Business Law Prof Blog

Observations from a Financial Regulation Academic on Carreyrou's Bad Blood

I’d like to thank the Business Law Prof Blog for the opportunity to be a guest blogger!  In this first post, I build on a subject of previous posts (here, here, and here): Theranos, a now defunct Silicon Valley health-care start-up.

I rely heavily on the Financial Times to follow developments in one of my main research areas: financial market clearing and settlement (I’ll plan to report next week on the upcoming December 4^th meeting of the Market Risk Advisory Committee, sponsored by CFTC Commissioner Rostin Behnam).  The FT recently announced that Wall Street Journal investigative reporter John Carreyrou’s book, Bad Blood: Secrets and Lies in a Silicon Valley Startup, had been named the FT/McKinsey Business Book of the Year 2018.  Having immensely enjoyed reading past winners, I wasted no time in ensuring that Amazon Prime speedily delivered it to my doorstep. 

Bad Blood is a riveting tale of Theranos’ spectacular rise and fall, and well-worth the reader’s time.  A fun fact is that a pathologist blogger, Adam Clapper (founder of the former Pathology Blawg), tipped Carreyrou onto the Theranos story (Chapter 19).  Additionally, in the months after Bad Blood’s publication, its founder and CEO, Elizabeth A. Holmes, and former COO, Ramesh “Sunny” Balwani, were charged by the Justice Department with wire fraud.    

I know little about the health-care industry.  Yet in reading Bad Blood, I was struck by links to and concerns shared with the financial industry (an area about which I know more).  Below, I make a few observations and invite reader comments on their importance in these and other industries.

Post-financial crisis, rock-bottom interest rates acted as a “key ingredient” to a new Silicon Valley boom (p.82).  Similarly, these low rates have also been a key ingredient for the many years of increasing stock market prices post-financial crisis.  Indeed, recent equity market declines made at least a temporary rebound yesterday after comments by Federal Reserve Chairman Jerome Powell at the Economic Club of New York.     

The increasing expansion of private markets enables companies such as Theranos to “avoid the close scrutiny” (p.178) to which public companies are subject (nevertheless, Theranos and Holmes settled fraud charges with the SEC).  Given current regulatory structures, it also risks severely limiting retail investment opportunities.  And it adversely impacts financial journalists’ access to information!  

When I teach Banking and Financial Institutions Law, the term “regulation-induced innovation” tends to amuse students.  The Theranos tale demonstrates, however, that such practices aren’t a laughing matter.  For example, its business strategies appeared to include: maneuvering in regulatory “gray zones” between the FDA and Centers for Medicare and Medicaid Services (p.88), exploiting “gap[s] spawned by outdated statutes” (p.125), and “operat[in]g in a regulatory no-man’s-land” (p.260).  Such practices can be troublesome enough in financial markets.  However, in Theranos’ case, the stakes (patient health) were much higher.    

Finally, who doesn’t love a good story?  Carreyrou, a two-time Pulitzer Prize-winning journalist, is an expert storyteller.  His portrayal of Holmes suggests that she too profoundly understood the power of stories, and that she had a bewitching talent for telling them.  Clearly, untruthful, non-fictional narratives are generally unethical and, depending upon the context, might also be illegal.  However, taking a cue from Holmes on the importance of stories and honing one's ability to tell them could assist financial market policymakers.  Indeed, several years ago, the FT’s Gillian Tett wrote an opinion piece entitled, “Central bank chiefs need to master the art of storytelling.”  Enhanced storytelling capabilities could also assist academics researching financial market regulation.  For both, the ability to compellingly communicate with the public about issues in financial markets and their broad-based importance is critical.  Even so, constructing a fascinating narrative about clearing and settlement along the lines of Bad Blood would be no small feat!  

Should You Ever Pierce the LLC Veil to Let a Member Recover? Probably Not.

Tom Rutledge, at Kentucky Business Entity Law Blog, writes about a curious recent decision in which the Kentucky Court of Appeals overrule a trial court, holding that the law of piercing the veil required the LLC veil to be pierced. Tavadia v. Mitchell, No. 2017-CA-001358-MR, 2018 WL 5091048 (Ky. App. Oct. 19, 2018).

Here are the basics (Tom provides an even more detailed description):

Sheri Mitchell formed One Sustainable Method Recycling, LLC (OSM) in 2013. Mitchell initially a 99% owner and the acting CEO with one other member holding 1%. Mitchell soon asked Behram Tavadia to invest in the company, which he did.

He loaned OSM $40K at 6% interest from his business Tavadia Enterprises, Inc. (to be repaid $1,000 per month, plus 5% of annual OSM profits).  There was no personal guarantee from Mitchell.  OSM then received a $150,000 a business development from METCO, which Tavadia personally guaranteed and pledged certain bonds as security.

Two years (and no loan payments) later under the original $40,000 loan, Tavadia agreed to delay repayment. OSM and Tavadia the created a second loan for $250,000, refinancing the original $40,000 and a subsequent Tavadia $12,000 loan.  This loan provided Tavadia a 25% ownership interest in OSM, but there was still no personal guarantee on the loan. Mitchell claimed this loan was needed to purchase essential equipment (no equipment was purchased). OSM then received a $20,000 loan from Fundworks, LLC, which was secured by Mitchell, who signed Tavadia’s name for OSM and she signed a personal guarantee in Tavadia’s name (both without permission).

Not surprisingly, in October 2015, OSM stopped operations, the equipment was sold, and more than half of the sale proceeds were deposited in Mitchell’s personal bank account, with the rest going to OSM’s account. OSM (naturally) defaulted on the Fundworks’ loan, which Tavadia learned about when Fundworks demanded repayment. The METCO loan also defaulted, and Tavadia was asked to provide funds from the bonds he provided as collateral.

Okay, so it sounds like Mitchell took advantage of Tavadia and engaged in some elements of fraud. What I can’t figure out from this case is why we’re talking about veil piercing.

First, the court states: “The evidence presented at trial demonstrated that Mitchell diverted OSM assets into her own account.” Tavadia v. Mitchell, No. 2017-CA-001358-MR, 2018 WL 5091048, at *5 (Ky. Ct. App. Oct. 19, 2018). So that money Mitchell owes to OSM, which owes money to Tavadia.  The court noted that at least half the funds from the sale of OSM equipment went into Mitchell’s personal account. That needs to go back to OSM, and if veil piercing has value, then a simple order of repayment should be, too. 

Second, the Fundworks loan, which Mitchell signed for, is really her loan, not Tavadia’s. He did not know about it until they sought payment, so it wasn’t ratified, and there is no other indication she has authority to enter into the contract. 

At a minimum, these funds are owed Tavadia (or OSM) and should be itemized as such.  Presumably, that is not enough money to make Tavadia whole. And I don’t know he should be. To the extent there were legitimate (if poorly executed) business attempts, he is on the hook for those losses. As such, I don’t see this as a veil-piercing case.

Instead, Tavadia should be able to sue Mitchell for her fraudulent actions that harmed him directly. And Tavadia should be able to make OSM sue Mitchell for improper transfers and fraud. 

Maybe there are other theories for recovery, too, but veil piercing should not be one. Mitchell did not use the entity to commit fraud. She committed fraud directly. Just because there is an entity, plus an unpaid loan, it does not make this a veil-piercing case. In fact, because Tavadia is a member of the LLC, I think there is a reasonable argument that (absent truly unique circumstances) veil piercing cannot apply. 

I am sympathetic that Tavadia was taken advantage of, and I think that Mitchell should have a significant repayment obligation to him, but I just don’t think this claim should be rooted in veil piercing.  At a minimum, like in administrative law, one should have to exhaust his or her remedies before proceeding to a veil-piercing theory. 

Employee Stock Options in Unicorns: Scholarship At the Intersection of Securities Law and Employee Benefits

Friend of the Business Law Prof Blog Anat Beck recently posted a draft of her article entitled Unicorn Stock Options - Golden Goose or Trojan Horse? on SSRN.  I heard presentations on earlier versions of this piece, which I personally find quite intricate and interesting.  An excerpt fro the SSRN abstract follows:

This article examines a contemporary puzzle in Silicon Valley – is there a shift in unicorn employees expectations that results in labor contracting renegotiations? It explores the challenges faced by unicorn firms as repeat players in competitive technology markets. It offers the following possible solutions. First, new equity-based compensation contracts, and critiques them. Second, alternatives to the traditional liquidity mechanisms, and critiques them.

It concludes with proposals to remove legal barriers to private ordering, and new mandatory disclosure requirements.

The article has been picked up by the Harvard Law School Forum on Corporate Governance and Financial Regulation and linked to in a Matt Levine column for Bloomberg.  This is a good read, especially for those of you interested in entrepreneurial business law (which is Anat's speciality).

Why Lawyers, Law Professors, and Judges Should Care About Blockchain

We’re a month away from our second annual Business Law Professor Blog CLE, hosted at the University of Tennessee on Friday, September 14, 2018. We’ll discuss our latest research and receive comments from UT faculty and students. I’ve entitled my talk Beyond Bitcoin: Leveraging Blockchain for Corporate Governance, Corporate Social Responsibility, and Enterprise Risk Management, and will blog more about that after I finish the article. This is a really long post, but it’s chock full of helpful links for novices and experts alike and highlights some really interesting work from our colleagues at other law schools.

Two weeks ago, I posted some resources to help familiarize you with blockchain. Here’s a relatively simple definition from John Giordani at Forbes:

Blockchain is a public register in which transactions between two users belonging to the same network are stored in a secure, verifiable and permanent way. The data relating to the exchanges are saved inside cryptographic blocks, connected in a hierarchical manner to each other. This creates an endless chain of data blocks -- hence the name blockchain -- that allows you to trace and verify all the transactions you have ever made. The primary function of a blockchain is, therefore, to certify transactions between people. In the case of Bitcoin, the blockchain serves to verify the exchange of cryptocurrency between two users, but it is only one of the many possible uses of this technological structure. In other sectors, the blockchain can certify the exchange of shares and stocks, operate as if it were a notary and "validate" a contract or make the votes cast in online voting secure and impossible to alter. One of the greatest advantages of the blockchain is the high degree of security it guarantees. In fact, once a transaction is certified and saved within one of the chain blocks, it can no longer be modified or tampered with. Each block consists of a pointer that connects it to the previous block, a timestamp that certifies the time at which the event actually took place and the transaction data.

These three elements ensure that each element of the blockchain is unique and immutable -- any request to modify the timestamp or the content of the block would change all subsequent blocks. This is because the pointer is created based on the data in the previous block, triggering a real chain reaction. In order for any alterations to happen, it would be necessary for the 50%-plus-one of the network to approve the change: a possible but hardly feasible operation since the blockchain is distributed worldwide between millions of users.

In case that wasn’t clear enough, here are links to a few of my favorite videos for novices. These will help you understand the rest of this blog post.

• Blockchain Expert Explains One Concept in 5 Levels of Difficulty
• 19 Industries That Blockchain Will Disrupt
• How Blockchain is Changing Money and Business

To help prepare for my own talk in Tennessee, I attended a fascinating discussion at SEALS on Thursday moderated by Dean Jon Garon of Nova Southeastern University Shepard Broad College of Law called Blockchain Technology and the Law.

For those of you who don’t know how blockchain technology can relate to your practice or teaching, I thought I would provide a few questions raised by some of the speakers. I’ve inserted some (oversimplified)links for definitions. The speakers did not include these links, so if I have used one that you believe is incomplete or inaccurate, do not attribute it to them.

Professor Del Wright, University of Missouri-Kansas City School of Law;

Del started the session by talking about the legal issues in blockchain consensus models. He described consensus models as the backbones for users because they: 1) allow users to interact with each other in a trustless manner; 2) ensure the integrity of the ledger in both normal and adversarial situations; and 3) create a “novel variety of networks with extraordinary potential” if implemented correctly. He discussed both permissioned (e.g. Ripple) and permissionless (Bitcoin) systems and how they differ. He then explained Proof of Work blockchains supported by miners (who solve problems to add blocks to the blockchain) and masternodes (who provide the backbone support to the blockchain). He pointed out how blockchains can reduce agency costs and problems of asymmetrical information and then focused on their utility in financial markets, securities regulation, and corporate governance. Del compared the issues related to off-chain governance, where decisionmaking first takes place on a social level and is then actively encoded into the protocol by the developers (used by Bitcoin and Ethereum) to on-chain governance, where developers broadcast their improvement protocols on-chain and then, once approved, those improvements are implemented into the code. He closed by listing a number of “big unanswered issues” related to regulatory guidance, liability for the performance of the technology and choice of consensus, global issues, and GDPR and other data privacy issues.

Professor Catherine Christopher, Texas Tech University School of Law;

Catherine wants to help judges think about smart contracts. She asked, among other things, how judges should address remedies, what counts as substantial performance, and how smart contract audits would work. She questioned whether judges should use a consumer protection approach or instead follow a draconian approach by embracing automation and enforcing smart contracts as drafted to discourage their adoption by those who are not sophisticated enough to understand how they work.

Professor Tonya Evans, University of New Hampshire School of Law (follow her on Twitter; see her blog on blockchain here);

Tonya focuses on blockchain and intellectual property. Her talked raised the issues of non-fungible tokens generated through smart contracts and the internet of value. She used the example of cryptokitties, where players have the chance to collect and breed digital cats. She also raised the question of what kind of technology can avoid infringement. For more on how blockchain can disrupt copyright law, read her post here.

Professor Rebecca Bratspies, CUNY School of Law;

In case you didn’t have enough trust issues with blockchain and cryptocurrency, Rebecca’s presentation focused on the “halo of immutability” and asked a few central questions: 1) why should we trust the miners not to collude for a 51% attack 2) why should we trust wallets, which aren’t as secure as people think; and 3) why should we trust the consensus mechanism? In response, some members of the audience noted that blockchain appeals to a libertarian element because of the removal of the government from the conversation.

Professor Carla Reyes, Michigan State University College of Law- follow her on Twitter at Carla Reyes (@Prof_CarlaReyes);

Carla talked about crypto corporate governance and the potential fiduciary duties that come out of thinking of blockchains as public trusts or corporations. She explained that governance happens on and off of the blockchain mechanisms through social media outlets such as Redditt. She further noted that many of those who call themselves “passive economic participants” are actually involved in governance because they comment on improvement processes. She also noted the paradox that off chain governance doesn’t always work very well because participants don’t always agree, but when they do agree, it often leads to controversial results like hard forks. Her upcoming article will outline potential fiduciaries (miner and masternode operators for example), their duties, and when they apply. She also asked the provocative question of whether a hard fork is like a Revlon event.

Professor Charlotte Tschider, William Mitchell College of Law (follow her on Twitter);

As a former chief privacy officer, I have to confess a bias toward Charlotte’s presentation. She talked about blockchain in healthcare focusing on these questions: will gains in cybersecurity protection outweigh specific issues for privacy or other legal issues (data ownership); what are the practical implications of implementing a private blockchain (consortium, patient-initiated, regulatory-approved); can this apply to other needed uses, including medical device applications; how might this technology work over geographically diverse regulatory structures; and are there better applications for this technology (e.g. connected health devices)? She posited that blockchain could work in healthcare because it is decentralized, has increased security, improves access controls, is more impervious to unauthorized change, could support availability goals for ransomware attacks and other issues, is potentially interoperable, could be less expensive, and could be controlled by regulatory branch, consortium, and the patient. She closed by raising potential legal issues related to broad data sharing, unanswered questions about private implementations, privacy requirements relating to the obligation of data deletion and correction (GDPR in the EU, China’s cybersecurity law, etc); and questions of data ownership in a contract.

Professor Eric Chason, William & Mary Marshall-Wythe School of Law;

Eric closed by discussing the potential tax issue for hard forks. He explained that after a hard fork, a new coin is created, and asked whether that creates income because the owner had one entitlement and now has two pieces of ownership. He then asked whether hard forks are more like corporate reorganizations or spinoffs (which already have statutory taxation provisions) or rather analogous to a change of wealth. Finally, he asked whether we should think about these transactions like a contingent right to do something in the future and how that should be valued.

Stay tuned for more on these and other projects related to blockchain. I will be sure to post them when they are done. But, ignore blockchain at your peril. There’s a reason that IBM, Microsoft, and the State Department are spending money on this technology. If you come to UT on September 15^th, I’ll explain how other companies, the UN, NASDAQ, and nation states are using blockchain beyond the cryptocurrency arena.

 

Energy and Business Nexus: Decarbonizing Light-Duty Vehicles

I am both a business law professor and an energy law professor, which is sometimes surprising to people. That is, some folks are surprised that have a research focus in two areas that are seemingly very distinct.  In one sense, that's true, at least in the academic realm.  Most energy law scholars tend to have a focus on more close related disciplines, such as environmental law, administrative law, and property law.  And business law scholars tend to trend toward things like commercial law, bankruptcy, tax, and contracts.  

There is substantial overlap, though, in the energy and business law spaces, as I have noted on this blog before. I am even working on some research that looks specifically at the role laws and regulations have on business and economic development.   My work with the WVU Center for Innovation in Gas Research and Utilization builds on this energy and business nexus. 

I am pleased to share a newly published article I wrote with Amy Stein from the University of Florida's Levin College of Law. The piece is called Decarbonizing Light-Duty Vehicles, and it appears in the July issue of Environmental Law Reporter. It is available here. This article is based on our forthcoming book chapter that will appear in Legal Pathways to Deep Decarbonization in the United States (Michael B. Gerrard & John C. Dernbach eds.) and published by the Environmental Law Institute.  The book expands on the U.S. work of the Deep Decarbonization Pathways Project, and was prepared in collaboration with that organization. Following is an excerpt that gives a sense of how energy and business law and policy sometimes intersect. 

    A last challenge surrounds the existing business models that revolve around the [internal combustion vehicle (ICV)]. First, a number of states have a strong incentive to maintain a core of ICVs due to their heavy reliance on the gasoline tax to fund highway infrastructure in their respective states. The gasoline tax has been in place since 1956 to help pay for construction of the interstate highway system.  Since that time, Congress has directed the majority of the revenues from this tax to the Highway Trust Fund (HTF).  At the federal level, Congress has not increased the tax in more than 20 years, leaving it at 18.4 cents a gallon.  As of July 2015, state taxes on gasoline averaged 26.49 cents a gallon, bringing the total tax on gasoline to about 45 cents per gallon.  All efforts to reduce reliance on gas-dependent vehicles therefore stand in sharp contrast to efforts to maintain a healthy highway fund. The interplay between fuel economy and the dependence on gasoline tax revenues should not be overlooked, as well as the conflicting demands placed on legislators.

    Second, dealers, mechanics, and gas stations have a strong incentive to maintain the dominance of ICVs. Dealers may not be as familiar with [alternative fuel vehicles (AFVs)] and so are less likely to be able to demonstrate specifics about available incentives, nor be able to exude confidence about charging, range, and battery life-span.  More importantly, dealers may also be hesitant to sell AFVs for some of the same reasons that customers may be inclined to purchase them—specifically, the expectation of reduced maintenance costs. These misaligned incentives exist because an essential part of a dealer’s business model relies on post-sale revenues related to the sale of used cars, oil changes, and engine maintenance repairs, avoided costs for AFV owners.  More car dealers may need to explore options that evolve with the technology, including maintaining and repairing fleets of autonomous vehicles.

    In short, although the United States has begun the transition to AFVs, there are a number of obstacles, financial, psychological, and cultural, that stand in the way of a greater shift to AFVs.

Amy L. Stein & Joshua Fershée, Decarbonizing Light-Duty Vehicles, 48 Environmental Law Reporter 10596 (2018) (footnotes omitted). 

European Academy of Management - Sharing Economy - Call for Participation

Our colleagues and friends at the Burgundy School of Business have informed me about an opportunity to participate in the European Academy of Management (EURAM) conference to be held in Reykjavik, Iceland from June 20-23.  (Note: these dates overlap with the 2018 National Business Law Scholars Conference.)  The Strategic Interest Group on Entrepreneurship (GIS 03) for the EURAM conference has established a sub-track on the "Sharing Economy" at the EURAM 2018 meeting. Djamchid Assadi of the Burgundy School of Business is coordinating this part of the program.

Djamchid is looking for both paper submissions and reviewers for the Sharing Economy sub-track.  Paper submissions are due by January 10 (2:00 pm Belgium time) and applications to serve as a reviewer are due December 31.  (Paper presenters are required to review at least two papers at the conference.)  Information about the conference can be found here.  The reviewer application form is available here.

Please contact Djamchid at Djamchid.Assadi@bsb-education.com if you are interested in submitting a paper.  He can tell you how to designate the paper for GIS 03.  Apparently, in GIS 03, you can declare your interest in the "The Sharing Economy" subtract.  Please feel free to use my name in any communications with Djamchid.

Washington Marijuana Law Has Entity Type Quirks (And LLCs Are Still Not Corporations)

A recent case in Washington state introduced me to some interesting facets of Washington's recreational marijuana law.  The case came to my attention because it is part of my daily search for cases (incorrectly) referring to limited liability companies (LLCs) as "limited liability corporations."  The case opens: 

In 2012, Washington voters approved Initiative Measure 502. LAWS OF 2013, ch. 3, codified as part of chapter 69.50 RCW. Initiative 502 legalizes the possession and sale of marijuana and creates a system for the distribution and sale of recreational marijuana. Under RCW 69.50.325(3)(a), a retail marijuana license shall be issued only in the name of the applicant. No retail marijuana license shall be issued to a limited liability corporation unless all members are qualified to obtain a license. RCW 69.50.331(1)(b)(iii). The true party of interest of a limited liability company is “[a]ll members and their spouses.”¹ Under RCW 69.50.331(1)(a), the Washington State Liquor and Cannabis Board (WSLCB) considers prior criminal conduct of the applicant.²

LIBBY HAINES-MARCHEL & ROCK ISLAND CHRONICS, LLC, Dba CHRONICS, Appellants, v. WASHINGTON STATE LIQUOR & CANNABIS BOARD, an Agency of the State of Washington, Respondent., No. 75669-9-I, 2017 WL 6427358, at *1 (Wash. Ct. App. Dec. 18, 2017) (emphasis added).  

 

The reference to a limited liability corporation appears simply to be a misstatement, as the statute properly references limited liability companies as distinct from corporations. The legal regime does, though, have some interesting requirements from an entity law perspective. First, the law provides:

 

(b) No license of any kind may be issued to:

 

. . . .

 

(iii) A partnership, employee cooperative, association, nonprofit corporation, or corporation unless formed under the laws of this state, and unless all of the members thereof are qualified to obtain a license as provided in this section;

Wash. Rev. Code § 69.50.331 (b)(iii) (West). It makes some sense to restrict the business to in-state entities given the licensing restrictions that state has, although it is not clear to me that the state could not engage in the same level of oversight if an entity were, say, a California corporation or a West Virginia LLC. 

 

The state's licensing requirements, as stated in Washington Administrative Code 314-55-035 ("What persons or entities have to qualify for a marijuana license?") provide: "A marijuana license must be issued in the name(s) of the true party(ies) of interest." The code then lists what it means to be a  “true party of interest” for a variety of entities. 

True party of interest: Persons to be qualified

 

Sole proprietorship: Sole proprietor and spouse.

 

General partnership: All partners and spouses.

 

Limited partnership, limited liability partnership, or limited liability limited partnership: All general partners and their spouses and all limited partners and spouses.

 

Limited liability company: All members and their spouses and all managers and their spouses.

 

Privately held corporation: All corporate officers (or persons with equivalent title) and their spouses and all stockholders and their spouses.

 

Publicly held corporation: All corporate officers (or persons with equivalent title) and their spouses and all stockholders and their spouses.

Multilevel ownership structures: All persons and entities that make up the ownership structure (and their spouses).

Wash. Admin. Code 314-55-035. 

This is a pretty comprehensive list, but I note that the corporation requirements are missing some noticeable parties: directors. The code states, for both privately and publicly held corporations, that all "corporate officers (or persons with equivalent title)" and their spouses and all stockholders and their spouses must be qualified. Directors are not "equivalent" in title to officers. Officers, under Washington law, are described as follows:

 

(1) A corporation has the officers described in its bylaws or appointed by the board of directors in accordance with the bylaws.

(2) A duly appointed officer may appoint one or more officers or assistant officers if authorized by the bylaws or the board of directors.

(3) The bylaws or the board of directors shall delegate to one of the officers responsibility for preparing minutes of the directors' and shareholders' meetings and for authenticating records of the corporation.

(4) The same individual may simultaneously hold more than one office in a corporation.

Wash. Rev. Code § 23B.08.400. Directors have a different role. The statute provides:

Requirement for and duties of board of directors.

(1) Each corporation must have a board of directors, except that a corporation may dispense with or limit the authority of its board of directors by describing in its articles of incorporation, or in a shareholders' agreement authorized by RCW 23B.07.320, who will perform some or all of the duties of the board of directors.

(2) Subject to any limitation set forth in this title, the articles of incorporation, or a shareholders' agreement authorized by RCW 23B.07.320:

(a) All corporate powers shall be exercised by or under the authority of the corporation's board of directors; and

(b) The business and affairs of the corporation shall be managed under the direction of its board of directors, which shall have exclusive authority as to substantive decisions concerning management of the corporation's business.

Wash. Rev. Code § RCW 23B.08.010.

 

The Code, then, seems to provide that directors are, as a group, exempt from the spousal connection. The code separately provides:

 

(4) Persons who exercise control of business - The WSLCB will conduct an investigation of any person or entity who exercises any control over the applicant's business operations. This may include both a financial investigation and/or a criminal history background. 

Wash. Admin. Code 314-55-035.  This provision would clearly include directors, but also clearly excludes spouses. That distinction is fine, I suppose, but it is not at all clear to me why one would want to treat directors differently than LLC managers (and their spouses).  To the extent there is concern about spousal influence--to the level that the state would want to require qualification of spouses of shareholders in a publicly held entity--leaving this gap open for all corporate directors seems to be a rather big miss (or a deliberate exception).  Either way, it's an interesting quirk of an interesting new statute.   

 

 

 

 

 

 

Law and Entrepreneurship - Association Call for Papers - Near-Term Deadline!

The twelfth annual meeting of the Law and Entrepreneurship Association (LEA) will occur on February 9, 2018 at the University of Alabama School of Law

The LEA is a group of legal scholars interested in the topic of entrepreneurship—broadly construed. Scholars include those who write about corporate law and finance, securities, intellectual property, labor and employment law, tax, and other fields related to entrepreneurship and innovation policy.

Our annual conference is an intimate gathering where each participant is expected to read and actively engage with all of the pieces under discussion. We call for papers and proposals relating to the general topic of entrepreneurship and the law.

Proposals should be comprehensive enough to allow the LEA board to evaluate the aims and likely content of papers they propose. Papers may be accepted for publication but must not be published prior to the meeting. Works in progress, even those at a relatively early stage, are welcome. Junior scholars and those considering entering the legal academy are especially encouraged to participate.

To submit a presentation, email Professor Mirit Eyal-Cohen at meyalcohen@law.ua.edu with a proposal or paper by December 31, 2017. Please title the email “LEA Submission – {Name}.”

For additional information, please email Professor Mirit Eyal-Cohen at meyalcohen@law.ua.edu.

Notre Dame Law Seeks Director for New Palo Alto Innovation Clinic

 

 

University of Notre Dame: The Law School

Director, California Innovation Intensive

Location: Palo Alto, California

---

Notre Dame Law School invites applications to serve as the inaugural full-time Director of the Law School’s new California Innovation Clinic.  The Clinic will provide transactional services and related advice to individuals or entities in the Bay Area seeking to start or expand their own ventures.  The Clinic will operate out of the Notre Dame California center in Palo Alto, California.

The Clinic will provide students, under the supervision of the Clinic Director, opportunities to serve the transactional needs of early-stage startup ventures. The services offered by the Clinic will depend in significant part on the background and skills of the Clinic Director, but we anticipate that the Clinic will assist clients with some or all of the following: entity formation, founder agreements, non-disclosure agreements, ownership agreements, licensing and/or freedom to operate agreements, and privacy and data security policies. Specific client matters will be determined by the Clinic Director, although decisions about the overall direction of the Clinic’s work will be made in consultation with the Dean and other law school faculty members.

The Director will be a full-time staff attorney or non-tenure track faculty member, with responsibility for all aspects of the Innovation Clinic, including client development, client representation, law student supervision, and classroom instruction. The Innovation Clinic will be one of six clinics at the Law School.

Responsibilities of the Director will include: 

• Developing a consistent and appropriate base of clients for the clinic;
• Designing and implementing the Clinic infrastructure including a curriculum, a case management system, and relationships with partner organizations;
• Providing transactional services to Clinic clients;
• Supervising up to 8-10 law students per semester, and approximately
  1-2 law students each summer, in direct client representation;
• Providing law students with instruction in substantive and procedural law necessary to effectively represent Clinic clients;
• Providing law students with training in core lawyering skills necessary to carry out client representation, including interviewing and counseling, fact investigation, negotiation, drafting corporate  agreements, and oral advocacy;
• Developing and teaching a companion course covering the range of legal issues that arise at different stages of a startup venture’s development;
• Collaborating with clinical and other faculty at the Law School;
• Collaborating with leaders of other entrepreneurship-related activities within the broader University, including the IDEA Center;
• Attending conferences and interacting with faculty at other institutions; and
• Assisting in the development of additional financial resources for the Clinic.

QUALIFICATIONS

The ideal candidate will have the following qualifications:

• A Juris Doctor degree from an ABA-accredited law school and at least 8-10 years of practice experience relevant to the representation of startup ventures in transactional matters;
• Excellent supervisory and communication skills;
• A commitment to instructing and supervising law students;
• Ability to work in a self-directed and entrepreneurial environment;
• An academic record that demonstrates the capacity to be an active participant in the Law School’s academic community and in the national clinical-education community; and
• A license to practice law in the State of California.

Term and Compensation: The position is full-time with a salary commensurate with experience, plus benefits, which include medical, dental, and retirement.  The initial contract will be for a two-year term beginning July 1, 2018, or as soon as possible.  

APPLICATION INSTRUCTIONS

Application Process and Deadline:  Applicants should submit a cover letter and a Curriculum Vitae.

The Search Committee will begin reviewing applications immediately.  The position will remain open until filled. 

For more information contact Professor Mark McKenna at 574-631-9258 or markmckenna@nd.edu.

This institution is using Interfolio's Faculty Search to conduct this search. Applicants to this position receive a free Dossier account and can send all application materials, including confidential letters of recommendation, free of charge.

---

This appointment is contingent upon the successful completion of a background check.  Applicants will be asked to identify all felony convictions and/or pending felony charges.  Felony convictions do not automatically bar an individual from employment.  Each case will be examined separately to determine the appropriateness of employment in the particular position.  Failure to be forthcoming or dishonesty with respect to felony disclosures can result in the disqualification of a candidate.  The full procedure can be viewed at http://facultyhandbook.nd.edu/university-policies/background-check-procedure-for-prospective-faculty/.

EQUAL OPPORTUNITY EMPLOYMENT STATEMENT

The University of Notre Dame seeks to attract, develop, and retain the highest quality faculty, staff and administration.  The University is an Equal Opportunity Employer, and is committed to building a culturally diverse workplace.  We strongly encourage applications from female and minority candidates and those candidates attracted to a university with a Catholic identity.  Moreover, Notre Dame prohibits discrimination against veterans or disabled qualified individuals, and requires affirmative action by covered contractors to employ and advance veterans and qualified individuals with disabilities in compliance with 41 CFR 60-741.5(a) and 41 CFR 60-300.5(a).

Blockchain-Based Token Sales, Initial Coin Offerings, and the Democratization of Public Capital Markets. Oh, My!

My UT Law colleague Jonathan Rohr has coauthored (with Aaron Wright) an important piece of scholarship on an of-the-moment topic--financial instrument offerings using distributed ledger technology.  Even more fun?  He and his co-author are interested in aspects of this topic at its intersection with the regulation of securities offerings.  Totally cool.

Here is the extended abstract.  I cannot wait to dig into this one.  Can you?  As of the time I authored this post, the article already had almost 700 downloads . . . .  Join the crowd!

+++++

Blockchain-Based Token Sales, Initial Coin Offerings, and the Democratization of Public Capital Markets

Jonathan Rohr & Aaron Wright

Best known for their role in the creation of cryptocurrencies like bitcoin, blockchains are revolutionizing the way tech entrepreneurs are financing their business enterprises. In 2017 alone, over $2.2 billion has been raised through the sale of blockchain-based digital tokens in what some are calling initial coin offerings or “ICOs,” with some sales lasting mere seconds. In a token sale, organizers of a project sell digital tokens to members of the public to finance the development of future technology. An active secondary market for tokens has emerged, with tokens being bought and sold on cryptocurrency exchanges scattered across the globe, with often wild price fluctuations.

The recent explosion of token sales could mark the beginning of a broader shift in public capital markets—one similar to the shift in media distribution that started several decades ago. Blockchains drastically reduce the cost of exchanging value and enable anyone to transmit digitized assets around the globe in a highly trusted manner, stoking dreams of truly global capital markets that leverage the power of a blockchain and the Internet to facilitate capital formation.

The spectacular growth of tokens sales has caused some to argue that these sales simply serve as new tools for hucksters and unscrupulous charlatans to fleece consumers, raising the attention of regulators across the globe. A more careful analysis, however, reveals that blockchain-based tokens represent a wide variety of assets that take a variety of forms. Some are obvious investment vehicles and entitle their holders to economic rights like a share of any profits generated by the project. Others carry with them the right to use and govern the technology that is being developed with funds generated by the token sale and may represent the beginning of a new way to build and fund powerful technological platforms.

Lacking homogeneity, the status of tokens under U.S. securities laws is anything but clear. The test under which security status is assessed—the Howey test—has uncertain application to blockchain-based tokens, particularly those that entitle the holder to use a particular technological service, because they also present the possibility of making a profit by selling the token on a secondary market. Although the SEC recently issued a Report of Investigation in which it found that one type of token qualified as a security, confusion surrounds the boundaries between the types of tokens that will be deemed securities and those that will not.

Blockchain-based tokens exhibit disparate features and have characteristics that make current registration exemptions a poor fit for token sales. In addition to including requirements that do not fit squarely with blockchain-based systems, the transfer restrictions that apply to the most popular exemptions would have the perverse effect of restricting the ability of U.S. consumers to access a new generation of digital technology. The result is an uncertain regulatory environment in which token sellers do not have a sensible path to compliance.

In this Article, we argue that the SEC and Congress should provide token sellers and the exchanges that facilitate token sales with additional certainty. Specifically, we propose that the SEC provide guidance on how it will apply the Howey test to digital tokens, particularly those that mix aspects of consumption and use with the potential for a profit. We also propose that lawmakers adopt both a compliance-driven safe harbor for online exchanges that list tokens with a reasonable belief that the public sale of such tokens is not a violation of Section 5 as well as an exemption to the Section 5 registration requirement that has been tailored to digital tokens.

Stonyfield's Struggles and Successes as a Social Business

Yesterday, I listened to How I Built This' podcast on Gary Hirshberg of Stonyfield Yogurt.

I assume most readers are familiar with Stonyfield Yogurt, and perhaps a bit of its story, but I think the podcast goes far beyond what is generally known. 

The main thing that stuck out in the podcast was how many struggles Stonyfield faced. Most of the companies featured on How I Built This struggle for a few months or even a few years, but Stonyfield seemed to face more than its share of challenges for well over a decade. The yogurt seemed pretty popular early on, but production, distribution, and cash flow problems haunted them. Stonyfield also had a tough time sticking with their organic commitment, abandoning organic for a few years when they outsourced production and couldn't convince the farmers to follow their practices. With friends and family members' patient investing (including Gary's mother and mother-in-law), Stonyfield finally found financial success after raising money for its own production facility, readopting organic, and finding broader distribution.

After about 20 years, Stonyfield sold the vast majority of the company to large multinational Group Danone. Gary explained that some investors were looking for liquidity and that he felt it was time to pay them back for their commitment. Gary was able to negotiate some control rights for himself (unspecified in the podcast) and stayed on as chairman. While this sale was a big payday for investors, it is unclear how much of the original commitment to the environment and community remained. Also, the podcast did not mention that Danone announced, a few months ago, that it would sell Stonyfield. 

Personally, I am a fan of Stonyfield's yogurt and it will be interesting to follow their story under new ownership. I also think students and faculty members could benefit from listening to stories like this to remind us that success is rarely easy and quick. 

Pollman and Barry on Regulatory Entrepreneurship

I recently finished Elizabeth Pollman and Jordan Barry's article entitled Regulatory Entrepreneurship. The article is thoughtfully written and timely. I highly recommend it. 

-------------

This Article examines what we term “regulatory entrepreneurship” — pursuing a line of business in which changing the law is a significant part of the business plan. Regulatory entrepreneurship is not new, but it has become increasingly salient in recent years as companies from Airbnb to Tesla, and from DraftKings to Uber, have become agents of legal change. We document the tactics that companies have employed, including operating in legal gray areas, growing “too big to ban,” and mobilizing users for political support. Further, we theorize the business and law-related factors that foster regulatory entrepreneurship. Well-funded, scalable, and highly connected startup businesses with mass appeal have advantages, especially when they target state and local laws and litigate them in the political sphere instead of in court.

Finally, we predict that regulatory entrepreneurship will increase, driven by significant state and local policy issues, strong institutional support for startup companies, and continued technological progress that facilitates political mobilization. We explore how this could catalyze new coalitions, lower the cost of political participation, and improve policymaking. However, it could also lead to negative consequences when companies’ interests diverge from the public interest.

Podcasts: "StartUp" and a $16 Cup of Coffee

As previously mentioned, I am always looking for good podcasts. I listen to podcasts while mowing our lawn and on road trips. 

StartUp is the latest podcast series that I have uncovered, thanks to a recommendation from my sister Anna who works for a media/marketing start up herself.

From what I have uncovered so far, StartUp seems to be quite like NPR's How I Built This, which I mentioned in a previous post. Hosts of both podcasts interview entrepreneurs about the founding of their businesses and the ups and downs thereafter. The biggest difference I see is that StartUp seems to focus on smaller companies (a number that I had never heard of), while How I Built This seems to focus on companies that are now quite large and successful. In early seasons of StartUp there appear to be a number of the podcasts that depart from the entrepreneur-interview model, but I haven't dug into the early seasons yet. I am mainly focused on the recent podcasts. 

Perhaps most interestingly, I recently listened to a podcast on StartUp about Mokhtar Alkhanshali and his specialty coffee. Mokhtar sources his coffee beans from war-torn Yemen and a cup of his coffee sells for $16 a cup. At first, this seemed like a ridiculous price for a cup of coffee, but after hearing how Mokhtar risked his life for his business in Yemen (bombings, escaping on a tiny boat, being captured, etc.) and listening to the specialty coffee to wine comparison, the pricing does make more sense. I might pay $16 once, just for the story, but I couldn't see a $16 cup of coffee becoming even a semi-regular purchase for me. That said, I know people who are getting increasingly serious about their coffee and perhaps it can be sustained in some cities. 

Making Friends with Entrepreneurs

Last year, I was asked to contribute to a symposium on law and entrepreneurship hosted at the University of North Carolina.  Although I had to Skype in for my presentation from Little Rock, Arkansas (where I had just given a separate, unrelated CLE presentation), the panel to which I was assigned was fabulous.  Great scholars, with great ideas.

For my contribution to the symposium, I chose to reflect on the unfulfilled promise of the potentially mutually beneficial relationship between an entrepreneur and a business finance lawyer.  I recently posted the published work memorializing my thoughts on the topic, featured this spring with several other articles from the symposium in a dedicated edition of the North Carolina Law Review.  The brief abstract for my article follows:

Entrepreneurs have the capacity to add value to the economy and the community. Business lawyers—including business finance lawyers—want to help entrepreneurs achieve their objectives. Despite incentives to a symbiotic relationship, however, entrepreneurs and business finance lawyers are not always the best of friends. This Article offers several approaches to bridging this gap between entrepreneurs and business finance lawyers.

My hope in writing this article was to infuse some energy into conversations about the role of business finance and business finance lawyers in the start-up and small business environment.  Too many principals of emergent businesses with whom I interact think that business entity choice and formation are divorced--wholly or in major part--from finance.  Of course, governance and tax matters (as well as, e.g., intellectual property and employment law concerns) are key.  But my personal view is that entrepreneurs and promoters of new businesses should map out their plan for financing firms from the start and take that plan into account in choosing the form of legal entity for those businesses.  I may be fighting an uphill battle on this (for a variety of reasons, mostly relating to the limited resource environment in which start-ups and small businesses exist), but I hope the article gives both clients and lawyers in this space something to consider, at the very least.

Should social entrepreneurs form nonprofits or benefit corporations?

On June 8, I will answer this and other questions during an interactive session for a group of social entrepreneurs at Venture Cafe in Miami. Fortunately, I will have an accountant with me to talk through some of the tax issues. I was invited by the director of Radical Partners, a social impact accelerator. We estimate that 75% of the audience members will work for a nonprofit and the rest will work in traditional for profit entities with a social mission.

Many entrepreneurs in South Florida have an interest in benefit corporations, but don't really know much about them. Our job is to provide some guidance on entity selection and demystify these relatively new entities. Some of the issues I plan to address in my 20 minutes are:

1) the differences between nonprofits, for profits, and benefit corporations

2) the differences between benefit and social purpose corporations (focusing on Florida law)

3) the biggest myths about benefit corporations (such as perceived tax benefits)

4) tax issues (for the accountant)

5) director duties

6) funding- changing funding model from donors to investors; going public

7) reporting, auditing, and certification requirements

8) benefit enforcement proceedings

9) the role of B Lab and the difference between a B Corp and a benefit corporation (currently 15 Florida companies are certified through B Lab)

10) transparency and accountability issues

We plan to leave about 45 minutes for questions. Not many lawyers in Florida have experience with benefit or social purpose corporations, so I am seeking guidance from our readers. If you are a practitioner and have dealt with these entities in your states, I'm interested in your thoughts. Are a lot of your clients asking about these entities? Have they converted? How do you help them decide whether this change is good for them? I'm also fortunate to have colleagues on this blog who are real thought leaders in the area, and am looking forward to their comments. Personally, I believe that for many business owners, benefit corporations may provide a perceived marketing edge, but not much more, Author Tina Ho has raised concerns about greenwashing. If I'm wrong, let me know below or send me an email at mweldon@law.miami.edu.

 

Summer Reading: Visions of Vocation by Steven Garber

In last week’s post, I mentioned Dr. Steven Garber. Recently, I finished his 2014 book Visions of Vocation: Common Grace for the Common Good. This book is among a handful of  books in the faith & work area that I have read over the past few months.

Visions of Vocation is beautifully written, lyrical and rich. Garber’s weaves philosophy, literature, and personal stories throughout the book’s 255 pages.

Garber’s thesis in this talk, which echoes in much of his work, is that “vocation is integral, not incidental to the Missio Dei (mission of God)." Garber says the book Visions of Vocation grew out of these questions: Can you know the world and still love the world? & What will you do with what you know? The first question hits home, as the flaws of jobs and people often become more vivid over time.  After the second question, Garber shows how stoicism and cynicism are unsatisfying responses.  

Garber offers no easy answers, which is, perhaps, on purpose. These are difficult questions in a difficult area, and easy answers may not exist. I finished the book still hoping for some clear principles for integrating faith and work, but maybe the stirring questions were the point. The stories of folks at International Justice Mission and Elevation Burger, among others, do help in thinking about how faith and work fit together, as do the references to Walker Percy and Wendell Berry.

Again, this is not a book that provides a few simple steps or quick takeaways, but for a number of days after finishing it, I am still pondering its contents. For that reason, I think the book was well worth reading.

Seven Ted Talks that Will Change the Way You Look at Business (According to Entrepreneur Magazine)

I try to watch at least one Ted Talk a day. I learn new substantive topics and I also learn from listening to the speakers break down complex topics in an engaging way--a key skill for the classroom. I don’t know that any of the videos in a recent article written for business people really transformed my thinking about business, but I did find some parts interesting and inspiring.

Here they are for your viewing pleasure:

• Myths of Entrepreneurship
• Why Work Doesn't Happen at Work
• 10 Things to Know Before You Pitch to a Venture Capitalist
• What Consumers Want
• What Makes us Feel Good about Our Work
• The Power of Time Off
• Build a Tower, Build a Team

Creating a More Productive Space for Social Entrepreneurship - A Unique Birthday Present

Today, I am spending my birthday attending and presenting at the Fifth Annual Midwest Symposium on Social Entrepreneurship in Kansas City, Missouri.  I owe my presence here to my entrepreneurship colleagues and friends Tony Luppino (UMKC Law) and John Tyler (Kauffman Foundation).  Thanks for the awesome birthday present, guys.

There's so much I have to say about just the first day of this event.  (I also will be here and presenting tomorrow.)  The proceedings so far have been incredibly thought-provoking and instructive.  Most intriguing has been the focus around creating an ecosystem for social entrepreneurship.  Of course, law and lawyers have roles in that.  Hence, this blog post . . . .

Specifically, I want to devote today's post to the four essential action-elements necessary to generate a successful, sustained future for social entrepreneurship as posited and described by Mark Beam, Maverick in Residence at the Kauffman Foundation, in his kick-off keynote presentation this morning.  (As an aside, I will note that Mark started his talk with a brief recounting of the origin of the word "maverick," which was independently fascinating.)  Here are Mark's four elements, as I captured them in my notes (likely imperfectly), together with a bit of summary definitional commentary.  He contended that, to build a sustainable ecosystem for social entrepreneurship, we must:

1. Redefine work (recognizing entrepreneurship as work; taking into account the power and effects of technology, but knowing it needs to serve us and the human potential)
2. Nurture entrepreneurial ecosystems that mimic and integrate natural systems (e.g., helping people to help themselves; moving resources from the “haves” to the “have-nots”)
3. Evolve our capacity to serve more of the entrepreneurial community through ecosystem design (referring to three megatrends outlined by Kauffman Foundation CEO Wendy Guillies--demography, geography, and technology; opening up entrepreneurship to all to increase business, start-ups employment, productivity)
4. Tell new stories (relating anecdotes that connect us; “we create the future through the stories we tell ourselves”—visioning the future through stories)

That may not sound like much, but trust me.  The talk (beautifully delivered with amazing graphics, photography, and media content) was much better than my quick summary of the outtakes.

What Mark said made a lot of sense to me based on my related experience and work.  But I found myself thinking about the role of the lawyer in these action items.  How can lawyers--especially business lawyers--who support social enterprise help social entrepreneurship to productively move forward?

Continue reading

Call for Submissions - Collective Book on Legal Innovation

COLLECTIVE BOOK ON LEGAL INNOVATION

Call for submissions

The program « Law & Management » developed by the European Center of Law and Economics (known as CEDE in French) of ESSEC Business School, is an innovative and pioneering research program which aims to study the use of law as a competitive factor.

In this regard, the members of the research program « Law & Management » have decided to publish a collective book focusing on legal innovation. This book, co-edited by A. Masson (ESSEC) and D. Orozco (Florida State University), will analyze, by crossing the points of view of lawyers and creative specialists, the concept and life cycle of legal innovations, techniques and services, whether they are related to legislation, legal engineering, legal services, legal strategies…, as well as the role of law as a source of creativity and interdisciplinary teamwork. All the techniques that could facilitate legal innovations from the perspective of design thinking to predictive design, through the customer experience will be analyzed.

The program Board is now opening the call for proposals. Papers proposals (consisting in a brief summary in English) of a maximum length of 1000 words, should be sent to A. Masson (massona@essec.fr) by May 8th, 2017. A least one practical example of legal innovations on which the papers will rely on must be mentioned in the proposals.

The proposals will be reviewed and selected by a scientific committee. Authors will receive a definitive answer by June 6th, 2017. The final manuscripts will be expected by October 9th, 2017.

A conference, following the publication of the book, will be organized in Paris in 2018.

With the support of the Paris Île-de-France Regional Chamber of Commerce and Industry and the French Corporate Counsel Association (AFJE).

The FairShares Model

On of the many interesting things discussed during the social enterprise law workshop at Notre Dame Law School was the "FairShares Model." Nina Boeger (University of Bristol-UK) brought the model to the group's attention, and the model was new news to me.

The FairShares Model was "created during a research programme on democratising charities, co-operatives and social enterprises involving academics at Sheffield Hallam University and Manchester Metropolitan University in the UK."

The FairShares Model cites the "Social Enterprise Europe Ltd" when noting that social enterprises "aim to generate sustainable sources of income, but measure their success through:

• Specifying their purpose(s) and evaluating the impact(s) of their trading activities;

• Conducting ethical reviews of their product/service choices and production/consumption practices;

• Promoting socialized and democratic ownership, governance and management."

To address theses aims, the FairShares Model offers social audits and suggests the issuing some combination of (1) founder shares, (2) labour shares, (3) investor shares, (4) user shares.

While I agree that significant corporate governance changes should be considered, at first glance this model seems a bit unwieldy if all four types of shares are issued. Still, I am interested in learning more.