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Recommended reading: Georgiev on Human Capital Management and Corporate Law

My friend George Georgiev has a new article on the longstanding question of whether corporate governance and law should deal with workers' rights. 

Corporations cannot exist without workers, yet workers are not part of the formal or informal governance structures established by U.S. corporate law. Commentators and policymakers have bemoaned this state of affairs for decades, to little avail. Since the mid-2010s, however, a concept related to workers, human capital management (HCM), has become an increasingly prominent part of U.S. corporate governance. HCM is premised on the notion that workers can be viewed as “assets” and ought to be managed just as carefully as firms manage physical and capital assets. In practice, HCM is an expansive concept that has been used to refer to workforce training, compensation and retention issues, gender pay equity, diversity and inclusion, health and safety, matters related to corporate culture, employees’ ability to participate in stock purchase programs, and various other matters.

The speed with which HCM has emerged and the depth and breadth of its reach have been surprising. While broadly fitting within the rubric of environmental, social, and governance (ESG) factors, HCM has quickly surpassed more traditional ESG topics in terms of prominence and uptake. Boards of directors have started to focus on HCM as part of their monitoring and oversight responsibilities, including by amending committee charters to cover HCM matters, identifying HCM as a desirable qualification for director nominees, and incorporating HCM metrics into executive compensation plans. Investors are now actively engaging with management and boards on questions pertaining to HCM. In August 2020, the Securities and Exchange Commission (SEC) adopted a new rule requiring HCM disclosure by public companies. Pending legislation could create HCM disclosure mandates that are considerably more extensive, while a variety of private standard-setting organizations (including SASB, GRI, and ISO) have already developed detailed HCM reporting standards, which firms have started to adopt. Taken together, these developments represent a powerful and heretofore unprecedented push to incorporate worker-related concerns in corporate governance—a phenomenon I describe as an “HCM movement.” By analyzing the origins, development, impact, and normative desirability of the novel HCM movement, this Article seeks to contribute to conversations about the need to update existing legal and institutional arrangements in light of the disruptions unleashed by the Covid-19 pandemic and the lingering economic dislocation caused by the 2008 financial crisis.

Subject to certain qualifications, the Article views HCM as a broadly positive and much-overdue corporate governance development: HCM disclosure contributes to more accurate firm valuation by shining a spotlight on a key driver of success in the modern knowledge-based economy; HCM oversight at the board level ensures that firms focus appropriately on the management of what has come to be referred to as a “mission-critical asset.” To realize HCM’s full promise, however, participants in the HCM movement should seek to disambiguate the HCM concept by breaking it down into its appropriate constitutive elements, and, to the extent possible, focusing the relevant discussions on those specific elements. In addition, boards should resist isomorphic approaches, particularly ones developed by organizations such as large asset managers that are lacking in regulatory legitimacy, accountability, and HCM expertise. The SEC can and should serve as a nexus for coordination among the various participants in the HCM movement. As an initial step, the SEC should revisit the HCM disclosure rulemaking process and reject the unstructured, “principles-based” approach reflected in the 2020 HCM disclosure rule, which is based on an impoverished understanding of the important concept of materiality. In its final part, the Article considers HCM’s limits as a solution to problems beyond the core concerns of corporate law and suggests that the rapid rise of the corporate governance HCM movement has in fact highlighted the need for a governmental human capital agenda aimed at the active development and protection of human capital, not just its management.

Georgiev, George S., The Human Capital Management Movement in U.S. Corporate Law (March 1, 2021). 95 Tulane Law Review 639 (2021), Available at SSRN: https://ssrn.com/abstract=3817747

The corporation is not a real entity and to argue to the contrary is "transcendental nonsense"

I've been reading the introduction to a new book that claims that the corporation is best understood as a "real entity." 

This book advances an entity theory of company law. It builds on the insight that organizations or firms are autonomous actors in their own right. They are more than the sum of the contributions of their participants. They also act independently of the views and interests of their participants. This occurs because human beings change their behavior when they act as members of a group or an organization. In a group we tend to develop and conform to a shared standard. When we act in organizations routines and procedures form and a culture emerges. These over time take on a life of their own affecting the behavior of the participants. Participants can themselves affect organizational behavior and modify routines, procedures and culture but this takes time and effort.

Organizations are a social phenomenon outside of company law. Company law finds this phenomenon and provides it with a legal structure. It makes available legal personality and a procedural framework facilitating corporate decision making and corporate acting. Company law evolves with a view to supporting autonomous action through organizations.

It will be shown in this book that a framework that conceives companies as vehicles for autonomous organizational entities that are characterized by their routines, procedures and culture explains the law as it stands at a positive level. The framework also helps to formulate normative recommendations guiding law reform and judicial decision making.

An entity approach is sometimes associated with a normative argument advocating for more influence for stakeholders such as employees. This book does not take a position on the normative question whether stakeholders should have more influence than they currently have. The thesis of this book holds irrespective of how the law fine-tunes the influence over corporate decision making.

Micheler, Eva, Company Law - A Real Entity Theory (February 11, 2021). Available at SSRN: https://ssrn.com/abstract=3783696 or http://dx.doi.org/10.2139/ssrn.3783696

So I'm going to revisit a discussion from 2012:

My clearest statement of my own views on the nature of the corporation appeared in The Board of Directors as Nexus of Contracts. (You'll want to download it, but that can wait until we're done here.)

In it, I wrote that:

In one sense, the corporation is a nexus.  To be sure, the traditional insistence that the firm is a real entity tends towards mindless formalism.  Yet, perhaps some deference should be shown the corporation’s status as a legal person. Corporate constituents contract not with each other, but with the corporation. A bond indenture thus is a contract between the corporation and its creditors, an employment agreement is a contract between the corporation and its workers, and a collective bargaining agreement is a contract between the corporation and the union representing its workers.  If the contract is breached on the corporate side, it will be the entity that is sued in most cases, rather than the individuals who decided not to perform. If the entity loses, damages typically will be paid out of its assets and earnings rather than out of those individuals’ pockets. To dismiss all of this as mere reification ignores the axiom that ideas have consequences.

If the connected contracts model is correct, and there is no nexus, employment contracts would cascade—looking rather like a standard hierarchical organization chart—with each employee contracting with his or her superior.  (Debt contracts would be even more complex.) Such a cascade would be costly to assemble, if not impossible.  Most corporate constituents lack any mechanism for communicating with other constituencies of the firm—let alone contracting with one another. Instead, each constituency contracts with a central nexus. Accordingly, constituencies must be (and are) linked to the nexus and not each other. 

Although I perhaps could have been clearer (I am reminded of a quip attributed to Ronald Dworkin: "Once again, my critics have deliberately misunderstood me," but that seems inapt to the present discussion), this passage should not be understood as embracing either the real or artificial entity theory of the corporation.

The passage must be put in context. I am responding here to connected contracts model advanced by my friends Mitu Gulati, Bill Klein, and Eric Zolt:

Gulati, Klein, and Zolt contend that the firm is usefully understood as a set of connected contracts.  Their model departs from contractarian orthodoxy, however, by denying the existence (and even the relevance) of the nexus concept. [Hence,] the firm described by Gulati, Klein, and Zolt neither is nor has a nexus. ...

In reply to which, I posed the question of whether "a model lacking the concept of a nexus [can] make useful predictions about the legal rules governing such firms?"

My answer to that question, obviously, is "no." In elaborating on that answer, I was trying to make the point that somewhere within the corporation there must be a nexus of contracts between factors of production. As I explained in the article:

In a more important sense, however, the corporation has a nexus. After all, to say that the firm is a nexus is to imply the existence of a core or kernel capable of contracting. But kernels do not contract—people do. In other words, it does us no good to avoid reifying the firm by reifying the nexus at the center of the firm. Hence, we must search for the person or persons who serve as the nexus of the set of contracts making up the firm….

If the corporation has a nexus, however, where is it located? The Delaware code, like the corporate law of every other state, gives us a clear answer: the corporation’s “business and affairs . . . shall be managed by or under the direction of the board of directors.”  Put simply, the board is the nexus.

Accordingly, as I explained in the introduction to that article:

The director primacy model proposed herein is grounded in the prevailing law and economics conception of the firm; namely, the so-called nexus of contracts model. 

Of course, I don't have a copyright on director primacy. Prof Padfield is free to reinterpret it as he sees fit. But I do want to take issue with his claim that:

Because director primacy theory at the very least has a lot in common with some versions of real entity theory, it seems better to locate it there than ignore it.  For example, real entity theory has been described by Reuven Avi-Yonah as the theory which “represents the most congenial view to corporate management, because it shields management from undue interference from both shareholders and the state” (quote from here). That seems quite consistent with director primacy.  

Just because two roads end up in the same place, doesn't mean that they are one and the same.

I argued in The Board of Directors as Nexus of Contracts (don't forget to download it) that the power of fiat within the corporation is an off-the-rack term of the standard form contract provided by corporate law:

... there is no necessary contradiction between a theory of the corporation characterized by command-and-control decision making and the contractarian model. The set of contracts making up the corporation consists in very large measure of implicit agreements, which by definition are both incomplete and unenforceable. Under conditions of uncertainty and complexity, the parties cannot execute a complete contract, so that many decisions must be left for later contractual rewrites imposed by fiat. It is precisely the nonenforceability of implicit corporate contracts that makes it possible for the central decisionmaker to rewrite them more or less freely. The parties to the corporate contract presumably accept this consequence of relying on implicit contracts because the resulting reduction in transaction costs benefits them all. It is thus possible to harmonize the Coasean and contractarian models without having to reject a theory of the firm in which the board of directors has the power to, say, direct the firm’s workers. Instead, the firm’s constituents voluntarily enter into a relationship in which they accept the board’s power of fiat, while reserving the right to disassociate from the firm.

Likewise, I argued that the business judgment rule--which shields most exercises of that power from judicial review--is another off-the-rack term of the corporate standard form contract.

To the extent that director primacy implies legal rules that shield "management from undue interference from both shareholders and the state," it therefore does so because those rules are majoritarian defaults provided by the law to facilitate private ordering. Not because the corporation is an entity.

Finally, I want to close by disclosing a personal foible. I have a very practical mind. Most abstract reasoning strikes me as metaphysical mumbo jumbo. When I look at the corporation, I thus find myself agreeing with Edward, First Baron Thurlow, who put it best: "Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?"

Apropos of which, in working on this post, I came across a truly wonderful old article: Felix S. Cohen, Transcendental Nonsense and the Functional Approach, 35 Colum. L. Rev. 809 (1935). As John Hasnas summarized the key part of the article (19 J.L. & Pol'y 55):

Felix Cohen began Transcendental Nonsense and the Functional Approach, perhaps the most entertaining law review article ever written, by describing a heaven of legal concepts in which could be found “all the logical instruments needed to manipulate and transform . . . legal concepts and thus to create and to solve the most beautiful of legal problems.” This heaven, which contained

a dialectic-hydraulic-interpretation press, which could press an indefinite number of meanings out of any text or statute, an apparatus for constructing fictions, and a hair-splitting machine that could divide a single hair into 999,999 equal parts and, when operated by the most expert jurists, could split each of these parts again into 999,999 equal parts . . . [was] open to all properly qualified jurists, provided only they drank the Lethean draught which induced forgetfulness of terrestrial human affairs.

This was the realm of transcendental nonsense in which legal questions were resolved by examining the relationships among abstract concepts divorced from any consideration of the practical consequences or ethical quality of the decision.

As his first illustration of transcendental nonsense, Cohen selected the law's treatment of corporations. He pointed out that in deciding whether a corporation incorporated in one state could be sued in the courts of another, one might expect courts to make “some factual inquiry into the practice of modern corporations in choosing their sovereigns and into the actual significance of the relationship between a corporation and the state of its incorporation,” to consider “the difficulties that injured plaintiffs may encounter if they have to bring suit against corporate defendants in the state of incorporation . . . [and] the possible hardship to corporations of having to defend actions in many states, considering the legal facilities available to corporate defendants,” and to decide the case “[o]n the basis of facts revealed by such an inquiry, and on the basis of certain political or ethical value judgments as to the propriety of putting financial burdens upon corporations . . . .” Yet, when the New York Court of Appeals was called upon to rule on this matter, “[i]nstead of addressing itself to such economic, sociological, political, or ethical questions . . ., the court addressed itself to the question, ‘Where is a corporation?’ Was this corporation really in Pennsylvania or in New York, or could it be in two places at once?”

But how is such a question to be answered? As Cohen pointed out,

Clearly the question of where a corporation is, when it incorporates in one state and has agents transacting corporate business in another state, is not a question that can be answered by empirical observation. Nor is it a question that demands for its solution any analysis of political considerations or social ideals. It is, in fact, a question identical in metaphysical status with the question which scholastic theologians are supposed to have argued at great length, “How many angels can stand on the point of a needle?”

Nevertheless, the court ruled that the corporation could be sued in New York because by maintaining an office there, the corporation had come into the state. The problem with this ruling is that

[n]obody has ever seen a corporation. What right have we to believe in corporations if we don't believe in angels? To be sure, some of us have seen corporate funds, corporate transactions, etc. . . . But this does not give us the right to hypostatize, to “thingify,” the corporation, and to assume that it travels about from State to State as mortal men travel. Surely we are qualifying as inmates of . . . [the] heaven of legal concepts when we approach a legal problem in these essentially supernatural terms.

Deciding cases by reifying the abstract concept of the corporation is a classic example of transcendental nonsense.

Put simply, I just can't wrap my head around the metaphysical abstractions required to think of the corporation as an entity--real or otherwise--rather than as an aggregate. Being unable to perform the mental gymnastics necessary to "thingify" the corporation, I am happy to find such a distinguished precedent for dismissing the effort so blithely. After all, as James Boyle wrote (62 U. Colo. L. Rev. 489):

The realist attack was particularly effective in corporation law, where the “constructed” nature of the subject was more apparent. In Transcendental Nonsense and the Functionalist Approach, Felix Cohen suggests that the question “where is a corporation” is the kind of nonsense you can expect from scholastics drunk on their own wordy theories. In fact, talking about whether the corporation is “in the jurisdiction”--or even exists at all--is simply a way of expressing our conclusions about the “policy question” of whether we wish to hold the corporation liable, or grant its directors immunity from suit, or whatever. In other words, to talk of the legal subject is merely to restate a conclusion reached on other grounds. Legal subjects pop in and out of being as a (mysteriously arrived at) set of policy conclusions changes and shifts.

Speaking as a "Reagan realist," i.e., someone who "recognizes the contingent nature of law but insists that such contingency is limited by moral, political, and cultural values that are essentially conservative" (47 Hous. L. Rev. 297), that strikes me as basically right.

Harvard's Jesse Fried on "Will Nasdaq's Diversity Rules Harm Investors?"

Fried, Jesse M., Will Nasdaq's Diversity Rules Harm Investors? (March 31, 2021). Available at SSRN: https://ssrn.com/abstract=3812642 or http://dx.doi.org/10.2139/ssrn.3812642

In December 2020, Nasdaq asked the Securities and Exchange Commission to approve new diversity rules. The aim is for most Nasdaq-listed firms to have at least one director self-identifying as female and another self-identifying as an underrepresented minority or LGBTQ+. While Nasdaq claims these rules will benefit investors, the empirical evidence provides little support for the claim that gender or ethnic diversity in the boardroom increases shareholder value. In fact, rigorous scholarship—much of it by leading female economists—suggests that increasing board diversity can actually lead to lower share prices. Adoption of Nasdaq’s proposed rules would thus generate substantial risks for investors.

Is California going to enforce the board of directors gender quota law? Does it matter?

Via Liz Dunshee, Keith Paul Bishop remarks on the California board gender quota law:

I blogged a few weeks ago that only 318 companies that are subject to California’s board diversity statute have filed a disclosure statement to report whether or not they have the required number of women on their board. I was surprised by that – but Allen Matkins’ Keith Bishop sent this point of clarification:

The statutes requiring publicly traded corporations to file the Corporate Disclosure Statement predate the statutes relating to board composition. There is no specific fine associated with failure to file the Corporate Disclosure Statement in those statutes.

The statutes governing board composition provide that the Secretary of State may impose a $100,000 fine for failure to file to timely file board member information with the Secretary of State pursuant to a regulation. However, the Secretary of State has not adopted a regulation and is not required to do so (the statutes say that the Secretary of State “may” adopt implementing regulations).

I am not aware of any enforcement activity by the Secretary of State for actual violations of the composition requirements. Any enforcement action is likely to be defended on constitutional grounds and that is already being litigated in state and federal court.

Keith also went on to say that his understanding is that the Secretary of State compiles the data for the report solely from the Form 10-K and Corporate Disclosure Statements. Through no fault of their own, but because of how the statute is worded, they do not look at proxies or other disclosures made by a company. That reinforces that the corporate disclosure statements – and the “Women on Boards” report – isn’t all that useful in analyzing whether companies headquartered in California are satisfying the underlying board diversity requirements in the statute. As Keith explained in a recent blog, companies are permitted to file updated disclosure statements – but it’s not required.

But maybe it doesn't matter. Dunshee continues:

Cooley’s Cydney Posner did pull up a few proxy statements – this blog summarizes her findings:

Should we assume that companies that did not file are not in compliance? I looked at the proxy statements for a number of the companies identified as “impacted corporations” that nevertheless were not reported as having filed Disclosure Statements — selected at random, unscientifically and completely arbitrarily — all of them had at least one woman on the board and often two or more. So, I would guess that the number of women on boards is probably much greater than the report indicates.

Unfortunately, however, to compile the report, the Secretary can’t simply look at companies’ proxy statements as I did. That’s because the language in the statute defines “female” as “an individual who self-identifies her gender as a woman, without regard to the individual’s designated sex at birth.” As a result, the Secretary is not reviewing 10-Ks or proxy statements to determine whether a company is compliant with the new board composition requirement, but is instead determining compliance based only on the California Statement, which includes a specific inquiry regarding the number of “female” directors. And if half the companies subject to the law don’t file, well, so much for the accuracy of the report.

It’s also worth noting that there are timing issues in connection with these annual reports and statements, resulting in “some gaps in available data” in the 2021 Report, as the report points out. Forms 10-K are due, generally depending on the size of the company’s public float, 60, 75 or 90 days after the end of the company’s fiscal year, and the deadline for filing the California Statement is 150 days after the end of the company’s fiscal year.

Furthering my discussion with Professor Pierluigi Matera about Delaware's dominance and the Wyoming challenge thereto

The other day I posted a comment on Professor Pierluigi Matera's article, Delaware’s Dominance, Wyoming’s Dare. New Challenges, Same Outcome? (March 1, 2021). Professor Matera responded with a very thoughtful email, in which he explains:

I agree with you about Wyoming’s chances to succeed. I do believe that Delaware’s dominance will remain intact. In my paper (I mean, in the extended draft version which is on SSRN https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3763106 ), I argued:

... to the extent that Wyoming’s strategy pays off, it will secure this jurisdiction a leading position only in that segment of the corporate charters market, whilst Delaware will continue to dominate the rest of it. That said, it is currently uncertain whether Wyoming’s policy is a calculated risk or an unreasonable hazard. 

….

However, to the extent that Wyoming’s tactic proves to be effective, it will earn this jurisdiction a leading position only in a segment of the corporate charters market, whilst Delaware will continue to dominate the rest of it. Clearly, the significance of this segment will depend upon the growth of cryptocurrencies.

In light of all this, Wyoming’s approach might look like a dare. In fact, this new challenge is likely to end up with the same result: Delaware’s dominance.

I also contend that Federal legislature is likely to intervene and end Wyoming’s ambition. But I doubt that Delaware would be able to follow Wyoming on the path of relaxing and liberalising laws on blockchain for the same reason which suggested Delaware not to follow Nevada. 

Comparing Nevada’s market segmentation approach and Wyoming’s challenge, I argued:

In this respect, Wyoming is replicating the market segmentation strategy already conceived and put in place by Nevada for small firms. This implies some similarities. As in Nevada’s case, Delaware is unlikely to follow Wyoming in adopting such liberal laws for virtual currencies. Should Delaware introduce laws that are too lax, federal legislature might intervene.

Unlike Nevada, Wyoming is creating a safe harbour by introducing exemptions or custom-made provisions in multiple fields of regulation, including state securities regulation. This is consistent with the aims of the cryptocurrency sector.

My response was premised on the assumption that to the extent the Wyoming statue was a move to the top, Delaware--as the leader in the so-called race to the top (to be sure, as I have said elsewhere, the race is more of a leisurely stroll, but it's still towards the top)--would simply copy the Wyoming statute--as Delaware has done with other developments--and thus trounce Wyoming.

As Professor Matera points out in his email, however, the Wyoming statute can be seen as a move to the bottom. If that proves to be the case, I suspect he is correct that Delaware would opt not to follow Wyoming, just as Delaware has opted not to follow Nevada.

But then the question becomes whether Nevada might not steal Wyoming's thunder by copying the Wyoming rules and coupling them with Nevada's lax corporate governance regime to create create a very attractive package for those who wish to lead an accountability free life?

In any case, strongly urge you to read Professor Matera's article, which captures some very important insights about a very interesting development.

Recommended reading.

I'm prepared to make a long bet that Wyoming will not put a dent in Delaware's dominance of the market for corporate charters

Pierluigi Matera discusses challenges to Delaware's dominance of the market for corporate charters.

This dominance has been regularly criticised by scholars but hardly put in serious jeopardy by challengers. Nevada is known as Delaware’s most important competitor, with an aggressive strategy that overrode the effort of any other jurisdiction. In order to attract incorporators, in 2001 Nevada broadened directors’ and officers’ protection from liability and became a truly liability-free jurisdiction. Yet, its success has been limited to a specific market segment: small firms with low institutional shareholding and high insider ownership. ...

In a recent paper I contend that a mounting challenge to Delaware’s dominance is mostly going off the radar. Wyoming is targeting a new segment of the market for corporate charters: cryptocurrency businesses. This jurisdiction is attempting to attract these incorporators by enacting liberal legislation and providing their companies with a safe harbour.

I've pondered challenges to Delaware in various places. In my article, "Why the North Dakota Publicly Traded Corporations Act Will Fail," 84 North Dakota Law Review 1043 (2008), I discussed North Dakota's adoption of "the Publicly Traded Corporations Act, which 'is designed to strengthen corporate democracy and improve the performance of publicly traded corporations.' ... The idea [was] that North Dakota will attract incorporations away from Delaware by being more shareholder-friendly than Delaware."' As I subsequently noted, the North Dakota effort proved to be a massive flop.

On major reason is that Delaware's legislature acts quickly to adopt developments in other states that prove successful. "The Delaware legislature pays close attention to keeping the GCL up-to-date and efficient. It has a longstanding relationship with the Corporate Law Section of the Delaware Bar Association, which frequently recommends, reviews, and drafts revisions to the GCL. William F. Griffin, THE DELAWARE ALTERNATIVE, CLHBU MA-CLE 10-1 (2015). 

As Wilmington attorney Black noted, however, Delaware's system is not easily emulated. “There are elements unique to Delaware that would be very hard to replicate, particularly in big states,” he says. Delaware benefits from having a unique combination of an enabling corporation statute, a legislature that keeps the statute up to date and that has developed a long and trusting relationship with the corporate bar, and judges who come from among the best and brightest attorneys in the state, he says. “

Donald F. Parsons Jr. & Joseph R. Slights III, The History of Delaware's Business Courts: Their Rise to Preeminence, 17 Bus. L. Today 21, 25 (March/April 2008).

In sum, if Wyoming starts to make gains, the Delaware legislature will just copy the Wyoming approach--probably with improvements--and remain dominant by adding to the statute the other advantages identified by Parsons and Slights.

As for Nevada's success, Delaware has opted not to emulate Nevada's approach of drafting a corporate law designed to appeal mainly to crooks seeking immunity from accountability.

Facebook Board Diversity Lawsuit Dismissal Motion Granted

Kevin LaCroix has been keeping track of the recent wave of shareholder suits alleging boards have violated state or federal law by not having diverse boards:

As I have documented on this site, over the last few months plaintiffs’ lawyers have filed a series of lawsuits against the directors of companies that allegedly lack African American representatives on their corporate boards. Many of these lawsuits, particularly at the outset of this litigation filing trend, were filed by the same law firm. Among the first of these lawsuits was a shareholder derivative lawsuit filed in July 2020 against the board of the social media company, Facebook. In an order dated March 19, 2021 (here), Northern District of California Magistrate Judge Laurel Beeler granted the defendants’ motion to dismiss the plaintiff’s complaint. The dismissal was without prejudice with respect to the plaintiff’s proxy misrepresentation claims under Section 14(a). As discussed below, the court’s ruling could have important implications for the other pending (and prospective future) board diversity lawsuits. ...

The complaint assert[ed] claims for breach of fiduciary duty; aiding and abetting breach of fiduciary duty; abuse of control; unjust enrichment; and violation of Section 14(a) of the Securities Exchange Act of 1934. ...

The defendants moved to dismiss the plaintiff’s complaint on several grounds: first, the defendants argued that the plaintiff had neither made the requisite pre-suit demand on the board nor provided sufficient allegations to establish that demand was futile; second, in reliance on the forum selection clause in the company’s restated certificate of incorporation (the text of which is set out below), the defendants argued that the plaintiff has sued in the wrong forum; and third, the defendants argued that the plaintiff had failed to state a Section 14(a) claim due to the failure to sufficiently plead false and misleading statements in the proxy statements at issue.

Mr. LaCroix then goes on to analyze the decision granting the motion to dismiss. He then summarizes the plaintiff's options:

The plaintiff will now need to consider whether to try to re-plead her Section 14(a) allegations or to simply accept that the next step is to try to refile her state law claims in Delaware Chancery Court. An obvious concern will have to be whether the remaining claims, shorn of the supposed board diversity concerns to which the initial complaint attached so much weight, are simply not enough to carry the claim.

Go read the whole thing.

How do you rebut the business judgment rule under Nevada law?

Keith Paul Bishop posted on a recent Nevada case holding that the inherent fairness standard cannot be used to rebut the business judgment rule:

In Guzman v. Johnson, ... the Court concluded that the inherent fairness standard cannot be used to rebut the business judgment rule and shift the burden to individual directors.  The Court found that to do so would contravene NRS 78.138(7) which insulates (with certain exceptions) directors and officers from individual liability in their capacities as such unless the plaintiff (i) rebuts the business judgment rule; and (ii) proves that the director’s or officer’s act or failure to act constituted a breach of his or her fiduciary duties as a director or officer and the breach involved intentional misconduct, fraud or a knowing violation of law.  

So how can a plaintiff rebut the business judgment rule?  The Nevada Supreme Court states that a plaintiff may do so by showing that the director or officer had a personal interest in the transaction.  However, the Court found that the plaintiff's complaint failed to plead facts that if true would rebut the business judgment rule.

In a February 2020 post, Bishop explained that:

NRS 78.138(7)(b) provides that, with certain specific statutory exceptions, a director or officer of Nevada corporation is not individually liable to the corporation or its stockholders or creditors for any damages as a result of any act or failure to act in his or her capacity as a director or officer unless it is proven that:

•  The director’s or officer’s act or failure to act constituted a breach of his or her fiduciary duties as a director or officer; and
• The breach involved intentional misconduct, fraud or a knowing violation of law.

While the statute makes no mention of gross negligence, some federal district courts in Nevada have applied a bifurcated analysis, requiring a showing of at least gross negligence to state a duty-of-care claim or "intentional misconduct, fraud or a knowing violation of the law" to state a duty-of-loyalty claim. ...

Yesterday, the Nevada Supreme Court declared this statement to be dicta and expressly disavowed a bifurcated approach to duty-of-care and duty-of-loyalty claims.  Chur v.  Eighth Jud. Dist. Ct., 136 Nev. Adv. Op. 7 (2020).  According to the Court, NRS 78.138(7) provides the sole avenue to hold directors and officers individually liable for damages arising from official misconduct.  

This leaves me somewhat puzzled. Is it the case that under Nevada law that the business judgment rule would not be rebutted by a showing of:

• directors were grossly negligent in failing to inform themselves of all material information reasonably available to them?
• the board failed to make a decision?
• failed to exercise oversight?
• waste?

Caremark, Board Oversight of CEO Personal Conduct, and Elon Musk

Ann Lipton remarks:

Tesla is being sued again, this time by a stockholder who claims that Elon Musk’s … colorful … behavior on Twitter violates his settlement with the SEC, is a threat to corporate value, and that the Board’s failure to rein him in represents a violation of its duty of good faith (and hey, as I was drafting this very post Musk did it again).  While I’m sure there are many things one could say about the lawsuit, the part that struck me was where the plaintiff alleged that the Board is dependent on Musk, in part, because Musk is indemnifying its members for any legal liability.

Check it out. With respect to the merits of the suit, it gets to issues we've discussed here a number of times:

My Pillow, Inc. and the perennial question of whether Caremark claims should lie when boards fail to monitor the CEO's personal life

Tom Lin argued that Caremark oversight duties continue to “present difficult issues concerning the monitoring of executive private behavior.”

CEO Private Lives in the Present Dystopia

"to what extent should a board have Caremark duties to monitor a CEO's private life." 

Ensuring good performance on material ESG issues is NOT part of a board's fiduciary duty and part of the corporate purpose.

Tensie Whelan, clinical professor of business and society and director of the Center for Sustainable Business at NYU’s Leonard N. Stern School of Business argues that:

It is becoming clearer to investors and corporate managers that material environmental, social, and corporate governance (ESG) issues need to be managed as part of an organization’s business strategy.   Climate change, racism, economic inequality, water scarcity, cybersecurity threats – these are just a few of the material ESG issues posing risk and opportunity.

Unfortunately, our research finds that board members may not be up to the task.  We analyzed the credentials of each of the 1,188 Fortune 100 board directors based on Bloomberg and company biographies in 2018 and found that 29 percent had credentials (such as board memberships and professional experience) relevant to ESG. ...

ESG advocates keep saying its clear that investors want woke capitalism, but I just don't buy it. Recall that table I posted the other day:

Most ESG proposal categories received average support levels of less than one-third. Only a tiny minority of ESG proposals passed. Investors are revealing their preferences every time they vote and those preferences are different than what pro-ESG academics and regulators want to believe.

In the paper on which her post draws, she argues:

Ensuing [sic] good performance on material ESG issues is now part of a board's fiduciary duty and, according to the Business Roundtable, part of the corporate purpose.

What court has said that "good performance on material ESG issues is now part of a board's fiduciary duty"? More important, what Delaware court has said so?

Whelan's argument fundamentally misrepresents American corporate law as set forth in Delaware law, which as we know provides that corporate directors cannot pursue a "business strategy that openly eschews stockholder wealth maximization—at least not consistently with the directors' fiduciary duty under Delaware law.” eBay Domestic Holdings, Inc. v. Newmark, 16 A.3d 1, 35 (Del. Ch. 2010).

She also ignores the critical role the business judgment rule plays in corporate fiduciary duty discussions. A shareholder claim that directors had breached their fiduciary duties by failing to perform "on material ESG issues" will not make it past a motion to dismiss. See Crescent/Mach I Partners, L.P. v. Turner, 846 A.2d 963, 984 (Del. Ch. 2000) ("In order for plaintiffs' duty of care claims to survive a motion to dismiss, they must sufficiently plead facts which if true would take defendants' actions outside the protection afforded by the business judgment rule.").

Lastly, as regular readers know, I have shown that the Business Roundtable statement on corporate purpose is (1) an erroneous statement of law and (2) mere greenwashing. 

 

Strine Speaks: The Business Judgment Rule is an Abstention Doctrine

From Brummer, Christopher J. and Strine, Leo, Duty and Diversity (February 18, 2021). U of Penn, Inst for Law & Econ Research Paper No. 21-08, Columbia Law and Economics Working Paper No. 642, Available at SSRN: https://ssrn.com/abstract=3788159 or http://dx.doi.org/10.2139/ssrn.3788159:

... the business judgment rule commands that courts not intrude on decisions about a corporation’s business philosophy and strategy. For that reason, Professor Bainbridge has rightly called the business judgment rule an abstention doctrine,³⁰⁴ which leaves stockholders dissatisfied with the board with recourse to the corporate ballot box, not the courthouse.

³⁰⁴ See generally Stephen M. Bainbridge, The Business Judgment Rule as Abstention Doctrine, 57 VAND. L. REV. 83 (2019).

Statistical analysis of the California women on boards statute

Keith Paul Bishop outlines the highlights of the California Secretary of State's Women On Boards report:

In a related post, Bishop reports on the status of the two currently pending challenges to the constitutionality f the California statute.

 

To whom do directors owe fiduciary duty with a digression into the two masters problem

Ann Lipton has a long blog post about Judge Rakoff’s decision in In re Nine West LBO Securities Litigation, 2020 WL 7090277 (S.D.N.Y. Dec. 4, 2020). She explains:

The short version is that Nine West was taken private in a leveraged buyout by Sycamore; as part of the deal, allegedly the Sycamore buyers caused the company to sell the profitable subsidiaries to its own affiliates for less than they were worth, and the whole thing ended in Nine West’s bankruptcy.  In the wake of all of this, the debtholders (many of whom held debt that predated the sale), via the litigation trustee, sued Nine West’s former directors – the ones who had approved the sale – for violating their fiduciary duties by negotiating a deal that would result in the company’s bankruptcy.  Last year, Judge Rakoff refused to dismiss the claims, in a decision that spawned a thousand law firm updates about directors’ duties when selling the company.

Professor Lipton then observes that "what I find interesting is how little anyone – including Judge Rakoff – seems to have interrogated the legal question of to whom the directors’ fiduciary duties were owed." She then launches into a very thoughtful and insightful analysis of that question. It's a highly recommended read.

I also wrote about that issue in my article Much Ado about Little? Directors' Fiduciary Duties in the Vicinity of Insolvency,  1 J. Bus. & Tech. L. 335 (2006-2007), available at: https://digitalcommons.law.umaryland.edu/jbtl/vol1/iss2/7, in which I argued that:

The insistence that the firm is a real entity is a form of reification—i.e., treating an abstraction as if it has material existence. Reification is often useful, or even necessary, because it permits us to utilize a form of shorthand—it is easier to say General Motors did so and so than to attempt in conversation to describe the complex process that actually may have taken place. Indeed, it is very difficult to think about large firms without reifying them. Reification, however, can be dangerous. It becomes easy to lose sight of the fact that firms do not do things, people do things.

In other words, the corporation is not a thing to which duties to can be owed, except as a useful legal fiction. The distinction between direct and derivative shareholder litigation is one area in which that fiction long has been thought useful. This article is not the appropriate forum for determining whether distinguishing between direct and derivative litigation continues to make sense. Having said that, however, it nevertheless seems useful to note the implications of contractarian theory for Credit Lyonnais’ notion that the duties of directors of companies in the vicinity of insolvency run to the entity.

At the outset, we must acknowledge that while the contractarian approach of treating the corporation as a nexus of contracts is an improvement on entity-based conceptions, it too is somewhat misleading. After all, to say that the firm is a nexus is to imply the existence of a core or kernel capable of contracting. But kernels do not contract—people do. In other words, it does us no good to avoid reifying the firm by reifying the nexus at the center of the firm. Hence, it is perhaps best to understand the corporation as having a nexus of contracts.

If the corporation has a nexus, where is it located? The Delaware code, like the corporate law of every other state, gives us a clear answer: the corporation’s “business and affairs . . . shall be managed by or under the direction of the board of directors.” Put simply, the board of directors is the nexus of a set of contracts with various constituencies that the law collectively treats as a legal fiction called the corporation. [I developed this argument at length in The Board of Directors as Nexus of Contracts, 88 Iowa L. Rev. 1 (2002).]

As such, it simply makes no sense to think of the board of directors as owing fiduciary duties to the corporate entity. Indeed, since the legal fiction we call the corporate entity is really just a vehicle by which the board of directors hires factors of production, it is akin to saying that the board owes duties to itself.

Professor Lipton went on to observe that "Nine West is, then, a real-world example of the “two masters” problem that is frequently used to justify shareholder primacy."

My Zone of Insolvency article discussed the two masters problem, as Professor Andrew Gold has explained:

When you are dealing with insolvency, with a zone of insolvency, you have what Professor Bainbridge has called a two-master problem.' If boards are supposed to look out for shareholders and also supposed to look out for creditors, they are in a very awkward spot because, whichever side they choose, they may end up, if they favor one side, being sued by the other side. And so, as you go into this area of insolvency and as you end up with potentially conflicting fiduciary duties, the business judgment rule becomes especially important.

Andrew Gold, Sidney Swinson L Ivan Reich,In the Zone: Fiduciary Duties and the Slide Towards Insolvency, 5 DePaul Bus.L Com. L.J.667 (2007) Available at: https://via.library.depaul.edu/bclj/vol5/iss4/4

Professor Bainbridge on Executive Compensation under Delaware Corporate Law: A ProfessorBainbridge.com Video

What course would you teach using my Advanced Corporation Law casebook?

A friend emailed to say she liked my new casebook on Advanced Corporation Law. But when I wrote back to encourage her to adopt it, she expressed doubt as to what course she would use it in.

A fair question. I use it in a course at UCLA called Advanced Corporation Law.