Covid and the Corporate Family

My article, Corporate Family Matters, proposes a definition of and governance regime for a particular type of corporate group – the family.  I define the family as an enterprise formed by weaving corporations, partnerships, and LLCs together into a mix of public and private entities acting for the benefit of a parent corporation or for the personal gain of one or more leaders of the enterprise.  A corporation should be treated like a family when: (1) there is more than one entity with shared ownership or management or when an entity is wholly-owned by another entity and (2) that entity operates for the promotion of the parent’s business purposes or the manager or owner’s business interests.  When businesses meet the standard for corporate family treatment, they are required to acknowledge influence and look to the real-party-in-interest when determining what is material, should be reported to shareholders, and constitutes a conflict of interest.  I believe that by acknowledging influence and treating the applicable corporations as a family, the market can gain a clearer and more accurate picture of business operations, enabling investors and consumers to make better choices.  Further, the corporate family enables statutes and regulations to achieve their intended goals.

Many corporate activities that shock the senses are not illegal but merely unseemly.  They challenge our beliefs of fundamental fairness and in some cases our definition of justice.  The legislative response to the economic catastrophe caused by Covid-19, the CARES Act and Paycheck Protection Program (PPP), illustrates how legal structure facilitates these corporate actions.  The programs were intended to aid “small businesses,” but because of the definition of that term in the legislation several national chains, publicly traded companies, and other seemingly undeserving ventures were able to take advantage of the programs – even receiving more than the intended beneficiaries.  Meanwhile, the mom-and-pop businesses that are the backbone of the American economy faced significant obstacles to obtaining the relief.

The policies and procedures lenders used to distribute the relief are partially responsible for the misapplication, but the definition of company found in the bill is also to blame.  The language of the bill, which provides aid for companies with no more than 500 employees at one location, enabled the publicly traded companies to take advantage, as many are organized as a web of subsidiaries, franchises, and affiliates, flying the name of the publicly traded entity but legally recognized as small individual businesses. No single location of Ruth’s Chris employs more than 500 people – even though the 15 locations are part of a publicly traded corporation with  favorable banking relationships, substantial goodwill, and other advantages unavailable to the kind of small businesses envisioned by the legislation.

Notably, if we viewed the likes of Ruth’s Chris and Shake Shack as a single corporate family, they would fall well beyond the parameters of the CARES Act.  The structure of these businesses is not illegal or unethical; they follow the norms of most chain restaurants and of many multinational corporations. Nevertheless, when someone in the general public dines in these restaurants, they do not believe they are patronizing a stand-alone independent business.  Patrons and investors have an expectation of brand uniformity and consistency that reflects the reputation and goodwill of the enterprise collectively.  These restaurant chains hold themselves out as one family, their consumers and investors engage with them as a single enterprise, so the law should treat them that way.

The failure of the PPP to reach only its intended beneficiaries illustrates one of the unanticipated collateral benefits of my proposal, which aligns the way corporate families are defined with the way they do business.  Once a corporate family classification is made on a state level, Congress’ use of language that has a plain meaning – a single business with 500 employees or fewer — could be given its intended effect, particularly by bankers, regulators, and others well-versed in corporate structure who would be familiar with the new proposed state law distinctions.

We should look to how companies choose to define themselves when we determine their personhood rights, and we should also give deference to how interrelated companies define their relationships when determining whether they should be regarded as a series of single stand-alone entities, a group, or as one corporate family operating for the good of the parent.  Groups and families are intended, by their founders, to operate together in the interest of a parent corporation or dominant individual with influence.  The entities agree to aggregate, so consideration should be given to the enterprise in the aggregate when appropriate.  If groups and families are treated as hybrid entities, then they can also maintain their separate real entity identities as they operate day-to-day in the world but be considered aggregate enterprises when it is required.  Doing so in the face of the pandemic would have enabled Congress to address only the entities they intended – rather than rely on private investigation and public shaming to prevent corporations from taking advantage.

The definition of family found in my paper is intended to have the greatest impact on management decisions that are discretionary but affected by choices made deliberately when structuring entities. Corporations take actions in a system that allows them to manipulate structures, as Sarbanes-Oxley, the Dodd-Frank Act, and other laws and regulations following corporate scandals leave in place a culture that continues to focus on quarterly and annual reports that show constant growth while ignoring the culture that the demand for such growth creates.  To prevent large corporations from engaging in market manipulation, or even taking advantage of programs intended for smaller businesses, requires states to address structural complexity.  The corporate family is one structural change that advances that goal.

This post comes to us from Professor Carliss Chatman at Washington and Lee University School of Law. It is based on her recent paper, “Corporate Family Matters,” available here.