May 2, 2011
What Do Sokol and Vizzini Have in Common?
So many others have said this better than I will already, but a couple of quotes from Delaware cases keep coming to mind as I think of David Sokol's probable upcoming litigation. Regardless of how the insider trading cases go, Sokol was, in this instance (as Prof. Bainbridge noted), a really bad agent. Here are the quotes:
“[A] cognizable claim is . . . stated on the common law ground that an agent is under a duty to account for profits obtained personally in connection with transactions related to his or her company.” In re eBay, Inc. Shareholders Litigation, 29 Del. J. Corp. L. 924 (2004) (not reported in A.2d)
“Conduct that does not run afoul of the corporate opportunity doctrine may nonetheless constitute a violation of the broader, and more fundamental, fiduciary duty of loyalty.” Gibralt Capital Corp. v. Smith, 2001 WL 647837, at *9 (Del. Ch. May 8, 2001)
And, in light of the extraordinary efforts of our military and everyday, unexpected heroes, I'm going to go ahead and suggest Mr. Sokol consider rethinking his rhetoric when it comes time for a trial. He says, via his attorney:
At all times he [Sokol] faithfully discharged his fiduciary duties to Berkshire, a company he heroically served and continues to regard with reverence.
With regard to Sokol's view of "heroically," I think I'll look to Inigo Montoya for the words used when he famously explained to Vizzini the meaning of inconceivable, "I do not think it means what you think it means."
Josh, focusing on your first quote, can we say for sure that the profits were "in connection with transactions related to his or her company"? At the time he purchased, there was no transaction related to Berkshire Hathaway. Clearly, he wouldn't be liable if he purchased Lubrizol and only later found out that BH was going to do a transaction with them. So was there enough there at the time he purchased? Here's a quote from Broz v. Cellular Information Systems, Inc.: "At the time that Broz was required to decide whether to accept the Michigan-2 opportunity, PriCellular had not yet acquired CIS, and any plans to do so were wholly speculative. Thus, contrary to the Court of Chancery's finding, Broz was not obligated to consider the contingency of a PriCellular acquisition of CIS and the related contingency of PriCellular thereafter waiving restrictions on the CIS bank debt. Broz was required to consider the facts only as they existed at the time he determined to accept the Mackinac offer and embark on his efforts to bring the transaction to fruition." Slightly different issue involved there, but the principle is the same. My view is that Sokol's liability is more likely than not, but there is some wiggle room for his counsel.
Posted by: Steve Bradford | May 3, 2011 6:06:44 AM
All good points, Steve, but I would differentiate the Broz situation on a number of levels. First, while Mr. Broz did not present the opportunity officially to the board, he did seek an informal approval from CIS's CEO and a couple directors, who indicated CIS was not interested in the Michigan-2 franchise. Perhaps Sokol could draw a link had he alerted Buffett to his pending purchase, but he didn't.
Second, PriCellular was trying to acquire CIS, but it was not clear that deal would go through. (I know there are some who disagree with the court's interpretation of that, but it's what the opinion indicates.) My read of the Broz case is that the court felt that Mr. Broz did not take an opportunity from CIS as it was constituted at the time Mr. Broz bought Michigan-2, and that the possibility that Michigan-2 would be deemed an opportunity post-acquisition by PriCellular was not something the court was willing to require Mr. Broz to consider. It is through that lens I read the quote you provide.
Third, Broz was an outside director, and he found out about the opportunity in his role as President and 100% owner of RFB Cellular, Inc. While that does not mean it can't be a corporate opportunity, it is again different from the Sokol situation as I understand it.
I certainly concede there is some wiggle room, but I view it as very limited. I think a court is likely to take the view that "in connection with transactions related to his or her company" includes anticipated transactions in which Sokol had some significant influence. Sure, there is a risk the deal won't go through, but Sokol had a pretty good chance to push it through. In fact, as I have noted before, the risk that Sokol would push the deal through is one reason I think shareholders should be angry. I just don't think agency law allows agents off the hook because there is some possibility of risk the agent's violation of their duties will backfire. If it backfires, there's just no profits to recover.
Posted by: Josh Fershee | May 3, 2011 7:31:02 AM
FWIW, I agree with Josh. Mainly because of his third point. Broz was brought in as an outside director with the company knowing he was, in fact, a competitor. CIS was no longer in the business of acquiring cell franchises.
In contrast, Sokol is an executive. Berkshire's line of business in a very real sense is corporate acquisitions. I think that makes a huge difference.
Remember Ed Rock's argument that Delaware law is about saints and sinners. Broz was a saint. Sokol is a sinner.
Finally, with respect to the "in connection with transactions related to his or her company" issue, you might want to take a look at the note following Watteau v Fenwick in my Business Associations casebook and the discussion in the teacher's manual. If Humble was selling the cigars and Bovril for his own profit, why is he liable to the principal? Agency law as defined in the restatement (Second) requires that the agent act on the principal's behalf. Isn't Humble acting on his own behalf?
Posted by: Steve Bainbridge | May 3, 2011 12:06:53 PM
I think people are missing my point about Broz. There are dozens of relevant differences between Broz and Sokol's case. My point was simply that the Del. Supreme Court in Broz made it clear that whether something is a corporate opportunity (and presumably whether something is any other kind of duty of loyalty violation) has to be evaluated at the time Sokol made his decision to purchase. We cannot consider the fact that BH subsequently decided to negotiate a deal with Lubrizol; we cannot consider anything that happened between BH and Lubrizol after Sokol purchased. And Broz indicates a surprising (to me) sympathy for the defendant's need for certainty in deciding whether to pursue the opportunity. Having said all that, I'm still betting against Sokol, and my guess is Sokol will pay a sizeable amount, perhaps all of his profits, to settle with BH once BH takes over the case.
Posted by: Steve Bradford | May 3, 2011 12:36:07 PM
Steve (Bradford) -- I think we just have a different reading of the importance of what the court says needs to be assessed within the context of Broz. When the court says Broz did not need to consider the "prospective, post-acquisition plans for CIS in determining whether to forgo the opportunity or seize it for himself," I think the court was essentially saying that it would not extend the fiduciary obligations Broz owed to CIS to a potential, but not certain, acquirer (PriCellular).
As the Broz court explains: "At the time Broz purchased Michigan-2, PriCellular had not yet acquired CIS. Any plans to do so would still have been wholly speculative. Accordingly, Broz was not required to consider the contingent and uncertain plans of PriCellular in reaching his determination of how to proceed. . . . Broz, as an active participant in the cellular telephone industry, was entitled to proceed in his own economic interest in the absence of any countervailing duty." Thus, Broz needed certainty as to whether there was a fiduciary obligation at all -- the court says Broz owed a duty to CIS that he did not violate, and (because of the uncertain nature of the acquisition) did not owe a duty to PriCellular. For Sokol, he clearly had fiduciary obligations to BH before and after his purchase of Lubrizol, so I still see it as different.
Suppose Sokol was in real estate and part of his job was to find land to purchase for BH. Suppose he found a piece of land that he thought would be perfect for a building BH was planning, then went out and bought a 20% interest in the land. He then calls Buffett and says, "Hey, I found a great piece of land -- BH should buy it for the new building." If BH buys it, then finds out about Sokol's interest, I think it's clear Sokol would have to give up the profits. In determining liability, I just don't think a court would find it compelling that Buffett might have said "no thanks," thus sticking Sokol with the land he bought. That is, the fact that Sokol couldn't be certain Buffett would agree to buy the land would not be a shield against agency liability. I see this as analogous to one of the cases I use (from the Bainbridge, et al. BA book), General Automotive Mfg. Co. v. Singer (120 N.W.2d 659 (Wis. 1963)).
Maybe I'm wrong on that, but that's how I'm thinking about this. And now I know what one of my exam questions should have been.
Posted by: Josh Fershee | May 3, 2011 2:01:24 PM