Thursday, June 27, 2013

Delaware corporate law: directors have no obligation to minimise taxes

We have written a fair bit recently about the question of whether or not corporate directors have a fiduciary duty to avoid taxes. Our blog on Wednesday traced profound historical changes in many countries from the high-growth era where corporate directors felt they had wide duties to society and to their shareholders, to the more recent situation where that focus narrowed ever further downwards to a focus on shareholders to the exclusion of society. The latter position, of course, would make corporate tax avoidance more acceptable to them (although it still says little about the fundamental question of just how aggressive they should be in trying to dodge tax.)

But the blog and preceding blogs also showed that while the changes in ideology and corporate culture have been profound, at an official level directors are still required to have regard for wider society, not just a narrow shareholder group, when they make their decisions. There is no duty on directors to dedicate their hours to dodging tax. The blog demonstrates this for the U.K., citing a U.S. professor as saying:

"The ideology of shareholder value maximization lacks any solid foundation in corporate law, corporate economics, or the empirical evidence."

Now, the Financial Times has published a letter by Wasima Khan at Erasmus law school in Rotterdam, pointing to something more specific related to the U.S. state of Delaware, which (through serving as a kind of de facto laissez-faire offshore haven for corporate governance within the United States) has become the most influential state for jurisprudence with respect to corporate governance.  (Hat tip: Katrin McGauran.) It cites Delaware court rulings:
This Court has concluded that “there is no general fiduciary duty to minimize taxes."
We have criticised Delaware for many reasons -- not least its role as a 'captured state' willing to pimp its laws out to financial interests from elsewhere -- but in this case the arguments are rather more nuanced.

The tax stance described above stems from Delaware's "business judgement rule" which gives corporate bosses quite wide leeway to run their businesses. This rule can have negative consequences, in that directors have sometimes been able to get away with some quite egregious abuses of shareholders, such as voting themselves huge compensation packages, and indeed this wide freedom to business bosses is one reason why so many have chosen to incorporate there. (This legal blog, aptly called Theracetothebottom.org, has endless material about this.)

But in this particular case the business judgement rule has had a more positive outcome. The same court ruling noted:
"a decision to pursue or forgo tax savings is generally a business decision for the board of directors. Accordingly, despite the Plaintiff’s contentions, Delaware law is clear that there is no separate duty to minimize taxes."
We noted earlier how John Kay described UK company law as requiring directors to have regard to a wide array of stakeholders, not just narrow shareholders, and cited Lynn Stout as saying that this was even more so for the United States. Delaware case seems to confirm that.

One more for our Corporate Responsibility page.

Finally, as a fascinating aside to this debate, which is only tangentially about the 'shareholder value' obsession, see Clayton Christensen's article in Deseret News entitled The New Church of Finance.

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