Chapter 4The Corporation and Society

Class Outline

(updated 23 Aug 06)

Chapter 4The Corporation and Society

  1. Introduction
  • Corporate social responsibility
  • Corporate money
  • Who should make the decision?
  • What’s lawyer’s role?
  • The social responsibility of multinational companies
  • How to assure legitimacy or accountability?
  1. Framing the Issues
  • The Berle-Dodd debate: Should corporations take societal interests into account in their business decisions?
  • Judicial approaches
  • Dodge v. Ford Motor Co.
  • fiduciary duties
  • duty of care: BJR
  • duty of loyalty: motivated by conflict
  • ALI Principles of Corporate Governance
  • §2.01 The Objective and Conduct of the Corporation
  • The special problem of multinational corporations
  1. The Role of the Lawyer
  • Corporate lawyers in differing contexts
  • Rule 2.1 Advisor, American Bar Association, Model Rules of Professional Conduct (2002)
  1. Corporate Charitable Contributions
  • Theodora Holding Corp. v. Henderson
  • Kahn v. Sullivan
  • ultra vires doctrine
  • rise and fall
  • modern powers/purposes
  • authorization of corporate charity

Class Notes

Chapter 4The Corporation and Society

B. Framing the Issues
Dodge v. Ford Motor Co.(Mich. 1919)
Ford Motor Company is the most successful organization of the industrial revolution -- its crowning jewel. Formed in 1903, the company has in less than 10 years become the largest automobile company in the world.
/ SALES (cars) PROFITS
191018,664 $4,521,509.51
191134,466 $6,275,031.07
191268,544 $13,057,312.24
191368,304 $25,046,767.43
1914248,307$30,338,454.61
1915264,351$24,641,423.17
1916472,350 $59,994,918.01 /
Henry Ford sits atop this roaring, bustling American success, with 57% of the company's shares and domination of the board. He has grand plans for his company. How does he plan to accomplish this?
 reduce the price of cars from $440 to $360
 become vertically integrated (mining iron ore, building ships to transport the ore, building smelters to make steel)
 employ even more men at $5 or more a day
/ The company has since 1908 paid regular dividends of $1.2 million annually -- a 60% return on investors' original $2 million investment. The company has also paid special dividends:
SPECIAL DIVIDENDS
1911 $1,000,000;
1912 $4,000,000;
1913 $10,000,000;
1914 $11,000,000;
1915 $15,000,000; /
In 1916 Ford stopped paying dividends. Why? What do the plaintiffs demand? What about the long term? What about the business judgment rule? Should directors consider / prefer non-shareholder constituencies? What does the Michigan Supreme Court say? What were Henry Ford's real motives? What about the Michigan court?
****************
Henry Ford:
"My ambition is to employ still more men; to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes. To do this, we are putting the greatest share of our profits back into the business."
***************
Michigan Supreme Court:
"The capacity of the plant ... would produce more than 600,000 cars annually. This number and more could have been sold for $440 instead of $360.... In short, the plan does not call for and is not intended to produce immediately a more profitable business but a less profitable one.
"A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the nondistribution of profits among stockholders in order to devote them to other purposes/"
"We are not, however, persuaded that we should interfere with the proposed expansion of the business of the Ford Motor Company. ... The judges are not business experts. It is recognized that plans must often be made for a long future, for expected competition, for a continuing as well as an immediately profitable venture. The experience of the Ford Motor Company is evidence of capable management of its affairs.
HYPOTHETICAL
Henry Ford (a strong-willed, opinionated and controversial figure) decides to abandon his semi-eleemosynary ways. He's takes steps to maximize the wealth for himself and the other shareholders. He drops his workers' wages to $2 per day -- the market rate. He raises the price of Ford cars by 20% -- the market will bear it. Can employees and customers complain under the modern "other constituencies" statutes? What about under the NC Bus Corp Act? What about according to the ABA's Corporate Director's Guidebook? / Pennsylvania Business Corporation Law
§ 1715. Exercise of powers generally
(a) General rule.--In discharging the duties of their respective positions, the board of directors ... may in considering the best interests of the corporation, consider to the extent they deem appropriate:
(1) The effects of any action upon any or all groups affected by such action, including shareholders, employees, suppliers, customers and creditors of the corporation, and upon communities in which offices or other establishments of the corporation are located.
(2) The short-term and long-term interests of the corporation, including benefits that may accrue to the corporation from its long-term plans and the possibility that these interests may be best served by the continued independence of the corporation.
(3) The resources, intent and conduct (past, stated and potential) of any person seeking to acquire control of the corporation.
(4) All other pertinent factors.
(b) Consideration of interests and factors.--The board of directors,committees of the board and individual directors shall not be required, inconsidering the best interests of the corporation or the effects of any action,to regard any corporate interest or the interests of any particular groupaffected by such action as a dominant or controlling interest or factor. The consideration of interests and factors in the manner described in thissubsection and in subsection (a) shall not constitute a violation of section1712 (relating to standard of care and justifiable reliance).
HYPOTHETICAL
Henry Ford is fickle. He now decides he is going to give away Ford Motor's profits to a new charity of his choice, the Ford Foundation. He has the board agree to set aside 5% of after-tax profits as a deductible charitable donation to the Foundation. Is this permissible? Do you want to know more about the gift, the Foundation and Henry Ford's reasons? Consider. /
  • N.C. Bus. Corp. Law.
  • ABA's Corporate Director's Guidebook?
  • Section 2 - Responsibilities of a Corporate Director
  • Section 11 - " Philanthropic Activities. A corporation may devote a reasonable amount of its resources to public welfare or charitable, scientific, or educational purposes. It is appropriate that a program of charitable giving have a philosophy, purpose, budget, and realistic management."

D. Corporate Charitable Contributions
Role of corporation
What is the role of the corporation in society? We know it is an amalgamation of capital and management, which comes in small and very large sizes. When a corporate board gives corporate resources to charity, pays employee bonuses, finances a business school - are the directors acting –
  • for shareholders, pursuant to a "shareholder wealth maximization" imperative that focuses on both the long term and short-term?
  • for corporate constituents (not only shareholders), in their role as overseers of a social institution and mediator of various constituents?
  • for themselves, as normal human beings who (if given the chance) will seek to aggrandize their power, prestige and general coolness?
If your answer is either of the latter, doesn't this suggest that ownership is separated from control -- that is, the shareholders who in theory own the business profits do not control how they are directed.
By the way, who is on the board of directors? Does this tell you anything about the focus of the board?
Corporate giving
Power
Can for-profit corporations give away money? Is this one of the purposes of the modern corporation? / NC BCA § 55-3-01. Purposes.
(a) Every corporation incorporated under this Chapter hasthe purpose of engaging in any lawful business unless a morelimited purpose is set forth in its articles of incorporation.
Do corporations have this power? / § 55-3-02. General powers.
(a) Unless its articles of incorporation or this Chapter provide otherwise, every corporation ...has the same powers as an individual to do all things necessary or convenient to carry out its business and affairs, including without limitation power: ...
(13) To make donations for the public welfare or for charitable, religious, cultural, scientific, or educational purposes;
(14) To transact any lawful business that will aid governmental policy;
(15) To make payments or donations, or do any other act, not inconsistent with law, that furthers the business and affairs of the corporation;
(b) It shall not be necessary to set forth in the articles of incorporation any of the powers enumerated in this section.
What is the ultra vires doctrine? What was its originalpurpose? What is its current purpose, viability? / NC BCA § 55-3-04. Ultra vires.
(a) Except as provided in subsection (b), the validity of corporate action may not be challenged on the ground that the corporation lacks or lacked power to act.
(b) A corporation's power to act may be challenged:
(1) In a proceeding by a shareholder against the corporation to enjoin the act;
(2) In a proceeding by the corporation ... against an incumbent or former director, officer, employee, or agent of the corporation; or
(3) In a proceeding by the Attorney General under G.S. 55-14-30.
(c) In a shareholder's proceeding under subsection (b)(1) to enjoin an unauthorized corporate act, the court may enjoin or set aside the act, if equitable and if all affected persons are parties to the proceeding, and may award damages for loss (other than anticipated profits) suffered by the corporation or another party because of enjoining the unauthorized act.
Theodora Holding Corp. v. Henderson (Del Ch. 1969)
Girard Henderson held a controlling interest of AD, Inc.For years he had the corporation contribute tens of thousands to his favorite charity, the AD Foundation - which Girard formed and ran.When Girard proposed giving land worth $467,000 and stock worth $528,000 to the Foundation, one of the AD directors (his former wife's daughter) balked. So Girard had reduced the board size, and she was gone.A shareholder (the holding company of his former wife, Theodora) sued Girard!He's taking her money - no?Can the corporation give away its profits, assets and stock?What is the standard of review?
Power
Del GCL 122 :
Every corporation created under this chapter shall have power to ... make donations for ... charitable ... purposes. / Are there any limits on how much a corporation can give away? Would it violate corporate purposes and be beyond corporate powers, if the gift had been excessive or wasteful?
Duties
Delaware court:
... the test to be applied in passing on the validity of a gift such as the one here in issue is that of reasonableness [as to which the IRC is a useful guide] ... The gift here was well within the federal tax deduction limitation of 5% of total income
... the placing of such gift in channels where it servers to benefit those in need of philanthropic or educational support, thus providing justification for large private holdings, thereby benefiting plaintiff in the long run / Does this mean that the tax deductibility standard governs corporate law? What if a corporation gave away to the local United Way, an excellent cause that helps employees and other corporate constituents, more than the deductible 5%?
Would the result have been different if Girard was using the Foundation as his own vehicle for personal aggrandizement? Isn't that likely the case?
Why should shareholders have to subsidize the charitable inclinations of management? Shouldn't corporate law demand tat shareholders vote or allocate their charitable giving as they choose - like the Presidential Election Fund on our tax returns? Or the way Berkshire Hathaway does it?
Kahn v. Sullivan (Del 1991)
Occidental Petroleum is the oil and gas business. Its CEO and chair, Armand Hammer was real character (complete with an FBI file) and an art collector. When his negotiations fell through to have his collection housed in the Los AngelesCountyArt Museum, he decided he would create "my museum." To fund this new museum, Hammer proposed to the Occidental board that the corporation should chip in. The board approved the concept and appointed a special committee to act on the proposal.A law firm looked at whether the proposed gift to the museum would be OK under corporate laws, another whether it would pass tax muster, and an accounting firm considered its financial impact. Ultimately the committee agreed to spend $85 million of company (read, shareholders) money. /
Sullivan (a shareholder) brought a derivative suit on behalf of the company against the Occidental board. The embattled board turned to the special committee again, this time to figure out a settlement. The committee negotiated a settlement with Sullivan giving Occidental more of a role in the museum and capping the corporate contribution at $50 million. (For their trouble, Sullivan's lawyers were to be paid $1.4 million.) Was the Chancery Court's approval of the settlement within the court's discretion - exercising its business judgment? That is, was the Chancery Court right in concluding this was an acceptable settlement for the corporation? This involved looking into the merits of the underlying claim against the board and the committee.
Standard of review
Would the board have been able to rely on the BJR? Or would the committee have been judged under a loyalty standard, given their close ties to Hammer? / Delaware Supreme Court:
Special Committee comprised of Occidental's outside directs was independent and made an informed decision to approve the charitable donation ...
On what basis does one decide a person's independence? to whom are we loyal?
Reasonableness
If the BJR is the standard, what must the directors show to justify their action? Is "waste" standard a measure of the board's power or of the exercise of its duties? / Delaware Supreme Court
... given the net worth of Occidental, its annual net income before taxes. and the tax benefits, the gift was within range of reasonableness
Adequacy of settlement
If the board was independent and reasonable, why did the committee even have to settle? That is, wasn't the original $80 million gift valid? Why was it important that Occidental got more name recognition and cost controls on the Museum project? / Delaware Supreme Court
The chancery's findings are supported ... Occidental would receive an economic benefit in the form of good will from charitable donation ... would derive an economic benefit from being able to utilize the Museum, adjacent to its corporate headquarters, in the promotion of its business.
Some final thoughts
Do you think the UCLA Hammer Museum is something Occidental should have funded? As Armand Hammer was quoted saying "regrets and recriminations only your soul." Were we would be, after all, without corporate charity? Then again, Occidental's stock price rose $550 million on the day Dr. Hammer died - see story. /

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Chapter 4 – The Corporation and Society