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Business Associations Outline

Definition Sole Proprietorship A business that is carried on by a single owner. The business is the owner. None Partnership An association of two or more persons to carry on as co-owners of a business for profit. None Corporations A separate legal entity created by authority of law…doesn’t exit until you go through formalities. Certificate of Incorporation; Bylaws; Issue shares of common stock; Shareholders = owners; directors elected @ board meetings; appoint officers regular meetings of various groups. Shareholders = Owners Directors/Officers = Management Limited to the amount of investment Double taxation; corporate tax on earners and personal tax on dividend income Indefinite: not at all tied to owners Sell shares.

Formalities

Control

The One Owner = Management Unlimited Direct (1 time)

Liability Taxation

All partners are both managers and owners, each share in the profit and loss. Unlimited, plus Profits divided among partners and reported in each tax return At the will of the partners, for the life of the partners. Power to exit at any time, but not necessarily the right to exit at any time

Lifespan

Exit

Coextensive with Owner, life of the owner…debts from Sole Proprietorship live on. None…sell assets

Part One: Agency & Partnership I. II. Introduction Business Concepts a. Business → any endeavor with a profit motive b. Accrual Method → a method of accounting that records revenue when earned and expenses when incurred, rather than when they are paid in cash. c. Risk → uncertainty, possibility that future returns will deviate from expected returns 1

III.

IV.

i. Leverage → use of debt in the business 1. Leverage creates risk a. potential for gain, but also the potential for loss b. Security Interest → An interest in an asset which secures payment of an obligation; allow the asset to be sold upon default to satisfy the specified obligation. ii. Covenants → Contractual obligation or prohibition a. in loan contract, binds the borrower and gives the lender an element of control 2. Indirect control to creditors a. Use of funds b. Maintenance of business c. Restrictions i. Limitations on taking of further loans ii. Limitations on withdrawals d. Control upon default 3. Reduce Risk Sole Proprietorships and Agency a. Characteristics of Sole Proprietorships → business carried on by a single owner: i. No Formalities ii. Management = owners; has total control iii. Unlimited liability iv. Direct taxation v. Life of sole proprietorship is life of owner vi. Owner can exit by selling their assets. b. 3 Elements of Agency Relationship under Restatement of Agency §1 i. Mutual Consent 1. express or implied manifestation of consent ii. Action on behalf of another iii. Control 1. Restatement of Agency §14O → veto power is not enough; there needs to be defacto control to be considered control. c. Agency Cases i. Gorton v. Doty 1. Doty lent automobile to coach to take football players to a game. 2. Shows application of the restatement. ii. A. Gay Jenson Famrs Co. v. Cargrill, Inc. 1. Very rare case where a lender will be held liable for the companies they lend to. Authority a. Actual Authority → Restatement § 7 i. Authority 1. 3 requirements: a. Mutual Consent b. On behalf of another c. Control

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b.

c.

d.

e.

2. Power to affect legal relations of the principal a. Agent can bind the principal in contract b. Limited by scope of authority 3. Based on the principal’s desires → Restatement § 33 ii. Creation of Actual Authority 1. Principal’s manifestation of consent to agent → Restatement § 26 iii. Incidental Authority 1. incidental; usually accompany; reasonably necessary iv. Mill Street Church of Christ v. Hogan → Implied Actual Authority Case 1. church painting case Apparent Authority → Restatement § 8 i. Apparent Authority 1. Power to affect legal relations of the principal 2. Person is not actual an agent ii. Creation of Apparent Authority 1. Principal’s manifestation of consent to third party a. Accidents, lies, uncorrected statements iii. Lind v. Schenley Industries, Inc. 1. Case where Lind sues for 1% commission in sales, which he never received. a. Company could have protected itself by putting the contract in writing. Agency by Estoppel i. Elements → Restatement § 8B 1. Belief in agency relation by third party 2. Reliance by third party a. Had to change position 3. Fault of the principal ii. Hodesson v. Koos Bros. 1. Plaintiff buys furniture from salesman who turns out to be not a salesman. Inherent Agency Power → Restatement § 8A i. Inherent authority is created simply by the act or contract entered into by the agent – even if expressly forbidden by the principal. 1. Best to think about inherent authority as a last resort. 2. Can’t have inherent agency power without an agency relationship ii. Watteau v. Fenwick 1. Bar owner was liable for agents purchasers even thou be expressly forbid them iii. Kidd v. Thomas A. Edison, Inc. 1. Company liable for agent overstepping his authorization to enter into contracts because of customary powers of similar agents. Ratification → Restatement § 82 i. The Principal acts in a manner which expresses or implies that she authorizes the contract after the fact, the principal will then be bound by ratification

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V.

1. Used if no actual, apparent or inherent authority is found to exist at the time of the agent’s action. ii. Botticello v. Stefanovicz Liability in Agency a. Master/Servant Relationship i. Employment 1. Master = employer (principal) Servant = employee (agent) 2. Key is the control over the physical conduct of the agent in the performance of the service b. Independent Contractors → §2 of the Restatement i. Key is there is no control over the physical conduct of the agent in performance of the service. ii. ICs can be agents (if principal has control) or non-agents (if the principal does not have control) c. Servants v. Independent Contractors i. Restatement of Agency § 220(2) list factors to consider whether someone is working as a servant or independent contractor: 1. Extent of control 2. Whether it is a distinct occupation 3. Who supplies location and equipment 4. Length of time and relationship 5. Method of payment 6. Parties belief ii. Relevance of different between Servant & IC is the extent of vicarious liability 1. Independent Contractors a. Principle is liable for the actions of an Independent Contractor when the principle authorized the conduct (i.e., had a contract) 2. Servants a. Principle is liable for authorized conduct AND unauthorized conduct that is within the scope of employment. i. Restatement §228 list things that are in the scope of employment ii. Liability is limited to scope of employment because it is fair and foreseeable. 3. Vicarious Liability a. Encourages Responsibility b. Cost Spreading → puts the burden on the company and they will spread the cost to all the customers. iii. Humble Oil & Refining Co. v. Martin → Servant v. IC iv. Hoover v. Sun Oil Company → Servant v. IC v. Murphy v. Holiday Inns, Inc. → Servant v. IC vi. Billops v. Magness Construction Co. → Tort Liability/Apparent Authority vii. Ira S. Bushey & Sons, Inc. v. United States → Scope of Employment

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legal relationship with enforceable duties ii. Fiduciary Duty → Restatement §13 i. Duty of Loyalty 1. Have to avoid all conflicts of interest 4. 2. Contractual Duties ii. Glenn i. v. Law says there are fiduciary duties to both the new and old employer 1. Agent to Principal i. Inc. Contractual Duties ii. Arguello v. Indemnification → §438 5 . Town & Country House & Home Serve. You are not allowed to use confidential information in competing c. 3. Extent of Duty of care depends on the status of the agent a. Reading v. Even after termination c. Singer i. b. v. Regem i.VI. Solider uses his authority to smuggle goods and gets money c. → Statutory Claims Fiduciary Duties in Agency a. Bancroft-Whitney Company v. More than a moral relationship. Inc. Newbery i.) iii. Duty of Care 1. Conflicting interests a. General Automotive Manufacturing Co. b. Manager violated fiduciary duty because he took employees with him when he left (used confidential information. Accounting for profits → §388 a. Principal to Agent i. Paid Agent = standard care + special skill b. As to the subject matter of the agency. ii. You are allowed to compete with your former employer. Non-competition a. Agent that makes profits in connection with his duties must give the profit to the principal. §13 → agent is a fiduciary with respect to the scope of the agency only.) ii. Gratuitous Agent = lower standard (what the person relied on you for. b. Must avoid situations where one conflicts with the other. Conoco. you are not allowed to compete. Signer was the general manager of an automotive shop but sent jobs he couldn’t handle to another place. viii. Confidentiality → §395 a.

1x) v. Unless it’s payment of debt. Agency Law i.g. Unemployment Compensation Commission 2. Unlimited liability. a. Sharing of profits is prima facie evidence i. but not necessarily the right to exit at any time. Rhode Island Builders Association. Consent to elements of partnership b. Pass-Through (i. doesn’t automatically make you partners 2. Each partner iv. unless…third party knows partner had no authority 6 . Inc. Joint ownership and management iii. Partnership Rights → UPA §18 i. Also not necessarily powers and obligations 2. sales commission) a. No right to salary v. v. Not joint interests in property a. salary. Not sharing of revenues alone (e. No Formalities ii.e. c. Southex Exhibition. 1. Sidley & Austin a. Not necessarily consent to partnership 2. Fenwick v. Every partner is an agent of the partnership 1. plus iv. only among partners a. Consent to adding partners 1. b.. Lifespan is the life of the partners vi.VII. Just because you have a joint interest in property. Elements → UPA §6(1) 1. All loses or expenses must be reimbursed as to the agreement or what is appropriate Introduction to Partnerships a. Consensual Association a. Interpretive Rules → UPA §7 1. Inc. Power to exit at any time. Business for profit ii. Formation of Partnership i. Agreement can vary partners’ rights 1. Day v. Most issues arise here 3. Not necessarily to the outside world though.. Equal share in profits and losses 1. Acts for apparently carrying on the business in the usual ways are binding on the partnership a. d. Had an executive committee that made decisions over many matters. Profit Sharing ins only prima facie evidence ii. Equal management iii. Characteristics of Partnership → Law: Uniform Partnership Act (UPA) i. Carry on as co-owners a.

if partnership is liable b. seems to exclude tort situations b. Assignment of partner’s interest: → UPA §27 a. you can not sell your managerial or power in the profits because the partnership is a voluntary organization that takes the agreement of all partners to change it. with consenting apparent partners i. ii. if they read the partnership agreement and realized that he has no authority 2. Shaof g. Partnership by Estoppel → UPA § 16 i. Rights of Partners in Management → UPA §18 i. as partner. not the partnership as a whole. 2. otherwise. Property Rights of Partners → UPA §24 i. Acts not for apparently carrying on the business in the usual way are not binding a. unless…act is authorized 3. Manifestation (false –part saying non-part is part) 2. Right in specific partnership property → UPA § 5 1. For actual partnership. Equal right to management 7 . partners who didn’t know aren’t liable. Interest in the partnership → UPA §26 (share of profit & losses) iii. Acting with authority e. or…public manifestation w/o reliance 3. 2. iii. Liability 1. Partnership is charged with wrongful acts of any partner… 1.i. Reliance on direct manifestation a. Elements 1. Conveys only interest in the partnership 3. An equal right to possess partnership property for part purposes. extension of credit by third party to the apparent partner ii. Only those partners who knew are liable. Young v. if authorized a. Putnam v. consent (of manifestation) of all partners is required to impose liability b. therefore partnership isn’t liable. Does not affect partnership v. *Extension of credit* a. For apparent partner: (creates virtual partnership) a. Right to manage the partnership iv. You only worry about apparent authority if the act is not authorized ii. Default rules: 1. Acting in ordinary course or business or 2. Jones f.

iii. Dooley 1. Kightlinger & Gray 1. Three Stages 1. Disagreement on ordinary matters settled by majority vote → §18(h) 3. Termination → the end of a partnership b. Salmon 1. Grabbing and Leaving i. Best statement of Duty of Loyalty: a. Always have the power. Partnership Dissolution a. Can be changed by agreement. Right to dissolve 1. Stroud 1. Winding Up → the process of settling partnership affairs after dissolution 3. but not of his former partners. Bane v. Ferguson 1. different outcome from the national biscuit case VIII. Fiduciary Duties of Partners a. in RUPA. the change in the relation of the partners caused by any partner ceasing to be associated with the partnership. Meinhard v. which is normally that partner can act & bind the partnership iv. Summers v. Absent a majority vote to settle disagreement. IX. c. the commencement of the winding up process. Duty of loyalty stands up until the point that you are not working at the firm. Dissolution → in UPA. Expulsion i. Lawlis v. National Biscuit Company v. Power to dissolve 1. No duty of care is owed to former employees of a firm a. for the withdrawal of a partner terminates the partnership as to him. revert to the status quo. ii. Duty of loyalty is not violated for being fired if you can be fired for any purpose. A partner is a fiduciary of his partners. Causes of Dissolution under UPA §31 i. Shaughnessy 1. Revised UPA gives an exhaustive list of duties iii. After Dissolution i. but not always the right. “owe to one another…the duty of the finest loyalty” b. Meehan v. d. Contravention of agreement requires unanimity ii. At will partnerships & 8 . You have the right to dissolve in: a. 2.2. Introduction i. Ending a Partnership under UPA §30 i. UPA is not very clear on fiduciary duties ii.

if any ii. Serious misconduct iv. Page v. If the court is convinced there is serious misconduct. As specified in agreement 2. by agreement 2. Partner’s fiduciary duties continue until the business is completely wound up. Future liabilities only with respect to: 1. Collins v. Partners who have not wrongfully dissolved → UPA§38 can continue the partnership 1. The jury rejected this. Unpredictability v. Vasso Corporation ii. Owen v. d. Partners’ profits. Effect on creditors → UPA§17 & §41 1. Authority is terminated 1. He wanted a dissolution form the court because Lewis did a really bad job running the business. Creditors other than partners 2. Cohen 1. Lewis 1. Page a. Insanity ii. Automatic dissolution 1. Except as to winding up. Partners’ return of investment 4. Monin 1. Monin v. Term expires 2. Other equitable circumstances vi. Partnership becomes unlawful 3. vii. Pav-Saver Corporation v. f. Distribution of Assets: 1. e. Certain innocent parties Winding Up i. Partners as creditors 3. Court decree Judicial Dissolution i. Partner may only dissolve an at will partnership if they do so in good faith. Collins wanted a dissolution but did not have the right to dissolve. ii. Winding up 2. Death or bankruptcy of a partner 4. iii.c. Continuing the Partnership i. the court will order dissolution. b. Continuing partnership remains fully liable 2. Effect of Dissolution i. Continuing partners remain fully liable 9 . Existing liabilities remain → UPA §36 iii. Inability iii.

Exception includes partnerships at will iii. ii. Uniform Limited Partnership Act §403 10 .X. Limited Partnerships i. Dissociation → in RUPA. G & S Investments v. Including winding up obligations 4. General Partner → a partner with the right to manage the business and with unlimited liability i.e. general & limited 1. not fair market value. 3. Sole Proprietorships Problems 1. Default Rule: partnership continues → RUPA §801 1. New partners liable for: a. Advantages of having a buyout agreement: a. Any profits gained during wrap-up of partnership is divided between partners according to their share of the business. Unlimited liability plus b. Jewel v. Allows the business to keep going c. In ever dissociation. Limited Funding 2. the change in a partnership caused by a partner’s ceasing to be associated in the carrying on of the business. New obligations b. Avoid litigation b. Dissociating partner’s interest must be purchased 2. funding 3. Old obligations. Partnership Problems 1. Limited Partnerships → partnerships with two types of partners. 2.. Disadvantages of having a buyout agreement: a. Unlimited Liability ii. Partnership Buyout → an agreement that allows a partner or shareholder to end her relationship with the other partners or shareholders and receive a cash payment in return for her interest in the business. either: 1. Better. Or partnership is dissolved and wound up iv. Ending a Partnership under RUPA → §601 i. g. but still limited. Former partners remain liable for old obligations a. Avoid unpredictability of judicial decision 3. i. Boxer 1. but only out of partnership assets iii. Too many managers 2. Undermines the entire relationship Limited Liability a. Price may not be set correctly b. capital account value = book value. Problems so far with Business Associations: i. a. Belman 1.

2. Select Name → §102 1. LLPs. Greater access to funding 2. there is not limited partnership. A limited partner that takes control of the business becomes a general partner c. d. §402 ii. Increasing diversity 1. Originally only had LPs and corporations 2. Contains minimal information 2. Generates filing fees for the state iii. Etc. Optional: written LP agreement 1. default rules will apply iv. must contain the words “limited partnership” ii. Limited Liability i. History of increasing availability 1. CANNOT be formed accidentally! 1. without the filling. If you don’t. De Escamilla 1. Originally only available for specific purposes a. Advantages of Limited Partnerships: 1. Based on the passive investor status 1. Now there are LLCs. Efficient management iii. Eventually available for all iii. Law used to give limited liability on a case by case basis 2. Expanded for industrialization 3. Holzman v. Provides notice of existence 3. Limited Partner → a partner with no right to manage the business but with limited liability i. Forming a Limited Partnership i. 11 . File Certificate of Limited Partnership → §101 1. Filing creates a LP. LLLPs. Passive investor status required to get limited liability §303 ii.

Fairness to passive investors 3. Liability: limited to investment 1. Is Limited Liability a good thing? 1. Corporations i. Encourages investors to engage in risky activities because the risk is externalized b. major drop of corporation form 2. Personal tax on dividend income vi..e. Exit: sell shares 1. Rights: fixed compensation first. Input: labor 2.Part Two: General Corporate Law I. Risk: low iii. It is harder for corporations that are not on open market exchange (i. Public Corporations 2. very little control 3. Not at all tied to owners vii. Limited Liability i. Closed Corporations 3. closed corporations) c. ii. Lifespan: indefinite 1. Regular meetings of various groups iii. Trade Creditors 12 . Formalities: many required 1. Just a web of contracts ii. Free transferability of shares 2. Employees 1. Officers are true managers 2. Taxation: double taxation a. Control: separation of ownership and management 1. Encourages investment 2. Contractarian Theory → a theory that views the corporation as a web of contractual relationships among various stakeholders rather than as a separate legal entity owned by the shareholders 1. Filings and other documentary requirements 2. Limits the cost to society of litigation ii. Corporate tax on corporate earnings 3. When you have separation of ownership and management you have conflicts of interest iv. You can’t lose anything more than you have put into the business v. Introduction to Corporations a. Is Limited Liability a bad thing? 1. Two types of Corporations 1. Can be in between → a public corporation that has control in a few investors’ hands. Increase stakes for creditors 2.

very little control 3. Provides notice of existence 3.g. Risk: high d. e. Sometimes interests diverge 1.g. Input: property 2. profit iii. Various other formalities v. management rights. control 3. Key players: Management and shareholders ii. state of incorporation f. Shareholders may want to replace management a. Input: cash. Risk: moderate v. responsibilities and benefits a. Rights: fixed principal + interest. defense tactics b. Risk: low iv. e. Fees 2. Rights: fixed payment first. agency costs 2. Forming a Corporation. Generates filing fees for the state iv. Rights: residual profits. Equity Holders 1. Competition among states 13 . Conflicts of Interests i. depends on state law) 2. Internal affairs doctrine →a choice of law rule under which courts look to the corporate law of the state of incorporation to determine the internal rights and duties applicable to a corporation 3.e. Interests of management and shareholders are usually aligned 1. State of Incorporation i. Select a name 1.” or similar title (corp.g. Input: cash 2. “bank” (depends on state law) ii. incorporation i. property and/or labor 2. Management wants to insulate itself a. proxy contest b. Must contain “Inc.. e. some indirect control 3. need not be the state you do business in 2. Cannot contain certain words.. File certificate of incorporation → document establishing and governing the internal affairs of the corporation: charter 1. Debt Holders 1. Cannot be formed accidentally! e. i.. Contains minimal information 2. For each state you look at the laws of that state iii.1. Benefits to state 1. hostile takeover 3. Select a state a. Related services industries ii..

Favors corporations over others 3. clarity / consistency c. Securities laws: continuous disclosure a. Responsiveness / service a. state corporate law should be able to change to the ever changing corporate environment 3. large minority interests can have no influence i. flexibility / innovation b. Public Corporations a. Big debate over whether this is a good thing or bad thing 2. less regulation 2. none with a controlling interest 2. Conflicts of interests 4. small group of owners. small minority interests can have large influence 3. Flexibility / innovation a. states like PA do not have to worry about this and blatantly act in favor of management h. ‘under the microscope’ ii. require that public corporations continuous disclosure various information about themselves b. many shareholders. Favors management over shareholders g. responsiveness / service 3. You can have 49% and still have no say (if the other half has 51%) 14 . with state legislature and officers respond to your needs 5. the actual law itself → are they good for you? iii. State of Preference for incorporation 1. Delaware → winning of race to bottom i. b. Clarity / consistency a. Now: legitimate benefits a. while benefits go to the one state who gets the fees 2. Control issues a. Control issues a. who have a real say in the business 2. Close Corporations a. Race to the bottom → theory that competition among states leads states to pass increasingly lenient corporate laws a. without getting the federal government involved. Main Issues i.a. individual shareholders have little control b. Why does Delaware act moderately? → Risks federal intervention a. clear statutes and consistent judicial decisions 4. Substantive content a. Originally: more favorable laws a. burdens of bad laws are shared by all states. They push as much as then can.

Select state of incorporation 3. beyond the scope of power allowed by the corporate law and/or charter d. because can limit your actions i. before issuing shares. or cosubsidiaries ii. is controlled by. authorized stock → number of shares that the company can issue and classes and series of stocks and their rights (normally want to authorize more than you plan to originally issue – planning for future) i. or is under common control with. parent corporation → one corporation that owns another (subsidiary) i.1404 2. File certificate of incorporation ii. Who can incorporate? 1. all we have is the incorporator/promoter iii.II. Elect directors iv. Adopt bylaws a. Freeze-out → action taken by the majority shareholders in a close corporation to frustrate the expectations of the minority shareholders Corporate Formalities a. Hold shareholder meeting 1. address c. that governs the internal affairs of a corporation 2.g. Overview → starting a corporation 1. nature of business → dangerous. name b. Incorporation i. Select name 2. How do you incorporate? 1. Contents a. common stock – security representing a basic ownership interest in the company (general voting 15 . Hold board of directors meeting 1. anything else will be ultra vires 1. First step → Certificate of incorporation/Charter a. document. form on p. deadlock 3.. parent and subsidiary. subordinate to the charter. subsidiaries can own other subsidiaries 2. e. Appoint officers b. unauthorized. b. another. DGCL § 102. affiliates → anyone who controls. Issues shares a. Hold organizational meeting 1. including another corporation → DGCL § 101(a) a. Anyone.

rights [one share/one vote]. for example. v. initial directors (if they are selected at the time of incorporation) g. $1 preferred stock will get $1 dividend before common stock gets anything. optional items i. Camcraft. Generally in corporate law → form matters 16 . e. par value is irrelevant now – don’t have to have it 1.. makes sense in closed corporation. lawyer and law firm ii. limits on directors liable for breach of fiduciary duty iii. but won’t get more than the $1 per share. names and addresses of promoter i. special voting rights (i. Inc.e. some state laws have done away with par value f. used to be the default rule. specified in a corporation’s charter. common ones: 1. par value → a dollar value. put in any rule you want to govern the corporation ii. Inc. 9. that establishes the minimum price for which a share of stock may be issued and which is set aside for the protection of creditors i. a. lawyer have put it at a penny 2. now you put them in the charter i. but not really for public corporations 2. Southern-Gulf Marine Co. and entitled to residual profits & dividends) ii. 1. No. preferred stock → preference on dividends (issued prior to common stock dividends) –limited voting rights 1. preemptive rights → the right of a shareholder to purchase enough newlyissued shares to maintain her percentage ownership in the corporation a. De facto Corporation Doctrine → a legal doctrine under which courts may treat a business that was not properly incorporated as a corporation if the promoters made a good faith effort to incorporate and treated the business as a corporation. may require a supermajority of shareholders to successfully vote on an issue) 3.

Have to file in each state to do business there 6. Organizational Meeting i. 1416 1. Doesn’t make much sense. Adopt bylaws a. relieve the incorporator of potential liability by official authorization or approval of his past acts. Fully Paid and Non-Assessable Share → share which has been purchased from the issuing company and paid for in full. record date → the date on which ownership is established for purposes of shareholder voting i. Issue shares a. Resolutions: what was decided 2. but can be contained in the Bylaws b.b. Bylaws i. Corporation by Estoppel → a legal doctrine under which court may prevent third parties from denying corporate existence if they acknowledged the corporate entity and would earn a windfall by subsequently denying corporate existence. Elect directors / appoint officers 4. 1406 1. 9. meetings i. whoever owns shares 15 days before the vote 2. c. Directors 17 . Minutes: what happened b. Set annual meeting of shareholders 8. DGCL § 108. Voting Rules HAVE to be in the charter. as how does someone make a good faith effort to file a certificate of incorporation yet not file it? 2. Authorization to do business in other states a. written consent in lieu of a meeting c. a. quorum (default is majority) e.. Approval of past acts a.a. you don’t have to have a stock certificate b. and with respect to which the issuing company cannot demand more money from the shareholder 5. Select fiscal year 7. unnecessary and archaic 3. Adopt stock certificate and corporate seal a. or too late d. uncertificated securities c. notice (for meetings) i. Any other business d. Form on p. book entry security → a security represented by an entry in a register. can’t be too early.k. Stockholders i. corporate seal i. form on p.

Limited Liability → the limitation of an investor’s liability to her investment in business. Board committees 4. and directors may or may not be able to (but usually can)) Piercing the Corporate Veil a. main offices 5. lost certificates 6. quorum f. seal c. Exceptions are very rare ii. but can be removed for no cause ii. Classified Board → a board of directors structured so that only a fraction of its members is elected each year for multi-year terms. number c. Stock a. meetings e. certificate b. fiscal year b. NY requires certain officers b. Bylaws may provide otherwise (can set any number or standard) iv. Some injustice b. Piercing the corporate veil → holding shareholders personally liable for the obligations of the corporation 1.. telephonic meeting/video conferencing 3. Miscellaneous a. Delaware is open for officers ii. the courts won’t either 2. amendment of bylaws (generally speaking. Failure to respect the corporate form b. Default rule is that each director is elected individually b.III. Failure to respect corporate formalities a. could have a staggered board (like the US Senate) with a % elected each year) iii. General rule: shareholders are not liable for corporate obligations 1.k. Failure to Respect Corporate Form i. staggered board d. take care of indemnification that is optional 7. a. Officers i. shareholders can.a. Indemnification of officers and directors a. i. Two Part Test a. Failure to incorporate 18 . such that business creditors cannot go after personal assets i. If you are not respecting the corporate form. term i. generally one year.

Unity of interest and ownership 2. 1. Other injustice 1. available. Walkovszky v. If there is truly is no money. Commingling of assets 3. Frigidaire Sales Corporation v. Unjust enrichment iv. Union Properties. Kinney Shoe Corporation v. Fraud iii. you need more. Issues: 1. based upon the nature and the 19 . Failure to maintain records ii. Court respect form over justice. Also viewed ex ante 3. Judged ex ante. Something more than just the general forming of a corporation b. Missing one or two meetings probably not enough. Third Prong introduced by the court: a. not just turning out that there wasn't enough. c. Big elaborate scheme.3. Inc. If an investigation would disclose that the corporation is grossly undercapitalized. Failure to hold meetings 5. it had to be clearly too little from the beginning. Domination by shareholder 4. but never holding them is almost certainly enough. Carlton 1. Undercapitalization → failure to provide adequate capital for the business when incorporating a. Polan 1. (Velasco likes this case. seems fishy 4. Siphoning of funds → excessive withdrawal of corporate resources for shareholder benefit a. In other words. ii. You have to have enough assets at start up to account for slowness in selling your product. Intentional scheme to evade responsibility a. that although legal. 3. The question is: how much is enough? Always a factual determination. Failure to maintain separate identity 1. it is undercapitalization and the corporate veil can be pierced 2. Veil was not pierced because inadequate capitalization alone will not lead to liability absent a finding that the corporation abused the arrangement by failing to follow corporate formalities. Cover foreseeable and natural expenses 2. Mere fact that the injured plaintiff goes uncompensated is not enough. Some Injustice 1. iv. not ex post i. “alter ego” or “dummy” iii.) v. b. Failure to issue shares 4.

such party will be deemed to have assumed the risk of the gross undercapitalization and will not be permitted to pierce the corporate veil. Reverse Piercing → going the other way with piercing the corporate veil i. a. Must put interest of the shareholders before monetary interests. 2. Sea-Land Services. all affiliates) liable for the obligations of a constituent corporation 1. Self-perpetuation 4. the owner of the entire corporate enterprise may still escape liability even if the entire enterprise is liable. v. ii. In theory. there must be fraud.e. Henry Ford could not run his corporation for social good. or a conflict or interest. a. A court will not uphold irrational decisions about dividends that it determines to be an abuse of the director’s discretion. Inc. it’s piercing corp veil) 2. Some injustice 3. d. Dodge v. By the Courts logic. owner can be liable for the owners own action in respect to the business. enterprise liability would be the rule and not the exception. Related Theories i. not in the best interest of the corporation because the IV. In re Silicone Gel Breast Implants Products Liability Litigation a. Profits for shareholders 2. The court will not enter a contested situation based only on poor business judgment. ii. Velasco HATES THIS CASE. Society allows corporation → Purpose thus is to benefit society. Holding persons liable for what they do. but rather for profit to shareholders. illegality. Pepper Source a. iii. Another word for enterprise liability 4. 20 .magnitude of the corporate undertaking. As between corporations (if its b/t corp & owner. This is not piercing the corporate veil. Lack of separate identity a. Enterprise liability → a legal doctrine under which a court may hold an entire business enterprise (i. Direct liability 1. Business decisions are in the hands of the Board. Ford Motor Co. Here it didn’t matter that the directors didn’t want to put in lights because it was in the neighborhood’s best interest. What is the purpose of Corporations? 1. Wrigley 1. Shlensky v. b. Provide goods or services to public 3. 1. The Purpose of Corporations a.. 2.

it’s taxed. moral duty to act well when forced to act at all) b. NY BCL §202(a)(12): Irrespective of corporate benefit (doesn’t matter) 2. ii. political lobbying groups. (29 states have general laws like this) 21 . Yes – corps have extensive resources i. Co. Statutes 1. b. Corps can monitor their resources better iii. If it goes to shareholders. 1. Socially responsible behavior is necessary (i.e. they are a choice. Constituencies Rules: a. v. No – i. Smith Mfg. don’t have to just consider profit or shareholder maximum value v. 4. Recent laws allow directors to consider any factors when making business decisions – basically they can do as they please for the benefit of shareholders.. A. suppliers. etc.P.. employees. Difference a. NOTICE THE DIFFERENCE BETWEEN THE FORD CASE AND WRIGLEY CASE. Del GCL §122(9): No mention of corporate benefit b. Corps better at giving b/c it’s more convenient to solicit $1 million from a corp than $1 mil from 100. 2. Charitable donations are not necessary. In Wrigley the court says that corporations can take into consideration socially beneficial or injurious factors (i. no taxes. Court is more accepting of charity that it was in the Dodge case. Modern corporations should have duties to society beyond wealth maximization 3. iv. Why should they get to spend shareholders’ money iii. Similarities – a.000 individuals. Barlow 1.property would become more valuable if it could offer night games. Should corporations be allowed to be charitable? a. Do we really want this amount of resources directed by those in the upper classes? ii. Donations are tax deductible – if it goes to charity.e. Cal CC §207(e): Regardless of specific corporate benefit (general) c. In both cases it is a decision to divert resources from profitmaximizing uses to 5. Tax counter-argument  you can just pay the tax and allow the gov’t to apportion it vi.

“a presumption that. in making a business decision. ii. shareholders are willing to gamble with the jobs/livelihoods of others. Other groups (employees. Credit Lyonnais Bank v. The fact that a decision was poor or less advantageous than an alternative is irrelevant. Shareholders don’t bear all the loss. 2. only the initial loss of stock value. In most cases. iv. etc). North 1. and in the honest belief that the action taken was in the best interests of the company” 1. a. Standard is gross negligence v. Kamin v. 2. directors normally win. (note: rational. An informed business decision.V. a. Pathe Communications Corporation 1. Interests of shareholders and Directors/Corporation are not aligned. the courts won’t look at the substance of the decision: 1. Facts: The Board declared a special dividend to the shareholders (causing a large tax liability) instead of liquidating a bad investment. You don’t win your case. If the courts decide that the BJR applies. (employees can lose jobs. They look at all the risk – positive and negative. iii. Shareholders will be looking at equity (Assets – Liab) while the corp may only be looking at assets. a. the directors of a corporation acted on an informed basis. Whose interest should be predominant? i. The court will only interfere if there was a lack of good faith. AND b. Joy v. When corp is near insolvency. Shareholder have the most incentive to take the best route for the company 1. 2. vi. they will be held without fault so long as the decision was rational. waste. The shareholders brought a derivative suit claiming a waste of the corporate assets. not reasonable) ii. You challenge the decision making process. the directors are not just agents of the shareholders. American Express Company (New York) 1. Business Judgment Rule a. Near Insolvency: a. carefully made in good faith and w/o conflict of interest. in good faith. but owe a duty to the corporate enterprise. VELASCO THINKS THIS CASE IS WRONG 2. Limits of Business Judgment Rule 22 . no win situation are the only ways to challenge the substance of a business decision. directors. Creditors bear risk of loss. Held: Declaring the dividend is a board decision that is protected by the Business Judgment Rule. totally irrational. b. Business Judgment Rule → a legal doctrine that protects business decisions from judicial review. Willing to risk losing the corporation if they stand to make tons o’ money. by challenging the substance of the decision 1. creditors) all they want to do is avoid risk.

a. 3. Director of bank in this case did nothing. Situation is so egregious as to amount to a no-win decision d. Bring it to the attention of the board b.a. Don’t have a duty to “enact a system of corporate espionage” to determine if there’s anything wrong. Sustain and systemic failure is the standard of review. Voting against it b. Directorial management does not require a detailed inspection of day-to-day activities. Director is responsible for enacting some time of compliance/auditing/information system is in effect – a duty to remain informed or provide a process by which he could remain informed. United Jersey Bank (New Jersey) 1. In re Caremark International Inc. Gross Negligence is the standard! i. Must resign rather than being a part of it 3. 2. Director owes fiduciary duties to shareholders. a. Situation is tainted by a conflict of interest c. Cases in which the corporate decision lacks a business purpose b. 5. but none of the potential profit/gain. VI. The bank had all the risk of loss. a. Talking to accountants 4. Why can clients sue in this case? It is an insurance company – ins cos and banks are different ii. b. 4. Extreme rare to find a case is a no-win situation (in this case it was the loan as a no-win situation. Absent grounds for suspicion. but rather a general monitoring of corporate affairs and policies. 2. Duty of Care a. the rest can be done by officers. Results from an obvious and prolonged failure to exercise oversight or supervision. This was a special case where the director owed fiduciary duties to creditors. substantive business decisions. b. Directors needs only make the most important decisions. board members cannot be held liable for assuming that employees were trustworthy c. 23 .) a. You have to take steps to try to prevent illegal activity: a. Derivative Litigation 1. Francis v. Courts are far better at making procedural decisions than they are at making ex post facto. Director has to object when they see the management engaging in illegal activity a. thus it was clear that she reached her duty of care. Standard of review is much lower than standard of conduct.

2. If it works. but someone is offering you $50 now (market value is $35) 6. The board signed the merger agreement without reading it even though they had almost no information as to whether it was a good price or deal. Borrowing money to buy a company and use the company’s profits to pay off the debt. But did they really? They could have made a decision in two hours. 2. 4. Facts: The CEO went to a friend to initiate a merger. Theoretically it might be worth $60. attorneys received almost $1 million. Two types of duty of care claims: a. The CEO told the board about the deal but they never saw it in writing. He offered this friend a low price--$55/share. Directors didn’t have to pay anything for their misconduct. Leveraged Buyout (LBO) a. Martha Stewart Living 1. The corporation had 90 days to accept other offer. Didn’t determine the intrinsic value (what’s it worth) b. Didn’t get the best price (what can you get for it) 4. Failure to act iii. and someone might give you that higher price someday. so the person can sell junk bonds 24 . Smith v. considering they were experienced directors 5. Banks may not want to make that risky loan. 3. Directors have an obligation to be informed. though? If the corp is all about her? iv. i. More Efficient Market Hypothesis – a.i. No negotiations occurred at any point. the business goes belly-up and you’re stuck with the debt b. Many of the terms of the deal were disadvantageous to the corporation. Directors violated their duty of care in this transaction. but no solicitations to potential purchasers were made. Van Gorkom (Delaware) 1. The deal was kept very quiet. Senior management was vocal about their disagreement with the deal. Why not. Corp didn’t have to monitor MS’s personal life/affairs. Breach would be a sustained and systemic failure – gross negligence 3. a. you end up owning the company for “free” (you don’t put much capital in) ii. Is there an intrinsic value that is more than market value? What does it matter if you think the company is worth $60/share but no one will pay more than $50/share? b. Bad decision – protected by the BJR – courts do not look at substance unless it is irrational – more concerned with decision making process b. If it doesn’t. even the lawyers were uniformed.

burden on the defendant b. Most often (Delaware) → business judgment rule. burden on plaintiff VII. Vcry similar situation. Many states passed laws allowing corporations to eliminate the duty of care 1. Fair Price b. Fallout: a. corporations can put a provision into the charter a phrase that says “directors cannot be liable for breach of duty of care” v. 25 . Fair Dealings 2. b. 1. There was a breach of duty of care so directors had to defend their decision under the strict entire fairness test. There is still the possibility of injunctive relief or voiding the deal. a. Default a. but the court found it to be gross negligence. burden on plaintiff 3. Less people wanted to be directors ii. Business judgment rule. Independent Shareholder Approval a. Very speculative 7.i. b. Bonds are rated based on risk. There is a duty of care. Cinerama v. Most people didn’t even see this as negligence. Insurance companies didn’t want to insure directors iii. BJR  rational basis test b. selling for a very high price. just not liquidated damages from directors 3. high return. Inc. Technincolor. If you have too much risk. Interested Transaction Law i. higher risk requires more interests ii. Director Interest 1. “Entire Fairness Test”  strict scrutiny Duty of Loyalty a. This was a very sophisticated set of directors. High risk. Entire fairness test. In other words. burden on the defendant 2. the bonds are not considered “investment grade” and are of lower quality (many banks can’t buy)  junk bonds iii. but the directors will not be personally liable for a breach of the duty of care. Some states suggest → Entire fairness test. a. Independent Director Approval – Unclear a. Court decided it was fair. i. court upholds VanGorkum (say they don’t get the protection of the BJR) and the “entire fairness test” applies a. with an inconclusive market test. even thou they breached their fiduciary duty.

iv. the majority shareholder secretly chose the option that would benefit them at the expense of minority shareholders. After the shares were redeemed. 2. Entire fairness test. Default a. 26 . Standard of care in duty of loyalty cases → most rigorous scrutiny 2. then liquidate second. In other words. 3. Independent Director Approval i. Independent Shareholder Approval a. b. This caused the minority shareholders to get less than had they just liquidated first. Courts have to limit what counts as a conflict of interest i. a. If this is even possible b. Controlling Shareholder Interest 1. Bayer v.ii. A director must use the kind of judgment that one would expect and give in similar situation to the conduct of his own affairs. Entire fairness test. burden on plaintiff 3. Business Judgment Rule requires undivided loyalty and the avoidance of the temptation of self interest. Beran (New York) 1. than entire fairness has to be kind of rare ii. It exercised its control over the Board to redeem all of its class A stock—a class that had no voting rights. If BJR is default. Basically a. The company could either liquidate or redeem – they chose to redeem first. Held: Transamerica unfairly used its controlling share of the corporation to profit at the expense of the minority shareholders thereby violating its fiduciary duty as a controlling shareholder. Entire fairness test. b/c the minority shareholders could have traded in their stock for the class B stock had they known what was going to happen. It is not improper to appoint relatives to responsible position in a company as long as it is done within the duty of care and does not violate the business judgment rule. the corporation liquidated and only Transamerica—the controlling shareholder benefited from the liquidation. Zahm v. i. Another class A shareholder sued claiming that he should have been allowed to benefit from the liquidation. Facts: Transamerica owned nearly all of a particular class of stock in the Axton-Fisher Tobacco Company. burden on defendant 2. Transamerica (Federal Case) 1. burden on plaintiff iii.

it was that the shareholders didn’t know what the company was worth before the liquidation. b. Shareholder Conflict on Interest 1. Shareholders get upward adjustment of book value i. Lewis v. Should we allow conflicted transactions? a. Must be a business judgment – this wasn’t. You have no fiduciary duty to other shareholders b. vi. giving the company a windfall. There are sometimes when a conflict of interest is unavoidable  courts will need to make a decision d. & E. The duty of loyalty problem was that the Company didn’t give them the valuation information which would have allowed them to convert. Levien (Delaware) 27 . There are no conflicts of interest w/ shareholders.. as there was no consideration given for the lease b. A ‘conflict of interest’ doesn’t mean something is wrong… it’s just the potential to be wrong b. 4. thus screwing the minority shareholders b/c they didn’t have the opportunity to convert.L. 1. Conflict of interest – self dealing – apply entire fairness test. S. Add in the rent you did not get over time 5. Basically the court finds that this was a conflict of interest situation – the company/majority shareholder didn’t disclose the value or the intent to liquidate. 2. v. This is in public corporations i. There was no interest in charging the best rent b/c they were charging it to another company it owned.4. yet they secured a below-market value rent for the renting company. Class B was controlling. Having to prove everything is fair will require the courts to look at the substance. Inc. Not as much so in private corporations. The BJR does not apply a. Tolerant of conflicts of interest as long as the transaction is fair. a. therefore could make decisions on their own. vii. 3. Duty of loyalty issue – not all the siblings owned both companies. 5. Individual shareholders can act in their own interests a. What did shareholders win? a. which is not consistent with the policies behind the BJR (courts not qualified to make these decisions) c. 2. Basically the class A shareholders (minority) can’t complain about the redemption. The real problem wasn't that the minority shareholders didn’t know the company was going to liquidate. v. Sinclair Oil Corp.

That’s under the BJR so long as Sinclair wasn’t actively taking away opportunities that Sinven already had. Such contracts required fixed high quantity purchases and full payment on receipt. The minority shareholder also claimed that Sinclair usurped corporate opportunity by stealing business from Sinven through its control as the majority shareholder. You’d have to show a conflict of interest to apply the entire fairness test to look at the substance ii. no preference or additional benefit was given to the controlling shareholder to the exclusion of the minority shareholder. Court applies entire fairness test b/c Sinclair is on both ends (contract between Sinclair and Sinven. but there’s no conflict of interest when all the shareholders get their fair share. which is controlled by Sinclair) viii. Conflict of interest?  apply entire fairness test 2. a. Conflict of interest: need ‘self dealing. Sinclair was directing opportunities to other subsidiaries instead of Sinven.. Sinclair owes levien a fiduciary duty as the majority shareholder in Sinven (with levien being the minority) i. Held: This is not a breach of the duty of loyalty because the minority received their appropriate share—the controlling shareholder did not benefit at the minority’s expense.’ i. Breach: i. Thus.e. When there’s a fiduciary duty. 3. there’s a fiduciary duty. 4. Sinclair needed money and caused Sinven to pay out to cover it..1. Notes a. The dividends were in excess of Sinven’s net earnings. Facts: Sinclair Oil owned 97% of a subsidiary. b. A minority shareholder of Sinven sued Sinclair claiming that the dividends were excessive and that Sinclair breached its duty as a controlling shareholder in paying them out since it received the majority of the benefit. you apply the BJR. (like being on both ends of the transaction. Fliegler v. Selfishness is ok as long as it doesn’t rise to the level of self dealing. When there’s control. Fiduciary duty  apply BJR b. It also claimed that Sinclair forced Sinven to enter into contracts with a wholly owned subsidiary. Sinven paid out very large dividends both to Sinclair oil and its minority shareholders. Plaintiff has to prove his transaction was intrinsically fair. c.selling & buying) iii. a. when the fiduciary gets something to the exclusion of the minority owner. Lawrence 28 .

Shareholder ratification automatically invokes the BJR and the burden is on the plaintiff to show the transaction essentially amounted to waste. no dispositive. Burden of proof: i. 2. Potential for greater influence by controlling shareholder iv. Vote counts as evidence of fairness. Note this is shareholder approval. the plaintiff will have to prove that its unfair. 51% would be presumed. Qucik Summery of interested transaction law i. a. This was a director transaction. not necessarily ‘disintrested’ shareholder approval. Shareholders Litigation 1. b. b. a. If you ask for a shareholder vote. Theoretically. you have a duty to fully and fairly disclose all relevant information. a. Ratification: Delaware law allows conflicted transactions to be made by non-conflicted parties. Burden of proof shifts to plaintiff if the transaction was approved by fully informed disinterested shareholders. but good evidence ii. Inc. Court says that the entire fairness test applies even if the transaction is ratified. 3. Why are the tests different? 1. Directors normally have burden to prove in “duty” cases that the decision was “fair” iii. Statute also allows the conflicted parties to prove ‘fairness’ w/o ratification to allow the transaction. If fully informed disinterested shareholders give approval it voids the duty of care claim. Shareholders weren’t fully informed c. c. In re Wheelabrator Technologies.1. they can ratify a transaction that benefits them. not controlling shareholder – court says there was no evidence that 22% was controlling. b. So why bother with the ratification? i. Plaintiff bears burden if the shareholders ratified the decision. Van Gorkum – why didn't shareholder approval extinguish duty of care claim there? i. Burden of proof shifts – instead of the defendant having to prove that it’s fair. default rule is EFT w/ burden on defendant 29 . Director: 1. ix. if the conflicted shareholders hold a majority. but shifts burden to plaintiffs to prove transaction was not fair ii. Controlling stockholder + fully informed disinterested shareholder approval = entire fairness test.

but consider these factors: a. Controlling shareholder interest 1. (no later ratification) iv. Some states say at the time of the transaction (ratified later provided the transaction was fair) b. a. Independent shareholder approval a. EFT: 1. expected to be able to extend lease and didn’t get it. If we have independent. Corporate Opportunities a. When does the transaction have to be fair? a. Independent shareholder approval a. 1. BJR. EFT. sometimes it’s EFT w/ burden on plaintiff b. EFT. fully informed. Independent director approval (assuming controlling shareholder didn’t appoint all directors) a. Real question is whether it is a corporate opportunity or personal opportunity. EFT. i. Business dealings w/ the director – director wants to engage in some business dealing with the company 3. burden is on plaintiff ii. use fully informed. CEO buying land with oil under it 30 . but it’s an everyday occurrence b/c every company has to set salaries. Delaware says the transaction must be fair at the time it is approved. Maybe shouldn’t matter – conglomeration is a corporation combined of different businesses (like potato chips and microchips) b. independent director approval – form a salary committee 2. Default a. disinterested director approval: (other directors are aware of conflict) a. Hostile takeovers or proxy contests VIII. The line of business – buying a direct competitor is more “in the line of business” than buying a secondary competitor. burden on defendant 2. more often its BJR w/ burden on plaintiff 3. Interest or expectancy – like an extension of a lease. As a general rule a fiduciary should not take an opportunity that belongs to the corporation for their personal benefit. There’s no clear test. Main Conflict situations 1.2. i. Derivative litigation – when shareholder wants to sue corporation 4. Salaries & benefits – management gets to set its own salaries. Have to prove that it is entirely fair (not perfect. burden on plaintiff 3. Transaction must be fair for the corporation and its shareholders 2. i. but fair) 3. burden on plaintiff iii.

Closer it is to the line of business the more likely it is a corporate opportunity 2. Some people say it has to be in the same line of business to be a corporate opportunity ii. Porter 1. Did not disclose to corporation ii. Failed to satisfy other elements. Directors have a greater duty to the business than a mere agent 1. Party involved 1. though i. Barber shop example: agent (barber) hears of other shop for sale – can quit and buy w/o informing. 3. NOTE: director votes – the interested director’s vote doesn’t really count (disinterested approval) b. 2. Energy Resources Corp v. 1. only wanted to deal with the scientist / director a. Closer you are to an officer the more likely it is to be a corporate opportunity a. 3. LESS PRO DIRECTOR 2. ii. Party involved – in order of most problematic: officers. directors. it’s more likely to be a corporate opportunity. Argued that Howard had “refused to deal” with the company. 3. Before a person may take advantage of an opportunity he must present it to the board. Factors to be considered on whether something is a corporate opportunity i. Source of opportunity iv. Director of barber shop is in a different boat. Line of business 1. there is no reason to present the opportunity to the board. had to inform other directors and they had to decide as a group if the shop should buy the other shop. Fairness – consider all the circumstances ii. Officer → Director → Employee → Shareholder v. Test: i. employees. c. Fairness c. Did not give reasons Howard wouldn’t deal so the corp could possibly make adjustments.IX. d. Where the director believes that the corporation is not entitled to an opportunity. Broz v. PRO DIRECTOR 2. Presenting to the board is just a safe harbor. Interest or expectancy iii. Inc. shareholders. (assuming it’s not a controlling shareholder) e. Source of opportunity – used corporate assets and time to develop or discover the opportunity. Cellular Information Systems. Shareholder Actions 31 .

Cohen v. Incentives i. Management would have to make this call ii. Derivative Litigation i. SHOULD HAVE BEEN A DERIVATIVE ACTION AND WAS FOUND NOT TO BE. Reason for derivative suit → management apathy iv. Reasons for allowing it: a. Inc. they would have to incur expenses of the litigation and then the corporation would get the benefit a. Atypical: on behalf of injured party 2. Derivative action → a lawsuit initiated by a shareholder on the corporation’s behalf against third parties (often management) because of management’s failure to take action against the third parties 1. normally he will get the full fee regardless of recovery 4. 3. injury to the individual is a direct action. Award of attorney’s fees a. Typical litigation: injured party sues ii. b. usually representing a percentage of the award a. Can’t allow each and every shareholder to make decision c. 1. Attorneys do have incentives iii. Direct action → a lawsuit initiated by an injured person on her own behalf 1. Elements 1. If they do sue. Flying Tiger Line. unpredictability 2. Beneficial Industrial Loan Corp. Direct vs. 2. Eisenberg v. 1. Injury to the corporation it is a derivative action. Shareholders have very little incentive to sue 1. Shareholders may have vendettas and have personal interests iii. Person is unable to sue 3. Shareholders may not understand all the issues d. Litigation expense a. normally attorney will be awarded fee if he is successful b. not shareholders i.a. Contingent fees make shareholders more willing to sue because it limits the incentive not to sue. Indemnification provisions 32 . this is a problem for people who like derivative action ii. Corporation should be able to say whether or not they want to sue. Contingent fee → a fee charged for a lawyer’s services only if the lawsuit is successful or favorably settled out of court. VELASCO THINKS THIS IS A BAD CASE. Problems with Derivative Litigation: a. Shareholders are not supposed to run the business b.

X. Shareholders rarely win in court (Business Judgment Rule) ii. a. iv. litigation costs (including attorney fees) will be awarded if successful i. in order to initiate a derivative action. Demand Requirement i. Settlements → there is a very small dollar recover 1. small dollar amount is relative. If directors don’t have to pay the judgment but are going to be indemnified by the corporation you have problems. but the potential for a jury to give you a lot of money 2.000 iii. but with the intention of obtaining a profitable settlement 1. it is rare that the shareholder will be liable if the corporation wins. Before a shareholder can bring a derivative action he has to bring it up before the board of directors. 2. there will be a record of their reasons and the court can say whether they make sense or not. Security 1. sometimes this is optional (“may” language) ii. making investment decisions with her time and taking the risk of profit and loss 3. Some states require that the shareholder post security for the corporations expenses a. iv. Some states (like NY) require that you are a shareholder at the time of action and at the time of the lawsuit. but it is there incase 2. Argument that this does not make sense: i. Contemporaneous ownership rule → the rule of standing providing that. They can decide whether it makes sense to sue a. a plaintiff must have been a shareholder at the time of the action complained of a. Statutory Solutions i. Demand The Demand Requirement a. Expenses 1. Counter to this is structural relief is often granted. All shareholders can have a real interest b. Exceptions: 33 . Strike suits → a lawsuit initiated not with the intention of winning on the merits. Reasons for thinking this: i. some changes in management c. 1. Courts and the Corporate World think that derivative actions are strike suits a. Awarded if successful a. Standing 1. Entrepreneurial attorney → an attorney acting as a businessman with respect to lawsuits. Weak case. If they say no. NY says you need to post but not if you own 5% of stock/$50.

not enough that they failed to take corrective action d. Note that this is more than a notice pleading requirement. Public information ii. Class Notes 34 . Use “tools at hand” available to shareholders i. Reasonable doubt means that the “board has a reasonable belief” 4. If time is a critical factor b. Grimes Test a. not enough to allege that they are all controlled or dominated by a shareholder 2. Demand Futility i. When would it be futile? 1. Mostly to avoid extra litigation costs ii. Irreparable Harm i. Donald (DEMAND FUTILITY IN DELAWARE) 1. you have to present a case a. 2nd prong sounds like duty of care b.a. Particularized allegations have to be made in the pleadings BEFORE you get to discovery a. If there is a conflict of interest. You can’t just argue that demand was futile. you can still argue wrongful refusal of demand i. the court has the right to dismiss the action. Once the directors make a decision it is protected by the Business Judgment Rule. NOT ALL STATES ALLOW DEMAND TO BE EXCUSED FOR FUTILITY a. not enough that they all participated in action b. Reasonable doubt needs to be created that directors are disinterested and independent or the challenged transaction was a product of a valid business judgment i. d. If demand futility cannot be shown. Once you make a demand. If there will be irreparable harm from making the demand. they don’t have to make it 1. Does demand futility sound like a loyalty issues? c. Conflict of interest (majority of board is interested in the transaction) ii. you waive demand futility a. 1. 1st prong sounds like duty of loyalty ii. it would be futile to ask the board to sue itself. the ball is in the directors court b. Grimes v. not enough that they all approved the action c. standard for this is the Business Judgment Rule 1. you must allege details before discovery b. Inspection rights 3. 5.

You can no longer plead demand futility (that demand is excused) ii. Why don’t they apply that here? i. takes out the reasonable doubt standard of Delaware Test st b. it’s probably rejected 1. Demand Futility in New York is established by: i. they have to prove it was valid under the “entire fairness” test a. where normally it would be the corp having to show it was not conflicted b. When the board is conflicted. 3rd prong → the directors failed to exercise their business judgment in approving the transaction 3. But the court puts the burden on the plaintiff to allege particular facts. Make demand. which is essentially challenging the BJR b. Difference b/t Delaware & New York tests a. Majority of board was disinterested so we respect to most of the board demand would not have been futile. Plan: i. applying the EFT would subject nearly all similar transactions to judicial review.a. Have to deal in particularized allegations. 35 . 2. Basically. Akers (DEMAND FUTILITY IN NEW YORK) 1. This is a derivative action so you need demand futility 2. b/c the other route is more than likely a dead end iii. New York does not require “reasonable doubt” i. This is the best route despite the difficulty. You can then make a claim for wrongful refusal. Harder to meet the New York test 5. New York – the plaintiff must have a reasonable belief that the board lacks independence 1. 1 prong → a majority of the directors are interested in the transaction or c. Argue demand futility 1. Delaware – does the plaintiff have a reason to doubt? ii. 2nd prong → the directors failed to inform themselves to a degree reasonably necessary about the transaction or d. 4. which is very difficult. but you’ll likely lose under the BJR ii. if demand is rejected (which will likely be the case) i. where the issue is director compensation. Marx v. The court realizes that in cases like this. You can try to argue wrongful refusal.

b. Basically. b. Balancing the interest of all the parties i. b. Is the new committee really disinterested? i. Zapata Corp. Delaware that there are risks in the situation a. The board placed the final authority to decide whether to pursue litigation into the hands of this committee. 3. v. Special Committees i. Maldonado (DELAWARE SPECIAL LITIGATION COMMITTEE) 1. New York is extremely deferential toward corporations iii. Court responds that if we don't trust the directors. basically the court will show great deference 2. we won’t have the BJR and the courts will have to make all the decisions. often times those same colleagues who got them their board position. Structural Bias → independent directors may be biased 1. These situations are generally used when demand futility is established as a way for the corporation to avoid litigation.b. or decision not product of valid business judgment. how they engaged counsel iii. Notes: 1. the BJR applies. Two Part Test: 36 . will look at procedures chosen ii. Not truly to dismiss cases after years of litigation 2. Rule in New York a. Two ways to establish demand futility: reasonable doubt as to independence of directors. properly appointed and after a good faith investigation concludes that it is in the best interest of the corporation to dismiss the derivative suit the Business Judgment Rule will apply. Ford created a special litigation committee whose decision was not questioned by the court a. the process can be inquired into. Class notes a. Courts are applying their own business judgment a. which was comprised only of disinterested directors appointed after the alleged incident giving rise to the litigation. Structural bias: directors will naturally be predisposed to be biased towards one another. ii. If you have a special litigation committee. They will have to make decisions about colleagues on the board. 4. but NOT the substance i. Auerbach v. if there is not a conflict of interest. i. Bennett (NEW YORK SPECIAL LITIGATION COMMITTEE) 1.

Compensation levels is clearly Business Judgment a. b. There is incentives for attorney’s to bring derivative suits a. c. Problems: 1. Costs i. but they can. Counteracts structural bias 3. Special Litigation Committee b. so… ii. i. Delaware Supreme Court creates a test where courts are applying their own Business Judgment i. Derivative Litigation i. disclosure of compensation packages is poor b. NEW YORK court is far extreme for trusting directors. Courts are not sympathetic because it is not a shareholder right but a corporation right Executive Compensation a. Disincentives for shareholders to sue a. Executive Compensation i. Courts don’t know what to do. Top executives get too much money a. Law focuses on disincentives to sue to counter this i. 2. Argument for: we have to set our salaries above average to get above average employees. maybe. The board is the one who decides whether or not to sue. Is there really arms-length negotiation here? If the directors are disinterested. We allow shareholders to sue on company’s behalf iii. Hard for a shareholder to win in derivative action i. Deleware doesn’t apply the BJR very often anymore. DELAWARE court if the far extreme for not trusting directors. Essentially Auerbach ii. ii. Need for some kind of balancing 1. Courts then apply their own BJR 1. they’re officers in other corporations. They really don’t apply their own business judgment. Demand requirement 1. Particularized allegation 2.XI. Odd development that is unique in corporate law c. iv. Who could justify this? i. but only if they win 2. We allow an award of expenses. but even then. 37 . But that was the whole point of the BJR 2. Concern with structural bias – directors are conflicted in a collegial sort of way (top officers are directors) and in a mutual interest way (directors are often directors for other companies) i. Growing problem 1.

Brehm v. Compensation is based on the short term performance iii. Executive compensation is under the business judgment rule. criminal action had to have believed that their actions were lawful b.XII. court fees. But everyone paying ‘above average’ causes salaries to increase exponentially. Indemnification → reimbursement of a loss or expense incurred by another. estimates in 2003 is 500 times ii. the CEO was fired and he got $140 million in compensation. Flexibility in Setting Pay 1. If defendant is liable to the corporation the court has to approve the indemnification as fair and reasonable c. Gap between Executives and average workers is growing: a. have to be acting in the “good faith” of company 2. Particularly in this case. meaning it was highly unlikely that they could win. DGCL § 145 a. In 1970s average gap was 40 times. Argument was that it was waste. If you set the wrong incentives you are in trouble 2. Paying executives based on performance a. reimbursement of cost of litigation expenses incurred by director. 3. you basically have to make your case with specific evidence in the pleadings. (a) allows indemnification in direct actions (suing CEO directly) i. Extreme deference to the corporation. Indemnification & Insurance. Duty of Care question  basically. Special Rules of Corporate Law that either require/permit/forbid indemnification 1. Inspection Rights a. argue that anyone putting the corp in this situation breached their duty. etc) ii. (b) allows indemnification in derivative actions (suing CEO on behalf of corp) i. 2. so irrational that it didn’t deserve the protection of the BJR i. Derivative suit a. Indemnification & Insurance i. officer or employee (attorney’s fees. Court said this decision had to be unconscionable. (c) requires indemnification if defendant is “successful on the merits or otherwise” 38 . 1. similar requirements to (a) ii. Eisner 1. 1. some requirements: 1. by 1991 average gap was 140 times b. 3.

(f) allows additional rights g. basically. Law only allows corporation to indemnify when they are acting in good faith 2. e. Inc. b. Valuation Issues c. Conticommodity Services. Proxy Contest 2. State ex rel. (g) allows liability insurance (even when indemnification is not allowed i. iii. the purpose is to protect you in advance for things you will be indemnified for. 1. 2. Power to indemnify is limited to good faith 3. Request has to be for a “proper purpose” a. Honeywell. the board has to decide whether or not to reimburse them. Inspection Rights i. So there’s a presumption that you’ll be indemnified. Citadel Holding Corporation v. Economic Interest b. Standard for allowing shareholder access 1. Why should only one slate of candidates have access to voters iii. Charter. Limit on advancement of funds is it has to be reasonable. Takeovers d. 39 . Political Activism iv. allows directors/officers insurance when indemnification is not allowed. (e) allows advancement of expenses f.d. list of shareholders ii. In theory is positively related to the corporation and the inspection rights would be a proper purpose v. Moral arguments are not good enough for inspection rights. Possibly goodwill concerns b. (d) requires specific authorization for any indemnification payment under (a) or (b) i. Waltuch v. Reasons for allowing inspection rights 1. Pillsbury v. minutes of board meetings. Inc. if you’re guilty. Roven 1. bylaws. shareholders can demand to see basic corporate records 1. Success is vindication as far as the court is concerned iv. 1. Generally. Basically. Derivative Litigation 1. Requests that would not be considered proper a.

Common law fraud → didn’t provide enough protection for the sale of securities.g. Federal securities regulation a. hard to prove fraud. state laws looked at investment and decided whether it was a good investment. History i.. Security → an instrument that evidences the holder’s ownership rights in an organization (e. Introduction to Federal Securities Laws a. like an initial public offering (IPO)) a. company is liable if the disclosure is inaccurate or incomplete 4. registration requirement → have to file detailed report (registration statement) to Securities & Exchange Commission a. 2. Securities Act of 1933 1. SEC reviews registration statement for the adequacy and not the accuracy 40 . You can sell any security you want to so long as investors are properly informed. Primary markets → the market for securities sold by issuers to investors (when the company is selling you a security.g. the holder’s creditor relationship with an organization (e. iv. Antifraud rules a. options) ii. private offerings are outside the scope of this law) 1. bonds). merit regulation i. or the holder’s other financial rights (e. Mandated disclosure a. in selling securities companies have to give adequate and accurate information to investors b. Stock Market Crash of 1929 1. done by filing detailed reports to government which are distributed to investors 3. helps investors make own (good) investor decision 2.. must register securities and deliver prospectus before selling securities to the public (public offerings covered.g. b. Blue sky laws → state security laws a. Brought federal law to the table. Great Depression a.. Federal Securities Laws i. stock). too speculative or not iii. No merit regulation a.Part Three: Federal Securities Law I. State securities regulation 1.

Brokers.g. iii. analysts. produce 1. etc are regulated. (but you have no mandated disclosure) 2. etc) iv. Valuation i. not only in reports but any communication from the company (press releases. also prohibits misleading statements of material fact (no half truths) iv. After this is completed. Same structure. Easier to price. c. b. must file periodic reports on company performance ii. while federal law is more concerned with substance 1. must file additional reports under certain circumstances iii.. interviews. liability for false or misleading statements or omissions of material fact (deception) i. Securities and Exchange Commission → the agency established to oversee the enforcement of federal securities laws iv. When it is complete. also prohibits misleading omissions of material fact (nothing left out) ii. standard prohibits false statement of material fact (no lies) iii. NASDAQ) i. Main focus is not on selling investor but issuing company i. SEC declares the registration statement effect 2. the prospectus is delivered a. Securities industry generally a. you’re liable. liability for manipulation or deception 1. unless…exemption is available b. have to deliver it as a sales document.b. Commodities → products that are abundant and fungible. Always contains the registration statement ii. Secondary Markets → the market for securities traded by investors among themselves (e. State law is concerned with form over substance. Prospectus  information about the offering. because of many buyers and sellers 41 . much tougher than common law fraud ii. Individual Liability – if you lie or misrepresent. NYSE. but implemented very differently b. There’s no ‘race to the bottom’ competition like states competing for corporations b/c there’s only one fed gov and it has preempted the field. e..g. Securities Exchange Act of 1934 1.

Strong Form of Efficient Market Hypothesis 1. but the share of stock is a commodity iv. Current prices reflex all publicly available information 2. only that they reflect all the public information 3. Not much info available. Price may not be accurate. so the price already reflects it. Current prices reflect all available information. You can’t read financial statements. not publicly traded so not very liquid. Special Goods → rare or unique items 1. d. industry. etc and decide which stock is better – all this information is already reflected in the stock price. public & private a. Very few mutual funds can consistently beat the market. So you can’t beat the market with private information b. Strong Market 1. Falling or rising price isn’t a good reason to buy or sell… the current price already reflects that. This theory assumes that insider trading has already happened by the time you get the information. trends. You can’t beat the market by looking at trends a. just that it reflects all available information ii. You can’t do better than you’re supposed to 3. should I buy? The strong form says no. Why? 1. This never claims that the prices are accurate. There are strong markets for public corporations 1. in a strong market. Availability of information  so you can analyze before the fact 3. General accepted as true iv.S. if I have secret information. as current prices reflect all public and private information. Weak Form of Efficient Market Hypothesis 1. Confident traders and strong market vi. Corporation as a whole is a special good. capital markets. Closed corporations do not have strong markets 1. Difficult to price  how much is “x” painting worth? iii. Semi Strong Form of Efficient Market Hypothesis 1. prices quickly reflect all available information i. such as U. Strong Liquidity  have to be able to buy & sell quickly 2. 42 . b. Basically. Current prices reflex all past price information 2. Combined efforts of all investors analyzing information creates an equilibrium price iii. Can’t beat the market through analysis a. Widely accepted as more or less true a. b. Pricing is through supply and demand ii.2. v. Efficient Market Hypothesis → the theory that. Efficiency  ability to buy and sell cheaply v.

Insider Trading → the use of material. but once they do so. viii. Rule 10b-5 i. nonpublic information in trading the shares of a company by a corporate insider or other person who owes a fiduciary duty with respect to such information 3. similar to. than security act 2. single most fundamental provision of federal security laws 2. If you diversify you are not gambling as much Lessons from Efficient Market Hypothesis 1. Basically a “buy & hold” strategy. but they do. it would suggest people couldn’t make money on insider trading. schemes and artifices to defraud 3. b. you can’t b. II. Analysts must analyze in order for the market to be efficient. If strong form is true. If this were true. Ramifications for Security Law 1. Invest in index funds i. it starts to rise around the time of the announcement. public announcements wouldn’t make a different. but broader. but they do.vi. Devices. in connection with purchase or sale of securities: a. leading to the belief that there were some leaks & insider trading going on. SEC rule under Exchange Act §10(b) a. Don’t try to beat the market a. Congressionally delegated authority ii. ii. they are useless b/c they can’t beat the market. public disclosure is most important thing because information is necessary 3. Basically. buy stocks on the NASDAQ or S&P 500 and hold on to them. Actively managed funds (typical mutual funds) have higher trading/management fees. If semi strong form is true. Practices which operate as a fraud or deceit 43 . broad antifraud rule b. Rule 10b-5 a. omissions are not so important because the price already reflects what is really happening 2. c. Not accepted as true a. vii. 2. Equilibrium level of disequilibrium 1. it doesn’t just jump at the moment of announcement. Forbids. Looking at the stock price over time. ix. analysts can only really hope to make enough $ to analyze. getting information into the hands of the public is not so important Diversification → the process of reducing risk by investing in multiple opportunities 1. If weak form is true. If it was true. Even if someone can beat the market.

e. An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would considered it important in deciding how to vote. How should materiality be defined? a.. False or misleading statements or omissions of material fact. SCOTUS hasn’t ruled) a. What court says about materiality: a. Silence absent a duty to disclose is not misleading under rule 10b-5. Enforcement 1. they are talking about the accuracy of disclosure a. Causation a. In this case. deception must be the cause of the harm 5. Purchase or sale 4. they didn’t have to say anything. Gives an expected value. Basically P x M = Expected Value ii. Reasonable investor? 2. i. fraud 2. iii. i. v. lower courts say yes. effect on the value of the corporation. Anything that would affect a decision i. Materiality → relevance/significance a. “To fulfill the materiality requirement ‘there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available. 2. Levinson 1. plaintiff must have actually been deceived v. etc. Elements of a cause of action under §10b-5 1. Reliance a.4. SEC → intended to be enforced by 2. Look at the probability and magnitude of the event to determine if it is material: 1. so you only need to disclosure material facts a. Basically. not little details are enough b. No Comment) 44 . iv. Private investors → courts have found an implied cause of action a. protection of corporate secrets 5. 4. Security Laws are about disclosure not protection. Not clear that Congress or SEC intended this.’” 3. anything important enough to effect a decision 3. Basic Inc. Consider facts such as the size of the corporation. Probability Magnitude Test (2nd Circuit) a. (i. Supreme Court is not talking about timing of disclosure. Reasonable person? ii. Scienter → intent to deceive (or recklessness.

There is no cause of action for breach of fiduciary duty (or any substantive fairness) under Federal Security Laws. But the courts say once you say something. seems to be a very broad interpretation that anything could lead to a purchase or sale. How to rebut? 7. Supreme Court says: i. If you want to have secrets you have to have a ‘no comment’ policy – if you deny some claims and say ‘no comment’ to others. 1. Does Federal Law protect against unfair behavior. Basically the efficient market hypothesis. low valuation was fraudulent b. Inc. Claims: a. i. The casual connection between the defendants’ fraud and the plaintiffs’ purchase of stock in such a case is no less significant than in a case of direct reliance on misrepresentations d. and the market was defrauded. 45 . Rule 10b-5 b. But it’s a rebuttable presumption. no ‘unfair’ claims under federal securities laws…. we’re relying on the market. Freezing out minority shareholders i. It was made to maintain the status quo during merger negotiations. This is derivative reliance.ii. Court ignores this. Problematic in this case b/c the misrepresentation wasn’t connected with the purchase or sale of securities. 6. v. Breach of fiduciary duty issue 2. Based on the hypothesis that.e.. the price of a company’s stock is determined by the available material information regarding the company and its business…. Court of Appeals says yes. Fraud-on-the-market theory: i. breach of fiduciary duty? a. it has to be materially true.so you always have to say ‘no comment’ b. vi. Green 1. the ‘no comment’ operates as a ‘yes’….only deception claims. Bascially. Fraud must be in connection with sale or securities a. Santa Fe Industries. in an open and developed securities market. it’s a clear adoption of the EMH b. Misleading statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements c. i. ii.

Texas Gulf Sulphur Co. Agassiz 1. Business Judgment rule does not apply  state matter vs. 1. Rule doesn’t require trading by speaker. Goodwin v. Chiarella v. It is connected with the purchase or sale if it causes people to purchase or sale\ ii. fed sec laws 5. Court ultimate rule on insider trading: a. Misleading Statements a. a false or misleading statement by the company. just that the fraud needs to be connected with the purchase or sale i. Insider Trading → the use of material. CEO duty to the company and not random shareholder 2. Included for historical purpose b. a. “Anyone in possession of material insider information must either disclose it. Mere possession does not mean that there is deception involved. How would this court decide the problems? a. Indirect harm is company losses goodwill i. But ‘any’ trading is enough for SEC 4. Basically. This is where the law stood before security law. or he chooses not to do so. there must be fiduciary duty 46 . Probability Magnitude Test a. Is there any harm to the corporation from Insider Trading? a. Whether facts are material will depend on any given time on a balancing of the probability that the event will occur and the magnitude of the impact. United States 1. Insider Trading a.” 2. must abstain from trading in or recommending the securities concerned while such information remains undisclosed. 3. or if he cannot in order to protect a corporate confidence. 1. Needs to be in connected with the trading b. None of the money from the stock market goes to company b.III. Harder for the company to do another primary offering 3. nonpublic information in trading the shares of a company by a corporate insider or other person who owes a fiduciary duty with respect to such information i. Securities and Exchange Commission v. This case is not the law anymore iii. There was no protection for insider trading ii. Disclose or Abstain Rule i. and subsequent trading by the purchaser is enough for the plaintiff to sue.

2. If a breach of fiduciary duty is deceptive it is actionable under federal security laws, not because it is a breach of fiduciary duty but because it is deceptive a. Deception or fraud is the only thing that is covered by rule 10(b)(5); if a breach of fid duty gives rise to an obligation to disclose, and no disclosure is made, it may be considered ‘deceptive’ 3. Non-fiduciaries do not violate Rule 10b-5 by engaging in insider trading iv. Dirks v. Securities & Exchange Commission 1. SEC didn’t see Dirks as a bad guy and only censored him a. They did this to create a rule of law for the future 2. SEC theory is that once you received insider information you become an insider 3. Supreme Court rejects SEC’s theory as trying to get rid of Chiarella a. Two Part Test: i. Says you can inherit fiduciary duty but only when 1. the insider has breached his fiduciary duty to the shareholder and 2. the tippee knows or should have known of this breach 4. Breach of Fiduciary Duty → needs to be a Personal Benefit (money or its equivalent) a. Direct to you b. Indirect to your friends or family c. Note that this personal benefit requirement is unique to federal securities law; state breach of fid duty doesn’t require a benefit. 5. Only way strangers will have fiduciary duty is if they inherit the duty a. There must be an unbroken change and you ask from each person to the next go through the two part test. v. United States v. O’Hagan 1. Tender Offer → a public offer to buy a minimum number of shares directly from shareholders at a fixed price, usually at a substantial premium and usually part of a takeover attempt 2. Court discuss classic theory: Chiarella a. → there is a deception only if there is a breach of fiduciary duty i. applies not only to personal insiders of the company, but also to accountants, attorneys, and others who may temporarily have access to that information.

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IV.

ii. Classical theory would say that O’Hagan had a fid duty to the buyer (GM), but O’H bought shares of P stock, to whom O’H owed no duty. 3. SEC tries to expand scope under 10b-5 a. Misappropriation Theory i. 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. ii. Basically, you can violate 10(b)(5) by breaching a duty to the source of the information. While he had no duty to P, he did have one to GM, and breaching his duty to GM falls under this theory. iii. Distinctions between classical theory and misappropriation theory are slight. See pg 503 for good description iv. Loophole: if you tell the party you got the information from that you’re going to use it for your own purposes, it’s no longer deception and you’re off the hook. This loophole doesn’t work with classical theory. 4. SEC has gotten what it wants in terms of tender offers vi. Rule 14(e)(3) 1. No trading w/any material nonpublic information regardless of fiduciary duty 2. Court says delegation of authority under 14(e)(3) gives the SEC authority to proscribe rules to prevent deception. Authority under 10(b)(5) was limited strictly to illegality and punishment of deception; this authority is a little broader. 3. Rule 14(e)(3) is limited to tender offers Proxy Solicitations a. Shareholder Meetings i. Due to shareholder apathy, shareholder’s have no reason to go to shareholder meetings 1. You can authorize people to vote on your behalf thou. 2. Management always seeks authorization to vote your shares a. They need a quorum to conduct business 3. If someone else asks you, they are opposing management ii. Proxy 1. (1) one who is authorized to act as a substitute for another, esp in corp law, a person who is authorized to vote another’s shares; 2. (2) the grant of authority by which a person is so authorized; 3. (3) the documents granting the authority; i.e., the agent, the authorization or the instrument

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iii. Proxy Contest → competition to obtain the right to vote shareholder’s shares, often as a part of a hostile takeover iv. Proxy Solicitation → an attempt to obtain the right to vote shareholders’ shares, most often conducted by management v. Proxy Statement → a document required by federal law to be delivered in connection with a proxy solicitation b. Coverage of Proxy Rules i. Exchange Act § 14(a) 1. Delegation of authority to SEC ii. Regulation 14A 1. Every solicitation of a proxy with respect to registered securities iii. Solicitation 1. Very broad definition a. includes any request for a proxy 2. Exceptions: a. Rule 14d-2(b): shareholder conversation i. Conversation among fewer than 10 people, it won’t count for proxy solicitation b. Rule 14a-1(l)(2)(iv): institutional investors i. If you just say that here is what I am going to do. c. Proxy Materials i. Proxy Statement 1. Serves the Federal Security law of Mandated disclosure 2. Schedule 14A sets out all the requirements ii. Proxy Card 1. Description of solicitor a. because shareholder’s may presume it is management 2. Blank space for date a. It is illegal to solicit a undated or postdated proxy i. Reason for this is because proxies are revocable 3. Separate identification of matters to be voted on a. discretion is an option d. Delivery of Proxy Materials i. Delivery to shareholders 1. Prior to any solicitation i. First thing you do has to give someone a proxy statement 1. You can’t first talk to them and then give them a proxy statement b. exception: Rule 14a-12 i. Allows a solicitation without a proxy statement. 1. You can have discussions, before you actually prepare a proxy statement ii. But before you give them a proxy card or ask you have to give them a proxy statement

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e.

f.

g.

h.

2. Management solicitation for annual meeting must include annual report ii. SEC filings 1. Preliminary proxy statement a. 10 days in advance 2. Final proxy statement 3. Other written materials Other Matters i. Opposing solicitations 1. Shareholder proposals a. may have to be included in management’s proxy 2. Proxy contest i. Have to spend their own money to do that. ii. Sometimes allow reimbursement for success proxy contest b. either mail materials at insurgent’s expense c. or provide shareholder list 3. State law always give the right to get the shareholder list a. This is not a conflict with the federal standard i. Federal law gives the option, State law doesn’t ii. Antifraud provisions 1. Information must be clearly presented 2. Civil liability for false or misleading statements or omissions of material fact J.I Case Co. v. Borak i. First case to recognize private cause of action under Rule 14(a)(9) ii. Argument that it doesn’t make sense: 1. Not necessarily the case that every group always need more help with the enforcement of the laws Mills v. Electric Auto-Lite Co. i. Has to prove three elements of proxy solicitation: 1. Materiality 2. Reliance 3. Causation of injury a. Proxy solicitation must have been an essential link to the transaction i. Votes were necessary to determine the outcome Virginia Bankshares, Inc. v. Sandberg i. If the directors actually believed that the price was fair, they didn’t lie. ii. To prove someone didn’t believe their opinion: 1. The statement must be objectively false or misleading, not just that they believed it to be unfair. iii. Freezeout merger – in glossary – look up – it’s forced upon minority shareholders b/c majorities have control to do it. iv. What is required to prove causation in proxy solicitations is Loss Causation, not just transaction causation.

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subject to criteria of exclusive. Bad merger? Must prove that the merger alone caused the loss. company would lack power or authority to implement d. a. a. How much access should shareholders have to the Proxy System? 1. Court. Improper under State Law i. violation of law b. Which state? ii. Either side can appeal SEC decision to court. often the shareholders who want to put in ideas are the ones that have problems with management b. What is proper for shareholders to decide under state law? 1. If it is management. Proposal must be 500 words or less 3.1. only the good ones will get through 3. V. we really don’t want courts making this type of business judgment 4. Electing director? Must prove that electing the director caused the loss. Company has to notify SEC either that they are going to include it or exclude it b. you can’t demand it or request it g. Company doesn’t want to upset SEC iii. What we have is a system where the company gets the first stab of it. Rule 14a-8 2. 2. Shareholder Proposals (DIDN’T COVER THIS SECTION) a. Shareholder can get proposals in. Shareholders don’t have money ii. If SEC disagrees they can take a stab at it c. specific dividends i. Criteria under Rule 14a-8: 1. v.000 or 1% worth of stock 2. We are going to have SEC decide what is proper under state law? iii. idea already brought up f. Shareholder Proposals i. BUT state law gives shareholders VERY limited powers 51 . Who gets to apply the standard is a real problem? a. Company can exclude the proposal if they can meet one of different standards: a. personal grievances c. Most Proposals according to Rule 14a 2. company has already done the suggestion e. i. This really doesn’t happen ii. Supposing that we have a good standard. Shareholder must have $2.

Shareholders can amend the by-laws and almost anything can be in the by-laws h. At least one director gets 35% or more b. Shareholder proposal to get access gets majority approval c. If it counts for 5% of company business it is relevant ii. Election i. iii. Care about shareholder proposals iv. Shareholder getting greater access to proxy materials: 1. it can be excluded 1. Relevance i. Who should decide whether issue “x” is relevant? i. Electing directors is the one thing that is most proper for shareholders to do under state law. Triggering Events a. Institutional Investors 1.a. so the two are in conflict 3. If the board fails to implement any shareholder proposal that gets shareholder approval 52 . If proposal relates to the election of directors.

Duty to disclose 53 . i. not shareholders ii. By-laws allowed for adjournment 2. Shareholder Control a. No right to manage business generally iii. (DELAWARE) 1. can’t vote ‘no’ on someone 4. most votes wins. combat other interference with voting b. 2) then the board has the burden to show a compelling reason for their actions 3. present includes by proxy 2. Courts are very hesitant to invoke Blasius because it is such a demanding standard 6. another exception to Business Judgment Rule b. 1) conditions: plaintiff must establish that the board acted for the primary purpose of thwarting the exercise of a shareholder vote (difficult test) ii. mergers 4. Legal requirement: can’t go beneath. Other matters submitted for shareholder vote 5. Voting standard 1. sets a minimum a. Shareholder voting rights are limited: 1. Shareholder Voting i. 2 Part Test: i. Special rule: majority of all shares (not just shares present) a. To elect directors 2. but can go down as low as a 1/3 5. Default rule: can go down.Part Four: Control Transactions I. To approve certain major transactions a. Default rule for quorum is half. for mergers b. Directors manage the business. iv. fraud on the part of shareholders or proxies 5. Peerless Systems Corp. Charter can provide different rules a. To amend charter or bylaws (approval from shareholders & Dir) 3. absent shares count as no 3. Facts: a. i. Management tried to increase the vote of the people that they thought would vote in their favor. Blasius Test a. What could a compelling justification be for thwarting the shareholder vote? a.e.e. General rule: majority of shares present a. 4. State of Wisconsin Investment Board v. election of directors → plurality i.

: If you have 12 shares. Class Voting → each class of stock can vote separately on some or all matters 1.g. preferred stock elects half of the directors f. Can apply to all votes ii. (true) control = 50% + 1 vote 1. Setting up different power arrangement 2. Minority shareholders get proportional representation 5. different dividend rights 1.g. class A stock gets 2 votes per share. E. 10 spots open. but under Delaware law a board of directors.. Each share is entitled to multiple votes a..g. Supermajority voting 1. E. All directors are elected together a. you always win ii. Number of shares needed to elect directors: ii. Majority shareholder (50% +1) can elect all directors ii. common stock elects half of the directors. Number of directors that can be elected: e. Effective control ‹ 50% 1. E.. Loose certain tax benefits 54 . i.e. no general duty to disclose under state law. Cumulative voting 2. e. Control i. action requires approval of each class i.. only certain classes entitled to vote on some or all matters a. So you just need majority of present shares 2. Electing Directors i. Cumulative Voting i. Each share is entitled to one vote per director 3.g. Opposing significant minority may be difficult c. b.. you have 12 votes and you can give all your votes to one person or split them. So you might have 15 candidates and 12 get elected 3. each share gets 10 votes 4. Default Rule 1. d. Each director is elected separately 2.g. 3. is under a fiduciary duty to disclose fully and fairly all material information within the boards control when seeking shareholder action 7. Power Arrangements i. Shares present and voting usually less than 100% a. preferred often can’t b. only common stock may vote for directors i. e. Influence ~ control a. e.g.. B gets 1 2. Ex. Classified shares → different voting rights. mergers require approval of each class. each class entitled to vote separately on some or all matters a. Each class of stock has different voting rights 1.a.

e. Gives general shareholders higher dividends at the expense of their voting rights so management gets stock w/ voting rights iv. Ownership – tend to have significant amount of shares. Courts are more excepting g. Capped voting 1. Problem: limited to 10 years a. shareholder agreement and voting agreement a. (could even hold 90% of stock. Actual transfer of shares. iii. Rational apathy – shareholders don’t really care. This prevents hostile takeovers. Similar to voting trust 2.g. management wins on plurality of votes 2. expensive for others to oppose. Control over proxy mechanism 1.e. a.a. So they imposed the 10 year limitation iv.000 shares → 150 votes 2. Voting trust → a plan in which shareholders transfer their shares to a trustee for the purpose of creating a voting block 1. Management has power to solicit your proxies.. Exchange offer for new shares with high voting rights but low dividends 2. a. Not necessarily clear what an interest is – but we know that employment contracts count. Retention of shares by shareholders 3..000 votes. promise an employee a proxy) 3. enough for control 1. 1. In order to be taxed as a partnership and avoid the double taxation you can only have one class of stock. your votes are capped at a certain amount. (i. Control by agreement 4. 100 shares → 100 votes. Court don’t like. Class voting 1. Stock options for execs can often lead to this situation ii. Proxy 1. thought it was a sneaky way to get control i. votes for directors) while the class B stock goes to financiers who get more profits per share ii. Pooling agreement → a plan in which shareholders agree to vote their shares together.. Problem: enforcement a. Normally revocable at will 2. Control by agreement or in one party 3. Holdings beyond a certain point carry reduced voting rights a. but only 200 of 200. even if you have 90% of the company.k. Irrevocable only if coupled with an interest a. Management Entrenchment i.) 3. 3. Could set it up where experts get class A stock with more control (i. S Corporation iii.e.a. usually original shareholders still get dividends 2. Downside is management reduces its voting power 55 .

so they won’t be as quick to opposed management. 1. as they run the day-to-day business. and have little responsibility to directors. Sometimes they will waive rules (Clark v. as these big shareholders can exercise more control. Transfer restrictions → a charter provision or agreement that restricts 56 . Freeze-Out → action taken by the majority shareholders in a close corporation to frustrate the expectations of the minority shareholders 1. choose who is on the ballot. Harder to sell than public. State legislatures: 1. ii. Parties that are not aware of technical requirements of corporation law.II. Shareholder Activism 1. 1. a. Special laws address two problems i. Institutional investors are rising. You have to have transfer restrictions a. You have to have no registered public offering 3. they tend to have more shares and tend to pay more attention. 2. Dodge) 2. ii. v. set the agenda. Delaware Closed Corporation Statute (most of the time we are not talking about a closed corporation statute) i. This could thwart this theory. Increasing trend among courts to treat closed corporations as special. Officers appointed by directors. Building more flexibility into general corporation law. Risk of piercing the corporate veil b. vi. In theory. But corporations can choose not to deal with these companies. You have to have no more than 30 shareholders 2. Close Corporations a. shareholders have the ultimate control 2. a. You could say the officers choose the directors  they set the meeting. Sometimes they will impose fiduciary duties on majority shareholder to minority shareholder iv. To get into the statute: 1. Burle-Means thesis (glossary) – says that officers ultimately have the final say. Activist companies 1. Closed Corporations i. deny employment in a closed corporation iii. directors elected by shareholders. Special Closed Corporation laws a. withhold dividends 2. and the shareholders essentially endorse their choices. Lets them run business they way they want to contract to.

pooling agreement give up the right to vote. shareholders cannot agree to force directors to do something. makes it a lot like a partnership but with the laws of limited liability. Difference between a pooling agreement and a voting trust: i. ii. Most closed corporations don’t fall under this statute because they are not aware of this option iii. You have to want to be governed by the closed corporation statute ii. Seems the problem is that some shareholders and creditors can get hurt in the deal – see next case 5. Clark distinguishes from McQuade: i. Barnum & Bailey Combined Shows v.a shareholder’s ability to sell her shares 4. If the statute applies: 1. voting trust you lose the power to vote 4. there is no real harm to have a special agreement controlling what the directors of the corporation do 1. but party did not comply with the standards. Parties did their own thing b. Same court as McQuade. Are pooling agreements illegal in New York under this case? i. just two years apart. 3. we are going to look the other way when all the shareholders are a party to the agreement 57 . i. Basically allows for management of corporation by shareholder. Affirmative selection: a. Ringling Bros. Clark v. Power to vote in realty telling the directors what to do. An agreement to try to control the actions of directors is invalid d. They did their own voting agreement c. c. Basically. McQuade v. b. If shareholders try to run the business. Ringling a. they are usurping the role of directors ii. You cannot have a pooling agreement among directors telling them what to do. Corporations should me managed by management and not by shareholders i. Dodge a. similar situation of shareholders telling directors what to do b. but not the power to vote ii. Stoneham a. Facts: State statutes permitted voting trust.

Unanimous consent of shareholders i.e. Federal Law 1. All shareholders must be individuals. No more than 100 shareholders c. d. no fraud or apparent injury to the public or creditors is present. or certain trusts i. Delaware closed corp statute – see other outline for details vi. i. 1.. Freeze out – actions taken by the majority shareholders to frustrate the expectations of the minority shareholders i. risk of piercing the corporate veil for noncompliance with rules they didn’t realize existed. the risk of disruption of the parties’ agreements – agreed to arrangement they didn’t know was illegal ii. When no one else is injured in a closed corporation. Requirements for S Corporation Status a. Pooling agreement statutes – Delaware closed corporations – protect against  i.” b. creditors) 6. Galler v. Denying employment – you think generally that in a closed corp the minority shareholders would expect employment. what are the odds that a mom & pop corporation have an annual meeting with 60 days notice? v. the shareholders can tell the directors what to do. Not another corporation – can’t be a subsidiary 58 . particularly with respect to closed corporations. e. In order to terminate S Corporation status you only need a majority b. Follows clark v. Closed corporations can avoid double taxation by becoming a S Corporation → a close corporation that has elected to be taxed as a partnership rather than as a corporation 2. Denying dividends – majority decides when the stock pays dividends. we can see no valid reason for precluding the parties from reaching any arrangements concerning the management of the corporation which are agreeable to all. and no clearly prohibiting statutory language is violated. For example. estates. dodge c. “Where no complaining minority interest appears. ii. Galler a.and no one else is being harmed (i. could decide instead to give himself higher salary. State corporate law is becoming more flexible  allowing for more customized arrangements to fit the variety of corporate structures.

1. and not just majority shareholders. i. The action must be the least restrictive means to accomplish the goal.” i. but still less than the entire fairness test. (Velasco now thinks that this may be more restrictive than the entire fairness test in some respects) ii. No shareholders can be non-resident aliens e. You can only have one class of stock i. General Rule: a. You can only have common stock 3. Many courts (especially MA in Wilkes) are less willing to protect shareholders when they planned ahead and it just didn’t work out they way they wanted. b. Wilkes v. Ingle was essentially like an employee rather than a partner 2. Ingle v. Abuse of Control a. a.III. Inc. a. “Stockholders in closed corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another. Why subject yourself to double taxation when you don’t have to. Limiting principle that this court adopts for fiduciary duty owed by majority shareholders. whether or not you take out anything. a. Abuse of Control i. 1. Most corporations that can elect S-corp status do so i. Controlling group must be able to announce a legitimate business purpose for their action. d. Nixon v. b. Blackwell (pg. This is something that corporations often do.e. Rule sounds like all shareholders. 659) 59 . Theoretically the problem is that you get taxed on everything the corporation makes. failed to plan ahead) 3.. Glamore Motor Sales. 2. In this case. Inc. Court announces 2 part Test for analyzing a breach of the strict goof faith duty owed: a. but it seems to allow ad hoc majority groups. we only want to impose the fiduciary duty when they are shareholders that are “essentially like partners” i. Any reinvestment is done after-tax as well. Springside Nursing Home. Courts are more likely to help you if you don’t have an agreement (i. This makes it more than just the BJR.

Court doesn’t think they are authorized to dissolve in this case: 60 . Corporate Dissolution a. opportunistic behavior 2. Would help minority shareholders in freeze-out situation a. Atlantic Properties.IV. by-laws. Delaware is not likely to help shareholders that didn’t plan ahead. Going Concern value → the value of a business if sold as a business. the minority could take control of the majority 3. Inc. Charter amendment a. Salvage value → the value of a business if its assets are sold individually. Inc. Requires board and shareholder approval iii. Corporate Dissolution i. 2. i. a. iv. Facts: Plaintiff (minority shareholder) was being frozen out of the corporation 2. profitable business b. by dissolving it. Alaska Plastics. Dissolution does not mean the end of the business i. Sale as a going concern c. Jordan v. 1. salvage value/liquidation value v. therefore dissolving it. usually higher than salvage value b. Judicial dissolution 1. They could have gotten out of the corporation. Inc. Interfere may be appropriate when parties are truly stuck i. Mitigating factors that should give comfort to courts to allow dissolution a. Shareholder vote 1. Courts are hesitant to dissolve corporations a. Duff and Phelps. Can limit the life of a corporate. or stockholder agreements.” iii. “It would be inappropriate judicial legislation for this Court to fashion a special judicially created rule for minority investors when there are no negotiated special provisions in the certificate of incorporation. Smith v. going concern value 1. Often requires super-majority vote ii. usually less than going concern value 2. if too easy. v. Alternative forms of relief iv. Court generally don’t want to interfere when shareholders have made an arrangement a. Coppock 1.

Some courts have a high standard: i. Courts give him his reasonable expectations of full salary till 75 and fair market value of his shares a.. Stuparich v. Frustration of reasonable expectations i. They feel that they are authorize to dissolve when there is “serious misconduct” b. a. Judicial Dissolution i. Who can seek a dissolution → shareholders 1. most states have some kind of ownership requirement in terms of the amount of shares ii. the complaining shareholder need not establish oppressive or fraudulent conduct by the controlling shareholder or shareholders. She was just a shareholder and not a partner (thus probably shouldn’t be entitled to fiduciary duties. Harbor Furniture Mfg. Violation of specific rights of minority c. Oppressive conduct by majority shareholders i. Pedro v. Middle standard: i. 1. plaintiff has to prove the transaction is entirely fair b. Reasonable expectations include expectations that the minority shareholders will participate in the management of the business or be employed by the company but limited to expectations embodied in 61 . Inc.a. When can you seek dissolution? 1. Facts: By firing him. harsh or wrongful conduct ii. What about the duty to mitigate? vi. they are forcing him to sell at 75% of book value instead of intrinsic value AND he will not be employed with the company 2. b. Subtle forms of misconduct d. What oppressive conduct is varies from state to states. Waste of corporate assets 2. Burdensome. they are either on both sides of the transaction or because they are getting something at the exclusion of others b. Breach of fiduciary duty of good faith and fair dealing ii. Self dealing a. You don’t not need a majority to seek a dissolution a. Corporation can not be run properly 3. In cases of closed corporations. 1.) v. invokes the entire fairness test i. Pedro 1.

that controlling interest at a premium price. Reasonable person? ii. a. 4. conversion of a corporate opportunity. Reasonable business person? b. NOT A GOOD DESCRIPTION OF THE LAW. Feldman 1. c. Sale of Directorship i. Who says whether the suspected person is a looter? i. Court rules against Feldman 2. 62 . USED FOR HISTORICAL PURPOSES ii. iii. a controlling stockholder is free to sell. Adolf Burley → It has been argued that a controlling shareholder can not sell his shares at a premium unless all can share in the premium and not for your own personal benefit. a. Egalitarian concerns 2. absent looting of corporate assets. Unless you know the purpose is a known looter or a suspected looter. Feldman breach his fiduciary duty by getting a corporate opportunity 3. Rational Apathetic. General Rule with respect to buying and selling shares 1. even thou they would not get it till a year from now. Hanson Holdings. Transfer of Control i. For the rule to be meaningful you have to go beyond known looter because nothing is truly “known” b. Deadlock a. Facts: Buyers had to pay for steel now. 1. fraud or other acts of bad faith. Selfish reasons etc. But.understandings. Among directors or shareholders b. ii. One share is supposed to be one vote. Shareholders can vote however they want for a directorship 1. ii. V. express or implied. Perlman v.” iii. Inc. among the participants. “It has long been settled law that. Whoever you elect thou…will have fiduciary duties to all the shareholders (including minority shareholders) 1. Should you be able to buy a directorship by buying shareholders votes? 1. Interest free loan is gained b. the rest of the shares have no realistic vote. and a purchaser is free to buy. people should be able to only keep the rights they want. 1. Super-majority voting provisions Transfer of Control a. Zetlin v. You are allowed to sell at a premium for the most part. it only protects waste and self-dealing. to the extent the business judgment rule applies. but once you have someone with 51%.

As between buyer and seller we can enforce it. Essex Universal Corporation v. Why have both a right of first refusal and take along right? a. Reasons for having this: i. 3. 4. b. You know you have control. ii. If director didn’t want to resign. but we will allow it if you are selling a controlling interest. Reasons for having this: i. Right of first refusal → an agreement providing that. before a shareholder can sell her shares to a third party. do they listen to him. c. How do we know when we have enough control to apply the rule? 1. by how you exercise it. a. Is formalism appropriate in this case? i. before a shareholder can sell her shares to a third party. This case dealt with a sale of assets. Jensen-Sundquist Agency. a. you can sell your own shares. 63 . 4. 2. This was not really a corporate law issue. but a contract interpretation issue. a. If they are selling at a good price you might want it. If you are transferring controlling interest. you can replace the directors right away. Frandsen v. You don’t want to be stuck with someone you don’t want in a closed corporation ii. Effective control can be less than 50% + 1. Replaced directors by one by one they resigned and then they filled the vacancies. If he can deliver then he has effective control. other shareholders would have the right to buy such shares at the price at which they would have been sold to the third party a. Yates 1. not sale of assets 5. Both of these agreements only cover sale of shares. New market for your shares (especially in closed corporation) i.iii. Take along right → an agreement providing that. Inc. You can only sell control if you have a controlling interest. 1. iv. Minority shareholders can take advantage of the premium 3. b. How many directors has he put in. it probably wouldn’t be enforceable by contract because of fiduciary duty. you can buy it for yourself…If it is a bad price. Approval of who the person is selling to ii. other shareholders have the right to sell their shares to such shareholder at the price at which the shares would have been sold to the third party a. 2. Can’t sell control. If it is a good price.

g. Merger → an acquisition in which an acquiror and a target combine into one surviving company a. A + B = A + B (two separate corps b4 & after) i. Can be the original company or a totally new company b. Approval of directors of each company 3. Target company is involved ii. Because both companies are effected. § 251 1. Surviving Corporation → the constituent corporation that survives a merger iii. c. Acquiring Another Company i. True Majority (50% + 1) 64 . Shares purchased directly from shareholders i. Target becomes a subsidiary b. No approvals 2. merger. Approval of target’s directors and shareholders needed i. we go with the meaning of the parties. Prepare merger agreement 2. In contracts we don’t go with form over substance. Asset purchase → an acquisition in which the acquiror buys the assets (and maybe liabilities) of the target (just about all assets) a. Approval of both companies’ directors and shareholders i. Like a marriage ii. Stock purchase → an acquisition in which an acquiror buys the stock of the target from the shareholders a. Approval of shareholders of each company a. but s/h of other company don’t get say over whether their company buys assets 3. Acquisition of Control a. 3 Ways to acquire another company 1..ii. Merger Procedures i. Del. A + B = AB i. Acquisition → a general term that refers to a business combination of any type(e. A = A + B (one new co takes on the assets of both old) b. Constituent Corporation → a corporation party to a merger ii. Target company is not involved 1. Resulting Corporation → a new corporation formed as a result of a merger b. Takeover → an attempt by an acquiror to gain control of a target iii. Each shareholder makes up his or her own mind c. 3 Possible outcomes i. Shareholders get say whether their assets are sold. VI. stock purchase or asset purchase) ii.

What if merging corporations are incorporated in different states? Follow both. especially the one that is more strict for each part. Appraisal Rights → the right to forego the contractual consideration in a merger (or similar transaction) and to receive instead the fair value of the shares i. Not for public corporations if you receive shares i.) this is a very simplified example. Not for all mergers b. Most states allow the option 2. Cash-out merger → a merger in which one company’s shareholders receive cash instead of shares in the surviving corporation i. but not for other type of transactions i. 2. where as in a closed corporation you wouldn’t be able to sell your shares easily 65 .i. Securities. b. Shareholders from each corp don’t have to get the same thing. Legal possibilities: 1. etc ii. d. c. Merger of Equals – both companies simply combine – no real acquiror or target. Delaware a. Shareholders being cashed out are usually from the target corporation. Stock purchase gives shareholders choice ii. amount of shares outstanding. also have to take in to account premiums paid. Law provides that a merger agreement can have any consideration a. cash. (so every share from A is worth twice a B share in new company. Very similar to a stock purchase 1. Allows for mergers. Cash-out requires approval of board b. vodka! b. You can sell your shares easily. File with Secretary of State 5. Dissenting shareholders have appraisal rights a. Appraisal Rights i. Number of shares depends on value of constituent corporations a. the ratio will be 2 to 1. EX: if A is worth $100 mil and B worth $50 mil. Consideration in a Merger i. Different consideration a. Appraisal rights 1. Differences between the two: a. Standard merger: 1. Abstentions count as no 4. Consideration is shares in surviving corporation 2. property. Shares sold to company ii.

e. Even if the fair value = merger consideration. worth more than the sum of its parts) ii. 1. You are still going to get stuck with the bad deal because the stock price will reflect the ratio 3. Fair value of shares may be less than merger consideration b. Court determines fair value of shares a. You can not take into account synergistic gains 2. asset purchase. 3. Cash-out merger ii. Often the subsidiary is a shell corporation. § 262(h) – Fair value of your shares is your shares standing alone. Petition for appraisal 5. 66 .. Premium → an amount above the market price paid by an acquiror to target shareholders in order to purchase the shares iii. Other states a. Not after the fact. Wise person only seeks an appraisal when you are really getting taken advantage of (like stock worth $50/share and the merger is going at $25/share) e. Company gives notice of appraisal rights 2. Delaware procedure → § 262 1. Reasons why it may be lower: i.1. Acquiror mergers its own subsidiary with a target. NOT when you are quivering over value ii. Triangular merger – merger between one company and a subsidiary of another 1. Advantages – you can avoid a shareholder vote of the acquiror. (i. 2. certain charter amendments i. Cannot vote in favor of merger a. c. Premium used to persuade shareholders 2. Acquirer often pays a premium to get the target shares. 1. Synergy → the advantage that results when a combination is greater than the sum of its parts 3. Each State’s laws have to be followed ii. Either has to vote against merger or not to vote 4. created only to merge with the target. Demand appraisal before vote (s/h must demand) a. When should one seek an appraisal? i. Form over substance i. Merger. you then have to deduct the cost of the appraisal.

f. iv.a. etc. AP=asset purchase. You can do the exact same thing that would happen in a merger. Can buy half liabilities. TM=triangular merger. 1. For example. SP & TM: keeps liabilities separate 3. Net cost compared to gross cost iii. without having to get shareholder approval vi. Cash-out merger 1. Need approval of only subsidiary. As long as it is a simple merger of a parent and subsidiary. b. Loopholes – ways to structure transactions to get around limitations 1. Merger between one company and the subsidiary of another a. TM = Triangular merger. SP=stock purchase. Subsidiary tries to merger with a target corporation a. you don’t need a shareholder vote. M = Merger. Subsidiary is usually a shell corporation 2. 1. but this was without a shareholder vote. AP: parties can (generally) decide a. AP = Asset purchase g. b. but not acquiror. SP = Stock purchase. PR reasons ii. Want to merge. Maintain business relationships. iii. whose votes are made by board of directors. ii. This avoids the shareholder vote of one of the companies because the subsidiary does not have its own shareholders. Short-form merger → a procedure under some states’ laws under which a corporation may merge with a subsidiary without a shareholder vote 1. v. can buy known liabilities. Triangular merger → a merger between one company and a subsidiary of the other 1. SFM=short form merger ii. do a triangular merger and then a short form merger. Key: M=merger. The rules are target and subsidiary must approve. Often used when acquiror knows it doesn’t have the support of its shareholders b/c paying a premium. etc. Practical Considerations i. Short-form merger  a procedure under some states’ laws where a parent corp can merge with a subsidiary w/o a shareholder vote. Liability 1. M & AP: one surviving company 67 . This would put the corporations in exactly the same place as if they just merged normally. TM followed by SFM 1. Structure 1. Target shareholders must approve. Form over law. Why would you want to buy liabilities? i. M: joins two companies’ liabilities 2. but you don’t want each corporation’s shareholders to be shareholders of the new company iii. MAIN REASON → you pay less for the company. ex.

Delaware: only for M 2. Merger → some rights transfer (as operation of law). Court would not let the form prevail over the substance. b. Ownership 1. There will be minority shareholders ii. not directors. b. Target company is not involved. SP: consenting shareholders. Glen Alden Corporation (PA) 1. Consequences 1. Appraisal rights: when corp combines w/ another so as to lose its essential nature & alter fundamental relationships of shareholders 68 . Legislatures here and in other states are trying to get rid of the statutory merger doctrine 3. but there may be non-transferable rights under Federal Law. 2. 4. Some states: M. Nontransferable rights a. 2. Hard to get. TM & AP vii. Stock purchase to get 51%. b. etc. With M or AP contracts will have to be renegotiated. Even thou the legislature said they got rid of the de facto merger doctrine the court wasn’t sure they wanted to go with that. Renegotiation of contracts a. M. 3. Everyone may not agree i. Farris v. Statutory language does not get rid of the de facto doctrine a. Create a subsidiary and then do a triangular merger and cash-out the minority shareholders v. Not really a problem with TM or SP. To get around this: i.VII. TM & AP: acquirer gets 100% ownership 2. Asset purchase → important to take into consideration. there are always people that don’t know/aren’t informed and don’t sell. De Facto Mergers Cases i. De Facto Merger Doctrine → a rule that transactions which are not styled as mergers but which essentially are mergers may be treated as mergers for purposes of shareholder vote and/or appraisal rights 2. Completely ignored the statutory mandate. Even if everyone agrees. only target’s shareholders 3. c. stuck with the de facto merger doctrine b. Appraisal Rights: 1. TM & AP: both sets of directors. SP & TM: two surviving companies iv. SP: acquirer may get less than 100% a. said that they will not blind themselves to the reality of the transaction. M: both sets of directors and shareholders. Approval 1. vi. Tax and accounting consequences De Facto Mergers and Freeze-Out Mergers a. 2.

a shareholder who doesn’t wish to continue may treat his membership as terminated and get cash for shares. you have to deal with it. (Delaware) 1. Courts say if you create the problem. but have to. Inc. Forced buy-out is the problem not the solution. Freeze-Out Mergers i. ii. Arco Electronics. but cant.) 1. Some shareholders do not agree and are forced to give up their shares. Facts: We have self-dealing. Weinberger v. BEST EXPLANATION OF ENTIRE FAIRNESS TEST (pg. ii. Freeze-out Merger → a merger in which minority shareholders are forced to receive cash for their shares and to lose their status as shareholders a. There were also directors of the other company and had a fiduciary duty to the other company b. involuntary cash-out merger b. They have to disclose to UOP. they have to prove under the entirefairness test unless there was fully informed disinterested shareholder approval. Directors of UOP had the duty to tell the company what it new. where minority shareholders’ expectations are frozen out due to lack of dividends. Hariton v. there the shareholders WANT to sell. 3. 734735) 69 . Note difference from freeze out. (Del. Freeze-Out Mergers Cases i. You have to keep fiduciary duties to both. UOP.among themselves & corp. Most states (almost all states) have moved away from the De Facto Merger Doctrine a. a. etc. even thou this is what they are trying to avoid in the first place. FORM PREVAILS OVER SUBSTANCE (de facto merger would be substance over form) b. but they were not fully informed 2. i. Here they don’t want to sell. Should they be permitted? a. a. PA/NJ are outliers 3. Cash-Out Mergers 1. employment. This is the majority rule 2. How do you reconcile this problem? i. The appraisal remedy just gives them cash. c. This may be the only real solution (appraisal) 2. but they can’t disclose to Signal c. Inc. c. There was disinterested shareholder approval.

1. Defendant bears the burden of showing a business purpose 1. Entire Fairness test b. Basically when there’s self dealing. This Case 1. Entire Fairness Test a. 1. To see if there is entire fairness. b. disinterested shareholder approval. §262(h) – the appraisal value can not include any benefits of the merger 6. you would need a majority of the minority to vote for approval. Shareholder vote is not necessarily the same as fully informed. You can use any tools to figure out what a fair value is. i. because he wants to be an owner in the Patriots 2. you look to 1) fair dealing and 2) fair price. This is the ONLY example of where there is an external variable with a plausible reason. Court may ignore fair price if it was obviously fair dealing. Legal Test Court Employs: a. c. disinterested shareholder ratification. a. Facts: Person wants his share. i. the burden shifts to plaintiffs to show it was unfair. ii. or may ignore fair dealing prong if the price is obviously right.) a. Inc. To say there is a business purpose test is doomed to failure. We will here the experts ii. 70 .4. Court says here the approval wasn’t fully informed! iii.\ ii. The defendant alleges the business purpose is an eternal variable (NFL wants single owners. Rejected the business purpose test. New England Patriots Football Club. Is there ever a valid business purpose to a freeze-out merger? i. Business Purpose Test ii. 2 Part Test i. Coggins v. (Mass. If there is fully informed.) 1. Test of lawyer’s creativity ii. Court liberalized the appraisal proceedings. 5. you apply this test. In the case where the majority of shares are held by the conflicted party. not cash.

Freeze-out merger to get 100% of the company 71 . Courts seem to be unable to recognize anything but the economic interest. Fair Dealing i. Philip A. Have to prove entire fairness a. iii. a. The rule must be that we are never going to allow Freeze-out mergers. may not be ok for people with fiduciary duties. not their shares. Fair Price i. Here they played with the timing of the transaction 3. when are we EVER going to allow freeze-out mergers 3. Takeovers i. Basically. Court says that there was not fair dealing: 1. normally done by a stock purchase i. a. Rabkin v. not exactly hostile to shareholders b. But these directors also had a fiduciary duty to the target company. Hostile Takeover → takeover that does not have the support of the directors of the target a. Hunt Chemical Corporation 1. under the contract only it was ok to wait and pay when the shares would be cheaper. Everyone agrees in this case that the price was fair. Disclosure b. because we are never going to have a business purpose that the court will accept.2. 2. 3. Court doesn’t buy this and has a strict reading of what is a legitimate business purpose. In the end. Any sort of misconduct results in lack of fair dealing 2. Factors: a. a. tender offer 1. Negotiations b. once you have 10% (via open market purchase) you make a tender offer for 51% of the company 2. Things that are normally ok. If this reason is rejected. all the person gets is money. Hostile Takeovers a. and they screwed that company by waiting until the contract expired and they could buy the shares for less. VIII.

ii. often results from the fact that assets or skills may be transferable a.. ex.e. if true. Shareholders like takeover (get premium). Internally – large company can earn a lot of money and support itself i. Financial Synergy led to the rise of Conglomeration – the process of internal diversification i. 2. Undervaluation 1. not that it is untrue. a. hard for shareholders to remove management c. Reasons for Takeover i. i. the risk that the agent may pursue her own interests instead of those of the principal a. Expansion into unrelated lines of business ii. Diversification can be a bad thing in that some companies can be doing poorly/some well and the poor performance can be hidden and there would be no pressure for improvment iii. Externally – cheaper to borrow or sell securities on a larger scale than for a smaller scale. Self-aggrandizement – management is tempted to improve size over profits. Financial synergy → the advantage that larger companies have over smaller companies in raising money a. Management likes bigger size because it gives them power and prestige b. often results from the fact that fixed costs are divided over a large number of units 3. using retained earnings to support new products b. Economies of scope → the reduction in unit costs generated by producing similar or related items. Efficient Market Hypothesis says that this is doubtful. management dislike (lose control/job) b. this would result in a net gain to society 2. stems from separation of owners and management b. Inefficient management 3. Excessive compensation 4.ii. is less than the fair value of the shares 2. Synergy → the advantage that results when a combination is greater than the sum of its parts a. 72 . Shareholders obviously would rather have profits. Takeover can help reduce agency costs. Agency costs → the costs associated with an agency relation. Market value of the shares. c. computer parts co can acquire a computer factory. 4. Negative of this is that it leads to a lack of focus iii. Economies of scale → the reduction in unit costs generated by buying or producing in volume.

Do account for some of the value created for shareholders 6. even if shareholders want to say no. with the explicit or implicit promise of a subsequent freeze-out merger offering inferior consideration to remaining shareholders b. BAD REASON for takeovers 2. Basically old creditors get screwed – low interest rates. Wealth taken from employees (taken by acquiror) a. Old creditors lent money when it was a lot less risky 1. a. sell shares (supposed to be unlimited power) a. There is NO evidence that all or most of the value comes from wealth transfers. 1. 2. Coercive offers 1. 2 main powers: 1. Best example is a two-tiered front loaded tender offer a. We are not worried about new creditors (knew what they were getting into and charged appropriate interest rate. problems with most of these reasons is that they are easy to claim but hard to prove or disprove. If management can resist a hostile takeover. often without a net benefit to society a. cut salaries. There is some evidence that some of the value that is created comes from wealth transfers. benefits or jobs 3. Wealth taken from creditors (taken by acquiror – LBO) a. Leads to shareholders stealing from bondholders 2. they have to say yes. Wealth transfers → a shift in wealth from one group to another. 4. ii. for fear of a worse deal 3. Originally coercive offers were pretty blatant 73 . After takeover business can be more risky b. c. Government a. Reasons for Defense – (opposing takeovers) i. Who gets to decide whether management gets to resist business? a. voting rights to remove management 2.) i. it is limiting your rights to sell your shares. seeking control but not full ownership. Save on taxes b. If hostile offer is coercive and shareholders really don’t have a choice it is appropriate for management to step in. Shareholders wealth is at the detriment of the government/society 5.iv. Shareholders: i. Management runs business b. → a tender offer at a premium.

k. Incompatibility 1.. community. they really don’t want to be on a board where they have to resist the owner of the company 3. i. as by a hostile takeover 1. vi. (pay less than shares are worth. society. Management tries to claim coercion but it doesn’t work. Of course management can not give this as a reason. Voting rights a... d. management argues that it’s not a good business decision for a potato chip company to purchase a microchip company. Don’t actually do much because once a takeover is accomplished. acting in shareholders interest. but we can get a better deal 2. Unfair to employees. but not for target shareholders 3. Staggered boards → a board of directors structured so that only a fraction of its members is elected each year for multi-year terms. All-cash.a. ex. but as courts became wise. shareholders hate this…instead of getting the premium they are paying the premium 74 . ii. or $50 in bonds on the backend 4. Additional mechanisms: 1. Management. $50 in cash. Takeover Defenses (the “HOW”) i. Opportunity loss 1. Way to get around this…. iv. Ways that make it difficult or impossible for someone to take over the company. no coercion in this offer b. Fact is they don’t much exist anymore a. Good deal for acquire.e. classified board a. but EMH makes this implausible) 2. a. Undervaluation 1. 5. Other constituencies 1. government. Courts protect this for a reason because management has a better idea of what the company is worth. Entrenchment → efforts by management to resist ouster. iii. 6. Shareholders want protection from coercive offers.a. All-shares offer → an offer to buy any and all shares for cash. Previously considered: 1. creditors. can claim this is a good deal. company has to pay premium to stay them off) a. they became more subtle i. environment vii. Greenmail → the repurchase by a target of its own shares from an acquiror at a premium (hostile buys 10% and threatens to buy all. Precisely because it is allowed to be resisted. Other constituency statues 2. with the promise to follow up promptly with a cash-out merger at the same price in cash a.auction v.

No-shop provision → a provision in an acquisition agreement that limits the target’s ability to deal with other potential bidders i. Share repurchase → the reacquisition by a company of its own shares from the public a. Not a better deal for shareholders. 5. Reduce the supply of willing sellers in the market.2. c. Justified because it would cost the White Knight money to win the fight c. Paying greenmail makes you vulnerable to more greenmail threats (they know you’ll pay) Crown jewel defense → a takeover defense in which the target sells its most valuable assets in order to become less attractive to the acquirer a. Acquiror agrees not to deal with anyone else. Management is giving itself an exit payment by directors i. a. Increase the management’s relative position. Lock-up option → a provision in an acquisition agreement designed either to preclude a competing bidder from acquiring a company or to provide compensation to the original bidder in case it loses in a bidding contest i. Similar to shooting yourself in the foot. considered to be the ultimate defense 75 . if White Knight gets advantages b. Do this to drive the price up and make it more expensive for the acquiror to acquire b. 4. ii. 3.a takeover defense in which shareholders of the target (other than the acquiror) are granted the right to acquire securities (or other assets) at a significant discount. Termination fee → a fee to be paid to a friendly would-be acquiror should the proposed transaction not be consummated i. of Stock Lock-Up 1. d. White knight defense → a takeover defense in which the target convinces a friendly third party to make a superior offer i. Considered part of there compensation package Poison pill → (PREMIER DEFENSE) . With this. you CANNOT complete a hostile takeover. Ex. Only if the White Knight loses so the bad acquiror would have to pay. Management is forced to pay greenmail to get you to go away. b. 6. Golden parachute → a large severance pay contract for top management that is triggered by a change in control a. White knight would get extra shares if the hostile bidder wins. c.

(Delaware) a. negotiate a better deal with management 1. not hostile. This rule does not apply if the corporate raid is a threat to the corporation’s interest as opposed to the director’s interest. Hostile Takeover Cases i. b. Directors have to have reasonable grounds to believe there is a threat to company  they can argue that they’re not acting in their own self interest ii. Reasonable investigation c. Cheff v. Statistics of the takeover: i. i. hostile. Good faith ii. who will then remove the poison pill e. Standard is satisfied by: i. Development 1. There was junk bond financing in second tier (back end)—thus the offer was very coercive to shareholders iii. Mathes (Delaware) a. 3 ways around the poison pill 1. Basis of suit: The bidder sued to enjoin the self tender claiming it was a breach of the director’s fiduciary duty. get a court to order the redemption of poison pill rights 1. A front loaded. gives everyone (all other shareholders) all of the money/assets and leaves hostile acquiror with nothing but the name. Introduction 1. iv. no poison pill iii. c. Director Defenses: i. Mesa Petroleum Co. b. Class Notes: i. A known corporate destroyer (frequent green mailer) financed the tender offer. Launch a proxy contest to replace board. Unocal Corporation v. all of which involve elimination of poison pill ii. two tiered tender offer for 37% of UNOCAL ii. Order management to do this as part of fiduciary duty. Redemptions can not be used by directors to prevent a corporate raid if the sole purpose is to keep the directors in office.i. b. Consulting with lawyers and outside investment bankers 76 .

In other words 1. The Board must perceive the bidders action as a threat to corporate policy. Reasonable grounds to believe there is a threat ii. 2 part test: i. ii. Courts have defined the Unocal “Enhanced Scrutiny” Intermediate Test – Proportionality: i. Note: Directors can’t act solely to perpetuate themselves in office. h. Reasonableness to believe there was a threat 2. Mathes 1. g. e. Must show that the Board’s action is proportional to that threat.d. forced to accept front end of two tier offer b/c afraid of back end) ii. Rule of law i. All Board defense actions are subject to enhanced scrutiny because of the “omnipresent specter” that the Board is acting in its own best interest. Self tender offer by the Board at a premium price that was not available for the shares owned by the bidder (Mesa) Held: There was no breach of the director’s fiduciary duty. Reasonable investigation a.g. This enhanced scrutiny requires that directors show they had “reasonable grounds for believing a danger to the corporate policy and effectiveness” existed. Cheff v. f. Response was proportional to threat What constitutes a threat? i. they merely attempted to remove the coerciveness. and they did not stop the tender offer. iii. The board acted in the shareholder’s best interest. Coercive offers (e. Defensive mechanisms may only be used as a method to thwart off a takeover attempt if motivated by a good faith concern for the corporation’s welfare free from fraud or misconduct. Response must be reasonable in relation to the threat posed. Only a majority of outside independent directors acted. ii. Inadequate offers iii. Good faith 2. Risk of non-consummation iv. Quality of securities being offered 77 .. ii. iii.

78 . Now in response to this case…Federal Securities law requires that a tender offer must be offered to all shareholders i. Thus. Revlon. a white knight. No more defensive mechanisms – The Board becomes an auctioneer and attempts to get the highest shareholder price. but there is a lot of discretion is still given to directors so there is not as much pressure as you would think there would be. Thus. i. the tender offer became inevitable. Revlon’s Board took action to thwart the tender offer. Held: The injunction was upheld. Revlon defines the Unocal standard—it changes when the sale becomes inevitable. Unocal is the basic test for defensive measures: i. does not need to deal with them on equal footing as long as it is achieving the best results for the shareholder. Revlon appealed the injunction. Directors are allowed to take defensive measures when they feel a takeover bid is not in the corporation’s best interest without violating their fiduciary duties. k. Facts: Pantry Pride Corporation attempted a hostile takeover of Revlon. The defenses include bidding with Forstmann. b. However. c. their duties shift and they must try to get the shareholders the best possible price. Inc. Tilted Playing Field – The Board owed no duty to the potential suitors and. (Delaware) a.i. They can no longer try to protect the corporation or other constituencies. 2. Inc. MacAndrews & Forbes Holdings. as soon as the dissolution or sale of the corporation becomes inevitable. Rule: As soon as a sale or dissolution of the corporation is inevitable. Reasonable measure to deal with threat 1. the defensive measures taken were in and of themselves legal. However. and eventually giving Forstmann a lock-up on key assets a no-shop provision (it appeared that the Board was making these defenses to protect Revlon’s note holders). MacAndrews. v. therefore. the controlling stockholder of Pantry Pride was granted an injunction to prevent Revlon’s board from continuing the defensive measures. Poison pill is considered reasonable. things change. Reasonable grounds for threats ii. Directors don’t always win and defensive measure are not always upheld. despite all of these efforts. Discriminatory offers are illegal under Federal law – offers must be open to all shareholders j.

d. Favored the white knight too much. Companies try to avoid the application of Revlon ii. g. ii. Defensive measures were used to end the auction 1. You can also try to get the best price by using defensive measures Here defensives were used improperly i. e. f. Real question is whether you have to get rid of the poison pill at some time? How do you know when a sale is inevitable? i. When there is definitely an auction out there…when there is a white knight ii. i. the Board can no longer favor other constituents over shareholders. Sales are relatively found to be inevitable Best way to get the best price is normally an auction i. ii. It is ok to use the poison pill in response to a threat ii. Defensives are not per se illegal 1. In Revlon. However. To insure that the white knight won. Want to stay in the realm of UNOCAL. 79 . that sale was inevitable because it became apparent that the corporation was going to be sold either to the bidder or the white knight. Otherwise. Revlon standard is pretty tough. h. Under Revlon you have to sell for the best price 2. Auctions are not required thou by the court ii. 1. Under unocal you have the ability to say no.

Ethical Responsibilities of Corporate Attorneys i. Security attorneys have responsibilities to society and not just their clients.Epilogue I. Responsibility is to report things that hurt the corporation 1. ABA Model Rules of Professional Conduct 1. Ethical Responsibilities of Corporate Attorneys a. Are they advocates or players? a.13 – most important – identify your client a. SEC enforcement 1. Some argue that you can go outside the company and it still will not violate confidence ii. Historically SEC has not been very active in enforcing against attorneys 3. 1. Your client is not a human being. Perhaps you can think of that as the Board of Directors and not the CEO 2. Your client is not the CEO ii. Attorney was found guilty of aiding and abetting a security laws violation c. For protection of investors. Corporate Attorney i. iii. ii. Players that actively participate and not just advise. SEC wants everyone involved in securities to behave responsibly 2. SEC greatest success in this regard (ethical responsibility of attorneys) b. § 307 – clearly authorizes SEC to define and enforce ethical standards for attorneys 80 . National Student Market Corporation Case a. SEC clearly wants this to be the case. Is there a special role for corporate attorneys? 1. Law says it is the corporation so you have to behave accordingly iii. you may have to resign iv. Are you not just representing your client and then do you have a duty to society. State Bars have not been very active really iv. i. Confidence is not violated by going up the ladder 1. You have to report up the ladder 2. it is the corporation 1. § 1. But ultimately it is the shareholders 3. If the company does not care. Sar-bans Oxoly may change all this: 1.

Little case law c. LLCs are the culmination of the flexibility in BA law. but smaller businesses are increasingly become LLC 3. Managers → a designated manager of a limited liability company (if any) vi. Argument that they don’t have the authority doesn’t exist c. 1. Proposed rule would have required a nosy withdrawal a. have to be some form of partnership. Is that the attorney withdraws but then the company has to tell the SEC. People unsure what they are dealing with d. charter iii. ii. b. Certificate of formation → an official document establishing and governing the internal affairs of a limited liability company. a.k. Public businesses are taxed regardless. Now you have to do this. Some think that there is no such thing as independence because they will always judge the other directors as they would judge themselves. How are they going to use this? b. SEC hasn’t passed this but hasn’t taken it off the table 3. Can make it as much like a corporation or as much like a partnership as you want. a. you have to quit and then tell the SEC that you are quitting for a reason b. Contemplates a codification of reporting up the ladder requirements i. 2. Simple a mixture of corporate law and partnership law. but it is a limited liability partnership 81 . Limited Liability Companies → an unincorporated legal entity created by authority of law 1. Increasingly they are. Rules makes securities law more risky vi. 2. SEC is more serious then it has ever been. Independent Directors Article 1. Problems: a. vii. Another possibility a.II. Has to be a partnership. You know nothing about a company when you see LLC. If going up the ladder does not work. Few statutory default rules b. Operating agreement → an agreement among the members of a limited liability company that sets forth the structure and terms of the company 1. iv. Law firms in some states can’t be LLC. 2.. Limited Liability Partnerships → a partnership with limited liability among the partners i. v. Members → an owner of a limited liability company v. Limited Liability Companies and Limited Liability Partnerships a. Why aren’t all businesses LLC? 1.a.

The LLC is simply their joint business vehicle. Piercing the “LLC” Veil i. *It is not to be presumed that the legislature intended to abrogate or modify a rule of the common law by the enactment of a statute upon the same subject. 2002) p. 2.ii. When a third party sues a manager or member of an LLC under an agency theory. Jaffari (Del. The Act is designed to permit members maximum flexibility in entering into an agreement to govern their relationship. Lanham (Colo. 1999) p. Policy of the Act is to give maximum effect to the principle of freedom of contract e.’s LLC Act defines the limited liability company agreement as any agreement. 2. an agent is liable on a contract entered on behalf of a principal if the principal is not fully disclosed. 300 1. Elf Atochem North America v. a principal whose existence. d. and LLC for amount due on contract for engineering services. Formation i. 2. the remedy of piercing the corporate veil was available against a company formed under the Wyoming LLC Act (Act). but not limited liability + 2. Kaycee Land and Livestock v. but not contracts iii. the principles of agency law apply notwithstanding the LLC Act's statutory notice rules. Third party brought suit against agents for LLC. 3. Waste & Land (Westec) v. 1998) p. 288 1. That is limited liability. Ct. in the absence of fraud. but not identity. Thus. More and more law firms are becoming LLPs c. 293 1. is known to the other party. an agent is liable on contracts negotiated on behalf of a partially disclosed principal. Whether. Members can alter the default jurisdictional provisions of the statute and contract away their right to file suit in Del. The statutory notice provision applies only where a third party seeks to impose liability on an LLC's members or managers simply due to their status as members or managers of the LLC. a. that is. The Operating Agreement i. Some people limited the shield to torts. 4. 3. Sup. Section 18-101(7) of Del. It is the members who are the real parties in interest. of the member or members as to the affairs of a limited liability company and the conduct of its business. Under the common law of agency. but limited liability for what your partner has done 1. written or oral. it is rather to be presumed that no change in 82 . Partners are responsible for your own actions. Flahive (Wy. Water. An agent who negotiates contract is not liable when he has given notice to the third party that there is a principal for whom he acts and also notice of the name or identity of the principal.

and then providing written notice to its known creditors containing information regarding the filing of claims. nor overturned except by clear and unambiguous language. Also. they breached their duty of loyalty to D manager by failing to act in good faith. LLC Mergers i. in essence. The rules of common law are not to be changed by doubtful implication. VGS. h. Dissolution i. Hunt Sports Enterprises (Ohio 1999) p. to compete with the company. the statute must be construed 83 .the common law was intended unless the language employed clearly indicates such an intention. *Wis. 3. 305 1. v. Appellees sought declaratory judgment that LLC operating agreement permitted members to compete for NHL franchise as well as judicial dissolution of LLC. Appellants' counterclaim alleged interference with prospective business relationships and breach of contract and fiduciary duty. Castiel (Del. Inc. *The court found that had D manager knew of the proposed merger. Ch. such general duty in this case must be considered in the context of members' ability. However. 311 1. App. 3. g. Haack (Wis. pursuant to operating agreement. limit or define the scope of the fiduciary duties imposed upon its members. 4. 1999) p. he would have taken steps to protect his majority interest. f. Reading the Act in light of the equitable maxim that equity looks to the intent rather than to the form. 2. the members of a dissolved limited liability company who have not wrongfully dissolved the company may wind up the affairs of the company. Fiduciary Obligation – similar to that imposed in a partnership i. New Horizons Supply Coop v. 183 expressly permits the importation of concepts such as "piercing the veil" from business corporation law into limited liability company law. 756 1. 2000) p. *An operating agreement of a limited liability company may. D failed to take the appropriate steps that were required by the statute to shield herself from any personal liability for the company's debts. members of limited liability companies owe one another the duty of utmost trust and loyalty. McConnell v. Except as otherwise provided in the operating agreement. In general terms. ch. A dissolved limited liability company may dispose of known claims against it by filing articles of dissolution. Stat. 2. After breaking away from original LLC. Since the minority managers were aware of this. When the company dissolved. appellees obtained an NHL franchise. 2. P's claim did not appear to exceed the value of any liquidation distribution D might have received from dissolution of the company.

It can not apply to an illusory. manipulative attempt to restructure an enterprise through an action taken by a "majority" that existed only so long as it could act in secrecy.to allow action without notice only by a constant or fixed majority. too clever by half. 84 . Nothing in the statute suggests that a court of equity should blind its eyes to a shallow. will-of-the wisp majority which would implode should notice be given.