Stakeholder Provisions

Stakeholder Laws Defined

Stakeholder laws permit directors, when taking action, to weigh the interests of constituencies other than shareholders- including bondholders, employees, creditors, customers, suppliers, the surrounding community, and even society as a whole-in the process of corporate decision making. In other words, such laws allow directors to consider nearly any factor they deem relevant in discharging their duties.

Stakeholder statutes exist in some form in 31 states. Attorney James J. Hanks classifies them as follows:[1]

Prevalence and Types of Stakeholder Statutes

• Permissive statutes permit, but do not require, directors to consider the interests of groups other than shareholders. The following states, for instance, have permissive statutes: Florida, Georgia, Hawaii, Idaho, Illinois, Iowa, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Minnesota, Mississippi, Missouri, Nevada, New Jersey, New Mexico, New York, North Dakota, Ohio, Oregon, Rhode Island, South Dakota, Tennessee, Vermont, Wisconsin, and Wyoming.

• Mandatory statutes require that a director consider the interests of other constituencies. Connecticut and Arizona have a mandatory statutes.

• Statutes that explicitly provide that the claims of shareholders need not be held above those of other stakeholders. These statutes presume the validity of directors' determination grant validity to the consideration of non-stakeholder interests if approved by a majority of disinterested directors unless it is proven after reasonable investigation that the disinterested directors did not act in good faith. Indiana and Pennsylvania have this type of statute.

• Bondholder protection statutes require that bondholders approve a merger or acquisition, the replacement of more than 24 percent of directors, the sale or disposition of certain amounts of assets, or the acquisition of certain amounts of debt. Wyoming has such a statute.

Notably, Delaware has no stakeholder law. However, the broad authority extended to directors of Delaware companies to consider the best long-term interests of the company under the so-called "business judgment rule" is well documented in Delaware case law. Similarly, Arizona and Texas permits directors to consider "the long-term as well as the short-term interests of the corporation and its shareholders."[2]

Most stakeholder statutes implicitly tie consideration of other constituencies with the company's best interests. Hanks observes that "these statutes add little, if anything, to existing corporation law since directors are already entitled to take into account any factors they believe to be in the best interests of the corporation and its stockholders . . . . Thus, the real purpose of non-stockholder constituency statutes must be to enable directors to provide benefits to non-stockholder groups even when doing so would not benefit the stockholders."[3]

Since all of these statutes are a reaction to the takeover boom of the 1980s, when directors felt vulnerable to raiders, it is only natural that some statutes address this concern directly. Thirteen states-Idaho, Iowa, Kentucky, Minnesota, Mississippi, Nevada, New Mexico, North Dakota, Ohio, Oregon, South Dakota, Vermont, and Wyoming- permit a director to consider the fact that nonshareholder interests "may be best served by the continued independence of the corporation."[4]

Most statutes permit directors to consider the effects of an action on other constituencies. Permitting other interests to be considered allows a broader scope of possible action. Several states-Illinois, Maine, Nevada, and Wisconsin- permit officers as well as directors to consider other constituencies when discharging their duties.

Arguments In Favor of Stakeholder Statutes

Defenders of stakeholder statutes note that no statute encroaches on a director's duty to act in the best interest of the corporation. In Pennsylvania, for example, the stakeholder law is prefaced by language that dates back to 1933:

A director of a business corporation shall stand in a fiduciary relation to the corporation and shall perform his duties as a director . . . in good faith, in a manner he reasonably believes to be in the best interests of the corporation and with such care, including reasonable inquiry, skill and diligence, as a person of ordinary prudence would use in similar circumstances.[5]

While some states broaden the issue to mandate that directors act in the best interest of the company and shareholders, most have used language similar to Pennsylvania's, which covers only the best interests of the company.

Arguments Against Stakeholder Statutes

Critics of stakeholder laws note that such statutes may be viewed as giving directors an excuse for any action detrimental to shareholders. Because many stakeholder statutes may limit the ability of shareholders to sue, directors are relieved, at least in part, of the responsibility to always protect shareholder interests and may take certain actions without fear of legal reprisal. In some court cases, actions taken primarily to benefit other constituencies have been protected so long as these actions had "some rationally related benefit accruing to the stockholders."[6]

Critics also argue that stakeholder laws are unnecessary because outside constituencies are already able to obtain contractual obligations from companies. Shareholders, on the other hand, cannot protect their rights by contract; instead, they receive a fixed set of rights in return for their investment. Paramount among these is the right to demand that directors act in shareholders' best interests (that is, the directors owe a "fiduciary duty" to shareholders). While the common law lacks a concrete mechanism to enforce directors' obligation to the company, the directors' fiduciary duty to shareholders is clear and has been well-established through judicial precedent.

Perhaps the most incisive criticism of stakeholder statutes is that they provide directors with a handy rationalization for too broad a variety of actions and may, as in the case of the Pennsylvania and Indiana statutes, expressly relieve directors of their obligation to prefer shareholders over other constituencies. These provisions reduce management's accountability to shareholders. Typically, they are embodied in state codes under director duties or standards of conduct and therefore cannot be opted out of. However, where constituency provisions are part of a business combination or similar statute, shareholders should support proposals to opt out of them where possible.