Tuesday, January 22, 2019
In Business Organizations, I am in the early part of teaching agency and partnership. In my last class, we discussed Cargill, which is a fairly typical case to open agency discussions. I like Cargill, and I think it is a helpful teaching tool, but I think one needs to go beyond the case and facts to give a full picture of agency.
Of note, the case deals only with "actual agency" -- for whatever reason, the plaintiffs did not argue "apparent agency" or estoppel in the alternative. A. Gay Jenson Farms Co. v. Cargill, Inc., 309 N.W.2d 285, 290 n.6 (Minn. 1981) (“At trial, plaintiffs sought to establish actual agency by Cargill's course of dealing between 1973 and 1977 rather than 'apparent' agency or agency by estoppel, so that the only issue in this case is one of actual agency. ”). I think this explains a lot about how the case turns out. That is, the court recognized that to find for the farmer, there had to be an actual agency relationship.
I don't love this outcome because one of the hallmarks of an agency relationship is its reciprocal nature. That is, once we find an agency relationship, the principal is bound to the third party and the third party is bound to the principal. In contrast, in a case of estoppel, the principal may be bound (estopped from claiming there is not an agency relationship), but that finding only runs one way. The principal still cannot bind the third party.
This is a problem for me in Cargill. That is, I don't see a scenario where a court would bind the farmers to Cargill on similar facts. (I know I am not the first to make this observation, but it seemed worth exploring a bit.) As such, I don't think it can rightly be deemed an agency relationship.
Assume the facts from the case to show agency, but suppose instead Cargill was suing the farmers because the grain prices had increased dramatically and that the farmers had a contract with Warren (the purported agent) to deliver grain at $5/bushel. However, spot prices were now $15/bushel. Warren had not paid the farmers for a prior shipment and did not have the ability to pay now. If the contract is with Warren, the farmers should be able to now sell that grain in the market and take the extra $10/bushel for themselves. However, if Cargill were really the principal on that contract, Cargill would have a right to buy it at $5/bushel. I just don't see a court making such a ruling on these facts.
For what it's worth, I do think there is an estoppel argument here, and I think the Cargill court had ample facts to support finding Cargill a guarantor through other actions (promises to pay, name on checks, etc.), some of which might support an apparent authority argument, too. But because I don't see this relationship as an agency relationship as a two-way street, I don't think it can be an "actual agency" relationship.
Incidentally, I see this reciprocal nature test as proper for partnerships, too. That is, unless a court, on similar facts, would be willing to find a partnership where it works to the detriment of the plaintiffs, one cannot find a partnership. Think, for example, of another classic case, Martin v. Peyton, 246 N.Y. 213 (N.Y. 1927). There, creditors of the financial firm KNK sued KNK, as well as Peyton, Perkins, and Freeman (PPF) who had loaned KNK money. The claim was that PPF was not a mere lender, but had instead become partners of KNK because of the amount of control and profit sharing included in the loan arrangement. If PPF were deemed partners of KNK, of course, PPF would be liable to the KNK creditors. Here, the court determines that no partnership exists.
While a reasonably close call, I think this is right. I don't think, based on a similar set of facts, that a court would find for PPF if the dispute were such that finding a partnership between PPF and KNK would reduce the amount KNK would pay its investors. If it can't run both ways, the partnership cannot exist. I appreciate that in some cases, there simply is not a good analog to test the reciprocal nature of the relationship. But where it's possible, I think this is a good test to determine whether there really is an agency or partnership relationship or if, instead, what we really have is a sympathetic plaintiff.
Monday, December 3, 2018
On November 15, the Securities and Exchange Commission (SEC) convened a Roundtable on the Proxy Process. (See also here.) I have not been following this as closely as co-blogger Ann Lipton has (see recent posts here and here), but friend-of-the-BLPB, Bernie Sharfman (Chairman of the Main Street Investors Coalition Advisory Council) has been active as a comment source. Both contribute valuable ideas that I want to highlight here as the SEC continues to chew on the information it amassed in the roundtable process.
Ann, as you may recall, has been focusing attention on the uncertain status of proxy advisors when it comes to liability for securities fraud. In her most recent post, she observes that
There’s a real ambiguity about where, if it all, proxy advisors fit within the existing regulatory framework, and while I am not convinced there is a specific problem with how they operate or even necessarily a need for regulation, I think it can only be for the good if the SEC were to at least clarify the law, if for no other reason than that these entities play an important role in the securities ecosystem, and if we expect market pressure to discipline them, potential new entrants should have an idea of the regime to which they will be subject.
I remember having similar questions as to the possible fiduciary duties and securities fraud liability of funding portals under the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012 (a/k/a the CROWDFUND Act)--Title III of the Jumpstart Our Business Startups Act (a/k/a/, the JOBS Act). I wrote about these ambiguities (and other concerns) in this paper, published before the SEC adopted Regulation CF. I know Ann's right that we have clean-up to do when it comes to the status of securities intermediaries in various liability contexts (a topic co-blogger Ben Edwards also is passionate about--see, e.g., here and here).
Bernie has honed in on voting process issues relating to both proxy advisors (the standard for making voting recommendations and the use/rejection of the same) and mutual fund investment advisers (the disclosure of mutual fund adviser voting procedures and SEC's enforcement of the Proxy Voting Rule). Specifically, in an October 12 letter to the SEC, Bernie sets forth three proposals on proxy advisor voting recommendations. His bottom line?
Institutional investors have a fiduciary duty to vote. However, the use of uninformed and imprecise voting recommendations as provided by proxy advisors should not be their only option. They should always be in a position of making an informed vote, whether or not a proxy advisor can help in making them informed.
Earlier, in an October 8 letter to the SEC (Revised as of October 23, 2018), Bernie recommends mutual adviser disclosure of "the procedures they will use to deal with the temptation to use their voting power to retain or acquire more assets under management and to appease activists in their own shareholder base" and "the procedures they will use to identify the link between support for a shareholder proposal at a particular company and the enhancement of that company’s shareholder value." He also recommends that the SEC "should clarify that voting inconsistent with these new policies and procedures or omission of such policies and procedures will be considered a breach of the Proxy Voting Rule" and engage in "diligent" enforcement of the Proxy Voting Rule. I commend both letters to you.
Ann's and Bernie's proxy disclosure and voting commentary also reminds me of the importance of co-blogger Anne Tucker's work on the citizen shareholder (e.g., here). It will be interesting to see what the SEC does with the information obtained through the proxy process roundtable and the related comment letters. There certainly is much here to be explored and digested.
[Postscript, 12/4/2018: Bernie Sharfman notified me this morning of a third comment letter he has filed--on proxy advisor fiduciary duties. It seems he may have a fourth letter in the works, too. Look out for that. - JMH]
Wednesday, August 1, 2018
I am probably late to the game on this, but I just realized that Uber promotes their drivers as "driver-partners." It's even in their ads. This seems unwise.
Uber has a history linked to the question about whether their drivers are employees or independent contractors. But what about the question of whether Uber drivers are partners or independent contractors? That is big, potential liability conundrum.
Now, just because one says they are partners, that does not make it so, at least as to each other. The converse is also true -- saying expressly "this agreement does not form a partnership" does not necessarily mean a court won't find one. See, e.g., Martin v. Peyton, 158 N.E. 77 (NY 1927) ("Statements that no partnership is intended are not conclusive."). But, as to third parties, at a minimum, affirmative statements that one is a partner, can create liability for those involved. The Uniform Partnership Act (1914) § 16. Partner by Estoppel, provides:
(1) When a person, by words spoken or written or by conduct, represents himself, or consents to another representing him to any one, as a partner in an existing partnership or with one or more persons not actual partners, he is liable to any such person to whom such representation has been made, who has, on the faith of such representation, given credit to the actual or apparent partnership, and if he has made such representation or consented to its being made in a public manner he is liable to such person, whether the representation has or has not been made or communicated to such person so giving credit by or with the knowledge of the apparent partner making the representation or consenting to its being made.
(a) When a partnership liability results, he is liable as though he were an actual member of the partnership.
(b) When no partnership liability results, he is liable jointly with the other persons, if any, so consenting to the contract or representation as to incur liability, otherwise separately.
Similarly, the Revised Uniform Partnership Act provides:
SECTION 308. LIABILITY OF PURPORTED PARTNER.
(a) If a person, by words or conduct, purports to be a partner, or consents to being represented by another as a partner, in a partnership or with one or more persons not partners, the purported partner is liable to a person to whom the representation is made, if that person, relying on the representation, enters into a transaction with the actual or purported partnership. If the representation, either by the purported partner or by a person with the purported partner’s consent, is made in a public manner, the purported partner is liable to a person who relies upon the purported partnership even if the purported partner is not aware of being held out as a partner to the claimant. If partnership liability results, the purported partner is liable with respect to that liability as if the purported partner were a partner. If no partnership liability results, the purported partner is liable with respect to that liability jointly and severally with any other person consenting to the representation.
Now, can I come up with plenty of counterarguments and ways to make this liability less likely, and those are compelling arguments, too, in many settings. However, I cannot come up with such a good argument that would make it worth using "Driver-Partner" as my term. How about "Driver-Teammate" or "Driver-Affiliate" or "Driver-Collaborator" or even "Driver-Member?" For me, the specificity of the term "partner," and the liability that can follow without formal action, would warrant avoiding its use. But maybe that's just me.
Tuesday, June 26, 2018
Call for Papers for
Section on Agency, Partnership, LLCs and Unincorporated Associations on
Respecting the Entity: The LLC Grows Up
at the 2019 AALS Annual Meeting
The AALS Section on Agency, Partnership, LLCs and Unincorporated Associations is pleased to announce a Call for Papers from which up to two additional presenters will be selected for the section’s program to be held during the AALS 2019 Annual Meeting in New Orleans on Respecting the Entity: The LLC Grows Up. The program will explore the evolution of the limited liability company (LLC), including subjects such as the LLCs rise to prominence as a leading entity choice (including public LLCs and PLLCs), the role and impact of series LLCs, and differences in various LLC state law rights and obligations. The program will also consider ethics and professional responsibility and governance raised by the LLC. The Section is particularly seeking papers that discuss the role of the LLC as a unique entity (or why it is not).
The program is tentatively scheduled to feature:
- Beth Miller, M. Stephen and Alyce A. Beard Professor of Business and Transactional Law, Baylor Law
- Tom Rutledge, Member, Stoll Keenon Ogden PLLC, Louisville, KY
Our Section is proud to partner with the following co-sponsoring sections:
- AALS Section on Business Associations
- AALS Section on Transactional Law and Skills
Please submit an abstract or draft of an unpublished paper to Joshua Fershee,Joshua.Fershee@mail.wvu.edu on or before August 1, 2018. Please remove the author’s name and identifying information from the paper that is submitted. Please include the author’s name and contact information in the submission email.
Papers will be selected after review by members of the Executive Committee of the Section. Authors of selected papers will be notified by August 25, 2018. The Call for Paper presenters will be responsible for paying their registration fee, hotel, and travel expenses.
Any inquiries about the Call for Papers should be submitted to: Joshua Fershee, West Virginia University College of Law, Joshua.Fershee@mail.wvu.edu or (304) 293-2868.
Monday, January 15, 2018
William Morris Endeavor and the Wahlberg/Williams Pay Disparity: A Role for Agency Law in Equality and Justice?
“Injustice anywhere is a threat to justice everywhere.”
Martin Luther King, Jr., Letter from Birmingham Jail, Alabama, 16 April 1963, in Atlantic Monthly August 1963
I had wanted to post a tribute to Dr. King here early on Monday. However, after posting the Emory conference announcement, I moved on to other work, and that work filled up the available time in the day. So, this late post including the quote above will have to suffice.
As I read meaningful quotes from Dr. King on social media and elsewhere all day on Monday, I found myself thinking of examples of inequality and injustice. Many are compelling; many are meaningful. Some are current events; and some of those involve business law questions.
For a number of days now (since before MLK Day) we have been showered with news stories relating to the compensation disparity between Mark Wahlberg and Michelle Williams for reshooting scenes from All the Money in the World in the wake of Kevin Spacey's replacement in the film resulting from allegations of sexual misconduct. (See here, among other places.) Most folks who follow Hollywood business issues know that gender discrimination is common. My sister, a visual effects producer (her current movie is Downsizing, which I enjoyed and recommend), has suffered the effects.
But I found myself focusing on the role of William Morris Endeavor Entertainment LLC (WME), the talent agency that represented both Wahlberg and Williams. Talent agents are regulated by guilds and unions as well as under California law (as represented here). But they also have fiduciary duties. Why did Wahlberg's contract not include a reshoot covenant (giving him the leverage to negotiate an outsized reshoot fee) while Williams's contract did? Did WME fail to act in a manner consistent with any applicable duty of care--or maybe loyalty--as an experienced agent representing both actors--with knowledge of an overall gender pay gap? Of course, there are many other possible explanations for the difference, and we are not privy to the terms of the two actors' talent contracts with WME (including any enforceable private ordering around agency law rules or confidentiality or privacy clauses). But the related questions seem worth asking.
Specifically, we might ask whether there is a question of WME's care, competence, or diligence under Section 8.08 of the Restatement (Third) of Agency. And, among other things, Section 8.11 of the Restatement (Third) of Agency imposes a duty of candor on agents that may be applicable here. And were there differences in the benefits that WME got out of each agreement that may have affected the firm's ability to act loyally for the principal's benefit under Section 8.01 of the Restatement (Third) of Agency? We may never know.
Intermediation likely cannot cure the evils of inequality and injustice. But where intermediaries are agents or otherwise owe fiduciary duties to their clients, those fiduciary duties may cause--or at least incentivize--the intermediaries to use their experience and knowledge to correct gender, racial, and other inequities where they exist. This is something I will continue to ponder.
Saturday, May 20, 2017
Loyalty has been in the news lately. The POTUS, according to some reports, asked former Federal Bureau of Investigation ("FBI") Director James Comey to pledge his loyalty. Assuming the basic veracity of those reports, was the POTUS referring to loyalty to the country or to him personally? Perhaps both and perhaps, as Peter Beinart avers in The Atlantic, the POTUS and others fail to recognize a distinction between the two. Yet, identifying the object of a duty can be important.
I have observed that the duty of government officials is not well understood in the public realm. Donna Nagy's fine work on this issue in connection with the proposal of the Stop Trading on Congressional Knowledge ("STOCK") Act, later adopted by Congress, outlines a number of ways in which Congressmen and Senators, among others, may owe fiduciary duties to others. If you have not yet been introduced to this scholarship, I highly recommend it. If we believe that government officials are entrusted with information, among other things, in their capacity as public servants, they owe duties to the government and its citizens to use that information in authorized ways for the benefit of that government and those citizens. In fact, Professor Nagy's congressional testimony as part of the hearings on the STOCK Act includes the following in this regard:
Given the Constitution's repeated reference to public offices being “of trust,” and Members’ oath of office to “faithfully discharge” their duties, I would predict that a court would be highly likely to find that Representatives and Senators owe fiduciary-like duties of trust and confidence to a host of parties who may be regarded as the source of material nonpublic congressional knowledge. Such duties of trust and confidence may be owed to, among others:
- the citizen-investors they serve;
- the United States;
- the general public;
- Congress, as well as the Senate or the House;
- other Members of Congress; and
- federal officials outside of Congress who rely on a Member’s loyalty and integrity.
There is precious little in federal statutes, regulations, and case law on the nature--no less the object--of any fiduciary the Director of the FBI may have. The authorizing statute and regulations provide little illumination. Federal court opinions give us little more. See, e.g., Banks v. Francis, No. 2:15-CV-1400, 2015 WL 9694627, at *3 (W.D. Pa. Dec. 18, 2015), report and recommendation adopted, No. CV 15-1400, 2016 WL 110020 (W.D. Pa. Jan. 11, 2016) ("Plaintiff does not identify any specific, mandatory duty that the federal officials — Defendants Hornak, Brennan, and the FBI Director— violated; he merely refers to an overly broad duty to uphold the U.S. Constitution and to see justice done."). Accordingly, any applicable fiduciary duty likely would arise out of agency or other common law. Section 8.01 of the Restatement (Third) of Agency provides "An agent has a fiduciary duty to act loyally for the principal's benefit in all matters connect with the agency relationship."
But who is the principal in any divined agency relationship involving the FBI Director?
Monday, August 29, 2016
Monday, June 13, 2016
This past week, I completed the second leg of my June Scholarship and Teaching Tour. My time at "Method in the Madness: The Art and Science of Teaching Transactional Law and Skills" at Emory University School of Law last week was two days well spent. I had a great time talking to attendees about my bylaw drafting module for our transaction simulation course, Representing Enterprises, and listening to others talk about their transactional law and skills teaching. Great stuff.
This week's portion of my academic tour begins with a teaching whistle-stop at the Nashville School of Law on Friday, continues with attendance (with my husband) at a former student's wedding in Nashville on Saturday evening, and ends (my husband and I hope) with Sunday brunch out with our son (and his girlfriend if she is available). Specifically, on Friday, I teach BARBRI for four hours in a live lecture. The topics? Well, I drew a short straw on that. I teach agency, unincorporated business associations (including a bit about both extant limited liability statutes in Tennessee), and personal property--all in four hours. Ugh. Although I am paid for the lecture and my expenses are covered, I would not have taken (and would not continue to take) this gig if I didn't believe that I could be of some help to students. These topics--especially agency and partnership law, but also personal property--often are tested on the bar exam. So, on I press.
I also am completing work this week on the draft article that I will present in Chicago and Seattle on the last two stops of my tour. I will say more about that article in next week's post. In the mean time, let me know if you have any suggestions (or good jokes) on the law of agency, partnerships, LLCs, or personal property (e.g., tenancies, gifts, bailments, adverse possession, replevin) for my lecture on Friday . . . . It's so hard to make these speed-lectures somewhat engaging for the students. [sigh]
Monday, May 16, 2016
OK. I count 17 Form C filings (not including a few amended filings, two of which are noted below) on "Day 1" of U.S securities crowdfunding. Not a bad showing for the first day out, in my view.
First in line? Bloomery Investment Holdings, LLC with an offering of LLC interests on StartEngine Capital LLC. The firm filed its Form C a bit after 6:30 AM. Early risers! Eager beavers! (Maybe too eager, since an amendment was filed less than two hours later--apparently because the attendant Form C .pdf was rejected in the initial filing.) The firm's subsidiary is a moonshine-based liqueur producer. At this writing, $11,700 of the target threshold funding of $300,000 (1000 units at $300 per unit) has been committed--$288,300 to go! ($600 came in while I was typing this post.) And it looks like the base of operations is in West Virginia, Josh! Do you know these folks? (Slogan: "Take a Shot on Us.")
StarEngine also is hosting another crowdfunded offering filed today. The issuer on this offering, GameTree PBC (yes, Haskell, a public benefit corporation!), a social network for gamers based in Solana Beach, California. GameTree is selling common stock at $2 per share and has set a threshold funding target of $100,000. As of this writing, the firm had raised $8,360--$91,640 to go. The Form C filing for this offering also was amended. The reason? "Needed to re-upload campaign screen shots. First upload did not work." So, it seems there may be some glitches--or at least propensities for operator error.
This is pure spectator sport for me right now. I am interested to see that issuers are actually fling and that offerings are attracting some financing commitments. But some of what I am reading is pretty funny stuff. I don't have time to do a play-by-play on any of these filings (too busy a week this week). I must admit that I am especially amused by this "financial risk factor" in the GameTree materials:
Management has no experience managing companies with publicly traded securities.
The legal issues related to public securities are Byzantine and myriad. While it is our intention to follow the law as we understand it and seek the advice necessary to follow best practices, we recognize that mistakes with negative financial results to investors can occur. Crowdfunding is a new method for raising capital and laws are quickly changing and evolving. Changes in securities law may void and/or alter equity arrangements with shareholders.
I just had to quote that one here . . . . I nearly fell off my chair laughing. And here is the GameTree risk factor on benefit corporation status, so Haskell can have something to look at and consider:
GameTree is a public benefit corporation and thus may engage in activities in pursuit of its public benefit at the expense of financial gain.
Unlike traditional corporations in which operations and business goals are tied exclusively to the pursuit of profit, GameTree may also take actions in alignment with its stated public benefit at the expense of profit maximization. It is still a forprofit corporation in distinction from a charitable nonprofit which has a benefit as its sole purpose.
These disclosures are not what I would've drafted in either case. But neither disclosure is inaccurate, in my view. And each is relatively simple.
It will be interesting to continue to look at some of the SEC filings and related online disclosures as time passes. I hope to be able to devote additional time to that after I have finished grading exams and papers. In the mean time, I would enjoy reading your reactions here.
Monday, November 16, 2015
Daniel Kleinberger: Delineating Delaware’s Implied Covenant of Good Faith & Fair Dealing (Contract Is King Micro-sympsium)
Guest post by Daniel Kleinberger:
Part I - Introduction
My postings this week will seek to delineate Delaware’s implied contractual covenant of good faith and fair dealing and the covenant’s role in Delaware entity law
An obligation of good faith and fair dealing is implied in every common law contract and is codified in the Uniform Commercial Code (“U.C.C”). The terminology differs: Some jurisdictions refer to an “implied covenant;” others to an “implied contractual obligation;” still others to an “implied duty.” But whatever the label, the concept is understood by the vast majority of U.S. lawyers as a matter of commercial rather than entity law. And, to the vast majority of corporate lawyers, “good faith” does not mean contract law but rather conjures up an important aspect of a corporate director’s duty of loyalty.
Nonetheless, Delaware’s “implied contractual covenant of good faith and fair dealing” has an increasingly clear and important role in Delaware “entity law” – i.e., the law of unincorporated business organizations (primarily limited liability companies and limited partnerships) as well as the law of corporations.
Because to the uninitiated “good faith” can be frustratingly polysemous, this first blog “clears away the underbrush” by explaining what Delaware’s implied covenant’s “good faith” is not.
Part II – A Couple of Major “Nots”
- Not the Looser Approach of the Uniform Commercial Code
The Uniform Commercial Code codifies the common law obligation of good faith and fair dealing for matters governed by the Code: “Every contract or duty within [the Uniform Commercial Code] imposes an obligation of good faith in its performance and enforcement.” The Code defines “good faith” as “mean[ing] [except for letter of credit matters] honesty in fact and the observance of reasonable commercial standards of fair dealing.” An official comment elaborates: “Although ‘fair dealing’ is a broad term that must be defined in context, it is clear that it is concerned with the fairness of conduct rather than the care with which an act is performed.”
The UCC standard thus incorporates facts far beyond the words of the contract at issue and furthers a value (fairness) which in the entity context is usually the province of fiduciary duty. The UCC definition provides some constraint by referring to “reasonable commercial standards,” but “[d]etermining . . . unreasonableness inter se owners of an organization is a different task than doing so in a commercial context, where concepts like ‘usages of trade’ are available to inform the analysis.” ULLCA (2013) § 105(e), cmt.
The Delaware Supreme Court has flatly rejected the U.C.C. approach for Delaware unincorporated businesses.
- Not the Corporate Good Faith of Disney, Stone v. Ritter, and Caremark
An obligation to act in good faith has long been part of a corporate director’s duty under Delaware law, but the concept became ever more important following the landmark case of Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). In Van Gorkom, the Delaware Supreme Court held directors liable for gross negligence in approving a merger transaction, a holding that “shocked the corporate world.”
Spurred by the Delaware corporate bar, the Delaware legislature promptly amended Delaware’s corporate statute. The amendment permits Delaware corporations to essentially opt out of the Van Gorkom rule. The now famous Section 102(b)(7) authorizes a Delaware certificate of incorporation to:
eliminat[e] or limit the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty …, provided that such provision shall not eliminate or limit the liability of a director: (i) For any breach of the director's duty of loyalty to the corporation or its stockholders; [or] (ii) for acts or omissions not in good faith….
In effect, the provision authorizes exculpation from damages arising from claims of director negligence, but for some time the exception “for acts or omissions not in good faith” was controversial. Where plaintiffs could not allege breach of the duty of loyalty, they sought to equate “not in good faith” with extreme negligence.
Notably, the meaning of “not in good faith” was pivotal in the lengthy and costly litigation arising from the Disney corporation’s termination of Michael Ovitz. However, the Supreme Court’s decision in In re Walt Disney Co. Derivative Litig. left the issue murky. Eventually, in Stone v. Ritter, the court made clear that in this context “good faith” is an aspect of the duty of loyalty. The Court then equated a lack of this type of good faith with a director’s utter failure to attend to his or her oversight obligations (the so-called Caremark I duties).
Thus, a Delaware director’s fiduciary duty of good faith has nothing to do with the “good faith” of the Delaware implied covenant of good faith and fair dealing.
This posting is derived from Daniel S. Kleinberger, “Delaware’s Implied Contractual Covenant of Good Faith and “Sibling Rivalry” Among Equity Holders,” a paper presented at the 21st Century Commercial Law Forum: 15th International Symposium in Beijing, at Tsinghua University’s School of Law, November 1, 2015 (all footnotes and most citations omitted).
Tuesday, April 28, 2015
Last week, the Deal Professor, Steven Davidoff Solomon, wrote an article titled, The Boardroom Strikes Back. In it, he recalls that shareholder activists won a number of surprising victories last year, and more were predicted for this year. That prediction made sense, as activists were able to elect directors 73% of the time in 2014. This year, though, despite some activist victories, boards are standing their grounds with more success.
I have no problem with shareholders seeking to impose their will on the board of the companies in which they hold stock. I don't see activist shareholder as an inherently bad thing. I do, however, think it's bad when boards succumb to the whims of activist shareholders just to make the problem go away. Boards are well served to review serious requests of all shareholders, but the board should be deciding how best to direct the company. It's why we call them directors.
As the Deal Professor notes, some heavy hitters are questioning the uptick in shareholder activism:
Some of the big institutional investors are starting to question the shareholder activism boom. Laurence D. Fink, chief executive of BlackRock, the world’s biggest asset manager, with $4 trillion, recently issued a well-publicized letter that criticized some of the strategies pushed by hedge funds, like share buybacks and dividends, as a “short-termist phenomenon.” T. Rowe Price, which has $750 billion under management, has also criticized shareholder activists’ strategies. They carry a big voice.
I am on record being critical of boards letting short-term planning be their primary filter, because I think it can hurt long-term value in many instances. I don't, however, think buybacks or dividends are inherently incorrect, either. Whether the idea comes from an activist shareholder or the board doesn't really matter to me. The board just needs to assess the idea and decide how to proceed.
[Please click below to read more.]
Friday, November 14, 2014
The Supreme Court of Wyoming recently decided to pierce the limited liability veil of a single-member LLC. Green Hunter Wind Energy, LLC (LLC), had a single member: Green Hunter Energy, Inc. (Corp). LLC entered into a services contract with Western Ecosystems Technology, Inc. (Western). The court determined that veil piercing – thus allowing Western to recover LLC’s debts from Corp – was appropriate for several reasons. I think the court got this wrong. The case can be accessed here (pdf).
The court provides the following rule for piercing the veil of a limited liability company, providing three basic factors 1) fraud; 2) undercapitalization; and 3) “intermingling the business and finances of the company and the member to such an extent that there is no distinction between them.” The court noted that the failure to following company formalities was recently dropped as a factor by changes to the state LLC statute.
Here’s where the court goes wrong:
(1) As to undercapitalization, the court completely ignores the fact that Western freely contracted with the LLC with little to no cash. If Western wanted the parent Corp to be a guarantor, it could have required that. If Western thought LLC was acting as an agent for Corp, Western should have claimed that. It seems to me this is directly analogous to an actual parent-child relationship. Western contracted with adult (but penniless) child. Child didn't have money when the contract was signed or when the bill was submitted. Western then calls parent and says, "Pay up." Western is free to call, but parent can say, “No. You dealt with my kid, not me, and I didn't agree to this debt.”
(2) There is a better argument this should be different if this were a tort suit where Western did not choose to engage with the LLC, but that's not the case here. I don't see how Western can claim undercapitalization now when they had the opportunity to ask before the contract was formed. Western is the least cost avoider here and assumed the risk of dealing with a lightly capitalized company. It seems to me that should be part of the assessment. Undercapitalization is, as the court notes, “a relative concept.” The court cites potential abuse of LLC laws if they were to adopt such a rule that motivates companies to ask for guarantees. instead adopting a rule that could incentivize companies like Western actively avoid ask ingfor guarantees. Why? Because if you ask for a guarantee and are refused, it could be used against you later. But if you don’t ask, you may get to piece the veil and seek a windfall recovery by getting a post hoc guarantee that was not available via negotiation.
The court’s rationale is as follows:
It makes good business sense for a contract creditor to try to obtain a guarantee from the member or retainer from the limited liability company itself. But we are mindful of the reality of the marketplace that many businesses are not in a position—competitively or economically—to insist on guarantees. For that reason, we decline Appellant’s invitation to find piercing inappropriate in this case because Western did not protect itself from Appellant’s misuse of the LLC by attempting to obtain a guarantee or other form of security. To do so would invite abuse of entities, as is the case here.
No way. If you can’t “competitively or economically” secure a guarantee, then too bad. If the legislature wants to create guarantees or minimum capitalization requirements for all entities, fine. Otherwise, this is absurd.
(3) Further, Court state that "the district court correctly concluded that the LLC 'failed to adequately capitalize the LLC, that LLC was undercapitalized at all times relevant to this suit and the LLC lacks corporate assets." Wrong. Again, if Western knew the finances of LLC at the time of contracting (as it could and should have), then it wasn’t undercapitalized. LLC simply existed and Western did not seek to avoid the risk of dealing with such an entity.
More important, though LLCs cannot have “corporate assets.” It’s a limited liability company, not a corporation. Sheesh. I’ll add this one to my list of courts getting LLC distinctions wrong. (See, e.g., here, here, here, and here.) I would have loved to see the Supreme Court correct the district court on that, at least.
(4) The court incorrectly suggests that the tax filings of the parent corporation and a subsidiary LLC can be a factor in the veil piercing analysis. Sorry, but no. For a single-member LLC, for federal tax purposes, the LLC will probably be a disregarded entity. As such, the LLC will usually (if not always) look like part of the parent corporation. To even consider the tax filing necessarily makes one factor weigh toward piercing. That’s wrong.
Early in the opinion, the court notes, “Piercing seems to happen freakishly. Like lightning, it is rare, severe, and unprincipled.” (quoting Frank H. Easterbrook & Daniel R. Fischel, Limited Liability and the Corporation, 52 U. Chi. L. Rev. 89 (1985) (internal quotation marks omitted)). In this case the court seems to be trying to make veil-piercing law in LLCs more predictable. I’m concerned they are – they are making is more likely the veil piecing will occur, at least in the single-member LLC context. To the extent we’re going to allow single-member LLCs, that’s unfortunate.
Tuesday, August 19, 2014
At West Virginia University College of Law, we started classes yesterday, and I taught my first classes of the year: Energy Law in the morning and Business Organizations in the afternoon. As I do with a new year coming, I updated and revised my Business Organizations course for the fall. Last year, I moved over to using Unicorporated Business Entities, of which I am a co-author. I have my own corporations materials that I use to supplement the book so that I cover the full scope of agency, partnerships, LLCs, and corporations. So far, it's worked pretty well. I spent several years with Klein, Ramseyer and Bainbridge's Business Associations, Cases and Materials on Agency, Partnerships, and Corporations (KRB), which is a great casebook, in its own right.
I did not make the change merely (or even mostly) because I am a co-author. I made the change because I like the structure we use in our book. I had been trying to work with KRB in my structure, but this book is designed to teach in with the organization I prefer, which is more topical than entity by entity. I'll note that a little while ago, my co-blogger Steve Bradford asked, "Are We Teaching Business Associations Backwards?" Steve Bainbridge said, "No." He explained,
I've tried that approach twice. Once, when I was very young, using photocopied materials I cut and pasted from casebook drafts the authors kindly allowed me to use. Once by jumping around Klein, Ramseyer, and Bainbridge. Both times it was a disaster. Students found it very confusing (and boy did my evaluations show it!). It actually took more time than the entity by entity approach, because I ended up having to do a lot of review (e.g., "you'll remember from 2 weeks ago when we discussed LLCs most recently that ...."). There actually isn't all that much topic overlap. Among corporations, for example, you've got the business judgment rule, derivative suits, "duty" of good faith, executive compensation, the special rules for close corporations, proxies, and so on, most of which either don't apply to LLCs etc.... or don't deserve duplicative treatment.
I have great respect for Prof. Bainbridge, and his writing has influenced me greatly, but (not surprisingly), I come out more closely aligned with my perception of Larry Ribstein on such issues, and with Jeff Lipshaw, who commented,
I disagree about the lack of topic overlap, and suspect Larry Ribstein is raging about this in BA Heaven right now. . . .
This may reflect differences among student populations, but the traditional corporate law course, focusing primarily on public corporations, is less pertinent in many schools where students are unlikely to be doing that kind of work when they graduate. It's far more likely that they'll need to be able to explain to a client why the appropriate business form is a corporation or an LLC, and what the topical differences between them are.
I completely agree, and I would go another step to say that I find the duplication to be a valuable reinforcement mechanism that is worth (what I have seen as limited) extra time. I am teaching a 4-credit course, though, which gives me time I never had in my prior institution's 3-credit version.
One thing I am doing differently this year is my first assignment, which seeks to build on what I see as a need for students here. That is, I think many of them will need to be able to explain entity differences and help clients select the right option.
I had my students fill out the form for a West Virginia Limited Liability Company (PDF here). I had a few goals. First, I don't like to have students leave any of my classes without handling at least some of the forms or other documents they are likely to encounter in practice. Second, I did it without any instruction this time (I have used similar forms later in the course) because I thought it would help me tee up an introduction to all this issues I want them thinking about with regard to entity choice. (It did.) Finally, I like getting students to see the connection between the form and the statute. We can link though and see why the form requires certain issues, discuss waivable and nonwaivable provisions, and talk about things like entity purpose, freedom of contract, and the limits of limited liability.
If nothing else, the change kept things fresh for me. I welcome any comments and suggestions on any of this, and I wish everyone a great new academic year.
Tuesday, March 25, 2014
(1) As I explained here, entities should be able to take on a racial, religious, or gender identity in discrimination claims. I would add that I feel similarly about sexual orientation, but (though I think it should be) that is still not generally federally protected. To the extent the law otherwise provides a remedy, I’d extend it to the entity.
(2) It is reasonable to inquire, why is discrimination different than religious practice? For me, I just don’t think religious exercise by an entity is the same as extending discrimination protection to an entity. There is something about the affirmative exercise of religion that I don’t think extends well to an entity. That is, discrimination happens to a person or an entity. Religious practice is an affirmative act that is different. Basically, reification of the entity to the point of religious practice crosses a line that I think is unnecessary and improper because discrimination protection should be sufficient.
As a follow up to that, I also think it's a reasonable question to ask: Why is religion different than speech? To me it is different because entities must speak, but entities don’t have to practice religion. The entity needs speech to conduct business. A public entity speaks in its public filings. Speech is not just something an entity could do. It is something it must do. Religion, at the entity level is not necessary.
(3) Reverse piercing is not as good a solution as it might appear. Professor Bainbridge suggests that reverse veil piercing is one way in which the religion of the shareholders could be used to justify extending a religious identity to the Hobby Lobby entity, thus allowing the entity to object to certain provisions of the federal healthcare mandate. His argument is, as usual, reasonable and plausible. Still, as explained above, I don't think this is necessary.
More important, though, I don’t like expanding the use of any form of veil piercing. Veil piercing is supposed to be used (at least in my view) solely as a heightened level of fraud protection. It is already used too often and too haphazardly, and further degradation of the line between the entity and others is a dangerous proposition, regardless of the purpose. That is, as people (and courts) get more comfortable with disregarding the entity, they are more likely to disregard the entity. As a general proposition, I think that’s a bad outcome. That alone is reason enough for me to hope the Court will pass on reverse veil piercing as a potential remedy.
Monday, March 3, 2014
Business law has a broad overlap with tax, accounting, and finance. Just how much belongs in a law school course is often a challenge to determine. We all have different comfort levels and views on the issue, but incorporating some level of financial literacy is essential. Fortunately, a more detailed discussion of what to include and how to include it is forthcoming. Here's the call:
Call For Papers
AALS Section on Agency, Partnerships LLCs, and Unincorporated Associations
Bringing Numbers into Basic and Advanced Business Associations Courses: How and Why to Teach Accounting, Finance, and Tax
2015 AALS Annual Meeting Washington, DC
Business planners and transactional lawyers know just how much the “number-crunching” disciplines overlap with business law. Even when the law does not require unincorporated business associations and closely held corporations to adopt generally accepted accounting principles, lawyers frequently deal with tax implications in choice of entity, the allocation of ownership interests, and the myriad other planning and dispute resolution circumstances in which accounting comes into play. In practice, unincorporated business association law (as contrasted with corporate law) has tended to be the domain of lawyers with tax and accounting orientation. Yet many law professors still struggle with the reality that their students (and sometimes the professors themselves) are not “numerate” enough to make these important connections. While recognizing the importance of numeracy, the basic course cannot in itself be devoted wholly to primers in accounting, tax, and finance.
The Executive Committee will devote the 2015 annual Section meeting in Washington to the critically important, but much-neglected, topic of effectively incorporating accounting, tax, and finance into courses in the law of business associations. In addition to featuring several invited speakers, we seek speakers (and papers) to address this subject. Within the broad topic, we seek papers dealing with any aspect of incorporating accounting, tax, and finance into the pedagogy of basic or advanced business law courses.
Any full-time faculty member of an AALS member school who has written an unpublished paper, is working on a paper, or who is interested in writing a paper in this area is invited to submit a 1 or 2-page proposal by May 1, 2014 (preferably by April 15, 2014). The Executive Committee will review all submissions and select two papers by May 15, 2014. A very polished draft must be submitted by November 1, 2014. The Executive Committee is exploring publication possibilities, but no commitment on that has been made. All submissions and inquiries should be directed to Jeff Lipshaw, Chair.
Jeffrey M. Lipshaw
Suffolk University Law School
Click here for contact info
Sunday, January 19, 2014
Donna M. Nagy recently posted “Owning Stock While Making Law: An Agency Problem and A Fiduciary Solution” on SSRN. Here is the abstract:
This Article focuses on Members of Congress and their widespread practice of holding personal investments in companies that are directly and substantially affected by legislative action. Whether entirely accurate or not, congressional officials with investment portfolios chock full of corporate stocks and bonds contribute to a corrosive belief that lawmakers can – and sometimes do – place their personal financial interests ahead of the public they serve.
Fiduciary principles provide a practical solution to this classic agency problem. The Article first explores the loyalty-based rules that guard against self-interested decision-making by directors of corporations and by government officials in the executive and judicial branches of the federal government. It then contrasts the strict anti-conflict restraints in state corporate law and federal conflicts-of-interest statutes with the very different set of ethical rules and norms that Congress traditionally has applied to the financial investments held by its own members and employees. It also confronts the parochial view that lawmakers’ conflicts are best deterred through public disclosure of personal investments and the discipline of the electoral process. The Article concludes with a proposal for new limitations on the securities that lawmakers may hold during their congressional service. Specifically, and as a starting place, Congress should prohibit its members (and their staffs) from holding securities in companies substantially affected by the work of any congressional committee on which they hold membership. But Congress should also explore the adoption of even stricter anti-conflict restraints, such as a statute or rule that would, subject to some narrow exceptions, prohibit members and senior staff officials from owning any securities other than government securities or shares in diversified mutual funds.
Saturday, January 18, 2014
My Akron colleague Will Huhn just posted “2013-2014 Supreme Court Term: Court's Decision in Daimler AG v. Bauman, No. 11-965: Implications for the Birth Control Mandate Cases?” over at his blog wilsonhuhn.com. Here is a brief excerpt, but you should go read the entire post:
On January 14, 2014, the Supreme Court issued its decision in favor of Daimler AG (the maker of Mercedes-Benz), ruling that the federal courts in California lacked personal jurisdiction over Daimler to adjudicate claims for human rights violations arising in Argentina. The ruling of the Court may have implications for the birth control mandate cases pending before the Court in Hobby Lobby Stores and Conestoga Wood Specialties…. In those cases the owners of two private, for-profit business corporations contend that their individual rights to freedom of religion "pass through" to the corporation -- that the corporations are in effect the "agents" of the principal shareholders, and that this is why the corporations have the right to deny their employees health insurance coverage for birth control. In Daimler the Ninth Circuit Court of Appeals had held that MBUSA was the "agent" of Daimler AG, and that the substantial business presence of MBUSA in California could be imputed to Daimler AG. The Supreme Court was not persuaded by this agency analysis…. It would be anomalous for the Court to adhere to corporate identity for purposes of personal jurisdiction and liability for tort, and yet to ignore corporate identity to give effect to the personal religious choices of stockholders.
Saturday, December 28, 2013
Sitkoff explains why “a mandatory fiduciary core is ... reconcilable with an economic theory of fiduciary law.”
Robert H. Sitkoff recently posted “An Economic Theory of Fiduciary Law” on SSRN. Here is the abstract:
This chapter restates the economic theory of fiduciary law, making several fresh contributions. First, it elaborates on earlier work by clarifying the agency problem that is at the core of all fiduciary relationships. In consequence of this common economic structure, there is a common doctrinal structure that cuts across the application of fiduciary principles in different contexts. However, within this common structure, the particulars of fiduciary obligation vary in accordance with the particulars of the agency problem in the fiduciary relationship at issue. This point explains the purported elusiveness of fiduciary doctrine. It also explains why courts apply fiduciary law both categorically, such as to trustees and (legal) agents, as well as ad hoc to relationships involving a position of trust and confidence that gives rise to an agency problem.
Second, this chapter identifies a functional distinction between primary and subsidiary fiduciary rules. In all fiduciary relationships we find general duties of loyalty and care, typically phrased as standards, which proscribe conflicts of interest and prescribe an objective standard of care. But we also find specific subsidiary fiduciary duties, often phrased as rules, that elaborate on the application of loyalty and care to commonly recurring circumstances in the particular form of fiduciary relationship. Together, the general primary duties of loyalty and care and the specific subsidiary rules provide for governance by a mix of rules and standards that offers the benefits of both while mitigating their respective weaknesses.
Finally, this chapter revisits the puzzle of why fiduciary law includes mandatory rules that cannot be waived in a relationship deemed fiduciary. Committed economic contractarians, such as Easterbrook and Fischel, have had difficulty in explaining why the parties to a fiduciary relationship do not have complete freedom of contract. The answer is that the mandatory core of fiduciary law serves a cautionary and protective function within the fiduciary relationship as well as an external categorization function that clarifies rights for third parties. The existence of a mandatory fiduciary core is thus reconcilable with an economic theory of fiduciary law.
Sunday, November 10, 2013
Martin Gelter & Geneviève Helleringer posted “Constituency Directors and Corporate Fiduciary Duties” on SSRN a few weeks ago, and I’m finally getting around to passing on the abstract:
In this chapter, we identify a fundamental contradiction in the law of fiduciary duty of corporate directors across jurisdictions, namely the tension between the uniformity of directors’ duties and the heterogeneity of directors themselves. Directors are often formally or informally selected by specific shareholders (such as a venture capitalist or an important shareholder) or other stakeholders of the corporation (such as creditors or employees), or they are elected to represent specific types of shareholders (e.g. minority investors). In many jurisdictions, the law thus requires or facilitates the nomination of what has been called “constituency” directors. Legal rules tend nevertheless to treat directors as a homogeneous group that is expected to pursue a uniform goal. We explore this tension and suggest that it almost seems to rise to the level of hypocrisy: Why do some jurisdictions require employee representatives that are then seemingly not allowed to strongly advocate employee interests? Looking at US, UK, German and French law, our chapter explores this tension from the perspective of economic and behavioral theory.
Friday, October 18, 2013
Really great piece by Justin Fox on “What We’ve Learned from the Financial Crisis” over at the Harvard Business Review. What follows is a brief excerpt, but you'll want to go read the whole thing.
Five years ago the global financial system seemed on the verge of collapse. So did prevailing notions about how the economic and financial worlds are supposed to function. The basic idea that had governed economic thinking for decades was that markets work…. In the summer of 2007, though, the markets for some mortgage securities stopped functioning…. [T]he economic downturn was definitely worse than any other since the Great Depression, and the world economy is still struggling to recover…. Five years after the crash of 2008 is still early to be trying to determine its intellectual consequences. Still, one can see signs of change…. To me, three shifts in thinking stand out: (1) Macroeconomists are realizing that it was a mistake to pay so little attention to finance. (2) Financial economists are beginning to wrestle with some of the broader consequences of what they’ve learned over the years about market misbehavior. (3) Economists’ extremely influential grip on a key component of the economic world—the corporation—may be loosening.
Fox goes on to dissect each of these shifts, putting them in historical perspective. As I said, I think it is well worth your time to read his entire piece. A couple of additional noteworthy quotes from his analysis of item (3) above follow:
- [M]ost economic theories also build upon a common foundation of self-interested individuals or companies seeking to maximize something or other (utility, profit) …. Still, one narrow way of looking at the world can’t be the only valid path toward understanding its workings. There’s also a risk that emphasizing individual self-interest above all else may even discourage some of the behaviors and attitudes that make markets work in the first place—because markets need norms and limits to function smoothly.
- I don’t think the shareholder value critics have come up with a coherent alternative. We’re all still waiting for some other framework with which to understand the corporation—and economists may not be able to deliver it. Who will? Sociologists have probably been the most persistent critics of shareholder value, and of the atomized way in which economists view the world. Some, such as Neil Fligstein, of UC Berkeley, and Gerald Davis, of the University of Michigan, have proposed alternative models of the corporation that emphasize stability and cohesion over transaction and value.