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July 18, 2014
Discerning Shareholder Consent to Profit-Reducing Religious Exercise
Posted by Alan Meese
I have previously suggested that profit maximization is a default rule, which shareholders in closely held firms may alter to induce firms to engage in religious exercise that reduces profits. Lyman of course takes issue with this claim, but let's assume for the sake of argument that I am correct. Moreover, even if I am wrong, courts applying what I consider Hobby Lobby 's shareholder primacy approach will have to discern whether a closely held corporation really is exercising the religion of what the Court called the corporation's owners.
Brett understandably wonders how shareholders should go about waiving the default rule that I have proposed. Brett also wonders whether say, the shareholders of Conestoga Wood in fact waived such a default rule and thus validly authorized that firm's religious exercise under the model I've proposed. These are very good questions I've been think about for some time, and I am happy Brett asked them. I also thank Brett for some off-list discussions of this topic that I have found very helpful.
Let me first suggest that the answers might depend upon the forum and legal context where the question is raised. For instance, federal courts evaluating RFRA claims might approach the question differently from state courts evaluating a claim that challenged conduct violates directors' fiduciary duties, for instance. Federal courts evaluating RFRA claims might simply ask: (1) has the corporation engaged in conduct that appears religiously-motivated (e.g., closing on a sabbath or declining to serve alcohol) and (2) if so, is the firm doing so at the behest of shareholders who own a majority of the firm's stock? Given the small number of owners in a closely held corporation, federal courts might answer this second question by asking whether any shareholders object to the practice in question. They could even take direct testimony about whether the shareholders approve of the practice.
By adopting this sort of test, federal courts could effectuate Congress's intent without getting bogged down in disputes about the meaning and application of the law of the particular firm's state of incorporation. By analogy, as Stephen Bainbridge has already suggested, federal courts applying RFRA might adopt a uniform "federal common law" definition of "closely held corporation" for applying Hobby Lobby that departs from the statutory definition in the particular state of incorporation. The majority opinion in Hobby Lobby seems to adopt this approach. The Court identified a practice that furthered the shareholders' religious beliefs and satisfied itself that these shareholders agreed with the challenged practice. The Court did not, so far as I can tell, identify any formal action by shareholders qua shareholders that approved or directed the practice.
What, though, about state courts adjudicating fiduciary duty claims? Take the following hypothetical. Let's say that one of the five shareholders of Craft Store, Inc., a Delaware corporation, believes that the firm should pursue profit maximization exclusively. (Each shareholder owns 20 percent of the firm's common stock.) He brings a duty of care claim challenging the firm's policy of closing on Sunday, refusing to sell alcohol-related products and over-paying employees. He adduces unrefuted evidence that the board, which consists solely of the other four shareholders, adopted each of these policies for religious reasons, knowing full well that profits would certainly fall as a result. While the Board could invoke the business judgment rule to defend its actions, e.g. claiming that high pay reduces employee turnover, it instead claims shareholder consent to these profit-reducing policies.
In our paper contending that business corporations are RFRA persons, Nate Oman and I identified several formal mechanisms that shareholders can employ to induce firms to pursue religiously-motivated objectives. Each would also establish shareholder consent to such profit-reducing policies. The most obvious such method would be language in the corporate charter providing that "this firm will be closed on Sundays," for instance. Bylaws adopted by the shareholders or valid shareholder agreements would also suffice. Moreover, Delaware at least allows closely held corporations to adopt charter provisions that "the business of the corporation shall be managed by the stockholders of the corporation rather than by a board of directors." See 8 Del. Code Section 351. Section 354 provides that shareholder agreements, bylaws or changes to the charter shall not be invalid because they empower shareholders to "to to treat the corporation as if it were a partnership or to arrange relations among the stockholders or between the stockholders and the corporation in a manner that would be appropriate only among partners." If such a firm adopts a provision eliminating the board of directors and empowering shareholders to run the business and affairs of the corporation, then shareholders have consented to whatever exercise of religion these shareholder/managers, who are now the equivalent of partners for this purpose, authorize.
But what if shareholders never adopted any such provisions? Can the Board comprised of four shareholders holding a supermajority of the firm's stock still claim to be exercising the shareholders' religion? One can imagine the Board's argument here: "Of course the shareholders consented. We should know. We ARE the shareholders." True enough, but when exercising their authority to manage the business and affairs of the corporation, and thus directing the firm to close on Sunday or decline to sell alcohol, these individuals were acting in their capacity as directors, not shareholders. By invoking their concurrent status as shareholders and purporting to speak for them, these directors blur the lines distinguishing different categories of corporate actor. While this may appear to be a "distinction without a difference," particularly in cases where all members of the board are also shareholders, we should not lightly allow directors to change hats in this way, given that directors and shareholders might be subject to different sets of duties, for instance. Moreover, absent some formal expression of shareholder religious preference it may be difficult to discern such preferences in close cases, particularly if director/shareholders that once embraced religious exercise purport to have changed their minds. Finally, relegating shareholders to the sort of formal mechanisms listed above can enhance transparency, a value that Joan Heminway has endorsed in this context. For these reasons, I would suggest that directors claiming shareholder consent for religious exercise must point to a formal manifestation of such consent via one of the vehicles listed above.
I should also note that there is a separate question of how specific formal expressions authorizing religious exercise must be. For instance, if shareholders rely upon changes to the charter, must they spell out and thus authorize each and every religiously-motivated practice? Perhaps not. Perhaps instead it would suffice to adopt a more general statement of religious purpose, delegating to directors the authority to execute that purpose.
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