ProfessorBainbridge.com

Ten Questions You Should Ask When Negotiating a Shareholders Agreement

A useful list.

Veil Piercing and Choice of Law

Keith Paul Bishop:

The internal affairs doctrine is a conflict of laws principle that recognizes that only one state should have the authority to regulate a corporation’s internal affairs.   Under the internal affairs doctrine, that special state is the state of incorporation.  But what exactly constitutes a corporation’s ”internal affairs”?  Many lawyers, particularly those in Delaware, take a broad view of what constitutes an internal affair.  However, the U.S. Supreme Court has actually enunciated a rather narrow view: “matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders”.  Edgar v. MITE Corp., 457 U.S. 624, 645 (1982). 

One might assume that the liability of shareholders for corporate obligations is an internal affair.  However, the Nevada Supreme Court has permitted piercing the corporate veil of a Washington corporation.  McCleary Cattle Co. v. Sewell, 317 P.2d 957 (Nev. 1957).  In Plotkin v. Nat’l Lead Co., 482 P.2d 323 (1971), the Supreme Court assumed that the alter ego doctrine could be applied to a Wisconsin corporation (although it declined to conclude that the owners were in the alter ego). 

I discuss this issue in Corporation Law, in which I explain that: New York law is instructive on this score, not least because that state seems to generate more veil piercing cases than any other. New York relies on a choice of law rule known as the paramount interest test, under which “the law of the jurisdiction having the greatest interest in the litigation will be applied and . . . the facts or contacts which obtain significance are those which relate to the purpose of the particular law in conflict.”[1] A number of federal decisions applying the New York standard have held that the state of incorporation (of the corporation whose veil is to be pierced) has the paramount interest with respect to veil piercing claims and, accordingly, applied that state’s law.[2] The state of incorporation’s interest derives from the fact that it is that state whose law confers limited liability on the enterprise in the first place.[3]

Surprisingly, Delaware courts do not always apply the law of the state of incorporation. Where a Delaware parent corporation is to be held liable for the acts of a nonDelaware subsidiary (i.e., the subsidiary’s corporate veil is to be pierced), Delaware courts have applied Delaware law.[4] On the other hand, where it is a Delaware corporation whose veil is to be pierced, Delaware courts do apply their state’s law.[5] Maybe the Delaware rule is just to apply Delaware law!

---

[1] Intercontinental Planning, Ltd. v. Daystrom, 248 N.E.2d 576, 582 (N.Y. 1969) (internal quotation marks omitted).

[2] See, e.g., Fletcher v. Atex, Inc., 68 F.3d 1451, 1456 (2d Cir. 1995); Soviet Pan Am Travel Effort v. Travel Committee, Inc., 756 F. Supp. 126, 131 (S.D.N.Y. 1991). An interesting wrinkle on the choice of law problem is presented when the veil piercing claim arises under a federal statute. In U.S. v. Bestfoods, 524 U.S. 51 (1998), the Supreme Court noted the “significant disagreement among courts and commentators over whether, in enforcing CERCLA’s indirect liability, courts should borrow state law, or instead apply a federal common law of veil piercing.” Id. at 63 n.9. Unfortunately for those who like doctrinal closure, the court declined to resolve that disagreement. Id.

[3] Soviet Pan Am Travel Effort v. Travel Committee, Inc., 756 F. Supp. 126, 131 (S.D.N.Y. 1991).

[4] Japan Petroleum Co. (Nigeria) Ltd. v. Ashland Oil, Inc., 456 F. Supp. 831, 840 n.17 (D. Del. 1978).

[5] Mobil Oil Corp. v. Linear Films, Inc., 718 F. Supp. 260, 267 (D. Del. 1989).

 

Is Starbuck's support of marriage equality a breach of fiduciary duty to its shareholders?

Short answer: No.

Longer answer: Think Progress reports that:

Starbucks CEO Howard Schultz continued to defend his company’s support for marriage equality at a shareholders meeting Wednesday, pointing out that “not every decision is an economic decision.” Shareholder Tom Strobhar suggested that the company’s stock dipped a bit when the National Organization for Marriage launched a “Dump Starbucks” boycott last year, but Schultz expressed no concern about the company’s viability moving forward:

STROBHAR: In the first full quarter after this boycott was announced, our sales and our earnings — shall we say politely — were a bit disappointing.

SCHULTZ:If you feel, respectfully, that you can get a higher return than the 38 percent you got last year, it’s a free country. You can sell your shares of Starbucks and buy shares in another company. Thank you very much.

Let's say Strobhar sued, claiming that Starbucks' management and board was breaching their fiduciary duties to the shareholders by alienating some customers. Would Schultz et al. have to prove that there were corresponding benefits that outweighed any such losses, such that Starbucks was a net gainer? (After all, a high return is no defense if you could have gotten an even higher one.)

No, of course not. The business judgment rule would stop the suit dead. I am reminded here of Shlensky v. Wrigley, 237 N.E.2d 776 (Ill. App. 1968).

Shlensky challenged Philip Wrigley’s famous refusal to install lights in Wrigley Field. Shlensky was a minority shareholder in the corporation that owned the Chicago Cubs and operated Wrigley Field. Wrigley was the majority stockholder (owning 80% of the stock) and president of the company. In the relevant period, 1961-1965, the Cubs consistently lost money. Shlensky alleged that the losses were attributable to their poor home attendance. In turn, Shlensky alleged that the low attendance was attributable to Wrigley’s refusal to permit installation of lights and night baseball.

In the course of rejecting Shlensky's claim, the court noted that “the effect [of night baseball] on the surrounding neighborhood might well be considered by a director.” Likewise, the court asserted that “the long run interest” of the firm “might demand” consideration of the effect night baseball would have on the neighborhood. (At that time, the corporation owned not just the Cubs but also Wrigley Field and the land on which it stands.) But the court went on to explain that:

By these thoughts we do not mean to say that we have decided that the decision of the directors was a correct one. That is beyond our jurisdiction and ability. We are merely saying that the decision is one properly before directors and the motives alleged in the amended complaint showed no fraud, illegality or conflict of interest in their making of that decision.

Thus, Wrigley did not have to show that his decision was supported by some sort of cost-benefit analysis. 

Also on point is the case of Bayer v. Beran, 49 N.Y.S.2d 2, 6 (Sup. Ct. 1944), in which the corporation began sponsoring a opera radio program and hired the CEO's wife to sing on it (along with many others). The court explained that:

To encourage freedom of action on the part of directors, or to put it another way, to discourage interference with the exercise of their free and independent judgment, there has grown up what is known as the “business judgment rule.”  ...  “Questions of policy of management, expediency of contracts or action, adequacy of consideration, lawful appropriation of corporate funds to advance corporate interests, are left solely to their honest and unselfish decision, for their powers therein are without limitation and free from restraint, and the exercise of them for the common and general interests of the corporation may not be questioned, although the results show that what they did was unwise or inexpedient.”  Pollitz v. Wabash R. Co., 207 N.Y. 113, 124, 100 N.E. 721, 724.  Indeed, although the concept of “responsibility” is firmly fixed in the law, it is only in a most unusual and extraordinary case that directors are held liable for negligence in the absence of fraud, or improper motive, or personal interest.

The court further explained that "It was for the directors to determine whether they would resort to radio advertising;  it was for them to conclude how much to spend;  it was for them to decide the kind of program they would use.  It would be an unwarranted act of interference for any court to attempt to substitute its judgment on these points for that of the directors, honestly arrived at."

In sum, the fact that shareholders don't like the positions on an issue of public import taken by a corporation states no grounds for legal intervention. Their choices are simple: (1) Try to persuade like-minded shareholders to elect new directors who will take a different position or (2) follow the Wall Street Rule (it is easier to switch than fight).

Speaking of fiduciary duties of bank directors

Apropos the prior post on the fiduciary duties of bank directors, I just read an excellent and provocative article by Chris Bruner. Conceptions of Corporate Purpose in Post-Crisis Financial Firms (March 5, 2013). Seattle University Law Review, Vol. 36, p. 527, 2013; Washington & Lee Legal Studies Paper No. 2012-29. Available at SSRN: http://ssrn.com/abstract=2228845. Here's the abstract:

Abstract: American "populism" has had a major impact on the development of U.S. corporate governance throughout its history. Specifically, appeals to the perceived interests of average working people have exerted enormous social and political influence over prevailing conceptions of corporate purpose - the aims toward which society expects corporate decision-making to be directed. This article assesses the impact of American populism upon prevailing conceptions of corporate purpose - contrasting its unique expression in the context of financial firms with that arising in other contexts - and then examines its impact upon corporate governance reforms enacted in the wake of the financial and economic crisis that emerged in 2007. 

I first explore how populism has historically shaped conceptions of corporate purpose in the United States. While the "employee" conceptual category best encapsulates the perceived interests of average working people in the non-financial context, the "depositor" conceptual category best encapsulates their perceived interests in the financial context. Accordingly, American populism has long fostered strong emphasis on the interests of bank depositors, resulting in striking corporate architectural strategies aimed at reducing risk-taking to ensure firm sustainability - notably, imposing heightened fiduciary duties on directors and personal liability on shareholders. I then turn to the crisis, arguing that growing shareholder-centrism over recent decades goes a long way toward explaining excessive risk-taking in financial firms - a conclusion rendering post-crisis reforms aimed at further strengthening shareholders a surprising and alarming development. While populism has remained a powerful political force, it has expressed itself differently in this new environment, fueling a crisis narrative and corresponding corporate governance reforms that not only fail to acknowledge the role of equity market pressures toward excessive risk-taking in financial firms, but that effectively reinforce such pressures moving forward. 

I conclude that potential corporate governance reforms most worthy of consideration include those aimed at accomplishing precisely the opposite, which may require resurrecting corporate architectural strategies embraced in the past to reduce risk-taking in financial firms. As a threshold matter, however, we must first grapple effectively with a more fundamental and pressing social and political problem - the popular misconception that financial firms exist merely to maximize stock price for the short-term benefit of their shareholders.

I don't agree with all of his arguments or conclusions, but he raises a lot of important issues. I would limit the discussion to systemically important financial institutions. My preferred solution would be to solve the "too big to fail" problem by capping the size of large financial institutions at a level at which their failure would not jepoardize the entire financial system and thereby solve the moral hazard problem created by the implicit taxpayer guarantee currently enjoyed by TBTF institutions.

If that proves politically or economically infeasible, however, I'm prepared to consider corporate governance reforms at such banks--perhaps including creating a fiduciary duty for managers of TBTF institutions running to taxpayers--as a second best solution.

The Fiduciary Duties of Bank Directors

A friend emailed me, asking:

I just read a statement from the OCC about the primary fiduciary duty of bank directors. Here it is:

"While holding companies of large banks are typically managed on a line of business basis, directors at the bank level are responsible for oversight of the bank’s charter—the legal entity. Such responsibility requires separate and focused governance. We have reminded the boards of banks that their primary fiduciary duty is to ensure the safety and soundness of the national bank or federal savings association. This responsibility involves focus on the risk and control infrastructure. Directors must be certain that appropriate personnel, strategic planning, risk tolerance, operating processes, delegations of authority, controls, and reports are in place to effectively oversee the performance of the bank. The bank should not simply function as a booking entity for the holding company. It is incumbent upon bank directors to be mindful of this primary fiduciary duty as they execute their responsibilities."

For whatever reason, I had never come across this before.

This raises some very interesting issues about whether the fiduciary duties of bank directors differ from those of ordinary corporate directors. 

First, should bank directors owe some sort of special fiduciary to the bank entity? As I explain in Much Ado About Little? Directors’ Fiduciary Duties in the Vicinity of Insolvency, 1 Journal of Business and Technology Law 335 (2007), there is a longstanding view that directors duties are owed (in part) to the entity:

Technically, Credit Lyonnais does not stand for the proposition that directors of a corporation in the vicinity of insolvency owe fiduciary duties to creditors of the corporation. Instead, Chancellor Allen held that the board of directors of such a corporation “owes its duty to the corporate enterprise.”  In a famous footnote, which is worth quoting at full length given its importance to the analysis, Chancellor Allen went on to explain how such a duty differed from the usual conception that directors owe their duties to the shareholders ….

Former Delaware Supreme Court Chief Justice Veasey has likewise embraced an understanding of the problem centered on the notion that directors owe duties to the corporate entity in this context, although we shall see that Veasey’s analysis ultimately proves to be somewhat more nuanced:

… it is important to keep in mind the precise content of this “best interests” concept—that is, to whom this duty is owed and when. Naturally, one often thinks that directors owe this duty to both the corporation and the stockholders. That formulation is harmless in most instances because of the confluence of interests, in that what is good for the corporate entity is usually derivatively good for the stockholders. There are times, of course, when the focus is directly on the interests of stockholders. But, in general, the directors owe fiduciary duties to the corporation, not to the stockholders. This provides a doctrinal solution to the incentive problem that is entirely consistent with the emphasis on board governance, namely, that the board’s duty is to do what is best for the corporation.

From a doctrinal perspective, this emphasis on fiduciary duties to the corporate entity is problematic. As to solvent corporations, the law already distinguishes between duties running to the corporate entity and to the shareholders. This distinction is what differentiates direct from derivative shareholder litigation, after all. ...

In addition to being doctrinally questionable, the notion that directors owe duties to the corporate entity is inconsistent with the dominant contractarian theory of the firm. The insistence that the firm is a real entity is a form of reification—i.e., treating an abstraction as if it has material existence. Reification is often useful, or even necessary, because it permits us to utilize a form of shorthand—it is easier to say General Motors did so and so than to attempt in conversation to describe the complex process that actually may have taken place. Indeed, it is very difficult to think about large firms without reifying them. Reification, however, can be dangerous. It becomes easy to lose sight of the fact that firms do not do things, people do things.

In other words, the corporation is not a thing to which duties to can be owed, except as a useful legal fiction. The distinction between direct and derivative shareholder litigation is one area in which that fiction long has been thought useful. This article is not the appropriate forum for determining whether distinguishing between direct and derivative litigation continues to make sense. Having said that, however, it nevertheless seems useful to note the implications of contractarian theory for Credit Lyonnais’ notion that the duties of directors of companies in the vicinity of insolvency run to the entity.

At the outset, we must acknowledge that while the contractarian approach of treating the corporation as a nexus of contracts is an improvement on entity-based conceptions, it too is somewhat misleading. After all, to say that the firm is a nexus is to imply the existence of a core or kernel capable of contracting. But kernels do not contract—people do. In other words, it does us no good to avoid reifying the firm by reifying the nexus at the center of the firm. Hence, it is perhaps best to understand the corporation as having a nexus of contracts.

If the corporation has a nexus, where is it located? The Delaware code, like the corporate law of every other state, gives us a clear answer: the corporation’s “business and affairs . . . shall be managed by or under the direction of the board of directors.” Put simply, the board of directors is the nexus of a set of contracts with various constituencies that the law collectively treats as a legal fiction called the corporation. As such, it simply makes no sense to think of the board of directors as owing fiduciary duties to the corporate entity. Indeed, since the legal fiction we call the corporate entity is really just a vehicle by which the board of directors hires factors of production, it is akin to saying that the board owes duties to itself.

I thus would prefer to see the question phrased as, "do bank directors owe special fiduciary duties to either the shareholders and/or depositors of a bank, which differ from those ordinary directors owe to the shareholders"?

Second, do bank directors owe such duties?

There is some precedent for the proposition that "it is well settled that the fiduciary duty of a bank officer or director is owed to the depositors and shareholders of the bank." Lane v. Chowning, 610 F.2d 1385, 1389 (8th Cir. 1979). See also Irving Bank Corp. v. Board of Governors of the Fed. Reserve Sys., 845 F.2d 1035, 1039 (D.C. Cir. 1988) (noting "Irving's fiduciary duty to protect shareholders and depositors alike"); Hoehn v. Crews, 144 F.2d 665, 672 (10th Cir. 1944) (declaring that bank directors owe high degree of duty to both stockholders and public at large); Gadd v. Pearson, 351 F. Supp. 895, 903 (M.D. Fla. 1972) (noting that bank managers have greater obligation to exercise duty of good faith and use powers in best interest of entity than other corporate officers); Francis v. United Jersey Bank, 432 A.2d 814, 824-25 (N.J. 1981) (holding that directors of reinsurance corporation owed fiduciary duty to creditors because relationship between creditors and corporation involved trust and confidence analogous to that between bank and its depositors); Campbell v. Watson, 62 N.J. Eq. 396, 427 (N.J. Ch. 1901)(establishing the principle that bank directors may owe a fiduciary duty to bank depositors as creditors especially if the directors were aware of a potential problem and did not address it).

Also, 12 U.S.C. § 1818(e)(1) (1982) provides:

Whenever, in the opinion of the appropriate Federal banking agency, any director or officer of an insured bank ... has engaged or participated in any unsafe or unsound practice in connection with the bank, or has committed or engaged in any act, omission, or practice which constitutes a breach of his fiduciary duty as such director or officer, and the agency determines ... that the director or office [sic] has received financial gain by reason of such violation or practice or breach of fiduciary duty, and that such violation or practice or breach of fiduciary duty is one involving personal dishonesty on the part of such director or officer, or one which demonstrates a willful or continuing disregard for the safety or soundness of the bank, the agency may serve upon such director or officer a written notice of its intention to remove him from office.

Note that "a willful or continuing disregard for the safety or soundness of the bank" thus is regarded as a breach of duty.

Similarly, Section 113 of the Federal Deposit Insurance Act prohibits the Federal Reserve Board from taking any action with respect to a functionally regulated subsidiary of a bank holding company unless "(i) the action is necessary to prevent or redress an unsafe and unsound practice or breach of fiduciary duty that poses a material risk to the financial safety and soundness of an affiliated depository institution or the domestic or international payment system ...."

Third, what are we to make of the idea that directors owe duties to both shareholders and depositors? As I explain in In Defense of the Shareholder Wealth Maximization Norm: A Reply to Professor Green, 50 Washington and Lee Law Review 1423 (1993), such multi-fiduciary duties are unsound:

As Green acknowledges, management occasionally faces situations in which it is impossible to advance shareholder interests and to protect simultaneously nonshareholders from harm. Yet, whose interests should management pursue when shareholder and nonshareholder interests are in irreconcilable conflict? Green's principal answer seems to be that management should make trade-offs between shareholder and nonshareholder interests, balancing the harms and benefits more or less equitably, although he is clearly prepared to permit management to eliminate shareholder value completely when necessary to protect nonshareholder interests.

His approach … raises a host of practical issues collectively making up the two masters problem. What happens when there is a conflict between shareholders and nonshareholders and also between various nonshareholder constituencies? Suppose, for example, that management is considering closing down an obsolete plant. The closing will harm the plant's workers and the local community, but will benefit share-holders, creditors, employees at a more modern plant to which the work previously performed at the old plant is transferred, and communities around the modern plant. Assume that the latter groups cannot gain except at the former groups' expense. By what standard should management make the decision?

According to Green, these problems are overstated:

[F]iduciaries of various sorts commonly find themselves pulled between competing duties. . . . In all these instances, professionals are expected to do the best they can by both developing and working within a framework of reasonable and defensible priorities. Why cannot corporate directors and senior managers be asked to do the same?

For one thing, what Green asks of them is more easily said than done. As a theological matter, the proposition that no one can serve two masters simultaneously is at least two thousand years old. As a secular proposition, it is certainly even older. Indeed, those of us who find the theological proposition persuasive do so in part precisely because we recognize its validity from our secular experience.

To take one of Professor Green's examples about which I have personal experience, being the “lawyer for the situation” is at best uncomfortable and not infrequently untenable. Consider the example of Louis Brandeis, who coined this term. After a thorough examination of Brandeis' professional conduct, John Frank concluded:

[T]he greatest caution to be gained from study of the Brandeis record is, never be “counsel for a situation.” A lawyer is constantly confronted with conflicts which he is frequently urged to somehow try to work out. I have never attempted this without wishing I had not, and I have given up attempting it. Particularly when old clients are at odds, counsel may feel the most extreme pressure to solve their problems for them. It is a time-consuming, costly, unsuccessful mistake, which usually results in disaffecting both sides.

Even authorities who are disposed more favorably toward the idea of lawyers for the situation acknowledge that that role “is not easy, may fail, and will often bring recrimination in its wake.”

Professor Green fails to offer us a solution for this problem. Instead, he simply ex-presses confidence that those of us in the legal profession will be able to “develop the outlines of a multi-fiduciary” duty after “years of painstaking legal reasoning.” Based on the legal profession's poor experience with “lawyers for the situation,” I am less sanguine.

Even if it proves possible to develop meaningful standards under which a multi-fiduciary duty might be enforced, however, it seems likely that those standards would operate mostly by virtue of hindsight, and thus deprive managers of the critical ability to determine ex ante whether their behavior comports with the law's demands. The conflict of interest rules governing the legal profession again provide a useful analogy. Despite many years of refinement, these rules are still viewed as inadequate, vague, and inconsistent; hardly the stuff of which certainty and predictability are made. Yet, despite the central importance of those virtues in corporate law, this is the principal model Professor Green wishes to foist upon us.

In sum, the OCC bulletin is a fairly accurate statement of what the law is. But not what the law ought to be.

Leo Strine throws yours truly a cite

A keen-eyed reader of both Delaware corporate opinions and PB.com spotted a cite to yours truly in a recent opinion by Delaware Chancellor Leo Strine:

For their part, the incumbent board argues that the standard of review is the plain vanilla business judgment rule, which requires that their decision be approved if it can be attributed to any rational business purpose. Thus, the incumbent board argues for something as close to non-review as our law contemplates.79 

79. See generally Stephen M. Bainbridge, The Business Judgment Rule as Abstention Doctrine, 57 Vand. L. Rev. 83 (2004) (arguing that, under the business judgment rule, courts refrain from reviewing directors’ decisions). 

Thanks to them both. For those without Lexis or Westlaw access, you can read a working draft of the article in question at SSRN:

Abstract: The business judgment rule is corporate law's central doctrine, pervasively affecting the roles of directors, officers, and controlling shareholders. Increasingly, moreover, versions of the business judgment rule are found in the law governing the other types of business organizations, ranging from such common forms as the general partnership to such unusual ones as the reciprocal insurance exchange. Yet, curiously, there is relatively little agreement as to either the theoretical underpinnings of or policy justification for the rule. This gap in our understanding has important doctrinal implications. As this paper demonstrates, a string of recent decisions by the Delaware supreme court based on a misconception of the business judgment rule's role in corporate governance has taken the law in a highly undesirable direction. 

Two conceptions of the business judgment rule compete in the case law. One views the business judgment rule as a standard of liability under which courts undertake some objective review of the merits of board decisions. This view is increasingly widely accepted, especially by some members of the Delaware supreme court. The other conception treats the rule not as a standard of review but as a doctrine of abstention, pursuant to which courts simply decline to review board decisions. The distinction between these conceptions matters a great deal. Under the former, for example, it is far more likely that claims against the board of directors will survive through the summary judgment phase of litigation, which at the very least raises the settlement value of shareholder litigation and even can have outcome-determinative effects. 

Like many recent corporate law developments, the standard of review conception of the business judgment rule is based on a shareholder primacy-based theory of the corporation. This article extends the author's recent work on a competing theory of the firm, known as director primacy, pursuant to which the board of directors is viewed as the nexus of the set of contracts that makes up the firm. In this model, the defining tension of corporate law is that between authority and accountability. Because one cannot make directors more accountable without infringing on their exercise of authority, courts must be reluctant to review the director decisions absent evidence of the sort of self-dealing that raises very serious accountability concerns. In this article, the author argues that only the abstention version of the business judgment rule properly operationalizes this approach.

Bainbridge, Stephen M., The Business Judgment Rule as Abstention Doctrine (July 29, 2003). UCLA, School of Law, Law and Econ. Research Paper No. 03-18. Available at SSRN: http://ssrn.com/abstract=429260

Using Reverse Veil Piercing to Vindicate the Free Exercise Rights of Incorporated Employers

Bainbridge, Stephen M., Using Reverse Veil Piercing to Vindicate the Free Exercise Rights of Incorporated Employers (March 6, 2013). The Green Bag, Vol. 16, No. 3, Spring 2013; UCLA School of Law, Law-Econ Research Paper No. 13-06. Available at SSRN: http://ssrn.com/abstract=2229414

Abstract: Reverse veil piercing (RVP) is a corporate law doctrine pursuant to which a court disregards the corporation’s separate legal personality, allowing the shareholder to claim benefits otherwise available only to individuals. The thesis of this article is that RVP provides the correct analytical framework for vindicating certain constitutional rights.

Assume that sole proprietors with religious objections to abortion or contraception are protected by the free exercise clause of the First Amendment and the Religious Freedom Restoration Act (RFRA) from being obliged to comply with the government mandate that employers provide employees with health care plans that cover sterilizations, contraceptives and abortion-inducing drugs. Further assume that incorporated employers are not so protected. This article analyzes whether the shareholders of such employers can invoke RVP so as to vindicate their rights.

At least one court has recognized the potential for using RVP in the mandate cases, opining that these cases “pose difficult questions of first impression, including whether it is “possible to ‘pierce the veil’ and disregard the corporate form in this context.” The court further opined that that question, among others, merited “more deliberate investigation.” This article undertakes precisely that investigation.

Invoking RVP in the mandate cases would not be outcome determinative. Instead, it would simply provide a coherent doctrinal framework for determining whether the corporation is so intertwined with the religious beliefs of its shareholders that the corporation should be allowed standing to bring the case. Whatever demerits RVP may have, it provides a better solution than the courts’ current practice of deciding the issue by mere fiat.

Number of Pages in PDF File: 18

Keywords: corporation, limited liability, reverse veil piercing, reverse pierce, veil piercing, free exercise, first amendment, Religious Freedom Restoration Act, RFRA

JEL Classification: K22

Is Nevada corporate law lax and, if so, is that a problem?

Keith Bishop collects legal scholarship on this not unimportant problem.

Strine et al. on derivative suit jurisdiction

Delaware Chancellor Leo Strine, law professor Larry Hammermesh, and practititoner Matthew Jennejohn have posted a very interesting new paper on derivative litigation procedure entitled Putting Stockholders First, Not the First-Filed Complaint:

The prevalence of settlements in class and derivative litigation challenging mergers and acquisitions in which the only payment is to plaintiffs’ attorneys suggests potential systemic dysfunction arising from the increased frequency of parallel litigation in multiple state courts. After examining possible explanations for that dysfunction, and the historical development of doctrines limiting parallel state court litigation — the doctrine of forum non conveniens and the “first-filed” doctrine — this article suggests that those doctrines should be revised to better address shareholder class and derivative litigation. Revisions to the doctrine of forum non conveniens should continue the historical trend, deemphasizing fortuitous and increasingly irrelevant geographic considerations, and should place greater emphasis on voluntary choice of law and the development of precedential guidance by the courts of the state responsible for supplying the chosen law. The “first-filed” rule should be replaced in shareholder representative litigation by meaningful consideration of affected parties’ interests and judicial efficiency.

Bainbridge's study aids for corporation law, agency & partnership, and/or business associations courses

Bainbridge on Agency, Partnerships & LLCs:

The emergence of the limited liability company has kindled renewed interest in unincorporated business associations among legal scholars. This revival was further stimulated by the multiple revisions made to the Uniform Partnership Act in the 1990s. By lending new intellectual respectability to the study of unincorporated business associations, these developments stimulated the supply side of the curricular equilibrium. Courses on unincorporated business associations have thus sprung up at many law schools. A number of very fine casebooks compete for that market, including one co-edited by the author of this volume. This text is intended to provide students taking a course in unincorporated business associations with a reader-friendly, highly accessible overview of the law and economics of unincorporated business associations. In addition, students taking a basic course in corporations or business associations may find this volume helpful as a more expansive treatment of the law of agency, partnership, and limited liability companies. The text does not shy away from bringing theory to bear on doctrine. While the text has a strong emphasis on the doctrinal issues taught in today’s unincorporated business associations classes, it also places significant emphasis on providing an economic analysis of the major issues in that course. Agency, Partnership and Limited Liability Companies thus offers not only with an overview of the black letter law of unincorporated business associations, but also a unifying method of thinking about the subject. Using a few basic tools of law and economics — such as price theory, game theory, and the theory of the firm literature — the reader will come to see the law in this area as the proverbial “seamless web.”

Bainbridge on Corporation Law:

Corporations classes present students with two related problems: First, many students have trouble understanding the cases studied because they do not understand the transactions giving rise to those cases. Second, Corporations classes at many law schools are taught from a law and economics perspective, which many students find unfamiliar and/or daunting. Yet, with few exceptions, corporate law treatises and other study aids have essentially ignored the law and economics revolution. 

This book is intended to remedy these difficulties. The pedagogy is up-to - date, with a strong emphasis on the doctrinal issues taught in today’s Corporations classes and, equally important, a mainstream economic analysis of the major issues in the course. As such, the text is coherent and cohesive: It provides students not only with an overview of the course, but also (and more importantly) with a unifying method of thinking about the course. Using a few basic tools of law and economics-price theory, game theory, and the theory of the firm literature-students will come to see corporate law as the proverbial “seamless web.” Finally, the text is highly readable: The style is simple, direct, and reader- friendly. Even when dealing with complicated economic or financial issues, the text seeks to make those issues readily accessible.

 

Memo to the left: AIG's board had no choice but to consider joining Greenberg's suit

In his capacity as an AIG shareholder (via his company Starr International), former AIG boss Hank Greenberg has filed a derivative suit against the federal government on AIG's behalf, in which he alleges that the federal government's takeover of AIG violated the Takings Clause by taking shareholder property without compensation. Greenberg recently filed a deamnd on AIG's board asking them to take up the suit.

Predictably, this outraged the know nothing left, including various Democrat congress people:

Democrats responded with outrage Tuesday to reports that insurance giant American International Group (AIG) might sue the federal government over the terms of its 2008 bailout. 

Sen. Elizabeth Warren (D-Mass.) and Rep. Elijah Cummings (D-Md.) called the potential $25 billion shareholder lawsuit "outrageous" and "unbelievable."

I expect this sort of thing from the Occupy Wall Street twits, who haven't bothered to learn anything about the institutions they're attacking, but I expected better from former Harvard bankruptcy law professor Liz Warren. But it seems she knows as much about corporate law as she does about her Cherokee ancestry.

Let me make it very simple: If Greenberg is going to have an opportunity to ventilate the very serious and legitimate concerns raised by his suit, he had no choice but to ask AIG's board to consider joining the suit and, once he did so, AIG's board had no choice but to consider doing so.

As I explain in Corporation Law, there are two types of shareholder litigation. 

“Direct” shareholder suits arise out of causes of action belonging to the shareholders in their individual capacity. It is typically premised on an injury directly affecting the shareholders and must be brought by the shareholders in their own name. In contrast, a “derivative” suit is one brought by the shareholder on behalf of the corporation. The cause of action belongs to the corporation as an entity and arises out of an injury done to the corporation as an entity. The shareholder is merely acting as the firm’s representative.

The basic test for distinguishing direct and derivative suits is: Who suffered the most immediate and direct injury? Note that it is not enough for a shareholder to allege that he was injured because the challenged conduct resulted in a drop in the corporation’s stock market price.

Here, the principal claim is that the government took AIG property without compensation and thus violated the Takings Clause. The initial injury thus was suffered by AIG. The injury to Greenberg and his fellow shareholders was derivative of that prior harm. Hence, this was a derivative suit.

The law provides that shareholders may not bring suit unless they first make demand on the board of directors or demand is excused. The demand need not be in the form of a pleading nor a detailed as a complaint, but rather simply must request that the board bring suit on the alleged cause of action. There being no facts here to excuse Greenberg from making demand, he was legally bound to make demand on the AIG board.

Once Greenberg did so, moreover, the board is legally obligated to undertake a two-step process. Rales v. Blasband, 634 A.2d 927, 935 (Del. 1993). The board must first inform itself of the relevant facts relating to the challenged transaction or other alleged wrongdoing, as well as the legal and business considerations attendant to resolving the matter. Any factual investigation must be reasonable and conducted in good faith, but within those parameters the board has great discretion. Levine v. Smith, 591 A.2d 194, 213-14 (Del. 1991). Having done so, the board must elect amongst the three principal alternatives available to it: (1) accepting the demand and prosecuting the action; (2) resolving the matter internally without resort to litigation; or (3) refusing the demand. See Weiss v. Temporary Inv. Fund, Inc., 692 F.2d 928, 941 (3d Cir. 1982) (identifying alternatives), vacated on other grounds, 465 U.S. 1001 (1984).

Critical to the current dispute, the Delaware supreme court has held that when a board of directors is confronted with a derivative action asserted on its behalf, the board cannot stand neutral. It must take one of the three alternatives. Kaplan v. Peat, Marwick, Mitchell & Co., 540 A.2d 726, 731 (Del. 1988).

Whether or not AIG's board should have accepted Greenberg's demand is a question on which reasonable people can differ, but the left's attack on that board for even considering doing so is as lawless as the AIG takeover itself. Democrat congressmen Peter Welch of Vermont, Michael Capuano of Massachusetts and Luis V. Gutierrez of Illinois, for example, told AIG's board:

According to The New York Times, AIG is actively considering suing the U.S. government for monetary damages after American taxpayers rescued your company from its reckless conduct with a $182 billion bailout.

Don’t do it.

Don’t even think about it.

In other words, they told AIG's board to break the law. As did Congresswoman Maxine Waters:

I would urge the board to drop its consideration of the lawsuit, thank the American public for the $182 billion rescue package that prevented the company’s collapse and support the reforms in the Dodd–Frank Wall Street Reform and Consumer Protection Act that ensure that systemically important financial institutions can no longer hold our economy hostage.

By the way, Waters is in line to take over the House Financial Services Committee if the Democrats take the House in 2014. 

I find this sort of political grandstanding appalling. The AIG board did what the law required it to do. If the rule of law means anything in the Obama era, the AIG board should be commended--not pilloried--for having done so.

Let Blasius go the way of the Dodo

Anti-Delawarite Jay Brown is offering up his annual list of the 5 most anti-shareholder Delaware decisions--i.e., the five Delaware decisions most likely to be correct. ;-))

For example, he cites:

Keyser v. Curtis, 2012 Del. Ch. Lexis 175 (Del. Ch. July 31, 2012), [which] was the latest salvo in eroding the Blasius standard.  We discussed the case back in October.  In effect, the court found that in a case implicating both the duty of loyalty and the standard from Blasius, it would apply the standard from the duty of loyalty.  In other words, the court opted for the test that was easier for the board to meet.  Moreover, the court did so largely by disparaging the Blasius standard, portending further erosion.  Id.  (opinion stating that the main role of Blasius "to the extent it has one" is as an iteration of the intermediate standard fromUnocal).  

If the Chancery Court has its way, the need for "compelling justification" will go the way of the Dodo.  

If Blasius really is on the way out, I would applaud loudly. I direct the reader's attention to Harry G. Hutchison, Director Primacy and Corporate Governance: Shareholder Voting Rights Captured By the Accountability/Authority Paradigm, 36 Loy. U. Chi. L.J. 1111 (2005), which deploys my director primacy model to very good effect in analyzing shareholder voting rights, and makes a compelling case for scuttling Blasius.

What you ask is Blasius? Well, Gordon Smith once explained that:

One of my favorite Delaware decisions is Blasius Industries, Inc. v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988), written by then-Chancellor Bill Allen.Blasius has a narrow assignment in Delaware jurisprudence, requiring a "compelling justification" for any corporate action "intended primarily to thwart effective exercise of the franchise." Not many corporate actions over the years have been subjected to that standard, but Allen's defense of the shareholder vote is a classic:

The shareholder franchise is the ideological underpinning upon which the legitimacy of directorial power rests. Generally, shareholders have only two protections against perceived inadequate business performance. ...

To which I must respectfully dissent. 

As I wrote in The Board of Directors as Nexus of Contracts:

“The theory of our corporation law confers power upon directors as the agents of the shareholders; it does not create Platonic masters.” So opines former Delaware Chancellor William Allen, whom many regard as the leading corporate law jurist of our era. To paraphrase a television commercial of my youth, when Chancellor Allen speaks, people listen. Yet, as Horace cautioned, “even the worthy Homer sometimes nods.” The central thesis of this Article is that directors are not mere agents of the shareholders. To the contrary, the corporation’s board of directors in fact is a Platonic Guardian. All others with interests in the corporation are mere constituents.

Hence, in Director Primacy and Shareholder Disempowerment, I described Allen's holding in Blasius as "mere ipse dixit."

Democrat-run pension fund goes after Qualcomm for info on political spending

Yahoo finance reports that:

New York State's $150-billion public pension fund has sued Qualcomm Inc., seeking to force the chipmaker to reveal its political spending, according to the state comptroller.

The suit was filed late on Wednesday in Delaware Court of Chancery, after Qualcomm refused the request by the New York State Common Retirement Fund -- a Qualcomm shareholder -- to inspect records detailing the use of corporate resources for political activities, said state comptroller Thomas DiNapoli, who oversees the fund.

"Without disclosure, there is no way to know whether corporate funds are being used in ways that go against shareholder interests," DiNapoli, a Democrat who is up for re-election in 2014, said in a statement.

The suit opens a new front in the fight over corporate political spending, which has risen dramatically since the U.S. Supreme Court's 2010 ruling in Citizens United.

In a way, it's sort of interesting that Democrat DiNapoli is going after Qualcomm. After all Qualcomm co-founder and ex-boss Irwin Jacobs is a huge Obama donor. But I don't think that renders the suit apolitical.

In any case, if the issue goes to court, things could get very interesting from a doctrinal point of view. As I explain in Corporation Law, DGCL § 220(b) authorizes shareholders to inspect the corporation’s stockholder list and other books and records upon making a written demand setting forth a "proper purpose" for the request. The statute further defines a "proper purpose" as one "reasonably related to such person's interest as a stockholder." If the corporation denies the shareholder access to its records, the shareholder may sue in the Chancery Court. Under subsection (c), where the shareholder only seeks access to the shareholder list or stock ledger, the burden of proof is on the corporation to show that the shareholder is doing so for an improper reason. Where the shareholder seeks access to other corporate records, however, the shareholder must prove that he is doing so for the requisite proper purpose.

Attempts to investigate alleged corporate mismanagement are usually deemed proper, although the shareholder must have some factual basis for making the request and is not allowed to conduct a fishing expedition. See, e.g., Nodana Petroleum Corp. v. State, 123 A.2d 243, 246 (Del.1956); Helmsman Mgmt. Servs., Inc. v. A & S Consultants, Inc., 525 A.2d 160, 165 (Del.Ch.1987); Skouras v. Admiralty Enters., Inc., 386 A.2d 674, 678 (Del.Ch.1978).

Improper purposes include attempting to discover proprietary business information for the benefit of a competitor, to secure prospects for personal business, to institute strike suits, and­—most pertinently to present purposes—to pursue one's own personal social or political goals. Tatko v. Tatko Bros. Slate Co., 569 N.Y.S.2d 783 (App.Div.1991).

The latter improper purpose—pursuit of noneconomic social or political goals—has proven an especially problematic subject for courts. In the well known State ex rel. Pillsbury v. Honeywell, Inc. decision, the plaintiff belonged to an antiwar group trying to stop Honeywell from producing anti personnel fragmentation bombs for the military. 191 N.W.2d 406 (Minn.1971) (interpreting Delaware law). After buying some Honeywell stock, plaintiff requested access to Honeywell's shareholder list and to corporate records relating to production of such bombs. In denying plaintiff access to those records, the court emphasized that plaintiff's stated reasons were based on his pre existing social and political views rather than any economic interest. Accordingly, the court carefully limited its holdings to the facts at bar: "We do not mean to imply that a shareholder with a bona fide investment interest could not bring this suit if motivated by concern with the long or short term economic effects on Honeywell resulting from the production of war munitions." The court further noted that the "suit might be appropriate when a shareholder has a bona fide concern about the adverse effects of abstention from profitable war contracts on his investment in Honeywell." As such, Honeywell puts more emphasis on proper phrasing of one's statement of purpose than on the validity of the purpose itself. So long as one's social agenda can be dressed up in the language of economic consequences, one gets access to the list.  See, e.g., Conservative Caucus Research, Analysis & Education Foundation, Inc. v. Chevron Corp., 525 A.2d 569 (Del.Ch.1987) (a political group successfully sought access to Chevron's shareholder list for the stated purpose of warning its fellow "stockholders about the allegedly dire economic consequences which will fall upon Chevron if it continues to do business in Angola").

Does this formalistic approach make sense? The Delaware Chancery Court seems to think not, as at least one Chancery decision opines that Delaware law has de facto rejected Honeywell's requirement that the shareholder's purpose must relate to the "enhancement of the economic value of the corporation." Food & Allied Serv. Trades Dep't, AFL-CIO v. Wal-Mart Stores, Inc., 1992 WL 111285 at *4 (Del.Ch.1992).

My guess is that the NY pension fund will be smart enough to claim they’re motivated solely by economic concerns rather than admitting that this is all part of the left’s effort to silence corporate political speech.

If so, Qualcomm’s best bet would be to argue that the request is too broad. The Delaware Supreme Court has held, however, that a request to access such records must be very narrowly tailored: “A Section 200 proceeding should result in an order circumscribed with rifled precision.” Security First Corp. v. U.S. Die Casting and Development Co, 687 A.2d 563 (Del.1997).

In addition, Qualcomm should argue that in the absence of any facts suggesting breach of duty on the part of management that the pension fund is engaged in a fishing expedition. Cf. Cooke v. Outland, 144 S.E.2d 835, 842 (N.C.1965) ("Considering the huge size of many modern corporations and the necessarily complicated nature of their bookkeeping, it is plain that to permit their thousands of stockholders to roam at will through their records would render impossible not only any attempt to keep their records efficiently, but the proper carrying on of their businesses.").

An insufficiently narrow fishing expedition should not be allowed, especially given that we all know what DiNapoli is really up to. 

Pileggi's Top Delaware Corporate Decisions of 2012

Francis Pileggi has posted the eighth annual edition of his invaluable summary of the top Delaware corporate decisions of the year. As always, it is a must read. So go read it right now.

Chutzpah + Corporate Personhood = Carpool Lane Access?

The California motor vehicle code defines a "person" as, inter alia, a natural person or a corporation. California's carpool lane law requires that a vehicle using the lane have two or more persons on board. So liberal activist Jonathan Frieman decided on a unique way of protesting Citizens United:

When Jonathan Frieman of San Rafael, Calif., was pulled over for driving alone in the carpool lane, he argued to the officer that, actually, he did have a passenger. 

He waved his corporation papers at the officer, he told NBCBayArea.com, saying that corporations are people under California law.

Frieman doesn't actually support this notion. For more than 10 years, Frieman says he had been trying to get pulled over to get ticketed and to take his argument to court -- to challenge a judge to determine that corporations and people are not the same. Mission accomplished in October, when he was slapped with a fine -- a minimum of $481.

Frieman has been frustrated with corporate personhood since before it became a hot button issue in 2010, when the U.S. Supreme Court ruled that corporate and union spending may not be restricted by the government under the First Amendment. ...

In an opinion piece posted to the San Rafael Patch site on May 14, 2011, Frieman broke down his argument. ... He imagined what he might say to the judge: “Your honor, according to the vehicle code definition and legal sources, I did have a ‘person’ in my car. But Officer so-and-so believes I did NOT have another person in my car. If you rule in his favor, you are saying that corporations are not persons. I hope you do rule in his favor. I hope you do overturn 125 years of settled law.”

I admire his chutzpah, but not his opinions.