[Update, May 2012: Leo E. Strine, Jr., Chancellor of the Delaware Court of Chancery, referenced this post in his thoughtful new law review article, Our Continuing Struggle With the Idea That For-Profit Corporations Seek Profit, 47 Wake Forest L. Rev. 135 (2012).]
Also, Todd Henderson has a riposte. He’s right that most companies can engage in modest philanthropic efforts without worry, but if a company starts putting its money where its mouth is on philanthropy, they’ll get eBay’d, just like craigslist was. Craigslist didn’t engage in “purely philanthropic ends,” they tried to protect the frugal, community-centric corporate culture that was a hallmark for their success. The Court held: no, sorry, can’t do that, because that conflicts with your duty to maximize shareholder value. Thus, the duty to maximize profits isn’t, as Henderson said, a “canard.” It’s an enforceable — albeit rare, since most corporations willingly maximize profits — legal doctrine, and it was just enforced against craigslist.]
Remember all the complaining conservative corporate law professors did back when Senator Al Franken decried the profit-seeking motives of corporations?
Here was Todd Henderson:
In a recent speech at the Netroots Nation, Senator Al Franken tried to frighten the crowd by trotting out the corporate bogeyman that greedily makes decisions without regard to anything other than profit. Franken told them: “it is literally malfeasance for a corporation not to do everything it legally can to maximize its profits.” Individuals across the political spectrum share this common canard. Those on the right, like Milton Friedman, argue that the shareholder-wealth-maximization requirement prohibits firms from acting in ways that benefit, say, local communities or the environment, at the expense of the bottom line. Those on the left, like Franken, argue that the duty to shareholders makes corporations untrustworthy and dangerous. They are both wrong.
While the duty to maximize shareholder value may be a useful shorthand for a corporate manager to think about how to act on a day to day basis, this is not legally required or enforceable ….
Under this legal regime, it is not malfeasance for boards or corporate chiefs to make decisions that do not maximize shareholder value.
And here was Stephen Bainbridge, following up on Henderson:
I agree. Indeed, I’ve made this point in my own writing on corporate social responsibility. See, e.g., The Bishops and the Corporate Stakeholder Debate. As I explain therein, however, while the business judgment rule has the effect of giving directors latitude to make decisions that deviate from the shareholder wealth maximization norm, that is not the purpose of the rule.
The fact that corporate law does not intend to promote corporate social responsibility, but rather merely allows it to exist behind the shield of the business judgment rule becomes significant in — and is confirmed by — cases where the business judgment rule does not apply.
Larry Ribstein jumped in, too: “The Franken misconception is widely espoused by those in the radical anti-corporate camp, such as the author of the widely read screed The Corporation.”
Somebody better tell that to the “radical anti-corporate camp” at the Delaware Court of Chancery, lead by Chancellor William B. Chandler, III, since apparently he’s doing it all wrong over there:
Jim and Craig did prove that they personally believe craigslist should not be about the business of stockholder wealth maximization, now or in the future. As an abstract matter, there is nothing inappropriate about an organization seeking to aid local, national, and global communities by providing a website for online classifieds that is largely devoid of monetized elements. Indeed, I personally appreciate and admire Jim’s and Craig’s desire to be of service to communities. The corporate form in which craigslist operates, however, is not an appropriate vehicle for purely philanthropic ends, at least not when there are other stockholders interested in realizing a return on their investment. Jim and Craig opted to form craigslist, Inc. as a for-profit Delaware corporation and voluntarily accepted millions of dollars from eBay as part of a transaction whereby eBay became a stockholder. Having chosen a for-profit corporate form, the craigslist directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of its stockholders. The “Inc.” after the company name has to mean at least that. Thus, I cannot accept as valid for the purposes of implementing the Rights Plan a corporate policy that specifically, clearly, and admittedly seeks not to maximize the economic value of a for-profit Delaware corporation for the benefit of its stockholders—no matter whether those stockholders are individuals of modest means or a corporate titan of online commerce. If Jim and Craig were the only stockholders affected by their decisions, then there would be no one to object. eBay, however, holds a significant stake in craigslist, and Jim and Craig’s actions affect others besides themselves.
That’s from the newly-released eBay v. Newmark opinion, courtesy of Francis G.X. Pileggi. I leave the reader to their own conclusions as to how a team of corporate law professors were bested in their understanding of fiduciary duties by a comedian.
Before we get to the merits of the eBay opinion, first things first: in additional to being one of the most influential corporate jurists in the country, Chancellor Chandler is known for the hilarious footnotes he inserts into his opinions, like when he relied upon that other famous legal scholar, 50 cent, to define the meaning of “whips.” (I highly recommend that His Honor review the fine fiddy scholarship undertaken by @English50cent.)
This time around, it’s footnote 23:
For example, during negotiations, Price sent an email to eBay executives explaining that Jim and Craig understood that if they insisted eBay sign a non-compete agreement it would be “a defcon 5/deal breaker issue” for eBay. PTX-30 (email from Garret Price to eBay executives (June 24, 2004)). I include this email in the story (1) to illustrate how strongly eBay felt about maintaining the right to compete and (2) because we all appreciate a good reference now and then to the Defense Readiness Condition (“DefCon”) of the armed forces. A good DefCon reference, however, is even better when it makes use of the appropriate DefCon level. Accordingly, Price’s DefCon reference would have been more adept if he had used DefCon 1, which signals “maximum force readiness.” See Description of DefCon Defense Condition, Federation of American Scientists, http://www.fas.org/nuke/guide/usa/c3i/defcon.htm (last visited August 12, 2010); see also WARGAMES (Metro-Goldwyn-Mayer 1983) (Dr. McKittrick: “See that sign up here—up here. ‘DefCon.’ That indicates our current ‘def’ense ‘con’dition. It should read ‘DefCon 5,’ which means peace. It’s still 4 because of that little stunt you pulled. Actually, if we hadn’t caught it in time, it might have gone to DefCon 1. You know what that means, David?” David: “No. What does that mean?” Dr. McKittrick: “World War Three.”). Price, however, referenced DefCon 5, which merely signals “normal peacetime readiness.” I assume, therefore, that Price’s reference to DefCon 5 is not an accurate characterization of what eBay’s negotiation stance would have been had Jim and Craig fired a mandatory non-compete across eBay’s bow.
Now, on to the merits.
In short, eBay purchased a minority stake in craigslist a few years ago, making them one of three shareholders in the company, the other two of which (Jim and Craig) have been pretty much in lockstep since the founding of the company. eBay knew that it was walking into a company with completely different values from its own, a company with a peculiar and iconic corporate culture that forsake typical emphasis on growth and profit maximization for a sense of Internet community and frugality.
Since eBay knew that it was entering into a relationship with majority shareholders who did not share its values, it contracted to protect itself as part of the purchase. I could not help but think while reading the first 40 or so pages of the opinion — in which the relationship sours, and so the majority owners, Jim and Craig, start looking for ways to minimize eBay’s present and future influence and/or encourage them to sell — that the case was very specific to these particular facts, because it revolved around the measures eBay took to protect itself via the shareholder agreement when it bought that minority ownership.
The Chancellor seemed to think the same thing:
Throughout this dispute, I have repeatedly read and listened to what look and sound like breach of contract arguments, which eBay uses not to prove Jim and Craig breached a contract, but rather to prove Jim and Craig breached their fiduciary duties. This has been an odd exercise, and I admit I am puzzled by eBay’s decision not to bring a breach of contract claim or, more promising perhaps, a claim for breach of the implied covenant, considering eBay expended significant effort arguing that the 2008 Board Actions violated both the technical provisions and the spirit of the SPA and the Shareholders’ Agreement. The fact remains, however, that eBay asserted neither a breach of contract claim nor a claim for breach of the implied covenant. Therefore, I make no ruling on whether Jim and Craig breached the SPA, the Shareholders’ Agreement, or the implied covenant of good faith and fair dealing by implementing the 2008 Board Actions. The legal conclusions in this Opinion only relate to whether Jim and Craig breached the fiduciary duties they owe to eBay by implementing the 2008 Board Actions.
So be it. Those Board Actions were:
(1) adopting a rights plan that restricted eBay from purchasing additional craigslist shares and hampered eBay’s ability to freely sell the craigslist shares it owned to third parties, (2) implementing a staggered board that made it impossible for eBay to unilaterally elect a director to the craigslist board, and (3) seeking to obtain a right of first refusal in craigslist’s favor over the craigslist shares eBay owns by offering to issue one new share of craigslist stock in exchange for every five shares over which any craigslist stockholder granted a right of first refusal in craigslist’s favor.
Chancellor Chandler found that the first and third violated Jim and Craig’s fiduciary duties to the company, and so rescinded those actions. It’s a “win” for eBay, sort-of. I bet they would trade winning on the first if they could get the second.
Gordon Smith has an early take on it over at The Conglomerate, viewing it as a minority shareholder oppression case. In the classic minority shareholder oppression case, the more powerful interests are actively trying to drive out the minority shareholder and/or diminish the value of that minority shareholder’s interest. (Here’s one of a trillion law review articles on such oppression.)
I think that’s true for the right of first refusal issue: without without getting into too much detail, the actual working of that right of first refusal would effectively make eBay’s shares worth less than those of Jim and Craig. That is plain-vanilla minority shareholder oppression, and, as a plaintiff’s lawyer, I’m glad to see the impropriety of that recognized even in a corporation with such few shareholders (i.e., three).
But I don’t see the same type of oppression with regard to the rights plan, which is the part that prompted the discussion of the profit-maximization role of corporations. In the rights plan, Jim and Craig set in place a number of ownership protocols that would hinder the ability of eBay to acquire further interests in the event that Jim or Craig died. As Chancellor Chandler characterized it, Jim and Craig were trying “shape the future of the space-time continuum.” The nominal corporate purpose of the rights plan was not to benefit Jim or Craig — they would be dead, of course — but to help preserve the corporate culture at craigslist, since they knew eBay, if it took over, would try to mold craigslist more towards eBay’s short-term profit-maximization culture.
Unlike Chancellor Chandler, I don’t think Jim and Craig did anything wrong by trying to protect the frugal, community-centered corporate culture at craigslist. Although it is certainly reasonable to presume that, in general, a shareholder invests in a for-profit Corporation for the purpose of maximizing their returns, it’s not like eBay bought shares of Halliburton and then watched as Halliburton forsake war in favor of soup kitchens and music programs for kids. It’s not Dodge v. Ford.
Instead, eBay knowingly and voluntarily bought a piece of Jim and Craig’s frugal, community-centered company. As such, the fiduciary duty owed by Jim and Craig to eBay has to be viewed in the context of the company itself – a company renowned for its tiny size, community service mindset, and its refusal to adopt typical principles of short-term profit-maximization.
That is to say, although Franken was right in general about the fiduciary duties corporate directors owe their shareholders — and, undoubtedly, most corporate directors presume that their duty is to maximize profit and most shareholders would sue to enforce that — I think those general principles should be considered in light of the specifics of each company. For better or for worse, eBay bought a piece of craigslist, not some generic ideal of a corporation, and they should be held to that. The idea of an arms’-length transaction among businesses works both ways; craigslist formed a for-profit “Inc.,” but eBay knowingly invested in an “Inc.” with a tangibly different idea of “for-profit.” As Joshua Fershee notes, Jim and Craig credibility testified that craigslist’s community service mission “is the basis upon which our business success rests. Without that mission, I don’t think this company has the business success it has.'” Jim and Craig had good and sound business reasons for their decision to protect the highly successful, if idiosyncratic, corporate culture at craigslist, and that decision should be protected by the business judgment rule.
But what I think should be the law — and what a couple politically-biased professors claim is the law — isn’t necessarily the law. Under eBay v. Newman, the law is as Franken said: “it is literally malfeasance for a corporation not to do everything it legally can to maximize its profits.” Just ask Jim and Craig; no one disputes it’s their company, but they’re legally prohibited from taking steps to preserve the profit-alongside-community-service mission that’s served them well. Maximize profits, or else.
The impact of this duty-to-maximize-profits stretches far beyond mere investments. Under Citizens United, corporations now have the First Amendment right to influence our fragile democracy however they want, since they’re “people,” just like you and me, albeit profit-maximizing zombies who care not for truth, justice, or the American way.
That being the case, maybe we should spend less time listening to the Hendersons, Bainbridges, and Ribsteins, and more time listening to Lawrence Lessig. Maybe it’s time for us real, living, breathing citizens to stop acting like we’re at DefCon 5.