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January 19, 2012
Corporate governance overreach by Carlyle?
The Deal Prof looks at The Carlyle Group's proposed IPO and figures it's a corporate governance dud. I agree. Carlyle's Amended and Restated Limited Partnership Agreement (Appendix A to the S-1A) has a dispute resolution provision that is reprinted in relevant part below (it's lengthy, sorry). It does two things. First, it requires that limited partners in Carlyle's soon to be publicly traded firm resolve all their dispute only in private arbitration and not in any court. Second, it prohibits any arbitration be brought in a representative capacity.
Now, I'm the first one to admit that there is plenty of abuse of shareholder litigation. These days, one can't imagine a merger announcement not being accompanied by shareholder litigation. But still, the correct answer can't be to eliminate representative shareholder litigation altogether. The way this arbitration provision is written, it's pretty clear that no one should ever bring any litigation against management at all ... ever. That can't be the correct result. For all its warts, in a world where shareholding is increasingly dominated by institutional shareholders who don't have incentives to provide intense monitoring and are not permitted to perform the "Wall Street walk", shareholder litigation is one of the few governance arrows left in the corporate governance quiver.
Sure, there are plenty of suits that aren't worth more than their nuisance value. (Steven Davidoff highlights the sheer volume of these transaction related lawsuits in his new paper examining the "Great Game" and the rise of transaction-related litigation). But, at the same time, there are other valuable cases like Delmonte or Southern Peru. If Carlyle's approach becomes the norm as firms go public there are real downsides to firms opting out of the formal legal regime.
First, there's a threat to the development and maintainence of the corporate law. This arbitration provision goes further than Delaware's optional arbitration system that I've blogged about before. If parties are required to bring all corporate litigation to private arbitrators, then corporate law litigation will quickly disappear from the courts and the law will begin to atrophy. Rather than having a deep and rich common law, the corporate law will become nothing more than an inside game with only a small number of litigators and professionals being in the "know" as to the current state of the private law.
Second, even if one accepts that a private law system is acceptable, and I don't think that's correct, then there are still important incentive effects associated with the elimination of representative litigation. If arbitration may not be pursued in a representative capacity, then the incentives for any plaintiff's counsel to be in this business quickly fall away. The result is, effectively, that shareholder arbitration for a publicly traded issuer would disappear.
Now, I guess if you are incumbent management eliminating pesky shareholders is a good thing. On the other hand, if you are an investor, you have less reason to be sanguine about managers taking away one more tool for you to monitor their behavior.
I've previously recommended exclusive forum provisions as a middle ground to reduce incentives to engage in nuisance-like shareholder litigation while leaving open avenues for litigants to bring claims before courts. That middle-ground strikes me as a better result than the more extreme route taken by Carlyle. Of course, Carlyle's managers have different incentives and care about different things than do the courts in Delaware or investors. The Deal Prof doesn't think that the SEC will permit Carlyle to go public with this provision intact. I hope he's right. In that event, Carlyle's Section 16.9(c) provides for an exclusive forum provision to govern disputes should the arbitration provision be voided by a court or otherwise be found to be as uneforceable.
Carlyle Amended & Restated Limited Partnership Agreement
Section 16.9. Dispute Resolution.
(a) The Partnership, each Partner, each Record Holder, each other Person who acquires an interest in a Partnership Security and each other Person who is bound by this Agreement (collectively, the “Consenting Parties” and each a “Consenting Party”) (i) irrevocably agrees that, unless the General Partner shall otherwise agree in writing, any claims, suits, actions or proceedings arising out of or relating in any way to this Agreement or any Partnership Interest (including, without limitation, any claims, suits or actions under or to interpret, apply or enforce (A) the provisions of this Agreement, including without limitation the validity, scope or enforceability of this Section 16.9(a) or the arbitrability of any Dispute (as defined below), (B) the duties, obligations or liabilities of the Partnership to the Limited Partners or the General Partner, or of Limited Partners or the General Partner to the Partnership, or among Partners, (C) the rights or powers of, or restrictions on, the Partnership, the Limited Partners or the General Partner, (D) any provision of the Delaware Limited Partnership Act or other similar applicable statutes, (E) any other instrument, document, agreement or certificate contemplated either by any provision of the Delaware Limited Partnership Act relating to the Partnership or by this Agreement or (F) the federal securities laws of the United States or the securities or antifraud laws of any international, national, state, provincial, territorial, local or other governmental or regulatory authority, including, in each case, the applicable rules and regulations promulgated thereunder (regardless of whether such Disputes (x) sound in contract, tort, fraud or otherwise, (y) are based on common law, statutory, equitable, legal or other grounds, or (z) are derivative or direct claims)) (a “Dispute”), shall be finally settled by arbitration conducted by three arbitrators (or, in the event the amount of quantified claims and/or estimated monetary value of other claims contained in the applicable request for arbitration is less than $3.0 million, by a sole arbitrator) in Wilmington, Delaware in accordance with the Rules of Arbitration of the International Chamber of Commerce (including the rules relating to costs and fees) existing on the date of this Agreement except to the extent those rules are inconsistent with the terms of this Section 16.9, and that such arbitration shall be the exclusive manner pursuant to which any Dispute shall be resolved; (ii) agrees that this Agreement involves commerce and is governed by the Federal Arbitration Act, 9 U.S.C. Section 1, et seq., and any applicable treaties governing the recognition and enforcement of international arbitration agreements and awards; (iii) agrees to take all steps necessary or advisable, including the execution of documents to be filed with the International Court of Arbitration or the International Centre for ADR in order to properly submit any Dispute for arbitration pursuant to this Section 16.9; (iv) irrevocably waives, to the fullest extent permitted by law, any objection it may have or hereafter have to the submission of any Dispute for arbitration pursuant to this Section 16.9 and any right to lay claim to jurisdiction in any venue; (v) agrees that (A) the arbitrator(s) shall be U.S. lawyers. U.S. law professors and/or retired U.S. judges and all arbitrators, including the president of the arbitral tribunal, may be U.S. nationals and (B) the arbitrator(s) shall conduct the proceedings in the English language; (vi) agrees that except as required by law (including any disclosure requirement to which the Partnership may be subject under any securities law, rule or regulation or applicable securities exchange rule or requirement) or as may be reasonably required in connection with ancillary judicial proceedings to compel arbitration, to obtain temporary or preliminary judicial relief in aid of arbitration, or to confirm or challenge an arbitration award, the arbitration proceedings, including any hearings, shall be confidential, and the parties shall not disclose any awards, any materials in the proceedings created for the purpose of the arbitration, or any documents produced by another party in the proceedings not otherwise in the public domain; (vii) irrevocably agrees that, unless the General Partner and the relevant named party or parties shall otherwise mutually agree in writing, (A) the arbitrator(s) may award declaratory or injunctive relief only in favor of the individual party seeking relief and only to the extent necessary to provide relief warranted by that party’s individual claim, (B) SUCH CONSENTING PARTY MAY BRING CLAIMS ONLY IN ITS INDIVIDUAL CAPACITY, AND NOT AS A PLAINTIFF, CLASS REPRESENTATIVE OR CLASS MEMBER, OR AS A PRIVATE ATTORNEY GENERAL, IN ANY PURPORTED CLASS OR REPRESENTATIVE PROCEEDING, and (C) the arbitrator(s) may not consolidate more than one person’s claims, and may not otherwise preside over any form of a representative or class or consolidated proceeding; and (viii) agrees that if a Dispute that would be arbitrable under this Agreement if brought against a Consenting Party is brought against an employee, officer, director or agent of such Consenting Party or its affiliates (other than Disputes brought by the employer or principal of any such employee, officer, director or agent) for alleged actions or omissions of such employee, officer, director or agent undertaken as an employee, officer, director or agent of such Consenting Party or its affiliates, such employee, officer, director or agent shall be entitled to invoke this arbitration agreement. Notwithstanding Section 16.10, each provision of this Section 16.9(a) shall be deemed material, and shall not be severable and this Section 16.9(a) shall be enforced only in its entirety.
January 19, 2012 in Litigation | Permalink
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In honor of Larry Ribstein, let me suggest that the title of this post should be "Uncorporate Governance Overreach." Importantly, Carlyle is going public as a limited partnership, and under Delaware law, limited partnerships are afforded "the maximum freedom of contract." If Carlyle were a Delaware corporation, I don't think courts would enforce this kind of arbitration provision against public shareholders.
Even in the alternative entity context, however, I'm not sure this type of arbitration provision is all that significant. As I noted over at the Deal Professor's blog, Carlyle's LP agreement already provides that (1) the firm's managers have no fiduciary duties to investors, owing only contractual duties (Section 7.9(a)), and (2) that even if the managers breach their contractual duties, they will have no liability to shareholders unless their breach satisfies some egregious standard of culpable conduct (bad faith, fraud or willful misconduct) (Section 7.8(a)). These types of provisions are largely consistent with those of other publicly traded alternative entities. For evidence of that see:
In practice, these kinds of provisions mean that virtually all shareholder lawsuits end before discovery on a motion to dismiss. The recent Gerber v. Enterprise Products decision is an excellent example of this. Given this reality, plaintiffs' counsel already have little incentive to bring an investor suit against publicly-traded alternative entities. So, Carlyle's arbitration provision may be just an unnecessary extra.
Posted by: Mohsen Manesh | Jan 20, 2012 10:56:15 AM
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