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What is a Constituency Statute?

We have had a few posts on articles related to history and progress of the U.S. legal infrastructure supporting  social innovation. This includes a look at U.S. case law that articulated the duty of a corporation’s board of directors to maximize shareholder wealth. And the buffer provided by the Business Judgment Rule (BJR) that protects court interference with a board’s decisions so long as certain criteria are met.

constituency statutesBut there’s more. There is the constituency statute.Through attending various talks, discussions, and CA State senate hearings on new legislation that would enable social entrepreneurship,the term “constituency statute” has come up multiple times.

In searching for a good explanation for the concept of constituency statutes I came across an excellent law review article mapping the relationship between corporate law and social innovation principles by Anthony Bisconti titled, “The Double Bottom Line: Can Constituency Statutes Protect Socially Responsible Corporations Stuck in Revlon Land?” (Loyola Law Review, 2009)

So, what is a constituency statute?

A constituency statute, also called a stakeholder statute, allows corporate directors to consider non-shareholder interests when making business decisions.

Have all states passed constituency statutes?

No, but a majority of states have. As of 2009 (when Bisconti published his law review article) 32 states had passed some form of constituency statute.

Which states have enacted constituency statutes?
 
As listed in footnote 13, the following states have constituency statutes:

  1. Arizona
  2. Connecticut
  3. Florida
  4. Georgia
  5. Hawaii
  6. Idaho
  7. Illinois
  8. Indiana
  9. Iowa
  10. Kentucky
  11. Louisiana
  12. Maine
  13. Maryland
  14. Massachusetts
  15. Minnesota
  16. Missouri
  17. Nebraska
  18. Nevada
  19. New Jersey
  20. New Mexico
  21. New York
  22. North Dakota
  23. Ohio
  24. Oregon
  25. Pennsylvania
  26. Rhode Island
  27. South Dakota
  28. Tennessee
  29. Vermont
  30. Virginia
  31. Wisconsin
  32. Wyoming

 

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What is the Business Judgement Rule? How Does it Impact Social Innovation?

Back near the start of Innov8Social, I overviewed the case and story behind Dodge v. Ford. To summarize, in legal analysis circles the case is prominent for articulating an immutable rule for corporation law—i.e. a corporation has a duty to maximize shareholder wealth. Dodge v. Ford took place in 1919 and just as the past century has seen significant changes in the we travel, how we communicate, and the kinds of toppings that are acceptable on pizza—so too have there been advents affecting a court’s right to assess a corporation’s actions.

 business judgment rule (bjr)

 

 

Corporate Directors 101

 
It is well-established that directors of a corporation (i.e. the elected or appointed individuals who oversee and direct the activities of a corporation) are bound by fiduciary duties of good faith, care, and loyalty to the corporation’s shareholders.

What does that mean?

Essentially corporate directors are barred from actions that would jeopardize the corporation or that would put an individual director above the corporation (i.e. self-dealing).

 

Business Judgment Rule: A Coming of Age

 

  

The Business Judgment Rule (BJR) provides a buffer between the court and the actions taken by a corporate board of directors.  For example, corporations may have found Dodge v. Ford troublesome not for its ruling in favor of shareholders, but for the court’s intrusion into a board of directors’ decision-making.

BJR states that business decisions are presumed to be outside of the review of court where the board of directors acts in good faith, in a manner that a reasonable person would act under similar circumstances, and in the best interest of the corporation. BJR requires that board of directors do not commit waste (i.e. overpaying for assets).

 

But, Why?

 

  
Arguably, successful businesspersons are often skilled risk-takers. And they would argue that though they require the capital investments that shareholders provide, they don’t want their actions or calculated risks to be limited by shareholder interests. Enter, the Business Judgement Rule.
It was devised to protect business decisionmaking by corporate directors. And, as articulated by various scholarly publications including Professor David Rosenburg’s law review article “Galactic Stupidity and the Business Judgment Rule” (2006), “[it] is a truth almost universally acknowledged that American courts will not review  the substance of the business decisions of corporate directors except under extraordinary
circumstances.”

 

How Business Judgment Rule Impacts Social Innovation

 

  
An excellent law review article that traces the relationship between corporate law and social innovation principles is Anthony Bisconti’s 2009 article in the Loyola Law Review titled “The Double Bottom Line: Can Constituency Statutes Protect Socially Responsible Corporations Stuck in Revlon Land?”
In short, by protecting the business judgement of corporate directors, BJR also gives a foot-hole to social innovators to make decisions that endeavor to achieve a successful triple bottom line.
In the absence of court acknowledgment of BJR, Henry Ford was barred by from taking an action for public good that did not maximize shareholder wealth (i.e. building a large expensive factory that would make cars more affordable, create employment, raise the standard of living for employees).
And though Ford’s plan may not reach muster in terms of today’s concern for social and environmental impact, the BJR can today be employed to protect decisions that may not necessarily maximize shareholder profits today but may maximize triple bottom line.

 

Is the BJR Enough to Protect and Promote Social Innovation?

 

  
The BJR is a step. So are constituency statutes, but we may find that these tools may be forcing a system designed to make profit above other concerns fit the shifting paradigms of social business and informed consumerism.

At the end of the day, we may be ready for a new corporate structure that can expand our conception of stakeholders and that can create quantifiable ways to measure progress of the bottom line (profits), double bottom line (community, profits), and triple bottom line (environment, community, profits).

And, this discussion is vital today, as new corporate structures are making their way into law across the U.S. in the form of the benefit corporation.

What do you think of the BJR? Has it paved the way for social entrepreneurship?

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Who Said Corporations Have to Maximize Shareholder Wealth?

Ask any law school graduate, and they will probably tell you that Michigan Supreme Court in Dodge v. Ford Motor Co. 170 N.W. 668 (Mich.1919) did.

Ford Overdrive

Dodge v. Ford: A Swashbuckling Tale for Maximizing Shareholder Profit

 

The historic case Dodge v. Ford tells a page-turning tale of astonishing innovation, mind-blowing wealth, deep rumination, distrust, and defection. There are larger-than-life personalities all-around, unafraid to use (legal) sword and shield to pursue and protect their interests.Less clear, however, is who is the hero and who is the villain. That can only be judged by the lens through which you see the story.

 

Ford Motor Co. Circa 1919: The Unstoppable Model T

 

In his enlightening law review article, “Everything Old is New Again: Lessons from Dodge v. Ford Motor Company” (December 2007) University of Chicago Law School Professor M. Todd Henderson sets the scene of the automobile industry in the early 1900’s.After two unsuccessful ventures, Henry Ford’s Ford Motor Company began expanding in a big way in the early 1900’s. With efficient mass production of cars, a growing market, and increased demand—the Ford Motor Co. was virtually unstoppable. The advent of assembly-line manufacturing led production of Ford’s original “Model T” to increase from less than 2000 cars per year in 1905 to over 2 million per year by 1923—growing over 700% in the span of 2 years.

 

An OMG Reaction to ROI

 

As reported by Henderson, financial life was not bad for the handful of Ford shareholders. Investments snowballed in their rate of returns. For example the brothers Dodge—who were shareholders at the time—made an initial investment of $10,000 and would yield over $35M over the next 13 years.

 

Restless Shareholders and Distrust

 

In his article, Henderson also paints broad brush strokes in describing the personalities of Ford and the Dodges. Henry Ford is described as suspicious and to some degree–unimpressed–that shareholders were so richly rewarded for investment of only money and no effort in creating the triumphant Model T.In the same vein, the Dodges were perhaps growing restless in the shadow of their overwhelmingly successful investment. And were ready to strike on their own. They knew of Ford’s plan to withhold dividends and build a factory—which would further lower the cost of manufacturing an automobile. And, incidentally, make it harder for them compete.

Legal Swords and Shields


Dodge v. Ford was not the first time Henry Ford stepped into a courtroom. He was well-acquainted with litigation and had filed cases to defend his name and reputation.

The Dodges decided to take action to prevent the building of the new factory by flexing their shareholder muscle. They first sent a letter to Dodge questioning the propriety of denying dividends and investing those funds in a large, expensive factory.

After their inquiry went unanswered, they filed a complaint demanding that the Ford Motor Co. establish a dividend policy that distributed all earnings except certain emergency funds and that an injunction be issued to prevent construction of the factory.

The Weight of Wealth


It is not clear whether Ford was always benevolent, strategically benevolent, or whether a sense of benevolence developed as he amassed great wealth. According to Henderson’s article, it may have been a complex hybrid.

Said Ford, “I believe it is better for the nation, and far better for humanity, that between 20,000 and 30,000 people should be contented and well fed than that a few millionaires should be made.”

It probably didn’t hurt the Ford Motor Co.’s prospects that the proposed actions (i.e. withholding dividend and reducing the cost of a car by ramping up production) would not only endear Ford to Americans but would also undercut future competition.

 

The Michigan Supreme Court Issues a Decision


While the lower court called for a special dividend to be issued and an injunction. The Michigan Supreme Court took a more subtle approach. It tried to keep courts at bay from making business decisions by declaring that courts must defer to the rational business judgment of a company. But allowed itself a loophole, by saying that Ford did not follow a rational business objective in denying dividends.

At the end, the Michigan Supreme Court gave Dodges their special dividend and Ford–the go-ahead for building his new factory.

 

Just a Load of Dicta?


In case law speak, judicial commentary articulating an opinion and not decisive to the case is known as “dicta” and is not binding in the court of law. The comments that have made Dodge v. Ford the single-most known case for defining a corporation’s duty to maximize shareholder wealth…comes in, well, dicta.

That has led some, such as UCLA Law Professor Lynn A. Stout to argue that Dodge v. Ford is not actually good law. She does so in her law review article “Why We Should Stop Teaching Dodge v. Ford“.

 

Why I am Fascinated by Dodge v. Ford


While I love learning the details of all of the law school cases I studied (note: this may be an overstatement :), I have truly been fascinated by the far-reaching implications of this case since the day I learned about it in a Corporation Law course. Whether or not the case has been misconstrued or is wrongly emphasized as an articulation of the maximize shareholder wealth principle, it is taught by law professors and learned by law students in that context.

And, in that context, the concept that the legal framework supports a single financial bottom line pursuit by corporations, I think, may impact the incentives and methodologies business chooses.

While, as Henderson argues, the Michigan Supreme Court may have found an ‘elegant’ solution to a complex situation of competing interests, the long-range result of emphasizing shareholder wealth above other measures suggests that other costs and outcomes are de-emphasized.

 

Triple Bottom Line and Shareholder Redefinition

Perhaps, to some degree, and according to the long-living dicta of Dodge v. Ford, businesses are not always incentivized to consider externalities such a corporation’s relationship to the environment, employee well-being, community involvement, and social justice.

If there was a way to work in such externalities to the ‘bottom line’ of rational business judgment outlined by Dodge v. Ford or expanding our definition of ‘shareholders’ to include non-monetary contributors it could literally change the way business is done by rewarding a company for its business acumen as well as its social innovation.

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