This post is dedicated to the students in my Business Associations class, who took their final exam this morning.

Two weeks ago, reflecting on Francis v. United Jersey Bank, 432 A. 2d 814 (N.J. 1981), I asked for commentary on the following question: “How would the Francis case be pleaded, proven, and decided as a breach of duty action under Delaware law?”  That post generated some commentary–both online and in private messages to me.  In this post, I forward an analysis and a related request for commentary.

A number of commentators (including BLPB co-blogger Doug Moll in the online comments to my post) posited that a Caremark oversight claim may be the appropriate claim, and that the cause of action would be for a breach of the duty of care.  I find the latter part of that answer contestable.  Here is my analysis.

I begin by agreeing that Mrs. Pritchard’s abdication of responsibility constitutes a failure to exercise oversight. Under the Delaware Supreme Court’s decision in Stone v. Ritter, I understand that claim to be Caremark claim. (“Caremark articulates the necessary conditions for assessing director oversight liability.”)  I think many, if not most, are also in agreement on this.

Here is where there may be some divergence.  Also relying on Stone, I understand that Caremark claim as a breach of the duty of loyalty, founded on a failure to act in good faith.  (“[B]ecause a showing of bad faith conduct . . . is essential to establish director oversight liability, the fiduciary duty violated by that conduct is the duty of loyalty.”)  This makes sense to me because of the Delaware Supreme Court’s opinion in Brehm v. Eisner, in which it circumscribes the duty of care.  (“Due care in the decisionmaking context is process due care only.”)

However, Brehm (as evidenced in the immediately preceding parenthetical quote) addressed the duty of care under Delaware law in a decision-making context.  Francis was largely a case about the absence of decision making.  Moreover, the Brehm court’s view on a substantive duty of care are rooted in the contradiction of that doctrine with the business judgment rule.  (“As for the plaintiffs’ contention that the directors failed to exercise ‘substantive due care,’ we should note that such a concept is foreign to the business judgment rule. Courts do not measure, weigh or quantify directors’ judgments.”)  So, Brehm‘s wisdom on the duty of care under Delaware law may be inapplicable to facts like those in Francis, since the business judgment rule is inapplicable because the board did not engage in decision making.

Nevertheless, Stone seems to erect barriers to a duty of care claim for oversight like that presented in the Francis case.  BLPB co-blogger Anne Tucker voiced this concern in a 2010 article in the Delaware Journal of Corporate Law

Exculpatory provisions that eliminate liability for negligence and gross negligence (i.e., the duty of care), combined with the assumption of the duty of good faith under the liability standard for the duty of loyalty, narrow the standard of liability for director oversight. The result is while directors have three fiduciary duties-the duties of care, good faith, and loyalty-the three standards of conduct are essentially collapsed into one actionable standard: the duty of loyalty.

Anne Tucker Nees, Who’s the Boss? Unmasking Oversight Liability Within the Corporate Power Puzzle, 35 Del. J. Corp. L. 199, 224–25 (2010).  Lyman Johnson similarly had commented, seven years earlier (and before the Stone case was decided)  that

care has been rendered a “small” notion in corporate law. It largely refers to the manner in which directors are to act. It is a process-oriented duty to act “with care.” Having confined care to that narrow chamber, the other meanings of care as found in the phrases “take care of” (the corporation) and “care for” (the corporation) remain fully available for infusion into corporate law through an expansive duty of loyalty.

Lyman Johnson, After Enron: Remembering Loyalty Discourse in Corporate Law, 28 Del. J. Corp. L. 27, 72 (2003).  Others also have written about this.

Based on the foregoing, I conclude that a duty of care cause of action is not available in Delaware for an oversight claim like that raised in Francis.  Delaware’s duty of care comprises the duty to fully inform oneself of material information reasonably available under Smith v. Van Gorkom.  As a result, an oversight claim based on facts like those in Francis is a claim for a breach of the duty of loyalty as described in Stone.

Agree?  Disagree?  Provide analyses and, if possible, relevant decisional law.

Once again, a court seems to arrive at the correct outcome, while making mistakes in the describing entity type. As usual, the court mislabeled a limited liability company (LLC).  Here we go:  

Andrea and Timothy Downs each held a 50% interest in a corporation, Downs Holdings, Inc. It held limited liability corporation (“LLC”) and limited partnership (“LP”) ownership interests. Eventually, the Downs agreed to dissolve the corporation and, as shareholders, passed a corporate resolution electing dissolution.

In re: ANDREA STEINMANN DOWNS, Debtor. NORIO, INC., Appellant, v. THOMAS H. CASEY, Chapter 7 Tr., Appellee., No. 8:16-BK-12589-CB, 2019 WL 6331564, at *1 (B.A.P. 9th Cir. Nov. 25, 2019) (emphasis added). 
 
The Downs did not follow the necessary formalities to dissolve Downs Holdings, Inc., and had instead ask that the corporation’s management company “distribute the payments and monies owed to Downs Holdings to each shareholder separately, 50% to Mr. Downs and 50% to Ms. Downs.” Id. Further, it appeared that the Downs asked to be treated as separate interest holders for both the LLC and LP. Id. Ms. Downs later borrowed $50,000 from Norio, Inc. and pledged pledged her claimed interests in the LLC and the LP as collateral. Id. at *2.

 

Because Downs Holdings, Inc., was the named interest holder in the LLC and the LP, and it had not been dissolved, and because there was no showing “that the assets transferred from Downs Holdings to Ms. Downs, the bankruptcy court did not err when it determined that Norio, Inc. lacked secured status.  Id. at *5. 

That all seems about right.  At the beginning of the opinion, the court states, 
 
We acknowledge that some of the bankruptcy court’s findings lack support in the record, but we ignore harmless error because the bankruptcy court’s ultimate conclusion is correct: Downs Holdings owned the relevant assets, and Ms. Downs could not pledge them to Norio as collateral for the loan.
Id.at *1. Calling a LLC a corporation in this context is, this time, anyway, harmless error. But I am not inclined to ignore it. I mean, the entity type is specifically at issue in this case, with respect to the corporate form. Making sure the corporation and the LLC are clearly recognized as distinct entity types may not be essential to finding right outcome, but it sure would be appropriate.  

One of the biggest corporate law battles today concerns the appropriate role of institutional investors – and especially mutual funds – in corporate governance.  There has been increasing concern expressed in the academy that mutual funds – especially index funds – don’t have sufficient incentives to oversee their portfolio companies, and/or that mutual fund complexes have become so huge that they dominate the economy.  The concerns are rising to a level where the funds themselves are responding; witness, for example BlackRock’s attempted defenses here and here.  And, of course, we have the SEC’s sneak attack on institutional power via proposed regulation of proxy advisors.

Which is why I found Fatima-Zahra Filali Adib’s new paper, Passive Aggressive: How Index Funds Vote on Corporate Governance Proposals, so interesting.  She studies index fund voting behavior and contribution to corporate value by focusing on the “close call” votes, i.e., ones that narrowly pass or narrowly fail.  She finds that index fund support is associated with value enhancement, and that these votes are not dictated by the proxy advisors (rebutting arguments that institutions blindly follow advisor recommendations).  On the other hand, she also finds that ISS recommendations are not well correlated with value-enhancement, at least on the “close calls” – a point supporting the claim that proxy advisors do not know what they’re doing.

Also, fascinatingly – in direct response to those who claim that index funds do not have resources or incentives to devote to corporate governance – she concludes that funds allocate more resources to the “close call” proposals, apparently in anticipation that these are the ones where their votes will be pivotal.  Her proxy for resource allocation is the fact that the fund voted against management (which suggests more attention to the issue).  Bottom line is, funds are more likely to vote with management if they are “busy” – i.e., there are a lot of other proposals that require fund managers’ attention – but they are not more likely to vote with management, no matter how busy they are, if the vote is a close call.  The voting behavior also suggests that index funds identify problem firms and continue to devote resources to them over time.

Anyway, that’s just a summary – there’s a lot here to dig into.

Senator Rand Paul has a new proposal out to (among other things) allow retirement savers to make tax-free withdrawals from their retirement accounts in order to pay down student loans.  The press release describes the plan this way:

As U.S. student loan debt hits its highest-ever levels, Dr. Paul’s HELPER Act would allow Americans to annually take up to $5,250 from a 401(k) or IRA — tax and penalty free — to pay for college or pay back student loans. These funds could also be used to pay tuition and expenses for a spouse or dependent. 

Why his office refers to him as Dr. Paul and not Senator Paul, I cannot fathom.  If I ever get elected to anything and start introducing legislation, I’m not going to be calling myself “Professor” in the press release.

For people paying down student loans, this could result in a substantial tax savings.  Think about it from the perspective of a person lucky enough to make good money and have the funds available to make significant contributions.  Routing funds through the 401(k) account would reduce taxable income and make it possible to pay $5,250 a year with pre-tax money. 

I’m not sure why we need to launder funnel through a 401(k) account. We could also deduct student loan payments (interest & principal) from income as well.  I’m not sure how necessary it is to use the 401k structure here.  If we want to simply make student loan repayment tax free, why put a cap on the amount that is tax and penalty free?  A cap creates an incentive to pay no more than the cap each year. If the thesis is that getting rid of higher interest rate debt early is a good idea, a cap may cause slower repayments.  

Consider a new doctor, heavily burdened with debt.  It may make sense to spend another year living like a resident and clear out the debt.  This is harder to do if higher tax brackets eat up much of the money earned.

Whether this proposal will, on balance, result in greater retirement savings at retirement, I do not know.  Its possible that some people may increase their 401(k) contributions to pipe student loan repayment money, tax-free, through these accounts.  Once the pipe is set up and running with a higher contribution level, they may continue those contributions after the student debt has been paid off.  On the other hand, some people might raid their retirements to get rid of student loan debt.

This may not be the best way to deal with student debt because it’s an option that will only be available to those with retirement funds and accounts.  About half of Americans simply don’t have any retirement savings.  If parents use their retirement funds to pay their children’s tuition, it may simply reduce their retirement savings.  That being said, it might help some people and lead to better results for some savers than the status quo.  

In reading, CFTC Relying More Heavily on Coordination with Criminal Prosecutors, I saw that the CFTC recently released their Division of Enforcement Annual Report for FY2019 (Report) (here).

Surprisingly, it’s only the second such report, and it aims to increase the transparency, continuity, and consistency surrounding the priorities of the Division of Enforcement (Division).  This strikes me as a good thing.  In case you’re wondering, the current priorities are: “preserving market integrity; (2) protecting customers; (3) promoting individual accountability; and (4) increasing coordination with other regulators and criminal authorities.”  The Report also provides several interesting charts and lots of metrics about the Division’s enforcement activities.

I found several items in the Report particularly interesting.  First, in May 2019, the Division made its Enforcement Manual public for the first time (here).  Second, the amount recovered in enforcement actions for FY 2019 – $1,321,046,710 – was the 4th highest amount ever for the CFTC!  Third, there’s much focus these days on entities’ compliance programs.  This should be of interest to the increasing number of law schools offering compliance courses/curriculum.  Indeed, the Report’s concluding paragraph states that “The ultimate goal is to foster among our market participants a true culture of compliance…And that’s the end goal at which our enforcement actions are aimed.” Fourth, the Division has had important wins in litigating fraud cases involving digital assets falling within the definition of commodity in the Commodities Exchange Act.  Fifth, we all know that data is king/queen everywhere these days – the Division is no exception! Increased use of data analytics is accelerating its ability to detect market misconduct.  Sixth, the Division’s Whistleblower Program is definitely on the rise.  In FY19, Whistleblower Awards totaled $15,384,664, and were linked to “judgements totaling more than $800 million.”   Indeed, “between 30 to 40% of the Divisions ongoing investigations now involve some whistleblower component.” 

Finally, “During the last Fiscal Year, we filed more cases in parallel with criminal authorities (sixteen) than any prior year.”  The Report states that “When criminal penalties are added to the broader range of other remedies the CFTC can impose, the result is a robust combination of sanctions which can be tailored to the violation at issue to achieve optimal deterrence.”  A 2003 WilmerHale publication is entitled: Parallel Criminal and SEC Prosecution Present New Risks for Public Companies and their Officers and Directors (here).  The increased number of parallel proceedings involving the CFTC is also likely to present new risks for firms and their officers/directors/employees.  A quick law review search suggests that little has been written on this specific issue – perhaps some BLPB readers could make it the topic of future research!

Win

In running circles, Nike has been in the news quite a lot this year.

In May, Nike was criticized for its maternity policy (of lack thereof) for sponsored runners (See “Nike Told Me to Dream Big, Until I Wanted a Baby”).

In September, Nike’s running coach, Alberto Salazar, was suspended for 4 years for facilitating doping. (See “Nike’s Elite Running Group Folded After Suspension of Coach Alberto Salazar”)

In October, Nike’s sponsored runner, Eliud Kipchoge, ran the first sub-2 hour marathon, wearing the much-hyped Nike Vaporfly shoes. (See “Eliud Kipchoge runs first ever sub-two hour marathon in INEOS 1:59 challenge”) (See also, “Achieving the Seemingly Impossible: A Tribute to Eliud Kipchoge” by our own Colleen Baker)

In November, former Nike-sponsored runner Mary Cain’s allegations of verbal abuse and weight shaming went viral. (See “I Was the Fastest Girl in America, Until I Joined Nike: Mary Cain’s male coaches were convinced she had to get “thinner, and thinner, and thinner.” Then her body started breaking down.”) (See also, “Mary Cain Speaks Out Against Nike and Coach Alberto Salazar Over Emotional, Physical Abuse”)

I think Robert Johnson of Let’s Run gets it right – Don’t Believe The Spin, Nike’s Treatment Of Mary Cain Is Very Much In Line With Its #1 Core Value: Win At All Costs. And, at least based on what I see among my serious running friends, the negative press is not hurting Nike’s sales. The Nike Vaporfly shoes are the best running shoes on the market, and the negative press appears to be rationalized or ignored by consumers. Even the author of the Mary Cain story for Sports Illustrated (which was extremely critical of Nike) donned a Nike kit and the Nike Vaporflies in his recent marathon.

So here is the perennial business law question: is Nike’s “ruthless winning” strategy proper, or even required? As we all know, the business judgment rule allows Nike’s board of directors a great deal of flexibility in their decision-making. But the pull of the shareholder maximization norm—and the fact that shareholders hold many more accountability tools than other stakeholders—makes the results above pretty unsurprising.

Former Chief Justice of the Delaware Supreme Court has posted a paper with some ideas for encouraging more prosocial behavior by U.S. corporations, but there are no easy solutions and still much academic work to be done in this area.

BLPB(LastPlatedMeal)

Last night, my husband and I made our last meal from Plated, our favorite home meal delivery kit merchant.  (As readers may recall, I have been a meal kit delivery fan for quite a while.  See here, here, and here.)  Plated announced that it would cease producing meal kits for home delivery last month.  The message I received from Plated, which arrived a full week after pubic announcement had been made of the closure of the home delivery business, was simple.

To our loyal customer,

Just in case you haven’t heard, Plated will be closing its subscription business. Our last boxes will be shipped on November 26, just in time for Thanksgiving. Please log into your account to manage your subscription at any time before that, or contact us if you have any questions.

Plated is part of the Albertsons Companies family of stores, including many of your favorite grocery store brands across the country, like Safeway, Vons, Acme Markets, Jewel-Osco and more.

Over the next year, Albertsons Companies will be moving Plated’s chef-inspired dinners, brunches and other delicious recipes to its family of stores.

You might not live near one of the stores that offers Plated, but that may change in the future. Please know we have enjoyed serving you for the past 7 years.

Forever grateful,
The Plated team

A true “loyal customer” (and I have been one) should receive notice of a business closure roughly simultaneously with any public announcement as a matter of courtesy (at the least).  But I will leave discussion of that for another day.

It seems significant to note from Plated’s message to me (and its public disclosures) that Plated meal kits are not, apparently, going the way of the dodo.  They will continue to exist, but not for home delivery.  Of course, home delivery has been an important part of the draw of this service for me and my husband.  We do not have an Albertsons Companies store anywhere near us.

The press on this business closure has covered a range of related issues, including (as one might predict) prognostications on the overall sustained profitability of meal delivery kit businesses.  One online outlet reports that “in recent months, it seems the tide has turned against meal kits, with countless headlines saying they’ve ‘fizzled,’ or worse, are ‘doomed to fail’ or already ‘DOA.'”  Another observes that “[t]he bloom is definitely off the rose for mail order meal kits. Blue Apron, a pioneer in the business, continues to limp along with dismal results. A report earlier this year from Nielsen said that sales of meal kits grew with in-store retail being the engine for meal kit growth.”  I certainly hope that reports of the industry’s death are premature (if not, as Mark Twain once said, “greatly exaggerated”).  But I understand it has been hard to make the business model sustainable.

In any event, in honor of our years of great service (and super recipes) from Plated, I am posting a picture of the meal we made last night (Chicken-Avocado Burgers with Lemon Aioli and Sautéed Haricots Verts).  It was delicious.  And we had fun making and eating it together.

Farewell, dear Plated.  Alas, we knew you well and enjoyed our time with you.  I hope others continue to enjoy your recipes and convenience by purchasing your kits in supermarkets.

Over at Kentucky Business Entity Law Blog, Tom Rutledge recently posted Respectfully, I Dissent: Dean Fershee and Elimination of Fiduciary Duties, in response to my recent paper, An Overt Disclosure Requirement for Eliminating the Fiduciary Duty of Loyalty. Tom and I have crossed paths many times over the past few years, and I greatly value his insight, expertise, and opinion. On this one, though, we will have to agree to disagree, but I recommend checking out his writing.  You may well agree with him.  

I actually agree with Tom in most cases when he says, “I do not believe there is justification for protecting people from the consequences of the contracts into which they enter.” Similarly, I generally agree with Tom “that entering into an operating agreement that may be amended without the approval of a particular member constitutes that member placing themselves almost entirely at the mercy of those with the capacity to amend the operating agreement . . . . ”  Nonetheless, I maintain that there is a subtle but significant difference where, as in Delaware, such changes can be made to completely eliminate (not just reduce or modify) the fiduciary duty of loyalty. 

As applied, Tom may be right. Still, until Delaware’s recent change, we had a long history, in every U.S. jurisdiction, prohibiting the elimination of the duty of loyalty. It is simply expected, that at some basic level, those in control of an entity owe the entity some level of a duty of loyalty. Because that is such a long-held rule and expectation, I remain convinced that the option to eliminate the duty requires some type of special notice to those entering an entity. Until now, even conceding that a lack of control could put an LLC member “almost entirely at the mercy of those with the capacity to amend the operating agreement,” the amending member’s power was still limited by the duty of loyalty.  

Ultimately, I tend to be a big fan of private ordering and freedom of contract, especially for LLCs. But, when we change fundamental rules, I also think we should more overtly acknowledge those changes, for at least some period of time, to let people catch up.  

I’m assuming most readers know the backstory here, but CBS and Viacom are both controlled by NAI, which in turn is controlled by Shari Redstone.  NAI owns nearly 80% of the voting stock of each company; the rest of the voting shares are publicly traded but held by a small number of institutions.  The bulk of each company’s capitalization, however, comes from no-vote shares, which are also publicly traded.

Redstone has long sought a merger of the two companies, which has been perceived as a boon to Viacom and a drag on CBS.  That’s why, when she proposed a merger in 2018, the CBS Board revolted and tried to issue new stock that would dilute NAI’s voting control.  That case resulted in a settlement whereby Redstone promised not to propose a merger for two years unless the CBS independent directors raised the issue first.  By sheerest coincidence, as luck would have it, mere months after the settlement was reached and the CBS board restructured, CBS and Viacom announced that they had reached an agreement and would merge by the end of 2019.

Of course, the immediate question among academics was whether, if the merger did proceed, Redstone would shoot for MFW-cleansing, which would require conditioning the deal on the approval of the disinterested shares.  And if Redstone did try to cleanse, would she give the no-vote shares the chance to vote?  Or would she try to cleanse with only the voting shares that are not held by NAI?  If the latter, would Delaware courts really permit a deal to be cleansed by the vote of unaffiliated shares representing such a small fraction of the total capitalization, especially when the no-vote shares have no say at all?

Sadly for those of us in the nosebleed seats, those questions are not going to be answered, because Redstone refused to condition the deal on any kind of unaffiliated shareholder vote (one of the points of objection among the 2018 CBS Board) – which is important for where we are now.

Where we are now is that a holder of CBS’s no-vote shares is (inevitably) seeking books and records in order to determine if there was wrongdoing in connection with the proposed deal.  (Spoiler: The shareholder thinks there was wrongdoing).  CBS and Viacom refused to provide all of the documents sought, leading to a lawsuit, and ultimately VC Slights’s recent opinion in Bucks County Employees Ret. Fund v. CBS.  Slights concluded that there was a “credible basis to suspect wrongdoing,” and granted the plaintiff access to a broad array of documents, if not everything identified in the initial requests.

There’s a lot that’s of interest here, including details that I didn’t see reported previously (they may have been, if so I missed it) suggesting Redstone influenced the transaction, by, among other things, pressuring what Slights describes as the “purportedly” unaffiliated CBS committee and offering increased compensation to CBS’s Chair and CEO in exchange for his support.  So, interested readers should really review the entire opinion.  That said, I’m going to highlight what I believe to be the most critical aspects:

(1) There is strong evidence that Redstone sought the merger as a mechanism of using CBS to bail out/shore up the failing Viacom. For example, after Redstone sought – and was refused – a merger in 2016, she complained that “the failure to get the deal done ha[s] caused Viacom to suffer,” admitted that she favored a deal because Viacom’s stock was “tanking,” and vowed to accomplish a merger by a “different process.”  Slights seemed quite persuaded by this evidence, and, of course, it will bolster claims of CBS stockholders that the deal was unfair to them.

(2) Following VC McCormick’s opinion in Kosinski v. GGP, Slights determined that the mere fact that CBS made no attempt to adhere to MFW cleansing was itself evidence of wrongdoing for Section 220 purposes.  That interests me for a few reasons.  First, it extends MFW into a novel space: previously, its purpose was to trigger business judgment review for controlling shareholder transactions, but now it will also be used to “cleanse” for the purpose of avoiding a 220 demand.  Moreover, as I’ve previously noted, the definition of a controlling shareholder transaction is itself malleable, and that malleability can be used to evade the strictures of Corwin.  Going forward, though the CBS/Viacom merger is very clearly a controlling shareholder transaction, I can imagine that in future cases, uncertainty as to whether a controlling shareholder is present in the first instance will wind up weighing in plaintiffs’ favor as they attempt to gain access to corporate records.

(3) In 2018, when CBS first tried to use nuclear tactics to avoid the merger, I said: “the main purpose of these legal skirmishes may be less to actually limit NAI’s power than to create an extraordinarily persuasive record that any attempt Shari Redstone may make to combine CBS and Viacom will be accomplished over the objection of the independent directors, and in violation of her duties as a controller.” That prediction has proved accurate; Slights explicitly read CBS’s 2018 resistance to the deal as evidence that the new deal proposed in 2019 was unfair to the CBS minority shareholders.  As he put it, “a straight line can be drawn between Redstone’s previous attempts to merge Viacom with CBS, which CBS maintained just one year ago ‘presents a significant threat of irreparable and irreversible harm to [CBS] and its stockholders[,]’ and the current attempt to combine these companies. This logical nexus is further evidence of wrongdoing…”

In short, the 2018 CBS Board – and Les Moonves – lost the battle, but may very well have won the war.