Business Law Prof Blog

Bankruptcy's Cathedral

At the 2018 Annual Conference of the Academy of Legal Studies in Business, I spoke on a panel, New Developments in Corporate Governance, with Vincent S.J. Buccola, Gideon Mark, Josephine Sandler Nelson, and David Zaring, the organizer (thanks again, David!). 

Buccola discussed governance aspects of corporate bankruptcy law in the modern economy.  I was particularly intrigued by his argument that “Bankruptcy law is potentially valuable…insofar as it can toggle from property to liability rule in domains where legal or practical impediments prevent investors from arranging their own, “tailored” toggles.” 

I’ve taught Corporate Bankruptcy, and in my research at the time, I was analogizing bargaining processes in the context of the recovery and resolution of clearinghouses to bargaining processes in private restructurings and formal bankruptcy filings.  I wondered about the potential application of Buccola’s work within the clearinghouse context, and have been eagerly awaiting his article.  I'm excited to share with readers that the wait is over!  Bankruptcy’s Cathedral: Property Rules, Liability Rules, and Distress, an impressive and significant new work, is forthcoming in the Northwestern University Law Review, and also now available on SSRN.  Here’s its abstract:            

What justifies corporate bankruptcy law in the modern economy? For forty years, economically oriented theorists have rationalized bankruptcy as an antidote to potential coordination failures associated with a company’s financial distress. But the sophistication of financial contracting and the depth of capital markets today threaten the practical plausibility, if not the theoretical soundness, of the conventional model. This article sets out a framework for assessing bankruptcy law that accounts dynamically for changes in the technology of corporate finance. It then applies the framework to three of the most important artifacts of contemporary American bankruptcy practice and, on that basis, points toward a radically streamlined vision of the field. I contend that bankruptcy’s virtue lies in its capacity to replace “property rules” that may protect investors efficiently when a company is financially healthy with “liability rules” more appropriate for distress, in domains where investors are unable to arrange state-contingent toggling rules on their own. This agenda plausibly justifies two important uses of Chapter 11—to effect prepackaged plans of reorganization and conclude going-concern sales—but casts doubt on what many suppose to be the sine qua non of bankruptcy, the automatic stay. More broadly, the analysis suggests that an “essential” bankruptcy law would look very different, and do much less, than the law we know.

Lorenzo: Back to 1994 (or at least 2008)

Earlier this week, the Supreme Court issued its opinion in Lorenzo v. SEC, and the thing that strikes me the most about it is that the dissenters do more to undermine Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), than the majority does.

I previously posted about Lorenzo here; the remainder of this post assumes you’re familiar with the problem posed by Lorenzo and its relationship to the earlier Janus decision.

[More under the jump]

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Nike, Avenatti, and the Business Judgment Rule

 

This Michael Avenatti extortion case is fascinating to me. I am not really sure why, other than it seems so absurd.  You may recall Avenatti as the lawyer who represented Stormy Daniels in her lawsuits against President Trump. He is a big personality and known for being outlandish at times.  

 

According to federal prosecutors, Avenatti tried to extort Nike for millions of dollars because he claimed to have evidence that Nike employees were illegally paying people to help recruit college basketball players.  Apparently, Avenatti believed he would be able to get Nike to pay him millions of dollars in exchange for the evidence. Instead, he ended up with the FBI. 

 

The New York Time reports:

According to people with knowledge of the cases, once Nike heard Mr. Avenatti’s claims, it acted to inform federal officials of the allegation that the company’s employees were paying players. The nature of the discussion with Mr. Avenatti raised the possibility that extortion was taking place.

That is, as soon as Nike was on notice of a potential problem right to the authorities.  How very Allis-Chalmers of them.  I am a fan of that old business judgment rule case, which state “it appears that directors are entitled to rely on the honesty and integrity of their subordinates until something occurs to put them on suspicion that something is wrong. If such occurs and goes unheeded, [only] then liability of the directors might well follow . . . “ Graham v. Allis-Chalmers Mfg. Co., 41 Del. Ch. 78, 85, 188 A.2d 125, 130 (1963).  So, as soon as Nike was on notice of wrongdoing, they disclosed it to officials.  

 

Nike took action to deal with the problem quickly, rather than acting like Caremark did years ago, when "there was an unconsidered failure of the board to act in circumstances in which due attention would, arguably, have prevented the loss [from fines resulting from bad employee behavior]." By taking action, Nike likely insulates the company (or at least mitigates the harm) it could face from alleged wrongdoing. Rather than engaging in a cover up (and potentially paying to hide the problem), the company acted proactively by disclosing the actions.  

 

Was this Avenatti's first attempt at such a thing?  It seems unlikely one would start with a company like Nike, but maybe the potential payoff seemed worth it. On the other hand, maybe such tactics have worked in other circumstances with smaller companies, so it seemed like a good idea. 

 

Regardless, it seems like Nike handled this wisely. The company recognized the issue before it, and fairly quickly realized that any of the alleged bad behavior was already done.  When such things happen, it is disappointing, to be sure, but it can't be undone.  The only question then is, "how are you going to respond."  For my money, going to the authorities was the right call, even though Nike had to know some bad press was going to follow.  

 

Now, I recognize it is possible that Nike knew about the behavior and reported nothing until Avenatti showed up. It would be interesting to find out, and if so, the analysis of whether they should have reported earlier would be an interesting one.  For example, would the company have faced more or less scrutiny had they reported on their own?  Or did they inoculate themselves to some degree by waiting and having the alleged Nike behavior overshadowed by Avenatti's alleged acts? Tough questions that require the exercise of business judgment. Thank goodness there is a rule about that.  

ICYMI: #corpgov Midweek Roundup (Mar. 27, 2019)

"We can think about the race to float ... as a refutation of the claim that public markets are so broken that Silicon Valley stars are choosing to stay private ...." https://t.co/z7O60ILFJV #corpgov

— Stefan Padfield (@ProfPadfield) March 27, 2019

"communications among two or more board members serving on behalf of a private equity firm regarding their actions as board members may constitute 'books and records of the company' for which any other director may ... demand the right to inspect" https://t.co/Bq9nfN8ouI

— Stefan Padfield (@ProfPadfield) March 25, 2019

"the majority in Citizens United v. FEC was describing its doctrine specifically in the realm of public discourse .... In other settings, courts have long treated certain speakers differently" 90 U. Colo. L. Rev. 441 #corpgov

— Stefan Padfield (@ProfPadfield) March 24, 2019

"Lyft plans to report revenue on a net basis, excluding the money paid to drivers. Uber ... will be hard-pressed to break the mold ..., given that the businesses ... share PwC as an ... auditor, something highly unusual for fierce competitors." https://t.co/2x0tNjRWF4 #corpgov https://t.co/kn68IBDrPe

— Stefan Padfield (@ProfPadfield) March 23, 2019

"The law of successor criminal liability is simple--corporate successors are liable for the crimes of their predecessors. Always."
36 Yale J. on Reg. 1 #corpgov

— Stefan Padfield (@ProfPadfield) March 24, 2019

Mindful Business Lawyering - Yoga's Role

Colleen's post yesterday--and more specifically the last interview questions she asked ("[H]ow can power yoga be particularly helpful for professors or students?“)--inspired me to write about some work that I have recently done in studying the benefits of mindfulness to lawyers and in lawyering, and more specifically in business lawyering.  Colleen's entrepreneur yogi noted the obvious benefits of power yoga to physical health.  But she also noted what she termed "clarity of mind."  More specifically, she said: "I practice yoga to allow time away from devices and work emails, which in turn creates some distance to clear my mind and create clarity in how I want to interact with my environment."

I do, too.  And I have noticed that it makes a difference in the way I interact with people.  I am not alone.

I recently was challenged by my friends at the Tennessee Bar Association to present an hour of continuing legal education on mindfulness, reflecting on some of what I learned in my yoga instructor training last year and linking it to law practice.  Three of the eight limbs of yoga--asana (poses), pranayama (breath control), and dhyana (object-focused meditation)--are traditional mindfulness practices that I studied in that training program.  Of course, there are many more mindfulness practices in which one may engage.

So, if yoga and other mindfulness practices offer clarity of mind, why?  What's the secret?  And how might mindfulness practices practices affect business lawyers and their work?  I will start by offering a brief definition of mindfulness.

Mindfulness, which is defined here as "the self-regulation of attention with an attitude of curiosity, openness, and acceptance,” involves a focused state of mind that screens out life's distractions and allows one to observe one's sense of being in the here-and-now.  We can practice mindfulness in many everyday situations: speaking and listening, cooking, reading, crafting, etc.  Mindfulness trainers have examples and exercises that they employ to illustrate some of these mindfulness practices.  We also can practice mindfulness through yoga poses, breath work, and meditation.  I showed the Tennessee Bar Association audience some chair yoga, a breathing technique, and positioning for a chair-seated meditation--mindfulness practices that folks can do at their desks in an office setting or at home.

Of course, a clear mind should enable more fluid decision-making in the problem-solving that business lawyers do day-in and day-out.  Overall, communication and drafting should be easier--more efficient and effective.  But there's more.

A 2014 article in Time reported that “scientists have been able to prove that meditation and rigorous mindfulness training can lower cortisol levels and blood pressure, increase immune response and possibly even affect gene expression. Scientific study is also showing that meditation can have an impact on the structure of the brain itself.” In fact, neuroscientists have found (see here) that mindfulness may better enable the brain's gray matter in the frontal cortex to control decision-making rather that allowing the amygdala (the fight-or-flight part of the brain) to control decision-making.

This means that mindfulness practice--including yoga--can impact business law practice by conditioning lawyers to "hit the pause button" and rationally think through contested matters. As a result, tmindfulness practice has the capacity to reduce professional stress and enhance civility and collegiality.  (See Jan Jacobowitz's take on this for the American Bare Association.)  I have seen a lot of lawyers--in practice and in the law academy--whose anger is hair-triggered by stressful situations (especially negotiations or disagreements on process that generate frustration--more on that below).  It seems that scientists have begun to establish that yoga and other mindfulness practice (meditation seems to be the most-studied practice) can help us keep our cool in those situations.

I know that when I am over-caff'ed or over-tired, I am more assertive, more easily angered, and less able to take into account the whole of a situation in approaching requests, responses, negotiations, and other communications.  I also know that if I have just engaged in a focused yoga practice (that's me holding a Warrior II--Virabhadrasana II--pose, with a prop, in the photo above), I am more careful and considerate of others in engaging in those same communications.  Overall, my mind seems less burdened, less cluttered, more able to sort the important from the unimportant.  Business lawyers--and especially transitional business lawyers--cannot afford to squander relationships with clients, colleagues, and opposing counsel (not to mention an opposing counsel's client!) by over-reacting or responding to queries in anger or frustration.  

A personal business law story seems appropriate at this juncture.  In practice, I once participated in an unexpectedly hostile transaction negotiation session in which a mindful colleague was confronted by an over-stressed opposing counsel.  He leaned across the conference room table in an angry manner, with a reddened face and an imposing physical attitude, yelling about open deal items.  A representative of the lawyer's client soon called him off (and took him aside privately outside the room for a bit). I have always been proud that the opposing counsel's client hired my colleague and me to represent it on a subsequent transaction.  The client representative who had been present at that ugly meeting called my colleague personally and asked if she and I would work with the firm on that later transaction.

My friend and Colorado Law professor Peter Huang published a piece in the Houston Law Review about two years ago that expands on much of what I have written here--and more.  The article, entitled "Can Practicing Mindfulness Improve Lawyer Decision-Making, Ethics, and Leadership?," includes information from a fascinating array of sources and, like Peter's work generally, is very readable (even if long).  Peter is an economist and a lawyer.  He teaches business law.  In the article, he notes that "Mindfulness is now a part of business and finance, yet is not part of business law." He's right about that.  But we have the power to make it so, if we believe that mindfulness is important to business law.  In concluding, Peter offers us the link: "Practicing mindfulness offers lawyers an empirically-validated, potentially sustainable process to improve their decision-making, ethical behavior, and leadership. Doing so can improve the lives of lawyers, their clients, and the public."

So be it.  A good note on which to end.

[Editorial note: Footnotes have been omitted from the quotes to Peter Huang's article.  Check out the original for cited sources.]

Entrepreneurs, Entrepreneurism, and Yoga

Entrepreneurs and entrepreneurism have always fascinated me.  Hence, I was thrilled to see that in a recent TCU Neeley Institute for Entrepreneurship and Innovation ranking that “tracks research articles in premier entrepreneurship journals for the past five years,” my colleagues in the University of Oklahoma’s Price College of Business Tom Love Division of Entrepreneurship and Economic Development, directed by Professor Tom Lumpkin, were 7th in the WORLD!  Boomer Sooner!

And since coming to OU, I’ve had the good fortune to meet an inspirational, 4^th generation Oklahoma entrepreneur, Merideth VanSant, in attending 405 Yoga OKC, the 2018 Best Yoga Studio in OKC, and one of four studios owned by VanSant.  The U.S. has more than 6000 yoga studios, so VanSant’s success is no small feat.  Yoga is big business: Americans spend about $16 billion a year on classes, clothes, and related equipment.  In fact, America is now a "Nation of Yoga Pants." 

VanSant has long made extensive use of her entrepreneurial and leadership abilities, whether in running award-winning yoga studios, supporting various federal agencies in the transportation and aviation areas (and receiving the 2014 National Senior Consultant of the Year Award for her work), or co-founding True U, a national social entrepreneurship enterprise bringing yoga, mindfulness, and leadership to underserved teens.  In her spare time, she’s completing an EMBA at NYU! 

Given our yoga, business school, entrepreneur, Oklahoma nexus, I thought it might be worthwhile (and fun) to ask VanSant a few questions, and to distill our Q&A for readers:

Always been an entrepreneur? VanSant grew up sandwiching the school day with working in her family’s lumber yard.  These early experiences instilled grit (great Ted Talk on its importance), a strong work ethic, and an appreciation for “working with my hands…[and] the sacrifice and sweat that goes into creating a successful business that serves the community.”

Why yoga studios? “As an undergrad in the Midwest, I started to see intelligent and gregarious women taking themselves out of the running for awards, title promotions, career mobility, opportunities, advanced education, the list goes on and on.  The more I listened, the more I heard that women in my community thought they had only limited opportunities available.  They were taking their foot off the gas pedal before they turned the car ignition on…I wanted women to feel empowered, which is why I opened our studios, empowering our community with a strong power practice that creates change from the inside-out.”  

VanSant’s mission appears to be creating empowering communities, with yoga studios and True U being vehicles to promote this objective.  From my own experience, I can attest to the powerful, empowering community at Yoga 405-OKC. 

Thoughts on how universities can best foster entrepreneurism at the undergraduate/graduate levels? “I would like to see universities opening up their entrepreneurship classes, services, and incubators to different majors, disciplines, and courses of study.  One of the challenges I see with emerging entrepreneurs is that they are skilled technicians but are missing crucial skills in business development and management.  To be able to connect medical doctors, therapists, engineers, lawyers, art teachers, to name a few, to university entrepreneurship services could allow professional trades and technicians to become well versed in high level business skills and administrative concepts that are both vital to the health of a company.”

Finally, how can power yoga be particularly helpful for professors or students? “I think power yoga is a life saver, students and professors included.  I practice yoga to allow time away from devices and work emails, which in turn creates some distance to clear my mind and create clarity in how I want to interact with my environment.  Practicing yoga also allows me to move my body daily in a way that is strength building, sweat inducing, and calorie burning – which are all important to maintain my physical health in a daily routine where I would otherwise be sedentary.  Students may benefit from clarity of mind and physical health since both may be important to handling academically rigorous courses and externships.”

 

 

  

Saturday Movie Blogging: The Inventor

A few months ago, I read John Carreyrou’s Bad Blood: Secrets and Lies in a Silicon Valley Startup about Elizabeth Holmes and the Theranos fraud, and I was very curious to see how the same story would play out in the new documentary The Inventor: Out for Blood in Silicon Valley.  (Sidebar: I am truly on the edge of my seat for the forthcoming Adam McKay adaptation starring Jennifer Lawrence – but that’s a whole ‘nother thing).  In general, I preferred the book: it has far more detail, and the documentary has little new information to contribute. That said, there was power in the immediacy of actually watching Elizabeth Holmes, hearing her speak, and seeing how people reacted to her.  So, below are some of my general thoughts.

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ICYMI: #corpgov Midweek Roundup (Mar. 20, 2019)

"where does the evidence leave the prevailing short-term thesis? Far short of the mark, to say the least. It may be an article of faith, but it is not supported by the evidence." https://t.co/3Ljoh9hSwe

— Stefan Padfield (@ProfPadfield) March 18, 2019

"Based on my knowledge of Bebchuk and Hamdani’s article, I raised sua sponte
whether their proposed [enhanced independence] legal framework should apply to this case, and I requested
supplemental briefing from the parties on that issue." #corpgov https://t.co/os9eNbICCF

— Stefan Padfield (@ProfPadfield) March 16, 2019

"circumstances in which the [UK's] Salomon principle – that a corporation is a separate entity – will be disregarded": "tort claims have a higher disregard rate than contract" https://t.co/JS8vo31bMC #corpgov

— Stefan Padfield (@ProfPadfield) March 15, 2019

"gender pay gap at treated firms shrank 7% .... entire effect comes from a reduction in the growth rate of male wages"; "Treated firms ... experienced a significant 2.5% decline in productivity" https://t.co/UrGXde4E9B

— Stefan Padfield (@ProfPadfield) March 15, 2019

Vintage forgot "to send the extension notice. Oops! The next day Rent-A-Center terminated the merger agreement and sent Vintage a bill for $126.5 million. The [RAC] stock is up 47% since then, closing yesterday at $21.30 per share. Good job!" https://t.co/p8oo3bWHWT #corpgov

— Stefan Padfield (@ProfPadfield) March 15, 2019

Clue, LLC Edition: This Time, the Judge (or the Judge's Clerk) Did It

Get this, from a March 15 ruling and order on a motion for summary judgment: 

Greenwich Hotel Limited Partnership [GHLP] is a limited partnership organized under the laws of Connecticut, and is the owner of the Hyatt Regency Greenwich hotel. Answer to First Amended Complaint, dated Dec. 16, 2016 (“Am. Ans.”), ECF NO. 62, at 8. Hyatt Equities, L.L.C. (“Hyatt Equities”) is a limited liability corporation incorporated in Delaware, and is the general partner of Greenwich Hotel Limited Partnership. Id. at 9. The Hyatt Corporation (“Hyatt Corp.”) is a limited liability corporation incorporated in Delaware, and is the agent of Greenwich Hotel Limited Partnership. Id. at 9.

Benavidez v. Greenwich Hotel LP, 3:16-CV-191 (VAB), 2019 WL 1230357, at *1 (D. Conn. Mar. 15, 2019). 

 

Once more, for the people in back: LLCs are "limited liability companies," not "limited liability corporations."As such, LLCs are not "incorporated." LLCs are formed or organized. In addition, corporations are entities that provide shareholders limited liability, but they are generally not referred to as "limited liability corporations" because they might be confused with a separate and distinct entity type, the LLC.  

 

Whenever I read a case with this kind of language, I wonder how it happened.  Sometimes, like today, I go to the docket (thanks, Bloomberg Law) to see if the source of the wrongdoing (evil doing) was the party/lawyer or the judge/judge's clerk.  This time, it's pretty clear the lawyer got it right.  The case made it easy, as the ruling cited to the Answer to First Amended Complaint, which I pulled.  Here's how the lawyer's answer framed these "facts": 

"Upon information and belief, defendant Hyatt Equities is a limited liability company organized under the laws of the State of Delaware, and is the general partner of GHLP.

. . . .

Upon information and belief, defendant Hyatt Corporation is a corporation organized under the laws of the State of Delaware and is the agent of GHLP."

Benavidez v. Greenwich Hotel LP, 3:16-CV-191, Answer to First Amended Complaint, dated Dec. 16, 2016 (“Am. Ans.”), ECF NO. 62, at 9. This is all properly stated, but somehow it didn't translate to the ruling and order.  

Kudos to the filing attorneys on getting it right. I wonder if this is something that can be corrected? One would hope.  Okay, at least I hope so. 

And Now for Something Completely Different . . . .

OK.  So, the title of this post is clickbait of sorts.  I am not writing about Monty Python, sorry to say.  But I am writing about something completely different for me--very outside my norm.  In fact, this past year, I have been researching and writing a bit outside my norm . . . .  

It all started with two blog posts here on the BLPB--here and here.  My posts, focusing on Trump's deregulatory promises and early pronouncements, followed an earlier one written by Anne Tucker.  Anne and I then organized an discussion group at the 2018 Association of American Law Schools Annual Meeting focusing on regulation in the Trump Era: "A New Era for Business Regulation?"  I then presented some of my research on business deregulation at the National Business Law Scholars ("NBLS") conference in June 2018.  A related Southeastern Association of Law Schools ("SEALS") discussion group followed later in the summer of 2018.

As I began to accumulate observations and information from these academic encounters, I came to vision a series of two papers that would enable me to engage in related research and make some observations.  (I first shared my conception for the two-paper series in my NBLS presentation.)  Thanks to an invitation from the UMKC Law Review to publish an administrative law reflection of my choice and an invitation from the Mercer Law Review to turn our SEALS discussion group into a published symposium volume, I was able to channel my curiosity about presidential deregulation and my research and writing energy into developing law review essays based on the two papers I had conceptualized.  

From the start, my interest in presidential deregulation was driven by my interest in business and business law, and the essays reflect that interest and bias.  In the first essay, I set out to explore the ways in which a U.S. president may fulfill deregulatory campaign promises and objectives.  As someone who [ahem] underachieved her potential (shall we say) in Constitutional Law in law school, I was challenged in this task from the get-go.  But I persevered and learned a lot from the Constitution itself and the work of administrative law scholars.  In the second essay, I aimed to make observations about what successful presidential efforts at deregulation look like by reviewing the perceived successes of the Trump administration's deregulatory initiatives to date.  This inquiry resulted in some interesting--even if somewhat predictable--findings.  

The first essay, Designing Deregulation: The POTUS's Place in the Process, was just released.  You can find it here.  The last two paragraphs of the abstract follows.

This essay interrogates the role of the president in deregulation at the federal level. The interrogation is designed to serve two principle goals. First, the essay sets out to identify and explain the president’s role in the deregulatory process from a legal and practical perspective. Second, with the knowledge gained in better understanding the nature of the president’s optimal role in deregulating, the essay offers a perspective and practical advice for use by a president in constructing and implementing a deregulatory agenda.

Ultimately, the essay suggests that the president assume the roles of change leader and fiduciary in meeting deregulatory promises and expectations. The role of change leader focuses the president on processes geared to foster lasting change; the role of fiduciary focuses the president on trustworthy conduct in a relationship with the public that allows for discretion yet demands accountability. The two roles are not mutually exclusive. They have the capacity to work together as complements.

Both this essay and the forthcoming one are limited-scope works.  My hope is that by having invested time in attempting to understand the current deregulatory environment, my ongoing work in securities regulation and other federal regulatory environments will be enriched.  Regardless, I have become a more educated consumer of presidential power and authority in the process of my research and writing.  Perhaps my work in this area also will offer some of you a bit of new information or a novel idea that helps you in your work--or at least in social conversation--as deregulatory efforts progress.

[Postscript, April 29, 2019: In reviewing this post for a subsequent post, I noted that this post has the year of the Southeastern Association of Law Schools discussion group (entitled "Corporate and Financial Reform in the Trump Administration") wrong.  It did, in fact, occur in 2017, and it therefore preceded the Association of American Law Schools conference discussion group also referenced in this post.  My apologies for the error.]

Nevada Introduces Legislation Authorizing Fee-Shifting Provisions

Earlier today, Senator Cancela introduced Senate Bill 304 in Nevada.  Although the bill's text is not yet available on the website, the digest reveals that the legislation will explicitly authorize fee-shifting provisions under Nevada corporate law.  (Update--the text of the draft legislation is now available.)

The digest indicates that it will also do a few other interesting things if it passes:

• Preserve and transfer any internal corporate claims to a Nevada corporation acquiring some other entity;
• Authorize the application of fee-shifting provisions to claims arising from a prior entity (so long as the transaction was approved by a majority of disinterested stockholders);
• Prohibit any provision that would forbid a shareholder from suing in Nevada courts;
• Authorize Nevada-specific forum-selection provisions;
• Authorize the Nevada Secretary of State to issue rules allowing lawyers to indemnify stockholders for any possible fee-shifting;
• Provide that Nevada will have personal jurisdiction over any shareholder that sues outside of Nevada; and
• Require the Secretary of State to study fee-shifting's impact on the business environment and report back to the legislature in three years.

Despite the problems with shareholder litigation, Delaware opted to ban fee-shifting right as a mass of public companies began to adopt it. This, of course, didn't stop corporations chartered in Nevada and other states from adopting fee-shifting provisions anyway.  By my count, seven publicly-traded Nevada corporations already have fee-shifting charter or by-law provisions. (Disclosure:  I consulted with legislative counsel on the initial draft. Nobody paid me any money.)

Nevada may want legislation on this issue to reduce uncertainty.  Unlike Delaware, Nevada does not have as deep a body of corporate law decisions.  Corporations interested in fee-shifting's benefits might not want to foot the bill for early test cases here without explicit legislative support.  Plus, introduction of the bill alone also highlights Nevada as the leading alternative to Delaware corporate law.  At least one study has found that Nevada corporate law may enhance value for some firms.

The legislation seems targeted to address major problems in shareholder litigation that Delaware has yet to solve.  Delaware and its vaunted judiciary now struggle to control shareholder litigation which has expanded "beyond the realm of reason."  Even when Delaware's judiciary tried to rein the suits and disclosure-only settlements in, shareholder plaintiffs simply shifted many of their filings to other forums or advanced other types of claims.  

Delaware's decision to ban fee-shifting was and remains controversial.  Despite Delaware's decision to go the other way, fee-shifting has been widely discussed and proposed by many informed commentators as a way to address the issue. Stephen Bainbridge even noted that Delaware's position on fee-shifting was a "self-inflicted wound" and "contrary to sound public policy and adverse to Delaware’s own interests."  His short piece on the controversy argued that jurisdictions where "the corporate bar wields less legislative influence thus may have a significantly easier time adopting legislation authorizing such bylaws."  Nevada may fit that description.

The legislation also seems to recognize reality--that the real party in interest in much shareholder litigation is the attorney advancing the claim.  To offset over-deterrence risks, the legislation would authorize the Secretary of State to put rules in place allowing shareholder attorneys to indemnify their clients for fee awards.   This might cover some of the concerns that these provisions would simply spook any shareholder away from suing. 

This will be interesting to watch develop as more information becomes available.  If it passes, Nevada may generate some evidence to resolve debates around fee-shifting provisions.  The digest describes a requirement for the Secretary of State to study the issue and report back after three years.  Presumably, if this passes and fee-shifting does unleash some parade of horribles as detractors of the idea fear, Nevada could simply repeal it.

Notes from the M&A panel at the Tulane CLI

Tulane just held its 31^st Annual Corporate Law Institute, and though I was not able to attend the full event, I was there for part of it.  Though the panels were very interesting and I took copious notes, as a matter of personal satisfaction, the single most important thing I learned is that it is pronounced Shah-bah-cookie.  You’re welcome.

That said, below are some takeaways from the Hot Topics in M&A Practice panel, and to be clear, this isn’t even remotely a comprehensive account of everything interesting; it’s just stuff that I personally hadn’t heard before.  (And thus, the exact contours of my ignorance are revealed.)

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What Happens When the CEO or the Face of the Business Is a Risk? #MeToo and Corporate Governance

Hundreds of men have resigned or been terminated after allegations of sexual misconduct or assault.  Just last week, celebrity chef/former TV star Mario Batali and the  founder of British retailer Ted Baker were forced to sell their interests or step down from their own companies. Plaintiffs lawyers have now found a new cause of action. Although there a hurdles to success, shareholders file derivative suits when these kinds of allegations become public claiming breach of fiduciary duty, unjust enrichment, or corporate waste among other things. Examples of alleged corporate governance missteps in the filings include: failure to establish and implement appropriate controls to prevent the misconduct; failure to appropriately monitor the business; allowing known or suspected wrongdoing to persist; settling lawsuits but not changing the corporate culture or terminating wrongdoers; and paying large severance packages to the accused. Google, for example, announced earlier this year that it had terminated 48 people with no severance for sexual misconduct, but until it became public, the company did not disclose a $90 million payment to a former executive, who had allegedly coerced sex from an employee. Earlier this week, Google acknowledged another $35 million payment to a search executive who had been accused of sexual assault. This second payment was revealed after lawyers filed a shareholder derivative suit in January. CBS, on the other hand, denied a $120 million severance package to its former head, Les Moonvies, who has demanded arbitration.

So what happens when a company knows that a prominent executive has engaged in misconduct? How does a company prevent the conduct and then react to it? Board members and rank and file employees are undergoing more training even as people talk of a #MeToo backlash. But is that enough? Should companies now discuss potential or alleged sexual harassment by executives as a material risk factor in SEC filings? One panelist speaking at the 37th Annual Federal Securities Institute last month suggested that board counsel needed to consider this as an option.

#MeToo has also affected M&A deals with over a dozen companies now inserting a "Weinstein clause" representing, for example that “To the knowledge of the company, no allegations of sexual harassment have been made against any current or former executive officer of the company or any of its subsidiaries” Other "#MeToo reps" require a target company to confirm that it “has not entered into any settlement agreements” with perpetrators of sexual misconduct. Clawbacks are also increasingly common both in M & A deals and executive compensation agreements. Some companies have even asked newly-hired executives to represent that they have not been accused of or engaged in sexual misconduct.

I expect these #MeToo reps, clawbacks, and other disclosures to become more mainstream for a few reasons. First, there's a steady stream of news keeping these issues in the headlines, and many states have banned or are considering banning nondisclosure agreements in sexual harassment cases. Second, women leaders may now play a larger role in changing corporate culture. California requires that publicly held corporations whose “principal executive office” is located in California include at least one female board member by 2019 and even more depending on the size of the board. See here for some perspective on whether more female board members would lead to fewer sexual harassment scandals.  Third, proxy advisory firms sounded the alarm on #MeToo in early 2018 and both ISS and Glass Lewis have issued statements about what they plan to recommend when there are no women on boards. Finally, BlackRock, the world's largest asset manager has made it clear that it expects to see women on boards.  Some people do not agree that these guidelines/laws will work or are even necessary. Indeed, it will take a few years for empirical evidence to reveal whether having more women on boards and in the C suite will make a meaningful difference.

Personally, I believe it will take a combination of new leadership, successful shareholder derivative suits, and a continuation of the social due diligence in the hiring and M & A context. Sexual misconduct is wrong but it's also expensive. Companies are spending hundreds of thousands of dollars and sometimes more to investigate claims and prepare reports that they know will likely be made public at some time. Conduct won't change unless there are real financial and social penalties for wrongdoers.  

Junior Faculty Forum

The University of Richmond School of Law will host the Third Annual Junior Faculty Forum on Tuesday, May 21 and Wednesday, May 22, 2019 in Richmond, Virginia.  More information is available here.  This is Richmond's description of the event:

This annual workshop brings together junior law scholars to present their scholarship in an informal collegial atmosphere. The workshop is timed to allow participants to incorporate feedback on early ideas or projects before the summer, and papers and works-in-progress are welcome at any stage of completion. To maximize discussion and feedback, the author will provide a brief introduction to the paper, but the majority of the individual sessions will be devoted to collective discussion of the papers. We will also have plenty of opportunities for networking and more casual discussions.  

Richmond Law will provide all meals for those attending the workshop, but attendees will cover their own travel and lodging costs.

 

ICYMI: #corpgov Midweek Roundup (Mar. 13, 2019)

"There simply are too many widely dispersed shareholders who have varying degrees of information about the company, differing goals and investment time horizons, and competing ideas about optimal business practices for their preferences to be aggregated efficiently." #corpgov https://t.co/bdyuwluNhF

— Stefan Padfield (@ProfPadfield) March 11, 2019

"Amidst the clamorous and wide-ranging debate over poison pills, few commentators have addressed whether these corporate defenses are consistent with NYSE’s and NASDAQ’s well-known prohibitions against large issuances absent shareholder approval (the '20 Percent Rule')." #corpgov https://t.co/DecatGFn1u

— Stefan Padfield (@ProfPadfield) March 8, 2019

"regulatory wave of early 2000s—Regulation FD in 2000, market decimalization in 2001, Sarbanes-Oxley in 2002, and the Global Analyst Research Settlement in 2003—cannot be the primary cause of declining U.S. listings, since the opening of the listing gap pre-dates them" #corpgov https://t.co/KjGIGCpIn7

— Stefan Padfield (@ProfPadfield) March 11, 2019

"An Ohio pension fund is the latest party asking for a court to legally stop Tesla CEO Elon Musk from tweeting .... 'Musk has breached his fiduciary duty by continually violating court orders ... by putting out tweets without pre-approval ....'” https://t.co/WfnQt8ltoe #corpgov

— Stefan Padfield (@ProfPadfield) March 11, 2019

"We observe a robust and significantly negative valuation effect of firms affected by the quota.... results translate into a value loss of around 57.2 million USD on average ...." https://t.co/MCb9HxVIgv

— Stefan Padfield (@ProfPadfield) March 8, 2019

LLCs Are Not Corporations, Spring Break Edition

It is Spring Break at WVU, so I am using this time to finish some paper edits and catch up on my email. Last week, I got an email about a recent case from the United States District Court for the Northern District of Illinois. It is a headache-inducing opinion that continues the trend of careless language related to limited liability companies (LLCs). 

The opinion is a civil procedure case (at this point) regarding whether service of process was effective for two defendants, one a corporation and the other an LLC.  The parties at issue, (collectively, “Defendants”) are: (1) Ditech Financial, LLC f/k/a Green Tree Servicing, LLC (“Ditech Financial”) and (2) Ditech Holding Corporation f/k/a Walter Investment Management Corp.’s (“Ditech Holding”). The court notes that it is unclear whether there is diversity jurisdiction, because

“the documents submitted by Defendants with their motion to dismiss suggest that there may be diversity of citizenship in this case. See [12-1, at 2 (stating Ditech Holding is a Maryland corporation with a principal office in Pennsylvania) ]; [12-1, at 2 (stating Ditech Financial is a Delaware limited liability corporation with a principal office in Pennsylvania) ].”

Clayborn v. Walter Investment Management Corp., No. 18-CV-3452, 2019 WL 1044331, at *8 (N.D. Ill. Mar. 5, 2019) (emphasis added).  

Why do courts insist on telling us the state of LLC formation and principal place of business, when that is irrelevant as to jurisdiction for an LLC?  Hmm. I supposed that fact that courts keeping calling LLCs “corporations” might have something to do with it.  The court does seem to know the rule for LLCs is different than the one for corporations, noting that “Plaintiff has not pled or provided the Court with any information regarding the citizenship of each member of Ditech Financial LLC. “ Id.

Despite this apparent knowledge, the court goes on to say:

Under Illinois law, “a private corporation may be served by (1) leaving a copy of the process with its registered agent or any officer or agent of the corporation found anywhere in the State; or (2) in any other manner now or hereafter permitted by law.” 75 ILCS 5/2-204. At least one court to consider the issue has concluded that Illinois state law does not allow service of a summons on a corporation via certified mail. Ward v. JP Morgan Chase Bank, 2013 WL 5676478, at *2 (S.D. Fla. Oct. 18, 2013); see also 24 Illinois Jurisprudence: Civil Procedure § 2:20; 13 Ill. Law and Prac. Corporations § 381. Plaintiff has not cited, nor has the Court located, any support for the proposition that a summons and complaint sent by certified mail constitutes one of the “other manner[s] now or hereafter permitted by law” to effectuate service. Consequently, the Court concludes that Plaintiff has not properly served Ditech Holding under Illinois law, and therefore cannot have served Ditech Financial.^{2 [see below]}

Id. Now the case gets more confusing.  Note that last line above: the court implies that proper service of the corporate parent may have been sufficient to serve the LLC, too. Footnote 2 of the opinion properly clarifies this, though the court then provides another baffling tidbit.

Footnote 2 provides:

Even if Plaintiff had properly served Ditech Holding, it would not have properly effectuated service upon Ditech Financial. Ditech Financial appears to be a limited liability company.[1]; [12]. Under Illinois law, service on a limited liability company is governed by section 1–50 of the Limited Liability Company Act. 805 ILCS 180/1–50; John Isfan Construction, Inc. v. Longwood Towers, LLC, 2 N.E.3d 510, 517–18 (Ill. App. Ct. 2016). Under section 1–50 of the Limited Liability Company Act, a plaintiff may only serve process upon a limited liability company by serving “the registered agent appointed by the limited liability company or upon the Secretary of State.” Pickens v. Aahmes Temple #132, LLC, 104 N.E.3d 507, 514 (Ill. App. Ct. 2018) (quoting 805 ILCS 180/1–50(a)). To properly serve Ditech Financial, Plaintiff would have had to deliver a copy of the summons and complaint to Ditech Financial’s registered agent in Illinois: CT Corporation System. [12, at 5.]

The court had already stated the Ditech Financial was an LLC, though it had called it a “limited liability corporation.” Is the court unclear about the entity type?  If entity type is in question, it would seem worthy of note in the body of the opinion. The court properly cites to the LLC Act, but it inconclusive as to whether Ditech Financial is, in fact, an LLC.    

To make matters worse, the court repeats, in footnote 3, its earlier mistake as to  what an LLC really is:

Service on a limited liability corporation, such as Ditech Financial, must be effectuated in the same manner as service on a corporation such as Ditech Holding. See, e.g., Grieb v. JNP Foods, Inc., 2016 WL 8716262, at *3 (E.D. Pa. May 13, 2016) (evaluating the effectiveness of service of process on a limited liability company under Pa. R. Civ. P. 424).

The court ultimately dismisses the claim without prejudice, which seems proper.  But the rest of this? Sigh. If you need me, I’ll be the one in back banging his head on the table.

Call for Papers - Takeovers and Value Creation: Comparative Perspectives

This "just in" from BLPB friends Beate Sjåfjell and Afra Afsharipour:

We are thrilled to co-organise a workshop at UC Davis School of Law on 26 April 2019, with the aim of facilitating an in-depth comparative analysis of the relationship between takeovers and value creation.

We invite submissions on themes concerning takeovers and value creation from any jurisdiction around the world as well as comparative contributions. Themes include but are not limited to:

What are the implications of a takeover on sustainability efforts?

What is the scope for using sustainability arguments as a defense by the target board in a takeover?

What should be the role of the bidder board?

What are the implications of large M&A transactions for building/growing a culture of sustainability at a firm?

Is there a distinct difference between planned mergers and uninvited takeovers?

How could takeovers be regulated to promote sustainable value creation?

We especially encourage female scholars and scholars from diverse backgrounds to submit abstracts. Participation at the workshop will be limited to the presenters, to facilitate in-depth discussions. Deadline for submission of abstracts: 27 March 2019!

Please feel free to send this call for papers on to colleagues who may be interested, and don’t hesitate to get in touch if you have any questions!

This looks like a great opportunity for those of us who work in the M&A space.  But the deadline is fast upon us!  Another thing to consider as a Spring Break activity . . . . 

Solving Banking's "Too Big to Manage" Problem

Jeremy Kress at the University of Michigan’s Ross School of Business recently posted on SSRN his new article, Solving Banking’s “Too Big To Manage” Problem, forthcoming in the Minnesota Law Review.  Here’s the abstract:

The United States’ banking system has a problem: many financial conglomerates are so vast and complex that their executives, directors, and shareholders cannot oversee them effectively. Recognizing this “too big to manage” (TBTM) dilemma, both major political parties have endorsed breaking up the banks, and bipartisan coalitions in Congress have introduced bills to shrink the largest firms. Despite this apparent consensus, however, policymakers have not agreed on a solution to the TBTM problem. Thus, a decade after the financial crisis, the biggest U.S. banks are significantly larger today than they were in 2008. 

This Article contends that the most prominent proposals to break up the banks—by reinstating the Glass-Steagall Act, capping banks’ size, or imposing onerous capital rules—each suffer from critical policy and political shortcomings. This Article then proposes a better way to solve the TBTM problem: using the Federal Reserve’s existing authority to compel divestitures when a financial conglomerate falls out of compliance with minimum regulatory requirements. In contrast to existing break-up proposals, this never-before-used approach would increase big banks’ incentives to comply with the law, reduce the systemic footprint of the riskiest firms, preserve economies of scale and scope for most financial institutions, and not require new legislation. This Article asserts that the Federal Reserve should use its divestiture authority in appropriate circumstances, and it proposes a novel framework to end the TBTM problem by putting this authority into practice.

In January, I had the honor of attending the Huber Hurst Seminar at the University of Florida’s Warrington College of Business, and participating in a lively discussion of this article with Kress and other seminar participants.  It’s an interesting, insightful paper, and the quality of its writing makes it accessible to all.  Definitely a worthwhile read!   

 

Does U.S. Soccer Have A Flawed Business Model?

Yesterday was International Women's Day and I was supposed to post but couldn't think of what to write. I simply had too many choices based on this week's news. It's no coincidence that three months before the World Cup and on International Women's Day, the U.S. Women's Soccer Team sued U.S. Soccer for gender discrimination based on pay and working conditions, including medical treatment, travel arrangements, and coaching. On the one hand, some argue that the women should not receive the same amount as their male counterparts because they do not draw the same crowds or generate the same revenue. The plaintiffs argue that they cannot draw the same crowds in part because they do not get the same marketing and other financial support. In their defense, the U.S. women have won the World Cup three times and have won gold four times at the Olympics. The men's team has never won either tournament and didn't even qualify for the 2018 World Cup. I was in Brazil for the 2014 World Cup and when the men advanced, people were genuinely shocked. No one expected it and I was able to get a ticket to that match 15 minutes before start time for pennies on the dollar. Yet the men earn more.

If U.S. Soccer followed a pay for performance model, the women would and should clearly earn more. But, it's more complicated than that. As the NY Times explained, "each team has its own collective bargaining agreement with U.S. Soccer, and among the major differences are pay structure: the men receive higher bonuses when they play for the United States, but are paid only when they make the team, while the women receive guaranteed salaries supplemented by smaller match bonuses." Even so, the union for the U.S. Men's team supports the lawsuit, stating "we are committed to the concept of a revenue-sharing model to address the US Soccer Federation's "market realities" and find a way towards fair compensation. An equal division of revenue attributable to the MNT and WNT programs is our primary pursuit as we engage with the US Soccer Federation in collective bargaining. Our collective bargaining agreement expired at the end of 2018 and we have already raised an equal division of attributable revenue. We wait on US Soccer to respond to both players associations with a way to move forward with fair and equal compensation for all US soccer players." I will follow the lawsuit filed by Winston & Strawn and report back. 

The other stories I considered writing about concerned the ouster Chef Mario Batali and resignation of the founder of UK retailer Ted Baker over sexual harassment allegations. I will save that for next week when I will discuss whether companies should consider listing sexual harassment/misconduct as a material risk factor in SEC filings.

 

  

Investors Should Be Seen and Not Heard

I am fascinated by the eyebrow-raising speech SEC Commissioner Hester Peirce delivered to the Council of Institutional Investors (CII) earlier this week.  In it, she said:

I have concerns about CII’s position with respect to the Johnson & Johnson shareholder proposal. As you know, a Johnson & Johnson shareholder submitted a proposal that, if approved, would have started the process to shift shareholder disputes with the company to mandatory arbitration…. CII also submitted a letter stating that “shareholder arbitration clauses in public company governing documents reflect a potential threat to principles of sound governance.”…

CII argues that “shareowner arbitration clauses in public company governing documents represent a potential threat to principles of sound corporate governance that balance the rights of shareowners against the responsibility of corporate managers to run the business.” Among your worries is the non-public nature of arbitration and thus the absence of a “deterrent effect.”…

The problem is that these class actions are rarely decided on the merits. Instead, the cost of litigating is so great that companies often settle to be free of the cost and hassle of the lawsuit.  Settlements are rarely public and certainly involve no publication of broadly applicable legal findings. Additionally, such suits can depress shareholder value since they often result in costly payouts to make the suit go away that do not inure to the benefit of shareholders.  Indeed, the cost of defending and settling these suits is a substantial cost of being a public company. The result is that the company’s shareholders are ultimately harmed by the very option intended to protect them: first by the company’s diversion of resources to defend often meritless litigation, and second by the resulting decline in the value of their shares. Case law remains untouched, and the shareholders not involved in the process have no idea what happened. A big chunk of shareholder money typically goes to nice payouts for the lawyers involved.

As I understand it, in her view, institutional investors are not capable of judging the value of securities litigation relative to arbitration, may not be aware that securities lawsuits often settle without definitive factual findings, and also may have never head the criticism that such lawsuits are expensive for companies and enriching for attorneys. 

She also appears to believe that institutional investors are unable to identify the types of corporate information that contribute to their understanding of firm value.  As she put it:

My concerns are mainly ones of focus.  I recently had a conversation with a boy who shares an obsession with many other children his age—the video game Fortnite.  He described to me how much he enjoyed long stretches of playing the game ... How is it that this simulated environment can drown out the real distractions around him? Clearly, the designers of that game and others like it have figured out how to concentrate the mind on objects of their own making....

I see a parallel in today’s investment world.  Many investors these days seem focused on non-investment matters at the expense of concentration on a sound allocation of resources to their highest and best use. Real dollars are being poured into adhering to an amorphous and shifting set of virtue markers. I do not want the SEC to become an enabler of this shift in focus. … We are being asked more and more to shift securities disclosure to focus more on matters that do not go to an assessment of how effectively companies are putting investor money to work….

Institutional investors [] have been a strong voice in favor of regulation that supports the incorporation of environmental, social, and governance (“ESG”) in investing. The International Organization of Securities Commissions, or “IOSCO,” issued a statement on ESG investing in January.  The statement directed issuers to consider whether ESG factors—which are not defined—should be included in their disclosures, …

I found the statement to be an objectionable attempt to focus issuers’ on a favored subset of matters, as defined by private creators of ESG metrics, rather than more generally on material matters. The U.S. securities laws already provide for material disclosures. Explicit consideration of ESG factors must therefore require something more than what is already contemplated by our laws …

When the SEC is asked to concentrate on issues other than protecting investors, facilitating capital formation, and fostering fair, orderly, and efficient markets, our focus shifts away from our mission. …

Yet despite this apparently low opinion of institutional investors’ ability to identify and advocate for their own interests, she also made the claim that:

If shareholders value the ability to bring class actions, they can divert their investments to companies that offer such options. I am sure that CII’s preferences will be well-attended by issuers seeking your investment money. I trust that shareholders like you are more than capable of handling the matter without our intervention.

I have to say, if institutional investors are distracted by nonmaterial ESG factors like a child playing Fortnite, I’m not sure how they’re supposed to go about pricing arbitration provisions in a publicly traded company. 

In fact, we may want to begin rolling back all of those exemptions from registration for institutional and accredited investors.  The premise of Regulation D, and Rule 144A, the “testing the waters” provision, and Section 4(a)(7) is that institutions are capable of bargaining for the information they need to make intelligent investment decisions, and they do not need the paternalistic protections of mandatory securities disclosure.  But if it’s true that they are ignorant even of the phenomenon of the securities nuisance settlement, I don’t have much faith in their ability to engage in the more complex task of valuing an illiquid limited partnership interest in a 10-year private equity fund. (To be fair, that’s also how institutional investors themselves see it; they’ve just asked the SEC for greater oversight of the private equity industry.)

Okay, I’m snarking, of course, but this highlights a greater tension in the law that we see both at the federal and state level: regulators like to say they’re relying on institutional investors’ own judgments and wisdom (Regulation D, Corwin, etc) right up until the moment that these investors start to advocate for things the regulator doesn’t like (ESG disclosure, hedge fund activism, reliance on proxy advisors), at which point, investors are like children: better seen and not heard.  It’s a way of making substantive regulatory choices while maintaining a pretense of deference to private ordering.  The greater truth, in my view, is that institutional investors themselves are a product of regulation; they couldn’t exist without it, it’s written into their bones.  They are so entangled with the regulatory state that the concept of private ordering becomes meaningless; there is simply one set of regulatory choices over another.