Assistant Professor Daniel Hemel on the “duty” of CEOs to minimize corporate taxes:
CNBC’s Jim Cramer came to the defense of Apple CEO Tim Cook yesterday, arguing that Apple’s CEO has a duty to minimize the company’s corporate tax liabilities. Cramer said on CNBC’s “Squawk on the Street”:
“One of the things I did take seriously when I was in law school was taxes. The main thing you learn is that tax avoidance is everybody’s . . . duty. You’re supposed to try to avoid.”
Cramer graduated from Harvard Law School in 1984, and it’s perhaps unfair to hold him at fault for misremembering what he learned in a tax course more than 30 years ago. But Cramer seems to be confusing “right” and “duty” here. Justice Sutherland famously said in Gregory v. Helvering that “[t]he legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.” 293 U.S. 465, 469 (1935). The claim that directors and officers have a “duty” to minimize a corporation’s taxes, though, can indeed be doubted. In fact, the Delaware Chancery Court recently rejected such a claim.
The question whether corporate directors and officers have a duty to minimize taxes arose in a 2012 case, Freedman v. Adams. That case concerned an executive compensation plan approved by the board of XTO Energy, Inc., a publicly traded company. Section 162(m) of the Internal Revenue Code generally prevents a publicly traded corporation from claiming a tax deduction for compensation to a CEO or other top executive in excess of $1 million a year. Section 162(m) allows a deduction, however, for payments made pursuant to a shareholder-approved plan and tied to “the attainment of one or more performance goals” (known as a “§ 162(m) plan”).
The plaintiff in Freedman argued that the XTO board “had a duty to adopt a § 162(m) plan” so that payments to top executives in excess of $1 million would be tax-deductible. The Delaware Chancery Court disagreed. As Vice Chancellor John Noble wrote:
The Plaintiff does not cite any case law of this Court or the Delaware Supreme Court directly supporting the purported fiduciary duty to minimize taxes. . . . For reasons that are both numerous and obvious, this Court is not convinced that it should endorse this proposed new duty. Tax strategy is a complex, dynamic area of corporate decision-making that affects and is affected by many other aspects of a company. . . . Minimizing taxes can also require large expenditures for legal and accounting services and may entail some level of legal risk. As such, decisions regarding a company’s tax policy are not well-suited to after-the-fact review by courts and typify an area of corporate decision-making best left to management's business judgment, so long as it is exercised in an appropriate fashion. This Court rejects the notion that there is a broadly applicable fiduciary duty to minimize taxes . . . .
Freedman v. Adams, 2012 Del. Ch. LEXIS 74, at *45-46 (Del. Ch. Mar. 30, 2012), aff’d on other grounds, 58 A.3d 414 (Del. 2013). (The Chancery Court reached a similar result three months later in Seinfeld v. Slager, 2012 Del. Ch. LEXIS 139 (Del. Ch. June 29, 2012), in which Vice Chancellor Sam Glasscock hewed closely to the reasoning in Freedman. For more on Seinfeld, see Stephen Bainbridge’s blog.)
Freedman might seem inconsistent with Cramer’s claim. But before dismissing Cramer’s assertion entirely, a few qualifications are in order:
First, Freedman is a Delaware case, and Apple is a California corporation. I am not aware of any California case directly addressing the duties of directors and officers to minimize corporate taxes. California courts often look to Delaware corporate law for guidance, though, so Freedman is at least suggestive as to how a California court would rule. See, e.g., Potter v. Hughes, 546 F.3d 1051, 1057 (9th Cir. 2008).
Second, Freedman is a decision of the Delaware Chancery Court, which is subordinate to the Delaware Supreme Court. The Delaware Supreme Court has yet to address this issue, and it would be free to go the other way. (The fact that Freedman is unpublished, however, doesn’t deprive it of precedential force, as “unpublished decisions have precedential value” in Delaware. See Case Financial, Inc. v. Alden, 2009 Del. Ch. LEXIS 153, *21 n.39 (Del. Ch. Aug. 21, 2009).)
Third, the Chancery Court in Freedman acknowledged that “under certain circumstances overpayment of taxes or a poor tax strategy might . . . result from breaches of the fiduciary duties of care or loyalty or constitute waste.” Freedman, 2012 Del. Ch. LEXIS 74, at *45 n.14. The court mentioned the case of Dodge v. Woolsey, 59 U.S. 331 (1855), in which the plaintiff argued that an Ohio bank had violated its charter by paying an unconstitutional tax. Perhaps Apple’s CEO would have a legal duty to minimize taxes if the corporation’s governing documents imposed such a duty. (This is all hypothetical, though, as no such provision appears in Apple’s charter or bylaws.)
Finally, the analysis above has all been about what the law is, not what the law should be. As a normative matter, the rule in Freedman strikes me as the right one. A fiduciary duty to minimize taxes would force directors and officers to navigate between the Scylla of tax law and the Charybdis of D&O liability: a tax strategy that’s too aggressive might trigger penalties, while a tax strategy that’s not aggressive enough might give rise to shareholder lawsuits. If shareholders think that courts are competent to engage in after-the-fact review of managers’ tax-related decisions, they can seek to insert provisions in corporate charters imposing a duty to minimize taxes on managers. Perhaps some courts would say such provisions are unenforceable on grounds of public policy. More likely, shareholders will decide that it’s not in their best interest to try.