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DISCLAIMER: ShittyShit Corps Class Notes (SSCCN) is shitty shit

August 23, 2016

(ASSIGNED: p. 1-5, 7-13; bunch of basic econ readings; Hanson v. Kynast h/o)

General Gent(i)le(wo)manly advice: take income taxation, watch Wall Street with Gordon Gekko and be into midwestern sports
but not Michigan sorry Paiv


Voluntary exchanges - no worries about duress, fraud, etc.; ASSUME MUTUAL ASSENT
Sophisticated parties - appropriate level of expertise
To make
Profits - everyone wants to get rich; everyone is trying to turn a profit

Capitalism = efficiency
Intuitively? Maximize output for given set of inputs, minimize waste
Pareto efficiency
(p. 4 AKS) no reallocation of resources can make at least one person better off without making at
least one other person worse off
fails to take into account the existing distro of resources
Impossible to satisfy
Kaldor-Hicks efficiency
(p. 5 AKS) at least one party would gain after all those who suffered a loss are fully compensated
Winners win more than losers lose
No account for existing distro of resources
No account for distributional consequences
Pretty much everything is analyzed by Kaldor-Hicks where you just want the biggest pot/pie in the biz
law realm and max output, min waste

Agency, transaction, organization costs: who bears the cost and how do we minimize it?

Agency Costs Transactional Costs Ownership Costs

Borne by agent Borne by parties individually Borne by parties collectively
Minimized by K Mind by governance structures Mind by ownership assignments

Agency cost theory - EX. Gekko hunting and fishing trips, steak lunches, etc. (EX. Dean Diller (DD) donut
CONTROLLED BY K B UT there will always be a residual loss because the A will never work as
hard as the P/owner would work
Monitoring (timesheets, clocking in)
Bonding (commission, sales-based, like a bonus)
Principal = engages A to act on his behalf
Principal pursues principals interests
Agent = engaged by P

A pursues Ps interests + own
Transaction cost economics (Williamson)
Bounded rationality = limited information (asymmetric), cognitive limitations, limited time (we are not
nearly as rational as we think we are though)
Behavioral assumption = self-interest with guile (hazard of opportunism)
Actors pursue their own interest and lie in a calculated way
feasible Ks? Every K is incomplete (missing info due to self-interest) and difficult to enforce
BORNE BY PARTIES TO K in relation to . . .
Frequency of interactions, degree of uncertainty
+ extent of asset specificity (e.g. barriers to entry like proprietary software THINK - Oracle)
CONTROLLED BY GOVERNANCE STRUCTURES (e.g. ownership stake = incentive)
Ownership cost theory (Hansman)
Ownership structure minimizes transaction costs for owners by bearing ownership costs + non-owners
Monitoring activities
Collective decision-making
Asymmetric info
Lock-in w/ specialized instruments
Market power

Role of Law? Form Ks, conduct standards

Normative considerations to increase social welfare by enhancing efficiency through protection of residual claimants
Positive considerations = efficiency matters less in partnership / agency law
Minimize acts by
Providing standard form arrangements
Permitting modifications of 3P rights
Limiting self-interest / opportunism by developing fiduciary duties
Role of Law(yers)? Specific Ks, enforcement suits of fiduciary duties (private and not govt)
Adds value to transactions by reducing agency/transxn/ownership costs
NOT by
distributive bargaining this is more COOPERATIVE and less confrontational
Regulatory arbitrage
Minimize cost with custom bespoke Ks
+ limit self-interest with lawsuits


Questions: what is the liability of the principal? What are the duties owed to the P by A? What about 3P injury?
Rst (3d) 1.01:
Agency . . . fiduciary relationship when P manifests assent to A . . . and A consents so to act
Agency relationship involves delegating some decision making authority to A

Jenson Farms Co. v. Cargill; p. 9-12 (right of first refusal)

Grain elevator, selling grain to Cargill where farmers drop off
@ Warren silos and Warren promises soon as we sell, well
pay you)
64 $175K, 67 $300k, 72 $750k, 76 $1250k, 77
$2000k to farmers but $3600 to Cargill
Cargill arg: creditor-debtor relationship! No agency
relationship or buyer-seller (B-S) relationship
(p. 12 AKS) - list of NINE factors the Ct considered
(1) constant recs by phone = agency
(2) right of first refusal on the grain / right to buy all grain first before sale to anyone else = B-S
(3) inability to enter mortgages, purchase stock, pay dividends w/o Cargill approval = creditor-debtor
relationship (C-D)
(4) right of entry . . . periodic checks and credits = Agency OR C-D (could be lender borrower situation)
(5) criticism, finances, officer salaries / inventories = agency
(6) strong paternal guidance = why hire an incompetent A? Onus is on P (sheer idiocy!)
(7) provision of drafts / forms imprinted = agency
(8) financing of grain / ops cost = C-D or agency (lending merely for one thing and not ALL ops)
(9) power to discontinue financing
EX. credit card declined because over limit? Das C-D
TOTALITY OF CIRCUMSTANCES + aggressive financing of Warren

Tomorrow? Let us go then, you and i, when the evening is spread out against the sky . . .
- J. Alfred Prufrock / Albert Einstein / Gents all around

August 25, 2016

(ASSIGNED: p. 13-27)

Review & Recap

Voluntary exchanges among sophisticated parties to make profits
Kaldor-Hicks Efficiency
Agency, Transaction, and Ownership Costs
Organizational Costs

Agency costs: I will not work as hard for Dean Diller as I will for myself
Dean Diller will engage in monitoring & bonding (no pay w/o selling 100 donuts)
There will always be some residual loss
Minimized via contract
Transaction costs
Ownership costs
constrain self-interest through law imposition of fiduciary duties
lawyers bring suits to enforce fiduciary duties
Suit by 3P to obtain damages to obtain damages from a (putative) principal

Jenson Farms Co. v. Cargill; p. 9-12

p. 12 lists factors; totality of the circumstances
RULE: Conduct of the parties (not their intentions) determines the existence of an agency relationship
Cargill let all the 3Ps feel as if Warren Grain & Seed Co. was their agent; all the checks and communications had
Cargill on them
Ct says: if you have an agent, and think that the agent needs guidance, either get the agent to do the work
properly or fire the agency
Gent says: principals of the world, not necessarily interested in your intent, if you start acting as a principal,
you better hold your agent liable
Cargill had to pay farmers on top of $3.6M lost - people who have money, tend to demand control; incentive structure

Hanson v. Kynast; h/o

Allen scores goal, stumbles and falls, Hanson comes to
rescue and grabs Kynast (taunter) in bear hug; Kynast
shakes off Hanson and Hanson grievously injured as
incomplete quadriplegic
Ct says: you are clearly buying education and
extracurricular activities such as lacrosse
You are buying, this is a Kual
relationship (seller = university,
buyer = student)
No scholarship, no compensation, players provide own equipment, no admission fee charged at games
p. 4; A student who:
(1) attends a university of his choice = buyer-seller
(2) receives no scholarship or compensation = Kual relationship
(3) voluntarily becomes a member of the university lacrosse team = buyer-seller
(a) engages in intercollegiate contests with other universities = ???
(b) for which games no attendance fee is charged = Kual
(4) purchases his own equipment = Kual
(5) receives instructions from a coach while preparing for and playing such games = agency
(6) but is not otherwise controlled by the coach = agency-ish
(7) participates = buyer-seller
COURT HELD: University NOT liable, only one factor that represents A-P relationship
Is ashland u liable for injuries caused by Kynast?
What is the basis for the decision?
What is the significance of the financial relationships among the parties?
Is the rule efficient? [Efficiency important to look at when sorting through issues of liability]

Hanson rule seems efficient b.c. if it was other way around, too much liability for universities. Clubs,
etc and schools would likely shut all those programs down



Rst (3d) 2.01: the agent reasonably believes in accordance
Types of actual authority?
Express: do everything possible
Implied: paying for the beets, paying the tolls, returning
If DD tells her to do shit and she doesnt and hes sued for it, but
actual authority then fail
Apparent authority:
Rst (3d) 2.03: when a 3P reasonably believes that the A has authority to act on behalf of the principal and that
belief is traceable to the principals manifestations
Looking for the communication = manifestation from P to 3P
Inherent authority (agency power):
Rst (2d) 8A: derived .. solely from the agency relation and exists for the protection of 3P harmed by dealing
with an agent
Binds disclosed principals and undisclosed principal when neither actual nor apparent authority exists
EX: [case of the undisclosed principal] drive to OH to buy beets for DD from a farmer; no actual authority if DD
didnt give to her; no apparent authority because farmer beets didnt even know DD existed
3d Restatement = no inherent authority (agency power)
Rst (3d) 2.01(b): importance of interpretation by the agent in the As relationship w/ P (will look
more closely at As relation with the principal)
use apparent authority [court will interpret same conduct lower court used to find was
inherent authority to fine apparent], estoppel, and restitution

White v. Thomas; p. 14-16

Simpson does everything for White; go to this farmhouse auction sale and do not pay
more than $250k; she ends up paying $375k for the land because she overbid
Thomas buy the farmhouse and the acres around it, but outbid by Simpson
around her
Simpson sells 45 acres so that overall cost for Mr. White is lower; White
almost has heart attack about fact of paying 30% more for the land
Thomas arg: apparent authority
Need manifestation from the principal down to the 3P (White had to have
communicated to the Thomases, even though White is in Europe and isnt
communicating with them at all)
Simpson had blank check; said YES had power of attorney to Thomases, but NO to auctioneer
Did Simpson have apparent authority to sell the land?
why is manifestation from the principal so important?
How do we evaluate the manifestation?
Is the rule efficient?
Where does the court draw the dividing line?
Reasonable indication of principals authority to do that thing
Gent says: Forces principals to be very CLEAR about what they want
White couldnt have expected her to buy beyond, and then have to sell the extra chaff; some of
the burden should be on the 3P

Ct says: she has no actual authority to SELL the land; expressed authority to BUY the land (p. 15)
Blank check with signature indicates limited authority, but no evidence that White knowingly permitted/expected
Simpson to SELL
Thomas failed to ask about power of attorney and did not attempt to contact White
While the declarations of an alleged agent may be used to corroborate

Gallant Insurance v. Isaac; p. 17-21

Isaac needs new insurance for the car that she is buying on Friday; Thompson-Harris says nbd, just pay us on Monday
Isaac gets into an accident over the weekend
Gallant saw accident happened on Saturday and insurance policy was paid on Monday
Isaac claim: inherent authority of Thompson-Harris on behalf of Gallant, reasonable belief not to know anything about
the Gallant K provision, just followed what I usually do
Gallant Insurance retaliate: contract = any changes to the policy become effective only when Gallant insurance
has the insurance premium paid
Not actual authority because Gallant-TH agreement said needed money to be paid
Not apparent authority because Gallant hadnt yet received the check, not effective yet
Is Gallant liable for the costs of Isaacs auto accident?
Why does the appellate court consider the inherent authority?
We find that neither an actual nor apparent authority theory applies (p. 19)
What is the source of inherent authority?
Ct finds this authority in the inherent unfairness of the situation
Agency relationship itself
Inherent agency power indicates the power of an agent that is not derived from actual or
apparent authority, but from agency relationship itself
Is the notion of inherent authority efficient?
Stops Ps from behaving in a way that is just unfair; cant just sue when your A does something you dont
want them to do
Turns on what is fair
How does the Indiana Supreme Court find that T-H had apparent authority?
(p. 20) apparent authority is the authority that 3P reasonably believes an A to possess because of
some manifestation from his principal . . . statements or manifestations made by the A are not sufficient
to create an apparent A relationship
(p. 21) every single time that Isaac dealt with Gallant, she just called/faxed T-H
March of the law away from inherent authority = MESSY
Ct says: this is the way Isaac has always dealt with Thompson-Harris
Thompson-Harris and Isaac knew that Gallant was the principal
Court did this because it just isnt fair whole purpose of inherent authority is to protect 3Ps harmed

So liability in CONTRACT? P sued on a K, you look for AUTHORITY

Actual - express or implied
Or, in cases of unfairness, inherent agency power?

Central question is CONTROL
Rst (3d) 2.04:
Respondeat superior - an employer is subject to liability
for torts committed by eees while acting within the scope
of their employment
Rst (3d) 7.07(3):
Eee = agent
Rst (3d) 7.07(2):

Eee acts within scope of employment when
Work assigned by eor OR
Conduct subject to eors control [overseeing work, etc]

Franchise Agreement: Co. or indiv. (franchisee) sells product or services or operating business pursuant to license from
another co. or indiv (franchisor). -- Gas Station cases are franchise agmts.


Oil company really the one you want to sue because they have all that CA$H
Proprietor (station operator)
Lots of agency costs in gas station operation, because gas stations are so spread out across the US
Rationale for the system:
Reduce the agency costs; there will be so much shirking by the surly eee
Bonding based on commission for sale of gas and maintenance
Reduce transaction costs
Buying advertisements in large volume; oil company runs the ad campaign for the benefit of all
the gas station owners that pay a small fee
Reduce ownership costs
Oil company isnt solely responsible for 100s of gas stations across the country, this all falls onto
the proprietor
Increase risk to oil companys reputation

Humble Oil v. Martin; p. 22-24 Hoover v. Sun Oil; p. 24-26

Love parks car, fails to brake, hits Martin and his 2 Barone is proprietor of station; Smilyk eee started fire
children; Station proprietor is Schneider; at rear of Hoover car via negligence
Issue: Issue:
Is Schneider independent Kor or eee? Is Barone independent Kor or eee?
Humble / Schneider Sunoco / Barone
Humble set the hours Barone set the hours
Schneider could only sell Humble goods Barone could sell any goods that he liked
Humble held title to goods (consignment) Barone took title to goods (would suffer
Lease terminable at will losses, because he held title)
Rent / utilities Lease terminable yearly
Didnt have to pay rent or utilities, Profit / subsidies
figured as %age of his profits (if no Oil co. subsidizes to match market
profits, then didnt have to pay rent rates if requiring cutting a loss
at all) No reports / advice
Periodic reports Did not need to report

August 29, 2016

(ASSIGNED: p. 27-35, 39-46)

Review & Recap

If P is being sued on a K, the question is whether or not A was AUTHORIZED to enter into the K on behalf of the P
Actual authority - manifestation to agent; what A believes can do on behalf of P

Very little litigation surrounding this
Express authority - when P tells A to do something explicitly (go buy donuts)
Implied authority - A can do everything that is incidental to what P authorized
Apparent authority - communication from P to 3P; manifestation to 3P
White v. Thomas: how do we figure out what apparent authority is?
Court looks to the reasonableness of the 3P (EX: DD emails the farmer)
Problem here is communication from P to 3P is a little murky (blank check here)
Power of attorney that A says she has but isnt able to produce
Cant just assume that blank check grants authority to SELL something, not just buy
Necessity of 3P action - is it reasonable to require the 3P to take action to confirm the authority?
Inherent (agency power) authority - protecting innocent 3P
Gallant Insurance Co: no modifications unless Gallant has the check, Gallant had A make mods all the time
even before the P gets the check
Permissibility of 3P reliance on communications by the A
Look at EFFICIENCY [to classify differing court opinions]
Apparent authority - You dont want the P engaged in every transaction, the 3P shouldnt be going to the P to
check everything
Inherent (agency power) authority - is it reasonable to allow 3P to recover under circumstances that may
ultimately lower the cost? (lowers cost between contracting parties and society as a whole)

Question isnt authority, it is CONTROL
Respondeat superior: employer/employee relationship acts within the scope of the employment
Does the P control the As performance of the work?
Are As acts within the scope of the employment?
The agent is doing work assigned by the principal?
Operational requirements financial structure
Gas Station Cases
Humble Oil Co: finds an eor-eee relationship Humble Oil is liable for the torts of Schneider
was not named as a along with Humble Oil
Schneider didnt have any money because was JUST an eee
Made monthly reports
Sunoco (Sun Oil): independent Kor finding (Barone)
named as a along with Sunoco
Saw that Barone was essentially an independent Kor with title to all the goods for sale in
the gas station, had all the profit from the gas station; made sense to sue him
Who sets hours of gas station? Who determines what products are sold in the gas station?
No monthly reports
Allocates liability consistent with the way the parties bargain for it (bargain of the parties) efficiently
Difference is in what the parties have negotiated


(1) Creation = conduct of the parties, not intent
(2) Liability of P to 3P
(3) A owes duties to P

Methods of governance
Exit rights - A will quit or P will fire

Very little incentive to P or A to make investment in the Co., whole relationship could end for no reason
Contract - specifies hire, fire stuff
Will always be incomplete, limited and asymmetric information, both likely to behave badly
Fiduciary duties - law fills in the gaps of the Ks
Duty of obedience - like actual authority - little litigation around it
Duty of care
Duty of loyalty - most important

Duty of Obedience
Rst (3d) 8.07: act in accordance with the express and implied terms of any K between the A and the P
Very clear cut, very little litigation
Duty of Care
Rst (3d) 8.08: act with the care, competence, and diligence normally exercised by As in similar circumstances . . .
[including] . . . special skills or knowledge
Some litigation around duty of care most people try to go around the world acting like everyone else in
their field, so very little breach of this duty of care
Duty of Loyalty
Rst (3d) 8.01: act loyally for the Ps benefit in all matters concerned with the A relationship
EX: buy a scratch off lotto ticket and win? Its Ps. Everything done in A relationship belongs to P
UNLESS able to get P to consent
Rst (3d) 8.02: duty not to acquire a material benefit from a 3P in connection with . . . As position
Rst (3d) 8.06: conduct by an A doesnt constitute a breach of duty if the P consents to the conduct, provided
(a) in obtaining P consent, the A
(i) must disclose
(ii) act in good faith (GF)
(iii) otherwise deals fairly with the P (fair dealing) [AND]
(b) Ps consent concerns either a specific act or transxn . . .that could reasonably be expected to occur in the
course of the A relationship

Tarnowksi v. Resop; p. 28-30

A (Resop) took statements of Seller at face value -

A reports that all jukeboxes were working well, less
than 6 months old (has the hippest music), 75
jukeboxes; generating more than $3,000/month in
Tarnowski (P) then finds out that this is all
not true
Rescinds K with the Seller - this is
not the biz that you said it was
Wins (see diagram)
Discovers that A received $2,000 secret
Tarnowski (P) now wants compensation for all losses, secret commission, attorneys fees
Can Tarnowski (P) recover the secret commission from his A, Resop? [Can P recover that secret commission?]
Tarnowski has been made completely whole, so the only part thats left is this secret commission
No evidence that the secret commission affected seller
p. 29: all profits made by an A in the course of an agency belong to the principal [regardless] of fruits of
P had absolute right to thereto
P 3P relationship doesnt matter

Matters not even if P has suffered no damage at all or if transxn was profitable for him
Is the rule efficient?
Money had no impact on the P; S wouldve either paid A or kept the money; doesnt harm the P
Want to strip away the As incentive to take secret commissions, no way to police this
Fair not to let the A keep the secret commission, makes A more willing to get the deal done

Rst (2d) of TRUSTS 203: trustee is accountable for any profit made by him through . . . the administration of the trust,
although the profit does not result from a breach of trust
Even if trustee didnt breach, profit still belongs to the P
Trust law largely mirrors agency relationship; trustee cant deal with property of the trust

In re Gleeson; p. 31-32
Mrs. Gleeson dies right before the farm season; worry is that the planting season is around the corner (around V-day) and
that the fields will lay fallow
1950-1951: Curtin partnership farmed it (one member was Holbrook); $6/acre
Feb 1952: Gleeson dies and funeral
1952-1952: Curtin partnership rents again; $10/acre
Colbrook not just tenant, but also trustee for trust Gleeson left for her children
P (Mrs. Gleeson) is dead, cant really go to her for permission
Cant talk to the beneficiaries because, if they were competent and capable of
managing the land, then wouldnt have made this trust
Colbrook prob a good family friend, doing this for the benefit of the Gleeson children
Why was he willing in the last year to raise the rent that he was paying unilaterally from $6 to $10?
T. Gleeson (minor child)s attorney was forced to sue because the attorney had fiduciary duty and saw
the breach of the trust
Is the trustee permitted to lease the farmland that is the subject of the trust?
Special circumstances re: lease of the land?
Mrs. Gleeson died right at the pivotal point, and field would lay fallow
2 weeks not enough time to find another group of farmers
Gleeson gets crops, children get $$$
Ct says: NO. you can never act in this way!
p. 32: no justification at all for dealing with the property
What must a trustee do to satisfy his duty of loyalty?
p. 32: must decide to either farm the land OR act as a trustee
Would be easier to find someone to act as a trustee

Reasons for partnerships
Operational expertise (synergies)
Financial support (investments)
(incomplete) partitioning of assets and liabilities
Partners share liability of what is owed; also may divide up the decisionmaking/control
When people have money/capital at risk, they will demand control
Difficulties with partnerships
Agency costs:
Still quite large between partners and eees
eees not going to work any harder
Still have monitoring, bonding costs + residual loss
Among partners
In addition to shirking that you do, still shirking among partners themselves
Transaction costs:
Still when the eees interacting with 3Ps
When partners interact with 3Ps
Ownership costs:
Collective decisionmaking among partners

UPA (1914) definition: NY still follows this instead of RUPA but always pull out the actual NY partnership law
6(1): An association of two or more persons to carry on as a co-owners a business for profit
7(3): Sharing of gross returns does not of itself establish a partnership
Eees share in gross returns though; partners get paid only after everyone else gets paid
all you have to do is carry on as business for profit, INTENT does not matter (similar to agency relationship like
Cargill - Cargill agreed to have Warren act as its agent - conduct of the parties only thing that matters)
If you carry on as business for profit, then you find yourself in partnership
Receipt of a share of the profits of a business is prima facie evidence that a person is a partner
7(4): UNLESS the profits were received in
payment of a debt,
as wages of an eee
or rent to a LL
or interest on a loan, through the amount may differ vary with the profits of the business
Consequences of Partnership (UPA)?
Share profits and also losses
9(1): Partners are agents of the partnership
???: Partners liable as Ps
15: Partners are liable for debts of the pship
18(e): All partners share equally in control
If no pship agreement (which can be oral), then everything is split equally
Why do people sue over partnership?
Typically about $$$

Vohland (younger) v. Sweet; p. 39-41

Vohland (old) retires, gives nursery business over to his son Vohland (younger); Sweet was hourly eee at nursery at time
Running a nursery is a lot of physical labor, got to get up and come in early, etc.
Vohland (younger) goes to Sweet with a deal
Vohland takes care of the financials, Sweet does all the actual work; Sweet gets 20%

invests a bunch of money into growing a bunch of plants prior to the time that Sweet is paid
Sweet(promised) = 20% of net profits
Sweet(paid) = 20% of [net profits - cost of purchased inventory]
Realize hes only getting 20% of profit after the inventory is subtracted out
Sweet(sues) = 20% of the inventory = 20% of $293,665 = $58,733
Sweet claims that they are sharing in the profits, left after everyone else has been paid saying that
they were in a pship, wants pship dissolved so he can get his fair share

Vohland = 80% Sweet = 20%

Responsibilities Responsibilities
Secure financing Nursery stock
Making sales Servicing customers = Vohland
Keeping books even says talk to Sweet, hes in
Tax return = no report of pship charge
Owns nursery Tax return = no report of pship
Pays commission to Sweet Self employed salesperson earning

Only reason to give 20% of profits is to incentivize Sweet to grow the business
Cts reasoning is somewhat circular because it says they share profits because they are in a pship and they are in
a pship because they share profits
Hypo: what if rather than Sweet suing Vohland to get 20% of profits Vohland sued Sweet to get 20% on a loan then the
court would likely not find a pship because they look at INCENTIVES not INTENT

September 1, 2016
(ASSIGNED: p. 4650, 10509, Jackson Accounting Handout)


The law considers partners to be tenants in partnership (UPA 25(1))
Pship property can only be used for pship business
Partners receive pship profits (through distributions)
How do we divide pship assets and debts when things go south?
Usually when pships go bankrupt so do their partners
UPA 40(h)(i) (JINGLE RULE)
Pship creditors get pship assets
Individual creditors get individual assets
Then whichever is left over then the creditors can go after the others assets i.e. pship creditors get
individual assets or individual creditors get pship assets
Almost never use this rule because as soon as you get into this situation becomes bankruptcy which is
federal matter and governed by modern rule
78 Act (723(c)) & RUPA (807(a))
Modern rule
Same as above except pship creditors get priority over individual assets before individual creditors can get
their hands on anything and individual creditors cant get any pship assets
We have this modern rule because it makes individual creditors more wary of extending credit to people in
By eliminating the assets that are available to the individual creditors this process becomes more
The people who have the most at risk also have the best knowledge (individual creditors)
If you have a bankruptcy it will always be the modern rule because it is federal statute

Legal structure
Pship decisions
UPA 18(h)
Any difference arising as to ordinary matters may be decided by a majority of the partners
No act in contravention of any agreement between the partners may be done without the consent
of all the partners - if Davidson decides that the donut company should also be growing apples

National Biscuit Co. v. Stroud; p. 46-48

Stroud: no longer personally responsible for bread
Freeman: request bread for two weeks ($171.04)
Is Mr. Stroud liable for the payment owed to National Biscuit Company?
Stroud is liable for the breadwe cant have one partner changing the course of the business because if any
partner could change course you would need all the partners to give assurances every time
It would be extremely inefficient to do it the other way
BUT Why not allow partners to opt out?Because once a majority has decided something only a majority can
change it.
Why not rely on financial contributions?Because you know that once you come into the partnership you know
things are going to be done by majority vote.
The problem for Mr. Stroud is that he never bothered to get a partnership agreement so he is stuck with
50/50 division of the vote.
In their two person partnership all decisions must in essence be made unanimously
What role does the individual wealth of each of the partners play?

Organize financial information for any business
Compare financial performance across businesses
Evaluate actions of managers
Determine whether managers have satisfied fiduciary duties
Use financial information for the business not the owners or any other stakeholders
Record monetary values in dollar amounts even when difficult to determine
Value of intangible assets is estimated
Contingent liabilities included based on probability
Extraordinary items
Match entries with time periodsall debts incurred while producing a product should be recorded in the
same period as the proceeds from the sales of that product (e.g. when produced in December and sold in
January sale should be recorded in December)
Balance sheet
Cash, accounts receivable, inventory, real estate etc.
Listed in order of liquidity
Recorded at lower of acquisition cost and current fair market value (e.g. Business school building
is recorded on Fordhams balance sheet as only $100,000 b/c they bought it in 60s)
Because loans are repaid regularly they remain pretty close to market value
Partners capital (shareholders equity)
The balance sheet is just a photograph as of one day
Income Statement

Net Income
revenues-expenses=net income
The income statement is like a movieit looks at net income over a 12 month period
On the income statement accountants consider depreciation instead of maintenance expenses
$12,000 asset lasts 12 yearswe record it as depreciating $1,000 per year out of convenience
even if it does not match the actual maintenance costs
Because of this net income may not match actual profit because it may record more or less
depreciation than there was actual maintenance costs
Statement of Cash Flows
Just constructed from the balance sheet and the income statement
Cash from operating+cash from investing+cash from financing
Partnerships dont pay taxespartners do
Prob #2 p. 50: total taxable income would be salary plus income from partnership

September 6, 2016
(ASSIGNED: p. 51-74)

Review & Recap

Use of partnership property - contribute for partnership business
Distribution of partnership profits - to partners for their individual use, including for assignment to 3P
Rights of partnership creditors, individual creditors (creditors to individual partners)
When the partnership go bankrupt, the partners also goes bankrupt, responsible for all liabilities of corp
Jingle rule:
UPA 40(h) + 40(i)
Modern rule: privileged access to individual assets of the partners, individual creditors much less likely to
extend credit (e.g. MasterCard wont increase small biz credit line, because assets of partner will be used along
with partnership assets to repay the partner debts)
78 act/ RUPA 807(a)

National Biscuit Co. v. Stroud; p. 46-48

Based on number of partners, not capital contributions
Vote split 50/50
Stroud couldnt make decision for the partnership without Friedman


Biz: organize financial information, compare financial performance
Law & lawyers: evaluate actions of managers in satisfaction of their fiduciary duties
How do we do it?
(1) focus on the entity - only look at what belongs to the entity (monetary value)
(2) use monetary values - IP portfolio, contingent liabilities are not quantifiable - estimate in terms of dollars, or
not include at all
(3) match entries with time periods
Financial statements?
Balance sheet - measures value by equity (partners capital) as of a specified date
ASSETS - LIABILITIES = EQUITY (every balance sheet will always balance)
Shortcomings - record assets (and liabilities) at lower of acquisition cost and the fair market value

EX. building next door was 160k, now worth about 100M; many assets are worth more than
their fair market value because use of historical value
Liabilities less likely to have this problem - short period of time (3/5/7/10 years)
Income statement - measures value by net income (profit)
Compare biz across time and industries
Record non-cash items, depreciation rather than maintenance costs
Cash flow statement - measures value by cash
Pickes out changes in companys cash position over that same year
Cash from operating activities +
Cash from investing activities + (e.g. repay mortgage, buy a new oven)
Cash from financing activities
Records the actual (cash) value of the company

Termination of partnerships - who gets what
Duties of partners (fiduciary duties)
Modification of the partnership form

Statutory provisions
Dissolution (breaking up)
Termination (winding up)
Distribution (payments)
Judicial oversight
Avoid a dissolution
Adams v. Jarvis
Initiate a dissolution
Page v. Page

Dissolution UPA 29:
Change in the relationship of the partners caused by any partner ceasing to be associated in the carrying on . . . of the
Winding up UPA 37:
Unless otherwise agreed, each of the partners . . . has the right to wind up the partnership affairs (including by the
Sweet: recall nursery business case
Distribution of partnership property UPA 38(1):
Each partner . . . unless otherwise agreed, may have the partnership property applied to discharge its liabilities and
the surplus applied to pay in cash the net amount owing to the respecting partners
You contribute assets, you can only use it for partnership business; cant take it back
Held as partnership in tenancy
Here, you dont get your stuff back, you get your pro-rated share of the sale of that asset
Rules for distribution UPA 40:
(a) the assets of the partnership are
I. the partnership property
II. the contributions of the partners necessary for the payment of all liabilities specified in clause (b) of this
You can sell shit (e.g. sell the table you contributed, but the table is the partnerships!)
Personal assets are added back to the partnership to cover liabilities

(b) liabilities of partnership shall RANK order of payment as follows
I. those owing to creditors other than partners
Eees, suppliers, utilities, etc. if not enough to pay these people, then partners have to
contribute to pay them
II. those owing to partners other than for capital and profits
After all the other creditors have been paid, debts, etc. to individual partners
E.g. loans extended to them, salary
III. those owing to partners in respect of capital
WA square pharmacy
Amount that theyve earned over time in partnership
IV. those owing to partners in respect of profits
Net income for year that partnership was wound up in

Adams v. Jarvis; p. 51-55 (Tomahawk Medical Ctr)

3 Drs. together to form partnership, medical imaging center
Lawyer drafted Para 15
The incapacity, withdrawal, or death of a partner shall not terminate this partnership
Opposite of what partnership statutes provide usually withdrawal of any partner terminates the
partnership unless otherwise agreed
Here they otherwise agreed would have to buy all new equipment
Para 16
Provides that a withdrawing partner shall be entitled to receive (1) any balance to his credit on the
partnership books, (2) share of profits, and (3) his capital account
accounts receivable will remain part of the medical clinic; NOT part of what is distributed
pretty much everything in medical context is probably accounts receivable; the only
thing the company has because no one pays when they show up (insurance and pay
after usually)
Dr. Adams: want the statute to control gather up all the assets and all liabilities and paid to partners
Does the partnership agreement or the statute determine the consequences of a partners withdrawal?
Does the partnership agreement or the statute UPA 38(1) control?
If agreement controls, then Dr. gets nothing
If statute controls, then that gets divided
p. 53 - partnership agreement provides not wholly dissolved as would be required under UPA 29 and 30
Payment to Adams under
ASSETS - LIABILITIES = EQUITY (PARTNERS CAPITAL) return to p. 49 balance sheet
Fighting about accts receivable (under assets) is not part of what is paid to Dr. Adams, take the
accounts receivable off the assets side of the balance sheet
So partners capital account is much lower, lower by the amount of the accounts
For something like a medical center, not much inventory
Pretty much everything in the accounts receivable
UPA 38(1) provides that unless otherwise agreed distribution should therefore be made pursuant to the
What is Dr. Jarvis entitled to receive upon leaving the partnership?
Going to get what is in the partnership agreement, but only for the portion of the year where there
Pay to Adams =
( = interest in partnership) * (5/12 = 5 out of 12 months of the year) * (1961 profits, which will
not include uncollected accounts receivable)
Court knows that Jarvis isnt trying to collect on accounts receivable
Williamson: every K is going to be incomplete
Accounts receivable should be collected in ordinary course of business should
have been in Para 16

What limitations are placed on Dr. Jarvis (and the other partner)?
Fiduciary relationship = gap-filling duties good faith effort to collect on accounts receivable
consistent with good business practices

Page v. Page; p. 56-58

Supplying hotels and restaurants with linens; linen supply company; 2 brothers who have gone into business
1949-1959: each brother contributes $43,000
1949-1957: -$62,000 (lost all of that, plus this amount)
Page the Elder loans them $47,000 - doesnt contribute more money to the partnership (LOAN to the partnership)
1958: +$3,824.41
1959: $2,828.30 (3 months) = might make $12,000 (projected)
Tried to oust the younger brother
Capital Accounts statement
Opening balance $43k, income = negative for many years, positive for last two years; closing balance =
Older Page trying to kick him out so doesnt have to pay the younger Page
Balance sheet
Assets = maybe some equipment to launder/iron, inventory perhaps
Notes payable $43,000 Page Elder just loaned to the company
Partnership capital is lower because of notes payable ($43k owed in the form of a
UPA means other creditors get paid, then any money lent to the partners to
partnership account, then capital, then profits
$62,000 first
Page Elder gets $43,000
Then everything else that is deeply negative
Page Younger would have to pay all this extra
Oral partnership agreement
We are going to be partners until this business is going to be successful
This is their 4th partnership, some with written partnership agreement
Pages had very different predictions about where business was going to go
Elder thought was going to make money; willing to give money
Vandenberg air force base - sailors use a lot of linen
Younger wanted to cut his losses
Younger brother said - shouldnt have been dropkicked out of this partnership
How is the term of a partnership determined?
Until profit is made (as Younger thinks)
Until one of us decides to leave the partnership (as Elder thinks)
Page Elder wants to terminate the partnership because wants the money and take advantage of profitable situation
Younger fears will receive very little
Trial ct:
Elder taking advantage of Younger (p. 57)
App ct:
p. 58 - Merely a hope UPA 31(1)(b) - everyone goes into biz to make enough money to pay
off all the expenses w/ hopes to be profitable
Fiduciary duty
Perhaps Elder knew about Vandenberg air force, and how he orchestrated all of this; at time of entering
partnership, he couldnt know that he was the one to figure this out first
p. 58 - dissolution of partnership power, like an other power held by a fiduciary, must be exercised
in good faith . . .
Law will not apply a term or determine if at-will


Meinhard v. Salmon; p. 59-63 (*** CARDOZO FAIL 1922 ***)

(CARDOZOs most heavily criticized opinion)
Hotel Bristol, Grand Central station has opened right beside it - was a RR station instead of a subway station at
the time
Meinhard, Salmon leased the Hotel Bristol from Gerry
$100,000 each - undeveloped, essentially pasture neighborhood to remake this hotel
Salmon is the manager, Meinhard is the passive co-venturer
$55,000 in rent per year
20 year lease
First 5 years - 60% to Salmon, 40% to Meinhard; 60 because Salmon did all the work
Next 15 years - 50/50
19 years, 7 months later; Mrs. Gerrys grandson now owns the property and larger property around the Hotel
Gerry wants someone to redevelop the same way Salmon did it to the Hotel Bristol
Gerry-Salmon agreement that Midpoint Realty Company (owned solely by Salmon) would lease entire
parcel of land for $3,000,000
Rent is $350,000/$475,000
As more property is renovated, the rent will go up
Lease is for 20 years, automatically renews 4 times unless Salmon or Gerry says they dont
want to renew
Meinhard finds out about this new agreement and sues
Just coming to the end of the partnership where splitting 50/50, now gone ahead and took this much
larger opportunity for yourself! You shouldve shared this with me!
What duty did Salmon owe Meinhard?
Duty to disclose p. 61
Trouble is that he excluded Meinhard, co-venturer, from any benefit that came to Salmon,
simply because Salmon was the one was working at the desk when baffled Gerry wandered in
Should have told Meinhard so they could compete for the reward
GENT: this is wrong, everyone knows this is wrong, and so do you
No chance that Meinhard and Salmon would agree to a K that would benefit
some 3P (Gerry)
They would have had to bid against each other
These sophisticated biz people would have never agreed to this in
their initial agreement
CARDOZO: (p. 62)
Applied the Tarnowski v. Resop agency principle (jukebox secret
Taking away the secret commission incentive
Sophisticated party would never agree to just benefit a 3P by bidding
against each other
This aint your bros lemonade stand
Meinhard gets to continue the business on the same terms
50/50 split on the new larger project
Salmon gets one extra share to remain the controlling partner, over
the entire 80 years
What factors are important to CARDOZOs decision? (Why are his knickers in a knot?)
Thinks that Salmon got lucky by just standing there in the hotel p. 61; Salmon looked as if he was the
only person in charge, as if the only person running the Hotel Bristol
Gerry came and saw Salmon while he was baffled in his search and made him the keystone
of the project
Punctilio paragraph: p. 61
Joint venturers like copartners owe to one another while the enterprise continues the duty of the finest

Many forms of conduct permissible in a workaday world . . . trustee is held to something stricter than
the morals of the market place
Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior
Punctilio > morals of the marketplace
Notion that you have to tell your partner and then compete silly Cardozo
Joint venture terms?
The never seen
Salmon = winner take all never see this winner take all of who gets opportunity gets to take it
Meinhard = same terms never see this
Court = competition in absence of written agreement, there should be competition never see this
CARDOZO employs this as clearly a penalty
Mr. Salmon actually breached his fiduciary duty
Avoid the penalty by writing your own agreement that makes sense
Wants people to go into business together, make an agreement that makes sense to you
or pay the penalty of competing each other
RIGHT OF FIRST REFUSAL - efficient solution
Cargill - grain elevator (recall!)
Whoever gets the opportunity, negotiates;
offers the opportunity in total to the partner OR
offers to split it
Make note about Andrews - we didnt even talk about it in class


Choice of partnership form - altered liability schemes
Tax benefits
Income statement
No provision for taxes
Partnership doesnt pay any taxes
General Partnership
All partners share in decision-making authority
All partners bear unlimited liability
Limited Partnership
At least one general partner
Limited Partners with
Limited liability
No decision-making authority
You cant find yourself in a limited partnership without expecting ityou have to file documents with the secretary
of state of a particular state
Limited Liability Partnership
General partnership with
Limited liability for partners regarding
Bad acts by other partners (and agents)
Partnership debts (in contract and tort)
In a few states contract and liability is limited to the signor/tortfeasor but this is minority
Every one of the partners is a general partner with respect to her own mistakes
And a limited partner with respect to others mistakes
Limited Liability Company
Member managed or manager managed (unlike limited liability partnership) with
Limited liability for all members
These are principally real estate investment groups

Pappas v. Tzolis; p.6972
2006 investments
Infantopoulous: 25,000
2007 sale to T
P+I sell their shares to T for 1M
Asks to sign certificate saying that they have done their own due diligence and they know what it is worth and
that selling their shares for .5M is the right price and that they have consulted counsel and are not owed any
fiduciary duty by T
T manages to resell the building for 17M
P+I sue saying that T breached fiduciary duty
Can LLC members waive fiduciary duty?
P and I were sophisticated
Represented by counsel
Their own allegations make it clear that at the time of the buyout the relationship between the parties
was not one of trust
Reliance on Ts representations would not have been reasonable
They should have been suspicious when T offered to pay them 20 times the original price
BUT why permit members of an LLC to waive unlike the members of a partnership?
Is the rule efficient
The nature of the rule of loyalty is efficiency
Cardozo is flipping over in his grave
BUT they know when they sign that waiver that there is going to be some funny business and it
is their responsibility to do as much due diligence as they can
If T comes to you and says invest 100,000 in this business and waive your fiduciary duty you will give
less because of the risk associated with waiving it
*If T had lied in obtaining the waiver it wont be any good because of fraud

September 8, 2016
(ASSIGNED: p. 75-82, 82-92, 95-98, 98-101)
(Dunkin Donuts case study)
(Pappas v. Tzolis)
About 18% of business organizations in the US are corporations
About 8189% of business receipts are made by corporations

State incorporations statutes
Used to have to go to a state legislature and ask them to pass a bill allowing you to form a corporation
Most of these were corporations for the public good
Benefit was that the state knows what corporations are in it and has control over actions
By the 20th century we gave up on this and now have general acts of incorporation
You just file with SoS and can conduct business for any lawful purpose
The advantage of using this modern approach is that anyone who wants a corporation can form
The barrier to formation is much lower than in a special act model
Disadvantage is that states no longer have control over what these corporations are doing
Governance terms
Used to have a lot of mandatory terms about
Paying bills
Who was in charge
Who made decisions etc. etc. etc
Now this is all over
Corporation codes are simply enabling statutes
They say that unless it is specifically prohibited it is permitted
The courts have filled in the gaps in these statutes with fiduciary duties
The statutes no longer provide and real control
Headquarter vs. incorporation
California, New York and Texas have most headquarters
Delaware has 50% of incorporations
Choice of state of incorporation
Legal consequences
Doctrine of internal affairs
Anything related to governance of the corporation will be controlled by the statutes of the state of
Practical consequences
You get to pick your law because you get to pick where you incorporate
Once you are incorporated as a corporation you get the power to act as a person
Since corporations are people they pay taxes like people
Also pay franchise taxes ( of DE budget)
Competition among the states
Race to the bottom (Cary)
Managers choose where corporations are incorporated and thus they will choose states with the
least regulation like Delaware because it allows them to take investors money more easily
Race to the top (Winter)
Race to the bottom cant be right because if everyone understands that the law in Delaware is
really good for the managers and really bad for the investors then no one would ever invest in
corporations that are incorporated in Delaware
Race in either direction depending on the topic (Bebchuk)

Which theory is applicable really depends on what you are talking about
Executive compensation is race to the bottom
Shareholder voting is race to the top
Competition between DE and Fed. Gov.
We went for 75 years with no federal regulation
After the depression there were some statutes then none until the 70s and 2000s
Delaware has won but there must be some times when the federal government steps in because the
Delaware law is not working

Close Corporations
Shares are held by relatively few shareholders
Who actively manage the business and
No market for shares exists so shares are sold in private transactions
Controlled corporation
Has a majority owner or a very large minority owner
Or a group acting together
Public corporations
Controlled corporation
Shares are held by the public at large
Who don't manage the business
Shares easily traded
Majority owner very large minority owner
Group acting together

Dunkin Donuts Articles of Incorporation (Dunkin Brands Group, Inc.)

Required Provisions of 102(a)
Name of the corporation 102(a)(1)
Name and address of the registered agent in the state of DE 102(a)(2)
Purpose of the corporation 102(a)(3)
Authorized classes of stock (capitalization) 102(a)(4)
Customized Provisions
Common stockholders
Right to dividends 173
VVoting 212(a)
Preferred Stockholders
Blank check/Preferred stock 151(g)
The preferred stock gets higher dividends and only sometimes votes 161
Board of directors
Number 141(b)
Vacancies 223(a)
Limitation on liability 102(b)(7)
Actual bylaws
Very detailed about every little thing about running the business
Mechanics of stockholder meetings
Who can come
Board meetings
What is decided
Can they be by telephone
How many committees
What the committees do

What are the titles
What are the responsibilities
Administration of stock certificates
What happens if you lose it
What happens if someone steals it
Indemnification of directors and officers
Why have bylaws that are so sophisticated where the certificate of incorporation is so barebones?
If you would like to amend the certificate of incorporation 242(b)
Board of directors has to propose and approve
Shareholders have to approve
Then you have to file the amended thing with the state
In order to amend the bylaws
Can be changed by stockholders OR
By the board of directors
Much easier and more flexible to change than putting it in the certifiate of incorp.

Dispersed ownership by shareholders
Where liabilities are greater than assets - corporation is bankrupt
Cant have negative equity like in a partnership
Benefits of limited liability
Reduction of agency costs
No need to monitor the managers
No need to monitor the other shareholders
Reduction in transactions costs
Shares are fungible
It is easy to buy and sell shares
Reduction in ownership costs
Focuses on profits (efficiency

September 13, 2016

(ASSIGNED: p. 143-52; Random Walk Down WS; Charlestown Boot & Shoe)

Review & Recap

Legal consequences - doctrine of internal affairs
Practical consequences
General enabling statutes (everything not prohibited is permitted)

Race to top
Favor shareholders and so efficiency
Race to bottom
Favor managers, engendering large agency costs

Required (form) provisions
statutory requirements
Customized (bespoke) provisions
Board of directors

Mechanics of meetings for stockholders, board of directors
Titles and responsibilities of officers
Administration of stock certificates

Close corporation
Relatively few shareholders who actively manage the biz
Public corporations
Shares are publicly held traded among investors (on exchanges) without corporations involvement


Reduces agency costs (ease of monitoring managers)
Reduces transaction costs (ease of financing)
Reduces ownership costs (focus on profits)

Reduces in agency costs (ease of replacing managers)
Reduces transaction costs (ease of buying and selling shares)
Reduces ownership costs (ease of diversification)

Charlestown Boot & Shoe Co. v. Dunsmore; H/O

DGCL 141(a): board of directors manages biz and affairs of the corporation
Business is not doing well at all, Osgood appointed to close up affairs
Osgood recommend sell equipment now, rather than waiting
Tried to sell the equipment, noticeably deteriorated, dont get money when they sell
Osgood recommend buying fire insurance for shoes and storefront
Board doesnt buy fire insurance, shoe store then burns to the ground
SHers say omg board you ignored the advice of person you hired/expert
May the directors ignore Osgood advice, an advisor whom they hired?
Who is entitled to manage the biz of the corporation?
Board of directors
The business of every such corporation shall be managed by the directors thereof
Does not compel directors to act with one who is not a director
So, what is Osgoods role?
As if he were never there
Vote choosing Osgood to join a committee; Osgood is not a director of the company so cant act with the
other directors of the company
Is the rule efficient?
Should blame the board of directors for anything that goes poorly in the company
Want liability to lie with board so then theyre forced to take their job seriously

Jennings v. Pittsburgh Mercantile Co.; p. 99-101

DGCL 142(a): every corp shall officers duties .. stated in bylaws or in a resolution of the board of directors
(b): officers shall be chosen by board of directors
Sale and leaseback - leases factory back so it pays regular rental payments over the next few years; refurbishment
Get money to modernize equipment; but then they have money to invest and pay back that loan by
paying rental payments
Egmore = treasurer, finances, board of directors, executive committee
Tells Jennings to go out and find sale-leaseback on roughly X terms

Tells Jennings exec committee would surely go along with these terms that I say
Board of directors normally rubber stamps what exec committee approves
Jennings shouldve been paid a $30,000 commission, wanted to cut him out of the commission; trying to
take advantage of Jennings
Jennings goes to court oh nonono, Egmore had apparent authority!
Recall White and auction of farm case White v. Thomas
Does Egmore have apparent authority to auth Jennings?
Does Egmore have apparent authority to bind the Pittsburgh Mercantile Co. to the K with Jennings?
What is the significance of the nature of the sale and leaseback transaction?
These are quite extraordinary (if just one factory, then just one sale-leaseback every 20-30 years)
p. 100 unusual and unprecedented
Q: Authority to accept some type of extraordinary transaction?
Are the statements Egmore made regarding his role, and the role of the Exec Committee, sufficient?
p. 100: Agent cant by his own words best himself with apparent authority
Are the prior dealings between Egmore and Jennings sufficient?
You shouldve seen this coming and shouldve known Pittsburgh wouldnt want to pay commission
You are experienced real estate agent
(1) similarity + (2) repetitiveness required
Is Egmores position in the corporation sufficient?
VP/comptroller role not enough; need decision from BOARD
Why is the court concerned that recognition of authority would be detrimental to the board?
Want to make sure only board has the authority to manage business and affairs of the company
p. 100 finding Egmore had apparent authority greatly undercut role of board
Would hold board liable for actions of the officers when board hasnt had chance to consider
What could Jennings have done? should have gotten board resolution


Theories of value
Firm foundation
Castles in air
Elements of value
Time value of money
Compensation for risk
Risk aversion and risk measurements
Benefits and limits of diversification
Valuation techniques

Dunkin Brands Group

Assets - liabilities = equity
equity/(shares in mkt) = ~$3.60 (per share)
DNKN ~ $47.90 on NASDAQ;
why is there such a big gap?
Because usage of historical values on balance sheet
Things like real estate have low levels on balance sheet
Dunkin donuts still owns first donut shop in MA from 1955, but not still paying on liabilities from
1955 duh
Still doesnt account for the big gap, so now we turn to Malkiels Random Walk Down Wall Street


Firm foundation theory - Williams / Graham and Dodd (taught Warren Buffett)
Stream of ca$h
Value of any company is just the cash that it produces; value is the company itself and the cash it produces
Buffett method
Look at the stream of payments (cash flows) paid over time (in the future)
Castles in the air theory - Keynes
You select the baby that is the most beautiful
You buy a share of stock in dunkin donuts because you
think someone else is going to pay that much money in
the future
So then you can sell share of stock in the
future based on which some asset in the
company can be sold for in the future
Price at which asset (company)
can be sold (in the future)

H/O Ackman and Dalio, Two Hedge Fund Titans, Size each other
Dalio (Bridgewater) - mad AI - doing better
Ackman (Pershing Square) - qualitative - aint doing as hot as normal


Intuitive notion:
Receive money today
Deposit money in the bank
Earn interest, so have more money next year
Receive money next year
No money to deposit in the bank
Dont earn interest so have less money next year
$100 you get today is worth $100 to you
But if you have to wait a year to get that money, then its worth somewhat less
Agree to make investment (buy stock) only if
The price today (which is a present value)
Is equal to
The (future) cash discounted to present value
First fundamental principle:
$1 today is worth more than $1 tomorrow

PV = (1+r)n
r == P V
did a bunch of exercises using these formulas
FV = PV (1 + r) ^n
FV = a (1 + r) ^n, where a = amount
PV = FV / (1 + r) ^n
PV = a / (1 + r) ^n, where a = amount


Downside losses weighted much heavier than upside gains = risk aversion
Declining marginal utility of wealth

Consequences of risk
Risk imposes costs on individuals, due to risk aversion
Individuals dealing with declining marginal utility of wealth
Downside losses weighed more than upside gaines
Investors must be compensated to bear the risk (risk premiums)
Second fundamental principle:
$1 for sure is worth more than $1 with risk

(Risky) Investments
Looking at bonds issued by the US govt w/ maturity of one year or less (avoiding the inflation problem) -- 1%
Essentially risk-less
Big companies -- 9%
VC companies -- 12%
Expected value (used that DD coin flip example)

September 15, 2016

(ASSIGNED: Ross, Jackson H/O;
AK 152-54, 671-74)

Review & Recap

Firm foundation theory
Corp is basically stream of payments (cash flow) paid over time
Castles in the air theory
Price at which asset can be sold

First principle: $1 today is worth more than $1 tomorrow
Due to opportunity cost

FV = a (1 + r) ^n
PV = a / (1 + r) ^n
Second principle: $1 for sure is worth more than $1 with risk
Due to risk aversion (declining marginal utility of wealth)



(refer to your yellow sheet for Class 7 Meeting)

Q: What is the expected value of the loan if the bank believes it has a 95% chance of being repaid in full and a 5% chance of
receiving $0?

= (0.95)($11.3M) + (0.05)(0) = $10.735M

Q: what is the present value of the (expected value of the) loan if the discount rate is 8.5%?
P V = a (1 + r)n= 10.735M / (1+0.085)^1 = $9.894M
Q: should the bank make the loan to the hotel?
-$10M + $9.894M = -$105,991 NOPE
Q: Dunkin brands question $47.50 E(FV) discounted to PV = $44.81

Intuitive notion
Pay price today; no need to discount because paying today
Receive cash in the future; futur case must be estimated/projected by determining its expected value
Agree to make investment (buy stock) only if the price today (PV) is equal to expected value (E) of the future cash
(FV) discounted to PV


Theories of value
Firm foundation
Castles in air
Elements of value
Time value of money
Compensation for risk
Risk aversion and risk measurements
Benefits and limits of diversification
Valuation techniques
Discounted cash flows / comparable companies
Market prices (efficient capital markets hypothesis)


Dont put your eggs in one basket - Grandma
Diversifiable (unsystematic) risk
Risks related to an individual company
Charlestown Boot & Shoe - shoe stores burns to ground, really bad for Charlestown Boot, but great for
their competitors
Losses for one company may result in gains to other companies (notably competitors)

Investors receive no comp for bearing diversifiable risk
Undiversifiable (systematic) (market) risk
Risks related to the entire economy
Investors are only compd for bearing undiversifiable risk
Because they cannot escape it


(refer to blue sheet labeled Class 8)

Firm Foundation Theory: value of any company is just the value of the stream of cash you receive in the future
PV = (1+r)n
Discount rate (r) time value of money + systematic risk
GENT: take corporate finance!


Share price = (metric of value)(factor)
(metric of value)
from a balance sheet (fair value of equity)
from income statement (net income)
from similar companies
Price to earnings/income ratio for comparable companies
DD stock price = (earnings for DD)(Average price / earnings ratio for comparable companies) = $51.50


Efficiency of a market
Information and profits
For a given set of info
Profits from trading on that info are, on average, zero
Information and prices
Prices immediately (and correctly) reflect all info in the set
Profits from trading on that information are, on average, zero

Semi-strong form - public information - most prevalent

Basic Inc. v. Levinson; p. 671-74

Sept. 1976
begin merger discussions with Combustion Engring
Oct. 21 + 2 more occasions:
Unaware of any development that would result in abnormal trading activity
Lying because theyre in discussions with Combustion Engr
Dec. 18
Suspend trading
Approached by another company
Dec. 20
Announce merger
Not okay, prices stabilized at low level and then announced a sale a year later!

What is the fraud-on-the-market theory?
What is material breach/reliance damages? (refresher) Statement wrong, material, relied on
false material statement; because of reliance, caused an injury
p. 672 open and developed securities market . . . price of co stock is determined by the available
material information regarding the company and its business
FOM theory creates presumption of reliance
Dont have to show reliance all you have to do is to show that the statements were reflected
in the stock price
FOM says available information is immediately and correctly incorporated in stock p
What does it mean to have a presumption?
Makes the burden of proof much easier
Stock price reflected that statement, making that demonstration is quite easy
SCOTUS has accepted semi strong ECMH - just have to show it on NASDAQ

September 20, 2016

(ASSIGNED: 143-147, 103-122)

Mechanisms for protections of creditors
1) Capital Structure
a) Assets (current and fixed), liabilities (bank loans, bonds, and A/P), and equity (preferred then common stock).
i) Contract, interest, and principal. Secured v. unsecured debt- determined by k.
ii) Secured debt is debt with a form of collateral to where creditors can get something if you are unable to
meet your debt obligations.
iii) Equity: Preferred stock with liquidation amount and dividends before common stockholders get dividends
(in event of bankruptcy or issuance of dividends). This is why common stockholders have right to vote,
everyone knows they get paid less so to be Kaldor-Hicks efficient they get voting rights. In the event of
bankruptcy they get nothing so incentive to avoid it by electing competent board!!!
b) Why do we protect creditors outside of contract?
i) To prevent debtor misbehavior
(1) Donuts are boring so Ill just invest in biotech, take money back whenever (sorry not sorry),
debtor could also just keep lending money and dilute claims.
ii) Protection of other stakeholders (not shareholders)-- employees, suppliers and customers all just want to
keep doing what theyre doing and making $. Members of the community benefit too via property taxes,
lets protect everyone by siding with the creditors so that we can keep it going.
2) Mandatory disclosure- Dont do much; unlikely to come in time to do anything. WORTHLESS
a) Statutory requirements- federal and state law.
b) Speciality service providers (think FICO) or credit rating agencies to rate how likely company is to pay debts.
3) Capital regulation: How much in dividends can be paid?
a) DGCL 170 (a): (nimble dividend test): may pay dividends out of capital surplus + retained earnings, or net profits
in current or preceding fiscal year (whichever is greater).
i) We can pay out surplus and nothing else. Surplus= equity- stated capital or in other words surplus= capital
surplus +retained earnings. Surplus can be negative brah. [Eva Q: I thought net income can be neg, not
surplus???? HALP]
ii) Stated capital makes sure assets remain in corporation to satisfy creditors-- surplus by using that lower par
value can make it hard for creditors to have access to anything, corporation can just pay everything out in
iii) No surplus?-- pay the net profit in dividends for this year or last year brooo. Delaware knows what youre
thinking. Reward those groupie shareholders, stand by yo man,
iv) See pg 110 for Alpha-- dividends can be paid as surplus = capital surplus + retained earnings.
300+500=800. Had surplus been 0 Alpha couldve paid out net profits from last yr ($400) or this yr ($120).
b) DGCL 154: stated capital is aggregated par value per share (stated capital= par value * # of shares). Capital
surplus= (price-par value) * # of shares. PAR VALUE is typically trivial, the rest appears in capital surplus and uses
the price based on firm foundation theories or comparable companies,
c) DGCL 173: dividends can be anything (cash, property, shares in corporations capital stock).
d) DGCL 174: Wilful/negligent in calculation then partners are personally jointly and severly liable.
e) RMBCA 6.40: fair market value test- may base dividends based on financial statements or on a fair valuation or
other method reasonable under the circumstances (so long as you can pay debts as they come due in regular course
of business or what is owed to creditors and preferred shareholders).
i) In ALPHA example would be significantly more-- DCF analysis values at 30k. OVER TIME: PAR
4) Duties Owed to Creditors
a) By directors- may owe obligation to creditors not to render firm unable to meet credit obligations by making
distributions to shareholders or others w/out receiving fair mkt value in return.

i) See Credit Lyonnais Bank: (pg 113) judgment for $51 million subject to appeal. Expected value
computation of judgment given %s of affirm, modified, reversed is $15.55 million. Company only has one
liability of $12m in bonds. Outstanding offers to settle for $12.5m and $17.5 but the shareholders probably
dont care about the expected value and want to go for it all ($51m).
(1) BLACK LETTER LAW: Board of Directors should accept settlement offers that are above the
expected value and reject those below it.
(2) Ensure adherence by conceiving corporation as shifting fiduciary duties of the directors to the
entire corporation when in the vicinity of insolvency.
(3) Highly scrutinized opinion: when are we in the vicinity of insolvency and what should the
directors actually do when they are in it?
b) By creditors to other creditors (fraudulent transfers).
i) UFTA (1984), Section 4: transfer is fraudulent when debtor 1) acts with actual intent to hinder, delay, or
defraud any creditor 2) without receiving reasonably equivalent value and the debtor i) FIX.
(1) Actual (1) or constructive fraud (undercapitalization or intent or belief that would incur debts
beyond ability to pay when due)
(2) Problem with severance and retention payments and trying to incentivize board not to leave.

September 22, 2016

(ASSIGNED: 122-138, 163-181, 188-201;
201-224 + Dunkin Donuts h/o)

Review & Recap

Current assets and fixed assets
Trade creditors
Bank loans (on creditor) and bonds (traded)
Preferred stock paid ahead of the common stock
Common stock paid absolutely last, incentives different from everyone else
Residual claimants


Protection of lending markets
(predictable) debtor misbehavior

Protection of other stakeholders
Employees, suppliers, customers, community

Statutory requirements company can go bankrupt in a matter of days
Specialty service providers paid by corporations themselves, little incentive to provide negative reviews
Contractual provisions provisions providing for disclosure, at best 30d disclosure period

Point is to keep some money/capital in the company so always going to have that there
Problem is that fixed amount wont always be there
Distribution constraints
Nimble dividends test allows the company to pay out profits from last year
Net income; surplus, retained earnings (income retained and reinvested in the

Fair market value test rely on IBers to value the firm

Then that money (???) is paid out as dividends

Duties of directors to creditors Credit Lyonnais Bank
Company in the vicinity of insolvency (this zone)
directors owe fiduciary duties to the corporation, not to any one constituency (notably not the shareholders)
Directors should (always) accept (settlement) offers with values > expected value
Duties of creditors
Creditors owe duties to one another?
Fraudulent conveyance reaches out to the creditors and unwinds the transactions to give back to creditors
Types of fraudulent transfers?
Actual fraud typically hard to find
Constructive fraud debtor transfers its assets for less than fair market value
(1) Less than reasonably equivalent value
(2) Unable to pay debts as they become due, or unreasonably small capital to operate
its business
Modern uses
retention/severance agreements


Equitable subordination
Assets takes assets and sell them
Current, fixed assets
Accounts payable, bank loans, bonds
Common stock sell bonds

Costello v. Fazio; p. 116-121 (equitable subordination)

Co. has less than $70 in cash
$160,791.87 in short term assets (less than a year) assets
Income statement
Net sales Net income
1951: 665,747.55 1951: 40,935.12
192: 389,543 1952: -$22,521.34

Accounts of Leonard Plumbing and Heating Supply Co. POST-CONVERSION?

CONVERSION TO CORPORATION American Trust Co. all remain the same
American Trust Co. Unsecured debt remain the same
Unsecured debt - trade creditors expecting to Fazio, Ambrose conversion to debt
be paid in 30/60/90 days COURT WANTS TO SHOVE THIS
Ambrose: $6,500 LAYER
Leonard: $2k Fazio, Ambrose, Leonard have ~$2,000 cap/ea in
Unsecured now shares the debt with
Fazio, Ambrose

Must the loans from the shareholders be subordinated to the loans of Fazio, Ambrose?
Court looks at the capital (amount of money) left in the corporation
p. 119 - elected to take all the money out of the company and convert it into debt; focus on
capitalization and taking all equity out of the company except $2000 to match Leonards position
$6000 left in the corp is 1/65th of the annual net revenue of last year
The more debt, the lower the net income
Converting equity to debt to avoid tax liability
acted to detriment of the corporation and its creditors (p. 120); remedy is to subordinate that debt and shove
it back down into the equity layer
When the claim is found to be inequitable, it can be subordinated to the claims of the other creditors


Disregard of the corporate form (by shareholders)
Ignore corporate formalities
Use the corporations money for personal expenses
Disregard of the corporate form (by courts) well ignore the corporation now that its bad for you, cant hide behind shield
Equitable tests
Absence of good books and records
Taking some funds to pay personal bills?
Good companies will have all the shareholder meetings, run elections, will make sure all the
subsidiaries are following all of the rules
if you have good books and records, then theres no veil piercing
Presence of misconduct (Q: what type of misconduct is enough?)
Limited liability makes it easy for the company to raise money
Equitable remedy
Hold shareholders personally liable for corporations debts
EX: Martha Stewart has admitted to her corporation that she essentially controls a bill for getting her hair done as a business
expense because shes out in public and needs to look fab; her GC rejected because understood good books and records to
ensure that there is no veil piercing claim
Otherwise Marthas private assets would be completely exposed

Sea-Land Services v. Pepper Source; p. 123-127 (piercing the veil)

$90,000 in peppers are shipped; Pepper Source does
not pay SeaLand
SeaLand sues and finds out that the company has
been dissolved because it has failed to pay its
franchise taxes
Sues Mr. Marchese; 100% owner of each
of the companies, moves funds between the
corporations and also pays himself through
Caribe crown, jamar corp,
salecaster distro, marchese fegan
associates, pepper source
Vet bills, tuition, child
support, etc.
Tie-Net Intl 50% owner
Reverse veil piercing - if we pierce the veil of pepper source, would only find Marcheses empty pockets
Up through the pepper source and then back down from Marchese to his companies
What assets are available to satisfy the debt owed by Marcheses corp (pepper source) to pay sealand debt?
Court says: Going to reverse pierce!

Pierce into Marchese through pepper source, and then back down to those other corps and check em out
p. 124 - Van Dorn test
(1) unity of interest and ownership that the separate personalities of the corpoation and the individual (or
other corporation) no longer exist
+ 4 factors:
Absence of good books, records
Commingling of funds/assets
Under-capitalization lack of money to operate the business (goes to first prong)
One corporation treating assets of another as its own
p. 125 - there can be no doubt that the shared control / unity of interest is met
(2) circumstances must be such that adherence to the fiction of separate corporate existence would
sanction a fraud or promote injustice
Intentional wrongdoing
p. 126 - sealand services hasnt alleged any particular wrongdoing on Marcheses part, all it
relied it upon is payment of its outstanding debt; court then references all of this stuff but says
claimant didnt claim an injustice
Appellate court says that this isnt enough; Marchese sucks but nothing suggesting
anything has happened other than that money hasnt been paid
p. 126 - need to show corporate fraud was used to avoid responsibilities OR one of the other
corporations will be unjustly enriched unless liability is shared by all
ON REMAND goes back to the trial court
Did the trial court rely on any of the examples in finding that the second Van Dorn prong has been satisfied?
They found tax fraud!

Kinney Shoe v. Polan; p. 127

Cabell County Commission - issues bonds to pay
Kinney shoe a factory
Kinney Shoe Corp - failed at being shoe
company so leased to Polan
Polan - only made the first payment
Leases Industrial Realty
Leases to Polan
What assets are available to satisfy the debt owed by
Polan to Kinney?
Laya test (West Virgina)
(1) unity of interest
Same factors as Sea-Land
(2) would an inequitable result occur?
(3) particular type of party . . . charged with the knowledge that a reasonable credit investigation would
disclose (p. 129) [PERMISSIVE THIRD PRONG]
What is the role of (insufficient) capitalization?
Simply not having enough money here in West Virginia is sufficient to pierce the corporate veil
(satisfies the second prong of Laya)
Test is much weaker!
What would have happened if Van Dorn test was applied here?
Court would have never pierced the corporate the veil then!
Why allow Kinney Shoe to pierce then? Subletting to Polan; would have easily seen that Polans companies
didnt have any money at all, didnt put any money into those companies because didnt have the money
Court declines to apply the permissive third prong
Failure to keep good books/records, undercapd

Walkovszky v. Carlton; p. 132-136
Seon Cab Corporation - has ten cab companies
On each of the companies, has minimum
required insurance ($10,000)
Not enough to pay Walkovszky
Wants to pierce and bring together the
assets from all ten companies, the 20
cabs and the $200,000 worth of
Cant get up to Carlton; all have good
What assets are available to Walkovszky outside of
what is available in Seon Cab Corporation (and reaching other 9 companies)?
p. 132 - New York test (more like Van Dorn)
(1) unity of interest
Same factors as Sea-Land
(2) prevent fraud or achieve equity
Putting those asset across those ten corps = fraud? Not enough to pierce the corporate veil; not
illegal to create lots of individual companies
Need some fraud among those companies, e.g. company needs to be a dummy
Seon cab corp is all paid by same accounts, same drivers; treating these companies as if operating as only one
Court allows Walkovszky to replead
So what role does inadequate cap play here?
p. 134 - it is not fraudulent for the owner-operator of a single cab corp to take out only the
minimum required liability insurance . . .enterprise does not become illicit/fraudulent merely
because of this
How does the Court of Appeals in NY fix this?
The problem isnt with the legal test, its with the insurance minimums
NY Court says: You need to take this up with the Legislature!


Company like Dunkin Donuts?
Shareholders electing the DD Board of Directors (staggered board)
Dunkin proxy card?
Shareholder voting very important yes to what board recommends, no to what board recommends, or
you abstain; there is no write-in for elections
DGCL 212(a) every statute works just like this
Unless otherwise provided in cert of incorporation every shareholder gets one vote per share
Any corporation in cert of incorporation can confer/grant . . power to vote . . . and also any other rights which
stockholder has . . .
DGCL 216(2)
Vote by affirmative vote . . of the majority of the shares present in person
DGCL 216(3)
Directors shall be elected by plurality of votes
Shareholder voting? 3 things
[ONE] DGCL 211(b) - election of directors
[TWO] Fundamental changes
DGCL 271 - sale of property and assets
DGCL 251 - merger with another corporation
[THREE] DGCL 242(b) - Amendment to cert of incorporation
Certificate of incorporation
Protection from takeovers v. vulnerable to takeovers
Q: How easy is it for someone to takeover a corporation? Getting the shers to agree with takeover?
DGCL 141(d) - staggered board of directors
Annual election of directors, but no need all directors
Directors can be divided into three classes
Takes two years to elect a majority of the board of directors
DGCL 211(d) - no shareholder ability to call special meeting
If cert of incorp specifies that shers cant call special meetings; then meetings are annual and
whenever directors call meetings
DGCL 228(a) - no shareholder action by written consent
If cert of incorp specifies no sher action by written consent
Initial directors on the board write the certificate of incorporation thus pretty much every cert precludes written
consent and the special meeting
Q: why would shareholders accept this type of shit?
Shareholders (and stakeholders) are willing to bear higher agency costs (makes board very hard to
be fired) to achieve lower transaction costs and lower ownership costs (if doing poorly, can just
sell shares)
DGCL 212(b)
Any stockholder entitled to vote at meeting . . . may authorize another person or persons to act for such stockholder
by proxy . . .
Ex: if board member brings in majority by proxy, board solicits the proxies
Insurgent shareholder can also solicit proxies but must prepare a proxy statement

Rosenfeld v. Fairchild; p. 175-177

Send us the proxy card as incumbent directors
But there is a group of insurgents that prepared proxy materials, including proxy card
Tells shers to send in proxy card you got from us and we will elect us as insurgents onto board
Proxy solicitation expenses
Incumbents reimburse themselves out of the corporate treasury ($106k)
Insurgents defeat them, reimburse themselves out of corporate treasury ($127k)
+$28k reimburse to incumbents out of goodness of their proxy hearts

Shers indignant that they are reimbursing themselves for their own proxy contest
Who gets reimbursed for costs of proxy solicitation?
When can corporate funds be used by board of directors to protect their position as board?
p. 176 - as long as contest of policy and not . . . purely personal power contest
Incumbents are reimbursed as long as the argument is about policy
Directors have to believe that it is in the best interest of the corporation
For the purpose of persuading the shers of the correctness of their position and soliciting their
What about the insurgents?
p. 176 - practical matter, reimbursed when they win
Stockholders . . . successful contestants . . . for expenses incurred by them in any such policy
contest (if the shers elect you, they must prefer you)
Why not prohibit the reimbursement of all proxy solicitation expenses incurred by the incumbents and the
Want to protect incumbents from any hostile takeovers if they dont have the cash money
Why not reimburse all proxy solicitations?
Want to discourage stupid proxy contests, limits insurgents unless they have a good ass idea

DGCL 220(b) - sher can inspect ledger, books/records (companys financial statements), sher lists for proper purpose
Proper purse shall mean a purpose reasonably related to such persons interests as a sher
Stock list
Corporation bears burden of showing improper purpose
(Almost nothing is improper)
Books and records
Shareholder bears burden of showing proper purpose
(almost nothing is proper)
Board of directors manages the biz and affairs of the corporation (DGCL 141(a))
Competitor is more likely to want to see the books and records

Schreiber v. Carney; p. 189-197 (vote buying, Lorenzo is a hottie)

TX Intl Airlines operating in TX
65% of the outstanding shares by shers
35% Jet Capital
Wants to merge itself into Texas Air Corporation
(another company that they formed); would be able
to purchase landing rights etc. (no restrictions)
Problem is that Jet Capital has the right to buy
additional shares (warrants) in TX Intl Airlines at a
fixed price
That price is lower than what would be
proposed in the proposed merger
Jet Capital would want to purchase more shares prior to the merger, but not doing well so
doesnt have the money to pay the price to exercise the warrants and buy more shares
TX Intl will loan Jet Cap $3.335M so that it an exercise those warrants to buy those shares, interest rate at 5%
(so that Jet Cap doesnt vote against the merger)
This is a BRIBE; get the loan, vote for the merger
Everyone agrees that this is a great idea, board thinks this is a good idea
Board mailed to the shers in a proxy statement
Is this vote buying? / Is buying corporate votes permissible?
Existing law was that vote buying is per se illegal

What is vote-buying? Does this loan to Jet Cap count as vote buying?
Court says: Yes. p. 191, just a voting agreement supported by consideration Jet Cap being bought out
vote-buying , despite its negative connotation, is simply a voting agreement supported by
consideration personal to the stockholder, whereby the stockholder divorces his discretionary
voting power and votes as directed by the offeror
This is a true agreement to vote one way b/c of exchange of consideration
What is the new standard for evaluating claims of vote-buying?
p. 193 - going to evaluate it on a case-by-case basis for its object or purpose
What types of arrangements (vote buying) will we prohibit?
Will prohibit those that are fraudulent (p. 193)
Rationale is that if shers are all voting yes based on a misstatement/fraud, they are
meaningless yes votes
What is the standard for assessing fraud/disenfranchising shareholders?
Intrinsic fairness -- vote-buying is so easily susceptible of abuse, it must be viewed as a voidable
Courts will determine intrinsic fairness based on the votes of the shers
Shers had all the information that they needed, and they still voted for it (in favor of
the transaction)
No reason for the court to set it aside
p. 194 - going to look at whether or not furthering the interest of all Texas Intl shers
Interest of all shers, not just Jet Cap
NEW MODERN RULE - vote-buying is not per se illegal, but voting agreements are fine as long as they are
intrinsically fair
Is this new rule efficient? Seems so, but also odd because if 65% of the shers voted for then why bother trying
to get Jet Cap in the beginning? Call their bluff
Gregs procedural question: If you wanted to sue w/ full disclosures, then you had to sue right after you
got all the proxy materials but before the vote


Mechanisms for control
Dual class equity structures
Two classes of common shares: one class with many cotes, one class with few votes
Class B held by entrepreneurs (insiders) with 10 votes per share
Ex: Zuckerberg
54% of the voting power
10% of the cash flows
Ex: Ford
40% voting power
5% of the cash flows
Class A shares held by public shareholders (outsiders) with 1 vote per share
If ECMH (efficient capital markets hypothesis) holds, then market should accurately
reflect value of share


Federal Securities Laws: regulate the market and the interactions between investors
Securities Act of 1933
Initial public offerings
Regulates the offering of new securities to the public
Securities Exchange Act of 1934
Secondary market
Regulates the sales of securities among investors
Creates the SEC
regulates actions in the market and also disclosure (SEC filings)
The Commission (SEC)
Independent agency

Enforces the securities laws
Promulgates rules and regulations to implement those laws more effectively
Costs of voting
All investors hold diversified portfolios
Each investor bears all the costs of becoming informed
Mandated disclosures required by the 1934 Act and rules promulgated by the Commission reduce the costs of
becoming informed (and improve efficiency of the stock market)
Individual investors remain apathetic and sell their shares when they become disappointed and so they remain
passive investors (passive apathetic investors)
Recall that shers are residual claimants; so they have incentive to vote for directors that are most efficient
But also shers have a reason not to want to be invested at all
Institutional investors hold portfolios that are too large to allow sales of shares will maintaining diversified
portfolios and so they become active investors
Activist hedge funds seek to profit by purchasing shares in disappointing companies and then seeking to reduce the
(extreme) agency costs
Hedge fund managers get about 20% of the profit; incentive structure to make profits, very active


Shareholder (addl) rights
Voting rights
Information rights
Separating (cash flow and voting) rights
Vote buying
= (essentially) bribes
Controlling minority structures
Exercising voting rights
Federal proxy rules
Comms with shers
Sher proposals
Antifraud rule
(state court) judicial oversight

Reg 14A (R 14a-1 to R 14a-7)
Substantive regulation of
The process of soliciting proxies
Comms among shers
Schedule 14A
Specification of the information
To be disclosed in a proxy statement
Distributed by the corporation (incumbents) or any shareholder (insurgents)
Lengthy document; 120 pages or whatever
Rule 14a-1
Solicitation = any communication reasonably calculated to result in procurement of a proxy
Rule 14a-3
Prohibits soliciting proxies unless a proxy statement containing the info specified in Schedule 14A is, or has been,
furnished to the shers
1992 exemptions dont have to prepare the proxy statements; exempted from talking to shers
Rule 14a-2(b)(1)
By shareholders who do not intend to seek proxies
Rule 14a-2(b)(2)

Solicitations to fewer than ten shers
Rule 14a-1(I)(2)(iv)
Announcements of intentions regarding vote (and reasoning)
Ex: p. 4 of DDs proxy statement listing everything that needs to be disclosed, need to talk all about the way the
company is governed, any transactions related to persons, disclosures re: executive compensation, all the proposals
Runs for about 100 pages and the type is pretty small
Rule 14a-4(d)(4) Short Slate Rule
All you have to do is identify who else you would keep on the board, cant force them to stay on the Board; just
running for 3 or 4 (asking for agreement)

Rule 14a-8(a)
You can simply ask the board of directors to do something
Recommendation or requirement that the company and/or its board of directors take an action at sher mtg
All you have to do is send it to the board, and the board will put it in the proxy statement
Rule 14a-8(d)
The proposal, including any accompanying or supporting statement, may not exceed 500 words
Rule 14a-8(i)
Company may exclude the proposal from proxy statement if [13 statements]
(1) it is improper under state law
Ex: dictating where the company is going to (proposing what the company is going to do) is not
allowed under DGCL 141 (board runs the company rule)
(5) Relates to less than 5% of the operations
If the proposal relates to operations which account for less than 5 percent of the company's total
assets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and
gross sales for its most recent fiscal year, and is not otherwise significantly related to the
company's business
(7) ordinary business operations
Salaries, loans, properly in purview of directors
Rule 14a-8(j)
Company must file its reasons with the Commission
Rule 14a-8(g)
The burden is on the company to demonstrate that it is entitled to exclude a proposal
Ex: If you exclude this proposal because its improper under state law, then no action will be taken (no
action letter)

Corporate governance proposals
Majority election of directors

September 27, 2016
(ASSIGNED: AK 214-232,
239-244, 248-255)

Review & Recap

Costs of voting
Transxn costs + role of diversification
Individual shareholders remain passive investors
Sell shares + buy shares in other companies (diversified)
Even though the theory is only shareholders cote, practical result is that no one reads it
Transaction costs are focused on hedge fund managers

Cost of becoming informed on vote

SEC laws
Disclosure: if we force companies to disclose, shareholders (institutional investors) can vote on informed basis
based on materials company makes
Efficient capital market hypothesis theory (ECMH)
Proxy rules
Statement with specified information
Solicitation = broad definition
Difficult for institutional investors to act because if they are found to solicit, they will be in
breach, so AMENDING allows institutional investors to comment if <10 shareholders, not
seeking proxy but announcing vote
We also allow short slate: 9 people running and institutional investors want to
nominate 4, you can choose 5 from the existing people (so can run people without
having to find all new 9 for board, when likely they will be defeated)
Incumbents can use corp treasury and will be reimbursed for policy reasons
Shareholder can add small item to meeting
Ex. majority election of directors, CSR proposals (environmental, benefits)
Low cost because submission of proposal + 500 word statement and it must
be included in proxy statement unless directors can state a reason
Rule 14a-8 (submission requirements, grounds/procedure)

Strong prohibitions because the entire system is disclosure-based
Rule 14a-9
Remember almost anything is solicitation (you getting proxy) and cant misstate material fact or omit material fact
Corrective disclosure >>>>>>>>>>> redo shareholder vote

Claim of fraud
materiality standard and what it means
(1) misstatement or omission
(2) of a material fact
(3) you need to be responsible, culpability
Majority: negligence
3d Cir: scienter
(5) reliance on statement, causation
Can be shown in ways like demonstrating the market price incorporates all info (fraud on market theory)
(6) harm

VBI v. Sandberg; p. 216-222

Bank wants to get rid of shareholders so combine banks so we have larger VA bank
Shareholders get $42/share
VA bank will still need annual, but now First Am owns 100% of the shares
Only 15% shares in market of First Am. Bank of VA; 85% owed by other company
First American Bank merged with VA bankshares
Shareholders given $42/share and First Am. Bankshares has 100% stake in VA bankshares
Directors said $42 high price + fair value
says Rule 14a-9 (misstatement of material fact)
board says nah, just our OPINION, which isnt actionable, shareholder should have figured it isnt
fair price and figure out our own opinion
We cant have endless litigation about whether directors have basis or dont
Does it matter if it is opinion?
TSC industries = federal standard
It is material if reasonable shareholder would reasonably consider it when deciding to vote
HOLD that statement is material
Court says must mislead on underlying facts
Must have evidence that directors thought it wasnt fair
Standard: they did not in fact believe the statement
Real estate equity is much higher, more like $60/share because market rate of real estate is much higher
Court knows for sure that directors did NOT believe $42/share was fair or high because they saw it as a
$60 value

Q: how do you figure out the value of a company?

A: add up the expected amounts
2018+2019+2020 expectations = X,
discount X to PV
Time value of money + systematic risk

Omnicare v. Laborers District Council Construction Industry; p. 222-224

Goes even further to say that statements of opinion lead shers to believe certain underlying facts are true when they are
not then this can be a misleading statement (e.g. we believe our conduct is lawful but havent consulted lawyer)
But could not prove reliance because would have to show that she read and voted yes because of statements
Also her vote did not matter because the parent company had 85% and therefore had the power to decide the vote
Q: can it just be pure statement of disbelief? (pure statement of opinion basis for fraud claim)
A: your opinion is enough if a reasonable investor could infer that the opinion is based on facts that dont exist
Ex. we believe that our conduct is lawful
Implies that board has hired lawyers and was told that

would have to find written opinion (under bank shares) that they didnt believe what they said
was true
Here, Kagan says that the implication that you hired lawyers is enough for a fraud
in VA could not have shown she relied on proxy statement -- dont rely on subjective state of mind of for notion of
causation of causation standard is Mills:
Vote has to be sufficient to matter to outcome
In this case, shareholder vote just formality (necessary not sufficient) because only 15% of the stock
Essential link = has to be necessary to the outcome
here cannot demonstrate the essential link (why she lost); she said that bank would have been
unwilling to proceed with merger if 15% voted; even though could have, reverse for publicity reasons
SCOTUS SAYS you dont know, we dont want to spend our time on endless litigation
Underlying facts of case . . . CLEAR evidence of fraud
Same is true for essential links; we want to know these matter instead of being driven by something else


Schnell v. Chris-Craft; p. 22526

Some of institutional investors arent happy with direction
Want three new people nominated for board without having to mount insurgent campaign
Board announces that it is moving meeting up one month to before the holidays (they claim for convenience)
Real reason is to quash the insurgents
May the board change the date of the meeting where the change is permissible under state law?
Management wants to catch dissidents off guard and keep their positions
Permissible under state law and company bylaws
But there are inequitable purposes
Inequitable action does not become permissible simply because it is legally possible
This only applies to shareholder voting because the entire code is based on the shareholders voting for
the directors


Controlling shers (Vickers)
Directors (Anderson Clayton)
Conflict with federal laws
Similar requirements
Invigoration of state law duty
Whenever directors
communicate w/ shers
Claim available to shers
But damages are bigger under
federal securities law so these
types of claims usually disfavored

Duty of care
ALI 4.01(a)

Good faith,
Best interest of corporation (reasonable belief)
Reasonably prudent person

------ (accountability) ---------------------------------------------------------------(ordinary negligence)----------------------(authority)-----

Gagliardi v. Trifoods Intl; p. 23132

What must shareholder plead?
Ordinary negligence or something greater?
Shers have diversified portfolios
When the company does well, the board of directors gains little but when it does badly they lose
A director will always play the 8-12 never 0-2
How do we make directors act like shareholders?
Business Judgment Rule

Business Judgment Rule

Where a director is independent and disinterested there can be no liability where good faith duty of care exists
401(c): Not interested, informed, reasonable belief in best interest of corporation
Now with this rule standard is gross negligence and far below ordinary negligence
We switch because imposing liability for ordinary liability ever time there is a bad decision, this convinces
them to take risky investments that the shareholders want
Also more procedurally efficient because very easy to dismiss claims and decided much earlier in litigation

Kamin v. AmEx; p. 24042

Want to distribute shares of DLJs failing stock
Since they are going down in value they lost 26M but can hide it by using to pay dividends because in surplus
Kaim says selling @ capital loss will reduce tax burden by 8M and would end up with 18M loss instead of 26M
Was this valid exercise of business judgment?
They considered both options
Entitled to exercise business judgment
Board has rejected efficient capital markets hypothesis
Is this efficient?
Encourages board to take risks
Most courts argue that this business judgment rule is efficient even for plainly stupid decisions
All they have to do is be informed (hire experts) and then can make as stupid a decision as they
want negligence claims are very very rare
Follow up Q:
What happens when the board of directors did not make a decision? It did nothing when it should have?

Francis v. United Jersey Bank; p. ???

Reinsurance company
Board did not keep separate accounts
Corporate profits
Loans to shareholders

When Pritchard dies, sons take more and more money until company goes bankrupt
Did Pritchard breach duty of care by failing to monitor?
Has to be proximate cause and here it is
Does not get the benefit of the business judgment rule
The court wants her to object and if they fail to correct their conduct then she should resign
The court expects her to make sure this bad conduct stops
E.g. reporting to insurance authorities
But whether other directors have further duties than to protest and resign is left to ad hoc basis


Chris-Craft (DE) inequitable action not permissible just because possible- move meeting VOTING IS SPECIAL

A. D
irectors and Officers (WTF on this section?)
Duty of Obedience Officers and Directors must comply with the charter and bylaws
o this is never litigated because this is black and white if its in the bylaws (you settle right away)
Duty of Candor honesty is required wherever directors communicate with shareholders
o usually litigated under federal securities anti-fraud law
o Exists but not terribly important b/c unlikely to result in any damages at all

1. D uty of Care
a. Requirements of the Duty (pg. 217-20)
Three requirements: The Director must act:
1) in good faith;
2) in a way she reasonably believes to be in the best interest of the corporation; and
3) the way a prudent person would act under the circumstances
(not evaluated based on expertise as in agency law) (i.e. lawyers held to skill of lawyer)
Articulated standard is ordinary negligence,
Liability is imposed only for gross negligence (if no reasonable person under the circumstance would have done this)
o Rationale we dont want directors to be more risk averse than they already are
o If they make a decision that makes sense at the time, and later turns out to lose money they shouldnt be liable
o Otherwise, if the transaction is good they get pro rata benefit, but if they lose they bare all the costs
o Otherwise, the shareholders would want the riskiest investments because if it wins the shareholders win big, but if it loses
the directors have to assume the loss in the form of a damages award for breach of duty of care

b. Protection of the Business Judgement Rule (pg. 227-32)

Directors and/or Officers will get protection of the business judgment rule if:
1) they are financially disinterested in the transaction (otherwise we cannot trust their good faith judgment);
2) they are fully informed before exercising judgment (have considered all the options); and
3) they have exercised their judgment in good faith effort to advance the interests of the corporation
Effect of BJR: increased authority and decreased accountability
American Express: Stupid decisions are protected so long as the directors considered all the options
o If you dont consider an obvious option this is bad judgment, but if you considered it you will get protection
o Pay out useless stock in marketable securities as dividend to the shareholders reduces assets
o They should have sold on the market and reduced net income reduce tax liability
o DE courts suspicious of ECMH: everyone can see that AmEx owned this bad stock, so should be priced in
o Market Efficiency: market knew AmEx lost $26M on the stock
o Kaldor-Hicks Efficiency: maximizes wealth and minimizes waste to allow boards to make stupid decisions as long as in
good faith, reasonably believe in best interest of the company even if stupid

Trifoods Intl while the articulated standard for the duty of care is negligence, because of the business judgment rule, liability is
only imposed for gross negligence, i.e., if no reasonable person under the circumstances would have authorized such a transaction in
good faith
o Justification: if they make a bad deal, their competitor will win so a well-diversified shareholder will not lose
o The idea is to overcome directors sub-optimal risk acceptance because they lose job and stock value if 0
o Under ordinary negligence, directors will never take risk that would go outside 8-12
o With BJR, directors can consider 0-20 game which the shareholders prefer anyway
Dismiss on pleadings if the business judgment rule applies, the case will not be considered on the merits

c. E
xtension of the Duty
i. Duty to Monitor
Board passivity if the directors failed to make any decision, they cant get protection of the business judgment rule
I f directors fail to act at all where a regular prudent person would act, they have violated the duty of care

September 29, 2016

(ASSIGNED: AK 255-258,
263-280, 283-286, 292-297)

Review & Recap

Exercising voting rights
State court (judicial oversight)

Chris-Craft Industries
Inequitable conduct restricting the sher franchise is prohibited even though action permitted under corporation code
and charter (and bylaws)
That which isnt explicitly prohibited is not necessarily permitted

Duty of candor
Honesty is required whenever directors communicate with shareholders
Malone v. Brincat
State law is just corrective disclosure, usually

Duty of care
ALI 4.01(a): good faith, reasonable belief / best interests of the corporation, care of ordinarily prudent person
Essentially just a negligence standard
Business judgment rule:
ALI 4.01(c): make a decision not (financially) interested, (duly) informed, rationall believe decision is
in best interests of the corporation

Trifoods Intl
Overcome directors suboptimal risk acceptance by eliminating...
Unless no person could have authorized transxn while attempting in GF to meet their duty of care

American Express
directors may exercise their honest biz judgment on the info before them (rejecting more profitable alternatives) so long
as they act in GF

Should have sold worthless stock and gotten discount on their taxes rather than paying that as sher dividend

Francis v. United Jersey Bank; p. 249-254

United Jersey Bank suing hapless Ms. Pritchard because she allowed her two sons to run the company into the
ground because of her failure to monitor the reinsurance business
Killed the business in two years
Duty to monitor?
At what point does the director become liable for the losses?
What does the court expect Mrs. Pritchard to do? (keeping informed about the activities of the corporation and
maintaining familiarity with its financial status, monitoring)
p. 251 - unfamiliar with the rudiments of reinsurance and made no effort to assure that the policies and practices
of the corporation, particularly pertaining to the withdrawal of funds, complied with industry custom or relevant
p. 252 - familiarity with companys corporate books and records . . . informed about the activities of the
Court here is looking for PROXIMATE CAUSE
neg of Mrs. Pritchard does not result in liability unless it is a proximate cause of the loss (p. 252)
Court wants her to (p. 252)
Duty to object!
and, if the corporation does not correct the conduct, to resign
(p. 253)
Scope of duties is to ensure bad conduct stops
Her duties extended beyond mere objection and resignation to reasonable attempts to prevent
misappropriation of the trust funds
Recall Tarnowsky/Resop (jukebox case)
Agent has to give back the secret commission
Have to strip away all incentives to take secret commission
How to determine appropriate response by a director?
Court says ad hoc basis; director-by-director determination (p. 254)

Duty of care type claim is hard to bring, lots of protection under the business judgment rule
Failure to monitor? Proximate cause, but what does a company need to do for oversight?


Requirements of duty
Protection of BJR
Extensions of duty
Duty to monitor
Min std
Oversight responsibility
Knowing violations of law

Graham v. Allis-Chalmers Mfring Co.; p. 255-258

Conspired with other mfrs and their eees to fix prices and rig bids to private electric utilities and govtl agencies
in violation of antitrust laws
Price fixing violating US antitrust
Guilty pleas to 1959 indictments
Decrees with the govt, pleads guilty, pays $Ms in fines

1937 consent decrees against DOJ for price fixing where neither admitted/denied but promised never to break
antitrust laws ever again
Shers say that you should have known based on 1937 decree
Did the directors breach fiduciary duties by failure to monitor the corps business?
Is the red flag doctrine efficient?
The company is very big! Couldnt possibly know what is going on
31,000 eees, 24 plants, 145 sales offices, 5,000 dealers
Made and sold all over the place
Directors could not know personally all the companys employees (p. 258)
Decentralize by delegating authority to the lowest possible mgmt level capable of fulfilling the delegated
Salespeople are the most likely to engage in price fixing (lowest level doing dis)
p. 258 - the very magnitude of the enterprise required the directors to confine their control to
the broad policy decisions
smaller decisions are delegated to those lower
What is the relevance of the 1937 consent decree? (court looks at the 3 directors)
Date became aware of consent decrees - all within 10 years of 1959 indictments
Satisfaction that never guilty now in compliance directors satisfied that the co. was never guilty
p. 257 knowing that the company did exactly this in 1937 doesnt matter; 3 directors
convinced themselves that co. no longer engaged in any of this bad conduct
Directors say not the same set of people and that they werent there in 1937
When does the DE supreme court hold that a duty to monitor arises?
Absent cause for suspicion there is no duty upon the directors to install and operate a corporate system
of espionage to ferret out wrongdoing which they have no reason to suspect exists (p. 258)
Nothing has changed at this company (still decentralized), so surprise in 1959 seems cray
p. 258 directors are entitled to rely on the honest and integrity of their subordinates until something
occurs to put them on suspicion that something is wrong
If directors are held liable, then theyll put in compliance (corporate espionage)
Shareholders pays the cost of compliance, but directors would bear the liability
Court is concerned about overcompliance
Would need to show that these eees now are engaging in this shit

Wells Fargo H/O: the WF case is brought by Consumer Finance Protection Bureau under Dodd-Frank Act; couldnt bring it under
Allis-Chalmers because there is no Red Flag here!
Stumpf remains CEO here, but stories from today is that he has forfeited all of his pay $44M for this year

Caremark Derivative Litigation; p. 265-270

Medical devices (e.g. strips to test for insulin)
Caremark entered into contractual agreements with hospitals and worried about kickbacks. To combat this, had a
compliance program in place, even with an 800 number where you could call in violations. Despite this,
employees were found breaking the rules.
Incentives to doctors to use their shit
Anti-Referral Payments Law:
Do not bribe the doctors! but vague re: what is a bribe;
Providing research funding for doctors? Not so clear
Caremark provides
Guide to contractual relationships (say what constitutes a bribe)
Puts in control structure (price waterhouse) is this program going to make sure that directors get all
the info that we need?
Ethics manual

Employee hotline
August 1994 (Minnesota), September 1994 (Ohio) breaches of ARPL (bribing docs law)
Did these directors breach their duty of Care by failing to monitor the corps business?
Did they do enough?
Distinction between this case and Allis-Chalmers
This company surely had red flags
p. 269 - can it be said today, absent some ground giving rise to suspicion of violation of law, that
corporate directors have no duty to assure that corporate info gathering and reporting systems exists
which represents a GF attempt to provide senior mgmt and the Board with info respecting . . .
compliance with applicable statutes and regulations?
I certainly do not believe so
So what constitutes the duty to be informed? (in modern, complex companies)
The board of directors must exercise GF judgment that the corps info and reporting system is in
concept and design adequate to assure the board that appropriate info will come to its attention in a
timely manner as a matter of ordinary business operations (p.269)
Need reporting system
What is the relationship between this duty to be informed and the red flag doctrine?
p. 270 - generally where a claim of directorial liability for corporate loss is predicated upon ignorance of
liability creating activities within the corporation, . . . only a s ustained or systematic failure of the
board to exercise oversight . . . will establish the lack of good faith that is a necessary condition to
Likely that directors will put this in place
Shareholders are the one to pay, directors trying to avoid liability

Stone v. Ritter (from notes afterwards)

p. 271
We hold that Caremark articulates the necessary conditions predicate for director oversight liability: (a) directors
utterly failed to implement any reporting or info system or controls; or (b) having implemented such a system or
controls, consciously failed to monitor or oversee its operations
This basically never happens?

Citigroup Shareholder Derivative Litigation; p. 272-277

Toxic assets (now aka legacy assets) take a bunch or mortgages and put in single company, that company
issues bonds; similar to reinsurance
People stop reading the mortgage documentation
Stop paying attention to FICO scores of the people getting the mortgages
People coming for mortgages arent lying (i aint got a job), but bank still issues the loan
Audit Risk Management Committee
Red flags?
Worsening conditions on the subprime mortgage market
Decline of economy
Did the directors breach their duty of care by failing to monitor the corps business risk?
s cite all these articles about the market crashing
court rejects these as red flags
Recall Allis-Chalmers where consent decrees were not enough of a red flag
p. 275 - is not sufficient to show that the directors were or should have been aware of any wrongdoing at
the company or were consciously disregarding a duty ... to prevent Citigroup from suffering losses
Why does the duty of directors regarding monitoring of biz risk differ from duty to monitor wrongful conduct?
Directors are allowed to make risk
receives the protection of the business judgment rule
p. 276 - to impose oversight liability on directors for failure to monitor excessive
risk would involve courts in conducting hindsight evaluations of decisions at the heart

of the business judgment of directors
Not crazy that directors manage the business risk, its crazy that no one paid attention along the way
How does the court justify this approach?
Suboptimal risk assessment from the POV of the directors
p. 277 - want directors to maximize sher value without having debilitating fear of personal liability
Doctrine also means, however, that when the company suffers losses, shers may not be able to
hold directors personally liable

Knowing violations of the law?

Miller v. AT&T; p. 278-281

$1.5M debt of Dem Natl Convention using AT&T
Violation of 18 USC 610 corporate campaign spending
Did the directors breach their duty of care (under NY law) by failing to collect the money owed to the
AT&T said that it was best for the shers and would be better to be in DNC good graces; wanted to curry favor
from the govt to eliminate being broken up (still got broken up)
p. 278 - cannot allow the BJR to apply to violations of law (illegality!)
Even though committed to benefit of the corporation, illegal acts may amount toa breach of
fiduciary duty
Even if done in the benefit of shers?
Ct: yea we dont care
LIMITATION on Duty of Care? (circumvents the BJR protection)
First requirement: board of directors cant be interested in the transxn
Hard for the courts to sort out if director is interested in the transxn

Why would a director enter into a transaction? (self interest question)

Sweetheart deal
Actually is good for the shareholders, because director has more information / is expert


Requirements of duty
Transaction cleansing
Safe harbor statutes
Requirements (for
Mechanisms (for
Special concerns

Dodge v. Ford (in notes, 285-286)

Dodge bros have idea in improving the engine of Ford, Ford says no
Dodge made own cars with better engines and only $100 more
Ford initially gave Dodge 10% equity of the Ford Co so that they would design shit for him
Now Dodge wants dividends paid out; want the $0.10 per $1 to finance their own company

Suit for failure of Ford to pay dividends
Ford doesnt want to pay dividends because wants to keep costs of car low so that everyone could buy a car; if paid
dividends, then would have to raise the cost of the car!
court says NAAAAH
p. 285 - it is not within the lawful powers of a board to shape and conduct the affairs of a corporation for the merely
incidental benefit of shareholders and for the primary purpose of benefiting others, and no one will contend that, if
the avowed purpose of the defendant directors was to sacrifice the interests of shers, it would not be the duty of the
courts to interfere
duty is owed to the shareholders

Hayes Oyster Co. v. Keypoint Oyster Co.; p. 293-296

Coast Oyster begins to struggle and needs cash
CEO Verne Hayes thinks the best thing to
do is to sell two of the oyster beds
Coast sells to Keypoint (50% is Engmans)
Sue Verne for breach of duty of loyalty, standing on
both sides of the transaction
Negotiating for Coast as CEO; nego for
Keypoint as largest shareholder
Verne 23% interest in Coast; 12.5% interest in
No incentive to cheat Coast
New managers have no complaints about the deal; only complaint is Verne is complaining about both sides

October 4, 2016
(ASSIGNED: AK 298-327; Shareholder Ratification Excerpt)

Review & Recap

Allis Chalmers Mfring

Can you ignore whats going on in the business?
Red flag doctrine

Directors have duty to be informed
Directors must implement an info and reporting system sufficient to assure timely receipt of appropriate
Liability for failure to be informed
Directors must utterly faily to implement an information and reporting system consciously fail to monitor the
information and reporting system

Protection of business judgment rule, which may be rebutted by showing gross negligence or bad faith

Miller v. AT&T
BJR does not protect illegal acts (even if they benefit the corporation)

Court are trying to tease out
Conflicted transactions
Not void
Not voidable
Due to conflict of interest

Hayes Oyster Co. v. Keypoint Oyster Co.; p. 293-296

Coast Oyster begins to struggle and needs cash
CEO Verne Hayes thinks the best thing to
do is to sell two of the oyster beds
Coast sells to Keypoint (50% is Engmans)
Sue Verne for breach of duty of loyalty, standing on
both sides of the transaction
Negotiating for Coast as CEO; nego for
Keypoint as largest shareholder
They dont challenge that $250k was a fair
price for those oyster beds
No complaint about price
Verne 23% interest in Coast; 12.5% interest in
No incentive to cheat Coast
New managers have no complaints about the deal;
only complaint is Verne is complaining about both
What argument do Hayes brothers raise in their
Made sure Coast received fair price in those
oyster beds! Hayes has larger interest in
Coast than Key
Court says: absence of disclosure is unfair in
itself (p. 294)
Nondisclosure by an interested director or officer is, in itself, unfair
P. 294 owe undivided loyalty, and a standard of behavior above that of the workaday world
Recall Meinhard v. Salmon (Cardozos punctilio case)
Salmon running the hotel
Force Keypoint Oyster to take the stock that was previously held by Hayes Oyster and give it to Coast
Is this rule per se rule against non-disclosure efficient?
Incentivizing? (Recall Resop jukebox case)

Requirements of duty
Transaction cleansing
Safe harbor statutes
Requirements (for
Mechanisms (for
Special concerns


DGCL 144: no contract or transxn between a corporation and 1+ of its directors can cleanse the transxn
(1) by approval of disinterested directors, even though the disinterested directors be less than a quorum
(all the directors that arent standing on both sides of the transxn)
(2) by approval in good faith by vote of the [disinterested] stockholders
Courts have interpreted this as disinterested stockholders
(3) demonstrate to the court that the transaction is fair to the corporation
Intrinsic/Entire fairness

Cookies Food Products v. Lakes Warehouse; p. 300-305

When Cook was running the business, biz not the best
Lakes Warehouse / Speeds Automotive - distributing all these car parts throughout the state (Herrig)
Herrig then becomes largest sher of Cookies Food Products; makes new
Uses Lakes warehouse to store (warehousing of products)
Speeds auto to distribute exclusive distributorship
Product development (taco sauce)
Herrig made sweetheart deals for all of the above; standing on both sides of the transaction and interested
Everything Herrig does is above market (paying more for storage than other facilities, more for
distribution than if used some other thing)
Shers not receiving dividends, Herrig doesnt care because he has all those agreements (is being paid along with
all the other liabilities)
Shers are stuck, no way to get money out of this investment
What is the std of review for determining whether Herrig breached his duty of loyalty to Cookies Food Prods?
BJR v. fairness test
Surplus = capital surplus + retained earnings
Can be paid as dividends
p. 303 -- like 144 of DGCL
(1) disinterested directors approval
(2) disinterested shers approval
(3) showing of entire fairness
p. 304, Iowa Ct says: duty of loyalty has grown out of the common law, notions of
cleansing have also grown out of common law
Iowa safe harbor statute will be interpreted in light of common law
Common law requires directors to show
Good faith, honesty, and fairness
Not just fair price, but also showing of fairness of the bargain (fair process)
What role does the inquiry of good faith play?

Showing in court; reserving to the court the final look of the transaction (right to take look to see if in
best interest of the corporation, see if directors really are disinterested)
What evidence supports the finding of fairness?
p. 304 No serious dispute that the four agreements in issue have all benefited the company as
demonstrated by its financial success
If company profitable, then can show GF, honesty, fairness
If unprofitable, doesnt mean that you CANT make that showing
What role does market value play in the fairness evaluation?
[DISSENT = worried about market test] p. 305 certainly Herrig is driver in success of company, this
does not mean the transactions were fair
Did not show the fair market value of his services or expense for freight, advertising, and
storage cost
courts in general reserve to themselves the ability to look into these transactions


Director approval
Shareholder ratification
No controlling sher
Claims for waste / BJR
Lewis v. Vogelstein
Claims for breach of the duty
of care
Wheelabrator Tech
Breach for breach of duty of
Wheelabrator Tech
Controlling sher
Fairness test

Cooke v. Oolie; p. 307-309

Oolie + Salkind
Directors and creditors of Cartoon Network
Want to combine with USA network - USA network has promised to pay off the money they lent to company
What is the standard of review to det. Breach of duty of loyalty to The Nostalgia Network?
Deferential BJR, or subject to exacting standard under fairness?
No true conflict, but court applies DGCL 144(a)(1)
Directors here are not on both sides of the transaction; not in USA network as owners or anything
Court here analyzes the fairness, but are they allowed to?
Salkind and Oolie are voting for transaction as creditors instead of as shareholders
p. 308 only Oolie and Salkind are interested, all the other directors are disinterested
If those disinterested directors approve by majority vote, then get protection of the BJR
Only directors that are interested are the ones that stand on both sides of the transaction
anyone not standing on both sides of the transxn is disinterested

Lewis v. Vogelstein; p. 310-311

(very messy, dont make sense)
About Mattel
Directors given a lot of incentive compensation tied directly to the stock price; negotiating on behalf of

themselves for their pay, and nego on behalf of Mattel on what to pay them
May shers ratify a transaction that constitutes waste?
How does sher ratification differ from the typical situation in which a P ratifies the act of her A?
Recall White v. Thomas (the farm and land auction bidding situation case)
p. 310 collective action problems
What is the rational thing for a sher to do when you get the proxy materials?
Bearing cost of gathering all the info, but only getting payout of their pro rata share
What about the case of waste?
p. 310 rule of unanimity
Every single sher must approve the transaction
Why need unanimous vote to ratify of a wasteful transaction?
p. 310 no one should be forced against their will to make a gift (of their money)
People get shares to get rich, makes no sense to just throw it all away
What is waste?
P. 311 a waste entails an exchange of corporate assets for consideration so disproportionately small as
to lie beyond the range at which reasonable person would be willing to trade.
Most often the claim is associated with a transfer of corporate assets that serves no corporate
purpose for which no consideration at all is received
standard for waste is very very very high

Wheelabrator Technologies; handout

Majority shers ratify
What is the impact of shareholder ratification?
p. 294 full-informed shareholder vote operates to extinguish a claim. . . that directors failed to exercise due
care to adequately inform themselves before committing the corporation to a transaction
Sher approval extinguishes the claim
What is the impact on a claim for violation of duty of loyalty:
If the transaction involves a director?
In most instances, the interested director will get the approval of the other directors
Only the directors standing on both sides of the transaction is interested in the transaction
All the other directors are disinterested
If the disinterested approve by majority of vote, then get protection of BJR
If transaction involves no controlling sher? (Cooke v. Oolie, Lewis v. Vogelstein)
Approval by fully informed, disinterested shers, invokes the BJR to protect the directors (p.
Only way to overcome the BJR protection is to show waste (tough standard)
Terms beyond where NO reasonable party would be willing to trade
Equivalent of giving corporate value away for no consideration
If the transaction involves a controlling sher? (Wheelabrator)
Pretty impossible to think of disinterested directors in the case of a controlling shareholder
Directors are elected (in DE) by a plurality of the votes; so a controlling sher could be
something less than 51%
DE courts are hazy about what they mean about controlling sher
subject to the fairness standard
Controlling sher has elected all of the directors, can get approval of all the shers
(court is going to look at the disinterested shers and look at circumstances of that
UNLESS, there is no conflict tranasactions
Sinclair v. Levien
Conflicted transactions
Weinberger v. UOP

Sinclair v. Levien; p. 314-317
Sinven paying out almost $38M in dividends than what it is
Comes from the surplus
DGCL Section 170(a)
Surplus = capital surplus + retained earnings
Drawing all of the retained earnings out of the
company by paying dividends and driving the
surplus to almost nothing
Violating duty of loyalty because drawing all of this money out
of this corporation; no retained earnings to repair the equipment
or purchase new equipment or anything
What is the std of review for determining whether Sinclair Oil
Corp breached its duty of loyalty to its subsidiary, Sinclair Venezuelan Oil Co?
BJR or fairness
What is the basis for the claim of the minority shareholders?
Company getting rid of all the money
What constitutes self-dealing?
p. 315 when the parent company gets benefits that are detrimental to the other shers in Sinven
If the transaction involves self-dealing, then std of review is test of intrinsic fairness
p. 316 Sinclair Corp gets nothing from the Sinven to the exclusion of the minority shers
What is the appropriate std of review?
When no benefit-detriment, then std of review is BJR (p. 316)
Context: at the time, Venezuela was seizing company assets and selling back to public
(nationalizing); wanted less left for the government

Weinberger v. UOP; p. 318-326

Shers own about 49.5%; Signal Co. owns about 50.5%
Signal successful, so looks for investment alternatives
Buy the 49% of UOP that they dont already
Signal has majority of all the stock, bring in Crawford
Signal offers $21/share (merger price)
Market price was $14.50
56% of minority shareholders vote on the merger; remaining
shers essentially throw the proxy materials out; with 51% of this 56% voting in favor it; (so really only 13% of
total shares are in favor of the merger)
Breach of duty of loyalty, that Signal Co. set price way too low
What is the impact of shareholder ratification?
p. 322 secret Arledge + Chitiea
8 items that ONLY benefit the signal company
All of these eliminate potential conflicts of interest, etc. etc.
But Arledge and Chitiea work at UOP and sit on the board of directors of UOP
$24/share would be a good investment for the Signal co.

October 6, 2016
(ASSIGNED: 330-342, 287-292, 343-355)

Review & Recap

Transaction cleansing
Sweetheart deal
Safe harbor statutes
DGCL 144: conflicted transactions (both sides of the transxn) cleansed by:
Approval by disinterested directors
Ratification by [disinterested] shareholders
Showing of [intrinsic] fairness to the corporation

Cookies Food Prods

Conflicted director must also show GF, honesty, fairness (Iowa) otherwise aint cleansed
Requirements from the common law

Mechanisms for cleansing

Director approval get all the disinterested directors to vote for transxn
Cooke v. Oolie
Shareholder ratification
Lewis v. Vogelstein

Cooke v. Oolie
Both sides of transxn as creditors
Approval of disinterested directors provides protection of business judgment rule (BJR)
(so long as no controlling shareholder)

Lewis v. Vogelstein
Definition of waste
Beyond the range of reasonableness (no rsble party would be likely to trade, difficult standard to satisfy)
Shareholder approval of a wasteful transaction must be unanimous

Wheelbrator Tech
Breach of duty of care
Sher approval extinguishes the claim
only need a majority (not unanimity)
Sher approval of a transxn
with a director provides the protection of BJR
What about if transxn with a controlling shareholder?
Shifts the BOP to the to show a LACK of fairness


Sinclair Oil / Sinven

Benefit to the detriment test
No conflict transxns, no breach of duty if the benefit-detriment test is satisfied

Otherwise (intrinsic) fairness is the std of review
Company paying out all $$$ in dividends, paying out 97% to private, 3% to the public sher; everyone was getting
their pro rata share though (which is rare)
Almost every instance the test will fail, court will find that there is a conflict, so intrinsic fairness is std of

What is intrinsic fairness?

Weinberger v. UOP
49.5% shers, 50.5% Signal co.s; board appoints Crawford UOP
Signal decides best thing to do is pay out the shers
$14.50 market price, Signal merger price proposed is $21.00
Bad thing is Signal was willing to pay up to $24/share
Also bad thing is most of work was done by two directors on UOP but part of
Signal; prepared report that listed all these benefits to Signal
56% of the minority shers vote on the merger, roughly 50% vote in favor of it
What is role of hte Arledge-Chitiea Report?
Used UOP data for the benefit of Signal Co
p. 322 UOP directors prepared, but for the exclusive benefit of Signal; didnt tell the other
directors not at Signal or even the shers that the $21 price was determined by best interest of the
Signal Co and not UOP
What is the role of Lehman Bros and its fairness op?
Report said $21/share was fair
After merger, only 1 company (Signal Co) and only 1 company to employ them (knew had to fudge
the financial$ a little bit)
Partner spends weekend skiing in VT
Underlings know that that financial data doesnt line up, so left the price per share was left [BLANK]
Partner just write in, by hand, $21
None of this is disclosed to sher or other directors; so everyone assumes Lehman is doing a good job
What does intrinsic fairness entail?
p. 323: concept of fairness has two aspects
Fair dealing = (p. 323) transaction timed, how initiated, structure, negod, disclosed to the
directors; how approvals of directors and shers obtained
Fair price = (p.323) all relevant factors [discounted cash flow analysis]
Assets, market value, earnings, future prospects, and any other elements that affect
the intrinsic or inherent value of a cos stock
Not a bifurcated test!
p. 323 all aspects of issue analyzed as WHOLE
A really fair/high price will overcome a very flawed process
How could the Signal Co avoided all of these problems?
p. 323 n.7 court wants to see some sort of arms length bargaining between the two parties
Independent negotiating committee of its outside directors to deal with Signal at arms length
Independent committees need to have some leverage, so bids just start lower
What is the purpose of a judicial determination (appraisal) of fair value of the shares purchased in a merger?
DE (DGCL 262), sher can come in and dispute this price
p. 325 proportionate interest in a going concern
Whats the value of a going concern?
Way to determine that is techniques/methods acceptable by financial community
Firm foundation theory (DCF); castle in the air theory (comparable companies)

Current stock price or rely on valuation of experts

We have: BUSINESS JUDGMENT RULE (no conflict, or conflict cleansed) v. FAIRNESS (fair process + fair price, intrinsic)


Close corporations
Just like pships (CARDOZO)
Puncitilio of honor most
Uses of corporate profits
Use of corporate profits for charitable
Executive compensation
When directors nego for own comp;
standing on both sides of transxn
What theyre paid, what paid to
CEO has a lot of control over
who is on board of directors
Insider trading


Donahue v. Rodd Electrotype Co.; p. 331-336

Rodd family 80% of the shares
Donahue family 20% of the shares
Donahue has passed away, Mrs. Donahue want
to sell to Rodd
Offers $40/share, then $200/share
Does Rodd Electrotype Co.s purchase of shares owned by
Mr. Rodd (controlling sher) constitute a breach of duty of
What characteristics define a close corp?
p. 333 small number of shers, no market for the shares, many of shers work as mgrs, directors of the
Troubling that the court has to define a close corp, not within a statute
Court bothers to define, because wants to impose much different fiduciary duty
What fiduciary duty?
p. 334 owe the same type of fiduciary duty that partners owe to each other
Meinhard v. Salmon (CARDOZO)
Punctilio of the honor most sensitive loses the more you go more into punctilio
have to give half of the biz minus one share in Meinhard
here the corp has to buy all of the shares at the same price at $800/share
If cant afford, then needs to buy pro rata (e.g. 30% of Rodd, 30% of Donahue)
What is remedy for breaching this fiduciary duty?
Rodd pay back money that he got, or Mrs. Donahue gets to sell her shares for same price
What is benefit of pro rata purchase on minority shers?

Makes sure that everyone gets a share of it
What benefit would a discretionary purchase of shares confer on a corp?
See this in the mktplace, usually a retirement or severance package in public cos, and now a lot of
closely held corps
If you dont have this, then CEO may be stuck because co doesnt have enough to pay everyone

Springside Nursing Home MA backs away from this rule

P. 338 controlling sher must demonstrate a legitimate business purpose
Minority sher must demo that same legit objective could have been achieved through an alt course of action less
harmful to the minoritys interest

Nixon v. Blackwell DE
P. 338 close corps provide similar insurance benefits to all shers
Follows EASTERBROOK instead of MA rule

Smith v. Atlantic Properties, Inc.; p. 338-341 (hapless attorney Smith)

80% provision (veto over corporate decisions)
Supermajority vote
Dr. Wolfson wanted this provision because scared
other shers would gang up on him
Couldve preserved this structure with the
Class A/B voting structure
E.g. give 10 B voting shares to
himself, bunch of A non-voting to others
Repairs to property v. payment of dividends
Wolfson refuses to vote for dividends, because wants to repair; other shers refuse to vote for repairs
IRS penalties (three years / settlement / four years)
You cant just sit here as a business hoarding cash; either pay up and we take your tax from dividends
or you reinvest it into the corp)
Penalize! 4 years later the same shit happens
Wolfson refuses to pay out dividends!
this is weird because hes a minority sher!
Did Wolfson breach his fiduciary duty to the other shers (as a
minority sher)?
Absent 80% provision in charter, then he wouldnt have
had any control!
What role do the Articles of Org play?
Tells corp what to spend on, etc.
Why did Wolfson oppose the payment of dividends?
Doesnt want to pay taxes, hes alzo crazy
Wolfson probably has more $$$ than the other 3;
probably didnt care that much, wanted to invest in the biz so that it could be sold for even more
What duty does a minority sher owe to the other shers?
p. 340 Wolfson acting out of avarice / spite
p. 341 running unreasonable risks (by having to pay IRS penalties)
Duty of utmost good faith and loyalty
Everyones $$$ goes down when have to pay IRS penalty out of corp trea$ury
MA Gen Corp Law (p. 340, n.6)
Majority shers, in the event of deadlock, at least may seek dissolution of the corp if 40% of the voting
power can be mustered, whereas a single stockholder with only 25% of the stock may not do so


A.P. Smith Mfring Co. v. Barlow; p. 287-289

$1500 charitable contribution to Princeton University
Using corp coffers to pay charitable contribution aint okay?
p. 288 business other those classed broadly as public utilities are created / invested in to make profits
Why do corps desire to make charitable facts using corporate funds?
P. 288 corps sound econ and social environment which in turn rests on . . . free and vigorous
nongovernmental institutions of learning
For what purpose may corps make charitable gifts with corporate funds?
p. 288 common law requires that those who manage the corp may not disburse any corp funds for
philanthropic . . .
Courts while adhering to the terms of the common law rule, have applied it very broadly to
enable worthy corp donations
What limits does the broad application of this common law rule?
Has to be reasonable
p. 289 cant be to a pet charity
Is the rule efficient?
Common (heh heh heh - Gentile)

Elements / trends (incentive pay)
Judicial review

Musicians Taylor Swift, One Direction

Athletes Ronaldo, Messi, Lebron
CEOs McKessen pharma, Ralph Lauren

Why does everyone care about CEO compensation?

Executive compensation not set by the market or result of arms-length bargaining

whatever youre paid like annually or whatever
Incentive compensation
designed to reduce agency costs (monitoring/bonding costs) including suboptimal risk acceptance (residual loss);
subject to severe agency costs (ineffective monitoring and bonding) including greater sub-optimal risk acceptance
Annual cash payments in addition to salary or wages based on performance
Straight off income statements; revenues - expenses = net income; if revenues goes up by or net
income goes up, then heres your bonus
Restricted stock
Grants shares of stock that vest over time
Typically vesting is tied to tenure (continued employment) and occasionally vesting is tied to
performance (measured by net income earnings targets or product development)

October 13, 2016

(ASSIGNED: 358-374, 616-621, 627-639)

Review & Recap
Business Judgment Rule
Failure to monitor
Duty of loyalty
Special concerns
Close corporations
Rodd Electrotype - in a close corp, the fiduciary of loyalty duty is identical to the duty partners
owe to one another, and requires the corporation to purchase of shares pro rata (Massachusetts)
Springside Nursing Home (MA) - permits companies to buy shares on non-pro rata
basis as long as can prove no alternative way to achieve these ends
Nixon v. Fitzgerald (DE) - different rule
Minority sher
Atlantic Properties - minority sher blocking transxn; breach of the duty of loyalty is
determined on a case-by-case approach reasonable interpretation (utmost GF and
Charitable gifts
AP Smith Mfring - permitted charitable contributions not made indiscriminately to a pet
Executive compensation
CEO pay not set by the market or arms-length bargaining
Incentive compensation: designed to reduce agency costs (including sub-optimal risk
acceptance); but subject to severe agency costs (including sub-optimal risk acceptance)
E.g. CEOs that are almost retiring and shit agency costs
Bonuses, (restricted) stock, (stock) options


Close corporations
Uses of corporate profits
Executive compensation
Incentive compensation
Judicial review
Insider trading
Duties under common law


Annual cash payments in addition to salary or wages based on performance
Performance is typically measured by sales (revenues) targets or net income (earnings) targets
(restricted) stock precluded from selling it for X period of time
Grants shares of stock that vest over time
Typically vesting is tied to tenure (contd employment) and occasionally besting is tied to performance (measured
by net income (earnings) targets or product development)
Call options
Right to buy a share of stock at a specified price for a specified period of time
Specified price = exercise (strike) price
Usually stock price
Specified period of time = maturity date
Maturity date is usually 10 years
p. 347 - graph in yo book


Costs of voting
Efficient Capital Markets Hypothesis: Mandated disclosures required by the securities exchange act of 1934 and
rules promulgated by the Commission reduce the (transaction) costs of becoming informed and improve the
efficiency of the stock market
Regulatory responses
Proxy statement disclosure
1993 amendments
Compensation table
Narrative description of contracts and rationale
Graph comparing share price to indexes
2006 amendments
Computation of single compensation number
Description of perquisites (perks)
2010 (Dodd-Frank Act, Section 953)
Relationship between execs compensation and annual change in share price
Ratio of CEOs annual comp and the median employees annual comp
now thats about 400:1 ratio
Repayment requirements
2002 (Sarbanes-Oxley, Section 304)
2010 (Dodd-Frank Act, Section 954)
Clawback all incentive compensation paid to
Current / and former / exec officers
Within the past 3 years
Upon any restatement of the corporations financial statements
2010 (Dodd-Frank, Section 951)
Non-binding sher advisory vote to approve exec compensation
Non-binding sher advisory vote on frequency of sher review
its advisory vote because DGCL 141a; board sets pay, not sher


Almost like a duty of loyalty question, esp wrt what the directors grant to themselves for pay
If theres no conflict, no fraud or illegality, then board is entitled to business judgment rule protection
First shareholder, then director

In re the Goldman Sachs Group, Inc. Shareholder Litigation; p. 360--368
~45% of net revenues is paid out in bonus to the employees
Hedge funds pay out half of this in comparison
2% of net revenues is paid out as dividends
Shers dont think that payout is quite fair; excessive compensation
Whatis the std of review for evaluating (bonus) compensation plans for employees?
What specifically does the complaint allege?
p. 362 - (1) that a majority of the board was interested . . . when it approved the compensation scheme
(2) that the board did not otherwise validly exercise its business judgment (UNINFORMED
(3) the boards approval of the compensation scheme constituted waste (WASTE
Does the approval of the (bonus) compensation plan for employees involve a conflict of interest?
p. 362 - claims that various donations by the GS Foundation to institutions upon whose boards various
GS directors served were [insufficiently particularized] to render such directors non-independent of the
Goldman insiders who qualified for the incentive compensation payments [under the plan]
Does the approval of the bonus comp plan for eees involve BJR?
p. 363 - board is allowed to do this; this is what boards do
Recall American Express - the tax strategy case
Why is the information considered by the directors important?
p. 365 - board just needs to consider relevant info; BJR requires the board to reasonably inform itself,
it does not require perfection or the consideration of every conceivable alternative
What is the significance of the claim that approval of the (bonus) compensation plan constituted waste?
p. 365 - by pleading particularized allegations that overcome the general presumption of GF by
showing that the boards decision
What is the purpose of defining waste as reasonableness like Lewis v. Vogelstein?
p. 365 - Courts are ill-fitted to attempt to weigh the adequacy of consideration under the waste standard
or, ex post, to judge the appropriate degrees of biz risk
Recall Lewis v. Vogelstein the standard is setting money on fire
How does this rationale influence the way in which the waste standard is applied to a (bonus) compensation plan
for employees?
p. 366 - Looked at the 31,000 eees as a whole
Absent such facts, these decisions are the province of the board of directors rather than the
What is the role of business risk in determining whether or not a bonus comp plan for employees constitutes
p. 367 - there should be no finding of waste. Even if factfinder would conclude ex post that transxn
was unreasonably risky. Any other rule would deter corp boards from the optimal rational acceptance of
risk (Lewis v. Vogelstein)

Gent: there is a small ray of hope for when directors are paying themselves

Calma v. Templeton; p. 369-374 (Citrix case)

Stock plan for directors (and others)
Not more than 1 million shares (restricted stock units) in one year to one person > $55M
What is the std of review for evaluating grants of restricted stock to non-employee directors?
Why does the complaining sher focus on non-employee directors?
p. 369 - these are excessive in comparison to compensation received by peers

What would be the applicable standard of review in absence of any action by the (disinterested) shers?
Intrinsic or entire fairness is left
p. 369 - review will look for fair process and fair price entire fairness of the restricted stock
awards as conflicted compensation decisions
What would be the applicable std of review in the event the (disinterested) shers effectively ratified the grants of
restricted stock?
Recall Wheelabrator BJR protection!
p. 373 - valid sher ratification leads to waste being the doctrinal std of review for a breach of fiduciary
duty claim
The affirmative defense of ratification is available only where a majority of informed,
uncoerced, and disinterested stockholders vote in favor of a specific decision of the board of
p. 369 - company did not seek or obtain sher approval of any action bearing specifically on the
magnitude of compensation to be paid to its non-employee directors


Close corporations
Uses of corporate profits
Executive compensation
Incentive compensation
Judicial review
Insider trading
Duties under common law
Duties under federal law
Duty to disclose or abstain
Bases for duty (to disclose or


Claim of fraud: misstatement or omission, materiality, culpability (neg or scienter), reliance (causation), harm
Recall VA Bank Shares - $60 as actual fair price of the share; reasonable sher and what they would consider as

Goodwin v. Agassiz; p. 618-621(Cliff Mining Co case)

Agassiz (director and president)
Theory of copper deposits (March 1926)
Exploration ended, after ten years (May 1926)
Goodwin sells 700 shares, Agassiz buys them
Mining co. starts doing really well because there is copper underneath there
Can Goodwin recover for loss of $$$ by selling to Agassiz?
To whom do directors owe their duties?
p. 619 - the contention that directors also occupy the position of trustee toward individual shers in the
corp is plainly contrary to the repeated decisions of the courts and cannot be supported
Why is the determination that directors owe their duties to the corp but not directly to shers important?
Important because it means Goodwin has no claim
p. 620 - purchases and sales of stock dealt in on the stock exchange are commonly impersonal affairs.
An honest director would be in a difficult situation if he could neither buy nor sell on the stock exchange

shares of stock in his corporation
Without first seeking out the other actual ultimate party to the transaction and disclosing to him
everything . . . he then knew affecting the real or speculative value
What is the applicable std of review when directors purchase or sell shares in impersonal markets?
p. 620 - where a director personally seeks a sher for the purpose of buying his shares w/o making
disclosure of material facts, the transaction will be closely scrutinized and relief may be granted in
appropriate instances
Strong v. Repide (SCOTUS case)
Why are those circumstances important?
When Agassiz bought, didnt know who sold
When Goodwin sold, didnt know who was buying
p. 620 - Goodin was no novice. He was a member of the Boston Stock Exchange and had kept
a record of sales of Cliff Mining Co stock. He acted upon his own judgment


Section 10, Securities

It shall be unlawful . . . (b) to use or employ in connection with the purchase or sale of any security . . . any manipulative or
deceptive device or contrivance in contravention of such rules and regulations as the Commission may proscribe as necessary
or appropriate in the public interest or for the protection of investors
There are criminal penalties! One of the few places in federal law (usually civil)

It shall be unlawful
(a) device, scheme, or artifice to defraud.
(b) to make untrue statement of a material fact or omit to state a material fact necessary in order to make the
statements made in the light of circumstances in which they were may, not misleading, or
(c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon
any person, in connection with the purchase or sale of any security
in connection with the purchase or sale of any security
We explore (a) and (c)


Texas Gulf Sulphur Co.; p. 630-635

Drilling exploration = good
Nov. 8, 1963 $17.375
Nov. 12, 1963
March 31, 1964
Purchase stock (and calls)
Receive some stock options
Apr. 13, 1964 - $30.125
Apr. 16, 1964 - $36.375
May 15, 1964 - $58.25
p. 634 - thus, any director or officer in possession of material inside information must either disclose it
to the investing public, or, if he is disabled from disclosing it in order to protect a corporate confidence,
or he chooses not to do so, must abstain from trading in or recommending the securities concerned while
such inside information remains undisclosed
How is materiality to be determined in the context of R. 10b-5?
Expected value, weighted average, value of ash at some point in the future


p. 634 - finally, a major factor in determining . . . was a material fact is the importance attached to the
drilling results by those who knew about it
Who is harmed by insider trading?

October 18, 2016

(ASSIGNED: 640-666)

Review & Recap


Judicial Review
Goldman Sachs incentive compensation for employees is a core function of the board of directors
Calma v. Templeton ratification requires the vote of a majority of informed, uncoerced, disinterested shareholders
(majority of a minority)
this sher assent grants the directors the protection of the business judgment rule
otherwise, the directors must show the entire fairness (R144a-3) of the compensation agreement

Insider Trading
Under common law, insider trading is just another species of fraud
Goodwin v. Agassiz directors owe their duties to the corporation (not individual shareholders)
Transactions in the market are impersonal affairs
Trades between directors and shareholders create no liability under state (anti-fraud) laws (absent appropriate
(special) circumstances)
Duty to disclose or abstain
Texas Gulf Sulfur Co. Anyone with material information must disclose the info to the investing public or
abstain from trading the corporations stock


Santa Fe Industries v. Green; p. 636-639

(similar to Virginia Bank Shares - merged two
companies together via proxy vote; misstatement of
material fact; board of directors did not have opinion
that $42/share was high price)
Kirby Lumber, 5% stock is public market remaining
95% is held by Santa Fe Industries
Once you own this 95% of the company,
dont really need a vote, since its pointless
(DE statute)
$150 = merger price
$65-$95 purchase price
Valuation reports
$640 (raw materials)
$125 (Morgan Stanley) 10b-5 fraudulent?

Violation of 10b-5?
p. 637 no indication that Congress meant to prohibit any conduct not involving manipulation or deception
p. 638 but we do not think Congress . . . meant to bring within the scope of 10(b) instances of corporate
mismanagement. . . in which the essence of the complaint is that shers were treated unfairly by a fiduciary
There must be DECEPTION wrt to duty to disclose or abstain


Close corporations
Uses of corporate profits
Executive compensation
Incentive compensation
Judicial review
Insider trading
Duties under common law
Duties under federal law
Duty to disclose or abstain
Bases for duty (to disclose or


Rule 10b-5 is based in policy on the justifiable expectation of the securities marketplace that all investors trading on
impersonal exchanges have relatively equal access to material information . . . The essence of the Rule is that anyone who
has access directly or indirectly . . . only for corporate purpose and not for the personal benefit of anyone may not take
advantage of such information knowing it is unavailable to those with whom he is [trading]
Matter of Cady Roberts & Co.
Texas Sulphur (p. 634)
Notion of market integrity
Ex. Gordon Gekko
Teldar Paper, Inc. (Board of Directors) stock has dropped to $10/share
Gekko Corporation (Board of Directors)
Gekko forms a corporation and is the sole owner
Gekko goes to bank and borrows a bunch of money
uses money to buy all the shares in Teldar Paper at $13/share for Gekko Corporation
Teldar Paper as subsidiary of Gekko Corporation
first problem with Gekko is that he is bidding against himself
Tender Offer I will buy any and all shares at a price of $13/share, so long as at least 51% of the
outstanding shares are tendered to me for purchase
Gekko goes into market to ask shers to tender their shares to him
He would be harmed by insider trading because everyone who knows about it would go
into market and start buying those shares (e.g. his employees); stock price goes up when
they start buying more of those shares
As stock price creeps up, Gekko would have to pay more in order to make premium
Corporate raiders are actually harmed by insider trading
SEC supports the equal access theory
Rule 14e-3(a): effectively equal access theory
If any person has taken substantial steps to commence, or has commenced, a tender offer, it shall constitute a
fraudulent, deceptive or manipulative act . . . within the meaning of Section 14(e) of the Act
(1) the offering person (the bidder)
(2) the issuer (the target company = Teldar Paper)

(3) any officer, director, partner, or employee of any other person acting on behalf of [the bidder or the
To purchase or sell . . . any of such securities . . .


Chiarella v. United States; p. 642-646

Chiarella = printer, markup man @ Pandick Press, Inc. (a financial printer - like a sophisticated admin assistant)
Chiarella figures out the companies
Gets ID of target companies, buys stock in target companies, earns $30k over 14 months
Did Chiarellas purchase of shares in target companies, based on confidential info gleaned from other (bidding
companies) violate 10b and R10b-5?
p. 643 not a corporate insider, received no confidential info from the target company, the market info on which
he relied only concerned the plans of the acquiring company
p. 645 duty to disclose under 10b does not arise from mere possession of nonpublic market
Then what creates the duty to disclose/abstain?
p. 643 relationship of trust and confidence between shareholders of corp and [whose companys
shares theyre trading]
Relationship of trust and confidence gives rise to a duty to disclose/abstain because of the
necessity of preventing a corporate insider from taking unfair advantage of the uninformed
What is SCOTUS rationale for rejecting Equal Access Theory?
p. 644 not all unfairness is fraudulent
Santa Fe no deception, because people couldve just read all the disclosure materials
(1) In order for there to be a breach, THERE HAS TO BE DECEPTION
(2) element required to make silence fraudulent is a duty to disclose (p. 644)

Dirks v. SEC; p. 647-651

Equity Funding of America sold life insurance policies, took employees and had them write out life insurance
policies (fake ones: Mickey Mouse, Donald Duck, etc.)
Secrist, former officer of Equity Funding of America = whistleblower went to Dirks to report
Discovered the fraud, went to superiors and told them, they fired him
Contacted by Secrist, conducts investigation, discusses info with clients, clients sold $16M in stock, stock price
drops from $26 to $15; stock trading then stops
Did Dirks violate 10b and 10b-5 by tipping his clients to fraud at corp in which he owned no stock?
Did Dirks trade on material nonpublic information?
Under what circumstances is a tippee subject to the duty to disclose or abstain?
FIND THE BREACH ( who breached?)
p. 649 a tippee assumes a fiduciary duty to the shers of a corporation not to trade on
material nonpublic information only when the insider breached his fiduciary duty to the shers
by disclosing the information to the tippee and the tippee knows or should know that there has
been a breach
DIRKS TEST: p. 650 the test is whether the insider personally will benefit, directly or indirectly, from his
disclosure. Absent some personal gain, there has been no breach of duty to the shers. And absent a breach by the
insider, there is no derivative breach
Whether the insider receives a direct or indirect personal benefit from the disclosure, such as a pecuniary
gain or a reputational benefit that will translate into future earnings (p. 650)
p. 650 undisputed that Dirks himself was a stranger to Equity Funding, with no pre-existing fiduciary duty to
its shareholders
p. 651 tippers received no monetary or personal benefit for revealing Equity Fundings secrets, nor

was their purpose to make a gift of valuable information to Dirks
What role did his profession (as a securities analyst) play in the decision of the SCOTUS?
SCOTUS supports semi-strong form of efficient capital markets hypothesis
p. 649 Imposing a duty to disclose or abstain solely because a person knowingly receives
material nonpublic information from an insider and trades on it could have an inhibiting
influence on the role of market analysts, which the SEC itself recognizes
Commonplace for analysts to ferret out and analyze information
p. 649, n.14 temporary insiders = people who are hired to do the deal
Lawyers, underwriters, accountants, consultants

Who has a relationship of trust and confidence giving rise to duty to disclose or abstain?
Classical theory: insiders and temporary insiders
If the tipper doesnt breach, no one in the chain is in trouble

United States v. Newman; p. 652-659

Receives information from financial analyst working with him about earnings reports prior to announcements
Buys stock and earns $4M
Did Newman violate 10b and 10b-5 by trading on infor provided to him by analysts working with him at his
hedge fund, Diamondback Cap?
What is a remote tippee?
The chain is attenuated here
p. 654 Newman was several steps removed from the corporate insiders, with respect to the Dell tipping chian .
. . Newman was three . . . levels removed from the inside tipper . . . NVIDIA . . . Newman was four levels
removed from the inside tippers
p. 656 First, the tippees liability derives only from the tippers breach of a fiduciary duty, not from trading on
material, nonpublic information
Second, the corporate insider has committed no breach of fiduciary duty unless he receives a personal
benefit in exchange for the disclosure
Third, even in the presence of a tippers breach, a tippee is liable only if he knows or should have known
of the breach
Recall Allis Chalmers
Trick here is that the tippee must know of the benefit to the tipper
Must the tippee know of the benefit the tipper receives from sharing the material nonpublic information?
Newman doesnt even know that the analysts below him have spoken to the investor relations people;
even though that is analysts job to talk to investor relations people
Court takes step closer to analysts and away from insider trading
P. 656 a tippees knowledge of the insiders breach necessarily requires knowledge that the insider
disclosed confidential information in exchange for personal benefit
So what are the elements?
p. 656 In sum, we hold that to sustain an insider trading conviction against a tippee, the Government
must prove each of the following elements beyond a reasonable doubt
(1) corporate insider was entrusted with a fiduciary duty
(2) insider breached his fiduciary duty by
(a) disclosing confidential info to a tippee
(b) in exchange for a personal benefit
(3) tippee knew of the tippers breach (know info was confidential, had relationship, was
divulged for personal gain)
(4) the tippee still used that info to trade in a security or tip another individual for personal
unsure if Newman allows for skipping of some levels of attenuation?

Is family somehow special?

Rule 10b5-2:
steps outside of classical tipping theory, gives tipper relationships leading to breach
Chestman case from notes (useless husband traded on the information from family; nothing happens under Dirks)
A duty of trust and confidence arises
(1) Whenever a person agrees to maintain information in confidence;
(2) Whenever the person communicating the material nonpublic information and the person to whom it is
communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information
knows or reasonably should know that the person communicating the material nonpublic information expects that
the recipient will maintain its confidentiality;
(3) Whenever a person receives or obtains material nonpublic information from his or her spouse, parent, child, or

October 20, 2016

(ASSIGNED: 375-385, 388-400)

Review & Recap

Equal Access Theory
Texas Gulf Sulphur - investors trading on exchange have justifiable expectation of relatively equal access
Rule 14e-3(a) SEC: tender offers (anti fraud provisions)
All trading is info obtained from bidder of target (or anyone working) violates prohibition on insider
trading everyone has duty to disclose or abstain
BUT SCOTUS rejects equal access theory
Classical Theory (fiduciary duty theory)
Chiarella - only people who have duty to disclose are those who have relationship of trust and
confidence with shareholder of target company arising from state law fiduciary duty of lotalty
These people have a fiduciary duty
Dirks - expands on Chiarella
Tippee inherits both relationship of trust and confidence (inherits breach)
If the tipper violates prohibitions on insider trading
Need to have tipper a personal benefit
Santa Fe requires some kind of receipt
Newman - scales back on Dirks
Remote tippers
Even a remote tippee must be aware that the tipper breached fiduciary duty
Striking development!
No reason Newman should assume people he hires will do illegal shit, so unless
Newman knew tipper breach fiducairy duty and knows tipper has personal benefit,
Newman is not liable


1. Equal access theory

a. Tender offers
2. Classical / fiduciary duty theory
a. Only to those who owe stakeholders new fiduciary duties AND Dirks people
3. 10b5-2
a. Like tender offer; personal relationship of trust and confidence that you can breach if
i. You agree to keep information confidential
ii. History of sharing confidences
iii. Close familial relationship (this is on appeal right meow)

b. Separate from classical and misappropriation theory; creates own relationship in and of itself
4. Misappropriation theory

United States v. OHagan; p. 663-666

Partner at firm not working on particular transaction (so not temporary insider)
His partners are working for Grand Met, who are thinking of buying Pillsbury
OHagan gets information because of billing data, makes $4.3M in two months
OHagan thinks that he is Chiarella because of relationship of trust and confidence, must be with stock
you are trading
Here, OHagan worked for firm working for the bidder and bought stock in the target company
Ginsburg lays down the law of Misappropriation Theory
How did OHagan acquire material non-public information?
From firm billing (and no relationship)
Court says you can have relationship of trust and confidence with SOURCE of your information (picks up all
those outsiders)
Leaps away from target and focuses on source of information
Relationship of trust and confidence with law firm (punctilio)
The 2 theories are complementary, government applies either classical or misappropriation,
depending on the case
What about associates?
No way paralegals and facilities people owe fiduciary duty like partners do
Restricted list creates 10b5-2 situation
You are TOLD you cant trade, so now if you trade, you are breaching your OWN personal
relationship with the firm of trust and confidence
We know it, at least, goes to brokers

What happens if company hires janitorial services? Is partner liable if she says to a janitor we are getting read to make a
big deal?
Janitor probably has requirement to never look at the trash
Absent this, probably really hard to prove
Partner tells son shes been working late because of launch, son is broker, is she liable here?
Basically unless you have a relationship of trust and confidence, you can trade info BUT DONT


With insider trading its SEC. but who enforces when director pay too much?
We need someone to stand up for shers when directors breach fiduciary duty of loyalty or care
Shers dont have money or time to pursue litigation in these instances, so how do we neofrce?
Director action = your sher is harmed b/c the corporation is harmed


Actions that hurt you as a stock holder
Ex. board makes disclosure into marketplace, so if you said you made decision on inaccurate info, you are
Corporation was harmed
Litigation incentives?

Fletcher v. AJ Industries; p. 380-382 (attorneys fees)
bar brings suit (finds Fletcher to serve as named )
Employment agent elects 2/9 directors
Replaces 4 directors and hire new CEO (replace
Arbitrate monetary claims (save $200k)
Can a lawyer get paid?
Isnt really a common fund
Problem = no $ came back to company (excessive compensation not yet paid)
Court adopts substantial benefit rule
Attorney can still be paid even if benefits non-pecuniary . . . as long as substantial benefits (p. 382)
Why have this rule?
We want attorney to take these cases because we assume these fiduciary duties mean something (no
sher will bring this suit)
Derivative suit is the only way to enforce fiduciary duty


1. Standing
a. FRCP 23.1:
i. has to be sher at time of disputed transaction
ii. Demand requirement: sher articulates actions she took to get board to sue itself (determining who to sue =
biz transaction)
1. Make requirement to board to sue itself OR reasons she didnt (e.g. futile to do so)
iii. Sher adequately represent interest of all shers
2. Judicial Oversight
a. Demand requirement: on board or state reasons not to (e.g. futile to do so)

Levine v. Smith; p. 388-391


Ross Perot case (i.e. Donald Trump of his time)
Sold company to GM in exchange he got shares (0.8%) but became largest sher and sits on board of directors
He thinks GM is run by idiots, regularly gives interviews stating that he knows managers are idiots
Board of directors buys his stock for $43M
Ross agrees to not compete or criticize the managers
bar sees this and says this is a loyalty breach for sure
You used our $$$ to buy his silence, standing on both sides of transaction!
Shers sue directors, board; sue yourselves, but shers SKIP demand step and sue
Board says, the sher didnt demand
Sher says fuck you, it would have been futile!
How do we figure out if demand is futile?
Aronson Test - clarified by Levine
(1) whether director is disinterested or independence is rebutted by well-pleaded facts,
(2) whether complaint pleads particularized facts to create reasonable doubt that challenged transaction
was product of valid exercise of business judgment (BJR)
Board either conflicted or
Uninformed or grossly negligent
What does sher need to plead?
Board interested in transaction or dominated by someone who is (loyalty)
Challenged transaction unlikely to receive BJR protection either because board is uninformed or
otherwise behaved in grossly negligent manner (care)
Transaction so egregious it is wasteful (overcomes BJR)
So the court becomes the referee who decides if the case goes on
Inserts court into process prediscovery [and pre board just writes a check] to make sure litigation is
based in some substance to see if board did manage breach of duty of care or loyalty
If you bring, you concede Board can evaluate demand and makes determination, acts on
informed basis, good faith, and no conflict (everything you conceded by making a demand)
The board is then afforded BJR
You conceded to the board to evaluate it
SO, screening function under Aronson means that basically no sher makes demands to board because of BJR

October 25, 2016

(ASSIGNED: 400-417, 422-426, 233-239,
421-422, 246-247, 311-313)

Review & Recap

Bases for Duty to Disclose or Abstain
Misappropriation Theory
OHagan: a duty to disclose or abstain arises from misappropriation of confidential information in breach of a
duty owed to the source of the information duty of loyalty to his partners
Derivative Actions
SEC charged with insider trading, DOJ for criminal
Breaches of fiduciary duty no govt enforcement, so we rely on the plaintiffs bar (this is a feature, not a prob)
no single sher will ever bring action, because will have to pay all litigation costs but only get pro rata
A.J. Industries: substantial benefit rule (attorneys can be paid from the corporate treasury as long as
they generate substantial benefit to corp) replaces common fund doctrine (limited atty to recovery of
monies that was returned to corp; e.g. $100k returned to corp, then attorneys only paid from that fund
and not the corporate treasury)

Board has very strong incentive to settle
Plaintiffs attorneys also want to settle because theyre only paid out after
rely on the COURTS to control the litigation
Get rid of strike suits
Board will settle even if its non-meritorious suits
Standing requirements
When shers have been harmed because board of directors have operated in negligent way; easy to find
sher to satisfy standing reqs
Rule 23.1:
(1) Contemporaneous ownership
(2) Demand / demand futility
Levine v. Smith: (Aronson Test for futility of demand)
We the court will agree with you the complaining sher that the board of
directors is disabled, for some reason incapable of fairly evaluating this
demand whether to bring suit against corp or some subset of directors
Directors lack independence (financial interest in transaction,
conflicted by the transaction)
Directors failed to exercise due care (reasonable doubt that the
transaction is protected by the business judgment rule; transaction
itself reflects that prior actions dont receive BJR protection)
(3) Fairly represent all shers

Rales v. Blasband; p. 393-399

Easco Hand Tools owned by Blasband; significant portion (52%)
owned by the Rales Brothers
Easco issues a bunch of bonds, claims to invest in the business;
excess into Treasury bonds
Instead, buy bonds in other companies to support Mr.
Claim is that breach is helping Millken
Rales brothers elects Danaher Corp Board, wants merger with
Blasband wants to sue Easco hand tools, but in merger
his shares were swapped for shares of Danaher Corp
What is the appropriate standard for thinking about the futility of demand?
Is Blasband exvused from making demand on Board of Directors because it would be futile to do so?
What is a double derivative suit?
Double derivative suit; Blasband is suing Danaher to tell Easco to sue itself
p. 394 - a sher of a parent corp seeks recovery for a cause of the action belong to a subsidiary corp
Thus cannot use Aronson Test
Inapplicability of Aronson Test
When Blasband sues, hes suing Danaher; complaining about use of bonds to invest in other Milliken
offerings; Easco hand tools board was the one to make that
When court evaluates futility of demand, doesnt use the Aronson Test
What test is used to determine futility of demand?
p. 395 - not Aronson, because Board considering the demand didnt make the biz decision which is
being challenged in the derivative suit
A trial court must determine whether or not the particularized factual allegations of a derivative
sher complaint create a reasonable doubt that, as of the time the complaint is filed, the board of
directors could have properly exercised its independent and disinterested biz judgment in

responding to a demand
How might (complaining) shers demo that the directors are interested and so incapable of properly exercising
their biz judgment in rejecting the demand?
Dont look at the transxn
p. 397 - A director is considered interested where he or she will receive a personal financial
benefit from a transxn that is not equally shared by the shers. Directorial interest also exists
where a corp decision will have a materially detrimental impact on a director but not on the
corp and the shers
the mere threat of personal liability for approving a questioned transxn, standing
alone, is insufficient to challenge either the independence or disinterestedness of
Suit must be rejected because shers did not bring demand


Litigation incentives
Mechanisms for controlling lit
Standing reqs
Judicial oversight
Settling litigation
Protection from costs of litigation
Indemnification and insurance
Statutory / doctrinal developments

Zapata Corp v. Maldonado; p. 400-406

June 1975 - ten directors in Zapata corporation
June 1979 - six directors, because four have retired and not replaced
Appoints two new directors (not on board to form a new
committee to evaluate the claims that Maldonado wants them to
Finds that will not bring suit (two directors up for
Demand is futile, how to evaluate the actions of special committee?
p. 402 - section 141(c) . . . board of directors can create a committee and delegate powers that the board of
directors has
p. 404 - special committee must conduct objective and thorough investigation . . . may cause its
corporation to file a pretrial motion to dismiss in the Court of Chancery. The basis of the motion is the
best interests of the corporation, as determined by the committee . . . thorough written record of the
investigation and its findings and recommendations
JMM: the shareholders pay
Means that the directors on the committee will always hire bankers and all this shit, because
shers pay and the directors get the benefit
What test? (Zapata Test)
p. 405 - First, special committee must be independent and operate in GF
Corporation bears burden of proving independence, good faith, and reasonable investigation
Second, after first step, Chancery Court discretion . . . determine, applying its own independent business
judgment, whether the motion should be granted
only thing in DE canon where no BJR protection
What factors should the Court consider in applying the permissive second step of Zapata test?
p. 405 - special consideration to matters of law and public policy in addition to the corporations best
p. 402 - a demand, when required and refused (if not wrongful), terminates a shers legal ability to initiate a
derivative action. But, where demand is properly excused, the sher does possess the ability to initiate the action

on his corps behalf
p. 404 - we must be mindful that dirs are passing judgment on fellow dirs in the same corp and fellow
dirs, in this instance, who designated them to serve both as dirs and committee members
J. QUILLEN OP (Recall Gagliardi v. TriFoods - suboptimal risk)

In re Oracle Corp. Derivative Litigation; p. 406-413

J. Strine now is CJ of DE supreme court
Gov of DEs chief of staff comes from a world that is
very different from academia
Ellison is CEO, chair of board of dirs, owns about 25% of
outstanding shares of Oracle
All of them (word missing behind head is Boskin) sell before
announcement trading on material non-public information
Appoints two brand new directors
Garcia-Molina (Stanford compsci)
Grundfest (Stanford law school)
Got $20k for research after speech
Lots of money was given to Stanford, corporate gifts
How should the DE chancery court complete the first step in the analysis under Zapata?
What facts does VC Strine consider important in analyzing the independence of the members of the special
litigation committee?
p. 411 - DE law should not be based on a reductionist view of human nature that simplifies human
motivations on the lines of the least sophisticated notions of the law and economics movement
Thickness of human relations
p. 404 - Nor should our law ignore the social nature of humans. To be direct, corporate
directors are generall the sort of people deeply enmeshed in social institutions. Such
institutions have norms, expectations, etc.
How does consideration of a complex ciew of human nature (includinf social nature of humans) impact the
independence analysis of Zapata test?
p. 413 - the independence inquiry recognizes that persons of integrity and reputation can be
compromised by their ability to act without bias when they must make a decision adverse to others with
whom they share material affiliations.
What roles does procedural posture (demand excused or demand futility) of case play?
At point of demand futility - Board of dirs here was interested in the transxn or dominated by someone
who is (Ellison)
p. 411 - Special litigation committees are permitted as a last chance for a corp to control a
derivative claim in circumstances when a majority of its dirs cannot impartially consider a

Joy v. North; p. 414-417 (opposite of Strine stance - make biz decisions)

Ross Perot case (i.e. Donald Trump of his time)
How should DE chancery court complete the second step in analysis under Zapata?
p. 416 - Judicial scrutiny of special litigation committee recommendations should . . . be limited to a comparison
of the direct costs imposed upon the corporation by the litigation with the potential benefits
Trick is finding these potential benefits
Which lit costs does J. Winter instruct trial courts to take into account?
p. 415 - attorneys fees and other out-of-pocket expenses related to the litigation and time spent by corp
personnel preparing for and participating in trial
Potential benefits?
p. 415 - a trial court should determine . . .the likely recoverable damages discounted by the probability of

a finding of liability
Is litigation just like any other decision?
Some of lit = strike suits, reputation ramifications is inconceivable!

Does Winters approach mean that trial court will mimic a loyal (committee of a) board of directors?
Should these types of decisions be left solely to a committee of the board of directors?
Probably why we relegate some authority for review by courts
Reductionist view = cant assume that special committee is completely independent


Most litigation is settled shers are paying the settlement

Verdict at trial Settlement

Benefits Benefits
Recovery to (change in) corporation Limited - Litigation expenses, negative publicity

Costs Costs
Very large Very little
Litigation expenses Most are nuisance settlements
Negative publicity Recovery to (change in) corporation

Carlton v. TLC Beatrice Intl Holding; p. 422-424

Lewis dead
What is std of review for evaluating decisions to settle derivative
p. 424 - the court does not attempt to make substantive
determinations concerning disputed facts or the merits of the
claims alleged . . . instead the court considers whether
How does the Chancery Court conduct the analysis required by
the first step of the Zapata test?
Mr. Lewis is dead
p. 424 - First, the SLC and its counsel proceeded in good faith . . . Second, the conclusions
reached by the SLC, which formed the basis for the amount of the proposed settlement, were
well informed by the existing record. Third, the proposed settlement falls within a range of
reasonable solutions to the problem presented. Finally, to the extent I am required by the second
step of Zapata, uncomfortably, to exercise some form of independent judgent concerning the
merits of the settlement, I cannot conclude that it is badly off the mark
It must have been designed to offer protection for cases in which, while the court could not consciously
determine on the first leg of the analysis that there was no want of independence or GF, it nevertheless
felt that the result reached was irrational or egregious or some other such extreme word

October 27, 2016

(ASSIGNED: 427-440, 442-450)

Review & Recap

Derivative Actions
Controlling litigation plaintiffs bar brings, not really shareholders; board of directors has a strong incentive to settle
Judicial oversight when demand is brought upon the board of dirs
Levine v. Smith Aronson Test
Rales v. Blasband double derivative suit (different board of directors), directors interested (benefit
or harm that differs from shers) at the time the complaint is filed
What happens after demand has been found to be futile?
141a: biz and affairs all managed by the board of dirs
Board creates a special committee
Zapata Corporation: DE sets standards for which acts of board are reviewed
Special litigation committee
Corporation proves independence, good faith, and reasonable investigation
Court may apply its own independent business judgment
This is about meritorious, very different from like what should we pay CEO
Oracle: (J. Strine)
Independence inquiry - court must be cognizant of the bias that results from sharing material affiliations
Joy v. North: courts business judgment comparison of direct costs and potential benefits (expected value
calculation of potential benefits)
What happens when the litigation is settled?
TLC Beatrice Intl: settlement subject to review under Zapata
Traditional review of independence of committee
Deferential review using independent business judgment

indemnification insurance

Reimburse Reimburse
Directors and officers Corporation
Litigation expenses Payments to directors and officers
Settlement costs

Directors and officers
Litigation expenses
Settlement costs
When corporation is unable to pay


Call options CEO has right to buy a share of stock
The right to buy a share of stock at a specified price for a specified period of time
Exercise (strike) price
Maturity date
Future contract
The obligation to buy or to sell an asset at a specified time in the future at a price agreed upon today
Delivery date
Futures price

Waltuch v. Conticommodity Services, Inc.; p. 233-238


Plaintiff, Norman Waltuch, sought indemnification for unreimbursed legal expenses from his former employer,
Defendant Contcommodity Services, Inc., after he defended himself from investors and the Commodities Futures
Trading Commission (CFTC) for work performed while working for Defendant
Waltuch dude wants indemnification under 145 for expenses for private lawsuits
$35M settlements / $1.2M legal expenses
$100k fine / $1M legal expenses
Is Waltuch entitled to reimbursement or legal expenses?
p. 236 - grant of indemnification rights cannot be inconsistent with the substantive statutory provisions
of 145, notwithstanding 145(f) [which provides that the right to indemnification under Section 145 is
not exclusive] . . .
DGCL Section 145(a)?
Gents favorite part ever
p. 236 - subsections (a) applies to 3P actions, and (b) applies to derivative actions
Both (a) and (b) require the office to have acted in GF
DGCL Section 145(c)?
p. 237 - unlike 145(a), which grants discretionary indemnification power, 145(c) affirmatively
requires corps to indemnify their respective officers and directors for the successful defense of certain
no surprise that some number of suits against directors will be nothing more than strike suits
p. 238 - vindication, when used as a synonym for success under 145(c) does not mean moral
exoneration. Escape from an adverse judgment or other detriment, for whatever, reason is determinative
Here, Waltuch was sued, and the suit was dismissed without his having paid a settlement . . .
Once Waltuch achieved his settlement gratis, he achieved success on the merits or otherwise
This conclusion comports with the reality that civil judgments and settlements are
ordinarily expressed in terms of cash rather than moral victory . . .


Litigation incentives
Mechanisms for controlling lit
Standing reqs
Judicial oversight
Settling litigation
Protection from costs of litigation
Indemnification and insurance
Statutory / doctrinal developments

DGCL Section 102(b)(7)

102 generally provisions in cert of incorp, (a) is about required information, (b) is information you could include but not necessary
The certificate of incorporation may also contain . . . a provision eliminating or limiting the personal liability of a director . . .
for monetary damages for breach of fiduciary duty as a director
Provided that such provision shall n ot eliminate or limit the liability of a director
(i) for any breach of the directors duty of loyalty
no monetary damages for breach of duty of care, but can get injunctive relief
(ii) for acts or omissions not in GF or which involve intentional misconduct or a knowing violation of law

Stone v. Ritter; p. 311-313

p. 312 - The fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary conflict of
interest. It also encompasses cases where the fiduciary fails to act in GF.

Walt Disney Company, Inc.; p. 311-313

p. 312 - fiduciary conduct that is motivated by an actual intent to do harm constitutes classic, quintessential bad faith
p. 312 - conduct that involves an intentional dereliction of duty, a conscious disregard for ones responsibilities . . . is
properly treated as a non-exculpable, non-indemnifiable violation of the fiduciary duty to act in good faith.


Transactions in control (blocks / positions)
Control premia
Sales of control blocks (duty of seller)
Market rule
Exceptions to the market rule
Purchases of control blocks (tender
offers) (duty of buyer)
Combination of companies (M&A)
Control contest (hostile bids / takeovers)



Efficiency enhancements
Private benefits of control
When control changes hands, about a 30% premium, up to 100% or more


Zetlin v. Hanson Holdings; p. 430-431

Breach of duty of loyalty by selling shares
Sells shares to Flintkote at twice the price of market price
Demand futility hearing
Special litigation committee
Are minority shers entitled to sell their shares at the same price as
the controlling shers?
Can minority shers share in the premium (make Flintkote
buy them all at same price)?
Court finds de facto control of Sylvestri fam
p. 430 - it is undisputed that the 44.4% acquired by Flintkote represented effective control of Gable
p. 431 - the premium is the added amount an investor is willing to pay for the privilege of directly
influencing the corporations affairs
What is the market rule?
Controller gets to sell at whatever the market will bear
p. 430 - absent looting of corporate assets, conversion of a corporate opportunity, fraud or other acts of
bad faith, a controlling sher is free to sell, and a purchaser is free to buy, that controlling interest at a
premium price
What are the consequences of the market rule for sales of controlling positions (control blocks)?

Virtually no oversight you negotiate with the controlling position


Perlman v. Feldmann; p. 431-436

Plaintiffs and Defendants were shareholders in Newport Steel.
Newport Steel provided steel sheets typically to regional
customers because their facilities were outdated. Due to the
Korean War, steel was at a premium and it turned Newport Steel
into a more profitable venture.
Newport began updating their facilities, but a third party, Wilport
Company, bought Defendants shares in an effort to secure more
steel output.
The over-the-counter price for the shares was $12 and
the book value was $17.03, but Wilport paid $20 per
share to Defendants. Plaintiffs sued to receive the same premium (attributable to the sale of corporate
power) for their shares, and the trial court denied their claims.
p. 431 - Plaintiffs contend that the consideration paid for the stock included compensation for the sale of a
corporate asset, a power held in trust for the corporation by Feldmann as its fiduciary
p. 433 - in the past Newport had used and profited by its market leverage by operation of what the
industry has come to call the Feldmann Plan . . .
The funds thus acquired were used to finance improvements in existing plants and to acquire
new installations
What is the source of Feldmanns fiduciary duty?
p. 432 - both as a director and as a dominant sher, Feldmann stood in a fiduciary relationship to the
corporation and o the minority shers as beneficiaries thereof . . .
Although the Indiana case law is particularly relevant to Feldmann as a director, the same rule
should apply to his fiduciary duties as a maj sher, for in that capacity he chooses to control
What does this fiduciary duty require?
p. 433 - CARDOZO quoted re: puncitilio of an honor the most sensitive Feldmann is gonna lose and
hes gonna lose big
The actions of Feldmann in siphoning off for personal gain corporate advantages to be derived
from a favorable market situation do not betoken the necessary undivided loyalty
Does the appellate court reject the market rule?
No, doesnt reject
p. 434 - we do not mean to suggest that a majority sher cannot dispose of his controlling block fo stock
to outsiders without having to account for his gains
EXCEPTION IS THUS but when the sale necessarily results in a sacrifice of . . corporate
good will and consequent unusual profit to the fiduciary
So in a time of market shortage, where a call on the corporations product commands
an unusually large premium, in one form or another, we think it sound law that a
fiduciary may not appropriate to himself the value of this premium
(Pretty hard to figure out where this exception is)
Why might we prefer the market rule to the equal opportunity rule?
Probably efficient in the KH sense, just compared to the status quo
Same question, vice versa?
If we have unusual market situations, might want the equal opportunity rule
Difficulty is defining unusual market situations

Peculiar situations?
When Im trying to sell my corporate office (p. 448)
Directors currently in power can appoint new directors to fill vacancies
If you surveyed all of these cases, youll find that the court determination doesnt turn on size of premium, but it turns on
what happens next (e.g. replacement of officers)

Republic Corporation Lin Broadcasting Corporation

CEO had 10% block for a very small premium (less than 5%) CEO had 4% block and sold at a 35% premium
Old directors resign, appoint buyers designees as directors Appoint buyers designees, CEO, two directors
New directors re-elected CEO fired

NOT A SALE OF OFFICE, allowed transxn to stand WAS SALE, court didnt allow transxn to stand

Carter v. Muscat (NY 1964) Brecher v. Gregg (NY 1975)

November 1, 2016
(ASSIGNED: 450-452, 459-464,
469-478, 487-491)

Review & Recap

Derivative Actions
Protection from the costs of litigation
Indemnification insurance: corporations themselves will reimburse dirs and officers for defending themselves;
corp purchases to reimburse under indemnification provisions
145(a) - can reimburse dirs and officers for costs of defending actions took in GF when suits brought directly
(b) is for derivatives
ContiCommodity: permissible indemnification (so long as acting in GF) required
reimbursement (so long as successful)
Waltuchs bad conduct, corp was required to reimburse him because he was successful
(escaped liability because the corporation paid the fine)
Statutory and doctrinal developments
102(b)(7) - provision of the charter; no monetary damages unless breach of duty of loyalty, acts in bad faith, or
knowing violations of law
No monetary damages for breach of duty of care
TLC Beatrice Intl: payment of money from the dirs to the corporation
Bad Faith - (second component) of duty of loyalty (together with conflicted transxns)
Stone v. Ritter: component of duty of loyalty is bad faith
Walt Disney Co: no conflict between dirs and officers of organization
Intentional dereliction of duty, conscious disregard for responsibilities beyond gross negligence
Structural transactions
Transactions in control (blocks / positions) - e.g. DD owns 60% of the shares, all you have to do is buy his shares
from him and control the company
Control premia - price for control
Premium over market price due to efficiency enhancements, private benefits of control (agency costs)
Separate efficiency
Hansen Holdings: de facto control (e.g. 40% of the shares, less than 50%) determined case-by-case
De jure control is 51%
Control premium need not be shared with minority shers

Perlman v. Feldmann: controlling shers ower the same fiduciary duties as directors
Punctilio of an honor the most sensitive (remember seeing that in closely held corps)
When a market shortage creates an unusually large premium
A controlling sher may not take the value of premium for himself (must share)
Trick here is that the Ct is explicit that its not overruling the MARKET RULE
In most cases, controlling sher can sell at premium without sharing premium
UNLESS market shortage that creates unusually large premium (e.g. price controls,
going to war in the U.S.)
Feldmann plan designed to get money it needed to maintain/modernize its facility
Recall Wilport only wanted steel concern of the court is that what Wilport co. was
going to do was essentially run Newport Steel into the ground
Sale of Office small stake, like 10% or less
Carter v. Muscat / Brecher v. Gregg
Determined by reference to size of block (how big it is compared to controlling position), amount of
premium, subsequent treatment of new directors and officers (what happens next - dirs must stand for
reelection after appointment in next annual meeting)
Court finds illegal sale of office when dirs arent retained; just a sale of stock when dirs are
Sale to Looters taking all the money of a corp, bankrupt it
Controlling shareholder owes duty of care not to sell to looters
Perlman v. Feldmann / Harris v. Carter
Recall like the red flag doctrine under Allis v. Chalmers (cause for suspicion)
If theres something that gives controlling sher cause for concern that person buying is going to loot the
corporation, then has affirmative obligation to not sell to that looter


Delphi Financial Group, Inc.; p. 442-448 (shers are idiots case)

Rosenkranz (class B shares) - 49.9% (13%)
He is an old dude tryna retire
Shers (class A shares) - 50.1% (87%)
Put into their charter that, if Rosenkranz were to sell Class B shares, then they would get to sell shares
for same price
TMH Company - Rosenkranz negos really hard with them and gets them to agree to pay $45/share while stock
was at $22 market price
Negod for $45 + $1 dividend paid out
Rosenkranz wants $59 for himself, $43 for Class A shers
Gets Board to agree for $45/$53 split; 76% premium
Must Rosenkranz share the premium he received for his Class B shares w/ the holders of the Class A shares?
Such distribution payment shall be made ratably on a per share basis among the holders of the Class A common
stock and the class B common stock as a single class
p. 446 - nevertheless, the Delphi Charter [restricts] . . . Rosenkranzs power . . . [It] provides that, in a merger,
the Class A shers and the Class B shers must be treated equally
p. 446 - despite a contrary provision in the Delphi Charter, Rosenkranz, in breach of his contractual and
fiduciary duties, sought and obtained a control premium for his shares
Why is the charter provision so important?
Wouldve paid more because expected there would be a change of control (shers)
p. 447 - The Delphi Charter gives the Class A shers the right to receive the same
consideration in a merger, as received by Rosenkranz. I assume that the shers in return for the

protection against differential merger consideration . . . paid a higher price for their shares
Shers prob paid for the protection in that charter
How does DE treat charters?
Like a contract
p. 447 - Our Supreme Court has stated that a corporate charter, along with its accompanying bylaws, is
a K between the corps shers. Inherent in any Kual relationship is the implied covenant of GF + FD
Did Rosekranz violate that covenant?
p. 447 - Presumably, Rosenkranz, clear of any impending sale, could have purchased the right to a
control premium back from the [Class A] shers through a negod vote in favor of a charter amendment.
But to . . . allow him to coerce such an amendment here would be to render the charter rights illusory
Clear coercion!
p. 447 - Plaintiffs are reasonably likely to be able to demo at trial that in negotiating for
disparate consideration and only agreeing to support the merger if he received it, Rosenkranz
violated duties to the shers
What is the remedy?
Stick with Rosenkranz or not get this money at all!
If shers make fully informed vote, then DE court will not overrule
Court falls back on this shers get to vote excuse
It takes a lot to set aside a sher vote on an informed basis
p. 447 - It is preferable to allow the shers to decide whether they wish to go forward with the merger
despite the imperfections of the process leading to its formulation


Transactions in control (blocks / positions)
Control premia
Sales of control blocks (duty of seller)
Market rule
Exceptions to the market rule
Purchases of control blocks (tender
offers) (duties of buyers)
Combination of companies (M&A)
Rationales / influencing factors
Assets & liabilities transfers
Control contest (hostile bids / takeovers)


Control premiums come from efficiency enhancements or private benefits of control looking for efficiency
A little messier when company is not subject to a controlling sher
Tender offer: I will buy any and all shares at a price of $X per share, so long as at least 51% of the outstanding shares are
tendered to me for purchase
When shers promise to sell their shares (tendering)
Typically this is done by some other organization (like another corporation as acquiror/bidder)
Corporation itself (seller/target)
Against opposition from board of directors (hostile)
With support of board of directors (friendly)
is just a way to buy shares in the marketplace, without influencing yourself; a technique

Acquisition of 5% (10%) Block (Section 13(d))
Disclosure and amendment requirements

Gives loyal board of dirs to hire investment advisors, maybe get a bank loan to launch its own tender offer, etc. to
defend against this sort of corporate raider (Gekko)
Tender Offer (Section 14(d) / Section 14(e))
Disclosure and amendment requirements TO; if borrowing money, etc.
Substantive requirements
Time period / withdrawal periods (about a month)
Allows for the board of dirs to start making investor calls after notice that Gekko got himself 5%
of the shares, gives them a month to come up with an alternative plan
Equal treatment of shers
designed to make sure that the market knows what is happening
only part of federal securities whatever with regulation


Transactions in control (blocks / positions)
Control premia
Sales of control blocks (duty of seller)
Market rule
Exceptions to the market rule
Purchases of control blocks (tender
offers) (duties of buyers)
Combination of companies (M&A)
Rationales / influencing factors
Assets (& liabilities) transfers
Control contest (hostile bids / takeovers)


One reason to pay premium for combination price is due to efficiency enhancements
EX: DD combined with Baskin Robbins, save on sugar, efficiency gains due to synergies
Want our laws to encourage this
Wealth transfers (from shers)
EX: why would DD pay the 30% premium? Because only need 1 of each executive, same with delivery drivers)
Law doesnt give a shit about this (minimize or ignore)
Mistakes (value destruction)
EX: AOL / TWC merger put TW content on AOL internet interface; lost $100B in 10 years thanks to Youtube
Law should eliminate this


Whip together assets and liabilities; acquiring company gives them cash to buy out the target company
If just payment of cash, then no need for creation of new stock
Trick is that it doesnt have to be cash, acquiring company can just pay with stock to the target companys shers
Can also give target cos shers bonds bonds cant vote, dont have cash and cant make a decision

DGCL 271:
(1) board approves sale of assets,
(2) shareholders have to vote to approve it

Katz v. Bregman; p. 470-471


Corp attempted to sell assets that constituted more than 51% of the corps total assets and generated about 45%
of the net sales; when the directors did not hold a shareholder vote to approve the sale, the shareholders who
were opposed to the sale sued to stop the sale

What constitutes substantially all?
Shers claim this is substantially all - say this deal is shit, because Universal is offering more to shers
Volcan probably offered the directors jobs or something like that (which would explain why they are
going with worse deal)
Making plastic drums is a radical departure from making steel drums according to the court
So preliminary injunction with going forward with action until shareholder vote
based on 271(a), an asset sale of this magnitude required a shareholder vote.
Delaware law says more than 50% assets is substantially all
Ways to fix it:
(1) Thorpe v. Cerbco: SCOTUS says substantially all transaction on quality in addition to
quantity (is transaction out of ordinary) AND substantially affects existence and purpose of
SCOTUS FIXES THE FUCK-UP; takes into account qualitative effects
(2) Hollinger Intl v. Black: (STRINE opinion)
p. 473 - A fair and succinct equivalent to the term substantially all would be
essentially everything.

Forward triangular merger: Reverse triangular merger:

November 3, 2016
(ASSIGNED: 502-529)

Review & Recap

Tender Offers (Duties of Buyers)
Williams Act 13(d): acquisition of 5% and then 10% there are disclosure requirements about holding for long term, etc.
(what they want to do with the stock)
Disclosure requirements including amendments
14(d) / 14(e): when you tender (d); or when company tenders (e) will buy any and all shares (tender offer)
Disclosure requirements (terms of the loans, etc.)
Substantive requirements (time period / withdrawal rights)
Equal treatment / best price everyone gets equal treatment in getting best price

Combinations of Companies
Efficiency enhancements society want Ct to select out
Wealth transfers society no care about this really
From stakeholders to shareholders (e.g. employees)
Mistakes (value destruction)
Integration failures / empire building (e.g. expanding the company)

Assets (and Liabilities), Stock, and Mergers

Purchase assets and liabilities from corporation
Negotiate with board of directors
DGCL Section 271: sale of all or substantially all assets approval by board, then shers approve by majority
Katz v. Bregman: determining what is substantially all assets for purposes for Section 271
Requires an evaluation of the context of the sale
Subject to significant transaction risk (incompletion)
Regulated by
market rule (and exceptions) (duties of selling controlling shers)
Williams Act (duties of purchasers) (from dispersed shers)
Pretty much everything here is a tender offer
Mergers are magic


Rationales / Influential Factors
Methods / classifications
Assets (and liabilities) stocks, and
Controlled corporations
Control contests (hostile bids / takeovers)
Market for corporate control
Defending against takeovers
Managing takeovers
Certainty of sale
Uncertainty of sale
Negotiated (friendly) sales

Determine how to merge
What do the acquired cos shers get? Give them cash AND/OR stock AND/OR bonds
Then you are required to disclose (certificate of merger)

regular merger v. triangular merger

DD can quite easily borrow money
Dummy corporation created to subsume target company (usually created the night before to avoid

Negotiate agreement
to see which corporation will be the surviving corporation
Representations and warranties about what is true about company, etc.
Conditions to completing the transfer (closing)
Price (discounted cash flows)
Obtain approvals
Board of dirs and shers
E.g. antitrust review
File certificate of merger
Make commercial and regulatory filings

Significant Risks
Minimal transaction risk (that shers will vote against you) very small risk because there is a significant premium
50% of shers voting (usually the target company is the shers that vote)
As opposed to a tender offer, shers may decide not to tender, e.g. want to buy 90% of the company and 20% decide
not to tender, then you wouldnt get 90%
Clear advantage is that:
You can do whatever you want to do
And minimal transaction risk
Unexpected business risk that merger doesnt work the way it should work

DGCL 251:
(a) any 2 or more corporations . . . may merge into a single corp, which may be any 1 of the constituent components, or one
that you make up
(b) board of dirs each corp most approve and recommend to shers
(c) when the transxn is big enough, both sides of shers must agree (unless not huge; e.g. Facebook buying WhatsApp, then
only WhatsApp shers voted)
once cert of merger is adopted, thats the end of the merger and the two companies are now one


How to get rid of a company?

Tender offer - buy any and all shares - problem is that not every shareholder would tender

More likely the sher doesnt know that they have the shares (e.g. death in fam, unsure when to tender, very short
time period to tender)

If merger consideration is cash, then theyre done - whenever they realize they have shares, you just pay off
CREATE an acquisition company
Elects board of dirs, merges DD into this one
Pays cash
51% of shers approve measure; doesnt matter what other 91% want
Anything above 90% is none as SHORT FORM MERGER under DGCL 253
Can skip the sher vote
Squeezing out minority sher
Because sher vote is expensive
Just tell everyone what youve done
(a) you just tell shers what youve done prepare a disclosure statement that tells them the terms and
conditions of the merger, dont bother wih a vote
File with Secretary of State - hello shers, your shers are now worth $14/share in cash, please
come and collect
Claim of inadequate (unfair) price (appraisal proceeding)
If price is found unfair, then you get the difference, not the other shers
(a) any sher . . . who holds shares of a stock on the date of the making od a demand . . . .
who continuously holds such shares thorugh the effective date of the merger or
consolidation, . . . and who has neither voted in favor of the merger or consented
Cant vote in favor of merger
complaining sher will have your own experts, etc. to testify re: fair value of the
shares (DCF - under firm foundation, comparative analysis - castle in the
Court will decree where fair price is $X
(b) appraisal rights only in 251 merger or 253 merger (quasi-appraisal proceedings)
You dont get them in sale of ALL assets
(1) dont get appraisal rights if stock is liquid
(i) traded on exchange
E.g. widely traded? You can just sell them on the exchange?
(ii) held of record by more than 2,000 holders
(2) you get appraisal rights if you are paid cash
The only time you get to obtain value from the company as a
ADVANTAGE: Limited remedy where courts will determine fair value of shares, your
only complaint needs to be PRICE
DISADVANTAGE: you are financing the litigation and shit is $$$ EXPENSIVE $$$

Claims of breach of fiduciary duty very rare, because shers paid for all of these lawyers, audit, etc.
Duty of care
Duty of loyalty (including claims of bad faith)


Rationales / Influential Factors
Methods / classifications
Assets (and liabilities), stocks, and
Controlled corporations
Control contests (hostile bids / takeovers)
Market for corporate control
Defending against takeovers
Managing takeovers
Certainty of sale
Uncertainty of sale
Negotiated (friendly) sales

separate ways of combining businesses (assets/liabilities, stocks, mergers)
most of that is tax driven
Recall UOP, Inc.:
56% of the minority shers vote on the merger, with 51% of
this group voting in favor of it
Ct said: of course this is breach of duty of loyalty - different
if company had created a special committee
Entire or intrinsic FAIRNESS
Fair process + fair price
fair price can overcome deficiencies in
fair process
Conflicted transactions, intrinsic fairness is std of review
Fair process (special committee) and fair price

Kahn v. Lynch Communications Systems; p. 505-509

Kahn to be named plaintiff claim for breach of duty of loyalty
Lynch Comms would like to expand biz by buying Telco Systems
Because of terms of charter, Alcatel has to approve all the
Alcatel could block, because there is a charter provision
Should buy Celwave system (which is owned by
french company)
Squeeze out/cash out
Lynch $17, Alcatel $14
Alcatel tries $15.25, $15.50
Alright, thats it! (says Alcatel) we are going to
launch a tender offer at that $14 price
Going to announce to shers and Kahn, conditioned on getting at least 90% of the
outstanding shares, which is premium over the existing market price, but less than
shers would have gotten in a merger

Compagnie Generale dElectricites (CGE) (defendant) indirect subsidiary, Alcatel U.S.A. Corporation (Alcatel)
(defendant) held 43.3 percent of Lynch Communication Systems, Inc. (Lynch) (defendant).
Alcatel selected five of Lynchs directors. Lynch wanted to acquire Telco Systems, Inc. (Telco). Alcatel
pushed Lynch to acquire Celwave Systems, Inc. (Celwave), another CGE subsidiary, instead.
Lynchs directors wanted the Telco deal, but Alcatels designated directors on Lynchs board refused,
saying, We are 43 percent owner. You have to do what we tell you.
Lynchs board created an independent committee to negotiate with Celwave. The committee balked after
Alcatels investment bank suggested an unacceptable ratio for a stock-for-stock merger. Alcatel then
offered to acquire the rest of Lynch for $14 a share.
The same committee was charged with negotiating the cash-out merger. The committee
countered and got Alcatel up to $15.50, but Alcatel threatened to make a tender offer. The
committee felt it had no choice but to approve, though it believed the price unfair.
Lynchs board approved, with Alcatels designated directors abstaining.
What is the std of review?
Or Weinberger entire fairness rule
What metric is used to determine whether or not sher is a controlling sher?
p. 507 - ct says you get to set compensation
At the August ` meeting, Alcatel opposed the ernewal of compensation contracts for Luynchs
top 5 mgrs . . . minutes reflect dirs left room . . . and the remaining board members then boted
not to renew the Ks
Alcatel can set compensation
p. 507 - At the same meeting, alcatel . . .
What is the std of review?
p. 508 - entire fairness
SCOTUS HERE MAKES EXPLICIT WHERE THE BURDEN LIES (so it goes with Weinberger and isnt
Burden lies with the corporation to satisfy entire fairness
p. 507 - the initial burden of establishing entire fairness rests upon the party on both sides of the
Kahn represented by a plaintiffs attorney who has to finance the costs of a litigation
How can the burden be shifteD?
Can shift it onto the complaining sher
p. 508 - have an independent committee that satisfies its duties OR transxn is approved by
majority of minority shers
However, an approval of the transxn by an independent committee of dirs or an
informed majority of minority shers shifts the BOP on the issue of fairness from the
controlling or dominating sher to the challenging sher-plaintiff
By forcing burden onto complaining sher, gonna have many fewer suits, because of this burden
p. 508 - First, the majority sher must not dictate the terms of the merger . . . Second, the special committee must
have real bargaining power that it can exercise with the majority sher on an arms length basis
Alcatel (in future) would start at low end of the range, make it look like special committee had real
bargaining power, then shift burden onto complaining sher to eliminate most of the suits

Kahn v. M&F Worlwide Corp.; p. 512-520

(note that this is another Mr. Kahn)
Stock price fell, $17/share when a year ago it was trading at $24/share
$25 merger price
MacAndrews & Forbes Holdings, Inc. (M & F) (defendant) was a 43 percent stockholder in M & F Worldwide
Corp. (MFW). M & F proposed to buy the remaining common stock of MFW to take the corporation private.

The transaction was subject to two stockholder-protective procedural
(1) the approval of a special committee to be appointed by the MFW
board of directors, and
(2) the approval of a majority vote of MFW minority stockholders.
The MFW board established the special committee, which approved the
The minority stockholders voted to approve the merger. Kahn, et al.
(plaintiffs) brought suit, arguing that even both protections combined
are inadequate to protect minority stockholders, because directors on
the special committee may be inept or timid and MFW minority
stockholders may be subject to improper influence.
The plaintiffs claimed that the entire fairness standard should apply to the merger. In addition, the
plaintiffs alleged that the special committee was not independent because of various relationships
between members of the special committee and M & F.
What is the std of review for evaluating cash out mergers undertaken by controlling shers that provide procedural
protections to minority shers?
Comparison to Lynch Comms
p. 515 - In Lynch, dirs can shift burden if:
(1) well functioning committee of independent dirs, OR
(2) transxn approved by majority of minority shers
in squeeze out merger, can get BJR
So how can controlling sher avoid an entire fairness review altogether (and receive protection of BJR)?
p. 518 - In controller buyouts, the biz judgement std of review will be applied IF AND ONLY IF:
(i) the controller conditions the procession fo the transcn on the approval of both a special
committee of dirs and a majority of the minority shers
(ii) special committee is independent
basically Weinberger
(iii) special committee is empowered to freely select its own advisors and to say no definitively
(iv) special committee meets its duty of care in engoing a fair price
(v) the vote of the minority is informed, AND
(vi) there is no coercion of the minority
if youve done none of these things, then you as corporation bears the BOP

NO independent committee YES independent committee

NO approval by maj of min BOP (fairness burden) BOP

YES approval by maj of min BOP BJR

November 10, 2016

(ASSIGNED: idk some shit)

Review & Recap

Company Combinations (M&A)
Mergers? Everything happens by magic
Controlled corporations
UOP, Inc. Signal companies case; approved merger by 51%
Conflicted transactions

intrinsic/entire fairness is the standard of review
Fair process (special committee - nego at arms length),
Fair price (how much paid for shares v. mkt price; can overcome a flawed process)
UOP shers have right to receive just the merger consideration
Problem is that this is very expensive
Lynch Comms
cash out merger (squeeze/freeze)-out merger force minority shers to accept case
In a cash out merger by a controlling sher, std of review is entire fairness
But controlling sher can shift burden to complaining sher to show lack of fairness, if the
controlling sher can show the following:
Approval of an effective special committee
Approval of a majority of the minority shers
Plaintiffs attorneys are financing the litigation themselves; will have to show fair process and fair price,
and need gather further material
M&F Worldwide
In a cash out merger by a controlling sher, the std of review can be business judgment
If the controlling sher
Ab initio conditions
We will not go further with this merger UNLESS
approval of effective special committee
the approval of a majority of the minority shers
Now plaintiffs attorneys needs to demo flaw in one of those two things (e.g. directors werent
independent, or that the approval of maj of min was somehow defective/uninformed)

CNX Gas Corporation Shers Litigation p. 521-527

Merger right to receive cash under UOP and M&F
CNX corporation
CONSOL energy (83.5%)
Made tender offer
Shers (16.5%)
T. Rowe price played large role in determining price; wants

What is the std of review for evaluating tender Os by controlling shers (followed by short ferm mergers) to cash
out minority shers?
Does a person/corp making a tender O have a (state law) (fiduciary) duty to pay a fair price?
p. 524 - Solomon the rule tha ta tender Oor has no duty to provide a fair price. But Solomon II did
not involve a freeze-out [of minority stockholders by a controlling stockholder].
... therefore does not hold that controllers never owe fiduciary duties when making tender Os,
nor does it eliminate the possibility of entire fairness for a two-step freeze-out transaction
What is the unified framework (under Cox Comms) for evaluating cash out transxns by controlling shers that
take the form of a tender O after a short-ferm merger?
p. 525 - essentially same framework as M&F Worldwide
If a first-step tender O is both (i) negotiated and recommended by a special committee of
independent dirs and (ii) conditioned on the affirmative tender of a maj of the min shares, then

the business judgment std of review presumptively applies to the freeze-out transaction
p. 525 - as with a merger, if both reqs are not met, then the transaction is reviewed for entire fairness
Did the cash-out of the public shers of CNX satisfy this standard?
p. 525 - First. . . the Special Committee did not recommend in favor of the transaction
Second, the Special Committee was not provided with authority comparable to what a board
would possess in a third-party transaction
Third, the plaintiffs have raised sufficient questions about the role of T. Rowe Price to
undercut the effectiveness of the maj of the min tender condition
Aka TRP here is sketchy
Whats so special about T. Rowe Price?
p. 525 - economic incentives matter, particularly for the effectiveness of a legitimizing mechanism like
a maj of the min tender condition or a sher vote
Has peculiar economic incentives
Stake in CONSOL is same as stake in CNX
Relying on TRP is prob wrong thing to do had relatively equal stake in CNX and CONSOL
p. 526 - TRPs roughly equivalent equity interests leave it fully hedged and
indifferent to the allocation of value between CONSOL and CNX
p. 526 - TRP has materially different incentives than a holder of CNX, thereby calling into question the
effectiveness of the maj of the min condition

Significant transactions
Transactions in control (blocks/positions)
Combinations of companies (M&A)
Control contests (hostile bids/takeovers)
Market for corporate control
Defending against takeovers
Managing takeovers


Icahn Effect stock goes up about 3% when hes interested in a stock (Hertz articles)


Management discipline
Stock options, performance-based equity stake
Reduces overhead
Product market (donuts + ice cream)
if you dont have a good product or have much higher expenses, its going to be very difficult for you to
remain the CEO
Capital markets (debt + equity)

Board of dirs (monitoring + bonding)
Hostile bid/ takeover (proxy contest)
people like Icahn wait for that significant price drop, so takeover offer is premium to the current market
Henry Manne (mergers and market for corporate control 1965)
Bad management share price will decline relative to other companies in the industry
Tender offer
Other corporation (acquiror/bidder)
Against opposition from board of directors (hostile)
Here, just tenders for the majority of the shares (not all the shares)
Management response
Acquiesce many bids at low prices
Defend few bids at high prices





Unocal Corp. v. Mesa Petroleum; p. 534-538

Plaintiff was a corporation led by a well-known corporate raider. Plaintiff
offered a two-tier tender offer wherein the first tier would allow for
shareholders to sell at $54 per share and the second tier would be
subsidized by securities that the court equated with junk bonds. The
threat therefore was that shareholders would rush to sell their shares for
the first tier because they did not want to be subject to the reduced value
of the back-end value of the junk securities. Defendant directors met to
discuss their options and came up with an alternative that would have
Defendant corporation repurchase their own shares at $72 each. The
Directors decided to exclude Plaintiffs from the tender offer because it was counterintuitive to include the
shareholder who initiated the conflict. The lower court held that Defendant could not exclude a shareholder from
a tender offer.
Unocal company oil drilling up in the Arctic
Shers own about 87%
T. Boone Pickens (Mesa Petros only sher) owns 13%

p. 534 - Mesa commenced a two-tier front-loaded cash
tender offer for 64 million shares, or approximately 37%, of Unocals outstanding
stcok at a price of $54 per share. The back end was designed to eliminate the
remaining publicly held shares by an exchange of securities purportedly worth
$54 per share.
Pro ration? (37/87)($54) + (50/87)($45)
You wont always tender
Unocal investment bank thought stock worth at least
$60 per share
Unocal BoDirs
p. 535 - Under the exchange of self-tender offer, if Mesa acquired 64< shares of Unocal stock through
its own offer . . . Unocal would buy the remaining 49% outstanding for an exchange of debt securities
having an aggregate par value of $74 per share

What is the std of review for evaluating defensive measures adopted to thwart a hostile bid (takeover)?
p. 537 - the subordinated securities to be exchanged for Mesas squeeze out of the remaining shers in
the back-end mergers were junk bonds worth far less than $54. It is now well recognized that such
offers are a classic (structurally) coercive measure designed to stampede shers into tendering at the first
tier, even if the price is inadequate out of fear of what they will receive at the back end of the transxn
In what ways is Unocals Corp defensive self-tender offer coercive?
Court isnt concerned about Unocal offer (which is now not to tender)
Why are the dirs not entitled to B JR protection?

p. 536 - Because of the omnipresent specter that a board may be acting primarily in its own interests,
rather than those of the corp and its sher there is an enhanced duty which calls for judicial examination
at the threshold before the protection of the BJR may be conferred
Intermediate scrutiny / enhanced BJR
In order to get protection of BJR, board must show some stuff
Threat to corporate policy
Defensive measure is reasonable in relation to the threat posed
p. 537 - a further aspect
p. 538 - unless it is shown by a preponderance of the evidence that the dirs decisions
were primarily based on perpetuating themselves in office, or some other breach of
fiduciary duty such as fraud, overreaching, lack of GF, or being uninformed, a court
will not substitute its judgment for that of the board.
What factors may a board use to determine?
p. 537 - inadequacy of price offered, nature and timing of the offer, questions of illegality, the impact
on constituencies other than shers (i.e. creditors, customers, eees, and perhaps even the community
generally), the risk of non-consummation, and the quality of securities being offered in the exchange

November , 2016
(ASSIGNED: idk some shit)

Review & Recap

CNX Gas Corp:
Squeeze out merger BoDirs dont really have any role in a tender offer
In a tender offer by a controlling sher (followed by a cash out merger), then BJR is std of review
Negotiated and recommended by an effective special committee AND conditioned on the tender of a
majority of the minority shers


Control contests
Efficiency enhancements (replace ineffective management)
Wealth transfers (from stakeholders to shers)
Gekko borrows most of the money to pay for most of the shares
Want minimal wealth transfers, maximize efficiency enhancements
Defending against takeovers
Unocal: enhanced business judgment (intermediate scrutiny)
In control contests, std of review is enhanced business judgment due to omnipresent specter
Directors must show a danger (threat) to corporate policy and effectiveness and balance (proportionality
- defensive measure is reasonable e.g. drilling in Arctic, obtaining and selling oil; T. Boone Pickens is
going to stop it, which is a threat)
p. 540 - Unitrin
Similar in facts to Unocal
Applies the same standard
How doe the DE SCt apply the first prong of enhanced business judgment review, that is, what
type of threat does the SCt recognize?
p. 540 - A threat may result from substantive coercion - concern that shers might be
coerced into tending their shares to the hostile bidder bc they do not fully understand
the value of their shares or the inadequacy of the consideration offered by the hostile
bidder THREAT = EASY
If the BoDirs defensive response is not draconian (preclusive or coercive)
and is within a range of reasonableness, a court must not substittute its
judgment for the boards NOT DRACONIAN = EASY

then go to 3rd prong defensive measure is reasonable in relation to the
threat posed?
Yes? Then BJR protection
Between BJR and entire fairness is this thing called Revlon

Acquisition of 5% (10%) Block section 13(d)
Disclosure + amendment requirements
Tender Offer (Section 14(d) / Section 14(e))
Disclosure + amendment requirements
Substantive requirements
Time period / withdrawal rights
Equal treatment of best price to shers
Prohibition against discriminatory tender offers

Blasius Industries v. Atlas Corp; p. 610-616

Atlas Corporation
Charter provision limits number of directors to 15
At all times you want 8, so that you can stay in control
Blasius Industries, Inc. (Blasius) (plaintiff) holds 9 percent of the stock of Atlas Corp. (defendant). Blasius
proposed that Atlas sell off some of its assets, issue bonds, and distribute a large one-time dividend to
shareholders. The directors of Atlas believed this was not in the companys best interest and rejected the idea. On
December 30, 1987, Blasius formalized their proposal and also requested the election of eight new board
members. This would increase the size of the board from eight to 15, the maximum allowed under the corporate
charter. Fearing a takeover by Blasius, the board held an emergency meeting the next day and amended the
bylaws to add two additional board members. This move was designed to prevent Blasius from seizing an eight to
seven advantage on the board at the next election. Blasius sued Atlas, seeking to void the boards December 31,
1987 action as inequitable.
What is the std of review for evaluating defensive measures that interfere with sher voting?
Why did the dirs of Atlas Corp expand the size of the Board of Dirs and add two new directors to fill the
To block Blasius Industries but not for dirs own benefit
p. 611 - thereby precluding the holders of a majority of the companys shares from placing a majority
of new directors on the board through Blasius consent solicitation, should they want to do so
Were the dirs acting in GF when they took these actions?
Ct finds: acting in GF
p. 612 - was in GF to protect its incumbency, not selfishly, but in order to thwart implementation of a
recapitalization plan that it feared, reasonably, would cause great injury to the company.
So why no BJR?
p. 612 - (voting is special)
The question is not one of intentional wrong or even neg, but one of authority as between the
fiduciary and the beneficiary (not simply legal authority i.e. as between the fiduciary and the
world at large)
Then why isnt enhanced BJ (EBJ) the applicable std of review?
p. 613 - (voting is special)
The sher franchise is the ideological underpinning upon which the legitimacy of directorial
power rests
p. 614 - After the complaining sher demonstrates that the board has acted for the primary purpose of
thwarting the exercise of a sher vote, the board of dirs bears the heavy burden of demonstrating a
compelling justification for its action

Poison pill = shareholders rights plan (invented by Lipton of Wachtell Lipton) usually about 10-15 pages
TRIGGER: Acquiring person becomes the beneficial owner of 15% or more of the companys common shares (trigger
usually around 10-20%)
At 15%, courts will definitely approve the poison pill
FLIP IN: everyone else can buy common shares having a total value equal to TWO TIMES (dilution price) purchase price
EXCLUDE BIDDER: other than the rights beneficially owned by the acquiring person
Board has power to redeem the pill
Avoid poison pill by conditioning offer on redemption or invalidation of the pill

Diller Donut Corporation Gordon Gekko

100 shares outstanding

$20 price per share
$2,000 value (100 x $20)

Poison pill
15% trigger Buys 15 shares
$50 purchase price (price $10, buy 5 shares; 2-for-1 discount) Pays $300 (15 x $20)

85 right exercisable
Buy 425 shares (85 x 5)
Pay $4,250 (85 x $50)

525 shares outstanding (100 + 425) Owns 15 shares

$6250 value ($2000 + $42450) Worth $178.50 (15 x $11.90)
$11.90 price per share ($6250/525) Represent a 3% stake (15/525)

Only been one instance where the bidder took over and tripped the pill
Recall Lynch Communications
Moran v. Household Intl -- can adopt this rule on a clear day GF, etc. requirements
Otherwise Unitrin (not draconian or preclusive defensive measure?)
Triggers at 15%, what if tender offer was conditioned on getting 95% of the outstanding shares? Then the dilution would be
very small

Control contests (hostile bids/takeovers)

Market for corporate control
Defending against takeovers
Managing takeovers
Certainty of sale
Uncertainty of sale

Smith v. Van Gorkom; p. 548-554

Sher vote
69.9% yes
7.25% no
22.85% not voted
Jerome Van Gorkom, the CEO of Trans Union Corporation (Trans
Union), engaged in his own negotiations with a third party for a
buyout/merger with Trans Union. Prior to negotiations, Van
Gorkom determined the value of Trans Union to be $55 per share
and during negotiations agreed in principle on a merger. There is no

evidence showing how Van Gorkom came up with this value other than Trans Unions market price at the time of
$38 per share. Subsequently, Van Gorkom called a meeting of Trans Unions senior management, followed by a
meeting of the board of directors (defendants). Senior management reacted very negatively to the idea of the
buyout. However, the board of directors approved the buyout at the next meeting, based mostly on an oral
presentation by Van Gorkom. The meeting lasted two hours and the board of directors did not have an
opportunity to review the merger agreement before or during the meeting. The directors had no documents
summarizing the merger, nor did they have justification for the sale price of $55 per share. Smith et al. (plaintiffs)
brought a class action suit against the Trans Union board of directors, alleging that the directors decision to
approve the merger was uninformed. The Delaware Court of Chancery ruled in favor of the defendants. The
plaintiffs appealed.
What must dirs do to satisfy duty of care when selling the corporation?
Why does the DE supreme court find that the board of dirs acted grossly negligently in approving the transaction
with the Marmon Group?
p. 551 - On this record . . . we must conclude that the board of directors did not reach an informed
business judgment [in approving the transaction] . . . without any documents before them concerning the
proposed transaction, the members of the board were required to rely entirely upon Van Gorkoms
20-minute oral presentation of the proposal.
p. 549 - 4 CEOs, dean of UChicago biz school, none was investment banker or trained financial analysts
Why is their status as successful business people with detailed knowledge about the company insufficient?
p. 551 - The Board had no other information on which to base a determination of the intrinsic value of
Trans Union as a going concern
p. 551 - simply looking at the premium over the current stock price isnt quite enough (in DE courts)
Why does the DE SCt find the market test to be ineffective for confirming the reasonableness of the dirs decision
to approve the transaction with the Marmon Group?
p. 551 - merger agreement did not give Board of Dirs the freedom to put Trans Union up for auction
sale to the highest bidder and a public auction was in fact not permitted to occur

November 17, 2016

(ASSIGNED: idk some shit)

Review & Recap

Unocal court identifies enhanced business judgment (intermediate scrutiny)
Unitrin defensive measure is NOT DRACONIAN + BALANCED (reasonable in relation to threat posed)
Doesnt preclude, or coerce shers to remain with dirs
Almost anything can be a threat
Almost nothing is draconian
Almost everything is reasonable in relation to the threat posed

Defending against takovers
Different if sher voting
Blasius Industries expansion of board from 7 to 15 members, precluding hostile bidder from launching a
proxy contest
Not BJR, not enhanced scrutiny, not entire fairness

If the defensive measure thwarts a vote of the shers, dirs must show a compelling justification
for their action

Smith v. Van Gorkom: to satisfy its duty of care a board of Dirs must draw upon information about the transaction (not
only their knowledge of the business)
To be effective, a MARKET TEST


Revlon v. MacAndrews and Forbes Holdings; p. 556-558

Perelman wants to own Revlon
Market price $25/share
Perelman launches a tender offer for any and all
shares conditioned on getting a controlling
position and will pay $47.50/share in cash
(Pantry Pride, Inc.)
$50, then $53, then $56.25
Hes bidding against himself
Company goes to borrow a bunch of money in the
marketplace (notes) to buy its own shares; board is
buying as many of the shares as possible, so that not so
many people tender into the offer
Notes preclude the selling of assets with anything other than approval of the independent dirs
Company calls up Fortsmann and say we would like you to buy the company
Board promises to make it worth his while if he tops Perelmans bid
$57.25/share and gets a lock up option on companys crown jewel assets
(40% trigger) if anyone gets 40% of the stock, well sell you our most important assets
What must dirs do to satisfy duty of care and loyalty when selling corp?
Why DE find that breach of duty of care?
p. 557 - Any distinctions between the rival bidders methods of financing the proposal were nominal at
best, and such a consideration has little or no significance in a cash offer for any and all shares. The
principal object, contrary to the boards duty of care, appears to have been protection of the noteholders
over the shers interests
Notes are clearly falling value, company will have a lot more debt, no one knows who is in
control of it
Buying notes at face value; Fortsmann would be the notes from the marketplace
Only pay this significant gap, when there is something more than a rational
business purpose (e.g. emotional investment)
Why did they breach duty of loyalty (DE)?
p. 557 - The principal benefit of Fortsmanns O went to the dirs, who avoided personal liability to a
class of creditors to whom the board owed no duty under the circumstances
How satisfy fiduciary duties when selling corp?
Act as an auctioneer!
p. 555 - when the sale of the company becomes inevitable, the directors role change[s] from defenders
of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale
of the company
Recall Unocal (ID threat to corporate enterprise - e.g. harm to stakeholders, suppliers,
customers, etc.) harm to the community even!
What factors may a board of dirs consider when selling a corp?
p. 556 - a board may have regard for various constituencies in discharging its responsibilities, provided

there are rationally related benefits accruing to the stockholders
However, such concern for non-stockholder interests is inappropriate when an auction among
active bidders is in progress, and the object no longer is to protect or maintain the corporate
enterprise but to sell it to the highest bidder
Need to protect the interests of the stockholders (getting the best price for them)
When are crown jewels lock-ups permissible?
p. 557 - While these lock-ups which draw bidders into the battle benefit shers, similar measure which
end an active auction and forclose further bidding operate to shers detriment [and so are
This was the showstopper - Gent
ECMH - market reflects all available information

Perelmans bid cost a fortune!

he now owns about 80% (handed out DealB%k article showing Revlon decline), he never closed it out

Many bids (at low prices)
Few bids (at high prices)
Do you want to be shers in a company with lots of opportunities for control premiums, or few offers (that
are high)?


No deal protections
Many bids (at low prices)
Deal protections
Not many bids
Few bids (at high prices)

Control contests (hostile bids/takeovers)

Market for corporate control
Defending against takeovers
Managing takeovers
Certainty of sale
Uncertainty of sale

Revlon it was clear the company was going to be sold and Fortsmann and Perelman were offering these huge premiums; what if the
board had put in place a poison pill and refused to do a deal with anyone? Would have stood for reelection and been fired. Thus, even
if Revlon allowed board to shut the whole thing down, the company would have been sold because the premium was so high. The
shers would have never re-elected them.
Inevitable sale in Revlon
Problem is that no one is really that crazy to bid at $50+ when market price is $20ish

Paramount Communications v. Time; p. 561-566

Time decided to seek a merger or acquire a company to expand their enterprise. After researching several options,
Time decided to combine with Warner. Time was known for its record of respectable journalism, and Warner was
known for its entertainment programming. Time wanted to partner with a company that would ensure that Time
would be able to keep their journalistic integrity post-merger. The plan called for Times president to serve as
CEO while Warner shareholders would own 62% of Times stock. Time was concerned that other parties may

consider this merger as a sale of Time, and therefore Times board enacted several defensive tactics, such as a
no-shop clause, that would make them unattractive to a third party.

In response to the merger talks, Paramount made a competing offer of $175 per share which was raised
at one point to $200. Time was concerned that the journalistic integrity would be in jeopardy under
Paramounts ownership, and they believed that shareholder s would not understand why Warner was a
better suitor.
Paramount then brought this action to prevent the
Time-Warner merger, arguing that Time put
itself up for sale and under the Revlon holding
the directors were required to act solely to
maximize the shareholders profit. Plaintiffs also
argued that the merger failed the Unocal test
because Times directors did not act in a
reasonable manner.
(Wasserstein, Perella & Co) = financial
firm $189-212 merger valuation; come
back with valuation of merged company $106-188 (big range)
Under what circumstances are defensive measures adopted to thwart a hostile bid (takeover) evaluated under
Revlon - when is sale so inevitable?
p. 564 - first, and clearer one, is when a corporation initiates an active bidding process seeking to sell itself or to
effect a business reorganization involving a clear breakup of the company
Revlon duties may also be triggered where in response to a to a bidders offer, a target abandons its
long-term strategy and seeks an alternative transxn also involving the breakup of the company
How are defensive measures evaluated when these circumstances are not present?
p. 564 - a board of directors reaction to a hostile tender offer is found to constitute only a defensive
response and not an abandonment of the corps continued existence, Revlon duties are not triggered,
though Unocal duties attach
p. 564 - we premise our rejection of the Revlon claim on . . . the absence of any substantial
evidence to conclude that Times board in negotiating with warner made the dissolution or
breakup of the corporate entity inevitable as was the case in Revlon
How does the DE SCt characterize the analysis under Unocal of the threat posed by a takeover bid?
p. 565 - the open-ended analysis mandated by Unocal is not intended to lead to a simple mathematical
exercise: that is of comparing the discounted value of Time Warners expected trading price at some
future date with Paramounts offer and determining which is higher
What is the open-ended analysis?
p. 565 - the court shouldnt determine what this value is defer to business judgment
of the board of directors
Indeed, in our view, the precepts underlying the BJR militate against a
courts engaging in the process of attempting to appraise and evaluate the
relative merits of a long-term v. short-term investment goal for sh;ers
Wo what is competent to determine the length of time used to eval business/investment decisions?
p. 563 - board gets to pick the corporate action, but also time in which considering that action
The broad mandate of DGCL 141(a) includes a conferred authority to set a corporate course
of action, including the time frame, designed to enhance corporate profitability
141(a) is Gents favorite

p. 563 - thus, the question of long-term v. short-term values is largely irrelevant because directors,
generally, are obligated to charter a course for a corporation which is in its best interest without regard to
a fixed investment horizon
Whats the threat?
p. 565 - The time board reasonably determined that inadequate value was not the only legally
cognizable threat that Paramounts all-cash, all-shares offer . . . presented
p. 565 - Time shers might elect to tender into Paramounts cash O in ignorance or a mistaken belief of
the strategic benefit which a business combo with Warner might produce
Substantive coercion - shers might be confused about value of their shares
p. 566 - Dirs are not obligated to abandon a deliberately conceived corporate plan for a short-term sher
profit unless there is clearly no basis to sustain the corporate strategy
Opportunity loss - promised to protect the Time culture/integrity of the Time editorial process
Recall Feldman - Feldman had plan to make Newport Steel Co. modernized, wanted
interest-free loans for company to modernize
When Wilport came along, wasnt interested in Feldman plan, really just
wanted the steel stock
Gent: No reason to expect Paramount would destroy Time culture threat to the time
culture here is enough to satisfy the first prong!!! Bizarre to think that one bidder would choose
to protect an asset that another would destroy
Whats reasonable in relation to the threat posed? (Times restructuring of Time-Warner combo reasonable?)
p. 566 - Times responsive action to Paramounts tender offer was not aimed at cramming down on
its shers a mgmt sponsored alternative, but rather had as its goal the carrying forward of a preexisting
transxn in an altered form. Thus, the response was reasonably related to the threat
The revised transxn did not preclude Paramount from making an O for the combined TW co.
Thus the response was proportionate
Paramount could wait, and then buy the combined TW
almost anything is a threat,
anything reasonable in relation to that threat,
nothing is draconian

November 29, 2016

(ASSIGNED: idk some shit)

Review & Recap

Enhanced Business Judgment (Unocal, Unitrin) - intermediate scrutiny
When selling the corporation, dirs must act as auctioneers seeking the best price for the stockholders
Crown jewel lockups are permissible only to draw bidders into the auction
Time, Inc.
A corporate sale is inevitable
when a corporation initiates an active bidding process when a company seeks to sell itself
in response to a bidders offer the corporation abandons its long-term strategy (including breakup of the
Court found long-term strategy was merger with Warner Comms. - in this case, not inevitable
that Time would be sold

Significant Transactions
Transactions in control (blocks/positions)
Combinations of companies (M&A)
Control costs (hostile bids/takeovers)

NOTE: Revlon also bleeds up into M&A
Control contests (hostile bids/takeovers)
Market for corporate control
Defending against takeovers
Managing takeovers
Certainty of sale
Uncertainty of sale
Negotiated (friendly) sales

Paramount v. QVC Network, Inc.; p. 568-578

Enters into merger agreement with Viacom
Redstone controls 85.2% of the stock
De facto and de jure control
Court recognizes shers with much less
than 50% (Perlman v. Feldmann)
Deal protection measures; Paramount doesnt
want a poison pill, but also doesnt want to
announce this transaction into the marketplace
Viacom had right to purchase 20% of shares of Paramount
Comms at predeal price if another company purchased
Paramount Comms
Option permitted Viacom to demand $20
Termination fee
If transxn didnt go forward, Paramount would have to pay Viacom some amount of money (like $20M)
to cover all of the due diligence costs (lawyers, valuation analysis of bankers, etc.)
Merger price is $70/share - nearly double - Redstone announces that this is a marriage set in stone
QVC Network (CEO Diller) that offers $80/share
Amended agreement
Not many different things in deal protective measures
QVC raise to $85 (Viacom match), QVC raise to $90, then sues, so shers of Paramount Comms can consider
tendering into this offer
Started off at $44/share!
Paramount wants to be treated like Time BoD!
Under what circumstances are deal protective measures implemented to thwart hostile bid takeover evaluated
under Revlon? (when is sale of company inevitable so that dirs must act as auctioneers in order to satisfy their
fiduciary duties?)
Court critical of Paramount - you had a higher bid of $80/share! Had a strong negotiating position, and all you
did in the amended agreement was to tweak a few things to get more money?
Here, Viacom has a controlling shareholder different because of the BIDDER
In Time, no controlling shareholder
Could get second control premium by buying combined
Redstone would get market treatment under Hanson Holdings
Dont want a poison pill trigger!
Deal protective measures come in once youve negotiated the deal
p. 575 - Court articules how to get into Revlon
When a corporation undertakes a transxn that will cause: (a) change in corporate control, or (b) breakup
of the corporate entity, the dirs obligation is to seek the best value reasonably available to the

How might dirs seek best value reasonably available to stockholders and so satisfy their fiduciary duties when
selling the corporation?
p. 573 - auction, canvas the market, etc. DE law recognizes that there is no single blueprint that dirs
must follow
p. 573 - key features of an enhanced scrutiny test are: (a) judicial determination regarding the adequacy
of the decisionmaking process, employed by the dirs, including the info on which the dirs based their
decision; and (b) a judicial examination of the reasonableness of the dirs actions in light of the
circumstances then existing
Directors have the BOP that they were adequately informed and acted reasonably
Why does DE find that merger would result in a change of corporate control?
Redstone has control of Viacom
p. 572 - public stockholders (in the agg) currently own a maj of Paramounts voting stock. Control of
the corp is not vested in a single person, entity, or group, but bested in the fluid aggregation of
unaffiliated stockholders
In the event the Paramount-Viacom transxn is consummated, the public stockholders will
receive case and a minority equity voting position in the surviving corporation. Following such
consummation, there will be a controlling sher who will have the voting power to: (a) elect
directors, (b) cause a breakup of the corp, (c) merge it with another company, (d) cashout the
public shers, (e) amend the cert of incorporation, (f) sell all or substantially all of the corp
assets, or (g) otherwise later materially the nature of the corp and the public shers interests
Why DE find that deal protective measures in merger agreement were not a sufficient basis for dirs failure to
nego with QVC?
P. 576 - such provisions, whether or not they are presumptively valid in the abstract, may not validly
define or limit the dirs fiduciary duties under DE law or prevent . . . dirs from carrying out their
fiduciary duties under DE law. To the extent such provisions are inconsistent with those duties, they are
invalid and unenforceable


Once subject to Unocal/Unitrin, then essentially BJR WIN
If it turns out the BoD is subject to Unocal/Unitrin, saw in Time Warner that almost anything can be a threat,
almost nothing is draconian, almost anything reasonable in relation to threat opposed
(enhanced is just not all that difference from BJR)
Threat in Time was to the Time culture (threat)
Draconian - preclusive, not necessarily coercive
Time did tender O for shares (court found not preclusive, because other company could buy combined
Revlon (sale of company is inevitable) DEFENDANT CORPORATION LOSES
Elect to sell the company
In response to hostile bid or whatever
Sale of control
Then duty is to get is the highest price from the shers (dont necessarily have to conduct an auction)
Whole other land?
Defense measures thwart sher vote (Blasius), must show compelling justification for what youre doing


Sale unlikely inevitable Sale likely inevitable

All stock - transaction may not All cash - court likely to consider
constitute a sale (Time transxn as one in which there is a sale
Warner) (Revlon duties applicable)
Can pay a premium One and only time they get
for that stock that control premium

All stock All cash Institutional

---------------------------------------- Consideration ------------------------------------------ competence
Merger of equals Whale/minnow Revlon
--------------------------------------- Size of the target ----------------------------------------
Size of acquiror

Only control

Widely held Controller
------------------------------- Acquiror shareholders (QVC) --------------------------------

Except when target has a controlling sher

Control contests (hostile bids/takeovers)

Market for corporate control
Defending against takeovers
Managing takeovers
Certainty of sale
Uncertainty of sale
Negotiated (friendly) sales

Lyondell Chemical Company v. Ryan; p. 584-590


Williams Act Schedule 13(d) - Blavatnik - 8.3% stake in
the company
Working with the managers of the company to
improve performance or seeking to acquire
Market price goes up $37/share
People know that there is gonna be a control
Lyondell is in play
Board of directors says interesting WAIT AND
Apollo management calls and offers to be a White Knight
Board says no
Blavatnik announces Huntsman Corporation,
Hexion Specialty Chemicals starts bidding war
Becomes clear to Blavatnik realizes he needs to pay more for Lyondell, offers $40/sharex
Dan Smith (defendant) was chairman and CEO of Lyondell Chemical Company (Lyondell) (defendant). Leonard
Blavatnik owned Access Industries (Access), which owned Luxembourg company Basell AF (Basell). Basells

2006 offer to acquire Lyondell was rejected. A year later, an affiliate of Access filed a Schedule 13D disclosure
indicating its right to purchase more than eight percent of Lyondells stock from another company and
Blavatniks interest in Lyondell. Lyondells directors (defendants) called a meeting. Though the Schedule 13D
made clear that Lyondell was in play, the directors elected not to take any action at that time. Blavatnik
renewed his offer to Lyondell at $40 per share on July 9, 2007. Lyondells board had a series of meetings to
consider the offer. After negotiating with Blavatnik, the offer was increased to $48 per share. The boards
independent financial and legal advisers concluded that the offer was fair and a better deal was unlikely. On July
16, 2007, the board voted to recommend the merger to Lyondells shareholders. The shareholders almost
unanimously approved the merger. Ryan and others (plaintiff) filed a class action suit in the Court of Chancery
against Lyondell and its directors claiming breach of fiduciary duties regarding the negotiations and final merger
agreement. The trial court dismissed all claims except the claims that the merger negotiation process was
inadequate and the directors should not have agreed to the protection provisions.

How do you satisfy duty of care or duty of loyalty under Revlon? (in negod friendly transxn)
p. 587 - Revlon did not create any new fiduciary duties. It simply held board of dirs must perform its
fiduciary duties in service of specific objective: maximizing sher value
p. 589 - No court can tell dirs exactly how to accomplish that goal, facing a unique combo of
circumstances, many of which will be outside their control


The cert of incorp may also contain provision eliminating personal liability
Cant eliminate personal liability for breach of duty of loyalty
Cant eliminate personal liability acts or omissions not in good faith or which involve intentional misconduct or a knowing
violation of law

Focus on duty of loyalty?

No reason at all to consider duty of care, because there cant be any relief
p. 587 - Lyondells charter as exculpation protecting dirs from liability from breaches of duty of
care (95% of companies have this, because dirs write the cert of incorporation)
p. 587 - case turns on . . . duty of loyalty, a breach of which is not exculpated
Here, conflict?
No, negoing with Lyondell as dirs
With Blavatnik on other side
Thus, must find that bad faith
p. 587 - board is independent no self interest or ill will
So what is bad faith?
Stone v. Ritter, Walt Disney
p. 312 - Fiduciary conduct that is motivated by an actual intent to do harm constitutes class,
quintessential bad faith Walt Disney
p. 312 - Conduct that involves an intentional dereliction of duty, a conscious disregard for
ones responsibilities is properly treated as a non-exculpable, non-indemnifiable violation of
the fiduciary duty to act in good faith Stone v. Ritter
Failure to act in the face of a known duty to act
Grossly negligent conduct, without any malevolent intent, cannot constitute bad faith
= breach of duty of care
No monetary damages because of exculpation clause
On what basis did court conclude dirs may have breached their duty of GF (why did trial court deny dirs motion
for summary judgment)?
p. 588 - trial court found the dirs failure to act during the two months after the filing of the Basell
Schedule 13D critical to its analysis of their good faith
slothful indifference
Languidly awaited overtures from potential suitors
Trial court is relying on Smith v. Van Gorkom (drawing an analogy)
Why did DE reject this approach?

Wrong time period! Once someone announces interest, your business judgment can be to wait & see
p. 589 - should have focused on the one week during which they considered Basells offer
What is std of review for evaluating the actions of dirs upon filing of Schedule 13D?
p. 589 - Basells Schedule 13D did put the Lyondell dirs and the market in general on notice that Basell
was interested in acquiring Lyondell
p. 589 - the dirs responded by promptly holding a special meeting to consider
whether Lyondell should take any action. The dirs decided that they would neither put
company up for sale nor institute defensive measures to fend off a possible hostile
Wouldve gone with Basell, lots of synergies, no one else would bid as much
for the company
p. 589 - Instead, [dirs] decided to take a wait and see approach that decision was entirely appropriate
exercise of the dirs business judgment
Court doesnt even consider Unocal/Unitrin - because there is NO omnipresent specter (not dirs seeking to
protect their own jobs rather than seeking to get best value for shers) threat to dirs position
At what point are actions of dirs subject to review under Revlon?
Once the dirs start negotiating with Blavatnik, then it becomes clear company will be sold
p. 589 - begins on a specific date
When the dirs began negotiating the sale of Lyondell = when its required to get highest price
for the stockholders
Lyondell dirs satisfaction of Revlon duties?
There is no blueprint! Yes, satisfied.
Intentional dereliction of duty (failure to act) is only thing they could be liable for
p. 589 - dont always have to conduct an auction or do a market check
Have to be able to demonstrate impeccable market knowledge of the value of the company
p. 590 - court recognizes standard is different when dealing with exculpation clauses
But if the dirs failed to do all that they should have under the circumstances, they breached
their duty of care. Only if they knowingly and completely failed to undertake their
responsibilities would they breach their duty of loyalty

C&J Energy Services - p. 592

(another friendly deal thats too boring to go over - Gent)
No defensive, entrenching motive arises from this record
In Lyondell, no concern of Unocal/Unitrin/Revlon, only failure to act liability (chose to wait and see), exculpatory barred
duty of care claims