Tuesday, June 13, 2017
I am such a fan of Sinclair Oil Corp. v. Levien, 280 A.2d 717 (Del. 1971), that I use the case in both Business Organizations and in Energy Law. The case does a great job of giving a basic overview of parent-subsidiary relationships, some of the basic fiduciary duties owed in such contexts, and it sets up the discussion of why companies use subsidiaries in the first place.
On fiduciary duties and when the intrinsic (entire) fairness test applies:
A parent does indeed owe a fiduciary duty to its subsidiary when there are parent-subsidiary dealings. However, this alone will not evoke the intrinsic fairness standard. This standard will be applied only when the fiduciary duty is accompanied by self-dealing — the situation when a parent is on both sides of a transaction with its subsidiary. Self-dealing occurs when the parent, by virtue of its domination of the subsidiary, causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority stockholders of the subsidiary
On what test to apply to parent-subsidiary dividends:
We do not accept the argument that the intrinsic fairness test can never be applied to a dividend declaration by a dominated board, although a dividend declaration by a dominated board will not inevitably demand the application of the intrinsic fairness standard. Moskowitz v. Bantrell, 41 Del.Ch. 177, 190 A.2d 749 (Del.Supr. 1963). If such a dividend is in essence self-dealing by the parent, then the intrinsic fairness standard is the proper standard. For example, suppose a parent dominates a subsidiary and its board of directors. The subsidiary has outstanding two classes of stock, X and Y. Class X is owned by the parent and Class Y is owned by minority stockholders of the subsidiary. If the subsidiary, at the direction of the parent, declares a dividend on its Class X stock only, this might well be self-dealing by the parent. It would be receiving something from the subsidiary to the exclusion of and detrimental to its minority stockholders. This self-dealing, coupled with the parent's fiduciary duty, would make intrinsic fairness the proper standard by which to evaluate the dividend payments.
. . . . The dividends resulted in great sums of money being transferred from Sinven to Sinclair. However, a proportionate share of this money was received by the minority shareholders of Sinven. Sinclair received nothing from Sinven to the exclusion of its  minority stockholders. As such, these dividends were not self-dealing. We hold therefore that the Chancellor erred in applying the intrinsic fairness test as to these dividend payments. The business judgment standard should have been applied.
On whether shareholder of one subsidiary should be allowed to participate in ventures pursued by other subsidiaries:
The plaintiff proved no business opportunities which came to Sinven independently and which Sinclair either took to itself or denied to Sinven. As a matter of fact, with two minor exceptions which resulted in losses, all of Sinven's operations have been conducted in Venezuela, and Sinclair had a policy of exploiting its oil properties located in different countries by subsidiaries located in the particular countries.
It makes sense for companies, often, to use subsidiaries to keep certain businesses well organized and to protect assets for shareholder. That is, I might only want to invest in a subsidiary doing business in Mexico because I trust that the assets there are secure. I may not want to participate in work in Venezuela, which I might deemed riskier. And it's not just shareholders who might feel that way. Creditors, too, may view such investments very differently and may only be willing to participate in ventures where the risks can be more easily assessed.
Tuesday, December 20, 2016
During the recent presidential campaign, there was a lot of talk the evil of “political correctness” or (PC). A lot has been said about this concept on social media, and I got to thinking about the legal applications of what PC means. This post is my first look the concept from a legal perspective and looks briefly at the legal origins and applications of the idea.
Speechwriter (and author and columnist) Barton Swaim has said that “Political correctness is an insidious presence in American life.” PC is generally seen (and criticized) as a product of the political left.
And the political right has a companion, “patriotically correct,” and that idea was recently explained in a popular article by Alex Nowrasteh, an immigration policy analyst at the Cato Institute’s Center for Global Liberty and Prosperity. Nowrasteh notes that political correctness has been a “major bugaboo of the right” in recent years and explains:
[C]onservatives have their own, nationalist version of PC, their own set of rules regulating speech, behavior and acceptable opinions. I call it “patriotic correctness.” It’s a full-throated, un-nuanced, uncompromising defense of American nationalism, history and cherry-picked ideals. Central to its thesis is the belief that nothing in America can’t be fixed by more patriotism enforced by public shaming, boycotts and policies to cut out foreign and non-American influences.
As for a definition of political correctness, I will borrow from Swaim again:
Political correctness, if I could venture my own admittedly rather clinical definition, involves the prohibition of common expressions and habits on the grounds that someone in our pluralistic society may be offended by them. It reduces political life to an array of signs and symbols deemed good or bad according to their tendency either to include or exclude aggrieved or marginalized people from common life.
But where did the concept come from? The first cited U.S. legal use of it appears to be one of the foundational Supreme Court cases, which ultimately led to passage of the Eleventh Amendment, states:
Sentiments and expressions of this inaccurate kind prevail in our common, even in our convivial, language. Is a toast asked? ‘The United States,‘ instead of the ‘People of the United States,‘ is the toast given. This is not politically correct. The toast is meant to present to view the first great object in the Union: It presents only the second: It presents only the artificial person, instead of the natural persons, who spoke it into existence.
Chisholm v. Georgia, 2 U.S. 419, 462, 1 L. Ed. 440 (1793) (emphasis added). This doesn’t seem to apply to the modern concept of what it means to be politically correct. The fact that the case draws a distinction between the artificial person (in this case, the United States of America) and the natural persons who make up the nation. That's concept that has application in the business law world, to be sure.
The phrase “politically correct” appears in 259 cases per a search on Westlaw, and the phrase took 191 years off after Chisholm v. Georgia. The phrase resurfaced in 1984, with a use that seems to combine the more modern usage with the 1793 use. Am. Postal Workers Union v. U.S. Postal Serv., 595 F. Supp. 1352, 1362 (D.D.C. 1984), aff'd in part, vacated in part sub nom. Am. Postal Workers Union, AFL-CIO v. U.S. Postal Serv., 764 F.2d 858 (D.C. Cir. 1985) (stating that a union “could find out what party a worker is affiliated with and, if not ‘politically correct,’ exert pressure on the worker to change).
In 1991, the phrase comes into more common usage, and we see a particularly modern spin in a Minnesota appeals court dissent in a case upholding a trespassing conviction against abortion protestors:
Both the issues of war and abortion produce a deep split in America's fabric. Oftentime an ugly split. Although it is not pretty, at least it proves that Americans feel strongly on both sides of the issue. Courts do not determine whether anti-war protests are more “politically correct” than abortion protests. It is not up to courts to pass judgment on the “worthiness” of appellants' cause. Trespass is a crime. This is a criminal case. I do not bother my head with whether appellants should protest against “X” (because I disagree with “X”) but not protest against “Y” (because I agree with “Y”). As criminal defendants, appellants are entitled to certain constitutional rights. We do not differentiate between “good” defendants and “bad” defendants. We treat all the same.
State v. Rein, 477 N.W.2d 716, 723 (Minn. Ct. App. 1991) (Randall, J., dissenting).
From a legal perspective, this 1991 case is a jumping off point for modern legal usages of the PC concept. The idea almost always connotes something negative. Take, for example, the most recent case in which a judge used the phrase as part of the opinion (there are more recent cases in which the court quotes others using the phrase). Here, again is a dissent, this time a Fourth Circuit case upholding a District Court order allowing a transgender student to use their restroom of choice:
Somehow, all of this is lost in the current Administration's service of the politically correct acceptance of gender identification as the meaning of “sex”—indeed, even when the statutory text of Title IX provides no basis for the position.
G.G. v. Gloucester Cty. Sch. Bd., 824 F.3d 450, 452 (4th Cir. 2016) (Niemeyer, J., dissenting), cert. granted in part Gloucester Cty. Sch. Bd. v. G.G. ex rel. Grimm, 137 S. Ct. 369 (2016).
I find it interesting that my quick search (admittedly not exhaustive), only revealed the term being used by courts in dissents. As such, when in the majority, the label is deemed unnecessary, even in discussing a counterargument. Is is just a matter of time, or is it more that the majority is deciding not to take a victory lap when on the winning side?
That's the quick look at the legal landscape of political correctness. Does it lead us anywhere? I don't know. At a minimum, I think we should try not to offend others when we can avoid it. And if we do offend others, apologize and try to move forward.
Beyond that, I have to get back grading. So far, not one person has called an "LLC" a "limited liability corporation." Doing so would be decidedly un-PC.
Wednesday, August 17, 2016
If it is true that “a good thing cannot last forever,” the recent turn of events concerning appraisal arbitrage in Delaware may be a proof point. A line of cases coming out of the Delaware Court of Chancery, namely In re Appraisal of Transkaryotic Therapies, Inc., No. CIV.A. 1554-CC (Del. Ch. May 2, 2007), In re Ancestry.Com, Inc., No. CV 8173-VCG (Del. Ch. Jan. 5, 2015), and Merion Capital LP v. BMC Software, Inc., No. CV 8900-VCG (Del. Ch. Jan. 5, 2015), have made one point clear: courts impose no affirmative evidence that each specific share of stock was not voted in favor of the merger—a “share-tracing” requirement. Despite this “green light” for hedge funds engaging in appraisal arbitrage, the latest case law and legislation identify some new limitations.
What Is Appraisal Arbitrage?
Under § 262 of the Delaware General Corporation Law (DGCL), a shareholder in a corporation (usually privately-held) that disagrees with a proposed plan of merger can seek appraisal from the Court of Chancery for the fair value of their shares after approval of the merger by a majority of shareholders. The appraisal-seeking shareholder, however, must not have voted in favor of the merger. Section 262, nevertheless, has been used mainly by hedge funds in a popular practice called appraisal arbitrage, the purchasing of shares in a corporation after announcement of a merger for the sole purpose of bringing an appraisal suit against the corporation. Investors do this in hopes that the court determines a fair value of the shares that is a higher price than the merger price for shares.
In Using the Absurdity Principle & Other Strategies Against Appraisal Arbitrage by Hedge Funds, I outline how this practice is problematic for merging corporations. Not only can appraisal demands lead to 200–300% premiums for investors, assets in leveraged buyouts already tied up in financing the merger create an even heavier strain on liquidating assets for cash to fund appraisal demands. Additionally, if such restraints are too burdensome due to an unusually high demand of appraisal by arbitrageurs seeking investment returns, the merger can be completely terminated under “appraisal conditions”—a contractual countermeasure giving potential buyers a way out of the merger if a threshold percentage of shares seeking appraisal rights is exceeded. The article also identifies some creative solutions that can be effected by the judiciary or parties to and affected by a merger in absence of judicial and legislative action, and it evaluates the consequences of unobstructed appraisal arbitrage.
The Issue Is the “Fungible Bulk” of Modern Trading Practices
In the leading case, Transkaryotic, counsel for a defending corporation argued that compliance with § 262 required shareholders seeking appraisal prove that each of its specific shares was not voted in favor of the merger. The court pushed back against this share-tracing requirement and held that a plain language interpretation of § 262 requires no showing that specific shares were not voted in favor of the merger, but only requires that the current holder did not vote the shares in favor of the merger. The court noted that even if it imposed such a requirement, neither party could meet it because of the way modern trading practices occur.
August 17, 2016 in Anne Tucker, Business Associations, Case Law, Corporate Finance, Corporate Governance, Corporations, Delaware, Financial Markets, Private Equity, Shareholders | Permalink | Comments (0)
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.
Tuesday, September 8, 2015
Limited liability companies (LLCs) are often viewed as some sort of a modified corporation. This is wrong, as LLCs are unique entities (as are, for example, limited partnerships), but that has not stopped lawyers and courts, including this nation's highest court, from conflating LLCs and corporations.
About four and a half years ago, in a short Harvard Business Law Review Online article, I focused on this oddity, noting that many courts
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).
I have been writing about this subject again recently, so I decided to revisit the question of just how many courts call LLCs “limited liability corporations” instead of “limited liability companies.” I returned to Westlaw, though this time it's WestlawNext, to do the search of cases for the term "limited liability corp!". (Exclamation point is to include corp., corporation, and corporations in my search, not to show excitement at the prospect.)
The result: 4575 cases use the phrase at least once.
That means that, since May 2011, 1802 additional cases have incorrectly identified the definition of an LLC. (I concede that some cases may have used the term to note it was wrong, but I didn't find any in a brief look.)
Even the United States Supreme Court published one case using the incorrect phrase, and it was decided around three years after my article was published. See Daimler AG v. Bauman, 134 S. Ct. 746, 752, 187 L. Ed. 2d 624 (2014) ("MBUSA, an indirect subsidiary of Daimler, is a Delaware limited liability corporation."). (Author's note: ARRRRGH!) The court also stated, "Jurisdiction over the lawsuit was predicated on the California contacts of Mercedes–Benz USA, LLC (MBUSA), a subsidiary of Daimler incorporated in Delaware with its principal place of business in New Jersey." Id. (emphasis added). (Author's Note: Really?)
This opinion was written by Justice Ginsberg, and joined by Chief Justice Roberts, and Justices Scalia, Kennedy, Thomas, Breyer, Alito, and Kagan. Justice Sotomayor filed a concurring opinion that did not, unfortunately, concur in judgment but disagree with the characterization of the LLC. The entire court at least acquiesced in the incorrect characterization of the LLC!
It appears things have to get worse before they can get better, but I will remain vigilant. I’m working on an article that builds on this, and it will hopefully help courts and practitioners keep LLCs and corporations distinct.
In the meantime, I humbly submit to Chief Justice Roberts, and the rest of the Court, that there are already some useful things in law reviews.
September 8, 2015 in Business Associations, Case Law, Corporations, Joshua P. Fershee, Law Reviews, Lawyering, LLCs, Partnership, Research/Scholarhip, Unincorporated Entities | Permalink | Comments (2)
Wednesday, May 13, 2015
As some readers may recall, I posted twice back in November about The University of Tennessee, Knoxville's decision to drop the Lady Vols moniker and mark from all women's sports teams at UTK other than women's basketball. The first post primarily wondered about university counsel's consideration of trademark abandonment in the rebranding effort. The second post unpacked some additional issues raised by the first post and addressed some readers' and friends' concerns about my stance opposing the rebranding.
Interestingly, adverse reactions to the branding change, which is effective on July 1 (the beginning of the new academic year at UTK), have not died down since those original posts. Letters from concerned citizens have been published in the local paper, and the paper even published a recent news article documenting some of the back-and-forth between Lady Vol fans and the campus administration. [Ed. Note: this article may be protected by a firewall.] I have followed all of this with some interest.
Honestly, part of me just cannot wait for the university to drop the mark altogether so that I can start using it to mass merchandise retro Lady Vols t-shirts, hats, and other merch. Entrepreneurial pipe dream? Maybe. But it seems like a great idea, yes?
And there's a case involving Macy's that I will be following to help me to assess whether and, if so, when to launch my venture. The case, covered in an article in the New York Law Journal on Monday, involves Macy's and its disuse/limited use of department store names forsaken as a result of its own rebranding efforts. You know the names well if you're a person of a certain age--A&S, Filene's, Marshall Fields, Stern's, etc. (I shopped at all of them. Eek!) The defendant in the action, Strategic Marks, claims the right to use these so-called "heritage marks" for bricks-and-mortar and online shopping services. Apparently, Strategic Brands filed intent to use applications and statements of use with the U.S. Patent and Trademark Office. In the case, Macy's challenges Strategic Marks's right to use the heritage marks--asserting, among other things, that the marks have not, in fact, been abandoned (given that Macy's still uses them on the occasional plaque, t-shirt, and tote bag.) The case had been scheduled for trial earlier this year, but the trial date was postponed to reflect new claims by Macy's regarding Strategic Marks's use of additional marks earlier registered by Macy's.
The case apparently raises some interesting trademark abandonment issues that also may apply to the Lady Vols rebranding effort as time moves on. Among them: the length of time a mark must be in disuse before it is considered abandoned (although a presumption of abandonment apparently arises after non-use for three consecutive years), the types of behavior that constitute an intent not to resume use of a mark, and the effect of residual goodwill associated with a mark on claims of abandonment. Although Macy's and Strategic Marks do not agree on the facts of the case, it is the law as applied to those facts that I am most interested in knowing.
Of course, since UTK is keeping the Lady Vols name for the women's basketball team, at least for now, the trademark abandonment issue is not ripe. Accordingly, I cannot yet think about quitting my day job to promote the Lady Vols brand to all the passionate UTK women's sports fans out there. But I am keeping my entrepreneurial eyes on this issue. If they do away with tenure in The University of Tennessee system, for example, I may need an opportunity like this . . . !
Thursday, May 7, 2015
Last year, I blogged about a Fourth Circuit case, Prousalis v. Moore, which held that the Janus Capital definition of “maker” in Rule 10b-5 did not apply in criminal cases. For those who are interested, a short article on wrote on that topic, “Make” Means “Make”: Rejecting the Fourth Circuit’s Two-Headed Interpretation of Janus Capital, is now available on SSRN.
The paper is to be included in a symposium honoring the late Alan Bromberg, an outstanding securities scholar, as well as a mentor and friend.
Friday, May 1, 2015
I’ve been thinking a lot about whistleblowers lately. I serve as a “management” representative to the Department of Labor Whistleblower Protection Advisory Committee and last week we presented the DOL with our recommendations for best practices for employers. We are charged with looking at almost two dozen whistleblower laws. I've previously blogged about whistleblower issues here.
Although we spend the bulk of our time on the WPAC discussing the very serious obstacles for those workers who want to report safety violations, at the last meeting we also discussed, among other things, the fact that I and others believed that there could be a rise in SOX claims from attorneys and auditors following the 2014 Lawson decision. In that case, the Supreme Court observed that: “Congress plainly recognized that outside professionals — accountants, law firms, contractors, agents, and the like — were complicit in, if not integral to, the shareholder fraud and subsequent cover-up [Enron] officers … perpetrated.” Thus, the Court ruled, those, including private contractors, who see the wrongdoing but may be too fearful of retaliation to report it should be entitled to SOX whistleblower protection.
We also discussed the SEC's April KBR decision, which is causing hundreds of companies to revise their codes of conduct, policies, NDAs, confidentiality and settlement agreements to ensure there is no language that explicitly or implicitly prevents employees from reporting wrongdoing to the government or seeking an award.
Two weeks ago, I spoke in front of a couple hundred internal auditors and certified fraud examiners about how various developments in whistleblower laws could affect their investigations, focusing mainly on Sarbanes-Oxley and Dodd-Frank Whistleblower. I felt right at home because in my former life as a compliance officer and deputy general counsel, I spent a lot of time with internal and external auditors. Before I joined academia, I testified before Congress on what I thought could be some flaws in the law as written. Specifically, I had some concerns about the facts that: culpable individuals could receive awards; individuals did not have to consider reporting wrongdoing internally even if there was a credible, functioning compliance program; and that those with fiduciary responsibilities were also eligible for awards without reporting first (if possible), which could lead to conflicts of interest. The SEC did make some changes to Dodd-Frank. The agency now weighs the whistleblower’s participation in the firm’s internal compliance program as a factor that may increase the whistleblower’s eventual award and considers interference with internal compliance programs to be a factor that may decrease any award. It also indicated that compliance or internal audit professionals should report internally first and then wait 120 days before going external.
Before I launched into my legal update, I gave the audience some sobering statistics about financial professionals:
- 23% have seen misconduct firsthand
- 29% believe they may have to engage in illegal or unethical conduct to be successful
- 24% would engage in insider trading if they could earn $10 million and get away with it
I also shared the following awards with them:
- $875,000 to two individuals for “tips and assistance” relating to fraud in the securities market;
- $400,000 to a whistleblower who reported fraud to the SEC after the employee’s company failed to address internally certain securities law violations;
- $300,000 to an employee who reported wrongdoing to the SEC after the company failed to take action when the employee reported it internally first;
- $14 million- tip about an alleged Chicago-based scheme to defraud foreign investors seeking U.S. residency; and
- More than $30 million to a tipster living in a foreign country, who would have received more if he hadn't delayed reporting
I also informed them about a number of legal developments that affect those that occupy a position of trust or confidence. These white-collar whistleblowers have received significant paydays recently. Last year the SEC paid $300,000 to an employee who performed “audit or compliance functions.” I predicted more of these awards, and then to prove me right, just last week, the SEC awarded its second bounty to an audit or compliance professional, this time for approximately 1.4 million.
I asked the auditors to consider how this would affect their working with their peers and their clients, and how companies might react. Will companies redouble their efforts to encourage internal reporting? Although statistics are clear that whistleblowers prefer to report internally if they can and don’t report because they want financial gain, will these awards embolden compliance, audit, and legal personnel to report to the government? Will we see more employees with fiduciary duties coming forward to report wrongdoing? Does this conflict with any ethical duties imposed upon lawyers or compliance officers with legal backgrounds? SOX 307 describes up the ladder reporting requirements, but what happens to the attorney who chooses to go external? Will companies consider self-reporting to get more favorable deferred and nonprosecution agreements to pre-empt the potential whistleblower?
I don’t have answers for any of these questions, but companies and boards should at a minimum look at their internal compliance programs and ensure that their reporting mechanisms allow for reports from outside counsel and auditors. In the meantime, it’s now entirely possible that an auditor, compliance officer, or lawyer could be the next Sherron Watkins.
And by the way, if you were in Busan, South Korea last Wednesday, you may have heard me on the morning show talking about whistleblowers. Drop me a line and let me know how I sounded.