Under current fiduciary rules, directors who fail to maintain an undivided loyalty to common shareholders are essentially “intruders,” exposed to shareholder retribution and liability for breach of fiduciary duty.
This Article argues that the increasing appointment of “constituency directors” has made the fiduciary principle of undivided loyalty to the common shareholders both outdated and normatively undesirable. A “constituency director” is a director designated to the board by a particular constituency (or “sponsor”). These constituency directors are generally appointed to advocate for investors who are not common shareholders, such as preferred shareholders, creditors, unions, and even the federal government. Contrary to conventional scholarly accounts, these kinds of investors (non-common equity, or “NCE,” investors) cannot always fully protect their interests through contracting alone. Thus, constituency directors are appointed to gain access to the added safeguards that only direct board advocacy can provide. By remedying this condition of “contractual failure,” constituency directors make NCE investments worth undertaking where they otherwise might not be.
This analysis suggests that the liability constituency directors face under current fiduciary rules may reduce a corporation’s access to important sources of capital. Hence, there is a normative case to be made for turning a director’s obligation of undivided loyalty to the common shareholders into a default rule. This reform would allow constituency directors to properly advocate for their sponsors, bridging the gap between corporate practice and corporate law, to the benefit of all involved parties and society as a whole.