Author: Lawrence Cunningham


Howard Stern’s Audience: One Group or Two?

11111Howard Stern is a wealthy man, but he sought to be some $300 million richer after his radio employer, Sirius, doubled his audience by acquiring rival XM. Stern thought his contract said as much but a court disagreed.  Businesspeople and lawyers alike can take a lesson from the deal, presented here in one of my three-part series this week on the unruliness of words–and numbers.  Following on my accounts of whether the attack 14 years ago today on the WTC was one occurrence or two and whether The Hobbit film trilogy released by New Line Cinema was one film or three, here’s the Stern story. 

The Howard Stern Show is a popular off-color program long aired on traditional radio. But in 2004, one of the leading satellite radio companies, Sirius Satellite Radio Inc., persuaded Stern to move his program to its service. Performance compensation under the resulting licensing agreement called for Sirius to pay Stern’s production company up to five separate awards of common stock in Sirius—each worth $75 million—if a series of ever-rising subscriber thresholds was met.

To implement this deal, the parties included in their formal written contract an exhibit setting out the company’s estimated number of subscribers as of year-end for each of the ensuing five years. The agreement then provided that the company would pay a stock bonus if at any year-end the actual number of subscribers exceeded the target by a specified amount: a first bonus for exceeding the target by two million; a second for exceeding it by four million; a third for exceeding by six million; a fourth for exceeding by eight million; and a fifth by ten million.

There was no dispute about what happened the first two years: at 2006, actual subscribers exceeded estimated subscribers by more than two million and Sirius promptly delivered $75 million worth of its stock to Stern; at 2007, actual subscribers did not exceed the target by more than four million, and therefore no bonus was due. A complication arose in 2008, however, because in that year Sirius acquired a rival, XM Radio, which had nearly ten million subscribers. So the parties disputed whether those subscribers counted as Sirius subscribers under the bonus provisions of the licensing agreement.

Resolution depended on determining the intended meaning of their contract in light of the specific terms of Sirius’s acquisition of XM. Before the acquisition, Sirius and XM were separate rivals of about equal size (Sirius had more than nine million subscribers)—and both had been wooing Stern to join them. After the acquisition, Sirius changed its name to Sirius XM, but the two continued to operate separately with their own subscribers, although subscribers could buy a premium package to add the other company’s offerings. About one million XM subscribers signed up for the Sirius package.

Counting only original Sirius subscribers, at year-end 2008, actual subscribers did not exceed target subscribers by more than four million contemplated for a second bonus award. Even adding the one million XM subscribers who bought access to Sirius, the target was not so surpassed. But if also counting the nearly ten million XM subscribers that Sirius acquired in the acquisition, then the target was exceeded by more than ten million, triggering all the bonuses and meaning Sirius owed Stern another $300 million worth of stock. Read More


Greatest Error: Was The Hobbit One Film or Three?

11111One of the greatest errors in contract history arose when Miramax sold the movie rights for “The Hobbit” to New Line Cinema.  Here’s the story which, in honor  of the trilogy fashioned from Tolkien’s fantasy work, is in an installment of three posts on lessons from such debacles (others consider whether the 9/11 attacks on the World Trade Center were one occurrence or two for applicable insurance contracts (see here for the answer) and  whether, when Sirius radio acquired another satellite radio service, it was obliged to pay Howard Stern $300 million because the deal doubled its subscriber base).   Each story has inherent interest, a bit of drama, and useful lessons for contract drafting.  These three stories will be in the upcoming second edition of my book, Contracts in the Real World: Stories of Popular Contracts and Why They Matter.

The Hobbit: One Film or Three?

In 1998, the film company Miramax sold New Line Cinema the film rights to J.R.R. Tolkien’s four books: The Hobbit: Or There and Back Again (“The Hobbit”) and The Lord of the Rings Trilogy: The Fellowship of the Ring, The Two Towers, and The Return of the King. Miramax had spent $10 million developing screen adaptations of Tolkien’s classic fantasy works, which required considerable technological dexterity to produce. In exchange for the film rights, New Line paid $11.7 million and promised to pay royalties equal to five percent of the gross receipts of the “first motion picture” based on each book, excluding any “remakes.”

More technically, under a “Quitclaim Agreement,” New Line agreed to pay Miramax “Contingent Consideration,” defined as five percent of gross receipts, for “Original Pictures.” The Quitclaim Agreement defined “Original Pictures” to mean “the first motion picture . . .  based in whole or in part” upon The Hobbit Book and each of the three books in The Lord of the Rings Trilogy and “excluding remakes.” The Quitclaim Agreement further provided that a motion picture constituted a film based on The Hobbit book if “the main story line of the book is substantially the same as the main story line of the movie, certain of the book’s events and characters are featured in the movie, or the title or subtitle of the movie contains the words ‘The Hobbit’ or ‘Hobbit’.”

Between 2001 and 2003, New Line released three Original Pictures based in whole or in part on each of the three books in The Lord of the Rings Trilogy. Pursuant to the Quitclaim Agreement, New Line paid Miramax total Contingent Consideration exceeding $90 million in connection with those three movies.  In 2012, New Line released a new film based on The Hobbit book, called The Hobbit: An Unexpected Journey, as the first of another trilogy. It acknowledged an obligation to pay Miramax royalties on that film—and had paid $25 million—but not on the second or third in the planned series. Miramax objected, saying it was entitled to royalties on all three Hobbit-based movies. Read More


Contracting with Unruly Words—and Numbers

11111Lawyers learn drafting lessons from previous cases involving disputes over the meaning of language. The result is often contracts with denser detail, attempting greater specificity to delineate intention using language. Yet words can be unruly and open to interpretation—well illustrated by a series of contemporary examples that also happened to involve numbers:

  • were the 9/11 attacks on the World Trade Center one occurrence or two for purposes of applicable insurance contracts? (Spoiler alert: both!)
  • was the blockbuster film trilogy The Hobbit three separate films or merely one film in three installments?
  • when Sirius radio acquired another satellite radio service, was it obliged to pay Howard Stern $300 million because it doubled its subscriber base–or not?

Each story has inherent interest, a bit of drama, and useful lessons for contract drafting.  These three stories will be in the upcoming second edition of my book, Contracts in the Real World: Stories of Popular Contracts and Why They Matter.  So, what about that attack or attacks?

WTC and 9/11: One Occurrence or Two?

On September 11, 2001, terrorists hijacked commercial aircraft and flew two of them into the World Trade Center in New York—another hit the Pentagon in Washington and a fourth was overtaken by passengers, forcing it to nosedive into a Pennsylvania field. Beyond the loss of 3,000 lives and many personal injuries, the assaults in New York destroyed or damaged twenty buildings, including the total collapse of five of the buildings that comprised the World Trade Center (WTC).

The insurance industry incurred an unprecedented $40 billion in claims, all pursuant to thousands of contracts, including aviation, life insurance, workers’ compensation, and liability policies. While many claims were filed and paid without incident, some generated significant litigation. One issue was particularly vexing: how many occurrences were there on 9/11 at the WTC: one, encompassing the destruction of the entire unitary complex, or two, given that two planes struck separate towers?

Commercial property insurance policies typically address claims on a per occurrence basis, including in terms of overall policy limits (the maximum payable) and the applicable deductible (in effect, the minimum loss before any coverage applies). When losses are within limits, the question of occurrences relates only to the deductibles and insurers tend to classify events into multiple occurrences to generate multiple deductibles; but when losses exceed policy limits, the number of occurrences defines that cap and insurers generally prefer to classify events as involving a single occurrence to cap liability. In the case of the destruction of the WTC on 9/11, losses vastly exceeded policy limits, turning what may seem like a semantic question into a $3.5 billion disagreement.

The WTC was owned by the Port Authority of New York and New Jersey, which had recently leased it to Silverstein Properties, Inc. The lease agreement required Silverstein to insure the WTC, and on September 11 it was in the process of putting insurance in place. Given the WTC’s size and scope, the insurance was large and complex, involving more than thirty insurers, each offering varying layers of coverage that aggregated $3.5 billion—“per occurrence.” Silverstein claimed there had been two occurrences, meaning $7 billion in total coverage; the insurers said there had been but one occurrence, meaning $3.5 billion in total coverage.

Despite posing the same question—what is an occurrence?—the answer differed for different insurers because the insurers were bound by different contract policies using different contract language. One group had bound itself to a policy (called the Willis form) which defined “occurrence” to mean “all losses or damages that are attributable directly or indirectly to one cause or to one series of similar causes.” Other policies either did not define the term occurrence or defined it differently. Court proceedings followed accordingly.

Interpreting policies using the Willis form’s definition of occurrence was relatively easy for the judges, with both the trial and appellate courts finding that the 9/11 attacks amounted to one occurrence. The reasoning was closely tied to the specific definition:  “no finder of fact could reasonably fail to find that the intentional crashes into the WTC of two hijacked airplanes sixteen minutes apart as a result of a single, coordinated plan of attack, was, at the least, a ‘series of similar causes.’” The liability of such insurers was therefore limited to the respective policy cap. The conclusion was reached on summary judgment—meaning as a matter of law without need for any trial.

Such an easy interpretation was impossible under the other policies, however. For those that lacked a definition of occurrence, both courts concluded that the concept is sufficiently ambiguous to require considering extrinsic evidence to determine contractual intention. This requires studying context: meaning is to be interpreted given the specific policy and facts of the case, not broad generalities or legal principles. The issue was therefore a matter for a jury. After listening to competing evidence and views, the jury decided that the 9/11 assault on the WTC amounted to two occurrences for purposes of coverage under the policies.

The jury was apparently persuaded by evidence offered at trial by Silverstein’s expert witness on the insurance business. Concerning policies that did not define occurrence, he explained that insurers generally take occurrence to have a narrow meaning—giving rise to multiple occurrences from given scenarios—principally because that increases the number of deductibles that apply. Insurers only prefer a broad conception of occurrence—one-occurrence interpretations—in total loss situations such as this, which are rarer. For policies that defined occurrence differently than in the Willis form—such as any loss or series of losses arising out of one “event”—the expert explained that the word event should likewise be construed narrowly.

The policy language is the starting point for making a deal and interpreting it. Want a specific definition, then supply it, and courts will enforce it accordingly; absent a specific definition, courts must dig into context, get all the facts, and let the fact finder decide. The latter setting obviously entails greater uncertainty, subjectivity, and contingency. Indeed, while some courts urge juries to contemplate the dictionary definition of occurrence, others adopt a logical perspective, which can vary according to emphasizing the causes of a loss (where all damage from a single, proximate cause is a single occurrence) or the effects (each separate incident of loss is a separate occurrence).

Lawrence Cunningham is a professor at George Washington University whose forthcoming books include the second edition of Contracts in the Real World: Stories of Popular Contracts and Why They Matter, which includes this story and fifty more. 

Sources: Scott G. Johnson, Ten Years After 9/11, 46 Tort Trial & Insurance Practice Law Journal 685 (Spring-Summer 2011); World Trade Center Properties, L.L.C. v. Hartford Fire Insurance Co., 345 F.3d 154, 180 (2d Cir. 2003).


Handshakes and Smiles: Founder Feuds from Snapchat to Facebook

11111In 2011, Frank Reginald “Reggie” Brown, IV was an English major at Stanford University, living in the Kimball Hall dormitory. There Brown conceived of an idea for a mobile device application that would let people send pictures from one phone to another, but with a novel catch: the picture would self-destruct shortly after viewing, so the recipient could not save or forward it. The idea would become the lucrative Snapchat product, at one point valued at $15 billion (an astounding figure considering that customers do not pay for the service and a way to make profits had not yet been devised). But Brown, having failed to formalize a contract, had to fight for his share of the value.

          As spring blossomed in Palo Alto that year, Brown was hanging out in the dorm room of a friend, Thomas Spiegel, when he explained the app. Spiegel called it a “million-dollar idea.” After Spiegel asked Brown if they could work on it together, Brown said yes, and the two shook hands. That night, they began searching for a computer coder to help. After interviewing several candidates, they chose Robert Cornelius Murphy. Another Stanford student and friend of Spiegel’s, the three were all also Kappa Sigma fraternity brothers.

The trio then agreed orally to develop the app—which Brown initially called “Picaboo”, after the children’s game—and split profits among them equally. Control and management would likewise be shared, and each would have specific roles: Spiegel, chief executive officer; Brown, chief marketing officer; and Murphy, chief technology officer.

By early summer, the three were deep into the venture. They decamped to work and live together on the start-up at the home of Spiegel’s father, on Toyopa Street in Los Angeles, which Spiegel called the “start-up house.” Brown wrote the terms of use, designed the product logo (a cartoonish smiling ghost), and the promotional pages for social media sites. The three jointly designed the app’s features, including the camera button, screen layout, and colors. Votes were taken on important decisions. When they communicated with friends about the project, each author put all three names in the signature.

In July 2011, they launched the app, which instantly drew strong interest and repeat customers. Through August, the three continued to share the work, even as Brown and Murphy went to their respective family homes for the rest of the summer. That’s when things turned ugly.  Read More


Berkshire Hathaway 50th Anniversary Symposium

I’m honored to be giving the keynote address at the Museum of American Finance symposium on the 50th anniversary of Berkshire Hathaway under Warren Buffett on Wednesday, November 11, 2015 at the Museum on Wall Street.  As the Museum explains:  “When Warren Buffett took control of Berkshire Hathaway Inc. in 1965, it was a small textile company. Through a combination of value investing, exceptional management and savvy acquisitions, Buffett has transformed the firm into one of the most profitable, successful and highly-emulated corporations in American history. ”  The impressive program schedule follows.

Museum of American Finance

8:00-9:00 am
Fireside Chat
Byron D. Trott, chairman and CEO of BDT & Company and source for several of Berkshire’s important acquisitions, will be interviewed by Carol Loomis, long-time editor of Fortune magazine and editor of Buffett’s annual letter to shareholders.

9:15-10:15 am
Panel 1: Investors Inspired by Berkshire Hathaway
Roger Lowenstein (moderator), financial journalist and author of the best-selling Buffett: The Making of an American Capitalist and, among other works, the newly-published America’s Bank: The Epic Struggle to Create the Federal Reserve
Bill Ackman, founder and CEO of Pershing Square Capital Management, L.P.
Seth A. Klarman, president and CEO of The Baupost Group, L.L.C.

10:30-11:30 am
Panel 2: Berkshire Hathaway Shareholders
Jason Zweig (moderator), Wall Street Journal columnist and editor of the revised edition of The Intelligent Investor
Paul Lountzis, president of Lountzis Asset Management LLC
Thomas Russo, partner at Gardner Russo & Gardner LLC
Whitney Tilson, founder and managing partner of Kase Capital Management LLC

11:30 am-12:15 pm
Lunch Break

12:15-1:15 pm
Panel 3: Value of Partnerships
Jim Grant (moderator), founder and publisher of Grant’s Interest Rate Observer
Thomas Gayner, president and chief investment officer of Markel Corporation
John C. Phelan, managing partner of MSD Capital

1:30-2:30 pm
Afternoon Keynote
Lawrence Cunningham, author of Berkshire Beyond Buffett, co-author of The Essays of Warren Buffett and the Henry St. George Tucker III Research Professor of Law at George Washington University

Tickets and Admission 

General admission: $325
Current MoAF and NYSSA members: $125

All guests will receive a complimentary copy of The Essays of Warren Buffett: Lessons for Corporate America, courtesy of the editor and publisher, Lawrence Cunningham.


Making Contracts on Kickstarter

11111In 2013, Chapman Ducote, a professional race car driver, and his wife, Kristin Ducote, had an idea for a new book about the world of professional motor sports, to be called Naked Paddock. Rather than the traditional route through book publishing—hiring an agent, seeking a publisher to pay an advance, and having the house handle the rest—they opted for a new approach of crowd-funding and self-publishing.

Crowd-funding refers to project financing generated from among the general public, usually facilitated by an internet-based service designed to match money to ideas. Creators post project proposals on the site and invite backers to buy the product in advance or stake funds in exchange for bonus mementos or voice in production. Proposals state the total amount sought to be raised and the deadline. If the goal is not reached on time, no funds change hands. But otherwise a deal is made: the facilitating site has enabled backers and creators to form a bargain.

Facilitators, such as Kickstarter, present on their web sites “terms of use” that all creators and backers must agree to in order to access the site. Such terms of use include standards designed to promote the commercial efficacy of the site. Kickstarter is where Chapman and Kristin Ducote hatched their book idea, posting their project and thus manifesting their assent to the terms of use.

The couple launched heavy promotional efforts, which included an appearance on a reality TV show—a spin-off of  But within a week, Kickstarer took it down because it violated its rules. The Ducotes sued for breach of contract, saying Kickstarter had no basis to remove the project. But they soon withdrew the suit acknowledging that they had made a contract with Kickstarter to abide by it rules yet failed to do so.

Kickstarter therefore had the right to remove the project.  While neither side disclosed publicly what rules were broken, they revealed that Kickstarrter acted in response to complaints from other users. Among likely violations were rules restricting what creators can do to promote projects—creators may not spam, use link-bomb forums, or promote on other Kickstarter project pages.

Terms of use flourish on the internet, where web site builders use them to define business models and a sense of community norms. While the means of assent vary from traditional means—clicking at prompts rather than signing a form—they have similar purposes, efficacy and limits.  While the traditional rules of contract formation fit the creator-facilitator relationship well, they require adaptation, at least conceptually, when considering other pairs of relationships in crowd-funding.

Consider that between backers and facilitators. On the surface, it may seem that the facilitator has agreed to provide a service to the backer, such as assuring product delivery and quality. But the sites disclaim such a traditional contractual relation, instead establishing the facilitator as a pure middleman without duties.   The Kicktarter terms of use state, for example: “The creator is solely responsible for fulfilling the promises made in their project.” Kickstarter’s terms of use declare that “Kickstarter doesn’t evaluate a project’s claims, resolve disputes, or offer refunds—backers decide what’s worth funding and what’s not.” The facilitator disclaims any duty to backers concerning product delivery, quality, warranties, or refunds. Read More


Spelman College, Bill Cosby, and Mutual Intent in Pledges

Spelman College’s decision to terminate a $20 million program supported by Bill Cosby, embroiled in allegations of drug-related seduction, reminds us that donors and recipients mutually depend on good behavior  and shared intentions, which are imperiled about once a decade for most charitable organizations.

The problem can originate on either side, as where a recipient wishes to disaffiliate because a donor’s behavior or reputation becomes objectionable–as in the Spelman-Cosby case–or where a donor objects that a recipient is not using funds as intended–as in the 1995 case of  Yale University returning $20 million after alumnus Lee M. Bass complained that the school had not used the donation to create classes in Western civilization the donation called for.

Litigation does not often result, but when it does, it can be ugly. Negotiations and structured solutions are usually preferred. Take an example of each: Princeton University’s acrimonious litigation with the Robertson family and Lincoln Center’s friendly accord with the Fisher family over renaming Avery Fisher Hall at Lincoln Center.

22222Princeton U. and the Robertson Family: Pyrrhic Victories for Each

In 1961, Charles and Marie Robertson made a $35 million endowment gift to Princeton for the purpose of educating graduate students for government careers. They embraced the spirit of the times, captured in President John F. Kennedy’s call to “Ask not what your country can do for you, but what you can do for your country.” Establishing the Robertson Foundation, Princeton invested the $35 million and used the rising investment income to fund such programs—along with many others outside the Wilson School. Indeed, the Robertsons’ gift—which grew to nearly $1 billion today—become a sizable component of Princeton’s overall endowment—about $15 billion today.

While Princeton administrators loved the large and seemingly flexible funding, the Robertsons’ children, who retained a role in overseeing the use of funds, objected. They insisted that Charles and Marie intended a specific and limited use of the funds, solely for training in government careers at the Wilson School. Unable to resolve the disagreement amicably, the Robertsons sued the University in 2002, seeking to terminate the gift and recover the principal.

In the acrimonious litigation, the Robertson family said the university allocated $250 million of foundation funds to non-foundation pursuits, including a new sociology department facility, international affairs programs, and public policy studies—none of which focused solely on training for careers in public service at the Wilson School. The family contended that the University commingled foundation funds with general university funds with the result of disguising how foundation funds were used.

Princeton countered that the University was a complex institution with multiple interconnected missions that result in overlap between Wilson School government careers and broader programming on public and international affairs. It argued that the narrow literal and historical reading of the donor’s intent should yield to a contextual, flexible and evolving understanding of donor intent in relation to the University’s needs.

After six years of legal wrangling during which the two sides incurred legal fees exceeding $40 million each, they settled. The Robertson Foundation was dissolved, with $50 million going to fund a new “Robertson Foundation for Government” independent of Princeton and under the family’s auspices. The University also agreed to pay the Robertsons’ legal fees.

While both sides claimed victory, informed observers saw mostly mutual defeat, a pair of Pyrrhic victories. After all, while the Robertsons wrested control of a foundation from Princeton rededicated to their perception of their ancestors’ vision, it was far smaller than what the original endowment had become, and the bruising litigation did not entirely promote family unity. While Princeton retained control over most of the funds along with an expanded authority over allocation, the philanthropic community saw a bald assertion of power over donor intent that is likely to make some donors unwilling to trust the school with their beneficence.

11111Lincoln Center and the Fisher Family: Mutual Gains 

In 1973, Avery Fisher, founder of Fisher Electronics Co., donated $10.5 million to support the renovation of New York City’s Philharmonic Hall, the music house built in 1962 on Manhattan’s upper West side.  The pledge agreement provided that the Hall would be renamed Avery Fisher Hall and called for that title to “appear on tickets, brochures, program announcements and the like . . . in perpetuity.” The site has hosted innumerable grand classical musical performances over the decades, and the name is etched in the consciousness of many a New Yorker, and gave Mr. Fisher, who died in 1994, a bid to immortality. Read More


Contract Law’s Majesty Over Digital Deals

11111On September 25, 2012, Adam Berkson was on a Delta Airlines flight from New York City to Indianapolis. Needing the internet to conduct important business, he flipped open his lap top and followed the log-on instructions on Gogo’s in-flight Wi-Fi service. Between options of $10 for the day or $35 for the month, he clicked the sign-up button for the month, entered his American Express payment information, and was surfing the web within one minute.

A few months later, however, Berkson discovered that Gogo was billing his AmEx card every month—as if he had subscribed—and when he requested a refund, Gogo refused. While AmEx reversed the charges as a customer courtesy, in 2014 Berkson nevertheless banded together with other aggrieved Gogo customers to file a federal class action lawsuit for additional damages. Gogo moved to dismiss the case by citing yet another surprising term on its web site, one providing that all disputes go to arbitration, not litigation.

This case is one of scores of disputes arising from electronic contracts formed on the internet, mostly between consumers and merchants. While billions of dollars change hands amid trillions of Internet transactions, most raising no issue, the novelty, dynamism, and ingenuity surrounding e-commerce and technology produces disagreements about how offers to contract are made, how they may be accepted, and what terms they contain. And while there is ongoing contention about how electronic contracting is or should proceed, the setting vividly shows the remarkable durability and capaciousness of venerable contract doctrine.

Most fundamentally, mutual manifestation of assent is the touchstone of contract formation and an essential element. When there is clearly an offeror and clearly an offeree, then the acceptance of the offer must be unequivocal.  Such principles signify that asset and acceptance on line must stimulate a degree of intentionality that many website formation devices lack.

Next, it is common in contemporary commerce to offer and form contracts without negotiation—standard terms on take-it-or-leave bases which are generally referred to as adhesion contracts. In order for traditional principles of assent and acceptance to work, law must assure that offerees at least have an opportunity to review terms if not negotiate them.

Finally, when assent is largely passive, as with electronic adhesion contracts, it becomes more important to probe whether the offeree had notice of the term at issue. Actual notice certainly suffices but inquiry notice would suffice too—that is the offeree need not know the specifics of the term but be on notice to inquiry about it.

Carnival Cruise

A prominent pre-internet illustration is Carnival Cruise Lines, Inc. v. Shute, whre the U.S. Supreme Court held that the terms of adhesion contracts are “subject to judicial scrutiny for fundamental fairness”. In Carnival Cruise, vacationers bought cruise tickets through a travel agent it later received by mail. A legend on the front read, in bold type and all capital letters: “SUBJECT TO CONDITIONS OF CONTRACT ON LAST PAGES IMPORTANT! PLEASE READ CONTRACT ON LAST PAGES 1, 2, 3.” Read More


Five Reasons to Cheer for Starr v. United States (AIG Nationalization Case)

AIG coverYesterday, the US Federal Court of Claims ruled that the US government and its leaders acted illegally in nationalizing AIG during the 2008 financial crisis, in a shareholder suit led by Hank Greenberg, the man who built AIG until his departure in 2005. But the judge (Wheeler) also ruled against awarding any damages, saying AIG shareholders were not harmed.

A top journalist at a major financial magazine asked me the following five questions, and I gave the answers indicated–being five reasons you should celebrate the ruling. Please note that I wrote the book, The AIG Story (Wiley 2013), with Greenberg, where we laid out the legal basis for Wheeler’s ruling on illegality.

1) Is this a moral victory for Hank Greenberg? Do you think he sees it that way? 
Yes, it is a moral victory for Greenberg and for everyone else who cares about the rule of law.  I can’t speak for Hank other than to say he cares deeply about the rule of law.

2) Andrew Ross Sorkin calls this a split decision in today’s New York Times. Is that true and if not who won?
It is a Solomonic split decision but designed to invite an appeal by Greenberg and not by the government, so Hank gets a second bite at the apple on appeal.

3) Given the collateral calls that were pending and the certainty of an AIG bankruptcy, did Greenberg ever have a real chance to recover $40 billion?
No, but given the possibility of hiving off the insurance companies outside of bankruptcy, Judge Wheeler’s conclusion on no damages is vulnerable to reversal on appeal.

4) What will this ruling mean for government intervention in future financial crises? Is that good or bad?
No more violating the law or the rule of law by government officials, whatever they may think at the time. Very good–a win for justice and true American legal values.

5) The judge says that government broke the law in taking over AIG. Do you agree with that assessment?
Yes. Virtually every major figure in the takeover violated the law, certainly fiscal authorities such as Bernanke and Geithner, and maybe cabinet secretaries such as Paulson, and many of their bankers and lawyers, including those from Davis Polk, Goldman Sachs and Sullivan & Cromwell. They should all feel disgraced.


NetJets Shuffle: Costs of Deviations from the Berkshire Model

aaaaaaaWarren Buffett just oversaw an executive shuffle at Berkshire Hathaway’s NetJets. He  accepted the resignation of Jordan Hansell, CEO since 2011, and hired into the top jobs two company veterans who had resigned last month, Adam Johnson and Bill Noe. Two narratives are emerging: that the shuffle strengthens the case that Berkshire’s 1998 acquisition of NetJets was a mistake or that they illustrate flaws in Berkshire’s model of decentralization and autonomy. Here’s a third alternative: the circumstances show the strength of the Berkshire model, with pitfalls revealed by deviations from it.

As background, Richard T. Santulli, who in the 1980s pioneered the fractional aviation industry at NetJets, by 2005 had joined the short list of people widely seen as a likely successor to Buffett.  A mathematics whiz, Santulli built NetJets by selling fractional interests in planes to multiple owners. In exchange for customer fees, NetJets operates the fleet, as well an additional fleet of company-owned planes necessary to make certain that there are always enough planes to meet customer needs at any time. The business model is challenging: capital intensive and competitive with unionized pilots and a demanding clientele (the likes of David Letterman and Tiger Woods).

In the early 1990s, Sanutlli personally guaranteed NetJets’ loans to escape bankruptcy and in the mid-1990s sold 25% of the company to Goldman Sachs to obtain capital.  In 1998, he sold the company to Berkshire. Despite thin margins due to high costs, NetJets had relatively low debt, an impeccable safety record, and growth prospects as a first-mover. While NetJets produced profits in most of its first decade with Berkshire, the recession that began in 2008 throttled it. NetJets took a $700 million write-down on its fleet, erasing years of profits and tallying a large loss that year. Yet it had also had incurred considerable debt to expand its fleet.

By late 2009, Buffett decided to change course, as he conferred with David Sokol, another Berkshire executive on the short list to succeed Buffett. Sokol, who built and was then running Berkshire’s energy business, was a ruthless cost cutter, and perceived NetJets to be bloated. Taking over as CEO of NetJets, while still running the energy business, Sokol slashed expenses right down the income statement. But Sokol, who stands out as the least Berkshire-like CEO—he built the energy business by hostile takeovers and used brokers to scout for acquisitions—soon resigned after being caught front-running, shattering Buffett’s erstwhile trust in him.

At NetJets, Sokol left behind both his thrifty business model and a successor, Hansell, whom Sokol had recruited from Berkshire’s energy business. NetJets’ pilots love Santulli and have always lamented his departure. They detest both Sokol and Hansell, and especially their low-cost strategy. After Santulli left, management-labor relations deteriorated steadily, and lately the union hurled invective at Hansell in aggressive campaigns from the internet to the Wall Street Journal and Omaha World Herald. Pilots picketed by the hundreds outside Berkshire’s annual meeting in 2014 and 2015.

Amid mounting turmoil, in early 2015, two Santulli-era senior executives resigned from NetJets and those are the two now returning to lead NetJets. Johnson has stated that their goal is to reengage NetJets’ employees in the business and return the company to greatness. In other words, they appear poised to abandon the Sokol business model in favor of Santuilli’s original concept.

From these circumstances, it is tempting to infer that Berkshire’s acquisition of NetJets was a mistake. Apart from first-mover advantage, its business moat was insubstantial and Buffett’s usual rationality may have been colored by his devotion to NetJets as a customer. Yet NetJets was profitable during most of its first decade with Berkshire and continues to show strengths. NetJets may well belong on the short list of costly acquisitions that are due to Buffett being Berkshire’s sole decision maker, with limited input from one or two trusted insiders. But I think there is another lesson to discern, also about Berkshire’s managerial model.

Today’s shuffle seems to recognize and correct two mistakes that involved deviations from the Berkshire model: replacing Santulli and installing Sokol. After all, Buffett does not usually second-guess subsidiary CEOs, especially not company founders, so intervening against Santuli violated the Berkshire model. Nor does Berkshire usually move executives from one subsidiary to another, especially not assigning two companies to a single CEO, so installing Sokol at NetJets also deviated from the Berkshire model. The pair of highly unusual moves amounts to the sharpest instance of exceptions to the Berkshire model in its history.  They are also costly, given Santulli’s departure and Sokol’s fate, but measurement is elusive. It would also be useful to know more inside information about how Santulli’s ouster and Sokol’s ascension came to be.

Lawrence A. Cunningham, a professor at George Washington University,  has written numerous books, including “Berkshire Beyond Buffett,” through which he interviewed Santulli, became acquainted with Hansell, and spoke with numerous NetJets pilots and union officials.