Thursday, March 28, 2019

Nike, Avenatti, and the Business Judgment Rule

 
This Michael Avenatti extortion case is fascinating to me. I am not really sure why, other than it seems so absurd.  You may recall Avenatti as the lawyer who represented Stormy Daniels in her lawsuits against President Trump. He is a big personality and known for being outlandish at times.  
 
According to federal prosecutors, Avenatti tried to extort Nike for millions of dollars because he claimed to have evidence that Nike employees were illegally paying people to help recruit college basketball players.  Apparently, Avenatti believed he would be able to get Nike to pay him millions of dollars in exchange for the evidence. Instead, he ended up with the FBI. 
 
The New York Time reports:
According to people with knowledge of the cases, once Nike heard Mr. Avenatti’s claims, it acted to inform federal officials of the allegation that the company’s employees were paying players. The nature of the discussion with Mr. Avenatti raised the possibility that extortion was taking place.
That is, as soon as Nike was on notice of a potential problem right to the authorities.  How very Allis-Chalmers of them.  I am a fan of that old business judgment rule case, which state “it appears that directors are entitled to rely on the honesty and integrity of their subordinates until something occurs to put them on suspicion that something is wrong. If such occurs and goes unheeded, [only] then liability of the directors might well follow . . . “ Graham v. Allis-Chalmers Mfg. Co., 41 Del. Ch. 78, 85, 188 A.2d 125, 130 (1963).  So, as soon as Nike was on notice of wrongdoing, they disclosed it to officials.  
 
Nike took action to deal with the problem quickly, rather than acting like Caremark did years ago, when "there was an unconsidered failure of the board to act in circumstances in which due attention would, arguably, have prevented the loss [from fines resulting from bad employee behavior]." By taking action, Nike likely insulates the company (or at least mitigates the harm) it could face from alleged wrongdoing. Rather than engaging in a cover up (and potentially paying to hide the problem), the company acted proactively by disclosing the actions.  
 
Was this Avenatti's first attempt at such a thing?  It seems unlikely one would start with a company like Nike, but maybe the potential payoff seemed worth it. On the other hand, maybe such tactics have worked in other circumstances with smaller companies, so it seemed like a good idea. 
 
Regardless, it seems like Nike handled this wisely. The company recognized the issue before it, and fairly quickly realized that any of the alleged bad behavior was already done.  When such things happen, it is disappointing, to be sure, but it can't be undone.  The only question then is, "how are you going to respond."  For my money, going to the authorities was the right call, even though Nike had to know some bad press was going to follow.  
 
Now, I recognize it is possible that Nike knew about the behavior and reported nothing until Avenatti showed up. It would be interesting to find out, and if so, the analysis of whether they should have reported earlier would be an interesting one.  For example, would the company have faced more or less scrutiny had they reported on their own?  Or did they inoculate themselves to some degree by waiting and having the alleged Nike behavior overshadowed by Avenatti's alleged acts? Tough questions that require the exercise of business judgment. Thank goodness there is a rule about that.  

March 28, 2019 in Corporations, Current Affairs, Joshua P. Fershee, White Collar Crime | Permalink | Comments (2)

Wednesday, March 20, 2019

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

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

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

Benavidez v. Greenwich Hotel LP, 3:16-CV-191 (VAB), 2019 WL 1230357, at *1 (D. Conn. Mar. 15, 2019). 
 
Once more, for the people in back: LLCs are "limited liability companies," not "limited liability corporations."As such, LLCs are not "incorporated." LLCs are formed or organized. In addition, corporations are entities that provide shareholders limited liability, but they are generally not referred to as "limited liability corporations" because they might be confused with a separate and distinct entity type, the LLC.  
 
Whenever I read a case with this kind of language, I wonder how it happened.  Sometimes, like today, I go to the docket (thanks, Bloomberg Law) to see if the source of the wrongdoing (evil doing) was the party/lawyer or the judge/judge's clerk.  This time, it's pretty clear the lawyer got it right.  The case made it easy, as the ruling cited to the Answer to First Amended Complaint, which I pulled.  Here's how the lawyer's answer framed these "facts": 

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

. . . .

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

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

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

March 20, 2019 in Corporations, Joshua P. Fershee, Lawyering, LLCs, Partnership | Permalink | Comments (0)

Tuesday, March 12, 2019

LLCs Are Not Corporations, Spring Break Edition

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

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

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

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

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

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

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

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

Footnote 2 provides:

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

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

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

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

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

March 12, 2019 in Agency, Corporations, Joshua P. Fershee, Litigation, LLCs | Permalink | Comments (0)

Tuesday, March 5, 2019

Quick Take on Polsky's Explaining Choice-of-Entity Decisions by Silicon Valley Start-Ups

Gregg D. Polsky, University of  Georgia Law, recently posted his paper, Explaining Choice-of-Entity Decisions by Silicon Valley Start-Ups. It is an interesting read and worth a look. H/T Tax Prof Blog.  Following the abstract, I have a few initial thoughts:

Perhaps the most fundamental role of a business lawyer is to recommend the optimal entity choice for nascent business enterprises. Nevertheless, even in 2018, the choice-of-entity analysis remains highly muddled. Most business lawyers across the United States consistently recommend flow-through entities, such as limited liability companies and S corporations, to their clients. In contrast, a discrete group of highly sophisticated business lawyers, those who advise start-ups in Silicon Valley and other hotbeds of start-up activity, prefer C corporations.

Prior commentary has described and tried to explain this paradox without finding an adequate explanation. These commentators have noted a host of superficially plausible explanations, all of which they ultimately conclude are not wholly persuasive. The puzzle therefore remains.

This Article attempts to finally solve the puzzle by examining two factors that have been either vastly underappreciated or completely ignored in the existing literature. First, while previous commentators have briefly noted that flow-through structures are more complex and administratively burdensome, they did not fully appreciate the source, nature, and extent of these problems. In the unique start-up context, the complications of flow-through structures are exponentially more problematic, to the point where widespread adoption of flow-through entities is completely impractical. Second, the literature has not appreciated the effect of perplexing, yet pervasive, tax asset valuation problems in the public company context. The conventional wisdom is that tax assets are ignored or severely undervalued in public company stock valuations. In theory, the most significant benefit of flow-through status for start-ups is that it can result in the creation of valuable tax assets upon exit. However, the conventional wisdom makes this moot when the exit is through an initial public offering or sale to a public company, which are the desired types of exits for start-ups. The result is that the most significant benefit of using a flow- through is eliminated because of the tax asset pricing problem. Accordingly, while the costs of flow-through structures are far higher than have been appreciated, the benefits of these structures are much smaller than they appear.

Before commenting, let me be clear: I am not an expert in tax or in start-up entities, so my take on this falls much more from the perspective of what Polsky calls "main street businesses." I am merely an interested reader, and this is my first take on his interesting paper. 

To start, Polsky distinguishes "tax partnerships" from "C Corporations."  I know this is the conventional wisdom, but I still dislike the entity dissonance this creates.  Polsky explains: 

Tax partnerships generally include all state law entities other than corporations. Thus, general and limited partnerships, LLCs, LLPs, and LLLPs are all partnerships for tax purposes. C corporations include state law corporations and other business entities that affirmatively elect corporate status. Typically, a new business will often need to choose between being a state-law LLC taxed as a partnership or a state-law corporation taxed as a C corporation. The state law consequences of each are nearly identical, but the tax distinctions are vast.

 As I have written previously, I'd much rather see the state-level entity decoupled from the tax code, such that we would 

have (1) entity taxation, called C Tax, where an entity chooses to pay tax at the entity level, which would be typical C Corp taxation; (2) pass-through taxation, called K Tax, which is what we usually think of as partnership tax; and (3) we get rid of S corps, which can now be LLCs, anyway, which would allow an entity to choose S Tax

As Dinky Bosetti once said, "It's good to want things." 

Anyway, as one who focuses on entity choice from (mostly) the non-tax side, I dispute the idea that "[t]he state law consequences of each [entity] are nearly identical, but the tax distinctions are vast."  From governance to fiduciary duties to creditor relationships to basic operations, I think there are significant differences (and potential consequences) to entity choice beyond tax implications. 

 I will also quibble with Polsky's statement that "public companies are taxed as C corporations."  He is right, of course, that the default rule is that "a publicly traded partnership shall be treated as a corporation." I.R.C. § 7704(a). But, in addition to Business Organizations, I teach Energy Law, where we encounter Master Limited Partnerships (MLPs), which are publicly traded pass-through entities. See id. § 7704(c)-(d).

Polsky notes that "while an initial choice of entity decision can in theory be changed, it is generally too costly from a tax perspective to convert from a corporation to a partnership after a start-up begins to show promise."  This is why those of us not advising VC start-ups generally would choose the LLC, if it's a close call. If the entity needs to be taxed a C corp, we can convert.  If it is better served as an LLC, and the entity has appreciated in value, converting from a C corp to an LLC is costly.  Nonetheless, Polsky explains for companies planning to go public or be sold to a public entity, the LLC will convert before sale so that the LLC and  C Corp end up in roughly the same place:  

The differences are (1) the LLC’s pre-IPO losses flowed through to its owners while the corporation’s losses were trapped, but as discussed above this benefit is much smaller than it appears due to the presence of tax-indifferent ownership and the passive activity rules, (2) the LLC resulted in additional administrative, transactional, and compliance complexity (including the utilization of a blocker corporation in the ownership structure), and (3) the LLC required a restructuring on the eve of the IPO. All things considered, it is not surprising that corporate classification was the preferred approach for start-ups.

This is an interesting insight. My understanding is that the ability pass-through pre-IPO losses were significant to at least a notable portion of investors. Polsky's paper suggests this is not as significant as it seems, as many of the benefits are eroded for a variety of reasons in these start ups.  In addition, he notes a variety of LLC complexities for the start-up world that are not as prevalent for main street businesses. As a general matter, for traditional businesses, the corporate form comes with more mandatory obligations and rules that make the LLC the less-intensive choice.  Not so, it appears, for VC start-ups.  

 I need to spend some more time with it, and maybe I'll have some more thoughts after I do.  If you're interested in this sort of thing, I recommend taking a look.

March 5, 2019 in Corporate Finance, Corporate Governance, Corporations, Joshua P. Fershee, LLCs, Partnership, Unincorporated Entities, Venture Capital | Permalink | Comments (0)

Tuesday, February 26, 2019

Can You Exclude Experts In Criminal Cases Because They Are "Partners" in the Same LLC?

Westlaw recently posted an interesting Massachusetts case at the intersection of criminal law and business law.  Massachusetts (the Commonwealth) sought to commit a defendant as a sexually dangerous person. Commonwealth v. Baxter, 94 Mass. App. Ct. 587, 116 N.E.3d 54, 56 (2018). The defendant was (at the time) an inmate because of a probation violation related to offenses of rape of a child and other crimes.  The Commonwealth retained Mark Schaefer, Ph.D., for an expert opinion, and Dr. Schaefer concluded that the defendant was, under state law, a sexually dangerous person. The hearing judge found probable cause to think the defendant was a sexually dangerous person and had him temporarily committed for examination by two qualified examiners, as required by law. Dr. Joss determined that the defendant was sexually dangerous, and Dr. Rouse Weir determined he was not.

Here's where the business law part comes in: 

After the reports of the qualified examiners were submitted to the court, the defendant moved to exclude Dr. Joss from providing evidence at trial, or in the alternative, to appoint a new qualified examiner to evaluate the defendant. As grounds therefor, the defendant alleged that Dr. Joss and Dr. Schaefer were both among six “member/partners in Psychological Consulting Services (‘PCS’), a limited liability corporation [LLC] based in Salem, Massachusetts.” He argued that the members of the LLC have a fiduciary duty of loyalty to the company and are necessarily “dedicated to [its] financial and professional success.” Because Dr. Schaefer and Dr. Joss were “intertwined both professionally and financially,” through their partnership in PCS, the defendant claimed that their relationship “create[d] a conflict of interest and raise[d] a genuine issue of Dr. Joss's impartiality in his role as a [qualified examiner].” The defendant offered no affidavit in support of his motion, and did not request an evidentiary hearing.

Commonwealth v. Baxter, 94 Mass. App. Ct. 587, 116 N.E.3d 54, 56 (2018) (emphasis added).  A substitute expert was substituted for Dr. Joss, and that expert determined that defendant was not sexually dangerous, and the Commonwealth appealed. 
 
In addition to the obvious error of calling an LLC a corporation (this is an error was in defendants allegations) and LLC members "partners", there is more here.  
 
The court noted that the expert reported was not admitted in the lower court "based on 'the appearance of an inappropriate and avoidable conflict,'” stating further the lower court judge even stated expressly, "This isn't about actual bias."  The court then states that "where a party seeks to disqualify an attorney for a conflict of interest, the mere appearance of impropriety without attendant ethical violations is insufficient to support an order of disqualification." The defendant was arguing that the "partnership" (meaning membership in the LLC) worked to incentivize Dr. Joss to have the same conclusion as Dr. Schaefer so there would be no "public perception" that Dr. Schaefer was “proven wrong.” Id.
 
The court then explains that this is not a situation where the "reliability or validity" of the expert's methods or experience were in question. As such, "In the absence of evidence suggesting that the reliability of the witness's testimony is in doubt or that the witness is under an actual conflict of interest, the remedy for the defendant's concerns is in forceful cross-examination and argument, not in exclusion." Id. at 59. 

This is interesting to me.  It seems to me this is not like traditional attorney conflicts, where we want to impute knowledge of one attorney to another in the same firm because the knowledge of the first attorney could harm the client of the second.  This case is more analogous to getting a second opinion from a doctor in the same practice (or maybe network). It's possible that the second doctor could be influenced by the first, but it's not clearly the case. 
 
That said, I think there is something to the idea that members of a firm might have a bias in favor of the other members of the firm. But I appreciate the court's point that it needs to be more than a mere association of the doctors.  The fiduciary duty claim here fails, in my view, without more because there is no showing that the firm benefits from a particular outcome. That is, in any given case, multiple qualified experts can come to different conclusions (as this case makes clear) and that's plainly acceptable.  
 
Separately, this case also underscores how close a call such things are. Various experts came to different conclusions, and to some degree, at least in this case, the luck of the draw (of experts) is outcome determinative for both the Commonwealth and the defendant. I am sure there are cases where that's less true, in favor of either side, but I suspect it's close a lot of the time.  
 
Ultimately, this seems like the court got the rule right for future cases, though I am also not entirely clear why the order of discharge cannot stand. That is, it seems to me that just because the lower court ordered another expert review, there is no showing that the replacement expert was somehow not qualified or proper in their report. At least to the extent the standard was unclear, I might have been inclined to let the prior decision stand because I'd apply the same standard of review to all the experts in the case before excluding their work.  Perhaps the reviewing court was concerned that the lower court was expert shopping or something similar, but that's not clear.  Regardless, it's usually interesting when entity law works its way into criminal law. 


 

February 26, 2019 in Corporations, Joshua P. Fershee, LLCs, Partnership | Permalink | Comments (0)

Tuesday, February 19, 2019

New Paper: Business Entities as Skeleton Keys

Christopher G. Bradley at University of Kentucky College of Law has posted his paper, Business Entities as Skeleton Keys.  The paper was also selected for the 2019 AALS Section on Agency, Partnership, LLCs and Unincorporated Associations program, Respecting the Entity: The LLC Grows Up.  

Chris notes the use of business entities to accomplish goals not attainable previously and the use of entities "to accomplish customized transactions and evade legal restrictions that would otherwise prevent them."  His observations and insights are good ones, and his paper is definitely worth the read.  I can't help but think that some of this is occurring more because of an increasing comfort with entities and a willingness to engage in creative transactions. We're seeing in beyond the use of entities, too, with the rise of derivatives over the last 20 or so years, not to mention cryptocurrencies.  Anyway,  it's a good paper and I recommend it. 

Here's the abstract:

This Article identifies the increasingly important phenomenon of what I term “skeleton key business entities” and discusses the ramifications of their rise. Modern business entities, such as LLCs, are increasingly created and deployed to accomplish customized transactions and evade legal restrictions that would otherwise prevent them. Rather than acting as traditional businesses, such entities are tools, or “skeleton keys,” used to open “locked doors” presented by existing bodies of law, including contract, property, bankruptcy, copyright, tax, national security, and even election law.

The Article centers on the example of the “Artist’s Contract,” a fascinating 1971 project, in which artists sought to retain rights in artworks they sold—to obtain a percentage of future appreciation in value, to exhibit the work upon request, and so on. As prior scholarship has noted, the transaction contemplated by the Artist’s Contract could not have been accomplished in regular contract form due to rules concerning privity, servitudes on chattels, and the first sale doctrine, among other things. But this no longer remains true. The emergence of modern business entity law provides the tools—i.e., skeleton key business entities—to “solve” all of these legal problems and allow for bespoke transactions such as those desired by the artists.

The rise of skeleton key business entities may unsettle numerous other bodies of law. They may bring efficiencies but may undermine important policies. After providing a range of examples, I suggest that scholars—including those outside the business and commercial law realm—should turn renewed attention to the remarkable capacities of these flexible, inexpensive, and surprisingly potent transactional tools. We should consider if it makes sense to force parties pursuing newly enabled forms of commerce to bear the costs of filtering transactions through business entities; or alternatively, which traditional doctrines should bind modern entities just as they bind parties outside of those forms.

February 19, 2019 in Contracts, Corporations, Joshua P. Fershee, LLCs, Partnership, Unincorporated Entities, Writing | Permalink | Comments (0)

Tuesday, February 12, 2019

Vague Operating Agreement or Not, LLCs are Not Limited Partnerships or Corporations

Sometimes, LLC cases are a mess. It is often hard to tell whether the court is misstating something, whether the LLCs (and their counsel) are just sloppy, or both.  My money, most of the time is on "both." 

Consider this recent Louisiana opinion (my comments inserted): 

The defendant, Riverside Drive Partners, LLC (“Riverside”) appeals the district court judgment denying its motion for a new trial related to its order of January 8, 2018, dismissing all pending claims against three parties in this multiparty litigation: (1) CCNO McDonough 16, LLC (“CCNO”); (2) R4 MCNO Acquisition LLC (“R4”); and (3) Joseph A. Stebbins, II. After review of the record in light of the applicable law and arguments of the parties, the district court judgment is affirmed. . . .

This litigation arises out of a dispute among partners in a real estate development related to the conversion of an existing historic building into an affordable housing complex. Pursuant to the Operating Agreement signed on September 30, 2013, McDonough 16, LLC, was formed to acquire, rehabilitate, and ultimately lease and operate a multi-family apartment project consisting of the historic building and a new construction building. In turn, McDonough 16, LLC had two members, also limited liability entities: (1) the “Managing Member,” CCNO [an LLC] and (2), the “Investor Member,” R4, a Delaware limited liability company with its principal place of business in New York. [Who cares? Jurisdiction of the LLC is based on the citizenship of the LLC member(s).] Likewise, CCNO had two limited liability partnerships as members: (1) CCNO Partners 2, LLC, [thus not an LLP, but and LLC] which was formed by two members who were residents of and domiciled in Orleans Parish: Mr. Stebbins and Michael Mattax; and (2) the appellant, Riverside, a Florida limited liability company [also not an LLP] with its principal place of business in Florida whose sole member, Jack Hammer, is a resident of and domiciled in Georgia. Iberia Bank was lender for the project.

CCNO McDonough 16, LLC v. R4 MCNO Acquisition, LLC, 2018-0490 (La. App. 4 Cir. 11/14/18), 259 So. 3d 1077, 1078 (comments and emphasis added)

The issue was whether Riverside, LLC, as a member of CCNO, was needed to agree for CCNO to enter a settlement agreement. The court noted,

Section 3. 13 of the CCNO Operating Agreement provides:
Overall Management Vested in Members and Managers. Except as expressly provided otherwise in this Operating Agreement or otherwise agreed in writing at a meeting, management of the Company is vested in the Members in proportion to their initial Capital Contributions, and every Member is hereby made a Manager. All powers of the Company are exercised by or under the authority of the Managers and Members and the business and affairs of the Company are managed under the direction of the Members and Managers. The Managers may engage in other activities of any nature. (Emphasis added).
CCNO McDonough 16, LLC v. R4 MCNO Acquisition, LLC, 2018-0490 (La. App. 4 Cir. 11/14/18), 259 So. 3d 1077, 1079.  One thing not clear from the case is the CCNO is a Louisiana LLC, which I was able to find out via a Louisiana commercial entity search. Louisiana LLC law, by default, provides that members manage the business unless the operating agreement says otherwise.  The operating agreement appears to confirm the members as managers. My read of this provision would be that this provision makes management subject to a vote. That is, I read "management of the Company is vested in the Members in proportion to their initial Capital Contributions" to mean management is decided by a vote in proportion to capital contributions.  It is not intended to mean, I don't think, that actual management is divided by voting rights (e.g., that Member A with 60% voting interest makes 60% of the decisions and Member B with 40% makes 40% of the decisions). If management is by vote, it would appear that CCNO, with at least 60% of the voting interest, could proceed to settlelment without Riverside, LLC. 
 
However, the opinion goes on to explain:
In addition, the CCNO Operating Agreement defines “Majority in Interest” as “any referenced group of Managers, Members or persons who are both, a combination who, in aggregate, own more than fifty percent (50%) of the Membership Interests owned by all of such referenced group of Managers and Members.” Notably, Section 2.05 of the CCNO Operating Agreement specifically provides that any amendment to the agreement requires the approval of the beneficiary of any mortgage lien, i.e., Iberia Bank.
Riverside does not dispute that it owns less than fifty per cent of the CCNO shares or that CCNO Partners 2, of which Mr. Stebbins is a member, owns proportionally more of the membership interest in CCNO. Rather, Riverside asserts that this does not matter because, although the CCNO Operating Agreement clearly established CCNO Partners 2 owned 66.67% of CCNO (and, concomitantly, that Riverside only 33.33%), a subsequent amendment altered the proportion of ownership to 60% (CCNO Partners 2) and 40% (Riverside) and redefined “Majority in Interest” to mean “more than 60%,” thereby making any settlement agreement reached without the appellant's consent invalid.
CCNO McDonough 16, LLC v. R4 MCNO Acquisition, LLC, 2018-0490 (La. App. 4 Cir. 11/14/18), 259 So. 3d 1077, 1079–80.
 
Though this lacks some context, it appears that the court is saying that in defining "Majority in Interest," the operating agreement was telling us what vote was needed to "manage" the LLC.  That might make sense, in that initially the agreement gave CCNO the power to manage because it had more than 50% of the voting interest. Then, apparently, there was an amendment to make a majority vote 60%+1, if properly executed, would have required Riverside's consent to settle. However, the operating agreement also required the mortgage lien beneficiary to approve any amendment, which was not apparently done.  
 
This all seems like it is likely the right outcome, but it sure is hard to piece together. Perhaps all LLC cases should require the court to attach the operating agreement to the opinion. After all, LLC decisions are largely driven by the operating agreement, so it would be helpful for all of us trying to learn from the case to have the full context.  

Two closing thoughts:

  1. Jack Hammer as an LLC member of a construction-focused entity sounds like one of my exam characters. Awesome. 
  2. Westlaw's synopsis states: "Managing member of limited liability corporation (LLC) brought action against investor member to enjoin removal as manager."  No. An LLC is a limited liability company, not a corporation. (Regular readers had to see that coming.)
  3. LLCs are not limited partnerships, either, even if they are structured similarly or even use the term "partner."  An LLC is a separate and unique entity.  Really. 

February 12, 2019 in Corporations, Joshua P. Fershee, Litigation, LLCs, Management | Permalink | Comments (0)

Tuesday, January 15, 2019

Sixth Circuit, Why Can't You Be More Like Your Sister, Eleventh Circuit? #LLCs

I am wading back into a jurisdiction case because when it to LLCs (limited liability companies), I need to. A new case from the United States Court of Appeals for the Sixth Circuit showed up on Westlaw.  Here's how the analysis section begins:

Jurisdiction in this case is found under the diversity statute 28 U.S.C. § 1332. John Kendle is a citizen of Ohio; defendant WHIG Enterprises, LLC is a Florida corporation with its principal place of business in Mississippi; defendant Rx Pro Mississippi is a Mississippi corporation with its principal place of business in Mississippi; defendant Mitchell Chad Barrett is a citizen of Mississippi; defendant Jason Rutland is a citizen of Mississippi. R. 114 (Second Am. Compl. at ¶¶ 3, 5) (Page ID #981–82). Kendle is seeking damages in excess of $75,000. Id. at ¶¶ 50, 54, 58, 64, 71 (Page ID #992–95). The district court issued an order under Rule 54(b) of the Federal Rules of Civil Procedure that granted final judgment in favor of Mitchell Chad Barrett, and so appellate jurisdiction is proper. R. 170 (Rule 54(b) Order) (Page ID #3021).

Kendle v. Whig Enterprises, LLC, No. 18-3574, 2019 WL 148420, at *3 (6th Cir. Jan. 9, 2019).

No. No. No. An LLC is not a corporation, for starters.  And for purposes of diversity jurisdiction, "a limited liability company is a citizen of any state of which a member of the company is a citizen." Rolling Greens MHP, L.P. v. Comcast SCH Holdings L.L.C., 374 F.3d 1020, 1022 (11th Cir. 2004).  As such the where the LLC is formed doesn't matter and the LLC's principal place of business doesn't matter. All that matters is the citizenship of each LLC member.  

In this case, I can tell from the opinion that Kendle and Rutland are "co-owners" of WHIG Enterprises. The opinion suggests there may be other owners (i.e., members).  The opinion refers to the plaintiff suing "WHIG Enterprises, LLC, two of its co-owners, and another affiliated entity." Kendle v. Whig Enterprises, LLC, No. 18-3574, 2019 WL 148420, at *1. The opinion later refers to Rutland as "another WHIG co-owner."  If we want to know whether diversity jurisdiction is proper, though, we'll need to know ALL of WHIG's members.  

Now, it may well be that there is diversity among the parties, but we don't know, and neither, apparently, does the court. That may not be an issue in this case, but if people start modeling their bases for jurisdiction on the Kendle excerpt above, things could get ugly. The Eleventh Circuit, as noted above. A more recent case further reminds us to check diversity for all members in an LLC.  Thermoset Corporation v. Building Materials Corp. of America et al, 2017 WL 816224 (11th Cir., March 2, 2017).

I figured that I should give a shout out to folks getting right, given all my criticism of those getting it wrong.  Come, Sixth Circuit, let's get it together. 

January 15, 2019 in Corporations, Current Affairs, Joshua P. Fershee, Lawyering, LLCs | Permalink | Comments (1)

Friday, January 11, 2019

Best/Worst Depictions of M & A Deals on TV or At The Movies?

I wasn't one of those people who decided to become a lawyer after watching To Kill a Mockingbird, Witness for the Prosecution, and Twelve Angry Men, but they were some of my favorite movies. These movies and TV shows like Suits, How to Get Away with Murder, and Law & Order "teach" students and the general public that practicing law is sexy and/or confrontational. When I teach, I try to demystify and clear up some of the falsehoods, and that's easy with litigation-type courses. When I taught Business Associations, it was a bit tougher but we often used movies or TV shows to illustrate the right and wrong ways to do things. As an extra credit assignment, I asked students to write a critique of what the writers missed, misrepresented, or completely misunderstood.

This semester, I will be teaching a transactional drafting course where the students represent either the buyer or the seller of a small, privately owned business. I would like to recommend movies or TV shows that don't deal with multibillion dollar mergers, but I haven't been watching too much TV lately. I'm looking for suggestions along the lines of Silicon Valley (which past students have loved) or Billions. If you have any suggestions, please comment below or email me at mweldon@law.miami.edu.

 

 

 

January 11, 2019 in Corporations, Current Affairs, Film, Law School, Marcia Narine Weldon, Teaching, Television | Permalink | Comments (1)

Tuesday, December 18, 2018

There Once was an LLC with a Partnership Agreement Governing the Minority Shareholder's Interest

Sometimes I think courts are just trolling me (and the rest of us who care about basic entity concepts). The following quotes (and my commentary) are related to the newly issued case, Estes v. Hayden, No. 2017-CA-001882-MR, 2018 WL 6600225, at *1 (Ky. Ct. App. Dec. 14, 2018): 

"Estes and Hayden were business partners in several limited liability corporations, one of which was Success Management Team, LLC (hereinafter “Success”)." Maybe they had some corporations and LLCs, but the case only references were to LLCs (limited liability companies).

But wait, it gets worse:  "Hayden was a minority shareholder in, and the parties had no operating agreement regarding, Success."  Recall that Success is an LLC. There should not be shareholders in an LLC. Members owning membership interests, yes. Shareholders, no. 

Apparently, Success was anything but, with Hayden and Estes being sued multiple times related to residential home construction where fraudulent conduct was alleged. Hayden sued Estes to dissolve and wind down all the parties’ business entities claiming a pattern of fraudulent conduct by Estes. Ultimately, the two entered a settlement agreement related to (among other things) back taxes, including an escrow account, which was (naturally) insufficient to cover the tax liability.  This case followed, with Estes seeking contribution from Hayden, while Hayden claimed he had been released. 

Estes paid the excess tax liability and filed a complaint against Hayden, "arguing Hayden’s breach of the Success partnership agreement and that Estes never agreed to assume one hundred percent of any remaining tax liabilities of Success." Now there is a partnership agreement?  Related to the minority shareholder's obligations to an LLC?  [Banging head on desk.] 

The entity structures to these business arrangements are a mess, and it makes the opinion kind of a mess, though I would suggest the court could have at least tried to straighten it out a bit.  It even appears that the court got a little turned around, as it states, "While Estes may have at one time been liable for a portion of Success’s tax liabilities incurred from 2006 to 2010, once the parties signed the Settlement Agreement, his liability ended pursuant to the release provisions contained therein."  I think they meant that Hayden may have been liable but no longer was following the release, especially given that the court affirmed the grant of summary judgment to Hayden.  

For what it's worth, it appears that the court analyzed the release correctly, so the resolution on the merits is likely proper. Still, blindly adopting the careless entity-related language of the litigants is frustrating, at a minimum.  But it does give me something else to write about. As long as these case keeping showing up, and they will keep showing up, Prof. Bainbridge need not wonder, "Is legal blogging dead?"  Not for me, and I don't think for those of us here at BLPB, anyway. 
 



 

December 18, 2018 in Contracts, Corporations, Joshua P. Fershee, Lawyering, Litigation, LLCs, Partnership | Permalink | Comments (0)

Tuesday, December 11, 2018

Not Every CEO Opinion is a Breach of Fiduciary Duty (Most Aren't)

Jack Welch, former GE CEO (1981 to 2001) was revered for his ability to maximize shareholder value.  Yet in 2009, he explained that shareholder value was

“the dumbest idea in the world. Shareholder value is a result, not a strategy... your main constituencies are your employees, your customers and your products. Managers and investors should not set share price increases as their overarching goal… Short-term profits should be allied with an increase in the long-term value of a company.”

This runs contrary to how many people think about the role of the CEO and the board of directors.  I think it's spot on, and it is a key reason the business judgment rule, and its role in preserving director primacy, is so critical.   

Last week, a Wall Street Journal article about Dick's Sporting Goods made the rounds. The article reported: 

Ed Stack, the chairman and chief executive of Dick’s Sporting Goods Inc., arrived at work the Monday after a gunman killed 17 people at a school in Parkland, Fla., nearly certain the outdoor retailer should limit sales of some guns.

. . . .

Dick’s Financial Chief Lee Belitsky asked, “So what’s the financial implication here?” according to Mr. Stack. “I basically said, I don’t really care what the financial implication is, but you’re right, we should look.”

Company executives convened the board via teleconference to explain the proposed plan, took some time to reflect, then gathered again a few days later to vote. “It was unanimous that we should do this and stand up and take a stand,” said Mr. Stack, whose family holds a controlling stake in the retailer.

This revelation led many folks to question whether Stack's statement that he did not "really care" about the financial implications was a breach of fiduciary duty.  The concern was buoyed by the reality that store sales had dropped about 3% to  4% for the year, and the drop was linked to the decision to limit certain gun sales. 

That said, a drop in sales does not mean there was a breach of any duty any more than an increase in sales means no breach occurred. Results may be evidence, but that's all they are. Part of the story. Incidentally, though it is not proof, either way, it is worth noting that Dick's sales dropped, but profits rose after the decision because the company cut costs by replacing some guns with higher-margin items. 

It seems like every time a CEO or board issues a decision that is controversial or chooses to say that he or she supports a certain course of action because they think it is the "right thing to do," the questions begin about whether either the duty of care or loyalty has been breached.  I maintain that a statement (or series of statements) like that is not sufficient to overcome the business judgment rule to allow a review of the decision.  

This is especially true where, like in the Dick's situation, there is evidence that the company deliberated appropriately. The WSJ article noted that company executives called together the board to explain the proposed plan, "took some time to reflect, then gathered again a few days later to vote." The vote was unanimous to end all assault-style weapons sales and to and stop selling guns or ammunition to those under 21 years of age. Interestingly, Walmart Inc. and other retailers followed Dick's lead later that day. If the deliberative process is a concern, it would seem those following Dick's should be more vulnerable to a fiduciary duty/business judgment rule challenge than Dick's. 

For what it's worth, I think Dick's or any store deciding NOT to change their sales practice would also be protected by the business judgment rule, just as I think Chick-Fil-A's decision not to open on Sundays should be protected by the business judgment rule (though if it were a Delaware corporation, I am not sure it would be). 

This is not to say I don't believe in fiduciary duties. I very much do. I just also believe in a strong business judgment rule, ideally enforced as an abstention doctrine. (I believe in lots of things.)  

I need more than a few public statements before I think anyone should be looking behind an entity's decision making. Recent examples raising entity fiduciary duty questions, like Dick's and Nike's Colin Kaepernick ads, have had positive financial outcomes of the entities, but it shouldn't matter.  The business judgment rule is there to protect all the decisions of the board that are not the product of fraud, illegality, or self-dealing, not just correct decisions. 

December 11, 2018 in Corporate Governance, Corporations, Current Affairs, Joshua P. Fershee | Permalink | Comments (6)

Friday, December 7, 2018

Do Investors Really Care About Environmental, Social, and Governance Factors?

In January 2018, Larry Fink of Blackrock, the world’s largest asset manager, shocked skeptics like me when he told CEOs:

In the current environment, these stakeholders are demanding that companies exercise leadership on a broader range of issues. And they are right to: a company’s ability to manage environmental, social, and governance matters demonstrates the leadership and good governance that is so essential to sustainable growth, which is why we are increasingly integrating these issues into our investment process. Companies must ask themselves: What role do we play in the community? How are we managing our impact on the environment? Are we working to create a diverse workforce? Are we adapting to technological change? Are we providing the retraining and opportunities that our employees and our business will need to adjust to an increasingly automated world? Are we using behavioral finance and other tools to prepare workers for retirement, so that they invest in a way that will help them achieve their goals?

In October 2018, Blackrock declared, “sustainable investing is becoming mainstream investing.” The firm bundled six existing ESG EFT funds and launched six similar funds in Europe and looked like the model corporate citisen.

So does Blackrock actually divest from companies with human rights violations or that do not provide meaningful disclosures on human trafficking, child slavery, forced labor, or conflict minerals? The company did not publicly divest from gun manufacturers although it did “speak with” them in February after the Parkland school shooting; the company has stated that due to fiduciary concerns, it cannot divest from single companies in a portfolio. 

In theory, a behemoth like Blackrock could have a significant impact on a firm’s ESG practices, if it so chose. It could set an example for companies and for other institutional investors by seeking (1) additional information after reviewing disclosures and/or (2) demanding changes in management if companies did not in fact, show a true commitment to ESG.

But I shouldn’t pick on Blackrock. Based on what I heard last week in Geneva at the UN Forum on Business and Human Rights, other investors outside of the SRI arena aren’t pressuring companies either.  I attended the Forum for the fourth time with over 2,000 members from the business, NGO, civil society, academic, and governmental communities. There was a heavy focus this year on supply chain issues because 80% of the world’s goods travel through large, international companies.The Responsible Business Alliance and others stressed the importance of eradiating forced labor. Apple, Google, Microsoft, Intel, and Amnesty International focused on tech companies, artificial intelligence, and human rights implications. Rio Tinto and Nestle allowed an NGO to publicly criticize their disclosure reports in painstaking detail. An activist told the entire plenary that states needed to stop killing human rights defenders. In other words, business as usual at the Forum. Here are some of the takeaways from some of the sessions:

  1. NGO PODER warned that investors should not divest when companies are not living up to their responsibilities  but instead should engage companies on ESG factors and demand board seats.
  2. The UN Working Group on Business and Human Rights observed that rating agencies can and should be a fast track to the board on ESG issues. 
  3. A representative from the Sustainable Stock Exchanges Initiative, a joint initiative of UNCTAD, PRI, the UN Global Compact, and UNEP-FI, indicated that investors want to know if ESG information is material. It may be salient, but not material to some. 79 stock exchanges around the world have partnered with the SSEI. 39 have voluntary ESG disclosures and 16 have mandatory disclosures.
  4. The Business and Human Rights Resources Center noted that of 7,200 corporate statements mandated by the UK Modern Slavery Act, only 25% met the minimum requirements required by law. As they shocked the audience with this statistic, news alerts went out the Australia had finally passed its own anti slavery law.
  5. 40% of companies in apparel, agricultural, and extractive industries have a 0 (zero) score for human rights due diligence, indicating weak implementation of the UN Guiding Principles on Business and Human Rights. The average score in the benchmark was only 27%.
  6. French companies must respond to the French Duty of Vigilance Law and the EU Nonfinancial Disclosure regulations, which have different approached to identifying risks. It could take six months to do an audit to do the disclosure, but investors rarely question the companies directly or the data. 
  7. SAP Ariba found that 66% of consumers believe they have a duty to buy goods that are good for society and the environment and that sustainability is mostly driven by millennials and generation Z consumers. 
  8. Nestle, the biggest food and beverage company in the world, requires its 165,000 suppliers to follow responsible sourcing standard especially for child and forced labor. The conglomerate partners with NGOs to conduct human rights impact assessments for their upstream suppliers. 
  9. Apple has returned 30 million USD in recruitment fees to workers since 2008 to address forced labor and illegal practices. HP has also returned fees. The hotel industry has banded together to fight forced labor. Most responsible businesses have banned the use of recruitment fees but many workers still pay them to personnel agencies in the hopes of getting jobs with large companies. 
  10. Many companies are now looking at human rights and ESG issues throughout their own supply chains but also with their joint venture, merger, and other key business partners.
  11. Rae Lindsay of Clifford Chance noted that avoiding legal risk is not the main role of human rights due diligence but lawyers working across disciplines can make sure that clients don’t inadvertently add to legal risk in deals. She encourages deal lawyers to become familiar with the risks and law and business students to learn about these issues. 

So do investors care about ESG? Are these disclosure rules working? You wouldn’t think so by hearing the speakers at the Forum. On the other hand, proxy advisory firm ISS recently launched an Environmental and Social Quality Score to better evaluate the ESG risks in its portfolio companies. I’ll keep an eye out for any divestments or shareholder proposals. 

I’m not holding my breath for too much progress next year at the Forum. While I was encouraged by the good work of many of the companies that attended, I remain convinced that the disclosure regime is ineffective in effectuating meaningful change in the world’s most vulnerable communities. Unless governments, rating agencies, investors, or consumers act, too many companies will continue to pay lip service to their human rights commitments.  

 

 

 

December 7, 2018 in Compliance, Conferences, Corporate Governance, Corporations, CSR, Current Affairs, Human Rights, International Business, International Law, Marcia Narine Weldon, Shareholders | Permalink | Comments (1)

Monday, December 3, 2018

More on the SEC Roundtable on the Proxy Process

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]

December 3, 2018 in Agency, Ann Lipton, Anne Tucker, Corporate Governance, Corporations, Joan Heminway, Securities Regulation | Permalink | Comments (0)

Friday, November 23, 2018

Is Fair Trade Really Fair?

IMG_1382

Greetings from Panama. Are you one of the people who look for products labeled "organic," "non-GMO," or "fair trade"? According to the official Fairtrade site:

Fairtrade is a simple way to make a difference to the lives of the people who grow the things we love. We do this by making trade fair.
Fairtrade is unique. We work with businesses, consumers and campaigners. Farmers and workers have an equal say in everything we do. Empowerment is at the core of who we are. We have a vision: a world in which all producers can enjoy secure and sustainable livelihoods, fulfill their potential and decide on their future. Our mission is to connect disadvantaged farmers and workers with consumers, promote fairer trading conditions and empower farmers and workers to combat poverty, strengthen their position and take more control over their lives....

Over and above the Fairtrade price, the Fairtrade Premium is an additional sum of money which goes into a communal fund for workers and farmers to use – as they see fit – to improve their social, economic and environmental conditions...

Fairtrade is about better prices, decent working conditions, local sustainability, and fair terms of trade for farmers and workers in the developing world. By requiring companies to pay sustainable prices (which must never fall lower than the market price), Fairtrade addresses the injustices of conventional trade, which traditionally discriminates against the poorest, weakest producers. It enables them to improve their position and have more control over their lives..

With Fairtrade you have the power to change the world every day. With simple shopping choices you can get farmers a better deal. And that means they can make their own decisions, control their future and lead the dignified life everyone deserves. 

In 2016, farmers received 158 million euros in Fairtrade premiums. 

This sounds great in theory, but according to a cacao farmer I spent time with in Panama, fair trade is not fair to the farmers. He and others in his indigenous tribe earn so little from the cacao exported to Switzerland for fine Swiss chocolate that he must resort to giving tours of his plantation in order to maintain the village school and pay for medical expenses for his tribe. His farm earns only 85 cents per half kilo of cacao (or 12 pods). This .85 cents is only for the exceptional cacao. Sometimes they earn even less. The Swiss tout the organic, non-GMO product and inspect the farms annually, which means that the farmers cannot use any fertilizers to combat the fungus that kills 85% of the crop every year. This also means that the farmers do everything by hand, including cutting, fermenting, roasting, and shelling the beans. The farmer/tour guide explained that they treat the cacao plants like a woman-- they love, cherish, and protect them every day. They use the same harvesting process that they have used for over 1,000 years. IMG_1375

Just like coffee farmers I met in Guatemala, the cacao farmer I met in Panama calls "fair trade" a marketing scheme for the Americans and Europeans. I assume the farmers I met represent the view of some portion of the 1.65 million farmers involved in the Fairtrade program.  For more on the Fair Trade debate, see here.

I will have more on this and other sustainability issues next week. I'll be at UN Forum on Business and Human Rights with 2500 companies, NGOs, academics, and state representative in Geneva. In the meantime, if you're buying someone Fairtrade chocolate for the holidays, do it for the taste because you're not really doing much to help the farmer.

IMG_1351

November 23, 2018 in Corporate Personality, Corporations, CSR, Current Affairs, Human Rights, Marcia Narine Weldon | Permalink | Comments (1)

Monday, November 19, 2018

Teaching Corporate Fiduciary Duties, Again . . . .

Even after 19 years or so of teaching Business Associations courses, I still marvel at how hard it is to teach corporate fiduciary duty doctrine to my students.  A lot of my frustration comes from the amount of (perhaps not-so-useful) judicially instigated labeling involved under Delaware law, as the leading state in the area.  In particular, there is the narrowing of the duty of care to exclude both substantive duty of care claims and Caremark claims.  And then there is the matter of how to best describe the nature of the business judgment rule and how to describe the interaction of disclosure (candor) with the fiduciary duties of care and loyalty. And finally there is a lingering doctrinal question as to whether, in other jurisdictions, good faith, classified as a subsidiary component of the duty of loyalty in Delaware, may be a free-standing fiduciary duty or, in the alternative, foundational, penumbral, etc. to the fiduciary duties of loyalty and care  . . . .  Tough stuff.

Is anyone else out there suffering in the same way I do in teaching fiduciary duties in a Business Associations or Corporations class?  How do you handle the legal complexity/labeling questions?  I continue to want to improve in teaching this material.  I am all ears.

[Postscript:  I failed to note in the original post the helpful comments that I received on a longer-form, less specific post on this issue two years ago.  Feel free to look there for more and for some ideas folks shared about their teaching then.]

November 19, 2018 in Corporate Governance, Corporations, Joan Heminway, Teaching | Permalink | Comments (7)

Tuesday, November 13, 2018

LLCs are Not Corporations, But That Does Not Mean LLC Diversity Rules Make Sense

Back in May, I noted my dislike of the LLC diversity jurisdiction rule, which determines an LLC's citizenship “by the citizenship of each of its members” I noted, 

I still hate this rule for diversity jurisdiction of LLCs.  I know I am not the first to have issues with this rule. 

I get the idea that diversity jurisdiction was extended to LLCs in the same way that it was for partnerships, but in today's world, it's dumb. Under traditional general partnership law, partners were all fully liable for the partnership, so it makes sense to have all partners be used to determine diversity jurisdiction.  But where any partner has limited liabilty, like members do for LLCs, it seems to me the entity should be the only consideration in determing citizenship for jurisdiction purposes. It works for corporations, even where a shareholder is also a manger (or CEO), so why not have the same for LLCs.  If there are individuals whose control of the entity is an issue, treat and LLC just like a corporation. Name individuals, too, if you think there is direct liability, just as you would with a corporation. For a corporation, if there is a shareholder, director, or officer (or any other invididual) who is a guarantor or is otherwise personally liable, jurisdiction arises from that potential liability. 
I am reminded of this dislike, once again, by a recently available case in which an LLC is referred to as a "limited liability corporation" (not company).  
Dever v. Family Dollar Stores of Georgia, LLC, No. 18-10129, 2018 WL 5778189, at *1 (11th Cir. Nov. 2, 2018). This is so annoying. 
 
The LLC in question is Family Dollar Stores of Georgia, LLC, which involved a slip-and-fall injury in which the plaintiff was hurt in a Family Dollar Store. Apparently, that store was located in Georgia. The opinion notes, though, that the LLC in question was "organized under Virginia law with one member, a corporation that was organized under Delaware law with its principal place of business in North Carolina." Id. 
 
It seems entirely absurd to me that one could create an entity to operate stores in a state, even using the state in the name of the entity, yet have a jurisdictional rule that would provide that for diversity jurisdiction in the state where the entity did business (in a brick and mortar store, no less) where someone was injured.  (Side note: It does not upset me that Family Dollar Stores of Georgia, LLC, would be formed in another state -- that choice of law deals with inter se issue between members of the LLC. )  
 
I'll also note that I see cases dealing with LLC diversity jurisdiction incorrectly referring to LLCs as "limited liability corporations." For example, these other cases also appeared on Westlaw within the last week or so: 
  • Util Auditors, LLC v. Honeywell Int'l Inc., No. 17 CIV. 4673 (JFK), 2018 WL 5830977, at *1 (S.D.N.Y. Nov. 7, 2018) ("Plaintiff ... is a limited liability corporation with its principal place of business in Florida, where both of its members are domiciled.").

  • Thermoset Corp. v. Bldg. Materials Corp. of Am., No. 17-14887, 2018 WL 5733042, at *2 (11th Cir. Oct. 31, 2018) ("Well before Thermoset filed its amended complaint, this court ruled that the citizenship of a limited liability corporation depended in turn on the citizenship of its members.").
     
    ALLENBY & ASSOCIATES, INC. v. CROWN "ST. VINCENT" LTD., No. 07-61364-CIV, 2007 WL 9710726, at *2 (S.D. Fla. Dec. 3, 2007) ("[A] limited liability corporation is a citizen of every state in which a partner resides.").
Coincidence? Maybe, but it's still frustrating. 
 

November 13, 2018 in Corporations, Delaware, Joshua P. Fershee, Litigation, LLCs | Permalink | Comments (0)

Sunday, October 21, 2018

5th Conference of the French Academy of Legal Studies in Business - June 20-21 - Paris

5th Conference of the French Academy of Legal Studies in Business (Association Française Droit et Management)

June 20 and 21, 2019 – emlyon - Paris Campus

CALL FOR PAPERS 2019 Social Issues in Firms

Social issues and fundamental rights occupy an increasingly important space in the governance of today’s companies. Private enterprises assume an increasingly active role not only in a given economy but also in society as a whole. Firms become themselves citizens. They recognize and support civic engagement by the men and women who work for them. Historically, the role of the modern firm that resulted from the Industrial Revolution has been torn between two opposing viewpoints.

[More information under the break.]

Continue reading

October 21, 2018 in Business Associations, Business School, Call for Papers, Conferences, Corporate Governance, Corporations, Ethics, Haskell Murray, International Business, International Law, Management, Research/Scholarhip | Permalink | Comments (0)

Saturday, October 13, 2018

Has the Dodd-Frank Conflict Minerals Rule Really Made a Difference and is Blockchain The Answer?

Last week Dr. Denis Mukwege won the Nobel Peace Prize for his work on gender-based violence in the Democratic Republic of Congo (DRC). This short video interview describes what I saw when I went to DRC in 2011 to research the newly-enacted Dodd-Frank disclosure rule and to do the legwork for a non-profit that teaches midwives ways to deliver babies safely. For those unfamiliar with the legislation, U.S. issuers must disclose the efforts they have made to track and trace tin, tungsten, tantalum, and gold from the DRC and nine surrounding countries. Rebels and warlords control many of the mines by controlling the villages. 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 stated purpose of the Dodd-Frank rule was to help end the violence in DRC and to name and shame companies that do not disclose or that cannot certify that their goods are DRC-conflict free (although that labeling portion of the law was struck down on First Amendment grounds). I  wrote a law review article in 2013 and co-filed an amicus brief during the litigation arguing that the law would not help people on the ground. I have also blogged here about legislation to end the rulehere about the EU's version of the rulehere about the differences between the EU and US rule, and half a dozen times since 2013.

I had the honor of meeting Dr. Mukwege in 2011, who at the time did not support the conflict minerals legislation. He has since endorsed such legislation for the EU. During our trip, we met dozens of women who had been raped, often by gangs. On our way to meet midwives and survivors of a massacre, I saw five corpses of villagers lying in the street. They were slain by rebels the night before. I saw children mining gold from a river with armed soldiers only a few feet away.  That trip is the reason that I study, write, and teach about business and human rights. I had only been in academia for three weeks when I went to DRC, and I decided that my understanding of supply chains and corporate governance from my past in-house life could help others develop more practical solutions to intractable problems. I believed then and I believe now that using a corporate governance disclosure to solve a human rights crisis is a flawed and incomplete solution. It depends on the belief that large numbers of consumers will boycott companies that do not do enough for human rights. 

What does the data say about compliance with the rule? The General Accounting Office puts out a mandatory report annually on the legislation and the state of disclosures. According to the 2018 report:

Similar to the prior 2 years, almost all companies required to conduct due diligence, as a result of their country-of-origin inquiries, reported doing so. After conducting due diligence to determine the source and chain of custody of any conflict minerals used, an estimated 37 percent of these companies reported in 2017 that they were able to determine that their conflict minerals came from covered countries or from scrap or recycled sources, compared with 39 and 23 percent in 2016 and 2015, respectively. Four companies in GAO’s sample declared their products “DRC conflict-free,” and of those, three included the required Independent Private Sector Audit report (IPSA), and one did not. In 2017, 16 companies filed an IPSA; 19 did so in 2016. (emphasis added).

But what about the effect on forced labor and rape? The 2017 GAO Report indicated that in 2016, a study in DRC estimated that 32 percent of women and 33 percent of men in these areas had been exposed to some form of sexual and gender-based violence in their lifetime. Notably, just last month, a coalition of Congolese civil society organizations wrote the following to the United Nations seeking a country-wide monitoring system:

... Armed groups and security forces have attacked civilians in many parts of the country...Today, some 4.5 million Congolese are displaced from their homes. More than 100,000 Congolese have fled abroad since January 2018, raising the risk of increased regional instability... Since early this year, violence intensified in various parts of northeastern Congo’s Ituri province, with terrifying incidents of massacres, rapes, and decapitation. Armed groups launched deadly attacks on villages, killing scores of civilians, torching hundreds of homes, and displacing an estimated 350,000 people. Armed groups and security forces in the Kivu provinces also continue to attack civilians. According to the Kivu Security Tracker, assailants, including state security forces, killed more than 580 civilians and abducted at least 940 others in North and South Kivu since January 2018. (emphasis added)

The U.S. government provides $500 million in aid to the DRC and runs an app called Sweat and Toil for people who are interested in avoiding goods produced by exploited labor. As of today, DRC has seven goods produced with exploitative labor: cobalt (used in electric cars and cell phones), copper, diamonds, and, not surprisingly, tin, tungsten, tantalum, and gold- the four minerals regulated by Dodd-Frank. The app notes that "for the second year in a row, labor inspectors have failed to conduct any worksite inspections... and [the] government also separated as many as 2,360 children from armed groups...[t]here were numerous reports of ongoing collaboration between members of the [DRC] Armed Forces and non-state armed groups known for recruiting children... The Armed Forces carried out extrajudicial killings of civilians including children, due to their perceived support or affiliation with non-state armed groups. .."

For these reasons, I continue to ask whether the conflict minerals legislation has made a difference in the lives of the people on the ground. The EU, learning from Dodd-Frank's flaws, has passed its own legislation, which goes into effect in 2021.  The EU law applies beyond the Democratic Republic of Congo and defines conflict areas as those in a state of armed conflict, or fragile post-conflict area, areas with weak or nonexistent governance and security such as failed states, and any state with a widespread or systematic violation of international law including human rights abuses. Certain European Union importers will have to identify and address the actual potential risks linked to conflict-affected areas or high-risk areas during the due diligence of their supply chains. 

Notwithstanding the statistics above, many investors, NGOs, and other advocates believe the Dodd-Frank rule makes sense. A coalition of investors with 50 trillion worth of assets under management has pushed to keep the law in place. It's no surprise then that many issuers have said that they would continue the due diligence even if the law were repealed. I doubt that will help people in these countries, but the due diligence does help drive out inefficiencies and optimize supply chains.

Stay tuned for my upcoming article in UT's business law journal, Transactions, where I will discuss how companies and state actors are using blockchain technology for due diligence related to human rights. Blockchain will minimize expenses and time for these disclosure requirements, but it probably won't stop the forced labor, exploitation, rapes, and massacres that continue in the Democratic Republic of Congo. (See here for a Fortune magazine article with a great video discussing how and why companies are exploring blockchain's uses in DRC). The blockchain technology won't be the problem-- it's already being used for tracing conflict diamonds. The problem is using the technology in a state with such lawlessness. This means that blockchain will probably help companies, but not the people the laws are meant to protect. 

 

 

 

 

 

 

 

 

 

October 13, 2018 in Compliance, Corporate Governance, Corporations, CSR, Current Affairs, Human Rights, International Business, International Law, Legislation, Marcia Narine Weldon, Securities Regulation | Permalink | Comments (1)

Tuesday, October 9, 2018

Bang Head Here: California and the LLC as a "Corporation"

California drives me nuts with lazy references to LLCs -- "limited liability companies" -- as" limited liability corporations." See, e.g., Dear California: LLCs are Not Corporations. Or Are They?

A 2010 case recently posted to Westlaw provides another example, this time from the local rules for the United States District Court for the Central District of California.  The case deals with an attorney withdrawing as counsel for an LLC, which requires the withdrawing attorney to provide notice to soon-to-be former client YPA, that as

a limited liability company that cannot proceed pro se, its failure to have new counsel file a timely notice of appearance will result in the dismissal of its complaint for failure to prosecute and of the entry of its default on the cross-complaint.

YOUR PERSONAL ASSISTANT, LLC, a Nevada limited liability company, Plaintiff, v. T-MOBILE USA, INC., a Delaware Corp., & DOES 1-100, inclusive. Defendants., No. CV1000783MMMRCX, 2010 WL 11598037, at *3 (C.D. Cal. Apr. 23, 2010)

This is fairly typical, as entities are generally not allowed to appear pro se -- that is reserved as an option for natural persons. However, because of poor drafting, the local rules keep open the possibility that an LLC could appear pro se.  As the court notes in footnote 9, the rules provide:

9. See CA CD L.R. 83-2.10.1 (“[a] corporation including a limited liability corporation, a partnership including a limited liability partnership, an unincorporated association, or a trust may not appear in any action or proceeding pro se.”)

Id. at *3 n.9 (C.D. Cal. Apr. 23, 2010).  The language here refers to an LLC a type of corporation, which, as a general matter, it is not.  A limited liability partnership is a type of partnership (with gaps often filled by partnership law), but corporations and LLCs are, most of the time, separate and distinct entities.
 
image from www.thefrugalhumanist.com
None of this is new, coming from me.  But I'm not giving up, even if I that tree I keep banging my head on is a Redwood. 

October 9, 2018 in Corporations, Joshua P. Fershee, Lawyering, LLCs | Permalink | Comments (0)

Tuesday, October 2, 2018

Symposium Announcement: The Urgency of Poverty

Following is an announcement for an upcoming symposium that will tackle some challenging topics, including those related to the role corporate law plays in addressing poverty.  I, of course, would probably talk about the role of "entity law," rather than "corporate law," but that's just me.  Regardless, this should be an interesting and enlightening discussion, and I look forward to seeing the papers that come from it.  

On Thursday, October 25, 2018, The University of Tennessee Law School and the Tennessee Journal of Race, Gender, & Social Justice will be hosting a Symposium titled The Urgency of Poverty. The Symposium reflects on the Poor People's Campaign of 1968 and the continued injustices which have led to the current revival. The Symposium further explores the important role transactional lawyers and scholars must play in advocating for economic justice in modern America.

The Symposium will include panels on (1) Environmental Justice, (2) Intersection of Civil Rights and Economic Justice, (3) Solidarity Economies, and (4) Reforming Corporate Law. Professor Philip Alston, the U.N. Special Rapporteur on Extreme Poverty, and Human Rights, will deliver the keynote. The Symposium is accompanied by a dedicated publication featuring essays and articles from Transactional Professors of Color.

More information is available here: https://law.utk.edu/alumni/get-involved/cle/the-urgency-of-poverty/

 

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October 2, 2018 in Corporations, Crowdfunding, Joshua P. Fershee, Research/Scholarhip, Social Enterprise | Permalink | Comments (0)