Intermediate Scrutiny for Corporate Political Contributions
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Florida State University Law Review Volume 44 Issue 3 Spring 2017 Article 5 Spring 2017 Intermediate Scrutiny for Corporate Political Contributions Joseph K. Leahy South Texas College of Law -- Houston Follow this and additional works at: https://ir.law.fsu.edu/lr Part of the Business Organizations Law Commons, Constitutional Law Commons, First Amendment Commons, and the Securities Law Commons Recommended Citation Joseph K. Leahy, Intermediate Scrutiny for Corporate Political Contributions, 44 Fla. St. U. L. Rev. 1119 (2018) . https://ir.law.fsu.edu/lr/vol44/iss3/5 This Article is brought to you for free and open access by Scholarship Repository. It has been accepted for inclusion in Florida State University Law Review by an authorized editor of Scholarship Repository. For more information, please contact [email protected]. INTERMEDIATE SCRUTINY FOR CORPORATE POLITICAL CONTRIBUTIONS JOSEPH K. LEAHY* ABSTRACT A corporation contributes to a Super PAC that supports a candidate for public office. A shareholder sues, alleging that management breached its duty of loyalty by making the con- tribution to promote its own political views rather than to serve the corporation’s best inter- ests—i.e., by acting in bad faith. What standard will a Delaware court apply when review- ing management’s decision to cause the corporation to make the contribution? Myriad scholars have opined that the court will apply the standard of review for ordi- nary business decisions: the management-friendly business judgment rule. Unfortunately for our shareholder plaintiff, this rule presumes that management acts rationally, without a conflict of interest, and in good faith. Further, management can easily concoct a justification for supporting any major-party political candidate. Thus, absent a “smoking gun” that points to bad faith, it will be extremely difficult for a shareholder to prove that management has acted disloyally. This Article departs from the scholarly consensus that courts should apply the business judgment rule to review corporate political contributions. Instead, courts should apply the intermediate level of scrutiny—the Unocal test—that is applied whenever management adopts defensive measures in the face of a hostile takeover. Delaware courts apply Unocal to defensive measures due to the “omnipresent specter” that management will promote its own interests over the corporation’s best interests. Under Unocal, management must earn the protection of the business judgment rule by establishing the reasonableness and proportion- ality of its defensive actions. Courts evaluating management’s decision to make a Super PAC contribution should apply Unocal for two related reasons. First, like corporate charitable donations, corporate political contributions give rise to serious agency cost concerns. These same concerns led prior commentators to propose applying intermediate scrutiny to charitable contributions; post-Citizens United, this proposal should be updated to include corporate political contri- butions. Second, upon closer review, corporate Super PAC contributions give rise to greater agency cost concerns than corporate charitable gifts, due to the increased potential of man- agement pretext in the former context. Indeed, although corporate Super PAC contributions do not pose an inherent conflict between management and the corporation, the possibility of pretext is so great that there is an “omnipresent specter” that management will serve its own purposes whenever it causes the corporation to make a political contribution. Therefore, by analogy to Unocal, a court evaluating a corporate political contribution should ask (1) whether management had reasonable grounds to believe that the contribution would directly or indirectly advance specific corporate interests, rather than some general political viewpoint; and (2) whether the contribution was reasonable, both as a method of addressing the specific corporate interest and in its amount. Only if management can show that the political contribution satisfies both prongs should it be protected by the business judgment rule. I. INTRODUCTION .................................................................................................. 1121 II. DERIVATIVE SUITS, THE BUSINESS JUDGMENT RULE AND THE UNOCAL TEST ............................................................................................ 1133 * Professor of Law, South Texas College of Law—Houston. Thanks to participants at the 2013 Southeastern Law Scholars Conference and the 2014 National Business Law Scholars Conference, and to my colleagues at South Texas, for their helpful suggestions. Thanks also to Joseph Collins, Kristina Rosado, and Matt Rowe for their helpful research assistance. 1120 FLORIDA STATE UNIVERSITY LAW REVIEW [Vol. 44:1119 A. The Two Traditional Standards of Review for Shareholder Derivative Actions........................................................................................................ 1133 1. The Business Judgment Rule—For Ordinary Business Decisions ...... 1133 2. “Entire” Fairness—For Conflicted Transactions ................................. 1134 B. The Unocal Decision .................................................................................. 1135 1. Factual Background of the Unocal Case .............................................. 1135 2. The Factual Backdrop: Takeover Battles on the Rise .......................... 1139 3. The Legal Backdrop: Cheff and Bennett ............................................. 1140 C. Unocal’s “Intermediate” Scrutiny: “Enhanced” Business Judgment Review ........................................................................................................ 1142 1. The Unocal Decision: A New Standard of Review ............................... 1142 2. Updating Unocal: Unitrin’s Modifications .......................................... 1144 (a) Factual Background to Unitrin ................................................... 1144 (b) Unitrin’s Modifications to Unocal ................................................ 1145 3. The Unocal Test vs. Entire Fairness and the Business Judgment Rule ...................................................................................................... 1146 C. Why Intermediate Scrutiny? The Famed “Omnipresent Specter” .............. 1147 1. Unocal’s Unclear Exhortation to an “Inherent” Conflict ...................... 1147 2. The Crux of the Conflict: Shareholders’ Premium vs. Directors’ Seats .................................................................................... 1148 3. Why Not Entire Fairness? .................................................................... 1152 4. The Important (but Oft-Ignored) Role of Potential Pretext .................. 1152 (a) Why Pretext is Important ............................................................. 1152 (b) Delaware Courts: Unocal “Smokes Out” Pretext .......................... 1155 (c) Unocal Forces Management to Make Its Case .............................. 1156 III. THE ARGUMENT BY ANALOGY: CORPORATE POLITICAL CONTRIBUTIONS RAISE THE SAME AGENCY COST CONCERNS AS CORPORATE PHILANTHROPY .............. 1157 A. When Corporations Simply Give Money Away .......................................... 1158 1. Corporate Gifts to Charity ................................................................... 1158 2. Corporate Political Contributions As Close Cousins ........................... 1161 B. The Problem with Just Giving Money Away: Enabling Agency Costs ...... 1162 1. Corporate Charitable Donations as Quasi-Self-Dealing ..................... 1162 (a) Understanding the Problem: A Hypothetical Example ................ 1163 (1) An Ordinary Business Decision ............................................. 1163 (2) A Decision to Make a Charitable Donation ........................... 1165 (3) A Different Take: Corporate Philanthropy As Corporate Opportunity ............................................................................. 1169 C. The Law of Corporate Charitable Donations and Critiques Thereof ........ 1171 1. Corporations’ Statutory Authority to Make Charitable Donations...... 1171 2. How Courts Review Corporate Gifts to Charity ................................... 1172 3. Calls for Judicial Scrutiny and Understanding the Precise Nature of the Problem .......................................................................................... 1175 D. One Proposal For Reform: Apply Intermediate Scrutiny ........................... 1177 1. Three Types of Corporate Contributions .............................................. 1177 2. Two Frameworks Rejected ................................................................... 1179 3. The Proposed Framework: Three Tiers of Review................................ 1179 4. Corporate Philanthropy and Defensive Measures Compared .............. 1180 E. Expanding Balotti and Hanks’s Framework to Include Corporate Political Contributions............................................................................... 1182 IV. BEYOND THE ANALOGY: CORPORATE POLITICAL CONTRIBUTIONS ARE MORE PROBLEMATIC THAN CORPORATE CHARITABLE DONATIONS ............................. 1184 2017] INTERMEDIATE SCRUTINY 1121 A. Corporate Political Spending Raises Greater Agency Cost Concerns Than Corporate Philanthropy ................................................................... 1184 1. Political Contributions Support Candidates, Not Policies .................. 1187 (a) With Politicians, Corporations Must Take the Good With the Bad ..............................................................................................