www.TheDefiningTension.com

[No. 95] Too Serious?

I’ve spotted this trick some time ago over at the blog of my co-author Mathias Siems, and been curious ever since to use it myself sometime. So here we go. The website Wordle.net has a feature that enables you to insert a bunch of text or, in our case, the link to a website containing text. Wordle then generates 'word clouds', which give greater prominence to words that appear more frequently in the source text. Below is the result for The Defining Tension:

A couple of observations and possible explanations (after all, we’re academics):

-    What stands out is the prominent featuring of the word 'director'. Clearly, this is the work of The Defining Tension-founder Bastiaan Assink, who wrote his PhD-thesis on 'Judicial Review of Director Conduct' and ever since is showing significant bias towards writing on director-related issues;
-    How about the mysterious '2:9'? It’s the section of the Dutch Civil Code on the basis of which directors can be held liable. See my previous comment for an explanation;
-    Then there’s a bunch of words that have no apparent meaning in English. That’s because their Dutch words. Long live our bilingual approach;
-    Personally, I’m a bit concerned about the relatively prominent featuring of the word 'serious'. There can be too much of a good thing. And the problem is, now I’ve mentioned it, the word 'serious' will only feature more prominently next time we create a word cloud. Thankfully, Wordle also has a function that enables you to delete individual words that you’d rather not show off. Aah, the wonders of technology.

[No. 94] Off the Bench... [Updated]

Some time ago, Delaware lawyer Francis Pileggi reported about the fact that Vice Chancellor Stephen P. Lamb isn't seeking reappointed after his term expires in July 2009 and wondered who would fill the vacancy. For some name-dropping, see here.

That last question is still unanswered, as the replacement process isn't finished yet, but word came out today - officially that is - where the departing Vice Chancellor will be heading in his post-judicial career: back to private practice.

UPDATE

Available here and here.

[No. 93] The Times They Are A-Changin'

In the past years, many corporate governance reforms took place in order to enhance the position of shareholders in Dutch corporations, especially listed corporations.

The real kick-off was the first Dutch corporate governance code of 2003, drafted in the wake of the reporting scandals that were revealed in the early years of this decade. The code, that was aimed at listed companies, emphasized the importance of transparency, sound supervision in the corporation on management and strengthening of intra-corporate accountability structures. It stated, among many other things:

The confidence of the stakeholders that their interests are represented is essential if they are to cooperate effectively within and with the company. Good entrepreneurship, including integrity and transparency of decision-making by the management board, and proper supervision thereof, including accountability for such supervision, are essential if the stakeholders are to have confidence in the management board and the supervision. These are the two pillars on which good corporate governance rests and on which this code is based.

The code was followed by several advisory documents drafted by the Monitoring Committee Corporate Governance in the 2005-2008 period. The 2003 code was also followed by amendments of the Dutch corporate statute in 2004, that were also intended to enhance the position of shareholders. The amendments included:

• the right of the general meeting of public corporations to approve certain board resolutions concerning fundamental corporate changes (section 2:107a DCC);
• the right for individual shareholders owning 1% of the issued shares to put items on the agenda of the general meeting (section 2:114a/224a DCC);
• more detailled rules concerning the public corporation's renumeration of management director policy, to be established by the general meeting (section 2:135 DCC); and
• the right to fire en bloc the supervisory board in large corporations (which board appoints and fires management directors), something that was impossible until then (section 2:161a/271a DCC).

In 2007, legislation was drafted that enabled shareholders to participate and vote in the general meeting by means of electronic communication (section 2:117a-117b/227a-227b DCC).

But in recent years, the sentiment has changed; did we go overboard with restoring the shareholders' position in the corporate governance framework? This was caused in part by several instances in which activist shareholders - including hedge funds and private equity - challenged the strategic course followed by the corporation or acquired the corporation (using the enhanced position of shareholders in Dutch corporations), ending up in highly publicized litigation before the Enterprise Chamber of the Amsterdam Court of Appeal; see, e.g., ABN Amro, Stork, PCM and recently ASM International. The concern grew that corporations may have been too focused on shareholder wealth maximization in the short run, without being too concerned with the corporation's long-term horizon and the interests of other stakeholders involved, which concern grew bigger when the credit crisis hit the world economy. The fact that the Enterprise Chamber made some controversial decisions, sometimes reversed by the Supreme Court, was also a factor.

There are strong signs that the 'emancipation of shareholders' era is coming to an end. For example, plans are being made to 'tweak' the right of inquiry, including a controversial advice by the Social Economic Council:

1. that seems intended to higher the bar for shareholders to apply the right of inquiry; and
2. that also includes the proposal to introduce a business judgment rule type of review in the right of inquiry (which, in itself, makes sense).

Another is the corporate governance code as updated in 2008:

1. that focuses more heavily on standards of conduct expected of the shareholders; and
2. that provides for a right of the board to apply a maximum 180 days stand-still period (a response time) when shareholders take initiative to contest the corporation's strategy, for example by putting on the agenda of the general meeting as item the firing of the supervisory board.

A third one is a recent legislative proposal, that includes:

• a lowering of the threshold for ownership disclosure in listed corporations from 5% to 3%;
• the introduction of an obligation for shareholders of listed corporations to make known their position as to the corporation's strategy to the Authority Financial Markets ('yes' when the strategy is opposed and plans are made to go active, 'no' in other cases), also everytime the intention changes;
• an increase of the threshold to put items on the agenda from 1% to 3% of the issued shares; and
• the introduction of the right of listed corporations to obtain information as to the identity of its shareholders prior to any general meeting (and, in effect, a corresponding obligation of shareholders to provide that information).

The cabinet is also exploring the possibility for statutory reforms aimed at enhancing long-term shareholdership, for example by making possible rewarding loyal shareholders with more voting rights or dividend. It will come as no surprise that this proposal generated quite some blow-back in shareholder circles, see, e.g., here. That said, it's clear that the times they are a-changin' for shareholders in the Netherlands, especially in listed corporations.

Interestingly, a different wind of change seems to be blowing in the US, where legislative proposals were drafted at federal level recently that aim to enhance the position of shareholders in the corporate governance framework. These proposals have generated critical comments, also from - dare I say - usual suspects. As one of them argues:

The financial crisis of 2008 and the ascendancy of the Democratic Party in Washington have created an environment in which proponents of expanded shareholder corporate governance rights are making considerable progress. Even before the crisis hit, of course, there had been a number of efforts to extend the shareholder franchise, principally so as to empower institutional investors. The crisis, however, has given them new momentum. The logic behind the shareholder empowerment project is that institutional investors will behave quite differently than dispersed individual investors. Because they own large blocks, and have an incentive to develop specialized expertise in making and monitoring investments, institutional investors could play a far more active role in corporate governance than dispersed individual investors traditionally have done. Institutional investors holding large blocks thus have more power to hold management accountable for actions that do not promote shareholder welfare. Their greater access to firm information, coupled with their concentrated voting power, might enable them to more actively monitor the firm’s performance and to make changes in the board’s composition when performance lagged. In fact, however, institutional investor activism is rare and limited primarily to union and state or local public employee pensions. As a result, institutional investor activism has not—and cannot—prove a panacea for the pathologies of corporate governance. Activist investors pursue agendas not shared by and often in conflict with those of passive investors. Activism by investors undermines the role of the board of directors as a central decision-making body, thereby making corporate governance less effective. Finally, relying on activist institutional investors will not solve the principal-agent problem inherent in corporate governance but rather will merely shift the locus of that problem.

For another criticaster, who writes about a 'legislative parade of horribles', go here.

[No. 92] Director Liability in Tort - Views From Across the Atlantic

In several posts I have written about the framework and rationale of corporate director liability in tort vis-a-vis third parties - like company creditors - under Dutch law. See, e.g., here, here, here and here.

Case law on point by the Supreme Court was labelled "curious from an American perspective" by a prominent American corporate law scholar. For my response see here.

Interestingly, a paper was published at SSRN by Martin Petrin that touches upon this topic - i.e., corporate director liability in tort towards third parties - from a US perspective. It's titled The Curious Case of Directors' and Officers' Liability for Supervision and Management: Exploring the Intersection of Corporate and Tort Law and here's the abstract.

Abstract:
Directors' and officers' liability under corporate and securities laws continues to be a hotly debated subject. Yet, their liability toward non-shareholder third parties under common tort law and statutory provisions has generated modest scholarly interest. Thus, it has gone almost unnoticed that corporate directors and officers can be held personally liable in tort to non-shareholder third parties based on failures in excercising their corporate duties - supervision and management.

However, as this article explains, the current liability regime in this area is in need of repair. It fails to distinguish between the corporation's duties and the duties of directors and officers, neglects the separate corporate personality of the corporation, unduly shifts the risk of doing business to directors and officers, and undermines the heightened liability protections provided to directors and officers by corporate laws. Consequently, a new approach is required.

This article proposes a novel model for corporate liability that is centered around the nature of the directors' and officers' duties and focuses on the individual's state of mind. At its core, the proposed model is based on the belief that in onrder to preserve the corporate shield, liability standards in tort law should not conflate the standards imposed on individuals with those imposed on directors and officers.

Keywords: directors' and officers' liability, corporate liability, tort, supervision and management.

JEL Classifications: K22, K13

Working Paper Series

At first glance, Petrin's reasoning doesn't seem all that curious to me.

[No. 91] Director Liability and Disculpation Defences - Muddy Waters

1. Pursuant to section 2:9 DCC, every director is expected to perform his/her task properly vis-a-vis the legal entity (like corporations). The second sentence of section 2:9 DCC provides that if a matter falls within the job parameters of two or more directors, every director is liable for the full amount in case of malperformance, unless the director cannot be blamed for the malperformance and he/she was not negligent in taking measures to avoid the consequences of the malperformance. In Dutch:

Een bestuurder is tegenover de rechtspersoon gehouden tot een behoorlijke vervulling van de hem opgedragen taak. Indien het een aangelegenheid betreft die tot de werkkring van twee of meer bestuurders behoort, is ieder van hen voor het geheel aansprakelijk terzake van een tekortkoming, tenzij deze niet aan hem is te wijten en hij niet nalatig is geweest in het treffen van maatregelen om de gevolgen daarvan af te wenden.

This notion of collective director liability - unless there is a ground for individual disculpation, which requires a director-by-director approach as to the director(s) who present(s) a disculpation defence - is based on the notion of collective board responsibility. Directors are in it together.

2. The Supreme Court has clarified that in order to be personally liable, a director must have made a serious mistake (ernstig verwijt). The Supreme Court has never really made clear what the anatomy of such a serious mistake in the section 2:9 DCC setting is. What it has made clear, since 1997, is:

• that such a serious mistake should be distinguished from conscious recklessness and intentional misconduct;
• that the circumstance that the director has violated a provision in the legal entity's articles of association that aims to protect the legal entity - like the provision mandating prior approval by supervisory directors for certain transactions - in principle results in liability (i.e., there is a presumption of a serious mistake), although the director does have the possibility to show that on balance that violation does not qualify as a serious mistake; and
• that the circumstances that could play a role in the personal liability analysis include:
  • the nature of the activities undertaken by the legal entity;
  • the risks generally involved with those activities;
  • a division of tasks within the board (if any);
  • guidelines the board has to take into account (if any);
  • information the director had or should have had at the time of the decision or act that is under attack; and
  • the knowledge and care that can be expected of a director that is up to his/her task and fulfills his/her task in a diligent manner.

I explained the essence of this case law, e.g., here, here and here.

3. There seems to be consensus in literature that if - in case of a board consisting of two or more directors - one director has made a serious mistake, all directors are liable for the full amount (jointly and severally) unless they are able to show grounds justifying they should not be (i.e., they can disculpate themselves). In this approach, the "if a matter falls within the job parameters of two or more directors" wording becomes part of the general disculpation analysis. However this may be, it is still unsettled in case law - due to lack of Supreme Court precedent - how the second sentence of section 2:9 DCC should be applied. The water is still muddy. Some clarity was provided more recently by the Ministry of Justice, when it presented its legislative proposal to introduce an optional one-tier board structure in Dutch case law (Dutch law traditionally applies the two-tier system, see, e.g., here), that also aims to modify section 2:9 DCC somewhat in light of this development. The proposal includes:

• adding to the new section 2:9 DCC the liability threshold introduced in case law (i.e., serious mistake); and
• that in case of a multiple-person board, an element in the disculpation analysis is the divison of tasks (if any).

But in the end, progress is typically made not by legislation but by application of the statutory framework in case law.

4. And there is something to report here. In a recent section 2:9 DCC case, the Leeuwarden Court of Appeal basically had to decide whether the disculpation defence advanced by one of the two directors made sense (I'm leaving some details aside here). Several board decisions were made in violation of the corporation's articles of association, meaning the applicablity of Supreme Court case law explaining that in such a scenario there is a presumption of a serious mistake and that it's up to the director(s) to rebut the presumption in order to avoid liability (leaving aside issues of damage and proximate causation). The Court of Appeal ruled in s. 9-10 that the director who appealed the ruling in first instance - in which both directors were held liable - failed to rebut the presumption, so that unless the director can disculpate himself, liability follows. The focus of the court then shifted to the second sentence of section 2:9 DCC. The disculpation defence of the director, as presented to the Court of Appeal (according to its judgment) was in essence that the other guy, and not him, had usurped all the power and made all the decisions, without him knowing what went on as to decisionmaking (he only stuck to operational activities relating to a different corporation). In short: the 'how was I supposed to know?' defence, implying the matter at hand did not fall within his job parameters. In Dutch:

11. [appellant] voert (met de grieven I,II en III) ter disculpatie aan dat Brander zich solitair met het bestuur van de vennootschappen bezig hield en dat hij ([appellant]) in het geheel niet in de besluitvorming werd betrokken en ook niet wist welke besluiten Brander nam. [appellant] hield zich bezig met het operationele aannemingswerk bij Aannemingsmaatschappij [persoonsnaam]; daarvoor was hij de verantwoordelijke man. Er was een duidelijke taakverdeling. Alle door Aquaverium [de vennootschap, BFA] aan de orde gestelde kwesties hebben zich geheel buiten het gezichtsveld van [appellant] voltrokken, aldus [appellant]. Bovendien stelt [appellant] dat, door de verschillende vennootschappen waarbij Brander betrokken was, het voor hem moeilijk te bepalen zou zijn geweest in het kader van welke vennootschap Brander de betreffende activiteiten verrichtte, zodat hij ook daardoor geen enkel wetenschap kon hebben van de door Aquaverium gestelde kwesties.

The court isn't merciful and dismisses this defence in s. 12, based on two grounds. These grounds follow from the fact, as established by the court, that the decisionmaking situation explained above did not rest on a division of tasks that was explicitly made by the directors, but was the result of a course of events taking place throughout the years as a result of which only the other director was actually performing his task as director of the corporation, while it was neither presented nor shown that the director before the court took any relevant action intended to perform his task as a director of the corporation. 

1. The director before the court thus failed to show that the matter at hand did not fall within his job parameters, basically already killing his disculpation defence; and

2. the fact that this director left the management of the corporation fully to the other director, while he himself (mainly) worked for another corporation, and without (i) having become clear that he even engaged in the smallest degree of control or influencing of  the conduct of the other director and (ii) another disculpation ground being presented to the court, is insufficient to find that as to the violation of the corporation's articles of association he did not make a serious mistake and that he was not seriously negligent in taking measures tot avoid the consequences of the malperformance.

In Dutch:

12.1. Nu [appellant] aan zijn stelling dat de onderhavige besluiten niet tot zijn takenpakket behoorden, ten grondslag legt dat Brander de bestuurstaken volledig naar zich toetrok, zónder hem ([appellant]) bij de besluitvorming te betrekken en zonder hem op de hoogte te tellen van de genomen besluiten, is daarmee naar het oordeel van het hof geen sprake van een op daartoe strekkende afspraken berustende interne verdeling van de bestuurstaken, maar van een feitelijk gegroeide situatie waarin de bestuurstaken enkel door Brander werden uitgeoefend. Gesteld noch gebleken is dat [appellant] enige relevante actie heeft ondernomen die ertoe strekte dat hij zijn verantwoordelijkheden als bestuurder kon (blijven) uitoefenen.
12.2. Daarmee heeft [appellant] naar het oordeel van het hof in de eerste plaats niet, althans niet voldoende onderbouwd betwist dat de onderhavige aangelegenheden behoorden tot zijn werkkring als bedoeld in art. 2:9, tweede zin BW, zodat hij krachtens deze bepaling jo. art. 2:11 BW in beginsel voor het geheel aansprakelijk is ter zake van de betreffende tekortkomingen.
12.3. In de tweede plaats is het hof van oordeel dat het feit dat [appellant] het bestuur van de vennootschap geheel overliet aan Brander en zelf (hoofdzakelijk) werkte voor een andere vennootschap (Aannemingsmaatschappij [persoonsnaam], zie punt 3.2 van de memorie van grieven), zonder dat gesteld of gebleken is dat hij op het handelen van Brander ook maar enige controle of invloed uitoefende, en zonder dat ook verder enige disculperende grond aan het hof is gepresenteerd, onvoldoende is voor het oordeel dat hem ter zake van de onderhavige overtredingen van de statuten geen ernstig verwijt kan worden gemaakt en dat hij niet in ernstige mate nalatig is geweest in het treffen van maatregelen om de gevolgen daarvan af te wenden.
12.4. Het hof sluit zich dan ook aan bij het oordeel van de rechtbank dat het beroep van [appellant] op disculpatie niet opgaat.

So the court dismissed the defence on all possible grounds.

5. Some initial views. I see the rationale of the second ground: it's difficult to justify disculpation under the regime of section 2:9 DCC if the director did not participate in the management of the corporation whatsoever - as the court ruled here - in view of the notion of collective board responsibility (implying that individual directors should not be excluded from the management and should inform themselves on a basic level what other directors are up to), even leaving aside the fact that the director failed to take any damage controlling measure. The first ground seems to assume that there was no division of tasks in the first place, only an abandonment of duty by one director. Based on the facts as presented by the court, that is not without merit. The court, however, does refer to a division of tasks based on an arrangement made by the directors to that effect. If the court is suggesting here that a division of tasks can only be based on such an explicit arrangement, I would find that troubling; granted, it's unclear whether the court is suggesting this, as the contradiction here - as I'm reading it - is not so much one between an explicit and an implicit arrangement as it is one between an arrangement and no arrangement at all, but  still. I am not inclined to rule out the possibility altogether that a division of tasks can be the result of 'the way things evolved over time'. The pivotal question in this respect is whether there is a division of tasks adhered to by the directors, less how that division came into place exactly.

6. In any event: a welcome application in case law of the section 2:9 DCC framework, that may even reach the Supreme Court and help to 'unmuddy' these waters. Who knows? The Defining Tension is patient...

[No. 90] SEC Charges Perry Corp. with Disclosure Violations in Vote Buying Scheme

According to a press release issued by the Securities Exchange Commisison yesterday, the SEC has

charged New York-based investment adviser Perry Corp. with securities law violations for failing to report that it had purchased substantial stock in a public company [i.e., Mylan]. Perry purchased the shares in order to vote them in favor of a merger from which Perry stood to profit.

Readers familiar with the work of Henry Hu and Bernard Black will recall that the Perry/Mylan case featured as a prominent example of empty voting in their seminal article The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership. But as Floyd Norris of the New York Times notes, "vote-buying itself was not the subject of the S.E.C. action. There is no case that indicates there is anything illegal about that." Rather, the SEC action essentially deals with a form of hidden ownership, as also occurred in the case of TCI/CSX (see post No. 64) . 

For other comments on the SEC's action, see here and here. For my paper exploring the reasons why we have ownership disclosure rules and why transparency of empty voting potential is a good thing, see here.

[No. 89] The End of an Era

As of August 1, 2009, the Enterprise Chamber of the Amsterdam Court of Appeal will no longer be chaired by Huub Willems (pictured), who retires - only as chairman? see here - as of that date. In any event it will not be a full retirement, if only because he was appointed as corporate litigation professor at the University of Groningen as of June 1, 2009. Huub Willems has been by far the longest presiding chairman in modern history of the Enterprise Chamber (that started in 1971), covering the 1996-2009 period. In the '80s, he was also involved in some major cases, involving Ogem Holding and Verenigde Bedrijven Bredero. For some personal background information see, e.g.,here, here and here. For his television appearances see here.

The Enterprise Chamber is well known for its role in inquiry proceedings, a very popular and important avenue for corporate litigation in the Netherlands that does not exist as such in other countries (like the United States). During his chairmanship, the right of inquiry became increasingly important in the Dutch corporate litigation landscape. For some empirical data as to the use of inquiry proceedings throughout the years, see here. Although inquiry proceeding case law has generated criticism (see, e.g., here and here) and the legal framework of inquiry proceedings is under review (it is likely to undergo some tweeking in the coming period, see, e.g., here), inquiry proceeding case law by the Enterprise Chamber - that frequently also resulted in involvement of the Supreme Court, most recently in the case of KPNQwest - has unquestionably been a major driver of corporate governance developments/discussions in the Netherlands in the past decade (see for example the Dutch corporate governance code, influenced in part by inquiry proceeding case law). Huub Willems has played a central role in this. For an example see, e.g., here.

In a sense, his retirement is the end of an era. A nice, short oversight article of the 1996-2009 period in which Huub Willems chaired the Enterprise Chamber is available here. I fully concur with the concluding remarks.

Met het vertrek van Huub Willems als voorzitter van de Ondernemingskamer komt een einde aan een markante periode. Ongeacht wie zijn opvolger is zal deze het niet makkelijk hebben op zijn eigen wijze vorm te geven aan het voorzitterschap van de Ondernemingskamer. Ook voor de ‘gebruikers' van de Ondernemingskamer zal het wennen zijn en is het de vraag in hoeverre lijnen die in het verleden zijn uitgezet in de toekomst doorgetrokken zullen worden.

[No. 88] Connecting Issuers and Shareholders II

In my previous blog [No. 83] I described the case of standardisation of issuer services. We have seen that standardisation ensures the arrival of information at the right place in a complete, correct and swift manner and incures the least possible (administrative) costs. The standardised format in which the shareholders information is delivered, can ideally be collected by one central party. From that central party, the consolidated information could be passed on to the listed companies or their representatives (issuing agents or other commericial service providers like ISS/RiskMatrix). 

Euroclear Netherlands recently published a whitepaper. In this whitepaper they survey the criteria the central party has to comply with. Amongst of others they mention the following criteria:

• Neutrality
  It is highly important that the central party plays a neutral role and is not in any way biased or unduly involved with the issuer, the intermediaries or the end investors. This neutrality will contribute to the sound governance process in respect of conflicting interests of various stakeholders. Furthermore, intermediaries may be more prepared to distribute confidential investor data to a neutral party than to a commercial market party/competitor.
• Expertise
  The service provider needs to have expertise and experience in providing ‘backoffice commoditised services’. This is an important principle, as the central point has to be able to safely process data of thousands of shareholders delivered by the various parties in the chain. At the same time, the data processed should be treated in a confidential manner, prohibiting inappropriate usage.
• Non-discrimination
  The service provider services should cover all security types from both large and small issuers, and all intermediaries, both big and small. This may seem obvious but most current service providers apply fees that may be detrimental for small issuers and are likely to focus on the main intermediaries representing the major holdings only. Since shareholder identification often precedes the execution of important corporate actions (like Annual General Meetings), shareholder identification services should be provided in a non-discriminatory manner, in order to enable all end investors to exercise their shareholder rights.
• Cost efficiency
  The central point should be organised to drive down costs per request, creating economies of scale in the back-office,
  while maintaining healthy competition in the value-added front-office services.
• Supervision and integrity
  The integrity and risk profile of the central point must be unspoken of and adequately supervised by the Dutch Central Bank and/ or the Dutch Authority for the Financial Markets.

The whitepaper continues examining the way in which Euroclear itself meet those criteria. It concludes that a Euroclear Netherlands is well positioned to fullfill the role of central point/ provider. Euroclear meets the principles to support an effective shareholder identification service. One could argue that this conclusion is not surprising, since Euroclear published/ wrote the whitepaper itself. Although the latter can not be denied, the whitepaper formulates fair and objective criteria and strives to solve (some of) the current problems which occur with identifying shareholders. (See blog [No. 81] for more background info of the current problems and their cause). The Euroclear whitepaper is a welcome initiative that tries to take into account all relevant parties interests. Only for these reasons alone, the whitepaper is worth examining with a non-pre-judiced mind.  

[No. 87] Heads Up on Review of Corporate Governance in UK Banks

In post No. 60, I wrote about recommendations (in English: "Restoring Trust") that were published in April this year by the Dutch Committee Maas (named after its chairman), aimed at drawing lessons in the Netherlands from the credit crunch for financial institutions in terms of corporate governance. The outcome is, in short, that the interests of the client should be leading, that the system of internal risk management should be enhanced, that the role of the supervisory board should be strengthened and that the renumeration policy should be renewed. This requires a fundamental change in mentality and refocus in the banking industry. So basically less excessive risk-taking and less 'perverse' short-term incentives through director renumeration. The recommendations are subject of discussion, as they should be (for some further thoughts on this blog, see post No. 61).

Now how are things in the UK progressing? Sir David Walker (pictured) is leading an independent review of corporate governance in the UK banking industry in the UK, upon request of the Prime Minister. The original Terms of Reference for the review are to examine corporate governance in the UK banking industry and make recommendations, including in the following five areas:

1. the effectiveness of risk management at board level, including the incentives in remuneration policy to manage risk effectively;
2. the balance of skills, experience and independence required on the boards of UK banking institutions;
3. the effectiveness of board practices and the performance of audit, risk, remuneration and nomination committees;
4. the role of institutional shareholders in engaging effectively with companies and monitoring of boards; and
5. whether the UK approach is consistent with international practice and how national and international best practice can be promulgated.

Yesterday, Walker published a consultation document called A Review of Corporate Governance in UK Banks and Other Financial Institutions. Walker seeks to boost the role of non-executives in the risk and remuneration process and encourage institutional shareholders to play a more active role as engaged owners of banks and other financial institutions. Key issues are qualifications of the board, the functioning of the board, investor monitoring and communications, risk management and renumeration management. Specific proposals include the following:

• board level risk committees are to be chaired by a non-executive;
• risk committees should have the power to scrutinise, and if necessary block, big transactions;
• more power for remuneration committees to scrutinise firm-wide pay;
• remuneration committee should oversee pay of high-paid executives that are not on the board;
• significant deferred element in bonus schemes for all high-paid executives;
• increased public disclosure about pay of high-paid executives;
• the chairman of the remuneration committee is to face re-election if the report gets less than 75% approval;
• non-executives are to spend up to 50% more time on the job;
• non-executives are to face tougher scrutiny under FSA authorisation process; and
• the chairman of board should face annual re-election.

The consultative document proposes that most of the recommendations are enforced through inclusion in the UK Combined Code on Corporate Governance, which operates on a ‘comply or explain’ basis. The second consultation period will run until 1 October, with conclusions in November 2009. This second phase is used to generate comments and reaction. See here and here for some first reactions, including one from an institutional shareholder commenting

"The recommendations look pretty similar to the countless others before it. We need radical thinking - but we got tinkering."

It will be quite interesting to see how this unfolds in the course of the year.

[No. 86] Dutch Members of Parliament to Government: Limitation of Shareholder Influence, Please

In post No. 61, I wrote about the competing views on the relation between shareholder influence and the financial crisis (for Steve Bainbridge's response, see here). Some seem to believe that shareholders were part of the problem, while others believe they are part of the solution. Now, Dutch MP's are weighing in the debate.

What's the story? Earlier this month, a majority of MP's supported a motion by the socialists requesting the government to come up with proposals to limit the influence of shareholders on companies. As noted by Agnes Kant, leader of the socialist party, "each share is being  transferred, on average, once a year. This implies that shareholders' priority is not the future of the company, but their personal short term gains".

A few weeks ago, a majority of parliament supported the motion. Hardly a week later, the government submitted a long awaited legislative proposal to parliament, which will make it harder for shareholders to put items on the agenda. Instead of 1% of the shares, they will need 3% to be able to do so (the proposal also contains other measures, such as lowering the threshold for ownership disclosure from 5% to 3%).   

Given that a recent report by Eumedion indicates that in the 2008 shareholder meeting season, only eight such proposals were submitted, and that this number was reduced to zero (!) in the 2009 season, one can't help but wonder what all the fuss is about. The move is even more remarkable in light of the fact that proposals in the UK and US seem to be geared towards increasing shareholder influence, rather than decreasing it.

While, obviously, there are various possible explanations for this divergence, here's one. In the US and the UK, the financial crisis necessitated government bailouts of banks whose bankers had been taking home huge sums of money in the form of salaries and bonuses. This did not fare well with the public - recall the controversy surrounding the payouts at Merrill Lynch.

In the Netherlands, too, the financial crisis necessitated government bailouts of banks - yet, public outcry wasn't primarily invoked by excessive compensation, but by the painful loss of two giants of the Dutch financial landscape - ABN Amro and Fortis. While the demise of these institutions inevitably is the result of a complex chain of events, in the public eye, much of it can be traced back to one particular event: activist hedge fund TCI's proposal to break-up ABN Amro back in 2007.

So, how do politicians respond? You guessed it - in the US and the UK, they are tempted to give in to public sentiment by curbing managerial influence, while Dutch politicians are tempted to do the same by curbing shareholder influence. A cynical explanation perhaps, but an explanation nonetheless.

[No. 85] Public Prosecution Service and Competition Authority: Partners in Fighting 'Crime'

Recently the District Court of The Hague decided that the Dutch Public Prosecution Service (PPS) was permitted to provide the Dutch Competition Authority (NMa) with recordings from telephone taps which pointed to forbidden price-fixing agreements in the meaning of article 6 of the Dutch Competition Act.

The PPS started an investigation against a construction company on suspicion of bribery. During the investigation the PPS made telephone taps. When it found suspicions that the construction company made illegal price-fixing agreements, the PPS provided the NMa with transcripts of the telephone calls on basis of article 39f of the Judicial Data and Criminal Records Act.

In interlocutory proceedings the construction company claimed that the PPS was not allowed to provide the NMa with the telephone taps and demanded the NMa to return the taps to the PPS. The company argued there is a distinction between information which has relevance for the prosecution of criminal acts (in this case bribery) and the by-catch which relate to the price fixing agreements – in this respect one should take into account that in the Netherlands a breach of the competition rules does not constitute a criminal offence but an administrative violation. According to the company the information which relate to the price-fixing does not form part of the criminal file and falls outside the scope of the Judicial Data and Criminal Records Act. The court, however, was of the opinion that the tap recordings are to be considered as a whole and therefore are in full part of the criminal file. As a result the information concerning the price-fixing is to be considered as judicial data in the meaning of the Judicial Data and Criminal Records Act.

The court continued to say that the PPS acted lawfully when it provided the NMa with the information, given that under the Judicial Data and Criminal Records Act the PPS may provide judicial data even outside the scope of criminal prosecution purposes if this is necessary for the purpose of an important public interest. In the opinion of the court this condition was fulfilled since the NMa is protecting the economic well-being which is an important public interest. For this interpretation the court refers to the legislative history where it is stated that in view of article 8 of the European Convention on Human Rights (ECHR), public interest must be understood as the interest of national security, public safety or the economic well-being of the country, the prevention of disorder or crime, the protection of health or morals, or the protection of the rights and freedoms of others. In the opinion of the court the interest of economic well-being of the Netherlands outweighs the privacy protection of the construction company also given the fact that the infringement on the privacy rights of the company was proportional (the construction company failed to make plausible that the price-fixing information could have been obtained in another, less harmful, manner as such collusive arrangements, as a rule, are not put in writing).

[No. 84] A Response to Professor Bainbridge

In my last post (see here), I explained the gist of the Dutch right of inquiry and highlighted a recent important Supreme Court decision in this field. Steve Bainbridge picked up the post and added some interesting thoughts from a US corporate law perspective.

I suppose the closest analogy in US law is the provision in Model Business Corporation Act section 8.09(a) for judicial removal of directors, but that provision requires much more serious misconduct than mere mismanagement:

The ... court of the county where a corporation’s principal office (or, if none in this state, its registered office) is located may remove a director of the corporation from office in a proceeding commenced by or in the right of the corporation if the court finds that (1) the director engaged in fraudulent conduct with respect to the corporation or its shareholders, grossly abused the position of director, or intentionally inflicted harm on the corporation; and (2) considering the director’s course of conduct and the inadequacy of other available remedies, removal would be in the best interest of the corporation.

The commentary to that section further indicates that policy disputes and business judgment arguments should be left to the shareholders usual corporate governance powers such as voting and suing for damages. In addition, this provision hardly could be described as "popular" or "important." To the contrary, judicial removal of directors is rare. After all, why should we think that judges (or shareholders, for that matter) are well-positioned to evaluate the merits of board actions? To the contrary, the logic of the business judgment rule is that, as I argued in The Business Judgment Rule as Abstention Doctrine, Justice Jackson famously observed of the Supreme Court: “We are not final because we are infallible, but we are infallible only because we are final.” Neither courts nor boards are infallible, but someone must be final. Otherwise we end up with a never ending process of appellate review. The question then is simply who is better suited to be vested with the mantle of infallibility that comes by virtue of being final—directors or judges?

Corporate directors operate within a pervasive web of accountability mechanisms. A very important set of constraints are provided by a competition in a number of markets. The capital and product markets, the internal and external employment markets, and the market for corporate control all constrain shirking by directors and managers. Granted, only the most naïve would assume that these markets perfectly constrain director decisionmaking. It would be equally naïve, however, to ignore the lack of comparable market constraints on judicial decisionmaking. Market forces work an imperfect Darwinian selection on corporate decisionmakers, but no such forces constrain erring judges. As such, rational shareholders will prefer the risk of director error to that of judicial error. Hence, shareholders will want judges to abstain from reviewing board decisions.

Not all decisions, of course. Self-dealing and the like are appropriately subject to judicial review. Yet, mere allegations of mismanagement would not rise to that level.

This is all good stuff. By way of a response, I offer some additional insights here.

• Steve refers to "much more serious misconduct than mere mismanagement". If I somehow raised the impression that it's relatively easy for the Enterprise Chamber to establish an 'obvious incorrect course of action', a key standard in the right of inquiry than can be framed - as I did in my last post - as "clear mismanagement", that impression is wrong. What is meant by such mismanagement is, as it's generally coined, careless behavior of such a magnitude that elementary principles of sound entrepreneurship have been violated. Granted, this is still pretty vague, but it aims to show that only serious misconduct can qualify as an obvious incorrect course of action. This often requires intentional misbehavior, a pattern of misconduct and/or misconduct that foreseeably results in serious damage to the corporation. This was emphasized again by the Supreme Court in two 2003 decisions of February 21, 2003 re HBG and VIBA. I'm not so sure this differs that much from the "much more serious misconduct" mentioned by Steve, referring to Section 8.09(a) MBCA.
• Clear mismanagement as referred to here is a broad term, that is not limited to enterprise issues. Close to forty years of inquiry right case law shows that such an obvious incorrect course of action can result from a host of - typically corporate governance related - fact patterns, including:
  • a deadlock in the board and the general meeting of shareholders, putting the continuation of the corporation at risk;
  • conflict of interests that damage the corporation;
  • making uninformed business decisions;
  • failing to pay dividend without any justification;
  • unfair treatment of minority shareholders;
  • inadequate disclosure of information to shareholders;
  • making misleading statements in the annual accounts and/or to investors;
  • unequal treatment of shareholders without justification; and
  • violation of rules laid down in statute and the articles of association.
• Judicial removal of directors does not happen that often, but if it does, this is typically caused by a deadlock in the corporation that needs to be solved urgently. So the problem of judges evaluating  the merits of board actions is not really applicable here. It is, however, true that Dutch corporate law does not really know a business judgment type of review mechanism (yet). Dutch courts traditionally use the standard of objective reasonableness when reviewing director conduct in the business judgment realm. Regular readers of this blog will know that I have been arguing for some time now - both on the blog (just type "business judgment rule" in the custom search bar) and in writing (see, e.g. here and here) - for the introduction of a Dutch business judgment rule in right of inquiry proceedings; the public debate is still ongoing. I have explained the upside of this approach quite extensively, as well as the problem that norms/standards used in inquiry proceedings lack real clarity. I used the Delaware model for inspiration; by the way, for an entertaining story on 'the art of judging in Delaware' see here.
• The popularity of the right of inquiry may be explained in part by the fact that Dutch corporate law does not know the derivative suit. As to director liability vis-a-vis the corporation only the corporation, and the trustee in bankruptcy when the corporation has gone bankrupt, can bring such proceedings, primarily based on section 2:9 DCC (improper conduct) and less often on section 6:162 DCC (tort). As boards of corporations normally aren't inclined for obvious reasons to litigate against their own - former - directors, section 2:9 DCC case law is - shall we say - not abundant. Things differ for liability proceedings based on section 2:138/248 DCC (brought by the trustee) and in tort (typically brought by third parties, often the corporation's creditors),  that I discussed, e.g., here. So the focus in the Netherlands as to litigation against directors is traditionally not on derivative actions (as it is in Delaware), but on inquiry proceedings - that doesn't center around liability, see here - and liability proceedings brought by third parties (such as the trustee in bankruptcy, individual creditors of the corporation or individual shareholders).

[No. 83] Connecting Issuers and Shareholders I

The past few years the corporate governance file was thoroughly discussed. This discussion tackled the rights and the duties of the issuer and its shareholders with the aim to construe a well-balanced corporate democracy. Up to now, however, little attention was given to the infrastructural manner in which the rights and duties of shareholders have to be exercised. Today’s environment, where securities are predominantly held through multi-tier book-entry systems, poses specific challenges for the efficient and effective processing of these rights and duties.

‘Issuer services’ is a collective term for up- and downstream1 services provided by third parties to support end investors or issuers in exercising their rights attached to securities via-à-vis the issuers or the end investors respectively. Examples of issuer services are:
• shareholder identification services;
• shareholder communication services;
• registration services; and
• information services (ownership statistics).

Issuer services, and shareholder identification in particular, leave a lot to be desired. The present processing of issuer services and shareholder identification arrangements are to a large extent non-standardised and paper-based and consequently defective, inefficient and expensive. This is quite remarkable in view of the fact that the processing of other corporate actions, such as dividend payments, are broadly standardised, commoditised and automated. Reflections of the above observations can be found in the reports on improvements to the securities trading infrastructure issued by the European Commission, Lamfalussy and Giovannini.

In order to tackle the ambiguities and complexities that can arise when the chain of intermediaries has numerous (international) links, the market developed all kinds of initiatives. These initiatives, amongst others, aim at  passing information to the end-investors (‘downstream’) and at simplifying granting of powers of attorney or casting votes (‘upstream’). The sheer number of initiatives in the issuer services area, involving different formats, procedures and service providers has resulted in the absence of a market standard.

In order to collect and process the required shareholder information, it is necessary to obtain a minimum degree of standardisation in the request for and delivery of data. This standardisation will ensure that the information will arrive at the right place in a complete, correct, and swift manner, and incur the least possible (administrative) costs. The standardisation will have to be based on common international standards, forming a pre-requisite for effective cross-border processing.

Ideally the role of the service provider, as described above, should be secured by a recognised central provider or institution. The central point will give the other parties in the custody chain (CSD, admitted institutions and other intermediaries) the option to provide the central point with the required information. From the central point, the consolidated information could then be passed on to the listed companies, or their representatives (issuing agents or other commercial service providers). In my next contribution will I focus on the question what characteristics an institutition should have I order to qualify as the ‘central point’.

[No. 82] The Purpose of the Right of Inquiry

1. In the past months, I have reported regularly about developments related to the right of inquiry. The right of inquiry is a very popular and important avenue for corporate litigation in the Netherlands; the framework as such does not exist in other countries. On June 26, 2009 the Supreme Court rendered an important decision that touches upon the foundation of this legal doctrine. I highlight the gist of it here.

2. What is the essence of the right of inquiry? The right of inquiry entitles shareholders - and trade unions, as well as some others, including holders of depository receipts - who own either 10% of the outstanding stock or shares with a nominal value of at least Euro 225.000 (or less if provided by the corporation's articles of association), to request the Enterprise Chamber of the Amsterdam Court of Appeal to review the course of action followed by/the affairs of certain legal entities, including corporations. In general, the subject matter of such a judicially ordered inquiry is the conduct of the corporation's organs, i.e.: the management board, the supervisory board (provided the corporation has one) and/or the general meeting of shareholders. Their conduct is attributed to the corporation, as the corporation is ultimately the subject of inquiry proceedings.

• In the so-called 'first phase' of inquiry proceedings, one of the central questions is whether there are 'well founded reasons to doubt the correctness of the course of action followed by the corporation' (section 2:350(1) DCC). If the answer is yes, the court may order an inquiry - after having balanced all the interests involved, including that of the corporation - and appoint one or more investigators. Other important questions are (a) whether the plaintiff is authorized to make the request (typically: does he meet the shareholding threshold?) and (b) whether the plaintiff (i) has informed the management board and supervisory board in writing of his complaints first and (ii) has given the corporation a reasonable period to investigate the complaints and take the necessary measures. The first phase ends when the investigators file their report with the court. This first phase is an independent proceeding: if the plaintiff wants to proceed with the inquiry proceeding, he will have to file a new request, which starts the so-called 'second phase'.
• In the second phase of inquiry proceedings, the court determines upon request, based on the investigators' report, whether the corporation has followed an 'obvious incorrect course of action' (section 2:355 DCC). This can be framed as clear mismanagement. Upon request, and if such mismanagement is established, the court can take one or more measures to put an end to this mismanagement. The court can for example nullify decisions taken by organs of the corporation, fire directors, or even order the dissolution of the corporation. The list of possible measures is limited.
• Throughout the proceeding, the plaintiff can also ask for one or more preliminary measures, i.e., injunctive measures (section 2:349a(2) DCC). This typically comes up in the first phase, when the plaintiffs asks for an inquiry and for one or more preliminary measures. The court can take such - often far-reaching - measures if this is in the interest of the corporation or the investigation. Although the court should not take such measures too easily (especially if it has not yet decided whether there are well founded reasons to doubt the correctness of the corporation's course of action), these measures must have a temporary/provisional character and the court must balance all interests involved in order to reach a proportionate outcome, it has great discretion as to the way a measure is framed. There is no list of possible measures, and these measures do not necessarily have to be in line with mandatory law. The court can, for example, order parties to refrain from certain conduct in order to preserve a status quo, suspend directors and freeze voting rights. The popularity of the right of inquiry can be explained in large part by the introduction in 1994 of the possibility for the court to take preliminary measures.

The costs of the inquiry are typically paid by the corporation. However, if the court establishes 'improper conduct' (which is a lower threshold than the abovementioned mismanagement), it can order those responsible for this conduct to pay the costs upon request of the corporation: this is essentially a question of liability. The court is on average not eager to do so, but it has happened more than once.

3. In a well-known judgment from 1990 (NJ 1990, 466 re Ogem Holding), the Dutch Supreme Court clarified the purpose of the right of inquiry. It stated, based on the legislative history, that the purpose of the right of inquiry is basically three-fold:

• end controversies in the corporation through measures;
• create transparency; and
• establish who is responsible for possible mismanagement.

It also clarified that the possibility of an inquiry may work to prevent misconduct from actually taking place, and that an inquiry can also be ordered when the corporation has already gone bankrupt. The Ogem Holding decision is widely recognized as a foundation of inquiry proceeding case law. The Supreme Court has repeated this scope of inquiry proceedings several times thoughout the years, and added in 2005 that when the complaints of the plaintiff do not relate at all to these objectives, for example because the conflict is essentially a contract dispute (and not a corporate dispute), the court does not have to look further into the request as the request is not suitable for inquiry proceedings. The same goes if the plaintiff has no power to make the request or has failed to inform the corporation of his complaints first. All of this also shows that the right of inquiry does not center around liability related questions, as it is not a proceeding primarily designed to establish liability of actors in the corporation for damage suffered by the corporation. If litigants want to initiate liability proceedings, they will have to address a different court in different proceedings. Sometimes inquiry proceedings are used as a stepping stone for liability proceedings, as it may be easier for a plaintiff to make his case in liability proceedings with the investigators' report in hand. Although a determination of mismanagement in inquiry proceedings does not automatically result in director liability, such a determination will generally give a plaintiff in liability proceedings a head-start, as the conduct reviewed by the Enterprise Chamber will typically be more or less the same as the conduct complained of in liability proceedings and the Enterprise Chamber is generally seen as a court specialized in business matters.

4. In the inquiry proceedings re KPNQwest, an ICT company that has gone bankrupt, the Enterprise Chamber ordered an inquiry on December 28, 2006. The court held that it could not be ruled out (a) that banks and investors were misled or inadequately informed by the corporation and (b) that the 2001 annual accounts as published by the corporation were misleading. The court was also critical of the conduct by the supervisory board. In view of all this, the court held that there were well founded reasons to doubt the correctness of the corporation's course of action sufficient to justify an inquiry. The court has taken a couple of interesting decisions in this proceeding so far, in part relating to the lack of funding to proceed with the investigation; some of them were brought before the Supreme Court. The most important matters brought before the Supreme Court concern three principal issues, that basically ask the Supreme Court to overrule its Ogem Holding holding and its progeny:

1. it is impossible to order an inquiry with the - sole - purpose to create transparency or to establish who is responsible for possible mismanagement and/or an inquiry cannot be ordered when the corporation has already gone bankrupt;
2. an inquiry cannot be in the interest of the corporation when the corporation has gone bankrupt; and
3. if the investigation cannot take place due to lack of funding, the court has to deny the request on this ground without any further investigation into the merits of the request.

The third issue relates to a different decision by the Enterprise Chamber, that of January 9, 2006.

5. In a pretty detailed decision, the Supreme Court fully rejected the argument advanced by the plaintiffs. I address the decision below the fold.

[No. 81] The European Political Economy [Updated]

In my paper, The Political Economy of Cross-Border Voting in Europe, which was recently accepted for publication in the Columbia Journal of European Law, I study the issue of cross-border shareholder voting. Shareholder voting plays a pivotal role in the corporate governance of European public firms, even more so than in the US. At the same time, cross-border share ownership has increased dramatically over the recent years. Taken together, these circumstances underline the need for a system that facilitates cross-border voting. European policymakers recognize this, yet they seem reluctant to push through the reforms necessary to put such system in place. As a result, the status quo has so far prevailed.

In my paper, I analyze the legislative process and suggest that the prevailing of the status quo can be explained in terms of the European political economy. The analysis shows, first, that policymakers’ positions at the various stages of the process often appear to have been based on reports prepared by market practitioners and public consultations. Next, it shows that the conclusions emerging from those reports and consultations generally tend to reflect the interests of the groups of market practitioners (such as financial intermediaries) that are relatively strongly represented among the authors of the reports or the respondents to the consultations. Intermediaries, who have an interest in maintaining the status quo, appear to have had a particularly strong voice throughout the process. Together, these findings may go some way in explaining why the status quo has so far prevailed.

The analysis has important implications for the legislative process going forward. While the involvement of market practitioners has benefits, policymakers should not rely on expert groups and consultations to represent the interests of stakeholders in a balanced way, much less to devise solutions that are socially most beneficial. Regardless of the outcome of the recent consultation, the European legislature will need to make its own independent judgment on how to increase social welfare.

The full paper is available for download here.

UPDATE:

Manifest, the UK proxy voting agency, has dedicated a nice blog post to the paper - see here. Thanks.

[No. 80] A Good Day

Although I'm not in the habit of writing here about my personal corporate litigation activities, I can't resist the temptation to mention that - and I'm understating here - today was a good day in that respect.

The judgment that was rendered at noon, and that concerns a dispute between shareholders in the joint-venture which owns the single Dutch nuclear power plant (as well as other parties), already generated media attention, e.g., here, here, here (with footage) and here (in English).

No doubt more coverage to follow.

[No. 79] Guest Author

We are happy to announce that Anatoli van der Krans will be guest authoring at The Defining Tension in the coming period.

Anatoli worked for five years as a lecturer in company law and financial law at the University of Utrecht. In 2009 he obtained a doctorate degree for his research on virtual shareholders’ meetings.

Anatoli currently works in the Banking, Finance & Insurance practice of a large Dutch law firm, where he has a particular focus on advising and litigating in the field of financial law. He is also involved in cross-border financing and various structured and insured financing transactions.

[No. 78] Executive Compensation

In post No. 26 (Director Compensation Going Down) and post No. 62 (Golden Handshakes in the Banking Sector) I reported about recent Dutch developments as to executive compensation.

Courtesy of The Harvard Law School Forum comes a nice post providing, e.g., some figures about the situation in the US. I guess the heading "Downturn in Pay Levels" is self-explanatory, but I add some figures below.

Several recent surveys indicate that median CEO pay levels declined in 2008; by comparison, in 2007 they increased over 2006.

*All percentage changes shown are based on changes in median Total Direct Compensation for the years involved. (The New York Times (Equilar) survey indicates that certain perquisites and other benefits also are included in that survey.) Methodologies used by the different surveys in computing compensation differ (including, among other things, the companies they include in their respective surveys). For an understanding of the methodologies used, the actual surveys need to be examined.

**The New York Times survey on CEO pay for 2007 (NYT, April 6, 2008) expresses the percent change in 2007 versus 2006 as a change in average level of pay rather than change in median level of pay. On this basis, the New York Times reported the change as an increase of 5% for 2007 over 2006.

Available CEO pay surveys also indicate that Total Cash Compensation (salary plus annual bonus) declined in 2008 from 2007.

The whole analysis is available here.

[No. 77] Forbidden Corporations

1. Pursuant to section 2:20(1) DCC, a legal entity - like a corporation - whose activities are contrary to public order, can be declared forbidden and dissolved by the Court of First Instance at the request of the public prosecutor's office. In Dutch:

Een rechtspersoon waarvan de werkzaamheid in strijd is met de openbare orde, wordt door de rechtbank op verzoek van het openbaar ministerie verboden verklaard en ontbonden.

This is a measure with a criminal law edge, but located in the corporate realm. This is quite a drastic measure, that is not applied frequently for obvious reasons: people should be able to establish and use legal entities as permitted by law, in the same vein as they are entitled to, e.g., freedom of speech, unless there is a compelling reason for the government to intervene and 'terminate' the legal entity. This implies section 2:20(1) DCC should be applied restrictively.

2. In the last few years, however, attempts have been made by the public prosecutor's office. For example in the northern part of the Netherlands (the province of Friesland, to be precise), aimed at having a foundation and a voluntary association belonging to the well-known Hells Angels declared forbidden and dissolved, basically because of alleged criminal activities attributable to these legal entities. Sortlike requests were made elsewhere in the Netherlands. Both the Court of First Instance of the city of Leeuwarden and the Court of Appeal of the same city denied this request. The Court of Appeal essentially reasoned:

• that when answering the question whether the activities of a legal entity are contrary to public order, the starting point is that the freedom of association and meeting - as laid down in section 8 of the Dutch Constitution and section 11 of the European Convention on Human Rights - is a foundation of a democratic state of law;
• that declaring a legal entity forbidden is a serious infringement of this foundation, that can only be reached as an ultimate remedy;
• that such a declaration therefore requires more than activities that are undesirable from society's perspective;
• that such a declaration should be seen as a necessary measure to prevent activities that have an actual and serious negative impact on essential elements of our state of law and that destabilize or can destabilize our society; and
• that in this case, this threshold has not been met, as the alleged activities can be qualified as undesirable from society's point of view, and possibly as criminal, but not as having such a serious impact on public order that the requested declaration is justified.

3. The public prosecutor's office has brought this case before the Supreme Court, that rendered judgment on June 26, 2009 (the other cases were put on hold in the meantime). In this important and complex ruling, that was preceded by a scholarly conclusion of Advocate-General Vino Timmerman, the Supreme Court affirmed the holding by the Court of Appeal and provided more guidance as to when a declaration as referred to in section 2:20(1) DCC is justified (also see, e.g., here and here).

4. The Supreme Court agreed with the line of thinking by the Court of Appeal as described under 2 above, and added some more contours that I highlight here.

• Contrary to what was argued by the public prosecutor's office, the term 'activities' referred to in section 2:20(1) DCC does not also cover activities of third parties that must be attributed to the legal entity solely because the legal entity failed to 'take sufficient distance' from those activities or the culture in which they took place. When the legal entity is not directly involved in activities of third parties, like members or either national or foreign sister organizations, in the sense that the board of the legal entity led those activities or knowingly facilitated them, such activities can only be qualified as activities of the legal entity in case of special facts and circumstances.
• In this case, the Court of Appeal decided that the public prosecutor's office failed to meet this standard, for which reason it ultimately reached the outcome described under 2 above (i.e., denial of the request), without violating any principle of law or using an inexplicable reasoning (these are the issues that can be made subject of scrutiny by the Supreme Court).
• In doing so the Court of Appeal did not fail to see that the reputation of the Hells Angels is 'extraordinary bad', and that this aspect in special circumstances could contribute to the conclusion that the activities of the legal entities could be contrary to public order. But what the Court of Appeals did is, after analyzing the position of the legal entities in relation to the international and national organizations of the Hells Angels, concluding - without violating any principle of law - that in short there is not such a tight connection that these legal entities can be held co-responsible for the acts of other clubs or members of those clubs.
• In view of all this, the circumstance that the legal entities would have failed to 'take sufficient distance' from the bad reputation of Hells Angels elsewhere in the Netherlands and in the world, did not have to compel the Court of Appeals from reaching its ultimate conclusion that the request should be denied.
• The Court of Appeals also recognized that according to the public prosecutor's office (i) criminal acts were committed by members of the foundation and by directors of the legal entities and (ii) that those persons had criminal records. But the Court of Appeals was not willing to conclude from this that the activities of the legal entities were contrary to public order. In doing so, the Court of Appeal considered of importance that although official police records pointed to the existence of criminal facts, no prosecution of these facts had taken place while all these facts taken together, and viewed in perspective of a longer period of time, on balance did not qualify as an infringement of public order serious enough to justify the requested declaration. In doing so, the Court of Appeal apparently also accepted that a 'structural situation and culture of committing acts contrary to public order - like committing criminal acts - by members (and directors)' could have carried a conclusion that there were activities contrary to public order, but it considered the existence of such a structural situation and culture insufficiently likely.
• As to the penultimate bullet, the Supreme Court stresses these are not only fact-heavy judgments that cannot be scrutinized in cassation, but also that this reasoning isn't inexplicable: what is key are not the details, but a judgment of the totality of the acts presented by the public prosecutor's office and an assessment of the seriousness of the criminal facts to the extent these were made likely and could have contributed to the aforementioned structural situation and culture.

5. In view of this result, apparently no more attempts will be made to have Hells Angels related legal entities declared forbidden and dissolved in the Netherlands.

6. In sum: it's possible under Dutch law for the public prosecutor's office to have a court declare a legal entity forbidden and dissolved, but this measure is an ultimate remedium and consequently a section 2:20(1) DCC case is pretty steep 'up-hill' to litigate in court. I wonder whether other corporate law jurisdictions also enable courts to declare legal entities forbidden and dissolved upon request, and if so what the requirements of doing so are.

[No. 76] The Economic Crisis Strikes Hard: a Doubling of the Number of Bankrupties in the Netherlands!

                                                                                                                                                                                                         

A recent investigation, carried out by Faillissementen.com at the request of the Netherlands Broadcasting Corporation (NOS), has shown that during the first six month's of this year, more then 4000 debtor's have been declared bankrupt, while during the same period last year, this was less then 2000. The most affected companies are those involved in trade, construction and - of course - financial services. To ease the additional workload of the already heavily strained judges involved in bankruptcies (see S.C.J.J. Kortmann, 'Bad bankruptcy governance', TvI 2003/6, p. 265-268), the Counsel for the Judiciary (de Raad voor de Rechtspraak) apparantly intends to recruit a hundred extra judges. The newsreport of the NOS can be found here. 

[No. 75] Discretionary Broker Voting Across the Atlantic

The US Securities and Exchange Commission (SEC) yesterday announced that it voted to approve a controversial NYSE proposal to eliminate broker discretionary voting for all elections of directors, whether contested or not (see here). The background to this proposal was that

Under the current NYSE and SEC proxy rules, brokers must deliver proxy materials to beneficial owners and request voting instructions in return. If voting instructions have not been received by the tenth day preceding the meeting date, Rule 452 provides that brokers may vote on certain matters deemed “routine” by the NYSE. One of the most important results of broker votes of uninstructed shares is their use in establishing a quorum at shareholder meetings.

Among the other matters which the current NYSE Rule 452 treats as routine is an “uncontested” election for a company’s board of directors. Such elections remain the general practice in corporate America today, with contested elections occurring relatively infrequently. According to ADP, there were only thirty-four officially contested elections in calendar year 2004.

However in recent years the definition of a “contested election” has been questioned by a number of parties and interest groups. This is because of the rise of a number of new types of proxy campaigns, including “just vote no” campaigns. Because these campaigns often do not result in competing solicitations, historically these efforts have not been considered “contests” for purposes of NYSE Rule 452, and thus broker votes have been counted. This has drawn the ire of some investor groups since generally brokers vote uninstructed shares in accordance with the incumbent board’s recommendations.

According to the SEC,

The NYSE’s proposal is designed to enhance corporate governance and accountability by helping assure that investors with an economic interest in the company vote on the election of directors. It also would address concerns that broker discretionary voting for directors has impacted election results.

Specifically, the NYSE proposal would add “election of directors” to the list of enumerated items for which a member generally may not give a proxy to vote without instructions from the beneficial owner.

As Dealbook notes, the change “could lead to more frequent shake-ups on corporate boards. That’s because incumbents will not be able to rely on the broker vote, which usually goes in their favor.” The change is also discussed here.

How does all this compare to the situation in the Netherlands? There’s really two ways of looking at this. On the on hand, Dutch law contains a provision (somewhat similar to section 8-506 U.C.C.) that instructs brokers to enable their clients to vote:

De instelling draagt desgewenst zorg dat de deelgenoten het aan de effecten verbonden stemrecht, ieder tot de hoeveelheid waarvoor hij in de aanwezige effecten deelgenoot is, kunnen uitoefenen (section 15 Wge).

Moreover, while brokers are entitled to exercise, under certain circumstances, rights on behalf of their clients, they are not entitled to exercise voting rights on behalf of their clients (section 11 Wge).

So far, so good. In practice, however, Dutch law appears to offer brokers more discretion than they will have under the revised US rules. For one thing, the relevant Dutch law provisions apply only to so-called aangesloten instellingen, brokers who hold an account directly with Necigef, the Dutch equivalent of the US Depository Trust Company (DTC). If their clients happen to be brokers as well, those brokers are not subject to the prohibition to vote on behalf of their clients, nor do they have a duty to enable their clients to vote – in other words, they are free to vote as they please. One situation where brokers’ clients are likely to be brokers as well – and the beneficial owner may thus be unable to vote – is in case of cross-border securities holding. I’ll be writing more on that soon.

Lately, the issue of voting by institutional investors has attracted increasing attention in the Netherlands. The revised Dutch Corporate Governance Code now sets forth a principle on the responsibility of institutional investors:

Institutional investors shall act primarily in the interests of the ultimate beneficiaries or investors and have a responsibility to the ultimate beneficiaries or investors and the companies in which they invest, to decide, in a careful and transparent way, whether they wish to exercise their rights as shareholder of listed companies.

The scope of this provision, however, appears to be limited to asset managers, pension funds, and the like. It’s not clear to me whether mere brokers who are entitled to vote and who have not received voting instructions (because their clients didn’t give them or because their clients weren’t offered the opportunity to give them in the first place) fall within the scope. If they don’t, such brokers may be free to vote at their sole discretion – unless, of course, there are contractual limitations, industry guidelines or other reasons why they are prevented from doing so. How does this work in practice? I'd be interested to hear other people's take on this.

[No. 74] Director Liability in Tort Revisited [Updated II]

1. In post No. 73 I responded to Steve Bainbridge's post, that was in turn prompted by my post No. 71. Now Steve has kindly added some thoughts on his blog about "the ability of directors to conduct business for the corporation."

In an earlier post, prompted by a post by Dutch law professor Bastiaan F. Assink on tort liability of directors of Dutch corporations, I noted that, in US agency law:

... a director acting alone and qua director is not an agent of the corporation. See Restatement (Second) of Agency § 14C (1958) (an individual director is not an agent of the corporation or its shareholders); Arnold v. Soc'y for Sav. Bancorp, 678 A.2d 533, 539-40 (Del.1996) (“Directors, in the ordinary course of their service as directors, do not act as agents of the corporation ... A board of directors, in fulfilling its fiduciary duty, controls the corporation, not vice versa.”).

In response, Bastiaan updated his post to inform us that, among other things, under Dutch law "the board as well as individual board members have the power to act on behalf of the corporation, unless the articles of association provide otherwise." I take that observation to mean that, under Dutch law, an individual director is an actual agent of the corporation.

The US doctrine that a director, acting alone, is not an agent of the corporation follows conceptually from the notion that the board of directors, acting collectively, is the embodiment of the corporate principal. I explored the policy rationale behind that rule in my article Why a Board?, in which I noted that:

Acting alone, an individual director “has no power of his own to act on the corporation’s behalf, but only as one of a body of directors acting as a board.” Moreover, as the MBCA puts it, “directors may act only at a meeting unless otherwise expressly authorized by statute.”

Why this emphasis on collective rather than individual action? The MBCA’s drafters offer the following answer: “The underlying theory is that the consultation and exchange of views is an integral part of the functioning of the board.” Or, as Forbes and Milliken opine, “the very existence of the board as an institution is rooted in the wise belief that the effective oversight of an organization exceeds the capabilities of any individual and that collective knowledge and deliberation are better suited to this task.” These arguments run afoul of the old joke that a camel is a horse designed by a committee, but they find considerable support in the literature on individual versus group decision making.

I wonder what the origins of the seemingly contrary Dutch rule were and what policy rationale is understood as explaining that rule.

I am, of course, more than happy to say a few words about how things work under Dutch law. See for the remainder of this post below the fold.

In an earlier post, prompted by a post by Dutch law professor Bastiaan F. Assink on tort liability of directors of Dutch corporations, I noted that, in US agency law:

... a director acting alone and qua director is not an agent of the corporation. See Restatement (Second) of Agency § 14C (1958) (an individual director is not an agent of the corporation or its shareholders); Arnold v. Soc'y for Sav. Bancorp, 678 A.2d 533, 539-40 (Del.1996) (“Directors, in the ordinary course of their service as directors, do not act as agents of the corporation ... A board of directors, in fulfilling its fiduciary duty, controls the corporation, not vice versa.”).

In response, Bastiaan updated his post to inform us that, among other things, under Dutch law "the board as well as individual board members have the power to act on behalf of the corporation, unless the articles of association provide otherwise." I take that observation to mean that, under Dutch law, an individual director is an actual agent of the corporation.

The US doctrine that a director, acting alone, is not an agent of the corporation follows conceptually from the notion that the board of directors, acting collectively, is the embodiment of the corporate principal. I explored the policy rationale behind that rule in my article Why a Board?, in which I noted that:

Acting alone, an individual director “has no power of his own to act on the corporation’s behalf, but only as one of a body of directors acting as a board.” Moreover, as the MBCA puts it, “directors may act only at a meeting unless otherwise expressly authorized by statute.”

Why this emphasis on collective rather than individual action? The MBCA’s drafters offer the following answer: “The underlying theory is that the consultation and exchange of views is an integral part of the functioning of the board.” Or, as Forbes and Milliken opine, “the very existence of the board as an institution is rooted in the wise belief that the effective oversight of an organization exceeds the capabilities of any individual and that collective knowledge and deliberation are better suited to this task.” These arguments run afoul of the old joke that a camel is a horse designed by a committee, but they find considerable support in the literature on individual versus group decision making.

I wonder what the origins of the seemingly contrary Dutch rule were and what policy rationale is understood as explaining that rule.