ProfessorBainbridge.com

Francis Pileggi said some nice things about yours truly

I very much appreciated his kind words:

Professor Stephen Bainbridge, a leading corporate law scholar whose many publications are cited in opinions of Delaware’s Court of Chancery and Supreme Court, recently provided learned commentary about the latest guidance by the SEC on Rule 14a-8 regarding shareholder proposals.

 

Hamermesh, Jacobs, and Strine on "Optimizing The World’s Leading Corporate Law": Part 1 Controlling Shareholders--Plus Lipton

There is an exciting new paper from Lawrence Hamermesh, Jack B. Jacobs, and Leo E. Strine (hereinafter HJS), Optimizing The World’s Leading Corporate Law: A 20-Year Retrospective and Look Ahead. Here we have two prominent and respected ex-members of the Delaware Chancery and Supreme Courts plus a highly respected academic expert on Delaware corporate law evaluating the state of Delaware corporate law.

Here's the abstract:

In a 2001 article (Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law) two of us, with important input from the other, argued that in addressing issues like hostile takeovers, assertive institutional investors, leveraged buyouts, and contested ballot questions, the Delaware courts had done exemplary work but on occasion crafted standards of review that unduly encouraged litigation and did not appropriately credit intra-corporate procedures designed to ensure fairness. Function Over Form suggested ways to make those standards more predictable, encourage procedures that better protected stockholders, and discourage meritless litigation, by restoring business judgment rule protection for transactions approved by independent directors, the disinterested stockholders, or both.

This article examines how Delaware law responded to the prior article’s recommendations, concluding that the Delaware judiciary has addressed most of them constructively, thereby creating incentives to use procedures that promote the fair treatment of stockholders and discourage meritless litigation. The continued excellence and diligence of the Delaware judiciary is one of Delaware corporate law’s core strengths.

But some recent cases have articulated standards of review that involve greater than optimal litigation intensity and less than ideal respect for decision-making in which independent directors and disinterested stockholders have potent say. Those standards also impair the integrity of Delaware’s approach to demand excusal in derivative cases and the identification of controlling stockholders. We also propose eliminating concepts like substantive coercion that do not provide a legitimate basis for resolving cases. Finally, we urge action to correct new problems such as the unfair targeting of corporate officers for negligence claims in representative actions and the frustrating state of practice under Delaware’s books and records statute.

There is so much in this article to discuss that I expect to get a number of blog posts out of it. Today, I'm starting with their discussion of controlling shareholders because there is also an important new article out from my Twitter friend Ann Lipton, The Three Faces of Control. Herewith her abstract:

Controlling shareholders are subject to distinct legal obligations under Delaware law, and thus Delaware courts are routinely called upon to distinguish “controlling shareholders” from other corporate actors. That is an easy enough task when a person or entity has more than 50% of the corporate vote, but when a putative controller has less than 50% of the vote – and is nonetheless alleged to exercise control over corporate operations via other means – the law is shot through with inconsistency.

What is needed is a contextual approach that recognizes that the meaning of control may vary depending on the purpose of the inquiry. Under Delaware doctrine, the controlling shareholder label subjects that entity to unique legal treatment along three distinct dimensions. First, controlling shareholders – unlike minority shareholders – have fiduciary duties to the corporation. Second, interested transactions with controlling shareholders – unlike interested transactions with other fiduciaries – are subject to a unique cleansing regime in order to win business judgment deference from reviewing courts. Third, when certain transactions involving sales of control are challenged in court, they may be treated as direct rather than derivative actions, even when similar transactions that do not involve control sales would be treated as purely derivative.

By teasing out these three aspects of the legal framework and analyzing them separately, courts can more closely attend to the reasons why control carries special significance, and ultimately develop a more rational and consistent set of definitions. Most critically, courts may properly designate someone a controlling shareholder for some purposes, but not others.

Herewith HJS' summary of their argument with the controlling person standard:

[They object to the way courts have enlarged] the definition of “controlling stockholders” to include persons having little or no share voting power, and to lump together unaffiliated stockholders into a “control bloc,” so that a different standard of review applies, thereby expanding the range of full discovery and judicial review for fairness. To address this concern, we propose limiting the concept of “controlling stockholder” to the situation where a stockholder’s voting power gives it at least negative power over the company’s future, in the sense of acting as a practical impediment to any change of control.

HJS note that "Under Delaware law, it was historically difficult to establish that a stockholder having less than majority ownership was a controlling stockholder." (35) Yet, as Lipton points out, the definition has evolved to include "so many factors and considerations that it allows for a great variety of actors to be designated as controllers." (3) HJS would agree, attributing that development to "the revival of Lynch’s inherent coercion theory has created pressure to expand the definition of controlling stockholder to reach persons having far less than a voting majority, but are either critically important to the company or associated with other stockholders as a group." (36)

There are some key differences in their analyses. Lipton is much more open to the idea that contract rights can make one a corporate controller, at least for purposes of deciding whether they owe fiduciary duties to the entity and the fellow shareholders: 

... if control over another’s assets is the hallmark of a fiduciary – and if it is the controlling shareholder’s dominion over corporate assets that gives rise to fiduciary duties on its part – then it follows that no particular level of stock ownership should be necessary before one can be deemed a controller. Indeed, there is no reason that stock ownership, specifically, should be required at all. This is particularly so because in a world where control rights are often allocated not through equity interests directly, but through shareholder agreements, the distinction between control emanating from stock holdings and control emanating from contractual rights is difficult to parse. (7)

In contrast, HJS argue that:

Another troublesome issue arises where a court accepts the claim (at least for purposes of a motion to dismiss) that a person is a controller, with concomitant fiduciary obligations, despite owning no shares of stock at all. ... Our concern, however, is that the amorphous concept of “soft power” not arising out of stock ownership could be applied to trigger the entire fairness standard and preclude dismissal, where the premise of control involves circumstances that reflect garden variety commercial dealings, such as “the exercise of contractual rights to channel the corporation into a particular outcome by blocking or restricting other paths, ... the existence of commercial relationships that provide the defendant with leverage over the corporation, such as status as a key customer or supplier, [or] [l]ending relationships, [which] can be particularly potent sources of influence.”The courts should heed doctrinal guardrails against overuse of this “soft power” concept: “authority [that] takes the form of a contractual right ... must give the nonstockholder power akin to ‘operating the decision-making machinery of the corporation’ (a ‘classic fiduciary’), rather than ‘an individual who owns a contractual right, and who exploits that right,’ forcing a corporation to 'react' (which does not support a fiduciary status).” (39-40)

It will often be the case that creditors, for example, have contractual rights that, if exercised, sharply limit corporate decision-making freedom but I don't think that should result in them being treated as a controller for any purpose. I'm thinking here of classic Business Association cases like A. Gay Jenson Farms Co. v. Cargill, Inc., 309 N.W.2d 285 (Minn. 1981), or Martin v. Peyton, 158 N.E. 77 (N.Y. 1927). Both involved situations in which contract creditors had certain contractual rights that allegedly resulted in the defendants having sufficient control rights to be deemed a principal of an agent in the former case and a partner in the latter. I think Coppola v. Bear Stearns & Co., Inc., 499 F.3d 144, 150 (2d Cir. 2007),got it right when the court explained that "the dispositive question is whether a creditor is exercising control over the debtor beyond that necessary to recoup some or all of what is owed, and is operating the debtor as the de facto owner of an ongoing business."

There seems to be a consensus, however, that where there is no majority shareholder courts should focus on whether the alleged controller's "degree of entrenchment and ... ability to retaliate against disobedient shareholders" (Lipton at 16) and "the potential to use affirmative voting power to unseat directors and implement transactions that the minority stockholders do not like, and use blocking voting power to impede other transactions." (HJS at 37)

I would love to see HJS and Lipton sit down to hash all this out.

In any case, both of these articles are well worth reading.

 

New and Continuing Challenges to California's Board Diversity Quota Laws

Keith Paul Bishop has the details:

Tomorrow, a trial is scheduled to begin in California Superior Court on the constitutionality of SB 826, California's female director quota law.  Crest v. Padilla (Cal. Super. Ct. Case No. 19STCV27561).   ...

In addition, there is a separate challenge to the law pending in the U.S. District Court for the Eastern District of California.  Meland v. Padilla (Case No. No. 2:19-cv-02288-JAM-AC). ...

Last week, the National Center for Public Policy Research filed a complaint in U.S. District Court challenging both SB 826 and AB 979.  The complaint has a single claim for relief based on the Fourteenth Amendment of the U.S. Constitution and 42 U.S.C. § 1983. 

I'll remind readers that I have taken the position that these laws are unconstitutional under the internal affairs doctrine, which is a penumbra formed by the emanations of the dormant Commerce Clause and the Full Faith and Credit Clause.

Video Debate: "Is ‘Woke Capitalism’ a Threat to Democracy?"

 

H/T: Stefan Padfield

Look what came in today's mail: The 11th edition of my Business Associations casebook

Longtime users will notice a major change to the cover of this edition. My friends and coauthors Bill Klein and Mark Ramseyer have decided to retire from working on our books. It has been an honor and privilege to work with them these many years. Going forward, I will be solely responsible for editing the books.

I do not plan any significant changes to the editorial style. In editing this book, I will continue to follow the six basic but apparently widely ignored principles that have informed the book since Bill’s first edition. Each principle is one that I think helps produce a book that teaches students the gist of the law they need to know; that trains them to apply it; and that (perish the thought) almost makes them enjoy the process.

What I need are some really rich conservatives to finance a Rule 14a-8 shareholder proposal campaign

I have a splendid idea to advance the pro-life cause while calling attention to the SEC's recent liberalization of the shareholder proposal rule. It came up in a Twitter conversation with SEC Commissioner Hester Peirce:

I'm still hoping there's an anchor in common sense--a company's proxy should be about the company. We'll have to evaluate, though, at the end of the proxy season.

— Hester Peirce (@HesterPeirce) November 30, 2021

Plus, imagine the havoc if some concerned law professor could persuade wealthy conservatives to mimic James McRitchie and John Chevedden. If there is no nexus, we could bombard companies with anti-abortion proposals and dare the SEC to say they lack social significance. pic.twitter.com/CwXTpKPMaW

— Steve Bainbridge (@PrawfBainbridge) November 30, 2021

An open letter to Heritage President Kevin Roberts: I used to be proud of my Heritage Foundation affiliation, but ....

Back in the early 1990s I had the privilege of being chosen to be a Salvatori Fellow at the Heritage Foundation. It didn't help my academic career, of course, but I was proud of it anyway.

But in recent years, either I've changed or Heritage has. They've taken a lot of positions that strike me as inconsistent with the sort of conservatism I learned from reading Russell Kirk and more consistent with a sort of nationalist populism:

• Going all in on an uncritical, unthinking embrace of the worst excesses of Trumpism.
• Supporting Trump's bogus election fraud claims.
• Increasingly nativist positions on immigration.
• Replacing thoughtful analysis with partisan bias.
• Climate change denial.\

And now this:

The Heritage Foundation has filed a lawsuit against President Biden’s COVID-19 vaccine mandate for private employers, claiming it is a "gross abuse" of government power and a violation of personal liberty, the conservative think tank announced Monday. ...

The lawsuit says the mandate also "exceeds the federal government’s authority under the Commerce Clause," and would "impermissibly" compel citizens "to act as the Government would have them act."

I'm as opposed to letting the government mandate that we all eat our broccoli as the next guy, but we're talking about a virus that has caused a global pandemic that has cost over 777,000 deaths in the USA alone. Plus, as Omicron demonstrates, allowing people to remain unvaccinated creates opportunities for the virus to evolve. The situation is different in kind and not just in degree.

Plus, one cannot help but wonder how far Heritage would press the point. Would it now oppose mandatory Diphtheria, Tetanus, and Pertussis shots for K-12 kids? How about Polio? How about Measles, Mumps, and Rubella? Would it have opposed mandatory smallpox vaccinations? How about quarantining TB patients?

The Black Death killed up to 200 million people. Would Heritage have opposed using a vaccine mandate to stop it?

The Heritage Foundation I was proud to be affiliated with would not have put MAGA politics ahead of the public good. But apparently this new era Heritage is fine with doing so.

Will the SEC now allow shareholder proposals on abstract political, social, and economic questions?

The SEC's latest guidance on Rule 14a-8 (the shareholder proposal rule) abandoned an important limitation on the scope of permissible shareholder proposals:

Rule 14a-8(i)(7), the ordinary business exception, is one of the substantive bases for exclusion of a shareholder proposal in Rule 14a-8. It permits a company to exclude a proposal that “deals with a matter relating to the company’s ordinary business operations.” ...

... staff will no longer focus on determining the nexus between a policy issue and the company, but will instead focus on the social policy significance of the issue that is the subject of the shareholder proposal. In making this determination, the staff will consider whether the proposal raises issues with a broad societal impact, such that they transcend the ordinary business of the company.

It has been speculated that this announcement "represents a wholesale abandonment of any assessment of relevance of a proposal to a company’s business (as compared to relevance to society at large)." If so, it would represent an abandonment of longstanding rules, including "the “nexus” concept was embedded in the 1998 Release, as stated in Staff Legal Bulletin 14E (Oct. 27, 2009), at footnote 4 (citing the 1998 Release), and reaffirmed in Staff Legal Bulletin 14H (Oct. 22, 2015)."

I am reminded in this regard of a 1945 SEC opinion, which concluded that "the phrase “proper subject for action” to mean proposals which relate directly to the affairs of the particular corporation and concludes that proposals which deal with general political, social or economic matters are not, within the meaning of the rule, 'proper subjects for action by security holders.'" The Sec Today Released an Op. of Baldwin B. Bane, Release No. 735 (S.E.C. Release No. Jan. 3, 1945). Has the SEC now abandoned that position, such that "proposals which deal with general political, social or economic matters" unrelated tp the company's business will now be includable?

This makes no sense. As the 1945 release explained, the purpose of the shareholder proposal rule is "to place stockholders in a position to bring before their fellow stockholders matters of concern to them as stockholders in such corporation ...." The clear implication is that there must be some nexus between the proposal and the company's bison's activities:

... in 1945 the Commission issued a release containing an opinion of the Director of the Division of Corporation Finance that was rendered in response to a management request to omit shareholder resolutions which bore little or no relationship to the company's affairs; for example, these shareholder resolutions included proposals "that the anti-trust laws and the enforcement thereof be revised," and "that all Federal legislation hereafter enacted providing for workers and farmers to be represented should be made to apply equally to investors." The Commission's release endorsed the Director's conclusion that "proposals which deal with general political, social or economic matters are not, within the meaning of the rule, ‘proper subjects for action by security holders.'"

Med. Comm. for Human Rights v. Securities and Exch. Commn., 432 F.2d 659, 677 (D.C. Cir. 1970), vacated, 404 U.S. 403 (1972). Are shareholder proposals "that the anti-trust laws and the enforcement thereof be revised" now admissible? It seems possible:

“By repealing longstanding guidance about treatment of shareholders proposals, the SEC has stated its preference to turn board rooms and shareholder meetings into political debate societies on issues the SEC admits have no nexus to the actual business of the company,” Tom Quaadman, an executive vice president with the Chamber, said in a statement. “This will all come at the expense of companies' ability to focus on long-term performance, including the welfare of their employees, customers, and shareholders.”

Commissioners Criticize New SEC Staff Interpretation on Rules Governing Shareholder Proposals, WGL-ACCTALERT VOL 15 NO 213.

All of which strikes me as problematic. After all, shareholders have a “First Amendment interest in not being forced to be associated with political speech that they do not support." Lucian A. Bebchuk & Robert J. Jackson, Jr., Corporate Political Speech: Who Decides?, 124 Harv. L. Rev. 83, 113 (2010). If that's true about political speech by the corporate, as Bebchuk and Jackson claim, should it not be even more true with respect to political speech foisted upon the corporation by government fiat regardless of whether the speech has any meaningful relationship to the company's business?

Milbank ducks the hard question: Why does the SEC get to decide what issues have social significance?

In an otherwise very useful post on the new SEC shareholder proposal rule guidance, Milbank ducks the really hard question:

As a result of the SEC’s most recent Staff Legal Bulletin[1] (“SLB”), shareholder proposals that focus on a “significant social policy” will not be excludable simply because the policy issue is not, in fact, “significant” to the company receiving the proposal. The SEC has decided it will no longer “focus on the nexus between a policy issue and the company.”  Previously, shareholder proposals that did not raise a “policy issue of significance for the company” were excludable under the “ordinary course of business” exception to Rule 14a-8.[2] The new Staff Legal Bulletin is a departure from past SEC practice, and led the SEC to simultaneously rescind three previous Staff Legal Bulletins on the same subject.

Leaving aside the issue of why the SEC – which is presumably dedicated to the regulation of securities – should be determining in the abstract which social issue are “significant,” it is clear from the new bulletin that climate change and human capital management are issues that will be considered “significant.” Beyond that specific guidance, the SEC promises only that “in making this determination [regarding significance], the staff will consider whether the proposal raises issues with a broad societal impact.” This is a standard that doesn’t exactly hem in the SEC or limit the imagination of activists and gadflies.

Given the new woke majority at the SEC led by wide awake Gary Gensler, we can expect firms to be forced into including all sorts of progressive proposals having no meaningful nexus to their business. In a world in which the First and Seventh Amendments had teeth, this would be a regulatory taking by compelled speech.

Outside Reverse Veil Piercing in California

Keith Bishop reports:

Reverse veil piercing involves subjecting an entity to the liabilities of its owner.  See Inside and Outside Veil Piercing.   As Professor Bainbridge has noted, there are two types of reverse veil piercing:

One type might be called insider reverse veil piercing, in which a shareholder seeks to disregard the corporate entity.

The other is so-called outsider reverse piercing, in which a personal creditor of the shareholder seeks to disregard the corporation’s separate legal existence to reach assets of the corporation to satisfy its claim.

In a decision issued yesterday, the California Court of Appeal considered the second type of reverse veil piercing - outside reverse veil piercing.  Blizzard Energy, Inc. v. Bernd Schaefers,  2021 Cal. App LEXIS 968.  The plaintiff had obtained a judgment for nearly $4 million against an individual in Kansas.  When the plaintiff had the Kansas judgment entered in California, it asked the court to add two limited liability companies to the judgment based on the reverse alter ego doctrine.   The defendant's spouse, who had filed for a divorce, has a 50% interest in these LLCs.  She was not a defendant in the Kansas action.  The court added the LLCs as judgment debtors and the defendant appealed.

To learn how the case came out, go here.

A personal book plug

Now available—"Business Associations: Cases and Materials on Agency, Partnerships, LLCs, and Corporations, 11th" by @UCLA_Law Prof. @PrawfBainbridge. Learn more at https://t.co/0elwnAywzU (https://t.co/k5jHRGpkFF). #WestAcademicAuthor pic.twitter.com/MMn9RL7uXl

— West Academic for Faculty (@WestAcademic) November 17, 2021

A couple of book recommendations

My friend Marc Steinberg's wonderful book "Rethinking Securities Law" was American Book Fest's best law book of 2021. Well deserved award.https://t.co/JOiZklAFP2 https://t.co/uIVAyUbGVp #lawtwitter

— Steve Bainbridge (@PrawfBainbridge) November 17, 2021

"Ends of War: The Unfinished Fight of Lee's Army after Appomattox" got a strong review in today's WSJ. https://t.co/fUAQO77Lgr The Country likely would be in a better place if we had hung some top Confederates and kept Reconstruction going a lot longer. https://t.co/ZSZ9eGnZ20

— Steve Bainbridge (@PrawfBainbridge) November 17, 2021