Saturday, May 31, 2008

The KMT Returns to China

Kuomintang (KMT) Chairman Wu Poh-hsiung has been visiting from Taiwan. The Chinese Communist Party has ensured that such a gesture be rewarded. Hu Jintao met with the KMT Chairman in a lavishly staged photo-op session. The CCP organ reported "Hu Jintao (R), General Secretary of the Communist Party of China Central Committee, shakes hands with Kuomintang (KMT) Chairman Wu Poh-hsiung at the Great Hall of the People in Beijing, capital of China, on May 28, 2008. Hu Jintao met with Wu Poh-hsiung and all the members of the visiting KMT group here on Wednesday." Hu Jintao Meets With KMT Chairman Wu Poh-hsiung, People's Daily On Line, May 29, 2008. The commonalities across party lines were emphasized in ways that were meant to send signals across all intellectual class lines. Much was made, for example, of Wu's visit to the mausoleum of Sun Yat-Sen. KMT chairman Pays Homage to Dr. Sun Yat´Sen's Mausoleum, People's Daily Online, May 28, 2008. These signals, though, werre not without their ambiguities. Wu produced a couplet for the visit to the Mausoleum capable of a variety of interpretations: "'tian xia wei gong, ren min zui da', which means 'The State belongs to the people. The people are all the important.'" KMT chairman Pays Homage to Dr. Sun Yat´Sen's Mausoleum, supra.

But there were more tangible benefits as well--to both sides. The Chinese were able to exploit an event that took Western media activity away from Tibet and its search for independence,. Indeed, a great value of this gesture was to oppose the "stubbornness" of the Tibetan priestly aristocracy against the forward thinking actions of what had once been the most intimately connected and greatest poltiical enemy of the CCP and its plans for China. Of course, whether this strategy works or not remains to be seen, But certainly, from the CCP perpsective, it is something worth attempting. . .and the Western press might be understood as both fickle and to some extent gullable (but self aware). See, e.g., Rafael Poch, Primera Visita a China, en 60 Años, del Líder del Kuomintang taiwanés, La Vanguardia, May 29, 2008 ("Todo lo negativo que Pekín encajó a nivel de imagen con la crisis de Tibet, viene más que compensado por los progresos realizados en el muy sensible ámbito taiwanés," Id., at p. 6).

More importantly, for both sides, there was agreement on resumption of talks and resumption of some more extensive contacts. Hu Jintao
called for resuming exchanges and talks, based on the "1992 Consensus", between the mainland's Association for Relations Across the Taiwan Straits (ARATS) and Taiwan's Strait Exchange Foundation (SEF), as early as possible, and practically solving problems concerning the two sides through talks on equal footing. Once the ARATS-SEF dialogue is resumed, priority should be given to issues including cross-Strait weekend chartered flights and approval for mainland residents traveling to Taiwan, which are of the biggest concern to people on both sides of the Strait, said Hu.

Hu says opportunity for cross-Strait relations should be cherished, People's Daily Online, May 29, 2008. Hu's statements produced quick action of the usual sort. "The mainland-based Association for Relations Across the Taiwan Strait (ARATS) Thursday sent a letter to the Taiwan-based Strait Exchange Foundation (SEF), inviting them for talks. The letter invites SEF Chairman Chiang Pin-kun and Vice Chairman and Secretary-General Kao Koong-lian to lead a SEF delegation to visit Beijing from June 11 to 14 for talks on the cross-Strait weekend chartered flights and mainland tourists' traveling to Taiwan." Mainland Based Association Invites Taiwan counterparts for Talks, People's Daily On Lin, May 29, 2008. And thus the reward. As the Mainland press noted: " The two topics have been discussed by related trade organizations many times and some consensus had been reached." Taiwan Foundation Accepts Invitation From Mainland Counterpart for Talks, People's Daily On Line, May 29, 2008. So it comes as no surprise that, now, "Ten airlines from the mainland and Taiwan will make 19 round-trip flights for the traditional Duanwu, or Dragon Boat Festival, from June 3-15, the Civil Aviation Administration of China said Thursday." Cross Strait Charter Flights Set for Dragon Boat Festival, People's Daily On Line, May 29, 2008. This serves the Chinese as well. "People in mainland celebrate their first "official" Dragon Boat holiday this year. The State Council (cabinet) revised the official holiday schedule late last year to add three traditional festivals -- Qingming, Duanwu and Zhongqiu -- in response to public demand." Id.

But there was talk of political ties as well, between the KMT and the CCP. In the grand vision, of course, the ideal would be to heal the rupture of 1927. But that is impossible. Still, time and experience--along with desire--sometimes heals even the greatest wounds (especially when the original protagonists are both dead and reinterpreted). And thus another potentially interesting palpable benefit of the trip, talks between the KMT and CCP. " Exchanges between the Kuomintang (KMT) and the Communist Party of China (CPC) will play an important role in the relations across the Taiwan Strait, according to visiting KMT Chairman Wu Poh-hsiung." KMT Chairman: Party exchanges across Taiwan Strait to play important role, People's Daily On Line, May 29, 2008. This is meant to supplement the the talks between the mainland-based Association for Relations Across the Taiwan Strait (ARATS) and the Taiwan-based Strait Exchange Foundation (SEF). Id. The importance of inter-Party ties on political relationships was not lost of the principals.
"Yang Yi said the summit between General Secretary of the CPC Central Committee Hu Jintao and KMT Chairman Wu Poh-hsiung was an important event for the two parties to achieve extensive consensus. Yang said both the CPC and the KMT, or the Nationalist Party of China, cherished the good momentum in the relationship across the Taiwan Strait. The two parties agreed to seize the opportunity to build mutual trust, lay aside disputes, seek consensus and shelve differences, and jointly create a win-win situation, Yang said."
CPC-KMT Summit Significant for Cross-Strait Relations, People's Daily On Line, May 30, 2008. Of course, there was a long history of such meetings in the old days. For the moment, the talks will be kept to safe subjects--the concurrent economic and exchanges negotiations. Id. Their future success, now that the progenitors of both parties are long dead, remains to be seen.

There were internal benefits for the Taiwanese as well. Wu needs to present some tangible benefits to a policy of less provocation. And because of the extent of Taiwanese investment in China, something with economic impact would likely serve him best. At the same time, he must be careful to avoid reminding his CCP benefactors of his suggestion, during the campaign that the Taiwanese ought to be able to choose their own destiny.
See, e.g., Rafael Poch, Primera Visita a China, en 60 Años, del Líder del Kuomintang taiwanés, La Vanguardia, May 29, 2008. Indeed, for this visit, Wu has been careful to emphasize the "correct" vision. "The KMT has won two important elections in Taiwan recently, Wu said, which showed that the mainstream opinion of the Taiwan people identified with what the KMT stood for, and most of the Taiwan people agree that the two sides on the strait can achieve peaceful development and a win-win situation." KMT Chairman Eyes Better Cross-Strait Relations, People's Daily On Line, May 31, 2008.

But Wu will have to tread carefully with his electorate in Taiwan. The KMT forgets its own history on Taiwan at its peril. In a sense, that history suggests that the KMT's own journey to Taiwan in the 1940s was a bit irregular, as was its imposition of government. It's relationship with the CCP, ancient, retains a certain ideological closeness that can be discerned even after nearly a century of bitter competition. For the CCP, the greatest victory, as well as a great irony, will be to have the KMT serve as its instrument in effecting reunification--both of territory and Party.

Thursday, May 29, 2008

State Subsidies and the Character of the Market Transactions of Sovereigns: The Case of EADS

The twin pillars of emerging European regulation of the participatory (rather than the regulatory) activities of state sovereigns in economic markets are the jurisprudence of free movement of capital provisions of the European Community Treaty (Art. 56 EC) and the regulation of state subsidies to business under the Competition provisions of the European Community Treat (Art. 87 EC). With respect to the former, the focus has been on the privatization of state enterprises where the state seeks to retain an interest or otherwise intervene to protect the national character of the enterprise. In virtually all those cases, the European Court of Justice has rejected assertions of state power, characterizing them as regulatory, and consequently in breach of a Member State’s obligations under Art. 56 EC. With respect to the latter, both Court and Commission has sought to narrow the scope of permissible state intervention in the form of investment by treating many forms of such formally private activity as public and consequently in breach of the competition provisions of the EC Treaty.

As I have written before with respect to golden shares, within the context of the free movement of capital, Advocate General Colomer perhaps best summarized the state of golden share jurisprudence and its general principles:

a) The Court examines the various national rules on intervention, essentially, in the light of the principles relating to free movement of capital: failure to observe those principles may, as an ancillary matter, give rise to an infringement of the principle of freedom of establishment.
(b) In so far as such rules are capable of impeding the acquisition of shares in the companies concerned and of deterring investors from other Member States, they amount to restrictions on the free movement of capital.
(c) Article 295 EC has no practical effect in this sphere.
(d) The free movement of capital may lawfully be restricted only by measures which, without being discriminatory on grounds of nationality, are a response to overriding requirements relating to the general interest and are suitable and proportionate to the objective which they pursue. Such measures, which must be adopted ex post facto, must be based on objective criteria which are known in advance to those concerned, to whom a legal remedy must be available.

Joined Cases C-463/00, Comm’n v. Spain & Case C-98/01, Comm’n v. United Kingdom, 2003 E.C.R. I-4584, I-4593 (Opinion of Advocate General Ruiz-Jarabo Colomer). The focus is on the special character of Member States’ interventions in their own economies. The object is to reduce all possible transaction costs to the free movement of capital that might be based on the “nationality” of that capital. Investors may be deterred by rules that discriminate on the basis of nationality, as well as other rules that make investment less attractive, for example, rules privileging state investment. The form of that privileging is immaterial. All state intervention that is accompanied by regulation, the threat of regulation, or indirectly supported by special regulation, constitutes an impediment to free movement. Derogations in the public interest are narrowly construed. This was the case, for example, in Case C-503/99, Comm’n v. Belgium, 2002 E.C.R. I-4809, paras. 46-47, where it was noted that the “Court has also held that the requirements of public security, as a derogation from the fundamental principle of free movement of capital, must be interpreted strictly.” In a general sense, then, a sovereign regulates even when it appears to be participating in the market—if it participates in the market that is the subject of its regulation. It is the regulatory character of the action that is key, along with the power to implement it within its territory. In that context, the private law offers no cover.

With respect to the application of the discipline of the competition law rules to dstate investment activity in their domestic enterprises, the European Court of Justice has long held that the purchase by a Member State of equity interests in a company might be characterized as a “state aid” (Art. 87(1) EC) under the competition provisions of the EC Treaty. (e.g., Case 323/82, Intermills SA v. Commission [1984]ECR 3809). In Case T-198/01 Technische Glaswerke Ilmenau GmbH v. Commission [2004] ECR II-2717 the Court explained that
“In order to determine whether the reduction of some of the applicant’s debts to the BvS constitutes State aid, it is appropriate, in the present case, to apply the test of a private creditor in a market economy, which was referred to in the contested decision and which, moreover, was not challenged by the applicant. . . . By granting the price reduction, the BvS did not act as a public investor acting in a manner comparable to that of a private investor pursuing a structural policy – whether general or sectoral – and guided by the longer-term prospects of profitability of the capital invested. That public body had in fact to be compared to a private creditor seeking to obtain payment of sums owed to it by a debtor in financial difficulties”
Id., at ¶¶ 98-99.

The Commission has applied a private investor test to gauge the validity of state aid. In a case involving the acquisition by Belgium of shares of a domestic company, and thereafter its efforts to increase the capital of that company, the Court agreed with the Commission that those actions were subject to review and the constraints of Article 87 EC as state aids. “In order to determine whether such measures are in the nature of State aid, the relevant criteria is. . . whether the undertaking could have obtained the amounts in question on the capital market.” (Case C-142/87 Re Tubemeuse (Belgium v. Commission [1990] ECR I-959). This approach is consistent with an application of private law standards to state participatory activity.

The framework is parity between state and private investors. In an early case, the Court explained:
“19 The Commission showed itself to be aware of the implications of the principle of equal treatment as between public and private undertakings in its communication to the Member States of 17 September 1984 on public authorities' holdings in company capital (published in the Bulletin of the European Communities, September 1984). In that statement it correctly observes that its action may neither penalize nor favour public authorities which provide companies with equity capital.
Case C-303/88 Italy v. Commission [1991] ECR I-1433 at ¶19, available at . From the principle of equal treatment, it fell to the Commission to determine whether the State’s investment programs corresponded to normal market conditions. If so, such investments “cannot be regarded as State aid. In the present case it must therefore be determined whether, in similar circumstances, a private industrial group might also have made up the operating losses of the four subsidiaries between 1983 and 1987.” Id., at ¶ 20.

The touchstone of the state aid cases appears to be some sort of idealized private investor, a metaphor serving a purpose similar to the Common Law’s reasonable person. The distinction is between action that can be characterized as private and that which is sovereign and regulatory, albeit indirectly. As such, all motives other than an interest in profitability are suspect. “[W]hen injections of capital by a public investor disregard any prospect of profitability, even in the long term, such provision of capital must be regarded as aid within the meaning of Article [87] of the Treaty, and its compatibility with the common market must be assessed on the basis solely of the criteria laid down in that provision.” (Italy v. Commission, supra, at ¶ 22.).

However, the “dividing line between general measures of economic policy and state aids may . . . be a fine one.” (Paul Craig and Gráinne de Búrca, EU Law: Text, Cases and Materials 1088 (Oxford: Oxford University Press, 4th ed., 2008)). Even if the state activity does not constitute state aid, investment activity of this sort would require pre-approval under the rules implementing the State aid limits, at least in companies within their jurisdiction, to comply with the notice requirements of the state aid provisions. This distinguishes state investment from private investment, at least with respect to timing. This distinction made sense in the context in which many of the state aid cases arose, which were similar to those of the golden share cases—involving state owned or controlled enterprises. Indeed, privatization of the sort that gave rise to the golden share cases may have implications under the state aid rules as well. For a discussion of the Commission’s position, see Andrew Evans, EC Law of State Aid 70-76 (Oxford: Clarendon Press, 1997).

The State aid jurisprudence might suggest congruence between standards of state interventions in economic activity when undertaken in a sovereign capacity under Art. 56 EC, and where undertaken in a private capacity under Article 87 EC. Still, this congruence might extend only to activities within the territory of a Member State. Both European Court of Justice (in the golden share cases) and Commission (in its elaboration of state aid through shareholding) were concerned with the effects of privatization and the creation of a European private market in place of the old controlled economies of the Member States. The Commission made its position clear in the 1980s. See Application of Articles 92 and 93 of the EEC Treaties to Public Authorities’’ Holdings, Bulletin EC 91984 (1984). The Commission noted, for example, four situations
“in which public authorities may have occasion to acquire a holding in the capital of companies: (a) the setting up of a company,(b) partial or total transfer of ownership from the private to the public sector, (c) in an existing public enterprise, injection of fresh capital or conversion of endowment funds into capital,(d) in an existing private sector company, participation in an increase in share capital.”

Id. At ¶ 2. All suggest the privatization or internal economic management context in which the golden share cases arose.

The application of these rules have become more complicated as the EU Member States move from privatization of state enterprises to engagement with globalized economies. In that context, states might seek to participate in global economic activities to some extent. The rise of sovereign wealth funds represents one aspect of this change. See Larry Catá Backer, Brazil Builds a Sovereign Wealth Fund and Norway Flexes Its Muscles: Private Participation in the Market or Regulation by Other Means, Law at the End of the Day, March 24, 2008. The willingness of states to invest in the enterprises of other states is another. See Larry Catá Backer, Missing the Point of the Ports Problem—Getting Foreign Governments Out of U.S. Security Related Business, Law at the End of the Day, March 26, 2006. The character of that activity remains highly contested. But the framework within which that will be decided is well elaborated—just tangentially applied.

Slowly, though, the Europeans are coming to grips with the reality of states acting in capacities substantially incomprehensible even thirty years ago. One great testing ground for the relationship between state-economic enterprises and law has been EADS, the parent of Airbus, the European aircraft manufacturer. EADS is governed by Dutch corporate law. (EADS, Business, Legal and Corporate Responsibility, General Description of the Company and Its Share Capital, 2007, at para. 3.1.3. A number of European states have a direct or indirect interest in EADS, including the French, Spanish and German states. (Id., General Description of the Company and Its Share Capital, 2007 at para. 3.3). The relationship between the company and its principal shareholders are based on a series of complex agreements that substantially shape the corporate governance of the entity and the way in which shareholder power is dispersed. (Id., at 3.3.2, pages 100-105).

“Airbus S.A.S. has been a wholly-owned subsidiary of EADS since the purchase of BAE Systems’ 20% stake in October 2006.” EADS, Annual Repòrt and Registraiton Document 2006, Airbus, Introduction and Overview, 2006. The European Commission has been quick to warn the public shareholders of EADS against seeking to alter shareholder agreements affecting governance as a potential violation of the free movement of capital principle. See Larry Catá Backer, The End of Golden Shares in the EU: The EU Commission Takes a Step in its Abolition, It Ought to Harmonize the Rules of Sovereign Investments Instead, Law at the End of the Day, March 9, 2008. Though this is a context that stretches the developing concepts of state ownership in the golden share cases, the European Commission’s position is consistent with a view that presumes that states can rarely act as market participants. This view is being extended even to cases where the object of investment is not domiciled in the country seeking to invest. I have suggested that this conception of the state in the market is neither inevitable nor necessarily the “right” one, even in the European context. (Larry Catá Backer, "The Private Law of Public Law: Public Authorities as Shareholders, Golden Shares, Sovereign Wealth Funds, and the Public Law Element in Private Choice of Law," Tulane Law Review, Vol. 82, 2008 Available at SSRN: ).

As recently reported (Mark Landler, Aircraft Subsidies Battle Revived Over Airbus Aid, International Herald Tribune, May 29, 2008), the other shoe has dropped as well—this time relating to the state aid provisions restraining state investment in private enterprises. In the wake of reversals at Airbus over the development and sale of its new aircraft, “European officials have reviewed the issue of subsidies, suggesting this week that their governments would chip in for the development of the Airbus A350, the rival to the Boeing 787.” Id. This is an interesting turn, especially in light of the ongoing battles centered on rival complaints by the Europeans ands Americans over the legitimacy of such subsidies under the WTO system. See Id. The Americans, apparently reading the European Court of Justice’s “state aid” cases better than the Europeans, have suggested, “’Airbus should fund its operations in the commercial market.’” (Id., quoting Ted Austell, Boeing’s vice president for international policy).

The combatants understand the WTO decision for what it is, merely a point of reference for a much larger battle, and with only limited (though cumulatively potentially great) effect. Commentators have argued that “whatever the WTO decides, governments will always find ways to funnel money to expensive, but politically popular civil aviation programs.” (Id.). Yet, there may well be a difference between loaning money to a company in which a state has an interest as a shareholder, and as the Americans have done with Boeing, provide “Pentagon research and development grants, tax incentives from states like Washington, and subsidies to suppliers of aircraft parts from the Japanese government.” (Id.). Private shareholders constantly loan corporations in which they have an interest money and other things. Why not in this case, especially where the corporation at issue is operated outside the states of investment. Perhaps, the loans might be capitalized, but prohibited?

Yet there is also something that makes these “loans” more like the American handouts than market transactions. It is exactly the absence of market transactions for the loans. The European Union itself has been quite clear of the sort of lending that would not constitute a state aid—loans that would be equivalent to those available in the private markets. It is not clear that easy loans to EADS would meet the requirements of Art. 87EC. And, indeed, why would it be impossible for EADS to seek public debt financing for its Airbus unit, and then permits the state shareholders to participate like other private investors? The answer might be easy, though troubling for the development of a private law of public investment. And it is the same reason that corporations seek loans form heavily invested shareholders—the terms will be that much better, and certainly better than market—that is, less costly to the corporation and the interests of shareholders in the enterprise. It is precisely because the government investors prefer to avoid the market that they are seeking to extend favorable private financing. And they should bump right into the state aid jurisprudence of the EU.

On the other hand, one is tempted to retort—so what? Private shareholders do this all the time. It is a perfectly rational reaction and designed to protect a financial investment, like a private investor would. This, ironically enough, mimics the presumption overturning rationale of the golden share cases. But in the state aid context, this is not enough. And again, the problem is not the act but the actor. In this case the argument might be buttressed because none of the government shareholder/stakeholders are in a position to affect the Dutch corporate regulatory context in which EADS operates. This argument is weakened, of course, because at the European level, all of those governments are free to try to change the regulatory framework for EADS. Yet it is not the same thing for a government to be able to regulate directly and to participate in a wider regulatory project where its direct power is limited (even in concert with other states).

Still, this may hardly be the way to make a case for application of private law. The law of under market and market questionable loans from shareholders, at least in the United States, has not had a stellar history. Such loans tend to be viewed with suspicion, as a corruption of the corporate governance framework, as a potential fraud on third parties and a potential interference with the property rights of stakeholders whose rights are superior to those of shareholders. The better case would touch on the application of the state aid rules where states purchase debentures in market transactions along with private shareholders. Even where states purchase the majority of the issue, it should be possible to make a stronger case that this is the sort of activity in which the public law of the EU ought not to apply.

Wednesday, May 28, 2008

Fiduciary Duty for Directors in Canada--From a Focus on Shareholders to Debt and Equity Holders?

Traditionally, at least in common law countries, corporate boards of directors owed a single minded fiduciary duty to its shareholders. Actually, more like a triple duty of care, loyalty and (sometimes) disclosure. At times the courts phrased that duty as one owing to the corporation. But the meaning was usually clear--the board of directors had a duty to maximize the welfare of equity holders in general and residual (common) shareholders in particular. Others needed less protection. For them, there was the availability of contract. Bondholders, in particular, have always been free to negotiate the terms under which they are willing to part with their money. In return, bondholders acquired an interest in the firm superior to that of equity holders. In the United States and elsewhere, there were always exceptions (that is the nature of law in common law jurisdictions in any case). In the usual cases, those special duties might arise because of the peculiar character of the debt or when the company became insolvent.

Of course, there has been a great effort to expand the nature of the duty of corporate boards. Thinkers everywhere have sought to include a host of stakeholders within the ambit of the board's duty. These could range from debt holders and employees, to virtually everyone on earth. There are a variety of reasons advanced, from the need to reduce the privileging of shareholders in law, to the utility of such an expansion in the accountability of corporations with respect to their "public" functions. These notions have been especially popular within the international community--perhaps because of the conceptual gulf between corporate and international law. See Larry Catá Backer, "Multinational Corporations, Transnational Law: The United Nation's Norms on the Responsibilities of Transnational Corporations as Harbinger of Corporate Responsibility in International Law," Columbia Human Rights Law Review, Vol. 37, 2005. In addition, int he United States, there have been tentative steps to incorporate a legal basis for stakeholder duty. These statutes are usually meant to be invoked only in the case of contests over corporate control and extend only to domestic corporations. Most importantly, these statutes might permit but do not compel an extension of a board's fiduciary duty. Indeed, some of these statutes insist that the duty of shareholders remains paramount. In any case, most of these efforts are overshadowed, in the United States, at least, both by the overarching importance of federal law and the power of the market to discipline corporate behavior.

Canada appears to be approaching the issue of fiduciary duty in a different way. And it has managed this foundational change in the essence of corporate governance through a judicial decision in a very large Canadian transaction, one worth about $52billion (Canadian). It seems "[i]n a unanimous ruling, the [Quebec Court of Appeal] declared the plan of arrangement of the $42.75-a-share offer put forward by a buyout group of private-equity funds, led by the Ontario Teachers Pension Plan, last summer was unfair to the firm's debt-holders, temporarily stalling the deal." Theresa Tedesco, BCE Wins Latest Round with Bondholders, The Montreal Gazette, May 27, 2008. The bondholders effectively argued that the board had a duty to reject an offer that might effectively reduce the value of their debt holdings. "The bondholders oppose the buyout because they claim the extra debt BCE will need for the privatization will increase the risk of default and degrade their debentures to "junk" status." Id. For a look at the company at issue see here.

Well, one might be tempted to argue, the debt holders are right. It is not nice of the board to spoil the bondholders' positions merely to suit the needs of the shareholders. But shareholders do not bargain for their rights. Those are usually statutorily hard wired. Of course, such hard wiring is almost infinitely flexible, as long as one has the votes to amend the corporate charter, and as long as those amendments do not otherwise violate public policy or the limits on flexibility imposed through the corporate statutes. With publicly traded shares, the range of flexibility is usually even more constrained. Shareholders buy a uniform, easily valued and homogeneous product. Ah. Surely, a clever lawyer could connect the dots, and for the benefit of the wealth maximizing lusts of shareholders, whom corporate boards are bound to protect, would have sought to sacrifice the bondholders' position (or at least the security of their loans) by engaging in corporate financing through equity, or transactions in equity without regard to bondholder's interests (though fixed, of course) in corporate income (ie interest payments) and assets (ie repayment of principal).

But this description of horribles hardly reflects reality. Corporations seek debt because they need it. Such debt is available only to the extent that lenders think that they cannot better value for their loans elsewhere. And bondholders have a powerful mechanism for ensuring that their loans are adequately protected (that is, that the aggregate value of their loans is no worse than available in alternative transactions). That mechanism is contract. Indeed, unlike shareholders, whose rights are essentially derive from statute, bondholders' rights are creatures of contract. And it is easy enough to build protections against shareholder abuse in debt instruments. Indeed, anyone who has ever reviewed the typical complex debt instrument is well aware of the availability of a variety of mechanisms to restrain corporate flexibility with respect to shares--from suspensions of dividends to approvals for changes in control, to conversion of debt for equity on the occurrence of certain events, to a host of covenants limiting the discretion of corporate boards (or better put, providing the debt holders with an opportunity to declare the debt in default on the occurrence of actions in breach of such covenants). This works as long as the price the debt holders are willing to pay for the sort of protection that can be extracted form a corporate debtor through contract generates positive value.

The great curiosity of this case, then, is the absence of such protections. Either they were unavailable because they would have reduced the yield to lenders (in which case lenders took the risk that the very thing that happened would occur), or lenders' counsel failed to propose or bargain for these protections. On the one hand, then, it is possible to characterize the case as one in which debtors are seeking to avoid the consequences of their risk taking. On the other, is is possible to suggest a failure of lawyering at the negotiation stage (either because the lawyers were unable, forgot or were instructed not to pursue appropriate protections). Whatever the case, apparently, these bondholders sought to make up for their contractual deficiencies through lawmaking. One can hardly blame them. But one need facilitate this move only if it makes sense under general principle sof corporate law. And it is not clear that is, or ought to be, the case.

The lawsuit, of course, is considerably more complicated that this sound bite. The decision, IN THE MATTER of a proposed arrangement concerning BCE Inc., Court of Appeal, Quebec, No. 500-09-018525-089, (500-11-031130-079), slip op.,(MAY 21, 2008) is worth a close read. For the arguments against the case by the losing party, see, Factum of BCE and Bell Canada – Quebec Court of Appeal (PDF 1.4 MB - Apr 24, 2008). It centers on the meaning of the fiduciary duty of Canadian companies when a corporation is "put in play." And those rules center on the interpretive possibilities inherent in Peoples Department Stores v. Wise, [2004] 3 S.C.R. 461. From Peoples the Quebec Appeals court extracted a broad based foundation for fiduciary duty by distinguishing between the consequences of imposing such duties for the best interests of the corporation rather than of the shareholders. While both terms tend to be used interchangeably int he U.S. and tend to refer to the aggregate long term best interests of equity, the Quebec Appeals Court quoted Peoples for the proposition "that "'the best interests of the corporation' should be read not simply as the 'best interests of the shareholders'" and enunciated: 'The various shifts in interests that naturally occur as a corporation's fortunes rise and fall do not, however, affect the content of the fiduciary duty under s. 122(1)(a) of the CBCA. At all times, directors and officers owe their fiduciary obligation to the corporation. The interests of the corporation are not to be confused with the interests of the creditors or those of any other stakeholders.'" IN THE MATTER of a proposed arrangement concerning BCE Inc., supra, at para 100 (quoting in part Peoples, supra. at 42, 43).

These were seasoned with an overtone of the well recognized exception under which a limited fiduciary duty is extended to debt holders in an insolvency context, and a hint of an inclination to broaden the concept of oppression in a manner that might contort the concept into another form of garden variety fiduciary duty--but one now applicable to stakeholders in the context of contests for control. See, e.g., Peoples Depart. Stores, supra. at para. 48:
"Creditors are only one set of stakeholders, but their interests are protected in a number of ways. Some are specific, as in the case of amalgamation: s. 185 of the CBCA. Others cover a broad range of situations. The oppression remedy of s. 241(2)(c) of the CBCA and the similar provisions of provincial legislation regarding corporations grant the broadest rights to creditors of any common law jurisdiction."

Cited by the Quebec Appeals Court, IN THE MATTER of a proposed arrangement concerning BCE Inc., supra, at para 57 (but noting, id., at para. 87 that "the Court will deal only with the plan of arrangement proceedings because if the plan is fair and reasonable, it cannot be said to be oppressive to security holders, or unfairly prejudicial to, or unfairly disregard their interests. Therefore, the Motions for Oppression Remedy become moot and the appeals from the judgment of the Superior Court will accordingly be dismissed, but without costs, given the circumstances.").

Nonetheless, the court appears to give in to temptation to boil down the aggregation of these concepts into a new mix, producing an obligation to stakeholders, at least in the context of a change in control. The court concluded that " the premise advanced by BCE that, once the corporation was in play, the Board could only consider ways to maximize the value for the shareholders, is erroneous." IN THE MATTER of a proposed arrangement concerning BCE Inc., supra, at para 102.

The Board's effort to obtain the best value reasonably available to the shareholders cannot be considered in isolation from other factors, such as proper consideration for the interests of debentureholders. Similarly, the elimination of adverse effects on debentureholders cannot be examined in isolation from the proper consideration of the interests of the shareholders. As between obtaining the highest price for the shareholders and the elimination of all adverse effects on the debentureholders it might be possible, through accommodation or compromise, to reach a solution that is fair and reasonable; one that is in the best interests of the corporation and that gives proper consideration to the interests of the shareholders and the debenture holders, taking into account all the circumstances, including the relative eight of their interests.
IN THE MATTER of a proposed arrangement concerning BCE Inc., supra, at 40, para. 122. As a consequence, the Appeals Court determined that "Besides looking to the contractual rights flowing from the Trust Indentures, the Board should have considered the interests (including reasonable expectations) of the debentureholders." Id., at para. 103.

On the one hand, this is a strange result. Effectively the Court suggests that bondholders are protected at two levels. They can negotiate a great amount of protection through their debt instruments. At the same time, they are entitled to the protections of fiduciary duty over and above those provisions int he context of a sale of control. Equity holders, however, are entitled only to those fiduciary protections. But it is not clear why these non residuary holders ought to be entitled to these enhanced protection. On the other hand, there is a certain attraction to the judgment. From an institutional perspective, the elaboration of a juridical doctrine of a duty to maximize corporate wealth (rather than shareholder wealth) recognizes the autonomous legal personality of the corporation as a juridical person apart form its stakeholders. At the same time it recognizes that the institution owes those stakeholders duties arising from its primal obligation to maximize entity wealth. Still, even under a duty to corporation standard, the inevitable consequence need not be the extension of a duty to debt holders. Or better put, the duty might require the corporation to avoid entering into agreements with debt holders which detract from the value of shareholder interests (the arguments made by the debt holders in BCE, but inverted). And this sort of game playing, of course, is the great danger of the case.

But this leaves shareholders in a strange place. Unlike bondholders, whose property rights are well established in contract and well understood in law, shareholders have a property right in the entity defined in large measure by statute. But those are property rights all the same. It might be argued that, as between shareholders (in the aggregate) and the entity, there is not a spcial relationship between autonomous juridical persons--a relationship that nicely characterizes that between bondholders and the entity--but one of property. In effect, the entity (like medieval monarchs) wears to aspects. To third parties it is an autonomous entity. To shareholders it is property. If one embraces this idea, then it makes little sense to accord to persons, whose property rights are elaborated in contract between equals (in law at least), the same rights or the benefits of the same legal relationship as between persons and their property (and the rights and obligations flowing therefrom). Shares represent an aggregation of control, ioncome and asset rights substantially different form that characterizing debt. Through it is possible to modify both debt and equity to approach an equivalence (in effect at least), the basic character of those instruments are different, the sources of their rights are different, the bargaining is different (with respect to debt holders between the entity and the creditor; with respect to the shareholder between shareholder, entity and the state). From this perspective the Quebec Appeals courts is not just tragically wrong, but fundamentally wrongheaded in its approach to the issue of the obligations of a board of directors. And Peoples, supra, itself might be worth a revisit.

Still, western developed states have long since moved beyond the simplicity of shares as property and relationships among others with the enity as something else. The engagement of entities in society, and their institutional autonomy merits considerable rethinking of the basis of the character and meaning of "equity" and "debt" and the consequences thereof,e specially in the context of fundamental corporate activity. Thus an elaboration of a duty-to-entity rather than duty-to-equity-holder doctrine is well worth considerably more thought. It makes sense, at least in part. But its greatest utility might be to liberate boards of directors of the traditional and over narrow framework within which fiduciary duty has been understood. For another short take on these issues worth considering, see Anita Anand, Backing the BCE Bondholders: Beyond Law and Contract, University of Toronto Faculty Blog, May 21, 2008.

For all that, the principal focus of a duty to the entity must be to increase the aggregate value of the entity as a whole rather than to preserve the interests of various classes of stakeholders. And because residuary stakeholders are least protected beyond law, then they might merit the greatest deference under the standard. As a result, the Quebec Appeals Court might have been right on the law (as a general proposition) but very wrong in its application to debt holders. The appellate decision ought to be reversed, but the opportunity taken to elaborate an appropriate fiduciary duty theory. Fortunately we will get a chance to return to these issues soon. The Canadian Supreme Court has indicated a willingness to tackle these issues on appeal.
BCE Inc. may gain on the Toronto Stock Exchange today after Canada's highest court agreed to expedite an appeal of a Quebec court ruling that blocked the Canadian phone company's record C$52 billion ($52 billion) leveraged buyout.

The Supreme Court of Canada late yesterday gave the two sides until May 30 to file the application for a hearing and responses. If the court agrees to grant the hearing, it would be held on June 17 in Ottawa.

Joe Schneider, BCE May Rise After Supreme Court Agrees to Expedite Appeal,, May 27, 2008. We will come back to this in more detail then.

Sunday, May 25, 2008

Human Dignity and Fundamental Value Systems in the International System, A Comment on Jan Smits, Human Dignity and Uniform Law

Michel Foucault, in explaining his notions of archeology famously described the framework of knowledge in two forms, as savoir (underlying knowledge) and as connaissance (formalized or formulated knowledge).
In a society, different bodies of learning, philosophical ideas, everyday opinions, but also institutions, commercial practices and police activities, mores—all refer to a certain implicit knowledge (savoir) special to this society. This knowledge is profoundly different from the bodies of learning that one can find in scientific books, philosophical theories, and religious justifications, but it is what makes possible at a given moment the appearance of a theory, an opinion, a practice.

Michel Foucault, The Order of Things, in Foucault Live (Interviews, 1966-84) 1, 2 (John Johnston, trans., Sylvère Lotringer, ed., New York: Semiotext(e), 1989). For Foucault, as for us, savoir/connaisance has a certain virtue—it serves as a means to “avoid every problem concerning the anteriority of theory in relation to practice, and the inverse.” Id. As a consequence, it is possible to “deal with practices, institutions and theories on the same plane and according to the same isomorphism’s.” Id. This can serve as a means to the excavating (and thus the archeological referent)” the underlying knowledge (savoir) that makes them possible, the stratum of knowledge that constitutes them historically.” Id.

I have suggested that, at least as a matter of savoir, concepts of human dignity have begun to drive international law as foundational urtext. See Larry Catá Backer, Neo Colonialism in Civil Society Clothing or the Rise of Human Dignity as the First Supra National Principle of International Law?, Law at the End of the Day, May 13, 2008. While the meaning of the term is hardly free form doubt, the invocation of human dignity as a fetish against international domestic practices that annoy the important actors in the international community is becoming difficult to resist. So Burma has recently found out. Practice will begin to invest the concept with content or meaning that may eventually lead to its theorization and ultimately to its more precise formulation as international law. Already, there is evidence of a turn in implicit knowledge that suggests the possibility of the construction of institutions, practices and theories of intervention and policing of state activity grounded in human dignity. Burma and its cyclone might point us in that direction. Yet, it remains both fetish and proxy for the attainment of the desires of those who invoke it.

But what of the excavation of human dignity in private law? After all, in a sense, private law is central to the elaboration of a supra-national legal framework and a reflection of the convergence necessary to deepen global economic activity. It was with this in mind that I recently read Jan M. Smits’ excellent essay, Human Dignity and Uniform Law: An Unhappy Relationship, in Essays in Honor of Saúl Litvinoff 749-760 (Olivier Moréteau, Julio Romanach, and Alberto Zuppi, eds., Baton Rouge, LA: LSU Press, 2008). The trigger for the essay is a consideration of Saúl Litvinoff’s call to humanize law in the wake of globalization—if only to control its potential excesses. See SSRN version, id., at 2. That humanization might call for the incorporation of the concept of human dignity into private law, corresponding to the incorporation of the concept in national constitutional orders of public law. The question he poses follows: “to what extent [are] such concepts . . . suited for legal harmonization or, in other words, to what extent is there one universal idea of public policy or human dignity n private law.” Id. He argues that because the concept of human dignity is “inherently vague,” it follows that “the existence of competing notions of what it entails, making use of this concept will not lead to uniform outcomes in similar cases.” Id., at 10. As a consequence, he posits a “distinctive role” for human dignity—something like the canary in the mines—“to invoke it is a warning sign that the very conditions for a meaningful human life come into danger.” Id.

Smits arrives at his conclusion by way of a careful comparative analysis of the application of human dignity as a legal concept in private law. He starts by seeking common ground in the civil law concept of ordre public (id., at 3) and its corresponding notions in common law . (Id.). These notions, Smits correctly notes, have been expanded, and to some extent constitutionalized, in the jurisprudence of both civil and common law states in Europe and the Americas. Id., at 3-5. As he astutely notes, the most interesting aspect of this juridical movement, especially “this constitutionalization is not so much that specific fundamental rights are being invoked in private relationships, but that in defining what public policy means, more and more reference is made to ‘human dignity.’” Id., at 5.

But it is one thing to name a common principle and quite another to fill it with meaning. And harmonization in description and application is the objective. But it is on the rock of application that Smits’ search for a principled basis of harmonization founders. Actually four rocks. Smits looks for the harmonizing effects of application of human dignity in private law in four places: international contract law, the jurisprudence of the European Court of Justice, a representative case form the Human Rights Committee of the United Nations, and in uniform interpretations of the concept at the national level. Id., at 6. He puts his greatest hopes of harmonization at its most efficient plane—international contract law. But search as he might, he finds little taste for the project in either CISG or the Unidroit principles. Id., at 6-7. The reasoning is a biot circular—because there is no consensus at the national level there can be no consensus at the international level within a harmonized system of contract law. Yet there is a glimmer from out of the Principles of European Contract Law. That instrument adopted the traditional formulation of the European Court of Justice—to seek meaning in the fundamental principles recognized in the law of the Member States of the European Union. Id., at 6. Again, Smits notes the circularity and contradiction. Id., at 7. Universalism is the weaker for seeking its expression in some sort of consensus derived form application of principles of national law. I am less convinced that this is not both useful and viable (and has worked to some extent in fashioning some movement toward harmonization in public law), see Larry Catá Backer, "God(s) Over Constitutions: International and Religious Transnational Constitutionalism in the 21st Century," Mississippi Law Review, Vol. 27, 2008, but I take the point.

It is downhill from here if the object is evidence of institutional movement toward harmonization. The second line of inquiry takes Smits to the jurisprudence of the European Court of Justice. Id., at 7-8. Here again harmonization is hard to find. But the failure, I think, is perfectly reasonable given the traditional jurisprudence of that court. Harmonization is not yet possible for the reasons that CISG and Unidroit gave the concepts a wide berth—Europe is ready to embrace the concept but not yet ready to define it. As such, the European Court of Justice reverts to its standard reaction, one that is also common in the European Court of Human Rights. It waits. The euphemistic language, of course, is that of margin of appreciation or margin of discretion. See Larry Catá Backer, Inscribing Judicial Preferences into Our Basic Law: The Political Jurisprudence of European Margins of Appreciation As Constitutional Jurisprudence in the U.S., 7 Tulsa Comparative & International Law Journal 327 (2000). This comes as no surprise, and Smits notes this in his discussion. The Court has been sensitive to the national sensibilities it has read into the derogations for public order and morality written into the black letter of the free movement of goods, workers and the like. Id., at 8. Curiously, Smits does not discuss the usual consequence when there is impatience in a “margin of appreciation” context—a push for mandatory harmonization through rulemaking. But perhaps the absence of will on that score—and power—make this less viable than in other areas ripe for harmonization. Still, this is easily a principle that can be made a European rather than a national issue through legislation. That it hasn’t suggests the lack of will toward harmonization rather than a lack of capacity.

The third line of inquiry was my favorite and the most redolent with contradiction. Human dignity becomes complicated when the dignity of multiple actors may be differently affected. That is the morale of the inquiry into the “dwarf-tossing” case considered by the Human Rights Committee of the United Nations. Id., at 8. Indeed, there is a deep insight here that might be worth excavating in more depth. Public law tends toward a vertical element, especially in the construction of relationships between the state and its citizens. But private law tends to be horizontal. Human dignity, in tat context must mediate among actors whose relationship does not necessarily suggest hierarchy and whose relationships are voluntary (at least to an greater extent than between an individual and the state). In this context, it is less likely that human dignity is easy to apply in the marginal case. An imposition from above, in these cases, as Smits shows, tends to do violence to the horizontal relationship. As Smits notes, “The truth is that, at least among private parties, both these rights are expressions of what we consider to be just societal norms; we value both autonomy and human dignity.” Id., at 8. Smits suggests that the “simple reference to human dignity is not helpful here.” Id., at 9. But, it might be as useful to suggest that the simple reference to human dignity here is revealing of a change in the framework, the referents, within which behavior norms underlying contract performance will be understood.

The last line of inquiry is also disappointing for Smits. Looking at national law, Smits looks at the wrongful birth cases to evidence national incoherence. Id., at 9. The spirit is willing enough, as principle, but the body of the law does not respond. But absent an imposition from above, it is clear that these cases would evidence the sort of incoherence tat also characterizes cultural, political and social understanding of these issues. It is hard to look for legal harmonization in the context of application in which coherence is nowhere to be found outside of law. It is clear that human dignity concepts ought to apply. But the manner of that application is as yet unclear at every level. From this incoherence, Smits finds it impossible to extract law, much less concepts capable of harmonized application. Id., at 10.

He is right, of course. Human dignity is a concept in search of a unifying identity. Yet, it appears everyone is searching—individuals, institutions, courts, and those with authority in moral matters. For the moment that search must content itself with the aggregation of a multiplicity of form and application—even within national systems—like so many pearls of various shapes, sizes and density. Still, from these singularities, a useful ornament might still be fashioned, coherent enough for application. Convergence is possible even in the absence of harmonization. And the essentials are there—a general shift in the knowledge that human dignity somehow infects private as well as public law systems. The stage is set though the manner of its realization remains veiled for the moment. Thus, Smits’ suggestions penetrate connaisance without completely excavating the essence of the savoir he so well describes. What Smits so well reveals is the construction of savoir—a movement from one set of understandings giving rise to theorizes and applications, to another. In the search for a connaissance of human dignity, we have unearthed its foundation in a savoir that, through the actions Smits describes, appears to be slowly building toward a new understanding. That it appears in private law, as well as public law, is a testament to its rising power as a foundational principle, even if it is still deployed merely as legal fetish. Whatever the case, as Smits powerfully suggests, we will be speaking of human dignity in public and private law for a long time to come at all levels of governance.

Saturday, May 24, 2008

Brazil Builds a Sovereign Wealth Fund and Norway Flexes Its Muscles: Private Participation in the Market or Regulation by Other Means

There was a time when states minded their own business. They tended to act through formal lawmaking (regulatory) authorityeither in the form of positive law or through the imposition of customary law through judicial systems designed for that very purpose. When states intervened in economic matters, they tended to focus their attention on domestic economies, and the intervention took the form of regulation or ownership. Whatever the state attempted, there was generally no question that the state was acting in its sovereign capacity (the only capacity it could exercise) and that its acts, regulatory in essence, were the subject of public law. Private law was reserved for non-sovereign (subordinate) entities. Even when their property was subject to seizure, it was understood that actions involved a unique entity not otherwise located within a superior formal legal frameworks.

But all that has been changing. The Americans have long distinguished between the private (participatory) and public (regulatory) actions of the state. American courts have recognized the choice of law implications of this division, treating participatory activity as a subject of private law, and regulatory activity as a matter of public law (to which, for example, the limitations on state power contained in the 14th Amendment of the American federal Constitution apply). For a recent case in which these issues were discussed and refined, see Dept of Revenue of Kentucky v. Davis, No. 06–666, argued November 5, 2007, decided May 19, 2008, slip op. at 7-10. The Europeans appear to be taking the opposite tack. Through a jurisprudence developed from out of theirgolden share” cases, the European Court of Justice appears to be embracing the position that state activity is presumptively public in character, at least when directed at domestic entities, and that such activity might contravene either the prohibitions on interference with the free movement of capital (Art, 56 EC Treaty) or with the regulation of state aid under the Competition provisions of the ECT Treaty (Art. 87 EC). (For a preliminary discussion of the cases and the development of a European conception of state activity in the market form a choice of law perspective, see Larry Catá Backer, "The Private Law of Public Law: Public Authorities as Shareholders, Golden Shares, Sovereign Wealth Funds, and the Public Law Element in Private Choice of Law," Tulane Law Review, Vol. 82, 2008).

Moreover, at the supra-national level, two things have helped changed the legal framework within which an analysis of the legal character fo state activity is taking place. First, globalization has limited the reach of state regulatory activity. Notwithstanding the great efforts of dominant states to project their law outward, and irrespective of what one thinks of this development, the current legal regime is seeing the construction of regulatory systems above and to some extent beyond the state. (Larry Catá Backer, "Economic Globalization and the Rise of Efficient Systems of Global Private Lawmaking: Wal-Mart as Global Legislator," University of Connecticut Law Review, Vol. 39, No. 4, 2007). Second, states have increasingly embraced the notion, sometimes partially and sometimes grudgingly, that there may be a higher law above that of political states. Whether grounded in formal international instruments, or international common law (customary international law or jus cogens), states are getting used to the idea that their sovereign activities are not unlimited--not as a practical matter but as a formal matter. (Larry Catá Backer, "Economic Globalization Ascendant: Four Perspectives on the Emerging Ideology of the State in the New Global Order," University of California, Berkeley La Raza Law Journal, Vol. 17, No. 1, 2006) In this changing legal context, it is more likely that a space can be reserved for the possibility of states to cease acting as a sovereign (especially where they cannot and will not) and to act as something else. The legal response to this possibility has produced a great problem of modern legal regulation with its own complexities.

It is one thing when a state seeks to invest in economic activity within the territory over which it has regulatory authority. In that case one might more forcefully (and effectively make a variant of a “form over substanceargument. Because states always control the legislative environment in which economic entities operate, any purported investment by states in private entities (or even the purported participation of states in the market by appearing to act like a private investor) might well retain a public character. States, in that context, are not in the same position as private investors. The state can always legislate its way around impedimentsothers must satisfy themselves with exit or participation within the entity. Moreover, states do not act under the same economic constraints as private individuals. Private individuals are said to seek to maximize economic value; states might be deemed to seek to maximize political capital. Assuming that those are different things, a state might not, in that context, be capable of participating in the market like a private individual. Consequently, all state activity is both regulatory and public in character. This form of reasoning is in line with the development of European thinking. But its appeal is offset by another compelling reality. First, the assumption that that states are incapable of acting like other economic actors may be misguided. If the point of economic theory is welfare maximization, and if welfare maximization is, to some extent contextual and subjectivethen the facts the some entities (states) value outcomes in a way that may be different from one’s grandmother, may make no real difference. Second, the Americans have rejected the presumptions of thisform over substanceapproach in favor of a more formalist approach with its own presumptions. States are presumed to act in accordance with the form of their actions; they are also deemed to be capable of welfare maximizing behavior compatible with private law. Only where it can be shown that the participation is disguised regulation, will public law apply. Otherwise, state activity in the market, including aberrational activity, is to be guided by private law. Thus, for example, state abuse of its position as shareholder will be judged by the same standards applied to shareholder abuse generally.

But what ought to be the governing law when one state seeks to invest in the economy of another state? This question has become particularly acute since the rise, over the last decade of a number of large funds controlled by states, the purpose of which is to invest in economic entities wherever they may be domesticated. On the surface, this might suggest the best case for the equal treatment of states with private entities. In this case, unlike that in which the state always has the potential to legislate changes to its corporate law, the state stands in the same shoes as a private investor. On the other hand, the state, even as a private investor, has the power to reach deeply into the economic affairs of other states by implementing its legislative program through shareholder activism.

It may be most useful to consider the problem by way of an example from contemporary practice. Consider for the purpose the current role of Norway as an increasingly important private shareholder within the European Union, and worldwide. Norway has twice rejected the opportunity to join the European Union, once in 1972 and the last time in 1994. (See Eur. Comm’n, External Relations, Norway). Norway, however, is heavily integrated with the European Union through its participation in the European Economic Area, the terms of which are governed by the Agreement on the European Economic Area (EEA). (Id.). The EEA has been in force since January 1, 1994 “and extends the Single Market legislation, with the exception of Agriculture and Fisheries, from the EU Member States to Norway, Iceland, and Liechtenstein.” (Id.). The EEA permits Norway to participate in many of the programs of the European Union, but membership in the EEA carries no voting rights in shaping European Union policy. (Id.). Norway thus is burdened with policy over which it has no direct control. “Norway also, along with its EEA/EFTA partners, contributes financially to social and economic cohesion in the EU/EEA. Norway is as integrated in European policy and economy as any non-Member State can be, and the close EU-Norway relations generally run smoothly.” (Id.).
But control can come in a variety of forms in an age in which the state can assert sovereign power using the mechanics of private action. The Norwegian Government Pension Fund (Folketrygdfondet) is the second largest sovereign wealth fund (SWF) in the world, and the largest in Europe. (Pension Funds Online, Top 100 Global Pension Funds). “Folketrygdfondet has been investing in the stock market since 1991, and its role as a financial investor is well entrenched.” (See Folketrygdfondet, Ownership Report 2007). It is currently estimated to be valued at 375 billion U.S. dollars. (Foreign Government Investment in the U.S. Economy and Financial Sector: Hearing Before the H. Subcomm. on Domestic and Int’l Monetary Policy and the Subcomm. on Capital Markets, Insurance, and Government Sponsored Enterprises of the H. Comm. on Fin. Servs., 110th Cong. 2 (Mar. 5, 2008) (Statement of Martin Skancke, Director General, Asset Management Department, Ministry of Finance, Norway).

The namepension fundis something of a misnomer, as Folketrygdfondet is funded from Norway’s considerable petroleum revenues. (Id.). In 2006, the Government Pension Fund—Global was merged with Norway’s National Insurance Scheme to form Folketrygdfondet by an act of the Legislative Assembly. (Id., at 111). The new entity has the long-term goals of management of petroleum revenues and the financing of Norway’s pension scheme, and it has become a model for transparency and ethical management among SWFs. (Norwegian Ministry of Finance, Report No. 24 (2006-07) to the Storting: On the Management of the Government Pension Fund in 2006, 6-7 (2006), [hereinafter Pension Fund Management Report No. 24].) This goal remained unchanged. See Norwegian Ministry of Finance Report No. 16 (2007-08) to the Sorting on the Management of the Government Pension Fund.

Folketrygdfondet is administered by Norges Bank Investment Management (NBIM), a division of the Norwegian Central Bank. (Id.). Norges Bank is also responsible for the publication of quarterly and annual reports on the fund, which are made public. (Id., at 21, Fig. 2.5). These reports include lists of all companies and commodities in which the fund is invested, rates of return, absolute and relative risk, and a strategic plan for the future. (Id., at 107). The Folketrygdfondet board of directors consists of nine members, who are appointed by the King to four-year terms. (Id., at 103). Investment regulations are set by the government. (Id., at 103-104). Up to 50% of the fund’s assets may be invested in shares, primary capital certificates, bonds, commercial paper, and deposits in commercial and savings banks. (Id., at 103). The fund is also subject to regional investment restrictions, with the majority of both fixed income and equity investments confined to Europe. (Id., at 101-102). Additionally, the fund is not permitted to own more than 5% of the equity shares, or exercise voting rights in excess of 5% of total voting rights in a single company. (Id., at 102). In 2008, the Fund reported that "[w]hile there are also plans to increase the limit on ownership stakes from 5 pct to 10 pct, this does not alter the Fund’s role as a financial investor. At the same time, the Minister is emphasizing the ethical obligations of the Fund, says Finance Minister Kristin Halvorsen." Norweigian Ministry of Finance, Prudent and Long Term Asset Management, Press release, published 04.04.2008, No.: 16/2008.

Investments are made by the Folketrygdfondet in accordance with a set of “Fundamental Ownership Guidelines.” (Folketrygdfondet, Ownership Report 2007, at 3). Among them is an obligation toattend to its ownership interests on the basis of a set of qualitative investment criteria within the areas of ethics and corporate governance. Evaluation against such criteria shall form an integral part of the investment methodology of Folketrygdfondet, and of its ongoing asset management effort.” (Id.). The Folketrygdfondet is also required to assume a shareholder activist role:
The financial interests of Folketrygdfondet shall be attended to by way of management monitoring, on an ongoing basis, financial developments on the part of the companies in which Folketrygdfondet is invested, hereunder by attending investor presentations held by the companies and by meeting with management representatives of the companies when deemed desirable. (Id.).

The Norwegian finance minister has publicly acknowledged her intention to incorporate a social agenda into Norway’s investment strategies by, for instance, paying careful attention to companies that emit greenhouse gasses. As she has explained, “[i]n a global economy, ownership of companies is the most important way to have influence.” (Mark Landler, Norway Backs Its Ethics with Its Cash, N.Y. Times, May 4, 2007, at C1.).

The Folketrygdfondet is not subject to the usual rules applicable to private or state pension funds. “Folketrygdfondet is not subject to restrictions in the form of ongoing return or capital adequacy requirements. This means that Folketrygdfondet enjoys a special position as far as asset management is concerned, and is well placed to adopt a long investment horizon.” ((Folketrygdfondet, Ownership Report 2007, at 2). Fund ownership must be geared to fosteringgood corporate governance.” (Id.). The Norwegian fund explains this approach:
The corporate governance principles adopted by Folketrygdfondet are premised on the Norwegian Code of Practise for Corporate Governance and the OECD Principles of Corporate Governance. Good corporate governance shall attend to the rights of the owners and other stakeholders in relation to the companies, and ensure that the management mechanisms of the companies work appropriately. (Id.).
For its 2007 report, the Folketrygdfondet targeted corporate officer remuneration models (Id., at 6-7). It also focused on activities relating to the issuance of shares, noting that “[w]e are of the view that a general authority to issue shares should normally not exceed ten percent of the share capital.” (id., at 5). It sought to take the position that “a general authority to issue shares should normally not exceed ten percent of the share capital.” (Id.). Lastly, it also targeted and on the creation of elections committees on boards of directors. “The role of the Election Committees is to ensure a good process for the appointment of Directors, with the proposed candidates enjoying the support of the main shareholders, and to ensure that the interests of the shareholders as a whole are attended to.” (Id., at 5).

On November 19, 2004, an Ethics Council was established by Royal Decree. (Council on Ethics, Norwegian Government Pension Fund-Global). The Council’s primary function is to evaluate companies in which the fund might invest to determine whether those companies meet certain ethical standards. The fund justifies this focus on ethics in both conventional and behavior modification terms.
The reason why we want ethics to form a key aspect of our company assessments is that we believe that a conscious and responsible attitude to ethical issues will over time contribute to enhanced value creation. This will again contribute to safeguarding our shareholder value, as entrusted to companies. Folketrygdfondet has therefore defined a set of investment principles for ethical investment assessments, and these are incorporated into our investment methodology and ongoing asset management efforts.

(Folketrygdfondet, Ownership Report 2007, at 8). The Council makes recommendations to the Ministry of Finance, which then has the power to exclude companies from the fund’s portfolio. (Ethical Guidelines, Norwegian Government Pension Fund—Global § 4.1, ). Subsequently, the Council is obligated to periodically evaluate excluded companies in the event that a company has ceased to engage in actions which are contrary to the ethical guidelines. (Id. § 4.6). In December 2005, the Council released ethical guidelines by which companies are to be evaluated. (Id. § 1). The guidelines state two principal aims. First, because the fund is concerned with long-term stability and solvency, it should seek to invest in companies who promote sustainability in theeconomic, environmental and social sense.” (Id.). Second, the fund should abstain from investments that might contribute to violations of “fundamental humanitarian principles, serious violations of human rights, gross corruption or severe environmental damages.” (Id.).

The Council has recommended the exclusion of companies who manufacture or aid in the manufacture of nuclear weapons or cluster munitions. (Pension Fund Management Report No. 24, supra, at 75-77). Such companies include Northrop Grumman Corp., Lockheed Martin, and GenCorp, Inc. (Id. at 77 tbl. 4.1). The Council has also excluded Freeport McMoRan Copper & Gold, Inc., and DRD Gold Limited for environmental abuses, as well as Wal-Mart Stores, Inc., for labor rights violations. (Id. at tbl. 4.2). The Council has even shown its willingness to exclude companies that deal with governments which have poor human rights records, as evinced in its exclusion of Total SA, for doing business with the ruling military junta in Burma. (Ministry of Fin., Recommendation of 14 November 2005 (Unofficial English translation)).

Some of these decisions have had political consequences, especially from the Americans. When the Folketrygdfondet put Wal-Mart on its “no-investlist of companies because of its alleged difficulties in keeping its supply chain relationships within ethical bounds, the Americans reacted. “The ministry said the council had foundan extensive body of material’ that indicated Wal-Mart had broken norms, including employing minors against international rules, allowing hazardous working conditions at many of its suppliers and blocking workersefforts to form unions.” (John Acher, Norway Dumps Wal-Mart from $240 Billion Investment Fund, USA, June 6, 2006). In response, American officials publicly criticized the Norwegians both for their conclusions and for their actions, which for the Americans had a flavor of indirect regulation. “[T]he American ambassador to Norway, Benson K. Whitney, . . . “accused the government of a sloppy screening process that unfairly singled out American companies. ‘An accusation of bad ethics is not an abstract thing,’ Mr. Whitney said. ‘Theyre alleging serious misconduct. It is essentially a national judgment of the ethics of these companies.’” (Mark Landler, Norway Backs Its Ethics with Its Cash, N.Y. Times, May 4, 2007, at C1.).

Were the Folketrygdfondet merely a private actor, there is little question that it would pose no particular problem in private law regimes. It would be clear that the rules applicable to all private investors would apply (as would whatever rules generally govern investment funds of the type created). The fund purchases stock on the market, does not take a majority position, has negotiated no special regulatory regime within the host states, and seeks ultimately to maximize the value of its investments in a way that is precisely articulated and approved by its holders.

But the result might be different under the emerging European jurisprudence. First, it is not clear that the investments are made like ordinary investments. The Norwegian legislature has conferred special rights on the fund to act more flexibly than equivalent private funds. Moreover, a significant objective of the investment might be deemed regulatory—the Folketrygdfondet means to be an active shareholder, both in its purchase decisions, and its relationship with entities in which it has taken a position. To the extent that such entities also have operations in Norway, the result would be little different than if the state had invested in a domestic entity; Norway has a privileged position with respect to its private investment.

On that basis its very investment is public rather than private in character and could impede the free movement of capital. That is to say, because of the regulatory effect, the fund would be treated as a state actor operating in its sovereign capacity (though indirectly so) rather than in a private capacity. By its own admission, the fund is seeking not merely to maximize its financial position, but also to advance a specific regulatory program. While that program is not specifically Norwegian, that does not change the regulatory—though indirectly regulatory—character of the investment project. From this perspective, Norway appears to be engaging in a bit of extra-territorial regulation through its control of key economic actors.

Yet, this would bean odd result if one examined the question from an institutional perspective. Norway is seeking to do little more than any other private investor could do. Its activism is limited by the regulatory framework within which it operates. It, like a publicly traded corporation with a large shareholding base, must be sensitive to those actions which its “shareholders” deem to be welfare maximizing. Ignoring these sentiments is not only anti-democratic from a corporate governance perspective (as well as from a public law perspective, of course), but might result in a reduction of the value of the concern. It has not sought to change the rules of corporate governance—clearly a sovereign activity. Rather it means to use them the way any other investor with a large stake might. That its motivations spring from the public policy of Norway should not distinguish it from, say a corporation whose investment strategy is grounded in a founder’s deeply held religious beliefs. (See, e.g., Cynthia L. Cooper, Religious Right Discovers Investment Activism, CorpWatch, Aug. 3, 2005, (discussing the growing popularity of Christian investment funds)). In either case, as long as the ultimate goal is stakeholder wealth maximization—however plausibly defined—then that should be the end of the story. The difference can only be supported by a presumption that states are different, and that the fiction of private action by public entities is just that.

It is in this context that Brazil adds another wrinkle. “Brazil will create a sovereign wealth fund with the primary aim of intervening in foreign exchange markets to counter the appreciation of Brazil's currency, according to finance minister, Guido Mantega.” (Jonathan Wheatley, Brazil Plans Sovereign Welfare Fund to Counter Rising Currency, Financial Times, Dec. 9, 2007). According to another report, the fund would start fairly modestly. ““A sovereign wealth fund to be established by Brazil’s government will begin with at least $10 billion in assets and will likely invest in securities issued by the BNDES Brazilian National Development Bank, among others, Brazilian Finance Minister Guido Mantega said Thursday.”” Brazil Min: Sovereign Fund To Start At $10B, Invest In BNDES, Dow Jones Newswire, Nov. 22, 2007 .

This takes the Norwegian fund practice one step farther from traditional investment objectives of privately held funds. “His statement adds to controversy surrounding the fund, first announced by Mr Mantega in October. Since then, funding plans and objectives have undergone several revisions. The uncertainty has caused concern among investors and officials at the country’s central bank. The SWF appears to differ substantially from funds operated by other countries.” (Id.). As the media has reported, “About two-thirds of sovereign funds are capitalized with cash from exports of oil or gas. The Abu Dhabi Investment Council, for example, is the largest sovereign wealth fund, with $875 billion of assets, according to the Sovereign Wealth Fund Institute. Other funds, like the $60 billion Australian Government Future Fund, are financed from budget surpluses.” (Isabel Versiani, In plan for sovereign wealth fund, Brazil charts a different course, The International Herald Tribune, May 14, 2008). Still, from a slightly different perspective, it might be argued that what separates Brazil from Norway is the sophistication of description of programs. I have suggested that Norway's investment might also be deemed to be public in some respect--it has chosen to express public policy goals through an aggressive program of investment that is expressed in the traditional language of finance, risk management, diversification, wealth production and the like. Even the choices of investment vehicle, so well grounded in policy, and limiting, are expressed in value maximizing terms. Brazil has not yet learned the use of the language of investment as an overlay of its investment strategies. Clearly, that is possible.

But Brazil has made no pretense of private objective—the purpose of the Brazilian effort is to maximize the welfare of Brazil by using its investment to build its wealth by preventing a rise in the value of its currency. “On Friday, Mantega revealed a few details on the source of the cash, saying it would come from the federal government's primary budget surplus of more than 4 percent of gross domestic product. He did not say how much of the surplus would be earmarked. The fund also will be fed by dollars purchased by the government to keep the dollar from falling even more, Mantega said.” Brazil Puts Final Touches On Bill Creating Sovereign Wealth Fund, The International Herald Tribune, May 24, 2008.

But. . . isn’t that sort of thought and action precisely we would expect from any private investor—to invest and vote their shares in a way that maximizes their personal (rather than the value of the target corporate) wealth. Why should the state be forbidden what a non-sovereign private participant is encouraged to do? The answer is, because Brazil is a state. But Microsoft is not a person born of a woman. Yet there is little difficulty treating as equivalent the investment behavior of natural and juridical individuals. If the state is different, it is because it can regulate. The large multinational enterprise, or the private wealth fund, can only threaten to withdraw an investment. States can regulate and affect the fortunes of its investment. Yet, that is not what Brazil intends. It merely tends to act privately to protect its public interest. Is that private in character or public. Or both?

And, indeed, the market has begun to react to Brazil’s strategy in the same way that it would value the worth of a large multinational corporation or publicly traded investment fund. This is no surprise. While people worry about the nature of private activity by sovereigns, the global economy has already decided—states acting in a non sovereign capacity (borrowing money, engaging in common transactions) will be treated like other private entities—although with a few quirks. See, Larry Catá Backer, "Ideologies of Globalization and Sovereign Debt: Cuba and the IMF, 24 Penn State International Law Review (2006).

In this case, the reactions have not been positive. Morgan Stanley recently downgraded Brazil from equal weight to underweight. Jonathan Garner, GEMS Equity Strategy, Country Model Update: Going Underweight Brazil, Morgan Stanley Global Strategy Bulletin, December 18, 2007 (reducing ranking from 12 to 17). The rationale is ironic: “In our view the “virtuous circle” of exchange rate appreciation, commodity price strength, sovereign risk premium reduction, and equity valuation convergence has now run its course in Brazil. Forward P/E has essentially reached parity with the rest of EM and is also now well above the 5-year historically observed fit level to the sovereign spread. In absolute terms it has only been higher 10% of the time in the last 10 years.” (Id.). Others have reported that “analysts say this plan could jeopardize Brazil's fiscal position because it would have to buy BNDES bonds in U.S. dollars to finance business abroad. The government might also have to subsidize the loans to make them attractive to businesses. As if that were not enough, the focus on national companies is atypical of sovereign wealth funds, which tend to diversify investments internationally to minimize risk.” (Isabel Versiani, In plan for sovereign wealth fund, Brazil charts a different course, The International Herald Tribune, May 14, 2008).

And, indeed, the media has not taken the fund seriously either—principally because it is coming from Brazil. It has been characterized as “a symbol of Brazil's emergence as a leading investment-grade economic power than a significant investor or earner of income.” (Isabel Versiani, In plan for sovereign wealth fund, Brazil charts a different course, The International Herald Tribune, May 14, 2008). And it has been dismissed as a gimmick. “Sovereign wealth funds have become popular with governments as emerging-market countries, in particular, seek to manage their newfound wealth as the world economy grapples with a credit crisis.” Id.
But the fear remains, a fear that haunts the development of European jurisprudence presuming states incapable of non-sovereign activity. And there is a point to this. Having gone to the trouble of getting the state—as a sovereign entity—out of markets, and then globalizing markets and economic activity, it seems odd to now permit states back into the market through the back door. If states still act as states, this might provide the states with a new method of regulation—incentive based, wealth based, and as coercive as direct positive legislation. Norway’s impulse to do good, multiplied, could substantially distort (that is redirect) the markets. And states might be tempted to use the markets for other goals—and thus threaten the integrity of the very thing that makes their private participation possible. But fears need not result in prohibition. It might instead require a new regulatory regime—a private public law. (Backer 2008, supra). Only time will tell, but the legal and economic ramifications will be profound in all legal orders.