Wednesday, May 4, 2016

Entities Should Ask About Politics and Religion: Round Two

In follow up to my post yesterday, my trusted and valued co-blogger Joan Heminway asked a good question (as usual) based one of my comments.  My response became long enough that I thought it warranted a follow-up post (and it needed formatting).  Joan commented: 

you say: "there should be no problem if, for example, Delaware corporate law did not allow a for-profit entity to exercise religion for the sole sake of religion. I think that is the case right now: that’s not a proper corporate purpose under my read of existing law." Are you implying that a corporate purpose of that kind for a for-profit corporation organized in Delaware would be unlawful? Can you explain?

My response: I am suggesting exactly that, though I concede one might need a complaining shareholder first. My read of eBay, and Chief Justice Strine’s musing on the subject, suggest that an entity that is run for purposes of religion (not shareholder wealth maximization) first and foremost, is an improper use of the Delaware corporate form. (“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 Chandler explained in eBay:

The corporate form in which craigslist operates, however, is not an appropriate vehicle for purely philanthropic ends, at least not when there are other stockholders interested in realizing a return on their investment.

I think this definition of philanthropic easily includes religious ends (or should).

Chancellor Chandler continued:

Jim and Craig opted to form craigslist, Inc. as a for-profit Delaware corporation and voluntarily accepted millions of dollars from eBay as part of a transaction whereby eBay became a stockholder. Having chosen a for-profit corporate form, the craigslist directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of its stockholders.

I don’t see how this should play any differently if it applied to religion. Consider, for example, this possible spin:

Jane and Carrie opted to form Religion, Inc., as a for-profit Delaware corporation and voluntarily accepted millions of dollars from BigCo as part of a transaction whereby BigCo became a stockholder. Having chosen a for-profit corporate form, the Religion directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of its stockholders.

Further to the point, Chancellor Chandler added:

I cannot accept as valid . . .  a corporate policy that specifically, clearly, and admittedly seeks not to maximize the economic value of a for-profit Delaware corporation for the benefit of its stockholders—no matter whether those stockholders are individuals of modest means or a corporate titan of online commerce.

Thus, a for-profit business can be religious in nature—e.g., make religious books or products or sponsor religious seminars—but as a Delaware corporation, the purpose of the entity must be to “promote the value of the corporation for the benefit of its stockholders.”

This is the potential problem with the Hobby Lobby case as to Delaware lawThere, the companies had a lot to lose:

If they and their companies refuse to provide contraceptive coverage, they face severe economic consequences: about $475 million per year for Hobby Lobby, $33 million per year for Conestoga, and $15 million per year for Mardel. And if they drop coverage altogether, they could face penalties of roughly $26 million for Hobby Lobby, $1.8 million for Conestoga, and $800,000 for Mardel.

These losses were justified in that case as being necessary to exercise religion, and not to further a corporate purpose. Of course, they had to make that claim, because otherwise they couldn’t get the benefit of RFRA, which requires demonstrating “an honest conviction,” which could be problematic if the reason was couched in business terms, and not religious ones. 

Incidentally, I think the business judgment rule should probably protect this decision, anyway, but I don’t know that Delaware law would support that view. In fact, it shouldn't based in recent case law, and I think plainly eBay says no on that one. The Supreme Court says RFRA protects the right to pursue religious ends. It doesn't mean Delaware law does.  (Note: Hobby Lobby is not a Delaware entity, so the rules are admittedly different.) 

Thus, my fix seek to balance these competing possible outcomes. Tell shareholders your plan, and they can’t question it later, even if that plan costs the company $475 million in losses. Where the law has evolved, I don't think it's fair to suggest it was part of the bargain for all companies, thought maybe investors in Hobby Lobby did know.  But it doesn't matter.  I thought craigslist’s long-standing business plan was sufficient notice, too. Chancellor Chandler disagreed.

https://lawprofessors.typepad.com/business_law/2016/05/entities-should-ask-about-politics-and-religion-round-two.html

Corporate Governance, Corporations, Delaware, Joshua P. Fershee, LLCs, Management, Shareholders | Permalink

Comments

For-profit corporations that want to be open about pursuing non-shareholder interests as ends unto themselves now have an alternative without the uncertainty you discuss....benefit corporations. Though, of course, there are other kinds of uncertainty with that new entity form.

Posted by: Haskell Murray | May 4, 2016 6:11:44 PM

Thanks so much for taking the time to write a responsive post to my little question! This is why I enjoy blogging with you. :>)

I accept Haskell's point, that you also make in your post from yesterday, about the clear current choice of a benefit corporation to do the kind of work you are talking about in both posts (relating to corporate prioritization of objectives other than simple shareholder financial wealth maximization for corporations organized in Delaware). But I am unwilling to read the parts of the eBay opinion to which you point as providing dispositive evidence that a charter-based corporate purpose prioritizing, e.g., religion over financial wealth maximization is unlawful as a matter of Delaware corporate law.

Without consuming too much time and space in the blogosphere over this, I will note that the eBay/craigslist situation is distinguishable in meaningful ways from the case you and I are struggling with here. Maybe I need to read the opinion more closely, but I will outline three of my key concerns about a broad reading of eBay in the paragraphs that follow.

First off, unless I am mistaken, the “cultural” aspects of craigslist to which the majority shareholders pointed in the eBay case were actually more operating philosophies or policies. These philosophies/policies were not embodied in craigslists’s certificate of incorporation. They were not, therefore, a fundamental part of the shareholder compact. Indeed, Chancellor Chandler indicates in the opinion that without eBay as a shareholder, a philanthropic purpose might be appropriate for a Delaware corporation. (“The corporate form in which craigslist operates, however, is not an appropriate vehicle for purely philanthropic ends, at least not when there are other stockholders interested in realizing a return on their investment.”)

Second, nothing in the Chancellor’s words indicates that financial wealth maximization is the only lawful wealth maximization that a for-profit corporation can have. What about other elements of wealth or value sought and derived by shareholders? I am not convinced that shareholders have no lawful ability to determine what “profit” or “wealth” or “value” means to them and embody those components in a for-profit corporate charter. Note footnote 105 of the eBay opinion in this regard.

Third, it may be important to note the legal context in which the Chancellor wrote the eBay dicta to which you point. The court was engaging an analysis under the first prong of Unocal (although at the end of the analysis the opinion appears to switch abruptly to the second prong by referencing the “range of reasonableness” within which a board must act). So, the court was determining whether there was a danger to corporate policy and effectiveness warranting the adoption of a rights plan. Whether and how the court—or the Delaware Supreme Court, for that matter (keeping in mind this is a Chancery Court opinion)—would credit craigslist’s philosophy/policy in other fiduciary duty contexts remains an open question, in my view.

That’s it on this, for now. I may write a primary post on this sometime, if inspired . . . .

Posted by: joanheminway | May 4, 2016 8:27:00 PM

Thanks, Joan. My quick replies to your comments.

To your first point, I agree that Chancellor Chandler may have meant it would be okay if everyone agreed or it was in the charter, though my read of the entire opinion suggests that when he says, “at least not when there are other stockholders interested in realizing a return on their investment,” he does not mean it becomes a proper purpose for the entity. It is just that, as he says later, “If Jim and Craig were the only stockholders affected by their decisions, then there would be no one to object.“ But, the Chancellor notes, “Having chosen a for-profit corporate form, the craigslist directors are bound by the fiduciary duties and standards that accompany that form.” As such, I think he is skeptical that craigslist is a proper for-profit entity at all. It does not appease me much to think that it would not have broader effect, in that he is clearly questioning the purpose of this entity through that purpose filter.

As to your second point, I have to push back a little. I do read him to be saying shareholder wealth maximization is at least part of the consideration. I may be reading too much into it, but that’s my take he says, “Directors of a for-profit Delaware corporation cannot deploy a rights plan to defend a business strategy that openly eschews stockholder wealth maximization—at least not consistently with the directors’ fiduciary duties under Delaware law.”

Finally, I have also looked at those points as dicta, which I think would be highly persuasive dicta that Chief Judge Strine has blessed in subsequent writings. But what if it’s not dicta?

The first Unocal prong (the reasonableness test) says that the board needs to show reasonable grounds for believing there was a danger to a corporate policy that would impede the entity’s effectiveness. Though Chancellor Chandler hedges a bit on this (“To the extent I assume for purposes of analysis that a craigslist culture was something that Jim and Craig reasonably could seek to protect . . . “), one could reasonably read the opinion to say that opinion actually means a community-based purpose is not a valid for-profit entity purpose worthy of protection. The opinions states: “Because defendants failed to prove that they acted to protect or defend a legitimate corporate interest and because they failed to prove that the rights plan was a reasonable response to a perceived threat to corporate policy or effectiveness, I rescind the Rights Plan in its entirety.” (emphasis added).

Yes, I concede I may be expanding eBay's reach more that is likely, but I still maintain it's real risk.

Posted by: Joshua Fershee | May 5, 2016 8:27:24 AM

[I wrote this before seeing Joan's comment addressing some of the same points, but I'll post my response anyway.]

I see nothing in the Delaware statutes that would prevent a church from organizing itself as a for-profit organization. Obviously it would not get the federal or state tax exemptions of a nonprofit, but I see no corporate law bar to it doing so. The statutes allow a for-profit to be formed for any lawful purpose. “Saving souls and reclaiming the world for Jesus through operating the First Church of Mount Zion” is a lawful purpose, and if that’s the purpose stated in the charter that seems to be it. If the statute said that corporations can be formed only for purposes which former Chancellor Chandler can “accept as valid,” things would be different. But, to paraphrase Holmes, the DGCL does not enact Mr. Milton Friedman’s economic theories. Faced with an actual case, I seriously doubt Delaware would be willing to back up Chandler’s statement.

Second point. Keep in mind that the losses facing Hobby Lobby were real, and it is tempting to say that there thus was no justification other than religion for its position. But given that (a) the entire company is built and marketed on the basis of its Biblical principles, (b) it is growing rapidly and profitably, and (c) its annual revenues are over $3 billion, a decision to embrace abortion might have resulted in a severe backlash and loss of profits that would dwarf the penalties. See, .e.g., Target’s stance on transgender bathrooms. It was not necessary to make the business justification in the case, but it's very easy to do.

I’m puzzled by what seems to be a Catch-22 in the argument. Assuming I understand you, and using HL as an example, if HL’s purpose is religious, it is protected by RFRA but runs afoul of the DGCL. But if its purpose is to make money, rather than further religion, it’s fine under the DGCL but not protected under federal RFRA. Is that the argument?

Posted by: Frank Snyder | May 5, 2016 9:00:00 AM

Thanks, again, Josh, for taking time to respond to my questions. I will leave you to address Frank's RFRA comments and questions if you desire to do so and just focus quickly on the Delaware corporate law doctrine and its implications for firms organizing as Delaware corporations. In particular, I think you may be missing the thrust of my second point in the May 4 comment above. I will try to be more clear here on that. Shareholder wealth maximization does not need to be all about money (i.e., financial wealth). It can be about total satisfaction--like total utility in consumer transactions. So, a board's actions to support a charter-based objective for the firm embodied in a corporate purpose clause may be consistent with shareholder wealth maximization (and therefore director fiduciary duties in Delaware) because the "wealth" the shareholder gets (and expects) is the benefit of the corporate purpose, as given effect by the board. If I am right about that, I then would argue that the "legitimate corporate purpose" of a Delaware corporation includes lawful charter provisions.

Should I write about this? I have had these ideas batting around in my head for a while. But maybe someone already has said all this . . . ?

Posted by: joanheminway | May 6, 2016 2:02:22 PM

I do hear you, Joan, and I agree that Delaware courts would be more likely agree if it were part of the charter. This is my problem, though. I think broader definitions of value should be clearly acceptable decision making, especially with the charter, but even without charter language.

And I certainly agree that value can be somewhat broadly defined. For example, even under Revlon, value can be include quality of offer (no junk bonds), likelihood of closing, etc. But, I see those as all related to "economic value" as Chancellor Chandler explained in my post above.

I think the advent of the benefit corporation makes it even more likely that courts will be more restrictive about what it means to make economic decisions. I do agree that courts will still likely defer to boards on what is likely to add value to the corporation on the margins, but if the decision goes to the entire way the entity is run, I still fear unwarranted scrutiny. I admit I am looking at worst case scenario, but as I have noted before, craigslist is a profitable company that is a market leader, yet corporate purpose was questioned.

I think the court was really worried about self dealing and conflated the two. Perhaps that's really how I should be framing this.

Posted by: Joshua Fershee | May 7, 2016 6:17:28 AM

Frank, that's is exactly my argument, under eBay. As I read Burwell, the threshold level of religiousness needed to satisfy that test runs afoul of eBay's "economic value" test. With Burwell setting forth the RFRA rule as it did, I think Delaware courts, if your take eBay and CJ Strine's musings seriously, HL would be operating for an improper purpose as to their healthcare decisions. I see eBay and HL in the same spot on that issue (actually, I see HL as more out of compliance than eBay). My intended point is that it's not right for either to be out of compliance with the DGCL for such decisions absent self dealing. But I see the law evolving differently.

Posted by: Joshua Fershee | May 7, 2016 6:25:49 AM

Joan, clearly it’s worth writing about. Go for it.

Joshua, would you then agree that Target and PayPal are operating for an improper purpose in pushing transgender restrooms?

BTW, does your argument apply to LLCs? I realize that a continuing conversation in the comments, however interesting, is kind of a waste of time, but given your interests you might think about a post on whether an LLC would have more right to pursue non-monetary goals than a corporation. Just a thought.

Posted by: Frank Snyder | May 7, 2016 2:43:22 PM

Thanks for the conversation, guys. Special thanks to you, Josh, for getting the rich conversation started. And Frank, I have an idea for how to spin this one out in writing--and where to do it, too. More on that later.

I will just say here that I also have feared that the advent of the benefit corporation will have untoward effects on the use of the traditional for-profit corporation for social enterprise or any "mixed" purpose bottom line. Many corporations of this kind exist, and are, imv, lawful for-profit businesses. Of course, statute drafters also acknowledged this possibility. Delaware pubic benefit corporation law provides:

"§ 368 No effect on other corporations.

This subchapter shall not affect a statute or rule of law that is applicable to a corporation that is not a public benefit corporation, except as provided in § 363 of this title."

We also crafted out own provision of this kind in the Tennessee For-Profit Benefit Corporation Act. What effect these provisions may have when push comes to shove, however, remains to be seen.

Posted by: joanheminway | May 8, 2016 6:23:59 AM

Frank, more good questions. And for comments, I will dial this back. On LLCs, I hope to follow up on that -- perhaps tomorrow, if I can get a little time. As for Target and PayPal, my initial reaction is no, but especially as to the latter, maybe I could be convinced otherwise with the right facts. (Again, though, this is as to Delaware corporate law, not the law I'd pick in any of the cases we'd discuss.) The short distinction is this: I don't see a true conflict between the economic policy and the stated policy like I see in craiglist and Hobby Lobby (or Ford, in Dodge v. Ford). So I would agree that there could be a time when I might lump them all together, but the facts as I know them suggest that Target and PayPal are more in the A.P. Smith Mfg. Co. v. Barlow range and not the Dodge v. Ford/eBay v. Newmark range.

Posted by: Joshua Fershee | May 9, 2016 5:24:14 AM

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