Splitsville, In­cor­po­rated


National Post (Latest Edition) - - FINANCIAL POST - Stephen Gan­del in New York Stephen Gan­del is a Bloomberg Gad­fly colum­nist cov­er­ing equity mar­kets. He was pre­vi­ously a deputy dig­i­tal edi­tor for For­tune and an eco­nom­ics blog­ger at Time. He has also cov­ered fi­nance and the hous­ing mar­ket.

Some divorces are so ran­corous that it takes a judge to sort out who gets what. So why should a nasty cor­po­rate breakup be any dif­fer­ent?

That’s the i ssue be­ing raised in a t hree- and- ahalf- year run­ning case in Delaware that pits two for­mer lovers who started a com­pany to­gether but now seem­ingly can’t stand to be in the same room with­out a team of lawyers. At the heart of the mat­ter is what role a court, and more broadly the gov­ern­ment, should have when a busi­ness is deemed dys­func­tional even if it’s thriv­ing fi­nan­cially. In other words, should own­ers be free to treat what they built how­ever they want with­out gov­ern­ment in­ter­fer­ence?

The case in­volves TransPer­fect, a New York com­pany with more than US$550 mil­lion in sales that trans­lates doc­u­ments for law firms, cor­po­ra­tions and other clients in sit­u­a­tions where lower-cost au­to­mated ser­vices can’t be trusted. Phil Shawe and his girl­friend at the time, El­iz­a­beth Elt­ing, founded the com­pany in his busi­ness school dorm room. The two di­vided own­er­ship of the com­pany with no pro­vi­sion for how to split it up in a dis­pute. That came back to haunt them.

In 2014, Elt­ing sued Shawe in Delaware, where the com­pany is in­cor­po­rated, con­tend­ing that af­ter years of dis­agree­ment and fight­ing — in­clud­ing ac­cu­sa­tions of out­landish be­hav­iour on both sides — they could no longer work to­gether and that the court should ap­point a cus­to­dian to dis­solve the com­pany. Shawe coun­ter­sued that Elt­ing had breached her fidu­ciary duty to the com­pany.

Last year, the court de­cided that the dys­func­tion was in­deed harm­ing the com­pany and ap­pointed a cus­to­dian who de­cided to put the com­pany up for auc­tion. Shawe is fight­ing the sale. But the Delaware Supreme Court up­held the rul­ing in Fe­bru­ary. In late Septem­ber, a fed­eral court dis­missed a suit chal­leng­ing the auc­tion. Fi­nal bids are due on Wed­nes­day.

Lawyer Alan Der­showitz, no stranger to big cases, is rep­re­sent­ing Shawe’s mother, Shirley, and by ex­ten­sion Shawe, who to­gether own 50 per cent of the com­pany. ( Shawe and Elt­ing orig­i­nally gave 1 per cent own­er­ship to Shawe’s mother so TransPer­fect could qual­ify as a woman- owned busi­ness.) Der­showitz con­tends that by seiz­ing a prof­itable pri­vate com­pany and sell­ing it to the high­est bid­der, the Delaware court is vi­o­lat­ing the con­sti­tu­tion. He’s hop­ing to take the case to the U. S. Supreme Court.

“The Delaware court has proven to be very in­tru­sive,” Der­showitz said. “This case is wreak­ing havoc with the law of tak­ing and in gen­eral cor­po­rate law.”

The case has drawn at­ten­tion not only be­cause of how the un­usual ac­ri­mony be­tween for­mer lovers has crossed into the board­room but also be­cause of its pe­cu­liar­ity. Courts man­age the sales of com­pa­nies all the time, but in nearly all those cases they are bank­rupt. TransPer­fect, on the other hand, has con­sis­tently ris­ing sales and is solidly prof­itable.

An­other rea­son is prop­erty rights, long a hot-but­ton is­sue in U. S. pol­i­tics. Econ­o­mists gen­er­ally be­lieve strong prop­erty rights are es­sen­tial to a work­ing econ­omy. Gov­ern­ment seizures can re­move the in­cen­tive of oth­ers to build a house or a com­pany if they think it could be taken away.

That’s why em­i­nent do­main laws re­quire a strong pub­lic in­ter­est and in­spire fights any­way. But a lack of in­cen­tive or com­pen­sa­tion is not the prob­lem here. TransPer­fect is worth more than US$ 600 mil­lion. So Shawe stands to col­lect hun­dreds of mil­lions of dol­lars in the auc­tion, more than in­cen­tive enough for other as­pir­ing en­trepreneurs.

Still, Der­showitz ar­gues Shawe is be­ing forced to give up his right to dis­pose of his as­set in the way he wants. What’s more, the method the court has drawn up, Der­showitz says, de­fies the pub­lic in­ter­est. He says the auc­tion will be won by a pri­vate equity “flip­per” that will de­stroy Amer­i­can jobs ei­ther by ship­ping them over­seas or slash­ing and burn­ing the com­pany to max­i­mize short­term prof­its.

But while pri­vate equity firms have had their share of blowups, Der­showitz seems to be paint­ing PE firms with too broad a neg­a­tive brush. On top of that, block­ing the sale seems to in­fringe the prop­erty rights of Elt­ing, who wants the sale to go through.

And while Shawe main­tains the dys­func­tion at the com­pany is min­i­mal, there is am­ple ev­i­dence to the con­trary. Dis­agree­ments be­tween Shawe and Elt­ing have left key po­si­tions open and scut­tled ac­qui­si­tions and ex­pan­sions, ac­cord­ing to court records. Shawe dis­putes this. He says TransPer­fect was op­er­at­ing fine be­fore Elt­ing be­gan to force the sales process in the courts.

“It’s a dan­ger­ous prece­dent that will de­stroy 4,000 j obs,” says Shawe, cit­ing TransPer­fect’s work­force. Shawe con­tends that the sales process, which he says has been filled with un­nec­es­sary fees and leaks of pri­vate cor­po­rate in­for­ma­tion to com­peti­tors, has al­ready dam­aged the com­pany. “I fight this as an Amer­i­can,” he says. Elt­ing could not be reached for com­ment.

Delaware Supreme Court Jus­tice Collins J. Seitz Jr., in his rul­ing up­hold­ing the sale, said there wasn’t re­ally a rea­son to be wor­ried about the con­sti­tu­tion or Delaware cor­po­rate law, which al­lows courts to sell off dead­locked businesses, even prof­itable ones. It’s part of the trade­off of in­cor­po­rat­ing in Delaware, which has long at- tracted businesses be­cause of its many le­gal ad­van­tages. What’s more, Seitz says rules to en­sure prof­itable com­pa­nies don’t spi­ral out of con­trol are ac­tu­ally pro-busi­ness.

The idea is that a lit­tle gov­ern­ment in­ter­ven­tion can be a good thing. In a broader ex­am­ple, soon af­ter the fi­nan­cial cri­sis, many home­own­ers owed more t han t heir houses were worth. Some ar­gued for so­called cram­downs, in which judges force banks to write down the value of a mort­gage. Banks op­posed cram­downs, con­tend­ing they vi­o­lated their prop­erty rights to both the debt that was owed them and the house that would soon been theirs in fore­clo­sure. Judges and law­mak­ers, in­clud­ing the Obama ad­min­is­tra­tion, gen­er­ally sided with the banks.

But new re­search sug­gests the econ­omy would have been bet­ter off if they hadn’t. Amir Sufi and Atif Mian ar­gued in their 2014 book House of Debt, which re- ex­am­ined the causes of the fi­nan­cial cri­sis, that cram­downs might have boosted con­sumer spend­ing by more than $125 bil­lion in 2009 alone and more later. It would have also low­ered fore­clo­sures that con­sumed hous­ing mar­kets, banks and the fi­nances of many fam­i­lies for years af­ter the fi­nan­cial cri­sis. Con­ser­va­tive econ­o­mists Glen Hub­bard of Columbia Uni­ver­sity and Martin Feld­stein of Har­vard Uni­ver­sity also ended up back­ing some sort of cram­down plan.

That’s a bit of a de­tour to get back to TransPer­fect, but it’s an im­por­tant one. In the end, the TransPer­fect case boils down to a clash be­tween the free mar­ket and an ef­fi­cient one. Some will un­doubt­edly side with the idea that own­ers should be al­lowed to de­stroy their com­pa­nies if they see fit, just as they should be al­lowed to build them, un­aided or abet­ted by the courts and the hands of gov­ern­ment.

But it’s not clear where that leaves TransPer­fect’s 4,000 work­ers, who have helped achieve the com­pany’s suc­cess and cer­tainly have a stake in its fu­ture. Free­dom is good. So is re­spon­si­bil­ity. If TransPer­fect is sold, it won’t open the flood­gates to the gov­ern­ment seizure of com­pa­nies. If bad blood has par­a­lyzed the own­ers, a dis­pas­sion­ate party should be able to step in for the com­mon good with­out threat­en­ing the fu­ture of cap­i­tal­ism.


How far should the gov­ern­ment go when a busi­ness is deemed dys­func­tional? A U. S. court is be­ing asked to de­cide.


Lawyer Alan Der­showitz con­tends seiz­ing and sell­ing a pri­vate busi­ness vi­o­lates the U. S. Con­sti­tu­tion.

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