Saturday, September 20, 2014

Chapter 7 (Law Beyond Law ― Social Norms, Contract Communities, and Disclosure Regimes): From "Elements of Law" to "Introduction to the Law and Legal System of the United States"--Building an Introductory Course to the Legal Curriculum for the 21st Century

(Pix (c) Larry Catá Backer 2014)

Since 2010, I have been posting on the development of a new course I have been developing for our first year law school students, "Elements of Law." The course originally had a quite modest objective--to introduce law students to legal research and reasoning through case law, statutory interpretation, and legal history, processes, and institutions. I chose to broaden its objectives within these specific parameters and development a framing and concepts course that would provide a deep foundation to law students on the legal system they were undertaking to study.
--Elements of Law 3.0: On the Relevance of a First Year Law Course Designed to Frame the Law School Curriculum).
--Developing a New Course--"Elements of Law"
--"Elements of Law" Course 2.0: A Framework Course for the U.S. Law Curriculum,
Grounded in the principles of the sociology of law, the course has morphed into an effort to introduce students to law as a self-referencing system with its own particular structures, premises, constraints and language, with its own logic and taboos and its own means of understanding the world. That systemicity (cf. Peter Checkland, Systems Thinking, Systems Practice, Chichester : John Wiley and Sons Ltd, 1999) is then a critical element in the way in which the legal system (in this case of the United States) interacts with the world, both as a legal and as a socio-economic-political actor. The course has also expanded from its original narrow and technical focus, to a broader focus on principles and the use of language and logic to build and operate a system of law. That broadening has made it possible to offer the course not just to first year law students, but also to graduate students in the social sciences and in international affairs, as a grounding in the legal systems that are important in their respective fields.

This and the posts that follow produces some of the materials I will be presenting to the class. I offer these materials in hopes that they may prove of use and that you might share comments, perspectives and suggestions as I develop those materials on this site. Thanks.

This post includes a draft of Chapter 7 (Law Beyond Law ― Social Norms, Contract Communities, and Disclosure Regimes).
Chapter 7

Law Beyond Law ― Social Norms, Contract Communities,
and Disclosure Regimes

I. Introduction.

            We have been considering the formal structures of law systems in the United States.  These included two related strands of judge administered law—common law and equity.  These are themselves complex interweaving of substantive law based on interactions between social norms and dispute resolution structures, of procedural methodologies—from the culture of precedent and deductive reasoning from cases, to the development of fairness based defenses, and of remedies. Beyond these two strands, we were introduced to the great modern structures of law making in the United States.  The first was statutory law—we considered the culture of statutory law making in the United States as more inclined toward statutory complication rather than to integrated legal code development.  That had significant consequences for the role of the courts in statutory interpretation and application, providing the opening by which statutes could be glossed through the application a a variant of common law judging techniques. Lastly, we considered regulation, a form of law making that is both highly specialized, and also lodged in agencies disconnected from direct accountability to an electorate. . Issues of jurisdiction and of conflict of interest in combining legislative, executive and judicial authority in regulating agencies were explored.  With this chapter we consider the last strand of U.S. law and governance sources—the acceptance of systems of rule making, governance, that does not emanate from the state.  This includes both influential sources of law making and private governance through non-state organizations. But in this century it has also come to mean more than that.  As a methodology, a technique, of assessment and monitoring, the mechanics of data gathering and the consequences of assessment have themselves become methods of regulating behavior that have the effect of law.

We will consider non-state law/governance systems in three respects: (1) as a source of influence on positive law, common law and equity; (2) as a source of law binding on the community that adopts it; and (3) as a series of techniques that have the functional effect of law by their ability to change behavior.

II. Chapter Readings

·      Gunther Weiss, The Enchantment of Codification in the Common-Law World, 25 Yale Journal of International Law 435 (2000).
·      Melvin Eisenberg, Corporate Law and Social Norms,[1] 99 Colum. L. Rev. 1252, 1255-64 (1999).
·      Michael Reed, “From the ‘Cage’ to the ‘Gaze’? The Dynamics of Organizational Control in Late Modernity,” in Regulation and Organizations: International Perspectives 17 (Glenn Morgan & Lars Engwall eds., 1999). READ 28-31.
·      Michel Foucault, Security, Territory, Population, Lectures at the Collège de France 1977-1978. (Graham Burchell, trans. New York: Picador Palgrove Macmillan, 2007). READ pp. 87-110; 115-120.
·      Larry Catá Backer, “From Moral Obligation to International Law: Disclosure Systems, Markets and the Regulation of Multinational Corporations,” Georgetown J. International Law, 39(4):591-653 (2008). Available[2]

III. Law Beyond Law ― Social Norms, Contract Communities, and Disclosure Regimes

            Over the course of the last several weeks the student has been introduced to the principle forms in which most political communities recognize what they would define as “law.” We first considered the frameworks within which communities tend to think about law (manifestation of justice, overarching principles, procedural fairness, accessibility, and highly contextual but layered understanding of the substantive meaning of just laws). We then explored the form and legal “cultures” of the principal forms of law in the American Republic. That required both a look back to origins to expose the essence of the nature of each form of law, and an understanding of the political context in which each has developed. We started with common law, an institutionalized form of customary law mediated through courts. We then considered statutes, a more instrumental and political expression of popular will through delegated structures of authority vested in government. We ended with an examination of administrative regulation. This form was particularly interesting for two reasons. First it introduced the student to the problem of democratic accountability for chains of delegated law making authority. Administrative regulations are a form of instrumental law-making delegated from legitimately elected representatives of popular power to appointed officials within increasingly complex administrative and managerial bureaucracies that simultaneously make, enforce and determine individual violations of its own rules. Second, these administrative regulations represented, like the movement form algebra to calculus, a shift from episodic intervention in the management of human conduct through commands, to seamless systems of organizing and managing human activity on a constant basis.

            To the command aspects of statute were added the techniques of surveillance to more minutely manage human behavior in selected activities of importance to the state. The concept and use of surveillance in and as law was useful as a framework for introducing students to several aspects of law that have emerged in the last half century. First, was the idea that the nature of regulation has been changing, from one based on commands and prohibitions, or one based on risk management and allocation for certain conduct, to one based on the seamless management of behavior centered on specific groups of human activities―financial markets, labor-management relations, product safety, activities that might affect environmental conditions, and the like. Those changes in the objectives of regulation have required a change in approach to regulation itself. First it helped shift the locus of regulation from legislatures to administrative agencies, as generalist legislatures increasingly sought to delegate management oriented regulatory projects to organizations staffed by experts who could devote substantially all their time to the object of regulation. Second, that move to management also required increasing reliance on the techniques of information gathering to better manage the behaviors that were the object of regulation. As a consequence the techniques of implementation, rather than the formal commends of formal regulation become increasingly important. As a further consequence what might be characterized as regulatory implementation techniques increasingly operate functionally as law. Third, this movement toward seamless management through what had been the techniques of operationalizing implementation opened the door to the idea that an organization could create methods that function like law without actually having to engage formally in conventional law making. Last, if it is possible to conceive of regimes of functional law without formal law, created and operated by states, it might also be possible to conceive of regimes of functional law in any form created and operated by non-state organizations, especially in those areas of governance (transnational) where state power is weakest.

            Thus, from common law to administrative regulation, the student could begin to see the spectrum of legal forms now at the disposal of the U.S. political community. Additionally, the student could observe in the movement from form to function in law making an increasing acceptance of the idea that law was changing from a system of command and risk allocation to one of behavior management in which the state could “make” law without adhering to the traditional “forms” of law. The answer to our initial question, what is law, then serves as an organizing framework for considering the growing range of forms, from (1) a passive system of socially based dispute resolution techniques with substantive content developed through within a slowly dynamic system of behavior rules extracted from the aggregate decisions of courts applying rules by close analogy to prior application, through (2) more proactive enactments meant to modify or steer behaviors and develop commands that furthered political policy objectives in the form of statutes, to (3) systems of behavior rules extracted from the articulation and application of complex sets of comprehensive rules by agencies that, in their own way, mimic the behaviors of common law but deliberately with statutorily defined objectives.

            Twenty years ago, though, our treatment of formal administrative regulations would have rounded out the typical introduction to the forms of law (and their attendant cultures). Law, we would have understood, was necessarily a product of, or a structuring of custom articulated through, one of a number of public national governmental institutions―courts, legislatures, administrative agencies and the like. The idea that there could be law beyond these forms or legitimate governance understandable as “legal” in nature removed from the state or deviating much form these forms, would have been incomprehensible to those in the business of law. But just as the move from medieval to early pre-modern periods in Europe consolidated the power of the state and the connection between states, governments, and legal structures (plus their substance)―so (1) the rapid development of globalization, (2) the proliferation of human activity that constantly crossed borders, and (2) the increasing taste for the management of defined fields of human activity on a constant and ongoing basis, has de-centered both the state and law from its mooring in government and in the traditional structures of law. For this class the student is introduced to the very new and emerging structures of governance without law and sometimes without government itself (e.g., Larry Catá Backer, Governance Without Government: An Overview and Application of Interactions Between Law-State and Governance-Corporate Systems[34]). This picks up and expands the possibilities and consequences of monitoring and information based regulatory regimes of the administrative state with which we ended out last class.

            Our first reading, from Gunther Weiss, The Enchantment of Codification in the Common-Law World, 25 Yale Journal of International Law 435 (2000), focuses on one of the most conventional, yet powerful, mechanisms for the production of rules outside of the state.  It is meant to introduce students to the American Law Institute (ALI), one of the most influential non governmental institutions for the production of compilations of law, one that has come to be relied on by courts and legislatures in shaping and reforming U.S. law—both its common law and its statutory law. The ALI is quite self conscious of its role—an institution that does not legislate, but in the process of restating law, contributes to its production.

The American Law Institute is the leading independent organization in the United States producing scholarly work to clarify, modernize, and otherwise improve the law. The Institute (made up of 4000 lawyers, judges, and law professors of the highest qualifications) drafts, discusses, revises, and publishes Restatements of the Law, model statutes, and principles of law that are enormously influential in the courts and legislatures, as well as in legal scholarship and education. ALI has long been influential internationally and, in recent years, more of its work has become international in scope.

By participating in the Institute's work, its distinguished members have the opportunity to influence the development of the law in both existing and emerging areas, to work with other eminent lawyers, judges, and academics, to give back to a profession to which they are deeply dedicated, and to contribute to the public good.[35]

The success of the ALI is due in no small measure in the overlap between those elements of the judiciary, legal academy, and leading lawyers, who by their positions, held key roles within the structures of government responsible for the production and implementation of law. “ALI's incorporators included Chief Justice and former President William Howard Taft, future Chief Justice Charles Evans Hughes, and former Secretary of State Elihu Root. Judges Benjamin N. Cardozo and Learned Hand were among its early leaders.”[36]  It chose to save the U.S. legal system by reconstructing it.  Its character, then, is not law, but it can inform law.  In this sense does it work as a social norm, or does it become law, in effect, to the extent it is applied as if it were law?  Consider these questions in the context of the following case:


The TORO COMPANY, et al.
No. 86–2800.
827 F.2d 155 (7th Cir. 1987)


RIPPLE, Circuit Judge.

In this diversity case, we are asked to review the judgment of the district court which held that the defendant accounting firm and individual accountants were not liable for alleged negligence to the plaintiff corporations, third parties who allegedly relied upon the reports of the accountants in extending credit to the accountants' client. For the reasons set forth in the following opinion, we affirm the judgment of the district court.


This case involves certain accounting services provided by an accounting firm, Krouse, Kern & Company, Inc. (Krouse) to Summit Power Equipment Distributors, Inc. (Summit) for the fiscal years 1981, 1982 and 1983. In each of those years, Krouse prepared yearly audit reports and monthly financial statements for Summit. During the same period, Toro Company was a major supplier of equipment to Summit, and its wholly-owned subsidiary, Toro Credit Company (Toro), was a major supplier of credit to Summit. Toro required audited reports from Summit in order to evaluate the distributor's financial condition. Summit supplied Toro with the reports prepared by Krouse to fulfill this requirement. The reports allegedly contained mistakes and omissions regarding Summit's actual financial condition.

Toro brought this action in the district court. Jurisdiction was based on diversity of citizenship. 28 U.S.C. § 1332. Toro alleged that, in reliance upon the audit reports, it extended and renewed large amounts of credit to Summit. The reports overstated Summit's assets, the complaint continued, and Toro extended credit that it would not have extended if the reports had been accurate. Summit was unable to repay these amounts. Krouse filed a motion for summary judgment that was granted by the district court. This appeal followed.

Holding of the District Court
A. Standard of Care

In an exhaustive and scholarly opinion, the district court analyzed the central issue in this case—the appropriate standard of care required of accountants under Indiana law. Surveying the law of the states of the Union, the court isolated three standards: 1) the Ultramares standard; 2) the Restatement standard; and 3) the “Reasonably Foreseeable” standard.

1. The Ultramares Standard

This standard was first announced by the New York Court of Appeals in Ultramares Corp. v. Touche, 255 N.Y. 170, 174 N.E. 441 (N.Y.1931). There, Chief Judge Cardozo disallowed a negligence action against an accounting firm brought by a plaintiff who had neither contractual privity, Id. 174 N.E. at 446, nor a relationship “so close as to approach that of privity.” Id. Recently, in Credit Alliance Corp. v. Arthur Andersen & Co., 65 N.Y.2d 536, 493 N.Y.S.2d 435, 483 N.E.2d 110 (1985), the New York Court of Appeals reaffirmed its reliance on the Ultramares standard:

    Before accountants may be held liable in negligence to noncontractual parties who rely to their detriment on inaccurate financial reports, certain prerequisites must be satisfied: (1) the accountants must have been aware that the financial reports were to be used for a particular purpose or purposes; (2) in the furtherance of which a known party or parties was intended to rely; and (3) there must have been some conduct on the part of the accountants linking them to that party or parties, which evinces the accountants' *157 understanding of that party or parties' reliance.

Id. 493 N.Y.S.2d at 443, 483 N.E.2d at 118.

2. The Restatement Standard[37]

This standard permits recovery for those who can be actually foreseen as parties “who will and do rely upon the financial statements.” Toro Co. v. Krouse, Kern & Co., 644 F.Supp. 986, 992 (N.D.Ind.1986) [hereinafter cited as Order]. In pertinent part, section 552 of the Restatement (Second) of Torts reads as follows:

(1) One who, in the course of his business, profession or employment, or in any other transaction in which he has a pecuniary interest, supplies false information for the guidance of others in their business transactions, is subject to liability for pecuniary loss caused to them by their justifiable reliance upon the information, if he fails to exercise reasonable care or competence in obtaining or communicating the information.
(2) Except as stated in Subsection (3), the liability stated in Subsection (1) is limited to loss suffered
(a) by the person or one of a limited group of persons for whose benefit and guidance he intends to supply the information or knows that the recipient intends to supply it; and
(b) through reliance upon it in a transaction that he intends the information to influence or knows that the recipient so intends or in a substantially similar transaction.

3. The “Reasonably Foreseeable” Standard

The district court determined that “[t]wo jurisdictions have proceeded beyond the ‘actually foreseeable’ test of the Restatement and adopted a ‘reasonably foreseeable’ test. Under this standard, accountants owe a duty of care to all parties who are reasonably foreseeable recipients of financial statements for business purposes, provided the recipients rely on the statements pursuant to those business purposes. See Rosenblum v. Adler, 93 N.J. 324, 461 A.2d 138 (1983); Citizens State Bank v. Timm, Schmidt & Co., 113 Wis.2d 376, 335 N.W.2d 361 (1983).” Order at 992.

The district court then noted that Indiana had not yet had occasion to address directly the question of accountant liability. The district court therefore turned to an analysis of Indiana cases that had addressed the issue of professional liability “to third parties who have had limited or no contact with the provider of services.” Id. at 992. After surveying the early cases, Brown v. Sims, 22 Ind.App. 317, 53 N.E. 779 (1899); Ohmart v. Citizens' Sav. & Trust Co., 82 Ind.App. 219, 145 N.E. 577 (1924); Peyronnin Constr. Co. v. Weiss, 137 Ind.App. 417, 208 N.E.2d 489 (1965), the court focused on the more recent holding in Essex v. Ryan, 446 N.E.2d 368 (Ind.Ct.App.1983). There, subsequent purchasers of property sued a surveyor who allegedly had made an inaccurate survey for the prior owner. After considering the three cases noted above, the Essex court held that the surveyor owed no duty to the successor owners because he had no knowledge that they would rely on his survey. The district court noted that the Indiana court in Essex had explicitly considered the three approaches for professional liability outlined above and had quoted with approval the “privity or near-privity” standard as outlined in Ultramares and had specifically rejected the “actually foreseeable” Restatement position. Id. at 373.

On the basis of this survey of the earlier cases, the district court concluded:

    It is clear that Indiana falls among those jurisdictions which follow the narrow Ultramares standard requiring either a contractual relationship between the parties or at least affirmative evidence of contact between the professional and the third party which indicates the *158 professional's knowledge of the third party's reliance. In Brown, the only case to allow the cause of action to go forward, this contact was extensive and explicit.

Order at 994.

The district court did not believe that the present situation should be distinguished from that presented in Essex. The district judge noted that the Indiana court in Essex had considered similar cases involving many other professions, including accountants. Moreover, noted the district court, the Essex court had squarely considered and rejected the Restatement position while relying on New York's Ultramares decision. Nor did the district court believe that there was any policy reason that might induce the Indiana courts, when confronted with the issue, to adopt a different standard in the case of accountants:

    Certainly an examination of the nature of exposure experienced by surveyors who negligently render their services as compared with accountants does not suggest that accountants should be subject to a more liberal standard. If such a comparison is at all helpful, it counsels the opposite conclusion. Surveyors generally base their opinions on fewer calculations from fewer sources than do accountants. This fact is readily demonstrated by Krouse's answer to Toro's Interrogatory No. 8, which recounts in detail the accounting methods and procedures utilized by Krouse in conducting the Summit audits. Fourteen procedures are outlined, each involving detailed examination and confirmation of various financial records and transactions.

Id. at 994.

B. Application of Standard to Facts of this Case

The district court then turned to an analysis of the facts of the case contained in the material submitted to it in support of and in opposition to the motion for summary judgment. It determined that Toro's submissions reasonably could be construed as meeting the first two prongs of the Credit Alliance test. A “reasonable inference can be made that Krouse knew that the reports it furnished to Summit were to be used by Summit to induce Toro's extension of credit and distributing rights based on Toro's reliance on the information contained in the reports.” Id. at 995.

However, the district court determined that, on the third prong, “the complaint and the supporting evidence fail.” Id. Toro's affidavits, concluded the district court, “fail to present evidence which shows the necessary connection between plaintiffs and defendants. They clearly show a relationship among three parties, with Summit forming the joint between Toro and Krouse. The third side of the triangle, however, remains open.” Id. at 995. The court failed to find in the remaining material submitted by either Toro or Krouse any allegation that would close the gap.2 Accordingly, it concluded:

Because Indiana would adopt the most restrictive of the three standards currently used to determine the availability of a cause of action to third parties allegedly injured by negligently performed services by an accountant, Krouse's motion for summary judgment must be granted. None of the evidence presents a genuine issue as to whether Krouse had the necessary contact with Toro which evinces Krouse's understanding of Toro's actual reliance on the reports Krouse furnished to Summit.

Id. at 996.

Finally, the district court turned to the statute of limitations issue. While its disposition of the liability issue made it unnecessary to reach this question, the district court held that

    if a different standard of liability applied in this case that would permit Toro to go forward with its cause of action, the dates that Toro received the reports at issue would control as to the statute of limitations issue. Further evidence would have to be developed on this point, since these dates are not apparent from the record. Presumably, however, Toro would have received the reports from Summit shortly after Summit received them from Krouse. In all likelihood, therefore, this would result in the elimination of the 1981 and 1982 reports as elements of the cause of action.

Id. at 997.



As the district court correctly noted, this case turns upon a proper identification of the standard of liability imposed upon accountants under the law of Indiana. We therefore address that question first.

1. The Submissions of the Parties

Toro acknowledges that Indiana has not adopted the Restatement standard. However, it argues that just because Indiana has rejected the Restatement position, it cannot be assumed that it has embraced the Ultramares standard. Rather, submits Toro, Indiana would impose liability not only when there is privity between the accountant and the injured party but also when there is actual knowledge on the part of the accountant that the injured party will rely on the work product. Appellants' Br. at 18. This standard is required, it submits, by the holding of the Supreme Court of Indiana in Citizens Gas & Coke Util. v. American Economy Ins. Co., 486 N.E.2d 998 (Ind.1985) where the court, discussing Essex, wrote, “[t]he surveyor owed no duty to subsequent purchasers of property because he had no knowledge they would rely on his survey and because he was not in privity with them.” 486 N.E.2d at 1001.
Toro continues by urging that sound policy reasons support its view as to the content of Indiana law. The audited financial report, it notes, “has been singled out by both federal and state legislation to be an important vehicle to encourage public confidence in the accuracy of financial information.” Appellants' Br. at 20. Moreover, “the business community has long recognized the responsibility a certified public accountant owes the public when engaged in an audit.” Id. at 21. The appellants note that the Supreme Court of the United States has stated:

An independent certified public accountant performs a different role. By certifying the public reports that collectively depict a corporation's financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client. The independent public accountant performing this special function owes ultimate allegience to the corporation's creditors and stockholders, as well as to the investing public.

United States v. Arthur Young & Co., 465 U.S. 805, 817–18, 104 S.Ct. 1495, 1502–03, 79 L.Ed.2d 826 (1984). Finally, Toro notes that the Indiana licensing scheme for certified public accountants contemplates a person who “is not only technically competent, but ... [whose] ... financial reports ... are worthy of the public trust and confidence.” Appellants' Br. at 22–23.

Krouse does not disagree with Toro on the identity of the controlling precedent and, like its opponent, grounds its argument on the holdings of the Supreme Court of Indiana in Citizens Gas and of the Indiana Court of Appeals in Essex. Its reading of those cases is, however, substantially different from that offered by its opponent. In Krouse's view, these Indiana cases set forth a test that is the equivalent of the test articulated by the Court of Appeals of New York in Ultramares and recently reaffirmed as the governing law in New York in Credit Alliance. Krouse notes that the Indiana Court of Appeals specifically relied upon the New York court's Ultramares holding in formulating its own holding in Essex. In turn, the Essex case, submits Krouse, “provides an essential cornerstone of the [Indiana] supreme court's Citizen's Gas decision.” Appellees' Br. at 18. There, the Supreme Court of Indiana, submits Krouse, reaffirmed the continued vitality of the privity principle in Indiana. Krouse also notes that the Essex court “specifically declined to adopt § 552, Restatement (Second) of Torts (1977), that extends liability for supplying false information to any one or more of a group of persons for whose benefit and guidance a professional supplies information, even if the person who becomes the plaintiff is not known to the professional as an individual.” Appellees' Br. at 18.

2. Our Conclusion

We have noted in Lamb v. Briggs Mfg., 700 F.2d 1092, 1094 (7th Cir.1983) that:
[W]here no authoritative resolution of a legal issue had been rendered by the state courts, the district court's construction of state law on that issue is entitled to great weight on appellate review.... In addition, precisely because the district court enforcing a state-created right in a diversity case is in substance “only another court of the state,” the federal court may not “substantially affect the enforcement of the right as given by the state.”
(citations omitted). In this case, where the district court's decision on the content of state law is the product of a comprehensive, well-reasoned and carefully-crafted opinion, we should be especially mindful of this principle. Nevertheless, we have independently studied the pertinent Indiana case law and, on the basis of that study, believe that the district judge correctly stated the present state of the Indiana law.

We begin our analysis by noting that Indiana has made some firm policy choices in the area under consideration. As the Supreme Court of Indiana noted in Citizens Gas,

    [t]he requirements of privity have been abolished by this Court and the Court of Appeals for products liability and contractor liability involving personal injury caused by a product or work in a condition that was dangerously defective, inherently dangerous or imminently dangerous such that it created a risk of imminent personal injury.

486 N.E.2d at 1000. This limited exception to the privity rule is based on a policy choice that, as a federal court whose jurisdiction is based on diversity of citizenship, we must accept. See generally Erie R.R. v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188 (1938).

The reason for Indiana's policy choice was stated succinctly by the Supreme Court of Indiana in Citizens Gas:

    The reasoning behind all of these cases that has created the exception to the general requirement of privity is apparent and is based on humanitarian principles. One who sells a product or does construction work pursuant to a contract with the owner of a building or premises which presents imminent danger to the health and safety of not only the party he contracts with but to other members of the public can be held liable for resulting injuries even though the third party injured is not privy to the contract. It does not follow that the same exception would be applied where the risk is only that of property damage. In Essex v. Ryan (1983), Ind.App., 446 N.E.2d 368, 372, the Essexes sought to recover damages arising from a survey which Ryan had negligently performed for their predecessor in title in 1955. The Essexes claimed damages because of the deceased's professional incompetence and because they were assignees of their predecessors in interest. The Court of Appeals found, however, that the surveyor owed no duty to subsequent purchasers of property because he had no knowledge they would rely on his survey and because he was not in privity with them.

486 N.E.2d at 1000–01.

It is true that, in those areas where privity still applies, there exists an “actual knowledge” exception. See Essex, 446 N.E.2d at 373. However, this “actual knowledge” exception, as articulated by the Indiana courts, is a very narrow and specific one. It requires proof that the defendant had actual knowledge that the particular person or entity bringing the law suit “would rely on the information given.” Essex, 446 N.E.2d at 372. In short, the Indiana courts have made a “distinction between knowledge that a third party will rely on the opinion given and an expectation that unidentified others might rely on it.” Id. (emphasis in original).

We further believe that the district court was correct when it held that this “actual knowledge” exception to the privity rule was the functional equivalent of the Ultramares test's insistence on “near privity.” . . . .

* * * * *

While Indiana has not had occasion to address the matter with quite the specificity found in the New York cases, we believe that a fair reading of the Indiana precedent, in its totality, establishes that the “privity requirement, subject to an actual knowledge exception,” explicitly recognized in Essex, 446 N.E.2d at 373, is designed to preserve the same policy concern as the New York formulation. The Essex court relied explicitly on Ultramares. More importantly, in discussing the earlier Indiana precedent, it pointedly distinguished between *162 those cases where the defendant had affirmatively undertaken to assist the plaintiff with respect to a particular task and those where there had been no such affirmative manifestation. In discussing Brown v. Sims, the Essex court noted that the defendant (a preparer of a title abstract) had personally assured the plaintiff that he could rely on the title's being free from any defect or lien. Essex, 446 N.E.2d at 372. By contrast, noted the Essex court, the savings and loan in Ohmart, (which negligently prepared a title abstract) had no such relationship with the plaintiff. “The distinction ... was that in Brown, the abstractor understood that it was of the essence of his employment that a report be made to, and for the benefit of, a third party, the lender, Brown.” Id. Again, in criticizing the holding in Peyronnin, the Essex court noted that “Weiss had actual knowledge that Peyronnin Construction would rely upon his work, and he was in contact with the company while preparing the estimates.” Id. (emphasis in original).


We must next examine the record to determine whether, in light of the standard we have chosen, Krouse is entitled to prevail on summary judgment.

* * * * *

Our own study of the record leads us to the conclusion that the district court did not err in granting summary judgment. The appellants failed to raise a question of material fact as to an essential element of their claim of accountant liability—whether there was some conduct on the part of Krouse linking them to Toro. There is simply not “sufficient evidence favoring the nonmoving party for a jury to return a verdict for that party.” Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 106 S.Ct. 2505, 2511, 91 L.Ed.2d 202 (1986). Accordingly, the district court properly granted the motion for summary judgment.

Like the district court, we need not reach the statute of limitations issue because the affirmance of the summary judgment issue concludes the entire case.


Accordingly, the judgment of the district court is affirmed.


            Our second reading, from Melvin Eisenberg, “Corporate Law and Social Norms”, 99 Colum. L. Rev. 1252 (1999),[38] exposes students to the governance frameworks that exist in what in the United States has come to be called (misleadingly and dismissively) as social norms. They are social norms and not law precisely because they do not conform to the conventional form of law: arising in common law, or statute or by way of administrative regulation. Yet they may well function like law in the sense of their organization and consent based power to extract or compel obedience. The interplay of form and function―something introduced with the discussion of the Institutes[39] in the first class, appear here again in another guide. Professor Eisenberg considers the way that social norms interact with and serve as a source of governance that supplements corporate law as developed through conventional statutes and judicial construction. Eisenberg starts by describing three kinds of social norms, which he describes as behavioral patterns, practices and obligational norms. He then considers the ways in which these social norms intermesh with core areas of corporate law, focusing on fiduciary duty, corporate governance, the composition of the board of directors, the role of institutional investors and takeovers.

Eisenberg defines social norms quite narrowly “to mean all rules and regulations concerning human conduct, other than legal rules and organizational rules.” (Eisenberg, p. 1255). Peyton Young, among others, have defined the term more or less broadly to suit their purposes and premises.

David Hume ([1739], 1978) was the first to call attention to the central role that norms play in the construction of social order. Norms define property rights, that is, who is entitled to what. They determine what commodities are accepted as money. They shape our sense of obligation to family and community. They determine the meanings we attach to words. Indeed it is hard to think of a form of interaction that is not governed to some degree by social norms.[40]

            Young suggests three general implications of social norms that are worth keeping in mind: The first he calls the “local conformity/global diversity effect,” that different societies often employ different norms for solving the same type of coordination problem. This follows from the fact that norms represent alternative equilibria that can become established through different sequences of chance events. (Young, supra, 12). The second Young identifies as the tipping or punctuated equilibrium effect, that, due to stochastic perturbations, norms occasionally shift, and these shifts tend to be quite rapid compared to the long periods of stasis when a given norm is in place. (ibid.). The third he identifies as stochastically[41] stable norms, “that some norms are inherently more stable or durable than others: once established they tend to remain in place for long periods of time even when buffeted by stochastic shocks.” (Ibid.). This suggests that like customary law, social norms are not inherently deterministic, though they are not random or erratic. They might well form the sort of stable systems of underlying premises of cohesion and expectation that makes law in its more elaborate forms possible, and may also constrain it as well. Taken to an extreme, by contemporary standards, these have been asserted sufficient to support society without a state (Gary Chartier, Anarchy and Legal Order: Law and Politics for a Stateless Society [42](Cambridge University Press, 2003).

            In any case, Eisenberg excludes legal rules as the base line system against he seeks to determine the characteristics and operative force of social norms. He excludes organizational rules―which he defines as “formal rules adopted by private organization” (Eisenberg, supra., 1255)―because he understands them as backed by legal sanctions and because “they tend to operate in a much different way than other legal norms.; in fact they tend to operate in many ways like legal rules.” (Ibid., 1256). I disagree with the exclusion of organizational rules from the study of social norms for precisely the reasons Eisenberg would exclude them―organizational rules, especially those of corporations and other non-state governance institutions, function like legal rules and the organizations from which they originate sometimes function like governments. (Backer, Larry Catá, Economic Globalization and the Rise of Efficient Systems of Global Private Lawmaking: Wal-Mart as Global Legislator.[43]University of Connecticut Law Review, Vol. 39, No. 4, 2007). It is that functional equivalence that makes this form of social norm among the most interesting vehicles for the expansion of law beyond the state that society has experiences in over half a millennium. (e.g., Backer, Larry Catá, Multinational Corporations as Objects and Sources of Transnational Regulation.[44]ILSA Journal of International & Comparative Law, Vol. 14, No. 2, 2008). We will discuss these possibilities, central to globalization, later in the course. Still, using Eisenberg’s definitional constraints is quite useful for distilling the critical insights about social norms that can help students understand the way that functionality, increasingly, has overtaken formal exposition, as a basis for governance, especially for the development of regulatory systems that function like but do not mimic the forms of conventional law and that are developed beyond the state.

            Eisenberg divides social norms into three broad categories, based on the degree of self-consciousness and obligation they involve. (Eisenberg, supra., 1256). The first category include most unconscious patterns of norms grounded for the most part in the natural order and corresponding, as the student will note, to the basest form of natural law identified in the Institutes. These are social norms that do not entail either a sense of obligation or any self-conscious direction. Eisenberg includes things like dressing warmly in cold weather and statistical regularities (he points to auto accidents peaking during holidays) (Ibid). But he also includes simple cultural habits―like drinking coffee with breakfast (ibid). Yet this last is not natural in the sense of the others; rather it refers to cultural norms which involve little or no repercussion if an individual disregards them. These are self-conscious but non-obligatory.

            The second category, which Eisenberg labels “practices” (Ibid, 1257) consists of “rules and regularities. . . self-consciously adhered to or engaged in” but which do not entail obligation (Ibid. 1256). These include determining the time for the start of classes in a law school. These Eisenberg suggests are adhered to consciously but do not entail any sense of obligation, because, as Eisenberg describes it, they can be waived with impunity. (Ibid). I am not sure that is entirely correct―his example, the commencement time for one hour classes that are held for fifty minutes during the course of a school day, I think suggest a much greater set of constraints that produce obligation than indicated in Eisenberg’s text. It is true enough as Eisenberg suggests that there would be no criticism of faculty who changed start and end times and perhaps even the length of the fifty minute hour “as long as she could comfortably fit the schedule of her class into the schedule of other classes” (ibid), but that may no longer be entirely true. The rule may in fact implement constraints that are memorialized in organizational rules (those producing ABA accreditation of the law school for instance) that may changing the fifty minute class rule more difficult and the law school itself may impose an organizational rule making such flexibility impossible. The point is that though Eisenberg is right within the very narrow context of the social norm rule standing alone, it is also likely that these second category social norms are almost always embedded in organizational or legal rules. As such, considered more fully, Eisenberg begins to tease out implicitly, the concept of polycentricity in law-normative systems―that is the idea that laws and rules may exist in a layered form with respect to any activity and that an individual unconsciously and consciously must navigate the relationships among these layered rules, especially where they may conflict. While the example Eisenberg gives is simple―its insight is important in a transnational context where national, international and soft law frameworks may apply simultaneously with respect to a specific activity.

            More importantly, Eisenberg categorizes legal terms of art as falling within this category―his example the industry usage rules of specific contract regimes, or signs for activities like hitchhiking (Eisenberg, supra, 1256-57). Again, these norms are deeply related both to organizational rules and legal rules. They are strengthened principally through their enforcement, for example, in contract, or by their use to signal obligation or meaning in proceedings involving risk allocation or fault. And they tend to operate like legal rules―these come closer to functional regulation though they may not take the form of rules―the common law of equivalent of social norm.

            The third category, obligational rules, “consists of rules or practices that actors not only self-consciously adhere to or engage in, but feel obliged in some sense to adhere or engage in, although (by hypothesis) the rule or practice is neither a legal nor organizational rule.” (Ibid., 1257). The touchstone is whether breach produces self-criticism or criticism by others. Eisenberg includes moral norms. This includes religion and moral-ethical rules. (Ibid., 1262-1263). But some moral rules may also be organizational rules, consider the rules in the Talmud or Canon law. Non moral obligations include the convention that one wears formal attire to opening night of the opera in New York City. (Ibid). Still one wonders whether the criticism for violating practice norms in the context of contract arrangements might produce a tendency toward greater criticism than the failure to wear black tie to the NYC Metropolitan Opera.

            Eisenberg then suggests that the effects of social norms are dependent on two variables, (1) whether the norm is obligation, and (2) if it is obligation, whether it has been internalized by the relevant actor.” (Ibid., 1257). Internalized norms are efficient―these avoid utility analysis or external monitoring; the actor follows the rule she presumes it is the only or right thing to do. (Ibid., 1258-59). Thus the utility of sin in religious systems and guilt in moral-ethical systems. “For regular Metropolitan Opera goers, not dressing formally for opening night may be no more of an option than picking pockets.” (Ibid, 1259). Yet what this may really suggest is that any social norm may be made obligation simply by internalizing its substance. In that sense communal expectations may transform anything into an obligational and internalized norm.

            Eisenberg distinguishes non-internalized norms by reference to the way in which individuals may come to adhere to them. For these, adherence is measured by personal benefit. (Ibid., 1260). Yet these instrumental reasons themselves, it seems, may produce internalization if the norm is to be stabilized―that is if the norm is to have a deep impact on behavior. Absent that, on-internalized obligational norms “will probably collapse.” (Ibid). Eisenberg notes the transitory nature of non-obligational norms, and its tendency to assume the character of obligational norms depending on the context and the perspective of the actors who may be subject to their strictures. All norms, though, will be applied, changed or managed by reference to the consent and application of the community of actors to whom these rules are important. To that extent, and in ways that are similar to the development and strength of customary law, social norms develop with respect to certain determinants of social consent: critical mass, tipping points and other aspects of equilibria (ibid, 1263-64). Critical mass, of course, effectively confirms that norms require a sufficiently large and sustained community of consenting individuals who by their action apply the norm. Tipping points refer to the number of individuals within a community necessary, by their actions, to point to a change in the way the norm is applied, interpreted or followed. Equilibria are those points where no intrinsic or extrinsic forces are sufficiently strong to cause tipping.

            Yet for Eisenberg, social norms appear to become important only when they interact with legal or organizational rules. It is in its subordinate though polycentric aspect that social norms might become interesting to law. Eisenberg considers this interaction of social norms with law in the corporate law. Eisenberg notes but does not focus on social norms explicitly incorporated into legal rules (ibid., 1265) but rather considers how the corporate law of fiduciary duty, corporate governance and takeover bids “is in significant part a result of social norms.” (Ibid). With respect to the first, Eisenberg argues that the fiduciary duty of care and loyalty standards have shifted as a matter of law to reflect substantial changes in the social norms of expectations of director conduct (Ibid., 1268-69; 1274-75); with respect to corporate governance the movement from what Eisenberg describes as a monitoring board to a managerial board, which effectuated substantial changes in expectations of board oversight of the corporation was also to some extent a movement of law to reflect changing social norms, from a passivity to an activity norm (Ibid., 1279-80); with respect to takeovers, the critical change to social norm from hostility to an embrace of hostile takeovers changed occurred when industry leaders chose to disregard the prevailing norm and adopt another (ibid., 1289-1290). Social norms, then, are powerful but dependent. Not law (and to the extent they are they mimic the form of law making), social norms suggest the interpretive underbelly of formal lawmaking. To that extent, certainly, Eisenberg suggests the semiotic element of law, a key area of lawyer training. (e.g., Jan M. Broekman and Larry Catá Backer, Lawyers Making Meaning: The Semiotics of Law in Legal Education II[45] (Dordrecht: Springer 2013)). Social norms provide the cultural foundation on which the commands of law are made intelligible and predictable. They are the glue that permits a shared meaning of their terms among the community of those who would be bound by the command of law. But they can be nothing more than interpretive foundation―to be more requires them to change their essential character from meaning or technique, to command, from social norm to law.

            With our next two readings, Michael Reed, “From the ‘Cage’ to the ‘Gaze’? The Dynamics of Organizational Control in Late Modernity,” in Regulation and Organizations: International Perspectives 17 (Glenn Morgan and Lars Engwall eds., 1999), and Michel Foucault, Security, Territory, Population, Lectures at the Collège de France 1977-1978. (Graham Burchell, trans. New York: Picador Palgrove Macmillan, 2007), we come to a very modern and still quite controversial notion that, indeed, social norms have become the principal basis for governance not merely of non-state organizations, but of the state as well. Here we see what teased out as an encrustation on law in Eisenberg, now freed of its dependence. Foucault provides a foundation for understanding how changes in our collective senses of the meaning and character of our collective institutions, public and private, have produced a movement not just toward the liberation of social norms from law (to assume an autonomous role of governance in their own right), but also how what these institutions are used for (their objectives) have now produced the incentives to move from the more traditionally formal characteristics of law (in judicial decision, statute and regulation) to law expressed in functional terms―as techniques of surveillance, monitoring and assessment. Not that law is dead―by any stretch―but that it no longer has either a monopoly of legitimacy nor does it occupy the field of the governance of human behavior.

            Reed focuses on changing forms of international regulation in contemporary organizations. The focus is on the development of forms of organizational control in which functional techniques substantially replace formal architectures of rulemaking. In particular, Reed picks up the concept raised in the Eisenberg reading―internalization―and now frees it from its dependent association with norms in the way that surveillance is freed from its dependent role as a technique of regulatory enforcement to become regulatory in its own right. Reed argues that “there is a growing perception of an immutable paradigm shift in in control regimes within contemporary work organizations which moves them away from continuing dependence on traditional mechanisms of bureaucratic control [the cage] and towards socially constructed networks of self-regulation and discipline [the gaze].” (Reed, supra, 18).

            Reed points to the tension in modern regulation that highlights the increasing inability of the forms of conventional law forms to meet the policy objectives of regulatory communities.

Bureaucratic control is based on an interconnected set of regulative mechanisms coordinating temporal, spatial and social relations in such a way that they became contained and fixed within a relatively stable and enduring regime of administrative structures. [But these have] become debilitating weaknesses in conditions where ‘smart control’―based on much more highly mobile, miniaturized and dispersed control techniques and practices―emerges as a prerequisite for organizational survival in a globalized economic, political and cultural marketplace. (Reed, supra, 28).

To this end, Reed builds on the foundations of the work of Michel Foucault and his analysis of “panopticon control.” For Reed, panopticon control “refers to the widespread diffusion of specialized techniques of surveillance and control―at every level of the ‘social body’ and utilized by a very diverse set or organizations (the army, police, schools, asylums, hospitals, clinics, prisons, etc.)―geared to the construction and maintenance of a new moral order.” (Reed, supra, 28-29). This new form of regulatory control is contrasted to the traditional forms of control over behavior and status through command. In contrast panopticon governance is centered around a coordinated set of social norms and expectations that produce practices that are “dedicated to the realization of internalized self-surveillance and discipline that largely dispenses with the need for the externally imposed structural controls so strongly emphasized” in traditional conventional models of law and regulation. (Reed, 29). Reed argues that this approach to regulatory control is most advanced in the internal operations of economic enterprises. (Reed, 31-34).

            Foucault’s Lectures at the College de France on Security, Territory and Population brings Reed’s insights back to government. In the assigned reading, Foucault starts by using the mechanisms of security to consider the problem of government and of the management of its population. (Foucault, supra, 88). He notes that traditionally the art of government, and now political science, was directed as advice to the prince (now the state). But government has always been an ambiguous term―government of the self, of the soul, of conduct, of children and of the state, were all common at the eve of the modern period in the West. These intersecting problems of government represented two simultaneous processes. The first was a move from feudal to territorial states, and form territorial to administrative states. The second was a movement of state centralization and religious dispersion so that the locus of government in all its senses could be consolidated within the state with few powerful enough entities to contest this movement of regulatory (governance) power. (Foucault, 89). A noteworthy consequence was a focus on the problem of defining the nature of the government of the state (now engorged with the government of others).

            Machiavelli’s Prince provides a focal point of the analysis; the insight here being that the analysis of the reaction against Machiavelli through the late 18th century provides a window on the way that the understanding of the power and character of government was reconstituted. (Foucault 89-94). For Foucault, that literature marks the movement, socially normative, from law based to managerial states centered on governments through which social norms are managed and applied. Among these changes are the movement from the idea of government as external to the state, one that was always under threat and which had to be protected against internal and external challengers (Foucault (91-92), to the idea of government as internal to the state and its embodiment. That is from the person of the Prince to the collective of the state apparatus (that included the many governments in social and political relations among individuals); “all these governments are internal to society itself, or to the state . . . [t]here is then both a plurality of forms of government and the immanence of practices of government to the state.” (Foucault, 93). But this multiplicity and immanence also produces hierarchy, “there is a specific from that has to be identified, that of the government to be applied to the state as a whole.” (Ibid). That hierarchy and consolidation, in the face of political consolidation and religious dispersion also produces a movement of political management of religion, reflecting the idea of consolidation of the management of morals and eventually as well the management of individuals, goods and wealth. (Foucault, 94). The state, then, comes to represent the aggregation of governance and the superior source for its management from individual to family to the state. Government, by the twentieth century, then, could be understood as the management of the state for the collective good through its “government” of people, things and territory. The ideal of the model state was generalized into the art of government of the state. “To govern a state will thus mean the application of economy, the establishment of an economy, at the level of the state as a whole, that is to say [exercising] supervision and control over its inhabitants, wealth and the conduct of all and each, as attentive as that of a father’s over his household and goods.” (Foucault 95).

            But this government is not directionless. The purpose of government is the arrangement of people, things and territory towards an end. (Foucault, 98). These include (1) self-preservation, usually understood as the common good or salvation for all (Foucault 98); (2) specific “finalities” (objectives, final ends) such goals as wealth maximization) (Ibid., 99); (3) the management of people and things to increase the power or wealth of the state (Ibid., 99-100). But Foucault notes the problems of government with each. For the common good, he notes that the public good can be reduced to obedience to the law, that is that the common good exists when all citizens obey the law and conform to the rules through which social harmony is maintained. “That means that the ends of sovereignty is circular” (Ibid., 98). For finalities, Foucault argues that government will be reduced to tactics rather than law; law recedes in the sense that it is no longer perceived as the major instrument in the perspective of what government should be. “For it is in fact the government of the family that best corresponds to the art of government that was sought: a power immanent to society (the father being part of the family), a power over ‘things’ rather than territory, a power with multiple finalities all of which concern the well-being, happiness, and wealth of the family, a peaceful, vigilant power). (Foucault 103, note).

            All of this changes in the 19th century as the idea of government and the state moves from the family to the collective―from organized and hierarchical replicating organisms modeled on the biological family, to mass politics, mass movements and mass government. (Foucault 103-104). This movement, Foucault argues, is made possible by advances in statics and technology. In effect both provide the ability to incarnate what had previously been incorporeal abstractions―the people, the enterprise, the collective, the social organization, etc. Now Foucault suggests, one can see each of these abstractions―and by seeing them (through aggregated statistics for people, through financial reporting conventions for enterprise, by corporate governance norms for collectives and organizations, etc.). (Foucault 104-105). To that end, the techniques of data harvesting, surveillance and social construction become the foundation of the state and its political economy. Surveillance, then, serves not just to change the face of regulation but also to organize the state as well and to incarnate what have now become its greatest stakeholders―the great collectives of individuals organized in a variety of ways and the entirely of the people now incarnated as “the people” with quite specific characteristics that can be unearthed by appropriate data harvesting and analysis. “In fact, statistics, which had heretofore functioned within administrative frameworks, and so in terms of the functioning of sovereignty, now discovers and gradually reveals that the population possesses its own regularities: its death rate, its incidence of disease, its regularities of accidents.” (Foucault, 104). Surveillance and reporting, then, become central to the organization and functioning of the modern state―and expressed in the form of its rule making, both formal and social―and the state itself becomes an incarnation of the masses (its population) to the management of the welfare of which it now devotes itself.

            We move from government grounded in popular sovereignty to one based on the organization and management of population and economy. In the face of the rise of the masses, what Foucault calls the population, the family recedes as a mere element within the population. The political consequence (and one affecting the breath of the scope of law making) is then that the family moves from the model of government to an instrument of governance; “it will become a privileged instrument for the government of the population rather than a chimera model for good government.” (Foucault 105). The masses (the population or collective) becomes the principle objective of government. And most important, the population is made to serve as the principal instrument of its own management. That last change requires new forms of governing―not just law but the techniques of management. “And the instruments that government will use to obtain these ends are, in a way, immanent to the field of population; it will be by acting directly on the population itself through campaigns, or, indirectly, for example, by techniques that, without people being aware of it, stimulate the birth rate, or direct the flows of population to this or that region or activity.” (Foucault 105). Lastly, the population will become the point around which the practice of government is organized. The management of the population becomes itself the object of government “The constitution of a knowledge of government is absolutely inseparable from the constitution of a knowledge of all the processes revolving around population in the wider sense of what we now call ‘the economy’.” (Foucault 106).

            Government and its regulatory structures, then, evolve form regimes of law and sovereignty to one of management and what Foucault calls governmentality. (Foucault 108. Governmentality refers to the way in which modern society is organized through “institutions, procedures, analyses and reflections, calculations and tactics that allow the exercise of this very specific, albeit very complex, power that has the population as its target, political economy as its major form of knowledge, and apparatuses of security as its essential technical instrument.” (Ibid). Governmentality is centered on government and its control of population through formal and functional approaches to management that is meant to produce self-administration among the subject population in whose name all of this is done. (Foucault 108-109). Governmentality points to the result of a 500 year process that has moved law and the state from one grounded in territory, customary and written law to an administrative state governed through regulation and individual disciplines to the emerging state of affairs: “a state of government that is no longer essentially defined by its territoriality, by the surface occupied, but by a mass: the mass of the population.” (Foucault 110). This is not merely governmentality but the world of globalization, of polycentric governance and of law that no longer assumes merely its ancient forms of command and the preservation of structures of hierarchy.

            With our last reading, Larry Catá Backer, “From Moral Obligation to International Law: Disclosure Systems, Markets and the Regulation of Multinational Corporations,”Georgetown J. International Law, 39(4):591-653 (2008), students are given a glimpse of the possibilities of approaches to law making in a world of governmentality. Students consider whether Eisenberg’s social norms, including organizational rules, can be liberated from their dependence on law for actualization in governance spheres in a context where, as Foucault suggests.

            Backer argues that international law ought to serve as a vehicle for the enhancement of a market environment in which corporate stakeholders, and principally consumers and investors, might incorporate information about corporate “social” behavior in their consumption and investment decisions. Without incorporating any particular set of “public” values, international law can make it easier for people to manage the “public” or “social” behavior of multinational corporations through a mandatory regime of global reporting. The heart of any such international regulation would be a mandatory system of information gathering, monitoring and disclosure. This then also picks up and seeks to develop a consequence of the move, discussed previously, from formal to functional law in the context of administrative regulations required to provide seamless management of a specific set of human activities.

            Backer posits that law does not appear to compel any sort of responsibility for the working conditions of indirect employees. Law is particularly unhelpful where the indirect employees are employed in a country other than that of the indirect employer. Recent efforts to create mandatory legal obligations touching on corporate social responsibility in the international level have been forcefully rebuffed, principally by representatives of developed states. There has been a strong objection to the use of law, and especially international law, to privilege one set of behavior norms over others in a context in which there is no consensus over appropriate conduct norms for economic entities.

            However, while in the recent past there might not have been even a moral obligation extending to such employees, contemporary standards suggest otherwise—there may now be a moral obligation of some kind to indirect employees. The source of this moral obligation might be derived from a variety of sources, both secular and religious, but it is not grounded in law enforceable by any state. Other sources of moral obligation might include human rights declarations from international organizations and supra-national human rights organizations. Yet even moral obligations can be enforced in the absence of enforceable standards written into hard law. Under the private law of contract, for example, the principal parties can bind themselves voluntarily to behavior standards they might deem proper. The nature and extent of that obligation may be dependent on the values of the stakeholders or the normative system under which all actors operate. Similarly, the parties might agree to certain behaviors in order to receive a certification of compliance with «good» behavior issued by a reputable third party in the business of making such certifications. Those obligations are usually enforced privately as well—through mandatory agreements to disclose information and permit the monitoring of behavior.

            Such moral obligations, and the methodologies of enforcement, are coming to be institutionalized in private regulatory efforts, principally in corporate ethics and behavior codes. Institutionalization of governance, however, is not law. Virtually all of these responses have been in the form of “soft law,” usually voluntary codes that are not enforceable by any political organization. Indeed, the rise of this much-touted corporate social responsibility movement has resulted in the proliferation of a number of responses at every level of governance. The soft law character of these efforts suggests deficiencies. Additionally, there is no institutionalized procedure for enforcement. Moreover, the proliferation of these private forms of regulating moral behavior pose a more fundamental substantive problems. These voluntary codes tend to be written in the most general terms, permitting a tremendous variation of behavior that can be claimed to be consistent with the form or substance of these codes. For those who are looking for both certainty and consistency the private elaboration of substantive behavior exacerbates the problem of uniform standards.

            The problem of indirect employees, then, suggests the overlapping dimensions of the problem posed by any effort to formally regulate the behavior of economic entities across borders through law: the disjunction between moral obligations across borders in the construction of economic relationships across such borders, the multiple sources of values informing regulatory policy even within states, and the difficulties of transposing moral obligation into a substantive law of corporate social responsibility that effectively reaches across borders. Yet, despite these limits it may be possible to construct a plausible system of mandatory regulation at the international level that adds value to economic activity without threatening the contemporary system of market based globalization. The foundation of that regulatory system is tied to monitoring, disclosure and reporting. These are each enforcement mechanics common to the private law of contract. Together they are the essence of modern soft regulation through which the disciplines of informed choice are realized. From out of the means by which moral obligations are enforced among private parties may come a framework for creating a plausible hard law at the international level. This framework would provide incentives (either positive or negative) for international business to consider “public” goals without actually mandating those goals in any specific form—the market would make that determination. These incentives can be provided through law, but in a way that retains a strong sensitivity to the current market bias of globalization—and to the privileging of private arrangements among stakeholders principally involved in economic transactions.

            For that purpose Backer posits a global system of disclosure and transparency, consisting of monitoring and surveillance. The object of these disclosure mandates would not be to establish a definitive set of behaviors, but rather to establish a framework within which corporate stakeholders—consumers, investors, labor, and others—could adjust their relationships on the basis of the behavior disclosed. In a sense, then, monitoring regimes can serve as a framework for incorporating moral obligations within a legal structure of relationships between economic actors, without hardwiring any particular set of ethical standards in law. Backer suggests that this sort of mandatory regulatory regime is plausible as international “hard” law for five reasons. First, it only requires actions on the part of economic enterprises (the gathering and dissemination of information) that have been well internalized by the great majority of these entities. Economic entities harvest, use and report information all the time—for example to government regulators, to investors and to consumers, among others. This is not so much a new task as a modification of a core activity of business. Second, the sort of social disclosure to be targeted under international monitoring regimes are already being provided in large respect through private contract, for example in the context of supplier chain arrangements. Third, information gathering has been a task long assigned to international and transnational public actors. This sort of regulatory activity is something well suited to that sort of organization. Fourth, international instruments already contain monitoring provisions. Thus, the international community already has the skill set necessary to draft this sort of hard law (as do the nation states that must approve such endeavors). Lastly, there already exist a number of frameworks that detail the sort of information that might plausibly be gathered and disclosed that have been developed by global civil society and public actors.

            Backer suggests that such a system will work at the economic level only to the extent that it can be promoted as a mechanics to global market efficiency, avoids making substantive or values driven behavior choices, limits enforcement to the compliance with the information gathering and reporting requirements of the international framework and vests enforcement at the nation-state or private level. The transformations of conventional law and administrative regulation, then, provide the template for the form of regulation, one that converts the techniques of regulation as its substantive form. The substance, like that of customary law, is derived from the social norms of the governance community (in the case of corporate social responsibility, the community of consumers, investors and enterprises). Values-based behavior would be dependent on what the principal participants think is important. The critical element that international law would add is the framework within which information is produced and choices can be made And control of the content of the values that are privileged would depend on the power to convince the critical stakeholders of the correctness of a value system put forward. In this context, values, like law, would be subject to the market, in this case the market for ideas (of values). In this market, private actors—churches, philosophers, social scientists, ethicists, and others—would have a primary role in seeking to offer product (values systems touching on matters of corporate social responsibility) and to market those products to the critical stakeholders.

            Eisenberg was able to draw attention to the relationship between law, organizational rules and social norms. But that analysis remains grounded in the traditional notion of the supremacy of law and the supplemental role of normative systems. Backer suggests the basis for embedding social norms within organizational rule frameworks in governance spaces where traditional law cannot reach, the activities of organizations that cross borders and cannot be contained or regulated by the law of a single state. Yet there are hints in Eisenberg’s analysis that such social norm systems might be both autonomous of law and coherent without reference to an outside and “superior” governance order. And Backer suggests the way in which the techniques of regulation can be used as easily to implement and add context to social norm governance systems as can be used as functional law within administrative regulatory systems. This form of transnational functional law combines the techniques of traditional implementation with the self-regulatory mechanisms of markets based discipline to create self-referencing systems of governance in which substance is contributed by the governance community through standards that are embedded (in Eisenberg’s sense of practice social norms) within flexible system through which to construct a market oriented basis for legal regulation of the behavior of multinational corporations that serves both the desires to ground regulation in public law and the necessity of vesting the power to determine the content of that behavior on the choices of non-governmental actors.

            For the lawyer in contemporary America, the results might eventually be quite profound. It means for her that the regulatory world facing her client is no longer the simple one defined by the structures of the traditional first year law curriculum. Indeed, to some extent, and from a client’s perspective, this curriculum is obsolete in the sense that it no longer reflects the extent of the regulatory universe within which she is now required to operate both within the territory of the state in which she operates but also in those other states, and between them, when her activities reach beyond the borders of the state of residence. A lawyer who knows only law (in the senses we have discussed (common law, statutes, regulation) knows only a portion of the regulatory universe that is now evolving. In the world in which lawyers are expected to operate in this century, a lawyer will have to learn to weave law and social norm as they intersect among public and private governance organizations, and all in the service of the interests of her client.
IV. Problem

            The focus of non-state based governance turns from the state to other actors whose collective association may produce rules that may function like law, in the sense we have come to understand the term as constituent parts of the U.S. legal system. We will consider the possibilities of governance systems beyond formal state based law by considering two problems.  The first centers on the ability of non-state based collectives to impose rules on itself well beyond the requirements of the domestic law of the territory where this group operates.  The second focuses on the ability to use the mechanics of surveillance and monitoring for substantive, behavior altering effects.  

            Problem 1: The Right to Force of Sale of a Sports Team for Violating Social Norms.  You are an associate in the firm of Partner and Partner.  You have been asked by Partner to accompany her to a meeting with a new client, Mr. A. Shilling, a part owner of a basketball team, the San Andreas Eliminators. At the meeting the following facts come to light. 

For many years, Mr. and Mrs. Shilling are equal owners of the San Andreas Eliminators (“SAE”), a basketball franchise which is a member of the National Basketball Association (NBA). The NBA was founded in 1946 and is based in New York, New York. Mrs. Shilling is an active owner and Mr. Shilling a passive one. Over the course of their ownership, Mr. and Mrs. Shilling have executed a number of agreements with the NBA related to profit distribution from television transmission rights, and related matters that included morals clauses—“Any Party may terminate this agreement if the other Parties or any of them shall at any time fail, refuse or neglect to conform his personal conduct to the standards of good citizenship and good sportsmanship or which shall subject any of the Parties to ridicule or contempt.”  In addition, when Mr. and Mrs. Shilling bought the SEA, they signed a contract that included a clause that stated that “an owner will not take any position or action that will materially and adversely affect a team or the league," and that the owner “will be upheld to the highest standard of ethical and moral behavior.".   

Mr. and Mrs. Shilling have been active members of their community and have donated substantial sums to the efforts of the local branch of the National Association for the Advancement of Colored People (NAACP).[46] SAE team members have included a large number of African American players, coaches and staff, along with members of other racial, ethnic and religious groups. SAE has been very proud of this and included information about its diversity efforts in its advertising.

Suspicious about potential embezzlement of funds by household staff, Mr. Shilling, without his wife’s knowledge, and with the aid of a longtime family friend, Ms. Bea Cee, began recording calls made to and from his wife’s home telephone. The initial suspicion proved to be false; however, the recordings revealed that Mrs. Shilling engaged in long conversations with business associates in which she lamented the number of African Americans on the team and suggested that she harbored a general dislike for African Americans and other ethnic minorities. She thought too many African Americans went to SAE games and lamented that she couldn’t do more to “bring good honest folks” back to the SAE home games. Virtually everyone who heard the tapes agreed that the comments recorded would be very offensive by the standards of the times.

Mr. Shilling was appalled but begged Ms. Cee to remain silent.  Instead, Ms. Cee made the recordings public by selling them to Sports Weekly Magazine, a well respected and large circulation sports magazine. Ms. Cee, in later interviews on national television, indicated that she sold the tapes because she needed the money and she didn’t like Mrs. Shilling. The public response was immediate and quite negative.  A large number of people from celebrities to high ranked government officials condemned the sentiments expressed and urged Mrs. Shilling to apologize and renounce her views.  The NAACP, which had been scheduled to bestow a “Humanitarian of the Year” Award to Mrs. Shilling cancelled the award and the banquet. Sports commentators, and many fans began to urge Mrs. Shilling to sell her interest in the SAE, and SAE team members, coaches and staff expressed their anger and disappointment at the comments and what it suggested about their relationship with Mrs. Shilling.  For her part, Mrs. Shilling, in a series of interviews with national news organizations, defended her comments and suggested that the reactions were “overblown.”  In any case, she said, “This was a free country and people were entitled to their opinion without prejudice.”  Both Mr. and Mrs. Shilling have refused all calls to sell their interest in the SAE.

Within a week of the release of the tapes, the owners and league officials of the NBA met. The NBA owners initially voted to fine Mrs. Shilling heavily, in accordance with the rules of the NBA.  Soon thereafter, they moved to force her to sell the Shilling interest in the team.  The failure to do so would have forfeited the SAE’s membership in the NBA and the right to play league sanctioned games and participate in NBA negotiated contracts. In supporting this effort, the NBA Commissioner argued that the tapes evidenced attitudes substantially detrimental to the NBA’s core commitment to diversity and inclusion, damages relationships with fans, harms NBA owners and players, harms relationships with marketing partners, and harms relationships with government and community leaders. The NBA asserted that such acts violated the NBA Constitution Article 13(d), Article 13(a), Article 13(c). Under the NBA Constitution and related agreements, Mrs. Shilling’s words, actions, and views are attributable to and deemed to be the actions of SAE itself.[47] More specifically, if the Board, by a 3/4 vote, sustains termination charges on the basis of Mrs. Shilling’s words, actions, and views, the Constitution calls for the entirety of SAE’s membership in the NBA to be “automatically” terminated.


Would Mrs. and Mr. Shilling’s potential lawsuit against a forcible sale of their interest in the SAE be inconceivable? If so, on what grounds? If not, will the NBA, as the drafter of the NBA’s Constitution, have problems defending their claims if in fact there is no explicit foundation for such a harsh penalty, since ambiguities are typically construed against those who create such legally binding documents? Does the NBA Commissioner’s decision of a forcible sale have the effect of a binding arbitration decision that could be enforceable in court? (Generally, arbitrations are often only reversed when a losing party can point to fraud or a serious conflict of interest on the part of an arbitrator.) Does the lack of a “moral clause” that would condemn an owner whose racism was expressed in private conversations in the NBA Constitution Article 13 that lists a series of enumerated wrongs in contrast to the inclusion of other provisions suggest that such a clause was intentionally omitted?

If Mrs. Shilling were successfully ousted from her ownership interest, would such a precedent be binding for the NBA and other similar associations in the future? If so, what could be the possible consequences of such a precedent?

Even though it is difficult to persuade a court to overturn a decision made by a private association and public policy at times prevails over decisions that would be more technically right, do you think that these arguments would justify the fact that the NBA might not have the strongest justification for the penalty it imposes on the current owners of the SAE?

Since Mr. Shilling has not been accused of any wrongdoing, what if he firmly decides not to relinquish possession of his part of the team without a fight? What rights does he have as a passive owner as opposed to an active owner? Does the answer depend more on the terms of the NBA constitution than on the law of community property? (viz. NBA Constitution Article 14(j): “The decisions of the Association made in accordance with the foregoing procedure shall be final, binding, and conclusive, and each Member and Owner waives any and all recourse to any court of law to review any such decision.” Under New York law and the NBA Constitution, an owner may challenge in court a termination decision not in accordance with the NBA constitution.)

Does it matter whether the remarks were recorded unbeknownst to Mrs. Shilling in her home where there is a heightened expectation of privacy? Did she "willfully" make a detrimental statement or engage in detrimental conduct? (viz. NBA Constitution Article 13(a).) Even though Mrs. Shilling’s views are bigoted, does it matter that there is no indication that the team is in any way managed in a racist manner?

Are normative surroundings and consequences of the potential forcible sale material to the issue? /OR/ If the SAE will not be a viable business as long as Mr. and Mrs. Shilling are the owners, does that provide the grounds, in itself, to force them to sell the team? (viz. harming relationships with marketing partners and fans etc.) Would therefore a public good argument tied to the fact that other teams as well as SAE players might boycott the games and thus impair the viability of the business of the NBA as a whole prevail over the fact that the ownership is Mrs. Shilling’s property (in the form of her ownership interest in a professional franchise) that is being taken from her without her consent?

Could Mrs. Shilling claim that any language in the NBA Constitution that speaks to discipline for owner misconduct was intended to apply only in cases where an owner has demonstrated incompetence in regards to financial matters? If so, could harming relationships with marketing partners and fans etc. be argued as incompetence in financial matters?

Please prepare a short memo explaining your conclusions.

In preparation for the writing of that memo and after some research you have gathered the following information:
NBA Constitution and By-Laws § 2: NBA is an unincorporated, non-profit association with limited membership and a franchise system. The NBA has an elected Commissioner with executive power and the owners are organized in a common council, called the "Board of Governors.” The Board includes one representative from each member club, usually the owner of the club. It has the power given by the Constitution and acts by affirmative vote of no less than three-fourths. The Commissioner is also present at each meeting of the Executive Committee. The Commissioner is elected by the owners and possesses disciplinary power, dispute resolution authority, and decision-making authority including the power to appoint other officers and committees. Basically, the Commissioner has executive power unless the collective bargaining agreement with the Players Association renders specific powers to other authorities. Generally, courts are reluctant to overturn decisions made by private associations as long as such decisions are made within the confines of their by-laws so the question can turn to whether the NBA’s Constitution itself has foundation to oust the Shillings out of their ownership.

NBA Constitution Article 2:
This Constitution and By-Laws constitutes a contract among the Members of the Association. This Association is organized to operate a league consisting of professional basketball teams, each of which shall be operated by a Member of the Association. The Association and each of its Members shall be subject to the oversight and control of the Board of Governors of the Association as set forth herein and shall be governed by the Constitution and By-Laws, rules, regulations, resolutions, and agreements of the Association, as they may be modified or amended from time to time. The Association shall not be operated for profit.

NBA Constitution Article 13:
The Membership of a Member or the interest of any Owner may be terminated by a vote of three fourths (3/4) of the Board of Governors if the Member or Owner shall do or suffer any of the following:
(a) Willfully violate any of the provisions of the Constitution and By-Laws, resolutions, or agreements of the Association.
* * * * *
(d) Fail or refuse to fulfill its contractual obligations to the Association, its Members, Players, or any other third party in such a way as to affect the Association or its Members adversely.
(a) Willfully violate any of the provisions of the Constitution and By-Laws, resolutions, or agreements of the Association.
(c) Fail to pay any dues or other indebtedness owing to the Association within thirty (30) days after Written Notice from the Commissioner of default in such payment.

NBA Constitution Article 14A:
The Membership of a Member or the interest of any Owner shall be terminated on the occurrence of any of the events described in Article 13 by the following procedure:
(a) Any Member of the Association or the Commissioner may charge that a Member or Owner has violated one (1) or more of the provisions of Article 13. Said charge shall be made in Writing and shall be filed with the Commissioner, who shall, no later than three (3) business days after the charges are filed, cause a copy thereof to be served by a Writing upon the Member or Owner against whom such charges have been made.

If a charge that a Member or Owner has committed any of the offenses described in Article 13 is sustained, two-thirds (2/3) of all the Governors may waive the remedy of termination, and instead direct the Member or Owner to pay a stated fine in a stipulated manner and by a stipulated date, which fine may be required to be paid, in whole or in 31
part, to any other Member or Members as compensation to such Member or Members for damages sustained by it or them by reason of such act or acts of omission or commission by such offending Member or Owner. Such fine shall be payable within five (5) days after its imposition. Moreover, the Board of Governors may, in its discretion, either in addition to, or in lieu of, such fine, direct the forfeiture of the offending Member’s Draft rights.

NBA Constitution Article 35A:
The provisions of this Article 35A shall apply only to Members and Owners; to Officers, Managers, Coaches, and other employees, agents or representatives of a Member or Owner; and to all Referees and other employees of the Association; except that the term “employees” as used in this Article 35A shall mean employees other than Players. The word “persons” as used herein shall include all such Members, Owners, Officers, Managers, Coaches, Referees, employees, agents or representatives of Members, Owners, or the Association, other than Players.
(c) Any person who gives, makes, issues, authorizes or endorses any statement having, or designed to have, an effect prejudicial or detrimental to the best interests of basketball or of the Association or of a Member or its Team, shall be liable to a fine not exceeding $1,000,000 to be imposed by the Commissioner. The Member whose Owner, Officer, Manager, Coach or other employee has been so fined shall pay the amount of the fine should such person fail to do so within ten (10) days of its imposition.
(Article 35A imposes a fine for each listed violation, but by imputation it could lead to an Article 13 termination.)
(d) The Commissioner shall have the power to suspend for a definite or indefinite period, or to impose a fine not exceeding $1,000,000, or inflict both such suspension and fine upon any person who, in his opinion, shall have been guilty of conduct prejudicial or detrimental to the Association.

Link to NBA Constitution full text:


Harold J. SILVER, doing business as Municipal Securities Company, et al., Petitioners,
No. 150
83 S.Ct. 1246
Supreme Court of the United States
Argued Feb. 25 and 26, 1963.Decided May 20, 1963.

* * * * *

The exchanges are by their nature bodies with a limited number of members, each of which plays a certain role in the carrying out of an exchange's activities. The limited-entry feature of exchanges led historically to their being treated by the courts as private clubs, Belton v. Hatch, 109 N.Y. 593, 17 N.E. 225 (1888), and to their being given great latitude by the courts in disciplining errant members, see Westwood and Howard, Self-Government in the Securities Business, 17 Law and Contemp. Prob. 518—525 (1952). As exchanges became a more and more important element in our Nation's economic and financial system, however, the private-club analogy became increasingly inapposite and the ungoverned self-regulation became more and more obviously inadequate, with acceleratingly grave consequences. This impotency ultimately led to the enactment of the 1934 Act. The House Committee Report summed up the long-developing problem in discussing the general purposes of the bill:
‘The fundamental fact behind the necessity for this bill is that the leaders of private business, whether because of inertia, pressure of vested interests, lack of organization, or otherwise, have not since the war been able to act to protect themselves by compelling a continuous and orderly program of change in methods and standards of doing business to match the degree to which the economic system has itself been constantly changing * * *. The repetition in the summer of 1933 of the blindness and abuses of 1929 has convinced a patient public that enlightened self-interest in private leadership is not sufficiently powerful to effect the necessary changes alone—that private leadership seeking to make changes must be given Government help and protection.’ H.R.Rep. No. 1383, supra, at 3.

It was, therefore, the combination of the enormous growth in the power and impact of exchanges in our economy, and their inability and unwillingness to curb abuses which had increasingly grave implications because of this growth, that moved Congress to enact the Securities Exchange Act of 1934. S.Rep. No. 792, 73d Cong., 2d Sess. 2—5 (1934); H.R.Rep. No. 1383, supra, at 2—5.

The pattern of governmental entry, however, was by no means one of total displacement of the exchanges' traditional process of self-regulation. The intention was rather, as Mr. Justice Douglas said, while Chairman of the S.E.C., one of ‘letting the exchanges take the leadership with Government playing a residual role. Government would keep the shotgun, so to speak, behind the door, loaded, well oiled, cleaned, ready for use but with the hope it would never have to be used.’ Douglas, Democracy and Finance (Allen ed. 1940), 82. Thus the Senate Committee Report stressed that ‘the initiative and responsibility for promulgating regulations pertaining to the administration of their ordinary affairs remain with the exchanges themselves. It is only where they fail adequately to provide protection to investors that the Commission is authorized to step in and compel them to do so.’ S.Rep. No. 792, supra, at 13. The House Committee Report added the hope that the bill would give the exchanges sufficient power to reform themselves without intervention by the Commission. H.R.Rep. No. 1383, supra, at 15. See also 2 Loss, Securities Regulation (2d ed. 1961), 1175—1178, 1180—1182.

Thus arose the federally mandated duty of self-policing by exchanges. Instead of giving the Commission the power to curb specific instances of abuse, the Act placed in the exchanges a duty to register with the Commission, s 5, 15 U.S.C. s 78e, and decreed that registration could not be granted unless the exchange submitted copies of its rules, s 6(a)(3), 15 U.S.C. s 78f(a)(3), and unless such rules were ‘just and adequate to insure fair dealing and to protect investors,’ s 6(d), 15 U.S.C. s 78f(d). The general dimensions of the duty of self-regulation are suggested by s 19(b) of the Act, 15 U.S.C. s 78s(b), which gives the Commission power to order changes in exchange rules respecting a number of subjects, which are set forth in the margin.


Louis J. CAPANO, Jr., Plaintiff,
No. CIV.A. 18037-NC.
2001 WL 1359254
Only the Westlaw citation is currently available.
Court of Chancery of Delaware
Submitted: June 18, 2001.Decided: Oct. 31, 2001.Nov. 1, 2001.
(Some footnotes omitted or renumbered)

JACOBS, Vice Chancellor.
The Wilmington Country Club, a private country club located in Greenville, Delaware (the “WCC” or the “Club”) has had from its inception a by-law authorizing its board of directors to expel a member for cause (the “expulsion by-law”). The WCC also has a separate by-law that requires a new member, as a condition of membership, to purchase shares of WCC stock that are restricted in terms of their transferability. One such restriction, which is contained in a separate by-law provision, requires that if a member dies or is expelled, his or her shares of stock are forfeited unless the shares are transferred to the member's spouse (the “compulsory stock transfer by-law”).

The plaintiff, Louis J. Capano, Jr. (“Capano”), became a member of the Club in 1981. In so doing, he contracted to be bound by those by-law provisions. In 1999, the WCC's board of directors voted to expel Capano for cause, in that he gave false testimony to a grand jury in a highly publicized criminal proceeding. Capano elected to challenge the expulsion by invoking the arbitration procedure provided for in the expulsion by-law, but he did not prevail in the arbitration.

In this action Capano challenges both the expulsion by-law and the compulsory stock transfer by-law, contending that both are facially invalid under Delaware corporate law principles. In his complaint Capano seeks, among other things, an order directing the WCC: (1) to permit his wife to transfer back to him the shares of WCC stock that he transferred to her after his expulsion, and (2) to reinstate Capano as a Club member.

Pending before the Court are cross motions for summary judgment. Those motions present two purely legal issues, namely, whether (1) the Club's expulsion by-law and (2) the compulsory transfer by-law are valid under Delaware corporate statutory and case law. I conclude that both provisions are valid and that consequently, Capano's motion for summary judgment must be denied and the Club's cross motion must be granted.


The material facts are undisputed. On April 24, 1901, the WCC was formed as a stock corporation under the Delaware General Corporation Law (“DGCL”) for the “maintenance of an association for social, intellectual, and recreative purposes.”[48]

The Club's certificate of incorporation provides that the Board of Directors will conduct the affairs of the corporation and are authorized “to make by-laws for the government of the corporation, and to alter, change or amend the same at any meeting.”[49]

From its inception, the Club had in effect a by-law (the expulsion by-law) which provided that, “[a]ny member may be suspended or expelled for cause, by the vote of three-fourths of the Directors present at any meeting”.[50] The expulsion by-law initially provided for one week's notice before expulsion, but later was amended to require two weeks' notice.

In 1992, the expulsion by-law was again amended, this time to provide a definition of “cause” for expulsion.[51] The amended by-law further provided that an expelled member could challenge the expulsion for the Club's procedural non-compliance with the by-law by means of an arbitration procedure spelled out in the by-law.

In its current form, the expulsion by-law states that:

    Any member may be suspended or expelled for cause by the vote of three-fourths of the directors present at any meeting.... Challenges to a determination by the Board alleging the Club's procedural noncompliance with this Section ... shall be submitted to private arbitration.”[52]

The Club also had in effect a separate by-law (the compulsory stock transfer by-law) which provided that “[a]ny stockholder ceasing to become a member of the Club by death or otherwise, shall forfeit his or her shares of stock to the Club except as provided in sub-paragraphs (b), (d) or (f) of this section.” Subsection (b), which is one of the exceptions to the forfeiture provision, provides that “[n]o stockholder is permitted to sell or assign any of his or her shares ... except shares may be voluntarily transferred once between spouses to qualify either one for membership.”[53] In obedience to this by-law, this transfer restriction appears as a legend on each of the certificates representing the Club's shares.[54]

Capano became a stockholder member of the WCC in 1981, at which time he purchased one share of WCC stock. He later paid for, and was issued, three additional shares of WCC stock.

On March 27, 1999, the Board of Directors of the WCC notified Capano in writing that it would hold a meeting to consider whether he should be expelled for cause from the Club on the ground that he had made false statements to a grand jury in the case of a highly publicized criminal proceeding. Capano attended that hearing, and was assisted by counsel who advanced the contention that Capano should not be expelled. The directors voted to expel Capano, however, and gave him formal, written notice of the expulsion on April 28, 1999. That notice also stated that, in accordance with the compulsory transfer by-law, Capano could transfer his WCC shares to his wife rather than forfeit them to the Club. Capano accordingly transferred his shares to his wife, thereby enabling her to become a member without purchasing stock.[55]

Shortly thereafter, Capano invoked Article II, Section III(c) of the WCC by-laws, requesting arbitration of the Board's decision to expel him from the Club. After a hearing at which Capano appeared with counsel, the arbitrator upheld the expulsion, having concluded that the Club had complied with its by-laws in all material respects.


The pending motions implicate three membership requirements, all contained in the WCC by-laws. The first is that members of the Club must, as a condition of membership, own WCC stock. The second is that the club's directors are authorized to expel a member “for cause.” The third is that if a member dies or is expelled, his or her shares are forfeited, unless they are transferred to the member's spouse.

A careful analysis of Capano's invalidity claim reveals that it challenges only the third of these requirements, namely, the compulsory stock transfer provision. Capano's argument, simply put, is that as a matter of Delaware corporation law that provision must be contained in the Club's certificate of incorporation. The argument is odd, because even if it were found to be valid, the relief that would flow to Capano would be of little utility to him: Capano's status as an expelled member would continue unaffected, and the only consequence of a ruling in his favor would be to allow him to retain his four WCC shares.

That result flows logically from the narrow scope of Capano's claim. Capano does not dispute that as a general matter a private club may enact governance procedures allowing the expulsion of a member for cause. Where the club is organized as a non-stock corporation, the expulsion provision may be contained in the certificate of incorporation or the by-laws. Where the club is a corporation authorized to issue stock, and there is no linkage between expulsion and stock ownership (i.e. there is no compulsory stock transfer provision), the expulsion provision could appear in either the certificate of incorporation or the by-laws. In both circumstances the expulsion provisions would affect the club member only qua member, not qua stockholder. Thus, if the WCC had no compulsory stock transfer requirement, Capano would have no claim, because the board voted to expel him for cause and Capano unsuccessfully challenged that expulsion in an arbitration-all in accordance with the procedure prescribed in the Club's by-laws to which Capano voluntarily agreed when he joined the Club.
Capano does, (because he must) attack the expulsion by-law. The basis for his attack is not that the by-laws must appear in the WCC certificate of incorporation, but rather, that Delaware corporate law forbids the directors of a corporation from expelling a stockholder. But that argument, even granting its correctness, is a non-starter, because its factual premise is irrelevant in this case. The WCC's Board expelled Capano only as a member, not as a stockholder, because the expulsion by-law operates only against members in that capacity, not in their capacity as stockholders. The only by-law provision that operates against an (expelled) member in his or her capacity as a stockholder is the compulsory stock transfer by-law. Accordingly, that is the only provision Capano may validly challenge on the basis that it must appear in the corporate charter. Thus, the only genuine corporate law issue presented on these cross motions for summary judgment is whether the compulsory stock transfer by-law provision must, as a matter of Delaware statutory law, be contained in the WCC certificate of incorporation.

Capano's by-law challenge rests upon 8 Del. C. §§ 102(a)(4) and 151, which (to paraphrase) provide that any rights, preferences, restrictions and limitations relating to any class or series of stock must be set forth in the certificate of incorporation. Thus, the implicit premise of Capano's argument is that the compulsory stock transfer by-law constitutes a “limitation” with respect to the WCC stock. That premise, however, is flawed because the compulsory transfer requirement is not a characteristic or attribute-such as a voting right, dividend right, or dividend or liquidation preference-that affects each individual WCC share. Rather, that provision operates only against the holder of the stock (in the event of that member's death or expulsion), not against the stock itself. Put in statutory terms, the compulsory stock transfer provision is not a limitation “with respect to” the WCC shares, and is therefore not statutorily required to be set forth in the Club's charter. The reasons for that conclusion are discussed in the analysis that next follows.


Two separate by-laws are challenged in this litigation: the expulsion by-law and the compulsory stock transfer by-law. As for the first, no one questions that the WCC has the legal power to expel a member and to adopt a by-law governing that procedure. Courts have given private clubs wide latitude to exclude and/or expel persons as members. Nor does Capano seriously contest that the WCC has that power. What Capano does seriously contest is the compulsory stock transfer by-law that required Capano to transfer his WCC stock to his wife (or suffer forfeiture) after being expelled as a Club member. Ultimately, I conclude that the compulsory stock transfer by-law constitutes a restriction on the transfer of stock that is authorized by, and is evaluated under, 8 Del. C. § 202. The validity of the expulsion by-law is addressed in Part III(A) of this Opinion; the validity of the compulsory stock transfer by-law is analyzed in Part III(B).

A. Validity Of The Expulsion By-Law

The first issue is whether the WCC expulsion by-law, standing alone, is legally valid. More specifically, the issue is whether the WCC may enact a by-law that authorizes the expulsion of a member from the Club for cause, by a vote of the three-fourths of its directors. The answer is clearly yes. As earlier noted, Capano does not dispute that as a general matter, a private club may enact governance procedures that authorize the expulsion of a member for cause.

The WCC is a private club organized as a stock corporation.[56] As a general matter, a private organization is given wide latitude to enact rules to achieve the club's purposes and to discipline its members.14 Membership in voluntary associations is generally viewed as a privilege that may be withheld, not as a right that may be independently enforced.[57] In rare cases where courts have scrutinized a private club's expulsion by-laws, it was only to determine if the club complied with its own by-law procedures, or whether the by-laws violated general public policy, or if bad faith motivated the enforcement of the by-laws against the affected members.[58] In this case, there is no claim that the WCC failed to comply with its own by-laws when it expelled Capano. Nor does Capano contend that his expulsion was motivated by bad faith on the part of the Club's Board of Directors, or that the expulsion by-law violates public policy.

Most important, Capano does not contest that the WCC has the power to exclude him as a member of the WCC at all. What he contends is that he cannot be removed as a stockholder. That argument, however, implicates the compulsory stock transfer by-law, not the expulsion by-law. Upon becoming a Club member, Capano agreed to be bound by the WCC's by-laws-including its expulsion by-law. He cannot now be heard to contest the validity of that by-law merely because its application did not work out in his favor.

Capano argues that his assent to the expulsion by-law does not bar him from attacking it, because the by-law is invalid on its face. Citing Oberly v. Kirby[59] and Frezzo v. Delaware Mushroon Co-op Ass'n,[60] Capano argues that a board of directors of a Delaware corporation can never be empowered to remove any of the corporation's shareholders. But neither that argument nor those authorities need be frontally addressed, because the argument proceeds from a false premise. The expulsion by-law does not result in the “removal” of a Club-member qua shareholder. It operates against a member only in his or her membership capacity.

Only because the WCC is organized as a stock corporation is Capano positioned to advance his “shareholder removal” argument. Even then, in order to make that argument Capano must resort to conflating the expulsion by-law and the compulsory stock transfer by-law provisions. But, as a legal matter those two by-laws are separate, and their requirements and operation are independent of each other. The very nature of Capano's argument (that a corporation's directors cannot legally remove the equity investors) only underscores that Capano's challenge, properly understood, is directed against the compulsory stock transfer-and not the expulsion-by-law. If any demonstration of that were needed, it is that even if Capano's challenge were to prevail, he would not gain reinstatement as a member, but only as a shareholder without membership privileges. The phyrric nature of such a legal victory is apparently what drives Capano's effort to conflate the expulsion and the compulsory transfer by-laws, and to treat them as if they were a single, unified, integrated, and non-severable requirement.

Because Capano has failed to demonstrate that the expulsion by-law is invalid under Delaware law, the sole issue is over the legal validity of the compulsory stock transfer by-law, which requires a member, after being expelled from the Club, to transfer his or her stock to the member's spouse or to forfeit the stock to the WCC. I turn to that issue.

B. The Validity Of The Compulsory Stock Transfer By-law

* * * *

Shareholders are free to contract with each other, and with the corporation, to restrict who may own the corporation's stock.43 Shareholders, particularly in closely-held corporations, customarily enter into contracts amongst themselves. Our Courts have upheld the validity of contracts that restrict the sale of shares to anyone other than a family member; that alter the voting rights of a stockholder based on the size of his or her stock holdings; that require the transfer of shares back to the corporation upon death; and that require the consent of stockholders for certain types of transfers. Section 202 authorizes restrictions of that kind.

As previously noted, the current Section 202(c)(4) expressly permits shareholders to agree to a restriction that requires the transfer of shares to the corporation or to some other person upon the happening of a defined event. Capano's argued-for construction of Sections 141(k) and 102(a)(4)-as depriving shareholders of the power to contract to transfer their securities back to the corporation in those circumstances-would place Section 202(c)(4) into direct conflict with Sections 102(a)(4) and 141(k). A construction of a statutory provision that would place it in conflict with other provisions of the same statute is to be avoided. A cardinal rule of construction requires the Court to adopt an interpretation that harmonizes all of the statutory provisions. On this basis as well, the compulsory stock transfer by-law is valid under Delaware law.


For the reasons set forth above, Capano's motion for summary judgment is denied, and the Wilmington Country Club's cross motion for summary judgment is granted. IT IS SO ORDERED.


[3] For the regulation of commercial transactions in the early decades of the Conference, see the Uniform Negotiable Instruments Law (1896), reprinted in National Conference of Commissioners on Uniform State Laws, American Uniform Commercial Acts 136 (1910); the Uniform Warehouse Receipts Act (1906), reprinted in id. at 185; the Uniform Sales Act (1906), reprinted in id. at 70; the Uniform Bills of Lading Act (1909), reprinted in id. at 213; the Uniform Stock Transfer Act (1909), reprinted in id. at 122; the Uniform Conditional Sales Act (1918), 3B U.L.A. 480 (1992); and the Uniform Trust Receipts Act (1933), 3B U.L.A., supra, at 588.
[4] On the history of the American Law Institute and the Restatements, see, for example, James Gordley, European Codes and American Restatements: Some Difficulties, 81 Colum. L. Rev. 140 (1981); N.E.H. Hull, Restatement and Reform: A New Perspective on the Origins of the American Law Institute, 8 L. & Hist. Rev. 55 (1990); and G. Edward White, The American Law Institute and the Triumph of Modernist Jurisprudence, 15 L. & Hist. Rev. 1 (1997). For a selective bibliography on the ALI and its activities, see Harry G. Kyriakodis, The Institute in Legal Literature--A Selective Bibliography (visited Feb. 20, 2000) .
[5] or a list of all past and present ALI projects see the ALI’s official website, Past and Present ALI Projects (visited Feb. 20, 2000) <>.
[6] Report of the Committee on the Establishment of a Permanent Organization for the Improvement of the Law Proposing the Establishment of an American Law Institute (Feb. 23, 1923), reprinted in The Life of the Law 145, 148-49 (John Honnold ed., 1964). For an analysis of the drafter’s goals, see Hull, supra note 423, at 55-96.
[7] See Charles W. Wolfram, Bismarck’s Sausages and the ALI’s Restatements, 26 Hofstra L. Rev. 817, 819-20 (1996) (noting that the Restatements’ impact on courts is unknown and difficult to discern).
[8] On the intent that Restatements function as a substitute for codification, see, for example, Varga, supra note 2, at 161-65; Berger, supra note 14, at 154; and George A. Bermann, La codification aux États-Unis, 82 Revue française d’administration publique 221, 223-25 (1997).
[9] Gordley, supra . . . . , at 140, 156-57.
[10] See Restatement Second of Trusts (1959); Californian Trusts Act, Cal. Prob. Code §§ 15,000-19,403 (West 2000); Uniform Trust Act (Draft, National Conference of Commissioners on Uniform State Laws, 1999). . . .
[11] Mitchell Franklin, The Historic Function of the American Law Institute: Restatement as Transitional to Codification, 47 Harv. L. Rev. 1367, 1367 (1934).
[12] The Life of the Law, supra. . . , at 144 (1964).
[13] [Arthur T. Von Mehren, Some Reflections on Codification and Case Law in the Twenty-First Century, U.C. Davis L. Rev. 659, 669 (1998) ]
[14] See Brian Leiter, Legal Realism, in A Companion to Philosophy of Law and Legal Theory 261, 270 (Dennis Patterson ed., 1996) (referring to a statement by Herman Oliphant).
[15] For example, a broker- dealer who violates the rules of the National Association of Securities Dealers may be expelled from that organization, and under the Securities Act a broker- dealer who is not a member of the NASD cannot effect any transaction in a security other than an exempted security or commercial paper. See Louis Loss & Joel Seligman, Fundamentals of Securities Regulation 629-48 (3d ed. 1995).
[16] Restatement (Second) of Contracts § 222 cmt. b, illus. 2 (1996).
[17] See Robert Axelrod, The Complexity of Cooperation 40 (1997).
[18] Kaushik Basu, Social Norms and the Law, 3 New Palgrave Encyclopedia of Law and Economics 476, 477 (1998). Basu calls the norms he describes in this passage “rationality-limiting norms” on the ground that “a person endowed with [such] norms may forego options which could have enhanced his utility” -- by which Basu seems to mean wealth--” and thus such a person would be considered irrational in terms of mainstream economics.” Id. at 477. In contrast, he says, some norms always enhance an actor's self-interest:
[C]onsider the norm, in many countries, of driving on the right. It is true that this norm is additionally fortified by the law; but it is arguable that even if this were just a norm or a convention and not the law, people would still drive on the right. This explains why the police have to be vigilant in enforcing the stop -sign rule or the speeding rule but not the drive -on-the - right rule. The first two are laws which are not in people's self-interest (they may of course be in their group interest). But the third is a norm which, once it is in place, happens to be entirely compatible with self-interested behaviour. In the absence of such a norm, there are at least two possible equilibria-- everyone drives on the left and everyone drives on the right. The norm is very different from the two discussed above because it simply helps people select an equilibrium.... I call such a norm an ‘equilibrium-selection norm.’ This is the norm the study of which is currently in vogue in economics and has generated a lot of literature, to the extent that economists tend to forget about the other kinds of norms-- conveniently so, since the equilibrium-selection norm is the one which is most compatible with conventional economics.
[19] [Robert D. Cooter, Decentralized Law For a Complex Economy: The Structural Approach to Adjudicating the New Law Merchant, 144 U. Pa. L. Rev. 1643 (1996)] at 1662.
[20] Martha C. Nussbaum, Flawed Foundations: The Philosophical Critique of (a Particular Type of) Economics, 64 U. Chi. L. Rev. 1197, 1211 (1997).
[21] . . . .  Obligational norms may also be effective because an actor has internalized a metanorm of adherence to the norms of a defined group with which he feels at one. The actor may then adhere to a specific group norm even though he has not internalized that norm and is not motivated by the external benefits or costs that may result from adherence or nonadherence to the norm. This phenomenon is most commonly found where the actor is a member of a special group that is working toward a shared end, or that shares a special ethos, that the actor believes to be important. In certain respects, membership in such groups simply sharpens some of the characteristic incentives to adhere to norms--in this case, the norms of the special group. For example, the sanction of disapproval may be especially salient and effective in such a group. However, there is also a special internal benefit in adhering to the norms of such a group just because they are the norms of the group --the pleasures of belonging, of acting in a special and good endeavor, and of surrendering narrow individuality to a larger cause.
[22] See H.L.A. Hart, The Concept of Law 56 (2d ed. 1994). The most significant exception is the kind of norm that Basu calls an equilibrium-selection norm, like keeping to the right. Once such a norm is in place, adhering to the norm is compatible with self-interested behavior even without regard to reputational effects. See Basu, supra. . . .
[23] Morris R. Cohen, The Basis of Contract, 46 Harv. L. Rev. 553, 582 (1933).
[24] See Robert C. Clark, Contracts, Elites, and Traditions in the Making of Corporate Law, 89 Colum. L. Rev. 1703, 1713, 1726-30 (1989).
[25] See Robert Axelrod, An Evolutionary Approach to Norms, 80 Am. Pol. Sci. Rev. 1095, 1107 (1986).
[26] [Robert D. Cooter, Decentralized Law For a Complex Economy: The Structural Approach to Adjudicating the New Law Merchant, 144 U. Pa. L. Rev. 1643 (1996)], at 1661- 64..
[27] Value -systems can be disaggregated from belief-systems. I treat values and other kinds of views about the world together here because it is often difficult to say whether a change in belief-systems is better characterized as a change in values or as a change in views about the implications or applications of values, and the difference is by and large not significant for purposes of this Article.
[28] See, e.g., Isaiah Berlin, Four Essays on Liberty 119 (1969):
Over a hundred years ago, the German poet Heine warned the French not to underestimate the power of ideas: philosophical concepts nurtured in the stillness of a professor's study could destroy a civilization. He spoke of Kant's Critique of Pure Reason as the sword with which European deism had been decapitated, and described the works of Rousseau as the blood-stained weapon which, in the hands of Robespierre, had destroyed the old regime; and prophesied that the romantic faith of Fichte and Schelling would one day be turned, with terrible effect, by their fanatical German followers, against the liberal culture of the West. The facts have not wholly belied this prediction.
(from the essay, Two Concepts of Liberty); see also A.C. Grayling, Family Feuds, N.Y. Times, Sept. 27, 1998, § 7, at 20 (Book Review) (reviewing Randall Collins, The Sociology of Philosophies: A Global Theory of Intellectual Change (1998)).
[29] Thomas C. Schelling, Micromotives and Macrobehavior 91-102 (1978).
[30] Id., at 94.
[31] Id., at 95-
[32] See id., at 101-102.
[33] See Robert Axelrod, The Complexity of Consideration 42 (1997) (“[In tipping processes] individuals are willing to act if enough others act first. Under certain circumstances, a slight change in the willingness of a few people to act first can get the ball rolling.... [C]ollective behavior sometimes... tips suddenly.”).
[36] ALI, ALI Overview, Creation, available
[37] There is one case from a federal district court holding that Indiana would adopt the “actually foreseeable” standard of care for accountants set forth in the Restatement (Second) of Torts § 552. Seedkem, Inc. v. Safranek, 466 F.Supp. 340 (D.Neb.1979). The district court rejected the rationale of the Seedkem opinion and neither party argues that the Restatement standard should be adopted.
[40] H. Peyton Young, Social Norms, Department of Economics Discussion Paper Series No. 307, Oxford University (ISSN 1471-0498, Jan. 2007, available He cites the following book length treatments: Lewis, David. 1969. Convention: A Philosophical Study.[40] Cambridge MA: Harvard University Press; Ullman-Margalit, Edna. 1977. The Emergence of Norms.[40] Oxford: Oxford University Press (Book review[40]); Sugden, Robert. 1986. The Economics of Rights, Cooperation and Welfare.[40]Oxford: Basil Blackwell; Young, H. Peyton. 1998. Individual Strategy and Social Structure.[40] Princeton NJ: Princeton University Press; Posner, Eric. 2000. Law and Social Norms.[40] Cambridge MA: Harvard University Press; Hechter, Michael and Karl-Dieter Opp, eds. 2001. SocialNorms.[40] New York: Russell Sage Foundation; and Bicchieri, Cristina. 2006. The Grammar of Society: The Nature and Dynamics of Social Norms.[40] New York: Cambridge University Press.)
[46] The NAACP was founded in 1909 and is the oldest and largest civil rights organization in the United States.
[47] NBA Constitution Interpretation (a)(8): ““Member” shall mean a person or Entity that has been granted a  Membership in the Association. For purposes of this Constitution and By-Laws, an action on behalf of a Member by any of its Owners, employees, officers, directors, managers, agents or representatives, or its Governor or Alternate
Governors, shall be the action of a Member.”
[48] Def. Op. Br. at Ex. A, ¶ 3 (certificate of incorporation)
[49] Id. at Ex. A, ¶ 8.

[50] Id. at Ex. B, Art. IV (By-laws, 1902-1903).
[51] The amended provision states that a “[p]roper cause for dismissal will include any conduct which, in the opinion of the Board, is disorderly or injurious to the Club's interests or reputation. The offender's conduct will be judged by the Board in accordance with the Club's purposes: the promotion of fellowship, sportsmanship, and the preservation of the highest standards of personal conduct.” Def. Op. Br. at Ex. C, Art. II, Sec. III(c) (By-laws, 1998).
[52] Id.
[53] Def. Op. Br. at Ex. C, Art. II, Sec. V(d) (By-laws, 1998).
[54] Def. Op. Br. at Ex. F (Stock Certificate).
[55] Def. Op. Br. at Ex. G (letter from Capano to the WCC, dated May 27, 1999, asking that his shares be transferred to his wife)
[56] If the WCC were organized as non-stock corporation, the membership requirements would have to be stated in the certificate of incorporation or (if provided by the certificate of incorporation) in the by-laws. 8 Del. C. § 102(a)(4).
[57] Med. Soc'y of Mobile County v. Walker, Ala.Supr., 16 So.2d 321, 324 (1944); Schroeder v. Meridian Imp. Club, Wash.Supr., 221 P.2d 544, 548 (1950). See generally 6 Am.Jur.2d Associations and Clubs § 18 (1999) (discussing the rights of members in voluntary unincorporated associations).
[58] Haas, mem. op. at 13-21; Calabrese, 384 A.2d at 583; Van Daecle v. Vinci, Ill.Supr., 282 N.E.2d 728, 732 (1972); Otto v. Journeyman Tailors' Protective & Benevolent Union, Cal.Supr., 17 P. 217, 219 (1888).
[59] Del.Supr., 592 A.2d 445 (1991).
[60] Del Ch., 152 A.2d 303 (1959).

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