  Each partner is the agent of her co-partners, and when any partner acts within the scope of the partnership, her acts will bind the other partners. Follow the Uniform Partnership Act (UPA) Revised Uniform Partnership Act (RUPA) - When looking at a question look to see which use, if not use RUPA

Entity and Aggregate Characteristics of a Partnership UPA: a partnership is treated both as a separate entity from its partners (for some purposes) and as though there is no separate entity but merely an aggregate of separate, individual partners.  Both Characteristics – a partnership is treated both as a separate entity from its partners (for some purposes) and as though there is no separate entity but merely an aggregate of separate, individual partners.  Aggregate Theory – Partners are jointly and severally liable for the obligations of the partnership. RUPA 201(a) -> Property is property of the partnership not partners - RUPA expressly states that a partnership is an entity, thus simplifying many partnership rules such as those on property ownership and litigation.  Entity Characteristics – For other purposes, a partnership is treated as a separate entity apart from its individual partners. o Capacity to sue or be sued o Ownership of Property – a partnership can own and convey title to real or personal property in its own name, w/o all of the partners joining in the conveyance. Agreement to Form a Partnership  There must be an agreement (express or implied) in order to form a partnership o If the partnership is to continue more than one year, the statute of frauds requires the agreement to be written  Duration – If no term is specified, then the partnership is terminable at the will of any partner.  Consent of Other Partners – A prospective partner must have the consent of all of the other prospective partners.  Intent of the Parties – Where there is any question, the intent of the parties involved is determined from all of the circumstances The Court looks at several factors: 1. The intention of the parties, including what was actually said in the agreement. [Intent]  The intent of the parties is not dispositive. 2. The right to share in profits. [Profit Share].  Co-owners typically share profit. Can be used to prove element of co-owner, not conclusive.

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The receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in the business. The obligation to share in losses. [Loss Share]. The ownership and control of the partnership property and business. [Control] Community of power in administration, and the reservation in the agreement of the exclusive control of the management of the business. [Management]. The language of the agreement. The conduct of the parties toward third persons. Rights of the parties on dissolution. 

Partnership by Estoppel – (Smith v Kelly) -> UPA 16 - CONTRACTS USUALLY  Liability of Alleged Partner – One who holds herself out to be a partner, or who expressly or impliedly consents to representations that she is such a partner, is liable to any third person who extends credit in good-faith reliance on such representations. Liability of Partners who Represents Others to be Partners - Under UPA §16, a person who represents himself, or permits another to represent him, to anyone as a partner in an existing partnership or with others who are not actual partners is liable to any such person to whom a representation is made who has, on faith in the representation, given credit to the actual or apparent partnership.

 To Establish a Partnership by Estoppel, 4 elements must be proven: o 1) Plaintiff must establish a representation, either express or implied, that one person is the partner of another – i.e.: that there was a holding out of a partnership. o 2) The making of the representation by the person sought to be charged as a partner or with his consent. o 3) A reasonable reliance in good faith by the third party upon representation. o 4) A change of position, with consequent injury, by the third person in reliance on the representation.

- Management and Operation (UPA 18) Summers v. Dooley
The Sharing of Losses: o As a general rule, in the absence of an agreement to the contrary, it is presumed that partners and joint venturers intended to share equally in profits and losses. o Where one partner or joint venture contributes to the capital while the other contributes skill and labor, neither party is liable to the other for losses. o Where one party contributes money and the other contributes services, in the event of a loss, each party loses the value of his own capital or contribution. Fiduciary Obligations of Partners  Duties of Partners to Each Other – the duties of one partner to all others are based on a fiduciary relationship. (Partner owes certain duties of care and of loyalty)  Opting out of Fiduciary Duties o A general partner of a LP has the same fiduciary duties as a partner in any other partnership, including the duty of loyalty.

Not all self-interested transactions violate the duty of loyalty. The question is not whether the interested partner is benefited, but whether the partnership or partners are harmed.  Withdrawing Partners Removing Clients from Firm o The fiduciary duty of a partner to his firm does not prevent that partner from secretly preparing to start his own law firm.  Expulsion of a Partner – when a partner is involuntarily expelled, it must be bona fide or in good faith. o Partner’s Interest in the Partnership     A partner’s interest in the partnership is her share of the profits and surplus which is personal property. Consequences of classification as personal property: A partner’s interest is personal property even if the firm owns real property. The partner’s rights to any individual property held by the partnership are equitable (partnership holds title) and this equitable interest is “converted” into a personal property interest.

Ownership Inters and Transferability -May assign the interest (profiting) but not the managing aspect - Unless there is a provision in the partnership agreement to the contrary) and unless the agreement provides otherwise, such an assignment will not dissolve the partnership.  The assignee has no right to participate in the management of the partnership (i.e.: he is not a partner, he only has rights to the assigning partners’ share of the profits and capital)  But the assignee is liable for all partnership obligations.  At dissolution you get the assets of partnership, ASIGNEE ONLY GETS PROFITS Third Party Liabilities  A creditor of an individual partner may not attach partnership assets. He must get a judgment against the partner and then proceed against the individual partner’s interest (by an assignment of future distributions, a sale of the interest for proceeds, etc.) LIKE AN ASIGNEE  Effect of Conveying a Partnership Interest : o The right in “specific partnership property” is a partnership tenancy possessory right of equal use or possession and is not an “interest” in the partnership’s assets. o Instead, the “real interest of a partner” is in her share of the profits and surplus as well as the partnership’s losses. o Accordingly, the partnership, not he partner, actually owns the property and assets. o When a partner conveys her interest in a partnership she does not convey property held by the partnership but only her interest in the partnership. o She does not have a specific interest in unknown choses in action relating to partnership property.

Creditors’ Access to Firm and Personal Assets:   Creditor of firm seeks to attach personal assets of a partner to collect debt. Allowed? Yes. Because it is a creditor of a law firm, the accident happened on the premises of the firm and the partner was negligent. (This is a drawback to the partnership agreement) Personal creditor [of one partner] seeks to attach firm assets [partnership assets]. Can the creditor seize partnership property to satisfy the debt? No. o Is the creditor out of luck? Must get charging order to charge the transferable interest of the partner to satisfy the debt. [Will garnish the partner’s profits from the partnership. Her profits from the partnership would not go to the partner but directly to the creditors].

The Rights of Partners in Management  Equal Rights – All partners have equal rights in management (even is sharing of profits isn’t equal) o The acts of a partner within the scope of the partnership business bind all partners. o One partner cannot escape responsibility by notifying a creditor. o Differences must be resolved by the majority. Partners may fashion an agreement as to who makes decisions

- Indemnification and Contribution (UPA 18(b) and RUPA 401(c)) - Fiduciary Duties - Duty of Loyalty - One partner cannot benefit at the partnerships expense - A general partner of a LP has the same fiduciary duties as a partner in any other partnership, including the duty of loyalty. - Not all self-interested transactions violate the duty of loyalty. - The question is not whether the interested partner is benefited, but whether the partnership or partners are harmed. - Duty of Care - Contractual Limitations
When Partners Disagree (DEADLOCK)   Because there are equal rights in the management and conduct of the partnership business upon all partners therefore, if there is one objection then the other partner does not have the power to override their objection. Why could he not hire the third person since it would be part of the ordinary course of business? o When there is a split in decision between the partners there is of course no majority. In a deadlock situation you can continue to do business however you have been doing it, you cannot change how you have been doing it. In Nat’l they had been ordering bread from them so could continue to order the bread from them because

there was no majority as to the decision not to. They cannot hire the replacement here because it is something NEW, you don’t have the majority to make the change.\ - Kessler v. Antinora - One party agreed to provide all funding and other the services - Party who takes a loss can not recover from other party  Absent an agreement, everyone gets one vote. If it’s silent management rights are split evenly amongst the people. Partnership Dissolution    Dissolution of a partnership does not immediately terminate the partnership. The partnership continues until all of its affairs are wound up. Causes of Dissolution: o Expiration of the partnership term  Fixed term – Even where the partnership is to last for a fixed term, partners can still terminate at will (but it will be a breach of the agreement by the terminating partner, which may result in damages charged to the terminating partner.)  Extension of Term – the partners can extend the partnership by creating a partnership at will on the same terms. o Choice of a Partner – Any partner can terminate the partnership at will (because a partnership is a personal relationship which no one can be forced to maintain). Where the partnership is for a term or even where it is a partnership at will, however, if dissolution is motivated by bad faith, it may be a breach of the agreement. o Assignment – An assignment of a partner’s interest is not an automatic dissolution, nor is the levy of a creditor’s charging order against a partner’s interest. But an assignee or the creditor can get a dissolution decree on expiration of the partnership term or at any time in a partnership at will. o Withdrawal or Admission of a Partner – Most partnership agreements provide that losing or admitting a partner will not result in dissolution. New partners may become parties to the preexisting agreement by signing it at the time of admission to the partnership. When an old partner leaves, there are usually provisions for continuing the partnership and buying out the partner who is leaving. o Illegality – Dissolution results from any event making it unlawful for the partnership to continue in business.

The Right to Dissolve: There always exists the power, as opposed to the right, of dissolution.  The Right to Dissolve - A court may order the dissolution of a partnership if it deems that the partners are having such quarrels or problems so that they materially hinder the carrying on of the business. Breach of Agreement - In a breach of agreement, damages may be sought by the injured party. Partnership at Will – If there’s an at-will partnership, one party has the power to dissolve the partnership upon express notice to the other. o Dissolution must be in good faith.

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o    -

A partner at will is not bound to remain in a partnership just because it is profitable.

Dissolution by act of one or more partners. Dissolution by operation of law. Dissolution by court order. Dissolution can be appropriate remedy because of a partner’s misconduct A partnership may be judicially dissolved where: o A partner’s conduct prejudices the carrying on of the business o Where the partner willfully and persistently breaches the agreement; or o Where he conducts himself in such a way as to make it impractical to carry on the business with him Dissolution can be “rightful” or “wrongful” Explicit term o Duration specified in partnership agreement o Specified purpose/object specified in partnership agreement Rule: UPA § 31(1)(b): Dissolution is caused . . . by the express will of any partner when no definite term or particular undertaking is specified. o Issues which may arise:  Sued for judicial determination of status of loan required.  Receiver probably needed for orderly liquidation  Potential for wrongful dissolution

Rules for Distribution upon Dissolution of Partnership:  In settling accounts between the partners after dissolution, the following rules shall be observed subject to any agreement to the contrary:  The liabilities of the partnership shall rank in order of payments, as follows: o Outside creditors. o Inside creditors → partners who lent the money. o Return of capital → whatever money still owed to partners based on capital account. o Remainder, if any, divided as profits.  Distribution in kind – where there are no partnership debts, or where the debts can be handled from the cash account, partnership assets may not be sold, but they may be distributed in kind to the partners.  Partnership Losses – where liabilities exceed assets, the partners must contribute their agreed shares to make up the difference. Rights of the Partners: o No Violation of Agreements – If the dissolution does not violate the partnership agreement, then the partnership assets are distributed as set forth above, and no partner has any cause of action against any other partner. Dissolution violates agreement – If the dissolution does violate the partnership agreement (e.g.-the fixed term of the agreement), then the innocent partners have rights in addition to those listed above.


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Right to Damages – innocent partners have a right to damages (e.g. – lost profits due to dissolution, etc.) against the offending partner. Right to continue the business – The innocent partners also have the right to continue the partnership business (not sell off and distribute the assets) by purchasing the offending partner’s interest in the partnership. Alternatively, of course, the innocent partners may simply dissolve and wind up the business, paying the offending partner her share, less damages.

Effects of Dissolution: o o Partners are liable until debts are discharged – the liability of partners for existing partnership debts remains until they are discharged. New partnership remains liable for old debts – when there has been a dissolution due to death, withdrawal, or admission of a new partner and the partnership business is continued, the new partnership remains liable for all the debts of the previous partnership. Retiring partner’s liability for debts incurred by partners continuing the process – dissolution ends the power of a partner to bind the partnership except to the extent necessary to wind up its affairs. If however, 3rd parties do not know of the dissolution, contracts entered into with a partner bind the partnership. Hence, a retiring partner must make sure that prescribed procedures are followed to terminate any possible liability for partnership obligations. The UPA provides that notice of withdrawal or dissolution may be published in a newspaper of general circulation. A partner may bid for the partnership’s assets at dissolution The partnership agreement and the UPA at dissolution


o o

 The Modern Limited Partnership o Created under Uniform Limited Partnership Act (ULPA) o Revised Uniform Limited Partnership Act (RULPA) – Adopted by most states Definition: A limited partnership is a partnership formed by 2 or more persons and having as its members one or more general partners and one or more limited partners.  General Partner - The “general partner” assumes management responsibilities and full personal liability for the debts of the partnership.  Limited Partner – The “limited partner” makes a contribution of cash, other property, or services rendered to the partnership and obtains an interest in the partnership in return, but is not active in management and has limited liability for partnership debts. Purposes: a limited partnership may carry on any business that a partnership could carry on. Liability: the general partner is personally liable for all obligations of the partnership. o A limited partner, however, has no personal liability for partnership debts, and her maximum loss is the amount of her investment in the limited partnership.  Exception: When a limited partner takes part on the management and control of the business, she becomes liable as a general partner.

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Rights o A limited partner are substantially the same as those of a partnership,  Except that she has no rights with regard to management.  Hence, he has rights of access to the partnership books, to an accounting as to the partnership business, and to a dissolution and winding up by decree of court. o A limited partner may lend money to, or transact business with, the partnership. o A limited partner’s interest in assignable, unless the agreement provides otherwise. The assignment vests in the assignee all rights to income or distribution of assets of the partnership, but unless and until the certificate of limited partnership is amended with the consent of all other partners, the assignee is not entitled to inspect partnership books, obtain an accounting, etc. Formation of a Limited Partnership:

Requirements for the Formation: 1. The partners must execute a certificate setting for the name of the partnership, the character of the business, the location of the principal office, the name and address of each of the partners and their capital contributions, a designation of which partners are “general” and which are “limited” and the respective rights and priorities (if any) of the partners; 2. A copy of the certificate must be recorded in the county of the principal place of business. The certificate may be amended or canceled by the following: a. If the cert. contains false statements, anyone who suffers a loss by reliance thereon can hold all of the partners (general and limited) liable. b. The purpose of the certificate is to give all potential creditors notice of the limited liability of the limited partners. c. The ULPA requires at least “substantial compliance in good faith” with these requirements. If there has been no substantial compliance, the purported limited partner may be held liable as a general partner. A purported limited partner, however, can escape liability as a general partner if, upon ascertaining the mistake, she “promptly renounces her interest in the profits of the business or other compensation by way of income.”    Name: The name must contain the phrase “Limited Partnership” or “Limited” of the abbreviation “L.P.” or “Ltd.” or the designation “LP.” 620.1108 Sharing of profits and losses: Subject to the contrary agreement both profits and losses are allocated among the partners on the basis of the value. NOT EQUAL. Unless there is an agreement to the contrary. Dissolution: Limited partner has neither the right nor the power to get out of the partnership, unless their agreement gives it to them. Would have to sell their share to someone else. o The general partner has the power but may not have the right. o Very limited way to actually get a judicial dissolution.

Limited Liability Partnership – Partnership that with limited liability to for the firms tort or contract obligations. Because of this all of the partners have the right to participate rather than a LP. - An LLP is a general partnership in all respects except that the statute provides that partners have no personal liability for firm obligations that exceed the assets of the general partnership. Formation - RUPA 101(5) Must satify certain statutory limitations 1. Is required to file documentation with the secretary of state 2. Some jurisdictions require an LLP to provide amount of liability insurance Liability - RUPA 306(c) (providing for broad limited liability shield): An obligation occurred while the partnership is a limited liability partnership, whether arising in contract, tort, or otherwise is solely the obligation of the partnership. A partner is not personally liable directly or indirectly, by way of contribution or otherwise, solely by reason of being or acting as partner. - However, partners in an LLP do have full personal libaility for claims arising from their own misconduct. - Enables the partners in Gen. Partnership to free themselves of acts (and ultimate liability) of other partners and their partner's employees. Limited Liability Corporation (LLC) - The limited liability company (LLC) is a non-corporate entity that offers limited personal liability to its owners. It is somewhat of a cross between a partnership and a corporation. The LLC is owned by members who either manage the company directly or delegate management responsibility to managers or officers. Benefits – Limited Liability, Pass through taxing, tremendous freedom to contract. Formation - The limited liability company is formed in much the same way that the limited partnership or business corporation is formed. Articles of Organization Document required to be filed with the proper state authority to form a limited liability company. - Board of Managers -Group of individuals elected by the members of a limited liability company to manage the limited liability company. Similar to a corporation’s board of directors. - Operating Agreement -Document that governs the limited liability company. Similar to a corporation’s bylaws. - Entity at Will -Entity that may be dissolved at the wish of one or more members or owners. of organization are filed with the secretary of state or other appropriate state authority. Piercing the “LLC” Veil  The scope of fiduciary duties of members of an LLC has not been clearly defined. It also remains unclear whether corporate principles of law, such as piercing the corporate veil, will be applied to LLCs. At least one court has held that the LLC veil may be pierced in a manner similar to piercing the corporate veil.  Uniform Limited Liability Company Act (ULLCA)  LLC Veil may be Pierced o Treated the same as Piercing the Corporate Veil

Dissolution An LLC will dissolve upon:  The expiration of any period of duration stated in the articles  The consent of all members  The death, retirement, resignation, bankruptcy, incompetency, etc. of a member unless the remaining members vote to continue the business; or  A judicial decree or administrative order dissolving the LLC for violation of law. ***The filing of articles of dissolution and notification of creditors is normally required.  Personal Liability Following Dissolution

Publicly Held or Closely Held: Public A.K.A: Publicly Held Ex: IBM or Microsoft Characterized by a public secondary market in which shares of the company are listed for trade. Close A.K.A.: Closely Held Characterized by absence of a secondary market for its stock. Often (but not always) a relatively small number of shareholders who actively participate in the firm’s management. [Limited number of people have ownership, like family owned]. Small number very active in firms management. Some are, in a sense, incorporated partnerships, without personal liability. In other senses looks and runs like a partnership

Exchange: NYSE or NASDAQ



Rule of Thumb:  Boards ACT – makes the rules  Shareholders REACT – shareholders react by voting them out if they don’t like their acts. Shareholders entitled to vote on:  Election of directors: 607.0803-.04  Any amendments to the articles of incorporation and, generally speaking, by-laws

Roles of Individuals Involved with the Corp. Shareholders- own the company; participate in the profits of the enterprise, limited involvement in the company’s affairs (vote for directors)

Directors: elected by shareholders Directors are not agents of corporation, only the board itself can act as a “super-agent” and bind the corporation.  What can the Board of Directors do?= broad policy makers o Select, evaluate, replace senior management o Oversee: strategies of management of corp. resources, o Review, approve major plans and actions o Other functions Officers: manage corp. PREMATURE COMMENCEMENT OF BUISNESS Promoters and the Corporate Entity – in the course of forming the corporation, promoters often contract for products or services on behalf of the corporation (not yet formed)  Promoter Liability: o The General Rule – Contracts solely under corporation to be = Not Liable - Promoter contracts in own name = Liable.  A court will attempt to determine the “intent” of the parties, and various factors enter in to the determination of this intent.  A promoter is not liable until there is a novation! Even if the corporation forms and accepts liability, the promoter must be released.  Exception – Agreement expressly relieves promoter of liability  Novation may be implied such as closing on property and title transfer to company o Corporate Liability – If the corporation ratifies or accepts the contract after incorporation, the corporation may be held liable on the pre-incorporation promoter contract (and may enforce the contract). Ratification may be express or implied from adoptive conduct of the corporation.  Quasi-contractual recovery – if the corporation repudiates the contract, it is still liable for the value of anything that it makes use of (in quasi-contract)  Adoption by Implication – The general rule is that ratification is retroactive and adoption is not. For a corporation to adopt a contract, it must have knowledge of the terms of the contract. (But who must know of the contract to impute this knowledge to the corporation?) Most jurisdictions recognize that adoption may be by implication. Such as using a lease. Liability for Pre-Incorporation Activity:   If the corporation hasn’t been formed yet then the promoter signing a contract for the corporation does not bind the contract. (clarify about the agent..) Once the articles are filed, does the corporation become a party to the contract? o Yes, but not automatically. The corporation must “adopt” the contract.  Adoption can be effected:  Expressly (typically by a novation → a new contract with some agreement that the partners will now release the promoter, but will 

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not happen unless the third party agrees, not just the promoter and the corporation); or  Implicitly (e.g.: ratification by acceptance of benefits). Once the articles are filed, is the promoter liable if the corporation breaches the contract? o All persons purporting to act as or on behalf of a corporation, having actual knowledge that there was no incorporation under this chapter, are jointly and severally liable for all liabilities created while so acting except for any liability to any person who also had actual knowledge that there was no incorporation. o What if corporation adopts the contract?  Promoter may be released from liability by other party to the contract. General rule: PROMOTOR IS GOING TO BE LIABLE unless there is a novation OR the 3rd party had actual knowledge that there was no incorporation o Novation: Promoter is personally liable under the articles are filed…  Novation occurs because that is what the parties agreed to in the contract If the articles are not filed, is the promoter liable on the contract? o Yes. “Except for any liability to anyone who had actual knowledge that there was no incorporation.” Rule: A third party who dealt with the firm as through it were a corporation and relied on the firm, not the individual defendant, for performance is estopped.

Defective Incorporation: o Introduction – Once there has been an attempt to incorporate, the first issue is whether or not a corporation has actually been formed, and if not, what the consequences are. “De Jure” Corporation – A corporation that has complied strictly with all of the mandatory provisions for incorporation cannot be attacked by any party (even the state). What is mandatory and what is “directory” is a matter of judicial construction of the state’s incorporation laws. “De Facto” Corporation – There is a body of common law indicating that, even if a corporation has not complied with all of the mandatory requirements to obtain de jure status, it may have complied sufficiently to be given corporate status vis-à-vis 3rd parties (although not against the state.) Corporation by Estoppel (Contract) – When a corporation is not given de jure or even de facto status, its existence as a corporation may be attacked by any 3rd party. However, there are situations where courts will hold that the attacking party is “estopped” to treat the entity as other than a corporation. The Corporate Entity and Limited Liability Piercing the Corporate Veil: 2 Requirements 1. There must be such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist; 2. Circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice.  Liability of the Parent to the Subsidiary o A parent corporation is expected to exert some control over its subsidiary. When, however, a corporation is controlled to such an extent that it is merely the alter ego




or instrumentality of its shareholder, the corporate veil should be pierced in the interest of justice. Note: The major difference between tort and contract cases is that in contract cases, the plaintiff had an opportunity in advance to investigate the financial resources of the corporation and had then chosen to do business with it. Thus, in contract cases, the intention of the parties and knowledge of the risks assumed in entering into a contract are factors to be assessed in making a determination as to whether the corporate veil should be pierced.  Situations where the Corporate Veil may be Pierced:  Fraud or Injustice – Where the maintenance of the corporation as a separate entity results in fraud or injustice to outside parties (such as creditors).  Disregard of Corporate Requirements – Where the shareholders do not maintain the corporation as a separate entity but use it for personal purposes (for example, corporate records are not maintained, required meetings are not held, money is transferred back and forth and commingled between individuals and the corporation, etc.) The rationale here is that if the shareholders have disregarded the corporate form, then the entity is really the alter ego of the individuals and decisions are being made for their benefits and not the entity’s – the individuals should not complain if the courts likewise disregard the entity .  Undercapitalization: A prime condition for piercing exists where the corporation is undercapitalized given the liabilities, debts, and risk it reasonably could be expected to incur. o Liability Insurance as evidence of undercapitalization:  Courts will pierce the corporate veil when necessary to prevent fraud or to achieve equality. o Requirements of Fairness:  The veil may also be pierced in any other situation where it is only “fair” that the corporate form be disregarded.

The way of getting around the shareholder being liable for any corporate actions is when the court decides to Pierce the Corporate Veil to hold them liable. o Allowing person to get to the shareholders personally if the corporation is doing something wrongful and is just incorporating to keep themselves from being litigated against. 1. (Control Prong): The Plaintiff must show that the corporation was a controlling shareholders alter ego. Unity of interest and ownership that the separate personalities of the corporation and the individual (or the other corporation) no longer exist and factors to look at for alter ego include:  Failure to maintain adequate corp. records  Comply with corp. formalities (meetings, etc.)  Comingling of funds or assets  Under capitalization  One corp. treated assets of another as its own 2. The plaintiff must also show adherence to fiction of separate corporate existence giving rise to limited liability would sanction fraud or promote injustice.  It is ok to set up a corporation to protect assets, so long as it is not done to defraud.

Multiple corporate structures are permitted to protect owners from personal liability. Court says that small business can carry lesser insurance – to promote small entrepreneurs o Court drew distinction between veil piercing, vertical, and enterprise theory (horizontal), as argued by π. Theories  Get all of the companies horizontally as a single enterprise (Enterprise Theory) o This theory is where we would get all ten cab companies together. With piercing the corporate veil, we would just go through the one cab company and to the owner himself.  Alter ego liability: o The corporation was the controlling shareholder’s alter ego; and o Adherence to limited liability would “sanction a fraud or promote injustice”  Enterprise liability: o Such a high degree of unity of interest between the two entities that their separate existence has de facto ceased o Treating the two entities as a separate would sanction fraud or promote injustice o Rule: “When two corporations hold themselves out to the public as a single enterprise and that enterprise involves an inherent risk to members of the public, both corporations incur tort liability for the torts of enterprise.” Usually, if you can come up with FRAUD, you will be able to pierce the corporate veil  This will not work every time, but this is the hardest argument to make and prove To pierce the corporate veil: must determine whether the corporation was thinly, or undercapitalized – Doesn’t have enough money Inadequate Capitizilation – SH must “put at the risk of business unencumbered capital reasonably adequate for its prospective liabilities.  No absolute Test but good way to look at it is, could “pay debts when they became due”  Shareholder characteristics: o Few in number o Actively involved in form management o Not well-diversified  Not a reason to pierce just typically when it occurs  Piercing usually occurs in small corporations because you have to show a unity of interest ***Whether a contract or tort action, law is the same. Courts are much less likely to pierce in a contract case then they are in a tort case. In a tort case, the victims are involuntary creditors. A contract victim is a voluntary creditor. Reverse Veil Piercing - Think of the Farm Case - Reverse piercing typically deals with a shareholder attempting to claim some benefit that is available to them individually, but would not be available if the corporate form is respected. - The shareholder wants you to forget about the corporation, and think of the shareholder individually; "think of me as if I had never formed a corporation."

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Because of the danger of a debtor being able to raise or lower his corporate shield, a reverse pierce should be permitted only in the most carefully limited circumstances. - Courts will allow reverse piercing when the identities of the shareholders and the corporation are so close that they are alter egos of each other (mere instrumentalities). A court will also reverse pierce when strong policies will be furthered such as HOMESTEAD (Farm Case, see page 254) Deep Rock Doctrine: Pepper v. Litton – SH claims he is a creditor of the company - This deals primary with bankruptcy law and/or dissolution of company - When a corporation becomes insolvent and the SH is owed, the courts will generally make him the last creditor (deep rock) Successor Liability – What happens to corporate liability when a company is acquired by another? - Courts are split on the issue (pg. 260)



The problem is that tort victims and occasionally contract creditors who bring law suits after the corp has manufactured the product that caused their injury has disappeared suggests that successor corps should be liable for the injuries caused by the products manufactured by the company that succeeded them. On the other hand, we want to encourage the free transferability of assets – don’t want to spring unexpected liability on companies. And you negotiate the cost based on how long you assume liability for. And if your company has “goodwill” that is going to increase the cost. The liability you assume should be the liability you negotiate for.

Normally, successor companies are NOT liable – but there are four exceptions: 1. There is an express or implied agreement to assume the liabilities 2. The transactions amounts to a consolidation or merger of companies 3. The successor entity is a mere continuation or reincarnation of predecessor entity 4. The transaction was fraudulent, not made in good faith, or made without sufficient consideration Nissen vs. Miller – Issue: Whether there should be a fifth exception added to the general rule. Court ultimately said no. What Should Happen - You negotiate the liability you will assume, and then the company that is selling/dissolving lets the customers know and let them know how long they have. This will affect the cost – if you are the purchaser, you negotiate for how long you will accept liability. The longer you accept liability, the less you pay. The less liability you accept, the more you pay.
Financial Matter and The Corporation - Chapter 7 – pg. 267 DEBT AND EQUITY CAPITAL
Debt Financing Contractual r/s involving promissory

notes orbonds that

Equity Financing Buying stock.

involve a promise to repay the investors’ loan at a certain rate of interest.
Exception: bankruptcy but you can get a charging order and Risk is low b/c it’s a contractual r/s and guaranteed your $$ back. Risk is high. Reward is lower for bonds b/c it’s a fixed amount & interest rate. Reward is higher b/c value of interest goes up. Law and contracts protect bondholders. Stockholders are protected by fiduciary r/s.

Ways to Raise Capital
1. Borrowing funds (from friends or banks) 2. Capital contributions: from owners or persons who wish to remain inactive – outside investors 3. Retaining earnings of the business (rather than distributing them to owners) Debt: must at some point be paid back; interest is paid periodically, and its repayment is not dependent on the earnings of the business. - Secured – Mortgage Bond - Unsecured - Debenture Equity Capital is composed of contributions by: 1. The original entrepreneur(s) 2. Other investors in exchange for ownership interests 3. Retained interests Types of Securites Common shares: represent residual ownership interest; they get whatever is left over after creditors, bondholders, and preferred s/hs are paid. They generally have voting rights but not dividends. Preferred shares: hybrid b/w debt and common stock. It has a preference on dividend versus liquidation. Traditionally not sold publicly, thus preferred stockholders would want conversion rights in articles of a closely held in order to convert their preferred to common if corp goes public. Three types of preferred dividends/shares: 1. Cumulative preferred: if dividends not paid in year 1 they rollover into year 2. 2. Non-cumulative preferred: if no dividends paid in year 1, too bad. 3. Partially cumulative: depends on financial status of corp. Ex: if dividends not paid in year 1 and corp had adequate earnings to pay in year 1, then it rolls over into year 2. NOTE: if you have preferred stock, corp CANNOT elect to be an “S” corp. Classification of Shares (MBCA § 6.01) - Shares may divided up into classes or series within a class, each having varying rights - Classes and Shares MUST be described in articles of incorporation o Prescribe the number of shares in each class o Prescribe distinguishing designation for each class o Describe the rights and preference of the shares - Classifications can include: o Voting Rights o Liquidation Preferences – Dividend and Liquidation right


o o

Redemption Rights – Corporation has the power to redeem or “call” back the preferred shares at any time at a fixed price when corporation anticipates that dividends on preferred may become more expensive than other forms of financing. Conversion Rights Protective Conversion

Participation Rights: If Corp pays out dividends to preferred and common and there is surplus in dividends, then preferred and common share. Non-participating: entitled to specified amount for dividend and liquidation and nothing else. Issuance of of Shares: Herein of Subscriptions, Par Value, and Watered Stock (MBCA § 6.20)  Subscription agreements: occurs when persons agree to purchase a specified number of shares contingent upon a specified number of capital being raised.  Now, we use (mostly) Contractual Agreements to purchase securities.  Does not become a contract until it is accepted by the corporation.  Irrevocable by the subscriber for 6 months unless the corporation release it  Failure to pay, the corporation may collect like any other debt AUTHORIZATION AND ISSUANCE OF COMMON SHARES UNDER THE MBCA  Prices for shares must be the same for, say “A” and “B” shares if they are to be treated equally, but the # of shares and corresponding price may be set at any level. PAR VALUE AND STATED CAPITAL Par value: represents amount that must be paid for shares so that they are issued as fully paid.  Par value is a “may” in RMBCA § 2.02(b)(2)(iv).  Par value does not apply to re-sale only applies to issuance.  MBCA (1969) §§ 54(d), 15 (second sentence), 18, 21.  Par value is whatever amount is designated by the drafter  could be one mill, one cent, etc.  If you issue stock for less than par value then you are liable for difference for what he paid for it and what the par value actually is. (Watered Stock) Watered Stock: stock issued for less than par value.  Two issues: 1. Non-cash consideration given for stock i. BOD gets deference, absent fraud, to accept but has fiduciary duty to assure that property is equivalent to shares issued. 2. Stock issued for less than par value for cash – instant liability.  If you don’t put a par value on the corp, then it is the document’s transactional value.  Cannot not issue for illegal consideration.  Cannot hurt creditors to advance interest of SH and SH economically.  § 45(MBCA) talks about dividends. You can’t pay dividends to SH if creditors would be negatively affected by it. Consideration – Can generally issue stock for any tangible or intangible benefit of the company - EXCEPT:MCBA 19- Promissory notes and Future Services!!!!! (Haneward v. Bryan) pg. 282 Par Value in Modern Practice - Corporate Directors may issue stock for whatever consideration they deem adequate as long as it is done with good faith. - Still may never be sold below the par value

Finance Definitions – Important when dealing with Dividends Stated capital: # of shares x par value Capital surplus: difference in amount paid per share minus par value (x) # of shares. Earned Surplus: the aggregation of income from all profit and loss s/ts going back to the time the corp was organized (i.e. amount of $$ corp has made since its inception).

Debt Financing Debt Securities o Something that must be repaid such as bonds and debentures o Fixed debt is one that has a fixed maturity date. o Periodic payments are typically interest, with total principal due on maturity.

Too much debt hurts - ability to pay it and if debt/equity ratio to high, creditor shareholder may lose their characterization as debt instead of equity.

Leverage o The ability to finance an investment with a small amount of one’s own funds such as down payment with balance consisting of borrowed funds. o The amount of money borrowed by party in business in excess of money or assets invested personally into the business. - Leverage is popular because SH puts less $$ into corp, and gets more $$$ out.. Leverage Important for 2 reasons 1. The more money you borrow, the more profits go to the shareholders 2. Tax Advantages - Interest payments by corp. are deductible as ordinary business expenses - Whereas dividends (from equity) are not deductible and are pure income to shareholders. - Lenders only pay taxes on interest and not principal amount/return of capital - But must watch to make sure lenders are not SH disguising equity as debt. Planning the Capital Structure for the Closely Held Corporation pg. 300 1. Will the structure work? 2. Will it provide the desired result? 3. Will it receive the desired tax treatment? 4. Might it give rise to unexpected liabilities? 5. Are clients financial contributions reasonably protected? Preemptive Rights  A preemptive right is a right of a shareholder to buy the same portion of any new issue of shares by a corporation as the shareholder holds existing shares.  Just like right of first refusal  Under the RMBCA – SH doesn’t have any but may UNLESS stated in AOI  CANNOT be waivered even if in writing  Established to benefit SH from dilution of equity and voting control Distribution in a Closely Held Corporation

3 Types of Distribution 1. Dividends can be paid out 2. Shares can be redeemed 3. Liquidation of companies assets - Problem in closely held corporations that minority shareholders are at the mercy of the majority: - Majority shareholders are on board and officers and get salaries. (minorities don’t) - Majority controls dividends and distributions. (and won’t issue them) - Shareholders are unable to sell there stock on a public market
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General Rule: Courts do not decide whether dividends should be granted. Even if there is surplus, SH are not automatically entitled to dividends unless there is a showing of bad faith or unreasonableness. If courts force dividends, it essentially means the judge is making a business decision Presumption of regularity to the board of directors. Given the protection of the business judgment rule that what they did is lawful.


Fiduciary relationship owed to minority shareholder in a closely held corp – corp had to offer same opportunity to minority shareholder. o Must offer for the same price and owe duty eachother o Majority controller may not use his position for a special advantage  May sell at a premium but not screw the other SH or be oppressive  Owes a duty of care, similar to a partnership
Difference in a corporation compared to a partnership:  When board of directors (majority shareholders) refuse to declare dividends, courts will generally not compel. Under the UPA, partner could dissolve. Under RUPA, he could get the value of his interest.

Management and Control of the Corporation pg. 376 – 406 –Chapter 8 Shareholders:  Own the company  Participate in the profits of the enterprise  Limited involvement in the company’s affairs Board of Directors  Board sets the overall policy for the corporation  Select, evaluate, replace senior management.  Oversee: Strategies, management of corporate resources  Broad policy maker  Responsible to the shareholders  The shareholders elect the board  Other duties as permitted by law Officers:  Manage the corporation  Are appointed by the board

Shareholder Derivative Actions  Direct and Derivative Suits: A shareholder may sue to enforce management’s duties. The suit may be direct or derivative depending on the nature of the claim. o If the claim is that management’s breach reduced the residual value of the business (e.g. shirking or self-dealing), the shareholder must sue Derivatively in the name of the corporation. o If the claim is that management’s breach deprived the shareholder of some other right (other than her contingent right to that residual value, e.g. right to inspect shareholder list), the shareholder must sue Directly in her own name.  Direct suits may also be brought as class actions.  Threat of Derivative “Strike” Suits: A person with a relatively small stake in the residual value of a business might be tempted to bring a derivative suit for the primary purpose of being bought off. Requiring the D to make payment to the corporation reduces this temptation for the complaining shareholder.  Limits on the Derivative Action: In an effort to limit “strike” suits and otherwise protect against over-deterrence, virtually all corporation statutes limit the shareholders who may bring derivative suits, and many states have enacted statutes requiring the plaintiffshareholder in a derivative suit, under certain circumstances, to post a bond or other security to indemnify the corporation against certain of its litigation expenses in the event that the plaintiff loses the suit. o When security must be posted: This varies with state statutes. Some provide that the plaintiff must post security if she owns less than a specified percentage of stock. Others state that security is discretionary with the court (and it is demanded only when there is no reasonable possibility that the action could benefit the corporation. o Who is entitled to security: In most states, only the corp. may demand security and only its expenses may be paid. Some states allow officers and directors to demand security and to receive reimbursement. o Covered Expenses: Normally, all expenses, including attorney’s fees, are covered. Also covered may be expenses of officers and directors that the corp is obliged to pay because it has indemnified them (it may indemnify officers and directors for actions taken in good faith and pursuant to their business judgment, but normally not for fraudulent actions.) o A stockholder who brings a derivative action assumes a position of a fiduciary nature. He sues as a representative of a class that did not elect him as a representative as they elected the corp director or manager. The state has plenary power to impose standards promoting accountability, responsibility, and liability upon such a representative w/o offending the constitution. o Settlements and Attorney’s Fees: When derivative suits reach settlement rather than proceeding to judgment, the company can pay the parties’ attorneys’ fees. When a judgment is rendered against the defendants, however, except as

covered by insurance, the defendants generally will be responsible for attorney’s fees and possibly costs. The Demand Requirement: All corporation statutes regulate settlement of derivative claims as well as requiring the complaining shareholder to exhaust internal remedies before bringing suit. Typical of these statutes is Rule 23.1 of the FRCP. o FRCP 23.1 – “In a derivative action…the complaint shall be verified and shall allege… that the plaintiff was a shareholder or member at the time of the transaction of which he complains or that his share or membership thereafter devolved on him by operations of law… The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors…or the reasons for his failure to obtain the action or for not making the effort. The derivative action may not be maintained if it appears that the plaintiff does not fairly and adequately represent the interests of the shareholders or members similarly situated in enforcing the right of the corp … The action shall not be dismisses or compromised w/o the approval of the court, and notice of the proposed dismissal or compromise shall be given to shareholders or members in such manner as the court directs.” o Delaware Approach: Parallels FRCP 23.1 – a plaintiff would have to allege particularized facts that would create a reasonable doubt about the independence or disinterestedness of the directors or whether the challenged transaction is “otherwise the product of a valid exercise of business judgment.” o “Universal Demand”: Requires a written demand unless “the plaintiff makes a specific showing that irreparable injury to the corp would otherwise result.” If a board rejects a demand, however, the ALI for example would subject the board’s decision to “an elaborate set of standards that calibrates the deference afforded the decision of the directors to the character of the claim being asserted.” The Model Business Corporation Act requires demand, but permits the derivative plaintiff to file suit within 90 days of the demand unless the demand is rejected earlier and to file even earlier if the corporation would otherwise suffer irreparable injury.  Florida has adopted a universal demand requirement!!!!! o New York Approach: E-mail her and ask if we need to know this****** o Abdication Claims:  Whether a claim may proceed as a direct or derivative action depends on the nature of the wrong alleged and the relief sought.  Claims seeking injunctive or prospective relief, like an abdication claim, are more likely to qualify as direct. Futility Exception: o The “futility” exception to the demand requirement permits shareholders to bring claims on behalf of the corporation when it is evident that directors will wrongfully refuse to bring such claims.

The futility exception would swallow the rule if conclusory allegations of wrongdoing against each member of the board excused demand. To qualify for the futility exception, a shareholder must allege with particularity that:  A majority of the board of directors is interested in the challenged transaction, by virtue of self-interest in the transaction or “control” by a self-interested director,  That the board of directors did not fully inform themselves about the challenged transaction to the extent reasonable appropriate under the circumstances, or  That the challenged transaction was so egregarious on its face that it could not have been the product of sound business judgment of the directors. Special Committees o Normally, before a shareholder may bring such a suit, he must request that the directors bring the suit, and they must refuse. If the directors refuse on the basis of a good faith business judgment, the court will dismiss the derivative suit.  Court may look into whether a committee has used good faith in dismissing the suit. Termination by a special litigation committee o A stockholder doesn’t have an individual right, once demand is made and refused, to continue with a derivative suit. o A stockholder has the right to initiate the action himself when demand may be properly excused as futile. o The court must find a balancing point where bona fide stockholder power to bring corporation causes of action cannot be unfairly trampled on by the board, but where the corporation can rid itself of detrimental litigation. Two –Step Process:  1) The court must recognize that he board, even if tainted by selfinterest, can legally delegate its authority to a committee of disinterested directors. However, the court may inquire on its own into the independence and good faith of the committee and the bases supporting its conclusions.  2) Apply its own business judgment as to whether the option to dismiss should be granted  Thus, suits will be heard when corporate actions meet the criteria of the first step, but where the result would terminate a grievance worthy of consideration. o

The Role and Purpose of Corporations Theories: A Corporation must have a Purpose or Goal

Business Theory: Deals in terms of “Strategy”. “Strategy” is the determination of the basic long-term goals and objectives of the company and the adoption of courses of action and the allocation of resources necessary to carry out the basic goals. Strategy includes: o Selection of target markets, definition of basic products to address markets, and determination of the distribution systems (all from among many alternatives) o Matching corporate resources and capabilities with necessary resources and capabilities for possible market alternatives, and, once alternatives have been selected, planning the necessary resources and their allocation. o Selection of alternatives in terms of management’s personal preferences and values. o Selection of alternatives according to perceived obligations by management to segments of society other than the stockholders. Legal Theory: Asks what purposes are within those bound s set by the articles and the statutory law under which the corporation was formed. In effect, the articles are a contract between the state and the incorporators. o Originally, the issue was whether a corporation had exceeded the powers granted under a state-given charter. o More recently, with general incorporation laws, the issue is whether the corporation has remained within the purposes set by the incorporators and the state law. o Closely related to the issue of proper purposes is the issue of proper “powers”. State law often sets forth the acts that a corp. may legally perform. These acts should be in aid of a proper corporate purpose. o If the corporation engages in an improper purpose or uses an improper power, that purpose or act is said to be “ultra vires” (beyond the corp’s power) Distinction between Purposes and Powers: o A Purpose means the end or objective and usually is a statement of the type of business that the corporation will engage in. o A Power means the kind of acts (such a mortgaging property) that a corp may engage in to pursue its corporate purpose.

Powers of a Corporation  Express Powers: A corp. has express power to perform any act authorized by the general corporation laws of the state and those acts authorized by the articles of incorporation. o General Powers: Most states have express statutory provisions allowing, corporations to sue and be sued, own property, make gifts to charity, borrow money, acquire stock in other companies, redeem or purchase corporate stock, etc. o Limitations: Most states also have some express limitations on corporate powers. For example, a transfer of substantially all of a corp’s assets normally requires the approval of a majority of the voting power of the shareholders.  Implied Powers: In most states, corporations also have implied power to do whatever is “reasonably necessary” for the purpose of promoting their express purposes and in aid of

their express powers, unless such acts are expressly prohibited by common or statutory law. Constructive Notice: All parties dealing with a corporation are held to have constructive notice of the corporation’s articles and of state corporation law.

The Objective of the Corporation – The issue here is the extent to which a corp may act in a manner not intended to maximize profits.  Social Responsibility of Corporations – Some argue a corps objective should be to produce the best possible goods and services, that no other legal standard is enforceable, and that any other standard allows an unhealthy divorce between management and ownership. Others say that corps have a “social responsibility” and that they must balance the interests of stockholders, employees, customers, and the public at large. Charitable Contributions Accumulation of Surplus o Corporations are organized primarily for the profit of the shareholders. The directors are to use their powers primarily for that end. They have reasonable discretion, to be exercised in good faith, to act for this end. o Directors have the responsibility to declare dividends and their amounts. Their discretion will not be interfered with unless they are guilty of fraud, misappropriation, or bad faith. Absence of Misconduct o The court will not disturb the “business judgment” of a majority of the directors, absent fraud, illegality, or a conflict of interest. o Corporations aren’t obliged to follow the direction taken by other, similar corporations. Directors are elected for their own business capabilities and not for their ability to follow others.

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The Incorporation Process: 1. Draft Articles of Incorporation a. Content: i. Optional Terms: 607.0202(2) ii. Mandatory Terms: 607.0202(1) 1. The names and addresses of the individuals who are to serve as the initial directors according to .0401. a. Must contain: Corporation, Company, or Incorporation; or the abbreviation Corp., Inc., or Co.; or the designation Corp., Inc. or Co. b. Must be distinguishable: from the names of all other entities or filings, except fictitious name registrations pursuant to 865.09, organized, registered, or reserved under the laws of this state, which names are on file with the Division of Corporations. 2. Registered Agent: 507.0501: Have to accept being a registered agent. Have to be open certain hours so that the process server can find your business open. Downside of being a registered agent because of

the responsibility of taking in paperwork → may be on vacation and miss receiving a summons and result in default judgment. a. How do you become one: file a statement with the state. b. How to you get out of it: you have to file a paper to get out of it. And can appoint one at the same time. c. Each company must have a registered agent. b. Corporation has perpetual duration unless articles state otherwise. c. Putting in too much information may cause you to have to amend your articles, which requires approval, and a fee paid to the state. [i.e.: Don’t put in the optional terms because they likely will change more frequently then the mandatory terms]. d. Difficult to dissolve → shareholder can sell shares but corporations lives on. e. Ultra Vires Doctrine: Beyond the Powers i. Corporate actions beyond its express or implied powers are Ultra Vires. ii. Remedies for Ultra Vires acts: 607.0304: 1. Shareholders suit to obtain injunction or recover damages. 2. Suit by corporation. 3. State action for injunction or dissolution. 2. File articles with the Secretary of State. a. The Incorporator is the one who files the articles. b. Incorporation begins when filing occurs or a date specified. i. 607.0203(1): Unless a delayed effective date is specified, the corporate existence begins when the articles of incorporation are filed or on a date specified in the articles of incorporation, if such date is within 5 business days prior to the date of filing (can’t put a date on there that is 30 days prior and say that you wanted to be a corporation but weren’t, can only be 5 days prior that you can be a corporation, however you can say 30 days early that you want to be a corporation just to file in advance before actually beginning to start working). In Summary: 1. Date prior if within 5 days of filing 2. Delayed date 3. Date you actually filed. 3. Post-Incorporation: a. Draft bylaws (607.0206) b. Organizational meeting (607.0205) i. Name directors, if necessary ii. Adopt bylaws iii. Appoint officers c. Issue Stock Direct vs. Derivative Actions A shareholder can bring two types of actions: 1. Direct Action: Shareholder brings direct action when the shareholder experiences direct harm by the corporation. a. Compel payments of dividends or inspection of books b. Compel shareholder meeting c. Enforce voting rights. d. Brought by the shareholder in his or her own name

e. Cause of acting belonging to the shareholder in his or her individual capacity f. Arises from an injury directly to the shareholder 2. Derivative Action: (607.07401): Shareholder brings a derivative action when the corporation experiences harm which indirectly harms the Shareholder. a. The indirect harm is usually a loss of value of his or her stock. b. An indirect injury to the shareholder c. Suit is brought for breach of fiduciary duty d. Recovery is to corporation e. Derivative suits allow shareholders to hold directors accountable i. Supreme Court called it a “remedy born of stockholder helplessness” f. Remember 90 day requirement g. Brought by a shareholder on corporations behalf h. Cause of action belongs to the corporation as an entity i. Arises out of an inquiry done to the corporation as an entity.  The Shareholder Derivative Action is a procedure by which a shareholder may enforce the substantive rights of a corporation. o i.e.: If the agents of a corporation do something wrong, they are not likely to sue themselves. Therefore, state corporate law provides shareholders the right to sure, on behalf of the corporation.  Florida Law: Derivative Actions: 607.07401: o (3): When the Court may dismiss a derivative action:  The court may dismiss a derivative proceeding if, on motion by the corporation, the court finds that one of the groups specified below has made a determination in good faith after conducting a reasonable investigation upon which its conclusions are based that the maintenance of the derivative suit is not in the best interests of the corporation. The corporation shall have the burden of proving the independence and good faith of the group making the determination and the reasonableness of the investigation. The determination shall be made by:  (a) A majority vote of independent directors present at a meeting of the board of directors, if the independent directors constitute a quorum;  (b) A majority vote of a committee consisting of two or more independent directors appointed by a majority vote of independent directors present at a meeting of the board of directors, whether or not such independent directors constitute a quorum; or  (c) A panel of one or more independent persons appointed by the court upon motion by the corporation. o (1): A person may not commence a proceeding in the right of a domestic or foreign corporation unless the person was a shareholder of the corporation when the transaction complained of occurred or unless the person became a shareholder through transfer by operation of law from one who was a shareholder at that time.  Must be a shareholder at the time of the wrongdoing.  Operation of law: usually by inheritance, etc.  Have to be a shareholder at the time the lawsuit begins. In Florida it is kind of open as to whether one has to be a shareholder the whole time of the lawsuit. EXAM NOTE → Would either be didn’t have it at the time or did, wouldn’t state that it was sold during the lawsuit.

Damages and Attorney’s Fees Any recovery goes to the corporate treasury, whether by settlement or trial victory Lawyer is real party in interest o Lawyer can get contingent fee out of any recovery o BUT corporation also must pay plaintiff’s legal fees if there is a substantial nonmonetary benefit 607.07401 (6) o In FL, corporation could also get attorney’s fees 607.07401 Basic Policy Issue When, if ever, should the corporation acting through the board of directors or a committee of directors, be permitted to prevent or terminate a derivative action? o Put another way, who gets to control the litigation: the shareholders or the corporation’s board of directors. Demand Futility Demand Required o Unless Excused  Excused when Futile - What is the standard for Demand Futility? o Del: Grimes v. Donald o NY: Marx v. Akers - The basis for claiming excusal would normally be that:  A majority of the board has a material financial interest or familial interest  A majority of the board is incapable of acting independently for some other reason such as domination of control  The underlying transaction is not the product of a valid exercise of business judgment. Test: Must determine who suffered the most harm [the shareholder or the company]? OR who gets the payout? OR who did the duty run?. Potential abuses – strike suits/nuisance suit brought for settlement; meritorious suits settled too easily (suffer a loss just to avoid a strike suit – willing to take a hit for avoidance) Plaintiff incentives – recovery goes to the corporation’s treasury; lawyer is a real party in the interest and gets a contingent fee out of recovery; corporation must pay the legal fees if substantial nonmonetary benefit, under 607.07401(6). In Florida, corporation could also get attorney’s fees. Policy issue – when should corporation be permitted to prevent or terminate a derivative action? Who gets to control litigation? Shareholder or Board of Directors? Examples: Breach of Fiduciary Duty - Derivative Failure to pay out Dividends to Shareholders – Direct Rational Plaintiff A rational plaintiff will file derivative suit before making demand o Consequences of not making demand trivial – if required, slight delay while you make demand




Preserves right to litigate:  Demand Futility

F.S. 607.07401 Demand Requirement  (2) Must allege with particularity the demand made to obtain action by the board of directors and that the demand was refused or ignored by the board of directors for a period of at least 90 days from the first demand unless, prior to the expiration of the 90 days the person was notified in writing that the corporation rejected the demand or unless irreparable injury to the corporation would result by waiting for the expiration for the 90 day period.  (3) MAY dismiss of one of the 3 groups made a good faith determination after conducting a reasonable investigation that the suit is not in the best interests of the corp. o Corp has burden of proving the independence and good faith of he group and the reasonableness of the investigation o 3 groups found in subsection A-C

The Duties of Officers, Directors, and Other Insiders
Corporation Breakdown: Shareholders

Board of Directors



Shareholders:  Own the company  Participate in the profits of the enterprise  Limited involvement in the company’s affairs Board of Directors     Board sets the overall policy for the corporation Select, evaluate, replace senior management. Oversee: Strategies, management of corporate resources Broad policy maker

 Responsible to the shareholders  The shareholders elect the board  Other duties as permitted by law Officers:   Manage the corporation Are appointed by the board

Roles and Purposes of the Corporation:  Rule: Corporations are permitted to make charitable donations if the board deems it appropriate and it is in accord with the relevant state statute. o “The basic rule of corporate choice of law in all states is that the law of the state of incorporation controls on issues relating to shareholders. [Based on the state of incorporation]. EXAM NOTE → Donations could be tied to conflict of interest. CEO’s wife could start a charity and they start donating all their money to her rather than the other donations they use to give. So would argue that it is a donation acceptable under 0302 but would be a conflict of interest.

Problem 269-270: Corporation wants to donate $100K anonymously to a charity in which the corporation’s CEO has a good friend involved in the organization. Can he make the donation anonymously? o The director can only make the donation in furtherance of what is in the best interest of the corporation. o FSA 607.0302: General Powers  (12): To make donations for the public welfare or for charitable, scientific, or educational purposes.  Articles of incorporation can say no charitable gifts, or gifts over a certain percentage.  Unless its articles of incorporation provide otherwise, every corporation has perpetual duration and succession in its corporate name and has the same powers as an individual to do all things necessary or convenient to carry out its business and affairs, including without limitation power.  Donation = tax break for the corporation o There is no clear cut answer as to whether the anonymity would be an issue. Would have to argue both sides on an EXAM for what the pros and cons would be in donating anonymously. Highlight the tax break, the trickledown effect of donating money to the community, as well as the importance of recognition and what the shareholders response would be to not getting the recognition.

FSA 607.0801: Requirements for and Duties of a Board of Directors:  Each corporation must have a board of directors except as provided in .0732(1).

All corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation managed under the direction of, its board of directors, subject to any limitation set forth in the articles of incorporation or in an agreement authorized under s. 607.0732.

FSA 607.0802: Qualifications of Directors:  Directors must be natural persons who are 18 years of age or older but need not be residents of this state or shareholders of the corporation unless the articles of incorporation or bylaws so require. The articles of incorporation or bylaws may prescribe additional qualifications for directors.

FSA 607.0803: Number of Directors:    A board of directors must consist of one or more individuals, with the number specified in or fixed in accordance with the articles of incorporation or bylaws. (2) The number of directors may be increased or decreased from time to time by amendment to, or in the manner provided in, the articles of incorporation or the bylaws. (3) Directors are elected at the first annual shareholders' meeting and at each annual meeting thereafter unless their terms are staggered under s. 607.0806.

FSA 607.0804: Election of Directors by certain Voting Groups:  The articles of incorporation may confer upon holders of any voting group the right to elect one or more directors who shall serve for such term and have such voting powers as are stated in the articles of incorporation. The terms of office and voting powers of the directors elected in the manner provided in the articles of incorporation may be greater than or less than those of any other director or class of directors. If the articles of incorporation provide that directors elected by the holders of a voting group shall have more or less than one vote per director on any matter, every reference in this act to a majority or other proportion of directors shall refer to a majority or other proportion of the votes of such directors.

FSA 607.0805: Terms of Directors      The terms of the initial directors of a corporation expire at the first shareholders' meeting at which directors are elected. (2) The terms of all other directors expire at the next annual shareholders' meeting following their election unless their terms are staggered under s. 607.0806. (3) A decrease in the number of directors does not shorten an incumbent director's term. (4) The term of a director elected to fill a vacancy expires at the next shareholders' meeting at which directors are elected. (5) Despite the expiration of a director's term, the director continues to serve until his or her successor is elected and qualifies or until there is a decrease in the number of directors.

FSA 607.0807: Resignation of Directors:

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A director may resign at any time by delivering written notice to the board of directors or its chair or to the corporation. (2) A resignation is effective when the notice is delivered unless the notice specifies a later effective date or an effective date determined upon the subsequent happening of an event. If a resignation is made effective at a later date or upon the subsequent happening of an event, the board of directors may fill the pending vacancy before the effective date occurs if the board of directors provides that the successor does not take office until the effective date. (3) A resignation that specifies a later effective date or that is conditioned upon the subsequent happening of an event may provide that the resignation is irrevocable.

FSA 607.0808: Removal of Directors by Shareholders:    The shareholders may remove one or more directors with or without cause unless the articles of incorporation provide that directors may be removed only for cause. (2) If a director is elected by a voting group of shareholders, only the shareholders of that voting group may participate in the vote to remove him or her. (3) If cumulative voting is authorized, a director may not be removed if the number of votes sufficient to elect the director under cumulative voting is voted against his or her removal. If cumulate voting is not authorized, a director may be removed only if the number of votes cast to remove the director exceeds the number of votes cast not to remove him or her. (4) A director may be removed by the shareholders at a meeting of shareholders, provided the notice of the meeting states that the purpose, or one of the purposes, of the meeting is removal of the director.

FSA 607.0820: Meetings:   (1) The board of directors may hold regular or special meetings in or out of this state. (2) A majority of the directors present, whether or not a quorum exists, may adjourn any meeting of the board of directors to another time and place. Unless the bylaws otherwise provide, notice of any such adjourned meeting shall be given to the directors who were not present at the time of the adjournment and, unless the time and place of the adjourned meeting are announced at the time of the adjournment, to the other directors. (3) Meetings of the board of directors may be called by the chair of the board or by the president unless otherwise provided in the articles of incorporation or the bylaws. (4) Unless the articles of incorporation or bylaws provide otherwise, the board of directors may permit any or all directors to participate in a regular or special meeting by, or conduct the meeting through the use of, any means of communication by which all directors participating may simultaneously hear each other during the meeting. A director participating in a meeting by this means is deemed to be present in person at the meeting. FSA 607.0820: Meeting: Board of Directors act as a group, they do not act independently. Typically together in a room, not independently. Statutes provide for use of modern technology. Do not have to be physically present, but must be able to hear each other and participate in the discussion, don’t have to actually see each other. o Necessary to fulfill their fiduciary duty obligation of making an informed decision. The information sharing is suppose to occur at the board meeting.

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FSA 607.0821: Actions by Directors without a Meeting: Acting without a meeting is possible when all directors give written, signed consent and is unanimous. And effective when last consent signed. o Permits you to conduct the same business without holding a formal meeting. Still provides for the ability to hear and discuss. o EXAM NOTE → pay attention to fact patterns where they sign on different days! FSA 607.0823: Waiver of Notice: Notice of a meeting of the board of directors need not be given to any director who signs a waiver of notice either before or after the meeting. Attendance of a director at a meeting shall constitute a waiver of notice of such meeting and a waiver of any and all objections to the place of the meeting, the time of the meeting, or the manner in which it has been called or convened, except when a director states, at the beginning of the meeting or promptly upon arrival at the meeting, any objection to the transaction of business because the meeting is not lawfully called or convened. FSA 607.0824: Quorum: Can discuss all you want in a meeting but cannot vote or pass anything unless quorum is met. o Must be proper notice of the meeting  FSA 607.0822: Notice of Meetings:  (1) Unless the articles of incorporation or bylaws provide otherwise, regular meetings of the board of directors may be held without notice of the date, time, place, or purpose of the meeting. o No notice required for regular meetings where notice is provided by by-laws.  (2) Unless the articles of incorporation or bylaws provide for a longer or shorter period, special meetings of the board of directors must be preceded by at least 2 days' notice of the date, time, and place of the meeting. The notice need not describe the purpose of the special meeting unless required by the articles of incorporation or bylaws. o At a special meeting, the board can only act on matters noticed in advanced, if notice of purpose is announced. o Notice for special meetings can be waived in writing before or after a meeting, attendance at meeting is considered a waiver. Attendance at meeting is a waiver, unless attendance is to object that it wasn’t properly noticed and you are waiving that. 607.0823. o Majority of the board of directors must be present

FSA 607.0821: Actions By Directors without a Meeting:  (1) Unless the articles of incorporation or bylaws provide otherwise, action required or permitted by this act to be taken at a board of directors' meeting or committee meeting may be taken without a meeting if the action is taken by all members of the board or of the committee. The action must be evidenced by one or more written consents describing the action taken and signed by each director or committee member. (2) Action taken under this section is effective when the last director signs the consent, unless the consent specifies a different effective date. (3) A consent signed under this section has the effect of a meeting vote and may be described as such in any document.

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FSA 607.0822: Notice of Meetings:   (1) Unless the articles of incorporation or bylaws provide otherwise, regular meetings of the board of directors may be held without notice of the date, time, place, or purpose of the meeting. (2) Unless the articles of incorporation or bylaws provide for a longer or shorter period, special meetings of the board of directors must be preceded by at least 2 days' notice of the date, time, and place of the meeting. The notice need not describe the purpose of the special meeting unless required by the articles of incorporation or bylaws.

FSA 607.0823: Waiver of Notice:  Notice of a meeting of the board of directors need not be given to any director who signs a waiver of notice either before or after the meeting. Attendance of a director at a meeting shall constitute a waiver of notice of such meeting and a waiver of any and all objections to the place of the meeting, the time of the meeting, or the manner in which it has been called or convened, except when a director states, at the beginning of the meeting or promptly upon arrival at the meeting, any objection to the transaction of business because the meeting is not lawfully called or convened.

FSA 607.0824: Quorum and Voting     Unless the articles of incorporation or bylaws require a different number, a quorum of a board of directors consists of a majority of the number of directors prescribed by the articles of incorporation or the bylaws. (2) The articles of incorporation may authorize a quorum of a board of directors to consist of less than a majority but no fewer than one-third of the prescribed number of directors determined under the articles of incorporation or the bylaws. (3) If a quorum is present when a vote is taken, the affirmative vote of a majority of directors present is the act of the board of directors unless the articles of incorporation or bylaws require the vote of a greater number of directors. (4) A director of a corporation who is present at a meeting of the board of directors or a committee of the board of directors when corporate action is taken is deemed to have assented to the action taken unless the director: o (a) Objects at the beginning of the meeting (or promptly upon his or her arrival) to holding it or transacting specified business at the meeting; or o (b) Votes against or abstains from the action taken.

The Obligations of Control  Duty of Care o Introduction: Directors are normally, by law, held to have the duty of management of the corporation. These duties are normally deleted to the officers; thus, the directors must supervise the officers. The legal duties of the





directors and officers are owed to the corporation; thus, performance of these duties is usually enforced by an action on behalf of the corporation brought by and individual shareholder (called a “derivative suit”). The Fiduciary Relationship of Directors to the Corporation: Directors are said to occupy a “fiduciary” position in relationship to the corporation and the management of its affairs (since they manage on behalf of the shareholders). This relationship has resulted in several legal standards that are applied to directors.  Duties of Loyalty and Good Faith – Directors are bound by rules of fairness, loyalty, honesty, and good faith in their relationship, dealings, and management of the corporation (as are officers.)  Duty of Reasonable Care – In addition, directors must exercise reasonable care, prudence, and diligence in the management of the corporation.  Business Judgment – “Business Judgment Rule” states that when a matter of business “judgment” is involved, the directors meet their responsibility of reasonable care and diligence if they exercise an honest, good faith, unbiased judgment. When this standard is applied, a director acting in good faith would only be liable for gross negligence or worse. Damages  Cause of Action – To form a cause of action, it must be shown that the director failed to exercise reasonable care and that, as a direct and proximate result, the corporation has suffered damages.  Joint and Several Liability – Either one director may be held liable for her own acts, or all directors may be held liable (all those participating in the negligent act). If more than one director is held responsible, liability is joint and several. The Duty of Reasonable Care  Specific traits, backgrounds, and abilities of directors: the specific circumstances of each director must be considered in determining whether that director violated her duty of care.  EX: if the director is not a resident of the state where the corporation is located, perhaps the director’s duty of care would be less than that for resident directors.  Standard Used: Courts look at the facts and determine whether the total situation is one in which the directors or officers should be held liable. Thus, they determine whether the director knew or reasonably should have known of the situation, and whether the director could reasonably have done anything about it.  This is applied to each director individually. Informed Business Judgment

Declaring a Dividend – The question of whether a dividend should be declared or a distribution of some kind should be made is exclusively a matter of business judgment for the board of directors.  Mere errors of judgment are not sufficient as grounds for equity interference, for the powers of those entrusted with corporate management are largely discretionary.  More than Imprudence or mistaken judgment must be shown. Informed Judgment in Merger Proposals  The business judgment rule presumes that directors act on an informed basis, in good faith, and in an honest belief that their actions are for the good of the company.  Plaintiffs must rebut this presumption.  Directors can be held liable if they are grossly negligent in failing to inform themselves. Director must be Familiar with the Company and Business  Directors are under a statutory duty to act in good faith as ordinarily prudent persons would under similar circumstances in like positions.  Generally, a director should have a basic understanding of the corporation’s business and knowledge about its ongoing activities, which require a general monitoring of its affairs and policies. The director has a responsibility to attend board meetings and regularly review financial statements. If there is illegal conduct, a director has the duty to object, and possibly either take reasonable means to prevent such conduct or resign.  The causation issue requires determining what reasonable steps a director could have taken and whether those steps would have prevented the loss. The failure to act must be a substantial factor in producing the harm.

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Florida Law: Look at 607.0830 duty of care and refer to (3): o In discharging his or her duties, a director may consider such factors as the director deems relevant, including the long-term prospects and interests of the corporation and its shareholders, and the social, economic, legal, or other effects of any action on the employees, suppliers, customers of the corporation or its subsidiaries, the communities and society in which the corporation or its subsidiaries operate, and the economy of the state and the nation. Rule: “In a purely business corporation the authority of the directors in the conduct of the business of the corporation must be regarded as absolute when they act within the law, and the court is without authority to substitute its judgment for that of the directors. Duty of Care: Exercise their best business judgment, exercise duty of care. o FSA: 607.0830(1): Directors are to act:  In good faith; AND


With the care of an ordinarily prudent person in a like position would exercise under similar circumstances; AND  In a manner he or she reasonably believes to be in the best interest of the corporation. Applying Florida Law: Apply .0830 to set the standards. Breach of standards would then apply .0831 to determine liability.  Standard in Florida is good faith. The court here found good faith.  Care of an ordinarily prudent person. Court said that it was based on personal opinion.  Best interest of the corporation. The court presumed that he acted in best interest, looked at legality of his actions. 

Exercising bad judgment does not constitute a breach of duty of care. Making a bad decision and just looking at the bottom line is not a breach of duty of care. o A director is not chargeable with ordinary negligence for having made an improper decision or having acted imprudently.  The court defines negligence as neglect of duties (i.e.: malfeasance or nonfeasance) and not simply misjudgment.  “The question of whether or not a dividend is to be declared or a distribution of some kind should be made is exclusively a matter of business judgment for the Board of Directors.”  Don’t substitute judicial judgment for the board of director’s judgment. If you don’t like what the directors are doing, vote them out and get new ones that will run the company the way you want. As long as they are exercising business judgment (even if bad) it is ok. Note: Courts will intervene when refusal to pay a dividend would amount to such an abuse of discretion as would constitute a fraud or breach of that good faith which they are bound to exercise towards the stockholders.  Duty of Care includes a duty to acquire at least a rudimentary understanding of the business of the corporation. o Directors are under a continuing obligation to keep informed about the activities of the corporation. o Directors may not shut their eyes to corporate misconduct and then claim that because they did not see the misconduct, they did not have a duty to look. o Directorial management does not require a detailed inspection of day-to-day activities, but rather a general monitoring of corporate affairs and policies. o What if a director resigns and there is a vacancy on the board? Refer to Florida Statute 607.0809. Shareholders can have an election or the remaining directors may fill the position.  Vacancy on Board: Whenever a vacancy occurs on a board of directors, including a vacancy resulting from an increase in the number of directors, it may be filled by the affirmative vote of a majority of the remaining directors, though less than a quorum of the board of directors, or by the shareholders, unless the articles of incorporation provide otherwise. Applying Florida Law: o 607.0830(2) allows a director to rely on the other directors:  In discharging his or her duties, a director is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, if prepared or presented by:

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(a) One or more officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the matters presented;  (b) Legal counsel, public accountants, or other persons as to matters the director reasonably believes are within the persons' professional or expert competence; or  (c) A committee of the board of directors of which he or she is not a member if the director reasonably believes the committee merits confidence. .0830(4): A director is not acting in good faith if he or she has knowledge concerning the matter in question that makes reliance otherwise permitted by subsection (2) unwarranted. .0830(1): what a reasonably prudent person would do. Could argue that a reasonably prudent person who was on notice that another director was acting in bad faith would inquire or somehow seek help or release her duties in the corporation.

Duty of Loyalty o Directors and Managers - The directors owe a duty of loyalty to the corporation. This means they must place the interests of the corporation above their own personal gains.  Problems arise when they are found to have other business involvements. Self-Interested Transactions – Rules have evolved  Common Law – any contract between a director and her corp, whether fair or not, was voidable by means of a shareholder derivative suit.  Disinterested Majority Rule – Later courts began to hold and some still do, that conflict of interest dealings were voidable only if the director had not made a full and complete disclosure of the transaction (its value, her interest, etc.) to an “independent board” (quorum of disinterested directors) or the transaction was shown to be unfair and unreasonable to the corporation. If either condition was absent the contract could be voided.  The Liberal Rule – Many courts now hold that it makes no difference whether the board is disinterested or not. The issue is whether the transaction is fair to the corporation. Part of the “fairness” requirement is that the director’s interest be fully disclosed. If the board is not disinterested, the contract will be given very close scrutiny.  The burden is on the directors to show the good faith of the transaction, but also to show inherent fairness to the corporation.


Delaware law provides a safe harbor for interested transactions if the material facts as to the director’s interest are disclosed and the board in good faith authorizes the transaction by a vote of a majority of the disinterested directors. Corporate Opportunities  The duty of loyalty of directors and officers to the corp. prevents them from taking opportunities for themselves that should belong to the corporation. 1. Use of Corporate Property – EX: a director can’t use corp. prop/assets to develop their own business or for personal use. 2. Corporate Expectancies - A director or officer may not assume for herself properties or interests in which the corp. is “interested”, or in which the corp. can be said to have a tangible “expectancy, or which are important to the corp.’s business purposes. a. EX: if a corp. has leased a piece of property a director can’t buy it for herself. b. If it is “Reasonably Foreseeable” that the corp. would be interested in the property, then there is the necessary expectancy. If opportunities relate very closely tot eh business of the corp., there is also the necessary expectancy. 3. Defenses to the Charge of Usurping a Corporate Opportunity a. Individual Capacity – Def’s may claim that the opportunity was presented to them in their individual capacities, and not as fiduciaries of the corp. b. Corp unable to take advantage of the opportunity – The law is now that an officer or director may take advantage of a corporate opportunity if it is disclosed to the corporation first and the corporation is unable to take advantage of it. 4. Corporation Refuses the Opportunity – If the opportunity, by independent directors or shareholders, turns down an opportunity, then fiduciaries may take advantage of the opportunity. 5. Remedies – If the fiduciary has usurped a corporate opportunity, then the corp. has the following remedies:


a. Damages – when the opportunity has been resold, the profits made by the fiduciary may be recovered by the corporation. b. Constructive Trust – The Corporation may force the fiduciary to convey the property to the corporation at the fiduciary’s cost. 6. Competition with the Corporation – Another area of conflict of interest arises when a director or officer enters into competition with the corporation. a. Use of corporate assets, property, trade secrets, etc. –A fiduciary may not use corporate assets, property, materials, trade secrets, etc to form a competing business. b. Formation of a Competing Business – A fiduciary (without using corporate assets) may leave the corp. and form a competing business. In some instances, the conduct of the fiduciary whole still with the corp. and preparing to leave to form the new business is questioned. 7. Collateral Investment Opportunities Dominant Shareholders  Shareholders aren’t free in every instance to cast their votes as they want.  They have responsibilities, in some cases, to the other shareholders.  EX: a shareholder can’t sell their vote  Also, a majority vote is not always effective where it is “unfair” to the minority shareholders.  Duty of Loyalty and Good Faith  The majority shareholders have a fiduciary relationship to the corporation and the minority shareholders.  EX: if a majority shareholder deals with the corporation (such as in a contractual relationship) the transaction will be closely scrutinized to see that minority shareholders are treated fairly.  Standard to be Applied: o Where there is self-dealing, the intrinsic fairness test must be applied, which puts the burden on the majority shareholders to show that the transaction with the subsidiary was objectively fair. o Business Judgment Rule – court will not disturb a transaction under this rule unless there is a showing of fraud or gross overreaching  Liquidation:


A majority shareholder may vote according to his own interests. o But a majority shareholder also has a fiduciary duty to the corp. and the minority shareholders the same as the directors. Actions taken by a majority must, therefore, meet the standards of fairness and good faith. o Directors owe a duty to All shareholders to act in their best interest. Ratification and the Business Judgment Rule:  Directors have a fiduciary duty to disclose fully and fairly all material facts that would have a significant effect on a shareholders vote.  When a board’s action has been ratified by shareholder’s the standard of review and burden of proof depends on the type of underlying transaction. There are two categories:  In “Interested Director” transactions, approval by fully informed, disinterested shareholders invokes the business judgment rule which limits judicial review to issues of waste or gift. The burden of proof is on the party attacking the transaction.  Second category involves transactions between the corporation and a controlling shareholder. These cases usually involve parentsubsidiary mergers. In that situation, the standard of review is normally entire fairness, with the directors having the burden of proof. o

A standard of liability for Business Judgment Rule: o Directors may be held liable for gross negligence in failing to make an informed decision. Business Judgment Rule is a valid defense when you have made the informed decision.   Defense to duty of care is the business judgment rule Defense to duty of loyalty:  1) Transaction is fair  2) Ratification by directors  3) Ratification by shareholders  If you can get your Plaintiff to argue either, breach of duty of loyalty is better because there is no business judgment defense to deal with. Burden of Proof for Breach of Duty of Loyalty? o Δ must prove that what they were doing was fair to the corporation or ratification. [See defenses listed above].  In Florida could also show ratification – See 607.0832:  (1) No contract or other transaction between a corporation and one or more of its directors or any other corporation, firm, association, or entity in which one or more of its directors are directors or officers or are financially interested shall be either void or voidable because of such relationship or interest, because such director or

directors are present at the meeting of the board of directors or a committee thereof which authorizes, approves, or ratifies such contract or transaction, or because his or her or their votes are counted for such purpose, if: o (a) The fact of such relationship or interest is disclosed or known to the board of directors or committee which authorizes, approves, or ratifies the contract or transaction by a vote or consent sufficient for the purpose without counting the votes or consents of such interested directors; o (b) The fact of such relationship or interest is disclosed or known to the shareholders entitled to vote and they authorize, approve, or ratify such contract or transaction by vote or written consent; or o (c) The contract or transaction is fair and reasonable as to the corporation at the time it is authorized by the board, a committee, or the shareholders. The Obligation of Good Faith o o o Directors and officers have a fiduciary duty to act in good faith in their relationships, dealings, and management of the corporation. Recall – Under the Business Judgment Rule, a director acting in good faith is only liable for gross negligence or worse. 3 different categories of fiduciary behavior are candidates for a “bad faith” label: 1. Subjective Bad Faith – where the conduct is motivated by an actual intent to do harm. 2. Involves action taken solely through gross negligence, without any malevolent intent. Gross negligence without more does not constitute bad faith. 3. Falls between the first two. Legally appropriate definition of bad faith. To prove corporate waste, a P must prove that the exchange was so one-sided that no business person of ordinary, sound judgment would conclude that the corporation received adequate consideration. Advisory Fees - A fiduciary must make full disclosure and play no tricks but is not subject to a cap on compensation.  The trustees not the court, should determine how much the advisory services are worth.  Investors can protect their interests by shopping around rather than seeking to have the courts regulate advisory fees through litigation. Oversight – Directors have a duty to attempt in good faith to ensure that the corp. has adequate internal control systems that are reasonably designed to prevent employees from engaging in illegal acts. A showing of bad faith conduct is essential to establish director oversight liability.





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Failure to act in good faith requires conduct that is different form, and more culpable than, conduct giving rise to a violation of the fiduciary duty of care. The obligation to act in good faith doesn’t establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty. Only the duties of care and loyalty, where violated, may directly result in liability; a failure to act in good faith may do so, but indirectly. Where directors fail to act in the face of a known duty to act, thereby showing a conscious disregard for their responsibilities, they breach their duty of loyalty by failing to discharge their fiduciary obligations in good faith. Sustained and systematic failure of a board to exercise oversight over its employees will establish the lack of good faith that is a necessary condition to liability. Necessary Requirements for Director Oversight Liability: 1. The directors utterly failed to implement any reporting systems or controls, or; 2. Having implemented such a system or controls, consciously failed to monitor the operations. Imposition of liability requires a showing that the directors knew they were not discharging their fiduciary obligations. By consciously disregarding their responsibilities, they breach their duty of loyalty.

Breach of Fiduciary Duty Review: 1) Duty of Care: FSA 607.0830 (General Standards for Directors) → You need 3 things (π would show that the director did not do the following therefore they have the burden): i. Lacked good faith. ii. Failed to act like a reasonable prudent person in similar circumstances. iii. Failed to act in a manner in the best interest of the corporation. b. Looking for an informed decision → get around the Business Judgment rule without this claim. i. Drunken widow, baseball case, VanGorkom, Ford c. Defense: Business Judgment Rule i. Absent fraud or waste there is protection by the business judgment rule. 1. i.e.: Amex didn’t add up to waste. ii. Once Δ raises this defense the π has to prove that it was such a bad decision it was wasteful. 2) Duty of Loyalty: FSA 607.0832 (Director Conflict of Interest). Triggered by conflict of interest, unless, the director or officer took a corporate opportunity. π has the burden of proving either conflict of interest or that they took a corporate opportunity. a. Conflict of Interest: (on both sides of the transaction). i. Opera singing wife (argued conflict in hiring his wife). b. Was it actually a corporate opportunity? Meinhard. i. 4 elements courts look at to determine if it was in fact a corporate opportunity: You do not need all of them, however, need at least line of business or interest/expectancy, the more you have the better. 1. Corporation is financially able to take the opportunity.

c. Defenses: i. Conflict of Interest: 3 ways to defend: 607.0832(1)(a)-(c): 1. Fairness → Opera singing wife a. Corporation has the burden of proving ultimate fairness 2. Ratification by Director: Fliegler and Wheelabrator cases. FSA 607.0832(2) a. Informed decision by the directors without the influence or vote of any interested directors. 3. Ratification by Shareholders: FSA 607.0832(3) ii. Corporate Opportunity: wasn’t a corporate opportunity, if I did take something I disclosed it. d. What if you are just an agent of the corporation and not a director or officer? Depends: ASK: i. What is their job in the corporation (nature of or responsibilities)? May come closer to having to disclose if you are in a position in which you would have direct interaction with the transaction at issue. i.e.: you work in the purchasing department and would have to negotiate the transaction for a purchase of land and you hear about the land deal outside of the office → would have to disclose you were interested in it if it could also be a corporate opportunity. ii. How did they hear about it? iii. What is the nature of the deal? 3) When the π can prove bad faith they will have some sort of relief. Good faith (which comes from FSA 607.0830 is an overarching requirement of the duty of care and duty of loyalty). Look at Disney case for what would be bad faith. a. Conduct motivated by subjective bad faith (i.e.: an actual intent to do harm). b. Intentional dereliction of duty, a conscious disregard for one’s responsibilities. c. Gross negligence DOES NOT equal bad faith. - Personal Liability of Director: 0832 and 0831(a) & (b), need 1 of 5 (b)’s. o 0831 applies to both duty of care and duty of loyalty issues. - EXAM NOTE → Would analyze both DoL and DoC because business judgment rule is a stronger defense for the directors, etc. and always say “assuming that there was a breach liability arises under .0831” FSA 607.0832 Directors Conflict of Interest:

a. Saying I knew that the corporation couldn’t afford it is not enough, you still have to disclose, give the corporation the opportunity to get loans or donations to take advantage of the opportunity. 2. Opportunity is in the corporation’s line of business. a. eBay case → look at how broadly the court interpreted eBay’s line of business. 3. Corporation has an interest or expectancy in the opportunity. a. Meinhard: Had been invested in the building, dealing in the real estate for 20 years, etc. 4. Embracing the opportunity would create a conflict between director’s self-interest and that of the corporation.

(1): No contract or other transaction between a corporation and one or more of its directors or any other corporation, firm, association, or entity in which one or more of its directors are directors or officers or are financially interested shall be either void or voidable because of such relationship or interest, because such director or directors are present at the meeting of the board of directors or a committee thereof which authorizes, approves, or ratifies such contract or transaction, or because his or her or their votes are counted for such purpose, if (Directors Defenses): (a): the fact of such relationship or interest is disclosed or known to the board of directors or committee which authorizes, approves, or ratifies the K or transaction by a vote or consent sufficient for the purpose without counting the votes or consents of such interested directors; 1. Directors vote couldn’t count if the director had an interest in what was being voted on. There has to be full disclosure by the director (b): The fact of such relationship or interest is disclosed or known to the shareholders entitled to vote and they authorize, approve, or ratify such contract or transaction by vote or written consent; or (c): (See Fairness Above): The contract or transaction is fair and reasonable as to the corporation at the time it is authorized by the board, a committee, or the shareholders. (2) For purposes of paragraph (1)(a) only, a conflict of interest transaction is authorized, approved, or ratified if it receives the affirmative vote of a majority of the directors on the board of directors, or on the committee, who have no relationship or interest in the transaction described in subsection (1), but a transaction may not be authorized, approved, or ratified under this section by a single director. If a majority of the directors who have no such relationship or interest in the transaction vote to authorize, approve, or ratify the transaction, a quorum is present for the purpose of taking action under this section. The presence of, or a vote cast by, a director with such relationship or interest in the transaction does not affect the validity of any action taken under paragraph (1)(a) if the transaction is otherwise authorized, approved, or ratified as provided in that subsection, but such presence or vote of those directors may be counted for purposes of determining whether the transaction is approved under other sections of this act. (3) For purposes of paragraph (1)(b), a conflict of interest transaction is authorized, approved, or ratified if it receives the vote of a majority of the shares entitled to be counted under this subsection. Shares owned by or voted under the control of a director who has a relationship or interest in the transaction described in subsection (1) may not be counted in a vote of shareholders to determine whether to authorize, approve, or ratify a conflict of interest transaction under paragraph (1)(b). The vote of those shares, however, is counted in determining whether the transaction is approved under other sections of this act. A majority of the shares, whether or not present, that are entitled to be counted in a vote on the transaction under this subsection constitutes a quorum for the purpose of taking action under this section.   Duty of Care: Look to 607.0830 when setting the standard of due care requires good faith:

EXAM NOTE → Mention good faith/bad faith in breach of fiduciary duty analysis, within 0830 analysis is fine, don’t try to make it another separate argument from care or loyalty.

(Old law) Caremark: “Every dog gets one bite.” Owner had to be on notice that dog had a propensity to bite, which could be either because they had bitten someone before or they were a vicious breed.  They would have the opportunity to be fined once and then take action and control and develop the system. o Now: it has yet to be determined if the corporation has to initiate the program before getting the initial fine/warning, some states are changing it so that once the statute applies to your business you must comply. You don’t have to comply to the point you spend millions but must be some sort of program. o Overseeing your people and making sure that they are doing their jobs right is another layer to the duty of care by the directors. Lack of oversight equals lack of care because they haven’t put the right policies and procedures into place to protect the corporation’s assets. As a matter of policy should have the correct procedures to follow in line with government regulations → standard operating procedures. o ***Good faith as an independent standard of liability??? NO. the obligation to act in good faith does not establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty. Only care and loyalty may directly result in liability, whereas a failure to act in good faith may do so also but indirectly.***  BUT, acts in bad faith breach the duty of loyalty.  Putting good faith under the duty of loyalty means there will be liability for acting in bad faith, even though good faith is not an independent fiduciary duty.  Triad = fiduciary duties including duties of care, loyalty and good faith Disclosure and Fairness o      The Federal Government and most, if not all, of the states regulate the dissemination of info by corps, particularly publicly held ones. This regulatory regime mandates certain periodic and episodic disclosure and prohibits fraud and a variety of “misrepresentations.” It also forbids “insiders” from trading shares in their corporations without disclosing “material, nonpublic” information in their possession. The Securities and Exchange Commission (“S.E.C.”) may enforce these regulations, and in some instances, private individuals may, too. The Disclosure System

The Securities Act of 1933 o The 1933 act primarily regulates the process of raising capital rather than trading securities.

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The act creates a scheme of mandatory disclosure for initial public distributions of securities by issuers, underwriters, and dealers (the “primary market”). Much of the scheme revolves around a disclosure document called a “registration statement”, whose contents are prescribed by the S.E.C. The first part of a registration statement is called the “prospectus” The 1933 Act bars any effort to sell securities before the registration statement is filed with the S.E.C. From the time the registration statement is filed to the time the S.E.C. makes it “effective”, the only written materials that an offeror may use are the registration statement and the prospectus. From the effective date to the completion of the distribution, usually a very short period, sellers may use other written materials, but only in conjunction with the registration statement or prospectus. The 1933 Act renders issuing corporations strictly liable for material “misrepresentations” or omissions in their registration statements. It also subjects to liability other participants in the distribution unless they can show that they exercised “due diligence”. This costly and elaborate regulatory regime would apply to every sale of a security except that the 1933 act exempts many securities and most securities transactions from its reach, including “transactions by any person other than an issuer, underwriter, or dealer.” Regulates the offering and sale of new securities

Not set up to keep you from buying a risky investment, but making sure that the disclosure that it is risky because you should be aware when investing Selling Securities under the SEC: o Submit Registration Statement with the SEC  No selling activity permitted yet, however offers are permitted (no sales).  The SEC reviews the statement looking at adequacy of disclosure, not merits o SEC approves Statement  Can sell shares o Necessary because public offerings can be useful, especially the IPO.  However, it is very expensive. Costs include attorneys fees and disclosure. Have a responsibility for ongoing regulatory exposure, a lot of litigation can come out of this as well. Can get around complying with the Securities Statute by taking advantage of a private placement. (Also, by saying you are not offering a security, but can’t hit the courts definition of a security). o Section 4: Not involving a public offer. See Doran v. Petroleum Mgmt. Co. o If it’s not a public offering you don’t have to comply.

The Securities Act of 1934   Regulates secondary market activity Created the Securities and Exchange Commission

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It is an independent agency Enforces the securities laws Congress passes the statutes but the SEC promulgates rules and regulations to implement those laws more effectively.  i.e.: Rule 10(b)(5)! o 5 Commissioners with multiple divisions and officers. The Commissioners cannot all be part of the same political party, limited to 3 from the same party. Securities Act § 2(a)(1) spells out what the term security means, including: o Any note, stock, bond, debenture, investment contract, or in general, any interest or instrument commonly known as a ‘security’. SEC v. Howey: Lead case to define a Investment Contract: o 1) A contract, transaction, or scheme whereby a person invests money, 2) in a common enterprise, 3) and is led to expect profits, 4) solely from the efforts of the promoter or a third party.  Immaterial whether the shares in the enterprise are evidenced by formal certificates or by normal interests in the physical assets employed by the enterprise.  The statutory term “security” was intended to capture all cases in which capital was invested to generate a return from its employment by others.  Investment of money? Does not have to be cash, anything considered legal consideration should satisfy the first prong of the Howey test.  Solely from the efforts from others? Courts do not take the word solely seriously. Virtually no court reads that phrase literally. In particular, no court has ever taken the word “solely” seriously.  The Test:  How much effort must the promoter put into o Whether the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure of success of the enterprise. o What has been considered an investment contract?  Time share → when you were not going to be living in it, but this requirement has been altered.  Earth worm rancher example → provided with the worms, multiply, and sell your own. Earthworms farm slow so you need a lot of ranchers for the earthworms…  Pyramid Schemes – Bring in people beneath you. o Per Se Rule or Case-by-Case?  Some instruments are per se securities:  Stock  In most cases, however, one looks at the economic realities in a totality of the circumstances way…. o The 1934 Act primarily regulates securities trading among investors (the “secondary market”) o It creates a scheme of mandatory continuous disclosure for corporations that:  List securities on a national exchange  Own at least $5 million in assets and have at least 500 holders in any class of securities, or  File a 1933 act registration statement that becomes effective. o o o

These corporations must file with the S.E.C. annual, quarterly, and event-prompted reports.  Investors do not receive these reports, although they may obtain them.  Professional analysts use them, and through them, so do investors. o Integrated Disclosure: Meshing the 1933 and 1944 Acts o In 1977, the S.E.C., began prescribing disclosure documents responsive to both acts. o Later, it promogulated regulations permitting some corporations to incorporate by reference material from their 1934 Act reports in their 1933 Act registration statements. o Later the S.E.C. adopted Rule 415, permitting qualified corporations to register stock for future sale, “shelf registration.” o Once the corporation files a registration statement incorporating by reference subsequently filed 1934 Act reports, it may sell the registered securities at any time during the following two years. o In promogulating these regulations, the S.E.C. relied on the “efficient capital market hypothesis.” o “Blue Sky” Regulation o The federal securities statutes explicitly provide for the simultaneous application of “blue sky” laws, state securities statutes. o Many of these statutes subject brokers, dealers and investment advisors to licensing regulations; most prohibit fraud; and most require securities registration with a state agency. o Some of the state statutes authorize a state bureaucrat to bar sales of securities on “substantive grounds”, without regard to disclosure. o The National Securities Markets Improvement Act of 1996 exempts all “covered securities” from state registration and other “blue sky” requirements. o The act defines “covered securities” as those traded on any S.E.C.-approved exchange. o The Securities Litigation Uniform Standards Act of 1998 preempted class actions and other consolidated or multiple party proceedings resembling class actions brought under state law for securities fraud in connection with “covered securities”. o Disclosure Requirements of Self-Regulatory Organizations o The NYSE, ASE, and NASDQS regulate the dissemination of information by listed corporations as part of their listing agreements. o Generally, these self-regulatory organizations require the prompt disclosure of material information except where delay would serve a legitimate business purpose. o The organizations enforce these obligations, not private investors. Definition of a Security 


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This determination is important for two reasons: 1) it indicates whether the registration requirements of the Securities act apply to the transaction. 2) plaintiff’s generally have an easier time bringing suit under the federal securities laws than under the state common law fraud rules. The elements of federal securities fraud are easier to prove. Application of the 1933 Act to “Securities” In order to come within the registration statement of section 5 of the 1933 act, the offer or sale of a property interest must constitute the offer or sale of a “security.” Categories of Securities – Act defines 3 types  Any interest or instrument commonly known as a security. EX: bonds, stocks, debentures, warrants, etc.  Types of securities specifically mentioned in the Act.  The act specifically mentions the following as being “securities”: pre-organization subscriptions for securities; and fractional, undivided interest in oil, gas, or other mineral rights.  Investment contracts and certificates of participation. The 2 most important clauses in section 2(1) are its broad, catchall phrases – securities are “investment contracts” and “certificates of interest or participation in any profit-sharing agreement.” The S.E.C. and the courts have defined these phrases so as to apply to a wide variety of financial schemes.  The Traditional Test for a Security – The traditional test for whether a property interest constitutes a security under these 2 broad phases is known as the “Howey Test”. In Howey, the Sup.Ct. held that an investment contract is any contract or scheme whereby a person invests his money in a common enterprise and expects to make a profit solely from the efforts of the promoter or a 3rd party who is responsible for management. Thus, the elements of the test are:  Is it a profit making venture?  Is the investor passive in management?  The Trend of Decisions. The trend of decisions is toward expanding the scope of what is regulated as a “security”. Whereas, originally under the Howey test, the scheme had to have a profit objective and the investor had to be totally passive in management, the S.E.C. and the courts have expanded the test to cover situations where investors do participate in management and the form of benefit derived by the investor may be something other than cash profits.  The Modern Tests. Modern courts are applying the following criteria to determine whether an interest is a “security” under the 1933 Act.

Is the property interest one that is specifically mentioned in the Act?  Is it the type of interest that is commonly thought to be a security?  Is it an investment contract or a participation in a profit making venture? o Does the investor derive something of substantial benefit? o Is the management principally provided by a third party other than the investors? Or, even if the investors are active in management, does the scheme involve the raising of capital and does control of this capital rest with a third party (the so-called “risk capital” test?)  Is there a need for the protection of the Act? Is there an “investment” so that investors need the protection of full disclosure? Examples:  Interests in Land – small tracts of land were sold to investors to be used for growing fruit; the seller’s company then managed the land for the investors and was responsible for growing the crops; the investors received a percentage of the net profits.  Pyramid Sales Plans – Exists where a promoter takes a product (such as dish soap) and creates a type of franchise system where persons are sold (i) the right to distribute the product and (ii) the right to sell further distribution rights to others (on whom they receive an override on sales, or they are able to mark up the price of the product in sales to these “sub distributors”). In essence, the scheme is really one of everyone selling distributorships and sub distributorships, rather than trying to sell the product. o To get around the Howey Test for a “security”, these plans initially require the purchasers to perform some minor management duties (like file reports), but the investors do not assume the major duties normally required of a person buying a franchise. o Many of these plans have been held to involve securities. Thus, the test for a “security” no longer requires total management passivity by the investor. The S.E.C. has indicated that it is enough if the promoter has “substantial control” over the


investor’s funds, even if other parts of management involve the investor. o These cases have also indicated that the benefit from the scheme need not necessarily be a share of the cash profits of the enterprise. Any “economic benefit” can constitute the property interest a “security.”  Sale of a Business – In the past, some courts has followed the doctrine that federal securities law did not apply to the sale of 100% of a corporations stock because the economic realities of such a transaction involved the sale of a business, not the sale of securities. The Supreme Court has since held that the sale of all of the stock of a company is a securities transaction subject to the antifraud provisions of the federal securities law. The Registration Process – Prior to the original issuance of securities, the issuer must file a registration statement with the S.E.C. The purpose of the registration statement is to disclose all of the information needed to determine whether the securities offered are a good investment. The most important information in the registration statement is digested into a shorter document – the prospectus – which is the document actually given to a purchaser prior to the purchase or at the same time as the purchased securities are delivered.

Initial Public Offering (IPO): The first sale of a corporation’s common shares to public investors. The main purpose is to raise capital for the corporation.  They impose heavy legal compliance and reporting requirements.
   Any later public issuance of shares is referred to as a Secondary Market Offering. Usually involve one or more investment banks as underwriters. The company offering the shares is the issuer, who enters into a contract with a lead underwriter to sell its shares to the public. The underwriter then approaches investors with offers to sell these shares.

Over the Counter Market: A security which is not traded on an exchange, usually due to an inability to meet listing requirements.  Usually very risky since they are the stocks that are not considered large or stable enough to trade on a major exchange.  They tend to trade infrequently, making the bid-ask spread larger.  Research about these stocks is more difficult to obtain.  Trading electronically like the NYSE and NASDAQ. Blue Chip Stock: A stable company, safe, in excellent shape and firmly entrenched as a leader in its field. i.e.: Exxon Mobile, Coca-Cola, Wal-Mart. Pink Sheets: An electronic company which display bid and ask quotation prices of securities. Mainly used by brokers who are dealing with Over the Counter Securities. Not a stock exchange, no requirements.

There are 7 Statutes which apply, however, only need to be familiar with 2 for the EXAM: (Securities Act of 1933 and Security Act of 1934.) Federal Law has preempted almost everything in the law of securities, therefore, do not need to know Florida Law in this area, need only be aware of Federal Laws. (There are state laws called Blue Sky Laws). Federal Security Laws involve disclosure and procedural rules for some transactions, e.g.: proxy contests and tender offers. - Origins of Securities Law: o Stock market crash causes Great Depression o Perceived would prevent further market crashes - Purposes: o Full disclosure: Make sure investors have all they need to make informed decisions o Prevention of Fraud: Agency cost problem re disclosure → How to make a credible bond? Rule 10(b) and 10(b)(5). Limited Partners as Investors  When you bought a limited partnership did you buy a security? o By definition in many states Limited Partner interests cannot have any control because they are considered to be investors. o When you see someone buying in as a limited partner they are buying in as an investment. (If buying in as a general partner that would be something different). Then would trigger the definition of a security. Determine then if they fit the exception of a private placement rather than an offer to the public. Purpose of Securities Law:  Full Disclosure o Make sure that investors have all the information they need to make informed decisions  Prevention of Fraud o Agency cost problem re: disclosure - how to make a credible bond? U.S. Code Section 10(b):  It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange o (b): To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection for investors. Rule 10b-5: SEC created rule in furtherance of 10(b):  It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange o (a) to employ any device, scheme, or artifice to defraud o (b) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or o (c) to engage in any act, practice, or course of business which operates or would operate as fraud or deceit upon any person, in connection with the purchase or sale of any security.

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Willful violation is a felony SEC can bring a civil action Private parties can bring actions: o No express cause of action o Supreme court implied the right Have to have people using interstate commerce, the mail, or the use of any securities exchange. Requirements: o 1) Jurisdictional Nexus:  Interstate commerce: Phone  Instrumentality: Money  Walking on the Street o 2) Transactional Nexus:  In connection with the purchase or sale of any security  What if the fraud was telling you bad news so you didn’t buy? Is that in connection with the purchase or sale of the security? Not enough → need the actual connection to the sale or purchase.  Basic’s dissent: Fraud only need to touch or concern a purchase or a sale. [The court only touched on this but felt that there was no purchase or sale so not enough to show fraud]. o 3) Material Misrepresentation or Omission of a Material Fact:  See Basic v. Levinson o 4) Reliance:  Presumed in omission cases: Affiliated Citizens of Utah v. US  Basic is a misrepresentation case, therefore not presumed.  Class certification implications  Fraud on the Market Theory: Presumption that investor relied on integrity of market price—so investor need not have seen misrepresentation.  Don’t have to prove reliance, entitled to rely on the marketplace and what information is out there.  Basic case: Makes the presumption that the shareholders who heard the Presidents statement relied on what he was saying and acted in reliance on it. o 5) Causation: 2 types:  Transaction Causation:  Presumption of Causation: Where reliance is presumed we assume transaction causation  Omissions  Fraud on the market Where reliance is not presumed we assume loss causation o 6)Scienter: (President) knew what he was saying was wrong or was reckless when he made those false statements. Either had the intent to defraud or reckless disregard of falsity of statement. o 7) Fraud or Manipulation: Only an omission and haven’t risen to a level of any action occurring, at some point the omission alone may become fraud or manipulation.  Fraud on the Market Theory:  Presumption that investor relied on integrity of market price—so investor need not have seen misrepresentation.

Basis? o The theory is based on the hypothesis that in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business.

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Where 10b-5 liability is premised on an omission of material fact, liability can only arise where the defendant had a duty to disclose Conduct only violates Rule 10b-5 if manipulative or deceptive. No “Federal Fiduciary Principle”: What was Congressional intent: o Congress’ purpose for the 1934 Act was to assure full disclosure o Once full and fair disclosure is made, the fairness of the transaction is a non-issue under federal law. o Here the conduct in question was a breach of fiduciary duty, a matter clearly the subject of state corporate law. Breach of fiduciary duty without fraud is not a violation of Rule 10b-5.

Insider Trading  Rule: Liability under 10b-5? YES. o Where an insider has material nonpublic information the insider must either disclose such information before trading or abstain from trading until the information has been disclosed. o 3 Words: Disclose or Abstain  Rational: All investors should have equal access to the rewards of participation in securities transactions [or equal access to material information]. All members of the investing public should be subject to identical market risks. o Level playing field 3 Categories of who Insider Trading Applies to Under 10b-5: o Insiders: Those within the company of the stocks being traded. [i.e., those inside Equity → have to abstain or disclose]. o Temporary or constructive insiders: People brought on by the corporation for a temporary period who are privied to information. [i.e., lawyers]. o Tippees: Can’t have a tippee unless there’s a tippor.  In general, the tippee’s liability is derivative of the tipper’s “arising from his role as a participant after the fact in the insider’s breach of a fiduciary duty.” A tippee therefore can be held liable only when:  The tipper breached a fiduciary duty by disclosing information to the tippee, AND  The tippee knows or has reason to know of the breach of duty.  Test that must then be applied here: Whether the insider personally will benefit, directly or indirectly, from his disclosure.  Absent some personal gain, there has been no breach of duty to stockholders.  And absent a breach by the insider there is no derivative breach. Example: Former coach of the Dallas Cowboys was at a track meet and overheard the CEO of a company telling his wife that he would be out of town next week because the company might be liquidated. Switzer and his pals traded on the information. Liability under Dirks?

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No. He is not an insider because he does not work for the company, he wasn’t temporarily employed by them and the CEO was not a tipper and therefore he does not qualify as a tippee. The CEO breached a duty of care, he didn’t breach his duty of loyalty, nor did he tell Switzer the information directly under the pretense of having Switzer trade on the information. Pure eavesdropper, no 10b-5 liability.

US v. O’Hagan:  Facts: O’Hagan worked for the law firm assisting Grand Met in issuing a tender offer to Pillsbury. Grand Met didn’t publicly announce its tender offer for Pillsbury until Oct, however, O’Hagan knew about it because he was working on it. In August O’Hagan began purchasing call options and stocks in Pillsbury. A month later he sold his call options and stocks and made a profit of more than $4.3mil. o Tender Offer: A public offer to buy a minimum number of shares directly from a corporation's shareholders at a fixed price, usually at a substantial premium over the market price, in an effort to take control of the corporation.  Valuable material information.  Holding: Is O’Hagan liable for insider trading? YES. o He is NOT liable under the Dirks analysis because he didn’t work for Pillsbury directly. Constructive insider? No, because he is a constructive insider to Grand Met NOT Pillsbury, and he invested in Pillsbury not Grand Met. Tippee? Because there is no tippor because there are no facts to suggest that anyone in Pillsbury provided him information for their benefit, again he was also working for Grand Met so he wasn’t receiving any information from Pillsbury. o The Court applies the misappropriation theory because the circuits were split. The Dirks analysis is still good law, this is an alternative theory. o EXAM NOTE → Do both the Dirks and misappropriation analysis even if you can find liability under Dirks.  Misappropriation Theory: A fiduciary’s undisclosed use of information belonging to his principal, without disclosure of such use to the principal, for personal gain constitutes fraud in connection with the purchase or sale of a security and thus violates Rule 10b-5. o A person commits fraud in connection with a securities transaction, and thereby violates → 10(b) and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. o O’Hagan is liable under the misappropriation theory.  Court addresses § 14(e) and Rule 14e-3(a): o Rule 14e-3(a): Prohibits insider trading during a tender offer and thus supplements Rule 10b-5:  Once substantial steps towards a tender offer have been taken, Rule 14e3(a) prohibits anyone, except the bidder, who possesses material, nonpublic information about the offer from trading in the target’s securities.  Rule 14e-3(d) prohibits anyone connected with the tender offer from tipping material, nonpublic information about it.  Must still get the information from someone in Grand Met or Pillsbury → one of the companies involved in the tender offer. o Rule 14e-3 is not premised on breach of fiduciary duty. o If O’Hagan had received information not going to the tender offer, he would not be liable under 14e-3 but would have been under misappropriation.

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Held: the misappropriation theory is a valid basis on which to impose insider trading liability. What if O’Hagan brazenly misappropriates? If the majority opinion is to be taken literally, O’Hagan should not be held liable in this situation as long as O’Hagan ex ante informed both principals that he intended to trade over their objections. In that case, there is no deception.

Section 16(b) (applies to): Officers, directors, and 10% shareholders must pay to the corporation any profits they make, within a six-month period, from buying and selling the firm’s stock.  10% shareholder at both ends of the transaction. 10% shareholder at the time of the sale and at the time of the purchase. o Owning 10% of the shares in the firm only applies to shareholders, it does not go to officers and directors.  This applies only to companies that have to register under the 1934 Act. EXAM NOTE → she will tell us if they have registered under 1934 Act.  Purchase and a Sale of a particular company within a 6 month time period. o You don’t have to buy and purchase the same shares in the company.  Could have purchased years ago, sold something recently and the next day buy again → constitutes a purchase and a sale within 6 months. o It could be a sale first and then a purchase, as long as it is within the 6 months.  Recovery: o Any recovery goes to the company o Shareholders can sure derivatively, and a shareholder’s lawyer can get a contingent fee out of any recovery or settlement. o Courts interpret the statute to maximize the gains the company recovers. Exam Note: There will be multiple choice like this on the exam!!!! Problems Page 507: 1. January 1st bought 200,000 of 1mil of companies shares for $10 a share: a. If he sells all 200,000 shares on May 1 for $50 per share is he liable under § 16(b): i. Because Bill is the CEO, § 16(b) applies to ALL of his transactions → he does not have to have a 10% shareholder investment. ii. A purchase and sale occurred within 6 months of Bill purchasing the stock. iii. Therefore, Bill owes $40 per share (difference in purchase and sale price) times 200,000 shares that he sold equals a total of $8,000,000 in profits that he owes to the company. iv. VARIATION TO A ABOVE: i. Bill has owned 200,000 shares for many years ii. Jan 1: Sells 200,000 shares @ $50 iii. May 1: Buys 200,000 shares @ $10 iv. Liability? Yes. It doesn’t matter what order he buys or sells and that he owned the previous shares for years is irrelevant, just illustrates that he has something to sell first. Anything that he does, whether buys or sells, starts the clock, he needed to have waited 6 months to do anything. 1. He made money from this selling and purchase. Had he bought back for more than $50 then there wouldn’t have been a profit and wouldn’t have been an issue. 2. $50 - $10 = $40 a. $40 x 200,000 shares = $8,000,000.

b. Purchases 200,000 shares on Jan 1. Sells 110,000 shares on May 1 for $50 per share. Sells the remainder, 90,000 shares, on May 2 at the same price. i. A purchase and 2 matching sales occurred within 6 months, therefore, Bill owes: i. $50 – $10 = $40 ii. $40 x 110,000 = 4,400,000 iii. $40 x 90,000 = 3,600,000 iv. 4,400,000 + 3,600,000 = 8,000,000 ii. The percentage of shares that he sold in each transaction is irrelevant as he is a director and owes the profits to the organization regardless. c. Purchases 200,000 shares on Jan. 1. Sells 110,000 shares on May 1 for $50 per share, resigns from SCLI and sells the remainder, 90,000 shares, on May 2 at the same price. i. Officers and directors are subject to § 16(b) if they were an officer or director at the time of either the purchase or the sale and thereafter sell or purchase. i. Therefore, liability is the same as in b above: 1. A purchase and 2 matching sales occurred within 6 months, therefore, Bill owes: a. $50 – $10 = $40 b. $40 x 110,000 = 4,400,000 c. $40 x 90,000 = 3,600,000 d. 4,400,000 + 3,600,000 = 8,000,000 Page 507 Problems Continued: 2. Renee is a shrewd investor with 200,000 shares of SCLI stock that she has held for several years. She is not an officer or director of the company. Determine her liability, if any, under § 16(b). [NOTE → Need to know what the total outstanding shares are in the corporation to determine what percentage of shares she owns in order to subject her to possible liability. There are 1mil outstanding shares in this company and she owns 200,000, which equals 20% of the total outstanding shares. Had to be the 10% share holder at the time that they made the call to their broker at the time they made the purchase or sale, not if after the fact they became a primary shareholder]. a. If she sells her entire holding of SCLI shares (200,000) on Jan. 1 at $50 per share, buys 50,000 shares on May 1 for $10 a share, and buys 110,000 more shares on May 2 at the same price. i. Many years: 200,000 shares ii. Jan. 1: Sells 200,000 shares @ $50 iii. May 1: Buys 50,000 shares @ $10 iv. May 2: Buys 110,000 shares @ $10 v. Liability? NO. 1. She only sold as a 10% shareholder, she didn’t buy anything as a 10% shareholder. b. She sells her entire holding on Jan. 1, buys 110,000 on May 1 and 50,000 shares on May 2. i. Many years: 200,000 shares ii. Jan. 1: Sells 200,000 shares @ $50 iii. May 1: Buys 110,000 shares @ $10 – She owns no shares before purchasing these shares, therefore, not liable on this purchase. iv. May 2: Buys 50,000 shares @ $10

v. Liability? YES. 1. At her purchase of 110,000 shares she was not a 10% shareholder before purchasing but became one when she purchased the 110,000. Now she purchases 50,000 more shares as a 10% shareholder and is subject to liability. If she doesn’t have the 10% status during a particular transaction, that transaction doesn’t count – it’s like a freebee. 2. Accordingly she is liable for her gain on 50,000 shares. c. She sells 110,000 shares on Jan. 1 at $50 per share, sells the remainder of her shares on Jan. 2 at the same price, and buys 300,000 shares on May 1 for $10 per share. i. Many years: 200,000 shares – 20% owner ii. Jan. 1: Sells 110,000 shares @ $50 iii. Jan. 2: Sells 90,000 shares @ $50 – only a 9% shareholder iv. May 1: Buys 300,000 shares @ $10 – becomes a 30% shareholder v. Liability? NO. 1. Renee was not a 10% shareholder when she bought her stock. Accordingly, we cannot match a purchase with her sale of her first 110K shares, and she is not liable. 3. Bill is still the CEO of SCLI, buys 100,000 shares on March 1 at $10 per share, 700,000 shares on April 1 at $90 per share and sells all his shares on May 1 at $30 per share. a. Did he make any money? i. For years: 200,000 shares ii. Mar. 1: buys 100,000 shares @ $10 iii. Apr. 1: buys 700,000 shares @ 90 iv. May 1: Sells 800,000 shares @ $30 b. For what amount, if any, is he liable under § 16(b)? i. 100,000 x $20 = $2,000,000 ii. 700,000 x -$60 = -$4,200,000 iii. The 700,000 shares are irrelevant because he suffered a loss. However, he made a profit on the 100,000 shares because bought for $10 and sold for $30. Therefore, he is liable to the company for the $2,000,000 profit on those shares. Shareholder Meetings:  Annual: § 607.0701: o Where: Anywhere. If no place is mentioned in the bylaws then it is held at the corporate office. o When: Annually – once a year as stated in the bylaws.  (3) The failure to hold the annual meeting at the time stated in or fixed in accordance with a corporation's bylaws or pursuant to this act does not affect the validity of any corporate action and shall not work a forfeiture of or dissolution of the corporation.  However, failure to hold annual meetings would be lack of formalities which would go to when someone is trying to pierce the corporate veil. o Notice: § 607.0705: Must provide shareholders with the time, date, and place of the meeting no fewer than 10 or more than 60 days prior to the meeting. o Can vote by proxy?: Yes. Will likely have to solicit a large amount of proxies because a lot of people will likely not come, won’t have control of 51%, need to have quorum.

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Nominating committee of the incumbent board of directors nominates a slate of directors to be elected at next annual meeting. o Incumbent board identifies other issues to be put to vote o At company expense:  Management prepares proxy statement and card  Management solicits shareholder votes (typically with aid of proxy solicitor). Special: § 607.0702: o Who can call: Board of directors and those authorized by the bylaws to do so. o Limited purpose .0702(3)  Only business within the purpose or purposes described in the special meeting notice required by § 607.0705 may be conducted at a special shareholders' meeting. o If you need a 2/3 vote for something, you still need the same number of votes at a special meeting. If not specified in bylaws then you only need 1 more than the majority. When can shareholders act without a meeting? [Remember directors acting without a meeting when they all give written unanimous consent and became effective upon the last signature giving consent]. Record Date: The date in which a stockholder must own shares to be entitled to vote or receive a dividend. o If not date is fixed in the bylaws the record date is at the close of business on the day on which the board adopts the resolution taking such prior action. Voting at Annual (or special) Meetings: o Most matters require a majority of shares present at a meeting at which there is a quorum.  Quorom: .0725(1) “Majority of votes entitled to be cast.”  Can be changed by Articles of Incorporation but cannot be less than 1/3  Voting: .0725(3): A matter is approved if votes cast in favor are greater than votes cast against.  Most shares come with 1 vote, but shares can be delegated to have more than one vote. Think Benihana case.  More YESES than NOs. Equal doesn’t pass it.  A few matters require approval by a majority of the outstanding shares (can make it more). Proxy Voting: 607.0722: Shareholder appoints a proxy (a.k.a.: a Proxy Agent) to vote his/her shares at the meeting. No proxy voting for directors, yes for shareholders. o Appointment effected by means of a proxy (aka a proxy card)  Can specify how shares to be voted or give agent discretion  Revocable unless 607.0722(5) is met.  A proxy is totally revocable. You can issue a proxy to one person and an hour later issue it to someone else, it is implied that the original one has been revoked. o Unless it is irrevocable when it is coupled with an interest. 607.022(5)(a)-(e):  (a) A pledgee;  (b) A person who purchased or agreed to purchase the shares; o

(c) A creditor of the corporation who extended credit to the corporation under terms requiring the appointment;  (d) An employee of the corporation whose employment contract requires the appointment; or  (e) A party to a voting agreement created under § 607.0731. Proxy card requirements are covered under Rule 14a-3. Don’t need to know the exact phrasing. o SEC § 14(a): It shall be unlawful . . . for any person . . . to solicit any proxy . . . by use of the mails or by any means or instrumentality of interstate commerce or of any facility of a national securities exchange or otherwise, in contravention of such rules of regulations as the commission may prescribe. o Rule 14a-3: Incumbent directors must provide annual reports before soliciting proxies for annual meeting.  Anyone who solicits a proxy must provide a written proxy statement BEFORE soliciting the proxy  Free writing generally permitted thereafter. o See J.I. Case Co. Below…. 

Problem Page 525: Stockholders want to use corporate funds to obtain proxy votes in order to install themselves as board of directors so that the corporation won’t open a new division that they feel will not be profitable for the corporation.  If you file a derivative suit challenging the use of the corporate treasury, what result? o This would be ok under Levin. They would not have to pay the corporation back.  How would your answer change if you establish that 80% of the stock of the public relations firm is held by the older brother of the True Love CEO? o Conflict of interest Shareholders can have state cause of action and federal under 14a and must decide whether material and misleading for them to be successful in the federal cause of action. Shareholder Inspection Rights:  Policy Concerns: o Shareholders have a legitimate interest in accessing information to hold the board accountable. o Nobody wants a junk mail distributor to get access to the shareholder list or a competitor to get access to the corporation’s trade secrets and other proprietary information.  Florida? o 1601: What are the corporate records and what shall they include? o 1602: Inspection of records by shareholders:  A shareholder is entitled to inspect and copy during regular business hours at the corporate office all of the records described in 1601(5)a-e.

A shareholder is entitled to inspect the following record if you meet subsection 3 of 1602.  You are entitled to: o Excerpts from minutes of any meeting of the board of directors, records of any action of a committee of the board of directors while acting in place of the board of directors on behalf of the corporation, minutes of any meeting of the shareholders, and records of action taken by the shareholders or board of directors without a meeting, to the extent not subject to inspection under subsection (1); o (b) Accounting records of the corporation; o (c) The record of shareholders; and o (d) Any other books and records.  1602(3) only permits the shareholder access to records if: o (a) The shareholder's demand is made in good faith and for a proper purpose; o (b) The shareholder describes with reasonable particularity his or her purpose and the records he or she desires to inspect; and o (c) The records are directly connected with the shareholder's purpose.

Shareholder Inspection Rights:  607.1602: “Absolute right” to inspect and copy records listed in .1601(5)a-e.  “Qualified right” to inspect .1602(2) records: Subject to “proper purpose” .1602(3)a-c. Shareholder Voting  FSA 607.0824: Voting: Quorom may be set by by-laws. Default is majority of fixed number of board members, or majority of directors prescribed or the number in office if not prescribed.  Seven board members → lowest quorum is 4. o However, quorum is limited by how low quorum can be: (2) The articles of incorporation may authorize a quorum of a board of directors to consist of less than a majority but no fewer than one-third of the prescribed number of directors determined under the articles of incorporation or the bylaws.  If you don’t want the board conducting business without you, make sure to specify a specific quorum number in the bylaws.  Seven board members → lowest quorum is 3. o Board members cannot vote by proxy. Questionable as to whether the articles or bylaws can provide otherwise.  Fiduciary duty issue → they have decided ahead of time. They have to be able to listen and discuss, they cannot decide ahead of the meeting, without the information, and make a decision about something being discussed at the meeting. You don’t send in a proxy as saying you are present in the meeting you are sending it in with a particular vote for something. It counts you as present and your vote.  If can’t be present can simply be on the phone while the board meets.


Shareholders can do that because they are acting in their own best interest. See FSA 607.0722. Must need a majority of votes from the directors present at the meeting.  Bylaws can provide otherwise. The statute is the low of what is required, but can make it higher by bylaw → super majority.  Failure to adhere to these requirements means that action taken is invalid and may be challenged.  Seven board members → 4 present at the meeting → 3 need to vote the same way.  Abstaining is the same effect as a no vote because only count the yes votes to pass something.

Straight Voting:      Assume ABC Corporation has 3 shareholders: A: owns 250 shares B:owns 300 shares C: owns 650. The bylaws specify a four member board of directors. Under standard voting procedures, directors are elected by a plurality of the votes case at the meeting on a one share-one vote basis. Suppose, for example, that each of A, B and C are supporting four different candidates for director, who gets elected? Whoever C votes for wins—because he has the most amount of shares and it is one vote per share What if A and B only support one candidate? They withhold their votes form C’s candidates and vote for themselves? o Who gets elected?  Whoever C wants—C still wins—C has more votes than A and B combined

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Cumulative Voting:  Each shareholder gets a number of votes = # of shares owned x vacancies. (If there are 4 board spots, there are 4 vacancies)  The following results: [knowing the shares can determine how they should use their votes]: o A: owns 250 shares, has 1000 votes o B: owns 300 shares, has 1200 votes o C: owns 650 shares, has 2600 votes  C votes for director 1 with 1201 shares  C votes for director 2 with 1201 shares  How many votes does C have left to vote for director 3?  How many votes does C have left to vote for director 4?  After C votes 1201 for C1 and votes for C2, C only has a total of 198 votes left. Cumulative Voting Equation: Number of Shares Necessary Number of Directors Desired x Number of Shares Outstanding

to Elect = Desired Number of Directors

Number of Directors Being Elected

+ 1 +1

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(Don’t always have to elect the entire board annually, can stagger elections → therefore number of directors being elected may be all members as designated by articles or just the amount being elected that year). Example: Assume ABC has 1000 shares outstanding and elects 7 directors annually. If the company has cumulative voting, how many shares do you need to own to guarantee you can put one person on the board of directors? o Formula:  1 x 1000 divided by the number of directors to be elected plus 1  1 x 1000 / 7 + 1 + 1 = 126 o [1000 / 8 = 125] o [125 + 1 = 126] o Here, not knowing the amount of shares each person owns in advance (unlike the example above with the A, B, C, breakdown), use this formula to determine how many shares would you need to own in order to guarantee yourself a seat on the board of directors. o Knowing it takes 126 shares to be elected to the board, client wants to know, how do I vote those shares?  To determine votes:  shares x number of positions: o 126 x 7 positions = 882 ballots to vote.  How should client use these 882 votes to get one of the 7 board positions?  She has to use all 882 votes for herself because there are 7,000 outstanding votes. Voting all shares for herself will guarantee her a spot, there is no way that she wouldn’t if she votes all for herself because of the remaining 6,148 remaining votes they can’t all be used against her, because they have to be used to fill the other 6 positions. o Client wants herself on the board, but her significant other wants a position on the board as well.  How many shares does client need to own to get them both on the board?  2 x 1000 / 7 + 1 + 1 = 251  251 shares gets client 1,757 of the 7,000 votes o Client now wants to get three seats on the board of directors.  How many shares must client own?  3 x 1000 / 7 + 1 + 1 = 376 o How many for four seats on the board [which would be the control of the board (half + 1)].  4 x 1000 / 7 + 1 + 1 = 501 o How many for five seats?  5 x 1000 / 7 + 1 + 1 = 626 o How many for six seats?  6 x 1000 / 7 + 1 + 1 = 751 o How many for 7 seats?

7 x 1000 / 7 + 1 + 1 = 876 Remaining would be 124 shares so anyone who owns those does not have the requisite number to lock in a seat on the board because again they need 126 to get one seat on the board.  However, someone with 100 votes could get on the board because there are people who may abstain or split their votes, 126 is the amount of shares to guarantee a seat on the board. o ***Cumulative Voting doesn’t give the minority shareholder control but it does gives them guaranteed representation.*** What if staggering the votes? First year elect 4 seats and the second year 3 seats (and they are on 2 year terms), again still 7 seats total: o Change the denominator to 4 or 3:  1 x 1000 / 3 + 1 + 1 = 251 OR  1 x 1000 / 4 + 1 + 1 = 201 o With 251 shares and staggering of elections that person could be guaranteed their vote elects who they want each year, whether a 3 person vote or 4 person vote.  

Distinguishing Control in This Hypo between Straight Voting and Cumulative Voting:  7 Board positions available: o 501 shares in both straight and cumulative voting = control. o However, it is a different kind of control:  Straight election with 501 shares – how many directors do you get to elect?  You would get to elect all 7 board members because your majority vote goes to all board members being appointed, you don’t lose your votes when you vote them towards a certain person.  In cumulative voting, with 501 shares – you have control but you can only use these votes to elect 4 seats of the 7 available. You lose votes when you elect a person to a seat. Shareholder Agreements  Florida - Shareholder Agreements for voting shares: o 607.0731(2): A shareholders' agreement created under this section is specifically enforceable.  In Ringling the agreement would have been enforced and A’s votes would not have just been excluded. o Could have created a Voting Trust under Florida Statute 607.0730:  Shareholder transfers “legal title” and therefore voting power to a trustee; shareholder retains economic and beneficial ownership; trustee owes fiduciary duties.  Signed written agreement.  Trustee must supply corporation with list of beneficiaries and the trust agreement. o What is an 607.0731 agreement compared to 607.0732?  607.0731: Doesn’t have to be unanimous. Must be in writing. Applies to how shareholders will vote their shares, they cannot agree to anything else in this type of agreement (if goes into more than voting, need to qualify it under 0732 or make it a voting trust or something else).  2 of 3 shareholders in Ringling could have entered into it → as was done here.  607.0732: Would have to be unanimous. Must be in writing.

All 3 shareholders in Ringling would have had to enter into the agreement.

Shareholder Agreements Constraining Director Powers:  Very common: o Require certain persons as officers o Specify compensation and/or dividend policy o Require shareholder approval of board actions. Common Stock as a Bundle of Rights:  Economic Rights: o Receive dividends (distribution of profits) when and as declared by the board of directors. o Residual claim on assets in liquidation  When a corporation goes out of business and everyone (creditors) are paid, where does the leftover money go? There has to be some class of shares to get those rights in the corporation. (Again must be put into AOI).  Voting Rights: o Elect directors o Approve some extraordinary matters  Can have shares that have non-voting rights or limited voting rights. Some shares have to be economic and some have to be voting. But there is no rule as to what you personally have to own, you investigate as to what you want. Shares as a Bundle of Rights:  Florida Statute 607.0601: o Game plan of shares must be in Articles of Incorporation → how you are designating the shares must be described in the AOI. o Must have at least one class of shares with unlimited voting rights o Must have at least one class of shares with residual claim o May be the same, but need not be.  607.0601(3): o Authorizes nonvoting stock and other variants on one share-one vote.  607.0601(5): o Shares entitled to dividend or liquid. o Preference shall not be designated as common:  There are 2 kinds of preferences:  1) Preference to pay out dividends: This preference gets you dividends first.  2) Preference at distribution: Get paid money first when the corporation goes out of business.  Cannot call preferences common stock, they are called preferred shares.  If preference is to voting rights, can call these stocks common shares. 607.0731 Shareholder Agreements:  2 or more: Need not be unanimous.  Signed written agreement  Applies only to how they will vote shares  Specifically enforceable in Florida (see: Ringling).

607.0730 Voting Trusts:  Shareholder transfers “legal title” and therefore voting power to a trustee. Shareholder retains economic and beneficial ownership. Trustee owes fiduciary duties. McQuade v. Stoneham: (Old Law):  Facts: Stoneham owned a majority of the stock in the NY Giants. McGraw and McQuade bought small equity interests in the Giants from Stoneham o Shareholder agreement by which all agreed that they would each do their best to elect each other directors and, in their capacity as directors, appoint each other officers at specified salaries. o There were 4 key provisions:  1) McQuade, McGraw and Stoneham to be elected directors  2) McQuade, McGraw and Stoneham to be appointed to specified officer positions  3) McQuade, McGraw and Stoneham to be paid specified shares  4) No fundamental changes in corporate governance structure unless parties all agree. There were other minority shareholders (owning about 19% of the stock) who were not party to the agreement. McQuade was fired, and sued seeking specific enforcement of the agreement to be reinstated in his position. o The majority shareholder brought in 2 other shareholders. Why? (He already had control over the control). To get their money as additional investors.  Holding: The contract was void for public policy because shareholders do not agree as to how board of directors appoint officers and board of directors use their fiduciary duties to appoint officers. Directors must exercise their independent business judgment on behalf of all shareholders. If directors agree in advance to limit that judgment, then shareholders do not receive the benefit of their independence. Agreement is therefore void as against public policy. o They went beyond an 0731 agreement. It is binding the directors as to who they will appoint as officers and the court said that they cannot do that. Directors have to appoint officers as per fiduciary duty and doing this ahead of time breaches their fiduciary duty.  Necessity of Agreement Binding Directors: o Given that vote pooling agreements are allowed, why might parties have thought they needed extra provisions?  Giants had 7 directors, 4 appointed by Stoneham  Being on the board doesn’t prevent you from being oppressed if other board members gang up on you, as McQuade discovered.  Alternative Solutions? o Get agreement that he will be elected as director. Have by-laws state that officers may be removed only for cause or by the unanimous vote of the directors.  Need to make sure that amending the by-laws requires unanimous director and/or shareholder action. o Alternatively, employment contract coupled with stock buy-out provision.  If they fire him, he can get damages and require them to buy back his stock (so he’s not stuck with his investment).

He would still need the first agreement to be elected as a director. But if they don’t do that, with an employment contract he can still sue on that money from being fired. Bylaws strictly keeps him in the position.

Unanimity is not required if:  1) The corporation is closely-held (i.e.: family owned)  2) The minority shareholder does not object  3) The terms are reasonable How would this work in Florida? It would not have worked because the minority shareholder did not agree. (See 607.0732).

607.0732 Agreements:  Distinguish from .0731: o Can ONLY be used by corporations with 100 or fewer SHAREHOLDERS (not individual shares) and NOT listed on an exchange. o The agreement must be unanimously agreed upon, in writing and signed by all.  This is why Galler would not be upheld. Double Taxation Issue:  Corporations pay taxes (tax number 1)  Corporation distributes dividends to shareholders  Shareholders pay personal taxes on dividend income (tax number 2)  How to avoid? o If a corporation qualifies as a sub-chapter S corporation they do not have to pay corporate taxes, they are charged as a partnership. This way shareholders can only be taxed once. You have to meet the IRS rules to be classified as a S corporation.  File a form with the IRS  The corporation has to have 100 or fewer shareholders.  All shareholders are individuals, estates, exempt organizations or trusts and NOT and ineligible corporation.  No nonresident alien can be a shareholder  Only one class of stock unless only difference in classes is voting rights. Sub-Chapter S Corp:  Designation by IRS  If qualify and file IRS From 2553: taxed as a partnership (only one tax instead of two) To Qualify:       100 or fewer shareholders All shareholders are individuals, estates, exempt organizations or trusts and not an ineligible corporation No non-resident alien shareholders Only one class of stock unless only difference in classes is voting rights Typical rule: shareholders do not owe fiduciary duties to each other Rule: Majority shareholders own minority shareholders fiduciary duties WHEN the corp is closely held

When people come together as partners and decide to form a corporation, under some circumstances you owe the duties that partners owe to each other Rule of law: o Majority must have some legitimate business purpose o If so, burden shifts to minority to show less harmful alternative o If so, court much balance the legitimate business purpose against the practically of proposed alternative o Rule: A minority shareholder, at least where he has a veto power over corporate action, has fiduciary duties to the majority. o Wolfson’s use of his veto power was inconsistent with that duty because it subjected the corporation to an unnecessary assessment of penalty taxes. The reasonable expectation of the shareholder is not a set rule needs to be based on the facts of the case.

Restrictions on Distributions:  Income Statement: o 3 parts:  1. Lists income or revenue – how much money you have coming in  2. Lists your expenses – owed/debt  3. Calculation – the difference between the two  The net income or loss  Balance Sheet: o Different then an income statement but some terms and numbers are the same. Fundamental financial statement that lawyers typically look at.  The static position of the financial position of a company, of the business at a particular time. o Assets = liability + equity o Balance sheet has 2 sides:  Assets on the left  Liability and Equity on the right  Assets Liability Equity Assets are not what she made in a month – but what she has in her bank account – everything that she owes. Par Value: Antiquated concept which at one time was the price at which the corporation initially sold shares to the public. o A fictional amount, doesn’t make it more value if you have a par value of 1000 or a penny. Does not relate to real value. Watered Stock: Another “historical concept” – when shares were sold by the corporation for less than the stated par value. o

Issuance of Shares in Florida:  607.0621(2) may be issued for consideration consisting of: o Cash o Property o Promissory note

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Perform certain services  Give the secret formula for certain amount of shares 607.0621(3): Directors determine if consideration is adequate (par value is not determinative). 607.0622: Shareholder liability for shares: (personal liability for shares): o Statute of limitation is 5 years for shareholder liability. o Liable for the issue price – whatever the corporation says.  Issue shares for $50 and you agree to buy for that price, the corp. gives it to them and you haven’t paid yet, you can be liable for that amount up to 5 years if they let you have the shares without receiving payment. o Another shareholder would sue this shareholder in a derivative suit. o EXAM NOTE → Shareholder liability if pierce the corporate veil – this is just shareholder liability as to shares, because the shareholder owes the money back to the corporation because the shareholder is mad you didn’t pay. Or the shareholder can demand that the corporation sue the shareholder. 607.06401: Restriction on Distribution: Flip side of demanding the payout of dividends. There are restrictions on how much a corporation can pay out. o Need to leave money available in the corporation for the creditors to get to, they can’t get the money from the shareholders because there is limited liability. o The Test: 06401(3): A corporation must satisfy both (3)(a) and (b) in order to pay out dividends.  (3) No distribution may be made if, after giving it effect:  (a) [The Equity and Solvency Test]: The corporation would not be able to pay its debts as they become due in the usual course of business [if a corp. cannot pay their debts as they come due they cannot pay out dividends]; or  (b) The corporation's total assets would be less than the sum of its total liabilities plus (unless the articles of incorporation permit otherwise) the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution. o Add liabilities and liquidation preferences and subtract from assets → this gives you the amount that you will be able to distribute after you satisfy both (3)(a) & (b).  Do you have a class of stock (in Florida it is preferred stock). Does that preferred stock have a liquidation preference? If it does have to figure out the amount per share.  Liquidated preferences may not exist – have to determine before doing the subtraction. o

Example: Fla. Corp. has 100 common shares, $1 par value, and 100 preferred shares, $10 par value. All 200 shares are issued and outstanding. The preferred shares carry a liquidation preference of $2 per share and a non cumulative dividend preference of $.25 per share. The total assets for Fla. Corp. are $10,000 with total liabilities of $9,500. The board of directors proposes to declare a cash dividend of $5 per share on its common stock. Advise the board.  Can briefly describe the purpose of the statute – creditor statute

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Go through 607.06401(3)(a) Then explain 607.06401(3)(b): The Equity and Solvency Test o $300 is the max amount that can be paid to shareholders.  would need $500 to be able to pay them $5 a share. o Can talk her through the math on the essay or give her the answer – if just give the answer and its right – then get full points – but if happen to be wrong better to show the math so can at least get partial credit. Explain that if they do give that extra amount they are held personally liable and would not want to violate the statute. Who gets the $.25? → DO NOT NEED TO KNOW THIS PART FOR THE EXAM o Times 100 shares = $25 o Will cost $25 to cover the cost of payout of shares to preferred before paying common. o Where does the $25 come from? Not from the $300. $300 is what u can give to common. 10K – 9500 = 500 and that’s what u can give preferred. You can give up to 300 to common shares and can still give an additional 25 to the preferred shares. Don’t need to know anything about par value!!!

Introduction    Every state has adopted an LLC statute. Each of them cloaks “members” – as the principals of the LLC are usually known – with limited liability. The LLC was designed for key actors seeking: 1. The opportunity to participate in day-to-day management 2. Limited liability; and 3. Flow thru tax treatment  Note: It is possible to combine these features in a corporate organizational form by electing Subchapter S status if the principals, their business activities, and the organization of their enterprise qualify for their status. A corporation does not qualify if it has:  More than 35 shareholders,  A corporate shareholder,  A nonresident alien shareholder, or  More than one class of stock.

Formation   An LLC is formed by filing articles of incorporation with the secretary of state. Most states require they include: o Names of the LLC o Address of Registered office and registered agent o Whether it’s a term company and if so, how long is the term

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If management of the company is vested in the managers Whether any member or members are to be liable for all or certain debts of the LLC No Limited Liability for LLC Members who Fail to Disclose Existence of their Business Organizations to 3rd Parties Limited Liability Partnerships o Registering a partnership as an LLP – by filing a “registration statement” with the secretary of state – typically gives the partners limited liability in connection with “debts and obligations of the (LLP) arising from negligence, wrongful acts, or misconduct… by another partner or an employee, agent, or representative of the partnership” unless that “person is under his direct supervision and control”. o o

The Operating Agreement  Although LLC’s are governed by statute, LLC statutes generally provide that the members can adopt an operating agreement with provisions different from the LLC statute. Generally, the operating agreement will control. Operating Agreement Controls if No Conflict with Statute o Default provisions may be in place in your jurisdiction which tell you what to do if the operating agreement is silent to something.

Cross between partnership and corporation: o Tax advantages of partnerships o Limited liability of corporation o None of the restrictions (e.g., number and type of shareholders) applicable to S corporations. Funding: o Members typically contribute capital o Contribution may be cash, property, services rendered, a promissory note, or other obligation to contribute cash, property or to perform services. Liability: o Members stand to lose capital contributions, but their personal assets are not subject to attachment. o No member or manager of a limited liability company is obligated personally for any debt, obligation, or liability of the LLC solely by reason of being a member or acting as a manager of the LLC. o But manager or managing member could be personally liable for failure to perform duties and  Violation of one of 608.4228(1)(b)1-5.  This is exactly the same as .0831(1)(b)1-5.  Tax consequence:  Florida statutes – Chapter 608 o Liability o Tax consequences o Formed by filing articles of organization  Formation:

Draft operating agreement:  The basic contract governing the affairs of a limited liability company and stating the various rights and duties of the members.  File Articles of Organization  Required and optional contents set forth  Existence begins when articles filed  The name of the LL must include the words limited liability company, limited company, the abbreviation LLC or LC. o Any person who knowingly participates or acquiesces in the omission is personally liable for any damage caused thereby.  Designate office and agent for service of process. Members interest: o A members rights include:  Financial interest  Profits shared in proportion to members’ capital contributions – but could specify otherwise  Management rights  Two options for management: [If forming it for someone – need to know what option they want to form. If don’t say anything in articles of incorporation they get member managed – looks like a partnership – every partner is a manager. If you want it to look more like a corporation with a CEO or President then you want to create a manager-managed LLC]. o Member managed: this is the default mode  Unless otherwise provided in articles of organization, management of LLC is vested in its members in proportion to the current percentage interest in the profits.  Looks more like a partnership with members managing  Most matters decided by majority vote (amount of votes in proportion to profit interest).  Members may appoint proxies to vote for them.  Agency Authority: Each member is an agent for purposes of its business. [Authority is just like in a partnership → actual or apparent].  Act of member apparently carrying on ordinary course of business binds the LLC.  If member lacks actual authority and person with whom member deals has notice, then member does not bind LLC.  Act of member not in ordinary course of business binds LLC only if member had actual authority.  If you don’t state what you are in FL, you are deemed member-managed. o Manager-Managed: o


Looks more like a Corp with owners managing Must be specified in articles of organization or operating agreement.  Elected or appointed by a majority in interest of members.  Members do not have any authority, only the managers are agents. Transferability of LLC Interest:  Unless otherwise provided in articles of organization a member may assign his financial interest in the LLC  An assignee of a financial interest in an LLC may acquire other rights only by being admitted as a member of the company if all the remaining members consent or the operating agreement so provides.  In manager-managed you cannot assign your interests.  Analogous to partnership rules.  

Piercing the LLC Veil: o To what extent should the corporate law rules apply to LLCs?  608.702: “The court shall apply the case law which interprets the conditions and circumstances under which a corporate veil of a corporation may be pierced under the law of this state.”  Distributions: o Standard of restrictions: similar to corporations in 607.06401. Same body of law!  Withdrawal of Member: o Only at the time or upon occurrence specified in articles or in operating agreement. Can sell or pass on financial rights not management obligations.  If there is nothing that says you can get your money out, there is no mechanism to have someone buy you out. You have to go find someone else to buy your shares.  Events of dissolution: o Upon the happening of any event specified by the LLC articles or operating agreement. o Unanimous vote of members o Upon court order:  When the preponderance of the evidence established that it is not reasonably practicable to carry on the business. Limited Liability Partnership:  Major advantage: General partnership law BUT partners are not personally liable for the LLP’s obligations, but  A partner remains personally liable for her own wrongful acts.  Formation: Must file a statement of qualification. Florida Rule: 607.0832 Director Conflicts of Interest:

Corporate Opportunity Doctrine: Subset of breach of duty of loyalty. When an officer or director takes something that belongs to the company for themselves, they have taken that corporate opportunity and violated that duty of loyalty. Objective: To deter appropriations of new business prospects belonging to the corporation Targets: o Officers and directors of corporation o Dominant shareholders who take active role in managing firm Rule: A corporate opportunity exists where: TEST: o o o o 1) Corporation is financially able to take the opportunity 2) Opportunity is in the corporations line of business 3) Corporation has an interest or expectancy in the opportunity 4) Embracing the opportunity would create a conflict between director’s selfinterest and that of the corporation  

Interest or Expectancy:  Expectancy is something that takes something, which in the ordinary course of things, would come to the corporation o If the officer took the renewal rights to a lease the corporation had, the officer took an “expectancy.” Interest is something to which the firm has a better right. o If officer bought land to which the corporation had a contractual right, the officer took an “interest.” IPO: “Initial Public Offering.” The first sale of stock by a company to the public. EXAM NOTE → argue both sides that the factors either point toward or against a corporate opportunity.

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Basic Principles: Shareholders acting as shareholders owe one another no fiduciary duties Controlling shareholders owe fiduciary duties to the minority; analogous to vicarious liability  Parent/Subsidiary Self-dealing When: A parent receives a benefit to the exclusion of the minority shareholders of the subsidiary and at the expense of the minority shareholders of the subsidiary. Accounting  Accounting is the process of recording, classifying, and communicating financial information. o Must be able to determine what money a business association has and whether the business association is making money. o Two most basic financial statements of a business:  Balance Sheet - purpose is to provide information about what a business entity owns and what it owes as of a particular date.  #’s on the left side are values of the stuff the business owns – “assets”  #’s on the right side are the amounts the business owes – “liabilities”  

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The owner’s equity or capital is the “plug” number/ difference between the assets and liabilities. Balance Sheet reflects the basic accounting formula: Assets = Liabilities +Equity Income Statement – Like a video that provides information about a business’ revenues and expenses over a particular period of time. Revenue – Expenses = Income (or Loss) Revenue is the money received by the business from the sale of its goods or services. Expenses are the costs incurred by the business in generating revenues Unlike a balance sheet, an income statement covers a period of time, not a specific moment in time. The period of time covered by an income statement is called an accounting period. (Usually one year) The excess of revenues over expenses for the accounting period is profit. If expenses exceed revenues, the business has incurred a loss for the accounting period.

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