1960). 187. See supra notes 54-58 and accompanying text. 188. There exists a corporate financing policy under which unanticipated wealth expropriations either do not occur or are neutralized. Galai & Masulis, supra note 27, at 66 & n.37, 68-69; K. Shastri, supra note 26, at 55-57. 189. Easterbrook & Fischel, supra note 122, at 715.
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