Saturday, November 28, 2015

And Now Another Corporate Inversion--And More Corporate Inversion Restrictions

A short while ago, some commentators declared that the Treasury had successfully ended corporate inversions. But after several recent corporate migrations, reports of the inversion’s death appear to have been greatly exaggerated.

A corporate inversion is a complicated and costly transaction used by American corporations to avoid particularly burdensome aspects of the U.S. tax code. The United States not only enforces the OECD’s highest corporate tax rate (the tax rate for most U.S. corporations ranges between 35% to 39%) but also worldwide taxation. This latter feature subjects an American corporation’s entire revenue stream to the United States’ extraordinary tax rate, whereas most countries tax only what is earned inside their territorial borders. In simplified terms, a corporation hoping to invert must merge with a foreign corporation—while satisfying some very idiosyncratic conditions—in order to reorganize in the foreign company’s country. After inverting, a company’s foreign generated income becomes subject to more favorable foreign tax rates, though it must still pay U.S. taxes on domestically generated revenue.

The rhetoric surrounding inversions has been heating up since Pfizer announced its intentions to invert into an Irish entity after acquiring Allegran in a $160 billion deal. The chief complaint against inversions is that inverted companies avoid their “fair share” of taxes (the United States likely lost 33.6 billion in tax revenue in 2014 alone). Not only that, the inversion trend perhaps shifts research and development and intellectual property innovation to foreign countries (see this excellent article by Omri Marian). President Obama famously declared that inversions are “unpatriotic,” Jon Stewart warned his viewers of the “Inversion of the Moneysnatchers,” and countless politicians have proposed ending the inversion loophole.

But why should we demonize inverted companies. First, consider an old Learned Hand quote: “[a]nyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose the pattern which best pays the treasury.” And considering that inverted companies must still pay U.S. taxes on U.S. generated income, the process shields only foreign-based revenue with which the United States has limited association. In fact, if the internal affairs doctrine incentivizes companies to incorporate in whichever U.S. state they wish, why should this policy not include foreign countries? 

In the end, what to do about inversions presents a number of complex issues. Critics offer very accurate arguments concerning the deleterious effects of inversions. However, in light of previous attempts, it seems quite unlikely that the tax code could be amended to prohibit future companies from inverting. As of a couple days ago the Treasury just added new inversion restrictions with the caveat that there is only so much that the Treasury can do. Indeed either lowering the corporate tax rate or ending worldwide taxation would likely be the most effective anti-inversion policy. Or the United States could take better aim at the income shifting transactions that corporations use to repatriate foreign income into the United States. But probably the best first step is for us to quit viewing inversions normatively; any well-informed policy prescription should avoid the very commonly used rhetoric of “good” guys and “bad” guys. After all, companies are just following incentivizes that the law offers.

For an excellent discussion of inversions, please read this Virginia Law Review article by Eric Talley.

November 28, 2015 in Corporations, Current Affairs, International Business, M&A | Permalink | Comments (0)

Tuesday, November 24, 2015

Contract Is King Micro-Symposium Wrap Up

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 Manesh contributed two posts (available here and here).

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 KleinbergerJeff LipshawMohsen Manesh, and Sandra Miller.will be panelists at the AALS meeting and joined by Lyman Johnson and Mark Loewenstein

November 24, 2015 in Anne Tucker, Conferences, Corporate Governance, Corporations, Delaware, Joan Heminway, Joshua P. Fershee, LLCs, Partnership, Unincorporated Entities | Permalink | Comments (0)

Thursday, November 19, 2015

Do Sophisticated Parties Really Prefer the Freedom of Contract? (Contract Is King Micro-Symposium)

I would like to thank the Business Law Professor Blog for this very important symposium. My brief thoughts are filling in for Marcia Narine. I became well acquainted with LLCs when I practiced in the alternative entities group of a Delaware law firm. What most stood out during my time there was the freedom enjoyed by LLCs and LPs to abridge fiduciary duties and deviate from other corporate orthodoxies. I constantly thought about whether this freedom of contract was a good thing; after all, case law tells only the tragic stories.

As mentioned in other posts, contractual freedom is ideal when sophisticated parties of comparable strengths are allowed to define their relationships. And generally, few problems arise from the LLC form. Law firms typically provide those seeking to form an LLC one of their standard, boilerplate operating agreements, which includes fiduciary duties. In turn, business owners are able to enjoy limited liability while avoiding many of the formalities, transactions costs, and tax burdens associated with traditional corporations. However, there seems to be an increasing number of cases where operating agreements resemble adhesion contracts, creating opportunities for abuse. Is it wise that unsophisticated are more at risk for contractual related harms so that sophisticated parties can contract freely?

The above narrative suggests that sophisticated parties benefit and enjoy the organizational flexibilities provided by the LLC form. It goes unnoticed, though, that sophisticated parties often reject this freedom of contract. Without question the trend in Delaware is towards the formation of LLCs and LPs versus corporations (at seemingly a 3:1 rate). But that doesn’t mean alternative entities always choose to keep their form. I was discussing this issue with a friend and practicing lawyer who mentioned that, in his transactional practice, when Delaware LLCs become big, and attract big funds, a condition of investment almost always requires an LLC to convert into a Delaware corporation. It seems that the lack of predictability associated with the freedom of contract scares potential investors who prefer the comforts of fiduciary duties, among other corporate staples. Upon some reflection, this anecdotally lines up with my experience as best as I can remember. So the parties who ostensibly are best served by contractual freedoms—i.e., sophisticated parties—appear to be the ones most likely to demand the traditional corporate form. And on a related note, this helps to explain why such a paltry number of LLCs and LPs have become public companies.

November 19, 2015 in Business Associations, Corporate Governance, Corporations, Delaware, LLCs, Venture Capital | Permalink | Comments (0)

Exalting the Distinct Nature of the LLC (Contract Is King Micro-Symposium)

Regular readers of this blog know that I am fervent that the distinction between entities matters, particularly when it comes to LLCs and corporation.  I’m happy to be a part of this micro-symposium, and I have enjoyed the input from the other participants. 

My comments relate primarily to the role of contract in LLCs and how that is different that corporations. Underlying my comments is my thesis that LLCs and corporations are meaningfully distinct. This view is in contrast to Jeff Lipshaw, who argued in his post:

[I]f uncorporations differ from corporations, it’s more a matter of degree than of any real difference.  Both are textual artifacts.  We have created or assumed obligations pursuant to the text at certain points in time, and we use the artifacts and their associated legal baggage opportunistically when we can.  I am not convinced that organizing in the form or corporations or uncorporations makes much difference on that score.

I tend to be more of a Larry Ribstein disciple on this, and I wish I had the ability to articulate the issues as eloquently and intelligently as he could.  Alas, you’re stuck with me. (Editor's note: As Jeff Lipshaw says in his comment below, he did not say the forms of LLCs and corporations are not distinct. He is, of course, correct, and I know very well he knows the difference between the forms. In fact, a good portion of what I understand of the practical implications of the LLC comes from him. I do believe that the choice of form matters, and at least should matter in how courts review the different entities, as I explain below. And I do think the LLC is better, or should be (if courts will allow it), because of what the form allows interested parties to do with it. The flexibility of the LLC form creates opportunity for highly focused, nimble, and more specific entities that can be vehicles that facilitate creativity in investment in a way that corporations and partnerships, in my estimation, do not.]

In his book, The Rise of the Uncorporation, Ribstein stated, “Uncorporations [his term for noncorporate entities] come in all shapes and sizes, and are increasingly encroaching on traditionally ‘corporate’ domain.  The thesis is that form matters.” He goes on to explain that the differences between corporations and noncorporate entities have practical implications for those in business (and their lawyers).  I think he was right. 

It seems that some view the limited liability protection that comes with both an LLC and a corporation as the main, if not sole, defining function of the firm. If that were true, then it would be accurate that LLCs and corporation are functionally the same. I think the evolution and purposes of the limited partnership, the LLC, and the corporation suggest that these entities at least should (if they don’t in fact) serve different purposes and roles for those who create them.

The LLC Revolution helped facilitate formation of entities with pass-through taxation and limited liability protection. And it is true, that limited liability one chief benefit of the corporation, and the rise of the corporation can be tracked to that benefit.  But, entity choice is more that just liability and taxation, too, at least where there are real entity choices that provide options. 

Corporations are far more off-the-rack in nature, and they have a tremendous number of default rules. These rules facilitate start up, and help skip a number of conversations that promoters and initial investors might otherwise need to have. (Of course, they probably should have these conversations, but if they don’t, there are more significant gap fillers than for other entities.) 

Ribstein observed, “Uncorporations not only explicitly permit, but also indirectly facilitate contracts.  A firm’s contractual freedom should be evaluated not only in terms of the flexibility permitted by a given business association statute, but in light of the alternative available standard forms.”  As such, the clearer and more distinct the terms of the various entity-form statutes are, the more significant a firm’s choice of form can be.  And if the choice is an LLC, that choice should be respected.

As my countless posts lamenting the fact that courts can’t seem to get the distinction between LLCs and corporations clear, there’s evidence that Lipshaw is right as to the current state of the law, or some meaningful portion of it. But that doesn’t make it right.

Continue reading

November 19, 2015 in Business Associations, Corporations, Delaware, Joshua P. Fershee, LLCs, Partnership | Permalink | Comments (6)

Wednesday, November 18, 2015

Call for Papers: Law and Ethics of Big Data

I recently received the following call for papers via e-mail


Law and Ethics of Big Data


Co-Hosted and Sponsored by:

Virginia Tech Center for Business Intelligence Analytics

The Department of Business Law and Ethics, Kelley School of Business


Co-Sponsored by:

The Wharton School

Washington & Lee Law School


April 8 & 9, 2016

Indiana University- Bloomington, IN.

Abstract Submission Deadline: January 17, 2016

We are pleased to announce the research colloquium, “Law and Ethics of Big Data,” at Indiana University-Bloomington, co-hosted by Professor Angie Raymond of Indiana University and Professor Janine Hiller of Virginia Tech.

Due to the success of last year’s event, the colloquium will be expanded and we seek broad participation from multiple disciplines; please consider submitting research that is ready for the discussion stage. Each paper will be given detailed constructive critique. We are targeting cross-discipline opportunities for colloquium participants, and the IU community has expressed interest in sharing in these dialogues. In that spirit, the Institute of Business Analytics plans to host a guest speaker on the morning of April Participants are highly encouraged to attend this free event.

Submissions: To be considered, please submit an abstract of 500-1000 words to Angie Raymond at and/or Janine Hiller at by January 17, 2016. Abstracts will be evaluated based upon the quality of the abstract and the topic’s fit with the theme of the colloquium and other presentations. Questions may be directed to Angie Raymond at or Janine Hiller at

Authors will be informed of the decision by February 2, 2016. If accepted, the author agrees to submit a discussion paper by March 26, 2016. While papers need not be in finished form, drafts must contain enough information and structure to facilitate a robust discussion of the topic and paper thesis. Formatting will be either APA or Bluebook. In the case of papers with multiple authors, only one author may present at the colloquium.

TENTATIVE Colloquium Details:

  • The colloquium will begin at noon on April 8th and conclude at the end of the day on April 9th
  • Approximately 50 minutes is allotted for discussion of each paper presentation and discussion.
  • The manuscripts will be posted in a password protected members-only forum online. Participants agree to read and be prepared to participate in discussions of all papers. Each author will be asked to lead discussion of one other submitted paper.
  • A limited number of participants will be provided with lodging, and all participants will be provided meals during the colloquium. All participants are responsible for transportation to Indiana University Bloomington, IN.

November 18, 2015 in Business Associations, Business School, Call for Papers, Corporations, Haskell Murray, Law School, Technology | Permalink | Comments (0)

Tuesday, November 17, 2015

Mohsen Manesh: Delaware’s Financial Commitment to Unlimited Freedom of Contract (Contract Is King Micro-Symposium)

Guest post by Mohsen Manesh:

In my previous post, I suggested that we are unlikely to see Delaware ever step back from its statutory commitment to freedom of contract in the alternative entity context. And that is true even if Chief Justice Strine, Vice Chancellor Laster, and others might believe that unlimited freedom of contract has been bad public policy.

Why? To be cynical, it’s about money.

It is well known that Delaware, as a state, derives substantial profits, in the form of franchise taxes, as a result of its status as the legal haven for a majority of publicly traded corporations. In 2014 alone, Delaware collected approximately $626 million—that is almost 16% of the state’s total annual revenue—from corporate franchise taxes. (For scale, that’s almost $670 per natural person in Delaware.)

Less well documented, however, is that Delaware also now derives substantial—and growing—revenues as the legal home from hundreds of thousands of unincorporated alternative entities. My chart below tells the story. Over the last decade, while the percentage of the state’s annual revenue derived from corporate franchise taxes has been flat, an increasingly larger portion of the state’s annual revenue has been derived from the taxes paid by its domestic LLCs and LPs. Unsurprisingly, in Delaware, alternatives entities have been a real growth industry.

Given the state’s increasing dependence on revenues from domestic LLCs and LPs, it is highly unlikely that the state would undertake any reforms that risk eroding this emerging and increasingly important tax base. Evidence, as well as experience, suggests that businesses (and their lawyers) are drawn to Delaware, in part, because of its unlimited freedom of contract and the ability to tailor and eliminate all fiduciary duties. [1] Thus, if Delaware were to alter its alternative entity law to curtail that freedom and impose some form of mandatory, unwaivable fiduciary duties, it would lose some number of LLCs. Too many other jurisdictions “give the maximum effect to the … freedom of contract”. [2]

Importantly, however, this concern is much less acute when the reform is one that is limited only to publicly traded alternative entities. For one, as I noted in my earlier post, Delaware’s 150 or so publicly traded LPs and LLCs represent a tiny sliver of the hundreds of thousands of alternative entities domiciled in Delaware. Moreover, those few publicly traded firms contribute only a nominal portion to Delaware’s overall revenues collected from alternative entity taxes.

As I have shown in earlier work, unlike Delaware’s corporate franchise tax, which is scalable based on a formula that tends to charge most to large, publicly traded firms (up to $180,000 annually), Delaware’s annual tax charged to alternative entities is flat. All LLCs and LPs, no matter how large or small, whether publicly traded or closely held, pay the state only $300 annually for the privilege of being a Delaware entity. Thus, unlike the corporate context, where Delaware’s business is dependent on attracting large, publicly traded corporations, in the alternative entity context, Delaware’s business depends on volume alone. And publicly traded alternative entities represent a negligible part of the state’s overall volume—accounting for approximately $45,000 of the total $195 million that Delaware collected from its domestic alternative entities last year.

The upshot is that although Delaware might be quite sensitive economically to curtailing the freedom of contract for all alternative entities, lest it loses some if this thriving tax base, the state may be relatively indifferent to losing the approximately $45,000 annually that it gets from its few publicly traded LPs and LLCs. 

Whether this indifference can be transformed into a willingness to amend its law to impose mandatory fiduciary duties in publicly traded alternative entities depends on whether Strine, Laster, and others can make a convincing policy case for making this change. Or more cynically yet, it might depend on whether Delaware’s legislature fears that in the absence of state-level regulation, the federal government might step in to preempt Delaware law on behalf of public investors. [3]

-Mohsen Manesh

* * * * *

[1] See Franklin Gevurtz, Why Delaware LLCs?, 91 Or. L. Rev. 57, 105 (2012).

[2] See, e.g., Ark. Code Ann. § 4-32-1304 (2001); Colo. Rev. Stat. § 7-80-108(4) (2009); Conn. Gen. Stat. Ann. § 34-242(a) (West 2005); Ga. Code. Ann. § 14-11-1107(b) (2003 & Supp. 2010); Kan. Stat. Ann. § 17-76,134(b) (2007); Ky. Rev. Stat. Ann. § 275.003 (West, Westlaw through 2010 legislation); La. Rev. Stat. Ann. § 12:1367(B) (2010); Miss. Code. Ann. § 79-29-1201(2) (2009); Mo. Rev. Stat. § 347.081(2) (2001 & Supp. 2010); Nev. Rev. Stat. § 86.286(4)(b) (2010); N.M.Stat. Ann. § 53-19-65(A) (LexisNexis 1978 & Supp. 2003); N.C. Gen. Stat. Ann. § 57C-10- 03(e) (2009); Okla. Stat. Ann. tit. 18, § 2058(D) (West 1999 &  Supp.  2010);  Utah Code Ann. § 48-2c-1901 (LexisNexis 2007); Va. Code Ann. § 13.1-1001.1(C) (2006); Wash. Rev. Code Ann. § 25.15.800(2) (West 2005); Wis. Stat. Ann. § 183.1302(1) (West 2002).

[3] Cf. Gerber v. Enterprise Prods. Holdings, LLC, 2012 WL 34442, *10 n.42 (Del. Ch. Jan. 6, 2012) (Noble, V.C.) (“This [case] raises the issue of just what protection Delaware law affords the public investors of limited partnerships that take full advantage of [the freedom of contracting.] If the protection provided by Delaware law is scant, then the LP units of these partnerships might trade at a discount or another governmental entity might step in and provide more protection to the public investors in these partnerships.”) (emphasis added).

November 17, 2015 in Business Associations, Conferences, Corporate Governance, Corporations, Delaware, LLCs, Partnership, Unincorporated Entities | Permalink | Comments (2)

Sandra Miller: Un-Sophisticated Parties Require Mandatory Duties at least in Publicly-Traded Entities if Not in all Entities (Contract Is King Micro-symposium)

 Guest post by Sandra Miller:

The ratio of LLC filings to corporate filings in Delaware from 2010 to 2014 was over 3 to 1.  Alternative business entities are no longer the province of a relatively small number of sophisticated investors.  Increasingly, corporations are becoming the “alternative” and LLCs and other unincorporated entities the norm.  Mom and Pop business as well as sophisticated real estate syndicators use alternative business entities.  Additionally, as discussed below, publicly-traded limited partnerships and LLCs are now being aggressively marketed. 

Accordingly, the assumptions that might once have justified greater reliance on private ordering in LLCs and alternative business entities should be revisited.  Not all investors are highly sophisticated parties and a relentlessly contractual approach to business entity governance is not appropriate for unsophisticated parties.   Nor is it appropriate for those without sophisticated legal counsel.  In backhanded fashion, this point was recognized by Larry E. Ribstein who advocated the removal of restrictions on waivers of fiduciary duties in limited partnerships when these entities were used by sophisticated firms that were unlikely to be publicly traded.   Ribstein expressly stated that limited partnership interests may be less vulnerable than corporate shareholders and are unlikely to be publicly traded.  (See Fiduciary Duties and Limited Partnerships)

Master limited partnerships (e.g. publicly-traded limited partnerships and publicly-traded LLCs) provide an important example of how capital from unsophisticated investors now flows readily into alternative investments.  According to the National Association of Publicly-Traded Partnerships (NAPTP) most MLP investors are individuals, the vast majority of whom are over age 50.  Many investors are individuals, estates, and retirement plans – unsophisticated economic players.  Thus, there are asymmetries in the marketplace that make it unlikely that the marketplace will efficiently discount the effects of waivers.  Given the investor profile, at a very minimum, the duty of loyalty should be non-waivable for publicly-traded entities.   (See Toward Consistent Fiduciary Duties)

            There are even strong arguments in favor of reinstating mandatory minimum fiduciary duties for all business entities, public or private.  Contractarians pre-suppose a level contractual playing field.  Yet, repeat players who structure similar transactions repeatedly are at a distinct advantage.  Moreover, there may not be equal legal representation of majority and minority investors.  (See A New Direction for LLC Research in a Contractarian Legal Environment) Moreover, it is total madness to think that a contractual approach to business entity governance reduces costs.  If anything, costs are increased by the lack of standard terms under a contractual regime. 

     In short, we have empirical data and years of experience with waivers that expose serious inefficiencies and injustices in a system that permits the waiver of all fiduciary duties.  It is time to reconsider the benefits of a mandatory duty of loyalty for all entities, public or private. 

-Sandra Miller


November 17, 2015 in Business Associations, Corporate Governance, Corporations, Delaware, LLCs, Partnership, Unincorporated Entities | Permalink | Comments (4)

Monday, November 16, 2015

Daniel Kleinberger: Delineating Delaware’s Implied Covenant of Good Faith & Fair Dealing (Contract Is King Micro-sympsium)

Guest post by Daniel Kleinberger:

Part I - Introduction

My postings this week will seek to delineate Delaware’s implied contractual covenant of good faith and fair dealing and the covenant’s role in Delaware entity law

An obligation of good faith and fair dealing is implied in every common law contract and is codified in the Uniform Commercial Code (“U.C.C”). The terminology differs:  Some jurisdictions refer to an “implied covenant;” others to an “implied contractual obligation;” still others to an “implied duty.”  But whatever the label, the concept is understood by the vast majority of U.S. lawyers as a matter of commercial rather than entity law.  And, to the vast majority of corporate lawyers, “good faith” does not mean contract law but rather conjures up an important aspect of a corporate director’s duty of loyalty.

Nonetheless, Delaware’s “implied contractual covenant of good faith and fair dealing” has an increasingly clear and important role in Delaware “entity law” – i.e., the law of unincorporated business organizations (primarily limited liability companies and limited partnerships) as well as the law of corporations.

Because to the uninitiated “good faith” can be frustratingly polysemous, this first blog “clears away the underbrush” by explaining what Delaware’s implied covenant’s “good faith” is not.

Part II – A Couple of Major “Nots”

  1. Not the Looser Approach of the Uniform Commercial Code

The Uniform Commercial Code codifies the common law obligation of good faith and fair dealing for matters governed by the Code: “Every contract or duty within [the Uniform Commercial Code] imposes an obligation of good faith in its performance and enforcement.”  The Code defines “good faith” as “mean[ing] [except for letter of credit matters] honesty in fact and the observance of reasonable commercial standards of fair dealing.” An official comment elaborates: “Although ‘fair dealing’ is a broad term that must be defined in context, it is clear that it is concerned with the fairness of conduct rather than the care with which an act is performed.”

The UCC standard thus incorporates facts far beyond the words of the contract at issue and furthers a value (fairness) which in the entity context is usually the province of fiduciary duty.  The UCC  definition provides some constraint by referring to “reasonable commercial standards,” but “[d]etermining . . . unreasonableness inter se owners of an organization is a different task than doing so in a commercial context, where concepts like ‘usages of trade’ are available to inform the analysis.” ULLCA (2013) § 105(e), cmt.

The Delaware Supreme Court has flatly rejected the U.C.C. approach for Delaware unincorporated businesses.

  1. Not the Corporate Good Faith of Disney, Stone v. Ritter, and Caremark

An obligation to act in good faith has long been part of a corporate director’s duty under Delaware law, but the concept became ever more important following the landmark case of Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985).  In Van Gorkom, the Delaware Supreme Court held directors liable for gross negligence in approving a merger transaction, a holding that “shocked the corporate world.”

 Spurred by the Delaware corporate bar, the Delaware legislature promptly amended Delaware’s corporate statute.  The amendment permits Delaware  corporations to essentially opt out of the Van Gorkom rule.  The now famous Section 102(b)(7) authorizes a Delaware certificate of incorporation to:

eliminat[e] or limit[] the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty …, provided that such provision shall not eliminate or limit the liability of a director: (i) For any breach of the director's duty of loyalty to the corporation or its stockholders; [or] (ii) for acts or omissions not in good faith….

In effect, the provision authorizes exculpation from damages arising from claims of director negligence, but for some time the exception “for acts or omissions not in good faith” was controversial.  Where plaintiffs could not allege breach of the duty of loyalty, they sought to equate “not in good faith” with extreme negligence.

Notably, the meaning of “not in good faith” was pivotal in the lengthy and costly litigation arising from the Disney corporation’s termination of Michael Ovitz.  However, the Supreme Court’s decision in In re Walt Disney Co. Derivative Litig. left the issue murky.  Eventually, in Stone v. Ritter, the court made clear that in this context “good faith” is an aspect of the duty of loyalty.  The Court then equated a lack of this type of good faith with a director’s utter failure to attend to his or her oversight obligations (the so-called Caremark I duties).

Thus, a Delaware director’s fiduciary duty of good faith has nothing to do with the “good faith” of the Delaware implied covenant of good faith and fair dealing.

This posting is derived from Daniel S. Kleinberger, “Delaware’s Implied Contractual Covenant of Good Faith and “Sibling Rivalry” Among Equity Holders,” a paper presented at the 21st Century Commercial Law Forum: 15th International Symposium in Beijing, at Tsinghua University’s School of Law, November 1, 2015 (all footnotes and most citations omitted).

November 16, 2015 in Agency, Business Associations, Conferences, Corporate Governance, Corporations, Delaware, LLCs, Partnership, Unincorporated Entities | Permalink | Comments (0)

Mohsen Manesh: Strine & Laster’s “Modest” Proposal to Limit Contract’s Realm (Contract Is King Micro-Symposium)

Guest post by Mohsen Manesh:

First, I want to give a big thanks to Anne and the rest of the Business Law Professor Bloggers for graciously hosting this mirco-symposium! As a longtime BLPB reader, it is a privilege to now contribute to the online conversation.

In this post, I want to explore the boundaries of the proposal recently made by Delaware Chief Justice Strine and Vice Chancellor Laster to address the problem, as they see it, that has been created by the unbound freedom of contract in the alternative entity context.  In their provocative “Siren Song” book chapter, the judicial pair advocate limits on the freedom of contract by making the fiduciary duty of loyalty mandatory.[1] But, importantly, they limit their proposal to publicly traded LLCs and LPs. [2]

This limitation is striking because it makes their proposal, in one respect at least, so very modest. There exists literally hundreds of thousands of Delaware LLCs and LPs. (121,592 LLCs were formed in Delaware in 2014 alone!) Only around 150 are publicly traded. [3] Thus, the Strine and Laster proposal for curtailing the freedom of contract affects only a tiny fraction of the alternative entity universe.

But in another respect, the Strine and Laster proposal is quite audacious and radical. Imposing mandatory fiduciary duties fundamentally cuts at their state’s famously strong statutory commitment to freedom of contract and the reputation that that has fostered in legal and business circles. After all, there is a reason why our symposium and AALS program are titled “Contract is King.” As a pragmatic matter, it is hard to see how Delaware could back away from its commitment to the freedom of contract.

Certainly, there is reason to single out publicly traded entities for special treatment. The agreements governing publicly traded alternative entities bear all of the hallmarks of contracts of adhesion: prolix and confusing, often unread and unnegotiated, offered on a take-it-or-leave it basis, and arguably stuffed full of terms that favor the drafting party (the firm’s managers and sponsors) at the expense of often unsophisticated, public investors. Indeed, my own research has shown that these agreements commonly contain clauses that eliminate the default fiduciary duty of loyalty or exculpate for damages arising therefrom, replacing the default duty with less rigorous contractual obligations.

And anyone who closely follows Delaware case law knows how these agreements have played out in practice. In recent years, the Delaware Supreme Court and Court of Chancery have dismissed case after case in which the public investors of alternative entities have alleged self-dealing on the part of the managers or controllers of the entity.[3]  And it’s clear that oftentimes the courts are dismissing these cases begrudgingly, despite their own feelings of fairness. [4] 

So, there might well be reason to change the rules for publicly traded entities to limit the freedom of contract by imposing a mandatory fiduciary duty of loyalty. But on the other hand, as I suspect others in this micro-symposium will argue, many 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?

Moreover, even if public investors do not read or understand the terms that they are agreeing to by investing, and even if those terms are unduly favorable to the managers of the entity, the units purchased by investors in a publicly traded alternative entity have been priced by a liquid market that is—to at least some degree—efficient, meaning that those management-friendly terms have been already priced into the units. So, to some extent, public investors are getting exactly what they pay for. [5] In contrast, the investors in private entities do not benefit from this kind of built-in market wisdom. So, don’t they deserve the judicial protection of a mandatory fiduciary duty even more so than their public investor counterparts?

Given all of this, even if one accepts Strine and Laster’s account of the problems created by the freedom of contract, does it makes sense to limit their solution to the narrow sliver of publicly held entities? Or is their proposed solution simply a pragmatic recognition that for better or worse “Contract is King” and that any reform to that bedrock principle must be modest and incremental.

As I’ll explain in my next post, from my perspective, it is hard to see Delaware stepping back wholesale from its commitment to the freedom of contract in the alternative entity context. But for publicly traded firms at least, I do see reasons why we might see a curtailment of the unlimited freedom of contracting.

-Mohsen Manesh

[1] The Siren Song of Unlimited Contractual Freedom, in Research Handbook on Partnerships, LLCs and Alternative Forms of Business Organizations 13 (Robert W. Hillman & Mark J. Loewenstein eds., 2015) (“In light of these problems, it seems to us that a sensible set of standard fiduciary defaults might benefit all constituents of alternative entities…. For publicly traded entities, the duty of loyalty would be nonwaivable.”)

[2]  Id.

[3] See, e.g., In re Encore Energy Partners LP Unitholder Litig., 2012 WL 3792997 (Del. Ch. Aug. 31, 2012) aff’d 72 A.3d 93 (Del. 2013); Gerber v. EPE Holdings, LLC, 2013 WL 209658 (Del. Ch. Jan. 18, 2013); Brinckerhoff v. Enbridge Energy Co., Inc., 2011 WL 4599654 (Del. Ch. Sept. 30, 2011) aff’d 67 A.3d 369 (Del. 2013); In re K-Sea Transp. Partners L.P. Unitholders Litig. 2012 WL 1142351 (Del. Ch. Apr. 4, 2012) aff’d, 67 A.3d 354, 360-61 (Del. 2013). But see In re El Paso Pipeline Partners, 2015 WL 1815846 (Del. Ch. Apr. 20, 2015) (judgment for damages against general partner for breach of contractual duty).

[4] See, e.g., Encore Energy Partners, 2012 WL 3792997, *13 (Parsons, V.C.) (acknowledging the “near absence under the [LP agreement] of any duties whatsoever [owed] to the public equity holders,” and advising “[i]nvestors apprehensive about the risks inherent in waiving the fiduciary duties of those with whom they entrust their investments may be well advised to avoid master limited partnerships.”);  Gerber v. Enterprise Prods. Holdings, LLC, 2012 WL 34442, *13 (Del. Ch. Jan. 6, 2012) (Noble, V.C.) (“The facts of this case take the reader and the writer to the outer reaches of conduct allowable under [Delaware law]. It is easy to be troubled by the allegations.”); Gerber v. EPE Holdings, 2013 WL 209658, *10 (Noble, V.C.) (“It is not difficult to understand [the plaintiff-investor’s] skepticism and frustration, but his real problem is the contract that binds him and his fellow limited partners.”).

[5] See Gerber v. Enterprise Prods. Holdings, LLC, 2012 WL 34442, *10 n.42 (Del. Ch. Jan. 6, 2012) (Noble, V.C.) (“This [case] raises the issue of just what protection Delaware law affords the public investors of limited partnerships that take full advantage of [the freedom of contract]. If the protection provided by Delaware law is scant, then the LP units of these partnerships might trade at a discount….”).

November 16, 2015 in Conferences, Corporate Governance, Corporations, Delaware, LLCs, Partnership, Unincorporated Entities | Permalink | Comments (4)

Jeffrey Lipshaw: Regarding Uncorporations, Is Contract a King or Mere Pretender to the Throne? (Micro-symposium)

Guest post by Jeffrey Lipshaw:

I’m honored to be asked to participate in this micro-symposium, and will (sort of) address the first two questions as I have restated them here.

  1. Does contract play a greater role in “uncorporate” structures than in otherwise comparable corporations and, more importantly, do I care?

                  Yes, as I’ll get to in #2, but indeed I probably don’t care. My friend and casebook co-author, the late great Larry Ribstein, was more than a scholar-analyst of the non- or “un-” corporate form; he was an enthusiastic advocate. It’s pretty clear that had to do with his faith in the long-term rationality of markets and their constituent actors and a concomitant distrust of regulatory intervention. Indeed, he argued the uncorporate form, based in contract, was more amenable than the regulatory-based corporate form to the creation of that most decidedly immeasurable quality, trust, and therefore the reduction of transaction costs. I confess I never quite understood the argument and tried to explain why, but only after Larry passed away, so I never got an answer. 

                  Unlike Larry (and a number of my fellow AALS Agency, Partnership, & LLC section members), I was never able to generate a lot of normative fervor about the ultimate superiority of the non-corporate form. I view all organizational and transactional structures, including corporations, LLCs, and contracts, as models or maps.  The contractual, corporate, and uncorporate models are always reductions in the bits and bytes of information from the complex reality, and that’s what makes them useful, just as a map of Cambridge, Massachusetts that was as complex as the real Cambridge would be useless.  

                  The difference between city maps and word maps is that the latter are artifacts we lawyers create to chart or control a reality that, in all its damnable uncooperativeness, insists upon moving forward through time and not necessarily respecting all that hard work we did trying to map its possible twists and turns. City maps may also become obsolete over time, but streets and buildings tend not to evolve and adapt quite as quickly or fluidly as human desires and relationships. So we have fewer issues with the gaps between physical maps and physical reality (notwithstanding the desire of my car’s GPS to sell me annual updates) than with the gaps between what we want now and what we wrote down some time ago (whether by way of bylaws, operating agreement, or supply contract) to see that we got it.  

                  Hence, if uncorporations differ from corporations, it’s more a matter of degree than of any real difference.  Both are textual artifacts.  We have created or assumed obligations pursuant to the text at certain points in time, and we use the artifacts and their associated legal baggage opportunistically when we can.  I am not convinced that organizing in the form or corporations or uncorporations makes much difference on that score.

  1. Is the unfettered ordering in LLCs and limited partnerships – like being able to eliminate wholly all fiduciary duties among the members or partners, as Delaware permits – a good thing?  Or should there be some standardized (and I presume therefore mandatory) fiduciary obligations for uncorporations, as Chief Justice Strine and Vice-Chancellor Laster suggest?

                  Having now gotten my general curmudgeonly-ness out of the way about the whole subject, and believing that a foolish consistency is the hobgoblin of little minds, I want to point out an area where the corporate model and its baggage indeed don’t match up to what normal human beings would expect as reasonable.  I confess it’s something that has been a bug up my backside for a number of years, in that I personally had to counsel on the dilemma, and would have loved it if we had organized this particular company as a Delaware limited partnership with only limited and specified fiduciary obligations.

                  Here’s the circumstance.  ABC Corporation spins off one of its businesses into a majority-owned subsidiary, DEF Corporation, possibly as the first step in a complete divestiture.  (There’s possibly a tax benefit doing it this way, but let’s not go there right now.)  DEF is now publicly traded, with a substantial minority, but ABC controls it both as to ownership (a majority share percentage) and management (posit that ABC appoints a majority of the board of the subsidiary).  Assume that DEF’s common stock is now trading at, say, $15 per share on the NASDAQ.  A third party, XYZ Corporation, contacts ABC’s CEO, and says the following: “We are prepared to pay $32 per share for all of DEF, both yours and the public minority, but we view this as pre-emptive, and if you shop the bid, we will walk away.”  ABC’s CEO’s visceral reaction is to tell XYZ that if it will send over the check, she will deliver the share certificate this afternoon.  Indeed, were DEF still wholly owned, that’s probably what would happen soon, if not that afternoon. 

                  But Delaware corporate law doesn’t like that at all when there’s a public minority.  See McMullin v. Beran, 765 A.2d 910 (Del. 2000) and Lyondell Chemical Co. v. Ryan, 970 A.2d 235 (Del. 2009).  DEF’s board is going to have to create a special committee of the independent (i.e. public) directors to undertake diligence satisfying the duty of care obligation.  That committee will feel obliged to hire independent counsel and its own investment banker.  It may believe that its duty requires a shopping of the bid, which could cause the pre-emptive offer to go away.  But how do we know that there isn’t a $35 per share offer just waiting out there?  (I commented on this in connection with Lyondell back in 2008.)  As any transactional lawyer knows, time means deal risk.

                  I’m not suggesting that the duty of care obligations imposed by the corporate law are wrong in change of control cases, but their imposition in Smith v. Van Gorkom (where the essence of the decision was that, regardless of the attractiveness of the offer, the board went too fast and wasn’t careful enough) provoked the adoption of §102(b)(7), exculpating the directors from monetary liability on account of any breach of the duty of care largely because they were held liable in a “devil if you do – devil if you don’t” circumstance.  That is to say, §102(b)(7) is an implicit acknowledgment that broad and standardized fiduciary obligations are sometimes overbroad.  But there’s really no way, at least logically, to tell a board when a bid is sufficiently pre-emptive as to trump the ordinary procedural precautions.

                  The great benefit of Delaware LLC and LP law, in providing that the usual fiduciary duties apply as a default matter, but permitting the parties to eliminate or modify them, as one cannot under the corporate law, is precisely the customization that would have been useful here.  Assuming no penalty in the market for having organized as a public limited partnership or LLC (see Blackstone Group LP), that form would have allowed the governing organizational document to waive any fiduciary obligation of the board or the majority owner in connection with the consideration of a seemingly pre-emptive offer, and avoided delay and the associated risk to the deal.

                  With all due respect to Chief Justice Strine and Chancellor Laster, I still don’t believe this has anything to do with the magic of private ordering in contract.  As I’ve written extensively, I think there’s significant illusion among lawyers and law professors about the extent to which any text capable of colorable competing interpretations actually reflects any mutual intention even if it was the subject of arm’s-length negotiation. That’s because I tend to believe that even sophisticated parties to sophisticated contracts put in a lot of boilerplate they hope maps accurately the twists and turns of future events or, more importantly, clearly favors them if there’s ever a dispute.  And when there is a later dispute, they turn to the text and hope to hell there’s something helpful in it.  So I’ve never been under the misapprehension that the operating agreement or partnership agreement of a publicly held LLC or LP reflects real intentions about the resolution of later disputes any more than corporate bylaws or the rights and preferences of a class of stock.

                  The LLC or LP form is just an alternative map or model, with alternative rights and obligations.  In the case that bugged me, it would have been a way to avoid a problem the corporate model really couldn’t quite get right.  Whether that’s “contract” or something else, reinstating standardized or mandatory fiduciary obligations strikes me as eliminating the very choice the different forms were meant to offer.

-Jeff Lipshaw

November 16, 2015 in Business Associations, Conferences, Corporate Governance, Corporations, Delaware, LLCs, Partnership, Unincorporated Entities | Permalink | Comments (1)

Friday, November 13, 2015

Building a Socially Responsible Brand

Last week I shared my thoughts on REI's #OptOutside campaign and concluded that the campaign appeared, in my opinion, to be more of a marketing ploy than anything truly socially responsible. 

I promised to discuss what I think it takes to build a respected socially responsible brand.

In my opinion, respected socially responsible brands are: (1) Authentic; (2) Humble; and (3) Consistent. 

These three work together. Authenticity comes, at least in part, from not over-claiming (also seen in humility) and from showing social responsibility in many areas over time (consistency). Authenticity with regard to social responsibility requires some serious sacrifice, at least in the short term. Humble companies admit their imperfections, work to right wrongs, and seek to improve. Building a socially responsible brand takes time, often decades.  As Warren Buffett supposedly said, "It takes 20 years to build a reputation and 5 minutes to ruin it."

Patagonia's "Don't Buy This Jacket" campaign was probably one of the best socially responsible advertising campaigns I have seen. This campaign seemed authentic because of Patagonia's consistent history of social responsibility and because it seemed clear that Patagonia was going to take a serious financial hit from this campaign. Patagonia's add was also humble in admitting the social costs of the goods it produces. Patagonia is not a perfect company, and their executives often admit that, and Patagonia may experience mission drift, but they continue to be one of the most socially responsible companies I know.  

November 13, 2015 in Business Associations, Corporations, CSR, Haskell Murray | Permalink | Comments (0)

Thursday, November 12, 2015

The Rise of the Whistleblowers

I have spent the past week immersed in whistleblower discussions. On Saturday, I served on a panel with plaintiffs and defense counsel at the ABA Labor and Employment Law Mid-Year meeting using a hypothetical involving both a nursing home employee and a compliance officer as potential whistleblowers under the False Claims Act, Dodd-Frank, and Sarbanes-Oxley. My co-panelist Jason Zuckerman represents plaintiffs and he reminded the audience both through a recent article and his presentation that Dodd-Frank has not replaced SOX, at least for his clients, as a remedy. Others in the audience echoed his sentiment that whistleblower claims are on the rise.

A fellow member on the Department of Labor Whistleblower Protection Advisory Committee, Greg Keating, represents defendants, and has noticed a significant increase in claims by in house counsel, as he told the Wall Street Journal recently. More alarmingly, a San Francisco federal judge found last month that board members can be held personally liable for retaliation under Sarbanes-Oxley and Dodd-Frank when they take part in the decision to terminate a whistleblower. This case of first impression involved the termination of a general counsel who complained of FCPA violations, but it is possible that other courts may follow the court’s reasoning, even though the judge acknowledged that it was a close call.

As the SEC continues to award whistleblower bounties to compliance officers and auditors, and as law firms continue to see in-house counsel raising concerns about their own companies, board members will have to walk the fine line between exercising appropriate oversight and not enmeshing themselves in the decisionmaking process.

November 12, 2015 in Compliance, Conferences, Corporate Governance, Corporations, Marcia Narine | Permalink | Comments (0)

Wednesday, November 11, 2015

Locked In: The Competitive Disadvantage of Citizen Shareholders

My recent article:  Locked In: The Competitive Disadvantage of Citizen Shareholders, appears in The Yale Law Journal’s Forum.  In this article I examine the exit remedy for unhappy indirect investors as articulated by Professors John Morley and Quinn Curtis in their 2010 article, Taking Exit Rights Seriously.  Their argument was that the rational apathy of indirect investors combined with a fundamental difference between ownership of stock in an operating company and a share of a mutual fund.  A mutual fund redeems an investor’s fund share by cashing that investor out at the current trading price of the fund, the net asset value (NAV). An investor in an operating company (a direct shareholder) exits her investment by selling her share certificate in the company to another buyer at the trading price of that stock, which theoretically takes into account the future value of the company. The difference between redemption with the fund and sale to a third party makes exit in a mutual fund the superior solution over litigation or proxy contests, they argue, in all circumstances. It is a compelling argument for many indirect investors, but not all.

In my short piece, I highlight how exit remedies are weakened for citizen shareholders—investors who enter the securities markets through defined contribution plans.  Constrained investment choice within retirement plans and penalties for withdrawals means that “doing nothing” is a more likely option for citizen shareholders.  That some shareholders are apathetic and passive is no surprise. The relative lack of mobility for citizen shareholders, however, comes at a cost.  Drawing upon recent scholarship by Professors Ian Ayres and Quinn Curtis (Beyond Diversification), I argue that citizen shareholders are more likely to be locked into higher fee funds, which erode investment savings.  Citizen shareholders may also be subsidizing the mobility of other investors.  These costs add up when one considers that defined contribution plans are the primary vehicle of individual retirement savings in this country aside from social security. If the self-help remedy of exit isn’t a strong protection for citizen shareholders, then it is time to examine alternative remedies for these crucial investors. 

-Anne Tucker

November 11, 2015 in Anne Tucker, Corporate Finance, Corporate Governance, Corporations, Financial Markets, Shareholders | Permalink | Comments (0)

Tuesday, November 3, 2015

LLCs Are Still Not Corporations: Finally, Someone Gets It Right (I Hope)

The Georgia Attorney General's (AG) office is trying to make the case that the Georgia Pipeline Act does not allow any entity other than a corporation to use the statute's eminent domain power.  Palmetto Pipeline is seeking a certificate for authorization to use that power, provided in GA Code § 22-3-82 (2014)

(a) Subject to the provisions and restrictions of this article, pipeline companies are granted the right to acquire property or interests in property by eminent domain for the construction, reconstruction, operation, and maintenance of pipelines in this state . . . .

The state AG has argued that a pipeline company must be a corporation, and thus a limited liability company (LLC)  cannot use the statutory power.  The AG is right.  In the Pipeline Act's definitions section, it provides, at GA Code § 22-3-81 (2014)

As used in this article:

. . . .

(2) "Pipeline company" means a corporation organized under the laws of this state or which is organized under the laws of another state and is authorized to do business in this state and which is specifically authorized by its charter or articles of incorporation to construct and operate pipelines for the transportation of petroleum and petroleum products.

Palmetto Pipeline LLC is a Delaware LLC, formed by Kinder Morgan for purposes of developing the pipeline.  According to news reports:

"Kinder Morgan will also be responding to the Department’s motion to dismiss, which mistakenly asserts that a limited liability company does not have the legal rights of a corporation,” [spokeswoman Melissa Ruiz wrote in an email]. “Kinder Morgan continues to strongly believe that the Palmetto Pipeline is good for consumers in the state of Georgia and the Southeast region, and we are committed to bringing this project to market.”

Sorry, Charlie, although it may be good for consumers, the statute is clear on this one.  In fact, Georgia utility law provides a good example of how to write a statue that expands the scope to other entities when desired.  The public utility law relating to natural gas in the state, at GA Code § 46-4-20 (2014), provides: 

As used in this article, the term "person" means any corporation, whether public or private; company; individual; firm; partnership; or association.

 Further, the act states:

(a) No person shall construct or operate in intrastate commerce within this state any pipeline or distribution system, or any extension thereof, for the transportation, distribution, or sale of natural or manufactured gas without first obtaining from the commission a certificate that the public convenience and necessity require such construction or operation. 

Unfortunately for Palmetto/Kinder Morgan, the eminent domain act has its own definitions and says "pipeline company" and not "person."  One might try to argue that the eminent domain statute somehow improperly restricts the rights of individuals and other entities by limiting the authority to corporations, and thus invalidate the law or provision, but I don't see that getting much traction.  The eminent domain law states in the legislative findings that

there are certain problems and characteristics indigenous to such pipelines which require the enactment and implementation of special procedures and restrictions on petroleum pipelines and related facilities as a condition of the grant of the power of eminent domain to petroleum pipeline companies.

GA Code § 22-3-80 (2014).  Given the history of utility regulation and oversight, including approval of capital structures by utility commissions, it is likely that a court would uphold the power to limit the types of entities that can be used by a regulated entity like a pipeline company.  

I don't mean to suggest here that the legislature should not allow pipeline companies to choose LLCs as their entity of choice. I leave that question for another time.  But I am saying that that the Georgia legislature did not allow pipeline companies to be anything other than corporations, which means an LLC cannot be a pipeline company that can use eminent domain power in Georgia. Here's hoping the court agrees.   

Hat tip and thanks to my best source for such cases and news items, Tom Rutledge at Kentucky Business Entity Law Blog

November 3, 2015 in Business Associations, Corporations, Joshua P. Fershee, LLCs, Unincorporated Entities | Permalink | Comments (1)

Monday, November 2, 2015

If You're a Board Member, Don't Say This

Pat Haden is the athletic director at the University of Southern California. Until Friday, he was also a member of the College Football Playoff selection committee. And, according to this story in the L.A. Times, he is also a director of at least nine non-profits or foundations and three businesses.

According to the Times, Haden spends an average of 70 hours a week on his U.S.C. job. As a playoff selection committee member, he was expected to spend countless hours watching football games and evaluating teams.

So where does he find the time to serve as a board member? Not a problem, according to Haden. He has “never been to one meeting” of some of the nonprofits he serves. And he spends “very little” time on his board positions.

Haden’s attitude is representative of an earlier era when outside directors merely showed up at meetings and nodded their head to whatever the chairman said. Those days are long gone. Today, board members are expected to spend much more time on their board duties, at the risk of liability if they don't.

Mr. Haden, a former Rhodes Scholar, is a very bright guy, but even bright guys can say stupid things. I just hope he’s never sued. (At least one of the businesses he serves as a director is a public corporation.) A plaintiff’s lawyer could use quotes like this to mince him.

In the meantime, I suggest he read something on modern corporate governance. He has a law degree, so he shouldn’t have any trouble understanding it.

November 2, 2015 in Business Associations, C. Steven Bradford, Corporate Governance, Corporations | Permalink | Comments (5)

Sunday, November 1, 2015

Are Arbitration Clauses All Bad, and If So, For Whom? A Look at the NY Times Expose

I teach both Civil Procedure and Business Associations. As a former defense-side commercial and employment litigator, I teach civ pro as a strategy class. I tell my students that unfortunately (and cynically), the facts don’t really matter. As my civil procedure professor Arthur Miller drilled into my head 25 ago, if you have procedure on your side, you will win every time regardless of the facts. Last week I taught the seminal but somewhat inscrutable Iqbal and Twombly cases, which make it harder for plaintiffs to survive a motion to dismiss and to get their day in court. In some ways, it can deny access to justice if the plaintiff does not have the funds or the will to re-file properly. Next semester I will teach Transnational Business and Human Rights, which touches on access to justice for aggrieved stakeholders who seek redress from multinationals. The facts in those cases are literally a matter of life and death but after the Kiobel case, which started off as a business and human rights case but turned into a jurisdictional case at the Supreme Court, civil procedure once again "triumphed" and the doors to U.S. courthouses closed a bit tighter for litigants. 

This weekend, the New York Times published an in depth article about how the corporate use of arbitration clauses affects everyone from small businesses to employees to those who try to sue their cell phone carriers and credit card companies. Of course, most people subject to arbitration clauses don’t know about them until it’s too late. On the one hand, one could argue that corporations would be irresponsible not to take advantage of every legal avenue to avoid the expense of protracted and in some cases frivolous litigation, particularly class actions. On the other hand, the article, which as one commenter noted could have been written by the plaintiffs bar, painted a heartbreaking David v. Goliath scenario.

I see both sides and plan to discuss the article and the subsequent pieces in the NYT series in both of my classes. I want my students to think about what they would do if they were in-house counsel, board members, or business owners posed with the choice of whether to include these clauses in contracts or employee handbooks. For some of them it will just be a business decision. For others it will be a question of whether it’s a just business decision. 

November 1, 2015 in ADR, Business Associations, Corporate Governance, Corporations, CSR, Current Affairs, Employment Law, Ethics, Human Rights, Marcia Narine, Teaching | Permalink | Comments (0)

Thursday, October 29, 2015

Have progressives flipped on corporate governance?

Kent Greenfield, Professor of Law and Dean’s Research Scholar at Boston College Law School, recently posted a provocative piece on the CLS Blue Sky Blog (here) in which he argues, among other things, that progressives have “flipped” from supporting “corporate citizenship” pre-Citizens United, to supporting “shareholder primacy” post-Citizens United.  (Kent has stressed to me that he does not believe this characterization extends to progressive corporate law scholars.) The piece is short, so I recommend you go read it before continuing on to my comments below, because I will simply be taking some short excerpts from his post and providing some responses, which will likely benefit from the reader having reviewed Kent’s post first. As just one disclaimer, Kent’s post is based on his article, “Corporate Citizenship: Goal or Fear?” – and I have not yet read that paper. Also, I consider the following to be very much an in-progress, thinking-out-loud type of project, and thus welcome all comments.

1. In 2010, the Supreme Court decided Citizens United v Federal Election Commission, ruling that corporations had a First Amendment right to spend money from general treasury funds in support of political candidates. Though seen as victory for political conservatives, the decision was in some ways based on a progressive view of the corporation. In the Court’s reasoning, corporations act as “associations of citizens” with rights of free speech.

Kent argues that the historical divide between progressives and conservatives can be viewed as one of “shareholder primacy” versus “corporate citizenship,” with progressives advocating for corporate citizenship while conservatives advance the cause of shareholder primacy. A couple of caveats are in order here. First, we must distinguish “shareholder primacy” as an assertion that shareholders should have the dominant (or at least more) controlling power within the corporation, from “shareholder wealth maximization,” which posits that the goal of corporate control is shareholder wealth maximization, independent of where the decision-making power resides. Second, we should keep in mind the competing corporate personality theories: aggregate theory, artificial entity (concession) theory, and real entity theory. I have argued in the past (see, e.g., here) that both aggregate theory and real entity theory tend to view the corporation as more private than public, with aggregate theory equating the relevant “association of citizens” with shareholders, while real entity theory looks to the board of directors – in either case positing a group of natural persons who can assert constitutional rights against government regulation. Artificial entity theory, on the other hand, views corporations as more public, at least in part because it is essentially impossible to mimic the corporate form solely through private contracting, and thus the state is entitled to more leeway in regulating corporations than natural persons acting in their purely private capacity. In light of all this, it may be better to view progressives as opposing shareholder wealth maximization as the sole goal of corporate governance, while being flexible as to the means used to achieve that end – be it shareholder primacy, director primacy, or “state primacy.” (I am not suggesting that a shift to shareholder primacy as the favored means of achieving the ends of progressive corporate governance is insignificant. Rather, I argue merely that a shift in means is less dramatic than a shift in ends, and thus less appropriately characterized as an ideological flip.) To the extent Citizens United is viewed as having merely strengthened the associational, private view of corporations without challenging the shareholder wealth maximization norm – it is hard to view it as advancing a progressive view of the corporation. In fact, it arguably stands simply as an opinion that gives more political power to corporations to pursue shareholder wealth maximization (or for managers to use shareholder wealth maximization as a justification for self-dealing) at the expense of other stakeholder concerns.

2. The biggest impediment to using the Citizens United moment to change corporate governance for the better is the progressive left.

In light of my comments above, I think there is a stronger argument to be made that the biggest impediment to changing corporate governance for the better is the continuing identification of corporations as purely private entities. It has been said that the greatest trick the devil played was convincing the world he didn’t exist. In this context, we might say the greatest trick played on progressives was convincing them their only viable choices are contractarian.

3. Justice John Paul Stevens’s dissent in Citizens United …. (perhaps unwittingly) bolsters shareholder supremacy by arguing that corporate speech should be limited in order to protect shareholders’ investments.

It may be better to view this part of Justice Stevens’s dissent as challenging the majority’s view that opening the corporate political contribution floodgates is not problematic because “corporate democracy” will address any problems. Meanwhile, Justice Stevens quotes Dartmouth College approvingly, and states that “corporations have been ‘effectively delegated responsibility for ensuring society's economic welfare,’” both of which place him squarely in the concession theory camp – despite his protestations to the contrary.

4. The irony runs the other way as well. In the 2014 Hobby Lobby case, the Court granted corporations the statutory right under the Religious Freedom Restoration Act to object to otherwise applicable regulations on religious grounds. Writing for the Court, Justice Samuel Alito recognized that corporations need not maximize the bottom line ….

Go here for my take on whether Hobby Lobby changed anything in terms of the ability of those who control corporations to pursue “socially responsible” ends.  It is worth noting that a corporation’s ability to pursue “socially responsible” ends as part of an overall shareholder-wealth-maximizing strategy in light of the business judgement rule is not necessarily the same thing as concluding corporations will pursue some optimal level of “corporate citizenship,” which may rather require recognizing state power to require such activity or prohibit related harmful activity.

5. The world is flipped. Progressives are championing shareholder rights. Conservatives are planting their ideological flag on the summit of corporate citizenship.

As noted above, to the extent one views progressives as seeking more corporate social responsibility, and being willing to consider alternative methods to that end – be it shareholder primacy, director primacy, or state primacy – I do not see a significant flip here. Meanwhile, to the extent conservatives can be viewed as having supported shareholder wealth maximization as the optimal, but not sole, means to the end of lifting all ships via a rising tide, in addition to being consistently united against government regulation, there is also arguably nothing here that constitutes a significant “flip.”

Of course, generalities like “progressive” and “conservative” typically suffer from significant amounts of imprecision, and it may be that the “flip” characterization is more or less appropriate given the strand of progressive or conservative one is considering.

October 29, 2015 in Business Associations, Constitutional Law, Corporate Governance, Corporate Personality, Corporations, CSR, Stefan J. Padfield | Permalink | Comments (0)

Wednesday, October 28, 2015

Preventing Client Executives from Violating Compliance Policies and the Law

I had the honor of being invited to speak at the annual symposium for the Wayne Law Review two weeks ago.  The event, which focused on Corporate Counsel as Gatekeepers, was well organized and attended--and also very stimulating.  Speakers included Tony West as a keynote, a few of us academics, and a bunch of current and former practitioners--prosecutors, in-house counsel, and outside counsel.

My presentation focused on a story that bugs me--a story built on an experience I had in practice.  In the story (which modifies the true facts), an executive flagrantly violates a securities trading compliance plan that I drafted in connection with a subsequent transaction that I worked on for the executive's firm.  Specifically, the executive informs a friend about the transaction the day before it is announced, believing that the friend will never trade on the information.  The friend trades.  The incident results in a stock exchange and Securities and Exchange Commission (SEC) inquiries.  No enforcement is undertaken against the firm.  However, the executive signs a consent decree with--and pays a cash penalty to--the SEC and, together with the firm, suffers public humiliation via a front-page article in the local newspaper (since the SEC would not agree to forego a press release).  This fact pattern gnaws at me because I wonder whether there is anything more legal counsel can do to prevent an executive from violating a compliance policy to the detriment of himself and the firm . . . .

Continue reading

October 28, 2015 in Compliance, Corporate Governance, Corporations, Joan Heminway, Lawyering, Research/Scholarhip, Securities Regulation, Teaching, White Collar Crime | Permalink | Comments (4)

Delaware Affirms "Effective" Control Standards for Non-Majority Shareholders

Earlier this month BLPB editor Ann Lipton wrote about the Delaware Supreme Court opinion in Sanchez regarding director independence (Delaware Supreme Court Discovers the Powers of Friendship).  On the same day as the Del. Sup. Ct. decided Sanchez, it affirmed the dismissal of KKR Financial Holdings shareholders' challenge to directors' approval of a buyout.  The transaction was a stock-for-stock merger between KKR & Co. L.P. (“KKR”) and KKR Financial Holdings LLC (“Financial Holdings”). Plaintiffs alleged that the entire fairness standard should apply because KKR was a controlling parent in Financial Holdings.  The controlling parent argument hinged on the facts that:

Financial Holdings's primary business was financing KKR's leveraged buyout activities, and instead of having employees manage the company's day-to-day operations, Financial Holdings was managed by KKR Financial Advisors, an affiliate of KKR, under a contractual management agreement that could only be terminated by Financial Holdings if it paid a termination fee.

Chief Justice Strine, writing an en banc opinion for the Court,  upheld Chancellor Bouchard's finding that KKR could not be considered a controlling parent where "KKR owned less than 1% of Financial Holdings's stock, had no right to appoint any directors, and had no contractual right to veto any board action."

The Delaware Supreme Court upheld the familiar standard of effective control, absent a majority, which focuses on "a combination of potent voting power and management control such that the stockholder could be deemed to have effective control of the board without actually owning a majority of stock."

Chancellor Bouchard had noted that plaintiff's complaint stemmed from dissatisfaction at the contractual relationship between KKR and Financial Holdings which limited the growth of Financial holdings.  Chancellor Bouchard wrote:

At bottom, plaintiffs ask the Court to impose fiduciary obligations on a relatively nominal stockholder, not because of any coercive power that stockholder could wield over the board's ability to independently decide whether or not to approve the merger, but because of pre-existing contractual obligations with that stockholder that constrain the business or strategic options available to the corporation.



Sometimes a "nothing new" case provides a good reminder of an established standard and provides clear language for recapping the concept to students.  This will become a note case on "effective" control in my ChartaCourse corporations casebook and also a good illustration of the role of private agreements in shaping how legal standards are applied.  

You can read the opinion at: Corwin et al. v. KKR Fin. Holdings et al., No. 629, 2014, 2015 WL 5772262 (Del. Oct. 2, 2015). 

-Anne Tucker


October 28, 2015 in Ann Lipton, Anne Tucker, Corporate Governance, Corporations, Delaware, M&A, Teaching | Permalink | Comments (0)

Tuesday, October 27, 2015

For the Love of All that Is Holy, LLCs Are Not Corporations

So, my rants about the problem of courts (and others) conflating LLCs and corporations are not new.  Unfortunately for the proper evolution of the law, but good fodder for my posts, I continue to get examples.  We now have a new one that raises the bar a bit.

 A recent case from the United States District Court for the Western District of Pennsylvania continues the trend. The beauty, if one can call it that, of the case is that there are failures to recognize the difference between LLCs and corporations at multiple levels. 

 First, though, let’s recap what LLCs are.  LLCs are limited liability companies, and they are creatures of statute. See, e.g., 6 Del. C. § 18-101, et seq.  As such, they are not corporations, which are creatures of other statutes. Cf., e.g., 8 Del. Code § 101, et. seq. In contrast, LLCs, like corporations and other associations, can be people.  See, e.g.,  Dictionary Act, 1 U.S. Code § 1 (“[The wor[d] 'person' . . . include[s] corporations, companies, associations, firms, partnerships, societies, and joint stock companies, as well as individuals.").

Back to our newest example, which I think of as a strikeout. The case was filed by the Pennsylvania General Energy Company, LLC, (PGE), which challenged the “constitutionality, validity and enforceability of an ordinance adopted by Grant Township that established a so-called Community Bill of Rights.” Penn. Gen. Energy Co., LLC, v. Grant Township, C.A. No. 14-209ERIE, at 1 (Oct. 14, 2015, W. Dist. Pa.), available here.   As Judge Baxter explains, “The Ordinance lays out the framers' beliefs that corporations should not have more rights than the people of its community and that the people have the right to regulate all activities pursuant to a right of local self government.” Id. at 2-3.    

The framers are our first group that does not appear to know that corporations are not the same as LLCs.  Strike one.  Here’s the ordinance (emphasis added): 

Section 3 - Statements of Law -Prohibitions Necessary to Secure the Bill of Rights

(a) It shall be unlawful within Grant Township for any corporation or government to engage in the depositing of waste from oil and gas extraction. 

(b) No permit, license, privilege, charter, or other authority issued by any state or federal entity which would violate the prohibitions of this Ordinance or any rights secured by this Ordinance, the Pennsylvania Constitution, the United States Constitution, or other laws, shall be deemed valid within Grant Township. 

So, unless the city has some definition or the other basis to say that an LLC is a corporation (which I did not see), this Bill of Rights does not apply to LLCs, partnerships, or other unincorporated entities.   

As such, the plaintiff’s first argument, I think, should have been that the statute does not cover us as an LLC at all.  The complaint (here) shows only an argument that LLCs are people  -- the argument that PGE was not a corporation was not made.  In fact, the complaint says LLCs are corporations. "The Community Bill of Rights Ordinance purports to strip corporations, such as PGE, of their status as natural persons and declares that corporations do not possess any other legal rights, privileges, power, or protections." Complaint ¶ 99.  Strike two.  

Finally, Judge Baxter, in what is mostly a reasonable opinion, skips right to equating LLCs and corporations, too. She explains, 

Defendant provides no precedential statute or constitutional provision authorizing its action other than its assertion that Plaintiff has no rights -- from contracting to do business in Grant Township to bringing a lawsuit to complain about an ordinance -- because it is not a person. This view is contrary to over one hundred years of Supreme Court precedent that establishes that corporations are considered "persons" under the United States Constitution.

Id. at 7-8. An arguably true statement of the law that is wholly irrelevant because plaintiff is not a corporation.  Plaintiff is an LLC, and the this is not transitive. That is, just because both LLCs and corporations can be persons, it does not mean that, therefore, LLCs are corporations.  Strike three.  

All in all, if the Grant Township ordinance has included all entities (or limited the options only to natural persons), then most, if not all, of Judge Baxter’s opinion would be correct.  As it is, it’s just wrong. Absent some other analysis, the ordinance at issue did not apply to the plaintiff at all. I, for one, hope Judge Baxter amends the opinion or the case is appealed so that the court can get it right.  The language here could set a terrible precedent. 

Who am I kidding? It just continues the long line of other terrible precedent. But it should still be fixed.

October 27, 2015 in Corporations, Joshua P. Fershee, Lawyering, LLCs | Permalink | Comments (3)