Tuesday, February 11, 2014

CVS: More Evidence Courts Are Creeping into the Boardroom

CVS/Caremark announced, on Feb. 5, 2014, that that the company would cease selling tobacco products in its 7,600 U.S. pharmacies.  Given that the entity estimated that it would lose about $2 billion in revenues from the decision, the world took notice.  CVS has managed the announcement well, and the company has received generally good press about the whole idea.

 Personally, I applaud the decision, both because I think it’s a sensible choice and because I think the board properly exercised its authority to set CVS stores up for long-term success. The company tried to maximize the feel-good story of the decision, but I think that message was tempered by the necessity that CVS explain the profit-seeking role of the decision with the announcement. Clearly, CVS’s counsel read eBay v. Newmark.

The CVS announcement had two components.  First, the media spin – for the aren’t-they-great? response:

“We have about 26,000 pharmacists and nurse practitioners helping patients manage chronic problems like high cholesterol, high blood pressure and heart disease, all of which are linked to smoking,” said Larry J. Merlo, chief executive of CVS. “We came to the decision that cigarettes and providing health care just don’t go together in the same setting.” 

Second, was the business-judgment-rule spin – a/k/a the hey-we’re-not-craigslist-or-Ford statement: 

The decision to exit the tobacco category does not affect the company's 2014 segment operating profit guidance, 2014 EPS guidance, or the company's five-year financial projections provided at its December 18th Analyst Day. The company estimates that it will lose approximately $2 billion in revenues on an annual basis from the tobacco shopper, equating to approximately 17 cents per share. Given the anticipated timing for implementation of this change, the impact to 2014 earnings per share is expected to be in the range of 6 to 9 cents per share. The company has identified incremental opportunities that are expected to offset the profitability impact. This decision more closely aligns the company with its patients, clients and health care providers to improve health outcomes while controlling costs and positions the company for continued growth.

Here’s the thing: CVS shouldn’t have to do this second part, in my view, though I would have advised them to because of the recent language used by the Delaware courts.  Unlike some, I still believe in the business judgment rule.  Absent conflicts of interest, fraud, or illegality, CVS should be able to make this decision without further justification.  The court should abstain.  But courts want more.

In eBay v. Newmark, Chancellor Chandler was not satisfied that craigslist was profitable or that the company had achieved market-leading status through its chosen course of operations.  He wanted more:

craigslist’s unique business strategy continues to be successful, even if it does run counter to the strategies used by the titans of online commerce. Thus far, no competing site has been able to dislodge craigslist from its perch atop the pile of most-used online classifieds sites in the United States. craigslist’s lead position is made more enigmatic by the fact that it maintains its dominant market position with small-scale physical and human capital. Perhaps the most mysterious thing about craigslist’s continued success is the fact that craigslist does not expend any great effort seeking to maximize its profits or to monitor its competition or its market share. 

For Chancellor Chandler, and Delaware courts, it was not sufficient that craigslist’s CEO testified “that craigslist’s community service mission ‘is the basis upon which our business success rests. Without that mission, I don’t think this company has the business success it has. It’s an also-ran. I think it’s a footnote.’” Would it have been sufficient if he had said “our profitability” instead of “business success?”  I doubt it. 

As such, CVS had to go further to show where this decision fit within their profit-making scenario.  Chancellor Strine agrees: “I simply indicate that the corporate law requires directors, as a matter of their duty of loyalty, to pursue a good faith strategy to maximize profits for the stockholders.”  Chancellor Strine immediately seeks to soften the blow by stating, “The directors, of course, retain substantial discretion, outside the context of a change of control, to decide how best to achieve that goal and the appropriate time frame for delivering those returns.”  The problem: that’s not really true if you add this philosophy together with eBay, which appears to require “great effort” to maximize profits, or monitor competition or market share, as opposed to pursuing a corporate philosophy that creates and maintains profitability and market leadership.

To be clear, this is not about CSR. This is about director primacy and keeping the courts out of the boardroom as much as possible. I think CVS should be able to decide to drop tobacco if they wish, just as craigslist should be able to decide that it wants to stay profitable and be a market leader forever.  If long-term success, in the board’s judgment, means not selling cigarettes or not monetizing and not taking risks of a boom and bust, they should be able to do that.

Was it essential that Boston Market and Krispy Kreme expand as fast as possible and as seek as much profit at they could in the near term?  I hope not.  The directors are supposed to be in charge and make such decisions, not the shareholders, and not the courts.  The business judgment rule is an abstention doctrine, and courts should stay out of it unless there is a strong indication of a conflict of interest, fraud, or illegality. CVS took the proper steps to minimize the risk of a court intervention. They just shouldn't have had to justify that decision to anyone but their shareholders at election time. 


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Great post. eBay may be an instance of a hard case (or at least bad facts) making bad law. Importantly, as Lyman Johnson and others have pointed out, the eBay court did not order the Craigslist directors to operate the business differently or more profitably. (Indeed, the Craigslist website is practically unchanged since the decision.) Instead, the court merely cancelled the board's poison pill. A bad ruling , to be sure, but a far cry from second-guessing a business decision like not selling tobacco.

Posted by: Mohsen Manesh | Feb 11, 2014 8:37:14 AM

As of August 1, 2013, CVS (and other companies) have the option to become a public benefit corporation in Delaware. One can reasonably wonder whether we will see more opinions like eBay now that companies have a for-profit alternative that explicitly allows (and requires) companies to focus on other stakeholders. The benefit corporation statutes were not meant to change traditional corporate law (and some of the statutes, including the Model statute, explicitly say that the statute should not impact traditional corporate law). I obviously agree that the BJR gives a great deal of freedom, but I am not sure the advisability of the second step you mention is going to disappear anytime soon for traditional for-profit companies in Delaware.

Posted by: Haskell Murray | Feb 11, 2014 10:12:41 AM

I agree, Mohsen - though Chandler did include some strongly worded dicta, which may create some doubt and may result in attorneys of Delaware corporations being careful about how they word announcements like this one.

Posted by: Haskell Murray | Feb 11, 2014 10:58:11 AM

I agree that the eBay factual situation created the chance for bad law, and certainly it's true that craigslist remains unchanged. Still, Chancellor Chandler took the bait, I think, and waded in unnecessarily. He's good, which means it wasn't an accident. While it's dicta, it sends a strong message, and at a minimum, I suspect it will at least create additional fodder for derivative suits. As a former public relations guy, I would have been frustrated to have legal telling me we have to combine this action with a clear profit motive, but as I said, if I were in legal, it's the advice I would have given. Thanks for the great comments.

Posted by: Joshua Fershee | Feb 11, 2014 11:08:56 AM

One final thought: If CVS is publicly making the business case for its decision, I doubt it is because its lawyers advised the board to do so. After all, nothing in corporate law would require it. Neither BJR nor the fiduciary duty of loyalty and good faith require directors to make public announcements rationalizing their decisions. And plaintiffs' attorneys who are wont to sue will sue no matter what is said. Instead, if CVS is publicly making the business case for its decision, it is because its shareholders demand it.

Posted by: Mohsen Manesh | Feb 11, 2014 8:38:14 PM

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