Tuesday, February 12, 2019
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).
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.
Two closing thoughts:
- Jack Hammer as an LLC member of a construction-focused entity sounds like one of my exam characters. Awesome.
- 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.)
- 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.
Sunday, October 21, 2018
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.]
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)
Tuesday, September 25, 2018
I was going to move on to other topics after two recent posts about Nike's Kaepernick Ad, but I decided I had a little more to say on the topic. My prior posts, Nike's Kaepernick Ad Is the Most Business Judgmenty Thing Ever and Delegation of Board Authority: Nike's Kaepernick Ad Remains the Most Business Judgmenty Thing Ever explain my view that Nike's decision to run a controversial ad is the essence of the exercise of business judgment. Some people seem to believe that by merely making a controversial decision, the board should subject to review and required to justify its actions. I don't agree. I need more.
First, I came across a case (an unreported Delaware case) that had language that was simply too good for me to pass up in this context:
The plaintiffs have pleaded no facts to undermine the presumption that the outside directors of the board . . . failed to fully inform itself in deciding how best to proceed . . . . Instead, the complaint essentially states that the plaintiffs would have run things differently. The business judgment rule, however, is not rebutted by Monday morning quarterbacking. In the absence of well pleaded allegations of director interest or self-dealing, failure to inform themselves, or lack of good faith, the business decisions of the board are not subject to challenge because in hindsight other choices might have been made instead.
Things are judgmenty. People are judgmental. At least, that’s my story, and I’m sticking to it. Plus, if I have learned anything in my 47 years, it’s that, in American English, if people say something enough, it becomes a word. That and the #OxfordComma is essential.— Joshua Fershee (@jfershee) September 25, 2018
Well, it seems like you've gotten a very small ball rolling. pic.twitter.com/yMCFkTNZ8D— Professor Bainbridge (@ProfBainbridge) September 25, 2018
So it appears.
Tuesday, September 18, 2018
Last week, I made the argument that Nike's Kaepernick Ad Is the Most Business Judgmenty Thing Ever. I still think so.
To build on that post (in part based on good comments I received on that post), I think it is worth exploring that ability and appropriateness of boards delegating certain duties, as this impacts any assessment of the business judgment rule.
As co-blogger Stefan Padfield correctly noted, directors "become informed of all material information reasonably available." However, does that apply to a particular ad campaign? Hiring of all spokespeople? Only certain ones? How about a particular ad? Or is it the hiring of a marketing and ad team (internally or externally)?
Nike has a long list of sponsorship (here) for teams and individuals. I sincerely doubt that all of those were run by the board of directors, though it is possible. The board may also weigh in from time to time, based on the behavior of the people they sponsor. Nike famously terminated contracts with Oscar Pistorius and Ray Rice in September 2014. Are these all board decisions? Maybe. Or maybe they have a protocol for dealing with such issues. Regardless, how they deal with this seems plainly within the BJR.
Now, I also would agree that there comes a time when the board would need to do more with regard to their advertising and sponsorships, if they were on notice of a problem with their sponsored athletes, not unlike a Caremark duty or its predecessor. In discussing the applicability of the business judgment rule, an older, but classic, Delaware case stated, “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).
When I started to write this, I did not know if Nike's board of directors saw this ad before it went out (more on that below). I expect they did (or at least knew about it), but I'm not sure. Even it if the ad were raised with the board for informational purposes, trusting the judgment and recommendation of your marketing executives seems imminently reasonable to me. It seems to me that how the board chooses to work with their marketing people fall plainly under the business judgment rule (BJR) unless shareholders can rebut the presumption that the BJR applies. It's not like marketing mistakes are not common. Most years there are recap articles about the works gaffes in marketing for the year. This one from 2017 is a particularly good example, and I don't think any of them would be likely to lead to director liability.
The scope and power of board delegation of such duties would be a good topic for further research. I certainly concede that there are times when such decisions look more like board decisions that require an appropriate process and perhaps some demonstration of due care. Maybe that goes to a need to review ads with certain risk factors, but you'd still have to delegate the decision about what needs to come to the board to someone. And do you need such a process absent notice that your ad folks are taking enormous risks? Is this a Caremark/Allis-Chalmers issue? Or could negligent hiring be the failure, if the ad folks are insane?
Support for my assumptions, and for the idea that Nike, at least, views this as a delegation question, arrived in this breaking news from CNBC, which appeared as I was writing this blog post:
But Comstock, also a former vice chair of General Electric, said Parker didn't need the board's permission before running a "Just Do It" campaign featuring the former San Francisco 49ers quarterback.
"Parker runs the company really well," Comstock said on CNBC's "Squawk on the Street," while also commenting about the new China tariffs. Parker "certainly doesn't need board approval to figure out where to run an ad," she added.
In the end, we know marketing decisions can harm stock prices, but we also know risky marketing decisions can improve stock prices. That very fact, I maintain, puts this decision squarely in the BJR zone.
Thursday, September 13, 2018
On Sept. 4, it was reported
Nike just lost about $3.75 billion in market cap after announcing free agent NFL quarterback Colin Kaepernick as the new face of its “Just Do It” ad campaign. It’s the 30th anniversary of the iconic TV and print spots.
At the time of this writing, the sneaker company’s intra-day market capitalization was $127.82 billion. On Friday, that number had been $131.57 billion.
Market capitalization is the market value of a publicly traded company’s outstanding shares.
Shares of NKE stock dropped about 4 percent on Tuesday morning, as #NikeBoycott has been trending on Twitter. The company’s valuation has since recovered a bit.
In light of the market cap loss, friend and co-blogger Stefan Padfield asked, via Twitter, "How much & what kind of information regarding projected backlash losses did Nike need to review in order to satisfy its duty of care to shareholders here?" My answer: very, very little and very, very limited.
How much & what kind of information regarding projected backlash losses did Nike need to review in order to satisfy its duty of care to shareholders here? "Nike Loses $3.75 Billion in Market Cap After Colin Kaepernick Named Face of 'Just Do It'" https://t.co/UIuZanOUon #corpgov— Stefan Padfield (@ProfPadfield) September 6, 2018
Now, it is worth noting that here it is Sept. 13, and as I write this, Nike is at or near its 52-week high. As such, the question is less pressing than it may have seemed a week ago. But even then, I maintain, this is not really even in the realm of a duty of care concern. Or, at least, it shouldn't be. (Also of potential interest, friend and co-blogger Ann Lipton provides a good overview of the varying takes on the ad here.
A while back I wrote, This I Believe: On Corporate Purpose and the Business Judgment Rule, which provided my thoughts on how director )ecision making should be viewed (short answer: "I believe in the theory of Director Primacy"). The business judgment rule provides that absent fraud, self-dealing or illegality, directors decisions cannot be reviewed. "Courts do not measure, weigh or quantify directors’ judgments. We do not even decide if they are reasonable in this context. Due care in the decisionmaking context is process due care only. Irrationality is the outer limit of the business judgment rule." Brehm v Eisner, 746 A.2d 244 (Del. 2000)(emphasis added)(footnote omitted).
Under this lens, regardless of the market cap impact, Nike's advertising falls within the scope of the business judgment rule. Did the board even know this ad was coming out? I don't know. Probably. But I also think it is clearly proper for the board to delegate duties to CEO to handle day-to-day operations. And it is customary and proper for that CEO to delegate to a marketing VP and/or marketing agency the role of designing and placing advertising. Could the CEO and/or marketing VP get fired for their choices? Sure. Or they could get bonuses. Either way, that would be the call of the directors.
I can come up with lots of reasons why Nike should not have done that ad, and I can come up with a lot of good reasons why it makes sense. The biggest reason it makes sense? Nike knows marketing. They won't get everything right, but they have been taking calculated risks for a long time. In 1992, the Harvard Business Review noted that
in the mid-1980s, Nike lost its footing, and the company was forced to make a subtle but important shift. Instead of putting the product on center stage, it put the consumer in the spotlight and the brand under a microscope—in short, it learned to be marketing oriented. Since then, Nike has resumed its domination of the athletic shoe industry. It commands 29% of the market, and sales for fiscal 1991 topped $3 billion.
Phil Knight, Nike founder, futher explained how Nike looked at using famous athletes:
The trick is to get athletes who not only can win but can stir up emotion. We want someone the public is going to love or hate, not just the leading scorer. Jack Nicklaus was a better golfer than Arnold Palmer, but Palmer was the better endorsement because of his personality.
To create a lasting emotional tie with consumers, we use the athletes repeatedly throughout their careers and present them as whole people. So consumers feel that they know them. It’s not just Charles Barkley saying buy Nike shoes, it’s seeing who Charles Barkley is—and knowing that he’s going to punch you in the nose. We take the time to understand our athletes, and we have to build long-term relationships with them. Those relationships go beyond any financial transactions. John McEnroe and Joan Benoit wear our shoes everyday, but it’s not the contract. We like them and they like us. We win their hearts as well as their feet.
Read in this light, it all makes sense. This is part of Nike's plan, and it always has been. Presumably, they expect that any business they lose because consumers are upset by the ads will be made up and then some by creating a "lasting emotional tie with consumers." That is, creating what we might call brand loyalty.
Not that is should matter to a court. While these explanations may be correct, they aren't necessary. The business judgment rule exists to allow companies, via their directors, to take these kinds of risks. It's how you create companies like Nike (and Apple, for that matter). And that's why there should be no question that this ad is beyond the scope of review, not matter how the public responds. If consumers don't like it, they can buy other products. If shareholders don't like it, they can vote the board out. And that's it. That's the recourse. It just doesn't get much more "business judgmenty" than who you pick for your ads. And that's exactly how it should be.
Tuesday, August 21, 2018
Senator Elizabeth Warren last week released her Accountable Capitalism Act. My co-blogger Haskell Murray wrote about that here, as have a number of others, including Professor Bainbridge, who has written at least seven posts on his blog. Countless others have weighed in, as well.
There are fans of the idea, others who are agnostic, and still other who thinks it’s a terrible idea. I am not taking a position on any of that, because I am too busy working through all the flaws with regard to entity law itself to even think about the overall Act.
As a critic of how most people view entities, my expectations were low. On the plus side, the bill does not say “limited liability corporation” one time. So that’s a win. Still, there are a number of entity law flaws that make the bill problematic before you even get to what it’s supposed to do. The problem: the bill uses “corporation” too often where it means “entity” or “business.”
Let’s start with the Section 2. DEFINITIONS. This section provides:
(2) LARGE ENTITY.—
(A) IN GENERAL.—The term ‘‘large entity’’ means an entity that—
(i) is organized under the laws of a State as a corporation, body corporate, body politic, joint stock company, or limited liability company;
(ii) engages in interstate commerce; and
(iii) in a taxable year, according to in- formation provided by the entity to the Internal Revenue Service, has more than $1,000,000,000 in gross receipts.
Okay, so it does list LLCs, correctly, but it does not list partnerships. This would seem to exclude Master Limited Partnerships (MLPs). The Alerian MLP Indexlist about 40 MLPs with at least a $1 billion market cap. It also leaves our publicly traded partnerships(PTPs). So, that’s a miss, to say the least.
Section 2 goes on to define a
(6) UNITED STATES CORPORATION.—The term “United States corporation’’ means a large entity with respect to which the Office has granted a charter under section 3.
The bill also creates an “Office of United States Corporations,” in Section 3, even though the definitions section clear says a “large entity” includes more than just corporations.
Next is Section 4, which provides the “Requirement for Large Entities to Obtain Charters.”
(1) IN GENERAL.— An entity that is organized as a corporation, body corporate, body politic, joint stock company, or limited liability company in a State shall obtain a charter from the Office . . . .”
So, again, the definition does not include MLPs (or any other partnership forms, or coops for that matter) as large entities. I am not at all clear why the Act would refer to and define “Large Entities,” then go back to using “corporations.” Odd.
Later in section 4, we get the repercussions for the failure to obtain a charter:
An entity to which paragraph (1) applies and that fails to obtain a charter from the Office as required under that paragraph shall not be treated as a corporation, body corporate, body politic, joint-stock company, or limited liability company, as applicable, for the purposes of Federal law during the period beginning on the date on which the entity is required to obtain a charter under that paragraph and ending on the date on which the entity obtains the charter.
Here, the section chooses not to use the large entity definition or the corporation definition and instead repeats the entity list from the definitions section. As a side note, does this section mean that, for “purposes of Federal law,” any statutory “large entity” without a charter is a general partnership or sole proprietorship? I would hope not for the LLC, which isn’t a corporation, anyway.
Finally, in Section 5, the Act provides:
(1) RULE OF CONSTRUCTION REGARDING GENERAL CORPORATE LAW.—Nothing in this section may be construed to affect any provision of law that is applicable to a corporation, body corporate, body politic, joint stock company, or limited liability company, as applicable, that is not a United States corporation.
Again, I will note that “general corporate law” should not apply to anything but corporations, anyway. LLCs, in particular.
The Act further contemplates a standard of conduct for directors and officers. LLCs do not have to have either, at least not in the way corporations do, nor do MLPs/PTPs, which admittedly do not appear covered, anyway. The Act also contemplates shareholders and shareholder suits, which are not a thing for LLCs/MLPs/PTPs because they don’t have shareholders.
This is not an exhaustive list, but I think it’s a pretty good start. I will concede that some of my critiques could be argued another way. Obviously, I'd disagree, but maybe some of this is not as egregious as I see it. Still, there are flaws, and if this thing is going to move beyond even the release, I sure hope they take the time to get the entity issues figured out. I’d be happy to help.
August 21, 2018 in Corporate Governance, Corporate Personality, Corporations, CSR, Joshua P. Fershee, Legislation, LLCs, Management, Partnership, Shareholders, Unincorporated Entities | Permalink | Comments (0)
Tuesday, June 19, 2018
An interesting new article appears in the Chronicle of Higher Education: What Happened When the Dean’s Office Stopped Sending Emails After-Hours, by Andrew D. Martin, dean of the College of Literature, Science, and the Arts at the University of Michigan and a professor of political science and statistics, and Anne Curzan associate dean for humanities and a professor of English. Interesting concept, and an idea worth considering. Here's what they tried:
What if we experimented with a policy that set some limits in the dean’s office? Here’s what we came up with:
Limit email traffic to working hours. Except for emergencies, work emails are to be sent between the hours of 7 a.m. and 6 p.m., Monday through Friday. Use the delayed-send function to ensure that emails to and from people working in the dean’s office arrive only within that window.
Try to communicate in person. Whenever possible, associate and assistant deans should communicate with one another and with other professional staff employees in person or by telephone during the business day. Our administrative assistants can help us find quick drop-in times.
Avoid email forwarding. Refrain from forwarding an email to chairs and directors and asking them to forward it to others. When possible, send it yourself directly to the audience you want to communicate with.
Respect working hours. The dean and the associate and assistant deans should not expect — or request — support from professional staff employees outside of the 7 a.m. to 6 p.m. window. An exception is for emergencies, and then only from salaried staff members.
The authors say the rules became part of the dean's office's culture, and although it was not enforced, it is largely followed and has led to more efficient and effective work.
I have to admit, I think it would be hard, and I am notoriously bad for being almost tethered to my email. But I can also see why it would help. I feel absolutely compelled to reply to inquiries and requests. Sometimes I resist the urge to do so, but even then, my mental space has been taken up by obligations. It's not ideal. More important, it means that when I am sending emails after hours, I am getting into other people's space when it is not necessary. Emergencies are one thing, and they happen, but I can definitely do a better job of staying out of people's personal time, and I am going to give it a try.
Monday, May 7, 2018
I was fascinated by Ann Lipton's post on April 14. I started to type a comment, but it got too long. That's when I realized it was actually a responsive blog post.
Ann's post, which posits (among other things) that corporate chief executives might be required to comply with their fiduciary duties when they are acting in their capacity as private citizens, really made me think. I understand her concern. I do think it is different from the disclosure duty issues that I and others scope out in prior work. (Thanks for the shout-out on that, Ann.) Yet, I struggled to find a concise and effective response to Ann's post. Here is what I have come up with so far. It may be inadequate, but it's a start, at least.
Fiduciary duties are contextual. One can have fiduciary duties to more than one independent legal person at the same time, of course, proving this point. (Think of those overlapping directors, Arledge and Chitiea in Weinberger. They're a classic example!) What enables folks to know how to act in these situations is a proper identification of the circumstances in which the person is acting.
So, for example, an agent’s duty to a principal exists for actions taken within the scope of the agency relationship. The agency relationship is defined by the terms of the agreement between principal and agent as to the object of the agency. The principal controls the actions of the agent within those bounds based on that agreement.
Similarly, a director’s or officer's conduct is prescribed and proscribed within the four corners of the terms of their service to the corporation. They owe their duties to the corporation (and in Revlon-land or other direct-duty situations, also to the stockholders). The problem then becomes defining those terms of service. For directors, a quest for evidence of the parameters of their service should start with the statute and extend to any applicable provisions of the corporate charter, bylaws, and board policies and resolutions more generally. For officers, the statute typically doesn’t provide much content on the nature or extent of their services. The charter may not either. Typically, the bylaws and board policies and resolutions, as well as any employment or severance agreement (the validity of which is largely a matter outside the scope of corporate law), would define the scope of service of an officer.
I have trouble envisioning that the scope of service (and therefore, reach of fiduciary duties) for a typical director or officer would extend to, e.g., private ownership of other entities and decisions made in that capacity. Yet, even where there is no technical conflicting interest or breach of a duty of loyalty, there is a clear business interest in having corporate managers—especially highly visible ones—act in a manner that is consistent with corporate policy or values when they are not “on the job.” While voluntary corporate policy or private regulation may have a role in policing that kind of director or officer activity (through service qualifications or employment termination triggers, e.g.), I do not think it is or should be the job of corporate law—including fiduciary duty law—to take on that monitoring and enforcement role.
Nevertheless, I remain convinced that better (more accurate ad complete) disclosure of (at least) inherent conflicts of interest may be needed so investors and other stakeholders can evaluate the potential for undesirable conduct that may impact the nature or value of their investments in the firm. As Ann notes, significant privacy rights exist in this context, too. There's more work to be done here, imv.
Thanks for making me think, Ann. Perhaps you (or others) have a comment on this riposte? We shall see . . . .
Tuesday, April 10, 2018
Last week, the Neel Corporate Governance Center at UT Knoxville hosted one of UT Knoxville's alums, Ron Ford, as a featured speaker. He gave a great talk on boards of directors, from his unique vantage point--that of a CFO. In the course of his remarks, he mentioned a public company corporate gpvernance policy that I had not earlier heard of: a CEO limit or prohibition on outside board service (other than local, small nonprofit board service). A 2017 study found that:
Only 22% of S&P 500 boards set a specific limit in their corporate governance guidelines on the CEO’s outside board service; 65% of those boards limit CEOs to two outside boards, and 32% set the limit at one outside board. One board does not allow the company CEO to serve on any outside corporate boards, and two boards allow their CEO to serve on three outside corporate boards.
This may be why I had not heard about governance policies limiting board service; it seems these policies may be relatively uncommon. I know from experience that CEOs do serve on outside boards and often consider that service an important way to learn valuable things that can be implemented at the firm that enjoys them.
What is the ostensible purpose of a policy restricting the outside board service of a firm's CEO? Perhaps it is obvious. It seems that most firms imposing this kind of restriction on CEOs desire to prevent the CEO from spending significant time on his or her service as a board member of another firm to the detriment of the firm by which he or she is employed as chief executive. An online article succinctly captures the capacity for distraction.
. . . CEOs must weigh . . . the potential disadvantage of having to navigate a crisis. David Larcker, a professor at Stanford Law School and senior faculty at the university’s corporate governance center, says that while most CEOs would say that serving on an outside board is highly valuable, everything changes if either company comes up against a big challenge.
“Where it gets really complicated for a sitting CEO is if something happens,” Larcker says. “You’re a takeover target. You have a big restatement. You’re replacing a CEO. That’s harder to predict and takes up a lot of time.”
Are there CEOs who have experienced this kind of distraction? Yes. A Forbes contributor offers a well-known example in an article entitled "All Operating Executives Should Never Serve On Any Outside Boards":
A good poster child of outside board distractions was Meg Whitman in her final 2 years at the helm of eBay (EBAY). During this time, she joined the boards of Proctor & Gamble and DreamWorks Animation. EBay flew Meg around to Cincinnati and LA board meetings on their private jet. EBay's stock sank. Meg bought Skype. It didn't help.
The same article also calls out two Yahoo! CEOs as further examples. And there are others. See also, e.g., here.
Tuesday, February 13, 2018
I suspect click-bait headline tactics don't work for business law topics, but I guess now we will see. This post is really just to announce that I have a new paper out in Transactions: The Tennessee Journal of Business Law related to our First Annual (I hope) Business Law Prof Blog Conference co-blogger Joan Heminway discussed here. The paper, The End of Responsible Growth and Governance?: The Risks Posed by Social Enterprise Enabling Statutes and the Demise of Director Primacy, is now available here.
To be clear, my argument is not that I don't like social enterprise. My argument is that as well-intentioned as social enterprise entity types are, they are not likely to facilitate social enterprise, and they may actually get in the way of social-enterprise goals. I have been blogging about this specifically since at least 2014 (and more generally before that), and last year I made this very argument on a much smaller scale. Anyway, I hope you'll forgive the self-promotion and give the paper a look. Here's the abstract:
Social benefit entities, such as benefit corporations and low-profit limited liability companies (or L3Cs) were designed to support and encourage socially responsible business. Unfortunately, instead of helping, the emergence of social enterprise enabling statutes and the demise of director primacy run the risk of derailing large-scale socially responsible business decisions. This could have the parallel impacts of limiting business leader creativity and risk taking. In addition to reducing socially responsible business activities, this could also serve to limit economic growth. Now that many states have alternative social enterprise entity structures, there is an increased risk that traditional entities will be viewed (by both courts and directors) as pure profit vehicles, eliminating directors’ ability to make choices with the public benefit in mind, even where the public benefit is also good for business (at least in the long term). Narrowing directors’ decision making in this way limits the options for innovation, building goodwill, and maintaining an engaged workforce, all to the detriment of employees, society, and, yes, shareholders.
The potential harm from social benefit entities and eroding director primacy is not inevitable, and the challenges are not insurmountable. This essay is designed to highlight and explain these risks with the hope that identifying and explaining the risks will help courts avoid them. This essay first discusses the role and purpose of limited liability entities and explains the foundational concept of director primacy and the risks associated with eroding that norm. Next, the essay describes the emergence of social benefit entities and describes how the mere existence of such entities can serve to further erode director primacy and limit business leader discretion, leading to lost social benefit and reduced profit making. Finally, the essay makes a recommendation about how courts can help avoid these harms.
February 13, 2018 in Business Associations, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Delaware, Joshua P. Fershee, Law and Economics, Lawyering, Legislation, LLCs, Management, Research/Scholarhip, Shareholders, Social Enterprise, Unincorporated Entities | Permalink | Comments (0)
Tuesday, February 6, 2018
A brand new Arizona case continues the trend of incorrectly discussing limited liability companies (LLCs) as limited liability corporations, but it does allow for an interesting look at how entities are sometimes treated (or not) in laws and regulations. Here’s the opening paragraph of the case:
Noah Sensibar appeals from the superior court's ruling affirming the Tucson City Court's finding that he had violated the Tucson City Code (TCC). He argues that the municipal ordinance in question is facially invalid because it conflicts with a state statute shielding members or agents of a limited liability corporation from personal liability.
City of Tucson v. Noah Sensibar, No. 2 CA-CV 2017-0087, 2018 WL 703319 (Ariz. Ct. App. Feb. 5, 2018).
About three years ago, the City of Tucson alleged that Sensibar, as “the managing member and statutory agent of Blue Jay Real Estate LLC, an Arizona corporation, was responsible for building code violations.” Id. (emphasis added). Notwithstanding the incorrect characterization of the entity type, it looks like the court at least reasonable (though not clearly correct) to hold Sensibar individually liable. Here’s why:
The Tuscon City Code states that “Any owner or responsible party who commits, causes, permits, facilitates or aids or abets any violation of any provision of this chapter . . . is responsible for a civil infraction and is subject to a civil sanction of not less than one hundred dollars ($100.00) nor more than two thousand five hundred dollars ($2,500.00).” Tucson Code Sec. 16-48(2) (Violations and penalties).
The Code Definitions in Sec. 16-3 provide the following:
Owner means, as applied to a building, structure, or land, any part owner, joint owner, tenant in common, joint tenant or tenant by the entirety of the whole or a part of such building, structure or land.
. . . .
Person means any natural person, firm, partnership, association, corporation, company or organization of any kind, but not the federal government, state, county, city or political subdivision of the state.
. . . .
Responsible party means an occupant, lessor, lessee, manager, licensee, or person having control over a structure or parcel of land; and in any case where the demolition of a structure is proposed as a means of abatement, any lienholder whose lien is recorded in the official records of the Pima County Recorder's Office.
As such, the Code seems to contemplate holding both entities and individuals liable. Still, Sensibar had an argument. The use of the term “manager” here causes some potential confusion because one can be a manager of an LLC, while the LLC might serve as the manager of the property. Thus, it could be that only the LLC should be liable. Another plausible reading, though, is that “manager” meant the natural person doing the managing as is common in property situations. Manager, like occupant, lessee, and lessor, is not defined in the Code, so it would seem the intended source of the definitions should be from a property perspective, not an entity perspective.
Similarly, the Code could mean a natural “person having control over a structure” can be liable. If that’s the case, and the court seems to have gone down this road, the argument would be that Sensibar was being held liable directly for his role as manager or person in control of the property and not vicariously for violations of the LLC. Given that occupants, lessors, and lessees, among others, can be held liable, it does appear that the Code could have intended to impose liability directly on multiple parties, including both individuals and entities. This would be sensible, in many contexts, though it would also be sensible to say explicitly, especially given that the term “person” clearly includes entities.
A simple improvement might be to update the definition of “responsible party,” as follows:
Responsible party means an, whether as an individual or entity, any occupant, lessor, lessee, manager, licensee, or person having control over a structure or parcel of land and in any case where the demolition of a structure is proposed as a means of abatement, any lienholder whose lien is recorded in the official records of the Pima County Recorder's Office.
That would, at least, be consistent with the decision. Because if the court is holding Sensibar liable for merely being the manager of the LLC, and not as the manager of the property, the case is wrongly decided. Too bad the notice of appeal was not timely filed – maybe we could have found out.
UPDATE: Based on a good comment from Tom N., I did a little more research. As of an LLC filing in 2009, Noah Sensibar owned at least a 20% interest. (It may be 50% because there were two listed members, but it was at least 20%.) As such, this suggests that the LLC does not have funding to cover the fines or that express indemnification is lacking and the other member(s) won't agree to cover the costs from LLC funds.
I will also note that a 2016 decision denying Sensibar's appeal stated, "The court also heard evidence that Sensibar, the managing partner of the LLC, was 'the person in charge' of the property." City of Tucson v. Sensibar, No. 2 CA-CV 2016-0051, 2016 WL 5899737, at *1 (Ariz. Ct. App. Oct. 11, 2016). Seriously? He's an LLC manager. That's all. LLCs are not corporations OR partnerships. THEY ARE LLCS!
Tuesday, December 19, 2017
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
(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;
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).
(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.
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.
(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.
December 19, 2017 in Corporations, Current Affairs, Entrepreneurship, Family Business, Joshua P. Fershee, Legislation, Licensing, LLCs, Management, Nonprofits, Partnership, Shareholders, Unincorporated Entities | Permalink | Comments (0)
Saturday, November 18, 2017
Quietly, just over two months ago, we got our Lady Vols back. As you may recall, back in 2014, The University of Tennessee, Knoxville decided to consolidate its athletic branding behind the ubiquitous orange "Power T." The women's basketball team was exempted from the brand consolidation and retained the Lady Vol name and old-school logo in honor of our beloved departed coach, Pat Head Summitt. (See here.)
Many can be credited with the revival of the Lady Vols brand (and I do consider it to be an accomplishment), although perhaps these five heroic women are owed the largest debt of gratitude for the achievement. I guess my earlier envisioned dreams of profiting from the abandonment of the trademarked Lady Vols logo will not soon be realized . . . .
There are lingering lessons in this affair for businesses and their management--and universities (as well as their athletic departments) are, among other things, businesses. Knoxville's former Mayor weighed in with comments on the matter in a recent local news column, advising "you need to be sensitive to what the customer likes." He concludes (bracketed text added by me):
People will speculate for a long time on how UT let itself get caught up in this unfortunate situation for three years. It did not have to happen. It can be a valuable lesson, if once leaders realize a mistake has been made, postponing a resolution does not improve it. Better to make amends and move on.
Hopefully, DiPietro [the university's President] has learned from this that it is better to get ahead of a volatile issue than to be consumed by it. Currie [the university's new Director of Athletics] and Davenport [the campus's new Chancellor] solved it for him. They have won considerable good will for themselves and the university.
From Coca-Cola and its disastrous New Coke introduction (mentioned in the article) to Google Glass (which may have better applications, for the moment, than the general consumer market), businesses and their management have learned these lessons over and over. Listen to the customer, and if you make a miscalculation, admit it and move on.
As law schools and law instructors continue to innovate to serve students, our universities (for those who are part of one), and the profession (among other constituencies), we may be able to learn a lesson or two from some of the broader experimentation in the business world in the introduction of new products and services. Change for the sake of change or for the sake of branding simplicity, without an understanding of the relevant constituents, certainly is a risky proposition. I hope that we can be thoughtful and consider all affected interests as we innovate. And I also hope that when we fail in our change efforts (and some of us will fail) we can cut our losses and re-appraoch change with new knowledge and renewed energy to succeed.
Getting back to those Lady Vols, our women's basketball team is now 2-0 with convincing wins over ETSU and James Madison. The next game is Monday against Wichita State, followed by a Thanksgiving evening match against Marquette. Go Lady Vols!
Friday, September 29, 2017
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.
Friday, August 18, 2017
On July 15 of this year, The New York Times ran an article entitled, “The Lawyer, The Addict.” The article looks at the life of Peter, a partner of a prestigious Silicon Valley law firm, before he died of a drug overdose.
You should read the entire article, but I will provide a few quotes.
- “He had been working more than 60 hours a week for 20 years, ever since he started law school and worked his way into a partnership in the intellectual property practice of Wilson Sonsini.”
- “Peter worked so much that he rarely cooked anymore, sustaining himself largely on fast food, snacks, coffee, ibuprofen and antacids.”
- “Peter, one of the most successful people I have ever known, died a drug addict, felled by a systemic bacterial infection common to intravenous users.”
- “The history on his cellphone shows the last call he ever made was for work. Peter, vomiting, unable to sit up, slipping in and out of consciousness, had managed, somehow, to dial into a conference call.”
- “The further I probed, the more apparent it became that drug abuse among America’s lawyers is on the rise and deeply hidden.”
- “One of the most comprehensive studies of lawyers and substance abuse was released just seven months after Peter died. That 2016 report, from the Hazelden Betty Ford Foundation and the American Bar Association, analyzed the responses of 12,825 licensed, practicing attorneys across 19 states. Over all, the results showed that about 21 percent of lawyers qualify as problem drinkers, while 28 percent struggle with mild or more serious depression and 19 percent struggle with anxiety. Only 3,419 lawyers answered questions about drug use, and that itself is telling, said Patrick Krill, the study’s lead author and also a lawyer. “It’s left to speculation what motivated 75 percent of attorneys to skip over the section on drug use as if it wasn’t there.” In Mr. Krill’s opinion, they were afraid to answer. Of the lawyers that did answer those questions, 5.6 percent used cocaine, crack and stimulants; 5.6 percent used opioids; 10.2 percent used marijuana and hash; and nearly 16 percent used sedatives.”
There is much more in the article, including claims that the problems with mindset and addiction, for many, start in law school.
After reading this article, and many like it (and living through the suicide of a partner at one of my former firms), I decided to do a series of posts on Law & Wellness. These posts will not focus on mental health or addiction problems. Rather, these posts will focus on the positive side. For example, I plan a handful of interviews with lawyers and educators who manage to do well both inside and outside of the office, finding ways to work efficiently and prioritize properly. My co-editors may chime in from time to time with related posts of their own.
Tuesday, August 1, 2017
My colleague, Joan Heminway, yesterday posted Democratic Norms and the Corporation: The Core Notion of Accountability. She raises some interesting points (as usual), and she argues: "In my view, more work can be done in corporate legal scholarship to push on the importance of accountability as a corporate norm and explore further analogies between political accountability and corporate accountability."
I have not done a lot of reading in this area, but I am inclined to agree that it seems like an area that warrants more discussion and research. The post opens with some thought-provoking writing by Daniel Greenwood, including this:
Most fundamentally, corporate law and our major business corporations treat the people most analogous to the governed, those most concerned with corporate decisions, as mere helots. Employees in the American corporate law system have no political rights at all—not only no vote, but not even virtual representation in the boardroom legislature.
Those on the right, like Milton Friedman, argue that the shareholder-wealth-maximization requirement prohibits firms from acting in ways that benefit, say, local communities or the environment, at the expense of the bottom line. Those on the left, like Franken, argue that the duty to shareholders makes corporations untrustworthy and dangerous. They are both wrong.
August 1, 2017 in Business Associations, Corporations, CSR, Delaware, Joan Heminway, Joshua P. Fershee, Legislation, Management, Research/Scholarhip, Shareholders, Social Enterprise | Permalink | Comments (1)
Tuesday, July 18, 2017
The more I read about social enterprise entities, the less I like about them. In 2014, my colleague Elaine Wilson and I wrote March of the Benefit Corporation: So Why Bother? Isn’t the Business Judgment Rule Alive and Well? We observed:
Regardless of jurisdiction, there may be value in having an entity that plainly states the entity’s benefit purpose, but in most instances, it does not seem necessary (and is perhaps even redundant). Furthermore, the existence of the benefit corporation opens the door to further scrutiny of the decisions of corporate directors who take into account public benefit as part of their business planning, which erodes director primacy, which limits director options, which can, ultimately, harm businesses by stifling innovation and creativity. In other words, this raises the question: does the existence of the benefit corporation as an alternative entity mean that traditional business corporations will be held to an even stricter, profit-maximization standard?
I am more firmly convinced this is the path we are on. The emergence of social enterprise enabling statutes and the demise of director primacy threaten to greatly, and gravely, limit the scope of business decisions directors can make for traditional for-profit entities, threatening both social responsibility and economic growth. Recent Delaware cases, as well as other writings from Delaware judges, suggest that shareholder wealth maximization has become a more singular and narrow obligation of for-profit entities, and that other types of entities (such as non profits or benefit corporations) are the only proper entity forms for companies seeking to pursue paths beyond pure, and blatant, profit seeking. Now that many states have alternative social enterprise entity structures, there is an increased risk that traditional entities will be viewed (by both courts and directors) as pure profit vehicles, eliminating directors’ ability to make choices with the public benefit in mind, even where the public benefit is also good for business (at least in the long term). Narrowing directors’ decision making in this way limits the options for innovation, building goodwill, and maintaining an engaged workforce, to the detriment of employees, society, and, yes, shareholders.
I know there are some who believe that I see the sky falling when it's just a little rain. Perhaps. I would certainly concede that the problems I see can be addressed through law, if necessary. I am just not a big fan of passing some more laws and regulations, so we can pass more laws to fix the things we added. My view of entity purpose remains committed to the principle of director primacy. Directors are obligated to run the entity for the benefit of the shareholders, but, absent fraud, illegality, or self-dealing, the directors decide what actions are for the benefit of shareholders. Period, full stop.
Thursday, July 6, 2017
Wisniewski, Yekini, and Omar on “Psychopathic Traits of Corporate Leadership as Predictors of Future Stock Returns”
Tomasz Piotr Wisniewski, Liafisu Sina Yekini, and Ayman M. A. Omar posted “Psychopathic Traits of Corporate Leadership as Predictors of Future Stock Returns” on SSRN on June 13, 2017. You can find their abstract here.
I was particularly interested in how the authors measured psychopathy. Here is a relevant excerpt:
Using UK data, we construct a number of corporate psychopathy indicators and link them to the returns that ensue over the next 250 trading days - a period roughly equivalent to one calendar year.
Even if clear guidance exists on how to diagnose psychopathic personality disorder in humans (Hare 1991, 2003), the practical difficulty is that executives will be generally unwilling to participate in time consuming surveys, particularly those that are likely to expose the dark side of their character. We choose to follow a more pragmatic approach and, similarly to Chatterjee and Hambrick (2007), collect information in an unobtrusive way by going through company-related archives and data. Firstly, using automated content analysis we assess to what extent the language in annual report narratives is symptomatic of psychopathy. This is done by counting the frequency of words that are aggressive, characteristic of speakers who are self-absorbed and who have the tendency to assign blame to others. Secondly, we look at likely correlates of managerial integrity. More specifically, we try to identify companies whose auditors have expressed reservations in the Emphasis of Matter section of the annual report and those that have experienced a publicized Financial Reporting Council (FRC) intervention. Thirdly, we consider a measure that derives from the observation that psychopaths require stronger external stimuli to experience emotions and, therefore, have the tendency to take high risks. We assume that excessive exposure in a corporation will result in a high degree of idiosyncratic risk. This type of risk, which is entirely company-specific and unrelated to the broader economy, is measured in our empirical inquiry. Lastly, we construct a variable to capture the reluctance of a company to donate to charitable causes.
Our empirical investigation documents a negative association between the presence of managerial psychopathic traits and future return on common equity.
Tuesday, June 13, 2017
I am such a fan of Sinclair Oil Corp. v. Levien, 280 A.2d 717 (Del. 1971), that I use the case in both Business Organizations and in Energy Law. The case does a great job of giving a basic overview of parent-subsidiary relationships, some of the basic fiduciary duties owed in such contexts, and it sets up the discussion of why companies use subsidiaries in the first place.
On fiduciary duties and when the intrinsic (entire) fairness test applies:
A parent does indeed owe a fiduciary duty to its subsidiary when there are parent-subsidiary dealings. However, this alone will not evoke the intrinsic fairness standard. This standard will be applied only when the fiduciary duty is accompanied by self-dealing — the situation when a parent is on both sides of a transaction with its subsidiary. Self-dealing occurs when the parent, by virtue of its domination of the subsidiary, causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority stockholders of the subsidiary
On what test to apply to parent-subsidiary dividends:
We do not accept the argument that the intrinsic fairness test can never be applied to a dividend declaration by a dominated board, although a dividend declaration by a dominated board will not inevitably demand the application of the intrinsic fairness standard. Moskowitz v. Bantrell, 41 Del.Ch. 177, 190 A.2d 749 (Del.Supr. 1963). If such a dividend is in essence self-dealing by the parent, then the intrinsic fairness standard is the proper standard. For example, suppose a parent dominates a subsidiary and its board of directors. The subsidiary has outstanding two classes of stock, X and Y. Class X is owned by the parent and Class Y is owned by minority stockholders of the subsidiary. If the subsidiary, at the direction of the parent, declares a dividend on its Class X stock only, this might well be self-dealing by the parent. It would be receiving something from the subsidiary to the exclusion of and detrimental to its minority stockholders. This self-dealing, coupled with the parent's fiduciary duty, would make intrinsic fairness the proper standard by which to evaluate the dividend payments.
. . . . The dividends resulted in great sums of money being transferred from Sinven to Sinclair. However, a proportionate share of this money was received by the minority shareholders of Sinven. Sinclair received nothing from Sinven to the exclusion of its  minority stockholders. As such, these dividends were not self-dealing. We hold therefore that the Chancellor erred in applying the intrinsic fairness test as to these dividend payments. The business judgment standard should have been applied.
On whether shareholder of one subsidiary should be allowed to participate in ventures pursued by other subsidiaries:
The plaintiff proved no business opportunities which came to Sinven independently and which Sinclair either took to itself or denied to Sinven. As a matter of fact, with two minor exceptions which resulted in losses, all of Sinven's operations have been conducted in Venezuela, and Sinclair had a policy of exploiting its oil properties located in different countries by subsidiaries located in the particular countries.
It makes sense for companies, often, to use subsidiaries to keep certain businesses well organized and to protect assets for shareholder. That is, I might only want to invest in a subsidiary doing business in Mexico because I trust that the assets there are secure. I may not want to participate in work in Venezuela, which I might deemed riskier. And it's not just shareholders who might feel that way. Creditors, too, may view such investments very differently and may only be willing to participate in ventures where the risks can be more easily assessed.
Tuesday, June 6, 2017
More than two years ago, I posted Shareholder Activists Can Add Value and Still Be Wrong, where I explained my view on shareholder proposals:
I have no problem with shareholders seeking to impose their will on the board of the companies in which they hold stock. I don't see activist shareholder as an inherently bad thing. I do, however, think it's bad when boards succumb to the whims of activist shareholders just to make the problem go away. Boards are well served to review serious requests of all shareholders, but the board should be deciding how best to direct the company. It's why we call them directors.
Today, the Detroit Free Press reported that shareholders of automaker GM soundly defeated a proposal from billionaire investor David Einhorn that would have installed an alternate slate of board nominees and created two classes of stock. (All the proposals are available here.) Shareholders who voted were against the proposals by more than 91%. GM's board, in materials signed by Mary Barra, Chairman & Chief Executive Officer and Theodore Solso, Independent Lead Director, launched an aggressive campaign to maintain the existing board (PDF here) and the split shares proposal (PDF here). GM argued in the board maintenance piece:
Greenlight’s Dividend Shares proposal has the potential to disrupt our progress and undermine our performance. In our view, a vote for any of the Greenlight candidates would represent an endorsement of that high-risk proposal to the detriment of your GM investment.
Another shareholder proposal asking the board to separate the board chair and CEO positions was reported by the newspaper as follows: "A separate shareholder proposal that would have forced GM to separate the role of independent board chairman and CEO was defeated by shareholders." Not sure. Though the proposal was defeated, it's worth noting that the proposal would not have "forced" anything. The proposal was an "advisory shareholder proposal" requesting the separation of the functions. No mandate here, because such decisions must be made by the board, not the shareholders. The proposal stated:
Shareholders request our Board of Directors to adopt as policy, and amend our governing documents as necessary, to require the Chair of the Board of Directors, whenever possible, to be an independent member of the Board. The Board would have the discretion to phase in this policy for the next CEO transition, implemented so it did not violate any existing agreement. If the Board determines that a Chair who was independent when selected is no longer independent, the Board shall select a new Chair who satisfies the requirements of the policy within a reasonable amount of time. Compliance with this policy is waived if no independent director is available and willing to serve as Chair. This proposal requests that all the necessary steps be taken to accomplish the above.
GM argued against this proposal because the "policy advocated by this proposal would take away the Board’s discretion to evaluate and change its leadership structure." Also not true. It the proposal were mandatory, then this would be true, but as a request, it cannot and could not take away anything. If the shareholders made such a request and the board declined to follow that request, there might be repercussions for doing so, but the proposal would have kept in place the "Board’s discretion to evaluate and change its leadership structure."
These proposals appear to have been properly brought, properly considered, and properly rejected. As I suggested in 2015, shareholder activists can help improve long-term value, even when following the activists' proposals would not. That is just as true today and these proposals may well prime the pumpTM for future board or shareholder actions. That is, GM has conceded that its stock is undervalued and that change is needed. GM argues those changes are underway, and for now, most voting shareholder agree. But we'll see how this looks if the stock price has not noticeably improved next year. An alternative path forward on some key issues has been shared, and that puts pressure on this board to deliver. They can do it their own way, but they are on notice that there are alternatives. An shareholders now know that, too.
This knowledge underscores the value of shareholder proposals as a process. They can and should create accountability, and that is a good thing. I agree with GM that the board should keep control of how it structures the GM leadership team. But I agree with the shareholders that if this board doesn't perform, it may well be time for a change.
June 6, 2017 in Corporate Finance, Corporate Governance, Corporations, Current Affairs, Financial Markets, Joshua P. Fershee, Management, Securities Regulation, Shareholders | Permalink | Comments (0)