OVERVIEW

What do businesses do and what do lawyers for businesses do o Why does someone own a business Most people own a business to make money Friedman: In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical customThe key point is that, in his capacity as a corporate executive, the manager is the agent of the individuals who own the corporation and his primary responsibility is to themthere is one and only one social responsibility of businessto use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud. o Views of courts & legislators Smith v. Barlow Defendant corporation made a donation to Princeton. Shareholders sued arguing that he was not authorized by the articles of incorporation to be able to make this gift. Court said that laws enacted after incorporation that allowed directors to make charitable gifts without approval from shareholders applied to this corp, and as long as the gifts contributed to the corporate interests, they were appropriate. 33-3-102(13) (p. C13) A corporation can make donations for the public welfare or for charitable, scientific, or educational purposes. Expressly allows charitable donations. 33-3-104 (p. C14) Ultra vires: beyond the scope of authority or power granted to a corporation (would void an action beyond the scope of authority) Of little practical significance today. Corporations are now deemed to have the power to engage in any lawful business activity. Cannot challenge acts of corporation on the grounds that it doesnt have the powers to act. Enacted to stop litigation that argued a company did something it wasnt authorized to do- but it still goes on Shareholders can still challenge to enjoin an act or in a proceeding by the corporation directly or through a receiver If brought by a shareholder, the court can award loss (other than profit) suffered by the corporation o The Board of Directors is not acting as an agent; it is functionally a principal (this is the common view although the officers waffle on this) o See 33-8-101 for Board of Directors o Provides that Board will manage the company o In theory these are the ones who manage the company this is true for large corporations, but not for small ones- our statute anticipates this and provides a few other options o Most people say that the Board acts as the principle and not the agent and therefore makes the decisions o Certificate of existence and articles of incorporation- a document issued by a state authority granting a corporation its legal existence and the right to function as a corporation- normally filed with Sec. of State o Cert of Existence says that the corporation is in good standing in SC- but 33-1-280 is deceptivemost of the problems a corporation has will not be with the Sec of State, so it will be in good standing even though it is in trouble with other agencies- Dept of Revenue

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33-2-102 is the Articles of Incorporation which lists what you have to do to set up a corporation o 33-3-102 provides General Powers of a corporation corporation lasts forever unless something happens corporation has the same powers as an individual would have to conduct its business General building block concepts: o The law views a business, at least a business in the corporate sense, as a separate entity, a separate legal person o A body of lawboth statutory law and case lawhas developed to control the actions of that separate entity or person o Real persons act for the corporationthey are agents o A business with more than one owner, at least a business with more than one owner that is a corporation, can distribute and use its funds in ways that are opposed by at least some of the owners The owner of a business can make money from the business by: o Receiving distributions of all or part of the money the business has earned (this is called a dividend) or o Selling all or part of her ownership interest in the business for more than she paid for it A lawyer for a business is hired: o To help the business make money or o To help the owner get money from the business or o To help the business and the owner protect that money from the claims of others How do you know how much a business is worth? See the financial statements 33-16-200 (p. C98): A corporation is required to furnish its shareholders with financial statements, etc. See also 33-44-408 and 33-41-520. o Partnership Records in SC o 33-41-520 just have to keep books in accordance with partnership agreement and all partners must have access to them o So not much guidance on what they have to have o LLC statute gives even less guidance on what financial statements they have to keep o They are prepared according to GAAP Generally Accepted Accounting Principles o Matching- costs or expenses should be booked in the same period as the revenues those expenditures helped generate o Conservatism- the date should be conservative they should present the firms financial data in an accurate way but err on the side of understating its revenues and the value of its assets and on overestimating its costs and liabilities o Off balance sheet financing- this is what Enron did- its liabilities were carried out through subsidiaries, so the liabilities didnt appear on the balance sheets o This only works when the subsidiaries debt is nonrecourse debt- meaning the parent company could never be liable for it- in Enrons case, the debt was recourse Income Statement Shows the profit for a corporation over a given period based on data about revenues and costs Formula = Income Expenses Depreciated value of assets Taxes= Net Income We depreciate because the machine is getting less valuable each year since we are using up part of it. The portion we use up is called depreciation. Accelerated depreciation might be used for tax purposes. Cash flow statement Shows how much more cash a business has at the end of the year than the beginning Formula = Profit after tax + depreciation taken out cost of investment in that year. o

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In other words, its the income statement over a year without allowing the business to depreciate the cost of investments. We put depreciation in because it is non-cash Balance sheet A snapshot of the value of a business at a particular time Assets on one side (include things like cash, land, buildings, accounts receivable, and machinery and equipment) Liabilities on the other (include things like accounts payable, wages payable, and debts) Assets = Liabilities + Stockholder Equity or Owners equity = assets - liabilities Thus, profits accrue to equity A key component in the valuation of any business is the future profitability, which is not necessarily reflected in the financial statements (look at cash flow/income statements) Problems on 27 o dont buy the company for 189k because there are significant liabilities but we would recommend buying for 80K because that is the amount of equity- but valuing business is a very complex topic so yes you want to know the assets and liability and equity but what the buyer would want to know is the future income stream- what is it going to make in the future it also depends on the type of business Lender would be interested in balance sheets, so it can determine whether they would be able to pay o Looking at cash flow statements Dont sell for 3,700 because thats the same amount you are making, and if you keep it, then you will make this again next year- and probably more 20,350 this is equal to the cash flow for five years, but this is still low The cash flow statements does help a prospective investor and certainly helps lenders The Sarbanes-Oxley Act and Corporate Governance o Mainly apply to publicly traded major corporations, but some of the general principles should still apply to the smaller business o Passed in 2002 in reaction to Enron. Purpose is to try and prevent fraud o Frauds had to do with the financial statements discussed above o Public corporation have an auditing committee the oversees the financial accounting including the SEC filling o Auditors will use a principle of sampling certain random transactions as well as looking at suspicious looking ones to make sure they really did happen o Fraud is motivated by the fact that if the numbers on financial statements look good, then stock prices will go up Managers want to make stockholders happy Also, they often receive bonuses when the numbers are good o Types of Fraud Off-balance sheet Move liabilities off you balance sheet and onto a subsidiary Hiding costs Two basic types are Representing the companys financial condition as better than it is Or misappropriating the wealth of the company for private gain o Sarbanes-Oxley clarifies the role of auditors, company management, and boards and audit committees as well as impose new process and responsibilities on these parties Ie- have to say whether their auditing committee has a financial expert 404 says the company must design internal controls and test their effectiveness CEO and Chief Financial officer must attest to accuracy of statements under penalty of criminal liability

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Lots of companies have said that this is to much regulation and is costing them way too much money to prove that they are honest To get out from under Sarbanes-Oxley, they are becoming private- cashing out the public holders and becoming private This means that we wont have anything to invest in What are the basic business structures? What are the primary driving forces behind structure choice? Taxes - how profits are taxed Liability - the exposure of the owners to liability for the corporations actions Sole Proprietorship A single person For taxes and liabilities, the person and the business are treated as the same person Profits are taxed as personal income Liability of the company goes straight to the owner Note that a sole proprietor doesnt need to file with the state Dont need an atty to form a sole proprietorship C- Corporation Owners of corp are protected from personal liability The corp pays taxes on income, and the recipients of dividends pay taxes on them (known as double taxation). The incentive for forming a c-corp is that if you can pay out all of your income as salaries, then the company will not show a profit and it will avoid the double taxation problem. S-Corporation SC 33-18-103 This entity is taxed like a partnership but has the liability protection of a corporation. Profits are distributed directly to partners, and as such are taxed only as the income of the partners no double taxation problem (this is known as flow through taxation and the tax is paid by the shareholders) IRS places a bunch of restrictions on who can be an S-Corp o Can only have one class of stock o Must be domestic, and wholly owned by US citizens o No more than 80% of revenue can come from non-US sources Ex Shrimp boat business in Charleston fishing in international waters. o No more than 100 stockholders o No more than 25% of revenue from passive sources (rent, interests, royalties). o Only individuals, estates, and certain trusts can be shareholders. Limited Liability Company (LLC) Just like the S-Corp Rather than complying with IRS laws, LLCs are governed primarily by state law. Offers protection both from liability and from double taxation (you are taxed as a partnership- only the individuals are taxed) SC dont need an atty to form an LLC Dont have to file an annual report with the SOS office. General Partnership taxes are paid only as money is distributed to partners; taxes are paid at the individual level; pass through taxation partners are EACH jointly and severally liable for actions of the partnership So an injured party can go after any partner for the full value of their claim.

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Limited Liability Partnership -(LLP) Has limited and general partners General partners have management responsibility/control and unlimited liability for the business You would make a corporation the general partner so the individuals are protected Limited partners are liable only for what their capital contributions to the business were. Family partnerships are common in SC because they are an estate tax avoidance technique. Factors that go into whether you choose one style of business over another Who will the investors and owners be? If small group of investors- then an LLC or partnership would work o What are the capital requirements and cash flow characteristics of the business likely to be? if you require venture capital, you will probably need to be a corporation bc venture capitalists wont invest in LLC because of the personal tax liability But this isnt really the case- people still invest, and its easier to change from an LLC to a corporation - but not visa versa Who will own the business? Who will manage it? Who will reap any profit? Who will bear the risk of loss? Who will pay taxes on profits?

SOLE PROPRIETORSHIPS
o The good things about sole proprietorships You dont need a lawyer or any forms to start one. Just start doing business

Problems of Sole Proprietorships: Employees and Agency Creates Contract Liability R3 1.01 and 1.02 definition of agency. o Agency is a fiduciary relationship. Created when: The principal manifests consent to act on his behalf to the agent The agent consents to act on the principals behalf subject to his control Authority the extent of the agents power to act and bind the principal Actual Authority R3 2.01, 2.02, 3.01 (R3 mixes actual and implied authority together) o Authority to do an act can be created by Written or spoken words (Express Authority) Other conduct (Implied Authority) o An agent acts with actual authority when, at the time of taking action that has legal consequences for the principal, the agent reasonably believes, in accordance with the principal's manifestations to the agent, that the principal wishes the agent so to act. Apparent Authority R3 2.03, 3.03, 7.08 o Apparent authority exists when a third party reasonably believes the actor has authority to act on behalf of the principal. o Created by manifestations of the principal to a 3rd party which reasonably cause the 3rd party to believe that the principal wants the purported agent to act for him. o The information can come to the 3rd party directly from the principal, through authorized statements by the agent, or from other indicia of authority.

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o No detrimental reliance is needed o Giving an agent a job that typically carries an authority can create apparent authority Ex hiring an atty grants the atty the apparent authority to act in the clients bests interests to protect the client. Legal Consequences of Actual or Apparent Authority See problems on p. 46. Problem 1: Agee might be legally obligated b/c R3 6.01, 6.02, and 6.03; Propp is bound by 2.01 Actual Authority; second part depends on whether the P is disclosed or unidentified or undisclosed if the first then no; if not then yes 6.01 and 6.03 Problem 2: Propp might be obligated to pay even though agent ordered more than principal allowed under the theory of apparent authority. Agee may or may not have to pay. It could be considered a tort claim instead of a K claim; prop is liable because there is apparent authority Prop knew that Agee had made prior orders from TP and that he has paid it, so TP would reasonably believe that Agee still has this authority. Propp should have taken action to let him know Is Agee liable to TP an agent is liable if he makes a misrepresentation to TP but authority is split on whether this is a K claim or a tort claim Problem 3: Propp would not be liable. Agee might be liable under a misrepresentation type claim; there is no express authority and there is no apparent authority because the call was made by the supposed agent and not the principle. Also this is outside the scope of Agees authority so there is no implied authority Finally, the Agee will be liable- even though the P is exposed, there is a misrepresentation- In SC you would have to pursue this as a K claim instead of a tort claim Disclosure of Principal When the agent is liable for a contract o R3 6.02 If the principal is known to the 3rd party, the agent is not liable for any contracts entered on behalf of principal. o R3 6.03 If there is partial disclosure of the principal (3rd party knows agent is an agent, but doesnt know who he is an agent for) then the agent is liable for the contract. o RSA 322 if the agent is purporting to act on his own behalf, but is in fact acting on behalf of an undisclosed principal, the agent is liable for the contract. Master/Servant Creates Tort Liability Must create a master/servant relationship to have tort liability R3 7.07(3) Creation of a employee o an employee is an agent whose principal controls or has the right to control the manner and means of the agent's performance of work o Why should an employer be liable for torts committed by the employee? Cost of business- employer is better able to shift the cost Employer maybe could have prevented the accident o All servants are agents but not all agents are servants o Some independent contractors are agents and some independent contractors are not agents. The independent contractors will not be servants. o Attorneys are typically independent contractors who are agents. o Factors to Consider finding employer/employee relationship Extent of control the employer can exercise over details of the work* Whether or not the person employed is in a different kind of business from the master Whether the type of work is generally done with or without supervision The skill needed by the employee

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Length of time of employment Whether work is regular business of employer Whether the principal is in business *Whether the employer supplies the tools (Imp in SC) *Method of payment per time or per job (Imp in SC) *Express manifestation of creation of employer/employee relationship (imp in SC) *Whether the principal has the right to fire the employee (imp in SC) R3 7.07 Scope of employment o TO find the employer liable, the worker must be an employee working in the scope of his employment. o Conduct is in the Scope of Employment It is what he was hired to do It occurred for the most part within time and space limits of employment Work is done to serve the employer If use of force is part of the job, then intentional torts might not be unexpected o Coming and going doctrine travel to-from work in most cases is not within scope of employment unless that travel is part of the job o Frolic v. Detour Generally depends on how different what the employee was doing was from acting in the service of the employer R3 7.07 kind of conduct within scope of employment o Conduct of the same general nature as that which is authorized o Determining whether conduct is so similar as to fall within scope of employment Whether or not commonly done by such employees Time, place, and purpose of the act Previous relations between employer and employee Extent to which the business of the employer is apportioned between different employees Whether or not act is outside the enterprise of the master Whether or not the employer has reason to expect that such an act will be done (forseeability) Similarity in quality of act done to act authorized Whether or not instrumentality of harm was furnished by employer to employee Extent of departure from normal method of accomplishing an authorized result Whether or not act is seriously criminal Problems on pg 49 Is Servantes a servant yes Whats the difference b/w servant and agent o A person who employs an agent is a Principle o A person who hires a servant employer o No term for hiring an IC How do the agent and employee groups overlap? o You have employees as a subset of agents the P must have control to be an employer circle would be inside the agent circle o THe IC circle would overlap because they could be agents or not

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 Attorneys o See page 49 The CEO of GM is a servant as is the pilot You would not be liable for the accountants tort because they are an IC Yes you are liable for the coffee spill employee = respondant superior Still liable even if he tells him not to spill coffee Is Servantes also liable Yes just because the employer is also liable doesnt get you off the hook for your own tort but he wont be able to collect twice Prop is not liable for the tort committed while Servantes was on the way to work- its outside the scope of employment Is Propp liable for the cook hitting the customer with a frying pan Employers are liable for some intentional torts but it depends how closely the act is related to the employment Does he need an atty if he hires an atty That would cover a lot of it, but not all o Other business agency relationships o Attorney-client o Note that an attorney is most likely an independent contractor who is also an agent. o Hayes v. National Service Industries Hayes sued for wrongful termination. Her lawyer settled, and Hayes tried to reject the settlement on the grounds that the lawyer didnt have the authority to settle. Rule on Attys Apparent Authority: The court held that simply hiring an attorney to deal with third parties creates apparent authority to act on behalf of the client UNLESS the client expressly limits the authority and communicates the limitations to the 3rd party. Note: the agent cannot create his own authority this case gave the lawyer apparent authority which is designed to protect the third party o The manifestation of authority comes from the act of hiring an attorney- which people will assume is your agent and has authority to act on your behalf Malpractice protects the attorney o The agent cannot create his own authority no matter how persuasive he is o Franchises o Agency will arise if the franchisor-principal has the requisite degree of control over the franchisee-agent, notwithstanding the customary boilerplate provision in the franchising agreement that the parties do not intend agency relationship o Sometimes courts apply the theory of apparent agency or estoppel to hold franchisors liable. Jurisdictions differ on the Ps burden of establishing detrimental reliance on an appearance of agency and in probative significance assigned to a partys failure to correct misimpressions that others may draw about the nature of a relationship. o Miller v. McDonalds Facts: Lady bit into a really classy heart shaped sapphire when she chowed down on a big mac purchased at a McDonalds franchise owned by 3K Restaurants. McDonalds tried to defend on the fact that they didnt own the restaurant. Specifically, the franchise agreement specified that 3K was an independent contractor and responsible for its own torts. P had two theories as to why vicariously liable: actual agency relationship (because of control asserted by McDonalds) and apparent authority/agency. Court looked at MASTER SERVANT relationship, and looked into the details of control that McDonalds could exert over 3K in its day to day operation, and decided that this created a right to control and thus was a question of fact as to whether McDonalds was a master and responsible for tort? The generally accepted principle is: If the relationship between McDonalds and 3K is such that McDonalds has the right to control daily operations, that is enough to cause them to be liable. Applies right to control test bc employer-employee relationship doesnt work well here 3k would be the servant so if the tort occurs within the scope

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Must not only set standards, but control day to day operations.(some courts might say that setting standards would be enough) Simply controlling the lay out and setting standards wouldnt be enough (Shell case) but controlling the detailed performance of the franchise and its employees in how they meet those standards does (Hilton) o it does here, so there is One big thing is that McDonalds controlled the food handling- which is the cause of the tort in this case One difficult problem that franchisors have is that to protect their trademark, they must exercise control over anyone using it Court also looked at RSA 267. RSA 267 Apparent Servant Doctrine. If a party (1) represents that another party is a servant and (2) a 3rd party reasonably relies on this representation then the apparent master can be responsible for torts. In this case, the use of the McDonalds name and uniformity of operations and appearance and the fact that patrons rely on the McDonalds name to find quality was enough to create a question of fact as to apparent servant. 267 appears to have disappeared from the Rest. 3d, but Burkhard assumes 267 is alive and well in SC. This is apparent agency, which is different from apparent authority; it creates an agency relationship that does not otherwise exist while apparent authority expands the authority of an actual agent See R3 on apparent authority Apparent agency is the wrong term because this is a tort problem it should be Apparent servant P must hold the franchise out as its agent and the TP must rely on that to her detriment Texaco case- apparent authority where national ads and logos at site lead customer to believe the service station was the A of Texaco Franchise agreement must require franchisee to act in ways that identify it with the franchisor this is the case here so there is apparent authority argues that there was a sign that said it was owned by 3k but that wasnt enough Centrally imposed uniformity is key does not have to prove that the other McDonalds she went to were owned by McDonalds rather than being franchises 3K is directly liable and McDonalds is vicariously liable Simmons v. Tuomey (SC Case from 2000) SC court adopted 429 as the basis for applying liability, but they did it in a strange way. They said a hospital owed a nondelegable duty to render services. They then applied Restatement of Torts 429 (essentially theyre saying that 429 is really an expression of nondelegable duty) to find a hospital liable for the torts of a doctor who would otherwise have clearly been an independent contractor. We dont know if 429 applies outside the world of hospital/doctor cases in SC?? That is the only place it has come up so far. Rest of Torts 429 - This restatement lowers the RSA 267 from detrimental reliance on the part of the third party to a reasonable belief. A plaintiffs attorney would rather 429 apply. Sum of Rest 267 cases win most of the cases- many people think it is stupid to hold the franshisor liable for torts committed by the franshisee others o Notes Agency by estoppel is used to hold liable a party who benefits from a relationship in which the parties did not intend the legal consequences of agency ie you dont get the benefit without the risk o To avoid this, the P should alert the public that there is no agency relationship o This article on page 67 is important because the author became the reporter of the Rest of Agency 3rd see 2.05 429 is better for because it only requires reasonable reliance and not detrimental reliance as Rest 2nd of Agency 267 does

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o o o

This is important in SC because in Simmons v. Tuomey Reg. Med. Center The employees working in the ER are not hospital employees but IC The SC Crt App and the SC both concluded that the hospital is still liable The Sup. Court adopts 429 as the basis for finding liability however the did so saying they did not adopt a view totally against delegable duty o Not sure if 429 applies outside the world of hospitals but it probably does. Assuming that it is not this is important because its BOP is lower than the Restatement of Agency Problems page 65 2) court didnt care about the agreement and it shouldnt, because it the acts, not the boiler plate. 4) YES you would take advice of counsel The indemnification clause is good As are the clear warnings especially the sign requirement which says the place is owned by someone other than the company There is almost always an agency relationship between franshisor and franchisee, but there is normally question of whether it goes to the employer/employee level Growing a sole proprietorship The owner can put his own money in, or he can take loans. If the owner puts in his own money, it will serve as an investment or equity; it is not a debt to be repaid Debt v. Equity Equity funding does not come with a legal obligation to repay; it is an investment that the business receives for selling a part ownership in the business Debt funding has a legal obligation to pay back, which of course, flows right to the sole proprietor Compared to being a creditor, being an owner has a higher risk, both up and down; the risk is higher, but so is the potential return. Debt is riskier to the business (leveraged is a term used when the company has debt funding; the lender has leverage against them and can force them to pay); the equity owner has no right to repayment Debt has a fixed cost: the interest rate the business pays to borrow the money is the cost of those funds. On the other hand, at the time the equity is sold, the cost to the business of the equity is uncertain. So a sole proprietor cant use equity funding and still be a sole proprietor; instead he must use debt funding Way to structure a loan so it will be perceived as low risk o Security - Pledge personal or corporate assets against the loan as a form of collateral to secure the loan o Promise to pay the money back in a short time = more certain predictions o Give the creditor some measure of control over the business Loan covenants Participation in business decisions- like a seat on the board Lender may also want profit share instead of interest Should you automatically arrange the company as a corporation so you wont be liable for the loan o Wont work because the bank will require you to personally secure the loan See handout with comparison of capital structures. The concept is called leverage. We are using other peoples money and paying less to them than we can make with their money (preferred shareholders). o

PARTNERSHIPS
o Estate of Fenimore DE Rule for finding a partnership o Facts: Fenimore died insolvent. His sister loaned him some money for his business. Later, Villabona loaned him some money for the same business. The estate inherited $20K, and both the sister and

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Villabona wanted a cut. If both were deemed to be creditors, sister would have priority as she made the first loan. Villabona argued that the sister was really a partner, and her loan was an equity investment. o Issue: Equity Investment in a Partnership vs. Loan., o DE Rule for the Existence of a Partnership: The court looked at the terms of the sisters loan. She said advanced rather than lent. Further, a condition of the loan was that she would receive profits from the business. The court said that receiving a share of profits was prima facie evidence of a partnership, and the fact that she made no decisions wasnt enough to rebut that evidence. Thus, she was a partner, and didnt get her loan back. The court acknowledged that she didnt intend to be a partner, but the court didnt care. You can create a partnership without realizing it. o Courts have said that not all partners have to share in the decision making and liability but they do have to have at least one- and there must be an intent to share profits not all courts would agree with this. These concepts are important, but not absolute o Agreement looks like a partnership Intent of parties Sharing of profits Allocation of expenses- ie sharing liability o The BOP is less strict when at third party is involved then when the dispute is b/w the 2 partners This lowered standard plus the fact above mean that this was a partnership agreement She may not have intended to enter into a partnership, but she has- this is common many people enter into partnerships just by going into business with another and that there are consequences o Therefore her claim to her brothers assets come in behind Villabona Problems page 78 o 2.1 using lend would have helped, but it probably wouldnt trump the profit sharing; it doesnt negate the other aspects o 2.3 taking out the profit sharing (or at least use clearer terms) and clearly writing the document to be a loan agreement. But there is a risk that a court will say it still meets the requirements of 210 o Note 5 Martin v. Peyton held that Peyton was not a partner where he had no active control, only reactive ie that he cannot initiated a transaction o Important but may not be controlling o But beware veto power may be enough o What is a partnership o For this class, we will be looking exclusively at the UPA (dont worry about RUPA) b/c SC mostly follows UPA. o UPA 6/ 33-41-210 Partnership Defined o A partnership is an association of two or more persons to carry on as co-owners of a business for profit o Persons includes entities o Rule: that anything not specifically formed as something else under the laws of the state is automatically a general partnership. o A corporation can be a partner. Often business entities become partners. o A joint venture is a limited purpose partnership (Meinhard). Entity approach (RUPA not followed in SC) the partnership is an entity in itself Tax the partnership reports income on one statement but the individual partners pay their portion of the taxes. Aggregate approach (UPA the SC approach) the partnership is an aggregation of individuals. Tax the NET INCOME of the partnership flows to partners, and is taxed to them on their individual tax returns. You are taxed on the money, whether or not it is paid out to them or not. o To become a limited liability partnership, look at 33-41-1110. You have to file to be a limited liability partnership. Also you must demonstrate that you have at least $100,000 of liability insurance or higher if your partnership renders professional services. 33-41-1130. Problems page 83

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Cant be both a sole proprietor and a partnership, nor can you start a partnership by yourself. But you can have a single member LLC. o Cant be both a corporation and a partnership youre one or the other o SC allows a corporation to be a partner 33-3-1029 o What is partnership law? o The rights and privileges of partners are primarily governed by the partnership agreement. The UPA contains fall-back provisions in the event there is no partnership agreement or the partnership agreement does not cover the issue. However, there are a number of provisions of the UPA that say they cannot be changed by K. o Both RUPA and UPA serve as the default rule when partners fail to agree on a rule in the agreement o So if you contribute 70% of the capital, you need to put in the agreement that you have the most say and get 70% of the profit, otherwise RUPA and UPA kick in and a majority vote rules decisions and profits are shared equally o Somewhat misleading the statute does allow you to trump it, but there are some that it does not allow you to side step it often this is when disputes with third parties are involved o Modification of the Partnership Agreement: o Under UPA-SC the lawyer drafting the agreement must look section by section to see if a particular section can have the rights and obligations modified in the agreement. Page 85 o You dont have to have a partnership agreement to operate as a partnership but they should o They dont need a lawyer. But if they do, they probably need separate ones but thats an ethic issue o However often only one lawyer does it but be sure to think carefully o Problem with sample agreement on 86 is that it doesnt tell us what mutual agreement is it doesnt say what the vote has to be on decisions this would get us in trouble; the language is imprecise o It may mean unanimity, but thats not totally clear, and you could make it clear with better drafting so do so o Extent of Partners Ownership Interests o Who owns what? o UPA 8/ 33-41-230 Partnership property o All property brought into the partnership or later acquired on account of the partnership is partnership property. o Unless there is some appearance of contrary intent by the partnership, property acquired with p-ship funds is p-ship property o You can buy property in the p-ship name, and as such can only be sold in the name of the partnership. o See 33-41-230 for what happens if real property is conveyed to a certain partner. o If property is owned by one before the partnership is formed and the partnership uses it Does the property get treated as a capital investment SC 33-41-230 All prop brought into the partnership stock is partnership property But not clear what is brought into the partnership so make it clear in agreement o What if property is acquired by the partnership with the funds from one partner what if it is in the individuals name o 33-41-320(4) says it doesnt matter, the equitable title passes to the partnership o UPA 24/ 33-41-710 (p. A8) Extent of Property rights of a partner o Has the right in partnership property o Has interest in the partnership o Has the right to participate in management this can typically be modified by the agreement o UPA 25/33-41-720 Nature of a partners right in partnership property o Partners are co-owners with tenancy in partnership o How tenancy in partnership works: The partners each have an equal right to use partnership property for partnership purposes, but no right to the property for any other purpose without consent of partners. o

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o o o o o o

Rights to property cant be assigned unless all partners assign their rights (Mutual Consent for Assignment) Creditors cant attach to partnership property unless they are making a claim against the partnership. On death, a partners right is vested in the other remaining partners. On death of the last partner, the property goes to his legal representative Next of kin cant attach to partnership property o Essentially you have the right to use the property that the partnership owns Partners rights in specific property is not assignable unless they are transferring everyones rights in the property so you cant sell a part of something unless the partnership agrees UPA 26/33-41-730 Nature of a partners interest in the partnership o Partners interest in the p-ship is his share of profits and surplus and his personal property. Problems p. 87 2. Cooking equipment used in restaurant might be partnership prop depending whether it was loaned or contributed 3. Cash and credit card receipts from operation are partnership property 4. New tables and chairs are partnership prop Who decides what the p-ship will do? Solving General Disagreements - UPA 18/33-41-510 (8) o If the partners disagree as to an ordinary matter, the disagreement shall be resolved by a majority vote. No act in contravention of any agreement between the partners may be done rightfully without the consent of all the partners. o Also, if an act goes against the p-ship agreement, it must be consented to by all partners. Partners as Agents UPA 9 / 33-41-310 o (1) Every partner is an agent of the partnership for the purposes of its business when he is apparently carrying on the business of the partnership in the usual way-binds the partnership In all likelihood, this usual way is considered from the perspective of a 3rd party. o (2) An act of a partner which is not apparently for the carrying on of the business of the partnership in the usual way does not bind the partnership unless authorized by the other partners. o (4) - If a partner is restricted from acting in some way, his actions arent binding if the 3rd party has knowledge of the restriction. Partnership agreements are private agreements that are not made public. Partners Duties to One Another Meinhard v. Salmon (NY) o This is the most important business case ever decided in the US. Cited more times that any other business case in America. Some people agree with the decision and some people dont o Facts: Meinhard and Salmon were in a partnership where Meinhard paid to renovate a building, and Salmon managed the building during a 20 year lease. Near the end of the lease, somebody approached Salmon with an offer to develop some new apartment buildings. Salmon took the deal and didnt let Meinhard have a shot at it. Salmon appropriated to himself in secrecy and silence. o Test for Partners Duties to One Another: Partners must treat one another with a punctilio of honor the duty of the finest loyalty. o Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arms length are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the marketplace. No honesty alone, but the punctilio of honor the most sensitive, is then the standard of behavior. o Because Salmons position within the p-ship gave him exclusive access to opportunities and information, he had a duty to disclose to Meinhard. Salmon breached that duty.

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o Basically, for a breach like this, youre looking for a partner taking advantage of the business of the partnership for his own personal gain appeared to the owner to have the lease in his own right, but in fact he held it as a fiduciary o If he had acted as such, the development plan would have been presented to both and , but he didnt act as such and acted as if he held it as his own He acted in secrecy If he had told the and they had competed for it, then he might be able to keep it as his own, but because he didnt the court is going to give the an interest in the venture o The fact that he had sole power to make decisions means he had an even higher duty to disclose He robbed of a chance of renewal So there is a graduated scale- if you are in charge, you have a greater duty to look out for your partners Dissent Says there wasnt a general partnership- merely a joint venture for a limited object to the end of a fixed time so it was a one shot deal o The new project is much bigger in size and duration it wasnt a mere renewal o If this had been a general partnership he would agree with the majority, but since its not, he sees no fid duty other then that which is within the scope of the limited venture He also thinks that these ventures are distinct enough that even if there was a partnership, the was still in the right to act alone 33-41-530- Duty of Partners to Give Information o Partners shall render on demand true and full information of all things affecting the partnership o Case law says that as a fiduciary a partner has a duty to make a disclosure regardless of demand UPA 21/ 33-41-540 Partner Accountable as a Fiduciary o Every partner must account to (present information to) the partnership for any benefit he gets from any transaction connected with the formation, conduct, or liquidation of the partnership or from any use of the partnerships property UPA 22 /33-41-550 A partner has a right to a formal accounting of p-ship affairs: o If he is wrongfully excluded from the business by his co-partners o If the agreement gives him the right. o If a benefit was received as described in 21 o catch all: Whenever the circumstances render it just and reasonable Problems on 96 o 1.2 you could say that the opinion would come out differently the nondisclosure issue wouldnt arise, but he still may have taken something that didnt belong to him; there is an argument that it would have come out differently; see 530 and 540 o Would SC find these two to be a partnership yes see 210 they are both in a lease arrangement to make money o Most attys would say that a joint venture is a kind of a partnership a limited purpose partnership o If so- 540 says a partner will hold as a trustee any profits derived by him without consent from the others from any transaction connected with the formation o 530 Partners shall render on demand true and full information of all things affecting the partnership to any partner or the legal representative of any deceased partner or any partner under a legal disability This wouldnt kick in in the Meinhard case because Meinhard never demanded the information However, case law shows that there doesnt have to be a demand and that a partner has a fid duty to make a disclosure regardless of demand o These two sections are the only times that the UPA talk about fiduciary duties o 1.3 probable would reach the same result Cardozo talks about managing partner having a higher duty but they still have a duty as partners o On page B-17 33-44-409

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o o o

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Fid duty as contained in the LLC statute its very different then what is in the partnership statute but is similar to page 98 of the text (RUPA) o Also look at B-5 LLC Operating agreement may not change Duty of loyalty but may id types of activities that do not violate those duties Cannot reduce standard of care Rules of goof faith and fair dealing What if Meinhard case was an a SC LLC what section would have helped Meinhard the most o 33-44-409(b1) To Salmon? o 409(e)- just trying to make some money Read 56 S.C. L.Rev. 275 (2004) o Compares fid duties of partnerships to LLC written by Toal o Takes position that despite 409 there are more fid duties owed by partners then by members of LLC Would the language in 5 work? o Problem is that not everyone will be in equal bargaining position, so there is room to challenge it Delaware - you can put in an LLC agreement that if anyone wants to steal, lie cheat, its fine, you can say there is no duty of loyalty this wouldnt fly in SC- the kicker is though that neither the Del. SC nor the Leg was willing to delete their language which we find in SC 409(d) which talks about K obligation of good faith and fair dealing o Burcky thinks this will be used by Del courts to reach the same result as you would if you said there was a duty of loyalty What is a punctilio? A detail about which one is fastidious, a point of honor Liability in Partnerships Partnership liability as an Entity o UPA 13 / 33-41-350 Liability for Wrongful Act of a Partner: The partnership itself is liable as an entity and is bound by any wrongful act of a partner acting in the ordinary course of business. If partner injures TP in scope of business, then the partnership is liable to the same extent as the partner When partner acting in scope of apparent authority, receives money or property from 3rd person and misapplies it, or if the partnership receives it and a partner misapplies it the partnership must make good the loss o UPA 14 / 33-41-360 P-ship is bound by a partners breach of trust. Partnership is bound to make good the loss when 1) one partner acting within the scope of his apparent authority receives money or property of a 3rd person and misapplies it and 2) when the partnership in the course of its business receives money or property of a 3rd person and the money or property so received is misapplied by any partner while it is in the custody of the partnership. Joint and Several Liability of the Partners o Liability of Partners RUPA partners are jointly and severally liable for all obligations of the partnership UPA partners are jointly NOT severally- liable in contract BUT ARE jointly and severally liable in tort SC partners ARE jointly and severally liable for K and tort- 33-41-370(a) o UPA 15 / 33-41-370 (modified in SC): Nature of Partners Liability (A) All partners are jointly and severally liable for claims against the partnership, regardless of whether they are tort or contract claims. (Except as provided in B below) Note that with joint and several, a plaintiff is free to go after a single partner, and force them to go out and get the rest of the partners. (B) A partner is not liable by way of indemnification, contribution, or otherwise, for debts, obligations and liabilities charged to the partnership arising from negligent, wrongful acts, or misconduct committed while the partnership is a registered LLP and in the course of the partnership by another partner or an employee, agent, or representative of the partnership Unless that person was under his direct supervision o

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Or a person rendering personal services on behalf of the LLP, unless the partner was at fault for appointing or supervising them. There is no protection against K claims o 33-41-510: A partner is entitled to contribution or indemnity from other partners if the personal liability was reasonably incurred by him in the ordinary and proper conduct of its business or for the preservation of its business or property o 33-41-1200(g): addresses the liability of the partner of a limited liability partnership for a partner who transacted business in a state without a license. o 15-5-45: Suing Partnerships A plaintiff can sue a partnership with or without joining any of the partners. Judgments against a partnership bind its real and personal property, and the partners are personally liable for any judgment. o 15-35-170: Judgment against a Partnership Burkhard says that this has never been used against partners (its purpose is to nail the unions). If you get a judgment against a partnership, you can go after the personal assets of the partners if you can manage to join them in the suit; due process says you cant collect from a party unless that party is a named party of the lawsuit. You better name all of the partners. o RSA 404 Liability of agent for use of principals assets Agent who uses for his own purposes the assets of a principals business is liable to the principal for the value of the use. Not liable for use of time he contracted to the principal in some other matter, unless he violates a duty not to act in competition with the principal. Problems page 100 o 1) looks like an easy answer, but there is nothing in SC act that give a TP the right to sue the business aggregate idea comes in and says you have to sue the partners o 15-5-45 and 15-35-170 on TWEN allows you to sue the partnership, and also allows the partnership to sue. o 1.2 yes P can sue A the tortfeasor o 1.3 yes, P could also sue E, who is another partner SC makes us severally liable; 370(a) o 2) how can P enforce judgment against the partnership o Because all the partners are not named in the case, which equals violation of DP if you arent named in the lawsuit so this is a problem because the statute says you are jointly and severally liable o So to collect against the partners they have to be joined name the partnership, the partners as partners, and the partners as people o 5) 510(2) the partnership must indemnify every partner in respect of payments made and personal liabilities reasonably incurred by him in the ordinary and proper conduct of its business or the preservation of the business or property o So yes, but he must qualify. Not sure how negligence would fall o 370 o Allows for some partnerships to qualify as a registered Limited liability partnership, which means they are not liable for the acts of others Doesnt protect from K claims o D) if you take part in the services you are liable If someone else in the limited liability partnership does it, then you are not liable for torts unless you are at fault for appointing, supervising or cooperating with them. o This statute is mainly the result of lobbyist for accountants from out of state said they were pulling out of SC unless they passed this statute o How do you become a limited liability partnership A-18 o 1110 (A) says you must file an application with the Sec. of State this is unlike a general partnership which can be created without any paperwork o Must renew registration every year Failure to do so will make you a regular partnership o Must have at least 100k of insurance

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Or more if your professional licensing board requires you to If you are a registered NC LLP and you come into SC to do business but forget to register in SC o 1210(C) Doesnt matter, you still are liable for the torts of your partners o Growing a partnership Contributions from Existing owners: Rules on Capital Calls o If the partners agree, they can decide that the partners will contribute capital to the partnership. o Normally, there should be something in the p-ship agreement that states what vote is required for a capital call, criteria for making a capital call, and how things will be handled if a partner cant or wont respond to a capital call. Input from outside lenders o Discussion on leverage. Debt in essence levers up the return on equity. It almost always increases the investors return but it also increases the investments risk. o If the bank forces a partner to sign a guarantee on a loan, the partner might not care because the bank could come after the partner anyway under joint and several liability. However, it would be easier if the partner signed the loan agreement. Additional Owners o UPA 18 / 33-41-510(7) adding a new partner requires consent of all partners unless the agreement specifies otherwise. If the partnership agreement requires the consent of all existing partners and they want to amend the partnership agreement to provide that admission can be approved by a majority, the question is whether amending the agreement is in the ordinary course of business. Problem page 104 Default rule says they all must agree, so they will need to change the agreement to add this which is why they come to you Answer depends on whether amending is in the ordinary course of the business if so then a majority vote will do if not, it must be unanimous Problem 2) o 390 partner IS liable for existing partnership obligations that arose before you joined except for liability that is to be satisfied only out of partnership property o Privity of estate says he will only be liable for property obligations from the time he enters to the time he leaves New partners are not liable for preexisting liabilities. Liable for the time period in which he enters to the time he leaves. Earnings from Business Operations o Must consider if the partnership can earn a higher return than the partners can individually o They should be distributed unless the partnership has some lucrative use for the funds o Problem 106 2 partners want to invest. 1 wants to use profits to pay school loans Majority vote rules because paying profits out is in the course of ordinary business (only need 51%) o How do owners make money? Salary o The assumption is that partners make money through distributions o UPA 18 / 33-41-510 allows salary if the partners put it in the agreement o Problems: o 1. Agee and Propp who work at the partnership can receive a salary while Capel does not (he doesnt work there) o 2. Capel can prevent Agee and Propp from increasing their salaries if the salaries are in the partnership agreement (cant change without the consent of all partners); if it is not in the partnership agreement, they could change it by a majority vote because it is an ordinary matter o 3. Capel cant compel the partnership to employ him and pay him a salary

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4. The partnership can pay Capel a salary even though he doesnt do any work for the partnership. They have discretion. The creditors care and the IRS cares (because this could be income shifting to get from a high bracket to a low bracket) Profits o Generally, profit distribution is specified in the p-ship agreement o UPA 18 / 33-41-510(1) provides default rule: each partner shares in profit and losses equally unless agreed otherwise; doesnt matter who put in what; when partnership ends partners would be repaid contributions before profit divided o Problems o 1. Default distribution is equal to all- they should put it in the partnership agreement what % they get. Dont get confused about liability to partners- that only comes up when the partnership ends. Aside: you do not have to make a capital contribution to be a partner o 3. Majority vote would rule for an ordinary matter regarding profits Sale of interest to 3rd party doesnt cause dissolution by default o Remember that the selling partner will have to find someone, get the other partners approval, and work out an agreement about his prior obligations, which the new partner does not inherit by statute o Also he can only transfer his right to share profits and losses and receive distributions so not control o UPA 26/33-41-730 a partners interest in the partnership is equal to his share of profits and surplus, and his personal property. o UPA 26/33-41-740 Effect of assignment of partners interest in partnership and this is assignable. (Does not by itself trigger dissolution) Doesnt give the assignee any mgmt or administrative rights in the partnership, only entitles them to receive in accordance with his contract the profits to which the assigning partner would otherwise be entitled. Selling financial rights doesnt necessarily end your participation in the partnership unless you quit. o UPA 18(g)/33-41-510(7) :by default, adding a partner requires consent of all partners So the sale of transferable interest to a third party does not automatically make that person a partner unless theyre voted in o Problems o 1) 740 says no- when you sell your interest, you only sell rights to distributions and liabilities this does not necessarily give a right to make decisions This is different than being a partner under 510 which requires a unanimous decision If you sell your interest you are really selling your financial rights this doesnt mean that you are no longer a partner. You have to quit to no longer be a partner o 2) not automatically unless he is voted in; o 3) Partners Share of Profits these are computed at the partnership level, so the partnership will determine how much the business made and then allocate on its books what everyones share is Right to receive distributions is the actual physical paying out of your % of the profits Sale of interest back to the partnership o Buy-Sell agreements the partners can agree to buy an individual partners interest from him. Easier to sell to the partnership then to an outsider = buy-sell agreements allow the partnership to do this Need to include Whether the partnership is obligated or has an option to buy What events trigger that option How is the selling partners interest to be valued What is the method of funding the payment Absent such an agreement, the partnership is still compelled to buy the partnership interest if the partner withdraws but how much he gets is up to the agreement and statutes Tells you what happens when someone dies or quits Normally you provide that you can buy out the dissociated partners share o

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Withdrawal / Dissolution Compelling the partnership to buy your interest, which leads to dissolution of the partnership. o Dissolution of the Partnership UPA 29 / 33-41-910 Dissolution Defined: a change in the relationship among the partners when any partner terminates his association with the partnership. UPA 30 / 33-41-920 The partnership is not automatically terminated upon dissolution, but continues until winding up of affairs is completed UPA 31 / 33-41-930 Causes of dissolution o Without violating the agreement Term Expiration - If the agreement specified a term and that term expired A partner expresses that he wants to dissolve if there is no express term or particular undertaking specified in the agreement. Express will of all the partners who havent assigned their interests or suffered them to be charged with their debts By expulsion of a partner in accordance with a power to expel conferred in the agreement o You can have a dissolution in violation of the agreement if a partner quits in a way that isnt provided for in agreement. This is wrongful and you have breached your K obligations. o If an event occurs that makes it illegal to carry on the business of the p-ship or for the partners to be associated with the p-ship o Death of a partner o Bankruptcy of a partner or the partnership o If the court says so in accordance with UPA 32 UPA 32 / 33-41-940 Dissolution by Decree of the Court UPA 38(1) &(2) How to handle dissolution situations o 38(1)/ 33-41-1030 When dissolution not in violation of partnership agreement Each partner can have partnership property credited against his liabilities and can have the net amount owed to him paid in cash. (unless otherwise specified in the partnership agreement) If the dissolution was b/c of an expulsion, and the expelled partner is discharged of all of his liabilities under 33-41-1010, then the expelled partner gets his net amount owed in cash. o Note that this can all be modified in the agreement 38(2)/ 33-41-1040 - Dissolution in Contravention of the Partnership Agreement -When a partner wrongfully dissolves o The partners who didnt cause the dissolution get all the rights under paragraph 38(1) -33-41-1030 (can get cashed out if his liabilities are paid off) and the right to damages for breach against the dissolving partner May continue the pship under the same name if they pay off the dissolving partner less damages for breach o The partner who caused the dissolution Gets his payout minus damages Does not get his share of the value of the good will of the business if the p-ship is continued o Note that this can all be modified in the agreement Dissolution is the beginning of the end and Termination is the end RUPA says any partner has the power to dissociate at anytime but there could still be legal issues Unless the agreement says otherwise- a partner in a partnership at will (one with neither a specified end date nor a specific undertaking to complete) can quit at any time without it being wrongful Problems 112 o 1) yes he can withdraw but it will be wrongful 930(2). When will he be paid - 1040 he is liable for damages (but not sure how to compute that) if they continue under the same name you pay him off do not consider value of good will in computing the assets so youre getting a discounted amount Creel v. Lilly (MD) o

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Facts: Creel started a NASCAR store and eventually entered into a partnership to expand. Creel died, and the partnership wound up and accounted and paid the estate Creels share. The wife was not satisfied with the accounting, and wanted the pship assets liquidated, presumably b/c they were selling memorabilia that was worth much more than its book value. The court states that the UPA entitles the wife to automatic liquidation unless specified otherwise in agreement. However, the court looked at the termination section of the p-ship agreement and decided that the partners intended this section to take the place of automatic dissolution under UPA and that the agreement doesnt mention forced liquidation. Section title Termination but really covers dissolution and winding up It says the assets and liabilities be ascertained but this does not mean by liquidation The followed the winding up method- full inventory, accounting and the deceased share of the remaining profit was distributed to him this is all the surviving members need do Document need not account for every continuation as long as intent is shown Burcky says the court is reaching here because the document isnt that great Court says agreement has a continuation clause in the form of a buy-out option by providing that the deceased partners share of the partnership goes to his estate If the estate wishes to sell that share, it must first be offered to the partnership Rule: If the partnership agreement provides for otherwise other than liquidation upon an event causing dissolution, such as the death of a partner, then the intent of the partners in the agreement will prevail. The Courts comment about the UPA rule requiring automatic dissolution of the partnership upon the death of a partner is wrong because when a person dies there is automatically a dissolution. The court said that if the agreement clearly states the intent of the partners, then that intent controls even though it didnt provide for every possible contingency, and in this case, the intent was clear that they didnt intend for liquidation b/c of the automatic dissolution absent consent from estate or provision in partnership agreement, many jurisdictions switched to RUPA UPA aggregate theory one dies, it ceases to exist o SC follows this o But court gets language wrong agreement cant prevent dissolution- it should say termination RUPA entity allows continuation, BUT remaining partners must elect to buy out the dissociating partner o UPA requires buy-out provisions to be in the agreement, but RUPA does not but they must actively choose to buy out Under RUPA the estate cannot compel liquidation Of course the partnership agreement can trump both Rule: Liquidation Value of a business: There is also a dispute between Book Value (Cost of the Goods in the Store) vs. Market Value (that would include Goodwill). Ct says this is ok b/c the Business in its infancy stages probably doesnt contain goodwill and Book Value is ok. Should make clear in the agreement which measure of value you will use. The court noted that RUPA doesnt have a forced liquidation, but Burkhard said that is wrong under UPA 33-41-1030 (below) Court is wrong to say that UPA wouldnt require termination if the agreement doesnt provide otherwise 33-41-1030 would require liquidation to pay off the debts and pay out the assets Comparing to SC LLC provisions: Our LLC provision 33-44-601 follows the RUPA description in the Creel case. The withdrawal of a member from an LLC is not an event of dissolution. When a member leaves an LLC, they have dissociated. It means something slightly different in the context of the LLC than it does in the partnership context. 33-41-602(b) points out what would be wrongful dissociation. 33-41603 explains the effect of an LLC members dissociation. Almost all of these provisions can be changed by an operating agreement. Key Points

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LLC is deemed like a corporation to be an entity (not aggregate) so if someone leaves, the entity is still there and the LLC can continue Withdrawal of member is NOT a dissolution, they have instead dissociated o When the LLC statute does use dissolution, it means that the is going to go into termination and liquidation 601 gives a laundry list of items of causes of dissociation o 1 is important it occurs when the company has notice of the members express will to withdrawal on the date given o 7 talks about when someone gets in financial trouble o Death, appointment of guardian, or judicial decision saying he is incompetent 602 o There are rightful and wrongful events of dissociation Wrongful methods result in consequences Withdrawal against agreement provision Bankruptcy o 602(a) has some ambiguity- says you can leave unless the agreement otherwise provided Not sure how this operates 603 withdrawal of member o What happens depends on whether you are an at-will LLC or a term LLC At-will means the other members will simply buy you out Term the members do not buy you out, you take the status of an assignee kind of like creditor you continue to receive your share of the profits (but they will vote to change these once your gone) When the term is over, you get your capital all of these default provisions can be changed by provision in an agreement if you cant agree on how much to pay someone who leaves an LLC, the court can decided for you 704 801 Events causing dissolution and winding up of corporations The must be wound up on occurrence of stated events 806 Tells you who gets what when you go out of business Problems page 123 6.a is he liable for the property lease o YES - 33-41-1010 dissolution does not discharge the existing liability of any partner 6.b is he liable for tort claim that arises after he leaves o Partnership doesnt end at dissolution so during windup phase, it is still a partnership, and he would still be part of the partnership, so if the tort happens during the winding up stage, there is a strong likelihood that the withdrawing partner is still liable 6.c liable to long time TP supplier for orders made after he leaves o 1011, 960, 970 o 970 is key after dissolution a partner can bind the partnership by any act for winding up and by any transaction that would bind the partnership if dissolution had not taken place . . . o Yes, he can be liable for K claims if windup is still going on merely because you leave the partnership does not get you off the hook for something that happens after you quit o Also read 980 Page 124 When one partner leaves, the other partners can continue to operate the partnership if the leaving partner allows it (?) After one partner leaves the other partners cannot continue after windup - 1030 right to liquidate What if withdrawing partner wants the partnership to terminate but the other partners dont they still have to liquidate under 1030

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If partner dies and widow wants the partnership to terminate, they have to liquidate under 1030 But if the withdrawing partner gives consent to the others to continue, then they may and the withdrawing partner becomes something like a silent partner (?) What if its a term partnership and one tries to leave before its over o 1040 says that the others can continue the partnership Page 125 Are the debts owed to a partner that he lent to the partnership treated differently than outside creditors o Yes - 1060(2) gives order outside creditors collect first If the partnership has no assets, outside creditors can collect directly from the partners o But from inside creditors issues of indemnification come up we wont look at this Page 127 (1)Yes they need to agree to partnership accounts because the beginning capital account for Capel is 250K, Propps is 150K , Agee 2,000 so their capital accounts are different (2)We also need to know how much money the partnership earned during the time the P was in business o 510 and 1060 say that each partner gets the remaining capital accounts at termination but these accounts will be reduced by what is distributed to them o C = 250 -150 = 100 o P 150-142= 8 o A 2-0 = 2 o So we owe the partners a total of 110 so deduct 110 from 200K (the remaining money) = 90K we then distribute 1/3 to each partner Problem 3 o Says only 20k is left over, so we dont have enough to cover the remainder of their capital account o So 20k 110K = -90k loss o Statute says the partners share the loss equally absent provision o So each suffers a 30K loss C is owed 70K P has to put back in 22k (8-30) A has to put back in 28 (2-30) o So 22 + 28 + 20 (money left over) = 70K Liability of Dissociating Partners o When a partner withdraws under RUPA, the partnership can either o Purchase his interest and continue the partnership o Dissolve, liquidate, and terminate o Under RUPA, dissolution isnt the end, but it means the scope of the partnership contracts to completing work in process and taking other such actions necessary to wind up the business o Winding up the business entails o Selling its assets o Paying its debts o Distributing the net balance, if any, to the partners according to their interests o When the winding up process is completed, the business terminates o RUPA rules for distributions to partners according to their interests o Unless partners agree to the contrary They share responsibility not only for the losses from operation of the partnership business but also for partners losses from investments in the partnership SEE page 126 o If the Partnership Agreement is Silent, UPA indicates 3 Ways that you can handle Dissolution o Liquidation - Sell the Partnership- the Accountant comes in and values the partnership and after bills are paid the partners divide up the remaining value. Problems - During the wind-up which can take a long time, the withdrawn partner is still entitled to his or her own share of the profits, then during liquidation the withdrawing partner or his estate gets his or her share of the value. One of the problems with the long wind-up is the estate or withdrawing partner may be subject to creditors claims. o o

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Ct will conclude that what happened in the post dissolution behavior is that the business has gone into a wind-up mode. The wind up can take a short time or a long time 33-41 -1030 Application of property upon dissolution not in contravention of agreement: at the end of the wind-up mode we liquidate the business Buy-Out Business Continuation all of the remaining partners get together and buy out the other ones share. one of the remaining partners buys-out the withdrawing partners share Problem - During the Business Continuation period the value is calculated at the day the partner dies so if they settle up 5 years later, the value of the partners capital is what it would have been the day he or she left. 33-41-1070 - Liability of Persons Continuing Business in Certain Cases (Business Continuation) The liability of the dissolved partnership attaches to the continuing business (7) the liability to a 3rd person becoming a partner in a partnership to creditors of the dissolved partnership can only be satisfied out of the partnership property. (8) creditors to the deceased partners interest in the partnership have a priority over other creditors of his estate (10) use of the deceased partners name does not make his individual property liable for any debts contracted by him or his partnership Death - In the event the dissolution is caused by death or incompetency, and the partnership agreement is silent as to what to do, the deceased estate can make 3 arguments and the court then decides what to do: Business Has Continued 33-41-1080 Rights of Retiring Partners or estate of deceased partner when business is continued. (Death of a Partner) o Deceased partner is entitled to the value of his interest at the date of dissolution with interest (Liquidation will be valued then) o or in lieu of interest the profits attributable to the use of his right in the property of the dissolved partnership. Liquidation Partnership will be valued at the time of death. Often problems arise with valuation/goodwill Estate is a New Partner One way to do this is to - Convert this partnership interest to a limited partnership interest. Usually the deceased partner will agree to this prior to death UPA 36 33-41-1010: Effect of Dissolution on Existing Liability of a Partner A withdrawal doesnt change the liability of the partner that existed before his withdrawal. He can agree with the creditor and the remaining partners to have his obligations assumed by the partnership this agreement can be inferred from a course of dealing between the partnership and the creditor If someone assumes the liability, the partner will be discharged from the liability if the creditor knows of and agrees to the new deal Tort Liability: Not clear whether a dissociating partner is liable for torts that accrue after dissolution. Apparently, he probably will be liable for anything that accrues before winding up. Statute is silent regarding liability for Tort Claims that occur after a partner withdraws. If this is an event that occurs during the wind-up, presumably, the former partner is on the hook. Ex - A lawyer who leaves a law-firm and then his partners subsequently commit malpractice, then the lawyer is liable Liability for Contract Claims UPA 33 / 33-41- 950 Effect of Dissolution on Partners Authority to Act. Dissolution terminates the partners authority to act for the partnership (with the exception as so far is necessary for the winding up affairs).

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UPA 34 33-41-960 Liability of Partner for Acts (BOC) of other partners after dissolution Contract Liability All the partners are still liable for any pre-dissolution contract liability claims caused by another partner, unless that partner knew at the time he created the liability of the dissolution. UPA 35 33-41- 970 - Power of a Partner to bind the p-ship after dissolution After dissolution, a partner can bind the p-ship: o with any act appropriate to winding up the business o with any transaction that would bind the p-ship if dissolution hadnt happened IF the other party had extended credit to the p-ship prior to dissolution and didnt know or have notice of the dissolution OR the other party knew of the partnership and had no notice or knowledge of dissolution, and the dissolution hadnt been advertised in the newspaper in the area where the business took place Liabilities created under (1) are charged against p-ship assets Exception (990): the partnership isnt bound by the act of a partner after dissolution if o dissolution was because it would be unlawful to carry on business unless the act was appropriate for winding up. o the partner has become bankrupt o where the partner has no authority to wind up affairs Winding up of Business Post Dissolution Winding up = selling assets, paying debts, and distributing the surplus to partners according to their interests UPA 40 /33-41-1060 Settling of Accounts between Partners: Rules for Distribution The assets of the Partnership are the partnership property and the contributions of the partners liabilities of the partnership ranks of creditors Settlement of Partnership Accounts Partners are responsible for operation losses and individual partners losses from investments in the p-ship. Track this with partnership account track how much each partner put in and how much each partner took out At Dissolution we must determine what the remaining capital accounts of all 3 partners is to determine what their share of the profits is. On dissolution, if a partner is owed money in account, the partnership has to pay it If some partners owe to the p-ship, they have to pony up and pay what they owe so that losses from investment are shared equally Option #1 - If there is a surplus after paying off all debts, its easy pay off the p-ship accounts and then divide the remainder equally. Ex: Capel puts in $250 (earlier distributions/withdrawal= $150)), Prop puts in $150 (earlier distributions/withdrawal= $142), and Agee puts in $2. So total owed to partnership is $110. If the partnership is worth $200 then all of them get paid off and then they divide the $90,000 equally so they all get $30,000 Option #2- If there isnt enough to pay all the accounts after paying debts: Determine how short the partnership is with respect to the partnership accounts Divide the short amount by the number of partners they divide losses equally Subtract this amount from each partners account and voila! You have the cash out amounts In Class Ex. Same example as above except profit is only $20,000, so $110 is owed, total loss is $90,000. Divide this loss equally and it will be shared equally amongst all partners. Section 510 - So subtract $30,000 from the amount all of these are owed. Capel now is owed $70,000. Prop now owes $22,000 and Agee now owes $28,000. Take the

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amounts they both owe and add the $20,000 the business made and this equals $70,000 which equals the amount owed to Capel Balances. Kovacik v. Reed (CA) o Facts: Kovacik invested $10K in a venture to do kitchen remodeling and told Reed that if he would be the superintendent, they would split profits 50-50. They didnt discuss loss. The venture ended up losing money and Kovacik came to Reed for his share of the loss. o Minority Rule CA Rule: Court stated the general rule that members of a partnership are expected to bear profits and losses equally. However, when one partner contributes money and the other contributes labor, neither party is liable for losses to the other without an express agreement to the contrary (Burkhard says that this is the ONLY case that has come out contrary to the statute so you would try to argue this case but it isnt the law so in SC dont allow your clients to get stuck in this relationship and draft the agreement that ensures your clients dont get stuck in). o Majority Rule - SC rule is that the worker owes the money to the p-ship UNLESS you have trumped the statute put in an express agreement; see 33-41-1060(2) and 510(1) o Law presumes that absent an agreement, partners and joint adventurers intend to share equally in the losses and profits of a common enterprise regardless of how much each contributed to the capital employed in the venture the losses are to be shared in the same proportion as the profits BUT this rule only applies where each party has contributed money, land, tangible property, or services that are to be paid for before profits are computed however the court might be misconstruing these cases- they didnt base their decision on this basis IN cases like this, where one contributes the money against the others skill, then neither is liable to the other for losses That way the each looses his capital one the money, and the other his labor so the doesnt get paid, but he doesnt have to contribute to the money loss Rationale is that the labor rendered is equal to the money spent o This is not a mainstream case and most of the time it would come out the other way Reaches fair result, but Burky doesnt think it follows the statute o 1060 - says who gets what when the P ends (2) the liabilities shall rank in order of payment and subection c says those owing to partners in respect to capital o Then look at 510 Each partner will be repaid his contribution and each partner will contribute toward the losses regardless of what he put in in relation to his share of profits o Reading these statutes together, the should have had to pay o If this same situation happened between members of an LLC, the working partner would not be liable for his half of the losses because the whole point of an LLC is to eliminate personal liability. Expulsion of a Partner Bohatch v. Butler & Binion (TX) o Facts: Partner in a firm reported another partner to the managing partner for overbilling. The firm expelled her by reducing her partnership distribution to zero and eventually voting to expel her. The girl is a brand new partner to the firm. o Rule: Court said that there is no duty that partners have to remain partners, and because the trust and loyalty that must exist between partners cant survive Bohatchs actions, it was ok to expel her. If they expelled a partner in bad faith (for personal gain), they would have breached their fiduciary duty. Partners have a fid duty to one another to deal in honesty, but they have no duty to remain partners at the heart of the partnership concept is the principle that partners may choose with whom they wish to be associated If she stays, how would they get around the tension and how would that effect the client Others say this doesnt make sense, the real reason is that your throwing her out for being stupid/ having bad judgment which you can do. No need to go into these ideas of trust and client tension o Focuses on the at-will nature of a partnership and even more importantly there is a fiduciary relationship and duty to the clients and this duty trumps all of the concern that the girl was not treated fairly (expelled her even though she did what she did in good faith)

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o o o o o o o

Some argued that there should be protection for a whistleblower, or else they would be discrouged from reporting unethical conduct even if they were wrong Court rejects this argument Partners must trust each other, and just like they could expel each other for other disagreements, they can do so for acusing each other Court says that partners cant expel each other for self gain- ironic because thats always why they are expelled So trust issue trumps here SC Rule: UPA does not give an automatic right to fire partners; reasons for expelling a partner have to be set out in the partnership agreement. When you read the dissent you get an entirely different approach than when you read the majority. Issue: Can you expel someone b/c her actions are unprofitable to the partnership (question 1.2 p. 137) Ct of Appeals - says you cant throw someone out for self-gain purposes, but this Court disagrees with them and suggests that anytime you throw someone out it is for self-gain When they threw her out, she had a right to be paid her share of the value of the partnership unless it was trumped by the partnership agreement. Freeze-out of a Partner Def of a Freeze Out: when a majority owner (superior financial position) acts to force a minority owner to sell their interest Page v. Page (CA) Facts: 2 brothers each chipped in equal amounts to start a laundry business. It lost money for a few years and the plaintiffs corporation made a big loan to the business. Then things started looking up, and the plaintiff attempted to terminate the partnership. One brother argued that it was a term partnership and that his brother was obligated to stay until he could pay-off all the notes. The other brother argues that it is a partnership at will and he can quit whenever he wants. Rule: If the partnership agreement does not contain an express term then the partnership can be terminated at will by either partner at any time. However, a termination that results in one partner freezing out the other and putting the business to his own use breaches the duty of good faith and is not permitted. Court found that this was a partnership with no term or purpose, so under UPA can be terminated by either partner at either time; however the termination was in bad faith and so the result is that the little guy gets to stay on as a partner Rule: a partner is not bound to remain in a partnership regardless of whether the business is profitable or unprofitable. A partner may not, however, by use of adverse pressure freeze out a co-partner for his share of the prospective business opportunity (two opposite sentences). In this regard his fiduciary duties are at least as great as those of a shareholder of a corporation. Court says that in this case, the P has the power to dissolve the partnership by express notice to the D. If, however, it is proved that the P acted in bad faith and violated his fiduciary duties by attempting to appropriate to his own use the new prosperity of the partnership without adequate compensation to his co-partner, the dissolution would be wrongful and the plaintiff would be liable pursuant to 1040. Page Case Rule: Whatever remedy the Court is suggesting, the court suggests that whenever a partner is dissolving he or she can not merely do what is in their bests interests; they have a fiduciary duty to his or her partner very different from Bohatch case SC Rule Toal would probably follow the Page rule. There is much debate about whether or not a dissolving partner in an at-will partnership has a fiduciary duty to his or her partner. SO you can dissolve at anytime, but not if the other partner shows you are doing so in order to take control of the business for yourself. If you do this, then you must adequately compensate the other partner i. Summary of the Different ways a persons partnership interest can end

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1. 2. 3. 4. 5.

Freeze out Expulsion Withdrawal followed by purchase of interest or dissolution Sale to third party of transferable interest Partnership converted into or merged into another corporate structure

CORPORATIONS
o o What is a corporation and how does a business become one?? A corporation is a creation of state legislatures where o It is its own legal entity o The owners usually arent personally liable for the debts of the corporation (the most you can lose is what you paid for the stocks) Most American corporations are very small business, but the economic impact of the few larger corporations is what drives the U.S. economy. Different from a partnership, with a SC or a Corp in any state you MUST file with the Sec of States Office. 4 Sources of Corporate Law: State Statutes Articles of Incorporation Case Law Federal Statutes Federal Securities Statutes Federal Tax Statutes What are the legal problems in starting a business as a corporation Necessary Papers = the articles of incorporation- 33-2-102 is the statute of articles of incorporation and the CL1 A corporation doesnt exist until these are properly executed and filed with the sec of state Once this is done, you issue shares to shareholders, who then elect directors, who will then create bylaws if needed The MBCA suggests that a corporation comes into existence as soon as articles are filed, but also seems to mandate that a corporation adopt bylaws normally statutes dont require this o Bylaws may provide any provision for managing the that is not inconsistent with the articles of incorporation Bylaws o Much more inclusive document than articles o Tells how corporation will be run o Title and description of officers o Procedures for calling meetings for directors and shareholders as well as how they will be run o How the organization will be run legally o Problem is that people dont sit down and go through each article Instead the atty normally downloads a form from the SC form book and then fills in the blanks So its boilerplate As long as everyone is getting along, there is no problem, but if something comes up, there can be trouble o Articles will trump the bylaws if there are any inconstancies but this shouldnt happen Avg atty cost for setting up corporation in SC is 1-2K which encourages many people to form LLC which they can do themselves Preparing the necessary papers o SC 33-2-xxx our incorporation statutes o Articles of incorporation (must be filed with the sec of state for all corps- the corporation doesnt exist until these are filed)

o o o

o o o o o

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SC CL-1 Form 33-2-102 - SC Articles of incorporation: Must have Mandatory!!! o Approved Name that satisfies 33-4-101 Cant use a name that is grammatically similar to one that is already on file with the Sec of State. Name recognition in SC and most states relies on CL principles There is nothing on the form that says you must use that name after commencing business Mere filing of name does not necessarily give you the right to use it o Number of shares and classes of shares that the corp can issue If I check box A, these are common shares If I check box B, you have to rank each class of stock by preference o street address (no PO box) and o name of agent Should it be someone in the company Or should it be the lawyer The signature line is not in the statute and could be waived if you were in a rush o name and address of each incorporator All they do is file the documents No real risk of getting sued for this o attorneys signature (this rule unique to SC) o Must have a signature o Must file the CL1 at the same time Some things on the form are not included in the statute or the articles, so for instance number 3 nature of the business- if you change it, you wont get in trouble Always say not yet commenced when asked for date the business started because you never start the business before articles are filed Issued shares zero because you do not issue shares until after the articles are filed Form is important because Goes to department of revenue It appears on every corporations tax return filed with dept of revenue in SC, so it is prepared every year and it is public information that a could get for a law suit May have - Discretionary!!! o names of the initial directors o provisions not inconsistent with law regarding purpose management and regulation defining, limiting, and regulating powers of corp, directors, and shareholders par value for shares imposition of personal liability on shareholders o anything that is permitted in the bylaws

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o o

What are the differences between Articles of Inc & bylaws: How do you decide what goes into each? Articles control the bylaws should not be inconsistent. The bylaws are a much more comprehensive document. The lawyer will tell the client that they need to have bylaws and will pull a set of boiler plate bylaws and stick them in the record book. No one thinks about it for 2 seconds. Thats wrong but its the reality. o Bylaws SC 33-2-106 You shall adopt bylaws The bylaws can contain any provisions for running the business that are not inconsistent with the law or the articles of incorporation. Articles of incorporation always trump bylaws Under the default corporate code, directors can change bylaws while the shareholders must vote on any amendments to the articles. Contracting Prior to Incorporation Promoter = someone who acts on behalf of the corporation before formation Sometimes you need to jump on a contract (e.g. a lease contract for retail space) before incorporating. Typically this is done through a promoter Promoter liability: 33-2-104 (Liability for Pre-incorporation Transactions) o Every state has a section similar to 104, but the language differs (the presumption of liability differs SCs is reasonably friendly to the promoter). o Anyone acting on behalf of the corporation before filing articles is jointly and severally liable. o Exception: If the person was acting under a good faith belief that the articles had been filed, no liability under this section (important defense) If the promoter enters into a contract, the corporation will not be liable when the articles are first filed o The corporation wasnt around when the K was entered into it must take some action to adopt the K Secret Profit Rule o Not a real issue in practice Promoters arent the bad guys, but the book is pointing out that once you agree to do this, you have to treat the investors fairly = fid duty o After incorporation, if the promoter sells property to the corporation, he must disclose any profit that he is making, if he doesnt, the corporation can seek to recover his secret profit o Arises out of fid duty to corporation o But there is no fid duty for pre-incorporation actions because the corporation is not yet in existence o Determining Profit For property acquired before he was acting as promoter, you look at the price the corporation paid minus the fair market value of the land, so you dont just look at what the promoter paid For property acquired while acting as promoter, you look at the amount the corporation paid minus the amount the promoter paid fair market value is irrelevant o If he discloses the profit, he gets to keep it Promoter liability: RSA o RSA 320 if the principal is disclosed, the promoter isnt liable o The promoter does owe a fiduciary duty to the company. o RSA 330 - However, if you misrepresent that you have authority to bind someone that you dont actually have, then you are personally liable for the loss caused by the misrepresentation Rule: Generally, the corporation has to adopt the actions of the promoter after incorporation in order to release him from liability and take it upon itself. o

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Best advice to a forming company is not to do anything until the articles are filed Problems page 155 o 1.1 - yes Under agency principle he has made a misrepresentation because there is no Bubbas Burritos yet so he cant say he is acting for it SC 33-2-104 says he will be jointly and severally liable when there is no corp yet One caveat if the promoter in good faith believes the articles have been filed, then he is not liable 1.2- same answer 1.3 there is a legal theory L&L can sue Agee on is the legal theory of acting as an apparent agent; or could argue they were jointly and severally liable under partnership law if arguing under 33-2-104 Agee could argue he was not purporting to act as or on behalf of a corporation- could interpret the language to say that he silent partner is off the hook; although split, some cases say only active partners may be liable o would argue under partnership principles that the three had a joint venture to start a corporation and so they are jointly and severally liable Caveat to 104 may come in if they all thought the articles had been filed Another defense is that we have no evidence that the other two are acting as or on behalf of the corporation, so they wouldnt be liable 2 Corp not liable unless it does something that directly adopts the action preincorporation usually done by the BOD ratification by implication is not enough Attorneys get burned here because simply agreeing to form the corporation does make it liable for your legal fees 3 Yes, Can still enforce the lease against Propp (promoter) individually; even if the corporation is on the hook, the promoter is still on the hook as well Until the corporation is formed, the people that are out there trying to put the corporation together owe NO fiduciary duty to their clients. Issuing Stock Shares of stock = the units of ownership in a corporation 33-6-103(a) A corporation can issue as many shares of stock as are authorized in the articles of incorporation. 33-6-102(b)(2)(iv) a corp can have par value stock in SC they can determine their own par value what are the implications of this? Says you may have par value, so you dont have to Accounts are going to want you to have par value 1220 is a tax statute that says that tax returns is based on a formula that basically results in the par value, but you dont have to have it, so make the accountant figure it out 12-20-50 - Tax statutes the license tax of a SC corporation is to be computed paid on the stated capital and capital surplus (the terms still exist in the tax statutes, however they are not defined) o The Accountants will insist that they have par value so they can determine the proper taxes on the company. When a company is formed and they become shareholders it is the company that is issuing stock. The articles will determine the # of shares and the types of shares that will become issues. o This is a big issue when setting it up how many shares should the corporation say it is authorized to issue then it initially does If you represent the minority share holder, you dont want many more authorized than are issued, bc you may lose what control you initially had A corporation does not have to issue all of its authorized shares

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o shares. o Outstanding shares consist of issued shares that the corporation has not reacquired (the corporation can buy stock back from shareholders, and those shares that have been issued and not reacquired are outstanding) o Common stock has two characteristics: unlimited voting rights and common stock gets the residual value of the corp when the corp goes out of business In SC, every company must have stock that has the two features of common stock. o Preferred stock is treated more favorably in one of the following areas than the other class of stock: dividend rights (ex. first guarantee on dividends or noncumulative right to get a certain amount per year), liquidation rights (typically you would see a fixed liquidation value), or redemption rights; preferred stock holders usually cant vote or have limited voting power Stock that gets special treatment such as being paid out first Normally pertains to Dividend rights such as being paid 3 times the amount of common stock more commonly it would be a set amount that must be paid out first if the corporation is liquidated. So you might get less, but you get first dibs incase there isnt enough o Looking at sample on 160 Here, it gets paid out before any common stock is but this is unusual normally they are paid out at the same time with the exception of liquidation Liquidation is also different because normally there is a fixed value, but here there is only a fixed minimum, so they get value equal to common stock Most preferred stock have provisions that can force the corporation to buy it out here there is a provision that says they can call a vote to make them do so Liquidation rights Redemption rights Family Business often use preferred stock You trust your kids and you want to get them money by having mandatory payouts and such o Par value = the minimum issuance price a corp can receive for a share of stock. Par value is just a minimum issuance price, not a fixed price. Many states dont require a par value. Also remember that par value doesnt apply to shareholders, only issuance form the company This is a concern in SC Some states require you to state whether common and preferred stock have a par valuewhich is set out in the articles Def- the minimum price for which a corporation can issue its shares Cant issue for less, but you can for more Also, this doesnt effect how much the holder could later sell that share for on the stock market States that require par value also require two separate funds Stated capital

When a corporation sells its own stock, it is an issuance A corp doesnt have to issue all the shares authorized by the articles Can have various classes of stock each of which comes with different rights Issuance terminology The shares that the corporation actually does issue are called issued

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Includes the aggregate par value of all issued shares of par value stock Ex 50 shares at 1K each = 50K stated capital fund o Cannot be distributed to shareholders supposed to serve as cushion for creditors Capital Surplus o When shares are issued in excess of par , the excess goes to the Capital surplus o This money can be distributed back out as dividends Market Capitalization total intake form stock sale = Stated Captial + Captial Surplus o Stated Capital = par value * number of shares sold $ went into this in theory could never be paid out by the shareholders and the $ that went into capital surplus you had to jump through a million hoops The purpose of this complex system is to protect the creditors many states have abolished this entire system. o Capital Surplus = price per share over par value * number of shares sold (premium over par value that the shares were sold for) o Market Capitalization: Total intake from stock sale = stated capital + Capital Surplus o If you sell stocks for less than the par value, each of the shares is worth less. The shares of people who already own them would decrease in value. 33-6-210: Issuance of shares o Power to issue generally reserved for directors, but can be given to shareholders through articles. o Shares can be issued in exchanged for any tangible (like land) or intangible benefit to the corporation. Rule: The board must decide if consideration received for shares is adequate, but they cant issue below par value. So consideration can be in many forms as long as the board considers it adequate. Any benefit could be a release from a claim. o If you issue for a promissory note or a promise of future services, the shares go into escrow until the note is paid or the services performed. If the note is never paid, the corporation can reclaim the shares and distributions. Exception: if the corporation is subject to the 1934 Exchange Act, the shares dont have to go into escrow when issued for future services if the plan has been approved by the shareholders. o You may run into setting up the issuance of preferred shares in the setting up of a small business in SC o

Problems 162 o 2) corporation cannot issue stock for less than par value o 3)corporation can sell it for more than the par value the excess goes into the capital surplus (today if there is a par value, most corporation make a tenth of cent so it isnt much) o 4) 6,000 because the stated capital is par value times amount of shared sold o 5) yes she can do it b/c par value only controls issuance price, not sales between shareholders o She would do this if the company is going down in value o 6) yes o 7) no, she doesnt care what the par value is or whether is one. It has no relation to the actual value of the stock o 8) Yes, if more stock is sold, your voting power will decrease o Also the price at which the additional stock is sold may effect the value of the corp and the shares Capel owns Say Capel and Propp both bought 100 shares @ $100 each

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o o

Later Agee says she will buy 100 shares @ $90 (remember, this must be adequate compensation which we assume it is here) What impact will the issuance to Agee have on Capel It lowers the value per share o Before 100 a share o Now its 96 a share, (29000/ 300)- figure these numbers out so Capel is hurt (if she pays more, then Agee will be hurt because here shares will be devalued) But if Agee is putting in property rather than cash, then we dont exactly know what the value is so this could be how this situation comes up Choosing the state of incorporation In SC the rule is you should always incorporate in SC unless you have a very good business reason. The laws of the state of incorporation become the default rules that govern the internal affairs of the corporation. You can incorporate in any state, even if you have no business there. Usually you incorporate either in the state youre doing business or DE Almost all the fortune 500 companies are incorporated in Delaware commerce clause instead the business must be intra state Reasons to incorporate in DE: o Delaware corporate law is the most sophisticated corporate law in the country o Highly developed; most questions will already be answered by caselaw o Secretary of State office is efficient o Protecting Management the law of DE is geared to protect mgmt not shareholders. Mgmt controls where the Co will be formed they have the power to move it to DE. Key Decisions always favor Mgmt. Reasons not to incorporate in DE o Higher legal fees If there is a squabble jurisdiction is in DE and your folks are not going to be happy going up to DE to resolve a conflict. o Double Tax - Corporation will be subject to taxes in DE and in the state of operation o You will have to file as a foreign corp in SC and be treated as a foreign company Foreign Corporations Obtain authorization from state agency Appoint a registered agent in the state File annual statements Pay fees and franchise taxes But you only have to do this if you are transacting business in the state o Most statues list what does not qualify as transacting business, but dont define what is Interstate business will not make you register as a foreign company because of interstate Ethical issue: If a SC corp wants you to incorporate them in DE, it is questionable whether you can even do this since you are not licensed in DE. Why do you want to invest in Cos as a shareholder? Want to make $ You have no personal liability as a shareholder Who is liable to the corporations creditors When will a shareholder be liable? See 649 S.E.2d 135- read this case before you take the bar exam, 344 S.E.2d 869 TP can sue corporation but not the shareholders

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Exceptions o Contractual if the TP makes the shareholder personally guarantee the payment TP lenders use this when they loan to corporation with limited assets o Judicial Cases will show below Piercing the corporate veil Dewitt v. Flemming Fruit Company (SC Case) lead case o Facts: Contract claim. Corp was formed with $5000 in capital; $2000 was immediately drawn out by shareholder. Flemming was the 90% owner of a fruit distribution company, and he had contracted with Dewitt to ship fruit around. The principle shareholder orally promised that he would personally pay if the corporation did not but this is not enforceable because of SOF The company couldnt pay, and so Dewitt sued to pierce the corporate veil and hold Flemming personally responsible There is no longer any requirement that you have to capitalize your corporation with any specific amount of money (there used to be a requirement like this). Issue: When is it ok to pierce the corporate veil and hold a S/H personally liable for the actions of the corporation? Says separate entity is just a theory and wont be recognized if doing so would extend the principle of incorporation beyond its legitimate purposes and produce injustices or inequitable consequences But piercing will be done reluctantly and cautiously Requires case by case analysis Holding: Court said that veil piercing was to be done on a case by case basis, and that a number of factors are to be considered: Rule: Factors to Consider in order to Pierce the Corporate Veil: o Fraud is NOT a requisite to pierce the veil o Substantial ownership by a single person combined with additional factors: Inadequate capital on hand Burkhard thinks that the most important one is undercapitalization, Arguably, this business was not undercapitalized b/c all he needed to run the business was a telephone, he had no overhead as a middle man. Elders suggests that inability to pay debts and high risk business are determinative for undercapitalization. Failure to observe corporate formalities Siphoning funds by dominant shareholder Insolvency Non-functioning of other officers or directors Absence of corporate records Non-payment of dividends Burkie says this is scary. The fact that the corporation is a faade for the operation of the dominant shareholder Fairness Consideration: Finally, the court will look to see if it would be fundamentally unfair or lead to injustice for it not to pierce o Alter Ego o Court looks at reality and not form of how the corporation operated and the shareholders relationship to that operation o One big thing looked at is the lack of capital in comparison to the undertaking The obligation to provide capital begins with incorporation and continues afterwards So how much do you tell him to put into it to assure that it isnt undercapitalized

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You have to look at what its doing- when the company started, all he had to cover was the phone so 5k would have been enough But you must adapt as things change, so once you had trucks involved, you needed more In this case, they didnt have shareholder meetings no formalities, Flemming tended to take money out of the corp as soon as it went in (undercapitalized) siphoning of funds by dominant S/H Also, it would be unfair to allow Flemming to make a bunch of money at Dewitts expense just by hiding behind the corporate veil. Fact always mentioned when this case is cited but then they say it wasnt important: oral guarantee to pay o Here it was closely held, there were no formalities such as records, owned 90% of the stock, and he, his wife, and atty were the incorporators o It was personally operated no other stockholder ever received a salary or dividend or exercised control o He withdrew what he wanted company operated for his good, not the stockholders o There was little capital for what he tried to do, and it appears that the corporation always operated on s capital So if the veil is not pierced, then gets the protections of the corporation without putting in capital and sharing the risk = unfair o All this combined with his personal assurance is grounds to pierce the veil o Two things also going on here o When Flemming got the check for the fruit, he dispersed money to the farmers so its kinds of like an escrow function of an atty, and we dont want him to escape liability to them o Oral guarantee the court says SOL takes this issue out, but its clear that it factors in Red Flag of Case: Suggests if you dont follow corporate formalities, courts will pierce. o Penalty Factors o If you dont play by the rules, it is less likely that your business will operate correctly. Problems page 176 o 1.1 yes you can have only one shareholder o 1.2 mystery of life o 1.3- capitalization begins with incorporation and continues afterwards (see Elders) so are these cases saying when we hit hard times and your capital drops you have to either go out of business or risk piercing the veil this worries Burcky big time o 1.4-its hard to say whether the was adversely affected by the failure to comply with corporate formalities. Some think you should just be penalized if you dont play by the rules o 1.5 yes creditor should be happy dividends arent paid out as long as its not be siphoned off Sturkie v. Sifly (SC) Expands Dewitt Piercing TEST!!!! Facts: Sturkie was hired as a sales agent by Ds company, and they didnt pay him. He went out and got a judgment for lost wages. However, the company closed before paying the judgment. Defendant had not complied with corporate formalities, and took money out of the corporation to satisfy loans they had made to the corporation. brought suit to pierce corporate veil under 33-11-240 for improper distributions to the s stockholders o Fails o One thing at play here is that the receiver is the instead of the injured party- which may have affected the holding Sifly and Water were sole stockholders in Carolina Furniture o Startup capital of only 5K o corporation was in trouble so S and W got personal loans which they then loaned to the company

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given.

o When the corporation had money, S and W would take from the account to satisfy the loans o No records or meetings corporation lost 265K in 1977, S and W then moved unfinished inventory to a company in NC held by W and Carolina Furniture ceased to exist Ruple won a 39K judgment later that year against Carolina Furniture for wages o is his receiver When a corporation is so controlled as to be the alter ego or mere instrumentality of its stockholder, the corporate form may be disregarded in the interests of justice. Piercing the veil is an equitable remedy In SC, piercing of the corporate veil is a 2 part test. o Factors from Dewitt o An element of injustice or unfairness if the acts of the corp are not regarded as the acts of the individuals. 2 PART FAIRNESS TEST: D had to be aware of Ps claim against corp D acted in a self-serving manner with regard to property of corp and in disregard of the Ps claim o In this case, Sturkie lost because he couldnt prove that the company was aware of the claim against them when they were draining the corporation. Of course, the argument that they were aware was that they had a contract they didnt pay and they transferred the furniture in a self-serving way, but whatever. You would think that would know that they werent paying the guy. But because there was a receiver involved things get skewed Plaintiff also made a claim under SC This provision comes up all the time. o Recover distributions made by respondents to themselves under 33-6-400 33-6-400: improper distribution to shareholders (c) no distribution can be made if (1) it would make the corporation unable to pay debts that come due or (2) if total assets would be less than total liabilities and the company wouldnt be able to satisfy the rights of people who would be higher in the chain of preference to the people who received the distribution if the corporation would be dissolved at the time of the distribution. (d) talks about how you can compute these numbers 33-8-330 talks about who is liable for unlawful distributions. Seems like it is a director. There is a safe harbor; no automatic liability. Only liable if they didnt perform their duties in compliance with a code section that talks about how you go about making decisions. Shareholders who receive the money can also be liable if the shareholder accepted knowing the distribution was made in violation Note that it seems we can skip the unfairness question in tort cases. Perhaps its a Hunting v. Elders (SC) Torts Piercing the Veil Case. Facts: Girl was injured by a drunk driver and sued the bar that got the driver all sloshed. She won, and when the bar couldnt pay she wanted to pierce the veil against the bar owner. She brought suit against Elders as the alter ego of the corporation. Apparently he was missing several important records, siphoned off money for his personal use, and had family members as officers who didnt even know it. EE was incorporated original to sell tires and had two shareholders. Elders then bought the other holder out o He then opened 2 bars on property he owned o Held liquor license in his name o 3 years later he reinstated EE to run the bars Capitalized with only 1,000 for each bar

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First Prong Change In LAW o Statutory Close Corporation Allows corporation to act with less formalities It may operate without board of directors Need not adopt bylaws in certain circumstances Need not have annual meeting unless the shareholders request one

Equipment was leased to EE from other business owned by Elders Later that year, he transferred several shares to his Wife and Niece Wife was VP Niece was Sec/Treasurer But she didnt know she had any shares or was an officer There was a record of these transfers o Money was siphoned for elders personal use Records were not kept for accounting o Evidence that Elders altered his personal tax forms before trial to hide dividend income from investment accounts Elders held while running the o Freeman testified that Elders was running the corporation as a faade and that the bars were grossly undercapitalized for the purpose of running bars and the risk of liability associated with alcohol In this case, there was a bifurcated trial as to liability and as to piercing. Question: when I bring my lawsuit initially, do I have to allege independent liability of the shareholders (I may not even know who they are) or can I wait and once I get my judgment against the corporation then bring an action against Elders alleging a piercing claim? This opinion suggests the second option. From a plaintiffs perspective, the second option is much better. It appears, from a SOL perspective, the clock doesnt start running until I file my piercing claim. It tolls the statute of limitations against the shareholder, and this is a huge advantage because it gives you time. This was a close corporation (with one shareholder) and it didnt have to meet the normal business formalities because it is not a standard corporation (it is a statutory close corporation). It is adopting an S-Corporation status so the factor considering the non-payment of dividends is not as important. 33-18-250 says that the failure of a statutory close corporation to observe the usual corporate formalities is not ground for imposing personal liability on the shareholders. This is an anti-piercing provision. The court says that this anti-piercing provision doesnt always work. The comment to this section says: this section does not prevent a court from piercing the corporate veil of a statutory close corporation if the circumstances should justify imposing personal liability on the shareholders where the corporation not a statutory close corporation. It merely prevents the court from piercing the corporate veil because it is a statutory close corporation. The court couldnt figure out how to apply the Sturkie factors in a close corporation setting, but decides that in many cases, and especially tort cases, undercapitalization is the most important one. Because a bar has lots of risks, it should be more capitalized than other entities, the defendant was undercapitalized and that along with the lack of formalities was enough to pierce. At what point is undercapitalization determined? It begins with incorporation and continues thereafter. The court writes, The essence of the fairness test is simply that an individual businessman cannot be allowed to hide from the normal consequences of carefree entrepreneuring by doing so through a corporate shell. The facts in the opinion dont say that the defendant was aware of the plaintiffs claim against the corporation, as the second prong of the Sturkie test requires. The court also clarifies the awareness test of the unfairness branch of Sturkie: notice of facts which, if pursued with due diligence, would lead to knowledge This is a scary case for small businesses in SC. o

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* purpose of law was to eliminate argument that shareholders can be personally liable for debts and torts of the business because the corporation did not follow the classical model of a corporation- ie that of a large corporation o **- SC statutory change has diminished the importance of several of these factors by allowing statutory close corporation status. Failure to observe corporation formalities Nonfunctioning of other officers Absence of corporation records o Also federal law allowing S corporations has diminished the importance of lack of dividend payment Statutory close corp this is something the court has to think about because its not a normal corporation ie the corporation formality factor doesnt matter. The Fact that it is an S corporation which means the dividend factor isnt important o Changes the required records and duties of officers o says he kept the minimum needed Court said he did have bare minimum, but was missing normal business records Income statements etc. Cash flow sheet May have been some fraud in the election of officer records Lack or records alone wont be enough, but court recognizes that the trial court coupled this with the siphoning on funds to make its decisions o Lack of dividend payments shouldnt have been considered Burcky comments on close corp and S corp o A statutory close corporation has unique features 33-18-250 says failure to observe corporate formalities is not ground for piercing the veil This provides some protection, but it wont save you from piercing if the other factors are met This statute is also in the LLC section and will probably have the same effect Issue of capital o The bars made plenty of money, but nothing shows money was ever put into their capital accounts o Also the inherit risk of alcohol increases how much capital it had o corporation was undercapitalizes according to court defends saying it could always pay its bills, but the risk analysis comes in o This is an important factor, but burcky suggests that it really isnt that big SO o Undercapitalization, siphoning of funds, and evidence that it was a faade go against the o Lack of records and dividend payments dont matter o Crt App Agrees that the 8 factor prong of the test is satisfied in favor of piercing Second Prong 1)knowledge of claim 2) subsequent self serving act and disregard of claim Knowledge prong o Constructive knowledge will do Here knew of the claims and still siphoned off money and comingled funds. Also transferred his own funds to other corporation he held. Also transferred stock to others without consideration and then dissolved the company Problem is that all this occurred before the accident occurred. The test says it has to be subsequent, but the court glosses over it This element is also satisfied so the veil is pierced Court says the essence of the fairness test is simply that an individual businessman cannot be allowed to hide from the normal consequences of carefree entrepreneuring by doing so through a corporate shell this isnt Sturckie, but not sure if it makes a difference

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Parent-Subsidiary Cases o Court is going to shift from Sturkie analysis once you get away from close held corps Notes o Well recognized basis for piercing is to avoid fraud- ie forming a corporation to avoid an obligation or liability you have already assumed- such as not to compete in a certain area o Corporations can also be shareholders o They are often the only shareholder of another corporation, which is known as a subsidiary A subsidiary is a corporation, a majority or all of the outstanding stock of which is owned by another corporation called the parent corporation o A parent corporation is not liable for the contracts, torts, and other obligations of its subsidiary corp unless there is a contractual or judicial exception to the rule In re silicone breast implants (AL)TORTS Peircing the Veil Case Parent/Sub Can you hold the parent liable for the torts of the sub? This different analysis applies when you start shifting from one individual shareholder to a corporate shareholder. Facts: Bristol Meyers Squibb was the sole shareholder and parent corp of MEC, which made and sold breast implants. We know what happened, and the class action tried to pierce the veil and get Bristol. The board of MEC consisted of MECs president and two officers from Bristol. MECs budget had to be approved by Bristol, and Bristol set MECs employment practices. Also, Bristol had its name and logo on the breast implant packages. Plaintiffs made 2 piercing claims: corporate control and direct liability. Relationship bw corporation o MEC has a 3 member board 2 members were Bristol executives The president was not employed by Bristol o One of the Bristol execs on the board couldnt be outvoted by the other two And several MEC presidents didnt recall having a board let alone being members to it o MEC prepared reports for Bristol on the implants. Basically Bristol controlled MEC Bristol also had to approve MECs budget, which consisted of filling out Bristol forms Bristol controlled employee polices o Other subsidiaries of Bristol distributed MECs implants o Bristols name was also included in the packaging o No dividends were paid out to Bristol They had consolidated federal tax returns but separate state tax forms o At time of suit MEC had ceased operation and only has a 57 million demand note towards Bristol and a 2 billion insurance policy suing on corporate control to pierce and also direct liability o The risk of abuse of the corporate structure is greatest when there is only one shareholder but the court recognizes that shareholders must exert some control over the subsidiary Limited liability is rule not exception o Must look to see if MEC is the alter ego of Bristol here have moved for summary judgment this is hard to do in alter ego case because it is so fact specific and jury needs to look at it o Court goes through totality of circumstances A parent corporation is expectedto exert some control over its subsidiary. Limited liability is the rule, not the exception. However, when a corporation is so controlled as to be the alter ego or mere instrumentality of its stockholder, the corporate form may be disregarded in the interests of justice. Court said that there was no need to show fraud in a parent/sub case, and there is definitely no need to show injustice in a tort case. Thus, court again looks at totality of circumstances and a bunch of factors to find corporate control

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Issue: What is the test to pierce the corp veil in a torts case for a claim of corporate control and direct liability? TEST to Pierce the Corp Veil for a Corporate Control Action: Parent/Sub o Common directors between parent and subsidiary o Common business departments o Parent and sub file consolidated tax returns o Parent finances subsidiary o Parent caused incorporation of sub o Sub is undercapitalized o Parent pays salaries and expenses of sub o All of subs business comes from parent o Parent treats subs property as its own o Daily operations of parent and sub are not separate o Sub doesnt observe corporate formalities The facts meet several of these factors o Fraud is not require to pierce Also most jurisdictions that require fraud in K cases, do not require it in tort cases This is becaues a party to a K can ask for further assurances from the parent o Significant is the fact that Bristol put its name on the packaging it would be against equity to allow Bristol to escape liability from those who were induced to believe it vouched for the product This is similar to McDonalds case that the court gets you because you represented yourself to the public So this would prevent summary judgment in favor of even if fraud was required (Restatement Torts 324A - Under a theory of direct liability), the fact that Bristol put its name on the implants was a showing of support for the product subjects Bristol to liability if it failed to exercise reasonable care.

Notes There must be control, not mere contacts for the veil to be pierced Piercing is almost exclusive to close held corps Public corps wont be pierced but they could be reached as a parent of a subsidiary Courts pierce more often to get at an individual than at another corporation Courts have actually pierced more for K claims than tort claims Piercing can also occur in LLC o Courts will pierce the LLC veil by applying the same test that is applied in the corporate situation o Hasnt happened in SC yet, but we will probably follow the other states Other Theories of Liability: o Parent liability under agency concepts (doesnt usually happen) o Agency is consensual, so the parent corp would have to consent to have the subsidiary act on its behalf and the sub would have to consent to act on the Parents behalf o This isnt how businesses work in this situation o Parent liability on a control theory o If the parent corp exerts direct control or operation of something owned by the sub, then it can be directly liable o Personal jurisdiction: sometimes you pierce the veil so that subsidiaries contacts with a state are imputed to the owner o Enterprise liability o Concept that although technically separate, two corps that are commonly-owned and in reality engaged in one enterprise together should be treated as a single legal entity for purposes of liability o Business today has developed so that a large-scale business doesnt have one company but instead has a holding company that owns smaller corps o o o o o o

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This is far from the conception of protecting individuals, instead, this allows a single corp to subdivide and reduce liability by being able to isolate it So the individual corps should be treated as a single enterprise that is liable as one If a plaintiffs theory of enterprise liability is successful, he would treat all the companies as one and the plaintiff would be able to recover from the combined assets of all the companies. See. P. 190-91. Walkovszky v. Carlton (2 cabs in each corporation) See facts they support the Enterprise theory you had , which owned a number of companies that owned 2 cabs and had the bare minimum to keep them running. Idea was to insulate Carlton. The all operated out of the same garage with central dispatch See Kincaid saved in SC Bar Exam folder. Kincaid applied enterprise liability. Family had several corporations One purchased land One advertised One actually built houses on the land There are reasons other than liability for having three companies instead of one sued all three companies for problem with house said you could only sue the company that built the house Crt App applied doctrine of Enterprise liability and said it was the business as a whole, so they could collect from wherever the money was See Mid-South Management also in bar folder: went after them under piercing theory (lost), enterprise theory (the court didnt buy this one), silicone breasts alter ego parent analysis (this test is now recognized in SC) o Reverse piercing Occurs when you are suing an insolvent shareholder of a company with no cash, and you go after his percentage of the assets of the company Generally cant occur because the shareholders claim to the corporate assets is subordinate to any creditors claims, and so the assets cant be taken out of the corp o Deep Rock Theory If a corporate insider has loaned money to a corporation, his claim will always be subordinate to claims of outside creditors o Page 174 statistical piercing analysis In 40% of piercing attempts, court actually pierced Always directed to closely held corps (less than 9 shareholders) Courts pierce more often to get an individual who is a shareholder in a corp (Dewitt) than to get to a corp who is shareholder in another corp (Bristol) Courts are less likely to pierce in tort claims than contract claims Undercapitalization and failure to follow corporate formalities are important, but only show up in a small number of cases Piercing has been used a lot in the environmental cleanup area. The feds love to go after the parent corporation. o Who makes decisions for the corporation? The general notion is that shareholders elect the board of directors, who in turn choose executives, oversee corporate policy, and watch over the executives Keep this statement in the back of your mind: Generally, if a corporation has more than four or five shareholders, most shareholders play virtually no role in making decisions regarding the operation of the business (for most shareholders of corporations with more than four or five shareholders, their only important decision is when to sell shares). In actual practice, the board of directors is the decision-maker for a large, closely-held corporation (although sometimes it is made by the president and rubber stamped by the board). For a small, closely-held company, the primary shareholder/owner will make almost all decisions and ignore the corporate formalities. This is what practically happens. Board members are not agents for a corporation but officers are Directors and Officers

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Powers of Directors o 33-8-101: Unless stated otherwise in the articles or bylaw, all corporate powers must be exercised under the supervision of a board of directors o RSA 14C neither the board nor individual directors are agents for the corp or the shareholders. They are the principal collectively (make the decisions) so not an agent- otherwise agency principles would make the shareholders liable for the actions of the company through the directors o The Directors generally make the big decisions that fall outside of the general operation of the business: mergers, significant policy changes and shifts in business direction o Directors can elect each other to be officers. Powers of Officers o See p. 196-197 for functions the board should and may perform o 33-8-400: the positions of officers in the company are established in the bylaws; an individual may hold more than one office at a time o 33-8-410: the duties of the officers are either set forth in the bylaws or prescribed by the board of directors or an officer authorized by the board to prescribe duties to other officers. o An officer IS an agent of the corporation, and may be able to bind the corporation Note 33-6-250: any stock certificate issued must be signed by two officers who are designated in the bylaws to have this power SO if youre making a loan to a corporation, make sure the person who signs it has authority to do so under the law of Agency. Also make sure the BODs has approved the loan! Ex The 2 things to think about to determine whether the actions of the Officer are valid under the law of Agency? Does the officer have actual authority? Does the officer have apparent authority? (b/c the reasonable law student would presume that the officer would have the legal authority to hire) o Does the officer have implied authority? Problems 198 1) does a VP of a corp have authority to bind the corporation if he offers you a job yes, implied and apparent authority Second probably no, it wouldnt be reasonable to think he had authority to do so; you as a third party probably dont have a right to rely on a title 2) you would want the President to sign the loan not the director or the shareholder, because he is the one that makes these actions. But also get proof that the board has approved the loan McQuade v. Stoneham - (NY Case) o Stoneham was a majority shareholder of the New York Giants. This is a closely held corporation with a limited number of shareholders. McQuade had a minority stake. As part of the transaction in purchasing his minority shares he entered into an agreement with Stoneham that the parties would use their best endeavors to have the same 3 people remain directors and officers AND that contract also fixed the officers salaries there was no durational aspect in the K. Then a new guy came in and Stoneham and McGraw didnt vote and allowed McQuade to be voted out of his position. McQuade sued for breach of contract for not using best efforts to keep him in his position as Treasurer. This was an action for specific performance; he wanted his job back. o McQuade Agreement: there shall be no change in salaries, no change in the amount of capital or the # of shares, no change in the amendment of the bylaws of the corporation or any matters which may in anywise affect , endanger, or interfere

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with the rights of minority stockholders, excepting upon the unanimous and mutual consent of the parties. The agreement said nothing was to be done to affect the rights of minority stockholders without unanimous consent. Also there werent supposed to be any change in the number of shares Later, the added 4 more board members, they were selected by him and he had complete control over them At a meeting in 1928, the and McGraw refrained from voting, the voted for himself to remain as Treasurer, and the 3 new members voted against him and in favor of Bondy, who became treasurer o Thus s didnt keep their agreement to use their best efforts to keep him as treasurer Lower court refused to reinstate him, but did award damages was ousted because of a falling out bw him and . He did nothing wrong, but got pissed bc challenged s control over the treasury. Court also found was protecting the company and minority stockholders argues the agreement was void because as directors, they had to exercise their best judgment to act for the company, and any agreement that compels their vote to keep someone in office is illegal RULE Directors may not by agreements entered into as stockholders abrogate their independent judgment So part X of the agreement is void because it attempts to abrogate authority of the Board to set salaries and give it to the shareholders IX does the same thing, so it is also void VIII is ok because shareholders can combine to elect directors. BUT the part that says they will try and control the composition of the officers- which the shareholders cant do because the directors must make these decisions Also, stockholders couldnt have an agreement to divest the directors of their power to fire an unfaithful employee Nor can stockholders by agreement control the directors exercise of judgment Stockholders can only combine to elect directors But this is limited to election, they cant contract to control them afterwards in their selection of agents o Section VIII is partially valid- stockholders may combine to elect directors, but shareholders cant elect officers o Section IX and X are invalid because the board, not the shareholders, make the decision as to compensation o Issue: Was the contract valid? (the part of the K that appointed the directors themselves was not invalid? o Ds argued that the K was void b/c the directors had a duty to act for the corporation and use their best judgment and that any K that compels a director to vote to keep any particular person in office and at a stated salary is illegal. o NY Rule: Under NY law shareholders of a closely held corporation CAN band together to make agreements to elect directors. However, a contract that places a limitation on the power of a director to manage the business of the corporation is improper and unenforceable as against public policy. S/Hs may not, by agreement among themselves, control the directors in the exercise of the judgment vested in them by virtue of their office to elect officers and fix salaries. Their motives may not be questioned so long as their acts are legal. The bad faith or improper motives of the parties does not change the rule. Directors may not by agreements entered into as S/Hs abrogate their independent judgment . The other directors duty was to the corporation and the S/Hs, not to McQuade as an individual, to be exercised according to their unrestricted

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lawful judgment. They were under no legal obligation to deal righteously with McQuade if it were against public policy. o Thus, the court would not give McQuade back his job as treasurer. (You cant take power from the Directors and put it into the shareholders pocket). o Note: The holding here is only that the contract wasnt specifically enforceable; McQuade could not be reinstated as Treasurer, however McQuade probably had an action for damages for wrongful discharge on breach of contract. o Note: This would be fine as long as it was approved by the directors- it is an employment K Note: NY has since changed its view from McQuade in closely held corps, the shareholders may enter into agreements controlling board decisions This is now the majority view Shareholders Villar v. Kernan (Maine Case) o Villar had 49% and Kernan had 51% of a brick oven pizza business. They had agreed that nobody would receive salary just distributions. After a while, Kernan entered into a consulting contract with the business and started getting $2K a week. Stephan later became a 2% holder taking one % from both Relationships fell apart Stephen became allied with entered into a so-called consulting agreement with the corporation whereby he got automatic payments of 2K a week This was ratified at a shareholders and board meeting at which the was not present s argument that this is outside the statute is wrong because controlling salaries is a direct limitation on the judgment of the Board eventually filed suit for breach of the no salary agreement o Maine Rule: Permits shareholder agreements to limit director and corporate discretion as long as are in writing or in the articles of incorporation, or if an amendment to the articles it must be adopted by a unanimous vote. Maine has a statute that allows such agreements to exist even if they restrict the powers of the directors, relate to a phase of affairs of the corporation such as management transfer management duties to the shareholders However, in addition to being in writing, the agreement must be included in the articles of incorporation and any subsequent shareholders must be made aware of it If these requirements are not met, it can still be enforced if the rights of the TP challenging them are not prejudiced there is no TP here but, the exceptions still not cover the writing requirement so all such agreements must be in writing o Basically what they needed to do in this case was to follow the statute. Has to be in writing claims it isnt covered by this section because it doesnt affect the right of shareholderswrong, it prevents from being hired as a consultant and it effects the distributions of dividends because money that would go to salaries would reduce that available for dividends this is a direct limitation on the board, which is why its covered by the board Therefore this type of agreement is covered by the statute, and because it fails to meet its requirements, it is not enforceable therefore was able to hire himself as consultant and pay himself a salary o Holding: Since this agreement was oral, it was unenforceable. o Most states say that if you meet many of the CL statutory requisites you can have a McQuade like agreement, SC has a specific statute If the shareholders want to control the board can they in SC? C-38 There are 3 types of Corps in SC

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 o o

Regular ones shareholders would have little control these are the big ones 33-8-101 Quasi- statutory close corporation o Unless otherwise provided in the articles or a unanimous agreement of the shareholders which is noted in the articles then you must operate in accordance with the statute- meaning you cant mess with the board o But if you make these changes, then you can o If authority of the board is limited, the articles shall describe who is to pick up these duties Statutory Close Corporation see the Elders case o On page C-105 o 33-18-210 different paper work is filed, and you operate as a partnership almost o Lets you get around all the formalities o If the agreement between these two had been in writing the case would have come out differently b/c the statute clearly states that if it is in writing it is enforceable. o Villar is stuck now. He cant sell his shares b/c there is no market for them. If the business was an at-will partnership, Villar could withdraw from the partnership and dissolution would take place, allowing him to get something from his partnership. The problem is that if this is viewed as a Partnership for a Term he would be viewed as a wrongful dissolver but he may be better off as a wrongful dissolver than being tied in a closed corporation. 2 Options in SC that Give Shareholders Ways to Control the Board: See pages C105-106 for ways to change or do away with board and bylaws Book notes that most people use the term close or closely held corporation to refer to a corporation with relatively few shareholders, the stock of which is not publicly traded, regardless of whether the corportation was incorporated in one of the 18 states with a special statute like SC o 33-8-101 Burkie says this may be the most important section of the corporate code!!!!!!! Shareholders can agree to limit or change the authority of the board, but it must be: unanimous agreement among shareholders AND disclosed in the articles AND on stock certificates Can be added into the AIs as an amendment via 33-10-103 2/3 vote to the amendment. You can put it in the articles and spell it out or you can put it in a contract if the contract is mentioned in the articles (incorporated) Burkhard says this provision allows for a quasi-close corporation!!! Basically makes a McQuade-like agreement possible (similar to a partnership) o 33-10-103 Amendments to the AIs by the BOD and S/H o 30-10-104 (d) shares are entitled to the voting rights granted by this section although the articles of incorporation provide that the shares are non-voting shares o 33-18-xxxx: Statutory Close corporation Second option (instead of the quasi-close corporation) I can operate my corporation almost as if it were a partnership (doing the kind of things they want to do in the McQuade and Villar case) You have to have special articles of incorporation and you have to specify that the corporation is a Statutory Close Corporation. You can set up a business that operates very differently from the standard normal business.

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 o o

SO in SC you can get create a very different type of corporation for your client as long as you abide by the statutory rules. 33-18-200: Shareholders can agree to eliminate or restrict the board 33-18-200(e) might give a way for a shareholder to dissolve the corporation if the right is contained in the articles of incorporation. (Villars could have had an option) One of the hallmark differences between a corporation and a partnership is the ability to dissolve the partnership 33-18-210 - If you are going to eliminate the BOD, you have to do it by amendment in the articles. Also indicates what the corporation should do if operating without a BOD. 33-18-220: You dont need bylaws 33-18-230: You are not required to hold an annual meeting 33-18-330: The articles can allow the shareholders to dissolve the corp at any time People usually refer to a corporation as a close corporation or a closely held corporation when there are few shareholders and the stock is not publicly traded. However, these dont always meet all the requirements to be a statutory close corporation. Problems p. 210 1) shareholder agreement that restricts directors discretion 2) No, it wasnt in the articles of incorporation, so the statute wont save it unless it doesnt effect another shareholders rights- which it does here Shareholder Voting Methods o Shareholders vote to choose the board of directors o Straight Voting A shareholder may vote their total number of shares for each available seat There is a separate election for each seat on the board. Each shareholder gets to cast her number of shares in anyway she desires for each of these separate elections Each share = one vote and because you can cast all your votes in each election, the majority shareholder will decide each one Ex If I have 50 shares and the other shareholder has 20 shares, and there are 3 director positions, I get to vote 50 times for each position and will basically determine who the 3 directors are. Result: if there is a majority shareholder, they will be able to select every director o Cumulative Voting Directors are not elected on a seat by seat basis Rather, each shareholder has votes = number of shares * number of open seats Those total shares can be cast in any way This tends to give minority shareholders a better chance at choosing a director or two. With the same example above, B would put all 60 of his votes on one guy or himself and A will put at least 61 of his votes on 2 people so as to be sure to get at least 2 people. Formula: Number of shares to elect one director: [S/(D + 1)] + 1 S= total number of shares voting (not multiplied by seats).

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 D = total number of directors to be chosen at election. Formula for more than one: [(NxS)/ (D+1)] + 1 N = number of directors the shareholder wants to elect S = total number of shares voting D = total number of directors to be chosen at the election Problems: there are nine directors to be elected and the corporation has 1000 outstanding shares. How many shares to ensure Epstein is elected to the board? 101 How many to ensure both Epstein and Roberts are elected? 201. Suppose now the board consists of only 3 directors. How many shares would be needed to elect Epstein? 251 Why would a corporation not want cumulative voting it protects the minority shareholder The less directors, the more shares you need so majority shareholders want fewer directors if they use cumulative voting If Im a majority shareholder and I want power, it is to my advantage to have a limited number of directors. Note that with staggered director voting, cumulative voting tends to reduce the influence the minority can have P. C35: SC 33-7-280: Voting for directors: cumulative voting Directors are elected by plurality of the votes cast by the shares entitled to vote. Shareholders have a right to cumulative voting unless the articles say otherwise o SO our default rule is to have cumulative But cumulative voting is only the default if the meeting notice or proxy notice conspicuously states that cumulative voting is authorized o Or a shareholder gives proper notice see statuteo So you have to do something before you can exercise your cumulative voting rights Unless provided otherwise, shareholder voting is cumulative 280(c) - Triggering event must occur to allow cumulative voting: o The meeting notice needs to say the voting is to be cumulative o If a shareholder is going to vote cumulatively, he must either give 48 hours notice OR give notice at the meeting and then they have 2 hours If a shareholder gives notice at the meeting of his or her intent to vote cumulatively - the other shareholders have a right to adjourn the meeting to figure out what they are going to do A minority shareholder would prefer to announce at the meeting his intention to vote cumulatively b/c there is a chance that the others will screw up their math in 2 hours 280(d) prevents the majority from being able to amend the articles of incorporation to prevent against cumulative voting = (if the # of votes cast against the amendment would be sufficient to elect a person onto the BOD if voted cumulatively) Note that cumulative voting is only used when adding (and tangentially, removing) directors. Problems p. 213

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o required Cause = fraudulent or dishonest acts or gross abuse of authority. There must be notice of the charges and the director must have a chance to refute the charges o If a director is elected by a voting group of shareholders, only the shareholders in that voting group may participate in voting to remove him. o If cumulative voting is elected majority cant fire you this is to preserve the minority protections of cumulative voting o With cumulative voting, you cant remove a director if the number of shares required to choose him as a director are cast against his removal (in other words, the minority shareholder has trump power) 33-7-280(d) does not allow the board to amend the articles to remove cumulative voting if the votes casts against the amendment would be sufficient to elect a director the board of directors Built in safety valve once the minority gets someone on board, you cant just get rid of him by firing him. you are protected against the majoritys removal of him. If minority gets someone on board the majority is stuck with them. o If cumulative voting is not authorized, a director may be removed only if the number of votes cast to remove him exceeds the number of votes not cast to remove him. o The meeting to remove the director must contain some notice that a vote to remove the director will be held o So if 7-280(d) prevents you from doing away with cumulative voting, the majority will want to reduce the number of directors so as to get more control o BUT 8-103 throws up some blocks If the number of directors is in the articles, then its harder. But if its in the bylaws, the directors can change it o So next they will stagger the terms so that fewer are elected at a time, which means the majoritys voting power becomes much stronger- this is also a takeover defense by making it harder to fire off the directors if a outside buyer comes in o Note class shares are a better protection than cumulative voting 33-8-103 Directors only serve their designated terms. 33-10-200 - the shareholders could amend the by-laws to reduce the # of directors, all the way down to 1. The majority is the one who is going to be able to elect that one (you can do that by combining 33-8-103 with 33-10-200 and 33-8-108). But Ohio court voted against this. o SC is one of the few states that reduced the # of staggering to 6 (you can have a staggered term board if you have a minimum of 6 directors) done to protect some majority shareholder of some corporation. 33-8-105 allows the majority to reduce the number of directors (or stagger the elections of the board; 33-8-106). This gives the majority shareholders greater power. This is another end-run. Uniformly shareholders have the right to vote on 4 fundamental corporate changes:

1. Conflict of Interest - If you represent the majority shareholder they dont want cumulative voting, if you represent the minority shareholder they want cumulative voting. If they come to you and ask whether you recommend cumulative voting, you cant say anything because it is a conflict of interest. 2. If a 48% shareholder is not a director, the company probably does not have cumulative voting or he would have gotten on the board. 33-8-108: Removing directors You can remove without cause unless the articles state that cause is

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o o o

o o

Amendment of articles of incorporation Dissolution Merger with another corporation Sale of all or substantially all of the corporate assets In SC Shareholder also has the right to: To create a SC corporation To change the form of business But on these decisions, the shareholder is merely giving approval of boards decision Normally a supermajority approval requirement No cumulative voting o Note that shareholder votes other than selecting directors is actually considered approval (or disapproval) of the boards actions o If I want to have a corporation run by the shareholders, the only provisions that are worth a hill of beans are 33-7-101 or the section on creating a closed corporation (above) Where shareholders vote and who votes: Special Terms o 33-7-101: There shall be an annual meeting (usually the only thing you do at an annual meeting is elect directors) o 33-7-102: Special meeting (any meeting other than the annual) At the call of its board of directors or If it isnt a public corporation (company whose stock is publicly traded on the NYSE), if 10% of the voting shares demand a special meeting, theyll get one (this is unusualmost states dont allow shareholders to call their own meeting) o 33-7-104: Action without meeting Shareholder action can be taken without a meeting if the action is taken by all of the shareholders who are entitled to vote. This is the way SC closely held corps vote If you dont want to have an annual meeting you dont have to. You can have your lawyer prepare a set of minutes and have each shareholder sign off (most SC corporations do it this way). o 33-7-105: Meeting notice Shareholders with voting shares must get notice between 10 and 60 days prior to the meeting date. If it is notice of an annual meeting, no purpose needed. You need notice of purpose for a special meeting o 33-7-107: Record date The person who has the legal right to vote at an annual meeting or special meeting of shareholders is the record owner. The bylaws can fix the records date 33-5-105 allows for notice 10 days prior to the meeting Not more than 70 days before the meeting Shareholder as of record date gets to vote regardless of whether they subsequently sold. If you bought after record date and its important to you to vote, you can enter into an agreement with the seller to cast his votes for you, except in event of a takeover vote Record owner person who has right to vote at annual or special meeting o corporation must send notice to them of meetings Record date 33-7-107 problems with giving notice come up because shares are sold by the holders, so corporation will fix a record date, and only record owners as of that date are entitled to notice of a vote at a meeting o So mainly used in public companies o o o o o

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Brokerage firm most people buy stock from brokers. The brokers are the ones who are the record owners in the corporation records. The real owner is in the brokerage firms records. This is called street name ownership o Laws make the brokers give notice to the street name owners, and the brokers have to vote how the real owner tells them too o If a bank is given bond in a corporation as part of a loan agreement, that bank doesnt have a right to vote because they collect first. Because the shareholders collect last, they need to be in control o A proxy can be revoked at anytime even if it says it is irrevocable o It is only irrevocable if it says that it is and is coupled with some interest in the stock look at SC statute for definition of this o There are Federal Rules regulating proxies because without them, most shareholders in publicly traded corporation wouldnt vote o R 14a-9 prohibits false or misleading statements in soliciting proxies o 14a-8 deals with shareholder proposals Problems page 217 o 1.1 looking at 105 and 107 the latest would be 10 days before the meeting and the earliest is 70 days before. There is not a precise answer to this question in our code. It must be between 10 and 70 days. o 1.2 Capel because he was the owner at the record date even though he isnt at the time of the meeting. (so owner at record date gets to vote even if they dont own at time of vote) o 1.3 you need to know if that got changed on the companys records. If it didnt then Shepard might not be able to vote o 2) no they wont have to approve this change; the board of directors can make business decisions without the approval of the shareholders Proxy Statements S/H authorization to Vote o Proxies are simply an agency appointment (I, as a shareholder, grant someone else the right to vote my stock because I dont want to be present at the meeting) o The agent is the party that is casting the vote o Proxies are the exclusive province of shareholders there are NO director proxies. o Proxies are generally only a feature of publicly traded companies, b/c you cant get everyone together to vote. o Generally a proxy is a yes/no vote on the director/shareholder action. o Proxies are generally revocable UNLESS it states that it is irrevocable and is coupled with an interest in the stock o 33-7-220 - Proxies Only a shareholder can vote by proxy A proxy appointment is effective when the appointment form or electronic submission is received by the secretary or other officer to agent authorized to tabulate votes. A proxy appointment expires if a time period is specified or within 11 months. Proxy appointment is revocable UNLESS the proxy form states that it is irrevocable AND the appointee is a pledge (lender who you pledge a stock of the security) someone who bought or agreed to buy the shares a corporate creditor where the terms of the loan required their appointment as proxy an employee whose contract requires their appointment a party to a voting agreement under 33-7-310 voting trust o

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We really need to have irrevocable agencies under certain circumstances A solicitation in the proxy statement cannot contain a statement which at the time it was made was false or misleading w/r/t a material fact or which omits to state a material fact necessary to make the statements made not false or misleading. We are one of the few states that has our own proxy fraud act; mirrors the federal proxy rule below You have a state and federal proxy fraud action o Proxy solicitation: when a shareholder receives a proxy, it usually comes with a statement that solicits the shareholder to grant the proxy for their shares. Federal Proxy Rules: false or misleading statement of fact o Rule 14a-9 (a) no solicitation shall be made in any proxy statement, written or oral, containing any statement that is false or misleading with respect to any material fact Non-disclosure of a material fact - Also specifies that an omission of a material fact in a proxy is a violation. This changes the normal fraud statutes because you cant have a defense of silence; an omission is actionable; thats key There is an implied right of action on behalf of individuals who have been injured by a violation of proxy rules. The shareholder must show that there was a material misstatement or omission in the proxy materials. All that is required is that the fact would have been regarded as important, or would have assumed actual significance in the decisionmaking of a reasonable shareholder. The shareholder does not have to show that he relied on the falsehoods. Instead, the court will presume that injury was cause as long as the falsehood or omission was material. The defendant had to knowingly make a misstatement or omission (?). Scienter is not required for insiders. Mere negligence is sufficient. There has to be an essential link between the solicitation and completing the transaction. If the Ps votes arent necessary, the P may not recover. Remedies: damages, injunction, or in an extreme case an undoing of a consummated transaction o Virginia Bankshares v. Sandberg (VA Case) VB owned 85% of the stock of a bank, and solicited the remaining shareholders for a proxy vote in favor of a merger that would get them high value for their stock and a fair price. Minority shareholders sued for a violation of Rule 14a-9. The merger was going to force the minority shareholders to sell their stock The corporation was going to pay them $42 per share The law didnt require their vote, but they wanted it corporation sent out proxy statement asking for their proxy Sandberg refused to give his proxy and sued for violation of 14a-9 which prohibits the solicitation of proxies by means of materially false or misleading statements Claims that the proxy lied in saying they were getting a high value for their stock. They should have gotten $60 per share The statement was conclusory in form purporting to give the reasons for why the directors were recommending the merger when in fact it was the s statements and not the directors Also Sandbergs approval wasnt needed anyway since the corporation had enough votes The Ps in this case are being cashed out; it is a freeze out merger (the merger is going to force the shareholders to sell their stock). One of the issues

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though was when we are voting on whether to freeze out shareholders then we dont need the votes of the minority shareholders (15%). The Ps argue the reason the directors lied was so they could keep their position on the board (the motivation behind your lying was to preserve your jobs) Fundamental Test as to what is MATERIAL: The court defined a material fact as one where there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. The court said that even though fair value sounds like a statement of opinion, because in the corporate context, a shareholder expects that opinions are based on facts that justify the statement. In this case, the statement of opinion was material. Note: a misstatement as to the directors motive for seeking the proxy may not be material, but a misstatement as to value of company or stock is material Note: if the statement includes enough correct facts to allow a shareholder to neutralize the misleading statement, then it may not be material. An opinion as to a general fact is not necessary a material misrepresentation. But under the rule, must show the misstatement was knowingly made argues that by publishing true facts with what is a false conclusion makes the misleading proposition too unimportant for there to be liability after all its only a material misstatement if it effects the shareholders vote, and if its obvious that the statement isnt true, then it shouldnt effect her vote But this all depends on the mix of the true and untrue The jury here found that the true facts did not neutralize the false conclusions Second issue should there be liability when the minority shareholders vote wasnt needed in the first place- this is the bigger issue here Mills v. Electric had 50% of vote but there had to be a 2/3. court had to decide if the minority shareholders had to show that the misstatement had a decisive effect on the outcome ie that they were actually mislead court said no, just that the misstatement was made in tenor of the solicitation in the number of minority shareholders needed to make the vote o This relation is called the essential link But that court wasnt dealing with a class of minority shareholders who had no right to vote anyway so no essential link o claims Mills statement of the essential link is here trying to expand it Either because wouldnt have proceeded without minority approval because of ill will that would stem Also claimed they were trying to keep their place on the board and this would help So they wouldnt have done it without them Or, because there was a conflict of interest issue because one of the Banks directors was also on the s board, so the minority approval was needed to keep this from voiding the merger Court disagrees- these 2 theories are the same as the essential link that solicitation played in Mills o is speculating about what the would have done. This isnt going to win the day. The COA only exists if the s vote is required and it wasnt here o He says I see what youre saying, but this solicitation would not cure those two problems. He likes the second theory but the facts are wrong here

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CAUSATION: The solicitation doesnt cause damages unless the proxy was given because the solicitation was necessary to complete the transaction; that there was an essential link between the solicitation and completing the transaction. In this case, because VB didnt need the proxy to complete the merger, there was no causation. Holding: So in this case the misstatement as to the value was material but there was no causation so no violation of Rule 14a-9. If the reason they wanted our vote was to keep the companys good name out there so that the board of directors can maintain their position, the minority shareholders argued there was an essential link. Souter said nope because there is no way to know the reason they wanted the minority shareholders to vote. The minority shareholders also argued that the minority votes would cure a later attack on the merger based on conflict of interest. Souter said that the minority votes were inadequate to ratify the merger under state law, and there was no loss of state remedy to connect the proxy solicitation with hard to minority shareholders irredressable under state law. Basically, Souter says not under these facts but maybe sometime under different facts. As a practical matter you cant determine if the reason someone voted the way they did was because of the solicitation. It is very RARE that you have disputes over proxies b/c it is usually very difficult for the shareholders to determine what is going on. Also, it is very expensive. Proxy Rules: Shareholder Proposals and Exclusions o It is important to distinguish between a full-fledged proxy solicitation and a shareholder proposal pursuant to Rule 14a-8 (often a political statement; not something that the shareholder actually wants to pass- not something that shareholders can mandatethey can only request) o Rule 14a-8 (handout): companies have to include shareholder proposals up to 500 words if the shareholder has at least $2000 in securities that hes held for at least a year. Under certain circumstances, a shareholder can require the company to send out a proxy solicitation regarding a proposal of the shareholder. o In addition to corporation soliciting their holders for votes, occasionally a shareholder will also try and solict the votes of other shareholders. Comes up when the shareholder is not happy with how the company is running But the cost is too expensive for this to come up a whole lot o 14a-8 provides that a shareholder can ask the company to send out a proxy solicitation regarding a proposal of what the shareholder wants and not the company. If you follow this rule closely, then the company has to send it out at no cost to you this saves you millions o The SEC allows the shareholders of a public company to request that the company send out a proposal for the shareholders to vote on. The company bears the cost of these proposals federal govt has stepped in and said this is something we are going to mandate on behalf of all the shareholders of publicly traded company o The company will submit and request a no-action letter by the SEC granting the companies exclusion of the proposal in the proxy if the SEC grants a no-action letter it will be essentially permitting the company to leave the proposal out of the proxy. o 2 Primary Types of Shareholder Proposals (most of the proposals come from organizations or church groups). Mgmt control devices - Directly addressing management issues of publicly traded companies. Politically & Socially Motivated cheap & efficient way to get the word out with our political concerns. o The company will try to avoid putting it in, and there are some reasons the SEC will allow them to keep it out and not recommend enforcement action to the SEC if the co. leaves the proposal out .

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To resolve issues related to 14a-8 (ie things the corporation wants to put in or leave our of its proxy solicitation), lawyers rely on SEC bulletins and no action letters o No action letters are recommendations by SEC staff that the full commission not challenge specified conduct Seek these in advance of taken a specific action- kind of like a declaratory judgment o But the SEC can be bypassed and the injured party can still sue in court but this is very rare o Rule 14(a)(8)(i) REASONS FOR EXCLUDING S/H PROPOSAL (reasons SEC might grant a no-action letter): Improper under state law- if the proposal is not a proper subject for action by shareholders under the laws of the jurisdiction of the companys organization (usually proper if phrased as a recommendation or request) Violation of law- if the proposal would, if implemented, cause the company to violate any state, federal, or foreign law to which it is subject Violation of Proxy Rules If the proposal violates Rule 14a-9 prohibits materially false or misleading statements in proxy solicitation materials Materially or directly impugns character, integrity or personal reputation Personal grievance; special interest: if the proposal relates to the redress of a personal claim or grievance against the company or any other person, or if it is designed to result in a benefit to you, or to further a personal interest, which is not shared by the shareholders at large Relevance: Proposal relates to operations that account for less than 5% of net assets or net earnings and not otherwise significantly related to companies business Absence of Power /Authority - Company has no power to resolve the problem Mgmt Functions: Relates to companys ordinary business operations Mcquade case Relates to election of directors (under the rules there is a limitation on that) Conflicts with the companys proposal: if the proposal directly conflicts with one of the companys own proposals to be submitted to shareholders at the same meeting Proposal has already been substantially implemented Duplication Resubmissions (there are specific rules about this) o Ex McDonalds shareholder proposal Coordinated campaign to try to address human rights concerns involving China. The lawyer used the word request in their resolution b/c, given the McQuade case, it is not within the scope of the shareholders sphere of authority; it is within the directors sphere of authority. o Ex Xerox proposal. The primary reason this shareholder proposal was excluded was b/c it related to the election of directors. o See page 236 Xerox wanted to exclude shareholder proposal asking for replacement of all inside directors Holder had stock through Employee Stock Ownership Program (ESOP) 3 step process of getting new directors o Inside those employed by the company o Outside those not employed by company Xerox claimed that it could leave it out under 14a-8(i)(8) because it deals with the election of directors

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A 1976 release from the SEC said that 14a-8 is not the proper means for conducting campaigns or effecting reforms in elections of that nature since other proxy rules including rule 14a-11 [election contests] are applicable But these have been directed at proposal for specific nominees or select group that the new directors are to be selected Also claims that 14a-8(i)(3) allows exclusion of anything against the proxy rules. Then argues that the proposal contains misleading statements and therefore violates 14a-9 for attacking character and personal reputation without factual foundation o SEC gave Xerox a no action letter o Based on 14a-8(i)(8) o So the SEC wont pursue an enforcement action to make this proposal be included in the proxy Looking at 14a-8 Shareholder Proposal o See handout o Motivation of SEC is that it wants shareholders to get involved in the operation of the company. And to do this, we need some way to communicate with the other shareholders. o Must own 2K or 1% of the companys securities for at least one year o You can only submit one proposal per meeting o Proposal and supporting statement must be 500 words or less o Deadlines must be received not less than 120 days before the date of the companys proxy statement released to shareholders in connection with the previous years annual meeting o Question 9 if you have complied with the procedural requirements, on what other basis may a company rely to exclude your proposal? o Improper under state law Most proposals that are requests are ok o Personal grievance o Relevance if it relates to less than 5% of companys total assets o Management if the proposal deals with a matter relating to the companys ordinary business operation So its hard to fit something in between this one and the Relevance of 5% o Election- or nomination this seems contrary to the fact that the one thing they always have a right to do, which is to vote for directors which means its hard to communicate with other shareholders about who they want to vote o Resubmissions If you want to keep submitting the same proposal there are requirements see # 12 Shareholders Inspection Rights o When can they look at books and records? o Kortum v. Webasto Sunroofs (DE CASE) Facts: WAG and Magna are 50% stockholders in the joint venture of WSI. Kortum is CEO of WAG, and a director of WSI, of whom WAG owns 50%. WAG also has a controlling interest in a competitor of WSI. WSI wants to prevent Kortum from having access to inspect books and records because they think hes going to give the information to WAG who will give the information to direct competitor. Issue: What is the scope of a S/Hs right to inspection when an agent of the S/H is a director of the Company. 273 action in DE DE has a law that provides a company like WSI (2 shareholder co) either of those shareholders can bring an action to dissolve the company. There are two requests for information: a director of the company and a shareholder The director and the shareholder are the same person here and asked for records in both capacities Director- to monitor performance

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Shareholder to value its shareholder interest said it would let him view in his director capacity but he couldnt share that with WAG Shareholder has brought a 230 action to view the records SC has nothing like this TEST for DIRECTOR INSPECTION (Kortum): Director has access to any records reasonably related to his position as director (almost unlimited rights of inspection and the burden is on the other side to prove there will be a misuse of the information). Once the director has demanded access, the burden is on the corporation to show why access should be denied or conditioned. The court says that the speculation that he will use the information competitively is not enough to restrict his access, and further, since he has promised not to do so, he should be granted unfettered access SC has no statutory director rights, but you could draft it into your AIs as a statutory or quasi close corp. TEST for SHAREHOLDER INSPECTION (WAG): A shareholder must show They complied with the form of making an inspection demand: a written demand under oath The stated purpose of the inspection they seek is the actual purpose and that purpose is legitimate. o Valuing ones shares is proper purpose, regardless of whether you plan to sell or not The scope of their inspection is essential and sufficient to their stated purpose. o SC statue requires these things for S/H inspection also!!! The shareholder has right to inspect. The court said that the fact that a shareholder was a competitor didnt reduce the entitlement, but may make conditions proper. In this case, the promise not to disclose to the competitor was sufficient. Notice that the shareholder has a much more restricted right to look at the records than the director. In SC: 33-16-xxxx We have no director inspection statute like DE does 33-16-101(e): Corporate Records: Mandates the types of records we have to maintain. SC 33-16-102: Shareholder Inspection Rights (a): Shareholder has a right to inspect anything in 101(e) with written demand and at least 5 business days notice. Also, if you have at least 1% interest, you can also look at tax returns. But this wouldnt give you what you need if you where in a Kortum squabble wouldnt let you figure out the value or what the directors have been doing You get this info in the annual report (b): KEY RECORDS In order to get the key records: minutes of the meeting, accounting records & shareholder record, you must establish 3 things (note: so for the good stuff, you have the DE limitations from Kortum.) (c) Your demand was made in good faith for a proper purpose Describe with reasonable particularity your purpose and the records you want to inspect The records you want to inspect are directly connected to your purpose (d) the right to inspection granted by this section may not be abolished or limited by the AIs or bylaws. 33-16-103: Scope of Inspection right:

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rights.

(a) The attorney or agent of the shareholder has the same inspection rights as the shareholder. (d) If a S/H or agent requests a S/H record it must be compiled no earlier than the date of the demand. SC 33-16-104: Court Ordered Inspection If the company gives you the Heisman on your 102(a) demand the court can order it, and if they do, copy costs go to the company. BIG NOTE: SC doesnt have statutory director inspection

Shareholder Voting Agreements Agreements btw directors are void McQuade o Agreements btw shareholders are valid Ringling o Ringling Brothers v. Ringling: DE Case - One of the most landmark cases The two Ringling sisters are in an agreement to cast their voting shares together, and if they cant agree as to who to elect, they will talk to an arbitrator who will decide for them. The arbitrator makes a decision, but one sister doesnt go along with it. At issue is a voting agreement bw shareholder regarding election of directors 3 shareholders Edith, Haley and John. E claims H was bound to vote for a certain slate of directors. H says the agreement was invalid or revocable Agreement said they would consult and vote together Arbitration was to be had if they failed to agree Said it could be terminated by mutual consent Voting was cumulative They each had enough individually to elect 2, and then a 5th by voting together (there were 7 total) See ft note 1 for the math Dispute E was to vote for herself, her son, and Mr Dunn - complied H was to vote for herself, her husband, and Mr Dunn voted only for H and her husband As a result, John was able to get in 3 of his directors instead of only 2 Trial court said the agreement was valid That when one party breaks the agreement, the willing party becomes the implied agent in possession of an irrevocable proxy of the breaching partys votes The court ordered a new vote to be had with Hs shares cast in accordance with the agreement alleges that a voting agreement is invalid because that takes voting power irrevocably away from the owner except an agreement that complies with 18 of Corp Law This section covers voting, voting by proxy, o Depositing stock in a person or corporation as a trustee with the right to vote as a Voting Trustee for up to 10 years o Her argument was that you had to set up a voting trust to do this Court says is wrong there are numerous ways shareholder can make agreements with each other about voting. This statute doesnt cover the type of agreement at issue here. o Class shares, irrevocable proxy, etc o So you can have shareholder agreements or a voting trust, and both are ok Pooling agreement this is what this is, and it is valid

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Remedy Johns votes should count since he breached no agreement Likewise Es votes should count But court throws Hs votes out completely, so the 6 people J and E voted for are now directors o Doesnt decide what to do about the vacant spot Issue: Is a S/H voting agreement that provides in the case of disagreement an arbitrator will decide the voting of the shares valid? Haleys basic argument that she can do whatever she wants with her votes (go against the agreement) Is b/s she suggests that you cant contract away shareholders voting rights DE law says that the way you do what you want to do is set up a voting trust Haleys primary argument: Basically, the argument is that Haley couldnt be forced to vote her shares according to the agreement because that would have required an irrevocable voting trust, which takes an interest in the stock coupled with the proxy. Holding: The court says that an agreement among shareholders to cast their votes in a certain way is valid and enforceable. As a remedy, they invalidate the votes that were cast against the agreement. Court says that the voting trust should not be the only way to control the voting rights rejects Haleys argument based on Section 18 of DE law. However, instead of requiring Haley to cast her votes according to the agreement, the court invalidated her votes and the result was that there ended up being only 6 board members when there should have been 7. o SC Rule on Voting Agreements, we allow specific performance of voting agreements as long as they are written and signed, so this case would have come out differently. o DE Rule: In order to mandate the votes there would have to have been a proxy coupled with an interest. Someone had to have agency authority to cast the votes. o Court said they didnt know if he had a proxy, and even if he did it wasnt irrevocable b/c it wasnt coupled with an interest (he didnt own shares), so Haley had the right to cancel this interest. o If Haley cancelled the K right, she might have been liable for damages but Ringling doesnt have a right to specific performance. Is the result in this case less favorable, more favorable or in the middle result to Ringling? o Ringling had the most power until there was a change in allegiance. If the votes had been required to be cast, then Haleys choice would have been elected and they would have had the majority on the board. The decision clearly favors Mrs. Ringling b/c the composition of the board when they throw the votes out makes any decision a stalemate. Distinction between Ringling and the McQuade Case: shareholders trying to influence a directors right, here we are dealing with shareholders trying to influence one anothers voting decisions. Shareholders are allowed to influence voting but are not allowed to do what they did in McQuade. 33-7-300 - 310

Shareholders have wide discretion to vote or agree however they want as long as they dont breach a duty owed to another shareholder Its fine for them to vote to gain an advantage

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 To get someone to vote the way you want them to, you can set up class shares, voting trusts, or pool agreements (contracts) 33-7-300: Voting trusts You can place your shares into a voting trust. You must file the trustee, beneficiaries, and agreement with the corporation. o When you transfer them you know longer have ownership of the shares and the person who contributed must now vote the shares. o One of the objections that was raised initially with these voting trusts is that a voting trust is public information. o Trustee has essentially absolute power over the shares. The trustee has the right to vote the shares as he/she chooses o If there are dividends, they are paid to the voting trust certificate holder Only valid for 10 years unless extended or amended You can get as much as a 10 year extension with approval of the trustee (d) indicates that the voting trustee is allowed to vote without the consent of the voting trust certificate holder Also indicates that the voting trust certificate holder has the right to dividends. Even though you have given up stock to trust, You get a voting trust certificate- so if there are any dividends paid, they are paid through the trust to you as the holder of the certificate no article that alludes what would happen if the voting trustees actions were injurious to them; he votes selfishly in a way that benefits him- unclear what would happen. Question is whether the certificate holders nac sue the trustee for a breach of fiduciary duty, some state laws allow it, SC doesnt. Ex - You might use something like this when youre giving interest in the family business to the kids, but you dont want them to begin exercising their voting power until theyre older cause they dont know jack The only reason to do this is to tie up the voting power - Why would you want to have a voting trust? (mostly an exclusive feature of small corporations) o You may have a small corp set up by one person, looking for investors, but wanting to maintain voting power people will still invest o Family situation where the parents want to control the votes and dont trust their children yet. 33-7-310: Voting agreements (Pool/contract agreement) 2 or more shareholders can agree to vote in a certain way with a written and signed agreement. the agreement is not subject to the provisions of the voting trust statute 33-7-300 the agreement is SPECIFICALLY enforceable (note distinction from Ringling would have forced the voting shares to have been voted according to the agreement) Can make the voting trust irrevocable under 33-7220 (d)(5) proxies. 33-8-104 Election of directors by certain classes of shareholders: If the AI authorizes setting up different classes of stock, the AIs may also authorize the election of one or more directors by holders of one or more authorized classes of shares.

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 It doesnt matter how many shares of stock are issued to each, the only thing that matters is that each one gets to elect one director, the statute allows for this. Each class constitutes a separate voting group. Different classes of shares is the traditional control device that lawyers recommend! o Duties and Responsibilities of Corporate Decision makers: Stockholder Derivative Suits Directors Duty of Care The directors of a publicly traded company are responsible to the shareholders. A closely held corporation is run by the owners (completely different) Breach of Duty of Care by Improper Board Actions BJR!!! o Shlensky v. Wrigley (IL -DE law applies) BJR Case Facts: Plaintiff was a minority shareholder in the Cubs. Sued the directors for mismanagement in not putting lights in Wrigley field, stating that the club would make more money if they had night games. Plaintiff states that the reason Wrigley isnt putting up lights is because he doesnt like night games, which is against the interests of the corp. This is a shareholder derivative action. The motivating force here is the lawyer, b/c if there is a big win then they get the fees. The court is not convinced that the decrease in revenue will be offset by installing lights b/c the decision may deteriorate the neighborhood. DE - BJR: The court will not evaluate the business decisions that the directors or the officers make unless they border on fraud, illegality, or conflict of interest. o Issue can a derivative suit be brought for something other than fraud, illegality or conflict of interest? should the Court evaluate the boards decision as good or bad Davis v. Louisville Gas & Electric Directors had one view and majority of shareholders have another They asked court to decide which view should prevail Court said it will not interfere with policy and business management The board is elected for this purpose- and their judgment absent fraud is final presumption that it was made in good faith and in best interest of the corporation o claims that directors are acting on personal interest and not those of the corporation Court is unconvinced bc integrity of the game and concern for the surrounding neighborhood are legit concerns for the company, and if the directors judge that this is better for the corporation then increased cash from night games, so be it Absent fraud, illegality or conflict, this is a proper decision for the board to make and it will stand o Rule- Derivative suit must touch on Fraud Illegality Conflicts You must Touch these before the court will look any deeper Shlenskys only option now is to sell his shares get the heck out of Dodge!!!! The laws of the state of incorporation, in this case DE, govern the internal affairs of the corporation. So in this case DE law governs the internal affairs of a baseball team that operates in Chicago. o Joy v. North (U.S. Ct App 2nd Circuit I think NY Case?)(most cited case on directors duty of care) NY BJR Case

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 Procedural Aspect: Shareholder filed a derivative suit on behalf of the corporation. The board of directors created a special litigation committee which decided to terminate the suit. The Special litigation committee is to act on behalf of the Co. and whether it is in the best interests of the Co. to continue the litigation. The special litigation committee decided to terminate the suit. 2 business decisions the court has to decide how to evaluate: The liability of the outside directors a director who is not an employee of the corporation. The vote of the litigation committee to terminate the lawsuit? BJR is the concept by which courts wont hold officers and directors liable for negligence simply for making bad decisions that lose money NY BJR: Court said that the business judgment rule applies unless there is evidence that a decision lacks a business purpose, OR is tainted by conflict of interest, OR Egregious as to amount to a no win situation (gross negligence) OR Results from an obvious and prolonged failure to exercise oversight or supervision. Reasons for the BJ rule: Bet At Your Own Risk: Shareholders assume the risk of bad judgment when they buy. Hindsight is 20/20: It is very difficult to recreate the decision process in hindsight - Looking back on a decision is a bad method of evaluation. Risk: The whole notion of risk is what is key to business the greater the risk, the greater the likelihood of return - Dont want to create legal incentives for directors to avoid risk. Holding: The Court said neither of these decisions are protected by the BJR. Court evaluated the decision of the inside directors to terminate the lawsuit b/c they had a conflict on interest. Court evaluated the process of the outside directors decision making and found that they did not get the benefit of the BJR b/c they were not informed Court says that lack of knowledge is not a defense, allowing the other directors to make a decision for them will still be considered a breach of fiduciary duty. Court discussed 2 forms of derivative suits: An action against the corporation for failing to sue when it should have An action on behalf of the corporation (that the corp. failed to bring) against the directors for harm to the corp. Court said that in most cases a shareholder must demand a corporation sue on its own behalf before bringing a derivative suit, and when the directors (or a committee of uninterested directors) refuse a demand, business judgment rule applies to the refusal to sue. In this case, however, the decision not to sue was so bad it could be considered gross negligence, and as such was not protected by the business judgment rule. Special Litigation Committees Decision to bring a suit falls under BJR

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So shareholders must first demand the directors to bring suit, and then the court will apply BJR to determine whether their refusal was proper The group that decides whether to bring suit is called the Special litigation Committee- so the court looks at their decision and applies BJR to see if they should have brought suit. o If so, they will be liable o If not, then the shareholder is out of luck Application Court looks at likelihood of success in bringing suit The wanted to sue its board of directors for being negligent in extending credit to a risky investment that had little gain to offer o The Board set up a special litigation committee to decide on the issue of whether to sue o Committee moved to dismiss action against outside directors ie the ones who arent officers because they werent given notice of what North was doing North was in control of the Banks board and management o He didnt provide materials or agendas to other members before meeting Under his direction, the Bank was extending credit to a developer named Katz that was very risky o It was no win he continued to give extensions. Despite risk, the only potential profit was the interest but the loss was the entire principle. The interest could have been earned by diversifying o So Special Litigation Committees report that there was only a possibility of finding negligence was wrong Court says the inside directors may dispute the outside directors claim that they had no knowledge of what was going on, and ignorance is no defense anyways, so the action shouldnt have been dismissed against them A directors who willingly allows others to make major decisions affecting the future of the corporation wholly without supervision or oversight may not defend on their lack of knowledge SO the BJR wouldnt prevent the derivative action from prevailing The court remands to have an individual review of outside directors to determine their role and why they didnt act 33-8-300: SC BJR - General Standards for Directors A director must discharge his duties as a director, including his duties as a member of a committee, in good faith with the care an ordinarily prudent PERSON in like circumstances would do (negligence std) in a manner he reasonably believes to be in best interest of the corporations. (b) - lists the 3 sources that the director is reasonable to rely on in making decisions Another officer or co. employee Legal counsel / Accountant Committee of the BOD which he is not a member (c) - a directors decision is in bad faith if he knows it is NOT REASONABLE to rely on one of the sources in (b) and he does anyway (d) SOL an action for a director for failure to perform his duties in this section must be brought within 3 years after the COA has accrued, or within o

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2 years after the time when the COA is discovered. SOL does not apply if the breaches of duty were concealed fraudulently. The duty runs to the shareholders and the corporation o You can draft the duty out in the articles of incorporation if it is a publicly traded company. o Smith v. Van Gorkom (DE case) BJR Case o (some lawyers say this is the worst decision, some say it is the best decision) Class action by shareholders seeking either to rescind a merger or get damages from the board. Van Gorkom negotiated a deal for merger of the company. He presented the possibility of the merger to the board at a meeting where none of the attendees knew they would be discussing a merger. The whole proposal was made orally in 20 minutes, and no written materials were presented. Finally, the Board agreed to selling the Co. for $50/share If the deal went thru in this situation the shareholder would have no choice cash out merger the shareholders would be forced to sell the stock. He didnt ask what the company was worth; rather he asked how long it would take the buyer to pay off the note they were going to incur. Key executives were opposed to it; they didnt even know about it before the meeting; the board decided to vote yes Subsequent to the Boards decision, a # of steps were taken to cover the Boards decision, there was a gap period where the Co. put themselves up for auction. The rule itself is a presumption 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 the best interests of the companyThus, a directors duty to exercise an informed business judgment is in the nature of a duty of care, as distinguished from a duty of loyaltyThe applicable standard of careis predicated upon concepts of gross negligence. So this is also different from both Jones and Shlensky must rebuke the presumption that the decision was an informed one The problem is not the substantive decision that was made but because they werent informed. DE - BJR: The court will not evaluate the business decisions that the directors or the officers make unless they border on fraud, illegality, or deceit. DE BJR Exceptions BOP is on P: Not making a informed decision or failure to use all of the material information available. o The court said that a director is fully protected if he relies in good faith on reports or informal personal investigations by corporate officers o Must inform themselves of all material info reasonably available to them prior to making the decision This is a fid duty owed bc he is acting on behalf of others Contrasts duty of care from duty of loyalty o Bad faith: Not investigating the source of the $55 offering - failure to investigate that is a failure of good faith. Gross Negligence DE BJR o VGs presentation did not rise to the level of a report because he didnt know about the information that provided the basis for his report. Thus, the directors were did not exercise due care and were grossly negligent in making this decision, and as such do not receive the benefit of the business judgment rule.

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o o o

Exceptions to BJR: gross negligence lack of due care* lack of good faith* - failure to investigate fraud, self dealing or other unconscionable conduct. Rule: The Burden is on the P with the duty of care - BJR cases and court will focus on the process Damages Award: The directors should have quit immediatelysome of the damages came from insurance $ but no one knows where most of the money came from. However, most of the $ came from the co. that bought the company. Breach of Duty of Care by Directors Failure to Act Oversight Liability Barnes v. Andrews (NY) Andrews was a director of an auto part maker. While he was a director a bunch of crap went wrong that cost the company money. There were two scheduled directors meetings, and he missed one. He didnt pay that much attention to the affairs of the company. The plaintiff claimed that the defendant failed to give adequate attention to the affairs of the company which had been conducted incompetently o No negligence in attendance of meetings o If there is liability it must rest on his failure in general to keep advised of the conduct of the corporation affairs So we see duty to stay informed o Directors arent to be involved with the actual conduct of the corporation - that is for the officers Directors can act individually only by counsel and advice to them Directors dont have to guarantee that his judgment is good Court said that: o Rule: Directors have an active duty to keep themselves informed in some detail of the operations of the company. BOP P: Apparently the duty is on the plaintiff/shareholder to show breach of the duty or directors failure to keep himself informed! Directors must make efforts to learn of the actual affairs of the corporation and not serve as a mere figurehead o Loss Causation: Upon a breach of that duty, plaintiffs have to show that had the director performed his duties, the loss would have been avoided (causation). Unfair to put the burden on the Director: If we were to put the burden on the director, the director would be in a very difficult decision to come up with the proof that they did in fact pay attention to detail they would be in a very hard position, and in part to protect the American way of doing business, the burden is on the shareholder. In this case, the director violated his duty to stay informed. However, the plaintiff was not able to show that if the director had known what was going on he could have made a difference. Thus, no liability for director. SC- follows the Barnes standard Duty is on the P to show failure to act and Causation. RULE An action against an inattentive director, a complaining shareholder must establish some linkage between the directors bad behavior and corporate loss ie causation Sarbanes-Oxley increases the duty of directors to stay informed and involved Francis v. United Jersey Bank was warned that if her H died and she inherited the stock, she couldnt trust the sons Her defense was that she wasnt involved and didnt know what was going on Court nails her anyway and holds her personally liable for the losses Graham v. Allis-Chalmers Mfg. Co. o o o o o

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Several mid-level employees of a large corporation were indicted and pleaded guilty to violating federal antitrust laws by engaging in price fixing shareholder brought derivative suit arguing that the directors breached duty of care by failing to monitor the employees o Court found in favor of directors Too many employees meant that board could only be liable for broad policy issues not immediate supervision o Went so far as to say that the board did not have a duty to set up a monitoring system until they had some reason to suspect that the employees were not being honest Next case shows that while board can depend on subordinates, this dependency must be reasonable In Re Caremark (DE Case) Caremark violated a bunch of Medicare rules and ended up with fines over $250M. Shareholders filed derivative action against directors for breach of duty of care in supervising employees. Court says there are 2 ways to bring liability: o BOD makes a bad decision that results in loss because it was ill advised or negligent. In this case, we apply the business judgment rule, and as long as the process used to come to the decision was rational and employed in good faith, there is no liability. Substance of the decision isnt important as long as the process is reasonable and in good faith Concern of after the fact review All that is required is a good faith effort to stay informed o * Failure to act or monitor in a situation where attention would have prevented the loss. This includes a duty to make sure that an adequate corporate monitoring system exists. The level of monitoring is a business judgment question. Before there had to be cause for suspicion before a duty to monitor arose o But court says this is wrong, the holding in Graham merely means that directors cant be held liable for assuming the integrity of its employees Noting the need for information, the court says that the board does have an obligation to ensure that its information is accurate o But the amount of such systems falls under the BJR There must be a good faith judgment that the corporations information and reporting system is in concept and design adequate to assure the board that appropriate information will come to its attention in a timely manner as a matter of ordinary operations, Thus, I am of the view that a directors obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists, and that failure to do so under some circumstances may, in theory at least, render a director liable for losses caused by non-compliance with applicable legal standards Here the record supplies essentially no evidence that the director defendants were guilty of sustained failure to exercise their oversight function. o For liability, there must be a sustained and systematic failure to exercise oversight hasnt show this here- there was a good faith system and if they didnt know, then there is no fault Holding: In this case, there was no evidence of a sustained violation of the oversight function, so no violation for directors. Most lawyers consider this to be a duty of care case, but the handout (Stone Case) says that Caremark deals with a duty of loyalty. McCall v. Scott (DE Case) Another derivative suit against directors of health care company for breach of duty of care. Senior management, allegedly with knowledge of board, was using illegal practices

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to increase revenue. There was a clause in the articles that removed the duty of care for directors for anything short of intentional misconduct. o Gross negligence is the standard for bringing a derivative suit o Test only a sustained or systematic failure of the board to exercise oversight- such as an utter failure to attempt to assure a reasonable information and reporting system exists o However- doesnt have to show a director intentionally acted to harm the corporation The had pointed to articles that says it requires intentional misconduct to overcome the waiver of liability What waiver they put in the articles that it had to be intentional There was a statute in Del that said you could put such a provision in your articles o However court interprets statute to mean that in addition to intentional wrongs, certain reckless acts or omissions also would not be in good faith and are therefore not capable of waiver Taking the totality of the facts here, the conduct could arise to recklessness and therefore could not be waived under the statute so they can be liable The court did not address the validity of the waiver. However, the plaintiffs alleged that because of the experience of the directors as managers, the only way the fraud could have taken place is with either reckless or intentional disregard of warning signs, and as such was enough to survive a motion to dismiss. o In particular, the Ps alleged that intentional or reckless disregard can be inferred from the failure to act in the face of audit information, ongoing acquisition practices, allegations brought against Columbia is a qui tam action, the extensive federal investigation, the NY times investigation into Cols billing practices and the inaction by the BOD. Holding: Ct held that the Ps pled particularized facts that presented a substantial likelihood of director liability for intentional or reckless breach of the duty of care. They reversed the motion to dismiss and remanded the case. Note that McCall seems to indicate that an allegation of recklessness is enough to get you into court when intentional is the standard. South Carolina 33-2-102(e): Limiting director liability for monetary damages for breach of duty of care o The articles can limit liability of a director for violation of fiduciary duty as long as there are no limitations on liability for: breach of duty of loyalty to the corporation or its stockholders **acts or omissions not made in good faith or made with gross negligence, intentional misconduct, or knowing violation of the law** important duty imposed by 33-8-330 (unlawful distributions) note that 330 refers to 33-8-300 Directors Duties, which seems to set up a negligence standard for the duty of care of a director. Note that 33-8-300 sets the standard for breach of duty of care for directors as negligence, so you can draft that out in the articles. transactions from which the director got an improper personal benefits. o Statutes like this were passed all over the country to negate the effect of the Van Gorkum Case. o Plaintiffs cant recover from directors who screw up. o This only applies to certain corporations o If the corp meets a bunch of qualifications (essentially, if youre big). 33-2-102 o Publicly held corp with over 25 million in assets or 500 shareholders may in their articles provide: A provision eliminating or limiting the personal liability of a director to the corporation or its shareholders for monetary damages for breach of fid duty as a director Provided that the provision shall not eliminate or limit the liability of a directors

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See C-10 The key is for acts or omission not in good faith or which involve gross negligence, intentional misconduct or a knowing violation of law Different from Del is that you cant indemnify for gross negligence but this means that we can indemnify for Negligence In other words, you can sue most companies in SC for mere negligence whereas in Del. They would have to meet gross negligence Knowledge and Notice 33-44-102 o Question is often when does an entity receive knowledge or notice of some event Actual knowledge Or when the event would have been brought to the entities attention if it had exercised reasonable diligence- which means it maintains reasonable routines for communicating significant information to the individual conducting the transaction for the entity and there is reasonable compliance with routines Recent statement of the BJR o Is that some decisions are just so bad that they are actionable SC and the BJR Dockside v. Dentions 294 SC 86 Dockside v. Detyens (SC) The closest thing we have to a case that talks about business judgment in SC. Probably holds that we recognize the business judgment rule in SC o One amt of votes were needed to pass assessment (60 percent), but a different amt was needed if it was an emergency (50 percent). o Votes came up short, so they declared it an emergency and it passed Court Said this decision fell under the BJR and that absent a showing of o Lack of good faith o Fraud o Self dealing o Unconscionable conduct The directors wont be liable Disney Case ( DE 2006)BJR Present Standing Handout! As evidenced by the language quoted above, the Caremark standard for socalled oversight liability draws heavily upon the concept of director failure to act in good faith. That is consistent with the definitions of bad faith recently approved by this Court in its recent Disney decision, where we held that a failure to act in good faith requires conduct that is qualitatively different from, and more culpable than, the conduct giving rise to a violation of the fiduciary duty of care (i.e. gross negligence). Caremark says director may be liable if it fails to monitor what goes on to the company if there is a sustained and systematic failure of the board to exercise oversight- such as an utter failure to attempt to assure a reasonable information and reporting system The BJR - 3 Part Test: BOP on the P o Presumption that in making a bus decision the directors of a corporation acted on an informed basisand in the honest belief that the action taken was in the best interests of the company (and its S/Hs). o The presumption applies when there is no evidence of fraud, bad faith, or self-dealing in the usual sense or personal profit or betterment on the part of the directors. o In the absence of this evidence, the BODs decision will be upheld unless it cannot be attributed to any rational business purpose When a P fails to rebut the presumption of the BJR, she is not entitled to any remedy, legal or equitable, unless the transaction constitutes waste.

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 o o o o o

o DE court makes a distinction between the a Breach of Fiduciary Duty of Care Gross Negligence associated with the Caremark case and Failure to Act in Good Faith which constitutes more culpable conduct. o 3 Exs of Failure to act in Good Faith (test for bad faith): Fiduciary intentionally acts with a purpose other than advancing the best interests of the corporation Fiduciary Acts with the intent to violate applicable positive law Fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for her duties. Necessary to establish oversight liability! DE said that Caremark applied the correct std - held that a necessary condition for oversight liability as a sustained or systematic failure of the BOD to exercise oversight-such as an utter failure to attempt to assure a reasonable information and reporting system exists. Or having implemented such controls failure to monitor or oversee its operations thus disabling themselves from being informed of the risks or problems requiring their attention. Ct says Failure to comply with good faith is not a separate, breachable duty does NOT establish an independent fiduciary duty only a subpart of the duty of loyalty. But then court goes on to say that failure to act in good faith is not ipso facto an establishment of director liability instead good faith goes to loyalty not care That good faith isnt a separate fid duty but a subsidiary of loyalty This is hard to swallow This is not SC or NY, its Delaware, but its likely everyone else will follow If its a breach of loyalty, then when you go to the statute it doesnt address loyalty in the section about liability for breach of duty of care so there is a defense here DE ct says that b/c a showing of bad faith conduct of this kind is essential in establishing director oversight liability, that the fiduciary duty violated by that conduct is really a duty of loyalty. Burkhard disagrees but this case is the law. He thinks Caremark is describing a duty of care when they talk about good faith. The Disney case is calling it a duty of loyalty. The Court has said in the LLC context that even though you can contract away your rights for breach, you cant contract away the duty of good faith. This might have an effect. Hes not sure where all of this is going, but its probably going to have significant influence down the line. Elements of Finding Director Oversight Liability: Where directors fail to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith. Duty of Loyalty (directors put own financial interests ahead of corporation) IN DE & SC you cant indemnify against breaches of a duty of loyalty!!! Breach of Duty of loyalty - Competing with the corporation Breach of duty is when your saying the board is lazy or dumb Breach of loyalty is when you say they are greedy and put their own interests ahead of the corporation Look for cases where the director o Competes with the company o Takes for herself a corporate opportunity o Has some personal pecuniary interest in a corporations decision Jones v. Burke (NY): A bunch of the directors got together and formed a new competing co. before they resigned. They got together to discuss buying out the business prior to resigning. They were talking to existing clients and set up a corp before walking out. The dates are important in this case

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June 28th, there was a meeting of s July 3rd one of the told Jones that he either has to sell or they are going to set up a new corp Aug 6th negotiations fail Aug 22 a new corporation is formed Before any of these dates, the s had already talked with the clients about coming with them o If they had done it on Aug 22, there would be no sanction o But since it happened prior to leaving the s corp, there is liability because they were directors and had a duty of loyalty to the company so we look at what happened before, not after If you are the s you have a serious problem that they have to deal with Jones is running the company into the ground- how do you fix it Ad agency, Duance Jones Co, began to suffer hard times because of behavior lapses of its founder. Several of the officers start a competing agency They stole key clients and employees and then resigned from Duane Jones o This cost the 6.5 million The had been flaking out, and the testifies that the customers either want the s to buy him out or start a new corporation They had entered into negotiations about buying him out, but it never went through The had already pre-sold the customers on their plan, and they incorporated before resigning from the s corporation o Also took majority of s employees with them The s here were shareholders and officers in the corporation Issue: Timing here is critical did the directors breach a duty of loyalty prior to leaving the firm - must determine when the bad things occurred prior to leaving the firm or after they left they are liable for disloyal acts while they were still employees Duty of Loyalty Test: Directors are prohibited from acting in any manner inconsistent with his agency or trust and is at all times bound to exercise the utmost good faith and loyalty in the performance of his duties. Holding: the directors are liable for advantages secured by them, after termination of their employment, as a result of opportunities gained by reason of their employment relationship. They pursued a course of conduct which resulted in a benefit to themselves through destruction of the Ps business, in violation of the fiduciary duties, imposed on defendants by their close relationship with plaintiff corp. They were bound to exercise the utmost good faith and loyalty in the performance of his duties You cant benefit yourself to the detriment of the corporation If they had quit and then started a new corporation, it might have been ok. But the conspiracy started while there was still a fid duty o Ct rejected the defense that the directors did not avail themselves of the benefit of the customers and personnel diverted from the P until after they informed the P that they were leaving. Rest (2nd) Duty not to Compete: Once you quit, then you may compete. However, there are some limitations that you cant use trade secrets NOR can you violate a continuing existing duty. Rest (3rd of Agency) - Section 804; dead silent on all of this (presumption is that once you leave your no longer an agent so whats the point in addressing it) Lawyer Tip: A co. like Jones can always draft or set up a covenant not to compete if it wanted to protect itself, although this is not easy. SC Case: Futch v. McCallister Towing:

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 Notes

Rule: Pre-Competition Set up Activities are OK and does not constitute a breach of loyalty. But some case law suggests that SC allows you to take some acts such as filing for articles of incorporation setting up the corporation going to the bank to get financing BUT CONTACTING EXISTING CLIENTS AHEAD OF TIME IS NOT OK!!!. APPLIES TO ATTORNEYS PREPARING TO HANG THEIR OWN SHINGLE!!!

o o

ALI says you cant compete unless The competition would benefit the corporation more than hurt it, or there is no foreseeable harm The competition is authorized in advance and ratified by disinterested directors by disinterested shareholders Serving on another board does not qualify as competition because you are not pursuing your own interests by doing so Breach of Duty of Loyalty - Usurping a corporate opportunity Must identify what a corporate opportunity is and what a director has to do when he is offered one Doesnt matter if you are an officer or an agent Northeast Harbor Golf Club v. Harris (Maine) Facts: Harris was president of the club for a while. It is unclear if she was a director. She was offered a piece of property b/c of her position. She bought it for herself and notified the club afterward. Later, while playing golf with the postmaster she found out about another parcel of land that might be available and bought it, disclosing later to the board that she bought it but indicating to the club that she was not going to do anything with the property that is not in the best interests of the club. The club didnt have the cash to buy the property anyway. Later, Harris decided to make a little subdivision out of the property. The club sued for breach of loyalty was president of corporation. During her tenure, the club thought about developing land to raise money but never did At one point, a broker contacted to see if the club wanted to buy some adjacent land o Fact that it was offered to her as President is key. bought it in her own name for 45K in 1979 without discussing it with the board. The board however took no action. She then bought another parcel in 1985 (which she learned about in individual capacity) in which she didnt tell the board until after the buy. Then another lot o She says she had no plans to develop at that time, and that such plans didnt develop until 1988 Court found that the club would have been unable to make these purchases because it never had any money- however this is somewhat disputed then tried to develop in 1988 and the board brought suit for breach of fiduciary duties claims she breached in buying the lots without giving notice to the corporation and time for it to buy the lots if it choose Seeks injunction and constructive trust Line of business test: If the opportunity is in the corporations line of business and the corporation is financially able to undertake the opportunity, then the officer or director cant take the opportunity for himself. o Court didnt apply this test b/c it is hard to decide if an opportunity is in a line of business and the ability to pay prong acts as a disincentive to resolve financing problems.

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 Maine applies- Corporate opportunity doctrine (5.05 -ALI test) 2 prongs page 323 o 1) Is it a corporate opportunity under (b)? o 2)How did you become aware of it? (A)As director of the company? (B)By using corp. materials? (2)Or, its closely related to the busness of the corporation o A corporate opportunity is Any opportunity to engage in a business activity of which a director or senior executive becomes aware either In connection with his job or under circumstances that would reasonably lead him to believe the opportunity is being offered to the corporation OR Through the use of corporate information or property and would reasonably expect it would be of interest to the corp. OR Any opportunity that is closely related to a business in which the corporation is engaged or expects to be engaged. (Broz Case would have applied here) o In this case, the first opportunity would definitely be a corporate opportunity because it was offered to her in her official capacity. The second opportunity might be a corporate opportunity because it might be closely related (they wanted to prevent development) o If it is a corporate opportunity - director or senior officer cant take the opportunity unless (full disclosure prior to taking the opp is key) first offers it to the corporation AND the opportunity is rejected by the corp AND the rejection is fair to the corp (burden on the insider to demonstrate fairness- they had proper disclosure) OR the opportunity is rejected in advance by disinterested directors following disclosure OR the opportunity is rejected by disinterested shareholders and the rejection isnt a waste of corporate assets (cant give away something that they shouldnt give away) o Special rule Concerning Delayed Offerings Way to Cleanse liability after litigation commences: Relief based solely on failure to first offer an opportunity to the corporation is not available if Such a failure resulted from a good faith belief that the business activity did not constitute a corp opp Not later than a reasonable time after suit is filed challenging the taking of the corp opp, the opp is offered to the corp and rejected according to the criteria above. Application o First- It was b/c it was offered to her in her capacity as president. o Second it was closely related to the business, so maybe. o So if the opportunity is closely related or the director learns of it while acting as director or with the understanding that it will be offered to the corp, then there is a opportunity Facts support this here ie first lot Board must then show it didnt have an opportunity to take it or that it didnt reject it properly

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She can then defend on grounds that taking the opportunity was fair but she cant use this where there was no offer of the opportunity to the corp Court adopts ALI test o Thinks Guff test is hard in that it asks you to determine what is in the line of business Also you shouldnt worry about whether the company has the ability to buy the property. o Questions page 325 1 the fact that the corporation couldnt purchase the properties is not determinative; finances wouldnt matter Broz v. Cellular information systems (DE) Approach to usurpation of corp opp. Facts: Broz was a director of CIS, and was also the sole stockholder of another cellular company. Broz was given a chance to buy cellular licenses in Michigan, and he did so without giving CIS a shot at refusal. CIS no longer had operations in Michigan. There was a company buying CIS that would have been interested in the licenses. never formally disclosed to the , but he did mention it to the CEO and one other member who said they werent interested in the license. He bought it for RFBC. At this same time, PriCellular was in the process of acquiring the , and it WAS interested in the license DE Court applies the Line of Business Test: o (1)there is an opportunity that is in the line of business of the corporation AND o (2)the corp is financially able to undertake it AND (3) the corporation has an interest or expectancy in the opportunity AND o 4) Director takes the opportunity, then he is breaching his duty UNLESS (meaning he can take it) the opportunity is presented to the director in his individual capacity AND the opportunity is not essential to the corp AND the corp holds no interest or expectancy AND the director has not wrongfully used corporate resources to exploit the opportunity Holding: Was not a Corporate Opportunity: Reasons ct held no corporate opportunity in this case o He became aware of it in his individual capacity. o CIS couldnt afford it not able to financially undertake o CIS had no interest or expectancy o He had no duty to disclose the opportunity, eventhough it would have been helpful for him to do it. o Further, Broz was only required to consider the facts as they stood when he accepted the offer, and therefore didnt have to consider the interests of the potential buyer. So, the fact that he didnt present the opportunity to CIS didnt create a violation per se. So CIS could not have an expectancy. Important - Under the ALI approach Corp Opp Approach: this could have been a corp opp (dont know if it was closely related or not) and if it had been then Broz was required to make the offer to the Board. Issue: What do you do if you are on 2 different Boards? o This problem only comes up in the context of closely held companies. o This problem rarely comes up with publicly traded companies.

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o Also in SC there are NO reported cases having come up on this issue. o Best advice to give to client is to take the opportunity to the board. REMEDY: Remedy is to unwind the transaction SC Rule: doesnt have an explicit rule, but it is likely that we will follow the ALI approach Breach of Duty of Loyalty- Self Dealing by Interested Directors Self Dealing: A contract or other transaction that occurs between a corporation and 1 or more of its directors or any other corporation, firm or entity in which one or more of its directors are directors or officers are financially interested. Cookies HMG v. Gray (DE) Facts: Gray is a director of HMG, and is their primary negotiator. He negotiates a sale of land to NAF, in whom he holds an interest. He did not inform HMG that he held an interest in NAF. There was also a director Fieber who had an interest in NAF which he disclosed. Fieber knew of Grays interest and did not disclose that interest. Gray and Fieber are two of five directors in corp, which buys and sells commercial real estate. Gray negotiated a sale to NAF Fieber owns an interest in NAF but he discloses and abstains from voting Gray, through relatives and related business entities also owns an interest in NAF but he does not disclose and he votes and he negotiated the sale to NAF o He is on both sides of the company Fieber knows of Grays buy-side interest but doesnt disclose it o Court finds breach of fid duty of loyalty and care Bad behavior was discovered 13 years later and the court still dives into it Proof of undisclosed self-dealing is suffcient to rebut the presumption of the BJR and its protections. Instead, the entire fairness standard is used Because the vote was made without disclosure it will be deemed non voidable only if fair to the at the time is was made have BOP to show that it was fair under careful scrutiny RULE on Validity of Interested Director Transactions: o Director self-dealing will not void a transaction if a majority of disinterested directors ratify the deal, OR the shareholders ratify the deal, but ratification is only valid if the material facts as to the directors interest are disclosed to the body that ratifies the deal. OR o If there is no disclosure, the transaction is not void if the self-dealing directors can establish the fairness of the deal: both (1) fair dealing and (2) fair price. BURDEN ON DIRECTORS (defendants). The court applies the socalled Entire Fairness Test. Fair Dealing You have to show the Process was Fair: Fairly timed, negotiated, disclosed, and assent to the deal obtained. In this case, there couldnt have been fair dealing because the main negotiator was on both sides of the deal. Cookies also added the BJR to evaluate this prong and added the aspects of Good Faith and Honesty. The defendants want the business judgment rule to apply so they dont have the BoP. Fair Price: You have to show that the result is fair. Just because a price is in the range of market price doesnt make it fair if the corp might have refused to make a transaction if it had known some material fact. Also profitability is not dispositive (Cookies)

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In its valuation the court says that the appraisals were out of date. The rental income from these properties was increasing. o The failing or passing of 144 test only establishes whether or not the transaction can be invalidated solely because its an interested transaction. Therefore even if it passes this test, the BJR can still be applied to challenge the transaction. 141 is a floor board conduct and not a ceiling. o Be careful to hire appropriate expert witnesses, they can be outcome determinative. In this case the expert was not reliable. o Holding: Gray, as the interested director, did not satisfy his BOP to show that the price was fair in other words HMG would not have gotten way more if he had been disinterested. Also mistake in valuation in this case: Fee Simple Value vs. Lease Value Court says if the property is subject to a long-term lease, you probably look at the value of the lease - however not the case in this instance so you need to look at the fair market value of the fee simple. REMEDY should be the difference in the fair value and the price they should have received. The Court here hammered the defendants (fairly unusual remedy). The Court partly unwound the transaction and gave some of the properties back to the company. Distinguish corporate opportunity cases from interested director cases: In corporate opportunity cases, one would expect the court to impose the following remedy: take the opportunity out of the pocket of the wrongdoing director and give it back to the company Corporate opportunity takes something away from the corp Interested director probably causes less total harm (here no one is stealingthe price just wasnt right, so somehow we make up the difference as the remedy) The remedies for each bear this distinction out Cookies v. Lakes Warehouse (IOWA) Cookies made BBQ sauce, and they werent very good at marketing. Herrig was a minority shareholder and owner of a distributing Co. They brought him in for help, and he started kicking butt. Eventually, Herrig became majority shareholder and put his guys in the directors chairs. Then made a bunch of deals giving his own businesses expanded deals and he gave himself a bunch of increases. Cookies, regardless of ass kicking, did not pay dividends, so other shareholders got squat. Shareholders argument is that he could have used the money he paid himself to pay off the loan so then they would be able to pay out dividends. Why are shareholders suing when company is making bank The minority guys arent getting dividends and cant sell it on the stock market because its not a public company so its harder to sell But they couldnt pay dividends because of the loan so why would they bring suit knowing this o You could take the money they were paying him to pay off the debt Cookies test for self dealing transactions (very similar statute to previous case): o The interest was disclosed or the deal approved by the BOD without the votes of the interested director (this case!), OR o Interest is disclosed to shareholders who authorize such a transaction by vote or written consent, OR o The contract or transaction is fair and reasonable to the corp. BOP on director (D) to establish that they acted in good faith, honesty, and fairness in duty of loyalty cases!

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 Fair price: Court said that profitability alone doesnt establish fairness. However, there was no evidence that Herrigs fees were too high. Fair Dealing: Court also applies the Business Judgment Test to assess whether they were fair or reasonable to the Company. o However, court says that in addition to showing one of these three, there must be a showing of good faith, honesty and fairness on the part of the interested party Seems like Del says the same thing but maybe not The question is had this deal been made nonvoidable by the statute: he disclosed his interest to the directors and they voted. The concern is that he put all his own guys on the board. Negotiations There must be an ear mark of arms length negotiations claims the court should look at market value of s services rather than the success brought to Court agrees that success should not be the sole criterion, but these facts dont show he was unfairly compensated Court finds the success is important though and court doesnt think the company would have been as successful without Herrig So they say they did meet this burden but they dont say how which is the dissents problem Duty to Disclose The duty does not extend to minority holders The decisions are management activities, so disclosure to board is enough The board here was aware of Herrigs interest, so there was disclosure SO no breach Holding: Court held that the self-dealing was ok b/c Herrig had disclosed his transactions and the material facts to the BOD who approved it (although there is the question of the fact they were all his guys). Dissent Agrees with law, but not with application Duty of good faith requires not just a showing of profitability, but also a showing of the fairness of the bargain to the interest of the corporation thinks this was not shown here failed to show that his rates were comparable to others in the locality. It was his BOP to show the fair market value and that his rates comported to that o This was his burden and simply showing profit doesnt meet it SC 33-8-300: General Standards for Directors: SC has specifically imposed a duty on directors to act in the best interest of company and shareholders. This is different from most states. A3 is unique to SC director has to act in best interest of the company and the shareholders so there is an added burden compared to most states SC 33-8-310 Test for Director Self-Dealing Apply the Same test in Cookies with 1 exception BOP on P. (a) If disclosure to directors or shareholders was proper and transaction was approved by the BOD, then the burden of proving that the transaction was unfair falls to the party claiming unfairness. Yes there can be challenges to the fairness of the deal but if its proved under (3) director has showed it is fair that is enough, but definitely is enough if the BOD has approved it. Conflict of interest transaction statute Not voidable by the corp solely because of directors interest if

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Disinterested board has approved Disinterested and informed shareholders approve Fair to the company If one or two has been accomplished, the burden of proving unfairness is on the party claiming unfairness Look at statute for other provisions Ie indirect interest if he has direct interest in another corporation is a party to the deal o 4th Circuit has stated that the immediate family of members of boards are not disinterested parties SC 33-8-111: addresses director compensation Unless the articles of incorporation or bylaws provide otherwise the board my fix the compensation of directors for their services as directors or any other capacity ie officers So this insulates compensation decisions from claims of conflict of interest SC 33-44-409: The LLC statute is very different. (e) a member of a member-managed company does not violate a duty or obligation merely because the members conduct furthers the members own interest F) a member of a member-managed company may lend money to and transact other business with the company. As to each loan or transaction the rights and obligations of the member are the same as those of a person who is not a member subject to other applicable law So LLC can have interested members Who sues and who recovers? Shareholder Derivative suits o A derivative suit is when a shareholder sues to vindicate a claim that the corporation should have made (questioning a corporate decision). On the one hand, we do not want to permit untoward secondguessing of management. On the other hand, there may be cases in which we question the directors ability to make an impartial decision about whether the corporation ought to sue. o She stands in the shoe of the corporation in asserting the claim against TP So the COA must be one that the corporation has o Right to sue is a management decision ie they did something wrong, so the BJR will apply Most derivative suits fall into this category o If the Corporation has a good faith reason for not wanting to sue, then the shareholder will not be allowed to bring suit o BUT if the suit is against a director, then there is a good chance that the corporation wont bring suit, but we may allow the shareholder to do so because the directors are not impartial o But there will be strict limits on the shareholders right to sue o One is that they must provide security against the corporation expenses Ie provide a bond in case he loses But many states dont require this if the shareholder has a large amount of stock in the company because they wouldnt sue and risk their investment unless it was really worth it o Distinguish derivative suits from direct suits in which the has a personal claim o One hint is that the conduct affects only some shareholders rather than all of them o Eisenberg v. Flying Tiger (NY) Plaintiff owned stock in Flying Tiger Airline which owned FTC which owned FTL. Flying tiger merged into FTL, but the shareholders of Flying tiger got stock in FTC, which was just a holding company, so they no longer had a vote in the company that runs the airline. o (owned stock in) Flying Tiger line (Flying Tiger) (freight and charter airline Flying Tiger Corp (FTC) (wholly owned subsidiary) FTL (subsidiary) Flying Tiger then merged with FTL so that Flying Tiger ceased to exist and FTL survived and ran the airline Stockholders in Flying Tiger got stock in FTC (not FTL)- so owns stock in the holding company, which has FTL as a subsidiary

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o o

Not saying the directors have done something bad and should be accountable, just that they made a bad decision sues arguing that this merger deprived him of any control of the company that runs the airline Issue: Is it a direct claim or derivative suit? Court said that a derivative suit was one brought in the right of a corporation to obtain a judgment in its favor. Ex of Direct Suit: Separate Injury S/H injury that was separate from the corporation A director action that restrained the right of conversion from preferred to common stock. Actions to compel dissolution are direct because the corporation cannot benefit from the action. A proposed recapitalization that will benefit one class of stock more than others is direct. Because you have one group of shareholders benefiting from the other group, but the corporation could care less because its not affected. Rule: Action by the directors that negatively impacts the ability of a S/H to vote his or her shares is a direct claim the harm is to the S/H not the corporation. But this case is in the gray area says it deprived stockholders of vote says it affected shareholders secondarily because the real affect was dissolution of the corporation Note that if this suit had been characterized as an action against directors for changing forms to a holding company, that would have been derivative because changing forms is a business decision and the duty runs only to the company Majority Rejects the old NY Test: whether the object of the lawsuit is to recover upon a chose in action belonging directly to the stockholders, or whether it is to compel the performance of corporate acts which good faith requires the directors to take in order to perform a duty which they owe to the corporation, and through it, to its stockholders. P. 356: suits are now derivative only if brought in the right of a corporation to procure a judgment in its favor. Majority Test for Determining Whether a Suit is a Direct Suit or a S/H Derivative Suit: Current DE test is found in Tooley: Who suffered the harm Corp or S/H o Independent of the Corp, was the duty breached a duty owed to S/H? o If youre going to have a direct claim, the harm to the shareholders must be separate from harm to corporation o You can have a direct suit even if there are a number of harmed shareholders Who will receive the benefit of recovery or remedy? Shareholder direct injury must be independent of any alleged injury to corp Shareholder must demonstrate that duty breached was owed to shareholders and she can prevail without showing an injury to corp Court sides with and finds this is a direct suit Lazar v Knolls held direct suit where shareholder was not allowed to attend a stockholders meeting This is similar to what challenges here that the has interfered with his right as a stockholder Horwitz v. Balaban sought to restrain the granting of conversion rights to the president by the corp = direct Why is this direct rather than derivative

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Not sure what conversion rights mean in the context of this case but presumably it gives the president some right to stock in the company, and if gets these shares wrongfully then it hurts the stockholders The action has to be brought to procure judgment in favor of the corp, not the shareholder this is the new test Cases show that where shareholder sues on behalf of himself and other shareholders to enjoin a proposed derivative right he is enforcing a right common to all the shareholders which runs against the company Here is it even stronger since the shareholders normally retain voice in the company after the merger here they no longer have voice in it o Fact that didnt sue for money is important because when you sue directors for money, there is a big incentive for them to settle = a strike suit. Preventing strike suits is one reason there are burdens in bringing derivative suits. Here is suing for his rights as a shareholder. Not for the companies rights o Whether it is derivative or direct depends on: who suffered the harm the Corp or shareholder individual who should receive the benefit of the recovery or other remedy corp shareholder o Both of these are recent statements by Del SC what was happening were a series of lawsuits where the defense was that it had to be a derivative suit because it wasnt to the individual shareholder, but to a number of shareholders #2 clarifies that this fact is not a bar to a direct suit the injury can happen to many S/H just not the corporation Direct v. Derivative Hypos problems pg 359 Conversion Rights: - right of a shareholder to convert their shares into preferred stock Direct Issuance of shares without regard to preemptive right (co. issues more stock and doesnt give the S/H the first right to buy more stock): Direct or Class Action Suit for failure to permit shareholder to inspect: Direct Directors enter into a new line of business not allowed under the articles: Derivative (nature of the business is something concerned to the corporation as an entity; trying to interfere with business operations of the company). Directors waste funds: Derivative because how company uses funds is related to the company Shareholder in a close corp improperly takes money from the corp: likely derivative even though it might only hurt one shareholder; the injury is to the corporation Vicarious liability problem 5.7 (bouncer punches guy the face)-: Direct; Shepherd can sue Freer and the company for vicarious liability Usurping a corporate opportunity is generally: Derivative Payment of Dividends?: Derivative step 1: must determine if $ should be paid out of the corporation and that consideration is a determination of what is in the best interests of the corporation. Robert is the minority shareholder in Co. X, which is a close corp. He sues the controlling shareholders, alleging that they have breached fiduciary duties by oppressing him. Specifically, he alleges that while they have had the corporation hire them and purchase their stock for cash, they have refused to allow the corporation to do such things for him: Could be Derivative or Direct harder to tell in this case Clearwater Trust SC didnt catch on to Del rule that a direct suit can involve injury to many shareholders instead it said that this type of case was a derivative suit

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Derivative Suit vs. Class action Rule: Derivative and class action suits are used to assert different substantive claims People tend to see derivative suits and class actions either as (1) wonderful tools for achieving justice or (2) legalized blackmail Burkhard thinks derivative suits are a method of preventing justice Derivative suit an individual steps up to sue on behalf of the bests interest to the corporation basically b/c the corp has failed to bring suit.; meant to protect shareholders from directors wrongs because they cannot be expected to sue themselves Class action is a direct representation of a whole mess of similarly situated shareholders; however, the representative is also asserting her own personal claim Common traits o Representative cases both s are representing someone other than themselves o DS and CA are often lawyer driven. Yes the in a DS could get higher dividends, and a CA may get something, but the big bucks go to the atty. So attys look for these claims and then finds a shareholder or class member to represent o Potential for abuse is real the will be willing to settle, which means the other class members or S/H wont get much Which is why there are regulations Such as security bond in DS to pay corporation litigation expenses if it wins New Chancery Court Rules have limited class action solicitation activity by attys : DE has stepped up with a new set of rules with who can be the head plaintiff and who can be the atty Procedural requirements of derivative suit 33-7-400: Procedure in Derivative Proceedings: Derivative suits may be maintained on behalf of SC corporations in Fed and State Ct in accordance with the applicable rules of Civ Pro. Joinder of corporation and alignment of parties o Corporation is a necessary party and must be joined because Recovery goes to corporation To ensure that the claim that the judgment will have a claim preclusive ie res judicta effect o Usually the corporation is joined as a defendant But because the corporation has failed to enforce the claim, it is named ad a nominal then realigned as a o Wrongdoers are joined as real o Because the corporation and the directors have different interests they will require different attys As a practical matter there has a been an atty representing the company for a long time and has had no contact with S/H but lots with the Directors so who do they represent in the derivative suit Stock ownership and Standing SC 33-7-400 and SCRCP 23(b) below o Must have been a shareholder at the time of the transaction you are complaining about o A transferee by operation of law can stand in the shoes of the shareholder who owned at the time of the transaction and sue. Idea here inheritance of shares after original shareholder died. o No minimum value of stock necessary o So you cant buy stock after the wrong and sue contemporaneous ownership requirement Assumption is that he didnt suffer an wrong because the stock would have had a lower value in reflection of the wrong doing Continuing wrong some courts allow standing if you owned stock at any point of the wrongdoing so you could buy it after the initial wrong and still bring suit if the whole impact hadnt occurred yet

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 o RCP. o

SC Civil Rule 23(b) page C36: Derivative Actions by S/H Has nothing in the Code on Shareholder Derivative Suits only have

Requirements of a Complaint: P must verify that he was a S/H or member at the time of the transaction about which he complains and that his share or membership devolved him by operation of the law. Must also verify with particularity efforts made by the P to obtain the action he desires from the directors or reasons why he failed to make the effort Action may not continue if it appears that the P does not fairly and adequately represent the interests of the S/H or members similarly situated. o B 39 LLC s33-44-1101-1104 - Derivative Suits Code Section So you have to consider both the Civil Rule and the Statute in dealing with S/H derivative Suits and LLCs Most of the time there are no inconsistencies between these two, however sometimes there are. Ex of a Difference btwn Corp and LLC: Corp - under Rule 23 if a S/H dies the stock devolves on the beneficiary beneficiary will still have standing without the allowance, no one could bring the suit. LLC statute person who receives an interest in an LLC b/c of death doesnt get same rights gets financial rights but not legal rights no standing to bring suit these limitations do not apply to an inheritance or devise of an interest in a corporation. Security for expenses o Required in NY o SC no requirement Demand on Directors o THIS IS THE BIG ONE!! 75% of all litigation involving derivative suits revolves around this o General Rule: you have to make demand on directors in a derivative suit unless demand would be futile. o Most states follow DE rule: the decision not to honor the demand or demand refusal can be tested P can commence an action and make a demand BOD Refuses Demand P can complain that the BODs refusal to honor the demand should be questioned BJR applied to BODs demand refusal - BODs decision will be honored unless the P meets his burden of showing the demand was reasonable under the circumstances. If BJR kicks in, you have to show lack of informedness or conflict of interest P almost always loses! o So the Norm in most jurisdictions is for the P to argue in their initial complaint that they dont have to make a demand demand is futile that is the norm in most jurisdictions that follow the NY mold. Demand Requirements Jurisdiction Depending: o Note: Most states have a rule requiring you to make a demand first. o Marx v. Akers (NY) - How to Argue the Demand is Futile. o Plaintiff brought a derivative suit against directors both for giving themselves improper raises and giving the executives improper raises. P moves to get the corp to reverse the increase in

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o o

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compensation/ Plaintiff made no demand. Ds moved to dismiss the case based on the pleadings in all of these types of derivative actions you are dealing generally with what is in the pleadings. Ds argument P was required and failed to make a demand, and even if they had, there is no cause of action for either of these types of behaviors Claim is that IBM wasted money by giving excessive compensation to its executives and outside directors ie self-dealing and breach of fid duty So two claims Paying officers too much Paying directors too much Issue: Is a Derivative Action based on Improperly Raising the Directors Compensation a Demand Futile Case? Two defenses Court finds that demand was not excused and no COA is stated so case dismissed reasoned that excusing the demand simply because all board members are named s would completely undermine the BJR as it applies to deciding when to bring suit Demand is not excused and no COA is made because there is a statue allowing the board to set compensation for its members without facing self-dealing accusations Remember that DS is brought on behalf of the corp to secure a judgment in its favor NY Ct states 3 Purposes of the Demand Requirement: Relieve courts from deciding matters of internal corporate governance by providing directors with opportunities to correct alleged abuses. Provide corporate boards with reasonable protection from harassment from litigation on matters clearly within the discretion of the board. Discourage strike suits commenced by S/hs for their personal gain rather than for the benefit of the corporation. 3 Different Approaches to Determining the Futility of a Demand: DELAWARE Approach: Must state with particularity the fact that you made demand on directors unless it would be futile OR establish with particularity the reason you did not make a demand was b/c the demand was futile. DE/NJ/SC -To Establish Demand Futility- Aronson: Ps must allege with particularized facts which creates a reasonable doubt that: Directors are disinterested and independent or there was undue influence by an interested party AND The challenged transaction was a product of a valid exercise of business judgment by the directors. o A reason to doubt that the action was taken honestly and in good faith or o SEE HANDOUT ON TWEN SITE Court says these two prongs are disjunctive o Meaning that the and should be or o So show either one and you win If you meet the first prong ie you show director interest the BJR is out and demand is not required o Or if you show the director was influenced by the interested party Whether there is valid business judgment depends on whether o They were informed (procedural due care) o And substantive due care - terms of the transaction Some criticize the reasonable doubt standard Note: in DE, making demand is an admission that the directors were disinterested, and as such making demand is an admission that demand isnt futile SC does NOT have this rule! UNIVERSAL DEMAND (ALI test): Demand required in all cases. Only allows filing before response to demand if there is threat of irreparable harm. If demand rejected, the decision to reject

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the suit is tested by balancing the character of the suit against the deference the directors must receive. This has been adopted by Georgia and NC among other states. This means that derivative suits are worthless since demand is a kiss of death Problem: If you have a universal demand and you follow the DE approach as the evaluation of the demand which is the BJR BOP on P, P always loses! This approach is somewhat plaintiff friendly. Series of complex rules to evaluate the BODs decision to reject the demand! NY 3 Prong Test: Must make demand unless you can state with particularity that: A majority of directors are interested in the transaction OR The directors failed to reasonably inform themselves about the transaction OR The directors failed to exercise their business judgment in approving the transaction. The challenged transaction was so egregious on its face that it could not have been the result of sound business judgment Considers Barr v. Wackman board accepted less favorable terms for a merger after being offered considerable compensation in various forms Demand was excused b/c of self-interest of board members for those receiving benefit Demand was also excused for outside members that were disinterested because it was a breach of due care and diligence to the company by rubber stamping the interested directors plan But you cant just make conclusory allegations o There must be particularity After Barr, cases were allowing conclusory allegations, so court states new requirements Particular allegations that majority of board is either directly interested or that it its members are controlled by interested directors Particularity that they did not fully inform themselves Particularity that it is so egregious that there could not be sound business judgment Ct. is harping that its important to plead particular fact. Holding: The court applied NY and excused demand in the claim against the directors because 12 of 15 were interested. However, the case was still dismissed because the complaint didnt state a cause of action because directors set their own compensation and the complaint didnt allege compensation rates excessive on their face, etc. claims directors were interested because they were awarding themselves compensation and that the others simply acquiesced Officers: demand was not futile to them because they do not make a majority Only 3 got a raise- there has to be a majority that is interested Doesnt say they failed to use business judgment So demand is not futile as to the inside directors Outside Directors However, the also alleged that a majority of the board was interested because the outside directors also set their compensation, and this consists of a majority of the board so demand would have been futile under this fact But there is no COA because the statute allows them to do this and the complaint only makes a conclusory allegation that it is excessive He needed to show breach of fid duty or fraud o BOP shifts depend on whether it was approved by interested of disinterested shareholders Here the raises werent excessive on their face to give rise to breach of fid duty or fraud The Court would be willing to question compensation in the case of fraud; where directors or officers appropriate the income so as to deprive shareholders of reasonable dividends, or perhaps

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so reduce the assets as to threaten the corporation with insolvency. If I was a shareholder, I would much rather bring the case as a direct suit. o SC 33-8-111 Compensation of Directors- Allows the BOD to set their own level of compensation. SC ct. would likely look to the language on page 288 that where the compensation looks like frau, the ct. will delve into it. o Why do we care about demand? If a shareholder makes demand, and the corporation rejects, that rejection is subject to the business judgment rule, P almost always loses. Thus, if the shareholder has to make demand, their suit is likely dead in the water What if the Demand is deemed futile and is allowed to proceed o Settle or litigate o OR directors will move to dismiss arguing that the potential benefits from the corporation continuing the suit are not worth the costs o Traditionally such motions are proper when the suit is against a TP because the shareholders are disinterested and the BJR applies o But if the DS is against the directors, then the court wont recognize the motion bc of the conflict o To get around this, the atty would have the board create a special litigation committee that excluded the interested members. This committee would then make the motion Problem is that the interested ones are involved in appointing members to this board Courts vary on how they address these committees o Special Lititgation Committee Hired to Evaluate Demand Refusal: Nowadays, usually a committee is appointed to evaluate whether or not the lawsuit will continue; universally the committee will consist of directors that have no relationship with the alleged wrongdoer. The committee will universally hire an expert to guide them in their evaluation and this will usually be a retired judge and hire an expensive corp law firm almost universally they will always decide to file a motion to dismiss! After you file a Motion to Dismiss these next cases deal with that: These cases come after the demand futility mechanism as a defense bar. o Auerbach v. Bennett (NY) Facts: Directors had been authorizing bribes, and shareholders successfully initiated a derivative suit. The company created a minority litigation committee of 3 disinterested directors to decide if they should pursue the litigation. argues that no SLC appointed by the directors should not be recognized Court rejects the directors are the only ones who can appoint such a board and the only ones that can authorize suit against the interested directors So court just assumes that the SLC is disinterested and independent To side with would be to deny the board its ability to make business judgments for the corporation regarding the suit o If someone outside the board made this decision, it would be a breach of the nondelegable fid duty of the directors to act in the best interest of the corporation Issue: They decided not to pursue, and the question is whether business judgment rule should apply to the decision to terminate the suit. 2 Prong Test to Evaluate Committees Decision to Terminate Litigation: Was the committee independent and disinterested Was their process satisfactory

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The court said that so long as the members of the committee were disinterested (the court assumes the committee was disinterested in this case), the action to dismiss was proper IF The committees procedures in pursuing the decision to dismiss were appropriate. o As long as the methodologies were created and followed in good faith, its cool. o This is the only consideration that the court will review o Courts are well equipped to review the method and procedures used to investigate facts and determine legal liability o Must choose the methods of investigation in good faith if you do this, the court wont review the decision o So basically have to show you were informed- or took measures to be informed If the decision to dismiss was properly predicated on the data produced by the process. o This decision is classic business judgment, so doesnt get looked at much Application o Record does not show deficiency in methods used by SLC. They made through investigation of pertinent areas o Use of special counsel o Reviewed report of audit committee o Questioners were sent out As a practical matter what these committees do today is to hire someone with high profile to advise the committee normally a retired judge = CYA o Also use best corporate law firm they can think of o 90% of the decisions are to dismiss everyone knows they will dismiss Often hang hat on saying that yes we can get money, but dragging this out will bring the corporation down or negatively effect the directors will hurt the company more than its worth o The reason they decide to dismiss does not have to relate to the merits of the claim So Auerbach limits review to the procedures and good faith investigation of the SLC without regard to the ultimate decision o Zapata v. Maldonado (DE) Facts: Plaintiff brought derivative suit without demand. He claimed that, since all the directors participated in the acts he specified, demand would be futile. Four years after filing, we got some new board members who were by definition disinterested, and Zapata made them into a litigation committee to investigate and decide what to do. Committee (in the shocker of the year) decided to dismiss the suit. Required them to pay a tax difference between the original value the stock was issued at and the price the stock is now selling. So if the price of the stock increased, it makes sense to exercise the option. It was to the directors advantage to have them exercise the option early. But the issue in this case is that the shareholder was going to have to pay tax on the differential. - $10 in this case. This is a derivative suit, so where is the injury? Who was injured? It just dont look right that you should be giving the directors this special benefit. The corporation was also going to get a larger deduction if the stock options had been exercised later down the line.

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And the company doesnt get as large a tax deduction if they exercise the stock option early like they wanted to do than it would if they waited to the date that they were initially allowed to exercise it The SEC has gone after a # of companies recently for going after stock options. How is the Co. hurt if they allow the S/H to do this? what is the injury to the Co.? (Remember: S/H derivative suits must show an injury to the Co.) 2 Theories: One argument was that it wasnt right Co. was going to get an equivalent deduction that was equal to the amount of tax that the people were going to get; they would have gotten a larger deduction later First issue was whether the SLC has the authority to make the decision to dismiss for the company Yes it does and this is the same in SC Issues S/H continuing right to maintain DS after the corporation decides not to sue SLCs authority to move to dismiss Role of court in resolving conflict bw SLC and the S/H Right of SH in a DS No right to continue with DS once demand is made and rejected Sohland prior case that says the SH could continue after the demand is rejected but NOT when the motion to dismiss is made SH only has right to start the law suit, not to continue it if the directors elect to dismiss Also Sholand had special facts in that the board voted against the suit, but helped him to bring it But BJR wont protect decision to dismiss if there is a breach of fid duty Two contexts Wrongful refusal to sue Meaning the BJR rule applies as well as its exception o Lack of being informed o Fraud When demand would be futile conflict of interest A big issue was whether the interested directors could appoint a SLC would it really be independent and disinterested says it cant be Court says that it can Someone has to act on behalf of the company and the directors are the only one to appoint the ones that will However, the decision to dismiss the case is NOT tested by the BJR Same as last case in looking at the procedure used But they differ on how they look at the decision made Del court is going to look at the decision if the corp shows it acted independently Two Part Corp has to show that it acted independently and disinterested procedure BJR to the decision Informed and in good faith But court says the lower court may look at this and in practice, few have elected to do so If there is a SLC the practical matter under either NY or Del, the has lost Rule #2: The court says if the S/H makes a demand and it was refused, the refusal will be evaluated using the BJR!!! page 393 FN. Rule #3: A committee of disinterested directors can dismiss the suit if the committee can establish that

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o o o o o o o o

it is independent, AND it acted in good faith, AND that there was a basis for its conclusions o Balancing Test : the final substantive judgment whether a particular lawsuit should be maintained requires a balance of many factorsethical, commercial, promotional, public relations, employee relations, fiscal as well as legal we are content that such factors are not beyond judicial reach Note: the BOP is on the Committee, not on the P, as it would be under the normal BJR. The court, applying its own business judgment rule taking account the various justifications above, will evaluate whether it thinks the case should be dismissed. The court in essence makes its own business judgment as to whether or not the case should be dismissed (THIS IS A HUGE CHANGE IN THE PHILOSOPHY OF COURTS IN THE PAST!) The court, however, has rarely opted to exercise its own BJR. o 33-8-250: Committees -you can establish an independent committee to evaluate the litigation. NJ Demand Rules Look this up on TWEN The New Jersey rule will apply if there is a motion to terminate or if there is a committee and a rejection Burden on the corporation to demonstrate that in deciding whether to terminate the suit: the parties were independent and disinterested, they acted in good faith with due care in investigation of shareholders allegation, and that the decision was reasonable (this last step is different) Demand Futile Does not have to be made (Aronson DE Test) o Claim that the majority of the directors are interested in the transaction OR o Create a reasonable doubt that the transactions were a valid exercise of business judgment Demand Made & Refused: BOD must prove 3 things to prove that refusal of demand was appropriate. Independent and disinterested Acted in Good Faith w/due care in their investigation of S/H allegation BODs decision was reasonable. A special litigation committee will almost always be appointed and they will almost make the decision to terminate the litigation b/c it is in the best interest of the company, then above 3 prong test. is used AGAIN to evaluate the committees decision to dismiss the litigation There is a split whether plaintiffs are entitled to a jury trial for a derivative suit in the Supreme Court. In SC, the rule is clear that this is an equitable action so there is no jury. Court has to approve the settlement. SC Demand Cases When you read these three cases, it is definitely implied that the court would adopt 7.01 in the right circumstances, even though it doesnt actually apply it in any of the above cases. Is claim derivative or direct? If direct, youre home free. If derivative, does ALI 7.01 apply? If yes, youre home free. If no, you have to decide whether to make a demand or claim the demand is futile. If the P makes a demand and the D rejects the demand P challenges Ds rejection and the test is: (a) Delaware=BJ or (b) NJ three prong If the D wins, (1) DE finished or (2) SC or if the P wins the suit continues Zapata p 395 suggests D may move to dismiss If the P claims the demand is futile, the D can do nothing and the defendant moves to dismiss in which case (1) Auerbach, (2) Zapata, or (3) New NJ test

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If the P claims the demand is futile, the D can challenge the Ps futility claim (a) DE, (b) ALI, or (c) NY if the P wins (the demand is futile) the D can move to dismiss and (1) Auerbach, (2) Zapata, or (3) new NJ test It is almost impossible from the plaintiffs case to win a derivative suit o Grant v. Gosnell (SC) Facts: Shareholder sued bank for mismanagement. Defendants claimed that the plaintiff didnt make demand, and as such the court didnt have jurisdiction. Issue: Do you first have to make a demand on the BOD to rectify the problem? SC TEST: Court said that generally you have to make demand unless you can show sufficient reason not to do so. Can do so by showing The directors or managing board are themselves the wrongdoers in a breach of trust and had control over the corporation. In evaluating whether or not to require a demand, the court should be lenient (the Whittle case cuts back on this a little bit) In this case, because Gosnell had control of the majority of the stock, it could be presumed that he wouldnt respond to demand and as such no demand was necessary. Factual question whether demand is excusable so case by case Here it was because a named owned 51% of corp. he was also on the board o Places more importance that the named have a majority of the stock and dismisses a requirement that the named consist of a majority of the board o Funny because its a director decision not shareholder decision to proceed and there was a new board (maybe court is saying they are not disinterested, but they dont say so) o Carolina First Bank v. Whittle (SC) Facts: Bank was involved with another company. The allegations were that the bank loaned Affinity, company, a lot of money. In exchange, Affinity gave the bank stock options. Some time later after that all occurred, the stock options were at a point that they could be exercised, but the bank could not itself exercise the stock options because of federal regulations. The bank simply gave the stock options to Whittle and some others directors of the bank as bonuses. They valued the options at $0.88 a share. At the time, they were worth a lot more money and Whittle and the board knew that or should have known that. They were really getting stock worth somewhere around $10-$12. The board had gotten a letter saying the shares were worth very little, but Whittle had a plan to go public, and he knew the stock would go up 20 fold. The company went public, and the bonuses went through the roof. Affinity was about to go public and Whittle knew it = insider trading didnt make demand. The court said that demand must identify the alleged wrongdoers, describe the factual basis of the wrongful acts and the harm to the corporation, and the requested relief. SC Heightened Pleadings Rule for Demand (SCRCP 23(b)(1) Court rejected the Ps claim on the basis that they did not make a sufficient demand on the BOD:The o The plaintiffs attached their demand letter, but did not refer to it as required in the rules of civil procedure, so the court said they didnt plead with particularity that they had made demand. o So b/c they did not refer to this issue in their initial complaint, they couldnt raise the issue on appeal Pleadings Rule! o This Complaint is not particular enough RULE at a minimum a demand must id the alleged wrongdoers, describe the factual basis of the wrongful acts and the harm caused to the corporation and request remedial relief If you fail to make a demand, the business judgment rule applies, same as Delaware.

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Issue #2: Can the Ps claim that failure to make a demand can be excused. The SC court also rejects the Delaware trap by stating that making demand is not an admission that demand isnt futile So if you make a demand and it is rejected then you can still argue a demand was not required in SC (or that demand can be excused). The court applied the SC test for demand futility from the Aronson decision: o Claim that the majority of the directors are interested in the transaction OR Ex -All of the board members are interested Ex - Board is controlled by Whittle Ex - All the board members are named as defendants Test: did the directors get the same improper benefit they are complaining about Argument that the board was controlled by Whittle (good argument but no particularized facts that board members were beholden to Whittle) o Create a reasonable doubt that the transactions were a valid exercise of business judgment. The Court found the plaintiff did not plead particularized facts that would excuse demand, so the particularized part is really strict The plaintiffs couldnt show that a majority of directors were interested b/c only 3 got the stock and there was no evidence that the remaining shareholders were beholden to Whittle. Further, judged under the available information at the time, the transaction looked like proper business judgment (the court makes a really strange argument about rescinding) SC Court will be strict in requiring particularized facts But if such facts are there, it will be lenient in finding demand was futile Aronson test will be applied in determining whether demand should be excused (Delaware case) o Whether the board was disinterested o Whether the decision was a valid exercise of the BJ claims that the following are basis for claiming futility The board is not disinterested The board is controlled by the wrongdoer Almost all board members are named as The board was responsible for the original actions complained of, which creates a reasonable doubt as to the boards business judgment WRONG First Prong of Aronson Test The interest must be more then involvement in the original decision- there must be a personal interest involved o The has claimed that only two members engaged in self dealing here, so the majority was not involved nor had self interest The second allegation the only made a conclusory allegation that the controlled the board must be particular in alleging that he controlled the other members o This argument would have worked if they had made particularized allegations Merely naming the board members as wont make demand futile if they arent interested Second Prong of Aronson Test

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 o o

then says if Del law is being applied then demand is excused if they create a reasonable doubt that the board exercised valid business judgment in making the decision and the fails to rebuke the assertion with particularized facts Court says the failed to create a reasonable doubt they allege that the board was misled in making its decision by Whittle and a few others. So no wrongdoing other than bad info so once the information became public the court says there is no reason to infer that they werent capable of rescinding the bonus if it thought it was good business judgment o This analysis is pretty weird because we are looking at the original decision. There is no mention of rescission. o Burky said it is difficult to believe that a bank would not have known about the pending IPO. Also its likely that another case in the country does not exist that states that a BOD couldve went back and undone the bad decision therefore it passed the BJR. Brown v. Stewart Facts: Brown partners with 3 other investors into this Health billing company. He invests 100,000. The other 3 decide to sell the company, and the majority of the proceeds were going to the 3 partners and Brown was being shafted. Issue: Was there a breach of fiduciary duty to the Brown? Was there a breach to that owed to the Corp? Derivative claim was thrown out. So Brown had to pursue it individually. The Ds claim that this is a derivative claim and Brown cant sue individually. Rule: P argues that an individual action is allowed if the alleged wrongdoers owe a F/D to the stockholder and full relief to the stockholder cannot be had through a recovery by the corporation. This exception allows a S/H to file an individual action for losses suffered by the corp if the reasons for requiring a derivative suit are absent. 1) it prevents a multiplicity of lawsuits by shareholders; 2) it protects corporate creditors by putting the proceeds of the recovery back in the corporations; 3) it protects the interests of all shareholders by increasing the value of their shares, instead of allowing a recovery by one shareholder to prejudice the rights of others not a party to the suit; and 4) it adequately compensates the injured shareholder by increasing the value of his shares. Ct. says that b/c Browns attorney cut two of the S/H out of the case, #3 is not present, all the shareholders arent being protected. Although the Ct. said it wouldnt apply this test it did. Burky said that if the right facts exist, SC may adopt this test. Davis v. Hamm (SC) o Facts: Davis was a shareholder and Hamm was president and director. The company had borrowed money to buy a computer and couldnt pay the loan, so the bank demanded the computer. Hamm gave the computer to the bank, but he had no right to take the computer from the company. Hamm tried to defend suit from Davis in that his duty ran to the corp. Davis brought a direct suit against Hamm because he had to sell his stock at a loss. o Issue Can a former SH bring a direct suit against an officer and director of the corporation for breach of duty owed to the corporation Court rejects proposition that former shareholder has standing to bring a direct suit This action belonged solely to the corporation There is some support that a direct suit can be brought by a minority shareholder in a close held corp but these dont apply here because sold his stock Jacobson v. Yaschick did allow a former shareholder to maintain a suit but there were only two SH in that Corp

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Rule from this case Officers and directors of a corporation must make a full disclosure of all relevant facts when purchasing shares from a stockholder o This is a minority rule This rule is inapplicable here because there was no failure to disclose and he sold to an outsider He might have been able to bring suit as a minority shareholder for oppression from the majority but he sold his stock and lost this standing We still have this statute allowing a minority shareholder to bring a direct action against an oppressive majority holder in a close corporation Court said it didnt apply because he was no longer a shareholder, but Burcky says he is being punished for doing the responsible thing in mitigating the damages o Rule: Any suit for misappropriation of the corp assets or liability for mismanagement of corp assets should be brought as a derivative suit. Rule 7.01 only applies if the suit would have been brought as a derivative suit but 3 requirements are met. o Court stated that 1) the assets of the corp belong to the corp, and 2) the liability for mismanagement belongs to the corp. In this case, any suit for misappropriation of the computer would have to be derivative. o P argued close corporation exception for direct suit where a plaintiff need not employ the form of a derivative action even though the action alleges in substance a corporate injury: if there was no danger to corporate creditors No danger of a multiplicity of suits, and No danger of prejudice to other shareholder interests. o ALI 7.01(d) (exception) pg 417 In the case of a closely help corporation the court in its discretion may treat an action raising derivative claims as a direct action, exempt it from those restrictions, and defenses applicable only to derivative actions, and order an individual recovery, if it finds that to do so will not: unfairly expose the corporation or the defendants to a multiplicity of actions materially prejudice the interests of the creditors of the corporation or interfere with a fair distribution of the recovery among all interested persons o GAs Thomas vs. Dixon applying 7.01 - reasons for Allowing a Direct Claim over a Derivative Claim: Prevents multiplicity of suits from shareholders. Protects corporate creditors by putting proceeds of recovery back in the corp. Protects the interests of all shareholders by increasing the value of their shares instead of letting one shareholder take all. Adequately compensates injured shareholder by increasing the value of his shares. 33-14-300: a shareholder who can allege and prove oppressive conduct; court responds saying his claim is not valid because he is no longer a current shareholder SC may allow direct over derivative when none of those factors are present SC upholds this ALI test- stated in the GA Thomas v. Dixon Case. SC 33-8-300 Directors fiduciary duty runs to corp & S/Hs!!! THERE is also a statute in SC that directors owe a fid duty to both the company and the shareholder Doesnt apply because she is no longer a shareholder Holding: Ct says that a director has a fiduciary duty to the corporation and the shareholders. Davis would have been allowed to bring this as a direct suit for

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misappropriation of corp assets under the close corp exception if he had not sold his shares. Burkhard thinks this was BS and is dead wrong! One of the first cases to acknowledge there would be a close corporation exception. Babb v. Rothrock (SC) Facts here are irrelevant squabble amongst the shareholders. Shareholders tried to argue for the right to sue directly for misappropriation of corporate assets. Relied upon a GA case which allowed a direct suit if certain criteria were met. Holding: Court rejects the 7.01 claim says you havent met the requirements for the exception. Unlike in Thomas this case involves the protection of corporate creditors (a reason compelling derivative action), by allowing the individual s/h to bring claims it could jeopardize the corp.s creditors claims. argues that s cant assert the claim for a setoff because it involved corporate property and is therefore the corporations suit Court agrees, they should have brought a derivative suit cite Thomas v. Dixon a Ga case where SH were allowed to bring a direct suit against a director where the reason for requiring a DS were absent Court says the facts are different here because there is an interest to protect corporate creditors o They have priority over shareholders, so it would be detrimental to the creditor to allow a SH to bring a direct suit to satisfy their personal debts by asserting a claim that belongs to the corporation Brown v. Stewart (SC) Brown bought 20% of mid Atlantic. As it turned out, the other shareholders used the cash he paid for his share to cash out their own investments in the corp (fraudulent representations). Value of corp went way down. Sued for breach of fiduciary duty and Brown tried to argue that he should have a direct claim that the duty should run to him, not the corporation. o Allegation Two Basic Claims Fraudulent Stock Sales ( you told me my money was being used for one thing, but it was used for something else) o Direct claim Mishandling of sale (breach of fid duty) o Derivative told they had each invested 25K when in fact they had characterized their funds as loans- they then used his investment to repay these loans with an interest of 16%. They had told him it would be used to buy equipment and hire people Also made misreps about the state of the company Also alleges breach of fid duty in negotiating a sale that was favorable to them and unfavorable to the o claims defenses for fraudulent stock sales They had no confidential relationship with to justify his reliance on their statements and that they didnt misrepresent anything Also that s loss is his own fault in failure to exercise due diligence Court concludes there were issues of fact that should go to trial o The fraudulent stock sale is a direct claim (even though he didnt win, the fraudulent stock sale claim is a potential winner) Did he have a right to rely jury issue

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 He didnt have a right to rely and he should have used due diligence and his failure to do that wipes out any fraud claim he might have had. Did he have a breach claim? Basic Defense against this claim: standing- should have been a derivative claim basic derivative suit o P says they have a way to get around it - can argue the 7.01 exception. Rule: Breach of duty of loyalty runs to the corporation. To get an individual action as a stockholder, your loss has to be separate and distinct from that of the corporation, which can only happen in this case if the fiduciary duty runs to the shareholder. The court stated the Thomas factors in Davis, but declined to apply them b/c the injury to Brown was the same injury the corp had incurred (not separate and distinct). Brown didnt join the other stockholders (he originally joined them but then he dismissed them; this was a silly mistake) Burkhard said that he could have also argued corporate opportunity. They started another company and excluded the plaintiff from that company. Burkhard says this behavior is more egregious than what is being argued in the case itself. Right to Jury Trial In SC you dont get one because the derivative suit arises from equity Federal Court if the COA that you are asserting on behalf of the company would entitle you to a jury trial (ie being an action in law) then you get one Court Approval of Settlement or Dismissal Because it is a representative action, the court must give approval it like it would for a class action Recovery in Derivative Suits The corporation recovers, but the shareholder is allowed to recover costs and fees o Recovery in derivative suits o Generally, the corporation gets the recovery o The successful plaintiff gets costs and attorneys fees o There is also a res judicata effect of the suit if the corporation wins o Who really pays with regards to these o Directors seek to protect themselves o Statutes allow them to limit liability except for o Intentional or reckless or gross negligence (in SC) o but these only cover claims brought by the shareholder or company and dont cover breach of loyalty Insurance All publicly traded companies have director insurance it is rare for small SC corps to have director insurance Indemnity Directors do not have a common law right to indemnification because the director isnt the agent of the company. So it has to come from statutes, bylaws and articles, and K o Rest 2nd Exceptions to CL directors right to indemnification: If Directors actions Illegal, OR Not to the benefit of their employer, OR Negligent o Rest 3rd of Agency814 - Agents of the corporation are entitled to indemnification

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 Principal has the right to indemnify an agent in accordance with the terms of the contracts, when an agent suffers a loss that should be borne by the principal under the circumstances 33-8-500(5) Distinction in capacity was it in his official capacity or was he working for someone else at the time? 33-8-510: Authority to indemnify o May indemnify if director (pre-conditions to getting the Cash) Conducted himself in good faith Reasonably believed that his conduct was in the best interest of the home company In the case of a criminal proceeding, he had no reason to believe the conduct was unlawful. o Rule: A guilty plea or a finding of liability do not preclude indemnification as long as the 3 requirements above are met o May not indemnify if Director is liable to the corporation Director gained an improper benefit from the transaction 33-8-520 Mandatory Indemnification o If a Director is found not liable (wholly successful on the merits or otherwise) he has the right to recover reasonable attys fees o This is still true even if he or she prevailed on a technicality such as a SOL. 33-8-530 Advance to Expenses: o Normally a corp can loan fees to its directors to defend, although this is not allowed under Sarbanes Oxley. The corporation may advance the director expense of the litigation if Written affirmation of his good faith Written underpayment in to repay the company if he looses A determination that the facts are such that he wouldnt be denied indemnification 33-8-540 Court Ordered Indemnification - court can order indemnification in some situations. 33-8-550 Determination and Authorization of Indemnification: Board has to determine if indemnification must be made, but they have to make the determination if the person is entitled to money and if they are entitled whether or not the payment can be made. Asking the company to indemnify Company cant do it unless Determination that director is qualified to be indemnified by the board Authorization- that the amount is reasonable got to make sure there is enough money to pay 33-8-560 Indemnification of Officers, Employees and Agents: an officer who isnt a director is entitled to indemnification. 33-8-570 Insurance: You can buy director insurance and it can be broader than the insurance provided for by statute 33-8-580 Application of Article: cannot change the scope of the statute in your articles. o If the AIs limit indemnification or advance for expenses, it is only valid to the extent it is consistent with the articles. 33-44-403 Indemnification for LLC o Members SHALL be indemnified for liabilities incurred in the ordinary course of business o It is possible to opt out of this requirement o

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Questions 405 o 1) she may be indemnified in both o 2.1 maybe but not likely o 2.2 Always put indemnification provisions in the articles Insurance o Corporations can buy liability insurance for their directors and officers (D/O insurance) o Most close held corps dont have this o Claims dont come up o Its to expensive o 411 Question 3: Our statute says in this case they are not allowed to pay (510) o D&O - Insurance Most states have provisions authorizing corporations to purchase and maintain liability insurance to cover their directors. For closely held businesses insurance is probably unavailable at economic cost. B/C there is no question as to whether or not a corp can purchase this insurance if they are willing to pay a premium. o Corp. Consideration in Purchasing D&O Insurance: o Business questions such as whether to buy D&O Insurance and if so what kind o Contract law questions such as what is covered by the policy and who makes what decisions with respect to litigating and settling claims. o How does a corporation grow? o To Grow, a corporation can o Borrow Money Lenders like borrowers with unencumbered assets that can be used as collateral for the loan Covenants used by lenders to require financial and operational commitments until the loan is repaid ex- limits on distributions Default is defined by the parties so it could reached if the assets reach a certain level o Sell interests in the corporation o Use Earnings o Borrowing Businesses often prefer debt over equity Adv of Debt Allows for leverage Less risky than equity Costs less to co. Interest pmts are deductible Loan payments get paid first Debt doesnt usually vote SC, we allow for voting debt Equity Adv Lenders only lend amt they are sure will get paid back fear of bankruptcy too much debt in low cash flow yrs Reduces risk in capital structure by lowering amt of debt and the fixed costs associated with debt. Debt v. Equity o Equity holders get higher return than creditors because they take a bigger risk o They are not guaranteed to be paid back o Have no collateral o Creditors get paid first o So you pay less for debt, and you get a tax discount so there is big incentive to use debt financing o But bankers will only give you so much, and debt has a greater risk of bankruptcy o Issuing more stock o Dilution if stock is issued so that the percentage of ownership changes, your interest is diluted if you own a smaller percent

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o o

Preemptive rights if you have this, then you have the right to purchase the number of shares of any new issuance of shares that will enable you to maintain your percentage of ownership Hypo o Close held corp- SH A, B, C Each owns 10 shares, so each can elect 1 of the 3 directors If A and B decide to gang up on C, they might cause more shares to be issued and have them issued to themselves or to a TP The would then be able to outvote C and get him out the picture So ability to issue more shares is very important o Now we have 5 SH Each puts in 200 per share Then sell more at only 100 per share The old guyes shares become less valuable so o So preemptive rights can be used to prevent diluting control and to prevent sell of shares at such a low price as to dilute the equity value of the shares of the prior SH Preemptive Rights and Other Rights of Existing Shareholders o Byelick v. Vivadelli (VA) Defendant held 90% of the outstanding stock, made a vote to eliminate shareholder preemptive rights, and then issued 50,000 shares, which he bought, reducing the control of the plaintiff from 10% to 1%. There is a question as to whether these 50,000 shares were originally authorized in the AIs or whether the shares had to be additionally authorized by an Amendment to the AI. If there needed to be an amendment to the AIs to issue more shares, whether the Minority shareholder would have had enough voting power to stop something from happening that will injure them down the road. owned 10% and owned 90% changed bylaws to do away with preemptive rights Issued more stock so only had 1% o If these shares were not already authorized, then they would have had to change the articles If so, there is a chance that the could have vetoed this SC would allow him to do so unless 2/3 voted to amend claims breached fid duty to him as a shareholder Close held exception applies here o Including fid duty to minority shareholders o Similar to SC in calling for duty to both the company and the shareholders Says had right to sue individually because shareholders in close corporations are similar in relation to partners o Cites Donahue case that says a close held corp should be treated more like a partnership than a corporation Applies ALI 7.01 BUT this might be able to be a direct suit regardless the argument is that they have reduced the s voting power and that you havent hurt the company o The counter is that the value of the company was diluted and so the company was injured But counter to this is that the shares have devalued and not the company so the individual shareholders can sue directly Issue #1: Do the Directors owe a parallel fiduciary duty to shareholders as well as the Corp? Holding: The court stated that the Defendant owed a fiduciary duty to the plaintiff, and the dilution of the shares implicated that duty. VA Rule: Under VA law the directors owe a fiduciary duty, not only to the Corp, BUT ALSO to the shareholders!!!

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SC Rule equivalent to Davis Case Issue: Was it ok to bring this suit as a Direct Suit rather than a Derivative Suit? Notions why a Derivative Suit would be appropriate- Injury to the Co they wanted a price less than the fair market value. o If bought at a price less than the FMV is there an injury? No b/c the corp bought at a price less than the FMV. Holding: Direct Suit is OK - 701(d) Exception for Close Corporations- when a ct may treat an action raising from a derivative claim as a direct claim Even though this is a federal case, VA would recognize and apply 701(d). o No indication of injury to creditors by virtue of successful challenge to the issuance of stock o no risk of multiple lawsuits b/c only 2 shareholders Issue #3: D alleges that P is only asserting a pre-emptive right in this case and that VA laws allow Dir to remove this right. Holding: Court says NO there was a general breach of fiduciary duty claim in this case, not just a claim about pre-emptive rights the preemptive statute does not relieve the of his fid duty to the shareholders Even if there are no preemptive rights, there is a still a fid duty in the issuance of shares- issuance at favorable prices to directors (but excluding other shareholders) or the issuance of shares on a non-proportional basis for the purpose of affecting control rather than raising capital may violate that duty VA Rule - BOP on the D to show no benefit of the BJR the boards consent to the issuance was fair to the corporation and the sale itself was fair If the Corp was able to show this was fair, then no breach of fiduciary duty. MAIN RULE OF CASE: dilution of shares without via removing a S/H to preemptive rights is a breach of directors duty. 33-6-300: Shareholders preemptive rights Shareholders automatically have preemptive rights unless the articles say otherwise. (opposite of the MBCA) If there is no express statement that there are no preemptive rights in the articles shareholders have preemptive rights to get proportional amounts of shares issued by directors shareholder can waive the right No preemptive right if the shares youre holding are: o Issued as compensation (stock options) o Issued to satisfy conversion or option rights o Shares issued within 6 months of incorporation (1st person to buy would then have the right to keep buying all of the stock, but we would allow the Co. to be able to sell the shares to a whole group of people). o Shares sold for something other than money. (d) IMP. - dilution of shares without regard to preemptive rights is a breach of directors duty. Codifies the result in the Vivadelli case!!!!! Burky says soon will be changed to apply only to close held corporations Venture Capitalists Venture capitalists are looking at 4 things before they invest: Downside protection such as liquidation preference Upside opportunities Voting and veto rights Exit opportunities One of the real concerns today is whether or not these types of firms will invest in LLCs. VCs will do this through private placements an exempt transaction.

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One third of venture capitalist companies wind up in bankruptcy. Consequently, venture capitalists demand high returns because the successful one-third of their investments must cover the losses generated by the other two-thirds. Venture capitalists demand protective covenants. Going Public Why go public Cheapest source of a lot of capital The folks on the inside use it as a way to make a lot of money. It is a way for the folks who start the business to convert their investment into cash. Should attempt to raise at least two years of operating capital maybe more depending on how long it will take to make a profit Why not? Expensive: o It costs hundreds of thousands of dollars to go public the stock is not priced until after all the hundreds of thousands of dollars are spent. o Sarbanes-Oxley makes it much more expensive to be a public corporation How to go public You hire an investment banker who goes out and shops your stock for you. 2 methods to go public: o Best Efforts the IB will give their best efforts to sell the stock at a specified price new companiesmost are best efforts o Firm commitment the IB buys all of the stock usually at a discount and they take the downside risk big companies with a track record are usually firm commitments Where does the $ go after the offering? o To the Co. o To the existing S/H o If venture capitalists were involved with the offering from the beginning, some of the $ goes to buy them out. o New shareholders benefit more if their money went into the company, where it could be invested on their behalf to generate earnings, rather than merely go to the old shareholders to make them rich How Much $? Fear vs. Greed o Greed- the more you raise, the more ownership you give up, which gives incentive to raise as little as is needed to grow o Fear go after as much as you can because if the Intial Public Offering goes bad, you might not get a second chance o This balance normally results in raising enough for 2 years- burcky doesnt agree Market value price of shares x number of outstanding shares But if you havent gone public yet, your valuation is harder to calculate and depends on future earnings, not past ones so its got a little art to it Then you figure our your current value often by comparing yourself to similar publicly traded corps Ie if McDonalds sells for 20 times it past earnings. Then Bubbas should sell for 20 times it expected future earnings Then divide that number by shares outsanding = value per share So if Bubas expected value is 10 Million then the current value is 200million (10 x 20). If it has issued 8 million shares to its founders, then the value per share = $25/share

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o This is the price it will sell new shares for If the company wants to raise 30 Million, then it needs to issu 1.2 million (30 / 25 = 1.2)

Public Offering o Involves a registration process and a marketing program o Underwriter normally an investment bank that manages the process of drawing up the offering memo that is filed with the SEC. it is responsible for structuring the offering, pricing the securities amd maintaining a market for the securities after the offering o The underwriter and the corporation officers go on a road show to do some marketing o The offering price is set the night before it goes public because the market changes so fast o Got to watch out for tricky underwriters that might undervalue the price so as to pass savings onto clients o Where does the money come from o Underwriter activities are conduct one either a firm commitment or a best efforts basis Firm commitment the money comes from the underwriter It buys all the shares that are being offered and then resells them Best Efforts underwriting Money comes from the public The underwriter helps with the marketing Most new companies only get this one o Where does the money go o Underwriters and attys take a large amount o If they are new shares, the corporation gets the money o If the founders are selling their own shares, then they get the money If a VC is selling, then its no big deal But if the CEO is selling then it is viewed disfavorably o Costs continue after the offering Legal Constraints on issuing stock Registration requirements for public offerings o SEC Federal Requirements Securities Act of 1933 requires The Securities Act generally requires companies to give investors full disclosure of all material facts, the facts investors would find important in making an investment decision. Prospectus (this is the offering document) o Preliminary o Final o The prospectus must be delivered to all offerees- all people who might buy your stock (probably not enforced) o Prospectus May Include: Description of business, What property you own, Competition Info regarding officers and directors and their compensation, Material transactions involved with your directors, Who the co. is selling securities to Legal proceedings involving company and its officers or directors Where the $ is going to go

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 What the risk is in investing in this company The SEC does not evaluate the merits of offerings, or determine if the securities offered are good investments. The SEC staff reviews registration statements and declares them effective if companies satisfy disclosure rules. However, if something doesnt seem right, they can require the company to make disclosures that would likely make it impossible to sell your stock. Practically make you tell the world that you are stealing. The SECs job is to review all documents to make sure that the corporation has made full disclosure of all factors an investor would want to look at The SEC staff reviews registration statements and declares them effective if companies satisfy disclosure rules. The key date is the effective date. This is when you can start selling. Registration Rule: Basic deal is if youre not subject to an exemption, and you sell a security without registering, your sale is unlawful Registration Rule: Even if the co. does fall under an exemption, you are still subject to the anti-fraud provisions. If you are a public co. and therefore have a federally covered security, then you are usually not required to register with the states SC USA. In addition to federal registration requirements, there are also SC registration requirements. Common Law Fraud and Misrep and Rule 10b-5 Constraints on Any Stock Issuance If you are exempt from registration, you are sill subject to CL fraud and Misrep o An investor can bring K claim of misrep to rescind her K to buy stock o Or bring a tort claim of fraud for damages 10b-5 covers all securities (there are no exemptions) and applies an antifraud rule o Comes from 1934 act 10b-5 o Unlawful for any person directly or indirectly by use IC, mail or facilities of a national securities exchange (or anything related to it) To defraud To make any untrue statement of material fact or omit to state a material fact necessary in order to make the statement made in the light of the circumstances under which they were made, not misleading Engage in any business that would operate as a fraud or deceit upon any person in connection with the purchase or sale of any stock o Most of the law around this rule deals with resale of stock or corporate combinations such as mergers rather than at the initial sale o Majors v. SEC (SC 2007) People in MB were selling tax lien certificates. Two issues: claimed they were selling unregistered securities and they were engaging in securities fraud. Mark Knight found they were selling unregistered securities but they were not engaging in securities fraud. Once a tax lien is filed on the property, the owner usually has a 1-3 year period to pay the taxes that are due as well as the interest and penalties. If the taxpayer doesnt pay within that time period his or her taxes, the property is either foreclosed and bought by the government or the holder of the tax lien now owns the property. The government sometimes sells the tax lien for the cost of the taxes and some of the interest thats due. Within a three year period, the homeowner will pay off the debt to the owner of the tax lien certificate. The problem is that sometimes the homeowner will elect not to pay the taxes and then the tax lien holder owns the house. In this case, the company, TLA, makes the deal that if that happens the tax lien holder owns half of the house and TLA owns half of the house. The way you can lose on this is if the taxes were worth more than the value of the property. o is president and sole shareholder of TLA, a SC corp

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o o

TLA is a purchasing agent of tax liens for its Principles For each one it buys on the principals behalf TLA gets a cashiers check made payable to the County Treasure for Tax Liens o Complicated process. If the lien is redeemed, the Principle keeps all the monies. But if not, TLA get 50% ownership So basically the principles invest money that TLA uses to by title lien certificates (TLC) these were all over the country. o If the Principle sells any of the liens, TLA gets first right of refusal o TLC Tax payer defaults State puts lien on the property and the owner has 2-3 years to pay it off plus penalties and interest If he doesnt pay it off, then the property is either foreclosed by the government and sold, or the holder of the tax lien owns the property People normally cant pay these liens off, so the county wants money and will sell the tax lien to people, and TLA assists in those sales You pay the county the taxes plus interest- put it will be a lower amt then the taxpayer owes Then the tax payer has to pay you the full amount what he would have owned anyways so you make money on the difference of what you paid But sometimes the taxpayer doesnt pay, and then you own the property if this occurred, TLA says it owns 50% of the property, and then you can sell the property You can loose out if the taxes are worth more than the property o SC Sec Commission saw this as an investment K, and thus a security that has to be measured The other way this could be a security is that it is a profit sharing agreement the opinion doesnt talk about this much Side note 33-1-102(29) if freaking broad any note! The alleges that is selling unregistered securities and engaging in securities fraud o Gave a notice of a right of hearing o The hearing officer found that was selling securities because all the Ks it had with its many principals were investment contracts Major Issue was s investment opportunity a security The court held that the sale of tax lien certificates is a sale of securities that requires registration in SC. First sub issue o Commission did have authority to issue a cease and desist order under 35-1-60 Second sub o Violation of DP because Commission had already issued the order before giving a hearing and had thus developed an interest in winning o WRONG there was no violation of DP o The Hearing Officer had no direct involvement in the case even if the Commission did DP is only violated when the admin officer who is involved in the investigation is also involved in the adjudication o So its ok that it issued the first order and then investigated because a non involved member was later appointed Security o If it is a security, it must be registered or exempt o Defined as any certificate of interest or participation in any investment K or, in general and any interest or instrument commonly known as a security o Also includes any profit-sharing agreement Possibility #1 is that this is an investment contract. Under the Howey test, an investment contract exists where there has been (i) an investment of money, (ii) in a common enterprise, (iii) with an expectation of profits garnered solely from the efforts of others. o o

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 There was an investment of money in this transaction. People are buying these certificates with cash. The three things that might be a common enterprise are vertical or horizontal commonality or both. Vertical might be divided into two parts. o An example of horizontal commonality is if you used several different investors to purchase one TLC. Horizontal commonality is the pooling of investor funds and interests. o As a general guide, vertical commonality requires only a pooling of the interests of the developer or promoter and each individual investor, while "horizontal commonality" requires as well a pooling of interests among the investors. Vertical commonality is the dependence of the investors' fortunes on the success or expertise of the promoter. The courts have further identified two kinds of vertical commonality: broad vertical commonality and strict vertical commonality. To establish "broad vertical commonality," the fortunes of the investors need be linked only to the efforts of the promoter. "Strict vertical commonality" requires the fortunes of investors be tied to the fortunes of the promoter. o Every state will accept horizontal commonality. The language in the opinion signals that is true. o The question is what kind of vertical commonality would work if anything? The court says that since this case was tried the legislature has amended the statute and has spoken as to the issue. They look at 35-1-102(29)(D): a common enterprise means an enterprise in which the fortunes of the investor are interwoven with those of either the person offering the investment, a third party, or other investors. Thus, the court adopts strict vertical commonality as the test. claims Commission erred in applying a strict vertical commonality test wrong o Horizontal commonality is not here because the had individual K and investments with each principal that resulted in one title lien certificate for each investor. To have horizontal commonality, he would have had to have pooled the investors money to purchase the TLC Courts have struggled whether a vertical or horizontal commonality is needed or both Vertical pooling of the interests of the developer and each individual investor Horizontal also requires pooling among the investors ie investor uses funds from several investors to buy one security There are two kinds of Vertical o Broad- fortunes of investors need be linked only to the efforts of the promoter where investor provides the money and the broker invests it o Strict- requires the fortunes of investors be tied to the fortunes of the promoter ex- when there is profit sharing between the two ( so are you linked with their work or with their profit) Strict is adopted, so because this exists under the current facts, there is a common enterprise 33-1-102(29)(D) spells out that we apply strict vertical commonality and we also allow horizontal commonality so both The third part of the Howey test is the efforts of others. Do the others have to do everything and I do nothing? The courts have said that is not what is required. You as the investor can have some involvement in the transaction and that doesnt defeat it from being a security. Investment contracts may be found where the investor has duties that are nominal and insignificant or where the investor lacks any real control over the operation of the enterprise. The key determination is whether the promoters' efforts, not that of the investors, form the "essential managerial efforts which affect the failure or success of the enterprise. asserted that the principals had a say in the TLCs and therefore were not solely dependant on the efforts of others

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o Article

BUT This is a relaxed prong As long as the s efforts form the essential managerial efforts which affect the failure or success of the enterprise which they did here The key determination is whether the promoters efforts not that of the investors form the essential managerial efforts which affect the failure or success of the enterprise They failed to register with the state of SC. That is what they did not do correctly. You have to go through the same three steps for interests in a limited partnership, a limited liability corporation, and maybe a general partnership. Almost every limited partnership interest will be a security. For an LLC, you need to know if it is a member run LLC (if member run the third element might not exist under the Howey test) or a manager run LLC. See 35-1-102(29)(E). Howey Test is applied to LLC and limited liability partnerships and probably general partnerships if one doesnt act as a manger For the LLC you must look to see if all the members are running it if so, then its not a security ie efforts of others If you set up a professional corporation for five doctors and they each invest money in their own professional practice and they are going to set it up as a PC and each doctor will receive from that PC shares of stock in the professional corporation. Do the shares have to be registered with the SEC and SC? The answer is yes unless theres an exemption. So, what I am usually doing is asking if there is an exemption at the state and federal level. Possibility #2 is that his is a profit-sharing agreement (this disappears from the opinion, but Burkhard thinks it is important b/c of the definition below) 35-1-102: a security means any note; stock, treasure stock, security future, bond, debenture, evidence of indebtedness, certificate of interest in a profit-sharing agreement, collateral trust certificateinvestment contract, etc. Burkhard thinks the court could have also said this was a certificate of interest in a profitsharing agreement Look up article on security exemptions and a table on Reg D on Westlaw and look at the securities problem and read leventis case Chapter 35 - SC Securities Registration Requirements 35-1-20(15) defines a security Note, stock, bondINVESTMENT CONTRACT Investment contract brings business relationships like partnership interest into the area of securities Interest in an LLC o If member run, not a security o If manager run, the interest is a security 35-1-810: Registration of SC Securities Must be registered in SC to sell a SC security unless it is federally registered Common exceptions to federal registration requirements PLI 4(2): Private placement exception - provides an exemption for transactions "by an issuer not involving any public offering." Ralston Purina co. wanted to allow their employees to buy stock at a discounted price/bargain price. This case is still sort of the gospel even thought its really old Issue: was this offering public Supreme Ct says that this offering does not qualify as an exemption under 4(2). In order to come within Section 4(2): Qualifications of a Private Placement:

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o Must look at everyone who is an offeree, not just purchasers o Offeree qualification each offeree must be sophisticated investors o Availability of information must have access to the same type of information that would have been made if the offering been public; doesnt necessarily have to be called a prospectus or have all the exact same information as long as the same type of information is provided o Manner of offering o Absence of redistribution Lawyer Tip: Try to structure your deal such that your offering has another exemption, with 4(2) being your last safety net!!! Never rely on 4(2)! Reg D Exemptions See Chart Note that all regulation D registrations require notice of sale to be filed with commission within 15 days of first sale. If you qualify under Reg D, you are NOT deemed to be a Fed Covered Security, still have to meet state requirements Rule 504 -See Chart!!! o Amount: Limited to $1M in a 12 mo period o Eligible issuers: No Exchange Act or Blank Check Not available to development stage corps with no business plan No large publicly traded corps No investment companies Rule 505- SEE Chart o Amount: Limited to $5M in a 12 mo period o Eligible issuers: No issuers involved in past securities wrongdoings o # Offeree restrictions: Unlimited accredited Not more than 35 non-accredited o Registration requirements: If purchased only by accredited: none If purchased by non-accredited: see List on sheet. Rule 506 (this is the 4(2) safe harbor) o Amount: No Limit o Eligible issuers: None. o Offeree restrictions: Unlimited accredited Not more than 35 unaccredited Investor Qualifications: sophisticated All unaccredited investors must be qualified by having financial knowledge such that he can evaluate risks/benefits

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Rule 501(a) - Accredited Investors. (8 categories of potential investors who will be deemed to be "accredited" for purposes of Rule 505 and 506 offerings) o certain types of financial institutions, o any entity with total assets in excess of $5 million, o directors, executive officers or partners of the issuer (this is the troubling one- a lawyer may try to end run the regulation process by saying all the buyers or offerees will become partners or executive officers- that may get them in trouble), o Persons whose net worth (or joint net worth) exceeds $1 million, o Persons whose individual income or joint income with spouse for each of the past two years exceeds $200,000 and $300,000, respectively, and is expected to exceed that amount in the current year. 4(6) exemptions Eligible issuers: no restrictions Amount: no more than $5M Offeree restrictions: accredited investors Method restrictions: no general solicitation Must file some notice with the SEC Regulation A offerings Limited to no more than $5M in a 12 month period Number of offerees: no limit Resale restrictions: none Must be non-publicly traded US or Canadian company No securities may be sold before the actual registration Registration requirements: must make a miniregistration to SEC with offering statement Must include offering circular to offerees Rule 147 - Intrastate Offering page D18 The exemption was intended to apply only to issues genuinely local in character, which in reality represent local financing by local industries, carried out through local investment. Persons claiming the availability of the rule have the burden of proving they have satisfied all of its provisions. Eligible issuers (must meet all): Company must be resident of same state as offerees (see D20 for more specific requirements) Issuer must derive 80% of gross revenues from operations in the state At least 80% of issuers assets must be located within the state At least 80% of proceeds from offering must be used within the state The principal office of the issuer is located in the state $ amount: no limit Offeree Requirements: All offerees must reside in the same state as the issuing company o corps: residence = principal office, individuals, residence = principal residence) o Ex - principle office must be in SC. o Must obtain a written representation from each purchaser as to his residence

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 Manner of offering: no restriction as long as offer is only made to residents of the state; however an inadvertent bad offer can spoil the deal Resale Restrictions: May not be resold for 9 months except to resident of same state Registration requirements: None o SC Registration exemptions SC USA Must meet federal and state exemptions Official Cmts to 35-1-102 o Reread them explains the Howey test in Majors. o Risk capital test there is a security when an investment is subject to the risks of an enterprise with the expectation of profit or other valuable benefit and the investor has no direct control over the management of the enterprise o You can be a seller of securities without being the owner if you solicit a purchase and are motivated in part by the desire to serve your own financial interest or the interest of the seller Pinter v. Dahl o SC is guided in defining the term security by federal cases interpreting the 33 Act o Look at economic reality, not the form of the security 2 Types of Exemptions in SC: 31-1-201 Exempt Securities 31-1-202 Exempt Transactions o (13): may sell to an institutional investor or a federal covered investment adviser o (14): no more than 25 purchasers over 12 months, no general solicitation or advertisement, no commission to anyone other than the broker-dealer, and the issuer reasonably believes that all the purchasers are purchasing for investment Sell or offer to sell to An institutional investor A federal covered investment advisor Any other person exempted by rule adopted or order issued under this chapter A sale or an offer to sell secured by or on behalf of an issuer, if the transaction is part of a single issue in which Not more than 25 purchasers are in SC during a 12 month consecutive period other than specified by the above bullet A general solicitation or general advertising is not made in connection with the offer to sell or sale of the securities A commission or other remuneration is not paid or given directly or indirectly to a person other that a broker-dealer registered under this chapter or an agent registered under this chapter for soliciting a prospective purchaser in this State, AND the issuer reasonably believes that all the purchasers in this State other than those in paragraph 13 are purchasing for investment 35-1-320: Exempt Transactions 1-8 - not important 9 Limited offerings o Must meet residency requirements of Rule 147(c) intrastate company and offerees o Offered to no more than 25 people Important: the commissioner can modify this exemption Commissioner has narrowed this to less than 10 purchasers (see below), no solicitation, no commissions paid

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Integration

10 Limited pre-organization subscriptions o Exempt if there are less than 25 subscribers o There is no remuneration paid for soliciting a subscriber o No subscriber makes a payment prior to filing articles of incorporation o Note: this section being eliminated in the revised statute Commissioner Rule - 113-22 Narrows 35-1-320(9) limited offerings- so that you are exempt if there are less than 10 purchasers No solicitation: You cant have general solicitation or advertising no commissions/renumerations: The person doing the soliciting cant receive a commission Commissioner Rule 113-21 You still have to file with the state commissioner

two or more issues can be integrated and potentially destroy the exemption Two tests o 6 month buffer before and after the offer or sell during which no other issue can be distributed if integration is to be automatically avoided o If a second issue does occur in this 6 month buffer, then we look at the following factors Are the offering part of a single plan of financing Do the offerings involve issuance of the same class of securities Are the offerings made at or about the same time Is the same type of consideration to be received and Are the offerings made for the same general purpose Shrimp Boat Problem Is he exempt under Fed Regs Reg D o Does it comply 504 Problem with the advertising Advisable filing requirement to the SEC of the prosepectus and he doesnt want to file anything o So NO 4(6) accredited investors o No the advertisement R 147 o No prohibition on ads o May not because the advertising will go outside of SC but you can get around it by saying offers only good to SC residents o But one issue is that Offers can only be made to SC residents as well so when talking with people, you got to make sure they all live here o Make sure you disclose enough to avoid fraud o Yes, you can pay broker commissions o No filing required o Does it comply with part C of this rule Nope if the boat goes into international waters or Ga waters (would have to stay in SC waters for the exemption to work) So you try and rely on 4(2) o But its a crap shoot and you need to know a lot about the offerees

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Cowburn v. Leventis (SC) Facts: Cash for title program. Ponzi scheme - $ contributed by later investors generates artificially high dividends for the original investors, which in turn attracts larger investments. Cowburn sued the lawyer for securities violations. Plaintiff believes Leventis is liable because he is selling unregistered securities (as an unlicensed broker). Notes are considered Securities under the SC USA. Cowburn also raises a Breach of Fiduciary Duty Claim Against Leventis in this case. o The Program, as it was described to Cowburn, engaged in the business of issuing short-term, high interest rate notes and bonds for the purpose of funding the automobile title lending industry o atty talked him into it He set up an account at Fidelity National Bank which allowed the Bank to invest in the program o Program got busted as illegal Ponzi scheme and lost money- so he sued bank and atty Does the Security Act apply o Yes the definition of security includes any note or bond. The received both of these for his investments into the program, so his securities were bought o But does the sale of those securities fall under the act? The act does provide a private action for fraud o There was a violation of the Act because failed to register these securities FN2. Section 35-1-1490 states that any person buying a security from someone acting in violation of sections 35-1-410 or -810 may "recover the consideration paid for the security, together with interest at six percent per year from the date of payment, costs, and reasonable attorneys' fees, less the amount of any income received on the security, upon the tender of the security, or for damages if he no longer owns the security. Damages are the amount that would be recoverable upon a tender less the value of the security when the buyer disposed of it and interest at six percent per year from the date of disposition." Issue #1: Were the short-term promissory notes from Leventis considered securities and if so were they exempt from registration? If the security is NOT exempt - Leventis will be required to pay the $ back that the other guy lost. Holding: Yes the statute says notes are securities. There are two kinds of notes short-term (9 month) and long-term (several years). Court finds that these long-term notes are not exempt as rollover transactions. Questions of fact as to whether he is a seller or broker and whether the securities are exempt Section 35- 1-310(9)exempts short-term commercial paper from the registration requirements of Some of s investments were short term commercial paper, but some were not- so there is no exemption claims these were rollover transaction but they arent because the didnt invest with the same issuer each time "[a]ny transaction pursuant to an offer to existing security holders of the issuer, including persons who at the time of the transaction are holders of convertible securities, [is an exempt transaction], if (a) no commission or other remuneration, other than a standby commission, is paid or given directly or indirectly for soliciting any security holder in this State or (b) the issuer first files a notice specifying the terms of the offer and the securities commissioner does not ... disallow the exemption...." Issue #2: Is Leventis Acting as a Seller An "offer to sell" securities is defined in section 35-1-20(13)(b) as "every attempt or offer to dispose of, or solicitation of an offer to buy, a security interest in a security for value." In this case, Leventis's role in the Program went beyond simply recommending an investment to a friend; rather Leventis played an integral role in the Program o Evidence supports a finding that he did make an offer of sale Page 107 of 183

Holding: yes he is a seller; Court also finds that Leventis is a broker still argues that the securities are exempt and the court says this wont get him out of trouble b/c theyre not sure if the securities are exempt To be a seller, Leventis does not have to own the notes and then transfer title to a purchaser other factors show that he is considered a seller Has introduced investors to the program Received referral fees this is probably what got the courts attention Provided investors with appropriate forms Regulation 97003: requires brokers to file some papers, which Leventis did not do (this regulation is probably no longer in existence) Questions of fact as to whether he is a seller or broker and whether the securities are exempt So there is a real issue of fraud, and also that didnt register as a broker so SJ shouldnt have been granted o Section 35-1-20 defines a "broker-dealer" as "any person engaged in the business of effecting transactions in securities for the account of others or for his own account" and an "agent" as "any individual, other than a broker-dealer, who represents a broker-dealer or issuer in effecting or attempting to effect purchases or sales of securities." Issue #3: Was Leventis a Broker and if so, was he exempt? o Broker: Assists in the Sale o Defense: Although I might qualify, since I am selling exempt securities, I havent run afoul of the statute. o Didnt file so there is no protection under regulation. o Coburn brings break of fiduciary duty. Burkie says lawyer may have made a tactical mistake. o Brings this against him as the broker RATHER than as his role as an attorney. Presumably, defense would have been that Leventis wasnt his attorney. Burkie says this defense is weak because courts focusing on what is reasonable expectation of the client and it would be a reasonable expectation on Coburns part. o argues he is exempt from registering because he only dealt with exempt securities- but there is an issue of fact about this as explained above ie they arent exempt so neither is he o also argues that he is exempt from registering because he acted on behalf of the company and didnt except payments court says he didnt comply with the requirements of this section o Also another argument that the company was a class D company that is exempt from registering securities- but this wasnt argued at trial o But fraud claims dismissal was upheld because failed to specify any misrepresentations o Cowburn argues there was a material issue of fact regarding his claim that Leventis owed him a fiduciary duty, violated that duty, and acted negligently. Cowburn maintains Leventis's duties to him arose because Leventis acted as a seller of securities, and Leventis breached this duty by failing to investigate investments under the Program. We disagree. o A broker or dealer of securities is an agent of the buyer, and therefore, generally owes the buyer fiduciary duties. These duties often include the duty to account for all funds and property belonging to the buyer, to refrain from acting adversely to the buyers interest to avoid engaging in fraudulent conduct, and to communicate any information he or she may acquire that would be to the buyers advantage. However, Cowburn has not cited any case that imposes a fiduciary duty upon a broker to investigate for any unknown potential risks of investment. So no duty on broker to invest in the wiseness of the investment Leventis is an attorney. He brings the breach of fiduciary duty action against him in his role as broker rather than his role as attorney. Burkhard says to watch out for this. Did the client think you were representing him? If it had been pursued this way, it seems like Cowburn would have had a much stronger claim. Gordan v. Drews (SC) Facts: Drews was going to start a hardware store in West Ashley, but they decided they needed shareholders. Drews went out and solicited potential buyers and

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got 11 shareholders. Gordan was one, and he bought in after assurances that a loan from the SBA was in the bag. Gordan sued under the SC Security act 35-1-810, and Drews tried to defend that he was exempt from registration Issue: Was his offering exempt under 35-1-320 as a limited offering? 35-1-1490 - creates liability for the seller of stock in violation of registration requirements, and he is liable directly to the person who he sold the stock to, so Drews is hosed if he cant find an exception Holding: Not exempted under 35-1-320 To be exempt, Drews would have had to OFFER to less than 25 people, and he couldnt prove that he offered to less. Even with the changes with 113-22 he would have been in bad shape because they got 11 purchasers Drews also tried to defend in that he received no remuneration. Received remuneration: However, there was a plan where hed get share for every share sold (to retain voting control), and the court said that this was remuneration Not a seller defense: TEST to determine Seller of Securities solicit the purchases be motivated at lest in part by a desire to serve either his own financial interest or the interest of the owner of the security he is selling Holding: In this case, he got a share for every share sold, so he was clearly soliciting and motivated, so Drews was liable for the sale Important note: the remedy included the loss on the security as well as lawyers fees for the purchaser Unique SOL on securities transactions (Ct talks about Laches which Burkie thinks doesnt have any real bearing on the case). Common Law Fraud and Misrepresentation and Rule 10b-5 Constraints on Stock Issuance o No transfer of stock is protected from Rule 10b-5, the securities anti-fraud rule promulgated by the SEC. Every securities transaction lives under its protective shade. o 10b-5 provides: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or the mails or of any facility of any national security exchange, (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, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business o which operates or would operate as a fraud or deceit upon any person in connection with the purchase or sale o This is different from the common law fraud requirements because silence is actionable under 10b-5. The cases that apply 10b-5 are primarily non-disclosure cases. o See problems on p. 440 o Rule 10b-5 does not require that the issuer be the bad guy o See outline in a couple of pages o How do owners of a corporation make money? o Typically, the decision about what to do with earnings for the year goes to directors (majority of the board of directors) o Problems on page 443 o Majority of the Board o Same

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o SHAREHOLDER OPPRESSION o Who decides which shareholders get salaries o Often, in a small corporation, people buy shares with employment as the only guaranteed return. Over the years, both legislative and judicial efforts have been made to ease the plight of the oppressed close corporation shareholder. Two significant avenues of relief have developed. First, many state legislatures have amended their dissolution statutes to include oppression or a similar term by the controlling shareholder as a ground for involuntary dissolution of the corporation. Moreover, when oppression is established, actual dissolution is not the only remedy at the courts disposal. Oppression has evolved from a ground for involuntary dissolution to a ground for a wide variety of relief. Particularly in states without an oppression-triggered dissolution statute, a second avenue of relief has developed for close corporation shareholders. Some courts have imposed an enhanced fiduciary duty between close corporation shareholders and have allowed an oppressed shareholder to bring a direct cause of action for breach of this duty. o Salaries do not qualify as distributions. Distributions are considered to be dividends and stock options. See SC 33-6-400 but this doesnt cover salaries o Hollis v. Hill (S/H Oppression Case) MA law applied Hill and Hollis were both 50% owners of a corp. that made loans. Hill didnt think Hollis was carrying his weight. Hill stopped paying Hollis salary and proposed a buy out which Hollis rejected. Hill stopped sending financial reports for a while. Then the business went really bad, and Hill reduced Hollis salary to zero again. At the time of the lawsuit, the companys value had declined to $100,000. Issue: Hollis sued for shareholder oppression. The question was whether Hill owed a duty of loyalty to Hollis, and whether a buy out was the proper remedy. First, note that the Texas court applied the internal affairs doctrine and applied the law of the state of incorporation: Nevada (doesnt have an oppression statute or case law, so they have to look at the law of other states) o Internal affairs of the foreign corporation, including but not limited to the rights, powers, and duties of its board of directors and shareholders and matters relations to its shares, are governed by the laws of the jurisdiction of incorporation o NV does not have a statute for oppression. (most states allow petition for dissolution when there is oppression) So the court turned on principles of duty o FFUSA seems to be more of a partnership than a corporation so court imposes fiduciary duties akin to a partnership. Ie two shareholders at 50% and splitting the managerial duties o Because NV doesnt have any laws on point, it doesnt necessarily mean that we will automatically find a duty exists. Court declined invitation to apply law of DE, instead applies a serious of cases out of MASSACHUSETTS . MA Rule: Duty of S/H to other S/H: Court followed Massachusetts law and found that there is a duty between shareholders in a close corporation that is the same as the duty between partners, so Hill had a fiduciary duty to Hollis. Shareholders in close corporations owe each other a duty of utmost good faith and loyalty. They argued that there was a legitimate business reason to do what we did. When a legitimate business purpose exists, the minority shareholder must be given an opportunity to demonstrate that the purpose could have been achieved through means less disruptive to shareholder interests. STEP 1 (Wilkes test): Determination as to whether a fiduciary duty to pay the S/H a salary existed: you would have to show that the shareholders interests in the investment took the form of employment. FACTORS: Whether the corp typically distributes profits as salaries. Whether the shareholder/employee owns a significant percentage of the corps shares. Whether the shareholder/employee is a founder of the corporation. Whether his shares were received as compensation Whether the shareholder/employee has made a significant capital contribution **Whether the shareholder/employee has shown that he had a reasonable expectation that the return on his investment would be in the form of continued employment

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*Exception: There is no breach, however, if the oppressed shareholder has an opportunity to redeem his shares at a fair price, or if the corporation redeems his shares for a fair price STEP 2 -(Wilkes test) BOP on P - Plaintiff must allege that the defendants have done something bad here, its termination of employment breach of a fiduciary duty. BOP on D - If the majority can show that the reason they did that was for a legitimate business purpose, this is a defense o Purpose - its the need to downsize b/c of lack of business. BOP back to P - When a legitimate business purpose exists, the plaintiff has the opportunity to show than the means could have been achieved by a less disruptive means to his interest. o The court found that the corp never paid dividends, so that without the salary, Hollis shares were worthless. Same analysis has been seen in SC, but not necessarily in business cases Remedy: Buy out - Ct held that the date to value the company for the buy-out remedy was the date the oppression began, which was when Hollis salary was reduced to 0. Dissent: NV would not apply MASS law. NV is a mgmt friendly state so they would apply DE law DE Rule no S/H oppression Dissent says that they should have followed Delaware law, which doesnt have shareholder oppression Although, Burkie notes that Grady states that if directors act on both sides of a transaction (which is essentially what Hill was doing), they have to show they acted with fairness, which might come to the same result, so DE might not be that much different from MA. Brodie v. Jordan MA Supreme Court 3 guys ran machine shop. One retires, then dies. Wife inherits. After that, co. stops paying her. Wife brings claim under Donahue-Wilkes rubric. Court says beh might have been viewed as oppressive but that doesnt give her the right to be bought out she would be getting more than entitled to. Unless shes bought out, shes still stuck in a mess. Value is in the stock which she now cant do anything with. MA cuts back a little bit. What are the legal limitations on salaries o Exacto Spring v. Commissioner of IRS (Fed Tax Ct) o Facts: IRS brought suit against Exacto Spring to show that they were giving an excessive salary to their CEO and principal owner (which is deductible) instead of awarding dividends (which are taxable). o was a close corporation Paid CEO 1 million in salary IRS thought this was excessive and applied the excess to the s income, which meant that was deficient in the taxes it paid Trial court found that a reasonable salary was somewhere between the numbers offered by the two parties o The purpose of 162 is to prevent dividends, which are not deductible from corporate income, from being disguised as salary, which is. o Issue: Was the salary reasonable? o Trial court applied this test: Director Salary Reasonableness Test: 7 Factors: Type and extent of services rendered Scarcity of qualified employees Qualifications and prior earning capacity of the employee Contributions of the employee to the business venture Net earnings of employer

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Prevailing compensation paid to employees with comparable jobs Peculiar characteristics of employers business o Court does not like the test the lower court applied because They are vague and non directive Doesnt say what weight is to be given to the factors Also they dont tie up well with the statute that allows the corporation to pay salary (or to prevent deductions when dividends are being paid out as salary) o That statute is mainly to prevent gifts from being disguised as salary so as long as services are rendered the corporation can determine what is a reasonable amt Also the tax court shouldnt be second guessing these decisions Lack of direction will result in arbitrary decisions uncertainty o Posner - Indirect Market Test: Btm page 467 (killing the goose that lays the golden egg) Hangs hat on fact that the directors that approved the salaries were disinterested in the sense that they were the ones being hurt if anyone was by the payment of these large salaries to the officers Rule: When the investors of the company are receiving a far higher rate of return than they had any reason to expect, the CEOs salary is presumed to be reasonable Rule: Presumption can be defeated by showing that the return is not due to the CEOs work (ex a company finds that it is sitting on oil reserves). Indirect market test a corp can be conceptualized as a K in which the owner of assets hires a person to manage them. The owner pays the manger a salary and in exchange the manger works to increase the value of the assets t that have been entrusted to his management the increase can be expressed as a rate of return to the owners investment The higher the rate of return (adjusted for risk) that a manager can generate, the greater salary he can command So the more he is making, the more he can be paid o However it must also be a bona fide salary- so evidence of it really being a dividend could make it fail this test o Criticisms of Posners analysis & the Indirect Market Test: Ratios may not be that accurate nothing says how to establish the baseline projections. Methods of proof that the increase on return is due to the efforts of the executive. o Holding: His salary was reasonable Ct rejected the govt argument that low level dividends paid by the co. indicated that the corp was paying Heitz dividends in the form of the salary. Ct noted that S/H may not have wanted dividends and instead have wanted to increase the value of the co. Also important factor in the result is that a bunch of directors who were getting paid nothing voted for the director to get this raise. His salary was approved by disinterested board members. o This Case represents a problem of closely-held corporations b/c: No market for shares if shareholders are unhappy with executive salaries Shareholders and directors and officers are often the same people SS taxes not paid on dividends this be a good or bad thing, depending on whose perspective is taken into account Giannotti v. Hamway (VA) o Facts: Plaintiffs were minority shareholders. They asserted that the defendants controlled the majority of the voting shares of stock, and that they voted huge salaries for themselves while not paying dividends. Plaintiffs sued to have the court dissolve the corp, liquidate the assets, and remit some of their salaries on the theory that the actions were oppressive. o The Hill v. Hollis case is based on common law; this case is based on a statute. Thats why both of these cases are included in the book.

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o o

VA View on S/H oppression: conduct by corporate managers toward stockholders which departs from standards of fair dealing. To comply with the standard, they must show that their actions were fair to the corporation. BOP on Ds b/c they are interested: (they voted big salaries for themselves), and as such they bore the burden of showing that the transaction was fair to the corporation. 33-8-111 might reverse that burden, but we dont know o Holding: The court relied upon the fact that the profit per bed of their nursing home business was far lower than average and found that, without the big salaries, the company would have been more profitable. Thus, the defendants didnt carry their burden, and were guilty of oppressive conduct. o Remedy: As for remedy, the court looked at the statute and decided that dissolution was the sole remedy, and the court couldnt use equitable powers to arrange to pay back the corporation. Thus the directors didnt have to pay back their salaries o The statute doesnt allow them to just pay a greater dividend to the shareholders and to just say they wont pay such high salaries in the future. o Dissent noted that while profit/bed was low, overall profitability numbers were through the roof. Judicial Dissolution Kiriakides v. Atlas Food Systems (SC) S/H Oppression Case o Facts: Atlas was a family owned company. Plaintiff was one of the brothers who had a 37% share. The plaintiff stopped getting along well with his brother who unilaterally made some business decisions without consulting him. He was offered $1 million and an $800 cancellation of a loan for his share, which was WAY low. Plaintiff sued for shareholder oppression. o (Alex) is majority holder and has been in charge of finance and corporate affairs He controls the board Alex and John had a rift between them and John became distrustful of s management of the corporation Alex pretty much ignored Johns impute on the company and acted unilaterally without putting decisions to a vote and also acted contrary to decisions that were put to vote John said he was going to quit. He then made it clear that this was not his intention Alex then told John he was no longer to be president of the corporation. Alexs son then became a board member and president Alex and corp then offered to buy out Johns interest John believed the offer was too low brought suit for accounting, buyout of his shares, and damages for fraud Subsequent offer of 4 million was made believes his shares are worth 10 million Trial court found evidence of fraud and oppression and that a buyout under 33-14-300(2) and 310(d)(4) were in order This statute allows a court to order a buyout rather than dissolution o Court cited to 33-14-300(2)(ii) that allows the court to force dissolution if it can be established that the directors or those in control acted in a manner that is illegal, fraudulent, oppressive, or unfairly prejudicial to any shareholder. Before the Kiriakides opinion, you would have said that the SC statute was more protective than the NC opinion/statute. However, the analysis in the case says we cannot focus on the interests of the minority shareholders. You almost have to focus on the expectation of the minority shareholders to recover. Burkhard says a compromise in SC would be to apply the Wilkes test. 33-14-310 Allows a court to grant relief other than dissolution, including a buyout o SC Rule on Opp - Court will find oppression using the totality of the circumstances on a case by case basis. Factors the court will look at are: A visible departure from the standards of fair dealing and a violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely; or A breach of the fiduciary duty of good faith and fair dealing; or o

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o o o

Whether the reasonable expectations of the minority shareholders have been frustrated by the actions of the majority; or A lack of probity and fair dealing in the affairs of a company to the prejudice of some of its members; or A deprivation by majority shareholders of participation in management by minority shareholders. SC rejects NC View on S/H Oppression: focuses on the reasonable expectations of the minority shareholders (like Hollis). The statute seems to say we can apply the reasonable expectation of the parties, but FN 25 then seems to say that we cant apply it (a court may never consider the parties reasonable expectations) SC says this is too broad (really focuses on the reasonable expectations element burcky says hes not sure this was such an important factor in the crt app test) Notes amendment adding unfairly prejudicial conduct allows remedy for the frozen-out minority shareholder when there isnt any fraud Note policy concern for the oppression of minority shareholder was a nation wide issue and particularly for close held corporations The meaning of oppressive fraud or unfairly vary from case to case and court looks at case law Lack of dividends o Not oppressive where suspended for purposes of improving the corporations finances o Yes where suspended to freeze out the minority shareholder Actions taken to depress value of corporate stock SC finds the factors listed by the Crt App are too strict bc the Leg didnt list such requirements Leg didnt intend for there to be dissolution based on the partys reasonable expectations This would require court to look into the intentions of closely held family corps it aint gonna do this Other courts place emphasis on rights and interests of the minority shareholder BUT SC places emphasis on the conduct of the majority so the Crt Apps. Reasonable expectations test was wrong o Statute focuses on conduct of majority shareholder, not the rights and interest of the minority shareholders as the NC statute says Criticizes reasonable expectation approach for providing too much protection to minority holder and not requiring a bad faith prong against the majority before holding them at fault BUT burcky says Toal was smoking some gonga the SC statute has much more language regarding the shareholder and that you have to focus on what the minority holders lost if you are to determine what the majority did o The court wont define oppressive or other terms absent Leg direction, so it must be a case by case determination They are elastic terms o You can consider the reasonable expectations, but they are not determinative o Lots of factors are listed at headnotes 11 and 12 o Its a bigger mess the Higby on a Saturday night after a fifth of tequilla and a shot of jager Application o This is a classic example of freeze out o Close held corps enable the majority holders to allocate the benefits of ownership arbitrarily

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o Occurs where the shareholder has a trapped investment and an indefinite exclusion from participation in business returns This is magnified in close corporations because there isnt the protection of being able to readily sell your stock So they are held hostage o Looks at lots of factors that show how benefited and how o BJR does not apply in S/H oppression cases: directors only get the benefit of the rule when they can demonstrate that they acted in good faith. o We find this case presents a classic example of a majority freeze-out, and that the referee properly found Atlas had engaged in conduct which was fraudulent, oppressive and unfairly prejudicial. Common freeze out techniques include the termination of a minority shareholder's employment, the refusal to declare dividends, the removal of a minority shareholder from a position of management, and the siphoning off of corporate earnings through high compensation to the majority shareholder. Often, these tactics are used in combination. In a public corporation, the minority shareholder can escape such abuses by selling his shares; there is no such market, however, for the stock of a close corporation. The present case presents a classic situation of minority freeze out. The referee considered the following factors: 1) Alex' unilateral action to deprive Louise of the benefits of ownership in her shares in Atlas, and subsequent reduction in her distributions based upon the reduced number of shares, 2) Alex' conduct in depriving John and Louise of the 21% interest of Marica stock, 3) the fact that there is no prospect of John and Louise receiving any financial benefit from their ownership of Atlas shares, 4) the fact that Alex and his family continue to receive substantial benefit from their ownership in Atlas, 5) the fact that Atlas has substantial cash and liquid assets, very little debt and that, notwithstanding its ability to declare dividends, it has indicated it would not do so in the foreseeable future, 6) the fact that Alex, majority shareholder in total control of Atlas, is totally estranged from John and Louise, 7) Atlas' extremely low buyout offers to John and Louise, and 8) the fact that Atlas is not appropriate for a public stock offering at the present time. SC Dissolution Statutes o 33-14-300: The court can grant dissolution o 33-14-310 - 320: Procedure for judicial dissolution allows for appointment of a custodian SC Close Corporations - Dissolution o 33-18-400 Court action to protect S/H: a S/H of a close corp may petition the court for any of the relief in 410-430 if the directors have acted illegally, oppressively, fraudulently, or unfairly prejudicial to the petitioner (whether in his capacity as a S/H, director, or officer of the corporation) Directors are deadlocked in the mgmt of corp affairs there exists other grounds for judicial resolution under 33-14-300 S/H can not commence a proceeding under this section if has agreed in writing to non-judicial remedy If S/H also has dissenters rights with respect to the corp action, he must commence a proceeding under this section 1st. o 33-18-410 ordinary relief Remedies for oppression basically allow the court to resolve the problem internally without dissolving the company. If one of these remedies will solve the problem, then order it. Reversal of action Termination of office or director damages pmt of dividends etc. o 33-18-420 extraordinary relief If ordinary remedies dont work those remedies wont work, order the company to buyout the complaining s/h intermediate step.

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o o

o o o

33-18-430 dissolution If the internal remedies and the buyout wont solve the problem, then the court may order dissolution o Receiving dividends from the corporation o Dividend is a payment to shareholders by the corporation out of its current or retained earnings in proportion to the number of shares owned by the shareholder o Its a management decision and most corps dont pay them (close held corps dont want to pay them because you would be taxed more, so they do it in salary; and most corps are close corps) but its more common for the big boys to pay them o Most publicly traded corps do pay dividends, but its a decision based on attracting investors o Two views Paying them may attract more investors making the company more valuable Not paying them demonstrates confidence that it has attractive investment opportunities that might be missed if it pays dividends o Creditors will complain if the corporation pays out too much in dividends Most corporations do not pay dividends; this is true because most corporations are closely held with salaried employees so they dont want to pay double tax; every corporation will avoid paying dividends if at all possible Many publicly traded companies do pay regular dividends- it depends on whether it will attract investors When can/must a dividend be paid Definition o The SC code defines anything that goes out to the shareholders as distributions o 33-6-400: Distribution to S/Hs Board of directors authorizes distributions subject to limitations in articles of incorporation If record date not set otherwise, it is the date the board authorizes the distribution You CANNOT make a distribution if The corporation would not be able to pay its debts as they become due in the normal course of business OR Total assets would be less than total liabilities of the corporation + the amount due to satisfy the preferential rights of shareholders whose preferential rights are superior to those who receive the distribution (e) how to calculate the value of a distribution when it is something other than cash. o 33-8-330: Liability for unlawful distributions A director who votes for a distribution that violates the distribution rules is personally liable to the corp for anything over the amount that would not have violated the rule IF it is shown that he didnt act in accordance with 33-8-300: SC BJR The director can get contribution from every other director who could be held liable under (a) as well as every shareholder who accepts a distribution knowing it violated 33-6-400 Modern approach: so dividend is valid as long as the corp is not insolvent and the dividend doesnt make it insolvent Traditional approach (NY and Del) Requires references to different funds or accounts o Earned Surplus (Retained Earnings) net income retained by the company; consists of value generated by the business itself Consists of all earnings minus all losses minus distributions previously paid This means you are making real money, and it is a proper source from which to pay dividends Accounts from sale of stock o Stated Capital Par value of a par issuance plus the amount allocated to stated capital on a no-par issuance Par means minimum issuance price if you are selling stock at $2 par value you must receive at least 2 per share o So 10,000 shares at 2 par = at least 20K and this goes to the stated value o

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o This cannot be used to pay dividends because it is a cushion for creditors But par is set at 1 cent to avoid the restrictions of the stated capital fund o Capital Surplus Whatever is raised in excess of the par value can be used to pay dividends o In a no-par issuance o There is no par value and the directors are free to allocate funds from stock issuances to either stated capital or capital surplus o But if they do nothing, the funds automatically go to the stated capital and cannot be used to pay distribution o three common types of distributions o dividends o repurchases o redemptions o can be paid in money or property o SO a company MAY pay distributions o In a Traditional approach when it uses only capital surplus funds or earned capital o In a modern approach as long as it isnt insolvent or would become so o Earned surplus (retained earnings): consists of value generated by the business itself; money made from running the business that hasnt been distributed as salaries, etc. o Stated capital: par value of the issued stock; under the traditional approach, stated capital cant be used for a distribution o Capital surplus: additional amount from sale of stock over the par value; can be used to pay a distribution o Zidel v. Zidel (OR) o Facts: Defendant owned 3/8 of the stock of a closely held corp, and was employed as a director. When his demand for a raise was refused, he quit. Then he demanded that the corp pay dividends. He then complained that the dividends were too small and not set in good faith. Claims that the corporations had large retained earning and that the actions of the majority shows a concerted effort to deprive him of his right to profits o OR Rule: Cos have a duty of good faith and fair dealing toward minority shareholders. But concerning dividends, that duty is met if the decision is made in good faith and reflects legit business purposes rather than the private interests of those in control o BJR - BOP on P complaining S/H must show that the decision was not made in good faith and did not represent legitimate business purposes o The result might have been different if he had argued that their salaries were too high. The BOP might not have fallen on the P. He basically conceded the main point. o The defense in Van Gorkam was that we knew the corporation, so it doesnt matter that we didnt study all the reports. In Van Gorkam, the court said it wasnt enough and found them liable. In this case, the P is arguing that the directors did not really make their decisions on the basis of the factors they claimed to, pointing to documents that they didnt rely on any documented financial analysis. The court doesnt buy that. o Holding: The plaintiff was able to show that the company could have paid a higher dividend. However, he didnt show that the dividend paid was so small as to be unreasonable. Thus, he didnt carry his burden and lost like the big fat loser he was. Notes o Some criticize the courts approach to the duty to minority holders it reduces it to not intentionally harming the minority holder rather than encouraging active pursuit of their interests o Case mainly just shows what to consider and how to approach a claim of oppression for failure to pay dividends o There are no cases were a court has ever forced the board to pay dividends Exception is the Dodge v. Ford case o Dodge v. Ford Motor o The only known case where the court required payment of dividend to shareholders. Ford kept the cash in the company and paid high salaries and had lower profit margins (but made an assload of cars).

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Ford had legitimate business reasons to use earnings for purposes other than paying dividends including expanding facilities and paying high salaries. He could have testified at trial that he wanted to use earnings to make cars less expensive and to pay higher wages to increase profits. He would have won. Instead, he said that the American public would benefit from his making cars as cheaply as possible. o Court thought this behavior made no business sense, and as such forced Henry to pay dividends Sinclair Oil v. Levien (DE)- Parent/Sub Case o Facts: Sinclair had a subsidiary, Sinven. Plaintiff held 3% of Sinven, while Sinclair owned the rest. Sinclair had total control over the directors of Sinven. Sinven paid out huge dividends (which go back to Sinclair), and plaintiff, as a minority S/H, brought a derivative suit because he thought Sinven lost opportunities for not having cash on hand. Plaintiff thought the motivation behind the dividends was Sinclairs need for cash. o SH claims the corp paid too much in dividends as opposed to too little (they also complained about diversion of business from Sinven to other subs and a number of other complaints) o Derivative action of a SH in Sinclair Oil Corp to require Sinclair to account for damages it sustained when it subsidiary (Sinven) paid out dividends Sinclair owns 97% of Sinvens stock So Sinclair ran Sinven and was basically taking all of Sinvens funds for itself o Lower court found that Sinclair had a fid duty to Sinven, which causes the DOP to shift and for it to meet a test of intrinsic fairness ie under careful judicial scrutiny that its transaction with Sinven were objectivly fair Sinclair argues the BJR should apply and not the intrinsic fairness test with its shift in BOP o Plaintiffs argued for the court to apply the intrinsic fairness test to the dividend, which would place the burden on the directors to show that the dividend was fair to the corporation. o App Sinclair caused Sinven to pay out so much that it became a corporation in dissolution concedes that the dividends were in compliance with the statute but were improper because they were motivated by Sinclairs need for cash Court says this isnt enough since the statute was complied with they will have to show that the decision wasnt grounded on reasonable business objectives BJR o Rule: Court said that the intrinsic fairness test only applies in cases of self-dealing (Sinclair is getting a benefit that the minority shareholders arent getting), and in this case since the shareholders all received the same proportional benefit, Sinclair was not self dealing. Since intrinsic fairness wasnt applied, the court applied the BJR and the Ps lost. o If this is a derivative suit, the injury is supposed to be to the corporation. The court technically should have focused on Sinven. We have to ask whether Sinven was injured instead of the minority shareholders. But this may be wrong this is a derivative suit, so the determination whether there was selfdealing that injured the - we should have looked at injury to Sinven, not the shareholders So court is inconsistent with the principles of a derivative suit o * Note: Intrinsic Fairness Test BOP on Directors applies to Self-Dealing, where BJR BOP on P, applies to S/H oppression cases. o 33-8-310: there is a conflict of interest in this case under 33-8-310(b)(2) because these directors are not disinterested so that their votes can cure the conflict. Therefore, even though they have approved it, since they are not disinterested under the SC statute, they dont get the benefit of the business judgment rule and the SC court would likely come out the opposite. Types of stock: o Cumulative preferred: if the dividends are to be paid in a certain year and they cant be paid then in subsequent years those dividends that were missed will be paid when the company has the money to do so. Would take precedence over common shareholders. So same facts as below, but its been 3 years since dividends were last paid out so 4 years worth are to be paid = 8 per share before the CS gets a cent Leaves 24K for the 10000 CS = 2.40 per share o Preferred participating stock not only gets paid first (because it is preferred), but also gets paid again. Participating thus means that these shares also get paid, along with the common shares, in what is left over after payment of the preference. So they get paid twice! o

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o o o o

Ex PPS gets $2 preference There are 2000 PPS and 10000 common stock Declared dividends = 40K PPS first paid out $2 per share = 4k (2000 * 2) = 36K left / 12,000 (10 CS and 2 PPS) = 3 per share CS = total of 3 per share PPS total 5 per share PPS is not cumulative, so if its not paid out one year, the holders would still only get 2 per share Common stock Preferred stock: paid first All the shares in a particular class must have the same rights, but different classes can have different rights Buying and selling stock at a profit o Common law Fraud and Rule 10b-5 o Rule 10b-5 - Securities act of 1934 o It is unlawful for any person by the use of any means of interstate commerce in connection with the purchase or sale of any security To employ any device, scheme, or artifice to defraud. To make an untrue statement of material fact OR to omit to state a material fact necessary in order to make statements made not misleading. To engage in any act which would operate as a fraud or deceit on any person o Note: Any security means any security. Registration exemptions have no effect on whether a transaction is subject to 10b-5 o Basic Inc v. Levinson (Federal Case 10b-5) Public Cause of Action o Facts: Defendant directors of Basic had conversations regarding a merger. They were asked questions and publicly denied that they were in merger talks. Plaintiffs brought a class action on the theory that they sold in reliance on the fact that there would be no merger, and they would have held on otherwise. They sold there stock at a lower price than they would have had they known about the merger. o Issues: What should the standard of materiality be with regards to preliminary merger negotiations? Whether a presumption of reliance based on the Fraud on Market Theory is appropriate to certify a class action? o An omitted fact is material if a reasonable S/h would consider it important in deciding how to vote. TSC Industries. In addition: There must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available. Basic Test o The Management argued that this test should be applied and a line should be drawn: the discussions become material at the point where they have agreed on price and structure. o Materiality Holding: Court rejects this argument and indicates the general materiality test in this case should be applied on a fact dependent basis indicia of interest in the transaction at the highest corporate level Probability / Magnitude Test - The court stated that the test would be a balancing of the probability of the event vs. the significance of the event. Probability factors: o indicia of interest at the highest corporate levels. o Board resolutions, o instructions to investment bankers, o and actual negotiations.

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Magnitude factors: o the size of the corporate entities, o potential premiums to be paid over market value. The Court remands the case on this issue for reconsideration of the question whether summary judgment is appropriate on this issue. o Presumption of Reliance Holding: The court also allowed reliance to be shown with a fraud on the market theory. This states that false public information creates a presumption of reliance for anyone suing on the transaction. Only four justices approved of this part of the opinion Theory that in public trading, the price of the companys stock is determined by the available material information regarding the company and its business. Misleading statements defraud purchasers therefore even if they dont rely on the misstatements directly Should there be a presumption of this reliance? Without it, there wont be a class action because each member would have to show personal reliance and then the individualized issues would overwhelm the common issues claims that allowing it means that the wont have to show reliance on the statements Court says reliance is an element of 10b-5, but the realities of modern market means that the concept of reliance must also evolve there will be a presumption because it would be an undue burden for to show The reasoning behind the theory is sound to sense information directly effects the price and therefore indirectly effects the shareholder A rule 10(b)5 action involves reliance. Fraud on Market Theory only applies to public misrepresentations - the market has incorporated misleading information into it and I have relied on this information, even if not directly, b/c the market reflects this information into the stock price. Court says these types of presumptions are helpful, supported by empirical evidence, and are common sense. Also the presumption can be defeated by: Rebut Loss causation show that market makers knew the truth and as such the market price wasnt effected No in this Case OR Rebut Transaction causation show that the seller would have traded anyway. No in this Case o Note: the court also says that the only way you can respond to a direct question in a way that isnt false is with a no comment Rule 10b-5, silence, absent a duty to disclose, is not misleading under Rule 10b-5. No Comment statements are generally the functional equivalent of silence If you dont like it then you can have legislature change the law. Bottom page 503. o Additional Notes: The Defendants in this case where the directors of Basic and the Corporation. Damages - conceivable the damages could skyrocket and become huge in this case, the stock could be sold a number of times after the merger. Lentell v. Merrill Lynch o A securities fraud plaintiff must prove both loss and transaction causation

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o o

Transaction causation is akin to reliance, and requires only an allegation that but for the claimed misrepresentations or omissions, the plaintiff would not have entered into the detrimental securities transaction. Loss causation is the causal link between the alleged misconduct and the economic harm ultimately suffered by the plaintiff. Thus to establish loss causation, a plaintiff must allege ... that the subject of the fraudulent statement or omission was the cause of the actual loss suffered, i.e., that the misstatement or omission concealed something from the market that, when disclosed, negatively affected the value of the security. Otherwise, the loss in question was not foreseeable. EP Medsystems v. Ecocath. (Federal 10b-5) Private Cause of Action o Ecocath made a fancy ultrasound machine. Ecocath IPOd and of course issued a prospectus that detailed risks. Six months after IPO, Ecocath CEO met with Medsystems to get them to invest. He told them in a private meeting that a bunch of contracts to sell the machine were imminent. Contracts never materialized, Ecocath tanked, and Medsystems sued under 10b-5 for making false statements in connection with sale of securities. o Court says this case in not the typical fraud on market case b/c here the P is not basing its claim on public misrepresentations or omissions that affected the stock price purchases, instead it deals with direct inducement as a result of personal representations made to its executives by EcoCaths executives and that those representations were false and misleading. o 1) Have to show materiality of statements Materiality: court said for a misstatement to be material the disclosure would have to be viewed by a reasonable investor as having significantly altering the total mix of available information. TSC/Basic Test 2 Defenses to Misrepresentations: Statutory safe harbor 1995 Reform Act - an issuer is not liable for statements identified as forward looking and accompanied by meaningful cautionary statements Bespeaks caution doctrine CL doctrine not statutory - Cautionary statements, if sufficient, render a misrepresentation immaterial as a matter of law. However, the statement must be forward looking, and the cautionary statements must be directly related to the statements. The court said that a term like imminent could not be forward looking, as it implied that the contracts were certain, rather than possible. The court was also pretty sketchy on allowing cautionary language in a 6 month old prospectus was proximate enough to the misrepresentations to apply o 2) Have to meet Scienter requisites There is no definitive test in a private COA as to what scienter is most lawyers think that the P must show the statement was made either intentionally or recklessly, nothing less. Scienter: court said that a complaint must plead with particularity facts that give rise to a strong inference that the defendant acted with scienter. o 3) Was there Reliance? (FOM theory not applicable b/c not dealing with public misrepresentations) Reliance: the plaintiff must show reasonable reliance on a false statement or omission of material fact. Waiver? - Weird Result - The court said that reliance followed as a matter of law, and ignored the fact that the plaintiffs signed a waiver stating that they did not rely on any representations o 4) Was there Transaction & Loss Causation?- Not the Usual Case

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o Normally the must show how the misrep caused the stock to decline in value and not just that it induced the transaction o But this case is different from most cases sense the misrep was personal and caused the specifically to purchase shares at an inflated value o This issue should be left to the jury after it makes a determination of causation o For along time there have been to notion of causation in 10b-5 claims Transaction causation the misrep was the but for cause of the investment Loss Causation the misrep caused the loss in value But this opinion doesnt clearly explain what loss causation is and how to apply Loss causation: Plaintiffs must show two kinds of causation Transaction But For causation: Misrepresentation caused the person to make the transaction or sale AND Loss causation: P must show that the Misrepresentations caused the pecuniary loss- decline in value. This is a huge burden, as the lie itself has to cause the decline in value. o Ex so the authors suggest that under the reform act, a P can only recover if the decline in the value of stock was a result of the misrepresentation. Notes o But-for causation you wouldnt have bought the stock but for the lie o Loss-causation must show both that the lie caused you to both buy the stock and to suffer a loss o So if the stock plummets for something other than the lie, you cant recover because of the Reform Act o But courts are still struggling with how to apply loss causation o For instance, how do you show an omission causes a stock to decrease in value? Note: Birnham rule a S/h who sits on their stock and does not buy or sell has no cause or action in order a private cause of action for damages under 10b-5, you must have bought or sold in the face of misleading information. See Case Below!!!!! If you decide not to act because of a misrepresentation or omission, you have no cause of action under 10b-5 Malone v. Brincat (DE) common law-state fraud action not 10b-5!! o Facts: Defendants were directors of Mercury, which overstated its earnings for 4 years. Plaintiffs sued for breach of fiduciary duty of disclosure. bring action for misreps that caused them not to sell their stock Birnbaum rule doesnt apply because they only bring state claims The misrep was in a document that was not related to any shareholder action Mercury had overstated its earning for 3 years. When it used the correct numbers, the Market capitalization (# of shares * value) fell by 2 billion alleges they breached fid duty of disclosure ( is one of the directors) o They didnt bring this as a 10(b)(5) COA because the plaintiffs didnt buy or sell anything. 10b-5 requires you to be a purchaser or a seller (not just holding on to stock). o Issue: Was there a duty of the directors to provide accurate information to the S/Hs without a S/H action? o Rule: This case deals with a state action for breach of duty, not a 10b(5) COA, b/c the guy that holds onto his stock. o Rule: The DE supreme Ct says YES there is a duty. Even in the absence of a request for information, directors who knowingly disseminate inaccurate info have violated either a corporate duty or a duty to the shareholders. In Delaware and SC, directors owe a duty to disclose.

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o Court said that directors have 3 duties that run to the shareholders: due care, good faith, and loyalty. There are three situations where a disclosure to the public can implicate the duties since this case was decided in 1988 the DE court has massaged this language dramatically. Reminder: the Disney case has substantially changed that; now good faith is apparently a subset under the duty of loyalty, at least in the corporate arena. o 3 types of Corp Disclosures that Trigger the Directors 3 Duties : Directors make a public statement to the market; including S/Hs any public statement is governed by SEC rule 10b-5. o May include routine advertising Directors make a statement to shareholders, but do not request shareholder action (this case) This gives rise to a state common law action The duties of care, good faith, and loyalty apply If the misinformation is deliberate, then there is a breach, which can result in a derivative claim or a cause of action for damages Informing S/H about the affairs of the company In order to have a claim against the directors for breach, all you have to show is that the misrepresentation is material. Directors make a statement to shareholders in conjunction with a request for a S/H action (request to vote) The court doesnt tell definitively how much information the company has to give when it is asking the shareholders to vote but it wants to keep information confidential for the benefit of the company. When action is requested, the MBC governs What are legal duties applicable to buying or selling stock o Holding: Directors owe a fiduciary duty to the company as well as to the shareholders to not make material misrepresentations to S/H Reason this duty should be imposed policy reasons to protect the beneficiary interests - Control is separated from ownership. DE rejects the Fraud on the Market notion No state claim because it is covered by federal regulations and because there was no sell here, Fed law wont give a coa Claim may be brought as a derivative claim, a direct claim or both. The plaintiffs, however, never expressly assert a derivative claim on behalf of the corporation. Here the complain it bad because it says the corp lost all its equity, so it should have been a DERIVATIVE suit but the filed a direct claim o But they should have leave to amend and file a derivative suit or make proper pleadings for a direct suit o On remand, the plaintiffs will have to prove reliance and damages. o Possibility of a Tort Action Rest 552 (p. 531) If the person provides false information for the guidance of others, the person may be subject to liability. This liability is limited to loss suffered by the person (or groups of persons) the informer intends to use, or rely on the information Has been used frequently by SC Courts (so far not against lawyers) 3rd Party info: Lawyer gives advice to a client, client passes it on to a 3rd party, who is a buyer of the clients company SC sup ct says buyer can definitely sue the atty or the accountant based on 552 This section gives third parties a claim against a lawyer; extends lawyer exposure

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Notes So I think this case says o 1) if the info was requested, you just have to show that the misrep was material But if it was nto requested you have to show all the factors laid out in the EP Medsytems case including reliance and lost cauastion But fid duty still applies o 2) if its a fed claim you have to have sold or bought But a state claim exists if you just sit 10b-5 and buying or selling with inside info Dura Pharmaceutical v. Broudo (Federal 10b-5 Private COA) Facts: Purchasers of stock in Dura brought securities fraud action (10b-5) against company and certain managers and directors, alleging that defendants' false statements regarding expected future (FDA) approval of a new asthmatic spray device artificially inflated price of stock. Issue: Is the 9th Circuit statement of Loss Causation Accurate. NO Holdings: The Supreme Court, Justice Breyer, held that: an investor may not establish loss causation by alleging that security price was inflated because of misrepresentation, and investors allegations were insufficient to state fraud claim. Analysis: The Ninth Circuit held that a plaintiff can satisfy the loss causation requirement simply by alleging that a security's price at the time of purchase was inflated because of the misrepresentation, Ninth Circuit's approach would allow recovery where a misrepresentation leads to an inflated purchase price, but does not proximately cause any economic loss. An inflated purchase price will not by itself constitute or proximately cause the relevant economic loss needed to allege and prove loss causation. First, as a matter of pure logic, the moment the transaction takes place, the plaintiff has suffered no loss because the inflated purchase price is offset by ownership of a share that possesses equivalent value at that instant. And the logical link between the inflated purchase price and any later economic loss is not invariably strong, since other factors may affect the price. Holding: Thus, the most logic alone permits this Court to say is that the inflated purchase price suggests that misrepresentation touches upon a later economic loss, as the Ninth Circuit found. However, to touch upon a loss is not to cause a loss,. The Ninth Circuit's holding also is not supported by precedent. The common-law deceit and misrepresentation actions that private securities fraud actions resemble require a plaintiff to show not only that had he known the truth he would not have acted, but also that he suffered actual economic loss. The complaint's failure to claim that Dura's share price fell significantly after the truth became known suggests that the plaintiffs considered the allegation of purchase price inflation alone sufficient. The complaint contains nothing that suggests otherwise. o Burkie says the problem with this case seems to be that ??? Dupuy v. Dupuy (Federal 10b-5) Facts: Defendant was trying to get his brother to sell his shares of the company at a deep discount, so he called him up and asked for the shares. He told him a project was stalled, and kept secret that he had sold land for a ton of money. Tried to defend on the fact that the telephone calls werent interstate commerce. Issue: What involvement of interstate commerce is required to have a 10b-5 claim? o

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Holding: Court found that intrastate use of a telephone is enough to constitute interstate commerce, and grant federal jurisdiction over the cause of action. Also it went through the banking system which involves commerce Note - 10b-5 actions can be brought by a buying or selling defrauded S/H the S/H does not have to be involved in the mgmt of the company. It is not hard to find enough of a interstate connection to bring a 10b-5 action. Goodwin v. Agassiz (MA) - (prior to 10b-5). Facts: Plaintiff sold stock in a mining co. on a public exchange, and it turned out that the defendant, who was a director of the mining company, bought the shares. Director bought shares b/c he was aware that the co. was buying land that was rich in copper deposits. Co. essentially stopped all mining activities in Michigan b/c they would be able to get the land cheaper. There was no communication between plaintiff and defendant b/c the trades were done on the open market. Plaintiff did not sue for buying with inside information but rather for failing to disclose material, the information that had he known, would he would have not sold his shares. Classic Case facts are identical to Texas Gulf Sulfur Case Issue: Do directors have a duty to their shareholders when buying their stock? Holding: Court said that the fiduciary duty of directors runs to stockholders, but generally a director has no common law duty to disclose inside information when buying or selling stock. Exception: Where a director personally seeks a stockholder for the purpose of buying his shares without making disclosure of material facts in his knowledge that the stockholder cant get from other available information, then relief may be granted to the stockholder. o In this situation, it was clearly an armslength transaction on an open market, so there was no breach of fiduciary duty to disclose. In addition, there was no representation here. The court found no grounds for inferring fraud or conspiracy. o If it had been a face to face transaction, the result might have been different. Court also took into consideration that the P in this case is a stockholder who has particular knowledge of this kind of injury (he was sophisticated). Note that this duty only arises from one who receives his information because of his position as an insider Also note that this duty only runs to shareholders, so it only exists on the buy side (unless the buyer already has some stock). Jacobson v. Yaschik (SC) Facts: Plaintiff owned of the stock in a Charleston corporation, Defendant owned the remaining . D bought Ps shares for $30K, but didnt tell the P that he had entered into a contract to sell all of his shares for much more, and he shorted her about 20%. Court stated 2 rules Majority (Goodwin Rule): there is no duty for a director to volunteer inside information when buying stock from a shareholder. o Special Facts Exception: The exception is when the insider has knowledge of special facts (facts not available on the books that enhance the value of the stock) that are not known to the shareholder, in which case he must disclose. Minority Rule (adopted by SC): Officers and directors stand in a fiduciary relationship with shareholders and regardless of special facts,

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the fiduciary duty requires full disclosure of all relevant facts when purchasing from a stockholder. o Key Language from the Case: The duty to disclose may be reduced to 3 distinct classes: where it arises from a preexisting definite fiduciary relation between the parties; where one party expressly reposes a trust and confidence in the other with reference to the particular transaction in question, or else from the circumstances of the case, the nature of their dealings, or their position towards each other, such a trust and confidence in the particular case is necessarily implied; where the very contract or transaction itself, in its essential nature, is intrinsically fiduciary and necessarily calls for perfect good faith and full disclosure without regard to any particular intention of the parties. Election of remedies: plaintiff can choose whether they want equitable or legal remedies. The problem is that the P might not know what they can prove. The courts generally force the plaintiff to make the election pretty darn early. SC Rule, unlike Goodwin, probably applies on buy and sell side o Problems Page 540-41: Under the Goodwin rule, a person that accidentally overhears insider information does not presumably does not have a duty to disclose b/c there is no fiduciary duty probably safe under SC rule too. Under Goodwin, the P loses. In SC, it is questionable whether it fits within the 3 classes of the duty of disclosure. These problems are easier to answer in SC because almost all of the answers in SC would be to pay up. SEC v. Texas Gulf Sulfur (Federal 10b-5) Facts: Defendant found a huge mineral deposit in Canada. Kept it quiet for a while in order to buy land on which to dig. A director, some employees, and their tippees bought stock. When the news broke, the stock went nuts. SEC brought a 10b-5 against defendant and directors. SEC alleged that defendants had bought on material inside information, and that defendants had tipped others for use in buying stock. A call option is a contractual right to purchase stock at a specified price in the future. If the stock doesnt go up in value, then the call is worthless. The nature of the investments in this case are key the fact that they purchased call options is indicative that they knew the stock was going to rise. Rule on Insider Trading: Directors with insider information that is MATERIAL must either disclose the info to general public or abstain from trading in the securities until disclosure is possible: The general rule under 10b-5 is that anyone trading for themselves who has direct or indirect access to information intended to be used only by the corporation knowing that the person they are trading with doesnt have the information is precluded from doing so. Material Test (insider info): balancing of the probability the event will occur with the magnitude of the event. The basic test of materiality is whether a reasonable man would attach importance in determining his choice of action in the transaction in question. When it is material, the people entrusted with the corporate information must either disclose or refrain from trading. Holding: Information was material and omission/nondisclosure of the material facts prior to trading was a violation of 10b-5(3). 10b-5(3) makes is unlawful to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person in connection with the purchase or sale of any security. The court also found that the tipper in this case was just as liable for any transactions that his tippees were involved in.

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 If all of the guys in this case are liable then what do you do as a corporate officer if you want to purchase stock in your company. Cos can have pre-existing stock options and employee purchase plans You cant buy stock immediately preceding the occurrence of a major corporate event. Rule: because this was not an action by a stockholder to recover but instead an action by the SEC against insider trading by a director, there was no need to show causation (transaction or loss). Notes One issue is when can insiders buy stock in the company (which is something we want so they have a personal stake in the company) o One method is to have a set amt of stock to be bought by them each month o Others allow them to buy after a public disclosure, but that they have to wait a reasonable amt of time for the info to fully disseminate and act Mr. Dark is also focused on here o He was the one who tipped of the tippees, which also makes him liable o One question is whether he is also liable for the amounts that these tippees made but not sure Damages o Courts have held that the wrongdoers have a duty to cover the amt that the seller missed out on Questions 2 no liability under Common law or Goodwin. a. Under Jacobson, yes he would be liable fid duty to share holder Reread note 6 Be sure that you do not give insider information that you obtain as a lawyer to your friends o Chiarella v. United States (Federal 10b-5) Facts: Chiarella worked at a print shop that published merger materials. He was smart enough to piece together the inside information and invest and make some quick money. US indicted him for violation of 10b-5. The court stated the general rule that a corporate insider must abstain from trading in shares of his corporation unless he has disclosed all material inside information known to him. However, the duty arises from the fiduciary duty to the shareholders, so doesnt run to Chiarella. Rule: The court held that, absent a pre-existing duty to the shareholders, Chiarella committed no fraud, and as such did not violate 10b-5. NO criminal violation. But in Cady the court held that a corporate insider couldnt trade in its own stocks unless it disclosed o So if you work for the company, you have a duty to disclose al material info that you learn about because of your position as an insider before buying or selling stock in that company o There is special relationship between the insider and shareholders of his corp So the fid duty creates a duty to disclose But if there is not a fiduciary relationship, then you would have to make an actual misrepresentation to commit fraud. Mere silence would not be a fraud without a relationship that creates a duty to disclose Therefore the did not violation 10b-5 or common law fraud because he had no duty to the shareholders that would require him to disclose Dissent wants to extend the duty to include people who have misappropriated nonpublic information he suggests we focus on the way in which the buyer acquires the information which he conceals from the vendor should be a material circumstance.

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 The majority says that they disagree b/c the jury wasnt properly charged on that theory. They dont necessarily say that they disagree with the theory. Notes o o o o The holding in Chiarella is said to espouse the Classical theory of insider trading Note SEC 14e-3(a) makes it unlawful to trade on material nonpublic information concerning a tender offer Chiarella is probably consistent with the special facts doctrine (ie fid duty) Dirks v. SEC (Federal 10b-5) Facts: Dirks was a broker, and got a tip from someone at Equity Funding that they were overstating revenue. He investigated and decided it was true. He couldnt get any of the newspapers to print it, but he did tell his clients. SEC brought him up on a 10b5, and tried to assign liability to him as a tippee. worked for a broker-dealer firm and specialized in analyising insurance companies o A former officer of Equity Funding of America told him the companys assets were overstated because of fraud and asked him to investigate o Some evidence corroborated the story. had no stock in the company, but he dicussed his finding with his investors, who sold their stock = 16 million o Equity eventually got caught and the SEC investigated Dirks SEC found that Dirks violated 10b-5 by giving the info to investors = tippees o Dirks really both a tipper and a tippee, but this opinion focuses on his role as a tippee o Where tippeesregardless of their motivation or occupationcome into possession of material corporate information that they know is confidential and know or should know came from a corporate insider they must either publicly disclose that info or refrain from trading Issue: When will a tippee be liable under 10b-5? Unlike insiders who have independent fiduciary duties to both the corporation and its shareholders, the typical tippee has no such relationships. Tippee responsibility must be related back to insider responsibility by a necessary finding that the tippee knew the information was given to him in breach of a duty by a person having a special relationship to the issue not to disclose the information. In determining whether a tippee is under an obligation to disclose or abstain, it thus is necessary to determine whether the insiders tip constituted a breach of the insiders fiduciary duty. The tippee is liable when the tippee: Receives the information improperly. o It comes from an insider in breach of his fiduciary duty to the shareholders - there has to be some type of improper behavior on the part of the tipper and the tippee must know about it AND o The insider received a personal benefit from the disclosure (benefit is required to show the breach). The test is whether the insider will benefit directly or indirectly from his disclosure. Some type of financial benefit The elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend Reputational benefits that will transfer into future earnings OR the tippee could also have entered into a special confidential relationship with the business and are given the information solely in regard to that relationship. This type of tippee carries the same insider duty. Sometimes the tippee will not be treated as a tippee but will instead be treated as an insider. Under certain circumstances, such as where corporate information is revealed legitimately to an underwriter, accountant, lawyer, or consultant working for the corporation, these outsiders may become fiduciaries of the shareholders. The basis for recognizing this fiduciary duty is not simply that such persons acquired nonpublic corporate information, but rather that they have entered into

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a special confidential relationship in the conduct of business with the enterprise and are given access to information solely for corporate purposes. Holding: Dirks is not an insider. So he cant be liable on that theory AND the tipper received no personal benefit so Dirks did not receive the information improperly. Notes o o Doesnt matter that insider was a former officer in this case because he obtained the info while he was still serving as an officer and had a duty to the shareholders There can be temporary insiders o Such as a lawyer or accountant working for the company these people will have a Cady duty o They will be treated as a tipper not a tippee ie as an insider, and the rules will be stricter o But they wont be liable if all they do is assist another insider US v. OHagan (Federal 10b-5) Facts: D was a partner in a law firm hired by Grand Met to help acquire Pillsbury. D didnt work on the case. He bought Pillsbury stock and made a shit ton of cash. He was indicted for criminal violation of 10b-5. worked with a law firm in Minneapolis. His firm was retained by Grand Met to negotiated a tender offer to acquire Pillsbury Co. o didnt work directly on the matter, but he learned of it and bought stock and stock options in Pillsbury o After the acquisition, sold his stock for a profit of 4.3K o Charged with 17 counts of securities fraud under 10b-5 o Side issue, used some of the profits to replenish client trust fund that he has converted money from o Trial court found him guilty, app crt. Reversed. SC found him guilty and adopts the misappropriation theory Classical Theory of insider trading also applies to attorneys o But this theory doesnt apply in this case because he wasnt an insider since he didnt work for Pillsbury Co. He worked for Grand Met. So he owes no fid duty to the Pillsbury shareholders o So classical theory applies only if you use inside info that you learn from your company to trade in shares of your company There is a theme running through the text that we shouldnt assume 10b-5 is the only thing out there, there are other ways for the SEC to prosecute the case. Misappropriation Doctrine: when someone misappropriates confidential information for securities trading purposes in breach of a duty owed to the source of the information. Under this theory, a fiduciarys undisclosed, self-serving use of a principals information to purchase or sell securities, in breach of a duty of loyalty and confidentiality, defrauds the principal of the exclusive use of that information. The misappropriation theory is thus designed to protect the integrity of the securities markets against abuses by outsiders to a corporation who have access to confidential information that will affect the corporations security price when revealed, but who owe no fiduciary or other duty to that corporations shareholders. So there must be a duty owed to source by the Outsider who has access to Material confidential information If someone receives this information, they can defeat the misappropriation theory by disclosing to the person that gave them the info that they are about to trade on it (then there is no deception) Of course, as soon as you make that statement, you have the proof for common law fraud (Burkhard says this is not trueyou would be fired and the law firm would stop you from doing it, but it would not be common law fraud according to him). The fraud is consummated, not when the fiduciary gains the confidential information, but when, without disclosure to his principal, he uses the information to purchase or sell securities.

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The Court also focuses on the fact that deception is a fundamental notion of 10b-5. Court holds that misappropriation theory falls under 10b-5(1) conduct involving a deceptive device or contrivance used in connection with the purchase or sale of securities But breach of duty isnt enough. There must be a deceptive act there is one case where the outsider stole from the company but no 10b-5 violation because the docs they used said they were stealing o Deception found in fact that took information the company trusted him with and used to to make a profit OHagan is not liable under a misappropriation theory b/c he bought the shares of the target, not his client, so there was no pre-existing duty against misappropriation. Holding: Hagan is liable under 10b-5- classic insider trading is when a corporate insider trades on the basis of material nonpublic information, and this qualifies as a deceptive device under 10b-5. This was not classic insider trading because he had no affiliation with Pillsbury. However, he violated the trust and confidence of his employer. 10(b)(5)(2) SEC attempt to define when there is a fiduciary relationship, that if breached in a securities violation, there is a 10b-5 violation. This new rule creates a fiduciary relationship when a person receives or obtains material, non-public information from his/her spouse, parent, child, or sibling. However, there can be circumstances when that doesnt apply. If the communication is intra-family, that information is supposed to remain confidential. o Deception is Important o If youd used the CL rule of a trustee relationship, then the would need consent to use the property entrusted to him o Under misappropriation theory or 10b-5, all you need is disclosure to be able to use the info o Court is adopting narrower sense of misappropriation theory the disclosure need only be made to the source here his law firm and Grand Met- this is different than the misappropriation theory advanced by Burger in Chiarella, which would require disclosure to the market o SO 10b-5 isnt violated if the outsider discloses to the source that he plans on trading on the nonpublic information But your gona get fired and stopped from doing it o The source of the information does not have to be involved in the transaction because the fraud occurs when he uses the info, not when he obtains it this is important because the fraud must be in connection with the purchase or sale of stock o 10b-5 says it applies to fraud connected with any sale or purchase. Not to the defrauding of any seller or purchaser so the fraud need only attach to the act, not the seller or purchaser involved in the trade o Remember that 10b-5 comes into play only if the uses the info to trade stocks o Finally says that misappropriation was not rejected in Chiarella because the argument was never submitted Questions on p. 578: Chiarella would be held to have violated 10b-5 after OHagan because he had a relationship of trust and confidence with his employer. Burgers misappropriation theory is different from the misappropriation in OHagan because in OHagan, the disclosure obligation runs to the source of the information as opposed to Burgers reading that the disclosure obligation ran to those with whom the misappropriator trades. FN 6 suggests that the shareholders of Pillsbury would not have a private cause of action. OHagan could have been charged as a temporary insider under Chiarella fn#14 if Pillsbury knew that they were going to try to buy them, but in this case they didnt know so fn#14 wouldnt apply. Reliance v. Emerson (covered at end of semester) 16(b) of the Securities Act requires an owner to pay back money to the corporation because it assumes you have used inside information (has something to do about within 6 months- look this o

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up). The question is who is a beneficial owner. That is what the case is all about. The statute talks about being a 10% shareholder at the time of purchase and at the time of sale. The problem presented in this case is that Emerson Electric acquired 13% of Dodge Manufacturing. The problem was that Reliance Electric came along and made a better deal. The question is whether Emerson has to pay profits back. Yes. So they tried to take advantage by selling stock to reduce their holdings to 9.96%. The argument is that the second sale that would occur shortly thereafter wouldnt be covered because they would no longer be a10% shareholder so they wouldnt have to pay back the company. Reliance said that doesnt work so you owe us the balance on all of it. The Supreme Court said that the lawyers for Emerson are correct and you dont link the two transactions together. Therefore, the profits on the second sale did not have to be paid back to the company. o 16B if you own 10% or more of a public company and buy stock and sell it within 6 months the corporation will be able to recover the profit you make o You dont link two sells together if there is a difference of time and buyer o Purpose is to prevent insider trading o Must own the 10% both at purchase and at sell, otherwise you wont be a beneficial owner and the act ownt apply o The company only gets the profit so if you by at $10 and sell at 20 the company only gets $10 a share o Government only looks at the difference, so even if you loose money, you stilll have to pay the difference see number 3 page 585 he made 1 million See problems on p. 584 Bradley v. Hullander (SC) The buyers of this automobile dealership noticed the following things were wrong: information in some of the financial statements was wrong, there were arguments that they hadnt disclosed changes in their accounting methods, there is an allegation that the offering document was wrong/misleading o was given exclusive right of sale over corporate stock of Pauls pntiac Buick a SC corp o hired Glen Covey Associates to locate a dealership for them to buy. They met the . And put down 10,000 in earnest deposit o retained control of the dealership unitl closing of the stock purchase agreement At closing the paid an additional 55K And gave a note for 160K o The total purchase price was 200k subject to any increase in value occuring between May 31 1974, and the takeover. There is always a gap between signing of K and closing nothing material is supposed to happen during this period o Originally only 90K was to be paid at closing, but the additional 34K was added and was to be used in opperating the business after the takeover at which time it would be paid to seller once the total net worth of the business was determined o After the took over, they had a CPA audit the corporation to determine the net worth and determine how much it owed to o Brings suit under 62-309 Which says it is unlawful to offer or sell securites by means of any untrue statement of material fact or by omission The buyer does not have the BOP to show that he didnt know the truth o Buyer may sue in law or equity to recover consideration paid plus 6% interest per year o How would you go after these guys o Fraud o Breach of K o 10b-5 o 35-1-509 / 12 unser SEC o Breach of warranty o The first cause of action is to sue them for fraud and try to rescind the contract.

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I also might sue them for breach of contract. Could sue for negligent misrepresentation Could sue under 10b-5 Might be able to sue under the Unfair Trade Practices Act Could sue under 35-1-509 (which is what they did sue under in the case) There is an argument that this isnt a security at this point because they were selling the whole business, not a security. The courts today say that because you are buying the stock of the company instead of the assets of the company, there would be no problem today bringing a security claim. o But this doesnt fly bc technically you are buying all the stock and the assets just come along with it The opinion seems to say that everyone is interested in the companys balance sheet so that automatically becomes material information (automatically material to the transaction). See discussion of 35-1-509 below (and additional discussion of differences below) o The SC 35-1-509 at issue is taken from 12(2) of the Sec. Act of 1933 I think the following applies only to the SC statute though because there are some differences between the two as discussed below plus we looked at 10b-5 in class, not 12(2) o To recover the must show The misstated or omitted to state certain material facts, That such misstatements or omissions rendered the statements made misleading And that did not know the truth o A material fact is a fact about which an average prudent investor ought reasonably to be informed before purchasing the security o DOES NOT have to show reliance, causation, or that the sale would not have occurred absent the omission (ie transaction causation) o s sophistication in the securities and the availablity of the information to is immaterial And they do not have to show that they could have discovered the falsity upon reaonable investigation o violates 12(2) by mere negligent misreps or ommissions o And BOP is on seller to show that he was not negligent or reckless or acted intentionally o SO under 12(2) all the has to show is that there was a material misreprestnation. The will then have to show that he didnt act negligently o As to Culpablity what is the difference between 35-1-509 and 10b-5 o In SC you need only be negligent o In 10b-5 you need to be reckless o How about a due diligence defense o SC allows this ie that didnt use due dilligence in finding out the truth o Not clear if 10b-5 would allow this In SC negligence is enough for culpability but under 10b-5 you have to be at least reckless. That is why you would bring an action under 509 instead of 10b-5. In SC you dont have to show reliance. Under 10b-5 you have to show loss causation and transaction causation. In SC, you bring a 509 claim in state court. You would bring a 10b-5 claim in federal court. Should the sellers be responsible for the prospectus (offering document) that they did not prepare? Yesif the accounting firm only used information that the sellers gave them. If the accounting firm/broker generated these on their own, it is a very difficult agency question to answer (unclear whether the sellers would be liable). Section 12(2) does not require that plaintiffs show reliance, causation or that the sale would not have occurred absent the omission. Biales v. Young o negotiated a 275K loan from for use in a Garden City Resort o Gwin served as s atty o o o o o

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o o o

o o o

Loan secured by promissory note and a second mortgage in the units. Also the received 2% equity participation in Litchfield plantation once the bought it o Gwin was to hold the loan in escrow until the plantation was purchased o But Gwin says he didnt know he was to act as escrow and distributed the funds directly to the Gwin gave notice to the that he had distributed the money and did not respond never bought Litchfield and eventually went into bankruptcy after spending the money claims Gwin breached his fid duty as escrow and violated SC Uniform Sec Act o Trial court found no breach because of waiver o And that no violation of Sec Act because Gwin was not a seller Sec Act Violation o 35-1-1490(2) Any person who: Offers or sells a security . . . (same language as above) o An offer or offer to sell includes every attempt or offer to dispose of or soliciation of an offer to buy a security or interest in a security value. o A sale includes every K of sale of or disposition of a security or interest in a security value Pinter Test: o A person who offers or sells is not limited to the owner of the sec. but they must Solicit the purchase And be motivated at least in part by a desire to serve his own financial interest or that of the owner of the security (ie a broker) SO you dont have to have Privity to come under the act, but you must try and sell it Gwin did not offer or solicit an offer nor did he pass title o Thus there was no offer or sale = no violation Clearwater v. Bunting (SC 10b-5/501) Facts: S/H were trust beneficiaries who relied on one of the officer, Buntings, statements that they were not going to merge in deciding to sell their stock back to the corporation. They lost $1.3 million because they didnt wait to sell the stock after the merge. Issue: Why wasnt this a classic 10b-5 case why didnt they sue under 10b-5? SOL problem. They also did not argue 35-1-509(c). Why not? This is a recent amendment to the statute that did not exist at the time this transaction occurred. 2 Basic claims: Claim #1: o 1) Misrepresented the status of the company, 2) Breached his fiduciary duty of disclosure, or o it is a violation under the S.C. equivalent to 10b-5? all the same claim. 35-1-501 however at the time of this case the law was clear that there was no private cause of action; this was enacted after the case was decided o SC - Now by legislative enactment there is a 10b-5 private cause of action in SC, but at the time of this case there wasnt. The plaintiff tried to argue that certain amendments created a private cause of actionthe court says no go! The plaintiffs argue that he had a dual role as a shareholder (as well as an officer) because the officer SOL had already run out, but another SOL hadnt run out. This opinion indicates that the reporters comments involving the code sections dealing with directors and one involved dealing with officers. o 33-8-300 BJR - General Standard for Directors: the comments then clearly indicate that the legal principle of a direct duty to S/H was retained in SC.

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Scary result for the court to say the ONLY fiduciary duties to a S/H are the ones read in the statute and that all the common law duties are null and void. Holding: Any duty that Bunting had owed was negated by the fact that the SOL had run the code rules and the SOL had run no chance of a COA on common law duties. Burkie says Incredible Result!!! for better or worse. Claim #2: Insiders issued stock options to themselves they are able to buy the stock cheaply, so when the merger occurs they are getting a larger share of the pie than anyone else Holding: The court throws this out saying this should have been brought as a derivative suit and the guy brought it as a direct claim the injury is not to the Co. it is to the individual S/Hs who are bringing the lawsuit. Differences between SC 501 and 10b-5 Jurisdiction: for 10b-5 to attach, all you need is interstate commerce which is never a problem For 501 to attach, the offer must originate from SC. Standing to Sue: 10b-5 covers buyers and sellers of securities 501 only allows the buyers of the security to sue the sellers Materiality About the same, although 501 talks about the average prudent investor which may be a lower standard Culpability under both 10b-5 and 501 the seller must be reckless in his omission or false statement Due diligence defense There is no defense to 10b-5 501 has the defense but you probably cant prove it Plaintiffs knowledge of the truth of the statement is a defense in both cases Causation 10b-5 and 501 requires proof of causation Remedy 10b-5 private cause of action - doesnt carry attorneys fees 501 private cause of action thru 509 carries o the security o consideration paid o interest o attorneys fees SC USA - Fraud & Liability Statutes 35-1-301 Registration of securities 35-1-501 (Used to be 1490)SC equiv to 10b-5 Fraud It us unlawful for a person, in connection with the offer, sale, or purchase of a security, directly or indirectly, to employ a device, scheme, or artifice to defraud 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, in the light of the circumstances under which they were made, not misleading or

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 to engage in an act, practice, or course of business that operates or would operate as a fraud or deceit upon another person. 501 - places liability on a sellers to buyers for illegal or fraudulent sales or offers Court also said that that selling an entire dealership is the same as selling a security Note the split the US supreme court has said that sale of a whole business is not a security 35-1- 509 Civil Liability- applies to buyers and sellers (b)A person is liable to the purchaser if the person sells a security in violation of 301 or 501 or, by means of an untrue statement of a material fact or an omission to state a material fact necessary to make the statement made, in light of the circumstances under which it was made, not misleading , the purchaser not knowing the untruth or omission and the seller not sustaining the burden of proof that the seller did not know and, in the exercise of reasonable care, could not have know of the untruth or omission. o 501 violations in 509- only requires proof materiality; does not require not loss or transaction causation, reliance. o Standard is negligence (b)(2) Purchaser can recover You can also just sue for damages r recover o Consideration paid for the security + 6% interest o Costs and ATTORNEYS FEES o Minus any income received for the sale of the security (g) Aider and Abettor J/S liability o Person who indirectly or directly controls person liable o Manager, officer, director o Individual who is an employee who materially assists in the conduct much narrower than the persons who used to be liable (under the Uniform Act the language is an individual associated with which opens up liability, but SC does not have this language) o A person with actual knowledge that a person is committing an act sufficient to violate 501 and intentionally furthers the violation becomes an aider and abettor and thus jointly and severally liable (j) cause of action must be brought in three or five years depending on which section is violated (m) unless there is a specific statutory remedy there isnt anything else purpose to cut off any implied private cause of action. Why would you want to bring a COA under 509b and not 501? Differences between 501 & 509: See Bradley case above for further discussion of the differences between 509 and 10b-5 There are no 501 cases in SC. Presumably all the jurisprudence that has grown up around the federal cases will be applied in SC, but we dont know if SC is going to adopt fraud on market. 501 requires the showing of scienter but the standard is recklessness or intentional. 509b standard of conduct is negligence Causation is another critical difference

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o 501 requires loss and transaction causation be proved o 509 Bradley case - NEITHER loss nor transaction causation need to be proved (at least under (c)). Essentially the only thing that needs to be proved is materiality. o Another thing that 509b does that the federal statute does not do is clarify what the remedies are there is not a private cause of action under SC 501. Common law duty of selling shareholder. Looking at situations where a majority SH is made an offer and knows that a minority SH also wants to sell o Is there a duty to condition sell on the offeror also buying the minority share Also where the SH has two offerees- one that is higher, but from a buyer that will ruin the company, and one that is lower but from someone who will help the company o Nothing tells us what to do in the statutes Control Premium o Extra amount a buyer will pay over the value of stock because that block will give him majority control o Some see this as a company assets but nothing requires the SH to actually demand it on the sale CL gives guidance to these issues DeBaun v. First Western Bank (CA) Derivative Suit Plaintiff was a minority shareholder in a closely held corp. The majority shareholder died, and the bank was the executor for his estate. The bank sold the shares to a guy who was clearly a corporate looter, and they didnt do any checks for outstanding judgments they trusted his reception at the Jonathan Club. The looter killed the company. o brought a direct and a derivative action against the bank Case proceeded as a derivative action Trial court found that Bank liable for breach of duty owed as the majority shareholder to the corporation it controlled Awarded 473,836 o Computed by adding 220K (value at time of transfer) o Plus amt equal to anticipated after-tax earnings of the corporation of the ensuing 10year period and considering an 8% growth factor o Also gave sum needed to defend against its creditors claim Rule: Duty of Goof Faith and Fairness encompasses an obligation of the controlling S/H in possession of facts such as to awaken suspicion and put a prudent man on his guard that a potential buyer of his shares] may loot the corporation of its assets to pay for the shares purchased o RULE In any transaction where the control of the corporation is material, the controlling majority SH must exercise good faith and fairness from the viewpoint of the corporation and those interested therein This duty requires the controlling shareholder in possession of facts Such that awaken suspicion and put a prudent man on his guard That a potential buyer of his shares May loot the corporation To conduct a reasonable and adequate investigation of the buyer Rule: Selling S/H, in any transaction where the control of the corp is material, has a Duty of Good Faith and Fairness- obligation to conduct a reasonable investigation of the buyer and not to sell if he finds facts that would put a reasonable person on notice that the buyer would loot the corp. In this case, the Bank clearly had the duty and breached. The court measured the damages that the bank was to pay TO THE PLAINTIFFS (this was a derivative suit). Damages:

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 pay the debts incurred during the looting pay S/Hs - their share of the value the corp would have had had it not been looted Attorneys fees b/c the real party in interest here is the trust, so thus it is appropriate to award atty fees. Goodwill factor and anticipated profits were properly added to the damages As was requiring Bank to pay off claims against Corporation by creditors Trial court found that Bank liable for breach of duty owed as the majority shareholder to the corporation it controlled Awarded 473,836 o Computed by adding 220K (value at time of transfer) o Plus amt equal to anticipated after-tax earnings of the corporation of the ensuing 10year period and considering an 8% growth factor o Also gave sum needed to defend against its creditors claim Is this overkill? Why does he have to put the company back to 100% of where it was when the only owned 30% o The other 70% goes back into the trust that the bank was presiding over for the family of the maj. Share holder If this had been a direct suit by just Debaun, presumably the remedy would have been much more limited How does the Lawyer help them investigate Pull a Dun & Bradstreet report on the buyer. Bank references ask for Certified Financial Statements if they are available Internet Search o (It could be malpractice not to do this). o Perlman v. Feldman Case is in every Corporate Text, has not been followed but the language in the opinion is important to think about. 37% shareholder of a publicly traded steel company sold his shares to a steel company that wanted to guarantee supply during tight markets. Shareholder got a premium for the controlling share. o Minority SH bring derivative suit against for damages incurred from his sale of his controlling interest in Newport Steel Corp was also CEO and President o claim along with shares, the sold a corporate asset- a power held in trust by the majority shareholder to control the corporate product in a time of scarcity- this was transferred by the act of resigning his old board upon the sale, which allowed the buyer to elect its own board So he didnt just sell his shares, he agreed to allow the buyer to replace the entire existing board You dont have to have 51% to control, it can be a lot less ie here it is only 30% If you can transfer control with your block of share, you will get paid more o claims that the minority SH should get a cut of the consideration given for this power ie the Control Premium the amt given in excess of the value of the shares in exchange for the control those shares confer Trial court said such a right doesnt exist and that majority shareholder is free to act in his own best interest absent a threat that the buyer will loot the company Also says failed to show inadequate consideration was given o What did he do wrong according to Sold control shares for a premium ie more than what anyone else could sell theirs for Corporate opportunity ie missing out on building business relations with other purchasers during this time of scarcity because they sold to a purchaser (and he got a premium) But the flip side is that the purchaser will be buying from them

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o o

Loss of Feldman Plan Way to get money they couldnt up the price of steel because we were at war and needed it. but they could get these loans in exchange for selling them steal Counter is that the purchaser is going to improve the company itself because it wants as much steel as possible Another issue was that there was another buyer who offred to pay a premium as well, but it would have gone to all the shareholders rather than just the him Book value of stock was 17.03 but it was selling for only 12 per share. The sold his block for 20 a share so we see a control premium did have a fid duty (as a maj SH and as a director) to corp and to minority SH As a director his conduct is closely scrutinized, and he must not have allowed his personal interest affect his business decisions He has this same duty as a majority SH becaue he selects the directors and thereby assumes their liability This isnt normally breach of fid duty But court is holding them to the punctilio of an honor standard So fact that took advantage of a favorable market situation is not consistent with the undivided loyalty he should have for the corp and minority shareholders Here he has taken a corporate opportunity for himself The opportunity need not be absolute as long as there was a possibility of corporate gain, the are entitled to recover Here the possible gain was to get Feldmann plan funds interest free advances from purchasers in exchange for a promise to supply them with steel. These funds could have been used to improve the corp However, because the sold his controlling shares, the buyer was able to make the Corp a supplier for only itself thus limiting it opportunity to grow = lost corporate opportunity had BOP to show that such opportunity did not exist, and it did not meat its burden Court not saying you can never sell majority shares to a buyer that has an interest in your product, but that you cant do so if it results in sacrifice Rule: Majority shareholder has a fiduciary duty to the corporation and to minority shareholders. The duty means he must exercise business judgment with respect to any dealings that may affect the corporation, including selling his shares. BOP on D - D had to show fairness in the deal by proving that there was no possibility that the company would do better under the Feldman plan o fiduciaries always have the burden of proof in establishing the fairness of their dealings with trust property. IN this case the sale meant the company would no longer operate the Feldman plan, where he used tight markets to secure interest free loans to expand the business. 3 Theories of what he did wrong in this case: Sale of Control and the receipt of a premium for that share is wrong cant usurp control of that. Usurped a corporate opp that belonged to the Co., the premium really represents a corporate opportunity. Cessation of the Feldman plan. See above. o Although there is another argument that the buyer themselves would actually put in the case to improve the facilities. Remedy is unusual in this case the Court says even though it is a derivative suit the remedy/award goes straight to the minority S/Hs not the corporation b/c the extent that the buyer should get any recover here they may still be in cahoots with Feldman - that they couldnt pay the proceeds of the suit back to the corporation, or the guy would probably just re-loot the money Stock deals that stack the board

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This is when a majority shareholder sells his share along with an agreement that his directors will quit, leaving room for the new guy to put his people in place immediately. The question is raisedarent you really selling your vote. Rule: sale of a true majority of stock can carry such a deal. Many courts say that lesser shares can carry such a deal, and that deal can be enforceable. To whom can a shareholder sell Redemption and Equal Access o Donahue v Rodd Electrotype (The Equal Access Rule) MA This case and the Wilkes case has been cited in shareholder friendly jurisdictions unlike those DE. Harry Rodd was the majority shareholder of Rodd electrotype. He wanted to retire, so the company bought out his shares. Plaintiff wanted to be bought out too, and the company denied her request. She sued the company to either force Rodd to buy back his shares or to buy her out. claims this breached the majority SHs fid duty to her has a minority shareholder o Ie that the majority shareholders were allowing corporate assets to be distributed to the majority shareholders but not the minority shareholders because it would only repurchase the majority shareholders shares claims there is no right to equal opportunity for such purchases Equal Access Rule: Court said that in a closely held corporation shareholders have a duty of utmost good faith and inherent fairness obligation similar to the heightened duty that partners have towards each other. So, if a stockholder whose shares were purchased was a member of the controlling group, the controlling shareholders must extend the same offer to all other shareholders. So Court found that a close corporation is essentially a partnership. Definition of a Close Corporation: a small number of stockholders no ready market for the corporate stock substantial majority stockholder participation in management Court concludes that we apply partnership standards of fid duty when its a close corporation as opposed to normal corporate standards The two are similar A close corporation is one where o There is a small number of stockholders o No ready market for the corporate stock o Substantial majority stockholder participation in the management, direction, and operations of the corporation Long opinion but basically says that SH in a close corporation depend on confidence and trust of the other SH, and it is much more like a partnership, so the same fiduciary duty applies o Majority SH cannot freeze-out the minority SH When the directors make self-serving decisions, the minority shareholders can bring action as a violation of the directors fid duty to the corporation The problem is that when it comes to dividends and salaries, the BJR will protect these decisions,

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SO when there is a freeze out, the minority SH must either suffer or seek a buyer this is a problem for minority SH in close corporations because there is no market and he lacks ability to dissolve the company o So they can only deal with the majority which is the whole purpose of the freezeout ie to make them sell at an inadequate price This duty therefore requires majority SH in a close corporation to act in good faith when entering into repurchase agreements so if the repurchase agreement is with the majority SH, the controlling SH mut cause the corporation to offer each stockholder an equal opportunity to sell a ratable number of his shares to the corporation at identical price This concept applies to any situation where the majority SH acts to confer a benefit or opportunity to the controlling group there must be equal access to this opportunity for the minority SH Court found that he did 2 things - utilized corporate assets in 2 ways - that were injurious to the minority S/H For a provision to market your own shares To provide access to corporate assets for your own use Alternatives Remedies: Court found that this was a close corp, and as such had two options. First, they could force Harry to buy back his shares, or, They could buy all of the plaintiffs shares at the price they paid Harry which is the option the P wanted they wanted equal access. Note: this is a direct suit, although much of the language in the case focuses on the derivative nature. Also, no one is contesting that the amount paid was invalid what is not contested is that the book value and the liquidating value is the same this is never the case as a practical matter. This rule applies in SC??(see below where it says it doesnt apply) Shoaf v. Warlick (SC) Facts: Owners of the coke bottling plant in Asheville wanted to buy out the Anderson plant and they bought out the controlling S/H. The minority S/Hs complained that the controlling S/H should not be able to get a premium on his stock over and above the amount the minority S/Hs were going to get. Court said that the majority S/H has an absolute right to receive a controlled premium for his stock SC Rejects Equal Access Rule: its not a breach of fiduciary duty to sell a controlling share for a premium and not share the premium with the rest of the shareholders Favors Majority S/H. Opposite of Feldman Case

Selling Fiduciary offices with the controlling interest o Sells of controlling blocks of stock often include agreements that directors that are friendly to the seller will resign =delivering a stacked board to the buyer o Everyone agrees that sell of a true majority of the stock will make such deals legit o But for those sells of less than 50%, courts require that the buyer purchase sufficient stock to give working control in view of the high dispersion of the remaining shareholders o Unlike Partnerships, there is no corporation law that requires the corporation to repurchase stock from its shareholders

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o BUT there is an equal access rule as developed in Donahue this will only come up in a close corporation because in a public one, there is a readily available market for the stock Buy-Sell agreements- Close Corporations o The stockholders of a close corporation will usually agree to limit the transferability of shares in the corporation. There are five principal techniques by which the transfer of shares in a closely held corporation may be restricted: o Right of first refusal o First option at fixed price; price determined by the agreement o Consent required for sale o Buy back rights: enable it to buy back shares on the happening of certain events whether the holder wants to sell or not o Buy-sell agreements: corporation is obliged to go through with the purchase upon the happening of the specified event Authors say that anytime you are involved in a small business, you should anticpate the Donahue typs of problems and should set up a mechanism that allows the minority shareholder at some point to exit the corporation ie buy-sell agreements o Every corporation should have one o This is a contract that requires the corporation or the majority shareholders to purchase shares in specified situations at a specified price o 3 Requirements in a Buy-Sell Agreement What events triggers the sale What price will be paid for the stock How the stock purchase will be funded. Sinking fund very uncommon life insurance owners in the corporation will buy these policies that will fund the repurchase of shares at certain events o usually someones death o sometimes at disability or retirement o You have to worry about estate tax and income tax o Majority of the buyouts are paid over time. o Generally 4 types of Buy-Sell Agreements One way: Enables a 3rd party to buy shares of a dead or departing owner. Tax rule: Usually the life insurance proceeds are not subject to tax unless they are owned by the decedent. Cross purchase: obligates surviving owners to purchase a deceased owners interest directly from the decedents heirs. All of the S/H would buy a % of the stock at a certain time. If using life insurance proceeds for the buy-out then there has to be many policies. Can shift control of the corporation so you have to be careful. Entity or Stock Redemption: Each owner agrees to sell back to the entity upon a triggering event, and the business agrees to purchase such interest. Requires less life insurance policies. Can shift control of the corporation so you have to be careful. Wait and see: Owner or estate is obligated to sell, but the business is not obligated to buy. If any stock remains after the corporation and S/Hs have had the opport. to exercise their options then the corp is required to purchase the remaining shares. o Ways to value the business Goodwill multiplier

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Rate of return on assets Last five years average earnings Use of a capitalization factor 2 book value methods Most common method is the combination book value approach establishes a value for the business based on its past and present financial position, general economic conditions, book value and earnings. Rule: The parties must all agree as to the valuation method and the value. Different prices depending on different triggering events. (i.e. firing vs death) In your agreement you need some sort of method as to deal with defining what constitutes disability SC - Buy-Sell agreements 33-6-270 Restriction on Transfer or Registration of Shares or Other Securities - When the company can place restrictions on a shareholders ability to sell his shares. o Must be noted conspicuously on the stock certificate and the stockholder must have knowledge of the restriction. o A restriction on the transfer or registration of shares is authorized Make sure that you comply with the federal requirements for s corporations To maintain the corps status when it is dependent on the # or identity of its S/Hs. To preserve exemptions under Fed or state securities laws For any other reasonable purpose. o One way, cross-purchase, entity/stock redemption, and wait and see all valid agreements A buy sell agreement can require the approval of the corp as long as the requirement is not manifestly unreasonable A B/S agreement can prohibit the transfer of restricted shares to a designated class of persons as long as it is not manifestly unreasonable.. o B/S agreements can include stock options or convertible securities. 33-18-103 definition of close corporation o Must contain a statement in the AI that it is a close corp o Can be incorporated into the AI by amendment - must be approved by 2/3 of the S/H of each class If a S/H objects he or she has dissenters rights. 33-18-109 Close Corp - notice must be printed on shares. the rights of a S/H in a close corp may differ from those of a regular corp, the AIs may restrict transfer or affect voting rights A S/H receiving notice of these restrictions is bound to them and even if they did not receive notice if they have knowledge they are bound to them. The notice required by this section satisfies all requirements of this chapter and of section 33-6-270 that notice of share transfer restrictions be given S/H may request these documents that indicate the restrictions at any time upon the S/H written request and the corp must provide them. 33-18-110 Close Corp share transfer prohibitions limitations on ability to transfer stock, not sell stock. Start with the notion that you cannot transfer stock of a statutory close corporation Can only not transfer shares except as permitted by the AIs. o Exceptions unless the AI provides otherwise:

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 Right of Refusal A S/H wishing to transfer his shares must first offer them to the corporation by obtaining an offer for the shares for cash from a 3rd person who is eligible to purchase the shares under 33-18-110(b). (Offer from the 3rd person must be in writing and state all the specifics) The S/H must offer the corp to purchase the shares on for the same price as offered by the 3rd person The corp has 40 days to call a S/H meeting and the offer must be approved by a majority vote of the shares entitled to be case at the meeting. If the corp does not deliver acceptance to the offeree within 75 days the offer is rejected. If the corp makes a counteroffer the S/H has 15 days to accept the counteroffer or it is rejected. If the corp accepts the S/Hs offer or the S/H accepts the Corps counteroffer the certificates must be delivered within 20 days. If the corp decides to purchase the shares it may allocate them as it wants, but the remaining holders of the same class of shares are given the first option to buy any remaining shares that have not been allocated. If the corp rejects the offer, the S/H has 120 days to transfer his shares to the third person in accordance with the terms of his offer to the cop 3rd person must purchase ALL of the shares. 33-18-130 Close Corp - Attempted share transfer in breach of prohibition. If a transferee received shares in violation of a transfer prohibition that is not binding on the purchaser b/c he didnt have notice, the corp has the right to purchase the shares from the transferee for the same price he purchased them and can specifically enforce this sale obligation 33-18-140 Close corp-if provided in articles, you can force the co. to purchase of shares after death. If this provision is being added or deleted to the AI by amendment it requires the 2/3 votes of each class of shares approval. If a S/H votes against the amendment he is entitled to dissenters rights if the amendment would alter or modify his rights to have his shares purchased. 33-18-150 through 33-18-170 do not prohibit any other agreement providing for the purchase of shares upon a shareholders death nor do they prevent a shareholder from enforcing any remedy he has independently of these sections 33-18-150 Close Corp If the estate of a S/H wants to exercise his compulsory right to have the corp purchase the shares then it must provide this request to

Transfers within the corp to the same class or series of shares Transfers to immediate family or to a trust of which the beneficiaries are immediate family (most people dont like this and you can prevent it by putting a restriction in the articles) Transfers approved in writing by all of the S/Hs Transfer to an executor upon death or a trustee as a result of bankruptcy, insolvency or dissolution or similar proceeding brought against the S/H Transfer b/c of a merger or share exchange Transfer of a pledge for a loan or collateral as long as the pledge has not voting rights Transfers made after the corp terminates as a close corp. 33-18-120 Close Corp Share transfers Corp has 1st

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the the corp via written notice within 120 days after death (Burkhard says this time period is way too short cause no one will think of it that fast) Corp has to call a S/H meeting within 20 days of receipt of notice and the vote to purchase requires a majority of S/H votes entitled to be cast at the meeting. Corp must deliver a purchase offer to the person within 75 days after the effect request notice accompanied by the corps financial statements. S/H must accept within 15 days. o Problem is that the period is too short in SC they probably will not be able to close out the estate within that time period. If the price and terms of the compulsory purchase are fixed in the AIs then the corp is bound to these terms and if they do not uphold them then they are in default and it is grounds for dissolution. 33-18-160 Close Corp - If the offer is rejected or no offer is made then the person exercising the compulsory purchase may commence a court action to compel purchase. Co must notify all of its S/H of the proceedings Court determines the fair value of the shares. o Co. can show financial reasons why the court should modify the value. Ct can order the corp to purchase shares or right to have corp dissolved. Jordan v. Duff Phelps (Federal 10b-5) Close Corporations. Facts: Plaintiff had purchased stock in a closely held corp pursuant to an agreement that required him to sell it back if he quit or was fired. He left for personal reasons and sold back his stock. He found out later that when he left the company was in the final stages of negotiating a merger which would have shot his value through the roof. If he had known, he would have delayed his decision to end his employment. Issue: Did the Co. have a duty to disclose the information or the pending merger negotiations to Jordan before he cashed out on Dec 1, 83? Was the info material What was the date of the sale? Rule on Duty in Close Corporation: when an insider or the corporation is buying stock, there is a duty to disclose material facts S/H have a duty to each other as in a partnership. The court said that you can contract this duty out in the stock sale, but that didnt happen here Page 632 lists information about mergers and intentions of board that the clams are material and that should have been disclosed at time he sold his shares claims that nothing after Nov. when the offered resignation had to be revealed o also claims there was info before November that should have been disclosed When was the Sale o Nov 16 - argues that resignation = irrevocable sale with differed delviery But court notes that agreed to value the stock at the Dec 31, 1983 date rather than the 1982 value, which suggests the sale may have been on the day of delviery There is also a possiblity that could have revoked resignation, so couple this with possiblity that jury could find the sale took place on the later date, and there may have been a continued duty to disclose o Note court says that if the sale is found to be in Dec. then as a matter of law, the information is material and had to be disclosed Was there even a duty o claims that it had not affirmative duty to disclose this information o Wrong Close corporations have a duty to disclose material information when buying their own stock Jaceabson case in SC

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This is also analogous to the special facts doctrine which holds that principle insiders in closely held firms may not buy stock from outsiders in person to person transactions without informing them of new events that substantially affect the value of the stock this doesnt apply in SC Timing: the judge decided that the information became material when they had structured the merger, and this was before his stock was valuated, so a jury could have reasonably found that the defendant had a duty to disclose and breached that duty. o Was the sale when he announced his retirement or when he got his check? Court said could be date he announced retirement o Was the withheld information up to that date material? Court said the information was material when they were negotiating Problems w/bringing this as a 10b-5 claim: difficult to show proper degree of Scienter Loss causation Non-disclosure caused the stock to rise Transaction causation problem showing that the non-disclosure caused Jordan to sell his stock. The Court also held that this was a close corporation if not the fiduciary duties of the shareholders would have changed a great deal. Notes o 2.1 wouldnt do any good to say this is not a trade of securities you cant modify out of it o But maybe you can say that termination of employment does not create duty to disclose o Berreman v. West Publishing (Minn) Close Corp - Common Law Non-Disclosure Case Facts: Berreman was an executive at West and had a bunch of stock. He decided to retire, and as part of the buy-sell agreement, West bought his shares. About 4 months later, West announced a merger that made the stock worth a lot more. At the time Berreman retired, there had been no discussions, but the directors had started to think about a merger First, the court noted that although there were hundreds of shareholders in West, it could still be considered a close corp because of the other close corp factors (Donahue Case). Holding: West was a Close Corporation and as such the shareholders owed one another a fiduciary duty as in a partnership utmost duty of care which includes a duty to disclose material facts. Factors to Determine Close Corp: Lack of a public market Managerial role of Wests S/Hs o Wests decision making was concentrated in only a few individuals and the numerical structure should be analyzed from that viewpoint. Rationale supports b/c majority S/H of a close corp can deny minority S/H income from their investment, minority s/h are in a vulnerable position. Materiality Test - Failed Court used the reasonable shareholder standard from Levinson to decide if it was material Probability Magnitude/Basic Test Applied: probability at the time of retirement was too low to be overcome even by the large magnitude of the transaction. o West had made no decision to solicit bids for the sale of West, much less initiated discussions with any potential buyers. o 7th circuit has gone no further than to say a corps decision to seek a buyer may be material. o

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 Burkie says this is a strange result, b/c most people would say that the Boards decision to consult with an IB firm and discuss financing alternatives would be material to someone considering selling their stock would be enough to meet the materiality test. One question is whether this case would have fared better in Federal Court 10b-5 claims are federal jurisdiction and common law non-disclosure claims end up in state court. o Corporate Endgames (Fundamental Changes to the Corp) o Fundamental Changes- things the BOD cant change on it own o Amendment to articles o Dissolution o Merger o Sale of all the substantially all the assets o Fundamental changes all follow the same pattern o BOD has to recommend it o Notice to SH o Special meeting to vote o If approved, sometimes SH that oppose it may have a right to force the corporation to buy them out (Dissenting SH right of appraisal) o Inform the state of the change by filing with Sec of State o Sometimes there are events that the SH can trigger o If SH approval is required, then a vote o All these events require filing with Sec of state o Voting schemes for these events can vary greatly depending on the event and the statutes also vary from state to state o By the time we take bar, SC requirements will be changed o For nonfundamental decisions, you only need a majority of the votes that are cast o This is the modern view o But for fundamental decisions the states vary many require a higher number than for nonfundamental issues DISSOLUTION Steps page 468 o Dissolution does not mean that the co. has ended o Co goes into a wind-up mode. o Must pay all debts bf giving any $ to S/H o Creditors who are not paid during dissolution may seek to recover from S/H o Notice of dissolution has to be filed with the Sec of States office give creditors notice of their right to be paid o No document that the Co. can file to bring finality. Dissolution Judicial dissolution allowed when a SH establishes that those in control have acted in a manner that is illegal, oppressive or fraudulent Voluntary Dissolution o Follows scheme above ie BOD approve it, SH vote, ect In both o The corporation continues after dissolution for limited purpose of winding up o Winding up includes Collecting and liquidating assets and usig the proceeds to pay creditors o Creditors must be paid in full before SH get anything If creditors not paid,, they can recover from SH to extent that they received money after dissolution o Notice filed in same records as articles o Written notice shall be given to known claimants and publication may be used for unknown Question page 648; see also p.649 How much will it cost them dissolve when they owe 100K to creditors and assets are only worth 90k

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How do you get out of this mess. If you do it in the right way, there wont be any personal liability, so the SH wont owe anything o so what does the atty do follow the statute step by step to make sure it is done correctly 33-14-102 Dissolution by the BOD and S/H how they approve o BOD must recommend the dissolution to the S/H unless it determines that b/c of a conflict of interest or some other circumstance it should not make a recommendation and communicates the basis for its determination to the S/H. o If the holders of at least 10% of any class of voting shares of the corp propose dissolution, the BOD must submit the proposal at the next meeting o Dissolution must be approved by 2/3 of the S/H entitled to vote unless the AIs require a different vote but it must be at least a majority. 33-14-103 Articles of Dissolution o After dissolution has been authorized co. may officially dissolve by delivering the articles of dissolution to the Sec of States office this will be the effective date of dissolution. 33-14-104 Revocation of Dissolution o Dissolution may be revoked within 120 days must be authorized in the same manner it was approved unless the authorization permitted revocation by the BOD alone. 33-14-105 Effect of dissolution o Dissolved Corp continues its corporate existence but may NOT carry on any business except as appropriate to wind up and liquidate assets. 33-14-106 Effect of known claims against the Corp o Co must provide written notice of dissolution to creditors and claim of creditors may be cut off if they dont respond to notice of dissolution in time. o If the Co. rejects a claim and the rejection gave the heads up on the 90 days deadline, a creditor only has 90 days to commence a proceeding. o A claim does not mean contingent liability or events post dissolution. 33-14-107 Effect of unknown claims give notice one time in newspaper of general circulation with a mailing address and the notice must state that claims must come forward within 5 years after the publication date. o A claim can be enforced against the corps undistributed assets or against a S/h of the dissolved corp, but only to the extent of his pro-rata share or the amount he received from the cos liquidation assets. 33-14-420 - If you have a corporation dissolved before 1999, no one can get any money from anyone connected with the corporation. MERGERS - 70% of mergers are structured in order to cash out on minority shareholders. 70% of mergers are structured to cashout minority shareholders Surviving Corporation and Disappearing corporation (one that disappears after merger) Find out whether there the surviving corp assumes debts and liabilities of disappearing Stockholder protection (4 types) o Sue the directors who approved the merger alleging breach of common law or statutory duty of care See 33-11-101 o Vote against the merger o Assert the dissenting shareholders right of appraisal No state requires unanimous vote but those that dissent may have right to be bought out at a fair value as determined at a judicial appraisal process Ex A merges into B merger agreement says A is work 3 million. SH owns 10%. Rather than accepting the 300K that SH would get from the merger (which could be stock in B, other stock, property or cash), he may assert the dissenting SH right of appraisal the court could appraise A at 5 million, so SH gets more But there are lots of requirements to get this o Sue the directors who approved the merger alleging a breach of loyalty Question 1 page 649 o 33-11-106 o

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Holds that McDonalds as the surviving corporation would assume the debts of Bubbas This applies to both secured and unsecured creditors Capel as a SH of Bubbas is entitled only to what is provided in the merger agreement This could be shares in the survivor But more than likely it will be a cash buyout of your shares. The value of which will be in the agreement o Unless you are able to bring a dissenting shareholder right of appraisal action Often the SH does not want to be cashed out o To do this, you have to bring it to a vote. So we look to 33-11-103 (e) and (f) This requires 2/3 votes so Capel at 51% could have stopped the merger unless he got stock Triangular Merger o M creates Newco. M transfers some shares into newco and Newco transfers all of its shares to M o B then merges into Newco and the shareholders of B now own shares of M whereas M now owns all the shares of B Purpose o Dont have to get approval of Ms shareholder (which you probably wont need anyway) o You might not want B to be a part of M there are more protections if you keep B as a subsidiary Question on 651 see 33-11-101 and 103 o 33-11-101 Definition of merger Sets forth what must be included in the plan of merger o 33-11-102 Share Exchange A corp may acquire all of the outstanding shares of one or more classes or series of another corp if the BOD of each corp adopts and its shareholder, if required by 33-11-103, approve the change. o 33-11-103 Action on Plan - what is required for a merger to be approved (a) Co. being acquired submits a plan of merger or share exchange to be approved by its S/Hs. (b) For the plan to be approved the BOD must recommend the plan and the S/H entitled to vote must approve the plan. (d) Corp must notify each S/H of the meeting, whether or not they are entitled to vote, and the notify them that the purpose of the meeting is to vote on the merger or proposed plan. (e) require 2/3 vote entitled to be cast on the plan (2/3 from each voting group). (f) the AIs can require a different vote but it must be at least a majority of the S/H of each voting group entitled to vote on the merger. (g) Separate voting by voting groups is required if the plan of merger contains a proposed amendment to the AI which would require action by separate voting groups under 33-10-104. (h)Vote of the surviving cos S/H is NOT required if The AIs of the surviving corp will not be different If the increased shares (voting or participating) are not going to exceed 20% of the shares of acquiring co pre-merger then a vote of the surviving S/H corp is required (if the number of outstanding shares will go up by more than 20%, then the shareholders in McDonalds also have to vote) See the statute for other circumstances The notion is that the shareholders of the surviving company normally do not vote on the merger. Normally it is only the shareholders of the disappearing company who are entitled to vote. o 33-10-104 voting on amendments by voting groups Holders are entitled to vote as a separate group in the following circumstances o 33-11-104 Merger of Subsidiary into Parent A parent corp owning at least 90% of the outstanding stock of the subsid. Corp may merge the sub into itself without approval of the shareholders of the parent of sub, Articles of merger under this section may not contain amendments to the AIs of the parent corp. o 33-11-108 Merger of parent into subsidiary A parent corp owning at least 90% of the outstanding stock of the subsid. may merge the into the sub without approval of the shareholders of the parent of sub,

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Articles of merger under this section may not contain amendments to the AIs of the sub corp except for amendments under 33-10-102 by the BOD. o 33-11-105 Articles of Merger or Share Exchange Surviving or acquiring entity must deliver to Sec of State a merger or S/E takes effect upon the effective date of the articles of merger or S/E. o 33-11-106 Effect of Merger or Share Exchange Everything vests into the surviving corp Surviving Corp has all the liabilities of each party to the merger A proceeding pending against a party to a merger may be continued as if the merger did not occur or the surviving entity may be substituted in the litigation. Former S/H are entitled only to rights provided in the articles of merger or dissenters rights under Chapter 13. o 33-11-107 Merger or Share Exchange with Foreign Corp 5 Steps for all 4 Methods of Corporate Change: o BOD approves the change o BOD must notify the S/Hs and its recommendation of the fundamental change must be approved o Special meeting of the S/H must be held, at which they vote on the deal. If it is approved the corp will go thru the change. o If the deal is approved the S/H who did not approved the change might have a right to force the corp to buy them out o Corp is usually required to inform the state of the fundamental change by filing a document with the sec of state. Stockholder Protection Rights of S/H who are unhappy with the fundamental corporate change o Sue directors for breach of duty of due care. o Vote against merger. o Sue the directors for breach of duty of loyalty (see below in outline-green) o Assert Dissenting shareholders right of appraisal Chapter 13- Dissenters Rights o Rule: If stock is traded on a public exchange, you cant have dissenters rights. o 33-13-101(3) Definitions (1) Dissenter must own the shares before the corporate action, or the surviving or acquiring corporate action by merger or share exchange of that issuer. (3) Fair value = With respect to a dissenters shares, the value immediately before the effectuation of the corporate action to which the dissenting shareholder objects, excluding any appreciation or depreciation as a result of the action to which the dissenter objects. The value of the shares is to be determined by techniques that are generally accepted in the financial community. o 33-13-102 Right to Dissent A S/H is entitled to dissent from, and obtain payment of the fair value of, his shares in the event of any of the following corporate actions: Merger o Must have right to vote against merger (and thus have done so) in order to be entitled to have right to dissent. Share Exchange Sale of Assets Amendment of the AIs that materially or adversely affects the rights in respect of a dissenters shares o Alters of abolishes a preferential right to the shares o Modifies a right to redemption o Modifies a preemptive right o Modifies the voting rights of the shares o Reduces the # of shares owned to a fractional amount if that amount is to be acquired for cash.

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Any corporate action that the AIs or bylaws provide a right to dissent Conversion or plan of conversion of the Co. into a LLC, GP or LP pursuant to 33-11-113 (B) no dissenters rights if the co. is publicly traded b/c theoretically you can share your stock easily if you dont like it 33-13-103 Dissent by Nominees and Beneficial Owner Partial Dissent is ok by Record S/H but must dissent as to all of the shares of a beneficial owner Beneficial owners of shares may assert dissenters rights only as to all of the shares they are the beneficial owner of Must notify the corp in writing and include the contact info for the record S/H. 33-13-200 Notice of Dissenters Rights If it is an action that is going to trigger dissenters rights you must tell them at the first available time or meeting that this action will trigger dissenters rights. If the action is taken without a vote of shareholders, the corporation shall notify in writing all shareholders entitled to assert dissenters rights under Section 33-13-102. o 33-13-210 Notice of Intent to Demand Payment Person who wishes to assert dissenters rights must Give a written notice to the corp prior to the vote of his intent to demand pmt for his shares Must NOT vote his shares in favor of the corp action (have to make a decision real quick) A vote in favor of the corp action by the holder of a proxy solicited by the corp will not disqualify a S/H from demanding pmt for his shares (? Statute doesnt say this and Burkhard didnt mention) o 33-13-220 Dissenters Notice If a corp action is authorized at a S/H meeting corp must notify w/in 10 days S/H who voted against it and satisfied their dissenters notice requisites under 33-13-210 and there is a deadline for re-submitting the payment demand back to the corp. o 33-13-230 Shareholders Payment Demand If the payment demand is not submitted in a timely fashion then S/H loses his right and is not entitled to payment. If a S/H complies with the time requisites he is entitled to all other rights of a S/h until these rights are canceled or modified by the taking of the corp action. 33-13-250 Payment If you comply with the payment demand requisites as soon as the corp action is taken, co must pay you the fair value of the stock plus interest, must be accompanied by an explanation of how the fair value was calculated, certain co. financial statements, and a notice of what steps to take if the S/H does not like the payment. 33-13-260 Failure to take Corp Action If the co. does not take the corp action within 60 days after the date set for demanding payment, the co. must return the share certificates and release the restrictions imposed. 33-13-280 Procedure if shareholder dissatisfied with payment or offer A dissenter may notify the corp in writing of his own estimate of the fair value of his shares and demand pmt of his estimate or reject the corps offer if he believes that the amount paid is less than the FMV or the interest was calculated incorrectly OR the corp fails to make pmt within 60 days after demand or fails to return the certificates after not taking the corp action. If the dissenter does not notify the corp of his demand in writing within 30 days after the corp makes the offer, he waives this right for additional pmt under this section o 33-13-300 Court Action provision for the court to set the value.

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If demand for additional payment under 280 remains unsettled, the corp shall commence a proceeding within 60 days after receiving the demand for additional payment and the court will determine the FMV. If the corp does not do this w/in 60 days they must pay the dissenter the additional amount requested Dissenter is only entitled to Cts determined amount if it exceeds the amount paid by the corp/ o 33-13-310 Court Costs and Counsel fees The court shall assess the costs for the attys and appraisers against the corp except to the extent the court can allocate part of the costs to the dissenters if the court finds that the dissenters acted arbitrarily, vexatiously, or not in good faith in demanding pmt under 33-13-280. HMO-W v. SSM (WI) Appraisal Case o This was a Direct claim o A bunch of corporations each formed a health care system (corporation), and each took a minority stake. HMO-W was set to merge, but SSM didnt want them to. SSM got a pre merger appraisal and it said the business was worth $18M. The HMO Board approved the Merger and sent a proxy statement to the S/Hs. When the merger was approved, SSM demanded appraisal. HMO-W went out and got a new appraiser and found the value to be $7.4M. SSM was pissed, and sued. SSMs expert said the value was $19M. o Issue Can minority discounts be applied to determine the fair value of the dissenters shares in an appraisal proceeding NO Minority Discount address the lack of control one the theory that non controlling shares of sotck are not worth their proportionate share of the firms value because they lack power to control corporate actions This is different from Marketability discount which address fact that there is a limited market for shares in a close corporation (not addressed here) o 2 Issues: Whether a minority discount may apply in determining the fair value of a dissenters shares Whether a court in making its fair value determination may consider evidence of unfair dealing relating to the value of the dissenters shares. Whether the S/H is entitled to bring an action for breach of fiduciary duty? Rule: When appraising shares, two types of discounts commonly apply Minority discount: reduce value for lack of control of block of shares non-controlling shares of stock are not worth their proportionate share of the firms value b/c they lack voting power to control corp. actions (they did apply this discount) Lack of marketability discount: reduce price for relative lack of liquidity of the shares on the theory that there is a limited supply of potential buyers in a closely held corporation (they didnt apply this discount in this case) Rule on Minority Discounts: Court said that the intent of the dissenting shareholders rights were to give the shareholders their proportion of the business, and as such a minority discount cannot be applied. Are we valuing SSM stocks individually or are we valuing the business as a whole. (SSM argues that you should value the entire business and give them their proportionate share) Court agrees with SSM - Appraisal rights represent a legislative response to the minoritys lack of corporate veto power and the consequential vulnerability to majority oppression. To fail to accord a minority shareholder the full proportionate value of his shares imposes a penalty for lack of control, and unfairly enriches the majority shareholders who may reap a windfall from the appraisal process by cashing out a dissenting shareholder, a clearly undesirable result. A dissenting shareholder is thus entitled to the proportionate interest of his or her minority shares in the going concern of the entire company. SC about to amend the statute to say this! o Rule: Consistent with the statutory purpose in granting dissenters rights, an involuntary corporate change approved by the majority requires as a matter of

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fairness that a dissenting s/h be compensated for the loss of the S/H proportionate interest in the business as an entity. Rule on Considering Unfair Dealing in Valuation of Minority Shares: Evidence of unfair dealing by the corporation when valuating shares can be considered in an appraisal proceeding. However, in this case getting an independent appraisal wasnt enough to make the court factor it in, so this argument was out. Court points out that the petitioners did not assert detrimental reliance. This is a very strange result b/c if the SSM shareholders had approved the merger to begin with they would have received the higher amount, even though the court ruled that they had to be paid the 16-18MM amount in the initial appraisal for their shares, the HMO S/Hs lost out b/c they paid too high a price. This case demonstrates that trying to value a co. is not a precise science, and it is a lot of guess work. The United shareholders appear to have been defrauded because they paid for the company based on the first appraisal. Appraisers are Important: If we were representing any of these companies you would need to know how your experts went about valuing the company. Tracing DSRA Arose to reconcile victimization of minority shareholders when states started allowing majority consent for fundamental changes (use to be that there had to be unanimous vote, so the minority shareholder had a veto power) Court concludes that applying such a discount frustrates the equitable purpose of DSRA so its not applied in appraisal Which Appraisal alleges unfair dealing, but didnt claim breach of fid duty o Ie that the corporation misrepresented the value on the proxy and then after vote they were told its worth a lot less Appraisal is the only remedy for a dissenter absent fraud or breach of fid duty o is trying to bring a claim for appraisal and for breach of duty that the misrep is wrongful and that they should get something for it But court says there are not two COA, there is only one o States split on whether breach of fid duty and fraud must be brought as separate action from appraisal o This court doesnt answer this question because it finds that unfair dealing goes directly to appraisal However, the unfair dealing here didnt change the value of the s shares because the inflated value was never accurate. Its not the same as if the had done something to affect the true value the misrep was of the Valuation, not the value ie you just miscounted the money, you didnt take anyway o Court finds the failed to show that the misrep was the but for cause of the merger The didnt rely on it because they didnt vote for the merger, and they asked for the appraisal The court is the sole body that determines the fair value, so the court was free to set the value regardless of what the prior appraisals said Therefore the value adopted by the trial court is fine, but the minority discount should not be subtracted from the s shares Appraisal Process in SC 33-13-101 o Fair Value make sure you know it 102 o Right to Dissent Includes that an amendment to the articles could trigger rights Look at all the notice statutes as well

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Know all of the 33-13-200s o And 300s Its real easy to screw up as a minority SH if you are trying to bring a DSRA o SC is changing statute to say that minority discounts are not to be applied o Woodside Finance prof COC Used comparable companies analysis of other cos like Dillards Ct rejected this method DCF analysis court accepted this method but this is weird b/c essentially you use cash flows from comparable companies like Dillards to run this model so it is essentially the same. Method of Valuation Ct takes from the Santee Case: Apply DEe block method, which entails looking at the net asset value, the market value, and the investment value, and then the court weights each assessment based on the relative value to the evaluation Net asset value the total assets minus liabilities Market value what shares have sold for recently Investment Value of the Dissenting Stock o look at similar companies o look at their published market cap Problem with this method - There is no indication in this opinion how the court assigned the % weights to each of the variable methods DE has actually rejected the DE block method, the question is should this be the method in SC? 3 Things the Court said the Appraisers did wrong Earnings method used an only 1 year average Used the wrong multiplier used a price earnings multiplier for a # of publicly traded securities which was wrong b/c they are not comparable Belk stores are privately owned. Have no idea how they got their ratios and they did not do any weighting of the methods. Court in this case gave low weight to market value because other recent transactions were not at arms length, gave low weight to investment value because there werent any really close examples of similar companies. Said the key factor in this case was the net asset value you can actually go out and value those assets. Presumably because it is the most reliable method. This is weird b/c with an ongoing business Net Asset Value is really not a good assessment of value. Finally the Court approved the using the block method in this case and assessed a 60% weight to the Net Asset Value, 15% to the market value using and EPS multiple, and 15% to the DCF multiple. No idea where they get these ratios. 33-13-103(3) key statue in SC for stock valuation Any legitimate method of valuing stock is acceptable in SC. Often you would use you look at what the stock would sell for at an arms length transaction (Problem in Close Corps b/cno marketability for the stock and selling to family members is not an arms length transaction. Rule: You should essentially use the most reliable method. o But probably in this case the shares were between family members and so they were sold at a reduced price so it is hard to get a FMV of the stock. o 12 S/H have no control of the company, it was a close corporation and therefore the minority shares were sold at a discount b/c there was no marketability. Liability of Interested Directors who approved the merger for Common Law Breach of Duty of Loyalty o Weinberger v. UOP (DE) Breach of Duty of Loyalty Facts: Signal owned 50.5% of UOP and controlled 7/13 directors. 2 of those directors who were also officers of Signal prepared a report for Signal that stated Signal (parent) should buy the rest of the shares of UOP (subsidiary) at up to $24/share. Signals people are controlling the UOPs board. They used information that would only be known to UOP and said it would be a good deal up to $24 a share. That information was never disclosed to UOP. The board of Signal and the

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board of UOP had to approve the merger. The UOP board approved a cash-out merger at $21/share, and the Signal directors didnt vote. UOP then solicited its shareholders recommending to vote for the deal. Arledge and Chitea were 2 of the Signal directors that made the disclosure to the Parent and not the Subsidiaries. They created reports suggesting that the Co. be valued at $20-21 instead of $24 but this difference would have limited impact on Signal but a significant impact on the S/H. Dissenting plaintiffs sued and wanted rescissory damages, case for rescission (undo the deal) not appraisal the plaintiffs want the value of their stock, but they have pursued this according to the common law notion that there was a breach of duty. If the merger were rescinded, it does not exist. They are asking for a valuation of the stock they currently hold as if there was no merger. Presumably, the stock will go up in value. Court said that since UOP had interested directors on both sides of the transaction, UOP had the burden of showing the overall fairness of the deal or be in breach of their duty of loyalty to UOP, meaning they had to show fair dealing and fair price. Rule: When directors are on both sides they are held to the utmost good faith and the most scrupulous fairness. They most show fair dealing and fair price in order to withstand a breach of the duty of loyalty Court said in a case like this must focus on Fair price and Fair Dealing (aka fair process): Process was not fair deal was controlled exclusively by Signal who also controlled the negotiations - looks at the timing (only gave them 4 days) and negotiation of the deal. In this case, there were no negotiations, and the UOP directors werent made aware of the $24 study. o Rule: If directors that are of both sides of the deal are involved in the merger negotiations there is no fair dealing b/c they could not have been at arms length. o Footnote 7: Although perfection is not possible, or expected, the result here could have been entirely different if UOP had appointed an independent negotiating committee of its outside directors to deal with Signal at arms length Price was not fair: the question would be based on an appraisal of the company. Court decided that in DE fair value would be calculated using all relevant factors: Rejected the DE method of weighting various methods (which is the Belk method of appraisal). o In this breach of fiduciary duty case, the Chancellor perceived that the approach to valuation was the same as that in an appraisal proceeding. Consistent with precedent, he rejected plaintiffs method of proof and accepted defendants evidence of value as being in accord with practice under prior case law. This means that the so-called Delaware block or weighted average method was employed wherein the elements of value were assigned a particular weight and the resulting amounts added to determine the value per share. This procedure has been used for decades. However, to the extent it excludes other generally accepted techniques used in the financial community and the courts, it is now clearly outmoded. It is time we recognize that in appraisal and other stock valuation proceedings and bring our law current on the subjectWe believe that a more liberal approach must include proof of value by any techniques or methods which are generally considered acceptable in the financial community. o Court in this case said they would permit any generally accepted method of valuation considered acceptable in the financial community Recommended DCF as the best analysis try to predict what the future cash flow over a relevant time period. Must pick out a DCF multiple. Court reversed for a determination under this calculation. Rule on Rescissory Damages: As to rescissory damages, the court said they would only be awarded when appraisal of a company isnt an adequate remedy. So you only get rescissory when appraisal wouldnt be fair to other parties who relied on the transaction. Page 154 of 183

o In this case the court says they will allow them to have rescissory damages. But said P should bring an appraisal action instead of breach of loyalty claim. Rule: This case suggests in DE, You need to bring an appraisal case before you bring a common law breach of duty of loyalty action for a merger that was approved by interested directors Finally, the Plaintiff tried to get the DE court to adopt a test that requires the merger to be a legitimate business purpose, and that a freeze out couldnt be a legitimate business purpose. Court shot that down b/c they say they cant see a business purpose if UOP is going out of business. Belk of Spartanburg v. Thompson (SC) o Merger btwn Belk of Spartanburg and Belk of Clinton. Thompson is one of the dissenting shareholders of the surviving corporation Belk of Spartanburg. She wants her stock to be re-valued. Under the SC statute, it is unusual for the S/Hs of the surviving corporation to have dissenters rights. Probably what is going on here is that Belk of Clinton bought Belk of Spartanburg but retained the Belk of Spartanburg name (similar to FU/Wachovia merger). o Issue: How to value the stock there was a large discrepancy. o Another weird thing is the scope of review here, the Ct of appeals gets to decide the facts de novo. o Three factors are usually considered in assessing value: they use the DE block test (see the factors from Weinberger); even though Weinberger threw it out years ago, SC recently applied it. The court does allow some modifications of the methods that are suggested. o 33-13-101(3): Fair value, with respect to dissenters shares, means the value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable. The value of the shares is to be determined by techniques that are accepted generally in the financial community. o The court said that the experts did not apply all three of the Weinberger factors and that the experts didnt determine a method of weighting the factors. o Appraisal is not an exact science, and the precise weight to be given to any factor is necessarily a matter of judgment for the court in the light of circumstances in each case. Santee Oil Co., 265 S.C. 270, 217 S.E.2d 789. In arriving at his final valuation, Woodside weighted each of his four methods equally; the trial court adopted Woodside's weighting. Although we largely agree with Woodside's methods (except, of course, the guideline public company value method), because we have some qualms about his reasonings, we accordingly distribute the weighting differently than the trial court. o The court uses large department store models to determine the ratios, but adjusted the figures to correspond to the size of Belk. The court allows the ratio for discounted cash flow (weighted it 15%), but it does not allow other types of ratios to be used. Burkhard says the court goes back and forth in its analysis. o The court throws out some of the factors based on the fact that they occurred after the time of the merger and cited to 33-13-101(3). Burkhard says this is wrong because the factors were not affected by the merger. o The court ultimately concludes that most of these transactions were arms length, but they say that that factor (market value) is not the be given much weight. Market value is the price paid for sales of stock. o Resulting Total Valuation. Based on our discussion above, we arrive at the following valuation: Determined Weighted Value/Share Weight Value/Share Net Asset $1,474.21 0.60 $ 884.53 Value:

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Discounted $1,606.93 0.15 241.04 Cash Flow: Market $1,493.90 0.25 373.48 Value: Final Determined Fair $1,499.05 Value: o Using this value, the value of Thompson's BDS stock on October 5, 1996, was $134,914.50 (90 x $1,499.05). Because BDS paid Thompson $132,749.10 on October 4, 1996, we find Thompson is due the additional sum of $2,165.40 from BDS. There is nothing in the opinion that they use to justify the weight that they give to the different factors. o It is odd that the Court of Appeals criticized the appraisers for not following Santee and the Court of Appeals also does not follow Santee in arriving at the weight to be given to each factor. o Clarkson and Way are the dissenters experts. Clarkson is a CPA and a lawyer and the former tax commissioner in SC and Way was a financial planner out of Charlotte no PHD. Used the Block Method Pick your experts wisely!! o Coggins v. New England Patriots (MA) (Not an Appraisal Case Class Action for Recission) Owner of NE patriots issued a bunch of nonvoting common stock. Owner was ousted, and had to borrow a bunch of money from the bank to buy back all the voting shares. A condition of the loans was that he had to structure the team to best pay back the loans, which included getting rid of those nonvoting shares as a marketing tactic. He made a new company and performed a cash out merger. The state law required majority vote of all affected classes of shares. Plaintiff had some of the nonvoting stock, dissented, and sued. He was supposed to pledge the corporate assets for the securement of the loan he used to cash out, and he cant do that so he tries to get rid of all the minority S/Hs He used the corporation to secure a personal loan. That is a serious, serious problem. He decides to get rid of all the minority shareholders so that he would be the only person who could complain (which he obviously wouldnt do). He set up a new company to merge with (the nonvoting stockholders voted for the merger). The nonvoting shareholders dont get stock in the new company but they are cashed out at $15 a share. SC 30-10-104 (d) shares are entitled to the voting rights granted by this section although the articles of incorporation provide that the shares are non-voting shares Issue: Is appraisal an exclusive remedy for an unhappy S/H? No see below This is not an appraisal case; it is a class action class being all the S/H who challenged the transaction. Sullivan argued that there were 3 corporate reasons he structured the deal in this way, when this was rejected he argued that this claim had to be brought as an appraisal claim. MA Rule- Court says that although the statute indicates appraisal is an exclusive remedy, in this case the Court can allow the action to proceed as a non-appraisal action (CL) for rescission. Applied the Business Purpose Test SC Rule: a decision was made NOT to include a provision, similar to the Mass one, that appraisal actions are the exclusive remedy of an unhappy shareholder. In SC, an unhappy S/H can bring a breach of fiduciary duty claim similar to Coggins. DE Rule: Appraisal is still an exclusive remedy, if a S/H is unhappy with the merger, and they are asking for more $. MA Court applied the business purpose test Rejected the DE Rule

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 business purpose. Merger:

DE Rule: There does not have to be a legitimate MA 2 Part Test to determine the fairness of a Freeze-Out

Was there a legitimate corporate purpose If Yes, then was the merger fair given the totality of the circumstances. o P bears the initial BOP of showing that a freeze out was taken for no legitimate business purpose. o Thenthe BOP shifts to the defendant to show that the freeze out was for a legitimate business purpose. o If the D can show a valid business purpose, then the court will analyze under fairness-TOT whether it it was fair to the minority (maybe by proving the value of the price was fair). Ct rejected Owners arguments that there were legitimate football reasons not to have the nonvoting stock floating around. Found that the real reason was to pay back personal loans, which cannot be a legitimate business purpose. So court did not have to go to the fairness analysis. Rule of Rescission Damages: Court said that while the typical relief for an improper freeze out is rescission of the merger, because it has been so long since the merger, other folks besides the minority S/H are effected by the merger, the ct said rescissory damages were allowed to be considered Rescissory damages are given as the present value of the stock as it would be if the merger were rescinded plus interest. SALE OF ASSETS - Successor Liability/ Effect of sale of assets on creditors General Rule: a buyer of corporate assets is not liable for sellers corporate debts Rule: A sale of assets doesnt automatically end existence of selling corporation unless the corporation subsequently dissolves. Effect of sale of assets on shareholders of seller and buyer First, creditors of the seller are paid Then, the seller distributes the remainder to its shareholders Franklin v. USX (CA) Successor Liability Sale of Assets o Girl was exposed to asbestos from her dad who worked for WPS. All of the WPS assets were purchased by ConCal, and ConCal agreed to assume all liability. ConCal then sold those assets to ConDel with no agreement. ConDel merged into US Steel who became USX. o Issue: Whether the WPS liability followed through the ConCal to ConDel sale. Whether Condel acquired successor liability. o 3 Ways to Acquire a Company: Buy all of the stock of the co. the acquired co. is a wholly owned subsidiary or merge the 2 cos into one. Acquire by Merger By all of the Outstanding Assets of the Co When you buy the assets you dont acquire all of the liabilities unless you expressly agree to it. o Rule of Successor Liability on a Sale of Assets: On a sale of all assets to another corporation, liability doesnt follow the assets UNLESS Agreement - Purchaser expressly or impliedly agrees to the assumption. De Facto Merger- Transaction amounts to a consolidation or merger. Key: Inadequate cash consideration

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o Cash purchase is more predictable than a stock purchase, because presumably there are creditors of the seller to protect, and they are going to want a solid asset to come after for debts. Continuation: Purchasing corporation is just a continuation of the selling corporation. Fraud - Transaction is entered into fraudulently to escape debts o Court said this could possibly be a de facto merger or a mere continuation of the business Test de- facto merger: o If consideration paid for the assets was solely stock of the purchaser. o If the purchaser continued the enterprise after the sale o If the shareholders of the seller became shareholders of the purchaser o If the seller liquidated o If the buyer assumed the liabilities necessary to carry on the business of the seller Test for Continuation of the Business (Ray v. Alad): o No adequate consideration paid for the corporate assets (most important) o Officers/directors of the seller became officers/directors of the buyer o Holding: The court said that since the transaction was adequately financed with cash, neither exception could apply, so USX cant be liable. o Additional Policy Reasons not to Impose Liability: Significant Time lapse: Also said that the imposition of successor liability on a purchasing co. long after the transfer of assets defeats the legitimate expectations the parties held during negotiation and sale. Ensure Marketability: Also b/c they want to make sure there is a market for troubled companies o 33-13-102 provides dissenters /appraisal rights for the selling corp.s S/Hs. Although SC does have the rule that a surviving cos S/H get must approve a merger if the it will increase the stock more than 20% - did not adopt the rule from the MBC that the buying co.s S/Hs in a sale of assets get to vote on the assets purchase if it would require the issuance of more than 20% issuance of additional stock. Hite v. Howard & Howard (SC) Share Exchange- Dissenters Rights and Equitable Remedies for Minority S/H o 2 SC Cos Florence & Columbia Companies. The people who are driving all of these transactions are the people of the Col. Co. their objective was to merge the 2 companies into one. You would assume that an easy way to do that would be to merge the two companies together. o Hite was minority shareholder of Flo co, and majority shareholder was another corporation, Col. Col authorized the issuance of more shares from Flo and then organized a stock exchange between the companies where Col rolled into Flo. The result was that plaintiffs control went from 33% to 11% and he wasnt allowed to have his shares purchased for fair market value. o Issue #1: Do the Col. Shareholders have sufficient voting power to approve the merger? Yes- 32-11-103(e) only requires 2/3 of the S/H votes to approve share exchange. The defendants had the exact number of votes

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required to approve the merger (Hite owned 55 shares and the majority shareholders owned 110 shares (2/3)) If they had merged the companies, Hite would have had dissenters rights. They decided to do a share exchange instead so they didnt have to deal with dissenters rights. o Issue #2: Does Hite have dissenters rights if it were a Merger?: 33-13-102 and 33-11-103(e) Yes - says if Hite has the right to vote he is entitled to dissenters rights for a merger. Scen #1: 33-11-103(2) If the surviving Co. is Columbia, Hite would have the right to vote. Scen #2: 33-11-103(h)(3)- -If Florence is the surviving Co., Hite would still have the right to vote against the merger b/c the # of shares of the surviving corp, Florence premerger would have increased by more than 20% post merger (165 to 600). Therefore, Hite would still have the right to dissent. So b/c Hite had dissenters rights either way if it were a merger, then, Columbias lawyers decided to do a stock exchange instead o The first thing the first step they took in order to implement the share exchange was to increase the number of shares. They did this my amending the articles of incorporation. Hite had the right to vote on the amendment. He did not vote no to stop this b/c of 33-10-103(f) because even if he had voted no they still had enough votes to pass this. 33-13-102(4) does not allow for dissenters rights by virtue of this action that they wanted to take. o Columbia distributed 110 shares to Florence shareholders so it was wholly owned by Florence. o Issue #3: Does Hite have enough shares to vote against the share exchange? No - 33-11-103(e) No he has less than 2/3. o Issue #4: Does Hite have dissenters rights in a share exchange? No - 33-11-102(a) Share Exchange: A corp may acquire all of the outstanding shares of one or more classes or series of another corps stock if the BOD of each corp adopts and its shareholders , if required by 33-11-103, approve the exchange. So both boards will undoubtedly approve the exchange in this case. The directors of Columbia will undoubtedly approve the exchange and the directors of Florence will approve the exchange b/c it is controlled by directors of Columbia 33-11-103(a) only the S/H of the corporation whose shares are to be acquired in a S/E must approve the deal; since Florence is the acquiring co., Hite has no right to vote and thus no dissenters rights under 33-13-102(A)(3). Ct rejected Mich Rule: where reduction of ownership percentage of an acquiring corporation could allow for dissenters rights where the acquiring corporation issued more than 100% of its original shares. o Our ending structure at this point in the game is that the plaintiff owns 55 shares. The defendants own 531 shares. Florence owns 4143 shares. In the next step, they are going to conduct a parent/subsidiary merger and the rules are different. o Issue #4: Should Hite have brought this as a derivative suit? - No The defendants also argued that this should have been brought as a derivative claim and not a direct suit. Loss of Voting Power Separate to Hite: No - Court concludes that this was properly brought as a direct suit b/c the fact

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that Hite lost his voting power was individual to him, separate and distinct. Loss in value separate to Hite: Also, if Hite is claiming loss in value, he can bring it as a direct claim b/c co hasnt really lost anything-it is just a shift in who owns the value o Holding: Court first said that this was a corporate action that caused a specific loss to a particular shareholder (voting rights), and therefore he could bring his suit directly rather than derivatively o Issue #5: If Hite has no dissenters rights under a Share Exchange were does this leave him? o 3 Things Hite is Mad About- Reasons he brings this action. Cut out of his dissenters rights His voting power has gone down the tubes. His shares have depreciated (his share value has gone down) exchange ratio is unfair Ds proportion of the entire co. is unfair o Hite argued that this was equivalent to a merger and he should have dissenters rights. o Holding: Court said rejected Hites argument that it was equivalent to a Merger and said that he did not have a right to vote under 33-11-103 and was not entitled to dissenters rights under 33-13-102 BUT said he had a remedy under 3314-310(d)(4). o Court says this is a free-standing remedy. Make sure you dont lose track of this case for other situations. There is no evidence that the grounds for dissolution have been met here. **** o 33-14-310 Procedure for Judicial Dissolution: provides for judicial dissolution and broad equitable remedies (d)(4) In any action filed by a S/H to dissolve the corp on the grounds enumerated in 33-14-300, the court may mane such order or grant relief, other than dissolution, as in its discretion is appropriate, including, without limitation, an order: (4) providing for the purchase at their fair value of shares of any S/H, either by the corp or its S/Hs. o What triggers this remedy is when the S/H requests dissolution under 33-14-300 and in this case Hite did not make the request Ct said it didnt matter but Burkie questions this. o Another question is whether Hite would have met the threshold under 33-14-300 that constitute grounds for dissolution 33-14-300 it is likely that he would have requested dissolution under (2)(iii) the directors in control of the corp have acted, are acting, or will act in a manner that is illegal, fraudulent, oppressive, or unfairly prejudicial either to the corp or to any S/H (whether in his capacity as a S/H, director, or officer of the Corp. o Why didnt Hite bring up the Pre-emptive Rights provisions why these provisions did not help him out o Burkhard wanted to know why Hite didnt argue preemptive rights. He couldnt because of the way the share exchange was structured. Simmons v. Mark (SC -2005) Successor Liability Tort Case o Worker brought products liability action against manufacturer of a scissor lift and company that purchased manufacturers assets at bankruptcy sale. SC Test for Successor Liability in Sale of Assets (Brown Factors) Similar to Test in USX - CA Agreement- There is an Agreement to assume debts

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o Note: article in SC Lawyer Magazine - If the K between the seller and the buyer is silent, then the successor is deemed to have assumed liability and accepted those liabilities. De-Facto Merger: Circumstances around the transaction warrants a merger of the 2 corps If a company transfers all of its assets in exchange for stock in a new company and then the company passes the stock along to its shareholders, that should be treated as a merger. Continuation: Successor co was a mere continuation of the predecessor Footnote: Essentially, the dissent advocates an expansion of the mere continuation exception. However, as noted by the dissent, the majority of courts interpreting the mere continuation exception have found it applicable only when there is commonality of ownership, i.e., the predecessor and successor corporations have substantially the same officers, directors, or shareholders. We decline to extend the exception to cases in which there is no such commonality of officers, directors and shareholders. Fraud: transaction was entered into fraudulently for the purpose of wrongfully deceiving creditors claims o Issue: was the purchaser of assets liable for a torts claim of a prior worker as a successor? o Holding: Co was not liable? o Dissent Burnet If you buy the goodwill, then you ought to get stuck with the liabilities that come along. Also critical of the notions that if you hold successor companies liable that lots of bad things will happen as a result. Domestication: In order to just legally move an existing corporation from Connecticut to South Carolina without merging (used to have to merge), you can use 33-9-100. It allows for the movement of a company from another state to SC. Chapter 9 - Domestication of a Foreign Corporation 33-9-100 Articles of Domestication: Contents o The motivating force being this chapter was the insurance co.s in SC, a captive insurance company is essentially an insurance company that is owned by its insured. o (a) Domesticating co. - Must file articles and an initial annual report o (b) Domesticating co. must file articles of dissolution with previous state w/in 5 days of domesticating Burkie objects to this b/c the co. has the option to merge the two o (c)(4) no S/H approval needed o (f)(1) - Addresses title search issue- if you have changed you co. name and the previous entity owned prop in SC must give notice of name change to the SC register of Deeds 33-9-110 Effect of Domestication: o All the former liabilities stand, co. is essentially the same co. o After domestication laws of SC apply and for prior claims laws of the foreign state apply o SC is maybe the 11th state in the US to add this domestication process in, we do not require confirmation of good standing with the foreign state.

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o o

From a Federal Tax point of view there are no tax ramifications.

Conversion of corporation to limited liability company: See 33-11-111. 2/3 votes are required for approval. There are now 11 separate code sections that provide for conversions of entities. Everything in SC can be converted into another thing. If you are converting and everyone is not getting an ownership interest, normally they would be protected by giving them dissenters rights. The conversion from a corporation to an LLC does provide dissenters rights. However, not all of the conversions provide for dissenters rights. That is one possible way to get rid of someone. You should never convert a corporation to an LLC because it will usually create terrible tax problems. Going from an LLC to a corporation will probably not create a huge tax problem. o Hostile Takeover Defenses Rule: A hostile takeover is an acquisition to gain control over the objections of a corporations directors Takeover defenses Unocal Corp v. Mesa Petroleum (DE) o Mesa (Raider) was trying to takeover Unocal (Target). Mesa already had 13%. Mesa had a 2 tiered offer where it would pay $54/share in cash for the first half of the shares it needs (37%) to reach the rest of the stock, and pay junk bonds for the rest of the stock. After it reached 51% it would go thru a merger, where it would be a cash-out merger, $54 per share but it would be in the form of junk bonds. o Defensive Tactic- Unocals board adopted a defense that if Mesa got close to control, Unocal would buy the rest of the stock for $72/share in debt securities (promissory note), but they are making the offer to every S/H except Mesa (cause that would defeat the purpose), also by offering debt securities the financial position of Mesa changes dramatically. Part of the motivation is to put Unocal into debt to make them less attractive. o Mesa sued because they are already minority shareholders and this exclusion breaches a fiduciary duty to Mesa. o Note: the directors are in a bad position b/c they have a duty to Mesa as a minority S/H, but they also have a duty to the other shareholders, and the corporation (to determine if it is not in the interests of the co.) o Issue: Can Unocals Board exclude Mesa from the offer? o A defensive measure like this one can get business judgment analysis if it meets some requirements. o Unocal thought this was okay because if they made the offer to Mesa, they would be financing Mesas takeover. They would be giving Mesa some value they could use, etc. They would be helping Mesa in their tender offer. o Unocal thought they were justified because Mesas bid was inadequate and coercive. o Unocal 2 Prong Test: duty to the minority S/H can be overcome and defensive measure upheld if: (different from the Business Judgment Rule, looks more like the fairness test- and the burden is initially on the board to show the reasonableness of their actions and decisions) BOP on Directors must show that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed (i.e. junk bonds are bad for the co. Satisfied by Showing: Good Faith o enhances when independent outside directors approve the defensive move b/c it prevents the minority S/H from arguing that they are approving the defensive tactic only to save their job (essentially b/c disinterested directors are not officers of the corp).

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o Because of the omnipresent specter that a board may be acting primarily in its own interests, rather than those of the corporation and its shareholders, there is an enhanced duty which calls for judicial examination at the threshold before the protections of the business judgment rule may be conferred. Reasonable Investigation Directors must show that the response to the takeover attempt was reasonable in relation to the threat posed : Factors to Consider in the Element of Balance: o the inadequacy of the price offered o Coerciveness: nature and timing of the offer o impact on constituencies other than shareholders (creditors, customers, employees) o risk of nonconsummation o quality of securities being offered in exchange o the board may consider the basic stockholder interests at stake, including those of short-term speculators, whose actions may have fueled the coercive aspect of the offer at the expense of the long term investor (Burkhard thinks this statement is wrong) o can also consider the effect on both short and long term stock price The term greenmail refers to the practice of buying out a takeover bidders stock at a premium that is not available to other shareholders in order to prevent the takeover. Chesapeake If an offer is too low, but isnt coercive, then board response might not satisfy Unocal. Chesapeake case: A boards unilateral decision to adopt a defensive measureis strongly suspect under Unocal and cannot be sustained without a compelling justification. Holding: In this case, because the offer was both inadequate and highly coercive, the threat was high, and the response was properly tailored to the threat. o Further, because the action was approved by disinterested directors, Unocal satisfied its burden of good faith and due care, and since Mesa couldnt prove that the directors were acting to save their jobs, the defensive measure gets the business judgment rule. ALI Test 6.02(c) Different from Unocol Test b/c the BOP is on the P - a person who challenges an action of the board on the ground that it fails to satisfy the standards of subsection (a) has the burden of proof that the boards action is an unreasonable response to the offer. Burkhard says this isnt very different from the Unocal test. Revlon v. Forbes (DE) (Directors Duty in a Bidding War) o Pantry Pride tried to takeover Revlon. First they offered $47.50/share. Revlon countered with an offer for $47.50 and 1/10 share of preferred stock that included covenants not to incur additional debt. Then FLC came in and offered $56/share, but would be getting more debt (in violation of the agreement on the preferred shares). Pantry Pride reupped, and then FLC re-upped and offered to take care of the preferred stock. Revlon accepted that deal which included a bunch of bad provisions if the deal fell through. Obviously, Revlon directors had stopped the bidding to protect themselves from a law suit from the preferred shareholders. o Issue: To what extent can the corporation consider the impact of a takeover threat on constituencies other than S/Hs? o Issue: What is the extent of a directors duty in the course of a bidding war?

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o Rule: Court restated Unocal rule that since Directors defensive measures always carry the appearance that they are self interested, they have to show reasonable investigation and reasonable response to threat to get business judgment for the defensive measures. There is a presumption that in making the business decision, the directors of a corp acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the corp. o Revlon Rule: Directors Duty During a Bidding War: However, once it is clear that there is a bidding war and the breakup of the company is inevitable, the directors duty changes from preservation of the corporation to maximization of the companys value. Directors duty job is to get the highest value possible for shareholders. No shop provision was a breach - market forces must be allowed to operate freely to bring the targets S/Hs the best price available for their equity. Thus as the trial court rules, the S/H interests necessitated the Board to remain free to negotiate in the fulfillment of that duty. o Court shot down the argument by Revlon directors that they were protecting other constituencies. Court said that the concern for the other constituencies (i.e noteholders) has to be rationally related to the benefits accruing to the shareholders. o Holding: In this case, the concern wasnt related because stopping an auction with active bidders is never related to shareholder interests. Also the directors could not make the requisite showing of good faith by preferring the noteholders and ignoring its duty of loyalty to the S/H, when the noteholders needed no further protection, their rights were already fixed by contract. Note a poison pill, also known as a Rights plan, is an action by the targets board that creates rights in the targets existing S/Hs other than the bidder, to acquire debt or stock of the target at bargain price upon the occurrence of specified events such as the bidders acquisition of a specified % of the targets stock. A poison pill makes a raider negotiate with management. We dont want to have these supermajority provisions for the board of directors, etc because we dont want new management to decide what is good for me. There is a fine line between management being able to negotiate a higher price and management interfering. Paramount v. Time I (DE) (Board Knows Best Rule) o Paramount made a big offer for Time. Time was in the middle of finalizing a deal with Warner that the directors said would be in the long term best interests of the S/Hs. Even though Paramounts offer was way over the share price, Time thought that the bid was a threat to the Time Culture and was concerned that the time shareholders wouldnt recognize the long term benefits of the Warner deal. Time directors approved defensive tactics. Paramount brought a Revlon claim and a Unocal claim. o Revlon duties to maximize corp value are triggered only in 2 circumstances. is claiming that by entering into merger agreement with Warner, the BOD of Time imposed the duties discussed in Revlon to maximize SH value this is wrong A merger doesnt trigger this role, it has to be inevitable that there will be a dissolution or a breakup When the corporation creates an active bidding process looking to sell itself or The directors can place the co. in an unintentional bidding war (Paramount v. QVC) In response to a bidders offer, a target abandons a long term strategy and decides to break up.

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In this case, Time was doing neither of these, so Revlon duties not triggered. This is unlike Revlon where the BOD considerd a bust up sale, and authorized agents to negotiate a sale If te BOD resoponse is found to only be defensive measures and an abandonment of existence is not intended, then Revlon doesnt apply but Unocal does o no violation of the Unocal rule. No violation on the first offer because they didnt put in defensive measures Unocal not implicated. o so Unocal doesnt come into play until a defensive measure is taken basic BJR applies When Time took the defensive measures, Unocal was implicated. Although it would appear that there was a violation because the price offer was more than fair, the court gave wide berth to the Time directors to preserve the long term strategy. It also helped that 12/15 directors were noninterested. Court also found that Time was well informed about risks and benefits of Paramont because of prior negotiations with it SO the threat can be more than inadequate cash value or threat of coercion it can be threat to long rang plans o Rule applied in this case: Board Knows Best rationale for implementing takeover defenses. - court gave wide berth to the Time directors to preserve the long term strategy. Paramount v. QVC (DE) o Now we have Viacom and QVC bidding for Paramount. Paramount entered into a deal with Viacom that basically would have placed complete control of the company in one man, since the Paramount shareholders were getting mostly non-voting stock in the exchange. The agreement with Viacom had some pretty stiff provisions if it were to fall through (no-shop, termination fee waiving of the poison pill, stock option). The stock option agreement is significant b/c if Paramounts stock went up then they would have to pay Viacom. Also, president of Paramount was going to get to stay on. QVC made a big offer anyway $80 a share. Paramount entered into a deal with Viacom that basically would have placed complete control of the company in one man, since the Paramount shareholders were getting mostly non-voting stock in the exchange. The CEO of Viacom owne 85% of its voting stock, so he pretty much runs the show Viacome initally offerd 61 per share in stock and cash, but Paramount wanted 70 Final agrement held that Parmount would merge into Viacom o each share of Paramount was to be .1 share of Viacom voting stock and .9 share of nonvoting stock. Plus 9.10 in cash o Note- at this time Viacoms stock value had increased allegedly because Redstone was infalting the market value by buying up stock o Both Viacom & QVC are close corporations. o Features that made this company less attractive to other buyers: There is a termination fee and there is a stock option with a feature that requires Paramount to pay to Viacom the difference between the value of the shares and what they would ultimately be paid in a competing offer back to Viacom. o Viacom upped their offer to $85/share. QVC then upped their offer to $90 a share. o Although a number of materials were distributed to the Paramount Board describing the Viacom and QVC transactions, the only quantitative analysis of the consideration to be received by the stockholders under each proposal was based on thencurrent market prices of the securities involved, not on the anticipated value of such securities

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at the time when the stockholders would receive them suggesting that is something the board should have done o Court said the normal rule of directors actions is the BJR, however the Court said that there are rare situations where enhanced scrutiny of the directors conduct are necessary There are two alternative tests that the court talks about: (1) the enhanced scrutiny test and (2) even higher scrutiny if there is self-interest which could possibly implicate the entire fairness test (they dont apply it but they alert you that is a possibility) This court applies the enhanced scrutiny test (see below) o The key features of an enhanced scrutiny test are: (a) a judicial determination regarding the adequacy of the decisionmaking process employed by the directors, including the information on which the directors based their decision; and (b) a judicial examination of the reasonableness of the directors action in light of the circumstances then existing. The directors have the burden of proving that they were adequately informed and acted reasonably. o Board actions in the circumstances presented here is subject to enhanced scrutiny. Such scrutiny is mandated by: (a) the threatening diminution of the current stockholders voting power; (b) the fact that an asset belonging to the public stockholders (a control premium) is being sold and may never be available again; and (c) the traditional concern of Delaware courts for actions which impair or impede stockholder voting rights. Unocal the approval of a transaction in a sale of control Revlon adoption of defensive measures in response to a threat to corp. control. Court when the sale of the control of a company gets the enhanced scrutiny of the Unocal test with the burden shifted to the board to show that they investigated and that their response was reasonable. Then the court will insert its own judgment on the reasonableness of the director action o The theme that runs through this case is that if we are selling control then the transaction changes. Control gets shifted from the public S/Hs of Paramount to Viacom. o Holding: Unocal Rule triggered in this case. As far as sale of control, Paramount was originally controlled by a fluid aggregation of shareholders and that control would go over to a single person in the Viacom deal, so the enhanced scrutiny is applied. The public stockholders are in the majority now and after this transaction a single person is going to have the majority voting rights. The former stockholders would end up owning only non-voting shares and have no control. There would no longer even be any public shareholders. The right to control is valuable and when that is being sold or transferred, those people who had it are entitled to be paid for it. o Triggers Revlon Rule: Court said that in a sale of control, the directors duty is to maximize shareholder value. Some of the ways a board can fulfill its obligation to seek the best value are: Conducting an auction Canvassing the market. etc. o Key features of enhanced scrutiny test Judicial determination regarding the adequacy of the decision making process employed by the directors, including the information on which the directors based their decision Judicial examination of the reasonableness of the directors actions in light of the circumstances then existing. Actions dont have to be perfect, just reasonable.

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o Paramount argued that they did not shop around because of the no-shop provisions. The Court essentially says you cannot contract away your fiduciary duties. Such provisions, whether or not they are presumptively valid in the abstract, may not validly define or limit the directors fiduciary duty or prevent the directors from carrying out their fiduciary duties. o Holding: The realization of the best value reasonably available to the stockholders became the Paramount directors primary obligation under these facts in light of the change of control. That obligation was not satisfied, and the Paramount Boards process was deficient. The directors initial hope and expectation for a strategic alliance with Viacom was allowed to dominated their decisionmaking process to the point where the arsenal of defensive measures established at the outset was perpetuated (not modified or eliminated) when the situation was dramatically altered. QVCs unsolicited bid presented the opportunity for significantly greater value for the stockholders and enhanced negotiating leverage for the directors. The court shot the whole thing down, and it appears the primary reason is that the QVC offer was so large, and there is no way the directors argument in favor of the reasonableness of their decision based on corporate vision cannot be justified b/c the shareholders are losing over $1B (Viacoms offer was $1 billion less than QVCs Directors primary duty in this case shifted to the maximization of S/H value. o Court also reiterates the Weinberger rule: where actual self-interest is present and affects a majority of the directors approving a transaction, a court will apply enhanced scrutiny. o Court rejected Paramounts argument of the holding Time Warner case in that the court clearly stated that in addition to the 2 circumstances there are other possibilities where Revlon duties may be implicated. In addition the Court said that this case also falls within the 1st category in that the Paramount Board, although unintentional, had initiated an active bidding process seeking to sell itself by agreeing to sell control of the corporation to Viacom in circumstances where another potential acquirer (QVC) was equally interested in being a bidder. Federal and State statutory regulation of Hostile takeovers CTS v. Dynamics (Fed) Preemption IND law o Indiana had a law that kicked in when a company got a control share of a public Indiana corporation. Only impacts a company incorporated in Indiana. If a company got control shares, the raiders shares immediately become nonvoting, and are not able to become voting unless the remaining target S/Hs approve or give them their voting rights back and it must occur at the next S/H meeting (which can be a long time) or the raider can ask for a meeting within 50 days (but the raider has to pay for the meeting). If the shareholders do not vote to restore voting rights to the shares, the corporation may redeem the control shares from the acquirer at fair market value, but it is not required to do so. The statute also says that it is not automatic; the co. has to elect to have the statute apply to it. o These types of statutes are passed to protect the Board and the Indiana Operations. It was passed to keep the companies safe and the jobs in the state. It is to protect the corporations. o Corporate raider tries to argue that the Indiana Law was preempted by the Williams Act and violated the dormant commerce clause. o Preemption Analysis Williams Act: Under the Williams act you have to disclose to the SEC whenever you get a big chunk of stock, and there are provisions that protect shareholders through the period of a tender offer. Court distinguished the Indiana law from an Illinois law that changed the Williams process.

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Rule: Court found that the Indiana law actually furthered Williams. The delay in getting the approval to vote the shares is ok under Williams. So, this isnt preempted. Dormant Commerce clause Rule: To violate the dormant commerce clause, the law has to favor Indiana raiders over other raiders. All raiders here are treated the same. Further, the court shot down an argument that this would impede tender offers. Court said that there are all sorts of ways states impede tender offers now (like higher votes for mergers under corporate law or staggered directors), and those dont violate DCC. Also dissenters rights are accepted. General rule is that corporate law is state law; law where you are incorporated governs. Holding: the ILL he statute can be said to protect S/H and there are substantial connections with the states interest. Amanda Acquisition v. Universal Foods (WI) o This is not a Sup Ct opinion; it is a 7th circuit opinion. o Wisconsin had a third generation takeover statute that forced corporate raiders to wait 3 years after gaining control to merge the target or acquire more than 5% of its assets. The statues also say that the board of the target can waive that provision. State created defensive mechanism that makes it way more difficult for a raider to take over a Wisconsin Co. that the govt doesnt like. Statute, unlike Indiana statue, was not self-electing but automatic. o Issue: This statute screwed Amanda because their financing was dependant on a quick second step merger. The financiers are after a lien on the assets. Getting to the assets is what secures the loan. Without the merger they cant do that. o Ct says the practical/economic effect of this is to eliminate all hostile leveraged buyouts of Wisconsin Corporations. The tender offer is the device for the shareholders to get rid of ineffective management. We believe that antitakeover legislation injures shareholders. Managers frequently realize gains for investors via voluntary combinations (mergers). If gains are to be had, but managers balk, tender offers are investors way to go over managers heads. (this statute protects management) o Skepticism about the wisdom of a states law does not lead to the conclusion that the law is beyond the states power. o Court said that as long as the state law doesnt alter the process in Williams, there is no preemption. The waiting period doesnt change the Williams disclosure procedures, so no federal preemption. o Court said that a Wisconsin buyer gets no advantage over a buyer from another state, so no dormant commerce clause violation. SC: 35-2-101 & 35-2-201, we have an equivalent of BOTH the Wisconsin and Indiana statutes. Since enactment, neither of these statutes have really come into play; the reason is that we dont have many publicly traded SC corporations left. Summary (ways to evaluate the directors behavior); page #s correspond to what has triggered the test and what the test might be; gets more strenuous as you go o Business judgment test 282+handout: Van Gorkam: the rule is a presumption that in making a business decision the directors acted on an informed basis, in good faith in the honest belief that the action was taken in the best interests of the company. Thus, the party attacking a board decision as uninformed must rebut the presumption that its business judgment was an informed one. In Deleware, the standard is gross negligence (maybe not in SC)

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Handout on TWEN: quote from Disney test: the business judgment rule is not actually a substantive rule of law but instead is a presumption that the directors were informed, acted in good faith, and in the honest belief the action was taken the best interest of the company and the shareholders. Fraud, bad faith, and self-dealing will knock out the application of the test. In the absence of this evidence, the boards decision will be upheld unless it cannot be attributed to any rational business purpose (allowed to consider the substance of the decision) or I can attack the substance of the provision and show no rational business purpose or that the transaction constitutes waste Unocal (may be a separate test from enhanced scrutiny or they might be the same) Trigger: 699 and 711: if management purchases shares in response to a tender offer, that would trigger Unocal; when the board implements antitakeover measures Test: 699 and 711: directors have the burden of proving they had reasonable grounds for believing there was a danger to corporate policy and effectiveness, a burden satisfied by a showing of good faith and reasonable investigation If there is a conflict (even if we dont think they did anything wrong but they are faced with a conflict), maybe there is a reason to apply Unocal instead of the BJR. Enhanced Scrutiny Trigger: 740, 742, and 599: defensive purchase of shares (unocal) or breakup of the company (Revlon) or Paramount; language in the Pearlman case that says the trigger is the sale of control by Pearlman of 33% of the company Test: 743: (a) a judicial determination and (b) a judicial examination and 599: burden of proof and fiduciaries language Compelling Justification Blasius v. Atlas, 542 A.2d 651 Not covered in our class!! Entire Fairness (both sides of the deal) Trigger: 664, 489: because of fiduciary duty and its control over S, its relationship with S must meet the test of intrinsic fairness; when there is an existing conflict situation (look at Weinberger and Sinclair for examples) Test: 335, 670, 489: involves high degree of fairness and a shift in the burden of proof; where directors stand on both sides of the transaction, they have the burden of demonstrating entire fairness (utmost good faith and the most scrupulous inherent fairness); fair dealing and fair price No Decision and Good Faith (off on its own) No decision has been made at all by the board and the shareholders argue that you should have done something and you didnt Trigger: 296: failure to act Test: 296+handout: we wont penalize the board for failing to act unless there has been a systematic failure; handout confirms that Caremark case is the current state of the law today (stone case) but more importantly in the Stone case the court talks about the role of good faith (see the handout)

LIMITED PARTNERSHIPS
o Why worry about Limited Partnerships? What would have been a limited partnership would now probably be registered as an LLC. There are a lot of them out there. Historically a lot of real estate deals were done as limited partnerships. A lot of people invest in Hedge Funds which are done as Limited partnerships Estate Planning Area Limited Partnerships as opposed to LLCs are the desired estate planning tool Ex I own a large tract of timber land in SC and I want the prop to be inherited by my kids and I want the least amount of tax possible. If I transfer all of the property into a

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limited partnership and start gifting out limited partnership interests to my kids, one of the things you can argue is that the limited partnership interests are entitled to discounts so you can transfer the property at a lower cost. At death, the property transferred is entitled to certain marketability discounts. Almost all hedge funds are done as limited partnerships; a lot of it is tax-motivated Because of the hybrid nature of limited partnerships, they are subject not only to limited partnership laws but also to general partnership laws. Rule: regular partnership statutes usually apply - If something is addressed in a limited partnership statute, go find it in the regular partnership interest. Limited partnerships are also subject to federal securities laws such as 10b-5 and state securities laws. Rule: Almost always, an interest in a limited partnership is going to be viewed to be a security and triggers registration rules. Generally Like a partnership with two types of partners General partners personally liable for the debts of the limited partnership Limited partners not personally liable for debts Subject to state and federal securities laws Advantages: 2 significant benefits over general partnership Less liability than a regular partnership if it is done right the limited partner is protected from any of the debts of the business General partners are still liable o You can make a corporation the general partner, which essentially means that no individual will have personal liability for the liabilities of the LLP Same Tax Benefits as Partnerships Taxed as a partnership rather than a corporation (no double taxation problem) Non-Dissolvable entity unlike partnership (need careful drafting to make it nondissolvable) If someone leaves a limited partnership, it does not automatically trigger dissolution You can structure the Lim Partnership if someone leaves the business or dies this does not affect the business Profit Distributions unlike partnership Are usually according to each partners contributions if the agreement is silent whereas with a normal partnership the distributions would be equal. What are the legal problems in starting an LLP? Do not come into existence until there has been a public filing 33-42-210 Certificate of Limited Partnership (a) Must file a certificate of limited partnership with state including: o Name o Address of office and name and address of agent o Name and address of each general partner o Latest date the partnership is to dissolve o Any other matters Some lawyers like to put the pship agreement here Clients dont want this stuff public since the agreement probably sets forth their shares (b) LLP is formed at the time of filing with sec of state or at any later time specified in the certificate if there has been substantial compliance with 210 Filing is required b/c the limited partners are not personally liable for the obligations of business, but they can file in any state they choose probably advantages and disadvantages to doing this. There are restrictions in naming the LLC.

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33-42-60 at minimum there has to be a written agreement/document at their office that contains certain limited information about the business. Need an Atty: Almost crucial that a lawyer be involved in forming a limited partnership b/c it is critical that the agreement be carefully drafted. 33-42-300 General Partners Authority SC LLP has to file the names of the general partners who are authorized to transfer property with the deeds. This is to help with title searches and make sure that property was transferred with proper authority. What are the legal problems in operating an LLP Control Start with the assumption that limited partners never have the right to vote although the partnership agreement can give them voting rights (almost all will give them voting rights in some circumstances) 33-42-420: Voting o Subject to 33-42-430, the agreement can grant the power to vote to all or a specified group of limited partners. o By default, the general partners make the decisions. o Different from a general partnership, in a limited partnership the decisions are generally made by the general partner, the limited partners dont vote. So usually the limited partners are in it strictly as investors, they have no mgmt responsibilities or control rights. Although the limited partners do not usually have voting rights, they can be granted voting rights. o 3 options of Voting rights of the Limited Partners Unanimous vote to do certain things Majority vote of limited partners to do certain things limited partners get no vote (consistent with statute). Liability To 3rd parties most critical o 33-42-430 Liabilities to 3rd Parties Unless provided otherwise, a general partner is liable for debts to third parties just like a partner in a regular partnership. If a limited partners participation in the control of the business is not substantially the same as the exercise of the powers of a general partner, the limited partner is liable only to the persons who transact business with the limited partnership with actual knowledge/reliance on his participation. Rule: The General Partners liability to 3rd parties can not be limited by the partnership agreement o 33-42-630 General Powers and Liabilities: GP has the liabilities of a partner in a regular partnership A GP is liable to the other partners just like a partner in a partnership the obligation and duties amongst and between the parties in an LLP can be changed in the partnership agreement: BUT NOT the GPs liability to 3rd parties. o 33-41-390 Liability of a Partner Joining Late someone who becomes a partner subsequent to the partnership formation is not liable for the pre-existing obligations of the partnership. Presumably, this statute would apply even though we are dealing with a limited partnership and not a regular partnership.

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o Zeiger v. Wilf (NJ) (Limited Partners Liability TO 3RD parties for acting like a GP) Wilf and his general partnership were limited partners in an LLP to renovate a hotel. Things started to go bad, and Wilf took over acting as an officer for the LLP. Things collapsed, and the plaintiff who was owed significant money came after Wilf under the theory that he had acted like a general partner, and therefore should be liable as one. Wilf was the bad guy - he negotiated the leases, ran the renovation project, arranged for financing, and has been in charge of the deal. When the Plaintiff transferred his rights to the partnership, the P was supposed to get a consulting payment for several years - $27K. When the deal fails, Wilf stops paying the P. Issue: Can Wilf be held personally liable for the $27K contracted and owed to P under the partnership? Under the statute is Wilf liable? Court said that you need controla limited partner is not liable for the obligations of a limited partnership unless he takes part in the control of the businesslike a GP (the language in this case is exactly the same as the language of the SC statute, which is strange because most statutes dont have the same language) you need reliance and knowledge by the other party: if the limited partners control of the business is not substantially the same as the power of the general partner, then the limited partner is only liable to people who transact with the LP with knowledge of the limited partners participation in control and rely on him. Statutory Safe Harbor Provision - Court noted that a limited partner acting as an officer, director, or shareholder cannot be found to be exercising general partner control o Important to note that the safe harbor provisions in the law have to be adopted into the agreement to take effect Holding: Wilf was not liable to the 3rd party: Wilf was acting as an officer not as a GP o It didnt matter that he didnt represent that he was acting in his capacity as an officer to the third parties. No reliance on the part of the plaintiff that Wilf was a general partner. o The plaintiff was aware of the structure of the business and knew Wilf wasnt a general partner There is an argument that even if P did rely, Wilf still might not be liable. There is an argument that the K to pay $27,000 was made before Wilf became a partner and there is a statute that says if that occurs you are not personally liable. 33-41-390. This is not discussed in the case but Burkhard brought it up. Wilf court says there is a distinction btwn the exercise of control and participation in control. If the person is really running the LLP and has all the powers of a GC then they are liable, but if they are just a participating a little bit in the running of the business then they are only liable to people who rely on them. SO that was the Ps problem in Wilf, he admits he never relied on Wilf as a participating general partner knew he was acting as VP of Trenton. o 33-42-430 Liability to 3rd Parties (a) - A limited partner is not liable for obligations of an LLP unless he is also a general partner or he takes part in the control of the business. that is the phrase that has caused all the litigation.

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 However, if control is not substantially the same as the exercise of the powers of a GP, he is liable only to third parties who have actual knowledge of his participation in control. Divides a limited partners wrongful behavior into two types: o Exercise of the powers of a general partner. o Knowledge of Participation in Control. (b) - Not participating in control if (SCs statutory safe harbor) Being a contractor for or an agent or employee of the LLP or of a general partner or being an officer, director or S//H of the GP that is a corporation. List of many other actions that do not constitute participation in control o GA Rule on Limited Partner Liability: A limited partner may take part in control of the business and if they do that is ok - says you can never hold a limited partner liable as if he were a general partner. o 33-42-440 when you erroneously believe youre a limited partner If you make a contribution and erroneously but in good faith believe youre a limited partner, you are not a general partner and are not bound by its obligations if, when you learn of the mistake, you Get the right certificate of limited partnership amended OR withdraw from future equity participation of the partnership If you do one of these two things you are protected against future claims and to some extent past claims against the P. However, youre liable to any third party who contracted before you withdrew or amended the agreement if that third party believed in good faith that you were a general partner. o Recent NC Case involving 33-42-440 -A # of people in a partnership bought condo units as investments in a condo complex, the problem was that the condo had financial trouble and there were huge assessments made against the units. The argument was that each of the partners was liable for a portion of the assessments. One of the investors says that she bought as a limited partner and was not liable for the assessments. She actually entered as a GP, but she doesnt know that. Court relied on SC 42-440 with regards to the Condo complex there is no clue as to who the partners are so it is highly unlikely that the folks who sold her the unit believed that she was a GP. So she was not liable. Rule: 33-42-440 - applies to ALL BUSINESS TRANSACTIONS where the person actually believed they were a limited partner. Ohio Case (Similar to Zieger) o 2 corporations created the general partnership of a limited partnership. Since they are corporations they can only act by the officers of the company. The P, a plumber, sues as the LP is going one of the vice presidents of one of the corporate general partners. Ohio court went back to Agency law and said that the partners were not acting as agents for a disclosed principal o Issue: Issue arises out of the Wilf case, Can you ever recover from a director of a corporate general partner? o Rule: A director of a corp GP can be personally liable to 3rd parties for his actions as an agent of the corp/GP if they did not disclose to the plumber that they were acting as agents of the corporation.

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o Burkhard: The Ohio Court said that they were liable. In order to get the protection, the plaintiff has to know who they are dealing with. There has to be disclosure that you are acting as a corporate officer who is one of the general partners in a limited partnership. The plaintiff has to basically understand the whole picture for the D to avoid liability. o The P did not rely on piercing the corporate veil case law in Wilf b/c there was no evidence that the corp was undercapitalized or the franchise was (the other factors necessary to pierce the veil). o Another theory you could argue for recovery is agency 602 or 603 of the restatement. Undisclosed or partially disclosed principal. Kahn v. Icahn (DE) o Derivative suit against the general partner of AREP, a LLP that buys and sells real estate. The general partner, API, is a corporation that is owned wholly by one person (Icahn). Suit alleged that Icahn made some investments on his own that he had a duty to offer to AREP first. The partnership agreement stated that API could compete directly with AREP. o Issue: Did the GP Usurp a Partnership Opportunity. o DE law: the partners can modify the fiduciary duties between the GP and the LLP - can be expanded or contracted by statute and this particular partnership agreement allows him to compete o DE Law post Kahn: after this case, the DE lawyers got the legislature to expand the law to say that duties could be expanded, contracted, or eliminated all together. o Issue: Is there a difference between usurping a corp opportunity and competition? o Then court looked at corporate opportunity doctrine: 3 Part Test: Opp is either essential to the corp or is one in which it has an interest or expectancy Corp is financially able to take advantage of the opp itself The party charged with taking the opportunity did so in an official rather than individual capacity., Court held that the corporation has to have an interest or expectancy in the opportunity before it can raise the argument. Holding: In this case, because of the compete clause, AREP had no legitimate expectancy, and thus could not raise the doctrine. Also the facts indicate that this opp did not come to him as a result of his status in the partnership, so there is the notion that it was not a corporate opportunity. In SC, would you be able to put a similar clause in a partnership agreement? You cant contract out a fiduciary duty in SC. But this is a limited partnership, so that probably wouldnt apply. However, if it is not covered in the llp sections, then the partnership sections apply. Look through the llp sections carefully to see if anything applies so we know if the partnership provisions can apply. See 33-42-630 for the answer. No, you wouldnt be able to put a similar clause in a partnership agreement in SC. In re USACafes (DE) Metsa bought all of the assets of USACAFEs LLP. A Corp was the GP of the LLP. Plaintiffs were the limited partners who thought the GPs got kickbacks from Metsa to sell at too low a price. The directors of the GP all received substantial side payments that induced them to authorize the sale of the LLP assets for less than the price that a fair process would have yielded. Issue: Whether directors of a corporate GP are fiduciaries for the LLP?

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Ps Claim: The GP caused all of the assets of the Corp to be sold too cheaply; the price was not fair to other members of the LLP. They are suing the corp and the directors for fiduciary breach of duty of loyalty and breach of duty of care. The directors said their duty runs to the corporation but not the LPs who were investors Court analogized to trust law, and said that a corporate trustee cannot intentionally use trust property in a way that benefits the holder of the trust in a way that harms the beneficial owner. Rule: GPs are like trustees for the LPs, and gave them a duty to the LPs not to convert property for their own use. Thus, the LPs at least have a cause of action against the GPs for this presumably self interested sale for too little. Rule: The Director of a Corp GP has a fiduciary duty to the LLP with regards to dealings with the partnerships property or affecting its business. duty not to use control over the partnerships property to advantage the corporate director at the expense of the partnership. Ct analogized to trust law where a director or officer of a trust institution who improperly acquires an interest in the property of a trust administered by the institution is subject to personal liability. How do owners of an LLP make money? Salaries Distributions o These statutes are different from the regular partnership statutes in terms of profit sharing and distribution provisions. o 33-42-830 sharing profits and losses Divided according to agreement If agreement is silent, divide according to contributions made by partners that is received but not returned. Note the difference between this and the default distributions for regular p-ships, which defaults to equal. o 33-42-840 Sharing Distributions Divided according to agreement If agreement is silent, divide according to contributions. o 33-42-1220: Assignment of Partnership Interest Pship interest is freely assignable unless agreement says otherwise Assignment doesnt dissolve the limited pship All the assignee gets is the distribution the seller would have been entitled to If the partner assigns his interest, hes no longer a partner unless the agreement states otherwise o 33-42-1020 Withdrawal of GP The general partner can withdraw at any time But if the withdrawal contravenes the agreement, the partnership can get damages from him resulting from breach o 33-42-1030 withdrawal of LP Can only do so at the time or upon happening of events specified in the partnership agreement if the partnership was formed on or after July 1, 1998. SC LP would qualify for special estate tax treatment if drafted correctly.

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 If the LLP was formed prior to 7/1/98 and it doesnt state in the agreement a LP wishing to withdraw must give 6 months prior notice to each GP They tried to make it retroactive, but Burkhard says it might not work for LLPs formed prior to 1998. You can redo the partnership agreement to make sure it applies. An LLP agreement formed prior to 7/1/98 can be amended to state specific events when an LP can withdraw This statute tried to be retroactive but there is still some question as to whether this applies to pre-1998 limited partnerships unless they specifically state it in the agreement. A bunch of this stuff is designed to make sure a SC LLP qualifies for tax benefits o 33-42-1410 Non-judicial Dissolution (one of the adv of a LP is it can be made to be non-dissolvable LP is dissolved upon one of the following time specified in the agreement ends any events specified in the agreement written consent of all partners withdrawal of a GP unless o there was another GP and the agreement specifies that the remaining partner can carry on, OR o within 90 days all remaining partners agree in writing to continue the business and to the admission of more GPs, as needed Judicial dissolution

LIMITED LIABILITY COMPANIES

o Most business today are being formed not as corporations but as LLCs o SC has adopted the Uniform Act DE has not. o Rule: Almost all of the provisions indicated in the LLC statutes can be modified in the LLC agreement with the exception of fiduciary duty and protection of 3rd parties (anything dealing with creditors claims). o 2 Reasons why LLCs are advantageous o Tax Advantages o Limited Liability for the Investors o Do not need at atty in SC o Do not need to file an annual report o Important Notes on LLCs Problems page 815 o Rule: Distinction Between Member Run & Manager Run LLCs: If it is member run, then we apply about the same rules that are required for a partnership any person can essentially bind the LLC if it is mgr run then only managers can bind the partnership o If you have a client who is considering contracting with a bus structured as an LLC it is crucial that they know whether it is member run or manager run, depending on which one it is different persons have different degrees of authority. o To make this determination you must check with the Sec of States office. o Rule: Members and managers of LLCs are usually not personally liable as investors, they are like S/Hs o Exceptions: if you are a manger acting as a member of an LLC and you commit tortuous actions, you are still liable as an agent for your actions Also, courts will pierce the veil of LLCs they will use the veil piercing test in the corporate are will be applied to the LLC transaction

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o o

There have yet to be any cases in SC, but in every other state where the issue has been raised, the courts have applied the corp test for piercing the corporate veil. Rule: In almost all States the Corp Opp Doctrine applies to LLCs SC LLC STATUTES o 33-44-203 LLC Articles of Organization Name of the Co. Just b/c the Sec of States office accepts the name does not mean you can use it in SC Address of the initial designated office Name and street address of the initial service of process Name and address of each organizer Whether the co. is to be a term company, and, if so the term specified Whether Member run LLC (looks like a GP) or a Manager run LLC (looks like a Corp) This is where the atty needs to spend a lot of time with the client to see what fits Whether one or more of the members of the co. are to be liable for its debts and obligations under 33-44-303(c) Articles of organization may include operating agreement, but most LLPs would want operating agreement to be private so wouldnt put it in the articles of organization. Articles of organization may not vary the nonwaivable provisions. As to all other matters, if any provision of an operating agreement is inconsistent with the articles of organization, the operating agreement controls as to managers, etc. and persons who reasonably rely on the articles to their detriment. 33-11-111 Conversion of corporation to LLC o After adopting a plan the board must submit it to the S/H to be approved. o The vote must be approved by 2/3 of the S/Hs entitled to vote. o There may be required to be voting by voting groups o A S/H may dissent to the plan of conversion and get the FMV for his shares according to 33-13101 33-13-310. o After approval must submit to secretary of states office. 33-11-112 Status of LLC post conversion o conversions takes effect it is essentially the same entity o all the debts/liabilities are the same o All S/H of the converted corp remain as members of the LLC but that can be changed according to the plan. 33-44-102(e) Knowledge and Notice: o Attempts to lay out rules as to what circumstances an LLC or an entity will be charged with information that may be known by one or more of its members. (So there is a notion that this statute may apply to every SC business entity today) Ex - Bus operates as an LLC- one member of the business knows that it has received $10k, another person knows that if the organization gets $10K it has to report it to the fed agency. So this section puts the 2 of these together to know when we will hold the business to be accountable for the information Rule essentially mandates that business businesses must come up with an internal reporting system. 33-44-201- LLC is an entity Attempts to solve the UPA problem as to whether an LLC is an entity or an aggregate. o Exception: LLC is treated for tax purposes as an aggregate each member reports his or her taxes separately. SC 33-44-208 Certificate of Existence

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you can ask the Sec. of States office for info regarding the status of the LLC (whether or not they are in good standing). SC 33-44-211 Annual Report not Required LLCs are not required to file an annual report with the govt maybe one advantage over corp. (as a result of logistical problems with Sec of States office). 33- 44-301 Agency of Members and Managers Liability When someone acting on behalf of the LLC will be able to bind the LLC. Each member of an LLC is an Agent and any act of a member in carrying on the normal course of business will bind the company, unless the member had no authority to act for the company in the particular manner and the person with whom the member was dealing knew or had notice that the member lacked the authority. An act of an agent not in the course of business will only bind the LLC if it was authorized by the other members. o broaden the exposure of the LLC for a member owned LLC so it is a lot easier to hold the LLC liable than a partnership liable for actions of the members. o (c) Addresses this hypo: If you have a member run LLC 20 people have invested and own a condo complex. One of the members sells the condo complex to Smith for x amount o Important: (c) says this is valid unless you put in the AIs a provision saying you cant do that all of the Law firms that file AIs for LLCs negate this provision. 33-44-303 Liability of Members & Mgrs (a)A member or manager is not personally liable for obligations and liabilities of the co. soley by reason of being or acting as a member or manager. (b) failure of an LLC to observe the usual co formalities or requirements relating to the exercise of its powers is not grounds for imposing personal liability on the members. (c) a provision in the LLC agreement can bind all LLC members liable for the LLC debts and liabilities. 33-44-404 Mgmgt Voting of an LLC (b)(3)A New mgr must be approved by a majority vote (c) Lists of matters requiring a unanimous vote o if you dont like that you can change most of it by contract. 33-44-405 Sharing and Right to Distribution -any distribution made by the LLC in winding up must be in equal amounts to each member- if you dont like it you can change it in your operating agreement. 33-44-406 - Limitations on distributions - parallel the corporate model you cant pay any money out of the business if o 1) you cant pay your outstanding bills coming due OR o 2) your debts > than assets if either one of these two occurs, distributions should not be made out of the LLC. 33-44-407 - Liability for unlawful Distributions 33-44-408 - Members Right to Information To Access & Inspect Records, Operating Agreement 33-44- 409 Gnrl Stds of Member and Mgrs Conduct Members of a Member owned LLS owe eachother Duty of Care and Duty of Loyalty & Fiduciary Duty o Duty of Loyalty To account to the co and to hold as a trustee for it any property, profit, or benefit derived by the member in the conduct or

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winding up of the business or derived from the use of the co. property or appropriation of a corp opp Not to deal with parties having adverse interests To refrain from competing with the co. in the conduct of the cos bus. Before the dissolution of the co. o Duty of Care Limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law o Must exercise rights consistently with an obligation of good faith and fair dealing. o A member does not violate this section merely b/c the members conduct furthers his own interest. Members of a Mgr owned LLC Do not have a Fiduciary Duty to Eachother 33-44-410 Actions by Members grants to an LLC member the right at any time to bring a direct action legal or equitable relief o Different from partnership model: If a partner is unhappy with another partners actions he can bring an action in equity for an accounting action adv of this an accounting action seems to be a direct claim maybe LLC member can do the same thing, (b) You can ask the court to reach back and account for prior wrongs - this statute says you cant do this but theres a gap may still bring a claim where the LLC is going on. 33-44-501 Members Distributional Interest: Similar to UPA LLC owns property not members If you have a distributional interest in LLC this interest is personal property and may be transferred in whole or in part. You can have stock certificates. 33-44-502 Transfer of Distributional Interest Distributional interest does not entitle the transferee to exercise any rights of a member, you will also have voting rights or mgmt rights with respect the LLC 33-44-5-503 Rights of a Transferee a transferee can have rights to an LLC if they receive a distributional interest if the operating agreement says that someone can transfer his financial and voting rights or if all the other members agree on it Transferee also becomes liable for the transferors liability to make contribution 33-44-504 Rights of Creditor: Provides what a creditor has to do is get a charging order against the membership interest exclusive remedy Different from the partnership statute says this section is the exclusive remedy by which a judgment creditor of a member or a transferee may satisfy a judgment. 33-44-601 Events Causing a Members Disassociation (Be careful the comments to this statute have not been updated) Disassociation in LLC context means someone has left the LLC. Dissolution means the actual process of going out of $. Attempts to define EVERY method by which someone could quit. o Notice of Quitting o Per the Operating Agreement o Transfer the members distribution interest (all of their financial rights) 602 suggests this may be modified in the operating agreement.

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 Presumably cover this in the operation agreement indicating this is not an event of dissolution. o Member becomes a debtor of bankruptcy o Death of Member o If a member is an entity and ceases being an entity 33-44-602 : Members power to disassociate; wrongful dissociation (a) a member has the power to disassociate at any time rightfully or wrongfully, unless otherwise provided in the operating agreement. o so LLC can lock members in by putting in a provision saying that a member cant voluntarily quit and you cant withdraw when you die Wrongful Withdrawalso If a member disassociates by becoming a debtor in bankruptcy o If a member quits At Will LLC Get cashed out Term LLC member becomes as assignee of the corporation entitled to financial interests, and then the term is over, member gets his share with everyone else. o A member who wrongfully dissacosiates from an LLC is liable to the co. and to the other members for damages caused by the dissacosiation. o If an LLC winds up as a result of a members wrongful disassociation, damages the co sustained must be offset by the distributions to the member 33-44-701: Company Purchase of Distributional Interest Buying out a person when they quit You can put in the operating agreement if a person quits an LLC they get nothing. 33-44-703- A Withdrawing member can still bind the LLC after a period of withdrawal 33-44-704 Notice of Withdrawal: But if the withdrawing LLC member files a notice then this puts people out there on notice that their action will not bind the LLC 33-44-801 Events Causing Dissolution and Winding Up of Companys Business Just b/c a member quits doesnt mean the LLC has to go out of business or wind up. 33-44-802- Post Dissolution Liability same as corp modes 33-44-803 Winding Up Process 33-44-805 Articles of Termination You can file an article of termination that put everyone on notice that the LLC is dead starts clock running to put creditors on claims 33-44-806 Scary section: Distribution of Assets in Winding up Creditors paid first Then owners o Tax Regulation issues attempts to address the default rule If the Co. is required to maintain a capital account per tax code, the rest must be distributed to members per IRS regulations. o This can be changed in the operating agreement 33-44-807: Known Creditors Claims against Dissolved LLC LLC Must give Notice 33-44- 808 Unknown Creditors Claims against Dissolved LLC Must give Notice 33-44-1101-1104 - Derivative Suits Problem if someone dies and there interest transfers to a family member, that assignee may not have standing to bring a suit, unlike the corporate model,

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33-44-1205 - Term Partnership includes LLCs Rule: Anytime the word partnership appears elsewhere in the SC code, it automatically includes LLCs (mostly applies to regulations of hunting, motorcycles) LLC vs. Corp - Directors Duty of Care and Loyalty DE Rule: LLCs can eliminate the duties of loyalty and care in their articles of organization. SC Rule: you cant eliminate the duty of care or loyalty you can tinker with it but no elimination. DE: Good Faith in the LLC context is deemed not to be a fiduciary duty but a contract principle. o SC follows this model Good faith is a contract principle. Waste, Water & Land Case- Prob 2 age 816 o The court says the fact that the card said EFRS does not give the client notice that they are dealing with an LLC; therefore he is liable. o If Roberts was the agent, Epstein was a principal. B/c it was a disclosed principal/agency relationship, Epstein is liable as the principal even though he did not do the negotiations (Clark was a disclosed agent for Lanhan not PIII- different names because actual case not covered in book) Rule: In dealing with 3rd parties you must advise your clients that they MUST disclose that they are dealing with an LLC. Lynch v. Carson (Kansas) o Three entities. Lynch, Rainbow, and Carson Trust, all own a portion of CLR. The three entities hired Carson the individual as the president of the company. The agreement had two relevant provisions: corporate opportunities have to be presented to the LLC and another provision saying you can do anything you want (engage in ventures) without owing income or proceeds to CLR. In the fall of 1996, Carson discloses opportunities to the other members. In 1997, Carson told Lynch about other opportunities. He then discussed this again with the other folks involved and running CLR. There is no question as to whether CLR was really interested. In October 1998, Carson sent proposed plans to other members of CLR for purchasing. Finally, Carson actually purchased the companies himself. o The key question is whether he has made an offer to the CLR members in a manner required by the operating agreement. Carson says that he just has to make them aware of the possibility of acquiring it. o The Court says all that is required is that the member offer the knowledge of this opportunity so he hasnt violated the operating agreement. o Rule: In almost all states, the corporate opportunity doctrine is going to apply to LLCs. Court held that the corp opp was disclosed to the other members of the LLC and thus Carson was ok to do what he did. Subsequently the members of the LLC threw him out and he filed another lawsuit saying they couldnt do it (breach of their duty to him and a breach of their duty to CLR). The first question is whether there is a fiduciary relationship between CLR and Gabelli (in charge of some of the members of the LLC). By influencing the managers to do what they did, Gabellis actions were injurious to CLR. Gabelli points out that Carson should have brought the suit as a derivative suit. He says he has a way around it because there is an ALI exception (close LLC exception). The court suggests that the lawsuit can go forward because they dont see any reason why a demand should have been made. The lawyer for Carson made another mistake because he didnt plead oppression.

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The defendants argued that all of this stuff is protected by the BJR, but the court says no. The BJR presupposes that directors acted on an informed basis and in the interest of the company. The BJR does not apply because the complaint shows they acted independently of business interests. Rule-Different Duties for Member vs. Mgr Owned LLCs: A member of a member-owned LLC owes a fiduciary duty to the LLC and to the other co-members of 33-44-409(d) but a member of a manager owned LLC does not owe a fiduciary duty to the other members of the manager owned LLC. 33-44-409(h)(1). This is what the statute says but Burkhard says dont assume it is that simple It appears that this suit should have been brought as a derivative claim. Lieberman v. Wyoming (Wyoming) o The issues in this case are mostly state specific so you need to look at the state LLC statutes. o Lieberman invests $20k in the business (in the form of services rendered and to be rendered) and he is credited with a 40% ownership of the capital of the bus for his $20k contribution. B/C the contribution was in the form of services it raises an immediate red flag for counsel b/c presumably that transaction created tax problems for Lieberman (this is something the atty for Lieberman should have covered on the front end). o There was an increase in capitalization of the LLC from 2 new members representing 2.5% of the ownership interest in the LLC it seems the math is wrong b/c these guys invested much more than Lieberman and they are worth much less but it suggests there was a drastic appreciation in the value of the LLC or that they were getting profit sharing o Lieberman was terminated as VP of the LLC Note: a SC LLC can have officers. He files a notice asking the LLC to cash him out if they are going to fire him he says he is entitled to $400K, they say that he is only entitled to $20K the initial amt of his initial capital contribution. o Court says he is definitely entitled to $20K initial capital contribution - but the issue is he entitled to more? o Holding: Even though he withdrew and the statute suggests he is entitled to $20K given his interest, he is also entitled to o his right to manage and o his capital contributions o share of profits *Court also focuses on the fact he has a certificate of interest Lieberman argues the statute on p. 829 should be applied because he would then be entitled to the value in his capital account. Court says no because the LLC hasnt been dissolved. The court implies he is still entitled to his equity which hasnt been paid to him. We dont really know what this means. Is he still entitled to his voting rights in the interim? We dont know. See SC statutes: 33-44-701, 33-44-501: doesnt affect my voting rights in the LLC; also see 33-44-801 which talks about events causing dissolution: if after the expiration of the specified term, the applicant may be able to request dissolution; presumably it would end and I would be paid off by virtue of receiving my share of the LLC If this happened in SC, you would want to see the operating agreement. You would want to see if it was a term LLC or an at-will LLC. If this is an at-will

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LLC. See SC statute below. If it is a term LLC, see the same statute (diff section). At the end of the term, you either buy them out or liquidate and distribute according to the winding up. o Rule: In these cases you have to pay close attention to the statue and the inter-relation of the operating agreement. must focus on the notion that the LLC member may be entitled to the FMV of his shares. o SC Rule: 33-44-701 LLC will purchase interest at the FMV at the date of disassociation: a term or at will LLC can purchase the distributional interest of a member who chooses to withdraw for its fair value determined as of the date of the members dissociation if the members disassociation does not result in a dissolution of the co. If you do this, he would no longer have voting rights. o Burkhard said the remaining members of the LLC could by unanimous vote extend the life of the LLC to prevent the term ending. o What do you get during the delay while youre waiting to be paid out. If you look at 33-44-603, you would be treated the same as a transferee. If you look at 33-44-503(e), he would be entitled to distributions. Although the section seems to suggest I have a right to early dissolution, Burkhard thinks this only applies when it is actually time for dissolution (so no early dissolution). o The remaining members would vote to change the distributions. The question will be whether or not this is a breach of fiduciary duty. o 33-44-806(b): all remaining cash must be distributed according to their positive capital account balances

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