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Much Buzz About the Internal Affairs Doctrine

Francis Pileggi:

For readers who follow the law regarding forum selection clauses, a recent article by Professor Joseph Grundfest should be of interest. The good professor addresses the December 2018 Court of Chancery decision in Sciabacucchi v. Salzberg (highlighted on these pages), and the intersection of Delaware law and Federal law in the context of forum selection clauses and the internal affairs doctrine. The abstract follows to his article titled: The Limits of Delaware Corporate Law: Internal Affairs, Federal Forum Provisions, and Sciabacucchi

A Harvard Forum post by Grundfest himself summarizes the paper. It explains the core problem and is typically punchy:

The Securities Act of 1933 provides for concurrent federal and state jurisdiction. Securities Act claims were historically litigated in federal court, but in 2015 plaintiffs began filing far more frequently in state court where dismissals are less common and weaker claims more likely to survive. D&O insurance costs for IPOs have since increased significantly. Today, approximately 75% of defendants in Section 11 claims face state court actions. Federal Forum Provisions [FFPs] respond by providing that, for Delaware-chartered entities, Securities Act claims must be litigated in federal court or in Delaware state court.

Sciabacucchi’s logic and conclusion are fragile. The opinion conflicts with controlling U.S. and Delaware Supreme Court precedent and relies critically on assumptions of fact that are demonstrably incorrect.

Moshen Manesh:

During a four-month span in late 2018, two events occurred at opposite ends of the country that could dramatically reshape the regulation of corporations in America. First, in September 2018, California enacted the nation’s first law mandating board gender diversity for all public corporations that are physically headquartered in California.[1] Second, in December 2018, the Delaware Court of Chancery in Sciabacucchi v. Salzberg ruled that a corporation may not in its governing documents regulate the rights of its shareholders arising under federal securities law.[2] Although seemingly unrelated, I argue in a forthcoming article that both events share at their core a challenge to the internal affairs doctrine – a doctrine that is at the foundation of the state-based system of corporate law in the United States. ...

Challenges at the edges of the internal affairs doctrine, like those that emerged in late 2018, are a problem unlikely to go away for Delaware. Since California enacted its first-in-the-nation board diversity statute, state legislatures in Illinois and New Jersey have considered similar bills. And earlier this year, an activist  shareholder initiated litigation against the New Jersey-chartered Johnson & Johnson, pressing it to adopt a bylaw provision mandating arbitration for all shareholder claims brought under federal securities law. These developments suggest that skirmishes at the frontiers of the internal affairs doctrine are likely to persist. And these skirmishes could both erode Delaware’s hegemony and fundamentally reshape the regulation of corporate America.

Ann Lipton:

By now, regular readers of this blog are aware that I’ve been especially forceful in arguing that litigation limits in corporate charters and bylaws can only address matters of corporate internal affairs, and that federal securities claims are beyond their scope.  Vice Chancellor Laster adopted a similar view in his Sciabacucchi v. Salzbergdecision, where he invalidated charter provisions that purport to require that all Section 11 claims against the company be brought in federal court.  Now that the matter is on appeal to the Delaware Supreme Court (Docket No. 346,2019) – and the opening brief is due today –  a lot of articles about the scope of the internal affairs doctrine are dropping. [She links a number of them]

Kevin LaCroix:

After the U.S. Supreme Court’s March 2018 decision in the Cyancase that state courts retain concurrent jurisdiction for ’33 Act liability actions, one idea that circulated was that companies could avoid securities class action lawsuits in state court by adopting a charter provision designating a federal forum for these kinds of suits. Unfortunately, in December 2018, Delaware Chancery Court Vice Chancellor Travis Laster held in Sciabacucchi v. Salzburg that under Delaware law federal forum provisions are invalid and ineffective, as discussed here. The Sciabacucchi decision, which is now on appeal, is the subject of a comprehensive critique in a recent article by Stanford Law Professor Joseph Grundfest, entitled “The Limits of Delaware Corporate Law: Internal Affairs, Federal Forum Provisions, and Sciabacucchi” (here). Professor Grundfest argues that Sciabacucchi was wrongly decided and that a under a “straightforward” application of applicable Delaware statutory law, federal forum provisions are valid and permitted.

I recommend reading all of them.

 

India's Experience with Corporate Social Responsibility Offers a "Cautionary Tale"

From CLS Blog:

The debate about the purpose of corporations seems to have heated up after Larry Fink’s annual letter to the CEOs of companies in which BlackRock invests and again after the statement from the Business Roundtable. Both Fink’s letter and the Business Roundtable statement referred to global problems and how companies should embrace a greater responsibility to address them. The statement by the Business Roundtable has been perceived variously as a major shift in corporate law or as a PR exercise to prevent government regulation.

Irrespective of its motivations, while an acknowledgement that a consideration of stakeholder interests is useful, an invitation for government to require actions by companies to address these world problems would be problematic. As Professor Jeffrey Gordon posted here on this blog, it is the government’s responsibility to address these problems via taxation and redistribution as well as regulation in areas other than corporate law. Although Professor Tim Wu argued here that this amounts to passing the buck to government, a situation where we allow the government to require companies to perform public duties would amount to the government passing the buck to corporations. The example of India’s CSR law provides a cautionary tale.

Kindly read the whole thing.

A Truth and Reconciliation Process for the Catholic Sex Abuse Scandal

As regular readers know, I have a long-standing interest in legal aspects of the Catholic sex abuse scandal, which intersects both my vocational interests and my faith as a Roman Catholic. I read with great interest a new paper proposing a truth and reconciliation component to the legal processes:

This article outlines the history of cleric sexual abuse from 1950 through contemporary times, and surveys past civil and criminal prosecutions of Roman Catholic sexual abuse cases. Contemporary theories of criminal liability may be either an alternative to – or an adjunct with – civil tort lawsuits, and injunctive relief is increasingly sought to investigate as well as to deter future abuse. Time will tell the impact of ongoing state and federal RICO Act prosecutions not just on perpetrators but also clerics and Church decision-makers remaining in active ministry. Restorative justice, forums for listening and sharing, through stories and prayer, may well offer the most opportunity for fostering healing and reconciliation within the bounds of the law yet not directly involving courts or legal processes. Restorative justice strongly shines the light of the Gospel on this scourge, where agents of such justice are mindful of the words of the Apostle Paul, in his Second Epistle to the Corinthians that “[a]ll this is from God, who reconciled us to himself through Christ and gave us the ministry of reconciliation.” Remediative and restorative measures outside the courts must augment legal remedies within halls of justice for multifaceted and effective means to address the past and ongoing criminal and civil law and public health crises arising from cleric sexual abuse, and to help prevent future abuses from taking place.

Govern, Kevin H., Truth, Justice, and Reconciliation in the Wake of Clerical Sexual Abuse in America (May 2019). Baku State University Law Review, Volume 5, Issue 2, 2019. Available at SSRN: https://ssrn.com/abstract=3450826

Justifying Benefit Corporations

I liked very much Brett McDonnell's new article, The Corrosion Critique of Benefit Corporations:

This Article evaluates what it labels the corrosion critique of benefit corporation statutes. These statutes have emerged as the leading new statutory alternative to enable and encourage social enterprises, businesses which seek both to generate financial returns for their investors while also pursuing social missions. Some persons who strongly support social enterprises have criticized benefit corporation statutes, arguing that they create a mistaken impression that companies organized under ordinary corporation statutes cannot consider the interests of non-shareholder stakeholders except insofar as doing so benefits shareholders in the long run. This corrosive effect on the understanding of most corporations may impede the adoption of socially responsible behavior.

The Article distinguishes three conceptions of the legal purpose of corporations and whose interests officers and directors should consider: shareholder-only, stakeholder-optional, and stakeholder mandatory. It also identifies two leading justifications of benefit corporation statutes. The enabling justification asserts that corporate law constrains the ability of directors and officers to consider the interests of stakeholders other than shareholders because it imposes the shareholder-only conception of corporate purpose. The branding justification asserts that benefit corporations help companies attract investors, customers, and employees by giving them a way to credibly commit to considering the interests of other stakeholders through adopting the stakeholder-mandatory conception.

Having established these categorizations, the Article offers a mixed verdict as to the validity of the corrosion critique. The critique does not apply to the branding justification. For the enabling justification, the critique is mostly valid in states with corporate constituency statutes, since such states have adopted the stakeholder-optional conception for ordinary corporations, and thus it is false to imply (as the enabling justification does) that ordinary corporations are constrained in considering the interests of various stakeholders. The corrosion critique does not, however, apply in Delaware and probably other non-constituency statute states, which have adopted the shareholder-only conception for ordinary corporations. The Article concludes that advocates of benefit corporations should stop using the enabling justification, which is subject to the corrosion critique in over half of all states (those with constituency statutes), and which justification is weak on other grounds as well. Focusing on the branding justification will direct transactional lawyers and businesses to the right reasons for considering becoming a benefit corporation, and will focus policymakers and scholars on the right questions to ask in evaluating the usefulness of benefit corporation statutes.

McDonnell, Brett H., The Corrosion Critique of Benefit Corporations (September 9, 2019). Available at SSRN: https://ssrn.com/abstract=3450747

An announcement for adopters of the Klein, Ramseyer, Bainbridge Business Associations Casebook

Attention adopters of Klein, Ramseyer & Bainbridge Business Associations casebook: We have posted updated PowerPoint slides for the entire book to our website https://t.co/fWddPKpi8e Free to use. Request password from your Foundation Press account rep. #lawtwitter #corporatelaw

— Professor Bainbridge (@ProfBainbridge) September 20, 2019

My Review of Conservatives Against Capitalism: From the Industrial Revolution to Globalization by Peter Kolozi

Conservatives Against Capitalism: From the Industrial Revolution to Globalization by Peter Kolozi https://t.co/jisXENO5ru

— Professor Bainbridge (@ProfBainbridge) September 18, 2019

Yours Truly on The Economist's Podcast on Corporate Social Responsibility

This was a fun podcast to do. My thanks to @TheEconomist and @tamzinbooth. https://t.co/AeNIq0xMyQ

— Professor Bainbridge (@ProfBainbridge) September 18, 2019

Mesa Petroleum's T Boone Pickens has died, RIP

T. Boone Pickens Jr. Dies. Lots of memories, including the landmark case, Unocal v. Mesa Petroleum. And representing him at Baker Botts. And meeting him on Capitol Hill. And his role in Anatomy of a Merger. RIP https://t.co/i18Gg4ERip

— Gordon Smith (@professor_smith) September 11, 2019

I once talked to Pickens about old stories of his raids, particularly Gulf, and the reception he got then vs activists today. My favorite quote: "One said 'He’s a fast buck artist.' Who in the hell wants to be a slow buck artist?" https://t.co/yUx33lMgsR

— Dave Benoit (@DaveCBenoit) September 11, 2019

There’s a great moment in this documentary at about 17:20 where T Boone Pickens calls himself a geologist and Sir James Goldsmith calls himself a grocer. If you were engaged in the corporate takeover wars of the 1980s, that’s Robin Williams level comedy. https://t.co/8lyitpfpg6 pic.twitter.com/3V5L2qUthz

— Professor Bainbridge (@ProfBainbridge) January 4, 2019

A First Challenge to California’s Board Gender Diversity Law

Cydney Posner:

As reported here on Bloomberg, a conservative activist group has filed a lawsuit, Crest v. Alex Padilla, in California state court on behalf of three California taxpayers seeking to prevent implementation and enforcement of SB 826, California’s Board gender diversity legislation. This appears to be the first litigation filed to challenge the new law. Framed as a “taxpayer suit,” the litigation seeks to enjoin Alex Padilla, the California Secretary of State, from expending taxpayer funds and taxpayer-financed resources to enforce or implement the law, alleging that the law’s mandate is an unconstitutional gender-based quota and violates the California constitution. 

I don't know enough about taxpayer standing under California constitutional law to know whether the lawsuit will survive a standing challenge. Nor do I know enough about equal protection law under the California constitution to know if the suit has substantive merit.

Interestingly, the issue about which I do know something is not involved in the suit:

Interestingly, there was no challenge to the legislation as a violation of the “internal affairs doctrine,” which generally provides that the law of the state of incorporation governs those matters that pertain to the relationships among or between the corporation and its officers, directors and shareholders. The new gender diversity mandate would likely be viewed as a matter of internal corporate governance, and Section 2115.5 of the new law purports to make the mandate expressly applicable to foreign corporations with outstanding shares listed on a major U.S. stock exchange—to the exclusion of the law of the jurisdiction in which the foreign corporation is incorporated. Of course, because of standing issues, different plaintiffs would have been required to make a claim of that nature.

Nell Minow on the Business Roundtable Corporate Purpose

Ms Minow and I have frequently disagreed over the years, but we're largely on the same page in disparaging the new BRT statement on corporate purpose. She's got an excellent 6-point commentary over at the Harvard Forum that is well worth reading.

I miss having masters and servants: The Restatement (Third) of Agency messed up the terminology of vicarious liability

In the preceding post, I discussed the NY Times article discussing how Amazon outsources delivery services to what purport to be independent contractors, but who actually may well be servants. I explained that principals can be held vicariously liable for the torts of those agents who are servants but not those who are independent contractors. 

The NYT article observed that:

FedEx has settled lawsuits in recent years brought by drivers who argued that they functioned as employees, not independent contractors. Last week, Uber and Lyft announced that they would spend $60 million to contest a proposed California law that would force them to treat their contract drivers as employees.

In lawsuits, people injured in crashes and drivers in wage disputes have argued that Amazon retains so much control that it effectively is the drivers’ employer.

But are principals vicariously liable for torts of their employees? This brings us to a point of terminology that is one of my pet peeves. As I explain in my book, Agency, Partnerships, and LLCs:

There is a growing tendency towards using the terminology of employer and employee rather than master and servant. The Restatement (Third), for example, does away with all three of the classic terms—master, servant, and independent contractor—and replacing them with employer, employee, and nonemployee agent. The old distinction between nonservant agents and nonagent independent contractors also was abolished in favor of the terms nonemployee agent and nonagent service provider.

Admittedly, the terms master and servant are archaic and politically incorrect. The implication of menial service, moreover, is usually erroneous. Yet, it is not clear that employer and employee are an improvement. In particular, both common usage and many legal regimes treat some agents as employees even though they would not be deemed servants under the Restatement (Second) definition. If vicarious liability is grounded in the principal’s ability to control the agent’s physical performance of a task, however, as it has been traditionally, it would seem that something beyond mere fulltime employment must be shown. A growing number of courts, however, seem willing to infer the requisite level of control from the mere fact of fulltime employment. Some courts have even abandoned the control requirement: “Thus in this case where it is agreed that a regular employee is sent upon a specific errand, using his own car with the knowledge and permission of the employer, and it is agreed he was acting within the scope of his employment at the time of the accident, the employer is liable for his acts whether it had control of his detailed operation of the motor vehicle or not.”[1] These courts have gone full circle back to the days of Jones v. Hart. The distinction between independent contractors and servants did not exist until the 1840s, prior to which time a principal was held vicariously liable for the torts of his agents of either type.[2] The distinction arose, however, precisely because it makes sense to impose vicarious liability only where the principal may exercise its control so as to prevent accidents. By eviscerating the terminological distinction between servants and independent contractors, the Restatement thus may contribute towards this unfortunate trend of treating principals as insurers of their agents.[3]

Are Amazon's delivery drivers servants or independent contractors?

The NY Times reports that:

In its relentless push for e-commerce dominance, Amazon has built a huge logistics operation in recent years to get more goods to customers’ homes in less and less time. As it moves to reduce its reliance on legacy carriers like United Parcel Service, the retailer has created a network of contractors across the country that allows the company to expand and shrink the delivery force as needed, while avoiding the costs of taking on permanent employees.

But Amazon’s promise of speedy delivery has come at a price, one largely hidden from public view. An investigation by ProPublica identified more than 60 accidents since June 2015 involving Amazon delivery contractors that resulted in serious injuries, including 10 deaths. That tally is most likely a fraction of the accidents that have occurred: Many people don’t sue, and those who do can’t always tell when Amazon is involved, court records, police reports and news accounts show.

Even as Amazon argues that it bears no legal responsibility for the human toll, it maintains a tight grip on how the delivery drivers do their jobs.

Their paychecks are signed by hundreds of companies, but often Amazon directs, through an app, the order of the deliveries and the route to each destination. Amazon software tracks drivers’ progress, and a dispatcher in an Amazon warehouse can call them if they fall behind schedule. Amazon requires that 999 out of 1,000 deliveries arrive on time, according to work orders obtained from contractors with drivers in eight states.

As I explain in my book, Agency, Partnerships, and LLCs:

A principal’s vicarious liability in tort depends not only on whether an agency relationship existed between the tortfeasor and the principal, but also on the kind of agency relationship that is involved. A principal is only liable for the acts of his agent if the agent is deemed the principal’s “servant.” (In which case the principal is known as a “master.”) If the agent is deemed to be the principal’s “independent contractor,” the principal is not liable for torts committed by the agent. As we shall see, it is not always easy to tell into which category a particular relationship falls. Moreover, we will also see a variety of exceptions to the general rule. Having said that, however, the distinction between a servant and an independent contractor still forms the starting point from which analysis must proceed.

Restatement (Second) § 2(2) defines a servant as “an agent employed by a master to perform service in his affairs whose physical conduct in the performance of the service is controlled or is subject to the right to control by the master.” By way of contrast, § 2(3) defines an independent contractor as “a person who contracts with another to do something for him but who is not controlled by the other nor subject to the other’s right to control with respect to his physical conduct in the performance of the undertaking.” In order for a master-servant relationship to be found, the master does not have to actually control the agent’s physical performance of the assigned task. The master merely must have the right to exercise such control. In contrast, where a principal sets forth the desired result but does not have the right to tell the agent how to achieve that result, the agent is an independent contractor.

A potential source of confusion must be addressed at the outset. All servants are agents, but not all independent contractors are agents. If Pam hires Al to build a house for her at a stipulated price and Pam reserves no power of direction over the conduct of the work, Al is an independent contractor but not an agent (typically referred to as a nonagent independent contractor).[1]Al has no fiduciary duties to Pam and has no power to affect Pam’s legal relations. Hence, for example, no contracts entered into by Al purporting to be on Pam’s behalf will be biding on Pam as a matter of agency law. We are concerned here only with those independent contractors who are also agents (referred to by some as agent-type independent contractors and by others as nonservant agents).

In some cases, of course, it is relatively clear which type of relationship is involved. For example, lawyers, real estate brokers and stock brokers are usually deemed to be independent contractors, rather than servants of their clients, because the clients have little, if any, control over the day-to-day conduct of their lawyer or broker. In contrast, a legal assistant typically would be viewed as the lawyer’s servant, because the lawyer is likely to have a great deal of control over the assistant’s work.[2]

Unfortunately, these simple examples are polar extremes on a spectrum of types of relationships and many arrangements fall into the vast grey area in the middle. As an aid to categorizing ambiguous relationships, Restatement (Second) § 220(2) identifies the following nonexclusive list of factors to be considered:

(a)      the extent of control which, by the agreement, the master may exercise over the details of the work;

(b)      whether or not the one employed is engaged in a distinct occupation or business;

(c)      the kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the employer or by a specialist without supervision;

(d)     the skill required in the particular occupation;

(e)      whether the employer or the workman supplies the instrumentalities, tools, and the place of work for the person doing the work;

(f)      the length of time for which the person is employed;

(g)      the method of payment, whether by the time or by the job;

(h)     whether or not the work is a part of the regular business of the employer;

(i)      whether or not the parties believe they are creating the relation of master and servant; and

(j)      whether the principal is or is not in business.

The commentary to § 220 suggests that the two most important factors, which together have “almost conclusive weight,” are the customs of the locality with respect to the degree of control exercised by the principal and the amount of skill required by the agent’s occupation.

Although several of the § 220(2) factors refer to employment, consideration is not required. Per Restatement § 225, a person serving gratuitously nevertheless may be deemed a servant. On the other hand, many courts stress that merely doing someone a favor does not make you their servant.[3]Instead, the gratuitous actor’s performance of the task must be subject to the physical control of the master and the master must have consented to the relationship.

With that background in mind, we can turn to a case that seems directly applicable:

Frank Frausto was a delivery driver for the Arizona Republic newspaper. Frausto’s car collided with a motorcycle driven by plaintiff William Santiago, who then sued the newspaper. The newspaper defended by claiming that Frausto was an independent contractor. The trial court agreed, granting the newspaper summary judgment on the issue as a matter of law. Applying an 8 factor test tracking Restatement (Second) § 220(2), the Arizona supreme court reversed and remanded for trial.[4]

First, as to control by the alleged master, the court noted that the newspaper exercised little actual supervision, but was able to give Frausto specific instructions with the expectation that they would be followed. Pointing out that the power to fire is regarded as “one of the most effective methods of control,” the court noted that Frausto could be terminated without cause on 28 days notice and, moreover, could be terminated for unsatisfactory service without any notice. Second, the court noted that Frausto had no independent delivery business. He worked only for the newspaper, payments went to the newspaper and not the carrier, and accounts were serviced by the newspaper. This distinguished the case at bar from other newspaper carrier cases in which the delivery firm bought the newspapers from the publisher and resold them to delivery customers at a profit. Third, the court noted that being a newspaper carrier required little specialized or skilled training, which suggests that Frausto was a servant. Fourth, while the newspaper did not provide all of the necessary supplies, it did supply the newspapers and designated the route to be covered. Fifth, the court observed that the relationship was of indefinite duration, which points towards finding that Frausto was a servant. Sixth, Frausto was paid a regular weekly salary. Seventh, newspaper delivery was a core part of the publisher’s business. Finally, Frausto stated that he regarded himself as an employee. In sum, on all of the § 220 factors there was at least some support for treating Frausto as a servant and summary judgment was inappropriate.

The parallels to the Amazon situation are obvious. To be sure, there are cases coming out the other way, but my view is that Amazon has some serious ability risk in these cases.

 

Why are corporations defined as entities?

I offer an answer here.

The lawyers are catching up to ProfessorBainbridge.com re The Business Roundtable statement on corporate purpose

Lawyers from Richards Kibbe & Orbe outline the limited legal implications of The Business Roundtable Statement:

Shareholders are the only constituency to which directors owe fiduciary duties and the only constituency wielding corporate law powers. Delaware corporate law is and remains resolutely shareholder-centric. ...

Of course, my readers have known that for quite a while now.

Using corporate governance to effect social changes is fundamentally undemocratic

Omari Scott Simmons argues:

The embrace of shareholder activism as a tool to bring about broad social change is a welcome development. It reflects a trend of outsourcing public functions and values to private actors and stems in part from a frustration with interest group politics and existing democratic processes in the public context. However, overreliance on shareholder activism and similar private tactics may lead to an expectations gap; they are not an effective surrogate for persistent, organized, mobilized social movements that employ diverse tactics in traditional democratic venues.

What we are seeing these days is yet another attempt by the left to by pass democracy and achieve social changes they prefer without getting approval from a majority of citizens. The left used the courts to bypass democracy for years (See, e.g., Roe v. Wade). Now that the Supreme Court has a fairly solid conservative majority, the left is shifting to corporate governance to coerce corporate leaders--some of whom themselves are social justice warriors eager to cooperate--into adopting leftist policy preferences.

There's a law review article here.