ProfessorBainbridge.com

No brag. Just fact. We are Persuasive.

Michael J. Vargas, Dodge v. Ford Motor Co. at 100: The Enduring Legacy of Corporate Law's Most Controversial Case, 75 Bus. Law. 2103, 2122 mm. 59 and 64 (2020):

Professor Stephen Bainbridge argues persuasively that the business judgment rule, though insulating board actions from review, nonetheless is intended to and does encourage maximum shareholder wealth generation by preventing costly and inefficient interference by judges, a situation that shareholders themselves would likely appreciate and for which they would bargain. Stephen Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 NW. U. L. REV.547, 600-05 (2003). However, Professor Bainbridge admits that the rule may have the effect of insulating boards that engage in actions that do not maximize shareholder value. Id. at 601 n.269.

Citing Shlensky, Professor Stephen Bainbridge has persuasively argued that the business judgment rule should be read as a rule of abstention rather than a substantive standard of liability, which would fully withdraw the courts from any review of the merits of business decisions unless a breach of trust is raised. Stephen Bainbridge, The Business Judgment Rule as Abstention Doctrine, 57 VAND. L. REV. 83, 95-102 (2004). 

New Article by Yours Truly: Long-Term Bias and Director Primacy

Long-Term Bias and Director Primacy (August 4, 2020). the Columbia Business Law Review (forthcoming), UCLA School of Law, Law-Econ Research Paper No. 20-04, Available at SSRN: https://ssrn.com/abstract=3666593

Abstract In an important recent contribution to the short-termism debate, Professors Michal Barzuza and Eric Talley what they call an “emerging consensus in certain legal, business, and scholarly communities … that corporate managers are pressured unduly into chasing short-term gains at the expense of superior long-term prospects. See Michal Barzuza & Eric L. Talley, Long-Term Bias (February 20, 2019), forthcoming in the Columbia Business Law Review, available at SSRN: https://ssrn.com/abstract=3338631. Instead, Barzuza and Talley contend that that “corporate managers often fall prey to long-term bias—excessive optimism about their own long-term projects.”

This article is an invited comment on Barzuza and Talley’s article. Subject to various quibbles raised herein, I broadly concur with Barzuza and Talley’s argument that corporate directors and officers can be biased towards long-term projects and, accordingly, may reject short-term projects offering higher returns.

But what law reforms follow logically from their conclusion, if any? With respect to judicial review, I want to differ with Barzuza and Talley on three points. First, I believe Barzuza and Talley overstate the risk of judicial intervention. Second, they fail adequately to distinguish between directors and managers, even though that distinction is central to the application of Delaware law. Third, I believe their analysis implies that judges should retain the deference to director decision making inherent in doctrines such as the business judgment rule and intermediate review.

With respect to encouraging shareholder activism, I argue that the responsibility for policing managerial hyperopia (or myopia, for that matter) should be assigned to the board of directors, not the shareholders. Heterogenous shareholders lack the proper incentives and knowledge to properly police management.

Keywords: corporate governance, management, directors and officers, short-term, long-term, behavioral economics

JEL Classification: K22

The Fourth Edition of Bainbridge on Corporate Law from Foundation Press' Concepts and Insights Treatise Series is Out

Many students find their Corporation Law class difficult because they do not understand the transactions giving rise to those cases. As with its predecessors, this fourth edition is intended to assist students by not only restating the law but also by putting the law into its business and financial context. The pedagogy is up-to-date, with a strong emphasis on the doctrinal issues taught in today's Corporations classes. The text is highly readable: The style is simple, direct, and reader-friendly. Even when dealing with complicated economic or financial issues, the text seeks to make those issues readily accessible.

This new edition brings the material up-to-date with complete coverage of developments in both state corporate law and federal securities law.

Law school faculty can view it here. Please consider recommending it to your Corporations and Business Associations students.

A Mini-Treatise on DGCL Section 220 Books and Records Inspections Inspired by Woods v. Sahara Enterprises, Inc.

Ar Francis Pileggi's invaluable corporate law blog, Frank Reynolds draws our attention to a new opinion by Delaware Vice Chancellor Travis Laster: Woods v. Sahara Enterprises, Inc. and links an earlier post on the same case from Mr. Pillegi himself.

Counselor Pileggi identifies the following takeaways from the case:

• A consequential aspect of this jewel of a decision is the instruction by the court that there is no basis in Delaware law to require a stockholder demanding corporate records under Section 220 to explain why the stockholder wants to value her interest in the company–in order to satisfy the recognized proper purpose of valuation. See Slip op. at 11; and 14-15.
• The court provided an extremely helpful list of many recognized “proper purposes” needed to be shown to satisfy Section 220. See Slip op. at 8-9.
• The court also recited several examples of what showing is recognized as sufficient to satisfy the “credible basis requirement” to investigate mismanagement pursuant to Section 220. See Slip op. 18-19.
• An always useful recitation of the basic elements of the fiduciary duty of directors of a Delaware corporation and the subsidiary components of the duty of loyalty and care, are also featured. See Slip op. at 20.
• The court categorized the specific requests for documents in this case as follows: (i) formal board materials; (ii) informal board materials; and (iii) officer-level materials. Then the court expounds on the different focus applicable to each category.
• Notably, after quoting the actual document requests, the court found that some of them were overly broad–but the court edited and narrowed some of the requests before concluding that the company was required to produce the court-narrowed scope of documents.

Reynolds summarizes key parts of the court's opinion as follows:

The Vice Chancellor said one of Wood’s purposes is to value her shares and, “valuation of a stockholder’s investment in a corporation, particularly where the corporation is privately held, has long been recognized as a proper purpose under 8 Del. C. § 220.”

He rejected Sahara’s argument that Woods failed to show she actually had a proper purpose and “the mere incantation of an accepted ‘valuation’ purpose in a private corporation is [not] sufficient.”  That position is “contrary to Delaware law,” because it “would require that a stockholder establish both a proper purpose (valuing shares) and an end use for the resulting valuation,” the court said.

Woods also established a reason to investigate wrongdoing, and “inspecting the company’s books and records can help the stockholder to ferret out whether that wrongdoing is real and then possibly file a lawsuit if appropriate,” Vice Chancellor Laster ruled.

Although the company’s poor performance, without more, has not been sufficiently protracted or extreme to draw an inference of wrongdoing, the tactical position that Sahara took during the litigation points to conflicts that might bolster Wood’s case, he said. ...

Regarding which documents must be produced for each category’s stated purpose, he said they must be “essential and sufficient to [its] stated purpose.”

How directors and senior officers are compensated and whether they are the beneficiaries of any related-party transactions are basic facts that stockholders are entitled to know and investors are entitled to know how their fiduciaries are taking money out of the corporation, the Court said. “A stockholder should not have to point to a valuation purpose or assert suspicions about corporate wrongdoing to be able to learn how much money the directors and senior officers are receiving.”

In addition, the vice chancellor said Sahara’s annual reports did not make clear who the various officers and directors listed worked for and investors are entitled to know (i) who the Sahara senior officers are, (ii) how much compensation they receive, and (iii) whether Sahara has entered into related party transactions with any officers or directors.

“The Trust’s desire to know this information is itself a proper purpose,” and the Trust is entitled to a court order for the production of any documents from the allied companies that their controllers could “access in the normal course of business,” he said.

All of which got me to thinking about Section 220.

A shareholder must have a proper purpose for requesting a 220 inspection.  If the Company denies the shareholder access to its records, the shareholder may sue in the Chancery Court. Under subsection 220(c), if the shareholder only seeks access to the shareholder list or stock ledger, the burden of proof is on the Company to show that the shareholder is doing so for an improper reason. If the shareholder seeks access to other corporate records, however, the shareholder must prove that s/he is doing so for the requisite proper purpose.

“The paramount factor in determining whether a stockholder is entitled to inspection of corporate books and records is the propriety of the stockholder’s purpose in seeking such inspection.”  CM & M Gp., Inc. v. Carroll, 453 A.2d 788, 792 (Del. 1982). “A proper purpose shall mean a purpose reasonably related to such person’s interest as a stockholder.” DGCL § 220(b) (emphasis supplied).

As Pileggi notes, Vice Chancellor Travis Laster’s new Woods opinion summarizes the proper purposes recognized by Delaware courts:

Prior cases have recognized that a stockholder can state a proper purpose by seeking

• to investigate allegedly improper transactions or mismanagement;
• to clarify an unexplained discrepancy in the corporation’s financial statements regarding assets;
• to investigate the possibility of an improper transfer of assets out of the corporation;
• to ascertain the value of his stock;
• to aid litigation he has instituted and to contact other stockholders regarding litigation and invite their association with him in the case;
• “[t]o inform fellow shareholders of one’s view concerning the wisdom or fairness, from the point of view of the shareholders, of a proposed recapitalization and to encourage fellow shareholders to seek appraisal”;
• “to discuss corporate finances and management’s inadequacies, and then, depending on the responses, determine stockholder sentiment for either a change in management or a sale pursuant to a tender offer”;
• to inquire into the independence, good faith, and due care of a special committee formed to consider a demand to institute derivative litigation;
• to communicate with other stockholders regarding a tender offer;
• to communicate with other stockholders in order to effectuate changes in management policies;
• to investigate the stockholder’s possible entitlement to oversubscription privileges in connection with a rights offering;
• to determine an individual’s suitability to serve as a director;
• to obtain names and addresses of stockholders for a contemplated proxy solicitation; or
• to obtain particularized facts needed to adequately allege demand futility after the corporation has admitted engaging in backdating stock options.

Woods v. Sahara Enterprises, Inc., 2020 WL 4200131, at *4-5 (Del. Ch. July 22, 2020).

Delaware courts have made clear that the existence of an improper secondary purpose is not enough to deny the shareholder access. Because “a shareholder will often have more than one purpose, [§ 220(b)] has been construed to mean that the shareholder’s primary purpose must be proper; any secondary purpose, whether proper or not, is irrelevant.” BBC Acquisition v. Durr-Fillauer Medical, 623 A.2d 85, 88 (Del.Ch.1992). This invites litigation as to what the shareholder’s primary purpose is and then whether it is proper.

Even if the shareholder manages to convince the court that his primary interest is, say, valuing shares, if the Company is able to show the shareholder also has an improper secondary purpose, the court may circumscribe the shareholder’s access so as to protect legitimate corporate proprietary interests. Safecard Servs., Inc. v. Credit Card Serv. Corp., 1984 WL 8265 (Del.Ch.1984).

A new hurdle is suggested by Travis’ new opinion in Woods. In it, he draws a sharp distinction between three distinct levels of corporate books are records:

• Formal Board Materials: “The starting point (and often the ending point) for an adequate inspection will be board-level documents that formally evidence the directors’ deliberations and decisions and comprise the materials that the directors formally received and considered (the “Formal Board Materials”). A corporation should be able to collect and provide its Formal Board Materials promptly and with minimal burden. In many organizations, the corporate secretary maintains a central file for each board meeting in either paper or electronic form that contains the minutes and other Formal Board Materials for that meeting.” Woods, 2020 WL 4200131, at *11.
• Informal Board Materials: “If the plaintiff makes a proper showing, an inspection may extend to informal materials that evidence the directors’ deliberations, the information that they received, and the decisions they reached (“Informal Board Materials”). Informal Board Materials generally will include communications between directors and the corporation’s officers and senior employees, such as information distributed to the directors outside of formal channels, in between formal meetings, or in connection with other types of board gatherings. Informal Board Materials also may include emails and other types of communication sent among the directors themselves, even if the directors used non-corporate accounts.” Id. at *12.
• Officer-Level Materials: “In an appropriate case, an inspection may extend further to encompass communications and materials that were only shared among or reviewed by officers and employees (“Officer-Level Materials”).” Id.

Personally, I think that hierarchy is the most important takeaway in the opinion. This is so, because Laster goes on to suggest that there is a clear hierarchy here. Woods is repeatedly given access to Formal Board Materials without much of a showing. A stronger showing is required for Informal Board Materials and Officer Level Materials:

Request (j) seeks “[d]ocuments, correspondence, reports or drafts thereof concerning any investment decision, business plan, valuation, budget, financial guidance, forecast or projections concerning the Company from January 1, 2015 to present.” JX 2 at ’199. The request does not distinguish among Formal Board Materials, Informal Board Materials, or Officer-Level Materials. The detailed nature of the request suggests that it seeks all three.

As framed, request (j) is overly broad. In the abstract, “[t]he importance of forecasts and projections to valuation of a company is so basic that it does not require citation.” Quantum Tech., 2014 WL 2156622, at *12 (Del. Ch. May 14, 2014). Woods is therefore entitled to inspect Formal Board Materials falling into this category. Woods has not proven that Informal Board Materials or Officer-Level Materials concerning financial guidance, forecasts, or projections are necessary and essential to her valuation purpose, and thus she is not entitled to those materials. If she receives Formal Board Materials and determines that they are inadequate for her purpose, then she may renew her request for Informal Board Materials and Officer-Level Materials.

Id. at *13. Earlier Delaware cases established that a Section 220 proceeding should result in an order "circumscribed with rifled precision.” Security First Corp. v. U.S. Die Casting and Development Co., 687 A.2d 563 (Del.1997).  Accordingly, the court of chancery must tailor its order for inspection to cover only those books and records that are “essential and sufficient to the stockholder’s stated purpose.” Thomas & Betts Corp. v. Leviton Mfg. Co., 681 A.2d 1026, 1035 (Del. 1996). The shareholder “bears the burden of proving that each category of books and records [being sought] is essential to accomplishment of the stockholder’s articulated purpose for the inspection.” Id.

Laster’s Woods opinion does not include the “rifled precision” quote but does draw on both Thomas & Bettsand Security First in setting the scope of the inspection to which Woods is entitled. Again, he principally tailors that access by focusing on the hierarchy between the various defined levels of materials:

According to Woods, requests (c), (d), (e), and (h) seek information about the Company’s investment strategies. Requests (c), (d), and (e) are actually much broader. They seek

(c) All minutes of meetings of the Company’s Board of Directors (the “Board”) or any committee thereof, including any attachments thereto, from January 1, 2015 to present;

(d) All presentations, agendas, reports or other materials provided to the Board or any committee thereof in preparation for, or review at, any meetings from January 1, 2015 to present; [and]

(e) All notes taken at any meetings of the Board or any committee thereof from January 1, 2015 to present.

JX 2 at ’198–99. These requests thus seek all of the Company’s Formal Board Materials from January 1, 2015, to the present, plus Informal Board Materials in the form of notes.

Request (h) seeks a subset of the foregoing materials. It asks for

[a]ll materials created for or provided to the Board or any committee thereof from January 1, 2015 to present concerning the Company’s investment strategies, any actual or proposed changes to the mix or types of investments made by the Company; returns from any investments; liquidity considerations; or tax consequences of investments for the Company or its stockholders.

Id. at ’199. Request (h) thus seeks Formal Board Materials relating to the Company’s investment strategies, investment holdings, and related issues.

The blanket request to inspect all of a Company’s Formal Board Materials, plus notes of all meetings, is not sufficiently targeted. Request (h) specifically requests Formal Board Materials concerning the Company’s investment strategy and investments, which is a core area of focus for the Demand. Books and records responsive to this request appear sufficient for Woods’ purpose. The Company shall produce materials responsive to Request (h). As to matters falling within the scope of Request (h), the Company shall produce the types of materials called for by Requests (c), (d), and (e). The Company need not produce materials that otherwise would be called for by Requests (c), (d), and (e), but which do not relate to the topics covered in Request (h).

Woods, 2020 WL 4200131, at *11.

All of which suggests that getting at the really interesting stuff—i.e., Informal Board Materials and Officer Level Materials—is going to be tough.

California's Racial/Ethnic Quota Bill Is Amended To Expand Definition Of "Underrepresented Communities"

Keith Paul Bishop has the details.

The Bainbridge Hypothetical Makes it into the National Law Review

From the National Law Review:

The problem of stakeholderism is brilliantly illustrated by the eponymous Bainbridge Hypothetical:

"[S]uppose that the board of directors is considering closing an obsolete plant. The closing would harm the plant's workers and the local community.  However, the closing would benefit shareholders, creditors, and employees at a more modern plant to which the work previously performed at the old plant would be transferred.  Moreover, the closing would benefit communities around the modern plant.  Assume that the latter groups cannot gain except at the former groups' expense. By what standard should the board make the decision?  Shareholder wealth maximization provides a clear answer to this otherwise difficult situation--close the plant.  The alternative to following the shareholder wealth maximization norm would, on the other hand, force directors to struggle with indeterminate balancing standards. In turn, such standards would deprive directors of the critical ability to determine ex ante whether their behavior comports with the law's demands, thereby raising the transaction costs of corporate governance."

BTW, it turns out that post was from Keith Paul Bishop.

Dorothy Lund's Passive Investing and Corporate Governance: A Law and Economics Analysis

I love literature reviews and wish more legal academics did them. Dorothy Lund's new chapter on passive investing for the Encyclopedia of Law and Economics is an excellent example of how a critical review of the literature can strengthen our understanding of a field.

Abstract: An important debate in corporate governance is whether passive funds — a term that includes ETFs and index funds — have incentives to provide adequate oversight of their portfolio companies. One set of scholars contends that agency cost problems likely thwart passive fund stewardship for several reasons. First, passive funds suffer from an acute collective action problem because any investment in improving the performance of a company will benefit all funds that track the index equally, while only the activist fund will incur the costs. Indeed, these scholars point out that investments in stewardship are particularly costly for the passive fund portfolio manager, which lacks the firm-specific information necessary to participate in governance in a beneficial way. Second, passive fund portfolio managers may have inadequate incentives to invest in beneficial stewardship because they capture only a small fraction of the gains. And third and finally, passive fund portfolio managers have ample incentive to be excessively deferential to management, who are often their clients. These scholars conclude that because of these flawed incentives, the rise of passive investing portends economic harm and justifies wide-ranging regulatory intervention — from incentivizing passive fund stewardship, to restricting passive fund voting rights. Another set of scholars contend that passive fund stewardship is likely to be as good as, if not better than, stewardship by other investors. They contend that passive funds compete for investor dollars not just against other passive funds, but also against actively managed mutual funds. This competition provides an incentive for passive funds to invest in stewardship that will attract asset inflows. In addition, the large size of the institutional investors that offer passive funds affords them economies of scale and scope in stewardship. And because these large institutional investors have massive stakes in portfolio companies, capturing even a small fraction of any gain will substantially increase their take home pay, providing an incentive to be engaged for a small number of material votes that occur each year. These scholars contend — in the words of Adam Smith, and later, Jack Bogle — that the invisible hand is all that is needed. This is a chapter from the forthcoming Encyclopedia of Law and Economics (Adam Badawi, ed., 2nd edition 2020).

Keywords: Mutual Funds, Passive Funds, ETFs, Index Funds, Corporate Governance, Law and Economics, Corporate Law

JEL Classification: K22, K20, K2

Lund, Dorothy S., Passive Investing and Corporate Governance: A Law and Economics Analysis (June 9, 2020). Available at SSRN: https://ssrn.com/abstract=3623381 or http://dx.doi.org/10.2139/ssrn.3623381

Making Sense of The Business Roundtable’s Reversal on Corporate Purpose

Bainbridge, Stephen Mark, Making Sense of The Business Roundtable’s Reversal on Corporate Purpose (July 30, 2020). UCLA School of Law, Law-Econ Research Paper No. 20-03, Available at SSRN: https://ssrn.com/abstract=3664078

Abstract: In August 2019, the Business Roundtable (BRT) issued a statement on the purpose of the corporation in which it reversed a longstanding position. Since 1978, the BRT has periodically issued statements on Principles of Corporate Governance, which purport to summarize law and best practice in this area. Since 1997, all versions of those statements had embraced the view that corporations exist primarily to serve their shareholders. In contrast, the 2019 version contains a much broader conception of corporate purpose, which posits that corporations should “commit to deliver[ing] value to all of” the corporation’s stakeholders.

Obviously, the BRT cannot unilaterally change the law. As this article explains, the law of corporate purpose remains that directors have an obligation to put shareholder interests ahead of those of other stakeholders and maximize profits for those shareholders.

What people do matters more than what they say. To date, the evidence is most BRT members remain committed to shareholder value maximization, despite their recent rhetoric to the contrary. This should not be surprising. The incentive structure faced by directors and managers still skews in favor of shareholders.

Why then did the BRT shift position? This article suggests two possibilities. First, the members may be engaged in puffery intended to attract certain stakeholders for the long-term benefit of the shareholders. Specifically, they may be looking to lower the company’s cost of labor by responding to perceived shifts in labor, lower the cost of capital by attracting certain investors, and increase sales by responding to perceived shifts in consumer market sentiment. They may also be trying to fend off regulation by progressive politicians. Second, some BRT members may crave a return to the days of imperial CEOS.

This article is a response to Jeffrey M. Lipshaw, The False Dichotomy of Corporate Governance Platitudes, Journal of Corporation Law (forthcoming).

Keywords: corporate law, corporate social responsibility, ESG, board of directors, corporate purpose

JEL Classification: K22, M14

Does California Corporate Law Really Look "Pretty, Pretty Good" Compared to Delaware?

I have developed tremendous respect for Keith Paul Bishop, whose blog on California corporate and securities law is essential reading, but I must respectfully dissent from his recent suggestion that California law looks "pretty, pretty good" compared to Delaware law.

The gist of his argument is that Delaware corporate law has become overweighted "with its intricate distinctions and interpretations.  At some point, this may prove to be Delaware's undoing as the law becomes just too inaccessible for most practitioners and their clients." In contrast, "California courts have not adopted in reported decisions many of Delaware's most famous decisions."

What Keith sees as a potential weakness, I think of as a strength. Delaware law is extremely detailed, which means a good lawyer can almost always--not 100% of the time, but close--come up with an answer to a client's question. In contrast, California corporate law is remarkably sparse and underdeveloped. Even experienced lawyers often have trouble finding clear answers to very basic questions.

• "Given the dearth of California case law, the California trial courts frequently look to Delaware law and apply their own interpretation of Delaware case law, even though no California precedent indicates that such borrowing is appropriate." Jeffrey S. Facter, Fashioning A Coherent Demand Rule for Derivative Litigation in California, 40 Santa Clara L. Rev. 379, 383 (2000)
• "Delaware now has a more robust canon of case law regarding corporate issues, leading to predictability of legal outcomes." -- Bryan Springmeyer
• In comparing incorporation of a startup in California or Delaware, DLA Piper notes "Delaware's well-developed body of corporate law."

A brilliant flow chart of Delaware corporate law standards of review

I wish I had done this, but I am glad to have found the brilliant flowchart by 3 Troutman lawyers accurately summarizing Delaware law standards of review.

H/T: Keith Paul Bishop

UCLA School of Law announces that Fall 2020 will be almost exclusively remote learning

Dean Jennifer Mnookin announced the policy in a lengthy letter to the faculty, students, and staff. Here's the key point:

Given the current situation surrounding the COVID-19 pandemic, especially here in Southern California, I have made the decision, with the approval of our Executive Vice Chancellor and Provost, that our fall semester’s courses at the law school, with very limited exceptions possible for a small number of live-client experiential classes, will be entirely remote. ...

It's worth reading the whole thing.

My new UCLA Law Colleague Andrew Verstein elected to the American Law Institute

I am delighted to report that my friend and new UCLA Law colleague Andrew Verstein has been elected to the American Law Institute, which drafts restatements of the law and other resources for legal scholars, judges and practitioners. An outstanding recognition for this brilliant young scholar.