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OL-Spring 2008

OL-Spring 2008

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Published by: Jim Schultz on May 01, 2011
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  • Limits of Limited Liability - Piercing the Vail and Related Doctrines
  • COGGINS – don’t understand notes given to me, look up
  • RABKIN – same thing

AGENCY Who’s An Agent; When Authority 3 kinds of issues: 1) what’s an agent, looking at the restatement of agency 2) what’s the

affect of an agent on legal relationships of principal 3) agent’s duties to principal To create an agent/principal relationship, you don’t need to formerly say “I will be your agent.” The agreement also does not absolutely need to be in writing. Parties contracting with the agent are liable to the principal. A principal is also subject to liability on contracts made by the agent on behalf of the principal. For a principal to liable for the action’s of the agent: a) the agent must be a servant/employee of the principal master. b) the tortious action must have been done within the scope of the agent’s service/employment. Sect 1 of Rest. defines agency. Agency is the fiduciary relation which results from a) the manifestation of consent by one person to another that b) the other shall act on his behalf and c) subject to his control and d) consent by the other so to act. Sec. 2 of Restatement says the master is a principal who controls or has the right to control the physical conduct of the agent. Court stretches to say a jury could find a principal/agent relationship where a teacher lends a car to a coach to drive students to the game and the coach gets in an accident (Gordon v. Doty) Court finds sufficient control by grain dealer to establish that a grain elevator was the agent of a grain dealer, such that farmers could sue the grain dealer for the grain elevator’s failure to pay. (Jensen Farms v. Cargill) Someone will be viewed as a subagent of a principal if the principal’s agent had express, implied, or apparent authority to hire the subagent. Apparent authority (sec. 5) deals with whether Sam thought Bill had the authority to employ him, while implied authority deals with whether Bill had the implied authority to employ Sam. Court finds that Bill had implied authority to hire Sam on behalf of the church, because it was implied that Bill would get help painting the church. Therefore, Sam was a subagent of the church. (Mill Street Church v. Hogan)


Court finds that supervisor had apparent authority to hire the plaintiff on behalf of the company, because plaintiff reasonably believed that the supervisor was authorized to make such a sweet deal. (Lind v. Shenly Industries) (check on result) “the principal is liable for all the acts which are within the authority usually confided to an agent of that character.” This is similar to, but not quite apparent authority. This principle the Court put forth is called “inherent authority.” Court finds manager of hotel had inherent authority to purchase cigars from the plaintiff on the hotel’s behalf. (Watteau v. Fenwick) To find apparent authority, we need to find conduct by Arco that truck stop owner could have interpreted as giving employee authority. Inherent authority would bind Arco if it is usual for an employee negotiating with the truck stop owner to be able to give discounts. To show this inherent authority, the normal customs of the trade with respect to the power of an employee to negotiate discounts would need to be demonstrated. Inherent authority thus seems to be a looser form of apparent authority. (Nogales SC v. Arco) Ratification requires intent to ratify with full knowledge of the material circumstances. It seems unlikely that the wife was aware of the full material circumstances of the lease with the option to purchase, so therefore she could not have ratified it. (Botticello) Ratification is usually used as a means of protection of 3rd parties, not the principal. Woman buys clothes from man in department store who was in fact an impostor. No real or inherent authority cuz the guy wasn’t an agent. No apparent authority either cuz the department didn’t really do anything to manifest that the guy had authority. The alternative theory the court uses is authority by estoppel, under which the Court requires the woman to show acts or omissions, intentional or careless, by the department store, which created the appearance of authority in the impostor. There has to be a good faith reliance on the appearance, and a change in position. (Hoddeson v. Koos Brothers) Liability in Contract & Tort Humble and Hoover deal with the level of control necessary to establish tort liability. Not a bright line rule but one of degree. Court found lack of control by Holiday Inn over the details of the day to day operations of the hotel, so that Betsy-Lenn was not a servant-type agent. Therefore, Holiday Inn not liable for accident. (Murphy v. Holiday Inn) Actual authority, implied actual authority, apparent authority, inherent authority, or authority by estoppel can create duties of principal to third person by way of agent. With respect to creating liability in principal for actions of agent, not any old agent who does something negligently will make the principal liable. The agent needs to be a servant type agent, not an independent contractor type agent.


Also, you can’t make a master liable for the actions of the servant if the servant is acting outside the scope of his employment. Old Restatement guidelines: conduct of servant is within scope of employment if and only if the action is 1) of kind he is employed to perform 2) takes place within time and location space limits 3) is motivated in part by a purpose to serve the master 4) not using force intentionally against someone else. Even though drunken coast guard sailor does not seem to be motivated by a purpose to serve the master when turning on the valves at a dock at which his ship is docked, court employs new foreseeability approach to say, the govt cannot “justly disclaim responsibility for accidents which may fairly be said to be characteristic of its activities.” Another way of saying this is that if the actions by the sailor are reasonably foreseeable by the government, the government should be liable. This conception relies on notions of fairness. (Bushey) The Restatement says that certain acts which are intentional torts may be within the scope of employment but the action “must be of the same general nature as that authorized, or incidental to that authorized.” Orioles found liable for actions of pitcher who purposefully pegged a heckling fan. (Manning v. Grimsley) Gas station employee uses racial epithets against customer following dispute over a credit card. Court says question of fact whether the employee was acting within the scope of employment, since the racial epithets were made while at work, while checking credit cards. And the employee may have been motivated to act in the interests of the employer. (Arguello v. Conoco) Govt hires independent contractor to do construction work, and contractor mistakenly damages a neighboring building, so neighboring building owner sues govt. There are 3 circumstances in which govt might be held responsible for independent contractor’s action: 1) (didn’t hear) 2) when the government negligently hires a negligent contractor 3) when the activity involved is a nuisance per se or inherently dangerous. Court finds that knocking down a building in an urban area like this is an inherently dangerous activity, such that the government can be liable. (Majestic Realty v. Toti) Fiduciary Obligations of Agents A few fiduciary duties of agents to their principals include obedience, care, loyalty. Agents cannot make secret profits from misuse of his position – if he does, he must turn them over to the principal. Therefore, soldier violated fiduciary duty when used his position to smuggle goods. (Reading v. Regem) Employee believes his company cannot do work for a client, so on his own refer the client to another company, earning himself referral fees. Court says employee violated his fiduciary duty to the company by not informing the company that the client tried to place an order with the company. Therefore, employee must give referral fees to his company. (General Automotive v. Singer) 3

Some employees leave company to start their own competing company and take many of the original company’s clients with them. Court finds breach of fiduciary duty because the original company spent a lot of time and money finding and developing these clients, so the list of clients was a kind of trade secret, and it would be unfair for the employees to leave and take those clients with them, without doing any of the work necessary to find and develop these clients. (Town & Country v. Newberry) There is a duty of loyalty that does not allow secret profits. This is true where there are conflicts of interest between the agent and principal, or when the agent uses his position in dealing with others (Reading) or uses property, knowledge or assets of the plaintiffs (sort of Town & Country). Fiduciary duties also mean that the agent should not usurp business opportunities of the plaintiff (Singer) or compete with the plaintiff. Also, no taking of property (broad sense) when the agent leaves the principal’s company (Town & Country). Fiduciary duties are not just applied to agents, but lots of other people who have discretionary powers, eg trustees, partners in partnerships, and directors in corporations. Degree of fiduciary duty depends on relationship and amount of control a party has. PARTNERSHIPS A lot more partnerships and proprietorships than corporations. Uniform Partnership Act (UPA) is the law in virtually all states, so they are more authoritative then is the restatement in the agency context. What’s a partnership? Who’s a partner? Partnership defined = a partnership is an association of two or more person to carry on as co-owners a business for profit. Partnerships are created by agreements or actions that signify agreements (mutual understandings) – this is in contrast to corporations which require specific formal acts (filing certain forms, etc.) So creation of partnerships is much less formal than with formation of corporations – people do not even have to necessarily know they are forming a partnership to have formed one. As a result of a lack of formality, there is a lot of line-drawing. Most rules are only default rules, and subject to contrary agreement among parties. Partners themselves pay taxes on the profits they receive; the partnership itself doesn’t pay income taxes.


if the assets of the partnership don’t cover the expenses of the suit. The Court says this is what lenders do. Even though it might destroy economic value. so PPF was not a partner in KNK. Southex seemed to have more of the control of the show. court said it seemed more like a service contract than a partnership. the entire partnership is liable for the wrongful act of the individual partner. and she did not have any control or management rights. where party exercising control was found not to be partner? Southex and RIBA run homebuilding show together. Moreover.Default rule is that when people create a partnership. Element of coownership is completely lacking. so that Southex was not entitled to any damages for RIBA hiring another company to run the show. unlike the receptionist in Fenwick. Despite the fact that the agreement said they were partners. and then third party gives credit to apparent partnership on the faith of such representation – or just gives credit. he has the right to just call it quits and get bought out. the individual partners can also be liable for the negligent actions of another partner. (Martin) Can Cargill case in which party exercising control was found to be principal be reconciled with Martin. Case law helps to distinguish partners from a) employees (Fenwick) b) lenders (Martin v. So the element of profit-sharing was present and relevant. If one of the partners acts negligently. each person has the same voting power. PPF has some control rights. (Southex Exhibitions) UPA 16(1) Partnership by estoppel – if A has represented to C that it is a partner with B or consented to B representing to C that A and B are partners. In addition to profit sharing. Southex bore all the risk of loss. the default rule is that everyone shares equally in annual profits. Therefore. RIBA had a right to dissolve the relationship with Southex. As for profit sharing. Peyton) c) contractors (Southex Exhibitions) Owner gave receptionist deal in which receptionist would get fixed salary plus 20% of the profits. So partnerships have joint and severable liability. the court said they were not partners because she did not have to put up any capital. (Young v. she would not share in any losses. Therefore. after each partner is repaid his contribution. but not enough. and the contracts they had were for fixed 5 years terms that could be renewed. Although there was profit sharing. If one of the partners wants to leave the partnership. the default rule is that you can always dissolve the partnership. then C may sue A on a theory of partnership by estoppel. (Fenwick) PPF loans KNK some money. if the representation was public. Jones) Fiduciary Obligations of Partners 5 . Court finds insufficient evidence of partnership by estoppel between Price Waterhouse US and Price Waterhouse Bahamas.

Very difficult under Court’s analysis to find a violation of duty of good faith. Meinhard) 103(b)(3) – a partnership agreement may not eliminate the duty of loyalty under 404(b). the duty of the finest loyalty…Not honestly alone. Shaugnessy) So what’s ok and what’s not ok when leaving a law partnership? They can leave a partnership. partnership was worth more 6 . Kightlinger) Partnership Property. Court finds that a firm firm does have a duty of good faith and fair dealing for expulsion under UPA 31(1)(d). They breached their fiduciary duty because 1) they lied months earlier by saying they were not going to leave the firm 2) bad process of soliciting clients. but the punctilio of an honor the most sensitive. they seem to be able to take associates with them. owe to one another. as long as those conditions are not manifestly unreasonable. really bad or committed intentional misconduct in order for the manager to be liable for a business decision.Salmon. though they can’t do things like dragging out cases so that the case is settled after they leave the firm instead of before. Once a partner retires. Court says Salmon violated fiduciary duty. Management Woman sells half her interest in company to Shoafs. because “Joint venturers. it is later discovered accountant had embezzled money so that after recovering money from him. like copartners. (Bane) Two partners leave law firm and take some associates and clients with them to start new law firm. you can bargain as to specific requirements of duty of loyalty. Law partnership expels partner with history of alcohol abuse. The business-judgment rule under corporations law says that just making a bad. (Bane) Violation of duty of care is very hard to prove and win on. and may be able to take clients if the process is right. but may not do away with the duty altogether. he is no longer part of the partnership. negligent decision is not enough to make a business manager liable. though that duty was not violated here. for example by delaying informing the other partners of what clients they wanted to take with them and 3) the prejudicial content of the letter to the clients in contrivance of the ABA’s ethical guidelines written in footnote 15. (Salmon v. which cannot be contracted out of. so that the managers of the firm had no fiduciary duty of care to him. goes around Meinhard. partners with Meinhard in lease of building. is then the standard of behavior. (Meehan v. (Lawlis v. The manager must have done something really. but the agreement may identify specific types or categories of activities that do not violate the duty of loyalty. he had an affirmative duty to disclose to Meinhard of the opportunity for leasing the block. while the enterprise continues. toward the end of the building lease. Negligent mismanagement is not sufficient to create a violation of fiduciary duty under the business-judgment rule.” So what exactly is the standard of conduct required of Salmon? It was not just enough that he didn’t lie. Capital. So yes. to lease the entire block where the building is located.

which means only possessory rights for partnership purposes only and those possessory rights are not assignable by an individual. Putnam did not have an ownership interest in any of the specific property. 1st partner pays the employee and then sues 2nd partner for half the employee’s compensation. There is no majority vote here since there are only two disagreeing partners. One tells Nabisco the partnership won’t buy from it. The possessory rights are only assignable by the partnership. Therefore. Individual partners can a) act as agent of partnership b) bind partnership by admissions. Interest in the partnership means the partner’s share of profits & surplus. Shoaf) What does a partner own and whether & how can it be transferred? UPA 24 says property rights are 3 fold: 1) rights in specific partnership property (sec. 27. (Putnam v. 2) Interest in the partnership. partner had right to buy from Nabisco and the partnership must pay Nabisco. Therefore. then the partnership would not have been liable to Nabisco for its sell of bread to Freeman. 26). (sec. whereas in Nabisco. it is an internal partnership dispute. 7 . Nabisco demands payment. but there was no majority here. if court ruled that the partnership did not have to pay Nabisco.than previously thought. breach of trust c) the bundle of such rights cannot be sold by the individual partners Two partners in store. (Nabisco v. but the other partner then buys from Nabisco. wrongful acts. the Shoafs get the other half of the money from the bookkeeper. (See 18g on how new partners get in – by consent of other partners) Management-type rights include various collateral powers. Dooley) Why the difference between Nabisco and Summers? Perhaps because in Summers. would be left in the lurch. a third party that had nothing to do with the internal partnership dispute. so the partnership is liable. Stroud) If there had been a majority vote and the partnership notified Nabisco not to sell. 3) Management rights: these are equal. 1st partner hires an employee even though 2nd partner disagrees. unless otherwise agreed (18e). She had no specific interest in the property of the partnership. This interest in the share of profits & surplus is personal property and is assignable under sec. (Summers v. knowledge. 25). So the only thing she could and did transfer to Shoaf was her interest in the partnership. partnership is not responsible for one partner hiring the employee. Court said that Mrs. Court says partnership can only prevent a partner from taking an action on behalf of the partnership if there is a majority vote. not just half of it. The partnership owned the property and she simply had an interest in the partnership. Court says since there was no majority vote on hiring the employee. then Nabisco. These management rights are not assignable by an individual partner. She claims she should recover all the money.

it doesn’t matter because his vote would not have affected the outcome of the merger vote. 3) If dissolution wrongful. Partnership Dissolution. Firm could have removed him at anytime. while other lawyers do have special clauses form themselves. Cohen asked the court to dissolve the partnership based on the defendant’s action rather than just dissolve the partnership himself before the term of the partnership was up. so that the partnership is responsible for the mother’s negligence. Main themes: 1) Partner X can dissolve or dissociate from partnership at any time. Court decides that the mother was acting as partner in the ordinary course of business when she negligent. (Day v. Sidley & Austin) Mother who is partner brings her child to work and child gets injured. Father of child sues. in potential contrivance of the partnership agreement. so why can’t a partnership sue a partner? UPA says otherwise for partnerships. he had no contractual right to be chairman. Court disagrees. 2) But consequences depend on wrongful/rightful distinction. saying that the partnership agreement has no special clause guaranteeing him chairmanship of the DC office. When 3rd party rights are not affected. but the fact remains he still can dissolve the partnership. giving individual partner the right to recover from the partnership for negligent actions they committed while in the ordinary course of business. the rights of partners to partnership property differs depending upon whether the dissolution is in contrivance of the partnership agreement or consistent with it. even if this knowledge that he was not guaranteed the chairmanship would have caused the guy to change his vote on the merger. but 8 . Therefore. Firm then merges with another firm so that the guy then becomes only co-chairman of DC office. and on other factors. note on LPs A partner can dissolve the partnership at any time he likes. (Moren v. a principal can try to collect against an agent. (Nabisco). when 3rd party rights are affected. 38. (this is in stark contrast to a shareholder not being able to dissolve a corporation or his relationship with it). X a) does have the right to be paid off at her interest. Plus. Guy rejoins firm as partner and chairman of DC office. That is why plaintiff in Owen v. the deadlock trumps agency power.So in short. According to Sec. He claims there was a misrepresentation and fraud by the partnership because they said that no partners will be worse off due to the merger. agency power trumps the deadlock. He claims he is worse off by becoming co-chairman instead of just chairman. and the partnership cannot recover from the mother. JAX) In real life. though of course he may pay damages if its in violation of the partnership agreement.

If he dissolves in bad faith. so the partner can dissolve only in contrivance of the agreement. Unless… . which says the partners should split the losses equally. in the absence of agreement. In that case.” Loss sharing by partners default rule: share losses same way as profits. but then opens up another linen business and has a lot of the same old clients. violating his fiduciary duty to his partner. Partnership is wound up and partners all get payment in cash. So if the one brother decides to dissolve the partnership. 701. with offset for damages.there are many issues of implementation. so it’s only fair that the capital providing partner should bear the capital losses. 4) If dissolution rightful. with all its consequences. eg potential damages.g. the Court will make the dissolving partner compensate the other partner. BUT the partners have a fiduciary duty of good faith in the dissolution and winding up of the partnership. death. dissolve latter-> wrongful (unless term over) -There are other triggers of dissolution. -dissolve former -> rightful. unless he fully compensates his co-partner for his share of the prospective business opportunity. e. unlawful business and some others. this would be a dissolution in bad faith. (Collins) partnership is a partnership at will. e. (Page v.g. waiver. the partner who supplies all the capital must pay for all the loss. 9 . agreement. saying there was no mismanagement. 5) Default rule distinction between partnerships at will v. Court disagrees. & other partners have right to continue partnership business. while the partner who supplies the labor/services does not have to pay for the loss. X is bought out at value of his interest. claiming mismanagement by his partner. Court says default doesn’t apply when one side supplies all the capital and the other supplies all the labor. court decrees about impossible partner may lead to wrongful dissolution remedies (Owen v. Page) “A partner may not dissolve a partnership to gain the benefits of the business for himself. and courts may assert equitable powers.b) perhaps paid over time or in future. Kovacik rule has been rejected by RUPA. Partner wants to get out of 30 year partnership. Cohen) 5) Default rules about who can dissolve rightfully under what conditions and how dissolution is carried out can be changed by contract between partners. those for a term or specific undertaking. so you can dissolve the partnership at any time. (Kovacik) The reason they make this rule is that the services providing partner is in a sense already losing the cost of his labor. See UPA 38 and RUPA 701.

which is owned by Carlton. (Walkovsky v.Partners file a suit to dissolve partnership and buyout a drug-using partner. (Meehan v. whereas partners liable for actions of partnership and often vice versa. but cab is owned by corporation. 2) More restrictions on transferability of interest in partnership than interest in corporation 3) Each partner can kill a partnership. and when capital accumulated. Shaugnessy) NATURE OF THE CORPORATION Why Corporations 1) Investors have limited liability in corps. claiming the corporation is a dummy corporation that is Carlton’s alter ego. So the key seems to be whether Carlton seems to operate the corporation in his individual. Injured man therefore wants to pierce the corporate veil and sue Carlton. one for all. If they took the clients unethically. Court says dissolution was not caused by the filing of a lawsuit. Court expounds piercing the corporate veil test: 10 . Court doesn’t see much wrong with setting up corporations to minimize corporate liability. because isn’t that the basic idea of corporations? It therefore refuses to pierce the corporate veil. power of corporation is mostly in the board Limits of Limited Liability . dissolution only comes with a judicial decree. (G&S Investments) Question of how partners leaving law firm should compensate the old firm for taking clients. Question whether filing the suit created dissolution because estate of drug-using partner will be compensated differently depending upon whether it has to be a buyout after dissolution or a buyout after death of partner. Carlton) Marchese uses lots of corporations with minimal assets similar to Carlton above to avoid liability. Corporate model of management is director primacy. then they have to disgorge all profits they make off these clients to the old firm. The corporation has minimum liability insurance and minimum capital legally allowed. or only as the director of the corporation. Carlton owns 10 of these cab corporations. such that it would be as if the partners continued to work for the old firm on these client matters. personal capacity. The drugusing partner then dies.Piercing the Vail and Related Doctrines Cab injures man. Carlton would withdraw assets as dividends as fast as he could. then they compensate based on the partnership agreement. If they took the clients ethically. Plaintiff seeks to pierce the corporate veil. The corporation is perpetual and can only be dissolved by majority vote 4) Managerial power – partnership model is all for one.

in breast implant products liability dispute. derivative distinction – Eisenberg v.1) such unity of interest and ownership –such control – that separate personalities no longer exist The factors we look at here are i) failure to have records or formalities ii) commingling of funds or assets iii) undercapitalization iv) treating corp assets as shareholder assets. it will be looked at as a fraudulent conveyance of money to which creditors have a right. But they do not technically participate in management and control of the limited partnership as themselves. Bennett. Limited partners have gotten around problem of having to choose between no liability and management power by setting up a corporation to be liable partner of the corporation. the subsidiary operates with grossly inadequate capital. they must not be involved in management decisions. (Frigidaire) Shareholder Derivative Actions On direct v. and Marx v. Akers On special litigation committees (SLC’s) – Auerbach v. adherence to the fiction of a separate entity would sanction fraud or promote injustice On remand. Question whether corporate veil of MEC could be pierced to sue its sole shareholder. Bristol. Bristol represents that the breast implants are its products. Donald. (Silicone Gel) Limited partners in a partnership – no liability for partnership but in exchange for no liability. Court upholds this scheme. corporate veil may be pierced at trial. but with them heading the corporation. Based on this. but not when you are insolvent or when the dividend leaves you with an unreasonably small amount of capital. etc. they can run the partnership but not be liable. In re Oracle Derivative Litigation 11 . Court uses totality of the circumstances test to determine whether Bristol had substantial domination of MEC which made the wholly owned subsidiary the alter ego of the parent company. ie a messy relationship 2) under the circumstances. (Sealand Services v. Flying Tiger Line On the demand requirement – Grimes v. Then. Zapata Corp v. so that limited partners are not personally liable. but as agents of the general partner corporation. Pepper Source) Fraudulent Conveyance Law . Therefore. Maldonado. court allows piercing corporate veil as well as reverse pierce of the other firms that Marchese owns. the companies filed consolidated financial statements and tax returns. Some of the important factors are that they have common directors and officers.it’s ok to be pay dividends and such. Piercing the corporate veil is a somewhat looser form of this fraudulent conveyance law.

the legal standard for judging the refusal is the BJR. but Court says you can’t claim demand would be futile after you make demand. not derivative action. Derivative action – brought by a shareholder on corporation’s behalf. you can only claim demand futility before you make the demand. which refuses. the directors are often able to refuse to take action under the business judgment rule. a board can create a special litigation committee with the power to investigate the transaction and offer a recommendation. Delaware Demand Fulility Test: Plaintiff must allege particularized facts (using ‘tools at hand’ before discovery) creating ‘reasonable doubt’ that board is capable of making a good faith decision on the suit. That would probably be the end of the case because it would be hard to show wrongful refusal of the demand. adequate process worthy of BJR protection. Plaintiff in derivative suit makes demand on board. When shareholder wants to bring a derivative action. nor post security for expenses. In that situation. Arises from an injury directly to the shareholder. Also demand can be excused where the plaintiff shows with particularity that the board did not engage in the minimally informed. Plaintiff could show: 12 . Demand will be excused where the board has a material financial interest and cannot be trusted to make a fair business judgment. In a direct action. Or the corp could also say no. Monetary recovery of other benefit goes to shareholder. If one’s voting rights are injured. he would need to post security for expenses of the corporation This requirement for posting security is used in order to prevent frivolous strike suits. because if he files a derivative suit. it is a direct action. the shareholder would have to first make a demand on the directors in the derivative suit. Court says Eisenberg correctly filed a direct suit. Cause of action belongs to the corporations as an entity. they won’t sue. Cause of action belongs to the shareholder in his individual capacity. Arises out of an injury done to the corporation as an entity. He then claims demand is futile. (Eisenberg) Direct action – brought by the shareholder in his or her own name. In response to a derivative action or not. (unless demand can be excused) Corporation could either agree to the demand and take over the case. after examining it. no need to make demand on directors nor argue about business judgment.Eisenberg sues in a direct action. Monetary recovery goes to corporation. (Grimes) When demand is made and refused.

there has been a shift to class action suits. good faith. they usually must make a demand first upon the board to take an action. Maldonado) (1) inquiry into independence/good faith of committee. and the success they did have has been modest. or that the board’s decision was way beyond any rational business judgment. who want to sue. Recently. esp. to overcome that refusal. and reasonable investigation by the special litigation committee. info gathering (3) ‘so egregious’ test Delaware standard for reviewing special litigation committee recommendation of dismissal? (Zapata v. Role and Purposes of Corps Charitable contributions are allowed if the directors judge that they “will contribute to the protection of corporate interests. 13 . If the board refuses. shareholders usually can’t just bring a derivative action. Derivative suits often have little success. (Barlow) Other states have different allowances for corporate donations – eg California and New York corporate code gives corporations the power to make donations. Akers): (1) Director interest/domination (2) Good process. rather than derivative suits.” Court therefore says the corporation was allowed to make the charitable contribution to Princeton. Key general issue: who counts as ‘independent’ director for purposes of getting judicial respect for special litigation committee recommendations? Directors who are university faculty members when defendant directors and officers have made modest gifts to university and have considered making very major ones? (Oracle Derivative Litigation) In sum. inquire into bases supporting committee’s recommendations (2) court may go on to apply its own business judgment as to whether case is to be dismissed. it is very difficult for the shareholders. The shareholders have to allege with particularity some facts that create a reasonable doubt that the directors were disinterested and independent. regardless or irrespective of specific corporate benefit. Corporation has burden of proving independence.• • • Majority of board has material financial or familial interest in transaction complained of Majority of board is dominated/controlled by alleged wrongdoer or interested parties OR Underlying transaction not product of valid exercise of business judgment (this leaves some discretion with the court) New York test (Marx v.

illegality. the Court is willing to assume that Wrigley is exercising his business judgment that being nice to the neighborhood is good for business. This case can be distinguished from Kamin in that here the wife made no business judgment whatsoever.) FIDUCIARY DUTIES OF OFFICERS ET. Eisner case (in executive compensation context). or the refusal to declare dividends amounts to such an abuse of discretion as to constitute fraud or breach of good faith that the directors are bound to exercise. “matters of conscience” exception allows corporations to cease participating in legal but seriously unethical business activities (ie involvement in apartheid. Because there are no statements like this. or conflict of interest in order to side with the plaintiff. Caremark opinion (dealing with proactively set up systems for dealing with legal violations) Plaintiffs sue claiming decision to give dividends in subsidiary as opposed to selling subsidiary a waste of corporate assets that violates the board’s fiduciary duty of care. Why does Wrigley win but Ford loses? The Court here uses a standard of showing of fraud. Ford Motor) Part owner of Cubs sues. (Shlensky v. (Dodge v. this is another assertion of primary corporate purpose and an attack on managerial assertion of stakeholderism. and courts will not interfer UNLESS it clearly appears they are guilty of fraud or misappropriation. illegality. There are no statements in this case by Wrigley which are like the statements of Henry Ford that he is looking out for the interests of workers and consumers. Court find she violated fiduciary duty of care. genocide. (Francis v. whereas at least in Kamin a business judgment. selfdealing by majority of the board. United Jersey Bank) 14 . not profit maximizing. This is a strong statement of the business judgment rule by the Court. etc. though perhaps bad one.Power to declare dividends is in the board of directors of alone. American Express) Mother shareholder pays no attention as her sons fleece the corporation by having the corp give loans to themselves. the Court holds that it won’t interfere with the director’s discretion just because the decision appears mistaken. claiming refusal of Wrigley to have Cubs night games is bad for business and motivated by concern for the neighborhood. The Court says it will only interfere if there is fraud. (Kamin v. bad faith. Court finds Henry Ford breached this standard by limiting dividends to shareholders and using the money to benefit employees and consumers of Ford cars (up-front stakeholderism or constituency approach to corporate purposes). Wrigley) Corporate charitable giving is in legal in almost every state. even if that business judgment is wrong. whereas the standard in the Ford Motor Company case was that there had to be a breach of good faith by the directors. or nonfeasance. Duty of Care Three important Delaware opinions: Van Gorkam case (in merger context). Brehm v. was at least made. AL. So like in Ford case.

Disney gives large severance package agreement to Ovitz. Companies want to pay their executives better than average. which causes a great ratcheting up of executive compensation. keep informed. not officers). A director has to take some minimum level of action to undertake her duties as director. attend meetings. So with respect to executive compensation.” Directors can protect themselves by relying on experts. Irrationality is the outer limit of the business judgment rule. because the board spent very little time analyzing the merger agreement. they will be safe under the business judgment rule. Derivative suit against board for failing to properly monitor actions of company. which resulted in company breaking law and having to pay major fines. Delaware and other states passed statutes saying that corporations may pass charter amendments which eliminate monetary damage of directors for violations of duty of care (statute doesn’t apply to violations of duty of loyalty or acts not in good faith and statute only applies to directors. Board rubber stamps decision of CEO to merger with another company. do general monitoring. (Smith v. Van Gorkom) Key legal point of Van Gorkom: The directors “breached their fiduciary duty of care to their stockholders 1) by their failure to inform themselves of all information reasonably available to them and relevant to their decision to recommend the Pritzker merger. Suit settled for attorney’s fees and better oversight procedures in the future. and then terminates him without cause. Question whether 15 . Must basically go through basic motions of being a director. Court ruled these board decisions were acceptable under BJR so that there was no violation of duty of care. Also. “Due care in the decisionmaking context is process due care only. Virtually all Delaware corps have adopted this charter provision shielding directors. the board never hired an investment bank to analyze the fairness of the proposal. So these two cases taken in conjunction suggest that as long as the directors go through the basic motions.So the lesson of the case is that the business judgment rule doesn’t protect a director from nonfeasance. Ratchet phenomenon – all the children are better than average. not just all material information reasonably available.” Notice here the Court requires the directors to get all information reasonably available. Court finds board violated duty of care. As a result of this case. can be liable for duty of care violation. resulting in much larger severance than if they terminated with cause. If not. saying the process by which the board approved the merger was wholly inadequate. (Brehm v. Affirmatively: director must know rudiments of business. Eisner) Key legal holding of Eisner: “Substantive due care” concept is foreign to the business judgment rule in Delaware. and in fact approved it sight unseen.

Beran) Shareholder sues. Director of company takes an opportunity to buy something. (Martha Stewart Litigation) The Delaware Supreme Court approved the Chancery’s decision. Litton from 1939. Directors pass this duty of loyalty test when they are sued for hiring the wife of the CEO to perform on a radio show sponsored by the company. said that when an interested-director transaction is challenged. as they never attempted to figure out fair rent and acted as if the corporation existed solely for the benefit of the other corporation.The Court. And the burden is on the directors to show that the lease was fair and reasonable to the corporation.” So the duty of loyalty seems a lot stronger than the duty of care. “the burden is on the director not only to prove the good faith of the transaction but also to show its inherent fairness to the corporation. all shareholders lose right to sue directors on this matter. His company wasn’t interested in that thing. (Lewis v. though there does need to at least be some legal monitoring system Court approves settlement as fair and reasonable because under this conception of the duty to monitor. Court find directors fail to satisfy this burden. (Bayer v. which is diluted in large part by the business judgment rule. the directors committed no breach of duty to monitor in failure to monitor Martha Stewart’s trading activities. Therefore. SLE) Corporate opportunity doctrine: If business opportunity is presented to D or O which 1) 2) 3) 4) corp is financially able to take is in corp’s line of business is one in which corp has an interest or a reasonable expectancy taking by the Do or O will bring his self-interest into conflict with corp’s interest then law will not permit him to take it. This is a classic example of self-dealing by directors. (Caremark) No duty to monitor the personal activities of one of its employees. Court says board of directors have duty of care to “attempt in good faith to assure…a corporate information and reporting system. despite friendships with Martha. but the corporation that was trying to buy his company was also trying to buy that thing. so it makes sense for the settlement to be modest. claiming directors are using one corporation for the benefit of another corporation for which they are directors in violation of their duty of loyalty.” but the level of detail appropriate for the required info system is a question of business judgment. Duty of Loyalty . citing a SCOTUS case of Pepper v. Court found the director did not have to take the interests of this 16 . saying that the plaintiffs failed to demonstrate demand futility since the majority of the directors were independent. it would be unlikely for the plaintiffs to succeed. the business judgment rule does not apply. but on different grounds.Interested Director Transactions and Corporate Opportunity Doctrine Key Legal Principle . Court says that because this is a conflict of interest situation.settlement is fair and reasonable. because once settlement is approved.

unless there is ratification by disinterested directors and shareholders. 3) For controlling shareholder-arranged mergers? Intrinsic fairness (stronger than inherent) needs to be shown and burden on defendant. and then the effect of shareholder ratification: 1) for arms’ length transaction? Business judgment rule with burden on plaintiff 2) for interested director transactions? burden on defendant to show inherent fairness of transaction.) What is important for ratification is not whether a majority of shareholders generally supported the transaction. Court finds self-dealing with respect to a contractual claim. then business judgment rule applies and burden on plaintiffs. So. CIS) In re Ebay – corporate opportunity doctrine violated Duty of Loyalty – Dominant Shareholders and Stockholder Ratification Sinclair has its subsidiary Sinven give out big dividends. Transamerica Corp. so that the Class A shareholders can decide whether to convert instead. had a fiduciary duty to fully inform Class A shareholders of the value of the firm when it calls Class A shares. (Fliegler) Easier to claim self-dealing decision by directors was not ratified if there was not full disclosure to the approving stockholders. if no self-dealing.acquiring corporation into account in determining whether to buy the thing. but whether a majority of the disinterested shareholders supported the action. (Zahn v. but that Sinven’s profits should have been used to expand Sinven’s operations. 3 standards of review. (Broz v. but not with respect to corporate opportunity claim as the plaintiffs have shown no opportunities that came to Sinven. any issues of self-dealing by the directors had not been cured. in which case the burden is on the plaintiff to show a violation of the BJR. (notice this difference with the later Broz case that didn’t requires that the opportunities independently come to CIS) (Sinclair Oil) Dispute over redemption of certain types of stock. So the claim is that Sinclar took Sinven’s corporate opportunities. intrinsic fairness rule applies with burden on Sinclair. Court finds controlling shareholder. then the burden is on the plaintiffs to only show that the deal is not fair (doesn’t need to show violation of BJR). who appointed a majority of the board. Because the self-dealing nature of the transaction had not been cured. which plaintiffs claim is used by Sinclair to expand its operations abroad. If self-dealing. which Sinven lost to Sinclair. since a majority of the disinterred shareholders did not support the purchase. So when there is a controlling shareholder-arranged merger rather 17 . the intrinsic fairness standard needed to apply and burden was on the directors to show the intrinsic fairness. but if there is ratification.

Deliver statutory prospectus to each buyer before sale. Great Lakes buys company from Monsanto. so that the sale of the limited partnership interest to him violated Sec. Five factor test on p.than an interested director transaction. 18 . it is easier for plaintiffs to win. stock. The purpose is to mandate full disclosure and deter fraud. What is an “offer” is broader than you think. b) c) Don’t sell securities until registration statement is “effective. Disclosure: registration of securities What’s a security? (Great Lakes) What’s a public offering? (Doran) Public offerings of securities must be registered with SEC. so that he says he should be able to rescind under 12(a)(1). Great Lakes sues. 413 Doran claims that there was no registration statement. because Monsanto made no registration statement to the SEC. Investment contract: 3 elements: a) investment of money b) in a common enterprise c) with profits to come solely from the effort of others Horizontal v. General partnership interest is not a security. 410 of what are the common features of stock: a) dividend rights b) negotiability c) right to pledge/hypothecate 4) voting rights 5) ability to appreciate in value.” Usually effective when SEC says so. Case turns on whether the company was a security under 33 or 34 of 1934 Securities Act. evidence of indebtedness. treasury bond. This was the case in Wheelabrator. alleging that there were material mistakes and omission (MMOs) in the sale of security to Great Lake. Vertical commonality – see p. not substantive regulation Section 5 rules of the road: a) Don’t offer securities for sale before registration statement filed. because this sale doesn’t seem like a public offering which would require registration with the SEC. There was nothing wrong with registration statement. Defendant claims it is exempt from registration as private placement under 4(2). and some open ended categories like investment contract. (Great Lakes) Security is any note. 5.

Consider four factors in determining whether this a private placement – 1) number of offeeres & relationship to issuer & each other 2) number of units offered 3) size of offering 4) manner of offering. Rule 10b-5 Even though merger negotiations were ongoing. Court said that the existence of negotiations could be material before an agreement in principle had been reached. Court found MMOS in registration statement filed by company. Directors then sued. publicly available (mis)information will affect the market price. the defendant must show that all offerees were financially sophisticated plus had access (either access because of actual disclosure or because of actual access to the offeror’s information). For expertised parts of the registration statement. To satisfy 1st factor. If director found guilty of this sec. Can plaintiffs show reliance on misstatements by invoking the fraud on the market (FOM) theory? Fraud on the market theory is that in an open and developed securities market. (Doran) There is now a private placement exemption safe harbor under Regulation D if you are offering interests that under certain values. (Escott) Later opinions have taken a more understanding approach to reasonable investigations. Levinson) The principle of materiality that a misstatement or omission is material if there was “a substantial likelihood that a reasonable investor would consider it important in deciding” whether to buy or sell. Court found defendant failed to satisfy these due diligence defenses. This seems to be a soft version of the efficient capital markets hypothesis. saying Basic’s false denials depressed the stock price. but 1st factor is the most important. Court says this is a private placement under latter 3 factors. they have to show they had a reasonable belief that the statements were true. as court says that omission by silence is ok as long as there is no duty to disclose. Soon after. (Basic v. merger completed. and there is no duty to disclose merger discussions. 11 violation. Very fact dependent standard Basic should have just said no comment. such that there is a rebuttable presumption that the denial of the mergers affected the market price. The Supreme Court accepts this theory. it doesn’t mean he was negligent. For non-expertised parts. so that it is therefore not necessary for 19 . the directors just need to show they had no reasonable belief that the statements were false. just that he was unable to prove due diligence. which makes it likely he will be able to be indemnified by the company and by insurance. but every offeree did. Shareholder who sold before merger was announced. And not just Doran had to be sophisticated and have access. Basic repeatedly denied that negotiations were taking place.

FOM Proof of loss causation? Needed. Investors who bought stock before the FDA disapproval sue. so buyer of option has standing under 10b5 to sue corporation and officers for MMO.. Ersnt & Ernst. Some minimum shareholders sue under Rule 10b-5. but FDA later disapproved. (SCOTUS. Santa Fe Ind. (West) Court concludes two misstatements were material: 1) that company had a patent.the individual plaintiffs to show that they read and relied on the merger denials in selling the stock. (Deutschmann) Rule 10b5 MMO Actions: Overview of Elements Implied private right of action? yes Jurisdictional prerequisite? Easy to satisfy – use of mails. Simply showing that the investor 20 . 1988) formulation Proof of reliance? Actual or. 1975) Must plaintiff show bad mental state of defendant? Yes. This holding allows plaintiffs to bring class actions based on misinformation. so there will be NO rebuttable presumption of reliance based on the FOM theory here. See Dura (SCOTUS 2005) Loss Causation – a causal connection between the material misrepresentation and the loss Dura claims it was going to get FDA approval. Rule 10b5 covers options. Court dismisses the case. Under the fraud on the market theory. such as a MMO. (SCOTUS. In this case. But the statue did offer minority shareholders the opportunity to get a reappraisal in the Delaware Courts. but none alleged here. (Pommer v. 1976) Scienter (includes recklessness) Must plaintiff show deception and manipulation? Yes. Only allegation is that there was a low-balled appraisal. (Sante Fe Industries) Key point is 10b and 10b5 only apply to manipulation and deception. whereas the deal was not even close to being completed. saying that an action under 10b and Rule 10b-5 requires deception or manipulation. 1977) Standard of materiality? Basic Inc. (SCOTUS. see blue chip stamps case. (SCOTUS. whereas they were only in the process of getting the patent 2) merger agreement was imminent. only publicly available (mis)information will affect the price. if appropriate. the misinformation was only privately available. claiming price offered was wholly inadequate. instruments of interstate commerce Must plaintiff be actual buyer or seller of security? Yes. Medtest) Majority shareholder seeks to buy out rest of shares of company.

2) insider’s access to material nonpublic information is for corporate purpose. members of class who bought after Dura’s statement will also have to have sold after the FDA disapproval was announced. then perhaps there would be a duty to disclose the inside information. How does one prove that the price went down after the FDA disapproval because of the FDA disapproval? And how does one prove that the price was inflated due to the overly optimistic statement by Dura? Court didn’t specify exactly how you go about proving loss. (Goodwin) SEC sues directors for insider trading on info about potentially massive copper discovery. (Dura Pharmaceuticals) Inside Information Old case .” So this ruling basically says that Rule 10b5 outlaws insider trading. The Court’s main holding is that. Two part test: 1) would a reasonable investor think this is important 2) and this encompasses any fact that in reasonable contemplation might affect the value/price of the stock. To prove loss causation. Man who sold stock to him sues the director. Court says information on possible copper discovery is material here. so he tells his clients to sell and he also tries to get the Wall Street Journal to publish a story about the fraud. there are no fiduciary relationships Dirks. so there was no duty to disclose here. but this was an impersonal trade through a broker. This is the famous “disclose or abstain rule. claiming the tippee inherits an insider’s disclose or abstain obligation whenever he receives inside information from an insider Court says the tippee inherits the duty when the insider breaches his fiduciary duty to the shareholders by tipping and the tippee knows or should know the insider is breaching. Also. (Texas Sulpher) Information is material if the information would affect the decision of a reasonable investor about whether to buy the stock or not. they either had to disclose the information or abstain from trading. SEC sues Dirks.bought at an inflated price is not enough to prove loss causation. When you are in arm’s length market transactions. not for personal benefit – “no secret profits” reasoning found in fiduciary law generally. If the insider does not get a personal benefit from tipping. If there was a personal relationship between the buyer and the seller. finds out about massive fraud at a company. Reasons for disclose or abstain rule: 1) Congressional purpose that all investors on impersonal exchanges have relatively equal access to material info. you have to prove other facts that nothing else was affecting the price at that time. The Court said the directors do not have a fiduciary duty as trustees to the corporation’s shareholders. if the insiders had material nonpublic information. They only have a duty to the corporation as an entity. under Rule 10b5. then he has not violated a fiduciary duty to the 21 . a broker.Director of company buys more company stock based on inside knowledge. The breach depends on the insider getting a personal benefit.

the lawyer is misappropriating confidential information from both Dorsey & Whitney. not just stock. 503 – “a person commits fraud in connection with a securities transaction. in breach of a duty owed to both of them. p. The insider didn’t breach duty by disclosing. (check on this) Dorsey & Whitney lawyer.shareholders. Court also relies upon another theory to find liability. from trading in a company’s stock in advance of the company receiving a tender offer. Even though the lawyer was not an insider of Pillsbury or even Pillsbury’s lawyer. you must own more than 10% at the time of both purchase and sale. He need not be a director or officer at both times. A director or officer is caught if he has this status either at the time of purchase or at the time of sale. but want not to deter prudent talented people from serving as fiduciaries. such as the lawyer. if these insiders both buy and sell a firm’s stock within a six-month period (the order is irrelevant). called 14b3. which specifically prevents certain people. Contrast this with Rule 10b5. and thereby violates 10b and Rule 10b5. and Grand Met. Indemnification & Insurance Competing policy considerations – want to deter fiduciaries from breach of their duties. in breach of a duty owed to the source of the information. when he misappropriates confidential information for securities trading purposes. Court used the misappropriation theory to find the lawyer guilty of violating Rule 10b5 insider trading.” So here. But if you are an insider by virtue of owning more than 10% of the stock. all those profits most go to the corporation. trades Pillsbury stock based on this secret information which he was supposed to keep secret. so 10b5 is much broader than 16b. since he got no personal benefit. working for Grand Met on tender offer it is going to make to Pillsbury. (O’Hagan) Misappropriation theory. It is clear that the lawyer violated 14b3. Go over p. Under 16b. 22 . and thereby maximize the amount that has to be paid over to the corporation. so that Dirks inherited no duty himself. Section 16(b) Directors or officers or those who own more than 10% of a class of equities are considered insiders. The rule is pretty brightline. 16b applies to only 34 Act filers. the sales & purchase are matched so as to maximize profits. 10b5 applies to trading in bonds and notes. The remedy for violation is by private derivative actions. If there are multiple sales & purchases within the 6 month period. 523 16(b) questions before exam.

and should have his legal fees paid for accordingly. but that he will be able to be indemnified if he settles.Sources of protection: a) exculpation provisions in charters Cf. and amounts paid in 3rd party suits if person acted in good faith & with reasonable belief. charters. which settles. b) Corp power to indemnify expenses only (no damages) in derivative actions if person acted in good faith & with reasonable belief and person not adjudged liable to corp (except…) c) Corp obligated to reimburse expenses if defendant is successful on the merits or otherwise. 145. Company sues employee for 16(b) violation. he has a right to an advance of the legal fees. the corporation has to pay a lot of money to the plaintiff but the employee doesn’t have to pay anything. Chance that director or officer may not be able to be indemnified if he loses. eg DGCL sec. Also. Rules that regulate advance of legal fees by corporation. To cover situations in which the corporation cannot indemnify directly the employee. which will indemnify the employee instead. Court says company has to advance legal fees even though the company would not have to pay legal fees if the employee settles or loses. Overview of subsections: a) Corp power to indemnify expenses. there is still a good faith indemnity requirement under 145(f) that must be followed. Dispute over whether corporation has to indemnify employee who settles lawsuit. etc d) D & O Insurance Indemnification under DGCL Sec. 145 c) contractual promises to indemnify in bylaws. If he does settle or lose. then he would presumably have to pay back the legal fees. Court agrees that the employee was therefore technically successful in the suit. 102(b)(7) b) Indemnification statutes. so until then. the corporation will often buy D & O insurance. But he hasn’t settled or lost yet. in suit against both corporation and employee. ie legal fees. etc. thereby encouraging him to settle lawsuits. Courts says despite corporate charter requirement to indemnify in absence of finding of good faith. (Citadel Holding) SOX AND RELATED REFORMS Major sources of corporate governance changes: Federal Sarbanes-Oxley Act of 2002 (SOX) 1) NYSE corporate governance rules added to listing requirements in mid-2003 2) Governance rating systems by independent agencies (the GRAs) 23 .

but now they have to do all this work under Sec. actuarial services. nominating committees.) b) Disclose size of non-audit & audit fees (which can affect governance ratings) c) GRA (government rating agencies) campaigns to limit non-audit work. etc. Oracle. eg making sure the company has documented procedures to make sure that numbers are input properly and not falsely (hundreds of little rules in this regard). valuations. 5) Supermajority of IDs? 6) Independent chairperson of board 24 . and Sec. fire.g.3) Stricter tone in state case law (e. 404 to ensure that the internal controls and processes are adequate. help doing internal audit work. 404 attestations. 4) Must have key committees: audit. 2) Financial literacy and expertise (in audit committee members) 3) New regulator: PCAOB (Public Company Accounting Oversight Board) (the regulations they pass are supposed to improve the quality of audits) Board-related Changes (conflict-reducing standards): 1) majority of independent directors (ID’s) 2) stricter definitions of independence 3) ONLY IDs on key committees. compensation. so there is a question whether the accounting firms have in fact benefited from SOX despite the limits on what kind of work they can do. Notice that what has happened is that we told accounting firms that they can’t do all this extraneous non-auditing work. pay the auditors (from management or board to audit committee and audit committee members have to have greater independence) 3) Reduce personal bonding between auditors and the audited (by mandatory partner rotation and limits on hiring audit firm employees such as with cooling off period) Audit related changes (inducing action): 1) Require internal controls. Disney) SOX-related corporate governance changes – 4 main themes: 1) fix audit process 2) change board of directors 3) improve disclosure 4) empower shareholders? Audit-related changes (reducing conflict): 1) limit auditors’ non-audit services: a) prohibit some (info tech consulting. 2) Shift power to hire.

Management depends on collegiality. other large transactions 3) substantive corp law on basic allocation of power among officers. 25 . Big issues today are executive pay. takeovers. eg majority voting.7) Regular executive sessions Board related changes (action-inducing standards): 1) financial literacy and expertise 2) limits on over-boarding (how many boards certain people can sit on. among others. etc.) Post-SOX Corporate Governance Changes Major legal change depends on a bandwagon effect. what is necessary is reform as a continuing work in progress. executive compensation.Some boost from SOX-related changes: 1) shift from staggered boards to annual election of all directors 2) shareholder nomination of directors (proposed SEC rule) 3) movement for “majority vote” requirement in director elections (ongoing) What’s a majority vote? A majority of the shareholder votes cast. The Big Questions: The SOX-related corporate governance changes all shift the Board’s role from the management to the monitoring side. 2) substantive corp law on mergers. Therefore. BUT. in order to make sure people have the time and ability to do an adequate director job) 3) director stock ownership (governance ratings agencies want this in order to align incentives of directors with that of shareholders) 4) governance guidelines & codes of ethics 5) self-assessments What do boards do? Management and monitoring. etc. and director elections. eg pay for performance. or a majority of the total possible shareholder votes? The vast territory of unchanged governance: Areas still under same state and federal laws that existed before SOX: 1) substantive corp law on self-dealing. shareholders 4) law on private enforcement of the above (derivative suits. private benefits of control. directors. How seriously does this hurt the board’s managerial role? Transparency enhancements: More and faster public disclosures Shareholder Empowerment . but monitoring depends on impartial policeman attitude. bandwagon-generated reforms may be very sub-optimal or even perverse.

Worcester) Corporation holds open polls during shareholder meeting because its resolution will lose. (Providence &. A lot of this depends on state law. and at this meeting it wins the resolution and closes the poll. It then holds another meeting later. Voting rights may be limited within a class of stock as well as between stocks. OR (3) in the distribution of its assets. Court found the primary purpose was to thwart the exercise of a shareholder vote and that it was doubtful there was a compelling justification to do so. Many people cannot attend these meetings. PROBLEMS OF CONTROL Shareholder Voting Control Court says non-dividend bearing shares representing a negligible investment amount can be considered shares for voting rights purposes. (2) in its surplus or profits. the challengers want the list so they know who the owners of big chunks of stock are and concentrate on them. See 14a 7-9 26 . Many state rules require corporations to give out the list. can either mail the challenging party’s proxy statement out or give them a shareholder list. If so – 2) Board then has burden to demonstrate a compelling justification for its actions. the corporation rarely will give out the list under the Federal rules. but it said the record needed to be developed further in this regard. Knowing this. (Stroh v. (SWIB v. Peerless Systems) Proxy fights. for which it had solicited certain shareholders to come and vote for its resolution. Private actions re Proxy Rules Corporations have to have meetings every year for the election of directors and for voting on other important issues. Certain notice rules and quorom requirements have to be met for these annual meetings. The Illinois constitution (and many states) now allow for different voting shares for different classes of stock.Big issue is that the Federal rules say that a corporation. In order to determine whether there was a breach of duty of loyalty by adjourning the meeting without closing the polls on proposal. and it’s not worth them to do so since they own so little stock. Blackhawk Holding) Illinois allows shares to be considered shares if (1) right to participate in control of a corporation. when faced with a different slate of directors. there is a two-part test: 1) Plaintiff must establish that the board acted for the primary purpose of thwarting the exercise of a shareholder vote/stockholders are not given a full and fair opportunity to vote. However. others have a staggered board. These people can have someone vote for them by proxy. Some companies have all directors up for election each year. though.

so instead damages should be granted to the extent the merger caused injuries. lower courts looks at preponderance of probabilities to see whether the MMO affected the voting result. Note that the expenses need to be linked to the dispute about business policies. with stockholder approval. saying. Borak) Material misstatement in proxy statement regarding a merger. Qualified stockholders under 27 . ie no need to show the particular defect was an essential link. SCOTUS overrules. Case makes false proxy statements regarding a merger. there is an implied private right of action to enforce this rule. In doing that. In examination causation. This is a pretty liberal view of causation. because these expenses were undertaken in an open and obvious manner. though that’s pretty radical. (Mills v. (Levin v. Shareholder sues. 14(a) and Rule 14a-9. Implied private right of action under 14a9 antifraud rule. Court says this was ok. Court said under Sec. (Case v. so no injuries and no damages. (lower court found merger fair. Directors of MGM pay for the proxy fight expenses for the directors’ upcoming election. The result might be different if the proxy fight was a personal dispute between incumbents and challengers. and 14a9 on antifraud rule. and these expenses were reasonable. not just personnel disputes. Plus. Inspection Rights Court says a qualified stockholder may inspect the corporation’s stock register to ascertain the identity of fellow stockholders for the avowed purpose of informing them directly of its exchange offer and soliciting tender of stock. Electric Auto-Lite) 14a7 on mail-or-give-list rule (mainly an issue with proxy fights). apparently the business judgment rule applies. on the assumption that the shareholders would have voted yes anyway if the merger was fair. it considers the fairness of the merger terms. there is sufficient showing of causation of a legally cognizable injury. Fairchild Engines) So incumbents can make reasonable expenses. but insurgents on the other hand only get reimbursed if they win and shareholders approve. Oral and written falsehoods are covered by antifraud rule. 14a8 on shareholder proposal rule. MGM) May successful insurgents get their proxy-fight expenses reimbursed by the corporation if they are successful? Yes. Do incumbent directors and officers need to get stockholder approval for proxy-fight expenses? No. these expenses are undertaken in a fight about key policy decisions of the company. SCOTUS said merger could be unscrambled as a remedy. such as those prohibiting false and misleading proxy statements. (Rosenfeld v. if it is found that a) there was a material defect in the proxy statement and b) the proxy statement was an essential link in the accomplishment of the transaction. 14a says it is unlawful for any person to solicit proxies in contrivance of rules adopted by the SEC to protect investors.Proxy fight over MGM. Shareholder Proposals.

Some shareholder proposals are cast as requests.” Compare this to rules under 14a-8 with proxy statement. (Lovenheim) 28 . in which you can have a noneconomic interest to get something on the proxy statement.’” Court says a desire to convince people to sell their stock does involve the business of the corporation. Why the difference? The cost of throwing in one more proposal in the proxy statement is not very much. there is a requirement that the shareholder proposal deal with something more than just ordinary business. (Crane v. as its an exception to the internal affairs doctrine. So Court defines corp’s business more broadly than just economic matters. To prove “proper purpose” to see books and records. the issue is otherwise significantly related to the corp’s business due to its ethical and social significance and the fact that it does implicate significant levels of sales. Anaconda) Bottom line: in Delaware and in NY. (Sadler) Several exceptions under 14a8 that allow a company to refuse to send out a proxy statement of a shareholder proposal. the corporation must show that shareholder does not have proper purpose. Shareholder submits resolution for proxy-statement about pate from force-fed geese. (Pillsbury) To prove “proper purpose” to see shareholder list. The power of stockholders to change bylaws can’t be taken away. Law says resolution can be excluded if it involves less than 5% of the companies business or is not otherwise significantly related to the corp’s business. Shareholder wanted shareholder list and corporate records so that he could tell shareholders that they should stop the company from selling munitions for the war in Vietnam. But the costs in inspection are much more Can NY state law and US constitution require an out-of-state corporation doing business in NY to provide resident shareholders with shareholder record where the requesting shareholders could not obtain such lists under the laws of the state of incorporation? Yes. as a proper purpose means an economic interest. that can be more easily passed. the shareholder seeking disclosure bears the burden of showing “proper purpose. it does not violate the commerce clause. Court says that although pate makes up less than 5% of company sales. Company seeks to exclude. For example. making a tender offer qualifies as a proper purpose (Del) or in the interest of the business (NY) in order to get access to a shareholder list.NY law have owned more than 5% of stock for over 6 months. The requesting stockholder must sign an affidavit that the ‘inspection is not desired for a purpose other than the business of the corporation and that the petitioner has not been involved in the sale of stock lists within the past 5 years. Court held that this does not constitute a “proper purpose” germane to his interest as a shareholder. rather than orders.

so that the complaining shareholder breached the agreement. Company seeks exclusion. nobody was harmed by the agreement. (NYCERS v. (McQuade v. saying that due to spiraling health care costs. 2 of the 3 decline to continue McQuade as director and officer.(Ringling Bros.) Three large shareholders in NY Giants baseball team make agreement to elected themselves and directors and choose themselves as officers. Dodge breaks the agreement. Dodge) Closed corps are different from regular corps. Con-Ed) Control in close corporations Shareholders make pooling agreement whereby they agree to pool their shareholder votes. Court disagrees. Court says it can be excluded under “ordinary business” exception. or minority SHs do not object. so a shareholder should have greater flexibility to protect his rights through a shareholder agreement. agrees to keep minority SH. these agreements are ok. even if that means appoint different officers. including because investors are likely to invest a great deal more of their wealth in the corp and because shares of a closed corp are more difficult to sell. Dodge. Court distinguishes the case from McQuade in that all the shareholder had signed this agreement. saying shareholders are allowed to make pooling agreements. but Court says a shareholder voting contract that precludes directors from changing officers is illegal and void. as directors have an independent fiduciary duty to do what’s best for the company. Since the proposal can be excluded under the ordinary business exception. McQuade sues. inefficiency. If they disagree. as direct and manager in exchange for Clarke giving Dodge a secret formula. etc. Clarke. and there was no attempt to “sterilize” the board. (Clarke v. an arbitrator tells them how to pool the votes. They make agreement whereby majority SH. because this is an ordinary business issue that can be worked out in collective bargaining. ordering Dodge to specifically perform it. Court found the shareholder agreement valid. Court rules shareholder 29 . which says that a proposal can be excluded which seeks benefit for proponents that would not be shared by shareholders at large. Eventually one shareholder refuses to vote the way arbitrator tells him. Court also disagrees with company claims that the proposal may be excluded as “beyond the registrant’s power” and by the “ordinary business operations” exception. claiming the pooling agreement is against public policy. Court disagrees. Therefore. Against the contract. As long as all shareholders agree. Company seeks to exclude the proposal from the proxy statement. claiming it has an insignificant relationship to its business.Shareholders seeks to have resolution on proxy statement regarding examining federal health reform proposals and their effect on the company. Stoneham) Only two shareholders of corp. in that the agreement says Clarke can be removed as officer by the board for incompetence. one majority. (Austin v. and Clarke sues. health care does have a significant relationship to its business. Dole Food) Employee shareholders submit resolution proposing that employees be allowed to retire after 30 years of service regardless of age. one minority. the Court doesn’t get to personal grievance exclusion.

the majority SH can try to show a legitimate business purpose for their action. there is not a total freeze out here as Ingle was compensated at price specified in agreement. ie freeze him out. Court says voting agreement valid even if corp was not a statutory close corporation. which gives widow of shareholder certain rights. Plus. He then offers to buy out minority SHs shares at a low price. (Galler) Court says. and gives himself a very large salary. He is eventually fired. shareholders do have fiduciary duties to each other. Springside Nursing Home) Shareholders in close corporations owe on another substantially the same fiduciary duties that partners owe one another. (Wilkes v. (Ingle v. under Cali law. creditors. Court found a freeze-out. so the Court might think that his reasonable expectations should be less than in Wilkes. the minimum SH can then try to show that the legitimate business purpose could have been achieved by a less harmful alternative course of action. Court notes there is no harm in the agreement to shareholders.agreement. So shareholders in close corp liable when they leave one of the shareholder employees off the salary list and don’t reelect him as director. ruling for the minority SHs. Court finds this action ok. Glamore Motor Sales) Court seems to see Ingle more like a hire hand than one of the founding partners. the Court orders breaching shareholder to sell his shares. 2) If majority SH does show legitimate business purpose. So under agreement whereby shareholder must sell his shares at certain price to the majority if he breaches the pooling agreement. enforceable. Majority SH refuses to employee minority SHs in a closed corporation. vote pooling agreements on election of directors are not illegal. (Sugarman) 30 . eg firing SH/employee for incompetence. That fiduciary duty is of the utmost good faith and loyalty. This was not shown in Wilkes. Ingle hired as a sales manager of a car company. Rodd) Court in Wilkes applies this Donahue standard with a two step test: 1) when minority SH sues majority SH under this standard. Court extends strict duty approach to situations involving more subtle freeze-outs from financial benefits that SHs in close corporations ordinarily expect to receive. and then becomes a shareholder in the business. per the shareholder agreement. or the public. (Donahue v. Estrada) Abuse of Control Close corporation relationships are more akin to partnerships than at will employment relationships regarding duties of loyalty and good faith to each other. In close corporations. as the written contract in this case allowed for termination of employee for any reason. does not pay out dividends. so that Ingle has no right as a minimum SH in a close corporation against an at-will discharge by the majority SH. and majority SH exercises right of repossession of shares at a specified price. (Ramos v.

but it did not provide for a transfer of the liability on the mortgage. but bylaws give each a veto power over company actions. if there is a reasonable alternative exit mechanism besides dissolution. When he resigns. resulting in the company paying extra tax to the IRS. but do not pay out any dividends. Duration. regarding participation in management or employment with the company. (Jordan v. Closed corporations has 4 equal shareholders. oppressive. which would vastly increase the value of the shares. then the court will not grant a dissolution to break the deadlock. Other SHs sue him to recover this lost extra tax money. so she gets nothing frm her ownership. the court orders dissolution. The reasonable expectations must be based on understandings. because the plaintiff would still be liable under the mortgage. claiming he would have stayed at the company had he known of the merger. The other shareholders pay themselves director salaries. were violated. Atlantic Properties) Courts should give deference to shareholder agreements and not interfere to give SHs rights that were not protected in the shareholder agreements. Employee later sues. (Meiselman) 31 . The LLC agreement calls for a buyout at fair market value. among the shareholders.Lesson is that courts especially like to find a fiduciary duty in a closed corporation where the majority freezes out the minority shareholders. so that he violated his fiduciary duty here. Talcott) Woman as part of divorce gets 1/6 of shares in closed corporation. Minority SH asks for buyout at fair price. Court says his claim survives summary judgment. The court rules the buyout provision is not a reasonable alternative exit mechanism. Blackwell). (Nixon v. (Haley v. Therefore. As part of employee agreement he must sell back his shares to the company.” or acted wastefully. express or implied. (Smith v. Duff and Phelps) Control. She sues. Court said dissolution or a buy-out could be ordered if the reasonable expectations of the minority SH. so one of the guys sues for a dissolution. and Statutory Dissolution Two equal shareholders in LLC agreemetn start feuding.” Basically. Delaware statue says a court may order dissolution of an LLC “whenever it is not reasonable practicable to carry on the business in conformity with the LLC agreement. so instead it orders that a buyout of her shares at fair market value be ordered if she can show at trial that the other owners acted in an “illegal. who owns some stock in the company decides to switch jobs. Employee of company. or fraudulent way. the company doesn’t tell him that it is in merger negotiations. 1 shareholder refuses to give dividends (presumably out of personal tax consequences to him). (Alaska Plastics) Dispute between majority and minority SH. Court views dissolution of company as too drastic a remedy. because he doesn’t want to be bought out and have to remain liable. Court finds he had a Donahue-type fiduciary duty when he used his veto power.

telling employees he had nervous breakdown. and did not get dividends. Conventional case law doctrine is that sale of control block at a premium is not wrong per se. Feldman is receiving a premium in essence for guaranteeing supply to Wilport which might have been guaranteed to Wilport had Wilport agreed to make an advance purchase of steel from Newport. honestly.” Court found that there was no bad faith conduct by the majority SH. and fairly.” Court also says Alfred should get lost wages because he had a reasonable expectation that his employment was not terminable at will. so found for plaintiff c) Stuparich – minority SHs received large dividends. Pedro) Disputes arose between majority SH and minority SHs about future of furniture company.Three brothers each own 1/3 stock in closed corporation. Selling a controlling block at a premium is not wrong in and of itself without any misconduct. And because the two brothers did not act in good faith. Frustrated that their concerns were not being addressed. Court says involuntary dissolution will be granted where “liquidation is reasonably necessary for the protection of the rights or interests of the complaining shareholders. as this takes place during the Korean War when there is a price control on steel. so that liquidation was not necessary to protect the rights of the minority SHs. and lies told to employees as to why minority SH fired. So this case can sort of be analogized to the corporate opportunity doctrine. so they sued for dissolution. in that Feldman took an opportunity that was available to the corporation by taking personal advantage of the fact that Wilport was desperate to guarantee a supply of steel. finds accounting discrepancy resulting in fight with other brother. Transfer of Control Two possible reasons for paying a premium – 1) to get the private benefits of control by taking more money from the company as a “salary” for running it 2) because the buyer believes that it can make the company worth more if it has control. Alfred. but that there was a lifetime employment agreement. (Pedro v. The other brothers place Alfred on mandatory leave of absence. and seller doesn’t have to share premium with minority SHs. but continued to receive large dividends. attorney fees should be awarded to Alfred. Hanson Holdings) Wilport buys Feldman’s controlling shares of Newport in order to guarantee itself supply of steel. so found for defendant. (Perlman v. 4) or involves other misconduct. (Stuparich) Key differences among cases: a) Alaska Plastics – minority SH not told about meetings. themselves chose not to attend meetings. Feldman) 32 . unless sale is 1) to a looter 2) diverts a corporate opportunity 3) is fraudulent. One brother. and merely disagreed as to business judgment of majority SH. so found for plaintiff b) Pedro – minority SH fired from employment. the minority SHs stopped attending meetings. Majority SH refused to buy their shares out. (Zeitlin v. Court found breach of fiduciary duty as the two brothers did not act “openly.

and that the right of first refusal agreement should be narrowly construed. Why do such a “reverse subsidiary merger?” 33 . But here we have a sale of office along with a control shift. Court disagrees. so that the agreement did not cover mergers. independent of control shift. etc. (check if it’s right that both boards need to approve) b) merger or consolidation They need a merger agreement (DGCL 251) and approval by both board of directors and a shareholder vote for both companies. Plaintiff claims the original offer to buy the majority bloc triggered the right of first refusal. and timely file. Court says naked sales of office. you can demand the fair market value of the shares in cash (which could be higher or lower than the value of the shares you would have received as part of the merger) Most common form of merger today: acquiring corporation forms new subsidiary. ACQUISITIONS. and Target company merges into it (or vice versa). so doesn’t result in automatic control shift cuz it is less than 50% but court believes 28% is enough to give effective control. A company offers and then withdraws offer to buy the majority bloc. (Frandsen) Contractual solutions to desires for an equal opportunity rule in sale-of-control situations include take-me-along provisions.Essex offers to buy controlling shares from Yates on condition that the board resign after the purchase so that Essex can immediately appoint new members and take control of the board. The fact that the sale is conditioned on immediate transfer of board control is therefore okay. (Essex Universal) Plaintiff has right of first refusal in case majority shareholders sell their shares. you will have a fiduciary duty of utmost good faith and loyalty. which requires equal treatment. and that even if it did not. the merger proposal did. in general: a) sale of assets plus liquidation The board of each company must decide whether this is expedient or in the best interests of the company. If you are a shareholder in a closed corporation. MERGERS. and vote against merger. AND TAKEOVERS Techniques. and a resolution is approved by a majority of the outstanding stock (not just a majority of the votes) at a shareholding meeting. charging a premium might in some circumstances violate this fiduciary duty. are forbidden. right of first refusals. There are appraisal rights. Appraisal right – if you don’t like merger. as opposed to having to wait for future shareholder meetings. saying the withdrawn offer didn’t trigger the right. (note that only 28% of stock transferred here. Yates was taking a premium basically to give up immediate control of the board. so that is why there a control shift here). So in close corporations. instead proposing a merger of the two companies.

then majority SH then has burden of proof to show entire fairness. so they have a conflict of interest. So this is done to avoid appraisal rights. such that the shareholders of the big company will get appraisal rights. Court says sale of assets statute and merger statute are independent of each other. The key danger of this merger is that the parent company owns a significant part of the target company. while if the big company absorbed the small company. Court says. Glen Alden Corp) The lesson here is that some courts will try to extend/recharacterize transactions as de fact mergers because of public policy. is paying not with cash.-avoid getting vote of acquiring company shareholders -but get technical efficiencies of merger -and keep liabilities of the target company in separate corporate entity from the acquiring company c) stock purchases d) tender offer for all shares. Arco Electronics) Freeze-out Mergers Big corporation seeks to acquire smaller company. The reason they do this is because based on choice of law considerations. If plaintiff does this. Therefore. that this is a de facto merger. So if you do a sale you don’t get appraisal. indicating unfairness & demonstrate some basis for invoking entire fairness obligation. e) proxy contest – characteristic of hostile acquisitions De Facto Merger Doctrine Smaller company absorbs stock of larger company and then liquidates it. But if the defendant majority SH can show that the merger was approved by an informed vote of the majority of the minority 34 . with equal dignity. but with stock in itself. The way they do it is like a simple sale. then there would be appraisal rights for the acquired company. merger. and some of the directors of the target company are also officers and directors of the parent company. except that Loral. court does not apply BJR to decision of the target company’s board to accept the merger offer at $21 per share. misrepresentation. which means showing that there was fair dealing and it was a fair price. (Hariton v. This is structured as an asset acquisition but you get the net result of a merger. Loral attempting to acquire Arco. other courts will refuse to extend merger rules to de facto mergers. Court says plaintiff initially must allege specific acts of fraud. not simple sale rules apply. So no de facto merger doctrine in Delaware. Because of this conflict. (Farris v. you do get appraisal. or some percentage of shares. though. or other items of misconduct. the acquired company shareholders will not have appraisal rights under a sale. and if you do a merger. the acquiring company.

remains the standard. Court disagrees. (Rauch v. Tremont) COGGINS – don’t understand notes given to me. Approval of independent committee or informed MOM vote shifts burden of proof to challenging shareholder plaintiff.) Takeovers Maremont wants to acquire Holland Furnace and change structure of company. which requires good faith and reasonable investigation 2) that the directors did not act for the primary purpose of preserving their own incumbency Why not use BJR? Because there is a conflict of interest – the board of directors are fiduciaries but they have a personal interest in whether Maremont takes over.” (Kahn v. 35 . Mathes) Burden of proof is on the target company directors to show 1) reasonable grounds to believe that a danger existed to corporate policy and effectiveness. says that a cash-out merger has an independent legal significance under Delaware law. Burden of proof shifts only if majority shareholder does not “dictate” the terms of the merger and the independent committee has “real bargaining power that it can exercise w/ the majority shareholder on an arm’s length basis. then the burden will shift back to the plaintiff to show that merger was not fair. Holland will pay Maremont a premium over market for his shares in order to prevent him from taking over the company.” (Kahn v. in other words. Lynch Communications) Entire fairness remains the standard even when IC used b/c “the underlying factors which raise the specter of impropriety can never be completely eradicated and still require careful judicial scrutiny. it would reduce the value of other shareholders’ stock.shareholders. (Cheff v. UOP) It would have helped to prove fairness had the target company used a special committee of independent directors to investigate the fairness of the price. Some shareholder sue for misuse of corporate funds. but RCA charter says RCA preferred stock have a redemption price of $100. RCA Corp. though. not BJR. Holland. so that the redemption provision should have been triggered. (Weinberger v. RCA stocks are to be cashed out at $40 a share. But if Holland used company funds to do this. Court finds burden did not shift back to the plaintiffs. but entire fairness. using company funds. He buys 10% of Holland and wants to buy more. so shareholders sue. offers him greenmail. because the vote was not informed. look up RABKIN – same thing GE is acquiring RCA. claiming the cash-out merger was in substance and effect a redemption. so that it is different from a redemption.

On the back end. he offers to buy up to 37% of the stock for $54 per share. the statute authorizes the action and b. but does not let Pickens participate. and must include the hostile bidders. Two aspects: a. and pay as consideration for the freeze-out junk bonds ostensibly worth $54. Encourages other bidders. In reviewing Unocal’s defensive measures. (Unocal v. which was already causing employee unrest.Maremont posed two possible dangers: 1) threat to liquidate 2) threat to change the business model. In defense. then the burden shifts back to the plaintiff. the firm’s charter does not forbid or restrict it 2) the board had reasonable grounds for believing that a danger to corporate policy and effectiveness existed a. Unocal makes an exclusionary tender offer for its own stock. Greenmail has dwindled greatly as a defensive tactic. he is going to do a freeze-out merger with his company to eliminate the minority shareholders. 874) that says that issuer or tender offers need to be offered to all shareholders. Mesa) That the hostile bidder was a greenmailer was relevant to the determination that the bidder posed a threat.” Court employs 3 part test to examine Unocal’s defensive tactics. 3) the defense was reasonable in relation to the threat posed If the defendants are able to show this. plus because of tax implications. Why? Doesn’t work too well. 36 . Court doesn’t fault them for honest mistakes or judgments. assuming he gets control. You cannot exclude any of the shareholders. who must rebut the BJR. On the front end. Court found the discriminatory self-tender was a reasonable or proportionate response. the directors satisfy this burden by showing good faith and reasonable investigation (cheff test). it adopts a conditional business judgment rule: “an enhanced duty which calls for judicial examination at the threshold before the protections of the business judgment rule may be conferred. Williams Act provides lots of rules for tender offers Pickens. owns some of Unocal’s shares and makes a two-tiered front-end loaded tender offer for the rest of Unocal shares. Court doesn’t want to apply the regular BJR because of specter of a conflict of interest. Burden is at first on defendants to show: 1) the action within the power or authority of the board. a greenmailer. Instead. But you can’t use this defensive tactic nowadays because the SEC adopted a rule (see p. though may be worth less.

What must the defendant board show? 1) Good faith. so therefore no BJR. they have a duty to maximize the company’s value by selling it to the highest bidder – “The directors’ role changed from defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company. and 2) that the defensive measures taken in response were proportionate and reasonable. Delaware court strikes down the lock-up. and otherwise satisfied the tests. rather the Revlon test applied: When the board puts the company up for sale. After lots of bidding back and forth. but there are tests to determine whether the defensive actions were reasonable and proportional. The option gave Forstmann the right to buy two Revlon divisions (two of Revlon’s more profitable divisions) at a price below their value and was exercisable if another bidder gets 40% of Revlon shares.” (though Court says company may consider other factors as well) This is the basic idea of the Revlon case. reasonable investigation that led to the conclusion that the hostile tender offer posed a threat to corporate effectiveness. so the result of the lock-up was not to foster bidding but to destroy it. Court says the Revlon board violated its fiduciary duties because the lock-up ended the bidding prematurely. White knight named Forstmann comes along to bid on Revlon. The Court distinguishes between lockups that draw a bidder in and lockups that end an active auction. Take-aways from Unocal – a board of directors and managers of a corporation may actively resist a tender offer. Some conflict of interest exits. Generalizing. But this no shop clause is invalid because it required the board to treat Forstmann more favorably than Pereleman and because agreement to negotiate only with Forstmann helped end auction prematurely. though.Many roads to apparent dilution: a) paying greenmail b) exclusionary self-tender offer c) shareholder rights (poison pill) plan d) asset lock-up e) share lock-up f) large termination (cancellation) fee All but the first listed put the main cost on the hostile bidder and so are used as defensive measures in hostile takeover situations.” (Revlon) The court also says that no shop clauses are not per se illegal.This case still important because basic Delaware formula enunciated in this case is still important – boards don’t have to be passive. 37 . Perelman is a hostile bidder for Revlon. Revlon granted Forstmann an asset lock-up option. saying that Unocal did not apply. “Forstmann had already been drawn in to the contest on a preferred basis. This meant the board did not act effectively in securing the best price for its stockholders. These tests can be applied to many other defensive tactics that boards may employ.

QVC comes in and bids on Paramount. Time passed the Unocal test and could go ahead and merge with Warner. Paramount is now a target and agrees to merger with Viacom. so as to avoid the shareholder vote. Pre-auction defenses still ok. Revlon applies only when board has decided to sell. How does the Court distinguish this situation from the Time-Warner case? Because there is a change of control if the merger with Viacom went through (from Paramount public shareholders to Sumner Redstone. as there would be a fluid aggregation of public shareholders who controlled the company both before and after the merger. (Paramount v. (Paramount v. to avoid having to submit to a vote on the merger between Time and Warner by Time’s shareholders. Time) Revlon duties are triggered under two scenarios: “1) when a corporation inititates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company… 2) in response to a bidder’s offer. Triggering Revlon – bringing in a white knight or management buyout in response to a hostile takeover would trigger it. and it will be applied to 1) grant of share-exchange option and no-shop provision and 2) the decision to recast the merger as a tender offer. Time and Warner want to merge. QBC gives us a restatement of legal principles about what triggers Revlon: 38 . Courts said response of switching to a cash-tender offer was reasonable and proportional under step 2. Court says Unocal does apply. Paramount v.Professor Gilson advocated the auction model – would permit only those defensive tactics designed to secure a better offer for the shareholders. Time and Warner restructure their deal from a merger to a cash-tender offer coupled with a freeze-out merger. while there was no change in control in Time case. Paramount adopts a bunch of defensive measures against QVC.” But Court says neither of these scenarios are triggered. because it was not aimed at cramming down a management alternative to a hostile bid but at carrying forward a pre-existing transaction in altered form and because Paramount could still make a tender offer for the combined Time-Warner entity. QVC) Court says Paramount’s defensive measures are subject to enhanced scrutiny a la Revlon. such as the release of information bearing on the adequacy of the offer or seeking an alternative bidder. Court finds cognizable threat under Unocal step 1 in that Paramount poses a threat to preexisting business strategy/plan and to pre-existing transactions to carry the strategy out. but Paramount swoops in and makes a hostile bid for Time. so Revlon does not apply. Therefore. a target abandons its long-term strategy and seeks an alternative transaction also involving the breakup of the company. CEO of Viacom).

Paramount should have modified the improper defensive measures. So the main idea of this case is the special concern for the voting rights of shareholders. ITT fails Unocal test because it fails to show a threat to corporate effectiveness. (Hilton Hotels v. coupled with Genesis locking up the votes of the majority of voting stock.” Court doesn’t like the board gutting its own powers. and the response wasn’t proportional because installing a staggered board was. (Ace Ltd. 815) Court says Paramount failed the Revlon test. Omnicare challenges the deal protections and win. In recent years. in words of Unitrin case. Hilton is a hostile bidder for ITT.” which includes a poison pill and a staggered board. There is nothing illegal about classified board. the director’s obligation is to seek the best value reasonably available to the stockholders. “preclusive. NCS agrees with Genesis to submit the Genesis’ proposal to a vote. (p. but there is something wrong with just changing to a classified board to fend off a hostile bidder. It undertakes a tender offer coupled with a proxy contest. Capital Re) Omnicare and Genesis both bidding for NCS. The Court says this is “close to self-disablement by the board. In sum. NCS) 39 . If a company already has a classified board (doesn’t just create one in response to a hostile bid) and then adds a poison pill. to take control of the board and prevent a poison pill. ITT responds with a “comprehensive plan. Genesis has guaranteed that it will get a vote and that it will win the vote. so as to prevent Hilton from getting control of the board and preventing the triggering of the poison pill. ITT Corp) The Nevada court uses a Unocal test coupled with a Blasius/Stroud test.” ITT fails Blasius test because adopting the staggered board disenfranchised ITT’s shareholders without the necessary compelling justification. then almost all hostile bids are going to be stopped. 816) Key features of enhanced scrutiny test: Judicial determinations regarding a) adequacy of directors’ decision-making process including the information the directors use b) reasonableness of directors’ action in light of the circumstances then existing (p. v.When a corporation undertakes a transaction which will cause a) a change in corporate control or b) a break-up of the corporate entity. Court says no talk clauses are too restrictive and it prevents the board from exercising its full fiduciary duties. (Omnicare v. because when QVC came into the game and Paramount subsequently modified the original merger agreement. a dominant defensive tactic has been the combination of a classified board and a poison pill plan to counter hostile acquirers who launch both proxy contests and tender offer bids.

Powell for majority says there are two parts to the commerce clause analysis: 1) does the Indiana statute discriminate against interstate commerce? No. the directors irrevocably locked up this merger. Dynamics) SCOTUS purports to use the same preemption standard as in MITE – 1) whether the state law stood as an obstacle to the accomplishment of the Congressional purpose underlying the Williams Act 2) the basic purpose of the Williams Act was said to be protection of the independent shareholder from both the offeror and target management. but that it did not do so in the agreement with Genesis.Court said the NCS’s board was required to contract for an effective fiduciary out to exercise its continuing fiduciary responsibilities to the minority stockholders. and by agreeing to a provision requiring that the merger be presented to the shareholders. 40 .” State TO legislation. etc. 2) are there inconsistent regulations that might hinder tender offers? No. This mitigates problem of inconsistent regulation. The action of the NCS board fails to meet those standards because. Key features of Indiana’s statutes are that it only applies to corporations headquartered in Indiana. v. the voting agreements. the NCS board assured shareholder approval. note on corporate debt Question whether Indiana’s takeover statute. and the state law that applies is the law of the state in which the corporation is incorporated. such as to justify deal protections? ”Deal protection measures must be reasonable in relation to the threat and neither preclusive nor coercive. and there is a minimum % of shareholders who are from Indiana. (CTS Corp. by approving. directors. is governed by state law. because it only deals with Indiana corporations and doesn’t discriminate based on the state of the bidder. Is the possibility of losing a deal a threat to corporate integrity. is constitutional. which seeks to protect Indiana-based companies from takeover and two-tiered tender offers. Internal affairs doctrine – rules governing relationships among shareholders.

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