The Business Judgment Rule in the Corporate World: A Comparative Approach
The purpose of this chapter is twofold. In Part I, we will review the state of American corporate law liability for acts of negligence by directors of for-profit and non-profit businesses. Part II explores whether Halakhah (Jewish law) endorses the business judgment rule for a Jewish profit or non-profit corporation or for Jewish managers and/or directors employed by American corporations. Part III offers a comparative analysis of how the two legal systems addressed this topic by examining the issue of the stakeholder debate and corporate social responsibility.
I. American Law
A. The Business Judgment Rule in the For-Profit Sector
According to state corporate law, directors oversee the affairs of the corporate venture. Whereas the board supervises management and the day-to-day operations and establishes corporate policy, the shareholders vote regarding the election of directors, sale of corporate assets, and approval of the corporate charter and amendments. In carrying out their managerial roles, directors are charged with approving, modifying, or disapproving corporate plans and financial objectives of the firm.
The general standard of conduct applicable to gauge the performance of the directors who actually manage the business of the corporation is “the business judgment rule.” As will be shown, this rule is a judicial creation that imparts recognition and deference to a board decision. It is generally used after a corporate decision has been made and as a defense to a challenge of the soundness of a corporate decision. Much attention has been focused on the proper understanding of the specific content of this rule.1Harold Marsh Jr., “Are Directors Trustees? Conflict of Interest and Corporate Morality,” 22 Bus. Law (1966), 35; Melvin A. Eisenberg, “The Divergence of Standards of Conduct and Standards of Review in Corporate Law,” 62 Fordham L. Review (1993), 437; R. Franklin Balotti and James J. Hanks, Jr., “Rejudging the Business Judgment Rule,” 48 Bus. Law (1993), 1337; Franklyn A. Gevurtz, “The Business Judgment Rule: Meaningless Verbiage or Misguided Notion?,” 67 S. Cal. L. Review (1993–1994), 287; Lyman Johnson, “The Modest Business Judgment Rule,” 55 Bus. Law (1999–2000), 625; Stephen M. Bainbridge, “The Business Rule as Abstention Doctrine,” 57 Vanderbilt Law Review (2004), 83.
Different courts have defined the business judgment rule differently. In Caremark, the court addresses the suit of shareholders of a corporation against bank directors to hold them liable for failure to prevent employees of the bank from violating the law. Chancellor Allen, writing for the court, states:
It was the board’s responsibility to monitor that information and reporting systems exist in the organization that are reasonably designed to provide to senior management and to the board itself timely, accurate information sufficient to allow management and the board, each within its scope, to reach informed judgments concerning both the corporation’s compliance with law and its business performance … It is important that the board exercise a good faith judgment that the corporation’s information and reporting system is in concept and design adequate to assure the board that come to its attention in a timely manner.2In re Caremark Int’l Inc. Deriv. Litig., 698 A. 2d 959, 970 (Del. 1963).
The business judgment rule thus may be seen as a standard whereby the director acts in good faith if he serves in accordance with the honest belief that the action taken or the omission of action was in the best interests of the firm. However, if he fails to set information systems in place, then he breaches his duty of good faith. This holding from Caremark, which defines the violation of the business judgment rule as entailing bad faith, a dereliction of duty, and a conscious disregard for one’s responsibilities, is subscribed to by various jurisdictions.3Hodges v. New England Screw Co., 1 R. I. 312, 346 (1850); Davis v. Louisville Gas & Electric Co., 142 A. 654, 659 (Del. Ch. 1928); Litwin v. Allen, 25 N.Y.S. 2d 667, 678 (NY Sup. Ct. 1940); Kors v. Carey, 158 A. 2d 136, 141, (Del. Ch. 1960); Miller v. American Telephone & Telegraph Co., 507 F. 2d 759, 762 (3d Cir. 1974); Panter v. Marshall Field & Co. 646 F. 2d 271 (7th Cir.), cert. denied, 454 U.S. 1092 (1981); Aronson v. Lewis, 473 A. 2d 805, 812 (Del. 1984); Stern v. GE, 924 F. 2d 472, 476 (2d Cir. 1991); In re Walt Disney Co. Deriv. Litig., 906 A. 2d 27, 64 (Del. 2006); Stone v. Ritter, 911 A. 2d 362, 370 (Del. 2006).
As of 2003, Delaware is the state of incorporation for half of all public companies and 59% of the Fortune 500. It should thus be no surprise that Delaware is the primary source of American corporate law. See Lucian Bebchuk and Alma Cohen, “Firms’ Decisions Where to Incorporate,” 446 J. L. & Economics, (2003), 383, 389. Other courts will investigate whether the process of arriving at the decision was reasonable and will abstain from addressing the merits of the decision.4Graham v. Allis-Chalmers, 188 A. 2d 125 (Del. 1963); Auerbach v. Bennett, 393 N.E. 2d 994, 996 (NY: 1979).
An alternate interpretation of the business judgment rule is that it insulates the director from ordinary negligence as long as there is no specter of conflict of interest, such as a board implementing defensive devices to protect a merger agreement. In Puma v. Marriot,5283 A. 2d 693, 694 (Del. Ch. 1971). for example, five disinterested directors of Marriot Corporation approved the acquisition of six other companies owned by the majority shareholder of the corporation, the Marriot family. In the absence of a showing of fraud or collusion, the court gave full deference to the board decision and concluded that the Marriot’s family influence did not dominate or control the directors in any fashion. This understanding of the business judgment rule has a long pedigree in Delaware law and other jurisdictions.6Guth v. Loft, Inc., 5 A. 2d 503, 510 (Del. 1939); Bayer v. Beran, 49 N.Y.S. 2d 2, 6 (Sup. Ct. 1944); Lewis v. S.L. & E. Inc., 629 F. 2d 764, 769 (2d Cir. 1980); Norlin Corp. v. Rooney, Pace Inc., 744 F. 2d 255, 265 (2d Cir. 1984); AC Acquisitions Corp. v. Anderson, Clayton & Co., 519 A. 2d 103, 111 (Del. Ch. 1986); Marciano v. Nakash, 535 A. 2d 400, 405 n. 3 (Del. 1987); Mills Acquisition Co. v. Macmillan, Inc., 559 A. 2d 1261, 1279 (Del. 1988); Unitrin, Inc. v. American General Corp., 651 A. 2d 1361 (Del. 1995).
A more far-reaching interpretation of this rule was invoked in Kamin v. American Express Co.7383 N.Y.S. 2d 807 (NY Sup. Ct. 1976), aff’d, 387 N.Y.S. 2d 993 (NY App. Div. 1976). In this case, the American Express’s board decision to distribute shares rather than sell them caused the company to lose over eight million dollars for the purpose of improving reported earnings and thereby maintaining the price at which the company’s stock traded. In an even stronger statement of the business judgment rule than Puma v. Marriot and Caremark, the Court in Kamin argues that directors are not liable for making mistakes, even if those errors result in substantial costs to the corporation and its shareholders. In effect, the holding implicitly gives a green light to the right of directors to hide losses and to report higher earnings in order to maintain the trading price of company stock.
Judicial abstention from review of the American Express’s board decision stems from the court’s enshrinement and endorsement of two goals of corporate management: maximizing profits for the corporation and seeking higher prices for selling shareholders. The courts therefore will abstain from second-guessing a business decision.8This holding, as well as Smith v. Van Gorkom, 488 2d 858, 872 (Del. 1985), Union Pacific Railroad v. Trustees, Inc., 8 Utah 2d 101, 329 P. 2d 398 (1958), and others, undermines the position that the implementation of the business judgment rule is unrelated to maximization of shareholder wealth. See Margaret M. Blair & Lynn A. Stout, “A Team Production Theory of Corporate Law,” 85 Va. L. Review (1999), 247, 303. An earlier decision from another jurisdiction further indicates that the business judgment rule operates even where the maximization of shareholder wealth is not at stake.9In fact, some have argued that the business judgment rule has undermined shareholder interests. See Margaret Blair and Lynn Stout, supra n. 8. In Shlensky v. Wrigley,10237 N.E. 2d 776, 778 (Ill. App. Ct. 1968). the plaintiff alleged that there were two grounds for the defendant’s refusal to install lights in Chicago’s Wrigley Field baseball stadium; both alleged reasons were unrelated to promoting the economic interests of the corporation. First, maintaining that baseball is a daytime sport, the defendant refused to host night baseball. Second, Wrigley alleged that instituting night baseball might cause the neighborhood surrounding the stadium to deteriorate. While these factors were not directly related to the corporation’s economic well-being, the defendant claimed that Wrigley’s long-term financial interests would be best served by continuing to furnish only daytime games. In this case as well, the court abstained from second-guessing a business judgment and held that the reasonableness of the decision is categorically off limits to judicial review. Absent allegations of fraud, illegality, or conflict of interest, the court will abstain from reviewing a director’s decision.
What emerges here is the lack of consensus as to the scope of the business judgment rule and what it purports to accomplish. Nevertheless, the common denominator of these holdings is that the business judgment rule entails a judicial policy of non-review in the majority of cases, rather than a framework for shaping judicial review of a director’s performance.11Michael Dooley, “Two Models of Corporate Governance,” 47 Bus. Law (1992), 461, 469–470; Johnson, supra n. 1; Bainbridge, supra n.1; Norman Veasey, “Should Corporation Law Inform Aspirations for Good Corporate Governance Practices or Visa Versa?” 149 U. Pa. L. Review (2001), 1279, 1282–3. A few jurisdictions argue that the rule is a standard of conduct for directors to act reasonably. See Cede & Co. v. Technicolor, Inc., 634 A. 2d 345 (Del. 1993). Minimally, in the absence of evidence of fraud, bad faith, illegality, an uninformed decision, or conflict of interest, the business judgment rule is judicially created doctrine that precludes inquiry into the merits of a director’s decision, protecting the power of the board to govern the company without having to account to courts for their decisions. The burden of proof is upon the plaintiff to rebut the presumptions that the board rendered a decision or decided to refrain from acting in good faith (in accordance with the law), that it was an informed decision, and that the directors had no financial interest in the decision.12American Law Institute, Principles of Corporate Governance: Analysis and Recommendations, Section 4.01(c).
Other courts construe the best judgment rule as the director’s standard of liability.13Cede & Co. v. Technicolor, Inc. 634 A. 2d 345, 361 (Del. 1993); Omnicare, Inc. v. NCS Healthcare, Inc., 818 A. 2d 914, 930 (Del. 2003). Generally speaking, directors are to manage the corporate affairs with the degree of care which an ordinarily prudent man would use in similar circumstances.14Graham v. Allis-Chambers Mfg. Co., supra n. 4, 130; Aronson v. Lewis, supra n. 3, 812; Norlin Corp. v. Rooney, Pace Inc., supra n. 6, 264. While one would expect that ordinary negligence would create tort liability, the business judgment rule dictates that a higher threshold of liability must be met by invoking a gross negligence standard.15Aronson v. Lewis, supra n. 3, 812; Smith v. Van Gorkhom, supra n. 8, 873; Devereux v. Berger, 284 A. 2d 605 (Md. 1971); Rabkin v. Philip A. Haunt Chem. Corp., 547 A. 2d 963, 970 (Del. Ch. 1986); Louisiana World Exposition v. Federal Inn. Co., 864 F. 2d 1147 (5th Cir. 1989); Washington Bancorporation v. Sid, 812 F. Supp. 1256 (D.D.C. 1993). Nonetheless, it still remains unclear whether claims may be limited to gross negligence. See FDIC v. Fay, 779 F. Supp. 66 (S.D. Texas 1991); FDIC v. Williams, 779 F. Supp. 63 (N.D. Texas 1991); FDIC v. Robert K. Castetter, 184 F. 3d 1040, 1045; 1999 U.S. App. LEXIS 16732. For additional cases, see Gevurtz, supra n. 1, 300, n. 64. In fact, there are some courts which uphold the ordinary negligence standard. See Gevurtz, supra n. 1, 292, n. 25. In the corporate context, gross negligence would appear to mean conduct of an extreme character, such as reckless indifference to or a deliberate disregard of the shareholders or a gross abuse of a director’s discretion.16Alloun v. Consolidated Oil Co., Del. Cah., 16 Del. Ch. 318, 147 A. 257, 261 (1929); Aronson v. Lewis, supra n. 3 at 813; Tomczak v. Morton Tahiokl, Inc., # 7861, 1990 WL 42607, at 12 (Del. Ch. April 9, 1990). This gross negligence standard focuses on the reasonableness of the board’s decision-making process, rather than the reasonableness and or substantive merits of their decision. Not surprisingly, it has rarely resulted in personal liability for directors for their decisions.17Joy v. North, 692 F. 2d 880, 885 (2d Cir. 1982), cert. denied, 460 U.S. 1051 (1983); Mary Budig et al., “Pledges to Nonprofit Organizations: Are they Enforceable and Must they be Enforced?,” 27 U.S. F.L. Review (1992), 47, 97–98. Within eighteen months of the Delaware Supreme Court’s decision in Smith v. Van Gorkom, which held that a board of directors acted in a grossly negligent fashion in granting uninformed approval of a merger proposal,18Smith v. Van Gorkom, supra n. 8. Delaware passed legislation limiting the director’s liability for a good faith, albeit negligent, conduct on the corporation’s behalf.19DEL. CODE ANN. Tit. 8, section 102(b)(7) (Supp. 1998). Subsequently, almost every other state legislature followed in the footsteps of Delaware.
Although the court’s role is to address the rationality of the board’s decision-making process and cases of fraud, illegality and conflicts of interest, there is one area in which the court will invoke the business judgment rule addressing the actual merits of a board decision. As the Delaware Supreme Court aptly notes:
To be sure there are outer limits [beyond which corporate decisions made with good process will not be respected], but they are confined to unconscionable cases where directors irrationally squander or give away corporate assets.20Brehm v. Eisner, 746 A. 2d 244, 263 (Del. 2000). Should the corporation receive some consideration in exchange and if there is a good faith judgment that the particular transaction is worthwhile, the transaction does not constitute waste.
Even in such cases, reducing a plaintiff’s claim for waste of corporate assets requires such an onerous burden of proof upon the plaintiff that such a claim will rarely comply with evidentiary standards.21Steiner v. Meyerson, # 15452, 1995 Del. Ch. LEXIS 95, at 3 (Del. Ch. July 19, 1995); Harbor Fin. Partners v. Huizenga, 751 A. 2d 879, 892 (Del. Ch. 1999); In re The Walt Disney Co. Derivative Litig., 907 A. 2d 693, 748–749 (Del. Ch. 2005). While there are holdings in cases of a director’s inattentiveness to corporate affairs resulting in the embezzlement of the company’s funds in which the burden of proof was satisfied,22Heit v. Bixby, 276 F. Supp. 217 (E.D. Mo. 1967); Francis v. United Jersey Bank, 432 A. 2d 814 (N.J. 1981); Gaillard v. Natomas Co., 208 Cal. App. 3d 256 Cal. Rptr. 702, 710 (Ct. App. 1989). in instances in which there was no fraud, illegality, conflict of interest, or waste, a director is entitled to protection if he failed to exercise oversight by guaranteeing reasonable information and reporting systems to inform himself of a company’s financial condition and instead relied upon the company’s employees.23McDonnell v. American Leduc Petroleums, Ltd., 491 F. 2d 380 (2d Cir. 1974); FDIC v. Castetter, supra n. 14. See also, Katz v. Chevron Corp., 22 Cal. App. 4th 1352, 27 Cal. Rptr. 2d 681, 690 (Ct. App. 1994); In re Caremark Int’l Inc. Deriv. Litig, supra n. 2.
It is not the case that the invoking of a gross negligence standard for an appraisal of a director’s conduct is due to the fact that the law has a higher expectation of his performance compared to a corporate officer’s behavior, which is judged by an ordinary negligence standard. Both case law and legal commentary extend the business judgment rule to officers who manage the corporation. See A. Gilchrist Sparks, III and Lawrence A. Hamermesh, “Common Law Duties of Non-Director Corporate Officers,” 48 Business Lawyer (1992): 215; Charles Hansen, “The Business Judgment Rule: Is There Any Doubt It Applies to Officers?,” LXX CORP. # 17 (Aspen 1999); Stephen Bainbridge, Corporation Law and Economics (2002), Section 6.4 at 285–6.
In short, whether one construes the business judgment rule as conveying a standard of liability or not, the common denominator of all these holdings is that absent fraud, illegality, conflict of interests, or any challenge to the process of the board’s information gathering and the fairness of the decision-making process,24Sinclair Oil Corp. v. Levien, 280 A. 2d 717 (Del. 1971); Weinberger v. UOP, Inc., 457 A. 2d 701 (Del. 1983); Smith v. Van Gorkom, supra n. 8. any director’s decision which will maximize shareholder profits rather than lead to corporate waste will be upheld by the courts. In fact, fiduciary duty mandates that corporate directors promote shareholder interests and therefore requires of them to maximize profits subject to legal constraints.25The classic formulation is articulated in Milton Friedman, “The Social Responsibility of Business is to Increase Its Profits,” New York Times (Sept. 13, 1970), Sect. 6 (Magazine), 32. See also Brehm v. Eisner, supra n. 20, 264; Stephen Bainbridge, Corporation Law and Economics (2002), 419–29; Michael Dooley, Fundamentals of Corporation Law (1995), 97; Frank Easterbrook and Daniel Fischel, “The Proper Role of a Target’s Management in Responding to a Tender Offer,” 94 Har. L. Review (1981), 1161, 1191–2.
Given the scandals involving misleading financial statements designed to pump up reported corporate earnings of Enron, Tyco, WorldCom, and others, some legal commentators have called for increased board accountability, and thus greater regulation of corporate governance by the courts.26Lawrence E. Mitchell, “The Sarbanes-Oxley Act and the Reinvention of Corporate Governance,” 48 Vill. L. Review (2003), 1189, 1189, n. 2. Others contend that directors are to be viewed as “mediating hierarchs” who manage the corporate assets and are empowered with the task of balancing conflicting interests of diverse groups, rather than being viewed as “agents” who only maximize shareholder interests.27In fact, 41 states, including Delaware, allow directors to consider non-shareholder constituencies, and the state of Connecticut obligates directors to consider such interests. See Margaret Blair and Lynn Stout, supra n. 8, 320–8; Einer Elhauge, “Sacrificing Corporate Profits in the Public Interest,” 80 N.Y.U. L. Review (2005), 733, 738, 762–3. Adopting such a perspective, which allows for consideration of stakeholder interests including those of its suppliers, clients, creditors, shareholders, rank and file employees, and local communities, would contribute to constraining the misuse of a director’s authority. Finally, some contend that current conceptions of corporate governance in general, and the need for good faith in particular set the groundwork to look to religious faith among the managers and directors to encourage socially responsible corporate conduct.28Helen Alford and Michael Naughton, Managing As If Faith Mattered: Christian Social Principles in the Modern Organization (University of Notre Dame Press: 2001), 55–57, 70–95, 99–100; Susan Stabile, “Using Religion to Promote Responsibility,” 39 Wake Forest Law Review (2004), 839; Susan Stabile, “A Catholic Vision of the Corporation,” 4 Seattle J. for Soc. Justice (2005), 181. In short, the application of the business judgment rule as a judicial policy of non-review directors’ decisions has evoked legal and religious responses to the need to reform corporate governance.
B. The Business Judgment Rule in the Not-for-Profit Sector
Similar to for-profit corporations, non-profit corporations are governed by a board of directors who have diverse tasks, many of which are similar to those in business corporations. As with for-profit corporations, the board is empowered to monitor management and approve major transactions of the non-profit. As we have shown, the business judgment rule serves as the mechanism of judicial oversight for directors’ decisions in the corporate world. Does the same rule hold sway in addressing the decisions of non-profit directors?
Despite certain similarities in the two forms of organization, non-profit directors may have limited business or financial experience; in certain instances, one or two directors may dominate the board, creating a nonresponsive board. This is unlike a business corporation, in which there is an infrastructure of information gathering mechanisms and systems for reporting management operations. Moreover, whereas in the corporate world profits are distributed among the stakeholders, such as directors, managers and the like, in the not-for-profit sector, earned profits are reinvested or earmarked for expenses or salaries rather than distributed among its members. Furthermore, whereas corporate directors are remunerated and accountable for their decisions, the majority of non-profit directors are public-minded individuals who serve without compensation on self-perpetuating boards who frequently either lack the information to arrive at informed judgments or who rubberstamp management decisions.
Yet, despite the difference in the working environments of these two types of organizations, the reasons justifying the business judgment rule in the corporate world have served as the same rationales offered by the courts and commentators for applying this rule to the not-for-profit sector. Aptly summarizing the rationales advanced for invoking this rule in the corporate context, one commentator writes:
The most frequently cited justifications of the rule include: (1) promoting risk-taking and allowing shareholders to voluntarily undertake risk; (2) encouraging competent directors to serve; (3) preventing judicial second-guessing; (4) allowing directors sufficient leeway in managing the corporation; and (5) permitting more efficient market mechanisms to manage director behavior.29Denise Ping Lee, “The Business Judgment Rule: Should It Protect Nonprofit Directors?” 103 Columbia L. Rev. (2003), 925, 945.
Though the rule originated in the for-profit world in encouraging innovative and entrepreneurial thinking, limiting litigation by disgruntled shareholders, promoting service by directors with expertise, and limiting judicial scrutiny, courts have implicitly argued that these same values and concerns are applicable to the non-profit world. The courts have therefore extended the rule to the not-for-profit sector and adopted the gross negligence standard as the yardstick for assessing a director’s liability for negligent decision-making.
II. Halakhah
A. The Business Judgment Rule in the For-Profit Sector
The foregoing discussion focused on the business judgment rule as a judicial doctrine precluding American courts from reviewing the decisions of directors and officers of the for-profit and not-for-profit world, provided that they are informed judgments and do not entail self-dealing, fraud, illegality, the absence of reasonable information and reporting systems, an unfair decision-making process, or corporate waste. Moreover, even a director who is grossly negligent will be exempt from liability. In short, a director’s simple negligence, misjudgment, or failure to follow the direction of corporate leadership will not result in legal accountability for his action. The business judgment rule contemplates judicial silence and justifies court intervention only under limited circumstances.
In our forthcoming discussion of Halakhah,30Halakhah is recorded in various authoritative literary sources: (1) the Talmud, the classical exposition of Jewish law; (2) perushim (commentaries) and hiddushim (novella – discursive critical investigations); (3) pesakim (restatements); and (4) she’eilot u-teshuvot (responsa literature) – juridical authorities’ decisions on legal queries of litigants, judges, community leaders, and other concerned individuals.
Juridical authorities have at their disposal 5 tools for arriving at legal decisions: midrash (canons of interpretation); takanah u-gezeirah (legislation); minhag and nohag (custom and usage); ma’aseh (precedent); and sevarah (legal logic). For further elucidation of the adjudicative tools and literary sources of Halakhah, see Menachem Elon, Jewish Law: History, Sources and Principles (Philadelphia:1994).
The sources and analysis in this section has benefited from Michael Wygoda and Hayyim Zippori, Agency Law (Ministry of Justice, Jerusalem, Israel) [Hebrew]. we will address whether Jewish law subscribes to this standard of liability for corporate leadership. To address this matter, we need to understand some of the various business organizations recognized by the halakhic legal system.
A type of partnership agreement termed an “iska” implicitly addresses our question. Halakhah prohibits the charging and paying of any amount of interest between two Jews, regardless of how reasonable the rate would be considered in the commercial world.31Shemot 22:24; Vayikra 25:37; Devarim 23:20–21. As such, interest-bearing loans are prohibited. In light of this proscription, there is a technique, dating back to the days of the composition of the Talmud, that allows for the structuring of a loan as a business investment for which profits may be paid.32Bava Metzia 104b. One individual, the investing partner (IP), invests the funds which are required for the business enterprise and plays no role in managing the business; the managing partner (MP) uses the IP’s capital to operate the business. Unless stipulated otherwise, all profits and losses are to be divided equally between the two partners. The agreement stipulates that on a specified date, the MP must repay the amount of the loan – that is, fifty percent of the funds advanced to him – regardless of any losses he may have incurred. Half of the profits from the portion of the loan are to be remitted to the MP and half of the profits from the deposit are given to the IP.
Describing this business arrangement, a contemporary authority notes:
The Talmud calls this arrangement “palga milveh u-palga pikadon,” half loan, half investment. The concept of “half loan, half investment” is based on the principle that each partner in a business is entitled to profits which are generated by his money. The iska agreement entitles the managing partner to receive 50% of the profits, despite the fact that he did not actually invest money into the business. This means that the agreement treats 50% of the invested funds as if they were the managing partner’s. This is because half of the money which was given by the investing partner is considered a loan to the managing partner, which he then uses to realize profits. The agreement also calls for the investing partner to receive 50% of the profits which are generated. This means that 50% of the business funds are considered his. Although he has actually advanced all of the business funds, the agreement treats only half of the money as the investing partner’s. This is the “half investment” portion of the business.33Yisroel Reisman, The Laws of Ribbis (New York: 1995), 379–80.
The iska agreement most closely resembles the secular legal concept of a limited partnership.34Clearly, an “iska” is not similar in all respects to a limited liability company. For example, whereas a secular partnership is vicariously liable for wrongs committed by each partner and employees during the course of its business, such liability does not exist in a halakhic partnership. See Fletcher Cyc. Corp. Sec 11.35 (1996 Cum. Supp.); Haim Hefetz, “Vicarious Liability in Jewish Law” [Hebrew], 6 Dine Israel (1975), 49. In a limited partnership, at least one general partner manages the business and is personally liable for the partnership’s debts, while the limited partner contributes capital and is neither involved in management nor personally liable for the partnership’s obligations.
If the MP decides unilaterally to borrow the monies for his own use, is he permitted to minimize the IP’s return on his investment? Replying to this question, the Talmud states:
It was said in Nehardea: Now that we say that it is a half-loan and a half-bailment, if he [the MP] wishes to drink beer from it [the loan portion], he may do so. Rava said: It is therefore called iska [business] because he can tell him, “I gave it to you for trading, not for drinking beer.”35Bava Metzia, supra n. 32.
The underlying logic of Rava’s view is that the IP’s focus is to maximize his profits. The creation of any other ventures unrelated to the goals of the partnership agreement will only dilute the IP’s efforts in managing the enterprise, as well as expose the capital investment to substantial risk. The resolution of this matter is addressed within the context of agency law. The iska arrangement, similar to a secular partnership, equally generates a principal-agent relationship whereby each partner is both an agent to his fellow partner and a member of the partnership is a principal.36Uniform Partnership Act Section 4(3), 9(1); Bi’ur Hagra, YD 167:1, HM 77:13; Netivot ha-Mishpat 77:4.
Addressing the above Talmudic scenario of the MP seeking profits for himself, diverting funds from the loan part of the iska for his personal use, Rambam rules:
Several rabbinical authorities have ruled that if [the agent] purchased the article for himself using the money given to him by his colleague after considering it to be a loan, he is considered to have purchased the article for himself. We accept the claim: “I considered the money that was given to be a loan.” I state that this is not true. Instead the purchase belongs to the principal, as will be explained with regard to the law of iska.37Mishnah Torah, Hilkhot Mekhirah 12:7.
Thus, according to Rambam, despite the MP’s intention to borrow the money for his personal use and divert the funds from the iska, the IP, who is the principal, retains ownership of the money; therefore, any profits accrued from the MP’s personal venture are to be shared with the IP. Stated somewhat differently, the third party who is engaged in business with the MP does not necessarily assume that the MP is the owner of the money, but views him rather as the agent of a principal who is the real owner and will receive the money from the transaction. Despite the MP’s intentions to borrow the monies for his personal use, profits accrue to the IP, as principal and any loss of the capital is the MP’s responsibility.38R. Shimon Shkop, Hiddushei Rabbi Shimon Yehuda ha-Kohen, Bava Metzia 17. See Michael Wygoda, “The Agent Who Breaches His Principal’s Trust,” 18 Jewish Law Annual (2009), text accompanying n. 124.
However, subsequent restatements of Halakhah disagree. As R. Karo states:
If someone gives to his friend money for an investment, even though half of it is a loan, he cannot use the money for his personal use and manage the investment with the other half of the money.39SA, YD 177:30.
According to this approach, if the MP, as an agent, acquired an article for himself with the assets of the IP, the principal, that object now belongs to the IP. Should this diversion of funds occur, Rema concurs with R. Karo:
If he deviates from the investor’s instructions and states that he is now working for himself rather than the iska, he is akin to a robber.40Rema, HM 183:3.
In other words, the misappropriation of the principal’s assets is construed as gezeilah, theft, and the agent is obligated to reimburse the original market value of the article and accrued profits to the IP, the principal. 41Pursuant to the ruling that robbers pay according to the value of the misappropriated item at the time of the theft. See Bava Kama 9:1.
Thus, there is a controversy regarding whether funds diverted by an agent from an iska arrangement for his own use belong to the principal or the agent. However, the common denominator of the two approaches is that the partner, as principal, has a legal claim against his other partner, as agent, who deviates from his mandated instructions for his own personal benefit.
In effect, the partnership relationship reflects the conventional principal-agency model. In the absence of a partnership arrangement, how does halakhic agency law address the case of an agent who harms the principal’s interests without deviating from his explicit instructions? Rambam states:
When an agent [intentionally] violates the instructions of his principal, his deeds are of no consequence. Similarly, if he erred even with regard to the slightest amount, the transaction, whether involving landed property or movable property, is nullified. For [the principal] can state: “I sent you to improve my [position] not to impair it.”42Mishnah Torah, Hilkhot Sheluhim ve-Shutefim 1:2, Eliyahu Touger (trans.) (New York: 1999), 556.
The agency is thus voidable. Should the principal continue to authorize this transaction even though it has harmed his interests, the agency relationship continues to be operative. However, should the principal be unwilling to accept this harm, the principal may elect to rescind the agency.
What happens if the principal cancels the agency? Is the principal or the agent liable to a third party for any losses incurred by the cancellation of a particular transaction? Rambam informs us:
When a principal transfers money to an agent to purchase real property and the agent purchases it for him without [requiring the seller to accept] financial responsibility, [if it is expropriated from the purchaser], he is considered to have damaged the principal’s position. The agent must purchase the property without financial responsibility, as he did for himself. Then he must sell it to the principal and accept financial responsibility. [This decision is rendered] because [the agent] purchased [the property] with money belonging [to the principal]. The agent must accept the financial responsibility himself.43Ibid., 556–8.
Third party redress is dependent upon whether we are dealing with a disclosed agency or undisclosed agency. If the agent is acting for a disclosed principal, it is the third party’s responsibility to verify the scope of the agent’s mandate prior to proceeding to engage in business with the agent. Consequently, if the agent deviated from his mandate, the transaction between the agent and the third party is nullified. However, Rambam is addressing the situation of an undisclosed agency.44Numerous commentators and legists have interpreted Rambam in this fashion. See Shimshon Ettinger, Agency in Jewish Law [Hebrew] (Jerusalem: 1999), 154–5; Hayyim Zippori and Michael Wygoda, Agency Law: Section 6 (Jerusalem: 2006), 16, n. 59. In such a case, if the agent, acting for an undisclosed principal, deviates from his instructions, the actions between the principal and the third party are not binding. Nonetheless, the agent’s actions are binding between the third party and himself. Given that the agent is aware that he harmed the principal’s interests and deceived the third party by representing himself as being authorized to act, he is personally liable for any losses. This position is endorsed by other legists, such as R. Shlomo ben Aderet (Rashba).45Teshuvot ha-Rashba 2:255. See also, Hiddushei ha-Ritva, Kiddushin 42b, s.v. ve-lo; Mahaneh Ephraim, Hilkhot Sheluhim ve-Shutfim 16. See Zippori and Wygoda, supra n. 44 at text accompanying nn. 78 and 83; Ettinger, supra n. 44, 157. For a different interpretation of Rashba, see Zippori and Wygoda, ibid.
The aforementioned position is predicated upon a transaction executed between the third party and the agent without the principal’s material or financial input. What happens if the principal’s assets are invested in the transaction either through the agent’s sale of a principal’s asset or use of the principal’s monies, resulting in harm to the principal’s interests? One approach is that the principal may decide to consent to the agent’s act and direct him to correct the harm. Another approach is that the principal must choose between the two options: either to accept the agent’s action and accept the loss, or rescind the agency and initiate a claim for redress for the harm caused by the agent. However, the principal may not choose both options. A third approach advocates that the agency is void and the agent is personally liable for any losses. The final view is that the agency relationship remains intact; the transaction is binding between the agent and the third party and the agent is responsible to indemnify any losses.46For a systematic exposition of these positions, see Zippori and Wygoda, supra n. 44, 17–24.
Is an agent liable even if there is no connection between his violation of the terms of the agreement and the actual losses? This question is the focal point of a seventeenth century Egyptian beit din decision. Reuven sent merchandise from Egypt to Italy to his shaliah (agent) instructing him to sell the merchandise there. In exchange, it was agreed that the shaliah should purchase certain merchandise and send it to Reuven via ocean freight. Due to time constraints, the shaliah deviated from the instructions and forwarded Reuven a different type of merchandise. Subsequently, the boat capsized and the merchandise was lost. The two sides appointed a dayan as arbiter to resolve whether the shaliah was liable for the loss. His decision was that the shaliah was liable, even though there was no connection between the deviation from Reuven’s mandate and the lost merchandise. Such a deviation is no different than the Talmudic case of the principal who instructed the agent to purchase wheat and he bought barley.47Ketzot ha-Hoshen, HM 183:5; Netivot ha-Mishpat, HM 183:7; Mahaneh Ephraim, Hilkhot Shelihim ve-Shutfim 1; Hayyim Zippori and Michael Wygoda, Agency Law Section 9 (Ministry of Justice, Jerusalem) [Hebrew], 14, n. 164. This decision is defended by some legists,48Teshuvot Maharashakh 3:66; Teshuvot Oholei Yaakov 45; Hayyim Zippori and Michael Wygoda, supra n. 47, 14–15. but others demur and argue that a shaliah’s responsibility is limited. Therefore, if there is no connection between the deviation from the principal’s instructions and the actual loss, the shaliah is exempt from bearing the loss.49Teshuvot ha-Mabit 1:179; Shakh, HM 183:7; Sma, HM 176:47.
A partner of an “iska,” which is akin to a limited partnership arrangement, generates a principal-agent relationship whereby each partner is both an agent to his fellow partner and a member of the partnership is a principal. Should an agent deviate from the explicit instructions of his principal, even if this deviation is unrelated to subsequent losses, or if he causes harm to the principal’s interests, the partner qua agent is liable for his actions. In effect, agency law serves to define the parameters of a partner’s liability.
On the other hand, one of the other distinctive consequences that flow from this “iska” relationship is that the partner is equally an employee, a po’eil. For example, regarding the IP setting the wages of the MP in the iska, the Mishnah states that the MP is receiving his remuneration as a worker.50Bava Metzia 68a. As such, although an iska arrangement is characterized as a limited partnership, the MP is comparable to a worker who has the right to withdraw from the venture. As R. Karo states:
If someone receives an iska for a prescribed period of time, the recipient may withdraw from it akin to any worker; however, the investor may not withdraw.51SA, HM 176:44.
Elucidating the rationale for this view, R. Falk observes:
A manager of an iska is different due to being viewed as a slave who works solely for the investor, as it says, “You, the community of Israel, are a servant to me.”52Sma, HM 176:44. See also Sma, HM 176:57–58. Implicit in this position is that a manager of an iska is similar to an employee who is akin to a non-Jewish slave, whose “hand is like his master’s hand.” See Mahaneh Ephraim, Hilkhot Sheluhim ve-Shutfim 11, in the name of Rashba.
Whereas the IP invested capital in the enterprise and therefore is not viewed as a worker, the MP’s investment of his time and effort to develop the venture deems him a worker, and he therefore may withdraw from the business at any time.53Teshuvot Torat Emet 113.
The identity of the partner as a worker is not limited to an iska, a limited partnership. Regarding damage committed by an employee in a proprietorship, Shulhan Arukh states:
Professional craftsmen who caused irreparable loss, he [an employer] can terminate him without forewarning, given that they are deemed forewarned by dint of his due diligence to perform his job.54SA, HM 306:8.
Irreparable loss is defined as spoiled goods that cannot be appraised. In such a situation, the contractor may be terminated. However, if the losses incurred are quantifiable, the employee is precluded from discharging the worker and may only seek monetary redress from him.55Sma, HM 306:20. On the basis of Shulhan Arukh’s position, Netivot ha-Mishpat analogizes this norm of an employer-employee relationship to every type of partnership. Just as a contractor may be terminated in cases of irreparable loss, a partner who has caused such loss may similarly be terminated from a partnership.56Netivot ha-Mishpat, HM 176:33.
Moreover, the applicability of halakhic labor law equally extends to any principal-agent relationship and is not limited to a partnership and proprietorship relationships. For example, any rank-and-file employee, whether employed by a corporation or proprietorship, has a right to withdraw from a labor agreement at any time. Interpreting the biblical verse, “For to me are the children of Israel servants,”57Vayikra 25:55. the Talmud expounds, “They are my servants, but not servants to servants.”58Bava Metzia 10a. Regarding whether a laborer is comparable to an agent in every respect, see Ettinger, supra n. 44, 79–84. Even if his salary was prepaid, the employee can withdraw from the job; if he doesn’t have the financial means to repay his former employee, the salary constitutes a debt which must be repaid. SA, HM 333:3. Cf. Shakh, ad loc. 15; Ketzot ha-Hoshen, ad loc. 5–6. Denying an employee the right to retract from a labor agreement would impair his autonomy.
Thus, R. Moshe Sofer opines:
If he desires to withdraw from his mandate, the law of the laborer who withdraws in the middle of the day is applicable to him.59Teshuvot Hatam Sofer, HM 178.
Analogously, the right of withdrawal applies to an agent. As R. Yehezkel Landau argues:
In the case of the agent and the principal … if he wants to withdraw, it is clear that the agent … has the status of a po’eil.60Teshuvot Noda be-Yehuda, Mahdura Kama, 30:9. The converse is equally true; a po’eil has the status of an agent. See Shakh, HM 105:1.
Given that we are dealing with a gratuitous agent, if he fails to carry out the mandate he undertook, he has committed a moral offense, but is not subject to any legal consequences.61For the scope of a paid agent’s liability for retracting from a job, see Shilem Warhaftig, Labor Law in Jewish Law [Hebrew] (Jerusalem, 1982), 1:22–24, 2:654–720. The agent is treated like an employee who resigns from his work; although possibly exempt from indirect damages (grama) or prevented from employment due to force majeure (ones), he is liable for direct damages that cause irreparable loss.62Divrei Ge’onim 96:23; SA, HM 333:2, 4–5; S. Warhaftig, supra n. 61, 2:654–720. Should he cause the damages unintentionally, he would be exempt from liability; see Shakh, HM 386:1, 6. If his actions are commonplace in the corporate world, he would be liable even for indirect damages; see Rema, HM 386:3; Bi’ur ha’Gra, HM 386:10.
In short, partnership and proprietorship arrangements are governed by the norms of halakhic labor law and agency law. Agents have the status of a worker and a worker is treated as an agent.63As we have briefly noted supra in the text accompanying nn. 57–61, given the particular circumstances of a partnership, there will be situations in which invoking halakhic labor law and agency law may lead to different results. There will be equally cases where labor law will trump agency law or visa versa and define an employee by applicable provisions of labor law or by agency law. This matter is beyond the scope of our presentation.
Based on the above conclusions regarding the applicability of agency and labor law to halakhic partnerships and proprietorships, we can now begin to address if the halakhic system incorporates the business judgment rule as a judicial mechanism for reviewing a director’s decision of a for-profit corporation.
In this context, we will not delve into the question of how Halakhah conceptualizes the role of directors of business corporations (as either owners, agents, or employees). For the sake of our presentation, we will assume the premises of American law regarding these individuals. For over a century, scholars have debated the issue of how to construe the employees of a business corporation. The dominant approach is the view that its assets are collectively owned by shareholders or that the shareholders are principals who employ officers and directors as agents to manage the assets on their behalf.64William Cary, “Federalism and Corporate Law: Reflections upon Delaware,” 83 Yale L. Journal (1974), 663; Victor Brudney, “Corporate Governance, Agency Costs and the Rhetoric of Contract,” 85 Colum. L. Rev. (1985), 1403; Melvin Eisenberg, “The Conception that the Corporation is a Nexus of Contracts and the Dual Nature of the Firm,” 24 J. Corp. L. (1999), 819, 825; Michael Dooley, “Two Models of Corporate Governance,” 47 Business Law (1992), 461; Stephen Bainbridge, “In Defense of the Shareholder Wealth Maximization Norm: A Reply to Professor Green,” 50 Wash. & Lee L. Rev. (1993), 1423, 1427–8; Stephen Bainbridge, “Director Primacy: The Means and the Ends of Corporate Governance,” 97 NW. U. L. Rev. (2003), 547.
For a thoughtful essay questioning the applicability of agency law, given the structure of contemporary corporate statutes, see Deborah DeMott, “Shareholders as Principals,” in Ian Ramsey (ed.), Key Developments in Corporate Law & Equity: Essays in Honor of Harold Ford (Butterworths, 2002), 105. Others contend that officers, managers, and rank-and-file employees of a corporation act as a team, providing services to a board of directors. The consequence is “that no one team member is a ‘principal’ who enjoys a right of control over the team.”65Margaret Blair and Lynn Stout, supra n. 8, 247, 277. In effect, the team members are employees rather than agents of the enterprise. Instead of conceptualizing the corporation as a hierarchical relationship,66Eisenberg, supra n. 64. some adopt the perspective that the corporation is a nexus of contracts or a nexus of reciprocal arrangements between directors, managers, rank-and-file employees, and shareholders in the corporate setting bound by certain legal rules.67Eisenberg, supra n. 64, 822–4. See also Michael Jensen and William Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” 3 J. Fin. Economics (1976), 305; Frank Easterbrook and Daniel Fischel, “The Corporate Contract,” 89 Colum. L. Rev. (1989): 1416; Stephen Bainbridge, “The Board of Directors as a Nexus of Contracts: A Critique of Gulati, Klein & Zolt’s ‘Connected Contracts’ Model,” 88 Iowa Law Rev. (2002), 1, 9–11. Alternatively, the firm is “those assets that it owns or over which it has control.” See Sanford Grossman and Oliver Hart, “The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration,” 94 J.Pol. Econ. (1986), 691, 693. As Alchien and Demsetz observe:
The firm has no power of fiat, no disciplinary action any different in the slightest degree from ordinary market contracting between any two people. [An employer] can fire or sue, just as I can fire my grocer by stopping purchases from him or sue him for delivering faulty products … Telling an employee to type this letter rather than to file that document is like telling my grocer to sell me this brand of tuna rather than that brand of bread.68Eisenberg, supra n. 64, 821–2, quoting Alchian and Demsetz, “Production, Information Costs, and Economic Organization,” 62 Am. Econ. Rev. (1992), 777–8.
Despite the many proponents of this contractarian approach, the dominant mode of thinking in corporate law69William Allen, “Contracts and Communities in Corporation Law,” 50 Washington & Lee L. Rev. (1993), 1395, 1399. continues to view directors as agents of the shareholders.70Bainbridge, supra n. 64, 6; Blair and Stout, supra n. 8, 290. Cf. Daniel Greenwood, “Fictional Shareholders: For Whom are Corporate Managers Trustees? Revisited,” 69 S. Cal. L. Rev. (1996), 1021, 1038–45; Deborah DeMott, “Breach of Fiduciary Duty: On Justifiable Expectations of Loyalty and Their Consequences,” Duke Law School Faculty Scholarship Series (2006), 1, 14. This conclusion is predicated upon the notion that shareholders have contracted for this right in exchange for their investment in the venture.71Ronald Colombo, “Ownership, Limited: Reconciling Traditional and Progressive Corporate Law via an Aristotelian Understanding of Ownership,” 34 J. Corp. Law (2008), 247, 259. Thus, regardless of which perspective we accept, the directors are either conceptualized as agents or employees of the corporation.
Assuming that directors are either agents or employees according to Halakhah, are the parameters of their liability relating to deviation from a principal’s mandate or causing irreparable loss identical to the scope of responsibility as we described above for partners, managers, and employees of a halakhic partnership or proprietorship?
At first glance, this question hinges upon how one conceptualizes a corporation. Does Halakhah subscribe to Chief Justice Marshall’s description of the corporation as “an artificial being, invisible, intangible and existing only in contemplation of law,”72Trustees of Dartmouth College v. Woodward, 17 U.S. (4 Wheat.), 518, 636 (1819). or is the corporate form to be construed as a partnership benefiting shareholder’s interests?73See Simcha Meron, “The Status of a Corporation in Jewish Law” [Hebrew], 59 Sinai (1966), 228; Y. Kurtzman, “The Legal Foundations of a Corporation in Jewish Law” [Hebrew] (Master’s thesis, Bar Ilan University, 2002); PDR 6:315; 10:273; 19:9; Michael Broyde and Steven Resnicoff, “Jewish Law and Modern Business Structures: The Corporate Paradigm,” 43 Wayne Law Review (1997), 1685; my Rabbinic Authority: The Vision and the Reality, vol. 2 (forthcoming).
Subscribing to the dominant halakhic view that construes a corporation as a general partnership, does the system recognize the business judgment rule as a mechanism to protect directors from derivative suits of shareholders except in cases of fraud, illegality, self-interest, corporate waste, and the irrationality of the board’s decision-making process? Given that a director is comparable to either an agent or an employee who is comparable to an agent,74See text accompanying notes 36–63. For authorities who view corporate directors as agents, see Teshuvot Mahari ha-Levi 2:54; Yad Shaul, 45; Teshuvot Minhat Eliezer 2:22; Teshuvot Tarshish Shoham, YD 34; Teshuvot Maharam Schick, YD 157. Cf. R. Schmelkes, who argues that a director is an owner; see Teshuvot Beit Yitzhak, YD, vol. 2, Kuntres Aharon 32. However, his position may simply reflect the era in which he lived, when directors were personally liable for debts. Others contend that a manager is an owner in terms of the laws of ribbit; see Shakh, Nekudat Kesef, YD 160: 11; Teshuvot Sho’el u-Meishiv, vol. 1, (2d edition), 136; Teshuvot Doveiv Mesharim 1:10. agency law or labor law ought to be applicable.
As we have shown, the provisions of labor law and agency law dictate compliance with the mandate of the shareholders – that is, the principals. The scope of discretionary judgment is limited. Consequently, Professor Aaron Levine’s conclusion is that the halakhic legal system would reject the business judgment rule, which gives wide latitude to corporate directors and refrains from second-guessing their decisions.75Aaron Levine, “Epilogue,” in Aaron Levine and Moshe Pava (eds.), Jewish Business Ethics: The Firm and Its Stakeholders (NY: 1999), 273, 281–286. In effect, from a halakhic perspective, a director’s corporate behavior should be scrutinized no differently than a rank-and-file employee of a partnership or proprietorship.
It seems, however, that this matter requires further scrutiny. What happens if the shareholder instructs the director that he may do any act that he wishes, even if it is detrimental to the corporation and its shareholders? In that case, is the harmful act of the director binding upon the shareholder? Based upon Shulhan Arukh’s ruling, it would seem that such an agreement would be valid. As Shulhan Arukh states:
If he stipulates with the agent that the agent act either for his benefit or for his harm … he cannot revoke the agency.76SA, HM 182:3. Such a conclusion equally applies to a partnership; see Shakh, HM 77:19.
Should we adopt this perspective, it would seem that Halakhah would, in fact, endorse the business judgment rule and refrain from scrutinizing a director’s decision even in cases of gross negligence.
Nonetheless, even the existence of such private ordering between the shareholders and the directors of the corporation fails to give them immunity for illegal acts. As we have seen, while an agent is bound to the principal’s instructions absent an agreement of the parties to the contrary, and is liable should he deviate from that mandate, should the principal direct the agent to commit an illegal act, such as a tort that may entail a criminal infraction, the agent is liable for the performance of these illegal acts. As the Talmud states:
If one dispatches a fire to a deaf-mute, an insane person, or a minor and then the bearer of the fire sets ablaze the property of another person, the one who sent him is exempt from liability under the laws of man … Why is the agent exempt? Let us rather say he is liable, since the person who set the fire acted as his agent and a person’s agent is considered to be like himself? [This case is different.] Here, the agent was commanded to commit a transgression [to damage the property of another], and one cannot be an agent to commit an act of transgression.77Kiddushin 42b.
Tur states the rule:
Just as one is proscribed from stealing … similarly, it is prohibited from injuring your friend.78Tur, HM 378. For further discussion, see Zalman N. Goldberg, “The Parameters of the Prohibition to Injure and the Duty of Grama According to Heavenly Law” [Hebrew], 1 ha-Yashar ve-ha-Tov (2006), 5. Cf. Broyde and Resnicoff, supra n. 73, 1779, n. 308.
Given that an agent cannot be authorized to execute an illegal act, a violation of ritual Halakhah,79Kiddushin 42b–43a. The rationale for this rule – whether agency authorization is predicated upon executing permissible acts or whether due to the principal’s expectation that the agent will not commit an illegal act agency was never created – is subject to debate. See Shakh, HM 348:6 and 388:67 and Sma, HM 182:2 and 348:20. Consequently, if an investment broker employed by a bank executed an unauthorized transaction, the broker would be personally liable for negligence for any incurred loss. See Rabbanut ha-Rashit le-Yerushalayim, Beit ha-Din le-Dinnei Mamonot ve-le-berur Yahadut 4:265, 268. Generally, a corporate employee, executive, or director cannot commit a violation of ritual Halakhah on behalf of his superior. See infra text accompanying nn. 96–100. if the agent, in this case a director, were to act negligently, he would be liable. Thus, whereas the best judgment rule would immunize in such cases from liability, Halakhah would find a basis for action.
By way of example, in Para-Medical Leasing Inc. v. Hangen,80739 P. 2d 717 (Wash. App. 1987). a company sued its manager for negligent mismanagement, but the court found in favor of the manager. Indeed, precedent can be found in earlier Washington case law for shielding officers from such liability.81Nursing Home Bldg. Corp. v. Deltort, 535 P. 2d 137 (Wash. Ct. App. 1975). In contrast, assuming the allegations are proven, legists of Halakhah would mandate liability in such a case. 82Even should the facts demonstrate that the actions are to be labeled “grama,” indirect damage, it may be actionable within the context of a beit din implementing the rules of pesharah, compromise. See Teshuvot Mahari Bruna 241; R. Z. Goldberg, Shivhei ha-Peshara, section 5 (letter sent to Kollel Mishpetei Aretz, Ofra, Israel).
Whether the principal would be monetarily responsible for such illegal acts is subject to dispute. See Teshuvot Noda be-Yehuda, Mahadura Kama, 64 and 75; Netivot ha-Mishpat 182:1. Similarly, in Craig v. Graphic Arts Studio, Inc.,83166 A. 2d 444 (Del. Ch. 1960). the court held that an officer or director is permitted to be employed in a competitor’s enterprise as long he does not violate any legal or ethical fiduciary duty with his own company. Because the officer was a minor shareholder in his company and failed to disclose to his company his real interest in the competitor’s business, the court held he had breached his fiduciary duty to his company. In the absence of such breach, however, the reasonable inference of the holding is that it was proper for the directors to be engaged in two businesses simultaneously; the court’s application of the business judgment rule would have granted him immunity in such a case. Here again, generally speaking, Halakhah obligates that an employee perform due diligence on his job and prohibits the performance of a second job, “moonlighting” that will impede his tenure of employment at his existing job.84Warhaftig, supra n. 61, vol. 2, 330–4.
A distinction between American law and Halakhah is also apparent when the director’s activities entail a degree of lying or misreporting. For example, in Kamin v. American Express, a company wished to increase its earnings per share by employing false accounting practices.85See text accompanying n. 7. In this case, the court held that the directors of American Express were shielded from liability based on the business judgment rule. In contrast, according to Halakhah, directors, officers, and shareholders alike must refrain from lying86Netivot ha-Mishpat 105:3; Aaron Levine, Economics and Jewish Law (NY: 1987), 23–24. Cf. those who argue that a partner assumes liability for his partner’s illegal actions such as theft; see Rashi, Bava Metzia 8a; Ketzot ha-Hoshen 348:3; Zafri, infra n. 97, 50. by way of altering financial statements to either mislead potential shareholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting statements. The potential victims of earnings management are, of course, the end users of the financial statement, including bond and equity investors, banks, suppliers, and institutional/individual investors. Misleading financial reporting designed to inflate earnings is a form of deceitful misrepresentation; the creation of a false impression, geneivat da’at, in the eyes of gentiles and Jews alike is a violation of Halakhah.87SA, HM 228:6; Aaron Levine, Free Enterprise and Jewish Law (NY: 1980), 122–124. One form of deceitful misrepresentation is negligent misrepresentation of financial advice by a broker to his client. See David Schonberg, “Aspects of the Jewish Law of Negligent Misrepresentation,” 13–14 Dinei Israel (1986–1988), 31; my “The Investment Advisor: Liabilities and Halachic Identity,” 57 The Journal of Halacha & Contemporary Society (Fall 2009), 107; “The Multi-Faceted Halakhic Identity of a Jewish Investment Broker,” 43 Tradition (2010), 51; “The Tort of Negligent Misrepresentation in Investment Planning: A Comparative Analysis,” 19 The Jewish Law Annual (2011), 141. For contemporary rulings relating to the liability of a bank employee or financial planner who proffer ill-advice on securities investments, see Piskei Din Yerushalayim 4:265, 12:51; PDR 9:16; Mishpatecha le-Ya’akov 2:34.
Although there appears to be little discussion of Hoshen Mishpat obligations of rank and file employees, directors, officers, and shareholders of a corporation, it is clear from rulings issued with regard to issues of Shabbat, ribbit, and chametz that such individuals must refrain from engaging in any ritual prohibitions. See Iggerot Moshe, OH 1:62; Teshuvot Minhat Yitzhak 4: 16, 18; Teshuvot ha-Elef Lekha Shlomo, OH 238. Although protected by the limited liability rule even for acts of tort (see James Cox and Thomas Haven on Corporations, Section 1.05 at 11, 2d ed. 2003), officers, directors and shareholders are proscribed from engaging in issurim. The same conclusion may be equally applied to rank and file employees. For example, engaging in hezek may involve a violation of returning a lost object or theft. Whether the employee will be personally liable depends on if he owns shares in the corporation or if he is employee without a personal investment in the corporation. In the former case, any hezek is a corporate responsibility; in the latter case, he will be personally liable if he deviated from the corporate mandate should there be an agreement that both the corporation and employee are jointly liable. Decisors of Halakhah would therefore have ruled very differently in this case. While the courts have attempted for decades to define the contours of the business judgment rule by fine-tuning the gross negligence standard as it relates to procedural due care in the director’s decision-making process,88Bayer v. Beran, 49 N.Y. S. 2d 2, 6 (Sup. Ct. 1944); Kamin v. American Express, supra n. 7, 811.
Aronson v. Lewis, supra n. 3, 812; Smith v. Van Gorkhom, supra n. 8; Cede & Co. v. Technicolor, Inc., supra n. 13. Halakhah invokes fair representation and negligence standards as guidelines for the imposition of liability regarding these corporate decisions relating to false misrepresentation and mismanagement and substandard job performance.
One might argue that since the systemic rule of dina de-malkhuta dina, “the law of the kingdom is law,” is applicable to liberal democracies such as the United States,89See Shmuel Shilo, Dina de-Malkhuta Dina [Hebrew] (Jerusalem: 1974), 109–14, 175–6. the business judgment rule should be determinative even in situations which are conflict with the norms of Halakhah. Rema argues that this principle applies even in cases in which the secular law contradicts Halakhah, and this is the position historically accepted by most legists in his wake.90Shilo, supra n. 89, 147–57. Normative Halakhah today rejects this approach. See e.g., Hershel Schachter, “Dina de-Malchuta Dina,” 1 Journal of Halacha & Contemporary Society (1981), 103. Nevertheless, there is a clear halakhic consensus that the rule may only be invoked regarding civil matters, mamona. In civil matters which entail an element of ritual law, issura, such as the tort matters in Para-Medical Leasing Inc. v. Hangen, Craig v. Graphic Arts Studio, Inc. and Kamin v. American Express, the Jewish legal system will refrain from incorporating the norms of the foreign legal system.91R. Yeshayahu Trani, Tosafot Rid, Gittin 10b; Teshuvot Tashbetz 1:158, 2: 290. See Shilo, supra n. 89, 115–16. See also Teshuvot Rabbi Akiva Eiger, 2d edition, 83.
This conclusion is based on the assumption that a director should be viewed halakhically as an agent and is therefore liable for his activities. As we noted above, however, a director’s conduct is equally governed by halakhic labor law. In some situations, an individual can serve in the capacity of an employee and yet be incapable of acting as an agent. For example, if someone was hired to seize a debtor’s property on behalf of a creditor, his action is valid despite the fact that his conduct will cause an economic loss to other creditors. Because “the hand of the worker is like the employee,” the action is valid. In contrast, if a gratuitous agent committed such an act, he would be unable to acquire the property on behalf of the principal.92Bava Metzia 10a; Shakh, HM 105:1.
Pursuant to the logic of this position, there are some authorities, including Mahaneh Ephraim, who validate the actions of an employee which entail infractions of halakhic ritual law.93Mahaneh Ephraim, Hilkhot Sheluhim ve-Shutfim 11, as understood by Teshuvot Sho’el u-Meishiv, Mahadura Kama, 2: 110. See also Hokhmat Shlomo, HM 182:1; Teshuvot Tarshish Shoham, YD 34. These actions are essentially considered those of the employer, despite the rule that “there is no agency to commit an illegal act.” According to this perspective, it would seem that the halakhic system would endorse the business judgment rule and refrain from scrutinizing a director’s judgment call, even in cases of gross negligence entailing an infraction of ritual Halakhah.94This conclusion assumes that a director is an agent. See supra text accompanying n. 75.
However, many decisors reject this approach and contend that employee conduct which involves the commission of sin is prohibited. As R. Shalom Schwadron notes, “Many disagree with Mahaneh Ephraim,”95Teshuvot Maharsham 1:20; Netivot ha-Mishpat 188:1; text accompanying n. 79. and R. Algazi observes, “The majority of decisors disagree.”96Maharit Algazi, Hilkhot Bekhorot le-Ramban 4:50. See also Sha’ar ha-Mishpat, HM 182:1; Teshuvot Shevat Tzion 53; Sma, HM 32:3. See Hayyim Zippori, Agency Law: Section 1 (Ministry of Justice, Jerusalem, 2008) [Hebrew], 50. See also Mishpat Shalom, HM 188:1. In effect, although a director has the status of an employee, and in certain instances this special status trumps agency law, in cases of violations of issura, such as negligent behavior vis-à-vis shareholders,97Teshuvot Noda be-Yehuda, Mahadura Kama, EH 64–65. Cf. others who argue that the rule that “there is no agent for illegal acts” is to be invoked for criminal matters and is inapplicable to civil matters such as torts. See Netivot ha-Mishpat 182:1.
On the other hand, there is a debate whether a corporate employee who engages regularly in commission of a sin involving his work is responsible for his behavior or whether his employer is liable. See Rema, HM 388:15; Shakh, ad loc. 67; Ketzot ha-Hoshen, ad loc. 12; Teshuvot Shevut Ya’akov 1:164. Clearly, however, the consensus is that either the employer or employee cannot hide behind the corporate veil and engage in issurim.
Even if the employee is a non-Jew and “there is no agent for illegal acts,” Halakhah still obligates the individual who authorized him to perform the halakhically illegal act as responsible for the non-Jew’s conduct either based upon the rationale that an exception to this rule is an employee whose “hand is like the hand of his employer” or grounded in the rule that someone who transfers assets of a Jew to a non-Jew (“moseir mamon Yisrael be-yad goy) is obligated to pay based upon garmi. See Sedei Hemed, kelal 49, Ma’arechet ha-Alef (p. 173), s.v. ve-hinei ra’isi; PDR 16:205, 208–209.
Similarly, all employees must refrain from violating issurim such as creating a false impression (geneivat da’at), and therefore must disclose all the details of a transaction. See SA, HM 228:6, 9; 231:7. Regarding officers, directors, and shareholders, see supra n. 87. For an exception to this rule, see Bava Metzia 76b; Tur, HM 333. there are grounds for corporate liability. Thus, a beit din would refrain from invoking the business judgment rule and would rule that such conduct is an infraction of Halakhah.
In summary, if Halakhah construes the corporation as a joint effort of partners, directors (and, for that matter, shareholders and officers) are either agents and/or employees who must comply with their individual obligations, agency law, labor law, and the defined interests of the corporation.98Shakh, HM 77:19. Clearly, he would be shielded from the payment of any corporate debt. For the differing rationales for recognizing the doctrine of limited liability, see PDR 6:315, 322. Since corporate law assumes that actual liability will be assumed by the corporation, any deviation by the individuals from such halakhic legal norms will result in corporate liability vis-à-vis the shareholders. Whereas the business judgment rule would shield a director or officer99See supra n. 23. from personal liability in these situations, Halakhah, although concurring that there would be corporate liability, would scrutinize their behavior and look askance at a director or officer engaging in improper behavior.
Alternatively, if a corporation is construed as an independent entity,100See supra n. 73. would the provisions of agency law lead to liability for directors (or officers, managers and employees) for conduct which is a violation of agency norms? Agency law is operative provided that the principal is Jewish and mentally competent. Consequently, a gentile, a minor, a deaf-mute, or a mentally deficient individual cannot serve as a principal in the establishment of an agency relationship.101SA, HM 188:1, 2; Ketzot ha-Hoshen, HM 188:2; Netivoth ha-Mishpat, HM 188:1. Being an artificial person, a corporation is bereft of any personality and has no mind and no ability to act on its own and cannot issue instructions to a person. Hence, agency law would be inapplicable to a corporation viewed as an artificial being.102Pithei Hoshen, Hilkhot Shomerim, 243, n. 8; Hilkhot Geneivah, 112, n. 51, 440, n. 22 (end). Thus, whereas secular corporate law squarely embraces agency law in this case,103Deborah DeMott, “The Mechanisms of Control,” 13 Conn. J. Int’l L. (1998–1999), 233; Donald Langevoort, “Agency Law inside the Corporation: Problems of Candor and Knowledge,” 71 U. Cin. L. Rev. (2002–2003), 1187. Halakhah discounts it.
Nevertheless, R. Blau aptly observes:
It seems that a manager or an employee of a corporation who is authorized may appoint an agent, since the principal is a private individual and the agent would be bounds by the laws of agency. Even if an individual cannot act as an agent, if he is remunerated for his work, agency law is applicable.104Pithei Hoshen, Hilkhot Shomerim, supra n. 102, 243–4, n. 8. See supra n. 87 (end). Cf. Teshuvot Rabbi Akiva Eger, 3d edition, 112, who argues that remuneration is not required.
Given that the directors, officers, and managers are employees of the corporation,105Frank Easterbrook and Daniel Fischel, The Economic Structure of Corporate Law (1991), 91, who argue that directors and officers are agents of shareholders. See supra nn. 64 and 70. there are grounds for shareholders filing derivative suits against them.
Even if one were to contend that a corporation cannot create an agency relationship with its directors, managers, and officers, such individuals nevertheless do retain the status of a po’eil, an employee who can perform actions representing the corporation, despite it being an artificial person. As R. Ephraim Navon explains, “An employee may serve as an agent.”106Mahaneh Ephraim, Hilkhot Sheluhim ve-Shutefim 11. See also, Shakh, HM 105:1; Netivot ha-Mishpat, HM 188:11. Cf. Pithei Teshuvah, HM 182:2 in the name of Sha’ar ha-Mishpat. Even though the corporation is an independent legal entity, given their status as employees, directors equally serve as agents, and as we have seen, an agent may not exploit his position in any fashion that will harm the interests of the principal. Should such an action transpire, the principal can advance the argument, “I sent you to benefit me rather than harm me.” Consequently, should the principal demonstrate that in fact his mandate has been undermined, the agency relationship is void and any action of the agent does not obligate the principal.107Kiddushin 42b; Ketuvot 99b; Bava Batra 169b. While whether the corporation would be liable for any damages depends on the employee; a director, officer or shareholder would be exempt from personal liability. See supra n. 87.
In effect, the implications of the plea, “I sent you for my benefit,” encourage shareholders, as principals, to file derivative suits against their agents, the directors who are undermining their interests. This would not necessarily be a beneficial result, as it would lead to third parties being circumspect regarding corporate decisions relating to themselves, always fearful that these decisions potentially would be subject to litigation and possibly overturned. Additionally, directors would likely become excessively cautious, aware that decisions that are subsequently determined to have been wrong could expose them to personal liability. In short, without a business judgment rule of some sort, the day-to-day affairs of the corporation would be difficult to sustain.
Consequently, Halakhah invokes an umdana, an appraisal of the intention of the parties. There exists an expectation that the shareholders will assume responsibility for all the managerial decisions of its directors lest third parties refrain from conducting business with the corporation. This appraisal of intention is grounded upon the determination that the director’s conduct is assumed by the corporate entity, and should there be any negligent behavior by its members, the corporation will assume responsibility. Alternatively, the assumption of the firm’s liability either is based upon the provisions of the corporate charter or individual members of the corporation obligating the enterprise to assume liability for their co-members’ behavior from corporate assets rather than the shareholders’ personal assets.108Bava Metzia 114a; Mishnah Torah, Hilkhot Shekhenim 12:7; SA, YD 334:43; Avraham Sheinfeld, Torts, 362; Sinai Levy, “The Liability of a Corporation Towards Third Parties” [Hebrew], 26 Tehumin (5766), 362, 366. In the absence of such an agreement or umdana, the burden of proof is upon the principal, i.e., the shareholder, to demonstrate that his mandate was “only for his benefit.” See SA, HM 182:4. Consequently, even if the directors or officers engage in issurim such as false misrepresentation, lying, and the like, any monetary claims for damages engendered by this improper conduct are satisfied by filing suit against the corporation, rather than the employees.
The practical ramifications of the corporation’s assumption of liability are that officers and directors will be encouraged to serve a corporation and the corporation will allow them sufficient leeway in managing the business. The legal consequences of this assumption of liability will vary depending upon a legal system’s view regarding the scope of the business judgment rule. According to American law, such liability reinforces the business judgment rule as an abstention doctrine developed by the courts to refrain from scrutinizing directors’ decisions. On the other hand, although Halakhah looks askance at the director’s or officer’s improper conduct and would require scrutiny of their decisions, barring any grounds (such as commission of fraud) for piercing the corporate veil should they fail to comply with basic halakhic norms, corporate liability may ensue pursuant to their duties as an employee.
In short, regardless of whether halakhically we construe a corporation as an independent legal entity or a joint effort of individuals employed by a corporation, they must comply with their obligations as members of a covenant-faith community. Whereas, the business judgment rule will shield a director or officer who owns shares in the corporation from liability in certain derivative suits, Halakhah would scrutinize their decisions and look askance at their improper conduct and mandate liability. Nevertheless, barring any piercing of the corporate veil, any monetary liability would be satisfied from corporate assets.
B. The Business Judgment Rule in the Not-for-Profit Sector
In the absence of sources directly relating to the modern charitable institution, such as a synagogue or Jewish day school, in the corporate context, in order to address whether the best judgment rule operates in the not-for-profit sector, we will examine the halakhic institution known as “hekdesh,” which may serve as an appropriate analogue to the modern not-for-profit institution.
This institution known in the sources as “hekdesh” originally referred to an administrative body which collected animals and money earmarked as donations for the maintenance of and the sacrificial service in the Holy Temple. These assets, which were originally the donor’s, were consecrated to the Temple, with the new owner being God. Although management of these assets was in the hands of the gizbar, who represented the interests of the Temple, similar to the modern corporate analogue,109Berle and Means were among the first commentators to note this distinguishing characteristic of a corporation. See Adolf Berle and Gardiner Means, The Modern Corporation and Private Property (NY:1932), 2–5. hekdesh was an independent identity with a separation between ownership and management.110Aharon Kirschenbaum, “Legal Person,” in Menachem Elon (ed.), The Principles of Jewish Law (Jerusalem: 1975), 160–4; Reuven Ungar, The Law of Trusteeship (Ministry of Justice, Jerusalem: 2008) [Hebrew], 13–15.
Thus, interpreting the biblical verse addressing the laws of bailment, “When a person gives his friend money or objects to guard …” the Mehilta notes, “The verse states ‘his neighbor’ – his neighbor and not hekdesh.”111Mehilta, Shemot 22:6; Bava Metzia 57b. Thus, if a bailment has been donated to hekdesh, the laws of bailment are inapplicable to this asset. Whether, a gizbar would be liable for acts of negligence is subject to debate.112Perishah, HM 301:5; Tumim, HM 66:67; Shakh, HM 66:126; Teshuvot Sha’ar Ephraim 122.
Following the destruction of the Temple, many Poskim expanded the institution of hekdesh to encompass all associations, including communal bodies, which perform and/or facilitate the performance of a mitzvah through the furnishing of religious, educational, health, or social services or providing charity to the respective Jewish communities established in Israel and the Diaspora.113Teshuvot Maharshdam, YD 17; Teshuvot Helkat Ya’akov, YD 61. Despite the destruction of the Temple, post-Talmudic authorities referred to charitable foundations as examples of hekdesh. See Teshuvot Tashbetz 3:152; Rema, YD 258:1.
Whether a family foundation is to be subsumed under the rubric of a “hekdesh dati,” a religious foundation such as a synagogue or yeshiva board and the like, is subject to debate. See Tzvi Weinman, “A Family Foundation is not Hekdesh” [Hebrew] 21 Tehumin (2001), 238. Dating back to the Talmudic period, there has been an ongoing debate regarding whether a communal association such as a charity fund should be equated with hekdesh, which is an independent entity, or viewed as a joint-effort of partners. Writing on behalf of the Supreme Rabbinical Court, R. Shlomo Daichovsky states, “A religious foundation is a legal personality separate from its trustees.”114Appeal 900031565-44-1, Musaioff Shlomo Foundation v. Bucharian Foundations et al., Rabbinical Court Decisions, Shurat Hamishpat, 2009, 1, 32. R. Daichovsky cites R. Samson Raphael Hirsch, Commentary on the Torah, Vayikra 27:14; Teshuvot ha-Ridbaz 1:261. For an overview of the varying opinions regarding this issue, see Mishpat ha-Tzava’ah, 524–61.
The majority of sources that we cite in this section have been gleaned from Baruch Kahane, Shomerim, 559–69, 1346–8 and Reuven Ungar, Laws of Trusts, Section 17 (Ministry of Justice, Jerusalem: 2009) [Hebrew].
During the post-Talmudic period, these communal institutions continued to be managed by a gabbai tzedakah, a charity manager. Just like hekdesh during Temple times, when there was no individual who was the owner of the Temple assets, charity, synagogue, and yeshiva funds have no owners.115Bava Kama 36b, 93a; Hullin 130b; Teshuvot ha-Rashba 1:656, 669, 1256; Teshuvot ha-Rivash 465; Teshuvot Tashbetz 3:152, 303; Teshuvot Helkat Yaakov,YD 67. For exceptions, see SA, HM 301:6. Teshuvot ha-Rema 31; Havot Da’at, SA, YD 160:10; Rema, YD 258:5. Given the association’s independent identity, one would expect that managers would be exempt from liability regarding their negligent behavior vis-à-vis the organization. As Rambam rules:
An individual who received the money of poor as a bailment … and he was negligent … he is exempt … it is money with no determinant plaintiffs.116Mishnah Torah, Hilkhot She’eilah u-Pikadon 5:1.
Numerous legists have endorsed Rambam’s posture.117See Perishah, HM 301:5; Sma, ad loc. 301:9; Yam Shel Shlomo, Bava Kama 8:71; Mahaneh Ephraim, Hilkhot Shomerim 17; Teshuvot Maharik, shoresh 6; Teshuvot Perah Matteh Aharon 2:78.
There are some decisors who contend that dinei Shamayim, heavenly law, mandates that there is a Jewish-moral duty, to remit funds to a charitable organization for damages, although this requirement is not enforceable in beit din. See Pithei Teshuvah, HM 301:6 in the name of Havot Ya’ir; Teshuvot Maharik, HM 14; Arukh ha-Shulhan, HM 301:9. Therefore, should a member of the community of the poor advance a claim for monies, the bailee may respond, “I want to give these monies to other poverty-stricken individuals.”118Tzofnat Panei’ah, Bava Kama 93a. Analogously, monies earmarked for educational, health, or religious services have no determinate group of beneficiaries. Addressing contributions to an educational institution, Rashba notes, “This money has no specific owners.”119Teshuvot ha-Rashba 1:669; Teshuvot ha-Rashba ha-Meyuhasot le-Ramban 222; Teshuvot ha-Rivash 465. R. Ya’akov Breish, focusing on the identity of a bank, similarly informs us that “the community has no determinate owners.”120Teshuvot Helkat Ya’akov, supra n. 115.
As a result, in the absence of the existence of actual owners, claims against a manager of a communal institution – including those relating to torts – generally cannot be advanced.
Others, however, argue that even though the funds are not designated for any particular individual, once the assets are under the manager’s control, the poor assume ownership.121Havot Da’at 160:10; Teshuvot le-Horot Natan 3:116. According to this view, one may advance a claim against a manager who acted negligently.122Hiddushei ha-Ritva, Hullin 130b; Mahaneh Ephraim, Hilkhot Shomerim 16.
In some situations, many authorities contend that a gabbai tzedakah would be liable for his negligent conduct because he is construed as a bailee. Assets of the community which are earmarked for a school, synagogue, cemetery, or the like are examples of “money which has determinate plaintiffs”; as a result, the manager has tort liability should he cause damage. Alternatively, should a manager or employee of the organization negotiate an agreement with a third party predicated upon an understanding regarding the association’s assumption of risk, and issues regarding the body’s liability subsequently arise, the address to advance such issues is to the association. In short, adopting the approach of Netivot ha-Mishpat, “Clearly, these are community funds, and it as if they are determinate plaintiffs.”123Netivot ha-Mishpat, HM 301:6, endorsed by Arukh ha-Shulhan, HM 301:10; Teshuvot Zekan Aharon (Walkin) 1:98; Teshuvot Naharei Afarsamon, HM 3; Teshuvot Shivat Tzion 99; Pithei Hoshen, Tzedakah u-Mishpat 10:8. Cf. Erekh Shai, HM 301:6. Or as R. Ephraim Navon observes, “All the members of the community are considered owners.”124Mahaneh Ephraim, Hilkhot Shomerim 16. Thus, in these cases, there are grounds for filing suits against a manager’s alleged misconduct.
Some have explained this position in the following fashion: Generally, a manager is exempt from bailment liability. However, an association construed as a halakhic entity is empowered to control the disbursement of funds and has an economic interest in maximizing the financial integrity of the organization by modifying the recipients of these funds. Therefore, the individual in control who has an economic interest – in our case, the manager or employee – is potentially personally liable.125Reuven Ungar and Eliezer Miller, Trusteeship: The Liability of a Trustee: Section 7 (Ministry of Justice, Jerusalem: 2007) [Hebrew], 7. In fact, Netivot ha-Mishpat argues that the manager controls these assets, selling and acquiring the funds in the name of the community charity foundation. He is thus the appropriate address for filing a suit against the communal association.126Netivot ha-Mishpat, HM 149:48 and Bi’urim, HM 149:15. See also Beit Yosef, HM 149:37.
Given the manager’s liability, however, would a beit din choose to scrutinize his alleged misbehavior? Addressing a charitable foundation, such as a communal charity fund, the Talmud states: “We do not calculate the disbursement of the funds of the charity collectors.”127Bava Batra 9a. For an attempt to prove that there is a halakhic duty to provide an accounting, see Ungar and Miller, supra n. 125, 8–9. According to the medieval legists, the absence of the requirement to submit a detailed accounting of the foundation’s activities is due to the fact either that the association is busy with hiring employees to service their activities and therefore cannot devote time to prepare records or due to our implicit trust in the honesty of the directors, who would only act properly.128Rashi, Bava Batra 9a, s.v. she-ein; Tosafot, Bava Batra 9a, s.v. she-ein. However, should circumstances indicate that the directors are untrustworthy, there is a duty to furnish an accounting. See Yad Ramah, Bava Batra 9a; Teshuvot Mahari Weil 173. Clearly, however, times have changed; foundations are increasingly capable of multitasking, and the presumed integrity of directors is no longer implicitly valid. It is thus unsurprising to find that Rema invokes “the duty to account”:
To be innocent in the eyes of God and Israel, it is proper to submit a record, and this refers to trustworthy collectors. However, one who is nefarious … must produce a record, and this equally applies to all communal officers …129Rema, YD 257:2; Bi’ur ha-Gra, YD 257: 1. Such a conclusion equally applies to a guardian appointed by a secular court or a manager of non-profit funds who is recognized by secular law. See Rema, HM 290:14; Teshuvot Minhat Yitzhak 9:112. For additional discussion regarding the requirement of transparency, see my “Self-Dealing in the Not-for-Profit Board Room: An Inquiry into a Trustee’s Multifaceted Halakhic Identity,” 43 Tradition (2010), 7.
In cases in which the documentation submitted by a trustee is missing information, a beit din will request either the appointment of a forensic accountant to review the records and/or additional information from the foundation.130Teshuvot Maharach Or Zarua 65; be-Sha’arei Beit ha-Din: Collection of Judgments Regarding Communal Institutions, 74, 115, 270. As noted by R. Ben Tzion Uziel:
Adjacently located to the beit din, there should be an administrative body of professionals experienced in commerce … who can monitor the affairs of the guardians and review their records.131Sha’arei Uziel, Hilkhot Apotropsut 2.
There is an ongoing concern that orphans’ assets will be protected from potential loss. A beit din is therefore mandated to establish standards of transparency for their affairs and ensure that all investments on their behalf will be pursuant to the standards of professional financial planners. Thus, Rashba mandates that guardians must “deal with orphan’s funds as is customary among professional investors …” 132Teshuvot ha-Rashba 1:1094.
The importance of document disclosure is not limited to an inquiry in communal charitable actions; it is also mandated by the rules of civil procedure. Invoking the posture of Rosh,133Teshuvot ha-Rosh 68:25. Professor Eliav Shochetman writes:
A beit din will obligate a litigant to disclose documents … assuming that the party possessing the documents admits that the opposing party has a right in them. In cases in which he does not admit this right, and the opposing party does not assert with certainty that he has a document that can assist him, beit din will refrain from mandating document disclosure. However, if he holds a document which the opposing side argues with certainty will assist him in proving his claims and the other denies it, beit din will obligate him to produce the document in order for the beit din to investigate the matter independently.134Eliav Shochetman, Seder ha-Din [Hebrew] (Jerusalem: 1988), 341.
Clearly, then, the halakhic system identifies with the business judgment rule in situations in which there is a need for procedural monitoring of a guardian’s judgment call.
Does the halakhic system equally endorse judicial scrutiny of a manager’s decision in cases of gross negligence as propounded by the business judgment rule? As we have shown earlier, a manager’s tort liability when he is viewed through the prism of bailment is subject to debate. If, however, we view a manager as an apotropos, a guardian, perhaps we can reach a stronger conclusion. Although the guidelines discussed above relate to guardianship of orphans’ assets, they equally apply to managers of communal foundations.135Teshuvot ha-Rivash 465; Teshuvot Binyamin Ze’ev 366; PDR 1:353, 359–60; 8:240. See Reuven Unger and Eliezer Miller, The Law of Trusteeship, Section 6 (Ministry of Justice, Jerusalem: 2006) [Hebrew], text accompanying n. 26. As Rashba notes, “Trustees are akin to guardians of the community.”136Rashba, cited in Beit Yosef, YD 169 (end). Rema similarly observes, “The community … is akin to guardians of orphans.” 137Rema, YD 169:17. For additional sources equating the two institutions, see Hokhmat Adam 147:19, 23; be-Sha’arei Beit ha-Din, supra n. 130, 301–2; PDR 8:240. The underlying premise is that one can appoint a guardian to oversee the assets of adults; see Pithei Teshuvah, HM 235:6.
The question that remains is whether a manager qua apotropos is responsible for damages caused by his behavior. An individual is liable for injuries that he or his property causes to someone else. Thus, if an ox causes damage three times, it becomes a forewarned ox (shor mu’ad), and the owner or bailor must compensate full damage for the incurred injury. If the ox belongs to an orphan, it is incumbent upon the beit din to appoint an apotropos who will monitor the ox’s activities and ensure that it will not cause injury or damage property. Is an unpaid apotropos personally liable if he allows the orphans’ ox to become a shor mu’ad, or are the damages collected from the orphans’ assets? The Talmud rules:
R. Yohanan stated: Payment must be made from the … estate of the orphans; because if … it is out of the estate of the guardians, people would certainly refrain from accepting this office.138Bava Kama 39a–b.
On this basis, R. Hayyim ha-Kohen rules that if a court-appointed apotropos conducts himself negligently with the orphan’s assets, he is exempt from liability.139Tosafot, Bava Kama 39a, s.v. de’i amaret. The assumption in our presentation is that a manager of a charitable foundation or communal association is equivalent to a court-appointed guardian, rather than one appointed by a minor’s father. See Teshuvot Shevat Tzion 99. Others, however, including Shulhan Arukh, rule that in such a situation, an unpaid apotropos would be liable for negligence.140R. Shlomo of Vardon, Tosafot, ibid.; Piskei ha-Rosh, Gittin 5:7; SA, HM 290:20; Shakh, HM 72:34, 290:24. Although the rationale for the latter position is unarticulated, it is possible that these decisors maintain that the guardian’s desire to assist orphans trumps his fear of being subject to potential litigation for negligent conduct.141In fact, Rashba mentions this factor regarding public servants; see Teshuvot ha-Rashba 5:101.
At first glance, according to R. Hayyim ha-Kohen’s posture, there would be grounds for judicial abstention in the case of a guardian’s negligent behavior (although this is a minority opinion).142Teshuvot Mishpat Tzedek 2:7; Teshuvot Lehem Rav 196. It is possible, however, to strictly construe R. Hayyim ha-Kohen’s position to be applicable to only the case at hand, which dealt with a guardian overseeing the affairs of orphans who were minors. In cases of a guardian monitoring the activities of adults, even R. Hayyim ha-Kohen may concur that there are grounds for liability.143Teshuvot Pnei Moshe 1:52. Should we accept this conclusion, there is a consensus that a guardian or a gabbai tzedakah who works as a volunteer is liable for judgment calls entailing financial mismanagement or negligent misrepresentation; he will not be shielded from immunity by invoking the business judgment rule within the context of a beit din proceeding.144Teshuvot Maharsham 1:101.
In the wake of a derivative suit against a non-profit director, does Halakhah endorse the invoking of the business judgment rule as defined by American law? As we have seen, the business judgment rule in both the for-profit and non-profit contexts is invoked in order to encourage a board to take risks, to create an incentive for directors to serve, and to allow directors sufficient latitude in managing the corporation. Similar to American law, Halakhah endorses the utilization of the business judgment rule vis-à-vis a for-profit board for the above reasons; this is based on an umdana, the expectation that the shareholders will assume responsibility for all the managerial decisions of its directors lest third parties refrain from conducting business with the corporation. This appraisal of intention is grounded in the determination that the director’s conduct is assumed by the corporate entity; it then becomes the communal association’s right to advance claims against their employees.145See Teshuvot Maharam di Boton 51; Teshuvot Maharsham 7:169; Teshuvot Pnei Moshe 1:32; Hayyim Zippori and Michael Wygoda, Law of Agency, Section 6 (Ministry of Justice, Jerusalem: 2008) [Hebrew], text accompanying nn. 290–295. Additionally, see Teshuvot Devar Avraham 2:19. However, under certain conditions, the beit din will scrutinize managerial decisions which fail to comply with the norms of Halakhah.
As we have shown, the business judgment rule is invoked within the framework of the for-profit corporate sector to determine whether a board decision is rational, made on an informed basis, and is not an instance of gross negligence. Does Halakhah endorse this rule within the non-profit sector? Based upon our review of the norms of apotropos and general civil procedure, the system will endorse the business judgment rule with certain limitations. On the one hand, decisors will agree that judicial review is to encompass the monitoring of a director’s decision to determine whether it is an informed and reasoned judgment. On the other hand, whereas the invoking of the business judgment rule by an American judge will generally result in an abstention from scrutinizing a director’s decision except in cases of gross negligence, a halakhic arbiter will review any and all decisions which entail even instances of simple negligence. However, as noted above, should a review of a decision of a for-profit or not-for-profit corporation mandate an award of damages to a third party, barring any grounds for piercing the corporate veil, relief will be satisfied from corporate assets.
Conclusion
We will sharpen our analysis by placing our topic within the context of the two conflicting visions of for-profit corporate governance addressing the stakeholder debate. One view, nurtured by proponents of political liberalism and possessive individualism, has been described in the following terms:
The individual is not only viewed as independent and separate from others, but to the extent that the existence of God or some other Ultimate Reality is acknowledged, the individual is also viewed as separate from that God/Ultimate Reality … If the individual is perceived as separate and apart from others, the individual’s concern will be the preservation and promotion of the self … The law and economics model, a dominant model for thinking about the corporation and the appropriate role of law in regulating the corporation, is a logical, natural byproduct of this secular view of the person … The secular view of the person discourages thinking of people in communal terms, viewing them solely as atomized, individualized beings … Law here merely ensures procedural fairness, creating a system of equal consideration of the needs and desires of individuals to pursue their individual conception of the good.146Susan Stabile, supra n. 28, 856–8.
If we adopt the approach, conceptualizing the corporation as representing various contractual relationships which sets the rights and duties of various parties who produce goods or services of the company,147R. H. Coase, “The Nature of the Firm,” Economica (N.S.) 4 (1937), 386; Frank Easterbrook and Daniel Fischel, “The Corporate Contract,” 89 Columbia L. Rev. (1989), 1416; Stephen Bainbridge, “Participatory Management within a Theory of the Firm,” 21 J. Corp. L. (1996), 657, 663–4. there are no grounds for imposing any additional duties on the firm other than those recorded in its web of explicit and implicit contracts. This conclusion equally applies to directors. Although it is subject to debate whether a director is hired by the employees or vice versa,148Margaret Blair and Lynn Stout, supra n. 8, 280. clearly directors are not under the control of anyone, including shareholders; their activities are circumscribed by contract law and the explicit project approval by the stockholders.149Blair and Stout, ibid., 290. Fiduciary duties mandate that directors promote shareholders’ interests and thereby maximize profits, subject to legal directives which require factoring into consideration the interests of stakeholder interests only insofar as those interests increase corporate profits.150However, there are thirty states where the law gives directors discretion to sacrifice profits in the public interest. See Elhauge, supra n. 27, 737. No state has passed legislation which mandates that directors maximize shareholder wealth. See ibid., 738.
Consequently, it is surprising to discover that in Shlensky v. Wrigley,151See text accompanying n. 10. the business judgment rule was invoked, in effect shielding a corporate director who chose to promote social interests instead of profits from liability. Unconcerned whether Wrigley was motivated by public interest concerns rather than corporate profits, since there were no allegations of fraud, illegality, or conflict of interest, the court abstained from reviewing the director’s decision.
Similarly, in Theodora Holding Corp. v. Henderson152257 A. 2d 398 (Del. Ch. 1969). and A.P. Smith Manufacturing Co. v. Barlow,15398 A. 2d 581 (N.J. 1953). the courts argue that directors may factor into consideration non-shareholder interests. Again, absent allegations of fraud, illegality, or conflict of interest, these courts abstained from scrutinizing a director’s decision that did not treat wealth maximization as the sole objective. In short, although the intent of the business judgment rule is to promote wealth maximization, the effect of the doctrine as reflected in these judicial decisions is to insulate a director’s liability regarding a decision which promotes non-shareholder interests.
Rejecting this conception of a corporation as advocating shareholder wealth maximization, there is a religious conception which offers a communitarian vision of the corporation. Developing the image of a corporation as a human community, one commentator writes:
As a social being, the person is not merely an autonomous bearer of rights, but part of a community that should be ordered toward the common good … In this vision, the corporation is an institution: (1) that must be dedicated to the flourishing of its employees as human beings; (2) in which the shareholders’ rights of ownership are constrained by duties to others within the corporate community, (3) whose managers must be concerned with the common good; and (4) which … must produce not just wealth, but the conditions under which human persons may flourish spiritually.154Mark A. Sargent, “Competing Visions of the Corporation in Catholic Social Thought,” Villanova University School of Law, School of Law Working Paper Series (2004), 3. For a similar perspective, see Stabile, supra n. 28, 865, 873–5.
Pursuant to this approach, which has been advanced by religious thinkers and corporate scholars alike, directors should adopt a more expansive view of their corporate duties to employees and consider the interests of non-shareholder interests, such as suppliers and local communities in which the business operates. The pursuit of shareholder-maximization values stems from social norms rather than from law and should be replaced by core religious beliefs which are marked by a communitarian vision.155See ibid., and infra n. 168; Lyman Johnson, “Faith and Faithfulness,” 56 Catholic Law Review (2007), 1. According to such a perspective, the business judgment rule properly understood empowers directors to engage in trade-offs between shareholder and non-shareholder interests and undermines the norm of shareholder maximization of returns.156See Blair and Stout, supra n. 8, 303.
How does Halakhah address the notion of regulation of corporate governance which promotes social interests unrelated to profitability? Does Halakhah identify with “the religious outlook,” which is grounded on reciprocal responsibility, or with “the secular perspective,” which subscribes to the profit maximization norm?
A cursory review of the sources would indicate the importance of exhibiting acts of hessed (kindness) and tzedakah (charity and aid). As Professor Isadore Twersky notes:
The Jewish theory of philanthropy … has often been discussed … Its centrality in Jewish life and its concomitant importance in Jewish literature … is documented. Many rabbinic statements which stress … the axial role of chessed are frequently quoted … For example, the dictum that “charity is equivalent to all the other religious precepts combined” … A study of the laws of charity yields paradoxical conclusions. On the one hand, it seems that the central figure is the individual … [who] is enjoined to engage unstintingly in charity work, and assiduously to help his fellow man … On the other hand, … Halakhah has assigned an indispensable, inclusive role to the community … Responsibility for the care of the needy – sick, poor, aged, and disturbed – is communal …157Isadore Twersky, Studies in Jewish Law and Philosophy (NY: 1982), 110, 116.
At first glance, one might conclude that a religious climate which promotes individual obligations of charity and fosters the establishment of public assistance programs should serve as grounds for advocating a position for corporate social responsibility. The managers of the corporation must address the social consequences of their actions; an individual is proscribed from operating a business solely on the calculation of self-interest and wealth maximization. In fact, Professor Walter Wurzburger, a rabbi and Jewish philosopher, identifies with such an approach.158Walter Wurzburger, “Covenantal Morality in Business,” in Aaron Levine and Moshe Pava (eds.), Jewish Business Ethics (NY: 1999), 27, 30–43.
In replying to the notion that Halakhah imposes certain social responsibilities upon each and every individual, Professor Aaron Levine writes:
These duties do not suddenly disappear within the context of a business entity … Shareholders cannot use organizational structure and chain of command as a mechanism to reduce or abrogate what Halakhah requires of them as principals. In a similar vein, as the agent of the shareholders, the manager must conduct himself with the stakeholders of the firm as Halakhah requires, whether or not the specific situation at hand was covered by his mandate.159Aaron Levine, supra n. 75, 285–6. This conclusion regarding the inability of shareholders to mandate that the corporation become socially responsible applies even according to the decisors who argue that a shareholder is an owner of some portion of the corporate assets. For authorities who endorse the view that a voting shareholder has an ownership interest in the corporation, see Teshuvot ha-Elef Lekha Shlomo 238; Teshuvot Minhat Yitzhak 3:1; 7:26; Teshuvot Mishnah Halakhot 6:277. Numerous authorities reject this position and argue that a shareholder is bereft of ownership interests. See Teshuvot Maharival 2:124; Teshuvot Mahari ha-Levi 1:54; Iggerot Moshe, EH 1:7.
It is evident that a corporate environment must be governed by the systemic norms of halakhic business law, including but not limited to labor relations, pricing, selling, advertising, and trading policies, as well as environmental safeguards. However, Professor Wurzburger argues that there is an individual mandate to act with beneficence towards one’s fellow man and affirm local custom which promotes philanthropic initiatives. It would therefore be laudable for a corporation to be socially responsible and fund public assistance programs and the like.160Wurzburger, supra n. 158.
In our view, Professor Wurzburger’s objection to the shareholder wealth maximization norm is in actuality a broader attack on capitalism and on economic self-aggrandizement in particular, reflecting unawareness of the continuous halakhic affirmation of profit maximization, albeit within the constraints set by the system.161Wurzburger, ibid., 29, 42. A cursory review of the following secondary works written in English on the interface of Halakhah and economics corroborates our conclusion. See Yehoshua Lieberman, Business Competition in Jewish Law [Hebrew] (Ramat Gan: 1989); Aaron Levine, Case Studies in Jewish Business Ethics (NY: 2000); idem., Moral Issues of the Marketplace in Jewish Law (NY: 2005). Consequently, whereas some proponents of shareholder wealth maximization would argue that subsistent wages and substandard working conditions, environmental pollution, workplace toxicity, unsafe products, and employment discrimination based upon race and sex may be beyond the purview of corporate and shareholder concerns, Halakhah would argue that these matters are required to be addressed and regulated by the corporation.
On the other hand, many halakhic legists would agree with proponents of shareholder wealth maximization that advocacy and funding of social programs are beyond the province of the corporate venture. Participants in the corporate form of business have chosen to enter an entity which pursues the goal of maximizing profits, a legitimate activity. Hence, corporate altruism is appropriate only if it is likely to furnish direct benefits to the corporation and profits to its shareholders. However, funding such projects for the sake of advancing the common good is beyond the ambit of corporate life and thus beyond halakhic reproach. Whereas American law, as expressed in Shlensky v. Wrigley and other holdings, would shield a director’s decision for invoking corporate altruism as grounds for judicial scrutiny, Halakhah would argue that such behavior undermines the corporate interest in maximizing profits and therefore would pass judgment upon such activity.
Without delving in a systematic fashion to prove our position, we can reinforce our view based upon halakhic partnership law. Since partners are construed as agents, Arukh ha-Shulhan notes:
There is an important principle regarding business partnerships: As long as no one deviates from commercial practice in matters that were not agreed upon and one is not negligent in engaging in business, one can negotiate for his partner no different than if it was his own business.162Arukh ha-Shulhan, HM 176:31.
In short, a cardinal rule of operating a partnership is that it is predicated upon how the partners conceived of the enterprise. If the raison d’être of the enterprise was to maximize profits, then a partner cannot unilaterally decide to embark on furnishing scholarships to the children of employees or donating funds to an educational institution. Such projects undermine the accepted agency law of “li-tekuni shedartikh ve-lo le-avati,”163Kiddushin 42b; Ketuvot 99b; Bava Batra 169b. “it is for my benefit that I have commissioned you to act, not to my detriment.” As a partner, he serves as a shomer (bailee),164SA, HM 176:8. and as such, his diversion of funds to such projects without prior authorization is an act of shelihut yad, misappropriation. Clearly, if a deviation from details may subject a partner to liability, a fortiori a substantive modification of the mandate, such as the introduction of social programming, will fail to pass muster. Analogously, a corporate manager or an executive is proscribed from deviating from the shareholder mandate to maximize profits and begin to initiate such social programs. If proponents of corporate social responsibility want to reform the activities of the corporation, they should seek redress and implement their objectives through the political process.165Daniel Fischel, “The Corporate Governance Movement,” 35 Vand. L. Rev. (1982), 1259, 1271.
Alternatively, as we explained earlier, the corporation entails a network of private contractual relationships. As such, should recent legal commentary become law empowering shareholders to initiate decisions which amend the corporate charter and intervene in corporate decision-making,166Lucian Bebchuk, “The Case for Increasing Shareholder Power,” 118 Harvard L. Rev. (2005), 833; Elhauge, supra n. 27. then the shareholders, who are owners of the firm,167See Teshuvot Maharshag, YD 3; Teshuvot Minhat Yitzhak 3:1; Iggerot Moshe, OH 1:90, 4:54. Secular law clearly views shareholders differently. Should the firm incur any financial loss, the shareholders will be exempt from liability; at best, the value of their shares will depreciate. may vote to approve such social activities.168However, pursuant to default provisions in many state jurisdictions, should there be a “class vote” of preferred stockholders which argues that such social goals adversely affect them, such an amendment may fail to pass muster. In fact, many charter provisions of preferred stockholders are negotiated and may entitle them with express voting rights. Absent such actions, shareholders are not empowered to commence corporate action and their voting rights are limited to electing board directors, corporate charter approval, sales of corporate assets, mergers and dissolving the corporation. See Michael Dooley, Fundamentals of Corporation Law (1995), 174–177. Pursuant to the amended charter, the directors would be obligated to initiate social programs unrelated to profitability. However, in the absence of such a mandate, Halakhah would have found that the director’s actions in Shlensky v. Wrigley, Theodora Holding Corp. v. Henderson, and A.P. Smith Manufacturing, which placed the interests of non-shareholder constituencies ahead of those of shareholders, were grounds for the director’s liability.
In short, the stakeholder debate has argued that “the religious outlook” inexorably leads one to a communitarian vision and therefore advances the notion of corporate social responsibility unrelated to profitability; the halakhic legal system, although imbibing a religious communitarian vision, nevertheless concludes that the shareholder maximization of wealth remains subject to certain halakhic legal constraints, such as imposing liability on a director who renders decisions which implement non-shareholders’ interests.
Thus, whereas the implementation of the business judgment rule by an American court implicitly promotes the profit maximization norm169Robert Charles Clark, Corporate Law (1986); Dooley, supra n. 168, 97; Stephen Bainbridge, Corporation Law and Economics (2002), 419–29; Kent Greenfield, The Failure of Corporate Law (Chicago, 2006), 224, 230. Cf. others who argue the rule empowers directors to consider non-shareholder interests; see Blair and Stout, supra n. 8, 303. and serves to insulate the directors and officers from liability for their corporate decision-making as long there is no illegality or conflict of interest, halakhic decisors will scrutinize the actions of directors in corporate as well as non-profit settings, and if the facts deem the behavior improper, will look askance at such conduct and may pierce the corporate veil.170Nonetheless, Halakhah will agree with the American legal stance that judicial review is proper in cases involving the monitoring of a director’s decision to determine whether it is an informed and reasoned judgment. On the other hand, in cases of a director’s malfeasance or making a decision based upon a non-shareholder interest, although halakhically their behavior would be protected by the corporate shield, the limited liability rule, their behavior would be violative of Halakhah. At the same time, unless the corporate charter and/or a statute permit the factoring of the public interest into a corporate decision, Halakhah, unlike American law, will affirm the obligation of corporate employees to maximize profits even at the expense of non-shareholder interests.
As we have demonstrated, the scope of halakhic intervention is far more expansive than that of an American court. In situations in which American courts abstained from scrutinizing a derivative suit based on the business judgment rule, Halakhah would have mandated an inquiry. Whereas in American law, by dint of its secular nature, the scope of justiciable disputes is more circumscribed, Halakhah, as a religious legal system, mandates judicial inquiry of such disputes. As the former Deputy President of Israel’s Supreme Court, Menachem Elon, observes:
The system (as a whole, which includes the legal and the religious part of Halakhah) is a system of prohibitions and permissions, and the system does (in this sense) relate to all activities of man … There is no such thing as a “Jewish legal vacuum.” The system of Halakhah, by its very essence, embraces all interpersonal and societal relations; all ethical, social, national issues or legal questions find a place within the system of Halakhah … However, the legal world, as our world exists today, is a limited world … limiting itself to those actions that have normative legal ramifications; contrasted with those are the numerous varied activities which are organized in accordance with social and ethical norms that exist outside the legal spectrum.171Jerczewski v. Prime Minister Yitzchak Shamir, 45(1) Piskei Din of Beit Mishpat Elyon (1991), 749.
We can sharpen our conclusion by adopting a jurisprudential framework suggested by a contemporary legal scholar of corporate law. He distinguishes between legal norms and social norms:
I use the term social norm to mean all rules and regularities concerning human conduct other than legal rules and organizational rules. By legal rules, I mean the principles and rules of a legal system. By organizational rules, I mean formal rules adopted by private organizations … I now turn now to the role of social norms in corporate law. I use the term corporate law here in a broad but standard sense to mean those areas of conduct that are within the scope of corporate law … Often, the operation of social norms is at or near the surface of corporate law. For example, some corporate law doctrines explicitly incorporate social norms. Thus, the ALI’s Principles of Corporate Governance provides that a corporation may take into account ethical considerations, even if corporate profit and shareholder are not thereby enhanced.172Melvin Eisenberg, “Corporate Law, Social Norms and Belief Systems,” Berkeley Program in Law and Economics, Working Paper Series (1999), 1, 4, 20.
Applying this framework, our focus here is the factoring of non-shareholder interests in a corporate director’s decision, which is an illustration of social norm that is not explicitly incorporated into corporate legal rules. Clearly, a director is not obligated to promote public interest at the expense of shareholder profits. On the one hand, the corporation conceived as a nexus of agreements entailing legally enforceable promises is governed by legal rules. However, on the other hand, these reciprocal arrangements do not mandate compliance with social norms, such as the promotion of non-shareholder interests.
The stakeholder debate involves a debate regarding whether to adopt a social norm into corporate life. In other words, what is the goal of the corporation – the pursuit of profits or the pursuit of social needs unrelated to wealth maximization? Due to the dispute regarding the incorporation of a social norm into the corporate world, the court in Shlensky v. Wrigley abstained from addressing this matter. A secular court will only address issues of noncompliance with legal rules, such as fraud, or certain potential non-compliance with legal rules, such as conflicts of interests and uninformed corporate decisions. Other social norms are beyond the purview of the court, and the business judgment rule is therefore invoked regarding such matters. On the other hand, Halakhah, as a religious legal system, advances a more expansive conception of legality. Thus, certain activities which may be labeled as social norms in a secular system, and are therefore considered non-justiciable, will be viewed by Halakhah as legal norms, and their infraction will therefore be subject to legal scrutiny and possible sanction.173For grounds for piercing of the corporate veil, see Teshuvot Mishnah Halakhot 6:277; Teshuvot Shevet ha-Levi, vol. 8, HM 306; File No. 379/63, Piskei Din Yerushalayim, helek 9, 419. Implicit in halakhic corporate piercing is the notion that the corporate network including but not limited to managers and employees are personally liable for certain halakhic infractions such as negligent misrepresentation. In other words, even if one assumes that a corporation is halakhically an artificial being, liability resides with the members of the corporate network even though they are not the owners of the business. See SA HM 395:1.