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The Government as an Unexpected Shareholder: Whose Interests Should Be Prioritized?

Until the 2008 financial crisis violently shook the foundation of the global economy, the United States federal government had never taken a controlling interest in a publicly traded company chartered under state law.1 While the government has since fully divested from its holdings acquired through the Troubled Asset Relief Program,2 this blog argues that it would be unwise for the federal government to rely on the same kind of program in the event future financial crises occur. This is not to imply that corporations with mixed ownership are inherently “bad” in all circumstances, but rather that the potential for harm to minority shareholders is greatly exacerbated by the current structure of corporate law in the United States. If the federal government continues to bail out failing corporations by taking control of them (regardless of whether such control is gained through acquisition of voting shares, through terms of crediting, or through contractual agreements),3 capital markets in the United States may face risk of depletion.4 Because minority shareholders are stripped of many of the protective rights they would otherwise be afforded in a privately-owned corporation, and because the need for such protection is intensified by the federal government’s interests outside of and often incompatible with corporate profitability, investors may be understandably more reluctant to invest in the market if the fate of corporate missions and the prioritization of profitability is jeopardized by the prospect of government intervention.

I.  History of Corporate Ownership by the Government

While the federal government had never taken a controlling interest in a publicly traded company chartered under state law prior to the Troubled Asset Relief Program implemented in response to the 2008 financial crisis,5 state ownership is not a completely foreign concept in the United States.6 The United States federal government’s involvement with corporate enterprises dates back to the 18th century, when the government created the Bank of the United States by enacting legislation which authorized the United States to subscribe 20 percent of the corporation’s stock.7 Twenty-five years later, following the expiration of the first mixed-ownership bank, Congress incorporated a second bank through legislation which provided that the United States would subscribe to 20 percent of the corporation’s stock, and that the President had the authority to appoint, by and with the advice and consent of the Senate, five of the bank’s twenty-five directors.8 Despite fundamental changes to the economy over the past 200 years, the government’s contemporaneous interests as a shareholder and its role as a corporate regulator nevertheless proved to be a source of tension, though this tension was largely grounded in the fact that access to corporate charters required a specific act of the legislature.9 The government, as shareholder of an existing corporation, would lack incentive to grant corporate charters to potential competitors due to the risk it would impose on the government’s own investment, but refusal to do so may not be in line with what is best for the general economy or general public welfare.10 State governments had no incentive to liberalize corporate charter policies until they divested from and discontinued their direct financial interest in the profitability of banks in 1837.11 As capital markets developed throughout the remainder of the 19th and 20th centuries, mixed ownership structures became rare in the United States.12

Perhaps unsurprisingly, notwithstanding the rarity of mixed enterprises through the 20th century, the federal government continued to gain a share in the profits of privately-owned corporations through taxation of corporate income.13 On the other hand, state governments profited from corporate franchise taxes, which—contrary to their former incentive to depress the presence of potential corporate competitors due to their former position as shareholders—drove legislatures to enact corporate codes that favored management in order to incentive new businesses to incorporate in (and thus provide tax revenue for) that state.14

In the wake of the Great Depression, a new group of government-created corporations were created by Congress in order to stabilize the economy and to make distress loans to specified sectors of the economy.15 In 1940, Congress empowered the Reconstruction Finance Corporation (RFC) with the authority to create corporations without direct congressional authorization.16 The RFC went on a government-created-corporation frenzy, and by the end of World War II, Congress aimed to temper both the number of government-created corporations, as well as their lack of accountability by enacting the Government Corporation Control Act (GCCA).17 The GCCA provided for enhanced reporting requirements for specific corporations with presence of government ownership and prohibited the creation of government corporations without specific congressional authorization.18

The immediate period following World War II and the enactment of the GCCA saw an absence of newly-created government corporations, but the 1960s brought with it a new appetite for government-created corporations which are still present today.19 Many of the newly-created entities followed the traditional model, in which the legislation providing for the creation of the corporation explicitly designated the corporation as a government agency within the existing government structure (hereinafter “Corporatized Agencies”).20 The government does not typically share ownership in Corporatized Agencies, the primary purpose of which is to simply utilize the corporate structure as an alternative to traditional modes of public governance in order for the government to obtain greater operational flexibility over conventional public agencies or bureaucracies.21 In addition to traditional Corporatized Agencies, the government began creating government-sponsored enterprises (GSEs) which are chartered by the federal government with the purpose of providing some benefit to the general public, but are privately-owned, listed, profit-oriented corporations.22 The government does not “sponsor” GSEs by taking an equity stake, but rather by providing them with government-conferred advantages which can include exemption from state taxes and portions of the securities laws, privileged access to capital, and perhaps most importantly, an implicit debt guarantee.23 While GSEs are profit-motivated, their government charters do not impose the same fiduciary duties that state laws impose on state-incorporated companies, allowing for GSEs to act in alignment with their stated public objectives which are otherwise unprofitable or inefficient.24

II.  Response to the 2008 Financial Crisis: Troubled Asset Relief Program

In response to an unprecedented credit freeze and impending collapse of the largest banking institutions in 2008, the federal government implemented the Troubled Asset Relief Program (TARP)25 authorized under the Emergency Economic Stabilization Act (EESA).26 The Act explicitly stated the goal of the implementation of TARP:

The purposes of this chapter are—

(1) to immediately provide authority and facilities that the Secretary of the Treasury can use to restore liquidity and stability to the financial system of the United States; and

(2) to ensure that such authority and such facilities are used in a manner that—

            (A) protects home values, college funds, retirement accounts, and life savings;

            (B) preserves homeownership and promotes jobs and economic growth;

            (C) maximizes overall returns to the taxpayers of the United States; and

            (D) provides public accountability for the exercise of such authority.27

While this overall purpose seems simple enough, it was (and still is) unclear precisely how the government would use and manage TARP funds to simultaneously achieve the various—and often incompatible—goals of the Act and exactly how interests of various groups, all of which would be affected, would be prioritized in the use and management of such funds.28 This lack of clarity is exacerbated when combined with the fact that the government decided that instead of purchasing toxic assets, it would purchase equity in order to facilitate the rescue of the failing institutions.29 By becoming a shareholder, the government implicitly added yet another interest to the mix—the interests of minority shareholders. Though the Act did not purport an intention to further the interests of the shareholders of failing institutions, the government undertook that obligation when it inserted itself into private corporations by attaining controlling shareholder status.30 Delaware law is fairly clear with respect to fiduciary duties owed to the minority shareholders, however when it is the government that suddenly undertakes a position that requires fiduciary duties, it seems that minority shareholders are left without recourse when the government breaches those duties.

The federal government’s impromptu role as a shareholder prompts an extremely unique scenario with respect to the protection of minority shareholders and it is worth exploring further. Because the need for such protection is intensified by the federal government’s interests outside of and often incompatible with corporate profitability, the obstacles embedded within the constructs of corporate law must be identified and statutorily rectified in future bailout plans in order to provide minority shareholders with opportunities for redress in the event they experience harm as a result of the government’s position as a shareholder.31

While the government’s method of intervention and resulting role in each of the companies that received TARP funding differed in many ways,32 it can be reasonably argued that the government was a controlling shareholder in at least some of the companies in which it held equity. It is well-settled law in Delaware that individuals other than directors owe fiduciary duties to the company,33 and the Court has suggested that status as controlling shareholder is inseparable from status as fiduciary.34 Thus, the murky area of the law is not whether a controlling shareholder owes fiduciary duties to the company, but rather whether a certain shareholder is considered “controlling” to impose those fiduciary duties. In Kahn v. Lynch Communication Systems, Inc., the Delaware Supreme Court explained:

This Court has held that “a shareholder owes a fiduciary duty only if it owns a majority interest in or exercises control over the business affairs of the corporation.” With regard to the exercise of control, this Court has stated: “[A] shareholder who owns less than 50% of a corporation’s outstanding stocks does not, without more, become a controlling shareholder of that corporation, with a concomitant fiduciary status. For a dominating relationship to exist in the absence of controlling stock ownership, a plaintiff must allege domination by a minority shareholder through actual control of corporation conduct.”35

It is clear from this description that the government was undoubtedly a controlling shareholder in companies in which it held more than 50% equity, but further inquiry is necessary to determine whether it would be considered a controlling shareholder in companies in which it held less than 50% equity.

The inquiry into whether a minority shareholder possesses “actual control of corporation conduct”36 can be facilitated by looking to the behavior and conduct of independent board members with respect to decisions that would uniquely impact the alleged controlling shareholder.37 When independent directors defer to a shareholder because of its position as a significant shareholder, and not because they decided in the exercise of their own business judgment that the shareholder’s position was correct, the shareholder is controlling and owes fiduciary duties to the other shareholders.38 Furthermore, notwithstanding the board’s or shareholders’ approval of a transaction that would uniquely impact the controlling shareholder, the transaction is nevertheless reviewed under the standard of entire fairness in order to provide minority shareholders with even more protection due to the inherent risk that controlling shareholders present:

The controlling stockholder relationship has the potential to influence, however subtly, the vote of ratifying minority stockholders in a manner that is not likely to occur in a transaction with a noncontrolling party . . . . Even where no coercion is intended, shareholders voting on a parent subsidiary merger might perceive that their disapproval could risk retaliation of some kind by the controlling stockholder. For example, the controlling stockholder might decide to stop dividend payments or to effect a subsequent cash out merger at a less favorable price, for which the remedy would be time consuming and costly litigation. At the very least, the potential for that perception, and its possible impact upon a shareholder vote, could never be fully eliminated. Consequently, in a merger between the corporation and its controlling stockholder—even one negotiated by disinterested, independent directors—no court could be certain whether the transaction terms fully approximate what truly independent parties would have achieved in an arm’s length negotiation. Given that uncertainty, a court might well conclude that even minority shareholders who have ratified a … merger need procedural protections beyond those afforded by full disclosure of all material facts.39

The court candidly acknowledges that controlling shareholders possess a dangerously potent influence on corporate decision-making whether it intends to exert that influence or not; the mere presence of the controlling shareholder provides pressure on otherwise independent actors to factor that controlling shareholder and how it is uniquely affected into its decision.40

The court’s rationale for providing non-controlling minority shareholders with additional protections with respect to these transactions weighs heavily in favor for at least some protection when the government financially intervenes pursuant to bailout. Regardless of whether the government has voting power, and regardless of whether the government affirmatively makes its preferences known the company, it would be naïve to suggest that the boards of the companies with the government as a shareholder as a result of accepting TARP funding did not take the government’s presence as a shareholder into consideration when making decisions.41 The federal government’s relationship and TARP dealings with Citigroup provide a useful example.

The federal government obtained roughly 36% of Citigroup’s voting common stock when it converted some of its non-voting preferred stock that it obtained pursuant to TARP.42 This conversion was a result of the government’s decision to transition from the Capital Purchase Program (CPP) to the Capital Assistance Program (CAP), motivated by the government’s desire to encourage private investment in the banks along with the market’s new preference in assessing a bank’s financial health by reference to its tangible common equity (TCE) ratio rather than its tier 1 capital ratio.43 While both ratios compare the residual interest of common stockholders to the pool of loans in which they have an interest, they are calculated differently.44 The tier 1 capital ratio included preferred stock, which led to a high ratio suggesting that the bank is financially healthy.45 On the other hand, the TCE ratio did not include preferred stock, which led to a low ratio suggesting that the bank is overleveraged.46 FBR suggested that tier 1 was an unreliable measure of leverage because the preferred stock had a liquidation preference akin to a creditor.47 Converting some of the government’s shares from preferred stock to common stock would drastically increase the TCE ratio (and therefore the market’s perception of financial health and willingness to invest) by increasing the amount of common equity without increasing assets.

Shareholder approval was necessary for this transaction because the conversion required an additional issuance of common shares, and while the conversion of the government’s shares provided Citigroup with genuine benefits, it also came along with genuine risks.48 The party who stood to benefit the most was the federal government—perhaps not financially, but certainly politically from the return of private capital to the banks.49 The shareholders approved the terms of the conversion.50 While Citigroup was able to dodge the 9% dividend that the preferred shares carried,51 the conversion immediately caused the price of Citigroup shares to drop 39% to reflect the dilution of other common equity shareholders, and afforded the government substantial rights to formally influence control and direction of the company.52 While the motivation for approval likely hinges on a number of reasons, it has been suggested that “the government’s interim securities prior to the approval were so coercive as to effectively guarantee that the Exchange Agreement would be approved by the shareholders.”53 While the shareholder approval of the conversion is certainly not dispositive of the government’s influence as a non-voting shareholder, the shareholders’ willingness to approve a transaction with such high risks to the company at least adds some weight to the suggestion that a significant shareholder’s mere presence can influence the corporate decision-making within the company.54

After the government held common equity and gained vocal rights in Citigroup, Citigroup engaged in a series of corporate decisions which—though not mandated by the terms of the conversion—were not profit-oriented; instead, the decisions reflected the furthering of the government’s interest, at the expense of decreasing the corporate efficiency of Citigroup.55 For example, Citigroup announced a plan to significantly lower monthly mortgage payments for homeowners who were recently laid off and were more than 60 days behind on their mortgages, and even expressed support for a congressional plan to allow judges to modify mortgages, which it opposed prior to the government’s involvement and something that the rest of the banking industry opposed.56 While such plans are normatively admirable for selflessly attempting to assist the greater good, “selflessness” is not only antithetical to the general vitality of a corporation, it is grounds for liability. Acts of selflessness (acting pursuant to an interest other than that of the corporation) are taken seriously by Delaware, in that the fiduciary duties most likely be alleged to have been breached by an act of selflessness are non-exculpable.57

  1. J.W. Verret, Treasury Inc.: How the Bailout Reshapes Corporate Theory and Practice, 27 Yale J. on Reg. 283, 286 (2010). See also Mariana Pargendler, State Ownership and Corporate Governance, 80 Fordham L. Rev. 2917, 2925 (2012). 

  2. See generally Chris Isidore, U.S. Ends TARP with $15.3 Billion Profit, CNN Money (Dec. 19, 2014, 11:27 AM),

  3. See generally Verret, supra note 1, at 299-307. 

  4. Cf. Pargendler, supra note 1, at 2921 (“[T]he role of the government as a controlling shareholder [has a negative influence] on the levels of a country’s legal investor protection and, consequently, on its capital market development.”); The U.S. Government as Dominant Shareholder: How Should Taxpayers’ Ownership Rights Be Exercised? Hearing Before the Subcomm. on Domestic Policy of the House Comm. on Oversight & Gov’t Reform, 111th Cong. (2009) (testimony of J. W. Verret, Assistant Professor, George Mason University School of Law) (“[G]overnment shareholders don’t have to play by the same rules as the result of us, a fact which will strain the governance mechanisms of the capital markets at a time when they are already in crisis.”). 

  5. Verret, supra note 1, at 286. 

  6. See, e.g., Lebron v. Nat’l R.R. Passenger Corp., 513 U.S. 374, 386 (1995) (stating that Amtrak, a government-owned corporation, was “not a unique, or indeed even a particularly unusual, phenomenon”); Verret, supra note 1, at 289 (“Government ownership of corporations is not without precedent in the United States.”); Pargendler, supra note 1, at 2925 (“[M]ixed enterprises…were virtually non-existent in recent U.S. experience until the 2008 financial crisis.”). 

  7. Lebron, 513 U.S. at 386-87. 

  8. Id. 

  9. See Pargendler, supra note 1, at 2927. 

  10. See id. at 2928. 

  11. See id. at 2929. 

  12. Id. at 2931. 

  13. Id. (explaining that after World War II, the U.S. corporate income tax rate was to “virtually make the state an equal partner [in the corporate enterprise] as far as profits are concerned.”). 

  14. See Pargendler, supra note 1, at 2932. Not only is this logically sound, Delaware has admitted that implementation of revisions to its corporate code is intended to attract corporations in order to product significant tax revenues. Ralph K. Winter, Jr., State Law, Shareholder Protection, and the Theory of Corporation, 6 J. Legal Stud. 251, 255 (1977). 

  15. See Lebron, 513 U.S. at 388; Pargendler, supra note 1, at 2931. 

  16. See Lebron, 513 U.S. at 388. 

  17. Id. at 389; Verret, supra note 1, at 291. 

  18. Lebron, 513 U.S. at 389-90. 

  19. See id. at 390; Verret, supra note 1, at 291. 

  20. Lebron, 513 U.S. at 390. 

  21. See Pargendler, supra note 1, at 2926 (“President Franklin Delano Roosevelt pitched the creation of the Tennessee Valley Authority in 1933, for example, as ‘a corporation clothed with the power of government but possessed of the flexibility and initiative of a private enterprise.”). 

  22. See id. (“GSEs are chartered by the federal government to pursue public objectives or cure perceived market failures.”); Verret, supra note 1, at 291 (explaining that GSEs are “created with the purpose permitting a private company to raise private capital, while also enjoying preferential treatment from the government at the same time.”); see also Lebron, 513 U.S. at 391. 

  23. A. Michael Froomkin, Reinventing the Government Corporation, 1995 U. Ill. L. Rev. 543 (1995); See also Pargendler, supra note 1, at 2926. Pargendler highlights that although the absence of the government’s role as shareholder mitigates conflicts of interest between the government and private investors associated with mixed-ownership models, private profit-motivated objectives combined with government-conferred benefits can create even more severe conflicts of interests, but now between the corporation (private investors) and taxpayers because the corporation’s stock price appreciates due to risky, potentially profitable activity, but the taxpayer does not stand to directly gain if the risky activity proves successful yet is directly impacted if the risky activity results in failure. Id. at 2927. 

  24. See Richard A. Epstein, The Government Takeover of Fannie Mae and Freddie Mac: Upending Capital Markets with Lax Business and Constitutional Standards, 10 N.Y.U. J.L. & Bus. 379, 386-87 (2014); Verret, supra note 1, at 293. 

  25. 12 U.S.C. §§ 5211-5241 (2012). 

  26. Id. §§ 5201-5261. 

  27. Id. § 5201. 

  28. Barbara Black, The U.S. As “Reluctant Shareholder”: Government, Business and the Law, 5 Entrepreneurial Bus. L.J. 561, 574 (2010). 

  29. See Steven M. Davidoff & David Zaring, Regulation by Deal: The Government’s Response to the Financial Crisis, 61 Admin. L. Rev. 463, 526 (2009). The authors explained why the government decided to pivot from its initial plan: “The markets did not respond well to the possibility of government purchases of hard-to-value assets. After a few days of stock market declines, continued credit market turmoil, and an increasing internationalization of the crisis as banks in Europe began to find their own balance sheets in crisis, observers began to call for the injection of equity into banks, with the idea roughly being that providing banks with the capital on hand to meet their obligations that would not be met if they had to sell their unsaleable assets would be better than taking the unsaleable assets off their hands.” Id

  30. Kahn v. Lynch Comm. Systems, 638 A.2d 1110, 1113-14 (Del. 1994). 

  31. The principle of sovereign immunity is the most obvious obstacle to holding the government liable for a claim of breach of fiduciary duties, however this blog does not explore whether a theory of liability could fit under one of the waivers to sovereign immunity. For a thorough analysis of the possible ways a minority shareholder could gain jurisdiction over the federal government to remedy harm caused by the government’s corporate actions, see Verret, supra note 1, at 307-15; and Marcel Kahan & Edward Rock, When the Government is the Controlling Shareholder: Implications for Delaware, 35 Del. J. Corp. L. 409 (2010). Instead, this blog addresses the issues within the realm of corporate law and the rights of minority shareholders notwithstanding the government’s sovereign immunity; even if the government were to waive sovereign immunity for corporate law claims brought by minority shareholders through an act by Congress, the construction of corporate law is not prepared to deal with the unique issues presented by a government shareholder. 

  32. See Steven M. Davidoff, Uncomfortable Embrace: Federal Corporate Ownership in the Midst of the Financial Crisis, 95 Minn. L. Rev. 1733, 1734 (2011) (“In each case, the acting government agency utilized different mixtures of common, preferred, and debt securities, and negotiated divergent corporate governance terms.”). 

  33. See, e.g., Ivanhoe Partners v. Newmont Min. Corp., 535 A.2d 1334, 1344 (Del. 1987) (“Under Delaware law a shareholder owes a fiduciary duty only if it owns a majority interest in or exercises control over the business affairs of the corporation.” (citing Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 958 (Del. 1985) and Aronson v. Lewis, 473 A.2d 805, 815 (Del. 1984) ); Gantler v. Stevens, 965 A.2d 695, 708 (Del. 2009) (“[C]orporate officers owe fiduciary duties that are identical to those owed by corporate directors.”); Sinclair Oil Corp. v. Levien, 280 A.2d 717, 719 (Del. 1971) (finding that a parent company with 97% equity of its subsidiary, combined with other elements of control, owed fiduciary duties to subsidiary). 

  34. Cf. Citron v. Fairchild Camera & Instrument Corp., 569 A.2d 53, 70 (Del. 1989) (suggesting that controlling shareholders have “concomitant fiduciary status”)(quoting Gilbert v. El Paso Company, 490 A.2d 1050, 1055 (Del. Ch. 1984).). 

  35. Kahn v. Lynch Comm. Systems, 638 A.2d 1110, 1113-14 (Del. 1994) (first quoting Ivanhoe Partners, 535 A.2d at 1344 (emphasis added); and then quoting Citron, 569 A.2d at 70). 

  36. Id. 

  37. Id. at 1115. This one analysis served two functions in the case: (1) Whether the minority shareholder was a controlling shareholder that owed fiduciary duties to the company; and after answering (1) in the affirmative, (2) whether the independent directors’ approval of a conflicted transaction with the controlling shareholder could “cleanse” the transaction in order to shift the burden of proving the entire fairness of the transaction to the plaintiffs. See id. 

  38. See id. 

  39. Id. at 1116-17 (emphasis added) (quoting Citron v. E.I. Du Pont de Nemours & Co., 584 A.2d 490, 502 (Del. Ch. 1990).). 

  40. See id. 

  41. See generally Verret, supra note 1, at 299-307. 

  42. See id. at 304. 

  43. See id. at 297 n.52. This shift in preference can be traced to a proposal by the investment bank Friedman Billings Ramsey (FBR). Id. 

  44. Id. 

  45. Id. 

  46. Id. 

  47. See id. 

  48. Converting to common shares made it possible for Citigroup to avoid a 9% preferred-stock dividend it would have otherwise been required to pay the government, but converting also came along with new rights for the government in terms of corporate decision-making and impositions of additional obligations and restrictions onto Citigroup. See id. at 298-99. 

  49. While it is true that Citigroup would also benefit from a steady return of private investment, the risks of the government having even more influence over the company triggers serious concerns surrounding Citigroup’s future commitment to profitability and efficiency. 

  50. Id. at 297. 

  51. Id. 

  52. See id. at 298-99. 

  53. Id. at 299 (citing Office of the Special Inspector Gen. for the Troubled Asset Relief Program, Quarterly Report to Congress 3 (July 21, 2009).). 

  54. See Citron v. Fairchild Camera & Instrument Corp., 569 A.2d 53, 70 (Del. 1989). 

  55. See Verret, supra note 1, at 305. 

  56. Id. (citing Ruth Simon, Citi To Allow Jobless to Pay Less on Loans, Wall St. J., Mar. 3, 2009, at A4). 

  57. Del. Code tit. 8, § 102(b)(7) (2017) (“A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director: (i) For any breach of the director’s duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv) for any transaction from which the director derived an improper personal benefit.”). It is worth nothing that a controlling shareholder—or anyone other than a director—may not be able to take advantage of an exculpation provision, even for a breach of duty of care. See also Gantler v. Stevens, 965 A.2d 695, 709 n.37 (Del. 2009) (“Under 8 Del. C. § 102(b)(7), a corporation may adopt a provision in its certificate of incorporation exculpating its directors from monetary liability for an adjudicated breach of their duty of care. Although legislatively possible, there currently is no statutory provision authorizing comparable exculpation of corporate officers.”).