My Business Organizations Outline Prof.

Ragazzo Spring 2006

AGENCY

I.

II.

Introduction
a. Agent a person who by mutual assent acts on behalf of another and subject to the
others control
i. Elements to create an agent:
1. Agreement
a. Both parties assent to the relationship
2. Control
a. The person is subject to the control of the principal
3. Benefit
a. The agent is acting on the principals behalf
ii. General Agent an agent who is authorized to conduct a series of transactions
involving continuity of service
iii. Special Agent an agent who is authorized to conduct only a single transaction,
or only a series of transactions not involving a continuity of service
b. Principal the person for whom the agent acts; can be disclosed, partially disclosed, or
undisclose
c. Agency law governs:
i. The relationship between agents and principals
ii. The relationship between agents and third persons with whom the agent deals
iii. The relationship between principals and third persons when the agent deals, or
purports to deal, with a third person on the principals behalf
Authority
a. Types of Authority
i. Actual Authority
1. Express If principals word or conduct would lead a reasonable
person in the agents position to believe that the principal wishes the
agent to so act
2. Implied Whether a reasonable person in the agents situation would
believe through all of the manifestations of the principal, that he had the
authority to do something
a. incidental subcategory
ii. Apparent Authority the type of authority a reasonable outsider would assume
the agent would have based on the principals manifestations to the third parties
1. Requires more than just representations . . . you need conduct, previous
course of dealing, etc.
2. Executives (Power of Position)
a. Often have apparent authority, but this differs from state to state
i. EX: The president of a company would always have
apparent authority to an outsider despite the fact that he
is in realty only a nominal figurehead with no power to
bind a company
b. Power of position might also apply to bank tellers, etc. . . . not
just executives
3. Implied Authority v. Apparent Authority Implied is essentially the
same as Apparent authority but it looks through the eyes of the Agents
perspective, so there may be times where the two might diverge
a. EX: Where everyone would assume that an agent had authority
to do something, but for some reason the principal has limited
the agent and the agent has not disclosed this to the third party

i. He would have apparent authority, but not implied

authority
iii. Agency by Estoppel general estoppel principle; if P led third party to believe
he was a principal and T relied on that representation to his detriment
1. The principal must
a. 1) intentionally or carelessly cause such belief on the part of T;
or
b. 2) having notice of such a belief and that it might induce other
the change their position, the person did not take reasonable
steps to notify them of the true facts
2. Very similar to apparent authority
iv. Inherent Authority only held by a general agent with continuous
obligations rather than one specific purpose
1. Arises where the general agent is charged with a broad task and needs to
do a smaller task in order to achieve the broader task
2. Operated much like respondeat superior in torts: it would be unfair to
allow the principal to reap the benefits of having an agent and escape
the detriments when the agent oversteps his bounds
3. 161 disclosed or partially disclosed principals
a. A disclosed or partially disclosed principal is liable for an act
done on his behalf by a general agent, even if the principal has
forbidden the agent to do the act if
i. The act usually accompanies or is incidental to
transactions that the agent is authorized to conduct; and
ii. The third person reasonably believes the agent is
authorized to do the act
4. 194 undisclosed principals
a. A general agent for an undisclosed principal authorized to
conduct transactions subjects his principal to liability for act
done on his account, if usual or necessary in such transactions,
although forbidden by the principal to do them
i. No 3rd party belief requirement
b. Ratification
i. The principal is bound to a third party if the agent purported to act on the
principals behalf and the principal, with knowledge of the material facts either:
1. affirms the agents conduct by manifesting an intention to treat the
agents conduct as authorized; or
2. engages in conduct that is justifiable only if he has such an intention
a. EX: the principal, with knowledge of the facts, receives or
retains something to which he would otherwise not be entitled
ii. Ratification need not be communicated to the third person, but must be
objectively manifested
iii. RULE If the principal ratifies the contract, then the ratification is retroactive
to the beginning o the contract
1. Travels backward in time to make everything okay from the beginning
and give the agent authority
a. This may matter
***NOTE: Remember its not possible for a corporation to ratify contracts
made before they came into existence, so they adopt; but the difference is
that adoption is not retroactive and cant travel backward in time
c. MORRIS OIL CO. v. RAINBOW OIL TRUCKING
i. Rainbow entered into an agreement whereby they would use Dawns trucking
license for oil fields owned by Morris. Morris and Rainbow entered into a K

directly, and M did not know Dawn existed. Rainbow did all of the grunt work.
Morris paid Dawn and Dawn would keep a percentage and a clerical fee and
forward the rest to Rainbow. Dawn also kept the books
1. Morris sued Dawn for debt incurred by Rainbow for buying diesel fuel
and building a fuel dispenser
a. Theory is that Rainbow is Dawns agent and therefore Dawn is
on the hook for everything.
2. Morris points to the agreement b/w Dawn and Rainbow where Dawn
reserves complete control over their operations
a. Also said that Rainbow was not the agent of Dawn and could
not incur debts other than those in the ordinary course of
business relative to terminal management
ii. Court views this as a case of undisclosed agency because Rainbow contracted
with Morris in its own name and not through Dawn.
1. RULE The undisclosed principal is subject to liability to third parties
with whom the agent contracts where such transactions are usual in the
business conducted by the agent, even if the contract is contrary to the
express directions of the principal
a. This draws on apparent authority principles
i. Any limitation on the agents authority will be binding
on the third party only if the third party had knowledge
of that limitation
2. Also thinks that Dawn ratified the transactions after learning of the
debts existence
a. They knew of the debts and assured Morris that they would
receive payment from the Rainbow funds that Dawn retained.
iii. They could have also found agency by estoppel
***NOTE: Dawn could have argued that this agreement did not make Rainbow an
agent. If Rainbow was just running their own business and paying a licensing fee
to Dawn, then there is an argument that there is no agency. However, if Rainbow
was really running Dawns business, then they would be an agent . . . . this could
be proved by looking at the money: if Dawn kept most of the money, then they
Rainbow was an agent, but if Rainbow got most of the money then Rainbow was
not an agent.
d. When is Third Party Liable to Principal?
i. RULE Whenever agents principal is liable, then third party is liable to the
principal as well
1. Exception
a. If the principal is undisclosed and the third party would not
have done the deal had he known the identity of the principal
e. When is Agent Liable to Third Party?
i. Where Principal is Bound
1. Disclosed Principal agent will not be bound to the third party where
the agent had actual, apparent, or inherent authority
2. Undisclosed Principal agent will be bound even though the principal
is bound as well
a. Theory: if the third person thought that he was dealing with the
agent then agent should be bound because that is how the agent
represented the transaction
b. Majority Quirk
i. If the third person obtains a judgment against the
principal, the agent is discharged from liability even if
the judgment is not satisfied

1. undisclosed principal is likewise excused if

third person obtains judgment against agent

III.

c. Minority
i. Neither the agent nor the principal is discharged by a
judgment against the other, but only by satisfaction of
the judgment
3. Partially Disclosed Principal general rule is that agent will be liable
where the identity of the principal was not known
Agents Duty of Loyalty
a. TARNOWSKI v. RESOP
i. P wanted to buy a business and employed A as agent to investigate a particular
business and advise him on it. A lied to P about the facts of the business and
cause P to buy the business. A received a $2000 secret commission from the
seller of the business.
1. The issue is what duty the agent has to the principal in regard to the
profits A received for making the sale
ii. RULE All profits made by an agent in the course of an agency belong to the
principlewrongly acquired or not.
1. Principle does not have to suffer damages
2. Policy
a. The law will not allow an agent to place himself in a position
where his own private interests diverge from those of the
principal
3. Principal will have an absolute right to the $2000 bribe, irrespective of
the success of the business, or any other recover made by the principal
iii. Two Major Duties:
1. Duty of Loyalty (fiduciary)
a. In this case, it is taking the bribe from the seller
b. Damages:
i. The principal is entitled to all benefits received by the
agent
ii. Also entitled to be indemnified by the agent for any
losses that result from the improper transaction
2. Duty of Care (Tort)
a. In this case, its the unwillingness to investigate the deal by the
agent
b. Damages
i. Answerable for all the injurious consequences of his
tortuous act that were reasonably foreseeable
1. Under a tort action, the agent can only be liable
if the business venture fails, because otherwise
there are no damages.
iv. The best thing to show is breach of Duty of Loyalty because you can avoid
questions of negligence, etc.
v. RAGAZZO: You could also probably sue for FRAUD if the agent knew the
representation were untrue because he had an obligation to disclose adverse
facts to his principal

PARTNERSHIP
I.
Partnership Formation
a. Introduction
i. RUPA 101(6) Partnership is an association of two or more persons to
carry on as co-owners a business for profit (same as UPA 6)

1. RUPA 202 receipts of profits of a business is prima facie evidence

of a partnership (UPA 7(4))
a. Creates a rebuttable presumption that you will have to
overcome with other evidence
ii. RUPA law of Delaware
1. Supersedes UPA
iii. Objective Fact-Based Standard
1. Court will look to the facts and circumstances of the relationship
2. The subjective intent of the partners does not matter, but instead what
matters is whether the circumstances of their relationship constituted the
requirements of forming a partnership.
iv. Liability
1. Each partner is personally liable for the debts of the partnership
a. This means that it is very helpful to plaintiffs if they can
establish that a partnership exists, because it puts more people
and pockets on the hook for their claim
v. Four-Element Test (non-UPA/RUPA)
1. Some court require all of the following four elements where there is no
express agreement:
a. 1) an agreement to share profits
b. 2) an agreement to share losses
c. 3) a mutual right of control or management of the business
d. 4) a community of interest in the venture
2. Other courts simply state that the presence or absence of these elements
is evidence, but not a requirement, of partnership relation.
b. MARTIN v. PEYTON
i. A banking partnership was in financial difficulties, so they entered into an
agreement with a few individuals to loan them liquid securities to get more
cash. In compensation for the loan, they were to receive 40% of the profits of
the firm until the loan was paid off and the return made.
1. They men did not believe that they were becoming partners, but rather
just lenders
a. We know that intent doesnt matter, but rather the nature of the
relationship
2. The issue is whether they are partners and whether they operated as coowners of a business for profit
ii. Court looks at the key provisions of the loan agreement:
1. Profits
a. There is a cap on how much money they can receive, so they are
not true business partners
2. Veto Power
a. Court says veto power alone doesnt give them enough control
to consider them partners . . . they need some control b/c $2.5
million of their money is at stake
i. They also have no affirmative control to bind the
company to any transaction or make the company do
something
3. Loss Sharing
a. This was limited by other measures for the lenders, but not for
the true partners
iii. Court determines that there is not enough to find a partnership based on these
facts
c. LUPIEN v. MALSBENDEN

II.

III.

i. Malsbenden works at the location but thinks that he is just a lender. He put up
$85K of his own money and spent a lot of time at the car dealership. The loan
had no provision for the payment of interest, and was to be repaid from the
proceeds of each car sold.
1. The plaintiff deals almost exclusively with Malsbenden
ii. Proof of Partnership:
1. An agreement, either express or implied, to place their money, effects,
labor, and skill, or some or all of them, in lawful commerce or business
with the understanding that a community of profits will be shared
a. Express agreement is not required . . . it is possible for parties to
not intend a partnership, but still create one
iii. Court looks at a number of factors to determine that a partnership existed
1. Loan did not have fixed payment schedule, but rather would only be
repaid as cars were sold
2. No interest on loan
3. Had the right to participate in the control of the business
4. He created the contract with the plaintiff
***NOTE: There is a tradeoff between being a lender and being a partner. Once
M decided to exert that much control, he gave up the ability to only be considered
a lender and instead assumed partner status.
The Legal Nature of a Partnership
a. Entity or Aggregate Status
i. UPA
1. A partnership is not a person and does not enjoy entity status the way
other business organizations do.
a. Consequences:
i. Partnership cannot sue under its own name . . . all
partners must join the suit
ii. A third party cannot sue the partnership
1. Instead, they must sue the individual partners
collectively
iii. Partners are jointly liable for the debt
1. Implicates the need to sue all partners in one
suit or else risk having the suit dismissed
2. Contrary to this theory, however, UPA allows partnerships to own
property in the partnerships name
ii. RUPA
1. 201 a partnership is an entity
The Ongoing Operation of Partnerships
a. Management
i. UPA
1. 18 all of the following provisions are subject to being altered by the
partnership agreement
a. (a) - each partner should be repaid for his contributions to the
partnership
i. each partner should share equally in the profits and
contribute to the losses according to his share of the
profits
b. (b) the partnership must indemnify a partner for any payments
made in the ordinary and proper conduct of its business
c. (e) all partners have equal rights in the management and
conduct of the partnership business

d. (g) no person can become a member of a partnership without

the consent of all of the partners
e. (h) any difference arising as to ordinary matters connected
with the business may be decided by a majority of the partners
i. no act in contravention of any agreement between the
partners may be done rightfully without the consent of
all the partners
f. RUPA 401 is substantially similar
ii. RUPA
1. 401 See UPA 18 above
iii. SUMMERS v. DOOLEY
1. Summer and Dooley entered into a partnership agreement. D couldnt
work anymore so S was the only partner actively running the business.
D hired a replacement, but S wanted to hire a third person as an
employee of the partnership, but D objected. S still hired the third
person.
a. S sued for reimbursement of the employment costs of the third
person under UPA 18(b)
2. D argues UPA 18(h) all decisions regarding ordinary matters of the
business require consent of the majority of the partners
a. Each partner gets one equal vote regardless of investment in the
partnership unless altered by the partnership agreement
3. S argues UPA 18(e) all partners have equal right in the
management and conduct of the partnership business
a. Therefore, S has just as much of a right to hire someone as D
does;
i. and by refusing to hire, S cant carry on the business of
the partnership
b. Ds rebuttal to this argument is that this reading of the statute
directly conflicts with 18(h)
i. Most would side with this argument and say that 18(e)
only means to say that all partners have a right to be
consulted on partnership decisions, but they might not
get to have their view followed b/c of 18(h)
4. Court follows 18(h) and states that a majority did not consent to the
hiring. He made it very clear and actively objected
a. Therefore, S had no right to hire the third person.
5. RAGAZZO: Absentee Partner Argument
a. 18(h) is just a default rule that can be contracted around.
i. By virtue of Dooleys non-participation, there was an
implicit agreement that Summers would run the
business and D would be more like a passive investor
1. This is an acceptable argument because
partnership agreements dont have to be in
writing
b. The only problem with using this argument in this particular
case is that S went to D and asked if it was okay . . . indicating
the S still thought D had a vote
***Even where there is a written partnership agreement, changes in
the way the partnership is actually conducted, not just changes in
the way in which it has been explicitly agreed that the partnership
will be conducted, may constitute amendments of the partnership
agreement for purposes of 18 or 401(j)

IV.

iv. Management of Partnerships

1. Changes in course of conduct
a. See note immediately above
b. If a partnership is managed in a way that is contrary to the
partnership agreement, this could create an implicit agreement
to amend the partnership agreement
2. Participation
a. UPA 18(e)/RUPA 401(f)
i. Both provisions state that all partners have equal rights
in the management and conduct of the partnership
business
b. Most courts treat this provision as simply requiring that ever
partner must be consulted in partnership decisions
i. This was the failing of Summers argument in the above
case
v. Choice of Law
1. UPA does not provide any guidance
2. RUPA 106 a general partnerships internal affairs are governed by
the law of the state in which the partnership has its chief executive
office
b. Indemnification and Contribution
i. UPA 18 (a)-(f)
ii. RUPA 401 (a)-(e), (h)
iii. Indemnification
1. If one partner pays off a partnership obligation in full, or more than his
share, he is entitled to indemnification from the partnership for the
difference between what he paid and his share of the liability
a. Partnership liability
i. Each partner will be liable in proportion to the profit
shares
iv. Contribution
1. Where the partnership pays off an obligation in full, the partnership has
a right to require contribution from each individual partner for their
share of the obligation
a. Partner liability
The Authority of a Partner
a. Apparent Authority
i. Every partner has apparent authority to carry out the ordinary business, unless
the third party has knowledge of the limitations placed on the partner in the
partnership agreement
1. This means that as to the outside world, every partner will be liable for
the actions of other partners acting with apparent authority
a. EX: Dooley will be on the hook to the employee that Summers
hired despite Dooleys lack of consent . . . the remedy will be
for Dooley to seek reimbursement from Summers
2. The partner who acted with actual authority, but with apparent authority
would then be liable to the rest of the partners to reimburse for any
losses
b. RNR INVESTMENTS v. PEOPLES FIRST COMMUNITY BANK
i. Limited partnership created to develop land and build houses. General partner
had all of the management decisions, but had to get approval from the limited
partners to go over budget on any one project. GP took a loan for more than
approved budget and then the company defaulted on the loan.

1. RNRs defense to foreclosure was that the bank failed to inspect the
partnership agreement which stated that GP had no authority to take out
this loan with prior approval form other partners.
a. Places duty on the bank to inspect
ii. RUPA 301 in order for apparent authority to be defeated, if the conduct was
in the ordinary course of partnership business, the partnership must give the
third party actual notification
1. Must either have:
a. 1) Actual knowledge
b. 2) Receive notification from partnership
i. effective upon receipt
***There is NO CONSTRUCTIVE KNOWLEDGE
2. Policy the risk of loss from partner misconduct more appropriately
belongs on the partnership than on third parties who do not knowingly
participate in or take advantage of the misconduct
iii. RUPA 303 can file a statement with a designated public official stating any
limitations of authority on some or all of the partners
1. Operates as constructive knowledge only for real property transactions
a. Any other transaction still requires the actual knowledge or
notification of the third party (see comments)
2. If the person had no notification of this, then this is of not help to the
third person in a non-real property transaction
a. No constructive notice
i. One exception is with real estate
iv. Test
1. Step 1: Whether the conduct is a normal incident of partnership business
a. If the loan is taken because of financial difficulty, then it is not
in the ordinary course of business and no apparent authority
i. If the loan a project loan, then it is a normal incident
b. In this case, taking loan is in the normal course of business
because they develop real estate
2. Step 2: Whether the third party had knowledge of the partners
limitations
a. See 301 above . . . just having the agreement on file at the
office does not give third-parties constructive knowledge
c. NORTHMON INVESTMENT CO v. MILFORD PLAZA ASSOCIATES
i. Court makes a distinction between the apparent authority to the outside world
and the ability to bind partners within the partnerships
1. Determines that the other partners are not bound to the agreement
because of their right to consent to agreement with third-parties
provided for in UPA/RUPA
2. Also points to their equal rights in the management and conduct of the
partnership business
ii. Court decides that other partners are not bound by the lease agreement entered
into by the other partner . . . therefore, any liability would fall squarely on the
one partner who entered into the agreement
d. UPA
i. 9 - Apparent Authority a partner has authority to bind a partnership by any
act for apparently carrying on in the usual way the business of the partnership
of which he is a member and third party does not have knowledge or
restrictions
1. Controversy

a. UPA is unclear as to whether they are talking about the course

of business of the particular partnership or the course of
business of similar partnerships in the same line of business
b. RUPA resolves this controversy in favor of the latter
2. Knowledge
a. Actual knowledge; or
b. When he has knowledge of such other fact as in the
circumstances shows bad faith
i. Creates an implied or inquiry notice that is ill-defined
ii. RUPA remedies this

V.

VI.

e. RUPA
i. 301 - Apparent Authority partner liable for act in ordinary course of: (i) the
particular partnership business; or (ii) the business of the kind carried on by the
partnership (i.e., other partnerships in a similar line of business) and third party
does not have knowledge of the restrictions
1. Knowledge
a. Only actual knowledge or receipt of a notification of a partners
lack of authority will meet the standard
i. No duty of inquiry for third party
ii. 303
Liability for Partnership Obligations
a. UPA
b. RUPA
i. 306 partners are jointly and severally liable for all obligations of the
partnership
ii. 307
1. (a) a partnership may both sue and be sued in its own name
2. Exhaustion rule
a. A judgment against a partner, based on a claim against the
partnership, cannot be satisfied against the partners individual
assets until the assets of the partnership are exhausted in
satisfying the judgment
3. A judgment against a partnership is not by itself a judgment against a
partner, and cannot be satisfied from a partners assets unless there is
also a judgment against the partner
c. DAVIS v. LOFTUS
Partnership Interests and Partnership Property
a. UPA
b. RUPA
c. RAPOPORT v. 55 PERRY CO
i. Two families owned 50% each of a partnership. Later, the Rappoports assigned
a 10% interest out of their share to the adult children. The Parnes family refused
to recognize the children as new partners.
1. R points to the partnership agreement which seems to indicate that in the
case of immediate family, no consent is required.
ii. RULE no new partners can be admitted without the unanimous consent of the
partners
1. An assignee may be made without consent, but he is only entitled to
receive the profits of the assigning partner
iii. Court determines that the provision only provides for the assignment of an
interest in the partnership, but not for the admission of new partners
1. This just means they have a right to receive whatever partnership
distributions are made in accordance with that interest

10

a. No right to see information or make decisions

2. Points to another provision in the agreement where they made it clear
that the heir of a dead partner could become partner
a. This shows that they knew how to do it
i. Granted all the rights and privileges
b. The language was different in the assignment clause, and
therefore, normal partnership law will apply
d. Partnership Property
i. Two Options for Property:
1. Partnership property
a. Can be transferred by the partnership
b. Creditors partnership can reach immediately, while creditors of
individual partners cannot
c. On dissolution, property must be sold or valued along with
other partnership property and distributed to partners
accordingly
2. Property of the partner that is loaned to the partnership
a. Cannot be transferred by the partnership
b. Creditors of individual partner can reach immediately, while
creditors of partnership cannot
c. On dissolution the property is normally returned directly to the
partner
ii. UPA treats the partnership as an entity for property ownership purposes
1. 25
a. Partners hold the property under tenancy in partnership
b. Partners have no right to possess property as an individual and
cannot individually assign his rights in the property
i. Therefore not subject to attachment by an individual
creditor of one partner
2. In practice, all incidents of ownership are vested in the partnership
iii. RUPA
1. 203 property acquired by the partnership is property of the
partnership and not of the partners individually
2. 204 presumptions concerning whether property is owned by
partnership or by individual partner
3. 501 a partner is not a co-owner of partnership property
a. purpose is to abolish UPA concept of tenancy in partnership
e. Partnership Interests
i. RULE You can freely assign partnership interests, but you cannot assign to a
person your status as partner
1. This means that partners can use their interest to secure a debt to
creditors
2. Assigning partner will remain a partner
ii. Limitations on Creditors
1. Creditor cannot levy on the interest so as to be a substituted partner
a. Also cannot sell their interest to a third party who will be
substituted as a partner
2. Creditor does have the right to receive any distributions to which the
assigning partner would otherwise be entitled as well as any dissolution
interest
3. RUPA 601(4)(ii) explicitly permits the non-assigning partners to
expel the assignor from the partnership
a. UPA allows for dissolution of the partnership

11

VII.

iii. How creditors of individual partners collect on debts

1. Get a charging order from a judge
a. effectively requires any distributions made to go straight to the
creditor
2. Foreclose on the interest (UPA 28; RUPA 504)
a. somebody will buy the right to distributions . . . often its the
creditor
3. Force dissolution
a. Buyer has the right to compel dissolution if:
i. the term of the partnership has expired; or
ii. the partnership is at will
iv. Creditor Priority
1. Partnership creditors have priority over separate creditors as to
partnership assets, and if debts to partnership creditors remain unpaid
after partnership assets are exhausted, partnership creditors are put on a
parity with separate creditors in dividing up the partners individual
assets
The Partners Duty of Loyalty
a. UPA
b. RUPA
i. 404 the only fiduciary duties a partner owes to the partnership and theother
partners are the duty of loyalty and the duty of care
1. Duty of Loyalty
a. To account to the partnership any profit or benefit received in
the conduct of the partnership business
b. To refrain from dealing with the partnership on behalf of a party
with adverse interests to the partnership
c. To refrain from competing with the partnership
2. Duty of Care
a. Limited to refraining from engaging in grossly negligent or
reckless conduct, intentional misconduct, or a knowing
violation of the law
3. (e) a partner does not violate a duty merely because the partners
conduct furthers his own interest
ii. 103(b)(3) Duties may not be waived or eliminated in the partnership
agreement, but the agreement may identify activities and determine standards
for measuring performance of the duties if not manifestly unreasonable (see
103)
c. MEINHARD v. SALMON
i. Partnership created between Salmon and Meinhard. Agreed to have partnership
for 20 years. At the end of the partnership, Salmon negotiate a new deal to
benefit himself and cut Meinhard out of the deal. Salmon had not told Meinhard
anything about the new negotiations.
1. Meinhard sues for breach of fiduciary duty
ii. RULE Partners owe to one another the duty of the finest loyalty . . . not
honest alone, but the punctilio of an honor the most sensitive, is then the
standard of behavior
1. Court equates this duty to that of a fiduciary
a. But remember that they are not true fiduciaries because all
partners have an individual interest in making money for
themselves
iii. Because of this standard of loyalty, Salmon was required to disclose the
negotiations he was in

12

VIII.

1. Salmon took advantage of his position of being the managing partner by

profiting from it rather than seeking the best interests of the partnership
2. At the very least, he should have told Meinhard about the opportunity
iv. This case stands for the proposition that partners have a duty to treat other
partners fairly
1. This opens managing partners up to suits and keeps them looking over
their shoulder
a. Obviously, the other partners could abuse this ability to sue, but
the danger of general partners abusing their position was
deemed ot be a greater danger than a few frivolous lawsuits.
d. TEXAS
i. Cuts out the fiduciary duty to other partners
1. So you will never see the term fiduciary in the Texas statutes and
instead they just list the duties:
a. Loyalty, care, not to cut partner out of business, but not
fiduciary
i. This is because there is some inherent selfishness
involved in the relationship
ii. Texas statute functions the same as RUPA, but just takes the overblown
language out.
e. Suits by a Partner Against a Partnership
i. UPA
1. Suits were limited to actions for an accounting (22) or for dissolution
ii. RUPA
1. 305 changes the wording of UPA 13 to allow for suits by partners
against the partnership on a tort or other theory during the term of the
partnership rather than being limited to only dissolution or an
accounting
Dissolution I: By Rightful Election
a. UPA
i. 29 dissolution of a partnership occurs any time a partner ceases to be
associated in the carrying on of the business
1. This means that a partnership dissolves every time a partner leaves . . .
however, most partnerships remedy this harsh consequence with a
continuation clause in the partnership agreement
ii. 30 when a partnership dissolves, it continues until the winding up process
is completed
iii. 31 The following are automatic causes of dissolution:
1. Termination of the definite term specified in the agreement
2. By express will of any partner when no definite term is specified
3. By express will of all the partners who have not assigned their interests
before or after the specified period
4. By expulsion of any partner according to their power bestowed by the
agreement
5. By the express will of any partner in contravention of the partnership
agreement
6. Death of a partner
7. Bankruptcy of any partner
8. By court decree
***Partners can avoid this by providing for its continuation in the
partnership agreement upon the happening of any of the above events

13

iv. 38 Unless the partners otherwise agree, each partner has the right to have
the partnership property applied to discharge its liabilities and the surplus paid in
cash to each partner upon dissolution and after winding up
v. 40 Rules for Distribution
1.
b. RUPA treats partnership as an entity
i. 601 Partner Dissociation
1. Same general event
2. The difference is that the partnership is not dissolved
a. See 801 for events that cause a mandatory dissolution
ii. 602
1. A partner has the power to dissociate rightfully or wrongfully at any
time
a. If wrongfully, will be liable for damages to the partnership
iii. 603 Effect on partners dissociation
iv. 701 Purchase of dissociated partners interest
1. Partners interest will be bought by partnership for a buyout price
a. Gets the greater of the amount that would be his share had the
partnership been liquidated or sold as a going concern
v. 801 Event causing mandatory dissolution
c. CREEL v. LILLY
i. Several guys creates a partnership to sell NASCAR memorabilia. The managing
partner dies. Wife of dead partner seeks to dissolve the partnership by winding
it up and selling the assets in order to make a final distribution. Other partners
just want to pay her the dead partners pro rat share of the partnership and
continue the business
1. Wife sues
ii. Court cites the default rules under UPA
1. A partnership dissolves upon the death of a partner
a. The partnership may continue its business upon the consent of
the dead partners estate or through the exercise of a
continuation clause in the partnership agreement
iii. RUPA changes the UPA default rules:
1. Considers partnership an entity
a. Allows for the partnership to continue even with the departure
of a member because it views the partnership as an entity
distinct from its partners
2. Calls it Partnership Dissociation
a. RULE upon the change of the membership of the
partnership, the existing partnership may be continued if the
remaining partners elect to buy out the dissociating partner
i. Otherwise, you can follow the old winding-up and
liquidation approach
3. 801 lists the specific events that still cause a dissolution . . . if not
listed, then the partnership can use the buy-out provision
iv. This court finds the UPA liquidation provision to be too harsh in practice and
looks for a way to get out of enforcing it
1. Policy
a. Liquidation can be harmful and destructive measure, especially
to a small business, and often unnecessary to determining the
true value of the partnership

14

2. Court announces that where there is a good faith and accurate valuation
of the partnerships assets, that liquidation is unnecessary so long as the
partnership makes a payment of the estates proportionate share
a. Otherwise, liquidation would be too unfair to the remaining
partners and probably even provide a lower price to the estate
***NOTE: One factor that the court considers in the legislatures recent
adoption of RUPA, which eliminates the UPA default rules . . . also seems to
have a soft spot for the small business context.
d. Distributions in Dissolution
i. UPA 40
1. Priority 1: outside creditors
2. Priority 2: partners for obligations other than capital or profits
3. Priority 3: partners in respect to capital
4. Priority 4: partners in respect to profits
ii. UPA 18
1. Partners must contribute to losses sustained according to his share of the
profits
e. Services Partners
i. The UPA rules create issued for service partners who contribute no capital and
only services
1. EX:
a. C: 100K; S: 0K
i. Profits are to shared 50/50, but nothing said about
sharing losses
b. Wind-up Value: $130K
i. Option 1: There is a 30K profit, so
1. C gets 115K
2. S gets 15K
ii. Option 2: Value Ss services at 30K, so
1. C gets 100K
2. S gets 30K
***Court will find an implied agreement that
personal services qualify as capital contributions to
the partnership
***Many courts are willing to interpret the situation
in this manner because the other result just seems
unfair
2. EX 2:
a. Some contributions
b. Wind-up value: 0K (loss of 100K)
i. Option 1 (UPA)
1. S must share in the losses, thus
a. S contributes 50K to C
ii. Option 2 (UPA-plus)
1. Give S credit for 30K in services
a. S: pays 35K to C
b. This way, both lose 65K
iii. Option 3
1. S can argue that there was an implied
agreement that S would not share in the losses
because he was a service partner

15

a. Therefore, B has to eat his 100K loss

because S was essentially like an
employee of the company

IX.

3. What court usually do

a. Profits usually find service to be a capital contribution
b. Losses usually follow option 3 but at worst follow option 2
***The problem with this area of the law is that court have to imply
agreements . . . we should fix the rule rather than implying another one to
get around the real rule
ii. RUPA 401 continues the UPA capital loss allocation rules
1. Comments point out that partnerships with service partners should
foresee this problem and take the time to alter this rule in the partnership
agreement
f. Joint Venture Dissolution Distributions
i. Special Rule some courts have held that a service partner need not contribute
toward a capital loss where the enterprise is a joint venture rather than a
partnership.
1. This rules seems to be more a product of courts finding a reason not to
use partnership law in this context
g. PAGE v. PAGE
i. Oral partnership agreement made by two brothers. The plaintiff is a one
partners wholly-owned corporation who holds a $47K demand note and wants
to dissolve the partnership to get its money out.
1. The issue is whether this is a partnership for a term because the UPA
allows automatic dissolution by the express will of any partner when no
definite term or particular undertaking is specified
a. D claimed that this was a for a term because they intended to let
the partnership run until the debts of the business were paid off
ii. Court determines that this was not a partnership for a term
1. What the partners claim was a term, was no more than a common hope
that the partnership earnings would pay for all necessary expenses . . .
the is not a definite term or particular undertaking
iii. UPA 31(1)(b) dissolution of the partnership occurs by the express will of
any partner where there is no fixed term
1. LIMIT
a. Good faith because of the fiduciary relationship between
partners, this is implied
i. As a partner, you cant obtain an advantage over other
partners by dissolving the partnership
iv. D claims Bad Faith; and this means that the dissolution attempt should be
unsuccessful
1. Thinks that now that the business is making money, he really just wants
to keep all the profits for himself
2. Court responds by stating that each partner has an absolute right to
terminate the partnership
a. If found to be a wrongful dissolution because of bad faith, there
are statutory remedies available to the other partner
***Remember MEINHARD CASE: you cant steal the business from your
partners
h. Partnership Breakup Under UPA
Dissolution II: By Judicial Decree and Wrongful Dissolution
a. UPA

16

i. 38 Where dissolution was wrongful, the remaining partners have the option
or remaining in business or winding up the business and distributing the assets
1. But they must buy out the dissolving partner (no goodwill)
b. RUPA
c. DRASHNER v. SORENSON
i. Three men formed a partnership. Drashner began drinking too much, got
arrested, bounced a check, and hung out in bars rather than attending to his
work.
1. Drashner was unhappy about he amount of money being paid out and
this seems to be the root of his neglect of his duties
a. Drashner demanded more money to be distributed, and the
partners refused, so D elected to dissolve the partnership
2. T.C. finds that Drashner committed a wrongful dissolution
ii. Court finds this to be a partnership for a term
1. Partnership was contemplated to exist at least until the advance of the
original capital was recouped
2. Therefore, dissolution of the partnership by Drashner was wrongful
iii. Remember UPA 38
1. Partners have the option of either winding up the business or continuing
the business where the dissolution is wrongful
a. Can disregard good will when valuing partnership
2. RUPA 701(b) is different
a. Wrongfully dissociating partners get a buyout price that
represent the greater of the going concern or liquidation value at
the time of dissociation
i. Goodwill Rule is rejected!
iv. RULE When dissolution of the partnership is found to be wrongful, the court
will not consider good will when valuing the partners share of the business (at
least under UPA)
d. Wrongful Dissolution
i. UPA (38)
1. Consequenc to wrongfully dissolving partners:
a. Damages
b. Valuation of his interest that does not include goodwill
c. Continuation of the business without him
2. These consequences are regardless of whether or not the dissolving
partner was acting in good faith
a. So the penalties for guessing wrong acts as a severe disincentive
to partners who want to dissolve
ii. RUPA (701)
1. 602 list types of wrongful dissociation . . . if not on list, then its
rightful
a. 1) a dissociation that is in breach of an express provisions of the
partnership
b. 2) a withdrawal of a partner by the partners express will before
the expiration of the partnership term or the completion of the
undertaking
c. 3) a partner has engaged in wrongful conduct that adversely and
materially affected the partnership business
d. 4) a partner has willfully or persistently committed a material
breach of the partnership agreement or of a duty of care, loyalty,
good faith, and fair dealing
2. Reject the No Goodwill Rule

17

3. Wrongfully dissolving partner will get the greater of going concern or

liquidation value, reduced by damages
a. Partner will always be subject to damages for the wrongful
dissolution (602)
4. Payments dont need to be paid until the expiration of the term if there is
one, but still bears interest
e. Rightful Dissolution
i. UPA every partner has the right to leave the partnership, whether rightfully or
wrongfully
1. If dissolved rightfully, then remaining partners may agree to continue
the business
a. If nothing in the partnership agreement, then they must include
the leaving partners in the decision to continue the business . . .
otherwise the leaving partner would want the assets distributed\
2. Leaving partner receives full share of the partnership . . . including the
value of goodwill
ii. RUPA
1. Two Forks
a. Dissociation 701
i. Just make the payment prescribed:
1. Greater of going concern or liquidation value
b. Dissolution 801 (winding up)
i. 801 list events that require winding up
f. Expulsion of a Partner
THE CORPORATE FORM
I.
The Characteristics of the Corporation
a. General Attributes
i. Limited Liability shareholders are not personally liable for corporate
obligations; managers are also typically not liable
ii. Freely Transferable Ownership shares of stock can be bought and sold freely
iii. Continuity of Existence the legal existence of a corporation is perpetual and
thus stable in terms of long-term planning
iv. Centralized Management normally managed by a board of directors and
shareholders have no right to participate in management
v. Entity Status a corporation is a legal person so it can sue and be sued, as
well as own property
II.
Selecting a State of Incorporation
a. Delaware
i. This is a popular state of incorporation for publicly-held corporations
1. Takes an enabling approach to regulation
b. Other states
i. Many smaller business choose to incorporate in whatever state they do most of
their business
1. This is because of tax consequences
III.
Organizing a Corporation
a. DGCL
b. Authorized and Issued Stock
i. Certificate of incorporation designates the classes of stock and the number of
shares of each class, that the corporation is authorized to issue
1. Certificate must either:
a. Designate the terms of each class or

18

IV.

b. Authorize the board to issue portions of the authorized class in

series from time to timeand to designate the terms of each series
as it is issued
ii. Issuance the actually sale of stock
1. Only stock that has been authorized can be issued
2. Just because stock is authorized does not mean that has been issued
3.
c. Basic Models of Corporate Finance
i. Bonds/Debentures a promise by the company to pay a certain amount on a
certain date
1. Represents money borrowed by the company from the general public
2. Bonds are secured obligations
3. Debentures are unsecured obligations
4. Indentures
a. General contract entered into between the borrowing company
and the trustee
i. Company has certain business obligations that are
monitored by the trustee
ii. Stock (Two Forms)
1. Preferred
a. Hybrid stock that combines the ownership element of common
stock and the senior nature of debt
i. No promise of repayment like bonds have
b. Gives the holders preference in the event that the directors are
able and willing to pay a dividend
c. Often carries a periodic dividend
i. Before dividends are paid to anyone else, they must first
go to preferred stock
ii. Often cumulative . . . must make all back payments of
dividends before dividends can be paid to common
stock
2. Common conceived as equity interests in the corporation so the
holders are the owners of the corporation
a. Lowest on the totem pole as far as payments are concerned
b. Investors require higher return
c. Usually carries voting rights, but doesnt have to
Preincorporation Transactions by Promoters
a. Liability of Promotors
i. RULE when a promoter makes a contract for the enefit of a contemplated
corporation, the promoter is personally liable on the contract and remains liable
even after the corporation is formed
1. Exception:
a. If the contracting party knew the corporation was not
inexistence and nevertheless agreed to loos solely to the
corporation for performance
b. Liability of Corporation
i. When corporation comes into existence:
1. Corporation is liable only if they ADOPT the contract:
a. Either impliedly, or expressly
2. Can adopt by any number of means, but if they accept the benefits of the
contract, then it is assumed that they have adopted the contract
ii. Is promoters liability released?
1. Generally NO!

19

V.

VI.

a. Unless the parties have agreed to release the promoter upon the
corporation coming into existence and adoption of the contract
Process to Become a Corporation
a. DGCL
i. 101(a) Any person or entity can become a corporation by filing with the
Secretary of State its Articles of Incorporation
ii. 102(a) The Articles of Incorporation MUST include:
1. Name of corporation
2. Address of company and name and address of registered agent
a. This is so anyone can know where to serve the corporation in
the event of a lawsuit
3. Nature of the business
4. Kinds of shares to be offered
5. Name and address of incorporators
a. These are just the people who actually file the documents
6. Name and address of persons who are to serve as directors until the first
annual stockholders meeting
iii. 102(b) Articles MAY include:
1. Any provision for rules of running the corporation
2.
3. Provisions reducing certain personal liability for directors with the
exception of duty of loyalty, good faith, and improper personal benefit
cases
***Essentially, you can put whatever you want into this section provided it
is not illegal
iv. 106 corporation comes into existence immediately upon the proper filing of
the certificate of incorporation
v. 108 after filing the certificate of incorporation, the incorporators of
temporary board members shall meet to adopt by-laws and elects board
members
vi. 109 By-laws
1. Shareholders have power to adopt/amend by-laws
2. Can also give this power to Board if in certificate of incorporation
3. You can have anything you want in the by-laws so long as they are not
illegal
Consequences of Defective Incorporation
a. DGCL
b. De Jure Corporation a corporation organized in compliance with the requirements of
the state of incorporation
i. It is legally in existence and followed all of the steps to register
ii. Substantial compliance is enough to satisfy this requirements
c. De Facto Corporation Exists when there is insufficient compliance to constitute a de
jure corporation, but the steps taken toward formation of a corporation are sufficient to
treat the enterprise as a corporation with respect to third parties
i. Even though registration was defective, you will still be treated as a corporation
with respect to the outside world
1. The significance is that shareholders continue to enjoy limited liability
despite the fact that they are not a coporation
ii. Elements
1. Statute under which incorporation is possible
a. Not really important because its possible everywhere
2. Must make a good faith colorable attempt to incorporate

20

VII.

3. Actually use or exercise corporate powers

d. Corporation by Estoppel equitable remedy whereby courts hold that a party who has
dealt with an enterprise on the basis that it is a corporation is estopped from denying the
enterprises corporate status
i. Effective only for a specific transaction
ii. Three Branches
1. Branch 1
a. Where representatives of the corporation claim that they are a
corporation to T and later T sues; the representatives are
estopped from claiming that they are a corporation
2. Branch 2
a. Technical Branch where defendant tries to keep corporation
from suing by claiming that they are not a corporation and
cannot sue
3. Branch 3
a. A third party who has dealt with an enterprise on the basis that it
is a corporation seeks to impose personal liability on the wouldbe shareholders, who in turn raise estoppel as a defense
i. This is the most important branch
1. Similar to De Facto theory
b. Difference b/w de facto and estoppel
i. Estoppel doctrine is broader than the de facto theory
1. Estoppel focuses on the assumptions of and
beliefs of the parties to the transaction
a. Only work in contract situations
2. De Facto looks at how close the corporation
itself came to actually incorporating (colorable
attempt standard)
iii. DGCL
1. 329 codifies these principals
iv. Model Act States
1. Allow the first two branches of estoppel, but eliminated as to providing
limited liability to would-be shareholders
a. This is because the Sec. of State returns a piece of paper
certifying as conclusive proof that you have complied with
incorporation requirements
b. Exception those who didnt know that incorporation was
defective are still protected
e. Who may be held liable?
i. If the corporation is neither de facto, dejure, nor corporation by estoppel then
courts differ on which shareholders may be held liable
1. Model Act 2.02
a. All those who assume to act for the corporation are liable
i. This means managing shareholders are liable while
passive shareholders still retain limited liability
2. General trend in all jurisdictions eliminates liability for those who dont
actively participate in the management of the business
The Classical Ultra Vires Doctrine
a. Classic Doctrine
i. RULE If you are not explicitly authorized to perform something in your
articles of incorporation, then any actions outside of your authorization is void
1. Includes contractual obligations

21

2. EX: Train company was not authorized to build railroads so all contracts
on that matter are void

VIII.

b. DGCL
i. Practically abolishes any notion of the ultra vires doctrine
ii. 124 a corporation is not allowed to use the ultra vires nature of its action to
escape an obligation under a contract
1. A shareholder only has standing to challenge contracts that are
executory (not fully performed) on the companys behalf
a. So even if you have standing you must fit into this requirement
2. A shareholder can always later sue officers for their former act under the
theory that it was ultra vires
a. The problem is that in practice most companies have VERY
GENERAL purpose statements
c. GOODMAN v. LADD ESTATE CO.
i. Director of Westover took out a personal loan, upon which Westover acted as a
guarantee on the loan. Director defaulted and Westover had to pay, so now
shareholders are challenging base dont he Ultra Vires doctrine
1. Nothing in the purpose clause of the corporation authorized the
company to act as guarantee on loans to their employees
ii. The court finds that this was ultra vires because not contained in the purpose
clause
1. This would still be ultra vires today because guarantying a loan on a
swimming pool has absolutely no legitimate corporate benefit
iii. NOTE: Corporations are not required to have a very detailed purpose clause
anymore . . . can simply state that their purpose is to make money
1. The only useful aspect of still using a detailed purpose clause is if you
are a minority shareholder and want to exert control over the company
iv. Taken Share Rule
1. Based on principal that you dont get to challenge corporate conduct that
you previously voted for
a. It follows that if a person buys your shares, they also have no
right to challenge the corporate action as long as the purchaser
knew of the action
d. INTERCONTINIENTAL CORP v. MOODY
i. There is a general rule that the corporation itself cannot challenge ultra vires
conduct, but a corporations shareholder can
1. RULE nevertheless, this case stands for the proposition that a
shareholder can try to enjoin an ultra vires action even if he has been
solicited to do so by the corporation, provided the shareholder is not the
corporations agent
e. Ultra Vires only comes up in TWO Situations
1. 1) When they actually admit that they were not acting in the interests of
the shareholders
a. See Ford Case . . . Henry Ford actually admitted that he was just
embarrassed about making crazy profits
2. 2) ??????
The Objective and Conduct of the Corporation
a. General Rule The corporation has an obligation to maximize corporate profits
i. However, there are a few slight exceptions to this general rule where it is okay
for a corporation to act in a manner that is not meant to maximize corporate
profits.
b. Interest Other than Maximization of the Shareholders Economic Wealth
i. AP SMITH MFG v. BARLOW

22

1. Corporation decided to make annual gifts to Princetons general fund

and the action was challenged for being ultra vires.
a. Corporation argues that they are expected to make contributions
by the public and that it will create goodwill
2. RULE you may do things to benefit society as a whole and that dont
necessarily benefit shareholders if the impact on shareholders is small
a. EX: Giving $100M to a charity
i. If you are a $600B company, then its probably okay
ii. If you are a $600M company then its probably NOT
okay
***RAGAZZO: There is always a way to make an arugment that an
action benefits the shareholders unless it is just completely crazy . . . just
dont be stupid like Henry Ford
ii. DGCL 122(9) explicitly authorizes corporations to make donations for the
public welfare or for charitable, scientific or educational purposes
CORPORATE STRUCTURE
I.
The Allocation of Legal Powers Between Management and Shareholders
a. DGCL 141(a) Unless otherwise provided in the articles of incorporation, the
business of the corporation shall be conducted by or under a board of directors
b. CHARLESTOWN BOOT v. DUNSMORE
i. Company had two directors: Willard and Dunsmore. In the process of winding
up the business, the shareholders want the directors to take the advice of how to
do so by and outside person. Directors dont ignore the shareholders and
proceed to lose a ton of money in liquidating the business
1. The issue is whether the shareholders can tell directors to deal with an
outside consultant
ii. Court holds that directors DO NOT have to listen to shareholders
1. Rule directors have full discretion in using their own judgment
unless the articles of incorporation or by-laws limit them
a. The shareholders remedy is to vote out directors or sell their
shares if they are unhappy with the management by the Board
2. Shareholder remedies
a. Vote them out
i. Provides no immediate help
b. Negligence suit
i. Directors are required to use ordinary care and diligence
in the care and management of the business
ii. But directors may have lost all of their money by then
iii. What is the solution for a case like this?
1. The shareholders want to add a director to the board, but the board is
resisting
2. Amend by-laws to say that there shall be three directors instead of two
a. DGCL 109 Shareholders can hold a vote to amend by-laws
i. You need to be able to call a shareholders meeting
b. DGCL 211 only directors can call a shareholders meeting
i. Model Act allows majority of shareholders to call a
meeting
c. DGCL 228 Written Consent
i. Any action required to be taken by a shareholders
meeting can be taken with out the meeting if you get

23

written consent from the required amount of

stockholders to taken the course of action
1. The idea is that if a majority consent, then there
is no need to meet
ii. In this case, 216 states that you need a majority vote to
amend by-lays . . . so if can get a majority written
consent, then the by-laws are amended
3. According to 228, you just need to type up a consent form stating that
that you are seeking to create a new seat on the Board, and once 51%
approve, the new seat is created.
4. Who takes the new seat?
a. DGCL 223(a)(1) default rule is that directors would elect a
person to fill the empty seat, unless otherwise provided for in
the AOI or By-laws
i. So we need to also amend the by-laws to state that
stockholders will fill the vacancy
b. While we are at it, we need to also include a provision
nominating Osgood as the third director
5. SUMMARY
a. The written consent will contain three things
i. 1) We hereby create a third director seat
ii. 2) We hereby amend the voting rules to state that
shareholders will fill vacant seats
iii. 3) We hereby appoint Osgood to the Board
6. Precatory Resolutions
a. 142(b) it is the job of the board of directors to hire and fire
officers
i. but that doesnt mean that shareholders dont have a say
in things
b. These are resolutions voted upon by the shareholders regarding
a decision that is really in the Boards discretion.
i. EX: If they want to remove an officer, only the Board
can do this, but they can still pass a precatory resolution
stating that it is the view of the shareholders that the
officer should be removed
1. The Board can then choose to listen or not, and
if they dont then you remove them through the
procedure outlined above.
c. Removal of Directors
i. DGCL 141(k) any director may be removed with or without cause by a
majority of the shareholders at a shareholders meeting
d. SCHNELL
i. RULE The directors hold legal power subject to a supervening duty to
exercise such powers in good faith pursuit of what they reasonably believe to be
in the corporations interest
1. This means that just because something is technically legal doesnt
mean that the Board can automatically do it . . . still subject to good
faith standard
e. BLASIUS INDUSTRIES v. ATLAS CORP
i. Blasius owned 9% of Atlas and proposed to do a huge financial restructuring of
the company. Wanted to pay a lump sum out to shareholders and create a highly
leveraged company . . . based on theory of making it lean and mean.
1. Directors disagree and block his proposal

24

f.

2. Blasius responds by proposing to add eight more directors to the Board

(the most allowed by by-laws) and thus gaining control of the Board
a. The Board responds by immediately adding two more seats and
appointing their friends
i. DGCL 109 allows Board to amend by-laws
ii. DGCL 221 allows board to fill seat vacancies
ii. Court frames issue as whether the Board may validly act for the principal
purpose of preventing the shareholders from electing a majority of new
directors.
1. States that the shareholder voting process is afforded more protection
than most other areas in the corporate structure
2. Have to get around rule that the corporation is owned by the
shareholders and run by the Directors
a. Sees the action more as directors protecting their own power
rather than the corporation making a decision about business
matters
i. Therefore outside of business judgment rule
iii. Adopts a Compelling Justification Standard
1. RULE In cases where board action interferes with shareholder
voting rights, the Board bears the burden of demonstrating a
compelling justification for such action
a. EX:
i. Might be okay where majority shareholder was taking
action that was detrimental to a minority constituency
b. Cannot simply be a paternalistic the board knows best logic
i. Paternalism can never be the argument
ii. Keep in mind that what is compelling is always in eye
of the beholder
2. In this case, this was a 9% shareholder . . . he was a minority himself,
and needed quite a bit of outside support to accomplish any of his goals
a. The board could have spent money to campaign against the
shareholder, but they were not allowed to undercut his voting
rights by taking their course of action of exercising power
iv. RAGAZZO: This should never have happened this way
1. The Board should have filled all of the potential director spots long
before this situation ever arose
a. With a full Board, it would have taken more than a year to gain
the majority of the Board because of staggered board
i. DGCL 141(d) allows for staggered boards
1. (k) if you have a staggered board, you can
only remove for cause
a. the purpose is to make sure change
happens gradually
b. But since they had open seats, there was an opportunity to take
over immediately and foil the purpose of the staggered board
INTL BROTHERHOOD OF TEMSTERS v. FLEMING CO
i. Board of Fleming adopts a poison pill which makes it impossible for a
takeover to occur unless the Board approves. The Teamsters object to this
because it limits their ability to make a bunch of money in a takeover
1. Teamsters propose an amendment to the by-laws requiring any
shareholder rights plan to be approved by the shareholders
a. The Board does not like this proposal and likes having a defense
that doesnt require a shareholder approval

25

II.

ii. Board argument

1. DGCL 157 subject to any limitations in the certificate of
incorporation, the corporation can issue any rights in regard to stock
a. According to board, any limitation would need to be in articles
of incorporation
i. 242 changes in articles of incorporation require
both shareholder and board approval
iii. Court rejects Board argument and states that this can be done by changing the
bylaws and not the articles of incorporation
1. Shareholder rights plan endorsement statutes
a. This state does not have one of these
b. Without one of these, the court says, the corporation is subject
to general corporate governance, which means that shareholders
can make rules by amending the bylaws
g. MM COMPANIES v. LIQUID AUDIO
i. MM held a large portion of stock in Liquid and proposed to elect two new
directors to current seats, and expand the board by four seats and nominate new
board members
1. Liquid refuses to call a special meeting and appoints two more of their
own people to director seats
***The only reason this was possible was because the AOI was poorly
drafted and did not contain a limit on the amount of board members . . . a
staggered board is worthless if there is not cap on number of directors seats
ii. Court uses Blasius Compelling Justification Standard in stead of business
judgment rule
1. RULE this standard is appropriate when a board of directors acts for
the primary purpose of impeding or interfering with the effectiveness
of a shareholder vote
a. Board bears the burden of proof of showing a compelling
justification
b. Actions do not have to prevent them from voting, but merely
impede the effectiveness of the stockholder vote in an election
iii. The point of this case is to show that De. Supreme Court will apply Blasius
The Legal Structure of Management
a. Choice of State of Incorporation
i. Choice of Law
1. A corporations internal affairs are governed by the law of its state of
incorporation
2. A firm can incorporate in any state it chooseseven in a state in which
they do no business
ii. Close Corporations
1. Usually incorporate in the state where they do the majority of their
business
2. Problems with incorporating in another state
a. You will have to pay several taxes:
i. 1) Franchise Tax
ii. 2) Doing-Business Tax
b. These taxes are lower if you incorporate in the state where you
do most of your business because the taxes overlap . . .
otherwise tax bill is higher
iii. Publicly-Held Companies
1. Delaware is a popular spot . . . why?
a. Adopts a hands-off enabling approach

26

III.

IV.

i. Makes it manager friendly

b. Everyone copies Delaware law
c. Predictive case law and a knowledgeable bench
i. Every judge is a corporate law expert and therefore you
know the decisions are at least informed ones
iv. Race to the Bottom Theory
1. E.g., Teamsters Case
a. Delaware allows a manager to stand between shareholders and
their money . . . and since managers get to pick where they
incorporate, they are going to pick where they personally
benefit the most
v. Race to the Top Theory
1. If managers were overly favored by Delaware, then shareholders would
make less money; but this is not the case
a. Therefore because people are still incorporating in Delaware, it
must mean that Delaware promotes efficiency in the corporate
structure
***RAGAZZO Delaware law may not be as manager-friendly as it is
cracked up to be (see Blasius, Liquid Audio, Flemming).
b. Directors Informational Rights
i. Common Law
1. A directors has a wide-ranging right to information concerning the
corporation, which may be exercised through inspection of books,
records, and documents
2. Split in cases law
a. Line 1 directors intent is deemed irrelevant
b. Line 2 director cannot have a hostile intent in exercising his
right to the information
Formalities Required for Action by the Board
a. DGCL
i. Quorum
1. 141(b) the default rule is the majority of the Board must be present;
may be altered to as low as 1/3 or as high as they want by the bylaws
a. Measured by total number of authorized seats
i. So if there are vacancies, they still count toward the
quorum
ii. Voting
1. 141(b) The vote of a majority of those present is required to take
action
a. Even when someone abstains, this is effectively a no vote
because those abstaining are included in determining what the
majority is
b. Requirements can be altered by the AOI or bylaws
i. LIMIT you have to at least require more than 50% or
else both sides could win
b. Committees
i. Boards can delegate decisionmaking authority to committees
1. There may be a short list of things that cannot be delegated, but almost
anything can be delegated
Authority of Corporate Officers
a. Authority in General mirrors rules of agency law
i. Express Actual Authority
ii. Implied Actual Authority

27

V.

1. EX: Officer has been given the authority to buy and sell real estate for
the company. He hires a realtor . . . this is implied.
iii. Apparent Authority
1. Jurisdictions are split in two
a. View 1: President has power to take ordinary actions, but not
extraordinary actions
i. EX: can hire an employee for two-year term, but cannot
sign a lifetime contract
ii. This is the majority rule
b. View 2: Officers have little or no apparent authority in regard to
their nominal position I the company
i. Substantial Minority
ii. TEXAS follows this rule
1. As a consequence, you have to make sure that
an officer has authority
a. Accomplished by having the secretary
of the company give a certificate
stating exactly what his authority
entails
b. Secretary will have apparent authority
to certify actions on behalf of the
company so at least they are on the
hook for this
b. Authority of Corporate Officers
i. President
1. Majority Rule president has apparent authority to bind his company
to contracts in the usual and regular course of business, but not to
contracts of an extraordinary nature
a. Factors
i. Economic magnitude of the action
ii. Extent of risk involved
iii. Time span of the actions effect
iv. Cost of reversing the action
2. Minority Rule Texas
ii. Secretary
1. Always has apparent authority to certify the records of the corporation,
including resolutions of the board
a. Certification is conclusive in favor of a third party relying on
the certificate
Formalities Required for Shareholder Action
a. DGCL
i. Notice
ii. Quorum
1. 216 majority of the shares entitled to vote constitutes a quorum
a. can be changed
iii. Voting
1. Ordinary Matters
a. 216 majority of shares present at meeting
i. abstaining votes count as no votes
b. TX majority of those voting
2. Fundamental Transaction
a. EX: amending AOI, merger, sale of substantially all assets,
dissolution

28

VI.

VII.

b. DE majority of those shares entitled to vote

3. Electing Directors
a. 216 Plurality wins from votes taken
4. Written consent
a. Shareholders can act by way of written consent
Cumulative Voting
a. Straight Voting a shareholder can cast, for each candidate for election to the board, a
number of votes equal to his number of shares
i. Under this system, 51% ownership gives you 100% of the power because you
can outvote the opposition on every matter and no one can stop you
b. Cumulative Voting a shareholders can cast for any single candidate, or for two or
more candidates, as he chooses, a number of votes equal to his number of shares he
holds times the number of directors to be elected
i. EX: 4 spots to be elected; holds 500 shares
1. Shareholders gets 2000 votes that he can cast is any way he sees fit
ii. This method allows for more proportionate representation on the board of the
minority ownership
c. Why would a minority want access to the board if their representative will always be
outvoted on the board?
i. Minority will have greater access to information
1. This is valuable to investors
d. DGCL 214 Delaware is a straight voting state unless otherwise provided for in the
AOI
i. Texas: used to be cumulative, but changed to mirror DE
Limited Liability
a. DGCL 102(b)(6) the AOI may include a provision imposing personal liability for
the debts of the corporation on its stockholders to a specified extent; otherwise, the
shareholders shall not be liable for the payment of the corporations debts.
b. Introduction
i. General Rule
1. under modern statutes, a shareholders risk is ordinarily limited to his
investment . . . amounts to whatever they paid for their shares
ii. Veil Piercing
1. Always
a. Siphoning of Money
b. Fraud
2. Sometimes
a. Inadequate capitalization plus failure to follow formalities
c. FLETCHER v. ATEX
i. Court finds no veil piercing
1. Alter Ego Theory
a. Elements:
i. 1) that the parent and the subsidiary operated as a single
economic entity
ii. 2) that an overall element of injustice or unfairness is
present
b. Notice that Delaware does not require a showing of fraud
ii. Court feels that all of the arrangements are legitimate and do not comply with
the alter ego standard
1. Cash management system
a. Even though some money is kicked up, they have strict
accounting for creditors and have all funds earmarked
2. Can only veto big decisions

29

a. This is common with any stockholder . . . they have no control

over day-to-day operation
b. Did not dominate the subsidiary
3. Atex followed all formalities
a. Common officers and directors is not enough
i. Overlap of the two boards was negligible
d. WALKOVSKY v. CARLTON
i. Carlton owns a cab company. He has ten corporations, each holding two cabs
per corporation. One of his cabs hits P and P want to reach assets of other
corporations holding cabs by piercing the veil
1. P wants to pierce in two ways
a. Horizontally makes the other cab corporations liable for the
action of the corporation that owned the cab that hit P
b. Vertically make Carlton personally liable for the liabilities
incurred by the corporation
ii. Viel Piercing
1. RULE Courts will disregard the corporate form whenever necessary
to prevent fraud or to achieve equity
a. Look at general rules of agency
i. Whenever anyone uses control of the corporation to
further his own rather than the corporations business he
will be liable
iii. Ps theory is FRAUD
1. Carlton had very little capital in the business, paid out much of the
corporations cash, and only carried the minimum insurance coverage
required by law
iv. Court determines that W does not make a claim because they allege no
allegations that he conducted the business in a personal capacity
v. Minimum Capitalization Principle
1. Court notes that there is not minimum capitalization requirement in NY
a. DE does not have one either
b. TX used to have one, but changed
c. This is a policy decision where the legislatures have decided
that it is more important to encourage business growth rather
than provide for adequate capital in the event of claims made
vi. Minimum Insurance
1. He complied with the statute, and therefore any more would be a
decision for the legislature
vii. RAGAZZO: The only thing you could allege that he has done wrong is
siphoning off money
1. It is unlawful for a corporation to make a transfer without adequate
consideration if it puts you in financial problems
a. 4 Uniform Fraudulent Transfer Act
2. You cannot intentionally cause inadequate capitalization once the
business has begun . . . this is fraud
a. In a piercing claim, you just need to show some siphoning in
order to get to the owner of the corporation
e. MINTON v. CAVANEY (CA)
i. Cavaney was the attorney for a corporation that ran a swimming pool. He also
acted as secretary, treasurer, and director. The company followed no formal
procedures and was inadequately capitalized. Now its bankrupt. Little girl
drowns in the pool
1. Issue is whether it is appropriate to pierce the veil

30

f.

ii. Inadequate capitalization by itself is not enough to pierce the veil

1. But it is always a factor
2. Failure to follow formalities can also play into piercing the veil if the
corporate structure is disregarded
a. In this case, the company had both factors cutting against them
iii. The court determines piercing was appropriate
1. Business was inadequately capitalized
2. Failed to follow formalities
a. Records were kept in Cavaneys office
iv. The way this case reads, it makes it look like inadequate capitalization might be
enough for veil piercing
1. RULE Many courts will hold that inadequate capitalization plus
failure to follow procedures would be enough to pierce
a. The court that would not follow this rule would argue that
failure to follow procedures can never be a factor because of our
policy toward small business that they do not have to follow
formalities
b. TX explicitly states that failure to follow formalities should
not be considered in veil piercing context
2. This case could have come out either way . . . it just depends on the
view of the particular court
***Siphoning is always always a justification, but beyond that its up for grabs . . .
it will depend on how the judge feels about the actions in relation to how unfair
the actions are to creditors
SEA-LAND SERVS v. PEPPER SOURCE
i. This is an extreme case of a man who owned several corporations. All of the
companies shared money and the owner took personal loans out from each
corporation
1. The more significant aspect of this case is that it is a contract case
ii. RULE
1. A corporate entity will be disregarded and the veil of limited liability
pierced when two requirements are met
a. 1) There must be such unity of interests and ownership that the
separate personalities of the corporation and the individual no
longer exists; and
b. 2) Circumstances must be such that adherence to the fiction of
separate corporate existence would sanction a fraud or promote
injustice
2. Factors
a. Failure to maintain adequate records or comply with formalities
b. The commingling of funds or assets
c. Undercapitalization
d. One corporation treating the assets of another corporation as its
own
iii. Contract Context
1. Usually, courts will say that the other party could have required the
owner of the corporation to personally guarantee the contract
2. States are split
a. TX (statute) no veil piercing in contracts cases unless there is
an actual fraud on the creditors
b. Middle Ground use all of the same weight factors unless
there is an actual fraud on creditors
c. Sea Land apply the rule the exact same as in a tort case

31

VIII.

g. UNITED STATES v. BESTFOODS

i. The plaintiff is trying to do something slightly different in this situation. They
are seeking to hold the parent liable without piercing the subs veil on the
ground that the parent directed the subsidiarys operations.
1. As a result, P seeks to make the parent directly liable rather than
vicariously liable
ii. This case shows that you are still liable for what you did yourself
1. Here, the parent took direct control of environmental clean-up from the
sub
a. Therefore they are directly liable
iii. Where individual wears more than one hat for parent and sub:
1. Just because he is liable as an officer of the sub does not mean that the
parent is automatically liable
a. You still need to build your Atex case that he was acting in the
role as officer of parent rather than officer of sub
Equitable Subordination of Shareholder Claims
a. RULE When a corporation is in bankruptcy, debt claims that a controlling
shareholder has against the corporation may be subordinated to the claims of other
persons, including the claims of preferred shareholders, on various equitable grounds.
i. The import of this rule allows the court to put parent corporation at the back of
the line if they find that parent acted unfairly in managing the sub.
1. Undercapitalization seems to play an important role
b. Not as much of a penalty as rescinding a fraudulent conveyance or piercing veil, but just
another tool in the courts bag when they find mismanagement and questionable
arrangements
c. Uniform Fraudulent Transfer Act
d. Bankruptcy Code 548

SHAREHOLDER INFORMATIONAL RIGHTS

I.
Shareholder Informational Rights Under State Law
a. Inspection of Books and Records
i. DGCL
1. 219
2. 220 shareholders can investigate matters reasonably related to their
interests as stockholders including corporate wrongdoing
a. (c) shareholder has the burden of proof to show his purpose is
proper for the types of records that he wants
ii. SAITO v. MCKEESON, INC
1. Shareholder suspects serious accounting wrongdoing so he wants to see
the books so that he can implement a derivative suit
a. The issue is what limitations on this right exist
2. 220
a. Must show proper purpose
i. Once established an secondary improper purpose will
not bar the information
3. No fishing
a. You have to have some objective reason to believe that the
corporation did something wrong
i. Inspection right is limited to those books and records
that are necessary and essential to accomplish the
stated, proper purpose
b. In this case, he had enough proof because they voluntarily
released the adjusted financials for the previous three years

32

4. Standing Problem
a. Company wont give up records from before P was an
owner . . . cites analogy to contemporaneous-ownership rule
i. Requirement under derivative action
b. The court rejects the companys argument
i. The inquiry is reasonably related to his complaint
ii. Even where in pursuit of derivative action:
1. Exception where the claim involves a
continuing wrong that predates purchase
c. RULE the date on which the stockholder first acquired the
corporations stock does not control the scope of records
available under 220
i. If pre-purchase activities are reasonably related to the
stockholders interest as a stockholder, then the
stockholder should be given access
5. Third-Party Documents
a. Corporation objects to providing document prepared by outside
advisors
b. RULE the source of the documents and the manner in which
they were obtained by the corporation have little or no bearing
on a stockholders inspection rights.
6. Subsidiary Documents
a. RULE stockholders of a parent are not entitled to inspect a
subs books and records absent a showing of a fraud or that a
sub is in fact the mere alter ego of the parent
iii. General Rules
1. Common Law a shareholder acting in good faith for the purpose of
advancing the interests of the corporation and protecting his own
interest as a stockholder has a right to examine the corporate books and
records at reasonable times
a. Most state have enacted more restrictive statutes
2. Mixed Purposes
a. Once it is determined that the shareholder has a proper purpose,
any improper secondary purpose is irrelevant
iv. PILSBURY v. HONEYWELL (Minn.)
1. Honeywell was making munitions for Vietnam war; Pillsbury opposed
the war and was a shareholder. They wanted Honeywells shareholder
list in order to make proposal to end munitions manufacturing at the
company
a. Burden is on the corporation to show the improper purpose
2. Corporation objects because this is a political motive and not an
economic motive
a. Stockholder claims that they have a right to communicate with
other sharheolders
b. Court agrees with Honeywell and says that the real purpose is to
oppose the Vietnam War and this is not a proper purpose
3. CREDIT BUREAU CASE (DE)
a. Rejects this Pillsbury Case as it applies to requests for
stockholder lists
i. The desire to solicit proxies for a slate of directors in
opposition to management is a purpose reasonably
related to SHs interest

33

II.

1. Any secondary purpose in seeking the list is

irrelevant
b. Pillsbury plaintiff would be able to get the shareholder list under
this Delaware rule
v. How do you counteract the Credit Bureau Case rule?
1. Keep the stock held in the name of the investing institutions (e.g.,
Goldman Sachs, Meryl Lynch, etc.).
a. People who want stockholder lists really want a NOBO list
i. This is the list of beneficial owners who tell the
investing institutions how to vote and where to send
their dividend
1. Investing institutions supply corporation with
this information
b. DE the company has to give you a NOBO list if they have
one, but do not have to create it for you if they dont have
access to one
i. Puts you on the same ground as the company in case of
a proxy fight
Proxy Contests
a. ROSENFELD v. FAIRCHILD ENGINE
i. New board of insurgents agreed to pay both sides expenses in a proxy context.
1. P challenges the propriety of these payments
ii. Incumbant Directors
1. RULE Incumbant directors have the right to incur reasonable and
proper expenses for solicitation of proxies and in defense of their
corporate policies, and are not obligated to sit idly by
a. Limitation:
i. Good faith
ii. Not a purely personal power contest
iii. Not grossly excessive spending
b. The company has an obligation to fight the insurgence and
inform shareholders as to what the dispute is about
***The kicker in this context is that you can make everything about policy
no matter how personal it is.
iii. Insurgent directors:
1. RULE Also, the new board can be reimbursed by affirmative vote of
the stockholders for reasonable and bona fide expenses incurred by them
in a policy contest
a. Same policy dispute limitation
b. So, the can get reimbursed ONLY IF:
i. They win, AND
ii. Shareholders vote and agree to reimburse
iv. Reasonableness
1. Test: were they incurred in good faith?
a. Proof
i. The board paid almost exactly what the insurgents paid
v. This rule is extremely favorable to incumbent board:
1. Most shareholders have a disincentive to engage in a proxy context:
a. If you run and lose . . . its your loss
b. If you run and win . . . you are at the mercy of the other
shareholders to vote for reimbursement
i. They share in the benefit, but you bear 100% of the risk

34

THE SPECIAL PROBLEMS OF CLOSE CORPORATIONS

I.
Introduction
a. The Close Corporation corporation with a small number of shareholders that has no
public market for its stock; often characterized by owner-management and restrictions
on the transferability of ownership interests.
i. DONAHUE v. RODD ELECTROTYPE CO.
1. Rodd and Donahue were the two sole shareholders of the corporation.
Rodd was retiring and the corporation offered to buy his shares at
$800/share (negotiated by Rodds son). The Donahues were upset and
offered their shares at the same price, but the corporation refused their
offer.
a. Donahues though the corporation overpaid for the shares, but
their real claim was that the corp did something wrong by
purchasing Rodds share, but not Ds
2. The issue in this case is whether shareholders in a close corporation
have a fiduciary duty to each other
a. If they have a duty, what is that duty?
3. Court announces that shareholders in a close corporation have a
fiduciary duty to one another similar to a partnership
a. Defined as utmost good faith and loyalty
i. Not honesty alone, but the punctilio of an honor the
most sensitive
b. RAGAZZO: This is not a true fiduciary duty, but rather a duty
of fairness
i. Must offer each stockholder the same opportunities
afforded to any others
c. This decision takes away some of the power that the majority
stockholder otherwise lawfully possesses . . . it is justified by
weighing the dangers of the minority losing their money with
taking power away from the majority.
4. Equal Treatment Principle
a. In a close corporation, shareholders owe a duty of good faith
and fairness to one another. Any opportunity afforded one
shareholder must be afforded all others
i. RAG: The problem with this standard I that you can
always make an argument the other way
1. In this case, you can argue that Donahue was
not retiring and therefore he was being treated
fairly because they were only purchasing the
shares of retiring individuals
b. This doctrine is no longer the rule
ii. NIXON v. BLACKWELL (Delaware)
1. RULE you can treat shareholders differently if they hold different
classes of stock; there is no general rule of equal opportunity and no
fiduciary duty.
a. This goes directly against the equal treatment principal, but at
the same time makes sense because you would otherwise be
undermining the concept of different classes of stock with
different rights attached thereto
2. Delaware takes a more contractual approach to the close corporation
problem
a. Prospective stockholders have the power to enter into
shareholder agreements that grant all kinds of rights

35

II.

Special Voting Arrangements at the Shareholder Level

a. DGCL
i. 212(e) a proxy may be made irrevocable regardless of whether the interest
with which it is coupled is an interest in the stock itself or an interest in the
corporation generally
ii. 218
b. Voting Agreements
i. RINGLING BROS v. RINGLING
1. Two minority stockholders have an agreement to vote together on all
matters. Share are voted cumulatively.
a. If they cant agree they were supposed to go to arbitration and
have the arbitrator decide
2. The court state that shareholders are free to make agreements to vote
together on issues
a. Any deadlock-breaking measure must be reasonable
i. Submitting to the arbitrator was reasonable because at
least one shareholders had to seek to enforce that
decision
3. RAG: The courts decision in this case is absurd because they give
North of the board
a. This is absurd considering hes a minority stockholder
b. The solution makes no sense
ii. Self-Enforcing Voting Agreements: Irrevocable Proxies
1. The corporation doesnt care about the agreement, but only cares about
who is lawfully entitled to vote
a. Going to arbitration or court like the case above is not what
anyone wants because its costly and time-consuming
2. SOLUTION: Irrevocable Proxy
a. Parties to the agreement give each other proxies
i. Courts have held that they impliedly give the majority
an irrevocable proxy
b. RULE Proxies are revocable unless coupled with an
interest
i. Without an interest it is treated as an agency agreement
that can be revoked upon the election of the principal
c. Coupled with an interest
i. Split in authority:
1. Proxy holder must have an interest in the stock
itself
2. It is enough that the proxy holder has an interest
in the company and not the shares
a. DGCL 212(e)
ii. Either way, this means that an arbitrator will normally
not be able to make a binding decision because they do
not have an interest in the company . . . would be an
illegal voting trust
3. Haft v. Haft
a. Father was CEO of Dart and transferred all of his voting shares
to his son in exchange for a promissory note which included a
proxy granting Father the power to vote the shares. Son later
wants to revoke the proxy
i. Court holds that Fathers position as CEO is enough of
an interest to make it irrevocable

36

1. Policy we just dont want someone voting

who doesnt really care about the fate of the
company

III.

c. Voting Trusts
i. DGCL
1. 218 expressly authorizes voting trusts; papers must be filed with
the corporation and open to inspection
ii. Shareholders put the share in a trust and make the trustee the legal owner of the
shares. Trustee then gives owners a certificate of trust which gives them the
equitable beneficial interest comprises all benefits except the voting rights.
1. Transfer can be made for any specified period by the owners as stated in
the trust agreement
2. EX In the Ringling Bros. case, they execute a trust document naming
Loos (the arbitrator) as the trustee, given to Loos in trust to vote as both
owners agree, but in the event of a disagreement, then in Loos best
judgment
a. The problem is that you really have to trust Loos, but
nevertheless self-enforcing
iii. Statutes
1. Many sate have specific statutes validating these trusts (DGCL 218)
2. Non-Compliance with Statute
a. 1) Failure to comply invalidates the trust (DE)
b. 2) Failure to comply merely makes it inoperative until they do
comply with the requirements (NY)
iv. Abercrombie v. Davies
1. The court determined that an Agents Agreement that was in the form
of voting agreement was actually in substance a Voting Trust.
Accordingly, they required the shareholders to comply with 218
requirements
a. RAG: This shows that courts are very willing to look beyond
the form of the agreement
2. Elements
a. Voting rights divorced from beneficial interest
b. Voting right transferred to fiduciaries
c. Transferred through medium of irrevocable proxies
d. All voting rights are pooled on behalf of the Agent and no
stockholder retains the right to vote their stock
e. On its face, the agreement has for its principal object voting
control of the corporation
v. In the Ringling Bros. case above, the only way to make the agreement selfenforcing and avoid litigation is to use the voting trust arrangement, but then
you are putting a great deal of trust into Loos
d. Classified Stock and Weighted Voting
i. Not covered
Agreements Controlling Matters Within the Boards Discretion
a. Introduction
i. This area concerns when agreements between directors and shareholders on
director voting interferes with the statutory provisions giving the board the right
to conduct the business of the corporation
ii. DGCL 141 its the job of the Board to make the decisions on how to run the
business, including hiring and firing officers
b. MCQUADE v. STONEHAM

37

i. M was a minority shareholder of the New York Giants. All of the shareholders
had to agreed to vote for each other as directors, and furthermore to vote for
each other as officers of the company.
1. M was treasurer, but then later gets fired because the majority of
directors votes for another guy. He is angry because he has the above
agreement promising to keep him as an officer of the company.
a. Then he was later dropped as a director also
2. Defense says that the agreement is void because you cannot compel a
directors to make any decision in regard to running the company (114)
ii. There are two parts of this agreement
1. The agreement between shareholders on who they will vote for as
directors
a. This part is okay
2. The agreement between directors/shareholders on who they will vote for
as officers while acting in their directorial capacity
a. This part is not okay
iii. The holds that the agreement is invalid
1. RULE A contract is illegal and void so far as it precludes the board
of directors from changing officers, salaries or policies, or retain
individuals in office
iv. How do we help McQuade in this situation under DE law?
1. To keep director spot: create different classes of stock
a. Class A majority holds this
i. Only holds the right to elect 6 of 7 directors
b. Class B given to McQuade only
i. Only has the right to elect the last director spot
1. He would obviously only vote for himself
c. 242 allows the corporation to alter its articles of
incorporation and change the rights of the existing stockholders
2. To keep treasurer spot:
a. Require a unanimous vote by the board to fire an officer
i. 141(b) a corporation can require any vote over a
majority by simply amending the by-laws
3. Statutory Close Corporations
a. 350 a written agreement between directors is not illegal on
the ground that it restricts the Boards discretion
i. But only applies to statutory close corporations
b. How to qualify as a statutory close corporation?
i. 342
1. 30 or less shareholders
2. Restriction on transferability of stock
3. Stock is never subject to a public offering
ii. 344 provision for an existing corporation that
elects to become statutory close corporation
1. Adopt an amendment to the articles of
incorporation
2. Requires 2/3 vote of all of the outstanding
shares of each class of stock
4. Amend the articles of incorporation
a. 141 prohibits the agreement in this case
i. But it allows you to amend the articles of incorporation
to dictate the duties of the Board

38

IV.

V.

b. So you simply amend the AOI to say that the board cant fire the
Treasurer
i. Requires a majority vote to amend
v. RAG: If we really believe in the rule of this case, it shouldnt be so easy to poke
holes in the result . . . which leads us to question the validity of the ruling
c. CLARK v. DODGE
i. Agreement between Clark (25%) and Dodge (75%)
1. Dodge would vote for Clark as director
2. Dodge, acting in directorial capacity, would continue Clark as general
manager so long as proved competent, faithful, and efficient
3. Clark would receive of the corporations net income
ii. Court held that there was no attempt to sterilize the Board as there was in the
McQuade Case
1. Therefore, the agreement was valid
d. GALLER v. GALLER
i. Close corporation shareholders enter into an agreement that dictates who the
directors and officers will be as well as how much dividend payments will go to
the shareholders
1. The court ultimately decides that this agreement is okay at least in the
close corporation context
ii. RULE When ALL of the shareholders have signed the agreement, and there is
no injury to creditors either, it is okay to give them what they bargained for in
the context of a close corporation
1. So, McQuade is still good law to the extent that the agreement harms
minority shareholders or creditors
Supermajority Voting and Quorum Requirements
a. SUTTON v. SUTTON
i. Close corp amended it articles of incorporation to require a unanimous vote by
the shareholders for the transaction of any business on the part of the
corporation.
1. The validity is now being challenged
ii. Rule as long as the AOI specifically require supermajority votes to take
action, then they will be enforced by the court
1. Can make them as broad or narrow as you want
iii. Why do we have supermajority provisions?
1. Especially in close corporations, it protects the investments of minority
stockholders.
2. The problem is that it can create deadlock
a. Courts generally take the view that if parties bargain for a
supermajority provision, then they should get it.
Fiduciary Obligations of Shareholders Close Corporations
a. DONAHUE v. RODD ELECTROTYPE
i. See above
b. WILKES v. SPRINGSIDE NURSING HOME
i. Classic freeze-out situation
ii. Wilkes is a director and officer of a nursing home. He claims that they agreed to
keep him in office and on the Board and that the agreement has not been
followed
1. Other members of the board ended his salary as an officer, then called
for a shareholders meeting and did not reelect him as a director
a. Effectively cuts him off from his investment
iii. RAG: He probably could have sued for being removed as a director
1. See 218(c) and Ringling Bros

39

a. Both authorize agreements to maintain the board between

shareholders
iv. Wilkes sues under a breach of fiduciary duty claim
1. cites Donahue Case
a. Shareholders of a close corporation have a fiduciary duty to
other shareholders of good faith and fairness
v. Court overrules Donahue decision
1. Do not want a strict standard where there may be a legitimate business
reason for making the decision
a. The Donahue equal treatment test was too far reaching and gave
too much power to the minority
2. TEST: When minority stockholder bring suit for breach of good faith
duty owed to them by majority
a. 1) Ask whether the controlling group can demonstrate a
legitimate business purpose for its action
i. Burden on majority
b. 2) If there is an asserted business purpose, could the same
objective have been achieved through an alternative course of
action less harmful to the minority interest
i. Burden on minority
vi. In applying the test, the court determines that there was no legitimate business
purpose
1. This was a true freeze-out designed to pressure Wilkes into selling his
shares
***NOTE: In applying the Wilkes test, the outcome will depend on the given facts
and whether there is a legitimate business purpose.
c. Delaware Law
i. See Nixon Case:
1. RULE There is no special duty owed to minority shareholders;
and there is nothing special about the CHC context
2. No fiduciary duty among shareholders . . . no legitimate business
purpose rule
3. The real question is whether the DE Supreme Court really believes this
and will say that this is all fine . . .
a. Option 1 they change their mind and distinguish Nixon by
saying its not a freeze-out case
b. Option 2 massage the law dealing with duties to all directors
in all forms of corporations
c. Option 3 they meant what they said and will simply say that
nobody has a right to be on the Board
i. Therefore no special duties owed
d. SMITH v. ATLANTIC PROPERTIES
i. 4 people form a corporation and put in the AOI and By-laws that no decision by
the Stockholders or Board could be made unless there was 80% approval of all
of the outstanding shares (this ensures unanimity since only 4 SHs and Board
members) . . .
1. A problem here is that its requiring a shareholder vote even for Board
decisions
a. 141 prevents this
b. But court ignores and simply reads into it that they really meant
the Board
2. The company had a bunch of money and one minority SH disagreed
with the others as to how the money should be disposed of

40

a. Wolfson repairs and improvements

b. Others dividend distribution
i. Wolfson vetoes this
3. Wolfson was given notice that if they didnt pay dividends the company
would have to pay IRS penalties, but he still refused
a. Corp pays the IRS penalties
b. IRS assesses penalty because they would have been able to tax
the money had they paid dividends
i. Have to show a reasonable business plan as to why
you are not making payments or else pay penalty
4. There was suspicion that Wolfsons real motive was for personal tax
avoidance
ii. Court agrees with the evidence that Wolfson was trying to avoid taxes
1. Other SHs argue Donahue case
iii. Court states that there are certain times in close sorporation context where
majority SHs need to be protected from a minority SH
1. The 80% Provision effectively reversed the normal roles by giving the
minority a substantial amount of power
iv. RULE Where the minority holds a veto power over the majority, they too
owe a duty to the majority in the same way the majority owes the duty to the
minority in a typical case
1. Wilkes Test must weigh the business reasons advanced by (a) the
majority group and (b) the minority group
a. Legitimate business purpose?
b. Less restrictive alternative?
v. Court determines that Wolfsons adamant refusal to vote for any sort of
dividends despite the threat of penalties violates the fiduciary duty he held
toward his fellow shareholders
1. This is because he acted recklessly
a. He need a plan of spending the money
b. Did not bring a definitive argument to the IRS to show why they
shouldnt pay dividends
c. Did not act reasonably
2. The problem is that when you play legal hard-ball, without any
justification at all, you need to cover your tracks
3. He also was possibly engaged in self-dealing
a. He was looking to minimize his own personal tax liability
b. DE doesnt take this approach in analysis . . . you only look
at the effect on the shares, and not to the effect on the
shareholders
i. So in DE we couldnt consider the evidence of selfdealing
e. SLETTELAND v. ROBERTS
i. Court found that it was a violation of the fiduciary duty for a SH to bring a
derivative action at a time when the corporation was trying to secure refinancing
on their principal investment
1. He knew that filing the lawsuit would thwart their plans, and the court
determines that the suit was brought specifically for that purpose
f. MEROLA v. EXERGEN CORP.
i. VP and minority stockholder brought suit for his termination as an officer and
employee alleging that majority SH violated fiduciary obligation by terminating
his employment without cause.

41

VI.

1. He began work full time with the promises that he would be a major
shareholder of the corporation . . . so he started work and began buying
stock as often as he could. Then he was fired.
a. Argued based on the Wilkes case
ii. Court distinguishes Wilkes case
1. There were no general policies guaranteeing continued employment
2. No other stockholders had expectations of continuing employment
3. He was never required to buy stock as a condition of his employment
4. Profits were not distributed only in form of salary
5. The price he received for his stock upon termination was fair price and
he realized a significant return on his investment
a. Bought for $2.50 and $5.00 and sold for $17
i. Wilkes got screwed out of his investment
iii. Although there was no legitimate business purpose for the termination of the
plaintiff, the termination was not for financial gain of the majority or contrary to
public policy
1. The controlling group in a close corporation must have some room to
maneuver in establishing the business policy of the corporation
2. This is just an employment decision and not a freeze out like in
Wilkes
iv. Why is this consistent with Wilkes?
1. There is no freeze-out
2. Firing him is not stealing any money or putting him out in any way
because he is getting his money out of the corporation by selling his
stock at a fair price
***NOTE remember for exam as to why this is consistent with Wilkes
Valuation
a. DGCL 262 governs Delaware valuation methods
i. (h) consider all relevant factors
b. Delaware Block Method
i. Steps
1. Look at Three Values
a. Determine the market value of the corporations stock
b. Determine value of the corporations net assets
c. Determine the corporations earnings value
2. Court assigns weights to each of the three values, depending on
reliability of each factor
3. This has fallen out of favor
c. PIEMONTE v. NEW BOSTON GARDEN CORP
i. The determination of value using the Delaware Block Method was appealed by
both sides in the acquisition fo the company owning the Boston Bruins and
Boston Garden
ii. Market Value
1. Where there is no established market for a particular stock, actual
market value cannot be used and judges can reconstruct market value,
but he is not obliged to do so
a. In this case, even though there was very little volume, the judge
was allowed to take the most recent sale as an indication of
market valu
2. Came up with price of $26.50
a. Might not be the best indication of the value because shares had
limited trading
iii. Valuation Based on Capitalization of Earnings

42

VII.

1. Process
a. Compute average earning over the last five (or three) years
i. Extraordinary gains/losses are thrown out
b. Then select multiplier to account for the risks in the industry
i. Court picks 10 as multiplier which reflects stability in
the market
ii. This should reflect essentially how long you think the
company
iii. Public Companies . . .
1. take earnings per share value and divide by the
a market value of shares
***with a company like this its not as easy
2. Did not have to consider dividend records
3. In this case, it was okay to include a franchise fee received from an
expansion team . . . there were plans for future expansion and so it
wasnt extraordinary to expect more in the future.
4. Strengths of Method
a. This method is more reliable because there is less judgment and
more concrete than fluid markets
5. Weakness of Method
a. We are only worrying about what we made last year . . . but
we need to know what are going to make in the future
b. SOLUTION Take cash flow coming into the company and
use a discount rate to reduce the money coming in the future to
present value dollars
6. Court finds it to be $52.60
iv. Valuation Based on Net Assets
1. Basically add up all of the values of the assets and divide them by the
total number of outstanding shares
2. Allowed to include concessions contract into both net assets as well as
earnings value
3. Court finds it to be $103.16
***This is crazy b/c theres no reason to run this company and make
$52 per share, when you can sell it off and double your money!
v. Assigning weight to each valuations
1. Judge has discretion to set whatever weight he wants based on their
reliability
a. Market Value 10%
b. Earnings 40%
c. Net Assets 50%
2. Comes out to $75.27
3. What is wrong with THIS picture?
a. Market value is concededly bad, but they still weight it
b. This number is way too high because you should proceed on the
assumption that you are going to run the business, or you are
going to sell it off
vi. Benefits of this approach
1. Checks and balances, balanced value
vii. Criticism of this approach
1. Backward looking and usually undervalues a company
2. DELAWARE New cases recognize the strengths, but also allows DE
court to use any method they want
Restrictions on the Transferability of Shares and Mandatory Sales Provisions

43

a. Introduction
i. Problems usually occur in this area where the restriction precludes the
shareholder from realizing the full value of his shares on a transfer.
b. FBI FARMS v. MOORE
i. Groups of family farms came together to incorporate all of their farms as one
entity. Each family held shares in the corporation.
1. Placed restrictions on the right to transfer the shares
a. All transfers must be approved by the Board
b. Corporation has first opportunity to purchase shares at no more
than book value
c. If corporation passes, any stockholder is given the next
opportunity to purchase at book value
d. If corporation and stockholders pass, then blood member of the
family gets next opportunity
2. Couple got divorced and the W got all of the share, but H had lien for
half the value on the shares
a. H wasnt paid so he foreclosed on his lien and sold the shares at
a sheriffs sale
ii. Court analyzes validity of transfer restrictions
1. Common Law could not restrict transferability of personal property
2. Modern Statutes allow transfer restrictions
a. The theory is that owners of corporation should be able to
control its ownership and management and prevents outsiders
from taking over
b. REASONALBENESS (Property Law)
3. Transfer restrictions are treated as contracts
a. But they are strictly construed b/c they restrict alienability
4. Party must have notice of the restrictions to be bound
a. Despite the fact that these restrictions did not comply with the
statute as being noted conspicuously H still had notice of
them . . . so he was bound by the restrictions
iii. Restrictions on Transfer with Board Approval
1. Reasonableness TEST
a. 1) Designed to serve a legitimate purpose of the party imposing
the restraint; and
b. 2) The restraint is not an absolute restrictions on the recipients
right of alienability
c. Factors
i. See p 417
2. Board approval is an acceptable means of implementing approval by
the Corporation under the statute
iv. Restrictions Except to Blood Members of The Family
1. Court finds this reasonable as protecting a viable interest
a. Points to the fact that these are family farmers
v. Involuntary Transfers
1. Intestacy okay b/c if it was a gift to that person during life, then
Board could veto the transfer
2. Divorce not okay b/c unreasonably interferes with the rights of the
spouse
3. Creditors not okay b/c they have a lien on the stock and would
otherwise have no recourse
a. RULE When creditor purchases shares at sale with notice of
restrictions then they are subject to same restrictions

44

i. UCC 8-302
vi. RULE Transfer restrictions on stock will be upheld as long as they are
reasonable which basically means anything short of absolute restriction.
c. EVANGELISTA v. HOLLAND
i. Court upholds provision allowing corporation to buy back stock for $75K upon
the death of any shareholder despite the fact that stock was worth nearly $200K
1. Did not violate duty of good faith b/c they all agreed to the provision at
the outset of the venture
d. DGCL
i. 202 Restriction on Transfer and Ownership of Securities
1. (a) Can enforce against any holder of security or any successor
(including executor, trustee, guardian)
a. Requirements
i. Noted conspicuously on certificate
ii. If not noted, then can only enforce againt person with
actual knowledge
2. (b) restrictions have to be in AOI, by-laws, or agreement among
stockholders
a. previously issued stock is exempt unless holders are party to
agreement, or voted in favor
3. (c) types of restrictions permitted
a. prior opportunity to purhase the securities
b. obligating corporation or shareholders to purchase the security
c. prior consent by corporation
d. automatic sale to the company
e. restricts ownership to designated persons
f. Any of the following restrictions on the amount of ownership
are automatically reasonable
i. Maintaining tax advantages
ii. Maintaining statutory or regulatory advantage
g. Any other lawful restriction is permitted
ii. 342 Close Corporation Defined; Contents of COI
1. Statutory close corporation MUST have
a. Restriction of 30 or less shareholders
b. Stock SHALL BE subject to one of the restrictions in 202
c. No public offering
2. MAY set forth the qualifications of stockholders
a. Specify classes of persons who can or persons who cant hold
the stock
3. joint or common tenancy is treated as one stockholder
iii. 347 Issuance or Transfer of Stock of CC in Breach of Qualifying Conditions
1. If stock is issued to person not allowed to own AND if stock certificate
conspicuously notes the qualifications, then the transferee is treated to
have NOTICE that they are ineligible
2. Same rule if it violates the >30 rule
3. Same rule for violation of provision permitted by 202
4. Whenever a person has or is presumed to have notice, the
corporation MAY, at its option, refuse to register transfer of the
stock into the name of the transferee
5. Consent by ALL STOCKHOLDERS destroys the provision above
iv. 348 status as close corporation terminates if transfer is made in violation of
342 unless they follow certain provisions

45

v. 349 Corporate Option Where a Restriction on Transfer of a Security is Held

Invalid
1. If a restriction on transfer is not authorized by 202, the company
STILL has a 30-day option to acquire the restricted security at a price
agreed upon by the parties or at fair value determined by the court.
e. Restrictions on Transferability
i. RULE Reasonable restrictions are valid and enforceable
ii. First Refusal prohibit the sale of stock unless the shares have been first
offered to the corporation, the othe shareholders, or both, on the terms offered
by the third party
1. Least restrictive
iii. First Option prohibit the transfer of stock unless the shares have been first
offered to the corporation, other shareholders, or both at a price fixed under the
terms of the option
1. Restrictiveness depends on the relationship between the option price and
a fair price at the time the option is triggered
iv. Consent Restraint prohibit the transfer of stock without the permission of the
corporations Board or shareholders
f. Mandatory Sales
i. Give the corporation or the remaining shareholders an option to purchase a
shareholders stock upon the occurrence of one or more designated
contingencies, even if the shareholder wants to retian the stock
g. Pricing Provisions
i. Book Value
1. May be unreliable to the real worth b/c it reflects the historical cost of
assets, rather than their present value and ignores good-will or goingconcern value
2. Standard
a. Values must be so different as to reflect fraud, mistake or
concealment
3. Not a good meaure where there is lots of goodwill
ii. Capitalized Earnings
1. Price based on multiple earnings
a. Leaves open interpretation problems
iii. Periodic Revisions
iv. Appraisal
h. The UCC
i. 8-204 a restriction on transfer of a security imposed by the issuer, even if
otherwise lawful, is ineffective against a person without knowledge of the
restriction unless:
1. the security is certified and restriction is noted conspicuously on the
certificate; or
2. the security is uncertified and the registered owner has been notified of
the restriction
i. GALLAGHER v. LAMBERT
i. The case is about the intersection between transfer rules and BOFD rules
ii. G bought stock in a close-corporation that employed him. He bought stock was
subject to mandatory buy-back provision stating that if employment ended
before Jan 31, 1985 he was required to sell the stock back at Book Value.
Afterwards, he would get fair value. He was fired two weeks before the buyback deadline. Difference between 89K and 3M
1. G claims BOFD b/c the purchase price was completely inadequate
iii. Court rejects claim

46

VIII.

1. G entered into a freely negotiate contract and got what he bargained for
so there is no reason for the court step in and invalidate the transaction.
a. Court ignores the fact that there doesnt seem to be any other
reason for the firing other than to cheat him out of his stock
iv. The outcome of this case depends on what kind of case you think it is
1. Pure Transfer Case law is clear that discrepancies between book
value and fair value makes no difference
a. This is the MAJORITY view
2. BOFD Case If they breached their duty of good faith and fairness,
then you can argue that he should have received his full value
a. Minority View
Dissolution for Deadlock
a. DGCL
i. 273 Dissolution where only two stockholder
1. If corporation is owned 50% by two people, either party can petition the
court to have the corporation dissolved
a. If no plan can be agreed upon, the Court may dissolve and
divide up the assets as it sees fit
ii. 275 Traditional Dissolution
1. A corporation can dissolve upon (1) vote of majority of entire Board;
and (2) vote of majority of outstanding SHs
iii. 355 Dissolution at Election of Shareholder
1. The AOI may include a provision allowing for dissolution of the
corporation at the election of any specified shareholder meeting the
requirements in the AOI
a. Applicable only to Statutory CHCs
b. WOLLMAN v. LITTMAN
i. Stock of CHC is held 50% by two families. One family is incharge of
production and the other is in charge of marketing.
1. On family want to steal the business, so they create a deadlock situation
in oder to use NY dissolution for deadlock statute
ii. Court refuse to dissolve because they recognize what is going on. Dissolution
would reward the family for trying to steal the business and creating deadlock
1. What can the court do if the corporation is left in deadlock?
a. Can appoint Custodian
i. Board is completely displaced and custodian has all of
the power
1. DGCL 226
b. Court can also appoint a provisional director
i. Sits as a tiebreaking vote on the board . . .definitely less
harsh remedy.
iii. DELAWARE
1. Section 273 is the only statute conferring court the affirmative authority
to dissolve a corporation
a. Applies where there are 2 SHs, each owning 50% of the
company
2. No other provision gives court the same authority
a. DE courts will use a limited equity power to dissolve
corporations, but only in the most extreme circumstances
***DE wants to be the least intrusive it can be into corporate affairs, so this
is consistent with that logic
c. Provisional Directors, and Custodians
i. DGCL

47

IX.

1. 226(a)(1) Authorizes court to appoint custodian

a. Empowered to act only in situations in which the board of
directors of have failed to reach unanimous decision
i. Decisions are binding and constitute the official action
of the corporation
1. See Giuricich Case (435)
2. 352 Can appoint custodian for statutory CHCs
3. 353 Can appoint provisional directors for statutory CHCs
a. Only applies in this context . . . there is no equivalent for a
general corporation in DE
ii. Provisional Directors
1. See above
2. Criticism is that provisional director will always have to take one of the
two sides and that create a disincentive for the side he is on to settle its
difference with the other side
Dissolution for Oppression and Mandatory Buy-Out
a. MATTER OF KEMP & BEATLEY, INC. (NY)
i. Ps are two former employee that were with the company for more than 35 yrs
and owned about 20% of stock. They are mad b/c company has not paid
dividends and they were fired.
1. Ps claim that they cannot be fired b/c they are SHs and when they
bought the stock they reasonably expected to have a job
ii. Dividends Issue
1. The company had a prior history of paying all excess money as
dividends, but when Ps are fired, they stop paying dividends and just
raise the salaried of the employees
a. These can be treated as de facto dividends and not bonuses and
therefore act to freeze out the minority
i. This is illegal
ii. Similar to WILKES
2. Court must determine if this action is oppressive under the mandatory
dissolution statute of NY
a. This court takes a different perspective than Wilkes:
i. TEST Asks whether it goes against the reasonable
expectations of the minority when they invested
1. NOTE: Wilkes asks whether or not the majority
did something wrong
ii. Court determines that the change in payment policy
immediately after firing of Ps amounted to oppression
1. They had reasonable expectations of
maintaining employment and receiving
payments for their stock . . . this was not met
iii. What Remedies?
1. Compensatory Relief Damages and give them their job back
a. This is not really practical because the majority is out to get Ps
2. Dissolution
a. Statute authorizes this
i. Not available in DE
b. The problem with this is that its unfair to majority b/c they
want to continue running the business without Ps
3. Buy-out
a. Company pays Ps fair value for their shares

48

b.

c.
d.

e.

i. This seems reasonable b/c Ps are no longer frozen out

and they get their money back, plus maj gets to
continue running business
iv. Court decide to give them an option of either buying them out or dissolving the
company
1. They hope that with dissolution hanging over their heads, the two side
can work out a deal
a. If they dont agree, then there will be dissolution
2. Under the NY Statute, it says that in cases of oppression the court can
decree any equitable remedy it sees fit that is short of dissolution
a. In this case, its perfect because both sides get what they want
***The court makes the point that dissolution is a very extreme remedy and
should only be used where there are no other alternatives, so they want to
avoid it any most costs . . . hence why they give them an option
MCCALLUM v. ROSENS
i. McCallum was CEO and in return for his job well done, the corporation gives
him $12K in shares as a bonus.. Later the relationship deteriorates and he gets
fired and he is frozen out. He never is given access to the information that the
company is being run into the ground and all money is being funneled out and
into companies that majority owns.
1. There is no allegation of a cut-off from dividends.
2. Company offers to buy back stock at book value, but P wants it
purchased at fair value
ii. Statute authorizes court to order Mandatory Buy-Out
1. TEST Consider the reasonable expectations of the SHs with respect
to each other and the company
a. Court finds that P was divested of his primary expectation of
playing an active role in the management of the company
i. Orders Buy-out at fair value before the illegal acts
occurred
iii. This case is different from KEMP
1. Here they are forcing a buy-out because of the statute
TEXAS: Adopts the view that mandatory buyouts are a lesser included power in the
power of ordering dissolution
i. Many court take this stance
DELAWARE: Does Kemp or McCallum come out the same way?
i. NO DE doesnt have an oppression statute and Nixon v. Blackwell says that
no special duties are owed by SH in CHC that dont exist in publicly held
companies.
1. In a public company you can fire at will employees and theres no
obligation to pay dividends or buy stock back
ii. YES Nixon didnt involve a case of a freezeout, so we have the question of
whether a DE court will apply Nixon in a situation where there is an obvious
freezeout like in the above two cases
1. If the court declines to follow Nixon, then they DO come out the same
way; or if the court to massages the law of public companies to have
these cases fall under the duties of public comp SHs
a. Obviously, the court could say that they meant what they said in
Nixon and rule that there are no special duties owed by SHs
If you are a minority SH in a CHC, how would you protect yourself form the above
situations?
i. 1) Put in certificate or by-laws that SH owning 15% of the stock may dissolve
the company

49

X.

1. See 355
2. Makes this more like a partnership if the SH can dissolve at will
a. This will encourage majority to buy you out at a fair price b/c
you can threaten dissolution
b. Downside of this technique is that the majority will recognize
that none of the money in the corporation is permanently in the
corporation
f. CHARLAND v. COUNTRY VIEW GOLF CLUB
i. Court says that there should be no minority discount where the minority is
forced out
1. This is because he is not choosing to leave the corporation
2. Furthermore, the stock would gain a huge control premium as soon as
the majority acquired the shares
a. Court doesnt like the idea of the majority getting this huge
windfall
3. The minority gets a windfall because they are able to sell their shares at
a higher price than they could get on the open market
a. The court feels that this is better than encouraging the majority
to effect dissolution of the corporation and oppress the minority
g. Minority and Marketability Discounts
h. Pace Photographers
Arbitration
a. RINGLING v. RINGLING BROS.

ALTERNATIVE FORMS: LPs, LLCs, and LLPs

I.
Limited Partnerships
a. The Uniform Limited Partnership Acts
i. Some form has been adopted by every state except Louisiana
b. Formation of a Limited Partnership
i. Limited Partnership a partnership formed by two or more persons under the
laws of this State and having one or more general partners and one or more
limited partners
1. General Partners liable to the maximum extent, just as in the general
partnership model
a. Corporations can act as general partners
i. Meaning that you can really have a situation where no
one is liable
2. Limited Partner enjoys limited liability
ii. RULPA 201 in order to form a limited partnership, a certificate of limited
partnership must be filed in the office of the Secretary of State
iii. Tax Benefits
1. You can choose how you want to be taxed by the IRS:
a. 1) Flow-through basis
b. 2) Corporate style . . . taxed as a legal person
c. Exception
i. If you are a public limited partnership, then you have to
be taxed as a corporation
iv. Internal Governance
1. How you run your business is essentially a matter of contract
v. TEXAS these are very popular
1. This is because LLCs have to pay franchise taxes, but LPs do not,
making them more attractive
c. Liability of Limited Partners

50

i. History
1. ULPA
a. A limited partner is not liable unless he exerted control over
the corporation
2. RULPA (1976)
a. To prove control you must show:
i. 1) the control is substantially the same as a general
partner; OR
ii. 2) creditor had knowledge of your controlling activity
3. RULPA (1985)
a. Prove:
i. Control; AND
ii. Reasonable belief by creditor; AND
iii. Based on conduct of the limited partner that he is a
general partner
4. ULPA (2001)
a. RULE No liability for limited partners, unless there is some
reason to pierce the veil
***Notice that the trend over time has been to make it more and more
difficult for limited partners to have personal liability for actions of the
limited partnership
ii. GATEWAY POTATO SALES v. GB INVESTMENTS
1. Sunworth was a limited partnership. GB was the limited partner.
Gateway sold potatoes to Sunworth thinking that it was a general
partnership because the president assured him that GB was a wellfinanced partner and actively participated in running the company.
Gateway never dealt with GB.
a. The issue in this case is where in the spectrum of standards
Arizonas statute lies.
2. The court determines that Arizona operates under the 1976 RULPA
standard:
a. Prove either:
i. 1) Limited partner exerted control substantially the
same as that of a general partner; OR
1. In this scenario, you would not need to deal
directly with the limited partner
ii. 2) If not substantially the same the third party
transacted business with the limited partnership with
actual knowledge of the limited partners participation
in control
1. In this situation you would need to deal directly
with the limited partner
b. Therefore, the statute imposes liability on a limited partner
whenever the substantially the same as test is met, even
though the creditor has no knowledge of the limited partners
control
i. Therefore, in this situation no contact is needed with the
limited partner
***NOTE: This case shows that how much control you have on a limited
partnership has huge implications with how much liability you have as a
limited partner
d. Corporate General Partners
i. Introduction

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1. RULPA/ULPA(2001) a corporation can be a general partner in a

limited partnership
2. There are certain situations where a director or officer of the corporate
general partner can be held liable for the debts of the LP
a. Failing to maintain their corporate identity in conducting
partnership affairs through the corporation, or if corporation
assets are intermingled with partnership assets, or if the
corporation is not sufficiently capitalized
ii. IN RE USACAFES, L.P.
1. Limited partners seek to impose liability on the directors of the
corporate general partner for selling assets at less than fair value and
taking side payments for doing so (breach of duty loyalty).
a. Defense claim that they do not owe any duty to them
b. The issue is whether the directors/officers of a corporate general
partner have a fiduciary duty to the limited partners of an LP
2. Court analogizes to Trust Law
a. Beneficiaries can sue the directors of a corporate trustee who
misuse the trust property
3. Court announces that at a minimum the duty encompasses a duty not to
use control over the partnership property to advantage the corporate
director at the expense of the partnership
4. RAG: How else could we bring a suit without recognizing this direct
duty?
a. Aiding and Abetting (tort)
i. The corporate general partner owes a duty to the limited
partners
1. You can allege that the directors aided and
abetted the corporation to breach its fiduciary
duty
b. Although this court wants to say that the duty runs directly to
the corporation, its not clear that other state will do the same
thing, so you may have to go about it this way
iii. Taxation of Unincorporated Business Organizations
1. Firm Taxation a business firm is taxable on its income
a. If the firm then makes distributions to its owners out of after-tax
income, the owners then ordinarily pay taxes on those
distributions
2. Flow-through Taxation a firm is not subject to taxation and instead
all of the firms income and expenses, and gains and losses, are taxable
directly to the firms owners.
a. Distributions are not taxed
3. The IRS allows alternative business entities to check the box an pick
which form of taxation it prefers
a. Exception:
i. Publicly traded limited partnership Firm taxation
ii. Sole owner entity flow-through
e. Fiduciary Obligations
i. GOTHAM PARTNERS v. HALLWOOD REALTY PARTNERS
1. This is a public limited partnership. The GP is a sub of HGI. The
partnership creates a reverse split and then makes an odd lot tender
offer. All of the odd lots are purchased by the parent and gives them
complete control over the Limited Partnership.

52

II.

a. Gotham is a limited partner and is angry because HGI paid too

low of a price for the stock and did not pay a control premium
either
i. By paying too low of a price, this takes money out of
the pockets of the rest of the partners.
2. The issue is what duties the GP owes to the rest of the partners
a. RULE a general partner owes the traditional fiduciary duties
of loyalty and care to the limited partnership and its partners
i. RULPA: allows partnerships to modify these duties
through the partnership agreement . . . new version says
that you can completely eliminate these duties in DE
ii. If not altered, any self-dealing transaction requires a
showing of ENTIRE FAIRNESS
1. Fair Dealing
2. Fair Price
3. Court looks to Partnership Agreement
a. 7.05 expressly permits self-dealing transaction with the GP
or its affiliate provided that the terms of the transaction are
substantially equivalent to terms obtainable from a third party
i. mimics fair price
b. 7.10 requires GP to form an independent audit committee to
review and approve self-dealing transactions
i. mimics fair dealing prong
4. Court decides that there was a breach of the duties provided for in the
Partnership Agreement
a. No audit committee
i. Fair dealing
b. No control premium
i. Fair price
c. Therefore, the parent is going to have to repay the whatever
value the shares would have sold for had they accounted for the
control premium
Limited Liability Companies
a. Introduction
i. Combines the elements of corporations and partnerships (relatively new)
1. Corporation limited liability
2. Partnership operational flexibility of a partnership agreement
ii. Management
1. Manager-managed
a. Similar to a board of directors
2. Member-managed
a. Similar to a partnership
iii. Formation
1. An LLC is formed by filing an articles of organization in a designated
state office
a. Can be formed by a single person
b. Usually contains
i. Name of LLC
ii. Address
iii. Address of agent
iv. Purpose of LLC
v. Names of initial managers/members depending on the
management decision

53

vi. Duration of LLC

iv. Operating Agreement
1. Critical foundation instrument
2. This is the agreement among members concerning the LLCs affairs
3. Provides for governance, capitalization, admissiona dn withdrawal of
members, and distributions
v. Voting
1. Majority have per capita voting as default, but all allow for alteration of
this rule in the operating agreement or articles of organization
vi. Agency
1. DE: Unless otherwise provided in the operating agreement, each
member and manager has the authority to bind the LLC
a. The odd thing with this is that the operating agreement is not a
public document, but it can still limit apparent authority
vii. Difficulties
1. LLCs are a very new form (13/14 years), so very little case law
2. There will always be a dispute as to how to treat an LLC when
partnership and corporation laws conflict
b. KAYCEE LAND & LIVESTOCK v. FLAHIVE
i. Kaycee leased the surface rights from Flahives LLC and later they found that
the LLC had contaminated the surface. LLC has no assets and Kaycee wants to
pierce the veil and hold Flahive personally liable
1. The issue is whether in the absence of fraud, the entity veil of an LLC
can be pierced.
a. The question becomes whether to treat this like a corporation
veil-piercing case
ii. Court decides to look to corporate alter ego theory for veil piercing
1. Court determines that there is no reason to not extend the veil piercing
common law for corporations to LLCs
a. If members and officers of an LLC fail to treat it as a separate
entity as contemplated by the LLC statute, they should not
enjoy immunity from individual liability for the LLCs acts that
cause damage to third parties.
i. This is not just for cases of fraud
ii. The court has to look at all the circumstances, just like
in a corporate veil piercing action.
iii. The lesson of this case is that every time an issue comes up under this form of
entity, you are going to have to fight the battle of whether to follow partnership
law or corporation law
c. SOLAR CELLS v. TRUE NORTH PARTNERS
i. Solar Cells and True North form an LLC, First Solar, for a business venture. SC
gave the patent, TN gave $35M to the LLC. Manager managed LLC. TN got
three managers, SC got two managers; TN ran the business; they owned it 50/50.
1. TN decided to effect a merger of the LLC into one of its own subs. SC
objected to this because they wanted to just bring in more partners . . .
also their ownership would go from 50% to 5% in the new company.
a. SC sought to enjoin the merger from going forward
2. SC claims that TN breached its fiduciary duty
ii. Court looks at clause in Operating Agreement.
1. TN claims that this was a waiver of all fiduciary duties
2. Court construes the provision as saying that it simply says that you cant
sue mangers for money based on breaches of fiduciary duties (liability).

54

III.

a. It does not say that the you cant sue for recission based on
breach of fiduciary duty (injunction)
i. They see this as different
***NOTE: The lesson here is that while you are free to contract
around fiduciary duties, courts will construe any provision as
narrowly as possible.
iii. Court looks at the circumstances of the transaction and determines it to be a selfdealing transaction that violates their fiduciary duty
1. Applies Entire Fairness Standard
a. TEST
i. 1) Fair Dealing
ii. 2) Fair Price
b. Fair Dealing
i. No negotiations at all
1. all decisions were made unilaterally through the
TN managers
ii. No notice
1. Just because the OA permits interested
transactions doesnt mean that they have free
reign to approve any transaction they see fit
iii. All of this points to the fact that they cant say there
was fair dealing . . . esp considering the fact that SC
will go from 50% ownership to 5% ownership
c. Fair Price
i. Flawed valuation of the company
1. Discounted cash-flow method
a. 1/3 of value set five months before
b. 35% minority discount rate
i. not allowed in DE
2. Did not cross-check the value with any other
method
iv. The court grants the injunction based on the failing of both fair price and fair
dealing
***Remember that there will be times where you can argue that an LLC is different
from a corporation . . . right now, its just looking at the statute and comparing it to what
was intended and the nature of the entity aas compared to that of a corporation and
partnership.
Limited Liability Partnerships
a. LLPs are general partnerships, with one core difference and on ancillary difference
i. Core Difference
1. Liability of general partners of an LLP is less extensive that the liability
of a general partner in an LP
ii. Ancillary Difference
1. LLPs must be registered with the appropriate state office
a. They are creatures of statutes.
2. Some states limit what types of organizations can hold LLP status.

THE DUTY OF CARE AND THE DUTY TO ACT IN GOOD FAITH

I.
The Duty of Care
a. The Basic Standard of Care
i. FRANCIS v. UNITED JERSEY BANK
1. Mom and two sons are directors of a reinsurance brokerage. Brokerage
did not keep separate accounts and the sons began taking loans from

55

the company treasury. Eventually, the magnitude of the loans left the
company without any money to operate. Mother was depressed and
drank heavily after father died and did very little in her capacity as
director. She later died.
a. The trustee for the creditors brings suit against all three
directors for breach of fiduciary duty.
b. The issue is whether the mother can be personally liable for a
breach of fiduciary duty by letting her sons steal money from
the company.
i. Duty of Care
2. RAG: Normally, this is a fraudulent conversion suit, but the problem
with this is that you are limited to getting what they took back.
Furthermore, mom didnt take anything, so you would have to get her
on aiding and abetting . . . but no mens rea!
a. So we cant get her for fraudulent conversion and shes the only
one with money . . . ergo breach of fiduciary duty.
3. Court decides that New Jersey law should apply:
a. Internal Affairs Doctrine
4. Did mother breach her duty of care?
a. Requires a finding that she had a duty to the clients, that she
breached the duty, and that the breach was a proximate cause of
their losses
i. Basic negligence standard
b. Standard of Care
i. Directors must discharge their duties in good faith and
with the degree of diligence, care and skill which
ordinary prudent men would exercise under similar
circumstances in like positions
1. Standard of care depends on who you are:
outside v. inside
c. Duty
i. Directors always have a duty to the shareholders
ii. No duty to creditors unless insolvent
iii. Trust Duty
1. Similar to that of a bank
2. RULE Directors of corporations owe a
similar duty when the corporation holds funds
of others in trust
a. This duty fits to this case because the
brokerage held funds of both insurers
and reinsurers
d. Breach
i. Mom never went to meetings, never looked at finances,
and had warning from her husband that this might
happen
1. Apparently its not reasonable to trust sons
because she was director
ii. Does it matter that she was sick?
1. Court says that she could have resigned
iii. Court announces that general obligations of a director
include understanding the business, keeping informed
of the activities of the corporation, general monitoring

56

of corporations affairs and policies, and regularly

reviewing financial statements
1. She did none of this
a. Despite her circumstances, she has no
chance of winning because the duty
will never be so low as to allow a
director to do nothing at all
iv. All directors are responsible for managing the business
and affairs of the corporation
1. She breached her duty
e. Causation
i. Gets a little difficult in this case because this was nonfeasance rather than misfeasance
1. Must determine the reasonable steps a director
should have taken and whether that course of
action would have averted the loss
ii. The act or failure to act must be a substantial factor in
producing the harm
1. Court determines that her actions contributed to
the climate of corruption
2. Where it is reasonable to conclude that the
failure to act would produce a particular result
and that result has followed, causation may be
inferred
iii. RAG: Basically, if there is a reasonable chance that
your negligence caused the lawbreaking, then you are
considered to be the but for cause
1. Uncertainty in causation should cut against the
wrongdoers
a. See Virginia Bankshares below . . .
court cuts uncertainty in favor of
wrongdoers
ii. DELAWARE Causation
1. If a plaintiff establishes that there was a breach of the duty of care, that
showing overcomes presumption of the rule and establishes a prima
facie case of liability, even without a showing of injury.
a. Burden then shifts to the defendants to show that the transaction
was entirely fair
b. The Business Judgment Rule
i. Business Judgment Rule
1. The business judgment rule basically provides that a substantivelyunwise decision by a director or officer will not by itself constitute a
lack of due care.
a. Three Requirements:
i. 1) No Self-Dealing
1. This is a breach of duty of loyalty to be
discussed infra
2. Directors cannot have an interest in the deal
apart from everyone else
ii. 2) Informed Decision
1. Follow some sort of reasonable decisionmaking
process
iii. 3) Rational Decision

57

1. You have to articulate a rational purpose, but

you dont have to show that you actually acted
on that purpose alone
2. This is lower than reasonable
iv. 4) Good Faith
1. Cant make the decision knowing that it
violates the law
b. If any of the four requirements are violated, then the BJR will
not protect the decision and a higher standard of Entire Fairness
will apply
i. Entire Fairness
1. Fair Dealing
2. Fair Price
c. If the four requirements are met, then we just worry about
whether the decision was rational
i. Remember that there is a difference between whether
something is reasonable and rational
2. Policy
a. Court are worried about boards getting attacked by minority
shareholders every time they make a decision that doesnt work
out with the benefit of hindsight
i. It would lead to the BOD never taking risks
b. Also worried about courts getting into the business of running
the company
c. Drawback
i. The BJR will increase agency costs
ii. KAMIN v. AMERICAN EXPRESS
1. AMEX bought a bunch of share of stock of a company for $30M and
the stock plummeted. They decided to make an in-kind distribution of
dividends to their shareholders. P sues claiming that they could have
sold the bad stock and used it to save $8M in taxes.
a. For accounting purposes, the divided doesnt look like a loss
because its like they gave SHs $30M even though it was really
only $4M. If they had kept it on the books and sold the stock,
they would get a $26M capital loss to put on their tax return.
i. But the Board doesnt want to tell the SHs that they lost
$26M . . . it looks better for publicity sake if they paid a
dividend.
b. SH wants to sue them for breaching their duty of care
2. The court announces that the Business Judgment Rule protects this
decision
a. RULE A complaint which alleges merely that some course of
action other than that pursued by the Board of Directors would
have been more advantageous gives rise to no cognizable cause
of action
i. You cannot attack the substance of a decision without
more
3. Because the BJR provides protection here, the court determines that the
decision was rational and therefore no liability
a. So long as they have been acting in GOOD FAITH, the BJR
protects them
iii. SMITH v. VAN GORKUM (DE)

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1. Directors were selling the business in an LBO. They never performs an

adequate study stating how much the company was worth to the, or
potentially to the other company. The CEO was willing to take $55
for his stock. The deal was very fast. They never hired an investment
banker to help value the company.
a. P sues for BOFD (Care)
2. DE BJR standard:
a. Director liability is predicated upon concepts of gross
negligence
i. Under this standard its pretty clear to the court that they
breached their Duty of Care
3. Court says the Board breach their duty of care:
a. Did not adequately inform themselves as to CEOs role in
forcing the sale at $55
b. Uninformed as to intrinsic value of the company
c. Grossly negligent in approving the sale of the company upon
two hours consideration, without prior notice, and with no
crisis
d. Court rejects their market test
i. The idea was that they would simply accept the $55 bid,
and leave themselves open to better offers for 90 days.
1. The market would be able to tell them if the
company was worth more because they would
get a higher bid if it was.
e. Court doesnt care about he 48% premium
i. This doesnt alleviate the duty of the board to value the
company
4. RULE You may not enter into a transaction without first performing
a study conducted by experts.
a. Anything less violates the duty of care
i. Therefore, you have a duty to value the company before
you sell.
b. Duty of be informed in transactions!!
c. RAG: Investment Bankers Relief Act
i. He calls it this because no company since this case has
not hired an investment banker
5. NOTE: 102(b)(7) allows companies to disclaim duty of care for
directors and 98% of DE companies do just that. The company here did
not do this
c. The Duty to Ensure that the Corporation Has Effective Internal Controls
i. IN RE CAREMARK INTL
1. Caremark is being sued by its SHs who are unhappy that Caremark is
paying large fines to the government for having been busted for
Medicare abuse. Despite corporate policies, employees were giving
kickback to physicians.
a. SHs sue under derivative action and the case settles. Settlement
is simply for change in corporate policy for better oversight of
employees in complying with the law.
i. Court must review settlement for its fairness b/c its a
derivative action
2. Court says that to win on a breach of duty of care for lack of oversight
claim, P must show
a. 1) that the directors knew; or

59

b. 2) should have known that violation of law were occurring;

c. 3) that directors took no steps in a good faith effort to prevent or
remedy the situation, and
d. 4) that such failure proximately resulted in the losses
complained of
3. The directors had a duty to ensure that proper procedures were in place
for proper information and reporting systems designed to provide them
with timely and accurate information as to its employees compliance
with the law
a. In this case, the court feels that they met this standard
i. They had created an oversight committee and were
trying to remedy the situation . . . however, the court
recognizes that they cannot be in every room at all
times
***EISENBERG: The boards role is to assure itself that an internal
control structure is in existence, is appropriate, and is effective. The
boards responsibility is not to ensure that specific controls never
fail or that every conceivable control is in place.
ii. SUMMARY
1. There is a big difference between review of substance and process
a. Process reasonable (DE says not grossly negligent)
i. Court will inquire into it
1. Perform like a reasonable board member
2. Duty to monitor and supervise
3. Duty to adequately investigate transactions
before they are done
b. Substance BJR
i. Board must simply articulate a rational business
purpose
1. The only thing that isnt rational is Waste
ii. So if you can show that the process was reasonable, you
can avail yourself of the BJR
2. Consequence
a. Most duty of care cases are really about a P who is not happy
with the substance of a Boards decision
i. But since the law forecloses that inquiry, they bring
Duty of Care cases
b. Most losing duty of care cases are in the vein of Smith v. Van
Gorkum
i. Theres usually a whiff of self-dealing, but not
enough to bring that kind of action
ii. Essentially the Board will only lose in two situations:
1. Conflict of interest/self-dealing
2. Not doing anything
iii. So duty of care cases that truly challenge the process
have a good chance of winning, but claims where they
are really challenging the substance dont have a good
chance
1. Exception to substance claims is where there is
some evidence of self-dealing
d. Liability Shields
i. DGCL 102(b)(7) A corporation can included in its articles of incorporation
a provision eliminating or limiting the personal liability of a directors to the

60

II.

corporation or its stockholders for damages for breach of fiduciary duty as a

director provided that it does not limit the liability for:
1. any breach of the duty of loyalty
2. any acts or omissions not in good faith or illegal
3. 174 liability; or
4. any transaction from which the director derived an improper personal
benefit
***NOTE: This provision essentially allows corporations to free their
directors of liability in breach of duty of care situations . . . but it doesnt
provide protections for duty of loyalty of good faith claims
ii. MALPIEDE v. TOWNSON
1. This is a white knight transaction where Fredericks of Hollywood is
selling their company to Knightsbridge for $6.14/share. Veritas them
comes in and offers $7.75. Knightsbridge agrees to match but makes
board include all sorts of protective provisions in the agreement,
including a bust-up fee. Veritas then comes in a offers $9/share if the
Board tears up the Knightsbridge deal.
a. SH suing for breach of duty of care and breach of duty of
loyalty
i. Board raises 102 defense
2. Court dismisses duty of loyalty claim
a. Only one interested directors and the deal was approve by a
majority of disinterested directors.
b. RAG: The whole problem seems to really be a duty of loyalty
problem
i. One director was going to get extra options. The other
two directors were concerned about keeping their jobs
after the merger.
1. This was a white knight transaction and they
knew Knightsbridge would treat them right.
2. They were entrenching themselves at the
expense of the shareholders
ii. But the court goes to bat for the company and finds this
to be a duty of care claim
3. Court looks at duty of care claim
a. P claims that the Boards hasty consummation of the
Knightsbridge merger, the restrictive merger agreement
provisions, and their failure to implement a poison pill
prevented them from realizing the highest possible price.
i. Therefore, they were grossly negligent and BJR doesnt
apply
b. RULE If a complaint solely asserts a duty of care claim, you
can dismiss as soon as the corporations 102(b)(7) provision is
invoked.
i. Because, in the courts mind, only a duty of care claim is
asserted, the case can be dismissed
The Duty to Act in Good Faith
a. IN RE WALT DISNEY COMPANY
i. Eisner hires his friend to be president of the company despite the fact that he
was talent agent and never went to business school. Eisner goes to the board
and says he wants them to hire Ovitz and the approve without any big deal.
Eisner gives him a HUGE compensation package; compensation committee

61

passively approved it by just reading the summary and spending very little time
on it. Once Ovitz begins the job its very clear that he was not good at it.
1. Eisner and Ovitz negotiate a Non-Fault termination agreement which
ultimately compensates him with $100M for being fired after one year.
a. The board approves it and did not explore any other options.
2. SH sues Board for breach of duty of care and loyalty and failure to act
in good faith and meet minimal proceduralist standards
ii. Court looks at claim
1. 102(b)(7) protects directors from their duty of care, but still open to
liability for loyalty, and good faith claims
a. Because the acts of the company raise questions as to whether
they were taken in good faith, they cant dimiss the suit
iii. Court determines that the hiring/firing process was devoid of any real
substantive review on the part of the directors
1. This amounted to a failure to act honestly and in good faith
a. RULE a breach of a directors duty to act honestly and in
good faith in the corporations best interest falls outside of the
BJR
b. In the courts eyes, this went beyond simply negligent conduct,
to almost intentional or knowing conduct.
i. Due to the way the court construes their conduct, the
Board cant argue BJR
2. They knew they were making decisions without adequate information or
investigation
iv. How would you tell Eisner to go about doing this right?
1. Hire a team of outside experts on employment compensation
a. This gives you a basis for whatever number you come up
with . . . these people are very good at justifying the number you
want to reach
i. You justify it by saying that he is the best man for the
job and Disney is the best corporation in the world, and
this requires
2. Tell Eisner to recommend him to the Board and then disappear
a. Everyone on the Board has been appointed by Eisner, so they
will do what he wants them to do.
3. When is goes to the compensation committee, there should be extensive
review
a. It should take WEEKS
b. Review mountains of evidence
4. Board should then review the recommendation of the compensation
committee and go through a similarly rigorous process
a. It should take several meetings to decide
5. When we fire him:
a. Have the Board meet and review for along time again
i. Use more experts . . . they will give a number that
seems justifiable under the circumstances
b. This process should take even longer . . . MONTHS!
***You will never lose a case like this if bring in experts and follow the
process outlined above.
***A case like this shows you that Delaware is not really leading the way in
allowing directors to do whatever they want . . . this could be a possible test
question.
b. MILLER v. AT&T

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i. Suit is base on the fact that AT&T did not collect its phone bill from the DNC.
SH claims this is a breach of the duty of care.
1. What claim can they bring?
ii. Duty of Care? NO
1. BJR
a. They analyzed the issue and decided that not collecting the bill
was worth the good will it would generate with the company.
iii. Duty of Loyalty? NO
1. This was not a self-interested transaction and was done to help the
shareholders down the road with future dealings with politicians
iv. Duty to Act Legally
1. Where the decision to not collect the bill amounts to an illegal act, then
different rules can apply
a. RULE illegal acts amount to a breach of fiduciary duty
2. Federal Election Statute
a. Requirements for violation:
i. Contribution to political party
ii. In a federal election
iii. For the purpose of influencing the outcome of an
election
v. The court says that if P can prove the underlying illegal act, then violation of the
law will suffice to sustain a claim against the directors.
1. Remedy pay back the losses into the corporate treasury
a. Usually, you would offset anything that the corporation
benefited by the action
b. Is the remedy wrong?
i. Maybe, because of the intangible benefits of the action
c. The rule is that if the benefit is intangible, it counts as zero and
you pay the full amount
i. If the benefit were tangible, then you cant make the
directors pay back anything because the shareholders
have already received a benefit
THE DUTY OF LOYALTY
I.
Self-Interested Transactions
a. LEWIS v. SL&E
i. Three brothers. B1 and B2 are on the board of both SLE and LGT. B3 is only
on board of SLE. The work out a deal where LGT uses facilities of SLE, and
SLE gives a huge break on the rent. Taxes were $11K but only charged $14K.
1. B3 sues other directors for waste of corporate assets by grossly
undercharging for rent . . . a breach of duty of loyalty to SLE.
ii. RULE The BJR does not protect transactions in which the directors have an
interest other than as directors of the corporation.
1. Because the brothers are engaging in a self-dealing transaction, the court
says that they cant avail themselves of BJR
2. Must satisfy Entire Fairness
a. Fair Dealing
b. Fair Price
iii. Court looks at transaction an easily determines that this was bogus
1. No appraisals were made, no thought given as to whether the rent was
fair and reasonable; never looked for other tenants
iv. See DGCL 144 for what they could have done to make this legal

63

1. Basically, they would need to either make full disclosure to the board or
full disclosure to the shareholders and have a majority of disinterest
directors or shareholders approve this transaction.
b. Remedies for Violation of Duty of Loyalty
i. Improper Self-Dealing
1. Rescission
2. Accounting for difference in the contract price and the fair price
a. If rescission not feasible
ii. Improperly Appropriate Corporate Opportunity
1. Impose a constructive trust in the corporations favor, conditioned on
reimbursement of the officers outlay in acquiring the opportunity
iii. These are much less severe than for violation of duty of care where directors
must pay damages although they made no gain from the wrongful action.
c. TALBOT v. JAMES
i. Talbot contributes land to a corporation and James agrees to contribute expertise
and planning and generally oversee the development of an apartment building.
Board and stock are equally divided between the two. James separate
construction company entered into agreement with corporation to act as GC an
extra $20K.
1. Talbot claims that James cannot be paid for being a GC because he was
already being compensated with stock of the apartment corporation to
fill that role.
ii. The court determines that signing a deal with himself is clearly a self-interested
transaction and violates the duty of loyalty.
1. He was required to make full disclosure to the Board
a. Moreover, it seems that in this case he actually concealed the
fact that he was going to be GC
2. This is a violation of the duty of loyalty
a. He was doing the same thing he had already agreed to do by
overseeing the construction since he subcontracted everything
out.
iii. What is required in Delaware under 144?
1. Escape Hatches 1 and 2?
a. The Talbots are going to have to agree with him on this and it
doesnt appear that they will.
i. So this automatically kicks us down to 3
2. Escape hatch 3: Entire Fairness
a. 1) Fair Dealing
i. Serious disclosure problems and this is probably the
most important part
b. 2) Fair Price
i. You would want to show what others would charge for
the same services . . . there was evidence that others
would have charged more
1. There is still the problem that he was already
being compensated to this work
c. You might have a chance under this if you can show that the
price is fair (this is much more important than fair dealing)
i. RAG: still not sure this complies because you still need
to get approval by the Board
1. Two things are necessary
a. 1) Fairness
b. 2) Approval by Board

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II.

i. They never approved him to

hire a GC because they thought
he was going to act like a GC
d. Even under this escape hatch, the Board still has to approve,
even if interested, AND there must be entire fairness
3. Do you have to show Fairness if you show disinterested approval?
a. In Delaware: NO!!!
i. 144 makes it clear because of the or to show you
that you only have to prove one of the three
ii. So you can have a self-dealing transaction without
Board approval if it satisfies entire fairness
iv. RAG: This is a questionable holding and you have to be hesitant to speculate as
to how far it applies because DE has a case that cuts against this in a deadlock
self-dealing situation
1. This is also in the book to show the Common Law approach:
a. Requires
i. Board approval; AND
ii. Good faith; AND
iii. Disclosure
b. Delaware statute doesnt require all of this as shown directly
above.
Statutory Approaches
a. DGCL 144 Conflict of Interest Transactions
i. Definition
ii. Escape Hatches
1. Disclosure of material facts to the Board in regard to the transaction;
approval of a majority of disinterested directors
a. Basically disclose everything that creates the conflict
b. What is necessary is that there be at least one disinterested
director and that he approve the transaction
2. Disclosure of material facts to shareholders with shareholders approval
a. Courts have implied a requirement that approval is required by
disinterested shares, but for some reason its not in the statute
3. The contract or transaction must be fair as to the corporation
a. Entire Fairness Test
i. 1) Fair Dealing
ii. 2) Fair Price
b. Directors will usually lose under this provision
***NOTE: If there is a controlling shareholder involved in the transaction, then
Entire Fairness is still required, but if the controlling shareholder goes through
escape hatches 1 or 2 and satisfies then the BOP shifts to the plaintiff.
b. COOKIES FOOD PRODUCTS v. LAKES WAREHOUSE
i. Ps are minority shareholders that are angry at Herrig who is a majority SH as
well as an officer and director. He made profits skyrocket by using the
distribution network for his auto parts stores to market taco sauce and BBQ
sauce. They claim that he breached his duty of loyalty by engaging in some
questionable self-dealing.
1. Questionable transactions:
a. Consulting Fee
b. Royalties
c. Distribution fees
d. Warehousing fees

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2. Herrig took became majority SH and appoint four of five directors to

Board before all of this happened.
3. The problem is that its a closely held corporation and despite its
immense success, they have no way of getting their money out of the
company because they dont pay dividends.
ii. This court looks to Iowa statute that is almost identical to Delaware
1. Decides that satisfaction of any one of the escape hatches still requires
satisfaction of the common law standard of proving good faith, honesty,
and fairness.
a. NOTE this is NOT how Delaware reads it . . . they made it
clear with the or after each hatch.
2. Despite this reading, the court still finds all of the transactions to be
legal
a. The Board was informed, everything was justifiable considering
the circumstances.
iii. How would you make this legal in Delaware?
1. Is it self-dealing? YES
a. Hes an officer/director in both corporations and has a financial
interest in both
2. Escape Hatch 1
a. There are five directors, Harrig nominated four . . . how many
are disinterested?
i. FIVE hes the only one benefiting from the
agreement, so none are interested
ii. ZERO four were nominated by him and the other
can be removed by him
iii. ONE the one that was not appointed by Herrig
b. You at least have a shot use this if you make the right
disclosures, but thats not the way they went here
3. Escape Hatch 2
a. Harrig owns 53% of the stock, so would need 24% of the stock
to vote with him
b. Again, they would have a shot . . . it depends on how many SH
are upset with the fact that they are not receiving dividends
4. Escape Hatch 3
a. Entire Fairnes
i. Fair Dealing
ii. Fair Price
b. Defense of Harrig
i. You get what you pay for . . . this guy is the best, and he
demands a premium to be with the company
5. RAG: If you were his lawyer, you would want to go through 1 or 2 first
because at least in Texas and Delaware, you wouldnt have to get into
fairness questions, which eliminates some uncertainty
c. Effect of Approval by Disinterested Directors of Self-Interested Transactions
i. Many jurisdictions still require some form of fairness review largely because of
the inherent dangers of reciprocal backscratching
ii. DELAWARE
1. Compliance with 144 permits invocation of the BJR and limits judicial
review to issue of gift or waste with the BOP upon the party attacking
the transaction

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III.

a. Once you show that directors approving the transaction were

truly independent, fully informed, and had the freedom to
negotiate at arms length, BJR applies.
2. Peculiarity
a. The statute just says it is not illegal which raises the questions
of whether or not it affirmatively makes the transaction legal
i. This leaves open the possibility of the court saying that
the statute only overrides the Common Law, and that
they can still review for overall fairness
b. Prof Eisenberg:
i. There might be an extra fairness requirement you
could read into the statute
1. court could require you to still show fairness in
the sense that the directors were truly
independent, i.e., they cant passively approve a
manifestly unfair transaction
c. TEXAS fixed this debate by explicitly saying it is legal
d. Waste and Shareholder Ratification
i. Principle of Waste an exchange of corporate assets for consideration do
disproportionately small as to lie beyond the range at which any reasonable
person might be willing to trade; usually the exchange serves no corporate
purpose
1. You essentially need NO consideration to constitute waste
a. This is because of courts reluctance to weigh what adequate
consideration actually is
2. If something is wasteful, then there is no protection under the BJR
ii. There is a difference between wasteful actions and self-dealing actions
1. Self-dealing
a. Requires just a majority approval of disinterested shareholders
2. Waste
a. Require UNANIMOUS shareholder approval in order to avoid
liability
e. Controlling Shareholders
i. RULE When you are a controlling shareholder, satisfying 1&2 does not give
protection of the BJR. It merely shifts the burden of proof to P to show that the
transaction is not entirely fair.
1. The idea is that when a controlling shareholder is involved, a board or
shareholder vote is never THAT disinterested because they are
constantly afraid that the majority shareholder will retaliate.
Compensation
a. DGCL
i. 141(h) The board has the authority to fix the compensation of directors
ii. 157
b. IN RE WALT DISNEY
i. See above for dangers of not following proper procedure in fix compensation of
an officer
c. Compensation in Publicly-Held Corporations
i. Difficult to challenge
1. Company has to have executives and they have to be compensated
2. Protected by the BJR
a. This is a very low standard given the fact that you can always
make the argument that the person is essential and that he
requires being paid at top dollar in order to retain him.

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ii. Usually accepted by courts as long as it is approved by disinterested

directors/shareholders
d. Compensation in Close Corporations
i. Court often holds executive compensation to be unreasonable in this context
because it differs in two critical ways:
1. executive compensation usually is not approved by disinterested
directors/shareholders
2. compensation usually involves a very significant fraction of the
corporations earnings
ii. Taxes
1. Compensation is a deductible expense
a. Therefore, payment of compensation reduces the corporations
taxable income
i. Paying dividends does not reduce taxable income
b. So shareholders/directors would rather have their money as
compensation rather than dividends
2. IRS reserves the right to challenge compensation in the closely held
corporation context as unreasonable when an exec pays himself too
much of a salary
a. Excess over reasonable salary will be treated as dividend
payments
iii. Derivative Actions
1. The shareholders that miss out on the money will often challenge excess
compensation as waste
a. This is because they want it paid out as a dividend so they can
get a return on their investment
e. Stock Options
i. Until recently, all execs preferred their compensation to come by way of options
ii. Benefit to company
1. Did not have to book the options at a very high value and could treat
them as almost worthless
a. Would not affect the bottom line
b. EX: If they pay $1M in salary, they would have to reflect this in
their costs, but if they issue options, they could book it at $1000
if they wanted.
2. SEC rule change
a. This benefit is largely taken away because they are now
required to value the options higher on the books
iii. Benefit to Execs
1. It hides some of the compensation they are actually receiving
a. It would look like they were only getting $1000, but in reality it
was $1M
b. Until recently, the SEC did not require companies to value this
compensation in their proxy statements
2. Options do not have a time limit
a. Because they are not tied to their tenure, the exec could get a
bunch of options today, and leave tomorrow with a boatload of
cash
i. Have been challenged as waste by shareholders, but
failed
1. Some plans will tie vesting of options to tenure
with company to avoid this

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2. RAG: doesnt think this is necessary

considering that no one would challenge a yearend bonus
f.

IV.

Compensation Rule
i. RULE when executive compensation is approved by a disinterested Board,
that the BJR protects the decision from attack as to its reasonability
1. The cost of changing this rule would be that it would be harder to retain
the best talent in corporate America
Use of Corporate Assets; Competition with the Corporation; The Corporate Opportunity
Doctrine
a. Three Fiduciary Principles
i. Corporate-Opportunity Doctrine prohibits a corporate fiduciary from taking a
corporate opportunity for himself
ii. Use-of-Corporate-Assets Principle prohibits a corporate fiduciary from using
corporate property, information, or position for personal gain
iii. Competition Principle prohibits a corporate fiduciary form competing with
the corporation
***In reality, one or all of these principles may apply to any given case, but they
are still distinct
b. HAWAIIN INTL v. PABLO [Use of Corporate Assets]
i. Pablo was president of Hawaiian as well as his own realty company. The board
sent Pablo to go acquire some land for the company as their representative. He
purchased land on behalf of the corporation and because he was a broker, he
split the commission with the selling agent. There was no disclosure and no
approval by board.
1. SH sues claiming he took an improper benefit as an agent of the
corporation
ii. Corporation uses agency law to determine that it was improper for him to keep
the profits.
1. RULE an agent cannot retain an undisclosed profit from the dealings
on behalf of the principle
a. This is a prophylactic rule to prevent agent from putting his own
interests ahead of that of the principal
b. See TARSNOWSKI CASE
2. According to this rule, Pablo has to return the commission received
from the deal
a. Would have been different had he disclosed this to the Board
and given them a chance to approve.
iii. RAG: What is wrong with him keeping the commission?
1. If he did not think he could keep the commission, he would have hired
an outside broker.
a. Its not reasonably to expect him to do all of this work for free
b. Therefore, the company does not lose anything by his taking the
commission and it would not have benefited by him not taking
the commission
iv. This case is an example of a way that you can breach the duty of loyalty even
though you are not usurping a corporate opportunity.
1. Keep this case distinct form Northeast Case below where a true
corporate opportunity is being taken away from the corporation.
c. NORTHEAST HARBOR GOLF CLUB v. HARRIS
i. Lady was the president of a golf club. Because of this, she was contaced by
several owners of land that abutted the golf course about possibly buying the

69

land. Harris decides to buy the land herself rather than the Club . . . she did not
disclose this to the Board. She later decides to develop the property and
1. The corporation sues her for stealing a corporate opportunity.
2. The issue is whether she usurped a corporate opportunity.
ii. The Corporate Opportunity Doctrine
1. RULE A corporate fiduciary has a duty of loyalty that includes not
taking any corporate opportunities for personal profit
2. Tests
a. Line of Business Test
i. A fiduciary cannot take an opportunity that is the same
line of business as the corporation if the corporation is
financially able to undertake it.
1. The question is whether the opportunity was so
closely associated with the existing business
activities as to bring that transaction within the
class of cases where the directors transaction
would throw him into competition with his
company.
b. Interest or Expectancy Test (TEXAS)
i. Asks whether it could be expected by the corporation
that this was an corporate opportunity as determined by
its existing business relationships
1. Proved through using minutes at a meeting that
there was some evidence that the corporation
was at least thinking about the opportunity
ii. Favorable to corporation
c. ALI Test
i. A corporate opportunity is either:
1. 1) An opportunity that either
a. comes to your attention in your
capacity as officer/director; or
b. you use corporate assets to discover the
opportunity
2. 2) Anything closely related to their business
ii. IF it is a corporate opportunity, the officer/director can
bring the opportunity to the Board
1. The board then decides whether to pursue it or
not
2. If it is not brought to the Board then entire
fairness standard applies
iii. No financial ability defense
1. The policy behind this decision was that th
executive is too closely related to the financial
well-being of the corporation . . . it gives them
an incentive not to use ingenuity in deriving
funding for a given project.
iv. RAG likes this test
1. It follows all of the other duty of loyalty law:
a. Informed/disinterred BJR
b. Interested/biased entire fairness
2. It also broadly defines corporate opportunity so
as to encourage disclosure ot Board
iii. The court decides to adopt the ALI test and apply to these facts

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V.

1. See RAG argument for justification for this rule over other forms of the
rule
2. REMEDY Find that president holds the land in constructive trust for
the corporation, then have her convey the land to the club and have the
club pay her for it.
d. Delaware Corporate Opportunity
i. Guth Test
1. RULE a corporate officer may not take a business opportunity for his
own if:
a. 1) The corporation is financially able to exploit the opportunity
b. 2) The opportunity is within the corporations line of business
c. 3) the corporation has an interest or expectancy in the
opportunity, and
d. 4) By taking the opportunity for his own, the corporate fiduciary
will be placed in a position inimicable to his duties to the
corporation
2. Defense: director/officer may take the corporate opportunity if:
a. Corporation not financially capable;
b. Opportunity was presented to the director/officer in his
individual and not his corporate capacity;
c. The corporation holds no interest or expectancy; AND
d. The director has not wrongfully employed the resources of the
corporation in pursuing or exploiting the opportunity
ii. Analysis
1. Is it a corporate opportunity?
a. Line of business test
b. Interest or expectancy test
c. NOTE No factor is dispositive . . . look at totality of
circumstances
2. Is there an affirmative defense?
a. Corporation has bypassed this opportunity or ones like it in the
past
b. Financial inability
3. If it is a corporate opportunity and there are no defenses, has the board
approved or rejected the transaction?
e. IN RE EBAY
i. Court finds that directors violated their fiduciary duty by being compensated
with IPO-price shares from the investment bank for using them in an acquisition
of PayPal.
1. Even though this wasnt a corporate opportunity, this doesnt mean that
they didnt violate their fiduciary duty to the corporation.
a. See Hawaiian Case above
i. Relies on Agency law just like Hawaiian Case
Duties of Controlling Shareholders
a. ZAHN v. TRANSAMERICA CORP
i. The issue is what duty a controlling shareholder has to the minority shareholders
1. RAG Can we really call this a fiduciary duty? No
a. A fiduciary duty involves selfless protection of anothers
interests . . . but these are two competing investors, so the duty
clearly cannot be called fiduciary.
ii. Transamerica was the controlling shareholder. Held a redemption right on Class
B stock. Trans exercised it redemption right for $80/share, then liquidated the
company at a value of $240/share.

71

1. Minority (Zahn) sues because they lost out on a lot more money,
claiming that Trans had a fiduciary duty to deal fairly with them.
iii. Trans Argument
1. This isnt unfair because they were merely exercising their contractual
rights afforded to them in the shareholders agreement
a. They werent doing anything illegal
iv. Court rejects Trans Argument
1. They did not disclose all relevant information to the minority
stockholders
a. Principally, that tobacco prices were going through the roof and
that they were going to get a sweet liquidation deal
2. Interprets the transaction as the majority stockholder telling the Board
what to do.
a. If they act as directors, then they have a fiduciary duty
i. The retort to this is that even when acting as a Board,
its not unfair for them to enforce contractual rights
3. The case seems to turn on a lack of disclosure of information
b. Duty of Disclosure by Controlling Shareholders Under DE Law
i. RULE Controlling shareholders must make full disclosure when they deal
with the minority
1. Examine what information the majority had and measure it against what
they gave to the minority stockholders, in a context which requires
complete candor
2. Must disclose information such as a reasonable shareholder would
consider important in deciding whether to sell or retain the stock
c. SINCLAIR OIL v. LEVIN
i. Sinclair owns 97% of the company which is a subsidiary/holding company, and
the public owns the other 3%.
1. Minority sues because they are angry about the amount of dividends
paid out by the corporation as wells as the fact that Sinclair was not
allowing corporation to expand.
a. Payments of dividends drained the corporation of available cash
that could be used for expansion
ii. Ps 1st Claim: Improper distribution of dividends that drained the company
1. Court has to decide if this is a self-dealing transaction:
a. Self-dealing Entire fairness
i. 1) Fair Dealing
ii. 2) Fair Price
b. Not Self-dealing BJR
i. Justify decision with a rational business purpose
c. DELAWARE TEST: Were all shares treated equally?
i. Delaware will never look beyond the effect the action
had on the shares themselves.
1. This is not the case in other states, who are
willing to look at the financial status of the
shareholders themselves rather than just at the
shares.
ii. Applying this test, the court determines that the shares
were all treated equally and therefore no self-dealing.
1. There was no benefit to the majority at the
exclusion of the minority
nd
iii. Ps 2 Claim: Sinclair usurped corporate opportunities of Sinven
1. There was no breach of corporate opportunity doctrine

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a. None of the opportunities came to Sinven, but rather they came

directly to Sinclair . . . and Sinclair had no duty to cut Sinven in
on the deal
i. The opportunity simply did not belong to Sinven
iv. Ps 3rd Claim: Sinclair set up a supply contract with Sinven where Sinclair
agreed to purchase all oil produced by Sinven. Furthermore, Sinclair did not
comply with provisions requiring them to buy a minimum and Sinven did not
enforce.
1. This is clearly self-dealing
a. Derived a benefit to the exclusion of minority shareholders;
furthermore they caused Sinven not to enforce its contractual
right of minimum purchases
i. They are getting non-competitive business from Sinven
which will greatly benefit their own business . . .
minority receives no benefit
b. Apply Entire Fairness:
i. 1) Fair Dealing
ii. 2) Fair Price
***NOTE: Compare this case to Nixon v. Blackwell and figure out how to make
the two compatible
d. KAHN v. LYNCH COMM
i. Alcatel held 43% of the outstanding shares of Lynch. Alcatel pushes board to
merge with one of their sister corporations instead of a third-party, but the
merger was not the highest price offered. Kahn claimed that Alcatel was a
controlling shareholder and therefore breached its fiduciary duty of loyalty by
conducted a self-dealing transaction.
1. Lynch forms an Independent Committee. IC rejects merger offer with
Alcatel sister company. Alcatel responds by making a cash tender offer
to acquire all of the stock in Lynch. IC ultimately accepts offer of
15.25/share.
a. Approved after Alcatel made a threat of a hostile tender offer
directly to shareholders
ii. Is Alcatel a controlling shareholder?
1. Argument Against
a. They can only elect 5 of 11 directors
2. Argument For
a. 43% is usually enough to be in control
b. They dominated the Board and used this to influence the
company
3. On remand, you would look at how often they got what they wanted . . .
if they usually got what they wanted, then they were controlling
a. There was evidence here that the Board did what Alcatel wanted
iii. Why is Alcatel an interested party?
1. SINCLAIR OIL STANDARD A party is interested if it benefits them
to the detriment of the minority
a. Always start with this standard
iv. Court states that Independent Committee did not revive the BJR in this case
1. There was some insinuation that committee was in bed with Alcatel on
this deal
a. Any notion of independence dissolved when the Independent
Committee gave in to the hostile takeover ultimatum
2. Entire Fairness standard still applies and the BOP is on D
3. What would they need to do to make this approved by the court?

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a. Hire independent investment bank that has never done any other
transaction for the company or the shareholder
b. Get independent lawyers
c. Appoint disinterested board members to the Independent
Committee
d. Keep negotiations at arms length
i. It is very important for independent committee to have
bargaining power
v. DE RULE In the case of a controlling shareholder, if you prove
independence, then the BOP will shift to the plaintiff to disprove entire fairness;
BJR is not revived
1. Entire fairness always applies in the case of a controlling shareholder
a. In order for BOP to shift, the controlling shareholder has to
show that approving directors were truly independent, fully
informed, and had freedom to negotiate at arms length
2. The policy behind this is that when a controlling shareholder is involved
in a deal, even when independent directors approve the deal, there is still
a threat of implied coercion
a. He is the 800-pound gorilla in the room
3. See summary on p702
***NOTE: Some states never revive the BJR, but merely shift the BOP in
all circumstances . . . DE chooses to only do this in the controlling
shareholder context.
e. JONES v. HF AHMANSON (California)
i. Company owns 85% of S&L. Transfers its shares to a holding company and
then takes the holding company public. This ruins the marketability of the
minoritys shares in the S&L. Majority offers to buy shares at fraction of their
value, but minority is essentially forced to sell because they have no market.
1. Why do this?
a. Its a way of leveraging your control because as long as you
retain 51% of the holding company, you still keep 100% of the
control of the S&L.
2. The issue is whether this was a breach of fiduciary duty by he majority
to the minority shareholders
ii. California is the only state that still follows the Equal Opportunity Doctrine
1. If you create a benefit for the majority, then that same benefit must
extend to the minority
2. RULE Any use to which the majority shareholders put the
corporation must benefit all shareholders proportionately and must not
conflict with the proper conduct of the corporations business
a. Ds Argument
i. They are only doing something with their own stock, so
this is not use of power over the corporation . . .
therefore, no equal treatment is required.
1. Minority only has the right to benefit from
corporate action
ii. This is like the Sinclair Oil argument above
b. Ps argument
i. You used you power to benefit yourself to the detriment
of the minority
iii. Court determines that the majority had a fiduciary duty to offer the same deal
with the holding company to the minority shareholders

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1. By excluding them, it because certain that no market would exist and

that they would effectively lose their investment . . . therefore they were
required to offer an equal opportunity to the minority
VI.

Sale of Control
a. ZETLIN v. HANSON HOLDINGS INC.
i. Zetline owns 2% of stock and majority owns 44.4%. In the sale of the company,
majority got more than double what Zetlin received ($15 to $7) as a control
premium. Zetlin sues because he think he has an equal opportunity to share in
the control premium.
1. Court states the Zetlin is wrong and tha the has no right to control
premium
ii. RULE A controlling stockholder is free to sell, and purchaser is free to buy,
that controlling interest at a premium price
1. Control premiums are justifiable because the purchaser is acquiring
control of the corporation
a. Benefits:
i. Managers will do what you say
1. lowers agency costs and risk
ii. Can replace management
iii. Synergy with existing business
iv. Self-dealing (legally)
2. This is a property right of the majority and therefore, the minority has
no right to share in it
Exceptions to the Zetlin Rule
b. GERDES v. REYNOLDS
i. Reynolds and Woodward sold their controlling interest in the corporation and
are defendants. P sues because they are angry that after the sale the new
controlling shareholders looted the company.
1. Sold stock at $2/share when it was really worth $0.06/share. This a
HUGE control premium
2. Purchasers ended up stealing about $900K
3. P claims that R&W had duty to investigate the purchasers and should
have known that they were frauds
ii. Court decides that seller had a duty to investigate the purchasers before selling
the shares.
1. Would have revealed that they had very little capital
iii. You can read this case two ways:
1. 1) Because of the character of the transaction and under the
circumstances, the sellers had an obligation to make a proper
investigation
a. Grossly excessive premium
b. Liquid assets (stocks, bonds, etc.)
i. No uniqueness
ii. Easy to steal
2. 2) There is always a duty to investigate potential buyer before
consummation of a sale
iv. Remedy
1. Two Parts
a. 1) Compensation for illicit premium paid
i. Have to return this even if there was no stealing, just
because it was gross overpayment
1. Viewed as an invitation to engage in selfdealing

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ii. Must distinguish between the good premium and bad

premium
1. The court allows for a very generous premium
of $0.75 even though only worth $0.06
2. Established through expert testimony
b. 2) Actual harm that resulted from the sale
i. They stole $900K, so sellers have to give this money
back to the corporation
v. DELAWARE RULE
1. There is a split of opinion:
a. Majority You only have to investigate when there is a red
flag
2. The supreme court has no yet ruled on this
c. PERLMAN v. FELDMAN
i. Majority sold control to customer of steel company for $20/share. Stock was
worth $12/share. P claims that this was a sale of a corporate asset in that they
could no longer set a monopolistic price on the market . . . instead they have to
settle for the competitive price
1. The issue is whether this is a sale of a corporate asset
ii. RULE You cannot sell a corporate asset when selling controlling stock . . .
therefore, the price cannot reflect this asset
1. This is because the asset belongs to the corporation
a. In this case, the asset is the ability to set the price and decide to
whom they would sell the asset.
iii. In this case, the court determines that the premium was for sale of this assets,
and therefore, the majority had to repay the premium to the corporation
1. The danger here is that the purchaser will sell the steel to itself at a
lower price than the corporation was getting before the sale.
2. The solution is that of the $8 premium, the court attributes $5.33 to the
license to steal and therefore requires them to pay this part back.
iv. NOTE: This is a prophylactic rule . . . so no harm has to result
1. They knew they were selling to a self-dealing company, so the danger
exists
2. This is selling a License to self-deal
d. BRECHER v. GREGG
i. Not covered in class
ii. RULE Sale of corporate office is illegal; You cannot sell your shares and
agree to resign for a premium
1. Whatever portion of the payment was taken as an incentive to resign
must be repaid
e. ESSEX UNIVERSAL CORP v. YATES
i. 28.3% stockholder sold shares, but the terms of the agreement included a clause
giving the purchaser an option to require a majority of the existing directors to
replace themselves, by a process of seriatim resignation, with a majority
designated by the purchaser.
1. The issue is whether this is a sale of corporate office
ii. RULE If sales of the business creates a transfer of complete control in the
company, then an agreement to have the board resign along with the transfer is
not improper
1. The logic is that the buyer should be able to gain immediate control and
be able to accomplish immediately what he achieve anyway if they
waited for director elections

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f.

a. As long as 28% of this company constitutes control then it

okay to have this requirement
2. This is different form a straight sale of corporate office transaction like
that in Brecher
iii. How do you determine control?
1. Look at the characteristics of the relationship between the seller and the
corporation:
a. Are there any other large shareholders?
b. How often has the seller got what they wanted in the past?
c. Have they eer lost control?
iv. DGCL 223 As long as the directors are all on board with the transaction,
this isnt a problem to have them resign seriatim, because as each resigns, the
rest will elect the nominated director.
General Overview
i. RULE Control is a property right of the majority shareholder which may be
sold at a premium. The premium is not required to be share with minority
shareholders because it is a property right belonging only to the controlling
shareholder.
1. Exceptions:
a. Sale of office without control (Brecher/Essex)
b. Sale of corporate asset (Perlman)
c. License to loot corporation (Geredes)
d. Self-Dealing Transaction
***REMEMBER: Nothing has to actually go wrong . . . these are
prophylactic rules that do not look at whether or not the corporation
was harmed.
2. Remedy
a. Seller will have to pay back to the corporation the part of the
premium that is illicit, plus any damages that may have resulted
to the corporation.
3. RAG: It seems that while the general rule is simple enough, the
exceptions are almost stronger than the rule. A seller can never be
completely sure that they are not doing something that violated one of
the exceptions . . . especially since the buyer doesnt have to have done
anything wrong
a. You can decide that the law has come down too far on either
side.

INSIDER TRADING (The first three sections are from pp 270-315)

I.
Shareholder Informational Rights Under Federal Law and Stock Exchange Rules
a. Securities Exchange Act of 1934
i. This Act created the SEC and gave them broad authority to oversee public
companies that issue securities
ii. Identifies and prohibits certain conduct
iii. Empower the SEC to require periodic reporting
b. Periodic Disclosure Under the 34 Act
i. 13 requires corporations subject ot regulation to file periodic statements
1. 10-K annual report
2. 10-Q quarterly report
3. 8-K within four days after specified events
II.
The Proxy Rules (I): An Introduction
a. Terminology
i. Proxy Holder a person authorized to vote shares on a shareholders behalf

77

III.

ii. Proxy the written instrument in which such authorization is embodies

iii. Proxy Solicitation the process by which shareholders are asked to give their
proxies
iv. Proxy Statement a written statement sent to shareholders as a means of proxy
solicitation
b. 34 Act 14
c. Overview of Proxy Rules
d. Annual Report to Shareholders
The Proxy Rules (II): Private Actions Under the Proxy Rules
a. Rule 14a-9 Proxy Solicitation Rule
i. No false or misleading statements; no omissions of material information may be
made in any proxy statement
b. J.I. CASE v. BORAK
i. Supreme Court announces that private parties do have a cause of action under
14 despite no explicit authorization.
1. The logic of this case was that whenever you have a statute intended to
protect a certain class, then that class has a cause of action
ii. This logic is not the same today
1. Today, we say that unless Congress specifically allows for a private
cause of action, then you dont have one
a. Previous ruling were grandfathered in, so Borak is still the rule
c. MILLS v. ELECTRIC AUTO-LITE
i. Autolite issued a proxy statement for a vote on a proposed merger. P claims that
the proxy statement contained misleading statements. They claim that the
statement did not disclose that the board recommended the merger without also
disclosing that the board was dominated by Mergenthaler, the company that
Auto-Lite was being merged with.
1. Court has to determine what proof is necessary to establish a claim
a. Because the private right of action was read into the statute,
there is no guidance
ii. Court looks to common law fraud:
1. Elements
a. Lie
b. Material
c. Scienter
d. Reliance
e. Loss Causation
f. Damages
iii. Examination of the elements
1. Lie
a. Any misrepresentation, half-truth, or omission
i. Notice that pure omissions are not a lie unless you a
duty to the other to make disclosure
2. Materiality
a. Standard Whether a reasonable in the same situation would
have wanted to know the fact in making a relevant decision
i. You dont have to show that he would have changed his
mind, but just that he would have wanted to know
b. In this case, there are two things missing
i. 1) the statement about Mergenthaler controlling the
Board next to the part where they say that the Board
recommends the merger
ii. 2) the general disclosure of power

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3. Scienter
a. This is a tougher question as to what the standard is:
i. Some say negligence
ii. Some say knowing conduct
iii. Some say it depends on who you are
b. It turns on how you read a 10b-5 case and transfer it over . . . to
be covered below
4. Reliance
a. Standard had you known the truth, you would have acted
differently
i. You dont have to show true reliance because that
would be a difficult standard to meet
b. RULE Show that the proxy statement itself was an essential
link in the accomplishment of the transaction
i. In this case, reliance is satisfied because they needed a
66% vote, so they needed the minority to be on board
with the merger . . . therefore, the proxy statement was
an essential link
5. Loss Causation
6. Damages
a. Standard economic loss
i. Prove the difference between the stock received and the
stock given up
1. The problem with this is that if the deal is fair
you damages will be ZERO!!
ii. This cuts against the principle that a shareholder
deserves to not be lied to, but theres no way around it
iii. If you can get to a court fast enough, you would be
entitled to an injunction until proper disclosure is made,
but this is unlikely
d. VIRGINIA BANKSHARES v. SANDBERG
i. Directors issued a proxy statement in connection with a pending merger. The
statement said that directors approved the merger because of the opportunity for
minority shareholders to obtain a high value and that it was a fair price.
1. P claims that their statements were false because their real reason was
that they believed they had no alternative if they wanted to remain on
the Board.
a. D argues that their subjective opinions are not actionable
ii. How do you determine if this is a lie? How do you decide that the directors did
not believe what they were saying?
1. Look at the underlying fraudulent facts
a. The purchase price was only a premium at to the book value of
the corporation, but assets appreciated, so book value is not
fair or high
b. Market value was skewed b/c the purchaser dominated the
market
c. At the time they were telling their shareholders that $42 was a
fair price, they had a study saying that the company was
worth $60!
***Any reasonable shareholder would have liked to know this
information . . . they dont want to be treated like children.
iii. Reliance

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1. RULE Court says that it is an affirmative defense to show that they

could have blessed the transaction without the minority votes
a. If you own enough votes to do it anyway . . . then lie to your
hearts content!
b. This is an example of where the court cuts the uncertainty
question in the favor of the defendants rather than plaintiffs . . .
i. This is where their policy decision goes against strike
suits rather than misinformation
2. See Francis Case!!! (Reinsurance case where borther were stealing
money)
a. The court decided the same issue in the exact opposite way!

IV.

e. Causation
i. Mills Rule A plaintiff just has to prove materiality in order to prove causation
f. Loss Causation
i. There must be a connection between what you were lied to about and the nature
of you loss
1. Loss Causation is similar to proximate cause
ii. The question becomes whether there is a connection between the lie ini the
statement and the loss of money:
1. Courts go both ways
a. 1) Some only require it to be a result of the bad actions of
directors
b. 2) Some require it to be a result of the lie
***NOTE Ask for clarification on this point
g. What level of scienter is required?
i. Courts are split on the issue:
1. Gerstle (Friendly) negligence suffices to establish liability
a. Plaintiffs do not need to prove an evil motive . . . if its
misleading, then this is negligent and thats enough
2. Other Courts scienter is required; the rule is intended to go after
deceptive conduct, not impose strict liability
ii. The Supreme Court has never ruled on this issue
The Proxy Rules (III): Shareholder Proposals
a. Rule 14a-7 allows shareholders to get a shareholder list from the corporation in the
case of a proxy contest
i. But company has a choice:
1. Provide shareholder with an actual list; OR
2. Offer to mail the proposal for the shareholder at their own expense and
not provide a list
a. Companies usually choose this option
b. Rule 14a-8 Allows you to ask the board to include your proposal in their proxy
statement
i. Must be a substantial shareholder
1. Hold for more than one year
ii. Unless one of the various exceptions apply, the board will have to mail your
proposal along with their proposal
iii. Very technical exceptions:
1. Not a policy concern exception
a. RULE If the matter is not a policy concern, then they dont
have to include it in their proposal
i. Everyday matters do not have to be included
b. What is a policy concern?

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V.

VI.

i. EX: Affirmative action

1. right now the SEC says it doesnt have to be
included, but some court disagree
a. put under hiring and firing decsions
ii. EX: Employee compensation matters
1. although top executives may be an exception
Insider Trading: Common Law Background (p 748)
a. Duties of Directors and Officers
i. Insider Trading using information, acquired by way of position in a
company, about that company to trade securities for personal gain
ii. Majority Rule A director or officer of a corporation could trade in its stock
without disclosing material nonpublic information concerning the corporation he
had acquired through his position; insider trading is legal
1. Exceptions:
a. Fraud (includes false statements and half-truths)
b. Fraudulent Concealment
c. Special Facts even if director has no general duty to
disclose, there are case where, by reason of special facts, such
duty exists
iii. After this, Securities Exchange Act was enacted and the common law froze
b. Common Law Fraud Action
i. Elements:
1. Lie
2. Material
3. Scienter
4. Reliance
5. Loss Causation
6. Damages
Insider Trading: Securities Exchange Act 10(b) and Rule 10b-5
a. 10(b)
b. Rule 10b-5 It is unlawful for any person, directly or indirectly:
i. To employ any device, scheme, or artifice to defraud,
ii. To make any untrue statement of a material fact or to omit to state a
material fact necessary in order to make the statements made, in light of the
circumstances under which they were made, not misleading, or
iii. To engage in any act, practice, or course of business which operates or would
operate as a fraud or deceit upon any person . . . in connection with the purchase
or sale of any security
c. THE WHARF LTD v. UNITED INTL HOLDINGS
i. Wharf sold United an option to buy securities. United claims that Wharf never
intended to honor the option and had really good proof of it.
1. 3(a)(10) specifically enumerates an option as being considered a
security for 34 Act purposes
2. The issue turns on whether Wharfs secret intent not to honor the option
was a misrepresentation as described in rule 10b-5
ii. Elements of a 10b-5 Claim:
1. Lie
a. This is the real issue this case turns on
b. Court announces that selling an option while secretly intending
not to permit the options exercise is misleading because a buyer
normally presumes good faith
2. Material

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a. Whether a reasonable investor would want to know the

information in making an investment decision
3. Scienter
a. Knowingly or recklessly
i. Either you knew it wasnt true, or you simply didnt
care
4. Reliance
a. If you had known the truth, would you have acted differently
5. Loss Causation
a. Economic loss must be related to the lie
6. Damages
iii. This case seems to clearly satisfy the requirements of 10b-5
iv. Court shoots down Ds arguments:
1. This is an oral contract
a. The Act applies to any contract so there is not reason to
exclude an oral contract
2. The lie did not relate to the value of the security
a. Court says that 34 Act is not that limited, but even if it were, the
lie directly affects the value of the option if it is never intended
to be honored
i. Ds thinking on this is that the courts rule would open
the door to strike suits . . . this allows them to go after
anything that they felt seller subjectively never intended
to honor.
d. Private Action Under 10b-5
i. Same logic applies as in Borak
1. Courts probably wont extend any more private action rights
e. Standing Requirement (Blue Chip Stamps)
i. RULE Under the in connection with clause, only a person who has
purchased or sold stock has standing to bring a private cause of action
1. Policy
a. Discouraging strike suits
b. Although this rule allows some securities fraud to go
unpunished, it does help make strike suits less probable
i. NOTE: The current supreme court believes strongly in
cutting the law in favor of preventing strike suits rather
than securities fraud
2. The biggest impact of this rule is on those who claim that they would
have sold stock that they owned had they not been induced to retain the
stock by misrepresentations
a. Also prevents those who claim that they decided not to buy
stock based on the information
f. Scienter Requirement
i. Under Rule 10b-5
1. RULE proof of scienter is required; you must know what you are
saying and have the intent for it to deceive or manipulate
a. Logic
i. Rule 10b-5 prohibits manipulative and deceptive
actions
1. Therefore the seller must have this same intent,
or otherwise he will not be liable
ii. Under 14(a)(9)
1. The statute doesnt say anything about deception or manipulation

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2. Courts are split on what to do

a. Some court make the distinction on scienter and dont require it
under 14
b. Some court extend the 10b-5 rule
c. Some courts say that when an insider is sued scienter is not
required, but for an outsider it will be required
g. SEC v. TEXAS GULF SULPHER
i. Insiders bought a bunch of stock based on report that they were going to hit a
huge new mine, but they didnt disclose this information. There were rumors in
the market that they hit it big, but the corporation issued a press release stating
that they were not sure and need to conduct more surveys. Four days later, they
issued a release stating that they hat found 25 million tons!
1. The main issue is whether their pure omission before the first press
release was enough to violate Rule 10b-5; and whether the speculative
information in the survey was material
a. RAG: What Ds did wrong here was that they got bargain stock
at a price that didnt reflect what the market would have done
had they disclosed the discover of the mine
ii. 10b-5 Elements
1. Lie
a. A pure omission is not a lie . . . unless there is a duty to disclose
i. You could read this case in two ways:
1. There is a duty to disclose this information
2. There is a fiduciary duty to
purchaser/stockholders (state law source)
2. Material
a. Whether a reasonable investor would want to know the
information in making an investment decision
i. Speculative Information
1. RULE In judging whether speculative
information is material, you look at the
probability that the event will happen and
weigh it against the magnitude of the event if it
does happen
b. In this case, the report is clearly material given the magnitude of
its potential impact
i. The problem here is that the insiders knew it wasa
material
1. The firs thing they did was go call their brokers
c. How do you avoid this?
i. Disclose to investors, then explain to them that it is
speculative and there is no guarantee
3. Scienter
a. In this situation, it means that you knew you were holding
information that was potentially valuable to sellers, but did not
do anything to disclose it
4. Reliance
5. Loss Causation
6. Damages
iii. When may insiders act?
1. RULE Before insiders may act upon material information, such
information must have been effectively disclosed and the market must
have time to absorb the information

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a. They have to wait for the public to digest the information and
adjust the market accordingly
iv. Execs accepted options from the company after they knew of the potential of the
mine
1. Only the top executives will be liable because they are the ones who
make the decisions about disclosure
a. The lower execs followed the instructions of the top execs
h. SEC v. ZANDFORD
i. Zanford got people to set up discretionary investment accounts for him to
manage and he subsequently siphoned off all of the money.
1. Client sues him for securities fraud under 10b-5
ii. The issue is whether this activity was in connection with the purchase or sale
of a security
1. D argues that it does not satisfy the in connection with requirement
a. The sale of securities was merely incidental to the fraud of
stealing their money.
b. No manipulation of the securities
i. No relation to market integrity
iii. Court adopts a broad reading of the statute
1. RULE As long as buying or selling securities is somehow related to
the fraud, then it will qualify
a. In this case, the sale of securities was required to steal the
money, so it is considered to be in connection with
i. It is enough that the scheme to defraud and the sale of
securities coincide
i. BASIC v. LEVINSON
i. Company was in negotiations to merge for two years; during this time, they
repeatedly and explicitly denied being involved in any merger. There was
excessive trading in their stock and they continued to deny knowledge of why
there was unusual activity. Shortly thereafter, they announced the merger to the
public.
1. The question is whether this is a fraud under 10b-5
ii. Elements
1. Lie
a. Is this an affirmative misrepresentation?
i. Yes the knew negotiations were going on, but still
denied them
ii. No the market can react because of any number of
factors
1. Therefore, we dont know is literally true . . .
but they have a pretty good reason to suspect
why there was increased activity
b. This is probably closer to a half-truth
i. They know merger negotiations often leak, so their
saying they dont know, while technically accurate, is a
half-truth because they have a pretty good idea
2. Materiality
a. Standard there must be a substantial likelihood that a
reasonable investor would consider the information important in
making their decision
b. TEST

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i. Look at the likelihood that the event will take place

TIMES the impact that the contingent possibility will
have on the market (TSC Industries)
1. EX: 10% chance of stock going up $100 equal
$10/share
a. If stock is worth $10 the is clearly
material, but if stock is worth $10,000,
then it might not be material
ii. In this case, its clear that they should have disclosed.
There was an increase of $26 and even if there was only
a 10% chance of it going through this is still a value of
$2.60 which is more than 10% of the initial value
c. Court rejected the Agreement in Principle Test
i. The benefit of a test like this is it provides more
certainty for execs than the TSC Test . . . but the court
wants to encourage early disclosure so that investors
can make their own informed choices.
***NOTE: this is an example of where the cour favors
strike suits . . . a soft rule increases settlement value for
plaintiffs
3. Scienter
4. Reliance
a. This is the biggest difference between common law and
statutory actions
b. Common Law Need honest-to-goodness reliance
c. 10b-5 Two exceptions reliance
i. Fraud on The Market Theory
1. Shareholders are entitled to rely on the efficient
market price, and when you withhold
information or disclose misstatements, then that
is a fraud on the market and reliance is not
required
ii. Where a duty to disclose has been breached
1. Remember there is typically no duty to disclose
for insiders
d. Court announces that there will be a presumption of reliance,
with the BOP on the defendant to disprove
5. Loss Causation
a. Test Did the misstatement cause their loss?
6. Damages
a. See remedies below
iii. Standing
1. The first trade misstatement was made on 10/21 . . . can a person who
bought on 10/20 sue? NO
a. The company has no duty to disclose the information so long as
it is not trading itself, but if company is not trading it has no
duty.
2. The class begins on 10/21
iv. Solution
1. Can you say No comment?
a. PROBLEM: You have to tread a very thin line with this one
i. This is a half-truth unless you uniformly respond to all
inquiries with no comment

85

j.

k.

l.

m.
n.

o.

ii. You cant say no comment in annual reports

2. The safe thing to do is to admit you are in negotiations, but to say you
are not sure of the likelihood of its consummation, but the runs the risk
of killing the deal
3. Scienter Defense
a. This is theoretically possible if you honestly believed them not
to be material and had no intent to deceive or misrepresent
Fraud on the Market
i. When you withhold information, this means that the market is not trading at an
efficient price, therefore you are committing a fraud on the market.
1. Because shareholders rely on the efficiency of the market, this is enough
to constitute reliance
Loss Causation
i. The defendants wrongful act must not only have cause the plaintiff to buy or
sell, but it must also have been the cause of the plaintiffs loss on the security
1. This standard seeks to prevent plaintiffs from being able to recover for a
loss caused by other market risks
Reliance
i. Two exceptions to proving reliance:
1. Omissions
a. RULE All that is necessary to prove reliance is that the
plaintiff prove the facts withheld be material (Ute, 803)
i. Derived from the idea that they have a duty to disclose
and did not
2. Misrepresentations
a. RULE Fraud on the market; as long as info was material,
reliance will be satisfied
i. Exceptions:
1. Where there is no well-developed market
2. Face-to-face misrepresentations
Forward-Looking Statements and the Bespeaks Caution Doctrine
i.
PSLRA (Pleading)
i. Plaintiffs who allege securities fraud must state with particularity facts giving
rise to a strong inference that D acted with requisite state of mind
1. Scienter problem how much to satisfy?
a. Old Test: plaintiff can show direct evidence of scienter, or that
the defendant had the motive and opportunity to commit fraud
i. There has been debate after PLSRA as to whether
Congress adopted this standard and the conclusion was
that it probably didnt change much
ii. REMEMBER: You have plead with particularity and even scienter with
some particularity
1. The problem with this is that you have to do this BEFORE you have
done any sort of discovery
a. This is another place where the policy decision has come
down in favor of preventing strike suits
Aiding and Abetting Liability Under Rule 10b-5
i. There is no aiding and abetting liability on a person under Rule 10b-5
1. However . . .
a. This doesnt foreclose the chance that secondary actors cannot
be held primarily liable under 10b-5

86

i. This would include lawyers, accountants, etc. as long as

they meet the 10b-5 test
ii. RULE If you pass a statement on to the company understanding that it would
then be passed on to the market, then you yourself can be liable
p. Remedies in Private Actions
i. Damages
1. Out-of-pocket Measure (Tort)
a. Allows P to recover the difference between the price paid for
and the true market value of the security
i. Effect is put P back into the same position he was in
before the fraudulent transaction
ii. EX:
1. Seller lies to buyer and claims that the value is
at $100; Stock is really worth $70
a. Out of pocket damages would be $30
2. Benefit of the Bargain Measure (Contract)
a. Gives P the chance to get the difference between value
represented and the real value; put him is the position he would
have been in had the representations been true
i. Exactly like expectancy damages in contract
ii. EX:
1. Seller states that value is $120, but he will sell
for $100; its really worth $70
a. Benefit of bargain damages would $50
b. This adds another $20 to the damages
than would have been recoverable
under out of pocket
3. Most courts view securities fraud as being more like contract
relationship rather than a tort relationship
a. viewed as a contract because they were induced to sell through
representations
b. If you are a defrauded seller, you can only get out-of-pocket
damages
ii. Recission
1. Not available for publicly held corporations because there is always an
adequate remedy at law since the stock is relatively liquid
a. Seller can cover, and the buyer can sell
2. Closely Held Corporations
a. Recission is available because often there is no market where a
defrauded seller/buyer can remedy the situation
i. Where the shares or money would simply be returned to
the aggrieved party
q. CHIARELLA v. UNITED STATES
i. D worked at a financial printer and had obtained information through some
merger documents he was preparing. H ebought a bunch of the stock and was
subsequently charged with violating 10b-5.
1. D claims that his actions do not satisfy the Lie requirement
a. Claimed that his silence was not a violation because he worked
for the buyer and therefore had no duty to company and hence
no duty to speak
ii. Court states that if there is no duty to disclose under state law, then there is no
duty to disclose under 10b-5

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r.

1. RULE In non-disclosure cases, there can be no fraud absent a duty

to speak
a. Insiders have a duty because they have an obligation to their
companys shareholders
b. Outsiders dont have this same duty
iii. Court finds no duty to disclose in this case
1. There was no duty extended to the selling company because he had no
prior dealings with them, he was not their agent, he was not their
fiduciary, and was a complete stranger to the sellers
2. They refuse to extend such a broad duty . . . it must arise from a specific
relationship
a. They dont want to rely on an integrity of the markets theory .
. . but rather look for a duty
iv. RULE A duty to disclose does not arise merely from possession of nonpublic market information; there must be a specific duty to the
company/shareholders
1. Therefore, the printer gets off the hook even though everyone knows
what he did was wrong.
2. This result has its roots in Texas Gulf Sulphur Case
a. They said in that case that duties to disclose come from state
law, instead of from the securities laws
b. Had they said that duty comes from securities laws, it would be
easier to find a duty here because you could say that the policy
of Securities Exchange Act is to protect the integrity of the
markets.
i. State law requires a specific duty under Texas Gulf, so
now we get a weird result like this
DIRKS v. SEC
i. D is a trader and he gets a call from a former board member telling him that
there was fraud going on at a Company by misstating the value of their assets.
The informant had previously gone to the news, insurance commission, and
SEC, but they all dismissed his claims. D investigates and discovers that the
claims are true, so he calls all of his buddies and they sell their holdings in the
company.
1. D charged with 10b-5 violation by SEC
a. SEC wants a rule that states where tippees come into
possession of confidential material information from an insider,
then the tippee steps into the shoes of the insider.
i. This rules would make the case easy because the tipper
directors had a fiduciary duty to the corporation and did
not publicly disclose
ii. The issue in this case is whether Dirks can be liable in light of the fact that he
and his buddies hold no duty to the corporation because he is an outsider.
iii. Court reiterates the Chiarella Rule that absent a duty to disclose, trading on nonpublic information will not violate 10b-5
1. TEST for tippee liability
a. 1) Insider must breach his fiduciary duty;
b. 2) The tippee must know or should know that there has been a
breach of that duty;
c. 3) The insider must benefit personally from his disclosure
i. Payment
ii. Reciprocal relationship
iii. Tippee is a donee (relative or friend)

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2. Court also closes another Chiarella loophole: Quasi-Insider Doctrine

a. RULE In the case of attorneys, accountants, underwriters,
etc., they cannot trade on the information because they have a
confidential relationship with the corporation
i. When info is revealed legitimately they are treated as if
they are insiders . . . different form Chiarella situation
iv. Tippee Liability
1. Tipper is liable for all foreseeable damages
2. Tippee is liable for all damages as a result of their actions
a. Remember in this case, that Dirks was both a tipper and a tippee
s. UNITED STATES v. OHAGAN
i. OHagan was representing Grand Met while they were buying Pilsbury. He
went out and bought a bunch of Pilsbury options and made a ton of money on it.
1. He is charged with violations of both Rule 10b-5 and Rule 14e-3(a)
2. The issue is whether he violated 10b-5 in light of the fact that his duty
ran to the acquiring company rather than the acquired company.
ii. Court says that a conviction is proper under the Misappropriation Theory
1. Misappropriation Theory a person violates 10b-5 when he
misappropriates confidential information for securities trading purposes,
in breach of a duty owed to the source of that information
a. The principal has an exclusive right to use the information
b. Punishes corporate outsiders not because of a duty owed to
the trading parties, but instead because of a duty owed to the
source of the information.
i. Essentially, you find a LIE by seeing if the party lied to
someone else other than the selling person
c. LOOPHOLE: Full disclosure forecloses liability under the
misappropriation theory
i. So theoretically, OHagan could go tell the law firm and
his client that he was going to trade on the information
and he would be relieved of liability under this doctrine.
***RAG: It seems that because of this exception, we are
really punishing him for a breach of his employment
contract and professional responsibility rather than a
breach of 10b-5
iii. In this case:
1. OHagan had a duty to both his cleint as well as his law firm
a. Because he impliedly represented that he would keep
information about the merger confidential, the misappropriation
theory places liability on him for breaching this promise
iv. 14(e) Violation
1. Rule 14e-3(a) It is illegal for any person to trade on any material
nonpublic information concerning a pending tender offer if receives that
information from an insider of either the bidder or the target
a. Hes obviously guilty, but the question is whether or not this is a
permissible rule
2. This is a prophylactic rule to prevent any chance of wrongdoing
a. Under 10(b) this wouldnt be allowed because of scienter
language in the statute
b. But 14 has broader language, and therefore its okay to have
this rule
i. RAG: This is the rule argued for by SEC in Dirks!!!

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1. See above (If you get information from an

insider, then you cant trade)
3. RAG: What the court has done now, is create a bunch of artificial
distinctions:
a. EX 1: You hear about a tender offer over dinner by chance
i. You cant trade because violation of 14
b. EX 2: You hear about the development of a new product over
dinner by chance
i. Trade to your hearts content . . . but dont forget to call
RAG first!
ii. Not a violation of 14
iii. Not a violation of 10b-5 because no duty to disclose
***Given the funny outcome of the two examples above, this might
lead us to say that it better to just state that Chiarella was wrong,
and Texas Gulf had it right the first time when they looked for the
duty based on the policy of federal security laws rather than a state
law duty.
t. Liability for Insider Trading
i. RULE Insider is liable to everyone who traded contemporaneously with
him
1. Includes all people who traded between the time of the transaction and
the time of disclosure
ii. LIMITS
1. Buyer
a. Maximum amount of liability is any gain made from the
purchase
2. Seller
a. Maximum amount of liability is the amount of loss they avoided
by selling early
***Damages are split pro rata between the other trading parties
u. SANTA FE INDUSTRIES v. GREEN
i. Santa Fe acquired Kirby Lumber stock, and then later executed a short-form
statutory merger. Minority got $150/share (going-concern price), but thinks that
they should have gotten $640/share (asset value).
1. P claims that this was misleading under Rule 10b-5
ii. P has state actions:
1. Breach of Fiduciary Duty
a. Unfair price
b. Theory Santa Fe owed a fiduciary duty to minority
shareholders as a controlling shareholder to get the highest
possible price
2. Appraisal Remedy
a. If you dont like the merger price, then you have the option of
asking for an appraisal
iii. P chooses to bring a 10b-5 action because they thought the practices were
manipulative
1. They claim they were forced to accept an artificially low price
a. Form of fraud
2. Court disagrees
a. RULE In order to fall under the ambit of 10b-5 the conduct
alleged must be fairly viewed as manipulative or deceptive
iv. The conduct here was neither deceptive nor manipulative

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VII.

1. In this case, Santa Fe disclosed all relevant information and fully

complied with the statute
a. Just because they may have breached their fiduciary duty
doesnt mean that their actions were deceptive or manipulative
2. Non-disclosure is always an element for fraud . . . no fraud without nondisclosure
a. So if all you are worried about is fairness of price, then there is
not a 10b-5 action because you need to show some form of
manipulation, which involves non-disclsure
3. What would be manipulative in this situation?
a. Wash Transaction Genrating an appearance of interest in
stock by buying and selling stock
i. Despite the fact that everything is on the table, they are
manipulating the market
v. Furthermore they have adequate state law remedies
1. If you granted P their claim, this would be allowing state law actions
into federal court
v. GOLDBERG v. MERIDOR
i. Despite the reluctance of Santa Fe to extend state law actions to 10b-5 actions,
this isnt exactly the case.
1. Courts allow derivative actions under 10b-5 in cases of non-disclosure
ii. RULE You can still challenge a transaction where there has been some
sort of misrepresentation/non-disclosure that caused the loss to the
shareholders despite the availability of a state law claim
1. Santa Fe is distinguished because there was no deception since they
had disclosed everything, hence no misrepresentation
iii. The circuit courts split three ways on the strength of the state law claim:
1. The claim must be colorable
2. You have to prove that there is a substantial chance that you will win
your state law claim
3. You have to prove that it was more likely than not that you would win
your state law claim
a. The problem with this last reading is that it overrules a great
deal of Santa Fe
Liability for Short-Swing Trading Under 16(b) of 34 Act
a. 16(a) requires covered persons in covered companies to disclose any changes in
their beneficial ownership of securities by reporting to the SEC within two days of the
trade
i. Covered Company
1. Required to register under 34 Act; or
2. Traded on any national stock exchange; or
3. More than $10M in assets and at least 200 shareholders
ii. Covered Person
1. Directors, officers, 10% shareholders
***These are the people that are likely to have valuable information
b. 16(b) any profit realized by an insider from any purchase and sale of any equity
security within any period of less than six months shall inure to and be recoverable by
the issuer; no intent; can neither buy and sell, nor sell and buy
i. This is a strict liability rule on insider trading
ii. Any shareholder can bring an action on behalf of the corporation to enforce this
1. SEC does not have enforcement power
2. Plaintiff can own any security issued by the company
iii. Over inclusive

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1. Will inevitably include statutory insiders who have no inside

information
iv. Under inclusive
1. As long as you wait six months between transactions, there is no 16
liability
v. Not a due process violation
c. Computation of Profits Under 16(b) [GRATZ]
i. Gratz Rule Match transactions so as to maximize profits to the great extent
possible; from any given transaction you can look ahead six months as well as
back six months to find the most profitable match.
1. Mechanics
a. Take the highest sale price and match against the lowest
purchase price; then take the second highest sale price and
match against the second lowest purchase price; continue until
all are accounted for
2. EXAMPLE
a.
d. KERN COUNTY LAND CO. v. OCCIDENTAL PETROLEUM
i. Occidental buys 10% of Kern, then later buys 10% more and makes a tender
offer for a takeover. Kern negotiates a friendly takeover with Tenneco. Tenneco
tries to get rid of Occidental by offering to buy back the stock they are going to
receive from the merger.
1. Exchange
a. On the date of the merger there will be an exchange of Tenneco
for Kern stock
2. Option:
a. Before merger is finished, Occidental offers Tenneco an option
to buy the stock before the merger occurs
3. Timeline:
a. 5/19 merger announced
b. 8/30 merger consummated; exchange occurs
c. 12/11 option exercised
4. Both of these transaction are potentially in the window of 16 liability
ii. Assuming no option existed:
1. Have to determine what a sale is for the purposes of 16
a. Is the exchange of Kern stock for Tenneco stock a sale that
violates 16?
b. Court announces that in such unorthodox transactions, they will
in quire as to whether the particular type of transaction involved
is one that gives rise to speculative abuse
2. TEST A transaction is involuntary and exempt if:
a. 1) Whether they had control of the timing of the sale or merger
occurring
i. They abstained from voting on the proposal
b. 2) Whether they could have possibly had access to inside
information
i. They are clearly on the outside looking in
c.
iii. The option problem:
1. What was given was an option to buy Tenneco stock, not Kern stock,
after the merger was over and six months had passed.
2. Is giving the option a sale? NO

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VIII.

a. They are not a covered person with respect to Tenneco

because they are not 10% shareholders, officers, or directors
e. Insider Status at Only One End of a Swing
i. What happens you are not a 10% owners on both sides of the transaction?
1. 16(b) [last sentence] Rules do not cover any transaction where a
more-then-10-percent owners was not such both at the time of the
purchase AND the sale (or vice versa) of the security involved
a. You have to hold 10% before making the purchase to be
covered
b. If you sell enough to go below 10%, then go to sell the
remainder, these subsequent sales are not covered
c. Open question as to whether after a sale taking you below 10%
you can later repurchase stock and have it not be covered
ii. Directors/Officers
1. What if you buy as a director, then resign, then sell?
a. RULE You cannot benefit from a short-swing sale if you are
a directors, then resign, then sell
i. Policy is that it would provide a very easy way to get
around 16
b. But, purchases and sales by a director before/officer before they
came into office are not subject to 16
f. Officer under 16(b)
i. 3(b)(2) definition
ii. Rule 16a-1(a)
1. Today, the defition is more functional than formal:
a. If you hold a senior policymaking function, then you will be
deemed an officer for 16 purposes
i. Exception
1. If your policymaking function is minor
ii. This avoids relying on titles given to individuals
Common Law Revisited
a. DIAMOND v. OREAMUNO
i. The chairman of the board and the president sold off all of their before releasing
information that the companys earnings had declined 75%. They got
$28/share . . . after information was released, stock dropped to $11/share.
1. P brought derivative action seeking to have them account for these
profits to the corporation.
a. D claims that corporation was not harmed by the transaction so
they dont have to pay it back
ii. Can there be a common law fraud action?
1. NO . . . at common law, pure silence is not a lie because no duty to
disclose
iii. Can there be a 16 action?
1. NO . . . there isnt a pair of transactions to match. They only sold and
there was no buying within six months.
iv. They could bring a 10b-5 action:
1. Lie omission of material fact where they have a duty to disclose
a. Based on silence in this case
b. They have a FD to shareholders to disclose the information (see
Texas Gulf, _____________)
2. Materiality whether a reasonable investor would want to know the
information in making an investment decision (TSC Ind)

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a. They would obviously want to now that costs were way up and
revenues were way down.
3. Scienter state of mind/intent
a. For pure omissions, scienter requirement is much lower and it
can be inferred from their conduct that they had the proper state
of mind to deceive
4. Reliance
a. Fraud on The Market Theory (Basic)
i. They have a chance to rebut by showing that the drop
was due to something else, but not likely
b. Reliance presumed in material omission cases (Ute Case)
i. Either way, you can get these guys
5. Loss Causation
a. When announced, the stock dropped $17 . . . assuming there are
not other major events, it looks pretty easy int his case
6. Damages
a. Total amount of money:
i. The loss the directors avoided by selling
1. $17 x (number of shares sold)
2. All of the people in the class of plaintiffs will
split up the money ratably in accordance to
their volume of trading
ii. Class:
1. All investors who bought between the time the
directors sold and the time the information was
disclosed to the public
v. This is an easily winning 10b-5 case, but the lawyers brought a common law
case because Texas Gulf had just been decided and they were probably unsure of
the law, so they sought a common law state remedy
1. The court is sympathetic and creates a common law action as well
vi. Court grants cause of action
1. The Securities Act does not preempt any state law remedies
2. 10b-5 is not clear as to classes and remedies
a. Therefore it is appropriate to supplement with common law
cause of action
3. Breach of fiduciary duty cause of action:
a. Directors have a duty to the corporation and its stockholders to
act in good faith
b. They have hurt the corporation:
i. Bad press
ii. Marketability of stock is lower
iii. Investors will insist on higher rate of return . . . raises
cost of capital
4. Remedy
a. Portion of profits are to be returned to the corporation . . . pure
disgorgement
b. The remedy goes to ALL shareholders, including continuing
shareholders . . . this is a much broader class than what would
be available under 10b-5
i. Doesnt seem like a good way of compensating the
shareholders, but maybe you can argue that this is more
about punishing the directors.
vii. DELAWARE

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1. Accepts this rule . . . Brophy v. City Servs.

a. RULE A corporation can sue directors for insider trading,
even though it is not a common law fraud, but SHs cannot sue
directors
i. Based on agency theory
1. Public policy will not allow a employee of the
corporation to profit form the information
acquired from employer
b. MALONE v. BRINCAT (DE)
i. Directors were intentionally pumping up companys earnings and financial
figures, and shareholders equity.
1. P sues under state law for breach of fiduciary duty
a. Ct. of App. Said that they had to proceed under federal law
ii. Can you sue under 10b-5?
1. Yes (Basic v. Levinson)
a. Squarely establishes that you can sue a director for lying about a
companys prospects
b. Prove reliance through fraud on the market
iii. Can you bring a common law fraud action?
1. The lie element is satisfied, but the difficulty here is that you have to
prove honest-to-goodness reliance by the plaintiff
a. No exceptions like in federal law
b. Reliance is what makes this case difficult to prove
iv. Shareholders bring a class action on their own behalf for a breach of fiduciary
duty
1. Not all plaintiffs could properly be 10b-5 plaintiffs
a. This includes anyone who is suing claiming that they would
have sold had they known the truth
i. Blue Chip Rule only actual purchasers and sellers
can bring a 10b-5 claim
v. Court sanctions the common law cause of action
1. RULE Despite the availability of a 10b-5 action for some plaintiffs;
there is also a breach of fiduciary duty claim against directors as long as
it is plead correctly
a. Directors have a duty to disclose accurate material information
i. Derives from a combination of all three duties: care,
loyalty, and good faith
b. Plead
i. Misstatement in connection with seeking shareholder
action:
1. Direct suit
ii. Deliberate misinformation, but not seeking shareholder
action
1. Derivative suit only
2. Benefits to state law action:
a. Get punitive damages
b. Assert aiding and abetting claims
c. Lower standing threshold
i. Dont have to be a buyer/seller
3. Court says that there is a cause of action, but that the plaintiff need to
replead their case and state exactly whether it is a derivative or direct
action

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SHAREHOLDER SUITS
I.
Introduction
a. Derivative Suits
i. These are necessary because without them there is a host of issue that would
never get lititgated because the Board gets to decide when to bring an action
ii. What is bad?
1. A small shareholder can sue and impose large costs on the business over
a small amount of shares
2. Abusive strike suits that are only looking to settle
a. These are problems, but the tougher you are lawsuit
requirements, the more illegal conduct that goes unpunished, so
its a trade-off
b. Who can bring a Derivative Action
i. The plaintiff must be a shareholders at the time the action is begun and must
remain a shareholder during the pendency of the action
1. Shareholder
a. Defined broadly
i. Record ownership is not required; legal ownership is
not required
ii. Some say that shareholder in parent corporation can
bring suit on behalf of sub.
c. Personal Defenses
i. Shareholders are barred from bringing the suit if they either:
1. Participate din the wrong
2. Consented to the wrong or explicitly ratified it
3. Is guilty of laches
4. He acquiesced to the wrong (only some opinions)
ii. Tainted Share Rule if a shareholder is barred from bringing suit because of
a personal defense, so is any transferee of the shareholder
II.
The Nature of the Derivative Action
a. TOOLEY v. DONALDSON, LUFKIN
i. Court announces a test for whether a suit is direct or derivative
1. TEST The issue must turn solely on the following questions:
a. 1) Who suffered the alleged harm?
i. The corporation or the suing stockholders
1. Ask whether the SH can demonstrate that they
have suffered an injury not dependent on an
injury to the corporation
b. 2) Who would receive the benefit of any recovery?
i. The corporation or the stockholders, individually
2. In this case, DLJ did not suffer any harm because the corporate treasury
stays exactly the same . . . its the SH who suffers because they are the
ones not getting their money on time.
a. It obviously follows that the recovery will go to the
shareholders.
b. However, court says that there is no claim here because their
contractual rights never ripened
i. Dismisses the case
b. BARTH v. BARTH (Indiana)
i. Closely held corporation. P (Robert) claims that the president (brother Mitchell)
stole money from the corporation by paying himself excessive salary, using
corporate employees to perform personal services, lowering dividend payments,
and appropriating corporate funds for personal investments

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III.

1. P brings direct action; T.C. dismisses because it should have been

brought as a derivative action; Ct. of App reverse
ii. Court Announces a special rule for closely held corporations:
1. RULE In the case of closely held corporations, the court has
discretion is whether or not to require shareholder to proceed under a
derivative action; determined by whether or not the policy reasons are
implicated in allowing a direct suit
a. Test Does allowing a direct action:
i. Unfairly expose the corporation or the defendants to a
multiplicity of actions?
1. policy of derivative actions is to put all the
claims into one suit
ii. Materially prejudice the interests of creditors of the
corporation? Or
1. policy of derivative suits is to put money back
in treasury so as to keep it available to creditors
iii. Interfere with a fair distribution of the recovery among
all interested persons?
1. policy of derivative actions is to put it back into
the corporate treasury so that all wronged SHs
benefit from the recovery
2. THIS IS THE LAW IN TEXAS!
iii. The usual case where the court will allow a direct action is where all SHs are
parties, and the company is solvent
1. In this case, one SH is not a party to the suit, so its a little more efficient
to go as a derivative suit, but not really that big of a deal
iv. DELAWARE RULE
1. Delaware takes the view that you cant look beyond the injury to shares
2. Because of this principle, they take a strong view that this type of action
is derivative and that there are no exceptions
a. See Nixon v. Blackwell
3. Rule if the injury is to the corporation, the fact that it is closely held
is immaterial and the action must be brought through the derivative suit
vehicle.
c. Distinction between direct and derivative actions
i. Derivative
1. Does the alleged wrong deplete corporate assets?
ii. Direct
1. Does the alleged wrong interfere with rights that are traditionally
viewed as either incident to the ownership of stock or inhering the
shares themselves?
a. A mere drop in stock price is not enough
Individual (Pro Rata) Recovery in Derivative Actions
a. GLENN v. HOTELTRON SYSTEMS
i. Two 50% owners of a corporation. D steal $360K and P sues. P wants the
recovery ($180K) to be paid straight to him instead of $360K to the corporation.
1. The question is whether the court can order payments directly to P
ii. Court determines that the recovery ought to go back into the corporate treasury
1. Reasoning:
a. 1) Its a derivative suit . . . this is the norm
b. 2) If they dont pay back to corporation it is effectively like the
court declaring a dividend for the corporation
i. Dividend declarations should be left for the board

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IV.

c. 3) Protect corporations creditors

i. While there is no economic difference to either P or D,
the people that have the real interest at stake are the
creditors
iii. It does not matter that D gets a small benefit by putting it back in the
corporation; if the $360K goes back to the corporation, D still gets benefit of the
money that he stole
1. RULE Normally, all derivative recoveries must be placed back into
the corporation
a. EXCEPT: Where putting the money back would somehow be
unfair/inequitable
i. The court is always able to decree that the payments
should be made differently, but they hae to find some
unfairness before doing so
2. In reality, for liquidity purposes, D might actually prefer to keep the
$180K in his pocket and simply cut P a $180K check.
b. Individual Recovery in Derivative Actions
i. Pro Rata Recovery the recovery from a derivative suit goes directly to
certain shareholders based on their percentage of ownership of the corporation
1. Most often decreed where the great bulk of the corporations share are
held by person who could not bring a suit because they are subject to a
personal defense
2. Also can be decreed in cases where the injured corporation has been
merged
3. Another situation is where such relief is the most effective technique for
dealing with the parties varying equities on a case-by-case basis
a. See Perlman v. Feldman
i. Given to those shareholder at the time of the decree
The Contemporaneous Ownership Rule
a. DGCL 327 Plaintiff is a derivative suit must state that they were a stockholders of
the corporation at the time of the transaction
i. You have to own shares at the time of the complained-upon transaction to be a
plaintiff in a derivative suit
1. Also at time of suit
2. Also at time at end of suit
ii. Exceptions:
1. You inherited the shares
2. Continuing wrong
a. If the wrong is continuing, you can sue even if the precipitating
act occurred before you took ownership
3. 16(b)
b. BANGOR PUNTA OPERATIONS v. BANGOR & AROOSTOOK
i. Amoskeag owns 99% of BAR, purchased from Bangor Punta. They cause BAR
to sue Bangor Punta for alleged mismanagement that occurred while Bangor
Punta owned the 99% of the shares. BAR is suing in its own name and this is
not a derivative action.
1. The question is whether the court can looks at substance over form and
treat this as a derivative action
a. If so, they can invoke the Contemporaneous Ownership Rule
and dismiss the suit.
ii. The court decides to treat the transaction like a derivative suit
1. They dismiss because this is really Amo trying to get value for their
shares that they did not pay for:

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V.

VI.

a. 1) They sustained no injury because they acquired their shares

from the wrongdoers after the disputed transactions occurred
b. 2) They had received full value for their purchase price
i. There was no fraud in the sale of shares
2. Any recovery that BAR got from the suit would be a windfall to Amo
a. RULE The company cannot bring its own lawsuit in the case
where the controlling shareholder is causing it bring its own
action and the controlling shareholder did not own shares at
time of wrong
3. The key to this decision is that the purchase price was not overvalued,
and therefore they had received full value for their purchase price
c. RIFKIN v. STEELE PLATT
i. Same basic facts as in Bangor Punta. P bought company and then discovers
previous wrongdoing by seller. P sues for breach of fiduciary duty.
ii. RULE If the court finds that the sale price of the shares did not reflects
sellers wrongdoing, then the corporation may bring suit
1. If the sale price reflected the wrongdoing, then they have to dismiss the
suit and have the same result as in Bangor Punta.
The Right to Trial By Jury
a. Old Rule
i. No right to trial by jury because it was an action in equity
b. New Rule
i. The parties have a right to a jury where the action would be triable to a jury if it
had been brought by the corporation itself, rather than by a shareholder
1. Legal 1) Look at pre-merger custom with reference to such
questions; 2) the remedy sought; 3) the practical abilities and limitations
of juries
***NOTE remember that this only applies to federal proceedings and that state court
decisions vary
Demand on the Board and Termination of Derivative Actions on the Recommendation of the
Board or a Committee
a. Introduction
i. Old Rule
1. Before bringing a derivative action, a shareholder was required to make
a demand on the board, unless demand was excused
a. Demand was excused if it was futile
i. Futile if a majority of the board was interested
1. not clear what made a director interested
2. Consequences if demand made and rejected were unclear
a. Some court said that suit could not proceed if demand rejected
by majority of disinterested directors
b. Others didnt make it clear what should happen
ii. New Rule
1. A series of cases held that even when a majority of directors were
interested, the board could still appoint an independent committee to
consider whether the derivative action was in the best interests of the
corporation
a. If committee decided not in best interest, and they followed
adequate procedures the court could dismiss the action
b. MARX v. AKERS (NY)
i. IBM board gave itself a new compensation structure comprising a bunch more
money. P filed lawsuit against IBM and IBM directors without first demanding

99

ii.

iii.

iv.

v.

the board initiate the lawsuit. P claimed he was excused from making the
demand because the board engaged in self-dealing.
1. D steps is and moves to dismiss claiming P failed to establish futility
of the demand
Policy behind demand requirement
1. gives corporation an opportunity to correct wrong complained of
2. provides corporate board protection from harassment
3. discourages strike suits
Court takes survey of different state approaches to the demand requirement:
1. Delaware Approach
a. RULE plaintiff must set forth in his complaint the efforts
made by him to obtain the action the plaintiff desires from the
directors or comparable authority and the reasons for the
plaintiffs failure to obtain the action or for not making the
effort
b. Two-pronged Test
i. Plaintiff must allege particularized facts which create
reasonable doubt that:
1. the directors are disinterested and independent;
and
2. the challenged transaction was otherwise the
product of a valid exercise of business
judgment
a. BJR Test
2. Universal Demand Approach (ALI)
a. RULE requires a demand in all cases, without exception, and
permits the commencement of a derivative action within 90
days of the demand unless the demand is rejected earlier
i. Could still file suit before 90 days if irreparable injury
would result
b. If the board decides to bar the suit, then the court will review if
the decision was interested if they turn you down
i. Worries about the decision on the back end
c. TEXAS LAW
Court announces a slightly different standard for New York
1. RULE a demand is futile if a complaint alleges with particularity
that:
a. A majority of the directors are interested in the transaction, or
i. Can be interested either with self-interest or a loss of
independence b/c director is controlled by a selfinterested director
b. The directors failed to inform themselves to a degree reasonably
necessary about the transaction under the circumstances, or
c. The directors failed to exercise their business judgment in
approving the transaction
i. Must be so egregious on its face
2. Demand can be excused even if directors dont receive a financial
benefit if they are alleged to breach their duties of care and diligence to
the corporation
3. It is not sufficient to merely name a majority of the directors in the suit
a. This is conclusory and does not make them interested by default
Court finds that dismissal of suit was correct because P had no excuse for not
seeking demand

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1. Executive Comp.
a. Court states that executive comp scheme was not enough to
constitute interested board
i. Only three directors are alleged to have received the
benefit of the executive compensation scheme
ii. Also, the procedures were correct
1. not faulty accounting
iii. Nothing calls business judgment into question
2. Outside Director Comp
a. Comprised majority of board
b. Rule a director who votes him or himself a raise in
compensation is always interested because they will receive a
direct financial benefit from the action not shared by
stockholders
i. Court finds that a demand was excused on this count
vi. Despite demand being excused, they still had to allege a complaint
1. Just voting for compensation by directors is not enough to give rise to a
cause of action
2. Test
a. Business judgment rule
i. Sinclair Oil
ii. Cant apply because they have the
3. The allegations are too conclusory
vii. Court dismisses for failure to state of claim . . . what is wrong with this picture?
1. Places burden on P
2. The burden should be on the D to show entire fairness
3. Requires them to have proof at the pleading stage!
4. Whats really going on?
a. They didnt think that $55K to be an outside director was really
that bad
b. Thought that it was ridiculous
viii. Why did they sue for outside directors compensation?
1. Standard for NY excuse:
a. Plead with particularity:
i. Majority of board is interested
ii. Breach of fiduciary duty
1. duty of care, loyalty
iii. Egregious on its face
b. particularity you must have knowledge of some of the facts
that would show this
c. Although the majority of the directors have nothing to do with
bringing the claim, they have to determine whether to the suit
should go forward
i. Therefore you sue the all the directors to make them
self-interested
ii. The court does not want to allow this because it
completely does away with the demand excuse
requirement
2. DE Reasonable Doubt Test
a. Must allege facts that create a reasonable doubt that the
business judgment rule would protect the transactions
i. Disinterested/Independence
ii. Duty of care or loyalty (Smith v. Van Hawken)

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iii. Where the terms of transaction itself give rise to

inference that it went wrong (Walt Disney Case)
b. How would you show that someone breached their duty of care?
i. Smith v. Van Hawken: analysts, procedures, time to
look at it
3. Both states say that you cant marry the two suits
a. sue the self-dealing directors for self-dealing
b. sue the careless directors for breach of duty of care . . .
i. if they werent careless you cant join them and name
them as defendants simply to get around demand
requirement
c. Futility
i. The point of this rule is that if we would respect the decision of the Board to not
go forward with the suit, then you must make a demand
1. A conclusion that you will have to bring a demand is equivalent to
saying that you can never bring a suit
d. What does board do after the plaintiff has brought the case and futility has been
satisfied?
i. Independent Legal Committee
1. First create new directors seats (see above for process)
a. You hope Board can amend by-laws
2. Then appoint new directors to these seats
a. Look for independent people from outside the corporation
with no real financial interest
3. Perform investigation
a. Hire lawyers, accountants, etc.
i. None of them should have any previous ties to the
corporation
4. What kind of factors should they consider?
a. Cost
b. Time
c. Reputation of corporation
i. Value of stock
ii. Standard of Review:
1. Duty of Loyalty
a. Entire fairness
2. Duty of Care
a. Reasonable director standard
3. Business Judgment Rule
a. If any rational basis for their decision, the case will be
dismissed
b. It is difficult for a court to second guess the directors when they
make a policy decision
iii. This is what you do if there were not enough independent directors to bar the
lawsuit on the front end
1. NY regardless of when they act, independent directors acting with
due care can get the case barred (Auerbach)
e. AUERBACH v. BENNETT (NY) [After Demand]
i. Company disclosed that after investigating itself, it had discovered that members
of the corporation had made improper payments to public officials in foreign
countries totaling $11M. P filed suit and made a demand to the Board. Board
formed a special litigation committee comprised by three disinterested
directors. SLC determined that suit was not in best interest of the corporation.

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1. The issue is whether it was proper for the committee to make the
decision and whether the BJR should apply to a special committee
decision of 3 members for a board of 15
a. The committed felt that the suit would be a public relations
disaster
ii. Court says that the Business Judgment Rule is the standard of review of the
decision for the special committee
1. The right to sue belongs to the corporation and the decision to sue lies
within the judgment and control of the directors . . . they can properly
submit this to a committee
2. TEST
a. Were the members independent?
i. If independent, then cant look into the deliberations or
conclusions
b. Court may examine the methodologies and procedures
implemented
i. Good faith standard
3. Key factors in this case
a. Members were not on board at time of wrong
i. No prior affiliation
b. Extensive procedure for investigation
i. Lots of questions, outside counsel, etc.
iii. RULE If a disinterested group of directors decides not to bring the lawsuit
despite initial futility
f. North Carolina Rule the court will always make its own decision on the merits as to
whether the independent committee came to the proper conclusion
i. Assymetrical law if a majority of the directors were disinterested, then you
are barred; but if you get over the hurdle, the best the corporation can do is
petition the court and the court can decide whether the or not to believe them on
the merits
g. Court always looks at the same TWO THINGS:
i. 1) Whether there is a duty of loyalty problem
ii. 2) Whether there is a duty of care problem
h. ZAPATA v. MALDANADO (DE)
i. Board decided to make a cash tender offer well above the trading price. They
then accelerated some of the executive options to prevent them from paying as
much tax, but in the process caused corp to get less of a deduction. P sues
claiming a breach of fid duty
1. P made no demand
2. Corporation independently formed an Independent Investigation
Committee of two new directors to investigate the lawsuit.
a. Comm. decided that the suit should be dismissed b/c not in
corporations interest
3. The issue is what power a special committee has to cause dismissal of
derivative claims
ii. NOTE: The context of this question is when a board tainted by self-interest can
delegate the decision to a committee where demand on the board is excused
iii. Court says that they are permitted, but not required to determine whether the
decision of the committee was 1) careful and 2) loyal
1. The power is discretionary
iv. Court decides that in this context the BJR is not the proper standard
1. Analogy

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VII.

a. Where P moves to dismiss because of settlement the court gets

to examine the substance of the settlement
2. Court can substitute its own Business Judgment
3. TEST
a. 1) Inquire into the independence and good faith of the
committee and the bases supporting its conclusions
b. 2) The court should determine, applying its own independent
business judgment, whether the motion should be granted
i. Weighs the corporate interest in dismissal
ii. This means that an independent committee can still be
overturned by the court
v. Distinction between Demand-excused and Demand-refused
1. In the context of this case,
a. There is a funny distinction in this case
i. If the board is required to make a decision, then there is
more respect for that from the court
ii. If the board decision is discretionary, then it is accorded
less deference
iii. This pops up all over DE law
2. Maybe the decision is a different kind of self-interested transaction
i. DE Futility Test
i. Demand is futile if under the particularized facts, a reasonable doubt is created
that:
1. the directors are disinterested and independent, or
2. the challenged transaction was otherwise the product of a valid exercise
of business judgment
j. SUMMARY:
i. NY (symmetrical)
1. RULE If dismissal is approved by disinterested directors, then the
decision is protected under the BJR
a. Directors can bar you on the front end or the back end
i. Meaning that if you go to them in the beginning they
can bar you, or if you dont bring demand, they can
enter the suit and prevent the suit
b. Notice that this is far more protective of directors than DE
ii. NC (asymmetrical)
1. RULE never defer to a decision; court will always review the merits
of the case and not protect the decision of the committee with the BJR
a. No deference
iii. DE (partially symmetrical)
1. RULE Court is permitted, but not required to look into the merits of
the SLC decision in demand-excused situations
a. Demand-excused cases (Zapata)
i. Court can substitute its own business judgment in
reviewing SLC decisions
b. Non demand-excused cases (Martha Stewart)
2. In Delaware, you will always go straight to the court and never make a
demand on the Board before you file suit b/c if you make a demand that
wasnt required, the BJR will protect their decision
a. You would rather fight this battle in court than let the SLC make
the routine decision that it was not in the corporations best
interest
Demand on the Shareholders

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VIII.

a. The Rules Vary

i. Demand not required
1. You do not need to make demand on the shareholders
ii. Demand required; exceptions
1. Demand must be made on other shareholders subject to certain
exceptions
a. Exceptions vary:
i. Where wrongdoers hold a majority of the stock
1. recognized by everyone
ii. Where there is a very large number of shareholders and
the costs would be too high
1. this is through a proxy fight
2. not recognized by everyone (split)
iii. Where there is a nonratifiable wrong
1. EX: suppose claim is that corporation has
committed waste . . . can only be ratified by a
100% shareholder vote
a. If shareholder cannot ratify wrong, then
they shouldnt be able to say you cant
sue about it
2. Some court follow this logic and other say there
is a difference between reatifying and deciding
not to sue because of the other adverse
consequences . . . it is a different decision from
approving the transaction
b. Old DE Law
i. Followed FRCP 23.1
1. Must make a demand if necessary
c. New DE Law
i. Taken sentence out
ii. A fair inference would be that they did so in order to say that its never required
d. Federal Rules requirements for derivative suits are always determined by state
law . . . so in federal court, you will follow the state of incorporation
Plaintiffs Counsel Fees
a. Why do we make an exception for awarding attorneys fees in a derivative suit?
i. We want to encourage the bringing of meritorious claims, no matter how small
they are
ii. When a shareholder brings suit and wins, it makes sense that all shareholder
should bear the costs equally because they are all benefiting
1. SH is already taking the risk if he loses
b. SUGARLAND INDUSTRIES v. THOMAS
i. Trial court awards attorney $3.5M in atty fees. This lawyer did a lot of extra
work. He first put together syndicate to make a better offer price on the piece of
land. Then he was successful in getting an injunction against the corporation for
selling a piece of land for too law of a price.
1. The issue is whether the amount for attorneys fees was okay
ii. Two Approaches:
1. Percentage Recovery
a. Look at amount of benefit created for the company by the legal
services
b. Assign a percentage that the court feel is justified
c. BENEFIT
i. Focuses on the benefits created

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IX.

ii. Not a windfall because they cant overbill hours

iii. Encourages settlement, where lodestar encourages
working up a bill
2. Lodestar Method
a. Start with hours worked
b. Pick an hourly rate
c. Adjust in regard to performance, quality or work, etc. either
upward or downward
d. BENEFIT:
i. Compensates them for their costs only
ii. Does not encourage settlement
1. This can be seen as good or bad
iii. Not a windfall
3. The court can choose which one of these approaches best fits the
situation
iii. Court also determines that lawyers should be compensated for work done to
settle another dispute:
1. No damages were recovered, but they achieved harmony and claimed
that this is as much of a benefit as anything
a. Problem with this approach:
i. It encourages strike suit
ii. Corporations that pay shareholders to go away will now
have to compensate attorneys
2. Assigns $50/hour
iv. The key thing to remember here is that no matter which method the court uses,
they always have a general number in mind that they think is fair. Under
percentage of recovery method, they will always keep an eye toward the hourly
rate they are compensating at
1. Even in the second recovery of this case, they seem to assign $50/hr
more because they are conscious of what ehy got in the other portion
c. TANDYCRAFT (DE)
i. RULE Even in a direct action, the court may award attorneys fees if the
plaintiff confers a large benefit on other shareholders
1. Benefit
a. The definition is broad . . . can include a change in policy or
increased disclosure
Security for Expenses
a. Rule
i. If a state has this rule, they require P to popst a bond in the beginning of the suit
set by the court. If P loses, he will be liable for the other sides fees up to the
amount of the posted bond
1. Policy this is a strike suit deterrent
ii. DELAWARE: Does not have this rule
1. Would rather allow more suits than discourage them
2. Yet another example of DE not being the most corporate friendly state
a. DE likes having these cases brought because it results in
substantial income to the state when these suits are brought
b. Texas
i. Does not require any bond to be posted on the front end, however courts have
the power and discretion to require P to pay Corporations expenses if they find
that the suit is frivolous
1. Much like Rule 11 of FRCP
c. Other States

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X.

i. Some say that you dont have to post a bond unless you own less than given
percentage or dollar value of stock
1. The solution around this rule is to get enough plaintiffs to gether to get
over the threshold for posting a bond
d. ALCOTT v. MEV CORP.
i. RULE Attorneys fees for defense are recoverable only out of a security
bond; if not bond is posted, then no attorney fees can be awarded
1. Policy
a. P should have some sort of notice on how much it will cost in
the event they are going to lose
Indemnification and Insurance
a. Indemnification
i. DGCL 145
1. Must be eligible:
a. Office or Director
b. Other employee may be eligible
2. Different Categories
a. Must indemnify
i. If successful on the merits or otherwise
b. May indemnify
i. Acted in good faith a reasonably believed he was acting
in the best interests of the corporation
1. This means that they can limit it to less that this
c. Cannot indemnify
i. Where adjudged in the proceeding to be liable for
negligence or misconduct
3. The corporation has to make the decision as to whether or not to
indemnify:
a. 1) the board (if a quorum and independent)
b. 2) a special committee (if no quorum of independent directors)
c. 3) stockholders can approve
d. 4) independent legal counsel can issue a written opinion
***Delaware says that this applies to directors and officers in all contexts,
but other states say that it only covers them in their official capacity in
connection with their corporate functions and not purely personal matters
ii. WALTUCH v. CONTICOMMODITY SERVS.
1. The issue in this case is what constitutes successful or otherwise
under the indemnification statute
a. Court determines the following are all successful or
otherwise:
i. If case is settled and you dont owe anything
ii. If case is dismissed on procedural grounds
iii. Split decisions
1. partial mandatory indemnification for the part
that they are successful on the merits
b. The only question the court can ask is what the result was, not
why it was
i. Therefore escape form any adverse judgment will be
considered successful or otherwise
ii. In this case, the corporation paid the settlement and the
officer did not have to pay anything and was released of
liability under the particular claim

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XI.

1. Therefore, he was successful or otherwise b/c

he did not have to pay anything.
2. What happens where the director did not act in good faith but
nevertheless was dismissed from the case?
a. W argues that he is entitled to indemnification absent good faith
because AOI provide for it:
i. Cites (f) says that corp can indemnify for more
1. Problem is that (a) had good faith requirement
ii. Court reconciles the two by saying that (f) lets you go
beyond the rights granted by (a) but that you cannot
violate (a)s good faith requirement
Settlement of Derivative Actions
a. CLARK v. GREENBERG
i. P filed derivative action against officers of AGECO. He later settled the settled
the suit for a cash payment. Company purchased Ps shares for seven times their
market value.
1. The issue is whether the plaintiff has to account to the corporation for
money received in a settlement
ii. Court says that the money has to go to the corporation
1. He brought the suit on behalf of the corporation and therefore any relief
obtained should go to the corporation and then to shareholders pro rata,
based on their shares.
iii. This couldnt happen today because most states require court approval for any
settlement in derivative litigation
1. Settlement must be fair, adequate, and reasonable
a. Under this standard, any payment that doesnt go to the
corporation will not be approved by the court
b. FRCP 23.1
i. Requires all settlements to be judicially approved
ii. Notice must be given to shareholder
***Typically, most states have a rule similar to this
c. Wolf v. Barks
i. RULE Compliance with Rule 23 is require where the parties are not settling
the suit, but rather the claim on which the suit was brought
d. HYPO
i. Director sells property to a company and you think he was paid too much. You
bring a derivative action for BODL and BODC. Assume you dont have to
make a demand.
1. Directors bring in 3 new directors and they say theyll settle the claim
and then they say that derivative claim should be dismissed
a. Bd has ability to act for corporation and corporation release
claim through settlement and then dismiss the suit.
2. This type of agreement DOES NOT require court approval
a. Argument that court DOES NOT have to approve:
i. Rule 23.1 requires court approval for the suit, not the
claim and corporation just settled the claim
1. See Wolf v. Barks
a. Corporation can do whatever they want
with a claim
b. Argument that court DOES have to approve:
i. If you get rid of the claim, then there is no suit, and the
Wolf case puts form over substance, which is generally
disfavored

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ii. All states allow the Board to do whatever they want with a claim before suit is
filed
iii. Wolf does not leave you without any remedy
1. You can sue board for BOFD for settling underlying claim
a. But you wont win this b/c BJR protects the decision as long as
board was independent and acted with due care
i. Board will bring in new directors and form a committee
so they are are going to satisfy this
2. Many states remedy this dilemma by requiring review of settlement of
claims underlying derivative suits as well.
STRUCTURAL CHANGES
I.
Corporate Combinations
a. Sale of Substantially All Assets
i. DGCL 271 A corporation may sell all or substantially all of its assets upon
the approval of a majority of the outstanding shares of the corporation
1. Sale can be for money or other property
a. Stock of another corporation can be the consideration
2. Does not apply if sale is in ordinary course of business
a. EX: A real estate company that buys and sells real estate
3. The key issue is what constitutes all or substantially all of the
corporate assets
ii. HOLLINGER INC. v. HOLLINGER INTL
1. Company sought to sell its telegraph business, which was a whollyowned subsidiary of the company. It constituted of the companys
newspaper operations.
a. The issue is whether the stockholder of the parent should get to
vote on whether the subsidiary sells its business.
2. Court thinks that parents shareholders should get a vote in the matter
according to 271
a. This is not functionally different from parent making the sale
i. Parent directed and controlled the sale, and was a
signatory on the sale documents
b. Policy Holding otherwise would be exalting form over
substance and corporations would always be able to make an
end run around 271 requirements by merely putting assets into
subsidiaries and then making the sale
c. Court passes on making this the determinative ruling on the case
and instead looks at whether this is all or substantially all
3. The determinative issue is whether they sold all or subst all of their
assets:
a. Did not sell all because that would be 100%
i. This is only 50% of their newspaper business
b. Is it substantially all?
i. There is no necessary qualifying percentage . . . dont
want to encourage trying to get around the statute
ii. TEST (Gimble)
1. A shareholder vote is required if the assets to be
sold are (1) quantitatively vital to the operation
of the corporation and (2) substantially affect
the existence and purpose of the corporation
a. Is it quantitatively and qualitatively
important?

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c. Court is uncomfortable with the Gimble test because they that it

essentially rewrites the statute
i. It is more accurate to read the substantially all
language as merely preventing a company from retain
1% so as to avoid a SH vote
ii. Uses the test, but always keeps an eye on the fact that it
has to be substantially all
d. Court determines that this is not substantially all of the assets:
i. Quantitative: the sale was of 56% of the assets, but the
company will retain economic vitality
1. The other part of the business will still generate
good cash flow
ii. Qualitative: The sale doesnt leave the SH with a
qualitatively different investment
1. Does not strike at the heart of the corporate
existence
***Its an interesting question as to whether the Sup. Ct. will stand with
Gimble, or whether they will take a more plain language approach the way
that this court did.
iii. TEXAS:
1. You have to have a SH vote if you sell all or subst. all not in the
ordinary course of business
a. Sale is in OCB if you are left with any assets at all and you
dont dissolve
2. So by trying to avoid DE inquiries, they now allow end-runs around the
statute
b. The Appraisal Remedy
i. Introduction
1. Appraisal rights are given to SH because a sale of the assets is not what
they bargained for. Therefore, they should have the right to ask a court
to evaluate the value of their shares and order payment from
corporation.
a. SH will be entitled to this right even if the majority votes to
approve the transaction
ii. DGCL 262 Grants SH appraisal rights in listed situations: mergers
1. Must follow the statutory process
a. 262(a) requires:
i. Cannot vote for the transaction
ii. Make written demand on corporation asking for
appraisal not less than 20 days prior to the meeting to
vote on transaction
1. This is the one everyone forgets
b. 262(e) requires
i. Within 120 days you have to file with Ct. of Chancery
when you dont agree with corporation about
compensation of fair value of shares.
2. 262(h)
a. Court must determine the fair value by taking into account
all relevant factors
i. Allows court to use any factor that modern financial
people use to value the company
1. Includes Delaware Block Method, but does not
require it

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2. Many courts rely heavily on the discounted

cash flow method
ii. Does not include any value flowing from the transaction
1. This is because they cannot receive any benefit
from the merger
3. DE does not allow appraisal in sale of assets transactions
a. Only applies to mergers/consolidation
b. Therefore, the seller is usually going to be a DE corporation
where assets are involved so as to avoid
iii. No Minority Discount Rule
1. DE there is no discount for minority shares (Cavalier Oil)
a. You should simply value the company as a going concern and
divide according to shares
i. This is a substitute for merger consideration and there is
not minority discount in that context
b. Also can argue that the shares must given fair value and not
market value
i. So just because a discount might result from sale on the
open market does not mean that we should use it in this
context
1. The statute says fair value
c. Seen as giving a windfall to the majority
i. Transfer of wealth from minority to majority as a result
of an involuntary transaction seems inequitable
iv. PIEMONTE v. NEW BOSTON GARDEN GROUP
1. Review this case to see why SH got an appraisal remedy
v. CHARLAND v. COUNTRY VIEW GOLF CLUB
1. Review for minority discount discussion
vi. Exclusivity of Appraisal Remedy
1. Many state statutes say that appraisal is your exclusive remedy
a. DE has a common law rule stating the same thing
i. Limited to non-self dealing transactions
1. EX: Where 51% SH independently performs a
merger to squeeze out minority then you get to
challenge it under entire fairness (BOFD suit)
2. So if you can bring a BOFD action against
directors/officers, then you are not limited to
the appraisal remedy
ii. Efficient Market Exception
1. (((get notes from Scott)))
b. TX statute say that appraisal is the exclusive remedy absent
fraud
i. Not clear if this is the same as BOFD (no case)
c. Statutory Mergers
i. Classical Mergers
1. DGCL
a. 251(a)-(e) authorizes statutory mergers
b. 259
c. 260
d. 261
2. Introduction
a. Process:
i. Letter of intent is signed

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ii. Merger submitted for approval by Board and

shareholders
iii. Articles of merger are filed with secretary of state
iv. Stock or other consideration is issued by the surviving
corporation to exchange for stock of disappearing
corporation
v. Disappearing corporation is fused into the surviving
corporation and loses its identity
b. Abandonment
i. Authority is usually given to the boards of both
companies to abandon the merger at any time up to the
effective date of the merger upon the occurrence of
various conditions
c. Consolidation
i. Transaction where two companies fuse and form a new
corporation
ii. Small-Scale Mergers
1. DGCL 251(f)
iii. Short-Form Mergers
1. DGCL 253 In a parent-subsidiary merger, iff the surviving
corporation owns at least 90% of the outstanding stock, then no
shareholder vote is required.
a. Minority stockholders have appraisal right under 262
b. All that is required is a vote approving the merger by the
parents board
c. No rights for parents shareholders:
i. No vote required from parents SHs
ii. No appraisal right for parent SHs
d. Tax Aspects of Corporate Combinations
e. The Stock Modes and the De Facto Merger Theory
i. Types of Transactions
1. Stock-for-stock
2. Stock-for-assets
a. De facto Mergers
ii. HARITON v. ARCO
1. Stock-for-assets transaction where Arco sells all its assets for Loral for
shares of Loral. Arco then votes to approve dissolution and gives the
Loral shares to its current shareholders.
a. The issue is whether this is a de facto merger that triggers all of
the rights incident to a merger
2. If we respect the transaction on its face, what are the rights?
a. Arco:
i. Board
ii. 271 Majority of outstanding shares
1. No appraisal rights in DE
b. Loral:
i. Board only
1. They are merely buying assets, so this is an
ordinary business decision left to the Board
ii. No appraisal right
iii. No vote for stockholders
3. If this is a real merger, what are the rights?
a. Both sides have appraisal rights

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b. Both sides have voting rights for SHs

i. So a Loral SH may object to the form of the transaction
because they are cheated out of a vote
4. Court to honor the form over the substance of this transaction
a. They treat this like a true sale of assets
i. As long as it takes the form of a sale of assets and not
that of a merger, then the court will honor the form of
the transaction
b. Doctrine of Independent Legal Significance
i. This is a common thread all over DE law that dictates
that you treat each statute as independent of others
ii. This puts premium on clever lawyering because where
one form may be illegal under one statute, you can look
for another statutory form to accomplish the same thing
5. This is about DE being an enabling jurisdiction
a. They dont want directors living in fear of a court overturning
its transactions
i. Provides certainty that when they avail themselves of a
statute it will be honored
b. RULE There are no de facto mergers in Delaware!!
6. Liability Consequences
a. A benefit to structuring this deal as a sale of assets is that he
asset purchaser does not take on any liabilities of the previous
company
i. Under a merger transaction the successor company will
inherit all liabilities from the acquired company
***NOTE: Arco was the bigger company here but they are the sellers b/c
they are the Delaware company and a sale of assets does not trigger
appraisal rights under 271 . . . so the DE company will always be the seller
iii. FARRIS v. GLEN ALDEN CORP (PA)
1. List is the seller of the assets; GA is the buyer. List sells assets to GA
for 3.6M shares in GA; List then distributed GA shares to its
shareholders. List then disappears and the new company will come to
be held by List/GA shareholders.
a. This could have easily been a merger, so GA SH sues because
they did not get voting/appraisal rights.
2. Company rights under this form:
a. List
i. SH gets vote under 271
ii. No appraisal rights
b. Glen Alden
i. No vote
ii. No appraisal
3. The issue here is whether the GA shareholders should have got merger
voting/appraisal rights
a. NOTE: The GA shareholder actually got two chances to vote on
this deal:
i. 1) Had to approve amendment to AOI to authorize
issuance of more shares
ii. 2) NYSE Rule requires SH vote for any transaction
increasing your share by more than 20%
4. Court here uses the De Facto Merger Doctrine

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f.

a. RULE The court will look beyond the form of the transaction
and determine the substance of it by looking at the terms of the
agreement and the consequences
5. Finding a de fact merger is only the first step, now you have to ask
whether the investors should have merger rights
a. Test
i. Does the combination so fundamentally change the
corporate character of the surviving corporation and the
interest of the shareholder?
b. If it changes the character of the SHs investment, then they
should have appraisal rights
i. EX: When a whale swallows a minnow, there is no
change in the nature of the investment and appraisal is
not appropriate
c. Court determines that in this case, their investment has changed
enough:
i. 7 times the amount debt
ii. Lists directors will run the business
iii. New line of business
iv. Shareholders have a much smaller share in a much
larger company
6. Court determines that this was actually a merger and therefore GA SHs
should have had all of the rights afforded dissenting shareholders in a
merger
***NOTE: After this case, the PA legislature rushed in and changed this
outcome
iv. TEXAS RULE
1. Statute says that in an assets transaction, there are no de facto mergers
a. They copy DE on this one
b. RAG: Regardless of whether it is a race to the bottom or the top,
DE has won the race!
v. Survivors Liability to Transferors Creditors
1. Statutory Merger
a. The surviving company becomes liable by operation of law for
all of the transferors obligations, including those that are
contingent or undisclosed
2. Stock-for-stock Combination
a. The survivor may remains liable because the acquired
corporation is a subsidiary
3. Stock-for-assets combination
a. Survivor remains free of liabilities it does not expressly assume
because it merely engaged in a purchase
Triangular Mergers and Share Exchanges
i. TERRY v. PENN CENTRAL
1. Colt is merging with Penn Centrals subsidiary holding company, PCC.
Penn Central gives the holding company Penn Central stock. PCC then
gives Colt the Penn Central stock
a. 251(b) the consideration in a merger can be the stock of
any corporation or any other property they agree upon
b. What is really happening is that Penn Central is merging with
Colt
i. Butt the way it is structured Penn Central SHs do not
get voting or appraisal rights

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2. The issue in this case is whether Penn Central SHs should get merger
rights because it was actually a de facto merger
a. Remember that PC cannot cheat them out of their voting rights
b/c of NYSE rule, but they can cheat them out of their appraisal
rights
3. Court decides to respect the form of the transaction
a. Penn Central is not a party to the transaction
i. parties those companies that actually combine in a
merger
ii. Penn Central and PCC will both survive the transaction,
so Penn Central is not a party
b. Also points to the fact that PA legislature abolished the de facto
merger doctrine after Glen Alden Case
ii. Benefits of Triangular Merger:
1. Surviving parent companys SHs do not get appraisal rights
2. Subsidiary takes of the liability of the acquired company
***In Delaware, this form will be honored
g. Freezeouts
i. Freezeout Techniques
1. Freezeout a corporate transaction whose principal purpose is to
reconstitute the corporations ownership by involuntarily eliminating the
equity interest of the minority shareholders
2. Forms
a. Dissolution Freezeouts
b. Sale-of-Assets Freezeouts
c. Debt Merger
d. Cashout Merger
ii. WEINBERGER v. UOP
1. Cashout merger; Signal owns 50.5% of UOP and wants to acquire the
rest of the stock by completing a cash-out merger. Signal seeks to
consummate the cashout merger at $21/share
a. Mechanics of cashout merger
i. Cash is the consideration for the merger
1. 251(b) can use any property for
consideration in a merger
ii. Acquired company is merged into the buying company
1. Acquiring company is a majority stockholder in
the acquired company, so voting rights dont
matter
2. DE majority of outstanding shares approval;
board approval
a. Signal controls both of these
b. Because Signal can force the merger to occur at $21/share, the
dissenting stockholder in UOP only have an appraisal remedy
i. Fair Value proportionate share of company as a
going business
ii. But $21 is 50% more than what share are being traded
for so they probably cant do any better with appraisal
2. Because SH could not do any better, they bring a BOFD action:
a. Self-Dealing Transaction
i. Because we are dealing with a controlling shareholder,
the entire fairness standard will apply not matter what
they do:

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1. Fair Dealing
2. Fair Price
3. Entire Fairness Analysis:
a. Fair Dealing
i. There was evidence that this was not met . . . the
question is whether the process mimicked an armslength transaction
1. Preserve fairness in the process
ii. UOP directors who were also officers of Signal
performed a study saying that $24 would still be a good
deal for Signal . . . using UOPs information!
1. They did not share this info with UOP
iii. UOP hired usual investment bankers . . . not
independent ones
1. Provided a hurriedly prepared fairness opinion
iv. Proxy statement did not contain all material information
v. Very little negotiation as to price
***All of these factors lead the court to determine that the
deal was sort of shoved down UOPs throat
b. Fair Price
i. In the merger context, you would go through the same
process that you would go through in an appraisal
action
1. DE RULE all relevant factors in setting a
value
ii. If $21 is at leas what you should have been paid, then
you are going to get ZERO damages
4. The court thinks that this case fails miserably on the fair dealing portion,
but the fair price portion is not violated . . . so what do you do about a
remedy where there are not damages?
a. If the Fair Dealing portion of the fairness test is to have any
bite, then the rescissory damages should be avialable
b. Rescissory Damages
i. Asks what the shares would be worth if the deal had
never happened
1. No causation element!
ii. Two major problems with this remedy:
1. No causation element
2. No way to determine what the share would be
trading for
iii. RAG: Doesnt know of any case that actually used this
remedy, but Sup. Ct. here says that its theoretically
available and they continue to insist that it is
appropriate to compensate for the fact that the
transaction never should have happened in the first
place
c. Equitable Remedies
i. The corut could also theoretically ordern an injunction
if you got the court in time to stay the deal . . . almost
never possible
5. Court reject Independent Business Purpose Rule

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a. Rule in order to effect a merger, you had to show that it was

for a legitimate business purpose independent of a motive to
force the minority out
i. Court reject this in this case
iii. NOTE: Delaware Entire Fairness Test
1. Delaware conceives of the test as a unitary standard
a. This means that you should consider both elements of the test to
determine the overall entire fairness of the transaction
2. Court will think about fair dealing and then think about fair price and
then decide if it is entirely fair
a. EX: theoretically, a really good price would outweigh any unfair
dealing that occurred
***RAG: this is another reason justifying the proposition that all we really
care about is fair price . . . the courts would be better served by just ensuring
that SHs get a fair price and moving on. The hang up is that we want to
encourage proper dealing in self-interested transactions
iv. GLASSMAN v. UNOCAL EXPLORATION
1. Unocal elected to used a short-form merger through 253. The
question here is whether the entire fairness standard should apply in
light of the fact that the summary nature of the statute has no chance at
satisfying the Fair Dealing prong.
a. P is minority shareholder of the acquired company and claims
BOFD and lack of disclosure
2. 253 Where a parent owns at least 90% of subsidiary, they can
merger by simply filing the paperwork with the state and paying the
minority its cash interest
a. Minority stockholders are afforded appraisal rights under 262
3. Court recognizes that there is no way for a company using 253 to
satisfy fair dealing prong if the transaction is challenged
a. Court announces that entire fairness does not have to be
satisfied
i. 253 has to be read to obviate the requirement of fair
dealing . . . thats the purpose of the statute
b. RULE Absent fraud or illegality, appraisal is the exclusive
remedy available to a minority stockholder who objects to a
short-form merger
i. Only look at fair price, but can consider all relevant
factors
1. This means that if merger was effected right
before a positive development, the SH can
introduce this evidence in an appraisal
proceeding and the court can adjust upwards
v. SOLOMON v. PATHE
1. CLBN was controlling shareholder of Pathe. CLBN makes a public
tender offer for minority shares at $1.50/share as a freezeout transaction.
After the tender offer they will conduct a short-form merger to get the
rest of the shares.
a. P files BOFD suit against Pathe directors because they did not
oppose the tender offer
i. Based on unfair price
2. RULE In the case of voluntary tender offers, courts do not
impose any right of the shareholders to receive a particular price.

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a. Voluntary no coercion; no materially false or misleading

disclosures made to SHs
3. Since the plaintiff did not allege any coercion, the suit is dismissed
4. Under this rule, the majority is free to make a voluntary tender offer at
whatever price it wants so long as they are not coercive
a. RAG: Whats wrong with this?
i. Tender offers can be inherently coercive just like
negotiated mergers
ii. SHs might be afraid that controlling shareholder will
bully them and somehow prejudice their rights down
the road
1. Offer an even worse price later
2. The stock could get delisted
iii. Controlling SH is always the 800-pound Gorilla in
the room!
***Pure Resources tries to remedy this problem
vi. PURE RESOURCES (vice chancellor opinion)
1. Recognizes the drastic difference in case law standards between
negotiated mergers and public tender offers despite the fact that they
seek to accomplish the same thing.
a. Glassman and Solomon makes the law so much easier on tender
offers and short-form mergers that a controlling SH will always
prefer to simply make a public tender offer to get to 90% and
then do a short-form merger
i. The courts dont care about fair price in the tender offer
and they dont care about fair dealing in the short-form
merger
1. Minority has a much tougher road if they want
to challenge the overall transactions
2. Announces rules to solve the Solomon/Glassman problems:
a. RULE The law will consider a tender offer by a controlling
shareholder non-coercive ONLY WHEN the following
elements exist:
i. 1) Full disclosure
ii. 2) Must guarantee short-form merger at same price if
after the tender offer they acquire more than 90% of the
outstanding shares
1. This protects shareholders who vote no
a. Ensures that there will be no penalty
iii. 3) Has to be subject to non-waivable majority of the
minority tender condition
iv. 4) No other threats of retribution
v. The controlling shareholder also has a duty to permit
the independent directors on the target board adequate
time to react to the offer, hire advisors, and give a
recommendation to the minority
***NOTE: Remember that this is a Vice-Chancellor opinion and it is a good
question as to whether or not the Supreme Court will accept this rule . . .
nevertheless, you can see the problems the tender offer line of cases has
created
Hostile Tender Offers
II.
Unocal v. Mesa Petroleum

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a. The stock is selling at around 20 and Pickens buys 13%. Why does he stop at 13%?
i. Because under SEC rules once you buy more than 13% of stock of a registered
company then you are required to register your stock with the SEC.
1. Also under the Williams act he had to report after buying 5% of stock
within 10 days of buying.
ii. The reason he bought as much stock as he could before he had to report under
the Williams act is that during this time he was able to buy at much cheaper.
1. Also because now he can easily bring derivative suit
2. And he can demand inspection of books AND
3. If someone else came along and offered more than he was in the tender
offer then he would make a nice profit.
b. Pickens tender offer comes in two stages
i. STAGE 1: 37% for $ 54 per share in cash
1. 37% plus 13% he already owned
2. He makes the tender offer a direct offer to the SHs
3. If he doesnt get his 37% the whole thing is off.
4. If more than 37% is tendered then securities laws require that he pick
them up pro rata
5. If this all succeeds and he pays them $54 in cash, he now owns a little
over of the company so he offers the second stage
ii. STAGE 2: He offers to buy the other 50% in exchange for $54 in bonds
1. Bonds go the SH, not the company
2. He would like the SHs to have no choice but to accept the bonds, so
how is he going to force people who might disagree with him to sell him
Unocal shares for these bonds that he says are worth $54?
a. Hes going to merge Unocal into a subsidiary (Mesa) which is
easy b/c
i. It requires a BOD approval
1. What if BOD doesnt approve(because they are
the old directors still)?
2. He can get a special SH meeting by written
consent and then at the meeting he will be able
to do anything allowed to be done at a meeting.
a. Can amend the bylaws to add a number
of seats, but the certificate might set a
limit so thats not the best way
b. Kick the board out under 141k you
can remove them with or without cause
i. Here it would be without cause
3. Now the directors are kicked out and you want
to elect a new board, but 223 says that the
board fills vacancies so we would have to
amend the bylaws to say that SH fill vacancies.
ii. So you file a written consent calling a meeting and say
that directors are kicked out under 141 and that you
amend the bylaws to say that SH fill open directors
seat.
1. All very easy because Pickens owns 50.1% of
stock.
b. Once Pickens gets over 50% he can force everyone who didnt
play at stage 1 to play at stage 2 because he has the naked
voting power to do a force out merger like we saw in
Weinberger

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c. What recourses do the SHs of Unocal have that dont vote in favor of the merger?
i. They get an appraisal under 262
1. This wont really help them because before the transaction the stock was
selling for $40 and appraisal doesnt give you any value from the
merger itself.
ii. The SHs could sue for BOFD under Wienberger and Pickens would have to
prove
1. Fair price and fair dealing
a. Maybe fair dealing problems
2. But this lawsuit wouldnt help either because the price is so fair that
they wont get any damages
iii. As a consequence once Pickens gets 50% of the stock the game is over because
he can force the merger; and the dissenting SHs recourse wont help them
because the price is so much higher than what the price of the stock is.
d. At the end of the day, Pickens is going to own 100% of Unocal which is important
because it was a multibillion dollar company and he had to put up the assets of Unocal to
secure the loan for the company.
i. So Pickens can only do this if he is the only one that owns the assets because
otherwise it was a BOFD(loyalty).
e. These were really Junk Bonds
i. Junk Bonds bonds where the risk is very high which there is here because
Unocal is being bought totally with borrowed money.
1. This is risky because there is a high rate of default; however, people
make a ton of money investing in junk bonds and they buy them
because they have a really high rate of return(this is why they are also
called high yield bonds)
a. So whether these bonds are a good investment is a matter of
opinion and not fact like cash is because its only a good
investment if it adequately compensates you for the risk
2. You cant really tell if this is a good investment or not
f. What did the board do in response to this tender offer?
i. The board decided to consider whether Mesas tender offer was adequate
ii. They found it was inadequate and they could not stop the transaction so they
decide that if his first stage succeeds then they will make a self tender which
will happen much quicker than the merger
1. Unocal will buy the remaining 50% of shares for a price of $72 per
share in high yield bonds so board has same problem as Pickens of
borrowing money.
2. If board is allowed to do this does this mean that Pickens cant go
forward?
a. No he still can because he owns the company, but he has to
be willing to pay them all $72 dollars
i. Because he will be the sole owner of Unocal if he goes
through with it so the money/debt will come out of his
pocket
b. How much does he have to think Unocal is worth to pay this
price.
i. $63 because its the difference between $54 and $72
c. The effect of the self tender is to raise the average price of
acquisition from $54 to $63
g. For review purposes how would we have handled this case had there never been any
new takeover rules. By what standards would we have judged the boards blocking of
Pickens takeover offer

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i. Entire fairness standard applies when there is a conflict of interest.

1. Do the directors have a conflict of interest?
a. Yes, these directors want to keep their jobs which wouldnt
happen if Pickens succeeds
b. So they arent thinking of the SHs they are thinking of
themselves
i. They are entrenching themselves at the expense of
shareholders
2. Notwithstanding that conflict of interest, the entire fairness standard
wouldnt apply here, the BJR would because:
a. You only apply entire fairness when there is evidence of self
dealing and self dealing is involved when the director is a party
of the transaction (has a direct financial interest in the
transaction)
b. Here the directors have no interest in the tender offer other than
the same interest as other SHs and the indirect interest they
have in tender offer not succeeding
3. If we apply the BJR what would the standard be can the directors
articulate any rational business purpose
a. Here just say the price is too low
ii. Before this case, the court would have said There is no direct financial
interest in the transaction so BJR applies and they have a rational reason so the
blocking is OK
h. DE Supreme court is uncomfortable with the traditional rules b/c the directors may have
a bigger interest in preserving their own job rather than in making sure the SHs got the
right price for their stock so the court creates intermediate scrutiny
i. TEST
1. Did the board have a reasonable ground for believing that the
takeover was a threat to the corporation?
a. Satisfied by showing (1) good faith and (2) reasonable
investigation
2. Were the measures taken reasonable in relation to the threat?
ii. QUESTION 1: Here, the board sees three threats:
1. Offer is simply inadequate
a. Goldman Sachs says that the offer is just too low based on lots
of research that is now required by Van Gorkon Case.
b. If they just liquidated the company the SHs could get $60
instead of $ 54
i. There is a logical problem here because if Pickens goes
away they arent going to sell the company and the
stock is going to go back to $40.
c. The court says that you have reasonable grounds for believing
the price is inadequate even though you are basing the price on
something that you have no intention on doing.
2. Coercion
a. Coercive because the second stage requires you to take junk
bonds if you dont take cash during first stage. It only forces
you to take the first offer if the bond price isnt adequate.
b. Here, the court sustains the board in believing that the second
stage is worth less than the first even though there is no
evidence that the bond price is inadequate

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III.

c. If the two tiers are equal then there is no coercion. So whether

there is coercion depends on whether Pickens is right when he
prices the bonds at $54
3. Pickens is a greenmailer pays someone off to go away
a. Board reasonably perceived a threat of greenmail because he is
known for that and he has done that in the past where you never
know whether he is really trying to buy the company or just
trying to get paid off to go away
***The first two grounds are probably enough to constitute a threat, but
courts generally allow this as an independent reason
iii. QUESTION 2: Were the measures taken reasonable/proportionate to the threat
1. Is the self tender proportionate to the threat of inadequacy?
2. Forcing Pickens to pay the price the board found to be adequate is
reasonable because it doesnt stop Pickens from taking the company, it
only makes him pay the price that the board thinks is adequate.
3. But now the coercion seems to be in reverse because the second stage is
worth more than the first.
a. Court is ridiculous to say that the response is proportionate to
greenmailing because the easiest way to stop greenmailing is to
just not pay
i. Summary On the first half of Unocal test
i. Inadequate pricing there is a reasonable fear
ii. etc
j. Summary on proportionality prong
i. Clearly proportionate on inadequacy
ii. Seems to be disproportionate on coercion
iii. On greenmail it is not disproportionate
k. RAG: even though the court says that this is an intermediate standard between entire
fairness and BJR, it seems that this is no different than BJR because all this court seems
to require is that you get Goldman Sachs to make an analysis which you had to do
anyway under Van Gorkom.
i. He doesnt think its tougher than BJR because he thinks that all it requires is
getting an opinion that the price was unfair.
REVLON INC. v. MACANDREWS & FORBES HOLDINGS
a. Perlman makes an offer of $47.50/share
i. The Revlon board response is to say that the price is inadequate and they offer
1. To buy 10million shares for bonds they say are worth 47.50 and
2. They will give you a preferred stock that they say is worth $10
3. So basically the package is $10 more than pantry prides
4. What is the point of Revlons actions?
a. They maybe want to get them to go away, but they dont go
away
b. The point of this was that Pearlman borrowed 6 million to buy
Revlon and he had to put up the assets as collateral which he
could do because his offer is contingent on getting all the stock,
but the entire point of this is that these notes have covenants and
these notes restrict how much debt they can take on. So point of
this was to put note covenants out there to prevent Pearlman
from making a highly leveraged offer.
5. The second thing the board does in response to Pearlmans first offer?
a. They came up with a Back Ends Rights Plan:

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i. They offer these rights to the SHs for every share they
own. The right gives them the power to exchange the
stock for $65 note plus 12% interest.
ii. You have the privilege to exercise this right when
someone acquires 20% of the stock (trigger). If
someone does this then you have the right to exchange a
share for a note.
b. If the first step of Pearlmans offer succeeds then he will own
much more than 20% and anyone left who didnt tender their
stock to Pearlman can choose to accept the $65 note rather than
being squeezed out by tendering party and only get $47.50
b. If we evaluated this action under Unocal what result
i. Did the board have reasonable grounds for perceiving a fear
1. Yes, they have a fear that the price is inadequate because they had an
investment banker saying the company was worth at least $60/share if
you broke it up.
a. Problem with this is that what the market is telling you is that
the management is doing a lousy job and the board of Revlon
doesnt seem to understand that their own investment bankers
assessment is a serious indictment of the current management.
2. But the Revlon Board doesnt say they are going to sell the company if
the Pearlman deal doesnt go through, they plan on continuing forward.
3. So is it Kosher to compare the value for what we could sell the company
for to Pearlmans offer even though we arent going to sell it if tender
fails?
a. Yes, because this is exactly what Unocal did
ii. Is what they did reasonably proportionate to the threat?
1. Does the back end rights plan stop any offer that Pearlman would make?
a. No, it just makes it about $10 more expensive which is quite
reasonable compared to the investment bankers opinion
because this simply requires him to pay what the company
would be sold for on the market as a whole.
i. So if we accept that banker is correct then it is probably
a proportionate response.
2. Had the this case ended right here it is fair to say that the board wins this
case under Unocal
c. The case doesnt end here because Pearlman raises the price to $56.25/share. At the
same time, Revlon board has found another buyr who offers $56/share. The new bidder
is Forsman Little and he offers $56 and their plan like Pearlmans is to break up the
company and sell it piecemeal.
i. The board then gets Forsman to increase to $57.25, but to get them to do this
they have to do 3 things
1. Lock-up Option
a. Allows forsman to purchase certain assets at very generous
prices if someone else buys Revlon.
b. Point of this is to provide a consolation prize
i. Downside is that it makes the company less attractive to
Pearlman because these divisions will be sold for less
than they were worth
2. No-shop Provision
a. Board cannot voluntarily participate in generating a better deal,
but if one comes along without any of the boards doing they
can accept it

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3. Bust up/Cancellation fee

a. $25 million kicks in if Forsman loses the bidding process.
b. This makes it $25 million more expensive for Pearlman to buy
the company because he will own Revlon and have to owe the
money to Forsman.
i. Another reason deals with transaction costs and they
want to cover the transaction costs because their
participation is necessary to drive up the price, and if
they lose they get a consolation prize.
4. Pearlman comes back in and offers $58/share
a. Challenges the deal with Forsman and seeks to get an
injunction.
ii. Why do we permit this, why dont we say that once there is an auction there has
to be a level playing field?
1. Standard for judging this conduct
a. the board has a duty to get the SHs the highest price and the
board doesnt owe any duty to the bidders.
2. Why dont we say you have to run a fair auction?
a. Because in some cases you can use these types of favoritism
to increase the price and if you increase the price we dont care
if you were unfair to the bidders.
d. ISSUE: So the question is whether the favoritism for Forsman here is designed to get the
SHs the best price or is the board doing it to fend off Pearlman?
i. Argument that it was to just stop the bidding process?
1. The $56 dollar bid from forsman was on the table before the board did
any of this so this makes it look like pure favoritism, not just getting the
bidding started.
2. If Forsman wasnt already in the game then these side deals may have
been necessary.
a. So these side deals did nothing to help the SHs
3. Court agrees with this argument.
ii. DE supreme court thinks that Forsman would have bid anyway.
1. NOTE: Look at how different this is from Unocal where the court
basically said the board can do whatever it wants, and here the court
second guesses Revlons purported reason for offering these incentives
to forsman
iii. RAG: Look at how much less deference there is to the Board here than there is
in Revlon. The court here basically inserts their own judgment that this bid
would have happened anyway even though the board says that they needed these
standards to entice the bidding.
1. The court is basically looking at the substance of the decision.
2. Does this distinction make sense?
a. Before you decide to sell the Unocal standard of deference
applies, but
b. After you decide to sell the company Revlon seems to apply and
the court looks at the substance of the decision
e. In this case the board went out and looked for a white knight, but in many cases the
board will just do what the white knight would have done and just sold off the company
and made the profits for themselves.
f. Forget about the SHs for a minute. One other justification the Board had was that the
Forsman bid agreed to support the notes and their covenants whereas Pearlman didnt
agree to honor the notes

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IV.

i. Once you decide to sell the company no bodys interest counts but SHs so this
isnt a legitimate reason
1. The court says that once it became clear the companys breakup was
inevitable, the Boards duty shifted from that of defender of the corporate
interest to auctioneer who had a duty to get the highest price possible for
the SHs . . . the Note holders are not supposed to be considered
ii. Before you decide to sell is this a legitimate reason?
1. Unocal says that before you decide to sell you can consider a wide
variety of constituencies besides just SH
iii. Why does the point of sale change this?
1. Because before the sale when you are helping other constituencies (like
employees) that actually benefits SHs
2. If we had a rule that said that Revlon applies universally couldnt you
still do all these things because you are benefiting SHs
iv. If the corporation benefits from other constituencies (society) before sale then
why cant the corporation pay them
v. PROBLEM
1. Does Revlon overrule all the other De cases that say that it is ok to
consider the interest of non-SH groups before case?
a. Impliedly those cases meant that you can only benefit non SH
groups when they actually infer some benefit on SH
i. If you believe this then Revlon didnt overrule those
cases
b. If you dont believe those cases meant that then this simply
carves out a dichotomy that says you cant consider the interests
of non SHs after deciding to sell
i. And basically overrules the cases that say that you can
confer benefits on non-SHs.
g. Main Holding of Revlon Once the board decides to sell the only thing they can care
about is getting the SHs the highest price possible
i. After the board decides to sell the court appears to say that they will look at the
substance of board action and judge for themselves whether the purpose of the
board action was to get the SHs the highest value possible.
h. 37 states have overruled the Revlon holding and allow board to consider non-SH
constituents even after deciding to sell
i. They have done this to enable boards to have flexibility to defend against the
offer.
ii. They see an opportunity to compete with DE here in the race (either to the top or
bottom depending on POV).
PARAMOUNT COMMS v. QVC NETWORK
a. Paramount seeks to merge with Viacom. Viacom offers $61/share (part cash, part stock).
Paramount asks for higher price.
i. Later QVC shows up and looks also to buy Paramount. Paramount really gets
serious and asks Viacom to put a deal on the table so they can take it.
b. Viacom changes price from $61 $69.14
c. Original Merger Agreement
i. 1) No Shop Clause
ii. 2) Termination Fee
1. provides compensation to the person beginning the bidding when they
dont actually win the bidding
iii. 3) Stock Option Agreement
1. Viacom will get the option to buy 19.9% of the company at 69.14/share

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a. The profit they will make will be the difference between the
price at which the bidder actually offers to pay and 69.14
i. Comes out to $500M at $90/share
d. If we judge under Unocal, is there any problem with what they have done?
i. If an investment banker came in and justified the price at $69.14, then this
would be fair
1. Unocal would say it was okay
ii. But QVC comes in and offers $80/share
1. Viacom responds to this buy offering $85/share
2. QVC comes back and says that they will bid $90 on the condition that a
court invalidates the Termination Fee and the Stock Options as a breach
of fiduciary duty
e. Should Revlon apply?
i. Much stricter standard of review
ii. In this case, after the Viacom merger, the CEO of Viacom would control the
company
1. CEO (Redstone) owns 85% of the voting stock of Viacom
a. If Viacom succeeded, we would combine the Viacom and
Paramount shareholders
b. CEO would still control the company after the merger
i. 1) They are getting part cash for the offer
ii. 2) They are getting non-voting stock in the corporation
1. The specific reason is so Redstones control
isnt lost
iii. After the merger, the minority shareholders will be put
into a situation where one person is a controlling
shareholder!
c. This changes things because there was no majority in
Paramount and now they are dominated by one person
i. Now they are at the mercy of one person: Redstone
d. Redstone could do several dangerous things:
i. Freeze-Out
1. But this isnt the worst thing because they could
get appraisal, or sue for breach of fiduciary duty
2. Fiduciary Duty Suit
a. Entire Fairness Test b/c hes a
controlling shareholder
ii. Stealing Money
1. Paying himself a large salary
2. Not pay dividends at all
3. Form holding companies and offer
opportunities to that corporation
***These are all illegal (breach of fiduciary duties) but
the law is not perfect, and people do things they get
away with all of the time; also, court is not free . . . for
these reasons, being at his mercy is not a good thing
even though there are legal doctrines that protect you
iii. Court also relies on loss of opportunity
1. They could have gotten a control premium
a. Now Redstone can sell for a control premium and not share the
premium with any of them

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iv.

v.

vi.

vii.
viii.

i. See ZETLIN control is a property right that they are

not required to share, subject to some very large
exceptions
b. Any chance you would have had to get a premium is now gone
The court says two things have happened
1. 1) At the whim of controlling shareholder
2. 2) Lost control premium opportunity
3. Because of this, the decide to apply the Revlon standard
REVLON STANDARD:
1. Board must prove that what they did was designed to get the best price
for the shareholders, and no one else
a. They cannot think of the interests of anyone except the
shareholders
2. Can you make a case for the Board?
a. Look at what they did at the moment they did it
b. The Termination Fee and the Stock Option Plan would seem to
be okay at the time because they had no other offers
i. It started a bidding process, secured a higher price
($69), and got the ultimate price of $90 offered; at the
worst, it also got $85 from Viacom
1. It made QVC come out of the wings
2. Therefore, satisfies Revlon
3. The counterargument:
a. It places impediments in the way of QVC to win the bidding
and makes it easier for Viacom to win the auction
i. The Board may be acting out their own self-interest
because they like Viacom better
4. Nevertheless, we have to balance the benefits and detriments created by
the plan
a. Is the cost more than the benefit?
i. YES the cost is that it hobbles the auction a bit
1. The problem here is that its pretty clear that
Viacom would have showed up anyway . . .
they didnt seem to need any encouragement to
put this on the table
ii. NO the benefit was that the offer was used to get
QVC to show up to the auction
The court is saying:
1. The bids would have happened anyway
a. Viacom would have made the higher bid because they were the
ones showing up
b. Its pretty clear that QVC would have showed up as well
2. So all the board is doing is stacking the deck to make sure the person
they want to win actually does win
If you really think that Viacom would have placed the $85 offer on the table,
then it cant pass the Revlon test
Another issue is that they decide to take the $85 offer instead of $90 offer
1. Under UNOCAL or BJR:
a. This is defensible
b. The board is entitled to say that they think QVC has overvalued
its own stock or that future value is better with Viacom because
they are a better fit . . . had investment bankers saying this
exact thing

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2. Under Revlon:
a. This is more difficult to satisfy because your duty is to obtain
the highest price possible
ix. RAG: This case turns on the fact that after granting the defensive measures, the
bids vastly exceeded the original agreements price, so there was no way to
justify the defense measures at that price, or the lack of negotiating once it was
clear that the company was going to sell for a lot more
1. Had the QVC offer come in and been $71, its not quite as clear that it
would be illegal . . . the catch in this case is that the bids went way over
the original offer with all of the defense measures
f. The court seems to have a different standard it wants to apply and that this is different
from Revlon:
i. Court analyzes the case in different phraseology:
1. Enhanced Scrutiny Standard the court is uncomfortable with the
Unocal standard (easy) and Revlon standard (very hard)
a. But they see it as two sides of the same coin
b. So they simply marshal it into the same big test
i. Insist that there is no different Revlon Test
1. Just like in Unocal
a. Reasonable
b. Proportionate
ii. RAG: Questions the characterization of the two cases . . . he thinks that in this
situation they would have been okay under Unocal and not under Revlon
1. RAG thinks that the answer really is that the two cases are different . . .
the two cases are too different to be under the same test
a. Revlon any time you make a conscious decision to sell the
company or sell control
i. Whether or not this applies depends on how later cases .
....
ii. Look at the reasons in QVC they thought that Revlon
should apply and decide whether or not it needs to
apply in other situations
b. Unocal applies to defensive decisions before the company
decides to sell
i. Board is allowed to consider other constituencies
besides just the SHs and implement reasonable and
proportionate defensive measures
g. REVLON Duties apply in three situations
i. 1) When a corporation initiates an active bidding process seeking to sell itself or
to effect a break-up
ii. 2) Where in response to a bidders offer, a target abandons its long-term strategy
and seeks an alternative transaction involving the break-up of a company
iii. 3) When approval of a transaction results in a sale or change of control
***In all of these situations, the Boards duty is to obtain the highest price for the
SHs

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