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CORPORATE GOVERNANCE AND THE
SHAREHOLDERS' DERIVATIVE ACTION:
RULES AND REMEDIES FOR IMPLEMENTING
THE MONITORING MODEL
This Note will be limited to a discussion of the rules and remedies designed to improve
corporate governance of publicly held corporations. A corporation is publicly held if its securities
are traded on an exchange or are quoted over the counter. See generally W. CARY & M.
EISENBERG, CASES AND MATERIALS ON CORPORATIONS 15-18 (5th ed. 1980) (listing the major
economic and legal characteristics of a publicly held corportion). Corporate governance of
closely held corporations poses different questions which are beyond the scope of this Note. See
generally Hetherington, The Minority's Duty of Loyalty in Close Corporations, 1972 DUKE L.J.
921 (examination of special fiduciary responsibilities in the setting of the closely held corpora-
tion); Hetherington, Special Characteristics, Problems, and Needs of the Close Corporation,
1969 U. ILL. L.F. 1 (detailed analysis of the problems facing a closed corporation and the needs
for appropriate legislative reform); Hornstein, A Remedy for CorporateAbuse-JudicialPower
to Wind Up a Corporationat the Suit of a Minority Shareholder,40 COLUM. L. REV. 220 (1940)
(comment upon the need and availability of dissolution to remedy wrongdoing in the closely held
corporation); O'Neal, Close CorporationLegislation: A Survey and an Evaluation, 1972 DUKE
L.J. 867 (outline of the inadequacies in legislation which fails to address the specialized concerns
of the closely held corporation); O'Neal, Oppugnancy and Oppression in Close Corporations:
Remedies in America and in Britain, 1 B.C. INDUS. & COM. L. REV. 1 (1959) (discussion of the
heavy impact of dissension in a closely held corporation and the remedies available to sharehold-
ers in that type of business organization). The courts have dealt differently with closely held
corporations than they have with publicly held corporations, especially with regard to the
shareholders' derivative action and the award of remedies. See Bradley, A Comparative Evalua-
tion of the Delaware and Maryland Close Corporation Statutes, 1968 DuE L.J. 525, 543-52
(dissolution by judicial decree initiated by shareholders of closely held corporations compared
with statutes authorizing dissolution by shareholder vote); see also DEL. CODE ANN. tit. 8,
341-356 (1974 & Supp. 1980) (special rules regulating the statutory closed corporation); Commit-
tee on Corporate Laws, Proposed Statutory Close CorporationSupplement to the Model Business
CorporationAct, 37 Bus. LAW. 269 (1981) (proposal for same).
2 A. BERLE & G. MEANS, THE MODERN CORPORATION AND PRIVATE PROPERTY (1933).
3 "Control" of the corporate enterprise was defined as possession of the power to select the
board of directors or dictate to management. Id. at 69-70.
1 Berle and Means found that in 65 of the 200 largest nonfinancial corporations in 1929, no
one shareholder or compact group owned as much as 5% of the company's stock and that in 16
more cases the largest block of shares was in the 5% to 20% range. More specifically, their
survey indicated that 65% of these 200 corporations were controlled by management or legal
device, 23% by minority blocks of shares (defined as about 20% of all shares) and in only 12%
was corporate control in the hands of a majority of shareholders, private owners, or a receiver.
Id. at 94-118.
628 CARDOZO LAW REVIEW [Vol. 3:627
The separation of ownership from control of the corporation noted by Berle and Means still
exists 40 to 50 years later. See Larner, Ownership & Control in the 200 Largest Nonfinancial
Corporations, 1929 and 1963, 56 AM. ECON. REV. 777, 783 (1966) (160 cases in which the
corporation was controlled by management); see also W. CARY & M. EISENBERG, supra note 1, at
212 ("Further dispersion . . . has undoubtedly taken place since 1963."); Jones, Corporate
Governance: Who Controls the Large Corporation?,30 HASTINGS L.J. 1261 (1979) (statistics
show that, expect in rare cases, management is firmly in control of the corporate enterprise).
Even in the quasi-publicly traded corporation, i.e., corporations with between 11 and 499
shareholders, the "public shareholders ... are not involved in active management." Knauss,
CorporateGovernance-A Moving Target, 79 MICH. L. REv. 478, 481 (1981). See generally M.
EISENBERG, THE STRUCTURE OF THE CORPORATION: A LEGAL ANALYSIS 38-56 (1976) (survey of the
statistics relevant to concentration of shareholdings in relation to the expectations of shareholder
participation in corporate affairs).
Cary and Eisenberg, however, warn that although this type of data "is impressive and
important," W. CARY & M. EISENBERG, supra note 1, at 211, control of the corporation by
management should be distinguished from shareholder participation in certain corporate activi-
ties. Id. at 211-12. See infra note 38 and accompanying text. In any event, there is a virtual
consensus that shareholder democracy is a myth. See infra note 40 and accompanying text.
5 See, e.g., DEL. CODE ANN. tit. 8, 141(a) (Supp. 1980) ("The business and affairs of every
corporation organized under this chapter shall be managed by or under the direction of a board
of directors .... ); N.Y. Bus. CORP. LAW 701 (McKinney Supp. 1981-1982) ("Subject to any
provision in the certificate of incorporation . . . the business of a corporation shall be managed
under the direction of its board of directors .... ); OHIO REV. CODE ANN. 1701.59 (Page
Supp. 1981) ("[E]xcept where the law, the articles, or the regulations require action to be
authorized or taken by shareholders, all of the authority of a corporation shall be exercised by or
under the direction of its directors."); MODEL BUSINESS CORP. ACT ANN. 35, para. 1 (2d ed.
Supp. 1977) ("All corporate powers shall be exercised by or under authority of, and the business
and affairs of a corporation shall be managed under the direction of, a board of directors except
as may be otherwise provided in this Act or the articles of incorporation."). For the significance
of the words "under the direction of" in many corporation codes, see infra note 18.
6. See, e.g., DEL. CODE ANN. tit. 8, 211(b) (1974) ("An annual meeting of stockholders
shall be held for the election of directors .... "). See also Dubin v. Muchnick, 108 Misc. 2d
1042, 1046, 438 N.Y.S.2d 920, 923 (Sup. Ct. 1981) (a shareholder agreement guaranteeing a
minority shareholder's continued tenure as director will not protect against his discharge for
cause. Such an agreement "is illegal as against public policy . . . [and] must be construed as an
obligation to retain him only so long as he keeps the agreement on his part faithfully to act as a
trustee for the shockholders.") (quoting Fells v. Katz, 256 N.Y. 67, 72, 175 N.E. 516, 517
(1931)); State ex rel. Ross v. Anderson, 31 Ind. App. 34, 67 N.E. 207 (1903) (charter provision
for permanent directors is invalid).
I Commentators have long asserted that the officers exert more power over corporate affairs
than the directors. See, e.g., Dwight, Liability of CorporateDirectors, 17 YALE L.J. 33 (1907)
(identifying nonworking directors as a factor resulting in management domination of corpora-
1982] MONITORING MODEL 629
words, this analysis suggests that not only are shareholders effectively
denied their franchise, as Berle and Means concluded, but directors
also lack a participatory role in governing corporate affairs. In place
of the legal model, a working model" which vests the management
function in the corporate executives rather than the board of directors
was suggested." The working model of corporate governance has
achieved universal theoretical acceptance.10 A variety of suggestions
have been advanced in an attempt to restructure or regulate the
corporation in order to avoid the perceived inadequacies of the legal
2
model. I These suggestions include: politicization of the corporation,
tions). Not until recent years, however, has sophisticated methodological research been brought
to bear on the question. See, e.g., J. BAKER, DIREcroas AND THEIR FUNCTiONs-A PRELIMINARY
STUDY (1945). For more detailed and updated findings of the composition and nature of the
modern directorship, see infra notes 55-61 and accompanying text.
8 W. CARY & M. EISENBERG, supra note 1, at 215, defines the working model of corporate
governance as "the model which embodies actual corporate practice [in which] most of the
powers supposedly vested in the board are actually vested in the executives."
9 This, of course, is an oversimplification of the actual organizational structure of most
publicly held corporations since the executives must delegate a significant amount of managerial
responsibility to subordinates. For sources detailing the organization and behavior of corporate
management, see studies cited in Coffee, Beyond the Shut-Eyed Sentry: Toward a Theoretical
View of CorporateMisconduct and an Effective Legal Response, 63 VA. L. REV. 1099, 1101 n.1
(1977). Compare 0. WILLIAMSON, CORPORATE CONTROL AND BUSINESS BEHAVIOR 46-47 (1970)
(because of the increasing complexity of the business enterprise, the burden of operational
decisionmaking has been reallocated from senior to middle-level management by decentraliza-
tion) with J. K. GALBRAITH, THE NEW INDUSTRIAL STATE (1967) (decisionmaking is exercised by
those people who comprise the corporate technocracy and who have access to information
regardless of their corporate titles). .
'0 W. CARY & M. EISENBERC, supra note 1, at 215 ("[A]ll serious students of corporate affairs
recognize that . . . in the typical large publicly held corporation the board does not 'manage' the
corporation's business in the ordinary meaning of that term."). The failure of the legal model
underlies all the major commentaries dealing with corporate governance. See, e.g., J. BACON,
CORPORATE DIRECTORSHIP PRACTICES: MEMBERSHIP AND COMMITTEFS OF THE BOARD (1973); M.
EISENBERG, supra note 4, at 156-70 (1976); H. KOONTZ, THE BOARD OF DIRECTORS AND EFFECTIVE
MANAGEMENT (1967); M. MACE, DIRECTORS: MYTH AND REALITY (1971); C. STONE, WHERE THE
LAW ENDS: THE SOCIAL CONTROL OF CORPORATE BEHAVIOR (1975); Dent, The Revolution in
CorporateGovernance, the Monitoring Board, and the Director'sDuty of Care, 61 B.U.L. REv.
623 (1981).
II Most of the suggested measures for remedying the malady of the legal model urge strength-
ening the board of directors and making it more independent from management. Mr. Harold
Williams, former chairman of the Securities and Exchange Commission, accurately summarized
the present discontent with the legal model when he observed that" '[t]he board, in effect, often
insulates management, rather than holding it accountable.' " Hubbard, Company
Boards Don't Need Uncle Sam, N.Y. Times, June 24, 1979, at F14, col. 3. In addition, Mr.
Williams
emphasized the need for corporations to restore public trust in their activities by
making changes in the way they are governed.
.. . Boards should redefine their own responsibilities, and take measures to
accommodate the changed role of the board of directors and the altered environment
in which corporations function ....
CARDOZO LAW REVIEW [Vol. 3:627
"The core question," he added, "is whether we can improve the existing process
and make it work better, or whether we should take steps to modify or replace it."
Id.
*2 See, e.g., C. STONE, supra note 10, at 152-83 (urging the use of public directors appointed
by and responsible to the public).
13 See, e.g., R. NADER, M. GREEN & J. SELIGMAN, TAMING THE GIANT CORPORATION (1976)
(presenting the case for federal chartering of American corporations); Cary, Federalism and
Corporate Law: Reflections Upon Delaware, 83 YALE L.J. 663 (1974) (federal minimum stand-
ards); Henning, Federal Corporate Chartering for Big Business: An Idea Whose Time Has
Come?, 21 DEPAUL L. REv. 915 (1972) (federal chartering).
Statutory proposals for the federal incorporation of the American corporation have met
with little success. See Cary, supra, at 700 (The case for federal incorporation is "politically
unrealistic. It has been raised many times in Congress and in the literature but has no public
appeal. American business would unanimously reject such a convenient vehicle for government
control of the major industries of this country."); Dent, supra note 10, at 638-44. For a criticism
of the federal minimum standards proposal, see Winter, State Law, ShareholderProtection, and
the Theory of the Corporation, 6 J. LEGAL STUD. 251 (1977). It is becoming clear that the
political climate in America is no more receptive to this proposal than to the federal chartering
suggestion. Professor Stone's remark that "legislatures are not inclined to come down hard on
their corporate constituents," C. STONE, supra note 10, at 50, applies equally to the United States
Congress.
" See, e.g., Douglas, Directors Who Do Not Direct, 47 HARv. L. REV. 1305, 1330 (1934)
(proposing organization of corporation to give "scattered and disorganized investors group
strength and power so that they can gain admittance to the councils of business and make their
influence felt around the negotiation table or in the courts."); Eisenberg, Access to the Corporate
Proxy Machinery, 83 HARV. L. REv. 1489 (1970); Note, A Proposalfor the Designation of
ShareholderNominees for Director in the CorporateProxy Statement, 74 COLUM. L. REV. 1139
(1974).
Some of these proposals are influenced more by the authors' prejudices than by a careful
understanding of corporate organization and its influence on corporate behavior. For example,
although in principle the Nader proposal has appeal, R. NADER, M. GREEN & J. SELIGMAN, supra
note 13, it is questionable whether the public interest director could really be expected to exert
much influence within the corporate organization which is, in fact, structured in ways that
seriously limit such a director's potential effectiveness. See infra notes 66-77 and accompanying
text. Unlike the proposals listed above, the monitoring model is an attempt to define the duties of
the board with a realistic view of corporate organization and management. The model is
intended to restructure the board's oversight responsibilities in order to overcome organizational
obstacles that impede effective board participation in the corporation.
15 See C. BROWN, PUTTING THE CORPORATE BOARD TO WORK 4-11, 27-29 (1976); M. EISEN-
BERG, supra note 4, at 164-77, 198-211; Coffee, supra note 9, at 1147-56; Leech & Mundheim,
The Outside Director of the Publicly Held Corporation, 31 Bus. LAW. 1799, 1804-06 (1976);
Soderquist, Toward a More Effective CorporateBoard: Reexamining Roles of Outside Directors,
52 N.Y.U. L. REV. 1341, 1358-63 (1977).
16 See J. BAKER, supra note 7, at 12; M. EISENBERG, supra note 4, at 139-48; R. GORDON,
BUSINESS LEADERSHIP IN THE LARGE CORPORATION 116-46 (2d ed. 1961); Coffee, supra note 9, at
1136 ("Boards do not set policy, do not veto management, seldom intervene short of a major
crisis, and do not even select their own successors or the next chief executive officer."); Dent,
supra note 10, at 625-29.
1982] MONITORING MODEL 631
tion, reviewing transactions between the corporation and insiders, overseeing management's
compliance with the law, selecting accounting procedures, and possibly reviewing long range
goals and major projects. See Dent, supra note 10, at 630-31. In performing the monitoring duty,
the board would also rely more heavily on independent outside directors, id. at 632 & n.48, and
oversight committees which would include some members of the board, id. at 633 & nn.50-55.
See infra notes 63, 188, 190-94 and accompanying text. These board functions are certainly
within the board's statutory grasp. See, e.g., DEL. CODE ANN. tit. 8, 141(c) (1974) (board
designation of committees); id. 142(b) ("Officers shall be chosen . . . and shall hold their
offices for such terms as are prescribed by the bylaws or determined by the board of directors or
other governing body. Each officer shall hold his office until his successor is elected and qualified
or until his earlier resignation or removal.").
20Dent, supra note 10, at 626 ("The directors' failure to manage springs not from personal
negligence but from a basic structural defect in the traditional model of corporate govern-
ance .... ).
21 See supra notes 10-11.
632 CARDOZO LAW REVIEW [Vol. 3:627
tional forces have overtaken the corporation: the chief executive offi-
cer often controls the board, 22 operation dominates policy,2 3 and in-
formation blockage is the rule rather than the exception.2 4 Finally,
various constraints of time, composition, selection, and tenure further
restrict the board's ability to manage the publicly held corporation. 25
Although these factors prevent the board from effectively managing
the day-to-day operations of the corporation, they do not prevent
effective monitoring of the executives. The board's ability to monitor,
however, is contingent on its ability to overcome these obstacles. The
board must be able to implement policy despite bureaucratic inertia,
and information must pass through the corporate hierarchy to the
board undistorted by employee self-interest. Only if this occurs will
the monitoring model achieve its ultimate purpose; namely, to "pro-
vide some meaningful check on self-serving behavior, incompetence,
or complacency on the part of management ..... 26
impetus for the implementation of the monitoring model: (1) the market forces which may
punish corporations that fail to implement the monitoring model will, in the final analysis, exact
punishment not on management but on the shareholders; (2) market forces operating through
outside directors are not likely to be sufficient; and (3) the market for corporate control is not so
efficient that a takeover will immediately, or ever, punish even the slightest deviation from
maximum efficiency. Dent, supra note 10, at 634-38; see also C. STONE, supra note 10, at 36-39,
88-92 (author rejects the "pocketbook" strategy of corporate control, i.e., reforming behavior by
enforcing or increasing monetary penalties for violations of the law, and recognizes the inability
of shareholders and consumers to pressure for corporate reform through the marketplace);
Brudney, The Independent Director-Heavenly City or Potemkin Village?, 95 HARv. L. REV.
597, 658 (1982) ("There is little doubt that the market is inadequate to foster responsible
corporate behavior in many areas.").
28 Shareholders are largely inactive, voice their disapproval by selling their shares, or have
selected stock investments precisely so that they do not need to be involved in monitoring
corporate activity. See infra note 40 and accompanying text.
2 For recent recommendations of proposed legal reforms, see Block & Prussin, The
Business Judgment Rule and Shareholder Derivative Actions: Viva Zapata?, 37 Bus. LAW. 27,
70-75 (1981); Coffee & Schwartz, The Survival of the Derivative Suit: An Evaluation and a
Proposalfor Legislative Reform, 81 COLUM. L. REV. 261, 330-36 (1981); Note, A Procedural
Treatment of Derivative Suit Dismissals by Minority Directors, 69 CALIF. L. REV. 885 (1981).
The prospects for more extensive reform are not encouraging. See Dent, supra note 10, at 641-44.
1982] MONITORING MODEL 633
30 See, e.g., 17 C.F.R. 240.14(a)-101, Item 6(d) (1981) (proxy statements must include a
description of the functions of an audit committee). An SEC proposal which would have
required companies under the jurisdiction of the Commission to maintain auditing committees
was not adopted. See id. The New York Stock Exchange now requires corporations to maintain
an audit committee as a condition to listing on the Exchange. 2 N.Y.S.E. GUIDE (CCH) 2495H
(March 9, 1977).
In addition, the SEC has creatively used consent decrees to impose corporate governance
reforms on mismanaged companies. See Mathews, Recent Trends in SEC Requested Ancillary
Relief in SEC Level Injunctive Actions, 31 Bus. LAW. 1323, 1331-52 (1976) (providing extensive
catalogue of cases involving ancillary decrees). In some instances, corporations consented to the
reform measures in an attempt to avoid jeopardizing the corporation's line of credit and wasting
time and resources during litigation. See id. at 1324; Mathews, Effective Defense of SEC Investi-
gations: Laying the Foundationfor Successful Disposition of Subsequent Civil, Administrative
and Criminal Proceedings, 24 EMORY L.J. 567, 570-72 (1975) (possible consequences of an SEC
investigation). For criticisms of the Commission's jurisdiction to use disclosure as a means de-
signed less to protect investors than to achieve substantive reform of corporate conduct, see
Freeman, The Legality of the SEC's Management Fraud Program, 31 Bus. LAW. 1295, 1295
(1976) (SEC's management fraud program has "gone beyond what is granted to [the Commis-
sion] by law.") and Malley, Far-Reaching EquitableRemedies Under the Securities Acts and the
Growth of Federal CorporateLaw, 17 WM. & MARY L. REV. (1975) (federal corporation law
inappropriately preempts state corporation law and should not be expanded absent congressional
consideration and consent thereto).
31 See Cort v. Ash, 422 U.S. 66, 84 (1975) ("Corporations are creatures of state law, and
investors commit their funds to corporate directors on the understanding that, except where
federal law expressly requires certain responsibilities of directors with respect to stockholders,
state law will govern the internal affairs of the corporation.").
Federal corporation law refers to that body of law arising from the Security and Exchange
Acts of 1933 and 1934, especially the demands by the Commission for ancillary relief. See
generally Farrand, Ancillary Remedies In SEC Civil Enforcement Suits, 89 HMAv. L. REV. 1779
(1976) (illustration of how ancillary remedies further the purposes and goals of the Securities
Acts); Fleischer, "Federal Corporation Law": An Assessment, 78 HAv. L. REV. 1146 (1965)
(description of the expanding impact of federal regulation on corporate law); Comment, Court-
Appointed Directors: Ancillary Relief in Federal Securities Law Enforcement Actions, 64 GEo.
L.J. 737 (1976) (ancillary relief is an essential supplement to statutory remedies as a means of
enforcing the federal securities law). The six primary statutes governing SEC operations each
contain a provision preserving the jurisdiction of state securities commissions. See id. at 748
nn.57 & 59.
32 See Report by the Committee on Corporate Laws, The Overview Committees of the
Board of Directors, 34 Bus. LAW. 1837 (1979) [hereinafter cited as Report]. See also infra text
accompanying note 202 (American Law Institute proposal urging adoption of the monitoring
model).
33 [M]any commentators challenged the proposition chat the Lproposed] "customary"
committee functions are accepted and stated that a definition of functions customar-
CARDOZO LAW REVIEW [Vol. 3:627
ily performed . . . would not allow for needed flexibility. Similarly, some were
concerned that a "laundry list" approach would set a ceiling or lowest common
denominator and discourage committees from performing different functions, thus
tending to deter the evolution of committee functions and limit experimentation.
16 SEC Docket 348, 356-57 (Dec. 6, 1978). Rather than attempt to define the committees'
functions, the SEC has left the matter to the "evolving nature of corporate committee systems
and the varying characteristics and needs of different issuers ..... Id. at 357. See Greene &
Falk, The Audit Committee-A Measured Contribution to Corporate Governance: A Realistic
Appraisalof Its Objectives and Functions, 34 Bus. LAW. 1229, 1235-46 (1979).
3' See infra notes 38-49 and accompanying text.
3' See infra notes 50-77 and accompanying text.
31 See infra notes 78-123 and accompanying text.
37 See infra notes 124-201 and accompanying text.
3' Compare Cary, supra note 13 (spirited attack upon the growing trend toward corporate
permissiveness among the states and appeal for increased regulation of corporate activity) and
1982] MONITORING MODEL 635
Latty, Why Are Business CorporationLaws Largely "Enabling?', 50 CORNELL L.Q. 599 (1965)
(same) with Arsht, Reply to Professor Cary, 31 Bus. LAW. 1113 (1976) (passionate defense of
government noninterference) and Winter, supra note 13 (same).
Noninterference by the state is widely believed to have led to the growth of corporations in
America. See Handlin & Handlin, Origins of the American Business Corporation, in PUBLIC
POLICY AND THE MODERN CORPORATION 3, 19 (D. Grunewald & H. Bass ed. 1966). But see id. at
24 (proliferation of corporations properly attributed to American democratic ideals). Ironically,
notions of a free democratic society have also been used to justify additional government
regulation of the publicly held corporation. See E. KEFAUVER, IN A FEW HANDS: MONOPOLY
POWER IN AMERICA 238-39 (1965).
In any event, the power of the board is limited to a small degree by the requirement of
many corporation codes that certain corporate transactions require shareholder approval. See,
e.g., DEL. CODE ANN. tit. 8, 109 (1974 & Supp. 1980) (amendment of by-laws, unless charter
provides otherwise); id. 251(c) (Supp. 1980) (merger proposals); id. 275 (1974) (voluntary
dissolution).
" See supra note 6 and accompanying text.
40 See A. CONARD, CORPORATIONS IN PERSPECTIVE 203-204, at 337-40 (1976) ("[S]harehold-
ers are impotent, partly because of the difficulty of organizing so many fellow investors, and
partly because of the ease of selling out instead of struggling .... Id. at 337-38. "Practically,
the shareholders are nonparticipants in the governance of the polymyriad corporations." Id. at
340); Manning, Book Review, 67 YALE L.J. 1477, 1488 (1958) (reviewing J. LIVINGSTON, THE
AMERICAN STOCKHOLDER (1958) ("The modern proxy contest has become a grotesque travesty of
an orderly machinery for corporate decision-making."). See generally Hessen, A New Concept of
Corporations: A Contractualand Private Property Model, 30 HASTINGS L.J. 1327 (1979) (al-
though shareholders do not participate in corporate affairs to any significant degree, nonpartici-
pation parallels shareholder expectations); Moore, Corporate Officer and Director Liability: Is
CorporateBehavior Beyond the Control of Our Legal System?, 10 CAP. U.L. REv. 69, 79 n.51
(1980) (Inactivity is "a deliberate decision for most shareholders. They are attracted to corporate
shares precisely because they will not be required to participate in managerial decision mak-
ing.").
Professor Stone has argued that the stock of the American corporation is divided among so
many people that shareholders are incapable of concerted action to oust management even when
clear wrongdoing has taken place. C. STONE, supra note 10, at 47-48.
In the majority of cases, the only protection afforded dissatisfied shareholders is the so-
called "Wall Street Rule"; namely, if dissatisfied with management, sell. Cf. Mutual Funds as
Investors of Large Pools of Money, 115 U. PA. L. REv. 669 (1967) (roundtable discussion of the
sale of large investments). But cf. W. CARY & M. EISENBERG, supra note 1, at 213 (remedy not
always available "since holdings may be so large that [shareholders] are locked in").
41 The shareholders' derivative action is a suit brought by the shareholder on behalf of the
corporation. H. HENN, HANDBOOK OF THE LAW OF CORPORATIONS AND OTHER BUSINESS ENTER-
PRIsEs 360 (2d ed. 1970). Since the suit is brought for the benefit of the corporation, recovery, if
any, belongs to the corporation. Mount v. Radford Trust Co., 93 Va. 427, 25 S.E. 244
(1896). Inasmuch as the primary right to seek redress belongs to the corporation itself, the
shareholder is made the nominal plaintiff and the corporation is the real party in interest. Ward
v. Atlas Constr. Co., 276 S.C. 346, 347, 278 S.E.2d 621, 622 (1981). The corporation is therefore
usually considered an indispensible party to the action. Broski v. Jones, 614 S.W.2d 300, 330
(Mo. Ct. App. 1981).
636 CARDOZO LAW REVIEW [Vol. 3:627
procedure the law has yet developed to police the internal affairs of corporations"); see Surowitz
v. Hilton Hotels Corp., 383 U.S. 363, 371 (1966); Cohen v. Beneficial Indus. Loan Corp., 337
U.S. 541, 548 (1949) (derivative action is "the chief regulator of corporate management"); 13 W.
FLETCHER, CYCLOPEDIA OF THE LAW OF PRIVATE CORPORATIONS 5941.1, at 362 (rev. perm. ed.
1980) ("Stockholders' suits are especially important as a remedy for minority stockholders to call
directors and controlling stockholders to account for mismanagement and fraudulent manipula-
tion."); Dykstra, The Revival of the Derivative Suit, 116 U. PA. L. REV. 74, 75 (1967) (derivative
actions "serve a basic and increasing need in the contemporary economy"). See also Friedman,
The Public Interest Derivative Suit: A ProposalforEnforcing CorporateResponsibility, 24 CASE
W. RES. L. REV. 294 (1973) (author suggests that a public interest derivative suit is essential to
the proper enforcement of corporation laws).
1982] MONITORING MODEL
The derivative action is now recognized in almost every jurisdiction. See Aiuz. REV. STAT.
ANN. 10-049 (1976); ARK. STAT. ANN. 64-223 to -224 (1980); CAL. CORP. CODE 800 (West
1977); CoLo. REv. STAT. 7-4-121 (1973 & Supp. 1981); DEL. CODE ANN. tit. 8, 327 (1974);
FLA. STAT. ANN. 607.147 (West 1977 & Supp. 1982); GA. CODE ANN. 22-614 to -615 (1977
& Supp. 1982); ILL. REV. STAT: ch. 32, 157.45a (Supp. 1982-1983); IowA CODE ANN.
496A.43 (1962); Ky. REv. STAT. ANN. 271A.245 (Bobbs-Merrill 1981); ME. REV. STAT.
ANN. tit. 13-A, 627 (1964); MAss. ANN. LAWS ch. 156B, 46 (Michie/Law. Co-
op. 1979); MICH. COMP. LAWS ANN. 450.1491-1493 (1973); Miss. CODE ANN. 79-3-93
(1972); MONT. CODE ANN. 35-1-514 (1981); NEB. REV. STAT. 21-2047 (1977); N.J. STAT. ANN.
14A:3-6 (West 1969 & Supp. 1982-1983); N.Y. Bus. CORP. LAW 626 (McKinney 1963); N.C.
GEN. STAT. 55-55 (1975); N.D. CENT. CODE 10-19-48 (1976); OKLA. STAT. tit. 18, 1.28(b)
(1951); PA. STAT. ANN. tit. 15, 1516 (Purdon 1967 & Supp. 1982-1983); R.I. GEN. LAWS 7-
1.1-43.1 (1969); TENN. CODE ANN. 48-718 (1979); TEX. Bus. CorP. ACT art. 5.14 (Vernon
1980); WASH. REv. CODE ANN. 23A.08.460 (1969); W. VA. CODE 31-1-103 (1982); Wis.
STAT. ANN. 180.405 (West 1957).
Many states which do not have statutory provisions for the derivative action provide for it in
their rules of civil procedure. See, e.g., S.D. COMP. LAWS ANN. 15-6-23.1 (Supp. 1982); see
also FErn. R. Civ. P. 23.1 (derivative actions and accompanying rules).
44 The theory of the stockholder derivative suit has been explained as follows:
[I]t is a suit having a double aspect. The stockholders have a right in equity to
compel the assertion of a corporate right of action against the directors or other
wrongdoers when the corporation wrongfully refuses to sue. The suit is thus an
action for specific enforcement of an obligation owed by the corporation to the
stockholders to assert its rights of action when the corporation has been put in default
by the wrongful refusal of the directors or management to make suitable measures
for its protection.
13 W. FLETCHER, supra note 43, at 363. The derivative action is considered an extraordinary
device since it reverses the corporate norm: the shareholder is entitled to make the decision to
bring the action even though it is the board of directors that supposedly manages the corpora-
tion. The board may at times decline to bring the action since it can hardly be expected to sue
itself. See United Copper Sec. Co. v. Amalgamated Copper Co., 244 U.S. 261, 263-64 (1917).
Although a derivative action may be brought directly against the corporate officers, this Note
focuses primarily on suits brought against directors for having failed to protect the shareholders
from company misconduct.
"5 See Ross v. Bernhard, 396 U.S. 531, 538-39 (1970); Gartenberg v. Merrill Lynch Asset
Management, Inc., 487 F. Supp. 999 (S.D.N.Y. 1980); 13 W. FLErcHER, supra note 43, 5990.
CARDOZO LAW REVIEW [Vol. 3:627
removing from agents and'trustees all inducement to attempt dealing for their own
benefit in matters which they have undertaken for others, or to which their agency
or trust relates."
Id. at 498, 248 N.E.2d at 912, 301 N.Y.S.2d at 81 (emphasis in original) (quoting Dutton v.
Wiliner, 52 N.Y. 312, 319 (1873)). But see Schein v.Chasen, 313 So. 2d 739, 741-47 (Fla. 1975)
(rejecting the Diamond argument and analysis of the purpose of a derivative action). For a
reasoned defense of the Diamond court and the need to view the derivative action as a deterrent
mechanism, see Coffee & Schwartz, The Survival of the Derivative Suit: An Evaluation and a
Proposalfor Legislative Reform, 81 COLUM. L. REV. 261, 302-09 (1981).
48 See D. DOBBS, supra note 46, at 135-36 (damages are substitutionary relief intended to
compensate plaintiffs loss). Punitive damages may be awarded to deter future misconduct;
however, such damages generally are not awarded in equitable proceedings on the ground that
plaintiffs would be unjustly enriched. Id. at 211; see also Bangor Punta Operations v. Bangor &
Aroostook R.R., 417 U.S. 703, 714-17 (1974) (equity will not permit a windfall for the defendant
notwithstanding that such recovery may deter future wrongdoing). But see Pelletier v. Schultz,
157 Ga. App. 64, 66, 276 S.E.2d 118, 120 (1981) (award of punitive damages in derivative,
action for tortious conduct); Holden v. Construction Mach. Co., 202 N.W.2d 348, 359 (Iowa
1972) (award of exemplary damages); Charles v. Epperson & Co., 258 Iowa 409, 431-32, 137
N.W.2d 605, 618-19 (1965) (same). See generally Annot., 67 A.L.R.3d 350 (1975) (analysis of
decisions concerning the allowance of punitive damages in derivative actions).
,1Imposition of monetary damages as a "remedy" for director misconduct has not been an
effective form of relief in the derivative action. In fact, the prospect of "fining" a director has
been offered as one reason for the judicial reluctance to find directors liable for wrongdoing. See,
e.g., Selheimer v. Manganese Corp. of America, 423 Pa. 563, 578, 224 A.2d 634, 643 (1966) (a
strict standard of due care may "render unattractive positions as directors of business corpora-
tions"); Smith v. Brown-Borhek Co., 414 Pa. 325, 333, 200 A.2d 398, 401 (1964) ("If the test of
negligence which is applicable in the field of torts . . . were similarly applicable in the business
.. .field, it would realistically be very difficult if not almost impossible to secure the services of
able and experienced corporate directors.") (emphasis omitted); see also SEC v. Texas Gulf
Sulphur Co., 401 F.2d 833, 866 (2d Cir. 1968) (Friendly, J., concurring) ("The consequences of
holding that negligence in the drafting of a press release . .'.may impose civil liability on the
corporation are frightening."), cert. denied, 404 U.S. 1005 (1971).
One obvious solution to allay the fears of the courts which argue that imposing monetary
damages might very well deter competent people from assuming positions as corporate directors
is to limit the amount of the damage award for which a director might be held liable. Conard, A
Behavioral Analysis of Directors'Liability for Negligence, 1972 DuKE L.J. 895. Professor Conard
suggests limiting the penalty in a derivative suit to one-year's salary of the defendant-director. He
also recommends that a structural change in the model of corporate governance, as suggested in
this Note, would be far more worthy of attention since, "[ilf observers of the corporate scene
became convinced [that by virtue of adoption of the monitoring model] executives are subject to
effective and independent supervision, they might willingly accept a diminution or even an
abandonment of the clumsy threat of liability for damages." Id. at 918. See also Dent, supra note
10, at 649 ("If directors were assigned tasks they reasonably could perform, however, requiring
them to perform these duties with reasonable care would not deter qualified persons from
serving.") (footnote omitted).
640 CARDOZO LAW REVIEW [Vol. 3:627
A second reason for preferring equitable remedies is that the impact damage awards might be
expected to have on director conduct is diminished by the availability of indemnification. See,
e.g., DEL. CODE ANN. tit. 8, 145(a) (1974) ("A corporation may indemnify ... a director [or]
officer . . . against expenses (including attorneys' fees), judgments, fines and amounts paid in
settlement . . . if he acted in good faith and in a manner he reasonably believed to be in or not
opposed to the best interests of the corporation .... ); id. 145(b) ("A corporation may
indemnify . . . a director [or] officer . . . against expenses incurred by him in connection with
the defense or settlement of [a derivative] action . . . except that no indemnification shall be
made [if] such person shall have been adjudged to be liable for negligence or misconduct . . .
unless . . . the court . . . [so permits]."); N.Y. Bus. CORP. LAW 722-723 (McKinney Supp.
1981-1982). A corporation may also protect its directors through liability insurance whether or
not the corporation would have the power to indemnify the directors. See, e.g., DEL. CODE ANN.
tit. 8, 145(g) (1974); N.Y. Bus. CORP. LAW 727 (McKinney Supp. 1981-1982). See generally
W. CARY & M. EISENBERG, supra note 1, at 952-70. It is common for the corporation to pay the
director's entire premium for liability insurance. Id. at 970; see also Bishop, Sitting Ducks and
Decoy Ducks: New Trends in the Indemnification of CorporateDirectors and Officers, 77 YALE
L.J. 1078, 1093 (1968) ("the existence of insurance against such liability is likely to encourage the
conduct on which the liability is grounded").
Finally, monetary threats are not likely to be effective when dealing with the corporate
personality for the very reason that corporations do not view threats to their profits in the same
way that a good bookkeeper would be expected to recognize that wrongdoing which results in
liability is a "bad bargain." C. STONE. supra note 10, at 35-57.
50 For purposes of remedying misconduct, the importance of the organization of the corpora-
tion cannot be overestimated; it is a virtual sine qua non to affording adequate remedies in any
derivative action. See Coffee, supra note 9, at 1108-13; see also Note, Judicial Intervention and
OrganizationTheory: ChangingBureaucraticBehavior and Policy, 89 YALE L.J. 513, 513 (1980)
(effective judicial remedies require understanding the nature of organization, limits of institu-
tional capacity, and opportunities for change).
1982] MONITORING MODEL 641
A. Executive Dominance
Although the legal model of corporate governance dictates that
the shareholders elect directors," who, in turn, select the officers,5 2 the
process in reality is reversed. Shareholders do not participate effec-
tively in the election process, 53 and the officers, usually the CEO,
select 54 or recommend 5 the directors. 56 Moreover, in exchange for a
board position, the CEO will often expect director fidelity and loy-
alty. 57 Selection of board members by the CEO also gives rise to
psychological and economic dependence on the CEO. 58 This depen-
dence becomes all the more exaggerated and problematic since the
directors generally spend a limited amount of time dealing with the
corporation's affairs, 59 lack an adequate staff, 0 and therefore depend
B. Organization Theory
The second important consideration for improving corporate
governance concerns a variety of counter-organizational forces. Officer
hardly be added that this kind of power over informationflow is virtually equivalent
to power over decision.
Id. at 216 (footnote omitted) (emphasis added).
"I See HEIDRICK & STRUGGLES, INC., supra note 58, at 5 (of 474 industrials surveyed, only
17.2% sent directors manufacturing data prior to the meeting, only 21.3% sent marketing data,
only 5.7% sent an agenda, and 11% sent no information at all). See generally M. EISENBERG,
supra note 4, at 144 (quality and quantity of information received by directors is "almost wholly
within the control of the corporation's executives").
" See supra note 16 and accompanying text.
'3 See, e.g., C. BROWN, supra note 15, at 31-32; C. STONE, supra note 10, at 127 ("[I]f there
is any hope of getting from the board some of the special functions we are after, some input over
and above that which management alone can provide, it lies, obviously, with outside directors of
some sort."); Report, supra note 32, at 1837; Goldberg, Debate on Outside Directors, N.Y.
Times, Oct. 29, 1972, 3 (Business), at 1, col. 3.
The past decade has seen an increase in the number of corporations with boards composed of
a majority of nonmanagement directors. See Small, The Evolving Role of the Director in
Corporate Governance, 30 HASTINGS L.J. 1353, 1356 (1979); Rise is Reported in Outside
Directors, N.Y. Times, Mar. 10, 1982, at D23, col. 2 (SEC report indicates a decline in the
numbers of corporate directors "who are either employed by or affiliated with the companies
they serve"). But cf. Brudney, supra note 27, at 598 n.3 (data compiled after 1977 suggests that
the trend has recently leveled off and that some statistical representations have been criticized for
employing a too imprecise definition of "independent" director); Korur/FEaaY INTERNATIONAL,
BOARD OF DIRCTORS STUDY OF BILLION DOLLAR INDUSTIALS 4 (Supp. 1979) ("The average
nominating committee of the Billion dollar respondents consists of one inside director and four
outside directors. However, under the SEC's previously proposed definition of an 'independent'
director, only two of the four outside directors would be considered independent.").
64 See Brudney, supra note 27; Solomon. Restructuring the Corporate Board of Directors:
Fond Hope-FaintPromise?, 76 MICH. L. REv. 581 (1978); Note, The Business Judgment Rule
in DerivativeSuits Against Directors, 65 CORNELL L. REV. 600, 618-22 (1980); see also S. VANCE,
THE CORPORATE DIRECTOR: A CRITICAL EVALUATION 4 (1968) ("[I]n only the rarest of instances do
outside directors have even the faintest idea of the technical processes, the competitive strains, or
the real financial status of the host company.").
1982] MONITORING MODEL 643
65 The bulk of corporate misconduct occurs in the middle-level echelons of the corporate
hierarchy. See Coffee, supra note 9, at 1105 & n.ll, 1112-13.
Id. at 1105. Managerial zealousness is primarily due to the short-term interests of manage-
ment which include the perception that (1) management's performance is likely to be judged
over the short term, (2) salary incentives depend on performance over the short-term, (3)
management personnel are likely to engage in risk taking in order to advance their careers, and
(4) management must take defensive maneuvers in order to divert take-overs. Id. at 1105 n.13.
Professor Coffee concludes that "proposals for new systems of corporate accountability that have
been designed primarily to combat traditional conflicts of interest may not be well adapted to
deal with [the] newer species of corporate misconduct, whose hallmark is managerial overzeal-
ousness." Id. at 1106.
In addition, the corporation's personnel become creatures of the corporation itself and
perform in ways that they would not outside the corporate framework. See C. STONE, supra note
10, at 3-7, 30-69; see also Stevenson, Corporationsand Social Responsibility: In Search of the
Corporate Soul, 42 CEO. WASH. L. REv. 709, 710 (1974) ("Frankensteinian creations of eco-
nomic necessity, corporate 'persons' are deficient in that concatenation of spiritual, social, and
political characteristics which in human personalities we call the 'soul.' ").
67 Coffee, supra note 9, at 1125.
6I Id. at 1129-36.
personnel lies where the power is, namely, with the officers and not
with the board of directors. Even assuming a willingness of corporate
employees to blow the whistle,7 5 and that these employees are in-
formed as to what constitutes intolerable wrongdoing, an assumption
of doubtful validity,76 the board would still not necessarily receive the
information that it needs to prevent misconduct. In fact, corporate
higher-ups are deliberately and systematically shielded from knowl-
77
edge of wrongdoing.
In order to confront and stem corporate misconduct, judicial
remedies must be designed in light of corporate organizational forces.
Admittedly, little can be done to offset the adverse effect on communi-
cation exerted by such factors as size or complexity of the corporation.
Nevertheless, by recognizing that such factors exist, a court will be
more likely to pinpoint the precise reasons for a given board's inability
to uncover or control misconduct. Having identified the problem, a
court will be better able to tailor the monitoring remedy to fit the
specific corporate organization. It is toward this end that the follow-
ing discussion is directed.
III. A NEED FOR REEVALUATION OF THE JUDICIAL
75 There is, of course, nothing more repugnant to the corporate mentality than a whistle
blower. A former chairman of General Motors noted, "[s]ome of the enemies of business now
encourage an employee to be disloyal to the enterprise. They want to create suspicion and
disharmony. However this is labeled-industrial espionage, whistle blowing or professional
responsibility-it is another tactic for spreading disunity and creating conflict." The Whistle
Blowers, TIME, Apr. 17, 1972, at 85. See also Crock, SEC Isn't Likely to Force Firms'Lawyersto
Tell Boards of Employee Wrongdoing, Wall St. J., Apr. 4, 1980, at 5, col. 2 (an SEC proposal
which would require corporate attorneys to report significant occurrences of misconduct to the
board of directors received "an avalanche of criticism" from corporate management).
76 See Coffee, supra note 9, at 1129-30 (noting that in the cases of questionable payments,
few corporations had submitted written guidelines to personnel in an effort to stop illegal
conduct).
77 See C. STONE, supra note 10, at 58-69. Professor Coffee notes that in attempts to isolate
senior officials from wrongdoing, corporations engage in "Kafkaesque" ploys involving the use of
middlemen and "linear structure of authority" which effectively structure information blockage
into the corporate system. Coffee, supra note 9, at 1133.
CARDOZO LAW REVIEW [Vol. 3:627
aberrant behavior which the directors are unable to foresee or deter. 78
For this reason, courts rarely impose liability on directors in connec-
tion with the wrongdoing of others.
Implementation of the monitoring model is inconsistent with the
current judicial reluctance to impose liability on directors. Courts
undoubtedly either hesitate or refuse entirely to impose monitoring
responsibilities on directors when they do not believe that the directors
should be held liable for failure to monitor in the first place. Conse-
quently, implementation of the monitoring model will require adjust-
ments in the judiciary's attitude regarding the scope of directors'
liability. The adjustments are justified not only because they will
facilitate the development of monitoring responsibilities, but also be-
cause courts have expanded the protections afforded directors to near-
total immunity. When the rules governing liability are reexamined
and properly applied, they will continue to protect the diligent, active
directors, but will not shield the negligent, inactive members of the
board.
The leading case holding that directors are not liable for the
misconduct of others that they did not foresee, and thus have no duty
to monitor corporate affairs, is the celebrated case of Graham v. Allis-
Chalmers Manufacturing Co. 79 On its face, this decision, if fol-
lowed,80 would surely impede the imposition of monitoring duties by
a court in a derivative action. Unless directors can be held liable,
courts will have no opportunity to impose equitable remedies designed
to implement the monitoring model. That is, courts will not be able to
effectively cure the disease if they are unwilling to examine its symp-
toms.
In Allis-Chalmers, a shareholder brought a derivative action
against the corporation's directors to recover criminal penalties paid
by the corporation as a result of federal antitrust violations committed
by various company employees. The plaintiffs attempted to prove that
the defendant-directors were liable as a matter of law by reason of
their failure to take action to prevent the illegal activity.,' The
Delaware court found for the defendants and held that, absent actual
78 See, e.g., Barnes v. Andrews, 298 F. 614, 617 (S.D.N.Y. 1924) ("Suppose I charge [the
director] with a complete knowledge of [corporate affairs]. What action should he have taken,
and how can I say that it would have stopped the losses. . . ? He would scarcely have helped to a
solution by adding another cook to the broth."); Allied Freight Ways v. Chofin, 325 Mass. 630,
91 N.E.2d 765 (1950); see also Bates v. Dresser, 251 U.S. 524, 529-30 (1920) (directors held not
liable for misconduct of others since wrongdoing was not foreseeable).
70 41 Del. Ch. 78, 188 A.2d 125 (1963).
80 See Ward, Fiduciary Standards Applicable to Officers and Directors and the Business
Judgment Rule Under Delaware Law, 3 DEL. J. Corn,. L. 244, 246 (1978) (suggesting that the
results attained in Allis-Chalmers should be reached by many courts today).
81 41 Del. Ch. at 80, 188 A.2d at 127.
1982] MONITORING MODEL
82 The plaintiffs unsuccessfully attempted to prove that the directors had actual notice of the
violations. Id.
81Id. at 85, 188 A.2d at 130.
84 Id.
85 Id. at 83-86, 188 A.2d at 130-31.
88 See supra note 66 and accompanying text.
87 See supra note 69 and accompanying text.
to that the case becomes reduced at last." 141 U.S. at 166 (emphasis added). Finally, although
Briggs has not been overruled, it has been severely limited in subsequent court decisions. See
cases cited in W. CARY & M. EISENBERG, supra note 1, at 523-24 (note on liability of directors of
banks and other financial institutions).
"I See, e.g., Panter v. Marshall Field & Co., 646 F.2d 271, 293, 296 (7th Cir.) (in absence of
fraud, bad faith, gross overreaching, or abuse of discretion, courts will not interfere with the judgment
of a corporate director), cert. denied, 454 U.S. 1092 (1981); Seagrave Corp. v. Mount, 212 F.2d 389,
396 (6th Cir. 1954); Feldman v. Pennroad Corp., 155 F.2d 773, 775-76 (3d Cir.), cert. denied, 329
U.S. 808 (1946); Northwest Indus. v. B.F. Goodrich Co., 301 F. Supp. 706, 712 (N.D. III. 1969);
Broski v. Jones, 614 S.W.2d 300, 304 (Mo. Ct. App. 1981) (court will not interfere with the board's
actions unless the matter is ultra vires, illegal, fraudulent, or where their business judgment is exercised
unfairly or in a dishonest manner); Grace v. Grace Inst., 19 N.Y.2d 307, 313, 226 N.E.2d 531, 533,
279 N.Y.S.2d 721, 725 (1967) (policy of the New York courts to avoid interference with the internal
management of corporations).
1982] MONITORING MODEL 649
HSee Elfenbein v. American Fin. Corp., 487 F. Supp. 619, 627 (S.D.N.Y. 1980) ("The
'business judgment' doctrine bars judicial inquiry into actions of directors taken in good faith and
in honest pursuit of the legitimate purpose of the corporation."), aff'd, 652 F.2d 53 (2d Cir.
1981); Ella M. Kelly & Wyndham, Inc. v. Bell, 266 A.2d 878, 879 (Del. 1970) (payment of
voluntary taxes falls within the scope of business judgment rule absent personal gain, bad faith,
or dishonesty); Casey v. Woodruff, 49 N.Y.S.2d 625 (Sup. Ct. 1944).
The directors are entrusted with the management of the affairs of the [corporation].
If in the course of management they arrive at a decision for which there is a
reasonable basis, and they act in good faith, as the result of their independent
judgment, and uninfluenced by any consideration other than what they honestly
believe to be for the best interests of the [corporation],it is not the function of the
court to say that it would have acted differently and to charge the directors for any
loss or expenditures incurred.
Id. at 642-43 (emphasis added).
The rule does not, however, bar inquiry into acts not carried out in good faith or decisions
which are unreasonable. See, e.g., Cramer v. General Tel. & Elecs. Corp., 582 F.2d 259, 275
(3d Cir. 1978) ("[W]here the shareholder contends that the directors' judgment is so unwise or
unreasonable as to fall outside the permissible bounds of the directors' sound discretion, a court
should, we think, be able to conduct its own analysis of the reasonableness of that business
judgment."), cert. denied, 439 U.S. 1129 (1979); Gimbel v. Signal Cos., 316 A.2d 599, 610 (Del.
Ch.) ("There are limits on the business judgment rule which fall short of intentional or inferred
fraudulent misconduct and which are based simply on gross inadequacy of price [for sale of the
corporation's wholly owned subsidiary]."), aff'd per curiam, 316 A.2d 619 (Del. 1974). Cf. W.
CARY & M. EISENBERG, supra note 1, at 1510 ("a long line of Delaware cases has held that even an
arm's-length combination is subject to judicial review for fairness").
The rule has been stated as follows:
A corporate transaction that involves no self-dealing by, or other personal interest of,
the directors who authorized the transaction will not be enjoined or set aside for the
directors' failure to satisfy the standards that govern a director's performance of his
or her duties, and directors who authorized the transaction will not be held person-
ally liable for resultant damages, unless:
(1) the directors did not exercise due care to ascertain the relevant and available
facts before voting to authorize the transaction; or
(2) the directors voted to authorize the transaction even though they did not
reasonably believe or could not have reasonably believed the transaction to be for the
best interest of the corporation; or
(3) in some other way the directors' authorization of the transaction was not in
good faith.
Arsht, The Business Judgment Rule Revisited, 8 HoFsTRA L. REv. 93, 111-12 (1979).
One rationale for the rule is that it protects directors from liability for corporate losses
caused by fluctuating markets, unforeseeable events, or other forces beyond the directors'
control. See Cramer v. General Tel. & Elecs., 582 F.2d 259, 274 (3d Cir. 1978), cert. denied, 439
U.S. 1129 (1979), where the court stated:
The business judgment rule originated as a means of limiting the liability of corpo-
rate directors and officers for mistakes made while performing their duties
.... The rationale for the rule is that in order for the corporation to be managed
properly and efficiently, directors must be given wide latitude in their handling of
corporate affairs.
Another rationale is that the rule promotes judicial economy. See, e.g., Karasik v. Pacific E.
Corp., 21 Del. Ch. 81, 97, 180 A. 604, 611 (1935) ("If [mere mistake warranted judicial
intereference], courts would be clogged with the pure business problems of corporations concern-
ing which individual stockholders were in disagreement with the officers and directors chosen by
CARDOZO LAW REVIEW [Vol. 3:627
considerable discretion, and if hindsight proves that the "wrong"
business decision was made, the courts will not substitute their judg-
ment 3 by holding the board liable as a guarantor of corporate suc-
cess.9 4 The business judgment rule is therefore an attempt to strike
the proper balance between the need to protect shareholders from
uninformed and reckless decisions of their agents 5 and the need to
protect directors from the unpredictability of the market and corpo-
rate business.
Significantly, application of the rule presupposes director in-
volvement in the corporation's business affairs and organization.
The rule is meant to apply only when decisions are in fact made; when
a board fails to supervise or monitor the corporation due to inatten-
tiveness, the rule simply is irrelevant in assessing liability for indeci-
sion.96 Likewise, the rule was not intended to grant immunity from
liability when uninformed directors have simply rubberstamped the
decisions of the officers; again, the rule assumes that informed deci-
97
sionmaking has in fact occurred.
the majority to think and decide for the corporate creature."). However, when the corporation is
unfairly prejudiced by the actions of its directors, conservation of judicial time should not take
precedence. See id. ("Of course if the error in judgment is contaminated by fraud, collusion or
other vitiating circumstance, a case arises which calls for judicial correction.").
'3Holmes v. Saint Joseph Lead Co., 84 Misc. 278, 283, 147 N.Y.S. 104, 107 (Sup. Ct. 1914)
(substitution of someone else's business judgment for that of directors' "'is no business for any
court to follow' ") (quoting Gamble v. Queens County Water Co., 123 N.Y. 91, 99, 25 N.E. 201,
202 (1890)). See generally Note, The Continuing Viability of the Business Judgment Rule as a
Guide for Judicial Restraint, 35 GEo. WASH. L. REv. 562, 564-65 (1967).
" Polikoff v. Dole & Clark Bldg. Corp., 37 I11. App. 2d 29, 35-36, 184 N.E.2d 792, 795
(1962) (" '[C]ourts of equity will not undertake to control the policy or business methods of a
corporation, although it may be seen that a wiser policy might be adopted, and the business
more successful if other methods were pursued.' ") (quoting Wheeler v. Pullman Iron & Steel
Co., 143 Ill. 197, 208, 32 N.E. 420, 423 (1892)); Casey v. Woodruff, 49 N.Y.S.2d 625, 643 (Sup.
Ct. 1944) ("The law recognizes that no director is infallible and that he will make mistakes
.... 'Wisdom developed after an event, and having it and its consequences as a source, is a
standard no man should be judged by.' Costello v. Costello, 209 N.Y. 252, 262, 103 N.E. 148,
152 [1913]."); Pollitz v. Wabash R.R., 207 N.Y. 113, 124, 100 N.E. 721, 724 (1912) ("the
exercise of [directors' power to make business decisions] for the common and general interests of
the corporation may not be questioned although the results show that what they did was unwise
or inexpedient").
"' See infra note 121.
91 See Arsht, supra note 92, at 112.
07 See, e.g., Casey v. Woodruff, 49 N.Y.S.2d 625, 643 (Sup. Ct. 1944), where the court
stated:
When courts say that they will not interfere in matters of business judgment, it is
presupposed that judgment-reasonable diligence-has in fact been exercised. A
director cannot close his eyes to what is going on about him in the conduct of the
business of the corporation and have it said that he is exercising business judgment.
See also Cary & Harris, Standardsof Conduct Under Common Law, Present Day Statutes and
the Model Act, 27 Bus. LAW. 61, 70 (Special Supp. Issue Feb. 1972) (before applying the rule
courts should require that directors have adequate information).
1982] MONITORING MODEL
91See Note, supra note 93, at 563 ("[The rule yields in]consistent result[s]. Many instances
can be found in which courts hold decisionmakers liable without proof of fraud; these instances
may exist side by side or even appear in the same case with summary dismissals of ordinary
negligence complaints."); 3A W. FLETCHER, CYCLOPEDIA OF THE LAW OF PRIVATE CORI'ORATIONS
1029, at 12 (rev. perm. ed. 1975) ("[T]he rules [which interpret the business judgment rule] are
laid down [in] .. .such glittering generalities that the case[s] could be decided either way
thereunder without violating the rules.").
Arsht has attempted to find consistency among the various and often apparently conflicting
standards of care used in the application of the business judgment rule. He reconciles the cases by
determining that an apparently overly lenient standard used in some cases represents a "[j]udicial
penchant for colorful phrases such as 'gross negligence,' 'gross abuse of discretion,' and 'palpable
overreaching' [which] simply fuels the fire [of confusion]." Arsht, supra note 92, at 94. Alterna-
tively, Arsht argues that many cases can be resolved by articulating a special rule for cases
involving parent-subsidiary relationships. Id. at 104-10. But cf. Dent, supra note 10, at 646,
where he explains:
Perhaps [Arsht is correct], but practicing lawyers and commentators give credence to
dicta [even if it represents a judicial penchant for colorful phrases]; judicial state-
ments appearing to adopt lenient standards of care no doubt discourage the bringing
of suits and influence the bases on which suits are settled even if lawyers have
misinterpreted those statements.
" See Brudney, supra note 27, at 614 n.50 ("However the business judgment rule is formu-
lated, its teaching imports virtually no liability for a director not visibly afflicted with a conflict
of interest or egregiously inattentive to his duties."); Cary, supra note 13, at 679-83 (criticizing
the business judgment rule in cases involving parent-subsidiary relations); Dent, supra note 10,
at 646-47 & nn. 136-37 (criticizing judicial applications of the business judgment rule that fail to
make any reference to a director's duty of care).
100316 A.2d 599 (Del. Ch.), afJ'd per curiam, 316 A.2d 619 (Del. 1974).
10, Id. at 614.
652 CARDOZO LAW REVIEW [Vol. 3:627
said to have passed an unintelligent and unadvised judgment.' "102
Given the circumstances of the case, this formulation of the business
judgment rule would insulate nearly every board decision from judi-
cial scrutiny.
The business judgment rule as applied in cases such as Gimbel
can impede implementation of the monitoring model. Courts that are
unwilling to scrutinize the directors' decisionmaking process will most
likely not find liability for ill-considered or uninformed decisions.
Even if they do find liability, they will probably be unwilling to
impose monitoring procedures designed to modify the board's deci-
sionmaking process.
The business judgment rule need not inhibit courts from impos-
ing significant monitoring responsibilities on the board inasmuch as
the rule itself implies a degree of care and awareness of corporate
affairs. The rule is intended to protect only informed decisions made
in good faith and in the best interests of the corporation. The Gimbel
approach, which elevates the rule to an almost irrebuttable presump-
tion in favor of directors' decisions, is inconsistent with the original
purpose of the rule and should be rejected. When properly applied,
the rule balances the directors' right to substantial discretion to act
without fear of liability with the shareholders' right to responsible
decisionmaking. 0 3 Since the rule does not protect uninformed deci-
102 Id. at 615 (quoting Mitchell v. Highland-Western Class Co., 19 Del. Ch. 326, 329-30, 167
A. 831, 833 (1933)). The court eventually issued a preliminary injunction on the ground that the
price was so unreasonable as to raise a question of whether the directors had acted outside the
bounds of reason in approving'the sale.
According to one commentator, the application of the business judgment rule in Gimbel
was correct since the directors' decision ultimately was not insulated from judicial scrutiny.
Arsht, supra note 92, at 124-25. That is, the rule served to insulate from judicial inquiry the
directors' decision to approve the transaction but not the reasonableness of the transaction itself.
This interpretation, however, does not comport with the general principle that the business
judgment rule only protects decisions made in good faith and in the best interests of the
corporation. See supra notes 92-94 and accompanying text. The rule does not insulate bad faith
or ill-considered decisions that fortuitously do not reach the standard of "unreasonableness."
Simply because a transaction does not reach the point of unreasonableness from a business
perspective, a shareholder should not be barred from challenging the approval of a transaction
when it evidences uninformed decisionmaking by directors who owe a fiduciary duty of loyalty
and due care.
103 One illuminating example of a proper application of the rule in a situation where the
directors ignored monitoring responsibilities is Syracuse Television, Inc. v. Channel 9, Syracuse,
Inc., 51 Misc. 2d 188, 273 N.Y.S.2d 16 (Sup. Ct. 1966). In Syracuse, an executive committee was
appointed 'which had a variety of oversight functions. Id. at 195, 273 N.Y.S.2d at 26. A Syracuse
shareholder suspected waste of corporate funds and misconduct in areas under the jurisdiction of
the executive committee and reported his suspicions to the board. For more than a year,
however, the board members refused to consider the shareholder's allegations. As a defense to the
subsequent derivative action, the directors argued, inter alia, that their "absence of action was
1982] MONITORING MODEL 653
the exercise of sound business judgment .... ..Id. at 191, 273 N.Y.S.2d at 22. The court
summarily rejected this defense on the ground that "[i]t can hardly be argued that the board
members exercised their sound business judgment by refusing to even consider the [shareholder's]
motion." Id. at 195, 273 N.Y.S.2d at 26. After determining that the relevant standard of care for
the committee members was defined by their membership on the executive committee, the court
held the directors liable for their inaction. As this case illustrates, when the business judgment
rule is properly applied, the board will not be able to hide behind a shield of immunity, but will
be compelled to be on its guard for corporate misconduct. See also Dent, supra note 10, at 646-
47 and cases cited therein (emphasizing the importance of defining the business judgment rule in
terms of a director's duty of care).
104 This is especially true since the standards utilized in business judgment cases, i.e., a
prudent businessperson in like position with the accompanying duties of good faith and loyalty,
would still apply once the monitoring model is implemented. The only difference is that the
standard of due care will be defined in terms of the committees upon which the directors serve
and the knowledge the board members could or should be expected to acquire. See Lanza v.
Drexel & Co., 479 F.2d 1277, 1306 n.98 (2d Cir. 1973); Feit v. Leasco Data Processing Equip.,
332 F. Supp. 544, 577-78 (E.D.N.Y. 1971); Syracuse, 51 Misc. 2d at 196-97, 273 N.Y.S.2d at 27;
Greene & Falk, supra note 33, at 1247 (discussing "differential liability" for board members who
sit on oversight committees).
654 CARDOZO LAW REVIEW [Vol. 3:627
105The right to rely is widely recognized in corporation codes. See, e.g., DEL. CODE ANN. tit.
8, 141(e) (Supp. 1980) ("A member of the board of directors . . . shall, in the performance of
his duties, be fully protected in relying in good faith upon the books of account or reports made
to the corporation . . . or in relying in good faith upon other records of the corporation."); N.Y.
Bus. CORP. LAW. 717 (McKinney Supp. 1981) (same); MODEL BUSINESS CORP. Acr ANN. 35,
para. 2 (2d ed. Supp. 1977). See generally Ferrara & Steinberg, The Role of Inside Counsel in
CorporateAccountability Process, 4 CORP. L. REv. 3 (1981) (consideration of the opportunity of
corporate counsel to inform directors of wrongdoing inasmuch as the counsel's advice is relied
upon by corporate clients); Handler & Christy, Texas CorporateDirectors'Standardof Care and
Right to Rely: A ProposedModification, 8 TEX. TECH. L. REV. 291 (1976) (statutory expansion of
right to rely accords with needs of complex organizational structure of the corporation); Hawes
& Sherrard, Reliance on Advice of Counsel as a Defense in Corporate and Securities Cases, 62
VA. L. REV. 1 (1976) (suggesting the proper limits of the defense of reliance on legal advice).
jo See MODEL BUSINESS CORP. Acr ANN. 35, para. 2, at 255 (2d ed. Supp. 1977) ("[active]
involvement is clearly neither practical nor feasible insofar as today's complex corporation . . . is
concerned"); 2 W. FtrcHE, supra note 18, 495, at 498 ("A policy of broad managerial
delegation adopted by the board of directors of a large corporation has been upheld by
the courts under the business judgment rule."); see also Nichols v. Brady Consultants, 305
N.W.2d 849, 851 (S.D. 1981) (although corporate directors and officers are chargeable with
knowledge of any matter that it is their duty to know, they may not be charged with the
knowledge of all the affairs of the corporation); MODEL BuSINESs CORP. ACr ANN. 35, para. 2,
at 255 (2d ed. Supp. 1977) ("[T]o the extent [that the duty of the director to manage the
corporation] might be interpreted to require active involvement by the board in day-to-day
affairs of the corporation, it does not accord with the realities of today's corporation[, particu-
larly the large diversified enterprise,] and should be clarified."); Handler & Christy, supra note
105, at 314.
107 See supra notes 96-97 and accompanying text. See also Dent, supra note 10, at 649
(although it would be "absurd" to allow the directors to rely exclusively on the opinions of
officers as to how they should vote at board meetings, "a limiting principle is hard to find").
108 The solution to the reluctance of outside directors to monitor effectively is,
however, simple enough: courts must impose sanctions on them for failing to assume
monitoring responsibility when that failure causes shareholder injury. In the last few
years, directors, faced with a "rising tide of lawsuits by disgruntled shareholders,"
have shown an increased awareness of their exposure to liability.
Soderquist, supra note 15, at 1362-63 (footnotes omitted).
The lack of clarity which now exists regarding the limits of a director's right to rely is a
direct result of the courts' uncertainty as to the duties a director is realistically capable of
performing. See Dent, supra note 10, at 648-49; Soderquist, supra note 15, at 1361; see also
MODEL BUSINESS CORP. Acr ANN. 35, para. 2, at 259 (2d ed. Supp. 1977):
Since the growth of the law in [the] dynamic corporate area [of the director's duty of
care and right to rely] will continue to come through judicial interpretation, it is
hoped that this clarification of the statutory premise [of the director's right to rely,
see infra note 111] will assist the courts in recognizing more clearly the practicalities
of accountability in the corporate model and thus permit the law to develop princi-
1982] MONITORING MODEL 655
pies of responsibility and liability which more accurately recognize the proper role of
the corporate director.
Barnes v. Andrews, 298 F. 614, 615 (S.D.N.Y. 1924) ("The measure of a director's duties [to keep
advised of the conduct of the corporate affairs] is uncertain; the courts contenting themselves
with vague declarations, such as that a director must give reasonable attention to the corporate
business.").
109For suggestions as to the oversight committees which the board can establish in performing
its monitoring duties, see infra notes 190-94 and accompanying text.
110E.g., DEL. CODE ANN. tit. 8, 141(e) (1974); N.Y. Bus. CoRn. LAW. 717 (McKinney
Supp. 1981).
.. MODEL BUSINESS CORN. Acr ANN. 35, para. 2, at 270-71 (2d ed. Supp. 1977) (emphasis
added). The Model Business Act also provides that when the director relies upon corporate
officers and employees, such reliance must be upon persons whom the director believes to be
"reliable and competent in the matters presented." Id. 35(a). When reliance is upon legal
counsel or public accountants, the matter relied upon must be "within [their] professional or
expert competence." Id. 35(b). And finally, when a director relies upon a board committee in
which the director is not a member, the committee must be such that "the director reasonably
believes to merit confidence." Id. 35(c). The Model Business Act modified its earlier rule
to broaden both (i) the range of situations . . . in which directors will have available
to them, by force of statute, the right to rely on others and (ii) the range of materials
on which directors will have the right to rely .. . .The amendment consequently
makes the right of reliance available to directors with respect to all mattersfor which
the board of directors is responsible.
Id. 35, para. 1, 2, at 254-55 (emphasis added).
I" See Handler & Christy, supra note 105, at 304-11 (critiquing this section of the Model
Business Act).
"I The alternative text of the statute might have read, "but he shall not be considered to be
acting in good faith unless he has knowledge concerning the matter in question that would cause
such reliance to be warranted." This alternative would directly impose a duty to be informed
which the monitoring model requires.
656 CARDOZO LAW REVIEW [Vol. 3:627
14 See, e.g., Barr v. Wackman, 36 N.Y.2d 371, 381, 329 N.E.2d 180, 188, 368 N.Y.S.2d 497,
507 (1975) (reiterating "the long-standing rule that [a nonaffiliated director] does not exempt
himself from liability by failing to do more than passively rubber-stamp the decisions of the
active managers"); Platt Corp. v. Platt, 42 Misc. 2d 640, 643, 249 N.Y.S.2d 1, 6 (Sup. Ct. 1964),
afJ'd, 23 A.D.2d 823, 258 N.Y.S.2d 629 (1965), rev'd on other grounds, 17 N.Y. 2d 234, 217
N.E.2d 134, 270 N.Y.S.2d 408 (1966), where the court stated:
It is the obvious duty of directors to know what is transpiring in the business
affairs of their corporation. . . . While corporate directors are not liable for errors of
judgment, nevertheless, the law holds them accountable for that which they reasona-
bly should have known or discovered in the discharge of their duties ....
Baker v. Mutual Loan & Inv. Co., 213 S.C. 558, 50 S.E.2d 692 (1948) (reliance on report of
corporate audit in an action alleging payment of illegal dividends is not available as a defense if
the corporate directors make no effort to inform themselves about the situation).
'"' See, e.g., Stein's, Inc. v. Blumenthal, 649 F.2d 463, 467 (7th Cir. 1980); Kutik v. Taylor,
80 Misc. 2d 839, 841, 364 N.Y.S.2d 387, 390 (Sup. Ct. 1975); Syracuse Television, Inc. v.
Channel 9, Syracuse Inc., 51 Misc. 2d 188, 273 N.Y.S.2d 16 (Sup. Ct. 1966); see also In re
Kauffman Mut. Fund Actions, 479 F.2d 257 (1st Cir.) (Coffin, C.J., concurring), cert. denied,
414 U.S. 857 (1973):
[T]hese are times when corporations are exceeding in size and impact even the
giantism of the past, when new layers and dimensions of corporate obligation are
being recognized, and when the importance of directorate oversight of the manage-
ment technocracy is greater than ever. A higher degree of professionalism, sensitiv-
ity, and scrutiny may fairly be expected on the part of directors today than in a
simpler era.
Id. at 268. See generally Handler & Christy, supra note 105, at 309-11 & nn.74-89 (citing
circumstances courts have considered as relevant when determining whether reliance was justi-
fied). Such an interpretation of the right to .rely would be wholly consistent with the presump-
tions of the monitoring model and would require that the director have access to all relevant data
before endorsing management proposals, see Moses v. Burgin, 445 F.2d 369 (1st Cir.) (implying
that when an officer fails to disclose fully in a conflict situation, the presumption would be that
the board would have denied the officer the right to act as he did), cert. denied sub nom.
Johnson v. Moses, 404 U.S. 994 (1971); DePinto v. Provident See. Life Ins. Co., 374 F.2d 37 (9th
Cir.), cert. denied, 389 U.S. 822 (1967). But cf. Lanza v. Drexel & Co., 479 F.2d 1277, 1281,
1306 (2d Cir. 1973) (under the Securities Acts, the violation of which requires intent or reckless-
ness, an outside director does not have an affirmative duty to solicit information but he must
consider any adverse information which comes to his attention). Alternatively, the right to rely
would require that a director actively solicit such information through his own information
network if unbiased information is unavailable. The director's right to rely would therefore be
readily assimilated into the monitoring model of corporate governance provided that the director
has sufficient information concerning the reliability and veracity of reports and dependable
accounts of employee integrity and competence.
116 202 Neb. 599, 277 N.W.2d 36 (1979). See generally Comment, Outside Directors'Liability
for Breach of Fiduciary Duty to Investigate-Doyle v, Union Insurance Co., 13 CrEIGHTON L.
Ray. 383 (1979). Although Doyle involved a closely held corporation, the court's reasoning is
equally applicable to publicly held corporations.
1982] MONITORING MODEL 657
than a fair price.'1 7 The facts demonstrated that the only involve-
ment of the outside directors was voting to investigate the transaction
and eventually authorizing the actual sale. Even though the directors
claimed that they were relying on an audit by a reputable accounting
firm and the approval of the State Director of Insurance," 8 the court
held the directors liable for failing to inform themselves of the under-
lying fairness of the transaction and the representations set forth in the
company's proxy statement, and for relying wholly on the insiders'
recommendations.1 19 More specifically, the court held that "[w]here
the duty of knowing exists, ignorance because of neglect of duty on the
part of a director creates the same liability as actual knowledge and
failure to act on that knowledge."' 20 The policyholders were thus
2
denied the benefit of their agents as fiduciaries.' '
A. Receivership
Appointment of a receiver for a corporation is a traditional equi-
table remedy1 26 employed by courts pursuant to their equitable
powers' 2 7 or express statutory authority.' 28 Normally, the appoint-
ed. 1979). There are various ways of categorizing receivers. A receiver may be referred to as
"passive" when his only function is to act as a custodian of specific property and to insure its
preservation during the pendency of the claim. On the other hand, a receiver may be appointed
for the corporation itself-to collect and distribute the judgment, to overhaul corporate manage-
ment, or to restore the corporation to economic health. Id. 7665-7666. Alternatively, a
receiver may be termed "temporary" when he is instructed to act until either a permanent
receiver is appointed or the prayer for a permanent receiver is dismissed. Id. 7666. In any
event, "there are few functions of a receiver that cannot be evolved by innovative use of the
inherent powers of the equity court. ... Id. 7665, at 13. See generally 3 R. CLARK, A
TREATISE ON THE LAW AND PRACTICE OF RECEIVERS 711-732.1 (3d ed. 1959).
121 See Sinclair v. Moore Cent. R. R., 228 N.C. 389, 45 S.E.2d 555 (1947) (power of court to
appoint a receiver is not limited by statutory authority, since it is one of the inherent powers of
the courts of equity); cJ. Koshaba v. Koshaba, 56 Cal. App. 2d 302, 314, 132 P.2d 854, 861-62
660 CARDOZO LAW REVIEW [Vol. 3:627
(1942) ("[I]t is well settled that a court of equity has inherent power to appoint a receiver at the
request of a stockholder on the grounds of fraud or mismanagement, or where, because of
dissensions on the board, it cannot properly function."); 16 W. FtcrcHER, supra note 126,
7668, 7673. See generally Grant v. Allied Developers, Inc., 44 Md. App. 560, 409 A.2d 1123 (Ct.
Spec. App. 1980) (distinguishing equity receiver from receivership authorized by statute).
128 CAL. CORP. CODE 1803 ( West 1977) (court appointment of receiver to protect corpora-
tion pending dissolution proceeding on the merits); id. 1804; DEL. CODE ANN. tit. 8,
226(a)(1)-(3) (1974) (court appointment of receiver custodian for deadlock or failure to take steps
to dissolve when corporate business had been abandoned); id. 322 (failure of corporation to
obey court order); N.J. STAT. ANN. 14A:14-2(2) (West 1969) (receiver may be appointed when
corporation is insolvent, has suspended ordinary business for lack of funds or is being conducted
at a great loss or in a manner greatly prejudicial to the interests of creditors or shareholders);
N.Y. Bus. CoRP. LAW 1202 (McKinney 1963).
' See Crites, Inc. v. Prudential Ins. Co., 322 U.S. 408, 414 (1944).
130 16 W. FLErCHER, supra note 126, 7666 & nn.16-17; cf. Orth v. Transit Inv. Corp., 132
F.2d 938, 945 (3d Cir. 1942), where the court stated:
It is fundamental, however, barring the existence of a statute which authorizes a
contrary course, that a federal court may appoint a receiver only as ancillary to or in
aid of the main object of the suit, an end or object which must be within the
jurisdiction of the court.
131 See generally H. HENN, supra note 41, 375; 4 J. PoMEaoY, EQUITY JuRIsPRuDENCE 1330
(5th ed. 1941). Receivership is generally an interim measure, and has been construed as a "means
to an end." Pioche Mines Consol. v. Dolman, 333 F.2d 257, 272 (9th Cir. 1964) (reversing
appointment of receiver on grounds that receivership is an ancillary remedy and the substantive
relief sought would not justify its use), cert. denied, 380 U.S. 956 (1965).
"I See SEC v. S & P Nat'l Corp., 360 F.2d 741, 750-51 (2d Cir. 1966) ("[T]he primary
purpose of the appointment [of the receiver] was promptly to install a responsible officer of the
court who could bring the companies into compliance with the law, 'ascertain the true state of
affairs * * * and report thereon' to the court and public shareholders and preserve the corporate
assets."); Blanchard Bros. & Lane v. S. G. Gay Co., 289 Ill. 413, 124 N.E. 616 (1919) (sale of
corporate property to prejudice of creditors required dismissal of receiver); Albre v. Sinclair
1982] MONITORING MODEL 661
Constr. Co., 345 Mass. 712, 189 N.E.2d 563 (1963) (receiver appointed to protect interests of
creditors); Tate v. Philadelphia Transp. Co., 410 Pa. 490, 190 A.2d 316 (1963) (receivership
order reversed on grounds that, inter alia, a receiver of a solvent corporation should be appointed
only when the rights of creditors and shareholders would not be substantially prejudiced).
133See Crites, Inc. v. Prudential Ins. Co., 322 U.S. 408, 414 (1944) (A receiver is "not free to
deal with the property under his control.., in such a way as to benefit himself or his associates.
Any profits that might have resulted from a breach of these high standards ... would have to be
disgorged and applied to the estate."); Phelan v. Middle States Oil Corp., 154 F.2d 978, 991 (2d
Cir. 1946) (derivative action) (A receiver "owes a duty of strict impartiality, of 'undivided loy-
alty,' to all persons interested in the receivership estate, and must not 'dilute' that loyalty. He is
'bound to act fairly and openly with respect to every aspect of the proceedings before the
court.' ") (quoting Crites, Inc. v. Prudential Ins. Co., 322 U.S. at 414). See generally 16 W.
FLETCHEa, supra note 126, 7811.
134 See generally 16W. FLETCHER, supra note 126, 7734-7740 (selection, eligibility, and
qualifications of receiver), 7810-7839 (powers, rights, duties, and nature of receiver).
13' See Poulakidas v. Charalidis, 68 Ill. App. 3d 610, 386 N.E.2d 405 (1979) (only when
dissension, dispute, fraud, or mismanagement renders impossible continuation of corporation or
preservation of corporate assets is appointment justified); Gettinger v. Heaney, 220 Ala. 613, 127
So. 195 (1930); Elevator Supplies Co. v. Wylde, 106 N.J. Eq. 163, 150 A. 347 (1930).
136United States v. Johnson, 98 F.2d 462, 466 (8th Cir. 1938), where the court stated:
The court, in its discretion, may permit a receiver to continue the conduct of a
business temporarily, when the interests of the parties seem to require it, but.., the
court should move "with great caution in conferring such authority and exposing the
property to the hazards of business;" and such action is justified only when clearly
necessary for the preservation of the rights of the parties.
Perhaps the most drastic remedy available to the plaintiff-shareholder in a derivative suit is
dissolution which contemplates the end of the corporation's life and the distribution of its assets
to creditors and shareholders. See generally 16A W. FLErCHEM, supra note 126, 8034-8035
(dissolution as an equitable remedy may be granted only in cases clearly warranting such relief);
Folk, supra note 121, at 952 (listing statutes that provide courts with less drastic alternative
remedies).
Some states authorize voluntary dissolution by a vote of a specified percentage of the
corporation's shareholders. See, e.g., DEL. CODE ANN. tit. 8, 275 (1974); N.Y. Bus. CoRP. LAW
1104 (McKinney 1963). A statutorily forced dissolution may also be authorized despite the
absence of a two-thirds or majority shareholder approval when serious corporate misconduct is
alleged. See, e.g., N.Y. Bus. CoR'. LAW 203(a)(3) (McKinney 1963) (ultra vires activities may
be asserted in an action to annul or dissolve the corporation); id. 1104-a(a) (McKinney Supp.
1981-1982) (holders of 20% of outstanding shares of certain corporations may petition for dis-
solution on the grounds that directors have been guilty of fraud or oppressive conduct or that the
corporate assets are being looted, wasted, or diverted for noncorporate purposes by those in
control of the corporation). See also MODEL BUSINESS CoRP. AcT. ANN. 97 (2d ed. Supp. 1977)
CARDOZO LAW REVIEW [Vol. 3:627
may seriously jeopardize the economic well-being of a corporation 137
(describing factual situations that justify dissolution). When dissolution is requested because of
serious corporate misconduct, the power of the court to dissolve the corporation is discretionary,
see, e.g., Polikoff v. Dole & Clark Bldg. Corp., 37 Ill. App. 2d 29, 184 N.E.2d 792 (1962);
Guaranty Laundry Co. v. Pulliam, 200 Okla. 185, 191 P.2d 975 (1948) (dissolution only in case
of no dissension among shareholders and only when no other remedy is available); cJ. N.Y. Bus.
CoRP.LAW 1111(a) (McKinney 1963 & Supp. 1981-1982) (dissolution at court's discretion), and
is rarely exercised, especially when less onerous remedies are available. See Baker v. Commercial
Body Builders, Inc., 264 Or. 614, 631-33, 507 P.2d 387, 395-96 (1973) (listing several alternatives
to dissolution including an injunction against the oppressive conduct, an order deducting exces-
sive salaries and bonuses, and an order of affirmative relief such as the declaration of a dividend
or an award of damages).
In determining whether to grant a request for dissolution, courts consider the probability of
resolving the deadlock; see RKO Theaters, Inc. v. Trenton-New Brunswick Theaters Co., 9 N.J.
Super. 401, 410, 74 A.2d 914, 918 (Ch. Div. 1950); Pachman, Divorce Corporate Style:
Dissension, Oppression, and Commercial Morality, 10 SEroN HALL L. RExv. 315, 330-32 &
nn.104-12 (1979) (explaining reasons for judicial reluctance to order dissolution); see also
Gidwitz v. Lanzit Corrugated Box Co., 20 Ill. 2d 208, 170 N.E.2d 131 (1960) (dissolution
ordered when acts of directors were oppressive and board was deadlocked); Laskey v. L. & L.
Manchester Drive-In, Inc., 216 A.2d 310 (Me. 1966) (dissolution compelled when board was
hopelessly deadlocked); whether the corporation is solvent, Hall v. John S. Isaacs & Sons Farms,
Inc., 39 Del. Ch. 244, 163 A.2d 288 (1960); whether dissolution would be oppressive to the
shareholders, Polikoff v. Dole & Clark Bldg. Corp., 37 Ill. App, 2d 29, 184 N.E.2d 792 (1962);
Leibert v. Clapp, 13 N.Y.2d 313, 196 N.E.2d 540, 247 N.Y.S.2d 102 (1963); and whether
dissolution would best serve the public interest, In re Collins-Doan Co., 3 N.J. 382, 70 A.2d 159
(1949). See 16A W. FL~rcHER, supra note 126, 8036.
Although courts generally have limited the dissolution remedy to small, closely held corpo-
rations, they have applied the remedy to some publicly held corporations as well. See, e.g.,
Fisher v. Bankers' Fire & Marine Ins. Co., 229 Ala. 173, 155 So. 538 (1934); Bernstein v. New
Jersey Bankers' See. Co., 109 N.J. Eq. 233, 156 A. 768 (Ct. Err. & App. 1931); Hall v. City Park
Brewing Co., 294 Pa. 127, 143 A. 582 (1928).
Since dissolution does not seek to modify corporate behavior, it is not a remedy that will
directly aid implementation of the monitoring model. Dissolution is not wholly useless in this
regard, however, since it serves as a powerful deterrent to future misconduct. For example, in a
derivative suit, a court may impose certain conditions on management to be met within a
specified period. The court may then retain jurisdiction and threaten management with dissolu-
tion of the corporation if the schedule is not met. See Kaybill Corp. v. Cherne, 24 I11. App. 3d
309, 320 N.E.2d 598 (1974) (corporation permitted to pay delinquent debts in lieu of and in
threat of dissolution). Thus, dissolution may be useful simply as a tool to insure compliance with
other remedies ordered in a shareholders' derivative suit. See Patton v. Nicholas, 154 Tex. 385,
398, 279 S.W.2d 848, 857 (1955) ("[E]quity may, by a combination of lesser remedies, including
exercise of its practice of retaining jurisdiction for supervisory purposes and reserving the more
severe measures as a final weapon against recalcitrance, accomplish much toward avoiding
recurrent mismanagement ....");Hornstein, supra note 1, at 232 (advocating use of threat
of dissolution to deter wrongful conduct); see also Laurel Springs Land Co. v. Fougeray, 50 N.J.
Eq. 756, 760, 26 A. 886, 887 (1893) (retention of jurisdiction to ensure payment of dividends);
Thwing v. McDonald, 134 Minn. 148, 158 N.W. 820 (1916) (less drastic form of relief awarded
with warning that if it were not effective, the corporation would be dissolved). Presumably, few
corporate directors or executives would have difficulty choosing between dissolution and the
implementation of monitoring procedures.
"I See SEC v. Bowler, 427 F.2d 190, 196 (4th Cir. 1970) ("[The appointment of a receiver]
carries connotations which may be ruinous in an industry where ready access to borrowed funds
1982]. MONITORING MODEL 663
since the investment community and the public often react adversely
to news of receivership. 38 Thus, if a receiver is appointed to improve
a corporation's financial standing, the opposite result may occur.
Likewise, if a receiver is appointed to take temporary custody of the
corporation's assets in order to prevent their dissipation, the attendant
lack of faith among the corporation's creditors may outlast the receiv-
er's tenure, thus impairing the corporation's financial stability. Fur-
thermore, the receiver is an officer of the court and may only act
within the court's order. 39 Generally, the receiver is appointed to
preserve the status quo, 40 which results in effective suspension of the
business and the inability of the company to participate in speculative
investment activities so essential to corporate growth.'
Since courts have the power to order receivership, they may
impose less onerous remedies designed to curb corporate manage-
ment's errant ways. In fact, courts have modified the remedy when
necessary to avoid some of the harsh consequences that normally
attend receivership. 42 Receivership thus illustrates both the broad
power available to a court in derivative suits as well as the flexibility
with which that power can be exercised.
Similar to the remedy of dissolution, 43 receivership does not
provide for continuing managerial role for existing executives and
directors. Nonetheless, the threat of receivership is available to a court
as a means for persuading management to adopt monitoring or other
144 Id.
141 Holi-Rest, Inc. v. Treloar, 217 N.W.2d 517, 527 (Iowa 1974).
146 Ferguson v. Birrell, 190 F. Supp. 506 (S.D.N.Y. 1960), af'd sub nom. Ferguson v. Tabah,
288 F.2d 665 (2d Cir. 1961); Roach v. Margulies, 42 N.J. Super. 243, 126 A.2d 45 (App. Div.
1956).
141 42 N.J. Super. 243, 126 A.2d 45 (App. Div. 1956).
148 The court did not explicitly state that the facts of the case justified appointment of a
receiver. The court did state, however, that "[ilt is well recognized that a court of equity has
inherent power in a proper case to appoint a receiver [and that] such drastic action is avoided
where possible." Id. at 244-45, 126 A.2d at 46-47. The court emphasized the flexibility of
equitable remedies, and noted that a "court of equity has the power of devising its remedy and
shaping it so as to fit the changing circumstances of every case and the complex relations of all the
parties." Id. at 245, 126 A.2d at 47 (quoting 1 J. PoMERoY, A TREATISE ON EQUITY JURISPRUDENCE,
109 (5th ed. 1941)). The court did not address the issue of the trial court's power to act sua
sponte, but presumably considered such action to be consistent with the broad equitable power.
See Holi-Rest, Inc. v. Treloar, 217 N.W.2d at 526 (sua sponte order appointing fiscal agent
where plaintiff requested "any and all other relief found to be equitable"), discussed infra note
157.
1982] MONITORING MODEL 665
previously granted the plaintiff the right to inspect the financial rec-
ords of the company.149 When the corporation's directors refused to
cooperate with the investigation subsequently conducted by plaintiff's
accountants, the plaintiff moved for appointment of a receiver.
The appellate court sustained the appointment of the fiscal
agent, explaining that the trial court had attempted to balance the
interests of the corporation's business operations with the sharehold-
ers' need for protection. 150 Appointment of the fiscal agent, the court
concluded, was "an ingeniously equitable pendente lite device un-
doubtedly hopefully contrived to avoid more stringent measures." ' 5'
The evidence showed that the company lacked adequate ac-
counting practices and that those who were disobeying the court-
ordered investigation were involved in self-dealing at the corpora-
tion's expense. The special fiscal agent was thus vested "with full
power and authority to check the propriety of all disbursements to be
52
made or proposed to be made by the corporation."
Although Margulies involved a closely held corporation, fiscal
agents have also been appointed in derivative actions involving pub-
licly held corporations. In Ferguson v. Birrell,'53 a bankruptcy
trustee-shareholder instituted a derivative action on behalf of a large
publicly held corporation alleging that over one million shares of stock
had been fraudulently issued as part of a conspiracy to enable the
149 Access to corporate records is crucial to the successful litigation of a derivative suit, and is
listed as one of the reasons for requiring a demand upon the directors before a derivative action
may be brought. Cf. Abrams v. Mayflower Investors, Inc., 62 F.R.D. 361, 369 (N.D. I11. 1974)
("[T]he Corporation. . .ought to be given the opportunity to sue [because] the corporate officers
and directors will undoubtedly be in possession of more information that is necessary to frame the
complaint properly and to pursue the action more efficiently.").
110The court did not consider the more traditional course of action of simply enjoining the
defendant from future wrongdoing. Presumably the court rejected the injunction for two rea-
sons. First, since the opinion was issued pursuant to an interlocutory appeal, the defendant
directors had not yet been held liable for any misconduct other than ignoring the trial court's
order to allow the investigation of the company's books. Therefore, the court had not yet
determined whether the requirements for issuing a preliminary injunction had been met. Sec-
ondly, in view of the alleged contempt, the chances that the defendant would obey the injunc-
tion were at best speculative, and therefore an injunction was an inadequate mechanism for
preventing dissipation of the corporation's assets.
15142 N.J. Super. at 245, 126 A.2d at 47. Appointment of a receiver would have "injur[ed] the
business in its relations with the.public and its large number of subscribers." Id.
151Id. at 244, 126 A.2d at 46. The order denying the receiver was made without prejudice. It
also empowered the fiscal agent to report any questionable disbursements to the parties who then
would be able to "apply to the court for relief with respect thereto if deemed advisable." Id. The
court thus retained jurisdiction over the case.
153190 F. Supp. 506 (S.D.N.Y. 1960), affd sub nom. Ferguson v. Tabah, 288 F.2d 665 (2d
Cir. 1961).
666 CARDOZO LAW REVIEW [Vol. 3:627
151 The chairman of the board had by this time left his position at the corporation in favor of
life as a fugitive in Brazil. His financial dealings left the corporation in chaos and spawned
numerous lawsuits. 288 F.2d at 667 n.l.
155 190 F. Supp. at 511. Five days after the district court declined to grant the request for a
receiver, all of the corporation's principal officers and directors were arrested by federal officers
and charged with violations of the securities laws. 288 F.2d at 670. Upon request of the plaintiff,
a receiver was appointed to replace the fiscal agent and to take over active operation of the
corporation. Id. The court of appeals affirmed the order, remarking that it was reasonable to
suspect that a watchdog over corporate expenditures would not, in light of the developing
circumstances and involvement of the corporation's management in dishonesty, be sufficient to
properly protect the corporation's assets. Id. at 674.
1"6190 F. Supp. at 511.
'17 See also Holi-Rest, Inc. v. Treloar, 217 N.W.2d 517 (Iowa 1974), in which the court
appointed a fiscal agent and retained jurisdiction over the parties and subject matter of the
litigation in the event that additional measures were needed. In Holi-Rest, the court ordered the
agent to immediately "assume exclusive control and operation of the . . . corporation, its
corporate books and records and its financial affairs." Id. at 527. The agent was also responsible
for collecting and distributing the judgment rendered in the suit, as well as conducting a full
audit of corporate transactions in order to ascertain the actual condition of the business. Thus,
the fiscal agent essentially replaced management. See Note, Holi-Rest v. Treloar: Egregious
Impropriety Elicits ExtraordinaryRemedy, 1 J. Cow'. L. 121, 128-29 (1975) (noting similarity
between functions of fiscal agent in Holi-Rest and duties of receiver appointed pursuant to Iowa
statute).
The broad powers granted the fiscal agent were deemed necessary in light of the defendant's
misconduct, which included barring the plaintiff-shareholder from participating in the opera-
tion of the business, keeping false minutes of meetings, some of which never occurred, draining
the corporation of capital, mismanaging company books, and drawing an excessive salary.
1982] MONITORING MODEL
10o In most cases involving removal, the directors themselves have engaged in conduct damag-
ing to the corporation. See infra note 171. Removal and replacement is intended simply to
eliminate a specific problem. When derivative actions allege misconduct by the officers or
executives, and only a failure by the directors to monitor, removal may not be justified, at least
under the traditional standards for removal. However, when it is clear that the wrongdoing
alleged in a derivative suit occurred because of the board's failure to monitor, and when it
appears that the board will be either unwilling or unable to monitor responsibly in the future,
removal and replacement should be considered as a possible remedy. Implementation of the
monitoring model in some cases surely will require an infusion of new blood into the board of
directors. Personal ties between executives and directors as well as established decisionmaking
procedures that include only a minimal board role may make it impossible to implement the
monitoring model without appointing new directors. When removal is necessary to implement
the model, it should not be frustrated simply because the directors were not directly engaged in
the alleged wrongdoing.
Moreover, in comparison to remedies such as the appointment of a special fiscal agent, the
appointment of new directors stands a better chance of achieving permanent governance reform.
Fiscal agents acting at the direction of the appointing court have limited authority which
generally does not extend to restructuring decisionmaking procedures. In contrast, new directors
do have such authority, and any reform implemented by the board is likely to be more effective
and permanent than reform ordered by a court.
1"I Under some circumstances, the directors themselves may remove other directors. See, e.g.,
N.Y. Bus. CoRP. LAW 706(a) (McKinney 1963) (directors may remove each other for cause if
the charter or by-law so provides). But cf. Bruch v. Nat'l Guar. Credit Corp., 13 Del. Ch. 180,
186-90, 116 A. 738, 741-42 (1922) (directors may not exercise power of removal). If removal by
fellow directors is not permitted or justified under the circumstances, directors may sue one
another derivatively for damages. The right of the corporate entity "to sue and be sued" is one of
the legal endowments of incorporation, e.g., DEL. CODE ANN. tit. 8, 122(2) (1974); N.Y. Bus.
CoRP. LAW 202 (McKinney 1963), and the directors, as the conductors of corporate affairs, see
supra note 5, exercise this right.
102 See supra note 6. Shareholders may request that a special meeting be held for the limited
purpose of electing new directors. In some jurisdictions, however, only the directors are empow-
ered to call a special meeting of the shareholders. See, e.g., DEL. CODE ANN. tit. 8, 211(d)
(1974) (special shareholders' meeting may be called only by directors and such persons author-
ized in charter or by-law); N.Y. Bus. CoRn. LAW 602(c) (McKinney 1963 & Supp. 1981-1982)
(same). But cf. Auer v. Dressel, 306 N.Y. 427, 432, 118 N.E.2d 590, 593 (1954) (holding that
when corporate by-laws provide that president shall call shareholders meeting upon request of
shareholders, proferring charges against four directors is a proper purpose for shareholder action
and president may be compelled, in a writ of mandamus, to call said meeting).
163 See, e.g., DEL. CODE ANN. tit. 8, 141(k) (Supp. 1980) (removal with or without cause by
majority vote); N.Y. Bus. CoRn. LAW 706 (a)-(b) (McKinney 1963) (majority vote for removal
1982] MONITORING MODEL 669
the absence of statutory authority for removal, some courts have held
4
that the right of removal is implied.1
Although available in theory, these avenues of relief may not in
fact be particularly useful to discontented shareholders. Removal of a
director through the electoral process is generally difficult to achieve
due to the board's control of the proxy machinery,'6 and the high cost
of a proxy fight. 60 When removal for cause is sanctioned by statute
or implied as a matter of right, a director may be removed only by a
majority shareholder vote. In addition, the shareholders' right of
removal is usually qualified by various procedural safeguards afforded
for cause and removal without cause if so provided in charter). See generally Travers, Removal
of the Corporate Director During His Term of Office, 53 IowA L. Rav. 389 (1967) (analysis and
criticism of various interests allegedly protected when shareholders lack the power of removal
and survey of different grounds for which removal has been permitted).
164 See, e.g., Campbell v. Loew's, Inc., 36 Del. Ch. 563, 572, 134 A.2d 852, 858 (1975) (right
of removal is implied, "otherwise a director who is guilty of the worst sort of violation of his duty
could nevertheless remain on the board. It is hardly to be believed that a director who is
disclosing the corporation's trade secrets to a competitor would be immune from removal by the
stockholders"); Auer v. Dressel, 306 N.Y. 427, 432, 118 N.E.2d 590, 593 (1954) ("it seems to be
settled law that the stockholders who are empowered to elect directors have the inherent power
to remove them for cause"). The shareholders' right of removal exists regardless of whether or
not the certificate of incorporation speaks to the question. W. CARY & M. EISBsERc, supra note
1, at 142-43.
165 In addition to control of the proxy machinery, the board enjoys the psychological prestige
of incumbency and will generally be reimbursed out of the corporate treasury for reasonable
expenses incurred during the proxy contest. See Campbell v. Loew's, Inc., 36 Del. Ch. 563, 581,
134 A.2d 852, 864 (1957); Rosenfeld v. Fairchild Engine & Airplane Corp., 309 N.Y. 168, 173,
128 N.E.2d 291, 293 (1955). See generally W. CARY & M. EIsraBEG, supra note 1, at 353-65
(proxy contests and expenses). These factors "place insurgents at a relative disadvantage, to say
the least, and make it doubtful that many challenges would successfully occur in reasonably
well-run companies even if managements were restricted to 'informing' shareholders."
Schulman, The Costs of Free Speech in Proxy Contests for Corporate Control, 20 WAYNE L. Rv.
1, 15 (1973). See 1972 U.S. SEc. ANN. REP. 30-31 (proxy contests for the election of directors took
place in approximately .5 % of meetings involving filings of proxy votes; incumbents prevailed in
only two of the 23 reported proxy fights in 1972). See generally Brudney, Fiduciary Ideology in
Transactions Affecting Corporate Control, 65 MICH. L. Rav. 259, 282 (1966) (use of corporate
funds to finance proxy contests "effectively curtails, rather than enlarges, stockholders' opportu-
nities to choose management."); Garrett, Attitudes on Corporate Democracy-A Critical Analy-
sis, 51 Nw. U. L. REv. 310 (1956) (after noting that proxy machinery is a practical necessity, the
author suggests several ways to reform the proxy system in order to facilitate corporate democ-
racy).
10 "The cost of a proxy contest in a widely held corporation can run into the hundreds of
thousands, if not millions, of dollars .... Note, Protecting the Shareholder's Right to Inspect
the Share Register in Corporate Proxy Contests for the Election of Directors, 50 S.CAL. L. Rv.
1273, 1277-78 (1977). "[T]he cost of reproducing a list [of shareholders alone] .. .range[s] from
$900 to $2,400." Id. at 1292 n.116. See E. ARANOW & H. EINHORN, PROXY CONTESTS FOR
CORPORATE CONTROL 543-44 (2d ed. 1968) (listing examples of costs in proxy contests). For this
reason, it is highly unlikely that shareholders who do not have an enormous financial interest in
the corporation would initiate a proxy fight for the removal of a corporate director.
CARDOZO LAW REVIEW [Vol. 3:627
167 See, e.g., In re Koch, 257 N.Y. 318, 322, 178 N.E. 545, 546 (1931) (a valid removal by the
shareholders is contingent upon service of specific charges, adequate notice, and full opportunity
for the director to rebut the accusations); Campbell v. Loew's, Inc., 36 Del. Ch. 563, 570, 134
A.2d 852, 859 (1957) (director may bring an action to challenge the shareholders' removal); 2 W.
FLrCHER, supra note 18, 360 (regularity and legality of removal proceedings), 363 (remedies
available to director removed or threatened with removal).
168W. CARY & M. EISENBERG, supra note 1, at 143. See also Travers, supra note 163, at 415-18
(attacking these "safeguards" as judicial paternalism).
109 Compare In re Burkin, 1 N.Y.2d 570, 573, 136 N.E.2d 862. 865, 154 N.Y.S.2d 898. 901
(I956) (relusal to entertain derivative action for removal of director since court would be
accomplishing what a majority of the shareholders failed to do on their own) with Brown v.
North Venture Rd. Dev. Co., 216 Cal. App. 2d 227, 230, 30 Cal. Rptr. 568, 571 (1963) ("Since
directors hold a position of trust, judicial power to remove them exists independent of statute.")
and Edward Sidebotham & Son v. Chandler, 183 Cal. App. 2d 823, 7 Cal. Rptr. 216 (1960)
(court's equitable powers permit removal of directors). Many cases that held that a director may
not be removed in an equitable proceeding, see, e.g., Feldman v. Pennroad Corp., 60 F. Supp.
716 (D. Del. 1945), afJ'd, 155 F.2d 733 (3d Cir.), cert. denied, 329 U.S. 808 (1946); Whyte v.
Faust, 281 Pa. 444, 127 A. 234 (1924), have been partially overruled by statute. See infra note
173.
"0 See, e.g., In re Burkin, 1 N.Y.2d 570, 573-74, 136 N.E.2d 862, 865, 154 N.Y.S.2d 898,
901-02 (1956). See also infra notes 177-80 and accompanying text (discussion of whether court
appointment of directors impermissibly interferes with shareholders' right to elect new direc-
tors).
171 In general, the standard for removal seems to be whether the director's actions
have caused
damage to the corporation. Cause for removal has been found where a corporate director has
misappropriated corporate funds, Hinkley v. Sagemiller, 191 Wis. 512, 210 N.W. 839 (1926),
diverted corporate funds to another corporation in which he has a financial interest, Edward
Sidebotham & Son v. Chandler, 183 Cal. App. 2d 823, 7 Cal. Rptr. 216 (1960); Fells v. Katz,
256 N.Y. 67, 175 N.E. 516 (1931), or has otherwise acted with fraudulent intent, Fox v. Cody,
141 Misc. 552, 252 N.Y.S. 395 (Sup. Ct. 1930). Impairment of the board's ability to operate may
also constitute cause for removal, since a violation of the cooperative conduct of the board, to the
extent that the board is no longer able to function, impedes the very purpose of the board's
existence. Examples of impairment include director insubordination, Freeman v. King Pontiac
Co., 236 S.C. 335, 114 S.E.2d 478 (1960), acting without authority, People v. Lyon, 119 A.
D. 361, 104 N.Y.S. 319 (removal of executive officer who held a position similar to a corporate
director), aff'd, 189 N.Y. 544, 82 N.E. 1130 (1907), bringing improper pressure upon the board
by stirring up employees, customers, and suppliers, McClayton v. W.B. Cassell Co., 66 F. Supp.
1982] MONITORING MODEL
have the theoretical right to remove the wrongdoer, and a court that
removed a director would merely be acting on the shareholders' be-
half. In other words, if courts recognized director removal as a rem-
edy in derivative suits, they would not be creating a new shareholder
right, but merely facilitating the exercise of an existing right. It is
anomalous to state on the one hand that directors are the duly elected
representatives and fiduciaries of the shareholders, and then insist that
a shareholder is powerless to seek the removal of a director who is
clearly acting contrary to the best interests of the corporation. Recog-
nition of the right of removal in a derivative action would neither
eliminate the requirement of proving cause for removal nor prevent
directors from rebutting allegations of wrongdoing. Recognition
would, however, ensure that shareholder impotence and apathy
would no longer serve as an impediment to protecting the corporation
from director misconduct.
According to one eminent commentator, the courts should be
able to remove a director from office since "[d]irectors have no per-
sonal interest in their office but may be compared with trustees, who
are subject to removal by the courts . ,17 Consequently, it is not
"...
165 (D. Md. 1946), and overall harassment of the board of directors, Campbell v. Loew's, Inc.,
36 Del. Ch. 563, 134 A.2d 852 (1957).
It is doubtful whether mere negligence or nonfeasance, standing alone, is a sufficient
ground for removal. See Bishop, supra note 64, at 1099 (directors of industrial corporations run
little risk of liability for ordinary negligence). Consequently, it is unlikely that a court would
accede to shareholders' demands to remove for directors guilty only of failing to monitor the
corporation's managers. Thus, implementation of the monitoring model would not increase the
risk of removal, unless of course the duty to monitor were considered a part of the directors'
general fiduciary duties or duty of care.
172 2 W. FLErcHER, supra note 18, 358, at 173. Professor Fletcher has found it "surprising"'
that many courts have declared "that there is no remedy in equity courts to remove legally
elected directors even if they are shown to be dishonest, incapable or unsuited to the perform-
ance of their duties." Id.
173 See, e.g., CAL. ConP. CODE 304 (West 1977) (courts empowered to remove directors in
suit brought by holders of at least 10 % of shares "in case of fraudulent or dishonest acts or gross
abuse of authority or discretion with reference to the corporation."); N.Y. Bus. CoRP. LAW
706(d) (McKinney 1963) (director can be removed in a derivative action by the holders of 10 % of
the company's outstanding shares). Recognition of the right of shareholder removal in a deriva-
tive action will often force a director to heed the wishes of a substantial block of shareholders.
Many directors will sometimes prefer to resign rather than enter into litigation or face a block of
shareholders who seek their removal. See Travers, supra note 163, at 397 & nn.57-58.
672 CARDOZO LAW REVIEW [Vol. 3:627
If removal is available, the next question involves how many
directors should be removed and how they should be replaced.
Whether a particular director or directors should be removed clearly
will depend on the peculiar characteristics of the corporation and the
type of misconduct at issue, as well as the nature and extent of the
director's involvement. A director who was actively involved in the
wrongdoing obviously would be a prime candidate for removal simply
by virtue of his wrongdoing. When removal is intended principally to
facilitate implementation of the monitoring model, however, the most
likely candidates will be directors with close affiliations and long-held
loyalties to executives guilty of wrongdoing since these directors in all
probability could not be relied on to perform effective monitoring
duties. In deciding which directors should be removed, courts should
be guided by the goal of forming a board of directors that will take
seriously its monitoring responsibilities. Directors who appear un-
suited to the task, for whatever reason, should be removed.
The replacement of directors may be accomplished either by
direct court appointment or by shareholder election. The authority to
appoint new directors derives from courts' authority to appoint receiv-
ers or special fiscal agents. The appointment of a receiver or fiscal
agent transfers control of corporate affairs or oversight responsibilities
from the directors and officers to a court-appointed caretaker. Given
the power to take such drastic measures, courts presumably have the
power to take the less drastic step of appointing a new director or
directors,'" leaving control of the corporation in the hands of corpo-
rate personnel.
M'The SEC has proffered the identical argument in requesting the appointment of directors.
See SEC v. Mattel, Inc., 5 SEC Docket 241 (D.D.C. 1974); Sporkin, supra note 138, at 123-24;
see also W. CARY & M. EISENBERG, supra note 1, at 143 ("[O]ther forms of relief may accomplish
the same purpose [as director removal]. Thus, a court may, for cause, enjoin the entire board of
directors from managing the corporation and vest management in a court-appointed receiver
or a custodian.").
To date, the SEC has succeeded in obtaining consent decrees imposing court-appointed
directors, SEC v. Charter Sees. Mgmt. Corp., 5 SEC Docket 584 (C.D. Cal. 1974) (appointment
of six independent, interim directors: two attorneys, one professor of law, one professor of
finance and two businessmen), court approval of directors who must meet certain criteria
satisfactory to the Commission, -SEC v. Canadian Javelin, 4 SEC Docket 620 (S.D.N.Y. 1974)
(board of directors is to consist of at least 40% of outside independent directors who meet the
Commission's criteria), and reorganization of the board of directors to contain a majority of
outside independent directors, SEC v. Mattel, Inc., 5 SEC Docket 241 (D.D.C. 1974) (Mattel to
appoint and maintain a board of directors, a majority of whose members should be unaffiliated
with Mattel, satisfactory to the Commission and approved by the court); SEC v. Westgate-
California Corp., 3 SEC Docket 30 (S.D. Cal. 1973) (board of directors to be reconstituted to
seven persons, five of whom shall be appointed by the court after consultation with the Commis-
sion and two of whom shall be nominated by the majority shareholder after notice to the
Commission and approval by the court). See generally Farrand, supra note 31; Comment,
Equitable Remedies in SEC Enforcement Actions, 123 U. PA. L. Rzv. 1188 (1975). The
1982] MONITORING MODEL 673
authority to appoint or control the selection of corporate directors in actions brought by the SEC
for violation of the Securities Acts derives from various forms of "ancillary relief" employed to
enforce the purposes and policies of the securities laws. See Comment, supra note 31, at 737-44;
cf. Chris-Craft Indus. v. Piper Aircraft Corp., 480 F.2d 341, 390-91 (2d Cir.) (explaining import
of "ancillary relief"), cert. denied, 414 U.S. 910 (1973).
State courts, pursuant to their general equity powers, possess similar authority to frame
appropriate remedies, and, in contrast to the SEC, are not limited as to authority and purpose of
the securities laws. See generally Freeman, supra note 30 (criticizing SEC for improperly
using enforcement powers to influence and mold corporate behavior). Nevertheless, state courts
have not followed the example set by the SEC cases. The reluctance of courts to appoint new
directors is perhaps a reflection of the traditional judicial hands-off policy which leaves control of
corporations in the hands of the elected directors. See supra note 91.
175 See Comment, supra note 31, at 750 ("[s]tockholder electoral rights have fallen into a state
of . . .nonuse"); supra note 40 and accompanying text; see also Manning, The Shareholder's
AppraisalRemedy: An Essay for Frank Coker, 72 YALE L.J. 223, 261 (1962).
176See supra note 38.
177See, e.g., DEL. CODE ANN. tit. 8, 223 (1974); N.Y. Bus. Corn'. LAW 705 (McKinney
Supp. 1981-1982).
17 See CAL. CORP. CODE 308(a)-(b) (West 1982).
179 Depending on the circumstances, courts might be able to adopt a middle position by
making temporary appointments and allowing the shareholders to elect permanent directors at
the next annual meeting. If the shareholders were satisfied with the performance of the appoint-
ees, those directors could then be elected to permanent positions.
674 CARDOZO LAW REVIEW [Vol. 3:627
real chance for improvement. Deferral to established procedures,
however, does not mean that courts should abstain from all involve-
ment. In some circumstances, judicial supervision of the elections may
be warranted to ensure the election of competent, disinterested direc-
tors. 0
Although removal and replacement will be an effective remedy
when directors themselves are guilty of misconduct, it offers no assur-
ance of improved corporate governance. Once elected or appointed,
new directors will face the same difficulties that led to the demise of
180 See, e.g., Orth v. Transit Inv. Corp., 132 F.2d 938, 947 (3d Cir. 1942) (ordering trial court
to "permit the stockholders of the corporate defendants as promptly as possible to elect boards of
directors from among competent and disinterested nominees and shall if necessary, supervise
these elections in order that competent and disinterested boards of directors may be obtained for
the corporations.").
At a minimum, courts could facilitate the election of competent directors by requiring
nominees to detail their own qualifications and disclose any relevant prior misconduct in the
proxy material. See generally Ferrara, Starr & Steinberg, Disclosure of Information Bearing on
Management Integrity and Competency, 76 Nw. U.L. REv. 555 (1981) (information bearing on
management's business expertise and reputation is highly material to shareholder decisionmak-
ing). Failure to comply with the court's order would also be grounds for voiding the election. See
Wyatt v. Armstrong, 186 Misc. 216, 59 N.Y.S.2d 502 (Sup. Ct. 1945) (order for new election
after proxy violation).
The opportunity for improving corporate governance might prove short-lived if newly
elected or court-appointed directors are not subsequently reelected by the shareholders. For this
reason, courts should attempt to structure the remedy of replacement to encourage the re-
election of the reformers. See SEC v. Vesco, 571 F.2d 129 (2d Cir. 1978). In Vesco, the court
upheld a special master's plan permitting court-appointed directors to stand for reelection by the
shareholders after the expiration of the directors' tenure under a court-supervised reorganization
of the corporation. The court so held despite the general rule that trustees in reorganization are
usually barred from acting as directors or officials of the reorganized company. The court
reasoned that the rule did not apply in the action sub judice and that
[e]xperienced management is a valuable corporate asset . . . . In the absence of a
compelling reason, a court should not preclude shareholders from the full exercise of
this right. Where experienced directors are court-appointed, the court should decide
on the facts of the particular case whether a sound reason exists for denying them
elected office.
Id. at 130. Moreover, in a subsequent derivative action challenging the election of the directors
by the shareholders, the same court held that in order to return the corporation to private control
a district court may provide that a candidate for directorship need only obtain the highest
number of votes, notwithstanding a state statute which might be interpreted to require receipt of
a majority of votes. Malhas v. Shinn, 597 F.2d 28 (2d Cir. 1979).
Reelection of a court-appointed director by the shareholders might also be accomplished by
informing the shareholders of the court's prior appointment and actions as well as the qualifica-
tions of the directors seeking office. Alternatively, the court might provide the court-appointed
or outside directors with control of the proxy machinery. The SEC has successfully employed
similar measures. See SEC v. Savoy Indus., 7 SEC Docket 492 (D.D.C.1975) (defendants to put
shares in a voting trust); SEC v. OSEC Petroleum, S.A., 5 SEC Docket 765 (D.D.C., 1974)
(corporation must grant proxy to a holder approved by the Commission and enjoined from
voting shares for 14 months); SEC v. Westgate-California Corp., 3 SEC Docket 30 (S.D. Cal.
1973) (future voting of stock must be approved by Commission).
19821 MONITORING MODEL
182 10 W. FLErCHER, supra note 181, 4860, at 302-03 & nn.1-9 and cases cited therein.
181Id. 4860, at 296.
114Aiple v. Twin City Barge & Towing Co., 274 Minn. 38, 45-46, 143 N.W.2d 374, 379
(1966); Abrams v. Textile Realty Corp., 97 N.Y.S.2d 492 (Sup.' Ct. 1949); see also DEL. CODE
ANN. tit. 8, 124(1) (1974) (shareholder suit for injunction); N.Y. Bus. CORP. LAW 203(a)(1)
(McKinney 1963) (same); W. CARY & M. EISENBERG, supra note 1, at 42 ("Although there are
cases holding that quo warranto is the sole remedy available to the state for an injunction and
that an equity suit by the state will not lie, there is substantial authority for permitting equitable
relief.").
185 See, e.g., R & J Bottling Co. v. Rosenthal, 40 A.D.2d 911, 337 N.Y.S.2d 783 (1972).
18' See, e.g., Lynch v. Vickers Energy Corp., 383 A.2d 278 (Del. 1977) (tender offer and
disclosure requirement); Fliegler v. Lawrence, 361 A.2d 218 (Del. 1976) (corporate opportu-
nity); Atlas Coal Co. v. Jones, 245 Iowa 506, 61 N.W.2d 663 (1953); Blakesley v. Johnson, 227
Kan. 495, 608 P.2d 908 (1980) (nondisclosure of offer to buy shares by third party is breach of
fiduciary duty by those with such knowledge).
187 Courts also could issue injunctions to prevent future conduct, but in terms of implementing
monitoring procedures, it is more likely that mandatory injunctions directing the board to take
certain actions would be used. Mandatory injunctions are traditional remedies available to a
court of equity, see Stern v. South Chester Tube Co., 390 U.S. 606, 609 (1968), and have been
issued in attempts to resolve a variety of corporate problems. See, e.g., Wood, Walker & Co. v.
Evans, 461 F.2d 852 (10th Cir. 1972) (mandatory injunction ordered when plaintiffs were
denied access to shareholders' list); Robbins v. Banner Indus., Inc., 285 F. Supp. 758, 763
(S.D.N.Y. 1966) (quoting with approval 2 L. Loss, SECURITIES REuLATIONS 1040 (2d ed. 1961)
("[t]he only [effective] sanctions for enforcing compliance with section 16(a) .. .are criminal
prosecutions and mandatory injunctions.")); Weil v. Beresth, 154 Conn. 12, 21-23, 220 A.2d
1982] MONITORING MODEL
456, 460-61 (1966) (injunction ordering specific enforcement of shareholders' agreement and, if
warranted by subsequent events, mandatory injunction requiring corporate director to resign
from the board); Chalfen v. Medical Inv. Corp., 297 Minn. 174, 210 N.W.2d 216 (1973) (in light
of substantial harm to plaintiff, temporary mandatory injunction granted ordering defendant
corporation to register notes in plaintiff's name); Hagy v. Premier Mfg. Corp., 404 Pa. 330, 172
A.2d 283 (1961) (shareholder's right to examine corporate records enforceable by mandatory
injunction); Patton v. Nicholas, 154 Tex. 385, 279 S.W.2d 848 (1955) (mandatory injunction
ordering payment of dividends).
While courts have issued mandatory injunctions with respect to areas normally within the
exclusive control of the board of directors, see 10 W. FtE'rCHER, supra note 181, 4853, they are
not always receptive to pleas for this type of relief. See, e.g., Kass v. Arden-Mayfair, Inc., 431 F.
Supp. 1037, 1041 (C.D. Cal. 1977) ("A court of equity is less favorably disposed to grant
mandatory rather than prohibitory equitable relief."); Neuwirth v. Merin, 267 F. Supp. 333,
335-36 (S.D.N.Y. 1967) (plaintiff denied mandatory enforcement of right to shareholder list
since a federal court will not entertain mandatory injunction where procedural remedy sought is
only relief prayed for); Union Pac. R.R. v. Chicago & N. W. Ry., 226 F. Supp. 400, 414 (N.D.
I11. 1964) (mandatory injunction for disbanding of shareholders' committee denied in lieu of
court enjoining shareholder meeting and court regulation of proxy contest); Gay v. Gay's Super
Mkts., Inc., 343 A.2d 577, 580 (Me. 1975) (judicial interference with management of corpora-
tion through mandatory injunction will not be permitted when decision not to declare dividend
does not amount to fraud, bad faith, breach of fiduciary duty or abuse of discretion); Crocker v.
Farmers & Merchants Bank, 293 So. 2d 438 (Miss. 1974) (mandatory injunction specifically
enforcing shareholders' voting agreement dissolved on grounds that agreement was too vague,
indefinite, and ambiguous to be enforced and that such injunction will be granted only in cases
of grave injustices and irreparable injury).
"s' See generally Report, supra note 32 (discussion of various oversight committees and their
respective functions).
189 Shareholders may request that an oversight committee be established, and a corporation
will be required to entertain a shareholder proposal to appoint an oversight committee. See SEC
v. Transamerica Corp., 163 F.2d 511, 517 (3d Cir. 1947) ("Stockholders are entitled to employ
watchmen to eye the guardians of their enterprise, the directors."), cert. denied, 332 U.S. 847
(1948). In addition, a court may hold the directors liable for failure to appoint such a committee
if the duty to do so was stated in the corporation's by-laws or charter. See Gamble v. Brown, 29
F.2d 366, 371-75 (4th Cir.), cert. denied, 279 U.S. 839 (1928). Finally, the appointment of
oversight committees at the request of the shareholders, perhaps in the form of a proposed
amendment to the by-laws, would probably not be construed as impermissibly abridging the
exclusive duty of the board to "manage" the corporation. See Rogers v. Hill, 289 U.S. 582, 588
(1933) (a statute which empowers the shareholders to amend or repeal the by-laws is considered
a plenary grant of authority); Eisenberg, Access to the CorporateProxy Machinery, 83 H~Av. L.
678 CARDOZO LAW REVIEW [Vol. 3:627
lines could be left with the directors, subject to court approval since
the directors are the most familiar with the corporation's organization
and existing oversight procedures, if any. Finally, leaving the details
of implementing monitoring procedures to the directors encourages
self-regulation and enhances the prospects of continued internal re-
200
form-the policy of the monitoring model.
In the final analysis, injunctive relief should be framed so that
corporate reform is internal and self-regulating, rather than judicially
coerced or imposed. The variations of relief are as many as the forms
of corporate misconduct and organization. The courts should provide
relief which seeks to place the directors as monitors of the corporation
so that their reform will be truly efficacious in remedying and pre-
20
venting corporate misconduct. '
CONCLUSION
report to the court with its findings. See, e.g., SEC v. Westgate-California Corp., 3 SEC Docket
30 (S.D. Cal. 1973); Note, supra note 50, at 516-17 (cataloging different tools which can be used
to aid judicial fact finding).
200 A court probably could not order a board of directors to amend the corporation's charter or
REP. No. 1807, 91st Cong., 2d Sess. 37 (1971) ("No amount of Government regulation can be as
effective as private enterprise carefully monitoring its own [corporate activities]."). See also Hub-
bard, Company Boards Don't Need Uncle Sam, N.Y. Times, June 24, 1979, at F14, col. 2. See
generally C. STONE, supra note 10, at 111-18. After listing examples of reforms adopted by vari-
ous corporations in restructuring the composition and functions of their boards of directors, Mr.
Hubbard, the chairman of a consulting firm, suggested that corporate executives favor voluntary
reform rather than mandatory regulation.
Many, not to say most, executives believe that further improvements [in corporate
governance] can and will be achieved and that they will be brought about more
effectively by corporations acting on their own rather than under cumbersome,
costly new legislation that would inevitably add expenses and limit flexibility in
solving new problems.
Hubbard, supra, at cols. 2-3.
1982] MONITORING MODEL
202 Lewin, The Corporate-Reform Furor, N.Y. Times, June 10, 1982, at D1, col. 3.
203The draft of the ALl proposal was to have been voted on at the Institute's annual meeting
in May, 1982. But the Business Roundtable initiated a lobbying campaign against adoption of
the Restatement and the vote was postponed. Id. at D6, col. 4.
204Id. at DI, col. 3.
205 Id. at D6, col. 4 (statement of Andrew Sigler, president and chairman of the board of
Champion International Corporation and head of the Business Roundtable's Corporate Respon-
sibility Task Force).
20e Id. A Business Roundtable letter to the Institute asking it to reconsider its view stated that
the "proposal was ill conceived, undesirable and 'based on false premises in areas where the
[Institute] reporters have little or no expertise."' Id. at D6, col. 5. Roderick Hills, a former head
of the Securities and Exchange Commissions thought it was " 'presumptuous for the legal
community to tell the business community what the methods of corporate governance should
be.' " Id.
207 Id. (statement of John Stichnoth, general counsel of the Union Carbide Corporation).
208With respect to the remonstrances of the corporate community, however, it might be noted
that "[tihe lady doth protest too much, methinks." W. SHAKESPEARE, Hamlet, in 5 THE WORKS OF
WILtIAM SHAKESPEARE 103 (Act III., Se. ii, Line 246) (1909).
682 CARDOZO LAW REVIEW [Vol. 3:627
Bruce Dickstein