Professor Bainbridge...on law, politics, religion, culture & food

Meinhard v Salmon

In a comment to a post over at CO, Jeff Lipshaw writes:

I’ve always thought Judge Andrews dissent in Meinhard v. Salmon was far more sensible (and in accord with common understandings) than Cardozo’s overwrought opinion.

He’s got a point. On the narrow legal issue of the duties of one joint venturer to another as the joint venture comes to an end, Andrews probably had the better analysis. Yet, as both a precedent for general partnerships and a teaching tool, Cardozo’s opinion is wonderful.

First, as background, you really need to read Geoffrey Miller’s wonderful essay on the case, which “offers a legal history of the northwest corner of 42nd Street and Fifth Avenue, the plot of land that, among other things, was the source of dispute in Meinhard v. Salmon, one of the leading business law cases in American history. Using the Meinhard case as a lens, the paper explores New York’s changing ethnic, social, and economic environment - the rise and fall of industries, the booms and busts of business conditions, the dispersal and commercialization of landed estates, the influence of immigrants, the role of yachting, horse racing, art collecting and charitable work in establishing social standing, and the importance of family and heritage in the development of New York City during the late Nineteenth and early Twentieth Centuries.” It’s a wonderful work of legal history and a brilliant exegesis of the case.

In my book, Agency, Partnership & Liabilitiy Companies, I wrote that:

If partners can withhold new information—such as the discovery of a new business opportunity—from each other, then each has an incentive to drive the other out so as to take full advantage of the information. As each incurs costs to exclude the other, or to take precautions against being excluded, the value of the firm declines. Accordingly, a legal rule vesting the firm with a property right to the information and requiring disclosure is more efficient than forcing the partners to draft disclosure agreements and monitor one another’s behavior. Note that this rule does not discourage the production of new information; the partners still have incentives to produce information because they share in its value to the firm. As no one will withhold information, however, the firm’s productivity is maximized.  As a result, we can confidently predict that the partners would agree ex ante to bar any one partner from taking an organizational opportunity for his personal gain.

While some such prohibition thus emerges from our hypothetical bargain as a majoritarian default, the form such a prohibition ought to take is less obvious. Does it matter if one partner is actively managing the business (as was Salmon) while the other is passive (as was Meinhard)? Should all outside business ventures be proscribed or only some? If the latter, how do we decide which are proscribed? Should we adopt a bright line rule or a flexible standard? What should be the remedy?

In a justly famous passage, Judge Cardozo adopted a wonderfully vague standard to govern these problems:

Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the “disintegrating erosion” of particular exceptions. Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. It will not consciously be lowered by any judgment of this court.

In applying this standard, Cardozo focused closely on the specific circumstances of the case. As such, he converted the vague default rule into one specifically tailored for the parties at bar. Hence, for example, Cardozo emphasized that Salmon was “in control with exclusive powers of direction....” Salmon “was much more than a coadventurer. He was a managing coadventurer.” Cardozo further acknowledged that:

A different question would be here if there were lacking any nexus of relation between the business conducted by the manager and the opportunity brought to him as an incident of management.... For this problem, as for most, there are distinctions of degree. If Salmon had received from Gerry a proposition to lease a building at a location far removed, he might have held for himself the privilege thus acquired, or so we shall assume. Here the subject matter of the new lease was an extension and enlargement of the subject matter of the old one. A managing coadventurer appropriating the benefit of such a lease without warning to his partner might fairly expect to be reproached with conduct that was underhand, or lacking, to say the least, in reasonable candor, if the partner were to surprise him in the act of signing the new instrument. Conduct subject to that reproach does not receive from equity a healing benediction.

One of the difficult questions about this case is how seriously we ought to take Cardozo’s high-flying language. Much of the opinion is devoted to lofty statements of a partner’s duties. One in particular springs to mind: “the thought of self was to be renounced.” What does that mean? Taken literally, this suggests that Salmon had a duty to let Meinhard share in the new opportunity. Indeed, this notion of renouncing self easily can be taken to rather silly extremes. Note the problem: Each of the partners must renounce thought of self. So Salmon says to Meinhard, “You first,” and Meinhard replies, “No, no, after you,” and so forth.

Cardozo’s rhetoric had two useful functions. First, the moralistic tone seems intended to invoke shame as a social sanction. Second, when the law is set out as a bright-line rule, people know exactly what they can get away with. This inevitably tempts them to go right up to the line. The strong judicial rhetoric found in these opinions serves to obscure the actual parameters of the law, depriving market actors of the guidance that a bright line rule would offer. By fudging the line, and by imposing severe consequences on those who skate across it, courts have sought to deter cheating. Having said all that, however, it remain true that Cardozo’s deliberate ambiguities strongly suggest the need for ex ante planning and resolution through contract.

Assuming we have a partnership opportunity at hand, what should Salmon have done? Despite Cardozo’s rhetorical flourishes, the emphasis seems to be on the duty to give notice. He emphasized, for example, that “only through disclosure could opportunity be equalized.” On the other hand, even here he is quite vague. Cardozo is careful not to foreclose an obligation to do more than simply provide notice: “we need not say” whether liability would still ensure if Salmon had given notice and, moreover, Salmon had a duty, “if nothing more,” to disclose the opportunity.

The idea that a partner could abscond with a new business opportunity simply by making disclosure seems inconsistent with notions of trust that are essential to a partnership. It would lead to lots of wasteful precautions. Requiring something more than disclosure—i.e., consent—is consistent with the closely related corporate opportunity doctrine. Under the prevailing view, mere disclosure of a corporate opportunity is not enough. Consent by the board of directors is required. The comments to UPA (1997) § 404(b) indicate that that statute requires consent by the other partners to the taking of a partnership opportunity rather than mere disclosure by the taking partner.

There’s a ton of great teaching questions in that passage: Might there be a method to Cardozo’s rhetorical madness? What would the majoritarian default be in these cases? Then tweak the nature of the case. Should disclosure be enough? What is the appropriate remedy?

So I love teaching Cardozo’s opinion. It’s one of the best teaching tools in my case book.