The Law and Other Anomalies

It is amazing how many corporations are set up “50-50,” which is to say two equal partners with equal ownership, and equal say on the board of directors. What happens when, over time, these shareholders come to violent disagreement?

The Massachusetts Supreme Judicial Court, in a September ruling (Indus Systems), applied the Massachusetts Corporate Statute to a tense shareholder dispute, declared the existence of a deadlock under the Statute, and sent the case back down to the Superior (Trial) Court to remedy the situation. The Massachusetts Statute provides that in the case of deadlock, the Courts have the power to dissolve a corporation.

Of course, in this case (a profitable going enterprise) it doesn’t make much sense to break up the company, wind down its contracts and lay off the workers. No problem for the Supreme Judicial Court: the Court declared that implicit in the power to dissolve is the power of the Court to take other action, including forcing a sale of the business to a third party or forcing a sale between the parties so that one shareholder remains standing.

Lawyers typically counsel at the formation of a company that some sort of an unwind procedure be built into the corporate documentation to meet the future contingency of deadlock. This is of course a negative message for a lawyer to deliver to two individuals who are anxious to get going with their business, and find it intrusive and unsettling to contemplate what might happen, years hence, when they violently disagree. Additionally, aside from this distraction, there is a cost to discussing and documenting an unwind procedure which sometimes can be as expensive as all the positive work of forming the company, issuing bylaws and issuing shares of stock. Along with addressing what happens in the event that one of the shareholders dies or becomes disabled, drafting provisions whereby, in the event of a deadlock, one shareholder might be forced to sell out to the other presents legal and interpersonal problems that are difficult to parse, particularly at the initial stages of forming a business.

But shareholders should not be relying wholly on statutory remedies because it is quite difficult to prove a “deadlock” within the meaning of the Massachusetts Corporate law. Suffice it to say that in the Indus case there were not only disagreements with respect to corporate policy, but also unilateral actions by one or the other of the shareholders, including the writing of a $690,000 personal check by one of the shareholders to his own order, against company funds.

2017 has been a banner year for activist shareholders approaching public companies. Major activists continue to target large companies, but the average market cap of targets is approximately $260,000,000. How should boards approach the discharge of their obligations, when an activist comes knocking?

An expert panel convened by the New England Chapter of the National Association of Corporate Directors on June 13 suggested that the first step is to be prepared. This involves identifying what the 72 hours following an initial approach by an activist shareholder should look like: who speaks for the company, how are legal and public relations and SEC inputs triggered, what is the general nature of the response? Of course, proper preparation also steps back further in time: since activists often are questioning fundamental corporate strategy, a board should oversee making corporate strategy generally known, on a continual basis, through SEC filings and shareholder conferences.

Old school was to “circle the wagons” and not listen to activists, many of whom were viewed as simply attempting to force a company sale in order to achieve short-term gain.

But this instinctive response may not be the wisest. Activists typically have carefully analyzed the company, and indeed may have identified other shareholders friendly to their position. The proper response is to engage, listen and evaluate. Many boards have “learned things” of value from activists.

It is appropriate for the board to make an independent judgement as to whether activist proposals make sense for the long term (not the short term) health of the corporation and its owner-shareholders. Boards, and management, ultimately are responsible to these owners, and sometimes violent resistance to activists serves the purpose of offending other shareholders and strengthening the hand of the activist.

Statistically, in the past year only about 20% of activists’ approaches to companies resulted in a formal shareholder proposal, and of these more than half ultimately were withdrawn based upon discussion with a target. Even if a company is not in agreement with what is being proposed, open discussion with activists seeking agreement on strategic changes (and possibly an addition to the board) is the preferred initial approach.

Who should speak for the board? Activists often want to speak to individual directors. This may be a growing trend but it is dangerous; a given director may not be the best-informed emissary, and may well not be prepared about compliance with Regulation FD, the SEC regulation requiring public disclosure to all parties if material confidential information is released to any party.

The main thing to understand about the future is actually two things: the first is that it is here now, and the second is that the rest of it is going to arrive much faster than you think.

Putting flesh on these generalities, futurist and author Jack Uldrich outlined for a Boston lunch audience (convened by Atlantic Trust Company) some highlights of the rapid pace of change:

The rate of technological change is not linear but exponential. Very shortly companies operating in the “millions” will be operating in the “billions.”

There are numerous “new verticals” which will disrupt just about everything: manufacture by printing, nanotech, robotics, the internet of things, the genome, AI, Big Data.

You need only look back 10 or 20 years and see whether the shape of the current world could have been imagined at that time. The answer of course was “no.” You have to look ahead with humility, and not assume that the ideas fixed in your head are going to have anything to do with the shape of the future and, consequently, your investments in same. Even the organization of the distribution of “stuff” will be changed; think “Amazon Go” and the sharing economy.

Underlying theme? Be humble, be flexible, look around you: the future is already here and discernable if you pay attention.

Query: who fully believes this in making investment choices?  History and logic suggest such things as diversification; does anyone put 100% into the new economy?

Does your company, whether public or private or nonprofit, have a crisis management plan? An expert panel convened by the National Association of Corporate Directors in Boston on May 9, 2017 all agree that a plan is necessary; they also agree that it is very hard to follow.

A written plan defines actions to be taken by lawyers, management, public relations, crisis management experts and the like. The first message from the company is very important as it sets the stage for a public understanding of the issues. This first statement must be immediate and is often at a time when all the facts are not known. The key things to remember in this first statement: a tone of concern, and a plan to mitigate or repair the damage.

If things are going well, the role of directors is to make sure that the crisis plan is in place and not to interface directly with implementation. If things are not going well, such as the recent United Airlines flap about injuring a removed passenger or the Wells Fargo flap about improper opening of customer accounts, boards have been known to make public statements.  Once you are in a crisis, boards should be busy monitoring. You can’t monitor a true crisis with weekly meetings; in the heat of things, daily attention is the order of the day.

One thing for boards to remember is that social media is very important for many companies, certainly those which are public-facing. It is important for someone understanding social media to advise the board in this regard, particularly because boards tend to be older and not skilled in this space.  It is also important to identify those constituencies most impacted so that your response addresses their concerns. Are you most interested in public consumers, employees, customers, or executives?

It was noted that many small tech companies, growing quickly, in fact do not have crisis management plans. Things are moving too fast and attention is diverted to growth. The obvious consensus: you nonetheless should have something in place.

One interesting omission in the discussion: when there is a crisis, lawyers often tell companies that the first people to contact are the lawyers, so that the lawyers can investigate, retain experts, and thereby maintain confidentiality of information based upon the lawyer-client privilege. This advice may be difficult to implement in the intense hours following the surfacing of a crisis.

Finally, a word about claims of sexual harassment from the top. There was unanimous sense that this must be, for all companies, a “zero tolerance moment” where the board must make sure that “the right thing” is done for the benefit of the company. Personal allegiances between senior management and the board may make difficult the enforcement of this fundamental position.

The term “nonprofit organization” is a misnomer, agreed a panel convened Tuesday by the New England Chapter of the National Association of Corporate Directors. Organizations performing public service need profit in order to be sustainable in the long-term delivery of their missions.

And beware of establishing endowment funds. Some problems are not continuous, and people like to invest in solving problems and not perpetuating them. By way of example, if you have a problem that $1,000,000 might cure, why establish a $1,000,000 endowment where the annual income at a 5% yield is $50,000? The proliferation of endowments may be inhibiting the meeting of certain mission goals.

Other panel takeaways included:

Beware of the practice of establishing “consent agendas,” the practice of sending out detailed board agendas and committee reports for pre-meeting analysis, followed by a vote adopting all corporate action required by that agenda. The argument is that this saves time for more important discussions. However, major weakness were noted, including particularly that the practice encourages board members to not read the material carefully because there would be no discussion; and, the temptation for management to use the technique to hide exactly what is going on within the organization.

Beware also, in the face of the trend of nonprofit organizations to have larger and larger boards, often driven by donor participation, that you do not place too much power in an executive committee. With larger donor driven boards, there is a tendency to view deciding everything within an executive committee as being more efficient. However, ALL board members have fiduciary duties and an executive committee is a small group. You gain benefit from discussion within a larger group. Further, concentrating power in the executive committee tends to make your better board members less attentive, as they sense they are becoming “rubber stamps.”