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Tensions

Jon v. Mindy

  • Jon rules, Mindy drools!

Major Protections of Shareholders

  • Fiduciary Duties (weak)
  • Voting (superweak)
  • Market Controls (see poison pills)

Agents/Partners v. Corporations

  • In agency & p'ship law, the courts are very concerned that partners will be screwing over each other (Salmon v. Meinhard, Vohland v. Sweet, Page v. Page) & 3d parties (ASME, Delaney).
  • But in corporation law, we assume that 3d parties will take care of themselves through contract or regulation; and we don't apply anything like the standards from Salmon, or even Page, to the manager/SH relationship. We say there's a duty of care, which makes the board like an agent to the SHs (the principals), but then we apply the BJ rule!

Berle & Means v. Dodd

  • The fight was between Berle & Means, who said that the problem of corporate law was conflict between SHs and managers, and Dodd, who said the problem of corporate law was protecting the nation from corporation.
  • But this is illusion of a fight -- they're both right. SHs need protection from managers, and the nation needs protection from corporations.

The MacroScript, in Theory and Practice

  • Element I. Shareholders have to be protected; for they are the only constituency out there that does not have adequate protection.
    • U.S. Steel: If managers had mislead shareholders as they mislead workers, it’s quite clear that securities regulation would have led to managerial liability.
  • Element II. All other constituencies are adequately protected by other institutions.
    • U.S. Steel: The suit was, as the court recognized, “a cry for help from steelworkers and townspeople” because of the “economic tragedy of major proportion to Youngstown and Ohio’s Mahoning Valley.”
  • Element III. Narrowing the maximand of directors helps them make good judgments: the only thing they have to maximize is profits and they need not be worried about other considerations.
    • U.S. Steel: The single-minded pursuit of profits is part of what what makes corporations so threatening to other constituencies. Indeed, it was to create profits that the management promised workers to keep the plant open.
  • Element IV. Similarly, narrowing the maximand makes it easier for courts to determine if boards are acting in a way loyal to shareholders. All will be based on just profit.
    • U.S. Steel: the Sixth Circuit upheld the District Court’s inability to choose between the different measures of profitability advanced by the plaintiffs and the defendants.
  • Element V. Judicial monitoring and intervention will provide sufficient protection for shareholders.
    • U.S. Steel (practice) : Judicial non-interference will harm other constituencies. That, in effect, is what shareholder primacy means: not that directors must focus on only shareholders’ interests; but that corporations need not take into account other constituencies and may, if they want to or are forced to by market influences, treat other constituencies quite poorly.

Shareholders can't take care of themselves

  • The problem is, shareholders face a collective action problem, cf. Berle & Means.
    • BUT -- the meta script says that the market will reach optimal outcomes -- why should we trust regulation here?
    • In the voting cases, we say that certain dubious transactions are OK when shareholders vote. BUT, somehow they can overcome collective action problems in voting??
    • And we say the shareholders can take care of themselves by voting out bad management. But this directly conflicts with the collective action problem.
    • And we say the shareholders can take care of themselves by being able to tender their shares to takeover artists who can make their investment more valuable than the current management. BUT, we allow poison pills.
    • So can SHs take care of themselves? Or can't they? Doesn't corporate law take away SHs' ability to take care of themselves -- allowing poison pills, allowing indemnification and D&O insurance for violations of duty of care/loyalty, letting suspect transactions slide when the avowedly useless tool of voting is used?
  • With respect to the particular form of managerial disloyalty under examination, shareholders are adequately protected by other sources, such as markets, contracts or regulators. Courts recognize that charitable contributions should be encouraged for social ends and shareholder ends.

Responsibility for anybody but shareholders is bad

  • Other constituencies can take care of themselves using contract and regulation
    • BUT Micro Script Element II: Unless corporate law gives wide discretion to corporate officers and directors, the survival of other important constituencies will be threatened. In the case of charitable contributions, not just the charities, but also our freedom and capitalistic system depend importantly board discretion.
    • Also, the constituency best placed to take care of itself -- contractual creditors -- get extra protection, sometimes -- using veil piercing.
    • Also, we allow managers to think about the interests of other constituencies in the takeover cases, cf. Unocal. We let managers claim concern for other constituencies when it serves their interests, but not when it doesn't (US Steel).
  • Managers don't know from social responsibility, and shouldn't be spending other peoples' money. Making decisions based on considerations other than profit is just taxing shareholders and giving it to other people without SHs' consent -- it's socialsm!
  • Milton Friedman: Spending on social responsibility is like “spending someone else’s money for a general social interest,” “taxation without representation.” Managers don't know what's good for society. They are self-appointed experts, doing things that only the government has a right to do.
    • BUT we allow corps to make charitable donations.
    • Also, we allow them to take other constituencies into account when they want to avoid a takeover.

Courts can adequately regulate corporations

  • Courts will overcome SH problems by monitoring managers.
    • BUT -- the meta script says that regulation is bad because regulators don't know what they're doing and they don't have the right incentives.
    • Also, the BJ rule says courts shouldn't be monitoring managers -- they are subject to hindsight bias, and they don't know what they're doing -- the meta script meets the micro script.
  • Micro Script Element V: Judicial intervention would be ineffective and would likely have significant unintended consequences and make things worse, not better, for shareholders.

Corporations seek only profits because SHs choose them to

  • A corporate charter can specify any goal. The fact that the goal of all corporations is profit is a result of choice.
    • BUT -- any corporation that doesn't seek profit is ground under foot by competition. This is choice???
    • Also, the law is built to enforce profit-seeking. Cf. Dodge v. Ford; Honeywell.

Profit should be the sole goal of corporate law

  • "Fairness" is too hard to measure, whereas profit is easy to measure -- in dollars.
    • BUT there are many ways to define profit. Look at the long-term vs. short-term profit analysis in the merger cases, or in US Steel.
  • Macro Script Element: Narrowing the maximand to just profit makes it easier for courts to determine if boards are acting in a way that is loyal to shareholders. Courts will be able to distinguish loyal from disloyal decisions.
  • Macro Script Basic Claim (theory): Shareholder primacy seriously constrains directors to pursue shareholder interests (and not their own) and it does so without harming the interests of other constituencies.
    • Practice: U.S. Steel: Shareholder primacy gives managers discretion to ignore other constituencies and license to manipulate and bamboozle other constituencies in the name of pursuing shareholder interests.
    • But when managers want to ignore profit to serve their own interest, such as keeping their jobs, we let them justify their actions as protecting other constituencies -- Unocal.
  • Micro Script Element IV: Judges are not able to make good business judgments; and for this type of decision, the considerations are many and complex. Judges lack the information, expertise, and perspective (hindsight problem) that would permit them to reliably second-guess such decisions. Too easy for boards to disguise their motives and courts are busy with other, more important questions.
  • Micro Script Element III: Serving shareholder interests does not necessarily mean simply pursuing their narrow, short-term profit interests; the profit calculus is actually more complicated, and demands a consideration of many other issues and other non-shareholder constituencies.

Other areas of law control corporations suffficiently

  • Corps are subject to tort law, environmental law, labor law, criminal law, etc.
    • BUT we let corporations lobby for laws that are favorable to them, and give to charities that serve corporate interests, cf. Smith v. Barlow.
    • Also, this same school of thought also believes in regulatory capture, where regulation actually serves corporate interest to the detriment of the public, cf. George Stigler.

We're worried about managerial self-interest

  • Macro Script Basic Claim: Goal of corporate law is to guard against the risk that those who control a firm (manager and directors) may act in their own interests and not in the interests of shareholders.
  • Micro Script Basic Claim: What might appear at first blush to be in the interests of managers or other non-shareholder constituencies and contrary to the interests of shareholders turns out, upon closer examination, to be in interests of shareholders. (BJ and managerial discretion)
  • Macro Script Element: Shareholders have to be protected; for they are the only constituency out there that does not have adequate protection against board decisionmaking.
  • Micro Script Element: With respect to the particular form of managerial disloyalty under examination, shareholders are adequately protected by other sources, such as markets, contracts or regulators.

Managerial discretion applied even when reasons for it don't apply

  • Hindsight

Duty of Care / Business Judgment?

  • Allen & Kraakman on the “duty of care”:

“The core of [the duty of care] standard is the level of care that we expect would be exercised by an ordinarily prudent person. This formulation appears to make the duty of care into a negligence rule like any other negligence rule in tort law.

  • Allen & Kraakman on the “business judgment rule”:

The core idea, however, is universal: courts should not second-guess good-faith decisions made by independent and disinterested directors. . . . Courts will not decide (or allow a jury to decide) whether the decisions of corporate boards are either substantively reasonable by the ‘reasonable prudent person’ test or sufficiently well-informed by the same test.”

Managers should not care about social responsibility

Topics

Agency

  • A master has at least the potential to control the physical actions of the servant. The independant contractor's physical actions cannot be controlled by anyone.
  • The master is subject to vicarious liability & respondeat superior.
  • Rules for respondeat superior:
    • tort committed while agent does kind of work hired to do;
    • occurs within authorized space and time, and then
    • "intent to benefit" test -- the agent's conduct must be "actuated, at least in part, by a purpose to serve the master."
  • Types of authority
    • Actual authority -- explicit or implicit authorization by principal
    • Apparent authority -- principal expresses or implies to 3d party that agent has authority
    • Inherent authority -- authority due to one's position (e.g., manager of P's store)
  • ASME v. Hydrolevel. M&M's employees make safety rules for boilers (using position in ASME, an industry group) that helps put Hydrolevel (a competitor) out of business. ASME is held liable since the M&M employees acted with its apparent authority. Take-home: Because ASME didn't control the situation of its agents, it allowed its agents to be anti-competitive. Basically, ASME was shallow-captured -- the industry used a credible 3d party to give the illusion of regulation while actually serving its own interest.

Partnerships

  • Meinhard v. Salmon. Meinhard and Salmon were joint venturers – agents of each other (like partners only little different). They took a 20-year lease. Salmon held the lease but Meinhard supplied half the capital. Just before the lease expired (while they're still in a joint venture) Salmon enters into a new deal with Gerry. Cardozo sez: treat your partner like your spouse. Don't go cheating. Or, at the very least, ensure that Gerry knows that Meinhard was behind Salmon -- that it wasn't all just Salmon's brilliance.
    • "“Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. . . . Only thus [can] the level of conduct . . . be[] kept at a level higher than that trodden by the crowd."
  • Three background rules of p'ships
    • Control -- A majority of partners gets to decide what the partnership will do.
    • Agency -- Every partner is an agent for the p'ship.
    • Liability -- Every partner is personally liable for the full amount of the p'ship's debt. Partners cannot change this relationship to 3d parties using p'ship law.
  • Joint Ownership is useful because owners work harder.
  • Vohland v. Sweet. Business owner treats employee like a partner, and employee acts like a partner (even puts up some capital) but then the owner treats emp'ee as an emp'ee when the emp'ee actually wants to dissolve the p'ship and cash out. Ct: It's wrong to entice someone to work like an owner but pay them like an employee.
  • Page v. Page. Big Page & Little Page each contributed $43k to a laundry business. Then Big Page loans the company $47k. When a big customer comes into the picture, Big Page tries to dissolve the business (since he holds a loan worth more than the business's equity, the business goes to him) even though Little Page built up the company. Ct: When you dissolve your p'ship, you have to do it in good faith -- can't just screw over your partner.
  • New inventions like the limited partnership are killing the traditional p'ship -- turning it into something like corporate law. Cf. Delaney v. Fidelity Lease (LLP where general partner was a corporation owned by the limited partners is not cool -- that screws over 3d parties who think they're dealing with a general partner.)

Limited Liability

Dividend Distribution

  • In theory, the corporation can't distribute too much dividends to its shareholders when there's large outstanding debt.
  • But this is illusion.
    • Bob Clark sez: "One sees in the statutes the increasing power of professional managers, which leads to the closing off of scrutiny of their decision making through the adoption of objective and mechanical, but trivial, rules.” It “shows the ultimate insignificance of this kind of legislation.”
    • A&K say: An obvious objection to distribution constraints ... is that they are easily avoided."
    • Thought note that the scholars claim that these protections are useless because it's efficient for them to be useless -- and contracting can help creditors better than distribution constraints.

Equitable subordination

  • If a controlling SH lends money to the corp, and causes the corp to act inequitably to the other creditors, that SH's contractual claims are subordinated to the other creditors'.
  • Costello v. Fazio. Partners take money out of partnership, change p'ship into corp, and replace their equity with loans, depleting equity that other creditors could seize. Ct sez: No actual fraud, but there was: egregious mismanagement, gross undercapitalization and inequitable conduct toward future creditors through unfair and unreasonable injury to the corporation and its creditors.

Veil Piercing

  • Very difficult to pierce veils:
    • limited to just closely held corporations with controlling shareholder
    • two Van Dorn prongs must be satisfied, the second of which comes very close to showing of fraud
    • simple to avoid piercing, even if the second prong were satisfied (process): abide corporate formalities and avoid commingling of assets. Courts in successful VP cases emphasize the lack of even the most basic formalities (ex. minutes, bylaws, etc)
    • law more concerned with punishing obvious bad apples than protecting vulnerable parties (see Polan, who could have protected himself by K)
    • same rule applies for tort and K creditors -- VP much more likely in K cases, not protecting more vulnerable parties.


  • Sea-Land Services v. Pepper Source: P seeks to "reverse pierce" the veil of D's owner's other corporations. Unity of interest prong well-satisfied. Fraud or injustice prong of Van Dorn requires more wrong than a creditor's inability to collect.
  • Van Dorn v. Future Chemical and Oil: Two requirements for veil piercing: 1) unity of interest and ownership such that the separate personalities of corporation and individual no longer exist; and 2) adherence to the fiction would sanction fraud or promote injustice. Four factors to look at: 1) failure to maintain adequate records or comply with corp formalities; 2) comingling assets; 3) undercapitalization; 4) one corp treating the assets of another as its own.
  • Kinney Shoe v. Polan: optional Laya third prong -- waiver where P should have done an investigation of D corp's credit/holdings (ex. financial lenders) doesn't apply here in leasing context -- the third prong is viewed as optional and sort of equitable. Note, even where creditor could have investigated, sometimes court will give veil piercing -- compare this to tort creditors, who can't exactly do any research!
  • Thompson Study: Where finding of misrepresentation, VP 92% of the time, where finding no misrep, 8%. Where no finding, 34%
  • Walkovszky v. Carlton: Cab case, ten cab companies and Carlton. Companies undercapitalized -- D can get to each of the other companies, but not C personally. This isn't great - medallions nontransferrable and taxis carrying liabilities. Cheap way to get around adequate liability insurance for dangerous activity. Lowers tort incentives to train drivers, etc.

Duty of care

  • Opting Out of Fiduciary Duties:
    • Charter Amdts
    • Insurance: Statutes allow corps to purchase li ins for dirs. When plaintiffs do sue, because of intentional violations of care, the Ps and dirs settle for recklessly negligent behavior, so that insurance covers it (insurance won't cover intentional). Incentives align: Ps want certain settlement and quick payout from insurers, and dirs don't want to have to pay anything. Then insurance premiums rise. Ironically, it's the SHs who bear the cost of the premiums (as owners).
    • Indemnification
      • Allen & Kraakman: “[M]ost corporate statutes prescribe mandatory indemnification rights for directors and officers, and allow an even broader range of elective indemnification rights. Generally, these statutes authorize corporations to commit to reimburse any agent, employee, officer or director reasonable expenses for losses of any sort (attorney’s fees, investigations fees, settlement amounts and in some instances judgments) arising from any actual or threatened judicial proceeding or investigation. The only limits are that the losses must result from actions undertaken on behalf of the corporation in good faith and that they cannot arise from a criminal conviction.”
  • Duty of care is important in theory, but...
    • Entirely looks to process and not substance (C. Allen)
    • Cox & Hazen: “Although directors are commonly said to be responsible both for reasonable care and prudence, the formula is continually repeated that directors are not liable for losses due to imprudence or honest errors of judgment." "In general, courts will not undertake to review the expediency of contracts or other business transactions authorized by the directors. Directors have large degree of discretion.”
    • Allen and Kraakman: "the duty of care is not just another negligence rule. . . . [T]here is an important policy reason why a business loss cannot be analogized to a traffic accident or a slip on a banana peel.”
    • Just need a reasonable basis for the decision
    • Board's attorney will induce board to develop sufficient investigation/record (John Coffee)
  • Rationale to limit Duty of Care (BJ Rule)
    • Encourage risk-taking for risk-averse managers. Otherwise, the SHs would get all the benefits of managers' smart decisions, and managers would be personally liable for the costs of managers' bad decisions.
    • Hindsight bias
    • Cts don't know about business
    • Proxy Contests and Hostile Takeovers better ways to combat bad management anyways -- market forces make duty of care superfluous (Cox and Hazen)
    • The mgrs are duly-elected reps of the majority of SHs. Any going against their acts is a violation of SH democracy. (BUT I thought we all decided that SHs can't act together effectively, and that voting is ineffective?)
  • Why bother having a rule with no liability behind it?
    • "social" reasons to inform directors what "doing the right thing" means.
  • Gagliardi v. Trifoods: Where no improper motive, "there can be no liability for corporate loss, unless the facts are such that no person could possibly authorize such a transaction if he or she was attempting in good faith to meet their duty." If no proof of conflict of interest or improper motive, activity must be egregious.
  • Kamin v. Am Ex: Dividend distributed (in stock that had devalued) that could have been used as a loss to offset capital gains taxes. Ct: dividend distribution exclusively a BJ -- no hint of improper motive. AmEx publicly traded, and realizing the loss could push down the stock -- that's a rational reason. But if you believe the stock market reflects accurately the fundamental value of the stock... is this just putting one over on the stock market? Many of the BJ rationales don't apply here - Ex. hindsight -- it was a preemptive action; ex. risk aversion -- the SHs wanted an injunction, that won't come out of dirs' pockets. Also, the directors' compensation was tied to the stock performance, so they'll take big risks with the company's actual value in order to preserve its stock value. Also, isn't it a little weird to say that tricking investors is a valid business judgment?
    • "Micro Script Principle: Director Discretion – Director should be deferred to even when their decision involve forgoing a significant tax gain in an attempt to hide a loss from shareholders, and even though corporate finance experts are doubtful regarding the efficacy of that effort, and even though the inside directors have a stake in maximizing earnings for their own personal compensation."
    • Smith v. Van Gorkum: "slow it down!" Trans-Union president initiates and rushes through quickly a sale to Pritzker for $55 a share. Grossly neg, even though SH approved. Possible self-dealing (hoped to keep job in new corp or just cash out, and VG is approaching mandatory retirement and a sale is the best get-rich-quick scheme). Management wanted to do its own buyout rather than get fired -- no one looking out for the SH. No exigency or emergency, so too quick, and no adequate valuation study to see if price was fair. Dissent said that directors of this caliber not usually taken in by a "fast shuffle"

Duty to Monitor

  • Vague: “In the last analysis, the question of whether a corporate director has become liable for losses to the corporation through neglect of duty is determined by the circumstances.” (Allis-Chalmers)
  • Weak:
    • NO DE CASE TO DATE has held board liable for failure to monitor
    • "“If he has recklessly reposed confidence in an obviously untrustworthy employee, has refused or neglected cavalierly to perform his duty as a director, or has ignored either willfully or through inattention obvious dangers signs of employee wrongdoing, the law will case the burden of liability upon him.” (Allis-Chalmers)
    • "only a sustained or systematic failure of the board to exercise oversight – such as an utter failure to attempt to assure a reasonable information and reporting system exits – will establish the lack of good faith that is a necessary condition to liability.” (Caremark)
  • Graham v. Allis-Chalmers: Suit against directors for antitrust activities of under-ees. Structure of the business was to put responsibility on the lowest level possible. H: directors are entitled to rely on the honesty and integrity of their suboordinates until something occurs to put them on suspicion that something is wrong. Absent cause for such suspicion, no need to "ferret out wrongdoing." Perverse incentives. "The very magnitude of the enterprise required them to confine their control to the broad policy decisions."
    • So... managers don’t need to monitor or investigate absent suspicious circumstances – particularly where the companies are large and the issues complex.
    • They're actually encouraged to insulate themselves from knowing what's actually going on in their companies, otherwise they might be held liable.
  • Francis v. United Jersey: Alcoholic widow allowed her sons to be fraudulent, never making an effort to investigate the status of the company. Generally, there's a duty to know what was going on, to object (file a dissent), and if the corp does not correct the conduct, to resign. Figuring out what was going on here didn't require special expertise, just a cursory reading of financial statements. Whether more than protest and resign is generally required is a case by case determination -- but it did apply here, where client funds were held in trust, and she should have hired an attorney and threatened suit.
    • Must: acquire rudimentary understanding of the business; have enough knowledge to exercise “ordinary care;” general monitoring of corporate affairs and policies; attend board meetings; have familiarity with financials (sometimes ensure they comply with industry custom); and “If one ‘feels that he has not had sufficient business experience to qualify him to perform the duties of a director, he should either acquire the knowledge by inquiry, or refuse to act.’”
    • Also needed causation: "they spawned their fraud in the backwater of her neglect. Her neglect of duty contributed to the climate of corruption; her failure to act contributed to the continuation of that corruption.”“[B]y virtue of her office, Mrs. Pritchard had the power to prevent the losses sustained by the clients . . . . With power comes responsibility. She had a duty to deter the depredation of the other insiders, her sons.”
    • Hanson thinks sexism may have contributed to this result -- the notion that "what business did she have being a director?"
  • In re: Caremark: There is a process-based duty to monitor -- must have reasonable reporting. This case created a "cosmetic change:" compliance programs de rigeur. Cost-benefit analysis as to monitoring *is* BJ, though, so safe harbor is easy to get.

Duty of loyalty: Charity and Self-Dealing Transactions

  • Duty of loyalty is where macro & micro are the same: to whom do you owe loyalty? The answer: SHs ... sorta.
  • Macroscript says loyalty extremely important to counteract monitoring problems. Directors must have a strong duty of loyalty to SH.
  • According to microscript, generally, everybody's interests are the same anyways during regular business activities of a solvent corp - increase value of corp. (Allen/Kraakman), OR we're worried about chilling valuable deals that directors might be better able to accomplish because of their personal connections.
    • "more a deep value than a legal rule" (Allen/Kraakman)
  • Charitable Contributions: As long as profit rationale articulated, is fine. Some state statutes even obviate this requirement, allowing limitless corporate giving at discretion of directors.
    • What do corporations know about giving for the benefit of society?
    • SH are giving to the common pool and not getting back from it.
    • Recognizes influence of corps over NGOs (ex. goodwill in community)
    • Allows deep capture
      • "grants grants and more grants in exchange for books books and more books"
      • Corps will only give money to produce pro-business ideas, see ex. Olin Ctr, etc.
      • See Powell memo ("this fight over the hearts and minds of the American people...")
      • Assets of conservative foundations greater than those of moderate or liberal ones.
  • Self-Dealing Transactions
    • Generally, disclosure required;
    • AND EITHER approval by disinterested board members (though often interested board members may count towards a quorum) or shareholders OR the deal is intrinsically fair.
    • Wait -- I thought courts didn't have the expertise to rule whether these decisions benefit SHs? Answer: Ordinarily yes, but here nobody's looking out for SHs, so the court can hardly do worse.
  • Corporate Opportunity: director or officer takes a business opportunity rather than allowing the corp. to have it. Two Step analysis:
    • The rule of recognition step: Was this business opportunity a corporate opportunity?

that is, was this the kind of opportunity that is typically assigned to the corporation rather than to the manager?

    • The defense step: If so, was there a defense – was there a legitimate reason to give the director or officer the opportunity, despite characterizing as a "corporate opportunity"? Was there actual or implied consent or corp. incapacity?
    • Vague law on this reflects conflicting schemas -- loyalty, and the idea of encouraging new business deals by managers


  • Dodge v. Ford: Ford announces he's acting in the interests of non-shareholders, and gets smacked down by the courts. Must articulate a SH-based reason for the action.
  • Smith v. Barlow: Gift to Princeton prior to charitable giving statute. Court goes out of its way to find profit-based reasons for the gift, most notably that allowing giving such as this "may be viewed strictly in terms of actual survival of the corporation in a free enterprise system." Some emphasis on Princeton being part of the community in which the corp operates. Ct

also says that "non-governmental institutions of learning" are important to our democracy.

  • Shlensky v. Wrigley: No lights on the field, even though all the other major league fields have them and earn much more at night games. Ct says that there hasn't been enough showing that it really harms profitablity, and that you need fraud, breach of good faith, or conflict of interest to breach the BJ protection here. Judges are not experts and it could be a long term plan. Directors needn't "follow the crowd." SO now if directors don't articulate a profit-based reason, the courts will step in to do it for them.
  • Hayes Oyster v. Keypoint Oyster: Even though the terms were fair, failure to disclose a conflict killed the deal. Court emphsizes the importance of disclosure and the easy application of the rule.
  • United Steelworkers v. US Steel: Promises made to ees that Youngstown (built around the steel mill) wouldn't close if profitable -- ees worked very hard and increased profit -- still got closed. Duty of loyalty can be used as a shield for managers who make promises they can't keep to other constituencies. Compare to Vohland v. Sweet, where Ct said, if you make people work harder by promising them a piece of the action, you have to give them a piece of the action.

Derivative suits

  • Generally: “If demand is required, the shareholder-plaintiff has very little prospect of success. If demand is excused the shareholder-plaintiff prospects improve – albeit not by much.” (Bainbridge)
  • The derivative suit is how we enforce duties (of care, loyalty, monitoring). So how well do we enforce these duties? In a word: sux0r.
  • Requirements:
    • Standing
    • Contingency Rules
    • Screening Doctrines
  • Procedural Lifecycle of a Derivative Suit
    • First, make demand (a corporate decision enjoying BJ protection and almost always refused), or allege "Demand Futile"
    • If demand is not excused, case is dismissed. If excused, the case proceeds (most used to settle before SLC, now fewer).
    • Next, a board's "Special Litigation Committee" (SLC) made up of credible third parties, can see if the suit is worthwhile and make a recommendation to the court.
  • Parties:
    • Plaintiff's atty's run the litigation, decide when to settle -- bounty hunters. Doesn't necessarily pick the cases that will do the most good for SHs -- only the cases that will best extract settlements.
    • Defendant director wants to pay off the atty more to reduce the settlement or keep issues out of the press. May not want to fix the problem either
    • Court wants to get these suits off its desk, and may not look so closely at settlement, especially since both sets of lawyers are arguing that it's fair.
  • SLC: new practice to combat derivative suits.
    • NY Ct of Appeals says that SLC decisions should be given BJ protection.
    • Zapata v. Maldonado: The Zapata two-step:
      • Inquire into the good faith and independence of the committee and bases supporting its conclusions -- allow limited discovery. Corp has the burden.
      • Court should make its own BJ as to whether the motion should be granted, giving concern to public policy as well as the corp's best interests.
    • Joy v. North: Adopts the Zapata approach and rejects BJ protection for SLC decisions, rejecting the SLC decision in the case at bar.
    • Carlton v. TLC: Chancellor Allen is supremely uncomfortable with the second prong -- says that courts should only make such judgements for "reasons of legitimacy and reasons of shareholder welfare." He disposes of the second prong saying that the SLC decision seems reasonable.

Exec. compensation

  • Absurdly huge, and much higher than in other countries.
  • It got so big because people thought you could use executive stock option plans to better align management interests with the interests of SHs (i.e., increasing share value). Problem: CEOs are short term investors, and will rape the company if they aren't monitored.
  • Precisely where you would expect courts to intervene to protect SHs, but courts allow extravagant exec. comp. when it's OK'd by so-called independent committees that are subtlely (and not-so subtlely) dominated by management.

Voting (is ineffective)

  • In theory...
    • Important Self-help remedy
    • oversight power
    • knowledge that SH have this power causes managers to act correctly
    • SH reduces judicial oversight for some transactions
  • Why Doesn't Voting Work? COLLECTIVE ACTION!
    • Everybody throws proxies away
    • Insufficient incentives
    • No good way to gain information for an informed vote, unless you're David.
    • Institutional investors provide a little help, but not the best incentives and still difficult to oust an ineffective board.
  • Why precisely do we give the most power to the group least able to exercise it? I mean, honestly?
  • Two ways to change control of a corporation
    • Tender offer (exit)
    • Proxy contest (voice)
  • Access to Books and Records:
    • Pillsbury v. Honeywell: P bought one share intentionally (had more unbeknownst) and wants SH lists so he can send a letter regarding Honeywell's production of fragmentation bombs. Honeywell refused, and P sued. Ct says P has no interest in H's business, only wanting to enforce his own sociopolitical values, and only bought stock to do this. Not a proper purpose.
    • Conservative Caucus v. Chevron: P wants SH lists to inform SH about activities in communist Angola which it alleges will be bad for profit. Ct says that we've got enough junk mail, a little more can't hurt. P stated that it is concerned about the economics and is not a sham party (like the labor union in Carpenter v. Texas Air.
  • Screwing with voting procedure:
    • Note: Even Chancellor Allen has not always applied Blasius -- often board's shenanigans are approved.
    • Schnell v. Chris-Craft: In the face of a proxy battle, board moves SH meeting earlier a month, and to an obscure town in upstate NY. Ct: Though this was permissible by statute, it's inequitable and designed to perpetuate the board in office. Injunction granted... because it's wrong.
    • Blasius v. Atlas: SH was trying to dilute Board vote by adding seats. Board amended the bylaws to add two seats to the board and filled them with their people in order to entrench themselves. Ct finds that the board action was motivated to prevent SH action - this renders it subject to judicial nullification. BJ does not apply to board actions with the primary purpose of interfering with a SH vote, even where in good faith (board argued they didn't agree with SH business plan). SH vote is important to legitimate certain decisions.

M&A

  • Illusion:
    • To benefit shareholders and managers: Increasing ability to acquire, merge, and combine
    • To benefit managers,
      • Increasing discretion to determine whether, when, and how a merger takes place.
      • Increasing deference to illusory forms of shareholder protection.
      • Where deals correspond to shareholders’ perceived interests, shareholders will be given a vote. Otherwise, they will not be.
      • Managers will be focused primarily on their interests – will use shareholder interests and, if necessary, stakeholder interests as cover. (e.g., Smith v. Van Gorkom)
        • Many rationales for M&A support managers, but may not add anything material to the company (cf "smoothing" shown not to benefit corps as it does the stability of manager pay)
      • Law will, except in extreme examples (bad apples), help to legitimate those decisions. (e.g., Smith v. Van Gorkom)
  • Functionally identical transactions can be structured in different ways so as to avoid meddlesome SH voting and other rights. Courts will not presume to add "merger-type protections" where the deal is not structured as such ("equal dignity" rule). Basically, where managers expect SHs to approve, they structure transactions that let them vote. Where managers expect SHs not to approve, they structure transactions that don't let them vote.
    • Mergers: Board Approval, SH approval from both corps, and SH maintain appraisal rights
    • Sale of Assets: Board approval, Only target (purchasee)'s SH get voting rights, sometimes appraisal rights.
  • Appraisal Rights
    • Dissenting SHs can be paid off.
    • Exist, but are costly and ineffective, and besides, SH are already protected by other means -- dissenters can sell their shares on the open market. This right is thus minimized.
    • In DE, corps listed on national exchanges are exempt from AR's, with the idea that the "unfair" transaction will be factored into the share price anyways.
    • Takes years, during which SH is not entitled to dividends or other SH benefits, does not gain the benefit of the merger, and risks the court's undervaluing the stock.

Takeovers & Their Defenses

  • Unocal Zone: Everything up until the point when you decide to sell -- where you are approached with an offer but there is no decision to sell. You can put up any defense reasonable in relation to the threat. With PARAMOUNT POWER, defense of a long term plan is reasonable. Thus, everybody got their longterm plan.
  • Revlon Zone: After you opt to sell, you are an auctioneer and can only consider the highest bidder.
  • Tender Offer Takeovers
    • Were once "saturday night specials," but after the Williams Act, mandatory window of 20 days was enforced (more recently expanded to ~2 months), and many equity rules -- all holders entitled to the offer, all at the best price, and pro rata purchase rule.
      • Scholarly disagreement as to whether the auction period is good or just reduced incentives to search for a really good takeover candidate.
        • In support of auctions: 1) The auction ensures that assets go to their highest valuing user with fewer transactions; 2) The auction ensures that target shareholders get returns from investing in targets; and 3) if there are no auctions, and all takeover gains therefore go to acquirers, then there will be too many tender offers.
      • After the Act, takeovers went down, premia went up.
  • Delaware faced a problem on managerial interference with tender offers, and in the face of threats that they would fall behind in the race to the bottom, encouraged third party legitimacy and formalities in order to give power to corps while maintaining appearance of legitimacy.
  • Before Unocal, the test for takeover defenses was the "policy conflict/primary purpose" test.
    • If management's primary purpose was to defend its business policies from a would-be acquirer, then its defensive tactics merited protection of the business judgment rule.
    • Alternatively, if the board's primary purpose was to entrench itself in office, then its defensive tactics would not enjoy business judgment protection -- usually meant that they were enjoined.
    • But the academic community realized that boards could come up with any "primary purpose," and criticized DE.
    • So DE's solution: take decision away from boards and give it to so-called independent third parties. Cf. Van Gorkom (Let's get fairness opinions from I-bankers), Unocal & Revlon (Let's have the courts weigh in with an intermediate standard of review).
  • Unocal v. Mesa. Takeover artist "greenmails" SHs, giving them a $20/share premium in cash if they come in on the front end, and giving them the same premium in junk bonds if they come in on the back end. Unocal tries to defend.
    • Judge calls this greenmailing coercive.
    • Ct will review takeover defense with intermediate standard to see whether the defense is reasonable in relation to the threat posed.
    • One of the threats can be the impact on other constituencies, contra to the macro script. You can, if you'd like, consider others, but you don't have to.
  • Moran v. Household. DE approves the pill.
    • How the pill works, according to A&K: "The result [of a poison pill] is that buying a substantial block of stock without the prior consent of the target’s board is ruinously expensive, which gives the board the power to veto a tender offer, just as it is able to veto a merger or asset sale under the corporation law.”
  • Revlon v. MacAndrews. Pantry Pride keeps trying to buy Revlon (possibly because PP's owner wanted hot babes). Rev uses poison pills. Then Rev's SHs turn up the heat, and Rev gives a lockup at $56/share to a white knight LBOer. PP offers $58/share, contingent on DE invalidating the lockup.
    • Ct: The pill is OK, but the lockup is not, because it violates Unocal. When the board decides to sell, it's obligation is to be a fair auctioneer. Also, now you can't consider other constituencies, just SHs -- doesn't matter that Martin Sheen will lose his job when the board decides to sell.
    • The big Revlon qustion is -- when has the board "decided to sell"?
  • Paramount (I) v. Time. Time & Warner haggled for a long time in deciding to merge. In the merger, Time's SHs would get no premium. When they finally decided to do it, they put in a lot of defenses to ensure that no hostile acquirers would interfere (contra Revlon). Paramount offered $200/share for Time, when time shares were going for $50/share. Time called that "grossly inadequate." Then changed from merger (which would have allowed SHs to vote down the no-premium Warner merger and approve the $150 premium Paramount offer) to a sale of assets (which gives no voting rights).
    • Is there a Revlon duty to go to auction?
    • Judge Horsey: Nope! There was a long term plan here, and we'll allow managers to defend their long term plans. Also, Unocal (et seq) is flexible & open-ended (read: we're going to give managers lots of discretion).
    • The result: every board develops a long term plan.
  • Summary (for the board). If you want to protect your job, you need only
    • Develop a long-term business plan and hide behind your pill – even if doing so involves rejecting a large premium.
    • Avoid behaving in ways that appear self-interested (beware of “lockups” and add process).
    • If you do want to merge with another firm, be certain to enter into a merger agreement as part of that long-term plan and be certain that control remains in public hands.
    • Or be certain that your firm is the acquiring firm – even if it means that your firm takes on huge amounts of new debt (without shareholder approval).
  • Courts will intervene only when there appears to be a breakup or change of control. If board jumps through procedural hoops and does not appear motivated (control, knowledge, intent) to unfairly favor one particular bidder (beware of “lockups”), courts will likely endorse the board’s decision.

Dispositionism

  • Thought and preference combine with will to produce behavior.
  • Dispositionism is attractive because:
    • It provides easy explanations for people’s behavior and attributions for bad outcomes.
    • Relatedly, it leads to relatively tractable policy questions, diagnoses, and prescriptions.
    • It provides reassuring sense of control over our situations (a perception we are eager to maintain).
  • An example: Tobacco
    • Industry collaborates to fight a "war" on behalf of tobacco.
    • First major use of PR in industry, under leadership of Edward Bernays. Example: Bernays got 1920s women to call their cigarettes "freedom torches," to show how liberated they were.
    • Industry found or created credible 3d parties.
    • Industry dominated cancer funding to control the research agenda, e.g., searching for genetic causes of cancer.
    • Promoted "doubt" and "controversy" over the relationship between cigarettes & cancer -- gets them a place at the discussion table under the cover of "fair & balanced"; lets people who want to see smokers as stupid choosers do so; lets smokers who want to think they're choosing wisely do so.
    • Industry framed attack on cigarettes as an attack on freedom & choice.
  • Another example: The Powell Memo

Situationism

  • Schemas allow us to place ambiguous perceptions into clear categories -- e.g., regulation=communism, market=freedom.
  • Placing things in different categories exagerates the differences between them (cow cups), and exagerates the similarities between members of the category.
  • The fundamental attribution error: we underestimate the influence of situation on behavior and overestimate the influence of disposition.
  • The law will reflect the attributional reactions of lawmakers, including judges and juries. Those attributional reactions will be subject to:
    • biases (including dispositionism)
    • situational framing (including shared attributional schemas)
    • motives (including group affirmation and system legitimacy)
    • All subject to capture, in favor of large commercial interests
  • Two ways to achieve outcome legitimacy
    • Achieve apparent procedural justice
    • Frame situation to make proximate cause of harm not even appear to violate duty of care (not to mention not be intentional), and make injured appear to assume the risk.

Capture

  • Shallow capture: Powerful interests will control the government, and use the facade of government regulation as an illusion of protection. Cf. ASME (credible 3d party rule-making group -- providing illusion of regulation -- captured by steam boiler industry)
  • Deep capture: Powerful interests will control whatever they can control to enhance their position -- most notably, the schemas we use to categorize and think about the world -- with the only limit being perceived legitimacy.

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