Author: Lawrence Cunningham

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As Yanks Fail to Pay A-Rod When Due, Is Settlement On Brew?

aaaa Alex Rodriquez roamed Washington DC’s power corridors Wednesday (pictured), while his agents back home in New York drafted grievance papers against the Yankees for nonpayment of $6 million, due Friday.[i] A-Rod claims the sum as an agreed bonus for hitting his 660th home run on May 1, tying Willie Mays for fourth place on the all-time list. The Yanks say the bonus isn’t due unless achieving the milestone is commercially marketable, which they signal it isn’t, without saying why. A-Rod’s advisors will challenge that conclusion as well as whether the team reached it in good faith, or as a pretext to avoid a sizable payday.[ii]

The outcome is uncertain. While both sides seem to agree that the sole test is whether the Yankees hold a good faith belief that the milestone is not commercially marketable, they may disagree about what those two concepts entail in this particular setting. When contract fights boil down to such disagreements over the contextual meaning of an abstract phrase, a good bet is that both sides will seek to settle rather than fight, as Michael McCann suggests might happen here.

The concept of commercial marketability is inherently elastic. Its meaning has ranged from simple readiness of an economic good or service for public sale or distribution to some reasonable prospect of achieving meaningful levels of sales or profits. In baseball, a player and his achievements have been recognized as such an economic entity whose identity and record translate into revenue and gain for players and teams alike. Broad standards like these leave a wide range of discretion in the party who gets to make the determination of commercial marketability. In this case, that party is the Yankees.

To constrain that discretion, the A-Rod/Yanks contract and general principles of contract law require that the Yankees exercise it in good faith. That means the team must make a determination based on information, experience and judgment about the prospects. They may weigh fan and media interest in home run races generally—the effects when number one Barry Bonds overtook number two Hank Aaron say—and probably would be constrained to consider other races A-Rod has been in, including his current quest for 3,000 hits. The team will heavily weight A-Rod’s poor reputation among fans, given drug abuse and other blemishes; many baseball fans detest the tarnished player’s run for records held by revered titans, like Willie Mays, the beloved “say-hey kid,” or his Godson, Bonds.

Bob MacManaman argues that it is also relevant how A-Rod’s recent performance contributes to the team’s commercial success. The team is in first place thanks in part to A-Rod. But helping the team win does not automatically mean that home run milestones are commercially marketable. Yet the Yankees muffled the marketing by downplaying the quest. They omitted the home run derby from the list media should watch for, as Billy Witz reported for the New York Times. They have not explained why. In contrast, they stoke other A-Rod quests, including his impending 3,000th hit. To raise doubt about good faith, A-Rod will stress that he and the Yankees have no bonus agreement about 3000 hits and other A-Rod targets they are promoting while ignoring the one that triggers bonuses.

It remains a close call and both sides will thus appeal to the equities—as they have been in the media and on the field. The Yankees must worry about perceptions of even handedness. They do not want to alienate other current or prospective players, which is why owner Hal Steinbrenner stresses that the Yanks honor all their contracts.

A-Rod has to improve his profile to reinforce arguments about commercial marketability. That’s why he has been so well-behaved during this episode. It may help explain why he spent Wednesday visiting with the Georgetown Hoyas in DC, though his enemies, like Phillip Bump, find it characteristically distasteful for A-Rod to be hanging out with DC’s pols in the afternoon.  All of this points to the prudence of settlement rather than arbitration, which is wasteful and risky.

 

Lawrence A. Cunningham, a professor at George Washington University, is working on a new edition of his book, Contracts in the Real World: Stories of Popular Contracts and Why They Matter, likely including analysis of the A-Rod v. Yankees case.  He is not jealous that A-Rod visited the campus of Georgetown University today. 

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[i] The due date appears to be “15 business days after reaching the milestone”, which was met on May 1, translating into this Friday May 22. A-Rod would have 30 days to file a grievance for nonpayment.

[ii] To the Yankees, the payout would include another $6 million to Major League Baseball, under its rules taxing luxurious player compensation in the name of equity across baseball teams.

 

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DuPont Victory Good Sign for Buffett’s Berkshire

aaaaaYou know the activists have made an impact when the prospects of targeting Berkshire Hathaway are taken seriously enough to warrant a question on the subject to Warren Buffett at the company’s famous annual meeting.  Buffett scoffed at the idea by stressing a combination of performance and size—but there is a bit more to say, and now is a good time to say it, in light of yesterday’s stinging rebuke of the notorious activist Nelson Peltz by shareholders of DuPont. (No, greed is not good.)

Berkshire is among the largest, most diversified and profitable corporations in American history. It owns nine subsidiaries that, if they stood alone, would each be a Fortune 500 company, and boasts scores of diverse companies generating revenue from $1 billion to $8 billion apiece. At present, no sensible activist would target the firm, since Warren Buffett built, runs, and controls it by owning 34% of the voting power.

But just as the 84-year old conglomerate builder plans for Berkshire’s fate beyond his lifetime, no doubt activists are planning too. After all, despite a whopping market capitalization of nearly $400 billion, most analysts agree that Berkshire is worth more—that the sum of the parts is greater than the whole.

Citing criticisms of the conglomerate business model, activists will urge management to sell Berkshire’s struggling units, spin-off the mediocre, and install new managers at any failing to meet publicized performance standards.  In the process, they would call for distributing the cash to shareholders. They would explain how what they offer is worth more than Berkshire shares alone: cash plus shares in spun-off subsidiaries along with the continuing Berkshire shares.

The counterargument, familiar to Berkshire’s stalwart shareholders, will stress the value Berkshire has created from its unique business model. It pledges to business sellers that it will hold them indefinitely and give managers autonomy. Such commitments have great economic value not necessarily reflected in either today’s stock price or the valuations of individual business units.  The only way to preserve that premium is sustaining the conglomerate. The value is amplified by the capacity to relocate capital across subsidiaries without taxes, interest, covenants or hassle. Keeping the whole together reinforces the economic value of these and other intangibles, including a culture of trust, thrift, and teamwork. Read More

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Berkshire’s Disintermediation

aaaaaDisintermediation” is the business phenomenon of the technology era, when consumers go straight to the source for everything from accommodations to crowdfunding. Yet the greatest exemplar of the practice is the era’s least technologically savvy company, Berkshire Hathaway. Berkshire, 50 years old as a conglomerate and now one of America’s largest public companies, almost never uses intermediaries — brokers, lenders, advisers, consultants and other staples of today’s corporate bureaucracies. There are lessons in the model for the rest of corporate America, as well as investors, and it is an honor to be including a full length piece on the broad topic of disintermediation in the Wake Forest U. symposium on the subject hosted by Alan Palmiter and Andrew Verstein.

While American companies borrow heavily, Berkshire shuns debt as costly and constraining, preferring to rely on itself and to use its own money. It generates abundant earnings and retains 100 percent, having not paid a dividend in nearly 50 years. In 2014, Berkshire earned $20 billion — all available for reinvestment.  In addition, thanks to its longtime horizon, Berkshire holds many assets acquired decades ago, resulting in deferred taxes now totaling $60 billion. These amount to interest-free government loans without conditions. The principal leverage at Berkshire is insurance float. This refers to funds that arise because Berkshire receives premiums up front but need not pay claims until later, if it all. Provided insurance is underwritten with discipline, float is akin to borrowed money but cheaper. At Berkshire, float now totals $72 billion, which it uses to buy businesses that continue to multiply Berkshire’s value.

American corporations tend to design acquisition programs using strategic plans administrated by an acquisitions department. They rely heavily on intermediaries such as business brokers and investment bankers, who charge fees and have incentives to get deals done; firms also use consultants, accountants and lawyers to conduct due diligence before closing. erkshire has never had any such plans or departments, rarely uses bankers or brokers, and does limited due diligence. In the early days, Berkshire took out a newspaper ad announcing its interest in acquisitions and stating its criteria — which it has reprinted in every annual report. Berkshire now relies on a network of relationships, including previous sellers of businesses.

Today, corporate America’s boards are intermediaries between shareholders and management. Directors are monitors involved in specific strategic decision-making. They meet monthly, using many committees, which in turn hire consultants, accountants and lawyers. American directors are well-paid — averaging $250,000 annually — including considerable stock compensation plus company-purchased liability insurance.  Berkshire’s board, in contrast, follows the old-fashioned advisory model. Composed of friends and family, they are directors because they are interested in Berkshire. They do not oversee management but provide support and advice. There are few committees, no hired advisers, and only two or three meetings a year. Berkshire pays its directors essentially nothing and provides no insurance. Berkshire’s directors are significant shareholders and bought the stock with their own cash — which is why they are there.

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Warren Buffett & Charlie Munger Annotated by Experts in Wall Street Journal

WB1996Warren Buffett’s latest letter to Berkshire Hathaway shareholders is annotated in The Wall Street Journal by 30 professors, authors, and investors.  Editors Erik Holm and Anupreeta Das assigned us each two sentences in the letter, and/or Charlie Munger’s addendum, to amplify.  Here are my two, followed by the list of contributors. Mine address the role Warren’s son Howard will play in succession and what Munger believes concerning what made Berkshire succeed.

Regarding Buffett’s reference to his son Howard (p. 36):   Buffett tries again to defend the choice of Howard to succeed him as board chairman. Many remain skeptical. But critics should appreciate the plan’s savviness. It deftly carves a niche for the son of a legend, as Howard will: (1) not be asked to perform any task his father has performed (like investing or capital allocation) and (2) be asked to perform only one task, which Warren has never performed (monitoring the CEO for adherence to Berkshire culture and dismissing any who fail). This shrewdly avoids the trap many children of legendary parents face of never being able to measure up.

Notably, besides Munger, Howard is the only individual Buffett identifies by name among Berkshire personnel in his anniversary message and, besides Buffett, Munger only names Abel and Jain. In fact, while Munger and Buffett mutually credit the other for minting the Berkshire model, they never credit any other Berkshire personnel for its success. The omission contrasts with Buffett’s letters, which rightly herald specific executives who power Berkshire and animate its culture. The difference is that these messages, while in form historical, are really about the future, and all three people identified by name are referenced in discussions of succession.

Where Munger asserts (p. 39) that “The management system and policies of Berkshire . . . were fixed early”:   Munger’s statements about how Berkshire’s “system and policies” were “fixed early” is vague. In one sense, it sounds as if they were part of a master plan at the outset back in the 1960s.  But Buffett has often stressed that Berkshire never had a strategic plan nor any business plan. And through the 1980s, most of Berkshire’s “business” consisted of investments in securities for its insurance companies, not wholly owned operating subsidiaries. So it doesn’t seem likely that, in the 1970s or even as late as the 1980s, Buffett’s goal was to create “a diffuse conglomerate.”

On the other hand, Munger subsequently clarifies (p. 40) that Buffett “stumbled into some benefits [of these policies] through practice evolution” over his career. And Buffett sculpted much of Berkshire’s culture late in the company’s life as part of a process that is still ongoing and extends well beyond these policies. Therefore these passages should not obscure the fact that the “Berkshire system” looks sharper from today’s vantage point than from Buffett’s desk “early” on. That’s important to recognize lest observers commit errors associated with hindsight bias like believing that observed outcomes were predictable, a weakness of human psychology which Munger often lectures against.

Cunningham is the author of Berkshire Beyond Buffett: The Enduring Value of Values and editor and publisher, since 1997, of The Essays of Warren Buffett: Lessons for Corporate America. For more commentary on this topic, see today’s New York Times Dealbook column, here. Read More

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Fed Officials Accused of Perjury in AIG Bailout Trial

In the financial trial of the century, the most important document is missing. The document is the term sheet that the government says it gave AIG’s board right before taking the company over in Sept. 2008.  The government says the AIG board thus approved the Draconian terms that benefited Goldman Sachs and other rivals. But other evidence, including  AIG’s contemporaneous securities filings, suggests the board was agreeing only to sell the government warrants not transfer 80% of the common stock to it for a song.  The missing document would prove which side is telling the truth.

That’s one of many amazing points of contention noted by Yves Smith of Naked Capitalism in her relentless digging into what government really did during the financial crisis. Most recently, she alleges and documents perjury and obstruction of justice by top federal officials in the pending case of former AIG shareholders against the US. The case alleges that the government trampled on corporate law rights and that the Fed exceeded its authority—allegations that I document in my book, The AIG Story, written with Hank Greenberg, lead plaintiff in the case.

Smith lays out her claims in an extensive blog post at Naked Capitalism, accompanied by reams of additional documents and examples. For those looking for a skinny version, here is an abridged adaptation. Most examples concern Scott Alvarez, general counsel of the Board of Governors of the Federal Reserve; there is one with with Tom Baxter, general counsel of the New York Fed, who worked with Tim Geithner. The shareholders are represented by the noted trial lawyer, David Boies. The point about the term sheet is at the end.

Example 1

Boies: Would you agree as a general proposition that the market generally considers investment-grade debt securities safer than non-investment-grade debt securities?

Alvarez: I don’t know.

 

Example 2

Boies: [Presents a copy of the Financial Crisis Inquiry Commission report stating that the Fed had lowered the standards it applied for the quality of collateral for its loans under two programs then devised to support lending and asks] Do you see that?

Alvarez: I see that. . .

Boies: . . . [W]ould you agree that the Federal Reserve had lowered its standards regarding the quality of the collateral that investment banks and other primary dealers could use while borrowing. . . ?

Alvarez: No.

Boies: You would not agree with that?

Alvarez: Right.

 

Example 3 Read More

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Milton Hebald, RIP

The great sculptor, Milton Hebald, passed away at age 97.  May he rest in peace.  The NYT has a fine obituary here.  Accompanying this post are photos of three of his numerous sculptures gracing the grounds at Morefar, the Brewster, NY estate of the late Cornelius Vander Starr, founder of what Hank Greenberg turned into the American International Group.

Boy flying kite at Morefar (pp. 33-34)

 

 

 

 

 

 

 

 

 

 

 

 

Boy Flying Kite

Statue at Morefar (pp. 33-34)

 

 

 

 

 

 

 

 

 

Handstand

2011-09-10 10.22.03

 

 

 

 

 

 

 

 

 

Tennis Anyone?

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Buffett on Family Business: Beat the Third Generation Curse

warren buffettWarren Buffett is very good at spotting great family businesses. What does he look for? How can his filters help family businesses prosper?

For one, they can mitigate one of the greatest dangers: the third generation “curse.” This refers to how few family businesses survive beyond the third generation, let alone prosper.

An under-appreciated fact about Berkshire Hathaway, the conglomerate Buffett built: virtually all its family businesses boast second or third generation descendants who rival or outshine previous generations. That is rare among family businesses.

So while every family and business situation differs, Berkshire’s two dozen family companies are a good place to look for insight about multi-generational prosperity in the family business.

Studying Berkshire’s family businesses, I found that they are united by the following values. These values are important factors in their success, in the founding generation and subsequent ones.

Family business members, and their professional advisors, whether in law, accounting, or other fields, would do well to ponder these points.

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Million Dollar Reward Case Over

aaa millionA claim to $1 million for meeting a lawyer’s dare made on Dateline NBC is now dead. The case is over thanks to an opinion, by Judge Wilson for the 11th Circuit, that will be in the next editions of all Contracts casebooks: it  provides a comprehensive, careful and contestable treatment of unilateral contracts.

Former law student Dustin Kolodziej filed the case in 2009 against high-profile Florida defense lawyer, James Cheney Mason.  Prosecutors said Mason’s client, a wealthy businessman on trial for  murdering his business partner and others, manufactured an alibi putting him in a La Quinta hotel in Atlanta on the day of the Central Florida murders.

On Dateline NBC, Mason explained his defense, that the state could not show that the trip they imagined the defendant took was possible within the time frame.  A vital leg of the journey involved getting off a plane at Atlanta’s busy airport to the hotel five miles away, in less than 30 minutes, where the defendant was seen in security tape early and late in the day.

Mason said he’d pay $1 million if proven wrong.  Kolodziej did just that,  reenacting the full trip, capturing it on his camcorder, and making the final leg in less than 30 minutes.    Kolodziej claimed a valid contract, formed by Mason making an offer of a reward for an act and Kolodziej accepting it by performing the act.   Mason called the claim ridiculous.

The case raises a classic issue in contract law, about whether dares to be proven wrong like this are recognized as offers or mere bluffs and jests.  The 11th Circuit, affirming a grant of summary judgment, sided with Mason.  Stressing context,  not only was his bluster about the million a joke, the full text of what he said makes clear he was daring the prosecutors to prove the point, not the general public.

Dave Hoffman correctly predicted this outcome–nice job Dave (here and here)! I thought the case a closer call, as I explained  here and in my book, Contracts in the Real World: Stories of Popular Contracts and Why They Matter (Cambridge U Press 2012).

While I am persuaded by Dave and the 11th Circuit’s opinion, I remain convinced that Mason was wrong to call the claim ridiculous.  The court takes the claim more seriously, to its credit, though I wish they had engaged more with the arguments  put forth in my book (which, alas, the court does not cite).

Hat tip to Jim Gross, currently clerking for the 9th Circuit, who wrote to remind me that we discussed this case on his first day of Contracts class at GW back in 2011.  Hat tip also to David George, the lawyer for Kolodziej, who also sent me a copy.

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Free Berkshire Book Trivia Quiz

Amazon BBB Book Cover - CopyExpert on Berkshire Hathaway? Try this trivia quiz based on Berkshire Beyond Buffett: The Enduring Value of Values. Submit answers to lacunningham@law.gwu.edu.

The first 10 people to get all 20 right by December 20 at 5 pm ET win a free signed copy of the book (free shipping within US). (Hint: all answers are easily found in that book!)

1. Who founded The Pampered Chef and what job did that founder holder before doing so?

2. Who founded FlightSafety and what was that founder’s favorite charity?

3. What medical scare did John Justin Jr. face in 1968?

4. At what age did Rose Blumkin pass away?

5. What was Lubrizol’s most pivotal acquisition under CEO James Hambrick? Read More

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Berkshire and Coca-Cola: Deja Vu All Over Again

 

 

In response to the business media frenzy over what challenges at the Coca-Cola Company mean for Berkshire Hathaway, which owns a large stake in the company acquired in 1988, herewith an excerpt for perspective from Berkshire Beyond Buffett, my book released yesterday.  The book focuses on Berkshire’s 50 main wholly owned businesses, but also has brief passages on some of the companies in which Berkshire owns a minority position.  The following is the passage on The Coca-Cola Company, pages 181-182.  You might call it: Berkshire and Coca-Cola: We Have Been Here Before. 

Before presenting the passage, a related note: when activist Coke shareholders (like David Winters) agitating for change complain about their futile efforts to lure Buffett into their fight, remember that Buffett works for Berkshire and its shareholders, not for Coke or its shareholders. While activism might boost Coke’s shareholders today, Berkshire’s patient quiet approach has boosted Berkshire’s shareholders year in and year out.  For example, the model of quiet patience is precisely why Berkshire was able to reap such enormous gains from its investments during the 2008 financial crisis.

CokeWith sales in 2013 reaching $50 billion, the Coca-Cola Company is about as powerful a brand and company as can be, at home in Atlanta and around the world. Its success is due ultimately to a single product, originally a mixture created in 1886 by pharmacist John Styth Pemberton of sugar, water, caffeine, and cocaine (extracts of the coca leaf and the kola nut). In 1891, fellow pharmacist Asa G. Candler gained control of the product and initiated steps to launch the business. Among early moves was the first bottling franchise in 1899, an investment in local partnerships that became the scaffolding to build the brand: the company makes concentrate for sale to bottlers that mix it into liquid form and package it for sale to retailers. Other early milestones include the 1905 removal of cocaine from the mix and the 1916 creation of the unique contour-shaped bottles.

In 1919, Candler sold the company to Ernest Woodruff and an investor group which promptly took it public. In 1923, Ernest’s son, Robert Winship Woodruff, became president, a position he held through 1954, followed by serving as a director through the 1980s. Coke went global in the 1940s, establishing bottling plants near the fronts in World War II. With the stewardship of CEO William Robinson, in 1960, Coke acquired Minute Maid Corporation and in 1961, launched Sprite, the first of many brand expansions it would continue as it developed its product line of five hundred different drinks.

Under Paul Austin during the 1970s, despite reasonable sales, the company stumbled from one problem to another. Bottlers felt misunderstood, migrant workers in the Minute Maid groves were mistreated, environmentalists complained about its containers, and federal authorities challenged the legality of its franchise bottling system. Although Austin launched Coca-Cola into China and was responsible for other international achievements, critics say he neglected the flagship brand by diversifying into water, wine, and shrimp. With investors punishing the stock, the board finally ousted Austin in 1980, replacing him with Roberto C. Goizueta, Coca-Cola’s most famous CEO, serving from 1981 through 1997.

A legendary businessman and Wall Street darling, Goizueta returned to basics, focusing on the Coke brand and rejuvenating Coca-Cola’s traditional corporate culture of product leadership and cost management. During his tenure, Goizueta led the company to widen profit margins from 14 to 20 percent, boosted sales from $6 billion to $18 billion, drove profits from less than $1 billion to nearly $4 billion, and pushed returns on equity from 20 to 30 percent.  These measures were propelled by expanding Coke’s global network and the successful 1982 launch of Diet Coke.

There were, of course, a few errors along the way. One, the lamentable 1985 birth and death of New Coke after it flopped with consumers, simply revealed the power of the core brand. Another was Coca-Cola’s 1982 acquisition and 1987 divestiture of Columbia Pictures after it had become disillusioned with the inscrutable ways of Hollywood. But this diversion simply proved the durability of Coke’s corporate culture—and was also lucrative, as the company paid $750 million for Columbia and sold it for $3.4 billion.

In 1988 and 1989, Buffett heralded Goizueta’s achievements when Berkshire bought the large block of Coca-Cola shares it still owns today and Buffett joined the board (on which he served until 2006). After Goizueta’s sixteen years, however, the company’s CEOs came and went more like temps, four in thirteen years. But despite mistakes, none could fail so spectacularly as to ruin the Coke brand or Coca-Cola’s corporate culture. Douglas Ivester (1997–2000) swapped the contour-shaped Coke bottle for a larger unfamiliar variant, compromising a valued trademark. Douglas N. Daft (2000–2004) fired large numbers of people, a slap in the face to the employee-centric culture that prided itself on lifetime employment.

Yet changing strong corporate cultures is not easy, and at Coca-Cola, successors quickly reversed course. E. Neville Isdell, who returned from retirement to right the ship, and Muhtar A. Kent, who took over in 2009, revived a decentralized structure and the professional style that Goizueta favored. They also understood the importance of international markets, especially in southeast Asia, where growth prospects remain strong. Kent celebrates Coca-Cola’s greatest tradition, epitomized by its history of using hundreds of bottling partners: being simultaneously global and local.

Coca-Cola has been a profitable investment for Berkshire—worth today twelve times what Berkshire paid for it. And Buffett’s son Howard has been on its board since 2010. The company appears to be prospering, and the Buffetts are bullish on it. Buffett and Munger continue to give the brand free advertising by sipping it on the podium at Berkshire’s annual meetings. But skeptics wonder about the durability of its economic characteristics in a health-conscious world turning away from carbonated beverages.