ProfessorBainbridge.com

Yours truly on the Federalization of Corporate Law from a 2009 Federalist Society Program

Public corporations, the public interest, concession theory, and limited liability

Is a private corporation somehow vested with a public interest? Do the facts that formation of a corporation requires a (purely ministerial) state act, that the state provides a set of off the rack rules for corporate governance in its business corporation law, and that that law provides both affirmative and defensive asset partitioning via the rules on limited liability and private creditor access to firm assets make the corporation somehow uniquely subject to regulation in the public interest?

To be sure, some scholars have argued that incorporation—and, in particular, limited liability—is a privilege granted by society that can be revoked at will.[1] This is the once widely shared “concession theory,” pursuant to which the corporation was regarded as a quasi-state actor exercising powers delegated by the state.[2] But it has been over half-a-century since corporate legal theory, of any political or economic stripe, took the concession theory seriously.^[3] See, e.g., Citizens United v. Fed. Election Commn., 558 U.S. 310, 432 (2010) (Stevens, J., concurring in part) (noting that "many legal scholars have long since rejected the concession theory of the corporation").

I note in passing that concession theory is especially problematic for those of us who accept the contractarian model of the firm, because our preferred understanding of the corporation treats corporate law as nothing more than a set of standard form contract terms provided by the state to facilitate private ordering.

Todd Henderson (Chicago Law) and I tackled concession theory as it relates to limited liability in our book Limited Liability: A Legal and Economic Analysis. In it, we explained that:

The notion that the purported privilege of limited liability amounts to a social subsidy in return for which society may demand certain forms of corporate behavior is also flawed. Limited liability is properly regarded as a subsidy only if it constitutes a wealth transfer from one segment of society to another. As Professor Herbert Hovenkamp concludes, however, “[i]t is hard to make such a showing about limited liability.”^[4] To the contrary, society benefits in a variety of ways from limited liability.[5]

In addition, limited liability could be created by contract, at least among the creditors that bargain with the firm. As applied to these creditors—for example, banks, trade creditors, employees, and government agencies—the concession theory makes little sense. In the absence of a limited liability rule, one could be created by contract for them. Nor does it make much more sense for tort creditors. Although tort creditors cannot literally bargain before they are injured, for the reasons discussed in this section, it is likely that the hypothetical bargain they would strike if they could would be limited liability. Of course, after one is injured in a tort, one strictly prefers shareholder unlimited liability. But this is also true for contract creditors! The relevant time of the hypothetical bargain inquiry is before the tort happens. And, at this time, the question is not whether the firm should pay or not, but rather which party is the most efficient bearer of risk. The firm can provide insurance to the victim for the tort, but the party can buy first-party insurance directly from an insurance company, and the government (through the social safety net) can also provide insurance. Once the tort system is seen merely as a way of providing insurance, then the question becomes which of these can provide the lowest cost insurance with the best incentive effects. When answering this question, one must take into consideration both the relative incentive effects the choice will have on the parties, but also the costs of obtaining a judgment or settlement of the claim, including error costs. So, for instance, if obtaining a judgment in litigation is more expensive and more uncertain than obtaining the same relief from an insurance company, net of fees paid, then the latter may be preferable. This is especially true if under prevailing legal standards companies can avoid paying (that is, being pierced) by doing things (such as dotting the I’s and crossing the T’s) that do not materially reduce the risk of harm to potential tort victims.

Are unpublished Delaware Chancery Court transcript rulings "law"?

Delaware Chancery Court rulings can take at least three forms: A published opinion, an unpublished opinion that gets posted to Westlaw, or an unpublished ruling from the bench that is not posted to Westlaw or Lexis but does circulate among the cognoscenti in transcript form. An interesting paper from Delaware practitioner Joel Edan Friedlander addresses the presidential value of the latter category of "opinions":

A large, ever-expanding corpus of unpublished transcript rulings issued by the Delaware Court of Chancery address all aspects of corporate law litigation. Practitioners regularly cite them. Written decisions address them. Yet, the juridical status of these transcript rulings is unsettled. Several years ago, then-Chancellor Strine proclaimed that transcript rulings are not law and have no inhibiting effect on future decisions. In 2020, members of the Court issued written decisions describing in different ways how transcript rulings are of lesser status compared to written rulings.

In this essay I argue that transcript rulings should be considered law in precisely the same way that written Court of Chancery opinions are law. They may be rejected, distinguished, or interpreted narrowly or broadly, but they are thoughtful judgments by expert jurists that warrant consideration in similar, subsequent cases. A practice of categorically disregarding transcript rulings decreases judicial accountability, increases uncertainty, and diminishes a repository of judicial wisdom.

I approach this subject from three perspectives. In Part I, I discuss the background and import of three transcript rulings that gave rise to three of the recent written decisions questioning the precedential value of transcript rulings. In Part II, I discuss the implications of a heated debate two decades ago between two leading federal appellate judges (among many others) about court rules prohibiting the citation of unpublished federal appellate decisions and deeming them non-precedential. In Part III, I discuss four transcript rulings of Leo Strine denying motions to dismiss. They are performances of equity that identify exceptions to rules and illustrate how transcript rulings add to our understanding about the breadth, vitality, slipperiness, and direction of black letter law.

Friedlander, Joel Edan, Performing Equity: Why Court of Chancery Transcript Rulings Are Law (January 4, 2021). U of Penn, Inst for Law & Econ Research Paper No. 20-58, Available at SSRN: https://ssrn.com/abstract=3760722

 

Employee representation on boards

Twenty years ago, I did a lot of work on the question of employee involvement in corporate governance--what we called participatory management back then--and concluded that it didn't make sense for the government to mandate it.

Bainbridge, Stephen Mark, Privately Ordered Participatory Management: An Organizational Failures Analysis (September 1997). Available at SSRN: https://ssrn.com/abstract=38600 or http://dx.doi.org/10.2139/ssrn.38600

American industrial enterprises long organized their production processes in rigid hierarchies in which production-level employees had little discretion or decision making authority. Recently, however, many firms have adopted participatory management programs purporting to give workers a substantially greater degree of input into corporate decisions. Quality circles, self-directed work teams, and employee representation on the board of directors are probably the best-known examples of this phenomenon.

These forms of workplace organization have garnered considerable attention from labor lawyers and economists, but relatively little from corporate law academics. This is unfortunate, both because the tools routinely used by corporate law academics have considerable application to the problem and because employee participation is ultimately a question of corporate governance.

According to conventional academic wisdom, perceptions of procedural justice are important to corporate efficiency. Employee voice promotes a sense of justice, increasing trust and commitment within the enterprise and thus productivity. Workers having a voice in decisions view their tasks as being part of a collaborative effort, rather than as just a job. In turn, this leads to enhanced job satisfaction, which, along with the more flexible work rules often associated with work teams, results in a greater intensity of effort from the firms workers and thus leads to a more efficient firm.

Although this view of participatory management has become nearly hegemonic, the academic literature nevertheless remains somewhat vague when it comes to explaining just why employee involvement should have these beneficial results. In contrast, my article presents a clear explanation of why some firms find employee involvement enhances productivity and, perhaps even more important, why it fails to do so in some firms. Despite the democratic rhetoric of employee involvement, participatory management in fact has done little to disturb the basic hierarchial structure of large corporations. Instead, it is simply an adaptive response to three significant problems created by the tendency in large firms towards excessive levels of hierarchy. First, large branching hierarchies themselves create informational inefficiencies. Second, informational asymmetries persist even under efficient hierarchial structures. Finally, excessive hierarchy impedes effective monitoring of employees. Participatory management facilitates the flow of information from the production level to senior management by creating a mechanism for by-passing mid-level managers, while also bringing to bear a variety of new pressures designed to deter shirking.

Interestingly, there is a new study that reaches conclusions broadly congruent with my analysis.

Blandhol, Christine and Mogstad, Magne and Nilsson, Peter and Vestad, Ola L., Do Employees Benefit from Worker Representation on Corporate Boards? (December 17, 2020). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2020-183, Available at SSRN: https://ssrn.com/abstract=3750960 or http://dx.doi.org/10.2139/ssrn.3750960

Do employees benefit from worker representation on corporate boards? Economists and policymakers are keenly interested in this question – especially lately, as worker representation is widely promoted as an important way to ensure the interests and views of the workers. To investigate this question, we apply a variety of research designs to administrative data from Norway. We find that a worker is paid more and faces less earnings risk if she gets a job in a firm with worker representation on the corporate board. However, these gains in wages and declines in earnings risk are not caused by worker representation per se. Instead, the wage premium and reduced earnings risk reflect that firms with worker representation are likely to be larger and unionized, and that larger and unionized firms tend to both pay a premium and provide better insurance to workers against fluctuations in firm performance. Conditional on the firm’s size and unionization rate, worker representation has little if any effect. Taken together, these findings suggest that while workers may indeed benefit from being employed in firms with worker representation, they would not benefit from legislation mandating worker representation on corporate boards.

 

My book "Corporation Law and Economics" turned up in the oddest place

Well, maybe not the oddest place. But a friend of mine on Facebook spotted this picture on his timeline and sent it to me. The original poster apparently is a French lawyer. Look carefully at the top book.

The book in question is my Corporations: Law and Economic Analysis (2002). It has a LOT more economic analysis than my Concepts and Insights version, so may be especially useful for academics. Lots of director primacy, of course.

 

Does DGCL 271 require shareholder approval when an insolvent corporation transfers all or substantially all of its assets to its secured creditors?

Keith Paul Bishop discusses VC Laster's recent decision in  Stream TV Networks v. SeeCubic, C.A. No. 2020-0310-JTL (Dec. 8, 2020):

On issue in the case was whether Section 271 of the Delaware General Corporation Law requires shareholder approval when an insolvent corporation transfers all or substantially all of its assets to its secured creditors.   Vice Chancellor Laster ruled:

"Interpreting Section 271 to require a stockholder vote before an insolvent or failing  corporation can transfer its assets to secured creditors would conflict with Section 272 of  the DGCL, which authorizes a corporation to mortgage or pledge all of its assets without  complying with Section 271."

As anyone familiar with Court of Chancery rulings, the Vice Chancellor has a lot more to say on the subject.

Keith concludes that California ought to interpret its corresponding statutes the same way.

 

Supreme Court tosses case challenging Delaware's judicial balance requirement for lack of standing, as I anticipated, but Justice Sotomayor's concurrence poses a couple of interesting questions

Regular readers will recall that I did a Supreme Court preview of Carney v. Adams, the case challenging the Delaware requirements that the membership of its courts be balanced between the two major political parties:

Delaware’s state constitution imposes two unique requirements on the state judiciary that differentiates its courts from those of all other states. Under the bare majority rule, no more than half of the total number of the members of the state Supreme and Superior courts and the Chancery Court can be from the same political party (50 percent plus one if there is an odd number of judges). Under the major party rule, those judges must be from a “major” political party.

James R. Adams is a Delaware lawyer who has been frustrated in his search for a Delaware judicial position because he is a political independent. Adams sued Delaware Governor Carney in federal court seeking to have the Delaware provisions declared unconstitutional. Delaware argued that Adams lacked standing and, in the alternative, that the judicial-selection provisions fell within the policymaker exception to the First Amendment’s ban on conditioning state government positions on membership in a specific political party. The district court ruled for Adams on both grounds.

On appeal, the Third Circuit held that Adams had sufficiently pled Article III standing. As to the merits, the Third Circuit addressed solely the major party rule. The court nevertheless struck down both it and the bare majority rule on grounds that the latter was not severable from the former.

Delaware successfully sought a writ of certiorari from the SCOTUS. I predicted that, if the Court reached the Marits, that Delaware should and would win. However, I also noted that:

In granting the state’s petition, however, the Supreme Court required the parties to also address the question of Adams’ standing.

The Supreme Court’s request for briefing on the standing issue suggests that the Court may be zeroing in on two key weaknesses in Adams’ case. First, Adams had been a registered Democrat until February 2017. While registered as a Democrat, Adams had once applied for a position on the state’s Family Court, as to which the major party rule does not apply, but had never applied for a position on any of the three courts to which that rule does apply. Second, since re-registering as an independent in 2017, Adams had considered applying for a Superior Court vacancy and a Supreme Court vacancy, but had not in fact done so. The Third Circuit found that Adams had nevertheless suffered the requisite injury on fact because it would have been futile for him—as an independent—to have done so. The Third Circuit also rejected Delaware’s argument that prudential considerations mitigated against recognizing Adams as having standing. Accordingly, it seems plausible that the Justices who voted to grant the petition may be teeing this cases up as an opportunity to clarify standing rules.

I was right. As Amy Howe explains over at SCOTUSblog:

The Supreme Court on Thursday tossed out a challenge to a Delaware constitutional provision requiring that appointments to the state’s major courts reflect a political balance. The justices unanimously agreed that John Adams, the Delaware lawyer contesting the requirement, lacks a legal right to sue, known as standing, because he did not show that he was “able and ready” to apply for a judgeship on one of the Delaware courts. ...

In a 12-page opinion by Justice Stephen Breyer, the justices agreed unanimously that Adams had not shown the kind of concrete and specific injury that he needed to challenge Delaware’s party-balance requirements. Emphasizing that the dispute before the court was a “highly fact-specific” one, Breyer wrote that Adams would need to show that he was “‘able and ready’ to apply for a judgeship in the reasonably foreseeable future” – which he could not do. Simply arguing that he would apply, without any references to past applications or efforts to determine when a vacancy might open up, is not enough, Breyer reasoned. Taken in context, Breyer posited, Adams’ argument seems to suggest only “an abstract, generalized grievance, not an actual desire to become a judge.” Moreover, allowing Adams’ lawsuit to go forward based only on his “few words of general intent” would “significantly weaken the longstanding legal doctrine preventing this Court from providing advisory opinions.”

Breyer cautioned that the Supreme Court was not deciding whether a statement of intent, without more, might be enough to provide a legal right to sue in another case. “But we are satisfied,” he concluded, “that Adams’ words alone are not enough here when placed in the context of this particular record.”

Interestingly, Howe notes that "Justice Sonia Sotomayor filed a brief concurring opinion in which" she previewed her views of the merits in case the case or a similar one gets back to the Court:

First, she noted, “there are potentially material differences” between the “major party” provision and the “bare majority” provision: the latter is a fairly common requirement that applies to many public bodies, while the former is “far rarer” and “arguably impose[s] a greater burden on” First Amendment rights. Second, she continued, those differences suggest that the best course of action for federal courts considering similar questions in the future might be to ask the state’s highest court for a ruling on whether the “bare majority” provision can survive even if the “major party” provision is deemed unconstitutional.

I'm not an expert on Supreme Court procedure, but it seems odd that she would preview the merits in case tossed for lack of standing. Likewise, I am not a scholar of severability but I wonder whether the constitutionality of the statutes under federal law would turn on a state court's view of whether they are severable. 

Over on Twitter, Ann Lipton opines:

severability is a question of statutory interp - what did the legislature intend. in this case, delaware's.

— Ann Lipton (@AnnMLipton) December 10, 2020

Are management buyouts subject to Corwin or MFW?

I've been grappling with the titular question in writing the fourth edition of my Mergers and Acquisitions treatise. Here's what I've come up with so far:

MBOs are a related party transaction writ very large. As agents and officers of the corporation, the top management team are fiduciaries of the entity and the shareholders. In that capacity, they are obliged to protect the shareholders’ interests and to help ensure that the shareholders get the best possible deal. At the same time, however, they are acting as buyers and have a selfish interest in paying the lowest possible price.[1] Unfortunately, in contrast to the extensive Delaware caselaw on most conflict-of-interest transactions, “the case law on MBOs is remarkably thin. Because there is no case squarely articulating the standard of review for MBOs, commentators generally reason by analogy from non-MBO cases that involve conflicts of interest.”[2]

One potentially applicable body of law comes from DGCL § 144, which governs contracts and transactions “between a corporation and 1 or more of its directors or officers, or between a corporation and any other corporation, partnership, association, or other organization in which 1 or more of its directors or officers, are directors or officers, or have a financial interest . . ..” The acquisition agreement between the corporation and the acquisition special purpose entity created by the management buyout group is just such a contract. Delaware caselaw provides that such transactions will be reviewed under the business judgment rule rather than entire fairness provided it has been approved by either a majority of the disinterested directors or a majority of the disinterested shareholders, provided there has been full disclosure of the material facts relating both to the transaction and to the management group’s conflict of interest.[3]

An alternative body of case law on which one might draw by way of analogy is provided by Revlon and its progeny. An MBO of a public corporation typically will constitute a sale of control. The firm goes from being owned by a large and diffuse collection of shareholders to being a privately held company owned by the management group and their private equity ally. As such, MBOs commonly should be subject to review under Revlon.[4] Accordingly, one might expect that the transaction should be subject to business judgment review if the target’s board complies with Corwin.[5] A widely used M&A treatise, however, claims that Corwin does not apply to MBOs because such transactions involve a controller on both sides of the transaction.[6] One might nevertheless argue that Corwin should apply to MBO for at least two reasons. First, the conflict of interest inherent in an MBO arguably is not as severe as is the case in controlling shareholder transactions. Unlike the case in which there is a controlling shareholder, the directors do not owe their election and positions to the management group. Second, Corwin’s rule that the business judgment rule applies when the transaction is approved by a fully informed vote of a majority of the disinterested shareholders parallels the analysis of shareholder approval under § 144.[7]

Having said that, however, there are some situations in which the entire fairness standard of Weinberger and its progeny applies to MBOs. In In re Cysive, Inc. Shareholders Litig.,[8] for example, a management buyout by the target’s CEO was subject to entire fairness review because the CEO was also the target’s controlling shareholder. In the older Mills Acq. Co. v. Macmillan, Inc.,[9] an MBO was subjected to entire fairness review where the board allowed the management group to control the decision-making process. In such cases, the standard of review should shift to the business judgment rule if the board complies with MFW.[10]

Can a Corporation Contract Out of (or Around) Appraisal? Updated

A friend (who uses my casebook, which gets him extra points) sent along this email:

I assume it is possible for a corporation to contract around appraisal in some meaningful way, but I'm having trouble finding a supporting citation.  Any suggestions?

For those joining us late, I explain in my book Mergers and Acquisitions

Mergers and sales of all or substantially all corporate assets can be likened to a form of private eminent domain. If the requisite statutory number of shares approves the transaction, dissenting shareholders have no statutory basis for preventing the merger. Granted, some of the minority shareholders may believe that the merger that is being forced upon them is unfair. They may want to retain their investment in the target or they may believe that the price is unfair.

Corporate statutes give hold-out shareholders no remedy where they simply want to keep their target shares—the statutes permit majority shareholders to effect a freeze-out merger to eliminate the minority. All the statute gives disgruntled shareholders is a right to complain about the fairness of the price being paid for their shares; namely, the appraisal remedy.

In theory, appraisal rights are quite straightforward. Briefly, they give shareholders who dissent from a merger the right to have the fair value of their shares determined and paid to them in cash, provided the shareholders comply with the convoluted statutory procedures.

Obviously, appraisal crops up in purchase agreements. Practical Law tells us that buyers sometimes "demand appraisal-rights closing conditions in their merger agreements. An appraisal-rights closing condition places a maximum limit on the percentage of common stock that can demand appraisal before the buyer can refuse to close." In addition, sellers sometimes offer a representation that appraisal rights are not available in connection with the transaction.

Also, of course, appraisal statutes commonly provide a "market" out that eliminates appraisal rights in certain transactions. Again, we turn to Practical Law:

Delaware, along with several other states (such as California, New Jersey, Texas, and Pennsylvania), maintains an exception to a stockholders' right to an appraisal. This exception, commonly known as the "market-out" exception, is based on whether a stockholder owns shares of a public company or stock that is held by a significant number of stockholders.

The market-out exception presumes that stockholders do not need appraisal rights when they are not being cashed out in the merger and there is a public and liquid market for their stock. If they disagree with a transaction, stockholders can sell their stock in the open market for the fair market value rather than involve the courts.

In Delaware, the market-out exception is only available if stockholders hold stock that is either:

• Listed on a national securities exchange.
• Held of record by more than 2,000 holders. (8 Del. C. § 262(b)(1).)

As of August 1, 2018, the market-out exception applies equally to two-step mergers conducted as front-end tender offers under Section 251(h) of the DGCL. ...

In Delaware, a stockholder owning public company shares listed on a national securities exchange regains the right to a statutory appraisal if the stockholder has to accept anything in the transaction other than:

• Stock of the surviving corporation.
• Stock of any other corporation that is or will be listed on a national securities exchange or held by more than 2,000 stockholders.
• Cash in lieu of fractional shares.
• Any combination of the above. (8 Del. C. § 262(b)(2)(a)-(d).)

None of this, however, speaks to the query. The question was whether you can get out of appraisal by contract. Before we can answer that query, however, we need to further refine it. Could the corporation include a provision in the articles of incorporation eliminating or limiting appraisal rights? Could the shareholders enter into a shareholder agreement that limited or eliminated appraisal rights? Does it matter whether we are talking about a public or a closely held corporation?

I start by looking at DGCL § 262, the appraisal statute. I don't see anything therein that provides a contractual out.

I then turned to the Model Business Corporation Act, which devotes an entire chapter (13) to what it calls dissenter rights. Section 13.02(c) provides a limited option to limit or eliminate appraisal rights:

... the articles of incorporation as originally filed or any amendment to the articles of incorporation may limit or eliminate appraisal rights for any class or series of preferred shares, except that (i) no such limitation or elimination shall be effective if the class or series does not have the right to vote separately as a voting group (alone or as part of a group) on the action or if the action is a conversion under section 9.30, or a merger having a similar effect as a conversion in which the converted entity is an eligible entity, and (ii) any such limitation or elimination contained in an amendment to the articles of incorporation that limits or eliminates appraisal rights for any of such shares that are outstanding immediately before the effective date of such amendment or that the corporation is or may be required to issue or sell thereafter pursuant to any conversion, exchange or other right existing immediately before the effective date of such amendment shall not apply to any corporate action that becomes effective within one year after the effective date of such amendment if such action would otherwise afford appraisal rights.

If you think of the articles as a contract (as I do), we have here a limited contract out. But it's very limited. In particular, it doesn't apply to common stock.

So I then turned to MBCA § 7.32, which governs shareholder agreements. It effectively only applies to close corporations, since it requires unanimity among the shareholders.

Nothing in § 7.32 expressly authorizes contracting out of appraisal, but there is a fairly broad catchall:

(a) An agreement among the shareholders of a corporation that complies with this section is effective among the shareholders and the corporation even though it is inconsistent with one or more other provisions of this Act in that it: ...

(8) otherwise governs the exercise of the corporate powers or the management of the business and affairs of the corporation or the relationship among the shareholders, the directors and the corporation, or among any of them, and is not contrary to public policy.

The commentary explains that:

Although the limits of section 7.32(a)(8) are left uncertain, there are provisions of the Act that may not be overridden if they reflect core principles of public policy with respect to corporate affairs. For example, a provision of a shareholder agreement that purports to eliminate all of the standards of conduct established under section 8.30 might be viewed as contrary to public policy and thus not validated under section 7.32(a)(8). Similarly, a provision that exculpates directors from liability more broadly than permitted by section 2.02(b)(4), or indemnifies them more broadly than permitted by section 2.02(b)(5), might not be validated under section 7.32 because of strong public policy reasons for the statutory limitations on the right to exculpate directors from liability and to indemnify them. The validity of some provisions may depend upon the circumstances. For example, a provision of a shareholder agreement that limited inspection rights under section 16.02 or the right to financial statements under section 16.20 might, as a general matter, be valid, but that provision might not be given effect if it prevented shareholders from obtaining information necessary to determine whether directors of the corporation have satisfied the standards of conduct under section 8.30. The foregoing are examples and are not intended to be exclusive.

Do dissenter rights "reflect core principles of public policy with respect to corporate affairs," such that they would fall within the non-exclusive list of provisions that may not be modified by contract? I was unable to find anything in the MBCA text or commentary that spoke to that issue.

Interestingly, however, Florida's version of § 7.32 formerly provided that:

For purposes of this paragraph, agreements contrary to public policy include, but are not limited to, agreements that reduce the duties of care and loyalty to the corporation as required by ss. 607.0830 and 607.0832, exculpate directors from liability that may be imposed under § 607.0831, adversely affect shareholders' rights to bring derivative actions under s. 607.07401, or abrogate dissenters' rights under §§ 607.1301-607.1320.30

Since Florida is an MBCA state, that sent me back to the history of § 7.32. The statutory comparison included in the MBCA Annotated says that Florida's version of § 7.32(a)(8) was unique.

A Westlaw search for the phrase "public policy" /s "dissent! right!" turned up noting pertinent except for a few references to the Florida statute. A search for the phrase "public policy" /s "appraisal! right!" kicked up one case claiming that courts have "have found a de facto merger or a continuation of the enterprise [where they] have involved public policy considerations which favor compensating tort victims or appraisal rights to minority shareholders." Atlas Tool Co., Inc. v. C. I. R., 614 F.2d 860, 871 (3d Cir. 1980). But the court cited only one case, Knapp v. N. Am. Rockwell Corp., 506 F.2d 361, 367 (3d Cir. 1974), which was a tort case not an appraisal case. A few courts have quoted Atlas, but without useful elaboration. 

A Westlaw search for (contract! /5 (around out)) /s "appraisal! right!" found only two results. The first was an article by Ian Ayres from 1991, in which he asserted that:

In the corporate context, for example, most states allow shareholders to contract around the default of preemption rights in the corporation's articles of incorporation, but minority appraisal rights are an immutable part of any corporate form of business. See Black, Is Corporate Law Trivial?: A Political and Economic Analysis, 84 NW. U.L. Rev. 542 (1990); see generally Bebchuk, The Debate on Contractual Freedom in Corporate Law, 89 Colum. L. Rev. 1395 (1989) (discussing mandatory and enabling aspects of corporate law).

Ian Ayres, Back to Basics: Regulating How Corporations Speak to the Market, 77 Va. L. Rev. 945, 999 (1991). As far as I could find, however, neither the Black nor the Bebchuk article speaks to contracting out of appraisal.

The other reference was a 1999 article by John Coates, in which he wrote that:

Some commentators have noted an alternative method for corporations in many jurisdictions to effectively avoid appraisal rights through the choice of transaction structure. See, e.g., Roberta Romano, Answering the Wrong Question: The Tenuous Case for Mandatory Corporate Laws, 89 Colum. L. Rev. 1599, 1600 (1989) (noting that the ability to choose transaction structure makes the rule that shareholders must vote on mergers “completely optional”). For example, the sale of substantially all of a Delaware corporation's assets does not trigger appraisal rights, while a merger does. Compared to “fair price” charter provisions, buy/sell agreements, and redeemable common stock (“discount contracts”), transaction choice is a blunt weapon. Discount contracts vary from traditional corporate structures only by specifying how the “fair value” will be determined. In addition, transaction choice only permits contracting around appraisal rights.

John C. Coates IV, "Fair Value" As an Avoidable Rule of Corporate Law: Minority Discounts in Conflict Transactions, 147 U. Pa. L. Rev. 1251, 1353 n.130 (1999). But this is not the sort of contracting out with which we are concerned. Instead, it's a transactional engineering out by opting for a transaction structure for which the law does not grant appraisal rights.

Turning back to Delaware law, it turns out that there are cases holding that preferred stockholders can waive appraisal rights. In Matter of Appraisal of Ford Holdings, Inc. Preferred Stock, 698 A.2d 973, 977 (Del. Ch. 1997), the certificate of designation governing the rights of the preferred stock in question purportedly limited appraisal rights by contractually specifying the price to be paid the preferred in the event a cash-out merger. Famed Delaware Chancellor William Allen began his analysis by noting that "preferred stock is a very special case." He went on to explain that:

All of the characteristics of the preferred are open for negotiation; that is the nature of the security. There is no utility in defining as forbidden any term thought advantageous to informed parties, unless that term violates substantive law. ...

It is my judgment ... that the terms of the Designations of the Cumulative Preferred clearly describe an agreement between the shareholders and the company regarding the consideration to be received by the shareholders in the event of a cash-out merger. There is no ambiguity ... regarding the value to be paid to shareholders if they are forced to give up their shares in a cash-out merger. The shareholders can not now come to this court seeking additional consideration in the merger through the appraisal process. Their security had a stated value in a merger which they have received.

See also In re Appraisal of Metromedia Intern. Group, Inc., 971 A.2d 893, 900 (Del. Ch. 2009) ("Given the contractual nature of preferred stock, a clear contractual provision that establishes the value of preferred stock in the event of a cash-out merger is not inconsistent with the language or the policy of § 262.").

But what about common shareholders?

At this point, I heard from a couple of friends who are experienced M&A practitioners. One pointed me to Manti Holdings, LLC v. Authentix Acq. Co., Inc., CV 2017-0887-SG, 2019 WL 3814453 (Del. Ch. Aug. 14, 2019). The shareholders of Authentix, Inc., a Delaware corporation, negotiated a merger with The Carlyle Group (a private equity fund manager). Under the terms of the deal, the former Authentix shareholders would remain shareholders of the post-merger entity, but with Carlyle now as a majority shareholder. The former Authentic shareholders, with the advice of counsel, unanimously entered into a shareholder agreement (SA) that waived any appraisal rights the shareholders might have in connection with the merger. In an unpublished opinion, Vice Chancellor Glasscock explained that:

The SA was not a contract of adhesion. As provided in the supplemental Joint Stipulation of Fact, the Petitioners—who were, I find, sophisticated parties—were represented by counsel, who exchanged drafts of the proposed SA before agreeing to a final contract. In other words, the sole owners of Authentix, Inc., with the help of counsel, negotiated the terms of the SA, as part of the 2008 merger with the Carlyle entity, Authentix, which merger was, I presume, valuable to the Petitioners. One of the provisions in that negotiated contract was, as I have found, a waiver of appraisal rights at issue here. The SA also rigorously limits the Petitioners' rights to sell their shares: the Carlyle majority must approve any sale, and the buyer must consent in writing to be bound by the SA's terms, including the waiver of appraisal rights. Presumably, the Petitioners have enjoyed the benefit of their bargain, through the time of the sale of Authentix.

The Vice Chancellor went on to hold that:

The SA is a clear, unambiguous contract, created as part of a merger, that was entered into by sophisticated parties, including the Petitioners here, who owned the entire interest in the entity to be merged. Modification of a statutory right to appraisal “must be express or at least very clearly implied.” This reasoning—that waiver of a party's rights is permitted, but must be clear—is found elsewhere in our law.

Here, Authentix Inc. was a private company (as is Authentix), and the Petitioners were its sole stockholders. There is no record evidence that the Petitioners were not fully informed; to the contrary, there is evidence that the Petitioners are sophisticated investors who were fully informed and represented by counsel when they signed the SA, under which they obtained some rights and relinquished others, and then accepted the benefits of that contract for seven years. The SA clearly and unambiguously waives appraisal rights; therefore, it should be enforced. I need not decide whether a waiver of appraisal would be upheld in other circumstances.

Notice the emphasis on four points: (1) this was a privately held company; (2) there was unanimity among the shareholders; (3) the parties were sophisticated investors represented by counsel; and (4) the terms are clear. To the extent Manti stands for the proposition that you can contract out of appraisal, it provides a very limited contractual out. 

My other friend sent along this detailed note:

... venture capital investors routinely waive appraisal rights. The standard National Venture Capital Association form of Voting Agreement provides, in pertinent part, that the investor agrees "to refrain from (i) exercising any dissenters’ rights or rights of appraisal under applicable law at any time with respect to such Sale of the Company, (ii) asserting any claim or commencing any suit (x) challenging the Sale of the Company or this Agreement, or alleging a breach of any fiduciary duty of the Requisite Parties or any affiliate or associate thereof (including, without limitation, aiding and abetting breach of fiduciary duty) in connection with the evaluation, negotiation or entry into the Sale of the Company, or the consummation of the transactions contemplated thereby...."

So it looks like you can ex ante waive appraisal via a unanimous shareholder agreement in a closely held corporation (possibly excepting Florida corporations), and at least limit appraisal rights of preferred stock in the certificate of designation. As for common shareholders of public corporations, however, it seems doubtful.

In closing, I feel constrained to ask: What other casebook author gives you this sort of service?

Update: A friend sent along a link to an article by Jill Fisch:

A judicial determination of fair value in a private company can be a difficult and imprecise process. This difficulty coupled with variations in way mergers are negotiated and structured and the potential for conflicts of interest lend uncertainty to appraisal proceedings. As a result, corporate participants have powerful reasons to seek to limit the uncertainty associated with an appraisal proceeding ex ante. The response has been the growing use of shareholder agreements that limit appraisal rights.

Appraisal waivers also offer a potentially attractive solution to a somewhat different concern, the growth of appraisal litigation in publicly traded companies. As with private companies, public companies face the problem that appraisal proceedings involve substantial cost and uncertainty. Although courts and commentators have grappled with how best to calculate fair value and the impact of that methodology on the incentives of participants in the merger process, they have failed to reach consensus. Appraisal waivers provide an alternative approach - a market-based mechanism to determine the efficient level of merger litigation.

Public companies have not followed the lead of private companies, however, in using appraisal waivers. As this Article explains, the likely reason is the impracticality of using shareholder agreements in public companies and a concern that appraisal waivers in a charter or bylaw would be invalid.

This Article considers both the normative and legal case for appraisal waivers. It argues that, with appropriate procedural protections – specifically the requirement that such waivers take the form of charter provisions -- appraisal waivers are normatively desirable. It then questions whether distinguishing between the use of appraisal waivers in private and public companies is appropriate and argues that it is not. The source of this distinction is a potential difference in the scope of private ordering available through shareholder agreements as opposed to the charter or bylaws, a difference that this Article critiques.

The Article concludes that, under current law, the legal status of appraisal waivers is unclear. Given the potential value that such waivers provide, and the particular value that market discipline would bring to the scope and structure of such waivers, the Article argues for legislation validating a corporation’s authority to limit or eliminate appraisal rights in its charter.

Fisch, Jill E., Appraisal Waivers (August 2, 2020). U of Penn, Inst for Law & Econ Research Paper No. 20-47, European Corporate Governance Institute - Law Working Paper No. 537/2020, Available at SSRN: https://ssrn.com/abstract=3667058 or http://dx.doi.org/10.2139/ssrn.3667058

The Chancery Daily Takes Note of Ann Lipton and Yours Truly's Commentary on Aronson and Rales

Thanks to my friend and fellow corporate law blogger Francis G.X. Pileggi who sent along an excerpt from The Chancery Daily that picked up on some of my recent blog work:

Fprtunately, TCD is more interested in learned exploration of Delaware case law than it is in claiming credit for have discovered anything. Accordingly, we are more than happy to direct subscribers to the learned analyses of others -- and we are aware of two such analyses of VCL's Facebook decision, which takes the great big Capital "O" step of proposing the retirement of the demand futility test under Senior Aronson, et al. v. Harry Lewis, No. 203, 1983, opinion (Del. Mar. 1, 1984), and adoption of the demand futility test under Steven M. Rales, et al. v. Alfred Blasband, No. 210, 1993, opinion (Del. Dec. 22, 1993; rev. Dec. 23, 1993), as the single standard applicable under Delaware law. Zuckerberg explains the reasoning for this in characteristic VCL deep-dive fashion, but we also note Professor Steven Bainbridge's A brief essay on Delaware Vice Chancellor Laster's Argument for Replacing Aronson with Rales, and Professor Ann Lipton's Not All Heroes Wear Capes -- both of which strike TCD as well-considered and informed by a kindred "don't let the door hit you in the *** on your way out, Aronson" sentiment. As TCD revisits those posts for purposes of retrieving hyperlinks, we note that Professor Bainbridge responded to one aspect of Professor Lipton's post with Professor Lipton asks "What about Blasius?" Well, what about it? TCD recalls Blasius having been referenced to a limited degree earlier this year in Marion Coster v. UIP Companies, Inc., et al., C.A. No. 2018-0440-KSJM (consol.), memo. op. (Del. Ch. Jan. 28, 2020), but we are unaware of it being an issue of current active litigation . . . so it's probably best that we just leave it at that.

Thanks much. But I do wish they had spelled my name correctly. It's Stephen, not Steven.

What Josh Fershee Believes

Fershee, Joshua Paul, This, I Believe: A New Look at Corporate Purpose, Director Primacy and the Business Judgment Rule (September 8, 2020). Transactions: The Tennessee Journal of Business Law, , Vol. 21, pp. 301-10, 2020, Available at SSRN: https://ssrn.com/abstract=3689236

I believe in the theory of Director Primacy. I believe in the Business Judgment Rule as an abstention doctrine, and I believe that Corporate Social Responsibility is choice, not a mandate. I believe in long-term planning over short-term profits, but I believe that directors get to choose either one to be the focus of their companies. I believe that directors can choose to pursue profit through corporate philanthropy and good works in the community or through mergers and acquisitions with a plan to slash worker benefits and sell-off a business in pieces. I believe that a corporation can make religious-based decisions — such as closing on Sundays — and that a corporation can make worker-based decisions — such as providing top-quality health care and parental leave — but I believe both such bases for decisions must be rooted in the directors’ judgment such decisions will maximize the value of the business for shareholders for the decision to get the benefit of business judgment rule protection. I believe that directors, and not shareholders or judges, should make decisions about how a company should pursue profit and stability. I believe that public companies should be able to plan like private companies, and I believe the decision to expand or change a business model is the decision of the directors and only the directors. I believe that respect for directors’ business judgment allows for coexistence of companies of multiple views — from CVS Caremark and craigslist to Wal-Mart and Hobby Lobby — without necessarily violating any shareholder wealth maximization norms. Finally, I believe that the exercise of business judgment should not be run through a liberal or conservative filter because liberal and conservative business leaders have both been responsible for massive long-term wealth creation. This, I believe.

It's not a bad creed.

Professor Lipton asks "What about Blasius?" Well, what about it?

In the preceding post, I commended to your attention Professor Ann Lipton's thoughtful post on VC Laster's recent decision in United Food & Commercial Workers Union v. Zuckerberg. (As she kindly notes, I also blogged about that case recently.)

After the extended and useful discussion of how the case exemplifies some of the key "pathologies associated with the common law," Ann turns to the merits of the case:

... when it comes to the underlying substantive dispute in Zuckerberg, I’m not sure I agree with Laster’s analysis.

The lawsuit arose out of Mark Zuckerberg’s ill-fated proposal to amend Facebook’s charter to create a class of no-vote shares, essentially to allow him to transfer much of his financial interest in the company while maintaining his hold on the high-vote B shares that give him control.  As many will recall, the Board recommended the charter amendment and the shareholders – dominated by Zuckerberg’s high vote shares – voted in favor, but in a subsequent lawsuit, stockholder-plaintiffs uncovered multiple irregularities that had occurred in the course of negotiating the proposal.  Zuckerberg dropped the plan, and that was that, until new plaintiffs brought a derivative lawsuit alleging that even though the plan was abandoned, all of the expenditures associated with it damaged the company.  Thus, the question before Laster was whether the Facebook Board was sufficiently disinterested and independent to decide whether to bring a lawsuit over the Board’s earlier approval of the charter amendments, namely, whether to sue many of its own members.  And that question turned, in part, on whether Reed Hastings and Peter Thiel, two of Facebook’s Board members, faced a substantial risk of liability for having voted in favor of the charter amendment in the first place.

So really, part of the underlying legal question here was whether Hastings and Thiel breached their duties of loyalty by recommending the charter amendment.  The plaintiffs argued, in part, that they did so because they were “biased” in favor of founder control – namely, they believed that corporate founders should be able to run their companies free from the meddling influence of public shareholders.

Laster held that even if this was their reasoning, it did not constitute a lack of loyalty:

A director could believe in good faith that it is generally optimal for companies to be controlled by their founders and that this governance structure is value-maximizing for the corporation and its stockholders over the long-term. Others might differ. As long as an otherwise independent and disinterested director has a rational basis for her belief, that director is entitled (indeed obligated) to make decisions in good faith based on what she subjectively believes will maximize the long-term value of the corporation for the ultimate benefit of its residual claimants.  If a director believes that it will be better for the corporation to have the founder remain in control, then the director may make decisions to achieve that goal. As long as a director acts in good faith, exercises due care, and does not otherwise have any compromising interests, a director will not face liability for making a decision that she believes will maximize the long-term value of the corporation for the ultimate benefit of its residual claimants,…

The belief that founder control benefits corporations and their stockholders over the long run is debatable, but it is not irrational.

To which I respond – what about Blasius?

In Blasius Industries v. Atlas, an incumbent board maneuvered to neuter the effects of shareholder consents that would otherwise have replaced it with a dissident slate. Chancellor Allen held that even if the Board sincerely and in good faith believed the dissident slate would harm the company and its own plans were better for shareholders, the incumbents would violate their fiduciary duties by taking the choice out of the shareholders’ hands. 

To which I respond, well, what about Blasius? I have huge respect for Chancellor Allen. But even mighty Homer nodded. Allen's record has more than a few glitches. Caremark was wrong when decided and gave birth to an increasingly awful body of law. Credit Lyonnais was a disaster waiting to happen, although the Delaware Supreme Court managed to nip that one in the bud. And Blasius may be the worst of the bunch.

By the way, I discuss Blasius in my new Advanced Corporation Law text (and it as much a text as it is a casebook, so practicing lawyers will want a copy too).

Ever since Allen invented Blasius, the Delaware courts have struggled to figure out what to do with it.As Former Delaware Chief Justice Leo Strine aptly observed in an opinion written while he was still on the Chancery Court, Blasius is not "a genuine standard of review that is useful for the determination of cases," but rather "an after-the-fact label placed on a result." Mercier v. Inter-Tel (Delaware), Inc., 929 A.2d 786, 788 (Del. Ch. 2007). 

Indeed, as Strine also observed, post-Blasius cases are commonly “threshold exertions in reasoning as to why director action influencing the ability of stockholders to act did not amount to disenfranchisement, thus obviating the need to apply Blasius at all.” Id. at 806. Personally, I think they're embarrassed by it and the failure to overturn it is one of those pathologies about which Professor Lipton was writing.

One of the first things the Delaware courts did to limit Blasius was to effectively subsume Blasius into the Unocal standard "where the board 'adopts any defensive measure taken in response to some threat to corporate policy and effectiveness which touches upon issues of control.'” Stroud v. Grace, 606 A.2d 75, 92 n.3 (Del. 1992)

Shortly thereafter they limited Blasius to cases of unilateral board action. See, e.g., Williams v. Geier, 671 A.2d 1368, 1376 (Del. 1996) ("Blasius is appropriate only where the primary purpose of the board's action [is] to interfere with or impede exercise of the shareholder franchise, and the stockholders are not given a full and fair opportunity to vote"; internal quotation marks deleted).

Strine built on that foundation when he was a Vice Chancellor Portnoy v. Cryo-Cell Int’l, Inc.,940 A.2d 43 (Del. Ch. 2008). He declined to apply Blasius to vote buying. To be sure, Strine’s opinion in Portnoy can be seen as part of a larger trend in Delaware corporate law towards judicial deference to informed, non-coerced shareholder votes. But if Blasius doesn't reach vote buying, what's left of it?

In another case, Strne declined to apply Blasius where the board of directors timed a shareholder vote to be held before a dual class capital structure expired even though the board knew that after that structure expired a favorable vote would be much harder to obtain.  In re Gaylord Container Corp. S'holders Litig., 753 A.2d 462, 469, 486-87 (Del. Ch. 2000) (Strine, VC). 

In light of such decisions, a New York court has suggested that Blasius is now limited to proxy contests involving director elections:

Blasius a... application has been largely limited to disputes over the election of directors. Accordingly, “courts will apply the exacting Blasius standard sparingly, and only in circumstances in which self-interested or faithless fiduciaries act to deprive stockholders of a full and fair opportunity to participate in the matter.” Of particular significance here, “the reasoning of Blasius is far less powerful when the matter up for consideration has little or no bearing on whether the directors will continue in office."

In re Bear Stearns Litig., 870 N.Y.S.2d 709, 733 (N.Y. Sup. 2008) (citations and footnote omitted).

So what about Blasius? "Blasius is simply an unworkable standard of review, as once a court triggers Blasius, it would seem impossible for the directors to provide a compelling justification for disenfranchising their shareholders.” Mary Siegel, The Problems and Promise of "Enhanced Business Judgment", 17 U. Pa. J. Bus. L. 47, 81 (2014).

It is also an unnecessary standard. In Schnell v. Chris-Craft Indus., Inc., 285 A.2d 437, 439 (Del.1971), the Delaware Supreme Court held that “inequitable action does not become permissible simply because it is legally possible."

The Schnell decision has been routinely used to strike down board of director action that improperly infringed on shareholder voting. Consider, for example, the unjustly overlooked case of Alpha Sunde Smaby and her almost successful campaign to be elected to the board of Northern States Power Company. The company used cumulative voting to elect directors. Smaby was put forward with support from environmental and consumer groups. Under the prevailing articles and bylaws, Smaby needed about 7% of the votes to be elected. She was thought likely to get the votes of about 9%. The board amended the bylaws to reduce the number of directors from 14 to 12 and to adopt a classified board. Under the new bylaws, with three classes of four directors each and only one class up for election in the current year, Smaby needed 20% of the votes to win. In reliance on Schnell, the court struck down the bylaw changes: 

In the instant case, the actions of the insiders, if not unfair, were certainly questionable in light of their fiduciary obligation to the plaintiff shareholders. Not only did the defendants change the rules in the middle of the game, but they refused to disclose the existence of the changes when approached by the plaintiffs. Both of these actions served to frustrate the plaintiff shareholders’ legitimate efforts to run for the Board of Directors and may well be a breach of fiduciary duty. ...

Coalition to Advocate Public Utility Responsibility, Inc. v. Engels, 364 F. Supp. 1202 (D. Minn. 1973). (It's in my Advanced Corporation Law book.) What more do you need?

Finally, and I will not expound on this point at any length, Blasius is fundamentally flawed because it rests on a deeply erroneous premise. It rests on Allen's belief that corporate law assumes corporate democracy. Disproving that claim, of course, has been my principal contribution to corporate law and my principal claim to fame. For a concise treatment, I refer you to my book The New Corporate Governance in Theory and Practice.

Recommended Corporate Law Reading: Lipton on Laster on Aronson and Rales

Ann Lipton has a great post on VC Laster's recent decision in United Food & Commercial Workers Union v. Zuckerberg. As she kindly notes, I blogged about that case recently. 

Ann uses the case as a launching pad for an extended discussion on "the pathologies associated with the common law." Here's a brief taste:

... the Aronson test conflated the issue of objectivity with respect to bringing a lawsuitwith liability on the underlying claim, and phrased the former in terms of the latter.

As time wore on, that conflation made the Aronson test difficult and confusing to apply ....

And here’s the part that’s interesting to me: Why would the law persist in this obviously maladaptive way?  Because, I believe, no litigant had any interest in arguing for a change.  At the end of the day, Rales and Aronson are asking the same question, and regardless of which is used, they come out the same way – a point that several Delaware courts have made.  Which means neither plaintiff nor defendant had much of an interest in briefing the distinction or arguing the law should be changed, and they didn’t.  Without any litigants to press for clarification, Delaware courts allowed this state of affairs to continue and torture corporate law professors and junior associates throughout the land.

It's a great analysis and I recommend popping over to give it a read.

If your corporate clients have their principal executive office in California, tell them to move

Keith Paul Bishop adds yet another reason to the ever growing list of reasons why companies should get their principal executive office out of California.

 

Fried and Wang on Short-termism in the EU

Are you as tired of the short-termism debate as I am? But the beat goes on and there is an interesting new paper from Harvard law professor Jesse Fried and Harvard business professor Charles Wang on short-termism in the EU:

Investor-driven "short-termism'" is said to harm EU public firms' ability to invest for the long term, prompting calls for the EU to better insulate managers from shareholder pressure. But the evidence offered---in the form of rising levels of repurchases and dividends---is incomplete and misleading, as it ignores large offsetting equity issuances that move capital from investors to EU firms. We show that net shareholder payouts have been moderate, that both investment levels and investment intensity have been rising, and that cash balances have increased. In sum, the data provide little basis for the view that short-termism in the EU warrants corporate governance reforms.

Fried, Jesse M. and Wang, Charles C. Y., Short-Termism, Shareholder Payouts, and Investment in the EU (October 9, 2020). European Corporate Governance Institute - Law Working Paper 544/2020, Available at SSRN: https://ssrn.com/abstract=3706499 or http://dx.doi.org/10.2139/ssrn.3706499

As typical of Jesse's work, it's very well done and deserves close attention.