Part Three: An Original Proposal for Stopping Corporate Inversions

Politicians, business leaders, and legal professionals have spent a great deal of time this year talking about corporate inversions.  As stated in the two previous posts in this three-post series, an inversion is a business transaction, usually a merger or acquisition, between a U.S. corporation and a foreign corporation with the objective of establishing the headquarters of the new combined corporation in the foreign nation to take advantage of a better corporate tax rate.

Opposition to corporate inversions has been increasing for several months.  However, it hit a fever pitch when American corporate icon Burger King announced plans to merge with Canada’s Tim Horton’s in order to take advantage of Canada’s lower tax rates.  This transaction was tangible to the average American in a way that few inversions can be.  Anyone with an idea for how to stop inversions was suddenly able to command the newspaper headlines and the lead segments of cable news shows.

As stated in previous posts, interested parties began rallying support around three very different proposals.  The three proposals, which are not necessarily mutually exclusive, are changing the U.S. corporate tax code, using the bully pulpit to pressure corporations into staying home, and using existing provisions in the tax code to punish and deter inversions.

I have given two of these proposals treatment in previous posts.  In the first post, I described the proposals to amend and overhaul the tax code by adding incentives to remaining and disincentives for inverting.  In the second post, I outlined the competing proposal to use existing provisions in the tax code to punish and deter inversions put forward by Professor Samuel C. Thompson of Penn State Law.  The proposal to use the bully pulpit to cower corporate boards into keeping headquarters in the United States is entertaining and popular, but it is too sophomorically simple to give serious attention to in an academic publication.

The leading proposals suffer from two substantial defects.  The first is that they rely on the action of a government that is terribly unpopular and ineffective.  The second is that pay too little regard for the business judgment of the corporate board and for the rights of shareholders.  Believing that the existing proposals are seriously flawed, I am going use this post to lay out an original proposal for curbing corporate inversions.

This  proposal for curbing corporate inversions calls for using corporate shareholder proposals to amend corporate bylaws so that they include anti-inversion rules.  Amending the bylaws of a public corporation in this way can be accomplished through the shareholder proxy vote provided for under existing SEC Rule 14a-8.  This rule, first promulgated in 1942, allows the shareholders of a public corporation to submit proposals for changes in corporate governance and social responsibility.

There are, of course, procedural hurdles in Rule 14a-8 that shareholders must cross to put the anti-inversion amendment in the corporation’s annual proxy statement.  For instance, the shareholder submitting the proposal must have an ownership stake of $2000 or 1% of the company, must have held that position for a year, and must continue to hold that position through the vote.  Shareholders must also submit their proposals by the date printed in the company’s previous annual report and proxy statement.  Shareholders, even those inexperienced in submitting shareholder proposals, can cross over these procedural hurdles with the smallest modicum of care.

Once shareholders clear the procedural hurdles, there are substantive hurdles they must face.  These are much trickier and more numerous than the procedural hurdles.  SEC Rule 14a-8(i) lists 13 individual substantive restrictions on shareholder proposals.  The list includes straightforward substantive areas like the amount of dividends, duplicative proposals, and proposals that have already been implemented.

Three more opaque provisions have become the tool of  corporate boards in blocking shareholder proposals.  These provisions allow boards to exclude proposals that violate state law, are not significantly related to the corporation’s business, and infringe on ordinary management responsibilities.  What emerges from these three rules is a difficult requirement.  Proposals must rest on that small bit of corporate domain between a proper shareholder purpose and the proper role of the board to be included in the proxy statement.

However difficult this terrain seems to navigate, shareholders manage to place hundreds of proposals on the proxy statements of America’s largest corporations each year.  Even among the Fortune 100 firms, the average of shareholder proposals appearing on proxy statements is more than two a year.  Of the proposals that appear, the adoption rate varies.  In 2009, the adoption rate was 10.8% as shareholders reacted to the corporate scandals of the financial crisis.  The adoption rate slipped to 7.2% in 2011 after Dodd-Frank incorporated corporate reforms.  The adoption rate bounded back in 2013 to 19.2% and the rate is 14.8% so far in 2014.  Shareholder proposals are becoming a legitimate way for shareholders to change corporate policies.

A general survey by the Manhattan Institute for Policy Research shows that proposals are split between corporate governance, executive compensation, and social policy statements.  A survey conducted by Institutional Shareholder Services (ISS) reveals that the shareholder proposals actually vary greatly beneath those general categories.  In 2014, there were 901 shareholder proposals submitted.  The same survey shows that 126 of those were related to political actions and lobbying, 68 were related to independent chairs, 56 were related to climate change, and the rest were split among many other topics.

In many ways, a shareholder proposal related to inversions would be in-line with recent developments in shareholder proposal submissions.  First, the shareholder proposal addresses an issue of real and immediate concern for many Americans.  Second, it straddles the line of corporate governance and social policy.  Using shareholder proposals to curb inversions can easily be analogized to proposals like climate change and corporate political spending that touch on corporate governance and social policy concerns.

One way in which the inversion proposal is different from those aforementioned proposals (and indeed almost all other proposals) is that it requires an amendment to the bylaws rather than makes a request of the board.  The bylaw amendment would be binding on the board and the board would not be able to undo the amendment unilaterally under Delaware General Corporate Law.

This idea is, of course, still in its infancy and purely theoretical.  However, proposed bylaw amendment would appear in a simple form as soon here:

WHEREAS, the defection of American companies to foreign states through corporate inversions harms American morale, and

WHEREAS, the federal government is dependent upon tax revenue from public corporations domiciled in the United States, and

WHEREAS, corporate inversions have the effect of increasing American unemployment, and

WHEREAS, the shareholders of this the corporation desire that the corporation serve an example of patriotic corporate citizenship, and

WHEREAS, the effect of corporate inversions on the corporations that execute them, their shareholders, and their employees is uncertain.

BE IT RESOLVED The Board of Directors shall not execute a reorganization which would have the effect of relocating the companys headquarters outside of the United States for the purpose of reducing the companys effective tax rate without first obtaining the consent of 75% of all shares issued and outstanding and entitled to vote, present in person or represented by proxy, at the companys regular annual meeting or a special meeting of shareholders as defined in Article I of the companys bylaws.

This provision shall not be repealed by the shareholders without first obtaining the consent of 66% of all shares issued and outstanding and entitled to vote, present in person or represented by proxy, at the companys regular annual meeting or a special meeting of shareholders as defined in Article I of the companys bylaws.

Seal of Delaware

I anticipate that the argument against using shareholder proposals to curb inversions will have two substantial elements.  The first is that the proposal is likely to fail because the corporate boards will mount aggressive campaigns to defeat the proposals.  The boards will argue that the proposals violate state law by restraining the board from fulfilling its fiduciary duties or that it touches on ordinary business activity.  The second argument is that the proposals are a piecemeal response to a pervasive problem.  Opponents will argue that it would be wiser to concentrate on securing broader prohibitions from the national government.

While I fully expect boards to fight the anti-inversions proposal as they would any other, I would disagree with the assertion that the boards will be able to defeat inversion proposals.  Boards will face two great logical problems in forming their arguments.  The first is that they would be forced to argue that their fight against empowering shareholders is actually for the good of the shareholders.  The second logical problem is that boards will argue that the proposal infringes on their responsibility to manage ordinary business operations when the transactions they are speaking of are often included in the definition of an extraordinary transaction.

I likewise disagree with the claim that a piecemeal approach should be abandoned in favor of pursuing a broader rule.  The premise that only one should be pursued is as misguided as saying townspeople shouldn’t build a recycling center because the UN is addressing climate change.  Like climate change, inversions should be slowed by any available legal means.  American business is too important for us to let slip away without a fight. Shareholders can do their part by submitting responsible proposals to their corporate boards.

This concludes my series on corporate inversions.  I hope that it has been informative if not inspirational.  Corporate inversions are a serious problem.  However, this series has highlighted the encouraging fact that there are many possibly solutions to this problem and the search for solutions is yet ongoing.

*John I. Sanders is a second year law student at Wake Forest University School of Law. He holds a Bachelor of Arts in History, with minors in Economics, from Wake Forest University. He also holds a Masters in Business Administration from Liberty University.  Upon graduation, he intends to practice corporate law.