ProfessorBainbridge.com

Who owns a company, the CEO or the shareholders?

I saw this question over on Quora and thought I'd offer an answer. It is one, of course, that long time readers know I've touched on often.

In the colloquial sense of the word “ownership,” shareholders own the corporation. In a technical legal sense, however, “[s]hareholders own neither the property nor the earnings of the corporation. Shareholders own only stock, from which their income is derived upon the liquidation of assets or the declaration of dividends by directors.” Nelson v. Anderson, 72 Cal. App. 4th 111, 126 (1999) (internal citations omitted).

The technical legal sense is conceptually more accurate. Ownership implies a thing capable of being owned. To be sure, we often talk about the corporation as though it were such a thing, but when we do so we engage in reification. While it may be necessary to reify the corporation for semantic convenience, it can mislead. Conceptually, the corporation is not a thing, but rather simply a set of contracts between various stakeholders pursuant to which services are provided and rights with respect to a set of assets are allocated.

Because shareholders are simply one of the inputs bound together by this web of voluntary agreements, ownership is not a meaningful concept. Someone owns each input, but no one owns the totality. Instead, the corporation is an aggregation of people bound together by a complex web of contractual relationships.

As I explain in detail in my article The Board of Directors as Nexus of Contracts, the shareholders' contract with the firm has some ownership-like features, including the right to vote and the fiduciary obligations of directors and officers.

Even so, however, shareholders lack most of the incidents of ownership, which we might define as the rights to possess, use, and manage corporate assets, and the rights to corporate income and assets. For example, shareholders have no right to use or possess corporate property. Cf. W. Clay Jackson Enterprises, Inc. v. Greyhound Leasing and Financial Corp., 463 F. Supp. 666, 670 (D. P.R. 1979) (stating that “even a sole shareholder has no independent right which is violated by trespass upon or conversion of the corporation’s property”). Management rights, of course, are assigned by statute solely to the board of directors and those officers to whom the board properly delegates such authority. Indeed, to the extent that possessory and control rights are the indicia of a property right, the board is a better candidate for identification as the corporation?s owner than are the shareholders. As an early New York opinion put it, “the directors in the performance of their duty possess [the corporation’s property], and act in every way as if they owned it.” Manson v. Curtis, 119 N.E. 559, 562 (N.Y. 1918).

Can shareholders replace a CEO or Chairman?

I saw the titular question over at Quora and thought I'd offer up an answer. Unless the bylaws so provide, shareholders have no right to remove a CEO. Delaware General Corporation Law sec. 142, for example, provides that: “Officers shall be chosen in such manner and shall hold their offices for such terms as are prescribed by the bylaws or determined by the board of directors ….”

In general, the practice is that the Chairman of the Board of Directors must be a member of the board of directors. In a few states (such as Ohio, if memory serves), this is statutorily required. In most, it is an understood best practice. At its first organizational meeting of a new year, the board will select one of its members to serve as Chairman. The chair serves at the pleasure of the board and can be removed from that position by the board at any time. But there is no provision under Delaware law for the board of directors to remove one of its members. Indeed, there is case law specifically holding that the board lacks power to remove one of its own members. See, e.g., Dillon v. Berg, 326 F. Supp. 1214 (D. Del. 1971). Hence, while the board may deprive the chairman of his position as chair, the removed chair will remain a member of the board.

Conversely, the shareholders may not remove a sitting chair from the chairman’s position they can remove a sitting chairman from the board. Under Delaware General Corporation Law § 141(k) shareholders are authorized to remove a board member. that right cannot be revoked in either the bylaws or articles.

VC Zurn rejects settlement in the AMC APEs litigation

I'm analyzing the opinion over on Twitter. Here's a link to the thread and the first tweet in the thread (which is now up to about 10+ tweets and growing): https://twitter.com/PrawfBainbridge/status/1682493057894350848

#AMCAPES #APES VC Zurn rejected the settlement in the @AMCTheatres $AMC litigation. https://t.co/GVr82eN00U

— Steve Bainbridge (@PrawfBainbridge) July 21, 2023

Stuff and Nonsense about Suing Woke Corporate Directors

From the website of an outfit called "The Association of Mature American Citizens" (it came up on the RCP news aggregator):

In early June, Elon Musk wrote on Twitter that it “won’t be long before there are class-action lawsuits by shareholders against the company and board of directors for destruction of shareholder value,” referencing the rise of corporate wokeism and so-called “environmental, social, and governance,” or ESG policies.

The prospect held out by Musk is one that, according to former Assistant Secretary of State and experienced litigator and congressional counsel Robert Charles, could indicate a coming flurry of lawsuits against individual board members and directors for breaching their fiduciary duty to shareholders. In an interview with AMAC Newsline, Charles said that the recent spate of boycotts against woke corporations such as Anheuser-Busch and Target are not enough on their own, and litigation should also be on the table.

Shareholders should “pierce the corporate veil,” Charles said, by taking aim at members of the corporate boards themselves—arguing that in some cases, board members should be held personally liable for violating their legal obligation to act in the best financial interests of their shareholders.

Let's start with the idea that piercing the corporate veil is somehow relevant to the fiduciary duties of directors (woke or otherwise). It isn't. Not even a little bit.

As Todd Henderson and I explained in our book Limited Liability: A Legal and Economic Analysis, piercing the corporate veil is an equitable doctrine pursuant to which creditors of the corporation may under some circumstances disregard the corporation's separate legal personality in order to hold the corporation's shareholders personally liable. The general rule, of course, is that shareholders have limited liability. If a corporation cannot pay its debts, the creditors cannot go to the shareholders and collect the debt out of the shareholders' personal assets. If the shareholders have used the corporation as their alter ego and respecting the limited liability rule would promote fraud or injustice, the creditors cqn pierce the vail to reach the shareholders' personal assets. Note, by the way, that in addition to being doctrinally irrelevant the empirical studies discussed in our book make clear that no one has ever pierced the corporate veil to hold public corporation shareholders liable.

Second, as I discuss in my book The Profit Motive: Defending Shareholder Value Maximization, while it is true that directors have a fiduciary obligation to maximize shareholder value it is also true that the law generally gives directors great discretion in how they pursue that goal. And that brings us to the business judgment rule, the central doctrine of corporate law and which makes no appearance in the column.

Let us therefore turn to one of my favorite corporate law cases: Shlensky v. Wrigley. 

Shlensky, a minority shareholder in the Chicago Cubs, challenged the decision by Wrigley, the majority shareholder, not to install lights at Wrigley Field. Shlensky claimed the Cubs were persistent money losers, which he attributed to poor home attendance, which in turn he attributed to the board’s refusal to install lights and play night baseball. According to Shlensky, Wrigley was indifferent to the effect of his continued intransigence on the team’s finances. Instead, Shlensky argued, Wrigley was motivated by his beliefs that baseball was a day-time sport and that night baseball might have a deteriorating effect on the neighborhood surrounding Wrigley Field.

Despite Shlensky’s apparently uncontested evidence that Wrigley was more concerned with interests other than those of the shareholders, the court did not even allow him to get up to bat. Instead, the court presumed that Wrigley’s decision was in the firm’s best interests. Indeed, the court basically invented reasons why a director might have made an honest decision against night baseball. The court opined, for example, “the effect on the surrounding neighborhood might well be considered by a director.” Again, the court said: “the long run interest” of the firm “might demand” protection of the neighborhood. Accordingly, Shlensky’s case was dismissed for failure to state a claim upon which relief could be granted.

So imagine a woke director who is accused of putting her personal political preferences ahead of shareholder value maximization. She will invoke the business judgment rule. She could defend her decision by arguing that business "have profit maximizing reasons for aligning themselves with woke coastal millennials, who are at the core of the supposedly most desirable marketing demographic." But she won't need to do so. The court will defer to the board's decision under the business judgment rule, absent evidence that a majority of the board (not an individual director) acted out of a conflict of interest.

Charles apparently thinks one could find such evidence:

Charles stressed that there are limits to a company’s freedom, comparing a company’s duty to its shareholders to a game of bowling.

“You can’t have a director bowl in the opposite direction or keep guttering the ball if the goal is to hit the pins. And so the bottom line here is if these directors—or any one of them—is vocal in board meeting minutes about the fact that they want to divert money to their personal political agenda, and this is not really being articulated to the investors, then I think you could make the [legal] argument that there’s been a breach of trust—that there’s been a breach of fiduciary duty.”'

I've been a corporate lawyer, consultant, and academic since 1986. In those 37-odd years, I have never seen a director so dumb as to put such a statement in the board minutes (or a corporate counsel so dumb as to include such a statement in the minutes). Remember that the minutes are not a word-by-word transcript of the meeting. They are carefully edited documents prepared in the knowledge that they could well be the subject of future litigation.

Also, notice Charles says you only need "any one of" the directors to make such a statement. As noted above, however, to rebut the business judgment rule you need to show that a majority of the board engaged in self-dealing, fraud, or some similar misconduct. See, e.g., Krasner v. Moffett, 826 A.2d 277, 287 (Del. 2003) ("when the majority of a board of directors is the ultimate decisionmaker and a majority of the board is interested in the transaction the presumption of the business judgment rule is rebutted").

In any case, even assuming that the tainted minutes exist and that they reflect the majority of the board laughing hysterically while spending money on woke causes their shareholders oppose, how does Charles think one would get one's hand on these tainted minutes? In Delaware (the home of most corporations that matter), you'd need to do a Section 220 books and records inspection. And our shareholder would thus bump up against the recent Disney decision.

In Simeone v. Walt Disney Co., 2022-1120-LWW, 2023 WL 4208481, at *1 (Del. Ch. June 27, 2023), a longtime Disney shareholder agreed to act as a nominal plaintiff so that some conservative activist lawyers could sue Disney's board of directors for opposing Florida's House Bill 1557, titled the “Parental Rights in Education” bill. Plaintiff's theory was that "that officers and directors of Disney may have breached their fiduciary duties to the Company and its stockholders by, inter alia, failing to appreciate the known risk that the Company's political stance would have on its financial position and the value of Disney stock.” (Sound familiar?)

Because (1) any lawsuit doubtless would have been derivative in nature, (2) the complainant in a derivative suit must allege facts with particularity, and (3) ine does not get pre-filing discovery in these cases, the plaintiff would have had to gather the requisite facts using what the Delaware courts call "the tools at hand." In other words, a shareholder request under DGCL 220 to inspect Disney's books and records. Which is what the plaintiff did.

(By the way, notice that I haven't even gotten into the problems that would be created for Charles' lawsuit by virtue of the suit being derivative in nature. It introduces a whole slew of procedural obstacles.)

The court began by observing that:

Delaware law vests directors with significant discretion to guide corporate strategy—including on social and political issues. Given the diversity of viewpoints held by directors, management, stockholders, and other stakeholders, corporate speech on external policy matters brings both risks and opportunities. The board is empowered to weigh these competing considerations and decide whether it is in the corporation's best interest to act (or not act).

This mattered because a Section 220 demand must state a proper purpose for inspecting the books and records. Shareholders are not allowed to paw through corporate files at will. They must get a judicial order and in order to do so they must demonstrate that they have a proper purpose for asking for the records in question, The court explained that:

The plaintiff's demand identifies four purposes; all center around the same desire to investigate wrongdoing. The second and fourth purposes—to determine whether Disney's opposition to HB 1557 was harmful to the company and to “explore possible remedial measures”—are derivative of and dependent upon whether there was mismanagement in the first place. ...

The plaintiff's theory is that Disney's “decision to express public opposition” to HB 1557 despite “the [G]overnor's warning” amounts to a possible breach of fiduciary duty by the Board and certain Disney officers.

But the problem was that:

The plaintiff is not describing potential wrongdoing. He is critiquing a business decision. “A stockholder cannot obtain books and records simply because the stockholder disagrees with a board decision, even if the decision turned out poorly in hindsight.” ...

At bottom, the plaintiff disagrees with Disney's opposition to HB 1557. He has every right to do so. But “disagreement with [a] business judgment” is not “evidence of wrongdoing” warranting a Section 220 inspection.Such an inspection would not be reasonably related to the plaintiff's interests as a Disney stockholder; it would intrude upon the “rights of directors to manage the business of the corporation without undue interference.”

Long time readers will recall that I've been accused of being a RINO as far back as the Gang of 14 filibuster deal. Maybe so. But this not about politics. It is about law. And the law is that suits claiming woke directors breached their fiduciary duties by their decisions about how the corporation behaves in the political arena are non-starters.

Delaware Merges Blasius and Unocal: Commentary on Coster v. UIP Cos., Inc.

In Coster v. UOP Cos., Inc., the Delaware Supreme Court finally addressed the longstanding debate over the validity of the Blasius doctrine. (The following is based in part on the discussion of Blasius and Unocal in my books Mergers and Acquisitions (Concepts and Insights) and Corporate Law (Concepts and Insights).)

In Unocal v. Mesa Petroleum,[1] the Delaware Supreme Court laid out what has been called an “intermediate” or “enhanced business judgment” standard of judicial review, but is perhaps best described as a “conditional business judgment rule,”[2] to govern target board of director actions taken in. response to an unsolicited takeover offer. In Unocal, the Delaware Supreme Court reaffirmed the target’s board general decision-making primacy, which includes an obligation to determine whether the offer is in the best interests of the shareholders. In light of the board’s potential conflict of interest vis-à-vis the shareholders, however, judicial review was to be somewhat more intrusive than under the traditional business judgment rule: “Because of the omnipresent specter that a board may be acting primarily in its own interests, rather than those of the corporation and its shareholders, there is an enhanced duty which calls for judicial examination at the threshold before the protections of the business judgment rule may be conferred.”

The initial burden of proof is on the directors, who must first show that they had reasonable grounds for believing that a danger to corporate policy or effectiveness existed. The directors satisfy this burden by showing good faith and reasonable investigation. The good faith element requires a showing that the directors acted in response to a perceived threat to the corporation and not for the purpose of entrenching themselves in office. The reasonable investigation element requires a demonstration that the board was adequately informed, with the relevant standard being one of gross negligence.[3] Assuming the directors carry their initial burden, they next must prove that the defense was reasonable in relationship to the threat posed by the hostile bid.

Because unsolicited takeover bids often end up involving a shareholder vote, such as when the acquirer conducts a proxy contest to elect a new board of directors for the target in hopes that the new board will remove any takeover defenses that may be impeding the offer, there long was a question about how Unocal applied when the target board’s actions allegedly disenfranchised target shareholders.

The problem was that in that context Unocal bumped up into another line of cases arising out of Blasius Industries, Inc. v. Atlas Corp.[4] In Blasius, the Delaware Chancery Court held that where the board of directors takes actions for the “primary purpose” of interfering with the free exercise of the shareholder franchise, the board must demonstrate that it had a “compelling justification” for doing so. Taken by itself, Blasius proved to be “an unworkable standard of review, as once a court triggers Blasius, it would seem impossible for the directors to provide a compelling justification for disenfranchising their shareholders.”[5]

When a board action affecting the shareholder franchise takes place in other contexts, such as a simultaneous tender offer and proxy contest, Unocal provide the basic standard of review for the board’s actions. In applying Unocal’s proportionality prong, however, the courts treated board action that purposefully disenfranchises the shareholders as “strongly suspect.”[6] Attempting to merge the two created an even more untenable standard.

I have never been a fan of Blasius.[7] (See my post Professor Lipton asks "What about Blasius?" Well, what about it?) So I pleased to learn that the Delaware Supreme Court has finally more or less killed off Blasius by essentially merging it into Unocal. See Coster v. UIP Cos. Inc.

I’m going to skip over the facts and the case’s convoluted procedural history, as Ann Lipton has a great post on the Chancery Court opinion and an excellent post on the Supreme Court decision.

The key passage is at 31-32:

First, the court should review whether the board faced a threat “to an important corporate interest or to the achievement of a significant corporate benefit.” The threat must be real and not pretextual, and the board’s motivations must be proper and not selfish or disloyal. As Chancellor Allen stated long ago, the threat cannot be justified on the grounds that the board knows what is in the best interests of the stockholders.

Second, the court should review whether the board’s response to the threat was reasonable in relation to the threat posed and was not preclusive or coercive to the stockholder franchise. To guard against unwarranted interference with corporate elections or stockholder votes in contests for corporate control, a board that is properly motivated and has identified a legitimate threat must tailor its response to only what is necessary to counter the threat. The board’s response to the threat cannot deprive the stockholders of a vote or coerce the stockholders to vote a particular way.

Critics of Unocal have long complained that it is an essentially toothless standard.[8] Assuming arguendo that they are correct, does this mean that judicial review of shareholder disenfranchisement will now be reviewed with a lenient eye?

There are suggestions in the opinion that Unocal is to be applied contextually. See Coster at 31 (stating that “the court’s review is situationally specific and is independent of other standards of review”). There are also suggestions that, as applied to shareholder disenfranchisement, the standard may not be Unocal but rather what might be called Unocal+. See Coster at 31 (“Unocal can also be applied with the sensitivity Blasius review brings to protect the fundamental interests at stake – the free exercise of the stockholder vote as an essential element of corporate democracy.”); id. at 33 (“Applying Unocal review in this case with sensitivity to the stockholder franchise is no stretch for our law.”). In other words, it is at least possible that Unocal will be applied in this context with a more skeptical eye than it is in other situations.[9]

There are also suggestions that the new Unocal/Blasius standard and the sensitivity it supposedly demands will be more limited in scope than early Blasius decisions suggested. Some 15 years ago, a New York court suggested that Blasius is now limited to proxy contests involving director elections:

Blasius has been largely limited to disputes over the election of directors. Accordingly, “courts will apply the exacting Blasius standard sparingly, and only in circumstances in which self-interested or faithless fiduciaries act to deprive stockholders of a full and fair opportunity to participate in the matter.” Of particular significance here, “the reasoning of Blasius is far less powerful when the matter up for consideration has little or no bearing on whether the directors will continue in office.”[10]

There are a few passages in the Supreme Court decision suggesting that the new standard is in fact limited to proxy contests over the election of directors and similar situations:

• Describing the standard as calling for “enhanced judicial scrutiny of board action that interferes with a corporate election or a stockholder’s voting rights in contests for control.” Coster at 30.
• “When a stockholder challenges board action that interferes with the election of directors or a stockholder vote in a contest for corporate control, the board bears the burden of proof.” at 31.
• Noting the need “[t]o guard against unwarranted interference with corporate elections or stockholder votes in contests for corporate control . . ..” at 32.

The key question here is whether by “corporate elections” the court meant all proxy contests or only proxy contests involving election of directors. If Unocal/Blasius is in fact now so limited, it will have important implications for cases like the current litigation involving the AMC APES shares, in which the AMC board allegedly interfered with the shareholder vote but not in the context of a proxy contest for electing directors. If so, is the standard of review now applicable to such matters the business judgment rule?

Finally, on a personal note, let me vigorously object to the Supreme Court’s claim that there are “fundamental interests at stake”; i.e., “the free exercise of the stockholder vote as an essential element of corporate democracy.” As regular readers know, much of my scholarly output over the last several decades has been devoted to the proposition that corporations are not democracies.[11] And I am not alone in saying that corporations are not democracies.[12]

Kalbi (Beef) Tacos Sous Vide with Ridge Vineyards Buchignani Ranch (Alexander Valley) Zinfandel 2017

• ¾ cup soy sauce
• 1 tablespoon Worcestershire sauce
• 1 tablespoon mirin
• 1 tablespoon honey
• 2 tablespoons toasted sesame oil
• Several grinds black pepper
• ½ medium pear, peeled and diced
• ½ cup canned diced pineapple
• 2 cloves garlic, diced

Combine marinade ingredients in bowl of a food processor and pulse until fairly smooth.

Brush both sides of 1-¾ pounds flanken style beef short ribs with marinade. Reserve remaining marinade in a small jar in the refrigerator. Place in a 1 gallon vacuum seal bag. Using the pulse setting on your vacuum sealer get as much air out of the bag as possible without pulling the marinade into the sealer. Use the seal setting to seal the bag. Note: this is not a recipe with which I would use the immersion method to get the air out of the bag. I worry about leakage and the zip-loc bag holding up for such a long sous vide session.

Around breakfast a day before you want eat the tacos, place bag in a very large pot (it just fit in my 12 quart stockpot). Put your sous vide machine in the pot. Set the temperature to 130° and the timer to 36 hours.

About an hour before you want to serve dinner, put reserved marinade in a small saucepan over high heat. Bring to a boil and reduce heat to low. Allow to reduce to a glaze. Remove from heat and set aside.

When marinade has cooled add 1 tablespoon to ¾ cup Sriracha Aioli and mix well. 

Heat a grill pan over high heat. Remove ribs from water bath. Open bag. Transfer ribs to a paper towel lined cutting board and pat dry. Brush both sides of the ribs with marinade glaze. Sear ribs on both sides in the grill pan and transfer back to the cutting board (sans paper towels). Allow to rest briefly. If the meat fails to fall of the bones, cut meat from them. Chop meat roughly. 

Serve with warmed taco size soft flour tortillas, the aioli, steamed rice, and my Asian Slaw or my Asian slaw with pears. 

I assemble my tacos by smearing some aioli on the tortilla, topping it with rice, beef, and slaw in that order. Helen goes beef, rice, slaw, drizzle of aioli.

We drank a Ridge Vineyards Buchignani Ranch (Alexander Valley) Zinfandel 2017, which was a great match. Medium strength bouquet. Good depth with medium finish. Dark red and black fruits. Blackberry, raspberry, and spice and dill (American oak). A dash of pepper on the finish. Very very good. In prime drinking form now and probably will last another 3-4 years.

Multicooker Beef Stew with Smith-Madrone (Napa Valley--Spring Mountain District) Cabernet Sauvignon 2019

• 1 pound beef chuck cut into 1-inch pieces
• ½ medium onion, diced
• 2 cloves garlic, minced
• 1 tablespoon tomato paste
• 1 tablespoon flour
• ¾ cup red wine
• 1 ½ cup water
• 2 teaspoons Better than Bouillon reduced sodium Beef Base
• 1 tablespoon Worcestershire sauce
• 1 tablespoon soy sauce
• 1 ounce dried porcini mushrooms, rinsed and cut into small pieces
• 1 bay leaf
• ½ teaspoon dried Italian parsley
• ½ teaspoon garlic powder
• ½ teaspoon onion powder
• 1 large Yukon Gold potato, diced
• 2 medium carrots, sliced into ¼-inch rounds
• ¾ cup frozen peas
• 1 package Better Than Gravy Beef flavor

Set multicooker on brown setting. Season beef with salt and pepper. Add drizzle of olive oil to multicooker pot. When it starts to shimmer, add half of the beef. Brown on both sides. Remove to a paper towel lined plate. Repeat with other half of the beef. Add onion to pot and sauté until translucent (about 7-8 minutes). Add garlic and tomato paste. Sauté for a minute. Add wine and bring to a boil. Boil 3 minutes. Add water. beef base, Worcestershire sauce, soy sauce, mushrooms, parsley, onion and garlic powders, and a grind or two of black pepper to pot. Return beef to pot.

Put lid on pot. Set mode control to pressure cook (high) and set timer to 25 minutes.

When timer expires, unplug the multicooker and allow to sit for about 10 minutes. Release any remaining pressure and remove lid. Add potatoes and carrots. Plug the multicooker back in and replace lid. Set mode control to pressure cook (high) and set timer to 15 minutes.

When timer expires, unplug the multicooker and allow to sit for about 10 minutes. Release any remaining pressure and remove lid. Plug the multicooker back in. Set mode control to brown and bring liquid to the boil. Add peas and cook for 3 minutes. Add gravy mix and stir thoroughly. Cook 1 minute.

Serve. I made some biscuits to go with the stew. I made some honey butter for the biscuits by mixing 3 tablespoons of salted butter with 1 tablespoon of local Malibu raw honey and 1 teaspoon of New Zealand Honey Co. Raw Manuka Honey.  

I still use my trusty Fagor multicooker. Sadly, you can't get them anymore, but the Zavor LUX 4 Quart Multi-Cooker is a good substitute.

We drank a 2019 Cabernet Sauvignon from our good friends at Smith-Madrone Winery. Deep purple. Powerful bouquet. Intense flavors with a long finish. Drinkable now with smooth tannins, but there's plenty of structure to support cellaring. If I drink another bottle in the near future, as I'm very likely to do, I would loosen it up a little by double decanting and allowing it to breath for about 30 minutes. Plenty of rich, dark fruits. Black currant, blackberry, and black cherry. There's also a green element that I associate more with left bank Bordeaux than Napa cabernets. Herbs and green bell pepper. Complex. Tasty. Excellent.

Some recent wine tasting notes

Had a @ThreeSticksWine 2019 Sonoma Coast Pinot Noir with beef stroganoff. Great match. Bright cherry and raspberry. Floral notes on the nose. Smooth tannins. Good acidity. Balanced. Accessible but drink young. Good food wine. Well done. pic.twitter.com/XqMZgXWkiV

— Steve Bainbridge (@PrawfBainbridge) June 25, 2023

Had a @RidgeVineyards 2013 Rousten Cabernet Franc with pork loin chops in a Marsala mushroom sauce. Lovely wine. Black cherry, blackberry, spice. Great depth. Complex. Long finish. Exceptional. #wine #winetasting pic.twitter.com/uEkCaAWi9h

— Steve Bainbridge (@PrawfBainbridge) June 25, 2023

High "social" scores on ESG measures are "positively correlated with the likelihood of corporate scandals"

If you believe the ESG hype, high scores on ESG metrics indicates high levels of corporate social responsibility. There has been a lot of work discrediting that proposition (much of which is discussed in my book The Profit Motive). And now there is more evidence:

In this paper, we study the impact of environmental, social and governance (ESG) ratings on the likelihood of subsequent corporate scandals. We find that the ‘S’ score (social responsibility) has a predictive power on scandals, while the overall ESG ratings has not. This finding holds for all our specifications. The underlying question that we want to address with this paper is whether the ratings reflect firms’ real efforts to act responsibly towards the society, or whether it constitutes deception. Our work contributes to the ongoing ‘aggregate confusion’ discussion amongst ESG scholars, showing that there is little informational content in an aggregate score (as it measures very diverse dimensions). Contrary to our expectation, the ‘S’ score is positively correlated with the likelihood of corporate scandals, suggesting that the ‘S’ score does not live up to measuring a company’s social responsibility, including the ‘commitment to being a good corporate citizen’ (Refinitiv, 2022). Our analysis is based on a hand-collected matched sample of 113 global corporate scandals.

Kjaer, Christina and Kirchmaier, Tom, Deceived by ‘S’: Corporate Scandals and ESG (April 25, 2023). Available at SSRN: https://ssrn.com/abstract=4428468 or http://dx.doi.org/10.2139/ssrn.4428468

Anti-ESG Backlash Comes for Pension Plans that Force Beneficiaries into ESG Investments: Could Somebody Sue UCRP?

Kevin LaCroix reports that:

On June 2, 2023, an American Airlines pilot filed an ERISA class action lawsuit in the Northern District of Texas against American Airlines; the American Airlines Employee Benefits Committee; the company’s benefits plan administrator; and the company’s benefits plan advisor. The lawsuit purports to be filed on behalf of participants in the company’s employee benefits plan. A copy of the complaint can be found here.

The gist of the complaint is that the defendants “breached their fiduciary duties in violation of ERISA by investing millions of dollars of American Airlines employees’ retirement savings with investment managers and investment funds that pursue leftist political agendas through environmental, social and governance (‘ESG’) strategies, proxy voting, and shareholder activism—activities which fail to satisfy these fiduciaries’ statutory duties to maximize financial benefits in the sole interest of the Plan participants.” ...

He also reports that a similar lawsuit is pending against Delta.

Which leads me to a point of personal privilege. By virtue of my job I am obliged to participate in the University of California Retirement Plan. In pension plan terms, the rules under which my pension operates is an involuntary defined benefit plan. I cannot opt out and I have zero control over how my money is invested.

So what is UCRP doing with my money? UCRP's investment policy states that:

The Office of the Chief Investment Officer (“OCIO”) shall incorporate environmental sustainability, social responsibility, and governance (ESG) into the investment evaluation process as part of its overall risk assessment in its investments decision making. ESG factors are considered with the same weight as other material risk factors influencing investment decision making.

The policy statement further states that the plan must not hold tobacco stocks. UCRP is also in the process of divesting from fossil fuel companies.

So the answer to the question, "what is UCRP doing with my pension plan," is going big on ESG. 

Not only is the basic UCRP pension plan gone whole hog on ESG, but so have the voluntary 403(b) retirement saving plan options. Almost all of the choices are fossil fuel free because they are subject to the UCRP's ESG investment policies.

Eli Lehrer and Robert Eccles recently argued that employers should offer employees a choice between ESG and non-ESG funds. Specifically, they argue for legislation ensuring that "state employees in defined contribution plans can select non-ESG options."

Laws passed in decidedly red North Dakota and Idaho offer good models in this regard. North Dakota’s law defines “social investment” as “consideration of socially responsible criteria…for the purpose of obtaining an effect other than a maximized return” and requires the State Investment Board to “demonstrate a social investment would provide an equivalent or superior rate of return compared to a similar investment that is not a social investment and has a similar time horizon and risk” before making it. The Idaho law contains language with similar effect and allows that state-defined contribution plans offer employees socially-oriented investment funds only so long as they offer alternatives as well. Both policies are worthy of emulation.

I don't expect a deep blue state like California to consider mandating that state pensions offer non-ESG alternatives, especially with virtue signaller in chief Gavin Newsom as governor, but maybe we can get there by litigation? I understand that state university pension plans are exempt from ERISA. But surely a conservative public interest law firm could come up with a theory that relies on other fiduciary duty theories.

Are the SEC’s Climate Change Disclosure Rules Really in Double Constitutional Trouble

Donald Kochan (George Mason) offers an affirmative answer to the titular question:

The first administrative and constitutional law infirmity in the SEC’s proposed climate disclosure rule rests on an application of the “major questions doctrine,” which the U.S. Supreme Court recently gave increased recognition through its 2022 decision in West Virginia v. EPA. ...

The second administrative and constitutional law infirmity derives from an application of the nondelegation doctrine.  For the SEC rules, this doctrine has received little attention.  Indeed, the inattention likely results from the emergence of a stronger major questions doctrine.  Many seem to hold a confused belief that the major questions doctrine is either the same as the nondelegation doctrine or a replacement for it.  Neither is true.  Seeing how each independently operate in a legal challenge to the expected SEC climate disclosure rule is a perfect way to correct these erroneous perceptions.

Go read the whole thing.

 

In re Match Group, Inc.: Do All Controlling Shareholder Transactions Require Cleansing, whether MFW or Ordinary?

Ann Lipton reports on an interesting new development:

Putting aside the question of how control is defined, we still have the issue of how conflict transactions are cleansed.  As I said, Chancery has settled on the proposition that all conflicted controller transactions are cleansed exclusively through MFW.  ...

at the end of May, the Delaware Supreme Court ordered the parties in In re Match Group Derivative Litigation, No. 368, 2022, to brief the issue whether MFW cleansing is required for all interested controller transactions, or whether ordinary cleansing is permissible outside the freezeout context.  The case involved a series of transactions by which the old Match Group reorganized its assets, in a manner that public shareholders claimed benefitted the controller at the expense of the minority.  VC Zurn held that MFW cleansing was satisfied and the public shareholders appealed, arguing that the stringent MFW requirements were not met – leading to the question whether MFW was even necessary to trigger business judgment review.

Significantly, this issue was waived by the Match Group defendants before the Court of Chancery; the Delaware Supreme Court said that notwithstanding that waiver, “the Court finds that resolving the issue raised by the IAC Defendants is in the interests of justice to provide certainty to boards and their advisors who look to Delaware law to manage their business affairs.”

Please go read Ann's post for her take on this important question. As for me, however, I'm going to take a dive into my archives to bring you my long-held view of the matter:

My own view is that not all controlling shareholder transactions need cleansing. I start with the Delaware Supreme Court's decision in

Sinclair Oil. v. Levien, 280 A.2d (Del. 1971). Under Sinclair Oil, the initial question is whether the controlling shareholder “has received a benefit to the exclusion and at the expense of the subsidiary.” (To be sure, Sinclair Oil involved a parent-subsidiary relationship, but the parent by definition is a controlling shareholder and the principles are the same.)

The fact that the controlling shareholder is a party to the transaction is not enough. The controlling shareholder must have gotten a benefit that is both at the expense of and to the exclusion of the minority shareholders.

This is made clear by the court’s treatment of the minority’s objection to the subsidiary’s dividend policy. Sinven (the subsidiary) had adopted at Sinclair Oil’s behest a policy of paying out the maximum lawful dividend. This benefited Sinclair Oil but did not constitute self-dealing by Sinclair Oil because Sinclair received nothing from Sinven to the exclusion of its minority stockholders.” Id. at 772.

Unlike Restatement subsection (3), moreover, it is not enough that the controlling shareholder get a benefit or even that the benefit is not shared. The controlling shareholder must get a benefit not only that excludes the minority but comes at their expense. This is made clear by the court’s treatment of the minority’s complaint that Sinclair Oil had denied Sinven opportunities to develop oil properties outside of Venezuela. “From 1960 to 1966 Sinclair purchased or developed oil fields in Alaska, Canada, Paraguay, and other places around the world. The plaintiff contends that these were all opportunities which could have been taken by Sinven.” Id. But the court rejected that claim: “Sinclair usurped no business opportunity belonging to Sinven. Since Sinclair received nothing from Sinven to the exclusion of and detriment to Sinven's minority stockholders, there was no self-dealing.” Id. Again, you must have both exclusion AND detriment.

I will grant you that some recent Chancery Court cases appear to assume that

any “interested” transaction involving a controller is subject to intrinsic fairness analysis (unless cleansed as per below). But that is not the law, at least in Delaware. Under Sinclair Oil, there are two standards of review. If the plaintiff can carry the burden of proof of showing that the controlling shareholder benefited itself at the expense and exclusion of the minority, then entire fairness is the standard. But if the plaintiff cannot, the business judgment rule is the standard of review.

The rule thus is not: Controlling shareholder > was controlling shareholder connected to transaction > fairness unless cleansing.

The rule is: Controlling shareholder > did controlling shareholder benefited at the expense of and to the exclusion of minority shareholders > if yes, fairness unless cleansed; if no, business judgment rule.

In other words, If the plaintiff can't carry the burden of proof of showing that the controlling shareholder benefited itself at the expense and exclusion of the minority, then no cleansing--whether ordinary Kahn v. Lynch or MFW--is required.

As a policy matter, it is certainly the case that cleansing is necessary when the controlling shareholder benefited at the expense of and to the exclusion of minority shareholders, such as in the freezeout merger context. The potential conflict of interest is especially pronounced in this context. After all, “a merger in which it is bought out is the most important event that can occur in a small corporation's life, to wit, its death . . ..” SEC v. Geon Industries, Inc., 531 F.2d 39, 47 (1976). In a freeze out merger, the transaction takes on even greater significance than in the ordinary case because the controlling shareholder is buying the company and thus has a strong incentive to minimize the prize at the expense of the minority. Freeze out mergers thus have long been the subject of especially close review.

Yet, as been ably said by a court otherwise quite protective of minority shareholder rights, “The majority . . . have certain rights to what has been termed ‘selfish ownership’ in the corporation which should be balanced against the concept of their fiduciary obligation to the minority.” Wilkes v. Springside Nursing Home, Inc., 353 N.E.2d 657, 663 (Mass. 1976). This seems to be the principle animating Sinclair Oil, which allows some controlling shareholder transactions the protection of the business judgment rule even without the sort of cleansing envisioned by either Kahn v. Lynch or MFW.

If I can get all the other stuff on my desk cleared by summer's end, I'm planning on turning the above into a law review article.