ARE ALL RISKS CREATED EQUAL? RETHINKING THE DISTINCTION BETWEEN LEGAL AND BUSINESS RISK IN CORPORATE LAW

Should corporate legal risk be treated similarly to corporate business risk? Currently, the law draws a clear-cut distinction between the two sources of risk, permitting the latter and banning the former. As a result, fiduciaries are shielded from personal liability in the case of business risk and are entirely exposed to civil and criminal liability that arises from legal risk-taking. As corporate law theorists have underscored, the differential treatment of business and legal risk is highly problematic from the perspective of firms and shareholders. To begin with, legal risk cannot be completely averted or eliminated. More importantly, decisions involving negligible levels of legal risk might yield significant profits for firms. Thus, the outright ban on legal risk-taking harms shareholders, who would have favored a more nuanced regime to optimize legal risk. In this Article we make two novel contributions to corporate law scholarship, one descriptive and one normative. Descriptively, we offer a novel justification for the differential treatment of business and legal risk. We argue that because board members are exposed to personal liability for losses resulting from legal risk, they will veto all policies and decisions implicating legal risk, minimal though they may be. Aware of this disposition, managers-whose compensation is often tied to performance and who are therefore more risk-seeking-will prefer not to raise policies and decisions that implicate legal risk to board discussion. This preference, however, works to the detriment of shareholders who are deprived of the protective mechanism of board overview with respect to legal risk. Legal risks, therefore, largely escape board scrutiny. While the justification we advance has stronger explanatory power than prior justifications, it leaves open the possibility that the law may be redesigned in a more nuanced and desirable way. This rationale leads to the normative contribution of the Article. Consistent with the modern philosophy toward risk that maintains that all risks can be managed, we propose that legal risks be divided into two categories of severity: (1) risks involving criminal prohibitions and (2) risks pertaining to noncriminal norms. Each category should then be further broken down into three classes of risk based on probability of occurrence: remote, reasonable, and probable risk. Combining our two criteria generates six classes of legal risks, for each of which we develop a unique liability regime. The framework that we advance will allow corporate executives and directors to address low and reasonable levels of legal risk in a responsible way that will benefit shareholders without eroding respect for law and morality.