New Article: “The Golden Leash and the Fiduciary Duty of Loyalty”

I’m delighted to share a new article by yours truly on corporate governance and shareholder activism, The Golden Leash and the Fiduciary Duty of Loyalty, that will be published in the UCLA Law Review.

The “golden leash” is a controversial form of third-party compensation under which activist hedge funds supplement the salaries of directors they nominate to the board, in exchange for increasing the value of the company. A director compensated pursuant to such an arrangement stands to earn millions of dollars rather than the $250,ooo paid to a typical director of a large public company, though the more richly compensated director usually works much harder and takes a lot of public abuse.

I offer a qualified defense of the golden leash, situating it in the context of other, more mainstream structures that depend on a more relaxed, porous conception of the fiduciary duty of loyalty than is commonly applied in the context of the golden leash. I also offer thoughts on how a properly disclosed golden leash can not only work for shareholders but improve procedural corporate governance more broadly.

The abstract follows. I welcome any comments on the draft.

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The Undead Norm of Unenforceability in Sovereign Debt

True story: two years ago, U.S. hedge fund NML Capital seized an Argentine navy vessel in Ghana. NML recently won an important series of rulings in US courts on defaulted sovereign bonds issued by the Latin American nation.

True story: two years ago, U.S. hedge fund NML Capital seized an Argentine navy vessel in Ghana. NML recently won an important series of rulings in US courts on defaulted sovereign bonds issued by the Latin American nation.

As the Argentina sovereign debt litigation hurtles towards its thrilling conclusion (or at least a new phase), I’ve sketched this proposal for a new paper and welcome any thoughts:

The Undead Norm of Unenforceability in Sovereign Debt

Historically, sovereigns have repaid their debts not because they feared court orders if they didn’t but to preserve their good name in global capital markets. Courts played along, tolerating transgressions of their enforcement authority even beyond what sovereign immunity would require. This dance has allowed courts to lend their expressive support to the fiction of enforceability while avoiding the downsides—for courts and markets—that aggressive attempts at enforcement against foreign sovereigns would bring. However, in NML v. Argentina, the latest round of litigation over Argentina’s 2001 default, the SDNY signaled a shift: it issued an unprecedented injunction prohibiting the world payments network from processing Argentina’s bond payments unless the sovereign also tendered payment in full to a group of holdout creditors. This ultimately pushed Argentina into default in July 2014, prompting some legal scholars and the financial press to declare that the episode would seriously impair future efforts to restructure sovereign debt.

In The Undead Norm of Unenforceability in Sovereign Debt, I intend to argue that the NML decision (which was upheld on appeal) is poised to close the gap between the rhetoric of obligation and the reality of enforcement, but only temporarily, and that the systemic effects many fear are unlikely to materialize. NML provides a clear example of some of the dangers I write about in Boilerplate Shock: Sovereign Debt Contracts as Incubators of Systemic Risk: standard terms in private, foreign-law contracts—in this case, a provision known as the pari passu clause—are driving macroeconomic events to a degree that no one anticipated.

However, the magnitude of the harm here will probably be contained. The near-term systemic impact has not been (and was unlikely to be) great in part because, unlike Greece (whose bonds I use as an example in Boilerplate Shock), Argentina is not a member of a monetary union. On a longer horizon, the effects seem even likelier to dissipate. Argentina’s contract-driven default is just the type of salient event that will prod the market to update boilerplate terms, in this case probably by restricting the reach of pari passu in future bond issues and perhaps in existing ones (by adding Collective Action Clauses, for example, which virtually eliminate the holdout problem). This should allow restructurings to continue on the flexible, ad hoc basis on which they currently occur—which is to say, without excessive judicial interference at the enforcement stage. Far from demonstrating that the norm of unenforceable sovereign debt is dead, this episode suggests it can’t be killed.

For this article, I’ll be standing on the shoulders of a rich literature on the Argentina dispute and drawing on research I’ve done at the intersection of commercial law, private international law, and financial regulation. In Boilerplate Shock, for example, I argue that currency and governing law clauses in Eurozone sovereign bonds are magnifying systemic risk in ways no one imagined when they selected those contract terms. In Ending Judgment Arbitrage: Jurisdictional Competition and the Enforcement of Foreign Money Judgments in the United States, I argue that fragmentation in the U.S. judgment enforcement regime post-Erie renders that system ripe for manipulation by savvy judgment creditors via a process I call “judgment arbitrage.”

Undead shares many commonalities with these two articles (particularly Boilerplate Shock). Perhaps most important, together they posit that private contracts—combined with choice of law rules and expansive conceptions of jurisdiction that make it possible to secure and actually enforce judgments based on them—are driving international economic events to a degree that no one anticipated. This is mainly a story of cascade effects, amplified by standardization: the interpretation of a given contract term impacts other actors (whose rights are determined by similar contracts) in the relevant market, and where that market is systemically significant, it can affect the global financial system.

As I suggest above and in the Boilerplate Shock abstract, I think the risk of contract-driven systemic failure (which I call “boilerplate shock”) is far more manageable today in the case of Argentina than in the Eurozone sovereign lending market. Let’s hope the risk does not materialize in Europe either; we already live in pretty exciting times.

Photo: Reuters/NYT

Harvard International Law Journal/Opinio Juris Symposium on “Judgment Arbitrage”

Yesterday, the Harvard International Law Journal and the blog Opinio Juris hosted a symposium on my article, “Ending Judgment Arbitrage: Jurisdictional Competition and the Enforcement of Foreign Money Judgments in the United States,” which was published in the Harvard International Law Journal last fall. The article is about the domestication of foreign judgments in the United States and focuses on an example of extreme forum shopping that I call “judgment arbitrage,” in which plaintiffs can exploit differences in state law to make it easier for them to enforce foreign judgments in states that otherwise would have rejected them.

Professor Christopher Whytock, an expert on international litigation at UC Irvine, wrote a very thoughtful response to the article. I replied.

I want to thank Chris for contributing, and also to make a quick note here about the value of these types of exchanges.

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My article on Eurozone sovereign debt, “Boilerplate Shock,” will be published in the Tulane Law Review

Pleased to share the news that my article on euro-area sovereign bonds,Boilerplate Shock: Sovereign Debt Contracts as Incubators of Systemic Risk,” will be published in the Tulane Law Review. Thanks very much to those of you who have provided feedback thus far (I welcome more of it, by email or in the comments). Here’s the abstract:

Scholars generally assess the usefulness of standard-form commercial contracts from the standpoint of the firms that use them. But these firm-centric accounts overlook the cumulative impact of standardization on a given market. Where the market in question is critical to the financial system, this oversight can be quite dangerous.

This article examines the coordinated use of two standard contract terms in European sovereign bonds, a market that many observers considered the greatest source of global economic instability in the five years following the 2007-09 financial crisis. These terms require that the bonds be paid in euro and that any dispute be resolved under foreign law. According to the existing scholarly consensus, these terms are benign, but a closer look reveals this view to be dangerously inaccurate. This conclusion has powerful implications not only for the multitrillion-dollar sovereign lending market, but for the future of securities contracts and financial regulation more generally.

Specifically, tenuous assumptions about the boilerplate terms that govern these debts reveal a perilous gap in financial regulation: when standard terms in private contracts become ubiquitous, they have the potential to inflict severe and unexpected harm on the broader financial system. Currently, the law lacks even a vocabulary to describe this dangerous externality, let alone a mechanism to manage it. By proposing a new rule that would address the problem of what might be called “boilerplate shock” in the Eurozone, the article argues for expanding the focus of financial regulation to encompass the potential of private contracts to become incubators of systemic risk.

Keywords: sovereign debt, financial regulation, systemic risk, securities regulation, monetary law, commercial law, contract design, boilerplate, bond, conflict of laws, eurozone, private international law, sovereign default, euro, european union, emu, lex monetae, isda, derivative, law of money, currency

JEL Classification: K00, K22, K23, K33, K41, E42, E44, E52, E58, E62, F02, F33, F34, F42.

Thank you to “The Conglomerate” and its readers

[cross-posted at The Conglomerate]

Signing off…
Posted by Greg Shill

Dear Glommers,

I feel very privileged to have had the opportunity to engage with this rich community of scholars these past two weeks. Thank you for your thoughtful feedback and commentary. I’d also like to express my gratitude to my hosts, for giving me an opportunity to opine on monetary law, my new paper “Boilerplate Shock” (SSRN), and the like. I have more shilling to do about all these things, but my time is up and frankly I’m running out of cartoon images that are capable of summarizing my scholarship. I’m actively hunting for new ones, however, because soon I will be writing more about my project on legal issues in unconventional monetary policy at Confessions of a Supply-Side Liberal, the blog of University of Michigan economics professor Miles Kimball.

Please keep in touch. I recently launched a blog of my own, “Just Shilling,” and am on Twitter (@greg_shill). And of course I am reachable by email and carrier pigeon.

It’s been a pleasure. Thanks!