ProfessorBainbridge.com

The Restatement of the Law of Corporate Governance: A Grammatical Quibble

Tentative Draft Number 1 uses the terms "decisionmaking" and "decisionmaker." This is error.

"Decision making" is a noun + a gerund. When used in the noun form it is open and unhyphenated. When it is used as a compound adjective preceding a noun it is to be hyphenated. See Chicago Manual of Style (17th ed.) at 449. Hence, for example:

• Decision making is hard.
• The corporation's decision-making process is flawed.

Decision maker is a compound noun with a single function; i.e., the first noun modifies the second noun. According to Chicago (17th ed.) at 450, such a noun is open and unhyphenated. Hence, for example:

• The Chief Reporter is an excellent decision maker.

Some commentators might use compound nouns, such as decision maker, as compound adjectives and give them a hyphen. See, for example:

• The Chief Reporter uses a Magic 8-ball as a decision-maker tool.

I find that usage awkward and probably inadmissible. I prefer:

• The Chief Reporter uses a Magic 8-ball as a decision-making tool.

The Restatement of the Business Judgment Rule: The Question of Rationality

Regular readers know I am working on a couple of projects dealing with the forthcoming Restatement of the Law of Corporate Governance. Not everything I think about the restatement will make it into a law review article, but they will make great blog fodder.

To with, the drafters have restated the business judgment rule in section 4.02 as follows (in pertinent part):

A director or officer who makes a business judgment is not liable to the corporation or its shareholders if the director or officer: ... (4) rationally believes that the business judgment is in the best interests of the corporation.

Reporter's Note 1 to that section explains that:

Delaware incorporates the fourth component of the black letter by explaining: “where the business judgment presumptions are applicable, the board’s decision will be upheld unless it cannot be attributed to any rational purpose.” . . . A line of cases decided under Delaware law support the test that under the business judgment rule, a corporate decision will be upheld unless it cannot be attributed to any rational business purpose.

I agree with everything the drafters say. But I would like to add a friendly amendment, which I hope they will consider incorporating into the text. I take the following from Stephen M. Bainbridge, Corporation Law and Economics (2002), at 274-75:

In Sinclair Oil Corp. v. Levien, the Delaware supreme court held that so long as the board’s decision could be attributed to any rational business purpose the business judgment rule precluded the court from substituting its judgment as to the merits of the decision for those of the board.[1] Similarly, in Brehm v. Eisner, the court held that the business judgment rule does not apply when the board has “act[ed] in a manner that cannot be attributed to a rational business purpose.”[2]

The reference to a “rational business purpose,” properly understood, does not contemplate substantive review of the decision’s merits. As Professor Michael Dooley observes, “Sinclair’s use of [the word] rational is to be equated with conceivable or imaginable and means only that the court will not even look at the board’s judgment if there is any possibility that it was actuated by a legitimate business reason. It clearly does not mean, and cannot legitimately be cited for the proposition, that individual directors must have, and be prepared to put forth, proof of rational reasons for their decisions.”[3] Consequently, as Chancellor Allen has stated:

[W]hether a judge or jury considering the matter after the fact, believes a decision substantively wrong, or degrees of wrong extending through “stupid” to “egregious” or “irrational”, provides no ground for director liability, so long as the court determines that the process employed was either rational or employed in a good faith effort to advance corporate interests. To employ a different rule—one that permitted an “objective” evaluation of the decision—would expose directors to substantive second guessing by ill-equipped judges or juries, which would, in the long-run, be injurious to investor interests.[4]

Instead, as Chancellor Allen observed elsewhere, “such limited substantive review as the rule contemplates (i.e., is the judgment under review ‘egregious’ or ‘irrational’ or ‘so beyond reason,’ etc.) really is a way of inferring bad faith.”[5]

Put another way, inquiry into the rationality of a decision is a proxy for an inquiry into whether the decision was tainted by self-interest. In Parnes v. Bally Entertainment Corp., for example, the Delaware supreme court stated that: “The presumptive validity of a business judgment is rebutted in those rare cases where the decision under attack is ‘so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.’”[6]In that case, Bally’s CEO allegedly demanded bribes from prospective takeover bidders and, moreover, allegedly received such a bribe from the successful bidder. In holding that the plaintiff shareholder had stated a cause of action, the court observed that “it is inexplicable that independent directors, acting in good faith, could approve the deal” when it was so tainted.

Litwin v. Allen is often cited as an exception to the foregoing proposition.[7] Put another way, Litwin supposedly creates an “incredible stupidity” exception to the business judgment rule. Under this reading of the opinion, it stands as an example of a board decision so irrational as to not deserve the protection of the business judgment rule. One problem with this analysis is that Litwin involved the directors of a bank, who are typically held to a higher standard of accountability than directors of other corporations. Another is that Litwin is a sport—a case that falls well outside the norm. It is cited so often, because it stands alone as plausible precedential support for the irrationality exception to the business judgment rule. Finally, consistent with our hypothesis that courts use rationality as a code word for self-dealing, the Litwin court found the transaction in question to be “so improvident, so risky, so unusual, and unnecessary as to be contrary to fundamental conceptions of prudent banking practice.” Although the court expressly declined to find a violation of the duty of loyalty, it seems fair to ask whether “we have reason to disbelieve the protestations of good faith by directors who reach ‘irrational’ conclusions?”[8]

In sum, it may be that there are some board decisions that are so dumb that the business judgment rule will not insulate them from judicial review.[9] Even if the set of such decisions is not an empty one, however, the tail ought not wag the dog. Because a prerequisite of rationality easily can erode into a prerequisite of reasonableness, courts must tread warily here. If they want to persist in requiring that there be a rational business purpose, at least they can ensure that that requirement lacks teeth.

The Restatement of The Geography of Revlon-Land

As regular readers know, I am working on several projects relating to the tentative draft of the restatement of the Law of Corporate Governance. As I've plowed through the draft, I noticed that the drafters touch in passing on the geography of Revlon-land.

Reporter’s Note 3 to Section 2.01 comments in passing on the issue of when Revlon duties trigger, suggesting that “when a corporation is sold for cash” and “all of the shareholders will be cashed out” “the board may not balance the interests of shareholders against the interests of other stakeholders. This is the clear holding of Delaware’s Revlon case and a long line of other cases.” It is true that Revlon clearly held that when Revlon duties have triggered, there can be no consideration of interests other than those of the shareholders.

The implicit suggestion that Revlon is always triggered by a sale for cash, however, is controversial. True, dictum in some Delaware Chancery Court decisions suggest that that all cash and some mixed consideration sales trigger Revlon.[1]I have elsewhere argued that those decisions are inconsistent with controlling Delaware Supreme Court precedent.[2] In my view, the relevant Supreme Court precedents clearly indicate “that an acquisition by a publicly held corporation with no controlling shareholder that results in the combined corporate entity being owned by dispersed shareholders in the proverbial “large, fluid, changeable and changing market” does not trigger Revlon whether the deal is structured as all stock, all cash, or somewhere in the middle. The form of consideration is simply irrelevant.”[3]

I have also argued that the Chancery Court dicta is inconsistent with the policy concerns that motivated Revlon.[4]The Chancery Court dicta is premised on the notion that Revlon is concerned with “whether there will be a tomorrow for the shareholders,” but Revlon was mainly concerned with whether the structure of the transaction allows the market to redress any conflicts of interest on the part of the target directors.[5] As long as the acquirer is publicly held, the conflict of interest concerns are muted and “diversified shareholders will be indifferent as to the allocations of gains between the parties. In turn, those shareholders also will be indifferent as to the form of consideration.”[6] It is that approach to Revlonduties that the drafters should restate.

George Will pans stakeholder capitalism

From the WaPo:

Semantic infiltration is the tactic by which political objectives are smuggled into discourse that is ostensibly, but not actually, politically neutral. People who adopt a political faction’s vocabulary also adopt — perhaps inadvertently, but inevitably — the faction’s agenda. So, everyone who values economic dynamism, and the freedom that enables this, should recoil from the toxic noun “stakeholder.” ...

Although progressives are especially disposed to break all private entities to the saddle of politics, factions of all persuasions can infuse politics into this and that: A Texas law, itself a political gesture, requiresbanks that underwrite the state’s municipal bond market to certify that their political gestures do not include forbidding transactions with the firearms or ammunition manufacturers and retailers.

But this is the money quote:

Self-proclaimed stakeholders, parasitic off others’ labor and accumulation, assert that everything is their business. Actually, although everyone has a right to advocate progressivism, no one has a right to insist on a stake in deploying others’ property for the stakeholders’ political ends.

Scalia on Restatements of the Law

I am working away at a couple of law review articles about the tentative draft of the Restatement of the Law of Corporate Governance. In doing so, a friend pointed me to a great quote from Justice Scalia:

[M]odern Restatements . . . are of questionable value, and must be used with caution. The object of the original Restatements was “to present an orderly statement of the general common law.” Over time, the Restatements' authors have abandoned the mission of describing the law, and have chosen instead to set forth their aspirations for what the law ought to be. . . . Restatement sections such as that should be given no weight whatever as to the current state of the law, and no more weight regarding what the law ought to be than the recommendations of any respected lawyer or scholar. And it cannot safely be assumed, without further inquiry, that a Restatement provision describes rather than revises current law.

Kansas v. Nebraska, 574 U.S. 445, 475–76 (2015) (Scalia, J., concurring in part) (citations omitted). I concur.

My blushes

Prominent Delaware corporate lawyer Francis Pileggi calls yours truly "Delaware’s favorite corporate law scholar, the prolific and widely-quoted Professor Stephen Bainbridge...."

Yours truly quoted in Christian Science Monitor re Woke Capitalism

Simon Montlake @sjmontlake, ‘Woke capitalism’ on the rise – and running into resistance:

“We’re starting to see a reaction,” says Stephen Bainbridge, a law professor at University of California, Los Angeles who studies corporate governance. “Companies are having to decide whether they’re going to take sides or to market to everybody.”  ...

That views of big business have also soured on the right, for different reasons, should concern company boardrooms, says Professor Bainbridge. 

“There’s a resurgence of right-wing populism that has very little in common with left-wing populism other than a deep distrust of big business. That’s the political dynamic of the moment. For the first time in a long time, you have strong populist wings in both parties that are skeptical of big business,” he says.

See generally Stephen M. Bainbridge, Corporate Purpose in a Populist Era, 98 Neb. L. Rev. 543 (2019)
Available at: https://digitalcommons.unl.edu/nlr/vol98/iss3/2

Is AI Sentient?

Elsewhere: "@Google engineer warns the firm's AI is sentient: Suspended employee claims computer program acts 'like a 7 or 8-year-old' and reveals it told him shutting it off 'would be exactly like death for me." https://t.co/ylwwK4cwcm Skynet anyone? https://t.co/MR207vnxft

— Steve Bainbridge (@PrawfBainbridge) June 12, 2022

In related news: The Daily Mail (consider the source) announces that a Goggle whistleblower claims its AI is sentient. https://t.co/ylwwK4cwcm https://t.co/xs2vzo6uix

— Steve Bainbridge (@PrawfBainbridge) June 12, 2022

Multicooker Lamb Shoulder Chops

• 2 lamb shoulder chops (either arm or blade)
• olive oil
• ¾ cup diced carrots
• 1 shallot, minced
• 2 cloves garlic, sliced thinly
• 1 teaspoon Herbes de Provence
• ½ teaspoon dried rosemary, lightly crushed between your fingers
• ½ to 1½ teaspoon harissa powder (I like Morton & Basset)
• ¼ cup red wine
• ½ cup beef stock
• ½ tablespoon Worcestershire sauce
• 14.5 ounce can diced tomatoes, drained
• Kosher salt
• Freshly ground black pepper

Heat multicooker using the brown setting.

Trim the chops of excess fat. Season with salt and pepper. Lightly coat the bottom of the inner cooking pot with olive oil. Brown the chops in the multicooker, doing it in two batches if necessary. Remove chops to a paper towel lined plate. Mop off and fat clinging to them.

Reduce heat to sauté setting. Add a drizzle of olive oil to the cooking pot. Add carrots and sauté for 2 minutes. Add shallots and sauté for 1-2 minutes. Season lightly with salt and pepper. Add garlic and sauté 1 minute. 

Increase heat to brown. Add wine to cooking pot, bring to a boil and allow to reduce by about half. Add beef stock and tomatoes.

Install lid (set to pressure). Switch to high pressure cook setting and set for 15 to 20 minutes depending on how thick the chops are and how tender you want the meat,

Remove chops to a plate. Strain liquid, reserving veggies. Defat liquid. Combine liquid and veggies and serve over lamb chops. 

Polenta goes nicely with the lamb chops, as does a Napa Cabernet Sauvignon.

Do we need a Restatement of the Law of Corporate Governance? (No.)

In 1978, the American Law Institute authorized a project originally intended to result in a restatement of corporate law.[1] As the decade long process of reaching consensus on the corporate governance project dragged on, it became what is still one of the most controversial projects the ALI ever attempted.[2] Indeed, one highly respected commentator went so far as to describe the project as “the most controversial event in the history of American corporate law.”[3] Perhaps because of the controversy surrounding the project, it has had little influence on judicial development of corporate law.[4]

Despite this dubious precedent the ALI has returned to the corporate governance field with a proposed Restatement of the Law of Corporate Governance (Restatement).[5] At the ALI’s 2022 annual meeting, the membership considered Tentative Draft No. 1, which contained provisions defining various terms, discussing the duties of care and loyalty, and the social purpose of the corporation.[6] Except for one of the duty of loyalty provisions, the membership approved the draft.[7]

It is probably too late to stop the Restatement project from going forward. The ALI membership voted to approve the idea of a Restatement and subsequently voted to approve most of the first tentative draft. The project has three reporters, all well respected corporate law academics.[8] There are dozens of very prominent and very influential attorneys, judges, and academics acting as advisers to the project.[9] There are 170 ALI members serving as a consultative group.[10] So the project has a lot of inertia and a lot of powerful individuals with a stake in seeing the project come to fruition. Granted, the time and effort expended to date are sunk costs that logically should be ignored in deciding whether to continue the project, but people are not very good at ignoring sunk costs.[11] The train has left the station and is unlikely to be derailed.

Nonetheless, to borrow a phrase from William F. Buckley, it is sometimes necessary to stand “athwart history, yelling Stop,’ especially “when no one is inclined to do so, or to have much patience with those who so urge it.”[12]

Courts are the main audience for Restatements and, as such, their content is “generally common law.”[13] The purpose of a restatement is to clarify “the underlying principles of the common law” that have “become obscured by the ever-growing mass of decisions in the many different jurisdictions, state and federal, within the United States.”[14]

It is here that we come to the crux of the matter. Unlike most common law topics, corporate law is not troubled by the potential for confusion that arises when many competing jurisdictions are all contributing to the development of the law with more or less equal claims to authority.[15] The law of corporate governance, especially that applicable to public corporations, is dominated by a single Leviathan.

Delaware is home to more than half of the public corporations listed for trading on U.S. stock exchanges.[16]Delaware’s share of large public corporations is even higher, with almost two-thirds of Fortune 500 corporations.[17] As far as the larger universe of business entities is concerned, Delaware is home to over 1 million, which consistently places it in the top 5 states of organization.[18] Most business entities form under the laws of their home state, of course, but Delaware is the leading choice of businesses that opt to incorporate outside their home state.[19] Because of the generally accepted choice of law principle known as the internal affair doctrine Delaware law will govern corporate governance disputes regardless of which U.S. jurisdiction in which the dispute is litigated.[20]

Delaware’s dominance of the corporate law field is further enhanced because many state courts follow Delaware law when their own state law does not provide an answer to the question at bar.[21] They presumably do so because of Delaware’s widely acknowledged mass of high-quality corporate law.[22] Even federal courts may look to Delaware law for assistance in interpreting federal law, as the Third Circuit observed in a case interpreting Bankruptcy Code § 328’s requirement that indemnification provisions in employment agreements be reasonable:

We look to Delaware corporate law as a guide primarily because it offers time-tested insights on how courts should best evaluate an issue similar to the one before us. Additionally, Delaware's law often cues the market.[23]

Accordingly, a Restatement of the Law of Corporate Governance is unnecessary. Courts and lawyers will look to the well spring of corporate law for guidance, rather than the product of an unelected think tank whose drafters lack the powerful incentives to get it right to which the Delaware legislature and courts are subject.[24]

Accordingly, I quipped on Twitter that:

We don't need a Restatement of Corporate Governance. We already have one. Folk on the Delaware General Corporation Law: Fundamentals, 2021 Edition . . ..[25]

Either the Restatement of Corporate Governance will restate Delaware law (in which case who needs it) or it will not restate the law but rather propose changes (in which case it will be ignored).[26]

 

Another Comment on Eric Orts' Comment on the ALI's Restatement of Corporate Purpose: Do Constituency Statutes Allow Consideration of Environmental Factors?

A few days ago, I directed your attention to a short article by Professor Eric Orts at the CLS Blue Sky Law Blog, in which he criticized the corporate objective provision of the forthcoming Restatement of the Law of Corporate Governance. (Go read Orts' article and come back.) As I noted, the article is thoughtful, as is typical of Professor Orts' work, for which I have considerable respect, but I disagreed with a couple of points (as is often the case because we have rather different normative priors).

I've decided to do an article on the Restatement provision and in working on it today, I realized I had a couple of other thoughts about Professor Orts' article. In a prior post, I addressed his criticism of the framing of the Restatement's approach whether directors may depart from shareholder value maximization norm. In this post, I address his criticism of the Restatement drafters' treatment of so-called constituency statutes.

The Restatement expressly splits out what it calls “stakeholder jurisdictions” from what it calls “common-law jurisdictions.”[1] Since Pennsylvania adopted the first constituency statute in 1983,[2] thirty states have adopted constituency statutes (a.k.a. non-shareholder constituency statutes or stakeholder statutes).[3] Although the details vary somewhat, the statutes generally authorize directors to consider various factors other than shareholder value maximization when making corporate decisions.[4] Massachusetts’ statute is typical:

(a) A director shall discharge his duties as a director, including his duties as a member of a committee: . . . (3) in a manner the director reasonably believes to be in the best interests of the corporation. In determining what the director reasonably believes to be in the best interests of the corporation, a director may consider the interests of the corporation’s employees, suppliers, creditors and customers, the economy of the state, the region and the nation, community and societal considerations, and the long-term and short-term interests of the corporation and its shareholders, including the possibility that these interests may be best served by the continued independence of the corporation.[5]

The Principles’ drafters did not address these statutes, instead relegating them to the comments, where the drafters opined that “it is clear that such statutes can be interpreted so as to be consistent with § 2.01.”[6]

In the Restatement, constituency statutes are promoted to the black letter law. Oddly, however, the black letter text of § 2.01(a)(2) suggests that in states with a constituency statute it is only licit for directors to consider the interests of various constituencies.[7] As even a cursory reading of the Massachusetts statute suggests, however, the name constituency statutes is somewhat of a misnomer. Massachusetts allows directors to consider such factors as the economy of the state or nation and “societal considerations,” for example, neither of which fit within a conventional definition of constituency.[8] Thirteen other states contain similar provisions.[9]

In contrast, § 2.01(a)(1) explicitly contemplates that directors of corporations in common law jurisdictions may go beyond the interests of the corporation’s constituencies to consider environmental and ethical concerns.[10] This difference led Professor Orts to complain that Restatement § 2.01 “misinterprets the legal import of corporate constituency statutes in a manner that unduly narrows the discretion of corporate directors and managers.”[11]

For example, “the environment” and “ethical considerations” are explicitly included as allowable decision-making factors in common-law jurisdictions but omitted in stakeholder jurisdictions (§ 2.01(a)).  Surely corporate decisionmakers in stakeholder jurisdictions may also take account of environmental and ethical considerations even if they are not specified as stakeholder interests.[12]

I respectfully disagree with Professor Orts’ reading of the constituency statutes. The factors most commonly authorized for director consideration by the statutes are the long-term interests of the corporation, firm profitability, growth prospects, employees, customers, supplies, creditors, and communities.[13] No state explicitly lists the environment as a factor directors are authorized to continue.[14] Only 10 states authorize directors to consider “any other appropriate factors,”[15] which may implicitly authorize consideration of environmental concerns. In this regard, the Restatement drafters got the law right.

Another Comment on Eric Orts' Comment on the ALI's Restatement of Corporate Purpose: Can Directors Act Ethically Without Regard to Profit?

A few days ago, I directed your attention to a short article by Professor Eric Orts at the CLS Blue Sky Law Blog, in which he criticized the corporate objective provision of the forthcoming Restatement of the Law of Corporate Governance. (Go read Orts' article and come back.) As I noted, the article is thoughtful, as is typical of Professor Orts' work, for which I have considerable respect, but I disagreed with a couple of points (as is often the case because we have rather different normative priors).

I've decided to do an article on the Restatement provision and in working on it today, I realized I had a couple of other thoughts about Professor Orts' article. In this post, I address his criticism of the framing of the Restatement's approach whether directors may depart from shareholder value maximization norm.

The ALI's 1994 Principles of Corporate Governance  § 2.01(b) obliged the corporation to obey the law, allowed it to consider appropriate ethical concerns, and allowed to engage in philanthropic activities, in all cases even if doing do did not promote shareholder value or corporate profit. In contrast, in Restatement § 2.01, engaging in philanthropic activities is the only action expressly permitted “whether or not doing so enhances the economic value of the corporation.”[1] The framing by the Restatement’s drafters led Professor Orts to object that:

Allowing only an “economic objective” forces out any ethical or environmental consideration that does not technically qualify as a long-term economic rationalization.  The Restatement’s § 2.01 departs from the recognition in the Principles that ethical considerations may conflict with the economic objective, and that directors and officers may nevertheless follow their consciences in these situations.  (Principles, § 2.01 & cmt. h.)  Even Milton Friedman, a famous (or infamous) champion of the economic objective in business corporations, conceded that profit-seeking must “conform[] to the basic rules of the society, both those embodied in law and those embodied in ethical custom.”  To employ an updated example, doing the right thing with respect to the climate emergency may require a particular firm (such as a big oil company) to sacrifice some profits even as calculated over the long term. The Restatement’s § 2.01 seems instead to require big oil companies to maximize their long-term profits even it means burning our planet beyond all recognition.  It seems also to require a corporation adopting an anti-racist personnel policy to justify it with an economic or “business case” rationale rather than an appeal to an ethics of mutual respect and equal treatment.[2]

It seems unlikely, however, that the drafters intended thereby to effect any substantive change vis-à-vis the Principles. Comment e to § 2.01, for example, states without limitation to specific jurisdictional types that “corporations may take into account their effects on the environment, as well as the social impact of their operations.”[3] Comment e also states that “the economic objective does not imply that the corporation must extract the last penny of profit out of every transaction in which it is involved.” Illustration 6 states that in all jurisdictions it would be licit for a corporation to adopt a mission statement committing the company “to creating a sustainable, low-carbon future, advancing equality and diversity, and fostering employee success.”[4] Illustrations 27 and 28 both involve hypothetical oil companies that voluntarily reduce oil production claiming that doing so will both save the planet and be profitable in the long term.[5] In both, the drafters conclude that § 2.01 is not violated.[6] Given that the business judgment rule almost certainly would protect an informed decision by the board that the reduction would produce sustainable, long-term profits,[7] Professor Orts’ concern seems misplaced.

 

The Spirit Deal Shows Investors are not Embracing Stakeholder Capitalism

It is a core tenet of my forthcoming book, The Profit Motive: In Defense of Shareholder Value Maximization, that investors are far more skeptical of ESG and stakeholder capitalism than their proponents want us to believe. Sure, you can cite survey data in which a substantial number of investors say they love ESG, but things look differently when you look at concrete examples of what investors do. 

As you may know, Spirit Airlines is currently the target of competing takeover bids from Frontier and JetBlue. The union representing Spirit flight attendants reportedly supports the Spirit-Frontier deal, while the union representing JetBlue flight attendants is opposed to the deal. f shareholders are concerned with ensuring that stakeholders like the flight attendants are protected, presumably shareholders would also favor the Frontier deal. But today's WSJ reports:

On Wednesday, [Spirit Airlines] postponed a shareholder meeting scheduled for Friday that would have included a vote on the acquisition bid made by its competitor Frontier Airlines. Spirit’s board of directors retains a strong preference for this merger, which seems like a perfect cultural fit, over a rival one proposed by JetBlue Airways. But the board’s latest move betrays hesitation that shareholders might not put the same value on non-pecuniary factors.

Investing is allegedly about making money and investors can get more of it from JetBlue.

It is an anecdotal example, of course [insert joke about lawyers, anecdotes, and date here.] But it is consistent with a point I make in The Profit Motive:

Turning to shareholders, despite the acknowledged proliferation of socially responsible and ESG investors, it remains the case that when most shareholders invest “in a corporation, they do not think that they are giving their money away.”  To the contrary, they expect “to receive a healthy return on their capital.”  As a harshly critical statement on corporate purpose signed by over 6,000 stakeholder theorists and other progressive academics concluded, “left to their own devices, most capital investors will not care for the dignity of labor investors; nor will they lead the fight against environmental catastrophe.”

Point of Personal Privilege: A Reply to the Letter of 30 Law Professors Supporting the SEC Climate Change Proposal

As regular readers know, I signed the letter of 22 law professors opposing the SEC's pending climate change disclosure regime proposal. Now there is a new letter from 30 law professors supporting the proposal, whose primary authors are Jill Fisch (Penn), George Georgiev (Emory), Donna Nagy (Indiana), and Cynthia Williams (Osgoode Hall). I don't propose a point by point reply to their letter, but I do want to exercise a point of personal privilege and rise in objection to the way the Letter of 30 uses my work.

Back in 2010, the SEC issued interpretative guidance for disclosure of business or legal developments relating to climate change. I wrote a blog post on January 28, 2010, in which I concluded that the guidance didn't change very much and that some of the criticism directed at the guidance was overstated.

The Letter of 30 quotes from that post:

A contemporaneous analysis of the Commission’s 2010 guidance and of critics’ reactions published by one prominent corporate law scholar concluded that “the requirement that firms discuss climate change is not new,” that “[a]ffected corporations already know that they need to provide climate change-related disclosure,” that “[c]orporate lawyers already know how to write such disclosures,” and that “claims that these disclosures will be ‘silly’ or will produce a ‘massive subsidy to charlatans’ are overstated.”⁵⁵ These observations from 2010 are equally valid with respect to the Commission’s 2022 Proposal.

⁵⁵ See Stephen M. Bainbridge, The SEC’s New Climate Control Disclosure Guidance: “Nonsense on Stilts”?, PROFESSORBAINBRIDGE.COM (Jan. 28, 2010) (summarizing and assessing commentary on the 2010 climate guidance, and noting further that the [principles-based] guidance might muddy the water so climate disclosures would become less rather than more informative for investors), https://www.professorbainbridge.com/ professorbainbridgecom/2010/01/climate-control-disclosure.html (last visited: May 29, 2022).

I stand by the 2010 blog post and the Letter of 22. Inconsistent? I don't think so. Rather, with all due deference, I completely reject the claim that my 2010 observations are pertinent to the 2022 proposal.

1. The Times are Different 

In 2010, despite a party-line split on the guidance, the Democrat majority on the SEC was careful to avoid staking out a political position and to at least appear to be keeping politics out of the process. As the Letter of 22 points out, the current Democrat majority on the SEC has jumped into the politics of climate change and come down on one side:

Climate change is a politically-charged issue. The Proposal would compel corporations and officials to regularly speak on these issues, explaining the views and opinions of their boards and officers.

Indeed, the proposal "would require companies to disclose extensive climate-related risks that have little to do with firms’ current financial outlook but serve an ulterior political purpose." The SEC is mandating the new disclosure regime in response to demands from politically powerful institutional investors with a specific progressive political agenda on climate change:

Another subgroup of investors the Proposal unfairly favors are those who, unlike traditional investors, are not focused on economic gain from their investments. For instance, the boards of public employee pension funds, such as CalPERS, include government appointees and elected officials, all of whom respond to politics, including the politics of climate change. Less overtly, the Proposal benefits fund managers promoting virtues other than investor protection, such as the pension funds of the AFL-CIO, which advocate shareholder proposals pushing a labor agenda.

The SEC once prided itself on being one of the most apolitical agencies in the federal government. The 2022 proposal reflects the increasing role political considerations are playing in the SEC's rule making procedures. Not surprisingly, this has generated pushback from Congress, such as the "letters from 19 Senators and 40 House Members challenging the SEC’s power and urging it to withdraw the Proposal."

Context matters. Given the increasingly polarized political debate over climate change, the Letter of 22 counseled that the SEC should defer to Congress on a matter of such “vast economic and political significance.” Indeed, the Letter of 22 suggests that it would be unconstitutional for the SEC to do otherwise.

2. The 2010 Guidance was Modest and Built on Longstanding Principles

Speaking of “vast economic and political significance,” there is an enormous difference between the 2010 Guidance and the 2022 proposal. The 2010 Guidance required only 29 pages. Most of that was background and context. The substantive guidance consisted of just 6 pages of principles-based recommendations. (FWIW, I note in passing that my views on principles-based regulation have evolved since 2010. I'm much more favorably inclined towards that regulatory mode these days, but that it a broad question for another day.)

The 2010 Guidance created no new disclosure requirements. Rather, it provided guidance as to how climate change disclosures might need to be worked into the existing framework. The SEC's 2022 Proposal admits as much:

The guidance did not create new legal requirements nor modify existing ones. Instead, it highlighted climate-related topics that registrants should consider in seeking to meet their existing disclosure obligations (e.g. the impact of legislation, regulation, international accords, indirect consequences, physical risks, etc.) and in what section they should be discussed.

Second, the 2010 Guidance actually was concerned at least as much with the potential adverse impact of climate change regulation as it was with climate change itself. The SEC warned, for example, that "significant developments in federal and state legislation and regulation regarding climate change ... may trigger disclosure obligations." This was self-evidently true. Companies had long included potential regulatory change as a risk factor, to cite but one example. Similarly, the SEC suggested that international accords or treaties might materially impact corporate profitability. In sum, out of the four issues the SEC saw as raising potential disclosure obligations only one related to the "physical effects of climate change."

Third, the 2010 Guidance consistently emphasized the concept of materiality. Climate change issues only had to be disclosed if they met the longstanding definition of materiality.

Fourth, there was no suggestion that every company would have to disclose any particular facts. The 2010 Guidance noted that "regulatory, legislative and other developments" might be significant for "some companies." Likewise, the SEC noted that "some companies might suffer financially" is certain laws were passed. In sum, the phrase "some companies" and "some registrants" appear four times in the 2010 Guidance. In contrast, the phrases "all companies" or "all registrants" do not appear in the guidance.

Finally, the issue of whether to provide disclosure and the issue of how to present it was left to the individual issuer. A typical formulation in the 2010 Guidance provided, for example, that:

Depending on the nature of a registrant’s business and its sensitivity to public opinion, a registrant may have to consider whether the public’s perception of any publicly available data relating to its greenhouse gas emissions could expose it to potential adverse consequences to its business operations or financial condition resulting from reputational damage.

There is no mandated disclosure. There is not even a mandate to consider disclosure. The necessity of disclosure is recognized to depend on company-specific considerations.

In sum, as my blog post from 2010 concluded, the complaints about the 2010 guidance were largely unwarranted. There was no radical change being effected. To be sure, the number of companies including climate change disclosures in their SEC documents rose after the 2010 Guidance was issued. According to a Gibson Dunn analysis, however, the guidance overall had little longterm impact:

... the 2010 Climate Change Guidance was not a focus of SEC staff comments in the years that followed.  According to a 2018 Government Accountability Office report (the “GAO Report”), the SEC staff issued a limited number of climate change comments to public companies and often without citing the 2010 Climate Change Guidance.  For example, the GAO Report noted that based on a review of SEC filings by companies in five industries particularly “affected by climate change-related matters” (oil and gas, mining, insurance, electric and gas utilities, and food and beverage), the SEC staff issued only 14 comment letters relating to climate-related disclosures to 14 companies, out of the over 41,000 comment letters issued from January 1, 2014, through August 11, 2017.

My 2010 self would not have been surprised by that outcome. I anticipated that the negative reaction to the guidance was much ado about little.

3. The 2022 Proposal is a Vast Change that Radically Departs from Traditional Disclosure Practices

The 2022 Proposal is completely different from the 2010 Guidance. The core document is a whopping 490 pages long with 1068 footnotes. 

Unlike the 2010 Guidance, the 2022 Proposal creates an entirely new disclosure regime. According to the SEC's fact sheet, that new regime requires registrants to provide disclosure in 14 categories and sub-categories. The Proposal itself reports that:

We are proposing to add 17 CFR 210.14-01 and 14- 02 (Article 14 of Regulation S-X) and 17 CFR 17 CFR 229.1500 through 1506 (subpart 1500 of Regulation S-K) under the Securities Act1 and the Exchange Act,2 and amend 17 CFR 239.11 (Form S-1), 17 CFR 239.18 (Form S-11), 17 CFR 239.25 (Form S-4), and 17 CFR 239.34 (Form F-4) under the Securities Act, and 17 CFR 249.210 (Form 10), 17 CFR 249.220f (Form 20-F), 17 CFR 249.306 (Form 6-K), 17 CFR 249.308a (Form 10-Q), and 17 CFR 249.310 (Form 10-K) under the Exchange Act.

Unlike the 2010 Guidance, the 2022 Proposal mandates disclosure. For example, it proposes requiring "all registrants to disclose their Scopes 1 and 2 emissions."  In total, the words require, requiring, requirement appear on 386 pages of the proposal. The word mandatory appears on 45.

In fact, the 2022 Proposal itself recognizes that the 2010 guidance is extremely modest compared to the current proposal. At pages 306-307, for example, the Proposal states:

A number of the Commission’s existing disclosure requirements may elicit disclosure about climate-related risks; however, many of these requirements are principles-based in nature and thus the nature and extent of the information provided depends to an extent on the judgmentof management.  As discussed above, in 2010, the Commission published interpretive guidance on existing disclosure requirements as they pertain to business or legal developments related to climate change.  The 2010 Guidance emphasized that if climate-related factors have a material impact on a firm’s financial condition, disclosure may be required under current Item 101 (Description of Business), Item 103 (Legal Proceedings), Item 105 (Risk Factors), or Item 303 (MD&A) of Regulation S-K.

Conclusion

In sum, the 2010 Guidance and the 2022 Proposal are very different beasts. the 2010 Guidance at least arguably was no big deal. The 2022 Proposal is unarguably a very big deal.

I recognize and appreciate that the Letter of 30 took some pains to note that I didn’t think highly of the 2010 Guidance. I also recognize and appreciate that the Letter of 30 deploys my analysis in a section of their letter making a historical argument about earlier environmental and climate-related disclosure rather than in a section dealing specifically with the 2022 Proposal. I also recognize and appreciate that they didn't claim there was an inconsistency between my 2010 post and the Letter of 22.

As such, I would have let the Letter of 30 slide but for the statement that:

These observations from 2010 are equally valid with respect to the Commission’s 2022 Proposal.

It is that statement to which I take umbrage. The rest of the passage seems unobjectionable.

In response to an earlier draft of this post, one of the Letter of 30’s authors has told me via email that the phrase I find objectionable, “equally valid,” applies only to the question clearly stated at the beginning of the paragraph: “Is climate change a ‘novel’ or ‘illegitimate’ subject matter for the disclosure regime?” I accept that that was their intent.

In my view, however, the Letter of 30 can be fairly read to suggest that my argument that corporate lawyers would be able to adapt to the 2010 Guidance without too much difficulty is “equally valid” with respect to the 2022 proposal. I therefore felt it necessary to object to any suggestion that my 2010 analysis is in any way pertinent to the enormous cost I believe will be required to comply with the 2022 Proposal.

A Comment on Eric Orts' Comment on the ALI's Restatement of Corporate Purpose

The American Law Institute has just published the first tentative draft of its new Restatement of the Law of Corporate Governance. Tentative Draft Number 1 is incomplete, but includes a foundational statement on corporate purpose. Section 2.01 is entitled "The Objective of a Corporation" and states that:

(a) The objective of a corporation is to enhance the economic value of the corporation, within the boundaries of the law;

(1) in common-law jurisdictions: for the benefit of the corporation’s shareholders. In doing so, a corporation may consider:

(a) the interests of the corporation’s employees;

(b) the desirability of fostering the corporation’s business relationships with suppliers, customers, and others;

(c) the impact of the corporation’s operations on the community and the environment; and

(d) ethical considerations related to the responsible conduct of business;

(2) in stakeholder jurisdictions: for the benefit of the corporation’s shareholders and/or, to the extent permitted by state law, for the benefit of employees, suppliers, customers, communities, or any other constituencies.

(b) A corporation, in the conduct of its business, may devote a reasonable amount of resources to public-welfare, humanitarian, educational, and philanthropic purposes, whether or not doing so enhances the economic value of the corporation.

As regular readers know, I have been working a lot on corporate purpose over the last two years, so I will have much more to say about the ALI draft as we go forward. Today, I want to direct your attention to a short article by Professor Eric Orts at the CLS Blue Sky Law Blog. (Go read it and come back.) The article is thoughtful, as is typical of Professor Orts' work, for which I have considerable respect, but I disagree with at least a couple of points (as is often the case because we have rather different normative priors).

First, I am far less certain than he that it is possible for corporations to opt out of the shareholder value maximization principle via the articles of incorporation. In fact, that question has been the subject of considerable debate. See, e.g., Joan MacLeod Heminway, Shareholder Wealth Maximization As A Function of Statutes, Decisional Law, and Organic Documents, 74 Wash. & Lee L. Rev. 939, 957 (2017) (arguing that “a charter provision that is inconsistent with the shareholder wealth maximization norm should be valid”); Stefan J. Padfield, The Role of Corporate Personality Theory in Opting Out of Shareholder Wealth Maximization, 19 Transactions: Tenn. J. Bus. L. 415, 439 (2017) (suggesting that “Chancellor Chandler’s comments in the eBay decision suggest that” efforts to opt out of shareholder value maximization may be unavailing). My own view at one time was that “state law arguably does not permit corporate organic documents to redefine the directors’ fiduciary duties.” Stephen M. Bainbridge, Interpreting Nonshareholder Constituency Statutes, 19 Pepp. L. Rev. 971, 985 (1992). Today, however, my view is that it is a question that has been essentially mooted by the availability of the public benefit corporation (PBC) option.

The benefit corporation point leads to my second disagreement. As I read Professor Orts’ analysis, he suggests that we should understand the widespread adoption of PBC statutes as being pertinent to understanding the duties of directors and officers of business corporations incorporated under a state’s general business corporation law. If so, I disagree.

Although it has not done so to date, the widespread availability of PBCs as an alternative to the traditional business corporation could alleviate the growing pressure on the latter to pursue ESG, since they provide an alternative by which social justice activists can pursue their ESG goals while still making a profit. In any case, the widespread adoption of PBC statutes confirms that shareholder value maximization—i.e., Dodge v. Ford Motor Co.—is corporate law’s general rule. After all, if Dodge were not the law, PBCs would be unnecessary. Boards of business corporations would be free to pursue public benefits without violating their fiduciary duties. The perceived need for PBC statutes suggests that boards are not free to do so absent the statute.

The drafters of the California PBC statute presumably had such an argument in mind when they including the following qualification in the statute: “The existence of a provision of this part shall not of itself create any implication that a contrary or different rule of law is or would be applicable to a business corporation that is not a benefit corporation.” Cal. Corp. Code § 14600 (b).