If the governor flips a coin, there's a 50% chance that a plaintiffs' lawyer will be the next Chancery Court appointee. And not just any plaitniffs' lawyer, but one leading the charge against investment banking conflicts of interest in Delaware.
Mr. Friedlander, a litigator, is best-known for representing shareholders in big class actions. In 2014, he won more than $75 million in a buzzed-about case against RBC Capital Markets LLC over the bank’s M&A advice.Mr. Friedlander, a litigator, is best-known for representing shareholders in big class actions. In 2014, he won more than $75 million in a buzzed-about case against RBC Capital Markets LLC over the bank’s M&A advice.
I don't follow the state, but I don't think this sort of thing is very common. You could certainly see the Royal Bank of Canada getting upset about it.
I'll end with this paragraph, versions of which I've typed and deleted at least twice. Here goes: Chancellor Bouchard closed his remarks with these words: "Tamika is just the second woman and the first African American to serve on the Court, and some may say, "Well, it's about time!" But I would like to think that we were just waiting, however patiently, for the right person, and that we found the right person, as many here today will attest." (4:00). Chancellor Bouchard's words gave me pause because I, for one, do think Delaware took too long on this--that there must have been other women and minorities that would have made fine candidates for the Chancery Court before Tamika. Still, I'm glad he said what he did. What he did in those few sentences was both acknowledge the historic importance of this particular investiture and then immediately turn the spotlight back onto Tamika as an extraordinary individual. Quite a grace note, when you come to think of it.
So this came in the mail....
I'm going to Delaware! I know, some people's reactions might be....
But, readers, you know my reaction is...
My erudite and awesome friend Steve Bainbridge swiftly responded to my earlier post on the notion of director independence as described in recent Delaware Supreme Court case Del. County Emples. Ret. Fund v. Sanchez with a typically spirited riposte that you should go read in its entirety. There he expanded on his earlier critique of the case:
My claim is that it will be much more difficult for plaintiffs use the "tools at hand" to develop sufficiently particularized facts relating to the nature of a friendship than an economic relationship. How often will a Section 220 books and records inspection produce evidence that the CEO and a director are life-long pals, for example. Or reading SEC filings, for that matter? Maybe plaintiffs will be able to find stories in the media about their lifelong friendship. A Google search turned up stories about Bill Gates being close friends at some point of his life with Paul Allen (still?), Water Buffett, Michael Larson, and Steve Ballmer (still?).
But what about less high profile CEOs with less high profile friends?
I await Usha's response eagerly.
Sadly, associate deaning duties and the myriad tiny tyrannies of a rainy day weekend spent at home with 3 children and 2 dogs, one of whom consumed not one but two chicken carcasses (he appears to be fine) conspired to keep me from responding to Steve earlier. But procrastination sometimes bears fruits, and this morning via an email my friend Andrew Schwartz offered some thoughts that he's allowed me to share.
people these days have much of their life up on Facebook, Instagram, Twitter, et cetera, and the trend seems on the increase (in part because young people today are growing into the executives of the future).
A plaintiff could investigate personal ties between directors and CEOs (and the families of each) using these and other social media sites. If she could show a CEO and director have commented on practically every Facebook post of the other for the past ten years, and that the director was the CEO’s first Twitter follower, and that there are selfies of the two of them on Instagram, then that might well be enough to survive a motion to dismiss on the basis of close, longstanding friendship.
First, given the elite status of most CEOs and directors, news profiles and vanity pieces may flush out friendships. Second, Andrew's excellently articulated point applies both to elite directors and to the comparatively rare "ordinary folks" director. Third, it occurs to me that plaintiffs might make use of social network analysis to plead some particularized facts raising reasonable doubt as to a director's independence. I am somewhat tentative in this suggestion because I'm not entirely clearly what social network analysis is, and class preparation demands my attention (In the immortal words of Rodney Dangerfield, "I'm gonna talk to that Dean. I mean, these classes could be a REAL inconvenience."). I would welcome reader insight here.
Finally, as Steve points out in an update to his own post
Of course, independence is an issue in many settings other than just demand excused cases. In many (most?) of those other situations, independence issues will be resolved at the summary judgment stage or even trial. Accordingly, in those cases, my objection is partially vitiated. Where to draw the line-something we must do even in a standards-based approach-remains a difficult question (IMHO).
Drawing the line here is a difficult question, and I think it's a strength of Delaware's "standard, not rule" approach that the doctrine acknowledges and embraces the complications inherent in assessing the relationship between two individuals. But regardless of whether I (or Andrew) convince Steve on this point, however, this kind of exchange is for me the best part of blogging.
Steve Bainbridge took up my gauntlet earlier this week, and threw it back, rejecting Sanchez for use in casebooks. Not a good choice for a principal case, says he. Delaware creating a muddle, says he.
I defer to Steve on most things--well, on wine and food for sure. And, not having authored a casebook, on his first point. I was suggesting Sanchez because of its brevity, and not thinking about how interesting/fun the facts would be as a principal case. I concede that the Sanchez facts are not gripping. Indeed, my position was "it's nice to see Chief Justice Strine doing what he does best--writing a clear, accessible opinion acknowledging that independence is complicated and contextual. In my opinion Oracle, Beam v. Stewart, and Sanchez now make up the triumvirate of cases on this issue." I think Steve and his esteemed co-authors did the right thing by including a reference to Sanchez in the notes but keeping Oracle as the main case. It's the interaction of the three cases that is compelling.
But, although Steve is a very, very smart guy that knows him some Delaware law, I disagree with the plaint at his post's end: "How the [expletive deleted] are trial courts supposed to distinguish between mere social friendships and enduring close relationships? Especially because the issue will often be decided on the pleadings before discovery."
Aronson's first prong and Zapata both, in different contexts, try to get at this question: should we trust the board that recommends dismissing a derivative suit? or are the directors too biased? Answering that question gives us a chance to play that perennial law school game, "Rules or Standards?"
Rules approach: Has the director been paid by the defendant in question? Are they related? If yes, they are biased. If not, they're fine. This beauty of this definitional approach, as with all rules, is that it's simply, blessedly clear. But it also may be over- and under-inclusive.
Standards approach: Let's look at the situation. What is the director's tie to the defendant? Does the director depend on the defendant financially? Are they related? How closely? Are they friends? Are they in the same social circle? How close? The beauty of this situational approach is that it's granular. The cost is that it is a whole lot harder to apply, and harder to plan around.
I favor standards over rules for this particular question. The derivative suit is at core a sorting mechanism, and it would be too easy to game a rule and stack the board with manager-friendly-but-not-financially-dependent directors, rendering the whole derivative suit mechanism a farce.
Bringing us back to the classroom, I also like that Delaware has opted for standards here because I can use it to make the weird animal that is the derivative suit come alive for the students. Most of our students came straight through from undergrad. When I ask them: "Would you be unbiased in deciding whether the board should sue the defendant, if the defendant was your college roommate?", I get a visceral reaction, one that gets them to engage with the complexities of the derivative suit. And that means that they're walkin tough, baby, because they're not blind to the ties that bind.
Yesterday the Delaware senate unanimously confirmed Tamika Montgomery-Reeves as the next Vice Chancellor of the Chancey Court. We could not be more proud of her here at Georgia Law.
Rarely do I get a scoop, but I found out about this at lunch today. As I told Tamika, it might be the best lunch I've ever had. Talking inside baseball politics with the awesome Bill Chandler and his delightful wife Gayle, AND learning that Delaware Governor has picked one of our grads to be the next vice chancellor of the Chancery Court? Forget about it! I am thrilled for Tamika, for UGA, and for Delaware.
Update: I was 99% sure, and now can confirm that Tamika would be the first African-American to serve on the Chancery Court. From Law 360:
If confirmed, Montgomery-Reeves would be the first African-American judge and only the second woman to sit on the Chancery Court bench, where some of the nation's highest-octane corporate disputes are decided. Former Delaware Supreme Court Justice Carolyn Berger was the first woman confirmed to the court, in the mid-1980s, and about a decade later became the first woman to sit on the First State's high court.
We could not be more proud of her here at UGA Law!
Speaking of casebooks, here's a pitch to my casebook author friends: include Del. County Emples. Ret. Fund v. Sanchez. What's not to love about this opinion? First, it's a Delaware Supreme Court opinion. Second, it's short and sweet--clocking in at a mere 13 pages (I'm looking at you, Steve Bainbridge). Third, it takes on a topic of interest to law professors and law students alike: friendship. Fourth, it makes human one of the most challenging topics for the new student of corporate law: the derivative suit.
I know from experience that the derivative suit is a challenge in the classroom. Amounting to a lawsuit about whether there should be a lawsuit, it's a foreign concept to the uninitiated. Aronson v Lewis provides guidance on how to balance the fact that per DGCL 141 the board is in charge of corporate decisions (including the decision about when to sue) against the point that in the derivative context the plaintiffs usually allege that some subset of the board itself, or the whole board, should be liable. So the derivative suit is about how to sift the meritorious suits from the nuisance ones.
Aronson's first prong says such suits get to go forward if the majority of the board is interested or not independent. Interested is easy--financial interest. Independence is far more tricky--and therefore far more fun. I spent my first article as a law professor puzzling over what independence means, and how Delaware's version of it is situational, rather than the SOX/SRO status-based definition.
Strine's jurisprudence, in particular, while he was on the Chancery Court did a terrific job of limning the nuances of independence. Here's Fetishization of Independence on Delaware cases discussing independence in the context of familial relationships. Strine is all over it:
In one case, for example, Vice Chancellor Strine observed that (wholly apart from significant financial ties) he was “incredulous” about the independence of a director who was the CEO's brother-in-law on the question whether the corporation should sue the CEO. Nevertheless, Delaware courts do not always find that bare familial relationships suffice to prove a lack of independence. In Seibert v. Harper & Row, Publishers, Inc., the Delaware Chancery Court found that the mere fact that a director was the cousin of an interested director, “without more,” was not enough to show domination or control.
Delaware's approach to familial relationships is thus more flexible than an ex ante status-based approach. In Mizel v. Connelly, Vice Chancellor Strine found that a grandson was not independent for the purpose of deciding whether the corporation should sue his grandfather for rescission of an interested transaction, calling the grandfather/grandson relationship “of great consequence.” Interestingly, in a footnote the Vice Chancellor noted that the ALI's Principles of Corporate Governance: Analysis and Recommendations “do not include grandparents in their definitions of ‘related persons”’ that trigger a label of interestedness. Thus, Delaware's transaction-specific, contextual inquiry can produce a more textured and probing analysis than the corporate governance model of what having an interest (and thus lacking independence) actually means. As Vice Chancellor Strine observed, a grandchild's relationship with his grandfather can be a close one: “I could not consider impartially such a demand as to my own grandfather . . . .”
So it's nice to see Chief Justice Strine doing what he does best--writing a clear, accessible opinion acknowledging that independence is complicated and contextual. In my opinion Oracle, Beam v. Stewart, and Sanchez now make up the triumverate of cases on this issue. Here's Strine in Sanchez:
Here, the plaintiffs did not plead the kind of thin social-circle friendship, for want of a better way to put it, which was at issue in Beam. In that case, we held that allegations that directors “moved in the same social circles, attended the same weddings, developed business relationships before joining the board, and described each other as friends, ‟ . . . are insufficient, without more, to rebut the presumption of independence.”
In saying that, we did not suggest that deeper human friendships could not exist that would have the effect of compromising a director’s independence. When, as here, a plaintiff has pled that a director has been close friends with an interested party for a half century, the plaintiff has pled facts quite different from those at issue in Beam. Close friendships of that duration are likely considered precious by many people, and are rare. People drift apart for many reasons, and when a close relationship endures for that long, a pleading stage inference arises that it is important to the parties.
True, Chief Justice Strine acknowledges in the next paragraph the economic dependence that the director in question also allegedly had to the defendant. But it is his eloquent defense of friendship that resonates for me. Just last week I paraphrased the Beam court as holding that "friendship alone is not enough." But I asked students if they would feel unbiased if they were a director and the defendant and fellow boardmember was their college roommate. Their answer was an emphatic no. I hazard that Chief Justice Strine might agree.
Update: In my excitement I neglected to link to Ann Lipton's excellent post about Sanchez. Give it a look, and the lively discussion from law profs in the comments.
The news from Delaware is that, for the first time ever the Judicial Nominating Commission recommended to Governor Jack Martell an all-female short list. Unless the governor takes the big step of rejecting all three of the candidates put forward as qualified, the Chancery Court will add a woman to the bench.According to Delaware Online, the candidates are Abigail M. LeGrow, Elena C. Norman, and Tamika Montgomery-Reeves.
I wish all the candidates well, but I'm pulling for Tamika. She's smart, funny, and she's a Georgia Law alum. Tamika is coming to Athens to teach a short course in Advanced Corporations next week, along with her colleague and distinguished former Chancellor Bill Chandler. But even though I do have a Dawg in this fight, more generally I'm pleased that we'll likely see a woman on the Chancery Court again. 21 years is a long time.
Hat tip: Jerrod Lukacs
I just posted a new paper on SSRN entitled "The Modern Business Judgment Rule." It's short, so it won't take long to read, especially if you skip the footnotes. My goal is to describe this complex doctrine in simple terms, but the paper is packed with insights that were new to me, even though I have been teaching and writing about this subject for 20 years. Here is the abstract:
For over 150 years, the business judgment rule performed a relatively straightforward task in the corporate governance system of the United States, namely, protecting corporate directors from liability for honest mistakes. Under the traditional version of the business judgment rule, when the board of directors is careful, loyal, and acting in good faith, courts refuse to second-guess the merits of the board’s decisions, even if the corporation or its shareholders are harmed by those decisions.
While modern courts continue to insulate directors from liability for honest mistakes according to this traditional formula, in the 1980s Delaware courts began assigning the business judgment rule a more expansive role. The modern business judgment rule is applied not only in cases without procedural infirmities, but in cases where procedural infirmities at the board level have been mitigated by a special committee, stockholder approval, or partial substantive review by the court. In these new contexts, a court must satisfy itself that a board decision is worthy of respect, not because the decision was substantively correct, but because the effect of the procedural infirmities was sufficiently muted. After the court reaches that point, the business judgment rule “attaches” to protect the substantive merits of the decision from (further) review.
The modern business judgment rule is not a one-size-fits-all doctrine, but rather a movable boundary, marking the shifting line between judicial scrutiny and judicial deference. In describing the transformation of the business judgment rule, this chapter focuses on Delaware judicial opinions, with special attention to cases involving mergers and acquisitions, where the most important changes in the business judgment rule have been forged. The scripting of the business judgment rule’s new role by the Delaware courts is a work in progress, and the current law is inconsistent and confusing. Nevertheless, I trace the development of the modern business judgment rule and attempt to rationalize that development around the simple idea that the rule guides courts through the review of director conduct and marks the point at which judicial evaluation of a decision ends.
I hope you find this paper worthwhile. Comments and insights are most welcome.
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?
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.