December 31, 2011
Litigation Pointer: Don't Mess With the Judge's Holiday
The Financial Times headline reads: Rakoff accuses SEC of misleading federal court. Stephen Bainbridge provides relevant commentary here and here. I thought I'd provide a taste of Judge Rakoff's order (emphasis added; hat tip: WSJ Blog):
On December 16, 2011, the SEC filed its original motion before this Court … seeking a stay pending appeal. The SEC expressly made the motion returnable December 30, 2011. Nonetheless, in the interest of expediting consideration of the motion, the Court, sua sponte … promised to … consider the matter on a more expedited basis than that originally proposed by the SEC. … The Court then spent the intervening Christmas holiday considering the parties' positions and drafting an opinion, so that it could file it on December 27, i.e., the first business day after the Christmas holiday (well before the December 30th date on which the SEC had originally made the motion returnable and well before any further proceedings in the case).
On December 27th, at around noon, without any notice to this Court and without inquiring as to when the Court was going to issue its decision, the SEC filed an “emergency motion” in the Court of Appeals, seeking a stay pending appeal or, in the alternative, a temporary stay, and representing that the motion was unopposed by Citigroup….
As the reason for proceeding on an emergency basis, the SEC stated that Citigroup had only until January 3, 2012 to answer or move to dismiss the underlying Complaint, and that “[i]f Citigroup files its answer, denying some or all of the allegations in the complaint, or if Citigroup moves to dismiss, challenging the complaint's legal sufficiency, it will disrupt a central negotiated provision of the consent judgment pursuant to which Citigroup agreed not to deny the allegations in the complaint.” This statement would seem to have been materially misleading ….
There appears to have been a similar misleading of this Court….
Accordingly, the Court is filing this Supplemental Order, both to make the Court of Appeals aware of this background and to attempt to prevent similar recurrences. Specifically, the parties are hereby ordered to promptly notify this Court of any filings in the Court of Appeals by faxing copies of any such filings to this Court immediately after they are filed in the Court of Appeals. In addition, this Court will send a copy of this Supplemental Order, as well as the Memorandum Order that it supplements, to the Court of Appeals with a request that they be furnished to the motions panel hearing the stay motion on January 17, 2012.
The "Shell Company" Controversy: Energy Version
Earlier this week, I was quoted in a Reuters story about a large energy company's use of smaller a "shell company" in making leases for a potential shale play in Northern Michigan. (MSNBC picked it up here, with the title: "Oil giant's shell game nets elderly farmers: Promises made, but not kept, and it's all legal."
The article explains:
Legal scholars say the operation serves as an intriguing test case of the use of shell companies.
The tactics "raise moral and ethical questions about how entities can be used," says Joshua Fershee, a contract law professor at the University of North Dakota.
Others, including Chesapeake, defend the need to use shell companies and front companies - contractors with local ties who do business on behalf of a larger corporation. John Lowe, a professor of energy law at Southern Methodist University, calls it "business as usual."
(Side note: I'm really a business and energy law professor, not a contracts professor.) From the quote, it may appear that John Lowe and I disagree, but I don't suspect we do. I stand by my quotes -- I do think the apparent use of a smaller shell company in this case raises some moral and ethical questions, as well as legal ones. But I, too, believe that larger corporations can and should be able to use smaller companies for a variety of ends, including creating local ties and managing the larger entity's risk. Still, there are boundaries.
The MSNBC article title notes that promises weren't kept, but "it's all legal." I'm not sure that's true in this case, but it's true it is legal to use smaller entities to manage risk. That shouldn't be a problem. That doesn't mean it's legal to commit fraud. So, for example, if the large entity created a small entity to take out leases and speculate on the land, it's probably legal. The entity can create a company to try new ventures like any of the rest of us. If, on the other hand (and as an example), the entity created a small LLC, instructed the LLC to draft leases with specific flaws or otherwise use deceptive practices so that the entity would only need to pay if the shale play was viable, that could certainly be a problem.
Furthermore, if the smaller entity was created to act as agent for the large entity, there may be liability for the larger entity as principal. And if the smaller entity were an alter ego of the larger entity, there may be a veil piercing opportunity if the smaller entity doesn't have the funding necessary to cover its debts. (Whether veil piercing is proper here is different than whether it's possible.)
One of the complaints here is that the large entity used a small "local" company to entice landowners to do business with the local entity over other companies. Of course, if it were so important that the landowner work with a local person solely, the landowner could contract for that protection by limiting transferability or adding some other change in control provision. That would reduce the value of the lease, but if it matters that much, ask for it. If you take the local person at his or her word, then you have signed up for the risk that your ability to judge character wasn't that good.
Ultimately, I can't tell whether this is a case of lessors wanting more than they bargained for or if it's a case of a large entity using a subsidiary lessee to speculate without taking on any concomitant risk. Frankly, it sounds like a little of both, but the facts available are limited.
Last July, when Reuters published another of story in a series on the use of shell companies, I said this:
[Another] thing worth mentioning is that corporations and LLCs are not inherently evil. Sure they can be used to help facilitate some bad things, but it doesn't take a corporation or an LLC to do evil. Individuals, sole proprietorships, and partnerships can all be pretty scummy, too. It has to do with the people running them, not an entity form.
I'm all for a little monitoring of bad behavior, but a some self policing can help, too. Among the reasons people claim to want to form a company is to make it look like their operation is bigger or more established. Before doing business with anyone, we all need to do our due diligence. Check financials and get personal guarantees if that's necessary. And if we don't care to check, then caveat emptor is still usually an appropriate rule. And if we do check, and it's a well-played scam, well, it's not the entity that is the problem. It's criminal behavior, that happened because of the criminal, not the corporate code.
I'd add to that that even if it's not criminal behavior, it may be traditional civil fraud, and that creates liability for the perpetrator, too. I am not naive -- I have noticed that corporations and LLCs can do bad things, and because they are often larger and have more resources than individuals, the harm can be broader. But people are not incapable of gathering information. At least some of the complaints about the "evil entity" are really complaints that we can't always get what we want. Unfortunately that's true, but if we get what we bargained for, we don't have a lot of room to complain about the legality of entities, even if we did deal with a scummy person.
December 29, 2011
15% Contingency Fee Award Spurs Discussion
The Wall Street Journal Law Blog discusses the $300 million plaintiffs’ attorneys’ fees awarded by a Delaware court in the Southern Peru Copper Corporation Shareholder Derivative Litigation here. (Our own Josh Fershee previously commented on the merits of this case here.) Stephen Bainbridge noted a few days ago that “there are a lot of folks in Delaware who are happily expecting this decision to encourage plaintiffs to come back to Delaware.” He quotes Jonathan Macey and Geoffrey Miller as explaining that “in Delaware well-intentioned judges can be expected to devise legal rules requiring that Delaware lawyers be consulted when important decisions are to be made. Moreover, if Delaware judges believe that the state judicial system well serves Delaware corporations, they will be more likely to approve rules that stimulate litigation in the Delaware courts.” But the Macey and Miller quote that caught my attention was this one: “The members of the Delaware Supreme Court are drawn predominantly from firms that represent corporations registered in Delaware.” Just for the fun of it I decided to search for this quote in other law reviews on Westlaw. Here’s what I found:
1. The inability of any province to fashion a provincial jurisprudence is also a function of the manner in which judges are appointed. In Delaware, as in other states, judges are state appointees. This ensures that the state can choose judges who will be sympathetic to corporate managers. As Macey & Miller (1986, p. 502) observe, “[t]he members of the Delaware Supreme Court are drawn predominantly from firms that represent corporations registered in Delaware. The bar and the judiciary are tied together through an intricate web of personal and professional contacts.” As a result, Delaware “judges are specialized in resolving corporate law disputes and as a consequence, the state can offer firms access to a system of corporate law rules that is stable, predictable and sophisticated relative to that of other states” (Macey & Miller, 1986, p. 500). Moreover, because judicial appointments are a state matter, the state can decline to renew the appointment of a judge who does not decide cases in a manner suitably sympathetic to corporate concerns. Douglas J. Cumming & Jeffrey G. MacIntosh, The Role of Interjurisdictional Competition in Shaping Canadian Corporate Law, 20 Int'l Rev. L. & Econ. 141, 157 (2000).
2. Although judges obviously are more isolated from interest group influences than legislators, Delaware's justices are likely to reflect the interests of the corporate bar. The most obvious source of sympathy is the judicial selection process. As described earlier, the Delaware bar plays a central role in selecting justices, and it can be expected to recommend individuals who have a natural affinity to the corporate bar. This natural inclination is amply borne out by even a cursory look at who is ordinarily selected to sit on the supreme court. Nearly all of the justices, both currently and as a historical matter, were members of the Delaware bar before donning judicial robes. David A. Skeel, Jr., The Unanimity Norm in Delaware Corporate Law, 83 Va. L. Rev. 127, 158 (1997) (quoting Macey & Miller in accompanying footnote).
Not exactly ringing endorsements of objectivity.
December 28, 2011
"Shareholder Primacy" in Delaware Still Only Matters When Buyers Benefit
Steven Davidoff notes, For Wall Street Deal Makers, Sometimes It Pays to Be Bad. He focuses on J.Crew’s $3 billion buyout management buyout and Del Monte Foods’ $5.3 billion acquisition by KKR, Vestar Capital Partners and Centerview Capital. Davidoff notes that a Delaware court found J Crew management's behavior to be “icky” and another Delaware court heavily criticized the Del Monte deal. Nonetheless, the deals went forward.
Davidoff says that the current state of the law makes it hard to come up with a penalty to to deal with bad behavior. He explains:
[T]he problem is what to do about the penalty. Depriving shareholders of a buyout, even at a bad price, would punish them.
He's right, but if you go back to poison pill cases, see, e.g., the Airgas decision, you can see that Delaware courts are willing to deprive shareholders of a buyout, as long as management wants to keep the deal from shareholders, even for an all-cash deal. As I have noted before, "I can't see a good justification for not presenting an all-cash offer to shareholders once . . . ample time has been given to entice other potential bidders into the game."
Anyway, I share Professor Davidoff's view that we need a good penalty, but I happen to think the big issue is that there is a lack of willingness, not ability. I mean, Delaware courts are really, really good at this corporate governance thing.
Maybe the answer to create a sort of shareholder's business judgment rule for all-cash deals. That is, after adequate time for gathering other offers has passed, we add a blanket rule that all, all-cash deals that offer a premium over the current trading price will be presented to shareholders (along with management's explanantions and recommendations). This would operate like a sort of all-cash Revlon trigger. I can imagine a scenario where shareholders might choose the wrong option in such a case, but I think part of shareholder primacy includes, from time to time, respecting possible shareholder stupidity.
December 26, 2011
The Ribstein Model
The passing of Larry Ribstein caught everyone off guard, and I'm not sure I have much to add. Nonetheless, the sense of loss I feel in his learning of his passing compels me to write something. So here it is:
Even without meeting him, Professor Ribstein taught me how I can be a better scholar. If he had something to say, he wrote an article or a blog post about it (usually both, it appears). He wrote with others, assisted countless more in their efforts, and still found time to seek out new opportunities. And he worked to ensure that his efforts were understood in context, not just cited.
Earlier this year, Professor Ribstein wrote an amicus brief in Roni v. Afra, a New York case regarding fiduciary duties in LLCs. In the brief he responded to criticisms that he was an "extremist." He wrote:
Instead of citing cases and authorities relevant to my arguments, including my distinction between LLCs and corporations, Respondents attack my reputation by falsely labeling me as an extremist (p. 26 n.25). My national reputation discussed above should amply refute this characterization. In any event Respondents' culling of thousands of blog posts and hundreds of articles produces three pieces of evidence that are not only irrelevant to the issues in this case but do not support Respondents' characterization of my positions. One cited post takes a position on market efficiency supported by mainstream finance experts, another aligns with the position of a majority of the U.S Supreme Court, and the only article cited is completely mischaracterized in a way that suggests that Appellant was misled by its ironic title and did not actually read it.
I did not know Professor Ribstein, but I loved reading his work in books, articles, and blogs. He was deliberate, careful, and specific, and he said what he thought. This amicus brief was no different. He analyzed the issues, explained his reasoning, and confronted what needed to be confronted. He wasn't afraid to say when he disagreed, but he didn't look for more conflict than was necessary. He understood the difference between argument and arguing.
The loss of his scholarly impact pales in comparison to the loss his friends and family are experiencing, and I share my deepest condolences. By all accounts I have seen, his was a life well-lived, scholarly and personally, and not necessarily in that order. He will be missed, and I'm glad to have been a contemporary, even if it was not for long enough.
December 25, 2011
The Inspiring Kindness of Larry Ribstein
If you haven't heard, Larry Ribstein passed away unexpectedly yesterday. The outpouring of condolences reflects his immense stature in the academy. As a relatively young scholar with overlapping interests, my own interactions with him were limited but nonetheless significant to me. What I remember most is that he never allowed whatever ideological differences we may have had to stop him from taking the time to respond to my queries. In fact, he even thanked me in one of his recent papers, and I can only attribute that to pure kindness--a little pat of encouragement--because I seriously doubt I could have added much of anything to his writing in light of his expertise and the brilliant scholars he clearly had close relationships with. Thus, while there is obviously much in terms of scholarship that Larry is worth remembering for, what I will primarily remember him for is his inspiring kindness.
PS--I think it is worth adding here, particularly in light of the recent civility tiff, that this willingness to spend time helping a young scholar regardless of ideology is something that I have witnessed emanating from a number of respected scholars throughout the academy (Stephen Bainbridge, in particular, comes to mind--but there are numerous others), and it is something that makes me feel very hopeful about our profession, and very grateful and proud to be a part of it.