Thursday, May 15, 2014

Leahy on Corporate Political Contributions as Bad Faith

Joe Leahy (South Texas) recently posted an early draft of an interesting article entitled Corporate Political Contributions as Bad Faith.  He would appreciate any comments readers care to share with him.  The abstract is included below:

A shareholder who files a derivative lawsuit to challenge a corporate political contribution faces long odds, particularly when the shareholder sues under traditional theories for breach of the duty of loyalty, such as waste or self-dealing. However, there is a better theory for a shareholder to employ when filing such a lawsuit: bad faith. Bad faith is a better basis for challenging a corporate political contribution than either waste or self-dealing because bad faith is a more flexible concept than self-dealing and a less difficult standard to satisfy than waste. Even if she intends no harm, a director acts in bad faith when she (1) takes official action that is motivated primarily by any reason other than advancing the corporation's best interests or (2) consciously disregards her fiduciary duties.

 

This Article identifies several examples of political contributions – both real and hypothetical – that are ripe for challenge as bad faith because they are made for reasons other than advancing the corporation's best interest. For example, a CEO acts in bad faith if she causes the corporation to make a contribution in support of her own political views or a friend who is running for office. However, in the absence of a "smoking gun," it will be difficult for a plaintiff to prove that the contribution was made for personal reasons rather than to advance the interests of the corporation.

 

To overcome the difficulty of proving motive, this Article offers a novel argument: essentially all corporate political contributions made by large, public corporations today constitute bad faith because they reflect management's conscious disregard for shareholders' political views. In our zero-sum, two-party political system, a board simply must know that a political contribution in support of a candidate from either major party will upset at least some shareholders. What's more, although the duty of loyalty typically demands that management consider the best interests of the corporation as a whole, not individual shareholders, a different rule should apply to political contributions. The policy rationales for vesting decisionmaking power in the board, rather than shareholders or courts, simply do not apply to political contributions. Political matters are outside of management's core competence and shareholders probably do not view management as a proxy for such matters. Further, political contributions differ greatly from most corporate spending, including charitable contributions. As a result, even if political contributions are not strictly ultra vires – i.e., beyond the corporate powers – they certainly verge on being ultra vires. When acting "in the vicinity of" ultra vires, the board's authority is at its lowest ebb; consulting the shareholders is necessary to shore up that authority.

 

If failing to poll the shareholders constitutes bad faith, boards wishing to contribute corporate funds in support of political candidates might nonetheless obtain protection of the business judgment rule in two ways. First, the board could submit a non-binding resolution to the shareholders at each annual meeting to gauge shareholder support for political contributions to each major party. Second, management could establish a good faith reason for not consulting the shareholders for a specific contribution – for example, it directly and unambiguously promoted the corporation's core business.

This article follows on Professor Leahy's related forthcoming Missouri Law Review article Are Corporate Super PAC Contributions Waste or Self-Dealing? A Closer Look.

http://lawprofessors.typepad.com/business_law/2014/05/leahy-on-corporate-political-contributions-as-bad-faith.html

Business Associations, Corporate Governance, Current Affairs, Haskell Murray | Permalink

Comments

Although there may be merit in asserting "bad faith" as in a derivative action, most organizations that I am acquainted with involve themselves in political contributions and "seed" both sides.

Posted by: Tom N | May 16, 2014 1:19:50 PM

As noted on my blog, I don't find his argument very persuasive. After all, as Chancellor Allen observed many years ago:

The corporation law does not operate on the theory that directors, in exercising their powers to manage the firm, are obligated to follow the wishes of a majority of shares. In fact, directors, not shareholders, are charged with the duty to manage the firm.... That many, presumably most, shareholders would prefer the board to do otherwise than it has done does not... afford a basis to interfere with the effectuation of the board's business judgment.

Paramount Communications Inc. v. Time Inc., Nos. 10866, 10670, 10935, 1989 WL 79880, at *30 (Del. Ch. July 14, 1989), aff'd, 571 A.2d 1140 (Del. 1990).

I see no reason that principle would not extend to political contributions.

Posted by: Stephen Bainbridge | Jun 4, 2014 11:05:16 AM

Professor Bainbridge:

Thank you for mentioning my article on your blog. I intended to respond there, but apparently I missed the window for commenting (as comments are now closed). I will therefore respond here instead. (Please feel free to cross-post my response to your blog.)

I heartily agree that the wisdom of Chancellor Allen that you quote above applies to all business decisions. However, Chancellor Allen’s quote is framed as a dichotomy: Should management follow the shareholders’ wishes or exercise its own business judgment? My view is that corporate political contributions are not business judgments. Therefore, the dichotomy does not apply here.

I realize that you disagree with this. Indeed, in an earlier (but alas, still forthcoming) article in the Missouri Law Review (see here: http://ssrn.com/abstract=2304852), I used one of your blog posts (see here: http://tinyurl.com/kgvtrnx) as my foil. In that post, you urged that:

"The basic problem [with shareholder challenges to corporate political contributions] is that corporate decisions about political expenditures differ neither in kind nor degree from any other decision to expend corporate funds. As such, there is no reason to think courts will – or should – treat the former class differently than they treat the latter."

Others scholars have, I believe, argued cogently that charitable contributions differ substantially enough from other business decisions that they ought to be treated differently. In my earlier article, I take the next step by exploring how corporate political contributions differ from even charitable donations. It is, in my view, not simply a matter of apples to oranges. It is apples to orangutans.

In the current article, I argue that, in addition to being wholly unlike ordinary business decisions, political matters are outside of management’s core competence. As such, one of the key arguments for the business judgment rule (and indeed, centralized management), simply does not apply.

Further, I argue that, in light of the history of restrictions on corporate political contributions to candidates for public office, shareholders probably do not view management as their proxy for electoral politics. That is to say, political contributions in support of candidates for public office fall outside of an implicit covenant between shareholders and management about what decisions shareholders have delegated to management. (In a future draft, I hope to expand on this argument by drawing on the history of the New York life insurance controversy, as described by your colleague, Professor Winkler, in his Georgetown Law Journal article.)

It may sound as if I am arguing that corporate political contributions are ultra vires. That is a tough argument to make, and I do not mean to go that far here. (I do expect to explore the question in a subsequent article, however.) For now, I simply urge that, even if political contributions are not technically ultra vires, they likely verge on being ultra vires in the view of many shareholders.

Therefore, the question with regard to political contributions in support of candidates for public office is not, as Chancellor Allen posed it, whether management should follow the shareholders’ wishes or exercise its own business judgment. Rather, the question is, when management makes what arguably is not a business judgment, and therefore acts in an area that shareholders likely believe is outside of management’s ambit, does management still have the same authority to act by fiat? I believe not. I urge that, where management is acting “in the vicinity of” ultra vires, its authority granted by DGCL § 141(a) is at its lowest ebb. Management must (or, at least, should) shore up that authority by consulting the shareholders.

Finally, I should address what may be an elephant in the room: If I believe that political contributions in support of candidates for public office are not business judgments, why am I not simply arguing that the business judgment rule does not apply to such contributions? In short, my paper would appear to be a timid first step, perhaps in the wrong direction, towards my goal. (A Van Gorkom, on the way to a Revlon, so to speak.) I understand this concern, and I should clarify something that I may not have made clear in the current draft of my paper: The foundation for my bad faith argument is not that political contributions in support of candidates for public office are not business decisions, per se. Rather, I mean to argue that many shareholders probably believe (and reasonably so) that political contributions are not business decisions.

Yet, ultimately, I do believe that political contributions are not, in fact, ordinary business decisions. So I must address the business judgment rule question head on.

As a result, I am currently writing a follow-up paper (tentatively) entitled Intermediate Scrutiny for Corporate Political Contributions. In that paper (an early work in progress), I argue that corporate political contributions in support of candidates for public office should not automatically be reviewed under the business judgment rule due to the “omnipresent specter” that such contributions are intended to advance management’s own interests rather than the corporation’s best interests. Therefore, I urge that courts should apply a test similar to Unocal’s enhanced business judgment review when evaluating such corporate political contributions. In short, when management causes the corporation to make a political contribution to a candidate for public office, management should be required to earn the protection of business judgment rule. (I am not by no means the first to suggest this idea in print, but I believe my article will be the first extended treatment of the idea.)

I am scheduled to present my working paper on Friday afternoon, June 20, at the National Business Law Scholars Conference in Los Angeles. If you are interested in hearing my argument (albeit in unfinished form), I hope you will consider attending my panel discussion. Either way, I will certainly send you a draft of my article when it is completed.

Best regards,
Joe Leahy

Posted by: Joe Leahy | Jun 5, 2014 12:07:36 PM

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