Investors have a number of rights under federal and state
law which they can enforce through litigation, including for example the right
to file individual or class actions for damages. But can investors be required
to submit these kinds of claims to binding arbitration in lieu of litigation?
That is the question posed by a two different initiatives corporate reformers
are currently pursuing.
One of the basic features of our system of corporate laws
is that aggrieved shareholder can enforce their rights or seek damages by
filing a lawsuit. But at the same time, our litigation system is costly and
court processes can be both time-consuming and burdensome. For that reason,
there have been many proposals over the years to provide for the arbitration of
shareholder disputes. For example, in its November 2006 report (here),
the Committee on Capital Markets recommended that public companies be allowed
to have shareholder votes on the use of arbitration to resolve shareholder
claims.
A couple of different developments are bringing these
issues to the forefront now. First, on January 10, 2012, the Carlyle Group, an
investment partnership preparing to conduct a public offering, submitted to the
SEC an amended
filing on Form S-1 that, among other things, specifies that its partnership
agreement will provide that all limited partners must submit any claims to
binding arbitration.
A January 18, 2012 Bloomberg article by
Miles Weiss entitled "Carlyle Seeks to Ban Shareholder Lawsuits Before IPO" (here)
discusses the mandatory arbitration provisions described in Carlyle's filing.
Susan Beck's January 18, 2012 Am Law Litigation Daily article about the
Carlyle filing can be found here.
The Carlyle offering is a little unusual, because the
firm does business as a limited partnership and the securities in the planned
offering will consist of limited partnership units. The rights acquired with
the units are defined by a limited partnership agreement. According to the
company's filing, the partnership agreement will provide that every
limited partner "irrevocably agrees" that "any claims, suits, actions or
proceedings arising out of or relating in any way to the partnership agreement
or any interest in the partnership...shall be finally settled arbitration." The
filings explain that the kinds of actions to which this dispute resolution provision
apply include without limitation disputes under the Delaware Limited
Partnership Act and the federal securities laws. The filing also explains that
the dispute resolution provisions specify that the each limited partner
"irrevocably waives" any objection he or she may have to arbitration. (The
filing's disclosures relating to the partnership agreement's dispute resolution
provisions can be found here.)
The arbitration requirements reported in the filing are
quite detailed. The dispute resolution provisions specify that the arbitration
must take place in Wilmington, Delaware. The arbitration proceedings must be
confidential and the amount of any award will not be disclosed. The provisions
further specify that the person bringing the claim may only pursue arbitration
in an individual capacity "and not as a plaintiff, class representative or
class member," and the arbitrators may not consolidate more than one person's
claim.
A separate unrelated development involves the efforts of
certain investors to put a proposal on 2012 proxy ballots to require
shareholder claims to be arbitrated. According to information provided to me by
University of Michigan Law Professor Adam Pritchard, shareholders at Pfizer and
Gannett are currently seeking to have proposals included on upcoming proxy
ballots that would amend the companies' corporate charters to require the
arbitration of shareholder disputes.
The companies are seeking SEC authorization to omit the
shareholder arbitration proposals from their proxy ballots, arguing that the
arbitration requirement would violate both state and federal law. The companies
contend that the arbitration requirement would violate Delaware law, which they
contend provides shareholders with the right to litigate claims in the Delaware
Court of Chancery absent a clearly expressed intent to arbitrate. The companies
also argue that the arbitration requirement would violate Section 29 of the '34
Act, which voids any contractual provision that would seek to waive any right
under the statute. Finally, the companies contend that the SEC itself
historically has taken the position that a mandatory arbitration charter
provision would be against public policy.
Advocates for the shareholders seeking to introduce the
shareholder proposals argue that there is liberal federal policy favoring
arbitration agreements and that there is no support for the argument that an
arbitration requirement would violate state law. They contend that Delaware law
allows the use of corporate charters to embody agreements between a corporation
and its shareholders.
They also argue that the Supreme Court has dealt with
anti-waiver clauses in federal statutes and has consistently supported
arbitration. In its January 10, 2012 opinion in CompuCredit v.
Greenwood, the Court held that a right to sue provision in the federal
consumer credit statute does not prohibit the enforcement of an arbitration
agreement. The advocates for the shareholders argue the antiwaiver clause in
Section 29 prohibits the waiver only of substantive rights, not procedural
rights and is not a barrier to the enforcement of an arbitration requirement.
The advocates (who include Professor Pritchard) contend that arbitration would
not undermine the remedial and deterrent purposes of the federal securities
law, arguing in further reliance on the CompuCredit case that the
Supreme Court has said that arbitration is the equivalent of litigation.
Each of these initiatives is poised to be addressed
shortly. The SEC will be called upon to respond to the Carlyle Group's offering
document and decide whether the offering may go forward with the dispute
resolution requirement unchanged. Among other things, the SEC will have to
determine whether or not Carlyle's partnership ownership structure is a
differentiating consideration. According to the Bloomberg article
linked above, in 1990 the SEC refused to allow the offering of a savings and
loan to go forward until the firm removed the arbitration clause from its
corporate charter.
The SEC will also have to determine whether or not Pfizer
and Gannett can omit the shareholder proposals from their proxy ballots. With
deadlines for proxy mailings approaching, the SEC will have to reach a decision
in time to allow the companies to prepare their proxy ballots. Of course even
if the shareholder initiatives are included on the proxy ballots, a majority of
shareholders would have to vote in favor of the proposals in order for them
arbitration requirements to come into force.
Discussion
The motivations behind these efforts to require
shareholder disputes to be arbitrated rather than litigated are perfectly
understandable. Anyone who has ever been involved in any way in a material
shareholder lawsuit knows that they are terribly costly and that they impose
enormous burdens on all of the litigants. Taken collectively, shareholder
litigation imposes an enormous cost on corporations in our country.
Reducing these costs is a highly desirable objective.
On the other hand, requiring shareholders to arbitrate
their corporate claims would represent a massive change in the way that
investor rights are addressed. Even if the U.S. Supreme Court thinks
arbitration is equivalent to litigation, the fact is that in arbitration
certain procedures are unavailable - like, for example, the ability to appeal.
And there are features of the Carlyle requirements that are clearly
designed to ensure that arbitration would not be equivalent to
litigation (for example, the prohibition against claimants proceeding
collectively).
A change of this magnitude that has at least been
approved by a shareholder vote has more of a sympathetic appeal. But even
if the Carlyle offering is allowed to go forward with its offering with the
dispute resolution procedures in its partnership agreement, or if Pfizer or
Gannett have a mandatory arbitration shareholder proposal on this year's proxy
ballot, it would remain to be seen what would happen and how the arbitration
provisions would be enforced when claims arise later. Court would then have to
determine whether or not the provisions were valid and enforceable.
If any of these initiatives are permitted to go forward,
it will be interesting to see what happens next. If Carlyle were able to
include the mandatory arbitration provision in its charter (and if the reason
Carlyle is permitted to do so is not linked to the fact that it is a
partnership), it would seem likely that other companies would seek to implement
similar provisions in the charters prior to their initial public offerings. And
if the activist shareholders are successful in getting the mandatory
arbitration issue on the Pfizer or Gannett proxy ballots, it seems likely that
shareholders at other companies would pursue these same initiatives.
Though I could see these kinds of initiatives quickly
spreading to other companies, these initiatives may not be popular with all
shareholders. Indeed, I could easily imagine many shareholders actively
opposing these types of efforts, taking the view that the opportunity to resort
to the courts to seek redress of grievances is a basic and important right and
an important tool to ensure that corporate officials abide by their legal
duties. The plaintiffs' securities bar undoubtedly would become actively
involved in resisting efforts to introduce these kinds of changes elsewhere.
Thus even of these current initiatives succeed, we would
still be a very long way from the elimination of our current system of
shareholder litigation. Nevertheless, it will be very interested to see where
these current initiatives lead. The possibility for the adoption of a
requirement for the mandatory arbitration of shareholder claims presents at
least the theoretical chance for a radial revision on our current system of
shareholder litigation.
One final note. The arbitration provision in the Carlyle
partnership provision is far from the only restrictive aspect of the Carlyle
structure. As Ohio State Law Professor Steven Davidoff notes in a January 18,
2012 post on the Dealbook blog (here),
Carlyle "is propsing the most shareholder-unfriendly corporate goverance
structure in modern history." He notes that under the Carlyle
structure shareholders have no right to elect directors and the company will
not hold annual meetings of shareholders. In light of thse constraints and the
arbitration provision, "the real question is whether prospective
shareholders protest and refuse to participate in Carlyle's IPO because of the
governance issues."
Thanks to the several readers who sent me links to the
Bloomberg article and very special thanks to Professor Pritchard for sending me
the information about the Pfizer and Gannett shareholder proposals.
Jobs Link: One of the great
blogs that I follow closely is The
FCPA Professor blog, which is written by Butler University Law
Professor Mike Koehler. Professor
Koehler's posts are always interesting and well written. Now there is
another reason to visit the site. Professor Koehler has added a Jobs link to
his site (here), in which he
will post job openings in his field. Great to see a fellow blogger expanding the
universe of blogging possibilities.
The M&A Litigation Problem: In
the latest issue of InSights, entitled "Why Mergers and Acquisitions
Related Litigation is Such a Serious Problem" (here), I take a look at
the issues arising from the growing levels of litigation surrounding M&A
transactions. These kinds of cases are becoming increasingly common and
increasingly costly, both of which pose significant problems for companies and
for D&O insurers.
Read
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
For more information about LexisNexis
products and solutions connect with us through our corporate site.