LadyVolsLogo

Readers who know me well understand that I am a die-hard fan of The University of Tennessee’s athletics teams.  As a former college athlete and continuing college sports fan, I embraced the Tennessee Volunteers and Lady Volunteers as if they were my own when I moved to Knoxville in 2000.  I first became a Lady Volunteer basketball ticket holder.  Then, I donated to the university and got myself in the queue for football tickets.  Men’s basketball followed once I began service as a member of the campus’s athletics board.

A week ago, the campus administration announced that the university would be dropping the Lady Volunteer brand for all sports except women’s basketball.  The press release is not a model of good communication to the multiple interested constituencies that could be expected to read it.  It manages to muddle the rationale for the change (citing to a campus rebranding effort, brand audits, and the campus’s new allegiance with Nike), send mixed messages (citing a perceived need for consolidation, but leaving the women’s basketball team out of the consolidation), and ignore the value of the Lady Volunteer brand to female athletes not playing on the basketball team (asserting that “[t]he Lady Vol logo . . . has long been the monogram of excellence and a tradition among our loyal basketball fans.” (emphasis added))–somewhat denigrating those non-basketball Lady Volunteer athletes and their fans in the process.  As my Facebook friends know, I am not happy about this change.  I believe that university is effectively (but admittedly not totally) giving the shaft to a valuable brand–a brand that has taken many years to build–one that is distinctive and meaningful because of its association with empowered, successful female athletes in many sports.

Apart from my disagreement with the change, however, I wondered whether legal counsel had–or could or should have had–any involvement in this “brand transition.”  I suspect so.  Among other things, I would expect that best practices would dictate that all press releases receive review from one of the university’s lawyers in the General Counsel’s office.

This realization led me to consider the possible role of trademark abandonment in the university’s decision to keep the Lady Volunteer brand for the women’s basketball team.  The university concedes in its press release that the Lady Volunteer brand, which includes its trademarked logo (reproduced above) has value–although it limits that contention to women’s basketball.  Under the Lanham Act, if the university had determined to discontinue use of the Lady Volunteer logo without having an intent to resume its use, the logo would have become available for use by others after three years.  By continuing use of the trademark for women’s basketball, the university may (in part) be endeavoring to protect the logo from expropriation by an opportunistic entrepreneur.

But maybe I am giving the university and its legal counsel too much credit . . . ?

For another (perhaps more interesting?) take on intellectual property law issues stemming from the university’s Power T rebranding campaign, see this post from one of our UT Law alums, Kevin Hartley (who practices at Stites & Harbison in Nashville).

Regular readers of this column know that I’m a strong supporter of a federal crowdfunding exemption, which would allow companies to sell securities online to ordinary investors without registration.

The SEC’s Foot-Dragging

The JOBS Act, passed in April 2012, included a crowdfunding exemption, but, 956 days later, the SEC still has not adopted rules to implement it. Last month, I complained about the SEC’s failure to adopt those rules. Now, I’m not so sure I want that to happen.

 A Little Legislative History

Why have I changed my mind? First, a little legislative history. The House originally passed a crowdfunding bill, sponsored by Representative Patrick McHenry, that was much less regulatory than the final law. Unfortunately, the Senate amended the JOBS Act to substitute the version that was eventually enacted into law. That final version is much more regulatory than Congressman McHenry’s version, and is riddled with errors and ambiguities. The House accepted that Senate substitution, probably because fighting would have risked everything else in the JOBS Act.

As I wrote shortly after the JOBS Act passed, the exemption that came out of the Senate is flawed and unlikely to be effective. If so, it’s not the SEC’s fault. The SEC has limited discretion to fix the problems in the statute.

A Better Way

Things have changed since my last post on crowdfunding. No, the SEC still has not acted. Things have changed in other ways.

The Republicans now control both houses of Congress, and the Republican-controlled Congress will undoubtedly be friendlier to small business and more concerned about the regulatory costs involved in raising capital. The new Congress is dominated by people like Congressman McHenry.

It might be better at this point to start over, instead of waiting for the SEC to finish its exercise in regulatory futility. And, this time, Congress shouldn’t wait for SEC action. It should put the final exemption in the statute itself, with SEC input. The SEC certainly can’t argue that they need more time to study the issue.

President Obama might threaten a veto and argue that we should wait to see if the existing provisions work. But keep in mind that the Obama administration endorsed the original House bill. Was that original endorsement mere political grandstanding, or does President Obama really want to provide an effective exemption?

Congress is unlikely to override a presidential veto, so if that happens, we’ll probably have to wait for a new President to get a workable crowdfunding exemption.

Back in 2011, Judge Rakoff famously delivered a blistering indictment of the SEC’s enforcement tactics when he rejected the SEC’s settlement with Citigroup over a CDO alleged to have been designed to fail. 

The decision was immediately appealed (and ultimately reversed), but was pending before the Second Circuit for over two years.  During that time, other district judges followed Rakoff’s lead, scrutinizing the SEC’s settlements more closely.

Judge Rakoff’s criticism was incredibly influential, or perhaps just captured a zeitgeist regarding the lack of serious sanctions against large financial institutions in the wake of the mortgage crisis – the SEC even announced it would revise its “no admit-no deny” settlement policy as a result.

After the Second Circuit reversed Judge Rakoff, he reluctantly approved the Citigroup settlement – but with a footnote warning (1) that the SEC would simply bring more cases administratively to avoid any court review at all, and (2) that such administrative decisions might be unconstitutional.  

Judge Rakoff seems a bit prescient in that respect, because the SEC has openly stated it plans to bring more administrative cases – and the data shows that’s apparently a smart move, since its administrative judges, at least recently, deliver victories to the Commission 100% of the time.  (I can’t tell whether the data controlled for the types of cases likely to be brought administratively versus in court).  Meanwhile, Judge Rakoff has continued to criticize the SEC – most recently in a speech lamenting the trend toward administrative trials, in part because federal appellate review is deferential.

And many of the “new” defendants are fighting back with challenges to the constitutionality of the SEC’s administrative forum.

Most recently, Justice Scalia, joined by Justice Thomas, penned a statement respecting a denial of certiorari in an insider trading case, in which he openly challenged the notion that the SEC may administratively interpret a statute in a manner that deserves deference from courts enforcing the crininal laws.  That argument may be a bit far afield from Judge Rakoff’s legally, but the policy concerns are similar – Judge Rakoff, too, extolled the virtues of having a federal court oversee the agency’s conduct and guide the development of the law.

(One can’t help but notice that this argument seems to have no purchase when private plaintiffs make it in reaction to boilerplate arbitration agreements concerning statutory claims.  But I digress.)

To be sure, there are obvious distinctions between these issues.  After all, the SEC’s decision to bring cases administratively may just be a function of new powers granted to it after Dodd-Frank, and may not reflect any desire to avoid scrutiny by judges like Rakoff.  Moreover, the new administrative cases do not concern mortgage-misconduct or even the misconduct of big banks – many involve insider trading, like the case that inspired Justice Scalia’s statement.  Finally, Justice Scalia’s statement goes well beyond the SEC, and could potentially extend to many administrative agencies. 

Nonetheless, it’s very hard not to suspect that Rakoff and other judges of his ilk play some role in the SEC’s calculus when deciding where to prosecute a case.  And the throughline of all of this, for me, is that the criticisms of the SEC all look like variations on the ongoing accusation that the SEC (and federal prosecutors) prefer easy wins in insider trading cases to aggressive policing of large financial institutions.  (It is, in a way, the same debate that is dividing the Commission right now regarding penalties to be imposed on Bank of America for crisis-related misconduct.)  Judge Janice Rogers Brown on the DC Circuit just yesterday delievered a similar attack on the SEC, writing that more accountability and openness is required because “Financial institutions and their regulators now frequently operate under a haze of public distrust fueled by repeated regulatory failures and massive, opaque and unaccountable bailouts.  The public now has good reason to doubt the rigor of our financial systems’ reliability and oversight.”

So I can’t help but wonder how much Judge Rakoff’s attack in 2011 is continuing to reverberate throughout the system.

I also have to say, the questions posed in the Scalia opinion are fascinating.  There has long been a palpable tension in courts’ interpretation of Section 10(b) between their desire to narrow the statute for private claims, and their desire to broaden it for SEC claims.  In Stoneridge Investment Partners v. Scientific-Atlanta (2008), for example, the Supreme Court dismissed the plaintiffs’ Section 10(b) claims by focusing on the element of reliance – applicable in private actions but not SEC actions – which set up a significant divide between the types of conduct that can form the basis of private actions, versus the types of conduct the SEC can target.  The Fourth Circuit then started on a path of interpreting the statute differently for criminal claims (one suspects because it was really trying to distinguish government from private, rather than civil from criminal). 

If Justice Scalia’s argument wins the day, will we see a proliferation of interpretations of 10(b) – public civil, criminal, and private?

 The Supreme Court of Wyoming recently decided to pierce the limited liability veil of a single-member LLC.   Green Hunter Wind Energy, LLC (LLC), had a single member: Green Hunter Energy, Inc. (Corp). LLC entered into a services contract with Western Ecosystems Technology, Inc. (Western).  The court determined that veil piercing – thus allowing Western to recover LLC’s debts from Corp – was appropriate for several reasons. I think the court got this wrong.  The case can be accessed here (pdf).  

The court provides the following rule for piercing the veil of a limited liability company, providing three basic factors 1) fraud; 2) undercapitalization; and 3) “intermingling the business and finances of the company and the member to such an extent that there is no distinction between them.”  The court noted that the failure to following company formalities was recently dropped as a factor by changes to the state LLC statute.

Here’s where the court goes wrong: 

(1) As to undercapitalization, the court completely ignores the fact that Western freely contracted with the LLC with little to no cash.  If Western wanted the parent Corp to be a guarantor, it could have required that. If Western thought LLC was acting as an agent for Corp, Western should have claimed that.  It seems to me this is directly analogous to an actual parent-child relationship.  Western contracted with adult (but penniless) child.  Child didn’t have money when the contract was signed or when the bill was submitted.  Western then calls parent and says, “Pay up.” Western is free to call, but parent can say, “No.  You dealt with my kid, not me, and I didn’t agree to this debt.”   

(2) There is a better argument this should be different if this were a tort suit where Western did not choose to engage with the LLC, but that’s not the case here.  I don’t see how Western can claim undercapitalization now when they had the opportunity to ask before the contract was formed.  Western is the least cost avoider here and assumed the risk of dealing with a lightly capitalized company.  It seems to me that should be part of the assessment.  Undercapitalization is, as the court notes, “a relative concept.” The court cites potential abuse of LLC laws if they were to adopt such a rule that motivates companies to ask for guarantees. instead adopting a rule that could incentivize companies like Western actively avoid ask ingfor guarantees. Why? Because if you ask for a guarantee and are refused, it could be used against you later.  But if you don’t ask, you may get to piece the veil and seek a windfall recovery by getting a post hoc guarantee that was not available via negotiation. 

The court’s rationale is as follows:

It makes good business sense for a contract creditor to try to obtain a guarantee  from the member or retainer from the limited liability company itself. But we are mindful of the reality of the marketplace that many businesses are not in a position—competitively or economically—to insist on guarantees. For that reason, we decline Appellant’s invitation to find piercing inappropriate in this case because Western did not protect itself from Appellant’s misuse of the LLC by attempting to obtain a guarantee or other form of security. To do so would invite abuse of entities, as is the case here. 

No way.  If you can’t “competitively or economically” secure a guarantee, then too bad.  If the legislature wants to create guarantees or minimum capitalization requirements for all entities, fine.  Otherwise, this is absurd. 

(3) Further, Court state that “the district court correctly concluded that the LLC ‘failed to adequately capitalize the LLC, that LLC was undercapitalized at all times relevant to this suit and the LLC lacks corporate assets.”  Wrong.  Again, if Western knew the finances of LLC at the time of contracting (as it could and should have), then it wasn’t undercapitalized.  LLC simply existed and Western did not seek to avoid the risk of dealing with such an entity. 

More important, though LLCs cannot have “corporate assets.” It’s a limited liability company, not a corporation.  Sheesh.  I’ll add this one to my list of courts getting LLC distinctions wrong.  (See, e.g., here, here, here, and here.) I would have loved to see the Supreme Court correct the district court on that, at least.  

(4) The court incorrectly suggests that the tax filings of the parent corporation and a subsidiary LLC can be a factor in the veil piercing analysis.  Sorry, but no.  For a single-member LLC, for federal tax purposes, the LLC will probably be a disregarded entity.  As such, the LLC will usually (if not always) look like part of the parent corporation. To even consider the tax filing necessarily makes one factor weigh toward piercing.  That’s wrong. 

Early in the opinion, the court notes, “Piercing seems to happen freakishly. Like lightning, it is rare, severe, and unprincipled.” (quoting Frank H. Easterbrook & Daniel R. Fischel, Limited Liability and the Corporation, 52 U. Chi. L. Rev. 89 (1985) (internal quotation marks omitted)).  In this case the court seems to be trying to make veil-piercing law in LLCs more predictable.   I’m concerned they are – they are making is more likely the veil piecing will occur, at least in the single-member LLC context.  To the extent we’re going to allow single-member LLCs, that’s unfortunate. 

In a 2012 article on securities crowdfunding, I warned about the U.S. securities law issues raised by foreign crowdfunding sites selling securities to U.S. investors. I pointed out that “some of those foreign sites also sell to U.S. investors, and some of the investments they sell would almost certainly qualify as securities under U.S. law.”

A recent SEC consent order involving Eureeca Capital shows that the SEC is well aware of the issue and willing to go after foreign sites that sell to U.S. investors.

According to the consent order, Eureeca, based in the Cayman Islands, operates a global crowdfunding platform that connects non-U.S. issuers with investors interested in buying equity securities. Eureeca had a disclaimer on its website that the securities were not being offered to U.S. residents, but it nevertheless allowed U.S. residents to invest in some of the offerings. Eureeca apparently knew these investors were Americans; they provided copies of their passports and proof of U.S. addresses before investing.

The consent order finds that these unregistered sales of securities violated section 5 of the Securities Act and also that Eureeca was acting as an unregistered broker, in violation of section 15 of the Exchange Act. Eureeca is required to pay a $25,000 fine (a fairly significant fine considering that the total amount sold to the U.S. investors, according to the order, was only $20,000).

Given the plethora of international crowdfunding platforms, I wouldn’t be surprised to see more actions like this in the future.

As a relatively new parent, I have been amazed at the insatiable curiosity of our son (19-months old). Like most parents, I think my son is special, but I see this curiosity in most children around his age. These young children want to investigate everything and will try anything. They make a lot of mistakes, but they are constantly learning and they seem to love learning.

Curiosity comes quite naturally. Obedience, however, needs to be taught. 

As a professor, I wish I could bottle my son’s curiosity and feed it to my students.

As a parent, I wish my young son obeyed as well as (most of) my students do. 

But I wonder, do we sometimes trade curiosity for obedience? Sir Ken Robinson has spoken about the problem of schools killing creativity. (Creativity and curiousity are related, I think). As a parent and as a professor, his talk is challenging.

If you are not prepared to be wrong you will never come up with anything original…we are now running national education systems where mistakes are the worst things you can make. We are educating people out of their creative capacities…Picasso once said this, he said that “all children are born artists; the challenge is to remain an artist as we grow up”…we don’t grow into creativity, we grow out of it, or rather we get educated out of it.   

Sir Ken Robinson’s talk is somewhat depressing, because much of it rings true. His talk has been watched over 29 million times. Unfortunately, I couldn’t clearly identify his proposed solution. Maybe I need to dig into his more detailed work.

How do we teach discipline (which may be a better goal than mere obedience) without killing curiosity and creativity? I do not think discipline and curiosity are mutually exclusive, but they seem to be in tension a fair bit. As a parent, I am already terrified that my son will lose his curiosity. As a professor, I want to help my students recapture theirs.   

Any thoughts would be appreciated. 

Understandably, business law professors get upset when people who should know better- judges for example- mischaracterize LLCs. I say we should be even more angry at the law clerks drafting the opinions. Many judges had no exposure to LLCs in law school but clerks graduating today certainly have. 
 
Given the ubiquity of LLCs now, I was surprised to learn that among the many outstanding CALI (Computer-Aided Legal Instruction) lessons, there are none on LLCs. (Hat tip to co-blogger Steve Bradford- my students love him now). I have volunteered to work on at least one and maybe more in the coming months. I canvassed some colleagues for their must-haves for these LLC lessons. In no particular order, here’s the current list:
 

1) Difference between LLCs, corporations and partnerships 

2) Del. and ULLCA coverage of fiduciary duties, and especially the issue of contractual waiver and default 

3) Ease of formation
 
4) Expense of formation
 
5) Ease of maintenance    
 
6) Expense of maintenance
 
7) Restrictions re. business purpose or activity
 
8) Continuity of life/limitations on existence
 
9) Label for/characteristics (incl. transferability) of ownership interests
 
10) Restrictions re. owners (number, type, or other)
 
11) Authority to bind/create liability for the firm
 
12) Personal liability of owners to outsiders
 
13) Form of management/rights to manage
 
14) Existence/characteristics of monitoring managers/board of directors
 
15) Other (additional governance rules, rights, obligations, etc.)
 
16) Entitlement to income and assets
 
17) Liability for taxes and other governmental obligations
 
18) How investors can get money OUT of an LLC
 

19) No right to distributions, and no right to vote for distributions if manager-managed

20) No right to salary or employment

21)  Taxable liability for LLC membership

22) Exit rights—voluntary withdrawals vs. restricted withdrawals, and whether or not that comes with the ability to force the return of an investment or a new status as a creditor of the LLC

23) Liability for improper distributions

24) Veil piercing, particularly given the lack of corporate formalities

I would love some feedback from practitioners as well. What do law students and practicing lawyers need to know about LLCs? What’s missing from this list? What should I get rid of? Please feel free to comment below or to email your thoughts to mnarine@stu.edu. 

 

 

 

We are covering freeze out mergers in my corporations class this week, which is great fun (and I even think a few students would agree with me on this).  Thinking about these issues reminded me that I needed to get comfortable with a spring 2014 Delaware Supreme Court opinion in Kahn v. M & F Worldwide Corp., 88 A.3d 635(Del. 2014), which applies the business judgment rule (rather than the entire fairness standard) to review these transactions if certain conditions are met.  The holding is summarized below: 

[I]n controller buyouts, the business judgment standard of review will be applied if and only if: (i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.

Kahn at 645.
 
This case is a great end-of-semester recap on some important themes.  It reviews the role of special committees (something that students can have difficulty conceptualizing outside of the context of derivative suits where they first learn them) as well as summarizes and applies the independence analysis of directors.
To show that a director is not independent, a plaintiff must demonstrate that the director is beholden” to the controlling party or so under [the controller’s] influence that [the director’s] discretion would be sterilized.. . .The inquiry must be whether, applying a subjective standard, those ties were material, in the sense that the alleged ties could have affected the impartiality of the individual director.

Kahn at 648-649.

The opinion also recaps the duty of care, proxy statements, the cleansing votes of a majority of minority shareholders, as well as provides a useful (and detailed) discussion of arm’s length transactions.  In describing the motivations behind deal protections and terms, the court sets up its analysis by analogy to a teenager. The court says that the dual protections considered in this case are good for shareholders, but that without the incentive of the business judgment rule, parties won’t agree to them.  
Assume you have a teenager with math and English assignments due Monday morning. If you tell the teenager that she can go to the movies Saturday night if she completes her math or English homework Saturday morning, she is unlikely to do both assignments Saturday morning. She is likely to do only that which is necessary to get to go to the moves–i.e., complete one of the assignments–leaving her parents and siblings to endure her stressful last-minute scramble to finish the other Sunday night. 
 
This case will likely be added to casebooks, if it isn’t already in your supplement.  For further reading, see Barnard Sharfman’s case commentary, Kahn v. M&F Worldwide Corporation: A Small but Significant Step Forward in the War against Frivolous Shareholder Lawsuits, appearing in the Journal of Corporation Law.  In this commentary, Sharfman laments that
“Because entire fairness makes it almost impossible for defendants to get the case dismissed prior to trial,  it has made it extremely tempting for plaintiffs’ attorneys, in order to earn attorney’s fees, to automatically file a class action lawsuit in a freeze-out merger without regard to the merits.”

The ruling in Kahn changes the defense landscape facilitating defendants’ “ability to seek dismissal of the suit prior to trial, thereby 

reducing, at least in theory, the pressure on defendants to automatically seek a settlement even if the suit is without merit.”

 

-Anne Tucker

 

About four years ago, despite decades of actively avoiding the idea, I started running. I am no Forrest Gump, but I run 3.5 miles on a reasonably regular basis– usually four or five times a week, sometimes more, and rarely less.   My primary running locations, North Dakota and then along the Monongahela River in West Virginia, are both quite windy.  The North Dakota winds so are significant, that they can mimic hills, which is what allowed cyclist Andy Hampsten to train for hills in “one of the flattest areas in the world.” 

I do a lot of out-and-back runs – out 1.75 miles and back along the same route.  During such runs, I often notice a similar phenomenon: I may not have any idea it’s windy if the wind is at my back when I start running.  When I get to my turnaround, though, I find a stiff wind in my face. This happens enough that I should probably figure out it is windy before I get to the turnaround, especially since it can lead to a faster pace on the way out, but I still rarely notice.  I just think I’m having a good pace day.

In contrast, it’s pretty hard to miss when the wind is in your face.  Everything feels hard. Everything feels sluggish and slow.  And it feels like, all of a sudden, you have barriers in your way. 

During these runs, it often makes me think about how many other places (in the figurative sense) this happens.  We all have our challenges, and we often have much to overcome.  But some have more challenges than others.  Because our individual challenges are real, it can be easy to miss that we may have fewer challenges than other people have.  

The things that are barriers to our goals are sometimes obvious to us. For example, as those in the current job hunt for a law professorship likely know, a lack of a top-14 law degree can be a significant limit on the number of options one might have entering the legal academy.  It certainly felt like a barrier to certain jobs when I was on the market, anyway. 

Because of that, it would be easy to discount other benefits I have because of who I am. I grew up in a safe neighborhood with good schools.  I am a white male, which means people have expectations for me that are different than others.  There is a level of presumed competence.  And, comparatively, presumed authority and ability.  If there’s no more text visible, please click below to read the whole post. 

Continue Reading Better Teaching Idea: Try to Notice When the Wind Is at Your Back