Author: Lawrence Cunningham

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Delaware Gets Tough on National Issues

Del State Seal.gifScholars often detect a strengthening of Delaware corporate law amid national crises that can ignite interest in having the federal government increasingly preempt state corporation law. Two recent cases may support that conjecture, allowing some surprising claims to withstand motions to dismiss:

(1) a claim against AIG’s directors asserting that they presided, with sustained and systemic neglect to control, over what was essentially a “criminal enterprise”; and

(2) a claim against Citigroup’s directors asserting that they committed waste in approving a lavish payout to a departing CEO who presided over the destruction of billions of dollars of wealth at the corporation.

The opinions coincide with rising public outage over executive compensation and strict federal laws capping executive compensation for scores of public companies, mostly banks, but also automobile companies and finance affiliates. They coincide with ongoing frustration over the government’s injection of more than $120 billion into AIG while it continues to report staggering losses reportedly exceeding $50 billion this quarter alone.

Calls will continue for federal legislation that limits corporate executive compensation, taking away Delaware corporation law’s role on the subject; calls may heat up for broader federal preemption of a wide range of state law, certainly in banking and insurance, and just possibly corporation law as well, at least for institutions of systemic significance.

Whether Delaware is really responding to those threats or simply taking the cases on the merits, the two opinions are of considerable interest, even though written merely by the trial court and merely addressing motions to dismiss.

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A-Rod’s Breach of Contract Claim?

Baseball Caps.jpgInspired by Dan’s post on the tort of breach of confidentiality: can a unionized baseball player win breach of contract claims if information the collective bargaining agreement requires to be kept confidential or destroyed is neither destroyed nor kept confidential?

The issue arises concerning public disclosures earlier this month of 2003 steroid test results for Alex Rodriquez that the CBA required the union and/or the league to destroy or keep confidential. Numerous issues appear, both factual and legal.

First, a threshold factual issue: exactly how was the information disclosed? The information was generated in 2003, kept at a third-party lab through April 2004, when federal agents with warrants seized it. The information is evidence in an ongoing government investigation and appears to be under seal by court order. It does not appear that either the union or the league were responsible for the public disclosure, which was reported by Sports Illustrated earlier this month.

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Anti-Lobbying v. Nationalization

US Treasury (2).jpg

Treasury Secretary Timothy Geithner swept into office announcing tough rules restricting lobbying by bank officials of public officials in connection with distribution of federal funds to the banking sector. At the same time, talk continues about how Treasury may yet determine that it is necessary to nationalize some banks. A conflict would appear.

The lobbying rules assume that public officials and bank officials are different categories of people. But if Treasury assumes control of a bank by nationalizing one, Treasury (or some other public official) will appoint bank officials. Then it will be difficult to distinguish between public officials and bank officials. Bank officials will be public officials.

Of course, this is just one of endless anxieties that would accompany any decision to nationalize US banks. Perhaps it is a sign that the Treasury Secretary means it when he says that nationalizing banks is not a desirable course.

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What’s in a [Corporate Stadium] Name?

Citi and Shea Together.jpg

Citigroup and other banks face populist rebuke for executive compensation and lavishness amid a financial crisis the banks may have fomented and resulting undercapitalization that puts them and the financial system on the brink of collapse.

The demotic backlash reaches particularly to Citi’s deal with The New York Mets concerning branding rights associated with the team’s new stadium, Citi Field, scheduled to open this baseball season. Citi has a 20-year contract with the Mets for various marketing programs, including naming the stadium, in exchange for $20 million in annual payments.

Other banks have similar sports-branding deals with other teams. Barclays, the British bank, signed a contract in 2007 on terms substantially similar to the Citi-Mets deal. It agreed to pay $20 million annually for 20 years in connection with promoting the New York Nets basketball team and naming their new arena.

Bank of America has a contract with the Carolina Panthers football team, under which it pays $7 million annually for marketing rights at that team’s stadium, including naming it. Notably, on a per-game basis, that figure is 4 times higher than Citi’s Mets deal and twice as a high as the Barclays deal.

Pressure on Citi heated up in late January when some in Congress demanded that Citi terminate its contract. Citi reportedly gave some thought to terminating the agreement, but promptly quashed speculation that it would do so. Others in Congress support that decision, emphasizing that the contract and marketing arrangements involve business decisions that it is not the job of Congress to second guess or micromanage.

Nevertheless, pressure remains, with a New York Times reporter suggesting the money would be better spent retaining workers, while others defend the deals on the grounds that they help the banks’ economic positions, both through improved branding and associated merchandising transactions.

How should informed people think about the Citi-Mets arrangement, and others, and assess the competing political, business and economic issues implicated?

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State Law Guidance for Treasury Investment Program

Del State Seal.gifAs the US Treasury Department continues to lend to or make senior equity investments in corporate America, especially its financial institutions, people debate whether those taxpayer investments should be accompanied by limits on investees’ right to pay cash dividends to common stockholders.

This is a fundamental issue in corporate finance, requiring mediation of a tension between senior investors, who want security of repayment, and common (junior) stockholders, who want periodic returns on their investment.

The balance and how to resolve it is reflected in state corporation law regulating dividends. In general, those laws provide a minimum level of protection to senior lenders and equity holders, restricting distributions to common stockholders to minimize bankruptcy risk, and assuring that a corporation has flexibility to make such distributions.

A review of state corporation law approaches may be useful to assess what policies Treasury should consider when investing taxpayer funds in senior loans or equity in corporate America. The review suggests that: (1) Treasury may go too far if it prohibits cash dividends altogether; and (2) tools it is developing to assess investee’s positions, called stress tests, routinely used under some state statutes to determine the legality of distributions to common stockholders, should be applied to determine, on a case by case basis, to what extent, if any, government investment of taxpayer funds should be conditioned on investees’ restricting dividends on common stock.

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New Treasury’s Shackled Dividend Policy

shackles.jpgGovernment is treating the country to a national conversation on corporate finance, focusing on a tension between common stockholders of corporations and those who lend or buy preferred stock. The government is deep into the business of lending or buying preferred stock with taxpayer money; the public is interested to know how secure those positions are and how likely they are to reinvigorate private investment in public companies.

While the Bush Administration made loans and bought preferred stock without insisting on many restrictions, the Obama Administration proposes a more restrictive posture. Both struggle with the inherent tension in corporate finance between protecting creditor and senior equity interests, on the one hand, and providing common (junior) stockholders with periodic returns on investment through dividends on the other.

Creditors and senior equity holders want assurance of repayment, so the temptation may be to prohibit common stock dividends entirely. This temptation explains why many populist critics rebuked Bush Treasury Secretary, Henry Paulson, for lending or investing in corporations without restricting their right to pay cash dividends to common stockholders. The rebuke may also explain Obama Treasury Secretary Timothy Geithner’s opposite proposal to prohibit such dividends, although this populist stance may prolong rather than shorten the current capital crisis.

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Two Ways to do Government Corp Fin

Money Bags.jpgThe United States government is one of the largest, and few, investors in corporate finance deals these days. Congress authorized Treasury to use up to $350 billion in government funds to invest in corporate America (with a contingent increase of another $350 billion). Its authorization to Treasury is very broad, and has allowed it to make any form of investment (mostly but not exclusively in financial institutions), on such terms as the Treasury Secretary deems advisable.

The approach to investing these funds appears strikingly different between Bush Administration Treasury Secretary Hank Paulson and Obama Treasury Secretary Tim Geithner.

Paulson took a tailored, deal by deal approach. He never published clear guidelines concerning in which companies he would invest. Sometimes he invested by lending and sometimes in preferred stock. Sometimes he’d negotiate for covenants from the other side and sometimes he would not. He did not publicize resulting investment contracts. In general, he did not impose covenants on investees, such as restrictions on making asset distributions to common stockholders, although in some cases he did extract those concessions (e.g., with General Motors Acceptance Corporation).

Geithner on Tuesday issued a general template for his investment program. He has published guidelines for what investees must do to earn his investments. They have to explain how they will use funds, requiring that they be used to run the business, not hoarded, meaning, for banks, lending money to customers. Investees have to make monthly reports to Treasury showing how they used the funds to make loans or support loans made by other institutions. Investees must undergo a threshold financial stress test, assessing their financial position, and capital needs.

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Case of the Mistaken (Illusory) Investment

Sherwood v Walker.jpgCan a spouse rescind a divorce settlement contract if it turns out that the valuation assigned to assets the spouse retained in exchange for a cash payment to the other was inflated due to fraud by a third party?

Several years ago, Husband, a prominent New York real estate attorney at a large firm, and Wife, entered into a contract as part of an uncontested divorce. In the negotiations, the two listed their marital assets, including several homes, and divided them roughly fifty-fifty.

The homes aside, it appeared that the couples’ total assets to split amounted to $13.2 million. The agreement apparently provided that Husband would retain these assets, in their extant form, in exchange for making a cash payment to Wife in the amount of $6.6 million.

It turns out, several years later, that the value of these other assets was overstated by $5.4 million. That portion of the assets are actually worth zero, because they were held in an investment account managed by Bernard Madoff, whose fund turned out to be a Ponzi scheme.

According to the New York Daily News, Husband seeks rescission and reformation of that part of the contract, along with restitution from Wife in the amount of $2.7 million (half the amount of the original valuation of that account). Can he? What grounds are available to do so?

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Little Interest in Global Accounting (IFRS)

globe.jpgThe Securities and Exchange Commission under prevoius Chair, Chris Cox, spent considerable resources in a quixotic plan to switch the US from its own accounting standards to international ones. Right before he left office last month, in mid-November, Cox had the SEC issue a release for public comment concerning a proposal to compel the switch by 2014 (calling the proposal a “Roadmap”).

Not surprisingly, few constituents consider this a good time to make any such switch or even a good time to comment on the proposal. Companies and investors have far more important matters to attend to than this bit of folly on which the previous SEC Chair spent so much time the past two years. Many comment letters on the proposal forthrightly declare that companies find it terribly inconvenient to comment now and that they need more time to consider such a fantastic proposal.

A few companies somehow have found the time to explain numerous concerns and problems, many of which I address in my newly-published article in North Carolina Law Review, which the SEC, under Chair Cox, simply overlooked or discounted.

Illustrative are the following excerpts from the comment letter contributed by Marriott, dated Monday. (References to IFRS are to International Financial Reporting Standards and to IASB are to the International Accounting Standards Board, the self-appointed private organization that put itself in charge ot setting global accounting standards.)

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Watching Clouds in Delaware: Gantler v. Stephens

clouds.jpgFifteen years ago, I and my colleague Chuck Yablon, wrote the following about Delaware corporate law (in 49 Business Lawyer 1593 (1994)):

[P]redicting developments in Delaware law has always been a somewhat foolish enterprise. Many learned commentators have written careful and lucid analyses predicting the trend of Delaware case law, only to have doctrinal prognostications shattered by the next big case. Predicting the course of Delaware law from prior case law is like watching clouds. They seem, at times, to take on recognizable shapes and forms, even to resemble something familiar. But you know that whatever shapes you think you see can vanish in a puff of wind.

I can’t make the same complaint about a Delaware Supreme Court opinion released last week, Gantler v. Stephens, that’s receiving surprising attention, despite saying little or nothing new. (One champion and devotee of the minutiae of Delaware corporate law even calls it, peculiarly, “very momentous” and a “major decision.”)

True, as Usha Rodriques at Conglomerate fairly notes, the case says that corporate officers owe their corporations the same fiduciary duties that directors do. But the court makes that point by citing Delaware opinions from 1939 and 1993 and Gantler is most about directors, not officers. Scholars may have paid inadequate attention to officer duties, but this case will not likely change the focus (though Professor Rodriques’s new article on the subject in Florida Law Review may do so.)

Also true, as a Paul Weiss client report sensibly notes, the opinion clarifies that shareholders can’t be held to ratify director actions, that statute requires them to approve, except through the statutory approval process.

Other than that, the opinion is doctrinally of little moment, as the following principal points show:

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