corporation, contract, community: an analysis of

CORPORATION, CONTRACT, COMMUNITY: AN ANALYSISOF GOVERNANCE IN THE PRIVATISATION OF PUBLICENTERPRISE AND THE PUBLICISATION OF PRIVATE

CORPORATE LAW

Michael J Whincop* and Mary E Keyes**

INTRODUCTION

To say that managers should be accountable to the market only begins the analysis. Theproblematic downside to this glib norm is that a volatile market can be a fickle masterwho may regularly override the superior judgment of his manager-servant. Thus, thecentral question from a public law perspective is how much accountability is too much.

John C Coffee, Jr l

The last two decades of corporate law scholarship in the United States have beenmarked by the ascendancy of law-and-economics research, the centrepiece of which isthe contractarian theory of the corporation and the corporate law.2 Contractarians seekto explain the corporation as the focal point for a process of contracting between

**

1

2

B Com (Hons) LLB (Hons) MFM (Qld), Griffith University.BA LLB (Hons) (Qld), Griffith University. The authors wish to thank Stephen Bottomley,Ian Ramsay, Tracey Rowland, Stuart Rowland, John Seymour, and two anonymousreferees for helpful comments; and Michelle Lowe and Oliver Bennett for their researchassistance.J Coffee, "Shareholders Versus Managers: The Strain in the Corporate Web" (1986) 85 MichL Rev 1 at 109.The key exposition of contractarian theory is F Easterbrook and D Fischel, The EconomicStructure of Corporate Law (1991). A somewhat different view is articulated in H Butler andL Ribstein, "Opting Out of Fiduciary Duties: A Response to the Anti-Contractarians" (1990)65 Wash L Rev 1. The implications of the concept were explored in a series of paperspublished in Symposium, "Contractual Freedom in Corporate Law" (1989) 89 Colum L Rev1395. The concept of the corporation-as-contract has its origins in R Coase, "The Nature ofthe Firm" (1937) 4 Economica 386, which provided the impetus for a neo-classical theory ofthe firm in A Alchian and H Demsetz, "Production, Information Costs and EconomicOrganization" (1972) 62 Amer Econ Rev 777 and M Jensen and W Meckling, "Theory of theFirm: Managerial Behaviour, Agency Costs, and Ownership Structure" (1976) 3 JFin Econ305. The first, and still the most trenchant critique of the theory is V Brudney, "CorporateGovernance, Agency Costs, And The Rhetoric Of Contract" (1985) 85 Colum L Rev 1403; seealso R Clark, "Agency Costs versus Fiduciary Duties" in J Pratt and R Zeckhauser (eds),Principals and Agents: The Structure of Business (1991) 55. An overview of the theory's placein corporate law scholarship is W Bratton, "The 'Nexus of Contracts' Corporation: ACritical Appraisal" (1989) 74 Cornell L Rev 407.

52 Federal Law Review Volume 25

various constituencies. Contractarians explain corporate law as a corpus of "defaultrules" which fills gaps where these contracts are less than fully specified, but which canbe excluded by the parties.3 In policy terms, contractarian theory is unique in weddingits behavioural assumptions about management with its normative rejection of theefficiency of mandatory law. Contractarian theory does not depart substantially fromthe assumption that managers are self-interested and opportunistic - which was thestarting-point for the "anti-managerialist" paradigm that was dominant at the timecontractarian theory emerged.4 Yet contractarians argue against the need formandatory terms. Because of assumptions about the way in which the shares ofcorporations are priced, contractarianism asserts that the costs of opportunistic misuseof managerial discretion - here referred to as "agency costs"5 - are imposed on thepromoters of the corporation. It follows that the promoters will be motivated to devisethe optimal governance structure to minimise these agency costs. Hence, corporate lawneeds to take suppletory, or enabling form, to permit this optimisation of governance.

Over roughly the same period, the comparative efficiencies of public and privatemanagement of enterprise re-emerged in political and social discourse. The critics ofpublic management sought the contraction of the boundaries of the state by, amongstother things, its divestment - the privatisation - of its public enterprises.6 This articleaddresses issues that arise, in an Australian context, from the collision of these themesof privatisation and the governance function of corporate law. Australia has, perhaps,not gone so far down the privatisation road as England or New Zealand. There hasnonetheless been a strong, and often rhetorical debate that reached a new plane in the

3

4

56

The notion of law as a means of fining incomplete contracts has its origin in R Coase, "TheProblem of Social Cost" (1960) 3 J L & Econ 1. An economic theory of default rules isdeveloped in I Ayres and R Gertner, "Filling Gaps in Incomplete Contracts: An EconomicTheory of Default Rules" (1989) 99 Yale LJ 87; I Ayres and R Gertner, "Strategic ContractualInefficiency and the Optimal Choice of Legal Rules" (1992) 101 Yale LJ 729; R Craswell,"Contract Law, Default Rules, and the Philosophy of Promising" (1989) 88 Mich L Rev 489;C Gillette, "Commercial Relationships and the Selection of Default Rules for Remote Risks"(1990) 19 J Leg Stud 535; A Schwartz, "Relational Contracts in the Courts: An Analysis ofIncomplete Agreements and Judicial Strategies" (1992) 21 J Leg Stud 271; R Scott, "ARelational Theory of Default Rules for Commercial Contracts" (1990) 19 J Leg Stud 597.See, eg, W Cary, "Federalism and Corporate Law: Reflections upon Delaware" (1974) 83Yale LJ 663; V Brudney and M Chirelstein, "Fair Shares in Corporate Mergers andTakeovers" (1974) 88 Harv L Rev 297.See generally M Jensen and W Meckling, above n 2.Privatisation refers to the process of transfer of management of and property rights inpublicly owned operations to the private sector. Privatisation has been employed as one ofa number of means for improving government service delivery, including corporatisationand contracting out, all of which centre on the imposition of market-based regimes ofefficiency. As an indication of current thinking regarding privatisation at Federal level, theNational Commission of Audit recently recommended that the Federal government should"shut down or sell public sector assets [including business enterprises] where thereappears to be no public interest reason for continued government ownership": NationalCommission of Audit, Report to the Commonwealth Government (1996) at 25. The generalfocus on improving efficiency by subjecting the public sector to market processes is alsorevealed in the Industry Commission (now the Productivity Commission) report intoCompetitive Tendering and Contracting by Public Sector Agencies (1996). Cf Economic PlanningAdvisory Commission, Private Infrastructure Task Force Report (1995). See also Symposium,"Competitive Tendering and Contracting" (1996) 81 Canb Bull Pub Admin 1.

1997 Corporation, Contract, Community: An Analysis 53

Liberal and National parties' proposal to privatise Telstra, Australia's largestenterprise, in the 1996 Federal election.7 Corporate law, too, has been in flux for sometime; Professor Hill, in an article in this Review in 1995, described it as moving with"breathless" pace.8 Some Australian scholars have begun in this decade to analyse thesechanges in contractarian terms.9

Our argument is that privatisation involves a change of governance structure.10

Understanding the effects of that change is a precondition to arguments advocating oropposing privatisation. Because contractarianism is essentially a theory of governance,its relevance to this change of governance needs consideration. This connectionbetween privatisation and contractarianism has been studied in Australia by ProfessorsFarrar and McCabe.11 Using contractarian theory, they advocate privatisation. Theyargue that because privatisation exposes the enterprise to various market mechanisms,the corporation's constituencies will be motivated to contract for more efficientgovernance structures. As a major contribution to the analysis of the governanceimplications of privatisation, this stro11g claim warrants critical re-examination.

Farrar and McCabe's conclusion resonates with conventional law-and-economicsanalysis, which posits that over time, only efficient institutional forms (such asgovernance structures) survive in competitive markets.12 This evolutionary argument

7

8

9

10

11

12

Legislation enabling the privatisation of one-third of Telstra was passed by the FederalParliament on 13 December 1996 in the form of the Telstra (Dilution of Public Ownership)Act 1996. See also A Davies, "Senate passes Telstra sale bill almost intact", Sydney MorningHerald, 12 December 1996, 2. The legislation reserves the power to the Minister forCommunications to direct the Telstra Board to act in the "national interest".J Hill, "At the Frontiers of Labour Law and Corporate Law: Enterprise Bargaining,Corporations and Employees" (1995) 23 F L Rev 204 at 204.I Ramsay, "Company Law and the Economics of Federalism" (1990) 19 F L Rev 169; IMcEwin, "Public Versus Shareholder Control of Directors" (1992) 10 C & SLJ 182; M Byrne,"An Economic Analysis of Directors' Duties in Favour of Creditors" (1994) 4 Aust J Corp L275; B McCabe, "The Roles and Responsibilities of Company Directors in a Takeover"(1994) 4 Aust J Corp L 36; M Whincop, "Gambotto v. WCP Ltd: An Economic Analysis ofAlterations to Articles and Expropriation Articles" (1995) 23 ABLR 276 (Gambotto);M Whincop, "A Theoretical and Policy Critique of the Modern Reformulation of Directors'Duties of Care" (Duties of Care); M Whincop, "Developments in Directors' Statutory Dutiesof Honesty and Propriety" (1996) 14 C & SLJ 157 (Honesty and Propriety); M Whincop, "AnEconomic Analysis of the Criminalisation and Content of Directors' Duties" (1996) 24 ABLR273 (Criminalisation); M Whincop, "Insider Trading, Property Rights and MarketMicrostructure: The Case of Primary Securities Markets Transactions" (1996) 7 JBFLP 212(Insider Trading); M Whincop, "Due Diligence in SME Fundraising: Reform Choices,Economics and Empiricism" (1996) 19 UNSWLJ 433 (Due Diligence); J Mannolini,"Creditors' Interests in the Corporate Contract: A Case for the Reform of our InsolventTrading Provisions" (1996) 6 Aust J Corp L 14; R Campbell, "Opportunistic Amendment ofthe Corporate Governance Contract" (1996) 14 C & S LJ 200.A governance structure might be thought of as the collective means by which parties tocontracts (including webs of contracts such as corporations) protect themselves fromhazards to the integrity of exchange: 0 Williamson, The Mechanisms of Governance (1996) at5.J Farrar and B McCabe, "Corporatisation, Corporate Governance and the Deregulation ofthe Public Sector Economy" (1995) 6 Pub L Rev 24.M Friedman, Essays in Positive Economics (1953); R Nelson and S Winter, An EvolutionaryTheory of Economic Change (1982); G Priest, "The Common Law Process and the Selection of


has been recently reconsidered by corporate law scholars, who have found its I

theoretical premises less secure than the conventional, intensely Darwinian analysissuggests.13 We argue that even if corporate governance structures are efficient, the I

transformation of that positive observation into a normative argument in favour ofprivatising public enterprise is fraught with perils.

Our argument involves two themes, both of which concentrate on crossing afigurative line that divides public from private. The location and fixity of that line arenot essential,14 but the concept of crossing it - somewhere - encourages ;concentration on various crucial limitations to efficiency claims. The first theme,addressed in Part I of this article, looks at the transition from public to private. We I

address Farrar and McCabe's claim that the contracts defining the governance structureof the privatised entity are impelled by an efficiency motivation supplied by I

competitive capital and product markets. We argue that the claim is defective. The I

claim fails to assess the full implications of the transition from public to privateownership.

Part I concludes that any attempt to make efficiency claims for governance requires i

attention to the contracts by which the corporation is constituted. Parts II and III I

address the second theme, which concerns the transition from private back to public.Part II analyses the political economy of the corporation. Calling a corporation "public" I

or "private" tells us little about the interests corporate law is meant to protect oradvance, and equally little about whether the individual or some larger social I

substratum is the appropriate unit of analysis. We argue that although Australian I

corporate law is primarily individualistic, it has scarcely considered whether there is I

any conflict between the interests of one set of individuals - shareholders - andanother, the members of the larger community. It is necessary to understand how such,conflict, which privatisation may engender or exacerbate, can be resolved, and inparticular, whether corporate law has a role in this resolution.

Part III analyses various recent developments in Australian corporate law applying I

to governance. We observe a surprising phenomenon - corporate law has started to I

assume emblems and norms that resemble those of public law. We describe this as the"publicisation" of corporate law, so contrasting it with the privatisation of enterprise.Some would disagree with the claim that corporate law is private law.1S That pointneed not be contentious in the present context if we assume that privatisation involvesa transition from public to private, where "private" implies a corporate form. It isdifficult to be precise about the nature of publicisation because the developmentsdiscussed in the article are recent. Our assessment begins by noting that the resolutionof questions concerning shareholders' rights and officers' liabilities has conventionally

13

14

IS

Efficient Rules" (1977) 6 JLeg Stud 65; P Rubin, "Why is the Common Law Efficient?" (1977)6 JLeg Stud 51.M Roe, Strong Managers, Weak Owners: The Political Roots of American Corporate Finance(1994); M Roe, "Chaos and Evolution in Law and Economics" (1996) 109 Harv L Rev 641;R Gilson, "Corporate Governance and Economic Efficiency: When do Institutions Matter?"(1996) 74 Wash ULQ 327.We acknowledge the profound problems of dividing public from private: see A Wolfe,"The Modern Corporation: Private Agent or Public Actor?" (1993) 50 Wash & Lee L Rev1673. Accordingly, our analysis concentrates on change towards one or the other of theends of a publiciprivate continuum. I

See below text accompanying n 108.


involved minimal judicial review. As cases fall to be decided by superior courts, and asthe Commonwealth Parliament turns its attention to corporate law reform matters, thefocus on accountability that pervades the discussion of many matters in public and,increasingly, private life,16 has affected the balance in three ways. First, the traditionalnorm of corporate law, the non-interventionist internal management rule, is in decline.As a consequence, decisions made by corporate officers and shareholders are becomingsubject to a form of judicial review that is new to corporate law. It concentrates onprocedural matters and relies on new substantive grounds.17 Second, this judicialreview is occurring in a jurisprudential vacuum. As it emerges, it draws implicitly frompublic law norms and concepts. Third, standing to invoke this judicial review is in theprocess of being extended to non-shareholder constituencies.

The publicisation of corporate law has significant implications for privatisation.Conventional accounts of the superiority of privatisation proceed on the assumptionthat managers of a private or privatised entity have a narrow range of interests whichthey are legally required to consider - primarily, perhaps exclusively, theshareholders as a collective body. Coupling this single focus of duty with theconventional assumption that a private body may do anything not forbidden to it,18proponents argue that privatisation liberates management from prescriptive policydominated by rent seeking interest groups. Privatisation simultaneously provides boththe incentive and the means for management to respond flexibly and efficiently to themarkets they face. If corporate law continues to develop along the lines that we suggestit is taking, its trend towards publicisation threatens this picture in various ways. Mostsignificant is the prospect of a much wider scope for the judicial review of corporatemanagement decisions, at the instance of a wider range of constituencies, and ongrounds that may not be coterminous with efficiency considerations. "Publicised"corporate law shows signs of becoming procedural and prescriptive in a way thatmilitates against the flexibility that is essential to selecting efficient actions. It follows

16

17

18

P Finn, "Public Trust and Public Accountability" (1994) 3 Grif L Rev 224. Publicadministration has been dominated since the early 1980s by the "New Managerialism",which has been concerned with improving accountability and efficiency. Public sectorpolicy and practice seek to import market conditions by imposing contestability andincreasing consumer choice in selection of products (including management): NationalCommission of Audit, above n 6, ch 2. See generally GECD, Governance in Transition: PublicManagement Reforms in OECD Countries (1995).Sealy also has noted these trends in corporate law, arguing that the review of directordecision-making has become more interventionist, and has shifted from an emphasis onbona fides to proper purpose: see L Sealy, '''Bona Fides' and 'Proper Purposes' in CorporateDecisions" (1989) 15 Monash ULR 265. Sealy notes a parallel between this new law and thegrowth of judicial review of administrative decision making: ibid at 265-6.This assumption rests on basic liberal concerns regarding the tension between individualfreedom and state regulation, and is given practical effect in what Raz describes as "closurerules": J Raz, The Authority of Law: Essays on Law and Morality (1979) at 61, 72 and 75-7. Inthe case of individuals, the closure rule operates as a presumption that anything which isnot prohibited is permitted (to be contrasted with the closure rule applying to the state andits agents, which is that everything is prohibited which is not permitted): see the discussionin C Sampford, "Law, Insitutions and the Public/Private Divide" (1991) 20 F L Rev 185 at201. Liberal theory equates private bodies with individuals, and so private bodies take thebenefit of this presumption. See below text accompanying nn 88-89.


that "publicising" corporate law can invalidate some of the efficiency claims made forprivatisation.

At a deeper level, our analysis suggests a need to re-consider the legal form of thecorporation for public enterprises that have significant external effects, whetherpositive or negative. We have suggested above that the pervasive accountabilityconcept is responsible for the transformative publicisation of corporate law. That trendcan only be exacerbated by privatising enterprises that have external effects on largenumbers of persons.19 Once the formal regulatory control of the body ceases, corporatelaw may be called on to mediate between those affected by the externalities, and theshareholders, the traditional objects of fiduciary duty. Responding to this need willcause the sorts of inefficiencies evident in the developments we study. At a more basiclevel, these changes will cause uncertainty in the substantive law, making propertyrights harder to define and transfer. Regulators must pay greater attention to thesuitability of the legal form of the corporation to the enterprises we refer to. In Part IV,we offer conclusions and comments, and speculate about the questions the "new"corporate law may be expected to answer in the context of privatised entities.

I FROM PUBLIC TO PRIVATE: THE UNCERTAIN CASE FOR THEPRIVATISATION OF PUBLIC ENTERPRISE

Property rights and agency costs

Efficiency claims made by the advocates of privatisation rest, implicitly or explicitly, onproperty rights economics.20 Property rights economics theorises that public ownershipwill lead to inefficient management of assets compared to private ownership. The moreattenuated the property rights of a person in an asset which she is responsible formanaging, the less incentive that person has to manage it efficiently. An asset will beused more efficiently if property rights in the asset are owned by a person who cancapture gains from its efficient use, and who bears the cost of his or her decisionsregarding the use of the property rights.21 The property rights of citizens in assetsowned by the state are highly attenuated. A problem arises, however, if the privateowner is a corporation managed by persons who do not own its "residual claims".22 A

19

20

21

22

For discussions of accountability in the context of economic regulation, see, eg,S Bottomley, "Regulating Government-Owned Corporations: A Review of the Issues"(1994) 53 Aust J Pub Admin 521; J Coates, "Government-Owned Companies andSubsidiaries: Issues in Accounting, Auditing and Accountability" (1990) 49 Aust J PubAdmin 7; M Taggart, "The Impact of Corporatisation and Privatisation on AdministrativeLaw" (1992) 51 Aust JPub Admin 369 (Impact); M Taggart, "Corporatisation, Privatisationand Public Law" (1991) 2 Pub LR 77 (Corporatisation).For example, A Alchian, "Some Economics of Property Rights" (1965) 30 Il Politico 816;A Alchian and R Kessel, "Competition, Monopoly and the Pursuit of Pecuniary Gain" inAspects of Labor Economics (1962) 157; H Demsetz, "Towards a Theory of Property Rights"(1967) 57 Amer Econ Rev 347; H Hansmann, "The Role of Nonprofit Enterprise" (1980) 89Yale LJ 835.For a critique of this concept, see E Brody, "Agents Without Principals: The EconomicConvergence of the Nonprofit and For-Profit Organizational Forms" (1996) 40 NYL Sch LRev 457.A residual claim is an interest in the assets and cash flows of the corporation after thedischarge of the claims of those contracting for fixed returns (such as employees, lenders,


privatised enterprise would very likely be such a corporation. In both the bureaucracyand the corporation, those responsible for decisions concerning the asset haveattenuated property rights in that asset.23 How does the prediction hold in these cases?In a corporation, shareholders have property rights in the corporation's residualclaims.24 Most importantly, they are able to sell these interests. The incentives createdby private ownership of the corporation's residual claims must create the incentive forefficient asset management, and provide a means to discipline inefficient managers.25

Much of the following analysis considers the work of Professors Farrar andIvIcCabe.26 They advocate privatisation, a conclusion that obviously accords withproperty rights analysis. Yet, Farrar and McCabe reach their conclusion rrimarilythrough an application of an "agency" theoretical analysis of governance.2 Agencytheory is at the heart of the contractarian theory of corporations. It demonstrates how"principals"28 will use contracts to control the opportunism of an imperfectlyobservable agent (such as a manager) who does not bear all of the wealth effects of hisor her action.29 Potential opportunism is partially controlled by contractual provisionsfor monitoring and incentive alignment. Residual opportunism exists becausecontractual controls are costly. Its expected effects are therefore reflected in the "price"- what the principal pays the agent. The existence of competitive markets in which

23

24

25

2627

28

29

and suppliers). The shareholders are the residual claimants in a corporation: see generallyA Alchian and H Demsetz, above n 2; W Klien, "The Modern Business Organization:Bargaining Under Constraints" (1982) 91 Yale LJ 1521 at 1521-1522. Taxpayers come closestto being the residual claimants in a state-owned bureaucracy.In the corporation, managers may capture some of the wealth effects of their managementby holding shares. Nonetheless, the fraction of the corporation the manager holds willgenerally be small. Further, any motivating effect of shareholding Inay be confounded bythe actions of other managers: see A Alchian and H Demsetz, above n 2; F Easterbrook andD Fischel, "The Proper Role of a Target Management in Responding to a Tender Offer"(1981) 94 Harv L Rev 1161 at 1172. Financial economists have demonstrated the inefficiencyof significant shareholdings by managers. See below text accompanying nn 49-50.A Alchian, above n 20 at 822-828; A Hirschman, Exit Voice and Loyalty (1970); W Baxter,"Enterprise Liability, Public and Private" (1978) 42 L & Contemp Probs 45.The disjunction between shares and conventional property rights has been a cogent themein corporate law: see A Berle and G Means, The Modern Corporation and Private Property (reved 1968) at 245-250. Compare A Alchian, above n 20 at 826-827. Contractarian theorydenies the significance of the disjunction, by asserting that markets control managerialdiscretion.J Farrar and B McCabe, above n 11.Contractarian theory grew out of property rights economics. Both partake of similar neoclassical economic method. Property rights economics is dominated by its study of theincentives of "owners"; whereas contractarian theory is more responsive to explaining,justifying and, at times, de-emphasising the management-controlled corporation.Because agency theory is a general theory, bipartite relations are characterised as beingbetween principal and agent. The agent exercises some discretionary power which haswealth effects on the principal. The principal's control over, and ability to observe, theagent are imperfect. Thus, in the shareholder-manager relation, the shareholders are theprincipals, the managers are the agents. Obviously, the theory does not rely on any legalconcept of agency: R Clark, above n 2.See generally K Arrow, "The Economics of Agency" in J Pratt and R Zeckhauser, above n 2,37; E Fama, "Agency Problems and the Theory of the Firm" (1980) 88 J Pol Econ 288;M Jensen and W Meckling, above n 2.


such prices are set is critical to the theory. If markets are efficient,3D they shouldestimate the expected degree of residual opportunism, given the governance structure'sconstraints, in an unbiased way.31 Farrar and McCabe thus argue that the privatisedentity is subject to more, and more efficient, markets than the public enterprise was.These motivate the contracting parties to seek more efficient governance structures,and motivate managers to act more efficiently.32 Markets and their monitoring effectsare hypothesized to motivate managers to act in the best interests of the residualclaimants.33 However, Farrar and McCabe acknowledge that the market for manageriallabour34 should not differentiate between the bureaucracy and the corporation.35

Farrar and McCabe argue that the product market36 compels managers to act in theshareholders' best interests. The rigours of competition deter inefficient management ofthe privatised entity.37 By contrast, a state-owned enterprise is unlikely to be subject tocompetition. However, we would argue that unless privatisation is accompanied by apolicy of market liberalisation, a monopolistic position (and therefore corporate

30

31

3233

34

35

36

37

See generally E Fama, "Efficient Capital Markets: A Review of Theory and EmpiricalWork," (1970) 25 J Fin 383; E Fama, "Efficient Capital Markets II" (1991) 46 J Fin 1575;JGordon and L Kornhauser, "Efficient Markets, Costly Information and SecuritiesResearch" (1985) 60 NYU L Rev 761.This is what it means for a market to be efficient: prices need not be "correct", but asinformation becomes available, its implications for price should be realised in a timely wayand without systematic under-estimation or over-estimation. If the pricing process isunbiased, the risk of error can be eliminated by holding a diversified portfolio of securities.JFarrar and B McCabe, above n 11 at 34-36.Farrar and McCabe's other arguments that do not concern market monitoring are tenuous(ibid at 34). First, they assert that governments will be more closely monitored than entitiesin the private sector. They treat this extra monitoring as necessarily inefficient. However,less should be expended to monitor government organisations, because opportunities toprofit from expenditure on information are minimal. Following the property rightseconomics model, there is no market to trade in the residual claims of the public entity: seereferences in n 24 above; A Alchian, above n 20 at 823; R Cass, "Privatisation: Politics, Lawand Theory" (1988) 71 Marq L Rev 449 at 481; A Downes, An Economic Theory of Democracy(1957). The prediction of inefficient over-monitoring is genuinely strange, if one assumes(as economists do) that people act according to rational expectations. It would require thatprivate gains of monitoring are greater than social gains, a result we do not profess tounderstand. Second, Farrar and McCabe argue that auditors will be more inefficient in thepublic sector. The notion that auditors feel a sense of duty to taxpayers collapses in the faceof the agency analysis employed by Farrar and McCabe: auditors are rational utilitymaximisers, not altruists.Economists argue that managers will refrain from opportunistic self-interest because it willnegatively affect the value of their human capital as managers. Managers have incentivesto act in the interests of residual claimants because to do so increases the value of thatcapital: see generally E Fama, above n 29. But cf B Black, "Is Corporate Law Trivial?: APolitical and Economic Analysis" (1990) 84 Nw UL Rev 542 at 579, describing the Famamodel as "plain wrong" because chief executives tend not to be mobile.There should be no differentiation because the same managers compete simultaneously tomanage private and public hierarchies.The product market is the market in which an enterprise sells its products and services tocustomers. If a market is not monopolistic (as is the case for some public, and a few privateservices), a corporation that cannot supply products and services at a competitive pricewill exit the market because it will be unable to earn a sufficient return on invested capital.JFarrar and B McCabe, above n 11 at 32.


managers) may be unaffected by privatisation.38 Liberalisation can be pursued eithertogether with or independently of privatisation.39 However, a government pursuing aprivatisation agenda may have minimal incentives to liberalise. Ceteris paribus, amonopolist will be worth more than a firm subject to competition, because it generatesmonopoly profits.40

If a public asset sells for lower than the price it otherwise might, taxpayers suffer,although customers and new sUj'pliers in the liberalised market may gain. While thismay be "Kaldor-Hicks" efficient4 - in the sense that winners win by more than loserslose - that does not necessarily endorse it as a policy.42 Given the denunciation byeconomic libertarians of wealth redistribution by governments,43 one notes a tensionbetween their advocacy of privatisation (most apparent in Thatcherism) andliberalisation. The approach adopted in England of privatisation without liberalisationhas generally been accompanied by further regulatory regimes in order to controlpotential abuses of power by the new private monopoly.44 However, these forms ofregulation involve substantial costs and compromises, including the possibility ofprivate capture.45 We conclude that the effects of product and managerial labourmarkets do not support a conclusion that the government should privatise.

38

394041

42

4344

45

See generally P Starr, "The Meaning of Privatisation" (1988) 6 Yale L & Pol Rev 6 at 18; JForeman-Peck, "The Privatisation of Industry in Historical Perspective" (1989) 16 129 JL &Soc at 143; S King, "Competition: The Missing Link in Australia's Privatisation Program"(1995) 10 Policy 12 at 14-16; JKay and D Thompson, "Privatisation: A Policy in Search of aRationale" (1986) 96 Econ J 18; S Domberger and J Piggott, "Privatisation Policies and PublicEnterprise: A Survey" (1986) 62 Econ Record 145; W Howard, "Privatisation andManagement" (1989) Aust Q 87 at 104. For a contrary view, see W Megginson, R Nash andM Van Randenborgh, "The Financial and Operating Performance of Newly PrivatisedFirms: An International and Empirical Analysis" (1994) 49 J Fin 403. Chicago schooleconomists have argued that the problem of technical monopoly can be resolved by meansof the state conducting a form of franchise bidding for the right to the monopoly: seeH Demsetz, "Why Regulate Utilities?" (1968) 11 J L & Econ 55; R Posner "The AppropriateScope of Regulation in the Cable Television Industry" (1972) 3 Bell J Econ 98. However,Williamson has pointed out that this can create ex post contracting problems: seeo Williamson, above n 10 at 85-86.P Starr, above n 38 at 18.See, eg, S King, above n 38 at 15.For an explanation of the Kaldor-Hicks criterion, see M Polinsky, An Introduction to Lawand Economics (2nd ed, 1989) at 7-10 and 119-130; R Posner, Economic Analysis of Law (4thed, 1992) at 12-16. Before one can conclude such a change is efficient in this sense, one mustconsider the transaction costs of liberalisation (eg, the costs of a public share offering or thecosts associated with any new regulatory bodies).G Calabresi, "The Pointlessness of Pareto: Carrying Coase Further" (1991) 100 Yale LJ 1211at 1221-1228 (critiquing Kaldor-Hicks as a sufficient basis for policy).See, eg, R Epstein, "An Outline of Takings" (1986) 41 U Miami L Rev 3.D McGrory, "Privatisation in the United Kingdom and Economic Regulation in the UnitedStates: Lessons in Administrative Law" (1989) 11 Liverp L Rev 117 at 123.For analysis of the incentive problems faced by regulated, private firms, see J Laffont andJTirole, "Privatisation and Incentives" (1991) 7 J L Econ & Org 84; T Olsen and G Tosvik,"The Ratchet Effect in Common Agency: Implications for Regulation and Privatisation"(1993) 9 J L Econ & Org 136. See also R Maddock, "Reforming Australia's Utilities:Deregulation and Reregulation" (1993) 9 Policy 14.


Capital markets and governance

Professors Farrar and McCabe's other major argument concerns the monitoring effectsof capital markets. This conforms with our analysis that the only necessary differencebetween bureaucracy and corporation is the private ownership of residual claims in thecorporation.46 None of these mechanisms supports the conclusions which Farrar andMcCabe draw from them. We accept that share trices provide a judgment of theperformance of the corporation and its managers.4 But Farrar and McCabe ascribe tothe market a stronger function than that of passive analogue. They argue that themarket reduces the cost of the agency relationship between shareholders andmanagers.48 First, Farrar and McCabe assert that by compensating managers partiallywith shares, the interests of managers can be bonded to those of their shareholders.Thus, they become interested in maximising value for shareholders. We find thisunpersuasive. Extensive bonding of this sort increases the amount of risk that themanager bears. The manager is inherently risk averse because her human capital isalready invested in the corporation in a way that does not permit risk reduction bydiversification.49 Thus, such bonding may be counterproductive. This seems to bereflected by empirical evidence that the observed bonding of managers to the interestsof shareholders is minima1.50

Second, Farrar and McCabe argue that capital markets penalise inefficientgovernance in a capital offering. Arguably, promoters who offer shares in efficientcapital markets51 have an incentive to establish an optimal governance structure inorder to maximise their return on the shares they are selling.52 In other words, theagency costs of divergences between the interests of managers and shareholders areborne by the promoter offering the shares. The implication is that the promoter will

4647

48

49

50

5152

See above text accompanying n 24. Residual claims are defined above in n 22.That judgment, as a means of assessing management performance, is nonetheless "noisy",because management's contribution to rises and falls in stock price may be dominated byfactors for which they are not responsible: see D Diamond and R Verecchia, "OptimalManagerial Contracts and Equilibrium Securities Prices" (1982) 37 J Fin 275 and L Stout,"The Unimportance of Being Efficient: An Economic Analysis of Stock Market Pricing andSecurities Regulation" (1988) 87 Mich L Rev 613 at 678-681.A share price depressed by inefficient management may lead to a takeover. This market for"corporate control" is discussed separately, as per Farrar and McCabe's analysis: see belowtext accompanying nn 70-79.If the corporation enters insolvency, the manager's reputation is substantially injured. Seegenerally K Arrow, above n 29 at 44-5; R Kraakman, "Corporate Liability Strategies and theCosts of Legal Controls" (1984) 93 Yale LJ 857 at 858-867; J Coffee, above n 1. See also abovetext accompanying n 23.M Jensen and K Murphy, "Performance Pay and Top Management Incentives" (1990) 98 JPol Econ 225; J Coffee, "No Exit?: Opting Out, the Contractual Theory of the Corporation,and the Special Case of Remedies" (1988) 53 Brooklyn L Rev 919 at 942-950; L Stout, aboven 47 at 644-651. It has been argued that the ability of managers to affect their compensationunilaterally by undetectable insider trading causes problems for "bonding" in privatecorporations: R Haft, "The Effect of Insider Trading Rules on the Internal Efficiency of theLarge Corporation" (1982) 80 Mich L Rev 1051; M O'Connor, "Toward a More EfficientDeterrence of Insider Trading: The Repeal of Section 16(b)" (1989) 58 Fordham L Rev 309 at342-346. This is not a problem in public enterprise, where there are no shares to be traded.See above text accompanying n 30-31.M Jensen and W Meckling, above n 2; E Fama, above n 29.


adopt a governance structure that minimises agency costs. Some commentators treatthis argument suspiciously.53 Coffee has argued that Inost corporations, especiallythose making an initial public offering, will find it difficult to differentiate the claimsthat they make for their governance from suspect ones that other corporations make.This follows from the extreme uncertainty of the nature of future managerialopportunism and the endogenous nature of this risk.54 If this is so, shareholders willsuffer from inadequate "price protection", or alternatively, good quality firms will bedriven from the market, unable to communicate their quality.55 Efficiency claims inthese circumstances are dubious.56

Consider the implications for privatisation if this "pricing argument"57 does nothold. A government that establishes an efficient governance structure will find it hardto get full value for it. If it does not get full value, taxpayers suffer a welfare loss,although shareholders gain. However, if a government fails to establish an effectivegovernance structure (because full value cannot be obtained for it), one cannot predictthat privatisation leads to a more efficient set of governance arrangements. This pointdemonstrates the importance of considering the significance of crossing the dividebetween public and private.

Let us assume that the pricing argument does hold. Farrar and McCabe reason thatthis leads to the establishment of an efficient governance structure for the privatisedentity. That conclusion is ironic indeed, and is inconsistent with property rightseconomics. According to agency theory, the promoter has the incentive to impose an

53

54

55

56

57

V Brudney, above n 2; R Clark, above n 2. These authors critique the notion that capitalmarkets function in a way which enables corporate governance to be treated as if it had acontractual basis between shareholders and managers. Brudney's critiques also attacksclaims that capital markets provide strong, efficient monitoring of firms whose securitiesare traded.JCoffee, above n 50 at 935-936. Compare H Butler and L Ribstein, above n 2 at 33-42. Whilethe management team of the privatised enterprise may be better known than that of otherinitial public offerors, privatisation nonetheless involves considerable uncertainty. Itsproponents have sketched privatisation as a profound restructuring of all aspects of theenterprise's management. Moreover, if each enterprise is a monopolist, market participantswill have less experience with the pricing of securities in comparable firms.G Akerlof, "The Market for 'Lemons': The Quality of Uncertainty and the MarketMechanism" (1970) 84 QJEcon 488. This situation provides a sound economic reason not toprivatise, as full value for the business would not be obtained: see below textaccompanying nn 62-65. For evidence of mis-pricing of initial public offerings, seeT Loughran and J Ritter, "The New Issues Puzzle" (1995) 50 JFin 23 (US evidence); P Lee,S Taylor and T Walter, Australian IPO Pricing in the Short and Long Run, Working PaperNo 94/6 (University of Sydney, Accounting Department, 1994) (Australian evidence). Thisevidence looks at returns generally, not at the pricing of "terms". For a review of theimplications of this evidence, see M Whincop, "Due Diligence", above n 9 at 445-448.Share offerings make an almost trivial contribution to the financing of publicly heldcorporations: see W Baumol, The Stock Market and Economic Efficiency (1965) at 69-70 (firmstry to, and do avoid the direct disciplining influences of the market) and L Stout, aboven 47. There is also a subtler point that while capital markets may be efficient, in the sensethat information may be rapidly realised in prices, the relationship between this"speculative efficiency" and the efficiency of resource allocation is unclear: J Gordon andL Kornhauser, above n 30 at 825-830. This point qualifies Farrar and McCabe's reliance onmarkets as the basis for superior governance of resource allocation.M Eisenberg, "The Structure Of Corporation Law" (1989) 89 Colum L Rev 1461 at 1515.


efficient governance structure, because the promoter bears the agency costs. Yet, inprivatisations, the government is the promoter. If we follow the argument, the capitalmarket gives the government incentives to select efficient governance structures. Yet,government's incentives are weak because of attenuated property rights. Why should agovernment care if it does not obtain the best price for its asset? Why should it startcaring now? It is impossible to ignore the irony: the suggestion is that a government,when selling the enterprise, can devise an optimal governance structure that it couldnot or would not devise when the asset was subject to public management.58 If thegovernment's incentive to establish an optimal governance structure is distorted, theshare market's significance to privatisation is restricted to two situations. One is atakeover, which we discuss below.59 The other situation is where the corporationdecides to return to the capital market to make a fresh offering of shares. Here, the newshares will be priced according to the governance structure offered. However, anypenalty through pricing is not borne by managers, who generally own only smallfractions of the corporation. Instead, as Farrar and McCabe note,60 the penalty issuffered by existing shareholders.61 Once a governance structure is established at thetime of the initial public offering, managers and directors have little incentive tosubsequently restrict their discretion by modifying that structure.

Other writers have argued that observed privatisations are likely to be theconsequences of interest groups' rent-seeking behaviour.62 This process is apparent inshare offerings. When making an initial public offering of shares in a privatisedcorporation, the government has political incentives to under-price.63 Under-pricingincreases the likelihood of the issue being over-subscribed. Although under-pricingrepresents an opportunity cost to government revenue and taxpayers, oversubscription is nonetheless desired by politicians as it suggests that the privatisationpolicy has succeeded.64 As we noted when considering liberalisation policy,65

58

5960

61

62

63

64

65

To put it another way, if the government is capable of designing an efficient governancestructure, why should it bother privatising? Cf P Jackson and C Price, Privatisation andRegulation: A Review of the Issues (1994) at 11.See below text accompanying nn 70-77.J Farrar and B McCabe, above n 11 at 32, footnote 33. The subsequent offering may neverhappen.JGordon, "The Mandatory Structure of Corporate Law" (1989) 89 Colum L Rev 1549 at 15731575.J Shearmur, "Public Choice, Contracting Out and Communitarianism," (1988) 71 Marq LRev 445; C Gillette, "Who Puts the Public in the Public Good?: A Comment on Cass" (1988)71 Marq L Rev 534 at 540-541; P Dunleavy, "Explaining the Privatisation Boom: PublicChoice versus Radical Approaches" (1986) 64 Pub Admin 13; G Priest, "The Aims ofPrivatisation" (1988) 6 Yale L & Pol Rev 1 at 3.C Hamilton, "Assessing the Arguments for Privatisation" (1995) 72 Curr Affs Bull (No 3) 14.Underpricing is well documented in the private sector as well: F Finn and R Higham, "ThePerformance of Unseasoned New Equity Issues-Cum-Stock Exchange Listings in Australia"(1988) 12] Bank & Fin 333; I Ramsay and B Sidhu, "Underpricing of Initial Public Offeringsand Due Diligence Costs: An Empirical Examination" (1995) 13 C & SL] 186.C Hamilton, above n 63; JQuiggin, Does Privatisation Pay?, Discussion Paper Number 2(The Australia Institute: Canberra, 1994). See also J Vickers and G Yarrow, Privatisation: AnEconomic Analysis (1988) at Table 7.1.See above text accompanying nn 38-40.


privatisation becomes a tool not of efficiency but of wealth transfer; the capital marketbecomes the medium for transfers of wealth.

Share markets are not the only capital markets. What effect do markets for debtsecurities have on governance? If our analysis that share markets (in which stateowned enterprises do not enter) do not playa substantial role in reducing agency costsin privatised enterprises, this conclusion applies a fortiori to debt markets, in whichstate owned enterprises are active. Debt markets may have an indeterminate effect onthe corporation's total agency costs.66 Creditors are not concerned with agency costsbesides those associated with their loans. Farrar and McCabe's analysis depends on afurther argument that the contractual restraints in debt agreements reduce the agencycosts attributable to relationships other than those with creditors. While sometheoretical analyses may be consistent with such a result,67 these do not purport tomodel the total level of agency costs in the corporation. Managers of privatecorporations will avoid using debt in the capital structure of the corporation, if they areable to do so. Debt increases the risk of financial distress, so jeopardising the manager'sundiversified investments of human capital in the corporation.68 Managers cantherefore be expected to choose other policies, such as a low-dividend policy, in orderto reduce the need to borrow.69

Finally, there is the disciplinary effect of the takeover. While the so-called marketfor corporate control provides residual discipline, it does not do so at "low cost", asFarrar and McCabe maintain.70 Acquirers pay large premiums, especially in hostiletakeovers.71 Therefore, only major managerial inefficiency is disciplined. The marketfor corporate control is therefore costly to shareholders, not in a direct sense, butbecause they must suffer substantial loss at managers' hands in order for "buyers" tobid for the corporation.72 This conclusion does not take into account the further coststhat shareholders "pay" when directors engage in self-interested defensive tacticsdesigned to entrench their own positions.73 In conventional law-and-economicsanalysis, the social gain of the takeover derives from the redirection of productive

66

67

68697071

7273

The borrower-lender relationship can also be analysed as an agency relationship, thecreditor being the principal, the borrower the agent. The borrower is the agent because theborrower has discretion in using the finance: M Jensen and W Meckling, above n 2;C Smith and J Warner, "On Financial Contracting: An Analysis of Bond Covenants" (1979)6 JFin Econ 117.See, eg, S Myers, "Determinants of Corporate Borrowing" (1977) 4 JFin Econ 147; M Jensen,"Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers" (1986) 76 Arner EconRev 323.J Coffee, above n 1 at 20-22.M Jensen, above n 67.J Farrar and B McCabe, above n 11 at 32, 36.B Black, "Bidder Overpayment in Takeovers" (1989) 41 Stan L Rev 597; G Jarrell et aI, "TheMarket for Corporate Control: The Empirical Evidence Since 1980" (1988) 2 JEcon Persp 49.V Brudney, above n 2 at 1425.See F Easterbrook and D Fischel, above n 23 at 1175-1176; D Fischel, "Efficient CapitalMarket Theory, The Market for Corporate Control and the Regulation of Cash TenderOffers" (1987) 57 Texas L Rev 1 at 30. For a critique of the market for corporate control as adiscipline on corporate governance, see J Coffee, "Regulating the Market for CorporateControl: A Critical Assessment of the Tender Offer's Role in Corporate Governance" (1984)84 Colurn L Rev 1145 at 1203-1204.


assets to more efficient uses by the successful bidder.74 Inefficient managers are thusdisplaced. The incentives of the successful bidder to exercise the property rightsassociated with his or her shares (that is, voting rights and rights to appoint directors)cease to be distorted by collective action problems or the passivity of other investors.75

Therefore the efficiency claims for takeovers depend primarily on the security of tenureof the corporation's managers, and on the existence of a person able to take control andimplement policies that maximise corporate value. When the enterprise is owned bythe state, control is not dispersed but centralised in the hands of the government. Thegovernment generally can act swiftly to replace bureaucrats or the directors ofcorporatised enterprises.76 Property rights theorists may object that governments lackincentives to manage efficiently. Even if we accept this, bureaucratic inefficiency mustbe balanced against the high premiums in the market for corporate control. Which sidethe balance favours is unclear. To assume market superiority would smack of the"reverse-Nirvana" fallacy of weighing imperfect, real governments against perfect, nonexistent markets.77 Various commentators have shown that governments privatisingpublic enterprises have retained powers that thwart any discipline imposed by themarket for corporate control.78 The main example is the "golden" share retained by theGovernment, which enables it to eliminate hostile takeovers it does not favour. The"golden" share demonstrates that the experience of crossing from public to ~rivate

often has different results to those which economic theory suggests are desirable. 9

While it seems intuitive to think that the organisation with more efficientgovernance is the preferable structure, this depends on the "other things" being equal.

74

75

76

77

78

79

H Manne, "Some Theoretical Aspects of Share Voting" (1964) 64 Colum L Rev 1427;A Alchian, above n 20 at 825; F Easterbrook and D Fischel, above n 2, ch 5.A collective action problem implies that the achievement of something for the collectivegood of a group is hindered by the structure of the group itself. This can occur where thenumber of members in the group is large. If co-ordination of the group is costly, a commongood may not be achieved because individual members lack sufficient incentives to attainthe good personally: M Olson, The Logic of Collective Action: Public Goods and the Theory ofGroups (2nd ed, 1971); B Black, "Shareholder Passivity Re-examined" (1990) 89 Mich L Rev520.See, eg, Government-Owned Corporations Act 1993 (Qld), s 94; State Owned EnterprisesAct 1992 (Vic), s 30. For anecdotal evidence, see R Wettenhall and I Beckett, "Movement inthe Public Enterprises and Statutory Authority Sector" in J Halligan and R Wettenhall(eds), Hawke's Third Government (1991), ch 8 at 222-224 (expeditious removal of the formerManaging Director of OTC, George Maltby). The termination of public officials'appointments depends on a number of issues, including whether the employee is theholder of an "office", the legislation governing the appointment, and the terms of thecontract of employment: E Campbell "Termination of Appointments to Public Offices"(1996) 24 F L Rev 1.H Demsetz, "Information and Efficiency: Another Viewpoint" (1969) 12 JL & Econ 1 at 1..3.Cf M Eisenberg, above n 57 at 1525-1526.C Graham and T Prosser, "Privatising Nationalised Industries: Constitutional Issues andNew Legal Techniques" (1987) 50 MLR 17; M Taggart, "Corporatisation", above n 19. Theretention of the golden share may reflect naive beliefs amongst the public that "the people'sassets" should stay in the hands of "the people" (ie, in the hands of a wide group ofdiversified shareholders), not those of a single entity. Such a belief fails to acknowledgethat such a situation permits real control to remain in management's hands, not "thepeople's" hands.See above text accompanying nn 62-65.


Our analysis has shown that the ceteris paribus assumption has no place in privatisation.One cannot compare public with private, if the object is to consider the effect ofcrossing between the two. One must study the implications of the crossing itself.Sectional interests frequently drive the ftrocess, especially when determining themarket structure and pricing the offering. 0 Farrar and McCabe's conclusion that thestate should reconsider its role in the economy cannot therefore be given theoreticalimprimatur.81 Such conclusions demand broader analysis of the costs and benefits ofprivatisation. Scholars, including exemplars of the law-and-economics school, haveargued that the incomplete nature of managerial contracts, potential final periodproblems, and various aspects of share pricing confine exclusive reliance on marketmechanisms for the governance of shareholders' contracts with management.82

Working from a different tradition, Eisenberg states that "neither markets, morals, norlaw are in themselves sufficient to curb ... conflicts." He adds: "Taken together,however, markets, morals, and law have shown themselves capable of achieving thatobjective."83

It is necessary to examine the contracts that are formed, and the law that applies tothose contracts. Contractarian theory is, after all, a theory of contracts. Efficiency claimsmade for privatisation depend on the effects of the law applicable to the managementof enterprises in public and private ownership. The differences between these bodies ofsubstantive law may affect the conclusions drawn from applying an economic theoryof governance to privatisations. Claims that private is preferred to public ownershiprequire consideration of the duties imposed on officers by the substantive law.

II BETWEEN SCYLLA AND CHARYBDIS: PUBLIC INTERESTS ANDPRIVATE DISCRETIONS IN CORPORATIONS

Law and policy in managerial discretion

Part I of the article showed that contractarian theory cannot be used to justifyprivatisation on efficiency grounds. Much of the analysis was concerned with the effectof markets on the evolution of efficient governance structures. The basic argument wasthat although markets are important to the control of managerial opportunism, and themanner of sharing the residual costs of opportunism, it does not follow that privateownership reduces the agency costs of management. Privatisation may have otheradvantages, however, besides those Farrar and McCabe claim for it. The policies of thegovernment of the day may significantly constrain the enterprise management frommaking the decisions that best serve its residual claimants and customers.84 In contrast,

808182

8384

See above text accompanying nn 38-45, 62-65.JFarrar and B McCabe, above n 11 at 43.F Easterbrook and D Fischel, above n 2 at 91; D Fischel, "Insider Trading and InvestmentAnalysts: An Economic Analysis of Dirks v. Securities and Exchange Commission" (1984)13 Hofstra L Rev 127 at 130-131.M Eisenberg, above n 57 at 1525.See, eg, D Bas, Privatization: A Theoretical Treatment (1991) at 7-8, T Frankel, "Symposium: ARecipe for Effecting Institutional Changes to Achieve Privatization: Foreword" (1995) 13Boston Uni Int LJ 295 at 299-300. Political parties do not have to "buy" the government, as abidder might, in the market for corporate control. Politicians holding offices in theexecutive government therefore rarely accrue significant wealth effects from their ownpolicy decisions. Their attenuated property rights in the assets they manage lead to


corporate governance structures confer significant discretion on senior managers anddirectors. An arguable case can be advanced for privatisation on the ground that thisgreater managerial discretion is a precondition of efficient management. The morediscretion is confined, the harder it is to make the "best" decisions at the time they aretruly needed. Just as policy might constrain efficient management, so too may the law.As we shall see, corporate law traditionally has placed only minor constraints on theexercise of the discretion conferred on management. That discretion has been regardedas an entitlement, emanating from contract, that the board of directors is entitled toenforce and protect.85 The discretion of public decision-makers is subject to judicialreview in accordance with the rules and precepts of administrative law.86 Such adichotomy depicts a larger theme in liberal theory that those exercising powers in thepublic sphere need to be restricted, to protect and promote the liberties of those inprivate spheres.87 While the corporation and executive government are bothhierarchies,88 some libertarians view the former as benign since individuals choosetheir associations with such hierarchies.89

This discussion helps to illustrate the idea, foreshadowed at the end of Part I, thatthe structure of the law has a powerful influence on arguments for or againstprivatisation. The law has a crucial role in delineating the legitimate bounds and usesof managerial discretion. A contractarian view of corporate law takes this idea onestage further. It holds that the law should permit shareholders and managers to definethese bounds by contract, and to agree whether there should be any right to remedies ifthese bounds are transgressed. If a claim made in favour of privatisation depends onthe benefits of liberating management discretion from restrictive policy and review, thestructure of Australian corporate law needs to be examined. In particular, attentionmust be directed to the grounds for the judicial review of managerial and othercorporate decisions, the interests that may be represented in that review process, andthe penalties for transgression of the bounds of legitimate authority. We demonstratehow the answers to these questions seem to be changing, and that the emerging

8586

87

88

89

inefficient resource allocation. Additionally, government decision-making may beunnecessarily risk averse, because politicians' human capital is not diversified.Government-owned corporations legislation sometimes reserves a power to the Minister todirect the Board to take a decision which the Board considers is not in the commercialinterests of the corporation: see, eg, State Owned Corporations Act 1989 (NSW), s 11. Asimilar power is reserved to the Minister under the Telstra privatisation legislation: seeabove n 7.John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113 at 134 per Greer LJ.For an early economic analysis of why the discretion of public decision-makers should bemore restricted, see A Alchian, above n 20 at 827-828. Administrative review is seen bysome as a major source of inefficiency in public management: R Cole, "The Public Sector:The Conflict Between Accountability and Efficiency" (1988) 47 Aust J Pub Admin 223. CfM Allars "Private Law but Public Power: Removing Administrative Law Review fromGovernment Business Enterprises" (1995) 6 Pub L Rev 44.This is based on the centrality of the protection of individual liberties in liberal theory andis reflected in the "closure" rule which applies to public entities: that is, anything which isnot permitted is proscribed: see above n 18.See generally G Frug, "The Ideology of Bureaucracy in American Law" (1984) 97 Harv LRev 1277.See, eg, F Hayek, The Constitution of Liberty (1960) at 258-262; 3 F Hayek, Law, Legislation andLiberty (1979) at 77-89. Hayek excluded private monopolies from this view.


structure of corporate law discernibly embodies principles that resemble those ofadministrative law. We describe this as the "publicisation" of corporate law.

Because the developments studied in this article are significant in their own right,they invite examination from a policy perspective. However, policy examinationdepends on a model of corporate law that makes explicit the interests served bycorporate law. The next section discusses competing models. We consider that thearticulation of a coherent model of corporate law is necessary if questions concerningthe role of corporations and corporate law in privatisation are to be addressedintelligently. In the absence of governmental control or regulation of the privatisedentity, the law applying to the privatised entity may be required to mediate betweenthe interests of the residual claimants of the entity and others affected by the exercise ofmanagerial discretion. Thus, if the corporation is the form selected, these issues need tobe addressed within the substantive structure of corporate law. An understanding ofthe interests that corporate law serves, and those it has the capacity to serve, is essentialto important policy decisions of the Commonwealth government. These include thereform of corporate law, the role of corporate law and other regimes in the regulationof privatised entities, and, indeed, whether or not to privatise.

Theories of corporations and corporate law

The article has already discussed the contractarian theory of the corporation. In thistheory, the corporation is a focal point for a process of market contracting. Becausethese contracts are bilateral agreements between rational individuals, the regulation ofthe corporation conflicts with liberal values emphasising freedom of contract.Identifying an opposing ideal that supports greater regulatory involvement incorporate affairs is less straightforward. An assertion made by some contractarians isthat those who endorse statism in corporations adhere to a "concession" theory.90 Inthat theory, the corporation is regarded as a concession of the parliament, havingneither existence nor rights, except to the extent of sovereign recognition of these.Although that perspective finds echoes in contemporary doctrine,91 few contemporarytheoreticians have justified their arguments on the basis of concession theory.92 Brattoncorrectly observes that the easy denunciation of concession theory by contractarians"wins some points, but it fails to win any points worth making."93

90

91

92

93

See, eg, H Butler and L Ribstein, above n 2 at 8-10, R Hessen, "A New Concept ofCorporations: A Contractual and Private Property Model" (1979) 30 Hastings LJ 1327. Thesame point has been made "by at least one Australian "contractarian" scholar: seeJ Mannolini, above n 9 at 17.See, eg, Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR 146 at 171-172;Nicholson v Permakraft (NZ) Ltd (in liq) (1985) 3 ACLC 453 at 459. In constitutional cases, seeBank of NSW v The Commonwealth (1948) 76 CLR 1 at 202 per Latham CJ; Huddart, Parker &Co Pty Ltd v Moorehead (1909) 8 CLR 330 at 394 per Isaacs J. A concession theory seems topervade New South Wales v The Commonwealth (1990) 169 CLR 482.W Bratton, above n 2 at 434-435. However cf S Bottomley, "Taking Corporations Seriously:Some Considerations for Corporate Regulation" (1990) 19 F L Rev 203 and M Lipton and SRosenblum, "A New System of Corporate Governance: The Quinquennial Election ofDirectors" (1991) 58 U Chi L Rev 187.W Bratton, above n 2 at 434.


What ideal underlies more active corporate regulation? There is no single answer tothis question for much turns on whether or not one regards corporations organically.94An organic approach uses larger structures and groupings as the appropriate unit forpolitical and social analysis. While such views do not ignore the existence of individualinterests, the significance of these is reduced by their perceived consonance withcollective interests; individual concerns are transcended by and logically subsequent tothe group's concern.95 When organicism is applied to corporations, the resulting ideal(sometimes described as corporatism) involves a limited number of hierarchies, eachrepresenting different interests, but which function in a cooperative, communal way inthe larger polity.96 Organicism vies with an individualist orieIltation. Larger scalestructures, such as hierarchy, are justified only to the extent that they advance theinterests of individuals.97 This pluralist perspective differs from corporatism because itassumes that individual interests conflict; in consequence, those groups or hierarchiesin which individual interests are represented will compete with each other. As Romanonotes, shifting coalitions and free entry and exit of organisations in markets and politicsare necessary for the representation of all interests.98 The conflict between pluralist andcorporatist paradigms can be observed in debates regarding corporatisation versusprivatisation. Advocates of the former see the corporation as a means of pursuingsocial welfare. Privatisation assumes that a narrow conception of stakeholders ispreferable.99

Contractarian theory is obviously pluralist. It would be incorrect, however, toassume that contractarianism is coterminous with pluralism. lOO Indeed, Alchian andDemsetz's neo-classical formulation of the firm purposefully deprived hierarchicalconcepts of significance. lOl If one takes a pluralist view, defining an appropriate rolefor government is difficult. Given the coercive and monopolistic quality of government,pluralists generally distrust government. However, a legitimate role for governmentmay exist to remedy market failure. Governments can coerce persons to internalise theexternal effects of their production and consumption decisions on those who are notparties to these exchanges. They can also promote the production of public goods (thatis, goods which have positive external effects). Markets may under-produce these inconsequence of the difficulties producers have in excluding others from using them. l02

94

9596979899

100

101

102

This analysis draws on the seminal comparison of corporatism and pluralism by ProfessorRoberta Romano: R Romano, "Metapolitics and Corporate Law Reform" (1984) 36 Stan LRev 923.Ibid at 931.Ibid at 934-937.See above text accompanying nn 87-89.R Romano, above n 94 at 940.For example, contrast J Farrar and B McCabe, above n 11 and M Taggart,"Corporatisation", above n 19.For a sharp critique of the individualistic basis of contractarianism, see A Wolfe, aboven 14 at 1687-1688.W Bratton, above n 2 at 417-419. It seems neither author really wants much to do with thatextreme position: H Demsetz, "The Theory of the Firm Revisited" in a Williamson andS Winter (eds), The Nature of the Firm: Origins, Evolution and Development (1993) 159 at 170; BKlein, R Crawford and A Alchian, "Vertical Integration, Appropriable Rents, and theCompetitive Contracting Process" (1978) 21 JL & Econ 297.The role for government defined by these externalities was profoundly shaken by thefamous Coase theorem, which asserts that bargaining among private parties can, and in


It is the existence of externality which defines views of corporations and corporate lawthat do not partake of the normative implications of contractarianism.

Given Adolf Berle's eventual conversion to corporatism,103 it is ironic that hisclassic, The Corporation and Private Property,104 co-authored by Gardiner Means, formedthe intellectual credo of an essentially pluralist, pro-regulation view of corporations,often described as a "managerialist" theory of corporation.105 Management became thestrategic centre of the corporation. It dominated the hierarchical bureaucracy, andimposed externalities on those outside the corporation. l06 This managerial view was,until the advent of contractarianism, unquestioned by either the advocates oropponents of regulation. The only difference was that opponents asserted thatmanagement would act responsibly, and function more effectively without additionalforms of accountability.l07 Advocates of regulation, the anti-managerialists, saw thecorporation as being a public entity, needing additional legal controls to coerce theinternalisation of external effects.108 This anti-managerialist view of the corporationremains pluralist. The interests of individuals - shareholders - remain paramount.Legal controls, and statism generally, found their legitimation in improving the welfareof shareholders. It follows that contractarians and anti-managerialists differ not in theappropriate ends, but in means. Contractarians assert that managerial hierarchy is nota source of externalities, because wealth effects are impounded in prices. Even if thatview were wrong, contractarians regard the mandatory controls that antimanagerialists propose as inevitably being less apt to ~rotect shareholders' intereststhan the choices that shareholders make for themselves.1 9

Corporate law as a mediator between constituency interestsThe reference to means and ends at the close of the last section is a key issue in thisarticle. The individual interests pluralistically represented in corporations tend to besynonymous with the interests of shareholders. This issue has been controversial sincethe early 1930s when it was debated by Berle and Dodd.110 Hill has argued that

103104105

106107108

109110

the absence of transaction costs, will, lead to the optimal social outcome: R Coase, aboven 3. Compare R Coase, "1991 Nobel Lecture: The Institutional Structure of Production"reprinted in 0 Williamson and S Winter (eds), above n 101, 227 at 232.R Romano, above n 94 at 936-938.Above n25.W Bratton, "The New Economic Theory of the Firm: Critical Perspectives from History"(1989) 41 Stan L Rev 1471 at 1493.W Bratton, above n 2 at 413.See generally G Frug, above n 88 at 1317-1322.W Bratton, above n 2 at 414, 437-438; C Stone, "Corporate Vices and Corporate Virtues: DoPublic/Private Distinctions Matter?" (1982) 130 U Fa L Rev 1441. Bratton notes that the antlmanagerial view of corporations as public bodies existed in two forms. One form saw thecorporation as functionally identical to the governmental hierarchies: see R Nader,M Green and J Seligman, Taming The Giant Corporation (1976) at 7. The other, weaker, formregarded the "public" as having a legitimate interest in the protection of reasonableexpectations and the maximisation of efficiency: see above n 2 at 437-438.R Romano, above n 94 at 930.See J Weiner, "The Berle-Dodd Dialogue on the Concept of the Corporation" (1964) 64Colum L Rev 1458. Note that Berle's corporatist views emerged after the debate with Dodd.See A Berle, The 20th Century Capitalist Revolution (1954) at 164-88.


Australian law protects wider interests than merely those of shareholders.111 However,the case she puts for it is not compelling even in purely positivistic terms. The strongestexample that Hill gives of a wider conception is the limited duties to creditors ofinsolvent companies. With respect, I find that case supports a limited conception, sincein insolvency, creditors become the residual claimants. Creditors supplantshareholders, and succeed to their rights.112 Hill also refers to cases which imply that adirector has a wider duty than to act in the shareholders' interests alone.113 Here, too, itis difficult to be convinced. The cases cited in support of the argument tend not toimply any duty enforceable by other constituencies. On the contrary, these cases arefundamentally pro-managerialist, and imply, at least in the context of the takeoversthey have involved, a broad managerial discretion with which courts do not readilyinterfere.114 We do not disagree that Australian law may be moving towards a widerconception of the corporation. However, we would cite very different evidence to thatrelied on by Professor Hill, and we do not share her optimism about the benefits ofthese new directions.

The purpose of the above is not to suggest that non-shareholder interests areunimportant but to highlight a historical absence of them from the conception of thecorporation that is central to Australian law.11S Such a conclusion accords with acontractarian perspective. Professor Macey has argued that fiduciary duties are owedto shareholders alone because they face the greatest difficulties in contracting withmanagement.116 The fiduciary duty thus fills gaps in a largely unspecified relationalcontract.117 Shareholders contract on identical terms, have no opportunity for periodicre-negotiation, and cannot withdraw assets from the corporation until itsliquidation. lIB Macey acknowledges that other constituencies also contract relationally,and in these cases, too, courts fill gaps, albeit not by the use of fiduciary duties.119

Nonetheless, not every constituency has a contract with the corporation; alternatively,for reasons of contracting costs, some contracts simply are not viable to negotiate. Thecommunity is the obvious example of such a constituency. In these cases, corporate lawsimply ignores these constituencies. Either their interests are assumed to align with the

111

112

113114

lIS

116

117

lIB

119

JHill, above n 8 at 212-217. See also S Fridman, "Super-Voting Shares: What's All the FussAbout" (1995) 13 C & S LJ 31.See 0 Williamson, "Corporate Governance and Corporate Finance" (1988) 43 J Fin 567. Forshareholders to remain the sole constituency in insolvency would lead to inefficientoutcomes. Under conditions of limited liability, shareholders do not bear wealth effects oftheir actions. See also M Whincop, "A Transaction Cost Rationale for the Insolvent TradingProvisions" (1997) 5 GrifL Rev forthcoming.JHill, above n 8 at 216.See below text accompanying nn 183-186. For a similar view, see JGordon "Corporations,Markets and Courts" 91 Colum L Rev 1931 at 1977.Cf D Millon, "New Directions in Corporate Law: Communitarians, Contractarians, and theCrisis in Corporate Law" (1993) 50 Wash & Lee L Rev 1373 at 1374.J Macey, "An Economic Analysis of the Various Rationales for Making Shareholders theExclusive Beneficiaries of Corporate Fiduciary Duties" (1991) 21 Stetson L Rev 23.See also F Easterbrook and D Fischel, "Contract and Fiduciary Duty" (1993) 36 J L & Econ425; I Macneil, "Contracts: Adjustments of Long-Term Economic Relations Under Classical,Neoclassical and Relational Contract Law" (1978) 72 Nw UL Rev 854.o Williamson, The Economic Institutions of Capitalism (1986) at 304-306; Whincop,"Criminalisation", above n 9 at 275.JMacey above n 116 at 40. See also A Schwartz, above n 3; R Scott, above n 3.


interests that corporate law does protect, or their interests are protected in some otherway. Coffee states that:

For decades, reformers from Adolf Berle to Ralph Nader have sought to increase thepower of shareholders to control corporate managers by a variety of means, includingincreased disclosure, independent directors, and reform of the proxy process.... [F]or atleast some of these reformers the motivation underlying their pursuit of increasedshareholder power was the assumption that shareholders had interests and values thatcoincided with those of the unrepresented constituencies they chiefly wished to protect(such as local communities, the poor, or the environment).120

We do not suggest that shareholders' interests are always antagonistic to those ofthe community. It is sufficient for us that there will be cases where they may be.121 Webelieve that this possibility is a sufficiently strong one to require consideration. It iseasy to envisage the demands of earning a risk-adjusted return on capital competingwith communitarian or equitable considerations. In the context of privatisation, thispoint is a central issue. As a business enterprise moves from private to public control, itpasses from a regime where it was responsible and accountable to a Minister of theCrown (who is responsible to parliament), to a regime where the primary, perhapsonly, responsibility has historically been to shareholders. It should be apparent thatthere is potential for interests represented in the political process to fall through thecracks of corporate governance. While governments may seek to contract with thenewly privatised entity as a means by which to seek to protect community interests,those contracts face similar limitations to those of all other relational contracts.122

Circumstances change unforeseeably in a way that creates scope for opportunism inperformance and re-negotiation. It is possible to conceive community interests beingaddressed through direct negotiation, but ~roblems of collective action are most acutewhen a group is large and dispersed.1 3 If contract and direct negotiation areinadequate, two possibilities remain for the representation of interests. One can bestyled as public, the other, private.

The public approach is through the political process or through economicregulation.124 Yet, there are problems and ironies here. The avoidance of these political

120

121

122

123124

JCoffee, above n 1 at 107-108. See also D Millon, above n 115 at 1375; W Simon, "WhatDifference Does it Make Whether Corporate Managers Have Public Responsibilities?"(1993) 50 Wash & Lee L Rev 1697 at 1698.E Orts, "The Complexity and Legitimacy of Corporate Law" (1993) 50 Wash & Lee L Rev1565 at 1622; J Macey, "Externalities, Firm-Specific Capital Investments, and the LegalTreatment of Fundamental Corporate Changes" [1989] Duke LJ 173.N Deakin and K Walsh, "The Enabling State: The Role of Markets and Contracts" (1996) 74Pub Admin 33 at 36-8. On the use of contract in the regulation of a privatised entity, seeC Graham and T Prosser, Privatising Public Entities: Constitutions, the State and Regulation inComparative Perspective (1991) at 164-171. Proponents of the New Managerialism argue thatcommunity obligations are best addressed explicitly by contracts. The NationalCommission of Audit stated that "community service obligations can be met through atendering process and explicit budget funding rather than through hidden crosssubsidies": above n 6 at 24.See above n 75.Macey argues that the political process is the proper place for communities to address theirconcerns: above n 116 at 42-43. He does not see any inconsistency between this conclusionand a contractarian theory of corporate fiduciary duties: see above text accompanyingnn 116-119.


constraints on managerial discretion and policy provides a key rationale forprivatisation.125 The efficiency problems of economic regulation are well known.126 Inthe political process, the privatised entity might be thought to wield considerableinfluence in its own right. The private approach involves corporate law as a means ofmediating between interests, in much the same way as administrative law might beregarded as mediating between interests in public spheres.127 We have alreadyexpressed our conclusion that corporate law historically has not offered thesepotentialities.128 Indeed, it is corporate law's narrow focus on the manager-shareholderrelationship that permits it to be regarded as private law that supplements privatecontracts. However, it is our opinion that this conclusion is changing. We demonstratethis in the next part of our article. Our normative analysis should not be regarded asadvocating corporate law as a mediator between conflicting interests. Indeed, ourinclination is to the contrary, primarily because of the limitations of judges who arerequired to undertake these difficult tasks. However, we believe that it is important torecognise that corporate law can be made to serve such a task, and that, having regardto its new directions, it may well be required to do so. If there is merit in our analysis,two things follow. The first is to consider whether corporate law is the appropriatecorpus of law to address these questions. If the answer is less than enthusiasticallyaffirmative, there is an occasion to consider whether privatised entities deserve a morespecialised regime, perhaps closer in spirit to Government Owned Corporationslegislation.129 The second question is whether a corpus of corporations law with asuitable "mediating" capacity is appropriate to other corporations with no significantexternal effects. Will the "new" corporate law simply make it harder in these cases forparties to contract with each other regarding property rights?130

125126127

128129

130

See above text accompanying nn 85-89.See above n 45.That corporate law may serve such a function is the premise of "communitarian" corporatelaw scholars. For references, see D Millon, above nIlS at footnote 40 and 1387. Millondescribes communitarianism as liberal and individualistic; however, it regards market"resolution" of social problems as inadequate: ibid at 1378, footnote 20. For a critique, see SBainbridge, "Trust, Community, and Statism in Corporate Governance Scholarship: AConservative Contractarian Critique of Progressive Corporate Communitarianism" (1996)71 Cornell L Rev forthcoming.See above text accompanying nn 111-113.See generally S Bottomley, above n 19 at 530. Bottomley argues that it may be desirable todistinguish between different types of government owned corporations, depending ontheir functions. However, the challenge of providing for an efficient, tailored regulatoryscheme may be undermined by the political activities of rent seeking coalitions.Bratton expresses this point very clearly. He notes that the recognition of an externality ofsome sort should not be treated as a cue for introducing a remedial tort. It is insteadnecessary to consider other means of legal recognition: see W Bratton, "Confronting theEthical Case Against the Ethical Case for Constituency Rights" (1993) 50 Wash & Lee L Rev1449 at 1467-1468. See also E Orts, above n 121 at 1623.


III FROM PRIVATE TO PUBLIC: THE PUBLICISATION OFCORPORATE LAW

Corporate law and administrative lawIn this Part, we focus on four recent developments of significance to corporategovernance. First, we consider the modern reformulation of the officer's duty of care.Second, we consider the officer's duty of propriety under the Corporations Law. Third,we consider limitations on shareholders' entitlements to alter articles of association.Fourth, we consider the standing of shareholders and others to bring litigation onbehalf of, or against the corporation. In these areas, corporate law has been changingsignificantly in recent years, both in the courts and in the Federal Parliament.

These developments are relevant to this article in several ways. We have assertedthat one of the key grounds for the advocacy of privatisation is managerial discretion.Corporate law has historically been characterised by courts refusing to intervene incorporate matters, except in cases of legal or equitable fraud. That policy is sometimesdescribed as the internal management rule.131 The rule applied not only to directors'exercises of discretion, but also to shareholders exercising their own powers in thegovernance structure. Thus, the limitation of such discretion by these recentdevelopments is important. A second, related matter is the way in which a courtexercises its power of review. Our analysis shows that not only is judicial review ofcorporate decisions increasing, but that grounds of review are undergoing ametamorphosis. In particular, new grounds of review resemble those familiar fromadministrative law, such as a review of the procedure of decision-making.132 A finalmatter which affects the content and application of these grounds of review is theinterests advanced by these developments. Although the internal management rulehad the indirect effect of chilling incentives to litigate (so depriving us of a large bodyof case law from which to extrapolate), courts have historically told directors that theyare required to act in the best interests of shareholders.133 Yet, the grounds for reviewin the "new" law seem not to serve, or at least they serve very equivocally, the welfareof shareholders. We are interested in whether this new model of judicial review has thecapacity to serve a wider conception of the corporation. In our analysis of thesedevelopments, we will employ a contractarian model to analyse how these cases effectthe governance of the corporation. To return to the theme of this article, three centralissues in corporate law - managerial and shareholder discretion, grounds and methodof judicial review, and represented interests - are crossing, or perhaps changing thelocus of, the line between public and private.

The notion that corporate and administrative law are based on common concerns isnot new. Professor Frug argues that the two corpora explain and justify bureaucratic

131132

133

See, eg, Burland v Earle [1902] AC 83 at 93.As mentioned in n 17 above, Sealy has also noted that judicial review of director decisionmaking relies less on the absence of bona fides, and more on the propriety of purpose of thedirectors: L Sealy, above n 17. The concept of proper purposes has evolved considerablysince Sealy's article was written, and is discussed below in connection with thejurisprudence of s 232(6) of the Corporations Law, the decision -in Gambotto v WCP Ltd(1995) 182 CLR 432, and the proposed reforms to shareholders' entitlements to bringderivative actions.See, eg, Ngurli v McCann (1953) 90 CLR 425 at 438.


power, and assuage the fears provoked by such power.134 Frug describes four modelswhich explain and defend corporations and administrative agencies, and the lawapplying to them. Of these models, two are particularly important to this article. One isa judicial review model in which bureaucratic power is limited by judicial review andinvalidation according to law.135 The other is a market/pluralist model in whichbureaucratic power is limited because markets and the political process disciplinemisuse of such power.136 Although Frug argues that all of these models are used tolegitimate public and private bureaucracies, the judicial review model in Australiancorporate law has been more circumscribed than in administrative law. The internalmanagement rule suggests such a conclusion. Some consider this to be a seriousdeficiency.137 The majority of writers, if they consider it at all, seem to accept it ascommonplace. In considering Australian law, however, Bottomley arrxes that rules ofstandin~ in corporate and administrative law have much in common. 38 As we discussbelow,1 9 standing is crucial as a case study in the publicisation of corporate law.Standing also has a catalytic effect on the other substantive law developments. Inparticular, for these developments to accommodate wider interests, theseconstituencies need to be able to bring actions asserting these new grounds of judicialreview.

The modern reformulation of the officer's duty of careEasterbrook and Fischel have described one of the puzzles of corporate law:

Courts apply [to managers] ... a hands-off approach that judges would not dream ofapplying to the decisions of administrative agencies. Yet administrative officials do notstand to profit from their decisions - and therefore, one might think, are not subject tothe pressures that cause managers' goals to diverge from those of investors. So courtsride herd on disinterested administrators while leaving self-interested managers alone.What can be going on?140

Th~ "hands-off" approach is an accurate portrayal of the duties of directors to exerciseskill and care, at least as they were articulated in the historic decision in Re CityEquitable Fire Insurance Corporation.141 That case is authority for two crucialpropositions. First, a director will be negligent only where she is cognisant ofcircumstances of such a plain and simply appreciated character that no reasonableperson would have made the decision in question.142 Second, a director is entitled to I

rely on the judgment, information and advice of other persons involved in themanagement of the corporation, unless there is a strong reason to be suspicious.143

134

135136137138

139140141142143

G Frug, above n 88. See also G Frug, "The City as a Legal Concept" (1980) 93 Harv L Rev I

1057. It will be noted that contractarianism is but the latest in a series of constructsdesigned to legitimate bureaucratic power. It achieves this by the unorthodox tactic ofdenying such power exists.G Frug, above n 88 at 1283 and 1334-1355.Ibid at 1283-1284 and 1355-1377.See, eg, I Eagles, "Public Law and Private Corporations" [1986] eLJ 406 at 406.S Bottomley, "Shareholder Derivative Action Actions and Public Interest Suits: Two I

Versions of the Same Story?" (1991) 15 UNSWLJ 127.See below text accompanying nn 238-280.F Easterbrook and D Fischel, above n 2 at 2.[1925] Ch 407.Ibid at 428.Ibid at 429.


These principles might be described as irrationality standards - they subject to liabilitythose decisions, whether substantive or concerning delegation, that have no rationalbasis.144 Although they take the form of a lower positive standard, they serve a similarpurpose to the defence known in the United States as the business judgment rule.145

Expressing principles in these terms serves to repose a great deal of discretion inmanagement and directors, because review of the exercises of that discretion wouldonly occur in exceptional circumstances. The principles are thus consistent with theidea that corporations are potentially superior to public bureaucracies because of thegreater scope of management discretion.V16

The principles can be defended on economic grounds.147 Any set of judiciallyadministered standards of care involves two possible error types. One is a failure tosubject a negligent defendant to liability; the other is subjecting to liability a defendantwho exercised reasonable care.148 The object is to minimise the costs of these two typesof errors (respectively described as Type I and Type II errors), plus the cost ofadministering the standard.149 On the basis of these standards, the old law had a greatdeal in its favour. Its outcomes were generally predictable - only very clear cases werenegligent. This decreased the cost of administering the standard. Its "laxity" reduced tovanishing point the cost of Type II errors. Obviously, the possibility of Type I error wascomparatively high. Yet, the implications of this standard (that is, the f<0ssibility ofincremental losses from negligence) might be anticipated in share price.1 0 Given thaterrors of judgment can sometimes produce inadvertent gain as well as loss, adiversified shareholder would eliminate or substantially reduce the cost of errors. Incontrast, more onerous standards transfer risk to the manager. The manager isincapable of diversification, because the manager works for one corl§0ration at a time,in which he or she makes significant investments of human capital. 51 The manager istherefore the more expensive bearer of such risk. Unable to diversify, the manager canonly reduce that risk by an insurance policy, or by making more risk-averse decisions.The latter course is unlikely to be in shareholders' interests.

144

145

146147

148

149150151

M Whincop, "Duties of Care", above n 9 at 81-82. For a recent application of an irrationalitystandard, see Wayde v New South Wales Rugby League (1985) 3 ACLC 799.See, eg, Graham v Allis Chalmers, 188 A 2d 125 (1963); Sinclair Oil Co v Levien, 280 A 2d 717(1971); Aronson v Lewis, 473 A 2d 805 (1984); Cede & Co v Technicolor, 634 A 2d 345 (1994).Although articulated in cases involving breaches of the duty to act in the best interests ofthe corporation, Anglo-Australian courts have similarly held that they are not tribunals forthe review of bona fide business judgments: Harlowe's Nominees Pty Ltd v Woodside (LakesEntrance) Oil Co NL (1968) 121 CLR 483; Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC821. See also Corporate Law Reform Act 1992 Explanatory Memorandum at para 87 andCorporations Law s 1318.See above text accompanying nn 84-89.One of us has done that: see M Whincop, "Duties of Care", above n 9. See also K Scott,"Corporation Law and the American Law Institute Corporate Governance Project" (1983)35 Stan L Rev 927.K Davis, "Judicial Review of Fiduciary Decisionmaking - Some Theoretical Perspectives"(1985) 80 Nw UL Rev 1.Ibid at 25-29.This is the pricing argument: see above text accompanying nn 51-56.See above text accompanying nn 48-50.


However, these standards seemed to be a source of discontent.152 This discontentfound utterance in the last decade when a new line of authority was articulated.Directors are expected to take reasonable steps to be informed of matters relevant tothe corporation and the director's office. This principle originally emanated from"insolvent trading" cases,153 in which directors were held personally liable for debtscontracted in insolvency. Legislation required the plaintiff to prove that reasonablegrounds existed to expect the insolvency of the corporation.154 This inferentiallyrequired a director to be aware of the corporation's financial position, and to beinformed of the implications of matters to which a reasonably prudent director wouldattend.155 The litigation in AWA Ltd v Daniels156 provided a more direct considerationof directors' duties of care. On appeal, Clarke and Sheller JJA imposed an onerous dutyfor a director to be personally informed.157 While the duty to be informed of corporateaffairs is an ongoing requirement, directors must also take special care of matterswhere a reasonably prudent person would be on guard. In these cases, reliance on thejudgment of others is unacceptable.158 The impossibility of delegating the duty to beinformed breaks with the City Equitable irrationality standards, and reverses JusticeRogers's approach.159

It is possible to view these principles as a change in the norms llnderlying corporatelaw. The more onerous standard creates a more intrusive judicial review model, andqualifies the discretion of directors. In this respect, the restriction on delegation isparticularly important. The principles underlying this restriction seem to be Eredicatedon a largely unspecified normative model of corporate decision-making. 60 In thismodel, directors are monitors, and their monitoring function must be performedpersonally. By mandating that certain decision-making power and monitoringresponsibilities be exercised at the board level, this IIlodel constrains the private

152

153154

155

156157

158159160

For connections drawn by courts between community opprobrium for mismanagementand revision of the law, see Statewide Tobacco Services Ltd v Morley (1990) 2 ACSR 405 at412-413,431; Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 115 at 126; AWA vDaniels (1992) 7 ACSR 759 at 875. See also Kirby P'S dissenting judgment in MetalManufacturers v Lewis (1991) 5 ACSR 255 at 271. The rhetoric of communitarianism is itselfsignificant.Corporations Law, ss 588G and 592; Companies Act, s 556.Companies Acts, s 556(1)(b); Corporations Law, s 592(1)(b). There was a correspondingdefence for the director: Companies Acts, s 556(2)(b); Corporations Law, s 592(2)(b).Metal Manufacturers Ltd v Lewis (1986) 11 ACLR 122 at 129-131; Statewide Tobacco ServicesLtd v Morley (1990) 2 ACSR 405 at 431-432 (affirmed on appeal (1992) 10 ACLC 1233 at1245-1247); Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 115 at 125-126; GrollpFour Industries Pty Ltd v Brosnan (1992) 8 ACSR 463 at 497-498, 509, 513.Daniels v Anderson (1995) 16 ACSR 607 sub nom AWA Ltd v Daniels (1992) 7 ACSR 759.(1995) 16 ACSR 607 at 666-667. Although the duty seems more imposing than the oneenvisaged by the trial judge, the revision may not be as great as it appears - seeM Whincop, "Duties of Care", above n 9 at 80-81. There is a grand irony about the Court ofAppeal's decision, which other commentators have not considered. While the Court ofAppeal identified a stronger conception of the duty of care, the effect of this was deleteriollsto the shareholders, because it was asserted· by a defendant seeking contribution from the'company plaintiff. This shows how non-shareholder constituencies can be the beneficiariesof more demanding requirements 'of directors and managers.(1995) 16 ACSR 607 at 666.(1992) 7 ACSR 759 at 868.M Whincop, "Duties of Care", above n 9 at 87-88.


ordering of governance structures. Such a focus on the "top" of the organisation mightalso be seen as a measure of accountability to those outside the managerial hierarchy.In other words, these principles use personal liability to prevent directors attributingblame for mistakes to lower levels of the organisation, so "bureaucratising" businessfailure.161

A public law perspective is also discernible in the fact that the duty to be informedhas what might be called an inherent procedural quality. As we have seen, courts havegenerally refrained from the review of decision-making unless the decision failedaccording to the irrationality standards. Thus, decision-making procedure was treatedas a black box. This was consistent with a philosophy that it is shareholders'responsibility to appoint competent directors.162 However, the articulation ofprinciples prescribing standards of informed decision-making departs from thisapproach. When a breach of the duty to be informed is pleaded, the court must reviewthe decision-making process itself. It must review the information a director relied onin making a decision. Judgments of the adequacy of informed decision-makingresemble the analysis of relevant considerations in administrative law.163 The positionhas not been reached where these considerations are enumerated or even ascertainableex ante, but the parallel exists.

This point is underlined by approaches to causation in these cases. Daniels vAnderson does not specify the nexus between the deficiency of information and thedamage suffered by the plaintiff. While damage is probably not a jurisdictional elementof a cause of action for breach of any contractual duty of care, or for establishing acontravention of s 232(4),164 it is a jurisdictional element of a negligence action; and thecorporation must prove damage if it alleges a civil cause of action based on breach ofs 232(4).165 Damage is relevant to causation questions raised by an application seekingan award of compensation or damages.166 The approach to causation questions is

161

162163

164

165166

However, at the same time, the law seems to be expanding towards the bureaucracy itself.The statutory duty of care in s 232(4), and other duties in the Corporations Law, apply to awider group than directors. The term "director" is defined expansively in s 60 to includeanybody, within or outside of the corporation, who gives directions or instructionsaccording to which the board is accustomed to act. The term can include a corporation: seeStandard Chartered Bank of Australia Pty Ltd v Antico (1995) 18 ACSR 1. It can also include aprofessional adviser or a bank: see generally P Koh, "Shadow Director, Shadow Director,Who Art Thou" (1996) 14 C & SLJ 340. The public law parallel is interesting: inadministrative law, decision-makers must not act on dictation. The so-called shadowdirector achieves a similar end by imposing all of the director's duties on such a person.Turquand v Mitchell (1869) 4 LR 4 Ch App 379 at 386.See, eg, Administrative Decisions (Judicial Review) Act 1977 (Cth) (ADJR Act), ss 5(1)(e),(h), 5(2)(a), (b) (cf s 5(3)); Padfield v Minister of Agriculture, Fisheries & Food [1968] AC 997;Murphyores Inc Pty Ltd v Commonwealth (1976) 136 CLR 1. In contrast, see Minister forAboriginal Affairs v Peko-Wallsend Ltd (1986) 66 ALR 299 at 310.Of the criminal offence constituted by a breach of the predecessor section of s 232(4), it hasbeen held that the prosecution must prove a foreseeable risk of harm as a result of the actsor omissions alleged to breach the section: Vrisakis v ASC (1993) 11 ACSR 162 at 211-212per Ipp J.Section 1317HD.While questions of causation do not (traditionally) arise in cases where compensation issought for breach of fiduciary duty, modern authority suggests the duty of care is not


inevitably obscure, because very few cases alleging breach of the duty of care are tried.Still fewer establish breach. Nonetheless, a recent authority, Permanent Building Societyv Wheeler,167 suggests an approach that may be taken.

In that case, a director failed to take reasonable care when in the context of an !

important decision before the board, he relied on information given to him by I

management and by another director. Reasonable care required him to seek I

independent advice. However, it was held that the breach did not cause damage, as thedecision would have remained the same even if the information that should have been I

obtained had been considered.168 The case thus involves the relationship between adecision causing damage to the corporation, and a failure to exercise due care byacquiring information relevant to that decision. An application of the doctrine of Icausation severed the nexus between the breach and damage. The crucial point is thatthe conclusion that the information would not change the commercial decision did notaffect the determination whether it was negligent for the director not to acquire the I

information. The apparent paradox is resolved only when it is understood that the I

duty to be informed is procedural: it requires compliance with a judicial conception ofcommercial propriety in decision-making. On the other hand, the substantive question I

of whether damage is caused can be analysed according to commercial realities. Such I

an approach has similarities to public law. It divorces the procedure for making the!decision from the substance and merits of the decision, in contrast to the traditional I

"black box" approach. The duty to be informed is thus exerting considerable pressure ~

on the traditional refusal by courts to review the commercial merits of decisionmaking.

Whose interests are served by the new law on the duty of care and the duty to be I

informed? One might assert that the duty serves shareholders by compelling greater I

diligence from directors. However, if one can breach the duty to be informed,!notwithstanding that the "negligent" act would have been taken anyway, the duty I

seems to have little to do with the interests of shareholders. In contrast, the duty to be ~

informed might advance a communitarian perspective. While shareholders are able to I

decrease or eliminate the risk associated with an individual corporation, the adverse I

consequences of a corporate decision on a local community, for example, are not I

similarly susceptible to mitigation.169 The duty of care could protect such external I

interests by compelling the collection of relevant information regarding the interests of I

external constituencies affected by the corporation. Its usefulness in protecting those I

interests in this way depends on liberalisation of standing requirements, a matter to!which we return later.

The officer's duty of proprietyA conventional analysis of the fiduciary duty is that it is a restraint on self-interest.1701

Contractarians explain fiduciary duties as a response to the difficulties of contracting:

167168169

170

fiduciary. Questions of causation therefore apply: Permanent Building Society v WheeZe1(1994) 14 ACSR 109 at 165-167.(1994) 14 ACSR 109.Ibid at 167.J Coffee, above n 1 at 108 (local community can have undiversifiable investments ircorporation).P Finn, "The Fiduciary Principle" in T Youdan (ed), Equity, Fiduciaries and Trusts, (1989) a;1.


between shareholders and officers. As explained above,171 the scope for managerialopportunism in corporate governance structures is great. However, the inability toforesee the forms of the opportunism at the time when the corporation offers shares tothe public, limits the ability to protect residual claimants against opportunism bycontract. Hence, fiduciary duties are relied on to supply a standard applying to futureexercises of discretionary power.172 The fiduciary duty thus fills gaps in contracts.Contractarians general7 consider that fiduciary duties, being contractual, can beexcluded by contract.17 However, the contractarian perspective on the nature of theagreement required to exclude fiduciary duties is unclear, as is dramatically illustratedby Judges Easterbrook and Posner's disagreement on this subject in Jordan v Duff-PhelpsInc. 174

Anti-managerial scholarship accepts neither the contractual basis, nor,consequentially, the excludability, of fiduciary duties.175 Especially in largercorporations, institutional factors prevent shareholders and managers bargaining in away that would permit fidtlciary duties being excluded without increasing the scopefor opportunism. This conclusion is extended to duties of care also.l76 Coffee haspersuasively argued that whereas the economic logic analysed above177 may support acase for the contractuallimitation178 of duty of care liability, fiduciary liability shouldremain mandatory. While the fiduciary duty imposes a risk of substantial liability onthe director, the director is able to avoid self-dealing transactions at lowest cost.179

Nonetheless, formulating a fiduciary standard for directors is difficult. Finn hasargued that a fiduciary standard requires selflessness.180 Equity's requirements of thetrustee - the fiduciary sui generis - instantiate such a standard. However, transferringsuch a standard to the director of a company is difficult because, compared to cestuisque trust, shareholders will generally have fundamentally different attitudes to risk.181

While judges have recognised this point,182 they have not recognised that a directorwho takes entrepreneurial risks is simultaneously endangering her own undiversifiable

171172

173

174

175

176177178179180181182

See above text accompanying nn 116-119.See F Easterbrook and D Fischel, above n 2 at 92-93; F Easterbrook and D Fischel, aboven 117.H Butler and L Ribstein, above n 2 at 28-32. But contrast R Romano, "Answering the WrongQuestion: the Tenuous Case for Mandatory Corporate Laws" (1989) 89 Colum L Rev 1599 at1601.815 F 2d 429 at 431 (1987). Judge Easterbrook regarded a contract of employment as nothaving excluded the fiduciary duty of an employer not to repurchase the shares of anemployee without disclosing an imminent merger; Judge Posner dissented. See H Butlerand L Ribstein, above n 2 at 30-31, footnote 129; J Coffee, "The Mandatory/EnablingBalance in Corporate Law: An Essay on the Judicial Role" (1989) 89 Colum L Rev 1618 at1663-1664.V Brudney, above n 2; D DeMott, "Beyond Metaphor: An Analysis of Fiduciary Obligation"[1988] Duke LJ 879. See also J Hill, above n 8 at 210.See, eg, V Brudney, above n 2 at 1411, n 19.See above text accompanying nn 147-151.But not exclusion: J Coffee, above n 50 at 951-952.Ibid. See also JGordon, above n 61 at 1594-1595.P Finn, above n 170 at 4.J Coffee, above n 50 at 950.See, eg, Anderson v Daniels (1995) 16 ACSR 607 at 658 per Clarke and Sheller JJA; AustralianSecurities Commission v AS Nominees Ltd (1995) 18 ACSR 459 at 470 per Finn J.


investment in the corporation. The director therefore has an inevitably intrusive selfinterest that fiduciary rhetoric cannot disguise.183 That situation has no parallel in thetrust, because the trustee is constrained from adopting risky strategies by conservativeprudential standards. This dilemma may be reflected in the ambiguities of thefiduciary standard in corporate law. On one hand, corporate fiduciary duties assumethe inflexibility which has characterised fiduciary doctrine since the decision in Keech v I

Sandford.184 This method is displayed in self-dealing cases, occasionally to the point ofincoherence, as in Regal (Hastings) Ltd v Gulliver.18 Elsewhere, courts have ceded todirectors a considerable (albeit not open-ended) latitude in matters in which they havea significant self-interest, most notably in takeovers.186 In the latter type of case,directors' conduct seems to be tested by a lower standard of restrained self-interest,which might be described as a standard of good faith. 187

Given such an unstable edifice as corporate fiduciary duties, one may be surprisedto find that the jurisprudence of the statutory prohibition on improper use of office waserected thereon. That duty is found in s 232(6). It provides that officers and employeesmust not make improper use of their positions, intending188 to gain an advantage forthemselves or any other person, or to cause detriment to the corporation.189 The sectionsubjects contraventions to various penalties, and also confers a cause of action on the I

corporation. Following Grove v Flavel,190 impro~riety refers to conduct inconsistentwith the proper discharge of the officer's duties. l 1 The cases confirm that these duties I

include fiduciary duties. The problem is that "fiduciary" duties do not have a single, ,determinate meaning. As noted above, they vary between an inflexible formulationand a lower good faith standard.192 Some clarity has been obtained as a result of the I

183184185

186

187188

189

190

191192

See generally JCoffee, above n 1; JCoffee, above n 174 at 1626-1627.(1726) Sel Cases Ch 61, 25 ER 223.[1967] 2 AC 134n. See also Aberdeen Railway Co v Blaikie Bros (1854) 1 Macq 461 at 473; :Liquidators of the Imperial Mercantile Credit Association v Coleman (1873) LR 6 HL 189;Transvaal Lands Co v New Belgium (Transvaal) Land and Development Co [1914] 2 Ch 488; ,Gemstone Corporation ofAustralia Ltd v Grasso (1994) 13 ACSR 695.See, eg, Australian Metropolitan Life Assurance Company Ltd v Ure (1923) 33 CLR 199 at 221222; Harlowe's Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Co NL (1968) 121 CLR 483 at493; Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 at 835-837; Darvall v North I

Sydney Brick and Tile Co Ltd (1989) 16 NSWLR 260 at 324-325; Pine Vale Investments Ltd v I

McDonnell and East Ltd (1983) 8 ACLR 199 at 209. See also W Bratton, above n 130 at 14571459.See P Finn, above n 170 at 1.The purposive element was preferred by a majority of the High Court in Chew v R (1992) 101ACLC 816 and Edwards v R (1992) 10 ACLC 859.For examinations of the provision, its history, interpretation and policy, see M Whincop""Honesty and Propriety", above n 9 and M Whincop, "Criminalisation", above n 9.(1986) 4 ACLC 654. Cited with approval in McNamara v Flavel (1988) 6 ACLC 802 at 807;:Jeffree v NCSC (1989) 7 ACLC 556 at 564-565; Southern Resources Ltd v Residues Treatn1ent &Trading Company Ltd (1990) 8 ACLC 1151 at 1168; Castrisios v McManus (1991) 9 ACLC 287'at 293-294; Chew v R (1992) 10 ACLC 816 at 823, 827; R v Yuill (1994) 15 ACSR 95 at 108;;ASC v Matthews (1995) 16 ACSR 313 at 317; R v Byrnes (1995) 17 ACSR 551 at 560.(1986) 4 ACLC 654 at 659.M Whincop, "Honesty and Propriety", above n 9 at 170-172; M Whincop, "Criminalisation",above n 9 at 281-282.


substantial extension of the impropriety concept by the High Court decision in R vByrnes; R v Hopwood. 193

In R v Byrnes, the conduct of the defendants (who were directors) breached theconflict rule. However, the defendants believed that the transactions in question wouldbenefit their corporation, and that after their plan succeeded, they would be absolvedof any transgressions. At the time of the case, the relevance of an officer's belief toascertaining impropriety had not been satisfactorily determined.194 The High Court'sdecision in R v Byrnes renders state of mind irrelevant to exculpating the defendant.Both judgments emphasise the "objectivity" of impropriety,195 which can be establishedby any breach of standards reasonably expected from the officer, including fiduciaryduties.196 Conduct is no less improper because the transaction appears beneficial, orbecause the officer believes that the transaction is necessary. The High Court also saidthat an officer who knows that she has no authority for her actions, makes improperuse of position.l97

The statutory duty is an obvious example of the publicisation of corporate law,since it effectively makes the Commonwealth a party to contracts that establishcorporate governance structures. The Commonwealth can use the civil penaltyregime198 in the Corporations Law to enforce standards "reasonably expected" of thedefendant. This public enforcement might be used to reinforce private contracts bydeterring conduct that is unambiguously contrary to the interests of shareholders. Yet,the irrelevance of the transaction's benefit (either actual or in the officer's estimation)demonstrates that the section enforces interests other than, or at least in addition to,those of the shareholders.199 Like the duty to be informed, the High Court's approachhas a strong procedural element. The "black box" approach to procedure is replaced bya procedural review, to which the substantive effects of the decision in question havelittle relevance. The key element in this procedural review is the existence of someconflict of interest, which invalidates conduct by the director. The fiduciary standard'scharacter is altered from a proscriptive standard to a prescriptive standard,200 thatcompels obedience to a set of judicially specified norms. The decision perfects theappropriation of the fiduciary duty as a public law device201 by transforming theprivate motivation underlying fiduciary duties into a public law motivation.

193194

195

196197198199200201

(1995) 183 CLR 501.Cf Chew v R (1992) 10 ACLC 816 at 819-820, per Mason CJ, Brennan, Gaudron andMcHugh JJ; R v Yuill (1994) 15 ACSR 313 and Byrnes v R (1994) 13 ACSR 219 (the decisionwas appealed to the High Court). See J Kluver, "Improper Use of Corporate Position: HowRelevant is a Director's State of Mind to Criminal Liability" (1994) Butterworths Corp LawBull [515].(1995) 183 CLR 501 at 514-515 per Brennan, Deane, Toohey and Gaudron JI, at 522 perMcHugh J. Nonetheless, the Court considered that impropriety can be established withreference to subjective bad faith: ibid at 515Ibid at 515 and 517.Ibid at 515.See Corporations Law Pt 9.4B. See below text accompanying nn 240-248.See generally M Whincop, "Criminalisation", above n 9 at 287-290.Contrast P Finn, above n 170 at 25-26.P Finn, above n 16; P Finn, "The Forgotten Trust: The People and the State" in M Cope (ed),Equity: Issues and Trends, (1995) 131; D Tan, "The Fiduciary as an Accordion Term: Can theCrown Playa Different Tune" (1995) 69 ALJ 440.


Breaches of s 232(6) are enforced under the civil penalty provIsIons of theCorporations Law. These reflect its procedural, non-substantive quality. A court can I

make a declaration that s 232(6) was breached in the absence of harm to the I

corporation.202 Given this remedial structure, a great deal turns on how prosecutorialauthorities choose to rely on s 232(6). In this regard it is noteworthy that the section has i

been contravened by conduct that prejudiced a prospective creditor.203 Although thisis not directly an expansive communitarian interpretation of impropriety, it indicates i

that the section can be used to protect those without contracts. That conclusion is I

reinforced by the flexibility of the High Court's reference to standards reasonably I

expected of a director. For instance, a director might contravene the section where the I

'alleged impropriety involved causing the corporation not to comply with a law. Aprovocative law-and-economics theme has been whether corporations are obliged to I

comply with laws which it is gainful for them to contravene.204 Self-interested illegality!is a paradigm problem where corporate law might be required to mediate between the ~

interests of shareholders and other constituencies protected by the statute. By reference'to standards reasonably expected of an officer, s 232(6) is an obvious means by which I

such mediation can take place.20S

Another issue relevant to publicisation is the High Court's holding that an officeruses his position improperly by knowingly engaging in unauthorised conduct.206 Like ~

the use of the duty to be informed as a means to procure accountability at a I

corporation's "top end", this development has strong public law overtones. Authority I

in private law is an outgrowth of agency principles. It is used to determine whether a I

principal (the corporation) is bound by the actions of its agent. An agent who acts i

without authority is not liable to her principal, unless there is some contract to that I

effect or the agent has breached another duty. The use of authority in s 232(6) therefore!becomes a means by which the State can enforce limitations on grants of power to I

corporate officers. It is analogous to the ultra vires doctrine in administrative law.207 I

Again, the black box of corporate decision-making and delegation of power is opened I

for judicial review.

The implied limitations on alterations of articles

This section deals not with constraints on the exercise of officers' discretions, but withlconstraints on the exercise of shareholders' discretions. In particular, what are the 'rights of shareholders to vary the articles of association? The High Court has recently,changed the substantive law in this area, so restricting the exercise of discretionsreposed in shareholders. These restrictions like those considered above operate by,

202203

204

205206207

Section 1317EA. The standard of proof is the balance of probabilities: s 1332.Jeffree v NCSC (1989) 7 ACLC 556. A sibling provision, s 232(5), which prohibits thE:improper use of information acquired by virtue of position, has been similarly appliedGrove v Flavel (1986) 4 ACLC 654; McNamara v Flavel (1988) 6 ACLC 802; Castrisios 1

McManus (1991) 9 ACLC 287.F Easterbrook and D Fischel, "Antitrust Suits by Targets of Takeover Offers" (1982) 80 MicfL Rev 1155 at 1174 and 1177. Contrast R. Buxbaum, "Responsibilities of TransnationaCorporations to Host Nations" in L L Heng (ed), Current Legal Issues in thiInternationalization of Business Enterprises (1996) 48. I

See below n 282 for a discussion of a statutory procedure operating in a similar way. ISee also R v Cook; ex parte Commonwealth Director of Public Prosecutions (1996) 20 ACSR 618.See, eg, Attorney-General v Fulham Corporation [1921] 1 Ch 440.


means of an intrusive judicial review which focuses on procedure and propriety. Thissection of the article shows a shift in a norm underlying the divide between public andprivate. Reflecting liberal values, private law has emphasised individual freedom. Thatfreedom should only be restricted by those laws necessary for others to enjoy theirfreedoms. However, in public law, emphasis rests on prohibiting actions of the state,other than those actions expressly permitted by constitutional sources of authority.20BThe limitations discussed in this section seem to be closer to a public law conception.We discuss first the traditional rights of majorities and how these conform to privatelaw norms.

In Allen v Gold Reefs of West Africa Ltd,209 Lord Lindley held that the power to alterarticles was to be exercised "bona fide for the benefit of the company as a whole, and itmust not be exceeded."210 The law traditionally allowed shareholders to decidewhether an alteration was for the benefit of the corporation. Courts interfered only ifthe alteration could not be regarded by honest shareholders as being for thecorporation's benefit.211 Analysed in these terms, this test embodies the internalmanagement rule in a similar way to the standard of care articulated in Re CityEquitable Fire Insurance Corp.212 Because the discretion to change articles is reposed inshareholders, courts defer to shareholders unless their decision fails by an irrationalitystandard - the resolution could not rationally be regarded as advancing any interestof the corporation. By that standard, an alteration would be invalid if it was proposedby a majority for its own aggrandisement, and sacrificed minority interests for thatpurpose.213 The use of the term "bona fide" is not gratuitous; as explained in connectionwith directors' fiduciarlI duties, a standard of good faith preserves, but in some cases,restrains, self-interest. 14 As with duties of care, Type I and Type II errors arepossible;215 the philosophy of the internal management rule favoured the minimisationof Type II errors.

The approach in Allen's case was extended in the High Court decision in Peters'American Delicacy Co Ltd v Heath.216 In that case, Dixon J rejected the notion that onecould strike down an alteration by applying a test that assumed the permanence ofshareholders' rights.217 A resolution passed to advance corporate interests would be alegitimate alteration. However, a resolution that merely adjusts and balancesshareholders' rights cannot be tested in terms of benefit to the corfloration as a whole.The benefit of the corporation is neither advanced nor decreased.2 B In these cases, onemust examine whether there is a fraud on the power having regard to the alteration'seffect on prevailing rights. Dixon J thus articulated a good faith standard, consistentwith the above analysis of Allen's case.

208209210211

212213214215216217

: 218

C Sampford, above n 18 at 190.[1900] 1 Ch 656.Ibid at 671.Sidebottom v Kershaw Leese & Company [1920] 2 Ch 124 at 136; Shuttleworth v Cox Brothers &Company (Maidenhead) [1927] 2 KB 9 at 22, 26.[1925] Ch 407 at 428-429. See above text accompanying nn 141-146.M Whincop, "Gambotto", above n 9 at 280.See above text accompanying nn 180-187 above.See above text accompanying nn 148-150 above.(1939) 61 CLR 457.Ibid at 507. See also Latham CJ (with whom McTiernan J agreed) at 481-482.Ibid at 508-512.


These principles were reconsidered in the High Court's controversial decision,Gambotto v WCP Ltd.219 In that case, a corporate group owned interests of over 99 percent of WCP Ltd. It attempted to alter WCP Ltd's articles. The object was to empowerthe group to compulsorily acquire the minority shareholdings. This would enable WCPLtd to enjoy the benefits of substantial tax losses available elsewhere in the corporategroup. The proposal was to acquire the shares at a price 25 per cent higher than theirfair value. The plaintiff, a minority shareholder, contended the alteration was beyondthe scope of the power to alter the articles. Such facts scarcely reveal any abuse ofpower or lack of good faith. First, the corporation benefited because the expropriationallowed WCP Ltd to take advantage of tax benefits. Second, the price paid toshareholders was not obviously unfair. However, the High Court held the alteration tobe invalid. Mason CJ, Brennan, Deane and Dawson JJ rejected the application of Allen'scase. They held that an alteration to create an expropriation provision would only bevalid if it was for a proper purpose and its exercise would not operate oppressively inrelation to minority shareholders.220 Additionally, the expropriation must be "fair",both procedurally and in terms of price.221

The case again demonstrates how the black box of corporate discretions andprocedures is increasingly being opened to judicial review. The High Court indicated a,villingness to judicially review decisions of shareholders. This is important because, inAnglo·-Australian law, majority shareholders have never been regarded as havingfiduciary duties to other shareholders,222 except in a small number of cases of insidertrading in closely held corporations.223 While the High Court did not disturb this rule,its decision constrains the exercise of a majority's property rights. In particular, itforeshadows that courts will review majority changes to the corporation and itsgovernance structure. This is relevant to privatisations, as the "mutability" ofgovernance structures is important in a world where institutions and marketsconstantly change.224

The case also demonstrates that these corporate discretions will be reviewedaccording to legal principles familiar from public law. This trend is evident in the dual

219

220221222

223

224

(1995) 182 CLR 432. For analysis of the decision, see M Whincop, "Gambotto", above n 9; IRamsay (ed), Gambotto v WCP Ltd: Its Implications for Corporate Regulation (1996); H Bird,What's in a Publicly Listed Share? One Analysis of the Conflict Between the Contractual andProprietary Models of Share Entitlements Following Gambotto v WCP Ltd (Conference paperpresented at Sixth National Corporate Law Teachers Conference 1996).(1995) 182 CLR 432 at 445.Ibid at 445-447. See also at 456-457per McHugh J.Peters' case (1939) 61 CLR 457 at 504. For a strongly stated view of the shareholder'sentitlement to act in self interest, see Pender v Lushington (1877) 6 Ch D 70 at 75-6.See Allen v Hyatt (1914) 30 TLR 444; Coleman v Myers [1977] 2 NZLR 225; Glavanics vBrunninghausen (1996) 19 ACSR 204. See generally M Whincop, "Precontractual Disclosureby the Insiders of Closely Held Corporations: The Economics of Restrained Self Interest"(1997) 10 JCL forthcoming (arguing that the "fiduciary" standard in these cases moreclosely approximates a standard of good faith).See generally R Gilson, above n 13; M Whincop, "An Economic Analysis of Gambotto" inI Ramsay, above n 219,102 at 107,111. For empirical evidence, see H Amour and D Teece,"Organizational Structure and Economic Performance: A Test of the MultidivisionalHypothesis" (1978) 9 Bell J Econ 106; P Joskow, "Asset Specificity and the Structure ofVertical Relationships: Empirical Evidence" in 0 Williamson and S Winter, above n 101,117.


requirements that the expropriation is for a proper purpose; and that the expropriationis not oppressive either in dealing or price. As noted above,225 the actions of privateindividuals are generally unrestricted unless they have been expreSSly forbidden. Arequirement of proper purpose for altering the articles seems precisely the opposite ofthis norm: alterations are forbidden unless permitted. This analysis is supported by thefact that the High Court would countenance an expropriation if it was pursuant to anarticle that had been included from the time of incorporation.226 Thus, the powerwould be valid only if it was permitted as part of an original charter of rights. Thearticles thus come to resemble the constitution of a polity rather than a private contract.

It is true that equity limits the exercise of legal rights through such doctrines asunconscionability. However, it does this in ways that are almost completely theopposite of using propriety of purpose as a precondition to validity. Thus, under thedoctrine of unconscionability, an exercise of legal rights is invalidated if there is anunconscientious use of a superior position;227 under fiduciary doctrine, the exercise oflegal rights is invalidated if the fiduciary has a personal interest or an inconsistentengagement with a third party.228 The invalidation of the exercise of a power ofalteration under the test in Allen 's case is analogous. These limitations are prohibitoryexceptions to a permissive rule.229 The use of proper purpose as a test of expropriationtherefore has stronger resemblances to a ground of judicial review in administrativelaw.230 This change is more than semantic, because the court ceases to be an arbiter ofinvalidity, but replaces the shareholder as the judge of the appropriateness of theresolution. The significance of these points is intensified by the paucity of logic thatcharacterises the High Court's analysis of propriety of purpose. Mason CJ, Brennan,Deane and Dawson JJ distinguished expro~riations that avoid detriments from thosethat gain an advantage for the corporation. 31 The former may be valid; the latter arenot. However, the argument collapses under its own weight, because a failure to gain abenefit is itself detrimental.

The requirement that there be no oppression also borrows from public law. Theshareholder seeking to expropriate must demonstrate the fairness of the price paid forthe shares, the procedures followed and disclosures made. In his separate judgment,McHugh J held that the alteration was oppressive for lack of fair procedure. Heconsidered the dealings were not fair, because the majority failed to show that they haddisclosed all relevant information. This conclusion was not changed by the fact that theprice seemed fair;232 or that objections to disclosure were not taken in the courts below.

225226227228229

230

231232

See above text accompanying n 208.(1995) 182 CLR 432 at 447. Cf M Whincop, "Gambotto", above n 9 at 281-282.Commercial Bank ofAustralia Ltd v Amadio (1983) 151 CLR 447 at 461.Chan v Zachariah (1984) 154 CLR 178 at 198-9 per Deane J.Directors, as fiduciaries, must exercise their powers for proper purposes: Whitehouse vCarlton Hotel Pty Ltd (1987) 162 CLR 285 at 288-289. Despite the literal parallel, the Gambottolimitation forbids certain alterations unless for a proper purpose; the fiduciary dutyprohibits fraud on the power and invalidates exercises for improper purposes, rather thanrequiring a proper purpose as a precondition.The impropriety of purpose for which a power is exercised is a long-standing ground ofjudicial review in administrative law: eg, Sydney Muncipal Council v Campbell [1925] AC338; ADJR Act s 5(1)(e), 5(2)(c); but cf Arthur Yates and Company Pty Ltd v Vegetable SeedsCommittee (1945) 72 CLR 37 at 68.(1995) 183 CLR 432 at 445-446.Ibid at 459.


McHugh J implies that there is a procedure to be followed in expropriations; a failureto follow it is fatal. The requirement is like procedural ultra vires23! in administrativelaw. Note also the linguistic transfiguration of the substantive connotations ofoppression in Peters' case.234 In Gambotto v WCP Ltd, McHughJ uses a very differentconcept of procedural oppression in order to provide for formal accountability by themajority to the minority.

There is a risk of reading too much into this case. As yet, the rule apflies only toalterations conferring expropriation power on a majority shareholder. 35 It is notdifficult, however, to imagine the principles extending to cases where the alterationadversely affects some shareholders, or where a majority shareholder votes in favourof some alteration. The first of these possibilities is evident in the High Court's decisionin Bailey v New South Wales Medical Defence Union Ltd.236 That case irlvolved the effectof a change to an article that provided for the availability of professional indemnityinsurance. The change eventually proved adverse to the interests of the personalrepresentative of a member of the company. One means by which the High Courtevaded the adverse consequences of the change was by finding a "special" contractbetween the member individually and the company, the terms of which remained thesame as the articles before the change. Although the decision did not rely on Gambotto vWCP Ltd, it exhibits a similar propensity to freeze the status quo. Perhaps the mostimportant matter is identifying the interests that the principles in Gambotto v WCP Ltdprotect. Does the decision implicate corporate law in balancing wider interests thanthose of shareholders? At surface level, the court seems to be championing the rights ofindividual shareholders. However, because the case involves competing individualinterests, it is hardly meaningful to say that it resolves matters in favour of the 'individual. A plurC;llist perspective acknowledges that interests do compete andconflict.237 The historical position of the law in relation to this conflict was to intervene 'only in cases of bad faith. What is interesting about the High Court's interpretation is ;that while the rule may apply in a way that favours an individual shareholder, the rule'nonetheless lacks a strong individualistic basis. The High Court clearly accepts that ashareholder can be expropriated if the purpose for doing so is proper. Various interests I

may enter into the calculus of propriety, perhaps including some interests external to I

traditional corporate law norms. We have already indicated that propriety in s 232(6) I

can accommodate broader interests. That conclusion may also apply here, because the'High Court's preference for a test of proper purpose, rather than the narrower "benefitof the corporation" used in Allen's case, is presumably more than semantic. The scope'for external interests is also served by making the court the arbiter of the change.

Standing in corporate law

The argument so far pursued in this article is that while greater managerial discretion I

might be regarded as a key advantage of privatisation, the law can significantly'constrain that discretion. While historically corporate law has not imposed constraints"

233

234235

236237

See, eg, Victoria v Commonwealth (1975) 134 CLR 81 at 180 per Stephen J; J Evans""Mandatory and Directory Rules" (1981) 1 Leg Stud 227.(1939) 61 CLR 457 at 513.Legal. Committee of the Companies & Securities Advisory Committee, CompulsoryrAcquisitions Report (1995) at 7-10; but cf H Bird, above n 219 at 57-59.(1995) 18 ACSR 521.See above text accompanying n 98.


the preceding three sections of this Part demonstrate that corporate law is undergoingchange. It is becoming less private and more public. Managerial discretion is beinglimited in various respects, most significantly by a judicial review model that relies onnew grounds of review. We have argued that the formulation of these grounds mayprovide scope to mediate between the interests of shareholders and otherconstituencies. Although other constituencies have not previously had a recognisedclaim to the attention of corporate law, their lack of standing to enforce the dutiesimposed on decision-makers prevented the conception of the corporation fromchanging. Other legal and private ordering means had to be relied on by theseconstituencies. Moreover, as can be seen from the exegesis of traditional formulationsof duty, it was difficult even for shareholders to succeed in enforcing recognised duties.The effect of deferential standards was greatly intensified by the so-called rule in Foss vHarbottle.238 This rule, of which the internal management rule was part, restricted theability of shareholders to sue to enforce these duties. The corporation rather thanshareholders was regarded as the beneficiary of duties owed by directors. Only wherea majority wrongfully prevented an action from being brought would a sharellolder beentitled to bring a derivative action. This exception is, like the rule in Allen's case,underpinned by the primacy of shareholder judgments regarding corporate litigation,subject to an exception embodying a good faith standard.

We have seen above that substantive corporate duties have changed much in ashort time. These duties demonstrate potential for expansion. However, the degree ofexploitation of that potential depends greatly on rules of standing. First, the ability tosue to enforce duties determines whether this potential expansion is considered bycourts, or falls into desuetude. Second, if rules of standing permit non-shareholderconstituencies to be represented, the substantive law is more likely to develop in a waythat incorporates the interests of these constituencies in the doctrine. Constituenciesthat lack standing will remain external to the formulation of doctrine. It is with theseconsiderations in mind that we turn to consider the revisions of standing in corporatelaw. Four matters are of interest to us. These are: (i) standing under the civil penaltyregime; (ii) injunctive relief under s 1324 of the Corporations Law; (iii) the revision ofthe rule in Foss v Harbottle; and (iv) the proposed derivative action procedures.

1 Civil penalty regime. We have already indicated that the civil ~enalty regime is asignificant development in the publicisation of corporate law. 39 By convertingdirectors' duties into obligations with penal consequences for breach, corporategovernance is brought into a public sphere. Of the substantive law developmentsdiscussed in this article, the officer's duty of propriety is a civil penalty provision.While the discussion of the duty of care has referred to common law authorities, thestatutory duty of care in s 232(4) should probably have a similar substantive content.Thus, the two key changes to the judicial review of officers' discretions are integral tothe civil penalty regime.

The essence of the regime is to serve the dual purpose of compensating injuredcorporations and deterring contraventions.240 The first purpose is served by conferring

238 (1843) 2 Hare 461; 67 ER 189.239 See above text accompanying nn 198-202.240 For the incompatibility of the two purposes, see M Whincop, "Criminalisation", above n 9,

280-282.


a cause of action on the corporation for the breach of the provision.241 Only thecorporation may recover compensation for loss, or seek restitution of the plaintiff'sprofits from the contravention. This provision denies standing to shareholders or otherconstituencies. The second purpose of deterrence is served by subjecting the defendantwho contravenes the section to such orders as requiring the defendant to pay apecuniary penalty, or banning the defendant from managing a corporation.242 Becausethe deterrence function relies on public prosecutions, shareholder and non-shareholderinterests can be represented. Although these constituencies do not have a right tocompensation under the civil penalty regime, the use of penalties can deter officers'behaviour that injures these constituencies.243

It follows that the interests that the Australian Securities Commission (ASC)represents are pivotal to the development of corporate law's publicisation potential.Australian evidence suggests that private enforcement of corporate rights and duties isdominated by public enforcement by the ASC.244 Therefore, if the ASC chooses torepresent a wider cross section of interests than shareholders, this potential may beactualised.245 The ASC's enabling legislation246 can be read as permitting the ASC torepresent wider interests. Section 1(2) requires, inter alia, that the ASC strive tomaintain and improve the "performance" of corporations in the interests of "reducingbusiness costs/ and the efficiency and development of the economy". The reference toperformance seems deliberately broader than the narrower calculus of "profit" or"value".247 The invocation of the interests of the economy gives sufficient scope for thecorporate regulator to represent non-shareholder constituencies. The ability of the ASCto represent public interests is confirmed by the ASC's power to bring representativepublic interest actions.248 Such actions involve the ASC itself litigating in the name of acompany where it believes it is in the public interest to do so. This power was recentlyconsidered by the Full Federal Court in ASC v Deloitte Touche Tohmatsu.249 In aconfirmation of the arguments pursued in this article, the Court held that the publicinterest should be read widely. In particular, the ASC was not required to consider theopposition of the directors of the corporation to the bringing of any action. The poweris not to be read subject to the considerations in Foss v Harbottle.250

2 Injunctive Relief Whereas the representation of non-shareholder constituenciesunder the civil penalty regime relies on public enforcement by the ASC, the injunction

241242

243

244

245

246247248249250

Corporations Law, s 1317HD.Section 1317EA. Under aggravated circumstances set out in s 1317FA, an offence will becommitted. The offence can be punished by imprisonment.On an application for a civil penalty order, a court can order compensation be paid to thecorporation in the event of finding a civil penalty provision has been contravened:s 1317HA. Thus, shareholders can be compensated in these suits.I Ramsay, "Enforcen1.ent of Corporate Rights and Duties by Shareholders and theAustralian Securities Commission: Evidence and Analysis" (1995) 23 ABLR 174. Ramsay'sevidence is, however, biased by its reliance on reported cases.Millon describes the equivalent regulatory body in the United States, the SecuritiesExchange Commission, as pursuing a "single constituency agenda" (ie, shareholders): seeabove nIlS at 1376.Australian Securities Commission Act 1989 (Cth).See W Bratton, above n 130 at 1456.Australian Securities Commission Act 1989 (Cth), s 50.(1996) 21 ACSR 332.Ibid at 364-365.


provision in s 1324 creates scope for private enforcement. The trigger for this provisionis a contravention of the Corporations Law. For example, injunctions could be soughtin respect of civil penalty provisions. The injunction can be mandatory or prohibitory.Standing to seek an injunction seems to be liberal. Section 1324 permits a person toapply for an injunction if his or her "interests have been, are or would be affected by"the contravention. Some authors have suggested that the section represents aconsiderable expansion of standing rights in corporate law.251 Section 1324's promiseremains a matter of speculation as it has not often been interpreted. Its predecessor inthe Companies Code, s 574, was regarded by one judge as being part of a legislativescheme desiwed to protect the public in respect of the commercial activities of thecorporation. 2 Its standing requirements were therefore interpreted broadly. Thejudge considered that the applicant did not need to prove a proprietary right. While ithas been suggested elsewhere that the issues of standing raised by s 1324 are"substantially the same" as under the general law,253 that comment seems only torequire the proof of an interest exceeding that of a member of the public in seeing thatthe law is upheld. If some section of the public could demonstrate that the conduct ofthe corporation had external effects on it, as has been a premise of this article, standingcould be established by a member of that section. Once such constituencies attainstanding, it follows from the earlier analysis that their interests may exert a strongerinfluence on the law.

A problem, of course, with injunctive relief is that the plaintiff may nonethelesshave insufficient financial incentives to bring the action. Some of these problems maybe partially resolved by s 1324(10). It provides that where a court has power to orderan injunction, it also has power to order the payment of damages by the person who isthe subject of the injunction. The provision potentially permits the assertion of rights ofnon-shareholder constituencies, although it has not been the subject of judicialinterpretation. One of its implications is that a non-shareholder constituency might suea director who, for example, has contravened s 232(6) by engaging in conductdeleterious to that constituency. Such personal liability on the part of the directorwould be valuable if the corporation was insolvent. Section 1324(10) might represent amajor "lowering" of the corporate veil, through unlimited officer liability.

On the other hand, it might not. A recent judgment held that a companyshareholder may not rely on s 1324 when alleging a breach of a civil penaltyprovision.254 Young J acknowledged the expaIlsive trend of earlier cases on the sectionand its predecessor. However, he rejected the notion that the section, used inconjunction with provisions such as s 232 that restated general law obligations, sweptaway the policy considerations underlying the rule in Foss v Harbottle.25 Accordingly,

251

252253

254255

R Baxt, "Will Section 574 of the Companies Code Please Stand Up (And will Section 1324 ofthe Corporations Act Follow Suit)" (1989) 7 C & SL] 388. Cf J Kluver, "Derivative Actionsand the Rule in Foss v Harbottle: Do We Need a Statutory Remedy" (1993) 11 C & SL] 7 at11-12; I Ramsay, "Corporate Governance, Shareholder Litigation and the Prospects for aStatutory Derivative Action" (1992) 15 UNSWL] 149 at 150.Broken Hill Pty Co Ltd v Bell Resources Ltd (1984) 8 ACLC 609 at 613 per Hampel J.QIW Retailers Ltd v Davids Holdings Pty Ltd (No 2) (1992) 10 ACLC 1162 at 1165. Cooper Jnonetheless agreed with Justice Hampel's analysis: ibid. See also Allen v Atalay (1993) 11ACSR 753 at 757-758.Mesenberg v Cord Industrial Recruiters Pty Ltd (1996) 19 ACSR 483.Ibid at 488-9.


only the ASC might litigate under s 1324 for an injunction restraining the breach ofs 232. While the decision represents, in its own terms, a substantial restraint on theopportunities afforded by s 1324, its analysis of the civil penalty provisions and theirinteraction with sections such as s 232, raises questions and doubts. Bird has provideda compelling critique of the decision.256

3 Revision of the rule in Foss v Harbottle. The key historical exception to the rule inFoss v Harbottle is the fraud on the minority exception. Under this exception, it isnecessary to demonstrate that a majority opposes the bringing of an action to enforce acorporate right. However, in large corporations, the problems shareholders encounterin taking the collective action required by the rule (such as convening a meeting toconsider the matter) could rule out the possibility of an action. It would not matter thatmanagement did not own a majority of shares. The possibility of a further exception"when the interests of justice require" has therefore long been a subject of speculation.A number of cases considered the issue, but none decisively affirms its existence. Thatposition changed, however, when Ipp J upheld the existence of this exception.257 HisHonour relied on the change in the nature of companies since the articulation of therule in Foss v Harbottle: shareholders have become larger in number and moredispersed.258 Although this development offers no promise to non-shareholderconstituencies, it clears the way for shareholders who seek the judicial review of theexercise of director and manager discretions.

4 Proposed derivative action procedures. The finalliberalisation of standing rules thatwe discuss are proposed frovisions that entitle shareholders to bring proceedings onbehalf of corporations.25 At the time of writing, these provisions have not beenintroduced, but they have been on the law reform agenda for some years.260 Theproposed Erovisions for statutory derivative actions aim to destroy the rule in Foss vHarbottle.2 1 Excepting the case of public interest representative actions by the ASC, theonly prior significant change to the common law on derivative actions is in s 260. Thissection entitles a shareholder to various forms of relief where, inter alia, the affairs ofthe corporation are being conducted in an oppressive manner. A court has discretion tomake various orders, including an order authorising a member to bring proceedings onbehalf of the corporation.262 Although s 260 provides a wide series of remedies andorders, it takes effect by extending the "fraud on the minority" exception to the rule inFoss v Harbottle. The proposed provisions differ greatly in the manner of theiroperation. Proceedings may be brought on behalf of the corporation either by amember or an officer of the corporation, a member of a related body corporate, or the

256

257

258259

260

261262

H Bird, "A Spanner in the Works: The Impact of Mesenberg v Cord Industrial Recruiters PtyLtd on Enforcement Rights under the Corporations Law" (1997) 25 ABLR forthcoming.Biala Pty Ltd v Mallina Holdings Ltd (1993) 11 ACSR 785 at 847-848. See also Mesenberg vCord Industrial Recruiters Pty Ltd (Nos 1 & 2) (1996) 19 ACSR 483; Ruralcorp Consulting PtyLtd v Pynery Pty Ltd (1996) 21 ACSR 161.See above text accompanying n 75.Attorney-General (Cth), Proceedings on Behalfofa Company (Statutory Derivative Action) DraftProvisions and Commentary (Canberra, September 1995) (Report on Proposed StatutoryDerivative Actions).See <;:::ompanies and Securities Law Review Committee, Enforcement of the Duties of Directorsand Officers ofa Company by means ofa Statutory Derivative Action (Report No 12, 1990).Report on Proposed Statutory Derivative Actions, above n 259 at 2-4, proposed section 245A(3).Section 260(2).


ASC.263 Except for the ASC,264 these persons may bring proceedings only if grantedleave by a court.265 The court must grant leave if it is satisfied that:

(a) it is probable that the company will not itself bring the proceedings or properly takeresponsibility for them ...; and

(b) the applicant is acting in good faith; and

(c) it is in the best interests of the company that the applicant be granted leave; and

(d) if the applicant is a~~lying for leave to bring proceedings - there is a seriousquestion to be tried ... 6

The new provisions are significant in two respects. First, they provide a means bywhich shareholders can obtain standing to review managerial exercises of discretion.Second, that means of review gives courts an unprecedented centrality in corporategovernance. The quoted section requires a judge to determine that it is in thecorporation's best interests for leave to be granted. This represents the subjection ofdecisions by the board concerning litigation - whether against corporate insiders ornot267 - to judicial review. This is separate from the judicial review of the matter thatis the subject of the substantive litigation. If one compares the ground of review to"unreasonableness" in administrative law, one registers the width of the ground.268 Thejudge is not instructed to ask: was the decision of the board not to bring proceedingssuch that no reasonable board, acting in the interests of the corporation, could makeit.269 Instead it asks: would this court's decision to bring proceedings be in the interestsof the corporation? The procedure approximates a complete review of merits incorporate litigious matters. While the report suggests that a corporation may havesound business reasons for not bringing proceedings,270 the provisions do not require acourt to respect such a judgment.271

263

264

265

266267268

269

270271

Proposed s 245A(1)(a). The section extends to former members and officers, and personsentitled to be registered as members. Section 260 only extends to present members of thecorporation.As has already been suggested in the context of the civil penalty regime (see above textaccompanying nn 242-248), the fact that the ASC is permitted as of right to bring actions onbehalf of a company may allow constituencies other than members and officers to litigateon behalf of the corporation.Proposed s 245B(1). Both Federal and State Supreme Courts can exercise this jurisdiction:see definition of "Court" in s 9 of the Law.Proposed s 245B(2).Report on Proposed Statutory Derivative Actions, above n 259 at 3.For an example of the application of the administrative standard of unreasonableness tothe governance of a private organisation (the New Zealand Rugby Union Council), seeFinnigan v New Zealand Rugby Union [1985] 2 NZLR 190, discussed and enthusiasticallyendorsed by I Eagles, above n 137 at 410.As to this paraphrased administrative law concept of unreasonableness, see, eg, AssociatedPicture Houses Ltd v Wednesbury Corporation [1948] 1 KB 233; Paramatta City Council v Pestell(1972) 128 CLR 305 at 327; Australian Broadcasting Tribunal v Bond (1990) 170 CLR 321 at356; Grech v Minister for Immigration, Local Government and Ethnic Affairs (No 2) (1991) 26ALD 197 at 201-202. For an application of such a standard in modern corporate law, seeWayde v New South Wales Rugby League (1985) 3 ACLC 79.Report on Proposed Statutory Derivative Actions, above n 259 at 6.In United States jurisdictions, a board decision (usually made by a litigation subcommittee) to terminate a derivative suit is generally assessed with reference to thebusiness judgment rule: see Auerbach v Bennett, 393 NE 2d 994 (1979), Roberts Alabama


The provIsIons carry a significant risk of Type I error; that is, where a judgemistakenly believes litigation is in the best interests of the corporation. Apart fromType I error costs, the provisions are also likely to be highly costly given the need tolead evidence that places a judge in a position of being able to make an informeddecision. These costs must be incurred even if leave is not granted.272 The procedurethus carries a high probability of generating deadweight losses. Generally, the costs ofplacing a judge in a sufficiently informed position will be inversely related to theprobability of Type I and Type II errors.273 It is also important to understand that thesecosts are likely to be borne by shareholders, because a court is able to order thecorporation to bear the plaintiff's legal costs before any decision on the merits ismade.274 An individual shareholder may not bear a sufficiently large proportion ofthose costs in order to make optimal decisions concerning applications for leave tobring a derivative action.275

The provisions concerning shareholder ratification also expand the jurisdiction ofcourts in corporate governance matters. Section 2450 provides that ratification ofconduct the subject of proceedings does not estop applications for leave, nor thebringing of proceedings once leave is granted. Nor does ratification concludeproceedings in favour of the party whose conduct has been ratified. Instead, the courtmay take the ratification into account, but must consider the disclosures made toshareholders when they were asked to ratify, and the propriety of purposes of thosevoting to ratify.276 Curial supremacy thus extends beyond the judgment of the board tothe expressed will of a majority of shareholders. The first consideration regardin~

disclosure is familiar from the case law concerning ratification of fiduciary breaches.2

However, the proper purposes requirement is notable. It conforms to the trends of thenew corporate law as evident in Gambotto v WCP Ltd and the duty of propriety.278 Asnoted above, shareholders - even majority shareholders - are not fiduciaries inAustralian law.279 Yet, the idea of "proper purposes" seems to imply that shareholders

272

273

274275

276277

278279

Power Co, 404 So 2d 629 (1981). Cf Zapata Corp v Maldonado, 430 A 2d 779 (1981). For adiscussion of the business judgment rule, see above text accompanying nn 145-146.Ironically, the fraud on the minority exception is also criticised for the costs and otherproblems of such "dress rehearsals" in which standing must be proved: PrudentialAssurance Company Ltd v Newman (No.2) [1982] Ch 204; Hurley v BGH Nominees Pty Ltd(1982) 6 ACLR 791.In other words, making a correct decision requires costly information; the moreinformation, the lower the probability of Type I and Type II errors.Proposed s 245G.For these and related criticisms of derivative actions, see, eg, D Fischel, "The CorporateGovernance Movement" (1982) 35 Vand L Rev 1259; D Fischel and M Bradley, "The Role ofLiability Rules and the Derivative Suit in Corporate Law: A Theoretical and EmpiricalAnalysis" (1986) 71 Cornell L Rev 261; M Dooley and E Veasey, "The Role of the Board inDerivative Litigation: Delaware Law and the Current ALI Proposals Compared" (1989) 44Bus Law 503; R Romano, "The Shareholder Suit: Litigation Without Foundation?" (1991) 7 JL Econ & Org 55.Proposed s 245D(1)(b) and (2).Winthrop Investments Ltd v Winns Ltd [1975] 2 NSWLR 666 at 684 per Samuels JA, at 706 perMahoneyJA.See above text accompanying nn 198-204, 225-229.See above text accompanying nn 221-223. See also North-West Transportation Co Ltd v Beatty(1887) 12 App Cas 589.


are obliged to exercise their power for the benefit of some other person. It would beinsupportable, however, if shareholders were not permitted to act in self-interest: thatis the basis for acquiring and holding shares. That very model of self-interested ownersis integral to advocacy of privatisation.

The application of the proper purposes test in this context is fraught withcomplexities. What purposes are improper? It is not clear from the section whether it isproper to have regard only to share110lders who also happen to hold a fiduciary office,and their associates. In particular, how can one distinguish between two persons,neither a fiduciary in the exercise of their voting powers, one of whom votes in selfinterest, the other voting to ratify his own breach of duty? To put matters in anotherway, if there are both sound and "improper" reasons to vote in a particular way, it isnot obvious why the latter should not be counted. As is inherent in Justice Ipp'sjudgment in Biala Pty Ltd v Mallina Holdings Ltd, the application of such a test inpublicly listed corporations with widely spread shareholdings is difficult. Manyshareholders to whom full disclosure is made may simply vote for managementbecause they have no reason to trust the insurgent shareholder. Apathy could inducesuch a result. Does that invalidate the vote? It is also unclear who bears the onus ofproving propriety.280 Because the rules are handicapped by the problems ofaggregating the purposes of a majority of shareholders, judges will be forced tosubstitute their own judgment, in place of the shareholders' judgment, on the questionfor ratification. As in Gambotto v WCP Ltd, the new directions of corporate law evidentin this proposal limit self-interested exercises of discretion by shareholders.

Although empowering shareholders to litigate on behalf of the company mightseem strongly individualistic, the ultimate question is whether derivative actionssignificantly reduce arency costs. Our impression is that these proposals will notreduce agency costs.28 The procedures are inherently expensive; the costs indemnitycan be seen to encourage inefficient litigation; and they reserve an inefficient andunclear jurisdiction for judicial review. Finally, the limitations on ability to ratify andthe centrality of courts in these governance issues seem to violate individualist andpluralist values without obvious benefit.

CONCLUSIONS: OF BLACK BOXES, MARKETS AND DIVIDES

A key theme in our analysis has been the need to examine changes in governance;normative analysis cannot simply make comparisons between states withoutconsidering the significance of the change between those states. It is tempting toconclude, as Farrar and McCabe do, that privatisation is preferred on efficiencygrounds because (1) markets have a role in the formation of efficient corporategovernance structures, and (2) a privatised corporation faces more markets than thepublic enterprise does. Yet the analysis breaks down at the theoretical level when onelooks at the implications of changing from one form to the other. In view of the failureof markets to supply a normative argument for privatisation, any efficiency claim mustconsider legal rules that define corporate governance structures and the exercise of

280

281

That is, must those relying on ratification prove that every person voting to ratify did nothave an improper purpose, or must the plaintiff prove an improper purpose?For empirical evidence, see 0 Fischel and M Bradley, above n 275. Fischel and Bradleywere unable to detect any statistically significant benefits from continuance of derivativeactions. Romano came to a similar conclusion: R Romano, above n 275.


discretion within those structures. Here, too, however, the issue of change is important.One must examine those legal rules in a temporal context, in order to understandchanges in the way corporate governance structures function. How is the lawchanging, and what does the change imply? Such a perspective is necessary in order tocomprehend the significance of the change in governance.

Farrar and McCabe, like other authors arguing that privatisation is to be preferredfor efficiency reasons, make an implied assumption that the corporation's governanceresponds to changes in the firm's external environment. The key assumption is that thegovernance structure facilitates the exercise of discretion in a way that reacts to theneeds and exigencies confronting the corporation. The purpose of our analysis has beento show that a crucial component of that governance, the effects of corporate law, arefar more complicated than might have been thought. Three points are significant. First,the law has changed greatly in its willingness to review and invalidate the exercise ofofficers' and shareholders' discretions. The law has changed from the noninterventionist internal management rule to a rule where the courts and the state haveimportant roles in corporate governance. It follows that the ability to make efficiencyclaims for privatisation is limited, because the privatised entity's freedom of action isconstrained by the new corporate law.

The second point is that aspects of corporate law doctrine are starting to resembleaspects of administrative law doctrine. We describe this as the publicisation ofcorporate law. As we stated in the introduction, the concept is nascent and imprecise.Essentially, it involves a transition from a regime in which the dominant norm was thatjudicial intervention depended on the existence of legal or equitable fraud, towards aregime having a far larger legitimate domain for judicial review of corporate decisionmaking.282 From the developments studied in this article, we can point to severalfeatures of this publicised judicial review. First, there is a model of the procedure ofcorporate decision-making. We observed this in the context of the duty to be informed,and the officer's duty of propriety. Procedure also recurs in the Gambotto rule againstoppression which mandates the disclosure of all relevant information, notwithstandingthe absence of any substantive injustice. Second, there are new substantive grounds ofjudicial review familiar from public law. This is obvious in the concept of proprietywhich pervades the High Court decisions in Gambotto and Byrnes, as well as the judicialreview of litigation under the proposed derivative action procedures. At the same time,the High Court in Byrnes eliminates a series of substantive defences such as thebeneficial quality, or an honest belief in the appropriateness, of the transaction. TheCourt does this by using fiduciary duty as an aspirational standard of private decisionmaking. Finally, standin§: rights have been liberalised by various common law andstatutory developments.2 3

282

283

An increase in the role of the courts in the judicial review of private decision-making isalso apparent in the United States, although these developments do not demonstrate thepublic and procedural qualities observed herein: W Car~ey, "The ALI's CorporateGovernance Project: The Death of Property Rights?" (1993) 61 Ceo Wash L Rev 898.We could also have discussed other statutory changes to the substantive law. An excellentexample is Pt 3.2A of the Corporations Law, which applies to financial benefits conferredon the related parties of public companies. The Part mandates an extensive process ofdisclosure to, and approval by shareholders. The procedure publicises fiduciary selfdealing prohibitions in a similar manner to R v Byrnes. In particular, the Part's procedurerequires a court to ignore that full value was given for the benefit: s 243G(3). Its application


We suggested in the introduction that this development may represent a"normalisation" of substantive corporate law in a way that brings it closer to other areasof law. Issues of accountability are very important here. Frug has observed that judicialreview is one of the ways we legitimate bureaucracy.284 A more forceful assertion of ajudicial review function serves to assuage fears concerning these bureaucracies in anage of reduced personal liberty. The increase in judicial review may suggest adisenchantment with the assurances provided by the alternative market/pluralistmodel that is central to efficiency claims for privatisation. Alternatively, thesedevelopments may appeal to critics of the public/private divide. Some have sug§estedthat private bodies should be subject to administrative controls of curial design; 85 or,that private and public law be fused to become "institutional" law, which might bereceptive to less subjective and less ideological matters than those inherent in thedivide between public and private.286 Taggart suggests, for example, that, "[T]hephilosophical approach to administrative law should be broadened to include theexercise of significant market ~ower by privatised enterprises and, ultimately, Ibelieve, by private corporations". 87 In contrast, the developments in this article do notresemble either a public law "takeover" or a private law-public law "merger". Thepublicisation of corporate law is quite different. The doctrine has not developed in amanner that consciously seeks to borrow from public law. Instead, judges perceive theneed for accountability by those in whom corporate power is reposed. From theseconcerns, and in the absence of well-specified jurisprudence, concepts have developedthat resemble and parallel public law doctrine.

The third and final point about the corporate law-privatisation connection raises adifficult question: for whose benefit does the law exist? One of the problems in thisarea is that courts and regulators, even in a time of publicisation, have never clearlyarticulated the interests that corporate law is meant to represent. It has been easy forjudges to say that managers should be more diligent; why and for whose benefit theyshould be diligent remains unclear. Historically, this has not been an issue of practicalsignificance as substantive causes of action were difficult to make out, and standingwas hard to demonstrate. However, its importance is intensified where the lawbecomes imprinted with an active model of judicial review, and the interstices of theemerging jurisprudence become large enough to accommodate new interests. Theimportance of this question becomes fundamental in the case of a privatisation wherepolitics dictates the withdrawal of the state and the end of executive interference withmanagerial discretion. Unless one makes patently unreal assumptions thatprivatisations benefit everyone (that is, they are Pareto superior), the issue for lawyers,scholars and regulators is to understand the means by which conflicting interests are tobe resolved. In the vacuum left by the departure of the state, corporate law must beacknowledged as a potential means of such mediation. While we acknowledge thatmuch remains to be seen, the new corporate doctrine and procedure gives theappearance of being more willing to mediate than the old law was.

284285

286287

to public companies perhaps reinforces the idea that these companies are justifiably treatedas public entities.See above text accompanying nn 134-136.G Borrie, "The Regulation of Public and Private Power" (1989) Pub L 552; M Taggart,"Corporatisation", above n 19; M Taggart, "Impact", above n 19.C Sampford, above n 18.M Taggart, "Impact", above n 19 at 371.


It may be instructive for the reader taking our account on faith to examine theapplication of the legal developments we have reviewed to hypothetical situations thatrequire resolution. Would the directors of a privatised telecommunications utility beable to discharge their duty to be informed if they did not have regard to rural interestsin making a decision on, say, time-charging local phone calls? What standards can be"reasonably expected" of a director regarding investment in politically unpalatableregimes? How, for the purposes of the derivative action legislation, will a court definethe "company", in order to assess what may be in its interests, in the case of privatisedentities performing emergency services? How would a court balance the interests in acase like Gambotto, if the business of the company was not property investment butpublic housing, and the advantage of acquiring 100 per cent of a corporation was nottaxation, but the (profitable) provision of housing services to indigenous peoples?

These questions ultimately need a categorical answer. They show us issues that castsubstantial doubt on whether the corporation is indeed the legal form, and corporatelaw the applicable corpus of law for monopolies that have significant externalities,positive or negative. Our fear is that corporate law will become a less efficient regimein the case of profit-seeking enterprises, and a still more unsuitable one for enterpriseswhose external effects are central to its existence.288 Our analysis suggests that in lightof the transformation of corporate law, the case for privatisation is becoming less andless soundly based in economic analysis. The fundamental shift that privatisation hasalways been thought to involve may prove less fundamental and appreciably more"fuzzy" than we had been led to believe.

288 This point is consistent with the leading economic theory explaining the existence of nonprofit enterprises as a means of "bonding" the interests of those who control the enterpriseto those who contribute resources to it: see generally H Hansmann, above n 20.

corporation, contract, community: an analysis of

Documents