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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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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Jack Jacobs is on the way out, and Governor Markell has nominated another Skadden attorney, Karen Valihura, to fill the vacancy on the Delaware Supreme Court. This follows the elevation of Leo Strine to the position of Chief Justice (joining Carolyn Berger, another Skadden alum) and the installment of Andy Bouchard as Chancellor. Nice run for Skadden Wilmington. Congrats, Karen!
Problems with the sale of the Canadian ambulance service have led to one of the strongest sanctions of an investment bank, let alone a board, that this outside observer can remember coming from a Delaware court. But for real insight, let's outsource to Steven Davidoff and Matt Levine:
in Rural Metro, RBC [the bank] seems to have had all the conflicts with none of the benefits. Rural Metro was thinking about selling itself at around the same time that a larger competitor, Emergency Medical Services Corporation, was also up for sale. RBC was not involved in the EMS deal, but hoped that it could get an assignment financing the EMS acquisition. According to the opinion, RBC concocted a plan: "if Rural engaged in a sale process led by RBC, then RBC could use its position as sell-side advisor to secure buy-side roles with the private equity firms bidding for EMS." The quid pro quo would be, you hire us to finance your EMS bid, and we will give you the inside track on the Rural Metro sale.
[T]his deal reads to me less like a story of the financing deal overwhelming the M&A advice, and more like a story of how investment banking is a sales business. From this opinion, you get the sense that RBC's efforts to drum up business, whether financing or advisory, were persistent and intense and occupied most of the attention of RBC's most senior bankers. Meanwhile, its actual execution efforts were sort of halfhearted and not all that well thought out.....
And here's Davidoff:
To find the investment bank liable, however, the judge also had to find misdeeds committed by the Rural/Metro board. Vice Chancellor Laster held that the Rural/Metro Board had breached its fiduciary duties because Mr. Shackelton and RBC effectively put the company up for sale without full board authorization and that the board had failed to properly supervise RBC. He also concluded that the Rural Metro board did not have an “adequate understanding of the alternatives available to Rural” and that its decision to accept the Warburg offer was not reasonable because of a lack of sufficient information.
The judge has yet to calculate damages, but they could be as much as $250 million, despite the fact that RBC was never retained to do the financing and earned only its $5 million fee.
Instead, perhaps we should rethink how companies are sold and who is held liable when things go wrong. The Rural/Metro case shows how skewed the incentives can be, and how the checks and balances can too easily go wrong. Next time, there may not be a bank that can be put on the hook so easily. In other words, the directors may once again get away with wrongdoing, and shareholders will be left with nothing.
The Chancery Daily flagged a pending case in the Delaware Court of Chancery, NAMA Holdings, LLC v. Related WMC, LLC, et al., involving a claim for "tortious interference with the implied covenant of good faith and fair dealing." A Westlaw search reveals that this is not an entirely novel claim. The earliest instance of such a claim appears to be Haynal v. Target Stores, 1996 WL 806706 (S.D.Cal.,1996), and the federal court drop-kicked the claim: "Plaintiff's attempt to convert a contract action into a tort action is not supported by law." Two other courts note the claim, but neither addresses its merits. No law review articles discuss the claim, and even Google shows no results ... well, until this post gets included in the search results.
Of course, lots of cases involve claims of "tortious interference with contract" and "breach of the implied covenant of good faith and fair dealing." The arguments against recognizing tortious interference with contract would seem to apply to a claim of "tortious interference with the implied covenant of good faith and fair dealing," but if you are willing to recognize the one, is there a reason not to recognize the other?
Kyle Compton is amazing. He produces an entertaining and useful email service called "Chancery Daily," which was first recommended to me by a member of the Delaware judiciary. The purpose of the service is to summarize proceedings pending in the Delaware Court of Chancery. The writing is insightful and accessible and sometimes even funny. I read every issue.
You can subscribe here. For members of the judiciary -- including court staff and law clerks, in Delaware and elsewhere -- and academic subscribers, the service is free (judicial subscribers should register using a government email address, and professors and current law students should register using a law school email address).
Leo Strine. Congratulations!
The WSJ: "a widely expected promotion for one of corporate law's biggest personalities." Indeed.
I have mixed feelings about this. I will miss reading Leo's solo opinions as Chancellor -- we can assume some moderation in Leo's opinions as a result of the unanimity norm that prevails on the Supreme Court -- but I assume he will help bring more coherence to corporate law issues in Supreme Court opinions.
So who is the next Chancellor? No inside information here, but it's hard to imagine a better choice than Larry Hamermesh.
Over the past few weeks, a handful of attorneys and academics have asked me exactly how specific the specific public benefit purpose(s) required by §362(a) of the DGCL for Delaware public benefit corporations (“PBCs”) must be. Section 362(a) reads, in pertinent part:
- “In the certificate of incorporation, a public benefit corporation shall. . . Identify within its statement of business or purpose . .1 or more specific public benefits to be promoted by the corporation”
Some of the early Delaware PBCs have used the general public benefit language from the benefit corporation’s Model Legislation to describe their specific public benefit purpose(s). (See, e.g., Farmingo, PBC; Ian Martin, PBC; Method Products, PBC; New Leaf Paper, Public Benefit Corporation; and RSF Capital Management, PBC). For those who are unfamiliar, the general public benefit language from the Model Legislation reads:
- “A material positive impact on society and the environment, taken as a whole, assessed against a third-party standard, from the business and operations of a benefit corporation.”
At least one early Delaware PBC has added the following to the general public benefit language:
- “specific public benefit . . .may be further specified from time to time in the Bylaws of the Corporation . . . or a resolution or resolutions of the Board of Directors of the Corporation.” (Socratic Labs, PBC).
- “for the specific public benefit of furthering universal access to the Internet” (Unifi Communications, PBC)
- "giving people access to, and the benefit of, health knowledge that is as complete and unbiased as possible." (Profile Health Systems, PBC)
In my personal opinion, using only the Model Act’s general public benefit purpose as a Delaware PBC’s specific public purpose is a bit risky and possibly conflicts with the drafters' intent. To be clear, I have not yet spoken with the drafters on this issue, and will update this post if I do. However, if the drafters had intended to allow the general public benefit language to suffice, then I think they would have simply followed the lead of the Model Legislation and would have defined and used the term "general public benefit".
Further, the FAQ about Public Benefit Corporations circulated by the drafters contained the following question and answer.
- Q: “Why does the statute require both the identification of a specific benefit or benefits and that the corporation be managed for the best interests of all those materially affected by the corporations conduct?” (emphasis in original)
- A: “….The requirement of a specific public
benefit is intended to provide focus to the directors in managing toward
responsibility and sustainability, and giving investors notice of, and some
control over, specific public purposes the corporation serves.”
That said, the Model Legislation’s general public benefit language
is more specific than “any lawful purpose” and Section 362(a) has no limit
on the number of specific purposes that can be listed, so a Delaware PBC could
conceivably list all of the specific interests the Model Legislation requires
directors to consider and achieve the same lack of focus as listing the Model Legislation’s
general public benefit language.
I have spoken to a few people in the Delaware Secretary of State’s office in an attempt to understand their stance on the specific public benefit issue. The main take-aways from those conversations were:
- they are aware of the controversy surrounding whether the Model Legislation’s general public benefit purpose suffices as a specific public benefit under the statute;
- they are currently accepting the Model Legislation’s general public benefit language as a valid specific public benefit, until it is formally challenged or they are told to do otherwise;
- they will not accept “any lawful purpose” language as a specific public benefit.
Also, for those who are interested, there were 49 public benefit corporations formed in Delaware between the August 1, 2013 effective date and October 16, 2013.
Thanks to Boston attorney Bruce Landay for excellent, in-depth conversation on this topic and for some of the certificates of incorporation cited in this post. As an academic, it is always nice to connect with attorneys who practice in my areas of interest. Thanks to Alicia Plerhoples at Georgetown Law who also provided some of the certificates of incorporation cited in this post.
It's effective August 1. Cass Brewer of SocEntlaw has some excellent thoughts, including this conclusion:
Perhaps the ultimate lesson here is that absent a much more uniform and rigorous qualification and enforcement regime under prevailing law—like the regime that exists for tax-exempt entities—only a few, overly diligent individuals will know whether and which companies genuinely care about stakeholders as opposed to shareholders. If this is indeed the case, then maybe all that is really needed and in fact effective to instill public trust in socially beneficial businesses is a commonly-accepted rating system, not a change in corporate law. B Lab and other such rating agencies already understand and are responding to this reality.
Go read the whole thing.
So says Friend of Glom Lyman Johnson over at CLS Blue Sky. That's a title that's going to get the attention of some corporate types!
Lyman first objects to Chancellor Leo Strine's recent decision In re MFW S’holders Litig. to give bjr protection to a controlling shareholder in a self-dealing transaction when there's an independent committee and majority-of-the-minority shareholder approval (for more see here and here), calling this move "incoherent" because shareholders don't exercise business judgment in the way directors do.
But then, he says, let's call the whole thing off:
As just one law professor who has grappled with teaching this material to law students for almost thirty years, I can say that presenting students with a coherent and cogent understanding of fiduciary duties is made more difficult by Delaware’s current business judgment rule construct. Students – having studied the concept of legal duty in diverse curricular offerings such as torts, trusts and estates, agency and partnership law, and professional responsibility – understand the importance of legal duties, including the scope of duty and situations of no-duty. The concepts of care and loyalty, in all their manifestations, are relatively easy to grasp, if of somewhat surprising contours.
Analytically and doctrinally, the teaching could stop there – with fiduciary duties and their breach – and students would have a solid and workable understanding. Little but unnecessary complexity in the law and pedagogy is added by then filtering all of the above through the threshold of the business judgment rule construct as a standard of review, particularly with the Cede breach of duty/burden shift feature.
Go read the whole thing.
Some interesting cases on the duties of independent directors coming out of Delaware...I have yet to read either of them, but there's a holiday weekend coming up, and its sounds like they'll make for some excellent beach reading for the corporate faithful. They are Rich v. Chong, C. A. No. 7616-VCG (Del. Ch., April 25, 2013) and In re Puda Coal Stockholders’ Litigation C.A. No. 6476-CS (Del. Ch. Feb. 6, 2013) (bench ruling).
David A. Katz of Wachtell and Laura A. McIntosh connect the cases by posing an intriguing question on the CLS Blue Sky Blog: Can an independent director just resign from the board of a troubled company? Answer: No, you lily-livered slacker. You've got to stay put and make things right. Or, as they put it:
In both of the cases discussed above, the Delaware Chancery Court was critical of the independent directors’ decision to resign. Chancellor Strine observed: “[T]here are some circumstances in which running away does not immunize you. It in fact involves breach of duty…. If these directors are going to eventually testify that at the time that they quit they believed that the chief executive officer of the company had stolen the assets out from under the company, and they did not cause the company to … do anything, but they simply quit, I’m not sure that that’s a decision that itself is not a breach of fiduciary duty.” Similarly, Vice Chancellor Glasscock commented in a footnote in Rich v. Chong, “It may be that some of the former independent directors … attempted to fulfill their duties in good faith…. Nonetheless, even though [two of them] purported to resign in protest against mismanagement, those directors could still conceivably be liable to the stockholders for breach of fiduciary duty…. I do not prejudge the independent directors before evidence has been presented, but neither are those directors automatically exonerated because of their resignations.” Both decisions found it “troubling that independent directors would abandon a troubled company to the sole control of those who have harmed the company.”
There's more on Rich v. Chong from Francis Pileggi. The oddest thing about the case for me, based on Francis' summary, is that the plaintiffs made a demand on the board. What was that about? You never made a demand on the board, because then you're stuck with near-impossible wrongful refusal standard: you concede the board's independence and capacity to evaluate the demand. The board gets business judgment rule protection, and you lose. Which is why everyone pleads demand futility, to the sorrow and confusion of BA students each year.
But the Rich v. Chong plaintiffs made a demand. Who does that? Next to no one, right? And yet plaintiffs lucked out because the defendants sat on the demand for 2 years. They not only failed to respond, but started an investigation, uncovered evidence of mismanagement, didn't do anything about it, and abandoned the investigation. So plaintiffs survive a motion to dismiss on Caremark claims, which also never happens.
See? Told you it sounded interesting...
Yesterday, attorneys for the shareholders of News Corporation announced an agreement in principle to settle derivative claims filed in various U.S. jurisdictions, including Delaware, against officers and directors of the corporation for $139 million (minus attorney fees, TBD). The payment will be made to the corporation from the various D&O insurance policies. The Memorandum of Understanding is here. The amended complaint is here. The parties agreed to file a stipulation with the Delaware Chancery Court within 14 days for approval. Kevin La Croix's expert commentary on the D & O issues is here.
So, what were the claims? The claims fall roughly into two big groups, both under the Duty of Loyalty: (1) the conflicted $615 million acquisition by News Corp. of an entity owned by (controlling shareholder, CEO and Chair) Rupert Murdoch's daughter; and (2) lack of oversight related to the illegal surveillance scandal involving News Corp.'s 100% owned subsidiary, News of the World. Sprinkled around these claims are accusations of Murdoch using the corporation as a vehicle for supporting his political agenda. The overarching thesis of the complaint is that the board allowed Murdoch to use News Corp. for his own personal purposes: family and political.
Historically, conflict-of-interest claims have teeth; oversight (Caremark) claims do not: waste claims don't even have a mouth. Something here had a lot of teeth given that the parties agreed to go to mediation prior to a ruling on a motion to dismiss and given the $139 million figure. For those of us waiting to see a winning Caremark claim, failure to oversee an ongoing pattern of illegal news-gathering activity that was well-known internally might be it. But, we may never know if the settlement is all about the acquisition or a little bit of both. Perhaps the oral argument for the motion to dismiss last year held some clues that the court thought the oversight claim was not going to be dimissed, at least.
The remedy section of the MOU has not only the monetary award but also positive remedial changes, such as more compliance, a compliance officer, an independent Chairman of the Board, and new definitions of "independent" for board members, etc., that might match up to oversight if the money merely lines up with the acquisition. And, interestingly, a new "Political Activity Policy":
Stay tuned to see if this is a throw-away provision (like most remedial changes in derivative settlements, or something to see.
2. The Company has or will implement a policy requiring annual public disclosure to its shareholders of political conributions made directly by the Company to state or local candidates, political party committees, political committees (e.g., PACs) or other political organizations exempt from federal income taxes under Section 527 of the IRC; payments to any other entity that is earmarked to be used for independent expenditures for a candidate or political party; or to a ballot measure committee. . . .
3. The Company will notify the Board (for its information and not approval) on an annual basis of payments in excess of $25,000 (including special assessments) that are not deductible under Chapter 162(e) of the IRC . . . and are. . .made to any US-based trade association, Section 501(c)(4) organization, or Section 501(c)(3) organization that coordinates directly with the Company in drafting proposed legislation or grassroots lobbying activities. . . .
Thanks to Usha for asking me to guest blog about the proposed Public Benefit Corporation amendments to Delaware’s General Corporation Law. This summer one of my planned projects is writing an article tentatively entitled Governing Public Benefit Corporations, and I will be floating some of my early ideas here. Comments will be appreciated.
On March 20, I mentioned the proposed Delaware Public Benefit Corporation (“PBC”) amendments on the Social Enterprise Law Blog (“SocEntLaw”)* shortly after I received word from Professor Brian Quinn and some of my friends in Delaware. Last week, both Usha and Stephen Bainbridge added thoughtful posts about the PBC.
For this guest blogging stint, I plan on authoring three additional posts, starting next week. Each post will compare and contrast the proposed PBC amendments with the model benefit corporation legislation. The twelve states that currently have benefit corporation statutes follow the structure and main provisions of the model legislation without too much variation. (The variations can be seen in my chart that Usha mentioned). Delaware, however, cuts its own path. In the three posts, I will focus on private ordering, director guidance, and brand strength.
* I will cross-post my guest posts on the Conglomerate at my permanent blogging home over at SocEntLaw. Last year, Cass Brewer (Georgia State), Deborah Burand (Michigan), Alicia Plerhoples (Georgetown), Dana Brakman Reiser (Brooklyn), a handful of practicing attorneys, and I (Regent) joined social enterprise lawyer Kyle Westaway (who is a Regent Law alum and a Lecturer on Law at Harvard Law School) at his blog. We welcome any and all readers.
From the Harvard Law School Forum on Corporate Governance and Financial Regulation, via Allen M. Terrell, Jr. of Richards, Layton & Finger, comes a summary of proposed amendments to the Delaware General Corporation Law. I had heard about the elimination of the vote in second-step mergers, but the public benefit corporation was news to me.
It sounds a lot like the benefit corporation legislation that's been spreading across the country (see this chart by Haskell Murray. At first blush I was surprised to see Delaware contemplating this kind of social enterprise legislation, since it's not really a stakeholders' rights kinda state. But on further reflection I guess a "let a thousand flowers bloom" attitude makes sense for Delaware's let-the-market-decide, opt-in attitude. Here's the description:
In general, under the proposed legislation, a public benefit corporation would be a corporation managed in a manner that balances the stockholders’ pecuniary interests, the interests of those materially affected by the corporation’s conduct, and one or more public benefits identified in its certificate of incorporation. To this last point, each public benefit corporation would be required, in its certificate of incorporation, to identify itself as a public benefit corporation and to state the public benefits it intends to promote. The proposed legislation generally defines “public benefits” as positive effects (or minimization of negative effects) on persons, entities, communities or interests, including those of an artistic, charitable, cultural, economic, educational, literary, medical, religious, scientific or technological nature.
Central to the proposed new subchapter’s operation is the statutory mandate that would be imposed on directors. The new subchapter would provide that directors, in managing the business and affairs of the public benefit corporation, shall balance the pecuniary interests of the stockholders, the interests of those materially affected by the corporation’s conduct, and the identified public benefits. The new subchapter also would provide that directors shall not have any duty to any person solely on account of any interest in the public benefit and would provide that, where directors perform the balancing of interests described above, they will be deemed to have satisfied their fiduciary duties to stockholders and the corporation if their decision is both informed and disinterested and not such that no person of ordinary, sound judgment would approve.
The new subchapter would impose special notice requirements on public benefit corporations, mandating periodic statements to stockholders regarding the corporation’s promotion and attainment of its public benefits. The new subchapter also would provide a means of enforcing the promotion of the public benefits. By statute, stockholders holding at least 2% of the corporation’s outstanding shares (or, in the case of listed companies, the lesser 2% of the outstanding shares or shares having at least $2 million in market value) would be able to maintain a derivative lawsuit to enforce specified requirements in the subchapter.
Update: Steve Bainbridge makes a good point: Delaware is moving to protect its market share.
Jesse Fried, Brian Broughman, and Darian Ibrahim have an excellent paper on Delaware's dominance in the market for corporate charters, arguing "that firms often choose Delaware corporate law because it is the only law 'spoken' by both in-state and out-of-state investors." Jesse described the paper in a recent blog post, and you can download it on SSRN. Jesse's summary of the evidence:
To test for a lingua-franca effect, we exploit a database of 1,850 VC-backed firms that provides precise information on the firm’s location, the identity and location of its investors, and changes in the firm’s domicile as its investor base evolves over time. We find, consistent with the lingua-franca effect, that the presence of out-of-state investors in each round of financing significantly increases the likelihood of Delaware incorporation or reincorporation. We also find that a startup is less likely to incorporate in Delaware if its out-of-state VC investors have already invested in firms incorporated in the startup’s home state, and thus have greater familiarity with home-state corporate law.