Business Law Prof Blog

Manesh on Contractual Freedom Under Delaware Alternative Entity Law

Mohsen Manesh has posted “Contractual Freedom under Delaware Alternative Entity Law: Evidence from Publicly Traded LPs and LLCs” on SSRN.  Here is the abstract:

Notwithstanding the ongoing academic debate, little is known empirically about how unincorporated alternative entities - LLCs and LPs - actually utilize the contractual freedom afforded under Delaware law. To what extent do alternative entities take advantage of contractual freedom to wholly eliminate fiduciary duties? And to what extent do alternative entities employ so-called “uncorporate” substitutes - certain contractual devices designed to discipline and incentivize mangers - in lieu of fiduciary duties? In response to calls for empirical evidence on this issue, this study analyzes the operating agreements of every publicly traded Delaware alternative entity in existence as of June 2011. This study, the first of its kind, provides a snapshot of contractual freedom as it is applied under Delaware alternative entity law.

In particular, this study finds that the use of fiduciary waiver and exculpation provisions among publicly traded Delaware alternative entities is widespread. Yet, despite the widespread use of such provisions, this study also finds that publicly traded alternative entities have either failed to adopt uncorporate substitutes or adopted uncorporate substitutes that only trivially constrain managerial discretion. Thus, this study suggests that publicly traded alternative entities have largely utilized the freedom of contract to reduce managerial accountability to investors without committing to significant offsetting constraints on managerial discretion.

SJP

Another Meaningless Question: Has the Check Cleared?

The New York Court of Appeals has decided that the term "cleared"  with regard to a bank check is ambiguous. Greenberg, Trager & Herbst, LLP v HSBC Bank USA,  2011 NY Slip Op. 07144 (Oct. 13, 2011). H/T Above the Law & Eric Turkewitz) 

From the opinion:

On September 27, 2007, a [Greenberg, Trager & Herbst, LLP (GTH)] partner called a representative of HSBC inquiring as to whether the check had "cleared" and if the funds were available for disbursement.[*4]According to GTH, a five year banking relationship existed between them. GTH was informed that the funds were available. Later that day, GTH wired $187,500 from its account to Hong Kong pursuant to the wiring instructions it received from Northlink. GTH claims that, but for the assurance that the check had "cleared," it would not have forwarded the funds. On September 28, 2007, HSBC confirmed to GTH that the wire transfer had been consummated.

On October 2, 2007, HSBC received an EARNS notice from Citibank that the check was being dishonored as "RTM [return to maker] Suspect Counterfeit." An HSBC Branch Manager later contacted GTH, informing them that the check had been dishonored and returned as counterfeit. HSBC then revoked its provisional settlement and charged back GTH's account.

. . . .

GTH's claim is based on the alleged oral statement by the HSBC representative that the check had "cleared" — an ambiguous remark that may have been intended to mean only that the amount of the check was available (as indeed it was) in GTH's account. Reliance on this statement as assurance that final settlement had occurred was, under the circumstances here, unreasonable as a matter of law. (footnote omitted)

Wow.  I would have thought that was the right question to ask, too.  The dissent explains:

HSBC makes much of the fact that the word "cleared" is not found in the UCC and the majority finds it to be ambiguous. However, UCC § 1-205 defines "course of dealing and usage of trade" as encompassing "any practice or method of dealing having such regularity of observance in a place, vocation or trade as to justify an expectation that it will be observed with respect to the transaction in question" (UCC § 1-205 [2]). The term "cleared" is used liberally in the banking business. Indeed, the Federal Trade Commission in a bulletin addressed to consumers states that "it's best not to rely on money from any type of check . . . unless you know and trust the person you're dealing with or, better yet — until the bank confirms that the check has cleared" (Federal Trade Commission Facts for Consumers, Giving the Bounce for to Counterfeit Check Scams, http://www.ftc.gov/bcp/edu/pubs/consumer/credit/cre40.pdf [January 2007]). Therefore, I disagree with the majority's position that relying on this statement was unreasonable as a matter of law (see majority op at 16)^[FN9]. I suspect many business professionals would have done the same thing as Trager. . . . 

Footnote 9: If the term “cleared” means anything in common banking usage, it is that final settlement has occurred (see Black's Law Dictionary [9th ed 2009] [defining the term as it relates to a bank as "to pay (a check or draft) out of funds held on behalf of the maker (the bank cleared the employee's check)"] [defining the term as it relates to "a check or draft" as "to be paid by the drawee bank out of funds held on behalf of the maker (the check cleared yesterday)"]). 

I agree that a lot of business professionals would have done the same thing, too.  If "cleared" is too ambiguous, what would I ask my banker? The majority doesn't suggest what would have been the proper question.  Does the bank never have to tell me if the money is really mine or not?  I just have to guess?   It appears so.  The courts explains that "GTH was in the best position to guard against the risk of a counterfeit check by knowing its client."  

Silly me.  I had always thought the bank, at some point, would be able to tell me whether a check was good or not, even if it came from a Nigerian prince or someone seeking help collecting on a divorce settlement "in my jursidiction."  I mean, this is all electronic -- if nothing else, isn't there a time when the bank knows the money is real?  It's one thing for a bank to say, "The money is available to you now, but we won't know for sure the money was actually transferred and available for X days, so you proceed at your own risk."  

I am no banking expert, but I do know there is a lot of nuance to all of this.  It just seems to me that the people in the best position to prevent this kind of loss, are the people who understand this nuance.  Why not have a rule that requires banks to tell it like it is, or at least say, "We're not sure, either."?  The reason the banking system works, and e-commerce has been so successful is because we can count on it. This decision says to me you can until you can't. Talk about ambiguous. 

--JPF 

BLPB Nominated for LexisNexis Top 25 Business Law Blogs of 2011

We made the top 25 last year.  Please vote for us again this year here.

SJP

Lin & Zhang on Price Implications of Privatizing Airports

Ming Hsin Lin (Osaka University of Economics - Faculty of Economics) & Yimin Zhang, Airline Pricing and Airport Charges in Hub-Spoke Networks with Congestion.  As someone who lives in a small airline market (served by a "spoke airport"), this article is of particular interest. Grand Forks International Airport (GFK) features the new Byron L. Dorgan Terminal, which cost of "$24.9 million, $18 million of which was federal funds Senator Dorgan helped secure."  GFK is served primarily by Delta, which means you can get almost anywhere in the world from here, as long as you go through Minneapolis.  And that "flexibility" comes at a premium.

This article is also worth a look because airlines are a classic regulated industry, even though much has changed over the years. Here's the abstract:      

This article investigates airline pricing and airport congestion charges in hub-spoke networks. When a public hub airport and two public spoke (local) airports independently levy their charges, airlines will eventually set a ticket price that overcharges the passengers for congestion delay cost and overcompensates for airline markups. Privatizing only local airports will always lead to more overcharge, whereas privatizing only the hub airport or all airports could result in lesser overcharge if the network markets are competitive. The degree of overcharge under a private hub and public local airports is always lesser than that under a public hub and private local airports, implying that privatizing a hub airport could yield higher social welfare than privatizing a local airport. Furthermore, investigation on compensation for airline markups also finds that privatizing a hub airport is preferable to privatizing a local airport. These findings have policy implications for airport privatization.

--JPF

Volcker Rule Proposed by the SEC

 

More than a year after the passage of Dodd-Frank, the S.E.C. voted today to propose a rule to implement section 619 of the Dodd-Frank Act, commonly known as the "Volcker" rule.  The Volcker Rule under Dodd-Frank generally prohibits federally-insured banks and their affiliates from engaging in derivative trading for the bank's own account.  Dodd-Frank also prohibits banks from owning or having a substantial relationship with a hedge fund or private equity fund. The SEC proposed rules seek to fulfill this mandate by requiring institutions trading in derivatives to report quantitative measurements to the SEC while also allowing for a broad range of exemptions to the registration and reporting requirements under the rule. (SEC Press Release; Commissioner Shapiro's comments on the Volcker Rule).  The SEC, which is acting in concert with the FDIC, Federal Reserve, and the OCC, will be taking comments on the proposed rule until January 13, 2012-- both the text of the proposed rule and the comment process are available here.

SSRN has a laundry list of articles dissecting Dodd-Frank, but here are a few that are focused on the Volcker Rule:

• Charles Whitehead (Cornell), The Volcker Rule & Emerging FInancial Markets
• Andrew Tuch (a Harvard SJD candidate), Conflicted Gatekeepers
• Hrishikesh Vinod (Fordham Econ Dept.), Financial Reform, Innovative Hedging and the Volcker Rule

--Anne Tucker

 

Discount M&A

Discount chains seem to be a hot source of M&A action this year.  Admittedly, I don’t know if this reflects a trend of generating higher-value within discount firms post-recession, or if there has traditionally been movement of this same nature within the industry.  

Today’s inquiry was prompted by news that the 99 Cent Only chain of stores agreed to a $1.6 billion dollar acquisition by Ares Management LLC and the Canada Pension Plan Investment Board who hope to find a permanent buyer for the company within 6 months.  For up-to-the minute financials and company information, check out the stats on 99 Cent Only (trading as NDN).  After a volitale month, the stock is trading high on the news of the merger.

99 Cent Only is not the "only" discount brand in play right now.  Earlier this year Big Lots (financials available here) was rumored to be for sale, but then acquired Liquidiation World, a Canadian discount retailer with 98 stores for $1.8 billion.  The initial news that Big Lots was being investigated by a Goldman Sachs client triggered rising stock prices in competitive discount chains like Family Dollar. In February of 2011, Family Dollar rejected a hedge fund bid (and adopted a 10% poison pill cap), but is now back in the M&A news as Bill Ackman's hedge fund has recently doubled its ownership interest in the company and is now courting Dollar General as a potential buyer.

Below is a snapshot of discount/value stores' trading performance today.

The industry as a whole is having a strong second and beginning of a third quarter, has been the subject of M&A action, and continues to trade well.  It will be interesting to see what else happens within this industry and how its performance continues for the remainder of 2011.

-Anne Tucker

How North Dakota Became Saudi Arabia & How to Keep It That Way

The Wall Street Journal's recent Weekend Interview was of particular interest to me, and I thought it worth mentioning.  The article was titled, How North Dakota Became Saudi Arabia: Harold Hamm, discoverer of the Bakken fields of the northern Great Plains, on America's oil future and why OPEC's days are numbered.

It's an interesting interview with Harold Hamm, who is the founder and CEO of Continental Resources. Mr. Hamm is certainly a leader in the U.S. oil resurgence, and his views carry a lot of weight in many circles. His facts are hard to refute, though I might put a little different spin on it.  Here's a key part of the article:

One reason for the [U.S. oil industry] renaissance has been OPEC's erosion of market power. "For nearly 50 years in this country nobody looked for oil here and drilling was in steady decline. Every time the domestic industry picked itself up, the Saudis would open the taps and drown us with cheap oil," he recalls. "They had unlimited production capacity, and company after company would go bust."

This is certainly true. OPEC cannot dictate the market in the same way as they once could, because the market for oil has increased so dramatically, especially in India and China. As such, increased production will simply lead to modestly lower prices, as emerging markets take all the oil the market is willing sell. The article continues: 

Today OPEC's market share is falling and no longer dictates the world price. This is huge, Mr. Hamm says. "Finally we have an opportunity to go out and explore for oil and drill without fear of price collapse." When OPEC was at its peak in the 1990s, the U.S. imported about two-thirds of its oil. Now we import less than half of it, and about 40% of what we do import comes from Mexico and Canada. That's why Mr. Hamm thinks North America can achieve oil independence.

This is true, too, although there is an implication here that OPEC is no longer a factor.  That's not true, just because their market share had dropped. Most certainly, OPEC's ability to impact price in the ways it did in the 1970s, 1980s, and 1990s, has been diminished.  Still, OPEC is a power player, and the revenues U.S. oil companies are seeing are coming into OPEC, too.  After all, it's nice to have 80% market share of a $1 million industry, but it's better to have 20% of $10 million market.  Of course, here were talking about a lot more zeroes than that.  

Further, oil independence has its appeal, certainly, but it's not all it might seem.  In this instance, the only reason we might be able to achieve independence from foreign-sourced oil is because oil prices are so high.  Are we really better off being energy independent with oil at $90 per barrel, or would the U.S. economy be better served with Saudi oil at $25 per barrel?  At $25 or even $50 per barrel, the broad-scale U.S. oil industry can't compete with other world producers.  

But the market has changed. Mr. Hamm is right that the U.S. oil industry doesn't need to worry about the boom-and-bust cycle of years past because the price is not going back to $25 per barrel.  The new market is great for him, great for those with new jobs, and great for those cashing royalty checks. And it's been great for many parts of North Dakota. I appreciate all of that, and I think regulators, politicians, and citizens should be looking at these facts as they consider energy and other economic policy.

Mr. Hamm finally argues that taxes are likely to stop drilling.  He explains:

The White House proposal to raise $40 billion of taxes on oil and gas—by excluding those industries from credits that go to all domestic manufacturers—is also a major hindrance to exploration and drilling. "That just stops the drilling," Mr. Hamm believes. "I've seen these things come about before, like [Jimmy] Carter's windfall profits tax." He says America's rig count on active wells went from 4,500 to less than 55 in a matter of months. "That was a dumb idea. Thank God, Reagan got rid of that."

Here's where we diverge. I am not arguing that President Carter's windfall profits tax had an impact -- it was not good policy at the time.  But that was in part because of OPEC's market power.  The U.S. oil industry was operating in the zone where the profit margin was such that the tax rate could impact drilling.  From what I understand, most North Dakota oil drilling is profitable with oil at about $65-$70 per barrel. Thus, at $85 per barrel, there's a lot of room to increase taxes without having an impact on the drilling. I'm not suggesting that a large new tax would be a great move, but it's not likely to have the dire consequences it could have had in years past. I'm at least okay with the status quo here. Perhaps we would get more drilling if we added more incentives to oil exploration, but my suspicion is that we would be rewarding people for doing what they were going to do anyway. 

I think the energy industry, including traditional resources, is vital to U.S. economic interests, and I think our policies should support the current growing and evolving oil and gas industry. I happen to think there is room for everyone.  My biggest worry for the oil and gas industry is that someone gets careless with their new drilling methods and causes a major environmental disaster. The harm to the environment would be a major concern, of course, but I think most people want that protected.  This is not news.

The greater harm to the industry, and the economy, though, of such a disaster is often missed.  The economic key to this oil and gas boom is to keep it going -- and the biggest threats are no longer OPEC, taxes, or the electric car.  It's an environmental disaster that leads to a large-scale shutdown.  That would be the ultimate lose-lose situation. 

--JPF

Pending Sales & Market Price

A phenomenon that is both interesting and difficult to explain to students in a general corporations class is the potential effect that a future sale can have on the value of a firm.  This is true in terms of both privately and publically held investments, although we can see the effects of this most clearly in terms of trading share price on the open market.  To this end, I discovered a great website MergerInvesting.com that tracks the stock value of companies with pending mergers (and well as performance of companies with mergers closed in recent years). See the screenshots below.

Pending 2011 Mergers

 

2010 Mergers

 
 

If you want to investigate a merger further, you can click on the symbol which takes you to a page with summary information on the merger, and a list of corresponding headlines, etc. 

 

This is a great find for teaching tools and there are endless data sets contained within website. Anyone doing research on mergers that can corresponded to share price—this website will be a great resource for you.

-Anne Tucker

 

 

 

Occupy Sesame Street

It had to happen. It was only a matter of time. Occupy Sesame Street.

-Steve Bradford

The Failure to Regulate as Success

H.R. 2308, the “SEC Regulatory Accountability Act,” would establish a significant number of additional specific standards for cost-benefit analyses for Commission rules and orders.  Said SEC Chairperson Mary Shapiro:

My fear about this legislation is that it layers so much analysis on top of what we already do that we’re set up to fail.  There is no way this agency or any other agency could do all of these things, some of which conflict.

Well, perhaps not so much “fail” as “fail to regulate.”  To some that’s failure, to others that’s success.

SJP