It sometimes seems like everybody but me in the law school world wants Hobby Lobby and Conestoga Wood to lose their pending Supreme Court case. The latest example is Mark Underberg, a "retired partner of Paul, Weiss, Rifkind, Wharton & Garrison LLP, and an Adjunct Professor of Law at Cornell Law School and the Benjamin N. Cardozo School of Law," who posted Corporate “Free Exercise” and Fiduciary Duties of Directors over at Harvard Law's corporate governance blog. Here's the gist:
This Spring, the Supreme Court will decide whether a for-profit corporation can refuse to provide insurance coverage for birth control and other reproductive health services mandated by the Affordable Healthcare Act (or “Obamacare”) when doing so would conflict with “the corporation’s” religious beliefs. Although the main legal issue in Sibelius v. Hobby Lobby Stores, Inc., et al. and Conestoga Wood Specialties Corp., et al. v. Sibelius concerns the extent to which the guarantee of free exercise of religion under the Constitution and the Religious Freedom Restoration Act may be asserted by for-profit corporations, the Court’s decision may also have important—and unsettling—implications for state corporate laws that define the fiduciary duties of boards of directors. ...
The companies’ Constitutional arguments are premised on a remarkable (though unremarked upon) notion of state corporate law: that boards of directors may pursue corporate policies based on religious principle with apparent complete disregard of the business interests of the corporation. Such a proposition should startle most corporate lawyers, who regularly and appropriately advise that boards of directors are duty-bound to manage the corporation “with a view to enhancing corporate profit and shareholder gain”. ...
Instructive is a 2010 Delaware Chancery Court decision in Ebay Domestic Holdings, Inc. v. Newmark, striking down a “poison pill” established by the board and controlling shareholders of a company (Craigslist) to prevent a minority shareholder (EBay) from acquiring future control. In the court’s view, the directors breached their fiduciary duties when they took steps to oppose potential future control by EBay “not because of how it would affect the value of the entity for its stockholders, but rather because of their own personal preferences [regarding the need to preserve Craigslist’s unique corporate culture]…. Having chosen a for-profit corporate form, the Craigslist directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of its stockholders.”
How would the boards of directors of Hobby Lobby and Conestoga measure up under these fiduciary standards? Not well—at least on the basis of the background provided in the lower courts’ opinions. There’s no indication that the boards of directors of Hobby Lobby, which operates arts and craft stores throughout the U.S. and Conestoga, a manufacturer of wood cabinets, gave any consideration whatsoever to how their companies’ interests would be served by resisting the Obamacare contraceptive and women’s health mandate. For the boards of Hobby Lobby and Conestoga, the sole relevant consideration appears to have been religious principle with no apparent relationship to “a rational business purpose”. ...
There’s little precedential basis for exempting directors from their duty to consider the best interests of the corporation simply because the directors believe that shareholders don’t want them to do so. In fact, the corporate laws of Oklahoma and Pennsylvania, where Hobby Lobby and Conestoga are incorporated, respectively, suggest otherwise—they do not permit shareholders to waive the duty of loyalty in corporate charters.
I bow to no one as a defender of the shareholder wealth maximization norm, but even so it seems obvious to me that Underberg is wrong.
- The legal principles to which Underberg refers are mostly intended to deal with public corporations or, at the very least, close corporations with a defined separation of ownership and control. Indeed, two of the three cases Underbergh cites -- Sinclair Oil and Disney -- are cases involving the duties of directors and controlling shareholders (in the Sinclair Oil case) of public corporations. But Hobby Lobby and Conestoga Wood are both family-owned closely held corporations. Granted, I believe that the relevant legal principles apply to all corporations, but I also believe that directors of closely held corporations have more flexibility to acquiesce in shareholder wishes than do those of public corporations without fear of even a technical breach of duty.
- “As a leading commentator in the field has observed: ‘unlike the typical shareholder in the publicly held corporation, who may be simply an investor or a speculator and cares nothing for the responsibilities of management, the shareholder in a close corporation is a co-owner of the business and wants the privileges and powers that go with ownership. …’” Simms v. Exeter Architectural Products, Inc., 868 F.Supp. 677, 682 n. 1 (M.D.Pa.1994) (citing (O'Neal, Close Corporations [2d Ed.], § 1.07, at pp. 21–22 [n. omitted]). Hence, shareholders of such companies tend to be much more actively engaged in firm management, with a consequent diminution in the role of the board and, in turn, the demands of fiduciary obligation on directors qua directors. Instead, the key issue in close corporations typically is not the duties of the firm’s directors but those of its controlling shareholders.
- I refer you to Baran v. Baran, 1947 WL 2915, which held of close corporations that "It is not in violation of any rule or principle of law for stockholders, who own a majority of the stock in a corporation, to cause its affairs to be managed in such way as they may think best calculated to further the ends of the corporation, and for this purpose to appoint one or more proxies, who shall vote in such a way as will carry out their plans." In that case, the court upheld an agreement among the shareholders to elect one another to corporate office. But why should the same rule not apply to a consensus among shareholders of a close corporation to define the ends of the corporation in religious terms? In the event the shareholders by agreement so define the goals of the corporation, how can it be a breach of fiduciary duty for the directors (who are probably the same people as the stockholders) to acquiesce?
- Although I have been unable to find any Pennsylvania or Oklahoma law on point, I note that § 7.32(e) of the Model Business Corporation Act provides that “An agreement authorized by this section that limits the discretion or powers of the board of directors shall relieve the directors of, and impose upon the person or persons in whom such discretion or powers are vested, liability for acts or omissions imposed by law on directors to the extent that the discretion or powers of the directors are limited by the agreement.” Because Baran suggests that Pennsylvania would uphold such an agreement, it seems reasonable to assume that Pennsylvania would agree with the MBCA that such an agreement implicitly relieves the directors of any liability for complying with such an agreement.
- Underberg alludes to such shareholder agreements when he opines that “an exemption would put boards in the risky business of divining shareholder intent and provide fodder for countless future court cases seeking to determine the extent of shareholder agreement that’s necessary to establish the ‘corporation’s belief’ short of unanimity.” But the general rule (as codified in MBCA § 7.32 and cases like Clark v. Dodge, 99 N.E. 641 (N.Y. 1936)), is that shareholder agreements infringing on the board’s authority must be unanimous. the same rule easily could be applied here, obviating Underberg’s concern. Remember these cases are about corporations that are closely held and family owned, where a requirement of unanimity would be appropriate and (probably) easily satisfied.
- Conestoga Wood is a Pennsylvania corporation. Pennsylvania has a so-called nonshareholder constituency statute (15 Pa. Cons. Stat. § 1715), which provides that "In discharging the duties of their respective positions, the board of directors, committees of the board and individual directors of a business corporation may, in considering the best interests of the corporation, consider to the extent they deem appropriate: (1) The effects of any action upon any or all groups affected by such action, including shareholders, employees, suppliers, customers and creditors of the corporation, and upon communities in which offices or other establishments of the corporation are located. (2) The short-term and long-term interests of the corporation, including benefits that may accrue to the corporation from its long-term plans and the possibility that these interests may be best served by the continued independence of the corporation. (3) The resources, intent and conduct (past, stated and potential) of any person seeking to acquire control of the corporation. (4) All other pertinent factors." I confess to thinking these statutes are mostly hokum, but it is on the books and on its face would seem to permit directors to consider factors other than shareholder wealth maximization. In particular, why doesn't "all other pertinent factors" cover the situation? As Keith Paul Bishop observes of the similar Nevada statute, “While it is true that NRS 78.138(4) does not mention religious interests per se, the interests of the community and of society could encompass religious interests.” The Rutherford Institute’s amicus brief in these cases makes an even more elaborate version of this argument, concluding that “Corporations operating pursuant to constituency statutes … are recognized by the States as making decisions that take into account these pro-public priorities without needing a non-profit platform for doing so.” In any event, why didn't Underberg at least mention them?
Update: At the request of a friend that I clarify the point, my contention in points 2-5 is that Clark v Dodge et al teach that if the shareholders of a close corporation are unanimous in agreeing to instruct the board to do something, they legally have the power to enforce that agreement and cause the board to effect their wishes, in which case the board could not be held liable for doing so. Galler v. Galler suggests they can do so even if not unanimous, so long as the minority does not object. Hence, as the MBCA makes clear, a shareholder agreement vitiates the board's fiduciary duties when carrying out shareholder instructions.