Business Law Prof Blog

Happy New Year & New Paper on Community Banks!

I want to get an early start on wishing a HAPPY NEW YEAR to all BLPB readers!  May 2020 be one of your best years yet!  I’m celebrating by going to my very first “Shrimp Drop” with my mom.  Turns out that Fernandina Beach, FL. is the “Birthplace of the Modern Shrimping Industry.”  I do love shrimp!

Other than this, I can’t think of a more exciting way to ring in 2020 than by reading a new, fantastic article on banking!  Fortunately, I didn't have to look far.  Jeremy C. Kress and Matthew C. Turk recently posted: Too Many to Fail: Against Community Bank Deregulation (here).  Legal scholarship has thus far paid scant attention to community banks.  After reading their work, you’ll understand why this shortfall is unfortunate, and this article so important.  Here’s the abstract:  

Since the 2008 financial crisis, policymakers and scholars have fixated on the problem of “too-big-to-fail” banks. This fixation, however, overlooks the historically dominant pattern in banking crises: the contemporaneous failure of many small institutions. We call this blind spot the “too-many-to-fail” problem, and document how its neglect has skewed the past decade of financial regulation. In particular, we argue that, for so-called community banks, there has been a pronounced and unjustifiable shift toward deregulation, culminating in sweeping regulatory rollbacks in the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018.

As this Article demonstrates, this deregulatory trend rests on three myths. First, that community banks do not contribute to systemic risk and were not central to the 2008 crisis. Second, that the Dodd-Frank Act imposed regulatory burdens that threaten the survival of the community bank sector. And third, that community banks cannot remain viable without special subsidies or regulatory advantages. While these claims have gained near-universal acceptance among legal scholars and policymakers, none of them withstands scrutiny. Contrary to the conventional wisdom, community banks were key participants in the 2008 crisis, were not uniquely burdened by post-crisis reforms, and continue to thrive economically.

Dispelling these myths about the community bank sector leads to the conclusion that diligent oversight of community banks is necessary to preserve financial stability. Accordingly, this Article recommends a reversal of the community bank deregulatory trend and proposes affirmative reforms, including enhanced supervision and macro-prudential stress tests, that would help mitigate systemic risks in the community bank sector.

 

What is Transactional Business Law?

The title of this post is the core question behind a transactional law laboratory that I am co-teaching with my amazing colleague Eric Amarante for a seven-week period starting next week.  The course is being taught to the entire 1L class (intimidating!) in one two-hour class meeting each week.  In essence, the course segments explore, principally through the subjects taught in the first-year curriculum, the nature of transactional business law.  This is our first semester teaching this course, which is a substantially revised version of a course UT Law added to its 1L curriculum three years ago.  We are pretty jazzed up about it--but understandably nervous about how our course plan will "play" with this large group.

Because 1Ls come to transactional business law from various different backgrounds and experiences (including different first-semester law professors), we plan to begin by striving to develop some common ground for our work.  To that end, I am asking for a late Christmas present or early New Year's gift from all of you: your answer to one or more of the following questions.  How would you define transactional business law?  What are some examples of this kind of practice?  What makes a good transactional business lawyer?  Why should every law student need to know something about transactional business law (and what should they need to know)?  Let me know.

These are the kinds of questions we'll be probing through discussions, drafting, problem-solving, and other in-class and out-of-class experiences in the context of contract law, property law, tort and criminal law, agency law, professional responsibility, and more.  The objective is substantive exposure, not mastery.  Although teaching 125+ students at once is a tall order (and we will be breaking the class down into small groups for various activities), I admit that I am a bit excited about this.  I hope you are, too, and that a few of you will respond in the comments or send me a private message.

In the mean time, enjoy the waning holiday season.  I wish a happy new year to all.  And (of course) I wish good luck to the many among you who also are starting a new semester in the coming weeks.

Fall 2019 Reading and Listening

This fall semester flew by. Hoping to make time to read and listen to more good content next semester. Always open to suggestions, especially podcasts because my commute is now about 30 minutes each way. 

Books

A Guide to the Good Life: The Ancient Art of Stoic Joy - William B. Irvine (Philosophy) (2009). Review of stoicism and an attempt at modern application. “Unlike Cynicism, Stoicism does not require its adherents to adopt an ascetic lifestyle. To the contrary , the Stoics thought that there was nothing wrong with enjoying the good things life has to offer, as long as we are careful in the manner we enjoy them. In particular, we must be ready to give up the good things without regret if our circumstances should change.” (46).

Utilitarianism - John Stuart Mill (Philosophy) (1863). Reread before my spring business ethics class. “It is better to be a human being dissatisfied than a pig satisfied; better to be Socrates dissatisfied than a fool satisfied. And if the fool or the pig think otherwise, that is because they know only their own side of the question. The other party to the comparison knows both sides.” (7). “Next to selfishness, the principal cause that makes life unsatisfactory is a lack of mental cultivation.” (10). 

Just Mercy - Bryan Stevenson (Non-fiction, Law) (2014). Stories of injustice in our criminal legal system. Reread in advance of our SEALSB Conference in Montgomery, AL. Stevenson founded the Equal Justice Institute (EJI) in Montgomery. The EJI’s museum and memorial are well worth your time; like the book, they are quite moving. 

Podcasts

The Dream - an investigation of multi-level marketing companies (MLM).

Road to the Olympic Trials - Peter Bromka ran just two seconds shy of the standard; he will take another shot at the Houston Marathon in January. 

Elizabeth Anscombe on Living the Truth (Jennifer Frey - University of South Carolina, Philosophy). Focuses on Anscombe’s theory of intentionality of action.

Ipse Dixit Legal Scholarship Podcasts (hosted by Brian Frye - University of Kentucky, Law)

More on Controlling Shareholders

I’ve previously blogged about – and written an essay about – how one of the knock-on effects of Corwin and MFW is to increase the distance between the treatment of controlling shareholder transactions, and other transactions, under Delaware law.  As a result, the outcome of many a motion to dismiss turns solely on the presence or absence of a controlling shareholder – which puts increasing pressure on the definition of control in the first place.  In particular, I’ve argued, courts uncomfortable with Corwin’s Draconian effects may be tempted to expand the definition of control in order to avoid early dismissals of cases that smack of unfairness.

The latest example of the genre comes by way of Vice Chancellor McCormick’s ruling on the motion to dismiss in Garfield v. BlackRock Mortgage Ventures et al.  There, an enterprise organized as an “Up-C” sought to transform itself into an ordinary corporation, largely for the benefit of the two founding investors, BlackRock and HC Partners, as well as several directors and corporate officers.  The question was whether the transaction was fair to the public stockholders, who overwhelmingly voted in favor of the deal.  If BlackRock and HC Partners were not deemed to be controllers, the stockholder vote would cleanse the deal under Corwin and the case would be dismissed; if they were, the court would be permitted to substantively examine the transaction’s fairness.

Together, BlackRock and HC Partners controlled 46.1% of the vote, had Board representation, and had blocking rights; thus, the court easily found that if they acted together, they had control. The critical question was whether they had, in fact, agreed to act in concert, or whether they simply had concurrent, but independent, interests in the transaction.  For these sorts of inquiries, the standard on which Delaware courts have settled is that to constitute a group, the putative controllers must be “connected in some legally significant way—such as by contract, common ownership, agreement, or other arrangement—to work together toward a shared goal.”

To determine whether this standard was met, McCormick looked for both transaction-specific facts suggestive of an agreement, as well as historical facts indicting that the defendants had agreed to coordinate in the past.  Here, BlackRock and HC Partners’s long history of coordinated involvement with the company, coupled with their critical roles in approving the reorganization, created an inference of concerted action.  As a result, the plaintiff had plausibly alleged the presence of a controlling group, and Corwin did not apply.  Motion to dismiss denied.

So, there are a couple of things that interest me here. 

First, it’s another example of “controller-creep.”  The cases on which McCormick relied, Sheldon v. Pinto, 2019 WL 4892348 (Del. Oct. 4, 2019) and In re Hansen Medical Shareholders Litigation, 2018 WL 3025525 (Del. Ch. June 18, 2018), also identified “historical” ties as a factor to consider when inferring the presence of an agreement among putative members of a control group, but in those cases, the courts demanded that plaintiffs identify multiple investments in multiple companies – and refused to infer an agreement without them.  Here, by contrast, McCormick found a history just due to the defendants’ investment in this single company.

Second, there are many areas of law where the presence of an agreement among parties, rather than simply concurrent self-interest, is critical (13D filings, antitrust law, RICO), and courts therefore have to closely examine the defendants’ behavior to see if such an agreement can be inferred.  There seems to be little cross-pollination in the caselaw, however (though in Hansen, one “historical” factor used to infer the existence of an agreement was a 13D filing from a previous venture), and to be honest, that’s how it should be – there are different policies at play in different areas of law, not to mention different legal standards on a motion to dismiss, and it makes sense courts would therefore approach the analyses differently.  That said, in the Garfield briefing, I detect efforts by the BlackRock defendants in particular to import antitrust concepts into the controlling shareholder inquiry, via the suggestion that agreements can only be inferred if there’s evidence that the parties sacrificed their immediate self-interest in service of a larger goal.  Correctly, I think, McCormick chose not to pursue that argument.

Third, though, I get back to my problem with this entire line of precedent, which is well-illustrated by this case.  We’re talking about a transaction structured to benefit a small number of shareholders with outsized voting power and management control; BlackRock and HC Partners had veto rights and were intimately involved in the planning stage even before the presentation to the Board.  If the goal is to protect the public stockholders, why on earth should it matter whether these two formally agreed to act together? Whether they did or they didn’t wouldn’t make the transaction any less favorable to them, or any less coercive to the public stockholders.  And that’s because control exists on a spectrum, not as an on/off switch, and two large investors with concurrent interests, board representation, and 46.1% of the voting power are just as threatening to the public stockholders, and exert just as much influence, whether they’ve formally agreed to act together or not.  Plus, recall that the whole (purported) reason controlling shareholder transactions cannot be cleansed by a shareholder vote is that we presume shareholders are afraid to buck a controller.  Shareholders can’t be intimidated by a secret agreement they know nothing about; if we were truly serious about inquiring into shareholder coercion, we’d be asking about shareholder perceptions of an agreement, not whether there actually was one.  So what we’re seeing, again, is how the “controlling shareholder” legal analysis imposed by Corwin/MFW is often divorced from the underlying business reality, which ultimately leads courts down a garden path of irrelevance.

ICYMI: #corpgov Midweek Roundup (Dec. 25, 2019)

"New laws designed to foster and govern social enterprises are propagating throughout the world.... This article identifies over 40 state initiatives across 30 countries to distinguish this international movement." 36 Windsor Y.B. Access to Just. 84 #corpgov #socent

— Stefan Padfield (@ProfPadfield) December 22, 2019

"The Akorn decision ... found that remediation costs that equated to ... 21% of the target’s ... equity value ... 'would be ‘material ....’' For the reasons explained below, Boston Scientific failed to demonstrate any material decline in Channel’s value." 2019 WL 6896462 #corpgov https://t.co/89ffM2eOTn

— Stefan Padfield (@ProfPadfield) December 19, 2019

"Janus counsels against forcing someone to associate with an organization that takes positions on 'controversial public issues.' Bar associations frequently take controversial positions ...." https://t.co/0hXFlVDbii

— Stefan Padfield (@ProfPadfield) December 20, 2019

"well over a hundred papers investigate the effects of state anti-takeover statutes or of state universal demand laws. How much should we trust the estimates of these papers? The short answer is: not much." https://t.co/vyHHRwMAwg

— Stefan Padfield (@ProfPadfield) December 19, 2019

"While characterizing the law in this area as 'murky,' the court appears to reaffirm the existing law that, generally, a stockholder will have a “proper purpose” only if the stockholder has credibly alleged 'actionable wrongdoing' by the board." https://t.co/nEKgIfEi5t

— Stefan Padfield (@ProfPadfield) December 22, 2019

Did A Child Die to Make Your Smartphone, Tablet, Laptop, or Car?

Happy holidays! Billions of people around the world are celebrating Christmas or Hanukah right now. Perhaps you’re even reading this post on a brand new Apple Ipad, a Microsoft Surface, or a Dell Computer. Maybe you found this post via a Google search. If you use a product manufactured by any of those companies or drive a Tesla, then this post is for you. Last week, a nonprofit organization filed the first lawsuit against the world’s biggest tech companies alleging that they are complicit in child trafficking and deaths in the cobalt mines of the Democratic Republic of Congo. Dodd-Frank §1502 and the upcoming EU Conflict Minerals Regulation, which goes into effect in 2021, both require companies to disclose the efforts they have made to track and trace "conflict minerals" -- tin, tungsten, tantalum, and gold from the DRC and surrounding countries. DRC is one of the poorest nations in the world per capita but has an estimated $25 trillion in mineral reserves (including 65% of the world's cobalt). Armed militia use rape and violence as a weapon of war in part so that they control the mineral wealth. The EU and US regulators believe that consumers might make different purchasing decisions if they  knew whether companies source their minerals ethically. The EU legislation, notably, does not limit the geography to the DRC, but instead focuses on conflict zones around the world.

If you’ve read my posts before, then you know that I have written repeatedly about the DRC and conflict minerals. After visiting DRC for a research trip in 2011, I wrote a law review article and co-filed an amicus brief during the §1502 litigation arguing that the law would not help people on the ground. I have also blogged here about legislation to end the rule, here about the EU's version of the rule, and here about the differences between the EU and US rule. Because of the law and pressure from activists and socially-responsible investors, companies, including the defendants, have filed disclosures, joined voluntary task forces to clean up supply chains, and responded to shareholder proposals regarding conflict minerals for years. I will have more on those initiatives in my next post. Interestingly, cobalt, the subject of the new litigation, is not a “conflict mineral” under either the U.S. or E.U. regulation, although, based on the rationale behind enacting Dodd-Frank §1502, perhaps it should have been.  Nonetheless, in all of my research, I never came across any legislative history or materials discussing why cobalt was excluded.

The litigation makes some startling claims, but having been to the DRC, I’m not surprised. I’ve seen children who should have been in school, but could not afford to attend, digging for minerals with shovels and panning for gold in rivers. Although I was not allowed in the mines during my visit because of a massacre in the village the night before, I could still see child laborers on the side of the road mining. If you think mining is dangerous here in the U.S., imagine what it’s like in a poor country with a corrupt government dependent on income from multinationals.

The seventy-nine page class action Complaint was filed filed in federal court in the District of Columbia on behalf of thirteen children claiming: (1) a violation of the Trafficking Victims Protection Reauthorization Act of 2008; (2) unjust enrichment; (3) negligent supervision; and (4) intentional infliction of emotional distress. I’ve listed some excerpts from the Complaint below (hyperlinks added):

Defendants Apple, Alphabet, Dell, Microsoft, and Tesla are knowingly benefiting from and providing substantial support to this “artisanal” mining system in the DRC. Defendants know and have known for a significant period of time the reality that DRC’s cobalt mining sector is dependent upon children, with males performing the most hazardous work in the primitive cobalt mines, including tunnel digging. These boys are working under stone age conditions for paltry wages and at immense personal risk to provide cobalt that is essential to the so-called “high tech” sector, dominated by Defendants and other companies. For the avoidance of doubt, every smartphone, tablet, laptop, electric vehicle, or other device containing a lithium-ion rechargeable battery requires cobalt in order to recharge. Put simply, the hundreds of billions of dollars generated by the Defendants each year would not be possible without cobalt mined in the DRC….

Plaintiffs herein are representative of the child cobalt miners, some as young as six years of age, who work in exceedingly harsh, hazardous, and toxic conditions that are on the extreme end of “the worst forms of child labor” prohibited by ILO Convention No. 182. Some of the child miners are also trafficked. Plaintiffs and the other child miners producing cobalt for Defendants Apple, Alphabet, Dell, Microsoft, and Tesla typically earn 2-3 U.S. dollars per day and, remarkably, in many cases even less than that, as they perform backbreaking and hazardous work that will likely kill or maim them. Based on indisputable research, cobalt mined in the DRC is listed on the U.S. Department of Labor’s International Labor Affairs Bureau’s List of Goods Produced with Forced and Child Labor.

When I mentioned above that I wasn’t surprised about the allegations, I mean that I wasn’t surprised that the injuries and deaths occur based on what I saw during my visit to DRC. I am surprised that companies that must perform due diligence in their supply chains for conflict minerals don’t perform the same kind of due diligence in the cobalt mines. But maybe I shouldn't be surprised at all, given how many companies have stated that they cannot be sure of the origins of their minerals. In my next post, I will discuss what the companies say they are doing, what they are actually doing, and how the market has reacted to the litigation. What I do know for sure is that the Apple store at the mall nearest to me was so crowded that people could not get in. The mall also has a Tesla showroom and people were gearing up for test drives. Does that mean that consumers are not aware of the allegations? Or does that mean that they don’t care?  I’ll discuss that in the next post as well.

Wishing you all a happy and healthy holiday season.

What is ESG Anyway?

I have previously commented that many investments describe themselves as “sustainable” or “ESG” (environmental, social, governance) focused, without much standardization as to what those terms mean – and I’ve criticized the SEC for failing to step in to create a set of uniform definitions.

Turns out, the SEC might finally be taking some action, though it’s not necessarily what I’d hoped for:

Many investment firms have been touting new products as socially responsible. Now, regulators are scrutinizing some funds in an attempt to determine whether those claims are at odds with reality.

The Securities and Exchange Commission has sent examination letters to firms as record amounts of money flow into ESG funds. These funds broadly market themselves as trying to invest in companies that pursue strategies to address environmental, social or governance challenges, such as climate change and corporate diversity.

But there have been critics of the growth in these funds. Some argue investment funds should focus solely on returns, and some firms have faced questions about how strictly they adhere to ESG principles….

One letter the SEC sent earlier this year to an investment manager with ESG offerings asked for a list of the stocks it had recommended to clients, its models for judging which companies are environmentally or socially responsible, and its best- and worst-performing ESG investments, ….

The SEC also homed in on proxy voting in the letter, which some investors say is a powerful tool that can be used to influence a company’s governance and might show how an investment fund is carrying out its ESG goals. The letter asked for proxy voting records and documents that related to how the adviser decided to vote on an ESG issue….

Senior SEC officials have sometimes expressed concern that focusing too narrowly on corporate morality could undermine a money manager’s duty to act in the best interest of clients. That could become a problem for pension funds pursuing ESG strategies if their retirees and beneficiaries aren’t as interested in sustainability but are nevertheless locked into funds’ investment choices, Republican SEC Commissioner Hester Peirce said last year.

Ms. Peirce has criticized ESG for having no enforceable or common meaning.

“While financial reporting benefits from uniform standards developed over centuries, many ESG factors rely on research that is far from settled,” she said in a speech last year to California State University Fullerton’s Center for Corporate Reporting and Governance….

Notice there are two separate ideas here, and the article blurs them together.  One idea is that retail investors can’t tell what they’re buying when a fund is labeled “ESG.”  Another idea is that funds should not be permitted to elevate “sustainability” metrics over wealth maximization, even if investors would prefer they did.  And that confusion goes to the heart of my problem with the ESG label as applied to funds.  It can mean at least three things:

(1) I morally/ethically do not want to profit off of some kind of activities, and therefore, even if they would maximize my returns, I don’t want to invest in them;

(2) I am hoping to use my investment dollars to encourage certain kinds of socially responsible activities that might not otherwise get sufficient funding, and I am willing to accept sub-par returns to do that (“impact investing”); or

(3) I believe ESG metrics are one mechanism for maximizing returns because social responsibility is ultimately profitable.

Now, within these categories, there are lots of questions.  Like, if you’re willing to accept below-market returns in order to make socially responsible investments – either for ethical reasons, or because you’re hoping to make an impact – what counts as an ethical investment, or an unethical one?  What kinds of “impact” do you want to have – i.e., how will you define the kinds of beneficial projects that otherwise would not be funded but for your social responsibility considerations?  And how far below market are you willing to go?  Is there a point where you’ll give up and say hey, I’ll go all in on Exxon if it’ll put food on the table? 

Additionally, before investors can make any kind of ESG-investment, they need metrics that describe the characteristics of a particular instrument, so that they understand what it means to say a particular project or instrument is “green” or environmentally-friendly or “sustainable.”  That’s why Europe is working toward a taxonomy that would categorize different projects according to their environmental impact.  Notably, Europe is explicit that these categorizations are based on the greenness of the project for the purpose of advancing environmental goals; they are not categorizations based on an idea that green projects are somehow long-run more profitable.  That determination, and its relevance to a particular investor or asset manager, is left to the investor, who will now simply be informed as to whether a project that says it has certain environmental effects really in fact has those effects.

In the US, of course, we don’t have any kind of labeling system – you can call any project green or sustainable and no one will stop you, which is why market actors will pay actual cash money for a clear assessment of the environmental impact of specific projects.  And because the SEC has apparently given up on developing standardized metrics in favor of, I dunno, preventing shareholders from communicating their priorities to portfolio companies, Europe’s going to be the market leader here.

(For the record, I’m not at all persuaded by Commissioner Peirce’s claim that the SEC’s hands are tied because financial reporting is more reliable than ESG reporting; as I previously argued, modern financial reporting standards are the product of a nearly century-old public-private partnership spurred by the federal securities laws.  Regulation creates the standardization; it’s not necessarily the other way around.)

But even after an instrument is accurately described in terms of its environmental and social effects, investors can’t decide whether those effects add up to “buy” “hold” or “sell” without a clear sense of why they’re asking about those effects in the first place, namely, their higher order strategy: Are they asking so they can follow their morals, so they can make an impact, or because they think ESG is wealth-maximizing? Because until you know that, you don’t know what to do with a specific green, green-ish, or brown investment opportunity.

And in the US, we don’t even have that higher order labeling system.  Europe, again, is ahead of us: UK’s Investment Association recently put out a framework that tries to distinguish between these categories, and urged asset managers to label funds accordingly.  But there’s no common language in the US.

And the reason there isn’t, I’d argue, is because there are a lot of different groups who have an interest in obscuring the distinctions.  Just as individual companies like to claim they have a broader social purpose in order to free themselves from responsibility to one constituency (i.e., shareholders and regulators), asset managers, as well, want to earn the higher fees that come with the ESG label while avoiding any of the commitments associated with it.  See, e.g., Dana Brakman Reiser & Anne M. Tucker, Buyer Beware: Variation and Opacity in ESG and ESG Index Funds (forthcoming Cardozo L. Rev.).  Meanwhile, various advocacy and interest groups have their own (obvious) reasons to try to convince investors that it is entirely costless to insist on socially-responsible behavior from their portfolio companies. 

All of which is to say, to the extent the SEC wants to make sure that ESG funds are clear on their strategy – THIS FUND IS FOR PEOPLE WHO WILL SACRIFICE WEALTH FOR MORALS, AT LEAST UP TO A POINT, AND HERE IS OUR PLAN versus THIS FUND IS FOR PEOPLE WHO BELIEVE THEY CAN DO WELL BY DOING GOOD, AND HERE IS OUR PLAN – I am all for it and believe it would be a great improvement in the marketplace.

But there’s a second issue that I’ve discussed in this space, namely, are funds even permitted to sacrifice wealth to achieve other goals?  Normally, you’d think, if a retail investor understands what they’re doing, why shouldn’t they be able to choose a fund that prioritizes morals over money?  But the latest suggestions from the Trump administration are that, at least to the extent the fund is regulated by ERISA, namely, it’s a private retirement fund, those choices are flat-out prohibited.  

And if that’s what the SEC is after, well, I have to ask – what does the SEC have against markets?

ICYMI: #corpgov Midweek Roundup (Dec. 18, 2019)

ICYMI: Great discussion of negative interest rates, as well as some thoughts on fed group think, and how tech is changing the business models of investment bankers and securities dealers. @DavidBeckworth interviews @biancoresearch. https://t.co/Ab9nwlHEiP #corpgov

— Stefan Padfield (@ProfPadfield) December 12, 2019

"Villains or visionaries? Hedge funds short companies they say 'greenwash'" https://t.co/H8JS2DK3if #corpgov #socent

— Stefan Padfield (@ProfPadfield) December 15, 2019

"In the Second Circuit’s words, 'disclosure is not a rite of confession, and companies do not have a duty to disclose uncharged, unadjudicated wrongdoing.'" https://t.co/jsxNJURzAt

— Stefan Padfield (@ProfPadfield) December 18, 2019

"DE is the dominant source of corp. law in this country. 60% of the Fortune 500 & more than half of the corps listed on the NYSE are incorporated in DE," which gets over 20% of the State’s budget "from incorporation fees & franchise taxes." #corpgov https://t.co/GMGjGBX0Pq

— Stefan Padfield (@ProfPadfield) December 14, 2019

Justifications "for the establishment of ... utopian socialism" abound. "In this sense, The Road to Serfdom is not a dust-covered relic but, instead, a dire warning to idealist political activists of the consequences of real-life socialism." https://t.co/pW0XEG0Vg1 #corpgov

— Stefan Padfield (@ProfPadfield) December 17, 2019

New Essay on: Restructuring United States Government Debt

As a historical matter, the U.S. has twice successfully restructured its finances: “once in the 1790’s under Alexander Hamilton’s debt repayment scheme and again at the start of the New Deal when it abrogated the gold clauses in its debt instruments.” (p.6)  Could the U.S. restructure its debt again?  Would it be constitutional?  Might the U.S. constitutional framework even facilitate this?  These are important, timely issues explored in a fascinating new essay, Restructuring United States Government Debt: Private Rights, Public Values, and the Constitution (here), by Edmund W. Kitch & Julia D. Mahoney.  

ABSTRACT. Mainstream policy discussions take as given that the United States will and must pay its debts in full and on time, and that “restructuring” is legally and politically impossible. In our judgment, this assumption is unwarranted. Far from being unthinkable, under some circumstances restructuring the debt of the United States would merit serious consideration, and these circumstances may well be fast approaching. We diverge from the standard wisdom for two reasons. First, we doubt that payments on treasury obligations will necessarily take precedence over what the electorate sees as more pressing needs, including national security and price stability. In particular, we suspect voters may balk if told that holders of United States debt securities have ironclad priority over Social Security claimants and others with well settled expectations of government benefits. Second, we think it wrong to equate restructuring with catastrophe. While we do not dismiss out of hand the dangers of not paying creditors in full and on time, we believe that—perhaps counterintuitively—the American constitutional framework could prove an asset rather than a liability when it comes to handling severe financial stress. Our conclusion on this point follows from the insight that the very dispersals of power that can fuel gridlock can also serve to enable the United States to offer credible assurances that its new financial structure will be stable going forward.    

Repost: CLS Blue Sky Blog on Blockchain and Corporate Governance

Earlier today, the CLS Blue Sky Blog published a post written by Adam Sulkowski and me (thanks to Adam for taking the laboring oar on this piece at the outset!) on corporate governance lawyering in the blockchain era--the topic of our recent article published in the Wayne Law Review.  A bit over a month ago, I posted the abstract for that article, together with some related commentary, here on the BLPB.

The CLS Blue Sky Blog includes some observations from our article about law practice in a corporate governance context if and as data storage and usage moves to blockchains.  I want to highlight them by repeating them here.

Our specific recommendations relating to lawyering cover several areas. First, we advise attorneys not only to stay updated about applicable law and relevant interpretations, but also to expand their awareness. Serving clients responsibly will require more familiarity and astuteness with technology and operations. Second, we urge our colleagues in the practice of law – including those involved in the making and administration of laws – to be uncharacteristically forward-looking. It is prudent to be proactive in the contexts of advising firm management and public policymaking. Overall, we highlight that counsel has a critical role in thinking through all the implications and contingencies resulting from a move of any governance function or process to a blockchain-based platform.

Why might that critical role look like?  I mentioned in my original post that Adam and I engaged in some visioning.  Among other things,

[i]t may well fall to attorneys to help clients see and appreciate irrevocable consequences and the potential risks and opportunities. We suggest that anyone engaged in the practice and study of law has a role to play in provoking conversations and new ideas for policy solutions in the context of ambiguities. Eliminating doubts about the adoption and consequences of blockchain-enabled corporate governance will create more certainty for market participants and society.

Perhaps more strikingly, in the article,

 . . . we discuss a conceptual reframing that several authors have suggested will be useful as a way of understanding our new role as attorneys. We proffer that that the lawyer’s role will evolve into that of a sort of translator – helping to transform human norms and values into software code. This is a key function in assuring that the deployment of technology serves its intended ends.

There are implications of these possible evolutions in the lawyer's role as corporate governance moves to blockchains.  Those implications extend to the legal education setting.

This reconceptualization of business lawyering is relevant to the functions of legal educators and law schools. Based on our observations, there undoubtedly will be a growing need for lawyers who are familiar with both how blockchain technology can be deployed and laws relevant to corporate governance. Law schools should consider evolving their courses and business law curricula accordingly.

Overall, in the CLS Blue Sky Blog post, Adam and I offer a longer playing summary of our work.  The additional information we provide there may help you to decide whether and when to read our entire article.  To the extent you are not inclined to read the article, however, I hope that this post or that post may at least provoke some thought.

The Implied Covenant of Good Faith Means The Contract Makes Some Sense (If Only A Little)

Prof. Bainbridge recently posted, Here's the thing I don't understand about the implied covenant of good faith and fair dealing. He explains: 

In Bandera Master Funds LP v. Boardwalk Pipeline Partners, LP, C.A. No. 2018-0372-JTL (Del. Ch. Oct. 7, 2019), the court reviews the Delaware law of the implied covenant:

“In order to plead successfully a breach of an implied covenant of good faith and fair dealing, the plaintiff must allege a specific implied contractual obligation, a breach of that obligation by the defendant, and resulting damage to the plaintiff.” Fitzgerald v. Cantor, 1998 WL 842316, at *1 (Del. Ch. Nov. 10, 1998). In describing the implied contractual obligation, the plaintiffs must allege facts suggesting “from what was expressly agreed upon that the parties who negotiated the express terms of the contract would have agreed to proscribe the act later complained of . . . had they thought to negotiate with respect to that matter.” Katz v. Oak Indus. Inc., 508 A.2d 873, 880 (Del. Ch. 1986). That is because “[t]he implied covenant seeks to enforce the parties’ contractual bargain by implying only those terms that the parties would have agreed to during their original negotiations if they had thought to address them.” El Paso, 113 A.3d at 184. Accordingly, “[t]he implied covenant is well-suited to imply contractual terms that are so obvious . . . that the drafter would not have needed to include the conditions as express terms in the agreement.” Dieckman, 155 A.3d at 361.

My question is simple: How do you know that the provision was left out because it was obvious? After all, if it was obvious, shouldn't the parties have put it in the contract? Put another way, how do you know the parties did think about it and decide to leave it out?

Agreed.  And I think this concept of the implied covenant matters more than ever, now that Delaware allows the elimination of the duty of loyalty in LLCs (my thoughts on that here). Even in allowing parties to eliminate the duty of loyalty in an LLC, such agreements always retain the duty of good faith and fair dealing. The Delaware LLC Act provides (emphasis added): 

§ 18-1101 Construction and application of chapter and limited liability company agreement.

. . .

(c) To the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties) to a limited liability company or to another member or manager or to another person that is a party to or is otherwise bound by a limited liability company agreement, the member’s or manager’s or other person’s duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement; provided, that the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing.

So what does that mean? I am of the mind that the implied covenant of good faith and fair dealing means that: (1) you get the express terms of the agreement, and (2) the agreement cannot take away all possible reasons for the deal in the first place.  As to the latter point, it means, quite simply, even without a duty of loyalty, there must be some reason for the contract to exist at all.  So, you may not be entitled to a fair share of proceeds from the agreement, or even a significant share.  But there must always be some value (or potential value) to have been gained by entering the agreement. At a minimum, it can't be an agreement to get nothing, no matter what. 

As one example, a Delaware court explained that a plaintiff's claim was lacking when the 

the incentive [gained by the defendant] complained of is obvious on the face of the OA [operating agreement]. The members, despite creating this incentive, eschewed fiduciary duties, and gave the Board sole discretion to approve the manner of the sale, subject to a single protection for the minority, that the sale be to an unaffiliated third party. . . . [T]he parties to the OA [thus considered] the conditions under which a contractually permissible sale could take place. They avoided the possibility of a self-dealing transaction but otherwise left to the [defendant] the ability to structure a deal favorable to their interests. Viewed in this way, there is no gap in the parties’ agreement to which the implied covenant may apply. The implied covenant, like the rest of our contracts jurisprudence, is meant to enforce the intent of the parties, and not to modify that expressed intent where remorse has set in.

Miller v HCP & Co., C.A. No. 2017-0291-SG (Del. Ch. Feb. 1, 2018). (More commentary on this case here.)

Furthermore, the implied covenant

does not apply when the contract addresses the conduct at issue, but only when the contract is truly silent concerning the matter at hand. Even where the contract is silent, an interpreting court cannot use an implied covenant to re-write the agreement between the parties, and should be most chary about implying a contractual protection when the contract could easily have been drafted to expressly provide for it.

Oxbow Carbon & Minerals Holdings, Inc. v. Crestview-Oxbow Acquisition, LLC, 202 A.3d 482, 507 (Del. 2019) (footnotes omitted). For more on this case see the Delaware Corporate &Commercial Litigation Blog. 

 

Parties have a lot of latitude, but I think the covenant of good faith and fair dealing means that there must be a reasonable effort to honor the express terms of the agreement and there must have been some reason to enter the contract. That's it.  It's not a lot, but it still has teeth where someone takes all of the things.  

The Votes of Retail Shareholders

Alon Brav, Matthew Cain, and Jonathan Zytnick have a fascinating new paper analyzing the voting behavior of retail shareholders (and I linked to it once before but I'm pretty sure since then it's been updated with a lot of new data).  Bottom line: They got access to the votes cast by retail shareholders from 2015 and 2017 and made a lot of interesting findings, including:

Retail votes matter. Collectively, they have as much influence on outcomes as the Big Three (Vanguard, BlackRock, and State Street).

Expressed as a proportion of the shareholder base, retail shareholders hold a higher percentage of small firms than large ones, and their participation in voting is higher in small firms.

Retail shareholders are more sensitive to management performance than the Big Three; they are more likely to turn out, and more likely to vote against management, when companies have underperformed.  The Big Three, by contrast, are less sensitive to performance in terms of voting behavior.

Retail shareholder voting has an observable cost/benefit component.  Retail shareholders vote more often when their economic stake is greater; when management has underperformed; in controversial votes; and when they live in a zip code less associated with labor income (suggesting more time to devote to their portfolio).

Retail shareholders with higher stakes in the subject firm are more likely to vote in favor of management proposals and against shareholder proposals as compared to institutions; by contrast, retail shareholders with lower stakes are less likely to vote at all, but when they do vote, they’re more likely support shareholder proposals – particularly for the largest firms. 

So what are the implications of all of this?

Well, first, I’m struck by how everyone from the Progressives (Adolf Berle, William Riley) to modern thinkers like Einer Elhauge have assumed that the separation of ownership and control would lead shareholders to be less concerned about corporate social responsibility – the theory being that as shareholders feel less responsible for corporate behavior, they’ll shed morality in favor of wealth maximization.  Yet, at least according to this data, smaller stakes and thus greater separation leads shareholders to greater support for social responsibility (i.e., shareholder proposals, many of which trend along these lines). Which makes its own sense: shareholders with smaller stakes may identify more as laborers, community members, etc than as shareholders, and feel less of an economic hit when companies sacrifice profits to benefit these other groups.  Plus, these results may not mean the general principle is wrong, exactly; the argument was always that dispersed shareholders were absentee landlords, and Brav, Cain, and Zytnick find precisely that, in that lower stakes are correlated with lesser involvement in governance.  Still, these findings are some counterweight to the assumption that dispersion breeds lack of social conscience.

Beyond that, we can ask what these findings suggest for those who would seek to enhance retail shareholder voice.  For example, some have argued in favor of technological tweaks that would make it easier for retail shareholders to vote.  What would the effects be? Well, it depends on who you think these nonvoters are.  Perhaps, like the retail voters in the study, they’d turn out to be more attentive to corporate performance, less supportive of underperforming managers, and less supportive to shareholder proposals, than the current crop of voters – but again, as Brav, Cain, and Zytnick suggest, the infrequent voters are not the same as the frequent voters, and technological fixes may boost infrequent voters specifically.  Thus, changes that enhance retail participation may in fact result in greater support for ESG initiatives.

And then there’s the question of requiring mutual funds to pass through votes to beneficial owners.  That’s been proposed by a number of academics, including Caleb Griffin, Sean Griffith (for certain types of votes), Jennifer Taub, and Dorothy Lund, and has – as I understand it – even been suggested even by Bernie Sanders, who wants to ban asset managers from voting workers’ retirement fund shares unless they are following instructions (though it’s unclear to me whether he envisions straight pass through or more like a separate workers’ organization that sets voting policy).  And here we have the same question: We might imagine the silent retail shareholders would become more like the retail shareholders who vote today, in which case they’d oppose ESG proposals and would be more hawkish on management performance as compared to institutional investors, or they might be more like the infrequent/lower stakes retail voters of today, who support ESG but barely bother to vote at all.  Or they might be something entirely different: as Jill Fisch, Annamaria Lusardi, and Andrea Hasler note, investors whose only market exposure is a 401(k) plan are far less financially sophisticated than other investors.  Presumably these are mutual fund investors whose voices would be promoted by a pass-through regime, and they might have particularly idiosyncratic preferences, if they have preferences at all.

We might also ask whether the retail voters from 2015 to 2017 are reflective of the retail voters of 2020, or 2021.  As I previously pointed out, new technologies may encourage greater retail ownership, and these new traders may have entirely different preferences, especially if – as some data suggests – they treat stock trading as more of a leisure pastime than an investment opportunity.

But my big takeaway is this: I’ve previously argued that we should have more disclosure of the identity of voting shareholders, and, in particular, votes of high-vote shares and insiders should be distinguished from the votes of low-vote shares and unaffiliated investors.  Brav, Cain, and Zytnick have convinced me that retail shareholders have a distinct point of view, as well, and – to the extent consistent with these voters’ privacy – their votes should be disclosed separately, as well.

Conceptual Securities Art

Brian Frye has released a new paper including an SEC No-Action Letter request.  His abstract describes the piece:

This article is a work of conceptual art in the form of a law review article. It argues that the sale of conceptual art violates the Securities Act of 1933. And it proposes to prove itself by requesting an SEC no-action letter holding that the sale of a work of conceptual art titled "SEC No-Action Letter Request" does not violate the securities laws.

Essentially, Frye argues that conceptual artwork meets the Howey test's four elements:

1. The investment of money
2. In a common enterprise
3. With the expectation of profits
4. From the efforts of others.   

It'll be interesting to see if the SEC responds to Frye's request.  Frye has also agreed to issue "ownership certificates" to the first 50 persons to email him with a request for a certified copy of the work.  As this conceptual art enterprise has not been nested within any limited liability business entity, I wonder whether the owners of certified copies of the work become anything like general partners in the enterprise under common law.  I'm not sure that a court would view this conceptual art piece as a business.

ICYMI: #corpgov Midweek Roundup (Dec. 11, 2019)

I actually thought the numbers were worse. "In the U.S., only about 50% of startups make it to their fifth birthday." https://t.co/GmFm1xHDSp #corpgov

— Stefan Padfield (@ProfPadfield) December 10, 2019

"threat of shareholder litigation plays a disciplinary role in curbing managerial rent extraction from tax avoidance activities" https://t.co/DS35DW4rk8 #corpgov

— Stefan Padfield (@ProfPadfield) December 10, 2019

"The St. Louis-based 8th U.S. Circuit Court of Appeals ruled ... that equity partner Joseph von Kaenel wasn’t a law firm employee and, as a result, he wasn’t covered by the federal age bias law." https://t.co/z6zF26XrBK #corpgov

— Stefan Padfield (@ProfPadfield) December 6, 2019

"Here we have more proof that those commentators who claim Delaware law does not mandate shareholder wealth maximization are either misinformed or disingenuous." #corpgov https://t.co/vhtJ4NFuxx

— Stefan Padfield (@ProfPadfield) December 6, 2019

True or false? "corporation law fails to ensure that corporations return business profits to shareholders.... without shareholder voting, the market for corporate control also fails to ensure a return to shareholders" 46 Fla. St. U. L. Rev. 861 #corpgov

— Stefan Padfield (@ProfPadfield) December 8, 2019

Farewell, Paul Volcker

As many BLPB readers know, former Chairman of the Federal Reserve System, “inflation slayer,” and namesake of the famous “Volcker Rule,” Paul A. Volcker, passed away Sunday.  He was 92.  Much has already been – and will continue to be – written about him.  To pay tribute to this great man and public servant, I wanted to share a few such pieces (in bold), with a quote from each (in italics).    

The Volcker Alliance (here)

Mr. Volcker worked in the United States Federal Government for almost 30 years, culminating in two terms as Chairman of the Board of Governors of the Federal Reserve System from 1979-1987, a critical period in bringing a high level of inflation to an end. He also served as Under Secretary of the Treasury in the 1970s, a period of historic change in international monetary arrangements.  Upon leaving public service, he headed two private, non-partisan Commissions on the Public Service, in 1987 and 2003; both recommended a sweeping overhaul of the organization and personnel practices of the United States Federal Government. His last official role in government service was as head of the President’s Economic Recovery Advisory Board, established by President-Elect Obama in 2008 to help steer the nation through the Great Recession.

Paul Volcker’s Greatest Lesson Wasn’t on Economics.  It Was on Being a Public Servant. (here)

Despite jobs at the epicenter of world financial power — early in his career he worked at Chase Manhattan, and he would lead the Federal Reserve Bank of New York before Mr. Carter picked him as Fed chair — he seemed uninterested in the trappings of wealth and power.

The strongest reason to mourn Volcker: He was willing to be unpopular (here)

Volcker did things that made him unpopular with presidents, with Congress and with the general public. He elicited their enmity not because he was a provocateur or masochist. He undertook unpopular actions because he believed they were the right things to do, and he cared more about the long-run health of the country than he did about his own career.

Paul Volcker, Who Guided U.S. Monetary Policy and Finance for Nearly Three Decades, Is Dead (here)

In retirement he was tapped repeatedly for high-profile international positions. In the late 1990s, he headed a committee investigating dormant accounts and other assets in Swiss banks that belonged to Holocaust victims. From 2000 to 2005, he chaired the International Accounting Standards Committee, developing global accounting practices. In 2004, United Nations Secretary General Kofi Annan tapped him to chair an independent panel investigating corruption allegations in the U.N.’s Iraqi oil-for-food program.

As Fed chairman, Paul Volcker made everyone mad (here)

The former Fed chairman said that, when he started his career, bank executives wouldn’t pay bonuses to individuals because it created the wrong culture. “You can’t imagine a bank these days debating that,” he said.

Billionaire Ray Dalio calls the late Paul Volcker 'the greatest American hero I've known' (here)

"I knew him personally as a man who had great wisdom, humility, and classic heroism in which he sacrificed his well-being for the well-being of others." [quoting Dalio]

There’s the Legend of Paul Volcker and the Man I Got to Know  (here)

One evening about two years ago, I was at Paul Volcker’s Manhattan apartment when the phone rang. It was Ray Dalio, the billionaire hedge fund manager, inviting Paul and his wife, Anke, to join him at the ballet on some future date. Soon after, Paul said that he and Anke had to leave for Brooklyn. They were attending a wake for his barber.

Factbox: Volcker quotes on U.S. banks, inflation, government (here)

ON MEETING WITH BANKS RESISTING REFORMS FOLLOWING THE 2008 FINANCIAL CRISIS

Wake up, gentlemen. I can only say that your response is inadequate. I wish that somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy, just one shred of information.” (Wall Street Journal interview, 2009)

Revised 12/11/19

Delaware's Duty of Care: Mrs. Pritchard Redux

This post is dedicated to the students in my Business Associations class, who took their final exam this morning.

Two weeks ago, reflecting on Francis v. United Jersey Bank, 432 A. 2d 814 (N.J. 1981), I asked for commentary on the following question: "How would the Francis case be pleaded, proven, and decided as a breach of duty action under Delaware law?"  That post generated some commentary--both online and in private messages to me.  In this post, I forward an analysis and a related request for commentary.

A number of commentators (including BLPB co-blogger Doug Moll in the online comments to my post) posited that a Caremark oversight claim may be the appropriate claim, and that the cause of action would be for a breach of the duty of care.  I find the latter part of that answer contestable.  Here is my analysis.

I begin by agreeing that Mrs. Pritchard's abdication of responsibility constitutes a failure to exercise oversight. Under the Delaware Supreme Court's decision in Stone v. Ritter, I understand that claim to be Caremark claim. ("Caremark articulates the necessary conditions for assessing director oversight liability.")  I think many, if not most, are also in agreement on this.

Here is where there may be some divergence.  Also relying on Stone, I understand that Caremark claim as a breach of the duty of loyalty, founded on a failure to act in good faith.  ("[B]ecause a showing of bad faith conduct . . . is essential to establish director oversight liability, the fiduciary duty violated by that conduct is the duty of loyalty.")  This makes sense to me because of the Delaware Supreme Court's opinion in Brehm v. Eisner, in which it circumscribes the duty of care.  ("Due care in the decisionmaking context is process due care only.")

However, Brehm (as evidenced in the immediately preceding parenthetical quote) addressed the duty of care under Delaware law in a decision-making context.  Francis was largely a case about the absence of decision making.  Moreover, the Brehm court's view on a substantive duty of care are rooted in the contradiction of that doctrine with the business judgment rule.  ("As for the plaintiffs' contention that the directors failed to exercise 'substantive due care,' we should note that such a concept is foreign to the business judgment rule. Courts do not measure, weigh or quantify directors' judgments.")  So, Brehm's wisdom on the duty of care under Delaware law may be inapplicable to facts like those in Francis, since the business judgment rule is inapplicable because the board did not engage in decision making.

Nevertheless, Stone seems to erect barriers to a duty of care claim for oversight like that presented in the Francis case.  BLPB co-blogger Anne Tucker voiced this concern in a 2010 article in the Delaware Journal of Corporate Law

Exculpatory provisions that eliminate liability for negligence and gross negligence (i.e., the duty of care), combined with the assumption of the duty of good faith under the liability standard for the duty of loyalty, narrow the standard of liability for director oversight. The result is while directors have three fiduciary duties-the duties of care, good faith, and loyalty-the three standards of conduct are essentially collapsed into one actionable standard: the duty of loyalty.

Anne Tucker Nees, Who's the Boss? Unmasking Oversight Liability Within the Corporate Power Puzzle, 35 Del. J. Corp. L. 199, 224–25 (2010).  Lyman Johnson similarly had commented, seven years earlier (and before the Stone case was decided)  that

care has been rendered a “small” notion in corporate law. It largely refers to the manner in which directors are to act. It is a process-oriented duty to act “with care.” Having confined care to that narrow chamber, the other meanings of care as found in the phrases “take care of” (the corporation) and “care for” (the corporation) remain fully available for infusion into corporate law through an expansive duty of loyalty.

Lyman Johnson, After Enron: Remembering Loyalty Discourse in Corporate Law, 28 Del. J. Corp. L. 27, 72 (2003).  Others also have written about this.

Based on the foregoing, I conclude that a duty of care cause of action is not available in Delaware for an oversight claim like that raised in Francis.  Delaware's duty of care comprises the duty to fully inform oneself of material information reasonably available under Smith v. Van Gorkom.  As a result, an oversight claim based on facts like those in Francis is a claim for a breach of the duty of loyalty as described in Stone.

Agree?  Disagree?  Provide analyses and, if possible, relevant decisional law.

Calling LLCs "Corporations" Is Sometimes Harmless Error, But It Can't Be Ignored

Once again, a court seems to arrive at the correct outcome, while making mistakes in the describing entity type. As usual, the court mislabeled a limited liability company (LLC).  Here we go:  

Andrea and Timothy Downs each held a 50% interest in a corporation, Downs Holdings, Inc. It held limited liability corporation (“LLC”) and limited partnership (“LP”) ownership interests. Eventually, the Downs agreed to dissolve the corporation and, as shareholders, passed a corporate resolution electing dissolution.

In re: ANDREA STEINMANN DOWNS, Debtor. NORIO, INC., Appellant, v. THOMAS H. CASEY, Chapter 7 Tr., Appellee., No. 8:16-BK-12589-CB, 2019 WL 6331564, at *1 (B.A.P. 9th Cir. Nov. 25, 2019) (emphasis added). 

 

The Downs did not follow the necessary formalities to dissolve Downs Holdings, Inc., and had instead ask that the corporation's management company "distribute the payments and monies owed to Downs Holdings to each shareholder separately, 50% to Mr. Downs and 50% to Ms. Downs." Id. Further, it appeared that the Downs asked to be treated as separate interest holders for both the LLC and LP. Id. Ms. Downs later borrowed $50,000 from Norio, Inc. and pledged pledged her claimed interests in the LLC and the LP as collateral. Id. at *2.

 

Because Downs Holdings, Inc., was the named interest holder in the LLC and the LP, and it had not been dissolved, and because there was no showing "that the assets transferred from Downs Holdings to Ms. Downs, the bankruptcy court did not err when it determined that Norio, Inc. lacked secured status.  Id. at *5. 

That all seems about right.  At the beginning of the opinion, the court states, 

 

We acknowledge that some of the bankruptcy court’s findings lack support in the record, but we ignore harmless error because the bankruptcy court’s ultimate conclusion is correct: Downs Holdings owned the relevant assets, and Ms. Downs could not pledge them to Norio as collateral for the loan.

Id.at *1. Calling a LLC a corporation in this context is, this time, anyway, harmless error. But I am not inclined to ignore it. I mean, the entity type is specifically at issue in this case, with respect to the corporate form. Making sure the corporation and the LLC are clearly recognized as distinct entity types may not be essential to finding right outcome, but it sure would be appropriate.  

Index Funds in Corporate Governance: Once More Unto the Breach

One of the biggest corporate law battles today concerns the appropriate role of institutional investors – and especially mutual funds – in corporate governance.  There has been increasing concern expressed in the academy that mutual funds – especially index funds – don’t have sufficient incentives to oversee their portfolio companies, and/or that mutual fund complexes have become so huge that they dominate the economy.  The concerns are rising to a level where the funds themselves are responding; witness, for example BlackRock’s attempted defenses here and here.  And, of course, we have the SEC’s sneak attack on institutional power via proposed regulation of proxy advisors.

Which is why I found Fatima-Zahra Filali Adib’s new paper, Passive Aggressive: How Index Funds Vote on Corporate Governance Proposals, so interesting.  She studies index fund voting behavior and contribution to corporate value by focusing on the “close call” votes, i.e., ones that narrowly pass or narrowly fail.  She finds that index fund support is associated with value enhancement, and that these votes are not dictated by the proxy advisors (rebutting arguments that institutions blindly follow advisor recommendations).  On the other hand, she also finds that ISS recommendations are not well correlated with value-enhancement, at least on the “close calls” – a point supporting the claim that proxy advisors do not know what they’re doing.

Also, fascinatingly – in direct response to those who claim that index funds do not have resources or incentives to devote to corporate governance – she concludes that funds allocate more resources to the “close call” proposals, apparently in anticipation that these are the ones where their votes will be pivotal.  Her proxy for resource allocation is the fact that the fund voted against management (which suggests more attention to the issue).  Bottom line is, funds are more likely to vote with management if they are “busy” – i.e., there are a lot of other proposals that require fund managers’ attention – but they are not more likely to vote with management, no matter how busy they are, if the vote is a close call.  The voting behavior also suggests that index funds identify problem firms and continue to devote resources to them over time.

Anyway, that’s just a summary – there’s a lot here to dig into.

Should Retirement Funds Be Used To Pay Off Student Loans?

Senator Rand Paul has a new proposal out to (among other things) allow retirement savers to make tax-free withdrawals from their retirement accounts in order to pay down student loans.  The press release describes the plan this way:

As U.S. student loan debt hits its highest-ever levels, Dr. Paul’s HELPER Act would allow Americans to annually take up to $5,250 from a 401(k) or IRA — tax and penalty free — to pay for college or pay back student loans. These funds could also be used to pay tuition and expenses for a spouse or dependent. 

Why his office refers to him as Dr. Paul and not Senator Paul, I cannot fathom.  If I ever get elected to anything and start introducing legislation, I'm not going to be calling myself "Professor" in the press release.

For people paying down student loans, this could result in a substantial tax savings.  Think about it from the perspective of a person lucky enough to make good money and have the funds available to make significant contributions.  Routing funds through the 401(k) account would reduce taxable income and make it possible to pay $5,250 a year with pre-tax money. 

I'm not sure why we need to launder funnel through a 401(k) account. We could also deduct student loan payments (interest & principal) from income as well.  I'm not sure how necessary it is to use the 401k structure here.  If we want to simply make student loan repayment tax free, why put a cap on the amount that is tax and penalty free?  A cap creates an incentive to pay no more than the cap each year. If the thesis is that getting rid of higher interest rate debt early is a good idea, a cap may cause slower repayments.  

Consider a new doctor, heavily burdened with debt.  It may make sense to spend another year living like a resident and clear out the debt.  This is harder to do if higher tax brackets eat up much of the money earned.

Whether this proposal will, on balance, result in greater retirement savings at retirement, I do not know.  Its possible that some people may increase their 401(k) contributions to pipe student loan repayment money, tax-free, through these accounts.  Once the pipe is set up and running with a higher contribution level, they may continue those contributions after the student debt has been paid off.  On the other hand, some people might raid their retirements to get rid of student loan debt.

This may not be the best way to deal with student debt because it's an option that will only be available to those with retirement funds and accounts.  About half of Americans simply don't have any retirement savings.  If parents use their retirement funds to pay their children's tuition, it may simply reduce their retirement savings.  That being said, it might help some people and lead to better results for some savers than the status quo.  

ICYMI: #corpgov Midweek Roundup (Dec. 4, 2019)

"CEOs that signed on to Business Roundtable statement are still about maximizing profits in one revealing way—their statement on corporate wokeness says nothing about exorbitant CEO pay" https://t.co/pPVS9MvoJN #corpgov

— Stefan Padfield (@ProfPadfield) November 28, 2019

"Goodyear Dunlop Tires SA v. Brown, Daimler A.G. v. Bauman, & Bristol-Myers Squibb Co. v. Superior Court ... limited personal jurisdiction over foreign corporations based on similar foreign policy concerns as those expressed in Kiobel & Jesner" 21 U. Pa. J. Bus. L. 757 #corpgov

— Stefan Padfield (@ProfPadfield) December 1, 2019

"An appeal is pending at the 7th Circuit – the same court that in Walgreen embraced Trulia. A landmark decision could be in the offing, signalling the demise of mootness fees as a substitute for the peppercorn and fee settlements." #corpgov https://t.co/R62ulrnCFs

— Stefan Padfield (@ProfPadfield) November 29, 2019

"many battles have moved into the less visible universe of committee charters, corporate governance guidelines and other corporate internal policies" https://t.co/n1awGhxkiz

— Stefan Padfield (@ProfPadfield) December 2, 2019

"manufacturing and farming—have taken direct hits .... But in an era of severe worker shortages, people losing jobs when a plant or a farm closes are quickly getting scooped up by others" https://t.co/wXwC8Wx864 #corpgov

— Stefan Padfield (@ProfPadfield) November 29, 2019