September 24, 2018

Social Responsibility — Doing Good While Also Making Money And Protecting Owner Interests

BLI_2015Editor’s Note: The following article is excerpted from Herrick Lidstone’s materials for the 2015 Business Law Institute on October 28, 2015. Mr. Lidstone is leading a panel discussion about social responsibility in business. For discussion of the questions he raises below, attend the Business Law Institute. Register here or by clicking the links below.

By Herrick K. Lidstone, Jr.

There are a huge number of issues surrounding corporate/entity social responsibility. Even understanding what “social responsibility” is in this context has a divergent path. For the purposes of this discussion, it can be described as “Doing Good While Also Making Money And Protecting Owner Interests.”[1] This demonstrates the potential conflict – should an investor in a business entity (the owner) look to the entity to “do good” or merely to comply with legal requirements (do not pollute; do not violate the law) while making money for the owners (profit maximization). Should the owner have a say in the business entity’s choices?

Should an entity selling t-shirts worry about the workers in Bangladesh? Should an entity selling coffee worry about how it is grown and harvested? Should an entity selling beef burritos worry about how the cattle are slaughtered?

The legal landscape in which these questions must be considered has changed dramatically in the last five years. Consumer attitudes toward many of these issues have also changed. Some businesses are now extolling their social responsibility, while others apparently continue to consider that to be a secondary consideration, at best. Citizens United v. Federal Election Comm’n, 130 S. Ct. 876 (2010), interprets the Constitution to give business entities the right of free speech in political campaigns in a manner that is not necessarily answerable to the owners.[2] Has Burwell v. Hobby Lobby Stores, Inc., 134 S. Ct. 2751 (2014), done similarly for social responsibility and business philanthropy?

The following points are more than can be discussed at one sitting, but hopefully will form a basis for an interesting presentation.

  1. Does Hobby Lobby change the landscape for business enterprises to consider factors other than profit in making their business decisions?
  2. The duties of the Board of Directors after Hobby Lobby – can a for-profit corporation consider social responsibility even if it has the effect of reducing profits?
  3. Where investors are concerned, what is the role of disclosure regarding consideration of alternative constituencies?
  4. Should a for-profit corporation desiring to include a focus on social responsibility at the expense of profit expressly so state in its articles of incorporation or adopt a form such as (in Colorado) a public benefit corporation?
  5. Is there a religious and moral side to profit maximization and corporate social responsibility?
  6. Is there a difference between corporate social responsibility and social entrepreneurship?
  7. Are alternative entities important, and must they be carefully crafted?
  8. Is it a question of marketing?
  9. Where does “blind philanthropy” fit in?
  10. Once you have done it, can you go back?
  11. Is it the Millennials (born 1980-1995) versus the Baby Boomers (born 1945-1960)?
  12. Whither the future?

[1] Of course, the concept of “doing good” has potentially a variety of meanings depending on political, moral, religious, and other deeply held beliefs. This paper will not focus on the potentially contradictory definition of “good.” In the most controversial extreme, consider the “rights of the unborn” versus “freedom of choice” as a justification for abortion. This paper will leave the definition of “good” to others.

[2] In August 2011, the “Committee on Disclosure of Corporate Political Spending” filed a petition for rehearing with the Securities and Exchange Commission (http://www.sec.gov/rules/petitions/2011/petn4-637.pdf) in which the committee asked “that the Commission develop rules to require public companies to disclose to shareholders the use of corporate resources for political activities.” Those rules still do not exist for 1934 Act reporting companies. The SEC does have rules prohibiting investment advisors from making political contributions to encourage political subdivisions to hire them as advisors. See 17 CFR § 275.206(4)-5.

Herrick K. Lidstone, Jr., Esq., is a shareholder of Burns Figa & Will, P.C. in Greenwood Village, Colorado. He practices in the areas of business transactions, including partnership, limited liability company, and corporate law, corporate governance, federal and state securities compliance, mergers & acquisitions, contract law, tax law, real estate law, and natural resources law. Mr. Lidstone’s work includes the preparation of securities disclosure documents for financing transactions, as well as agreements for business transactions, limited liability companies, partnerships, lending transactions, real estate and mineral property acquisitions, mergers, and the exploration and development of mineral and oil and gas properties. He has practiced law in Denver since 1978.

 

CLE Program: Colorado Business Law Institute

This CLE presentation will take place Wednesday, October 28, 2015 at the Grand Hyatt Denver Downtown. Live program only – click here to register or call (303) 860-0608.

Can’t make the live program? Click here to order the CD homestudy or click here for the MP3 audio homestudy.

Compensation During Dissolution of Law Firm LLCs

Editor’s Note: This article originally appeared in the Colorado Bar Association Business Law Section’s January 2015 newsletter. Click here for the Business Law Section webpage.

HerrickLidstoneBy Herrick K. Lidstone, Jr., Esq.

The Colorado Limited Liability Company Act was front-and-center in a January 2015 decision from the Colorado Supreme Court. The case, LaFond v. Sweeney, 2015 CO 3 (January 20, 2015) involved the dissolution of a law firm organized as a two-member LLC with no written agreement regarding the treatment of assets and liabilities on dissolution. Richard LaFond brought a contingent fee case into the law firm and performed a significant amount of work on that case before the firm dissolved. He continued his work on the matter after dissolution. His now former partner, Charlotte Sweeney, claimed an interest in the contingent fee.

Mr. LaFond brought a declaratory judgment action against Ms. Sweeney to obtain a judicial determination regarding her right to any portion of the contingent fee. The trial court entered judgment for Ms. Sweeney, finding that she would be entitled to one-half of the fees earned from the contingency case, up to a maximum of $298,589.24 potentially to be paid to Ms. Sweeney (based on the time spent by the LaFond & Sweeney law firm before dissolution and assumed billable rates).

Ms. Sweeney appealed the trial court’s decision to the Colorado Court of Appeals. Ultimately, the Colorado Supreme Court ruled that absent an agreement to the contrary, all profits derived from winding up the LLC’s business belong to the LLC to be distributed in accordance with the members’ or managers’ profit sharing agreement, and the LLC Act does not grant winding up members or managers the right to receive additional compensation for their winding up services.

Court of Appeals Decision

In its decision (2012 WL 503655, Feb. 16, 2012), the Court of Appeals recognized that it would have to decide:

[That since] there was no written agreement that specifically described how the contingent fee generated by the case should be distributed[,] we must look to other authority to decide the ultimate issue raised by this appeal: should the contingent fee be divided between LaFond and Sweeney, and, if so, how?

The Court of Appeals went on to decide that:

  1. Cases belong to clients, not to attorneys or law firms;
  2. When attorneys handle contingent fee cases to a successful resolution, they have enforceable rights to the contingent fee; and
  3. A contingent fee may constitute an asset of a dissolved law firm organized as a limited liability company.

The important conclusion by the Court of Appeals and affirmed by the Supreme Court was that when a limited liability company formed under Colorado law dissolves, the members/managers owe a duty to each other to wind up the business of the LLC, and unless otherwise agreed between the parties, no additional compensation is paid for winding up activities.

Supreme Court Decision

The statute in question is § 7-80-404(1)(a), which provides that members in a member-managed LLC and managers of a manager-managed LLC have a duty to:

Account to the limited liability company and hold as trustee for it any property, profit, or benefit derived by the member or manager in the conduct of winding up of the limited liability company business or derived from a use by the member or manager of property of the limited liability company, including the appropriation of an opportunity of the limited liability company.

The Supreme Court noted that, in 2006, the General Assembly added C.R.S. § 7-80-803.3 (entitled “Right to wind up business”) to Colorado’s limited liability company act, but did not include any provision allowing the person winding up the business of the LLC to be compensated for such actions, absent an agreement for such compensation. The Supreme Court also noted that the 1996 version of the Uniform Limited Liability Company Act did contemplate compensation to members who engage in winding up activities: (“A member is not entitled to remuneration for services performed for a limited liability company, except for reasonable compensation for services rendered in winding up the business of the company.” See Unif. Ltd. Liab. Co. Act § 403(d) (1996)). Colorado did not adopt this provision even though, as the Supreme Court noted, “the General Assembly’s 2006 amendments to the LLC Act incorporated some elements from the Model Act.”

The Supreme Court also noted that, in 1997, the General Assembly enacted the Colorado Uniform Partnership Act which, in C.R.S. § 7-64-401(8) “explicitly states that a partner is entitled to additional compensation for services performed in winding up the business of the partnership.” The Supreme Court went to the next logical conclusion:

If it wished, the legislature could have included language that would give members or managers the right to additional compensation for their services in winding up the LLC, but did not do so in the original LLC Act or its subsequent amendments.

Based on its analysis of the Colorado limited liability company act, the Colorado Supreme Court affirmed the Court of Appeals’ decision and concluded that:

  1. an LLC continues to exist after dissolution to wind up its business;
  2. upon dissolution, pending contingency fee cases are an LLC’s business;
  3. absent an agreement to the contrary, all profits derived from winding up the LLC’s business belong to the LLC to be distributed in accordance with the members’ or managers’ profit sharing agreement; and
  4. the LLC Act does not grant winding up members or managers the right to receive additional compensation for their services in winding up LLC business.

Members and Managers Fiduciary Duties?

In another portion of the opinion (at paragraphs 36–37), the Supreme Court addressed fiduciary duties in the LLC context in a manner that is inconsistent with the Colorado LLC Act. While acknowledging that the client has the right to choose legal counsel and to enter into and to terminate engagements with counsel, the Supreme Court said:

Under Colorado law, members and managers of an LLC cannot act to induce or persuade a client to discharge the LLC for the benefit of a particular member or manager of the LLC to the exclusion of the others; they breach their fiduciary duties to the LLC if they attempt to do so.

Unfortunately this misinterprets the Colorado LLC Act which carefully does not use the term “fiduciary duty” to define the duties of the members and managers. Furthermore the Supreme Court’s language treats the duties of members and managers as being identical, whether or not the LLC is member-managed or manager-managed. For example, the duty to “account to the limited liability company and hold as trustee for it any property, profit, or benefit derived by the member or manager in the conduct or winding up of the limited liability company business” (C.R.S. § 7-80-404(1)(a)) only applies to members of a member-managed LLC, not to members of a manager-managed LLC. Members of a manager-managed LLC only owe the obligation to “discharge the member’s … duties to the limited liability company and exercise any rights consistently with the contractual obligation of good faith and fair dealing.” (C.R.S. § 7-80-404(3)) The Supreme Court’s ultimate conclusion is not dependent on the fiduciary duty analysis which may, in fact, be applicable in other forms of ownership (such as a general partnership).

In this case, the articles of organization reflect that LaFond & Sweeney was, in fact, organized as a member-managed LLC and, therefore, the members did in fact have the duties to “hold as trustee” for the benefit of the LLC. In a trust as described in C.R.S. § 15-16-302, a trustee “shall observe the standards in dealing with the trust assets that would be observed by a prudent man dealing with the property of another, and if the trustee has special skills or is named trustee on the basis of representations of special skills or expertise, he is under a duty to use those skills.” This arises to a higher duty than the “contractual obligation of good faith and fair dealing. ” The Court should have reached a similar conclusion in the context of this case without using the overly-broad language referring to fiduciary duties.

In the end, Mr. LaFond is obligated to share the contingent fee with his former law partner under the same sharing ratio as the two had shared things during the existence of their law firm, and he was not separately compensated for his efforts in finishing the case as part of his obligation to wind up the business of the LLC. Is it fair that Richard LaFond took the case to a successful conclusion after the dissolution of LaFond & Sweeney while his former partner shares on a 50-50 basis in the award? Is it fair that had the decision been under CUPA or the Uniform Limited Liability Company Act the decision would likely have been different? Whether the Colorado LLC Act should be amended to provide for “reasonable compensation for services rendered in winding up the business of the limited liability company” is an open policy question.

Herrick K. Lidstone, Jr., Esq., is a shareholder of Burns Figa & Will, P.C. in Greenwood Village, Colorado. He practices in the areas of business transactions, including partnership, limited liability company, and corporate law, corporate governance, federal and state securities compliance, mergers & acquisitions, contract law, tax law, real estate law, and natural resources law. Mr. Lidstone’s work includes the preparation of securities disclosure documents for financing transactions, as well as agreements for business transactions, limited liability companies, partnerships, lending transactions, real estate and mineral property acquisitions, mergers, and the exploration and development of mineral and oil and gas properties. He has practiced law in Denver since 1978. He writes for many publications, including the Colorado Bar Association Business Law Newsletter, where this article originally appeared.

The opinions and views expressed by Featured Bloggers on CBA-CLE Legal Connection do not necessarily represent the opinions and views of the Colorado Bar Association, the Denver Bar Association, or CBA-CLE, and should not be construed as such.

More Changes to the SEC’s “Neither Admit Nor Deny” Consent Decrees

HerrickLidstoneBy Herrick K. Lidstone, Jr., Esq.

The Securities and Exchange Commission (the “SEC”) has the power and authority under the Securities and Exchange Act of 1934 to bring enforcement actions against persons who violate the securities laws. Most of these actions are settled well before trial by the defendant agreeing to a court-ordered “obey the law” injunction, where the defendant neither admits nor denies the factual statements alleged by the SEC to support the injunction. The SEC has received significant criticism from commentators and legislators for entering into settlements without requiring the respondent to admit allegations against it. These have included significant criticisms by Hon. Jed. S. Rakoff (S.D.N.Y.) in his November 28, 2011 memorandum order denying a joint motion by the SEC and Citigroup for approval of a $285 million settlement of certain allegations by the SEC. (SEC v. Citigroup Global Markets, Inc.) This was discussed in more detail in the January 2012 Business Law Section Newsletter.

Obtaining settlements where the defendant “neither admits nor denies” the allegations is a practice that commenced long before 1972, but was formalized in 1972 (17 CFR § 205.5) with the additional SEC requirement that consent judgments be accompanied by a formal written agreement by the defendant “not to take any action or to make or permit to be made any public statement denying, directly or indirectly, any allegation in the complaint or creating the impression that the complaint is without factual basis.” This changed the prior practice by defendants who would deny the underlying facts immediately after entering into a consent decree with the SEC.

Perhaps as a result of the outcry from Judge Rakoff and others, in January 2012, the Director of the SEC’s Division of Enforcement announced that the Division would no longer permit those convicted or who otherwise admitted the facts in a parallel criminal action to settle with the SEC based on ““not admitting or denying” the facts.

On June 18, 2013, SEC Chair Mary Jo White further refined the SEC’s “neither admit nor deny” policy when she advised the investment community that even in non-criminal settings, the SEC may require admissions in cases “where heightened accountability or acceptance of responsibility through the defendant’s admission of misconduct may be appropriate” (as reported in the New York Times at page B-1, June 22, 2013). In those cases, the SEC enforcement staff has been advised to seek admissions or litigate the case. This may, of course, make litigation more frequent since many defendants may have believed in their innocence, but chose the “neither admit nor deny” settlement to avoid the time, expense, and uncertainty of litigation. Chair White anticipates that the admissions will be required in cases involving “particularly widespread harm to investors” and “egregious intentional misconduct.”

The SEC defense bar has raised a number of concerns about Chair White’s announcement and the anticipated effect of the new SEC practice. Among these concerns is whether this new policy might be subject to arbitrary application by staff. Equally significant, where a defendant is given the option of making admissions (which can then be used in subsequent shareholder litigation or even a criminal proceeding) or contesting the claims, defendants are more likely to contest the claims and seek vindication. Where settlements used to be simpler, the resulting litigation will likely involve a significantly greater amount of SEC resources to prosecute and corporate (that is, shareholder) resources to defend. Defense lawyers have also pointed out that the SEC’s recent track record on significant litigation has not been stellar.

Predictably, the plaintiffs’ attorneys applauded this change since they will now be able to use any admissions in their civil litigation. This fact, itself, will be a significant disincentive to targets of investigation to settle cases with admissions of wrongdoing.

It will be interesting to see how this new policy plays out.

Herrick K. Lidstone, Jr., Esq., is a shareholder of Burns Figa & Will, P.C. in Greenwood Village, Colorado. He practices in the areas of business transactions, including partnership, limited liability company, and corporate law, corporate governance, federal and state securities compliance, mergers & acquisitions, contract law, tax law, real estate law, and natural resources law. Mr. Lidstone’s work includes the preparation of securities disclosure documents for financing transactions, as well as agreements for business transactions, limited liability companies, partnerships, lending transactions, real estate and mineral property acquisitions, mergers, and the exploration and development of mineral and oil and gas properties. He has practiced law in Denver since 1978. He writes for many publications, including the Colorado Bar Association Business Law Newsletter, where this article originally appeared.

The opinions and views expressed by Featured Bloggers on CBA-CLE Legal Connection do not necessarily represent the opinions and views of the Colorado Bar Association, the Denver Bar Association, or CBA-CLE, and should not be construed as such.