ProfessorBainbridge.com

What course would you teach using my Advanced Corporation Law casebook?

A friend emailed to say she liked my new casebook on Advanced Corporation Law. But when I wrote back to encourage her to adopt it, she expressed doubt as to what course she would use it in.

A fair question. I use it in a course at UCLA called Advanced Corporation Law.

Reflections on being a Corporate Lawyer

A video from my new YouTube playlist on corporate law.

Professor Bainbridge on Corporate Law: Videos

I've created a playlist on Youtube of my videos on corporate law. You can access it here.

Kansas City Steak Soup

• 1 teaspoon baking soda dissolved in one tablespoon cold water
• 1 pound ground beef
• ½ cup diced onions
• ½ cup diced celery
• ½ cup diced carrots
• 3 cloves garlic, minced
• 1 tablespoon tomato paste
• ½ cup white wine (something not very oaky like Pino Grigio)
• 2 ½ cups low sodium beef broth
• 1 cup undrained crushed tomatoes
• 2 tablespoons A-1 steak sauce
• 1 tablespoon Worcestershire sauce
• 1 teaspoon Better than Bouillon roast beef base
• 2 medium red potatoes, peeled and diced

I always grind my own meat when I make this soup, using my KitchenAid meat grinder attachment. When I do a grind, I usually grind several pounds of meat and freeze some for hamburger patties or meatballs. In this instance, I ground 1 pound of chuck, 1 pound of top sirloin, and 1 ½ pounds of various assorted cuts that included trimmings from tenderloin, skirt steak, and bottom round. I ran half through once using just the course grinder plate and the other half through twice using the coarse grinder plate followed by the fine grinder plate. I used half a pound of the coarse grind and half a pound of the finely ground beef for this recipe.

Sprinkle the baking soda mixture over the ground beef and toss lightly to combine. This is a great Cook's Illustrated tip that helps keep the meat very tender and moist.

Warm a Dutch oven over medium heat. Add a pat of butter and a drizzle of olive oil. When the butter stops foaming, add the onions, celery, and carrots. Cook for 10 minutes (or until the veggies have softened and slightly browned on the edges). Add the garlic and tomato paste. Cook for 1 minute, stirring regularly.

Add the wine. Raise the heat to high and bring to a boil. reduce heat to medium-high and allow to reduce until the wine is a glaze. Add beef stock, tomatoes, A1 sauce, Worcestershire sauce, beef bouillon (this is a trick that amps up the beed flavor), and potatoes. Return heat to high. Bring to a boil. Reduce heat to medium-low and cover. Cook for 15 minutes. 

While the soup base is cooking, brown the ground beef. I did it in two batches in my All-Clad 9-inch nonstick skillet, so as to prevent the meat from crowding in the pan and stewing rather than frying. To keep the meat from getting tough and gritty the way ground beef can do, I kept the meat in fairly big chunks and cooked it just to medium-rare. I drained the meat on a paper towel-lined plate.

I added the meat to the Dutch oven and cooked it uncovered for 5 minutes.

As for what we drank, it was a 2018 Ridge Vineyards Lytton Springs. It doubtless would have aged, but it’s yummy now. Black cherry, raspberry, blueberry, blackberry. Juicy but not jammy. Well balanced.

Ownership Piercing by Lécia Vicente: Recommended Reading

I am reading a very interesting paper by Lécia Vicente, which argues that:

In this article, I develop the concept of "ownership piercing." I use the expression to suggest that courts engage in a process of evaluative reasoning to clarify who owns property rights and controls the limited liability company. I show under what circumstances courts should do that. Ownership piercing entails investigating the reality of the company's governance and tracing the real ownership profile of the company. It means defining who materially controls the company (i.e., managers or members?) and how "tamed" or, in other words, restricted the members' property rights are considering the consensual agreements the members and other stakeholders entered into. The idea that there may be situations in which courts should ownership pierce rests on the substance over form principle, which maintains that the economic substance of transactions rather than their legal form be disclosed.

Vicente, Lécia, Ownership Piercing (February 21, 2021). Available at SSRN: https://ssrn.com/abstract=3790108 or http://dx.doi.org/10.2139/ssrn.3790108.

She explains that:

Ownership piercing is not the same as the company's veil piercing. I define ownership piercing as a process of evaluative reasoning that courts undertake to complement the material participation test. Ownership piercing may also shed light on the level of control and the manager's decision-making role. Ownership piercing may help courts understand if an agent occupies a control or decision-making role despite acting under the control of a principal who has the final decision-making authority. In other words, ownership piercing helps understand who exercises ultimate control in the LLC.

I think she is very much on to something here. In particular, I think her work will do much to inform our analysis of cases like AG Resource Holdings, LLC, et al. v. Terral and Focus Financial Partners v. Holsopple. In both of those cases, the question of status as an owner or employee matter a great deal. Ownership piercing gives us a starting point for parsing them out.

Professor Vicente uses Metro Storage International LLC v. Harron to frame her analysis. (I commend to your attention Francis Pileggi's blog post on the case.) On one level, Harron is a constitutional law/civil procedure case, as the question before the court was whether a Delaware court had personal jurisdiction under 18-109(a) of the Delaware code, which implies consent to jurisdiction on the part of both de jury and de facto managers of an LLC. As Professor Vicente points out, however, deciding those issues required the court to parse out what it means to own and control an LLC.

Those who own are not always in control. Therefore, those who control should be held accountable like the owners would if they were in control. ... I am dealing with situations where standard contractual terms give the managers exclusive decision-making power. The role of an acting manager who had that type of exclusive power was analyzed by the Delaware Chancery Court ("Court") in Metro Storage International LLC v. Harron (“Harron”). In light of the company's contractual framework, members are peculiarly vulnerable since they cannot remove the managers, nor is it easy for them to sell their units. I suggest that, under these circumstances, courts may be less willing to give managers the benefit of the doubt as it is done through the application of the business judgment rule.

The first thing that sprang to mind when I read that was Martin Petrin's work on the responsible corporate officer doctrine, which is an analogy I encourage Prof. Vicente to pursue. 

In any case, she poses the question "What does it mean to participate materially in the management of the company?" In doing so, she does a deep dive into there hybrid property and contractual nature of LLC member's rights.

I was interested by her attempt to use the biological concept of pleiotropy to understand legal rights. It's an ambitious attempt at intellectual arbitrage. I'm not 100% convinced, but I admire her scholarly ambition and the modesty that prompts her to forthrightly acknowledge that "legal pleiotropy needs to be continuously studied, particularly to determine the applicable contractual clauses' scope and depth."

There's a digression into some empirical research she did into the UK equivalent of LLCs, which I'm not sure advances the ball. I would urge her to tie it more throughly into the argument throughout. (Or to dump it.)

At page 27, we come to her detailed exposition of how ownership piercing would solve the problems laid out in the preceding sections. What I would encourage her to develop in this section is a clearer statement of how ownership piercing would work. Set out a practical test that a judge could adopt and apply. In particular, it strikes me that she could adapt the veil piercing standard to say something like:

1. Does this individual have de facto managerial control whether by contract or otherwise?
   1. The laundry list of factors used in veil piercing cases could be adapted to ask whether this LLC has de facto allowed this individual to take over the members' control of the company and effect a separation of ownership and control.
2. Would not treating this individual as a controller lead to inequitable results?

Obviously, I'm shooting from the hip here but I think it would be helpful for her to flesh out what it means when she says "Ownership piercing means that the courts engage in a qualified process of evaluative reasoning." How does the court go about unveiling "the company's real owners, that is, the managers."

In sum, I think Prof. Vicente's article has the potential to make a very substantial contribution to an important area of the law that has not been well served by courts or commentators to date.

 

I also note with amusement that my friend Joshua Fershee will be pleased by Prof. Vicente's admonition that "THE LLC IS NOT A BERLE-MEANS CORPORATION." As Josh has often pointed out, much confusion has resulted from courts' failure to understand that point. 

Prof. Vicente draws three points from that distinction:

1. The LLC consists of autonomous individuals and the individualistic aspects of the LLC "do not favor weaker members." The cases in which courts have validated "predatory competition" within LLCs (with appropriate fiduciary duty waivers) come to mind here.
2. The principal-agent problem takes a different form that is "exacerbated by majority rules, the power of controlling or activist members, and the benefit of hindsight of the knowledgeable manager acting opportunistically."
3. The "common understanding in the literature that in LLCs, members are usually part of the management" is simply not true in manager-managed LLCs, where members "grant the managers autonomy, but in the process, become dependent on them to the point that unclear property rights in the units are not sufficient to overcome self-dealing by the management. Hence, without self-motivated investors minding the company's business, managers' effective constraints are small."

 

In the Corporate Social Responsibility Debate, do Fiduciary Duties Matter?

An interesting new paper argues that the answer to the titular question is no:

This paper provides a crucial corrective to the “corporate social responsibility” debate, which concerns whether corporations have the obligation to protect or serve the interests of groups other than their shareholders, like employees or customers (often called “stakeholders”). Scholars on one side of the debate have repeatedly presumed that corporate directors’ fiduciary duties to shareholders play an important role in protecting shareholders from decisions that favor stakeholders at their expense. Scholars on the other side agree that fiduciary duties provide meaningful protection against unfavorable conduct, but argue that directors should also owe fiduciary duties to stakeholders so they may be similarly protected. I argue this shared premise is empirically mistaken: fiduciary duties in practice play almost no role in director decisions to favor one corporate group over another. I first explain that courts and scholars rarely note the difference between two distinct definitions of the duty of loyalty—one broad, one narrow—and argue that only the broader definition would allow this duty to have any impact on directors’ distribution of corporate resources. Under this narrow definition, fiduciary duties to shareholders prevent directors from acting in their own self-interest, but not from acting in the interests of stakeholders at shareholders' expense. I then argue that Delaware law enforces only the narrower definition of loyalty due to the triggering conditions of the judicial standards of review, which largely eliminates shareholders’ ability to protect themselves from directors’ decisions that favor stakeholders. Finally, given this is true for shareholders, I argue it would likewise be true for employees (or any stakeholders), were they to be owed fiduciary duties by directors. Because fiduciary duties do not protect against such unfavorable conduct, I conclude it is a mistake to debate to whom directors should owe fiduciary duties. Advocates for shareholder or stakeholder protection should therefore focus on other mechanisms to obtain it.

Povilonis, Jonathan, The Use and Misuse of Fiduciary Duties: Why Corporate Fiduciary Duties Aren’t Worth Fighting For (August 1, 2020). Available at SSRN: https://ssrn.com/abstract=3752756or http://dx.doi.org/10.2139/ssrn.3752756

I particularly liked the discussion at pp. 39ff of my argument that "while Delaware law does not strictly enforce the Exclusive Benefit norm in every case, this is merely 'an unintended consequence of the business judgment rule.'" This is a point that a lot of folks on the CSR/ESG side of the debate often overlook or fail to grasp. Mr. Povilonis acknowledges the argument and gives it a fair description, but then spins the perspective to examine "not what directors can do but what shareholders have the power to prevent them from doing." Where we differ, however, is highlighted by his argument that:

To be clear, I don’t dispute that the standard of conduct for Delaware directors is that they must act for the exclusive benefit of shareholders—that is, the broad principle of loyalty I have been calling Exclusive Benefit. My point is that the standard of review by which Delaware courts evaluate directors’ stakeholder-interested conduct is so deferential that it virtually eliminates shareholders’ ability to hold them to that standard by suing for breaches of fiduciary duty. ...

... under current Delaware law, this deference virtually eliminates shareholders' ability to prevent directors' apparent stakeholder-interested conduct by suing for breaches of fiduciary duty.

But the same deference is a feature of Delaware law with respect to virtually all board decisions, other than those few decisions subject to review under enhanced scrutiny or the duty of loyalty. That deference is a core part of the board-centric system of governance established by Delaware law. The business judgment rule thus functions as an abstention doctrine, which obliges courts to abstain from reviewing almost all director decisions whether motivated by concern for stakeholders or not. See Stephen M. Bainbridge, The Business Judgment Rule as Abstention Doctrine, 57 Vanderbilt Law Review 83 (2019), available at: https://scholarship.law.vanderbilt.edu/vlr/vol57/iss1/3. 

My point is that director decisions motivated by concern for stakeholders differ neither in kind nor degree from almost all other board decisions. Put another way, the fact that judicial "deference virtually eliminates shareholders' ability to prevent directors' apparent stakeholder-interested conduct by suing for breaches of fiduciary duty" is of far less interest than the fact that "deference virtually eliminates shareholders' ability to [hold directors accountable for their] conduct by suing for breaches of fiduciary duty"

My Pillow, Inc. and the perennial question of whether Caremark claims should lie when boards fail to monitor the CEO's personal life

The WSJ reports that:

One of the largest makers of voting machines in the U.S. on Monday sued a prominent supporter of former President Donald Trump, alleging that the businessman had defamed the company with false accusations that it had rigged the 2020 election for President Biden.

Dominion Voting Systems sued Mike Lindell, chief executive of Minnesota-based MyPillow Inc., and his company in the U.S. District Court for the District of Columbia, seeking more than $1.3 billion in damages.

In its complaint, the company cites a number of statements made by Mr. Lindell, including in media appearances, social-media posts, and a two-hour film claiming to prove widespread election fraud.

I'm not sure whether My Pillow has minority shareholders or an independent board, but let's assume that it at least has some minority shareholders. If so, could those shareholders bring a Caremark claim against the board for failing to monitor CEO Lindell's political activities.

Directors are not expected to know, in minute detail, everything that happens on a day-to-day basis. Instead, a director is expected to have a rudimentary understanding of the firm’s business and how it works, keep informed about the firm’s activities, engage in a general monitoring of corporate affairs, attend board meetings regularly, and routinely review financial statements.[1] Beyond these obligations, the question remained as to whether boards have an obligation to monitor proactively the conduct of corporate subordinates.

In Caremark Int’l Inc. Deriv. Litig.,[2] Delaware Chancellor Allen opined that a board of directors in fact has an obligation proactively to take affirmative compliance measures:

[I]t would, in my opinion, be a mistake to conclude that our Supreme Court’s statement in Grahamconcerning “espionage” means that corporate boards may satisfy their obligation to be reasonably informed concerning the corporation, without assuring themselves that information and reporting systems exist in the organization that are reasonably designed to provide to senior management and to the board itself timely, accurate information sufficient to allow management and the board, each within its scope, to reach informed judgments concerning both the corporation’s compliance with law and its business performance. . . .

Thus, I am of the view that a director’s obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists, and that failure to do so under some circumstances may, in theory at least, render a director liable for losses caused by non-compliance with applicable legal standards.

Even though Caremark was dicta and arguably inconsistent with supreme court precedent, it quickly became well accepted by the chancery court as good law.[3] Yet, for over a decade, the Delaware Supreme Court found no occasion on which to address squarely Caremark’s validity.

In Stone v. Ritter,[4] the Delaware Supreme Court confirmed that “Caremark articulates the necessary conditions for assessing director oversight liability.” In doing so, however, the court described Caremark as a case in which the operative standards are good faith and loyalty rather than care, stating that:

[T]he Caremark standard for so-called “oversight” liability draws heavily upon the concept of director failure to act in good faith. That is consistent with the definition(s) of bad faith recently approved by this Court in its recent Disney decision, where we held that a failure to act in good faith requires conduct that is qualitatively different from, and more culpable than, the conduct giving rise to a violation of the fiduciary duty of care (i.e., gross negligence). In Disney, we identified the following examples of conduct that would establish a failure to act in good faith: . . . where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.

The Court further explained that such an intentional failure “describes, and is fully consistent with, the lack of good faith conduct that the Caremark court held was a ‘necessary condition’ for director oversight liability, i.e., a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists.”

As a practical matter, liability under Caremark and Stone has been most common where the board completely ignored compliance issues with respects to aspects of the business that are central to the company’s operations. Perhaps the closest case to My Pillow was posed in Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart,[5] involving Martha Stewart’s alleged insider trading:

Defendant Martha Stewart (“Stewart”) is a director of the company and its founder, chairman, chief executive officer, and by far its majority shareholder. . . . Stewart, a former stockbroker, has in the past twenty years become a household icon, known for her advice and expertise on virtually all aspects of cooking, decorating, entertaining, and household affairs generally.

The market for [Martha Stewart Living Omnimedia, Inc. (“MSO”)] products is uniquely tied to the personal image and reputation of its founder, Stewart. MSO retains “an exclusive, worldwide, perpetual royalty-free license to use [Stewart’s] name, likeness, image, voice and signature for its products and services.” In its initial public offering prospectus, MSO recognized that impairment of Stewart’s services to the company, including the tarnishing of her public reputation, would have a material adverse effect on its business. . . . In fact, under the terms of her employment agreement, Stewart may be terminated for gross misconduct or felony conviction that results in harm to MSO’s business or reputation but is permitted discretion over the management of her personal, financial, and legal affairs to the extent that Stewart’s management of her own life does not compromise her ability to serve the company.

Stewart’s alleged misadventures with ImClone arise in part out of a longstanding personal friendship with Samuel D. Waksal (“Waksal”). Waksal is the former chief executive officer of ImClone. . . . Waksal and Stewart have provided one another with reciprocal investment advice and assistance, and they share a stockbroker, Peter E. Bacanovic (“Bacanovic”) of Merrill Lynch. . . . The speculative value of ImClone stock was tied quite directly to the likely success of its application for FDA approval to market the cancer treatment drug Erbitux. On December 26, Waksal received information that the FDA was rejecting the application to market Erbitux. The following day, December 27, he tried to sell his own shares and tipped his father and daughter to do the same. Stewart also sold her shares on December 27. . . . After the close of trading on December 28, ImClone publicly announced the rejection of its application to market Erbitux. The following day the trading price closed slightly more than 20% lower than the closing price on the date that Stewart had sold her shares. By mid-2002, this convergence of events had attracted the interest of the New York Times and other news agencies, federal prosecutors, and a committee of the United States House of Representatives. Stewart’s publicized attempts to quell any suspicion were ineffective at best because they were undermined by additional information as it came to light and by the other parties’ accounts of the events. Ultimately Stewart’s prompt efforts to turn away unwanted media and investigative attention failed. Stewart eventually had to discontinue her regular guest appearances on CBS’ The Early Show because of questioning during the show about her sale of ImClone shares. After barely two months of such adverse publicity, MSO’s stock price had declined by slightly more than 65%. In August 2002, James Follo, MSO’s chief financial officer, cited uncertainty stemming from the investigation of Stewart in response to questions about earnings prospects in the future. . . .

Count II of the amended complaint alleges that the director defendants and defendant Patrick breached their fiduciary duties by failing to ensure that Stewart would not conduct her personal, financial, and legal affairs in a manner that would harm the Company, its intellectual property, or its business.[6]

The court held that:

First, plaintiff does not allege facts that would give MSO's Board any reason to monitor Stewart's activities before mid–2002 when the allegations regarding her divestment of ImClone stock became public. Second, the quoted statement from Graham refers to wrongdoing by the corporation. Regardless of Stewart's importance to MSO, she is not the corporation. And it is unreasonable to impose a duty upon the Board to monitor Stewart's personal affairs because such a requirement is neither legitimate nor feasible. Monitoring Stewart by, for example, hiring a private detective to monitor her behavior is more likely to generate liability to Stewart under some tort theory than to protect the Company from a decline in its stock price as a result of harm to Stewart's public image.

Even if I accept that the board knew that Stewart's personal actions could result in harm to MSO, it seems patently unreasonable to expect the Board, as an exercise of its supervision of the Company, to preemptively thwart a personal call from Stewart to her stockbroker or to fully control her handling of the media attention that followed as a result of her personal actions, especially where her statements touched on matters that could subject Stewart to criminal charges. Plaintiff has not cited any case to support this new “duty” to monitor personal affairs. Since the defendant directors had no duty to monitor Stewart's personal actions, plaintiff's allegation that the directors breached their duty of loyalty by failing to monitor Stewart because they were “beholden” to her is irrelevant. Count II is dismissed for failure to state a claim.[7]

In a subsequent opinion, the Delaware Chancery Court again held that “directors of Delaware corporations generally have no duty to monitor the personal affairs of other directors and officers.[8]

Some observers, however, have raised the question of whether subsequent social and legal developments make it increasingly likely that private misconduct by executives will lead to viable Caremarkclaims. In a post-#MeToo article, however, Tom Lin argued that Caremark oversight duties continue to “present difficult issues concerning the monitoring of executive private behavior.”[9] He explained:

First, because of the high bar for attaching liability pursuant to a director's Caremark duties, directors bear little risk for not aggressively monitoring the private affairs of their fellow executives. Even if such matters are subject to some oversight, reasonable attempts that do not “utterly” or “consciously” fail is all that the law requires of directors. In fact, the court in Caremark stated that these types of cases may “possibly [represent] the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” As such, companies have not bolstered their compliance and oversight of executive private conduct as much as they have in other corporate areas because there is little risk of liability and there remain open questions about whether the executive private matters should even be subject to corporate monitoring.

Second, creating and sustaining systems to oversee executive private conduct may be highly undesirable and impractical. After all, which senior executive is happy to subject themselves to being monitored by their fellow executives? Furthermore, it would be difficult to establish a surveillance system for senior executives concerning their private conduct, given the wide range of private travel and behaviors. This is to say nothing of the norms of collegiality, privacy, and legality that may be breached as a result of such a corporate surveillance system.[10]

Morris James' Delaware Corporate and Commercial Cases of 2020 in Review

Morris James offers a top 10 list of 2020 Delaware cases in corporate and commercial law, including a few personal favorites:

• AmerisourceBergen Corp. v. Lebanon Cty. Employees’ Ret. Fund, __ A.3d __, 2020 WL 7266362 (Del. Dec. 10, 2020) (Traynor, Justice)  

  •   I think this one goes in the casebook

• In re Dell Tech. Inc. Class V S’holders Litig., 2020 WL 3096748 (Del. Ch. Jun. 11, 2020) (Laster, Vice Chancellor)

  •  Probably not for the BA casebook, but possibly for the M&A casebook

• In re Anthem-Cigna Merger Litigation, 2020 WL 5106556 (Del. Ch. Aug. 31, 2020) (Laster, Vice Chancellor)

  • I'd love to include this opinion on efforts clauses, a topic of longstanding personal interest, but VC Laster brought the opinion in at 300 pages! How am I suppose to edit that down to something manageable?

If UCLA is losing millions at university sports, why are we doing it?

According to the UCLA Faculty Association, the university athletic department has suffered over $40 million in operating deficits in fiscal years 2019 and 2020. So why do we keep doing it?

Is Having Your Principal Executive Office in California a Risk Factor?

The risk factors section of a prospectus is often one of the most interesting parts. Keith Paul Bishop reports that at least one company is now treating having its principal executive office in California as a disclosable risk factor.

Choice of Law when an Organization's Organic Documents and an Employment Agreement Clash

Interesting post by Ann Lipton.

Phillip I. Blumberg was one of the giants of mid-20th Century corporate law; RIP

Phillip Blumberg was a well-regarded corporate lawyer on Wall Street before entering the academy as a law professor at Boston University and then serving as dean of the University of Connecticut law school. His magnum opus, The Law of Corporate Groups, remains an invaluable resource. Sadly, he passed away on February 14.

Connecticut law school posted an obituary here.

I never had the privilege of meeting him, but I was and am an admirer of his many contributions ti=o corporate law.