ProfessorBainbridge.com

Guest Post: Russell Powell responds to my comments on his new paper Spirit of the Corporation

I am delighted that Russell Powell offered a guest post responding to my recent comments on his paper Spirit of the Corporation. His comments follow:

Thanks to Professor Bainbridge for taking an interest in and recommending my article “Spirit of the Corporation,” which was presented at the recent Berle Symposium (this year focused on religion and corporate law). His question, whether considering spirit as opposed to corporate culture does any significant work, is one that was raised at the symposium, and I acknowledge that the ideas are overlapping. I do not object to readers choosing to consider my formulation of corporate spirit a variation of corporate culture discourse. That said, in this work I am attempting to seriously engage theological traditions in their own contexts (Catholicism and broader Christianity, in particular). In my symposium presentation, I explained that I was attempting to use Rawlsian method regarding public discourse by presenting my private, religiously-based reasons along with parallel, secular reasons. Professor David Skeel appeared to take a similar approach with his very interesting paper “The Corporation as Trinity.”

I am comfortable with the range of definitions for spirit in the paper, but I do not focus on corporate culture explicitly. There is obviously a rich and diverse body of literature on corporate culture from a variety of fields over the past fifty years. Many of those descriptive and normative approaches would be consistent with my characterization of corporate spirit. However, I would argue that there are distinctions, even from a purely secular perspective. Definitionally, I am uncomfortable completely conflating spirit with culture. Is the spirit of the law (its essence or ideal) completely synonymous with legal culture or the culture of law? I think of corporate culture as the granular social facts that shape the tacit values, customs, traditions, and meanings within a particular business organization. In much of the business literature, there is an emphasis on internal mechanisms, policies and incentives, while legal scholars tend to emphasize the role of external rules. Corporate spirit might be considered a broader, inclusive category which focuses on the orientation of the entity toward particular goods, rather than the myriad mechanisms that contribute to that orientation. Although changing internal structures and external incentives can impact corporate culture, I wonder whether religious traditions that emphasize the need for internal transformation may contribute a helpful insight regarding the necessity for internal transformation as an important predicate for institutional reform.

Like Professor Bainbridge, I do not attribute to corporations a soul. From a Christian scriptural perspective, the soul may be distinguished from the spirit (e.g., I Thessalonians 5:23 and Hebrews 4:12). Though undoubtedly an oversimplification, I would argue from a Christian perspective that soul consists of mind, emotions, and will (aspects not easily attributable to institutions), while spirit reflects a person’s orientation toward the divine (or more generally, the good). Scholars of structural sin might identify a “spirit of violence” or a “spirit of joy” within a human institution. However, even in a Christian theological context, this does not mean that separate ethereal entities are created by human-institutional interactions, and that is not my contention. Furthermore, I am not arguing that there is something eternal about the spirit of Nike or McDonalds. Corporations wind up, sell their assets, are purchased or merged in ways that dissolve the entity or radically transform internal culture as well as their essential orientation toward particular goods. Think, for example, of the purchase of Whole Foods by Amazon and the macro and micro changes in management that followed.

My paper is not meant as an endorsement of any specific contemporary approach to corporate decisionmaking or purpose (though I note several); instead, it is primarily a reflection on Berle’s essay “Corporate Capitalism and the City of God,” wrestling with the question whether corporate managers ought to consider the common good along with or as part of their obligation to act in the best interests of the corporation. To that end, I wanted to bring theological perspectives to the discourse, and I am heartened that the piece has generated some fruitful cross-discipline interest and dialogue.

Yours truly will be a speaker on the Acton Institute University Panel on Corporate Social Responsibility June 23

See this discussion of the panel and my fellow panelists.

An abridged case against making it easier for shareholders to sue woke CEOs

As regular readers know, I am not a fan of woke capitalism--particularly when committed by social justice warrior CEOs. But what should we do about it, if anything?

I've heard some folks suggest a federal law making it easier for shareholders to bring derivative suits against directors or officers who inject their corporation into woke politics. I'm sympathetic to the goal, but skeptical of the means.

First, it would represent a further step towards the federalization of corporate law. I address the arguments against expanding the federal role in corporate governance in my book, Corporate Governance After the Financial Crisis at 261-70. The supremacy of federal law and the uniform opposition of Congress and the SEC to private ordering eliminates opportunities for experimentation with alternative solutions to the many difficult regulatory problems that arise in corporate law. As Justice Brandeis pointed out many years ago, “It is one of the happy incidents of the federal system that a single courageous State may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of country.” New State Ice Co. v. Liebmann, 285 U.S. 262, 311 (1932) (Brandeis, J., dissenting). So long as state legislation is limited to regulation of firms incorporated within the state, as it generally is, there is no risk of conflicting rules applying to the same corporation. Experimentation thus does not result in confusion, but instead may lead to more efficient corporate law rules.

In contrast, the uniformity imposed by federal law precludes experimentation with differing modes of regulation. As such, there will be no opportunity for new and better regulatory ideas to be developed—no “laboratory” of federalism. Likewise, the persistent refusal to accommodate private ordering eliminates solutions from emerging from competition in the market. Instead, the federalization of corporate governance has resulted in rules that were wrong from the outset or may quickly become obsolete, but are effectively carved into stone with little prospect for change.

I would also draw the reader's attention to an older article, The Creeping Federalization of Corporate Law, Regulation, Spring 2033, at 26. In it, I explain that:

The corporation is a creature of the state “whose very existence and attributes are a product of state law.” States have an interest in overseeing the firms they create. States also have an interest in protecting the shareholders of their corporations. Finally, as the Court noted in CTS v. Dynamics, a state has a legitimate “interest in promoting stable relationships among parties involved in the corporations it charters, as well as in ensuring that investors in such corporations have an effective voice in corporate affairs.” In other words, state regulation not only protects shareholders, but also protects investor and entrepreneurial confidence in the fairness and effectiveness of the state corporation law.

According to the Supreme Court’s CTS decision, the country as a whole benefits from state regulation in this area. As Justice Powell explained, the markets that facilitate national and international participation in ownership of corporations are essential for providing capital not only for new enterprises but also for established companies that need to expand their businesses. This beneficial free market system depends at its core upon the fact that corporations generally are organized under, and governed by, the law of the state of their incorporation. . . .

Competitive federalism promotes liberty as well as shareholder wealth. When firms may freely select among multiple competing regulators, oppressive regulation becomes impractical. If one regulator overreaches, firms will exit its jurisdiction and move to one that is more laissez-faire. In contrast, when there is but a single regulator, exit is no longer an option and an essential check on excessive regulation is lost.

Second, we know that much derivative litigation is meritless. Unless the legislation is extremely narrowly focused, changes intended to “increase stockholder plaintiff’s chances of making it pass the pleading stage” will simply increase the settlement value of such suits. Suppose, for example, in the wake of a tragic mass shooting Walmart decides to stop selling firearms. Do we really want some plaintiff lawyer filing suit against Walmart in that instance? Especially since trial lawyer political contributions primarily go to Democrats?

Third, unless the legislation is extremely narrowly drafted, it will likely involve delegating substantial discretion to a Democrat-dominated SEC.

Fourth, it takes a procedural approach to a substantive problem. A derivative suit is a procedural device mainly used to allow shareholders to bring suit against the firm’s directors and officers for breaching a fiduciary duty owed to the corporation. At present, the sort of woke decisions to which I object almost certainly would be insulated from judicial review by the business judgment rule. See my post Can Tim Cook Ignore ROI When Deciding How to Design an iPhone? So the law would have to create an underlying cause of action.  Which would make the intrusion on state corporate law even greater.

Finally, such proposals are just slapping a Band-Aid on a deep systemic problem. I address the underlying problem in my article Corporate Purpose in a Populist Era at pages 568-577. In short,  I think the rise of CEO social justice warriors resulted from a combination of virtue signaling, the business world equivalent of the Linda Greenhouse effect, and the Ivy League/Upper East Side bubble most of them live in. Most large corporation CEOs these days live in families and social circles where social conservatism is regarded as moronic, retrograde, trailer trash, flyover country nonsense. Acting out as SJWs keeps their spouses and kids off their backs, ensures that the NY Times will say nice things about them, gets their pictures on the society pages, and gets them invited to all the best parties. It lets them hobnob with Hollywood elites and hang out with at Clinton Foundation functions. And it differentiates them from the proles in the GOP base. Tinkering with corporate law at the margins is unlikely to do much until the dynamics of the underlying social phenomena change.

At somewhat greater length, I suggest that what we’re seeing is the culmination of what Christopher Lasch called The Revolt of the Elites. In his 1995 classic, Lasch identified an emergent split between what he called the New Elites and the rest of society. The changes Lasch spotted became trends that accelerated in subsequent years. In particular, Lasch explained that “the new elites . . . regard the masses with mingled scorn and apprehension.”  They dismissed the masses’ values as “mindless patriotism, religious fundamentalism, racism, homophobia, and retrograde views of women.”  This tension was perhaps nowhere more pronounced than with respect to religion. When Lasch wrote over two decades ago, he opined that “[a] skeptical, iconoclastic state of mind is one of the distinguishing characteristics of the knowledge classes. . . .  The elites’ attitude to religion ranges from indifference to active hostility.”

If anything, today’s elites have become even more hostile to religious values. As Samuel Gregg observes, the Davos Man’s moral creed is “a mélange of social liberalism, environmentalism, and a new order of a borderless world. . . . [R]eligion is considered the refuge of fanatics and anyone stupid enough to be skeptical of gender ideology and techno-utopianism.”

A quarter-century later, Lasch’s new elites have risen to the top of corporate hierarchies. They brought their values into the C-suite. CEOs increasingly reflect the values of the Blue state coastal bubbles in which they are embedded, especially on environmental and social issues. No Fortune 100 CEOs contributed to Donald Trump’s 2016 presidential campaign, for example, but eleven gave to Hillary Clinton. More generally, “liberal groups accounted for eight of the top ten ideological causes of the ultra-rich, and seven of the ten congressional candidates most dependent on money from such people were Democrats.” Even one of the progressive movement’s favorite whipping boys—David Koch—publicly self-identifies as “a social liberal.”

As a result, as a Slate essay observed, “Fortune 500 companies today are socially liberal, especially on areas surrounding diversity, gay rights, and immigration; they are unabashedly in favor of free trade and globalization, express concern about climate change, and embrace renewable energy.” In doing so, they are simply reflecting the changing values of their CEOs.

Tinkering with corporate law at the margins is unlikely to do much until the dynamics of the underlying social phenomena change.

SEC Chairman Gary Gensler to Finally Tackle Rule 10b5-1 Reform: I Offer a Few Suggestions

The WSJ reports:

Speaking Monday at The Wall Street Journal’s CFO Network event, SEC Chairman Gary Gensler said he is seeking to revise rules that govern the arrangements, known as 10b5-1 plans. Insiders set up plans ahead of time and use them to schedule future trades. The arrangement gives executives a defense against insider-trading claims that would stem from having undisclosed material nonpublic information at the time of a trade.

I suspect that I will be opposing most of Chairman Gensler's proposals over the next few years, but on this issue I am in complete accord. I discuss Rule 10b5-1 planes in my book Insider Trading Law and Policy (Concepts and Insights). As I explain therein, Rule 10b5-1 plans are widely abused:

There is growing evidence that many executives are abusing Rule 10b5–1 by establishing or amending trading plans while in possession of material nonpublic information on the basis of which they proceeded to trade while using the plan for cover.

I also discuss a number of best practices that could be mandated so as to reduce the current ease with which Rule 10b5-1 plans are abused:

• Corporate insiders should have only one Rule 10b5-1 plan in effect at any given time. Insiders with multiple Rule 10b5–1 plans with overlapping execution terms, can game the choice of plans to take advantage of material non-public information.
• Plans should have a term of at least one year, because short-term plans are more likely to be have been motivated by inside knowledge.
• Require the issuer's board of directors' Compensation Committee take responsibility for overseeing Rule 10b5-1 plans by the Named Executive Officers.
  
  • Adoption by an NEO of new Rule 10b5–1 plans, plan amendments and plan terminations should be pre-cleared by the committee.
• Adoption by an NEO of new Rule 10b5–1 plans, plan amendments and plan terminations should be pre-cleared by the issuer's internal audit function or its compliance office.
• Rule 10b5–1 plans should be adopted, modified, or terminated only at times when the corporate insider can buy or sell securities under the company’s insider-trading policy, such as during an open trading window or soon after an earnings announcement (when material non-public information will be communicated to the public).
• Bar corporate insiders from adopting new Rule 10b5–1 plans for six months or a year after a plan termination.
• Bar insiders from taking in the issuer's stock outside of a Rule 10b5-1 plan.
• A Form 8-K should be filed whenever an NEO adopts, modifies, or terminates a Rule 10b5-1 plan.
• With respect to Section 16 officers, their Form 4 disclosures should specify whether the trade was made pursuant to a Rule 10b5-1 plan.
• There should be a waiting period of 30 trading days between adoption of a plan and execution of the first trade pursuant to the plan.

Recommended Reading: Carney & Sharfman on Judicial Appraisal (Let's Just Call the Whole Thing Off)

Important new article from Bill Carney and Keith Sharfman:

Abstract For many years, we and other commentators have observed the problem with allowing judges wide discretion to fashion appraisal awards to dissenting shareholders on the basis of widely divergent, expert valuation evidence submitted by the litigating parties. The results of this discretionary approach to valuation have been to make appraisal litigation less predictable and therefore more costly and likely. While this has been beneficial to professionals who profit from corporate valuation litigation, it has been harmful to shareholders, making deals costlier and less likely to complete.

In this Article, we propose to end the problem of discretionary judicial valuation by tracing the origins of the appraisal remedy and demonstrate that its true purpose has always been to protect the exit rights of minority shareholders when a cash exit is otherwise unavailable, and not to judge the value of the deal.

While such reform would be costly to valuation litigation professionals, their loss would be more than offset by the benefit of such reforms to shareholders involved in future corporate transactions. Shareholders presently have adequate protections, both from private arrangements and legal doctrines involving fiduciary duties.

Their "thesis is simple: Whenever a dissenter can exit for cash or its equivalent, there is no need for appraisal."

I concur. In 2010, I wrote: 

I see no useful purpose in the modern appraisal proceeding. As Thompson notes, it has become a vehicle for dealing with some--but not all--instances of majority shareholder oppression in connection with some--but not all--freezeout transactions. Better to abolish appraisal and let shareholders pursue a class action for damages.

At the end of a long 2012 post on valuation in appraisal, I threw up my hands in disgust and wrote:

this issue presents yet another area in which the law governing appraisal rights appears to be broken. Once again, the student comes away from the cases with the unavoidable impression that the Delaware courts are just sort of making this stuff up as they go along. Accordingly, one again comes to the conclusion that the best thing to do would be to toss out current law in its entirety and start over with a blank sheet of paper.

In 2019, referring to an earlier Carney and Sharfman article on appraisal, I wrote:

Do go read the whole thing. And then answer me this question: Why not just abolish appraisal?

I'm Puzzled: Board Diversity Lawsuit Against Oracle Tossed on Motion to Dismiss But Not on Failure to State a Claim

Kevin LaCroix reports:

Regular readers will recall that last year and earlier this year, plaintiffs’ lawyers filed a series of shareholder derivative lawsuits against the directors of several companies alleging that the lack of diversity on the companies’ boards breached the directors’ fiduciary duties. ...

The Oracle complaint asserts that the company’s board is “one of the few remaining publicly-traded companies without a single African American director.” The complaint alleges further that the directors “repeatedly made gross misrepresentations in the Company’s public statements by claiming to have a multitude of policies, internal controls, and processes designed to ensure diversity both at the management level and the Board itself.” ...

The complaint asserts claims for breach of fiduciary duty; aiding and abetting breach of fiduciary duty; abuse of control; unjust enrichment; and violation of Section 14(a) of the Securities Exchange Act of 1934.

The defendants filed a motion to dismiss, contending that the plaintiffs had not sufficiently pleaded demand futility and, in light of the forum selection clause in the company’s by-laws, that the plaintiffs’ state law claims must be asserted in the Delaware Court of Chancery. ...

On May 21, 2021, Northern District of California Magistrate Judge Jacqueline Scott Corley granted the defendants’ motion. A copy of Magistrate Judge Corley’s order can be found here.

The court agreed that the state law claims could only be brought in Delaware Chancery Court, reinforcing the power of forum selection clauses. It severed the federal Securities Exchange Act Section 14(a) claims and held they could be dismissed for failure to plead demand futility.

For discussion of the implications of this dismissal and two earlier dismissals in similar cases, go read the whole thing. As usual, it's a detailed and very cogent analysis.

Here's my question: I don't understand why plaintiff framed his Section 14(a) claims as derivative. Since the Section 14(a) implied private right of action was created by the Supreme Court, the law has been that "a right of action exists [under that statute] as to both derivative and direct causes. J. I. Case Co. v. Borak, 377 U.S. 426, 431 (1964). "It is well settled law that a Section 14(a) claim may be brought directly or derivatively." In re Trump Hotels Shareholder Derivative Litig., 96 CIV. 7820 DAB, 2000 WL 1371317, at *10 n.5 (S.D.N.Y. Sept. 21, 2000).

In the Trump case, the plaintiff's suit was dismissed for failure to make demand solely because the plaintiffs were “[p]roceeding in a purely derivative capacity in the right and for the benefit of the Company." Id. Which is what also happened here.

So why didn't the plaintiff in either case bring a direct cause of action under Section 14(a)?

 

Recommended Reading: Russell Powell's new paper Spirit of the Corporation

I read with great interest Russell Powell's new paper Spirit of the Corporation (May 4, 2021). Seattle University Law Review, Vol. 44, No. 2, 2021, Available at SSRN: https://ssrn.com/abstract=3839820.

Abstract: Christian theologians have analyzed the productive and destructive qualities of institutions, sometimes attributing to them human virtues and vices. In City of God, Saint Augustine describes a utopian vision of human community within a Christian context as an alternative to the flawed “City of Man.” Contemporary theologians and sociologists have described collective structures of human behavior in institutions as having a kind of “spirit” analogous to the individual human “spirit.” Institutions are then assumed to take on an existence separate from the individuals within them, and in fact, the “spirit” of an institution influences the behavior of individuals. In The 20th Century Capitalist Revolution, Adolf A. Berle Jr. considers the tradition of religious utopianism and whether corporate capitalism has a spiritual character that impacts communities and individuals for good or ill and whether this might have implications for corporate managers. This Article provides a contemporary theoretical framework for Berle’s insight as a basis for considering its legal and ethical implications for corporate governance. It attempts to unpack contemporary understandings of spirit in order to provide a helpful working definition. It also considers the origins and essential traits of the modern business corporation in the United States, and discusses the question posed by Berle—whether corporations can or ought to have a sort of moral orientation. The Article ponders potential policy shifts that might tilt the orientation of the “spirit of the corporation” toward the common good and considers the limits of legal reform and the role of individuals and subgroups in changing corporate paradigms.

As longtime readers know, I am deeply skeptical of efforts to invest the corporation with a real personality or soul. My primary statement of this view is in my post Is the corporation an entity? With application to the SCOTUS. It elaborates on my favorite quote of all time, from Edward, First Baron Thurlow: "Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?"

On close examination, however, it seems to me that what Professor Powell is really talking about is not some metaphysical spirit but rather what others might call corporate culture.

Powell states, for example, that "If the spirit of a corporation is formed in part by the institutions that support and constrain them (such as law), then legal change may result in a change in the essence of a corporation beyond isolated behaviors" (389). Compare that statement to these:

• "This corporate culture [of retaliating against whistleblowers] must change, and the law can lead the way." Carnero v. Boston Sci. Corp., 433 F.3d 1, 12 (1st Cir. 2006).
• "If we truly want to inspire long term changes in corporate culture, then we need to think carefully about how we might overhaul corporate and securities laws." Miriam H. Baer, Organizational Liability and the Tension Between Corporate and Criminal Law, 19 J.L. & Policy 1, 14 (2010).

Powell elsewhere quotes Walter Wink's observation that "the spirituality that we encounter in institutions is not always benign. It is just as likely to be pathological." (382) Compare that to:

• "This is not to deny that one might understand calamities like Enron in other ways. Clearly this was a pathological corporate culture ...." David A. Westbrook, Corporation Law After Enron: The Possibility of A Capitalist Reimagination, 92 Geo. L.J. 61, 127 (2003).

Interestingly, in Part V, Professor Powell shifts gears and discusses a number of case studies involving positive or negative corporate cultures using the word culture.

The question then is what do we gain by invoking the concept of a spirit? Powell's conclusion states:

There are strong theological arguments from a variety of traditions attributing a spiritual character to human institutions if not an individual spirit. A purely secular approach could conclude that such institutions have identifiable characteristics and cultures which, though created by human persons and other structures, take on an identity separate from those shaping them that may persist. I assert that both views may be identified as something we may understand as “spirit.”

Professor Powell deploys the concept of spirit to discuss a set of corporations whose "spirit" is oriented towards the common good and those who have a "negative impact" because their "essence has been 'corrupted.'"

I am--as most of you know--a big fan of law & religion scholarship. In this case, however, I'm not convinced invoking the concept of a corporate spirt does any useful work that could not be accomplished by invoking corporate cultures. 

Say on Pay Remains a Toothless Tiger: So What's the Point?

From Semler Brossy comes a report on say on pay votes to date in the 2021 proxy season:

22 Russell 3000 companies (3.3%) failed Say on Pay thus far in 2021.

If there was ever going to be a year in which one might have expected say on pay votes to show real teeth, surely 2021 was the year. As The Guardian reported:

The millionaire chief executives of some of the American companies with the lowest-paid workers saw an average pay raise of 29% last year while their workers saw a 2% decrease, according to a report released Tuesday. ...

The compensation hike came as companies gave their top leaders hefty bonuses and forgiving performance benchmarks during the pandemic, allowing the top executives to cash in while their low-wage employees were essential workers.

The WSJ likewise reported that:

CEO pay surged in 2020, a year of historic business upheaval, a wrenching labor market for many workers and unprecedented challenges for many leaders.

Median pay for the chief executives of more than 300 of the biggest U.S. public companies reached $13.7 million last year, up from $12.8 million for the same companies a year earlier and on track for a record, according to a Wall Street Journal analysis.

Pay kept climbing in 2020 as some companies moved performance targets or modified pay structures in response to the Covid-19 pandemic and accompanying economic pain. Salary cuts CEOs took at the depths of the crisis had little effect. The stock market’s rebound boosted what top executives took home because much of their compensation comes in the form of equity.

Yet, say on pay votes remain within the historic pattern of shareholder rubber-stamping CEO pay. So what's the point?

Collins v. Lewis cafeteria eventually opened but finally closed in 2014

Collins v. Lewis was a staple of Klein, Ramseyer & Bainbridge Business Associations casebook for many years. A friend sent along this article that tells something of the backstory.

Best judicial smackdown of the year (maybe ever)

#appellatetwitter Also, the Ninth Circuit makes it official, holding that, as a matter of law, Disney’s THE LAST JEDI was “mediocre and schlocky.” https://t.co/G0RE56hPXP pic.twitter.com/Cxkstoy6Ji

— tedfrank 💉 (@tedfrank) June 1, 2021

Forthcoming: Rethinking Securities Law by Marc I. Steinberg

Marc Steinberg is one of the preeminent securities law scholars in the country. His new book Rethinking Securities Law should be a strong candidate for the law book of 2021.

From Amazon:

The system of securities regulation that prevails today in the United States is one that has been formed through piecemeal federal legislation, Securities and Exchange Commission (SEC) invocation of its administrative authority, and self-regulatory episodic action. As a consequence, the presence of consistent and logical regulation all too often is lacking. In both transactional and litigation settings, with frequency, mandates apply that are erratic and antithetical to sound public policy. This book focuses on "rethinking" the securities laws, with particular emphasis on the Securities Act and Securities Exchange Act.

In 1978, the American Law Institute (ALI) adopted the ALI Federal Securities Code. The Code has not been enacted by Congress and its prospects are dim. Since that time, no treatise, monograph, or other source comprehensively has focused on this meritorious subject. The objective of this book is to identify the deficiencies that exist under the current regimen, address their failings, provide recommendations for rectifying these deficiencies, and set forth a thorough analysis for remediation in order to prescribe a consistent and sound securities law framework. By undertaking this challenge, the book provides an original and valuable resource for effectuating necessary law reform that should prove beneficial to the integrity of the U.S. capital markets, effective and fair government and private enforcement, and the enhancement of investor protection.

This will be a must read for business lawyers and scholars.

Using Insider Reverse Veil Piercing to Vindicate the Free Exercise Rights of Close Corporation Shareholders

Kent Greenfield and Daniel Rubens want courts to invoke the legal fiction of corporate personhood to frustrate the free exercise rights of close corporation shareholders (although they frame the issue somewhat differently):

Corporations increasingly assert the right to discriminate, based either on free speech claims, religious freedom claims, or statutory claims arising from the Religious Freedom Restoration Act. Such claims have been considered by the Supreme Court in Hobby Lobby (RFRA) and Masterpiece Cakeshop (First Amendment), and in both cases the Court held in favor of the business.

In neither case, however, did the Court address a fundamental flaw with the arguments of the company asserting the speech and religion claims: that the claims depend on the rejection of corporate personhood. The putative religious and speech claims arose not from the beliefs of the companies but of their dominant shareholders. But corporate “personhood” means the interests of the firm are distinct from those of the shareholders. Allowing companies to assert the beliefs of shareholders as their own contradicts established doctrine and risks corporate manipulation of regulations designed to be generally applicable.

Greenfield, Kent and Rubens, Daniel, Corporate Personhood and the Putative First Amendment Right to Discriminate (April 29, 2021). Forthcoming in the Research Handbook on Corporate Purpose and Personhood (Elizabeth Pollman & Robert B. Thompson, eds.,Edward Elgar Publishing),  https://ssrn.com/abstract=3836962

As long time readers know, I am not a far of either veil piercing or reverse veil piercing in its role as a corporate law doctrine. To the contrary, I have urged its abolition as a corporate law doctrine.

But the fact that a doctrine is not fit for one purpose does not mean that the doctrine may not be fit for another purpose.

I believe that insider reverse veil piercing makes sense as a constitutional law doctrine. Indeed, in this context insider reverse veil piercing is the only doctrinal way of deciding when a corporation's shareholders may assert their free exercise rights when the state infringes on those rights by regulating their corporation.

I was prompted to examine this issue by a colloquy between U.S. District Court Judge Reggie Walton and Department of Justice lawyer Benjamin Berwick in Tyndale House Publishers, Inc. v. Sebelius, which was one of the cases that led up to the Holly Lobby decision:

Berwick argued that employers who chose to incorporate their business are precluded from raising First Amendment free exercise of religion-based objections to regulations affecting their business. In response, Judge Walton posed the following hypothetical:

[M]y wife has a medical practice. She has a corporation, but she’s the sole owner and sole stock owner. If she had strongly-held religious belief and she made that known that she operated her medical practice from that perspective, could she be required to pay for these types of items if she felt that that was causing her to violate her religious beliefs?

Berwick replied that the corporation and its shareholders are separate legal persons. The judge thereupon summarized his understanding of the government’s position as being that his wife would “have to go as an individual proprietor with no corporation protection in order to assert her religious right.” Berwick did not contest that characterization.

I find Berwick (and the government's) position on this issue nonsensical. According to Berwick, a sole proprietor could raise a valid free-exercise-based challenge to the mandate, but otherwise identically situated businesspersons who had incorporated their company lose the ability to do so. Talk about elevating form over substance, which often makes sense in a transactional setting but makes no sense when fundamental rights are at issue. Remember we dealing here with a right the Founders expressly embedded in the very first amendment to the Constitution.

Insider reverse veil piercing is the only doctrinal option that allows courts to make the sort of fine distinctions that are at issue here. As I explain in my article, 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,  https://ssrn.com/abstract=2229414. In it, I assert that:

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.

I proposed a three-pronged version of RVP that should be adopted in the mandate cases:

Is there such substantial identity of the shareholder(s)’s religious beliefs and the manner in which the corporation is operated and the purposes to which it is devoted that the corporation is effectively the shareholder’s alter ego?

How strong is the government’s interest in ensuring that the corporation’s employees get the mandated insurance coverage?

Would reverse piercing this corporation’s veil advance significant public policies?

I elaborated that a court would balance a number of factors:

• Veil piercing is a close corporation doctrine.  In this context, in particular, a public corporation with many shareholders holding diverse views is a poor candidate for RVP-I. In contrast, a closely held corporation – even if quite large by metrics such as assets or employees – with a small number of shareholders holding common religious beliefs is a good candidate. 
• Do the corporation’s articles of incorporation include a statement of purpose referencing religious beliefs and goals? 
• Is the ownership structure of the corporation designed to ensure continuity of its religious purposes even after the original founders have retired or died? 
• Are the directors and officers of the corporation obliged to share the founders’ religious beliefs? If so, are they required to document that fact, such as by signing a statement of faith? 
• Are religious practices such as devotions, prayer, scripture reading, or worship services routinely made a part of corporate meetings? 
• Are such practices made available to employees?
• Is some substantial portion of the corporation’s profits donated to religious charities or otherwise used to advance the founders’ religious beliefs? The biblical concept of a tithe springs to mind here as a possible metric.

The more of these factors that a court finds to be present, the more willing the court should be to treat the corporation as the shareholder’s alter ego.

In Hobby Lobby, no less than 44 corporate law professors--including Greenfield--thought it necessary to file an amicus brief arguing that the essence of a corporation is its “separateness” from its shareholders and that, on the facts of these cases, there is no reason to disregard the separateness between shareholders and the corporations they control. My argument apparently so scared the 44 professors that their brief expressly tackled my argument, asserting that my “argument fundamentally misunderstands the reverse piercing remedy.”

In fact, it was the 44 professors' brief that was replete with errors, overstated claims, or red herrings, and misdirection. I took on the brief in  A Critique of the Corporate Law Professors’ Amicus Brief in Hobby Lobbyand Conestoga Wood (February 21, 2014). 100 Virginia Law Review Online 1 (2014),  https://ssrn.com/abstract=2399638

My article ticked off a lot of problems with the brief, as the table of contents will suggest:

II. The Brief Overstates the Corporation’s Separateness From Its Owners

III. The Corporation’s Separate Existence Does not Always Protect Shareholders from Liability for Corporate Debts

IV. The Brief’s Attack on Reverse Veil Piercing is Overstated and Inaccurate

A. The Brief Misrepresents Hobby Lobby’s and Conestoga Wood’s Argument 

B. The Law Does Not “Strongly Oppose” Reverse Veil Piercing

C. The Brief’s Sleight of Hand Should Not Obscure the Important Policy Issues at Stake

D. The Supreme Court Should Invoke RVP-I to Prevent the Government from Continuing its “Shell Game”

E. Applying RVP-I in the Contraception Mandate Cases Would not be “Disruptive to Business”

1. Protecting the Minority Shareholders’ Interests is Straightforward 

2. The Brief’s Misleading Use of Cede & Co. v. Technicolor, Inc.

F. RVP is not Outcome Determinative 

G. Even Assuming RVP-I Would Give Hobby Lobby and Conestoga Wood a “Competitive Advantage,” They Would not be Alone 

H. RVP-I Will Not Lead to “Disruptive Proxy Contests” 

At bottom, however, my core objection goes to a point Douglas Laycock made that echoed Judge Walton's point:

Laycock observes that:

The threshold issue in Sebelius v. Hobby Lobby Stores and Conestoga Wood Specialties Corp. v. Sebelius is whether any plaintiff’s free exercise of religion is substantially burdened within the meaning of the Religious Freedom Restoration Act.

On that issue, the government’s argument is a shell game. Only the individuals have religious-liberty rights; only the corporations are regulated. And more: Even the individuals have no rights when they act or refuse to act as directors, officers, or managers of the corporation. Not only are the individuals separate persons from the corporation, but the individuals are divided into additional separate persons, depending on the capacity in which they act. This is formalism in the extreme.47

By advancing the same sort of extreme formalism, the Brief provides academic cover for the government's shell game.

In Barium Steel Corp. v. Wiley,the Pennsylvania Supreme Court allowed a RVP-I claim so as to prevent just such a shell game. In that case, the court allowed the plaintiff shareholder (itself a corporation) to pierce the veil in reverse to recover damages suffered by a later-created subsidiary due to a breach of warranty, on the grounds that absent RVP, the defendants would never be liable for their breach due to lack of privity with the sub and the fact that the sub was not an intended third-party beneficiary.The Supreme Court likewise should use RVP-I in this case to prevent just such a shell game.

As I have argued elsewhere, the corporation is not a real entity and to argue the contrary is “transcendental nonsense." The legal fiction of corporate personhood should not stand in the way of free exercise of religious belief by shareholders of a closely held incorporated business.

For more on veil piercing, see: