The Law and Other Anomalies

Okay, all the publicity is about crypto-currency, its volatility, its hack-ability ($530M lost yesterday), its potential for fraud (SEC action announced today against a so-called “bank” permitting trades in 700 crypto-coins, or so they said).  While all this is going on, among other wholly legitimate uses of blockchain is the maintenance of corporate stock records.

The dumbed-down description of blockchain is that it is just a set of bookkeeping entries, recorded electronically and accessible to anyone with a computer.  In my subsequent efforts to understand what it is, I did much more reading and discovered it is just a set of bookkeeping entries recorded in electron…. well, you get the idea.

It also seems perfect for keeping a stock ledger, recording holdings and transfers and stop-transfers and the like, replacing registrars and transfer agents and all sorts of intermediaries which have costs to incur.  As it turns out, the methods for doing all that by blockchain seem congruent with the laws that control stock transfers, probably without need to alter those laws.  While one alleged crypto-currency advantage of blockchain, total anonymity, is not possible with share ledgers (companies, brokers,  proxy solicitors, regulators need to know who’s who), there is no reason why names cannot be made accessible to appropriate, and only to appropriate, parties.

An interesting article in The Business Lawyer (vol 73, Winter 2017-18 at 85) describes the experience of one public company the shares of which are handled in this fashion.  The article is suitable for perusal by non-attorneys also as, unlike much legal writing, this piece appears to be written in English; and, the references to the statute (UCC Article 8) are easily skip-able.

When you leave your executive position, you are often asked to sign a “standard” severance document which reminds you of restrictions binding upon you, and addresses your entitlements upon leaving employ.  Sometimes, the form of this document is set forth as an attachment to your original employment agreement or is in a company handbook. These letters or formal agreements typically contain a release of all claims against your employer.

In a just-decided Massachusetts Appeals Court case, a departing executive signed such a general release and failed to except out his right (contained in his option grant agreement) to exercise his fully vested stock options for a period of time after employment terminated.  The court held that the executive forfeited his vested options and could not exercise them.  In Massachusetts, a general release will be literally enforced.  The former employee must expressly list those rights that survive.

While there is no standard check-list of surviving exceptions, and while companies present these agreements as boilerplate, the employee needs to record everything that is not being paid on the spot.  Clearly stock options and rights in other deferred comp plans need to be listed.  How about these: rights in all health, insurance, disability and like plans; rights to unpaid and accrued compensation and bonuses and expenses;  unpaid sick or vacation days; rights under any company-funded coverages; rights to exoneration, indemnity and defense under any charter, by-law, company policy or contractual provision that protects the executive from claims for breach of duty or wrong-doing; right to retrieve any personal property left on premises; rights under any out-placement program or understanding for maintenance of an office or support services; right to purchase a company vehicle.  This list is suggestive; departing employees need to think about what they are to retain, and employers typically will permit modification of the general release to reflect those things to which the executive is in fact entitled.

This third and last post, based on noteworthy Delaware Court decisions during 2017 which I had not addressed in posts during the year, engages the seemingly technical question of what if any duties does a general partner owe to limited partners where the partnership agreement, not atypically, waives all fiduciary duties owed by the GP.

We are all aware of the waivers of duty obtained by sponsors of deals, allowing them to self-deal without running afoul of the fiduciary obligation owed by partners to each other under basic partnership law.  Recognizing that a GP cannot, however, contract with someone to permit that GP to steal from investors, often LLC and partnership agreements have mechanisms to protect the investors from what I will call in lay terms an “outrageous overreach,” typically drafted into sections that allow the controlling party to enter into transactions for his or her own account, or the account of his or her controlled entity, without facing some legal claim.

There is also in contract law (LLCs and partnerships are after all just contractual arrangements) an ill-defined but time-honored rule of construction that imposes on all parties an obligation to act with good faith and fair dealings with all other parties in the transaction.

In the January, 2017 Delaware Supreme Court Decision in  Dieckman v Regency, a GP undertook an interested party transaction and attempted to comply with both of the procedures set forth in that particular LP agreement.  He sought approval from a Conflicts Committee, which was allegedly tainted by self-interest.  He also sought a vote of the independent investors, but the complaint alleged that the materials given to the investors to induce approval for the transaction were false and misleading.

The Chancery Court below held that the complaint must be dismissed because all fiduciary obligations were waived in the contract and thus no argument could be made that misrepresentations violated such obligations.

The Supreme Court reversed and ruled that even where all fiduciary duties are waived, the implied covenant of good faith and fair dealing prevented the GP from misrepresenting to the investors to induce their approval.  In reaching this not-very-startling conclusion, the Court tripped over itself to explain that a waiver of fiduciary duty is not a license to lie and thus deprive the investors of their contractual right to approve or disapprove the transaction.  The covenant protects against action taken “arbitrarily or unreasonably, thereby frustrating the fruits of the bargain that the asserting party reasonably expected.”  What are these fruits of the bargain, as they are not expressly stated in the document; and indeed appear to have been waived?  Some “fruits” are so implicit that they need not be expressed, as their existence is “necessary to vindicate the apparent intentions and reasonable expectations of the parties.”  These fruits are “so obvious … that the drafter would not have need to include the conditions as express terms of the agreement.”

What then can we deduce as the legal meaning of the implied covenant of good faith and fair dealing?  “You cannot lie, cheat or steal.”  Not radical concepts, and it would be amazing if a Court could not find its way to so holding.  As for how the Court explains and relies upon the implied covenant — well, it seems to me that my articulation is more direct and understandable than the lawyerly and extensive explanatory efforts of the Supreme Court.

And if a GP is tempted to seek a waiver, in the partnership agreement, of any claims based on an implied covenant of good faith and fair dealing, thus meeting the covenant head-on?  One might expect the Court to void that waiver as against public policy, putting aside that even the most jaded of investors might blink at such a startling provision.

Caremark is a notable Delaware Court decision establishing the principle that, while corporate directors are protected from suit based on errors made in good faith and without self-interest, directors nonetheless can be liable if they simply ignore significant corporate matters which ultimately injure their company.  It has been difficult in fact to find successful assertion of a breach of this duty to diligently supervise, however.  Last month, the Delaware Supreme Court again highlighted that difficulty.

Duke Energy suffered liability for numerous environmental violations.  The board was sued for  breach of its duty properly to supervise the response to this liability; suit was brought without a prior demand on the board to cure its actions on the theory that such demand would be futile under the statute.  Noting that the majority of the board consisted of independent directors, the Court found that the plaintiffs indeed failed to make a required demand as such demand would not have been necessarily futile.

It was conceded that the board was indeed aware of the environmental liability, even based on criminal activity.  But knowledge did not mean that the board permitted illegal behavior through failure to maintain sufficient internal controls.  Plaintiffs failed to establish at the pleading stage that the board knew that the company was ignoring the violations, even though the board knew of these violations.

The Court decision is facially startling.  One might expect a vigorous response on the record from an independent board knowing of criminal environmental wrongdoing.  The decision emphasizes the hesitancy of the Delaware Courts to affix liability to directors, not involved in self-dealing, based on their exercise of their judgment about how to handle all manner of issues. A dissent from one justice hearing the case would have decided the case differently, but clearly the extent of breach of duty is a matter of judgment resting in the eyes of the beholder, and directors seemingly can be pretty far off-base without incurring legal liability for their actions absent self-interest.

An expert panel convened this week by the National Association of Corporate Directors – New England identified current issues occupying compensation committees as they begin to engage on policies for the coming fiscal year.

One surprise: tremendous attention to the much-maligned SEC Rule requiring that current proxies contain a disclosure of the earnings ratio comparing a company’s CEO to the earnings of a “mean” employee.

I recently posted that ISS, in survey, had discovered that this much-criticized and much-delayed disclosure had actually proven to be of interest to investors, notwithstanding the fact that analysis during the Rule’s adoption debate suggested that the data was superfluous. The panelists speculated that such disclosure will cause executives to question whether all management is being properly paid, and will trigger discussions about compensation strategy throughout the organization, and about the entire “employee value relationship.”

What is the value proposition for an employee, why should that employee want to work where now situated and at current compensation? Millennials might be more attuned to such issues; millennials do not anticipate permanent employment relationships and may be more interested in what a company offers by way of career development.

The panel also noted that much more attention was being paid to “fair compensation” of minorities and women. Since 55% to 60% of current college graduates are women, boards should ask for hiring metrics for women at all levels. The absence of women at senior levels, and sitting on boards, is “a problem” and comp committees should make sure that pay is monitored by gender and that accurate data is provided. It is necessary to specifically call out wage disparities, as the only way to eliminate them: “if it is measured, it gets done.”

The perennial issue of balancing compensation incentives between rewarding short-term goals and rewarding long-term strategic goals was discussed at length. It is necessary for the compensation committee to determine what results are most important, and to provide a compensation and bonus strategy that specifically rewards desired outcomes. There is a problem where strategic goals are long-term: how do you craft a bonus plan, for example, where somebody is working during the first year of a five year strategic program? The general approach for rewarding people working on long-term strategic issues is to provide individualized bonuses, and not to rely on the over-all comp/bonus program (which is generally driven by financial metrics).

Finally, the operational aspects of the compensation committee were discussed. Often there is not enough time to deal with matters which must be addressed as a matter of corporate governance, and then have time to discuss the philosophy of compensation. Ways around this include: an organized and strong chair; receiving the board package well in advance so that members of the comp committee can discuss by email or telephone some of the issues presented prior to the actual meeting; a dinner of the committee prior to its formal meeting, in order to provide soft exposure for ideas and to facilitate communication (a practice of many boards but not committees).