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Markkula Center for Applied Ethics

The Intersection of Corporate Law and Ethics

Perspectives from the Delaware Court of Chancery

Margaret Steen

Although lawyers aren't primarily in the business of considering ethics, they are nonetheless guided by ethical principles, said The Honorable John W. Noble, a vice chancellor at the Delaware Court of Chancery since November 2000.

Noble was speaking to the Business and Organizational Ethics Partnership at Santa Clara University's Markkula Center for Applied Ethics. In a talk entitled, "Business Ethics and Delaware Corporate Law," he explored how laws, regulations, and ethical principles work together in corporate governance.

"The law is procedural in nature," Noble said, and unlike ethics does not necessarily address moral issues. Laws are often answers to particular problems: Sarbanes-Oxley, for example, can be seen as a response to Enron and other scandals. Because of this, laws often fall short in addressing unforeseen events.

Corporate governance is just one small area of the law. Some of its rules are motivated by ethical considerations; others are designed to efficiently allocate economic resources. Finally, some rules are designed to provide certainty to business professionals about the consequences of their acts.

Companies follow corporate governance rules that come from several places. A major source is Delaware law, since so many major corporations incorporate in Delaware. There are also numerous federal laws, many of which relate to the disclosure of accurate and timely information about a company's activities. In addition, corporate entities may create governance mechanisms to meet the requirements of their funders.

Delaware's rules, Noble said, are roughly divided between law and equity.

The Delaware General Corporation Law governs the mechanics of creating and running corporations, including how to create a corporate charter and bylaws, how common stock and preferred shares are created, and how different types of mergers work.

But these laws are really just a baseline for evaluating corporate behavior. Even if an action is legal, it may not be permissible if it is inequitable, Noble said.

A look at the concept of fiduciary duty shows how this can work. A fiduciary holds assets for one person for the benefit of another. "Trying to technically define fiduciary duties is not helpful," Noble said. "It turns out to be situational - each case is fact-based and stands alone."

In this area of the law dealing with what is equitable, corporations get general guidelines but not clear safe harbors. "You don't have certainty here, and judgment is required in formulating the appropriate strategy," Noble said.

What are these fiduciary duties?

Corporate directors have a duty of care, a standard that asks whether the directors have engaged in a reasonable process of decision-making and acted on that basis. The second fiduciary responsibility is the duty of loyalty, which asks whether directors have favored personal or other interests over the interests of the shareholders.

Delaware law offers companies certain safe harbors – they can use board meeting minutes to show that they followed a careful process in making a decision, for example. But following these procedures isn't enough by itself to avoid regulatory scrutiny. "Where such acts are simply a façade, then a Delaware court may find a breach of the duty," Noble said.

Delaware law doesn't exist in isolation. In response to a question about globalization, Noble said, "We get a lot of new entities and they have all kinds of interesting problems. Sometimes I think they don't understand the rules; sometimes they come into the U.S. to set up an entity and hope to raise money and take it back where they came from."

The court is seeing more cases involving companies based overseas partly "because of globalization and the desire of businesses located elsewhere to tap into American capital," Noble said.

Margaret Steen is a freelance author.

Nov 9, 2013