Last week, I blogged about the dominance of Delaware organizational law and its implications for the laws of other states.  Which is why I was so interested to when Omari Scott Simmons posted his new paper, The Federal Option: Delaware as De Facto Agency, which takes a (sort of) different view.  He argues that Delaware has become de facto federal agency, delegated by the federal government the power to make corporate law nationally, and that this system works well for now, though there might be circumstances where federal chartering – and the structural oversight that would come with it – might be appropriate.  These could include situations where companies have received governmental bailouts, or where companies have committed significant wrongdoing and subject themselves to federal oversight as part of their settlement.

Of course, the concerns I’ve expressed in my posts are of a slightly different order – they’re about Delaware organizational law extending beyond the boundaries of internal affairs (and Delaware’s ability to define those boundaries in the first place) – but still, it’s an interesting holistic look at Delaware’s role in the corporate governance ecosystem.  Here is the abstract:

Despite over 200 years of deliberation and debate, the United States has not adopted a federal corporate chartering law. Instead, Delaware is the “Federal Option” for corporate law and adjudication. The contemporary federal corporate chartering debate is, in part, a referendum on its role. Although the federal government has regulated other aspects of interstate commerce and has the power to charter corporations and, pursuant to its Commerce Clause power, preempt Delaware, it has not done so. Despite the rich and robust scholarly discussion of Delaware’s jurisdictional dominance, its role as a de facto national regulator remains underdeveloped. This article addresses a vexing question: Can Delaware, a haven for incorporation and adjudication, serve as an effective national regulator? Following an analysis of federal chartering alternatives, such as the Nader Plan, the Warren Plan, the Sanders Plan, and other modes of regulation, the answer is yes, but with some caveats and qualifications. Delaware’s adequate, if imperfect, performance as a surrogate national regulator of corporate internal affairs argues against the upheaval of the existing corporate law framework federal chartering would bring. Even in the contemporary moment where longstanding concerns about corporate power, purpose, accountability, and the uneasy relationship between corporations and society are amplified, Delaware can continue to perform an important agency-like role in collaboration with federal regulators, and regulated firms. A deeper examination comparing the merits of federal corporate chartering with Delaware’s de facto agency function illuminates the potential of existing and future reforms. This article concludes that federal chartering proposals have an important impact despite not being adopted for centuries. First, federal chartering proposals encourage policymakers to look beyond the status quo toward greater hybridization in regulatory design. Second, elements of previous federal chartering proposals have historically become successful “à la carte” reforms or part of other successful reform measures. Third, federal chartering proposals provide value as a bargaining tool where the threat of more intrusive federal regulation makes other reform methods more palatable to diverse corporate constituencies.

Carliss Chatman and Najarian Peters recently posted The Soft-Shoe and Shuffle of Law School Hiring Committee Practices, which is forthcoming in the UCLA Law Review Discourse.  The piece presents their perspective on the hiring process for legal academics and how many students currently experience the academy.  Since it was posted, it has averaged well over a hundred downloads a day.

The abstract also captures attention:

“We have too many Black and Brown faculty,” said no one ever in any law school. Each year we sit in appointments discussions and hear the same things. The classics-oldies but goodies from appointments committees are:

“We can’t find any qualified Black candidates.”

“There weren’t any in the Faculty Appointments Register (FAR), we scoured websites and emailed our Black friend yet found no one.” One of our colleagues actually lifted a large binder filled with leaflets from the FAR from one year over her head with both hands and waved it side to side to punctuate this very point in a faculty meeting. Everyone around the room including the Brown and other non-white faculty shook their heads in agreement co-signing. Seeing this made one of us wonder whether the FAR binder was some kind of Bible or holy text the girth of which triggered some kind of irrational response or hypnosis to accept the rhetorical fuckery that proceeded the lift. Like that table of manilla folders filled with paper that Trump used in his press conference to prove he had turned over control over his businesses to his sons or that weird blank book that Kayleigh McEnany gave “60 minutes” reporter Leslie Stahl more recently.

The piece has resonated and some scholars are sharing stories about their experiences in the hiring market and with fielding questions that no one would ask someone like me.  For example:

Since we’re telling horror stories: I was asked by a dean at the meat market what I would do to improve the school’s relationship with the Black community and the BLM movement. I said “do they need to form an LLC? Cause I teach business law.” I did not receive a fly back. https://t.co/hmQXY2d7gT

— Carliss Chatman (@carlissc) February 21, 2021

I found the following in my inbox this morning: Facebook, Twitter, United Airlines and other large companies pledge to boost numbers of diverse leaders (“Nowhere in corporate America have I seen these metrics or an initiative with these types of metrics,” said SVLG CEO Ahmad Thomas in an interview with MarketWatch before the announcement of the initiative.).

That reminded me of some commentary Rod Dreher posted last year in response to similar initiatives by Microsoft and Well Fargo (here):

Nadella didn’t say that Microsoft will attempt to do that; he said that Microsoft will do that. You can only double the number of blacks at the company through discriminatory hiring and firing. If you are white, Asian, or Hispanic, and work at Microsoft, you will not have the same chance at promotion, or perhaps you will even have to be laid off to make room for black managers…. How is Wells Fargo going to double black leadership in five years without actively hiring and firing people on the basis of race? ….

According to theorists of “antiracism” like Ibram X. Kendi, any time you see fewer blacks within an institution …, that is conclusive evidence of racism. Racial discrimination is the only explanation. It could not possibly be that, for example, fewer blacks chose to study finance (Wells Fargo), tech (Microsoft) or in related fields that would have brought them into the workplace at those particular companies. Only racism explains it…. This is what Microsoft apparently believes. This is what Wells Fargo apparently believes. This is what they are committed to doing: discriminating against non-black employees to fit this ideological idea of antiracism.

Relatedly, Ed Whelan had the following to say about Coca-Cola’s new diversity guidelines for outside counsel (here):

Title VII of the Civil Rights Act of 1964 broadly prohibits employers from discriminating on the basis of race, including in assigning work. But that’s exactly what Coca-Cola would have law firms do. It’s often thought that the Supreme Court’s anti-textual ruling in United Steelworkers v. Weber (1979) gives a green light to racial preferences that favor blacks. But the Court’s actual holding is much narrower than that …. While declining to “define in detail the line of demarcation between permissible and impermissible affirmative action plans,” the Court emphasized that the plan at issue was “a temporary measure” and was “not intended to maintain racial balance, but simply to eliminate a manifest racial imbalance” resulting from the systematic exclusion of blacks from craft unions…. Far from adopting its guidelines as “a temporary measure” to “eliminate a manifest racial imbalance,” Coca-Cola contemplates that the guidelines will operate in perpetuity to achieve and “maintain racial balance.” Indeed, the guidelines explicitly state that their “minimum commitments will “be adjusted over time as U.S. Census data evolves.” In short, there is little reason to think that the employment discrimination that Coca-Cola’s guidelines call for would fall within the Weber exception to Title VII.

Richard Epstein makes the further point (here) that if there is a known pipeline problem (i.e., based purely on the current number of Black attorneys, the quotas appear to require reaching further into the talent pool) then a breach of duty claim might also be possible: It is also worth asking whether a shareholder could succeed with a derivative legal action that held that the adoption of Coke’s decision to hire weaker minority workers was a breach of its fiduciary duty.

It is easy to find at least some of the foregoing analysis offensive and/or just plain wrong, but the question remains for discrimination law experts: In terms of surviving a motion to dismiss in a reverse-discrimination case, how much (if at all) do these corporate diversity commitments help plaintiffs?  In terms of Epstein’s fiduciary duty point, I find it very difficult to imagine a set of facts that would preclude management from claiming a pro-corporate cost-benefit analysis sufficient to dismiss a fiduciary duty claim.  You’d basically need “smoking gun” evidence of decision-makers having a Henry Ford or Tim Cook moment to even have a chance of avoiding that as a plaintiff (i.e., some version of “we have reason to believe this might destroy shareholder value but we don’t care”).

I’ve previously expressed concern about Delaware organizational law intruding into other states’ spaces.  A new entry into the genre is VC Slights’s opinion in AG Resource Holdings, LLC, et al. v. Thomas Bradford Terral.

In AG Resource Holdings, Thomas Terral cofounded an LLC called AG Resource Management.  The business was eventually bought out by a private equity firm and restructured as a holding company, AG Resource Holdings LLC, that wholly owned the operating subsidiary, AG Resource Management LLC.  Terral was designated as one of several managers of the LLCs, and also was an officer.

Terral’s contractual obligations were embodied in separate agreements.  First, he had an Employment Agreement, which had various noncompetes, and a Delaware choice of law clause.  Second, the LLC agreements themselves required him to act in good faith and not compete, and chose Delaware law, and Delaware forums, to resolve any disputes. 

Terral was fired after it was discovered he was planning to compete with the companies, and he filed a complaint in Louisiana seeking to have the noncompete in the Employment Agreement declared unenforceable.  Terral’s argument – which a Louisiana court accepted on a motion for a preliminary injunction – was that because the work was performed in Louisiana, Louisiana law naturally governed the Employment Agreement, and under Louisiana law both the noncompete and the Delaware choice of law clause were unenforceable. 

The companies then sued in Delaware seeking to enforce the agreements.

Examining all of this, Slights agreed that, in the absence of the choice of law clause, Employment Agreement was governed by Louisiana law as the state with the greatest interest.  Louisiana would not have permitted employees to waive Louisiana law, or waive the right to compete (at least not in the way the agreement was drafted), therefore, those provisions were unenforceable.  For that reason, the Louisiana court action took precedence over the Delaware action.  So, the companies’ action to enforce the Employment Agreement was stayed in favor of the Louisiana action.

But the LLC agreements were a different story.  First, Terral had not sued under those agreements in Louisiana, so those issues were not before the Louisiana courts.  More importantly, though, those agreements were part of “the constitutive documents of a Delaware entity,” and even in the absence of choice of law/forum clauses, Delaware law would control by default.  And under those agreements, Terral had agreed to act in good faith and not to compete, and the companies had the right to enforce those agreements in Delaware.  As Slights put it:

Moreover, while Louisiana may possess a public policy interest in regulating the actions of employers toward employees within that state, Louisiana has no interest in regulating the governance or internal affairs of a Delaware entity. And, while LA. STAT. ANN. § 23:921(L) provides that, under Louisiana law, non-competes within LLC agreements will be subject to nearly identical restrictions as those within employment contracts, there is no indication that Louisiana purports to extend those restriction to fiduciaries acting within Delaware LLCs.

To state the distinction most directly, the claims under the Employment Agreement rest on Terral’s conduct as employee (regardless of whether he occupied a fiduciary status), while the claims under the LLC Agreement rest on Terral’s status as a member of the Company’s Board of Managers. In drawing this distinction, I acknowledge there may be some overlap in the litigation and adjudication of claims arising under the Employment Agreement on the one hand, and the LLC Agreements on the other, and further acknowledge there is at least some risk of inconsistent outcomes. Nevertheless, as discussed here, Terral is alleged to have engaged in wrongful conduct as a “manager” and “officer” of a Delaware entity. The Company is entitled to litigate that claim in this Court.

All of that contains a surface level appeal, but the problem is – at least as described in the opinion (it’s possible there’s more nuance to the underlying documents) – the LLC Agreements obligated Terral to basically do the same things as the Employment Agreement, as part of a relationship that substantively would be characterized as an employment relationship.  If that’s right, then it shouldn’t matter whether the LLC Agreements are labeled “LLC Agreements” or “Employment Agreements” or “Ishkabibble,” they are substantively contracts for employment and should carry with them the same restrictions.  If Terral, as someone who performs management services for the companies, is legally barred from waiving his right to compete under Louisiana law, then it shouldn’t matter what document the impermissible restriction is contained in. 

I mean, it’s absolutely possible that Terral had different responsibilities and legal rights as a member of the LLCs Board of Managers, and as an employee of the company, making it possible to distinguish between the different contracts, but if so, nothing in the opinion itself explains what the differences would be.

To put it another way, if someone is labeled an LLC “manager,” does that mean their relationship with the LLC is necessarily a question of Delaware organizational/entity law, or is there some particular type of relationship that is more appropriate for regulation under business organizational law rather than employment law, and if so, what is the scope of that relationship?

Interestingly, VC Laster confronted a somewhat similar situation a few months ago in Focus Financial Partners v. Holsopple.  There, an employee working out of California received as compensation certain units of a Delaware LLC.  As a condition of his employment, he signed “unit agreements” regarding the transfer of the units, which contained various noncompete/nonsolicit clauses, and stated they were governed by Delaware law with a Delaware forum selection clause.   Additionally – and I’m simplifying, there were amendments over time, it was a whole thing – the LLC itself had an operating agreement with a Delaware forum selection clause.

There was eventually a dispute over whether Holsopple had violated the noncompetes, and Focus Financial sued in Delaware.  The only way that Delaware would have personal jurisdiction over Holsopple was through the choice of forum/law provisions of the unit agreements and the operating agreement.  Holsopple, however, claimed that these provisions were all part of his employment contract, his employment contract (in the absence of these agreements) would be governed by California law, and California law would render them unenforceable.  Laster agreed.  Notwithstanding the fact that the provisions did not appear in the employment agreement per se – they appeared in unit transfer agreements and the LLC operating agreement – they were functionally part of his employment contract. 

Now, Laster had an easier time of it than did Slights in AG Resource Holdings, because Holsopple was not a manager of the LLC.  In fact, as Laster pointed out, “the units generally did not have ‘any voting or other consent or approval rights.’ Focus Parent is a manager-managed LLC in which holders of units have minimal rights.”  But that only begs the question whether – going back to to AG Resource Holdings – Slights should have conducted a more searching inquiry of Terral’s powers and responsibilities to determine if even his “manager” role was functionally that of an employee.

Notably, in Focus Financial, Laster had a very interesting footnote where he anticipated the corner into which Delaware had boxed itself:

Delaware court have confronted with increasing frequency situations in which parties have attempted to use choice-of-law provisions selecting Delaware law to bypass the substantive law of sister states. In this court, the conflicts most often involve agreements containing restrictive covenants.  … This court has also confronted a conflict between agreements selecting Delaware’s contractarian regime and the substantive law of a foreign jurisdiction. … Other Delaware courts have confronted similar issues in other contexts. …Because Delaware’s role as a chartering jurisdiction depends on other states deferring to the application of Delaware law to the internal affairs of entities, the increasing frequency with which parties use Delaware law to create conflicts with the substantive law of other jurisdictions raises significant public policy issues for this state. See Diedenhofen-Lennartz v. Diedenhofen, 931 A.2d 439, 451–52 (Del. Ch. 2007) (“If we expect that other sovereigns will respect our state’s overriding interest in the interpretation and enforcement of our entity laws, we must show reciprocal respect.”).

The point is, Delaware’s increasingly contractual approach to entity is organization is putting pressure on the boundaries of the internal affairs doctrine.  Also relevant here is the growing prevalence of shareholder agreements – studied by Gabriel Rauterberg in this paper and Jill Fisch in this one – which may very well select a law other than Delaware’s, so that the entity is organized under Delaware law but crucial governance matters are controlled by the law of another state.  See, e.g., KT4 Partners v. Palantir Technologies (shareholder may obtain books and records under Section 220 to investigate violations of stockholder agreements governed by California law).  These are going to create thorny choice-of-law issues going forward and, I worry, undermine the utility of the internal affairs doctrine itself.