Corps Short Outline KF 2009

Corps – Clark – Spring 2009 KF 1 of 173

1. AGENCY

DEFINITION – RSA §1o Agency is the fiduciary relationship which results from:

(a) the manifestation of consent by one person to another; (b) the other shall act on his behalf; (c) subject to his control; (d) consent by the other so to act;

Effect of Agency : o If the agent enters into a contract on the principal’s behalf, then both the principal

(§144) and the other party to the contract (§292) are bound.o Types of authority: actual (§7), apparent (§8), inherent (§8A), estoppel (§8B),

ratification (§82).o Kinds of liability: contract and tort, special rules for master-servant (§219) vs.

independent contractor. Agent’s duties to the principal :

o Obedience (§385), care (§379), loyalty (§387).o Fiduciary nature of duties (§13).

Master / Servant vs. Independent Contractor

Master / Servant Independent Contractor

Master employs and has right to control physical conduct and other performance

In Torts: responsible for that which is performed in the scope of employment.

All servants are agents

Hired by someone but not controlled

In Torts: NOT responsible for torts of IC.

Not all IC’s are agents.

(A) Who is an agent?

(If someone is your agent, you are liable for his actions)

Gordon v. Doty o Woman who agreed to lend a car to football team as long as coach drove it =

principal (liable for actions of the agent coach, her agent). Not clear he was acting on her behalf (Part 2 of test) Court focuses on #3 she had control based on condition that he had

to be the drivero RC : Ct was stretching for a sympathetic pl; Loss spread to insurance

Jenson Farms v. Cargill


o Facts: Warren Seed operates grain elevator; Cargill financed Warren. o Holding: Warren was an agent of Cargill and Cargill was responsible for

Warren’s obligations to the farmers. To establish agency, there must be an agreement, which can be proved

by circumstantial evidence that shows a course of dealing between the parties.

A creditor who assumes control of his debtor’s business may become liable as principal for the acts of the debtor in connection with the business if the creditor assumes de facto control of management of the debtor’s business. (RSA §14 O).

A supplier is generally not an agent, as long as he: (1) gets a fixed price; (2) acts in his own name; (3) has an independent business other than with the “principal.” (RSA §14K).

o Factors For Agency: ( de facto control –> paternalistic relationship) Right of 1st refusal Inability to enter into mortgages/purchase stock Constant recommendations and help Approval before major projects and expenses

o Factors Against : Relationship was merely buyer-seller or lender-borrower The financier was merely protecting his investment

(B) When Authority?

Forms of Authority:

Actual (Express or Implied)

Authority expressly or implicitly given to agent.

Implied Actual Authority: Agent reasonably believes the principal wishes him to act in a certain way and have certain authority. Factors: Authority typically granted for this job; authority accepted based on past dealings. (Mill Street)

Apparent (Implied) Communicated by principal to a 3rd person – (perhaps just via impression). (Lind commission)

Inherent (Implied)Arises solely from the designation by the principal of a kind of agent who ordinarily has those powers. (Applies to both disclosed and undisclosed principals.) May be found if an agent does something similar to what he’s authorized to do, but in violation of orders, if the other party reasonably believes that the agent is authorized to do this (§161, 194). Perhaps just a looser form of apparent authority: reasonable reliance on the customs rather than on the principal’s


representations to 3rd party.

Note on Undisclosed principal(Like inherent). An undisclosed principal is liable for acts of an agent “done on his account, if usual or necessary in such transactions, although forbidden by the principal.” Likewise, an undisclosed principal is liable for transactions made by the manager of the principal’s business that are “usual in such business,” even though the acts were contrary to the principal’s orders.

Actual Authority o Authority given expressly or implicitly to an agent

Implied Actual Authority o Whether the agent reasonably believes that the principal wishes him to act in a

certain way or have certain authority Authority typically granted for such a job or accepted based on past

dealings

o Mill Street Church Bill hires Sam to help paint church; Sam gets hurt and wants WC Held: Bill had implied authority to hire his brother because of:

o Practically necessary to carry out the delegated duties – (Need to hire help to do the task)

o Prior course of dealing – (Had done work in the past and always allowed to hire help)

Bill also had apparent authorityo Authority the agent is held out by principal as possessing

on which 3rd parties come to rely Sam’s past experience being hired by brother,

Apparent Authority – (when agent has authority, but not actual—neither implied or express)

o TEST : Principal acts in such a manner as to convey the impression to a 3 rd party that an agent has certain power

“Holds out” – (principal holds out to 3 rd party that agent had authority of this sort)

o Lind v. Schenley Industries : Facts : Sales rep claims he was told by middle manager that he would get

a really good commission. Issue is whether the middle manager had authority to bind employer to this commission arrangement.

Held : Doesn’t have actual authority from higher-ups, BUT has apparent authority because principal gave appearance to a 3rd party that agent had that type of authority

Dissent : 3rd party must reasonably believe


Inherent Agency Authority – Arises solely from the designation by the principal of a kind of agent who ordinarily possesses certain powers

o Mere Custom/Relationship/Title Watteau v. Fenwick

Facts : Manager of pub (Humble) is face of pub, but explicitly had no authority to buy certain items;

Held : P liable for all acts of the agents which are within the authority usually confided to an agent of that character

o Undisclosed principal is not relieved of liability for things within the “ordinary authority” of an agent.

RSA §194: - an undisclosed principal is liable for acts of an agent “done on his account, if usual or necessary in such transactions, although forbidden by the principal.” Likewise, an undisclosed principal is liable for transactions made by the manager of the principal’s business that are “usual in such business,” even though the acts were contrary to the principal’s orders.

Liability in Contract and Tort to Third Parties: Contract

o Inherent Authority / Unauthorized Acts of Agent (Nogales Service Ctr) TEST for Liability : (§161 – Unauthorized Acts of Agent)

You know he’s an agent Does something he’d usually be able to do to accompany his

authority You reasonably believe he had that authority

o Agency by Ratification – (§82): requires acceptance of the results and intent to ratify, with full knowledge of all the material circumstances

Something is done on your behalf, which did not bind you originally, BUT you gave it effect as if you authorized it by ratification.

Affirmance – (§83): Express or impliedo Manifestation of an election to treat an unauthorized act as

authorized, ORo Conduct by the person justifiable only if there were such an

electiono Can have implied affirmation from acceptance of results

when it’s uncostly to opt out (Silence = affirmation)

Botticello Facts : Sale of property by husband = controversy. Wife says she

never approved TEST :

o Acceptance of resultso Intent to ratifyo Full Knowledge of material circumstances

Applied : No intento No full knowledge of all material circumstances


o Agency by Estoppel – (§8B) is when Δ has a chance to deny or prohibit an agency relationship but does NOT do so, such that it appears Δ ratified actions of the “agent.”

TEST : (1) Acts/omissions (intentional or careless) caused the appearance

of authority (2) Reasonable good faith reliance (3) Change of position – (damages)

Hoddeson v. Koos Bros : “A tortious dereliction of duty owed to an invited customer”

Impostor at furniture store Held :

o D had duty to customers of reasonable care and vigilance. D has chance to deny/prohibit agency relationship

but doesn’t do so

THREE WAYS YOU CAN GET NAILED FOR CONTRACTS

Inherent Authority Ratification Estoppel

Rely on someone who: You know is an agent Does something he’d

usually be able to do to accompany his authority

You reasonably believe had that authority

Nogales

Even if you didn’t authorize up front, if someone does something on your behalf and you give effect to it as if you authorized it in the first place

Botticello

Cause – (your acts/omissions caused appearance of authority)

Reliance – (reasonable good faith reliance)

Damages – (change of position)

Hoddeson

Tort o Background:

In general, a “master” is liable for the intentional torts of his “servant” A servant must work on behalf of the master and be subject to the

master’s control over the manner in which the job is performed (RSA §2)

An independent contractor may or may not be an agent. Test is how much control the principal has over the physical conduct of the task being done.

o A non-agent independent contractor works independently to achieve a result via an arm’s-length transaction.

Why we distinguish between employee and IC: Least cost avoider. Person with control can reduce risks and


prevent accidents.o Franchise Agreements – (Servant vs. IC)

Concerned with the nature and extent of control Definition of servant (RSA §220) – a servant is a person employed to

perform services in the affairs of another and who, with respect to the physical conduct in the performance of the services is subject to the other’s control or right to control.

Largely turns on legal right to control the manner in which the IC/employee performs his job.

Factors to consider: Extent of control which master can exercise under the agmt Distinct occupation or business? Kind of occupation with reference to whether this type is usually

done under the direction of the employer or by a specialist without supervision

Skill req’d in the particular occupation Whether the employer provides the tools and location Length of time employed Method of payment – (time vs. job) Whether work is part of regular business of employer Whether or not the parties believed they were creating M-S

relationship Whether principal is or is not in business

Planning : Make clear that franchisees are really ICs

o Risk : lose the branding and standardization – (you may get a rogue franchisee who ruins the brand)

Require insurance – (customers won’t have to go after the big dog in the first place)

Emphasize safety and accident prevention in franchise manual (Last 2 help with loss spreading)

o Master-Servant If you want to get to the principal, you have to show that employee was an

employee of the oil company and not just the gas station. Key test: nature and extent of control. Humble Oil v. Martin

Facts :o Car parked in Humble gas station rolls down and hits

people Held :

o This was a master-servant relationship and the oil company is liable for the station’s torts.

o Enough control to put liability on them – (contractually empowered to give orders)

o Overall the station was subject to control of the oil company


Miller v. McD’s Facts :

o Finds stone in Big Mac. Sues on the idea that franchise was an agent of McDonald’s.

Held :o Apparent Agency: Public may not know the difference

that some McD’s are centrally owned and some are independently owned

Actual vs. Apparent Authority :o Actual – “right to exercise sufficient control over the daily

operations” maybe, maybe noto Apparent – McD’s held out the franchise as its agent and P

justifiably relied on that statuso Independent Contractor

Hoover Facts :

o Fire started by negligence of smoking employee. Held : the station is a non-agent independent contractor, so Sun

Oil cannot be sued for tort damages:o Not enough control – (voluntary suggestions and no control

over day-to-day ops) Murphy v. Holiday Inns

Facts :o Slip-and-fall at franchised hotel. Murphy wants to sue

Holiday Inn who claims not liable because hotel was not master/servant relationship.

Held :o Motel retained day-to-day control over the hotel operations

not an agent or servant. Looking for an element of continuous subjection to

the will of the principal which distinguishes the agent from other fiduciaries

Humble Oil / Miller v. McD’s Hoover / Holiday Inn

M-SEnough control to put liability on them Contractually empowered to give

ordersApparent authority – (P may not know the difference)

Liability

ICNot enough control Voluntary suggestions No control over day-to-day ops

No Liability


Scope of Employment o Why this matters:

Servant’s torts (RSA §219) – a master is subject to liability for the torts of his servants committed while acting in the scope of employment. An act may be within the scope of employment even if it is criminal or tortious (§231).

o Idea: “Deeply rooted sentiment” that business enterprise cannot escape responsibility for accidents which are characteristic of its activities”

Note the disagreement over the meaning of “scope of employment” => “purpose of serving the master” test (§228) vs. Ira Bushey (“arising out of, and in the course of”).

o TEST : – (§228) Activity of the kind he is employed to perform Authorized time and space limits Purpose is to serve the master Use of force is not unexpected by the master

o TEST II – (§229(1)) Scope = same general nature as that authorized, or incidental to that

authorized

Scope of Employment RSA § 228

Of Kind employed to perform

Happened during authorized Time/Space

Actuated at least in part by a Purpose to serve the master.

If intentional force, Use of force not unexpectable

(same general nature as that authorized, or incidental to that authorized)

Other factors (broadened version) “arise out of and in the course of” as long as sort of connected to employment in tiem and space, it’s

connected.. Foreseeability Was presently interfering with employee’s ability to do job

YES:o Ira Bushey v. US (2nd Cir. 1968, Friendly)

Facts : Drunken sailor returns and damages dock. Dockowner sues Coast Guard on theory that Lane was acting as an

agency and his employer was liable for his negligent acts. Held :

Note: Friendly rejects the narrow “purpose of serving the master” test in the RSA §228


Test: Employers are liable for risks caused by employees that “arise out of and in the course of his employment of labor.”

o He only had access to area due to his status “arose out of”

o Reasonably expectable Foreseeability if so, seems unfair to let the gov’t off

o Fairness / Intuition Counter :

Inefficient – (hard to prevent). Dockowner probably was in better position to prevent this.

o Manning v. Grimsley Facts :

Orioles pitcher warming up beamed a heckler. Heckler sues Orioles as his employer. Argument: not within the scope of employment.

Held : Orioles liable. To recover damages from an employer for an assault by

employee, plaintiff must show that assault was in response to conduct that was presently interfering with the employee’s ability to perform his duties successfully

o Looking for an affirmative attempt to prevent employee from carrying out assignments – (because that implicates the employer)

(This is in contrast to common law rule which said that principal is not liable if servant intentionally did wrong)

o Recognized difficulty in controlling employeeso NOW: §231 – (activity can be in scope of employment

even if consciously criminal or tortious) Planning :

Team can put in player’s K that he loses pay or gets fired if he does these things

o NO: Clover v. Snowbird Ski Resort

(Rejects Bushey “foreseeability” and sticks with the Restatement is he in the scope of employment?)

Statutory Claims o Courts sometimes use agency principles to determine if employees have sufficient

control for statutory claims Ct employs agency law rather than coming up with its own standards of

who’s an employeeo Arguello v. Conoco

Facts : Minorities claim they were discriminated against at Conoco stores Issue: could the oil company be sued in addition to the individual

stores and individual employees.


o (Conoco claims no daily control and that this was not within the scope of employment)

Held : (1) Conoco is not liable for branded stores because there is no

agency relationship:o No agency relationshipo Look at control – (some guidance, but no day-to-day

control) (2) At the Conoco-owned stores, this survives SJ on scope of

employment o Conoco can’t get SJ on actions of employee fact-

specific inquiry is required into scope of employment; remanded.

o §229 factors : Departure from normal methods Setting Intentional Tort

Tortious conduct is not necessarily outside the scope of employment for statutory violations.

Liability for Torts of Independent Contractors o Majestic Realty v. Toti

Facts : Toti does a poor job of taking down building and damages

Majestic’s property Maj sues parking authority.

Issue : Is parking authority (gov’t) liable for actions of Toti? Held :

In general, a person is not liable for the acts of an IC, BUT there are 3 exceptions:

o 1. If owner retains control of the manner and means of doing work

o 2. If owner negligently hires an incompetent contractoro 3. If the activity contracted for is a nuisance per se –

(broad definition: “inherently dangerous” activity) ie, an activity that requires special skill or care;

peculiar risk or harm to other unless special precautions are taken

Planning : Better job screening Check to see if they have bond (negligence in hiring incompetent

IC may include financial incompetence, ie not bonded. Issue not briefed)

Torts of Independent Contractors


A person is generally not liable for the acts of an IC, BUT there are 3 exceptions: Control of manner/means

Negligent hiring

Nuisance (“Inherently dangerous” activity)

Fiduciary Duties of Agents Fiduciaries owe more than just what’s in the contract

o Special obligations that can’t be waived – (element of good social design)o Rationale :

Power Responsibility / Authority Accountability When discretionary power is granted for the purpose of assisting others,

legal rules are created to control any attempt by the fiduciary to get benefits not explicitly granted by the terms of the relationship

Duties Owed o Obedience – (385)

Agent must obey all reasonable directions in regard to the manner of performing service; not act “contrary to” directions of the principal

o Care – (379) Duty to act with “standard of care and skill”

o Loyalty – (387) Act solely for benefit of P in all matters connected with the agency and

should not receive personal benefit unless they disclose the benefit to the principal and the principal approves.

RULES :o No “secret profits” / “implicit compensation”o No use of positiono No use of property/knowledge/assets of Po No usurping business activities / competing

o Conflict of Interest – (389) Can’t deal with P as adverse party w/o P’s knowledge. Can’t be on both

sides of a transaction

Agents are fiduciaries (RSA §13)

Duty § Standard

Obedience 385 Obey all reasonable directions regarding manner of performing svc

Not act “contrary to” directions


Care 379 “standard of care and skill”

Loyalty 387 Act solely for benefit of P in all matters No “secret profits” (disgorgement) / “implicit compensation” (§388) No use of position No use or taking of property/knowledge/assets of P No usurping of business opportunities

Conflict of Interest

389 Can’t deal with P as adverse party w/o knowledge

Duties During Agency o Reading v. Regem

Facts : Solidier getting payoffs in Cairo; gov’t sues

Held : Agent can’t make secret profits from the misuse of his position.

If he does, he must turn the profits over to the principal.o §388 – an agent who makes a profit in connection with

transactions conducted by him on behalf of the principal is under a duty to give such profit to the principal. Doesn’t matter if the principal couldn’t have done it itself.

If use of his position predominates wrt why he got the profits, he is subject to P for profits

o §404 – uses for his own purposes the assets of P’s businesses subject to liability to the P for the value of the use – (uniform / position)

(Great moral condemnation against secret profits)o Unjust enrichment

Was the Principal hurt? 1. Lost the “sole loyalty” and full commitment of the A 2. May have hurt P’s credibility/reputation

o Army acknowledges that they could not have made these secret profits themselves, BUT establishes a prophylactic rule to deter conflicts of interest and ensure “sole loyalty”

Hard to measure the “cost” to the gov’t, so we have a prophylactic rule to deter. Penalty default rule even if your transaction would have been approved, you still must disgorge if you didn’t disclose it in advance. This gives employees an incentive to disclose as much as possible when you’re not sure.

Close Cases : Army hero gets endorsements OK because getting paid for

celebrity and not because of employment status


HLS Prof makes a lot of money doing TV appearances selling his own skills/experience, but probably benefiting from HLS name/position – (most schools have rules)

o Gen’l Automotive Manfg. v. Singer Facts :

Singer is highly-skilled machinist with full-time job – (K says he must give “entire time, skill, labor, and attention”)

Subcontracts extra work out when GA has too many orders and makes $64k by taking a cut of the profit – (no disclosure or approval)

Issue: Did he act in good faith? Held : NO; conflict of interest, so must disclose!

Fiduciary duty requires an agent to exercise “utmost good faith and loyalty”

o Duty to exercise good faith by affirmatively disclosing to P all the facts regarding the manner – (not his decision to make since he was self-interested)

o Don’t want you to act adversely to the interests of the P by serving of acquiring any private interest

(Action forcing default rule: encourages agent to disclose as much as possible when conflicts may arise)

Note : because this was decided on fiduciary duty, not contract, the penalty was harsher. Breach of fiduciary duty=disgorgement. Breach of contract=remedial damages.

Duties During and After Termination of Agency o Town & Country Home Svcs. v. Newbery

Facts : Newbery is former employee who is soliciting business away from

a small house-cleaning corporation. Held :

A former employee may not solicit his former employer’s customers if they are not openly engaged in business or if their availability as customers cannot be readily ascertained, but whose patronage has been secured by years of effort and goodwill on behalf of company

o Factors : Customer list not readily ascertainable TC

invested in developing the list Access to secret info Misuse of asset given Fid Duty to emp

Rule: Confidential information (RSA §396) – after termination of

agency, the agent has a duty not to use or disclose any trade secrets, lists of names, or other confidential matters given to him only for the principal’s use. But the agent may use general


information about the method of business, and the names of any customers retained in his memory, if not acquired in violation of his duty as agent.

This means that fiduciaries have a duty not to take trade secrets, goodwill, etc., when they leave. It’s analogous to the duty of loyalty.

During After

Can’t make secret profits thru the misuse of position – (Regem v. Reading)

“Utmost good faith and loyalty” – (Singer)

Can’t solicit former employer’s customers if patronage has been secured by years of effort and goodwill on behalf of company – (Town & Country)


2. PARTNERSHIP

6 background issues in partnerships: Do they have a legal personality? NO What are the management rights? EQUAL What is the profit sharing arrangement? EQUAL What are the liability rules for the partnership and partners? Proportional to investment Liquidity of investment?

Sources of partnership law: Uniform Partnership Act (UPA), Revised Uniform Partnership Act (RUPA) – unlike the

RSA, these actually are the law in almost every state.o Most of these are default rules, but partners can opt-out by express agreement.

DEFINITION Association of 2 or more persons to carry on as co-owners of a business for profit

o Usually done by agreement, but doesn’t have to be written; can be oral or implied (unlike corporation)

o Case law helps distinguish from employees, lenders, or contractors.

Basic Doctrine Legal Standing

o Not a person for diversity purposeso Not a person for tax purposes

Just pass-through to individuals who pay own taxes on their shares. Advantage : No double taxation

Management rightso UPA §18(a) – all partners have equal rights in the mgmt and conduct of business

§18(h) – decide differences based on a majority BUT every partner is an agent of the Partnership, so if one partner went

off and signed a deal, then he could have bound the partnership even if the other 2 disagree

o BUT can be waived/modified by agreement Profit-sharing

o Each partner shall be repaid his contributions and then share EQUALLY in the remainder.

o So, profits are shared per person, not based on contributiono The share in profits is the same as the partner’s share in losses if the partnership

tanks.o Salary: no partner is entitled to salary unless bargained for up front.

Liabilitieso Can sue the partnership for wrongful acts done by one of the partners in the

ordinary course of business (generally torts, UPA §13)o Standard :o Torts jointly and severally liable


o Other debts or obligations jointly only Apportionment of Liabilities: Each partner is liable for losses or

obligations according to his share in the profits. Default rule = equal distribution of losses (§18(a)).

If the agreement divides up profits but doesn’t address losses, the division of profits is default rule for how to divide losses under UPA.

o NOTE - RUPA §306(a) says that all partners are jointly and severally liability is for ALL obligations of the partnership.

BUT new partners are not liable for any obligations incurred before they became partners (§306(b).

BUT creditors must exhaust the partnership property before going after individual partners (RUPA §307(d))

Rights of partners upon dissolution: Right to Buyout

o Rightful dissolution (§31): When:

If no violation of the p’ship agmt, then dissolution is caused:o When the term of the undertaking expireso By an explicit statement by any of the partners – (if they

don’t agree otherwise, it’s a partnership-at-will and can be dissolved by any partner at any time

What happens : P’ship property is used to pay all the liabilities and the surplus is

paid in cash to the partners - §38(1)o Wrongful dissolution :

When : Partner attempts to dissolve the p’ship in violation of agmt

What happens : Partners who haven’t violated are entitled to their share of the

surplus in cash and then have a right of action for breach of K against wrongful partner

“Rightful” Partners may continue the p’ship, but “wrongful” partners must get bought out

o If one partner wants out, others could choose to buy him out in order to keep the partnership going

Element

Legal Standing Not a person for tax or diversity purposes

Management Rights All Partners have equal rights

Caveats Can be modified by agmt


Majority used to decide differences Actions of one can bind the whole

Profit-Sharing Repaid for contributions then share equally – (can K)

Loss-Sharing Shared proportional to investment – (can K)

Right to Buyout If Rightful Dissolution: P’Ship property used to pay all the liabilities and the

surplus is paid in cash to the partners

If Wrongful Dissolution: Non-violating Partners entitled to their share of the surplus

in cash and then have a right of action for breach of K against wrongful partner

“Rightful” Partners may continue the p’ship, but “wrongful” partners must get bought out

Distinguishing Partnership: From Employees :

o Fenwick v. Unemployment Comp. Commission Facts :

Company trying to avoid paying unemployment by arguing that the receptionist is a partner, not an employee. She’d been given her a cut of the profits (20%) instead of salary raise.

Held : she is an employee Simple profit-sharing is not dispositive with regard to whether

someone is a partner or not Factors – RUPA §101(6)

o Factors present (but not dispositive) Profit-sharing Language in K

o Other factors lacking: Co-ownership Loss-sharing No capital contribution Distribution/dissolution rights Control/Mgmt Conduct toward 3rd parties

From Lenders :o Martin v. Peyton

Facts : KNK losing money and needs capital; gets loan from Peyton,

Perkins, & Freeman


o Give securities to use as collateral; gives cut of profits during loan; gives option to PPF to join KNK as partners; gives other control provisions such as demanding resignation of KNK members.

o BUT PPF could not bind KNK nor initiate KNK transactions

KNK engages in risky transactions and fail Creditors try to go after PP&F under P’ship theory

Held : NO P’Ship – (some control, but not pro-active control).

o PPF was a lender, not a partner. Factors :

o No co-ownership – share in profits only in a limited manner and no loss-sharing agreement

o BUT veto/information rights + some profit-sharing – (makes it close) Question of degree!

Planning : Lose the “veto” right and simply ban certain risky transactions. Don’t have the resignation letters Monitor the borrower more closely

From Contractors :o Southex v. RIBA

Facts : RIBA contracts with SEM (later purchased by Southex) to put on

home shows; SEM does organizing, advertising, and insurance. Profits split 55/45. RIBA later hires a different exhibitor.

Held : NOT a partnership! Non-agent independent contractor (service contract)

Contractor/subcontractor: NOT a p’ship – (hired to put on the show and not necessarily a partner)

Totality of the circumstances:o FOR

Split profits (55/45) Language in preamble saying saying “partners” RIBA could veto some aspects

o AGAINST All losses on SEM SEM had control/mgmt Fixed term contract Never adopted a name for the “partnership” Never filed for partnership taxes.

RC: Close case. Could have found partnership. Planning :

Watch your language – don’t say “partner” in preamble Figure out an end strategy. There should have been a clause about

how to dissolve the deal.


Estoppel : Broadens modes of finding a partnership.o Young v. Jones

Facts : Audit letter from PWC-Bahamas which said money would be

protected Plaintiff tried to sue PWC-US, claiming PWC-B and PWC-US

were partners.o Defense 1: separate legal entity – (true)

Claim 2: partnership-by-estoppel – “you held yourself out to the world and we relied upon that”

o Letterheads/brochures Held :

NO. Not a partnership by estoppel – (UPA §16(1))o Partnership-by-estoppel is a representation that one is a

partner of another (or consent to such representation) when a 3rd party gives credit to the apparent partnership on the basis of such representation

Must have actually relied on these representations. And give credit may mean narrowly, literally give credit (extend a loan)

Broader formulation: §308(a) – “If a person, by words or conduct,

purports to be a partner… the purported partner is liable to a person to whom the representation is made, if that person, relying on the representation, enters into a transaction with the actual or purported partnership”

Some P’Ship Factors Partnership by estoppel UPA

Profit-sharing Language in K Co-ownership Loss-sharing Capital contribution Distribution rights Control/Mgmt Conduct toward 3rd parties Estoppel – (representation)

UPA §16(1) A representation that one is a

partner of another (or consent to such representation), AND

A 3rd party gives credit (relies on and, perhaps literally, gives credit) to the apparent partnership on the basis of such representation

RUPA §308(a) (broader): A “relying on the representation,

enters into a transaction with the actual or purported partnership.”

Fiduciary Duties of Partners


Loyalty o RUPA §404(b)

3 requirements Duty to account for all profit, property, or benefit derived from the

partnership Duty to refrain from dealing with the partnership as or on behalf

of a party having an interest adverse to the partnership – (Conflict of Interest)

Duty to refrain from competing with the p’ship in the conduct of p’ship business

CANNOT waive the fiduciary duty of loyalty – (RUPA §103(b)(3)) BUT can specify specific activities that do not violate the duty of

loyalty as long as the opt-out is not manifestly unreasonable You do not violate the duty of loyalty simply by looking out for

your own interest – (§404(e))o Meinhard v. Salmon

Fact : Salmon bring in Meinhard as partner on long-term lease; as lease

nearing end, lessor offers the whole block to Salmon Salmon accepts for his own corporation w/o consulting Meinhard

Held : Duty of Loyalty violated. Salmon owed duty of disclosure to Meinhard

o Joint venturers owe to one another the finest duty of loyalty while the enterprise continues

o Once he discloses, Cardozo doesn’t say what his obligation is, but he must at least disclose

“punctilio of honor” – honor in every dimension “Trustee” – something stricter than the morals of

the marketplaceo Fact that Salmon had more power adds to this duty to

disclose. o Remedy: Meinhard is offered a chance to buy in 50-50

even though this was for more land than the original lease. Opportunity lost, so should get half of that.

Quote: Joint venturers owe to one another while the enterprise continues, the duty of finest loyalty. Many forms of conduct permissible in an arms-length contract are forbidden to those bound by fiduciary ties – a trustee is held to something stricter than the morals of the market. Not honesty alone, but the punctilio of an honor the most sensitive is then the standard of behavior. Courts have been uncompromising in refusing to undermine the rule of undivided loyalty by the “disintegrating erosion” of exceptions. The level of conduct for fiduciaries has been kept at a level higher than that trodden by the crowd. (pretty elitist).

Dissent (Andrews):


Existing project was just a limited scope 1 project, set to expire This was a new opportunity outside the scope of the fiduciary duty

o Cardozo : Nexus of Relation The new opportunity is related and just a continuum

of the relationship only got it because of where you stood with the partnership

Policy : People can bargain away from specific pieces of §404 (partner

conduct), but not “fiduciary duty” as a whole Possible terms in contract :

o Meinhard can participate in any new opportunity on the same terms as in the 20-year venture

o Competition/Renegotiation: Salmon must inform Meinhard who can compete for the opportunity

o Salmon’s option: Salmon can keep the new opportunity or offer a piece to Meinhard

Planning : Salmon should have made clear that the original partnership was

for JUST 20 years and no moreo Peretta v. Prometheus Development Company (2008)

Facts : PDC is the General Partner of PIP (an LLC).

o General partner in an LLC has unlimited liability, so that’s why it is a corporation

There is a merger of PIP and PIP Partners (owned by Diller) so that he has more stake going forward

Issue: What vote of the limited partners limited partnership is necessary to ratify a self-interested transaction proposed by the partnership’s general partner?

Holding: Absent a partnership agreement modifying the default rule, would

need a UNANIMOUS vote to ratify a self-dealing approval. o Here, they had an agreement to the contrary.

Can permit ratification of a breach of duty of loyalty. But can’t be manifestly unreasonable.

o But: it would be “manifestly unreasonable” for a partnership agreement to include votes cast by an interested general partner or its affiliates in a ratification vote. Can’t count the votes of the interested parties in order to get to the majority.

Strict concept of fiduciary duties. Strong public policy against interested party transactions.

o Meehan v. Shaugnessy Facts :

Lawyers jumping ship and taking clients with them.


Rumors start to spread and they lie, secretly recruit associates, and contact clients before they leave

Held : Breach of Duty of Loyalty – (Partners have a duty to render on

demand true and full information of all things affecting the partnership to any partner”) UPA §20

Problems :o Lies to other partners: secrecy and extensive preparationo Process : Delay in providing info to partners about clients

they would solicit. Recruited clients too earlyo Content of letter :One-sided letter to clients: didn’t tell of

choice to stay with firm Policy :

Rules of competition are stricter when fiduciaries involvedo Can’t compete against former partners as vigorously as you

could an unaffiliated corp. Care : duty only owed to other partners and is subject to BJR (more than negligence)

o §404(c) Partner’s duty of care is limited to refraining form grossly negligent or

reckless conduct, intentional misconduct, or knowing violations of law [Business Judgment Rule]

o Bane v. Ferguson – (Care) Facts :

Retired law partner gets pension plan Following disastrous merger with other law firm, firm dissolves

and pension gone Bane sues firms’ management council for breaching fid duty

Held : 1. Partners do have a duty of care and loyalty, but No Fid Duty to

him not a partner anymoreo Keep in mind who is the fiduciary

2. Even if there was one BJR, which requires more than negligence

o You have a duty of care, but can’t hold them liable unless you go beyond proving mere negligence – (he’s just alleging that they didn’t do a good job)

“Gross Negligence” – (more extreme) Duty of Good Faith (for expulsion)

o §31(1)(d) Expulsion must be “bona fide” or in “good faith”

o Lawlis v. Kighlinger & Gray Facts :

Alcoholic partner given 2nd chance later expelled by majority vote

Held : expulsion was lawful.


Wrongful dissolution NO – (was in accordance with the partnership agmt)

Breach of Fid Duty of Good Faith NOo No “predatory purpose” – (he claimed they were trying to

increase their own ratio, but ct finds no support for it)o

Fiduciary Duty Standard

Loyalty Duty to account for all profit received Duty to refrain from dealing / competing Duty of full disclosure for p’ship opportunities – “punctilio of

honor” – (Meinhard v. Salmon) Duty to render info on demand – (Meehan v. Shaugnessy)

Care

§ 404(c)

Duty owed, but only to partners. Subject to BJR: Duty to refrain from grossly negligent or reckless

conduct, intentional misconduct, or knowing violations of law – (BJR=more than negligence)

Good Faith Can fire someone without cause, but expulsion must be “bona fide” or in “good faith.” No “predatory purpose”– (Lawlis)

Note: can’t contract out of duty of good faith

Partnership Property Property Rights are 3-fold : (UPA §24)

o Rights in Specific Partnership Property – (§25) Possessory right to use for partnership purposes This is NOT assignable by individual partners – it’s all controlled by “the

partnership” (§25(2)(b)). Partner, as an individual can’t transfer, bequeath, or assign any

individual partnership asset unless it is done by the partnership.o Interest in the Partnership – (§26)

Partner’s interest = his share of profits + surplus (financial flow)

YES personal property YES assignable by an individual

BUT not a very big mkt for partnership shares since much of business depends on the individual person who is the partner rather than ownership of an equity interest.

o Management Rights – (§18(e)) Equal rights unless different arrangement NOT assignable by an individual

New partners can only get in by consent of other partners.


(Very unlike corporation…can sell your shares) Putnam v. Shoaf

o Facts : Putnam’s wife needs money and conveys her share of cotton gin

partnership to Shoaf. After she gets out, it’s revealed that the old bookkeeper was stealing

money, so $$$ comes back in Putnam’s wife wants a pieceo Held :

NOT entitled to refund A partner has no specific interest in the property or assets of a

p’ship. o She just had a pro rata shareo She thought she was conveying the 1st thing above, but she

could only convey the 2nd Can’t convey only certain assets or parts can only convey

your share of the p’shipo If oil is found on p’ship property after one partner gets out,

that oil belong to the p’ship, not to the old partner

Partnership Right Standard

Rights in specific p’ship property

Right to use for p’ship purpose No right to assign by individual partner

Interest in the Partnership

Personal property assignable

Management Rights Equal rights unless different arrangement – (NOT assignable)

Management Rights Various collateral powers Individual agent can:

o Act as an agent of the partnershipo Bind the p’ship by admissionso Imputed knowledgeo Wrongful actso Breach of trust

But note:o Bundle of mgmt rights CANNOT be sold by an individual partner.

Partner Deadlock :o Nabisco v. Stroud

Facts :


Stroud told Nabisco (bread supplier) that he would not be personally liable for anything sold to partnership

Other partner (Freeman) tells Nabisco to keep selling Business fails and Nabisco comes to collect from Stroud

Held : Freedman had equal rights in the partnership and he could bind the

partnership because this was in the ordinary course of business. So Stroud is liable even though he specifically said he would not be.

Rule :o Need a majority to make binding ruleso BUT the refusal of one partner is not binding on the other –

(the other keeps his right to act as agent on behalf of the partnership)

o Summers v. Dooley Facts :

Two trash collectors; Summers wants to hire a new guy and Dooley does not

Summers does it anyway and wants reimbursement Held :

Reimbursement decision is subject to majority rule Rule :

o Business differences must be decided by a majority of the partners, absent agmt to the contrary – (§18(h))

o Reconciling Nabisco and Summers : It’s first mover advantage => if acting in the ordinary course of business,

a partner can take action unless forbidden by a majority (§9). But the partnership is not bound to reimburse a partner for action taken in a private capacity, unless there is majority support for this.

Competing Principles : §9 – each Partner is agent of Partnership for ordinary business §18(h) – need majority vote if partners disagree

Rule : Need a majority to bind the p’ship to certain rules / policies

o When 3rd party involved: agency power trumps the deadlock

o When it’s a deadlock, one partner can’t use agency power against the partnership

Planning : Be more explicit in agmt about deadlock risk and authority

Moren v. JAXo Facts :

Son of partner puts hand in dough machine Father sues the Partnership

Partnership/Insurance company seek indemnification from the mother for negligence

o Held :


Mother wins. She was acting in the normal course of business, so company must indemnify!

Rule : UPA §401(c)

o P’ship shall indemnify a partner for liability incurred by the partner in the ordinary course of business

[So even if the P’ship won the suit against the mother, if it was in the normal course of business, they would have had to indemnify her – (circular!)]

Day v. Sidley & Austino Facts :

Day runs Sidley DC and is upset with merger – (has to move to different office and be a co-chair)

Day sues alleging misrepresentation by merger cmt and breach of fiduciary duty to him

o Held : S&A is not liable to Day 1. No fraud or misrepresentation

He had no legal right to the chair in the P’Ship Agmt 2. There was no breach of fiduciary duty:

Three main fiduciary duties: (1) partner must account for profits acquired in a manner injurious to the interest of the partnership; (2) partner cannot acquire for himself without consent partnership assets, and cannot divert opportunities to his own use (Salmon); (3) must not compete with other partners within the scope of the business.

Any withheld information merely related to the internal structure of the firm. The partners gained nothing by withholding this, in terms of money or power.

3. Executive Cmte had right to make the decisions that it did Law firm partnership agreements create control arrangements Similar to corporation with voting rights A lot of the power on day-to-day basis is in a Board Cmt

o It’s possible to frame a P’Ship agmt in the same way as a corp – (UPA has a default arrangement, but you can contract around that)

If he wanted special rights, he should have found a way to get it in the P’Ship Agmt

Partnership Dissolution Basics :

o (1) One partner can dissolve (or “disassociate”) from the P’ship at any timeo (2) BUT there may be consequences: depends on whether “rightful” or

“wrongful” (A) In conformity with the agreement? Rightful

Types of rightful dissolution: o If partnership-at-will, any partner may dissolve at any time


o Death of a partnero Bankruptcy of the p’shipo Dissolution decree by a cto Proper expulsion of partnero Dissolution to avoid unlawful activity

If rightful :o X gets bought out at value of interesto P’Ship is “wound up” and partners all get payment in cash

“Wound up” – (one of 4 things) 1. Distribute assets 2. Sell to 3rd party 3. Other partners buy out at FMV 4. Go to court, get “receiver” and sell at a

public auctiono UNLESS other partners agree to continue the p’ship or put

it up for auction Business does not necessarily break up just because

one partner leaves Good partnerships DON’T use the default rules.

Explicit buy/sell agreements. (B) Not in conformity with agmt? Wrongful

Types of wrongful :o Dissolution in breach of p’ship agmto Dissolution before expiration of the term

At-will = always right to dissolve Term = wrongful unless term is over

o Partner is expelled by a ct or for being in bankruptcy If wrongful :

o Gets paid back for his interest in the partnership, o BUT 3 consequences :

Only paid out over time – (not right away) Offset for damages – (may be disruption for getting

out midstream) Other partners have right to continue the business –

(don’t get “going concern”)o Default rules for dissolution and its consequences CAN and SHOULD be

modified Good partnerships have explicit buy-sell agreements and they spell out

rules, formulas, and procedures in detail

Rightful Wrongful

If partnership-at-will, any partner may dissolve at any time

Death

Dissolution in breach of p’ship agmt Dissolution before expiration of the term

o At-will = always right to


Bankruptcy of the p’ship Dissolution decree by a ct Proper expulsion of partner Dissolution to avoid unlawful activity

dissolveo Term = wrongful unless term

is over Partner is expelled by a ct or for being in

bankruptcy Partner is just interfering – (Collins)

Owen v. Coheno Facts :

Bowling alley partnership gone bad Owen put up initial funds started out profitable, then turn worse Cohen being an ass, not doing much work

Owen sues for dissolutiono Held :

Owen wins P’Ship dissolved Remedy: Own gets a decree of dissolution and a sale of partnership

assets – (gets his loan + ½ profits) Rule (UPA §32)

Court may decree dissolution of partnership if:o (1) a partner “has been guilty of such conduct as tends to

affect prejudicially the carrying on of the business;o (2) a partner willfully or persistently breaches the p’ship

agmt, or otherwise conducts himself in matters relating to the p’ship that it is not reasonably practicable to carry on the business in p’ship with him

(even individually trivial acts can be enough to warrant dissolution when they are taken in the aggregate)

o (3) other circumstances render dissolution equitable Why not just dissolve?

Maybe there was an implied term such that if Owen invoked his right to dissolve, he would have violated the agmt, making this a wrongful dissolution.

Also, Owen put up the initial funds since business was losing $$$, he would get totally shut out if he just dissolved

Collins v. Lewiso Facts :

Cafeteria business Collins puts up $$$ / Lewis does ops

Major cost overruns Collins wants out blames Lewis and wants judicial dissolution

Collins has power to get out, but consequences (wrongful dissolution because fixed term)


Wants judicial dissolution so he can avoid damages without having to keep pumping in $$$

o Held : Dissolution not granted

Jury decides Lewis was a competent manager and Collins was interfering

Collins argues that p’ship should be dissolved because it was futile (no economic purpose) NO, jury blames Collins for interference

o Planning : Collins should have capped the amount of $$$ he was willing to pay in

don’t agree to such an open-ended commitment Page v. Page

o Facts : Linen business. Slow at first, but then picking up Air force base built and one brother wants out to start his own unit

o Held : Dissolution OK

Partner-at-will has no duty to remain in the partnership, regardless of how profitable it is

BUT the departing partner cannot “freeze-out” a co-partner to appropriate the business to his own use

Duty of good faith extends to dissolutiono Implied agmt not to wrongfully exclude a co-partner from a

valuable business opportunityo Must fully compensate partner for the prospective profits –

(high “going concern”)o Planning: have a buy/sell agreement.

Prentiss v. Sheffel : We didn’t read this.o Issue :

What is the right of parties to bid in a judicially-supervised auction when p’ship has been wound up?

Minority partner claims the 85% partners shouldn’t be able to bido Held :

Bidding was proper – no “paper dollars” argument You’re still better off if they are participating because price is

higher for you (no indication that exclusion was done for the wrongful purpose of

obtaining the p’ship assets in bad faith rather than merely the result of inability of partners to function together in harmony)

Loss-sharing Default :

o Each partner shares in profits equally and each must contribute toward losses according to his share of the profits – (RUPA §401(b))

BUT can contract around that Kovacik v. Reed


o Facts : Kitchen business

Kovacik = $$$ / Reed = labor/skill Profit sharing is 50:50 and default says losses are 50:50 too

o Held : If one partner has contributed all the capital and the other has

contributed only skill and labor, there’s no recovery for losses of capital partner. Labor partner does not have to contribute to the losses.

If business goes bust:o Capital guy loses investmento Labor guy loses opportunity to work and work he’s already

put in.o Kovacik vs. RUPA §401(b)

RUPA rejects Kovacik Default rule = profits equal; losses according to profits – (even if

one partners contributes no capital)o Planning :

Contract for your rights!

Loss-Sharing

Usually equal BUT:

If one guy is all labor and the other guy is all capital, we won’t go after the labor guy when things go bust

Buy-out Agreements G&S Investments v. Belman

o Facts : Nordale manages apt complex and is crackhead Other partners sue to dissolve, buy out, and continue the business

BUT then he dies question of how to distribute?o K said that other partners could continue the p’ship

business and can purchase the interests of the leaving partner at value of “capital account.”

o Held : Nordale gets nothing

Under the agmt, they have to value his “capital account,” but his value is negative

Courts must give effect to the language of the K, absent fraud or distress


No ambiguity here in how the “capital account was to be calculated

o Planning : Even careful planning is not full-proof Establish “trigger” events for buyout Establish buyout formula

Meehan v. Shaugnessyo Facts :

Law firm dissolution – (they leave firm and toy with clients)o Held :

For clients taken away fairly: Could take clients if they had been responsible for bringing them

in (“through the efforts or connections” of the partner) and if they compensated the firm for expenses incurred in servicing that client up until that time

For clients taken away unfairly (breach of fiduciary duty): If they wouldn’t have otherwise left and the firm was harmed:

Disgorgement of profits. Just share as would have if still partners.

o Policy : Take away all the benefits of wrongful breach

(but we’ll give them the opportunity to prove that everything was OK)

Limited Partnerships Concept :

o Goal was to avoid bad tax consequences of the corporate form while preserving limits liability

o Allows investors to be treated like SHs as long as they don’t participate in the management

o Seen today : Real estate – (need a lot of money up front and investors can be passive +

investors like early accounting losses) Holzman v. DeEscamilla

o Facts : Two “money” partners want to escape as just limited partners to avoid

liability for unfulfilled obligationso Held :

They were too involved in mgmt general partners Made decisions as managers

Rule : A partner in an LLC is not liable as a general partner unless, in

addition to his rights and powers as a limited partner, he also takes part in the control of the business

Rationale :


Want to give people an incentive to get involved as creditors to small businesses without having a lot of liability

BUT once you take control, we’ll hold you fully liable and you’ll lose the benefits of your “limited” status.

RUPA :o Makes it more lax just consulting and advising doesn’t make you a general

partnero Exposure to 3rd parties is limited to situations when the 3rd party transacts business

with the limited partner (contract/not tort) and reasonably believes the partner is a general partner

Limited Partnerships

We’re fine treating you as a SH as long as you’re not participating in the management Give unlimited liability to truly limited

partners


3. NATURE OF THE CORPORATION

Why corporations exist Rise of the Corporate Form

o Conditions : 1. Technology

Need for BIG firms – (i.e. railroads) 2. Wealth Distribution

Not as clustered in just a few wealth families 3. Private Property

Legal system protects private property so you need firms to raise capital on their own.

4. Political Preconditions Political system that will enforce contracts

o Conditions : Need a business form that best aids:

1. aggregation of large of K from many investors 2. operation of firm with many owners and employees 3. is best fit to survive

Four features:o (1) Investor liabilityo (2) Investor ability to transfer assetso (3) Legal personality of the firmo (4) Managerial power arrangement


Compare Basic Characteristics to Partnership :

INVESTOR LIABILITY

Why it matters? Contract and tort What does form say about it? Can you contract around?

Partnership Corporation

Joint and several liability for torts and breach of trust

Joint liability for other p’ship debts under UPA (or joint and several under RUPA)

Must contribute to p’ship losses Must share in others’ unmet contributions Mutual agency can be bad bound by

others

Limited Liability – (SHs only liable for agreed subscription price)

Function: Corporation wins for investors on this prong.o Able to spread investment on many people for big projects while allowing limited

liabilityo Shift risk to the better bearer – (large entity can be in position to control risk)o Reduce transaction costs

Credit evaluation – don’t want banks to have to look at each individuals’ position and ability to recover

Enforcement of judgment – can just go after one entityo Shift cost of business to others – (liability is limited, so may not be able to pay out

fully to tort victim)


INVESTOR ABILITY TO TRANSFER INTERESTS

Why it matters? Can you get it out efficiently, quickly, and easily? What is the information like? What features of the form help or hurt?


Partner can transfer interest in p’ship, but don’t get full rights. Get to use property and share of it upon dissolution. NO TRANSFER

o Specific p’ship propertyo Mgmt rights (need consent of all)

YES TRANSFERo Money stream – (interest in

p’ship)BUT Information rights are poor

o Can’t gain right to demand info from other partners

o Block of information inhibits the trading mkt

No negotiable instrumento No note; simply at the mercy of

the seller who may have already pledged it to someone else.

“Double Issuer” Problemo If you buy a partner’s interest,

you’re concerned with 2 things: 1. How well the whole

p’ship does 2. How well the selling

partner does – (does he keep doing his job? Remains a partner even after selling his interest, but has little incentive!)

No organized trading mkt

Rights are multiple and variableo $$$ - (dividends / liquidation

rights)o Voting rightso Information rights – (inspect

books, etc.) (these are embodied in the

share) Transferable:

o As a unit (attached to shares, not to a person)

o w/o others’ consento as a negotiable instrumento in an organized market

“Single Issuer” o Only have to worry about the

company’s success; not the role of the seller

Function:o Greater investor liquidity – (easy and cheap to cash out because there’s a market; less

confusion and negotiation)o Lower cost of capital – (investors know they can get out easily/low cost, so you don’t


have to promise them as much on the front end to compensate)

LEGAL PERSONALITY OF THE FIRM

Why it matters? Does law allow the firm to contract and/or buy property? Purpose to monitor Durable lifespan?


Powers: (list of things the entity can do)o Can buy real estateo Enter in Kso Make charitable contributions

(often, but not always, in the entity)

Lifespan: unstableo Each partner can kill it –

(rightful/wrongful rules). If there’s a buyout right, may create liquidity problems.

Purpose:o For-profit business!

Powers: (entity can do everything except list of things they cannot do)

o Same as individual – (all legal rights of natural person)

Lifespan: indefinite (stable)o Perpetual – (hard to kill)

Voluntary dissolution requires majority vote: BOD must propose, majority has to vote to accept it,

No automatic redemption rights: can’t demand that you sell back your interest / can’t force massive buyout

Purpose:o Profit-max

Function of a strong legal personality:o Easier to put powers in a fictional entity: mechanical efficiencies for legal acts

because no change as person comes or goes (unlike partners).o Makes lifespan durable: reserves “going concern” value with minimal disruptiono Clear purpose of profit max: better performance and accountability while preserving

state’s ability to regulate. Gives investors peace of mind.


MANAGERIAL POWER

Why it matters? What is default? Investors as managers?


All Prs have equal mgmt rights All Prs are agents of the p’ship

o Bound by: Admissions Knowledge Notice Wrongful Acts

(Start with a presumption of difference between economic rights and mgmt rights) Directors manage SHs have little say; vote on:

o Election of directorso “organic changes” – (mergers,

voluntary dissolution, sales of subsidiaries, major revisions to certificate of incorporation).

Employees have little say, except:o By principles of Agency o By delegation

Function of central management:o Allows specialization of roles – (investor / mgr / emp can be different people.)o Eliminates redundancy

Don’t have to fully inform every investor and get their consent – (costly)o Set up optimal communication-and-control network to control internal affairs more

efficiently

GENESIS OF CORPORATE LAW

Thesis Antithesis – (why we have law)

Limited Liability Fraud and unfairness to creditors Pierce corporate veil?

Transferable Shares Fraud and unfairness in securities mkt People don’t know each other Unfairness wrt info

Legal Personality Corporate power & lack of social conscience

Centralized mgmt Give large discretionary power to Bd dangerous Whose wealth are they maximizing? –

(conflict of interest and agency problems =


bulk of corporate law)

The LIMITS of Limited liability Piercing the Corporate Veil Special situations where we want to call off limited liability TEST

o Sea Land v. Pepper Source Facts :

SL ships for PS; PS doesn’t pay and “dissolves” with no assets SL sues Marchese (controlling SH of PS) and 4 firms he owns

Issue: Could Marchese be sued in his personal capacity? Are other firms liable? Has corporate veil been pierced?

2-part test : (conjunctive test) (1) Such unity of ownership and interest (control) that separate

personalities of the corporation and the individual no longer exist.

o Other courts call this “mere dummy” or “alter ego” or “mere instrumentality.”

o 4 Factors : Failure to keep records and formalities (meetings of

BOD, minutes) Commingling of funds or assets Undercapitalization Treating corporate assets as SH assets

(Is it a “messy” relationship?)o D loses on this prong

(2) Under the circumstances, adherence to the fiction of a separate entity would sanction fraud and/or promote injustice

o Factors : Avoidance of obligations Unjust enrichment Heaping liabilities onto an asset-free entity

o Note: not all courts require this “fraud or injustice” prong. For some, unity of ownership and control is enough to get PCV.

o PCV vs. FCL : RC’s thesis is to look to fraudulent conveyance law to understand PCV.

Allows creditors to go after debtors when transfers are made or obligations incurred that are actually or constructively fraudulent

Provisions of FCL : (1) Making transactions in which you don’t get something

equivalent in return AND you become insolvent as a resulto When in distress, must give primacy to existing creditors

Law requires you to be “just” before “generous” Exs.

Sell to brother for cheap


Gift to spouse (2) Intent to defraud and unfair transfers that leave transferor with

“unreasonably small capital” (3) Paying a dividend shortly before the corp goes insolvent

Comparing : For FCL must prove that each transaction was fraudulent and

can only recover for what you can prove For PCV law is more loose; just looking for some evidence of

misbehavior – (find some examples and the sort of unity/confusion of ownership)

Applied here : D loses on #1

o No bylaws or articles of incorporationo Corporate expenses used to pay personal expenses

Remand on #2o A mere unsatisfied judgment is not enough

RC : Looking for:

o Confusion of Goals +o Clear evidence that the controlling SH is taking stuff out

and not giving back

TEST for PCV – (Sea Land)

1. Unity of ownership and interest – (separate personalities no longer exist), Factors :

o Failure to keep records and formalitieso Commingling of funds or assetso Undercapitalizationo Treating corporate assets as SH assets

2. AND (but not always required) Would sanction fraud or promote injustice to maintain separation Factors :

o Avoidance of obligationso Unjust enrichmento Heaping liabilities onto an asset-free entity

Unsuccessful o Walkowsky

Facts :


Carlton is main SH in 10 cab corporations and buys the minimum level of insurance for each individual company

After taxi injury, victim cannot get injury fully covered by one company, so sues Carlton (asset-partitioning!)

Held : Neither fragmenting assets nor undercapitalizing one’s company is

illegal Rule :

o In order to PCV, the complaint must allege “sufficiently particular facts” that the D was actually doing business in individual capacity and intermingling funds without regard to corporate formalities.

Must be more specific if claiming that corp is a “dummy” for individual’s interest

Note: other 9 corps may have been liable under enterprise liability, but Carlton in his personal capacity could not be sued.

Dissent : Abuse of the corporate privilege

o Shouldn’t allow him to intentionally drain dividends to make sure the company was insolvent and there were no current claims

Policy : Should businesses be able to be set up this way and prevent PCV

on behalf of tort victims?o Legislatures could require more insurance, court could find

PPCV, or legislature could require minimum level of capitalization.

o Roman Catholic Facts :

Buys dog from Swiss monastery, but dog never gets delivered Attempts to sue in San Francisco, claiming unity of ownership and

interest between archbishop of SF and the church – (cross-piercing)

Held : NO

o “Alter Ego” theory might work to make the Pope (parent) liable as alter ego, but it’s a stretch to hold a sibling corporation liable when it appears to be clearly separate. Sibling only liable if total intermingling of assets.

SF had own assets/liabilites and controlo Frigidaire

Facts : General partner of a limited partnership is a corporation

o Corporation = Generalo Individuals = Limited – (set up this way to get limited

liability with good taxes)


BUT the individuals involved as limited partners are also the owners/directors/officers of the corporation

o They’re getting the pass-thru benefit of partnership but they control the General Partner as agents

Held : NOT liable – 3rd parties knew how this was set up

o Substance < Form Policy :

We’re conditioning limited liability on non-participation in management – (don’t want to make you liable for things you have no control over)

Successful o In re Silicone Gel Breast Implants

Facts : MEC (wholly owned sub of BMS) produces breast implants In products liability action, plaintiffs try to nail BMS, the parent.

o BMS has the $$$ Held :

Plaintiffs get past SJ – (BMS will likely settle) TEST :

o The corporation is so controlled as to be the alter ego or mere instrumentality of its SH

Can disregard the corporate form in the interests of justice

o Factors : Marketing power

Inequitable and unjust to allow BMS to avoid liability when people believe it’s their product

Common officers/directors Consolidated financial statements and tax returns Loans to sub Parent pays salaries and expenses of subsidiary. Parents uses sub property Daily ops not kept separate Subsidiary does not observe corporate formalities

(Clearly met here – lots of intermingling) Planning :

Leave name off – (marketing is big; representational theory) Keep everything really separate It is REALLY bad to drain via dividends so that you have no

assets.o NOTE - DE (unlike NY) does NOT require a showing of fraud/injustice if you

can prove that a subsidiary is merely an instrumentality of its sole stockholder. Also, some jurisdictions require fraud/injustice for contract cases but NOT for tort cases.


Court notes that regardless of the test, there was enough evidence here to survive SJ on the fraud/injustice claim.

Bristol was helping to market MEC’s products, so it would be inequitable and unjust to allow Bristol to avoid liability for those induced to believe that Bristol was vouching for this product.

TAKEAWAY – when the parent company uses its marketing power to help the subsidiary sell its products, it helps pierce the corporate veil on prong 2.

o This is important when a big, strong company gets behind a product, it gives it more gravitas as far as consumers are concerned. To then refuse to hold the company liable allows the company to take the sweet but not the bitter.

Policy: Should we really let major corporations break up to avoid liability in mass torts?

YES PCV NO

Unity of ownership and interest – (no separate personalities)

Sanction fraud / promote injustice

Fraudulent Conveyance type

Alter ego / mere instrumentality – (Silicone)

Marketing Power

Must plead facts with particularity

Undercapitalizing or fragmenting assets alone.

General partner of limited partnership is corporation – (even with same officers)


Shareholder Derivative Suits

Shareholders’ essential rights:o Right to dividends and residual payouts.o Right to vote (can be limited).o Right to exit or sell shares.o Information rights some provided by state statutes, others provided by federal

disclosure rules for public companies.o Right to bring a lawsuit (incl. derivative suits).o

Direct vs. Derivative :

Direct Lawsuit Derivative Lawsuit

Brought by SH in own name – (or class action) SH on Corp’s behalf

Cause of Action

Belongs to SH in individual capacity Belongs corporation as an entity

Injury to Directly to SH Injury to Corp – (SH indirectly affected)

Recovery to SH Corporation – (SH benefits very little because only owns small piece)

Demand? No – (suits is for your injury, so no board approval)

Yes – (must 1st ask Bd for permission)

Types MMO that cause you to make transaction you wouldn’t otherwise make

False proxy statements or press releases affect stock price or result in flawed voting

Corporate reorganization dilutes SH voting power

Note: can be on own or as a class action.

Enforcement of corporation’s K claims

CEO’s unfair self-dealing Board’s unfair self-dealing Board’s negligence in assessing

self-dealing transaction involving CEO

Allegations of excessive pay, waste

o Eisenberg Facts :

Flying Tiger (air freight company) creates sub who creates own sub

After a complicated series of mergers within the company, Eisenberg sues for dilution of ownership, claiming he has no vote in the company.


Direct or Derivative? Eisenberg claims it’s direct

o Direct harm to me!o If it were derivative, he’d have to post security for costs of

litigation in NY – (NY wants to prevent harassment suits) Company says it’s derivative

o He’s just claiming corporate harm due to dissolutiono This is just a good business decision

Held : Direct

o If the “gravamen” of the complaint is injury to the corporation, then the suit is derivative, but if the injury is one to the plaintiff individually as a SH, then the suit is direct

He is challenging his exclusion form proper participation direct

o Lawyers : Direct pay your own Derivative company pays if demand met

Derivative suits are often brought by aggressive lawyers who want fee/settlement/publicity

o Rationale for Derivative Actions : Direct actions won’t be able to reach certain disloyalty Voting and public enforcement have problems – (below)

The Requirement of Demand o Process :

Allege futility Due to BJR, derivative plaintiffs will try hard to avoid the demand

requirement Test for futility :

o Majority of the Bd is self-interested in the suit, oro Majority of the Bd is not self-interested but is dominated by

interested parties (these are tough tests to meet, so whether demand is

req’d is generally dispositive) Seek demand

Before bringing derivative action, must demand that Bd bring suito If they agree OKo If they don’t BJR protects their decision – (DGCL

§141(a)) Bd responsibly for managing the company, so their

decisions regarding business matters are entitled to great deference)

Even if Bd rejects, they will want to debate the matter, show minutes, make the whole process look good


Can argue wrongful refusal but hard to win Special Litigation Committees

Bd may appoint a cmte of disinterested directors to evaluate the derivative suit and decide whether to proceed

Alternatives (We have derivatives to allow SHs to go after waster, disloyalty,

and conflicts of interest, even if the Bd doesn’t want the suit but there are other ways too)

1. SH voting: can vote out bad executives who are self-dealing or incompetent.

o Problem: collective action; expensive to get info out and it only gets the voters a little money (and no recovery for past waste)

2. Sell your shareso Problem: your shares are worth less now due to

inappropriate behavior 3. Public Enforcement – (leave to SEC)

o Problem: politics / scare resources

Process for Demand

1. Allege Futility:

2. Seek Demand BJR

(May then have to deal with special litigation committee)

o Grimes v. Donald Facts :

Large severance package for CEO if discharged w/o cause BUT he’s the one who gets to decide if he was “constructively

terminated” SH makes 2 claims:

o 1. Abdication of Directors’ role – (surrendered their obligation)

o 2. Breach of fiduciary duty of care and waste of corporate assets

Held : (1) Abdication Fails on merits (BJR)

o Direct Claim Claim for an injury which is separate and

distinct from that suffered by other SHs or a wrong involving contractual right of SH that


exists independently of any right of the Corporation.

RC: this makes no sense. Must be that individual shareholder has right to have company run by the board.

o BUT fails Just because Bd has limited its future freedom does

not mean it has abdicated its duty exercising BJR – (maybe they had to make this concession to bring in CEO)

RC: Note FN 4 criticizing board for this decision even though they won.

(2) Fidudciary Duty Fails for lack of Demando Derivative Suit

Alleged waste and excessive compensation would be owed back to the corporation

o BUT Demand is req’d Bd must decide whether to bring the claim and SH

must either allege that demand was futile Test for Demand Requirement :

If a claim belongs to the corporation, the board must decide whether to bring the claim. Demand is required – stockholder must either allege that the Board rejected his demand, or he must show that demand should not be required.

TEST for Futility : (DE) Particularized Facts

o Problem: Have to use “tools at hand;” can’t get real discovery; must do this with public filings or maybe use state law to look in

There is reasonable doubt that the Bd can’t make an independent good faith decision about the suit

o 1. Majority of Bd has a material financial or familial interest

o 2. Majority of Bd is incapable of acting independently due to domination/control

o 3. Transaction is not the product of valid business judgment

Procedure : 1. Must allege futility first 2. If that fails, make your demand


o Can’t allege futility after demand is rejected

o Marx v. Akers TEST for futility : (NY)

Complaint alleges with particularity that:o Maj of the Bd is interested in the transaction

Self-interest OR control/dominationo Maj of the Bd was not fully informed to a reasonably

appropriate extento Transaction was so egregious on its face that it could not

have been the result of sound business judgment (recently, a lot of litigation in NY on the 3rd prong. Hard to prove

“so egregious”)

TEST for Futility

Prereq: Particularized Facts

Burden: Plaintiff

Note on two tests: Clark thinks these are pretty similar.

DE – (Grimes) NY – (Marx)

There is reasonable doubt that the Bd can’t make an independent good faith decision about the suit:

1. Majority of Bd has a material financial or familial interest, or

2. Majority of Bd is incapable of acting independently due to domination/control, or

3. Transaction is not the product of valid biz judgmt

1. Maj of Bd was self-interested in the transaction, or

2. Maj of Bd was not fully informed to a reasonably appropriate extent, or

3. Transaction was so egregious on its face that it could not have been the result of sound business judgment – (source of a lot of litigation)

Special Litigation Committees o Auerbach – (NY)


Facts : Company directors involved with bribes and kickbacks Plaintiff initiates derivative suit Bd appoints SLC who says the suit should not proceed – (not in

corp’s best interest) Held :

Cmte’s decision upheld RULE :

o Substantive Judgments of SLC protected by the BJR as long as the SLC directors are disinterested and independent

Weighing of legal, ethical, commercialo Methods and Procedures get less deference

Must be done in good faith – (no pretext or sham) Look at adequacy of investigation

(Pl has burden to show inadequacy)o (Also, here all the members of the cmte were disinterested

and independent) Disterested / independent / no bias

o Zapata – (DE) Facts :

Excess compensation case No demand made; excused as futile Bd appoints SLC and they recommend dismissal (even though

demand was excused). Held :

TEST – (DE 2-step) for reviewing SLC determinations: o (1) Inquiry into independence, good faith, and

reasonableness of SLC Includes inquiry into bases supporting the

committee’s recommendation Procedures + Investigation

Limited discovery allowed Corp has burden Compare to Demand Futility Test :

Plaintiffs bear burden of showing non-independence for demand futility

Ds bear burden of showing independence here

No discovery for demand futility Interplay :

o Pl will try to say that demand is futile; if they get past that (which might be hard because there’s no discovery), Bd may appoint SLC and then they have the burden of showing independence, etc.


o (2) Court may apply its own business judgment about whether dismissal is proper

Cts should not tie their hands if justice may be required by a particular case

(more open test) Why? Because DE is better than NY at

corporate law and can apply its own judgment.

o In Re Oracle – (DE – Strine - 2003) Facts :

SLC recommends dismissal of suit against directors for insider trading, negligence.

Case comes down to an “independence inquiry” regarding 2 Stanford professors on the SLC

o Who is an “independent director” for purposes of an SLC? Held :

Not fully independento FOR independence :

No personal interest Not dominated by CEO Very valid process

o AGAINST : Possible gifts from Oracle and its directors to

Stanford and the possibility of making big donations in the future

Rule :o Open and difficult test for independence – (probing)

DE has a VERY strict rule for “independence” of Committee members.

Planning : Make sure your SLC is entirely independent of the directors

and executives. Be really careful!

TEST for Special Litigation Committees

(Remember Strine test about independence strict)

DE – (Zapata): looks like demand futility test

NY – (Auerbach): only really looks atprocess

Inquiry into independence, good faith, and reasonableness of SLC Supporting bases Procedures + Investigation (Limited discovery allowed)

Substantive Judgments of SLC protected by the BJR Weighing of legal, ethical,

commercial


Court may go on to apply its own business judgment about whether dismissal is proper Won’t tie their own hands

Burden: Corp – (opposite of demand futility)

Methods and Procedures get less deference Good faith – (no pretext or sham) Look at adequacy of investigation

Burden: Pl to show inadequacy

Policy/Pattern in recent Derivative Lit o Patterns :

Minority of Derivative suits go to trial and Pls lose 90% of these Why not @ trial ?

Significant # are dismissed for failure to make demand Majority are settled for:

o Money to corp (often insurance money)o Guarantees of better processo New directorso (Plaintiff’s lawyers do well)

o Why these patterns? If it’s a legitimate claim, the company settles it before they lose

Concern about personal liability of directors Reputational concerns

Some fighting usually takes place in order to prove to plaintiff’s lawyers that they won’t be pushed around

Plaintiff’s lawyers OK to settle for risk reduction Are derivative suits socially good, on balance??

o In theory, they’re great (overcome collective action problem, great deterrent effect).

o But in practice, maybe not. The settlement incentives are warped, the lawyers get too much, and these suits may not actually affect corporate behavior.

o Empirical studies show that pending derivative suits have almost NO effect on share price. Maybe these suits don’t matter much at all, since settlements tend to be small relative to the size of the corporations.


Role and Purposes of Corporations Can Bds and Managers consider interests other than that of the SHs for whom they are

supposed to be fiduciaries? Charitable Giving

o (Cases are about corporations making charitable contibutions)o Policy

PRO Good for community and public welfare/education Improves corporate image Corporations have $$$ - (where wealth is in our society)

CON CEO’s generous with other people’s money, but not their own Elephant bumping – (just status-seeking) Corps give to rich people charities only

o Law NJ – (Tight)

Must tie to corporate interest or profit-max in long-run NY/CA – (Lax)

NY: Can make donations irrespective of the corporate benefit CA uses “irrespective of specific corporate benefit”

DE – (Middle) You have power, but don’t explicitly say whether you need to tie it

to the goals – (legislature punts; may have to give deference to Bd) PA

Consider impact on all sorts of 3rd parties – (stakeholder statute)o Must be aligned with interested, but all sorts of leeway

o AP Smith v. Barlow Facts :

SHs challenge $1500 gift made to Princeton – (don’t think this helps them)

N.J. Stat: allows corps to give to charity as long as it “will contribute to the protection of corporate interests”

o Pls claim the statute was enacted after the corp was chartered and the articles of incorporation remain unchanged

Held : This is a reserved power of the corp

o Articles of Incorp (reserved powers of corps/directors) are subject to modification at the discretion of the legislature.

Stakeholder Approach o Dodge v. Ford Motor

Summary: example of where someone takes an anti-profit stance and gets hit for it.

Facts : Ford owned 58% and plaintiffs were in minority


Ford used to give very large dividends for years, but then stops paying the special dividend and plans to use the $$$ to build new plants and cut prices

o Ford is up-front about his stakeholder/constituent approach to corporate purpose – he’s not just in it to make $$$

o Pls sue Held :

Business corp is primarily concerned with SH profit Bd has discretion, but that goes to means, not the end itself

o Ford should have been generous with his own money, not that of the minority SHs – (similar to FCL be just before generous)

Power to declare dividends is normally in Bd, but exceptions:o 1. Fraud/misrepresentationo 2. If the refusal to declare dividends was a breach of

good faith toward stockholders Applied :

o OK to want to build new planto BUT the goal of building up people’s lives and spending

more on employees seems like charityo Shlensky v. Wrigley

Facts : Wrigley owns Cubs and won’t play night games even though

losing money – (concern for neighborhood / purist) Shlensky doesn’t think this is a valid concern – (not going for

profit max, but concerned with some other goal) Held :

Wrigley wins Rule :

o Decision is within Bd’s discretion absent: Fraud / Illegality / Conflict of Interest

o (suggests Bd has lots of leeway; unlike in Ford) Difference: not saying out loud that they’re doing it out of altruism. Just

have to say you have a profit motive. POLICY :

o Is this a good model? Profit-max and SH value vs. Social Responsibility / Stakeholders

o Chancellor Allen’s 2 models of Corporations Property Conception

Corp’s purpose is to increase owner’s wealth Directors’ duty is to max SH value

Social Institution Corp’s purpose is to promote general welfare Directors have duty of loyalty to ALL constituents involved or

affected by the Corp


Allen’s 2 Models of Corps

Property Conception Social Institution

Corp’s purpose is to increase owner’s wealth

Drs’ duty is to max SH value

Corp’s purpose is to promote the general welfare

Drs’ duty is loyalty to ALL constituents involved or affected by the Corp

o Clark’s Restatement of the Traditional View Not helpful to speak of a corporation’s “purpose”

Should analyze the total impact on society separately from question of directors’ duties

Law should promote human welfare in general Elected Legislators should structure laws to optimize corporations’ total

impact on human welfare Directors have a fiduciary duty to max SH value, subject to important

constraints 1. Obey the law (even if wouldn’t get caught) 2. Meet all obligations to non-SH constituents – (BIG) 3. Respond to mkt/social/normative forces so as to keep

constituents optimally involved – (can increase profit max in long-run by building loyalty, etc.)

2 caveats : Charitable giving by Directors is OK Directors should force corps to cease participating in clearly and

seriously unethical action (even if it is profit-maximizing and legal)

Why like Clark over SH model? Promotes better monitoring of corporate directors/officers Locates public policy in a better place – (legislatures rather than

boardrooms)


4. FIDUCIARY DUTIES OF OFFICERS

Duty of Care Directors owe their corps a fid duty of care

o Problem : Drs decisions are generally protected by the BJR Can D be held personally liable for violation of duty of care given the

BJR? Key issues :

o What is the BJR? How formulated? When and under what conditions can you get around it?

o When will violations of the Duty of Care be found? What’s the duty? What sort of things do cts look at to find a violation?

o Do violations lead to personal monetary liability? Under what conditions? If not, what’s the point of the duty of care?

Key Cases:o Kamin v. Amex: meaning and force of BJRo Francis v. United Jersey bank: Limits on BJR; clear example of non-applicability

and potential liability for nonfeasance (neglect of duty)o Smith v. Van Gorkom: Due care in mergers. Need informed decisionmaking.

Major fallout.o Brehm v. Eisner: Due care in executive comp. Due care is process due care (with

irrationality limit). o Disney Deriv: spells out due care, waste, good faith.o Caremark: duty of due care includes monitoring for violations, setting up

information, reporting and law compliance systems Kamin v. Amex

o Facts : Issue dividend-in-kind instead of selling the shares as a corporate asset;

SHs disagree because could have taken a capital loss and saved money in taxes.

SHs bring derivative action alleging violation of DoC Bd says they considered it but ruled out because of share prices

tanking if they reported a loss.o Held:

Bd is fine Rule : Business Judgment Rule

Courts won’t interfere with Bd’s discretion and impose Dr liability just because decision seems mistaken

Only interfere if:o Bad faitho Fraud


o Self-dealing by maj of Bdo Nonfeasanceo Illegality

Underlying idea : don’t interfere unless there is a defect of process. Possible Conflict-of-Interest?

4 officers had compensation tied to profits, but ct says not enough evidence and not a majority

Francis o Facts :

Husband dies and leaves all his shares to wife and sons Sons are awful and steal from company while wife does nothing and

knows nothing Creditors come after her

o Held : Wife is liable to creditors for lack of care. Her disinterest in the company

affairs was the proximate cause of theft. Rule :

Directors must acquire a “rudimentary understanding” and become familiar with fundamentals

Bound to exercise a duty of “ordinary care”o Can’t plead ignorance as a defenseo Must either gain necessary knowledge or resign

Actions :o Monitor corporate affairso Maintain familiarityo Pay attention to potential misconducto Go to meetingso If find something illegal, reject or resign

o Takeaways : Don’t serve on a Bd if you don’t’ know what you’re doing In insolvency directors owe fiduciary duties to creditors as well as SHs.

And if corp holds funds of others in trust, higher fiduciary duty. BJR doesn’t automatically protect you from nonfeasance. It’s not enough

that there’s no malfeasance, fraud, or conflict of interest. You have an affirmative duty.

o Must keep informed and do general monitoring Smith v. Van Gorkom (DE 1985)

o Facts : CEO arranges leveraged cash-out merger into Pritzker entity for

substantial premium over mkt price; Gets resounding approval from SH and deal closes

Bd approves the buy-out after a 20-minute presentation by Van Gorkom who doesn’t even explain how he got the price

Other bidders drop out – (some funny business) Class action suit alleging violation of DoC for low price


o Rule: The initial burden is on Π to rebut the presumption that the business judgment of the board was an informed one – this turns on whether the directors have informed themselves prior to making the decision of all material information reasonably available to them (Francis). The standard is gross negligence – it requires unintelligent or unadvised judgments.

o Held : Directors approving the merger violated duty of care; were grossly

negligent because the process was flawed . Why?

o Process – (Quick meeting)o No fairness opinion – (no expert help)o “Big premium” defense is insufficient – (could have done

better maybe)o Collective wisdom defense insufficient – (not enough that

officers have experience; they’re not valuation experts)o Market Test defense insufficient – (court thinks that

process for competing firms was rigged) NOT saved by subsequent SH vote because proxy materials were

flawed. RULE :

Drs breach DoC when they fail to inform themselves of all material information reasonably relevant and available

o May include : Info gathering / use of experts / deliberation

What happened : Drs personally liable in settlement

o Aftermath : Legislature changed the law: §102(b)(7)

Corps can eliminate or limit monetary damages of directors to the Corp for breach of fid duty

BUT can’t waive damages for:o Breach of duty of loyalty (NOT care)o Acts/omissions of bad faitho Violation of §174 – (payment of dividends)o Improper self-dealing

Focus on PROCESS: Standardization of Procedures for Mergers:

o Hire I-Bankers and outside law firmo Consider “alternate strategies” and partnerso Get formal valuation study & fairness opiniono Prefer auction – “real” mkt check – (concern about deal

protection agreements)o Long meetings

Brehm v. Eisnero Facts :


Ovitz has generous severance plan and gets huge payout SHs due for breach of duty of care

o Held : Bd wins Rule :

Due care in decisionmaking context is PROCESS due care onlyo “Substance Due Care” is foreign to BJR – (Irrationality is

the outer limit of the BJR) Must be irrational or unsconscionable

o (Bd’s decision on compensation generally gets great deference)

What Process? o Information Component

Bd responsible for considering material facts that are reasonably available

o Experts – (§141(e)) Holding: the 1995 Board did not violate fiduciary

duty in approving the Ovitz contract because they reasonably relied on an expert.

Rule: Drs are protected by reliance on experts UNLESS:

Didn’t in fact rely Reliance not in good faith Didn’t reasonably believe advice was in

expertise Expert not selected with reasonable care Subject matter was material and reasonably

available Decision of Bd was unconscionable – (waste

/ fraud) (All of these must be alleged with particular facts)

Relying on Experts – §141(e)

Drs are protected by reliance on experts UNLESS: Didn’t in fact rely Reliance not in good faith Didn’t reasonably believe advice was in expertise Expert not selected with reasonable care Subject matter was material and reasonably

available Decision of Bd was unconscionable – (waste /

fraud)

Take Walt Disney Derivative Litigation – (1996)


o (Case goes back down in 2000 and SHs get better discovery)o Facts :

Put in different perspective, Ovitz’s success and income @ CAA and demand for downside protection

2 of 4 Comp Cmte members were closely involved in negotiationso Issue : o Held :

Our law presumes that “in making a business decision the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in best interests of the company”

BUT rebuttable if Pl shows that the Drs breached their fid duty of care or loyalty or acted in bad faith

If yes, burden shifts to Drs to demonstrate that the challenged act or transaction was entirely fair to the corp and its SHs

Applied : 1. Cmte did not fail to use due care in approving the pkg

o Ct says they weren’t perfect, but it’s OKo (should used best practices/spreadsheet)

2. Due Care of Bdo Gathered all relevant and material info that was reasonably

avialble 3. Good faith of the Drs not effectively challenged

o If bad faith, then personally liable Bad Faith is very impt

What is “bad faith”?o Conduct motivated by actual

intent to do harm to the company or its SHs

o Intentional dereliction of duty or conscious disregard of one’s responsibilities

The plaintiff, in order to rebut the BJR, must proved bad faith

4. Claims that transaction was so one-sided as to constitute waste and not a valid business judgment NO

o Waste is only found in rare unconscionable case where directors intentionally squander or give away corporate assets

o Van Gorkom vs. Disney Disney wins because:

Better procedures / use of experts Employment is the quintessential business decision Different era

o Judge in Van Gorkom may have been trying to crack down on corps

Disney had tremendous revenue


2 flavors of the BJR : Substantive Rule

o BJRs raise the std of liability from mere negligence to gross negligence or recklessness

Abstention Doctrineo BJR simply says that cts will not intervene in corporate

matters unless Pl rebuts presumption of good faith As long as process is fair, we won’t worry about

substantive results Source of BJR = §141(a)

o The Board shall manage the “business and affairs of every corporation”

Impact on Bds post- Disney Law firms read and craft memos about how to avoid this situation Compensation consultants hired Lake Wobegone effect – (everyone is above average)

TEST for Bad Faith

Conduct motivated by actual intent to do harm to the company or its SHs

Intentional dereliction of duty or conscious disregard of one’s responsibilities

In re Caremark Derivative Litigationo Facts :

Federal law forbids referral payments to induce referral of Medicaid/medicare patients

SHs claim that Drs breached their DoC by failing to adequately supervise employees, therefore exposing them to liability/fines

o Posture : Corp wants to settle in which they receive no money.o Held : Settlement is approved. Real issue: Theory of Director Liability (dicta)

DoC wrt Company-wide monitoring Dr’s obligations include a duty to attempt in good faith to

ensure that adequate corporate information and reporting systems exist

o Ct rejects idea that due care does not imply some affirmative pro-active duty to engage in some sort of monitoring

Goes beyond Francis – (said you must do something); here, you need a system

The “level of detail” appropriate for the req’d info system is a question of business judgment


Distinguishing Graham Graham – no need to impose legal monitoring system absent

evidence of a problem Here – D’s personal liability depends on “sustained and systematic

failure” of oversighto Recap: Two theories of director liability:

(1) Ill-advised or negligent action – good faith decisions are generally protected by the BJR, and we require much more than negligence.

What matters is the PROCESS, which must be rational, in good faith, and free from conflicts of interest. If the process is fair, there is no liability for directors on the basis of substantive decisions.

(2) Failure to monitor – these are circumstances in which loss happens due to “unconsidered inaction.”

Director’s obligations include a duty to attempt in good faith to ensure that adequate corporate information and reporting system exists. Failure to create such a system, in some cases, might make director liable for losses caused by non-compliance w/ the law.

o To show failure to adequately control employees, Π would have to show that directors knew or should have known that violations of the law were occurring, and that the directors took no steps in a good faith effort to prevent or remedy that illegality, and that such failure proximately resulted in losses.

Nothing in this record shows that the Directors knew of the violations of the law. And there was no sustained or systematic failure of the Board to exercise oversight – there was an information and reporting system and there was no evidence of bad faith.

o Court admits that the level of detail appropriate for the corporation is a question of business judgment.

Martha Stewart Litigation:o Facts: Shareholders bring suit against directors for failing to monitor Martha’s

personal stuff (violation of duty of care under Caremark) Theory: she is the corporation; should have been monitored closely.

o Held: for directors Limits to monitoring: requirement extends just to the corporation and not

to the personal conduct of any officer or director. Held that this was consistent with Graham v. Chalmers which held that

there’s not such duty. But is this consistent with Caremark? Maybe, maybe not. And with Oracle? Lost on failure to make a demand. But here aren’t

directors at least as influenced since they were her friends?


DUTY OF CARE QUICK RULES

BJRCourts won’t interfere with Bd’s discretion and impose Dr liability just because decision seems mistaken – (Kamin)Due care is PROCEDURAL ONLY – (Eisner) Only interfere if:

o Bad faitho Fraudo Self-dealing by maj of Bdo Nonfeasanceo Illegality

Have affirmative duty to know what’s going on and to develop a rudimentary understanding – (Francis)Don’t serve on Bd if you don’t know what’s going on

Drs breach DoC when they fail to inform themselves of all material information reasonably relevant and available – (Van Gorkom)Has led to standardization of complex procedures for major transactions

Dr’s obligations include a duty to attempt in good faith to ensure that adequate corporate information and reporting systems existNeed to affirmatively help put systems in place – (Caremark)

SUM – (Disney) We’ll presume that Drs of a corporation acted on an informed basis,

in good faith, and in the honest belief that it was in corp’s best interests

BUT rebuttable if Pl shows that the Drs breached their fid duty of care

o If yes burden shifts to Drs to demonstrate that the challenged act or transaction was entirely fair to the corp and its SHs

As long as process is fair, we won’t look at substantive results

o NOTE – the business judgment rule comes from DE §141(a), which states that the BOARD shall manage the “business and affairs of every corporation.


Duty of Loyalty Interested Director Transactions

o Basic self-dealing transactionso §144

Self-interested transactions shall not be void solely because of self-interest IF::

Material facts are disclosed and Bd/cmte votes in good faith Material facts are disclosed and SHs vote in good faith Contract or transaction is substantively fair:

o Need / price / comparisons / quality Burdens

If disclosure was not made D must show intrinsic fairness If full disclosure was made and transaction was approved by

disinterested directors or SHs P has burden to show unfairnesso Bayer v. Beran

Facts : Radio campaign and they hired wife of CEO as singer Plaintiffs sue for breach of fid duty

Held : In general, the business judgment rule protects the decisions of

directors and executives, but this is subject to the rule of undivided loyalty.

o There is a duty of loyalty in every situation in which a trustee deals with another in such close relation that possible advantage to such other person might influence, consciously or subconsciously, the judgment of the trustee. BJR doesn’t apply when it’s an interested director transaction.

When interested director transaction is alleged, the burden is on the Dr to prove:

o Good faith – (process)o Inherent Fairness to the Corp – (substance)

(Burden is switched) How to meet :

o Wife was good singero Comparable payo Adequately considered the optionso Plausible business purpose

Planning: have a formal board meeting!o Lewis v. SLE, Inc.

Facts : 6 brothers spread across 2 closely-held companies

o LGT – tire dealershipo SLE – landlord


SLE charging LGT super-low rent thanks to active brothers controlling Bd at SLE

Suit by minority SHs of SLE Held :

SHs win. Rule :

o Burden must be on D to show that in a self-interested transaction, the contract and transaction was fair and reasonable to the corp

BJR doesn’t apply in conflict-of-interest situation Planning :

To avoid issue, better buyout agreement, get non-family members to approve the rent, better initial setup of the companies.

o Benihana of Tokyo v. Benihana Inc. Facts :

Rocky owns Benihana of Tokyo with new wife and 6 kids; this controls Benihana Inc.

Rocky sues Bd claiming breach of fid duty of loyalty (interested transaction)

o Abdo was member of Benihana Bd AND SH/officer in the financing company

o Claims Bd was not aware of all material facts Held:

Deal was OKo Transaction was not automatically voidable

Looks like once D shows he’s met §144(a)(1) by informing Bd of all material facts, the burden shifts back to P who may try to show was waste, unfairness, or violation of BJR

(Case shows that cts are willing to do a deep inquiry into whether the Bd is aware of the transaction and any Drs’ interest and incentive)

o Cinerama v. Technicolor Rule :

Even if only a minority of Drs are self-interested, the BJR may still be overcome if either:

o The interested drs control/dominate the Bdo The interested dr fails to disclose his interest and a

reasonable non-interested Bd member would regard the material interest as a “significant fact” in evaluating the transaxn

o Strategy for these cases: Look to:

Power – does this person have power to rip off the corp Incentive – does this person have incentive


o Bayer – low power (only 1 Bd member) and low incentive (pay for the ad was low)

Ways for corp to insulate self-dealing transactions : Bring in outside opinions Disclose as much as possible Special cmte of disinterested directors Structure deal to prevent incentives (where possible)

Recap on the Duty of Loyalty- Even if only a minority of directors are self-interested, the business judgment rule may

still be overcome if either (Cinerama v. Technicolor, DE):o (1) The interested directors control or dominate the board, oro (2) The interested director fails to disclose his interest and a reasonable non-interested

board member would regard the material interest as a “significant fact” in evaluating the transaction.

- FOR CONFLICTS OF INTEREST, ALWAYS REMEMBER – POWER AND INCENTIVES. Does this person have the power to rip off the corporation, and does he have the incentive to make a profit by being on both sides of a transaction.

o Bayer – low power (only 1 board member was interested), and low incentive (her pay was pretty low).

- Ways to insulate self-dealing transactions from duty of loyalty scrutiny: o (1) Bring in outside opinions about fairness – bankers, lawyers, appraisers, etc.o (2) Disclose as much as possible BJR burden doesn’t shift if disclosure is made.o (3) Special Committee of disinterested directors – have them investigate, evaluate,

and approve or disprove the transaction. Give them real power.o (4) Anything else that prevents incentives to self-deal.

Statutes on Self-Interested Transactions- Interested directors (DE §144) – no transaction between a corp and one or more of its

director-officers or between the corp and any corp in which a director/officer has a financial interest is void or voidable SOLELY because of the self-interest, IF AND ONLY IF:

o (1) All material facts are known to the board or committee of the board, and the board in good faith authorizes the transaction by a majority of disinterested directors; or

o (2) Material facts of the self-interest are known or disclosed to the shareholders, and the deal is approved by good faith vote of the shareholders; or

NOTE – under this prong, the shareholder approval must be by a majority of disinterested shareholders (Fliegler).

o (3) The contract or transaction is “fair as to the corporation” as of the time it is authorized, approved, or ratified by the Board, a Committee of the Board, or the shareholders (even if there has NOT been disclosure).

NOTE – this allows the transaction to be possibly OK, even if disclosure is not made up front.

NOTE – self-dealing directors still get BJR protection except the burden is on THEM to show fairness rather than on Π to show unfairness.

o Burdens of proof (REALLY important, often dispositive): If disclosure was not made, then the burden is on the defendant to prove


intrinsic fairness. But if full disclosure is made, and the transaction is approved by disinterested directors or shareholders, then the burden is on the plaintiff to prove unfairness.

- NOTE – this statute is not exclusive. Courts can impose other duties on directors are well. All this says is the agreement is not void under this section if you meet these three criteria.


o

Interested Director Transactions

Burden: D

To Show: Good Faith – (proper process) Inherent Fairness to the Corp – (substance)

Even if only a minority of Drs are self-interested, the BJR may still be overcome if either:

o Interested drs control/dominateo Interested dr fails to disclose his

interest and a reasonable non-interested Bd member would regard the material interest as a “significant fact” in evaluating the transaxn

Corporate Opportunities o Broz v. Cellular Information Systems

Facts : Broz is Pres/sole SH of RFBC (cellular provider) CIS is a public corp in the same business and Broz is on the Bd MacKinack is 3rd company seeking potential buyers for service

license, including RFBC but not CISo RFBC buys the license over PriCellularo PriCellular then merges with CIS and sues Broz for being a

bad Dr, alleging he wrongly usurped a corporate opportunity of CIS and violated his DoL

Held : Broz’s purchase was OK Rule :

o The law will not permit a Dr of Off to take a biz opp which:

(1) Corporation is financially able to take on (2) Is in corporation’s line of business (3) Is one in which corporation has an interest or a

reasonable expectancy; and (4) Taking by the D/O will bring his self interest

into conflict with the corp’s interesto BUT Safeharbor:

Present/disclose opp to the Bd before you take it for yourself – (but not req’d to present to the board if


you think the corporation is not entitled to the opportunity)

Applied :o (1) Financial ability was lacking. CIS didn’t have the $$.o (2) It was technically in their line of businesso (3) But, given the business plan, there was no interest or

reasonable expectancy BUT there was no presentation to the Bd

o (4) No resulting conflict, unless you think he had to take into consideration the interest of the acquirer

Other notes:o We evaluate the situation ex ante, not ex post. It’s not

Broz’ job to anticipate what the company MIGHT want in the future. All that matters is whether the company would have wanted the opportunity at the time of the transaction.

o Also, Broz learned about this in his individual capacity, not in his capacity as director of CIS – indeed, CIS was never even offered the license.

Some jurisdictions have slightly different formulations. For example ALI §5.05 asks how the director/officer learns of the opportunity – through his function as a corporate officer, or through his own private business.

This just looks like prong (3) – if you find something in your own private business, then the corp doesn’t have an “interest or reasonable expectancy.”

o In re eBay SHs Litig Facts :

Goldman Sachs gives D/Os of eBay opps to get into the IPOs of other companies

SHs sue this business opportunity should have gone to eBay itself rather than D/Os

Applying the Broz Test : (1) eBay was financially able (2) It was in their line of business because they were invested a lot

in securities and management (3) eBay might have an interest/expectancy (4) created a conflict because eBay could have gotten a rebate

instead of a bribe to the directors. Held :

Not saying that any investment opportunity belongs to the corporation, but this seems like a bribe to get GS more business.

o Alternate Claim :


This violates agent’s duty to account for profits made by him on account of transactions conducted on behalf of the principal

But were IPO shares bought ‘on behalf of eBay’? Violates RA 2s §387: Agent must act solely for the principal’s benefit in

all matters connected with Agencyo Other possible rule :

ALI §5.05 asks how D/O learned of the opportunity Corporate officer role or thru his own private business? (BUT this mirrors #3 if you learned about it in your own

business, the corp probably doesn’t have a “reasonable expectancy” in it)

o note: This case is here to show a creative application of the corporate opportunity doctrine.

Corporate Opportunity Doctrine

Dr or Off can’t take business opportunity which: Corporation is financially able to take on Is in corporation’s line of business Is one in which corporation has an interest or a

reasonable expectancy Taking by the D/O will bring his self interest into

conflict with the corp’s interest

BUT Safeharbor: Present/disclose opp to the Bd before you take it

for yourself o (but not req’d to present to the board

if you think the corporation is not entitled to the opportunity)

How did you LEARN about it?


Dominant Shareholders Often use subsidiaries in order to:

o Get around gov’t regulationso Avoid taxeso Shield assets from liability

Sinclair Oilo Facts :

Big oil company with many subsidiaries S.O. owns 97% of SinVen; 3% owned by minority SHs

The 3% sue Claims :

o SinVen paying excess dividends to parento SinVen not allowed to expando Sinclair Int’l breached K with SinVen and SinVen did not

pursue recovery (S.O. owns both)o Held :

Shareholders are generally NOT considered to have fiduciary duties, BUT: Parent has fiduciary duty to minority SHs in parent-subsidiary cases

Parent is on both sides of transaction with sub, so we review under “intrinsic fairness” std – (burden on D)

Self-dealing is present if the parent causes the sub to act in such a way that the parent receives something from the sub to the exclusion and detriment of minority SHS of sub

o If so “intrinsic fairness” test Applied :

Excessive Dividends NOo BJR applieso Dividends proportionally equal for all shares – (no specific

benefit to the majority) Non-expansion NO

o BJR applieso Can’t point to any opps that came to SinVen but were lost

because of parent’s conflict of interesto Note: this might have come out differently under 4-part

Broz test. Contract recovery OK

o S.O. has burden to show that the failure to enforce the K was intrinsically fair

o Planning : Make sure sub has independent and outside Drs

(not just officers from parent) Give them power on cmte to approve all intracompany transactions

Gather objective evidence and experts Let them meet alone and document everything

Zahn


o Facts : Transamerica is controlling SH of A-F Two kinds of stock:

Class A Class B

Annual Div $3.20 $1.60

Liq Div 2x B ½ of A

Conversion Yes – able to convert to B No

Callable? Yes – $60 No

Voting? No Yes

T OWNS 66% 80%

Trans has elected a majority of the Bd of A-F – (thru B shares) Trans causes Bd to call all the A shares for $80 ($60 + $20 in unpaid

dividends), then liquidates the firm Zahn claims Class A would have received $240/share if not called before

the liquidation Claims the Bd had duty not to redeem

o Held : Bd did not have a “duty not to redeem”

Right was in the charter (reason we set it up this way) Remember when acting as a shareholder, you can vote based on

your own interests, but when acting as a director, you must represent ALL stockholders as a fiduciary.

BUT did have a duty to disclose Must fully inform of relevant info Must give accurate info about the value of the firm (affirmative

duty even if not req’d by SEC) Rule :

Fid Duty of a Controlling SH is to fully inform of the value of the firm. Duty of DISCLOSURE.

Dominant SH

Self-dealing is present if the parent causes the sub to act in such a way that the parent receives something from the sub to the exclusion and detriment of minority SHs of sub If so “intrinsic fairness” test

Controlling SH has Fid Duty to fully inform of the value of the firm.


Shareholder Ratification Fliegler v. Lawrence:

o Facts : Lawrence (President of Agua) buys mine properties in his personal

capacity, transfers to USAC (a closely-held corp), who then gives option to Agua

SHs sue claiming that Agua overpaid for the option due to Lawrence’s self-dealing

Lawrence defends on ground of SH ratification: a majority voted to approve the purchase.

o Held : If a majority of disinterested SHs ratify an “interested transaction,”

then the burden of proof shifts to Pl to prove waste Who counts?

o Not just those who voteo Not just majority vote of all SHs o Need a majority of the disinterested shareholders to vote in

favor. Note: this requirement exists even though DGCL §144(a)(2)

doesn’t mention “disinterested” shareholders. §144(a)(1) does. Applied :

Not approved by a majority of disinterested SHs, so no burden shift D must show the objective and intrinsic fairness of the deal

o Met *see notes p. 95-96 for interaction between 144 and this case law.

In re Wheelabratoro Facts :

WM buys 22% of WTI and wants to buy a controlling interest – (33% more by merger)

WM has 4 of 11 Drs of WTI SHs of WTI sue, claiming merger was not fair even if approved by all 7 of

the disinterested drso Held :

Rule : Effect of informed SH ratification :

o For arm’s-length transaction BJR applies (SH approval cures process defects)

o For Interested Dr transaction: Burden on D: must show intrinsically and

objectively fair After SH approval P: gift or waste

o For Controlling SH Transaction (eg. parent/sub) Burden on D: entire fairness After SH P: unfairness

o Why is Interested Dr/Controlling SH different? Harder for Directors?


Maybe a perception that controlling SHs have indirect but strong representation on the subsidiary Bd

Controlling company likely to have power and incentive to do wrongful self-dealing than just a couple directors. So we make it easier on Plaintiffs.

Here :o Arm’s length BJR

No vote Vote of a Majority of Disinterested SHs

Arm’s Length Transaction

BJR (Hard to overcome, but maybe Pl

can show Bd did not make informed business judgment. Cf Smith v. Van Gorkom)

SH approval cures process defects Note all are disinterested because it

was arms length

Interested D/O Transaction

D intrinsically and objectively fair Price/data about comparable

transactions Business need, etc.

P “gift or waste” i.e. evidence that other supplier could

have done so @ 10% less

Controlling SH Transaction

D “complete fairness” Fair dealing (process) + Fair price

(data)

P “unfairness” (hard, but not as hard as “waste”)

Duty of Good Faith (?) o Is there a separate “good faith” fiduciary duty?

RC : NO Thinks it’s a condition and component of both the duty of care and

of loyaltyo (though this may be a stretch of disloyalty you can act in

bad faith w/o really being “disloyal”) Acting in bad faith could result in personal liability for Drs

No exculpation or indemnification by corpo Disney Deriv Lit. (Del. Sup. ’06)

Facts: Post-trial findings put allegations in (pro-defendant) perspective

after the long trial: Ovitz was wildly successful and had to leave a very lucrative job.

His downside protection was heft: but there was a reasonable rationale for it.

Holdings :


(1) Due Care of Compensation Committee: D’s win.o Members did NOT fail to use due care in approving the

Ovitz Employment Agreement.o Although they may not have used best practices, they did

enough. (2) Due Care of Board of Directors: D’s win (3) Good faith of directors: P, to rebut BJR, has burden to prove

Bad Faitho Definition of Bad Faith :

Conduct motivated by an actual intent to do harm (subjective bad faith), or

Intentional dereliction of duty or conscious disregard for one’s responsibilities.

But: Gross Negligence is NOT enough to prove bad faith

o Why this matters: can’t exculpate directors for BAD FAITH (102(b)(7)(2)

(4) Waste Claim: Ds wino Waste: exchanges so one-sided that no person of ordinary,

sound judgment could conclude that the corporation ahs received adequate consideration. Waste found “only in rare, unconscionable case where directors irrationally squander or give away corporate assets.”

o Stone v. Ritter Facts :

AmSouth owns 100% of AmSouth Bank A regulatory investigation leads to $50M in fines SHs bring derivative action against 15 Bd members and claim

demand is futileo Theory : failed to fulfill duty of oversight and law

compliance – (Caremark-type claim; but framed as a breach of duty of good faith)

Assessing the Demand Reqmt : (Ct can’t do Grimes test dealing with inaction on the part of the

Bd). o Not concerned with whether they acted out of self-interest

or unsound business judgment But demand is not automatically excused. TEST :

o At the time the complaint is filed, there is a reasonable doubt the Bd could have properly exercised its independent and disinterested judgment in responding to the demand

Assessing the Oversight Responsibility : Court confirms Caremark standard:

o Have officers established info/reporting/compliance systems?


Assessing the liability standard : If you in bad faith didn’t have an adequate law

compliance/reporting systemo “sustained or systematic failure” of Bd to exercise

oversighto Depends on lack of good faitho “Utter failure” to assure a reasonable info and reporting

system Lift from Disney : emphasis on mental state

o Cause company to violate the lawo Intentional failure to act in the face of a known duty to

acto Demonstrate a conscious disregard for his duties

Applied here :o Plaintiff loses:

Longstanding compliance program Audit/KPMG report Bd heard annual presentations Adopted employee policies

AFTERMATH : May be more diligent in light of the tough standard BUT Drs won and a high std was established for Plaintiffs to meet

o Bd got off, but some trouble – (heightened process and procedures in boardrooms now)

Like Disney


Disclosure and Fairness 2 basic federal disclosure schemes

Securities Act of 1933 SEC Exchange Act of 1934

Transactional RS filed with SEC / Prospectus to investors

Req’d in connection with any public sale

Periodic Affirmative disclosure obligations

Forms 10 (once) 10-K (annual) 10-Q (quarterly) 8-K (episodic)

Only req’d of registered companiesAnti-fraud provisionsRegulation of proxy statement

o Securities Act of 1933o SEC Exchange Act of 1934

1933 Securities Act Basics o Public offering of securities must be registered with the SEC

Purpose : Mandate full disclosure and deter fraud Not : Substantive regulation of risk; just rely on mkt forces for that.

o Section 5 Rules : Don’t offer securities for sale before registration statement is filed

“Offer” can be broader than you think Don’t sell securities to public until registration statement is effective

(usually 20 days unless you hear otherwise) Deliver statutory prospectuses to each buyer before the sale

o Process is expensive: Elaborate requirements Need to use experts

Notes on Civil Liability under the Securities Acto At common law, Π would have to prove all four elements of common law fraud:

reliance, causation, scienter, and injury. BUT it was nearly impossible to prove reliance because most securities

fraud involves failure to disclose rather than affirmatively false statements.

o Fraud in the Registration Statement (Sec. Act §11) – express cause of action aimed at material misrepresentations or omissions in the Registration Statement.

There is NO requirement to prove reliance or causation. Indeed, the defendant bears the burden of showing that the MMOs did NOT cause Π’s damages.


§11(a) has no privity requirement, so liability might extend to anyone who signed the registration statement, executives, directors, outside experts, underwriters, etc.

Knowledge/scienter requirements under §11: Issuers are strictly liable under §11(b). If there is a MMO, they are

liable, even if it was a completely inadvertent mistake and Δ used reasonable care.

Δ’s other than the issuer – are held to a regular negligence standard, under which reasonable care IS a defense. This requires reasonable investigation and reasonable ground to believe the statements were true. §11(b)(3).

o BUT the burden is still on Δ to show non-knowledge of the MMO.

NOTE – find out if “issuer” just means the company, or directors/execs too??

o Escott v. BarChris seems to say just the COMPANY Issuing the stock, since it considered (but rejected) due diligence defenses for officers.

Damages (§11(e)) – may be reduced if Δ can show that the reduction in value of Π’s security is due to factors other than the MMOs.

o Failure to register (Sec. Act §12(a)(1)) – imposes strict liability on sellers for offers or sales in violation of §5. E.g. failure to register, improper registration, gun-jumping, etc.

The remedy is rescission – buyer can recover his investment, plus interest, minus income paid on the security. If this is not available, damages can be awarded.

o MMOs in the Prospectus or Oral Communications (Sec. Act §12(a)(2)) – imposes civil liability on a person who makes an MMO in connection with an offer or sale.

Π’s prima facie case: (1) sale of security; (2) interstate commerce; (3) by means of prospectus or oral communications; (4) containing MMOs; (5) by Δ who offered or sold the security; (6) Δ knew or should have known of the untrue statement.

Π need not prove reliance. Defense – Δ who conducts a reasonable investigation or who could not

have known about the MMO is not liable (but burden on Δ to prove this). This only applies to public offerings, not secondary market transactions or

exempt private offerings (Gustafson).o Due diligence is the only possible defense to a §11 claim (for non-issuers only),

and it is a defense to §12(a)(2) claims. This is often delegated to lawyers prior to an offering.

BUT if lawyers who are delegated due diligence work screw up, the defendants are still liable (but have legal malpractice claim against lawyer).

Definition of “security”


o Types : Stock / Bond / Debenture (obligations to creditors) / Note (short term

obligation) / Investment Ko Defining “security” is important for two main reasons:

(1) It tells you whether you need to register under the 1933 Act. (2) Whether it’s a security depends on which types of antifraud suits can

be brought. If it’s a “security,” you can sue under the securities laws (much easier to win), but if not, you must sue under common law fraud, which is much harder to win.

o Securities Act of 1933 §2(a)(1)): a security is: (1) Specific instruments such as stocks, bonds, notes, etc. (2) Evidence of indebtedness, investment contracts, or “any instrument

commonly known as a security.” BUT there is an “unless the context otherwise requires” clause in §2(a),

which can exclude from the Act’s coverage something that otherwise looks like a security.

o United Housing v. Forman 5-Factor Test of “Stock”

Dividend rights Instrument embodied in negotiable instrument that could be

transferred easily Right to pledge/hypothecate Voting rights Ability to appreciate in value

5-Factor TEST of “Stock” – (United Housing) TEST for Investment K – (Howey)

Dividend rights Instrument embodied in negotiable

instrument that could be transferred easily Right to pledge/hypothecate Voting rights Ability to appreciate in value

Investment of $$$ in a “Common Enterprise” with expectation of profits solely from

the efforts of others

o Robinson v. Glynn Facts :

Glynn forms LLC to develop and use technology Induces Robinson to sign letter of intent and make a $25M

commitment with an “operating agmt”o R is treasurer and member of Exec Cmte and can appoint 2

of 7 Bd members Robinson later learns that technology was not implemented and

sues Glynn for fraud under the federal securities laws Held :

Howey TEST for Investment K :


o Investment of $$$o in a “Common Enterprise”o with expectation of profits solely from the efforts of others

(later cases drop “solely” and look to “economic reality”)

Applied :o NOT an Investment K

Yes Investment of $$$ Yes Common Enterprise NOT profits from others with no meaningful control

over the investment – (not a passive investor, so he loses here)

Note: if you call it stock and it is traditional stock, then this is enough. It’s a security. But if you call it stock and it’s non-traditional, then apply the Forman 5-factor test.

Type Security?

Stock Yes

Bond Yes

Debenture Yes

Note issued by public corp Yes

Note issued by close corp Yes

General Partnership InterestNo – (“investment K” language. Management powers.)

Limited Partnership InterestMost likely Yes, but line-drawing – (Howey test.)

Interest in LLCDepends – (look at op agmt, apply Howey test)

Registration Process o 3 Basic Registration Rules – (§5)

(1) Security may not be offered for sale unless first registered with SEC §5(c)

Disclosure about finances and business model, corporate info, financial data, confirmation by banks/lawyers

(2) Securities may not be sold until the registration statement is “effective” §5(a)

A prospectus must be delivered to the purchaser before the sale Exemptions :

(a) Transactions by someone other than issuer, underwriter, or dealer


(b) Transactions by an issuer not involving a public offering – (some safe harbors for initial sale depending on the size of the offering)

o Can’t advertise + Must later file noticeo Failure to Register – (§12(a)(1))

Imposes SL on sellers for offers or sales in violation of §5 Remedy :

Rescission – (buyer can recover investment, plus interest, minus income paid on the security)

o Doran – (when do we have a public offering that must be registered?) Facts :

PMC organizes Limited P’Ship to drill for oil; Doran is one of 8 people contacted and buys an interest

Regulatory problems occur later and he sues under 1933 Act 12(a)(1) to get his $$$ back claims public offering that req’d SEC

o Since no registration statement, sale of interest in the limited p’ship violated §5

o Doran can now rescind under §12(a)(1)o PMC claims private placement OK under §4(2)

Held : Remand for full inquiry as to whether it was a private placement

o “Private Offering” = affirmative defense Policy: These individuals have the expertise to

protect themselves. Factors : (4)

o 1. # of offerees and their relationship to issuer and to each other

Looking for: Sophistication AND access on part of each

offeree such that they had the kind of info that a reg statement would provide

o Actual disclosureso Position-based access

Offerees’ relationship to issuero 2. Number of units offeredo 3. Size of the offering

If small, less worry about disclosureo 4. Manner of offering

Targeted vs. public advertising Use of 3rd parties

Applied :o Last 3 factors all cut in favor of the company

When “private offering” must be registered?


1. # of Offerees and their relationship to issuer and each other

a. Sophisticationb. Accessc. Relationship

2. # of units offered3. Size of the offering

a. If small, less worry about disclosure4. Manner of offering

a. Targeted vs. public adsb. Use of 3rd parties

o Safe Harbors : “Private Placement” (Regulation D)

Small offering exemption – no registration needed if less than $1M raised (Rule 504)

o If above $5M, can sell up to 35 buyers, but only if they meet the sophistication reqmts

o Can sell to unlimited “accredited investors” without registering

Generally can’t advertise BUT beware of “resale-and-integration” problem

“Private offering” exemption is only for the initial sale, so if the buyer wants to resell, must find another exemption

Rule 144 – allows buyers to resell non-registered stock that they acquired as long as they:

o Hold it for two yearso Only sell in limited volumes

Fraud in Registration Statement o Securities Act §11

Reqmt Standard

Who Can Sue? Buyers of offered securities

Who Can be Sued? Issuers, Drs, Execs, Anyone who signed the statement, accountants, underwriters

Standard Material Misstatements or Omissions in the registration statement No need to show reliance or causation No need to show it was intentional,


reckless, or negligent just “material falsehood”

Knowledge / Scienter Issuers strictly liable Other Ds regular negligence std –

(reasonable care is a defense)o Reasonable Investigation +

Reasonable Ground to believe statement was true

Defense D can use “due diligence”

Remedy Price paid minus mkt value @ time of suit/sale

May be reduced if D can show reduction in value was due to factors other than MMO

o Escott v. BarChris Construction Facts :

BCC built bowling alleys in 1950s sold debentures to raise money

Files registration statement in 1961 that hides troubles; bankruptcy in 1962

Buyers of debs bring action under Securities Act §11 Held :

All Ds liable Rule :

o MMO “material” Must be matters to which an average prudent

investor ought reasonably to be informed before purchasing the security

o Due Diligence defense: For parts of RS expertised by others:

Show “he had no reasonable ground to believe, and did not believe” that there were MMOs at the time RS became effective

For other parts: Show “he had, after reasonable

investigation, reasonable ground to believe, and did believe,” that the statements were true, with no MMOs

Reasonable investigation : std of reasonableness req’d of a prudent man in the mgmt of his own property


Applied here :o 3 kinds of falsities/omissions :

1. overstatements of good things 2. understatements of bad things 3. failure to disclose suspicious things

o Ct rejects the “due diligence” defense for all : Owners and Execs – (Unlikely they would have

understood anyway, BUT should have made investigation)

GC – (should have seen enough to investigate) Outside Dr – (did some investigation but signed RS

without reading it) Treasurer – (relied on outside accountants) Outside lawyer and dr – (didn’t know anything was

untrue, but didn’t dig deep) Aftermath :

Corporate bar nervous all firms review docs more closely – (elaborate services and large teams)

Planning : Drs and offs insist on max insurance and indemnification from the

corp Hire experienced lawyers to do due diligence

MMO

Must be matters to which an average prudent investor ought reasonably to be informed before purchasing the security

Due Diligence Defense – (Escott)

Parts of RS expertised by others Others Parts

Show “he had no reasonably ground to believe, and did not believe” that there were MMOs at the time RS became effective

Show “he had, after reasonable investigation, reasonable ground to believe, and did believe,” that the statements were true, with no MMOs

Reasonable investigation = std of prudent man in mgmt of his own property

Implied Private Rights of Action under 1934 Act:


SEC Rule 10b-5 o Remedies for misstatements and omissions made by company/officers that affect

them in your trading Implied private right of actiono Exchange Act of 1934, §10(b) :

It is unlawful for any person to “use or employ, in connection with the purchase or sale of any security … any manipulative or deceptive device of contrivance in contravention of SEC rules and regulations.”

o Rule 10b-5 It is unlawful for any person, in connection with the purchase or sale of

any security: (a) to employ any device, scheme, or artifice to defraud (b) to make any untrue statement of a material fact or to omit to

state a material fact necessary in order to make the statements made not misleading

(c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person

Do we like this private right of axn? PRO

o Gov’t not good / no resourceso Less incentive for gov’t

CONo Improper motives / lawyers

o Requirements :

Reqmt Standard

Implied Right of Axn OK – cts have found repeatedly

Jurisdictional pre-requisite Need interstate commerce easy to show

Plaintiff Must be actual buyer or seller – (can’t be someone who claims to have not exercised option) – (Deutschman). Option owner works too.

Scienter “intent to deceive, manipulate, or defraud Reckless disregard for truth is enough Due diligence is a defense

Action by D P must allege deception or manipulation.– (Santa Fe)

Std of Materiality Substantial likelihood that a reasonable investor would consider it important when deciding whether to buy or sell “affects total


mix of info” – (Basic)

Proof of RelianceActual reliance or FOM Rebuttable presumption Info must be public

Info must be public

Damages (Usually settle)

o Basic v. Levinson Facts :

Combustion thinking of buying Basic, but merger rumors were denied on 3 separate occasions. It then eventually goes through.

Plaintiffs were a class of investors who sold stock between denials and claimed lower sale price than if denials hadn’t been made 10b-5

Held : Rule :

o Materiality TSC Industries – “substantial likelihood that a

reasonable shareholder would consider it important in deciding whether to buy or sell.”

For contingent or speculative info/events: Balance probability of event occurring with

the magnitude of event in light of the totality of the company’s actions

o Since mergers are major events in a company’s life, information about them is generally material at an earlier stage

Line unclear, but do have to reveal before “agreement in principle.” That’s too late.

Note: Management can say “no comment” and stay out of trouble. No affirmative duty to disclose if not prudent in your business judgment

o Reliance / Causation Fraud-on-the-Market Theory

In an open and developed securities mkt, publicly available info will affect the mkt price

o Assumptions : Open mkts will internalize all

available material info


Misleading statements will defraud purchasers even if they don’t actually rely

SCOTUS accepts this as a rebuttable presumption

o D may rebut by showing that the misrepresentation had no effect on price or that an individual Pl would have traded despite knowledge of the MMO

Plaintiffs can get individual reliance by invoking this

Why this matters : can sue as a class action (because reliance doesn’t have to be proved by each individual).

Dissent – (White) Objects to the reliance claim

o People buy because they think the price does NOT reflect true value or info

Also, case has odd facts and it looks like a windfall to people who made money anyway

Materiality – (TSC Industries)

“substantial likelihood that a reasonable shareholder would consider it important in deciding whether to buy or sell.”

Fraud on the Market Theory

In an open and developed securities mkt, publicly available info will affect the mkt price Plaintiffs can get individual reliance by invoking this

Assumptions: Open mkts will internalize all available material info Misleading statements will defraud purchasers even if they

don’t actually rely


Rebuttable Presumption: D may rebut by showing either:

o Misrepresentation had no effect on price, ORo Individual Pl would have traded despite

knowledge of the MMO

Info must be public – (West)

o West v. Prudential Securities (Easterbrook, 7th, 2002) Facts :

Stockbroker @ Prudential makes up info and hypes a stock to 11 clients

Other people sue based on FOM – (info caused inflated stock price)

Held : Non-public info does not lead to presumption of

reliance/causationo FOM depends on assumption of public lies and

misinformation – (implausible that price would be affected by this broker’s lies)

o Easterbrook admits that strong form of FOM theory has been discredited.

o Santa Fe Industries v. Green Facts :

Santa Fe owns 95% of stock of Kirby Lumber; want 100%, so they use “short-form merger statute” §253 to cash out minority SHs – (process requires only approval from parent Bd). Some take appraisal rights.

Plaintiffs don’t like the price sue under 10b-5 claiming price was wholly inadequate and based on “fraudulent appraisal” by MorganStanley.

Held : 10b-5 requires deception and manipulation

o Deception = MMOso Manipulation = term of art

Here: just claiming a breach of fid duty..o Fid duty claim w/o deception or manipulation is not enough

to bring a claim under §10(b) Policy :

Purpose of 1934 Act = Full & Fair Disclosureo Anything regarding Fid Duty is merely subsidiary to this

disclosure Federalism


o State law deals with fiduciary duties and the court is hesitant to federalize this claim under the 1934 Act

o Deutschman v. Beneficial Corp. Facts :

Pl bought some stock options and now upset with MMO Issue :

Does buyer/seller of an option on a corporation’s stock have standing under 10b-5 to sue corp and its officers who make MMOs that affect stock price?

o Are stock options “securities”? Held :

Standing existso A purchaser of an option on an underlying security has

standing to seek damages under §10(b) for MMOs made by the defendant

Purpose of 1934 Act is to protect actual participants in the mkt – (no reason to treat options differently than securities since value of options is tied closely to value of securities)

o Dura Must plead and prove loss causation with sufficient certainty.

FOM is just a presumption about injury NOT about causation. So have to prove that the MMO caused the loss. RC : this has chilled securities actions.

Insider Trading Rule :

o Anyone who, trading for own account in the securities of a corporation, has “access, directly or directly, to info intended to be available only for corporate purposes and not personal benefit” may not “take advantage of such info knowing it is unavailable to those with whom he is dealing.”

10b-5 read to have IT provision for inside information – (must disclose material non-public info)

o Who’s Covered? Traditional Insiders

Those who have fiduciary duty Controlling SHs Employees Temporary insiders – (lawyers, consultants, accountants)

Tippees – (People who get info from traditional insiders) Tippees who get a tip from an insider who is breaching a duty by

giving the tip outo i.e. Improper personal benefit from giving out info

(Tipper can be sued too)o Who can sue?


SEC DOJ Investors?

Too hard to trace to the SH who sold to insider Maybe anyone selling @ time he was buying – (but damages could

be huge)o Calculating Damages – (§272)

Liability to contemporaneous traders for insider trading Private rights of action Disgorgement – (diminished by SEC order)

Traditional Insider Tippees “Inherent Unfairness”

Those who have fiduciary duty Agency relationship Controlling SHs Employees Temporary insiders – (lawyers,

consultants, accountants) Position of “trust and

confidence” that affords access to insider info only intended to be for corporate purposes

Tippees who get a tip from an insider who is breaching a duty by giving the tip out i.e. Improper personal benefit

from giving out info

Allowing corporate insider to take advantage of info by trading without disclosure

POLICY:

AGAINST THE RULE FOR

Compensates entrepreneuers that’s a good thing – (working hard and should be able to make money)

No clear connection between who you want to compensate and who gets the informationNo “secret profits” Harm to capital mkts

Helps pricing of securities. This helps get the information out.

Better to have ALL people knowing info Slows release of information if insiders

can withhold and take advantage

Can’t be stopped – (wasteful to try) Legal rules deter a significant amount

Let states decide Federal involvement increases investor confidence – (comparative advantage)

Let individual corps and their investors contract about it

Collective action & agency problems – (need strong legal default rule)

Allow opt out at least NO – not enough investors will get the msg and they’ll all allow managers to opt out.


Goodwin v. Agassizo Facts :

Agassiz (CEO) learns of copper deposits near company’s land in non-public report and buys stock on public exchange from Goodwin

Goodwin claims breach by trustee/fiduciaryo Held :

Suit dismissed Rule :

Trustees don’t owe duty to specific SHs but only to corp as a whole

o (case is in book to show that common law cts applying state law were not very aggressive against insider traders no general rule against IT)

SEC v. Texas Gulf Sulphuro Facts :

TGS team finds copper but keep it a secret while buying stock SEC sues under 10b-5

o Held : Rule :

Insider trading (10b-5) – anyone who, trading for his own account in the securities of a corporation, has “access, directly or indirectly, to information intended to be available only for corporate purposes and not personal benefit” may not “take advantage of such information knowing it is unavailable to those with whom he is dealing” (i.e. the investing public).

2 Options :o Disclose Tell the Public o Abstain don’t trade in or recommend the security

If there’s a business reason for not disclosing, then you should just abstain

When :o Must wait until the market can reasonably digest the info

and reflect it in the price Can’t put out a release and then just run out of the

room and make trade Who :

o If you disclose to some investors, you must make it available to all – (Reg FD)

Materiality : o Only applies to material inside information – i.e. if a

reasonable man would attach importance in determining his choice of action in the transaction in question.

Policy : Level the playing field – (all investors should have equal access to

material info and be subject to same mkt risks)


Not for personal benefit, no “secret profits” – (don’t treat stuff as implicit compensation to a fiduciary)

Dirkes v. SECo Facts :

Equity fund engaged in large-scale fraud Ex-Fund officer (insider) tells Dirkes who investigates and tells his clients

they sell and avoid major losses when fraud becomes public SEC sues Dirkes

o Held : Dirkes does not inherit the insider’s disclose-or-abstain position

Breach depends on whether the insider gets personal benefito Officer was insider, but wasn’t doing anything improper by

sharing (not breaching his duty) Dirkes did not inherit the fid duty

Rule : Forbidden from trading on material non-public info ONLY

when:o Insider has breached fid duty by making the tip ANDo Tippee knows or should have known there was a breach

Test for breach of fiduciary duty: o Will the insider personally benefit? Without benefit, no

breach. Thus no derivative breach by the trustee. Note: this focuses on the “breach of fiduciary

relationship” rationale for regulating insider trading (as opposed to “equal access” rationale.

Who inherits? o Existence of a:

fiduciary relationship agency relationship or position of “trust and confidence” that affords

access to insider info only intended to be for corporate purposes

o “Inherent Unfairness” Allowing corporate insider to take advantage of info

by trading without disclosureo (sometimes tippee inherits, sometimes not)

US v. O’Hagano Facts :

Grand Met wants to buy Pillsbury O’Hagan is lawyer @ D&W, but not working on the Grand Met matter

buys Pillsbury stock before the takeover is announced Issue: O’Hagan is not a fiduciary of Pillsbury bc he’s not even their

lawyer.o Held :

O’Hagan is Guilty under misappropriation theory Traditional ways :


o He’s NOT an insider/fiduciary of Pillsbury or Pillsbury’s lawyer – (his form worked for GM)

o He’s not a tippee of any insider @ Pillsbury Rule :

Misappropriation Theory of Insider Trading o It is fraud under 10b-5 when a person misappropriates

confidential info for securities trading purposes Breach of duty owed to source – (D&W) Premise : Deception of those who entrusted him

with confidential infoo Gov’t can sue him even if Pillsbury cannot

Policy : Protect integrity of mkt against abuse by outsiders who have access

to confidential info but do not necessarily owe a fiduciary duty to that corp’s SHs

o Rule 14e-3(a) It is a fraudulent/deceptive/manipulative practice under §14(e) of the 1934

Act for a person to purchase or sell securities in connection with a tender offer if:

Material info Know or should know Non-public Acquired from offerer/issuer/officer/director/employee of offerer

or target (Rule 14e-3(a) is OK because it is a means reasonably designed to prohibit

IT on material non-public information) Implication :

Even if he 1st spoke to D&W and Grand Met and told them he wanted to buy Pillsbury stock, he would not have violated 10b-5 because he would have told the people whose info he was appropriating BUT he would still have failed 14e-3

Misappropriation Theory

Cannot misappropriate confidential info for securities trading purposes

Rule 14e-3(a)Fraudulent/deceptive/manipulative for a person to purchase or sell securities if he has material non-public info acquired from insider

Background rules :o SEA §20A


Liability in private actors extends to contemporaneous traderso SEA §21A

SEC can bring actions to enforce civil penalties and treble damages Can be severe; only a civil std

o SEA §16(a) Classic insider filing requirements – (must file with SEC when making

purchases and sales)o Rule 10b5-1

It’s not enough to prove they had material non-public information, but also that they used it

BUT SEC says possession presumes use UNLESS Safe-Harbor Trading program (automated)

o Rule 10b5-2 Duties of trust or confidence in misappropriation IT cases – (family ties). Non-exhaustive list:

(1) Whenever someone agrees to maintain information in confidence.

(2) Between two people who have a pattern or practice of sharing confidential information such that the recipient of the information knows or should know that it is expected to remain confidential (JMH – printing store case?).

(3) Whenever someone receives or obtains material nonpublic information from a spouse, child, parent, or sibling.

Short-Swing Profits – Rule 16(b) Basic Rule

o In 6-month period, we’ll presume that any profits made on own stock is from IT If you buy/sell within 6 months of each other, the profit can be

recovered by the company. No proof of knowledge, intentionality, scienter, or materiality needed.

o Rationale : Bright-line rule – takes away from profits from designated insiders –

(over- and under-inclusive) Prevent unfair use of inside info – not designed to remedy actual use – it’s

merely prophylactic Elements :

Element Explanation

Insiders Directors, Officer, SHs over 10%

(10(b)-5 is much broader because it catches anyone with a fiduciary relationship (all employees))

Companies Anyone filing under the 1934 Act (listed on stock exchange, assets more than


$5m or more than 5000 shareholders).(Different than 10b-5 all companies)

Securities Equity securities (includes debt that can be converted into equity, but not other forms of debt: bonds, non-convertible debentures)

(Also narrower than 10b-5, which covers bonds and notes in addition to stocks.)

Sale & Purchase Need both within 6 months (order is irrelevant)

(Not a requirement under 10b-5)

Time Both buy and sell within 6 months

Multiple Transactions If multiple sales and purchases, we’ll match lowest purchase price with highest sale price to “maximize” your profits

Remedy Disgorgement to the Corp

10(b)(5) remedy is disgorgement to shareholders.

Enforcers SEC/DOJ, but mostly private derivative actions (attorneys will bring class action on all people trading in opposite direction)

How Caught §16(a) filing requirements

Interpretive Issues :o D or O may be caught if he has status @ time of 1st transaction, then resigns, then

does 2nd transaction within 6 months §16(b) applies as long as you were a covered insider at ANY TIME during

the past 6 months (EITHER at time of purchase or sale). BUT to catch a 10% beneficial owner, he must own that much at

the time of BOTH purchase and sale (e.g. if a sale takes you below 10% ownership, then you are outside §16(b)).

o HYPO – you buy 12% of the stock, then sell it one month later. Issue is whether you become a 10% owner at the time of purchase or just after purchase.

“At” means “just before” (Reliance Electric). So this guy’s OK. You must be a 10% owner BEFORE you buy the stock for §16(b) to apply.


o Unsure about how mergers / call options would be interpreted 10% shareholder buys some stock, and 2 months later the company

merges with Company B. You get stock in Company B after the merger (???).

What about giving a call option (???).o Kern County

Facts : Exchange of stock in a merger

Held : Court says it was involuntary and no possibility for abuse OK Factors :

o Volitional transactiono Influence on transactiono Access to inside info on target

Treat 16(b) purposively, not formalistically

Indemnification and Insurance Does the law allow D/Os to be reimbursed for liabilities arising from their roles?

o YES – (but subject to limits)o POLICY :

AGAINST (no indemnify) Want to deter fiduciary duty breaches

FOR Don’t want to deter capable people from serving as fiduciaries

o Where rules/policies come from : Exculpation provision in charter – (DGCL §102(b)(7))

Can eliminate liability except for:o Disloyal (breach of duty of loyalty)o Bad Faitho Improper personal benefit

Indemnification Statutes – (DGCL §145) Contractual promises to indemnify in bylaws/contracts D&O Insurance


§145 Rule

(a) In 3 rd -party (direct) suits , Corporation has the power to indemnify expenses and amounts paid IF: Person acted in good faith and with reasonable belief that it was in best

interestso (Corporation determines good faith)

(includes expenses, attorneys fees, settlements, judgments)

(b) In derivative actions, Corporation has power to indemnify expenses only IF: good faith and reasonable belief AND person not adjudged liable to the company (and ct finds that D is “fairly and reasonably entitled” to indemnification)

(DON’T get indemnified for liability or settlement…just fees)

(c) Corporation is obligated to reimburse for reasonable expenses if D is successful on the merits

(settlement ≠ success on the merits)

(d) Who decides whether to indemnify for legal fees and settlement? Directors – (might use independent drs) Committee Counsel – (usually use outside counsel) SHs – (but not likely to put to vote)

(e) Corp has power to advance expenses, but dr may have to pay back later if not entitled

(Dr will usually try to contract for this) – (Citadel Holding)

(f) (Section not intended to be exclusive of other rights. Can contract for more unless it violates any of the above provisions)

(g) Corporation has power to buy D&O insurance

Direct Derivative

Expenses and Liability/Settlement paid Expenses only (if not adjudged liable)


Waltucho Facts :

Waltuch traded silver for firm’s clients he and the company sued for fraud/manipulation after crash (settles)

Company pays $35M Suit against W is dismissed pays $0, but has $1.2M in legal fees

CFTC also sues him (settles) $100k fine $1M in legal fees

Waltuch sues for indemnificationo Held :

§145(a) is NOT exclusive of other rights to get indemnified BUT can’t do anything that’s inconsistent with §145(a)

(Art 9 of company charter requires indemnification of W for his legal fees even absent a finding of “good faith” illegal)

Can’t bargain away from the “good faith” requiremento §145(f) – acknowledges there are other rights that might

still exist – (corporations can go beyond the rights provided in §145(a)

o BUT cannot do so in contravention of §145(a) Planning :

o “Company is required to indemnify to the fullest extent possible under DE law.”

§145(c) requires indemnification of expenses of officers for “successful” defense of suits “on the merits of otherwise”

Doesn’t matter why successful vindication is enougho Company claims he was not “successful,” because they

paid substantial amount NO Citadel Holding v. Roven

o Facts : Roven has detailed indemnification with advancement of expenses Company sues him alleging 16(b) violation and he contests it and wants

expenses covered per his contracto Held :

§145(e) allows (but does not require) corps to advance director’s costs of defending a suit (even if against the corp itself)

(he wins)o Planning :

Shows importance of getting good agreement negotiated ahead of time


5. CORPORATE GOVERNANCE

Setting 1990s boom followed by bust in 2000-02 Scandals – (financial manipulation / self-dealing and extravagance) Stories/outrage/bandwagon Major changes

Sources of Change Congress SOX NYSE Corp Governance rules – (listing requirements) Governance Rating Systems by independent agencies Stricter tone in state case law – (Oracle / Disney)

Themes of Change 1. Fix Audit Process

o Conflict Rules Rules about audit and non-audit services

Limit non-audit work Must disclose size of non-audit and audit fee

Audit Committee Shift power to hire/fire/pay auditors

Reduce personal bonding between auditors and audited Mandatory partner rotation and limits on hiring audit firm

employeeso Top 2 from accounting had to rotateo Firm can’t hire former auditors for certain time

o Action Rules Must establish internal controls and §404 attention

Exs .o Write stuff downo How things get recorded and whether they’re trueo Dealing with ex-employees and access

Expensive! Financial Literacy and Expertise

Audit cmte members must be financially literate Must disclose whether you have a financial expert

PCAOB – (create new regulator) 2. Change Bds

o Conflict Rules Majority of Independent Drs

NYSE requires Stricter definition of independence – (NYSE)

Test :o No former employee in last 3 years


o No close relativeo No significant business relationshipo No large gifts to non-profit

Key Committees can only have independents – (NYSE) Audit / Compensation / Nominating – (MUST have these cmtes)

Suggestions of independent agencies – (help your rating) Supermajority of Independent Directors Independent Chairperson

o Desire to reduce influence of the CEOo Action Rules

Financial literacy and expertise on board Limits on over-boarding

Can’t sit on too many; not enough time Mandatory Dr stock ownership

Financial incentive Governance guidelines / Codes of Ethics Self Assessments

o POLICY : PRO

Fresh perspective Fewer Conflicts

CON Less business knowledge Costs more to have outside drs More lawyers’ fees

o Goes to heart of what boards do : The monitoring and management functions of Bds can come into conflict

and the insistence of independent directors tends more to the “monitoring” part

Monitor Manage

Look out for frauds / self-dealing / bad performance

Decide and vote on conflict-of-interest situations

“Impartial Policeman” Attitude

Bds good for knowledge and risk-reduction – (“Intelligent and interactive audience” role)

Decide and vote on major business issues

“Collegiality” Attitude

3. Impose Disclosure / Transparency o Looking for more and faster public disclosures:

Off-balance sheet arrangements Reconciling pro-forma figures to GAAP “critical accounting policies”


Related party transactions Expensing of options (accelerated filing reqmts)

o Action-inducing : SOX reqs certifications by CEO and CFO New crimes and new penalties for misconduct

4. Empower SHs o Get some boost from SOX changes:

Shift to annual elected from staggered boards SH nomination of Drs Movement for “majority vote” reqmt in Dr elections

Effect :o Non-audit services no effects foundo SOX 404 surveys

VERY costly Benefits unclear

o Bd Independence and Firm profitability no clear correlation


6. VOTING RIGHTS AND PROBLEMS OF CONTROL

Proxy Fights SHs do not have a specific claim (like bondholders) Instead, they are at the mercy of

management and company performance BUT:

o Better upsideo Certain control mechanisms:

Vote – (hypothetically, you can get new Drs in) Sell – (tender offers) Sue – (limited)

3 problems with SH voting :o Collective Action Problem – (everyone assumes other investors are keeping up)o Rational Apathy – (cost of reading/investigating proxy statement is so high and

benefit seems so low that it seems irrational to go to effort)o Big Investors – (investors free-ride on the big investors who do have an incentive

to monitor and vote) Background on fights :

o All corps must hold annual meetings (and sometimes special meetings)o Most SHs don’t go, so they appoint agents or “proxies”o Proxy fights often used to gain control – (insurgents will try to oust current

management by getting enough proxies so that it can elect its reps on the board) Funding Proxy Fights :

o Levin v. MGM Facts :

O’Brien is incumbent and dominates the MGM Bd; Levin is a dr and big SH and wants to propose his own slate

Levin sues, claiming incumbent group is causing MGM to incur expenses for a proxy fight – (proxy solicitations, PR firm, ads)

o (Levin’s own expenses are not being paid) Ct :

Companies are free to fund expenditures for informing SHs as long as amounts are not excessive and tactics are not unfair or illegal.

o Also, there was a real business conflict (as opposed to personal power or advantage)

TEST :o Not excessiveo Not unfair or illegal (full disclosure…etc)o Personal Business Conflict

o Rosenfeld v. Fairchild Engine Corp. – (reimbursement) Facts :

Proxy fight held and outsiders win then proceed to reimburse both sides

Rosenfeld disputes reimbursements by the corp of insurgents


Held : Rule :

o Incumbents : Don’t need SH approval for proxy-fight expenses

for contest over corporate policy OK to incur reasonable and proper expenses

in good faith for solicitation of proxies, unless money is being spent for personal power, individual gain, or private advantage

o Insurgents : Can get reimbursed if successful w/SH approval

“reasonable and bona fide” expenses incurred in fights over policy

Dissent : These were excessive expenditures

o Look to loyalty / put burden on the spenders POLICY :

By allowing incumbents to spend on corporate policy issues, it lets them defend their work

Probably discourages insurgents because they don’t get paid unless they win (BUT deters frivolous fights)

o Maybe we should pay them a risk-premium if they win. But then over-incentivize?

Levin Rosenfeld

Companies can fund expenditures as long as they are: Not excessive Not unfair or illegal Personal Business Conflict

Incumbents NO SH approval if contest over corporate policy Reasonable and proper expenses Unless spent for personal power,

individual gain, or private advantage

Insurgents Can get reimbursed if successful with SH approval


Proxy Rules Federal Statute

o Exchange Act §14(a) – SEC can regulate proxy solicitation; illegal to violate SEC proxy rules

o Exchange Act §14(b) – SEC can regulate brokers and exchanges SEC Rules

o 14a-7 – Mail-or give-list rule Corporation can either send out proxies for you, or can elect to give you

the list of SHs They generally choose to send because they don’t want to give up

the listo 14a-8 – SH Proposal Rule

Gives SHs the opportunity to send a proposal (Discussed below)

o 14a-9 – Antifraud forbids MMO in solicitation of proxies

(akin to 10b-5 no MMO in connection with purchase/sale of any security)

JI Case v. Borak – (SCOTUS) Facts :

o Case merges with American Tractoro Case SH brings private action for proxy rule violation

Question of whether there is an implied right of action under the proxy rules

Held :o There is an implied right of action for proxy violation

under Exchange Act §14(a) and Rule 14a-9. 14a-9 says you can’t solicit proxies in ways

contrary to rules adopted by SEC to protect investors; no false or misleading omissions.

Look to intent of the statute: “protection of investors”

§27: jurisdiction given to federal courts, but never specifies who can bring it

Read as granting private right. Note :

o Ct considers this to be a derivative action Rationale :

This was before class actions, so if it was direct action, the payment to the lone SH would have been low ct reads liberally to make this derivative

Miller v. Electric Auto-Lite – (SCOTUS) Facts :

o Misleading omission in a proxy about a merger


o Mergenthaler owns 54% of A-L wants to merge A-L into Mergenthaler

Bd approves (easy considering all Drs of A-L nominated by Merg)

Puts to SHs via a proxy statement (need 2/3 vote) BUT didn’t say all A-L Drs were nominees of the

parento Plaintiff sues claiming MMO under 14a-9

Held :o (Remanded for more determinations based on fact)o Materiality – (ct assumes materiality)

Reasonable investor might have considered it impt NOW: Use TSC “substantial likelihood that a

reasonable investor would consider it impt” More strict / might have mattered

o Causation – (did omission cause merger?) TEST for causation :

Defect was material Proxies were an “essential link” in the

accomplishment of the transactiono (Don’t have to show that the defect

itself was an essential link, just the proxy statement as a whole).

7 th Cir. Test – (rejected) : Look at “preponderance of possibilities” to

see if the MMO affected voting resultso Look at actual price and see if it’s

“fair” if so, defect didn’t cause injury to P

o (SCOTUS rejects as too subjective) But see Breyer in Dura. Would S.Ct. have

rejected this test today? Prob not if weren’t for this precedent.

o Remedies Possibilities :

Enjoin merger beforehand under 14a-9 Unscramble Merger Grant damages after the Merger

o Only allowed damages if mergers resulted in a reduction of earnings potential of the shares

o Look to fairness of terms – (so on remand, the 7th cir. just did what they did at the causation stage above. Fair terms so no damages.)

o Attorneys’ Fees


When a SH sction results in subsequent benefit to the corporation, he can recover costs and expenses (even if he loses) as long as the suit:

“prevents an abuse” or “affects the enjoyment and protection of an

essential right of SHs” eg. If you can prove MMO and causation

that looks like enough to get your fees paid by the corporation.

Policy : Rule ensures that fees of beneficial suits that

vindicate corporate rights will be spread across ALL SHs

TEST for whether omission caused merger

Defect was material Proxies were an “essential link” in the

accomplishment of the transaction

(Don’t have to show that the defect was an essential link, just that the proxies containing a material defect were)

Attorney’s Fees Test

SH can recover cost and expenses of lawsuit (even if no damages awarded) if action results in subsequent benefit to the corporation as long as: “prevents an abuse” or “affects the enjoyment and protection of an

essential right of SHs”

Shareholder Proposals

Overview of Proxy Rules- Statute:

o §14(a) – SEC can regulate solicitations of proxies


o §14(b) – SEC can regulate brokers, exchanges- Rules :

o 14a-1 – Definitionso 14a-2 – Solicitations to which the rules apply – these only apply if a shareholder is

soliciting proxies for itself (e.g. literally asking for proxies).o 14a-3 – Information to be furnished – shareholders must be given proxy statements

that make certain disclosures and must be filed with the SEC (see also -4, -5, -11). Fairly extensive disclosures in the proxy statement are required for managers

and incumbents when elections are contested.o 14a-4 – Requirements as to proxy statement – boilerplate stuff.o 14a-5 – Presentations of information in the proxy statemento 14a-6 – Filing requirements – copies must be filed with the SECo 14a-7 – Mail-or-give-list rule – corp can either send out the proxies for you, or can

elect to give the list of shareholders to the supporters of the proxy. They generally choose to send the proxies (not surprisingly).

o 14a-8 – Shareholder proposal rules: Requirements: Must hold at least $2,000 of stock or 1% of company’s voting stock. Proposal must be 500 words or less and must clearly state the course of action

that the company should follow. Possible reasons for exclusion of shareholder proposals (14a-8(i)):

Proposals must be cast as recommendations or requests, and NOT as binding orders (generally a state law requirement).

Proposals may not deal with management functions (i.e. ordinary business matters).

Proposals may not merely relate to personal grievances or special interests not shared by other shareholders at large.

Relevance – proposal may be excluded if it relates to operations that account for less than 5% of assets or earnings, and is not otherwise significantly related to the corp’s business.

Proposals may be excluded if they relate to elections for the board. This is a pretty big exception.

Proposals may be excluded if they violate law or proxy rules. Proposals may be excluded if the company lacks the power or

authority to implement it, or if it has already implemented it. Proposals may be excluded if they duplicate recent proposals.

The company MAY include in its own proxy statement reasons why it opposes the shareholder proposals (unless false or misleading).

To exclude a shareholder proposal, the company must files reasons with the SEC. Burden is on the company to show why proposal should be kept out.

The SEC referees this process. Companies request exclusion and if the SEC staff agrees, they issue a “no-action letter” recommending no enforcement proceedings (which can be appealed). Or it may signal that it intends to bring an action if the proposal is excluded.

The losing party can always seek an injunction in district court.o 14a-9 – Antifraud rule – forbids solicitation of proxies (whether in proxy statements

or other communications) that are false or misleading with respect to any material


fact, or which omit to state any material fact necessary to make the statements not misleading.

o 14a-12 – Solicitations before proxy statement.

Rule 14a-8o Reqs :

Must hold at least $2k stock or 1% of voting stock for 1 yr Proposal must be 500 words or less and must clearly state the cause of

action that the company should followo Numerous exceptions under which corp can exclude a SH proposal :

Must be cast as recommendation or request (not binding order) May not deal with mgmt fxns (ordinary biz matters) May not merely related to personal grievance or special interests not

shared by SHs at-large Has to be relevant – (>5% of assets or earnings) Proposals may be excluded if they relate to elections for the Bd – (big

exclusion) Rationale : 14a-7 deals with elections; 14a-8 is more general

corporate stuff May be excluded if they violate law or proxy rules May be excluded if company lacks power of authority to implement May be excluded if they duplicate recent proposals

AFSCME v. AIGo Facts :

AFS proposes SH resolution for inclusion on AIG’s proxy statement that would allow a SH owning 3% or more of AIG stock to nominate a Dr candidate to appear on the corporate ballot.

SEC agreed with AIG that this could be excluded, but suit brought anyways.

o Held : can’t exclude the statement. Court interprets the exclusion for stuff relating to elections to refer to

particular elections, but NOT proposals that would establish procedural rules for elections generally

SEC later amends exclusion to include proposals that relate to “a procedure for such nomination or election”

o Policy : AFS has desire to wage low-cost proxy contest at company’s expense AIG wants to be able to exclude because then the insurgents have to pay

under the mail-or-give-list rule (14a-7)o Note: Shareholders can amend the bylaws to do this without the board’s

consent. And Directors can adopt or amend bylaws as well if the charter allows them (and all do). BUT they can’t UNDO what shareholders do. Can’t contradict current bylaws.

Lovenheim v. Iroquois Brandso Facts :


Pl owns shares of D and disapproves of its force-feeding methods for geese for fois gras wants a SH proposal in proxy to form cmte to study methods and whether it causes undue suffering

D wants to exclude as having an insignificant relationship – (less than 5% of company’s business)

o Held : YES – significantly related

Not just economic / moral relationship can be just as impt TEST :

Implicates significant levels of sales + Ethical and social significance

Reasoning: Court concedes that this is less than 5% of corp’s business. But the

proposal IS otherwise significantly related to the corp’s business. “Otherwise” implies that some non-economic activities are nonetheless “significant.”

Ct ignores likelihood of success this is about giving SHs access to communications. So there’s irreparable injury just by denying access even though it’d clearly lose.

NYCERS v. Doleo Facts :

NYCERS (large SH) wants proxy about major healthcare reform proposals wants a proposal that they form a cmte to study the debate

Company wants to exclude: Relates to ordinary business operations Insignificant relationship Beyond company’s power to effectuate

o Held : Burden of proof is on the company to show the exclusions apply Statement could NOT be excluded

Not “ordinary” issue of social significance Not insignificant huge expenditures (more than 5%) Not beyond power we just want you to do a study and report –

(impact of public policy on this company) Austin v. Con Ed

o Facts : 3 SHs submit proposal for non-binding resolution favoring employees’

right to retire after 30 years. The SHs are also shop stewards of the union. Must be cast as recommendation/request – (non-binding) Must comply with state law – (Bd has to have say over operations,

so must be framed as a recommendation)o Held :

Excluded under 2 exceptions Ordinary business operations

o This is a mgmt function and can be handled in collective bargaining


Personal Grievance Exceptiono Proposal seeks to benefit proponents, but would not be

shared by SHs at-largeo (Ct focuses on #1)

Proposals Today :o Corporate Governance

“Say on Pay” – Executive compensation disclosure + approval SEC lets a lot thru and many are successful

Dr elections Bd independence Takeover Defenses

(these have arguable link to SH value)o Social Responsibility

Environment Political Contributions Equal Opportunity Animal Welfare

o This year: Say on pay resolutions Cumulative voting Special stockholder meetings Reincorporation in N.Dakota!

o POLICY : Why do activists submit so many if most lose?

Draw attention—free publicity! Not too costly

Why do mgmt try to persistently to exclude? Pestering Deterrence – (fight these so people don’t think door is open)

Do we like it? YES – (SH empowerment) NO – (pestering / have other forums)

Ways to Knock Out SH Proposals – [Rule 14a-8]

Reqs: SH owned less than $2k stock or 1% of voting stock for 1 yr Proposal is over 500 words and does not clearly state the cause of

action that the company should follow

Exceptions Cast as binding order – (not recommendation or request)

Deals with management fxn – (“ordinary business matters”)


Personal grievance / not shared by SHs at-large

Not relevant – (must deal with more than 5%)

Can’t relate to elections

Can’t violate the law

Company must have power to implement

Can’t duplicate past proposals

BURDEN IS ON THE COMPANY TO SHOW EXCEPTION

Shareholder Inspection Rights A little different than 14a-8

o There: Cts more permissiveo Here: more stingy

Small SH interest can be a large disruption Why have it (this is all invoked under state law ):

o Company will do mailing for you under 14a-7 (proxy fights) and 14a-5 (tender offers)

o BUT: You may want the lists to lobby large SHs directly You may be concerned about company dragging its feet

State ex rel Pillsbury v. Honeywello Facts :

Activist buys 100 shares to seek SH list and look at books/records for Vietnam War activity company opposes

o Held : Inspection CAN be compelled, but not proper here

Inspection Rights (DGCL §220(b)) o SHs may demand access to corporations’ SH lists or

books/recordso BUT need “proper purpose related to your economic

interest as a stockholder” (can’t inspect books to help competing firm or for

your own political ideals. Need to be economic interests as a shareholder or out of concern for the company).

o Burdens of proof (220(c)) To get SH List Company has burden to show Pl

doesn’t have proper purpose To get Books/Records SH has burden to show he

does have proper purpose Applied :


o Not a proper purpose here not about SH value or profit-max

Should have framed it as economic purpose concern about bad PR which will hurt business

Crane v. Anaconda Co.o Facts :

Crane makes hostile tender for A and seeks SH list from A pursuant to NY BCL §1315

Note: NY shareholders can use NY law for any business doing business there.

NY §1315: any resident who has been a SH of a foreign corporation for 6

months has the right to examine the shareholder list, as long as the inspector files a statement saying that the inspection is “not desired for a purpose” which is in the interest of another business.

Anaconda refuses, claiming §1315 was not met because the inspection is not desired for the interest of A

Is inspection for purpose of telling SHs about a tender offer related to the business of the target?

o Held : Inspection allowed Rule :

SH desiring to discuss relevant aspects of TO should be granted access unless sought for purpose hostile to corp or its SHs

o TO has “potential substantial effect” on company’s well-being and mkt value, so it affects business

o Burden on corp to show improper purpose for SH lists Sadler v. NCR Corp.

o (Case illustrates complexity of getting a SH list)o Facts :

AT&T makes cash tender offer for all shares of NCR and wants SH list – (NCR Bd opposes, declines to redeem poison pill, so AT&T needs 80% to call a “special meeting” and elect a new board)

AT&T wants both of these lists:o CEDE – brokerage firms who hold stock for the benefit of

the customerso NOBO – owners who WANT to have their info made

public (AT&T hadn’t held stock for 6 months and didn’t have 5%, so they

got Sadlers to make the request)o Held :

AT&T can get the NOBO list Sadlers are eligible to sue NY residents who qualify under

§1315


If a corporation is authorized by the SEC to collect data for a NOBO list, then NY §1315 allows qualifying SHs to demand both the compilation and the production of such a list

o Ct says that §1315 was designed to help SHs, so it must be liberally construed you can make the list quickly, so we’ll make you do that

But NY Leg later changes §1315 to extend only to information already in existence

o DE Ct is more narrow – (RB Associates)


SH Inspection Rights Cheatsheet

Policy Concern:We want you to have these rights because the company may be dragging its feet under the mail-or-give-list rule BUT a small SH could be a large distraction, so we’re willing to limit

DGCL §220(b)SHs may demand access to corporations’ SH lists or books/records BUT need “proper purpose related to your economic interest

as a stockholder”

NY §1316: any resident who has been a SH of a foreign corporation for 6

months has the right to examine the shareholder list, as long as the inspector files a statement saying that the inspection is “not desired for a purpose” which is in the interest of another business

Burdens: SH List: Company show Pl doesn’t have proper purpose Books/Records: SH show he does have proper purpose

SH desiring to discuss TO should be granted access unless sought for purpose hostile to the corporation or its SHsTO has “potential substantial effect” on company’s well-being and mkt value, so it affects business – (Crane)

Both compilation and production may be ordered – (Sadler)NY liberally construe for benefit of SHsDE may be tougher

Shareholder Voting Control SWIB v. Peerless

o Facts : Peerless has 3 proposals at annual meeting

Proposals 1 & 3 are relatively uncontroversial easy Proposal 2 would greatly increase shares for the stock option

program controversial – (SWIB opposes) The Chairman/CEO sees that Proposal is going to lose, so he declines to

close the polls and adjourns the meeting; they then solicit more support and gets it to pass

SWIB sueso Held :


Standing? SWIB has standing even if they were not present at the meeting

and failed to object thato Purpose of proxy system is to enable voting w/o all SHs

having to be present Note: for shareholder proposals you do have to

show up. Breach of Fid Duty of Loyalty?

TEST : (Blasius Test)o Pl must show Bd acted for the primary purpose of

thwarting the exercise of a SH voteo Bd then has burden of establishing a compelling

justification for its actions Applied :

o Prong 1 met – (had a quorum; not necessary for higher turnout)

o Prong 2 court remands for further findings Peerless made 3 claims :

No duty of loyalty – (Ct said CEO had personal interest)

No disenfranchisement because anybody could vote again in the 2nd meeting – (NO – deliberate interference with the voting process)

Higher turnout desired – (No – you had a quorum)

o (Court basically says in FN: “New vote or settle”)

Blasius TEST for Voting Manipulation

1. Pl Bd acted for the primary purpose of thwarting the exercise of a SH vote

2. Bd Establish compelling justification for its actions

Stroh v. Blackhawk Holdingo Facts :

Blackhawk had 2 classes of stock A – real stock – (dividends / assets @ distribution / vote) B – just have a vote – (no dividends)

Issue: IL Constitution said that stockholders must have a right to vote based on the number of shares they own.

Pl claims Blackhawk’s scheme is illegalo Held :


Dual-class common stock is allowed Stock involves 3 “rights” :

o Management/control rightso Rights to earningso Rights to assets

Corps may eliminate the rights to assets and earnings in different classes of stock but CANNOT remove the mgmt right incident to ownership

o But voting must remain proportional to number of shares owned; not to your initial investment

Applied: A split like this one (that dilutes voting rights for one class) is fine, as long as voting remains proportional to your ## of shares.

o Policy Regarding dual classes of stock: Cynical argument: promoters think that they’re the best people to run the

business, and they want to keep others from encroaching. Good argument: people should have the flexibility to decide whether they

want to pay more for stock with different rights attached. BUT there can’t be fraud, overreaching, etc., even if these dual

arrangements are allowed. Today, most state corporate laws DO allow creation of different classes of

common stock with different voting rights and preferences. BUT most institutional investors don’t like different classes of stock. The SEC doesn’t like dual-class stuff and they’ve tried to regulate, but

this has been undone by courts. Stock-exchange rules make it hard (not impossible) to do multiple

classes. NOTE – under DE §151(a), corporations may issue various classes of

stock “which have such voting powers, full or limited, or no voting powers.”

Control in Close Corps 2 problems in close corps :

o Voting agreementso Dissolution

NY BCL §620 o SH voting agmts OK if signed and in writingo Restrictions on management OK if:

In the certificate of incorporation Unanimously approved by incorporators or by ALL SHs voting on

amendment to certificate Subsequent purchasers of shares are given notice

Agmts in Close Corps: NY statutory approach NY §620

Voting


OK if signed an in writing

ManagementOK if: In the certificate of incorporation Unanimously approved by incorporators or by

ALL SHs voting on amendment to certificate Subsequent purchasers of shares are given

notice(In general (Galler), for closely held corporations, agreements requiring the appointment of certain people as officers or employees ARE enforceable as long as they are signed by ALL shareholders.)

Voting trusts (DE §218) – shareholders can turn their shares over to a trustee, who votes the whole block accordingly.

Agreements upheld o Ringling Bros. v. Ringling

Facts : Family-held business where some SHs made agmt about how they

would vote their shares for election of Ds – (given the cumulative voting system—multiply the number of shares by the number of positions open…then distribute among candidates as you wish), they could get 5 of 7 Drs)

o Haley defects and Ringling sueso Haley claims the vote-pooling is invalid

Held : Agreements by SHs to decide how they’re going to vote for

directors are VALIDo Vote-pooling agmts are OK provided they’re not unfair or

fraudulent (Ct doesn’t count Haley’s votes because they violate the agmt)

o Reqmts : Must be in writing Filed with Corp Specified term – (irrevocable for whole term) Term can’t exceed 10 yrs

o Clark v. Dodge (NY) Facts :


D (75%) and C (25%) together own stock of 2 corps and have an agmt that D will keep selecting C as Fr and mgr

o He must remain faithful/effective/competent and he will get some salary and dividend

D declines to continue to make C mgr and he sues for specific perf Held :

Agmt is valid – (unlike Mcquade v. Stoneham)o Parties to agmt are the ONLY SHs

No one else would be harmed – (They have wider scope to make agmts that limit their respective rights and powers)

All SHs agreed to the deal No attempt to “sterilize” the Bd – agmt was

moderate and reasonable; had to be on good behavior

Note: a partnership may be better for these people!o Galler v. Galler

Facts : 2 brothers run wholesale company and have SH agmt:

o Votes for specific Drso Pay annual dividendso Payments form corps to widows if bro dies

(each owns 47.3% and employee 5.4%) Held :

Enforceableo Rule :

SHs in close corp may make agreements about the management of the corp (including dividends) if:

No complaining minority interest ‘o Not “all must agree” but rather “none

object” No fraud/injury to the public or creditors

o Note on duration : voting trusts are limited to 10 years, but this Is not a voting trusts.

o Close corps are different SHs likely to be Drs/Offs Public companies – clearer separation of roles Harder to sell your stock in a close corp so you

want to maintain control via agreementso Ramos v. Estrada

Facts : TV, Inc. owned by two groups:

o Broadcast Group – 5002 shares (5 directors)o Ventura 41 Group – 5000 shares (4 directors)


BG members enter into voting agmt that all will vote for the directors that the majority of BG supports

o Tila votes against the group (doesn’t violate JBA because that was only for directors) and BG proposes a slate of directors NOT including Tila.

o Tila repudiates the JBA (refuses to vote herself out.) o Group demands that she sell her stock – (as per the agmt)

Held : Vote pooling agmt not illegal under CA law

o Valid even though : not a statutory close corp not objectionable as a failed version of something

else it resembles indirect influence over behavior of Drs as Drs when

making corporate business decisions – (contra McQuade)

o Specifically enforceable Close enough to a closed corp to be treated as such

Agreements not upheld o McQuade v. Stoneham (NY)

Facts : 3 SHs (McG, McQ, Stoneham) have agmt to vote for one another

as directors and officers (with certain salaries/powers) Stoneham and McG go against and decline to elect McQ

o He sues for specific performance Held :

Vote-pooling agmts are OK to elect drs BUT can’t agree beforehand on how to act once you’re a Dr.

o Cannot preclude a director’s power from changing officers o “abrogate their independent judgment”

Can’t constrain independent discretion over business matters

o Drs have judgment by virtue of their office to elect officers and fix salaries

OK NOT OK

Agreements by SHs to decide how they’re going to vote for directors are VALIDVote-pooling agmts are OK provided they’re not unfair or fraudulent – (Ringling)

Parties to agmt are the ONLY SHs

Cannot agree beforehand on how to act once you’re a DrCan’t abrogate independent judgment


No one else would be harmed – (Clark v. Dodge)

In close corp, OK to agree about mgmt if: - (Galler) No complaining minority interest No fraud/injury to the public or

creditors

If close enough to a Close Corp to not be objectionable as a failed version of something else – (Ramos)

Abuses of control in close corp :o Differences btwn close corp and public corp :

Close corp doesn’t observe strict separation of roles of mgr and investor (including what you get by rights and economic claims in each role)

Exit opportunities are less – (can’t just put shares on mkt) Practical reality – (for most, this is main source of owners’ wealth) Less planning ahead – (expect to do well; most are friends and family)

o Donahue Facts :

2 controlling SHs do a share buyback, but refuse to give 3rd guy the same price for his shares

Rule : SHs in close corps owe one another substantially the same

fiduciary duty that partners owe to one anothero “Utmost good faith and loyalty”

o Wilkes v. Springside Nursing Home Facts :

Wilkes and 3 others invest equally as SHs in SNH, with understanding that all will participate actively in mgmt and receive equal monies. No dividends, just salaries.

Eventually have bad blood and W says he wants out; the other 3 then leave him off the salary list and don’t re-elect him as a Dr he sues

Held : He wins. TEST :

o (1) LBP: When the minority SH sues the majority SH, the majority can show a legitimate business purpose for their action – (e.g. employee was incompetent)

o (3) LHA: If the majority does this, minority SH can try to show that there was a less harmful alternative


Applied :o No legitimate purpose for leaving him off. Gets the salary

he should have received. Other factors that favor Wilkes:

o Longstanding agreement, expectation of continued employment. Wilkes’ shares became worthless.

Planning : Be more explicit – (i.e. “if one person gets fired as employee, he

also has right to have shares bought out”) Wilkes should have asked for employment K SHs could have signed voting agmt agreeing to elect each other as

drso (but in vast majority of close corps, things work out fine, so

no need to spend tons of money figure these contingencies out)

Close Corps Conflict TEST

Minority SH sues Majority SH1. LBP: Majority SH can show legitimate business purpose for

action

2. LHA: If met, Minority SH can try to show there was a less harmful alternative

CAN CAN’TFire employee even if contractually agree to repurchase agreement – (no right against at-will discharge)

Freeze out of ordinary financial benefits – (Sugarman)

Abuse duty of “utmost good faith and loyalty” – (Donahue)

Abuse controlling interest – (Smith)

Hide material info / behave opportunistically – (Jordan)

o Ingle v. Glamore Motor Sales Facts :

Ingle (employee) enters into SH agmt and able to buy 40% of company (Glamore keeps rest)

o SH agmt contains repossession right for Glamore if Ingle ceases to be an employee for any reason


Ingle eventually fired by Glamore’s sons and they exercise repossession right give him $96k (he bought in $75k)

o He sues Held :

Ingle loses Rule :

o Minority SH in close corp who contractually agrees to repurchase agmt does NOT acquire a right against at-will discharge

Rights as SH ≠ Rights as Employee Ingle vs. Wilkes

1. Written Ko K is about repurchase, not employment

Clash : Employment at-will discharge

vs. Partner-like right of Minority SH in close

corp 2. Wilkes was a founding partner – (looks like a partner) 3. Ingle at least got his investment equity back (albeit low); Wilkes

was totally frozen outo Sugarman v. Sugarman

Held : Unlawful freeze out in Closely held corporation extended:

o Can’t freeze shareholder out of financial benefits that they ordinarily would have received

Should have paid dividends Compensation was excessive

(classic self-dealing) maybe they should have brought derivative suit and force him to show “entire fairness”

o Smith v. Atlantic Properties Facts :

4 SHs own 25% each in corp holding real estate; corp has 80% vote reqmt so everyone has veto power

Wolfson does not want dividends to be paid; prefers retained earnings – (he is in high tax bracket)

Company repeatedly being fined by IRS for high retained earningso Others sue to make Wolfson reimburse company for the

IRS penalties Held :

Wolfson loseso Veto power makes him an “ad hoc controlling interest” so

he’s subject to Donahue breached duty of “utmost good faith and loyalty”

Kept using veto to block dividends despite the fine


Ct notes he had no plans for earningso When everyone has a veto, everyone has a fiduciary

dutyo Jordan v. Duff & Phelps

Facts : Jordan is analyst with good prospects; gets offer to leave firm and

tells D&P he wants to leave Under his K, he had a buyout right and entitled to get adjusted

book value of the stocko He waits until end of yr to get higher price for stock

BUT 10 days later, merger came and stock increased dramatically (20x)

Held : Other SHs breached duty to disclose – (affirmative)

o “Material info that a reasonable investor would consider important in deciding how to act”

o There is a duty not to behave opportunistically implied in EVERY employment K

Decision to sell shares is an investment as well as an employment decision he was an investor

Dissent : (Posner) No duty to disclose in his contract

o 10b-5 does not apply They could have fired him @ will anyway OR they could have

bought him out for the explicit reason of keeping him from getting the financial benefits of the merger

Trouble in Close Corporations: Control, Duration, and Statutory Dissolution (cases where minority SHs try to use special statutory provisions that allow corps to order

dissolution in certain circumstances) Alaska Plastics v. Coppock

o Facts : S/G/C own AP equally – (have been the only D/Os)

C divorces and M gets ½ of his shares = 1/6 of total S/G/C get $ in directors’ fees and personal travel expenses; G also gets

$30k per year as GM; M gets nothing S/G/C offer M $15k for shares, but she refuses – (too low)

M sues under 10 different individual and derivative actionso Held :

Buyout is ordered for unspecified reasons of “oppression” 4 Theories under which a ct can mandate a buyout of min SH :

(1) Articles of incorporation or bylaws or contracto Contract giving SH a buyout right

(2) Statutory Appraisalo Ct can look at value of shares and order the majority to buy

out minority SH


o (BUT only applied in cases of merger or major asset sales) (3) Breach of Fiduciary Duty by Majority group

o Controlling majority can’t use its power to give the majority benefits that are not shared equally by the minority

Here : no unequal treatment – (nothing offered to majority, but not her)

Maybe she should have tried to make a constructive dividends argument that the Drs fees and expenses they were receiving were unfair

(4) Dissolution Statute (AK law)o Shareholder can bring action to liquidate the corp upon

showing “illegal, oppressive, or fraudulent” acts by the controlling parties OR

o Waste or misapplication of corporate assets (Ct finds equitable authority under this statute to

order a less drastic remedy than dissolution such as buyout even though statute doesn’t actually authorize this)

Key is oppression o RC :

There was a forced buyout and RC thinks it was wrong. on remand, Π was awarded a buyout of $32,000 for her shares, on the ground that the majority was “oppressive.”

Questionable to allow buyout instead of dissolution. Makes it look like a partnership

Not clear that these facts constitute oppression

o Planning : If C did not have enough money for full buyout, maybe he should have set

up to buy stock over time If the other 3 knew that marriage was in trouble, should have set up right

of 1st refusal to buy stock before transfer Pedro v. Pedro

o Facts : 3 brothers each own 1/3 of company and have an agmt that if anyone

leaves, the company will buy back stock @ 75% of book value (including goodwill)

Alfred finds accounting problems and suspects the others who proceed to fire him

He sues and is awarded $767k under retirement plan and $563k more for breach of fid duty at trial.

o Held : Damages upheld


Rule : Under MN statute, Court can order dissolution for:

o Deadlock SH deadlock = 2 yrs of not being able to elect drs Dr deadlock = irreparable injury is threatened and

normal biz can’t be conducted due to deadlocko Waste of corporate assetso Controlling party acts that are unfairly prejudicial to

minority SHs (looser than “fraudulent/oppression” standard in

AK) Look to reasonable expectations of shareholders

Remedy :o Under MN statute, if a close corp is involved (35 or fewer

SHs), a ct may order alternative remedy of buyout @ fair value payable in installments

o Ct may take into account duty to act in honest/fair matter and the reasonable expectations of SH as they exist at the inception of the relationship or develop out of the relationship

Note: he also won on “implied contract” for lifetime employment. Clark thinks this is dramatic but not crazy.

Stuparicho Facts :

Closely held family furniture company also owns mobile home park (making lots of money)

Own non-voting stock equally but M owns 52% voting M is CEO and gets big salary; others get big dividends, but C and

A not employed (don’t want to be) and think M is dumb sue for dissolution

o Held : Dissolution is not req’d

BJR – (M had majority and nothing wrong with him making management decisions)

They’re still getting dividends No bad faith / unequal treatment

Rule : (CA statute: Third Generation) Ct can order dissolution when reasonably necessary for the

protection of rights or interests of the complaining SHso No fault/wrongdoing necessaryo BUT minority SHs are not entitled to substitute their

business judgment for majorityo Takeaway :

Tough to get corp dissolved – (even in a liberal state that allows no-fault dissolution)

Need to show no dividends, no value, lockout, etc.


Haley v. Talcotto Facts :

Basically a joint venture between T & H – (50% interest each in Real Estate LLC – own land and lease to restaurant)

T owns restaurant, H is not a shareholder but is an employee (manager of the restaurant)

Deal is that after initial loan paid off, they’ll share 50-50 H&T have fight and H loses mgr job deadlocked at LLC level

Restaurant lease expires, but restaurant continues as at-will tenant – (which T likes because he owns it and rent is low)

H sues for dissolution under DE LLC Act §18-802 (not reasonably practical to carry on business in conformity with original LLC agreement)

T says that H is limited to buyout per their agreemento 2 exit paths :

1. Contract H can quit LLC and T may elect to buy him out at FMV as

determined by 3 arbitrators 2. Statute

Ct can decree dissolution of LLC “whenever it is not reasonably practicable to carry on the business” in conformity with the LLC agmt

(H doesn’t like #1 because he’ll be stock with the mortgage and won’t be a principal, but #2 may be hard to meet because he could just keep getting rent)

o Held : (Strine) Consider impact of deadlock on carrying out any NEW task by the LLC

They’ll qualify under #2 because just taking your monthly rent check doesn’t count as “carrying on the business”

(Posner might say, “Too bad, you signed a K that specified how you could exit.”)

Solution : Auction (efficient? Goes to highest bidder!)

CAN get Dissolution CAN’TArticles of incorporation or bylaws or contractK giving SH a buyout right

Statutory AppraisalCt can look at value of shares and order the majority to buy out minority SH – (merger / sale of major asset)

Breach of Fiduciary Duty by Majority groupControlling majority can’t use its power to give the majority benefits that are not shared

Mere questioning of majority’s business judgment – (Stuparich)


equally by the minority

Oppression – (Alaska Plastics)By controlling parties

Waste or Misapplication of Corporate Assets

Deadlock – (Haley v. Talcott) Dr deadlock = corporation cannot carry on

any NEW task SH deadlock = 2 yrs of not being electing

drs

Controlling party acts that are unfairly prejudicial to minority SHs – (Pedro)


Transfer of Control – (51% block) Why would you pay a premium for control?

o Run the company better If you get control, you can run company better, leading to higher profits,

so it’s worth paying moreo Private Benefits of Control

Just want to be closer to the assets of corporation for unfair self-dealingo Incentives

If you want #1, you’ll buy as much as possible If you want #2, you’ll just grab a bare majority

o Critique : If you believe in efficient mkts, you would say that the share price already

reflects the risk that the company will be bought by a lousy owner Doctrine :

o Sale of control block @ premium is not per se wrong and seller does NOT have to share premium with minority

o BUT exceptions : Fraudulent – (Zetlin) Sale to a looter – (Drooley Bear) Diverts a corporate opportunity

o Why not have uniform equal opportunity rule? Shares of individual property SHs don’t have fid duty to one another

Zetlin v. Hansono Rule :

A controlling SH is free to sell a controlling interest for a premium absent:

Looting Conversion Fraud Bad Faith

o (claimed to be a “long-settled” rule) (In all other situations, no “control premium” is necessary)

Perlman v. Feldmano Facts :

Steel company with control group run by Feldman and many minority SHs Wilport Co wants to buy steel company and offers to buy stock from

control group @ $8 premium (Min SH would get $0) they sue

o Held : Feldman must account to minority for part of his premium Rule :

In the time of mkt shortage , if a product would command an unusually large premium, then a fiduciary could not appropriate this premium to himself


o This was Korean War and price controls limit amount that firms could charge, so Feldman/Wilport were trying to get around price control by just paying more to buy the actual company (as opposed to the product)

o BUT since they’re only buying the Feldman part instead of paying to the whole company, Feldman was usurping a corporate opportunity

The opportunity was the opportunity to command a premium price, which was shifted from the corporate level (high prices for goods) to the shareholder level (high prices for the company).

Essex Universal v. Yateso Facts :

Yates is controlling SH and bargains to sell controlling share to Essex Essex wants a new Bd right away, so bargains for resignations and interim

appointments At last minute, Yates wants to back out (probably for a better offer), so he

claims it was illegal sale of officeo Held :

Contract is legal Rule :

In general, a buyer is free to sell a control block of stock at a premium. If the sale is conditioned on immediate transfer of board control, this is OK as long as the buyer purchases more than 50% of the shares.

Note: Π can still attempt to show that a transfer of less than 50% is “not tantamount to majority control.” Π can show that the amount of control possessed by Δ is not necessarily enough to be able to elect directors.

o Theory: if the buyer gets more than 50%, he could vote himself into power at the next meeting anyway, so there’s no harm.

o Concurrence (Friendly): This would be PER SE illegal if the buyer purchases less than 50% of the

shares, since then it is not certain that any of the buyer’s slate would be elected.

In such cases, it is essentially sale of office and liability should be imposed if the buyer’s cronies are appointed as new directors by the outgoing directors.

Frandsen v. Jensen-Sundquist Agencyo Facts :

JSA was main SH in holding company that owned majority of stock of a bank

Sells 52% to family, 8% to Frandsen, 40% to others BUT if a majority wanted to sell, they had to first offer to Frandsen

AND if he said NO, they had to offer to buy his stock at the same price – (either they buy his or he buys theirs)


o Frandsen worried about a new majority pushing him out of control

First Wisconsin (big bank) comes in and wants to buy the entire holding company

Frandsen argues this would be equivalent to sale of majority interest and he is entitled to buy out first

Instead, FW offered to just buy the shares of the bank under the holding company to get around Frandsen – (J-SA would sell its bank stock to FW than liquidate)

Frandsen sues claiming substance over formo Held :

F loses Posner :

o There is a difference between a sale and a mergero You were an experienced businessman and you signed a K.

Could have bargained for protection in the event of a substantial sale of assets.

Skeptical of “substance over form” argumentso Takeaway :

There are contractual provisions that the minority SHs will bargain for that ensure minority will be given the same terms/prices as the majority

Rights of 1st refusal

Sale of Control Block for Premium

OK provided no: Looting Conversion Fraud Bad Faith Usurping corp opp (Perelman)

(can contract for bd seats too – Essex)


7. MERGERS, ACQUISITIONS, AND TAKEOVERS

Basics Why do it?

o Eliminate costs/overhead economies of scaleo Marketing: combine brand names and pool ads o Dominate a mkt / raise price / eliminate competition (bad reason)o Tax reasons – (use losses to offset other income)

History :o Cyclical.

End of 19th C: Horizontal 1920s: Vertical 1960s: pure conglomerates 1980s: hostile takover 1990s: IT and banking (less hostile) 200s: global M&A and LBOs

Techniques :o Substantial Sale of Assets (DE §271)

Sell all stuff – (cash / K rights / assets / liabilities) Then liquidation and distribution of proceeds Does not require appraisal rights, but must be approved by a majority of

the target’s shareholderso Statutory Merger or Consolidation (DE §251)

Companies formally combine Both corps must spell this out in a merger agreement. Shareholders of either corp who voted against the merger could demand

that they be paid in cash for the fair value of their shares (right of appraisal).

o Stock Purchase (“practical” merger) Acquiring company buys enough to gain control and operates as sub

Avoid having to get permission from purchasing company No vote required (deal is between individual shareholders); no appraisal

rights.o Tender Offer

Try to purchase controlling stock at once at a premium priceo Proxy Contest

Get your friendly Drs elected Sale of Assets vs. Merger

o SIMPLE SALE OF ASSETS 1. Acquisition of Assets

DE §271o Corp may choose to sell all of its property at any meeting

of the boardo Sale still must be approved by an absolute majority of

voting SHs (no just quorum or plurality).


o Board must propose it first. 2. Dissolution and Liquidation

DE §275o If Bd supports, they put to SH voteo Reqs absolute majority of SHso (also some filing reqmts)

o SIMPLE MERGER One firm merges into the other and SHs receive stock in the combined

firm §251

Need SH AND Bd approval from BOTH sideso Bd approves then submits the merger agmt to SHs at a

special meeting where it must be approved by absolute majority of voting shares

BUT no SH vote is req’d of the surviving corp if:o 1. merger agmt does not amend the articles of incorpo 2. each share of outstanding stock remains an identical

share of the corp after the merger, ANDo 3. any shares issued or delivered under the merger agmt

constitute 20% or less of common shares of the issuing corp

§262 Appraisal rights available


DIFFERENCES AND SIMILARITIES BETWEEN SALES OF ASSETS AND MERGERS

ElementSALE (cash asset purchase +

liq)MERGER (with common stock)

Acquired company, SH’s investment

Terminated. After sale, you have cash instead of shares and you’re no longer an investor.

Continued, but changed – (stock is now of the merged company)

Acquiring company, consideration given to buy target

Replaces assets gives up cash and gets back assets. No bigger or wealthier after

the sale

Extends assets merged company is now much bigger Whole entity is larger

Acquiring company’s SHs – their investment position and voting rights

Unchanged. Approximately same voting power and entitled to same share of assets.

Diluted. All of target’s SHs now become SHs of new corp. (so you have more assets, but less

control over them)

Acquired Company Corporate life may end – (if they dissolve)

Corporate life DOES end – (now just merged)

Management Dual Unitary Firms now only have one

common mgmt structure May lead to antitrust issues

Dual Unitary Firms now only have one

common mgmt structure Same antitrust concerns

Technical point – inclusion of assets and liabilities in the transfer

How do assets and liabilities get to acquiring corp?

Piecemeal, by affirmative acts. You must transfer on piece-

by-piece basis Need a different transfer

document for each thing being transferred – (lots of work for lawyers/accts)

Global, by operation of statute Everything goes at once

Liabilities Acquiring corp only gets liabilities that are EXPLICITLY transferred in the purchase/sale agmt Concern that company can

sell off all assets, pay huge dividend, then declare bankruptcy – (BUT likely nailed on fraudulent conveyance)

Acquiring corp also acquires any liabilities of the target Old liability can really come back

to haunt you


LEGAL AND OTHER TREATMENT

Element SALE (asset purchase + liq) MERGER

Tax Treatment Investors here “cash out” Give up investment for a

gain, so they get taxed on the gain – (realization event)

BUT sale of assets for stock is a “corporate reorganization” and is not considered a taxable event

“Reorganization Investors continue ownership in a

merger No taxable event because you

generally just receive stock in the merged corp – (taxed if you later choose to sell)

Accounting Treatment Purchase Accounting Formerly pooling, now purchase accounting

Antitrust Need to ask if it’s anticompetitive Need to ask if it’s anticompetitive

Securities Regulation Proxy statement by the acquired company – (since target corp’s SHs must vote on whether to approve the sale)

Proxy statement by both companies and a registration statement needed by the acquiring company (issuing new stock)

Business Corporation Statute – (DE)

Acquired Company’s SH:Vote, no appraisal

Acquiring Company’s SH:NO VOTE

Acquired Company’s SH:Vote, appraisal

Acquiring Company’s SH:Vote, appraisal

(some exceptions in §262(b))-no voting rights of acquiring if issuing <20% of outstanding shares-no appraisal rights for acquired if listed on national exchange or 2000+shareholders

Just think about different legal implications of the 2 formso Large: Tax distinction, votingo Takeaway : Form usually not as impt as substance

Appraisal Rights :o In a merger, BOTH companies’ SHs generally get appraisal rights – (DE §251)

A corps can grant appraisal rights beyond this statute in their certificates of incorporation.

o But not available if :


Stock is listed on a national securities exchange and held by more then 2000 different entities, OR

(not going to waste time on appraisal if you can just sell on the mkt)

If merger did not require SH approval under §251(f) – (if new stock was worth less than 20% of value of the corp)

(Not available if you voted in favor of the merger)o Procedure : §262(d)

Before voting on merger, SH must notify the corp that he wants appraisal If merger goes through, corp must notify SH and he must demand

appraisal within 20 days If it has been 120 days after merger and corp has not paid the SH, he may

petition Court of Chancery Court determines:

o “fair value” of the shares, excluding any element of value arising from the merger or consolidation

o (Factors listed in §262(h))

Appraisal

1. Before voting, notify corp that you want appraisal

2. If merger goes through, corp must notify SH and he must demand within 20 days

3. If over 120 days pass, SH can petition Court of Chancery – (“fair value”)

Other Forms of Acquisition (other than sale of assets or mergers) Many variations and hybrids are possible. E.g. share-for-share exchange between

acquiring company and target company shareholders where target becomes a wholly-owned subsidiary of the acquiring company. All of the target’s shareholders would get stock in the parent, and the parent would own 100% of the shares of the subsidiary.

Why do it this way?? o Keep the target’s liabilities apart from the acquiring company.o Taxes and legal fees.o The shareholders of the acquiring company wouldn’t need to vote and wouldn’t

be offered appraisal rights. The corporation is purchasing stock.o So why would they NOT do this??

Maybe it has to do with which state you’re incorporated in. Forward Subsidiary Merger: acquiring company (A) forms subsidiary (S), subsidiary

buys stock of the target (T). Target gets stock from the acquiring corp (A). o Issue: holdout not tendering stock.


De Facto Merger Doctrine Farris v. Glen Alden – (PA)

o Facts : 1. List (the big corp) buys 38.5% of GA for cash 2. List sells ALL of its assets and liabilities to GA in exchange for lots of

newly issues GA stock. 3. List dissolves and liquidates – (all of GA stock given to SHs) 4. GA changes name to “List Alden.” And former List stockholders have

the majority because it was the larger company. Result in substance is a merger w/o appraisal rights for GA

shareholders Farris sueso (Just selling assets, so no vote triggered on GA side)

o Held : Substance > Form merger enjoined. De Facto Merger. Rule :

When one corp dissolves and:o its liabilities are assumed by the othero its executives take over the other, and o the SHs acquire a majority of the other’s shares that’s

not merely a sale of assets, but a merger that requires appraisal rights.

Fundamental change in corporate character = de facto merger

Hariton v. Arco Electronics – (DE)o Facts :

1. Sale of Arco assets to Loral in exchange for Loral stock 2. Loral Stock to Arco SHs; company liquidated

Arco stock now gone Hariton says is was illegal and unfair Why do it this way?

o Straight merger reqs appraisal rights and need voteo Sale of assets only voteo Dissolution only vote

(Can get the job done without appraisal which could result in paying out more cash and would be more costly)

o Held : Form > Substance Legal transaction

DE has multiple ways of achieving a merger and as long as each step in the process is legal, then the whole transaction is legal

o Each statutory provision is of “equal dignity” Policy: This sale of assets plus dissolution was in substance identical to a

merger. But every step was perfectly legal. Court says, “Let the legislature deal with this!”

Glen Alden (PA) versus Hariton (DE)


o DE lets you bargain for appraisal rights above and beyond the minimum req’d in the statute, so the SHs in Hariton could have asked for more in connection with the sale of assets

Ct is reluctant to provide when you didn’t ask for them. problem: imperfect bargaining, lack of foresight.

Glen Alden HaritonSubstance > Form

When one corp dissolves and: its liabilities are assured by the other its executives take over the other, and the SHs acquire a majority of the other’s

sharesthat’s not merely a sale of assets, but a merger that requires appraisal rights

Fundamental change in corporate character = de facto merger

Form > Substance

DE has multiple ways of achieving a merger and as long as each step in the process is legal, then the whole transaction is legal

“Equal Dignity” for each step

De Facto Non Merger Rauch v. RCA (2nd Cir)

o Facts : RCA merges with wholly owned sub of GE

RCA common and preferred to be cashed out at $40 – (but per RCA charter, redemption price was $100)

Pl says the cash-out merger was in substance and effect a redemption was forced to give up shares for money, so wants the contractually agreed price

o Held : Not entitled to redemption Rationale :

2 distinct legal events:o Merger Statute – (§251)o Redemption Statute – (§§151(b) and 160(a))

“equal dignity” with “independent legal significance”

Form > Substance (similar to Hariton) Doesn’t matter that same ultimate results can be obtained by

different statutory provisions.


o In short: there is NOT a de facto merger doctrine OR a de facto non-merger doctrine.

Comparing this with Freeze-out merger issues: DE will NOT use de-factor merger concept to recharacterize a corporation’s sale of all

assets followed by a liquidation. That would trigger appraisal rights, but DE court won’t do this.

DE courts WILL use judicially created concept of “Fair dealing” to fault a formally approved cash-out merger that was arranged by “manipulative conduct” or “bad faith.”

Freeze-out mergers- Some SHs are cashed out and they don’t like it Weinberger v. UOP– (DE)

o Facts : Signal Corp. is oil conglomerate with extra money to burn Rather than pay a dividend, it bought a bare majority of UOP – (50.5%) Signal elects 6 of 13 Bd members and replaces CEO Now they want to buy the rest of UOP

Both Bds approve cash-out merger with a MOM provision Min SHs get $21/share

o “Majority of Minority” – to avoid problems with conflict of interest, they require the deal to be approved by a majority of the minority SHs – (but only majority of those who show up at mtg)

(Review: Maj SH forced buyout upon Min to merge company with Maj SH’s company)

o 5 Issues : (1) Std of Review :

Entire Fairness – (Fair Dealing + Fair Price)o Parent Company owes fiduciary duty of care and loyalty o Not protected by BJR – (classic self-dealing)

Min SHs are eliminated in a cash-out merger with parent corp – (incentive to cheat for own interest)

o Fair Dealing : Time / structure / negotiations / PROCESS May not use superior knowledge to mislead the

minorityo Fair Price :

Asset values / mkt values / future earning potential / SUBSTANCE

(2) Burdens of Proof (1) Plaintiff must first allege specific acts which indicate

unfairness and demonstrate some basis for invoking the fairness obligation

o --THEN SHIFT-- (2) Maj SH must show “entire fairness”


o BUT if approval was by an informed vote, then the Pl has burden to prove “unfairness”

Maj SH has burden of showing it was informed – (“completely disclosed all material facts”)

Special Committees o FN 5 says a “special committee” of independent drs can be

strong evidence of procedural fairness. Does this shift the burden back to the plaintiffs to prove unfairness?

o BUT later developments : Kahn v. Lynch

Independent committee or informed MOM vote shifts burden to Pl to show unfairness

BUT the BOP shifts only if : o Majority SH does not dictate merger

terms ANDo Independent Cmt has real bargaining

power Kahn v. Tremont

Entire fairness remains the standard even when an independent cmte is used

o (Ct preserving the right to determine wrongdoing if something seems funny)

Standards / Burdens applied here :o MOM approval YES, but no full disclosure, so no burden

shifto Failed to meet “entire fairness” in light of bad process –

(rushed and no real bargaining power) Planning :

o Signal should have appointed an independent cmte with real bargaining power

o Keep Signal people on the Bd away from any valuation or feasibility study

o Hire new independent I-bankers to do valuation study and give an opinion

o Take time to deliberate and negotiate and maybe give some improvement in price

o Give full and complete disclosure to minority SHs and voluntary MOM provision

(these have become highly scripted practices in buyout mergers)

(3) Business Purpose Test (Whether ct could consider purpose of the transaction) Ct rejects any inquiry into purpose

o Look to “independent legal significance”


[rejection of “substance over form”] If there had been, how to beat it?

o Say you just prefer full ownership Less disclosure More efficient Fewer procedures Litigation risk

o Focus on synergies to increase value of the combined corp (4) Remedies

Appraisal is the ordinary remedy, but not exclusiveo Cts can give other remedies when there is fraud / self-

dealing / waste Why wasn’t §262 enough for him?

o Appraisal not available in particular transactions If shares are publicly traded Asset sale and not stock sale

o Pl may have failed to perfect his appraisal rights If he voted for merger

o Attorney’s feeso May wish to enjoin the merger entirely not possible if

you go for appraisal rightso Use class action to get more leverage for a good settlement

(5) Valuation in Appraisal Proceedings OLD – DE “Block Method”

o Use weighted avg of asset value, mkt value, and capitalized earnings

(all relatively objective, but not necessarily meaningful in economic sense)

NEW – More wide openo “any techniques or methods which are generally considered

acceptable in the financial community and admissible in ct” Discounted Cash Flow / Comparable Sales

Coggins v. New England Patriots – (MA)o Facts :

Sullivan formed the Pats with 9 others – (he had control but sold 120k non-voting shares to the public) but now he wants 100% ownership

Wants to eliminate the non-voting shares Pulls complicated move with loan, sets up brand new corporation

called “New Patriots” (he owns 100%)o Merges his “Old Patriots” stock into NP stocko Merges non-voting shares into NP stock and gives them

$15/share SHs of both classes of stock approve Coggins is mad

o Held : Illegal freeze-out merger TEST :


Merger must be for the advancement of a legitimate corporate purpose, and if so, the transaction must be fair based on the totality of the circumstances

Rejects Weinberger and extends business purpose test (reasoning: the dangers of self-dealing or abuse of fiduciary duty are very high in freeze-out mergers in which the minority is totally bought out)

o Extends “fair dealing” concept of Wilkes to cash-out mergers generally

Acceptance of “business purpose test” in cash-out mergers

Why good? o Ensures drs will further the goals of

the corp rather than their own endso (dangers of self-dealing and abuse of

fiduciary duty are very high in freeze-out mergers where minority is totally bought out)

The controlling shareholder who is also a director on both sides of the transaction bears the burden of showing that the transaction does not violate fiduciary obligations i.e. entire fairness – fair dealing/price.

FACTORS :o Totality of the Circumstances

Presence of a business purpose Adequacy of disclosure Fairness of price

Applied :o Wrongful freeze-out that served no purpose other than Maj

SH’s Remedy :

o When there’s a breach of fiduciary duty, statutory appraisal is NOT the sole remedy and damages can be awarded

o It’s many years later, so we won’t undo the buyout, but will give reasonable damages – ($80)

o DE vs. MA : Business purpose can be fuzzy and sure what a “legitimate” purpose is

Maybe it should be up to the Bd to determine what is legitimate DE requires “entire fairness”, thus it already requires “fair dealing and fair

price” Those are elements of “business purpose” maybe tests are the

same But note: in Delaware this is probably okay, as long as process and

price are fair. But in MA this was probably NOT Sullivan’s REAL purpose, so he lost.


Rabkin v. Phillip Hunt Chem Corp.

o Facts : Olin Corp buys 63.4% of Hunt Stock from T&N @ $25/share and

promises that if they buy out the rest of the SHs within a year, they’d pay $25 to them as well

(Concerned over litigation wrt control premium) Wait 1 yr and then decide to buy get fairness opinion ($20) and

negotiate a bit with a “special committee” but price doesn’t move Merger eventually happens without a MOM condition @ $20/share

Pls bring Weinberger-type class action Argue that their $25 contract right was unfairly destroyed by

Olin’s manipulative conduct.o No MOM. And Special Committee appears dominated.

o Held : Company loses case may proceed to trial

Weinberger is not limited to cases of deception or fraud – (concerned about a broader notion of procedural fairness and fair dealing)

o Look to timing / structure / negotiations / disclosures Applied here :

o Manipulative conduct / conscious timing NOT fair dealing

Note: maybe it’s like Easterbrook – can’t take opportunistic advantage of another party to your contract.

DE looks at behavior, not just price!

New technique for freeze outs :o Tender Offer Freeze Out

2 steps : Parent Co makes TO for one of its subsidiaries If it then has 90% or more of sub stock, it effects a “short-form

merger” under §253 to cash out the remaining min SHso SH vote not req’d / appraisal is available

Standard : DE exempts this pattern from “entire fairness” review – (only used

for “long-form” cash mergers)o Siliconix

Entire fairness review does not apply unless there are “actual coercion or disclosure violations” because DE law provides no statutory role for target/sub Bd in takeover

o Pure Resources TO held not to be coercive BUT court says they will

look at the Tender Offer.


Safe harbor (escape fairness review) ONLY applies if:

Offer is subject to non-waiveable MOM tender conditions

Controller (parent) guarantees prompt §253 merger at same price if it gets more than 90% approval

Controller makes “no retributive threats in negotiating with the special cmte

Rationale : Firms like this because “entire fairness” review can be tough So minority shareholders in these parent-sub mergers def. do

worse.

Freeze-Out Merger Cheatsheet

[Maj SH forced buyout on Min SH to merge with Maj SH’s company]

Std of Review: (Weinberger)Entire Fairness Fair Dealing – (PROCESS)

o Time / structure / negotiationso Maybe use special committeeo Look to manipulative conduct – (Rabkin)

Fair Price – (SUBSTANCE)o Asset values / mkt values / future earning potential

Burdens of Proof1. Plaintiff Specific acts which individuate unfairness + some basis for invoking fairness

obligation2. Maj SH “entire fairness”2a. If informed SH vote Plaintiff “unfairness” (burden is on Maj SH to prove that SHs were fully informed)

Look at the Business Purpose? Weinberger NO – “independent legal significance” Coggins YES – (legitimate corporate purpose; fair based on the totality of

the circumstances)

Remedy:Appraisal – “any techniques or methods which are generally considered acceptable in the financial community and admissible in ct”


Standard/Scripted Procedures now: Appoint independent committee with real bargaining power Keep interested drs away from any valuation or feasibility study Hire new independent I-bankers to do valuation study and give an opinion Take time to deliberate and negotiate; maybe give some improvement in price Full & complete disclosure MOM provision – (avoid conflicts of interest)

Tender Offers Williams Act – (Basic regulation of Tender Offers) – Fed regulation / 1968

o Grant of authority to SEC to make rules for TOs Goal : disclosure and antifraud

Williams Act § What is it

§14(d) Disclosures required of Tender Offerors

§14(e) General antifraud rule – (like 10b-5 and 14a-9)

§13(d) Early warning provision Keeps you from acquiring a lot without the corporation

noticing – (5% for one person; “person” defined broadly) Have 10 days to file, so could do a lot

§13(e) Issuer repurchases subject to SEC rules Must make certain disclosures

SEC Rule What is it

14e-1 Minimum offer period – (20 days, but usually TO’s are way longer than this)

14d-10 Offer must be open to ALL SHs of same classBest price rule: All SHs who tender must get the same price

14e-5 Can’t got “outside” tender offer and buy at different prices. Must buy only within TO.

13e-4(f)(8) If you make TO for your own stock, you must make the offer equally available to all – (NO DISCRIMINATORY TOs)

§14(d)(6) Withdrawal rights


SHs who tender can withdraw up to the point when the offer closes (promotes competition)

§14(d)(7) Pro Rata Rule If more shares are tendered than the offeror wants, then the

purchases are made on a pro rata basis among tendered shares (can’t discriminate)

o Policy : Easterbrook thinks it’s unfair to the hostile bidder they are identifying

slacking companies and finding opportunities to improve them, but must wait 20 days

BUT Lipton shows that firms that resist the hostile bidder end up doing better

5 ways to dilute and defend a TO

Tactic What is it Cases

Pay Greenmail Pay premium above mkt for raider’s shares to get him to go away

Cheff v. Mathes

Exclusionary TO Company makes higher TO that only non-raiders can accept Now limited by Rule 13e-4(f)(8)

Unocal

Poison Pill If SH receives certain % of shares, then each holder except the raider gets an option to buy multiple shares at a lower price

Asset/Share Lock-Up

Promise favored bidder that if the deal falls through, they have the right to buy one of the divisions at a bargain option price (or buy certain % of shares at low price)

Revlon

Large Termination (Cancellation) Fee

If we don’t end up taking you over, you’ll pay us big Large cancellation fees inhibit other buyers –

(premium)

All but the first put main cost on hostile bidder – (discriminatory treatment)

1. Greenmail Cheff v. Mathes

o Facts : Maremont tries to acquire Holland – (buys 11.3% and demands Bd seat)


Holland resists (see him as a raider) and Maremont presents buy-sell offer to founding family trust. Holland offers GREENMAIL to get Maremont to go away.

o H will pay M premium over mkt for his shares Min SHs sue H directors in derivative action for misuse of Corp funds

o Held : Directors win Rule

Burden : o On the DIRECTORS – (target)

To show : o Reasonable grounds to believe that danger to corporate

policy and effectiveness existed Buyback necessary to maintain proper business

practices Reqs good faith and reasonable investigation

o Drs must also show they did not act for the primary purpose of preserving incumbency

Comparison to BJR :o It’s more than BJR because Directors have BOP (as

compared to BJR where P has high BOP) We want more than BJR bc of possible conflicts of

interest of directors wanting to stay in powero BUT maybe this isn’t really tougher looks like threat of

change in business model or employee unrest is enough to justify the buyback.

o So this is not a true Conflict of Interest standard. Seems like ct was very deferential to the Bd Maybe this is BJR, but with burden on Drs instead

of Pls o Notes on Greenmail :

Empirical evidence shows it’s GOOD for all SHs Drs motivated into action afterwards Often triggers other bids – (competition)

But greenmail rarely happens because it’s taxed at 50% (congress doesn’t like it)

Greenmail

Drs have burden of showing:

Reasonable grounds to believe that danger to corporate policy and effectiveness existed

Good faith + Reasonable investigation


Did not act for primary purpose of preserving incumbency

2. Exclusionary Tender Offer: Unocal

o Facts : Mesa (T.Boone Pickens, a notorious greenmailer) owns 13% of Unocal

and wants more Offense :

o Mesa makes 2-tiered front-end loaded TO Front: Buy 37% of stock for $54 Back: freeze out merger to eliminate the minority –

(give “meaningless” $54 junk bonds)o (Taking advantage of collective action problem SHs will

be afraid if they don’t take the front end, they’ll be stuck with the back end, so they tender immediately)

Defense :o Unocal makes an exclusionary TO Loyal SHs can buy,

but Mesa is not eligible – (give debt security worth $72) Makes it a better bet for the other SHs to not tender

to Boone Also, dilutes the value of the shares that Mesa is

buying because paying out a big premium now, leaving less cash in the reserves

Boone sues, challenging the defensive tactic discriminatory self-TO to defeat a hostile bid

o Held : Unocal wins Standard of Review

NOT the BJRo Underlying concern is that Bd is acting in own self-interest

– “omnipresent specter” (Bd has incentive to use defensive measures to

preserve its own jobs at the expense of SHs) Conditional BJR

o “an enhanced duty which calls for judicial examination at the threshold before the protections of the BJR can be conferred”

Cts will be a bit tougher when analyzing takeover defenses

Burden shifting scheme Start: Bd If they carry: shift back to Pls to rebut


If they don’t: D must pass the “intrinsic fairness” std for duty of loyalty

Unocal TEST for Defensive Tactics : If you meet these, the Bd’s defensive actions get BJR protection

and upheld absent:o Fraudo Overreachingo Bad Faitho Mere desire to perpetuate themselves in office

Prereqs :o Must be within the power or authority of the Bd

Action must be authorized by statute Corp’s charter must not forbid or restrict

1. Bd has reasonable grounds for believing that a danger to corporate policy and effectiveness existed - (Cheff)

o Show good faith + reasonable investigationo (easier to show if defensive measures were proposed by

majority of independent drs) 2. Defense must be reasonable in relation to the threat posed

o Factors : Inadequacy of the price offered Nature/timing of the offer Questions of illegality Impact on other “constituencies” – employees,

creditors, customers, community TEST is basically :

o THREAT + PROPORTIONAL RESPONSE Application :

Unocal winso Reasonable grounds for wanting to resist Boone and

concluded that he was a threat to corporate policy Notes his rep as a greenmailer Offer was coercive and inadequate

o Defensive measures were proportionate If they couldn’t selectively exclude him, the defense

was useless Reasonably related to goal of protecting min SHs Did not benefit Bd more or less than other SHs

o Aftermath : SEC doesn’t like this amends Rule 13e-4(f)(8) to say that issuers who

make TOs to their own SHs must make them available to all SHs


Unocal Test for Defensive Measures

Prereq:Must be within the power or authority of the Bd Action must be authorized by statute Corp’s charter must not forbid or restrict

Drs must show 2 things:1. Danger to corporate policy and effectiveness

existeda. Good faith and reasonable investigationb. Can consider threats to business strategy

or plans2. Proportional Response

Factors:a. Inadequacy of the price offeredb. Nature/timing of the offerc. Questions of illegalityd. Impact on other “constituencies”e. (Drs not obligated to abandon a

deliberately conceived corporate plan for a short-term profit – Time)

3. Poison Pills If SH receives certain % of shares, then each holder except the raider gets an option to buy

multiple shares at a lower priceo Causes mass dilution in the shares, thus deterring the raider

How? o Adopted by Bd without SH actiono (Can be redeemed (i.e. not used) by the Bd if it wants the takeover to go through)

Rationale :o Self-help mechanism that puts control over TOs in the Bd/Mgmto Not per se unreasonable (as long as they can be redeemed), BUT possible for

Bd to use them unreasonably. See Moran v. Household; Unocal framework. RC :

o Poison Pills were bad development SHs of companies that resist and remain independent do worse than those

who get bought outo SHs of acquiring company do WORSE because acquirer overpays

4. Asset/Share Lock-up Keep Bd from selling any of the assets

o Strategy :


If you have a number of bidders, but you only like one, you give them a bargain deal which says that if the deal falls through, they have the right to buy one of the divisions at a bargain option price

(raider can’t compete because losing major value) (Share lock-up is much the same promise the favored one right to buy

shares at true bargain) Revlon

o Facts : 2 players

Pantry Pride makes hostile bid for Revlon Revlon finds white knight (Frostmann Little) and wants to sell to

themo LBO – FL will borrow a lot of money to pay SHs a large

premium, but loans are then transferred back to the company that was taken over

Interplay PP offers $47.50 if Bd will redeem the poison pill Revlon defends with exclusionary exchange offer and most SHs go

for it Then PP and FL have several rounds of bidding Eventually Revlon accepts FL’s last bid:

o Higher than PP’s last bido Protects note holderso Had financing lined up

Terms : Asset Lock-up Option

o FL has right to buy 2 Revlon divisions at price way below value – (crown jewels)

o Why do this? Major dilution to other bidders – (ties up valuable

assets) Bd could do this without SH approval – (sale of

divisions not substantially all assets) Cancellation Fee – ($25M) “No Shop” Clause

o PP Sueso Held :

Revlon’s lock-in measures enjoined as breach of fid duty Rule :

When Bd puts company up for sale (when dissolution is inevitable), they have a duty to maximize the company’s value by selling to the highest bidder

o Drs’ role changes from defenders of the corporate bastion to auctioneers charged with getting the best price for the SHs and selling the company


Once it becomes clear the company will be sold anyway, you can’t favor a white knight to exclusion of a hostile bidder (unless hostile bidder will adversely affect SH interests)

There is a difference between lock-ups that draw in a bidder vs. those that end an active auction

o (Not per se illegal, but cts draw distinction) Non-SH constituencies :

o Bd may have regard for different constituencies, but only insomuch as they related to benefits for SHs

Applied : Burden on Drs to show:

o Good faith and reasonable investigationo Threat to corporate policy o Proportional response

Assessing the Defenses :o Poison Pill

Ct says it was reasonable PP’s first bid was inadequate and bid started

bidding war (Plus, advice came from independent banker)

o Exclusionary self-TO Reasonable early offers were inadequate

o Asset Lock-up Breach of Fid Duty

Lock-up was not for purpose of getting the highest price; just ended the bidding prematurely

o FL was already in the auction; didn’t need more

o (RC thinks this test is mushy)o No-Shop

Unreasonable – (too preferential)o SUM :

Want to stay out of Revlon because it brings strict scrutiny of deal provisions

o Revlon vs. Unocal : Not sure when we would use each

Maybe Revlon used for transactions which will result in change of control

Use Unocal for other stuff Easterbrook :

o Total passivity. Board just gets to argue that the takeover is a bad idea but does not get to adopt defensive measures.

Gilson’s Auction Model :


o Law allows for defensive measures undertaken by a Bd on the theory that Bds may know things that SHs don’t BUT only get to do things to secure a better offer

o Gilson advocates auction model: Extensive defensive measures seem extreme Permit only defensive tactic designed to secure a better offer for SHs, such

as release of info bearing on the adequacy of the offer or seeking an alternative bidder

Give them corporate money to defend against it PR to make their case

Gives more active role for Bd in conducting auction Broader than Revlon because that only applies when Bd has

decided to sell

Applying Revlon and Unocal : When is Revlon triggered? Paramount v. Time Warner

o Facts : Act I

Time-Warner merger agmt –(synergy)o WB to merge into Time in a stock for stock merger; WB

stockholders get new Time-Warner stock Deal protections:

o W gets 11% of T stock / T gets 9% of W stock if someone else makes a hostile bid

o T agrees not to shop itself aroundo Banks promise not to finance a 3rd party acquisition of T

Act II Paramount wants in HUGE all cash Tender Offer for Time –

($175/sh) T Bd rejects as inadequate claiming threat to T’s culture Warner triggers the share exchange to make it harder for

Paramount Act III

T & W restructure deal instead of doing a statutory merger, T will make cash Tender Offer for 51% of W’s shares to be followed by a freeze-out merger in which remaining W shares would be acquired

o (T would take out a lot of debt) Why change it up?

o Different approvals! Statutory Merger:

T – (Bd + SHs) W – (Bd + SHs)

New deal: T’s TO

o T – Bd


o W – nothing – (W was not fighting it, so up to W’s SHs to decide individually when to sell)

Freeze-out Part:o W – Bd would have to approve, but

T would be its majority SHo Would also need approval of the new

sub, but T would be its SH (Would never need the consent of T’s SHs)

Act IV Paramount ups its offer again but T rejects and refuses to cancel

deal protections T SHs sue:

Revlon – deal with W put T “up for sale” so Bd should NOT have locked in deal while Paramount was raising bid

Unocal – T’s defensive measures were wrongfully designed to serve Bd’s interests, not the company’s

o Held : Revlon NO

(Shocking holding would have brought parts I and III under strict scrutiny)

TEST – 2 situations in which Revlon is triggered o 1. Corporation initiates an active bidding process seeking

to sell itself OR effect a reorganization involving a clear breakup of the company

Mere merger agmt does not put company up for saleo 2. If, in response to a bidder’s offer, a target abandons its

long-term strategy and seeks an alternative auction or transaction involving the breakup of the corp

Revlon – Bd was just looking for bidderso (Mere adoption of safety devices, without more, does not

trigger Revlon) Applied:

o Here there was no evidence that dissolution or breakup was inevitable

(Impt holding because invoking Revlon means strict scrutiny)

Allen opinion :o Refused to invoke Revlon because there was no change of

control Both before and after the original merger agmt,

Time would be controlled by a “fluid aggregation of unaffiliated SHs” who made up a voting majority

Unocal NO; test applies but Time-Warner wins (Paramount challenged lock-up and no-shop as well as Time’s

decision to recast merger as a TO)


TEST o 1. Threat to corporate policy (+ good faith + reasonable

investigation) Target can consider threats to business strategy

or plans (not limited to just coercion or inadequate value)

Prong Met: Time had detailed business plan for merging with Warner

o 2. Proportionality of Response Drs are not obligated to abandon a deliberately

conceived corporate plan for a short-term SH profit unless there is clearly NO basis to sustain corporate strategy

Prong met: Restructured deal was related to the threat because it was not aimed at preserving management’s role, but aimed at preserving a pre-existing transaction

Paramount v. QVCo Facts :

Viacom wanted to bid for Paramount to get it content; QVC wants it too Paramount (target) agrees to merge with Viacom but takes defensive

measures: Poison pill / No Shop / $100M cancellation free / Lock-up

QVC makes a more generous proposal (conditioned on cancellation of defensive measures)

Paramount refuses to conduct formal auction citing contractual obligations to Viacom and the Time ruling

QVC counters with Revlono Held :

Paramount’s defensive measures violate both Revlon and Unocal Rule :

IF a corporation undertakes a transaction which will cause either:o (a) change in corporate control (Allen’s idea) ORo (b) break-up of corporate entity

THEN the Drs’ obligation is to seek the best value reasonably available for SH

o (no concern for 3rd party constituencies) Obligations of Drs under Revlon :

Drs must secure the best deal possibleo Should assess:

Bidder’s identity Financing Feasibility Fairness Likelihood of success Bidder’s plans for the corp


Burden to show :o (a) Adequacy of decisionmaking process, and

Info relied upon + process usedo (b) Reasonableness of drs’ actions in light of the

circumstances Must actively negotiate and act in good faith

Applied : Sale of control – (control block is shifting form a fluid group of

disaggregated SHs Viacom)o Therefore, Revlon Applies. Paramount must ensure it’s

getting the best deal for its SHso BUT they did not:

No-shop provisions too harsh Lock-up measure was draconian Bd had opportunity to ditch defense in QVC bid and

didn’t Bd should have known that the defensive measures

were keeping Paramount’s SHs from getting a better deal

o Distinguishing from Warner : Sale of Control

Revlon does not necessarily require a “break-up,” but DOES require that the company’s control block is being put up for sale

o Disaggregated Group Viacom – (SHs therefore lose their chance of ever getting any control premium, so Bd must work to maximize their value)

After Time and QVC :o SHs have a right to get a premium for sale of control bloc

If no control bloc is being transferred no Revlon (because they will still have the right to control premium later)

If control bloc IS being transferred Revlon is triggered (SHs lose any chance to get a future premium, so Bd must

maximize SH value NOW)


Revlon Test for Defensive Measures

When dissolution of company is inevitable, Bd has duty to maximize the company’s value by selling to the highest bidder Once it becomes clear the company will be sold anyway, you

can’t favor a white knight to exclusion of a hostile bidder (unless hostile bidder will adversely affect SH interests)

o (Difference between lock-ups that draw in a bidder vs. those that end an active auction)

When Triggered: (Paramount v. Time)1. Corporation initiates active bidding process to sell

itself or reorganization involving clear breakupa. Mere merger agmt does not put company up for

sale (Paramount v. Time-Warner)2. In response to offer, target abandons its long-term

strategy and seeks an alternative transaction involving the breakup of the corp

a. Hostile tries to buy you and go in a totally opposite direction

Modified a bit in Paramount v. QVC : IF a corporation undertakes a transaction which will cause

either:o (a) change in corporate control ORo (b) break-up of corporate entity

THEN the Drs’ obligation is to seek the best value reasonably available for SH

o (you have a right to control premium!)

Factors to look at: Bidder’s identity Financing Feasibility Fairness Bidder’s plans for the corp

Burden: on Board Adequacy of decisionmaking process

o Info relied upon + process used Reasonableness of drs’ actions in light of the

circumstanceso Must actively negotiate and act in good faith


Further “Defensive Measure” Cases o Unitrin v. American General

Defensive measures approved by an independent bd are permissible as long as they’re not draconian

“coercive” or “preclusive” of other offerso Carmody v. Toll Brothers

Struck down the dead-hand pill provided that only drs who had been in office when the pill was approved could redeem it

(Goal had been to keep hostile bidders from redeeming pills after winning proxy fights)

o Impermissibly reduced the power of some drso Disenfranchised SHs who might want to elects drs who will

redeem the pillo Mentor Graphic v. Quickturn

Struck down the no-hand pill prevented ALL members of a new board from redeeming the pill if the bd members were supported by the hostile bidder

Ct held this impermissibly restricted Bd in takeover/sale decisions fundamental area of Bd responsibility

o Limits discretion in mgmt policy and forces them to violate their own fiduciary duties

Extension of the Unocal / Revlon Framework Hilton Hotels v. ITT Corp

o Facts : ITT is a recovering conglomerate with 3 divisions (hotels/casinos, tech

schools, yellow pages) Hilton starts unwanted Tender Offer and proxy contest wants the

hotels/casinos and will sell the rest Need both TO and proxy: to redeem the poison pills AND take

control As defensive move, ITT develops a “Comprehensive Plan” splits up

into 3 companies, changes to staggered board with tough voting reqmts and has Poison Pill

Hilton sues to enjoino Held :

Injunction against defensive practices is granted When an acquirer launches both a proxy fight AND a tender offer,

courts must apply both Unocal and Blasius Bd’s unilateral decision to adopt a defensive measure that affects

“issues of control” and disenfranchises SHs is “strongly suspect” and reqs “compelling justification

If relates to corporate power over assets :o Unocal


(1) Board shows: threat to corporate policy or effectiveness – (reasonable investigation + good faith), AND

(2) Proportionate response – (not “coercive” or “preclusive”)

If relates to relationship between corporation and SHs :o Blasius

(1) Pl shows primary purpose was to thwart exercise of SH vote

(2) Bd must then show compelling justification Applied :

Fails Unocalo Adequate price + no reasonable investigationo Disproportionate response

Preclusive Fails Blasius

o No compelling justification Normally it’s okay to have a staggered board, but

NOT when primary purpose of staggered bd was to prevent SHs from voting in favor of hostile takeover. Must have compelling justification and they don’t.

o Comparisons : Ct does not do Revlon because not enough evidence to show break-up

ct punts More like Time Warner than QVC

Maybe if Unocal + Blasius was used in Time, that would have come out differently! Time’s whole purpose for change in merger plan was voter disenfranchisement

o Poison Pill + Staggered Board Deadly combo because:

Pill ensures can’t get a majority of shares thru a TO in order to vote in your friendly directors

Classified Bd means that a hostile trader can’t hope to win a majority of directors thru a proxy contest

Studies (Subra, Coates, Bebchuck) showed that this is very successful. But that it leads to WORSE results for investors.

When these are voted on now, they almost never win. How might the law deal with it?

Hilton if a company adopts a classified (staggered) bd in the face of a takeover, then it is illegal disenfranchisement

o BUT then maybe they’ll put staggered bd in the charter from the very beginning

(use big institutional investors to put pressure on bds to de-stagger) Legislative solution: isn’t going anywhere.


Bebchuk proposed a judicial solution when a company has pill + staggered board and the hostile raider wins the first proxy vote, then the pill gets redeemed.

Clark – doesn’t know what can be done, but it’s clearly a problem.

OmniCare v. NCS Healthcareo Facts :

NCS is a bankrupt healthcare corp and Omnicare wants to buy them; Genesis wants to buy too

In bankruptcy sale, Omnicare offers $313M – less than outstanding debt – (NCA SHs would get $0 and creditors would get some)

Genesis proposes merger in which it would pay off ALL debts, give substantial recovery for holders of NCS notes, and would give NCS SHs a small return

Deal protections:o Termination fee – (fairly low)o §251 provisions – lets them put it to SHs even if bd rejects

merger recommendationo No-shopo SH lock-up arrangement (2 board members are

shareholders and agree to vote=66%, automatic win) Omnicare counters but NCS takes the Genesis offer

Omnicare sueso Held :

Omnicare wins: (1) Unocal:

o Lock up is unreasonable (2) Lack of Fiduciary out:

o NCS’ board was required to contract for an effective FIDUCIARY OUT to exercise continuing fiduciary responsibilities to minority SHs

Have authority to give a bidder reasonable structural and economic defenses

[DE ct seemed hostile to overly-protective deal protections and board self-disablement]

Deal protection measures must be reasonable in relation to the threat, and neither preclusive nor coercive

o Dissent : Shouldn’t be a Unocal application (no specter of interest) Even under Revlon, should win This is made up: not in Delaware statute Let’s hope this is restricted to its facts

o Postscript : Mentor Graphic v. Quickturn Struck down the no-hand pill prevented ALL members of a new board

from redeeming the pill if the bd members were supported by the hostile bidder


Ct held this impermissibly restricted Bd in takeover/sale decisions fundamental area of Bd responsibility

o Limits discretion in mgmt policy and forces them to violate their own fiduciary duties

Note similar rationale: anti self-disablement or future board disablement.

Summary of M&A related judicial standards in Delaware: BJR, sometimes

o Smith v. Van Gorkom would have but didn’t do informed investigation and deliberation

Inequitable action/motivation constraint o Schnell v. Chris-Craft, numerous other cases. Cf. “bad faith” cases

Enhanced judicial scrutiny of defensive measures o Intermediate standard, in between strict and BJR – the 2 prong Unocal Standard

Best deal duty o Revlon mode

Compelling justification test or vote-thwarting defenses o Blasius et al.

No impermissible restrictions of Board authority and fiduciary duty o Quickturn, Omnicare

Entire fairness for Freeze-out merger o Weinberger & more recent cases

Note: Which could be seen as just spelling out the second prong of Unocal?Note: Do these 7 principles fit together in a coherent way? Is this an optimal, or reasonably good, set of doctrinal standards? Is there a better approach? What??

State and Federal Legislation Types of Anti-Takeover Statutes :

o Fair Price Provisions – (IL) Calls for equal treatment Impinges on control premium

o Control Share Acquisition Statutes – (IN) Even once you get controlling shares, you must get a vote of existing SHs

to give you voting power.o Business Combination Statutes

Ex. If bidder gets 15% of target stock, it can’t engage in business combination with target for 3 years keeps you from buying out minority SHs for 3 years – (DE §203)

Exceptions :o Ban does not apply if bidder gets 85% or moreo Target bd approves before 15%o Target bd approves and 2/3 of independent SHs do as well

o Non-SH constituent statutes – (PA §515) Allowed to consider effects on employees / suppliers / community


PA board can just say we’ll just focus on shareholder value. But the point is to give them more excuses to avoid the takeover.

Note that lots of corps opted out of this provision because shareholders thought it was bad for them.

This conflicts with shareholder primacy. DE caselaw focuses on fiduciary duty to shareholders (Revlon said: can consider other interests but only as they relate to shareholder interests).

o Explicit authorization of discriminatory poison pills Some states will remove any cloud of ambiguity and just let you blatantly

discriminate against a SH who gains control CTS v. Dynamics

o Facts : Edgar v. Mite

SCOTUS struck down IL Business Takeover statuteo 3 prongs of IL statute:

For 20 days, ONLY mgmt could talk to SHs to defend itself against takeover

Ways in which hearing could be delayed indefinitely

Secretary of State could review the overall fairness of a takeover bid

IN has similar statute Certain control mechanisms kick in at certain milestones. Namely

if you gain a certain amount of stock, you lose your voting power. Get vote back if you get the vote of the disinterested shareholders.

o Inducement to promise things people will like and vote for. Differences from IL act:

o No fairness requiremento No indefinite delay by state officialso If you make a hostile bid, the SHs must approve the change

or else there’s no transfer of voting power Stricter than Williams act :

o Under Williams Act, have to keep offer open 20 dayso Here, you have to keep the offer open at least 50 days!o Extra delay makes it significantly harder

o Held : IN statute is upheld

1. Not preempted by the Williams Acto Test: Whether state law frustrated or stood as an

obstacle to the Congressional purposes underlying the Williams Act

Williams Act – purpose is protection of the independent SH

IN statutes does this! There are extra protections for shareholders.


Note that this differs from the rationale expoused in the MITE case – goal seemed to be neutrality between offeror and target mgmt

o Test: Is compliance with both state and federal laws is a physical impossibility?

Applied: They hold it is not. 2. Does not violate Dormant Commerce Clause

o (a) Does NOT discriminate against interstate commerce Note: Posner below said this hinders the interstate

market in corporate control.o (b) There are no inconsistent regulationo (c) Potential to hinder tender offers? Balancing test:

Does burden on interstate commerce [market for corporate control] outweigh articulated local benefit?

Internal Affairs Doctrine o Most corporate rules are created by the state of

incorporation, which has power over this Only applies to corps charted in IN and only those

which have other contacts with INo Compeittion between states for corp laws is a good thing

Bottom line: many states have adopted laws like this. Control share acquisition statutes are okay as long as you don’t go too far

o Themes: States Regulate corporate governance Protection of shareholders is the purpose and is OK Don’t second-guess economic policy judgments

o Convincing?

OK State Statute – (IN CTS) NOT OK – (IL Edgar)

Whether state law frustrated or stood as an obstacle to the Congressional purposes underlying the Williams Act Court balances whether burden on

interstate commerce (mkt for corporate control) outweighs the articulated local benefit

o Internal Affairs Doctrine vs. DCC

For 20 days, ONLY mgmt could talk to SHs to defend itself against takeover

Ways in which hearing could be delayed indefinitely

Secretary of State could review the overall fairness of a takeover bid

CONCLUDING THOUGHT Can you understand all of the issues and legal doctrines studied in this course as deriving


from one or more of the four fundamental features of the corporate form?o Limited liability on part of investors.o Strong legal personality (corporation treated as legal entity for purposes of suing,

contracts etc. Particularly in sense that investors can’t kill it very easily. Need approval and shareholder vote.)

o Shares are freely transferable (quid pro quo because hard to kill) and all your rights are bundled into the shares. Allows markets in shares to arise. Creates better liquidity.

o Lots of discretion in centralized management – decision making power concentrated in board, not spread among investors. Pretty powerful representative form.

And if so, which of the four accounts for most of the legal action??o Centralized management!

Fiduciary duties are created when 3 conditions met:o When somebody given discretionary power over the affairs of a business.

(directors or officers)o When the purpose of their having the power is to exercise it for the enterprise as a

whole and particularly for investors. It’s not to maximize their own interest. o When there are transactions/situations when power holder has power to bias the

decision in his own personal interest and against the interests of the beneficiary. Examples of fiduciary duties being implemented:

o Basic self-interested director transactionso Executive compensation – because always suspicion the executive had some

influence over the decision about his own compensation.o Doctrine of corporate opportunities o Insider trading – federal law, it’s basically an implementation of fiduciary trading

concept. Ties duty to disclose or abstain back to fiduciary concepts. It’s about trying to get optimal control of discretionary power.


TOPIC SUBTOPIC CASE RULE

AGENCY Who is an agent? Gordon v. Doty Control

Jenson Farms v. Cargill Look to control factors – (financier vs. major purchaser)

When Authority?Mill Street Church

Implied authority for this type of job / past dealingsALSO: apparent authority to the brother

Lind – (promise of a raise) Apparent authority – (principal holds out appearance of employment)

Watteau – (bar mgr) Inherent Authority based on his position

Liability in K Nogales Type of stuff a truck stop mgr is normally able to do

Botticello Ratification

Hoddeson Estoppel

Liability in Tort Humble Oil Sufficient control to be M-S

Miller v. McD’s Public may not know the difference – (apparent authority)

Hoover Not enough control

Murphy v. Holiday Inns Motel had day-to-day control IC

Bushey v. US – (sailor) “arising out of and in the course of his employment” / foreseeability

Manning v. Grimsley – (pitcher) Presently interfering with employee’s ability to perform duties

Clover v. Snowbird Ski Resort Rejects foreseeability test

Arguello v. Conoco Fact-specific inquiry into scope of employment at Conoco stores

Majestic Realty v. TotiNot liable for IC’s actions except inherently dangerous activity, negligent hiring, or control manner/means

Fiduciary Duties of Agents

Reading v. Regem No “secret profits” from misuse of position

Gen’l Automotive v. Singer “Utmost duty of good faith and loyalty” – affirmative disclosure duty

Town & Country v. Newbery Former employee can’t solicit if yrs of effort/goodwill from company


PARTNER Distinguishing from other relationships

Fenwick Can’t just make an employee a partner – (look to RUPA factors)

Martin v. Peyton Lender did not have true co-ownership, so no p’ship

Southex v. RIBA Contractor not partners – (no liabilities, no control)

Young v. Jones – (PWC) Partner by estoppel NO

Fid Duties of Prs LOYALTY

CARE

GOOD FAITH

Meinhard v. Salmon Owe duty of disclosure for new p’ship opportunity – (nexus)

Meehan v. Shaugnessy Duty to render on demand true and full information about p’ship

Bane v. Ferguson BJR – can’t hold liable unless you prove more than mere negligence

Lawlis v. Kightlinger & Gray No “predatory purpose” to removing from p’ship – “bona fide”

Partnership Property Putnam v. Shoaf

Partner has no specific interest in property/assets; can’t convey only certain assets or parts, only your share

Management Rights

Nabisco v. Stroud Actions on one can bind wrt 3rd parties

Summers v. Dooley – (each other) Business differences between each other must be by majority

Moren v. JAX – (dough machine) Indemnify for liability occurred by partner in ordinary course of biz

Day v. Sidley & Austin Shows that you can contract for management rights in p’ship

Partnership Dissolution

Owen v. CohenCt may decree dissolution if “not reasonably practicable to carry on the business”

Collins v. Lewis Won’t decree dissolution if partners was just interfering

Page v. Page Duty of good faith extends to dissolution – (no “freeze-out”)

Prentiss v. Sheffel No “paper dollars” argument – maj owners can bid too

Loss-SharingKovacik v. Reed

If one partner has coniributed all the labor and other all the skill, then the labor partner is not liable

Buy-out Agmts G&S Investments v. Belman Courts must give effect to the language of K, absent fraud/distress

Meehan v. ShaugnessyCould take client if they had been responsible for bringing them in and if they compensated the firm

Limited P’Ships Holzman v. Escamilla You can avoid liability, but only if you truly stay away from control



NATURE OF THE CORP.

Reasons4 Reasons we have corps

(1) Investor Liability; (2) Ability to transfer interests; (3) Legal personality of the firm; (4) Managerial power)

PCVSea Land

Unity of Ownership & Interest + Would sanction fraud / promote injustice - FCL

FCL “Just before generous”

Walkowsky – (Taxi)Neither fragmenting assets nor undercapitalizing is illegalALSO: “sufficiently particular facts” – (BUT discovery problem)

Roman Catholic No “alter ego” found here

Frigidaire Corporation as general partner while officers get limtd partners benefit

Silicone Gel Breast Implants Corporation so controlled as to be alter ego Marketing is big

SH Deriv Suits Eisenberg Challenging his own exclusion so it’s Direct – (injury to him)

Demand Futility

Particularized facts – (BUT discovery issues)

Grimes v. Donald – (DE)

Reasonable doubt that Bd can’t make an independent good faith decision about the suit because (1) maj of bd has material financial or familial interest; (2) majority of bd under domination/control; and (3) transaction is not the product of valid business judgment

Marx v. Akers – (NY)(1) Maj of bd is interested in transaction (self-interest or control/dom); (2) Maj of bd was not fully informed;(3) transaction was so egregious on its face that no sound BJ

Special Litigation Committees

Auerbach – (NY)Substantive judgments of SLC protected by BJR; methods and procedures get less deference

Zapata – (DE)(1) inquiry into independence, good faith, and reasonableness of SLC(2) ct applies its own BJ about whether dismissal is proper

Oracle Strict test for independence for SLC

Role & Purpose of the corporation

AP Smith v. Barlow Charitable giving is reserved power of the corp under NJ statute

Dodge v. Ford Motor Should be generous with own money; duty to SH to max profit

Shlensky v. Wrigley(More leeway) – decision within bd’s discretion absent fraud, illegality, or conflict of interest



FIDUDICARY DUTIES OF OFFICERS

Duty of CareKamin v. Amex

Cts won’t interfere with Bd’s discretion and impose Dr liability just because a decision seems mistaken – (need bad faith, fraud, self-deal, nonfeasance, illegality)

Francis Affirmative duty of “rudimentary understanding” / “ordinary care”

Van GorkomDrs breach duty of care when they fail to inform themselves of all material info reasonably relevant and available – (standard procs)

Brehm v. Eisner Due care is PROCESS due care only

Walt Disney Derivative Litig.Bad Faith defined as “conduct motivated by actual intent to do harm” or “intentional dereliction of duty or conscious disregard”

CaremarkDrs must attempt in good faith to ensure proper info/reporting system

Duty of LoyaltyBayer v. Beran – (wife as singer)

When interested dr transaction, burden on dr to prove (1) good faith, and (2) inherent fairness to the corp

Lewis v. SLE – (low rent)Burden on D to show that transaxn was fair and reasonable to the corp – NO BJR in Interested Dr transaxn

Benihana (Cts are willing to do a deep inquiry into Bd awareness/incentive)

Cinerama v. TechnicolorEven if only a minority of Drs are self-interested, the BJR may still be overcome if either interested drs control/dominate or failure of dr to disclose his interest could be regarded as a “material fact”

Corporate Opporunities

Broz v. Cellular Info Sys.

Dr or Off cannot take business opp which: (1) corp is financially able to take on(2) is in corp’s line of business(3) is one in which corp has interest or reasonable expectancy, or (4) taking would bring his self-interest into conflict with corp’s interestSAFEHARBOR: present/disclose to Bd 1st

In re eBay Apply Broz YES

ALI §5.05 How did you learn about it?

Duty of Good Faith Stone v. Ritter

Intentional failure to act in face of known duty OR conscious disregard



(CONTINUED)


Dominant SHsSinclair Oil

Self-dealing is present if parent cause sub to act in such a way that parent receives something from sub to the exclusion and detriment of minority SHs of sub if so, must show “intrinsic fairness”

ZahnControlling SH has fid duty to fully inform min SHs of the value of the firm

FlieglerIf a majority of disinterested SHs ratify an “interested transaction,” then the burden of proof shifts to Pl to prove waste

Wheelabrator

Effect of informed SH ratification: Arm’s length transaction BJR applies – (cures process

defects) Interested Dr transaction intrinsically and objectively fair

o (Pl must counter with gift/waste) Controlling SH transaction complete fairness

o (Pl must counter with unfairness)

Disclosure and Fairness United Housing v. Forman

5 factor test of “stock” Dividend rights / negotiable instrument / right to pledge / voting

rights / ability to appreciate in value

HoweyTest for “Investment K”Investment of $$$ / in a common enterprise / with expectation of profits solely from the efforts of others

Registration Process

§12(a)(1) Failure to register can result in rescission

Doran

4 Factors for when public offering must be registered1. # of offerees and their relationship to issuer and each other2. # of units3. Size of the offering4. Manner of the offering

Fraud in Reg Statement Escott v. BarChris Construction

Must be matters to which an average prudent investor ought reasonably to be informed before purchasing the security

10b-5 Rule Unlawful to lie in purchase/sale of any security

Basic v. Levinson MMO = “substantial likelihood that a reasonable SH would consider it impt in deciding whether to buy or sell”



Accepts FOM

(CONTINUED)


10b-5 cont. FOM In open/developed mkt, publicly available info will affect price

West v. Prudential Securities Non-public info does not lead to presumption of reliance/causation

Santa Fe Industries 10b-5 requires deception/manipulation; not just breach of fid duty

Deutschmann v. Beneficial Purchaser of option has standing to seek damages

Dura Must plead and prove loss causation with sufficient certainty

Insider Trading Goodwin v. Agassiz (common law cts applying state law not very aggressive)

SEC v. Texas Gulf Sulphur Disclose or Abstain – (must wait until info is digested)

Dirkes v. SECInheritance of insider status – trading forbidden only when insider breached fiduciary duty by making the tip and tippee knew of breach

US v. O’Hagan Misappropriation Theory – (breach of duty owed to souce)

Rule 14e-3(a)

It is a fraudulent/deceptive/manipulative practice to purchase or sell securities in connection with TO if material, non-public and acquired from offerer/issuer/officer/director/employee of offerer or target

Short Swing Profits - §16(b) Rule

In 6-month period, we’ll presume that any profits were made off of insider trading – (Dr, Off, owners over 10%)

Kern County Treat §16(b) purposively, not formalistically

Indemnification and Insurance

WaltuchCan’t bargain away from the “good faith” reqmt§145(c) requires indemnification of expenses of officers for “successful” defense of suits “on the merits or otherwise”

Citadel Holding§145(e) allows (but does not require) corps to advance dr’s costs of defending a suit (even if it’s against the corp itself)



CORPORATE

GOVERNANCEFix Audit Process Conflict Rules Rules about audit/non-audit svcs

Audit cmte Reduce personal bonding by making people rotate

Action Rules Must establish internal controls and give §404 attention Financial Literacy and Expertise PCAOB

Bd Changes

Think of conflict between monitoring and managing

Conflict Rules Maj of Independent Drs Stricter definition of independence Key cmtes can only have independents Supermajority of independent drs Independent Chair

Action Rules Financial literacy and expertise on board Limits on over-boarding Mandatory dr stock ownership Governance guidelines / codes of ethics Self-assessment

Disclosure and Transparency

Disclosures Looking for more and faster public disclosures

Action Rules SOX reqs certifications from CEO and CFO New crimes and new penalties for misconduct

Empower SHs Boost from SOX Shift to annually elected from staggered bds SH nomination of Drs Movement from “majority vote” reqmt in Dr elections



VOTING RIGHTS AND PROBLEMS OF CONTROL

Funding Proxy Fights

Levin v. MGMCompanies are free to fund expenditures for informing SHs as long as amounts are not excessive and tactics are not unfair or illegalALSO: need REAL business conflict – (not a personal thing)

Rosenfeld v. Fairchild Engine Corp.Incumbents don’t need SH app to spend for corporate policy contest Insurgents can get reimbursed if successful w/SH approval

Proxy Rules 14a-7 Mail-or-give-list

14a-8 SH Proposal rule

14a-9 Antifraud

Proxy Fraud JI Case v. Borak Implied right of axn for proxy violation

Miller v. Electric Auto-Lite

Test for Causation:1. Defect was material2. Proxies were an “essential link” in the accomplishment of transaxn

ALSO: when a SH action results in subsequent benefit to the corp, he can recover costs and expenses (even if he loses) as long as the suit “prevents an abuse” or “affects the enjoyment and protection of an essential right of SHs”

SH Proposals Rule 14a-8 Remember ownership reqmts + must avoid exception

AFSCME v. AIG Relating to an election – (SEC changes rule)

Lovenheim v. Iroquois Brands Implicates significant levels of sales + ethical/social significance

NYCERS v. DoleStatement about healthcare reform could not be excluded – (issue of social significance; huge expenditures; not beyond corporate power)

Austin v. Con Ed Can be excluded if ordinary biz operations or personal grievance

SH Inspection State ex rel Pillsbury v. Honeywell SHs may demand access to corp’s SH lists and books/records BUT



(CONTINUED)


Rights need “proper purpose related to you economic interest as a SH”

If SH list Company has burden of showing no proper purposeIf books/records SH has burden of showing he has proper purpose

Crane v. Anaconda SH desiring to discuss relevant aspect of TO has proper purpose

Sadler v. NCR Can demand both the compilation and the production of lists

SH Voting Control

SWIB v. Peerless

Blasius Test 1. Pl must show Bd acted for the primary purpose of thwarting vote2. Bd has burden of establishing a compelling justification for actions

Stroh v. Blackhawk HoldingCorps may eliminate the right to assets/earnings in different classes but CANNOT remove mgmt right incident to ownership

Voting and Mgmt Agmts in Close Corps

Ringling Bros. v. Ringling Agmts by SHs to decide how they’re going to vote for Drs are valid

Clark v. Dodge Mgmt agmt is valid if parties to agmt are the only SHs

Galler v. GallerSHs in close corp may make agmts about the mgmt corp if there’s no complaining min interest and no fraud/injury to public/creditors

Ramos v. Estrada Vote pooling agmt in close corp is not illegal under CA law

McQuade v. Stoneham Vote-pooling agmts are OK BUT can’t agree to bind yourself as dr

Abuse of Control in Close Corps

DonahueSHs in close corps owe one another substantially the same fiduciary duty that partners owe to one another

Wilkes v. Springside Nursing HomeTESTWhen min SH sues maj SH, maj can show legitimate business purpIf maj does this, min SH can show “less harmful alternative”

Ingle v. Glamore Motor SalesMin SH in close corp who contractually agrees to repurchase agmt does NOT acquire a right against at-will discharge

Sugarman Can’t freeze min SHs out of financial benefits ordinarily received

Smith v. Atlantic Properties Where each has a veto (controlling interest), each has fid duty

Jordan v. Duff & Phelps Duty not to behave opportunistically; aff duty to disclose mat info

Control, Duration, Alaska Plastics v. Coppock Can order dissolution for “illegal, oppressive, or fraudulent” acts



(CONTINUED)


and Statutory Dissolution Pedro v. Pedro

Court can order dissolution for controlling party acts that are unfairly prejudicial to min SHs

StuparichCt can order dissolution when reasonably necessary for the protection of rights or interests of complaining SHs BUT min SHs not entitled to substitute business judgment for the min

Haley v. Talcott Dissolution OK if deadlock – (effect on NEW business)

Other Methods Articles of incorporation Breach of fid duty by minority group Waste or misapplication of corp assets

Transfer of Control – (51%) Zetlin v. Hanson

Controlling SH is free to sell controlling interest for a premium absent: looting / conversion / fraud / bad faith

Perlman v. Feldman Can’t usurp corporate opportunity in time of mkt shortage

Essex Universal v. Yates OK to condition sale on immediate transfer of bd control

Frandsen v. Jensen-Sundquist (Form > Substance) – OK to lock them out



M&A De Facto Merger Doctrine Farris v. Glen Alden – (DE)

When one corp dissolves and liabilities are assured, executives take over, SHs acquire majority of shares, that’s a MERGER app rights

Hariton v. ARCO Electronics – (PA) As long as each step in process is legal, we’re OK

De Facto Non-Merger Rauch v. RCA “equal dignity” with “independent legal significance”

Freeze-Out Mergers

Weinberger – (DE)

Std of Review: Entire Fairness – (Fair Dealing + Fair Price)

Burdens:Pl must 1st allege specific acts which indicate unfairnessThen Maj SH must show “entire fairness” – (except if approval was approved by an informed vote, then Pl has burden of “unfairness”)

Weinberger rejects any “business purpose test”

“Wide Open” std for appraisal – “any techniques which are generally considered acceptable in the financial community and admissible in ct”

Coggins Merger must be for a “legitimate corporate purpose”

Rabkin Broader notion of procedural fairness and fair dealing

Tender Offer Freeze Out

ProcessParent Co makes TO for sub and then does short-form if gets more than 90% - (exempt this pattern from “entire fairness” review

SiliconixEntire fairness review doesn’t come in unless there are “actual coercion of disclosure violations”

Pure Resources Limits when the TO Freeze Out safe harbor is in effect



(CONTINUED)

M&A

Tender Offers and Defensive Measures

Williams Act

Sets rules for regulation of TOs Must be open to all SHs at same price Pro Rata Rule Withdrawal rights Antifraud Early Warnining Provisions

Cheff v. Mathes

Greenmail – Drs have burden of showing reasonable grounds to believe that danger to corporate policy and effectiveness existed – (buyback necessary to maintain proper business practices and not just done so drs could save their jobs)

UnocalExclusionary TO – (no longer allowed)Threat to Corporate Policy + Proportionate Response

Poison Pills Not per se unreasonable, BUT bd may use them unreasonably

Revlon

Once it becomes clear that company will be sold anyway, drs have a duty to maximize the company’s value by selling to highest bidder

Look to adequacy of process + reasonableness of drs actions

Paramount v. Time Warner

Revlon triggered when:(1) company initiates active bidding process or reorganization involving clear breakup of the company(2) target abandons long-term strategy in response to a bidder’s offer

Target can consider threats to business strategy or plans

Paramount v. QVCLook for sale of control block – (if so, req’d to seek the best value reasonably available for SHs)

Hilton Hotels v. ITT Corp.When an acquirer launches proxy fight AND tender offer, cts must apply both Unocal and Blasius

Omnicare v. NCS Healthcare Fiduciary Out

Antitakeover Legislation CTS v. Dynamics

IN statute is OK – (state law does not frustrate Congressional purpose; burden on interstate commerce is not too severe)

Documents

Corps Short Outline KF 2009