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[No. 221] Three Links and Some Commentary to Wrap-Up 2009

Okay, too much interesting stuff going on that could not escape the attention of this blog. Here we go, wrapping up our first year in the blogosphere with three links and some commentary.

1. On Friday December 22, the Dutch Supreme Court rendered a decision concerning nullification of a decision taken by the shareholder outside a formally convened general meeting. Pursuant to section 2:227(4) DCC, managing directors and supervisory directors (if any) have an advisory vote in the general meeting; this implies they have to be invited for the general meeting and be able to exercise their advisory vote, while non-adherence to this requirement creates a ground for nullification of the decision by the shareholders  (see DSC March 10, 1995, NJ 1995, 595 (Janssen Pers)). The Supreme Court now clarified with so many words that this regime also - and still, in line with DSC March 10, 1995, NJ 1995, 595 (Janssen Pers) - applies in case the articles of association allow decisionmaking by shareholders outside the general meeting and the shareholders use this option; also in that scenario, managing directors and supervisory directors (if any) must be brought in a position in which they can exercise their advisory vote. Here's the money quote:

3.4 Onderdeel 1 van het middel strekt ten betoge dat art. 2:227 lid 4 niet van toepassing is bij besluitvorming die op de voet van art. 2:238 BW op andere wijze dan in een vergadering is geschied. Het onderdeel faalt, omdat het voorschrift van art. 2:227 lid 4 in beginsel ook in acht moet worden genomen bij besluitvorming als bedoeld in art. 2:238 (HR 10 maart 1995, nr. 15577, LJN ZC1657, NJ 1995, 595). Zoals is vermeld in de conclusie van de Advocaat-Generaal onder 3.2 bestaat het voornemen dit uitdrukkelijk in de wet op te nemen, hetgeen een argument temeer vormt voor handhaving van genoemde rechtspraak.

The court also clarified that in case the decision is nullified by order of the court, the decision must be deemed to never have existed (i.e., must be deemed to have been void ab initio).

De vernietiging van een besluit van een orgaan van een rechtspersoon brengt mee dat het besluit van meet af aan niet rechtsgeldig is geweest.

Not a stunning outcome really, in view of prior case law (the 1995 decision) and section 3:53(1) DCC (that deals with nullification), but useful nonetheless.

2. We've been discussing the reshaping of Dutch corporate law in the field of private companies several times (see, e.g., here with links). Now that the first tranche of the legislation process in parliament has been completed (the Second Chamber has accepted the proposal with some amendments), the waiting is for the second and last tranche, to be completed by the First Chamber (that chamber can only say yes or no, it cannot amend); if the process is picked-up and completed before April 1, 2010, the expectation is that the new regime for private companies will be operational as of July 1, 2010. So we're actually getting somewhere here, or so it seems.

In the meantime, the Dutch corporate governance code as updated in December 2008 - finally - replaced the old 2003 code as the code referred to in section 2:391(5) DCC, by means of a December 10, 2009 governmental decree (published on December 21, 2009). Section 2:391(5) DCC requires listed companies to include in their annual accounts the way they comply with the Dutch corporate governance code (which works with a 'comply or explain' mechanism). Background info on the 2008 code is available here.

3. Francis Pileggi has a nice interview with Delaware Supreme Court Chief Justice Myron T. Steele. The Q&A I found most interesting was the following:

Blog: How would you respond to the comment of some scholars that there are too many “standards of review” under Delaware corporate law, which in turn leads to indeterminacy? Chief Justice: Different standards are needed to address different factual situations, but that does not necessarily result in indeterminacy. There is a rational basis for using different rules for different situations. Indeterminacy as to which standard applies should not mean that it is unpredictable to know which standard applies. If one is familiar with Delaware law, the applicable standard should be clear.

This multi-level standard of review issue has been raised several times in the past, most notably in 2001 by three judges/scholars who are/have been active in the Delaware Chancery Court and are sometimes refered to as "The Three Tenors" of corporate law (go and read The Business Lawyer 2001, p. 1287 et seq. if you want to find out who I'm talking about here). For other interviews with Steele and Delaware Supreme Court Justice Jack B. Jacobs go here.

[No. 220] On the Need for Transparency

In Post No. 124 I discussed a recent legislative proposal to expand the scope of the Dutch ownership disclosure rules so as to include cash-settled derivatives such as contracts for differences. I wrote an op-ed on the same issue that was published in today's Financieele Dagblad, the Dutch financial daily. The article can be accessed here (subscribers only).

[No. 219] Voting Record Date: Cure or Disease?

Well, a little bit of both it would appear, at least when it comes to empty voting:

Dutch law currently permits listed companies to set a voting record date (art. 2:117b (3) DCC). The voting record date cannot be set at an earlier date than 30 days prior the date of the shareholders meeting.

Last year, as part of a legislative proposal implementing the European Shareholders' Rights Directive, the Dutch minister of Justice proposed to fix the voting record date at 21 days prior to the date of the shareholders meeting for all listed companies.

Now, MP Ewout Irrgang, of the Socialist Party, argued that to counter the problem of empty voting (voting without corresponding economic interest), the period between the meeting and the voting record date should be longer than that, and proposed that the voting record date be fixed at 28 days instead.

Adjusting the voting record date to counter empty voting, sound familiar? In Delaware earlier this year, the General Corporation Law was also amended to counter empty voting, but in such a way that the period between the meeting and the voting record date can be made shorter - in fact, the voting record date can now be set at any date prior the shareholders' meeting (for a discussion of the amendment, see here).

What explains this difference in approach?

Irrgang's proposal is motivated as follows: (1) a voting record date makes it harder to borrow shares just prior to the meeting and engage in empty voting; (2) a voting record date enables lenders of shares to assess whether shares are borrowed merely for purposes of obtaining the voting rights (as opposed to dividend stripping); (3) the longer the voting record date, the stronger these effects.

By contrast, the Delaware legislature's proposal is motivated as follows: (1) the longer the period of time between the voting record date and the shareholders' meeting (in Delaware, this period can be up to 60 days), the more shareholders will have traded their shares and the less the population of investors entitled to vote will match the population of investors holding shares at the date of the shareholders meeting; (2) the shorter the voting record date, the smaller the risk of empty voting.

So, who's right? On a theoretical level, both are, to some extent. A long voting record date does enable institutional investors like pension funds to first vote their shares and subsequently lend them to dividend strippers (for how long this practice continues to be profitable remains to be seen, but that's a different issue). And a short voting record date does minimize the change in shareholder population.

On a practical level, however, I'm not so sure the changes will have much effect. For one thing, those who are determined to engage in empty voting can easily obtain voting rights without economic exposure through the use of derivatives instead of securities lending. Neither of the legislative proposals takes this into account. This suggests other measures may be necessary. The challenge, of course, is to design such measures and make sure they are proportional to the problem.

 

[No. 218] Some Links and Happy Holidays

During the remaining days of 2009 blogging will be light at TDT, at least on my part; the Assink posse is heading down to the beautiful capital of France.

I'm signing off - with the caveat that unexpected but extremely 'bloggable' developments may force me to return before 2010, wife permitting (ahum) - with two links that caught my eye: one to Mark Roe's recent article Delaware's Shrinking Half Life (for those interested in the intricacies of Delaware's position in the federal/state debate), the other to Trey Drury's musings about The Mosaic Theory of Developing Scholarship (for those interested in, well, scholarship).

Enjoy and happy holidays!

[No. 217] The Janus Head of Corporate Law

On Thursday January 21, 2010, I will accept my appointment as corporate law professor at the Erasmus University Rotterdam with an inaugural lecture called "The Janus Head of Corporate Law".

I am going to focus on the facilitating and regulating character of corporate law and try to connect corporate law with entrepreneurship.

The lecture, that is public (if you're interested, you're cordially invited), will begin at 11.00 hrs.; further information is available here.

[No. 216] Dividends & Law Reform: Parliament Votes in Favor of Board Approval

In post 205 and 193 Bastiaan and I expressed our concerns with the proposed regulation for dividend payments in private companies. We both argued that the second amendment of the proposal - that abolished the boards’ right to approve a distribution - was a mistake and incoherent with the general duty that Dutch law imposes on directors. Today the Dutch parliament voted on an amendment of a member of parliament, that takes the regulation of dividend payments back to square one; back to the requirement of formal board approval. The good news is that (according to the results published on its website) the parliament voted in favor of the amendment. This means the requirement of board approval is part of the proposal again. In my opinion, this is a huge step in the right direction.

[No. 215] The Monitoring Report 2009 by the Dutch Corporate Governance Monitoring Committee

Is available as of today. A thorough 72 page document, full of:

• interesting stats of code compliance by Dutch listed companies;
• a useful overview of national and international developments in the corporate governance realm (mostly Europe, but also US); and
• a list of focus points the committee will use in its coming research of the corporate governance landscape, including director and shareholder behavior and possible ways to provide ex ante incentives for proper conduct.

The press release is available here.

[No. 214] The State of Corporate Governance Research

I just read an interesting paper by Lucian Bebchuk and Michael Weisbach, written as the introduction to a special issue of the Review of Financial Studies dedicated to corporate governance. From the abstract:

This paper, which introduces the special issue on corporate governance co-sponsored by the Review of Financial Studies and the National Bureau of Economic Research (NBER), reviews and comments on the state of corporate governance research. The special issue feature seven papers on corporate governance that were presented in a meeting of the NBER‘s corporate governance project. Each of the papers represents state-of-the-art research in an important area of corporate governance research. For each of these areas, we discuss the importance of the area and the questions it focuses on, how the paper in the special issue makes a significant contribution to this area, and what we do and do not know about the area. We discuss in turn work on shareholders and shareholder activism, directors, executives and their compensation, controlling shareholders, comparative corporate governance, cross-border investments in global capital markets, and the political economy of corporate governance.

A special issue indeed, given that several of the relevant papers have been widely cited even before the issue has been published (Becht, Franks, Mayer, and Rossi's study of activism by Hermes' U.K. Focus Fund, to name but one). Of course, the paper also provides an opportunity to determine whether one's research falls within one of the major corporate governance research areas (which may or may not be a good thing, depending on how you look at it). The full paper is available here.

[No. 213] Jeff Skilling and the SCOTUS

In post No. 210 I wrote about the Conrad Black case that is now pending before the US federal Supreme Court. In that post, I noted the same applied to some other white-collar cases that are of more than average interest to the legal community. One of those cases concerns former Enron CEO Jeff Skilling. Enron, need I say more?

The Black hearing took place earlier this week. Skilling, who - like Black - appealed his criminal conviction on honest services wire-fraud charges under 18 U.S.C. § 1346 before the SCOTUS, filed his brief on the merits last Friday. The hearing in his appeal will take place in February or March 2010.

Lots of background info about both cases - including relevant papers - can be found on the site of Houston's Clear Thinkers. Here's a key passage from the brief on the merits that captures the heart of the matter, namely the reason why Skilling was convicted in the first place.

The Government’s theory is not that Skilling received bribes or kickbacks, or that he directed money or property to an entity in which he had a personal interest, or indeed that he acted for any private gain that was distinct from his ordinary compensation incentives. The Government openly conceded at trial that Skilling stole no money from Enron, that the case against Skilling was not about “greed,” that Skilling sought to pursue Enron’s “best interests,” and that every act for which he was prosecuted was undertaken for the purpose of protecting Enron and promoting its share value.

The Government proceeded on the theory that Skilling nonetheless committed honest-services fraud simply because he took on too much risk for the long-term good of Enron, and improperly touted the company. It did not seek an instruction requiring jurors to find that Skilling acted pursuant to undisclosed personal financial interests in conflict with Enron’s. Instead the Government urged the jury to send Skilling to prison simply because he breached his “duty to do [his] job and do it appropriately.” That theory of honest-services fraud has no grounding in pre-McNally caselaw, and is totally at odds with the Government’s current conception of the statute.

The implications of that theory, moreover, extend far beyond what Congress reasonably could have intended when it enacted § 1346 to overrule McNally, a public-official kickback case. In the private sector, corporate officers are expected to take business risks and cheerlead for their enterprises. A rule that criminalizes every business decision that seems imprudent to prosecutors or lay jurors in hindsight — but does not involve the corrupt pursuit of private gain— would force officers to proceed at their peril in making everyday business judgments. Fortunately, the theory of honest-services fraud the Government advanced below is not the law, as the Government now recognizes.

As emphasized by Tom Kirkendall (the clear thinker from Houston), pointing at the 'honest services wire-fraud charges' in the Skilling case: "making a bad decision or doing a poor job in running a business is a crime. Almost nothing else need be said in explaining why the Skilling appeal is of paramount importance to the protection of taking risk and creating wealth in the American business community."

This 'policy rationale' based skepticism makes sense to me. In fact, it's the same skepticism I put forward late September - and repeated last Tuesday at the annual Vereeniging 'Handelsrecht' meeting (to be published soon) - when certain Dutch politicians started to talk about criminalizing financial mismanagement by bank directors. This is not the right way forward for Dutch society to hold corporate directors responsible for conduct that is seriously sub-par. Not even close.

[No. 212] Shareholder Duties

Jay Verret has an instructive post about government ownership in the private sector, i.e., the state as shareholder in major corporations and the interplay between that position and the fiduciary duties that typically rest on controlling shareholders. Under Delaware law, that is. We're basically talking here about the impact of controlling stockownership by the state on the modern (Delaware) model of corporate governance.

But this topic of course isn't limited to the US factual and legal landscape. The Netherlands saw some similar developments in the fall of 2008; think of the Dutch state's position as controlling shareholder in the Dutch Fortis group and ABN Amro. Some Dutch scholars have started to explore this interplay/impact from the Dutch perspective, but so far I haven't seen a real fundamental attempt to tackle this thorny issue.

There is a broader picture here. Part of the problem for Dutch scholars is, of course, that to date - unlike Delaware corporate law - Dutch corporate law hasn't really progressed in outlining specific duties that rest on (controlling) shareholders, other than the general obligation to act in accordance with the requirement of reasonableness and fairness, laid down in section 2:8 DCC. In no. 3.2.3 and 3.3.2 of my latest book I tried shed some light on the Dutch way forward in this respect.

We'll see where it goes from here; although the 'state as controlling shareholder' issue may simply blow over when the state steps back from that position (something, I guess, the state would like to do rather sooner than later), the fact remains that as to shareholder duties, Dutch corporate law has quite some grow potential left. That evolution will take place in case law, typically inquiry proceedings, and will - thus - take time.

In the meantime, we could (should) for example look to relevant foreign jurisdictions, if only for inspiration; what type of solutions are proposed elsewhere, why, would it work, what would the implications of these proposals be for the Dutch situation (if any), etc.? Three suggestions for further reading, to be found:

here:

Abstract
Corporate law theory and practice considers shareholder relations with companies and the implications of ownership separated from control. Yet through the TARP bailout and the government's resultant shareholding, ownership and control at many companies has merged, leaving corporate theory and practice for the financial and automotive sectors in chaos. The government's $700 billion bailout is a unique historical event; not merely because of its size, but because of a resulting ripple through corporate scholarship and practice. This article builds on the author's four testimonies before Congress during the financial crisis and implementation of the TARP bailout and his consultation for the Inspector General for TARP. It updates the six central theories of corporate law to reveal that none function adequately when considered with a controlling government shareholder that enjoys sovereign immunity from corporate and securities law. From agency theory and nexus-of-contracts thought to the shareholder/director primacy debate, even to notions of progressive corporate law and the team production model, existing theory breaks down when a government shareholder is present. The article also develops an economic model of incentives facing political decision-makers in exercise of their shareholder power. After considering corporate theory, the article offers predictions for how Treasury's stock ownership reshapes the practice of corporate law. In short, TARP will result in a tectonic shift for current understanding about insider trading, securities class actions, share voting, and state corporate law fiduciary duties. The article closes with three recommendations. First, that Treasury take frozen options, an invention explained in the text, rather than equity. Second, that Congress pass legislation establishing a fiduciary duty for Treasury to maximize the value of its investment, a suggestion that has contributed to Sens. Warner and Corker's introduction of implementing legislation. Third, that Treasury adopt a sales plan for closing out its TARP holdings.

here:

Abstract
The financial crisis of 2008 was the worst economic disaster since the Great Depression. It nearly resulted in a collapse of the global capital markets. A key event in the history of the crisis was Bank of America’s acquisition of Merrill Lynch. While this acquisition was pending, Merrill Lynch was accruing losses at an astonishing rate, so much so that Bank of America considered exercising the merger agreement’s material adverse effect clause to abort the deal. The board of directors ultimately decided against doing this, but only after the government, fearing the injection of more systemic risk into the financial system if the deal fell through, threatened to fire the board and management. This episode, unique in modern business history, provides an object lesson on the public-private nature of corporate governance during a national crisis. This topic is important, and thus far has not been developed in either the judicial or scholarly literature, presumably because this country has not experienced a crisis of this scale since the 1930s. In time of national or global crisis, fiduciary duty and board authority are elastic concepts sufficient to encompass the promotion of the public welfare as the primary objective of corporate action. Moreover, where the government has strong supervisory authority, such as the banking sector, the episode has shown that the government can in fact use substantive regulation of an industry as a device of corporate governance to serve a broader public purpose such as the mitigation of systemic risk during the financial crisis of 2008, and such potential has significant implication on the politics of corporate law.

and here:

Abstract
The Bear Stearns/JP Morgan Chase merger placed Delaware between a rock and a hard place. On the one hand, the deal's unprecedented deal protection measures - especially the 39.5% share exchange agreement - were probably invalid under current Delaware doctrine because they rendered the Bear Stearns shareholders' approval rights entirely illusory. On the other hand, if a Delaware court were to enjoin a deal pushed by the Federal Reserve and the Treasury and arguably necessary to prevent a collapse of the international financial system, it would invite just the sort of federal intervention that would undermine Delaware's role as the de facto provider of U.S. corporate law. Faced with a choice between undermining the delicate and subtle balance struck between managers and shareholders and standing in the way of the imperatives of national and international economic policy, Delaware found a third way that avoided both horns of the dilemma: it took advantage of a pending New York action to stay the Delaware action and avoid making any decision at all. In this article, we tell this story, analyzing the doctrinal issues under Delaware corporate and procedural law, and discussing the implications of this episode for our understanding of the landscape of US corporate law making.

[No. 211] Update re Van der Moolen II (The Legal Battle Has Begun)

In post No. 154 (with links to post No. 122, 128 and 129) I wrote about the troubling situation at now bankrupt securities trading and brokerage firm Van der Moolen and the VEB's announcement that it would ask the Enterprise Chamber to order an inquiry into the policy and affairs of Van der Moolen.

In the meantime, the VEB has indeed prepared the necessary legal documentation and formally made the request to the Enterprise Chamber. The request is based on malfunctioning corporate governance, flawed entrepreneurship and possible conflicts of interests.

De VEB en door het faillissement gedupeerde aandeelhouders die zij vertegenwoordigt, zeggen ‘gegronde redenen’ te hebben ‘om te twijfelen aan juist beleid bij Van der Moolen’.

Het verzoek om een enquête dat de VEB vandaag bij de ondernemingskamer indient, leest dan ook als een lange opsomming van klachten over het beleid vanaf het moment dat Van der Moolen in 2005 Curvalue overnam, het optiebedrijf dat was opgericht door Richard den Drijver, die vervolgens topman werd bij Van der Moolen.

Zo stelt de VEB in zijn verzoek aan de Ondernemingskamer onder meer dat geen van de initiatieven van Den Drijver om het bedrijf winstgevend te maken succesvol bleken en alle uitmondden in geld verslindende projecten.

Ook het feit dat het bestuur, in tegenspraak met zijn eigen statuten, tijdenlang uit één persoon – Den Drijver – bestond en de raad van commissarissen uit drie of twee personen, terwijl dat er vijf zouden moeten zijn, heeft volgens de VEB op zijn minst bijgedragen tot de cultuur die leidde tot het uiteindelijke faillissement.

De VEB vat haar kritiek samen als ‘tekortschietende corporate governance, structureel falend ondernemingsbeleid en misleiding van het beleggend publiek.’

(De Volkskrant)

This approach may give the court an opportunity to finetune its modus operandi as to judicial review of director conduct in the business judgment realm. A small piece of advice; check out no. 3.3.3 of my recent book. In any event, rough water ahead for Van der Moolen's directors.

[No. 210] Conrad Black and the SCOTUS

In Ondernemingsrecht 2008-4, no. 48, p. 170-177 I discussed the adventures of Lord Conrad Black. Well, not his 'living larger than life' adventures (do go and check the article for some insights, you won't be disappointed), but the ones:

1. Before the Delaware Chancery Court, where VC Strine found that Black had violated is duty of loyalty towards Hollinger Int., Inc. (for another nice opinion, also a classic Strine analysis really, go here); and
2. The federal courts, where he was: convicted for obstruction of justice and three counts of mail fraud; sentenced to 78 months in prison; required to pay Hollinger $6.1 million; and fined $125,000.

Ouch.

The first case in Delaware was confirmed by the Supreme Court in 2005 (in a Per Curiam opinion). The court captured the disloyalty part of the Chancery Court's ruling as follows.

(...) the Court of Chancery determined that Black had breached his fiduciary duties during the process leading to the Barclays transaction. Specifically, the Court held that Black violated his duty of loyalty by: (1) purposefully denying the International board its prerogative to consider fairly and responsibly a strategic opportunity within the scope of the Strategic Process (the opportunity to sell The Telegraph) and by diverting that opportunity to himself; (2) misleading his fellow directors about his course of conduct and not disclosing his dealings with the Barclays, in circumstances where full disclosure was expected; (3) improperly using confidential information of International to further his own personal interests and not those of International, without the authorization of his fellow directors; and (4) urging the Barclays to make improper inducements to International’s investment banker to betray its client (International) by attempting to secure the Company board's assent to the Barclays transaction.

Pretty clear language.

The second case was appealed before the Seventh Circuit Court, which upheld his conviction. It is now before the federal Supreme Court; so Black, known for his occasional one finger salutes and the statement that prison would be a bore, but quite endurable, isn't done fighting yet. The SCOTUS hearing was yesterday, part of a flurry of other 'white-collar' cases. For background materials go to The Conglomerate and Scotusblog. I'm pretty interested to see how this comes out; the court granted certiorari, which I guess - not being a hardcore SCOTUS watcher and all - it wouldn't have done if it had nothing important to say about this matter.

For now, here is some footage of Black leaving the court, having just been convicted to 6.5 years of jailtime. As Black is well known for his autobiography and three substantial biographies of controversial twentieth-century figures (including Nixon), it may well be that in a few years from now, we'll get to know in his own writing whether jail really was quite endurable, although a bit of a bore...

[No. 209] Are Shareholders the Only Residual Claimants?

This post comes from

J. Matthijs de Jongh
Law clerk at the Dutch Supreme Court

Arnoud Boot, professor Corporate Finance and Financial Markets at the University of Amsterdam, just published De ontwortelde onderneming (Footloose Corporations). Boot argues that corporations seem to be in permanent reorganization. Divestments and takeovers have become the order of the day, and anyone who follows the share indices will be familiar with massive fluctuations in their composition. A sense of discomfort has developed concerning the place of companies as they relate to the financial markets. Even within the organizations themselves.

I can highly recommend this book for lawyers interested in corporate governance, especially because it takes a corporate finance perspective, rather than a legal starting point. A different perspective often breeds new ideas. This book stays well clear of formulas and mathematics, so even lawyers like me are able understand it.

Of course, this book also deals with one of the defining tensions of corporate governance: the stakeholder and shareholder model. Boot takes a balanced approach in this discussion. The differences between the two should not be overstated. In a stakeholder model the interests of shareholders cannot be ignored, whereas a company cannot create shareholder value without paying attention to the interests of employees, creditors etc. In certain situations, however, the different models are relevant, for instance in a takeover situation, or if a company has a monopoly. The shareholder model is superior from a theoretical perspective. However, in practice, a focus on shareholder value has a ‘dark side.’ Information asymmetries, risks of manipulation, short termism of the financial markets (investor myopia) may contribute to the management pursuing short term strategies in stead of taking a long term view.

I won’t deal with the practical complications of the shareholder model. Instead, I’ll make some comments on Boot’s opinion that shareholder value is superior to the stakeholder view from a theoretical point of view. Boot argues that, theoretically, companies should pursue a strategy that maximizes shareholder value, because they have the residual interest in a firm. If a person has a residual interest, the expected value of his future dealings with the firm increases as the firm's value increases, and decreases as the firm's value decreases. A residual claimant is a person whose relationship to the firm gives rise to a significant residual interest in the firm's success (see, for instance, Bernard Black, or Fama and Jensen).

There can be no doubt, that shareholders are residual claimants of a firm: the dividend (or liquidation surplus) they’ll receive depends on the company’s success. If the company makes large profits, the company’s dividends are likely to rise, whereas if the company goes bankrupt, shareholders are last in line to receive their part of the liquidation surplus – if there is anything left over at all. The value of the shareholders’ residual claim is reflected in the share price and may go up or down, depending on the company’s prospected profits. On the other hand, the interests of employees and (other) creditors are well defined and protected by law); they are not likely to go up or down, depending on the company’s success. Compared to employees or creditors, shareholders take a subordinate position. This subordinate position justifies that the company should aim at maximizing shareholder value, so the argument goes. As shareholders will only receive money once all other creditors have been paid, a focus on shareholder value will also serve the interests of other stakeholders. Boot:

De vaak zeer gedetailleerde contracten (arbeidscontract respectievelijk leenovereenkomst) en uitgebreide wetgeving (arbeidsrecht en de bescherming van crediteuren in de faillissementswet) steken nadrukkelijk af tegen de zeer indirecte, en weinig afdwingbare, specificering van het contract van aandeelhouders. Aandeelhouders hebben inherent aan hun positie als ‘residual claimants’ geen directe juridisch afdwingbare claim. Met andere woorden, aandeelhouders hebben gezien hun achtergestelde positie de minste bescherming. Hun residuele claim op het resultaat van de onderneming betekent dat zij pas hun compensatie ontvangen nadat alle andere partijen – waaronder werknemers en crediteuren – zijn voorzien. Deze residuele claim is min of meer de uitlaatklep van de onderneming. Als het iets beter of iets slechter met de onderneming gaat dan is er een onmiddellijk effect op de waarde van de residuele claim. Ongetwijfeld is er bij majeure veranderingen ook een effect op de positie van werknemers en crediteuren, maar zij liggen in de tweede linie; zij hebben een mate van bescherming die aandeelhouders niet kennen.

Boot acknowledges that employees and creditors are not fully protected either, because their contracts aren’t complete either. For instance, he agrees that conflicts of interest are possible, especially if the company is facing bankruptcy:

Voor aandeelhouders die de ondergang van de onderneming morgen verwachten zou dit reden kunnen zijn om ‘vandaag’ extra risico te nemen – niet gegokt is misgegokt. In hun achterhoofd hebben ze dan de gedachte dat ze, zonder risico te nemen, morgen waarschijnlijk toch niets krijgen. Aandeelhouders staan immers achteraan. Risico nemen kan – net als een gokje in Las Vegas – zorgen voor een onwaarschijnlijke turn around. Uiteraard is een dergelijk gokgedrag niet waardemaximerend voor de onderneming als geheel. Iemand betaalt hiervoor. Dit zijn de verschaffers van vreemd vermogen: zonder het gokken was er nog iets voor hen over, na het gokken meestal niet.

This is an example in which creditors are residual claimants as well, just like the shareholders. But there may also be other stakeholders that are residual claimants. Let’s take the position of employees. It seems to me that the residual claimant-theory (implicitly) relies on a view on the labor contract that differs to some extent from the continental European view on the labor contract. Employees in the US have less protection than they usually have in (continental) Europe. The protection of employees in the USA is more limited to the payment of the wages than it is the case in Europe. More than it is the case in the US, employees in Europe often enjoy some protection with respect to the continuation of their contract; they often receive a larger compensation in case of termination of the contract. Many employees have a stronger position than their US counterparts. This approach certainly has some disadvantages (it makes the labor market more inflexible; it protects insiders and weakens outsiders), but it also provides some security for employees; it enables them to enter into long term mortgage contracts.

For instance, in the Netherlands, the protection of an employee after the termination of the labor contract depends on the circumstances: the age of the employee, the duration of the labor contract, which party is to blame, whether the company is facing difficult circumstances or not. If a 60 year old employee is fired after 20 years without him to blame that the contract is terminated and if the company is doing well, the employee is likely to get quite some money after termination of his contract. However, if, ceteris paribus, this employee is fired because the company is bankrupt, he’ll get nothing. Is he a residual claimant? The value of his claim to the company depends on the value of the firm. Although the residual claim of employees will probably vary less than the residual claim of a shareholder, for an employee there is usually much more at stake if he looses his job, compared to a shareholder who looses his money. Once one acknowledges that employees also have a residual claim, it may be argued that the company should not (only) pursue a shareholder maximization strategy, but it shall also take into account the interests of other residual claimants, such as employees or creditors.

Furthermore, there is a special category of companies whose shareholders are certainly not the principal residual claimants: these are the so called ‘systemic banks,’ i.e. banks which may not go bankrupt, because this would otherwise disrupt the financial system. The residual claimants of these companies are the tax payers, who are securing that the company survives in a situation in which another (non systemic) bank would go bankrupt. The fact that tax payers are the residual claimants of systemic banks not only makes a strong case for regulation of these banks, but it may also have consequences for corporate law. It may well be argued that these banks should take into account the public interest in their corporate policy. And it may also be argued that shareholder control rights should be limited in a special situation in which the public interest is really at stake.

In fact, we have seen some examples last year. For instance in Belgium, Fortis wanted to sell Fortis Bank Belgium to BNP Paribas, just after it had been saved by the Belgian government. The Belgian government argued that shareholders should not have a decisive vote on this transaction, as the public interest required it to take place. In The Netherlands, the Dutch government supported, amongst others, ING, and insisted on the appointment of two supervisory directors on behalf of the government. Maybe, we even do have other systemic companies as well. Companies, whose bankruptcy would have important local or national consequences. Guess who saved General Motors and appointed new board members …

In short, I am not convinced that a shareholder model is preferable from a theoretical perspective, at least when it is based on the assumption that only shareholders are the residual claimants. Rather, it seems to me that there are often several residual claimants – or stakeholders if you like.

One of the few advantages of the current crisis is that is creates many new questions that we previously didn’t ask ourselves. For instance: are shareholders always the only residual claimants? And, if not, what consequences should this have for corporate law?

[No. 208] ASMI to the Supreme Court

In post 103 Bastiaan commented on the decision of the Dutch Enterprise Chamber to grant the request for an inquiry by investment funds (and ASM International shareholders) Hermes and Fursa into the policy and affairs of ASM International. He concluded:

My guess is that chances of Supreme Court litigation in this matter are rather high. And the outcome of such corporate governance related disputes is not always easy to predict, as evidenced by the discrepancy between the approach taken by the Enterprise Chamber and the Supreme Court in the ABN Amro Bank matter.

Bastiaan's guess was accurate, as today the Dutch Financial Times reports that founder and minority shareholder of AMSI Arthur del Prado and the foundation have appealed to the court of cassation. According to sources of the newspaper, the emotions of the respective parties are starting to play a role in the conflict. This never ending dispute is once again to be continued…

[No. 207] The European Private Company: an Eclectic View

On June 25, 2008, the European Commission presented a proposal for a Statute on a European Private Company (Societas Privata Europaea, SPE). I already briefly touched upon this topic in post 132. According to the Commission, this new company form will enable small- and medium-sized enterprises (SME’s) to do business throughout the EU, with the aim of cutting costs and encouraging growth in this area. The SPE is an important component of the Commission's Action Plan on Modernizing Company Law and Enhancing Corporate Governance in the EU. It also forms part of the Single Market Review and is one of the key features of the Commission's Small Business Act, which was announced in November 2007 and seeks to make the Single Market accessible to SME’s. The latter is  not a legislative act containing provisions applicable to small businesses, but rather a policy document aimed at governments and institutions.

According to an impact assessment of December 2008, only 8% of SME’s in the European economy engage in cross-border trade and only about 5% have set up subsidiaries or joint ventures abroad. These figures clearly are a thorn in the Commission’s flesh and the introduction of a company form at supranational level governed by supranational laws should therefore change them. Nevertheless, more than a year has passed since the Commission has published its proposal, in which it did not take any further steps towards realization of the project. The European Parliament, although explicitly supporting the introduction of the SPE, passed a resolution on 10 March 2009, which proposes no less than 72 amendments to the Commission’s proposal.

The most pressing question is obviously whether the SPE is fit for the purpose. Of course, to answer this question, an in-depth review of the Commission’s proposal is required. I do not intend to provide one here, instead I refer to a critical analysis of the EU draft statute that recently has been published and to which I contributed. In this post, however, I offer some eclectic insights and points of criticism.

1. Applicable law. Since private company law is more nationally distinctive than that applying to public companies, the Commission aims only to refer to national law sparingly. The SPE is primarily governed by the applicable mandatory provisions of the Regulation. This Regulation requires a range of matters to be regulated in the articles of association (summed up in Annex 1). Matters which are not covered by the regulation or by annex 1 are governed by national law. The relevant applicable law is the law that applies to private limited-liability companies of the Member State where the SPE has its registered office. Apparently, the drafters intended this applicability of national law to be limited. However, significant areas of law fall entirely outside the scope of the proposal, such as employment law, insolvency law and tax law. This raises the question how uniform the different SPE’s will actually be.

2. Cross border element . The incorporation of an SPE does not require the presence of a cross-border element. This puts the SPE in direct competition with existing national company forms (and in the near future probably the Dutch flexible BV). It has been argued that this lack of a cross border element gives rise to the question as to whether the SPE statute is in compliance with the subsidiarity test articulated in Article 5 EC Treaty. The European Parliament therefore proposes to insert such a requirement, providing that a cross border component is demonstrable within two years of the company being founded. However, such a requirement is easy to circumvent and could become an unnecessary obstacle that would reduce the attractiveness of the SPE. Therefore an apparent solution for this problem seems to be missing.    
 
3. Minimum Capital. The proposal requires € 1 minimum capital. As many countries nowadays (or in the near future will) offer a limited liability corporate form without a minimum capital requirement, the Commission’s decision to refrain from such an obligation for the SPE is to be welcomed in my opinion. Such a condition could deter entrepreneurs from establishing an SPE, whilst it is (almost) impossible to find anyone that still believes that a minimum capital offers any protection to the company’s creditors. This child of the 19th century is nowadays water under the bridge.

4. Distributions. Shareholders of the SPE can decide by resolution to distribute dividends. This is, however, only possible on the basis of a proposal by the management body. Moreover, distributions have to satisfy a balance-sheet test, namely the assets of the SPE must fully cover its liabilities after the distribution. The Proposal neither defines ‘assets’ nor ‘liabilities’, but the Commission states that the relevant accounting provisions apply, i.e. the Fourth Directive. Although German scholars have argued the opposite, the current wording of the relevant provision can lead to no other conclusion than that the distribution of the company’s capital to its shareholders is permitted. The articles of association may require the board to sign a solvency certificate before distribution, certifying that the SPE will be able to pay its debts as they become due in the normal course of business within one year of the date of the distribution. The European Parliament though prefers this solvency test to be obligatory if the SPE’s capital is less than € 8000. In my opinion, an optional solvency test is not desirable, as it could give the wrong impression that if no certificate is required, the board should not consider the company’s financial position at all. I submit that the board is always obligated – no matter if it is or is not required to sign a solvency certificate – to examine whether the company will be able to pay its debts when they become due after a distribution. This lies within its duty towards the company, as stipulated in Article 31.1 of the Regulation: ‘a director shall have a duty to act in the best interests of the SPE’. It will never be in the best interest of the SPE to distribute such an amount that it will not be able to pay its debts afterwards. If a director fears that a distribution will harm the company’s financial position to this extent, he should not propose such a distribution and resist a pay out; this duty does not depend on a certificate. Directors will therefore always have to look further than the balance-sheet when considering a distribution. (A similar discussion is currently going on with respect to the Dutch proposal to amend the law applicable to private companies, see posts 205 & 193.)

5. Liability of shareholders and directors. The regulation contains only one provision considering the liability of shareholders, which provides that any shareholder who has received distributions made contrary to the balance-sheet test or optional solvency certificate requirement, must return those distributions to the SPE, provided that the SPE proves that the shareholder knew or, in light of the circumstances, should have been aware of the irregularities. This narrow definition raises the question to what extent national law will apply to the liability of shareholders. In many EU countries, shareholders can be held liable for distributions and other withdrawals that prejudice creditors, on the basis of broader concepts of private law. As the proposal does not ‘cover’ the liability of shareholders vis-à-vis the company’s creditors or its trustee in bankruptcy, it is submitted that these national legal concepts will be applicable to the SPE. Piercing of the corporate veil, tort law and insolvency law (for instance actio pauliana) of the applicable national law will be used by the trustee and creditors of an insolvent SPE to claim restitution for unlawful distributions and other withdrawals of assets. This implies that national law will govern a very important part of the creditor protection. This also applies to the liability of directors. As the regulation does not ‘cover’ the liabilities of directors vis-à-vis creditors or the trustee in bankruptcy or the rights of individual creditors to directly sue the directors, national law will apply.

The question remains if the SPE will ever see daylight. The Council’s progress report of May 8, 2009 mentioned employee participation, the cross-border element, minimum capital and safeguards, compliance control and directors’ duties as main issues that need further discussion. These are evidently not minor issues. In my view the differing opinions of the respective Member States constitute a risk that the SPE will turn out as a weak compromise. The fact that national law will mostly govern the important area of creditor protection, doesn’t add to its attractiveness either. However, one can never be sure what will happen once the Commission has set its mind on promoting SME business in Europe. Maybe the SPE will prove to be the successful sibling of the SE after all.

[No. 206] Corporate Governance Reform in the UK

Thanks to Matthijs de Jongh, two links to Corporate Governance reform initiatives in the UK:

The first one's to the Financial Reporting Council's proposed reforms to the UK Corporate Governance Code;

The second one's to the Institutional Shareholders' Committee (ISC)'s Code on the Responsibilities of Institutional Investors.

One thing that's interesting is that the code provisions addressed to shareholders will probably be removed from the UK Corporate Governance Code, per Sir Walker's recommendation, and be replaced by the forthcoming Stewardship Code for institutional investors - based on the ISC's principles. In the Netherlands, the provisions addressed to shareholders have been expanded over recent years but for the time being are likely to remain included in the Dutch Corporate Governance Code.

Enjoy!

[No. 205] Private Company Law Reform and Dividend Payment to Shareholders

Our guest author Jaap Barneveld took a moment in post No. 132 to explain developments re private company law reform in the Netherlands. In post No. 193, Jaap discussed a hick-up in the legislation process centering around the payment of dividends to the company's shareholders. Some nuggets from his observations.

The Dutch proposal also amends the rules concerning the payment of dividends to the company’s shareholders. Contrary to the abolition of the minimum capital, this part of the proposal has met a considerable amount of criticism. Under current Dutch law, distributions have to satisfy a balance-sheet test; it is not allowed to distribute the company’s share capital. As the General Meeting of Shareholders (GMS) has the power to resolve on distributions, the responsibility of the Board of Directors for these payments is not clear. However, case-law indicates that this does not imply that the directors do not bear any responsibility at all: in several cases, directors that had paid dividends prior to the company’s bankruptcy, have been held liable.

The bill replaces the balance-sheet test with a solvency approach. Distribution of dividends will primarily be subject to a liquidity/solvency-test. The par value of the capital may be distributed. Initially, the bill required the Board of Directors to perform a solvency test before approving a distribution. This test implied that the directors were obligated to check whether, after the distribution has been made, the company would continue to be able to pay its debts as they fall due. If the Board approved a distribution knowing that the payment failed this test, the directors could be held liable for the deficit. This rule threw some light on the role and responsibility of the Board with regards to dividends, without introducing a new liability risk, as directors can already be held liable for such payments.

However, an amendment of the Proposal in February 2009 (Tweede Nota van Wijziging), deleted the boards’ right to approve the distribution and the formal requirement of a solvency test. The Confederation of Netherlands Industry and Employers (known as VNO-NCW and the largest employers’ organization in the Netherlands) strongly objected to the increased role of the Board with respect to dividends. It feared extra liability risks for directors and argued that directors would experience pressure from shareholders if they tried to block a distribution. Since the GMS decides on distributions, it would be incoherent to provide the directors with a right of veto, it argued.

The February 2009 amendment was received with mixed feelings among scholars. I argued in my recent book (no. 3.1.3) that the amendment was seriously flawed and needed reconsideration pronto. So did Jaap in his post. The legislation process seems to be back on track, in view of this amendment introduced by three members of parliament who are part of a committee that is doing the groundwork for the plenary discussion (that has been postponed for some time). The committee is convening today. The amendment attempts to take the regulation of dividend payment back to square one, back to the requirement of formal board approval.

Problem solved? No, not yet. But it's a start.

[No. 204] The Lisbon Treaty - Off we go

Today – relatively quietly – the Lisbon Treaty came into effect. As a result the Treaty on the European Union (TEU) and the Treaty establishing the European Community (EC Treaty) are amended. The 'old' EC Treaty will in the future be known as the Treaty on the Functioning of the European Union (TFEU). Amongst many other things the most striking differences between the old and new treaties are that:

• there will be a permanent president of the European Counsil – Herman van Rompuy is the first the 'EU President'
• there will be a High Representative of the Union for Foreign Affairs and Security Policy – Catherine Ashton will be the first 'EU Minister of Foreign Affairs'
• the will be a more important role for the European Parliament
• under the TFEU the so-called pillar structure will disappear
• the European Union will have legal personality and will replace the European Community

A consolidated version of the TEU and TFEU can be found here.

[No. 203] I Didn't Sell Any Shares At This Time

Those familiar with Dutch securities law - and those familiar with losing money in the internet bubble - will instantly attribute this quote to Mrs. Nina Brink, former CEO of internet access provider World Online, which went public in early 2000 at the height of the bubble. The IPO price was EUR 43, the share started trading at over EUR 50 and, well, from there on, it went down, down, down.

Investors were not amused, and litigation ensued. After lengthy proceedings, the Supreme Court issued the final word last week (see post No. 200). The Court's opinion offers plenty of food for thought, but here's one aspect that I found particularly interesting from the perspective of my own research on ownership disclosure rules:

In my forthcoming article "The Case for Mandatory Ownership Disclosure" I describe the various mechanisms through which ownership disclosure improves market efficiency, and make the following observations, among others:

The function of ownership disclosure is to enable investors to make their own informed assessment as to how the ownership structure of a particular firm may impact the value of the share. This also explains why securities laws typically require disclosure of the ownership structure in the prospectus. (...)

(...) disclosure of insider trading may [also] improve market efficiency. To begin, the mere fact that insiders (particularly, managers) own shares constitutes fundamental information. (...) Disclosure of inside ownership, by signaling the potential for increased or reduced agency costs, enables investors to assess the implications of inside ownership for the value of the share. By the same token, disclosure of transactions changing the level of inside ownership allows investors
to re-assess incentive and entrenchment effects and to assess the implications for the value of the share.

Disclosure of transactions by insiders also contributes to market efficiency through a different mechanism. As with disclosure of transactions by major shareholders, disclosure of transactions by insiders may convey underlying fundamental information driving the transactions. Even though the prohibition on trading on non-public information applies, managers can be expected to possess such information and their trades therefore potentially convey new information on the firm’s prospects. (...)

The Supreme Court's opinion ties these various elements together in an interesting way that I hadn't touched upon in my article. Not only did the ownership structure of World Online need to be disclosed in the prospectus (per applicable securities laws), movements in the ownership structure (i.e., transactions) in the year preceding the IPO also needed to be disclosed (again, per applicable securities laws), including, according to the Supreme Court, the price against which such transactions were conducted. This is interesting, because securities laws in force at the time did not explicitly require this (nor do securities laws in force today, if one looks at the relevant European regulation).

Information on the price against which Mrs. Brink sold shares prior to the IPO - just over USD 6, rather meager compared to the IPO price of EUR 43 - should have been included in the prospectus, according to the Supreme Court, because the Listing Particulars Directive required, as a general matter, that "[t]he listing particulars shall contain the information which (...) is necessary to enable investors and their investment advisers to make an informed assessment of the assets and liabilities, financial position, profits and losses, and prospects of the issuer (...)".

The information on price was necessary to enable investors to make such an informed assessment because, essentially, this price conveyed information about Mrs. Brink's own estimate of the prospects (and hence value) of the company, information that was particularly relevant given the difficulty of adequately valuing an ICT company without a meaningful track record. The fact that the sales price of roughly USD 6 didn't tell the whole story because the relevant transactions were more complex and were entered into at an earlier time under different circumstances, according to the Supreme Court did not imply that the price needed not be disclosed, as World Online (and the Advocate General to the Court) had argued.

As far as Mrs. Brink's statement that she "didn't sell any shares at this time" (i.e., the time of the IPO) is concerned, this statement didn't help much either. The Supreme Court held that since the sales that occurred prior to the IPO constituted relevant information, Mrs. Brink should, on the same occasion, have mentioned these sales as well, basically to offer a complete view on the issue.

In sum, the Court's opinion serves as a powerful reminder that prospectus disclosure can hardly be too extensive - expect prospectuses to grow in size further after this decision.