This foundational principle bears repeating: Legality is not the same morality. It is perfectly illegal to jaywalk across an intersection during a moment when there is no traffic, but it is not an act of immorality to do so. Likewise, it may be perfectly legal to curse at your grandmother, but absent an extraordinary context, it would be immoral to do so.
This distinction—that some immoral acts may be legal—has become relevant again upon encountering the Wall Street Journal news item that former General Electric CEO Jeffrey Immelt frequently obtained a second jet plane to follow him as he met with government officials and other business leaders to secure GE contracts and evade anti-trust punishments during mergers. The latest development in this storyline is that Immelt did not seek the approval nor provide notice of the arrangement to the GE Board of Directors.
Some GE shareholders, and media analysts, have called for civil litigation against Immelt for failing to notify GE’s Board of his princely travelling arrangements on the shareholder’s tab.
I regard this type of complaint as spouting off—trying to claim something is illegal because it has correctly been identified as immoral. We all know that it is a crude combination of excess and self-interest to ferry about an extra jet in case of an emergency.
But that does not mean it supports a shareholder suit. A shareholder, or the Board, can only wage successful standalone civil litigation against a corporate executive for violating the terms of the Articles of Incorporation, the corporation’s bylaws, the fiduciary duty of loyalty, or the fiduciary duty of reasonable care.
We can eliminate the first two automatically. GE’s Articles of Incorporation impose no duties on its corporate executives, and the bylaws only require that GE’s executives follow the applicable fiduciary duties.
This leaves us with the duty of loyalty and the duty to exercise reasonable care.
Like many Fortune 500 companies, General Electric is a Delaware-organized entity. This means that we should look to the Delaware Supreme Court to determine what constitutes a breach of the duty of the loyalty. Delaware decisional law does state that a corporate executive breaches his duty of loyalty to the corporation when he “diverts corporate assets, opportunities, or information for personal gain.”
While that language might sound promising, the Courts have read the phrase “personal gain” to mean “personal financial gain.” Examples from the case law include a corporate executive hiring his wife to sing at a corporate Christmas party for hundreds of thousands of dollars or charging a 10% management fee for oil pipes that he was overseeing in his duties as a corporate executive. Breach of the duty of loyalty is a species of self-dealing. The extent to which the accommodations are lavish do not create breaches of the duty of loyalty; it is when the accommodations are unrelated to carrying out the duties of the executive that such a breach occurs.
The final option, then, is to analyze this second GE jet according to the duty of reasonable care standard. All corporate officers have a duty to make reasonable decisions on behalf of the corporation. There are cases, in Delaware and elsewhere, that regard lavish executive accommodations as a breach of the duty of the reasonable care. However, the caveat is that these cases have involved context in which the lavish accommodations constituted a “material” amount of expenses in relation to the size of the corporation—in 1993, the CEO of a mapmaking company spent $124,000 on hotels and travel while the company only generated profits of $750,000. The expenditures were “material” compared to the size of the company, and thus, the breach occurred.
This means that the executives of the largest companies are somewhat insulated from breaches of the duty of reasonable care for their lavish spending because it is difficult to personally consume a material amount of corporate assets that would meet the “materiality” standard—even if the second jet cost a million dollars to run each year, that is not material when compared to a company generating hundreds of billions of dollars in revenue per year.
It is important to remember that the Board of Directors and the corporate officers have a bifurcatory relationship—the Board makes broad policy, but the officers are enlisted with implementing it. As a result, the officers don’t have a duty to provide notice to the Board about their expenditures in carrying out the corporate mission. Criticizing Immelt for not notifying the Board about the second jet is not some naughty breach of fiduciary duty—it is a moral transgression that is remedied by public shame and embarrassment rather than by penal/civil punishment.
Incidentally, if there is a lawsuit against Immelt for breaching a fiduciary duty, it is likely the shareholders of GE who will suffer from this litigation. When a plaintiff’s litigation firm alleges a breach of fiduciary duty, they often do not take the case to trial. Instead, they settle for a change in corporate policy—e.g. a company like GE might agree to implement a policy governing approval for corporate jets. When a company agrees to make any change to its corporate policy as part of the settlement, the company itself is then obligated to pay the attorney’s fees for the costs of the shareholder suit (the logic behind this rationale is that the new policy improves the company, and if the fees were not reimbursed to the shareholder brining the suit, no shareholder would ever have the financial incentive to correct miscreant behavior.)
Executives at large companies can be held accountable for their actions by dealing with the reputational effect of their actions. If a fiduciary acts in a way that is excessive, then other boards and companies should be reluctant to hire that executive because of the reputation that precedes him. Relying on litigation to correct this behavior is not supported by current case law, and most likely, would require the shareholders of GE to pay for the litigation costs associated with this strategy choice. Immelt deserves public ridicule for the second jet—however, the talk of a lawsuit for violating a fiduciary duty will not bring the shareholders the relief they seek.
Originally posted 2017-10-29 21:04:06.