Biz Orgs Outline Fall 2011 (Forst) (1)

7/30/2019 Biz Orgs Outline Fall 2011 (Forst) (1)

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BUSINESS ORGANIZATIONS

OUTLINE

TYPES OF BUSINESS STRUCTURES

What you want to know in counseling client on how business should be organizedPurpose of business (product/service, profit/nonprofit)

How big; how long it will take to make a profit; when will you make thatprofit

If there will be lossesDistribution of profit/dividends (or keep money it earns in the business)If short-term business proposition or long-term (if children will inherit, likelyownership will change)*If liabilities, who will bear them

Product, Employee/Vicarious

DebtCreditors

Investorpassive or active, how many , how business will be financedInsuring risksHow many people will be involved (owners and employees)Location of business*Taxes (subject to tax, which bracket)*Who manages/*Who owns*Transferability

Easy to leave business or notClients objectives can help determine which organization to pick, what stage business is

in (could develop as general partnership and evolve into corporation)Ownership Management Liability Taxes Transferability

Sole Proprietorship One Owner Personal Personal No form as legaentity; assets cansold but no businto sell

General Partnership Two or More Partners 50-50 or eachis 100% liable(joint andseveral)

Pass-through (onpersonal taxreturns)

Partnership intercan be sold

Corporation (C

Corp.)

Shareholders Owners or

Employees(centralizedmgmt.)

Only on the

corporation,limited(ownerslimited to amtof capitalcontributed)

Double taxation

(business filesand distributesmoney to ownerswho paypersonal taxes)

Relatively easy t

sell all or part ofcorp.

Corporation (SCorp.)

Shareholdersmust be natural

Owners orEmployees

Limited Pass-Through Relatively Easy


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persons and UScitizens (max of100)

Limited Partnership One or moregeneral, one or

more limited

Generalpartner is

active, limitedis passive(investor)

GPPersonalLP- Limited

Pass-Through Difficult

Limited LiabilityCompany

May have 1 ormore

By Employeesor Owners

Limited Pass-Through Difficult

FINANCIAL STATEMENTS

I. Purpose of a Financial Statementgauge of judging how healthy a businessis/measuring device (owners can determine how they are doing)

Summarizes 3 aspects

Measure of own profitsConvince others to invest (Show 3rd parties)Can take variety of forms

3 partsBalance sheet, Profit and Loss/Operating Statement, CashFlow

II. Balance SheetTo show assets and liabilities of businessNet worth is classified as equity

III. Statement of Income/OperationsRevenuegive results as profit or lossRecord of that years operations

IV. Cash FlowWhere is money coming from and where is it goingWhether there is enough cash to keep the business going

Financial statements tell us where company has been, not where its going(picture of financial position at a point in time)

Financial statements do not look forward (new customers, technology,event that will propel corporation to be more successful)

Financial statements do not predict the futureIntellectual property is not on the balance sheet

Still have cash = still in business (cash flow)

SOLE PROPRIETORSHIPS

Owned, operated and managed by one personNo formalities in forming sole proprietorship

AGENCY


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Someone with authority to act for someone elseagentGorton v. Dotycoach driving parents car gets into accident

Plaintiff argued Doty was the principal, coach was agent, assigned to drive her carIn principal/agent relationship, principal asks person to act for and on theirbehalf, that person become agent

Opportunity under law to make someone responsible for conductof anotherStrategic decision to hold principal liablemake himresponsible

Case predates Law of AgencyNow in Restatement

Actual, consensual relationshipPrincipal appoints agentAgent accepts appointmentPrincipal controls agents conduct (agent acts withinauthority and under control of principal)

Fiduciary Duty (seen in partnerships and corporate law)

PRINCIPALS AND AGENTS

I. Fiduciary RelationshipAttorney-ClientAgent gives undivided loyalty to best interest of principalConfidentiality, Agent has duty to keep confidences privateAccountability, agent must account to principalDiligence, agent must exercise reasonable diligence in carrying outbusiness of principal

II. Scope of EmploymentArguello v. Conocoracist gas station attendant

Company-owned vs. branded stationsDefendant argued independent contractorcannot control day-to-day activitiesMust control means, manner and method

III. Agency TypesActual/Expressagents with actual authority

Client hires a lawyer, told lawyer to do his taxes (express)Implied/Inherentprincipal does not authorize agent to act

Authority is implicit in actual authority given

Explicit to do taxesimplied to contact IRSMill Street v. Hoganpaint church

Hired brother, ladder broke and brother was injuredDid Bill, as agent, have authority to hire someone else?

Actual authority circumstantially proven which theprincipal actually intended the agent to possess andincludes such powers as are practically necessary tocarry out the duties actually delegated


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Apparent Authoritycreated by manifestations of principal to 3rd partyManifestation must be attributable to principal, must lead 3rd partyto reasonably conclude that someone is an agent for the principal

Communication must come from principalHayes v. National Service Industrieswrongful discharge

Plaintiff argues she did not give authority for her attorney to settleDecided on apparent authority, believed he had actual authorityGeorgia lawlawyers have apparent authorityBut lawyer told third party, not client (principal)

Better argument for implied authorityattorney could negotiatesettlement

LIABILITY

EMPR/EMPEE AGENTS ICCONTROL yes no

TORTS yes no

CONTRACTS yes/no (scope of emp.) yes/no (depends on auth.)

Independent Contractor has control over means, manner and method of their workAgents

Can create obligations and liabilities for principalsCan bind 3rd parties to principalPrincipal appoints agent who accepts and carries out direction (express)How apparent authority is created

Only established by purported principal makingmanifestation/communication to a 3rd party that the business/person is thatprincipals agent

Agent claims to be an agentdoes so at their own liabilityWhere party attempts to disclaim agency, if principal has accepted the benefits of thebargain, they cannot disclaim agency

PARTNERS AND PARTNERSHIPS

I. In Re: Estate of FenimoreReceipt of part of profits is prima facie evidence that person is a partner

(partners collect after creditors)RUPA gap-fillers apply when agreement is unclear

She would be obligated as a partner for debts of the businessCould avoid this by explicitly stating it was a loan, terms of agreement,promissory note

II. RUPAlaw in most states, including AZSection 202Formation of a Partnership


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Association of two or more persons to carry on a business, whetherthey intended to be partners or not

Section 103Effect of Partnership Agreement; Non-waivable ProvisionsRelations among partners and between partners and the partnershipare governed by partnership agreement. To the extent partnership

agreement does not otherwise provide, Act governs relationsamong the partners and between the partners and the partnership.Relations of partners to each other and third parties iscontrolled by the partnership agreementRUPA only applies when there is a deficiency in theagreement or if no partnership agreement

Why do lawyers encourage agreements if there is a statute?RUPA gives law about general partnership, could be verydifferent legal results than intended partnershipsRUPA assumes its two or more people, small businesses,partners actively engaged in day-to-day business and share

in management and profits and losses of the businessSection 306Partners LiabilityAll partners are liable jointly and severally for all obligations ofthe partnership

Section 301Partner Agent of PartnershipEach partner is an agent of the partnership

Have actual, inherent and apparent authorityIII. General Partnership

Ownership or Two or MoreManagement equally by partnersTaxation pass-throughLiabilityjoint and severalTransferabilitydifficulta. More likely in a general partnership and did not know it (inadvertent

Fenimore)b. National Biscuit Company v. StroudGP between Stroud and Freeman,

dispute regarding sales of breadStroudclaimed no personal responsibility for bread sold by P to grocerystoreFreeman kept creating liability by ordering bread

With respect to 3rd

parties, partners stand equal as agents ofpartnership3

rdparty can argue apparent authority if agreement said partner

could not enter into contracts with 3rd partiesPartnership Agreementenforceable between 2 parties butas to rest of world, cannot change partnership law (jointand several liability)

Look first at partnership agreement to determine roles; otherwise, equalRUPA401f


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Each partner has equal rights in the management and conduct ofthe partnership business

401jA difference arising as to a matter in the ordinary course ofbusiness of a partnership may be decided by a majority of the partners; anact outside the ordinary course of business of a partnership and an

amendment3 partnersshould be based on ownership percentage ofpartnership but absent partnership agreementRUPA

401b Each partner is entitled to an equal share of thepartnership profits and is chargeable with a share of thepartnership losses in proportion to the partners share of theprofits

IV. Law of Partnershipa. Pertinent Sections of RUPA

103Agreementin absence of partnership agreement, this isdefault

202Formation301Relative to 3rd

Parties401Relative to Each Other

BProfitsFManagementCIndemnityINew PartnersJDecisions

502, 503Transfer of Instrument305, 306, 307Liabilities601, 602, 603Exit

b. ProblemRUPA assumes small, dispute=vote, partners dividing profitsand losses equally (set of assumptions)

V. Meinhard v. Salmonplanning to refurbish apartment building, Salmonleased from Gerry, Meinhard provided money to Salmon for renovationsHad partnership with partnership agreementGerry and Salmon entered into agreement without Meinhard

Concept of fiduciary duty; duty of highest loyaltyBusiness trumped by fiduciary duties

Fiduciary will not put interest over interest of partnerNo duty if completely separate to the ventureTipping point?If deal is brought to partner, in what capacity is 3

rdparty

approaching that partner?Salmon came into it as role of agent with respect to partnership

VI. Liabilitiesa. RUPA sections 305, 306, 307

RUPA 305A partnership is liable for obligations of partner306joint and several liability306badmitted as partner, not personally liable for claims incurred by thepartnership prior to admission


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401(c)as between partners, if one partner creates liability for partnershipnot authorized to create, must indemnify partnership and partner

Problempartner is still an agent to partnership, right ofindemnification only as good as the partner (cannot protect selffrom joint and several liability)

307b, c and d

Proceed against partnership, judgment against partnershipthat goes unsatisfied, can go to individual partners since they are jointlyand severally liable703dissociation

Does not relieve obligations incurred during tenancy of partnership703bpartner who withdraws is liable as partner to 3rd party fortwo years after you left (apparent authority)

VII. Transferabilitya. Section 502only transferable interest of a partner in the partnership is

the partners share of the profits and losses of the partnership and thepartners right to receive distribution; interest is personal property

i.

Cannot sell interest without permission of the partnersSection401iBut partner can convey economic interest in the partnership(get profits and losses but wont be a partner)

b. RUPAdefault statutedoes not apply unless no partnership agreementor insufficient partnership agreement

Business law is essentially pro-business; individuals better capableof looking out for their own best interest than the law

c. Bohatch v. Butler & Binionpartners terminated, exit from partnershipSuspected partner was overcharging; terminated after discoveredaccusations ill-founded

Argues partnership law is fiduciary law, partnership has fiduciaryduty to terminated partner

Courtno fiduciary duty to keep a partner because it is an at-willrelationship

Law allows expulsion of partnerEntitled to contract damages, though, breach of contract

d. Creel v. LillySurviving spouse sues partnership to dissolve businessUnder common law, any of the events like death would dissolve thepartnership

What RUPA did not embracewithdrawal of partner does notdissolve partnership

Section 601DissociationEquivalent to withdrawal (expulsion, notice, death, etc.)As opposed to dissolutiontermination and liquidation

Two Types of Partnerships1. At Willif do not have time limit in partnership agreement

termination and liquidation)2. For Termagreement says it expires in certain amount of time

or when purpose of partnership is achieved


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Withdrawal of partner does not affect dissolution701In partnership for term and die, will be bought out bypartnership

VIII. Form GPcan mitigate things you do not likeHave wellwritten agreement

Require partners keep capital in business, indemnification provisionsInsure around risk

CORPORATIONS/FORMATION/STOCK ISSUANCE

I. FormationCorporations, like partnerships, are a creature of statute (based on State)

MBCAlaw in most states, including AZNo such thing as federal corporate lawNo such thing as a federal corporation

a. General corporation laws of a state are not a gap filler, state law is THELAW

b. Other sources with State Lawi. Articles of Incorporation - only public contract governing

operations of corporationii. Bylawsinternal rules of organization, can be changed at any time

by Directors without even telling owners of businessiii. Case Law

c. Characteristicsi. Ownership1 or more; Concept that ownership of corporations is

not necessarily tied to organization, management or future ofbusiness

Partnershippartner dies, general partnership dissolvesLife span similar to sole proprietorship

For corporations, it is PERPETUAL EXISTENCE (cancontinue forever)ownership may trade withoutinterruption

ii. Managementoften can be and is separate from ownershipCharacterized as CENTRALIZEDmanagement isisolated from ownership

Owners may be passive but interested, do notparticipate in running organization

iii. Liabilitylimited, no personal liability for shareholders or ownersJoint and several liability among ownersOwners may stand to lose investment but thats it

iv. Taxesdouble, corporations net expenses from revenueprofitpay taxes at end of fiscal yeartaxes paid at corporate rate

If corporation passes profits onto shareholders or owners,individual must show it on personal income tax

v. Transferabilitycan be easy; form of stock/shares, may becontractual restrictions


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d. Facilitates wealth formation by committing investor capital to riskyventures

e. Two Typesi. Publicregisters corporation with regulatory authorities; freely

transferable shares; shareholders are anonymous to managers;

usually large, publicly-traded1. Transparent, required by lawa. Know management and qualifications, their pay,

right to voteb. Law requires it disclose financial situation

(borrowing money, raising capital, etc.)ii. Privateowned by one or a few people; may trade between family

members and investors (privately-held or close corporation);designation that corporation has number of shareholders likelyknown to each other and interested and may participate inbusiness; no newcomers can come in to ownership without

contractual undertakingf. MBCAi. Section 1.40Definitions

Articles of IncorporationCorporation means for-profit, not a foreign corporationForeign Corporationincorporated under law other thanlaw of this stateNonprofitShareholderShares

ii. Section 2.01Incorporators not necessarily founderusuallyLawyers

iii. Section 2.02Articles of Incorporationiv. Section 2.03Corporations existence begins when Articles of

Incorporation are filedRisk1. Until corporation formed, do not have benefit of limited

liabilityv. Section 3.01Purposes

vi. Section 4.01Corporate Namesignals limited liabilityII. Stock Issuance

a. SharesSection 6.21Decision made by BoardConsideration can be anythingcash, property, notes, services(corporation can be capitalized through consideration)

b. Authorizedhow many shares a corporation may issueMaking determinationmake it big number to accommodatepossible future holders

Can continue to issue share after share without restrictionc. Issuedhow may stocks are actually issued; determine what number to

issue to shareholders for what consideration


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i. Number of shares issued depends on capital, price determined onhow much you can get per share (could be more or less than lastissuance of shares)

d. Outstandingshares that remain in hands of shareholderse. ClassesPreferred (Class A, B C)f.

SeriesInside a ClassClass A shares have certain rights, subset Series 1has additional rights

i. 6.01distinguishing designation for each Class or Seriesg. 6.03cCommon Stock

Share proportionally to total issued shares of your rightsTells how many votes you have, what percentage ofcompany (share represents ownership of company)

Liquidate companyget same percentage of company, return toowners the assets of the corporation

i. Preferred StockMust have common, can have preferred stock

Rights superior to common stockholdersh. Possibilities for Preferencesi. Liquidationpreferred payouts, first dibs before common

stockholders get anythingii. Dividendsget paid first or will pay 8% dividend on my shares

every year (common stockholdersno rights to dividends)iii. Votingcould take legal form, entitled to 2 votes for every share

they own; my class of shares is entitled to 1 director (can put 1Director on BOD)

iv. Redemptionright to get money back from corporation, havecorporation buy their stock back at a date certain or at an event(required to buy back shares for money they paid)

Corporation established preferred class to make it attractive and bring insignificant level of capital

i. Par ValueA legacy concept, example of how law has evolved to simplifyWhen authorize capital stock, going to say authorize 1M shares incommon stock, $1 value never sell below par value

Problemmust amend Articles and get shareholders to agree toreduce par value if needed

Lawyers often set Par Value at 1 penny or lessj. Discovering outstanding, authorized, issued shares, etc.

Financial Statements, specifically Balance SheetsIII. Limited Liability/Corporate Veil

a. Section 6.22Only exposure investor has is the amount he paid, limitedliability

Once shares are issued for full consideration, they are notassessableOnce you pay consideration for shares, all you have at risk is whatyou pay for those shares


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b. DeWitt Truck Brokers v. W. Ray Flemming FruitContract - Flemming and DeWitt; F did not pay billDefendant is F PERSONALLY, NOT CORP.

Piercing the Corporate VeilNo StatuteJudicially-created concept (standards vary

from state to state and case to case)c. Concept of the Corporate Veil3rdParties can ignore corporateness and ignore shareholder orfirst go to corporate assets until exhausted then go to shareholderuntil debt is satisfiedAccording to Flemming Courtconcepts to determine when topierce the veil

1. No formal meetings of BOD (expect BOD to meet toconduct business)

2. Took money out even though not authorized by BOD3. F owned 90% of stock

Personal liability does not look to only oneshareholder4. Never had evidence BOD was ever elected5. No shares/stocks were issued6. Although corporation formed, never treated like a

corporationMUST ENTER INTO TRANSACTIONS IN ACORPORATE FASHION

SHOWS LACK OF CORPORATE FORMALITIES7. Business was undercapitalized

Sometimes this happensbut look at business frombeginning of its time up to date of claim, amount ofmoney it would routinely take to pay itscreditors/bills

F would just take corporate money and put itin his pocket (whenever money in business)eliminated cushion for creditors

8. Alter Ego/InstrumentalityF was alter ego of corporationShareholder(s) treat business as own personalfinancesCommingling of funds or other assets; corporationis not only under the influence and governed by thatperson, but there is such a unity of interest andownership that the individuality or separateness ofsuch person and corporation has ceased

Court will look at totality of circumstancesd. In Re Silicone Breast Implants Liability LitigationBristolmedical

engineering corp. (parentownership interest in MEC/formed MEC)MEC is subsidiary corp. for implants


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Manufactured and sold productClass action suittrying to pierce the corporate veil(Bristol has the money, MEC cannot satisfy claim)

Some evidence of LACK OF CORPORATE FORMALITIESsubstantialdomination

Parent and subsidiary had common directors/officers (common)File consolidated financial statements and tax returns (legallyrequired)Parent finances subsidiary (common)Subsidiary operates with grossly inadequate capital (strongerargument)Daily operations not kept separate (problematic for Bristol)

Could have brought under Agencyapparent authoritye. Cannot go to other subsidiaries, can only argue getting to a parent

(enterprise liability)f. When piercing case, it is exception to the lawlaw is limited liability

Having one or two owners makes piercing more likely to happenMore likely treating it as his own business/comminglingfunds

g. Four Theoriesi. Fraudcollecting money while claiming to provide services

ii. Failure to follow corporate formalitiesiii. Alter Egoiv. Undercapitalization

IV. Corporate Governancewho gets to decide what; who is responsible to what?a. Duties of Board and Officers

i. Management/Decision-MakingConcept of centralized management

Separation of management from its ownersii. Pyramid (reality is more upside down)

Bottom: Shareholdershave least amount of controlMiddle: BODtrying to figure out roleTop: Officershave the most power

iii. Policy IssuesShareholders should have more power, BOD more responsibility,Management less power?

iv. ShareholdersRole and Powernot exactly one-size fits all (depends on numberof shareholders)Have voting rights for BOD6.03ca corporation cannot exist without common stockcommon stock must have voting rights

7.01a, 7.21, 7.28

All Statute confers on shareholders is limited right to vote, solely once ayear at an annual meeting and solely with respect to election of Directorsand solely on plurality (not majority)


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No right of shareholders to have a vote on operations, product we make,etc.

b. Board of Directors8.01each corporation required to have BOD8.01b

Law does not give much guidance, more custom and case lawStatutory provision open to interpretation8.03Number and election of directorsProfile of someone required to be on BOD

Past history as OfficerPrevious business experience at high level8.02Qualifications of Directors, law mandates none8.05Terms of Directors, expire at 1

stannual meeting

8.20Liberal about how Board does jobMeetings8.21Action without Meeting

Write down resolution of Board and send for everyone to

sign8.11Board may fix compensation8.25Board may create one or more Committees, may do thosethings that Directors as a whole do

c. Officers8.40Board may elect individuals for one or more officers

Assign certain responsibilities8.41Functions of Officers

Similar statutory challenge, despite perceptions, statute gives littleguidance (do things delegated by Board)

d. McQuade v. StonehamS was majority owner of NY GiantsSold shares to M and McGrawminority shareholdersAll were BOD and OfficersEntered into contractnamed directors, officer/positions for each and setsalariesOthers added to BOD, controlled by defendant

Voted to replace plaintiffAlleges did not use best efforts to keep M as treasurer

Contract illegal if precludes BOD from changing officersShareholders elect Directors

BODtrustees of business, hire and monitor officersContract cannot blur roles, Shareholders cannot say who officersare going to be

Contract could saythese people will be Directorse. Villar v. KernanV and K go into business together

V owns 49%, K owns 51% - good thing not 50-50Agreement never get a salary only distributionS comes in for 2%K enters into consulting agreement with company, salaryMcQuade no longer good law


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Nuance of statutes say written agreements are enforceable (this was oral)V could sell his sharesbut private corporation, who will buy?

If partnershippartner can dissociate, withdraw and law requirespartner to buy other partner out

V. Shareholder Rightsa.

Section 7.32

Shareholder AgreementsSmall/Private Large/Public

Share RolesShareholderBODOfficer

Observes Hierarchy

Interact Numerous ShareholdersAnonymousPassive

Consensus Competing Interests

Shareholder Agreement No Shareholder Agreements

b. No Shareholder Agreements in large/public companiesAgreement isContract, cannot effectively by done with large number of people andshareholders changing every day

c. Voting Rightsi. Straightseparate election for each set on the BOD

Each shareholder gets to cast her number of shares in anyway she desires for each separate electionMajority shareholder can win out every time

ii. CumulativeDirectors not elected seat-by-seatOne at-large in which the shareholders cast votesTake number of shares you have times the number of

Directors to be elected and can allocate shares any way youwantMajority shareholder cannot control BoardPoint is to prevent majority shareholder from dominating(give minority access to Board)

iii. 7.28Voting for Directors; Cumulative VotingStraight voting is the common practice, cumulative ispermissibleAZwritten in state constitutioncumulative voting isrequired in AZ corporationsbad thing aboutincorporating in AZ

iv.

8.06

Staggered Terms for Directors may be provided by Articlesv. Staggered/Classified9 Directors3 will expire in 2011, 3 in 2013, 3 in 2014EffectMechanism by which management can maintaincontrol changing Board and not displaced by minorityaction, ensure continuity (maintain incumbency)

vi. Super MajoritySection 7.27Greater quorum or Votingrequirements


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Act says that corporations controlled by votes, control willbe 50% plus one vote, super majorityany action byshareholders requires 75%

Protects either majority or minority making thedecisions harder or easier

vii.

Preferred StockModified traditional voting rights of shareholders if issuepreferred stock

viii. MBCA7.01Annual Meetingfixed in bylaws

Most are not attended by shareholders, proxy process7.02Special Meetingon call of BOD or if holders of at least10% of votes request meeting

Uncommon7.04Action without Meetingif action is taken by allshareholders to vote on action, signed by all shareholders

Written resolution, if one shareholder is holdout, invalidmeeting7.22Proxyshareholder may vote shares in person or by proxy

Written document in which shareholder makes decisionknown, also a person whom the proxy is given/actingpursuant to ballot

7.07Record Ownerdesignation by a corporation who owns theshares, shareholder is record owner of sharesRecord Datemust be a record owner as of this date to voteStreet Namein large public corporations, records are consideredin street name, not your name

d. Shareholder Proposalsgiving shareholders a legal right to makeproposalsLovenheim v. Iroquois Brandscompany does not want to includeproposal regarding goose treatment in proxy materialsArgumentdoes not concern a significant portion of the companysactions

Exception to SEC Rule: If accounts for less than 5% of businessand is not significantly otherwise related to the business, can keepit out

Court looks at legislative historyotherwise significantlyrelated concerns policy and social issues

If something has ethical or social dimensions, proposal can go forwardIf there is a shareholder proposal and shareholders approve by 75% Boardstill does not have to institute practice (in charge of business decisions)Shareholder proposals are popular but advisory only

But effectgood chance of losing shareholders, Board coming upfor electionshould not ignore shareholder vote

VI. Business Judgment Rule


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a. Joy v. Northbankshareholder brought suit; shareholder unhappy bankloaned money to real estate developer/unhappy with lending policyKept loaning more money that was not paid backWhat does it take to breach duty of careBusiness Judgment Ruleentitled to presumption that acted in good faith

Judicially-created concept, not in Statute, varies from state to stateand changes oftenb. Overcoming BJRnegligence is not the standard, must be something

morec. Policy Justifications for BJRbuying stock is voluntary act

Will not second guess decisionshindsight (after-the-fact litigation isimperfect)

Business imperatives call for quick decisions with less than perfectinformation

Potential profit corresponds to potential riskDo not want courts to create overly cautious business decisions

d.

Exceptions to the BJRmore than negligenceStandard must be something like recklessness or gross negligenceDecision lacks a business purpose, tainted by conflict of interest,so egregious as to amount to a no-win decision

VII. Duty of Carea. Breach ofproof to overcome the BJRb. Barnes v. AndrewsA was largest shareholder, asked friend to join BOD

as PresidentReceiver is suing Director for his conduct as director

Line between managing the business and failure of the businessEven though he was a figurehead and did not do this job to the best of hisability, cannot link failure to Director

Never really took active role, did not stay well-engaged, onlylistened to his friend

Causation is the issue herecan look at conduct of directors, assert notengaged but element of proof is proximate causemust show relationshipbetween losses and directors actionsCan breach fiduciary duty but may not have BJR defense becausejudgment was not madeWill have to find proximate cause in breach of duty case

c. Smith v. Van Gorkomshareholders suing BOD in decision to sellcompany for $55 per shareDid not do their duty to investigate that they were getting the best stockprice (only CEO and COO were involved) other Board members did notknow anything except until at the meeting, CEO made presentationFor duty of care case, court looks at process by which decision was made

Courtbreach of duty of care through making uninformeddecisionReasonable reliancehow credible was the person on whom theyrelied?


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d. Breach of Duty of Carei. Action/Decision

ii. Inattention (Barnes)iii. Uninformed (Smith)

e. Outgrowth ofSmith Lawsuitwhen directors might be able to be sued forprocess of decisions, increased lawsuits, Delaware legislatureno longera desirability in being a Delaware corporation

i. Passed a statutelimit directors liability duty of care, can bebreached but directors not personally liable for duty of care

ii. MBCA 2.02b4Articles may set forth a provision eliminatingor limiting liability of a directorCovers directors, does not protect officers (statutory immunitydoes not extend to officers)

f. Caremark International Derivative Litigationshareholder derivativeactionalleging failing to supervise employees under Duty of CareOverstating Medicare and Medicaid claimspaid fines to feds

Duty of Carefailure to monitor (Boards inaction causedproblems)Must prove knew or should have known of misconductMust be pervasive and systemic (to show lack of good faithnecessary to show liability)

Hereno liability, settlement sufficientLarge corporations have programs and processed to train employees,supervisory systems, codes of ethics (lawyers design systems)

g. McCall v. ScottColumbia owned and operated 45% of all for-profithospitalsUpcoding, etc. variety of fraudulent practices against MedicarePlaintiffs allege Board knew of different schemes

Failure to monitor, did not have adequate system to ensurecompliance

Certificate of Incorporationadopted immunity provisionbutexceptions for intentional misconduct, breach of duty of loyalty or acts oromissions not in good faith

Reckless may be intentional misconducth. Current CaseIn re Citigroupfailing to adequately protect corporation

from exposure to subprime lending market and CEOs compensationCaremark standardfailure to monitor, knew or should have known therewas systemic risk

Different situation hereknowledge of RISK of business they arein

Must be able to take risks without debilitating feari. In re Walt Disney Companycontract from BOD to replace CEO

Termination dealgolden parachute was the issueShareholders claim breach of duty of care, not acting in good faith

Grossly negligent in decision regarding compensationDefenseBJRgross negligence can overcome rule


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Facts to prove not grossly negligentCompensation Committee, hired consultant,approved and taken to BOD for approval

Courtno gross negligenceArgument of not in good faithCharter provision

Delaware court gives standard of liabilityprove intentionaldereliction of duty or conscious disregard of ones responsibilitiesDirectors must be informed, attentive, reasonably supervise and monitorthe business

Can be breached by action or inaction; must have proximate causeIntentional dereliction of duty and conscious disregard for onesresponsibilities to fail good faith

VIII. Duty of Loyaltystandards of conduct and behavior expected is a little moreinstinctive

Duty of Careis there a legal claim for mismanagement of bad conductLoyaltyeasier to understand

a.

Competitioni. Jones Co. v. Frank Burke, Jr.founder made bad decisions, poorremarks; officers wanted to buy him out, negotiations fell through;broke off and started new businessClaimbreach of duty of loyalty by acting inconsistently withtrust, stole clientsCompeting with the Corporation problemthey begancompeting before they had resigned (no breach if they had resignedfirst)Issue of Timingconsideration of starting to compete occurredwhile employed and on the companys time

Approached clientswould have been okay if started owncompany then talked to clients

Duty of loyalty is not implicated if it occurs outside theemployment context

Unless non-compete clause in employment contractallowed by law as long as reasonable

Principleblue lineagrees he will not compete for 3 years inSouthwest, court entitled to BLUE LINE provisions that theywould be enforceable (court can edit1 year in AZ)

ii. Duty of Loyalty regarding competition is found in Agency andapplies to officers and directors, Tortious interference of contract

b. Corporate Opportunitiesi. Northeast Harbor Golf Club v. Harrisusurping of corporate

opportunities (taking advantage of your role in corporation)Officer or director encounters opportunity for corporation; cannotuse it for their own personal interest

Harris was club president, jumped on opportunities to acquire propertiesadjacent to golf course after broker informed her assuming club would beinterested


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Trial Courtno usurpation, club lacked financial capability, real estateacquisition was not in line of business of golf club

Expectancy/Interestdid corporation have an interest in the matteror, if not an interest, expectancy?

Subjective, prone to hindsight, what if club would want to

buy it to prevent development?Line of Businessgolf business, not real estateBut it came to her under her title role, not on personal basis

If use financial ability of business as a test, undermining financialability of corporationParty who challenges corporate opportunity has the burden ofproof (shifts to officers and directors to prove it was fair to thecompany)burden not on plaintiff

ii. In re eBay, Inc.- Goldman Sachs was giving preferred stock tooriginal owners to keep them coming back for investment needsGS was underwriter for eBay (help assist in continuing access to

capital, selling stock for corporations for a fee)Took them public, raised more and more money, want tokeep eBay happy

Went to Officers and Directors, reserve themopportunity to buy shares in IPOway to triplemoney rapidlybecame popular and market couldnot buy shares

Line of Business Argumentif Goldman Sachs had brought IPOshares to corporation, corporation would have bought them insteadofficers bought them for their own benefit

eBay has money and buys stock in other companies, if wantto buy this stock, in line of business

Line of business test here, any corporation couldprevail on it

iii. MBCA Sections 8.618.63Where there is an area of law of subjectivity, law will promulgaterulesif abide by, will have prima facie case8.61if there is a director transaction that involves a conflict, adirectors conflicting interest transaction may not be the subject ofequitable relief, or give rise to an award of damages or othersanctions against a director, in a proceeding by a shareholder or byor in the right of the corporation, on the ground that the directorhas an interest in the transaction if

Go to Board and get approval of disinterested directorsGet approval of majority of disinterested shareholders ofcorporationDisinterested Directorperson who has no interest in theoutcome of the decision

Companys best interest is to have a majority ofindependent directors but not a majority of


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disinterested directors (party who has no financialinterest in the outcome of a corporate decision)

Safe Harborapproval by majority of disinteresteddirectors, approved by majority of disinterestedshareholders or may accept the burden of proof that it was

otherwise fair to the corporationiv. Section 2.02b4exoneration statute does not protect officers ordirectors for breach of duty of loyalty

c. Conflicts of Interesti. HMG/Courtland Properties v. GrayG and F were directors

HMG bought and sold commercial real estateG negotiated major sale of HMG to NAF; F owned interestin NAF, disclosed his interest but G did not disclose hisinterest

G had financial interest in outcome of offer, confusion about whichinterest he would be preferring

Information he had about real estate he did not disclose toNAF or trying to give NAF lower priceIX. Shareholder Litigation

Eisenberg v. Flying Tiger LinePlaintiff is shareholder for Flying Tiger,created wholly-owned subsidiary, FTC and FTC created FTL

Merger between Flying Tiger and FTLoperated under FTLShareholders given considerationshares in FTC (now own shares inholding company)Eisenberg claims lost vote and influence as shareholderCourt must decide whether Direct or Derivative

a. Directpersonal claim, one in which a shareholder is trying to assert apersonal claim regarding damages to that shareholder (personal loss,personal harm)can be more than one shareholder

Eisenbergs harm theory is his right to vote/shares in thecorporation is right tied to his personal shares, corporationdeprived him of a vote (right or economic interest of shareholder)

i. Van Gorkemdirect, harm to shareholdersb. Derivativewhen interest of corporation is affected, which in turn affects

shareholdersHarm or damage to corporation and therefore shareholder(s) indirectlyShareholders bring claim, derived from corporations harm

To vindicate rights or harms to corporationDefendant inEisenberg argues it is derivativeevaluate case oncorporations interest instead of shareholders interestParticular requirement for derivative suit was Security for Expenses

Deposit financial security for expenses of litigation for defendanti. Disneyderivative, matter complained was breach of duty of care,

misuse of corporate fundsii. Marx v.Akers- shareholders bring derivative lawsuit but any

damages that are paid go to the corporation


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MBCA 8.56 and 8.57

8.56Corporation may indemnify and advance expensesunder this subchapter to an officer of the corporation who isa party to a proceeding because he is an officer of thecorporation

8.57Corporation may purchase and maintain insuranceon behalf of an individual who is a director or officerFunding indemnification (insurance fundsindemnity and indemnity funds the officer)

c. Proximate cause can be a problem in bringing a direct lawsuit as ashareholder

Derivative lawsuitlegal theory of recoveryduty of cared. Procedural Requirements

i. Security for Expensesii. Demandmust send demand to directors to initiate a lawsuit

against the corporation (shareholder has directors look at claim and

bring suit to redress)Litigation is in the province of directorsbusiness decisionof whether corporation has been harmed is decision forBoard

Shareholder must show procedure to the courtProblem with Demandshareholders are demanding Board to suethemselves (have personal interest in not pursuing litigation)

Demand can be excusedFutilitynot waste time and money to servedemand and wait for Directors to respond

X. Capitalization for Growtha. Raising Capital

Assume corporation and founders have come to limit of financialresources/end of their appetite to keep using their own money

Look outside corporation for funds (technology, equipment,employees, etc.)Even well-run business does not necessarily have money neededbecause continuing to use it in the business

Options to find money to fund growthDebt, Equity, Retained Earnings

Process with debt or equity is lawyer-driven, count onfinancial people to do math

Debt Equity Preferred

Definition

Characteristics

Borrowed Money

RepaymentReturn - Certain

Contribution by anowner in return forownership interest

No repayment

HYBRIDrights ofpreferred stock iscontractual matter,characteristics of debtand equity


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Cash Flow

Restrictions (lenderimposes on borrower)

How loan will be used

What business can beinOther capital

restrictionsMajor expenses or

purch.Default/Remedies

No Ownership

obligationNo fixed/assumedreturnNo cash/no obligationto distribute cash to

youNo Restrictionscannot tell them howto use the money

Will only get whatsleft after everyone elsegets paid

Ownership interest

May have term set atwhich stock will be re-purchased, guaranteedreturn of 8% every

year; also may getnothing back, may beowners (right to electdirectors)

b. Venture CapitalFirst money in corporation comes from founding shareholders,subscribing to initial shares and maybe additional shares

Exhausted willingness or ability to capitalizeGo to Angel Investors

Wealthy individuals, not professional investors but may bewealthy enough that they make personal investments

NextdependsMay be capable of borrowing money/debt

Venture capitalistsfirms/professional investors, collectmoney from wealthy individuals and form partnership,search for ways to invest money

Vehicle for venture capitalists is preferred stockBargain for will loan money but wantdividend, right to sit on BOD for votingpreference, if corp. failspaid first(liquidation)

Initial Public Offeringbecoming public, when VCs get theirmoney back

c. Debt and Equity Financingi. Debt

Has most rights, then preferred then equity/commonIn terms of risk and reward, equity/common has most risk andreward followed by preferred (corporation has right to buy thisback) then debtRights in capital structure are inverse to rewards


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Lawyers will be heavily involved in negotiation and drafting ofterms of debt agreements, contractual rights of preferredstockholders and represent common stockholdersWhy borrow money?May not be able to issue more sharesonly source

Multiply return on investment, want to benefit fromprinciple of Leverageby putting a little equity in andborrowing company/leveraging company, enhanced return

ii. EquityWhy would you want to be an Equity Holder?What you get outof it is potentially moremore risks=more potential rewards

Owners stand to gain in a way lenders never would1. Byelick v. VivadelliB owns 10% and V owns 90%Directors, V eliminated shareholders preemptive rights inbylaws (if issue more stock, current stockholders would haveopportunity to buy it)

Preemptive rightswant to hang on to percentage youhave, do not want it diluted, can obtain stock before othershave accessconfer upon existing shareholder the right tosubsequent issuance of shares that will maintain theiroverall percentage ownershipUnder statute6.30 of MBCApreemptive rights are theexception, not the rule, permissive only in corporation thatadopt (in articles of incorporation or bylawsa littleunusual)

Defendants decided to amend bylaws and remove preempted rightsbecause 90% shareholders and on Board of Directorswithintheir rights to do thisPlaintiff argues reduction in percentage was breach of fiduciaryduty to him

Diluted his percentage from 10 to 1%Key was that 30 days later, they issued more sharesto themselves to reduce him to 1%

There would not be a case if they had notdone this

What duty?loyalty (defendants on both sides of transaction)(Court allowed as direct suitridiculous to make a 2-personcorporation make plaintiff bring this as derivative suit withprocedural hurdles)

Virginia law for close corporationscan bring direct suitwhen it would technically be derivativeDo not know answer in AZ, but would probably make youbring a derivative suit

Plaintiff, must show that they breach duty of loyaltyBurden shifts to defendantsmust show they acted fairly


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If corporation has preemptive rights, holder must have firstopportunity to buy shares at issuing price

Percentage ownership of other shareholders would not bediluted

Dilution = diminished voting rights

All dilution is not baddifference between ownership andeconomic dilutionown lesser part of company but whatyou own has substantially greater worth

2. Legal Issues for EquityPreemptive RightsDilutionPreferences

d. In capital structure of corporationmay see debt, equity and preferredstock

All will be on balance sheetXI. Going Public

$Company stock Underwriter stock Public (trading) ExchangesIssuerIPO SEC Registration FirmSecondary 33 Act BE 34 ActProfilea. Public Corporations

Will have shares that are obtainable by the pubicCompared to a private company

Larger CapitalizationPrivatedo not have to disclose financials

i. As private company, why would you make decision to go public?1. Access to large amounts of capital (tipping pointexhausted

private contacts they know)2. Owners want to recognize benefits of their work (liquidity)

Opportunity to sell shares and get money in returnAlso important to venture capitalists

3. Also want continuing access to capital4. Status (not so much anymoreprotests and regulation)

ii. Chilling Effects about decision to go publicIf unsuccessful, have not created a lot of wealth could be in troubleVery time-consumingBusiness becomes fully transparent

iii. How it Becomes PublicThrough registration, issues stock to underwriter which payscapital to company in consideration for sharesUnderwriter becomes intermediary and puts stock in hands of thepublic in turn for paying for the sharesPublic become ultimate owners of the sharesMoney/Capital goes to company to finance it


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First time that a private company is the IPOinitial public offer(selling stock)

After that, make secondary offersiv. SEC Registrationgoverned by two federal laws

1. Securities Exchange Act of 1933What must companies do to become publiccompaniesSEC is regulatorUnless registration statement is in effect, unlawfulfor personal to make use of interstate commerce tosell securitiesMake reasonable investor knowledgeable about thestockregistration provisionProvisions regarded as self-executing

Law has accomplished goal if requiresdisclosuresjust regulatory review of

disclosures, whether they are there and if so,can go public2. Securities and Exchange Act of 1934

Now public, laws and regulations governing yourbehavior

Corporate Securities lawyers run process in terms of dealing withcompanies, represent underwriters

Manage registration processRegistration Statement, filed with SECApproved by SEC, go to underwriters (investment banks)

Advise companiesTradingPublic OffersDetermine Number of Shares and at what price, distributethrough Network of Brokers

Once public, subject to 1934 ActConsequences for not making proper disclosure inregistration statement is extensive

SEC and individuals in stock market can bringaction

Must on continuous basis make complete disclosure to thepublic regarding aspects of the business

Form 10-Qfiled with SEC at conclusion of eachfinancial quarter, discloses to public what positionisAnnual Basismust file 10-Kmore extensivedisclosure, results of financial audit, financialposition, new risk factors

b. Public Offerings and Private Exemptionsi. Doran v. Petroleum Management Corp.


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Federal Lawevery security must be registeredUnlawful to sell stock unless registration statement is filedwith SEC

Unless can find exemption in federal lawExemptions

1.

USC 4(1)do not need registration statement2. USC 4(2)transaction by offerorBurden on Company to prove transaction by issuernot involving public offering

When does it become a public offering?For exemptions, must know number of investors,relationship to each other, offeror, number of units, size andmanner of offering

SECRegulation DRegulation under 33 Act, Private Offering ExemptionGives some certainty

1. 35 investors or less2. Access to information (can show investors had sameinformation they would have had if was registered)3. Manner of offering (no general solicitation)knowinvestors, referred to them, networked to them (websitessolicitation)4. Resale limitationdoing a private placement, buyermust agree not to resell investment for a period of time(holding period is usually 2 years)SAFE HARBORPublic Policyto make sure that investors know what theyare getting themselves into if there is a small number ofinvestors and no need of federal protection

c. Investment ContractsChallenge of Registration, Exemption

Law keeps making reference to securitySecurityany stock, note, bond, venture, evidence ofindebtedness, etc. (an interest)

Trap in definitioninvestment contractSEC v. Howeycitrus farmer, did not havefinancial capability to conduct operation;give people who help share of profits; SECinvolvedplaintiffs were soldsecurity/investment and entitled toprotection of federal law under securitieslaw (sold them investment contract)

Investment Contractinvestment of money in a common enterprise withexpectation of profit solely from the efforts of others

The Howey Test (4 factors)


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No limit to imagination of what can be investmentcontracts

Key Element of Proofsolely from efforts of othersd. Section 5 of Securities Exchange Actunlawful to sell securities by

means of interstate commerce without registration

Every time sell Securities, must register them unless ExemptionXII. Making MoneySize of company, complexity, capitalization, private or public make a bigdifference in terms of distribution of capitala. Compensation

i. Hollis v. HillHill argues Hollis being paid too much, stoppedpaying his salary, shut down his officer, stopped sending financialreports

Hollis sued, wanted Hill to buy him out, oppressive actsCase introduces new concept of fiduciary dutyduty of majorityshareholder to minority shareholder to minority shareholder and

majority shareholder engaging in oppressive actsbreach offiduciary dutyHill could have argued financial issuescorporate restructureCould have avoided mess with forming partnershipentitled to bebought out, easier to exit or corporation with shareholdersagreement

ii. Exacto SpringsIRS thought principal owner , Heitz, was beingpaid too muchShareholders do not objectIRSwhat was taken as compensation should have been taken asdividend (taxed differently)deduction for corporation vs. taxedtwiceC-Corp.pass-through, would not have dispute is S. Corp.

iii. Giannotti v. Hamwayminority vs. majority shareholdersPlaintiffsdefendants authorizing excessive compensation forofficers (selves)

Argue liquidityWant dividendscorporation is doing well but theyare not reaping the economic benefits

BOD decides who should be paid and how muchBreach of Duty of CareBJR

No showing that there was a disinterested BoardNo Breach of Duty of CareBreach of Duty of Loyalty (on bothsides of transaction)

Burden goes to BODargue behaved fairlyCourts can fashion remedy at discretion

Orders liquidationextremekilling the golden gooseb. Dividendstransfer of money from corporation to shareholder if made a

profiti. MBCA 1.40(6)


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Distributionbroadly aimed categoryIncludes dividends

ii. Total pool of dividends paid pro rate to shareholders equivalent topercentage of their ownership

iii. Dodge v. FordDodge brothers suing Fordinstead of payingdividends, will reinvest in the companyDividend policyat end of the year, retained earnings

would pay substantial dividend based on profitDodge brothers wanted money for own companyCorporations can use business judgment whether to pay dividends

Policy decisionencourage investmentNo dividendsreinvest in company

Most corporations do not pay dividendssmaller companymorelikely to see in order to provide liquidity for shareholdersCan compel to pay dividendsbreach of duty of care

Ford not exercising duty of care that shareholders can profit

Shareholders rarely ever succeed with thisiv. Zidell v. Zidellbrothers, minority and majority shareholdersMinority argued failed to pay dividend, left company after disputeand wanted dividendJurisdiction does not recognize oppressionWeaknessleft company then wanted dividendMajority viewpaying dividends is within business judgment

Must show intense hostility of controlling faction,extraordinarily high compensation and desire to push outminority shareholder

Company can find good faith reason with legitimate businesspurposewill not be compelled to pay dividend

Company justified no dividends, court will not secondguess

v. Creditors have great interest in whether dividends paidCannot pay dividend if makes you insolventMBCA 6.40

Cannot pay dividends if would not be able to paydebts as they become dueInsolvency Test

Cannot pay dividends if total assets would be less than totalliabilitiesBalance Sheet Test

Only restriction on paying dividends is related to protection ofcreditors measured by Insolvency or Balance Sheet Tests

vi. MBCA 8.33Directors Liability for Unlawful DistributionsDirectors who approve dividend or distribution that violates one ofthe two tests are held personally liable

vii. MBCA 2.02(4)protection of monetary damages, directors do nothave to personally pay damages for lawsuits against company

Exception is 8.33


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viii. Why have cumulative dividend featurepreferred stockholderbargained for preferred dividend and corporation does not havelegal source of funds

Violation of insolvency test if paid that yearix. Two Other Types of Distribution

1.

Repurchasecorporation makes repurchasediscretionary, decision to repurchase sharesTo increase share price/stock value

Repurchase from common stockholdersthrough buying in the open market

2. Redemptionwhat occurs when corporation buys backstock from stockholders

Also a feature of preferred stockCommon stock does not have this right

c. Selling Stocki. In Private Corporation

Decision by Shareholderwant value of work they put inCan sell all stock to new buyer (sold company)Can sell some stock to obtain capital

ii. Impediments1. Finding a Buyer for less than majority interest (liquidity

and minority rights)2. Valuation

In public companyeasy to value and sell shares(stock exchange value)

What shares are worth is based oninformation

1. Financial Statements filed with SEC2. Guidancecommunicating to

public, suspect what will come tobenefit in next quarters(to beintroduced, foreseeable problems)

3. Analystsworking for investmentbanks, trained to make informedjudgments of value of stock

4. Correlators/Comps5. Price Trends6. Media7. Brokerssimilar to analysts, get tips

iii. Securities Act of 1934where 8-K, 10-K and 10-Q comes fromIf public company, obligations regarding information

Section 16insiders of companySection 14mergers and acquisitions, proxiesSection 10anti-fraud provision (Vast)

iv. Fraud and Misrepresentation


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1. Basic, Inc. v. Levinsonpublic company, manufacturedsteel

Combustioninterested in acquiring BasicPeople sold stock, not knowing about merger(companies had discussions)

Issuepublic statementsdirectly influencedecisions; claim directors made false statements thatviolated 10b10b-5monster of all securities regulations; it shallbe unlawful for any person, directly or indirectly, bythe use of any means or instrumentality of interstatecommerce, or of the mails or of any facility ofnational securities exchange to make any untruestatement of a material fact or to omit to state amaterial fact necessary in order to make thestatements made, not misleadingin connection

with the purchase or sale of any securityOnly applies to securities regulationViolationin discussion for company to besold; statements contradicted what wasgoing on; false statement/omissionsoldstock on this basis

2. Dupuy v. DupuyM and C own company with motherOne brother selling stock to other; fraud claimmisrepresented and concealed factsCan you use 10b-5 with respect to intrastate phone calls

If meet jurisdictional requirement10b-5 appliesIs phone instrumentality of state commerce?

Courtquestion of congressionalintentyes

Cannot think of circumstance where 10b-5 would not applyApplying to all purchases and sales of securities

All transactions of private and publiccompanies, individuals selling securities

3. Purpose for 10b-5Efficient Market Theoryif allinformation is in the market, individuals can makeinformed decisions

4. Elements for 10b-5a. Standingb. Jurisdiction (Dupuy)c. Act - misrepresentation or omissiond. Materialityif there is a substantial likelihood a

reasonable investor would find the fact important inbuying or selling securities

e. Scienteralso use in false claims actmust intendthat statement you make will mislead OR that you


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know the statement you are making would tend todeceive

f. Relianceplus causation (plaintiffs must hear info,rely on it and cause them to do something)

Can apply Fraud in the Marketplace

material was out there regardless if read itg. In connection with purchase or sale of stockh. Damages

5. Issues of Full transparencya. Competitive product will be copiedb. Could be prematurec. Could be misleading, misconstruedd. Quality of information goes down (no judgment

regarding materiality)Lawyersbalance is x (in middle between no info and allinfo)

Dilemma addressed with Private SecuritiesLitigation Reform Act (PSLRA)Encourage companies to put info out thereand provide protection for so doing (frombeing sued)

6. EP Medsystems, Inc. v. EchocathMed claims E mademisrepresentations regarding imminent contractsAgreement to buy shares of Es preferred stock(privateoffering exemption)Elements of 10b-5 provenEs defense while E made representations orally,significant amount of available information to M thatinvestment was risky

Taking advantage of SAFE HARBOR underPSLRA

People read information and cannot sue youif things turn out differently

Problem is oral representations made right beforeinvestment decision, directors to directors

Present statements of imminent facts, person toperson (as opposed to good faith projections offuture eventswhat PSLRA applies to)

XIII. Securities Regulationa. Insider Trading

i. Securities and Exchange Commission v. Texas Gulf Sulphur Co. Defendants are insiders of TGSstarted buying land in area butkept land test a secretsilence, no statements/misrepresentations

Bought stock to make profit once information went publicTook advantage, made personal profit


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*If in possession of material, non-public information, must eitherdisclose or abstain from trading in that security10b-5no face-to-face deception but missed out on potentialprofits

May be difficult argument to make for fraudeasier to

argue FAIRNESS for the market (preserve integrity ofmarketplace)ii. Could have proper business purpose for secrets

Yes, no requirements to disclose all information (entitled tokeep information secret as long as proper)

iii. Chiarella v. USANYONE in possession of material insideinformation?Chiarella works for printerfinds sensitive financial documents

Agent to Buyer companyPurchased stock without disclosing his knowledge

Conviction overturnedinsider tradingthose who must be

punished must be breaching some sort of fiduciary relationshipWithout fiduciary nexus, there is no duty/liabilityCould be considered fiduciary for buyer but boughtstock in target

iv. United States v. OHaganfirm hired to structure Pillsbury buy-out dealworked at firm and heard about itRepresented buyer, bought stock in Pillsbury

Chiarella still good law, took different routeMisappropriation TheoryDuty to the source, if you are in aposition where you would expect confidential information to comeinto your possession and source would reasonably expect you tokeep it in confidence, that is establishment of relationship, may nottake info for own benefit

v. Can create insider in one of two waysClassic Fiduciary,Misappropriation

vi. Dirks v. SECCame into possession of information that EquityFunding was operating massive fraud

SECDirks in possession of material non-publicinformation

Objection to him discussing it with clientsTipping

InsiderSecrist (told Dirks about issues)TipperDirks, told clientsTippeeClients of Dirks buying and sellingstocks (can become Tippers if shareinformation)

Problem with SECs framing of insider trading (tests)1. To have insider information, must originate with insider

(Secristformer employee, not status of insider)2. Liability occurs only if there is a trade


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3. Tipper must expect getting something of value in return fortipping to be liable

XIV. Selling Controla. Protecting Minority Shareholders

i. Perlman v. Feldmansteel company, F was president andmajority shareholder; W bought Feldmans sharesMinority shareholders upset; W paid more than shares worth (theycould not sell shares at same price)1st PrincipleControl Premiumshares held by majorityshareholder are probably worth more than minority because theyare control shares

W bought majority interest at control premiumMinority argues buying valuable asset (breachedduty of loyaltydisguised sale of asset)

Corporate OpportunityNot a good case

ii.

Frandsen v. Jensen-Sundquistif majority wanted to sell shares,offer first to minorityF is minority shareholder in JProvisionif at any time, majority wanted to sell shares, minorityshould get right of first offer (ROFRright of first refusal)

Normal provisionReciprocalif I do not exercise my ROFR, agree to buy my sharesat price selling to 3

rdparty

If sell majority interest to new shareholder, I get to goalong (less common)

Within power of J and Board to sell bank/assetNever offer to break shareholder agreementnot sellingcorporate control, no question of breach of fiduciary duty(contract case)

Illustrates use of shareholder agreements and how they will affectsale of shares by majority shareholders (particularly sale of controlof company)

MERGERS AND ACQUISITIONS

Uber-sale of Stocksale of all stock of corporationessentially the sale of the company1. Corporations that fail can come in form of liquidation and dissolution

Shareholders can apply to court to dissolve corporation and liquidate assets(judicial dissolution)Corporation has not succeeded, shareholders can vote to cease operations, marshalassets, liquidate and hand out assets and dissolve corporation

2. Corporation is a success, sell itSmall corporationsell for liquidity, personal decisionGetting larger, more complex, need more capitalgo public, sell corporationMotivation of buyerbuying competitor, technology/IP, want to grow


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Mergers and Acquisitions/Asset PurchaseHave very different legal consequences

Each designed and structured in different way, set of different rules butoutcome will be same

I. Mergerspecific legal structurea.

HMO-W v. SSM Health CareHMO shareholders were minority shareholders; SSM is plaintiffShareholderDiscussion between HMO and Unitedmerger (Unitedsurvivingcorporation, HMO is disappearing); Buyer is United (Acquiring) andHMO is Seller (Target)Disputevaluation of HMO, State law for dissenting shareholders

Minority shareholder can object properly to valuation being paid,can demand appraisal/ex part courtspecial proceeding forvaluation

Dissenters Appraisal Rights

MBCA 13.02

Right to Appraisal, Cannot mess up steps or case will bethrown outDissenters Rights not frequently argued

Complex, lawyers, experts to value (costly strategy)Board of companies put a lot of thinking in terms ofvaluation because avoiding lawsuit of breach of duty ofcare

Gamble in appraisalHMO did not make material misrepresentations toshareholders(b) allow shareholders to merger to always complain except whencorporation is a public corporation (obvious what value is worth)

b. Characteristicsi. Shareholders of Target have more money in their pocket at the end,

rights are overii. MBCA 11.02one or more domestic business corporations may

merge with one or more domestic or foreign corporations(c) Plan for mergerlegal contract that sets out terms of merger

Principlemost important debatewhat is the value to bepaid for shares

iii. Once determine valuation, for every share you tender, we will giveyou $x

Can pay consideration in to shareholders in cash, property,debt or shares (can split between them)Called the straight merger

iv. Parent corporation will be acquireridentifies selling/targetcorporation

Creates subsidiary, plan of mergertarget merges withsubsidiary and parent pays considerationTarget disappears


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Called triangular mergersame result as straightmerger1. Triangular MergerParent, Target and

SubsidiaryLawyers frequently structure mergers this way

Shareholders tender shares to subsidiary(target disappears)Protecting parent corporationcan go aftersubsidiary but not parent

Addresses biggest concernsucceeding unknown liabilities,mitigates risk of liabilitiesLiabilities vest with subsidiary, notparent, subsidiary acquires liabilitiesand parent is not on the hook

c. MBCA 11.04Proceduresi.

Plan of merger must be adopted by BODii. After adopting, BOD must submit plan to shareholders forapproval

iii. Plan of merger requires majority of shareholders to consentShareholders vote is required for fundamental decisions

Merger includedrights as a shareholder couldpotentially disappear with corporationCan also vote on dissolution and acquisition (inaddition to changes in Articles of Incorporation)

d. File Articles of Mergerlegal public filing, A has acquired T,shareholders have been paid and continue as A

e. Legal Effect of MergerMBCA 11.07Merger becomes effective, surviving corporation continuesSeparate existence of other corporations ceasesAll property owned by and contract right possessed by T is vested into AAll liabilities of T are vested in A

All assets, contracts and rights of T become those of A; also ALLliabilities (scary for lawyers)known and unknown

Liabilities could include Tort Claims, Contract Disputes,Employment Discrimination, Environmental and DebtAll assets include Property, Equipment, Customers(contractsmay not go with A), Employees (if notterminated), Contracts, Accounts Payable, AccountsReceivable, Supply Relationships

Survivor/Buyer Target/Seller Target Shareholders

New AssetsNew Liabilities

Disappears If merger approved, getcash or shares of survivor


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New Shareholders (maybe-Consideration paid was

shares, not cash)When faced with prospectof merger, could vote itdown, dissent/appraisalrights, can sue (duty of care

by their BOD or loyaltyboth sides of transaction)

f. Weinberger v. UOPSignal decided to purchase majority stake in UOP,acquisition50.5%; Weinberger with public owned restWeinberger sues Directors, unhappy with purchase price

Public companyno seeking of appraisalClaimin decision of BOD to approve merger and making businessdecisionviolation of duty of care (protected by BJR)

Recast as duty of loyaltyconflict of interestOn both sides of dealvoted on own proposal (BOD owes

duty to shareholdersthemselves and minority)BJR is no defenseplaintiff has burden to proveentire fairness

g. Shareholders of Target Corporationi. Rights and Remedies

1. Opportunity to Voteif passes by majority, merger willoccur and will be paid (even if you vote no, unless Dissent)

2. Dissenters Right/Appraisal Right avoid minority holdingmerger hostage

3. Lawsuit against BoardULP caseDuty of Loyalty or Duty of Care (but BJR)

h.

Making a Tender Offeracquiring corporation communicates directly toshareholders (Tendered for majority, if do not get majority, will nothappen)

i. Why make tender offer?Could get merger accomplished quickly, avoiding negotiations ofwhat company is worth

II. Acquisition/Purchase or Sale of Assetsa. Franklin v. USXmesothelioma case

Mother was employee of WPS, Con Cal purchased WPS assets and agreedto assume liabilitiesCon Cal sold assets to Con DelCon Del merged into USXPlaintiff argues USX should be responsible

Argues mergerassumed liabilities, known and unknownCourtWPS did not merge with USX, could only have sued Con Cal

If hold USX responsible, would destroy asset purchase concept

b. Characteristics


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Have same outcome in asset purchase as in merger but structure, legalconsequences and legal operation are very different

i. Buyer, Sellerii. Buyer purchases assets only

iii. Consideration/$ goes to Seller who decides what to do with themoney (shareholders have no decision, no control over assets)Total amountnot per share

iv. MBCA 12.01No approval of shareholders of corporation isrequired to sellany or all assets in usual and regular course ofbusiness

v. MBCA 12.02requires approval of shareholders if dispositionwould leave corporation without significant continuing businessactivity (essentially selling company)

vi. MBCA 13.02(a)(3)shareholders entitled to vote in sale of all orsubstantially all assets; can dissent (divide interestif separategroup, what would shareholders have received?)

vii.

MBCA 11.07buyer succeeds to assets and seller continuesviii. Transaction does move liabilities to buyerc. Assets

Land (deed), Trucks (title), Leased Office Space (landlordapproval), Contracts (assign and assumptionbuyer will assume ifassigned to them), Property with Mortgage (Release), Employees(Seller fires then buyer hires), Technology/IP (patent, assumelicense), Name of Seller (agreement, seller must change name withACC)

i. All of this must be done before asset purchase can beconsummated

1. Pay off creditors, banks, satisfy mortgageUCC releasesliens

d. LiabilitiesBank Loan (paid out of proceeds of sale), Real Estate Mortgaged(need seller to consent with lender, agree for buyer to take onmortgage), Payables/Amount owed to Creditors (maintainrelationships with suppliersbuyers assumes payables),Unknowns (buyer disclaims assumption of other liabilities)

e. Mergerassets are automatically transferred, can avoid legal work ofasset purchase; liabilities taken on by survivor

Also, asset purchase easier with small company; big/multi-nationalpublic companymust hire lawyers in each state land is in, patentsare in, etc.

f. Aware of sellers environmental implications unknown liabilityAsk for Indemnificationif buyer is sued in connection withunassumed liability and lose, seller will pay (seller usually agreesto time or money limit)only as good as indemnifior

g. After purchase consummated, what are sellers optionsi. Could reinvest/continue


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ii. Dissolvecash stock goes to shareholders after pay creditorsAsset Sale Merger

Assets Negotiated All

Liabilities Negotiated All

Consents Yes No

Liens Must be Released NoWhich is Easiest - Depends

III. Stock Purchasea. Buyer wants to own selling corporationcan buy stock

Buyer asks shareholder to purchase their stock (if sell, buyer ownscorporation)

b. Legal consequences more like a merger (buying all stock)noenumeration or transfer of assets; take all liabilities

c. Why not do this all the time?A lot of shareholderssome may not be willing

For merger, just need 50% plus 1IV. S-Corporations

a. Difference with C-Corp. is taxationpass-through with Sb. All pertains to S-Corp. except when business is formed

i. Articles filed, may elect to be taxed as pass-throughc. Differences

i. Can have only one class of stockii. Must have fewer than 100 shareholders

iii. Shareholders must be US citizensiv. Shareholders must be natural persons

Suggest must be small domestic companytax benefit

d. Fewer and fewer S-Corpse. Desirable featureslimited liability and pass-throughLIMITED PARTNERSHIPS

I. Like S-Corp.declining in use; benefits of limited liability and pass-throughII. Characteristics

a. Ownership1 or moreb. Managementin the general partner; limited partners are there for

investors/pass-throughc. Liabilitiesgeneral partner has all liabilities as joint and several with

other general partnersLimited Partners have no liability for business or general partners,no personal liability (passive investors)

d. Taxationpass-throughe. Transferability/FormalityStatutecannot inadvertently form a limited

partnership, must file certificate with Secretary of State in AZIII. Limited Partnerships are governed by the Uniform Limited Partnership Act,

AZ adopted


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Zeiger v. Wilfplaintiff did not receive consultant fee; Wilf is defendant, offered topurchase property from Z, consultant fee part of purchase price

Formed corporation to limit liability; W has a GP (general partnership formed fortax reasons)Z and Trenton formed limited partnership for assets (capitalize with passive

investors)Among limited partners is Wilfs GPTrenton and LP filed for bankruptcy, Z looks to collect from W (only one leftstanding)

Argued officer in corporation, assumed control over LP=assumed personalliability

Lawin LP, limited partners cannot have limited liability unless act like generalpartners

Court sides with Wrunning business as corporation would if still solventProtected by corporate shield as agent

Pursue another theory for Z

Fiduciary duty to Z as limited partner (general partner to limited partner)Corporation and limited partnership operated informallypierce corporateveil

Failed to follow corporate formalitiesgo after shareholderpersonally

IV. Reasonable Reliancewhat do entities believe regarding who isresponsible/liable?

Relevant but not dispositiveV. Why would someone be a general partner in a limited partnership?

a. Opportunity to run business, execute ideas and use other peoples moneyControl

b. Feesfor managing partnershipc. Way profits of business are divided up

4 limited partnerseach get 25% of profits until receive moneyback, then general partner will get 20% of fees and limited partnersare reduced to 20% each

Ability to change economics of businessVI. When limited partnerships are used

a. For establishing, financing and running business with specific purpose andspecific end date (real estate development)

b. Limited partnerships are very project-discrete = single purposeCommon with hedge funds

Frigidaire v. Union PropertiesF gets contract with Commercial, limited partnershipUnion is general partner, Mannon and Baxter are ownersF argues Commercial breached contract, individuals have all money

Trying to get Mannon and Baxter to payargues asserted controlDefenseacting as directors of Union

Formed as GP to limit liabilityCourtmere fact company undercapitalized does not mean it cannot function asrole in limited partnershipF should have argued piercing corporate veil


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Mere instrumentalitynot following formalitiesBest shot would have been Undercapitalization

LIMITED LIABILITY COMPANIES

I. Uniform LLC Acta. Effort like RUPA and MBCA to bring uniformity among states but leastadopted of the Uniform Acts

b. StatuteLLC intentionally looks like a corporation and a generalpartnership (MBCA and RUPA)

c. Specific SectionsSection 101 (10)

(11)

(12)

If form LLC, designate whether manager-managed ormember-managed; default will be member-managed

Section 201

LLC is legal entity distinct from membersSection 202OrganizationFiled with ACCSection 203Articles of Organization112

404- Management of LLC (like RUPA)making managementdecisions by majority vote

Members share equally in managementPart bin manager-managedvest in manager all powerto conduct business

405

406Limitations on Distributionsmade when members

determine according to percentage interest; distribution may not bemade if(solvency test)303Liability of Members and Managers (most litigated,probably); not liable for debt, obligation, or liability of thecompany solely by reason of being or acting as a member ormanager

(b)failure to follow formalities is not ground forimposing personal liability on members or managersIn corporation, corporate veil is common lawLLCdiscussing piercing in statute (defensedrafters didnot want members to be personally liable)

But what about undercapitalization?if defending amember, problem with b is it only mentions one groundsfor being unable to pierce the veil (not a lot of clarity)

409General Standards of Members and Managers Conduct(a)only fiduciary duties member owes are duty of loyalty

and care, (b) and (c) are limitations103All members may enter into operating agreement; actgoverns relations unless operating agreement provides (sounds like


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RUPApeople can form business and run it any way they want aslong as have agreement)LLCscode is default

Operating Agreements will be final word on a lot ofcomplex issues

Not a lot of case law for LLCsnew and largely a

matter of contract law (contract is litigated, not thecorporate law)*Pitfall for LLCa lot of LLCs form by printing pre-printed forms off the internet, people have no concept ofwhat they signed up for(b)if have operating agreement, cannot eliminate duty ofloyalty but can have areas that do not as long as notmanifestly unreasonableCannot unreasonably reduce duty of care or eliminate goodfaithas long as not manifestly unreasonable

Can contract out of duty of care and of loyalty as

long as not being manifestly unreasonable301Agency of Members and Managerssounds likepartnerships, each member is an agent and can bind the businessunless had no authority and person they were dealing with hadnotice they did not have authority

Binds company only is authorized by other members-Apparent Authority (a)1, 2Part bIn manager-managed companymember isnot an agent of the company

II. LLCfastest growing form of business organizationa. Is becoming or is most popular form in USb. Idea to be as flexible as possiblec. Case law is almost non-existent and Code is vague

III. Characteristicsa. Ownership1 or moreb. ManagementCan be manager-managed (organized such that there is a

manager and owners are passive)like corporations; can be member-managed (nomenclature given to owners of LLCs is members in statute)like general partnership

c. Liabilitieslimitedd. Taxpass-through or double (depends if more favorable to be taxed as

partnership or as corporation)can elect tax treatment at tax time everyyear

e. Transferability/Formalitiesmust be legally formed like corporation;transferability is more problematicevidence ownership by percentagemembership interest

IV. Lawsuitsagency and piercing the veila. Westec v. LanhamLanham and Clark formed PII (an LLC); Clark got

business from Westec, contract never signed; Westec never paid and


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argued Lanham and Clark never disclosed PII on business card was anLLCDefendants claimed not personally liable because LLCDistrict CourtClark is not liable because he was acting as agent forLanham and the business

Case is more an agency law casedisclosed and undisclosed principalIn agency relationship, principal is liable on contract, not the agentLaw of undisclosed principaldoes not disclose he is an agent,law of agency says agent is liable on the contractPartially-disclosed Principaldoes not identify principalspecifically, Courts less consistent heresome say agent is liableothers say agent is only partially liable

CourtNot much value to raise idea of LLC because it was not identified;partially-disclosed he was working for Lanham but not thebusiness/PII

Defendants try to argue constructive notice since filed as LLCCourt says NoStatute requires them to use LLC as part of the company name when theyfile as an LLC

Gives notice to third partiesb. Webber v. US Sterling SecuritiesRetail Relief LLC, Orrs are members

of LLCSend unsolicited fax advertisement to Webber, violation of federal lawOrrs argued limited liabilityApplying Delaware lawwhere LLC was established

Not about solely being members of LLC, it is about theirindividual acts

Characterization as personal, not business, conductMay be a great argument in LLC or corporation

c. Kaycee Landtrying to pierce the veilDefendantstatuteno personal liability for membersWyoming Courtcannot presume legislature intended to abdicatecommon law principles

Under Wyoming law, LLCs and members subject to losing protectionof limited liability

Not going to try to make any laws, thoughArgument of policy to the courtNot very helpful

d. In Re Suhadolnikattempt to argue piercing is barred under allcircumstances, including fraudCourtIn Illinois, piercing availablealter ego, fraud, etc.

Recognizing corporate piercing for LLCsV. Arizona

a. Allowing to pierce the corporate veil for LLCs has not been decided


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b. Does not contain a provision similar to 409no list of fiduciary duties ofLLCs

i. Also does not have provision discussing operating agreements thatsays cannot eliminate but can modify rights

1. Neither imposes fiduciary duties nor negotiate or eliminatethemVI. Problems

a. Piercing corporate veilDoes law give right to pierce LLC veil

b. Fiduciary DutiesDuty of Care and of LoyaltyBut operating agreement allows to limit and negotiate fiduciaryduties

c. AZ does not have provision that establishes fiduciary dutiesArgue fiduciary duties embedded in common law/case law (whoknows)

Operating agreement can include provisions not conflicting withlawMaybe can say eliminate all fiduciary duties

Bottom Linewe do not knowVII. ULLCA

501Members Distributional InterestMember has distributional interest but no provision that it must bedescribed or their rights (statute is silent regarding more than one class,preferred class, etc.)

Presume meant to be flexiblecould create classes of membershipinterest

Represented by Certificatesuggest use shares502Transfer of Distributional Interest

Can transfer shares but just get economic rights in business503transferee may become member of LLC if transfers rights in accordancewith operating agreement (like partnership)504rights of creditor; very consistent with partnership law; creditor canattach economic interest in LLC but does not become member with all ofmembers rights601, 602 and 603parallels partnership law; owner in LLC can withdraw,rightfully or wrongfully but cannot prohibit from withdrawing

At-will LLCsoperating agreement does not exist or is silentcan bebrought outOtherwise, Paid out when everyone else is paid at termination of company

700s and early 800sdissolution, withdrawals805terminating LLC

Documents

Biz Orgs Outline Fall 2011 (Forst) (1)