Over at The Race to the Bottom Blog, Jay Brown has posted a 3-part series reviewing Klaassen v. Allegro Development, a case currently pending before the Delaware Supreme Court, which deals with the issue of how much notice a board is required to provide a CEO before firing him or her.  What follows are brief excepts from each of the three parts, but you should definitely follow the links for the full discussion if this material is of interest to you.

Part 1

Increasingly … governance cases involve disputes among directors.  What does a management friendly approach mean in that context?  Most likely, it means an approach that favors management directors (i.e., the CEO) over non-management directors, particularly independent directors…. This hypothesis provides an interesting template for a review of Klaassen v. Allegro Development.  The case essentially involved a dispute between a CEO and the non-management directors…. At a meeting held on Nov. 1, 2012, the board voted to remove the CEO [Klaassen].  Klaassen eventually filed suit challenging the dismissal…. The board in turn asserted that the actions were at most voidable and subject to equitable defenses.  They argued for, and the Chancery Court found applicable, the equitable doctrines of laches and acquiescence. The case is now on appeal. 

Part 2

In Klaassen, the Chancery Court conducted a tutorial on the developpment of notice requirements for directors…. Beginning in the 1990s … the courts, as VC Laster put it, “took a very different approach to advance notice for special board meetings.”  Unlike the 1980s, when shareholders could occasionally win a major governance case (recall Van Gorkom or Unocal), the 1990s began a period of decision making where this was less likely to occur…. In Klaassen, the Vice Chancellor described the [Fogel] decision as “dramatically expanding” the existing line of authority. The case essentially required advance notice to a CEO before termination.  “If Fogel is correct, then a board with a Chairman/CEO cannot fire its CEO without first giving the CEO explicit advance notice and an opportunity to call a special meeting of stockholders at which the composition of the board might change, regardless of how few shares the Chairman/CEO owns.”

Part 3

The management friendly nature of Delaware dictates that its Supreme Court will either reaffirm (or at least not overturn) the obligation of boards to notify the CEO in advance of an impending termination.  The Court will affirm (or at least not overturn) the obligation to provide this notice irrespective of the percentage of shares owned by the CEO.  In other words, the aftermath of the opinion will be that CEOs are entitled to advanced notice of their termination…. As a result, the instances of CEO removal will decline…. As to the actual decision in Klaassen, any prediction is a bit more problematic…. But, to go out on a limb, we predict that the Court will not just tamper with the reasoning but will actually reverse the Chancery Court opinion.  The case was written by a Vice Chancellor [Laster] that has shown significant independence.  Indeed, the decision in Klaassen was to uphold the dismissal of a CEO by a non-management board. Moreover, under the race to the bottom, management has incentive to find jurisdictions with favorable law….  Reversing a decision that permitted removal of the CEO without advance notice will be an outcome that management will see has highly favorable.

Once my son realized that the life of a lawyer bore no resemblance to the fun and games of Take Our Kids to Work Day, he quickly changed career paths. Now he’s applying to art and design schools to study visual arts, photography, and writing. Almost every school he wants to attend requires students to take a basic accounting course as a prerequisite for the Bachelors of Fine Arts degree. This led me to ask why law schools don’t require the same.

Two weeks ago I attended a local bar association luncheon during which several deans of Florida law schools informed the group of practicing lawyers and judges about the state of legal education. The deans also received an earful from the audience members about the kind of training they expect from the schools. More than one attorney bemoaned the lack of practical skills and business training from today’s law schools, which prompted one dean (not mine) to challenge the audience member’s hypothesis about the need for required courses beyond business associations. The dean asked why schools should force students to take additional courses if they want to litigate or do appeals. Some audience members disagreed with this response and so do I. When I was in law school I was convinced that I would become a public interest lawyer until I took tax and secured transactions and realized that there was another world out there that I had never considered.

As a commercial litigation associate in a large New York law firm I had the privilege of learning from the corporate partners about derivatives and mortgage-backed securities during mandatory firm-provided training. When I went in-house my company paid for me to attend a three-day course in accounting for lawyers, which enabled me to have more credibility with my internal clients. But the firm training was in the early 90’s and my general counsel had an incentive for me to understand the language of business. Most of today’s law firms don’t have the time or the inclination to provide that kind of training.

So should law schools have the time or the inclination for this kind of education? The second-year student who thinks she wants to be an appellate or family lawyer may change her mind after a few years (or months). Or, the only job that she can find may require her to advise small businesses, entrepreneurs, employers, nonprofits, divorcing spouses where a business is an asset, white-collar criminal defendants, or any number of clients for whom financial literacy would be required for her to provide competent legal advice. Co-blogger Anne Tucker discussed what the market wants in an earlier post here.

A number of law schools offer accounting or finance courses, but not many require them, and perhaps faculties should rethink that. Part of the reason that the arts schools require accounting courses is that art is a business. Of course, law is a business too. It would be a shame if my son, the aspiring artist knows more about a balance sheet and EBITDA after graduation than the lawyer he hires to represent him. 

This paper is a look back, but it seems appropriate for today. Happy holidays, all!  Who Owns the Christmas Trees? – The Disposition of Property Used by a Partnership, by Daniel S. Kleinberger.  Abstract: 

Abstract:      

Two partners form an enterprise. One (the K partner) supplies the assets used by the enterprise. The other partner (the L partner) supplies only labor. When the enterprise ends, the partners disagree about how to divide the property used in the partnership business. The K partner wants his or her property returned. The L partner wants his or her share of the business assets. If some of the property has appreciated while in partnership use, the dispute will be especially complicated. How do the partners divide the value of the property as originally brought into the business? Who benefits from the previously unrealized appreciation? 

This Article explores the property allocation issues that arise when the members of a K and L partnership lack a dispositive agreement. In such circumstances the default rules should provide clear guidance, and the Uniform Partnership Act (U.P.A.) seeks to do so. Unfortunately, many of the decided cases misapply or distort the U.P.A. As a body, the decided cases point in three different and mutually exclusive directions. Individually, they often ignore basic principles of partnership law. 

This Article takes those basic principles as its lodestar and seeks to determine how the law of partnership should analyze a K and L dispute over property disposition. Part II sets the context for the analysis, introducing partnership law as the applicable law. Part III explains the four basic partnership law concepts necessary to a proper analysis of the Christmas tree paradigm. Part IV describes the three different and mutually exclusive ways that courts have applied partnership concepts to evaluate the courts’ incompatible approaches. 

The analysis presented in Part IV suggests outcomes that some readers may find unfair. Part V confronts the problem of unfairness and tries to determine why courts find K and L property disputes so troublesome. Part V begins by highlighting some of the unbalanced results produced by strict application of partnership law principles. Part V then explores the rationale behind those principles and suggests that courts sometimes disregard the letter of the law in order to serve that underlying, and largely hidden, rationale. Part V next identifies the philosophical and practical problems that arise when courts disregard the clear letter of the law in favor of hidden rationales and instead twist a generally applicable statute in order to avoid reaching a particular unpalatable result. Part V concludes by offering an approach to the Christmas tree problem that substantially alleviates the unfairness problem while remaining faithful to the law. Part VI exemplifies the suggested approach, using concepts developed in previous Parts to resolve correctly the actual Christmas tree case.

Here, Professor Bainbridge kindly asks for my thoughts on Keith Paul Bishop’s article Would Hobby Lobby Stores, Inc. Have A Stronger Case As A Flexible Purpose Corporation?   

I agree with Bishop’s conclusion that the question is still open.  Both the Flexible Purpose Corporation (“FPC“) and the Benefit Corporation version of social enterprise legal forms are quite new and each became available in California as of January 1, 2012.  The FPC is only available in California (though Washington state’s social purpose corporation is similar in many respects) and the Benefit Corporation legislation has passed in 20 U.S. jurisdictions (19 states and Washington D.C.), starting with Maryland in 2010.  As the name suggests, the FPC allows managers more flexibility in choosing their particular corporate purpose(s), whereas most of the Benefit Corporation statutes require a “general public benefit purpose” to benefit “society and the environment” when “taken as a whole” but also allow additional “specific public benefit purpose(s).”  Delaware’s version of the benefit corporation law (called a “public benefit  corporation”) requires the choosing of one or more specific public benefit purposes.  

Converting to an FPC or a Benefit Corporation, without more, likely would not be much help to companies fighting the HHS mandate.  The statutes are simply too broad, and I think courts would want more evidence regarding the corporation’s stance on the issue.  Obviously, people would disagree on whether a “socially focused”  corporation would oppose certain types of contraceptives.  And it seems that the majority (though certainly not all) of those in the social enterprise area lean left of the political center. But, if an FPC or Benefit Corporation made its particular social/religious purpose(s) clear in its articles of incorporation, including enough information to determine a stance against certain types of contraceptives, I think the entity’s argument could be strengthened.  

In some states, like Oregon and Texas, relatively recent amendments to their state corporation statutes make clear that a social purpose can be included in the articles of incorporation of a traditional corporation.  In other states, whether such a social purpose would be acceptable in a traditional corporation is a debatable question, and thus social enterprise legal forms would clear the way toward including a social/religious purpose that would suggest (or clearly state) opposition to the mandate.  

In short, the social enterprise forms, without customization, are likely insufficient, but use of a social enterprise form, with language in the articles of incorporation that suggest that the corporation would be opposed to the mandate, could strengthen the argument of those fighting the HHS mandate.  In some states, as mentioned above, a social enterprise form would likely be unnecessary, and a traditional corporation with customized language could be used.

I think the question posed by Keith Paul Bishop and Professor Bainbridge is an interesting one and would love to hear additional thoughts from others, especially any Constitutional Law scholars.     

My favorite Christmas movie is It’s a Wonderful Life. I have watched it at least 50 times, but the final scene never fails to bring a tear to the eye of this hopelessly sentimental romantic.

The basic premise, for those of you who have never seen the movie, is how much the good deeds we do affect those around us. George Bailey, on the brink of suicide, is shown by his guardian angel Clarence how Bedford Falls, George’s community, would have changed if George had never been born.

As much as I like the movie, I have always been a little bothered by its portrayal of Bailey’s nemesis, Henry F. Potter, played brilliantly by Lionel Barrymore. Potter is the personification of “heartless capitalism.” He mistreats people, eschews charity of any kind, and has only one goal in life: the accumulation of wealth. The idea of sacrificing profit to help others is foreign to him.

I wouldn’t want to be Potter and I wouldn’t want to work for Potter. But is the picture the movie paints totally fair to Potter or, more generally, to profit-seeking capitalism? The best way to answer the question is to ask same question the movie uses to evaluate George Bailey’s contributions: what would have happened to Bedford Falls if Henry Potter had never been born?

  • The town’s bank would have failed in the depression. It survived only because Potter was there to bail it out. All of bank’s depositors, instead of getting 50 cents on the dollar, would have lost their money.
  • The Bailey Building and Loan would have failed after George’s father died. George’s incompetent Uncle Billy was slated to take over the business when George’s father died. That didn’t happen only because Henry Potter convinced the board to close it unless George took over. Without Potter’s actions as director, Uncle Billy would have taken over and almost certainly would have ruined the institution.
  • Poorer people who could not afford to build a house in George Bailey’s Bailey Park wouldn’t have rental housing available because Henry Potter wasn’t there to build it.
  • Adults in Bedford Falls would have fewer entertainment choices because the downtown bars and dancing halls wouldn’t exist. Only the amoral capitalist Potter was willing to fund businesses like that.
  • Most of the other businesses in town would not exist. They relied on Potter for capital; according to the movie, Potter controlled the entire town except for Bailey’s building and loan.

So don’t be so quick to condemn Mr. Potter. Even heartless capitalists have value.

Happy holidays to all our readers from our resident Scrooge.

Sofya Manukyan has published “Can the ICESCR Be an Alternative for Environmental Protection? Analysis of the Effectiveness of the ICESCR in Holding State and Non-State Actors Accountable for Environmental Degradation” on SSRN.  Here is an excerpt of the abstract:

[O]ne method for tackling the problem of environmental degradation is creating universal mandatory norms to which all corporations would adhere. Another method, however, which is considered in this work in more details, is the approach to the issue of environmental degradation from the human rights perspective, particularly from the perspective of each human being having the right to live in a healthy, clean environment. As the reflection of this right is found in the state binding UN Covenant on Economic, Social and Cultural Rights (ICESCR), we consider this indirect approach to the environmental protection as a possible effective method for addressing the issues of environmental degradation.

Therefore, in this work we first justify our choice of approaching the environmental protection from the perspective of state’s human rights obligations, rather than from the perspective of voluntary guidelines adopted by corporations and financial institutions. We then analyze how relevant articles of the ICESCR address the issue of environmental degradation. After this analysis we identify possible obstacles which may hinder the fulfillment of the Covenant provisions. Based on the observations, we summarize the extent to which the ICESCR can serve as an alternative for environmental protection, acting as a temporary measure, until the guidelines adopted by the corporations and financial institutions aimed at protecting human rights and the environment become universal and mandatory.

Laura Brandstetter & Martin Jacob have posted “Do Corporate Tax Cuts Increase Investments?” on SSRN.  Here is the abstract:

This paper studies the effect of corporate taxes on investment. Using firm-level data on German corporations, we investigate the 2008 tax reform that cut corporate taxes by 10 percentage points. We expect heterogeneous investment responses across firms, since firms with a foreign parent have more cross-country profit shifting opportunities than domestically owned firms. Using a matching difference-in-differences approach, we show that, following the corporate tax cut, domestically owned firms increased investments to a larger extent than foreign-owned firms. Our results imply that corporate tax changes can increase corporate investment but have heterogeneous investment responses across firms.

Andrew F. Tuch has posted, “Financial Conglomerates and Chinese Walls,” on SSRN.  Here is the abstract:

The organizational structure of financial conglomerates gives rise to fundamental regulatory challenges. Legally, the structure subjects firms to multiple, incompatible client duties. Practically, the structure provides firms with a huge reservoir of non-public information that they may use to further their self-interests, potentially harming clients and third parties. The primary regulatory response to these challenges and a core feature of the financial regulatory architecture is the Chinese wall or information barrier. Rather than examine measures to strengthen Chinese walls, to date legal scholars have focused on the circumstances in which to deny them legal effect, while economists have focused on demonstrating Chinese walls’ practical ineffectiveness in a range of important contexts.

This paper discusses the phenomenon of failing Chinese walls, explains why it occurs, and proposes a regulatory solution. The paper argues that limits on market discipline and evidential difficulties in detecting and proving the use of non-public information account for the failures of Chinese walls. It shows how the Volcker Rule, a core plank of the Dodd-Frank Act, will likely reduce harms flowing from failing Chinese walls, despite the rule’s intended focus on financial stability. To address the ongoing regulatory challenges, the article proposes the use of statistical inference to both detect and prove trading by financial conglomerates using non-public information and thus the failure of Chinese walls. Employed in so-called forensic finance to detect wrongdoing, the analyses can be used to rule out benign rationales – including superior trading skill and mere coincidence – for financial conglomerates’ abnormal trading returns. The article designs a regulatory strategy based on the use of statistical analyses. Although recognizing limits with the strategy, the article argues that it nevertheless holds promise in addressing the regulatory challenges of financial conglomeration.

On December 5th and 6th I attended and presented at the third annual Sustainable Companies Project Conference at the University of Oslo.  The project, led by Beate Sjafjell began in 2010 and attempts to seek concrete solutions to the following problem:

Taking companies’ substantial contributions to climate change as a given fact, companies have to be addressed more effectively when designing strategies to mitigate climate change. A fundamental assumption is that traditional external regulation of companies, e.g. through environmental law, is not sufficient. Our hypothesis is that environmental sustainability in the operation of companies cannot be effectively achieved unless the objective is properly integrated into company law and thereby into the internal workings of the company.  

Members of the Norwegian government, the European Commission, the Organisation for Economic Cooperation and Development (“OECD”), and the United Nations Environmental Programme  (UNEP) Finance Initiative also presented with academics and practitioners from the US, Europe, Asia and Africa.

I did not participate in the first two conferences, but was privileged this year to present my paper entitled “Climate Change and Company Law in the United States: Using Procurement, Pay and Policy Changes to Influence Corporate Behavior.” The program and videos of the entire conference (click on the link of the panel discussions) are here. I presented last and my paper, with the others, will appear in a special edition of the Journal of European Company Law in 2014.

Professors David Millon and Celia Taylor rounded out the US delegation. Millon, who I learned first coined the phrase “shareholder primacy,” proposed a constituency statute for Delaware, but acknowledged that his proposal (even if it were passed) might not have much impact because of the twin influence of inventive-based compensation for executives and the role of institutional investors, who also seek short-term profit maximization. Taylor discussed the SEC Guidance on climate change disclosures recommending that they be made mandatory, but cautioned against disclosure overload and potential greenwashing.

Others provided insight on shareholder primacy and board duties from the UK, Norway, and Indonesia, and Tineke Lambooy presented the results of a meta study regarding boards and sustainability.  Gail Henderson, from Canada, used the concept of “undue hardship” in human rights law to propose a new burden to reduce environmental impacts. Mark Taylor, who was one of the many attendees who like me came straight from the UN Forum on Business and Human Rights, explained due diligence provisions in EU member state laws and argued that due diligence is emerging as a standard for compliant businesses.  Carol Liao discussed “catalytic innovation” and hybrid entities. Her blog about the conference is here.

A number of presenters focused on: auditing; integrated reporting; insurance, bankruptcy, contract, and insolvency law; and the role of sustainable investors (there are 50 sustainable stock indices), particularly large sovereign pension funds.  One of the more interesting proposals came from Ivo Mulder of UNEP, who is conducting a study on a sovereign credit risk model.  Sovereign bond markets represent 40% of global bond markets but there is no integration of environmental, social or governance factors even though risk mitigation is a key factor in fixed-income investing. He called for a new way of thinking about how bond securities are valued in primary and secondary markets.

Perhaps one of the most innovative proposals came from Endre Stavang, who suggested an “environmental option.” Specifically he and his co-author recommend enacting legislation that will empower certain green companies to transfer a call option to buy a block of its shares to an established company of their choice. He stressed that the option is free and that the exercise price would be the price of the green company’s share at the time of the transfer. The non-green receiving company would have a period of five years to exercise.

The abstracts from all of the presenters are available here. It was an intense two days of creative presentations, but hopefully these kinds of substantive public policy discussions, which include government, intergovernmental organizations, stakeholders and academics will have an impact. It’s the reason I joined academia.

Happy Holidays to all, and to my new Norweigian colleagues, Gledelig høytid.

 

 

 

 

For those of you who haven’t seen it, the SEC has issued its rules proposal for so-called Regulation A+. It’s available here.

Section 401 of the JOBS Act required the SEC to exempt from registration public offerings of securities with an aggregate offering amount of up to $50 million per 12-month period. The Act does not go into much detail, but it does impose some conditions on the exemption the SEC is supposed to adopt:

  • the securities may be offered and sold publicly
  • the securities are not “restricted securities,” meaning they may be resold freely
  • the issuer must file an offering statement with the SEC and distribute that offering statement to prospective investors
  • the issuer may solicit interest in the offering prior to filing an offering statement with the SEC
  • the issuer must file audited financial statements annually
  • certain issuers are disqualified
  • the SEC may require the issuer to file periodic disclosures.

Section 401 does not mention Regulation A, but the statutory requirements are similar to the requirements in Regulation A, so everyone has been referring to it as Regulation A+. The SEC could have chosen to issue a new exemption completely separate from Regulation A, but it has not done so. The proposed rules create a two-tiered exemption within Regulation A: what was the old Regulation A exemption, with some updates; and the new exemption.