Friday, December 6, 2013
There's an interesting slide show available on Forbes, 10 Terms You Must Know Before Raising Venture Capital.
It's interesting, but it overlooks the most important thing entrepreneurs should know before raising venture capital: the need to hire an experienced lawyer. Learning the terminology won't substitute for representation by someone who knows what he or she is doing.
Tuesday, December 3, 2013
Here in West Virginia, it's exam time for our law students. For my Business Organizations students, tomorrow is the day. For students getting ready to take exams, and for any lawyers out there who might need a refresher, the Kentucky Supreme Court provides a good reminder that LLCs are separate from their owners, even if there is only one owner.
Here's a basic rundown of the case, Turner v. Andrew, 2011-SC-000614-DG, 2013 WL 6134372 (Ky. Nov. 21, 2013) (available here): In 2007, an employee of M&W Milling was driving a feed-truck owned by his employer. A movable auger mounted on the feed-truck swung into oncoming traffic and struck and seriously damaged a dump truck owned by Billy Andrew, the sole member of Billy Andrew, Jr. Trucking, LLC, which owned the damaged truck. Andrew filed suit against the employee and M & W Milling claiming personal property damage to the truck and the loss of income derived from the use of damaged truck. Notably, the LLC was not a named plaintiff in the lawsuit.
Hey issue spotters: check out the last line of the prior paragraph. (Also: a bit of an odd twist is the Andrew chose not to respond to discovery requests, though that was not critical to the issue of whether the LLC had to be named for Andrew to recover.)
A limited liability company is a “hybrid business entity having attributes of both a corporation and a partnership.” Patmon v. Hobbs, 280 S.W.3d 589, 593 (Ky.App.2009). As this Court stated in Spurlock v. Begley, 308 S.W.3d 657, 659 (Ky.2010), “limited liability companies are creatures of statute” controlled by Kentucky Revised Statutes (KRS) Chapter 275. KRS 275.010(2) states unequivocally that “a limited liability company is a legal entity distinct from its members.” Moreover, KRS 275.155, entitled “Proper parties to proceedings,” states:
A member of a limited liability company shall not be a proper party to a proceeding by or against a limited liability company, solely by reason of being a member of the limited liability company, except if the object of the proceeding is to enforce a member's right against or liability to the limited liability company or as otherwise provided in an operating agreement.
Not surprisingly, courts across the country addressing limited liability statutes similar to our own have uniformly recognized the separateness of a limited liability company from its members even where there is only one member.
Sunday, December 1, 2013
- Matteo Tonello on “The Separation of Ownership from Ownership”
The increase in institutional ownership of corporate stock has led to questions about the role of financial intermediaries in the corporate governance process. This post focuses on the issues associated with the so-called “separation of ownership from ownership,” arising from the growth of three types of institutional investors, pensions, mutual funds, and hedge funds.
- Frank Reynolds: “Delaware must fix state takeover law now, law professor warns”
Originally, the anti-takeover law passed its court challenges because the judges accepted faulty data that showed investors could acquire at least 85 percent of the target corporation and satisfy the Williams Act, Subramanian said. But none of the cases used to support the anti-takeover law actually allowed hostile suitors to acquire a controlling 85 percent of a target company, he said, and plaintiffs using research from new studies would be able to convince a judge that the statute is unconstitutionally restrictive.
- Pascal-Emmanuel Gobry: “Let’s Listen to Pope Francis on Economics”
For me, the financial crisis was an eye-opening moment. I’ve long believed in free market economics and believed that the Church would do a lot of good in the world if it embraced it. And I still believe those things. But what the financial crisis has laid bare is that the most conventional version of free market economics was actually dead wrong.
- Martin Lipton: “Some Thoughts for Boards of Directors in 2014”
In many respects, the relentless drive to adopt corporate governance mandates seems to have reached a plateau: essentially all of the prescribed “best practices”—including say-on-pay, the dismantling of takeover defenses, majority voting in the election of directors and the declassification of board structures—have been codified in rules and regulations or voluntarily adopted by a majority of S&P 500 companies…. In other respects, however, the corporate governance landscape continues to evolve in meaningful ways.
Thursday, November 28, 2013
On Saturday evening I leave for Geneva to attend the United Nations Forum on Business and Human Rights with 1,000 of my closest friends including NGOs, Fortune 250 Companies, government entities, academics and other stakeholders. I plan to blog from the conference next week. I am excited about the substance but have been dreading the expense because the last time I was in Switzerland everything from the cab fare to the fondue was obscenely expensive, and I remember thinking that everyone in the country must make a very good living. Apparently, according to the New York Times, the Swiss, whom I thought were superrich, "scorn the Superrich," and last March a two-thirds majority voted to ban bonuses, golden handshakes and to require firms to consult with their shareholders on executive compensation. Nonetheless, last week, 65% of voters rejected a measure to limit executive pay to 12 times the lowest paid employee at their company. According to press reports many Swiss supported the measure in principle but did not agree with the government imposing caps on pay.
Meanwhile stateside, next week the SEC closes its comment period on its own pay ratio proposal under Section 953(b) of the Dodd-Frank Act. Among other things, the SEC rule requires companies to disclose: the median of the annual total compensation of all its employees except the CEO; the annual total compensation of its CEO; and the ratio of the two amounts. It does not specify a methodology for calculation but does require the calculation to include all employees (including full-time, part-time, temporary, seasonal and non-U.S. employees), those employed by the company or any of its subsidiaries, and those employed as of the last day of the company’s prior fiscal year. A number of bloggers have criticized the rule (see here for example), business groups generally oppose it, and the agency has been flooded with tens of thousands of comment letters already.
The SEC must take some action because Congress has dictated a mandate through Dodd-Frank. It can’t just listen to the will of the people (many of whom support the rule) like the Swiss government did. It will be interesting to see what the agency does. After all two of the commissioners voted against the rule, and one has publicly spoken out against it. But the SEC does have some discretion. The question is how will it exercise that discretion and will the agency once again face litigation as it has with other Dodd-Frank measures where business groups have challenged its actions (proxy access, resource extraction and conflict minerals, for example). More important, will it achieve the right results? Will investors armed with more information change their nonbinding say-on-pay votes or switch out directors who overpay underperforming or unscrupulous executives? If not, then will this be another well-intentioned rule that does nothing to stop the next financial crisis?
Wednesday, November 20, 2013
I was recently asked to evaluate a corporation’s obligation to indemnify a director named in a derivative suit initiated by the corporation alleging that the director usurped corporate opportunities. The MBCA establishes a standard framework for optional and mandatory indemnification of directors and officers, sets the appropriate boundary of indemnification obligations (i.e,. no reimbursement of derivative suit settlements or intentional misconduct), establishes the procedures for indemnification and advancement of expenses, and provides mechanisms for directors to enforce their indemnification rights through court orders. The standard procedures for indemnification require the corporation to authorize the indemnification and make a determination that the conduct at issue qualifies for indemnification.
MBCA § 8.55 Determination and Authorization of Indemnification
(a) A corporation may not indemnify a director ….[until after] a determination has been made that indemnification is permissible ..[and].. director has met the relevant standard of conduct ….
(b) The determination shall be made:
(1)…. a majority vote of all the qualified directors…., or by a majority of the members of a committee;
(2) by special legal counsel ….or
(3) by the shareholders, but shares owned by or voted under the control of a director who at the time is not a qualified director may not be voted on the determination.
(c) Authorization of indemnification shall be made in the same manner as the determination that indemnification is permissible…..
The determination is tricky for advanced expenses because the determination is made before the adjudication and with limited facts. Yet, as the comments to the MBCA reflect, access to advance funds is often necessary to provide directors/officers with full protection because few individuals have personal resources to finance potentially complex and protracted litigation. Some states, like Georgia OCGA § 14-2-856 and Delaware § 145, broaden the indemnification provisions established in the MBCA by providing procedures for shareholder agreements to expand the scope of corporate indemnification obligations and avoid the “determination” of complying conduct required under the MBCA. A writing mandating an advance of expenses creates a vested right that cannot be unilaterally terminated. More importantly, statutes that recognize a vested right to advanced expenses avoids the requirement of a determination regarding the advance, which will often constitute a self-dealing transaction (director named in suit and seeking advance, also votes on determination of conduct qualification for indemnification) and therefore requires the entire fairness evaluation.
The expanded indemnification statutes raise all sorts of interesting questions about the scope of indemnification (the Georgia statute for example is intended to expand the scope to possibly include derivative suit settlements and fines), the process required for the mandatory advances (i.e., whether a shareholder vote approving the obligation can later be attacked because a defendant, who is now conflicted, voted shares in favor of the obligation), and whether these provisions violate public policy. If you know of cases addressing these issues or litigating these expanded indemnification statutes in other jurisdictions, please respond in the comments.
Friday, November 15, 2013
I have posted an updated draft of my latest paper Rehabilitating Concession Theory, which is forthcoming in the Oklahoma Law Review, on SSRN. I have made only minor changes to the the prior draft, but I thought I’d post the abstract and link to the paper here in case any blog readers haven’t seen the paper before and might be interested in the content.
In Citizens United v. FEC, a 5-4 majority of the Supreme Court ruled that, “the Government cannot restrict political speech based on the speaker's corporate identity.” The decision remains controversial, with many arguing that the Court effectively overturned over 100 years of precedent. I have previously argued that this decision turned on competing conceptions of the corporation, with the majority adopting a contractarian view while the dissent advanced a state concession view. However, the majority was silent on the issue of corporate theory, and the dissent went so far as to expressly disavow any role for corporate theory at all. At least as far as the dissent is concerned, this avoidance of corporate theory may have been motivated at least in part by the fact that concession theory has been marginalized to the point where anyone advancing it as a serious theory risks mockery at the hands of some of the most esteemed experts in corporate law. For example, one highly-regarded commentator criticized the dissent by saying: “It has been over half-a-century since corporate legal theory, of any political or economic stripe, took the concession theory seriously.” In this Essay I consider whether this marginalization of concession theory is justified. I conclude that the reports of concession theory’s demise have been greatly exaggerated, and that there remains a serious role for the theory in discussions concerning the place of corporations in society. This is important because without a vibrant concession theory we are primarily left with aggregate theory and real entity theory, two theories of the corporation that both defer to private ordering over government regulation.
Thursday, November 14, 2013
This week two articles caught my eye. The New York Times’ Room for Debate feature presented conflicting views on the need to “prosecute executives for Wall Street crime.” My former colleague at UMKC Law School, Bill Black, has been a vocal critic of the Obama administration’s failure to prosecute executives for their actions during the most recent financial crisis, and recommended bolstering regulators to build cases that they can win. Professor Ellen Podgor argued that the laws have overcriminalized behavior in a business context, and that the “line between criminal activities and acceptable business judgments can be fuzzy.” She cited the thousands of criminal statutes and regulations and compared them to what she deems to be overbroad statutes such as RICO, mail and wire fraud, and penalties for making false statements. She worried about the potential for prosecutors to abuse their powers when individuals may not understand when they are breaking the law.
Charles Ferguson, director of the film “Inside Job,” likened the activity of some major financial executives to that of mobsters and argued that they have actually done more damage to the economy. He questioned why the government hadn’t used RICO to pursue more criminal cases. Former prosecutor and now private lawyer Allen Goelman pointed out rather bluntly that prosecutors aren’t cozy with Wall Street—they just won’t bring a case when the evidence won’t allow them to win. He also reminded us that greed and stupidity, which he claimed was the cause of the “overwhelming majority of the risky and irresponsible behavior by Wall Street,” are not crimes. Professor Lawrence Friedman wrote that the law “announces the community’s conceptions of right and wrong,” and if we now treat corporations like people under Citizens United then we should likewise make the executives who run them the objects of the community’s condemnation of wrongdoing.
Finally, Senator Elizabeth Warren concluded that if corporations know that they can break the law, pay a large settlement, and not admit any guilt or have any individual prosecuted, they won’t have any incentive to follow the law. She also argued for public disclosure of these settlements including whether there were tax deductions or releases of liability.
This brings me to the second interesting article. Former SEC enforcement chief and now Kirkland & Ellis partner Robert Khuzami recently said, “I didn’t think there was much doubt in most cases that a defendant engaged in wrongdoing when you had a 20-page complaint, you had them writing a big check, you may well have prosecuted an individual in the wrongdoing.” While not endorsing or rejecting current SEC Chair Mary Jo White’s position to require certain companies to admit wrongdoing in settlements, he raised a concern about whether this change in policy would place undue strain on the agency’s limited resources by forcing more cases to go to trial. He also raised a valid point about the legitimate fear that firms should have in that admitting guilt could expose them to lawsuits, criminal prosecution, and potential business losses. Chair White did not set out specific guidelines for the new protocol, but so far this year 22 companies have benefitted from the no admit/no deny policy and have paid $14 million in sanctions. But we don’t know how many executives from these companies lost their jobs. On the other hand, would these same companies have settled if they had to admit liability or would they have demanded their day in court?
Should the desire to preserve agency resources trump the need to protect the investing public—the stated purpose of the SEC? If neither the company nor the executive faces true accountability, what will be the incentive to change? In a post-Citizens United world, will Congressmen strengthen the laws or bolster the power and resources of the regulators to go after the corporations that help fund their campaigns? Have we, as Dostoyevsky asserted, become “used” to the current state of affairs where drug dealers and murderers go to jail, but there aren’t enough resources to pursue financial miscreants?
What will make companies and executives “do the right thing”? Dostoyevksy also wrote “intelligence alone is not nearly enough when it comes to acting wisely,” and he was right. Perhaps the fear of the punishment for clearly enumerated and understood crimes, and the fear of the admission of wrongdoing with the attendant collateral damage that causes will lead to a change in individual and corporate behavior. I agree with Professor Podgor that there is clearly room for prosecutorial abuse of power and that the myriad of laws can lead to a no-mans land for the unwary executive forced to increase margins and earnings per share (while possibly getting a healthy bonus). While I have argued in the past for an affirmative defense for certain kinds of corporate crimial liability, I also agree with Professor Black and Senator Warren. At some point, people and the corporations (made up of people) need more than “intelligence” to act “wisely.” They need the punishment to fit the crime.
Tuesday, November 12, 2013
Today is November 12, 2013, or 11/12/13. (It also happens to be my 43rd birthday. Yay me.)
In honor of the unique date, I decided to take a look at some business cases from the most recent prior 11/12/13. I found a couple of interesting passages. One case, Cotten v. Tyson, 89 A. 113, 116 (Md. Nov. 12, 1913), provides a good overview of some basic corporate principals:
 The principle is elementary that a stockholder, as such, is not an owner of any portion of the property of the corporation and, apart from his stock, has no interest in its assets which is capable of being assigned. [citing cases]
 Where one person is the owner of all the capital stock of a corporation, it has been held bound by his acts in reference to its property. [citing cases]
 But it is entirely clear upon reason and authority that a stockholder of a corporation, while retaining his stock ownership, cannot assign the interest represented by his stock in any particular class of the corporate assets. Such an attempted alienation would not only be incompatible with the retention of title to the stock in the assignor but its enforcement would be altogether impracticable. The stockholder himself could not require the corporation to segregate and distribute a specific portion of its property, and certainly he could not create and confer such a right by assignment.
 . . .Even if a stockholder could effectively assign an interest in the choses in action of his corporation, such a result could obviously not be accomplished by a mere assignment of his interest in the assets of its debtors.
Another, and in contrast, Smith v. Pullum, 63 So. 965 (Ala. Nov. 12, 1913), provides a sound example of terrible legal jargon:
The bill . . . alleges that it was agreed between the three parties, viz., G.W. Smith, William Pullum, and W.K. Pullum, that upon the purchase of the property for the above sum a corporation was to be formed, with a paid in capital of $4,500; that $1,650 of the said capital stock was to be the property of W.K. Pullum, $600 of said capital stock was to be the property of said Wm. Pullum, and $2,250 of said capital stock was to be the property of said G.W. Smith.
The case uses the term "said" seventy-five times. It's a four-page case.
Here's hoping we can dispense with said practice posthaste.
Sunday, November 10, 2013
Martin Gelter & Geneviève Helleringer posted “Constituency Directors and Corporate Fiduciary Duties” on SSRN a few weeks ago, and I’m finally getting around to passing on the abstract:
In this chapter, we identify a fundamental contradiction in the law of fiduciary duty of corporate directors across jurisdictions, namely the tension between the uniformity of directors’ duties and the heterogeneity of directors themselves. Directors are often formally or informally selected by specific shareholders (such as a venture capitalist or an important shareholder) or other stakeholders of the corporation (such as creditors or employees), or they are elected to represent specific types of shareholders (e.g. minority investors). In many jurisdictions, the law thus requires or facilitates the nomination of what has been called “constituency” directors. Legal rules tend nevertheless to treat directors as a homogeneous group that is expected to pursue a uniform goal. We explore this tension and suggest that it almost seems to rise to the level of hypocrisy: Why do some jurisdictions require employee representatives that are then seemingly not allowed to strongly advocate employee interests? Looking at US, UK, German and French law, our chapter explores this tension from the perspective of economic and behavioral theory.
Saturday, November 9, 2013
As Marc O. DeGirolami notes here: "In an extensive decision, a divided panel of the U.S. Court of Appeals for the Seventh Circuit has enjoined the enforcement of the HHS contraception mandate against several for-profit corporations as well as the individual owners of those corporations.” I have not had a chance to read the entire decision (which you can find here), but I did do a quick search for “corporation” and pass on the following excerpts I found interesting.
The plaintiffs are two Catholic families and their closely held corporations—one a construction company in Illinois and the other a manufacturing firm in Indiana. The businesses are secular and for profit, but they operate in conformity with the faith commitments of the families that own and manage them…. These cases—two among many currently pending in courts around the country—raise important questions about whether business owners and their closely held corporations may assert a religious objection to the contraception mandate and whether forcing them to provide this coverage substantially burdens their religious-exercise rights. We hold that the plaintiffs—the business owners and their companies—may challenge the mandate. We further hold that compelling them to cover these services substantially burdens their religious exercise rights…. Nothing in RFRA [the Religious Freedom Restoration Act] suggests that the Dictionary Act’s definition of “person” is a “poor fit” with the statutory scheme. To use the Supreme Court’s colloquialism, including corporations in the universe of “persons” with rights under RFRA is not like “forcing a square peg into a round hole.” [Rowland, 506 US 194, 200 (1993).] A corporation is just a special form of organizational association. No one doubts that organizational associations can engage in religious practice…. It’s common ground that nonprofit religious corporations exercise religion in the sense that their activities are religiously motivated. So unless there is something disabling about mixing profit-seeking and religious practice, it follows that a faith-based, for-profit corporation can claim free-exercise protection to the extent that an aspect of its conduct is religiously motivated.
The quote I focus on above is: “A corporation is just a special form of organizational association.” I have argued previously that when courts render decisions like the Seventh Circuit did here, they seem to be giving mere lip service to the word “special” in that sentence. For more on that, you can go here.
Friday, November 8, 2013
The Economist has an interesting piece on how “[a] mutation in the way companies are financed and managed will change the distribution of the wealth they create.” You can read the entire article here. A brief excerpt follows.
The new popularity of the [Master Limited Partnership] is part of a larger shift in the way businesses structure themselves that is changing how American capitalism works…. Collectively, distorporations such as the MLPs have a valuation on American markets in excess of $1 trillion. They represent 9% of the number of listed companies and in 2012 they paid out 10% of the dividends; but they took in 28% of the equity raised…. [The] beneficiaries, though, are a select class. Quirks in various investment and tax laws block or limit investing in pass-through structures by ordinary mutual funds, including the benchmark broad index funds, and by many institutions. The result is confusion and the exclusion of a large swathe of Americans from owning the companies hungriest for the capital the markets can provide, and thus from getting the best returns on offer….
Another booming pass-through structure is that of the “business development company” (BDC). These firms raise public equity and debt much like a leveraged fund.… What they all share is an ability to do bank-like business—lending to companies which need money—without bank-like regulatory compliance costs….
Andrew Morriss, of the University of Alabama law school, sees the shift as an entrepreneurial response to a century’s worth of governmental distortions made through taxation and regulation. At the heart of those actions were the ideas set down in “The Modern Corporation and Private Property”, a landmark 1932 study by Adolf Berle and Gardiner Means. As Berle, a member of Franklin Roosevelt’s “brain trust”, would later write, the shift of “two-thirds of the industrial wealth of the country from individual ownership to ownership by the large, publicly financed corporations vitally changes the lives of property owners, the lives of workers and …almost necessarily involves a new form of economic organisation of society.” … Several minor retreats notwithstanding, the government’s role in the publicly listed company has expanded relentlessly ever since.
November 8, 2013 in Business Associations, Books, Corporate Governance, Corporations, Current Affairs, Financial Markets, LLCs, Partnership, Securities Regulation, Stefan J. Padfield, Unincorporated Entities | Permalink | Comments (0)
Thursday, November 7, 2013
In 2011, I met with members of the SEC and Congressional staffers as part of a coalition of business people and lawyers raising concerns about the proposed Dodd-Frank whistleblower provision. Ten days after leaving my compliance officer position and prior to joining academia, I testified before a Congressional committee about the potential unintended consequences of the law. The so-called “bounty-hunter” law establishes that whistleblowers who provide original information to the SEC related to securities fraud or violations of the Foreign Corrupt Practices Act are eligible for ten to thirty percent of the amount of the recovery in any action in which the SEC levies sanctions in excess of $1 million dollars. The legislation also contains an anti-retaliation clause that expands the reach of Sarbanes-Oxley. Congress enacted the legislation to respond to the Bernard Madoff scandal. The SEC recently awarded $14 million dollars to one whistleblower. To learn more about the program, click here.
I argued, among other things, that the legislation assumed that all companies operate at the lowest levels of ethical behavior and instead provided incentives to bypass existing compliance programs when there are effective incentive structures within the existing Federal Sentencing Guidelines for Organizations. Although they are no longer binding, judges use the Guidelines to sentence corporations that plead guilty or are so adjudicated after trial. Prosecutors use them as guideposts when making deals with companies that enter into nonprosecution and deferred prosecution agreements. I recommended: (1) that there be a presumption that whistleblowers report internally first unless there is no viable, credible internal option; (2) that the SEC inform the company that an anonymous report has been made unless there is legitimate reason not to do so and (3) that those with a fiduciary duty to report be excluded from the bounty provisions of the bill and be required to report upward internally before reporting externally.
Fortunately, the final legislation does make it more difficult for certain people to report externally without first trying to use the compliance program, if one exists. Nonetheless, the Wall Street Journal reported yesterday that a growing number of compliance personnel are blowing the whistle on their own companies, notwithstanding the fact that they must wait 120 days under the rules after reporting internally to go to the SEC. One of the attorneys interviewed in the WSJ article, Gregory Keating, is a shareholder Littler Mendelsohn, a firm that exclusively represents management in labor matters. His firm and others are seeing more claims brought by compliance officers.
This development leads to a number of questions. What about compliance officers who are also lawyers, as I was? NY state has answered the question by excluding lawyers from the awards, and I am sure that many other states are considering it or will now start after reading yesterday’s article. What does this mean for those forward thinking law schools that are training law students to consider careers in compliance? I believe that this is a viable career choice in an oversaturated legal market because the compliance field is exploding, while the world of BigLaw is contracting. Do we advise students considering the compliance field to forego their bar licenses after graduation because one day they could be a whistleblower and face a conflict of interest? I think that’s unwise. What about compliance personnel in foreign countries? Courts have already provided conflicting rulings about their eligibility for whistleblower status under the law.
Most significantly, in many companies compliance officers make at least an annual report to the board on the activities of the compliance program in part to ensure that the board fulfills its Caremark responsibilities. These reports generally do and should involve detailed, frank discussions about current and future risks. Will and should board members become less candid if they worry that their compliance officer may blow the whistle?
Could the Sentencing Commission have avoided the need for compliance officers to blow the whistle externally by recommending that compliance officers report directly to the board as the heads of internal audit typically do? This option was considered and rejected during the last round of revisions to the Sentencing Guidelines in 2010. Compliance officers who do not report to general counsels or others in the C-Suite but have direct access to board members might feel less of a need to report to external agencies. This is why, perhaps, in almost every corporate integrity agreement or deferred prosecution agreement, the government requires the chief compliance officer to report to the board or at least to someone outside of the legal department.
To be clear, I am not opposed to the legislation in principle. And for a compliance officer to report on his or her own organization, the situation internally was probably pretty dire. Gregory Keating and I sit on the Department of Labor’s Whistleblower Protection Advisory Committee, which will examine almost two dozen anti-retaliation laws in the airline, commercial motor carrier, consumer product, environmental, financial reform, food safety, health care reform, nuclear, pipeline, public transportation agency, railroad, maritime and securities fields. During our two-year term we will work with academics, lawyers, government officials, organized labor and members of the public to make the whistleblower laws more effective for both labor and management.
State bars, government agencies, boards, general counsels, plaintiffs’ lawyers and defense lawyers need to watch these developments of the compliance officer as whistleblower closely. I will be watching as well, both as a former compliance officer and for material for a future article.
Friday, November 1, 2013
Grant M. Hayden & Matthew T. Bodie have posted “Larry from the Left: An Appreciation” on SSRN. Here is the abstract:
This essay approaches the scholarship of the late Professor Larry Ribstein from a progressive vantage point. It argues that Ribstein's revolutionary work upended the "nexus of contracts" theory in corporate law and provided a potential alternative to the regulatory state for those who believe in worker empowerment and anti-cronyism. Progressive corporate law scholars should look to Ribstein's scholarship not as a hurdle to overcome, but as a resource to be tapped for insights about constructing a more egalitarian and dynamic economy.
Thursday, October 31, 2013
Although I blog on business issues, I spent most of my professional life as a litigator and this semester I teach civil procedure. A few weeks ago I asked my students to draft a forum selection clause and then discussed the Boilermakers v. Chevron forum selection bylaw case, which at the time was up on appeal to the Delaware Supreme Court. The bylaws at issue required Delaware to be the exclusive venue for matters related to derivative actions brought on behalf of the corporation; actions alleging a breach of fiduciary duties by directors or officers of the corporation; actions asserting claims pursuant to the Delaware General Corporation Law; and actions implicating the internal affairs of the corporation.
While I was not surprised that some institutional investors I had spoken to objected to Chevron’s actions, I was stunned by the vitriolic reactions I received from my students. I explained that Chevron and FedEx, who was also sued, were trying to avoid various types of multijurisdictional litigation, which could be expensive, and I even used it as a teachable moment to review what we had learned about the domiciles of corporations, but the students weren’t buying it.
Perhaps in anticipation of the likelihood of an affirmance from Delaware’s high court, the plaintiffs voluntarily dismissed their appeal, which may have been a smart tactical move. Now let’s see how many Delaware corporations move from the wait and see mode and join the 250 companies that already have these kinds of bylaws. Interestingly, prior to the dismissal, only 1% of those surveyed by Broc Romanek indicated that they would never institute a forum selection bylaw. Given how broad some of these bylaws are, it may stem the tide of some of the litigation that I blogged about here as plaintiffs’ lawyers are forced to face Delaware jurists. Yesterday, as we were discussing venue, I broke the news about the dismissal of the appeal to my students. Needless to say, many were disappointed. Perhaps they will feel differently after they have taken business associations next year.
Sunday, October 20, 2013
Sarah C. Haan has posted “Opaque Transparency: Outside Spending and Disclosure by Privately-Held Business Entities in 2012 and Beyond” on SSRN. Here is a portion of the abstract:
In this Article, I analyze data on outside spending from the treasuries of for-profit business entities in the 2012 federal election – the very spending unleashed by Citizens United v. FEC. I find that the majority of reported outside spending came from privately-held, not publicly-held companies, including a significant proportion of unincorporated business entities such as LLCs, and that more than forty percent of spending by privately-held businesses was characterized by opaque transparency: Though fully disclosed under existing campaign finance disclosure laws, something about the origin of the money was obscured. This happened when political expenditures were spread among affiliated business-donors, typically donating similar amounts to the same recipient(s) on similar dates, and when for-profit business entities were used as shadow money conduits. I also argue that, due to differences between access-oriented and replacement-oriented electoral strategies, for-profit businesses engaged in outside spending in a federal election are likely to be experiencing insider expropriation. The expropriation of a business entity’s political voice by a controlling person is another potential way in which voters are misled in our current disclosure regime. In light of these spending patterns, and evidence of insider expropriation of the political voice of many privately-held business donors, I argue that privately-held business entities that engage in federal election-related spending should be compelled to reveal the individual(s) who control them.
Friday, October 18, 2013
Really great piece by Justin Fox on “What We’ve Learned from the Financial Crisis” over at the Harvard Business Review. What follows is a brief excerpt, but you'll want to go read the whole thing.
Five years ago the global financial system seemed on the verge of collapse. So did prevailing notions about how the economic and financial worlds are supposed to function. The basic idea that had governed economic thinking for decades was that markets work…. In the summer of 2007, though, the markets for some mortgage securities stopped functioning…. [T]he economic downturn was definitely worse than any other since the Great Depression, and the world economy is still struggling to recover…. Five years after the crash of 2008 is still early to be trying to determine its intellectual consequences. Still, one can see signs of change…. To me, three shifts in thinking stand out: (1) Macroeconomists are realizing that it was a mistake to pay so little attention to finance. (2) Financial economists are beginning to wrestle with some of the broader consequences of what they’ve learned over the years about market misbehavior. (3) Economists’ extremely influential grip on a key component of the economic world—the corporation—may be loosening.
Fox goes on to dissect each of these shifts, putting them in historical perspective. As I said, I think it is well worth your time to read his entire piece. A couple of additional noteworthy quotes from his analysis of item (3) above follow:
- [M]ost economic theories also build upon a common foundation of self-interested individuals or companies seeking to maximize something or other (utility, profit) …. Still, one narrow way of looking at the world can’t be the only valid path toward understanding its workings. There’s also a risk that emphasizing individual self-interest above all else may even discourage some of the behaviors and attitudes that make markets work in the first place—because markets need norms and limits to function smoothly.
- I don’t think the shareholder value critics have come up with a coherent alternative. We’re all still waiting for some other framework with which to understand the corporation—and economists may not be able to deliver it. Who will? Sociologists have probably been the most persistent critics of shareholder value, and of the atomized way in which economists view the world. Some, such as Neil Fligstein, of UC Berkeley, and Gerald Davis, of the University of Michigan, have proposed alternative models of the corporation that emphasize stability and cohesion over transaction and value.
Tuesday, October 15, 2013
Early this month, the United States District Court for the Middle District of Pennsylvania decided Gentex Corp. v. Abbott, Civ. A. No. 3:12-CV-02549, (M.D.Pa. 10-10-2013). The outcome of the case is not really objectionable (to me), but some of the language in the opinion is. As with many courts, this court conflates LLCs and corporations, which is just wrong. The court repeatedly applies “corporate” law principles to an LLC, without distinguishing the application. This is a common practice, and one that I think does a disservice to the evolution of the law applying to both corporations and LLCs.
I noted this in a Harvard Business Law Review Online article a while back:
Many courts thus seem to view LLCs as close cousins to corporations, and many even appear to view LLCs as subset or specialized types of corporations. A May 2011 search of Westlaw’s “ALLCASES” database provides 2,773 documents with the phrase “limited liability corporation,” yet most (if not all) such cases were actually referring to LLCs—limited liability companies. As such, it is not surprising that courts have often failed to treat LLCs as alternative entities unto themselves. It may be that some courts didn’t even appreciate that fact. (footnotes omitted).
To be clear, though, Pennsylvania law applies equitable concepts, such as piercing the corporate veil, to LLCs. Still, courts should not discuss LLCs as though they are the same as corporations or improper outcomes are likely to follow. When dealing with LLCs, the concept should be referred to as “piercing the LLC veil” or “piercing the veil of limited liability.” Instead, though, courts tend to discuss LLCs and corporations as equivalents, which is simply not accurate.
By way of example, the Gentex court states:
Helicopterhelmet.com's principal place of business is in South Carolina, while Helicopter Helmet, LLC is a Delaware corporation with its principal place of business also in South Carolina.
Gentex Corp. v. Abbott, 3:12-CV-02549, 2013 WL 5596307 (M.D. Pa. Oct. 10, 2013) (emphasis added). It is not! It is a Delaware LLC!
Further, the court says:
From the record, it does not appear that Helicopter Helmet LLC was anything less than a bona fide independent corporate entity, or that Plaintiff intends to allege as much.
Id. (emphasis added). Again – no. An LLC is NOT a corporate entity. It is as, Larry Ribstein liked to say, an uncorporation. In fact, I would argue that Pennsylvania law, in Title 15, is called Corporations and Unincorporated Associations for a reason. Chapter 89 of that title is called Limited Liability Companies.
In fairness to Judge Brann, who wrote the Gentex opinion, Pennsylvania courts have merged the concepts of LLC and corporate veil piercing in other cases, even when discussing the differences between the two. In Wamsley v. Ehmann, C.A. No. 1845 EDA 2009 (Pa. Super. Ct. Feb. 28, 2012), summarized nicely here, the court explained:
These factors [for determining whether to pierce the veil] include but are not limited to: (1) undercapitalization; (2) failure to adhere to corporate formalities; (3) substantial intermingling of corporate and personal affairs; and (4) use of the corporate form to perpetrate fraud. [citing Village at Camelback Property Owners Assn. Inc.] . . .
Certain corporate formalities may be relaxed or inapplicable to limited liability corporations and closely held companies. Advanced Telephone Systems, Inc., supra at 1272. An LLC does not need to adhere to the same type of formalities as a corporation. Id. (finding lack of financial statements, bank accounts, exclusive office space, and tax returns was not evidence of failure to adhere to corporate formalities because entity was LLC with limited scope). In fact, the appropriate formalities for an LLC “are few” and, depending on the purpose of the LLC, it may not need to be capitalized at all. Id. Moreover, not all corporate formalities are created equal. Id. at 1279. To justify piercing the corporate veil, the lack of formalities must lead to some serious misuse of the corporate form. Id.
Okay, got that? The rules that apply to corporations apply to LLCs. Except when they don’t because LLCs are sometimes different. To justify piercing the “corporate veil,” then, an LLC must have seriously misused the corporate form, even though an LLC is a distinct form from the corporation. This is not especially helpful, I am afraid.
Veil piercing is difficult enough to plan around, and the seemingly random nature of veil piercing is often noted (with some, such as Prof. Bainbridge, arguing that we should do away with it altogether). There has not been much of a move to abolish veil piercing, and there hasn't even been much progress to make the standards for veil piercing more clear. Still, given the prevalence of LLCs, it’s high time courts at least help LLC veil piercing law evolve into murky standards specifically designed for LLCs. That doesn’t seem like too much to ask.
Sunday, October 13, 2013
1. Russell G. Pearce & Brendan M. Wilson on Business Ethics
This Essay makes three contributions to the field of business ethics …. First, the Essay identifies the dominant approaches to business ethics as profit maximization, social duty, and ordinary ethics, and summarizes the claims made by proponents of each perspective. We intend this categorization as a way to refine the distinctions between and among various views of business ethics and to address the conundrum that John Paul Rollert has described as the “academic anarchy that is business ethics…. Second, the Essay explores the strengths and weaknesses of these three approaches. It suggests that their emphasis on viewing business persons and organizations as existing autonomously, rather than within webs of relationships, helps explain why the field of business ethics has had minimal influence on business conduct, as does the false dichotomy between economic and ethical conduct that proponents of these approaches often embrace…. Third, the Essay proposes an alternative approach that would locate business ethics at the center of business conduct. This approach embraces the relational character of business behavior. It offers a conception of self-interest that recognizes the relational dimension of self-interest and identifies mutual benefit as the goal of business conduct. The text of the essay is available in the book itself or on Professor Pearce's Fordham University web page.
2. John Robinson Jr. on Social Public Procurement: Corporate Responsibility Without Regulation
The growing perception in the developed world that multi-national corporations conduct social and environmental exploitation abroad raises numerous questions about corporate social responsibility. That those corporations would not get away with, nor probably even attempt, such exploitation in their home countries complicates the dialogue: to what extent are the home governments responsible for ensuring their native corporations act responsibly abroad? The E.U. answers this question affirmatively and takes an active role in promoting social responsibility. One major mechanism they use is socially responsible public procurement, which incentivizes good social outcomes by awarding contracts based, in part, on social criteria…. This Essay explores the E.U.’s framework for achieving these social goals and suggests that the U.S. should undertake many of the same policies.
3. Tony A. Freyer & Andrew P. Morriss on Creating Cayman as an Offshore Financial Center: Structure & Strategy Since 1960
The Cayman Islands are one of the world’s leading offshore financial centers (OFCs). Their development from a barter economy in 1960 to a leading OFC for the location of hedge funds, captive insurance companies, yacht registrations, special purpose vehicles, and international banking today was the result of a collaborative policy making process that involved local leaders, expatriate professionals, and British officials…. [T]his Article describes how the collaborative policy making process developed over time and discusses the implications of Cayman’s success for financial reform efforts today.
Thursday, October 10, 2013
US Chamber of Commerce Event on the State of Corporate Governance and the 2014 Proxy Season-October 16
On October 16th, the US Chamber of Commerce’s Center for Capital Markets Competitiveness will host a half-day event to examine trends from the 2013 proxy season and look ahead to 2014. The day will start with a presentation from the Manhattan Institute about the 2013 season and then I will be on a panel with Tony Horan, the Corporate Secretary of JP Morgan Chase, Vineeta Anand from the Office of Investment of the AFL-CIO, and Darla Stuckey of the Society of Corporate Secretaries and Governance Professionals. Our panel will look back at the 2013 proxy season and discuss hot topics in corporate governance in general. Later in the day, Harvey Pitt and other panelists will talk about future trends and reform proposals, and depending on the state of the government shutdown, we expect a member of Congress to be the keynote speaker. The event will be webcast for those who cannot make it to DC. Click here to register.
Wednesday, October 9, 2013
I am emerging from a rabbit hole of research that began approximately 3.5 hours ago. The question was inspired by teaching the 2002 Delaware Supreme Court case, Download Gotham 817_A.2d_160, in my unincorporated business associations class and students' drafting of fiduciary duty waivers in a limited partnership agreement. Many of you are already aware that Delaware allows for the complete elimination of general partners' fiduciary duties. I knew that Delware was an outlier in this area, but I wasn't certain by how much. So 3.5 hours and a 50 state (plus D.C.) survey later, I have a concrete answer. Only Delaware ( Download Delaware GP Fiduciary duty statute) and Alabama ( Download Alabama Statute) statutes allow for the complete elimination of fiduciary duties for general partners. The remaining 49 jurisdictions surveyed only allow for the expansion or restriction of fiduciary duties, but not the elimination. Of those 49 jurisdictions, 20 have a stand alone provisions that outline the fiduciary duties of general partners, and 29 statutes establish the minimum fiduciary duties for general partners by linkage to the traditional partnership statutes. Of the 29 jurisdictions that rely on linkage to traditional partnership statutes, 13 use a Uniform Partnership Act (1914) "accounting" style fiduciary duty provision and 16 use a revised Uniform Partnership Act (1997) enumerated fiduciary duties style provision.
My initial research table is available here: Download LP Fiduciary Duty waiver Chart.
My findings raise several questions. The first is a curiosity as to where else are Delaware statutes outliers and what does this say about the reach of Delaware law? The ubiquity of Delaware law is limited by the incentives for foreign entities to avail themselves of Delaware state laws, the challenge to Delaware's dominance is seen most clearly with closely-held firms.