ProfessorBainbridge.com

The prospect of an Amy Comey Barrett nomination to the Supreme Court has unhinged both right- and-left wing anti-Catholic bigots

I think we can reasonably debate such things as:

• Is the Supreme Court too powerful in US life?
• Is it hypocritical for the GOP to nominate someone now after blocking Merrick Garland?
• Is it hypocritical for the Democrats to invoke Garland as a precedent for doing nothing now?
• Does the nominee (if there is one) have the proper legal skills and judicial temperament?

But what I will not put up with is the sort of modern Know-Nothingism being spewed over on Twitter and in some corners of the media at the mere possibility that Amy Comey Barrett might be the nominee. It's proving once again that anti-Catholicism is the last acceptable prejudice.

This good and decent person is being branded a "Catholic fascist," a harbinger of The Handmaid's Tale becoming real, "the Catholic version of Dolores Umbridge," and even worse. Much worse.

It's not just the left. Ann Coulter moronically asks: ""Would her ... idiosyncratic view of the vast deference Catholics owe the pope on political issues...lead to the ongoing influx of immigrants who overwhelmingly vote for pro-choice candidates?"

Towards a Navy Corps of Nuclear Power Engineering: Operationalizing NuScale's small modular nuclear reactor plant

There's a really interesting article in today's WSJ about NuScale's small modular nuclear reactor plants:

... the same folks who fought nuclear energy tooth and nail are now complaining that it’s too expensive—like saying they’re orphans after killing their parents.

I mention all this now because earlier this month, and almost miraculously, the Nuclear Regulatory Commission approved the design and issued a final safety evaluation report for a Small Modular Reactor, or SMR, by NuScale based in Portland, Ore. NuScale’s design, funded by engineering firm Fluor and the U.S. Energy Department, joins six older federally approved designs. But it’s the first that looks as if it can scale and reduce costs. ...

The NuScale reactor is smaller—only 65 feet tall and 9 feet in diameter, with much installed below grade. It has a really small core, 1/20th the size of larger reactors, and, importantly, it comes with passive safety features. Using buoyancy, water circulates internally without pumps. Motors lift the control rods such that if electricity is lost, gravity drops them back into the core, stopping the reactor. Safety first.

Each SMR can generate 60 megawatts of power, and a dozen can be linked together at one site. California’s recent blackouts were from a shortage of 4,000 megawatts of power, so only six SMR groupings could have solved the problem, carbon free.

That article got me to thinking about a column I wrote for TCS Daily back in 2010 or so. I had to dig it out of the Wayback Machine archives and offer it up here.

Almost since its founding, the Army Corps of Engineers has had a major domestic, peace-time function in civilian civil works projects. So there is a precedent for having the military run such projects.

I got to thinking about that precedent when I read Bradford Plumer's TNR post, which notes that:

Obama wasn't kidding when he gave all those shout-outs to nuclear power in his State of the Union address on Wednesday. According to Bloomberg, Obama's 2011 budget will request $54 billion in loan guarantees for new nuclear reactors—triple the previous amount.

I'm inclined to agree with Andrew Sullivan that "There's no way to tackle our carbon addiction without nuclear energy as part of the solution." But I also appreciate Plumer's observation that "the case against comes from the Union of Concerned Scientists, which argues that big nuclear projects have historically been very risky—prone to delays and cost overruns—and that the default rate on these loans can be quite high, sticking taxpayers with the bill. Instead, says UCS, it'd be better to direct that money toward cheaper, more reliable options for reducing emissions—efficiency or waste-heat capture or even wind power."

I've got a better idea. The WSJ reported in September of last year that:

 

Babcock & Wilcox, a unit of McDermott International, has designed a small 125-megawatt reactor that would be built at its U.S. factories and then delivered to power-plant sites by rail or barge. This would eliminate a bottleneck and the associated higher costs for ultra-heavy forgings that are required for large reactors. Small reactors could be built at a number of domestic heavy-manufacturing sites. The Lynchburg, Va., company has been building small reactors and other key components for Navy ships for decades, at plants in Indiana and Ohio.

Another plus of small reactors: They're designed to be refueled less frequently, reducing the number of refueling outages. Instead of every 18 months to two years, they could go four or five years, reaping a saving from having less down time. Another feature of some reactors is the ability to do more maintenance while plants are running, again reducing idle time.

... critics say that the economics of small plants simply don't work: The licensing costs are so great for nuclear plants, somewhere between $50 million and $100 million per site, and security and construction costs are so high that the economics work only for big plants, with lots of output, so costs can be spread over many kilowatt-hours of electricity.

So here's where my idea comes into play. The Navy already operates dozens of small nuclear reactors in aircraft carriers and submarines, with an outstanding record of safety and reliability. They have an established training program that churns out nuclear-capable officers.

By analogy to the Army Corps of Engineering, we could create a Navy Corps of Nuclear Engineering. It would build and operate dozens of small nuclear power plants around the country. To address security concerns, the first plants would be built on military bases, where the garrison can provide security. Licensing costs would be cut because the government would own and operate the plants.

The proposal should not offend small government sensibilities. Nuclear power is rife with market failures (and government failures). Huge research and development costs associated with traditional large scale nuclear power plants may be beyond the ability of private firms to finance. In addition, we know that private firms tend to underproduce the sort of basic R&D necessary to develop new generations of power plants. But the Navy already spends money to develop new naval reactors, which presumably could be scaled up at reasonable costs. Since the Navy need not worry about earning market competitive rates of return on its investment in R&D, moreover, there's no economic disincentive to conducting that sort of R&D in the Navy.

Private utilities are subject to state utility regulators who notoriously meddle, typically to "protect" consumers from rate increases, but usually with the outcome of making plants nonprofitable. A federal Naval Corps of Nuclear Engineering presumably would be outside the scope of state regulation.

Private utilities used cost-plus contracting when building nuclear power plants--with all its notorious problems--because there were serious problems of incomplete information when dealing with large scale, non-standardized plants. Smaller, standardized plants should be amenable to fixed price contracts.

Private parties have a hard time adequately insuring against very low probability but very high magnitude events. Since the taxpayer likely would ultimately be on the hook anyway, why not have the government own the plant and self-insure? And profit from selling electricity?

Another advantage of my proposal is that lots of military bases are brown field sites that would require mega-investments in environmental cleanup before being converted to civilian use. So why not build a nuclear plant there?

So I'd say Obama's half right. Oddly, however, this time I think his problem is that he's leaning too much on the private sector. The Navy knows how to run small nuclear reactors. Small nuclear reactors are the future of the industry. Why not put them together?

*****

Glenn Reynolds has had several relevant posts. #1:

MARK WHITTINGTON: “To paraphrase a line often made by Instapundit’s Glenn Reynolds, they told me that if I voted for John McCain we would see a massive push for nuclear power—and they were right! It seems that President Obama has embraced nuclear energy.”

#2:

WILL COLLIER: When It Comes To Nuclear Power, Companies Should Think Small.

The latter is especially relevant to the discussion here, as Collier argues small scale reactors are cheaper and safer than the traditional mega-monsters.

There's a really interesting article in today's WSJ about NuScale's small modular nuclear reactor plants:

... the same folks who fought nuclear energy tooth and nail are now complaining that it’s too expensive—like saying they’re orphans after killing their parents.

I mention all this now because earlier this month, and almost miraculously, the Nuclear Regulatory Commission approved the design and issued a final safety evaluation report for a Small Modular Reactor, or SMR, by NuScale based in Portland, Ore. NuScale’s design, funded by engineering firm Fluor and the U.S. Energy Department, joins six older federally approved designs. But it’s the first that looks as if it can scale and reduce costs. ...

The NuScale reactor is smaller—only 65 feet tall and 9 feet in diameter, with much installed below grade. It has a really small core, 1/20th the size of larger reactors, and, importantly, it comes with passive safety features. Using buoyancy, water circulates internally without pumps. Motors lift the control rods such that if electricity is lost, gravity drops them back into the core, stopping the reactor. Safety first.

Each SMR can generate 60 megawatts of power, and a dozen can be linked together at one site. California’s recent blackouts were from a shortage of 4,000 megawatts of power, so only six SMR groupings could have solved the problem, carbon free.

That article got me to thinking about a column I wrote for TCS Daily back in 2010 or so. I had to dig it out of the Wayback Machine archives and offer it up here.

Almost since its founding, the Army Corps of Engineers has had a major domestic, peace-time function in civilian civil works projects. So there is a precedent for having the military run such projects.

I got to thinking about that precedent when I read Bradford Plumer's TNR post, which notes that:

Obama wasn't kidding when he gave all those shout-outs to nuclear power in his State of the Union address on Wednesday. According to Bloomberg, Obama's 2011 budget will request $54 billion in loan guarantees for new nuclear reactors—triple the previous amount.

I'm inclined to agree with Andrew Sullivan that "There's no way to tackle our carbon addiction without nuclear energy as part of the solution." But I also appreciate Plumer's observation that "the case against comes from the Union of Concerned Scientists, which argues that big nuclear projects have historically been very risky—prone to delays and cost overruns—and that the default rate on these loans can be quite high, sticking taxpayers with the bill. Instead, says UCS, it'd be better to direct that money toward cheaper, more reliable options for reducing emissions—efficiency or waste-heat capture or even wind power."

I've got a better idea. The WSJ reported in September of last year that:

 

Babcock & Wilcox, a unit of McDermott International, has designed a small 125-megawatt reactor that would be built at its U.S. factories and then delivered to power-plant sites by rail or barge. This would eliminate a bottleneck and the associated higher costs for ultra-heavy forgings that are required for large reactors. Small reactors could be built at a number of domestic heavy-manufacturing sites. The Lynchburg, Va., company has been building small reactors and other key components for Navy ships for decades, at plants in Indiana and Ohio.

Another plus of small reactors: They're designed to be refueled less frequently, reducing the number of refueling outages. Instead of every 18 months to two years, they could go four or five years, reaping a saving from having less down time. Another feature of some reactors is the ability to do more maintenance while plants are running, again reducing idle time.

... critics say that the economics of small plants simply don't work: The licensing costs are so great for nuclear plants, somewhere between $50 million and $100 million per site, and security and construction costs are so high that the economics work only for big plants, with lots of output, so costs can be spread over many kilowatt-hours of electricity.

So here's where my idea comes into play. The Navy already operates dozens of small nuclear reactors in aircraft carriers and submarines, with an outstanding record of safety and reliability. They have an established training program that churns out nuclear-capable officers.

By analogy to the Army Corps of Engineering, we could create a Navy Corps of Nuclear Engineering. It would build and operate dozens of small nuclear power plants around the country. To address security concerns, the first plants would be built on military bases, where the garrison can provide security. Licensing costs would be cut because the government would own and operate the plants.

The proposal should not offend small government sensibilities. Nuclear power is rife with market failures (and government failures). Huge research and development costs associated with traditional large scale nuclear power plants may be beyond the ability of private firms to finance. In addition, we know that private firms tend to underproduce the sort of basic R&D necessary to develop new generations of power plants. But the Navy already spends money to develop new naval reactors, which presumably could be scaled up at reasonable costs. Since the Navy need not worry about earning market competitive rates of return on its investment in R&D, moreover, there's no economic disincentive to conducting that sort of R&D in the Navy.

Private utilities are subject to state utility regulators who notoriously meddle, typically to "protect" consumers from rate increases, but usually with the outcome of making plants nonprofitable. A federal Naval Corps of Nuclear Engineering presumably would be outside the scope of state regulation.

Private utilities used cost-plus contracting when building nuclear power plants--with all its notorious problems--because there were serious problems of incomplete information when dealing with large scale, non-standardized plants. Smaller, standardized plants should be amenable to fixed price contracts.

Private parties have a hard time adequately insuring against very low probability but very high magnitude events. Since the taxpayer likely would ultimately be on the hook anyway, why not have the government own the plant and self-insure? And profit from selling electricity?

Another advantage of my proposal is that lots of military bases are brown field sites that would require mega-investments in environmental cleanup before being converted to civilian use. So why not build a nuclear plant there?

So I'd say Obama's half right. Oddly, however, this time I think his problem is that he's leaning too much on the private sector. The Navy knows how to run small nuclear reactors. Small nuclear reactors are the future of the industry. Why not put them together?

*****

Glenn Reynolds has had several relevant posts. #1:

MARK WHITTINGTON: “To paraphrase a line often made by Instapundit’s Glenn Reynolds, they told me that if I voted for John McCain we would see a massive push for nuclear power—and they were right! It seems that President Obama has embraced nuclear energy.”

#2:

WILL COLLIER: When It Comes To Nuclear Power, Companies Should Think Small.

The latter is especially relevant to the discussion here, as Collier argues small scale reactors are cheaper and safer than the traditional mega-monsters.

Dodge v. Ford Motor Co. and Shareholder Ratification

A friend sent along this question via email:

Would shareholder ratification/approval immunize the dividend policy in Dodge v. Ford (assuming Ford's votes don't count, and the Dodge brothers can't otherwise control the outcome)?  The reason I don't immediately say "yes" is because I wonder about the extent to which the dividend policy can be characterized as waste or bad faith -- thus potentially limiting the effect of SH approval/ratification.

If the facts of Dodge[1] came up today, my analysis would start with the premise that Henry Ford was the controlling shareholder of FMC. In Kahn v. M & F Worldwide Corp.,[2]  the Delaware Supreme Court expanded the protections potentially available to controlling shareholders. It held that a freeze-out merger would be reviewed under the business judgment rule rather than the fairness standard if six conditions are met: (1) the controlling stockholder conditions the transaction on the approval of both a special committee and the majority of the minority stockholders, (2) the special committee is independent, (3) the special committee is empowered to select its own advisors and to say no definitively, (4) the special committee meets its duty of care in negotiating a fair price, (5) the vote of the minority stockholders is informed, and (6) there is no coercion of the minority stockholders. A vote by the majority of the minority shareholders, standing alone, thus is not enough to invoke the business judgment rule as the standard of review.

To be sure, Dodge involved a closely held corporation not a public company. But that is not a problem, because MFW has been applied to transactions involving  privately held companies.[3]

Likewise, Dodge did not involve a freezeout merger. Again, however, this is not a problem, because the expanded protections offered by MFW are not limited to freeze-out mergers, but have been extended to other types of controlling shareholder transactions. In Tornetta v. Musk,[4]  for example, the Delaware Chancery Court provided new guidance on how to structure conflict of interest transactions to which a corporation’s controlling shareholder is a party. The case involved a shareholder lawsuit challenging an incentive compensation plan granted to Tesla, Inc.’s CEO, Elon Musk.

Are we sure MFW applies?

Henry Ford might argue that MFW is inapplicable because he did not personally benefit from the transaction. Accordingly, he would argue, that the decision to cancel the special dividends  would not trigger entire fairness review. Because MFW is intended to shift the standard of review from entire fairness to the business judgment rule, it is inapplicable. This argument would find some support in the older Sinclair Oil v. Levien[5]decision. It held that controlling shareholders owe a fiduciary duty to the company’s minority shareholders. But what standard of review should a court apply to such disputes? The Delaware Supreme Court identified two standards potentially applicable in such situations: the business judgment rule and the intrinsic fairness rule. Under the business judgment rule, the directors of Sinven get the benefit of a rebuttable presumption of good faith. Under the intrinsic fairness test, the burden of proof is on the directors to show, subject to close scrutiny, that the transactions were objectively fair to Sinven.

Under Sinclair Oil, a court will apply the intrinsic fairness standard, as opposed to the business judgment rule, when the parent has received a benefit “to the exclusion and at the expense of the subsidiary.” In other words, the more exacting intrinsic fairness standard comes into play only when the parent is on both sides of the transaction and, moreover, used its position to extract non-pro rata benefits from a transaction to the minority shareholders’ detriment.

If the transaction is subject to business judgment rule review from the outset, shareholder ratification would eliminate any duty of care-based claims.[6]

Assume MFW is not limited to conflicted interest transactions

As I read the Tornetta opinion, there is a strong argument that MFW is not limited to conflicted interest transactions.

In his opinion, Vice Chancellor Joseph Slights acknowledged that Delaware courts normally approach boards’ executive compensation decisions with a high degree of deference. Critically, however, Musk is not just Tesla’s CEO but also its controlling shareholder.[7] A controlling shareholder has been analogized to the proverbial 800-pound gorilla,[8] which gives rise to “an obvious fear that even putatively independent directors may owe or feel a more-than-wholesome allegiance to the interests of the controller, rather than to the corporation and its public stockholders.”[9]

In Tornetta, the Tesla defendants argued that MFW was irrelevant to the facts of this case:

They rely heavily on a “statutory rubric” argument, claiming MFW’s dual protections, devised in the context of a squeeze-out merger, mimic the approvals required by 8 Del C. § 251 but have no practical application to transactions where our law does not mandate approval at both the board and stockholder levels. . . . I do agree with Defendants that nothing in MFW or its progeny would suggest the Supreme Court intended to extend the holding to other transactions involving controlling stockholders.

Vice Chancellor Slights, however, observed that the risk of coercion is just as present when a conflicted controller enters into a compensation arrangement as when it proposes a freezeout merger:

Indeed, in the CEO compensation context, the minority knows full well the CEO is staying with the company whether vel non his compensation plan is approved. As our Supreme Court observed in Tremont II:

[I]n a transaction such as the one considered . . . the controlling shareholder will continue to dominate the company regardless of the outcome of the transaction. The risk is thus created that those who pass upon the propriety of the transaction might perceive that disapproval may result in retaliation by the controlling shareholder.

These words apply with equal force to the compensation setting.

Accordingly, in order for a conflicted controller transaction to be reviewed under the business judgment rule rather than entire fairness, the transaction must satisfy all of MFW’s requirements.

Because the Tesla board had not satisfied all of those conditions, VC Slights invoked the older Kahn v. Lynch rule,[10] which explained that in controlling shareholder transactions:

The initial burden of establishing entire fairness rests upon the party who stands on both sides of the transaction. However, an approval of the transaction by an independent committee of directors or an informed majority of minority shareholders shifts the burden of proof on the issue of fairness from the controlling or dominating shareholder to the challenging shareholder-plaintiff.

Likewise, in Dodge, if the board did not comply with all of the MFW conditions, the burden would have shifted to the Dodge brothers to show that the transaction was unfair. Because “an entire fairness analysis is the only proper standard of judicial review,” however, shareholder ratification—absent full compliance with MFW would not invoke the business judgment rule.

Assume MFW applies and was fully complied with

If we assume that MFW applies and that FMC’s board complied fully with all six requirements. What happens next?

If they did, then a version of the business judgment rule applies under which the only remaining claim is one for waste. See In re Books-A-Million, Inc. S’holders Litig., 2016 WL 5874974, at *1 (Del. Ch. Oct. 10, 2016), aff’d, 164 A.3d 56 (Del. 2017) (TABLE). The waste exception is more theoretical than real, because to state a claim for waste, the terms of the transaction must be so extreme “that no rational person acting in good faith could have thought the [transaction] was fair to the minority.” In re MFW S’holders Litig. (MFW Chancery), 67 A.3d 496, 500 (Del. Ch. 2013), aff’d sub nom. MFW, 88 A.3d at 635. At that point in the analysis, two groups of rational people—the committee and the minority stockholders—would have approved the transaction. It is “logically difficult to conceptualize how a plaintiff can ultimately prove a waste or gift claim in the face of a decision by fully informed, uncoerced, independent stockholders to ratify the transaction.” Harbor Fin. P’rs v. Huizenga, 751 A.2d 879, 889 (Del. Ch. 1999). The resulting version of the business judgment rule is thus rightfully described as “irrebuttable.”[11]

I'm not sure how you would attack a decision to cancel a dividend as waste.

Video of the Zoom Conference Should Boards Have Duties to Stakeholders? Lessons from the COVID-19 Crisis

Delaware Chancery Court Holds Failure to Disclose "Intrinsic Value" Precludes Corwin Defense

A post from Tyler O'Connell of MorrisJames informs us that:

In In re USG Corp. S’holder Litig., 2020 WL 5126671 (Del. Ch. Aug. 31, 2020), the Court of Chancery granted the director-defendants’ motions to dismiss post-closing money damages claims arising out of the sale of USG Corporation (“USG”) for less than what USG’s directors allegedly thought was its intrinsic value. Although the failure to disclose such “intrinsic value” prevented dismissal under Corwin v. KKR Financial Holdings, LLC, 125 A.3d 304 (Del. 2015), Vice Chancellor Sam Glasscock III held that, in the circumstances, that omission and the directors’ approval of the sale did not suffice to plead a breach of the directors’ fiduciary duty of loyalty.  ...

The Court reasoned that, as recent Delaware appraisal cases have suggested, “intrinsic value” or “fair value” are “nebulous, even illusory, concepts.” With a “but see” cite to Delaware’s appraisal statute, the Court reasoned that “[b]elief in any particular intrinsic value, by any being less than an omniscient god, is necessarily a belief that is subjective in nature.” The Court held, however, that “because the Proxy Statement disclosed that the Board held a view of intrinsic value and frequently referenced such a view during its disclosures about the sales process, USG’s stockholders were entitled to know the Board’s opinion of USG’s intrinsic value, even if it was unachievable due to market forces and Knauf’s threats to launch a hostile takeover.” 

An asset (including a business) has no intrinsic value, of course. Instead, it is worth only what the buyer with the highest reservation price is willing to pay. The Delaware courts have recognized this. But the USG board apparently doesn't understand basic finance and they paid the price for being that dumb.

Professors of a certain age struggling with remote teaching

A dear friend sent this along. I don't know where he got it, so can't give credit:

Lowell Milken Institute Program on Should Boards Have Duties to Stakeholders? Lessons from the COVID-19 Crisis

The Lowell Milken Institute for Business Law and Policy at the UCLA School of Law is sponsoring a Zoom stayconference on CSR during the pandemic today. I'll be speaking, along with David A. Katz, who is a partner at Wachtell, Lipton, Rosen & Katz, and Professor Jeffrey M. Lipshaw of the Suffolk University Law School. Regular readers will recall that Jeff and I have dueling papers on the Business Roundtable's August 2019 statement on corporate purpose:

Bainbridge, Making Sense of the Business Roundtable’s Reversal on Corporate Purpose

Lipshaw, The False Dichotomy of Corporate Governance Platitudes

The moderators (my colleagues Iman Anabtawi and Jim Park) circulated a list of questions, which I'm reposting below along with notes I've prepared to use in answering them:

Question: Let’s begin by having each of the panelists describe their position on the question of whether boards should owe duties to corporate stakeholders other than shareholders.

• There is no such duty under current law and the law should not create one.
• You don’t have to take my word for it. Former Delaware Chief Justice Leo Strine has always been very clear this question: "within the limits of their discretion, directors must make stockholder welfare their sole end, and that other interests may be taken into consideration only as a means of promoting stockholder welfare."[1]

Question: The Business Roundtable issued a statement last year expressing “a fundamental commitment” to corporate stakeholders. Was the corporate response to the pandemic consistent with that statement?

• The BRT statement is just woke-washing. It signaled the CEOs’ advocacy for stakeholders but didn’t change much.
• Lucian Bebchuk and Roberto Tallarita found that the vast majority of signatory CEOs had not gotten board approval to sign it. “Even “imperial” CEOs tend to push major decisions through the board rather than disregard it. … The most plausible explanation for the lack of board approval is that CEOs didn’t regard the statement as a commitment to make a major change in how their companies treat stakeholders.”
• There’s evidence that the CEOs in fact do not walk the walk.
  • Anecdotally, WSJ reported in late August that: “A day after Salesforce.com posted record quarterly sales, the business-software company notified its 54,000-person workforce that 1,000 would lose their jobs later this year.”
    • I don't think even Scrooge would have told his employees that in a few months down the road 2% of them would be fired, leaving them to twist slowly in the wind for months while worrying whether they'll be among those who get fired.
    • What makes all of this especially pertinent is that Saleforce CEOMarc Benioff is one of the leading social justice warrior CEOs, constantly bragging about what a great human being he is.
  • There’s a study by a pair of economists, entitled “Do the Socially Responsible Walk the Talk?,” which found “that Business Roundtable signatories exhibit worse records with respect to labor and the environment than their peers.”

Question: Recently a group of 322 long-term institutional investors with $9.2 trillion in assets under management issued an “Investor Statement on Coronavirus Response” asking corporations to take a variety of steps including providing paid leave to employees, taking measures to maintain employment and exhibiting financial prudence by suspending share buybacks. If shareholders themselves are pushing for greater attention to employee interests, shouldn’t boards respond ?

• The question is whether you think those investors will change their behavior or whether you think this is just more woke washing. I believe that the emphasis on ESG investing that we’re seeing from BlackRock, Vanguard, and State Street is mostly advertising. There is survey data that millennials apparently prefer to work for and purchase from companies that are perceived as socially and environmentally responsible. Accordingly, there is an increasingly widely held view in the investment community that to attract Millennial and Generation Z customers, companies must project an image as social justice activists.
• But none of the Big Three have lived up to their commitments. They devote relatively few personnel and resources to monitoring ESG issues at their portfolio companies. Despite the fact that the Big Three collectively own enough shares to determine the outcome of the vote on pro-ESG proposals made by other shareholders,  they rarely vote in favor of such proposals.

Question: Our health care system was initially overwhelmed during the pandemic because sufficient supplies had not been stockpiled and much of our manufacturing is now offshore. Is this failure evidence that a focus on increasing shareholder wealth is problematic from a public policy perspective?

• It’s not a business’ responsibility to anticipate unknown and unpredictable events that will widely affect society.
  • What incentive does a for-profit business have to invest in a drug that may never be needed?
• It was a series of failures of government policy over a two-decade period:
  • We’ve known about zoonotic diseases at least since the AIDS epidemic began. Ebola looked like a nightmare waiting to happen.
  • There have been many proposals to prepare for pandemics. But the proposals were either never funded, underfunded, or defunded.

Question: In Marchand v. Barnhill, the Delaware Supreme Court held that the failure of the board of Blue Bell Creameries to adopt a monitoring and reporting system that would ensure it was informed about food safety issues could support aCaremark It observed that Blue Bell could “only thrive if its consumers enjoyed its product and were confident that its products were safe to eat.” Does this case recognize that the board must be attentive to the interests of stakeholders such as consumers?

• Marchand was decided by Chief Justice Leo Strine. Strine has explained that “a clear-eyed look at the law of corporations in Delaware reveals that, within the limits of their discretion, directors must make stockholder welfare their sole end, and that other interests may be taken into consideration only as a means of promoting stockholder welfare.”
• The cause of action was a derivative shareholder suit brought to enforce the duty of loyalty owed shareholders. The claim is based on the losses the shareholders suffered as a result of the product recall, shutdown of production, lawsuits, and a dilutive private equity offering necessary to keep the company afloat.

Question: How should the board consider situations where the interests of stakeholders conflict? For example, during the pandemic, keeping businesses operating may benefit consumers while risking the health of employees?

• Obviously, one size will not fit all.
• Boards need discretion to decide what is in the company’s best interest in these unusual circumstances.
• The business judgment rule exists precisely so as to ensure that directors can exercise that discretion without fear of liability.
• What directors should not do is to make tradeoffs between the interests of shareholders and stakeholders.
• The core problem of corporate social responsibility is that directors who are responsible to everyone are responsible to no one.

Leo Strine on Milton Friedman on the Social Responsibility of Business

We recently celebrated the 50th anniversary of the publication by The NY Times of Nobel economics laureate Milton Friedman essay The Social Responsibility of Business Is to Increase Its Profits.

Corporate social responsibility raises two questions that often get bollixed up even 50 years later:

1. Do corporations have a social responsibility, as a matter of law.
2. Should corporations be socially responsible?

This is, of course, an example of the classic is/ought dichotomy. (Not, as you may have thought, the is-ought problem.)

Former Delaware Chief Justice Leo Strine has always been very clear on the "is" question: "Despite attempts to muddy the doctrinal waters, a clear-eyed look at the law of corporations in Delaware reveals that, within the limits of their discretion, directors must make stockholder welfare their sole end, and that other interests may be taken into consideration only as a means of promoting stockholder welfare." Leo E. Strine, Jr., The Dangers of Denial: The Need for A Clear-Eyed Understanding of the Power and Accountability Structure Established by the Delaware General Corporation Law, 50 Wake Forest L. Rev. 761, 768 (2015).

So some might be surprised by his recent NY Times op-ed (with Joey Zwillinger, who is the co-founder and co-C.E.O. of Allbirds), in which Strine has some very harsh words for Friedman and his seminal essay. (I'm going to be going back and forth between the Wake Forest and NYT articles. To avoid confusion, I am marking WFLR quotes in blue and the NYT quotes in red.)

Strine's oped strikes a left-of-center populist note:

In the past 50 years, instead of gains for stockholders and top management tracking gains for workers — as characterized by the period when Mr. Friedman wrote — the returns of our capitalist system have become skewed toward the haves.

(As I have written elsewhere, of course, this is a concern shared by right-of-center populists. See my essay Conservative Critiques of Capitalism.)

Strine also takes a left-of-center shot at the libertarian views of espoused by Friedman and his allies:

Mr. Friedman sought to weaken the rules of the game by opposing basic civil rights legislation, unions, the minimum wage and other measures that protected workers, Black people, and the environment.

Of course, some folks would call that a 20th Century version of classical liberalism, which advocates a limited role for government so as to promote maximal freedom and responsibility for everyone. But let's not get bogged down with who says what about whom.

Instead, I want to make a couple of points. First, although Strine's op-ed does not suggest a change in his views on the "is" question, it does suggest a shift in his views on the "ought question" In his earlier Wake Forest Law review article, Strine wrote that:

I am more than moderately sympathetic with those who argue that for-profit corporations should behave lawfully, responsibly, and ethically.

... It is more productive to take the legal rules and corporate power structure as it is, and to advance proposals that make sure that corporations operate in a way that encourages more responsible behavior and that maximizes long-term welfare, within the bounds of that structure.

As I have always read that passage, what Strine wanted was for the legislature to set regulatory bounds within which the corporation operates. Instead of asking directors to be socially responsible, he simply wanted to ask them to obey the law--albeit a much more aggressively regulatory body of law than he believes currently exists.

Now, however, it appears Strine has changed his mind and wants boards "embrace an affirmative duty to stakeholders and society." 

By committing to goals of responsible citizenship, companies allow stakeholders, institutional investors and the public to hold them accountable to their inclusive ideals. In doing so, corporate leaders will also set an example that institutional investors should be required to follow in their own investing and voting policies.

This is pretty surprising. Let's go back to the Wake Forest article:

Under the current legal rules and power structures within corporate law, it is naïve to expect that corporations will not externalize costs when they can. It is naïve to think that they will treat workers the way we would want to be treated. It is naïve to think that corporations will not be tempted to sacrifice long-term value maximizing investments when powerful institutional investors prefer short-term corporate finance gimmicks. It is naïve to think that, over time, corporations will not tend to push against the boundaries of whatever limits the law sets, when mobilized capital focused on short-term returns is the only constituency with real power over who manages the corporations. And it is naïve to think that institutional investors themselves will behave differently if action is not taken to address the incentives that cause their interests to diverge from those people whose funds they invest.

One wonders what has changed so that it is no longer naive to "expect that corporations will not externalize costs when they can" and so on? One also wonders how Strine squares his view of what boards ought to do with his view of what the law allows boards to do. Back to WFLR: "Dodge v. Ford and eBay are hornbook law because they make clear that if a fiduciary admits that he is treating an interest other than stockholder wealth as an end in itself, rather than an instrument to stockholder wealth, he is committing a breach of fiduciary duty." 

How do we square that blunt statement with Strine's current embrace of "a stakeholder-centric governance model"? Does he think directors can do the latter without breaching their fiduciary duties? If so, how?

I think Strine's evolution (assuming he is evolving--I would LOVE for him to do a guest post in reply to my comments, but I am not holding my breath) is being driven by his visceral loathing of the Citizens United decision. Strine has written 8 law review articles (by my count) in which Citizens United comes up and none of them have anything good to say about that decision. In particular, he has argued that Citizens United unleaded a flood of corporate money into politics (of course, it also unleashed a food of union money), which has had deleterious effects:

Because corporate wealth far exceeds that held directly by human beings, if corporations are able to act directly to influence who is elected to office, the laws and regulations in our society will increasingly tend to tolerate the imposition of greater externalities, because they will be enacted by politicians who have been elected in an expensive process in which money matters, and in which securing the support of nonhuman corporate money with a monocular focus on profit will be important to electoral competitiveness.

Leo E. Strine, Jr. & Nicholas Walter, Conservative Collision Course?: The Tension Between Conservative Corporate Law Theory and Citizens United, 100 Cornell L. Rev. 335, 389 (2015).

Although Citizens United goes unnamed in the NYT op-ed, we see the same concerns:

Business leaders must ... stop using corporate funds to distort our nation’s political process. That means ending corporate political spending without shareholder consent, and not contributing to dark money or political party committees. It also means ensuring that spending plans recommended to shareholders only allow contributions to candidates whose views on issues like racial inequality, climate change and fairness to workers are consistent with the corporation’s stated values.

In response, I refer you to my essay Corporate Social Responsibility in the Night Watchman State: A Comment on Strine & Walker, from which I'll draw a few quick points. 

As I have observed previously, “in the 2008 election cycle, the total amount spent on all political campaigns by all actors was, according to OpenSecrets.org, $5,285,680,883.” To put that figure in context, it is less than the amount Procter & Gamble alone spent on advertising in 2008. “As a society, we spend much more money selling stuff to wipe our bottoms with than we do deciding who should run the most powerful country in the world,” which perhaps suggests that the amounts at issue are not as unreasonable as Strine and Walter seem to think.

Instead, the more serious objection posed by Strine and Walter goes to the core of their argument; namely, that corporate political spending is deployed to erode regulations necessary to constrain the externalities inherent in corporate business activity… In fact, however, much corporate political spending is likely to be defensive. As The Economist recently observed:

When America was founded, there were only three specified federal crimes-- treason, counterfeiting and piracy. Now there are too many to count. In the most recent estimate, in the early 1990s, a law professor reckoned there were perhaps 300,000 regulatory statutes carrying criminal penalties--a number that can only have grown since then. For financial firms especially, there are now so many laws, and they are so complex (witness the thousands of pages of new rules resulting from the Dodd-Frank reforms), that enforcing them is becoming discretionary.

In this environment, it seems plausible that much corporate political spending goes to stave off additional regulation rather than to repealing existing laws. In the absence of a showing that the benefits of foregone regulations exceed their costs, there is no reason to assume that corporate political spending increases the extent to which corporations can externalize costs. Strine and Walter offer no convincing evidence that corporate political spending in fact has the effect they posit.

Strine and Walter also fail to take into account the likelihood that much corporate political spending will simply cancel out spending by other corporations. It seems intuitively obvious that specific regulations rarely advantage all businesses. If so, spending by opponents of particular laws or rules likely will be countered by those who benefit from them. Accordingly, Citizens United’s alleged anti-regulatory effect will be self-minimizing.

In addition, Strine and Walter fail to explore the implications of the fact that large corporations dominate corporate campaign spending. First, spending by such corporations is highly constrained by reputational considerations due to “the seriousness with which large corporations treat any potential threats to their goodwill arising from ... negative publicity” generated by unpopular contributions. Second, and more important, while Strine and Walter assume corporations use political spending exclusively to externalize the negative costs of their activities, the reality is that large corporations frequently support regulations that force corporations to internalize social costs. They do so because such regulation can create significant costs for smaller competitors and barriers to entry for startups. Because regulatory costs frequently do not scale, they are often borne disproportionately by small businesses and startups. This observation is not offered as a defense of corporate political spending, but solely as a critique of Strine and Walter’s assumption that corporate political spending is inevitably anti-regulation.

I go on to explore reasons why, even if Strine and Walker were right, I would still oppose corporate social responsibility. But that’s a story for another day (and, in any event, has been oft explored in these pages.)

Guest Post by JW Verrett: Forensic Accounting, Corporate Law, The CIA, & The Hunt for Aldrich Ames

J.W. Verret here.

I have recently embarked on a career shift to focus study on accounting, specifically forensic accounting, and how it relates to the core issues in corporate, securities and banking law that have previously been the focus of my scholarship.  That has included getting certified as a CPA and as a CFF (certification in financial forensics).

Along the way I’ve learned a ton about using financial accounting and forensic accounting techniques to catch bad guys.  Forensic accounting is a core tool for financial fraud investigations under the securities laws (10b-5, FCPA, etc.) and banking law.  It is also a core tool used by Delaware companies to meet their Caremark oversight obligations as forensic accountants design internal controls to prevent compliance violations and utilize forensic accounting to catch violators. 

Before digging into issues at the intersection of forensic accounting and corp/securities law, I thought I would introduce readers to forensic accounting through the story of the FBI and CIA’s efforts to catch Aldrich Ames.  This spy hunt was only successful because of evidence put together by a forensic accounting team conducting a net worth analysis, a common tool of forensic accountants which shows that changes in a subject’s net worth cannot be sufficiently explained by their legitimate sources of income.

Aldrich Ames sold information to the KGB about the identity of our intelligence assets within the USSR, and at the time of his arrest he was responsible for the greatest intelligence leak in American history.  He identified at least ten active agents for the US, some of whom were later executed by the Soviets as a result of his tips.

A classic tool used by forensic accountants to guide investigations is the “Fraud Triangle.”  Three factors that are nearly universal in frauds studied in an early survey of embezzlers by criminologist Donald Kressey.  Its components are pressure, opportunity, and rationalization.  In Ames’s case, pressure for money came initially from an expensive divorce and then from a lavish spending lifestyle he shared with a new wife (when she was arrested, investigators found 60 purses and 500 pairs of shoes among other items). 

Opportunity (a prong that usually reflects poorly on the organization) was here created by his ability to walk out of headquarters with armloads of documents to give the Soviets (since remedied by the agency).  Opportunity also came a result of his legitimate cover for meeting with handlers, which was often that he was attempting to recruit them in reports he would file with the agency about the meetings. 

Rationalization in his case was a personal grudge over being passed over for promotion because of the impact of his drinking on his work.  He would frequently return from long lunches unable to function.

The Fraud Triangle doesn’t only help to explain an embezzler, financial fraud, or in this case spy’s behavior after being caught.  It informs key aspects of an internal investigation, from the email keywords used in email searches to the questions asked during internal interviews as a fraud investigator attempts to track down the perpetrator.

The fascinating details of the investigation of Aldrich Ames can be found in a Senate Intelligence Committee Report, available here.

The first 40 pages outline an intelligence disaster, a ten-year period during which Ames lived a dangerous double life.  Some of his methods utilized sophisticated tradecraft, code names and the famous “dead-drop” mailbox where he would leave markings to indicate he left intelligence in one of several KGB dead drop locations for pickup.

Near the end of the story, the FBI and the CIA know they have a mole on their hands and have seen entire intelligence networks overseas rolled up by the KGB (and later the FSB) overnight.  The first break they have in the case is a tip that Ames cover for his excessive spending, that he inherited the money from his wife and her family, was bogus.  Subsequent forensic analysis of his spending showed him spending cash amounts of nearly $1.4 million and credit card billings of another $500,000 between 1985 and 1993.  During that 8 year time-frame his aggregate CIA take home pay was $336,000.

Ames covered his tracks in part through the classic money laundering techniques of placement, layering, and integration.  Placement takes illicit cash and enters it into the financial system.  He would make structured cash deposits just below the SARs reporting threshold at which banks must report them to the Treasury Department of $10,000.  He would then move the money overseas between various accounts, and then wire it back to the US to make it appear that the money came from his wife’s family.

One challenge CIA officials faced in investigating Ames was that, despite their tips concerning his strangely lavish spending, they did not have the authority themselves to obtain information from banks where he may have done business.  And, at least early in the investigation, the CIA wasn’t eager to expose their dirty laundry to the FBI to pursue a FISA warrant.

From the initial tip about Ames’ odd spending, until his arrest, Ames was able to continue giving away secrets for four years!  At one point a CIA officer went to Bogota to determine whether Ames’ wife was the source of his money.  His was able to vaguely confirm that her family was successful, and had donated to a local sports stadium for naming rights, but specific details like Ames’ assertion about a windfall of money from his mother-in-law’s insurance policy were never nailed down.

It took some time for the FBI to gain access to his bank accounts to review the cash transactions.  Once they did, the investigation quickly focused on him.  One piece of smoking gun evidence in the case was the fact that roughly $9,000 cash deposits, in amounts at multiple banks appearing to be structuring transactions designed to stay below the suspicious activity reporting (SARs) threshold, seemed to take place just after incidents in which Ames was documented meeting with Soviet officials.  Some of those meetings were documented by Ames as his efforts to “recruit” potential agents who were in fact his handlers.  Some of those meetings were documented by FBI agents tailing the Soviet officials (who recorded Ames’ meeting with them) but suspiciously not documented by Ames in violation of procedure.

Spy stories are fun.  Similar fact patterns play out in corporate internal investigations every day as corporations seek to maintain compliance with the federal securities and banking laws and fulfill their oversight duties under Caremark.  The Fraud Triangle and other techniques of forensic accounting utilized in the mole hunt for Aldrich Ames are also used to design internal controls and to conduct investigations of suspected fraud in corporations.  As a fan of cold war era spy fiction (I’ve probably read Le Carre’s George Smiley series a half dozen times) I think that is pretty cool.

Three nights of Ridge Zinfandel

We had Ridge Vineyard reds every night this weekend (in the PB.com household, Thursdays count as a weekend night).

Up first with Hello Fresh's Brown Sugar Bourbon Pork Chops with Apple Pan Sauce, Scallion Mashed Potatoes & Roasted Green Beans was Ridge Wild Cattle Creek Zinfandel (Dry Creek Valley) 2017. Deep purple-ruby. No sediment to speak of. Not a vin de garde, but offering very enjoyable near-term drinking. Cherry cola. Blackberry and raspberry. Plenty of American oak. On the light side for Ridge. Grade: B+

Friday night was a Caesar salad with skirt steak and air-fried French fries. We drank a Ridge Geyserville (Alexander Valley) 2012. Mature but still in its prime. Would have aged well for a while, but it gave a lot of enjoyment now. Enough sediment to justify decanting. Rich and savory bouquet of dried red and black fruits. Well-balanced. Improved with time in the decanter. A big wine. Cherry, blackberry, and discernible American oak. Grade: A-

Saturday night was quail stuffed with jambalaya (with more jambalaya on the side). We had it with a Ridge Lytton Springs (Dry Creek Valley) 2012. It was very interesting to compare it to our notes of the Geyserville from the same vintage. Both Helen and I strongly preferred the Lytton Springs, which was unusual on Helen's part since she is usually prefers Geyserville (I'm just the opposite).

Still a deep ruby-purple, despite having thrown enough sediment to justify decanting. Rich bouquet suggesting blackberries and plums. Rich and complex on the palate. Blackberry. Black cherry. Prunes. Tobacco. Long finish. Probably would age well for a few more years, but providing plenty of enjoyment now. Grade: A-/A

Three great wines.

Disgraced former Theranos CEO Elizabeth Holmes wants to plead mental disease or defect as a defense to the securities fraud charges against her

Reuters reports:

U.S. District Judge Edward Davila in San Jose, California overruled defense objections to letting a psychologist and psychiatrist chosen by the government examine the 36-year-old Holmes for 14 hours over two days, and having the examinations recorded on video.

Davila authorized the examinations after Holmes’ lawyers said they intended to introduce expert evidence from a clinical psychologist “relating to a mental disease or defect or any other mental condition of the defendant bearing on the issue of guilt.”

The defense expert, Mindy Mechanic, is a California State University at Fullerton professor specializing in psychosocial consequences of violence, trauma and victimization, including violence against women, and often testifies in cases involving interpersonal violence, according to her university biography.

I've been in this business for a long time and this is the first time I've heard of the mental disease or defect defense being used in a securities fraud case. A quick Westlaw search turned up about 3 or 4 similar cases, with the opinions mainly dealing with whether a defendant was competent to stand trial. In contrast, It appears from a CNN report that Holmes wants to plead mental disease or defect as a substantive defense to the charges:

This week, Judge Edward Davila of the US District Court for the Northern District of California granted federal prosecutors the ability to have Holmes examined by two experts -- a psychologist and a psychiatrist -- over two consecutive days and for no more than 14 hours combined. The ruling comes after Holmes' defense team previously notified the government of intent to "introduce expert evidence relating to a mental disease or defect or any other mental condition of the defendant bearing on ... the issue of guilt," according to the filing.

I couldn't find any precedent indicating that the defense would play out differently in a securities fraud case than it would in any other criminal case. 

The Ninth Circuit has held that the following jury instruction on the defense was proper:

A defendant is insane if, but only if, at the time of the crime charged,

1. The defendant had a severe mental disease or defect; and
2. As a result, the defendant was unable to appreciate the nature and quality or the wrongfulness of his acts.

The defendant must prove insanity at the time by clear and convincing evidence—that is, that it is highly probable that the defendant was insane.

U.S. v. Elliott, 91 F.3d 156 (9th Cir. 1996).

It's somewhat hard to predict how things will play out, especially because the court's order is redacted with respect to the scope of Dr. Mechanic's proposed testimony.

At a high level, the testimony would cover [redacted], all during the period of the alleged conspiracy. ...

Mechanic does not propose merely to speak “generally” about “the effects of a particular condition,” ... rather, she intends to offer an opinion as to whether Defendant Holmes [redacted]

UNITED STATES OF AMERICA, Pl., v. ELIZABETH A. HOLMES, Def.., 18-CR-00258-EJD-1, 2020 WL 5414786, at *3 (N.D. Cal. Sept. 9, 2020).

I'll be following this case with interest.

Were Easterbrook and Fischel right that target company boards should remain passive in the face of a hostile takeover bid? A comment on Sharfman and Moore. Part 4

In Part I of this essay, I discussed a new article by Bernard Sharfman and Marc Moore, in which they propose reviving the passivity thesis, which argued that target boards faced with a hostile takeover offer should be passive.

In Part II of this essay, I discussed my article, Unocal at 20: Director Primacy in Corporate Takeovers,[1] in which I explained why I disagree with the passivity thesis. My analysis grew directly out of my director primacy model of corporate governance. Because I still think a board-centric approach to corporate governance is appropriate, even in the context of a hostile takeover bid, let me summarize my argument here. I encourage you to go read the whole thing, however.

In Part III, I discussed the final and perhaps most important argument for treating negotiated and hostile acquisitions differently with respect to the scope of the target board’s authority, which rests on the conflicted interests inherent in corporate takeovers.

In this Part, I defend Delaware's approach to takeovers against one aspect of Sharfman & Moore's passivity thesis.

In their discussion of the UK system, which adopts a variant of the passivity thesis, and which they support, Sharfman and Moore point out that (at 32):

Notably, the board passivity rule is an effect- rather than intention-based doctrine, which enables the United Kingdom’s non-judicial Takeover Panel to enforce the rule against target directors and other relevant parties in an administratively straightforward manner, unencumbered by the vexing questions of factual inference and fiduciary duty conformance that typically confront U.S. trial and chancery courts.

In contrast, I think Delaware’s motive-based analysis gets it exactly right.

In its takeover jurisprudence, Delaware has balanced the competing claims of authority and accountability by varying the standard of review according to the likelihood that the actions of the board or managers will be tainted by conflicted interests in a particular transactional setting and the likelihood that nonlegal forces can effectively constrain those conflicted interests in that setting. In other words, the Delaware cases suggest that motive is the key issue. As former Delaware Chancellor Allen explained in the closely related context of management buyout transactions: “The court’s own implicit evaluation of the integrity of the . . . process marks that process as deserving respect or condemns it to be ignored.” Assuming that a special committee of independent directors would be appointed to consider the proposed transaction, Allen went on to explain: “When a special committee’s process is perceived as reflecting a good faith, informed attempt  to approximate aggressive, arms-length bargaining, it will be accorded substantial importance by the court. When, on the other hand, it appears as artifice, ruse or charade, or when the board unduly limits the committee or when the committee fails to correctly perceive its mission—then one can expect that its decision will be accorded no respect.”[1] Our claim is the same is true with respect to board resistance to unsolicited tender offers. If the conflict of interest inherent in such resistance has matured into actual self-dealing, the court will invalidate the defensive tactics. If the board acted from proper motives, even if mistakenly, however, the court will leave the defenses in place.

Former Delaware supreme court Justice Moore argued, for example, that his court’s “decisions represent a case-by-case analysis of some difficult and compelling problems.”[2] He later elaborated:

We did not approach [takeover] cases with the question of whether to allow the corporation to continue in its present form or to permit someone else to acquire the company. . . . [T]he question before the Court was whether the directors acted properly in accepting or rejecting the competing offers. . . . As long as the directors adhered to their fiduciary duties, it would have been most inappropriate for any court to intrude upon a board’s business decision. No court has a role in disciplining directors for the proper exercise of business judgment, even if it turns out to be wrong.[3]

Former Delaware Chancellor Allen made much the same point in RJR Nabisco, where he indicated that the basic question is whether the board acted with due care and in good faith:

Surely the board may not use its power to exercise judgment in [an auction of control] as a sham or pretext to prefer one bidder for inappropriate reasons. . . . But the board of directors continues, in the auction setting as in others, to bear the burden imposed and exercise the power conferred by Section 141(a). Assuming it does exercise a business judgment, in good faith and advisedly, concerning the management of the auction process, it has, in my opinion, satisfied its duty.[4]

A federal court similarly described the Unocal standard as asking “whether a fully informed, wholly disinterested, reasonably courageous director would dissent from the board’s act in any material part.”[5]Motive is the consistent theme throughout these summations of Delaware law.

In light of Sharfman and Moore’s description of Delaware law as not being administratively straightforward and being encumbered by vexing questions, they presumably would agree with those who argue that the difficulty of distinguishing between proper and improper motives is so great in this context that courts should simply eschew a motive-based analysis.

Granted, motive analysis is always difficult, but in every other conflicted interest context the board’s authority to act depends upon the validity of the directors’ mo­tives.[6] Unless we are to accept the passivity model and strip the board of decision-making authority in the takeover context, a motive-based inquiry is inescapable.[7]

The Delaware Supreme Court’s leading decision in Paramount Communications Inc. v. QVC Network Inc.,[8]explained that the enhanced scrutiny test Delaware courts use to review takeover defenses is basically a reasonableness inquiry to be applied on a case-by-case basis: “The key features of an enhanced scrutiny test are: (a) a judicial determination regarding the adequacy of the decision-making process employed by the directors, including the information on which the directors based their decision; and (b) a judicial examination of the reasonableness of the directors’ action in light of the circumstances then existing.” The burden of proof is on the directors with respect to both issues. They need not prove that they made the right decision, but merely that their decision fell within the range of reasonableness.

The new reasonableness standard is a logical culmination of our argument that motive is what counts. While a cynic might argue that it is merely a way of justifying a particular result, the reasonableness test in fact is well-calibrated to preventing improper motives from skewing the competition for control. Notice that the reasonableness test parallels the definition of fairness used in the former Revised Model Business Corporation Act provisions governing interested director transactions, namely, whether the transaction in question falls “within the range that might have been entered into an arms-length by disinterested persons.”[9] Both standards seem designed to ferret out board actions motivated by conflicted interests by contrasting the decision at hand to some objective standard. The implicit assumption is that a reasonable decision is unlikely to be motivated by conflicted interest or, at least, that improper motives are irrelevant so long as the resulting decision falls within a range of reasonable outcomes. The operating norm seems to be “no harm, no foul,” which seems sensible enough.

QVC, moreover, strongly indicated that a court should not second-guess a board decision that falls within the range of reasonableness, “even though it might have decided otherwise or subsequent events may have cast doubt on the board’s determination.” In Interco, Chancellor Allen had warned that “Delaware courts have employed the Unocal precedent cautiously. . . . The danger that it poses is, of course, that courts—in exercising some element of substantive judgment—will too readily seek to assert the primacy of their own view on a question upon which reasonable, completely disinterested minds might differ.”[10] QVC made clear that, so long as the board’s conduct falls within the bounds of reasonableness, Delaware courts will not second-guess the board’s decisions.

If that point was insufficiently clear after QVC, it was driven home in unmistakable terms by the Delaware supreme court’s subsequent decision in Unitrin v. American General Corp., in which the court approved an everything but the kitchen sink array of defensive tactics.[11] Unitrin’s board adopted a poison pill, amended the bylaws to add some shark repellent features, and initiated a defensive stock repurchase. The chancery court found the latter “unnecessary” in light of the poison pill. The supreme court reversed. The court deemed “draconian” defenses—those which are “coercive or preclusive”—to be invalid. (Note the parallel to our discussion of the post-Time status of the just say no defense.) Defenses that are not preclusive or coercive are to be reviewed under QVC’s “range of reasonableness” standard. On the facts before it, the court concluded that the shareholders were not foreclosed from receiving a control premium in the future and that a change of control was still possible. Accordingly, the defensive tactics were neither coercive nor preclusive. More important, the supreme court held that the chancery court had “erred by substituting its judgment” for that of the board. The court explained:

The ratio decidendi for the “range of reasonableness” standard is a need of the board of directors for latitude in discharging its fiduciary duties to the corporation and its shareholders when defending against perceived threats. The concomitant requirement is for judicial restraint. Consequently, if the board of directors’ defensive response is not draconian (preclusive or coercive) and is within a “range of reasonableness,” a court must not substitute its judgment for the board’s.

Note, once again, how the balance tips towards authority values even in a context charged with conflicts of interest. Given the significant conflicts of interest posed by takeovers, courts recognize the need for some review. But the Delaware courts also seemingly recognize that their power of review easily could become the power to decide. To avoid that unhappy result, they are exercising appropriate caution in applying the range of reasonableness standard.

In sum, the search for conflicted interests reflects the Delaware courts’ solution to the irreconcilable tension between authority and accountability. Concern for accountability drives the courts’ expectation that the board will function as a separate institution independent from and superior to the firm’s managers. The court will inquire closely into the role actually played by the board, especially the outside directors, the extent to which they were supplied with all relevant information and independent advisors, and the extent to which they were insulated from management influence. Only if the directors had the ultimate decisionmaking authority, rather than incumbent management, will the board’s conduct pass muster. But if it does, respect for authority values will require the court to defer to the board’s substantive decisions. The board has legitimate authority in the takeover context, just as it has in proxy contests and a host of other decisions that nominally appear to belong to the shareholders. Nor can the board’s authority be restricted in this context without impinging on the board’s authority elsewhere. Authority thus cannot be avoided anymore than can accountability; the task is to come up with a reasonable balance. Properly interpreted, that is precisely what the Delaware cases have done.

Reminder: If you want much more detail, be sure to check out my article Unocal at 20: Director Primacy in Corporate Takeovers, 31 DEL. J. CORP. L. 769 (2006), on which the posts have drawn.