Wednesday, June 29, 2016
The doctrine of shareholder oppression protects minority stockholders in closely held corporations from the improper exercise of majority control. When a minority shareholder claims abuse at the hands of a majority investor, courts applying the oppression doctrine will subject the majority’s conduct to a considerable amount of scrutiny. Approximately thirty-nine states have statutes providing for dissolution or other relief on the grounds of “oppressive actions” by “directors or those in control.” See Douglas K. Moll & Robert A. Ragazzo, Closely Held Corporations § 7.01[D][b], at 7-69 n.192 (LexisNexis 2015).
The factors that give rise to the oppression problem in the closely held corporation context are also present in the LLC setting. See, e.g., Douglas K. Moll, Minority Oppression & the Limited Liability Company: Learning (or Not) from Close Corporation History, 40 Wake Forest L. Rev. 883, 925-57 (2005). Indeed, the same combination of “no exit” and majority rule—a combination that has left minority shareholders vulnerable in the closely held corporation for decades—exists in the LLC. Despite these similarities, only nineteen states have LLC statutes providing for dissolution or other relief on the grounds of oppressive conduct or similar language.
Why the difference? Why do twice as many states provide oppression-related protection in the corporation setting (as compared to the LLC setting)? Some thoughts:
(1) Differences in default exit rights: In the corporation, state statutes do not provide default exit rights. In the LLC, the situation is similar, as the passage of the check-the-box regulations led to most states eliminating default exit rights for estate planning and related purposes. See id. at 925-40. Nevertheless, in a small handful of jurisdictions (5 states by my count), default exit rights still exist in LLCs. Such statutes usually indicate that the dissociation of a member leads to a buyout of the member’s ownership interest or dissolution of the company. When minority owners have a statutory mechanism for exiting the venture with the value of their investments, there is little need for an oppression doctrine, as the oppression doctrine typically seeks to provide the same outcome (i.e., exit and return of capital).
(2) The oppression doctrine is too vague and unpredictable: In many jurisdictions, oppressive conduct is defined as “burdensome, harsh, and wrongful conduct” by the majority, or a frustration of the minority’s “reasonable expectations” by the majority. These definitions have been criticized on the grounds that they are too vague and general to provide any meaningful guidance to litigants and courts. Importing the oppression doctrine with these definitions into the LLC setting may be viewed as compounding the problem. One could argue, however, that oppression is no more vague and open-ended than the concept of fiduciary duty, particularly in jurisdictions where the scope of manager and member fiduciary duties is not circumscribed by statute.
(3) Other dissolution grounds are broad enough to encompass oppressive conduct: Almost all LLC statutes provide for judicial dissolution on the ground that it is not reasonably practicable to carry on the business in conformity with the governing documents of the LLC. Such a ground is presumably broad enough to encompass certain types of oppressive behavior. For example, if the majority consistently deprives the minority of distributions to which the minority is entitled, such conduct would likely run afoul of the operating agreement and would show a pattern of the majority violating the governing documents. If this dissolution ground can handle oppressive conduct, the need for a dissolution statute explicitly tied to oppressive behavior is lessened.*
On the other hand, some types of oppressive conduct fail to fit neatly within the “not reasonably practicable” language. In a classic freezeout where the minority is terminated from employment and denied any management role in the LLC, there may be no technical violation of the articles or the operating agreement. Cf. Dennis S. Karjala, Planning Problems in the Limited Liability Company, 73 Wash. U. L.Q. 455, 471 (1995) (“[I]n Arizona, Delaware, and Oregon, a court may order dissolution in an action by a member if it is established that it is ‘not reasonably practicable to carry on the business’ according to the articles or an operating agreement. Yet it is often possible to carry on the business while freezing a minority interest out of any return.” (footnote omitted)). Thus, a more explicit dissolution-for-oppression statute may still be useful.
(4) Fiduciary duties to members exist in the LLC: Perhaps the most compelling reason for the lack of LLC dissolution-for-oppression statutes is that minority members may already be protected from oppressive conduct by fiduciary duties owed to them by managers (and, possibly, other members). In the corporation setting, directors and officers traditionally owe fiduciary duties to the corporation itself, but not to individual shareholders. By contrast, in the LLC setting, many jurisdictions indicate (either by statute or judicial decision) that a manager owes a fiduciary duty to an individual member as well as to the LLC itself. See, e.g., RULLCA § 409 (2006). A member’s ability to bring a breach of fiduciary duty claim on his own behalf lessens the need for an oppression action, as the oppression action is also designed to allow a minority owner to assert, on his own behalf, that he has been unfairly treated.
That said, it is not clear that the scope of a manager’s fiduciary duty would be construed as broadly as the oppression doctrine has been construed, particularly with respect to protecting the minority’s participatory rights in the business (i.e., employment and management rights). In fact, in some jurisdictions, a manager’s fiduciary duty of loyalty is limited by statute to harm caused to the LLC itself (and not harm caused to an individual member). (Note: I discussed this in the partnership context in a prior post.) In addition, broad remedies for oppression, such as a buyout of the oppressed minority’s holdings, are already well-established in the case law. Although a court has significant remedial discretion in fiduciary duty actions as well, in many jurisdictions there is no precedent for a buyout as a remedy for breach of fiduciary duty.
What am I missing? Are there other explanations for significantly fewer oppression statutes in the LLC setting?
* Some LLC statutes allow for dissolution when member conduct makes it not reasonably practicable to carry on the company’s business with that member. This ground seems even more tailored to oppressive conduct, but it is only present in seven jurisdictions.
Tuesday, June 28, 2016
SEC Chair Mary Jo White yesterday presented the keynote address, for the International Corporate Governance Network Annual Conference, "Focusing the Lens of Disclosure to Set the Path Forward on Board Diversity, Non-GAAP, and Sustainability." The full speech is available here.
In reading the speech, I found that I was talking to myself at various spots (I do that from time to time), so I thought I'd turn those thoughts into an annotated version of the speech. In the excerpt below, I have added my comments in brackets and italics. These are my initial thoughts to the speech, and I will continue to think these ideas through to see if my impression evolves. Overall, as is often the case with financial and other regulation, I found myself agreeing with many of the goals, but questioning whether the proposed methods were the right way to achieve the goals. Here's my initial take:
June 28, 2016 in Corporate Finance, Corporate Governance, Corporations, Current Affairs, Financial Markets, Joshua P. Fershee, Securities Regulation, Shareholders, Social Enterprise | Permalink | Comments (1)
Monday, June 27, 2016
I am still at Berle VIII with Haskell Murray and Anne Tucker. One more day of my June Scholarship and Teaching Tour to go--and I have a final presentation to do. Then, back to Knoxville to stay until late in July. Whew!
As you may recall or know, my Berle appearance this week follows closely on the heels of a talk on the same work (on corporate purpose and litigation risk in publicly held U.S. benefit corporations) that I made at last week's 2016 National Business Law Scholars conference. While I am thinking about this conference, please join me in saving the date for the next one: the 2017 National Business Law Scholars conference. Next year's conference will be held June 8-9 at The University of Utah S. J. Quinney College of Law, with Jeff Schwartz hosting. I will post more information and the call for papers, etc. once I have it.
June 27, 2016 in Anne Tucker, Business Associations, Conferences, Corporate Finance, Corporate Governance, Corporate Personality, Corporations, CSR, Haskell Murray, Joan Heminway, Research/Scholarhip, Teaching | Permalink | Comments (0)
Sunday, June 26, 2016
"popular engagement w/ the nature of corporate personality..should not be dismissed as irrelevant to tax law" 84 FordhamL.Rev. 2583 #corpgov— Stefan Padfield (@ProfPadfield) June 20, 2016
"tag jurisdiction...would be in accord with...affording corporations rights equivalent to those of natural persons" 46 N.M.L.Rev. 1 #corpgov— Stefan Padfield (@ProfPadfield) June 20, 2016
Delaware Schnell doctrine: "compliance w/..corporate statute is..minimum..not..sole, requirement for legality" 5Am.U.Bus.L.Rev. 159 #corpgov— Stefan Padfield (@ProfPadfield) June 20, 2016
Saturday, June 25, 2016
Section 11 imposes liability for false statements in registration statements. See 15 U.S.C. §77k. Section 11 is distinctive in that the plaintiffs do not have to show fault on the part of any defendants - a sharp contrast with Section 10(b), which requires plaintiffs to prove that the defendants acted with scienter.
When it comes to imposing liability on corporate auditors who approve false financial statements, very often, Section 11 is the only viable option for plaintiffs. This is because it is very, very hard to show that auditors acted with scienter – especially at the pleading stage. When a company blows up, typically a lot of information becomes available that would help the plaintiffs demonstrate that there was fault within the corporate ranks. But it is far less typical for information to become available against the auditor. So Section 11 is really the only way for plaintiffs to go.
In Querub v. Moore Stephens Hong Kong, 2016 U.S. App. LEXIS 9213 (2d Cir. N.Y. May 20, 2016) (unpublished), the Second Circuit held that for Section 11 purposes, audit opinions are “opinions” in the manner described in Omnicare, Inc. v. Laborers Dist. Council Constr. Indus. Pension Fund, 135 S. Ct. 1318 (2015). This means that audit opinions can only be shown to be false – and liability based on them can only be imposed – if the plaintiffs show either that the auditors did not believe the opinion (the functional equivalent of scienter), or that the auditors left out critical facts regarding the manner in which the opinion was formed (which in most cases is likely to mean that the auditor failed to comply with Generally Accepted Accounting Standards (GAAS)).
It’s my view that this holding contradicts the text of Section 11.
Section 11, provides that if a registration statement contains a false statement or material omission, liability will lie against:
every accountant, engineer, or appraiser, or any person whose profession gives authority to a statement made by him, who has with his consent been named as having prepared or certified any part of the registration statement, or as having prepared or certified any report or valuation which is used in connection with the registration statement, with respect to the statement in such registration statement, report, or valuation, which purports to have been prepared or certified by him...
On my reading, this language directs courts to ask whether the corporate financial statements are false. If they are, then liability is imposed on the auditor who “certified” the statements – automatically. The act of auditor certification of a false financial statement is what triggers liability, period. No further inquiry into the truth or falsity of the certification itself – independent of the underlying financial statement – is permitted.
But, the auditor is permitted to offer a defense. Auditors (who are “experts”) may avoid liability if they prove that:
as regards any part of the registration statement purporting to be made upon his authority as an expert or purporting to be a copy of or extract from a report or valuation of himself as an expert … he had, after reasonable investigation, reasonable ground to believe and did believe, at the time such part of the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading….
In other words, the auditor will not be liable if it believed the financial statements were true, based on a reasonable investigation. Presumably, the auditor will try to meet this standard by showing that it complied with GAAS, which itself would require a showing of good faith and professional due diligence. If the auditor makes that showing, it avoids liability.
The Second Circuit (and, I must confess, several other courts) undermine this scheme when they put the burden on the plaintiff to make an initial showing that there was a failure to comply with GAAS.
This is a problem that may be broader than audit certifications, and extend to the proper interpretation of Section 11 generally - occasioned not so much by Omnicare's definition of opinion falsity, but by its capacious definition of what counts as opinion in the first place - but in the context of audit opinions, the tension looms particularly large.
Now, one counterargument is that auditors do not “certify” financial statements any more. Certification is an old terminology; it fell out of favor several decades ago (after the passage of the Securities Act), to be replaced by the “opinion” phrasing, which more accurately reflects the fact that auditors don’t guarantee the accuracy of corporate financial statements. And indeed, today, SEC regulations dictate that auditors offer “opinions” (not certifications) of financial statements.
But to me, this is beside the point. As far as I know - and I'd be curious if anyone has any contrary evidence - these changes in terminology were never intended to change the liability scheme, let alone shift Section 11's burden of proof (something that presumably auditors could not do unilaterally).
Friday, June 24, 2016
Recently, I came across this discussion on Poverty Inc. by Bill Easterly (NYU Economics) and the film's creators (Michael Matheson Miller and Mark Weber). I posted on one of Bill Easterly's books here.
In the discussion at NYU, I especially liked this quote from Michael Matheson Miller: "We tend to treat poor people as objects--as objects of our charity, objects of our pity, objects of our compassion.--instead of subjects...Poor people are not objects; they are subjects and they should be the protagonists in their own stories of development." The personal story Mark Weber tells of his trip while he was studying at Notre Dame was moving, but you will have to watch the discussion to hear it, as it would be tough to summarize. Some of the audience questions are a bit long-winded, but I think the panel does a nice job deciphering and answering.
The film's trailer, the discussion, and the Q&A with the audience are all worth watching.
Thursday, June 23, 2016
The Cuba Conundrum: Corporate Governance and Compliance Challenges for U.S. Publicly-Traded Companies
My latest article on Cuba and the US is out. Here I explore corporate governance and compliance issues for US companies. In May, I made my third trip to Cuba in a year to do further research on rule of law and investor concerns for my current work in progress.
In the meantime, please feel free to email me your comments or thoughts at email@example.com on my latest piece
The abstract is below:
The list of companies exploring business opportunities in Cuba reads like a who’s who of household names- Starwood Hotels, Netflix, Jet Blue, Carnival, Google, and AirBnB are either conducting business or have publicly announced plans to do so now that the Obama administration has normalized relations with Cuba. The 1962 embargo and the 1996 Helm-Burton Act remain in place, but companies are preparing for or have already been taking advantage of the new legal exemptions that ban business with Cuba. Many firms, however, may not be focusing on the corporate governance and compliance challenges of doing business in Cuba. This Essay will briefly discuss the pitfalls related to doing business with state-owned enterprises like those in Cuba; the particular complexity of doing business in Cuba; and the challenges of complying with US anti-bribery and whistleblower laws in the totalitarian country. I will also raise the possibility that Cuba will return to a state of corporatism and the potential impact that could have on compliance and governance programs. I conclude that board members have a fiduciary duty to ensure that their companies comply with existing US law despite these challenges and recommend a code of conduct that can be used for Cuba or any emerging markets which may pose similar difficulties.
June 23, 2016 in Comparative Law, Compliance, Corporate Governance, Corporations, CSR, Current Affairs, Human Rights, International Business, Law Reviews, Marcia Narine, Research/Scholarhip | Permalink | Comments (0)
Wednesday, June 22, 2016
Do partners in a general partnership owe a fiduciary duty of loyalty to one another? “Of course!” you say. “Everyone knows that.” In one of the most famous passages in business organizations law, Justice Cardozo observed:
Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arm's length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the ‘disintegrating erosion’ of particular exceptions. Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. It will not consciously be lowered by any judgment of this court.
Meinhard v. Salmon, 164 N.E. 545, 546 (N.Y. 1928).
On its face, RUPA § 404 (1997) seems consistent with Meinhard, as it indicates that “[t]he only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care set forth in subsections (b) and (c).” Even though this language acknowledges a partner-to-partner duty of loyalty, it explicitly blocks that duty from having any meaning. Indeed, § 404(b) states that a “[a] partner’s duty of loyalty to the partnership and the other partners is limited to the following,” and the situations described all involve harm to the partnership itself—not harm to an individual partner:
(b) A partner's duty of loyalty to the partnership and the other partners is limited to the following:
(1) to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity;
(2) to refrain from dealing with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership; and
(3) to refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership.
What does it mean to set forth a duty that is owed to a partner, but that is defined solely by reference to harm to the partnership? Take an extreme example: assume that two partners gang up on a third partner and deny that third partner his share of partnership distributions. Are we really saying that the third partner cannot sue for breach of the fiduciary duty of loyalty because the harm was to him personally and not the partnership? Perhaps we don’t care because the third partner could surely sue for conversion or, perhaps, breach of the good faith and fair dealing obligation (see RUPA § 404(d)). Yet the broader point remains—there are countless ways in which majority owners can gang up on minority owners and treat them unfairly. If that happens in a partnership, and if there is no direct harm to the partnership itself, the duty of loyalty nominally owed to a partner is of no practical use.
In the 2013 version of RUPA, this problem is squarely addressed. RUPA § 409(a) (2013) eliminates the “only” fiduciary duties language, and § 409(b) eliminates the “limited to” language for the duty of loyalty. The Official Comment squarely addresses the issue:
This section originated as UPA (1997) § 404. The 2011 and 2013 Harmonization amendments made one major substantive change; they “un-cabined” fiduciary duty. UPA (1997) § 404 had deviated substantially from UPA (1914) by purporting to codify all fiduciary duties owed by partners. This approach had a number of problems. Most notably, the exhaustive list of fiduciary duties left no room for the fiduciary duty owed by partners to each other – i.e., “the punctilio of an honor the most sensitive”). Meinhard v. Salmon, 164 N.E. 545, 546 (N.Y. 1928). Although UPA (1997) § 404(b) purported to state “[a] partner’s duty of loyalty to the partnership and the other partners” (emphasis added), the three listed duties each protected the partnership and not the partners.
Thus, under RUPA (2013), this problem disappears. But the majority of jurisdictions still operate under RUPA (1997). Unless those jurisdictions have eliminated the “cabining in” problem by deleting “only” and “limited to” in their versions of § 404, the problem persists. And Cardozo would not be happy . . . .
Today is the rare day where I feel like a professor. Dressed in jeans and drinking coffee in my office, I have been reading Colin Mayer's book Firm Commitment in advance of the Berle VIII Symposium in Seattle next week (you can also see Haskell's post & Joan's post about Berle). That's not a typo, my agenda for the day is reading. And not for a paper or to prep for class, I am just reading a book--cover to cover. I can hardly contain my joy at this.
I have been struck by the elegantly simple idea that corporations' true benefit is to advance (and therefore) balance commitment and control. I have long viewed the corporate binary as between accountability and control. Under my framework the two are necessary to balance and contribute to the checks and balances within the corporate power puzzle of making the managers, who control the corporation, accountable to the shareholders. Colin Mayer posits that the one directional accountability of the corporation to shareholders without reciprocity of commitment from the shareholders to the corporation is a corrosive element in corporate design.
"The most significant source of failure is the therefore that we have created a system of shareholder value driven companies who detrimental effects regulation is supposed to but fails to correct, and in response we week greater regulation as the only instrument that we believe can address the problem. We are therefore entering a cycle of the pursuit of ever-narrower shareholder interests moderated by steadily more intrusive but ineffective regulation."
In developing the notions of commitment and control, I have found the following passages particularly thought-provoking:
"The financial structure of the corporation is of critical importance...The commitment of owners derives from the capital that is employed in the corporation. What is held within it is fundamentally different from what remains outside as the private property of its owners. What is distributed to owners as dividends is no longer available as protection against adverse financial conditions and what is provided in the form of debt from banks and bondholders as against equity form shareholders is secure only as long as the corporation has the means with which to service it."
"While incentives and control are centre stage in conventional economics, commitment is not. Enhancing choice, competition, and liquidity is the economist's prescription for improving social welfare, and legal contracts, competition policy and regulation are their basic toolkit for achieving it. Eliminate restrictions on consumers' freedom to choose, firms' ability to compete, and financial markets' provision of liquidity and we can all move closer to economic nirvana. Of course, economics recognizes the problems of time inconsistency in us doing today what yesterday we promised we would not conceive of doing today; of reputations in us continuing to do today what we promised to do yesterday for fear of not being able to do it tomorrow, and of capital and collateral in making it expensive for us to deviate from what we said yesterday we would do today and tomorrow. But these are anomalies. Economics does not recognize the fundamental role of commitment in all aspects of our commercial as well as our social lives and the way in which institutions contribute to the creation and preservation of commitment. It does not appreciate the full manner in which choice, competition and liquidity undermine commitment or the fact that institutions are not simply mechanisms for reducing costs of transaction, but on the contrary means to establish and enhance commitment at the expense of choice, competition, and liquidity. Commitment is the subject of soft sentimental sociologists, not of realistic rational economists. The sociologists' are the words of Shakespeare's 'Love all, trust few. Do wrong to none', the economists' those of Lenin: 'Trust is good, control is better.'"
Tuesday, June 21, 2016
Last week, a federal court determined that an insurance disclosure that asked about an "applicant's" criminal history did not apply to an LLC member's individual criminal past. In Jeb Stuart Auction Servs., LLC v. W. Am. Ins. Co., No. 4:14-CV-00047, 2016 WL 3365495, at *1 (W.D. Va. June 16, 2016), the court explained:
“Question Eight” on the [insurance] application asked, “DURING THE LAST FIVE YEARS (TEN IN RI), HAS ANY APPLICANT BEEN INDICTED FOR OR CONVICTED OF ANY DEGREE OF THE CRIME OF FRAUD, BRIBERY, ARSON OR ANY OTHER ARSON-RELATED CRIME IN CONNECTION WITH THIS OR ANY OTHER PROPERTY?” Hiatt, on behalf of Jeb Stuart (who [sic] was the sole [LLC] applicant for the insurance policy), answered, “No.” Hiatt signed the application and left.
As you might imagine, Hiatt had been convicted of "hiring individuals to wreck cars so that he could receive the proceeds from the applicable insurance policies," and, yep, about a month later, the building burned down. Id. at *2.
The insurance company cancelled the policy because it claimed Hiatt had lied on the application, and Hiatt sued for the improper cancellation of the policy because he did not lie (he prevailed) and for attorneys fees claiming “the insurer, not acting in good faith, has either denied coverage or failed or refused to make payment to the insured under the policy.” Id. at *3. Judge Kiser determined that not attorneys' fees were warranted:
Neither party was able to rely on a case on point regarding the issue of whether questions on an LLC's insurance application asking about criminal history applied to the members of the LLC, to the corporate entity, or to both. Although I believe the answer to that question is clear, I am not aware of any other court being called upon to answer it. Therefore, although it was unsuccessful in asserting its defense to Jeb Stuart's claim, West American's position did present a novel legal question. As such, the final Norman factor weighs in favor of a finding of good faith.
Monday, June 20, 2016
Having helped a few Tennessee bar applicants get straight on their knowledge of agency, unincorporated business associations, and personal property law last Friday at my BARBRI lecture (such a nice group present at the taping to keep me company!), it's now time for me to wrap up my June Scholarship and Teaching Tour with a twofer--a week of travel to two of my favorite U.S. cities: Chicago, for the National Business Law Scholars Conference and Seattle for Berle VIII. At both events, I will present my draft paper (still in process today, unfortunately) on publicly held benefit corporations, Corporate Purpose and Litigation Risk in Publicly Held U.S. Benefit Corporations. Here's the bird's-eye view from the introduction:
Benefit corporations—corporations organized for the express purpose of realizing both financial wealth for shareholders and articulated social or environmental benefits—have taken the United States by storm. With Maryland passing the first benefit corporation statute in 2010, legislative growth of the form has been rapid. Currently, 31 states have passed benefit corporation statutes.
The proliferation of benefit corporation statutes and B Corp certifications can largely be attributed to the active promotional work of B Lab Company, a nonprofit corporation organized in 2006 under Pennsylvania law that supports social enterprise (“B Lab”). B Lab works with individuals and interest groups to generate attention to social enterprise generally and awareness of and support for the benefit corporation form and B Corp certification (a social enterprise seal of approval, of sorts) specifically. B Lab also supplies model benefit corporation legislation, social enterprise standards that may meet the requirements of benefit corporation statutes in various states, and other services to social enterprises.
Benefit corporation statutes have not, by and large, been the entity law Field of Dreams. Despite the legislative popularity of the benefit corporation form, there have not been as many benefit corporation incorporations as one might expect. In the first four years of benefit corporation authority, for example, Maryland reported the existence of fewer than 40 benefit corporations in total. Tennessee’s benefit corporation statute came into effect in January 2016, and as of May 2, 2016, Secretary of State filings evidence the organization of 26 for-profit benefit corporations. However, a review of these filings suggests that well more than half were erroneously organized as benefit corporations. Colorado, another recent adopter of the benefit corporation, does appear to have a large number of filings (90 in total as of June 12, 2016 based on the list of Colorado benefit corporations on the B Lab website). However, as with Tennessee, a number of these listed corporations appear to be erroneously classified. These anecdotal offerings indicate that published lists of benefit corporations—even those constructed from state filings—over-count the number of benefit corporations significantly.
Research for this article identified no publicly held U.S. benefit corporations. For these purposes (and as referenced throughout this article), the term “publicly held” in reference to a corporation is defined to mean a corporation (a) with a class of equity securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (“1934 Act”), or (b) otherwise required to file periodic reports with the Securities and Exchange Commission under Section 13 of the 1934 Act. Yet, benefit corporations may be subsidiaries of publicly held corporations (as Ben & Jerry's Homemade Inc., New Chapter Inc., and Plum, PBC have demonstrated), and corporations certified as B Corps have begun to enter the ranks of publicly held corporations (perhaps Etsy, Inc. being the most well known to date). It likely is only a matter of time before we will see the advent of publicly held U.S. benefit corporations.
With the likely prospect of publicly held U.S. benefit corporations in mind, this article engages in a thought experiment. Specifically, this article views the publicly held U.S. benefit corporation from the perspective of litigation risk. It first situates, in Part I, the U.S. benefit corporation in its structural and governance context as an incorporated business association. Corporate purpose and the attendant managerial authority and fiduciary duties are the key points of reference. Then, in Part II, the article seeks to identify the unique litigation risks associated with publicly held corporations with the structural and governance attributes of a benefit corporation. These include both state and federal causes of action. The reflections in Part III draw conclusions from the synthesis of the observations made in Parts I and II. The closing thoughts in Part III are intended to be of use to policy makers, academic observers, and advisers of corporations, among others.
As Haskell mentioned in an earlier post, he and Anne and I will be together at the Berle VIII event. What a great way to end my June tour--with my friends and colleagues from the Business Law Prof Blog! I look forward to it.
Sunday, June 19, 2016
Saturday, June 18, 2016
As Rodney Tonkovic discusses in more detail, the plaintiff in Fried v. Stiefel Labs, 814 F.3d 1288 (11th Cir. 2016), has petitioned the Supreme Court to delineate disclosure duties in the context of trading by private companies.
Richard Fried was the former CFO of Stiefel Labs, which was privately held. As an employee, he received stock as part of a pension plan. When he retired, he sold the stock back to Stiefel (I don’t know much about the market for Stiefel stock, but I’m guessing that, since it was privately held, Fried didn’t think he had many alternative options). Sadly for Fried, shortly after his sale, it was announced that Stiefel was being acquired by GlaxoSmithKline, and that negotiations had been in the works at the time of his sale. By selling to Steifel instead of waiting for GSK’s acquisition, he missed out on, roughly, an additional $1.62 million. He sued Stiefel, alleging that Stiefel had been obligated to disclose the negotiations to him at the time of his sale.
This is not something that comes up very often, but the case law that does exist tends to hold that insider trading principles apply both to private and public companies and, in particular, that when a company buys its own stock back from an employee, it has a duty to disclose material inside information. See, e.g., Castellano v. Young & Rubicam, Inc., 257 F.3d 171 (2d Cir. 2001); Jordan v. Duff & Phelps, Inc., 815 F.2d 429 (7th Cir. 1987).
The issue is a bit of a theoretical muddle, though, not least because it is the company – not a particular employee – who is doing the trading, and thus the precise fiduciary duty at issue is harder to nail down. The employee knows the price is not being set by the market generally, and the employee's expectations regarding the company's superior information depend - well - on the existing background legal regime of required disclosures. (The SEC filed a brief in a related case, where it argued that “where a company trades in its own stock it does have a duty to disclose material information or abstain from trading.” SEC Brief, Finnerty v. Stiefel Labs, 2013 WL 2903651, at *9-*10. This was an odd statement because that’s a hard case to make if the company is selling its stock, at least to the extent it’s relying on a Section 5 exemption.) So what the employee might reasonably expect, or rely upon - and thus be deceived by - is something of a moving target.
I’m not going to hazard a guess as to whether the Supreme Court is likely to grant cert in the Fried case– my track record on these sorts of predictions is embarrassingly terrible – but I will say that there are some uphill battles Fried may have to climb. First and most importantly, the Eleventh Circuit never actually decided the issue of whether a private corporation counts as an "insider" for insider trading purposes, because it rejected the claim on essentially technical grounds – i.e., that Fried should have requested jury instructions under 10b-5(a) or 10b-5(c), not 10b-5(b). The Circuit's failure to address the substantive issues detract from its utility as a vehicle for addressing the duties of a private corporation. Indeed, the “questions presented” in Fried’s petition do not even mention the Eleventh Circuit’s focus on the distinctions between 10b-5(a), (b), and (c) - which, as we know, are really important distinctions to the Supreme Court, see Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011).
Even leaving that point aside, because of the dearth of caselaw, the Court might reasonably say these issues need more development in the lower courts. And though Fried argues that this case involves the question whether 10b-5 prohibits trading in possession of material inside information, or only trading on the basis of inside information, that point was only mentioned by the Eleventh Circuit in passing, and it certainly has nothing to do with the far more interesting question of the duties owed by private companies repurchasing their stock.
But, as I said, I’m not going to try to predict what the Court is likely to do here. I’ll simply say that assuming the Supreme Court rejects Fried’s petition, it almost certainly will have other chances to get at these problems, because of the increasing tendency of companies to stay private for prolonged periods of time, and to go through multiple rounds of financing. As Bloomberg reports:
[T]he more money you have, the more information you get in private markets. Sven Weber launched the SharesPost 100 index fund in 2012 to let unaccredited investors (with a net worth below $1 million) own shares in late-stage startups, including DocuSign Inc., Spotify AB and Social Finance Inc., with a minimum investment of $2,500. He could only write $500,000 checks at first and it was hard to get information to gauge if he was getting a fair price. As the SharesPost 100 grew to 34 startup positions and $71 million under management, he got more access.
Weber said one Silicon Valley unicorn provided virtually no information when he was trying to purchase shares last year. Based on historical statements and publicly available documents like articles of incorporation, he invested anyway. During the past year, he increased his stake, got to know company executives and eventually convinced them to share quarterly revenue updates and forward-looking statements.
The differential access to information has attracted not only SEC attention, but also other lawsuits like Fried’s - and I'm assuming there will be more to follow. So the really interesting question is, when you invest in a private company, to what extent are you assuming the risk of this kind of informational asymmetry?
Friday, June 17, 2016
By now, I am sure all readers are aware of the horrific, hateful mass shooting that occurred in Orlando earlier this week.
If your social media feeds are anything like mine, it did not take long for politicians, pundits, and friends to politicize this tragedy. The tragedy was quickly used, by people all along the political spectrum, as evidence supporting their views on guns, religion, sexuality, and immigration. There is certainly a time and need for solutions, but there needs to be space to mourn. Orin Kerr (George Washington Law) summarized my thoughts well when he tweeted:
It's impressive how national tragedies prove to everyone that they were right all along.— Orin Kerr (@OrinKerr) June 13, 2016
What could and should be done immediately after a tragedy? I am not entirely sure, but those who took steps to donate blood and financial resources should be commended.
Some local businesses also attempted to help. For example, it was reported that Chick-fil-A, which is famously closed on Sundays, cooked and gave away food to those waiting in line to donate blood. This is an admittedly small gesture, but at a time when our nation often seems hopelessly divided, I am thankful for the gesture. Chick-fil-A and its conservative Christian COO Dan Cathy were, of course, at the center of controversy regarding views on marriage. I have seen no indications that Dan Cathy has changed his views on marriage, though Chick-fil-A does appear to have made changes in its donations. In any event, I am so glad to see a business looking past differing views and caring for human beings in the aftermath of tragedy.
[Disclosure: While no company is perfect, my family and I are Chick-fil-A fans, and I have friends, including a former roommate, who work for the company.]
On Wednesday, the EU finally outlined its position on conflict minerals. The proposed rule will affect approximately 900,000 businesses. As I have discussed here, these “name and shame” disclosure rules are premised on the theories that: 1) companies have duty to respect human rights by conducting due diligence in their supply chains; 2) companies that source minerals from conflict zones contribute financially to rebels or others that perpetuate human rights abuses; and 3) if consumers and other stakeholders know that companies source certain minerals from conflict zones they will change their buying habits or pressure companies to source elsewhere.
As stated in earlier blog posts, the US Dodd- Frank rule has been entangled in court battles for years and the legal wranglings are not over yet. Dodd-Frank Form SD filings were due on May 31st and it is too soon to tell whether there has been improvement over last year’s disclosures in which many companies indicated that the due diligence process posed significant difficulties.
I am skeptical about most human rights disclosure rules in general because they are a misguided effort to solve the root problem of business’ complicity with human rights abuses and assume that consumers care more about ethical sourcing than they report in surveys. Further, there are conflicting views on the efficacy of Dodd-Frank in particular. Some, like me, argue that it has little effect on the Congolese people it was designed to help. Others such as the law’s main proponent Enough, assert that the law has had a measurable impact.
The EU's position on conflict minerals is a compromise and many NGOs such as Amnesty International, an organization I greatly respect, are not satisfied. Like its US counterpart, the EU rule requires reporting on tin, tantalum, tungsten, and gold, which are used in everything from laptops, cameras, jewelry, light bulbs and component parts. Unlike Dodd-Frank, the rule only applies to large importers, smelters, and refiners but it does apply to a wider zone than the Democratic Republic of Congo and the adjoining countries. The EU rule applies to all “conflict zones” around the world.
Regular readers of my blog posts know that I teach and research on business and human rights, and I have focused on corporate accountability measures. I have spent time in both Democratic Republic of Congo and Guatemala looking at the effect of extractive industries on local communities through the lens of an academic and as a former supply chain executive for a Fortune 500 company. I continue to oppose these disclosure rules because they take governments off the hook for drafting tough, substantive legislation. Nonetheless, I look forward to seeing what lessons if any that the EU has learned from the US when the member states finally implement and enforce the new rule. In coming weeks I will blog on recent Form SD disclosures and the progress of the drafting of the final EU rule.
June 17, 2016 in Compliance, Corporate Governance, Corporations, CSR, Current Affairs, Financial Markets, Human Rights, International Law, Legislation, Marcia Narine, Securities Regulation | Permalink | Comments (0)
Thursday, June 16, 2016
8th Annual Berle Symposium - Benefit Corporations and the Firm Commitment Universe - June 27-28, 2016 - Seattle, WA
Three Business Law Prof Blog editors (myself included) are presenting at the upcoming Berle Symposium on June 27-28 in Seattle.
Colin Mayer (Oxford) is the keynote speaker, and I look forward to hearing him present again. I blogged on his book Firm Commitment after I heard him speak at Vanderbilt a few of years ago. The presenters also include former Chancellor Bill Chandler of the Delaware Court of Chancery. Given that Chancellor Chandler's eBay v. Newmark decision is heavily cited in the benefit corporation debates, it will be quite valuable to have him among the contributors. The author of the Model Benefit Corporation Legislation, Bill Clark, will also be presenting; I have been at a number of conferences with Bill Clark and always appreciate his thoughts from the front lines. Finally, the list is packed with professors I know and admire, or have read their work and am looking forward to meeting.
More information about the conference is available here.
June 16, 2016 in Anne Tucker, Business Associations, Conferences, Corporate Governance, Corporations, CSR, Delaware, Financial Markets, Haskell Murray, Joan Heminway, Law School, Social Enterprise | Permalink | Comments (0)
Wednesday, June 15, 2016
Starting 2 weeks ago at Law & Society, I began participating in a series of conversations that can be boiled down to this: Artificial Intelligence and the Law. Even the ABA is on to this story, which means it has reached a peak saturation point. Exciting, scary, confusing, skeptical and a variety of other reactions have been thrown into the conversations across the legal studies gamut from algorithms in parole & criminal sentencing to its use to generate social credit scores (thank you Nizan Packin for opening my eyes to this application). In another LSA shout out, I want to highlight to forthcoming scholarship of Ben Edwards at Barry College where he criticizes the conflicts of interest in investment advise channels. One possible work around he explores is relying on robo-advisors: In the few years since I have looked at digital investment advise, the field has changed, matured, grown! So much so that FINRA has issued a report on digital investment advise, and is unsurprisingly skeptical of the technology application that poses a significant threat to its members (new release synopsis available here). For the uninitiated, check out this run down of popular robo-advisors and Forbes article. Skepticism about the sustainability of low-fee model can be found here; and optimism about its ability to change the world can be found here.
A robo-advisor (robo-adviser) is an online wealth management service that provides automated, algorithm-based portfolio management advice without the use of human financial planners. Robo-advisors (or robo-advisers) use the same software as traditional advisors, but usually only offer portfolio management and do not get involved in more personal aspects of wealth management, such as taxes and retirement or estate planning.
Tuesday, June 14, 2016
Thanks to the BLPB for inviting me to guest blog! I'm excited to be here. I'll probably write a few substantive posts to start out and finish up with some musings on teaching.
Here’s a head scratcher: interested director provisions have long been a part of corporation statutes, and they are making appearances in LLC statutes as well. The statutes generally address transactions between a corporation and one or more of its directors (or between the corporation and another entity to which the director is affiliated) and provide a mechanism for cleansing the “stink” of the conflict of interest.
The fundamental problem with interested director transactions is that we do not trust the interested director to put the entity’s interests before his own. Correspondingly, in such transactions there is a need to find a “trustworthy decisionmaker” to review the transaction with the entity’s interests in mind. See, e.g., Franklin Gevurtz, Corporation Law § 4.2.1, at 325 (2000); Douglas K. Moll & Robert A. Ragazzo, Closely Held Corporations § 6.03[B][b], at 6-59 (LexisNexis 2015). Interested director statutes in corporate law can be viewed as providing three trustworthy decisionmaker options: disinterested directors, disinterested shareholders, or a court. Section 144 of the Delaware General Corporation Law is fairly typical of such statutes:
§ 144 Interested directors; quorum.
(a) No contract or transaction between a corporation and 1 or more of its directors or officers, or between a corporation and any other corporation, partnership, association, or other organization in which 1 or more of its directors or officers, are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee which authorizes the contract or transaction, or solely because any such director's or officer's votes are counted for such purpose, if:
(1) The material facts as to the director's or officer's relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; or
(2) The material facts as to the director's or officer's relationship or interest and as to the contract or transaction are disclosed or are known to the stockholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the stockholders; or
(3) The contract or transaction is fair as to the corporation as of the time it is authorized, approved or ratified, by the board of directors, a committee or the stockholders.
(b) Common or interested directors may be counted in determining the presence of a quorum at a meeting of the board of directors or of a committee which authorizes the contract or transaction.
Although § 144(a)(2) does not explicitly indicate that a vote of disinterested shareholders is required, case law in Delaware has imposed a disinterested requirement. See, e.g., Marciano v. Nakash, 535 A.2d 400, 405 n.3 (Del. 1987); In re Wheelabrator Technologies, Inc. S'holders Litig., 663 A.2d 1194, 1203 (Del. Ch. 1995). If the purpose of the statute is to find a trustworthy decisionmaker—i.e., a decisionmaker lacking a conflict of interest in the transaction at issue—this disinterested requirement is eminently sensible. Moreover, why require disinterested directors for director authorization, but permit interested shareholders for shareholder authorization? After all, particularly in a closely held corporation, the interested directors are almost always significant shareholders. If they are not to be trusted to bless the conflicted transaction at the director level, why trust them to bless the transaction at the shareholder level? See also MBCA §§ 8.61(b)(2), 8.63(a) (requiring disinterested shares for shareholder authorization purposes).
The New York Times ran the article How Donald Trump Bankrupted His Atlantic City Casinos, but Still Earned Millions last weekend. It's an interesting piece that provides a look at Donald Trump's east coast casino experience. The article is, as one might expect, critical of his dealings and notes that Trump made money even when his ventures when bankrupt.
Though I will not defend any of Trump's dealings, there are few issues raised that I think are worthy of a some discussion and clarification.1 The post that follows suggests how to consider Trump's business history and place that history in a political context.
Monday, June 13, 2016
This post welcomes Doug (Douglas K.) Moll to the Business Law Prof Blog. He'll be posting with us a few times over the next month or so.
Doug is the Beirne, Maynard & Parsons, L.L.P. Law Center Professor of Law at The University of Houston Law Center. He teaches a variety of transactional business law courses: Business Organizations, Doing Deals, Business Torts, Secured Financing, and Sales and Leasing. I have had the pleasure of working with him in other capacities (he is a fellow Tennessee BARBRI instructor and presented with me at the 2015 ABA LLC Institute, for example) and value his observations about transactional business law. I also know him to be a highly decorated teacher--having won (according to his website bio) six teaching awards since 1998. I look forward to his posts--and I am sure you will enjoy them!