Business Association

INTRODUCTION
Business Association is
 Law about controlling business
 Private ordering of business
Main themes
 Planning –ex ante (vs. ex post)
o Try to get things done legally
 Form v. Substance
o Form matters
 Agency problem
o The problem of not being faithful—fiduciary duty
o Fiduciary duty: demands agencies to act on owner’s interests
o Standard of review v. Standard of conduct
 Standard of conduct: what law expect people to do
 Standard of review: how the law judge people’s actions (usually more stringent
than conduct)
 Eg. SoC might be ordinary care, and the SoR might be negligence.
 Rulemaking authority
o State v. Federal
 Traditionally: state law
 Exceptions: Federal Security Law etc…
 Federal law has been intruding
 State law: may pass laws that help their state while hurt others
 Federal law: imposed uniformity detracts from the “laboratory of democracy”
idea.
 Depend on which one is better
o Law v. Contract
 Should the rules be in contract or be in law
 Corporate law is moving towards enabling rules
 Purpose
o Owners v. Society
Ethics
 ABA Model Rules of Professional Conduct (State law)
o Most important: Rule 1.13
 Identify the client (the BA, not the agents)
 Protect the corporation, not the individuals
 SEC Standards of Professional Conduct (Federal law)
o The government wants corporate attorneys to act as gatekeepers to protect society as
a whole
o Mandatory reporting up
 Specifically to chief legal officer, if no response, to board of directors.
 Morality
o Different from legal ethics
SOLE PROPRIETORSHIP

Sole Proprietorship Partnership Corporation
Definition Business carried on by a An association of two Separate legal entity
single owner, owned by a or more persons to created by law
single individual carry on as co-owners
of a business for profit
Formalities None None Many required
Control Management= ownership Joint ownership and Separation of
management ownership and
management
Liability Unlimited (debts of the Unlimited liability plus Limited to investment
business are debts of owner) (see later pg ) (you only lose what
you have invested)
Taxation Direct (taxed once) Pass-through Double taxation
(corporate and
personal)
Lifespan Coextensive with owner At will of partners, for Indefinite (not tied to
life of partners owners)
Exit None/sell assets Power to exit at any Sell shares
time (not necessarily
the right to exit at any
time)
Problem of Sole Proprietorship:
 Limited funding—only what you have
 Unlimited liability
AGENCY
Terminology:
 Agency: a consensual relationship in which one person acts on behalf of and subject to the
control of another
 Principal: the one for whom action is to be taken in an agency relation
 Agent: the person who by mutual assent acts on behalf of another and subject to the other’s
control.
Elements of agency relation: if the elements exists, there is an agency relationship

 [Restatement of Agency §1]
 Formalities: none
o Intention doesn’t matter. Even if you intended not to have an agency, if elements
fulfills, there’s still an agency relationship
 Mutual consent (express or implied manifestation of consent)
o Parties must consent to the elements of the agency relation, not necessarily to the
agency itself.
o Manifestation:
 Objective indication of consent—written or spoken words or other conducts
which, reasonably interpreted, causes belief
 Express or implied
 Action on behalf of another
o Motive is irrelevant.
 No matter it’s out of payment (employees), or good faith.
 Control
o Element of subservience from agent to principal—agent must be doing what the
principal want
o Need not to be total or continuous control, but the principal must be in charge.
o Veto power is not enough. There needs to be a de facto control.
Authority
Restatement (Second) of Agency
Five basis of liability
Actual Authority §7
Authority: power of the agent to affect the principal by transaction of the parties
 The act of the agent can bind the principal into a contract
o Even if the third party doesn’t know that the person he is dealing with is an agent and
thought he was the principal
 Scope of the authority: based on principal’s desire
o Subject to objective standard—the desire can be reasonably inferred.
Creation
 Principal’s manifestation of consent to agent (express or implied)
o Manifestation: reasonably interpreted (objective) causes belief (subjective)
Incidental authority §35
 The authority to do incidental acts that are reasonably necessary to accomplish an actually
authorized transaction
Termination

or estoppel Derived solely from the agency relation not about principal’s desires  Even if the action is expressly forbidden by the principal  There must be an agency relation Exists for the protection of persons harmed by or dealing with an agent  The concern of fairness. apparent authority. the answer will be: there may be one . or fail to cure the belief o © You cannot cure something if you don’t know about it. Inherent Agency Power §8A Not authority. Method:  Actual authority  apparent authority  authority by estoppel  If still no. but the person is estopped from denying the agency because of his previous conduct Elements:  Belief in agency relation by the third party o Doesn’t have to be a justifiable belief (different from apparent authority)  Reliance by the third party o Change of position based on belief of the agency  Fault of principal: The principal has to cause the belief.  Both principal and agent have the power to terminate the relationship at will  But not necessarily the right to terminate (might be liable for damages) Apparent authority §8 Definition  Power to affect legal relations of principal professedly as agent Creation:  Principal’s manifestation of consent to third party o By accidental—may did not intend to make someone your agent o By lies—lie to someone that another is an gent when he is not o By uncorrected statement – there used to be an actual authority but no longer exists  Agents are always authorized to describe their authority truthfully Agency by estoppel §8B No actual agency. At most. then go to inherent agency power.

o The last resort Ratification §82 Definition: the affirmance by a person of a prior act which did not bind him but which was done or professedly done on his account. Elements:  Professedly done on “principal’s” account  Affirmance o Either a manifestation of election o Or conduct justifiable only if there were such an election  Not acquiescence o If agent keeps doing something and principal fails to stop him from doing that—actual authority and give rise to apparent authority to the third party Spectrum of agency (§2-3)  General agent v. Special agent o General agent: be authorized to conduct a series of transaction involving continuity of service o Special agent: be authorized to conduct single transaction. whereby the act.229  Section 228: Time and space . type of agent o Principal has control over the physical conduct of the agent in the performance of the service  Not just quantitative. is given effect as if originally authorized by him. type of principal o Servant: employee. as to some or all persons. but qualitative  Factors:  What I can control and how to control  Who supplies tools and locations  Part of regular course of business  Duration  Method of payment  Parties’ beliefs o Master can be liable for torts of servant within scope of employment  Section 219  What is within the scope of employment: Section 228. or a series of transactions not involving continuity of service  Master/servant o Master: employer.

 Policy: who should bear the burden of the conduct unauthorized  Employer is much more likely to be able to pay for the compensation than the employees. Independent Contractor o The extent of vicarious liability  Servant: Principal is liable for both  Authorized conduct and  Unauthorized conduct within the scope of employment  IC: Principal is liable for the action of the IC when he authorized the conduct  Stranger o No liability Principal’s status  Who is responsible for the contract  Disclosed principal o Principal is liable o Agent is not liable o The third party is liable  Partially-disclosed principal o Principal is liable o Agent is liable  Section 321 default rule  The third party is acting on the agent’s reputation since he does not know the identification of the principal o The third party is liable  Unless he manifest the intention not to be bound by the contract anymore  Undisclosed principal .  Independent contractor o Person who contracts with another person to do something for him but is not controlled by the other nor subject to the other’s right of control o No agency relation  IC not agent  No vicarious liability o If agency relation  IC is an agent  Then principal will be liable for the authorized conduct  Servant v.

o Principal is liable o Agent is liable o The third party is liable Morris Oil v.000. Rainbow went bankrupt and owed Morris $25. opened an escrow account to settle claims arising from Rainbow’s operations. Conclusion: Dawn was an undisclosed principal. so liable for acts done in normal course of business. Fiduciary Duties of agents Definition: Agency is a fiduciary relationship marked by upmost good faith and loyalty  Fiduciary duties with respect to matters within the scope of his agency. Dawn when Rainbow ceased its operations. not everything. And Dawn ratified the open account after learning of its existence.2) Fact: Rainbow was using Dawn’s certificate and Dawn reserved complete control over Rainbow’s operations. Rainbow is not Dawn’s agent  Actual on behalf of another: Rainbow was using D’s certificate  Control  No consent: they said explicitly that Rainbow is not the agent Apparent authority?  Secret instruction. Duties: Contractual duties §377 o The agent must do what he has promised to do  Duty of Care §339 o Paid agent: standard care + special skill  Standard care depend on locality o Gratuitous agent: lower standard based on the reliance of principal  Section 323. Therefore the third party did not at that time know about their relationship Authority by estoppel?  No. Rainbow Oilfield Trucking (pg. The third party did not know about the relationship Ratification:  Dawn affirmed the relationship by opening an escrow account after learning of the debt.324  You cannot make somebody worth off because someone is counting on you  Duty of Loyalty .

. Resop (pg. maybe P would want to expand and be able to take the work. Attorney General (pg. the employer should get it.  No double recovery you cannot get both the thing and the value  Reading v.  Decision: dismissed Reading’s claim to recover the seized amount  His position and uniform were the sole reasons why he was able to do what he did.20)  Facts: Sergeant in uniform sold goods and the Crown seized them. the law will not permit him to place himself in a position in which he may be tempted by his own private interests to disregard those of his principal. The owner should have the opportunity to decide. and also the amount of damage thereby caused.  Conclusion: Liable  The standard is a strict one.”  Tarnowski v.o Act solely for the benefit of the principal §387  Al matters connected to agency o Accounting for profits §388 – agent who makes profit in connection with agency must give profits to principal  Exception: tips. And D collected secret commission from sellers.  A fair decision?  He was off-duty at the time. or its proceeds.  Actual injury to the principal is not necessary  Damages: §407(1) entitled to both the commission and damages  The principal is entitled to recover from the agent what he has so received.  D did not benefit P. but made only a superficial investigation.19)  Facts: D as an agent represented that he had made thorough business investigation. its value.  Although P couldn’t do the work. not within the scope of the employment  Who should get the damages?  The government should not receive the damages since smuggle is illegal and the money would not go to the government anyway. Singer (handout)  Facts: D sent jobs elsewhere which P couldn’t handle and made commission. if customary  ©: If specific rule: “no tips.  What can D do:  Disclose the situation to P. rather than make the decision by himself. even though D was not a bad guy. if D told P.  General Automotive MFG v. but did benefit himself.  Conclusion: P as principal is entitled to the commission and damages  Fidelity in the agent is what is aimed at.  Windfall instead of the bad guy getting it.

.’s interest. D helped MB hire away P’s employees by disclosing employee salaries and misleading P’s president in considering giving a salary raise.  But he is not allowed to take out people with him  Cannot coordinate to help them to leave  Cannot do is by using confidential information such as salary list. not on thought  RUPA allows a filing to form a partnership. you cannot quit and then use the confidential information. but you don’t have to.  Bancroft-Whitney v.  Rule: must not only protect corp.  A mere disclosure that he is stealing the employees from the company does not necessarily solve the problem  MB: also liable as being the principal of D by authorizing him or ratifying his action  Conflict of interest: D owes fiduciary duty to both companies and must satisfy both. send them away.  Contract law consideration: a breach of contract  “not to engage in any other business or vocation of a permanent nature during the term of this employment…” o Non-competition §393 o No conflicting interests §394 o Confidentiality §394  Agent cannot use confidential information obtained during agency for benefit of anyone except principal  Even though the information is not related to the transaction the agent is authorized to conduct  Even after the termination of agency relation. based on substance. still effective in many states  RUPA: Revised UPA o Drafted more recently.  He could just refuse the customers. in effect in majority of states Formalities: none  Can be created incidentally. Glen (handout)  Facts: D was P’s employee. different from competition or conflict of interests. but also refrain from doing anything that would injure the corp. PARTNERSHIP Introduction Two bodies of law:  UPA: Uniform Partnership Act o Drafted in early 20th Century.  Conclusion: D violated his fiduciary duty  D: at will employee and can leave at any time.

 Partnership is thought as:
o UPA—group of people acting together, association
o RUPA—separate legal entity
 But sometimes overlapping in practice
Control: joint ownership and management
 Each partner is an owner and a manager, share loss and profits
o Problem of agreement and trust
 Partners can alter their rights by agreement but not necessarily their powers.
Liability: unlimited plus
 You plus your partners’
 You can alter your own liability by agreement, but only between the partners, cannot against
the third party
Taxation: pass-through (one time)
Lifespan:
 At the will of the partners
 For the life of the partners
 UPA—everytime there is a change of partner, there is a new partnership
 RUPA—partners can disassociate the partnership without effecting the partnership
o Practically: no difference
Exit: power to exit at any time
 Not necessarily the right to exit

Formation
Statutory elements (RUPA§202) –the first thing to consider in analysis
Consensual association
o Consent to elements of the partnership, not consent to the partnership
Carry on as co-owners (RUPA§202c)
o Interpretive rules:
 Share of interest of property is not enough
 Sharing of revenues is insufficient by itself (i.e., salesman receive commission,
but they are not partners)
 Sharing profit is a prima facie evidence of partnership

 Exception: sharing profits at the payment of debt, salary or interest
DOES NOT count as a partnership
A business for profit
o The intent to make a profit
 Marriage is not a partnership
Case law elements—when there is no specific partnership agreement, courts use different tests
 An agreement to share profits—a strong indication
o Doesn’t have to be equal share
 An agreement to share losses
 A mutual right of control or management
o Doesn’t have to be equal, just some. And sometimes you don’t want equal control
 A community of interest in the venture
o Not always easy to separate from profits/losses

Partnership by Estoppel (RUPA§308)
Elements:
 Manifestation
o By the purported partner, or with his consent
 Reliance on manifestation
o Enter into transaction based on belief that there is a partnership
o Public manifestation (i.e., advertisement), then the direct manifestation is not
necessary
Liability:
 For partnership, if the manifestation is authorized by all partners
o Partnership is liable for the imaginary partnership
 For purported partner:
o As partner, if partnership is liable
o Otherwise, with consenting purported partners
 The partnership itself is not liable
 A virtual partnership between the consenting purported partners
Martin v. Peyton (pg.63)
Facts: Peyton and others agreed to loan money to KN&K firm.

 Facts for partnership: veto power; sharing profits; information right (the right to inspect firm
book etc); option to join firm; hold resignation letters from other partners
 Facts against partnership: no actual agreement; no intent; no actual power to manage; profit
sharing as to repay debts
CONCLUSION: NO partnership
 Elements:
o Association: yes
o Business for profit: court said no
 ©: merely supervising the business? To protect the investment? Just by saying
it’s a loan doesn’t mean it’s really a loan.
Lupien v. Malsbenden (pg.67)
Facts: Malsbenden loaned money to Cragin without interest and worked on day-to-day basis before
and after C left. M was getting payment directly from profits.
CONCLUSION: Partnership
 Statutory elements:
o Association: yes
o Business for profit: yes
o Carrying on as co-owner: M is working on a day-to-day basis
 Case elements:
o Financial interest: getting payment by the profits
o Presumably share in loss
o Participate in the control of the business: involve in daily business operation
o Suggestion of community of interest
What advice you can provide to M?
 Don’t tell him to lie or to hide assets
 Tell his what the law is and what he can do and he cannot do
o Such as don’t share profits, but be repaid by the interest instead.

Partnership rights in partnership
Partnership property: property that belongs to the partnership rather than to the partners
individually
 UPA: tenancy in partnership
o UPA: aggregate
o Partners have full rights to possess partnership property for purpose of partnership
 RUPA§§204, 501: Partners have no interest in the partnership property

12 talks about admitting partners. Creditors  Old rule under UPA: dual priorities o Theoretical dissolution o Partnership assets pay off partnership debts first and personal assets pay off personal debts first. serious limit on liability  New rule under RUPA: partnership creditors get paid first . CONCLUSION: NO. Facts: P assigned 10% interest to his children and tried to add them as partners. Interest in the partnership  Partners can only sell their interest (share) in the partnership RUPA§503  Assignment of interest does not effect partnership o The seller remains the partnership. they’ll still have a stake. o RUPA: partnership is a separate legal entity o The property is solely owned by the partnership.12: limiting partners’ right to assign interest to strangers o If the children. Par. o Partners can still use the property when authorized  Real issue: whether the property is a partnership property or not o If is: it can be used to pay partnership debts o If no.12 of partnership agreement allows assignment for immediate family without other’s consent Issue: whether the partner can introduce new partner without the consent of other existing partners. But it doesn’t mean they can be the partners  Other parts of the partnership agreement other than Par. Rapoport v. and then the cross between them  Unfair to the creditors. 55 Perry Co. the buyer doesn’t become a partner  The seller is merely selling the right to receive money from the partnership o Other non-assigning partners’ rights:  UPA: non-assigning partners can dissolve the partnership  RUPA: non-assigning partners can expel the assignor  Purpose: other partners may not trust the new person assigned interest. P needs consent from other partners  Law: assignments are allowed  Par. cannot.

not against the third parties  §401(b): Equal share in profits (and losses) o not necessarily to be equal  §401(f): Equal rights in management o right to participation. but only among the partners. the members of the committee might have the whole power to make management decisions. o Then they can go after partners on equal footing with individual partners’ creditors Capital accounts  An account on a partnership’s balance sheet representing a partner’s share of the partnership capital (or equity)  percentage of ownership property  Capital account = contributions + profits o What you put into the partnerships + what the partnership makes – what the partnership has already given you Indemnification v. contribution  Indemnification: reimbursement of a loss or expense incurred by another o Partner has a right to be indemnified by partnership o Partnership liability  Contribution: the right of a person who pays a debt to recover proportionally from others who are also liable on the debt o Partnership has right to ask for contribution from its partners o Liability of partner Rights and duties of partners Rights  Default rule: RUPA o Only applies when partnership agreement is silent o Partnership can change the rules.  §403: Right to information  §401(i): Right to consent to addition of partners o Only with consent of all partners  §401(h): No right to salary o Because the partners are sharing profits o The rule can be changed Management of partnership . to engage in discussion  Some partnership has executive committee.

Partnership agreement restricted GP’s authority. and P pays out of his own pocket. Dooley (pg. not constructive notice o Has to be something told.85) o Facts: P’s general partner (GP) entered into construction loan agreement and mortgage.  CONCLUSION: D doesn’t have to reimburse o It’s an ordinary course of business and there was no consent by majority  What if there’s no majority? . People 1st Community Bank (pg.Every partner is an agent of the partnership (RUPA§301)  Generally. o CONCLUSION: for D. P then defaulted. slightly changed by statute. things beyond the scope of partnership. management beyond the life of partnership o Exception: when the third party has notice that the partner has no authority  Either actually knows. or was given notice  The partner is not liable even if it’s within the ordinary course of the partnership o RNR Investment Limited Partnership v. all rules of agency apply. typical decisions o Won’t include: exceptional/rare decisions. P is liable  Bank could rely on GP’s apparent authority (didn’t have actual) unless it had actual knowledge or notice  Apparent authority in ordinary course of business: yes  Actual knowledge of the bank? NO  Did bank get notice?  D: Bank was given the partnership agreement and the restrict on GP was stated in it. D refuses to pay. Act not for apparently carrying on business in ordinary course are not binding o Unless the acts are authorized  Partnership liable for wrongful acts in ordinary course of business RUPA§305 Differences in ordinary course of business may be decided by majority  Every partner has equal vote by default  Other differences require unanimous consent  Summers v. not something you could have divined  RUPA provides greater protection for third party than UPA did.74)  Facts: P hires a worker but D says no.  There has to be an actual notice. Acts for apparently carrying on business in ordinary course are binding o Ordinary course: everyday course.

Loftus (pg. not clear on fiduciary duties Duty of care (very narrow) o Limited to refraining from engaging in grossly and recklessly conduct. and every agent can bind partnership into a contract o If the partnership is bound. Obligations of partners Partners have joint and several liability for obligation of partnership RUPA§404: Partners have fiduciary duties to each other  Under UPA: it was open-ended. Duty of loyalty/ no competing interests (§404b) o A strict approach.92) Facts: Some partners were named “income partners” who made a contribution to the firm.consenting partners do to protect themselves?  Ex ante—spell it out in the partnership agreement  Dissolve the partnership Davis v. Salmon (pg. didn’t share in profits/losses. and if the partner has the right to enter into the contract. Pension benefits ceased when firm dissolved o CONCLUSION: no fiduciary duties exists.105) o Facts: D and P had joint venture where D was manager and P mainly funded. D is not liable  P ceased to be a partner after retired  Even if there is a duty of care owed to retired partner. o Every partner is an agent of a partnership. nor management Arguments that they are partners?  Bonus based on company’s profitability –community interest  Management: equal control right. and had no voting rights. or knowing violation of law o Bane v. CONCLUSION: not partners not liable  No share of profits.  Business judgment rule. it was not breached. When lease was about to end. the non-consenting partner is liable too. A lot of big partnerships have an executive committee and some of their partners don’t have the right to manage. . D entered into a new lease without P and did not tell P about it. refraining from dealing business for adverse interest and refraining from competing with the partnership o Meinhard v. with no exception o Limited to accounting for profits. A mere fact of an unwise business decision doesn’t mean there is a breach of fiduciary duty  Court takes a loose approach of duty of care as opposed to duty of loyalty. o What can non. Ferguson (handout) o Facts: P has retired from firm.

o CONCLUSION: D is liable, P got value of 1/2 of entire lease
 It’s the same venture. D got the information because he was a partner of the
joint venture
 He is stealing the business from the partnership
 What D should do ?
 Share the information. P should be given the knowledge for chance to
compete
 Now D have to share the value of the new venture because it’s the only
remedy
o Arguments that D is not liable:
 D had given to the enterprise time and labor as well as money, it was always
his own business, he has made the business profitable
 The previous lease was 20 years and the partnership is end. The new venture is
a different one.
Good faith and fair dealing

Partnership Dissolution
Ending a partnership
 UPA: three stages to end
o Dissolution: the beginning of the end of a partnership
o Winding up: the process of settling partnership affairs after dissolution (partnership
continues)
o Termination: the end of the partnership
 RUPA: adds dissociation §601
o Dissociation: the change in the relation of the partner caused by any partner ceasing to
be associated with the partnership
o Default rule: partnership continues
 Dissociation is NOT a dissolution
 Major exceptions
o In every dissociation:
 Either partnership is dissolved and wound up
 Or dissociating partners’ interest is purchased (buy out)
Causes of dissociation (RUPA§601)
 Each partner always has power to dissociate, but not necessarily the right to dissociate
o At-will partnership: partners have right to dissociate
o Partnership by term: no right
o If you don’t have the right, you pay damages and some other possible consequences.

 As per partnership agreement
o Can also specify involuntary dissociations where other partners can kick you out.
 By unanimous agreement, if partner has assigned her interest in the partnership
o Partner can always sell his/her interest in partnership and it does not effect partnership
o But disincentivizes other partners can use as excuse to kick that partner out (even if
they have no right)
 Judicial decree for misconduct
o If partner is misbehaving (willful and material breaches etc.), court might order
dissociation
o The misconduct has to be adversely and materially effect the benefit of the partnership
business
 Certain bankruptcy events
o Automatically because partner can no longer be responsible for taking losses,
contributing, etc.
 Death or incapacity
o Physical, mental or emotional incapacity
o The partnership may still continue
Wrongful dissociation §602
 In breach of an express provision of partnership agreement
 Before expiration of a term
o Regardless of whether in express provision or not
 Judicial decree: court will decree it’s wrongful
 Bankruptcy
 (Death or incapacity is not wrongful dissociation because although bankrupt might be
someone’s fault, if you die, it’s probably not your fault.)
Causes of Dissolution §801
 Partnership at will (unless agreement says otherwise)
 By agreement (before or ex post)
o Ex post: if one partner has already dissociated, might agree that it’s best to dissolve
 Expiration of a term
 Illegality
o If a business becomes illegal, the partnership from a legal perspective is over.
 Judicial decree of impracticability
o Either because of economical circ’s or personal circ’s.
 Judicial decree to protect transferee

o i.e., one partner sells interest to creditor and other partners won’t give creditor its
share creditor can say that partnership needs to be dissolved in order to protect his
rights.
Effect of Dissociation
 Dissociated partner is no longer member
o Authority: no longer have actual authority, but may still have apparent authority
 RUPA§702 provides two-year window for protection of innocents
o Liability: general rule is no future liabilities.
 RUPA§703(a): Still liable for preexisting liability, joint and severally
 RUPA§806: while the partnership is winding up, you still have winding
up obligations
 RUPA§703(b): subsequent two-year window for protection of third parties
 Dissolution process:
o Wind up: finish up work-in-progress
o Sell of assets: reduce it all to cash
 Two methods:
 Liquidation value: value of a business if its assets are sold individually
 Sell different things to different persons
 Going concern value: value of a business if assets are sold together
 Much larger than the liquidation value when the business is
healthy. But if business is doing poorly, then liquidation value is
higher.
 Court hates to order dissolution, they think it as wasteful and unfair.
o Pay off creditors (including partners)
 Creditors who are not partners> partners as creditors (partners for obligations
other than profits, partnership loans)> partners in respect of capitals
o Distribute net proceeds
 Alternative: buy-out
o Dissociation doesn’t always lead to dissolution, partnership may continue, but just buy
out dissociated partner
o RUPA§701(b): partnership has to buy dissociated partners for the same amount that
partnership would’ve paid them if there had been a dissolution
o Why virtual dissolution
 No transaction costs
 Quicker resolution of current and future matters
 Less destructive
 Privacy concerns
 Difficult to find buyers, especially if you want to sell it now.

but just cannot expel him for bad reason What can P do?  Continue partnership/ offer to buy D out/ settle . but will be liable for damages if there is bad faith  There is no evidence of a term. the trend in partnership law to allow the continuation of business without disruption McCormick v. P claimed partners continue business under new name and used partnership assets and she had right to compel dissolution and require an actual liquidation. District Ct. while Creel it’s a death. CONCLUSION: partnership must be dissolved and wound up (liquidation) Why different result from Creel?  Here was a judicial decree on dissolution. Brevig Facts: D used partnership assets for himself. ordered dissolution. Lilly (pg. o Partners may avoid the automatic dissolution of the business upon the death of a partner by providing for its continuation in their partnership agreement. unless he fully compensate his co-partner for his share of the prospective business opportunity  If D can prove that P is terminating the partnership in bad faith. the estate of the deceased partner no longer has to consent in order for the business to be continued.  Under RUPA.  Consequences of wrongful dissolution o Damages o Deferred payment§701h o No right to participate in winding up Creel v. evidence offered was mere hope for profit Fiduciary duties concern: a party may not dissolve a partnership to gain the benefits of the business for himself. P wants a judicial dissolution to make sure he was not doing a wrongful dissolution CONCLUSION: It’s an at-will partnership P can dissolve partnership. CONCLUSION: for D. but no need to liquidate here.  Legislature intent: disfavor the compelled liquidation of businesses. D claims that P cannot terminate because it’s a partnership by term. Partners did inventory while P refused to review. Page (pg. 134) Facts: P wants to terminate partnership.  Winner’s curse avoided: the winner of an auction is likely to overpay and regret. especially if partners are bidding o What’s wrong with virtual dissolution  Hard to figure out the value of the business. but allowed D to buy out P.  When a partnership’s dissolution is court ordered. No dissolution  Under UPA: liquidation is required upon a partner’s death.117) Facts: P’s husband died. the partnership assets necessarily must be reduced to cash Page v. nor does she have the right to compel liquidation. then he breaches duty of good faith and fair dealing o Wrongful expulsion: you can expel a partner for good reason or for no reason.

Advantages Greater access to funding o More investors are willing to invest because they won’t have to worry about managing or liability Efficient management o Smaller number of general partners who can manage the business.  Purpose: notice of existence . duration. o Can be any number of limited partners. o Limited funding o Unlimited liability plus Limited partnerships: general partners + limited partners Two classes of partners:  General partners: a partner with management rights and with unlimited liability o There must be at least one general partner (there has to be someone liable)  Limited partners: a partner without management rights and with limited liability o As default rule. You can also include anything you want. Forming a limited partnership  Cannot be formed accidentally  File a certificate of limited partnership o RULPA§201: only minimal information is necessary  Name of the partnership. members. limited partners have no control over the business o RULPA§302: an agreement can provide some voting rights o Limited partners can only lose what they invested in the business. don’t have to worry about huge partnership votes. cannot lose any more. address of building and general partners. even with zero limited partner.Limited Liability Shortcomings of  Sole proprietorship o Very limited funding o Unlimited liability  Partnership o Too many managers  Trust issues etc.

then direct contact is required. therefore is liable o Gateway Potato Sales v. Increasing diversity  Originally: LPs and corporations  Eventually: LLCs.154) o Facts: P sold company on promises that D was actively involved. then you may be considered one. and only liable on the part you exercise control on. for economy to grow  Eventually: universal availability o Anyone can have limited liability options. History of increasing availability  Originally: specific purposes (that needed great effort) o States allowed them to have limited liability because people wouldn’t go to the effort if they have liability risks  Expanded for industrialization o Needed the funds for companies. etc. have control over the bank account. participate in the management of the farm. but it’s always good to have one. get the general partner to resign. cannot use name of limited partner because that suggests that he is a general partner. o No file general partnership with unlimited liability  Written agreement is optional o There are default rules.  If “substantially same as” test not met. even if you call yourself a limited partner  RULPA§303(b): certain activities that make you a general partner o Consulting/advising is not enough to make you a general partnerdictating might o Some voting power (on fundamentals) will not be enoughbut voting on everyday might o Old rule: control creates automatic liability (if you meet threshold. Investment Co. bad for business paying taxes. you are completely liable as general partner—even if it’s one thing) o Holzman v. Pros and Cons Good Bad Encourages more investment Provide less protection for creditorscould be Helps society indirectly by providing more jobs. o Issue: whether limited partner can be liable as a general partner if he did not interact with creditor o CONCLUSION: P’s claim shouldn’t be dismissed. LLLPs. then limited partner is held liable regardless of any other factors. De Escamilla (handout) o Facts: “Limited” partners told “general” partner what to do and signed for funds. providing services etc. Remand to determine extent of control by D. (pg. Limited Liability: the legal limitation of an investor’s liability to her investment in the business.  Statute: actual knowledge  Court interpreted as actual contact  [Velasco: should be actual knowledge] o New RULPA: more lenient you may be liable only to those you have direct contact with. Encourage business risks Ordinary people also have investment opportunities. G. o CONCLUSION: D is general partner.  Name limitations o RULPA§102: have to indicate that it’s a limited partnership with that phrase o Cannot use certain name. to prevent the rich people getting richer and poor people getting poorer Encourage business innovation for risk-averse .  Standard: whether creditors have actual knowledge that D was exercising control like a general partner  Either “direct contact” or “substantially same as” test  Substantially same as test: if limited partner’s actions are substantially same as the general partner. Had no contact with D. such as business creditors cannot go after personal assets. LLPs. such as “bank”. Passive investor status  RULPA§303(a): if you act as a general partner.B.

CORPORATION Introduction Laws:  Corporate law is state law  Model Business Corporation Act: model provision. not actual law o Many states adopt with modifications Corporation Formalities: many requirements  Corporation doesn’t exist if you don’t follow these formalities o Filings o Separate books o Regular meetings Control: Separation of ownership and management  Board of directors do the management  [but shareholder could elect himself as director who could appoint as officer] o Even though. he is running the business as a director not as a shareholder Liability: Limited to the investment  The obligations of the business are never the obligations of the owners .

the state of incorporation.e. shareholders can argue that the officers and directors do not have the authority  Most corporation get around by putting “permitted to do any lawful action” in charter o Classes of stock (Delaware§102(a)(4))  List the total number of shares of all classes that corporation shall have authority to issue and specify which rights each class has (capital structure)  If more than one class. depending on states (Delaware General Corporation Law§102(a)(1))  You cannot use other words such as “bank” o Powers of corporation (Delaware§102(a)(3))  Anything not included in the charterultra vires  Protects shareholders: if corporation is hurt by third parties. such as inc. Shareholders are not personally liable and cannot be required to invest more Taxation: Firm/double taxation Lifespan: Indefinite (forever or until dissolved) Exit: Sell shares – easy  Free transferability of shares  Separation of ownership and management allows selling of shares to not impact running of corporation. directors and shareholders.)  File certificate of incorporation/ charter  [Certificate of incorporation: the document establishing and governing the internal affairs of a corporation (notice of existence)] o Name of the corporation (must contain certain words. etc. you have to specify it. labor. terms specified in charter  If you want anything different from default rules.  Common stock: security representing basic ownership interest (default)  Right to vote on limited matters (i... you have classified stock: stock issued in different classes. corp. Incorporation: establishment of a business as a corporation  Select state of incorporation o Internal affair doctrine: choice of law principle—only one state should have the authority to regulate a corporation’s internal affairs.  To prevent corporations from being subjected to inconsistent legal standards. The importance of stability  Prevent forum shopping  Internal affairs: matters that pertain to the relationship among or between the corporation and its officers. o Even if all business is conducted outside the state o Won’t apply to actual business operations (environmental. elect directors)  Right to residual profits if corporation decides to distribute  Preferred stock: security representing ownership interest that includes some preferential claims but also some limitations .

or under direction of.  Limited right to vote  Preference in form of dividends—paid first before common stock dividends can be paid  Can specify any rights wanted (Delaware law has maximum flexibility) o Incorporator/ initial directors (Delaware§102(a)(6))  Promoter: person who establishes a new corporation  Possible liability: do business for corporation before corporation was formed prevent by waiting or specifying that you are doing it on behalf of to-be-formed corporation  Anyone can establish a corporation. If no directors. the board of directors o Appoint officers:  Delaware§142?152?: allows as many officers as you want . then promoter is the initial director o Any other matter not contrary to law  Hold organizational meeting o Presence: directors. even a corporation can set up a corporation  Parent corporation and subsidiary  Usually don’t want names of initial directors in charter  Delaware§107: if no directors listed in the charter. then promoter or incorporator o Adopt bylaws  Bylaws: document more detailed than charter but subordinate to it that governs the internal affairs of the corporation  Charter as constitution and bylaw as statutes o Issue shares: directors have to sell shares  Authorized but unissued shares: shares which have been authorized by corporation charter but have not been issued  Only stock that has been authorized in the certificate of incorporation can be issued  Outstanding stock: shares which have already been authorized and issued and not cancelled  Treasury stock: shares which have been authorized and issued but are not outstanding because they have been repurchased by corporation –doesn’t apply anymore  Hold shareholder meeting o Elect directors o Delaware§211: must have annual meeting o Delaware§216: must have quorum: minimum presence necessary to have valid meeting  Default—majority of outstanding shares  Hold directors meeting o *Delaware§141: business is run by.

S. society  Race to the bottom: laws may be passed that benefit corporations. but not society.  New York requires four (P. VP.  Costs are externalized. consistence. management  States always want to impress decision maker. o Shareholders v. as well as their subsidiaries  Reasons:  State legislature keeps law cutting edge and revisits every year— amend corporate law to keep it fresh to meet the needs of corporations  Secretary of State is extremely responsive to requests for information  Specialized judiciary (Court of Chancery)—corporate law experts o Small states have advantage  Revenue from fees and taxes relatively large . States will always benefit the directors at the expense of shareholders o Race to the top: competition benefits society eventually  Corporations need to seek out most efficient laws since bad laws make business fail  Shareholders won’t buy shares from business incorporated in states with management friendly laws  Competition forces efficiency and improvement  Delaware—winner o Most large corporation incorporate in Delaware.  Management is the decision makers. T)  Office title is meaningless—but CEO is real boss  Some bylaws don’t even specify responsibilities in order to be flexible and not run into ultra vires problem Race to the Bottom & Up Internal affair doctrine—where you choose to incorporate depends on costs (taxes and fees) and benefits  The quality of the state law matters Competition  States competes to get more corporation to incorporate there for taxes and fees  How? o Service: innovation. responsiveness to social changes o Substance: pass favorable laws  Who benefits? o Corporation v.

directors are their agents (everyone else is third party who does not matter) o © But shareholders don’t have control directors more like trustees  ©© But shareholders can elect directors not like trustees  Purpose of corporation: maximize the profits for shareholders o The implication that directors have to do what shareholders expect. Ford pg. not whether to make profits or not Contractarian theory—most common in academics. but a web of contracts  Everyone is an investor who expects a return Input Rights (Expectations) Shareholders Cash. social benefits (jobs) guarantees corporation to function).e. the Congress can pass laws that can affect Delaware  Delaware attracts a lot of attention for it’s success in attracting corporations  Delaware has more to lose since it’s the winner. all the harm from federal intervention will fall on it. a provision binding the borrower. you have to keep current CEO) Trade creditors Property (materials. which gives the lender an element of indirect control (eg.S economy o Federal intervention  If corporate laws become too lopsided. Payment plastic/wood) Employees Labor Wages Customers Revenue (cash) Products/service Society Security (national security Taxes.  Other states can compete and pass even more corporate friendly laws Purpose of corporations Traditional views:  Shareholders are owners.  Harm to the U. labor Residual profits and control (i.. Infrastructure . If I lend you money. which is to make money  Dodge v. sometimes a covenant. in a loan contract.  D lower the price of the car to capture larger market share  D raised salaries to maintain workforce. but not law  Corporation is not a thing solely owned by the shareholders.253 o Facts: D decided not to pay dividends when company is profitable.S is small because Delaware makes up small percentage of U. elect directors) Lenders Cash Interest. Covenant: a contractual obligation or prohibition. but instead invest back into the company because D wanted to prevent other competition and avoid double taxation. property. such as experienced workforce and experts o CONCLUSION: P as shareholder is entitled to the dividends o Directors have the discretion on how to maximize profits for shareholders.

$12M liability = $3. They have little to lose but so much to gain when equity approaches 0 incentive to engage in risky activities coz a slightly profitable investment is not going to attract them o Credit Lyonnais  Expected value= ∑(probability × value)  Example: corporation has one asset (judgment for $51M on appeal) and one liability ($12M)  To corporation:  25%(chance of upholding judgment)×$51M = $12.75M  70%×($4M-$12M)=$0  5%×$0=$0  ∑= $9.55M  To shareholders:  If settle:  $15. but will have gain a lot more by not settling.75M  70%(chance it’ll reduce to $4M)×$4M = $2.55M equity will b distributed among shareholders  If don’t settle:  25%×($51M-$12M)=$9.55M o $3. Purpose of corporation: enable people to do things to benefit shareholders o Shareholders are the only ones who have a proper incentive to run a corporation  They bear risk of loss at the same time benefit of the profits o Shareholder’s profits is a proxy for society wealth: everyone benefits if we seek shareholder profits o © Shareholders don’t always have a proper incentive to run a business limited liability  Insolvency triggers bankruptcy  Insolvency: inability to pay debts when they become due  Bankruptcy: legal process for liquidation/ reorganization of business that is often triggered by insolvency  Shareholders do not bear all losses.55M expected value.55M  Rational person would settle for $15.8M  5%(chance it’ll reduce to $0)×$0 = $0  Expected value(∑)=$15.75M  Incentive: shareholders would rather be risky when approaching insolvency and not settle because they wont pay those liabilities.  To creditors:  If settle:  Creditors get $12M liabilities .

prevent pollution. as director. o Charity .8M o NACEPF v. the more benefit the society gets  Create more jobs.8M  Incentive: Creditors are risk averse and would be happy to settle for 12M. Cheewalla (handout) o Facts: P.  If don’t settle:  25%×$12M=$3M  70%×$4M=$2. Social Responsibility Theories Concession theory (Traditional view) o Shareholders are owners o Quid pro quo: socially responsible behavior in return for limited liability Communitarian theory o Everyone is a stakeholder—web of relationship principle o Don’t believe that shareholder wealth is the proxy for society health  Social responsibility behavior o Pursue profits  Shareholders’ wealth is proxy for society wealth Excel at business  The more profitable the corporation is. which was in zone of inolvency. sell at fair price etc.  Reject Credit Lyonnaisreject vicinity in insolvency theory  Nothing changes in the face of insolvency on director’s duty  Creditors of a Delaware corporation that is insolvent/zone of insolvency have no right to assert direct claims for breach of fiduciary duty against its directors  But for derivative claims. better services and products o Social consciousness  Treat employees well. creditors can take the place of shareholders and hold directors for breach of fiduciary duty  Directors’ duties are for best interest of company for benefit of shareholders. claimed that D favored shareholder’s agenda instead of fiduciary duties as directors of their corporation. o CONCLUSION: affirms traditional view.8M  5%×$0=$0  ∑=$5. even for $5.

 CONCLUSION: donation is a valid exercise of corporation power o Common law: manager of the corporation cannot disburse any corporate funds for philanthropic or other worthy public cause unless it would benefit the corporation o Courts: apply it very broadly to enable donations with indirect benefit to the corporations. . o Charter: Charter inherently agreed that the state could change the law. primary to make society better  A.256  Facts: Directors contribute to Princeton.Better to spread out the cost to a lot of people . who are .Doesn’t make sense from agency standpoint— . suspension and repeal. The shareholders consented to it by forming the corporation. are willing to want them to take on only risks they can handle invest.P.  Efficiencies:  Avoid double taxation by allowing charities to be given at corporation level  Giving more money at once rather than giving singularly (more effective)  Agency problem:  Directors instead of shareholders who want to give  CEO gets benefit/popularity  not pursuing interest of shareholders  Give to different charities (opera v.Unfair to allow some people to profit on upside shareholders don’t have control but not worry on downside. but State law did authorize donation came after Charter. we conclude that benefits of charity outweigh the benefits  Legislature allows charity  Difference between social consciousness and charity  Both are about diverting resources from profit maximizing use for some other socially beneficial use  Morally  charity is optional on some level while social responsibility is not optional because you have moral obligation to engage in safe practices  Pursue interests of society (not realistic): profits as secondary goal. Limited Liability Limited liability: the legal limitation of an investor’s liability to her investment in the business. Barlow pg.Encourage investment–more people. in the discretion of the legislature. the poor)  Conclusion:  As a society. More investmentmore capital . o Should not neglect the realities and the long-visioned corporate action in recognizing and voluntarily discharging its high obligations as a constituent of the modern social structure. Charter did not authorize donations. such as business creditors cannot go after personal assets.  Legislature: Every corporate charter thereafter granted shall be subject to alteration.Permits shareholders to externalize risk—we otherwise deterred by liability. General rule: Others (shareholders/managers/employees) are not personally liable for corporate obligations—unless in certificate of incorporation  Why? o Separate entity status o Double taxation (price you pay for limited liability) Good Bad . Smith MFG v.

not much downside—company gets full benefits of profitable companies and would care if investments kill people o What happens if we don’t give corporation LL?  Investors will just run separate business and there will be no subsidiaries  Limited liability v.Limits?  Contracts v. no liability o Really no liability—you invest and that’s it. small businesses o Public corporations—passive investor status  Investors don’t have control therefore shouldn’t be held responsible o Small businesses—mom and pops are doing everything so should be held to unlimited liability  © Small business should be entitled to LL? Otherwise. corporations o Should a parent corporation be held responsible for its subsidiary?  Depends on circ’s  Control: passive or aggressive  What type of corporation o What happens if we give corporations LL?  More corporations are willing to take more risks. not our fault o Whether investors should be liable may depend on foreseeability  Public corporations v. If company goes bankrupt. . There is no liability after o © Liability that limited  Call on shareholders: shareholders put up certain necessary amount (to pay for liabilities) or lose stock if don’t  Pro rata liability: liable. torts o Piercing the veil seems more common in contract cases o Contracts—voluntary relationship. you knew what you were doing so you should pay o Torts—surprise element  Eg. wouldn’t have undertaken the risk  individuals v. riskier investments go to subsidiaries  A lot of upside. but not joint and severally  Just for your percentage  Could discourage investment nobody wants big percentage then.

g didn’t maintain records. could avoid injustice prong  Intentional scheme to evade reasonability  Unjust enrichment  Walkovszky v. and something happens to go wrong. Piercing the corporate veil  Holding shareholders personally liable for actions of company  Rare: People rarely try because going to lose (extremely rare for public corporations)  Two-part test: o Some sorts of failure to respect the corporate form  Failure to maintain formalities (e. Dummy corporation. P claimed that D used this set-up to avoid liability o It’s not illegal—law permits incorporators to set up companies to avoid personal liability  CONCLUSION: No cause of action o Formality: Complete respect of corporation form  D did everything to separate the corporations appropriately o Injustice: no . don’t syphon. but you will win if you can prove)  Undercapitalization (failure to provide adequate capital for business when you started it)  Syphoning of funds (excessive withdrawal of corporate resources for shareholder)  Different from undercapitalization because of timing—if you put in enough money. Carlton (pg. you are a sole proprietorship or partnership (if multiple people) o Tradition rule: unlimited liability o Modern trend: only people who are actively participated in the management to be imposed liability  Fair? Would it be too tough to hold people liable for one little form  De facto corporation doctrine: Courts may treat business that was not properly incorporated as a corporation if promoters made good faith effort to incorporate and treated business as corporation  Corporation by estoppel: Courts may prevent someone from denying corporation existence if they acknowledged the corporation entity and would earn windfall by subsequently denying corporation existence. unity of interest and ownership) o Injustice  Inability to pay debts is not enough  Fraud (difficult to prove. didn’t incorporate)  Failure to maintain separate identities (eg. D owned 10 corporations with 2 cabs a piece.Exceptions Failure to incorporation  General rule: if you didn’t incorporate.422)  Facts: P was injured by a cab.

416) Direct liability: Theoretically. o They use their best business judgment o “The power of directors is original and undelegated” . usually go along with whatever CEO wants  Don’t want to disagree with the boss who can fire you o Outsiders: tend to be insiders of other corporation o Most boards consist of outsiders  Trend: increasingly more outsiders Agency problem  Directors are supposed to act in shareholders’ interests.  Uncompensated victim is not enough  No fraud  No undercapitalization  The mere fact that he cannot pay liability is not enough  Could be undercapitalization if the capital is not enough to function  Although it’s foreseeable that a cab will hit someone.) can be held liable for his own actions not really piercing the corporation veil. Management Directors Job description  Part-time job  Board consists insiders and outsiders o Insiders: have job in that corporation. anyone (employee/management/parent corporation etc. Court’s job is not to mandate insurance but to decide whether corporation was adequately capitalized.  Entity liability: hold entire business enterprise liable for liabilities of constituent corporations o Same two-part test o Fletcher v. Atex (pg. we don’t expect people to have money around for liabilities o D met insurance minimum requirement of state even though it does not give proper capitalization o Court doesn’t require more if you want more. but same result  Court generally won’t go after individuals Shareholders v. go to legislature. not in the interest of their own offices  Directors are not agents o They are not under control of shareholders.

Litigation  Can sue to enforce other rights (Limited) Structural Accountability for directors  Market for corporate control (contractarian theory) o Wall Street rule: shareholders buy shares if they are satisfied with the corporation’s management and sell the shares when they are dissatisfied. directors have to disclose information. Authority  Statutorily very broad o Delaware law§121(a): managed by or under board of directors. beneficiary has no say  © Shareholders have some say and can elect directors  Directors are fiduciaries that are kind of like agents. directors are seeking shareholders to vote. unless said otherwise in provision or in charter. kind of like trustees. if directors don’t do what shareholders want.  When a lot of sellers and few buyersstock price goes down . could vote them out more difficult Information  Directors cannot ask for shareholder action what full disclosure—any time. o Courts: fundamental precepts—must separate the control and management  Equitable fiduciary duties o Directors MUST act in the interest of shareholders  Practically limited by shareholder rights (elect directors) Shareholder rights Economic rights:  Distribution rights o Residual claims (right to profits after everything has been paid off_ o Entitled to dividends (profits)—only if and when declared by directors  Selling o Default rule: Shareholders can sell their shares whenever they want to without permission and can keep any profits from the sales Control  Fundamental matters: right to vote on certain matters such as important transactions  Election of directors: theoretically. Directors are more like trustees o Trustees holds assets for beneficiary’s benefit.

not telling them what to do)  Shareholders influence directors Rational Apathy Shareholders in public corporations  Dispersed  Small investment  Diversified reduce risks by investing in multiple opportunities Consequences:  Individual vote is meaningless  Coordination problems  Irrational to pay attention Rational apathy: indifference based on reasoned conclusion that attention is futile  Why should we follow Wall Street Ruleeven if I pay attention. usually by managing other people’s money o Less dispersed: concentrated o Larger economic interest: mom and pops just investing $100. what can I do about it? Changing circ’s Rise of institutional investors  Many people don’t buy their own stocks now—they invest in institutional investors instead. become sole or major shareholder and replace the management directors don’t like that.  Result: executive officers in charge (as factual matter.  Higher price: make it hard for people to buy out the company Corporate Hierarchy Purely legal view: Directors are in charge Old view: Ultimately shareholders are in charge they can elect directors also elect themselves to directorship “Traditional” view: Berle-Means Thesis  Actual separation of ownership and management due to dispersal of shareholding.  Institutional investor—institution that trades large volumes of securities. not legal) New view:  Executive officers run business  Directors monitor officers (just monitor. institutions invest millions o More sophisticated: financial experts .  Give people chance to buy cheap.

v. Atlas still has majority with 9. shareholders don’t have a say Blasius Industries v. Dunsmore (pg. but not as much Voting rights Shareholder access Metaphors Agency  Shareholders are principal and directors work for them Trusts  Directors can do what they want. but also places its other officers and agents under their direction. but must be accountable to the electorate (shareholders) Division of authority  Each has different role o Shareholders: make investment decision and take the risk o Directors: manage and protect business Charlestown Boot & Shoe Co. (pg. Atlas Corp. but within shareholder’s interest Representative democracy  Directors have some degree of freedom. have to follow shareholders’ suggestions or have to get insurance o Losses uncompensable—risk of business  Trust model: directors manage. which later burned down Rule: Directors manage business and have great latitude CONCLUSION: For D  DE§141(a) entrusts the management of the business of the corporation to the directors. o Their votes can make difference  Still some rational apathy with institutional investors.274) Facts: Shareholder Blasius wanted to put a majority on the board. D also did not get insurance for shop. o No laws say that they have to dissolve. CONCLUSION: Breach of fiduciary duty  Directors: whether the business decision is valid o 2 part test:  Whether the directors are acting for the primary purpose of thwarting the exercise of shareholders’ vote  Even in good faith .269) Facts: Shareholders voted for D directors to close up affairs with another guy. but D contracted new debt instead. Atlas called emergency meeting of board and voted to amend bylaws to increase board and appoint two of their people so that even if Blasius appoints 7 to fill up 15 maximum.

but 9 shareholders total  True majority: 5  Majority of votes present: 3 of those 5  Majority of votes cast: only 3 vote and 2 abstain. What possibly can directors do delay the vote and take the time to explain to the shareholders.  The division of authority  Shareholders have the right to elect directors  Board has burden to demonstrate compelling justification  Mere proof of shareholder’s bad decision is not enough. but can make more than a majority or less than it  Many states have minimum—DE§141(b): 1/3  Majority vote  Majority of votes present: affirmative majority by those present and eligible to vote (abstention=no)  True majority: affirmative majority of all possible votes. Corporate Actions/Voting Director Action Directors must act as a group (individual directors have no authority)  Meeting (to act together) o Substantive protection (supplement) o Notice of meeting  Typical: 10-60 days  Minimum: to give directors time to get to meeting  Maximum: so that people won’t forget  Quorum present: usually a majority. . then majority of votes cast is 2 out of 3  Virtual meetings o Most states allow conference calls as long as everyone can hear o Written consent  Most states allow unanimous consent by writing without a meeting  Why? Impractical to gather every shareholder. whether present or not (abstention/absences=no)  Majority vote in cast: affirmative majority of votes cast (abstention doesn’t count)  Ex: 5 at the meeting.

 Titles are meaningless o Different corporations may handle it differently—depend on corporation’s structure o Bylaws may not be helpful since it might be too general and vague Case law:  Borrow from agency law  Decide on a case-by-case basis Shareholder Action Limited voting rights  Election of directors  Charter amendments (also need directors approval)  Fundamental transactions (eg. Mergers) –varies from state to state  Other matters directors put before them . majority vote)  Need not be advisory. but can be given final authority Informal action  If directors don’t follow formalities. Treasurer  Doesn’t say what each title is. Problem with binding a future board  General rule: today’s board cannot bind a future board of directors o Board can always change its mind  But logically it’s inevitable that some decisions will take away some freedom from a future board Officers Statutory law: woefully inadequate  Some states have no rules  Some states specify certain officers o NY: President.  Downside: no chance for discussion Committees:  Made by the board of directors. it might not count  But courts will often look the other way especially close corporations or if its not a critical matter. having responsibilities for certain things  Same rules (meeting. quorum. Secretary. VP.

and the minimum is 1/3  Written consent DE§228 o Requirement: unanimous  Only applies to close corporation cannot really get with public held corporations  MBCA: charter can allow with less than unanimous Election of Directors Historically: plurality voteelection in which candidates/options with most affirmative votes win. shareholder proposals) Requirements (DE§211.216)  Meeting o Won’t actually all meet—vote through representative or proxies o Notice required o Quorum: Defaultmajority.g. Staggered board Minority representation—charter can specify  Class voting—DE§102(a)(4) o Can have different types of stock  Cumulative voting—DE§214 . But can change  Voting o Default: majority vote (Delaware)  Fundamental matters: true majority (DE)—51% of all outstanding share  Increasing trend: majority of votes cast o Charter or bylaws can change quorum and voting requirements  You normally cannot lower the standard  Quorum you have to specifically say that you want to lower the standard. without regard to absentees or abstentions Consequence:  Majority shareholders elect all directors (because they have 51% of votes)  Incumbent directors always win unless challenged o They will vote for themselves o They are rarely challenged in public corporations. o According to board option. even though the law doesn’t require them to vote o Legal requirement (e.

withholding still has the effect because it prevent from contributing to affirmative majority prevent re-election  Modified plurality voting o Directors are still elected by plurality voting.  Majority voting o Even if shareholders cannot vote no. 3 shareholders Shareholder Shares Director Votes SH Shares Director Votes R 315 2 R&H 630 5 H 315 2 N 370 3 N 370 2 . Ringling (pg. you’ll win every time. o A voting scheme in which each voter has multiple vote which they can distribute among the candidates freely. v. Can have effective control with <50%  Not all shares vote  Influence (of the minority shareholders as a whole) ≈ control Ringling Bros. no matter what voting structure is.457) Facts: Cumulative voting (each share gets to vote 7 times). include multiple votes per candidate o Get proportional representation under this scheme  Capped voting: a voting scheme in which shareholders have reduced voting rights as their holding increase o Consequence: more difficult to have controlling shareholders and concentrate power o Unpopular  Management even though don’t like shareholders to have too much power. but those who did not reach majority are subject to removal by remaining boardmembers Control True control=majority voting power  If you have true control. their own power is capped too  Biggest group of shareholders in large corporation are management and officers  Difficult to expect someone to take the company over Voting against directors  In plurality voting almost cannot  Abstain o Technically doesn’t matter  © Send a strong signal if a lot of shareholders don’t vote.

H & N become buddies and vote together. often as part of a corporate takeover Reasons for  Proxies: o Quorum requirement o Rational apathy: shareholders don’t attend meeting. Conclusion or revote.e. so need proxy voting  Federal rules: o Accountability  Shareholders rarely vote against management so need something to keep management honest  Inadequacy of state law Federal rules . R & H have a falling out. Voting agreement: valid  General rule: Shareholder can vote however he wants (no matter by what motives). as long as he doesn’t violate his duties to other shareholders CONCLUSION: H’s vote doesn’t count. one authorized to vote another’s shares) (agent) o Grant of authority by which a person is so authorized (authorization) o Document that gives the authority (instrument)  Proxy solicitation: o Any attempt to obtain the right to vote shareholders’ shares (often by management) o Governed primarily by federal law  Federal law is not like state law  Federal: form does not trump substance  State: form trumps substance  Proxy contest: Competition to obtain the right to vote shareholders’ shares.. which one is more fair?  Revote4-3(R)  Conclusion3-3better for R Proxy Solicitations Definitions:  Proxy: o One who acts as sub for another (i. R & H enter into voting agreement where they will elect 5 directors they agree on (to create a majority) or they’ll go to an arbitrator.

stocks…  Annual report to shareholders o Financial statements.  No half-truth or deceptions o A much higher standard than the common law standard of fraud  Materially accurate o Standard of materiality: an omitted act is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote  Don’t have to be completely accurate Who enforces Rule 14a-9  The law is silent  SEC can enforce as an agency o © Too many companies and too many proxies for SEC to enforce all of them  Private right of action for the private shareholder Mills v. how’s the profits. how company’s doing… o Only apply to management (only management can give annual report) Adequate: SEC lists specific things to be included. maybe they need and appreciate the info Mandate adequate and accurate disclosure Disclose what:  Proxy statement o Specific rules on what’s to be included  Eg. management analysis. requires filing with SEC Accuracy:  Anti-fraud rule Exchange Act Rule14a-9 o No false or misleading statements or omissions of material fact  No lies. Electric Auto-Lite Co.387) Facts: P. how’s the company doing. Conflicts of the interest. Basic purpose  Get shareholders the info to decide whether or not they should give proxies o © It won’t matter if you give all the info if people are rationally apathetic  ©© But if things are really changing with large institutional investments. (pg. shareholders claimed that merger approval was obtained with false and misleading representations in proxy statements 3 part test: .

then didn’t cause your harmno causation o © Essential link is necessary but not sufficient o Two theories of causation:  Loss causation—deception caused the loss  Transaction causation—deception caused the transaction that caused loss (reliance)  Reliance and causation are separate elements courts more and more require loss causation  © Hard to prove in proxy solicitations o Virginia Bankshares v. so lie was not an essential link  P’s argument on causation:  Caused the loss of state remedy coz their lie made minority shareholders harder to sue  Court: The chance to sue is only lose when the minority shareholders are fully informed about the merger. Materiality of falsehood o If there is a materiality there is a causation o Opinions are actionable if you can prove that  The speaker did not believe what he said AND  The statement itself was misleading/not true  Have to prove both subjective and objective fact o How to prove: use circumstantial evidence (Virginia Bankshares v. but here the approvals are from deceived shareholders Relief: broad discretion by court  Monetary damages if can prove monetary damages (hard to prove) . Sandberg  NO causation  Proxy solicitation was unnecessary—VA had enough votes to pass transaction. assume reliance  Materiality invites conclusion that it might have been considered important by shareholders when deciding to vote  Causation of injury o Material +essential link o Could be implied if  Misstatement is material AND  Proxy statement is essential link (the proxy contest has to be necessary)  If it wasn’t necessary. Sandberg)  Reliance on falsehood o If material.

may pursue matter . it seems like they’re no longer acting on behalf of shareholders. personal gain/entrenchment.Cost-effective & efficient -Giving individual (seems almost impossible shareholders a status they don’t have that shareholders can run their Potential for abuse (special own proxy) interest groups doing things that aren’t really co. disagreement —important to allow management to defend its side against potential insurgents o Don’t want management to spend own money?—if we have them spend own money. RULE: When directors act in good faith in a contest over policy. end up spending a lot of money Shareholders have right to reimburse successful challengers for reasonable and bona fide expenses  Don’t have to. in proxy contest. if doesn’t agree.  Injunctive relief o Stop merger ex ante and get truthful disclosure o Split the company after merger into two extremely difficult Funding proxy contests and reimbursements Rosenfeld v. treasury reimbursed both sides in a proxy contest for their expenses. they have the right to make reasonable and proper expenditures from the corp. but could via vote o But maybe should have to? shareholder voted and reaped benefit—why would they want?  If insurgent wins. everyone agrees & just need quorum. could end up paying for both sides CONCLUSION: P’s case dismissed Shareholder Access How much access should shareholders have to proxy mechanism?  Management has complete access—prepare proxy system with corporation funds  Shareholders have to spend their own money up front and convince apathetic shareholders SEC Rule14a-8—shareholder democracy  Shareholders can have proposals included in the management proxy Pros? Cons? . treasury for purpose of persuading stockholders and soliciting support  but not allowed for personality conflicts. they write “no action” letter. but rather themselves o Though management will always say it’s for policy. corp. or unreasonable  Management generally allowed to spend corp. trust that they act in good faith  Downsides to rule: uses funds to keep themselves in power. funds to solicit proxies (had to when people weren’t coming to meetings)  general rule applies to proxy contests: management can use funds to defend its position in proxy contests  Rooted in the notion that it’s in good faith and for the benefit of the company o In normal cases. Fairchild Engine & Airplane Corp.’s interest) Procedure:  Corporation gets to tell SEC that they are planning to exclude a proposal  If SEC agrees. Facts: Corp.

or with a few that have controlling interest Public corporation: corporation with many shareholders and which is required to register with SEC . but at least won’t automatically be kicked out Some tendency in proposals  Corporate governance proposals: relate to control of corporation o Get most shareholders supports. but to define process by which those decisions will be made  © Sometimes hard to distinguish substantial and procedural requirements in the bylaw. (2) if adopted. but not substantive  Function of bylaws is not to mandate substantive business decision. o Here. would it violate state law  Tension between DE§141(a)—directors manage except by law/charter—and §109(b)—bylaws can include anything that’s not inconsistent with law/charter o Court tries to walk middle line—permit procedural changes. it’s taking away the duties that directors have in that area (can’t have fiduciary duty for something you can’t do)—but court says this is just semantics CONCLUSION: shareholder proposal is not allowed CLOSE CORPORATIONS Close corporation: corporation with a small number of shareholders. o P argues: if shareholders are taking that decision away from shareholders. AFSCME Employees Pension Plan (pg.000 market value or 1% shares  Proposal has to be 500 words or less (proposal and explanation)  Company can exclude on specific grounds: o (i)(8) Relating to elections  Although elections should be what shareholders have a right in. v.285) Facts: Shareholder submitted proposed bylaw for inclusion in the proxy—wanted mandatory reimbursement of stockholders when they nominate a candidate for director election Issues: (1) whether or not it’s a proper subject for shareholders.  If a proxy contest is motivated by personal interest director’s fiduciary duty to compel the reimbursement. amending bylaws only need approval from either directors or shareholders  © Too much power to shareholders? CA Inc. which require both approval from shareholders and directors. Doesn’t mean it’ll get in. but really procedural (about elections)  But this can violate state law o Directors may be forced to violate fiduciary duties if required to pay reimbursements  DE law: a board may expend corporate funds to reimburse proxy expenses “where the controversy is concerned with a question of policy as distinguished from personnel or management. management has to include a lot of info and cannot expect people to vote based on 500 words o (i)(l) Improper under state law  political/moral issues often permitted  It’s ok for shareholders to just request. higher chance to be included and get an actual win  Some increasing concern: o Shareholders say on pay  © Shareholders are ill-suited to understand how much directors should be paid  ©© Management might be self-interested  They are shareholder’s agent and shareholders should have a right to decide how much to pay them  Law: within directors business action o Nominating directors  DE§112: Shareholders can nominate directors as long as permitted by bylaws  Unlike amending Charter. the proposal has a substantive effect.  Either side could appeal it to the courts o Shareholders: too expensive to sue o Corporation: don’t really want to mess up with SEC Criteria  Limit to which shareholders can do this o Must have lower of $2.

Double taxation on dividends Easy exist (e. hire Informal attorneys/accountants) Dividends Employment (money comes from salary/employment) Why prefer salary than dividends? . Public corporation Close corporation Many shareholders Few shareholders Dispersed shareholders Close-by shareholders Diversified shareholders (small % of Invested shareholders (greater % of wealth invested in each co. Minority has no control (even 49% shareholder has no control because there’s someone with 51%) Agency problem Abuse of minority shareholders (freeze out minorities) Should courts treat close corporation differently with public corporation  No: o They are both corporations. Personal knowledge (run business/know disclosures w/ SEC) who is) Formal (must file with SEC. Wall Street Rule) Transfer restrictions (obligations that limit ability to sell) Minority control possible.g.) wealth invested) Apathetic shareholders Involved shareholders (Shareholder can actually be the CEO and work for himself) Public information (media. Same corporations should apply same law o Predictability reduce risk and uncertainty o Difficult to draw line—no clear distinction between the two ..

is good enough. o Corporate law is formal o You can contract around it if you don’t like the rule  Yes: o They are in fact very different in reality o Close corporation is more like partnership Most states have a statute for close corporation  © Very few people elect in statutory close corporation law o They don’t know about the law o They got enough protection from public corporation statute anyway o So much you can do under general corporate law to protect close corporation  Easier for close corporation to amend the charter  Create different class of stocks  Enclose various procedures and requirements in the bylaws Control Arrangements—What do shareholders do to work around default corporate laws? Class voting—divide the power as you wish  Eg.. proxy interest isn’t in stock. Have Class A&B shares. but only Class A can vote Irrevocable proxy  One shareholder can authorize another to vote his shares. we don’t want people who don’t have an economic interest—we want voter to have the economic interest of the shareholder so they won’t do harm in how they vote  But in most close corp. is enough  Some legislatures/courts have passed laws to that effect  DE § 212(e) Voting trust . borrow money and offer shares as collateral—give lender an irrevocable proxy for life of the loan b/c lender has interest in stock  As policy matter. can be to management or another shareholder o Problem: generally revocable at will—can take it away for no reason  At common law. not in the stock. when proxy has interest in shares. there is an interest. should be revocable  but in other situations. cases.g. but with the corporation—this won’t work under common law traditions  Courts have loosened the standards  Acknowledged that some times. but in the corporation  Said an interest in the corp. solution was that proxies were irrevocable if coupled w/ interest in stock  So in normal situations. employment with corp. will be irrevocable:  E.

e. but be consistent with this rule?  Offer damages for breach of contract: rather than saying agreement is void for other policy reasons. you promised to fire anybody who will fire him (keep kicking out directors until he gets hired again)  Clark v. and no prohibitory statutory language. but cannot agree to bind directors (i. Galler (pg.472) Facts: Shareholders entered into a voting agreement.  CONCLUSION: for Clark. General RULE: Shareholders may pool their votes to elect directors.. just wearing different hats) or friends—so silly to make a distinction What could the court have done if it wanted to help McQuade.. only has control)—divorce of ownership and control  Mistrusted at first(used to amass power).476)  Facts: Agreed to have P maintained as director and officer if he does not reveal trade secrets.  Galler v. agreement is valid  Clark court is allowing what McQuade court didn’t—same court.  Definition: Plan in which shareholders transfer their shares to a trustee for the purpose of creating a voting block  Trustee is a registered holder o Trustees own the stock (but in practice.476) . shareholders cannot elect officers)  Directors exercise their own independent judgment—§ 141(a)  Arguments against this rule: in a close corp. could owe damages for promising the undeliverable  Interpret agreement as saying they will only vote for directors who do what they want. then agreement will be honored. no fraud or apparent injury to public/creditors. D did not keep their agreement. shareholders and directors are often the same people (same people. Stoneham (pg. but different decision o Policy shift? EXCEPTION TO RULE: If no complaining minority interest. Dodge (pg. agreeing to vote a specific way as directors in electing officers—one of which is to keep McQuade as treasurer. but eventually with limits  Formation: written trust agreement and transfer o Public disclosure—the trust agreement should be open for inspection  Duration: limited to 10-year time period Pooling agreement  Definition: A plan that the shareholders agree to vote their shares together  Difference between pooling agreement and voting trust o Pooling agreement: no attempt to separate ownership and voting power o Enforcement issue  Modern trend: to grant specific performance o Perhaps a better idea to award money for pooling agreement and specific performance for voting trust  Cruel to force people to work together McQuade v.

to buyout a shareholder’s shares in any case—just that if corp.. rejected the offer. the corp. is going to buy from one. there is no market to sell shares  Court isn’t requiring a corp. Rodd Electrotype Co.  Facts: Shareholders (brothers) created a pooling agreement to provide for their widows after one died (would bind co.  CONCLUSION: for brother’s widow. When minority shareholder (only other) offered theirs. minority is entitled to relief  In a close corp. bought majority shareholder’s shares. and directors. but really was a gift by a dying person S Corporation Internal Revenue Code Subchapter S: certain close corporation can elect to be taxed as a partnership rather than a corporation Requirements:  Unanimous consent of the shareholders o Can be terminated by majority  No more than 100 shareholders  All shareholders must be individuals o Cannot be a subsidiary  No shareholders can be alien  Can have only one class of stock Pros/Cons:  Pros: avoid double taxation  Cons: you have no choice but be taxed on income Fiduciary Duties of Controlling Shareholders (in Close Corporations) Duty of utmost good faith and loyalty General rule: Shareholders don’t hold fiduciary duties to each other. granted the specific performance on the agreement o No complaining minority interest—minority shareholders have the right to have the directors to exercise at the best of their business interest. (pg. CONCLUSION: for minority shareholder Duty of equal opportunity: when controlling shareholders exercised their power over the corp.  Not an insurance policy. Shareholders can act selfishly Different rule in close corporation: shareholders owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another. it should offer to all .489) Facts: Corp. too). to deny minority equal opportunity in stock purchases.  Reason: Wall Street Rule no longer applies in close corporation Donahue v.

. but other 3 only had 75%)  Looked like tax evasion—ppl have strong incentive to retain earnings instead of paying dividends b/c it increases value of co. invested/worked equally and received equal share. (pg. then D might have legit business purpose.. Later.505) Facts: 4 equal investors. Atlantic Properties Inc. wanted money CONCLUSION: Wolfson is at fault & ordered to repay penalty taxes  D as an actual majority shareholder he essentially had veto power (needed 80%. one did not. which is taxed at lower rate o Two ways to avoid being punished by IRS:  Reinvest  Pay dividend  The only thing IRS doesn’t allow is for the corporation to accumulate the money without using it Fault on both sides:  Wolfson’s fault: . Smith v. other 3 (as directors) cut off P’s salary and didn’t re-elect him as a director/officer. by turning dividend income to capital gain income. could not deny only P: duty to pay to all Court is concerned with Donahue standard because it may hamper flexibility in running a business —developed two-part test:  (1) Majority shareholders have burden of proving they had legitimate business purpose for its action  (2) Weigh legitimate business purpose against practicability of a less harmful alternative  Even if there is a business purpose.498) Facts: 4 established co. Some shareholders wanted to pay dividends.  D chose not to have dividends and pay salaries (so only 3 get)  but if they chose to pay dividends.  “Preferential distribution of assets” o Selling shares is not really a distribution of assets dividend is distribution Remedy: 2 alternatives  Undo the transaction  Force company to buy equal number of shares Wilkes v. Bylaws made all decisions subject to 80% vote. subject to excess tax.  No self-dealing on Wolfson’s part  didn’t want dividends because he partly wanted them to reinvest into the co. but he’s also in a higher tax bracket than the others and didn’t want to give it to gov.  Selfishness on both sides—3 didn’t care about Wolfson. Springside Nursing House (pg. Corp. minority shareholder could show there’s a better alternative o Friendly test to majority: allows them to do what they can while keeping minority interest in mind  not about protecting minority interest at all cost  Donahue remedy is not intended to place a strait jacket on legitimate business activity CONCLUSION: D breached their fiduciary duties  (1) had no business purpose  no need for part (2) o If he wasn’t being productive.

To make sure you know who your partners are Buy-out agreement: . if 50-50 co. P wasn’t like a partner Delaware tends to not give protection to minority shareholders  Delaware is more concerned about big and public-held corporations  Bargain special protection if you want  Rules are like this.Try and lock (with regards to firing.. too activity) early) . o Refuse to pay dividends and lead to IRS’s penalties  Other three shareholders’ fault: fail to reinvest Normally. ..Could give too much agreement that onerous transfer restriction power to company: sold in many allows/requires . to that shareholder at the Majority shareholders. stuck with people in (prevent people majority. prices aren’t what you thought they’d be Take-along right: .Keeps price down to the that restricts shareholder’s . thinking he could become major shareholder and continuous employment. provision/agreement group . without . despite even illegal from selling out.Could give too much partners/shareholders and having to negotiate or be power to shareholders (difficult receive cash payment in without money) for other shareholders to buy the return for her interest in the one who wants to leave for no business reason.Could lead to abuse .Hampers ability to sell charter.Protection on shareholder to sell the chance to sell their shares minority shareholders. Later.So they are not . CONCLUSION: not a situation where breach of fiduciary duty  Freeze-outs are wrong. case.Cause problems for the before a shareholder can sell stuck if someone else is seller her shares to a 3rd party. other trying to jump ship * Difficult for majority shareholders should be given .) Specified events can lead to uncertainty.Minimize risk of extent you want to sell ability to sell her shares hostile takeover . Exergen Corp.To keep it in the . partner/shareholder to end of retirement package (set shareholders. might not have worked out how you wanted.Can use as a type different ways (at option of co.510) Facts: P (minority) came to work full-time at co. esp. same price before they can sell their shares to the others. fired. P bought shares. majority rule works. no extra protection Transfer Restrictions and Buy-outs Reasons people Problems want Transfer restriction: . have to take the count to buy the whole company. but their contract doesn’t say majority (it says 80%)—so seems unfair that court says majority wins Possible argument: 3 was at fault and could’ve done something that Wolfson couldn’t have—seek to dissolve company (Wolfson couldn’t have because dissolution requires 40%) Merola v. but an employment case) o Not every discharge of an at-will employee of a close corporation who happens to own stock of the corporation gives rise to a breach of fiduciary duty claim  Only if shareholder is essentially like a partner will he be owed fiduciary duties  here. esp.Might be a less . specified events) her relationship with other up from the start. (pg. but this isn’t a freeze-out  Majority had right to terminate P—he was an at-will employee who just happened to be a minority shareholder (this isn’t a close corp.

gave a right of first refusal Right of first refusal: before a shareholder can sell her shares to 3d party. gave him pre-1/31 ($89k). didn’t exercise its right of first refusal. P resigned for personal reasons. other shareholders have right to buy shares at the price at which would’ve been sold to 3d party Law: statutes allow transfer restrictions (as long as not obviously unreasonable) & rights of first refusal  To control its ownership and management and prevent outsiders from inserting themselves into the operations of the corporation. F.. even though it was aware of sheriff’s sale  A restriction is reasonable if it is designed to serve a legit purpose and is not an absolute restriction on shareholders’ alienability o Reasonability at time of the agreement—here. didn’t fire him. Corp.—inducement to stay longer). didn’t ask for shareholder action. 544) Facts: At-will employee bought stock with buy-back provision (at termination before 1/31. let him keep working for 6 more weeks to get more money. they knew Special facts doctrine: co. (pg. P argues that difficult relationships made it reasonable afterwards.  Restrictions: required board approval before you could sell. but didn’t tell him there’d be a merger (& in general no duty to disclose). but only if shareholders are essentially partners (also see Merola case) o You may be a shareholder. even if they fired him. didn’t try to buy his shares. Lambert (pg. He was fired and wanted post 1/31 amount ($3M). could have another sub-exception [involving shareholder agreements]—dissent says you cannot actively block the purpose of the contract Jordan v.I Farms v. Duff And Phelps Inc. P argues that D breached fiduciary duty by taking advantage of him—firing him so they don’t have to pay $3M CONCLUSION: summary judgment to D  P is a loser  Fiduciary duties do not apply to all shareholders. P has to prove that he would’ve stayed—difficult to prove & disprove Why take-along right and right of first refusal . have to sell back to corp. but co. Moore (pg. merger fell through—so P would’ve resigned then. buying their own stock have a duty to disclose material facts  Directors cannot take advantage of minority shareholders  © Argument: Co. every contract has an implied term of good faith and fair dealing (but doesn’t really mean much in contracts) o Exception: at-will employment o But if court wanted. corp. & P would’ve stayed longer o But co. still had book value from before On remand. o Voluntary transfer v. and here it was voluntary. why should co. could’ve fired him anyway o Also. CONCLUSION: reverse trial court’s summary judgment for D  chance for P on remand Material issue of when P quit (Nov/Dec?)—in Nov. might’ve been a merger. 536)  Transfer registration bars only voluntary transfers. buyer agreed to automatically sell. but if you’re really an employee with shares and not a partner. co. involuntary transfer  Sheriff sale: involuntary transfer transaction passes  Voluntary transfer transaction doesn’t pass  Sellers has to disclose Gallagher v. he knew about the buy-back going in o But generally. have to tell P this secret info when no one else knew?  Court says when P quit.B.e. then you’re not owed fiduciary duties  Contract claim—P got what he bargained for. didn’t lie to him. involuntary = to creditor). but court says no o Factors of reasonability (pg. in Dec. Majority tried to cancel shares & transaction. thinking shares’ transfer restrictions don’t apply b/c not a voluntary sale (i.  Common law: restraints on alienation were impermissible: interferes w/ ownership & commerce CONCLUSION: restrictions did not prevent sale. remain applicable to P’s shares. are reasonable  Co.547) Facts: P bought shares with buy-back (after termination for any reason).531) Facts: P buys ex’s shares at a sheriff’s sale to satisfy settlement. should’ve told him about merger talks.

minority shareholders can exercise the take-along right o If it’s a bad price. you can only stay  if only the take- along right. Method of Dissolution Charter amendment  Charter can provide for unlimited life or until a certain date  Any charter amendment needs approval of BOTH directors and shareholders Shareholder vote  Some states allow voting for dissolution o Ex: in New York. used to be a super majority. no just a majority o Don’t need director approval Judicial Decree  To protect the minority shareholders right to call for dissolution otherwise minority shareholders cannot necessarily get enough shareholder votes  Judicial reluctant: Courts are reluctant to dissolve a corporation o Traditional concern: don’t want to shut down a profitable business just because shareholders are squabbling  © Not really a valid concern  If a non-event. minority can exercise right of first refusal and buy the company  If you only have the right of first refusal. Theoretically expands the power of whoever has those rights o If it’s a good price. it doesn’t matter  If a major event. can only leave Corporate Dissolution Corporation: seen as a separate entity and doesn’t necessarily to have an end. can always sell the business as a going concern  Possibility for the minority shareholders to abuse this option o Alternative form of relief: Mandatory buy-out  Usually the majority who has to buy out minority  but court could theoretically allow minority shareholder to buy out majority  Reasons for judicial dissolution o Waste of corporate assets  Not that it’s not being profitable now. but that it can NEVER be profitable o Deadlock: inability to obtain votes necessary for an action  Among shareholders (two 50% who cannot agree on election of directors) .

o “Dissolution is a serious and severe remedy”  Not taking a stance against dissolution—court has broad latitude in fashioning an alternative relief. didn’t give shares to everyone. Inc. unfair play  Clear casehigh standard. not a mere hope  Disappointment≠Oppression  Matter of Kemp & Beatley. He wanted to sell stock back for $5M but company only offered $600k (lowball offer). but shouldn’t hesitate to order dissolution  How to determine “reasonableness” examine the entire history of the participants’ relationship. Rosen’s Diversified Inc. allows for more subtle forms of misconduct  Reasonable expectations being frustrated  Much loser standard  The expectation has to be reasonable. (pg. (pg. CONCLUSION: for P  Reasonable expectations were frustrated—not that he was fired. gave to P b/c he’s important and is a highly valuable employee Reasonable expectation found in the inception of the relationship o Not determinative. but that he was fired & then given low-ball offer so he wouldn’t get economic benefits  Court didn’t want to say that any time an employee of this type is fired that remedy will be offered  Only shareholders who are essentially partners will be given partnership-like fiduciary duties— co.558)  Facts: P wasn’t receiving distribution of company earnings. but court interprets as “reasonable expectations” (most generous)—might not make sense since not everything bad that happens to me is always oppressive  CONCLUSION: reasonable expectations frustrated  not unreasonable for lower ct. prove that the majority actually did wrong things. to order dissolution  But courts should determine whether there is some other form of remedy and whether dissolution is not necessary. Later fired. claimed fraudulent and oppressive conduct by board.  Sometimes minority shareholders are also allowed to seek dissolution under deadlock they can cause deadlocks through veto power  Among directors o Oppressive conduct  Illegal or wrongful conduct  Explicit violate the minority shareholder’s rights. courts should consider reasonable expectations of shareholders with respect to each other and corporation  But court is not extending the holding—simply holding that terminating CEO and then offering to redeem his stock constituted conduct to invoke the statute .  Not acting in good faith or fair dealing  Looser standard. but factors that court considers Remedy: mandatory buy-out at fair value  When considering whether to order a buy-out. McCallum v.  Statute: NY § 1104-a: sounds like “illegal or wrongful conduct” (least generous standard).568) Facts: CEO awarded stock in close corp.

you might have to buy everyone’s shares. Issues: whether minority discount or marketability/liquidity discount should be applied  Minority discount: reduction in pro rata value of co. has right to buy out shareholder instead: first negotiate a fair value. but if buying out. he might be incentivized to oppress minority into seeking dissolution  then the more majority oppresses. no money. there is no market so you won’t get as much as you would for an equivalent public corp. then co.  Fair? If there were dissolution (sell) at 80% of value. the lower the price (since nobody would want minority share)  And doesn’t make sense: in dissolution.). is sold & if option. State law says if shareholder seeks dissolution. Jordan (handout) Facts: Other 2 shareholders freezing out P (no info. but did not receive b/c of fiduciary breach  Remedy should neither grant the minority a windfall nor excessively penalize the majority  Neither corporation nor shareholders have the obligation to buy the minority shareholders out when minority shareholders want a way out.’s ownership interests o In a close corp. etc.  take-along right Charland v. co. then minority would only get 49% of 80% (majority 51%). no reasonable expectation to buyout. then court will give valuation. so getting 100%  Would have same practical effect as the minority discount: reward oppressive majority for oppression Brodie v. then co. is still functioning at 100% and just being consumed by majority—if discount. it shouldn’t be a low offer—incentive then is to not make an offer in first place  If you offer to buy someone’s shares. get pro rata value after co. but seems unclear—P technically made bid first. o Court says impression was that co. counter-offered at a much lower price. fired P and offered to buy the stocks at low price. Country View Golf Club (pg. CONCLUSION: reasonable expectations frustrated  but not entitled to buyout of shares  Freeze-out a minority shareholder by majority shareholders in a close corporation breach of fiduciary duty  Remedy for freeze-out is to restore minority to position she would’ve been in if no wrongdoing  to those benefits which she reasonably expected..575) Facts: P sought dissolution (alleging illegal activity). makes an offer. o Court doesn’t want to say company must buy him out. the dispute never ends) o Just because someone in the close corporation wants a way out doesn’t necessarily mean he/she can destroy the whole company and the life of every other shareholders  Different situation if the person is oppressed majority shareholder no longer has clean hand . majority shouldn’t be better off  so both dissolution & mandatory buy- out should be pro rata  Make sense if selling the shares to the outsiders but doesn’t make sense when selling to the majority shareholders. then majority would bank on that theoretical loss from dissolution o Court says marketability discount should not be applied  Majority is getting to consume business.  P would be put in better position than before wrongdoing if buy-out o ©Really? isn’t she just getting money for an illiquid stock and value of her stock? o ©Benefits to a buy-out would be to put an end to all this and a buy-out does not harm the company (otherwise. if they can’t agree. due to lack of power held by minority o Voting power is different between shareholders & can translate into economic issues  so minority shares might be worth less than would otherwise be o Court says minority discount should not be applied because of serious consequences  If majority shareholder knows there is a minority discount.  Marketability discount: reduction in pro rata value due to lack of market for co. but seems to say if co.

but older cases  internal affair doctrine Business judgment rule A very high level of review for directors If apply business judgment rule. the misappropriations would not happen. clear he had expectations (he worked at co. they will not be held liable for the result as long as the decision was rational (doesn’t say reasonable) . If you don’t want to do either.  Francis v. or hire an expert.  Duty of care owed to: normally the shareholders o Here: courts allowed clients/creditors to sue for the breach  Special protection on special industry such as bank.  CONCLUSION: D breached fiduciary duty of care  What are directors’ duty of care: o A general monitoring of corporate affairs and policies  Have to be well-informed about the business  Doesn’t need to cover all day-to-day activities but could raise suspicion to misconduct  Lack of knowledge is not a defense  Either acquire the knowledge required. care and skill that an ordinarily prudent man would exercise under the same/similar circumstances in like positions. Sons (directors) withdrew loans & co. And let the counsel help you to find out possible solution  Vote against the issue  Threat to sue. United Jersey Bank (pg.  What would P get for her shares if buy-out? Unfair to say full value since she didn’t really have expectations  but maybe it should be based on husband’s expectations: if he were in wife’s position. o Duty to object  Sought the advice from the counsel once suspicious to make sure whether it’s legal or not. sought injunction from the court  If still cannot work you should quit. the management almost always win General rule: If management carefully makes an informed business decision in good faith and without a conflict of interest. other cases do this sometimes.622)  Facts: Director didn’t know anything about business. until he was fired and stopped receiving money) Duty of Care & Business Judgment Rule Fiduciary duty of care:  Exercising standard care (expected of people in that industry) + special skills  Fulfill duties in good faith and with diligence. failed. then don’t be the director. was incorporated in NY. And insurance company here is kind of like a bank  A trust relationship gives rise to a fiduciary duty to guard the funds with fidelity and good faith  Causation: should she pay attention to that and threat to sue.  Jurisdiction: Corp. but NJ law was applied o —Velasco thinks this would probably be wrong today.

 As long as the decisions are rational. not liable even if later the decisions turn out to be bad ones. which seems so lenient? o Francis looked at standard of conduct: states how a person should conduct a given activity or play a given role  Ordinary care o Kamin looked at standard of review: states the test by which an actor’s conduct should be reviewed to determine whether judicial relief should be granted  Business Judgment Rule. irrationality. Business Judgment Rule is a presumption  Kamin v. Have to prove that decision was so bad that it was based on waste.  CONCLUSION: summary judgment to D o Business judgment: the question of whether or not a dividend is to be declared or a distribution of some kind should be made is exclusively a matter of business judgment for the board of directors. don’t invest in risky industry or risky company o Shareholders can always diversify the investment to lower the risk . o Process: decision-making process  Protection is less strong. and Kamin. gross negligence. Directors distributed shares instead because loss would affect their earnings and stock prices. but as long as they are in good faith o Conflict of interest:  P: the directors are tying their retirement salaries to the financial statement  Court: too speculative. not shareholders or courts. In Delaware. to sell shares at a loss of profits so they could pay less taxes.  Business is inherently risky: results don’t tell us much about the quality of decisions  Assumption of risk by shareholders o Its shareholders’ choice. (pg.  How reconciled with Francis case. o Good faith: Directors may be mistaken.638)  Facts: Shareholders wanted co. or no one could make such decisions. Process o Substance: the actual decision  The protection is complete – courts do not want to entertain this. but still far beyond mere negligence Justifications for Business Judgment Rule:  DE§141(a): Directors manages corporations o Directors are specifically authorized by law to make the decisions. need more proof  Only 4 of the 20 directors have the conflict of interest will not influence the whole board to make a valid decision. which seems so demanding.  Very rare situation where directors are acting irrationally  Ex: Waste  Substance v. Amercian Express Co. if you don’t want risk.

couldn’t have a conflict—any conflict would make the transaction voidable  By 1910.& E. SLE had been renting property to LGT. 3 of them were LGT shareholders. profits by SLE split among 6—and low rent to LGT means more profits to DEF Entire Fairness Rule: Burden of proof on D to prove that the transaction was fair and reasonable to the corporation o Prove that LGT couldn’t afford to pay more and couldn’t rent to anybody else. but on the other hand. S. Business Judgment Rule doesn’t apply:  Business Judgment Rule requires an actual business decision—no decision here because SLE board (3 on LGT board) didn’t even consider a new lease (if you just didn’t think about it. won’t be protected by BJR)  There was a conflict of interest  apply Entire Fairness Test o ABCDEF = directors for SLE. etc. (pg.. When Donald (not shareholder of LGT) was supposed to sell SLE shares to others. o D failed to prove that the rent was fair CONCLUSION: D didn’t satisfy its burden  take difference in rent in what actually charged and should have been charged. add to book value.718) Facts: 6 siblings were SLE shareholders. key issue was fairness Lewis v. if approved by disinterested directors. the way you couch the truth is important Duty of Loyalty & Entire Fairness Test More stringent standard when there is conflict of interests  It’s usually difficult to prove entire fairnessshareholders always win Historical trend of law:  Historically. might’ve been true: in 1880. refused and claimed others had wasted SLE’s assets. but duty of care seems to require a lot out of you  You have a duty not to lie to your client. but not charging enough.  Necessary to protect incentives o Willingness to be a director no upside except getting salaries but assume all the downsides when the business turns bad  Spreading costs  Courts are not business experts and don’t want to guess what a good business decision is Ethics  Client comes in to talk to you about duty of care—what do you tell him?  Two sides here: it’s true you can get away with anything under BJR. transaction would be permitted if fair  By 1960. DEF = directors for LGT o Profits made by LGT split among 3. and then sell shares (already agreed to book value in shareholder agreement) Two elements for Entire Fairness Test .L. Inc.

but not self-dealing because paid dividends fairly to all—motives are irrelevant. but directors rejected them because a lot of them had other relationships with company and thought new company might not keep those related business (make more with own co. Negotiating on behalf of both sides of the transaction  The fiduciary cause the exclusion of.  Conflict of interests & Self-dealing (conflict of interest that rises to level of self- dealing) o Self-dealing: when a fiduciary stands on both sides of a transaction.  Instead. unless you can show they’re improper  Dividend policy works just like this.  Parent owes a fiduciary duty to its subsidiary when there are parent-subsidiary dealings. or causes the company to act in such a way that fiduciary receives something from the company to the exclusion of. 708) Facts: Advisors said external offers were good. where I’m sole shareholder).  (2) denied opportunities to expand  Sinven had no particular right to them so no self-dealing—really Sinclair’s and chose to put them in wherever. Levien (pg. and detriment to. the shareholders  Two basic meanings:  Dealing with myself. especially with respect to classified stock  Here. passed recapitalization exchange: an exchange of securities intended to restructure the company’s capital structure. sometimes it’s better to reinvest and sometimes it’s better to cash out. o CONCLUSION: no self-dealing  apply Business Judgment Rule o Claims:  (1) excessive dividend claim (more than it has profits)  Sinclair needed more money. The opportunity doesn’t belong to Sinven at the first place  (3) breach of contract claim  Late payment  Sinclair contracting with its subsidiary is self-dealing  apply intrinsic fairness test  Late payments clearly breach of contract  Failure to meet the minimum amount  Purchase—Sinclair didn’t buy as much as promised. 814) o Facts: Sinclair was 97% owner of Sinven. Courts are going to require more than complete reasonableness. and detriment to the minority shareholders o Sinclair Oil Corporation v. Gantler v. but complete fairness . Sinven’s minority shareholder claimed that Sinclair breached fiduciary duty. but no voting rights)— purpose was to gain more control CONCLUSION: amounts to self-dealing  erred in dismissing  Stop the takeover to preserve their jobs and their side businessself dealing  A trial is needed to prove the facts before the court determines whether Ds were acting reasonably or not. Stephens (pg. exchanged common stock for preferred stock (get more dividends. but bought everything Sinven produced  Sinclair cannot ask Sinven to stop producing just because they don’t want to buy anymore.

sophisticated board. D came up with price and presented to board in a 2-hour meeting. read agreements. structure. unless you can prove that the friend is like his family  Job o Job is the proxy for money o © But job cannot count as money.  Fair price (Substance) Where to draw the line  The balance between authority and accountability o If place threshold too high (dollar amounts). child. Spouse. CFO okay-ed it. Whether the board was well-informed? Yes No (court said no) Maybe simple decision. then might get courts involved too much Business Judgment Rule in Delaware Smith v.. it was “virtually meaningless” given time limits  Allowed co. relied solely on 20-minute Boston Group study to evaluate co. Van Gorkom (pg. can see if better offers are made o Here. significantly above market thought it was bottom of “fair” (maybe he was just price. had no documents.  Officers have same fiduciary duties as directors Self-dealing what kinds of conflicts count  Money conflict  Family interest? o Close family member. then real conflicts will go unpoliced because they won’t be cognizable  but if too low. auction o Once offer is made & there is time to complete it.648) Facts: Directors wanted to sell co. how approval occurred. had recent 2-hour meeting. didn’t figure out where price came external constraint to make quick decision from or what intrinsic value of co. but not seek them. was Did co. & recent presentation. didn’t actually 5-year internal review. other shareholders trying to appease his boss) approved it  Market test: an opportunity for the market to present alternatives to a proposed transaction in the way of competing bids. didn’t actually allow an auction . you can get another job. market test. parents o Friends?  Usually don’t. think price was fair? Yes No D thought it was fair. Other executives didn’t seem to agree—CEO CEO proposed it. immediate family member. So losing job is not enough  Belief? Entire Fairness Test:  Fair dealing (Process): time of transaction. because they couldn’t use federal income tax benefits and could get more with un-used benefits. to entertain higher bids.

other potentials weren’t for sure—and no one would give up one deal without knowing another is for sure. for free. D offered what most would be willing to pay—and got it (can’t go back and get more after other side accepts) Any negotiations? Pritzker didn’t want market test. not best price o Came up with $55 by running numbers and determining the price at which LBO would make sense o LBO (leveraged buy-out): purchase of business financed primarily through debt. might still be a better idea to take what’s offered now  Board/shareholders/market all thought their price was okay. junk bonds—if successful. didn’t negotiate terms  Why not negotiate under these circumstances? o Two possible strategies in negotiations: offer what most willing to pay and negotiate up  or give best price and others negotiate down o Here. end up with co. if not. Low risk bond charges low interest. is really worth much more (court seems to implicitly reject EMH) and thinks board knew market consistently undervalued their stock o © But even if you think intrinsic value is worth more. esp. based on analysis of info. didn’t seek the best price—they only sought what was fair price.  © But market always knows these co. I-banker just goes with payer  but worst person to decide is the court because not business experts!  Co. are entertaining offers. didn’t seek to determine intrinsic value: theoretical value of company. but premium of intrinsic value  Fair? EMH says market value is best indicator  Court is suggesting that co.  Junk bonds/High yield bond—higher risk and higher return o MBO (management buy-out): LBO by management Court finds problematic that co. “real” value. or what price “should be” o Just because it’s a premium over market value doesn’t mean it’s a fair price  can’t just look at premium of market price. and they had hired an I-banking firm to go out and find people to make better offers (based on contingency) Court had two concerns with approaching price  Co. go bankrupt  Bonds—price based on risk. insurance companies were afraid (b/c didn’t know where line of liability was) . much less gross negligence o Sophisticated board with no conflict of interests o High price and unsuccessful auction  Sent shockwaves throughout industry  people were afraid to be directors. wanted lock-up option  Lock-up option: a provision in an acquisition agreement designed either to preclude a competing bidder from acquiring a company or to provide compensation to the original bidder in case it loses in a bidding contest (defense mechanism)  So even if Pritzker loses. he would still make a profit (compensation for efforts)—but might deter people from bidding since there are more shares then and buyer would have to buy more CONCLUSION: directors acted grossly negligent and don’t benefit from BJR  held to damages Aftermath  Here. BJR case but directors found liable o Many people didn’t even believe this was negligence.

just 8 years later. Result: Many states adopted statutes allowing companies to eliminate liability except in worst cases  DE § 102(b)(7): allows co. v. where directors quickly accepted a high offer with no market test (makes it seem worse). court found for defendants anyway. Technicolor Inc. CONCLUSION: court upheld Van Gorkom and remanded  BUT on appeal. which plaintiff has to rebut  How to rebut with respect to duty of care? Gross negligence  With respect to duty of loyalty? Conflict that rises to level of self-dealing (though don’t have to prove that they actually did something wrong) . directors of corp. strongly suggesting that DE has backed away from Van Gorkom Conflicts of interest does not automatically invoke entire fairness test  Individual director v. or allows the limitation of. Same court. acted on an informed basis (i. and duty of care o Good faith was never put on equal footing with care and loyalty o Care: decision-making process o Loyalty: conflicts of interests o But court doesn’t say what good faith is… Redefined relationship between Business Judgment Rule and Entire Fairness Test  Traditionally.. to limit directors’ personal liability for breach of duty of care  Exculpation statute: law that limits. loyalty. director liability for breach of fiduciary duty  Doesn’t eliminate duty of care. entire board o Individual director’s conflict of interest does not invoke entire fairness test if rest of the board doesn’t have one o Makes sense? Gets a pretty good business decision  but hard to figure out how much influence person has on rest of the board Financial issues do not automatically invoke entire fairness test  Need materiality—not just going to be any financial interest. thought of fiduciary duty as: (and how many still think of it as) But this case applied it differently: Business Judgment Rule is “a presumption that in making a business decision. (handout) Facts: Similar situation to Van Gorkom. with due care). but a material financial interest  Materiality analysis: need material financial interest of more than one person to invoke entire fairness test  Must be material to BOTH the independence of the individual director and the entire board Duties in corporate law  Traditionally only talked about two—then called it triad of good faith. in good faith and in honest belief that action was in nest interest of the company” BJR is a presumption that directors fulfilled fiduciary duties. just damages for it—so could still have equitable relief Cede & Co.e.

but only after rebuttal of BJR (which is difficult to prove) Disinterested Approval When there is a conflict of interest:  Use judicial scrutiny and apply EFT. but here. so apply fairness on top  Technical legal reason: statute just says that such transactions aren’t automatically voidable if you do this—but doesn’t mean it’s automatically okay to do this  Clear that this is probably what statute meant despite language because DE adopted this from other states that interpret this way  Bottom line: statute doesn’t preclude fairness after the fact—only voidable if it’s unfair “fully informed disinterested directors” and “fully informed shareholders” . disinterested directors. corporate law has accepted that un-conflicted board members can make the decision  DE § 144 specifically allows conflicted decisions to be made by un-conflicted decision makers DE§144: an interested transaction is not void/voidable because a conflict in a transaction if it is:  a: approved by fully informed. burden goes back to the defendant to prove fairness of transaction  BJR should be like rational review. With respect to good faith? Intentional misconduct If rebutted. we’re going to end up with EFT. now it goes to EFT  P doesn’t have to prove damages. not that different from traditional model o Only real difference is that with duty of care.  b: by fully informed shareholders. D does  now a heavier burden Practically. may not completely be an arms-length transaction Mostly. this framework isn’t that different from the traditional view  Very hard to prove gross negligence  So really. or  c: if it’s fair acts determined by the courts Court interpretation: require entire fairness along with 1 of the three  Policy problem with what “disinterested” means o Maybe court is uncomfortable with what “disinterested” means. but courts don’t like to do that  Courts would rather eliminate the conflict of interest  Cede said: o Conflicts have to be material (financial conflict) o Conflict of one director not necessarily conflict of entire board—but even though they’re not directly conflicted themselves.

he has brought the company much more than he got CONCLUSION: dismissal of P’s claims affirmed Court based its decision on success of business  Before D became majority shareholder. record that they try to force people)  Standard of review: entire fairness with burden on defend we go back to default because we don’t have independent director approval Have to decide whether independent committee is really independent—look for real bargaining power Burden and Shifts . 738) Facts: Cookies and D (w/ distributing co. but that doesn’t mean that:  Co. Later D became majority shareholder.820) Facts: Alcatel owned 43% of Lynch. still need EFT and courts are not going to approve it anyway DE tends to say that if you have truly fully informed disinterested director or truly fully informed disinterested shareholder approval. royalty agreement for recipe. Minority shareholders complained that D was self-dealing: entering into contracts with himself. how negotiated. unanswered whether all threats are wrong…  Even without § 144. couldn’t until recently)  Arguments for fair price: made co. storage facility agreement. could they do same thing? Kahn v. consulting agreement. but had veto power (require 80%). so Alcatel tried to buy out Lynch. a great success so he deserves the money. BJR  Alcatel had a fiduciary duty not to unduly influence other directors (almost certain that they didn’t have duty to not veto first transaction. not paying dividends (but not big deal since co.  But courts still read in “disinterested shareholders”  Reading this way just gets rid of common law  Not automatically void or voidable. material b/c lots of money involved Entire fairness looks at fair dealing & fair price (but must be examined as whole) (Kahn. but focuses on threat of tender offer at lower price (legal). got rid of troublesome management. couldn’t have made more money—but majority probably doesn’t want to get into that hypo and co. Lynch’s independent committee rejected Alcatel’s proposal to buy a co. isn’t required to pay dividends. Committee rejected three offers. 700) Fair dealing (process)—when the transaction was times. Lynch Communication Systems Inc. is making a lot of money doesn’t mean that D isn’t overpaying himself  Argument that another person could’ve been brought in to do the work for less—but that person might not have the same skill. how approvals from the disinterested directors and shareholders is obtained. theoretically. he had no fiduciary duty to them and his contracts had been approved by previous disinterested shareholders (DE § 144) Dissent: maybe D did a good job. Rises to self-dealing: in a contract where on both sides. and co. then entire fairness test might still apply. veto over any other alternative. dominated the board and replaced board with his people—so essentially him making the decision  Arguments for fair dealing: previous directors had given him the contracts and now these previous directors are the plaintiffs Fair price (substance)  Arguments against fair price: he was overpaying himself.) entered into contracts. conflicted directors can create independent committees (made up of independent directors w/o conflicts) to make final decisions. not Business Judgment  burden does not shift to P  Have to look at entire fairness (Alcatel still not safe under § 144 w/ independent committee): not really an arms-length board because Alcatel has control over Lynch (threats. (pg.50 because no other possible offers (Alcatel could veto) and Alcatel threatened to go to shareholders directly with tender offer of lower price. then took $15.  Arguments against fair dealing: didn’t disclose profits (court rejected this). Cookies Food Products v. was floundering before him  Or just because co. Lakes Warehouse (pg. then BJR applies  but if not truly the case.  Worried about tender offer here because they didn’t want to be stuck with angry Alcatel—it only needed 7% more to have complete control—court doesn’t focus on this. but not issue here) Court then discusses how an independent committee could sanitize an otherwise conflicted transaction – often by shifting the burden of proof on the issue of fairness (see below)  This was state remedy that VA Bankshares was talking about—but court said it can’t be a lost remedy because you either have a fully-informed group (no fraud) or don’t have fully-informed (then committee doesn’t sanitize conflicted transaction) CONCLUSION: committee acted because of Alcatel’s position.

then that vote will not count as ratification and will not shift the burden of proof If ratification was not required and was specifically requested. whereby the act.g. for a merger agreement). shareholders approving director conflict. is given effect as if originally authorized by him So if the shareholder vote was already legally required (e.. then stick with fairness and just shift the burden  E. directors approving shareholder conflict... burden on P Independent Business judgment rule Entire fairness test shareholder approval Burden on P Burden on P * But often difficult to prove that you have independent director approval—directors will be appointed by controlling shareholder and that relationship has potential to influence (might not have fully informed disinterested shareholders. as to some or all persons. then go with BJR o E. not superior  EFT o But directors approving directors is an unclear area of independent director approval Ratification Definition: the affirmance by a person of a prior act which did not bind him but which was done or professedly done on his account. it will shift the burden of proof Cleansing effect of the ratifying shareholder vote is to subject the challenged director transaction to Business Judgment Rule as opposed to extinguishing the claim altogether  Van Gorkom had said shareholder ratification would extinguish claim altogether  Gantler says it does not extinguish—just brings us back to BJR (though not that far from extinguishing) Corporate Opportunities Corporate opportunity doctrine: a fiduciary should not take an opportunity for himself that belongs to the corporation Basic issue: is the opportunity a corporate opportunity or just a personal one Factors: Financial ability . are superior  BJR o But if not a superior source.g. shareholders approving shareholders.g. Director interest Shareholder interest Default Entire fairness test Entire fairness test Burden on D to prove entire fairness Burden on D to prove entire fairness Independent UNCLEAR (different cases say different Entire fairness test director approval things) Burden on P* Delaware: Entire Fairness Test with burden on P Some states: business judgment rule. directors are not superior to shareholders  stick with EFT  E. just scared shareholders) Why shift to Business Judgment Rule when director conflict of interest but still Entire Fairness Test when shareholder conflict of interest  How great the shift depends on the source of the approval—depends on how superior the source of the conflict  If approval is superior source.g..

then more likely to be a corporate opportunity o Could be dispositive for corporate opportunity  Party involved o The more significant/higher position the person is. give it back even if principal isn’t hurt) . Hawaiian International Finances v. just what courts think is right.  If Pablo had disclosed and company had approved. his loyalties aren’t going to be entirely to the corporation. CONCLUSION: D is liable for commissions received  Company was hurt by this—could have paid less if commission wasn’t paid o Even though argument that another realtor would’ve just gotten commission anyway. the more likely o ©Irrelevant big company can expand the scope of business  Conglomeration: doctrine of internal diversification  Interest or expectancy o If corporate has interest in opportunity or expectancy arising out of interest o Very vague and difficult to apply  Resulting conflict o Fiduciary cannot have a conflict of interest o It’s better for the fiduciary to disclose and quit and then buy  Source of opportunity o If you use the corporate’s assets (including time) in acquiring this opportunity or came as a result of assets/time. o The corporate has to have the financial ability to take the opportunity  No harm o © Irrelevant corporate can find a way to raise money. may be more likely that it’s a corporate opportunity. discourage the director who wants this opportunity the incentive to find a way to finance for company  Line of business o If in the same line of business. then Pablo could’ve kept the commission Could’ve gotten to same result with accounting for profits (agent has to account for profits.780) Facts: On behalf of co. Pablo (pg.. D contracts land and gets commission through his realty company. The more closely related. we just don’t want D in the future situation where he’d work for himself—once he’s conflicted. the more likely we are going to say it’s a corporate opportunity o Reality: Officer>Director>Employee>Shareholder  Extent of involvement—officers are closer to the inside information to the company and has the most responsibility of running the company  Fairness o Considering all circumstances o Not really a test.

following such disclosure. Harris (pg. following such disclosure. it must show  either that D did not offer it to it or  that P did not reject it properly o If P did not reject opportunity by a vote of disinterested directors after full disclosure. Northeast Harbor Golf Club v. highest person on hierarchy o Fairness—she didn’t tell them in advance before buying CONCLUSION: adopted ALI test  remand ALI Principles of Corporate Governance § 5. by disinterested shareholders. had no financial ability o Line of business—club was only a business of running golf course. by disinterested directors. she may not defend Fair test? Could be asking a lot to have directors/officers disclose everything they could have non- corporate opportunities taken away just because they wanted to be safe and disclose This court thinks you can’t do after-the-fact approval—but not what Principles of Corporate Governance requires  (a)(3) gives you three different options: approval in advance by directors.05: NOT law (a) A director or senior executive may NOT take advantage of a corporate opportunity UNLESS:  (1) The director or senior executive first offers the corporate opportunity to the corporation and makes disclosure concerning the conflict of interests and the corporate opportunity  (2) The corporate opportunity is rejected by the corporation. or o (c) The rejection is authorized in advance or ratified. but maybe they disagree on how property should be developed o Source of opportunity—clear case for the first property.  But if D failed to offer the opportunity at all. which took no formal action. source called D (president) because he thought P would be interested in buying. . shareholders. or it’s fair  suggests that if you have approval in advance. but you don’t need approval if fair in advance  Problem is that after-the-fact approval is dangerous—provides strong incentives for getting approval in advance  Actually favorable for the director: both sides are going to evaluate at the same time.  Is it a corporate opportunity? Not clear o Financial ability—trial court had said co. and the rejection is not equivalent to a waste of corporate assets Once P shows the opportunity is a corp.784) Facts: President of golf club heard about properties surrounding the course being sold and personally purchased. you don’t need fairness. opportunity. but property adjacent would affect value of golf course o Resulting conflict—not going to be direct competition. o (B) The opportunity is rejected in advance. She then told the board. and  (3) Either: o (A) The rejection of the opportunity is fair to the corporation. then D can defend that the taking of the opportunity was fair to corp. a little bit vague for the second property o Party involved—she was president.… in a manner that satisfies the standards of the business judgment rule. but sometimes thought of expanding  © Golf will be interested in buying the land for not building the houses on the land o Interest or expectancy—didn’t seem that interested based on line of business. Why not disclose earlier to let the company evaluate the opportunity before the circ’s changes and the evaluation goes higher.

co. Porter (handout) Facts: Howard and P were to submit a grant proposal. P could’ve made a better deal. to work on this project. 3d co. P wasn’t important to this opportunity Duty of Good Faith Good faith located:  Business judgment rule o A presumption that. co.)  Corporate opportunity and entirely fair are enough o Assuming it was corp. the directors of a corporation acted… in good faith. D was fair to CIS—he was always upfront about his conflict of interest. Broz v. v. opportunity  but in order to argue refusal to deal. D resigned. opp. Howard didn’t want P involved. in company’s line of business. Cellular Information System Inc. you are estopped from arguing “refusal to deal” defense o Court won’t just trust you. came to have this expectancy. opportunity for CIS:  line of business suggests: yes  interest or expectancy: no. in making business decision. must have unambiguously disclosed the opportunity together with reasons for refusal o If you didn’t disclose. told them of opp. resulting conflict  D argued that Howard refused to work with P so not a corp. D could’ve worked with whomever he wanted. but all didn’t want. and…  §144—board authorization o …if… the Board or committee in good faith authorizes the contract or transaction…  §102(b)(7)—director exculpation . right away o Argument that he wasn’t: he didn’t formally go to board to discuss/vote—court sees as technicality D did not have a duty to future companies or possible shareholders of CIS  Too speculative.)  © Velasco doesn’t think this is the case for a refusal to deal—ultimately it was D’s opportunity/decision: he was the main guy. opportunity for P: used corp. was negotiating to buy CIS stocks. D talked to CIS directors about sale of cell-phone area. and became owner. doesn’t want after-the-fact manufacturing of reasons—wants to give co. didn’t tell P why. colleagues weren’t even that important. When grant was awarded. chance to test the deal (if D had disclosed. was going to acquire in 9 days and had means to buy Energy Resources Corp.. opp. CONCLUSION: D breached fiduciary duty  Corp. (pg. of RFBC and outside director of CIS. CONCLUSION: for D Corp. CIS went bankruptcy DE does not require disclosure—but disclosure helps (safe harbor that it’s not a corp. CIS was selling the license instead of acquiring the licenses  financial ability: No. assets. had financial ability. but wanted D to form own co. doesn’t owe to 3d parties where no fiduciary duties owed  Argument that he should owe a duty? 3d co. etc. which knew.794) Facts: D was pres. reassured.

Derivative Litigation (handout) Facts: CEO pushes co. to hire friend as president. but people get careless some time. but they had adequate info. but standard of review is lower (may have been negligent. Pres. deliberate indifference and inaction in the face of a known duty to act. important to split up duty of care and duty of good faith:  With duty of care. doesn’t mean you are bad  Loyalty talks about material financial conflict o You can be conflicted but that doesn’t mean you are evil  Good faith boils down to intentional misconduct—you are bad In re The Walt Disney Co. Duty of care claim: no breach  They fell short of best practices. Ritter (handout) . you are really trying  Decency—outrageousness o Not being outrageous  Legality—Intentional violation of law o Organizational documents and statutes Different from normal duty of care/loyalty  Care talks about careful decision-making process o Careless. agrees. enough to make a decision  Standard of conduct says they should’ve done a lot more. we’ve eliminated liability for breach of duty of care (exculpation statute)  But company can’t eliminate liability for bad faith Stone v. but have to prove gross negligence) Duty of good faith claim:  P argues that trial court is using different standard of good faith. where the fiduciary acts with the intent to violate applicable positive law.. doesn’t work out and terminating him triggers $130M payout. a conscious disregard for one’s responsibilities  Mere gross negligence without more is not enough to constitute breach of good faith o But “disregard of duty” with “intentional” all sound like on same continuum of negligence/recklessness (due care)? o Don’t want to conflate duty of care with duty of good faith. o …provided that such provision shall not eliminate or limit the liability of a director… for acts or omissions not in good faith… Content of good faith—bad faith:  Honest—Dishonesty o Not trying to mislead  Sincerity (effort)—intentional misconduct o You are doing your best. co. which is substantively incorrect—but court says two different ways of saying same thing (all about intent)  Standard of good faith: the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corp.

but co. but careful enough to avoid liability—weren’t grossly negligent . for wrongdoing. Ovitz wanted downside protection  but just because you pay market value for something doesn’t make it a good deal  Negotiations? Ovitz wanted huge signing bonus. system of espionage to ferret out wrongdoing o Absent grounds to suspect deception. significant chance in a large corp.. you have a fiduciary duty to act Management Compensation In re The Walt Disney Co. just general ideas Two duty of care issues:  (1) Care in authorizing in the first place o They weren’t careful. negotiated for money on backend if he stayed for awhile (sounds like good negotiations)  but P argues they were shifting things around.  Caremark (1996): you have to put in a system that might catch these wrongdoings (even if no suspicion. no duty on directors to install and operate a corp. reduce chance + general monitoring to run business) o Caremark claim is duty to monitor  sounds like care. but now in loyalty  duty of care was exculpable (clear from blame).  Seemed reasonable: co. once you know. Allis-Chalmers (1963): absent cause for suspicion. Facts: Caremark claim: Employees violate law. Derivative Litigation (handout) Facts: Terminating pres. duty of loyalty and duty of good faith  Now: o Duty of care o Duty of loyalty  Traditional loyalty  Good faith Consequences:  Leads to liability: Caremark was care.  to protect P How do we satisfy monitoring?  Set up a system (Caremark said “reasonable” system) How do we show intentional disregard?  Ignore “red flags”—facts showing that board was aware but ignored the signs (consistent with Graham). was trying to lure Ovitz away from agency co. co. D bears a heavy burden in loyalty claim. neither board nor senior officers can be charged with wrongdoing simply for assuming the integrity of employees and the honesty of their dealings on the company’s behalf. no reports when deciding. with systems in place. gets in trouble. but this court said it’s loyalty o Caremark is about good faith (analogize to conscious disregard of duties) o Duty of good faith is in duty of loyalty Result: No more triad of fiduciary duties (good faith is part of loyalty)  Before: Duty of care. and shareholder wants to sue directors for not preventing it (should’ve been aware & stopped)  Graham v. trying to make it look like negotiating. triggers $130M payout because agreed amount for non-fault termination. but now turn it into a case that is non-exculpable  Change of burden of proof: P bears a heavy burden in good faith claim by showing D are evil.

o Court said they knew enough. contracts are written so cause for termination is bad misconduct (protects a lot of misconduct)—so board couldn’t get a termination for cause here because they contracted only for truly extreme situations and now bound by it. was better off without Ovitz  P argues that contract was designed to incentivize Ovitz to get himself terminated (stronger argument): court says it’s fanciful and without proof that Ovitz did that—but issue is about what directors did. experts in good faith  So that directors can focus on making business decisions. Racial divisions. saving money. borderline case. national divisions… Result:  Despite admitting that this was a troubling case in Brehm. do not weigh. it’s not waste). also said co. maybe structural bias/conflict of interest is a real problem . documents. but still dismissed in Brehm) o Tough standard: cannot be attributed to any rational business decision  There’s no way a reasonably informed board could make this decision. measure. will overlook more  In group bias/psychological phenomenon: o People always have a bias in favor of their group subconsciously and instantly o i. recruiting device. board was fair o Generous no-fault provisions exist b/c conflict of interest (Ks made by same people who have them). but a no-fault termination means he would get everything he would’ve gotten if he were successful  Ex ante. Eisner (earlier case on pleadings): court said nobody made relevant calculations for how much Ovitz was going to get if he totally failed o But okay because directors deferred to compensation expert  DE §141(e): protects directors in relying on corp. but in the end.e. courts reserve the right to look at numbers o Brehm dismissed on pleadings instead of sending it to trial Why not a loyalty case:  Courts have a hard time dealing with issue of friendship because they don’t want to turn everything into a duty of loyalty issue Structural Bias A prejudice that members of a board of directors may have in favor of one another and of management Three models:  Implicit conspiracy: pursue the same interests  Relationship: o Friendship/collegiality—not going to be rigorous as other times. had two sources of info: demands and valuations o Brehm v. where directors irrationally squander or give away corporate assets  Was termination payment waste? Court said they had to make payment under contract. not what Ovitz did  Did the directors enter into a contract so horribly designed as to constitute waste? o Brehm (pleadings): there are incentives for Ovitz because he would’ve gotten even more pay and options (but is it enough?) o Sheer amount issue: courts do not want to look at dollar amounts. and growing  On the one hand. it may not really be a lot and just sounds like it to a normal person  On the other hand. employees. protects risk-taking Issue of waste  Waste in general o Waste will almost never be found (here. so not waste (if you have to do it. the court still allowed the amount under BJR  then Disney decided no liability So it’s not unfair to conclude that directors can do whatever they want and they’ll be protected by BJR Compensation Top executives make an astronomic amount. or quantify directors’ judgments  trying to revert back to substance. not on waste time in making sure each number is accurate  Limits:  You cannot count on the information that is clearly wrong  Experts clearly unqualified  If the director himself is the expert in that field (2) Care in terminating the agreement  Prior agreement: Termination for cause means he gets nothing.

but will May not have expected counteract disincentives of risk.—but superstars have actual arms-length negotiations. Arguments against Arguments for Gap between executives Superstar mentality: see other areas and regular employees continue to where superstars deserve it. similar to grow superstars in corps. not the case with executives because in practice. you’re negotiation with your buddy (directors) To get above-average talent. result taking  incentivize management to Might create wrong take more risk to get more incentives compensation Problem of who sets the standards Too low or too high? How do we judge? Stock options: right to buy stock in the future at a price set at beginning of the contract  Provide incentive: if director/executive has option to buy stocks for the next 5 years. they make money (almost) no matter what  So is it really tied to performance. he’ll try and raise the price of the stocks to buy  Problems: o Stock price is going to rise anyway if we allow people to buy next year’s stock at $30. or is it just natural expectation? o Difficulty in determining how much we actually have to pay o Bad incentives: other ways to make prices go up when fails to raise the stock price legitimately . you have to pay above-average salary—but it can’t be that everyone is paid above-average salary… Solutions “Pay by performance” or incentive compensations  You can align the interests of shareholders and management: both want to make stock interests increase  Good/bad idea? Good idea Bad idea Won’t be perfect fit. even if price goes up to $40.

like DE. but you know there will be bad news to announce—so you have management the hit  Say on pay by the shareholders o Amount of compensation is clearly a business judgment  Courts don’t really want to get into when/how/etc. but problem if deceptive or unauthorized—In re Tyson Food  Bullet-dodging: Practice of granting stock options after the announcement of bad news so that the recipient is not hurt by the announcement  Ex: Normally you give stock options on Nov. in an options contract. we use entire fairness test  Courts want to use business judgment rule. generally because it was lower  Backdating is a breach of fiduciary duty (lying)—Ryan v. 3. pay someone  We have a special corporate rule because we trust management’s judgment  but when we don’t trust management (conflict). have executives submit compensation packages to shareholders for a vote  Wouldn’t be a binding vote because shareholders do not run the business  Some states.  Accounting fraud/ Engaging in a lot of risks o Cheating by the company:  Backdating: Practice of dating a contract earlier than the date of actual execution. it refers to setting an exercise price from an earlier day. Gibbons  Backdating is illegal under Federal Security Law  Spring-loading: Practice of granting stock options before the announcement of favorable news so that the recipient can benefit from the announcement  Could be legitimate provided it’s done properly. has changed the law to enable this (but not require)  Federal government  Attempt to require greater disclosure: Regulation S-K o Require one giant compensation figure o Include compensation discussion and analysis of how compensation was decided  Have suggested more substantive regulations in light of new financial troubles o Require say on pay o Salary cap o Limits on bonus (keep companies from being competitive to draw out best talent)  But how much limit? And should it be same for all companies? o Should shareholders have a say on pay?  Agency model of corporation: maybe yes . but critics are saying that there are conflicts here o This is an issue  Shareholders are angry about it  Starting to push for “say on pay”—through by-laws.

then B wants to redeem / if worth less.804) Special provisions in charter:  Voting rights: A had limited.  “But when [stockholder] votes as a director he represents all stockholders and cannot use his office as a director for his personal benefit at the expense of the stockholders” (682) But state court in Speed v. Transamerica said directors could favor Class B shareholders .  Trusty model: maybe no  Authority model: management should decide. B was mostly Transamerica (D). Shareholders don’t have that competency of running a business  Democratic system: If shareholders don’t like it they can come out. Transamerica Corporation (pg. B gets $80 (1/3) o If redeem: A gets $60 (redemption price). Class A shareholders would have the opportunity to convert their shares in good time. A wants to redeem Facts: A was mostly minority shareholders.  What would a disinterested impartial board do? Have fiduciary duties to all shareholders. B gets nothing (everything else)  If $240 in assets: o If liquidate: A gets $160 (2/3 of total). Caused co. Ultimate problem: majority shareholders had a duty to disclose to minority shareholders  Problem wasn’t the redemption (because if they did opposite of liquidation. o Redemption: Class A shareholders have a conversion right anyway and if they know that there are $240 in assets. to redeem A’s shares and liquidate. pursuant to contractual right  Conversion rights: shareholder can convert Class A to Class B at any time o Conversion: exchange of one security for another with the issuing company Factual applications  If $60 in assets (co. is worth a lot. is doing well (~$240 hypo). Fiduciary Duties of Controlling Shareholders (II) Zahn v. would be favoring minority)—problem was lack of disclosure  Should the directors disclosed. A wants to liquidate / if worth less. they would convert into Class B. but doesn’t seem like there’s one thing to do that’ll favor all o Litigation: Class A sacrificed their voting right to get their liquidation right and they deserve that right. is worth a lot. B gets $20 (1/3 of total) o If redeem: A gets $60 (redemption price). B had control  Liquidation rights: A = Class B x 2  Redemption rights: company can redeem Class A at $60 per share at any time o Redeem: force a buy-back of stock by the issuing co. and co. B wants to liquidate  If co. D wants minority shareholders out. B gets $180 (everything else)  If co. is worth $60): o If liquidate: A gets $40 (2/3 of total).

H. Hanson Holdings (720)  Argument: The shareholder is not just selling the shares. can redeem you. for United Financial shares (250 for every 1 Assoc. which has control of Assoc. o Difficult to sue looter—will do things that BJR would protect (but doesn’t make sense because if you can’t sue seller. all shareholders should share in that money CONCLUSION: for P—theory is that D shouldn’t be able to sell 100% of the control for 51% of the shares—people are paying a premium to capitalize on that control GENERAL RULE NOW: majority shareholders can sell at a premium  “Absent looting of corporate assets. RULE: majority shareholder has duty to minority shareholder of fair dealing  Shareholder can do what he wants with his assets. need less to maintain control It could have been easy for the majority shareholders not to harm the minority shareholders but they chose to harm. such as fraud.  Mere fact that you’re selling is not breaching your fiduciary duty  © Fiduciary duty requires much more. and a purchaser is free to buy. but you also bargained for the conversion feature—so the co. shares. assets Majority could have let corp. Assoc. fraud or other acts of bad faith. you have to give shareholders realistic means to be able to execute them if wanted  Needed disclosure because of the conversion feature—it’s an independent right to trade up. would redeem for $60 when market value is above $60 (duh) But it’s not really favoring one class over another—just saying that once you have special charter provisions. Shareholder Suits . became even more unmarketable. UF share prices rose tremendously. but cannot use corporate assets to harm other shareholders—still can’t do it here even though harm was not with corp. Feldmann (pg. A would want to convert whenever B shares were worth more  So co.853)—no longer good law Facts: P argues that D can’t pocket premium money. or if the shareholder is selling to a known looter. but Assoc. Perlman v. plus. engage in a stock split: technical splitting ea.F. but also selling the control o © But it’s true all the time. has to treat you fairly with respect to that  Directors owe fiduciary duty to the shareholders to disclose them the information when the directors asked/caused the shareholders to act or to make choice. a co. Ahmanson & Co. but at distorted value.). (pg. conversion of a corporate opportunity. that controlling interest at a premium price—Zetlin v.  Knew what the terms were when buying A stock—that redemption of Class A stock was a continuing option. Jones v. can’t catch them  Suspected looter o now can’t sell to a suspected looter for something he may do and for someone who might flee and we can’t find o But who to suspect? How much suspicion?  Paying a premium?  The mere fact that a person keeps buying failing companies doesn’t necessarily means he is a looter.) and then sold UF shares. share into 2 or more shares  Just split each share into 250 shares and make them more marketable  Easy to dojust amend the Charter  Why not to split: But majority might have wanted to retain control with a smaller percentage— by leveraging control through another intermediary (have control of UF. how can you sue the looter?).833) Facts: Difficult to sell Assoc. a controlling stockholder is free to sell. Later given chance. D exchanged Assoc. minority were denied access to UF action.

breach of fiduciary duty  Why allow derivative actions: o Director conflicts  Nobody wants to sue himself or his colleagues o Police misconduct  Allowing shareholders to sue brings back accountability and allows policing of directorial behavior o Enforce indirect shareholder rights  Shareholders are ultimate beneficiaries of the corporation  Why not allow derivative actions: o Director authority  §141a: directors make judgment. can sue Shareholder Suits (2 kinds) Direct Actions: Lawsuit initiated by injured person on her own behalf—shareholder sues on behalf of shareholder’s specific rights  Very few direct actions in Corporate Law  Limited things a shareholder can sue directly on: o Declared dividends—if the corporation has already declared dividends. And suing is a business judgment  Legit reasons why not to sue even there is a harm:  Cost of litigation  Business relationship worth to settle than to sue . in corporate law. Shareholder rights Shareholder Protections Voting Elections  Charter amendments  Allow shareholders to kick out directors  Other proxy solicitation access  But problem of rational apathy  Etc.. drive prices up o If low. sets up for hostile takeover Information Sue Courts  As a last resort. and they don’t pay you. you can sue under direct actions  © Corporation can always choose not to declare dividends  Denial of voting rights  Securities law violations Derivative Actions: A lawsuit initiated by one person on behalf of another. especially. buy more shares  if others like. Selling Markets  Products: directors need to make company profitable  Credit markets  Security markets  Market for corporate control o If like co. a suit brought on behalf of the corporation by its shareholders  Example: embezzlement.

courts and society o Incentives  Director incentives  Directors have a low chance of liability due to Business Judgment Rule. making investment decisions with her time and taking the risk of profits and loss. And the only thing shareholder can get is the attorney fees.  Attorneys incentives  Profitable: either win the trial or settlement get an award of attorney’s fees + directors’ strong incentive to settle  Rise of entrepreneurial attorney: attorney acting as a businessperson with respect to lawsuits. the liability can be fatal  Directors might like to settle and let the corporation to pay the spends.  To avoid potential counterclaims  Hurt your own reputation by bad press  Uncertainty of success  Time and effort consuming o Shareholder incompetence  Shareholders aren’t necessarily business experts  Too many shareholders a huge bite on courts if any one of them can sue  Shareholders can actually be crazy o Litigation costs to litigants. CONCLUSION: not a derivative action  no recovery to the corporation  but also not direct because there’s no cause of action at all Test applied by lower court: . but once lose. Test on whether derivative action or direct action:  Who suffered the alleged harm  Who would receive the benefit of any recovery or other remedy o If both shareholders direct action o If both director derivative action Tooley v. Lufkin & Jenrett Inc. (pg. but with the intention of obtaining a profitable settlement. Donaldson.1057) Facts: D was acquired by CreditSuisse which allowed for certain delays in the merger. The minority shareholders sued because of the delay (loss of time-value of money).  © Settlement is dangerous—might encourage even more suits.  Shareholder incentives  Don’t have much incentives because the expense come out of their own pocket.  Give rise to strike suits: lawsuit initiated not with the intention of winning on the merits. They are risking their own money yet the compensation will go to the corporation and shared by everyone.

and notice of the proposed dismissal or compromise shall be given to shareholders or members in such manner as the court directs. the problem unsolved if we let the attorneys get the fees Dismissal of derivative actions: a derivative action shall not be dismissed or compromised without the approval of the court.1144) Facts: P brought derivative action. CONCLUSION: reversed trial court’s dismissal Some policies might not apply in close corporations  Shareholders in a close corporation stand in a fiduciary relationship to each other.) Why not allow to settle? It’s really the corporation’s suit—harming other shareholders who could share in large recovery. you should be able to sue on your own behalf.  Special injury test o A wrong that is separate and distinct from that suffered by other shareholders  here. no special injury so has to be derivative A better test as long as you have the right and it’s harmed. but seemed derivative because the harm was to the corp.) and recovery would go to corp. the delay affected all the shareholders equally. it’ll always be a direct action—just that if policies suggest we don’t need it to be a derivative action. or  (iii) interfere with a fair distribution of the recovery among all interested persons Facts: P brought a direct action. must deal fairly. regardless to the fact that every shareholders are harmed. Derivative action and direct action in close corporations Barth v.1065) In a close corporation case. Supreme Court applied the test above.  (ii) materially prejudice interests of creditors. (misappropriated funds—taking money from corp. CONCLUSION: P is accountable to corp. it’s the attorney who has the bad incentive decision. could enhance strike suit potential. Greenberg (pg. court may use discretion to treat an action raising derivative claims as a direct action if it finds that to do so will not:  (i) unfairly expose the corp. and as such. but not as much owed to corp. directors have incentive to settle and may pay larger amount than what P is entitled. honestly.. Barth (pg. settled for a private recovery.  Here: same  © In most cases. for amount received What to do about attorney’s fees?  Normal situation: shareholders’ attorney gets the attorney fee paid. and other shareholders sue to share. Why would we allow P to settle? P used own money to bring suit and has decision to keep going (otherwise. . and openly with the corporation and with their fellow shareholders  No concern to the corporation creditors  No other non-participating disinterested shareholders involved Court is not saying that if it’s close corp. then saying you have to keep spending own money to help corp. we will make an exception Settlement Clarke v. or defendants to multiplicity of actions.

or  The directors failed to exercise their business judgment in approving the transaction  When the futile demand is excused: . Particularly don’t want entrepreneurial attorneys to manufacture Ps  Rifkin v. An injunction to stop a merger  Different standards for demand futility o New York:  When the demand is futile  Majority of the directors are interested in the transaction. reasonableness and adequate Limits on Shareholder Suits Limitations on standing Contemporaneous ownership rule  Shareholder has to have had ownership when harm occurred and has to maintain ownership through to judgment  Reasons: o Prevent the manufacture of the shareholder. Steele Platt (pg. o The corporation could not maintain the action for wrongs that occurred before the new shareholders’ acquisition of the shares Demand requirement  Shareholder must have had a demand on the directors that they pursue the action complained of o Shareholder must ask the board of directors to sue on behalf of corporation  Exceptions: o Demand futility  When there is conflict of interest (such as suing a director personally.1080)  Facts: both derivative and direct actions. or  The directors failed to inform themselves to a degree reasonably necessary about the transaction. Harm done prior to P’s acquisition o Direct action: fraud o Derivative action: the bad thing done that hurt the corporation  CONCLUSION: remand to consider whether purchase price reflected prior wrongdoings  to prevent a windfall. silly to ask him) o Irreparable harm result from making the demand  If there is a time-sensitive issue—a delay itself by the board would cause harm  Eg. Standard of review: fairness.

easy to lose  Demand futility: hard to fulfill particularity requirement . Akers (pg. Shareholder argued demand futility. you should choose it. o Delaware:  A reasonable doubt on whether  Directors are disinterested and independent (duty of loyalty). and  The challenged transaction was the product of a valid exercise of business judgment (duty of care)  Whether the directors exercised due care on both o Procedural (informed decision) and o Substantive (terms of transaction)  Very easy to establish a reasonable doubt  Easier than New York reasonable doubt of honesty v. you waive the demand futility exception  If you have a choice of demand futility. because if there is no demand futility.1086)  Facts: Shareholders bring derivative suit. alleging excessive compensation of IBM directors.  Derivative b/c corp. duty of good faith  Particularity: insufficient merely to name a majority of the directors as parties.  Marx v. is harmed by paying too much salary  CONCLUSION:  demand is futile as to the compensation set for outside directors.  When a complaint alleges with particularity that a majority of the board of directors is interested in the challenged transaction. Either self-interest in the transaction. you will face something resembling the Business Judgment Rule.  Allow the board to make the decision. or loss of independence because controlled by a self-interested director  Sounds like duty of loyalty  When a complaint alleges with particularity that the board of directors did not fully inform themselves about the challenged transaction to the extent reasonably appropriate under the circ’s  Sounds like duty of care  When a complaint alleges with particularity that the challenged transaction was so egregious on its face that it could not have been the product of sound business judgment of the directors  Sounds like waste. reasonable belief of dishonesty  If you make a demand. give honest directors a chance to deal with issue honestly o If agree bring the action o If reject they should record why not and judge will determine whether they were right or not o Dilemma: argue demand or argue demand futility  Demand: Business Judgment Rule.  but not futile for the compensation set for the executive officers.

The co.  No benefit to discovery o Universal approach (Model Business Corp. whether the motion should be granted  Court has a serious concern on structural bias  But judges are not business experts.1103) o Facts: Derivative action against 10 officers. Maldonado -Delaware (pg. o Issue: Structural bias—subconscious abuse  Co. moves to have case dismissed. Demand was futile because of great conflict of interest. applying its own business judgment. rather than on extraneous influences Difficulties of pursuing derivative actions  First face contemporaneous ownership rule  Then face demand requirement o If you demand  BJR  Then have to face special litigation committee  Find a breach of standard of review (not just that they were negligent. Disinterestness o Being disinterested: not having a material financial stake (traditional duty of loyalty) o Being independent: able to make decision on substantive merits. formed an independent investigation committee with brand new directors (who theoretically wouldn’t have conflict) whose decision was binding and final (board can give final authority to committee via statute)  but court realistically recognizes that these new directors have to vote against their colleagues who voted them to the board (structural bias concern) o Two-step test  The court inquires into the independence and good faith of the committee and the bases supporting its conclusions  The court determines. but grossly) .  2nd prong really no much impact  Many states such as New York refuse to follow such test  Court has created an intermediate standard of review o Process—we trust directors  BJR o Material financial conflict of interest—we don’t trust directors  EFT o Derivative where we don’t quite trust directors but no material financial conflict  intermediate standard of review where directors prove independence  Independence v. Act)  A demand is required in all cases without exception  The commencement of a derivative proceeding is permitted within 90 days of the demand  Unless the demand rejected earlier  Or irreparable harm  Independent committee Zapata Corp v.

but if the inferences do not support a valid legal claim. DE§102(b)(7)  Purpose of the statute: permit shareholders to adopt a provision in the certificate of incorporation to free directors of personal liability in damages for due care violations. exculpation and no damages  But if duty of loyalty case.  And if it happens to be a duty of care case. o Freed up directors to take business risks without worrying about negligence lawsuits Affirmative defense Burden of proof: on directors  If P is only seeking damages and case only has duty of care issues. but could entertain better offer  No-talk: may not even entertain a competing offer until current offer is dealt with (buyer will offer more and seller doesn’t think he’ll get more offers. corp.684) Facts: Co. but not duty of loyalty violations. then notwithstanding that exculpation is an affirmative defense.  No-shop: can’t go shopping for better offers. the complaint should be dismissed without the need for the Ds to file an answer and without proceeding with discovery  Court said P didn’t show sufficient facts for a breach of duty of loyalty (didn’t show conflict)  left only duty of care o Ds will raise the exculpation statute to bar the claim no valid legal claim  If P also alleged breach of duty of loyalty D would have to argue that they didn’t breach duty of loyalty in order to raise the exculpation defense. bad faith claims and certain other conducts. D argues that this case should be dismissed because of exculpation clause. gets recovery o If you argue demand futility  need to make particularized allegations w/o benefits of discovery Exculpation. approved offer with no-shop provision. P claims that directors breached their duties under Revlon by entering into a no-talk agreement. courts can dismiss on the pleadings Malpiede v. when someone else offered. Indemnification DE§145:  (a) allows for indemnification in direct actions o if the directors sue directly o only if he is acting in good faith in the interest of the corporation  (b) allows in derivative actions o good faith o the indemnification has to be approved by the court as fair and reasonable . but illegitimately used if agree with first person to come along) Court dismissed duty of care claim  Ps are entitled to all reasonable inferences flowing from their pleadings. Indemnification and Insurance Exculpation States have passed exculpation statutes that limit director liability for breaches of duty of care. original offered higher with no-talk provision. Townson (pg.

Clients sued both and in the settlement D ended up paying $35mil. CONCLUSION: P is not entitled to indemnification under charter provisions. shall have power to indemnify: what you can do. but was successful “otherwise”  Escape from judgment. just pool money together for insurance o Even if indemnification isn’t allowed. Claims were eventually dismissed against P. case was dismissed o Court: P wasn’t successful on merits. 1121) Facts: P was vice-president of D. Conticommodity Service (pg. but entitled because of § 145(c)  Not entitled to indemnification under Charter provisions: o § 145(a) and (b) both say that agent has to be acting in good faith—P wasn’t even arguing good faith because didn’t have good argument o (f) says rights are not exclusive and can be expanded under terms of charters —but this cannot be in contradiction to the statute  You cannot allow what the statutes explicitly prohibits  (g) says we can insure even when we can’t indemnify—so that means there are situations where we can’t indemnify  Focuses on two words: rights and powers  (a) and (b) say corp. an authorization clause—anything that’s not in here. you can’t do  (f) says additional rights. as long as not inconsistent with power)  Entitled to indemnification under (c): o (c) requires indemnification if defendant is successful on merits or otherwise—here. P sued for indemnification. for whatever reason.  (c) requires indemnification if D is “successful on the merits or otherwise” o If they win. the corporation MUST indemnify them  (d) requires specific authorization for any indemnification payment under (a) or (b) o means if you lose. can still have liability insurance—to offer incentives for people to become directors o Difference between indemnification and insurance  Insurance: outside money is paying Waltuch v. is vindication and allows for indemnification under (c) What rights you can expend under (f)?  Mandatory indemnification wherever it is permissible by statute . not powers (rights can be expanded. you need specific authorization  (e) allows advancement of expenses o allows company to advance litigation expenses. so hopefully you will win o Also provides that the agents have to reimburse corporation if it turns out they were not entitled  (f) allows additional rights (via charter)  (g) allows liability insurance o Instead of paying huge amounts for indemnification.

was independent of the indemnifications paragraph  “Advancement not conditioned on indemnification makes sense without absurd result” (but it does sound absurd here since co. Roven (handout) Facts: Roven demanded indemnification greater than the charter provided when he became a director.)  Delaware§220 Reason allowing inspection rights:  As a matter of self-protection. will pay for advancements). minutes. Someone brought a 16(b) lawsuit against him and he demanded advancement for costs. the shareholder was entitled to know how his agents were conducting the affairs of the corporation of which he or she was a part owner. as opposed to permissive  Accelerated procedures for indemnification  Litigation appeal rights  Default indemnification procedures  Reasonable funding mechanisms Citadel v. 16(b) lawsuits (insider trading) were not covered by indemnification agreement  But Roven argues that advancements are unconditional CONCLUSION: Citadel required to pay advancements to Roven  Advancement provision was unconditional (co. Limits on shareholder’s right to information Shareholders must have a proper purpose to seek information o Proper purpose: purpose reasonably related to such person’s interest as a shareholder  Intent to sue derivative action  Wage a proxy battle  Investigate a wrongdoing  Determine the value of shares o Mixed purposes: As long as you have one proper purpose. bylaws.  Contemporaneous ownership rule: Shareholders at the time of the transaction o Exceptions:  Continuing wrong . etc. list of shareholders) and other documents under certain circumstances (studies.  Mandatory advancements. wouldn’t indemnify him on 16(b) claims anyway) But advancements have to be reasonable Shareholder Rights to Information Inspection rights: right of a shareholder to inspect the corporation’s books and records  State law provides that shareholder can get basic documents (charters. the secondary purposes are irrelevant. reports.

Verizon Communications. Delaware): materiality  Eventually. wanted to change law (doesn’t make sense to require evidence in order to gather evidence) Credible basis RULE: in order to seek inspection.  Foundation in events that transpired earlier Seinfeld v. poor enforcement . etc. you have to provide some evidence to suggest a credible basis from which you can infer a wrongdoing. Inc (handout) Facts: P wanted to investigate if executives were being overpaid. everyone is going to ask for information  A proper purpose for one type of documents doesn’t mean you can inspect all documents you want Other rights List of shareholders  Shareholders often want shareholder list to communicate. We don’t want shareholders to hide their real intent to get the information o Monitoring is costly o So many shareholders. P provided no evidence suggesting credible basis. we’d have to always allow inspection  Reasons: o We don’t want fishing expedition. you have to get the approval of the states if you want to sell o © Didn’t help all that much—limited jurisdiction. (38)  Court says this is the lowest possible burden—we just want some evidence  Suggests that general concerns to monitor is not enough—otherwise. federal securities law takes care of it FEDERAL SECURITIES LAW History of securities regulation State securities regulation  Common law fraud  Blue sky laws o Merit regulation—states would decide the merit of securities. one allowed. particularly to wage proxy contest Required disclosures  Generally law doesn’t require corporations to make disclosures to shareholders  Exception: whenever corporation is requiring any kind of shareholder action. you must give information Duty of candor  Cannot lie or mislead  Traditional: complete candor  State courts standard (esp.

Stock Market Crash of 1929 gives rise to federal securities regulation  Originally supplemented state regulation then displaced the state regulation  Features: o Trying to help people to make good decisions o Mandated disclosure o Antifraud liability – much stronger than common law fraud o No merit regulation Federal Securities Laws Securities Act of 1933  Regulates primary markets (IPO etc. updates every quarter) o Must file additional reports under certain circ’s. no half truth.)  Mandate disclosure o Must register securities and deliver prospectus before selling securities to the public  File detailed registration statement with SEC  SEC reviews it not for accuracy but for adequacy  Deliver prospectus to investors: documents used to offer securities for sale in a public offering  Unless exemption is available  Antifraud liability o Company is responsible for false or misleading statements/omissions of material facts (deception)  No lies. Merger)  Antifraud liability o Manipulation or deception o Deception on company’s part o Liability of seller  Regulates securities industry generally . after corporation initially sells  Mandate disclosure o Must file periodic reports on company performance (detailed one annually. Securities Exchange Act of 1934  Regulates secondary markets: market for securities sold by investors among themselves o Much larger than primary market. no misleading. (eg.

schemes and artifices to defraud  Practices which operate as a fraud or deceit  False or misleading statements or omissions of material fact Enforcement: By SEC By private investors through an implied cause of action Elements: Interstate commerce (commerce clause)  Almost always satisfied in reality Material misstatement or omission: material deception Scienter: intent to deceive (or recklessness is sufficient) Connection with a purchase or sale of securities Reliance Causation  As opposed to just correlation Damages: can only recover economic loss Basic Inc. Standard of materiality: a substantial likelihood that a reasonable shareholder would consider it [the disclosure or omission of the information] important in deciding how to act. o Securities and Exchange Commission (SEC) oversees enforcement of the federal securities law Federal securities law v. Cannot tell whether or not there would be a merger .915) Facts: Basic was in merger negotiations with Combustion. but denied when shareholders asked. in connection with purchase or sale of securities:  Devices. Merger negotiation—speculative. After a later merger announcement. State corporate law  State corporate law: form prevails substance  Federal securities law: most courts do opposite o No need to worry about race to the bottom Rule 10b-5 Congressionally delegated authority Content: Forbids. shareholders sued the company for misleading them. v. Levinson (pg.

 No specific duty to disclose a merger o Materiality is about the accuracy of the information. follow a consistent functional equivalence of silence (“no comment”—but if you say “no” sometimes.928) Facts: D owned 90% of Kirby lumber. o © Merger is the most important event in a close corporation.  © No one believes that EMH is completely true o Class action management tool: adopting a rebuttable presumption just allows litigation to proceed. we presume they relied o But might not be fair (dissent says not fair)—getting rid of reliance just because it’s difficult to prove and on a theory that’s not completely accepted o How to rebut:  Each of the P did not rely  The market makers didn’t believe the lie therefore didn’t reflect the price  There’s not an efficient market the market doesn’t reflect the information quickly Connection with a purchase or sale of securities  Corporation was not trying to buy or sell anything or causing people to buy or sell securities. not about the timing o Absent a duty to disclose. D had the shares valued at $125 and offered shareholders $150 for them. he sued under 10b-5. They wanted to eliminate the other 10%. court merely means that the merger negotiation is not always immaterial. almost always a connection Santa Fe Industries v. Green (pg.  Probability/magnitude approach –expected value calculation o Look at both the magnitude and probability  [chances it will occur]×[the impact it will have]  lower court Agreement-in-principle [rejected] o Merger discussions do not become material until the price and structure of the transaction has been reached between the would-be merger partners. P is supposed to prove reliance (an element). negotiations can become material at a much earlier stage because of great magnitude  But doesn’t mean merger negotiation is always material. cannot lie o If someone asks you whether there are merger negotiations. then people will understand it to mean “yes”) Class action & Reliance:  Fraud on market theory: a rebuttable presumption o Sounds like efficient market hypothesis—prices will reflect all publicly available information (semi-strong EMH)—people rely by relying on stock price. P believed they were worth $722.  P’s claims: fraudulently acquired low-valued appraisal. but it’s too hard for every P in a class action to show reliance  so in a class action. but cannot be misleading. improper purpose to freeze out minority shareholders (breach of fiduciary duty) Issue: Does Rule10b-5 reach fiduciary duty? HOLDING: No cause of action for breach of fiduciary duty or any other substantive complaint under Rule 10b-5 unless there is manipulation or deception  Rule 10b-5 is not about breaches of fiduciary duty—unless there’s manipulation/deception . a mere merger negotiation  Very expansive approach. Instead of seeking an appraisal under state law. This was allowed in DE as long as the minority shareholders were paid fair market value. corporation can simply keep silent.

if known. Price: P said should’ve been $772  Morgan Stanley said $125  D offered $150  Liquidation value was $640  going concern value was $254  Which one is fair price? o Doesn’t matter as long as the company disclosed the information Insider Trading Definition: use of material. but silence in face of a duty to disclose is deceptive and actionable. U. There was a tender offer and Chiarella. There is an impartial market SEC’s position on insider trading law:  inside information cannot be used to gain profit Disclose or abstain rule: anyone in possession of material inside information must either disclose it to the investing public. The insider trading has to be deceptive to be actionable under Rule 10b-5. for 10b-5 purposes  But P is not without a remedy—state law specifically allows for an appraisal  Fundamental purpose of 10b-5: full disclosure. Insider trading is not necessarily deceptive but insider trading with a breach of fiduciary duty is deceptive  Silence absent a duty to disclose is not deceptive (Santa Fe). no deceptive conduct . if he is disabled from disclosing it in order to protect a corporate confidence. Their choice was fairly presented. Why inside information is inherently fraudulent  A justifiable expectation of the securities market that all investors trading on impersonal exchanges have relatively equal access to material information. 968) Facts: D worked for a financial printing company. his shares rose and he sold. everything else is secondary  Here: the minority shareholders were furnished with all relevant information on which to base their decision. in stock exchange o Face-to-face transaction: trust based on knowing each other’s identification the issue of fraud or reliance o Stock exchange: your sale is different from my purchase. or. or he chooses not to do so. or reject it and seek an appraisal. must abstain from trading in or recommending the securities concerned while such inside information remains undisclosed. When the takeover was announced.S. He was charged with violating §10b and 10b-5. Chiarella v. (pg. non-public info in trading the shares of a company by a corporate insider or other person who owes a fiduciary duty with respect to such information State law:  Liability in face-to-face transaction v. would affect their investment judgment  When one party has information that the other party is entitled to know because of a fiduciary or other similar relation of trust and confidence between them Here: Chiarella is an outsider no fiduciary duty owed to the person he brought stock from. o Not all fiduciary duties are about manipulation/deception  Rule 10b-5 is about fairness o This was not a securities issue. o When do you have a duty to disclose material information:  When material facts known to one party by virtue of their position but are not known to persons with whom they deal and which. they can either accept the offer. by virtue of his job. identified it and bought shares of target stock though a broker.

D investigated and he revealed information to investors. they should disclose or refrain from trading. After officers were convicted of fraud. regardless of their motivation or occupation. defrauds the principal of the exclusive use of that information. The SEC brought charges on misappropriation theory. No better than Chiarella o Too broad to say anyone who CEO talked to have a fiduciary duty to disclose 2-part test: a tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information ONLY WHEN  The insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee o Insider breaches fiduciary duty when there’s a personal benefit to the insider from the breach o © Fiduciary duty can be breached even without a personal benefit o A broad interpretation of “benefit”—both direct and indirect benefit  The tippee knows or should know that there has been a breach of fiduciary duty Application:  Under this test.991) Facts: Former insider informed D that co. Fraud was exposed. insider did not receive any personal/monetary benefit  he was motivated by a desire to expose the fraud  If insider didn’t do anything wrong. usually a substantial premium over market price. then D didn’t inherit insider’s fiduciary duties Chain of inherit: unbroken chain of fiduciary duty is needed for the fiduciary duty to be inherited United States v. there is no “deceptive device” and thus no 10b violation—although may still liable under duty of loyalty . SEC went after him mainly because they wanted to expand Chiarella  Where tippees. number of shares directly from shareholders at a fixed price.  Tender offer: public offer to buy a min.  Here: D deceived the company because he breached his fiduciary duty of confidentiality to GrandMet  Chiarella result would be different from this case o Misappropriation theory. Loophole: disclosure kills liability  If the fiduciary discloses to the source that he plans to trade on the nonpublic information. which represented GM while made tender offer to acquire Pillsbury. D didn’t directly profit/trade off this info—but not a saint. and usually part of a takeover attempt o A great opportunity for insider trading Classical theory doesn’t workO’Hagan is the insider of GrandMet but not Pillsbury SEC expanded the ruleMisappropriation theory  A fiduciary’s undisclosed. By using the information he got from the printer by trading with the company. come into possession of material information that they know is confidential and know or should know came from a corporate insider. D knew that price was going to rise so he began buying Pillsbury stock and sold them for a huge profit. was engaged in fraud. self-serving use of a principal’s information to purchase or sell securities. he breached the fiduciary duty to the printer as an agent of the printer. O’Hagan (pg.976) Facts: D was a partner in a law firm. many of whom sold their stock. in breach of duty of loyalty and confidentiality. SEC went after D. SEC (pg. Dirk v. he would not get the insider information if he doesn’t work for the printer.  © Supreme Court: rejected it. which required him to keep the information secret.

not deception of an identifiable purchaser or seller. Connection with purchase/sale of securities  The misappropriation theory requires deception in connection with the purchase or sale of any security. don’t have to look at Chiarella and Dirks.  Scope: limited to tender offers. They are still good law BUSINESS COMBINITION Acquisition  Acquirer—target Three main ways to do acquisition Stock purchase—acquisition in which an acquirer buys the stock of the target from the shareholders  The target becomes a subsidiary of the acquirer. even things that are not perceptive. 10b  Both anti-fraud provision  Differences: o 10b:  Delegation to SEC is limited on prescribed manipulation and fraud—define the fraud  Scope: covers all kinds of security exchanges o 14e:  broader delegation  Reasonable designed to prevent manipulation and fraud. Rule 14e-3 Created after Chiarella and Dirks Nobody can trade on material non-public information regardless of fiduciary duty adopting disclose/abstain rule 14e v. just to make sure that there will not be a fraud. but most of the time will not b a 100% owned subsidiary  A+B=A+B  Purchase shares directly from shareholders  Two different companies before or after acquisition  No approval necessary –directors don’t have a say because each shareholder is deciding for himself whether to sell or not Asset purchase—acquisition in which the acquirer buys the assets (and often liabilities) of the target  A+B=A .  If a tender offer case.

a. B or C)—very flexible in how to structure  One company remains  Constituent corporation: party to a merger (A & B)  Surviving corporation: constituent corporation that survives  Need approval from BOTH companies’ directors and shareholders Procedures: each state has a statutory provision authorizing this  DE§251 o Prepare merger agreement  Controlling document  Including consideration for the shareholders.k. how the new Charter is going to be… o Approval of directors of each company o Approval of shareholders of each company  One of the few things shareholders can vote on  DE standard: true majority—50% of all the controlling shares entitled to vote  Non approval = no o File with Secretary of State (certificate of merger or merger agreement)  Certificate of merger: considerably shorter o Dissenting shareholders have appraisal rights  Appraisal right: the right of a shareholder in a constituent corporation to forego the contractual consideration in a merger (or similar transaction) and to receive instead the fair value of the shares. normally formed for a specific purpose o There’s going to be only one company in the end. o Approval from acquirer is not necessarily required Merger: acquisition in which acquirer & target combine into one surviving company  A+B=AB(A. o Need approval from target’s shareholders and directors  Director approval—selling assets  Shareholders approval—specific state law requirement  Eg. but only one operating company and another becomes a shell company.  Reason why shareholders have a say is ONLY because law says so. o Technically 2 companies.a. such as which one is the surviving corporation.. Selling substantially all the assets of the co.  If you have a merger between corporations of two different states. dissenters’ rights. apply both merger standards—take the one that’s most demanding and comply with both Consideration: .

 Standard merger o Consideration is shares in surviving corporation o Number of shares depends on value of constituent corporation  Figure out what the appropriate ratio is  Legal possibilities o Any consideration: securities. cash. property o Can provide different consideration for different people  Cash-out merger: one company’s shareholders receive cash instead of shares in the surviving corporation. you have an appraisal right a concern that the amount of the cash you get might not be a fair price o Procedure: §262  Company gives notice of appraisal rights  Shareholder demands appraisal before vote happens  Cannot vote in favor of merger  Petition for appraisal  Court determines fair value of shares  Reasonable financial technique—not just DE Block Method  No minority or liquidity discount applied in appraisal  Fair value might be less than merger consideration . not even all mergers o Not for public corporations if you receive shares  You can always cash out your shares on the market  © if you receive cash in public corporation. asset purchase or certain charter amendments  Delaware: can get appraisal rights for mergers ONLY. Sct o More expansive rights o Appraisal remedies for mergers.  Starts to look like asset purchase  Clear who is acquirer (end up with everything) who is target (end up with cash)  Merger of equals—a merger that has no real acquirer or target and each company is equally merger  too ideal to be true Appraisal rights  Most states allow this option  Provide the shareholders who don’t want the merger a way out  Other states: Model Business Corp.

o Exceptions: fraud o But if you’re just displeased. as under § 271 (board can sell all or substantially all of its property/assets only with stockholder approval) Two different defenses:  Sales of a distance subsidiary. you theoretically pay cash for assets.  Synergy gaining: The value of the combined corporation shares might be much higher than the value of your own shares in corp. really is the participant because it is the signatory to the contract—they are signing and guaranteeing performance of subsidiary  Avoid this by not having parent sign (but harder to sell then—parents usually guarantee quality. A or B. in substance. o Seek appraisals only when you think you are really being taken advantage of Hollinger v.  ∴Not substantially all Exclusivity of the Appraisal Remedy  Availability of appraisal rights normally does preclude a shareholder from seeking to recover on an allegation that the transaction does not provide fair compensation for the shares.  Premium: Acquirer usually pays more to get merger  Appraisal is costly o Almost bound to happen if you are the only shareholder. you can’t get another remedy Form and Substance in Business Combination (Structure transactions to get around limitations in the law for mergers and acquisitions) Loopholes: Stock-for-assets  Engage in asset purchase. but could be other value (such as stock) . 1169) Issue: whether shareholders must be giving opp. without paying cash o In asset purchases. (pg. Hollinger International Inc. to vote on the sale of a subsidiary since the sale involves “substantially all” of International’s assets.  Economic quality whether the transaction leaves the shareholders with an investment that in economic terms is qualitatively different than the one that they possess. but still only 50%  Qualitative—parent will still be profitable without it. not a sale of our assets under § 271 o Court rejected this as too formalistic  Parent. so buyer wants those warranties before entering deal)  Not a sale of substantially all of its assets o What is “substantially all”  Quantitative-qualitative test  Quantitative—the subsidiary may or may not be the single most important asset.

o A doesn’t want shareholders to vote because acquirer is buying the target and has to pay premium to the target  Harder to get acquirer (A) approval  Acquirers are unhappy these because they pay a lot  Then follow up with a short-form merger between A and B  A o Without triangular merger. Cash-out mergers  Different considerations for different shareholders  Acquiring shareholders gets stock while target shareholders get cashresembles an asset purchase  Fair to allow this because there’s still shareholder approval and appraisal remedy Short-form mergers—where a corporation may merge with its subsidiary without shareholder voting  DE§253 o Parents must own at least 90% of subsidiary o Must be simple merger o Cant use merger to slip things into the charter  Shareholders have appraisal rights Triangular merger—a merger between one corporation and a subsidiary of another  The subsidiary is often a shell corporation with the purpose to merger with the target  Still have to get B shareholder approval. you are not able to get 100% of the stocks. who are the directors of parent corporation. because of limited liability  all of liabilities in B would stay with B  but once you merge. o Which means you cannot do what you want with those assets—if you do something unfair. Triangular mergers. minority shareholders can sue Liability  Join liabilities: merger . and asset purchases  Stock purchase: minority shareholders always exist. o Sounds like a merger  end up with a surviving corp. but now you don’t need parent corporation’s shareholder approval—just need subsidiary’ shareholder approval. but needed A’s shareholder approval to get there Considerations: Structure  One surviving company: merger and asset purchase  Two surviving companies: stock purchase and triangular merger o May want to avoid having one co. still would’ve ended up with A. then all of B’s liabilities end up with A Ownership  Acquirer get 100%: Merger.

1200) – upside down format Facts: List purchased 38% of Glen Alden. whereby Glen Alden was to purchase all of List’s assets and liabilities in exchange for stock. but Farris decided to sue for an injunction. They entered into a reorganization agreement. you may need to renegotiate all contracts so they’re compatible with each other  Non-transferrable rights (some assets are non-transferrable) o If stock purchase. (pg. restructure so it doesn’t cause transfer o If merger. eliminate such rights. The Shareholders approved. but in an asset purchase. distribute the stock to their shareholders and then dissolve. not considered a transfer for state law purposes  Tax & accounting o Modern trend: equate all transactions—so increasingly less significant Ferris v. Glen Alden Corp. there is no transfer (stays with individual co.. but also to the consequences of the transaction and to the purposes of the provisions of the corporation law (look to both form and substance) o When a corporation combines with another so as to lose its essential nature and alter the original fundamental relationships of the shareholders among themselves and to the corporation… o © But corporate law looks at the procedures and forms of the transaction. but essentially a merger: stockholders of both companies become stockholders of surviving co. target’s shareholders: triangular merger and asset purchase  None (consenting shareholders): stock purchase Appraisal rights (expensive and create uncertainties)  Delaware: only mergers get appraisal right  Other states: merger and asset purchase (in some states. also triangular merger) Consequences  Renegotiation of contracts o In stock purchase and triangular merger. not the substance o © so many situations under which corporation loses their essential nature o © Rejected later . target co.  Keeps liabilities separate: stock purchase and triangular merger  Liabilities optional: asset purchase o Why purchase liabilities?  cost less  Assets – liability = equity Approval  Both sides of directors and shareholders: Mergers  Both directors. just go away  De facto doctrine: must refer not only to all the provisions of the agreement. CONCLUSION: really a merger—have to comply with requirements and allow appraisal remedy  In the form of an asset purchase. cannot give non-transferrable rights—so then have to renegotiate. stockholders of the target co.) o If asset purchase. end up with two different companies so theoretically might not need renegotiation o But if you have a merger.

1196)  Issue: An agreement of sale of assets embodies a plan to dissolve the selling corporation and distribute the shares so received to the shareholders of the seller. Seeing Corporate law as mandatory or enabling  Mandatory De facto doctrine makes sense. Arco Electronic Inc. UOP (pg. you cannot escape liability for a merger by calling it something else  Enabling  Equal dignity rule makes sense o Equal dignity rule—Followed by most states now. Weinberger v. o Framers of a reorganization plan may resort to either type of corporate mechanics to achieve the desired end. Freeze-out Mergers Should a cash-out merger be allowed?  Not inherently problematic—approval from both directors and shareholders o Could be doing something that everyone wants and if everyone agrees  Even if there is a problem (some shareholders don’t agree)—appraisal rights o If we need a unanimous approval from shareholders—incentivize bad faith of shareholders. They wanted to buy the remaining shares at the same price for a merger. P sought to enjoin. Equal Dignity Rule (rejected De facto doctrine) Equal dignity rule: different sections of a law are of equal dignity. w/common directors). but most majority shareholders approved.  Rushing through the proceedings and just handing down the price . but 2 factors to be considered together o Here. not fair dealing  Information not fully disclosed. so as to accomplish the same result as would be accomplished by a merger of the seller into the purchaser. 1216) Facts: Signal acquired a majority interest in UOP for $1/share. and majority shareholders stood to get the company while minority only got cash  Apply Entire Fairness Test unless got approval from fully informed disinterested shareholders o Fair dealing+ fair price  Not a 2-part test. directors were on both sides of the transaction. (pg. and that action taken under one section will not be judged by the requirements of another section  Hariton v. Is the sale legal?  CONCLUSION: The sale-of-assets statute and the merger statute are independent of each other.  Rose to level of self-dealing: directors of UOP used confidential UOP info to prepare report for Signal (UOP’s parent. insufficient Freeze-out merger: action taken by majority shareholders in close corporation to frustrate the expectation of minority shareholders  Essentially an involuntary cash-out merger  Majority shareholders can freeze out minority shareholders with majority approval  Problem: minority shareholders don’t want to sell their shares.

from low percentage o Then you do a tender offer to the public – get you at least control (51%) . they got premium at a higher price  How: usually done through tender offer o Gain foothold through open market purchases. Glassman v. Unocal Exploration Corp. o Fair price remand on the issue  Any reasonable method to prove value Coggins v.  Court: we cannot give the shares 10 years ago back to you. (pg. To eliminate the minority shareholders. The corporation was to pay the bill for that. they just want their shares. appraisal remedy is the exclusive remedy o Statute: the company can do short-form merger unilaterally without negotiation between the two companies no dealing. therefore hard to apply Entire Fairness Test o Appraisal remedy already looks like fair price  Exception: fraud/illegality o Duty of full disclosure remains  Whenever the company causes the shareholders to act or make choice (whether to accept the merger or to ask for appraisal). but it couldn’t guarantee unless he was only shareholder  Fairness: fair dealing + fair price Remedy:  Shareholders wanted to undo the merger: o Shareholders were not arguing that the price was not fair. Legal test: Business purpose + fairness  Business purpose here: NFL wanted a controlling shareholder (but not necessarily sole shareholder) o Court: © D was a controlling shareholder and didn’t have to get rid of the remaining vestiges of shareholders o ©©: In order to get the loans to control was to get co. Let’s try to figure out what they’d be worth o Nobody is happy here. slowly. he cashed them out and the shareholders sued. Takeovers Definition: attempt by acquirer to gain control of target Hostile takeovers: takeover which does not have the support of board of directors of target company (hostile to management)  Stock purchase in this situation because the directors are unlikely to approve a merger  Shareholders tend to love takeovers. quietly. New England Patriots Football Club. to back him.1232)  RULE: in a short-form merger. Inc (handout) Facts: Sullivan acquired all the voting shares of the patriots. the company has to disclose information.

even at cost of profitability  May value size more because of power  Takeover can help reduce agency costs to some extent  Controlling shareholder taking over business and running it directly © Wealth transfers: shift in wealth from one group to another. borrow money from the company which earns a lot of money. o Then once you have control. It’s lot cheaper than borrowing money from other financial institutions. can do a freeze-out merger and kick out remaining shareholders  Shareholders like being taken over because they usually get targets – don’t necessarily like being acquirer  Management is opposite: directors don’t like being target because they might lose their jobs Reasons why takeovers happen Undervaluation  Market value might be less than fair value  EMH suggests that this doesn’t carry much weight Synergy  The combination of A & B values more than A+B  Why? o Economies of scale: cost reduced with the increase of quantity o Economies of scope: cost reduced by producing similar products o Assets may be transferrable o As well as skills o Financial synergy  Internally raising money. often without net benefit to society  Not creating wealth . expansion into unrelated lines of business Agency cost  Agents problem (problem of loyalty) o Inefficiencies—Hard to get rid of directors  Proxy cost.  Conglobation: internal diversification. rational apathy o Excessive compensation o Self-aggrandizement  Profits help shareholders – shareholders ideally want small investment that makes lots of profits  Management want a huge company (lots of assets/employees/activities). If you can raise money internally.

At least they will be brought out.  Employees: cut cost by reducing salaries. even shareholders who reject the initial offer will be forced to accept that offer for fear of an even greater loss  If takeover succeeds at premium price. they should be getting something higher  Government: shareholder wealth comes from tax savings Reasons for defense Coercive offers: shareholders may not have a fair choice so the directors shall step in to protect the shareholders  Eg. but really worth $100. then they’ll freeze out shareholder in freeze-out merger at market price  Not because he wants. Two-tier tender offer: tender offer at a premium seeking control. the premium is actually a discount (trading at $50. but not ownership. while give shareholders the economic interest . so the tender offer of $75 is actually a discount)  But EMH says this is impossible Opportunity loss: can block this deal because a better on is coming  © How do you know?  Some says: alternative is to have a market test  Shareholders are going to be skeptical on it and decide by themselves Incompatibility: a good reason from corporate perspective  But shareholders won’t care. eliminating jobs o Shareholder wealth comes from employee loss  Creditors: business is going to be more risky o But because of contract. it’s the acquirer who is bearing the risk Other constituencies: deal may be unfair to everyone else besides the shareholders  © Other people have their own remedies and don’t need directors’ protection Entrenchment: efforts by management to protect against ouster really to protect their own jobs Takeover defenses Previously considered:  Constituency statutes  Staggered board o Doesn’t actually block. creditors are locked in into a lower rate when economically. with illicit/explicit promise of a freeze-out merger o That means. benefits. but makes it more expensive to engage in takeovers  can only replace 1/3 at a time  Voting rights o Split up voting rights by classes of stock  give management the voting shares. but because he’s being coerced—afraid of what everyone else is going to do Undervaluation: The market value is less than the intrinsic value.

prevent an acquirer to ever have control Additional mechanisms  Greenmail: repurchase by target of its own shares at a premium o Sounds like blackmail o Shareholders hate this: instead of getting a premium for their shares. rest gets $72 (average = $63. and Unocal was only responding to protect against Mesa’s coercive offer . they only get co. but if it doesn’t work out. we’ll give you $100M (we’ll pay you for your troubles)  This also raises acquirer’s cost—have to pay a higher bid. o © Certain advantages management gives to white knight  Termination fees:  Ask white knight to make an offer. Did this because Mesa came along and offered $54. the original market price. without the important asset  Incentivizes white knight to come in. which is what they’re really worth). shareholders will be forced to tender. Management’s response was also a selective repurchase: after Unocal gets 51% of company. but if it can’t. we will then buy the remaining 49% for $72 of high quality bonds.  No-shop provision: promise the white knight not to solicit other offers  No-talk provision: cannot entertain any other offers  Even more difficult for acquirer to engage in any type of negotiation  Poison pill—ultimate defense  Three ways to get over with poison-pill o Can negotiate a friendly deal because target management can remove the poison pill o Get court to order redemption (argue it’s a breach of fiduciary duties—but might not work so well) o Can launch a proxy contest—most effective way.  Impossible to go forward the deal hen the poison-pill is in place Unocal Corp v. they have to pay a huge premium  White Knight Defense: the target convinces a friendly third party to make a superior offer o Management wants to stay independent. but also prevents acquirers  Stock lock-up: The right to buy 20% new shares at $33. they now have to pay 120% shares. Mesa Petroleum (pg. and if they win. replace board of directors and have them remove the poison pill and buy co. that they came up with the horrible deal. you still have 20% shares at $33. So half shares go at $54.  Mesa argued that this is a breach of duty—management is not treating all shareholders fairly  Unocal argued that this was Mesa’s fault. it would rather be employed by a friend than an enemy o Shareholders like it—they get more.  If you lose. have to pay this fee  Lock-up option:  Asset lock-up: give white knight the right to buy the most important asset at a discount  Then acquirer doesn’t want to buy because even if they win. 1253) Facts: Mesa did a two-tier tender offer (coercive). More expensive for the acquirer coz instead of paying 100% of shares. o Or capped voting.

will have to sell to takeover co. or white knight)  Once you have a white knight. MacAndrews & Forbes Holdings (pg. they can get $72  But $72 is conditional on $54 offer happening  so $72 offer won’t happen because $54 will never happen  So this is a two-tier backhanded offer—everyone holds out and deal never happens  Court doesn’t see this problem. nature and timing of the offer. questions of illegality. so they can uphold this  This deal will prevent any deal from happening  No one will tender at $54 because if they hold out. but once you start it.  The duty of the board of directors changes from preservation of the company (Unocal) to maximization of the company’s value for the benefit of the shareholder.  Here. R kept negotiating with and giving benefits to Fortsmann to the exclusion of PP. securities being offered Response/defense must be reasonable in relation to the threat o Reasonable:  To extent that threat was inadequate offer. Directors: inherent conflicted—ask for more than Business Judgment Rule The inherent danger in the purchase of shares with corporate funds to remove a threat to corporate policy when a threat to control is involved 2-part test: Reasonable ground to believe there was a threat o Directors must show good faith and reasonable investigation o Examples of the belief: inadequate offer. and just because it could be a problem doesn’t mean it should be viewed as one CONCLUSION: directors satisfied enhanced scrutiny  entitled to BJR Revlon v. you have to get the best price. PP made several offers but were rejected by R. by itself it’s illegal. Defenses:  Not illegal per se to seek a white knight. R entered lock-up option and no-shop provision with Fortsmann. we can continue it o Unreasonable:  This should be illegal: directors are not supposed to discriminate against shareholders  © But court has already decided that shareholders can be discriminated against  © Upheld greenmail. risk of non-consummation. fighting fire with fire. including Fortsmann (white knight). break-up of company was inevitable and it was easy to tell because D started recruiting a white knight (either way. impact on constituencies. this makes sure that offer ends up being adequate  but problematic again because you could just come up with a number  To the extent that threat was coercive. Fortsmann’s deal provided better for the note-holders.1291) –white knight Facts: Pantry Pride expressed an interest in acquiring R but R didn’t want them to. you can no longer say you have a better option for staying as you and can no longer say that price is not high enough (now it’s just about comparing two prices) Board tried to consider bondholder interests—consider constituencies (Unocal) . to use advantages or poison pills because the directors are protecting shareholders’ best interest Once the sale becomes inevitable. who began negotiating with other parties.

 This is not the shareholders’ interests o Once we’re selling the company. we only care about the bottom line—we don’t care about anyone else o You can consider constituencies only if they are related to shareholder interest Best price?  Means: o Conduct an auction and whoever offers most money. you have to have a good justification—getting best price Other Forms of Business Associations LLCs and LLPs History of BA has clearly evidenced flexibility over time LLC*: limited liability company  Like a corporation. but to destroy it o Favored white knight very heavily  If you’re going to play favorites. wins  Not mandatory o Negotiate (with hostile bidder/white knight/everyone)  Here: at some point. it became clear that they weren’t trying to get a good price o Result of lock-up was not to foster bidding. but it isn’t—unincorporated  The law is a mixture of corporate law and partnership law  Few basic differences: o Certificate of formation*: charter for LLC  It’s not an LLC. so no certification of incorporation o Operating agreement*: agreement that sets forth structure and terms  Can be seen as analogy of partnership agreement or charter o Members*: owners of LLC  Don’t call them shareholders or partners o Managers*: designated managers of LLC  Optional  Don’t call them directors. call them managers .

law firms in some states have to be partnerships  But this lead to changes  some states develop PCs* and LLPs* LLP  Don’t confuse with limited partnership  Means that you’re responsible for your own actions. contractarian o Traditional – you had rules you had to follow o Contractarian – corporate law is actually more enabling o Is there a place for traditional theory in a word of contractarians? . if limited life (partnership) o Transfer or nontransferable o So make like shares or partnership interests o Double-taxation or single-taxation o Even fiduciary duties can be specified (within limits)  De facto LLCs. but not for partners’ actions Unlimited liability for yourself. Business increasingly being LLCs (so much flexibility)  Reasons not to have LLC o Fewer statutory default rules o Smaller body of case law – so some risk  You might think you know how court will interpret. if not. Operating agreement can make LLC as much of a corporation or as least as you like  You have to look at operating agreement to tell anything about the business (completely freedom) o Can make it member-managed (partnership) or manager-managed (looks like corporation) o Can share profits and losses as desired (like partnership) o Can decide limited liability (if so. partnership) o If lives forever (company). piercing the LLC veil. etc. limited for partners  Depends on state Some states also create LLLPs  It all comes down to giving people flexibility  Traditional view v. but could be wrong  Hard to get investors if they have to look at operating agreement to understand what’s going on  Some businesses can’t be corporations or LLCs o For example. corporation.

but double-taxation  partnership vice-versa Now. in LLC. you can do single-taxation and limited liability  you can have your cake and eat it too  is this fair? Basic Accounting Balance sheet: snapshot of a business on one day  Assets = Liability + Equity o Assets=sources of assets  Most liquid asset is cash o Liabilities: outside sources (that have corresponding assets) o Equity: inside sources or proprietorship (stake in the business)  Categories:  Paid in capital: funds invested in business in exchange for interest  Returned earnings  Income statement o Performance over time o Revenue-expenses=income (Profit/return)  Income: net income before tax  Revenue: cash in  Expenses: cash out  Cash basis accounting v.  Maybe it’s another option – to increase options to people  Different levels of rigidity  One option is to have complete freedom  Other option is to have more rigid rules Are LLCs fair? Corporation: you get limited liability. creditor≈lender . accrual method of accounting o Large corporate business use accrual method more Basic Financing Introduction to debt  Debtor= borrower.

And sometimes you might not be able to pay it back.10 will become $0. possibility that future returns will deviate from expected returns Return: profit Directly related: Risk & return are inversely related—in order to earn more profit.10  2nd year: $1 to $1. o Potential for profit: you invest by the money you borrow. earn more than you borrowed  Leverage creates risk for everyone . you might double the production.21  1st year: $1 to $1.05 tomorrow. you have to pay them back.10 o If after 2 years. I will not be able to buy it o Opportunity costs $1 today > $1 tomorrow >> $1 later on  compounding o If I have $1 and I get 10% after a year = $1. if I get $1 tomorrow.10  but $0.11 (everything 10%) o Becomes significant amount over time Risk & Return Risk: uncertainty. o Debtor: one who owes a monetary obligation to another o Creditor: one to whom a monetary obligation is owed  Debt = monetary obligation o Repayment of principal o (periodic) payment of interest  short term: principal + interest  long term: probably periodic interest every year and principal in the end Interest: time value of money  $1 today > $1 tomorrow Why? o Risk—chance that you won’t get that $1 tomorrow o Inflation—widget costs $1 today but $1. you must accept more risk  No risk. I’ll have $1. no return Leverage creates more risk  Leverage: use of debt in a business o Potential for loss: once you borrow money.

but risk is very different (expected return is just weighted average) o Risk is measured by variants and averages. o Borrower: takes on risk of losing profits by repaying loan o Lender: risk on losing money if borrower cannot repay  The more they lend. things balancing out  Expected return doesn’t tell us about risk o Ex: coin toss—  Can bet $10 on one flip for a possible return of $20 (so you get either $20 or $0)  Or can bet $1 on 10 flips for possible return of $20  Get a more rounded curve—good probability of breaking even  Expected return is the same. Each is unique o Has to be valued subjectively  Stock can be a commodity – a market for stock  Features for a strong market o Liquidity—can be converted in to cash (able to buy/sell quickly) . your entire fortune is tied to its success o If you have multiple investments. the more risky they are Diversification reduces risk  Diversification: reducing risk by investing in multiple opportunities o If you invest in only one company. the spread of likely outcomes Valuation & Efficient Market Hypothesis Valuation Special goods: rare/unique item  Difficult to value an asset o Appraisal—very subjective o Auction—try and actually sell. but might just get 2 nd best price +$1 Commodities—products that are abundant and fungible  Easy to value by looking at the market o Look at supply and demand Corporation  Special good. more likely of a moderate result.

in a strong market (e. by the time you get it. will drive price down Three forms of Market Efficiency Weak:  Current pries reflects all pre price information so you cannot beat the market by looking at the trends o Tells you nothing about what will happen tomorrow o An all-time high/low is insufficient to know o You may see the trend. U. but around that upward trend. high transaction costs. capital markets). but so does everyone else  Generally accepted as truth (but not universally) o Proof: prices move randomly all the time  But not entirely random—generally looks like an upward trend. not much transaction costs or hassle  Public corporations: a strong market  Close corporations: no o No stock buyers. no knowledge on how to run the business Efficient Market Hypothesis (EMH) Definition: the theory that. no public disclosure of information.. Wall Street. etc. o Availability of information—know what you are buying o Efficiency—ability to buy/sell cheaply.g.S. prices move randomly Semi-strong:  Current prices reflect all publicly available information  so you cannot beat the market with fundamental analysis and the information in the market o Not just past info. but media info (NY Times. prices quickly reflect all available information  Market quickly reflect the value o The stock price doesn’t mean how much the corporation worth o It’s everyone’s best guess as to how much the corporation worth  Reason: o EMH deposits that there are many different investors who are analyzing company at all times  Combined efforts provide equilibrium price for stock  If price is too low.) o Because current price already reflects current info. people will realize that so more people will want to buy at that price and more people will want to sell  this will raise the price up  Inverse is true—if information suggests price is too high. it’s old and stale  Widely accepted as more-or-less true o Proof: randomness—new info to extent it’s new is actually random/unpredictable .

buying and holding o Opposite of mutual funds. shouldn’t happen  But EMH doesn’t say it reflects accurate price. If you cannot beat the market.. which try to buy and sell to maximize profit  If everyone else is wrong. you can still lose) Delaware block method  Weighs different techniques to determine value of business in judicial process Ways of evaluation:  Market value  Asset value  Earnings value  Piedmont v. but then concludes that it gains you nothing o It works anyway:  Over time. o © Problems:  Inconsistencies  Anomalies show that market is not totally efficient  E. stock prices tend to be higher on Fri.. then it becomes investing o Eventually. just guess  Internally contradictory  Demands that there is a lot of analysts in order to have supply & demand work.g. then public announcements would not have an effect on prices  but they do  You could not make money from inside trading  but people can and do make money –and then go to jail… o But it doesn’t mean there is no truth in it. it doesn’t matter if you’re right (even if you’re right. public and private  so you cannot beat the market even with inside information o Insider trading has already adjusted the price  The trade has already be undertaken. people stop doing research. is investing a gambling?  Yes—if just one or a few stocks. New Boston Garden Corp. lower Mon. o Experience demonstrates that very few people can consistently beat the market.513)—illustration No longer used in DE . but not really as much by not doing  Real point of EMH is that you can’t beat the market Strong:  Current prices reveal all info. then EMH says it’s gambling  No—if you diversify. things vacillate—as markets become more efficient. Everyone involved in the trade knows about it  Not accepted as true (it’s a theoretical placeholder) o Proof:  If true. (pg. (should theoretically disappear if people know)  Big events—like Stock Market Crash of 1987  If markets are so efficient. you are eliminating all specific risk and just investing in the market to make expected return. then becomes less efficient. and people think they can make more money by researching  Enough inefficiency to compensate people for efforts: people can make money by doing. just diversify  Diversify through mutual funds and index funds o Index funds try to match the market. You can earn the market rate by making the market Lesson: don’t try to beat the market.