I'm late to the eBay party, but  have a few thoughts on this fascinating case.  When the opinion came out Gordon made the link to Dodge v. Ford, and  I think he's right on. Gordon does a nice job summarizing the complicated facts, but for my purposes all you need to know is that founders Jim and Craig took some money from eBay in exchange for a minority investment in craigslist.  The relationship was fraught from the beginning, with fault on both sides:  eBay made use of craigslist's nonpublic information; Jim and Craig ultimates used their majority position to dilute eBay and eliminate its board seat. 

I have a few thoughts on how my theory of nonprofits relates to the case.  Chancellor Chandler rightly invokes the Unocal analysis, and accordingly discusses craigslist's argument that its actions were taken to defend its corporate culture, a permissible goal when adopting a takeover defense under Paramount Communications, Inc. v. Time, Inc. 

Chandler calls craigslists's invocation of "corporate culture" a "fiction," used "almost talismanically" to fit within the Time precedent.  However, he concludes from his observations at trial that "Jim and Craig did prove that they personally believe craigslist should not be about the business of stockholder wealth maximization, now or in the future."  He goes on to observe that the for-profit Delaware corporation, the form of organization eBay chose, is "not an appropriate vehicle for purely philanthropic ends, at least not when there are other stockholders interested in realizing a return on their investment."

What eBay says to me is that form matters.  My thesis is that the nonprofit form gives meaning.  It does something a for-profit form cannot do by creating a special flavor of social identity.  eBay reminds us of the converse, of the central meaning of "Inc.": "acting to promote the value of the corporation for the benefit of its stockholders."  You can't create a for-profit corporation, and you especially can't take money from an outside investor, and then openly claim that your corporate culture isn't interested in making money at all.

I quibble with Chancellor Chandler's characteristically well-reasoned and well-written opinion (which weaves in references to cultural sources ranging from David-and-Goliath to '80s movie Wargames) in only one regard: I don't think that eBay's claim about corporate culture was a fiction.  Jim and Craig really believed that craigslist's culture wasn't about making money.  The problem wasn't that there wasn't an authentic corporate culture, but that the community-focused culture wasn't "corporate", or more precisely, wasn't  "for-profit corporate" enough.

Permalink | Corporate Law| Delaware| eBay | Comments (0) | TrackBack (0) | Bookmark

Former Delaware Chief Justice Veasey: "The financial meltdown of 2008–2009 was not, in my opinion, the result of a pervasive failure of good governance practices of the boards of the thousands of U.S. public companies."

Absolutely right. So what is he worried about now? That courts outside of Delaware will get corporate governance wrong, just like Congress does:

The law relating to risk is still evolving, and the prevalent media/political condemnation of "excessive risk" may drive some bad results in litigation, just as it apparently has driven Congress to assume (erroneously in my view) that pervasive corporate governance failures caused the 2008–2009 financial meltdown.

Permalink | Corporate Governance| Corporate Law| Delaware | Comments (0) | TrackBack (0) | Bookmark

During our Poison Pill Forum, I blogged about Vice Chancellor Noble's opinion in Selectica, Inc. v. Versata Enterprises, Inc. In that case, the board of directors of Selectica adopted a poison pill with a 4.99% trigger and capped existing shareholders who held a 5% or more  interest to a further increase of only 0.5%. The stated rationale for these unusually tight restrictions on share ownership was a desire to protect Selectica's net operating loss carryovers. When Trilogy, the would-be acquiror in this deal, exceeded the cap, Selectica sued for declaratory judgment. After Selectica implemented the dilutive exchange provision pursuant to the pill, the board of directors adopted another poison pill with a 4.99% trigger. Trilogy challenged both pills and the dilutive exchange. VC Noble reasoned that "the protection of corporate assets against an outside threat is arguably a more important concern of the Board than restricting who the owners of the Company might be." Given the elevated threat, the severe defensive action was considered reasonable. Today, the Delaware Supreme Court affirmed that decision, and Francis Pileggi has posted Justice Holland's opinion.

The Court applied the well-known Unocal standard (because "any Shareholder Rights Plan, by its nature, operates as an antitakeover device" ... does this sound familiar?), the first prong of which requires Selectica's board to show that it had reasonable grounds for concluding that a threat to the corporate enterprise existed. This is normally a very easy hurdle for target boards, and Selectica had no problem convincing the Supreme Court that "the Board was reasonable in concluding that Selectica’s NOLs were worth preserving and that Trilogy’sactions presented a serious threat of their impairment."

Under the second prong of Unocal, the Court examines whether the actions taken by Selectica's board of directors were proportional to the threat. As reframed by Unitrin, the Court inquires "whether a board’s defensive response to the threat was preclusive or coercive and, if neither, whether the response was 'reasonable in relation to the threat' identified." Trilogy claimed that the 4.99% trigger was preclusive, meaning that it "makes a bidder’s ability to wage a successful proxy contest and gain control either 'mathematically impossible' or 'realistically unattainable.'" Here, Trilogy was attempting to show the latter, but the Supreme Court was unconvinced, reasoning, "The key variable in a proxy contest would be the merit of the bidder’s proposal and not the magnitude of its stockholdings." (The Court also held that the adoption of the pill was within the "range of reasonableness.")

All of that is interesting enough, but I also appreciated the Court's nod to Interco (alas, without citing the case):

In other cases, we have upheld the adoption of Rights Plans in specific defensive circumstances while simultaneously holding that it may be inappropriate for a Rights Plan to remain in place when those specific circumstances change dramatically. The fact that the NOL Poison Pill was reasonable under the specific facts and circumstances of this case, should not be construed as generally approving the reasonableness of a 4.99% trigger in the Rights Plan of a corporation with or without NOLs.

... The Selectica Board has no more discretion in refusing to redeem the Rights Plan than it does in enacting any defensive mechanism. Therefore, the Selectica Board’s future use of the Reloaded NOL Poison Pill must be evaluated if and when that issue arises.

While this opinion has some of the feel of cases in the Unitrin era, when the Court (in my view) was too forgiving of target boards of directors, the new opinion also displays a fairly careful narrowing of the target board's discretion. You can see this in the Court's repeated emphasis on the special context of this case (protection of NOLs), as well as in the Court's observation that withstanding Unocal's enhanced scrutiny at this point in the process "does not end the matter." As noted above, the Court's approval of the pill's adoption does not give Selectica's board of directors carte blanche to refuse redemption of the pill in the future.

Permalink | Corporate Law| Delaware | Comments (0) | TrackBack (0) | Bookmark

Christine posted on the perils of blogging in connection with the Todd Henderson kerfuffle. My story is less dramatic. Sometimes in an effort to write quickly, I mess up. It happens less than I feared when I first started blogging, but every time it happens, I am upset and embarrassed. The best strategy in such situations is to just fess up and move on. So I am fessing up.

The first part of my analysis of the Airgas and Air Products case was wrong. You can probably perceive in the original post my uncertainty ... the case as I understood it seemed too easy. Well, it was. Fortunately, someone pointed out my error and even supplied some documents to help. So I have made some corrections below and hope to be saying more about the case in the near future.

Permalink | Corporate Law| Delaware | Comments (0) | TrackBack (0) | Bookmark

Time is a key resource in hostile takeovers. Bidders want to move fast, and targets want to slow them down. A potent obstacle raised by many targets is the combination of a poison pill and a staggered board of directors. The poison pill deters the bidder from acquiring a controlling stake in the target, so most hostile deals proceed only after the pill has been redeemed by the target board of directors. Thus, bidders typically look to gain control over the target board of directors by waging a proxy contest.

The staggered board -- which provides for the election of one-third of the directors at each annual meeting of stockholders -- ensures that the bidder would need to win two proxy contests to gain control of the target board of directors. Many bidders are simply not willing to wait two election cycles or to make that sort of investment.

Enter Air Products.

In attempting to acquire Airgas, Air Products waged a successful proxy contest in September, placing three of its nominee directors on the Airgas board, which has a total of ten directors and is "classified" (i.e., staggered) in accord with DGCL 141(d).

Air Products also claims to have adopted a new bylaw requiring a January 2011 meeting of stockholders, in spite of a recommendation "against" the proposed bylaw by various proxy advisory firms. Airgas admits that "more than a majority of the shares represented and voted at the meeting" endorsed the bylaw, but contends that the bylaw is not effective, as approval required 67% of the outstanding shares and Airgas did not receive that level of support. That bylaw has prompted litigation in the Delaware Court of Chancery, with a trial before Chancellor Chandler set to begin Monday.

[The following paragraph as originally written was based on some false premises, and I have inserted a new paragraph after to provide additional information.]

The strongest claim for Airgas appears to be that the bylaw was not approved by the requisite number of votes. The Airgas Charter provides that Article III of the Airgas Bylaws cannot be amended "without the affirmative vote of the holders of at least 67% of the voting power of all the shares of the Corporation entitled to vote generally in the election of Directors, voting together as a single class." Article III of the Airgas Bylaws is entitled "Directors," and it includes a provision regarding the setting of the date for the general meeting of stockholders. [Oops! This is not true. That provision is in Article II of the Bylaws.] So what am I missing? I haven't seen anything from Air Products about this -- other than this unhelpful press release -- but this looks like a pretty straightforward win for Airgas.

[The argument from Airgas is not as straightforward as I has portrayed. The 67% vote requirement applies to amendments to Article III, but the provision regulating the setting of the date for the general meeting of stockholders is actually in Article II. Thus, Airgas has to argue that the new bylaw is "inconsistent with" Article III, which states that directors "shall be elected to hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election." For reasons discussed immediately below, this argument seem implausible to me, and I now believe that the new bylaw will survive.]

If the bylaw survives this argument, Airgas has a secondary challenge, which seems to be the focus of most of the press in this case. Airgas is claiming that the January meeting is unlawful because "it will be in the same fiscal year as it was at its 2010 annual meeting." Thus, the "Bylaw is invalid because it conflicts with both the Delaware General Corporation Law and the Airgas Charter, both of which provide that directors are elected to a term extending three annual meetings to be held approximately one year apart." The big shortcoming of this argument is that neither the DGCL nor the Airgas Charter says what Airgas claims.

DGCL 141(d) provides that directors on a classified board are elected for a "full term," but it doesn't specify a term of three calendar years, just three annual meetings. And it doesn't require that the meetings be held approximately one year apart. Neither does DGCL 211, which regulates the timing of annual meetings. That section provides, "an annual meeting of stockholders shall be held for the election of directors on a date and at a time designated by or in the manner provided in the bylaws."

The Airgas Charter doesn't help the cause much, either: "At each annual meeting of stockholders of the Corporation, the successors to the class of Directors whose term expires at that meeting shall be elected to hold office for a term expiring at the annual meeting of stockholders held in the third year following the year of their election." The Airgas complaint places heavy emphasis on the references to "years" in the DGCL and "third year" in the Airgas Charter, but everyone agrees that "years" in this context is not an exact measure, so Airgas is required to argue that the "common understanding" of Delaware corporations is that a three-year term means "approximately" three calendar years. Elsewhere in the complaint, Airgas observes that the January meeting would "be in the same fiscal year as it was at its 2010 annual meeting," but neither the statute nor the Airgas Charter makes reference to the fiscal year as the relevant year.

While the textual arguments for the invalidity of the bylaw are not strong, Airgas seems poised to make the policy claim that the proposed January meeting would unlawfully shorten the terms of certain Airgas directors. Thus, if the Court of Chancery approved the new bylaw, hostile bidders would have a template for undermining staggered boards. I do not find this argument persuasive. Delaware law does not stake out a firm position on the time between annual meetings (unless that time is too long). The timing of annual meetings is left to the bylaws, which usually may be amended by the board of directors or the stockholders, and I suspect that the Delaware courts would be happy to enforce whatever the bylaws tell them. If a company wanted to make this tactic less available to hostile bidders, it could create a supermajority requirement for amending the bylaws ... and this is precisely what Airgas did or take other measures, but it appears that Airgas failed to do that in this case.

Permalink | Corporate Law| Delaware | Comments (0) | TrackBack (0) | Bookmark

Thanks to Steven Davidoff, Eric Talley, and our own Christine and Gordon for sharing insights on the eBay v. Newmark  case and other poison pill cases this year.  We are closing the forum now, but intend to keep track of this issue as appeals wind there way through the Delaware Supreme Court and new cases on poison pills loom.  We'll be sure to invite experts back.

You can read all the posts in our Poison Pill forum here:

Permalink | Corporate Governance| Corporate Law| Delaware| Forum: Poison Pills | Comments (0) | TrackBack (0) | Bookmark

City Capital Associates Ltd. Partnership v. Interco Inc. 551 A.2d 787 (Del.Ch. 1988) is one of my favorite Delaware opinions. Written by Chancellor Allen in 1988, Interco was the case in which Unocal was famously labelled "the most innovative and promising case in our recent corporation law." Ironically, Interco earned a red flag in Westlaw when the Delaware Supreme Court described the case as a "narrow and rigid construction of Unocal" and "reject[ed] such approach as not in keeping with a proper Unocal analysis." See Paramount Communications, Inc. v. Time Inc., 571 A.2d 1140, 1153 (Del.,1989). Now, over 20 years after Interco's apparent demise, Steve Davidoff suggests that Delaware's recent poison pill jurisprudence may be making room for Interco again. I agree.

Though Interco is still well known among corporate lawyers as a case in which Chancellor Allen ordered the redemption of a poison pill under Unocal, the case expresses some concern about Unocal's implications:

The danger that [Unocal] poses is, of course, that courts--in exercising some element of substantive judgment--will too readily seek to assert the primacy of their own view on a question upon which reasonable, completely disinterested minds might differ. Thus, inartfully applied, the Unocal form of analysis could permit an unraveling of the well-made fabric of the business judgment rule in this important context. Accordingly, whenever, as in this case, this court is required to apply the Unocal form of review, it should do so cautiously, with a clear appreciation for the risks and special responsibility this approach entails.

In retrospect, this hand wringing seems quaint, as the Delaware courts (particularly the Delaware Supreme Court) have routinely deferred to defensive actions by target directors. Indeed, after Unitrin modified the Unocal standard in 1995, it was hard to imagine a defensive measure that would be invalidated. The Delaware Supreme Court seemed so deferential to target boards that Bob Thompson and I declared Unocal a "dead letter" in 2001, though the Court of Chancery had invalidated a "dead hand" pill and a "no hand" pill a few years earlier. Our point was simply that defensive measures had to be extreme -- "show stoppers" in the parlance of the Delaware courts -- before they would be invalidated. Anything short of that extreme -- even a pill that makes a hostile takeover substantially harder, such as the 5% pill in Selectica, Inc. v. Versata Enterprises, Inc. -- would be approved as a proportionate response to almost any cognizable threat.

Interco offered a more nuanced interpretation of Unocal than the one developed in the subsequent Delaware Supreme Court cases. According to Chancellor Allen, "in the setting of a noncoercive offer, absent unusual facts, there may come a time when a board's fiduciary duty will require it to redeem the rights and to permit the shareholders to choose." 

Note that the premise for redemption in Interco is a noncoercive offer. As Professor Davidoff observes, Vice Chancellor Strine seems to invoke the spirit of Interco in Yucaipa American Alliance Fund II, L.P. v. Riggio, decided last month, when he writes: "there is a plausible argument that a rights plan could be considered preclusive, based on an examination of real world market considerations, when a bidder who makes an all shares, structurally non-coercive offer has: (1) won a proxy contest for a third of the seats of a classified board; (2) is not able to proceed with its tender offer for another year because the incumbent board majority will not redeem the rights as to the offer; and (3) is required to take all the various economic risks that would come with maintaining the bid for another year."

The bigger point that I would like to make in this post, however, is that Interco was animated by a sophisticated analysis of the threat prong under Unocal. Where the threat is relatively mild (e.g., "in the setting of a noncoercive offer"), the response should be accordingly muted. The Court of Chancery has been more attentive to this sort of analysis in recent years, and all three recent poison pill cases have something interesting to say on this issue.

• In Selectica the target board of directors was attempting to "prevent the inadvertent fortfeiture of potentially valuable assets, not to proteact against hostile takeover attempts." Vice Chancellor Noble reasoned, "the protection of corporate assets against an outside threat is arguably a more important concern of the Board than restricting who the owners of the Company might be." Given the elevated threat, a more severe defensive action was considered reasonable. (For an argument that the Delaware courts have gone too far, see the latest by Paul Edelman and Randall Thomas.)
• In Yucaipa, Vice Chancellor Strine identified the "threat that the corporation's stockholders would relinquish control through a creeping acquisition without the benefit of receiving a control premium." This does not seem like a terribly severe threat, given the existence of 13D filings that would place the market on alert for creeping acquisitions. Nevertheless, the defensive action in this case was not severe. Yucaipa conceded that the Rights Plan was not preclusive, which left only the issue of whether the Rights Plan fell within the "range of reasonableness" -- a business judgment rule-like inquiry that target boards rarely fail to satisfy.
• In eBay v. Newmark, as noted in my earlier post, Chancellor Chandler held that the target directors did not reasonably perceive a threat to the corporation's policy and effectiveness. Thus, the poison pill was unjustified.

While we might debate the correctness of any of these decisions, I applaud the Court of Chancery for continuing to develop its Unocal jurisprudence. Like Chancellor Allen, I have long thought that Unocal has great potential to calibrate the actions of incumbent directors. The question remains: will the Delaware Supreme Court embrace this more nuanced analysis?

Permalink | Corporate Law| Delaware| Forum: Poison Pills| M&A | Comments (0) | TrackBack (0) | Bookmark

Steven Davidoff (Connecticut) has some incisive analysis of eBay v. Newmark on his Deal Professor column on the New York Times' Dealbook site. 

He ends the column by engaging our own Conglomerate forum topic on poison pills.  He starts with a comment that eBay isn't all that interesting as a poison pill case.  To follow Christine's analysis (and to borrow from craigslist lingo), perhaps we should flag Chancellor Chandler's posting as "miscategorized" -- is the case really about takeovers or about minority shareholder oppression or disenfranchisement?

Steven then gives a nice summary of what two cases that clearly do change poison pill jurisprudence -- Selectica and the Vice Chancellor Strine's opinion in the Barnes & Noble litigation -- mean for the looming legal battle over Air Product's takeover attempt on Airgas. 

Permalink | Corporate Governance| Corporate Law| Delaware| eBay| Forum: Poison Pills| M&A | Comments (0) | TrackBack (0) | Bookmark

Chancellor Chandler's opinion in eBay v. Newmark, issued today, is a fascinating read, and it would be impossible to do this opinion justice in a single blog post. The facts of the case are rather complex (see Chirstine's post over two years ago on this case), but Chancellor Chandler did a magnificent job with the analysis, as usual. The aspect of the opinion that most caught my eye on the first reading was its resemblance to the iconic Dodge v. Ford Motor Co., which I examined in some detail in The Shareholder Primacy Norm, and I will focus on this part of the opinion here.

The case stems from a minority investment (28.4%) by eBay in craigslist. The other two stockholders in craigslist are Craig Newmark (42.6%) and James Buckmaster (29%). When eBay made its investment in August 2004, the three stockholders negotiated a Stock Purchase Agreement and a Stockholders' Agreement, both of which contained provisions of interest in the litigation. Perhaps most importantly, the Stockholders' Agreement expressly reserved eBay's right to compete with craigslist, but specified various consequences that would follow from such competition: (1) eBay would lose various negative covenants (which Chancellor Chandler calls "rights to consent") with respect to craigslist; (2) eBay would lose any preemptive rights in connection with the issuance of craigslist shares; and (3) eBay would lose its right of first refusal with respect to any sale of shares by Newmark or Buckmaster. On the bright side, eBay would be freed from any right of first refusal belonging to Newmark or Buckmaster with respect to the sale of shares by eBay.

The craigslist charter provided for a board of directors of three people, who would be elected under cumulative voting. Under these voting rules, eBay had enough shares to ensure itself one director position. Newmark or Buckmaster had entered into a voting agreement, which ensured that they would have the other two director positions.

Chancellor Chandler describes the relationship between eBay and craigslist as "oil and water." eBay was interested in monetizing craigslist, but Newmark or Buckmaster were having none of it. Not long after the investment, eBay launched Kijiji, an international classified ads service. When eBay expanded Kijiji to the U.S. in June 2007, craigslist sprang into action, eventually making three moves that were the focus of eBay's lawsuit: 

(1) implementation of a staggered board through amendments to the craigslist charter and bylaws (the “Staggered Board Amendments”); (2) approval of a stockholder rights plan (the “Rights Plan”); and (3) an offer to issue one new share of craigslist stock in exchange for every five shares on which a craigslist stockholder granted a right of first refusal in favor of craigslist (the “ROFR/Dilutive Issuance”).

While the right of first refusal seems like a good candidate for a statutory challenge, Chancellor Chandler decided eBay's challenges to all three actions exclusively on fiduciary duty grounds. As is so often the situation in Delaware, the search for the right standard was central to the decision. In this case, Chancellor Chandler held as follows:

• The Rights Plan "implicates Unocal concerns in my view because rights plans (known as 'poison pills' in takeover parlance) fundamentally are defensive devices that, if used correctly, can enhance stockholder value but, if used incorrectly, can entrench management and deter value-maximizing bidders at the stockholders’ expense." I might have some quibbles with this, but I will reserve those for a later day. The analysis of the Rights Plan is the most interesting part of the opinion to me, and I will say more about that below, but for now, let's just accept Chancellor Chandler's conclusion that Unocal applies.

• The Staggered Board Amendments "do not function as a defensive device under the unique facts of this case"; therefore, the amendments are not subject to review under the Unocal standard. The Staggered Board Amendments in this case function to deprive eBay of its board seat, nullifying the effect of cumulative voting. You might be forgiven for thinking that staggered boards, like poison pills, "fundamentally are defensive devices," but Chancellor Chandler's rejects this conclusion because the voting agreement between Newmark or Buckmaster ensures that eBay cannot capture control of the board of directors.

Hmm ...

For eBay the Staggered Board Amendments still make the difference between having a board representative and not having a board representative. While I can see Chancellor Chandler's point, this effect seems defensive to me. In any event, Chancellor Chandler concludes that the Staggered Board Amendments should be subject to the business judgment rule, and he ultimately upholds the amendments. (Lots more one could say about this, but, again, I will save it for another post.)

• The ROFR/Dilutive Issuance is subject to the "entire fairness" standard because Newmark or Buckmaster "stood on both sides" (i.e, they are simultaneously the directors who approved the issuance and the stockholders who benefit from the issuance). Chancellor Chandler cleverly analyzes the ROFR, concluding, "it actually costs eBay more to grant a right of first refusal over five of its craigslist shares than it costs [Newmark or Buckmaster] to do the same." As a result, the action is not entirely fair, and Chancellor Chandler orders recission of the action.

We already know the punchline of the case: Newmark and Buckmaster breach their duties to eBay. But let's take a closer look at Chancellor Chandler's analysis of the Rights Plan, and you will see an amazing similarity with Dodge v. Ford Motor.

• First, this is a minority oppression case. Chancellor Chandler invokes theUnocal standard, and he never mentions the word "oppression," but the case has oppression written all over it. craigslist is a closely held corporation, and Newmark and Buckmaster are acting in concert as controlling stockholders (think Henry Ford). Chancellor Chandler observes, "controlling stockholders are fiduciaries of their corporations’ minority stockholders." Similarly, the Dodge court noted, "There should be no confusion (of which there is evidence) of the duties which Mr. Ford conceives that he and the stockholders owe to the general public and the duties which in law he and his codirectors owe to protesting, minority stockholders."
• Second, Chancellor Chandler gives us an impassioned defense of shareholder primacy, which contrasts with the controlling stockholders' public-service orientation:

"[Newmark and Buckmaster] did prove that they personally believe craigslist should not be about the business of stockholder wealth maximization, now or in the future. As an abstract matter, there is nothing inappropriate about an organization seeking to aid local, national, and global communities by providing a website for online classifieds that is largely devoid of monetized elements. Indeed, I personally appreciate and admire [Newmark's and Buckmaster's] desire to be of service to communities. The corporate form in which craigslist operates, however, is not an appropriate vehicle for purely philanthropic ends, at least not when there are other stockholders interested in realizing a return on their investment. Jim and Craig opted to form craigslist, Inc. as a for-profit Delaware corporation and voluntarily accepted millions of dollars from eBay as part of a transaction whereby eBay became a stockholder. Having chosen a for-profit corporate form, the craigslist directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of its stockholders."

You can see in this passage the echoes of Dodge:

"A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the nondistribution of profits among stockholders in order to devote them to other purposes."

• Third, the principal wrong to which the controlling shareholders are responding is competition from the minority shareholders. In this case, eBay is competing directly with craigslist, and craigslist was attempting to prevent eBay from gaining a competitive advantage by virtue of eBay's stock ownership in craigslist. Similarly, in Dodge, the Dodge brothers were setting up a new car manufacturing company to compete with Ford Motor Company, and Henry Ford wanted to prevent them from gaining capital by virtue of their stock ownership in Ford Motor.

This lawsuit is an interesting and unusual context for the application of the Unocal standard, which normally applies to large, publicly traded companies. As a doctrinal matter, the case is also unusual in that Chancellor Chandler held that Newmark and Buckmaster did not reasonably perceive a threat to craigslist’s corporate policy and effectiveness. This is a rare holding, as the Delaware courts traditionally have little problem locating a threat and spend most of their analytical energy on the proportionality prong of Unocal. Whatever the doctrinal clothing, it seems to me that Chancellor Chandler got the right result.

UPDATE: Josh Fershee explores the Ford analogy and finds a distinction between the cases:

For Ford, there seemed to be something of a change in the business model (and how the business was operated with regard to dividends) once the Dodge Brothers started thinking about competing. All of a sudden, Ford became concerned about community first. For craigslist, at least with regard to the concept of serving the community, the company changed nothing. And, in fact, it seems apparent that craiglist’s view of community is one reason, if not the reason, it still has its “perch atop the pile.” 

Thus, while it is true craigslist never needed to accept eBay’s money, eBay also knew exactly how craigslist was operated when they invested. If they wanted to ensure they could change that, it seems to me they should have made sure they bought a majority share.

When I first picked up the case yesterday, I wondered if Chancellor Chandler might go in this direction. This seems consistent with Delaware's history with regard to minority oppression cases (see, e.g., Nixon v. Blackwell), and it's not an unreasonable response to eBay's complaint.

Permalink | Corporate Governance| Corporate Law| Delaware | Comments (0) | TrackBack (0) | Bookmark

Mohsen Manesh's new paper, Delaware and the Market for LLC Law, is a fascinating project, and I am grateful to him for allowing us to feature his paper in the Junior Scholars Workshop. Like Larry Ribstein and Bob Lawless, I admire Mohsen's scholarly ambition, but I feel like this paper has some distance to travel before it is complete.

Mohsen begins with the claim that Delaware lacks the sort of market power in the competition for LLC charters that it has in the competition for corporate charters. His evidence for this claim is the lack of price discrimination in LLC taxes. Like Larry and Bob, I am skeptical of this claim, but I am willing to play along for the sake of argument. I am more interested in his examination of contractability and indeterminacy under LLC law, and my interest in these arguments eventually leads me back to Mohsen's initial claim regarding Delaware's supposed lack of market power.

Indeterminacy in corporate law is often said to play a crucial role in enhancing Delaware's market power. On the nature of indeterminacy in corporate law, Mohsen observes: "Delaware corporate law, and in particular its judge-made law of fiduciary duties, tends to favor contextual, fact-intensive standards over bright-line rules." Note that the charge of indeterminacy is not necessarily an indictment of Delaware law. Indeterminacy is probably inherent and almost certainly desirable in fiduciary law. The somewhat counterintuitive claim that this indeterminacy enhances Delaware's market power is based on two observations: (1) indeterminate law is hard to copy, and (2) indeterminate law increases the importance of judges (and Delaware has the best judges).

So far, so good. Now the crucial move: Mohsen asserts that LLC law is less indeterminate than corporate law because LLCs are "creatures of contract." In Mohsen's words:

Virtually all of the default provisions specified in the Delaware LLC Act may be superseded or otherwise contractualized by the terms of a LLC’s governing agreement. As a result, many of the mandatory and indeterminate provisions that are imposed under Delaware corporate law—including the judge-made law of fiduciary duties—may be contractually waived, modified or clarified under Delaware LLC law.

According to Mohsen, one implication of this contractability is that LLCs can avoid the cost of uncertainty inherent in corporate law. I have several problems with Mohsen's argument.

First, Mohsen selects an unfortunate example to illustrate the mandatory indeterminacy of Delaware corporate law. He argues that DGCL Section 271, governing the sale of "all or substantially all" of a corporation's assets is a mandatory provision, meaning that it "cannot be modified, clarified or otherwise waived by the terms of a corporation's governing documents." While the statute does not expressly allow for contrary terms in the corporate charter, the process for selling assets is often subject to contractual specification. If powerful shareholders want a say in the sale of assets -- even when that sale constitutes less than "all or substantially all" of a corporation's assets -- they simply have to insert a negative covenant into their deal terms.

Second, while Mohsen illustrates how an LLC's governing documents could "contractualize" certain matters that, in a corporate context, might be evaluated under a mandatory, indeterminate, fiduciary standard, he does not provide evidence that LLCs routinely avail themselves of this opportunity. He rightly acknowledges that drafting highly specified contracts is expensive and difficult, and that should lead him to ask: would most Delaware LLCs invest in such contracts? The answer to this question depends on what these LLCs look like, and I agree with Bob Lawless that it would be nice to know more about this. Are most of these LLCs Mom-and-Pop businesses? Or are they non-operating companies? In any event, my guess is that the vast majority of Delaware LLCs are tightly controlled by one individual or parent company, thus eliminating the need for highly specified contracts.

Third, if one of the major advantages of LLCs is contractability, which reduces indeterminacy, why are so many LLCs formed in Delaware? Mohsen observes that many states have copied Delaware's LLC Act, which provides that its principal policy is "to give the maximum effect to the principle of freedom of contract." If contractability is the key feature of LLC law, why don't other states compete more effectively with Delaware? Under Mohsen's theory, contractability reduces indeterminacy, which implies that Delaware judges have no special advantages. Rather than puzzling over Delaware's lack of market power, I am left puzzling over Delaware's success in attracting LLC formations when its product has no discernible advantages.

By the way, Larry Ribstein disagrees with Mohsen on this point, arguing, "The contractual nature of LLCs increases the value of Delaware courts’ contract-enforcement technology." In other words, the important thing about Delaware is how the judges will interpret future contracts, and that feature of the Delaware system is not easily replicated by other states. This seems plausible to me, but it is in tension with the notion that contractability reduces indeterminacy and, thus, poses a significant challenge to Mohsen's paper.

Fourth, Mohsen dismisses the importance of the contractual duty of good faith and fair dealing too quickly, arguing, "the Delaware courts have made clear that the implied contractual covenant is doctrinally distinct and substantially narrower than the open-ended fiduciary duties imposed by corporate law." The Delaware courts have certainly made statements like this, but my sense is that the treatment of this doctrine is far more complex than Mohsen gives credit. Indeed, earlier this summer, I heard Chief Justice Steele address two distinct lines of cases involving the contractual duty of good faith and fair dealing and suggesting that these precedents were in serious conflict.

In the end, all of my points revolve around a single complaint, namely, that Mohsen exaggerates the extent to which the contractability of LLCs reduces indeterminacy when compared to corporations. Given that his argument rests on this claim, however, it is a point worth arguing.

Permalink | Corporate Governance| Delaware| Junior Scholars| Partnerships | Comments (0) | TrackBack (0) | Bookmark

I am very happy to see somebody exploiting the theoretical and empirical potential of expanding the study of business organizations to fully include unincorporated business entities. And I applaud Professor Manesh’s selection of an intriguing question to study, something that I’ve been curious about but never pursued: Why do Delaware’s fees for forming LLCs look so much different than those for corporations?

To briefly summarize his thesis, Manesh argues that Delaware’s flat $250 fee for LLCs, compared to its much higher and graduated fees for corporations, indicates Delaware’s lack of market power in the market for LLCs. Kahan & Kamar (Price Discrimination in the Market for Corporate Law, 86 Cornell Law Review 1205 (2001)) theorized that Delaware’s scaling of corporate fees to firms’ capitalization showed price discrimination, something a producer can do with market power. Since Delaware doesn’t do that for LLCs it must not have market power in that area.

One problem with this analysis is that it assumes LLCs and corporations are comparable for purposes of pricing. But there is no reason to think this is the case. Corporations are standardized products. Delaware builds on this standardization to compute the corporate franchise tax in ways that apply fairly simply to all corporations in the state, as described in the article. LLCs’ main attraction, by contrast, is that they are not standardized, but rather creatures of contract, as Manesh discusses. LLCs’ capital structures depend on idiosyncratic contracts rather than statutory standard terms. If Delaware tried to apply something like the corporate franchise tax to LLCs they would simply engage in regulatory arbitrage to minimize the tax.

Why doesn’t Delaware force LLCs to be just as standardized as corporations so it can charge for them like it does for corporations? First, there just isn’t as much money in it because there’s much less variation in size of LLCs than corporations. Second, if Delaware forced LLCs to be as standardized as corporations, LLCs would lose a lot of their attraction, as Manesh himself argues. As a result, Delaware would get a lot fewer LLCs. By contrast, corporations, or at least large Delaware corporations, benefit from standardization apart from law compliance: they are traded in a public securities market, where variations cause information costs that would be reflected in securities prices. Corporations trying to arbitrage Delaware’s franchise tax would have to pay a penalty for being different.

(A broader problem with Manesh’s analysis is that the relationship between price discrimination and market power is less clear than Manesh assumes. See Kobayashi and Wright on Illinois Tool Works vs. Independent Ink on the non-inference of anti-competitive markets from price discrimination in the antitrust context. )

So, contrary to Manesh’s assumption, Delaware doesn’t necessarily lack market power in the LLC market just because it doesn’t price discriminate. But having made his assumption, Manesh then explains why the assumed fact about lack of market power is true: LLC law is based on the parties’ contracts and therefore is less indeterminate than its corporate law. Delaware therefore cannot attract LLC business to its courts through indeterminacy as it does for corporations.

I agree with Manesh’s observation about corporate vs. LLC indeterminacy – in fact I wrote and published that article a couple of years ago. I don’t necessarily buy K & K’s reasoning as to corporations. Rather, as discussed in my indeterminacy article, I think indeterminacy is inherent in the corporate form. But even assuming LLCs and corporations differ in this respect, I disagree with where Manesh goes from there.

Let’s begin with the evidence that Delaware does attract LLCs to its courts. Kobayashi and I find that Delaware is a massive winner in the national market for formations of large LLCs. Although this would be seem to suggest Delaware has power in the LLC market, Manesh doesn’t seem troubled by this finding, since he is relying on the absence of price discrimination. More interesting for present purposes is that Kobayashi and my regression analysis indicates that Delaware’s success is not because of any feature of Delaware’s law that we could find. Indeed, Manesh also notes that the feature that one might expect would attract LLCs to Delaware – the statutory provision allowing freedom of contract – has been replicated by other states. This suggests that large LLCs are attracted to Delaware because of Delaware’s legal infrastructure of courts and lawyers.

So why are LLCs drawn to Delaware’s courts if, as Manesh concludes, there’s relatively little those courts need to do for LLCs?The answer is that courts do have a lot to do for LLCs – that is, enforce their contracts. The contractual nature of LLCs increases the value of Delaware courts’ contract-enforcement technology. It is easy for a state to say in its statute that its courts will enforce contracts, but much more difficult to actually follow through on that promise, and to come up with intelligible and coherent contract-enforcement jurisprudence. As I have discussed in several writings, including my indeterminacy article above, my book (Rise of the Uncorporation and a number of blog posts (e. g. , Delaware courts have developed a very sophisticated approach to contract interpretation and enforcement in unincorporated firms. Other states can’t pick up formation business simply by linking to Delaware’s law because they also need to provide assurances as to how they’ll decide future cases.

In other words, LLCs are not flocking to Delaware just because it enforces contracts, but because of the way it enforces contracts. Although Manesh thinks that the “network” of Delaware’s cases is all about interpreting mandatory rules, in fact it is at least partly about applying any rules, whether or not contractual, to necessarily unpredictable fact situations. If Delaware were to follow Manesh’s suggestion and become more indeterminate to compete for LLCs, this would threaten, not solidify, its dominance in the market for LLCs.

(As an aside, I have a quibble about Manesh’s analysis of “network externalities” as a reason for the attractiveness of Delaware law. This confuses network effects in business association law and network externalities. My article with Kobayashi about choice of form, which Manesh cites a couple of times, shows some pretty good evidence that these aren’t network externalities. Contrary to Manesh’s brief discussion of this paper, this holds for both choice of form and choice of law, since the basic constraints are the same in both areas. )