Monday, November 23, 2015
Last week was the 30th anniversary of the Delaware Supreme Court’s decision in Moran v. Household International, Inc., 500 A.2d 1346 (Del. 1985). In Moran, decided on Nov. 19, 1985, the Delaware Supreme Court upheld what has become the leading hostile takeover defensive tactic, the poison pill.
Martin Lipton, the primary developer of the pill, even makes an appearance in the case—and obviously a carefully scripted one: “The minutes reflect that Mr. Lipton explained to the Board that his recommendation of the Plan was based on his understanding that the Board was concerned about the increasing frequency of ‘bust-up’ takeovers, the increasing takeover activity in the financial sector industry, . . . , and the possible adverse effect this type of activity could have on employees and others concerned with and vital to the continuing successful operation of Household even in the absence of any actual bust-up takeover attempt.”
I’m not sure the takeover world would be that different today if Moran had rejected poison pills. I’m reasonably confident the Delaware legislature would have amended the Delaware statute to overturn the ruling, as they effectively did with another ruling decided earlier that same year, Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). Shortly after Van Gorkom made it clear that directors might actually be liable for violating the duty of care, the legislature added section 102(b)(7) to the Delaware law, allowing corporations to eliminate any possibility of damages for duty-of-care violations.
As my colleague Joan Heminway has pointed out, 1985 was an incredibly important year for M & A practitioners. In addition to Moran and Van Gorkom, a third major case was also decided that year: Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).
Van Gorkom was decided in late January of 1985, Unocal in June, and Moran in November. Corporations casebooks and treatises are filled with Delaware Supreme Court decisions, but that has to be one of the most important ten-month periods in Delaware corporate law jurisprudence—especially in the mergers and acquisitions area.
Friday, November 20, 2015
The micro-symposium has generated interest in a broad range of topics, so we are adding the following post by Peter Molk & Verity Winship discussing their recent scholarship on dispute resolution in LLC operating agreements and its intersection with the "contract is king" discussion this week.
This post highlights a particular area of private ordering within the LLC and other alternative entities: contractual provisions within the operating agreement that set the rules for resolving internal disputes. These terms determine how disputes are resolved, such as by specifying when claims must be submitted to arbitration, where disputes can be heard, and whether parties waive the jury right or impose fee-shifting of litigation costs. They apply to internal disputes, meaning they govern the dispute process among the LLCs’ members, managers, and the LLC itself.
How do these provisions fit with the debate over whether contract should be king? The broadest connection is straightforward. Dispute resolution provisions allocate rights and duties within LLCs, so the debate about the proper bounds of freedom of contract in the LLC space has implications for them as well. But how firms set the rules for internal disputes is also relevant to the particular debate about the imposition of fiduciary duties. Suppose that fiduciary duties were to become mandatory in publicly traded LLCs and LPs, as Delaware Chief Justice Strine and Vice Chancellor Laster have proposed and as Sandra Miller and Mohsen Manesh discuss in their posts in this micro-symposium. Imposing fiduciary duties, by expanding the actions that disgruntled members can bring, in turn puts particular pressure on the dispute resolution clauses.
To see the connection, look no further than the debate in the corporate context about private ordering of shareholder litigation in corporate charters and bylaws. Contract is not king in the corporate context – a host of mandatory rules, including fiduciary duties, are imposed to protect investor rights. Since corporations cannot respond by waiving fiduciary duties, some have instead taken the step of nevertheless effectively eliminating these protections by contracting out of enforcement mechanisms. Recent efforts at imposing fee shifting can be characterized as indirectly weakening mandatory protections by reducing the probability of enforcing them.
For corporations, the Delaware legislature eventually stepped in to ban fee-shifting provisions in the organizational documents of Delaware stock corporations. The legislative response is telling. It targets only stock corporations, using the business form as a proxy for characteristics that trigger a need for additional protections. This takes us back to the question of whether contract should be king, and whether business form is a good rough indicator of characteristics (sophistication, consent) that we care about.
In an empirical study we are conducting, we identified dispute resolution provisions in a sample of operating agreements of privately owned Delaware LLCs. More than a third of the agreements in our sample selected the forum for resolving disputes, primarily through exclusive forum provisions or mandatory arbitration provisions. The agreements also modified litigation processes through terms that imposed fee-shifting, waived jury trials, and, less commonly, through other means like books and records limitations.
We can think of these practices as altering the calculus parties engage in when deciding whether to enforce their rights that exist under the agreement. While looking at dispute resolution provides a more accurate picture for LLCs’ governance regimes, it also complicates the contract-as-king debate. Strengthening LLC members’ mandatory protections beyond the duty of good faith and fair dealing, as several earlier posts propose, does little good if LLCs respond by cutting back parties’ ability to enforce these protections.
Thursday, November 19, 2015
Contract Law, Fiduciary Duties, Good Faith, Fair Dealing, and the Legal Status of LLC Operating Agreements (Contract Is King Micro-Symposium)
The title of this post undoubtedly promises too much. But that won't prevent me from trying to establish a few points that approach the many topics that could be discussed under a title that includes this much great stuff. I make that attempt here.
I start with contract law. As I noted in my prior post for this micro-symposium, one of my appearances at last week's ABA LLC Institute included a debate on whether an operating agreement is a common law contract. This question arose in connection with my teaching of operating agreements (and also has arisen in my teaching of partnership agreements) in Business Associations. Of course, lawyers understand that not all agreements are contracts. A significant amount of energy is spent on this matter in the beginning of the standard contracts course in law school.
Is an LLC operating agreement a contract? I like the question not just for its face value, but because I believe that the answer does or may matter for purposes of resolving other questions arising in and outside LLC law. I captured some thoughts about this question in a draft essay soon to be published in revised form in the SMU Law Review. (I blogged about it here over the summer.) Among other things, with judicial and legislative attention on freedom of contract in the LLC, the status of the LLC as a matter of contract law may shed light on the extent to which contract law can or should be important or imported to legal issues involving LLC operating agreements.
I would like to thank the Business Law Professor Blog for this very important symposium. My brief thoughts are filling in for Marcia Narine. I became well acquainted with LLCs when I practiced in the alternative entities group of a Delaware law firm. What most stood out during my time there was the freedom enjoyed by LLCs and LPs to abridge fiduciary duties and deviate from other corporate orthodoxies. I constantly thought about whether this freedom of contract was a good thing; after all, case law tells only the tragic stories.
As mentioned in other posts, contractual freedom is ideal when sophisticated parties of comparable strengths are allowed to define their relationships. And generally, few problems arise from the LLC form. Law firms typically provide those seeking to form an LLC one of their standard, boilerplate operating agreements, which includes fiduciary duties. In turn, business owners are able to enjoy limited liability while avoiding many of the formalities, transactions costs, and tax burdens associated with traditional corporations. However, there seems to be an increasing number of cases where operating agreements resemble adhesion contracts, creating opportunities for abuse. Is it wise that unsophisticated are more at risk for contractual related harms so that sophisticated parties can contract freely?
The above narrative suggests that sophisticated parties benefit and enjoy the organizational flexibilities provided by the LLC form. It goes unnoticed, though, that sophisticated parties often reject this freedom of contract. Without question the trend in Delaware is towards the formation of LLCs and LPs versus corporations (at seemingly a 3:1 rate). But that doesn’t mean alternative entities always choose to keep their form. I was discussing this issue with a friend and practicing lawyer who mentioned that, in his transactional practice, when Delaware LLCs become big, and attract big funds, a condition of investment almost always requires an LLC to convert into a Delaware corporation. It seems that the lack of predictability associated with the freedom of contract scares potential investors who prefer the comforts of fiduciary duties, among other corporate staples. Upon some reflection, this anecdotally lines up with my experience as best as I can remember. So the parties who ostensibly are best served by contractual freedoms—i.e., sophisticated parties—appear to be the ones most likely to demand the traditional corporate form. And on a related note, this helps to explain why such a paltry number of LLCs and LPs have become public companies.
Regular readers of this blog know that I am fervent that the distinction between entities matters, particularly when it comes to LLCs and corporation. I’m happy to be a part of this micro-symposium, and I have enjoyed the input from the other participants.
My comments relate primarily to the role of contract in LLCs and how that is different that corporations. Underlying my comments is my thesis that LLCs and corporations are meaningfully distinct. This view is in contrast to Jeff Lipshaw, who argued in his post:
[I]f uncorporations differ from corporations, it’s more a matter of degree than of any real difference. Both are textual artifacts. We have created or assumed obligations pursuant to the text at certain points in time, and we use the artifacts and their associated legal baggage opportunistically when we can. I am not convinced that organizing in the form or corporations or uncorporations makes much difference on that score.
I tend to be more of a Larry Ribstein disciple on this, and I wish I had the ability to articulate the issues as eloquently and intelligently as he could. Alas, you’re stuck with me. (Editor's note: As Jeff Lipshaw says in his comment below, he did not say the forms of LLCs and corporations are not distinct. He is, of course, correct, and I know very well he knows the difference between the forms. In fact, a good portion of what I understand of the practical implications of the LLC comes from him. I do believe that the choice of form matters, and at least should matter in how courts review the different entities, as I explain below. And I do think the LLC is better, or should be (if courts will allow it), because of what the form allows interested parties to do with it. The flexibility of the LLC form creates opportunity for highly focused, nimble, and more specific entities that can be vehicles that facilitate creativity in investment in a way that corporations and partnerships, in my estimation, do not.]
In his book, The Rise of the Uncorporation, Ribstein stated, “Uncorporations [his term for noncorporate entities] come in all shapes and sizes, and are increasingly encroaching on traditionally ‘corporate’ domain. The thesis is that form matters.” He goes on to explain that the differences between corporations and noncorporate entities have practical implications for those in business (and their lawyers). I think he was right.
It seems that some view the limited liability protection that comes with both an LLC and a corporation as the main, if not sole, defining function of the firm. If that were true, then it would be accurate that LLCs and corporation are functionally the same. I think the evolution and purposes of the limited partnership, the LLC, and the corporation suggest that these entities at least should (if they don’t in fact) serve different purposes and roles for those who create them.
The LLC Revolution helped facilitate formation of entities with pass-through taxation and limited liability protection. And it is true, that limited liability one chief benefit of the corporation, and the rise of the corporation can be tracked to that benefit. But, entity choice is more that just liability and taxation, too, at least where there are real entity choices that provide options.
Corporations are far more off-the-rack in nature, and they have a tremendous number of default rules. These rules facilitate start up, and help skip a number of conversations that promoters and initial investors might otherwise need to have. (Of course, they probably should have these conversations, but if they don’t, there are more significant gap fillers than for other entities.)
Ribstein observed, “Uncorporations not only explicitly permit, but also indirectly facilitate contracts. A firm’s contractual freedom should be evaluated not only in terms of the flexibility permitted by a given business association statute, but in light of the alternative available standard forms.” As such, the clearer and more distinct the terms of the various entity-form statutes are, the more significant a firm’s choice of form can be. And if the choice is an LLC, that choice should be respected.
As my countless posts lamenting the fact that courts can’t seem to get the distinction between LLCs and corporations clear, there’s evidence that Lipshaw is right as to the current state of the law, or some meaningful portion of it. But that doesn’t make it right.
Daniel Kleinberger: Delineating Delaware’s Implied Covenant of Good Faith and Fair Dealing Part III (Contract Is King)
Part III Another Major “Not” and the Uniform Act’s More (!) Contractarian Approach
C. Not Whatever is Meant by a Contractual Provision Invoking “Good Faith”
Some limited partnership and operating agreements expressly refer to “good faith” and define the term. As the Delaware Supreme Court held in Gerber v. Enter. Products Holdings, LLC (Gerber), such “express good faith provisions” do not affect the implied covenant. In Gerber, the Court rejected the notion that “if a partnership agreement eliminates the implied covenant de facto by creating a conclusive presumption that renders the covenant unenforceable, the presumption remains legally incontestable.” 
The rejected notion arose from on an overbroad reading of Nemec v. Shrader  – namely that “under Nemec, the implied covenant is merely a ‘gap filler’ that by its nature must always give way to, and be trumped by, an ‘express’ contractual right that covers the same subject matter.” Invoking Section 1101(d) of the Delaware Revised Uniform Limited Partnership Act, the Gerber opinion stated: “That reasoning does not parse. The statute explicitly prohibits any partnership agreement provision that eliminates the implied covenant. It creates no exceptions for contractual eliminations that are ‘express.’”
Some agreements contain express good faith provisions but omit to define the concept. Such omissions render the agreement ambiguous  and impose on the courts an interpretative task that involves looking not only to other, related provisions in the agreement  but also to the negotiations, if any, and other circumstances that led up to the agreement being made. A few Delaware cases have even resorted to the corporate fiduciary duty concept of good faith. In any event, if, as held in Gerber, an agreement that expressly defines “good faith” cannot affect the implied covenant, a fortiori neither can an agreement that uses the term but omits to define it.
D. Uniform Limited Liability Company Act (ULLCA) Approach – More Contractarian than Delaware (!)
Perhaps ironically (or some might even say “counter-intuitively”), the Uniform Limited Liability Company Act (2006) (Last Amended 2013) permits an ULLCA operating agreement to go where a Delaware operating agreement cannot. Although an ULLCA operating agreement may not “eliminate the contractual obligation of good faith and fair dealing …., [it] may prescribe the standards, if not manifestly unreasonable, by which the performance of the obligation is to be measured.”
This provision entered uniform laws with the Revised Uniform Partnership Act, which took the concept from the Uniform Commercial Code. ULPA (2001) followed suit, as did ULLCA (2006). In my opinion, this importation was a bad idea. But, in any event, the comment to ULLCA (2013) § 105(c)(6). at least provides examples:
EXAMPLE: The operating agreement of a manager-managed LLC gives the manager the discretion to cause the LLC to enter into contracts with affiliates of the manager (so-called “Conflict Transactions”). The agreement further provides: “When causing the Company to enter into a Conflict Transaction, the manager complies with Section 409(d) of [this act] if a disinterested person, knowledgeable in the subject matter, states in writing that the terms and conditions of the Conflict Transaction are equivalent to the terms and conditions that would be agreed to by persons at arm’s length in comparable circumstances.” This provision “prescribe[s] the standards by which the performance of the [Section 409(d)] obligation is to be measured.”
EXAMPLE: Same facts as the previous example, except that, during the performance of a Conflict Transaction, the manager causes the LLC to waive material protections under the applicable contract. The standard stated in the previous example is inapposite to this conduct. Section 409(d) therefore applies to the conduct without any direct contractual delineation. (However, other terms of the agreement may be relevant to determining whether the conduct violates Section 409(d). See the comment to Section 409(d).)
EXAMPLE: The operating agreement of a manager-managed LLC gives the manager “sole discretion” to make various decisions. The agreement further provides: “Whenever this agreement requires or permits a manager to make a decision that has the potential to benefit one class of members to the detriment of another class, the manager complies with Section 409(d) of [this act] if the manager makes the decision with:
a. the honest belief that the decision: i. serves the best interests of the LLC; or ii. at least does not injure or otherwise disserve those interests; and
b. the reasonable belief that the decision breaches no member’s rights under this agreement.”
This provision “prescribe[s] the standards by which the performance of the [Section 409(d)] obligation is to be measured.” Compare Section 105(c)(6), with Nemec v. Shrader, 991 A.2d 1120 (Del. 2010) (considering such a situation in the context of the right to call preferred stock and deciding by a 3-2 vote that exercising the call did not breach the implied covenant of good faith and fair dealing).
Looking to Delaware law, the comment advises that “[a]n operating agreement that seeks to prescribe standards for measuring the contractual obligation of good faith and fair dealing … should expressly refer to the obligation.” The comment refers to Gerber v. Enter. Prods. Hldgs., L.L.C., 67 A.3d 400, 418 (Del. 2013) as distinguishing between the implied contractual covenant and an express contractual obligation of “good faith” as stated in a limited partnership agreement.
Coming Next to a Blog Near You: So, what is Delaware’s implied contractual covenant of good faith and fair dealing?
This posting is derived from Daniel S. Kleinberger, “Delaware’s Implied Contractual Covenant of Good Faith and “Sibling Rivalry” Among Equity Holders,” a paper presented at the 21st Century Commercial Law Forum: 15th International Symposium in Beijing, at Tsinghua University’s School of Law, November 1, 2015 (footnotes converted to endnotes).
 E.g., DV Realty Advisors LLC v. Policemen's Annuity & Ben. Fund of Chicago, 75 A.3d 101, 109 (Del. 2013) (stating that, “[i]f the parties wanted to use the UCC definition of good faith, they could have so provided in the [limited partnership agreement] or incorporated it as a defined term by reference.”); In re El Paso Pipeline Partners, L.P. Derivative Litig., No. CIV.A. 7141-VCL, 2014 WL 2768782, at *17 (Del. Ch. June 12, 2014) (“In this case, the LP Agreement supplies a definition of ‘good faith’ that governs whether the defendants have complied with provisions of the LP Agreement that utilize that term.”)
 Gerber v. Enter. Products Holdings, LLC, 67 A.3d 400 (Del. 2013), overruled on other grounds by Winshall v. Viacom Int'l, Inc., 76 A.3d 808 (Del. 2013)
 Id., at 420, n. 48.
 Nemec v. Shrader, 991 A.2d 1120 (Del. 2010).
 Gerber, 67 A.3d at 420, n. 48.
 Del. Code., tit.6, § 17-1101(d). The subsection has been amended since then but the relevant language is unchanged: “the agreement may not eliminate the implied contractual covenant of good faith and fair dealing.” Unlike the uniform partnership, limited partnership, and limited liability company acts, the Delaware statutes do not authorize a partnership or operating agreement to “prescribe the standards, if not manifestly unreasonable, by which the performance of the [implied contractual] obligation [of good faith and fair dealing] is to be measured.” UPA (2013) § 105(c)(6); ULPA (2013) § 105(c)(6); ULLCA § 105(c)(6) (identical wording in each).
 Gerber, 67 A.3d at 420, n. 48. See also In re El Paso Pipeline Partners, L.P. Derivative Litig.:
The defendants … try to defeat the implied covenant claim by arguing that the LP Agreement expressly defines the term “good faith,” leaving no room for the implied covenant. According to the defendants, the implied covenant does not apply because the LP Agreement makes “good faith” the standard for evaluating whether the Conflicts Committee validly gave Special Approval and further defines “good faith” as subjective good faith. The defendants argue that when the parties have “agreed how to proceed under a future state of the world” (i.e., in the face of a conflict transaction), their bargain (i.e., the LP Agreement) “naturally controls.” The Delaware Supreme Court has rejected similar arguments.
No. CIV.A. 7141-VCL, 2014 WL 2768782, at *16 (Del. Ch. June 12, 2014) (citing and quoting Gerber v. Enter. Prods. Hldgs., LLC, 67 A.3d 400, 418 (Del.2013), overruled in part on other grounds by Winshall v. Viacom Int'l, Inc., 76 A.3d 808 (Del.2013) and DV Realty Advisors LLC v. Policemen's Annuity and Benefit Fund of Chi., 75 A.3d 101, 109 (Del.2013) (recognizing that the agreement's “contractual duty [of good faith] encompasses a concept of ‘good faith’ that is different from the good faith concept addressed by the implied covenant of good faith and fair dealing”)) (parentheticals in the original).
The El Paso opinion further explained: “In this case, the LP Agreement supplies a definition of ‘good faith’ that governs whether the defendants have complied with provisions of the LP Agreement that utilize that term. The definition is not a means of implying terms to fill contractual gaps, and the implied covenant does not turn on whether the counterparty acted in subjective good faith.” El Paso., at *17.
 E.g., DV Realty Advisors LLC v. Policemen's Annuity & Ben. Fund of Chicago, 75 A.3d 101, 107 (Del. 2013); Allen v. Encore Energy Partners, L.P., 72 A.3d 93, 105 n.44 (Del. 2013) (referring to “the undefined term ‘bad faith’ in the LPA's exculpation provision”); Norton v. K-Sea Transp. Partners L.P., 67 A.3d 354, 362 (Del. 2013) (noting that (i) “the LPA broadly exculpates all Indemnitees … so long as the Indemnitee acted in ‘good faith;’” but (ii) “the LPA regrettably does not define ‘good faith’ in this context”).
 DV Realty Advisors LLC v. Policemen's Annuity & Ben. Fund of Chicago, 75 A.3d 101, 107 (Del. 2013) (noting that the failure of a limited partnership agreement to define the term resulted in “ambiguity”).
 See, e.g., Norton v. K-Sea Transp. Partners L.P., 67 A.3d 354, 362 (Del. 2013) (noting that “the LPA broadly exculpates all Indemnitees … so long as the Indemnitee acted in ‘good faith’ [but] regrettably does not define ‘good faith’ in this context;” dealing with “the parties' insertion of a free-standing, enigmatic standard of ‘good faith’ by construing the term to be consistent with another, related provision; stating that “[i]n this LPA's overall scheme, ‘good faith’ cannot be construed otherwise”).
 The ambiguity precludes application of the parol evidence rule. Schwartz v. Centennial Ins. Co., No. CIV. A. 5350 (1977), 1980 WL 77940, at *5 (Del. Ch. Jan. 16, 1980) (stating that “[t]he parol evidence rule is unavailable to plaintiffs to bar the admission of [defendant’s] evidence to show the true meaning of the ambiguous term”). In the Delaware Court of Chancery, the other circumstances may even include common drafting practices within the informal community of (mostly Delaware) lawyers whose practices regularly involve negotiating and drafting very sophisticated partnership and LLC agreements. See In re El Paso Pipeline Partners, L.P. Derivative Litig., No. CIV.A. 7141-VCL, 2014 WL 2768782, at *22 (Del. Ch. June 12, 2014) (“[P]recedent suggests that if the drafters intended for a disclosure obligation to exist, they would have included specific language. A recent decision by this court interpreted a limited partnership agreement that utilized a similar structure for conflict-of-interest transactions, with four contractual alternatives including Special Approval. The language authorizing the Special Approval route stated that it would be effective ‘as long as the material facts known to the General Partner or any of its Affiliates regarding any proposed transaction were disclosed to the Conflicts Committee at the time it gave its approval.’ The inclusion of this condition in [that other] agreement indicates that without this language, a general partner and its affiliates would not have an obligation to disclose information.”) (citation and footnote omitted).
 DV Realty Advisors LLC v. Policemen's Annuity & Ben. Fund of Chicago, 75 A.3d 101, 110 (Del. 2013) (“In our recent opinion in Brinckerhoff v. Enbridge Energy Company, Inc. [67 A.3d 369, 373 (Del.2013)], we defined the characteristic of good faith by its opposite characteristic – bad faith. We applied a traditional common law definition of the business judgment rule to define a limited partnership agreement's good faith requirement. We used the formula describing conduct that falls outside business judgment protection, namely, an action ‘so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.’ That definition of good faith, as set forth in Brinckerhoff, is appropriately applied in this case as well.”). Thus, no single definition exists for the meaning of “good faith” when a limited partnership or LLC agreement expressly includes the term. The meaning depends first on what, if any, definition the agreement provides. In the absence of a definition, uncertainty is initially inevitable; the term means whatever the court determines the term to mean. In contrast, it is certain that the implied covenant is not a fallback definition for an undefined express good faith provision. Opinions dealing with such provisions never use the implied covenant even as a frame of reference. See, e.g., DV Realty Advisors LLC v. Policemen's Annuity & Ben. Fund of Chicago, 75 A.3d 101, 107 (Del. 2013); Allen v. Encore Energy Partners, L.P., 72 A.3d 93, 105 n.44 (Del. 2013); Norton v. K-Sea Transp. Partners L.P., 67 A.3d 354, 362 (Del. 2013). Moreover, using the implied covenant as a fallback definition would render the undefined provision duplicative, because the implied covenant exists in every limited partnership or LLC agreement as a matter of law.
 ULLCA (2013) § 105(c)(6).
I so appreciate the opportunity to be a part of this micro-symposium, in which we can explore important issues at the intersection of contract law and fiduciary duties in the fastest growing form of business entity in the United States: limited liability companies (LLCs). Today, I contribute some foundational information relating to, but not directly responding to, the micro-symposium questions. These observations come from a panel discussion at the 2015 ABA LLC Institute in Washington, DC in which I was a participant. I blogged from the Institute last week and promised this post in that first post.
The session at the Institute that I feature in today's post explored the legal and practical nature of an operating agreement (a/k/a, a limited liability company agreement). Since the operating agreement is the typical locus of private ordering in the LLC form, its status under LLC and other law should be of interest to us. Among other things, understanding the operating agreement may better enable us to understand when it is a valid, binding, and enforceable obligation among the parties. That's an issue I have been exploring in some of my work. But there is more in the legal status of the operating agreement than meets the eye . . . .
Wednesday, November 18, 2015
I recently received the following call for papers via e-mail
Law and Ethics of Big Data
Co-Hosted and Sponsored by:
Virginia Tech Center for Business Intelligence Analytics
The Department of Business Law and Ethics, Kelley School of Business
The Wharton School
Washington & Lee Law School
April 8 & 9, 2016
Indiana University- Bloomington, IN.
Abstract Submission Deadline: January 17, 2016
We are pleased to announce the research colloquium, “Law and Ethics of Big Data,” at Indiana University-Bloomington, co-hosted by Professor Angie Raymond of Indiana University and Professor Janine Hiller of Virginia Tech.
Due to the success of last year’s event, the colloquium will be expanded and we seek broad participation from multiple disciplines; please consider submitting research that is ready for the discussion stage. Each paper will be given detailed constructive critique. We are targeting cross-discipline opportunities for colloquium participants, and the IU community has expressed interest in sharing in these dialogues. In that spirit, the Institute of Business Analytics plans to host a guest speaker on the morning of April 8.th Participants are highly encouraged to attend this free event.
Submissions: To be considered, please submit an abstract of 500-1000 words to Angie Raymond at firstname.lastname@example.org and/or Janine Hiller at email@example.com by January 17, 2016. Abstracts will be evaluated based upon the quality of the abstract and the topic’s fit with the theme of the colloquium and other presentations. Questions may be directed to Angie Raymond at firstname.lastname@example.org or Janine Hiller at email@example.com.
Authors will be informed of the decision by February 2, 2016. If accepted, the author agrees to submit a discussion paper by March 26, 2016. While papers need not be in finished form, drafts must contain enough information and structure to facilitate a robust discussion of the topic and paper thesis. Formatting will be either APA or Bluebook. In the case of papers with multiple authors, only one author may present at the colloquium.
TENTATIVE Colloquium Details:
- The colloquium will begin at noon on April 8th and conclude at the end of the day on April 9th
- Approximately 50 minutes is allotted for discussion of each paper presentation and discussion.
- The manuscripts will be posted in a password protected members-only forum online. Participants agree to read and be prepared to participate in discussions of all papers. Each author will be asked to lead discussion of one other submitted paper.
- A limited number of participants will be provided with lodging, and all participants will be provided meals during the colloquium. All participants are responsible for transportation to Indiana University Bloomington, IN.
Tuesday, November 17, 2015
Mohsen Manesh: Delaware’s Financial Commitment to Unlimited Freedom of Contract (Contract Is King Micro-Symposium)
Guest post by Mohsen Manesh:
In my previous post, I suggested that we are unlikely to see Delaware ever step back from its statutory commitment to freedom of contract in the alternative entity context. And that is true even if Chief Justice Strine, Vice Chancellor Laster, and others might believe that unlimited freedom of contract has been bad public policy.
Why? To be cynical, it’s about money.
It is well known that Delaware, as a state, derives substantial profits, in the form of franchise taxes, as a result of its status as the legal haven for a majority of publicly traded corporations. In 2014 alone, Delaware collected approximately $626 million—that is almost 16% of the state’s total annual revenue—from corporate franchise taxes. (For scale, that’s almost $670 per natural person in Delaware.)
Less well documented, however, is that Delaware also now derives substantial—and growing—revenues as the legal home from hundreds of thousands of unincorporated alternative entities. My chart below tells the story. Over the last decade, while the percentage of the state’s annual revenue derived from corporate franchise taxes has been flat, an increasingly larger portion of the state’s annual revenue has been derived from the taxes paid by its domestic LLCs and LPs. Unsurprisingly, in Delaware, alternatives entities have been a real growth industry.
Given the state’s increasing dependence on revenues from domestic LLCs and LPs, it is highly unlikely that the state would undertake any reforms that risk eroding this emerging and increasingly important tax base. Evidence, as well as experience, suggests that businesses (and their lawyers) are drawn to Delaware, in part, because of its unlimited freedom of contract and the ability to tailor and eliminate all fiduciary duties.  Thus, if Delaware were to alter its alternative entity law to curtail that freedom and impose some form of mandatory, unwaivable fiduciary duties, it would lose some number of LLCs. Too many other jurisdictions “give the maximum effect to the … freedom of contract”. 
Importantly, however, this concern is much less acute when the reform is one that is limited only to publicly traded alternative entities. For one, as I noted in my earlier post, Delaware’s 150 or so publicly traded LPs and LLCs represent a tiny sliver of the hundreds of thousands of alternative entities domiciled in Delaware. Moreover, those few publicly traded firms contribute only a nominal portion to Delaware’s overall revenues collected from alternative entity taxes.
As I have shown in earlier work, unlike Delaware’s corporate franchise tax, which is scalable based on a formula that tends to charge most to large, publicly traded firms (up to $180,000 annually), Delaware’s annual tax charged to alternative entities is flat. All LLCs and LPs, no matter how large or small, whether publicly traded or closely held, pay the state only $300 annually for the privilege of being a Delaware entity. Thus, unlike the corporate context, where Delaware’s business is dependent on attracting large, publicly traded corporations, in the alternative entity context, Delaware’s business depends on volume alone. And publicly traded alternative entities represent a negligible part of the state’s overall volume—accounting for approximately $45,000 of the total $195 million that Delaware collected from its domestic alternative entities last year.
The upshot is that although Delaware might be quite sensitive economically to curtailing the freedom of contract for all alternative entities, lest it loses some if this thriving tax base, the state may be relatively indifferent to losing the approximately $45,000 annually that it gets from its few publicly traded LPs and LLCs.
Whether this indifference can be transformed into a willingness to amend its law to impose mandatory fiduciary duties in publicly traded alternative entities depends on whether Strine, Laster, and others can make a convincing policy case for making this change. Or more cynically yet, it might depend on whether Delaware’s legislature fears that in the absence of state-level regulation, the federal government might step in to preempt Delaware law on behalf of public investors. 
* * * * *
 See Franklin Gevurtz, Why Delaware LLCs?, 91 Or. L. Rev. 57, 105 (2012).
 See, e.g., Ark. Code Ann. § 4-32-1304 (2001); Colo. Rev. Stat. § 7-80-108(4) (2009); Conn. Gen. Stat. Ann. § 34-242(a) (West 2005); Ga. Code. Ann. § 14-11-1107(b) (2003 & Supp. 2010); Kan. Stat. Ann. § 17-76,134(b) (2007); Ky. Rev. Stat. Ann. § 275.003 (West, Westlaw through 2010 legislation); La. Rev. Stat. Ann. § 12:1367(B) (2010); Miss. Code. Ann. § 79-29-1201(2) (2009); Mo. Rev. Stat. § 347.081(2) (2001 & Supp. 2010); Nev. Rev. Stat. § 86.286(4)(b) (2010); N.M.Stat. Ann. § 53-19-65(A) (LexisNexis 1978 & Supp. 2003); N.C. Gen. Stat. Ann. § 57C-10- 03(e) (2009); Okla. Stat. Ann. tit. 18, § 2058(D) (West 1999 & Supp. 2010); Utah Code Ann. § 48-2c-1901 (LexisNexis 2007); Va. Code Ann. § 13.1-1001.1(C) (2006); Wash. Rev. Code Ann. § 25.15.800(2) (West 2005); Wis. Stat. Ann. § 183.1302(1) (West 2002).
 Cf. Gerber v. Enterprise Prods. Holdings, LLC, 2012 WL 34442, *10 n.42 (Del. Ch. Jan. 6, 2012) (Noble, V.C.) (“This [case] raises the issue of just what protection Delaware law affords the public investors of limited partnerships that take full advantage of [the freedom of contracting.] If the protection provided by Delaware law is scant, then the LP units of these partnerships might trade at a discount or another governmental entity might step in and provide more protection to the public investors in these partnerships.”) (emphasis added).
Sandra Miller: Un-Sophisticated Parties Require Mandatory Duties at least in Publicly-Traded Entities if Not in all Entities (Contract Is King Micro-symposium)
Guest post by Sandra Miller:
The ratio of LLC filings to corporate filings in Delaware from 2010 to 2014 was over 3 to 1. Alternative business entities are no longer the province of a relatively small number of sophisticated investors. Increasingly, corporations are becoming the “alternative” and LLCs and other unincorporated entities the norm. Mom and Pop business as well as sophisticated real estate syndicators use alternative business entities. Additionally, as discussed below, publicly-traded limited partnerships and LLCs are now being aggressively marketed.
Accordingly, the assumptions that might once have justified greater reliance on private ordering in LLCs and alternative business entities should be revisited. Not all investors are highly sophisticated parties and a relentlessly contractual approach to business entity governance is not appropriate for unsophisticated parties. Nor is it appropriate for those without sophisticated legal counsel. In backhanded fashion, this point was recognized by Larry E. Ribstein who advocated the removal of restrictions on waivers of fiduciary duties in limited partnerships when these entities were used by sophisticated firms that were unlikely to be publicly traded. Ribstein expressly stated that limited partnership interests may be less vulnerable than corporate shareholders and are unlikely to be publicly traded. (See Fiduciary Duties and Limited Partnerships)
Master limited partnerships (e.g. publicly-traded limited partnerships and publicly-traded LLCs) provide an important example of how capital from unsophisticated investors now flows readily into alternative investments. According to the National Association of Publicly-Traded Partnerships (NAPTP) most MLP investors are individuals, the vast majority of whom are over age 50. Many investors are individuals, estates, and retirement plans – unsophisticated economic players. Thus, there are asymmetries in the marketplace that make it unlikely that the marketplace will efficiently discount the effects of waivers. Given the investor profile, at a very minimum, the duty of loyalty should be non-waivable for publicly-traded entities. (See Toward Consistent Fiduciary Duties)
There are even strong arguments in favor of reinstating mandatory minimum fiduciary duties for all business entities, public or private. Contractarians pre-suppose a level contractual playing field. Yet, repeat players who structure similar transactions repeatedly are at a distinct advantage. Moreover, there may not be equal legal representation of majority and minority investors. (See A New Direction for LLC Research in a Contractarian Legal Environment) Moreover, it is total madness to think that a contractual approach to business entity governance reduces costs. If anything, costs are increased by the lack of standard terms under a contractual regime.
In short, we have empirical data and years of experience with waivers that expose serious inefficiencies and injustices in a system that permits the waiver of all fiduciary duties. It is time to reconsider the benefits of a mandatory duty of loyalty for all entities, public or private.
Monday, November 16, 2015
Daniel Kleinberger: Delineating Delaware’s Implied Covenant of Good Faith & Fair Dealing (Contract Is King Micro-sympsium)
Guest post by Daniel Kleinberger:
Part I - Introduction
My postings this week will seek to delineate Delaware’s implied contractual covenant of good faith and fair dealing and the covenant’s role in Delaware entity law
An obligation of good faith and fair dealing is implied in every common law contract and is codified in the Uniform Commercial Code (“U.C.C”). The terminology differs: Some jurisdictions refer to an “implied covenant;” others to an “implied contractual obligation;” still others to an “implied duty.” But whatever the label, the concept is understood by the vast majority of U.S. lawyers as a matter of commercial rather than entity law. And, to the vast majority of corporate lawyers, “good faith” does not mean contract law but rather conjures up an important aspect of a corporate director’s duty of loyalty.
Nonetheless, Delaware’s “implied contractual covenant of good faith and fair dealing” has an increasingly clear and important role in Delaware “entity law” – i.e., the law of unincorporated business organizations (primarily limited liability companies and limited partnerships) as well as the law of corporations.
Because to the uninitiated “good faith” can be frustratingly polysemous, this first blog “clears away the underbrush” by explaining what Delaware’s implied covenant’s “good faith” is not.
Part II – A Couple of Major “Nots”
- Not the Looser Approach of the Uniform Commercial Code
The Uniform Commercial Code codifies the common law obligation of good faith and fair dealing for matters governed by the Code: “Every contract or duty within [the Uniform Commercial Code] imposes an obligation of good faith in its performance and enforcement.” The Code defines “good faith” as “mean[ing] [except for letter of credit matters] honesty in fact and the observance of reasonable commercial standards of fair dealing.” An official comment elaborates: “Although ‘fair dealing’ is a broad term that must be defined in context, it is clear that it is concerned with the fairness of conduct rather than the care with which an act is performed.”
The UCC standard thus incorporates facts far beyond the words of the contract at issue and furthers a value (fairness) which in the entity context is usually the province of fiduciary duty. The UCC definition provides some constraint by referring to “reasonable commercial standards,” but “[d]etermining . . . unreasonableness inter se owners of an organization is a different task than doing so in a commercial context, where concepts like ‘usages of trade’ are available to inform the analysis.” ULLCA (2013) § 105(e), cmt.
The Delaware Supreme Court has flatly rejected the U.C.C. approach for Delaware unincorporated businesses.
- Not the Corporate Good Faith of Disney, Stone v. Ritter, and Caremark
An obligation to act in good faith has long been part of a corporate director’s duty under Delaware law, but the concept became ever more important following the landmark case of Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). In Van Gorkom, the Delaware Supreme Court held directors liable for gross negligence in approving a merger transaction, a holding that “shocked the corporate world.”
Spurred by the Delaware corporate bar, the Delaware legislature promptly amended Delaware’s corporate statute. The amendment permits Delaware corporations to essentially opt out of the Van Gorkom rule. The now famous Section 102(b)(7) authorizes a Delaware certificate of incorporation to:
eliminat[e] or limit the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty …, provided that such provision shall not eliminate or limit the liability of a director: (i) For any breach of the director's duty of loyalty to the corporation or its stockholders; [or] (ii) for acts or omissions not in good faith….
In effect, the provision authorizes exculpation from damages arising from claims of director negligence, but for some time the exception “for acts or omissions not in good faith” was controversial. Where plaintiffs could not allege breach of the duty of loyalty, they sought to equate “not in good faith” with extreme negligence.
Notably, the meaning of “not in good faith” was pivotal in the lengthy and costly litigation arising from the Disney corporation’s termination of Michael Ovitz. However, the Supreme Court’s decision in In re Walt Disney Co. Derivative Litig. left the issue murky. Eventually, in Stone v. Ritter, the court made clear that in this context “good faith” is an aspect of the duty of loyalty. The Court then equated a lack of this type of good faith with a director’s utter failure to attend to his or her oversight obligations (the so-called Caremark I duties).
Thus, a Delaware director’s fiduciary duty of good faith has nothing to do with the “good faith” of the Delaware implied covenant of good faith and fair dealing.
This posting is derived from Daniel S. Kleinberger, “Delaware’s Implied Contractual Covenant of Good Faith and “Sibling Rivalry” Among Equity Holders,” a paper presented at the 21st Century Commercial Law Forum: 15th International Symposium in Beijing, at Tsinghua University’s School of Law, November 1, 2015 (all footnotes and most citations omitted).
Jeffrey Lipshaw: Regarding Uncorporations, Is Contract a King or Mere Pretender to the Throne? (Micro-symposium)
Guest post by Jeffrey Lipshaw:
I’m honored to be asked to participate in this micro-symposium, and will (sort of) address the first two questions as I have restated them here.
- Does contract play a greater role in “uncorporate” structures than in otherwise comparable corporations and, more importantly, do I care?
Yes, as I’ll get to in #2, but indeed I probably don’t care. My friend and casebook co-author, the late great Larry Ribstein, was more than a scholar-analyst of the non- or “un-” corporate form; he was an enthusiastic advocate. It’s pretty clear that had to do with his faith in the long-term rationality of markets and their constituent actors and a concomitant distrust of regulatory intervention. Indeed, he argued the uncorporate form, based in contract, was more amenable than the regulatory-based corporate form to the creation of that most decidedly immeasurable quality, trust, and therefore the reduction of transaction costs. I confess I never quite understood the argument and tried to explain why, but only after Larry passed away, so I never got an answer.
Unlike Larry (and a number of my fellow AALS Agency, Partnership, & LLC section members), I was never able to generate a lot of normative fervor about the ultimate superiority of the non-corporate form. I view all organizational and transactional structures, including corporations, LLCs, and contracts, as models or maps. The contractual, corporate, and uncorporate models are always reductions in the bits and bytes of information from the complex reality, and that’s what makes them useful, just as a map of Cambridge, Massachusetts that was as complex as the real Cambridge would be useless.
The difference between city maps and word maps is that the latter are artifacts we lawyers create to chart or control a reality that, in all its damnable uncooperativeness, insists upon moving forward through time and not necessarily respecting all that hard work we did trying to map its possible twists and turns. City maps may also become obsolete over time, but streets and buildings tend not to evolve and adapt quite as quickly or fluidly as human desires and relationships. So we have fewer issues with the gaps between physical maps and physical reality (notwithstanding the desire of my car’s GPS to sell me annual updates) than with the gaps between what we want now and what we wrote down some time ago (whether by way of bylaws, operating agreement, or supply contract) to see that we got it.
Hence, if uncorporations differ from corporations, it’s more a matter of degree than of any real difference. Both are textual artifacts. We have created or assumed obligations pursuant to the text at certain points in time, and we use the artifacts and their associated legal baggage opportunistically when we can. I am not convinced that organizing in the form or corporations or uncorporations makes much difference on that score.
- Is the unfettered ordering in LLCs and limited partnerships – like being able to eliminate wholly all fiduciary duties among the members or partners, as Delaware permits – a good thing? Or should there be some standardized (and I presume therefore mandatory) fiduciary obligations for uncorporations, as Chief Justice Strine and Vice-Chancellor Laster suggest?
Having now gotten my general curmudgeonly-ness out of the way about the whole subject, and believing that a foolish consistency is the hobgoblin of little minds, I want to point out an area where the corporate model and its baggage indeed don’t match up to what normal human beings would expect as reasonable. I confess it’s something that has been a bug up my backside for a number of years, in that I personally had to counsel on the dilemma, and would have loved it if we had organized this particular company as a Delaware limited partnership with only limited and specified fiduciary obligations.
Here’s the circumstance. ABC Corporation spins off one of its businesses into a majority-owned subsidiary, DEF Corporation, possibly as the first step in a complete divestiture. (There’s possibly a tax benefit doing it this way, but let’s not go there right now.) DEF is now publicly traded, with a substantial minority, but ABC controls it both as to ownership (a majority share percentage) and management (posit that ABC appoints a majority of the board of the subsidiary). Assume that DEF’s common stock is now trading at, say, $15 per share on the NASDAQ. A third party, XYZ Corporation, contacts ABC’s CEO, and says the following: “We are prepared to pay $32 per share for all of DEF, both yours and the public minority, but we view this as pre-emptive, and if you shop the bid, we will walk away.” ABC’s CEO’s visceral reaction is to tell XYZ that if it will send over the check, she will deliver the share certificate this afternoon. Indeed, were DEF still wholly owned, that’s probably what would happen soon, if not that afternoon.
But Delaware corporate law doesn’t like that at all when there’s a public minority. See McMullin v. Beran, 765 A.2d 910 (Del. 2000) and Lyondell Chemical Co. v. Ryan, 970 A.2d 235 (Del. 2009). DEF’s board is going to have to create a special committee of the independent (i.e. public) directors to undertake diligence satisfying the duty of care obligation. That committee will feel obliged to hire independent counsel and its own investment banker. It may believe that its duty requires a shopping of the bid, which could cause the pre-emptive offer to go away. But how do we know that there isn’t a $35 per share offer just waiting out there? (I commented on this in connection with Lyondell back in 2008.) As any transactional lawyer knows, time means deal risk.
I’m not suggesting that the duty of care obligations imposed by the corporate law are wrong in change of control cases, but their imposition in Smith v. Van Gorkom (where the essence of the decision was that, regardless of the attractiveness of the offer, the board went too fast and wasn’t careful enough) provoked the adoption of §102(b)(7), exculpating the directors from monetary liability on account of any breach of the duty of care largely because they were held liable in a “devil if you do – devil if you don’t” circumstance. That is to say, §102(b)(7) is an implicit acknowledgment that broad and standardized fiduciary obligations are sometimes overbroad. But there’s really no way, at least logically, to tell a board when a bid is sufficiently pre-emptive as to trump the ordinary procedural precautions.
The great benefit of Delaware LLC and LP law, in providing that the usual fiduciary duties apply as a default matter, but permitting the parties to eliminate or modify them, as one cannot under the corporate law, is precisely the customization that would have been useful here. Assuming no penalty in the market for having organized as a public limited partnership or LLC (see Blackstone Group LP), that form would have allowed the governing organizational document to waive any fiduciary obligation of the board or the majority owner in connection with the consideration of a seemingly pre-emptive offer, and avoided delay and the associated risk to the deal.
With all due respect to Chief Justice Strine and Chancellor Laster, I still don’t believe this has anything to do with the magic of private ordering in contract. As I’ve written extensively, I think there’s significant illusion among lawyers and law professors about the extent to which any text capable of colorable competing interpretations actually reflects any mutual intention even if it was the subject of arm’s-length negotiation. That’s because I tend to believe that even sophisticated parties to sophisticated contracts put in a lot of boilerplate they hope maps accurately the twists and turns of future events or, more importantly, clearly favors them if there’s ever a dispute. And when there is a later dispute, they turn to the text and hope to hell there’s something helpful in it. So I’ve never been under the misapprehension that the operating agreement or partnership agreement of a publicly held LLC or LP reflects real intentions about the resolution of later disputes any more than corporate bylaws or the rights and preferences of a class of stock.
The LLC or LP form is just an alternative map or model, with alternative rights and obligations. In the case that bugged me, it would have been a way to avoid a problem the corporate model really couldn’t quite get right. Whether that’s “contract” or something else, reinstating standardized or mandatory fiduciary obligations strikes me as eliminating the very choice the different forms were meant to offer.
Friday, November 13, 2015
Last week I shared my thoughts on REI's #OptOutside campaign and concluded that the campaign appeared, in my opinion, to be more of a marketing ploy than anything truly socially responsible.
I promised to discuss what I think it takes to build a respected socially responsible brand.
In my opinion, respected socially responsible brands are: (1) Authentic; (2) Humble; and (3) Consistent.
These three work together. Authenticity comes, at least in part, from not over-claiming (also seen in humility) and from showing social responsibility in many areas over time (consistency). Authenticity with regard to social responsibility requires some serious sacrifice, at least in the short term. Humble companies admit their imperfections, work to right wrongs, and seek to improve. Building a socially responsible brand takes time, often decades. As Warren Buffett supposedly said, "It takes 20 years to build a reputation and 5 minutes to ruin it."
Patagonia's "Don't Buy This Jacket" campaign was probably one of the best socially responsible advertising campaigns I have seen. This campaign seemed authentic because of Patagonia's consistent history of social responsibility and because it seemed clear that Patagonia was going to take a serious financial hit from this campaign. Patagonia's add was also humble in admitting the social costs of the goods it produces. Patagonia is not a perfect company, and their executives often admit that, and Patagonia may experience mission drift, but they continue to be one of the most socially responsible companies I know.
Just a quick report from the 2015 ABA LLC Institute, an annual event held in the fall in Washington, DC that attracts anally compulsive (and I do mean that in the most positive way possible) business lawyers (academics and practitioners) interested in limited liability companies (LLCs) and other alternative business entities. The agenda for this year's program is full of nifty stuff and great presenters (present company excepted). Co-blogger Josh Fershee would love the LLC Institute. No one here confuses the LLC with the corporation! (I will just link to one of Josh's fabulous posts on that topic as a reference point.)
For this year's institute, I chaired a panel on dissolution in the LLC and also participated in a panel that explored just what an LLC operating agreement really is. I was wowed in each case by my co-paneleists. Because the norm at this conference is to interrupt the panelists and comment on their presentations as they speak, the discourse was engaged and lively.
I will save my comments on the operating agreement panel for next week's micro-symposium. Today, I want to briefly cover highlights from the dissolution panel. Specifically, we focused a lot of attention on the evolution of dissolution events under the uniform and prototype LLC acts and various state LLC statutes since the adoption of the federal income tax "check the box" rules. There's more in and related to that topic than you might think . . . .
Thursday, November 12, 2015
Next week, the BLPB is hosting a micro-symposium organized by the AALS section on Agency, Partnership, LLCs, and Unincorporated Associations. Confirmed participants include Joan MacLeod Heminway (BLPB editor), Dan Kleinberger, Jeff Lipshaw, Mohsen Manesh, and Sandra Miller.
The micro-symposium will explore the role of private ordering in LLCs and other alternative business entities, a broad topic that encompasses many interesting questions:
(1) To what extent, and in what ways, does contract play a greater role in LLCs and LPs than in otherwise comparable corporations? Is it helpful to conceptualize private ordering in this context as contractual?
(2) Does unfettered private ordering reliably advance the interests of even the most sophisticated parties? Does it waste judicial resources? In their book chapter, The Siren Song of Unlimited Contractual Freedom, two distinguished Delaware jurists, Chief Justice Leo Strine and Vice Chancellor J. Travis Laster, raise these concerns and argue in favor of more standardized fiduciary default rules.
(3) Should the law impose fiduciary duties of loyalty and care as safeguards against abuse of the unobservable discretion managers enjoy because those duties reflect widely held social norms that most investors would expect to govern the conduct of managers?
(4) If the parties themselves would choose to waive their fiduciary obligations, is there nevertheless a continuing role for mandatory terms and judicial monitoring of the parties' relationship?
(5) Does it matter whether an LLC or alternative business entity is closely held or publicly traded?
We look forward to an engaging discussion next week via blog, and we invite everyone who will be at AALS to attend our section meeting on January 7 at 1:30pm. Joined by panelists Lyman Johnson and Mark Loewenstein, we will continue the conversation in person.
Friday, November 6, 2015
REI recently announced that they will close their stores on the busiest day in retail, Black Friday. They are encouraging their customers and employees to spend time outside. REI is also paying their employees on Black Friday even though their stores will be closed.
At first, I was proud of REI for this move; Black Friday can be materialism at its worst.
But I think REI made a poor strategic move by over-promoting this announcement and buying numerous social media advertisements for their #OptOutside campaign. REI's self-congratulatory ads have been following me around the internet for the past few days.
Advertising about your social responsibility is really difficult to do well.
Convincing customers that you are socially responsible through advertising is like trying to convince your friends you are generous through social media posts. Both are likely to backfire. As Wharton professor Adam Grant recently wrote, you shouldn't say "I'm a giver;" that determination is for others to make.
In my opinion, praise of a company's socially responsible behavior should come primarily from its stakeholders. REI received plenty of third-party press regarding their announcement (see, e.g., here, here, and here), but their self-promotion has convinced me that this is primarily a financially-focused marketing ploy, not mainly a move to benefit society at large.
Next week, I will look at some companies that I think do a better job of building their socially responsible brand.
Tuesday, November 3, 2015
The Georgia Attorney General's (AG) office is trying to make the case that the Georgia Pipeline Act does not allow any entity other than a corporation to use the statute's eminent domain power. Palmetto Pipeline is seeking a certificate for authorization to use that power, provided in GA Code § 22-3-82 (2014):
(a) Subject to the provisions and restrictions of this article, pipeline companies are granted the right to acquire property or interests in property by eminent domain for the construction, reconstruction, operation, and maintenance of pipelines in this state . . . .
The state AG has argued that a pipeline company must be a corporation, and thus a limited liability company (LLC) cannot use the statutory power. The AG is right. In the Pipeline Act's definitions section, it provides, at GA Code § 22-3-81 (2014),
As used in this article:
. . . .
(2) "Pipeline company" means a corporation organized under the laws of this state or which is organized under the laws of another state and is authorized to do business in this state and which is specifically authorized by its charter or articles of incorporation to construct and operate pipelines for the transportation of petroleum and petroleum products.
Palmetto Pipeline LLC is a Delaware LLC, formed by Kinder Morgan for purposes of developing the pipeline. According to news reports:
"Kinder Morgan will also be responding to the Department’s motion to dismiss, which mistakenly asserts that a limited liability company does not have the legal rights of a corporation,” [spokeswoman Melissa Ruiz wrote in an email]. “Kinder Morgan continues to strongly believe that the Palmetto Pipeline is good for consumers in the state of Georgia and the Southeast region, and we are committed to bringing this project to market.”
Sorry, Charlie, although it may be good for consumers, the statute is clear on this one. In fact, Georgia utility law provides a good example of how to write a statue that expands the scope to other entities when desired. The public utility law relating to natural gas in the state, at GA Code § 46-4-20 (2014), provides:
As used in this article, the term "person" means any corporation, whether public or private; company; individual; firm; partnership; or association.
Further, the act states:
(a) No person shall construct or operate in intrastate commerce within this state any pipeline or distribution system, or any extension thereof, for the transportation, distribution, or sale of natural or manufactured gas without first obtaining from the commission a certificate that the public convenience and necessity require such construction or operation.
Unfortunately for Palmetto/Kinder Morgan, the eminent domain act has its own definitions and says "pipeline company" and not "person." One might try to argue that the eminent domain statute somehow improperly restricts the rights of individuals and other entities by limiting the authority to corporations, and thus invalidate the law or provision, but I don't see that getting much traction. The eminent domain law states in the legislative findings that
there are certain problems and characteristics indigenous to such pipelines which require the enactment and implementation of special procedures and restrictions on petroleum pipelines and related facilities as a condition of the grant of the power of eminent domain to petroleum pipeline companies.
GA Code § 22-3-80 (2014). Given the history of utility regulation and oversight, including approval of capital structures by utility commissions, it is likely that a court would uphold the power to limit the types of entities that can be used by a regulated entity like a pipeline company.
I don't mean to suggest here that the legislature should not allow pipeline companies to choose LLCs as their entity of choice. I leave that question for another time. But I am saying that that the Georgia legislature did not allow pipeline companies to be anything other than corporations, which means an LLC cannot be a pipeline company that can use eminent domain power in Georgia. Here's hoping the court agrees.
Hat tip and thanks to my best source for such cases and news items, Tom Rutledge at Kentucky Business Entity Law Blog.
Monday, November 2, 2015
Pat Haden is the athletic director at the University of Southern California. Until Friday, he was also a member of the College Football Playoff selection committee. And, according to this story in the L.A. Times, he is also a director of at least nine non-profits or foundations and three businesses.
According to the Times, Haden spends an average of 70 hours a week on his U.S.C. job. As a playoff selection committee member, he was expected to spend countless hours watching football games and evaluating teams.
So where does he find the time to serve as a board member? Not a problem, according to Haden. He has “never been to one meeting” of some of the nonprofits he serves. And he spends “very little” time on his board positions.
Haden’s attitude is representative of an earlier era when outside directors merely showed up at meetings and nodded their head to whatever the chairman said. Those days are long gone. Today, board members are expected to spend much more time on their board duties, at the risk of liability if they don't.
Mr. Haden, a former Rhodes Scholar, is a very bright guy, but even bright guys can say stupid things. I just hope he’s never sued. (At least one of the businesses he serves as a director is a public corporation.) A plaintiff’s lawyer could use quotes like this to mince him.
In the meantime, I suggest he read something on modern corporate governance. He has a law degree, so he shouldn’t have any trouble understanding it.
Sunday, November 1, 2015
I teach both Civil Procedure and Business Associations. As a former defense-side commercial and employment litigator, I teach civ pro as a strategy class. I tell my students that unfortunately (and cynically), the facts don’t really matter. As my civil procedure professor Arthur Miller drilled into my head 25 ago, if you have procedure on your side, you will win every time regardless of the facts. Last week I taught the seminal but somewhat inscrutable Iqbal and Twombly cases, which make it harder for plaintiffs to survive a motion to dismiss and to get their day in court. In some ways, it can deny access to justice if the plaintiff does not have the funds or the will to re-file properly. Next semester I will teach Transnational Business and Human Rights, which touches on access to justice for aggrieved stakeholders who seek redress from multinationals. The facts in those cases are literally a matter of life and death but after the Kiobel case, which started off as a business and human rights case but turned into a jurisdictional case at the Supreme Court, civil procedure once again "triumphed" and the doors to U.S. courthouses closed a bit tighter for litigants.
This weekend, the New York Times published an in depth article about how the corporate use of arbitration clauses affects everyone from small businesses to employees to those who try to sue their cell phone carriers and credit card companies. Of course, most people subject to arbitration clauses don’t know about them until it’s too late. On the one hand, one could argue that corporations would be irresponsible not to take advantage of every legal avenue to avoid the expense of protracted and in some cases frivolous litigation, particularly class actions. On the other hand, the article, which as one commenter noted could have been written by the plaintiffs bar, painted a heartbreaking David v. Goliath scenario.
I see both sides and plan to discuss the article and the subsequent pieces in the NYT series in both of my classes. I want my students to think about what they would do if they were in-house counsel, board members, or business owners posed with the choice of whether to include these clauses in contracts or employee handbooks. For some of them it will just be a business decision. For others it will be a question of whether it’s a just business decision.
Friday, October 30, 2015
Jill Fisch (Penn) recently posted an essay entitled The Mess at Morgan: Risk, Incentives and Shareholder Empowerment.
The entire essay is worth reading, but I think her argument can be summed up with this quote:
This essay argues that the effort to employ shareholders as agents of public values and, thereby, to inculcate corporate decisions with an increased public responsibility is misguided. The incorporation of publicness into corporate governance mistakenly assumes that shareholders’ interests are aligned with those of non-shareholder stakeholders. Because this alignment is imperfect, corporate governance is a poor tool for addressing the role of the corporation as a public actor. (pg. 651)
Jill Fisch argues that economic regulation may be a better solution to the problem of protecting the public than shareholder empowerment. (pg. 684).
While I acknowledge the essay's mentioned limitations on shareholder empowerment, I don't think economic regulation is the only alternative solution to the problem of protecting public values. As Jill Fisch notes "shareholder empowerment might be defended on the basis that it is less intrusive than direct regulation." Corporate governance mechanisms other than shareholder empowerment may be both less intrusive and more effective than direct regulation. For example, (non-shareholder) stakeholder empowerment may make sense, as I plan to explain in a future article that is currently in its very early stages.