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Another state decides to take on Delaware. Reserve a space for Wyoming on Boot Hill.

In corporate law, Delaware is kind of like the movie gunslinger that "every piss-ant prairie punk who thought he could shoot a gun would ride into town to try out." And like that gunslinger, Delaware "must have killed more [states] than Cecil B. DeMille." (Bonus points for spotting the source of the quotations.) 

Most recently, North Dakota tried. I predicted that effort would fail. It did.

Bloomberg reports that now Wyoming's going to try:

Wyoming is looking to compete with Delaware as a corporate-friendly destination by creating a specialized court that offers lower fees and speedy dispute resolutions.

The proposals are part of a broader push by Wyoming lawmakers to make the state that invented the limited liability company (LLC) into a fintech friendly “Delaware of the West.”

Separate bills planned for the Wyoming state legislative session that started this week would use blockchain technology for commercial filings and business registrations and create a special purpose state-chartered depository bank intended to serve the blockchain industry.

Good luck with that.

A proponent of Wyoming's effort told Bloomberg that “when you go to other competing jurisdictions, a lot of times they have specialty courts that can deal with those specific issues.” It's true that the Delaware Chancery Court specializes in corporate law. But what that overlooks is that Delaware has a 100+ year head start. What matters is not having a specialized court, but having a huge volume of case law. What transactional lawyers (who advise their clients on where to incorporate) want is predictability and certainty. The vast volume of Delaware decisional law makes it possible, in most cases, to write an opinion letter with confidence. Wyoming's new court will be starting from scratch.

As for the much ballyhooed blockchain laws, Delaware's legislature is an expert at spotting new trends and incorporating them into its law. On the blockchain front, Delaware has already moved and doubtless will be evaluating what Wyoming does. If need be, Delaware will copy (and likely improve) the Wyoming laws. 

So I fully expect Wyoming to join North Dakota, Nevada, Pennsylvania, etc... who "finally found a home under the boot hill grave that bears [their] name."

Pileggi's Annual Review of Key Delaware Corporate and Commercial Decisions

Francis Pileggi's invaluable Annual Review of Key Delaware Corporate and Commercial Decisions for 2018 is online. It's a must read for anybody working in corporate law.

Speaking of "principal executive office" under California corporation law, what exactly does it mean?

In the preceding post, I noted the centrality of the term "principal executive office" to the application of California's corporate board gender quota bill. Keith Paul Bishop notes California corporate law fails to define this key term despite its appearance I numerous provisions of California corporate law.

Similarly, SEC Form 10-K and 10-Q require that the corporation disclose its principal executive office without defining that term. Having said that, Rule 3b-7 defines “executive officer” as the company’s “president, any vice president ... in charge of a principal business unit” or any other “officer” or “person” who “performs similar policy making functions.” Logically, "principal executive office" would mean the place where the CEO and most other executive officers work most of the time.

In federal tax law, "principal executive office" is "generally understood to mean 'the head office, the place where the principal officers generally transact business, and the place to which reports are made and from which orders emanate.'” Dimmitt & Owens Fin., Inc. v. Unique Industries, Inc., 589 F. Supp. 14, 16 (N.D. Ill. 1983), aff'd sub nom. Dimmitt & Owens Fin., Inc. v. U.S., 787 F.2d 1186 (7th Cir. 1986).

 

 

The ambiguous application of California's Corporate Board Gender Quota Law (SB 826)

Keith Paul Bishop has spotted two key ambiguities:

SB 826 (Jackson) is reputably the first state law requiring publicly held corporations to have a minimum number of female directors.  It is generally assumed that the law applies only to those publicly held domestic and foreign corporations having their principal executive offices in California.  But is that what the new law actually provides?

The bill adds two sections to the California Corporations Code.  The first, Section 301.3, expressly imposes a quota on "a publicly held domestic or foreign corporation whose principal executive offices, according to the corporation’s SEC 10-K form, are located in California".  This language is ambiguous as to domestic corporations.  Did the legislature intend to impose gender quotas on all publicly held domestic corporations or only those with principal executive offices in California?

The scope of law becomes even more muddied with respect to publicly held foreign corporations.  While Section 301.3 includes a requirement that the foreign corporation's principal executive offices be in California, SB 826 also added a new Section 2115.5 that provides:

"Section 301.3 shall apply to a foreign corporation that is a publicly held corporation to the exclusion of the law of the jurisdiction in which the foreign corporation is incorporated."

Noticeably absent from this section is any requirement that the foreign corporation's principal executive offices be in California. 

I hope Keith is right that "it is unlikely that the legislature believed that it could impose its will on foreign corporations with no connections to California." But then again the California legislature has done odder things than that. In any case, I definitely agree with Keith that the statute is probably unconstitutional even if we assume that the bill implicitly requires that the foreign corporation have its principal executive office in California.

Fisch and Solomon on Sunset Provisions in Dual Class Stock

An important and insightful new article on a hot topic:

An increasing percentage of corporations are going public with dual class stock in which the shares owned by the founders or other corporate insiders have greater voting rights than the shares sold to public investors. Some commentators have criticized the dual class structure as unfair to public investors by reducing the accountability of insiders; others have defended the value of dual class in encouraging innovation by providing founders with insulation from market pressure that enables them to pursue their idiosyncratic vision.

The debate over whether dual class structures increase or decrease corporate value is, to date, unresolved. Empirical studies have failed to provide conclusive evidence as to the effect of dual class structures, and calls for regulators or stock exchanges adopt prohibitions banning dual class structures outright have been unsuccessful, although several index providers have banned dual class stock from major indexes such as the S&P 500.

As a result, some commentators have advocated a compromise position permitting corporations to go public with dual class structures but requiring that they be required to include mandatory time-based sunset provisions. The sunset provisions would automatically convert the dual class structure to a single share structure after the passage of a pre-determined period of time. The Council of Institutional Investors has asked the New York Stock Exchange and Nasdaq to refuse to list the shares of dual class firms unless they contain a time-based sunset provision that would convert within seven years.

We do not take a position on whether dual class structures are value-enhancing, but we challenge the proposition that time-based sunsets are an appropriate response to the debate over dual class and that they should be imposed through regulation or stock exchange rules. To the extent that dual class structures are problematic, sunsets do not solve that problem. Moreover, time-based sunsets are an arbitrary response to the concern that developments such as the decline in a founder’s economic interest or the transfer of high-vote shares to third parties may reduce the attractiveness of the dual class structure. In addition, time-based sunsets create potential moral hazard problems. We further argue that the limitations of time-based sunsets cannot be addressed through a retention vote by the minority shareholders due to the problematic incentives of the minority shareholders.

We observe that event-based sunsets, which have received less attention, focus on the specific developments that are likely to erode the potential value of dual class, and we call for market participants to explore them further through private ordering. Nonetheless, we argue that, at the present time, investors and policymakers lack sufficient information about either dual class or sunsets to justify using regulation, index requirements or stock exchange rules to force companies into adopting sunsets. We further argue that, rather than relying compulsory sunsets to evade the difficult policy issues raised by dual class, the debate should encompass a more thorough framing of the role and importance of shareholder voting rights.

Fisch, Jill E. and Davidoff Solomon, Steven, The Problem of Sunsets (December 17, 2018). Boston University Law Review, 2019, Forthcoming; U of Penn, Inst for Law & Econ Research Paper No. 19-04. Available at SSRN: https://ssrn.com/abstract=3305319

Delaware forum selection clauses cannot apply to "rights or relationships" not created by Delaware law

Francis Pileggi throughly analyzes the important new Sciabacucchi v. Salzberg decision, in which "the Court determined that a forum-selection clause in a certificate of incorporation was invalid and ineffective to the extent that it purported to 'require any claim under the Securities Act of 1933 to be brought in federal court' (the 'Federal Forum Provisions')."

California appeals court enforces forum selection bylaw of Delaware corporation

Keith Paul Bishop:

Below are some notable observations from the opinion by Justice Franklin D. Elia:

• "[N]either California nor Delaware law requires forum selection clauses be freely negotiated to be enforceable."

• "The forum selection bylaw is entirely consistent with Drulias's reasonable expectations at the time he chose to purchase stock in 1st Century."

• "Forum selection bylaws have the effect of consolidating such litigation into a single forum, thereby reducing litigation expenses and avoiding duplication of effort (not to mention promoting efficient use of judicial resources), which is beneficial to corporations and their shareholders alike."

Samuel Moyn misunderstands the purpose of teaching corporate law

Michael Simkovic:

In a thought provoking essay in the Chronicle of Higher Education, Professor Samuel Moyn argues that law schools' focus on judge made law in general, and the Supreme Court in particular, is counterproductive especially when justified on ostensibly progressive grounds.  Offline, Professor Moyn suggested that, to better help students understand how the legal system influences the distribution of economic and political power, progressives should focus more on teaching business law subjects like taxation and anti-trust.

Samuel Moyn, Law Schools Are Bad for Democracy: They whitewash the grubby scramble for power, Chronicle of Higher Education, Dec. 16, 2018.

In re the highlighted portion, insert eye roll here. Personally, I thought the purpose of training students in business law was to make them more effective business lawyers by teaching them the skills transactional lawyers use in the real world, not to fill their heads with a bunch of progressive nonsense about the evils of capitalism.

Event studies suggest California's corporate board gender quota law is destroying shareholder value

2 event studies have reported California gender quota destroyed shareholder value. If New Jersey adopts, expect more such studies, probably same results. @ProfBainbridge @stevendsolomon https://t.co/H8V3af6G7h

— Jesse Fried (@jessefried) December 26, 2018

"As California goes, so goes the nation? The impact of board gender quotas on firm performance and the director labor market"

Steven Davidoff Solomon and three coauthors report that:

On September 30, 2018, California became the first U.S. state to introduce a mandatory board gender quota applicable to all firms headquartered in the state. Using a large sample of publicly-listed firms headquartered in the U.S., we find that the introduction of the quota is associated with significantly negative announcement returns to California-headquartered firms. Consistent with the quota imposing frictions, this effect is larger for firms requiring more female directors to comply with the quota. There is also evidence of spillover effects to non-California-headquartered firms. We find evidence in support of two channels through which these spillover effects operate: First, we find spillover effects to be larger for firms operating in industries in which California-headquartered firms lack more female directors to comply with the quota, suggesting that non-California-headquartered firms may lose valuable female directors to California-headquartered firms. Second, we document negative spillover effects for firms headquartered in states dominated by the Democratic Party, consistent with the idea that these firms are more likely to become subject to a board gender quota as well. Finally, we show that, already as of month-end November, female representation on the boards of California-headquartered firms increased. Newly appointed female directors differ significantly in terms of age, independence, and experience from incumbent and leaving female and male directors.

von Meyerinck, Felix and Niessen-Ruenzi, Alexandra and Schmid, Markus and Davidoff Solomon, Steven, As California goes, so goes the nation? The impact of board gender quotas on firm performance and the director labor market (December 19, 2018). Available at SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3303798 

One worrisome result is their finding that:

... newly appointed female directors are significantly less likely to possess work experience at another firm in the same two-digit SIC code industry (industry experience), experience as a director of another listed firm, and experience as an outside director of another listed firm than incumbent female and male directors (Panel A). ... These tests provide some evidence that newly appointed female outside directors are more likely to be employed in lower-level executive positions at other firms, for instance, as a Vice President, and are less likely to be employed as top executives at other firms, for example, as an inside director or a CEO, but differences are not statistically significant for all comparisons. Finally, we find some evidence that newly appointed female directors are less likely to qualify as independent outside director when compared to incumbent female and male directors.

Those results suggest that the women being appointed to satisfy the quota are going to be less experienced and bring less expertise to the table. 

For instance, Drobetz, Oesch, Schmid, and von Meyerinck (2018) and Hoitash, Hoitash, and Faleye (2018) show that director industry experience is positively related to firm value. Fich (2005) and Fahlenbrach, Low, and Stulz (2010) find that directors simul- taneously serving as CEOs in other firms are associated with higher firm values. Knyazeva, Knyazeva, and Masulis (2013) document similar findings for independent outside directors.

 

Dear Empirical Corporate Law Scholars: Why Not Study Which Delaware Chancery Court Member is Most Frequently Reversed?

Who is the Delaware Chancery Court's Ninth Circuit?

My new paper, "Rethinking the Board of Directors: Getting Outside the Box," is now online

Bainbridge, Stephen Mark, Rethinking the Board of Directors: Getting Outside the Box (December 17, 2018). UCLA School of Law, Law-Econ Research Paper No. 18-15. Available at SSRN: https://ssrn.com/abstract=3302927

In our new book, Outsourcing the Board: How Board Service Providers Can Improve Corporate Governance, Todd Henderson and I change the conversation about corporate governance by examining the origins, roles, and performance of boards with a simple question in mind: why does the law require governance to be delivered through natural persons? Through tracing the development of boards from quasi-political bodies to the current 'monitoring' role, we find the reasons for this requirement to be wanting. Instead, we propose that corporations be permitted to hire other business associations—known as 'Board Service Providers' or BSPs—to provide governance services. Just as corporations hire law firms, accounting firms, and consulting firms, so too should they be permitted to hire governance firms, a small change that will dramatically increase board accountability and enable governance to be delivered more efficiently.

This essay will serve as the introduction to a forthcoming symposium about our book.

Do CEOs breach their fiduciary duty when they express political opinions? (a.k.a. Do social justice warrior CEOs get business judgment rule protection when they spout off?)

Josh Fershee has a very sound analysis, followed by a back and forth with Stefan Padfield.

Group Company Liability

My former SJD student Martin Petrin is an outstanding young scholar. His latest article on group liability is typically insightful and helpful:

According to a universal bedrock principle of corporate law, corporations have separate legal personality and limited liability. These principles apply equally to corporate groups. Accordingly, a parent company is normally not liable for legal infractions and unpaid debts of its subsidiaries. In relation to torts and other misconduct committed by corporations, however, the bedrock principles of corporate law are increasingly subject to criticism, in particular where such claims cannot be brought by tort victims due to undercapitalization of subsidiaries, among other problems.

While the doctrine of veil piercing may allow for relief in certain scenarios, this practice has fallen out of favour with many courts and the legal requirements for doing so have become increasingly strict. Thus, courts have developed new approaches to holding parent companies liable such as holding the parent directly liable.

In view of these significant shifts, this article examines the law and policy considerations governing parent company and—more broadly—group liability. It argues that reform is necessary, which may be found in a model that involves combinations of voting equity ownership-based enterprise liability concepts with modified vicarious liability for corporations.

Petrin, Martin and Choudhury, Barnali, Group Company Liability (October 1, 2018). Eur Bus Org Law Rev (2018), Vol. 20, pp. 1–26; Faculty of Laws University College London Law Research Paper No. 1/2018. Available at SSRN: https://ssrn.com/abstract=3284380

KPB on "Do Ineffective Internal Controls Expand A Shareholder's Right Of Inspection?"

Keith Paul Bishop reports:

Section 1601 of the California Corporations Code establishes a shareholder's right to inspect the "accounting books and records and minutes of proceedings of the shareholders and the board and committees of the board".  A shareholder's inspection, however, must be for a "purpose reasonably related" to the shareholder's interest as a shareholder. Id.  This is commonly referred to as a "proper purpose" requirement.

When a corporation provides its audited financial statements to its shareholders, can a shareholder have a proper purpose in seeking inspection of the underlying financial records?  Professor Harold Marsh Jr. theorized that in such cases, a shareholder would have to show that "there was some substantial reason to believe that the reports submitted to the shareholders were erroneous".  Marsh's California Corporation Law §15.09[B].  

In  Farnum v. Iris Biotechnologies, 2018 Cal. App. Unpub. LEXIS 8069, the California Court of Appeal took note of a corporation's disclosure in its Form 10-K that management had concluded that the corporation's internal controls over financial reporting were not effective.  Thus, the Court concluded that the company had recognized that its "audited financial statement" [sic] was "incomplete".  This is an odd statement in light of the fact that the company's Form 10-K included the requisite financial statements and an auditor's opinion.  Nonetheless, the case is an example of ineffective internal controls over financial reporting providing a basis for expanded shareholder inspection.  The opinion, however, is not precedential because the court did not certify it for publication or order it to be published.