Author: Lawrence Cunningham

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Delaware Back to Sturdy Doctrine; Good Faith in Coma

death knell for good faith.jpgLast week, the Delaware Supreme Court backed off any notion that directors owe their corporations any special duties of good faith (or absence of bad faith) and retreated to the more traditional standards of corporate duties. In a refreshingly lucid and terse (easily edited to 5 pages of casebook text) opinion, Justice Carolyn Berger, for the Court en banc, clarifies that directors do not have to follow any specific steps when deciding to sell corporate control and that reasonable steps to that end are enough to reject any claim that they failed to act in good faith—even on a motion for summary judgment.

This decision, Lyondell Chemical Co. v. Ryan, is noteworthy because in two other noted opinions in 2006 (Disney and Stone v. Ritter), the Delaware Supreme Court suggested, in dicta, that there were potentially recurring contexts in which directors might fail to act in good faith such that, apart from any other duty, they may be personally liable for that. Delaware’s latest marks return to more familiar doctrinal terrain. The role of good faith, ultimately, is to prevent fiduciaries who engage in particularly egregious conduct, or “conscious disregard of duty,” from avoiding liability for money damages or enjoying corporate indemnification, both under Delaware statutory law.

Of course, given Delaware’s notoriously shifting corporate law, what Justice Berger settles in Lyondell could change in Delaware’s next big case. After all, Delaware courts, consciously seeing themselves as judges in equity, may, on egregious facts, revive the notion of good faith as an independent fiduciary duty or some vital aspect of obligation, such as a component or cognate of the duty of loyalty. But, for now, Lyondell puts the notion of good faith in something of a coma. Not dead, but nary alive.

Where that leaves Delaware corporate fiduciary duty doctrine is on more familiar terrain. The following is a snap shot of that terrain for directors and officers.

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AIG’s Unsupervised Capital Structure Conflicts

Chaos.jpgChaos occurs when government uses private deal making to invest in corporations. AIG gives lessons in this (as William Sjostrom explores) that characterize scores of other deals the New York Federal Reserve and US Treasury have been cooking up for a year, on-the-fly and without any administrative law or other legal supervision (as David Zaring and Steve Davidoff explore).

To see some of the problems, start with the following rundown of AIG’s current capital structure, as constituted by the NY Fed and Treasury without any oversight.

Senior Debt. The NY Fed is AIG’s senior secured lender, with about $50 billion in credit extended, along with other lenders to whom the company owes another $130 billion in long-term debt.

Senior Equity. The US Treasury holds AIG’s senior equity, a series of non-voting, non-convertible preferred for which it paid $40 billion (which AIG used, in turn, to reduce borrowings from the NY Fed). The US Treasury also holds warrants to buy about 2% of AIG’s common. It says it is about to acquire another series of non-voting, non-convertible preferred for $30 billion.

Mezzanine Equity. A Trust whose sole beneficiary is the US Treasury holds convertible preferred stock which, before conversion, commands 77.9% of AIG’s total share voting power.

Junior Equity. Finally, junior equity, the common stock, is held by numerous institutional and other sophisticated investors, with 10% of that held by AIG’s former CEO Maurice Greenberg.

The presumed purpose of this unsupervised intervention is to put voting control in the Trust so that, eventually if AIG is rehabilitated, that controlling interest can be sold in an orderly transaction to private investors, perhaps along with Treasury’s senior equity, and certainly after the NY Fed’s senior debt is repaid. Trouble is, the deal for the Trust’s equity is incomplete, and the overall structure seems replete with conflicts of interest.

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AIG: What “Taxpayers” “Own” and “Invest”

Meaning.jpgTwo shorthand references often used these days are how “US taxpayers own 80% of AIG” and “the government has invested more than $170 billion” in bailing AIG out. There is something in both common expressions. But the entire corporate finance and corporate governance structure put in place, and endlessly changing, is so unorthodox, that these expressions do not reflect their usually meanings.

Using them can be misleading in two different directions: (1) in terms of the 80% ownership notion, “taxpayers” have vastly diminished rights compared to the usual rights of corporate shareholders and (2) in terms of the $170 billion figure, the taxpayers have vastly less invested than that.

As to the ownership notion, a Trust whose sole beneficiary is the Treasury Department owns a series of AIG preferred stock (called Series C) that is convertible into AIG common stock that would represent 77.9% of AIG’s outstanding common shares, if converted. For now, the Trust also gets to vote on proposals to AIG’s common shareholders, including director elections, as if the preferred were converted, and receive dividends paid on common stock, as if it were converted.

But surely the “taxpayers” do not own that stock and certainly have no right to elect AIG’s directors. The Trust does. That Trust, in turn, is managed by three Trustees. These people are appointed by Treasury, not by taxpayers. The Trustees do not stand for election. Further, the Treasury Secretary is not elected by taxpayers, or removable by them, but is appointed by the President, and removable by him. The President, of course, serves a four-year term, whereas corporate director elections occur annually.

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6

AIG Defends Bonus Payments

Contract.jpgAs a companion to my post , AIG Contracts Questions, consider the following summary analysis of a fascinating memo, undated, unsigned and “produced quickly,” AIG explains the legal and business grounds for why it had to pay $165 million in bonuses to 400 employees of its complex financial contracts business. These payments, which range from $1,000 to $6 million, cover services during 2008, pursuant to employment agreements, and an employee retention plan, all entered into in early 2008.

After defending the payments on legal and business grounds, the memo promises, somewhat incongruously, how AIG will use its best efforts to reduce bonus amounts that may become due for services during 2009. Following is a summary and elementary assessment of these three parts of the memo: legal, business, future efforts.

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23

AIG Contracts Questions

Contract.jpgUnder what legal theories may an employer refuse to perform promises to pay bonus compensation to employees? That is the contract law question that US President Barak Obama and New York Attorney General Andrew Cuomo pose to the country today. Both seek to prevent AIG, the beleaguered and possibly criminal enterprise, now nearly 80% owned by the US government after its $170 billion bailout, from AIG’s planned payment of $165 million in cash bonuses to various employees.

AIG says it is contractually obligated to make these payments. The President instructs his Treasury Secretary to “pursue every single legal avenue to block these bonuses.” The New York Attorney General is doing so. His letter to AIG today requests copies of the contracts, background on how they were negotiated and descriptions of the job performance of covered employees.

In the spirit of President Obama’s call and Attorney General Cuomo’s quest, following are some admittedly spontaneously developed and potentially speculative legal avenues to block payment of the bonuses. Please feel free to add or subtract from these preliminary notations.

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Florida on Post-Crisis Economic Geography

Credit to Sean McCabe from Atlantic.jpgRichard Florida, University of Toronto, writes a fascinating piece in the March 2009 Atlantic. It begins as follows: “To a surprising degree, the causes of this crash are geographic in nature, and they point out a whole system of economic organization and growth that has reached its limit. Positioning the economy to grow strongly in the coming decades will require not just fiscal stimulus or industrial reform; it will require a new kind of geography as well, a new spatial fix for the next chapter of American economic history.”

Home ownership became a part of the American dream as a direct result of the New Deal. Then, long term mortgages were invented to reduce monthly payments; government sponsored mortgage finance expanded access; and the mortgage interest deduction (in effect from 1913 to today) spurred home ownership. Maintaining artificially low interest rates from time to time sustained access to the dream. Assembly lines later cranked out automobiles; residential developments in areas outside cities spurred the spatial fix of suburbanization.

That model of economic geography made sense for its time. Then, escaping cities was appealing. “Making and moving things” were the pumps of economic activity. But the current crisis reveals excessive reliance upon home ownership as a means of building and leveraging wealth and expanding consumption beyond fundamental means. Moreover, it shows the relation between those propensities and the spatial fix, especially suburbanization. The economy’s shape has been distorted. The model is certainly unsuited to an economy pumped by “generating and transporting ideas.”

Policy implications follow directly.

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Notes on Bernanke’s Vision of Fin Reg Reform

Wrench.jpgAt the Council on Foreign Relations Tuesday, Fed Chair Ben Bernanke summarized four big ideas for financial regulation reform:

(1) too big to fail: tighter supervision of very large firms whose failure poses systemic consequences;

(2) infrastructure: strengthened infrastructure to trade, clear and settle novel financial instruments like credit default swaps and to stabilize money markets and commercial paper markets;

(3) accounting/regulatory: reform of requirements that exacerbate market swings (like accounting rules requiring valuing assets at prevailing market prices or capital requirements that prevent building capital reserves amid prosperity that can be absorbed amid adversity); and

(4) senior risk regulator: establishing a senior systemic risk authority to oversee all financial institutions at a macro level.

Popular press reports often concentrated on selected items, as with The New York Times report that allocated ¾ of the space to item (3).

More informed assessments appear in other media, especially David Zaring’s blog post at Conglomerate. (David’s summary reflects his and my thinking elaborated in our joint article on the subject, The Three of Four Approaches to Financial Regulation, shortly to be posted on SSRN).

Among the more notable and under-reported parts of the presentation was the follow up Q&A, especially the following colloquy between the Chair and my GW Law colleague, Steve Charnovitz, concerning item (4), the senior risk regulator:

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GW’s “Panic” Conference

GW Panic Conf Logo.jpgIn July 2008, I posted an assessment of whether the then-building financial problems were a panic (mere behavioral phenomenon) or a crisis (reflecting substantive conditions). I reported that we at GW Law School were organizing a conference to explore that and the dozens of profound radiating issues.

We can now formally announce the convening of our conference. It is called the Panic of 2008 and will be held at GW on April 3-4, 2009, at the Law School in Washington DC. (The title does not necessarily answer the question posed in my July post!)

The amazing list of participants, from all walks of relevant life, includes the following:

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Steel, Patience amid Adversity

Climbing Twisting Stair Case.jpgRecent posts on this blog (Dave’s and Deven’s) about the state of the legal profession, and especially lawyer employment and legal scholarship (in comments to both), prompt the following reflections. No doubt, times are tough and may get tougher; but there is likewise little doubt that we, as a people, and law, as a profession, have faced them before and come to prosper. Steel and patience are vital here.

The stock market crashed in October 1987. Corporate finance and deal activity contracted. Law firms lost work. Associates were let go and firms cut back hiring. I graduated from law school in June 1988, and it was difficult to find jobs for many law graduates at the time. Luckily, my firm took me on board in September 1988, anyway, despite there being limited work. Shortly, however, deal flow resumed. By 1990, I had plenty of work. My firm and others resumed normal hiring, and later expanded it.

In September 2001, after terrorists attacked lower Manhattan, the stock market closed for several days. Corporate finance and deal activity contracted. Law firms lost work. Associates were let go and firms cut back hiring. Eventually, work resumed, with deal flow flourishing.

Then a professor, I went to the library to leaf through the law reviews published in the period just after the bombing of Pearl Harbor that brought the United States into World War II. I also read books about law firms during that period.

Amid World War II, people were terrified, deal flow contracted, associates at large firms were let go and hiring contracted. Scholarship appeared to have been cut back, but in corporate and securities law, did not seem to abate or shift course due to the attacks or resulting war. Eventually, the war ended, markets resumed, expanded, deals flowed, associates were hired, paid, made partner, and prosperity resumed.

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Silver Lining and Lesson Department

silver lining in a cloud.jpgA compressed portrayal of US failures evident in the current crisis may arise from the following list of representations:

(A) firms: Countrywide, Fannie Mae, AIG, Citigroup, Moody’s, Lehman Brothers, General Motors;

(B) industries: mortgage origination, mortgage finance, insurance, commercial banking, rating agencies, investment banking, automobile manufacturing and finance;

(C) regulators: state mortgage, insurance and banking overseers; Federal Housing Finance Agency; Securities and Exchange Commission and Commodity Futures Trading Commission; Federal Reserve, Treasury, Office of Comptroller of the Currency; Federal Deposit Insurance Commission;

(D) lawmakers: Congress, Congress, Congress, Congress, Congress.

What representations do not appear on this list? Deloitte Touche et al, the auditing industry, and the Public Company Accounting Oversight Board. Three cheers.

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