Friday, February 5, 2016
Starting on the first day of my Advanced Business Associations course, I attempt to tease out the policy underpinnings and theoretical conceptions of entity law and, in particular, corporate law. This turns out to be a somewhat difficult task, since most students in the course, to the extent that they remember anything at all from their experience in the foundational Business Associations course, are more focused on what a corporation is and does than why we might have one in the first place. As the semester proceeds and the readings unfold, the students get more comfortable talking about the rationale for certain aspects of the corporate form and why corporate law structures and operating rules promise to achieve the goals of those organizing a firm as a corporation. But it's a slow process.
I have to believe that some of my fellow law professors face similar challenges with their students. I also believe that instructors in other educational settings face analogous difficulties when they incorporate abstract notions into the teaching of more "black letter" (for want of a better term at this point in my day) concepts. My approach has been to assign readings of primary and secondary material and use classroom discussion time and projects to reveal things about why the corporation exists, why venturers form them (as opposed to conducting business as sole proprietors or using another business form), and what issues we observe and might expect to observe as among corporate constituents as time unfolds. So, I plan to cover everything from the general role of entity law in fostering the conduct of business (by offering off-the-shelf rules for use by venturers in structuring and operating businesses) to notions of corporate personhood and the role of the corporation in society.
I am wondering if there is an alternative to my approach that any of you use in a similar course, or whether there is a particularly good set of foundational readings that you use to approach this set of issues in a business law offering. At the end of this semester, I will have taught this course in this general format twice, and I will be taking stock to shore it up to make sure the third time's a charm. [FYI, I start the semester with Bebchuk and Bainbridge, take a tour through the public company using the Disney case and its corporate documents, then move on to compare/contrast the publicly held firm with closely held corporations and unincorporated business associations before moving into some depth topics (M&A, complex business litigation, corporate social responsibility and the benefit corporation, etc.). It is a two-hour course.] Suggestions and other thoughts in comments or by email are welcomed.
Thursday, February 4, 2016
For the past four weeks I have been experimenting with a new class called Transnational Business and Human Rights. My students include law students, graduate students, journalists, and accountants. Only half have taken a business class and the other half have never taken a human rights class. This is a challenge, albeit, a fun one. During our first week, we discussed CSR, starting off with Milton Friedman. We then used a business school case study from Copenhagen and the students acted as the public relations executive for a Danish company that learned that its medical product was being used in the death penalty cocktail in the United States. This required students to consider the company’s corporate responsibility profile and commitments and provide advice to the CEO based on a number of factors that many hadn’t considered- the role of investors, consumer reactions, the pressure from NGOs, and the potential effect on the stock price for the Danish company based on its decisions. During the first three weeks the students have focused on the corporate perspective learning the language of the supply chain and enterprise risk management world.
This week they are playing the role of the state and critiquing and developing the National Action Plans that require states to develop incentives and penalties for corporations to minimize human rights impacts. Examining the NAPs, dictated by the UN Guiding Principles on Business and Human Rights, requires students to think through the consultation process that countries, including the United States, undertake with a number of stakeholders such as unions, academics, NGOs and businesses. To many of those in the human rights LLM program and even some of the traditional law students, this is all a foreign language and they are struggling with these different stakeholder perspectives.
Over the rest of the semester they will read and role play on up to the minute issues such as: 1) the recent Tech Terror Summit and the potential adverse effects of the right to privacy; 2) access to justice and forum non conveniens, arguing an appeal from a Canadian court’s decision related to Guatemalan protestors shot by security forces hired by a company incorporated in Canada with US headquarters; 3) the difficulties that even best in class companies such as Nestle have complying with their own commitments and certain disclosure laws when their supply chain uses both child labor and slaves; 4) the Dodd-Frank conflict minerals debate in the Democratic Republic of Congo and the EU, where students will play the role of the State Department, major companies such as Apple and Intel, the NGO community, and socially-responsible investors debating some key corporate governance and human rights issues; 5) corporate codes of conduct and the ethical, governance, and compliance aspects of entering the Cuban market, given the concerns about human rights and confiscated property; 6) corporate culpability for the human rights impacts of mega sporting events such as the Super Bowl, World Cup, and the Olympics; 7) human trafficking (I’m proud to have a speaker from my former company Ryder, a sponsor of Truckers Against Traffickers); 8) development finance, SEC disclosures, bilateral investment treaties, investor rights and the grievance mechanisms for people harmed by financed projects (the World Bank, IMF, and Ex-Im bank will be case studies); 9) the race to the bottom for companies trying to reduce labor expenses in supply chains using the garment industry as an example; and 10) a debate in which each student will represent the actual countries currently arguing for or against a binding treaty on business and human rights.
Of course, on a daily basis, business and human rights stories pop up in the news if you know where to look and that makes teaching this so much fun. We are focusing a critical lens on the United States as well as the rest of the world, and it's great to hear perspectives from those who have lived in Europe, Africa, Asia, and South America. It's a whole new world for many of the LLM and international students, but as I tell them if they want to go after the corporations and effect change, they need to understand the pressure points. Using business school case studies has provided them with insights that most of my students have never considered. Most important, regardless of whether the students embark on a human rights career, they will now have more experience seeing and arguing controversial issues from another vantage point. That’s an invaluable skill set for any advocate.
February 4, 2016 in Business Associations, Comparative Law, Compliance, Corporate Governance, Corporations, CSR, Current Affairs, Ethics, Financial Markets, Human Rights, International Business, International Law, Investment Banking, Law School, Lawyering, Marcia Narine, Securities Regulation, Teaching | Permalink | Comments (0)
Wednesday, February 3, 2016
Laurence Fink, CEO of BlackRock, the largest asset manager in the U.S., wrote a letter to the CEO's of S&P 500 Companies urging reforms aimed at fostering long-term valuation creation and curbing a myopic focus on near-term profits. Fink has long been a public advocate of long-term valuation creation for the health of American companies and the wealth of society (for an example see this April 2015 letter on the "gambling nature" of the economy"). His message has been consistent: long term, long term, long term.
Citing to increased dividends and buyback programs as evidence of corrosive short-termism, Fink laid out a modest play for action. He asks every CEO to publish an annual strategic plan signed off on by the board. The CEO strategic plan should communicate the vision for the company and how such long-term growth can be achieved.
[P]erspective on the future, however, is what investors and all stakeholders truly need, including, for example, how the company is navigating the competitive landscape, how it is innovating, how it is adapting to technological disruption or geopolitical events, where it is investing and how it is developing its talent. As part of this effort, companies should work to develop financial metrics, suitable for each company and industry, that support a framework for long-term growth.
Fink wants companies to create these long-term vision statements as a routine part of governance and not just in the context of hedge-fund motivated proxy fights. The idea is that informing the investing public as to the long-term direction of the company and short-term obstacles frames the company message and dampens the "quarterly earnings hysteria". Also interesting to me as I approach a class on corporate social responsibility is Fink's encouragement of companies to pay more attention to social and environmental risks as increasingly difficult obstacles that must be addressed as part of a long term plan. Fink also called upon lawmakers to incentivize a long-term view by thinking beyond the next election cycle as would be needed to enact tax reform (specifically capital gains) and increased resources for infrastructure.
As readers of the blog know, I am in interested in the long-term/short-term debate and have written past posts about it. How controversial would such a CEO statement be? Venture capital/private equity funds investing in companies often require an annual CEO statement. If the language can be crafted to avoid liability for future statements, what are the downsides? Tipping off competitors and losing information advantages or first actor advantages? Letting lesser competitors free ride and adopt market leaders's plans a year or two later? Exposing the board of directors and officers to breached duty claims for failure to meet the objectives? (this last one seems very unlikely given the liability standards and exculpation provisions.)
The financial press and blogs are awash in stories on this. If you are interested in the related commentary, here are a few:
Wednesday, January 27, 2016
In December, 2015, Dow Chemicals Co. and DuPont announced a proposed merger between their two companies. Under the proposed deal, and with the approval of stockholders and regulators, the two agro/chemical giants will merger their companies in 2016 to create DowDuPont, with an estimated $130 billion value. Within 18-24 months of closing, DowDuPont will be split into three independent, publicly traded companies .
The proposed "merger of equals" is structured to share power equally between Dow and DuPont and its leadership in the new company. Dow and DuPont stockholders will each own roughly half of DowDuPont. There will be 16 members on the new DowDuPont board of directors: 8 from each company. The roles of Chairman and CEO will be split with Andrew Liveris (Dow) serving as Chairman and Edward Breen (DuPont) as CEO.
Questions of equality and perceived power imbalance arise when we examine the relationships between (1) corporate boards and activist investors; (2) various shareholders (hedge funds vs. institutional investors vs. retail investors, etc.), and (3) possibly, CEO's.
Let's tackle the first (and tangentially the second) imbalance by talking about hedge funds. Last year, Trian hedge fund targeted DuPont in a very expensive, public and close proxy contest. DuPont defeated Trian, even with ISS recommendations to vote with Trian. The DuPont defense was widely regarded as a model proxy contest defense strategy (see here, e.g.,) and even more enthusiastically as
"a victory not only for DuPont and its chief executive, Ellen Kullman, but for others in corporate America concerned that activist investors’ influence has grown too strong and that companies have capitulated to their demands too readily." WSJ May 13, 2015
By October, Ellen Kullman, the trimphant CEO of DuPont, however stepped down. By December DuPont announced the mega-merger with Dow. DuPont's role in the mega-merger with Dow is being cast as a reaction to and attempt to seek protection from activist investors, which are increasingly garnering ISS and institutional investor support. DuPont's success against Trian rested largely on their ability to convince its three largest shareholders—Vanguard Group, BlackRock Inc. and State Street Corp.—which all manage index funds to vote with it (and against ISS recommendations). The inference here is that DuPont didn't want to roll the dice again and risk losing control in a future contest with Trian or another activist.
Dow Chemicals hasn't been immune to the hedge fund threat. Third Point LLC, Dan Loeb's hedge fund, has a 2% position in Dow and nearly pursued a proxy fight in 2015. Third Point has been making noise about the continued roll of Andrew Liveris in DowDuPont demonstrating that the hall monitor is still on duty.
The gaining strength of hedge fund campaigns in 2015 and the increasingly alignment of hedge funds and indexed funds has many boards running scared. The DealBook Deal Professor, Steven Davidoff Solomon, writes of the mega-merger:
The proposed combination of Dow Chemical and DuPont shows that in today’s markets, financial engineering prevails and that only activist shareholders matter....
This plan is one easily understood by a hedge fund activist or investment banker in a cubicle in Manhattan with an Excel spreadsheet. To them, it makes perfect sense to merge a company and then almost immediately split it in three.
Merger and acquisition volume was at a record high (too soon to say peak) in 2015 as companies sought, in part, to achieve paper returns and cost efficiencies in a slow-growth economy. When large (and voting) shareholders are index and mutual funds with pressures to earn returns for their investors, it can produce corresponding pressure on operating companies for tactics, if not actions to produce those returns. In the DuPont proxy fight, the large block of retail investors in the old-guard public company was a big barrier to Trian, but in companies with less percentage held by retail investors (e.g., newer companies), the hedge fund agenda can drive the company.
Finally, it is interesting to note the rise and fall of DuPont CEO Ellen Kullman in this story. She successfully warded off a proxy contest and seemed to have fended off hedge fund advances, but ultimately her fate and DuPont's were largely driven by Trian's agenda. Reading about this merger reminded me of the spate of stories last year about how hedge funds disproportionately target companies with female CEO's. This is an issue that as a female law professor, I am particularly sensitive to, but that bias not withstanding, the story received quite a bit of play in the financial press last year: DealBook, Bloomberg, and here, and here.
Friday, January 22, 2016
Two weeks ago I posted about whether small businesses, start ups, and entrepreneurs should consider corporate social responsibility as part of their business (outside of the benefit corporation context). Definitions of CSR vary but for the purpose of this post, I will adopt the US government’s description as:
entail[ing] conduct consistent with applicable laws and internationally recognised standards. Based on the idea that you can do well while doing no harm … a broad concept that focuses on two aspects of the business-society relationship: 1) the positive contribution businesses can make to economic, environmental, and social progress with a view to achieving sustainable development, and 2) avoiding adverse impacts and addressing them when they do occur.
During my presentation at USASBE, I admitted my cynical thoughts about some aspects of CSR, discussed the halo effect, and pointed out some statistics from various sources about consumer attitudes. For example:
- Over 66% of people say they will pay more for products from a company with “good values”
- 66% of survey respondents indicated that their perception of company’s CEO affected their perception of the company
- 90% of US consumers would switch brands to one associated with a cause, assuming comparable price and quality
- 26% want more eco-friendly products
- 10% purchased eco-friendly products
- 45% are influenced by commitment to the environment
- 43% are influenced by commitment to social values and community
- Those with incomes of 20k or less are 5% more willing to pay more than those with incomes of $50k or more
- Consumers in developed markets are less willing to pay more for sustainable products than those in Latin America, Asia, the Middle East, and Africa. The study’s author opined that those underdeveloped markets see the effects of poor labor and environmental practices first hand
- 75% of millennial respondents, 72% of generation Z (age 20 and younger) and 51% of Baby Boomers are willing to pay more for sustainable products
- More than one out of every six dollars under professional management in the United States—$6.57 trillion or more—is invested according to socially-responsible investment strategies.
- 64% of large companies increased corporate giving from between 2010 and 2013.
- Among large companies giving at least 10% more since 2010, median revenues increased by 11% while revenues fell 3% for all other companies
From marketing and recruiting perspectives, these are compelling statistics. But from a bottom line perspective, does a company with lean margins have the luxury to implement sustainable business practices? Next week I will post about CSR in larger companies and the role that small suppliers play in global value chains. This leaves some small businesses without a choice but to consider changing their practices. In addition, in some ways, using some CSR concepts factors into enterprise risk management, which companies of all size need to consider.
January 22, 2016 in Business Associations, Corporate Governance, Corporations, CSR, Current Affairs, Entrepreneurship, Ethics, Management, Marcia Narine, Nonprofits, Research/Scholarhip, Social Enterprise | Permalink | Comments (1)
Wednesday, January 20, 2016
Second Circuit Affirms High Misconduct Standard for Caremark Claims in Cent. Laborers’ Pension Fund v. Dimon
In early January, the Second Circuit Court of Appeals ruled in Cent. Laborers’ Pension Fund v. Dimon to affirm the dismissal of purported shareholder derivative claims alleging that directors of JP Morgan Chase--the primary bankers of Bernard L. Madoff Investment Securities LLC (“BMIS”) for over 20 years--failed to institute internal controls sufficient to detect Bernard Madoff’s Ponzi scheme. The suit was dismissed for failures of demand excuse. Plaintiffs contended that the District Court erred in requiring them to plead that defendants “utterly failed to implement any reporting or information system or controls,” and that instead, they should have been required to plead only defendants’ “utter failure to attempt to assure a reasonable information and reporting system exist[ed].” (emphasis added). The Second Circuit declined, citing to In re General Motors Co. Derivative Litig., No. CV 9627-VCG, 2015 WL 3958724, at *14–15 (Del. Ch. June 26, 2015), a Chancery Court opinion from earlier this year that dismissed a Caremark/oversight liability claim. In In re General Motors the Delaware Chancery Court, found that plaintiffs' allegations that:
[T]he Board did not receive specific types of information do not establish that the Board utterly failed to attempt to assure a reasonable information and reporting system exists, particularly in the case at hand where the Complaint not only fails to plead with particularity that [the defendant] lacked procedures to comply with its . . . reporting requirements, but actually concedes the existence of information and reporting systems. . . .
In other words, the Plaintiffs complain that [the defendant] could have, should have, had a better reporting system, but not that it had no such system.
The Second Circuit's opinion in Central Laborers' affirms that Caremark claims require allegations misconduct sufficient to satisfy a failure of good faith, and cannot rest solely on after-the-fact allegations of failed reasonableness of the corporate reporting system.
Wednesday, January 6, 2016
The AALS Annual meeting starts today in New York. The full program is available here, and listed below are two Section meeting announcements of particular interest to business law scholars:
Thursday, January 7th from 1:30 pm – 3:15 pm the SECTION ON AGENCY, PARTNERSHIP, LLC’S AND UNINCORPORATED ASSOCIATIONS, COSPONSORED BY TRANSACTIONAL LAW AND SKILLS will meet in the Murray Hill East, Second Floor, New York Hilton Midtown for a program titled:
"Contract is King, But Can It Govern Its Realm?"
The program will be moderated by Benjamin Means, University of South Carolina School of Law. Discussants include:
- Joan M. Heminway, University of Tennessee College of Law
- Lyman P.Q. Johnson, Washington and Lee University School of Law
- Mark J. Loewenstein, University of Colorado School of Law
- Mohsen Manesh, University of Oregon School of Law
- Sandra K. Miller, Professor, Widener University School of Business Administration, Chester, PA
BLPB hosted an online micro-symposium in advance of the Contract is King meeting. The wrap up from this robust discussion is available here.
Friday January 8th, from 1:30 pm – 3:15 pm join the SECTION ON BUSINESS ASSOCIATIONS AND LAW
AND ECONOMICS JOINT PROGRAM at the Sutton South, Second Floor, New York Hilton Midtown for a program titled:
"The Corporate Law and Economics Revolution Years Later: The Impact of Economics and Finance Scholarship on Modern Corporate Law".
The program will be moderated by Usha R. Rodrigues, University of Georgia School of Law, and feature the following speakers:
- Frank Easterbrook, Judge, U.S. Court of Appeals for the Seventh Circuit, Chicago, IL
- H. Kent Greenfield, Boston College Law School
- Roberta Romano, Yale Law School
- Tamara C. Belinfanti, New York Law School
- Kathryn Judge, Columbia University School of Law
- K. Sabeel Rahman, Brooklyn Law School
At the conclusion of the program, the officers of the Section on Business Associations would like to honor 13 faculty members
for their mentorship work throughout the year.
I hope to see many of you in New York soon!
January 6, 2016 in Anne Tucker, Conferences, Corporate Governance, Corporations, Delaware, Financial Markets, Joan Heminway, Law and Economics, Law School, Teaching, Unincorporated Entities | Permalink | Comments (0)
Kent Greenfield recently published a provocative article with Democracy on ending Delaware's dominance over corporate law. As is Greenfield's way, he makes a familiar story sound fresh and raises an interesting question. Is it democratic for a state with less than 1% of the country's population to have its laws control more than half of the Fortune 500 companies? Greenfield says no.
Power without accountability has no democratic legitimacy. If companies could choose which state’s environmental, employment, or anti-discrimination law applied to them, we’d be outraged. We should be similarly outraged about Delaware’s dominance in corporate law.
Greenfield suggests two alternative paths for ending Delaware's dominance. First: states could amend their business organization statutes so that the law of the state of incorporation (Delaware) doesn't govern the corporation, rather the law of the principal place of business would. Second, and perhaps more radically, nationalize corporate law.
The undemocratic critique is an astute observation. It takes the debate outside of the "race to the bottom" standard trope and into territory with perhaps more broad public appeal. Leaving aside the state competition for headquarters, tax base and jobs with solution one and potential political friction with solution two, both solutions address the undemocratic critique.
Tuesday, January 5, 2016
On Saturday, January 9, 2016, I will be spending the day at the AALS Section on Socio-Economics Annual Meeting at the Sheraton New York Times Square Hotel. Among other things, I will be part of a panel discussion from 9:50 - 10:50 AM, Death of the Firm: Vulnerabilities and the Changing Structure of Employment. My co-panelists will be June Carbone and Katherine Stone (I am very tempted to give up my 15 minutes and just sit back and listen to these two great scholars, but please don't use the comments section to encourage me to do that). As I understand it, the gist of the discussion will be that while firms once supported a significant part of the safety net that provided employee health and retirement benefits, they have recently abdicated more and more of these responsibilities. At the same time, however, what may be described as subsidies granted by the state to firms -- particularly corporations -- as part of a social contract whereby these firms provided the aforementioned benefits, have not been correspondingly reduced. In fact, the rights of corporations have been expanded by, for example, cases like Citizens United and Hobby Lobby -- suggesting a possible windfall for the minority of individuals best positioned to reap the benefits of corporate growth and insulation. Obviously, competing interpretations of the relevant history abound. Regardless, please stop by if you have the opportunity. Continuing to beat a favorite drum of mine (see here, here, and here), I will be applying the lens of corporate personality theory to the foregoing issue and arguing that corporate personality theory has a role to play both in understanding how we got here and how best to move forward. Additional details, including the entire day’s program, can be found here.
On Monday, January 11, 2016, I will also be participating in the Society of Socio-Economists Annual Meeting, also at the Sheraton. Program details are available here. Again, please stop by if you have the opportunity.
January 5, 2016 in Business Associations, Conferences, Constitutional Law, Corporate Governance, Corporate Personality, Corporations, Current Affairs, Employment Law, Financial Markets, Law and Economics, Shareholders, Stefan J. Padfield | Permalink | Comments (0)
Thursday, December 31, 2015
The Five Corporate Scandals That Defined 2015 and Why I Resolve to Sneak More Ethics and Compliance into My Teaching
This is the time of year when many people make New Year’s resolutions, and I suppose that law professors do so as well. I’m taking a break from teaching business associations next semester. Instead, I will teach Business and Human Rights as well as Civil Procedure II. I love Civ Pro II because my twenty years of litigation experience comes in handy when we go through discovery. I focus a lot on ethical issues in civil procedure even though my 1Ls haven’t taken professional responsibility because I know that they get a lot of their context from TV shows like Suits, in which a young “lawyer” (who never went to law school) has a photographic memory and is mentored by a very aggressive senior partner whose ethics generally kick in just in the nick of time. It will also be easy to talk about ethical issues in business and human rights. What are the ethical, moral, financial, and societal implications of operating in countries with no regard for human rights and how should that impact a board’s decision to maximize shareholder value? Can socially-responsible investors really make a difference and when and how should they use their influence? Those discussions will be necessary, difficult, thought-provoking, and fun.
I confess that I don’t discuss ethics as much as I would like in my traditional business associations class even though some of my 2Ls and 3Ls have already taken professional responsibility. This is particularly egregious for me since I spent several years before joining academia as a compliance and ethics officer. I also use a skills book by Professor Michelle Harner, which actually has an ethics component in each exercise, but I often gloss over that section because many of my students haven't taken professional responsibility and I feel that I should focus on the pure "business" material. Business school students learn about business ethics, but law students generally don’t, even though they often counsel business clients when they graduate.
Yesterday, I tweeted an article naming five corporate scandals that defined 2015: (1) the Volkswagen emissions coverup (2) the "revelation" regarding Exxon’s research warning of man-made climate change as early as 1981 and its decision to spend money on climate change denial; (3) climate lobbying and the “gap between words and action,” in particular the companies that “tout their sustainability credentials” but are “members of influential trade associations lobbying against EU climate policy”; (4) the Brazil mining tragedy, which caused the worst environmental disaster in the country’s history, and in which several companies are denying responsibility; and (5) the “broken culture” (according to the Tokyo Stock Exchange) of Toshiba, which inflated its net profits by hundreds of millions of dollars over several years.
All of these multinational companies have in-house and outside counsel advising them, as did Enron, WorldCom, and any number of companies that have been embroiled in corporate scandal in the past. Stephen Bainbridge has written persuasively about the role of lawyers as gatekeepers. But what are we doing to train tomorrow's lawyers to prepare for this role? Practicing lawyers must take a certain number of ethics credits every few years as part of their continuing legal education obligation but we should do a better job as law professors of training law students to spot some of the tough ethical issues early on in every course we teach. This is especially true because many students who graduate today will work for small and medium-sized firms and will be advising small and medium-sized businesses. They won’t have the seemingly unlimited resources I had when I graduated in 1992 and went to work for BigLaw in New York. Many of the cases I worked on were staffed with layers of experienced lawyers, often in offices from around the world. If I naively missed an issue, someone else would likely see it.
So my resolution for 2016? The next time I teach business associations, I may spend a little less time on some of the background on Meinhard v. Salmon and more time on some of the ethical issues of that and the other cases and drafting exercises that my students work on. If you have ideas on how you weave ethics into your teaching, please comment below or email me at firstname.lastname@example.org.
I wish all of our readers a happy and healthy new year.
December 31, 2015 in Business Associations, Business School, Compliance, Corporate Governance, Corporations, CSR, Current Affairs, Ethics, Human Rights, Law School, Marcia Narine, Teaching | Permalink | Comments (1)
Wednesday, December 30, 2015
OK. No more complaining about grading--at least for another few months. Whew! I think I am getting too old for this crazy few weeks in December that involve holiday preparations and reading for the purpose of assessment.
This week, as I promised last week, I do want to say a bit more about the exams themselves, however. I noticed certain patterns of wrong answers this year (some of them common to ones noted in prior years that I have tried in various ways--unsuccessfully--to address in my teaching). I sent a message to my students that captured those common mistakes. An edited list of the observations I shared with them about those errors is included below.
- Management/Control vs. Agency. Management and control as an entity attribute is not the same as agency. The former involves internal governance--who among the internal constituents of the firm has the power to exercise the firm's rights and keep it operating, from a legal (and practical) point of view. The latter relates to the firm's liability to third parties. These two matters are set forth in different rules in each statute we covered in our course last semester. In the corporation, for example--the most complicated firm we studied, the board has the highest level of management and control rights. The officers have management and control power delegated by the corporation's organizational/organic documents (charter and bylaws, and maybe a shareholder agreement) and by the board. The shareholders have more limited management and control powers (through electing directors and approving charter and bylaw amendments, mergers and acquisitions, sales of all/substantially all the corporation's assets, and voluntary dissolutions). Of those three internal constituents, only the officers are agents of the firm who can bind the corporation to contracts and transactions with third parties. [I continued by offering other examples from partnership and LLC law.] . . . The main point is that one should not conflate management/control and agency. They are separate considerations.
- Compensation vs. Distributions. Rights to compensation and distribution are both financial benefits to the recipient, but they are different from each other in almost all respects. Compensation (salary and benefits) is paid in exchange for services. . . . Distributions represent returns (including current returns, like dividends, as well as amounts paid in dissolution--at the end of wind-up) to owners/equity investors. The MBCA also defines distributions to include amounts received in exchange for shares when the corporation buys them back from its shareholders.
- Limited Liability - Owners vs. Managers. Both shareholders, as corporate owners, and directors/officers, as corporate managers, may enjoy some form of limited liability. Separate those concepts out, however. Shareholders are afforded limited liability under the statutes in a different way than directors/officers. This is largely because the former do not typically have fiduciary duties to the firm, while the latter do. So, the latter must be accountable for the interests of the firm in taking action for or on its behalf.
- The Judicial Process. When asked to convey information about how a court addresses cases in an area, the best approach is to identify the court's standard of review or methodology/process as evidenced in the applicable body of cases--not to summarize each case individually . . . . Although the case summary approach may ultimately respond to the inquiry, it is not a sure way to do that and it is not efficient in any case. Imagine a client sitting through a series of case summaries after asking how a court handles a particular issue . . . . Ask yourself: would the client know that her question was answered in the end, and if so, would she be able to understand the answer?
- Using IRAC. IRAC is a legal reasoning approach used to apply law to facts to resolve a legal question involving a legally cognizable action. If you are asked a question on an exam about a rule of law that does not engage a fact pattern, then you do not need IRAC. Part B of the exam did not involve the application of law to dispute resolution or other activities. Yet, some of you tried to set out an answer in IRAC form for that part of the exam. It wasn't ultimately very successful (since there could not be an "A").
- Avoiding Redundancy/Inconsistency. In using IRAC or another legal reasoning technique, state the legal rule once in all of its relevant detail; then, use it. A number of you repeated the rule several times (sometimes with differing levels of detail) in answering a single exam query. This redundancy cost you time that could have been better spent on other parts of the exam, in many cases, and the approach sometimes led to inconsistent applications of the rule (because it was stated differently). For example, many of you stated (correctly) that the current RULPA allows limited partners to enjoy limited personal liability for the obligations of the limited partnership even if the limited partners exercise control. But later in the same response, some of you took that back by noting (incorrectly) that certain types of control would subject limited partners to personal liability for the obligations of the firm. Both cannot be true . . . .
- Using "Held" and Other Variants of "Holding". . . . [S]tatutes do not have holdings. Lawyers do not say that statutes "hold" particular rules. Rather, statutes "provide" or "state" or "set forth" matters or rules. Also, many of you misuse the word "hold" when referring to information from cases. A holding in a case is the response to a legal issue raised in the case. So, you should not say that a case "held" something unless that something represents the response to a legal issue raised in the case. For example, it's inaccurate to say that a case "held" something that represents a policy consideration or dicta.
That's it. (Although I cannot resist, especially in light of Josh Fershee's post yesterday, adding that one student did refer to LLC owners as shareholders--a bad cut-and-paste job from an earlier answer, imv.) I suspect that many who teach Business Associations see some of these same things with their students. Some of these mistakes are generic errors that also may be observed in other courses. No doubt, as I observed last week, some of these errors would not be made in situations that do not involve the stress and time pressure that an in-class examination entails. To me, however, all of these issues were important enough to bring to the attention to the entire class. I also invited--encouraged--all students to come back and review their exams, whether they "did better, as well as, or less well than . . . expected, hoped, or wanted." I hope that many of my students do take me up on that offer/suggestion. But I am not holding my breath.
Tuesday, December 29, 2015
The Pep Boys – Manny, Moe & Jack (NYSE: PBY) merger triangle with Bridgestone Retail Operations LLC and Icahn Enterprises LP is proving to be an exciting bidding war. The price and the pace of competing bids has been escalating since the proposed Pep Boys/Bridgestone agreement was announced on October 16, 2015. Pep Boys stock had been trading around $12/share. Pursuant to the agreement, Bridgestone commenced a tender offer in November for all outstanding shares at $15.
Icahn Enterprises controls Auto Plus, a competitor of Pep Boys, the nation's leading automotive aftermarket service and retail chain. Icahn disclosed an approximately 12% stake in Pep Boys earlier in December and entered into a bidding war with Bridgestone over Pep Boys. The price climbed to $15.50 on December 11th, then $17.00 on December 24th. Icahn Enterprises holds the current winning bid at $18.50/share, which the Pep Boys Board of Directors determined is a superior offer. In the SEC filings, Icahn Enterprises indicated a willingness to increase the bid, but not if Pep Boys agreed to Bridgestone's increased termination fee (from $35M to 39.5M) triggered by actions such as perior proposals by third parties. Icahn challenged such a fee as a serious threat to the auction process.
Regardless of which company ends up claiming control over Pep Boys, this is a excellent example of sale principles in action and also shows the effect of merger announcements (and the promised control premiums) have on stock prices. This will be a great illustration to accompany corporations/business organizations class discussions of mergers and the role of the board of directors. For those teaching unincorporated entities as a separate course or component of the larger bus.org survey course, Icahn Enterprises is a publicly-traded limited partnership formed as a master limited partnership in Delaware-- BONUS! Bridgestone Retail Operations LLC, as in limited liability company, is a wholly-owned subsidiary of Bridgestone Corporation ADR, a publicly traded corporation.
See you all in the New Year! Anne Tucker
EDITED January 4, 2016. Based on the thoughtful observations of fellow BLPB editor Haskell Murray, I removed the inarticulate references to this bidding war as a "Revlon" transaction. As Haskell pointed out, Pep Boys is a Pennsylvania corporation and subject to a constituency statute. The constituency statute modifies directors' "Revlon" duties by authorizing (but not requiring) directors to consider:
The effects of any action upon any or all groups affected by such action, including shareholders, members, employees, suppliers, customers and creditors of the corporation, and upon communities in which offices or other establishments of the corporation are located.
(2) The short-term and long-term interests of the corporation, including benefits that may accrue to the corporation from its long-term plans and the possibility that these interests may be best served by the continued independence of the corporation.....15 Pa. Stat. and Cons. Stat. Ann. § 515 (West)
Thursday, December 17, 2015
A year ago today, President Obama shocked the world and enraged many in Congress by announcing normalization of relations with Cuba. A lot of the rest of the United States didn’t see this as much of a big deal, but here in Miami, ground zero for the Cuban exile community, this was a cataclysmic event. Now Miami is one of the biggest sources of microfinance for the island.
Regular readers of this blog know that I have been writing about the ethical and governance issues of doing business with the island since my 10-day visit last summer. I return to Cuba today on a second research trip to validate some of my findings for my second article on governance and compliance risks and to begin work on my third article related to rule of law issues, the realities of foreign direct investment and arbitration, what a potential bilateral or multilateral investment agreement might look like, and the role that human rights requirements in these agreements could play.
This is an interesting time to be visiting Cuba. The Venezuelan government, a large source of income for Cuba has suffered a humiliating defeat. Will this lead to another “special period” for the nation similar to the collapse of the Soviet Union? Major league baseball players who defected from Cuba just a few years ago announced a homecoming trip today. Yesterday, the US government authorized commercial flights to return to Cuba. The property claims for the multinationals and families who had homes and business confiscated by Castro are being worked out, or so some say.
Over the next few days in between touring Old Havana and fishing villages, I will learn from lawyers and professors discussing arbitration law in Cuba, foreign investment law 118/2014, tax and labor implications for the foreign investor, the 2015 amendments to the Cuban Assets Control Regulations, requirements for gaining government approval and forming state partnerships, and the Cuban banking system.
Strangely, I am excited. While I should be decompressing from the shock of reading student exams discussing “creepy tender offers” and “limited liability corporations,” I can’t wait to delve into the next phase of my research and practice my business Spanish at the bar of the Parque Central in La Habana. My internet access will be spotty and expensive but if you can think of any pressing questions I should ask leave a comment below or email me at email@example.com.
December 17, 2015 in Comparative Law, Compliance, Corporate Governance, Corporations, CSR, Current Affairs, Ethics, Food and Drink, Human Rights, International Business, International Law, Law Reviews, Marcia Narine, Religion, Writing | Permalink | Comments (0)
Wednesday, December 9, 2015
Divestment campaigns have been a popular form of corporate activism. With divestment pensions, institutions, endowments and funds withdraw investments from companies to encourage and promote certain social/political behaviors and policies.
Erik Hendey in his article Does Divestment Work (in the Harvard Political Review) recounted recent divestment campaigns including:
"sweatshop labor, use of landmines, and tobacco advertising. But undoubtedly the best known example of divestment occurred in the 1970s and ’80s in response to the apartheid regime of South Africa. Retirement funds, mutual funds, and investment institutions across the country sold off the stocks of companies that did business in South Africa."
A current divestment campaign is focused on guns. In the wake of the San Bernardino, California mass shooting, this issue is poised to gain momentum. The widespread investment in gun manufacturers will also make this campaign relevant to many investors. Andrew Ross Sorkin at the NYT DealBook writes in Guns in Your 401(k)? The Push to Divest Grows:
"If you own any of the broad index funds or even a target-date retirement fund, you’ve got a stake in the gun industry. Investments in gun makers, at least over the past five years, have performed well. Shares of Smith & Wesson are up nearly 400 percent since 2010. On Monday, shares of Smith & Wesson reached their highest price since 2007 after President Obama called for more gun control laws, leading investors to anticipate a rush of gun sales ahead of any restrictions."
If you are curious/concerned, Unload Your 401(k) is a website where you can check and see if you are personally invested, through your retirement savings plan, in one of the three major gun manufacturers.
Individuals may allocate their personal 401(k) money to socially responsible investment funds or in traditional funds that do not include gun manufacturers. A traditional fund is a hard bet because even if the fund doesn't currently invest in a gun manufacturer at the time of the individual's investment, it could become a part of the portfolio. Only funds with investment parameters that specifically exclude gun manufacturers can provide such a guarantee.
But what about endowments and pension funds-- large institutional investors who are often the target of divestment campaigns because when they choose to divest (or simply not to invest in the first place) this is where the real pressure can be applied to companies. Many stewards of such funds manage them according to certain social principles, especially if those principles are advocated by the beneficiaries of the funds (as is the case with student activists behind the fossil fuel divestment campaigns). Applying social pressure through such funds and on behalf of beneficiaries raises question of whether such actions are in appropriate fidelity to the trust position over the money (not the morals) the trustees are appointed to preserve. Bradford Cornell, at California Institute of Technology published a 2015 paper estimating the cost of fossil fuel divestment of major educational endowments, which for Harvard he figured to be over $100 million.
Thursday, December 3, 2015
Earlier this month, the DC Circuit denied a petition for rehearing on the conflict minerals disclosure, meaning the SEC needs to appeal to the Supreme Court or the case goes back to the District Court for further proceedings. At issue is whether the Dodd-Frank requirement that issuers who source minerals from the Democratic Republic of Congo label their products as “DRC-conflict free” (or not) violates the First Amendment. I have argued in various blog posts and an amicus brief that this corporate governance disclosure is problematic for other reasons, including the fact that it won’t work and that the requirement would hurt the miners that it’s meant to protect. Congress, thankfully, recently held hearings on the law.
I’ve written more extensively on conflict minerals and the failure of disclosures in general in two recent publications. The first is my chapter entitled, Living in a material world – from naming and shaming to knowing and showing: will new disclosure regimes finally drive corporate accountability for human rights? in a new book that we launched two weeks ago at the UN Forum on Business and Human Rights in Geneva. You’ll have to buy the book The Business and Human Rights Landscape: Moving Forward and Looking Back to read it.
My article, Disclosing Disclosure’s Defects: Addressing Corporate Irresponsibility for Human Rights Impacts, will be published shortly by the Columbia Human Rights Law Review and is available for on SSRN. The abstract is below:
Although many people believe that the role of business is to maximize shareholder value, corporate executives and board members can no longer ignore their companies’ human rights impacts on other stakeholders. Over the past four years, the role and responsibility of non-state actors such as multinationals has come under increased scrutiny. In 2011, the United Nations Human Rights Council unanimously endorsed the “UN Guiding Principles on Business and Human Rights,” which outline the State duty to protect human rights, the corporate responsibility to respect human rights, and both the State and corporations’ duties to provide remedies to parties. The Guiding Principles do not bind corporations, but dozens of countries, including the United States, are now working on National Action Plans to comply with their own duties, which include drafting regulations and incentives for companies. In 2014, the UN Human Rights Council passed a resolution to begin the process of developing a binding treaty on business and human rights. Separately, in an effort to address information asymmetries, lawmakers in the United States, Canada, Europe, and California have passed human rights disclosure legislation. Finally, dozens of stock exchanges have imposed either mandatory or voluntary non-financial disclosure requirements, in sync with the UN Principles.
Despite various forms of disclosure mandates, these efforts do not work. The conflict lies within the flawed premise that, armed with specific information addressing human rights, consumers and investors will either reward “ethical” corporate behavior, or punish firms with poor human rights records. However, evidence shows that disclosures generally fail to change behavior because: (1) there are too many of them; (2) stakeholders suffer from disclosure overload; and (3) not enough consumers or investors penalize companies by boycotting products or divesting. In this Article, I examine corporate social contract theory, normative business ethics, and the failure of stakeholders to utilize disclosures to punish those firms that breach the social contract. I propose that both stakeholders and companies view corporate actions through an ethical lens, and offer an eight-factor test to provide guidance using current disclosures or stakeholder-specific inquiries. I conclude that disclosure for the sake of transparency, without more, will not lead to meaningful change regarding human rights impacts.
December 3, 2015 in Comparative Law, Compliance, Corporate Governance, Corporations, CSR, Current Affairs, Human Rights, International Law, Marcia Narine, Securities Regulation | Permalink | Comments (0)
Wednesday, December 2, 2015
I am about 10, if not 15 years late to this party. This is not a new question: have investment time horizons shrunk, and if so, in a way that extracts company value at the expense of long-term growth and sustainability?
Since this isn’t a new question, there is a considerable amount of literature available in law and finance (and a definition available on investopedia). This may seem like great news, if like me, you are interested in acquiring a solid understanding of short termism. By solid understanding, I mean internalization of knowledge, not mere familiarity where I can be prompted to recall something when someone else talks/writes about it. I have some basic questions that I want answers to: What is short-termism?, What empirical evidence best proves or disproves short-termism? Which investors, if any, are short-term? What are the consequences (good and bad) of a short-term investment horizon? If there is short-termism, what are the solutions? I’ll briefly discuss each below, and my utter failure to answer these questions with any real certainty thus far.
What is the definition of short-termism and does it change depending upon context or user? There appears to be consensus on the conceptual definition of foregoing long-term investments in favor of corporate policies maximizing present payouts like dividends and stock buy-backs among hedge funds. As for what determines “short-term” with institutional investors- responsiveness to quarterly earnings? Over-reliance on algorithmic trading models? The definition gets less clear when we start looking at different types of investors.
How can one test the presence of short-termism? Stock holding patterns and redemption rates and turnover would be the obvious answers. This information is hard to aggregate, much of it is proprietary. Second, the issue of outliers, like high value high-frequency trades, may distort the view if most shareholders or at least the most influential shareholders like institutions, aren’t operating with a short-term time horizon. But that can mean different things for different investors. Once again which investors we are looking at drives this question in part.
This brings us to the next question, WHO might be short term? Hedge Funds? Institutional Investors like pensions and mutual funds? High Frequency Traders? Retail investors? Retirement Investors (I call these folks Citizen Shareholders)?
Looking to the next question: what are the consequences of a short-term investment horizon? Shareholders like hedge funds whose investment model differs from institutional investors, often employ shareholder activism to change management and corporate policies as a means to increase the share value of the company, after which the fund usually divests significantly, if not completely. The evidence here too is mixed (see e.g., conflicting findings by Bebchuk & Coffee).
For many the anecdotal evidence of short-termism pressures coming from board rooms is powerfully persuasive and hard to ignore even where researchers can’t pin down the source. I don’t use anecdotal in a derogatory sense at all, there is truth in experience and limitations in our ability to quantify naturally occurring phenomenons. Perhaps the question of short-termism is like trying to identify what smells bad in a pantry. You know it is there; finding the cause is much more difficult. Consider the position of Martin Lipton who wrote in response to the Bebchuk article:
"To the contrary, the attacks and the efforts by companies to adopt short-term strategies to avoid becoming a target have had very serious adverse effects on the companies, their long-term shareholders, and the American economy. To avoid becoming a target, companies seek to maximize current earnings at the expense of sound balance sheets, capital investment, research and development and job growth."
Also consider a survey of corporate board members reported that over 60% felt short term pressure from investors. It is a real problem to directors and one that corporate governance cannot ignore. A fair question to ask is whether or not the fear is misstated or if the concern is another way of arguing for greater control. And this brings us to the last question.
If there is short-termism, what are the solutions? Aligning corporate managers/directors incentive payments has been critiqued. Giving corporate boards more power and isolating them from shareholders tips the scales of the corporate power puzzle heavily towards managers which brings threats of agency costs and managerial abuses. But on the other hand, if a short-term investment perspective extracts company value in a way that causes externalities that undercuts the contractarian argument for shareholder primacy. If shareholders’, or at least some shareholders’, primary investment stake isn’t to be residual claimants in the traditional sense then their incentives aren’t aligned with the interests of other stakeholders. Those shareholders aren’t acting in everyone’s best interest. The debate often devolves into one of consequences, or perhaps it is the starting point for many who write in the area. If short-termism doesn’t exist or isn’t bad then there is no push back on shareholder primacy. If short-termism does exit and it does cause externalities then it is a powerful argument in favor of director primacy.
I am weeks into this inquiry and all I have done is further confuse myself about what I thought I knew, expanded my questions list and flooded my dropbox with articles (tedious, dense, often empirical articles).
A few things have come out of this quagmire. First, I have great discussion points for my corporate governance seminar and certainly a supplemental segment for my casebook. Second, I am increasingly thinking the tremendously important insights provided by many law and finance scholars isn’t the complete picture. I can’t get to the bottom of this question, because there might not be one (or one that I understand) yet. So where are the gaps? What do we still need to know to further explore this topic? These big, heavy, interdisciplinary questions are hard to tackle alone at our desks and benefit from engagement, dialogue, and rapid fire thinking that takes places at conferences/symposiums.
In terms of blogging, let’s focus back on you readers. I’ll check back in periodically on this topic by sharing my reading list on the topic and also highlighting some of the articles on my list. If you have a seminal article that you found help explain short-termism to you (or your students) please share. If you are working on any papers in this area, please email me separately (firstname.lastname@example.org) as I am working on putting together a symposium for summer 2017.
I so often find Keith Bishop's blog, California Corporate & Securities Law, both informative and entertaining. Monday's post in that forum is no exception. In that post, Keith describes three important principles of Delaware corporate law that are not codified in the General Corporation Law of the State of Delaware (commonly and fondly known as the Delaware General Corporation Law or DGCL). No surprise, but the three principles he identifies and describes are:
- the business judgment rule;
- derivative suit pleading requirements; and
- the intermediate standard of review applicable in certain limited fiduciary duty actions.
Great list. And I agree with what he says.
Of course, anyone who teaches corporate law has had to consider (and, to sone degree, call out) the areas of that body of law that derive from decisional, rather than statutory, law. I often have been heard to say, in the basic Business Associations course, that if students forget--or need to leave behind--one of the two required texts (a casebook and a statutory resource book) when they come to class, most days, they should forget/leave behind the casebook, since it is more important for them to have the statutory law in front of them to answer most Business Associations law questions. I note, however, that there are two large areas of exception: veil piercing and fiduciary duty. For those two doctrinal areas, I inform them that they won't need the statutory resource book as much as the casebook.
Friday, November 27, 2015
I try to read everything Lyman Johnson writes, so my Thanksgiving break reading is his recent book chapter The Reconfiguring of Revlon. The abstract is below:
Three decades later, an irksome uncertainty still impedes a settled understanding of the Delaware Supreme Court’s landmark ruling in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. For such a towering doctrine, Revlon’s underlying rationales remain controversial, its exact contours and demands continue to be surprisingly unclear, and it holds out scant hope for remedial relief. In spite of these troubling features of today’s Revlon jurisprudence, however, Revlon is slowly being worked back into the larger fabric of Delaware’s fiduciary duty law and away from being a gangling, standalone doctrine. The organizing themes of this judicial project are strong deference in the deal context to decisions made by independent directors without regard to deal structure, the substantially reduced likelihood of equitable or monetary remedies in all types of deal-related lawsuits, and a nascent effort at harmonizing Revlon with Delaware’s more general, and ill-defined, doctrine on corporate purpose.
This chapter discusses the original Revlon decision and its rapid expansion before turning to lingering uncertainties surrounding the reach of Revlon, the decline of Revlon’s remedial clout, and where Revlon stands today in relation to Delaware’s overall fiduciary duty law. Revlon’s sharp focus on immediate value maximization was a breakthrough pronouncement on corporate purpose, a subject of longstanding national debate but one on which the Delaware Supreme Court had been strangely silent. However, grave reservations about whether and when corporate directors should be required to pursue short term goals found useful cover in sustained judicial murkiness over the boundaries of Revlon. Only if Delaware courts resolve the underlying issue of corporate purpose more generally will Revlon either be fitted into the larger body of Delaware law or continue to stand uncomfortably to the side as a doctrinal loner of diminished significance.
Tuesday, November 24, 2015
This post concludes the Contract Is King, But Can It Govern Its Realm? Micro-symposium. The symposium was hosted as part of the AALS section on Agency, Partnership, LLCs and Unincorporated Associations in advance of the section meeting on January 7th at 1:30 where the conversation will be continued.
I summarized the conversation and provided links to all of the individual posts. Bookmark this page-- there is great commentary at your finger tips on a range of topics. Please keep reading (and commenting) on these great contributions by our insightful participants to whom we are very grateful.
Jeffrey Lipshaw kicked off the symposium conversation with his post (available here) questioning, in practice, how different LLCs are from traditional corporations. He used a great map analogy to talk about the role of formation documents and default rules as gap fillers.
“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.”
After asserting that LLCs differ from corporations only in matters of degrees, Jeff went on to to them illustrate how degrees of difference may still matter. He provided a good example of a situation where the ability to eliminate fiduciary duties may produce the right result—an option only available in alternative entities not corporations.
Mohsen argued that if contract is king, business revenue rules the reign in Delaware. Franchise taxes and revenues generated from being the business domicile of so many businesses, in all forms, is a source of riches, one that Mohsen argued will be protected by preserving a commitment to freedom of contract.
“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.”
In his first post, Mohsen also addressed Delaware Chief Justice Strine and Vice Chancellor Laster’s provocative “Siren Song” book chapter, where the pair advocate for mandatory fiduciary duties in publicly traded LLCs and LPs. Mohsen questioned the limitation arguing that
“[M]any of critiques that Strine and Laster levy at publicly traded alternative entities– unsophisticated investors, the absence of true bargaining, and confusing contract terms that often unduly favor the managers—could be levied at many private entities as well. If so, then why should Strine & Laster’s proposal be limited to public entities?”
Sandra Miller blogged here about investor sophistication and its relationship to fiduciary duty waivers. She highlighted her scholarship in the area and provided helpful links to her papers discussing her points in greater detail.
“[T]here 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.”
Joan Heminway questioned whether LLC operating agreements are contracts, and if not the implication for fiduciary duties, statue of frauds, capacity and public policy challenges and enforceability against third parties.
“[W]ith 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...So, while contract may be king in LLC law, we may question whether a contract even exists under LLC law.”
Joan also highlighted her recent appearance at the ABA LLC Institute in a related post available here and shared the many functions of an operating agreement (whether contract or not!).
Daniel Kleinberger contributed to the conversation in four parts (appearing in three separate posts here (1), here (2) and here(3)). Daniel focused on Delaware’s implied contractual covenant of good faith and fair dealing and the covenant’s role in Delaware entity law. He carefully distinguished the covenant from the UCC implied covenant of good faith and fair dealing and from the corporate standards of good faith as articulated in Stone v. Ritter and Smith v. Van Gorkum. Thirdly he addressed waivers of good faith and fair dealing both in the governing agreement and arising from contract in Delaware and under the Uniform Limited Partnership Act.
“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.”
In his final post, available here, Kleinberger addressed interpretation questions with implied covenants analogizing the analysis to that used with impracticability.
“For impracticability or a breach of the implied covenant to exist, the situation at issue must have been fundamentally important to the deal and yet unaddressed by the deal documents. Put another way: the notion of a “cautious enterprise” means that only a condition that is egregious or at least extreme is capable of revealing a gap to be remedied by the implied covenant.”
BLPB editor, Joshua Fershee, was inspired by the topic and contributed his own post to the micro-symposium. In his post, he declared himself a Larry Ribstein devotee and highlighted how the structural differences in the LLC form, as opposed to the corporate form, provide business benefits for LLC members.
“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.”
Greg Day, another BLPB-generated contribution to the conversation, blogged about sophisticated parties’ utilization of freedom of contract in LLC, and sophisticated investors demand for the conformity of traditional corporate formation over LLCs.
“[W] hen 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. …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.”
Finally, Peter Molk & Verity Winship also contributed a last-minute addition to the symposium highlighting their empirical work on LLC operating agreement dispute resolution provisions as it relates to the question of contracting rights in unincorporated entities. They reported some of their early findings and linked it to the discussion about contractual freedom and the implications of mandatory fiduciary duties.
“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.”
Participants in the Micro-Symposium were asked to respond to a series of questions (available here) that will be further discussed at the AALS section meeting. Joan MacLeod Heminway (BLPB editor), Dan Kleinberger, Jeff Lipshaw, Mohsen Manesh, and Sandra Miller.will be panelists at the AALS meeting and joined by Lyman Johnson and Mark Loewenstein.
Monday, November 23, 2015
Daniel Kleinberger: Delineating Delaware’s Implied Covenant of Good Faith and Fair Dealing (Contract Is King Micro-Symposium)
Guest Post by Daniel Kleinberger
Part IV– Delaware’s Implied Contractual Covenant of Good Faith and Fair Dealing
Delaware case law applying the implied contractual covenant of good faith and fair dealing to a limited partnership dates back to at least 1993,[i] and Delaware’s limited partnership and limited liability company acts have expressly recognized the covenant since 2004.[ii] However, the contents of the implied covenant have not always been crystal clear.[iii]
A passage from a 2000 Chancery Court decision is illustrative:
The implied covenant of good faith requires a party in a contractual relationship to refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits of the contract. This doctrine emphasizes faithfulness to an agreed common purpose and consistency with the justified expectations of the other party. The parties' reasonable expectations at the time of contract formation determine the reasonableness of the challenged conduct. [C]ases invoking the implied covenant of good faith and fair dealing should be rare and fact-intensive. Only where issues of compelling fairness arise will this Court embrace good faith and fair dealing and imply terms in an agreement.[iv]
This formulation was correct as far as it went, but it omitted the all-important frame of reference. In the “fact-intensive” inquiry, what types of facts matter? Where does the court look to determine “the agreed common purpose” and “the justified expectations of the [complaining] party”? What evidence is admissible to prove the expected “fruits of the bargain”?
The answers to these questions determine whether “implying obligations based on the covenant of good faith and fair dealing [remains] a cautious enterprise.”[v] The broader the frame of reference, the more likely is the covenant to become “a judge's roving commission for determining fairness.”[vi]
Fortunately, over the past five years the Court of Chancery and the Delaware Supreme Court have provided both clarity and context. The frame of reference is confined to the actual words of the agreement; the reasonable expectations must be gleaned from those words.[vii]
Thus, the actual words of the agreement control the application of the implied covenant, both as to “fair dealing” and “good faith”:
“Fair dealing” is not akin to the fair process component of entire fairness, i.e., whether the fiduciary acted fairly when engaging in the challenged transaction as measured by duties of loyalty and care …. It is rather a commitment to deal “fairly” in the sense of consistently with the terms of the parties' agreement and its purpose. Likewise, “good faith” does not envision loyalty to the contractual counterparty, but rather faithfulness to the scope, purpose, and terms of the parties' contract. Both necessarily turn on the contract itself and what the parties would have agreed upon had the issue arisen when they were bargaining originally.[viii]
When a court considers a fiduciary claim, the “court examines the parties as situated at the time of the [alleged] wrong…. [and] determines whether the defendant owed the plaintiff a duty, considers the defendant's obligations (if any) in light of that duty, and then evaluates whether the duty was breached.”[ix] In contrast, because the actual words of the agreement control the application of the implied covenant:
An implied covenant claim ... looks to the past. It is not a free-floating duty unattached to the underlying legal documents. It does not ask what duty the law should impose on the parties given their relationship at the time of the wrong, but rather what the parties would have agreed to themselves had they considered the issue in their original bargaining positions at the time of contracting.[x]
A successful implied covenant claim depends on finding a gap in the contractual language; therefore, an implied covenant claim cannot override an express contractual provision.[xi] For example, if a limited partnership agreement creates options for limited partners under specified circumstances and not otherwise, the implied covenant will not extend the option right to circumstances not specified.[xii] Expressio unius est exclusio alterius.[xiii] There is no gap.
But inevitably gaps will exist:[xiv]
No contract, regardless of how tightly or precisely drafted it may be, can wholly account for every possible contingency. Even the most skilled and sophisticated parties will necessarily fail to address a future state of the world ... because contracting is costly and human knowledge imperfect. In only a moderately complex or extend[ed] contractual relationship, the cost of attempting to catalog and negotiate with respect to all possible future states of the world would be prohibitive, if it were cognitively possible. And parties occasionally have understandings or expectations that were so fundamental that they did not need to negotiate about those expectations.[xv]
For example, suppose that: (i) a limited partnership agreement authorizes the general partner to restructure the organization as the general partner sees fit provided a competent expert provides a “fairness opinion” stating that the restructuring is fair to the limited partners; (ii) a competent expert furnishes the opinion; but (iii) the expert omits to consider the value of certain contingent assets of the limited partnership, namely the value of pending derivative litigation.[xvi] Because the limited partnership agreement “[does] not specify whether the fairness opinion [has] to consider the value of derivative litigation,” the expert’s omission reveals “a gap for the implied covenant to fill.”[xvii] The gap is filled with what the court concludes “the parties would have agreed to themselves had they considered the issue in their original bargaining positions at the time of contracting.”[xviii]
In this respect, the implied covenant analysis resembles the analysis for determining whether a party’s contractual duties are discharged by supervening impracticably. “In order for a supervening event to discharge a duty …, the non-occurrence of that event must have been a ‘basic assumption’ on which both parties made the contract.”[xix] For impracticability or a breach of the implied covenant to exist, the situation at issue must have been fundamentally important to the deal and yet unaddressed by the deal documents. Put another way: the notion of a “cautious enterprise”[xx] means that only a condition that is egregious or at least extreme is capable of revealing a gap to be remedied by the implied covenant.[xxi]
[i] Desert Equities, Inc. v. Morgan Stanley Leveraged Equity Fund, II, L.P., 624 A.2d 1199, 1207 (Del. 1993) (“Desert Equities alleges that the defendants breached their implied covenant of good faith and fair dealing when they, in bad faith, breached the Partnership Agreement.”).
[ii] 74 Del. Laws, c. 265, §15 (revising Del. Code tit. 6, § 17-1101(d) to provide inter alia that “the partnership agreement may not eliminate the implied contractual covenant of good faith and fair dealing”). The same change was made to the limited liability company act by 74 Del. Laws, c. 275, § 13 (revising Del. Code tit. 6, § 18-1101(c) to provide inter alia that “the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing”).
[iii] Cincinnati SMSA Ltd. P'ship v. Cincinnati Bell Cellular Sys. Co., 708 A.2d 989, 992 (Del. 1998) (stating that “[t]he articulation of the standard for implying terms through application of the covenant of good faith and fair dealing represents an evolution from previous Delaware case law” and that “Delaware Supreme Court jurisprudence is developing along the general approach that implying obligations based on the covenant of good faith and fair dealing is a cautious enterprise”). See also, e.g., Desert Equities, Inc. v. Morgan Stanley Leveraged Equity Fund, II, L.P., 624 A.2d 1199, 1207 (Del. 1993) (reversing the Chancery Court’s dismissal on the pleadings of plaintiff’s implied covenant claim; accepting the seemingly redundant notion that bad faith breach of the partnership agreement could breach the implied covenant; and suggesting the general partner may have acted in bad faith by “act[ing] unreasonably”). For a decision that addresses the redundancy issue, see Painewebber R & D Partners, L.P. v. Centocor, Inc., No. C.A. 96C-04-194, 1998 WL 109818, at *4 (Del. Super. Feb. 13, 1998) (“The Court is satisfied that the payment obligations of Centocor are encompassed by the express terms of the PPA and, as a matter of law, cannot be the subject of any implied covenant.”)
[iv] Cont'l Ins. Co. v. Rutledge & Co., 750 A.2d 1219, 1234 (Del. Ch. 2000) (internal quotations and footnotes omitted).
[v] Cincinnati SMSA Ltd. P'ship v. Cincinnati Bell Cellular Sys. Co., 708 A.2d 989, 992 (Del. 1998).
[vi] Daniel S. Kleinberger, Two Decades of "Alternative Entities": From Tax Rationalization Through Alphabet Soup to Contract as Deity, 14 Fordham J. Corp. & Fin. L. 445, 469 (2009) (first presented as the keynote address at the 2lst Century Commercial Law Forum – Seventh International Symposium 2007 – sponsored by School of Law, Tsinghua University, Beijing, People’s Republic of China). See also Nemec v. Shrader, 991 A.2d 1120, 1128 (Del. 2010) (“Crafting, what is, in effect, a post contracting equitable amendment that shifts economic benefits from [one set of shareholders to another] would vitiate the limited reach of the concept of the implied duty of good faith and fair dealing…. The policy underpinning the implied duty of good faith and fair dealing does not extend to post contractual rebalancing of the economic benefits flowing to the contracting parties.”); Lonergan v. EPE Holdings, LLC, 5 A.3d 1008, 1019 (Del. Ch. 2010) (criticizing and rejecting attempts to “re-introduce fiduciary review through the backdoor of the implied covenant” of good faith and fair dealing). This point is precisely what divided the majority and dissent in Nemec. The core of the dissent is this statement: “[U]nder Delaware case law, a contracting party, even where expressly empowered to act, can breach the implied covenant if it exercises that contractual power arbitrarily or unreasonably.” Nemec, at 1131 (Jacobs, J. dissenting). The statement does not recognize that the frame of reference must be the words of the contract. Cf. ULLCA (2013) § 409(d), cmt. (stating that “the purpose of the contractual obligation of good faith and fair dealing is to protect the arrangement the members have chosen for themselves, not to restructure that arrangement under the guise of safeguarding it”). But cf. HB Korenvaes Inv., L.P. v. Marriot Corp., Del. Ch., C.A. No. 12922, Mem. Op. at 11, Allen, C., (June 9, 1993) (“Indeed the contract doctrine of an implied covenant of good faith and fair dealing may be thought in some ways to function analogously to the fiduciary concept.”) (quoted in Gale v. Bershad, No. CIV. A. 15714, 1998 WL 118022, at *5 n. 24(Del. Ch. Mar. 4, 1998); Gale v. Bershad, No. CIV. A. 15714, 1998 WL 118022, at *5 (“The function of the implied covenant of good faith and fair dealing in defining the duties of parties to a contract, is analogous to the role of fiduciary law in defining the duties owed by fiduciaries.”); Blue Chip Capital Fund II Ltd. P'ship v. Tubergen, 906 A.2d 827, 832 (Del. Ch. 2006) (stating that “[t]he court [in Gale v. Bershad] explained that the implied covenant of good faith and fair dealing defines the duties of parties to a contract and is analogous to the role of fiduciary law in defining the duties owed by fiduciaries”) (citing Gale v. Bershad, No. CIV. A. 15714,.1998 WL 118022 at *5, (Del.Ch. Mar. 3, 1998)).
[vii] These points are analogous to Professor Williston’s four corners approach to determining ambiguity for the purposes of the parol evidence rule. See, e.g., Wallace v. 600 Partners Co., 86 N.Y.2d 543, 548, 658 N.E.2d 715, 717 (1995) (stating that “[t]he question whether a writing is ambiguous is one of law to be resolved by the courts” and that “excursion beyond the four corners of the document” is warranted only when the wording is not “clear and complete”) (citing Williston, 4 Williston, Contracts, § 610A, at 513 [3d ed.]). The “roving commission” notion resembles Professor Corbin’s approach to the ambiguity question. “According to Corbin, the court cannot apply the parol evidence rule without first understanding the meaning the parties intended to give the agreement. To understand the agreement, the judge cannot be restricted to the four corners of the document.” Taylor v. State Farm Mut. Auto. Ins. Co., 175 Ariz. 148, 153, 854 P.2d 1134, 1139 (1993) (citation omitted). Delaware takes the Williston approach. GMG Capital Investments, LLC v. Athenian Venture Partners I, L.P., 36 A.3d 776, 781-84 (Del. 2012) Schwartz v. Centennial Ins. Co., No. CIV. A. 5350 (1977), 1980 WL 77940, at *5 (Del. Ch. Jan. 16, 1980) (stating that “parol evidence may not be used to show an ambiguity in the first place”).
[viii] Gerber v. Enter. Products Holdings, LLC, 67 A.3d 400, 418-19 (Del. 2013) (quoting ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member, LLC, 50 A.3d 434, 440–42 (Del. Ch. 2012), aff'd in part, rev'd in part on other grounds, 68 A.3d 665 (Del. 2013)) (footnotes omitted) (citations omitted) (internal quotations omitted without ellipsis by Gerber).
[ix] Gerber v. Enter. Products Holdings, LLC, 67 A.3d 400, 418 (quoting ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member, LLC, 50 A.3d 434, 440–42 (Del. Ch. 2012), aff'd in part, rev'd in part on other grounds, 68 A.3d 665 (Del. 2013)) Del. 2013). Gerber was overruled on other grounds by Winshall v. Viacom Int'l, Inc., 76 A.3d 808 (Del. 2013). See also Gilbert v. El Paso Co., 575 A.2d 1131, 1142-43 (Del. 1990) (enforcing express conditions pertaining to a tender offer; stating that “[a]lthough an implied covenant of good faith and honest conduct exists in every contract … such subjective standards cannot override the literal terms of an agreement”).
[x] Gerber v. Enter. Prods. Holdings, LLC, 67 A.3d 400, 418 (Del. 2013) (quoting ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member, LLC, 50 A.3d 434, 440–42 (Del. Ch. 2012), aff'd in part, rev'd in part on other grounds, 68 A.3d 665 (Del. 2013)) (emphasis added) (footnotes omitted) (citations omitted) (internal quotations omitted without ellipsis by Gerber). In this respect, the implied covenant parallels the contract law doctrine of unconscionability. See Restatement (Second) of Contracts § 208 (1981) (stating that the unconscionability analysis addresses whether “a contract or term thereof is unconscionable at the time the contract is made”) (emphasis added); UCC § 2-302 (stating that the doctrine applies only if “the court finds the contract or any clause of the contract to have been unconscionable at the time it was made”) (emphasis added).
[xi] Nemec v. Shrader, 991 A.2d 1120, 1127 (Del.2010) (“The implied covenant will not infer language that contradicts a clear exercise of an express contractual right.”).
[xii] See Aspen Advisors LLC v. United Artists Theatre Co., 843 A.2d 697, 707 (Del. Ch.) aff'd, 861 A.2d 1251 (Del. 2004) (“By specific words, the parties to the Stockholders Agreement and the Warrants identified particular transactions that would provide the Warrantholders with the right to receive the same consideration paid to common stockholders (e.g., in mergers involving United Artists) and the right (if they had exercised their Warrants) to tag along (i.e., in certain change of control transactions). Similarly, the parties also (by omission) defined the freedom of action other parties to those contracts (such as United Artists, the UA Holders, and Anschutz) had to engage in transactions without triggering rights of that nature.”).
[xiii] “[T]o express or include one thing implies the exclusion of the other.” EXPRESSIO UNIUS EST EXCLUSIO ALTERIUS, Black's Law Dictionary (10th ed. 2014).
[xiv] However, whether a gap matters depends on whether a party’s conduct makes the gap apparent – i.e., whether one party’s conduct exposes an issue on which the parties would have agreed had the issue arisen when the deal was being made.
[xv] Allen v. El Paso Pipeline GP Co., L.L.C., No. CIV.A. 7520-VCL, 2014 WL 2819005, at *11 (Del. Ch. June 20, 2014) (internal quotations and citations omitted).
[xvi] In simplified form, this example reflects one of the transactions – the 2010 merger – addressed in 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).
[xvii] Allen v. El Paso Pipeline GP Co., L.L.C., No. CIV.A. 7520-VCL, 2014 WL 2819005, at *14 (Del. Ch. June 20, 2014). The opinion refers to the omission “creating a gap,” id. but the author respectfully disagrees. The gap existed ab initio. It remained hidden until revealed by the expert’s omission.
[xviii] Gerber v. Enter. Prods. Holdings, LLC, 67 A.3d 400, 418 (Del. 2013) (quoting ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member, LLC, 50 A.3d 434, 440–42 (Del. Ch. 2012), aff'd in part, rev'd in part on other grounds, 68 A.3d 665 (Del. 2013)) (emphasis added) (footnotes omitted) (citations omitted) (internal quotations omitted without ellipsis by Gerber). It might be more consistent with actual practice to revise the quoted language so that the sentence read: “The gap is filled with what the court concludes the now complaining party would have insisted on as a condition to going forward with the deal, if the party had then considered the issue in the party’s original bargaining position at the time of contracting.”
[xix] Restatement (Second) of Contracts § 261, cmt. b (1981)
[xx] See n. 66.
[xxi] In this respect, the implied covenant is similar to the unconscionability doctrine of contract law. See Restatement (Second) of Contracts § 208. cmt. b (1981) (“Traditionally, a bargain was said to be unconscionable in an action at law if it was ‘such as no man in his senses and not under delusion would make on the one hand, and as no honest and fair man would accept on the other….”) (quoting Hume v. United States, 132 U.S. 406 (1889), which in turn was quoting Earl of Chesterfield v. Janssen, 2 Ves.Sen. 125, 155, 28 Eng.Rep. 82, 100 (Ch.1750)).