Blinded by ‘Fairness’: Why We Need (Strong) Procedural Safeguards in Screening Self-Dealing and Obtaining a Fair Price Is Not the Answer

Abstract

Ex post court review of related party transactions (RPTs) is one of the main mechanisms to deal with the problem of value diversion in public companies via self-dealing and is extensively made use of in Delaware and until relatively recently in most continental European countries. Such court review has also become to be known as the ‘fairness test’ whose contours may change depending on the jurisdiction and contexts in which it is applied. This study takes issue with the court review of actualized transactions under certain standards from two different perspectives. Firstly, it is argued that the behavioral insights derived from studies by behavioral economists and psychologists suggest that a legal regime that solely depends on the court review of substantive merits of RPTs without any (strong) procedural safeguard may fail to create a robust regime against value diversion. Secondly, acknowledging that the court review of substantive merits of RPTs may be inevitable in some cases, the study then turns its attention to the fairness test itself that compares the terms of an RPT to an arm’s length transaction, and argues that such an objective test fails to fully prevent value diversion. Accordingly, a recalibration of the test and a new framework are proposed.