5 days ago the WSJ published an opinion piece on Delaware's fee shifting bylaws. I read it with interest, thinking "Maybe I should blog about that." Life intervened. In the meantime, my friend Steve Bainbridge posted not one, but two blogposts--footnoted, no less--on the topic.
I feel dispiritingly inadequate. But I also feel hearteningly efficient: Steve's made my work easier by first describing the fee-shifting bylaw on the merits (first post), and then applying an interest group analysis (second post)
You should read both Steve's posts, but what grabs me is the interest-group question. Steve takes as his starting point Larry Ribstein's riff on Macey & Miller's article, which is a candidate for the single law review article that most changed my view of corporate law. Usually at the end of my Corporations class's discussion of the duty of good faith, I say something like, "Yes, it's fuzzy. Maybe it's supposed to be..." Cue M&M:
Delaware could stimulate litigation by supplying legal rules that are unclear in application. The bar therefore has some interest in reducing the clarity of Delaware law to enhance the amount of litigation. But the bar risks killing the proverbial goose that laid the golden egg because it is primarily the certainty and stability of Delaware law that creates the opportunities for profits in the first place. The bar as a whole does not have an interest in making the law so unclear that corporations begin to move elsewhere in large numbers. The bar should instead favor an equilibrium point of uncertainty at which the marginal increase in bar revenues from litigation fees equals the marginal loss in revenues due to reduced incentives to incorporate in Delaware.
By this point in the semester I've waxed rhapsodic to my class about Delaware law. So I feel some guilt at disillusioning them by suggesting that the indeterminacy that so bedevils them and their outlining efforts may be by design. I can't help it, though. It's too much fun.
I digress. Steve's second post first asserts that:
Both sides of the litigation bar thus have a strong interest in banning fee shifting bylaws. Such bylaws would raise plaintiff costs, deterring lawsuits, reducing fees for all litigators.
To which I say, "Amen, brother." But then Steven suggests that
All corporate lawyers—litigators and transactional—have a strong incentive to oppose fee shifting bylaws. Hence, it was no surprise that the Delaware legislature—dominated in this area by the Delaware bar—leaped to ban such bylaws. The business groups that favor fee shifting bylaws were able to delay that action. But the final decision remains pending.
But that's not quite true, right? Certainly litigators want litigation. But deal lawyers don't want it--at least, not this particular kind of litigation. Indeterminacy over doctrinal areas like good faith is good for transactional types as well as litigators, because it gives them more nuances and risks to have to explain at length to boards as they advise on various types of action. The type of fee-shifting bylaw we're discussing, in contrast, is bad for deal lawyers--at least, if you think, as Steve does, that
There is a serious litigation crisis in American corporate law. As Lisa Rickard recently noted, “where shareholder litigation is reaching epidemic levels. Nowhere is this truer than in mergers and acquisitions. According to research conducted by the U.S. Chamber Institute for Legal Reform, lawsuits were filed in more than 90% of all corporate mergers and acquisitions valued at $100 million since 2010.” There simply is no possibility that fraud or breaches of fiduciary duty are present in 90% of M&A deals. Instead, we are faced with a world in which runaway frivolous litigation is having a major deleterious effect on U.S. capital markets.
If these suits amount to nothing more than a litigation tax on deals, then they discourage deals. And that's bad for deal lawyers.
Steve's posts left me with 2 questions:
- Small bore: Where are Delaware's transactional lawyers?
- Large bore: Will Delaware really be so short-sighted as to kill its corporate franchise goose?
As I blogged a few days ago, I've been reading Larry Cunningham's Berkshire Beyond Buffett: The Enduring Value of Values. The thesis is that Berkshire Hathaway's value will endure beyond its founder, Warren Buffett, because of the larger values of the organization. After making his case he argues (like a good lawyer) that a precedent and analogous case already exists: the Pritzger's Marmon Group.
You know you're a corporate law geek if the mere mention of the Marmon Group made you sit up and take notice. The Marmon Group plays a role in 2 classic corporate law stories. Larry mentions one: every student of corporate law should remember the Marmon Group as the bidder in the infamous corporate law case Smith v. Van Gorkom. If you don't remember the 1985 Delaware Supreme Court case, you didn't have me as a Corporations professor. Spoiler alert: the directors are found to have breached their fiduciary duty and are thus personally liable for potentially millions of dollars in damages.
What many casebooks omit--but not Klein, Ramseyer, Bainbridge, which I am happily using this term--is that the case settled for $23 million. $10 million came from D&O insurance, and "almost $11 million came from the Pritzkers." The Pritzkers had no legal duty to pay for the directors' settlement--but they did it because they felt it was the right thing to do.
The Marmon Group's second corporate law claim to fame is as a player in Barbarians at the Gate, thhe father of corporate tick-tocks. The Marmon Group backed one of the bidders, the First Boston Group. There's this great scene where in a second round of the auction they need to raise more money. First Boston makes a 45-minute presentation to a British sugar company, S& W Berisford, on a Saturday night. First Boston hoped that Berisford could make a decision by Tuesday. 20 minutes later, the company committed $125 million.
One of First Boston's advisors asks "Do these people have any idea what they're doing?... I mean, they're going to commit $125 million. Why should they do it."
Handelsman stared at Finn as if it was the silliest question he'd ever heard. "Jay [Pritzker] asked them to."
The common theme from these two stories? Sophisticated businesspeople regularly act for motivations other than money. Again and again in Berkshire Beyond Buffett, either Berkshire itself or one of its subsidiaries demonstrates that money is not ultimately what drives them. Most notably, many of Berkshire's current subsidiaries turned down higher offers from other acquirers because they valued the reputation for hands-off management that Berkshire promises.
Here's a concrete example I used with my Corporations class when discussing conflicting interest transactions. One of Berkshire's subsidiaries was operated by a devout Mormon whose stores were closed on Sundays. He wanted to expand out of the state, but Buffett was skeptical. He thought the model could work in highly religious Utah, but not beyond. Here is Cunningham quoting Buffett:
Bill then insisted on a truly extraordinary proposition: He would personally buy the land and build the store--for about $9 million as it turned out--and would sell it to us at his cost if it proved to be successful. On the other hand, if sales fell short of his expectations, we could exit the business without paying Bill a cent.
The store was "an instant success", and Berkshire wrote the Bill a $9 million check. Bill refused to take a penny of interest. It's a good example of insider transactions that benefit the firm. It also suggests Larry might actually be right about Bershire's staying power. I can't help thinking there is a lot of value in offering businessmen like this the combination of liquidity and autonomy Berkshire provides, insulating them from the demands of Wall Street.
For our last guest post, Robert and I would like to share our experiences using the five pathways in the classroom to teach legal strategy to business students. Overall, applying this research in the classroom has been a rewarding experience that has challenged us to improve the framework’s conceptual foundation and demonstrate its relevance in the business world.
When we first experimented using the five pathways in our respective graduate business courses three years ago, we were unsure about how well it might be received. To our relief, the framework was well received from the start. In a recent end of year survey that I give to my MBA students, several of them mentioned that the framework was one of the learning highlights in their required business law course. Various students mentioned that the framework allowed them to view the law in a different way and also helped them appreciate the opportunities and benefits of engaging attorneys to help solve business problems. This is in contrast to the viewpoint, held by some managers, that law is an external, dense and static force that constrains business behavior as opposed to enabling value creation.
Robert and I introduce the framework early in our courses, and then apply it to examples and cases throughout the term. To drive home the framework’s applicability, we created a specific team-based homework assignment (Download HW 1) that asks students to choose a recent news story involving a business law issue that follows the prevention, value or transformation pathway, and to analyze the issue from a law and strategy perspective. The articles that students recently have chosen to analyze include stories about NFL contract negotiations, the FCC’s review of the Comcast Time Warner merger, and Airbnb’s legal fight against the New York Attorney General. These cases provide plenty of material for discussion in class, and serve as potential research topics.
Although the framework has yet to be applied in the context of a law course, we think it could potentially engage law students and attorneys who seek to understand how the law strategically relates to their clients’ business.
Ultimately, we’d like to see the framework applied in diverse learning environments, so we encourage you to make use of the framework and contact us if you have any questions or ideas about how to apply it. If you decide to use the five pathways in your classroom or company, we’d love to hear about your experiences.
We’d like to conclude by extending a warm thanks to The Conglomerate and its readers for allowing us this opportunity to share our ideas related to law and strategy. We’ve greatly enjoyed participating as guest bloggers in such a distinguished collaborative space.
David and Robert
In an exciting day for the University of Georgia, PepsiCo's CEO Indra Nooyi spoke on campus yesterday. Her remarks were titled "The Role of the Corporation in the Modern Age," and she spoke to our business and law students about Pepsi's "Performance with Purpose" initiative. She drew a sharp contrast between two visions of corporate social responsibility. The first, dominant in the 90s when she joined Pepsi, focused on "what we do with the money we make" (corporate philanthropy, volunteering at local organizations). The second type of corporate social responsibility focuses on "how we make our money," and has led Pepsi towards acquisitions like Tropicana and Quaker Oats, to diversifying their offerings with more nutritious foods, and to working towards water conservation in its manufacturing around the globe. Of course, there are limits to diversification: the public seems to be moving away from fruit juices. And Nooyi stressed that Quaker Oat's Gatorade was for athletes, not "people sitting on the couch watching athletes."
One student asked about the NFL domestic violence controversy, and she said she's said publicly all she would about that. But then she said that they were a corporate partner and held them to high ethical standards, and they were waiting to see the results of the Mueller investigation.
Asked for advice about becoming a CEO, Nooyi said this (I'm paraphrasing) "Don't go in thinking you want to be a CEO--that guarantees you won't ever become one. If you have an office with two windows, don't be thinking about how to get one with three. Instead, be brilliant at the job you're doing. Ask for the hard jobs. You might think you want the easy jobs, but you don't get noticed if you do an easy job well."
Interestingly, Nooyi said she had never asked for a promotion, but instead had always been recognized for doing a good job and tapped for the next level. The standard advice to women in the corporate world used to be to ask for raises and promotions, like men do. But recent studies suggest there is a social cost to women who do negotiate.
All in all, a great day for UGA. It's not every day the world's 13th most powerful woman visits campus.
In this post, which follows our earlier discussion of legal strategy, we’ll offer examples of companies situated within each of the five pathways. As Robert and I mentioned in our article, most companies follow the compliance pathway. Such companies insource legal compliance through their in-house legal department, or they may choose to partner with an external compliance verification service. A firm such as ISN, for example, has built a business handling compliance issues for corporations and their subcontractors. According to the Society of Compliance and Corporate Ethics, compliance is a thriving industry due to the increased legal penalties and regulations that companies face in today’s heightened legal environment.
The avoidance pathway is less frequent, given the high stakes and liability attached to this type of strategy. General Motors may have engaged in avoidance if it misled regulators about its faulty ignition switches. Avoidance issues tend to be costly to deal with, given the loss of trust and enhanced penalties that arise from this behavior.
The more interesting and rare pathways involve prevention, value, and transformation. An interesting and controversial prevention legal strategy involves trademark policing, which, in its most egregious form, devolves into the unethical and legally dubious practice of trademark bullying. For example, Chik-fil-A employs an aggressive strategy that targets large and small companies alike and uses the threat of trademark litigation to prevent anyone from encroaching upon its trademarked brands and brand equity. Setting aside the overreaching and legally dubious aspects of this approach, some companies legitimately use a preventive legal strategy that involves cease and desist letters, litigation, and U.S. Patent and Trademark Office administrative oppositions to protect the value of their brands and advertising. The Chik-fil-A case serves as a useful reminder, however, that aggressive legal strategies may push the boundaries of ethical behavior, sound legal argument, and public opinion.
Two recent examples illustrate how employing a legal strategy in the value pathway can generate positive and tangible financial returns. The first instance involves hedge funds investing in a corporate acquisition target and then filing suit in Delaware to challenge the valuation and seek an appraisal from the court. This legal strategy is referred to as appraisal arbitrage. Many of these cases either settle or result in substantially higher prices for the party seeking the appraisal.
Another value strategy that has been in the headlines recently involves tax inversions. Burger King’s recent decision to acquire Canada’s Tim Horton’s will yield business synergies, but it also exploits a legal maneuver allowed under current tax law permitting a company acquiring a foreign entity to reincorporate in the foreign jurisdiction. By reincorporating in Canada, Burger King will effectively lower its tax rate from 35% to 15%.
The last and rarest of legal strategies is transformation. This occurs when the top executives in a corporation integrate law as a core aspect of the firm’s business model to achieve sustainable competitive advantage. Few companies are able to achieve this strategic pathway, and it’s certainly not for everyone. One company that notoriously used law to achieve abnormally large market share and margins in the ticket processing industry was Ticketmaster. The ticket service provider used venue ticket licensing contracts that included several key provisions such as long term renewable exclusivity terms (up to 5 years), and more infamously, fee sharing provisions. Ticketmaster’s business model was, essentially, to take the bad rap for charging exorbitant convenience fees and sharing those fees with the venue, thus contractually locking them into a highly profitable and exclusive business system. It didn’t hurt that Ticketmaster’s pioneering CEO Fred Rosen was a Wall Street attorney turned impresario.
Another company that is showing signs of attempting to pursue a transformative legal strategy is Tesla Motors. Tesla’s recent announcement to offer open licensing terms for its battery and charging station patents illustrates a pioneering mentality that seeks to build a business ecosystem with other auto manufacturers. By doing so, Tesla has made a major legal bet that giving up patent exclusivity rights in the short term will yield long-term competitive advantage by helping to diffuse electric battery and recharging technology. The other legal strategy Tesla has pursued relates to its pioneering distribution model of direct sales to the consumer, bypassing the traditional dealership model established for conventional automobiles. To achieve this direct-to-customer model, Tesla has engaged state regulators to achieve exemptions from state dealership franchise laws. Tesla is clearly strategizing and innovating along many fronts that involve business, technology and law. It remains to be seen, however, whether these legal strategies will offer Tesla a long-term sustainable competitive advantage.
In our next and last post, we’ll discuss our experience teaching the five pathways of legal strategy to business students and how it has been a valuable resource in the classroom.
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In our last post, we discussed our framework for legal strategy called the five pathways. Today, we’d like to address how companies navigate within these pathways to attain the best results. As we mentioned in our MIT Sloan article, there is no one-size-fits-all approach to developing a legal strategy. Companies and industries are simply too diverse for such a simplistic solution. Instead, what we find is that legal strategy often is dependent on internal and external variables, such as company size, corporate culture, regulation, pace of technological change and the company’s maturity stage.
That is not to say, however, that a large and mature company in a regulated industry cannot cross the divide from risk management to a value creation pathway. One well established transportation company recently engaged in a strategic and cross functional (legal and finance) assessment of freight contracts to evaluate which ones to renew, cancel or negotiate. The company, which was operating at full capacity, changed its legal strategy to optimize its operations for the near and medium terms. This type of strategic contract assessment clearly fits within the value pathway.
To cross the divide and move from a risk management pathway (avoidance, compliance, prevention) to a value-enabling pathway (value and transformation) we suggest that C-level executives must view the law as an important and enabling resource for achieving strategic goals. This perspective requires a strong working knowledge of law, or legal astuteness, and organizational commitments such as the deployment of resources and authority to develop and test legal strategy.
Our research suggests that successful legal strategies require a champion, or what we refer to as a chief legal strategist. This is someone who is authorized by top management and recognized across the organization as the point person for driving legal strategies. Sometimes that individual is the general counsel, such as Twitter’s former chief legal officer, Alexander Macgillivray, who once stated that fighting for free speech is more than a good idea, it is a competitive advantage for the company. We find, however, that an associate general counsel is more often able to devote time to legal strategy execution. These individuals often possess strong legal and business fluency, leadership capabilities and the ability to work dynamically in teams.
For our next post, we'll offer more examples of companies operating within each pathway.
The question: to con law or not to con law?
The context: Steve Bainbridge responding to Anne Tucker's post on including a Citizens' United/Hobby Lobby discussion in a BA course (see Anne's reply to Steve here). The question is a timely one for me: Georgia Law started classes this week, and I (the rare bird who rotates casebooks because she is easily bored) am happily back teaching from Steve's casebook, co-authored with Klein & Ramseyer, which I highly recommend. I never hand out a syllabus with assigned readings because invariably we move quicker or slower than I anticipate. I have to cut or add material, and I find that students find such midstream changes unsettling. So I don't tell them where we're going til we get there.
But I do have a "working syllabus" I hash out for myself at the semester's opening and tweak as the classes unfold. As Anne and Steve point out, the semester is ridiculously crowded. In 3 credits I cover partnership, corporations, and LLCs, and I cover the MBCA and Delaware corporate code. It's way too much material (as I told my class Wednesday as part of my "drop this class" introductory speech). My working syllabus has material for each of the 42 50-minute classes I'm allotted, and I agonize over the choices I make in filling each one. This year, for the first time ever, my roughed-out working syllabus includes a day for Citizens United/Hobby Lobby.
Why? Steve makes a terrific case for private law, and I am with him. I love teaching BA for BA's sake. Explaining to students the basic puzzle of ownership versus control, the different ways to run the railroad in terms of choice of entity and the tradeoffs among them? Throw in the importance of private ordering and the ability to read a statute, and I'm in heaven. I'm no public law scholar in sheep's clothing. I'm a true believer, proselytizing for the beauty of business law in what sometimes does feel like a con law desert.
But I have got more doctrinal material than I can possibly cover. Throw in a class where I invite in a practitioner, a class for Bill Chandler to talk about whatever the heck it is he wants to, and a review session, and we're talking precious few classes to cover a lot of material.
So why cede a precious class to public law jibber-jabber? I'm still not sure I will. But the reason came to me on a playground, chatting with an English professor mom. We were commiserating over our lack of preparation for the start of the semester (secret: professors procrastinate, too), and she said, "well, it must be nice to teach a subject so interesting to students. Hobby Lobby, Citizens United." She nodded knowingly.
The comment brought me up short. Nobody things corporations are interestng. At least, no one used to. But now they do. And sure it's for the "wrong" reasons--not for coprorate law reasons, but for reasons that deal with corporations' role in society. And I think that might be enough to devote one class out of my 42. Not for Anne's reason, "to “hook” students who didn’t come to my class with an interest in corporate law." I'm confident I can hook them on the merits. But because, as she also says, "Corporate law also matters to general members of society because corporations wield tremendous power in elections, in lobbying (regulatory capture anyone?), in shaping retirement savings, in religious and reproductive rights debates and setting other cultural norms around issues like corruption, sustainability, living wage, etc." It struck me on the playground that the "legal literacy" reason I give for taking Corporations--it's just something that every lawyer should know--may apply here as well. With Hobby Lobby we might have reached the point where corporate law literacy demands a passing understanding of these two cases.
Maybe not. The CU/Hobby Lobby class may well end up on the cutting room floor. But one last thing: as I get older, it is increasingly less clear to me that my students retain much past the exam. What I want them to get out of the class, ultimately, is a basic knowledge of the relevant codes, of the importance of codes, an ability to read statutes, an understanding of the importance of default rules versus mandatory ones, agency costs, the trade-offs in choice of entity, the business judgment rule, and fiduciary duty. Looked at that way, perhaps one public law class out of 42 isn't too much of a sacrifice in terms of coverage.
Steve Davidoff Solomon and I have put together a paper on the litigation between the government and the preferred shareholders of Fannie Mae and Freddie Mac. Do give it a look and let us know what you think. Here's the abstract:
The dramatic events of the financial crisis led the government to respond with a new form of regulation. Regulation by deal bent the rule of law to rescue financial institutions through transactions and forced investments; it may have helped to save the economy, but it failed to observe a laundry list of basic principles of corporate and administrative law. We examine the aftermath of this kind of regulation through the lens of the current litigation between shareholders and the government over the future of Fannie Mae and Freddie Mac. We conclude that while regulation by deal has a place in the government’s financial crisis toolkit, there must come a time when the law again takes firm hold. The shareholders of Fannie Mae and Freddie Mac, who have sought damages from the government because its decision to eliminate dividends paid by the institutions, should be entitled to review of their claims for entire fairness under the Administrative Procedure Act – a solution that blends corporate law and administrative law. Our approach will discipline the government’s use of regulation by deal in future economic crises, and provide some ground rules for its exercise at the end of this one – without providing activist investors, whom we contend are becoming increasingly important players in regulation, with an unwarranted windfall.
Since reading Barbarians at the Gate in the early 1990s, I have been a huge fan of business histories. Although I have read scores (perhaps hundreds) of business histories, my list of "must reads" is still long. Recently, I decided to read one of the books on that list, The Soul of a New Machine, Tracy Kidder's account of Data General's efforts to build a minicomputer in the 1970s. This book was published in 1981, and it deals with events during my high school years, so it is a great trip down memory lane.
Here is an observation about the founders of Data General early in the book:
Some notion of how shrewd they could be is perhaps revealed in the fact that they never tried to hoard a majority of the stock, but used it instead as a tool for growth. Many young entrepreneurs, confusing ownership with control, can't bring themselves to do this.
Hmm. The distinction between ownership and control is a familiar one in corporate law circles, but this Berle-Means concept is typically applied to large corporations. What does it mean in the startup context?
Chuck O'Kelley examines the connection between entrepreneurship and the Berle-Means corporation in his 2006 article, The Entrepreneur and the Theory of the Modern Corporation, 31 J. Corp. L. 753, but I am curious about viewing this from the other direction. As noted by O'Kelley, the separation of ownership and control is used by Berle and Means to describe firms after the decline of the classical entrepeneur, so it seems somewhat surprising to see Kidder use those terms to describe a startup.
Founders often exert a tremendous influence on a company, even when shares are held by other employees and investors. This control may emanate from their formal positions within the company (CEO, CTO) or perhaps from the respect they are paid from other employees. But I think it is fair to say that ownership matters a great deal in the startup context because it is more concentrated than in the public company context. Thus, to a large extent, ownership is control in a startup.
Two recent developments in the law and practice of business include: (1) the advent of benefit corporations (and kindred organizational forms) and (2) the application of crowdfunding practices to capital-raising for start-ups. My thesis here is that these two innovations will become disruptive legal technologies. In other words, benefit corporations and capital crowdfunding will change the landscape of business organization substantially.
A disruptive technology is one that changes the foundational context of business. Think of the internet and the rise of Amazon, Google, etc. Or consider the invention of laptops and the rise of Microsoft and the fall of the old IBM. Automobiles displace horses, and telephones make the telegraph obsolete. The Harvard economist Joseph Schumpeter coined a phrase for the phenomenon: “creative destruction.”
Technologies can be further divided into two types: physical technologies (e.g., new scientific inventions or mechanical innovations) and social technologies (such as law and accounting). See Business Persons, p. 1 (citing Richard R. Nelson, Technology, Institutions, and Economic Growth (2005), pp. 153–65, 195–209). The legal innovations of benefit corporations and capital crowdfunding count as major changes in social technologies. (Perhaps the biggest legal technological invention remains the corporation itself.)
1. Benefit corporations began as a nonprofit idea, hatched in my hometown of Philadelphia (actually Berwyn, Pennsylvania, but I’ll claim it as close enough). A nonprofit organization called B Lab began to offer an independent brand to business firms (somewhat confusingly not limited to corporations) that agree to adopt a “social purpose” as well as the usual self-seeking goal of profit-making. In addition, a “Certified B Corporation” must meet a transparency requirement of regular reporting on its “social” as well as financial progress. Other similar efforts include the advent of “low-profit” limited liability companies or L3Cs, which attempt to combine nonprofit/social and profit objectives. In my theory of business, I label these kind of firms “hybrid social enterprises.” Business Persons, pp. 206-15.
A significant change occurred in the last few years with the passage of legislation that gave teeth to the benefit corporation idea. Previously, the nonprofit label for a B Corp required a firm to declare adherence to a corporate constituency statute or to adopt a similar constituency by-law or other governing provision which signaled that a firm’s sense of its business objective extended beyond shareholders or other equity-owners alone. (One of my first academic articles addressed the topic at an earlier stage. See “Beyond Shareholders: Interpreting Corporate Constituency Statutes.” I also gave a recent video interview on the topic here.) Beginning in 2010, a number of U.S. states passed formal statutes authorizing benefit corporations. One recent count finds that twenty-seven states have now passed similar statutes. California has allowed for an option of all corporations to “opt in” to a “flexible purpose corporation” statute which combines features of benefit corporations and constituency statutes. Most notably, Delaware – the center of gravity of U.S. incorporations – adopted a benefit corporation statute in the summer of 2013. According to Alicia Plerhoples, fifty-five corporations opted in to the Delaware benefit corporation form within six months. Better known companies that have chosen to operate as benefit corporations include Method Products in Delaware and Patagonia in California.
2. Crowdfunding firms. Crowdfunding along the lines of Kickstarter and Indiegogo campaigns for the creation of new products have become commonplace. And the amounts of capital raised have sometimes been eye-popping. An article in Forbes relates the recent case of a robotics company raising $1.4 million in three weeks for a new project. Nonprofit funding for the microfinance of small business ventures in developing countries seems also to be successful. Kiva is probably the best known example. (Disclosure: my family has been an investor in various Kiva projects, and I’ve been surprised and encouraged by the fact that no loans have so far defaulted!)
However, a truly disruptive change in the capital funding of enterprises – perhaps including hybrid social enterprises – may be signaled by the Jumpstart Our Business Start-ups (JOBS) Act passed in 2012. Although it is limited at the moment in terms of the range of investors that may be tapped for crowdfunding (including a $1 million capital limit and sophisticated/wealthy investors requirement), a successful initial run may result in amendments that may begin to change the face of capital fundraising for firms. Judging from some recent books at least, crowdfunding for new ventures seems to have arrived. See Kevin Lawton and Dan Marom’s The Crowdfunding Revolution (2012) and Gary Spirer’s Crowdfunding: The Next Big Thing (2013).
What if easier capital crowdfunding combined with benefit corporation structures? Is it possible to imagine the construction of new securities markets that would raise capital for benefit corporations -- outside of traditional Wall Street markets where the norm of “shareholder value maximization” rules? There are some reasons for doubt: securities regulations change slowly (with the financial status quo more than willing to lobby against disruptive changes) and hopes for “do-good” business models may run into trouble if consumer markets don’t support them strongly. But it’s at least possible to imagine a different world of business emerging with the energy and commitment of a generation of entrepreneurs who might care about more in their lives than making themselves rich. Benefit corporations fueled by capital crowdfunding might lead a revolution: or, less provocatively, may at least challenge traditional business models that for too long have assumed a narrow economic model of profit-maximizing self-interest. James Surowiecki, in his recent column in The New Yorker, captures a more modest possibility: “The rise of B corps is a reminder that the idea that corporations should be only lean, mean, profit-maximizing machines isn’t dictated by the inherent nature of capitalism, let alone by human nature. As individuals, we try to make our work not just profitable but also meaningful. It may be time for more companies to do the same.”
So a combination of hybrid social enterprises and capital crowdfunding doesn’t need to displace all of the traditional modes of doing business to change the world. If a significant number of entrepreneurs, employees, investors, and customers lock-in to these new social technologies, then they will indeed become “disruptive.”
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Corporate disclosure, especially in securities regulation, has been a standard regulatory strategy since the New Deal. Brandeisian “sunlight” has been endorsed widely as a cure for nefarious inside dealings. An impressive apparatus of regulatory disclosure has emerged, including annual and quarterly reports enshrined in Forms 10K and 10Q. Other less comprehensive disclosures are also required: for initial public offerings and various debt issuances, as well as for unexpected events that require an update of available information in the market (Form 8K).
For the most part, corporate disclosure has focused on financial information: for the good and sufficient reason that it is designed to protect investors – especially investors who are relatively small players in large public trading markets. Some doubts have been raised about the effectiveness of this kind of disclosure and, indeed, the effectiveness of mandatory disclosure in general. A recent book by Omri Ben-Shahar and Carl Scheider, More Than You Wanted to Know: The Failure of Mandated Disclosure, advances a wide-ranging attack on all mandatory disclosure. (I think that their attack goes too far: I’ll be coming out with a short review of the book for Penn Law’s RegBlog called “Defending Disclosure”). Assuming, though, that much financial disclosure makes sense, what about expanding it to include other activities of business firms?
Consider three types of nonfinancial information that might usefully be disclosed: information about a business firm’s activities with respect to politics, the natural environment, and religion.
1. Politics. One good candidate for enhanced corporate disclosure concerns business activities in politics. Lobbying laws require various disclosures, and various campaign finance laws do too. It is possible to obscure actual political spending through the complexity of corporate organization. (For a nice graphic of the Koch brothers’ labyrinth assembled by the Center for Responsive Politics, see here.) Good reporters can ferret out this information – but they need to get access to it in the first place. My colleague Bill Laufer has been an academic leader in an effort to encourage public corporations to disclose political spending voluntarily, with Wharton’s Zicklin Center for Business Ethics Research teaming up with the nonpartisan Center for Political Accountability to rank companies with respect to their transparency about corporate political spending. The rankings have been done for three years now, and there are indications of increased business participation. Recently, even this voluntary effort has been attacked by business groups such as the U.S. Chamber of Commerce for being “anti-business.” See letter from U.S. Chamber of Commerce quoted here. Jonathan Macey of Yale Law School has also objected to the rankings in an article in the Wall Street Journal, arguing that the purpose of political disclosure is somehow part of “a continuing war against corporate America.” These objections, however, seem overblown and misplaced. What is so wrong about asking for disclosure about the political spending of business firms? One can Google individuals to see their record of supporting Presidential and Congressional candidates via the Federal Election Commission’s website, yet large businesses should be exempt? Political spending by corporations and other business should be disclosed in virtue of democratic ideals of transparency in the political process. Media, non-profit groups, political parties, and other citizens may then use the resulting information in political debates and election campaigns. Also, it seems reasonable for shareholders to expect to have access to this kind of information.
In Business Persons, I’ve gone further to argue (in chapter 7) that both majority and dissenting opinions in Citizens United appear to support mandatory disclosure as a good compromise strategy for regulation. One can still debate the merits of closer control of corporate spending in politics (and I believe that though business corporations indeed have “rights” to political speech these rights do not necessarily extend to unlimited spending directed toward political campaigns). It seems to me hard to dispute that principles of political democracy – and the transparency of the process – support a law of mandatory disclosure of corporate spending in politics.
2. Natural environment. Increasingly, many large companies are also issuing voluntary reports regarding their environmental performance (and often adding in other “social impact” elements). Annual reports issued under the International Standards Organization (the ISO 14000 series), the Global Reporting Initiative, and the Carbon Disclosure Project are examples. The Environmental Protection Agency (EPA) has also established a mandatory program for greenhouse gas emissions reporting, which is tailored to different industrial sectors. One can argue about whether these kinds of disclosures are sufficiently useful to justify their expense, but my own view is that they help to encourage business firms to take environmental concerns seriously. Many firms use this reporting to enhance their internal efficiency (often leading to financial bottom-line gains). As important, however, is the engagement of firms to consider environmental issues – and encouraging them to act as “part of the solution” rather than simply as a generating part of the problem.
One caveat that is relevant to all nonfinancial disclosure regimes: The scope of firms required to disclose should be considered. I do not believe that the case is convincing that only public reporting companies under the securities laws should be included. (For one influential argument to the contrary, see Cynthia A. Williams, “The Securities and Exchange Commission and Corporate Social Transparency,” 112 Harvard Law Review 1197 (1999)). Instead, it makes to sense for different agencies appropriate to the particular issue at hand to regulate: the Federal Election Commission for political disclosures and the EPA for environmental disclosures.
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Thanks to Gordon Smith and my Wharton colleague David Zaring for inviting me as a guest blogger on The Conglomerate. I am a new entrant in the blogosphere here, and I appreciate this invitation very much.
What follows is a written version of remarks that I presented at the Society for Business Ethics in Philadelphia on August 3 at a panel on “Corporate Personhood – For or Against or Whether It Even Matters?” organized by Kendy Hess of Holy Cross. (Thanks, Kendy!) The panel also included excellent presentations on the topic by two of my Wharton colleagues, Gwen Gordon and Amy Sepinwall, as well as Kendy. A longer version will be presented in a conference in London in September, and a written version will also be included in a book that I'm co-editing with Craig Smith called The Moral Responsibility of Firms (forthcoming in Oxford University Press). It will also inform chapter 1 of a book that is underway (and still forthcoming) currently called Rethinking the Firm: An Interdisciplinary Interpretation (also under contract with OUP).
In these posts, I've been kindly invited to revisit some themes of my new book on Business Persons: A Legal Theory of the Firm. So I hope that I'll generate some interest in the book: or perhaps make some of the ideas there more accessible in "blog-sized" pieces. The following contribution is a first entry.
Let me be provocative first and say affirmatively: Corporations are legal persons and it matters. The thesis is qualified, however, by the fact that to say that corporations are persons is a conclusion that only then begins arguments about what it actually means in practice with respect to particular issues. The fact that corporations are “persons” means only that we provide them – through law – with certain capacities and powers, and certain rights and obligations. It remains to be decided what the nature and limits of these capacities and powers, and rights and obligations, may and will be.
Three main arguments support my claim.
1. Firms exist. Some economists (and lawyers following them) have argued that firms do not really exist. They are mere fictions, they say, and any serious epistemological analysis must look past the “legal fiction” of the firm – or the “corporation” in the form we are discussing here – to the actual human beings who are involved. Although this methodological reduction may be useful for some kinds of analysis (economic modeling, etc.), it is wrong from a realistic legal and social perspective. Firms exist because the law has evolved to say that they exist. They are constructions of human relationships that are socially sanctioned and legally recognized. They are “fictions” in the sense that they are created through the artificial mechanisms of law and government. They are also “real” because people acting under law and in society believe in them and make them real. Firms are therefore what I’ve called “real fictions”: both nominalism and realism are right, but only when they are combined together into a nominalist realism. See Business Persons, ch. 1. Philosophers such as Margaret Gilbert, John Searle, and Philip Pettit support this view. People acting in social groups form collective realities, which are reinforced and articulated by organizational law. Business firms – including for-profit corporations – are in this sense social constructions. Corporations are like money and nation-states. Exxon-Mobil and Patagonia are as real as China and the United States. They exist because we believe in them. We act as if they exist – and so as social constructions they exist. They have power and authority.
2. Firms are persons. The method of legal recognition is to bestow “personality”: The law recognizes an individual human being as a “person” who has “standing” to bring or defend a claim in court. A person has rights: personal rights against mistreatment and rights against violations of one’s dignity and physical integrity. The law matters here. Consider the situation of a slave (historically not so very long ago in the United States) or an illegal immigrant (such as children from other countries crossing the southern border of the United States today). The law does not recognize them fully as “persons” – or at least not to the same level of available rights and obligations as “citizens.” Even children of citizens do not have a complete set of rights: they cannot drive cars or enter contracts legally until reaching an age allowing legal capacity. The law makes other distinctions: “person” is a legally denominated concept. It is extended (or not) for various reasons of philosophy and social policy. Is a fetus a “person”? What rights does a “terrorist” have? Even: is a dog, such as my dog Butterbean, a legal person for certain purposes? I cannot, for example, torture him for fun (assuming that I’m that kind of person, which I’m not). In this sense, then, a dog too is a person: he has some minimal rights recognized under law (though he'll need someone else to speak for him).
An analogous argument applies to firms. They are “persons” because the law recognizes them as such and as having certain rights and obligations: standing in court, holding of property, a party to contracts, an organizational principal, a target for tort liability, and a potential plaintiff to insist on its “rights,” whatever they may be. The exact nature of these various rights of firms remains to be decided: The controversial recent cases of Citizens United and Hobby Lobby extend claims of political and religious freedom to include corporations as persons. Are these cases correctly decided? The answer does not, I believe, turn on whether they are considered “persons” or not. Firms are uncontroversially legal persons for many purposes. The question is whether or not we should extend certain kind of rights to firms as “persons” derivatively – representing the people who act collectively through them. Note that the answer can be qualified. We may say: “Yes, corporations hold property and should have standing to object on constitutional grounds if a government attempts to expropriate the property without compensation.” But we may also say: “No, corporations usually represent diverse groups of people regarding religion, so in these cases it is not correct to say that corporations should have religious rights" (contrary, of course, to the holding of Hobby Lobby). I make this latter argument in a previous blog for The Conglomerate on Hobby Lobby here.
3. Legal personality matters, but it is not dispositive. Firms exist, firms have legal personality, and it matters. The fact that a corporation is a person does not settle the argument for or against an assertion of rights or obligations. This is a mistake in argumentation, in my view, that opinions on both sides of the divided Justices of the Citizens United and Hobby Lobby cases make. In these kinds of cases, the Court should ask – as legislatures and citizens should as well – what is the purpose of a firm and of a corporation given the question that we're asking? Arguably, as Justice Alito argues in Hobby Lobby, business firms are not just profit maximizers (as some students are taught in some business school classes). They are moral creatures because the people who compose them are moral creatures (or, at least they have the potential to be moral -- nobody's perfect!) But we then have to dig deeper and ask “who” is involved in the firm. Why are we asking the question: “persons” for what purposes? Perhaps firms should have political rights, but perhaps also they should be constrained in this respect for good reasons of political theory and modern democracy. Perhaps some kinds of firms should have religious rights, but the scope of these potential rights should be constrained. Rights of employees may be equal to those of owners and managers in this context. There are other limits in principle that need to be drawn here too: but my main point here is that doing so assumes that “legal personality” matters. It is then a question of filling in the institutional portrait: who is this person? What kind of person? And how does the nature of this person relate to the considerations in play on a specific issue?
4. Conclusion. My argument is designed mostly to set up rather than to answer the hard questions, so I hope that my position will not be too controversial. Here again are my main propositions.
a. Firms exist. For our purposes here, corporations are a kind of firm. (The difference between for-profit and profit corporations raises another set of issues.)
b. Firms, including corporations, have legal personality. The question is not whether firms are persons, but what the fact that they are persons means with respect to particular further questions regarding the rights or obligations that we should extend to them as persons.
c. Legal personality matters, but is not dispositive. To argue about whether firms are persons or not persons does not advance the ball very much. The popular debate conflates the meanings of "persons" and "people." Firms are persons; begin there. And then engage the substantive policy issues as hand. Move the discussion forward, while recognizing the truth of the “real fictions” of firms as legal persons.
Home from teaching bar prep, I've just finished the Burwell v. Hobby Lobby opinion. What does the opinion teach those highly stressed would-be attorneys about corporate law--or at least, the justices view of it? Let's see, shall we?
Justice Alito's majority opinion:
Entity theory rejected--anyone for a nexus-of-humans theory?:
A corporation is simply a form of organization used by human beings to achieve desired ends. An established body of law specifies the rights and obligations of the people (including shareholders, officers, and employees) who are associated with a corporation in one way or another. When rights, whether constitutional or statutory, are extended to corporations, the purpose is to protect the rights of these people. For example, extending Fourth Amendment protection to corporations protects the privacy interests of employees and others associated with the company. When rights, whether constitutional or statutory, are extended to corporations, the purpose is to protect the rights of these people...Corporations, “separate and apart from” the human beings who own, run, and are employed by them, cannot do anything at all.
(UR: this sounds like my first day of BA speech, where I reassure the humanities majors that "business law is all about relationships, relationships between people and groups of people).
Shareholder wealth maximization vs. corporate social responsibility:
Some lower court judges have suggested that RFRA does not protect for-profit corporations because the purpose of such corporations is simply to make money. This argument flies in the face of modern corporate law. “Each American jurisdiction today either expressly or by implication authorizes corporations to be formed under its general corporation act for any lawful purpose or business.” 1 J. Cox & T. Hazen, Treatise of the Law of Corporations §4:1, p. 224 (3d ed. 2010) (emphasis added); see 1A W. Fletcher,Cyclopedia of the Law of Corporations §102 (rev. ed. 2010). While it is certainly true that a central objective of for-profit corporations is to make money, modern corporate law does not require for-profit corporations to pursue profit at the expense of everything else, and many do not do so. For-profit corporations, with ownership approval support a wide variety of charitable causes, and it is not at all uncommon for such corporations to further humanitarian and other altruistic objectives. Many examples come readily to mind. So long as its owners agree, a for-profit corporation may take costly pollution-control and energy-conservation measures that go beyond what the law requires. A for-profit corporation that operates facilities in other countries may exceed the requirements of local law regarding working conditions and benefits. If for-profit corporations may pursue such worthy objectives, there is no apparent reason why they may not further religious objectives as well.
(UR: Kumbaya, my friends! Shareholder wealth maximization does not rule with the majority, that's for sure. Milton Friedman be damned, CSR is alive and well on the Supreme Court.
Tax is always with us:
For example, organizations with religious and charitable aims might organize as for-profit corporations because of the potential advantages of that corporate form, such as the freedom to participate in lobbying for legislation or campaigning for political candidates who promote their religious or charitable goals.
(UR: those pesky IRS 501(c)(3) restrictions! I always stress the importance of tax in BA.)
New corporate forms:
In fact, recognizing the inherent compatibility between establishing a for-profit corporation and pursuing nonprofit goals, States have increasingly adopted laws formally recognizing hybrid corporate forms. Over half of the States, for instance, now recognize the “benefit corporation,” a dual-purpose entity that seeks to achieve both a benefit for the public and a profit for its owners.
(UR: I was wondering if the Court would mention benefit corps. Kind of surprised the majority does, because one could see the existence of a hybrid form as undermining the Hobby Lobby/Conestoga argument, i.e., if you were serious about your religion, why didn't you pick a different form? I'm looking at you, Haskell Murray.)
General incorporation statutes, internal affairs doctrine, and ultra vires:
In any event, the objectives that may properly be pursued by the companies in these cases are governed by the laws of the States in which they were incorporated—Pennsylvania and Oklahoma—and the laws of those States permit for-profit corporations to pursue “any lawful purpose” or “act,” including the pursuit of profit in conformity with the owners’ religious principles. 15 Pa. Cons. Stat. §1301 (2001) (“Corporations may be incorporated under this subpart for any lawful purpose or purposes”);Okla. Stat., Tit. 18, §§1002, 1005 (West 2012) (“[E]very corporation, whether profit or not for profit” may “be incorporated or organized . . . to conduct or promote any lawful business or purposes”); see also §1006(A)(3); Brief for State of Oklahoma as Amicus Curiae in No. 13–354.
Closely-held vs. public corps.
These cases, however, do not involve publicly traded corporations, and it seems unlikely that the sort of corporate giants to which HHS refers will often assert RFRA claims. HHS has not pointed to any example of a publicly traded corporation asserting RFRA rights, and numerous practical restraints would likely prevent that from occurring. For example, the idea that unrelated shareholders—including institutional investors with their own set ofstakeholders—would agree to run a corporation under the same religious beliefs seems improbable. In any event, we have no occasion in these cases to consider RFRA’s applicability to such companies. The companies in the cases before us are closely held corporations, each owned and controlled by members of a single family, and no one has disputed the sincerity of their religious beliefs.
(UR2: One limitation for closely-held is Section 12(g) of the Exchange Act--which requires companies to make public filings when they reach 2000 investors (I'm omitting a lot, but that's the gist). Look for me for more on this topic soon).
The certificate of incorporation governs the corporation:
The owners of closely held corporations may—and sometimes do— disagree about the conduct of business. 1 Treatise of the Law of Corporations §14:11. And even if RFRA did not exist, the owners of a company might well have a dispute relating to religion. For example, some might want a company’s stores to remain open on the Sabbath in order to make more money, and others might want the stores to close for religious reasons. State corporate law provides a ready means for resolving any conflicts by, for example, dictating how a corporation can establish its governing structure. See, e.g., ibid; id., §3:2; Del. Code Ann., Tit. 8, §351 (2011) (providing that certificate of incorporation may provide how “the business of the corporation shall be managed”). Courts will turn to that structure and the underlying state law in resolving disputes.
(UR: Alito is dead right about this--if you want to change the default rules, don't settle for a puny bylaw--get it in the charter).
Now we move to Justice Ginsburg's dissent. She doesn't talk about the corporate form or corporate law as much--except to distinguish nonprofits from for-profits (if only she'd cited me!). I'll give one highlight:
By incorporating a business ,however, an individual separates herself from the entity and escapes personal responsibility for the entity’s obligations. One might ask why the separation should hold only when it serves the interest of those who control the corporation.
I also note that while the conservative majority moves to embrace progressive CSR-style rhetoric, Justice Ginsburg resists the counter-move that for-profit corporations exist to maximize profit or shareholder wealth.
Those familiar with US corporate law are well aware that, in this field, a single small jurisdiction looms very large. The state of Delaware is today the legal home to more than half of US public companies and about 64% of the Fortune 500. It’s widely understood that no other US state even comes close, and there’s a substantial US corporate legal literature exploring the contours of, and seeking to explain, Delaware’s domestic dominance. As I’ve ventured into the field of cross-border finance, however, I’ve been struck by the fact that Delaware isn’t really unique. Taking a broad view of the regulatory fields relevant to cross-border corporate and financial services, there’s a set of small jurisdictions that are not merely successful in their respective fields of specialization, but are in fact globally dominant in those fields.
In a current working paper I’ve selected a handful of these jurisdictions that I find particularly interesting; assessed whether extant theoretical paradigms can shed much light on their successes; and proposed an alternative approach that I think better captures their salient characteristics and competitive strategies – the so-called “market-dominant small jurisdiction,” or MDSJ. The jurisdictions studied include Bermuda, well-established among the world’s preeminent insurance markets; Singapore, a rising power in wealth management; Switzerland, the long-standing global leader in private banking; and Delaware, the predominant jurisdiction of incorporation for US public companies and a global competitor in the organization of various forms of business entities.
The interesting question, of course, is why these small jurisdictions have been able to achieve global dominance in their respective specialties – and the paper includes an extended treatment of various theoretical lenses to which one might turn for an explanation. None, however, can account for the range of jurisdictions that I identify. Notably, while taxation (or lack thereof) certainly looms large as a competitive strategy in each case, the “tax haven” literature can’t explain the global dominance of these particular jurisdictions. Simply put, it’s implausible that a new entrant could meaningfully challenge the competitive position of any of these jurisdictions simply by copying their tax codes, or any other component of their regulatory structures for that matter. Each has a substantive domain of service-based expertise providing a source of real competitive advantage beyond the jurisdiction’s black-letter law – and this renders it effectively impossible to compete with these jurisdictions simply by copying and pasting their laws into one’s own books.
The“offshore financial center” literature looks beyond tax, emphasizing cross-border services as such, yet encounters its own problems. This literature has been heavily preoccupied with recent entrants, reflecting strong preoccupation with the global acceleration of cross-border finance since the late 1960s – an inclination that’s tended to distract this literature from the commonalities with early movers like Delaware and Switzerland, which rose to prominence in the early 20th Century. In this light, it’s critical to observe that some of the most successful of the small jurisdictions active in cross-border finance aren’t actually “offshore” at all – again, including Delaware and Switzerland. I argue that the onshore/offshore distinction has obscured more than it illuminates; it simultaneously fails to provide a comprehensive account of what’s truly distinctive about the range of successful small jurisdictions, and overstates the distinction between “us” (onshore) and “them” (offshore) – particularly in terms of involvement in problematic practices, which occur in both settings (of which more below). The rhetorical function of this distinction is largely to paint small jurisdictions’ activities as uniquely and exclusively problematic, obscuring both small-market positives and big-market negatives.
In developing my alternative – this “market-dominant small jurisdiction” (MDSJ) concept – I draw upon these and other literatures while endeavoring to avoid their limitations. I argue that, notwithstanding substantial differences, these jurisdictions do exhibit fundamental commonalities in their contextual features and economic development strategies:
MDSJs are small and poorly endowed in natural resources, limiting their economic development options. This creates a strong incentive to innovate in law and finance, while rendering credible their long-term commitment to the innovations undertaken. These jurisdictions substantially depend on their legal and financial structures, and the market knows it.
They possess legislative autonomy – the critical resource for such innovation. This is obvious for sovereigns like Singapore and Switzerland, yet full-blown sovereignty isn’t required. Delaware possesses sufficient room to maneuver under the internal affairs doctrine, and Bermuda – a British overseas territory – benefits from an express delegation of legislative authority.
MDSJs tend to be culturally proximate to major economic powers, and favorably situated geographically vis-à-vis those powers. These ties can arise in various ways – through colonialism, common histories, and/or geography. But in each case, their identification with – and capacity to interact closely with – multiple powers positions them to perform important regional and global “bridging” functions in cross-border finance.
- Bermuda has long bridged the Atlantic, maintaining strong ties with the UK and North America alike. They benefit from the substantial ballast of association with the British legal system and insurance market (i.e. Lloyds) on one side, and proximity to the massive US economy and insurance market on the other.
- Singapore has long bridged East and West, having been established as a British colony to maintain an East Asian trade route. Their location allowed them to contribute to the creation of a 24-hour global securities trading system – in the morning taking the baton from US markets that just closed, and in the afternoon handing the baton to European markets that just opened. Since the 2000s Singapore has developed a two-way wealth management strategy, serving as the entry point for Western money into East Asia, and the entry point for rapidly accumulating East Asian money into the West – a strategy facilitated by a highly educated, bilingual (Mandarin-English) working population.
- Switzerland, located in the heart of Europe, borders on and transacts in the native languages of each of the surrounding economic powers. German, French, and Italian are all official languages, and English-language proficiency is widespread as well.
- Delaware plays an under-explored bridging function in the US political economy, standing between and interacting with both the finance capital (New York) and the political capital (DC) – a geographic feature touted in corporate marketing materials.
In addition to these contextual commonalities, MDSJs exhibit similar economic development strategies. Notably, they’ve heavily invested in human capital, professional networks, and related institutional structures. The aim is to foster a community of financial professionals with the incentives and capacity to develop high value-added niche specializations – a project eased by the fact that these are small places. In each case the relevant public and private stakeholders often know one another personally, facilitating consensus and responsiveness to evolving markets. Additionally, these public and private constituencies share largely homogenous interests – they all prosper if finance prospers.
Finally, MDSJs consciously seek to balance close collaboration with, and robust oversight of, the relevant professional communities – the aim being to at once convey flexibility, stability, and credibility. Essentially these jurisdictions seek to avoid over-regulation frowned upon by the market, while at the same time avoiding under-regulation frowned upon by regulators in other jurisdictions. In so doing, they generally try to bring private-sector experience to bear upon the regulatory design process, seeking to maintain cutting-edge regulatory regimes while at the same time conveying stability and credibility to global markets and their foreign regulatory counterparts. In each case this dual aim is reinforced by additional confidence-enhancing features – notably, low levels of perceived public corruption, and multi-party support for the development of financial services capacity.
The paper explores the embodiment of these characteristics in some depth, and ultimately suggests that examining such jurisdictions through this lens could offer tangible benefits as we continue to assess their costs and benefits in cross-border finance. While potential abuse of the structures available in each of these jurisdictions is acknowledged – including money laundering and tax evasion – these problems are not unique to so-called “offshore” jurisdictions. Notwithstanding Delaware’s extraordinary contribution to the development of substantive corporate law – principally attributable to their expert bench and bar – the state has been roundly criticized for creating some of the world’s most opaque shell companies. At the same time, US calls for greater tax transparency are undercut by the fact that we ourselves don’t tax interest income on – and accordingly don’t require 1099s for – non-resident alien accounts. In this light, to avoid charges of a regulatory double standard, US policymakers seeking greater financial and tax transparency – efforts I broadly support – may have to start by cleaning up their own backyards.
While my writing on comparative corporate governance has focused principally on the core issues of power and purpose – that is, the division of governance authority between boards and shareholders, and the aims toward which board decision-making ought to be oriented – this work brought another striking divergence to my attention. While in the US we refer to “fiduciary duties” (plural) to describe directors’ duties of loyalty and care, other common-law jurisdictions generally conceptualize only the duty of loyalty as “fiduciary” in nature. That a well-functioning corporate legal system needn’t describe the duty of care as a fiduciary duty led me to ask, in a recent essay, whether there might be some practical utility in drawing such a clear distinction between loyalty and care concepts – and what costs might attend not doing so.
The rationale for applying the “fiduciary” label solely to the duty of loyalty is two-fold. First, the duty of loyalty is unique to fiduciary status, whereas the duty of care isn’t. Second, breaches of these respective duties involve differing consequences that ought to be distinguished analytically. Millett L.J. summarized this position – in a manner consistent with approaches taken in Australia and Canada as well – in the UK Court of Appeal’s 1996 decision in Bristol and West Building Society v. Mothew,  Ch. 1 (Eng.):
The expression “fiduciary duty” is properly confined to those duties which are peculiar to fiduciaries and the breach of which attracts legal consequences differing from those consequent upon the breach of other duties. Unless the expression is so limited it is lacking in practical utility. . . .
It is . . . inappropriate to apply the expression to the obligation of a trustee or other fiduciary to use proper skill and care in the discharge of his duties.
The issue of which duties ought to be described as “fiduciary” in nature has received some attention over recent years among US legal academics, and articulate advocates have urged narrower and broader frameworks, respectively. Compare, for example, the approaches of William Gregory (endorsing the Mothew approach and arguing that equating duties of loyalty and care amounts to “bad law and worse semantics”) and Julian Velasco (arguing that there are five fiduciary duties – care, loyalty, objectivity, good faith, and rationality – corresponding with distinct standards of review). In my essay I approach the issue somewhat obliquely, crediting the Mothew framework as a rational and comprehensible alternative and then asking what costs might have attended the differing US framework. I conclude that describing both loyalty and care as fiduciary in nature has led judges – notably in Delaware – to conflate distinct analytical approaches to evaluation of board conduct, with consequences for the development of US corporate law that are not entirely positive.
The duty of loyalty has historically been enforced more aggressively, an approach aiming principally to reduce conflicts of interest that scrupulous directors could realistically detect ahead of time, and thus avoid – associating a correlative moral stigma with breach. The duty of care, on the other hand, generally has gone unenforced in order to promote entrepreneurial risk-taking – reflecting an assumption that even scrupulous directors could not manage their own liability exposure so straightforwardly, and accordingly diminishing the moral stigma associated with breach. (I say that it has “generally” gone unenforced because this has not historically been the case in banking, where skepticism regarding the social benefits of risk-taking resulted in more robust enforcement of the duty of care – a dynamic that I explore here.) As I describe in some depth, however, Delaware’s tendency to conflate the two duties as reflections of a singular fiduciary concept embodied by the business judgment rule (BJR) has tended to blur this core distinction – rendering Delaware’s analytical framework for the evaluation of board conduct considerably less coherent.
The confusion latent in Aronson, 473 A.2d 805 (Del. 1984) – which described the BJR as a presumption of both informed and disinterested director decision-making (in contrast with an earlier formulation suggesting that only disloyalty could give rise to monetary liability) – fully manifested itself in the Cede litigation, 634 A.2d 345 (Del. 1993), where the Delaware Supreme Court depicted the BJR as the primary embodiment of the demands of “fiduciary” status, accordingly describing the duties of loyalty and care alike as mere elements of, and means of overcoming, the BJR. In turn the court reached the remarkable conclusion that a care breach – with no showing of resulting injury – rebuts the BJR and “requires the directors to prove that the transaction was entirely fair,” the standard typically applied in the loyalty context, rendering rescissory damages available. As Steve Bainbridge has observed, rescissory damages in a duty of care case could “have the effect of ordering the defendant directors to return a benefit that they never received,” and “threaten to be so astronomical as to substantially chill the decisionmaking process.”
It is critical to recognize that each step in the development of this muddled analytical framework rests upon the conflation of loyalty and care as twin reflections of a singular fiduciary concept (via the BJR). In this light, I believe that corporate law would have benefited from a clearer conceptual distinction between loyalty and care duties, fostering a clearer analytical distinction between the desirable enforcement regimes in these differing contexts.
So, do I favor pursuing such clarity through a formal re-styling of the duty of care in non-fiduciary terms? No. While I might have favored such an approach if we were writing on a clean slate, we’re most assuredly not writing on a clean slate – and I think it quite reasonable to fear that abruptly re-styling care as non-fiduciary might be misinterpreted as some sort of demotion, potentially undercutting whatever degree of compliance might arise from motivations other than fear of damages. A better approach, in my view, would be a statutory damages rule permitting imposition of monetary damages for loyalty breaches, but not for care breaches (along the lines that I initially proposed here). Such an approach would permit the duty of care to retain whatever fiduciary oomph it currently possesses in the marketplace, while foreclosing the sort of analytical confusion described above and simplifying Delaware’s complex and convoluted framework for evaluating disinterested board conduct.