Choosing Entity Structure for Business: Sole Proprietorship vs Partnership

PART #A: CHOICE OF ENTITY
1. Structure of Power
2. Fiduciary Duties
a. Duty of Care: standard for business decisions
b. Duty of Loyalty: putting the corp. and s/h ahead of own financial interest
c. Duty of Stockholders: majority s/holders owe a fiduciary duty
3. Voting
Factors in deciding choice of entity:

1. Liability – who is liable for debts of business if business cannot pay?
2. Control/ management – who controls and makes decision pertaining to business?
3. Transferability of ownership interest – how easily can one’s stake be sold?
4. Continuity of existence – how long can the business last?
5. Taxation – how is the business taxed? (i.e. entity level tax, or flow-through tax)
6. Raising addition capital – how easily can the business raise additional $$?
1) Sole Proprietorship (SP)

• Needs only 1 person and 1 business
• If more than 1 person in business then they are employees (agents) and the SP is
the principal
• No government filings required
• dba (doing business as) is the only form that would be required
1. Liability
o SP is only person liable for debts
o Unlimited personal liability b/c no distinction
between person and business
o Worst form for individual
o It’s not an entity so there is no distinction between
the person and the business’ assets
o Insurance can insulate individual from liability
2. Control/ management
o SP controls
3. Transferability of ownership interest

o SP can sell the business but it must sell all its assets
(i.e. IP – the business name, equipment, client lists, etc.)
4. Continuity of existence
o Business lasts as long as SP wants
o Death, sale, or bankruptcy can end business
5. Taxation
o SP taxed directly on his tax situation b/c no
distinction between business and person
o “Schedule C” 1040 tax form used to calculate SP
loss/profit
o “Above the line” all expenses that reduce income
tax for business expenses
o “Below the line” watered down deductions based on
income
6. Raising addition capital

o SP can take out a personal bank loan
2) General Partnership (GP)

• GP is a consensual association
• 2 or more persons to carry on a business
• Governed by partnership agreement
• If no partnership agreement then governed
by statutory provisions UPA and RUPA (RUPA 103(b) mandatory provisions)
• UPA (default provisions): govern aspects
of the partnership relation in the absence of express agreement on those aspects.
• UPA (mandatory provisions): govern the
relationship among partners that probably cannot be varied by the agreement of
the partners (i.e. fiduciary duty among partners, power of every partner to
dissolve, unlimited liability of each partner, etc.)
• No formal agreement required
• No written instrument required (handshake
ok)
• RUPA § 202(a): not subjective intent of
parties  objective intent is required to determine if parties intended to form a
partnership. Look at surrounding facts and circumstances (i.e. profit sharing,
written statements, testimony, circumstantial evidence). Combines UPA 6 and 7
– the addition of “whether or not..” merely codifies the universal judicial
construction of 6(1). 202(b) provides that business organizations formed under
other statutes (i.e. corp, LP, LLC) are not partnerships.
• RUPA § 101(6)): Partnership: association
of 2 or more persons to carry on as co-owners a business for profit formed under
202, predecessor of law, or comparable law of another jurisdiction.
• RUPA § 101 (7): Partnership agreement:
agreement among the partners concerning the partnership, including amendments
to the agreement.
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1. Liability
o Each partner is jointly and severally liable for all debts even if that partner
did not incur the debt
o If one is required to pay they can sue the other partner for their
contribution
o UPA 7: newly admitted partners
o RUPA 306(b): newly admitted partners
o RUPA 405: a partnership may maintain an action against a partner for a
breach of the partnership agreement, or for the violation of a duty to the
partnership, causing harm to the partnership
o Malpractice insurance can insulate individual partners
o Recourse only assets of company and not each party but that is a provision
that the 3rd party must agree to
o RUPA 303: statement of partnership authority  delineates the authority
of each partner to bind the partnership
o Legal distinction between partner and individual  a creditor cannot
attack partnership to seize for personal debt but can seize their shares in the
partnership
o 303 is new. The most important goal of the statement of authority is to
facilitate the transfer of real property held in the name of the partnership.
o Partners control
o UPA 18 (e) and RUPA 401(f): all partners have equal rights unless the
partnership agreement states otherwise.
o RUPA 401(i): a person may become a partner only w/ the consent of all
of the partners
o RUPA 401(j): in the absence of an agreement to the contrary, matters
arising in the ordinary course of the business may be decided by a majority of
the partners.

o General rule: A partner can transfer his financial interest b/c its personal
property. Transfer does not pertain to managerial control unless partners
decide otherwise. Partnership agreement must specify terms.
o UPA 27(1) and RUPA 503 (a) and (b): a partner can, by default, transfer
his interest to a 3rd party but that is only the beginning of the analysis.
Financial rights to receive distributions of $$ and allocation of profits and
losses for tax purposes are transferable to 3rd party
o RUPA 502: financial interests are considered personal property. Only if
all partners consent can 3rd party become an actual partner and enjoy
managerial control befits
o UPA 18(6): partnership agreement may lower managerial threshold.
o Hypo: if someone sells partnership interest, who gets managerial control
after that person dies? The managerial aspect remains w/ the transferor
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o Hypo: who has joint and several liability for debts? The person w/
financial interest – the transferor – follows the managerial control aspects of
partnership interest. Joint and several liability stays with the transferor.
o Policy: person in control making decisions should be liable
(accountability)
o RUPA 503 (d): makes clear that transferred interest is only $$ and
transferor retains management interest and is personally liable for all
partnership obligations
o Most agreements require that the partnership must buy back interest
o Generally partnership lasts until events of dissolution (death of a partner,
completion of project, specified date) UPA 29. If no partnership agreement
then UPA and RUPA refer to events which dissolve partnership. Dissolution
automatically triggered upon an event. Partnership not terminated, but
relationship between partners changes. Partners must agree to new
partnership.
o Dissolution: the first phase of the termination process (NOT a
termination). It merely ends the carrying on of the business in that
partnership. (according to UPA - a change in legal status)
o Winding up: the second phase of the termination process which is the
moment at which the event that sets termination of the business in motion (i.e.
paying off debts, settle its contracts, find purchaser for capital, etc.)
(according to UPA – describes the economic event of liquidation that follows
dissolution)
o Termination: the final phase of termination is complete once the winding
up phase has been completed and all partners have agreed upon termination
5. Taxation
o Flow-through taxation: the partnership is not taxed. All income and
expenses, gains and losses, are taxable directly to the owners. Based on
allocated profits or losses.
o IRS form 1065: informational tax return – allocation of profit or loss of
each partner claimed on line 17 of personal tax form 1040
o Schedule k-1: tells each partner their allocation of loss or profit to report
on 1040. If there is a loss then it offsets income
o Problem w/ flow-through taxation: pays out your allocated share, not
what is actually paid out. If entity decides to invest profits instead of
distributing, the partner still has to pay taxes. To avoid, the partner can
include a provision in the partnership agreement that the partnership will
make best effort to pay out enough to cover taxed amount.

o The partnership can bring in new partners who have to buy their way into
the partnership
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o Law firms will normally garner partnership allocations until the new
partners amount to buy in is paid off
o Borrow $$ (usually through a revolving line of credit)
Martin v. Peyton
Pg. 32, CB
*Demonstrates the efforts some parties make to distinguish themselves from a partner to
a lender to avoid joint & several liability
Facts:
• Π: Martin/ Δ: Peyton (lenders)
• K&K owed Martin $ but they couldn’t pay so Π argues that Δ is
a partner in K&K so they are jointly and severally liable for Peyton’s debt
• Peyton loaned $500k to Hall
• Hall offered partnership to K&K but they declined
• K&K loaned $2 mil of liquid securities (investments that can
quickly and easily be converted into cash – like government bonds)
• In return, Δ was to receive 40% of profits until loan was paid off
and the option to become a partner
Issue:
• Did Δ intend to become partners in the business when they gave the loan?
Law:
• UPA 6(1): definition of partnership
• UPA 7(4): share of profits are prima facie evidence of partnership HOWEVER
UPA 7(4)(d) states that if profits are for payment of loan then the inference cannot
be made (also in RUPA 202 (c) (3) (v))
Holding:
• Δ was not a partner in the partnership so not liable for debt
• Presumption is if one receives profits they are a partner, unless, the profits
are being paid as repayment for a loan (UPA §7 and RUPA §202)
Lupien v. Malsbenden
Pg. 36, CB
*Control v. Co-Ownership
**Co-owner does not mean joint title to assets; rather, it is the right to make
decisions/control
Facts:
• Π purchased “kit car” by VW from Cragin but never received it
• Cragin fled the country leaving only Malsbended as a Δ so Π
claimed that Cragin and Malsbended were partners thus making them joint and
severally liable
• Δ claims that he was only a lender and not a partner
• Π claims Δ was a partner b/c his loan was interest free, he had a
say in decision making of business, he wrote checks from his personal account for
the business, and w/out Cragin present Malsbenden was in control
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Issue:
• Does co-owner/partner mean jointly owned assets or right to control?
Holding:
• Right to control is essence of co-ownership. Rights to assets and title of parties
is dispositive (footnote 4, pg. 37)
Notes:
• Difference between Lupien and Martin is control
• In Lupien – Δ exerted control over business decisions that was consistent with
that of a partner
• In Martin – Δ’s control was typical control that any lender would assert
Summers v. Dooley
Pg. 43, CB
Facts:
• Π and Δ own trash collection business together
• Π hired a 3rd person to work but Δ refused so Π paid for 3rd party
out of his own pocket
• Π claims that Δ was unjustly enriched by the 3rd man so he
should be required to pay
Issue:
• Whether an equal partner in a 2 man partnership has the authority to hire a new
employee in disregard of the objection of the other partner and the attempt to charge
the dissenting partner with the costs incurred as a result of his unilateral action
Law:
• ID default provision: any difference arising from ordinary matters may be
decided by majority of partners
• UPA 18(h): in the absence of an agreement regarding decision making power,
majority regardless of partnership percentage (look at control %)
Holding:
• In a 2 person partnership both must consent as both have equal veto power when
their control is 50/50
• Δ objected to hiring so he is not bound to pay
Hypothetical
Pg. 46
A, B, and C enter into a partnership.

A – 90% of capital and 90% of profits or allocation of losses
B – 5% of capital and 5% of profits or allocation of losses
C – 5% of capital and 5% of profits or allocation of losses
In a dispute A votes one way and B/C vote another. B/C win b/c 2 out of 3 is majority
RUPA 301(f): partners have equal stay unless partnership agreement states otherwise
Sanchez v. Saylor
Pg. 44, CB
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Facts:
• Π and Δ were equal partners w/out partnership agreement
• They applied for a loan for the business but Δ refused to submit
her personal financial records so they lost the loan
• Π brings suit against Δ claiming he breached his fiduciary
obligations
Holding:
• All partners have equal rights in management and conduct of business of the
partnership. Δ was legally invested with an equal voice in the management of the
partnership affairs and neither partner had the right to impose his will or decision
concerning the operation of the partnership business upon the other
Law:
• ID default provision: absent an enforceable agreement covering such
circumstances of disagreement, when both partners in a two-partner partnership
disagree on advantageous prospective business transaction, it is dissolution, not an
action for breach of fiduciary duty, that is the appropriate avenue of relief
Meinhard v. Salmon
Pg. 71, CB
Facts:
• Lease for property on 42nd and 5th.
Holding:
• Gerry excluded his coadventurer from any chance to compete, from any chance to
enjoy the opportunity for benefit by virtue of his agency. He was under a duty to
concede
Law:
• Joint adventurers, like copartners, owe to one another, while the law enterprise
continues, the duty of the finest loyalty. Pursuing an opportunity for self-
gratification breaches that duty RUPA 403 and 404(b)(i)
UPA 103(b)(3): the partnership agreement can define what a fiduciary duty means, but
CANNOT eliminate the fiduciary duty entirely
Note on Joint Ventures (JV): Formed for a single transaction/ sole purpose.
o Thin line between joint ventures and partnerships
o General rule is that JV’s are governed by partnership law
o UPA 18(a) and RUPA 202
3) Limited Partnership (LP)

• Has 1 or more general partners and 1 or
more limited partners
• Limited partners have limited liability but
in return do not have control or management
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• Old ULPA 201: requires statutory filing
of certificate of limited partnership with the sec. of state
• Limited partners have limited liability not
joint and several so public must be put on notice
• Exactly the same as general partnership
with the exception of Liability and Control/Management
1. Liability
o General partners have joint and several liability but in return they get to
control and make decisions
o Limited partners invest (like silent partners) and enjoy limited liability. In
return, they lose control in management
o General partners have joint and several liability but in return they get to
control and make decisions
o Limited partners invest (like silent partners) and enjoy limited liability. In
return, they lose control in management
o EXCEPTION: if LP gets too engaged in business then becomes GP and
assumes joint and several liability
o Control rule: if you want limited liability you must give up control (new
ULPA 303: abolishes control rule in order to make LP more competitive with
LLC.
3. Transferability of ownership interest: same as GP – only financial interest
4. Continuity of existence: same as GP – until a specified event
5. Taxation: same as GP – flow-through tax entity
6. Raising addition capital: same as GP – borrow or add more partners
Notes from class 5.29.08

• Nagging problem of LP is that at least one person has j&s liability which is not
user/investor friendly
• To avoid make LP a corporation – interpose LL between person and corporation –
The LP can form a corporation to act as the GP that makes all the managerial
decisions (BOD – sole owner) and controls what the LP does and are indirectly in
control. This reduces/ eliminates j & s liability of investors if LP has a loss. Law
suits will be brought against corp. b/c they have j&s liability and once it pays out
all that it can that is it and investors are not subject to j&s liability
Gateway Potato Sales v. GB Investments

Pg. 468, CB
Facts:
• Gateway sued limited partner rather than general partner b/c they
had deeper pockets
• Sunworthy Packing (LP) defaulted to creditors (Gateway) so
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• Π argues that GB crossed line from LP to GP b/c they managed
and acted like GP (activities described on 469/70)
Holding:
• Liability for an LP whenever the LP exercised substantially the same control as
GP, even though the creditor had no contact w/ LP and no knowledge of LP’s
control
Law:
• AZ statute 1st sentence (same as old ULPA 303(a)): LP can go too far. If they act
like a GP they are jointly and severally liable.
• 2nd sentence waters it down (same as old ULPA 303(b)): however, if the LP’s
participation in the control of the business is not substantially the same as the
exercise of the powers of a general partner, he is liable only to persons who transact
business with the LP w/ actual knowledge of his participation in control.
• Clandestine problem: if you act like a GP, even in secret, you are on the hook but
only to people w/ actual knowledge (the 2nd sentence completely eliminates this
problem)
• Indirect knowledge problem: based upon LP’s conduct, the only requirement is
that the creditor had actual knowledge of the LP’s participation in control. 2nd
sentence does not help
Takeaway:
*Control rule – LP acting like GP deemed have j&s liability regardless of their title
**Control rule has been watered down by new UPA – exceptions of LP actions that will
still not let them lose their limited liability
In re: USAcafes
Pg. 476, CB
Holding:
• Directors of the GP owed the LPs no duty of loyalty or care, but owed the GP
and shareholders duty of loyalty.
• Fiduciary duty – one who controls property of another may not, w/o implied
or express agreement, intentionally use that property in a way that benefits the
holder of the control to the detriment of the property or its beneficial owner.
• Human being still owes fiduciary duties to partners (Cardozo
called “duty of finest loyalty”)
4) Limited Liability Partnership (LLP)

• LLP is essentially a GP formed under a
statute by professionals
• LLPs use this status to limit malpractice
• All partners are j&s liable for all general
obligations (same as GP)
• In respect to malpractice, each partner
only liable for his own personal acts of malpractice – no vicarious liability for
torts, K, or otherwise
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• This is the allure of LLP – pro-
professional and anti-client
• This is why LLP’s are required to maintain
malpractice insurance so to put prospective clients on notice also why they must
register with sec. of state
• RUPA 101(5): limited liability
partnership: means a partnership that has filed a statement of qualification under
1001 and does not have a similar statement in another jurisdiction.
• RUPA 1001 : any partnership may
become a limited liability partnership by filing a statement of qualification
• RUPA 1002: LLP must be in name or title
5) Limited Liability Company (LLC)

• Creatures of statutes – articles of
organization filed w/ sec. of state
• 70% of the time – LLC is the best way for
a new business to go
• Designed to take best of partnership form
and best of corporate form
• RULLCA 201: must file articles of
organization w/ sec. of state
• RULLCA 104: an LLC is an entity
distinct from its members and has perpetual duration
• RULLCA 108: must contain LLC in title
• Can have a 1 member LLC
• No requirement to be a partnership first
then convert to LLC
• Members
1. Liability
o Like a corporation, all owners have limited liability (only lose investment)
which is a plus from the owner’s perspective
o Member: owner of LLC. Statutory requirement to put people on notice of
limited liability. In NY, requires filing of article of organization with sec. of
state but then they must place ad in paper and if that paper is NYT then its
really expensive. No need to actually file (per Haas)
o Like a partnership, incredibility flexible
o All member by default have equal control unless otherwise stated in
operating agreement (much like a partnership agreement) – same topics
o Operating agreement can place control in hands of only a few members
(manager-managed LLC) or all can have equal control (member-managed
LLC) (RULLCA 102)
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o Is your LLC member managed or Manager managed? – operating
agreement will say – depending on the number of owners, it will tell who is
managing

o Essential same as a partnership – governed by operating agreement
o Default rule allows transfer but only financial attributes.
o Transferee always maintains limited liability by statute
o Not until other managers approve can a new member receive managerial
control does liability lay with awaiting member
o NO J & S liability
o Voting structure decided in operating agreement – if you want to limit
transferability then require unanimous vote
o Essential same as a partnership – when certain events occur specified in
operating agreement or as specified in statute – members decide to keep LLC
or they can agree on dissociation (like dissolution)
o RULLCA 102(c): an LLC has perpetual duration
5. Taxation
o Flow-through tax entity
o No income tax, it sends its members a scheduled K-1 that allocates to
member profits, losses, shares, etc.
o Line 17 of W-10

o Essential same as a partnership – additional managers allowed in
contingent upon operating agreement (differs from S Corp. in this way)
o Extremely flexible b/c manager can have many different ownership
rights – different classes of ownership interest
o Whatever people want to agree to
6) Corporation
• Creature of statute - must be granted
corporate charter by state of incorporation
• States have general incorporation laws –
state generally today, used to have to go to state legislature and then granted to do
a particular job
• States passed general incorporation laws –
no longer necessary to ask legislature
• Separate and distinct legal entities –
artificial person in the eyes of the law – from those who own and manage them
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• Publicly-traded must register w/ SEC
• Shareholders: are owners
• Managers: are Board of Directors
(shareholders elect) – more of a watchdog
• Officers: carry out day-to-day decisions
(CEO, CFO (controller), President, GC) RULLCA 102)
• Officers can carry more than one title
• Officers can be manager (director)
• Large corporations bifurcate the CEO
from the Chairman of the Board
• BOD selects the officers or least approves
them
• Officers select the lower managers (senior
executives)
1. Liability
o Owners (shareholders) have limited liability (quintessential example of
LL) – not liable personally, but can lose investment as shareholder
o Can lose this by Piercing the corporate veil
o Owners have power to enter into K, power to be sued, power to bring suit,
ability to commit crime, ability to subject to income taxes
o Corporations have constitutional rights (Due Process Clause and equal
protection, attorney-client privileged, protected from illegal searches and
seizures, can sue for defamation, expansive 1st amendment rights)
o Corporations CANNOT plead the 5th and do not have right to privacy
o NYBCL 630: 10 largest shareholders have j&s liability for all debts
o Direct management is removed from shareholders  separation of
ownership and control  agency cost – cost of management separated
o NYBCL 701 & DGCL 141(a): control of corp. resides in hands of BOD
in publicly traded corps (in a closed-corp. the owners are managers,
shareholders, officers, etc.)

o As general matter, shares are freely transferable
o Privately held corps have more restrictions like the operating agreement of
LLC, in the shareholder’s agreement
o Fed and state securities law govern the transferability
Publicly Traded Private/ Closely Held

1. Capital Raising Trade on a publicly traded Sell to a select group of
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market (i.e. NASDAQ) investors
In order to go public, corp
must register, file disclosure
document, and have IPO
(initial public offering)
2. Management/ control Separation of owners Multiple hats
(shareholders) and
controllers (BOD)
3. Transferability Part of IPO register w/ SEC Not liquid b/c difficult to
and list on publicly traded find someone who wants to
market so very liquid buy shares. Plus, agreement
usually places restrictions
4. Transparency Must file periodic reports Information is proprietary/
that are publicly available confidential. Only available
(10K, 10Q, O, 8K) when applying for loan or
interacting w/ financial
institution.
o Corp has perpetual existence by default
o No dissociation or dissolution
o An expiration can be placed in corporate charter but this is rarely done
5. Taxation
o Sub C: Entity level tax and shareholder’s taxed = double-taxation
o Sub S: treated as flow-through tax entity (no entity level tax). Taxed pro
rata (based on # of shares)
o Sub S qualifications:
 No more than 100 shareholders
 Shareholder must be a natural person (or qualified estate/ trust) or
another Sub S corp
 Must be U.S. citizen or resident alien
 Corp can only issue one class of stock
 Have 90 days from filing charter to file for Sub S
o Restrictions: S corp may buy stock in and C corp but cannot be owned by
any C corp.
o Policy reasoning for S: to help small businesses b/c they generate job
growth and we do not wan tot deter small businesses to become corporations
and still benefit from flow-through taxation – that is why # of stockholders
and domicile is important
o Problem w/ S: WY introduced LLC which is way more appealing. Most
S corps grow into C
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“C” can flexibly raise capital through debt securities or issuance of stock (preferred or
common). They are K claimants, not ownership claimants. Capped interest rate,
priority in the event of liquidation.
a. Securities:
o Bonds: long-term, secured, collateralized.
o Debentures: long-term IOUs, not collateralized. Naked promise to repay.
o Notes: short-term IOUs, secured or unsecured.
o Trade debt (accounts payable) – amounts that a corporation owes for goods
and services at any point in time.
o Bank debt (loans payable) – financing from commercial-bank loans.
b. Preferred stock: *Dividend preference: until the current stock dividend to

preferred stockholders are paid up, you cannot pay dividends to common
shareholders. *Liquidation preference: once all the creditors are paid in full, the
preferred shareholders are paid second according to the stated dollar amount in
the K.
i. Difference between debt and preferred stock – debt holders have a fixed
claim on the corporation for interest and principal while preferred
shareholders normally have no fixed claim for distributions.
c. Common: common shareholders get everything else after the creditors and
preferred stockholders are paid off. Normally, common stock carries the right to
vote in the election of directors and certain other matters.
Hierarchy of Repayment – “Food Chain”

1. Creditors
• Secured creditors - those who have
secured collateral (i.e. land)
• Senior creditors
• Subrogated creditors – lowest on the food
chain b/c they demand higher interest rate
• Subordinated – if you agree to be here,
you get a higher rate of interest (“junk bonds”)
2. Preferred Stockholders
• Liquidated preference + any accrued/ unpaid dividends
3. Common Stockholders
• They get whatever is left
Delaware is popular b/c:

1) Statutorily liberal: minimal restrictions on managerial control which aids in
agency costs (i.e. 1st state to adopt take-over defenses like “poison pill”) The
DGCL minimizes shareholder ability to vote which gives managers more power
2) Higher level of predictability: case law precedent covers almost every case that
can come up b/c so many corporate decisions decided under DE law
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3) Efficient judiciary: DE Chancery Court quick to hear and decide cases. Also,
allows lawyers admitted to any state’s bar to issue a corporate law opinion –
incentive for out of state corps to incorporate there
Problem #1
Pg. 2, SCM
Facts:
• Harman – part owner w/ daughter of box manufacturing company which is on
decline
• Roberta – daughter who wants to expand business
• Lindsey – box designer w/ no $ but will contribute time and skills and would
receive “sweat equity” in return
• JP Smith – investor (capital provider)
• Business current value = $200k (book value)
• Book Value equals total assets minus total liabilities [BV= TA – TL]
• Smith is investing $75k
• Lindsey is investing services
• The terms are to “share and share alike”
Analysis of 6 factors to determine best form of business for Harman
1. Liability: He’s contributing real $ so liability is important. An LP, LLP,
LLP, or corp. would work. If corp. formed in NY he would have j&s liability b/c
of NYBCL 630 which holds the top 10 shareholders liable so this would be out.
Limited liability in small business is not favored by creditors so they will usually
require personal guarantee from shareholders
2. Control/ management: He cares about control as he devoted his whole life
to this company. Would want LLC, corp. LLP, but not LP b/c he wants control.
JP Smith would want LP if he is limited partner.
3. Transferability: He is closest to death so he wants someone to be able to
inherit his interest and control (continuity not that big) so GP, LP, or LLP and
handle it in partnership agreement
4. Continuity: not that big of a deal
5. Taxation: He would want flow-through so S corp would be good b/c
flow-through taxation and flexibility in raising capital
6. Capital: not an overriding concern for him so LLC or C corp would be
easiest way to raise capital
**LLC would be best
Analysis of 6 factors to determine best form of business for Roberta

Raising additional capital would be an overriding concern for her b/c she wants to
grow this business so LLC would be good b/c of flexible capital structure. C corp.
would work but would be subject to double tax. S corp. is out of the question b/c
limited flexibility to raise additional capital
**LLC or C corp. would be best
Analysis of 6 factors to determine best form of business for Lindsay
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1. Liability: she has no liability but she has not assets to lose so GP wouldn’t
hurt her unless business started becoming extremely profitable
2. Control/ management: she would want control b/c these are her ideas
being implemented so this is her most important factor. An LP could work b/c
UPA/ RUPA allows employees
3. Transferability: She is just starting out so this is not a concern to her now,
however, if the business takes off this will be of interest to her
4. Continuity: she wants the business to go on long enough for her ideas to
take off
5. Taxation: she can be screwed two ways here: 1) if they reinvest profits
instead of distributing them and she gets taxed w/out an allocation and this is her
only source of income then she has no way to pay taxed amt; and 2) if there is a
loss and she has not other income to offset then it won’t help her at all.
6. Capital: this is just as important to her as the other players b/c this
company needs to take off. We would need to point this out to her b/c she may
not realize it.
**Almost any form, except S, would work for her. S corp does not allow flexibility to
raise additional capital. She is only one that can go with almost all forms.
Analysis of 6 factors to determine best form of business for JS Smith

1. Liability: He wants a LL b/c he doesn’t want to lose more then his
investment if something goes wrong his personal assets aren’t exposed
2. Control/ management: he is a silent investor and putting his trust in them
to run this business so LP would work for him if he were a limited partner
3. Transferability and Continuity: he does not want to be locked in forever
b/c he wants either a large company to buy or find an investment bank to take this
public. He needs an exit strategy so transferability very important
4. Taxation: because he has other investments this would be advantageous to
him both ways. If they meek $ then gets an allocation of profit. If loses $ he can
use the loss to offset profits he made elsewhere.
5. Capital: he wants other potential buyers to come in and he wants it to
grow so he wants flexibility here too.
**LP as a limited partner would be best for him. Corp could work as long as it goes
public later. LLC works too
Recommendations for group: 1) Manager-managed LLC w/ operating agreement all but

JS Smith as a manager; 2) S corp to get flow-through tax until they grow enough to
change into C corp (becoming C corp would be good sign of growth); 3) LLC would be
good b/c you can have more than 100 shareholders and foreign shareholders and if
investment bank comes in to take it public then they can file corp. charter.
Corporate form: you can make S election but Smith and Mr. Harman would prefer it b/c
older generations are afraid of LLC’s
Concerns:
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• Corp is high maintenance b/c of statutory housekeeping (board meetings, formal
notice of meetings) which is costly especially b/c lawyers need to do this and so
it’s an ongoing legal expense.
• Partnerships and LLC have less restrictive corporate governance
• Corporations are required to distribute profits on pro rata basis (proportionate to
# of shares)
• An LLC can always convert to corp. later
Haas questions 6.3.08

1. In which state should a new corporation incorporate?
• Closely-held: should incorporate in the state they are doing business b/c do not
want to pay extra taxes (taxed in state doing business and where they are
incorporated). DE laws do not benefit smaller corps
2. What if incorporated in NY then decide to go public – can a company change the state
of incorporation right before going public?
• Yes, the process is called reincorporating
• NY corp can form a new subsidiary corporation called a drop-down, incorporated
in DE then merge the 2. The NY corp. becomes obsolete with all assets and
liabilities automatically belonging to DE corp.
Class #3: Capital Structure
Capital: the amount in the company’s stock account. Funds, cash, property – assets
contributed to business in return for stock that business uses to make $.
Legal capital: amount of capital that stockholders contribute to the company that, by
statute, must remain permanently in the company to satisfy the claims of creditors.
Legal capital rule: a corp must always maintain a minimum capital cushion on right side
of balance sheet which is offset by left side of balance sheet. It is a compromise between
creditors and common/preferred stockholders. Passed to ensure that dividends/
distributions not paid to shareholders to detriment of creditors.
• DE Legal Capital Rule based on par value
Par value: legally allowable, minimum amount of consideration that an investor must
pay by law for common or preferred stock (the floor price).
• When it’s available for creditors, it’s off limits to shareholders
• Protects creditors – maximize the capital cushion by raising the par value
• BOD determines the p.v. in the corporate charter. They can pick any amount they
want. BOD cares more about stockholders than creditors so lower p.v. = smaller
capital cushion, hurts creditors. Higher p.v. = larger capital cushion
• Common shares are issued for a price higher than the par value
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Par value and # of shares to be issued located on balance sheet, certificate of
incorporation, corporate charter, stock certificate, financial statement
No par value stock: BOD can state $ amount at time they issue stock so they leave
amount blank until they do this. It is an ad hoc determination. If they aren’t decided then
it goes into CSA which is beneficial to creditors
DGCL 151(a)
NYBCL 501(a)
Watered stock: stock which was issued w/out corresponding pay-in assets valued @ an
amount lower than what other stockholders paid yet they still have equal ownership
rights. Not fully paid and assessable – corp and creditors can come after holder to get $
owed
Legal issued water stock: paid lower than p.v. for shares so those shares are not fully
paid and not non-assessable so company can come after you or if company is no longer in
existence then creditors can come after you.
NYBCL 504(c)
DGCL 153(a)
Capital structure (capitalization): where did funds, assets come from?

Equity contribution: property in exchange for shares/ownership, loans expected to be
repaid
Balance sheet: Financial statement that provides capital structure information.

• Assets: inventory, balance in accounts, property, IP (left side of balance sheet)
• Liabilities: what is owed to 3rd parties by bank/ trade debt, debt securities (right
side of balance sheet)
• Owner’s equity: shareholder’s equity (corp.) partner’s equity (GP, LLP) (right
**Left and right side must always balance = (TA-TL) - capital
Assets Liabilities
1. Current Assets (CA) 1. Short Term (ST)

2. Fixed Assets (FA) (PPE) 2. Long Term (LT)
3. Intangible Assets (IA)
4. Other Accounts (OA)
Owners’ Equity
Capital Contribution
Shareholders’ Equity:
CSA = # of o/s shs of c/s

x p.v./ shs
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PSA = # of o/s shs of p/s
x p.v./ shs
APIC
Retained Earnings or Deficit (RE/D)
Total Assets = Total Liabilities + Owners Equity
Left side:
*In order of liquidity
1. Current Assets: turned into cash easily (i.e. securities, inventory)
2. Fixed Assets: tangible assets used in operations of business but not easily turned into
cash and used in day-to-day business.
• PPE (property, plant, equipment): value of PPE depreciates over time and has to
be deducted on balance sheet. Depreciation charge flows into income statement.
• Appreciation of land does not show up on balance sheet
3. Intangible Assets: IP (trademarks, patents)
4. Other Assets: pre-paid expenses (i.e. if you pay for full year rent then the other 11
months are considered pre-paid expenses)
Right Side:
Liabilities: Borrowed money that has to be repaid. Amounts and due dates are
predetermined.
1. Short-term debt./ current liabilities: due within the next year or sooner (i.e. current
portion due of long-term bond, accounts payable, bills)
2. Long-term debt: things due in later than a year
Creditors – Contract Claimants

• Indenture is the contract for bonds and debentures.
• Indenture trustee: the bond holder. Not in privity of K. They are 3rd party
beneficiaries of K.
• If publicly traded then they must comply w/ SEC (i.e. Trust Indenture Act of 1939
which governs the relationship of trustee to the issuer)
Shareholder’s Equity
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Capital: what shareholders contribute in exchange for their equity (common stock CSA
and preferred stock PSA)
Retained earnings or deficit: What portion is being retained and not paid out
**loss suffered is reflected here
= cumulative earnings – cumulative earnings distributed to owners of dividends
Other comprehensive income or loss: if business generates gains/ losses not continuing
business profits/losses
CSA (common stock account): equals the number of outstanding shares of common
stock, multiplied by par value per share of common stock
• CSA = # of o/s sh of c/s x p.v./ sh
• DGCL 4 capital
• NYBCL 506 stated capital
PSA (preferred stock account): equals the number of outstanding shares of preferred
stock, multiplied by par value per share of common stock
• PSA = # of o/s sh of p/s x p.v./ sh
• DGCL 154 capital
• NYBCL 506 stated capital
APIC (additional paid-in capital)/ overage: amount s/h pay that is over and beyond par
value (aka capital surplus account)
APIC= amount paid over par value x #of o/s
RE/D (retained earnings): the profits and losses of the business since inception. Money
not given back to shareholders can be reinvested in the business. A corporation’s
accumulated income after dividends have been distributed
Ex. 1
c/s 50 shares @ $100 each
p.v. = $5
p/s 10 shares of Series A @ $20 each
p.v = $20
Assets Liabilities
Cash Stockholder Equity
$5000 (50 sh x $100) CSA = $250 (50 sh x $5 pv)

$200 (10 sh x $20) PSA = $200 (10 sh x $20 pv)
APIC = $4750 [50 sh x ($100 - $5)]
$5200 $5200
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DE Legal Capital Rule: Directors may declare and pay dividends upon the shares of its
capital stock (CSA or PSA) either (1) out of the company’s surplus or (2) if there is no
surplus, out of the company’s net profits for the current fiscal year and/or the preceding
fiscal year (very friendly to shareholders)
• Even if no surplus, no APIC, RE/D – can still pay dividend if company had
profits last fiscal year. This comes from amount reflected in CSA & PSA (the
capital cushion)
• DE very friendly to shareholders and BOD
• Less friendly to common shareholders
• Less friendly to preferred shareholders
• Not at all friendly to creditors (backwards from the payment hierarchy)
DGCL 170(a)
Formula: S = (TA – TL) – capital

S = surplus (excess, if any, of company’s net assets over the amount determined to be
capital)
TA = Left side of balance sheet
TL = net assets – amount by which company’s TA exceeds its total liabilities (upper right
Ex. #1
Pg. 335, Nutshell
c/s = 100,000 o/s sh

p.v. = $2 p/sh
TA = $3mil
CSA = $200,000 (100,000 sh x $2 p.v)
TL = $2.6 mil
Net earnings = ($400,000)
Net earning preceding year = $100,000
S = (TA – TL) – capital

= ($3 mil - $2.6 mil) - $200,000
= $200,000 surplus
*so can pay aggregate dividend of $200,000
** so $2 p/s ($200,000 / 100,000 sh)
Ex. #2
Pg. 335, Nutshell
c/s = 100,000 o/s sh

p.v. = $2 p/sh
TA = $3mil
CSA = $200,000 (100,000 sh x $2 p.v)
TL = $2.9 mil
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S = (TA – TL) – capital

= ($3 mil - $2.9 mil) - $200,000
= ($100,000) loss this year but last year profit of $200,000
*so can pay aggregate dividend of $100,000
** so $1 p/s ($100,000 / 100,000 sh)
**The net profit test is an and/or test**
What if director of DE corp declared dividend that violated legal capital rule:
DGCL 174(a): directors generally are j&s liable for approving a dividend that illegally
reduces the corporation’s capital cushion. They are liable to the corporation or, if the
corporation is in dissolution, the corporation’s creditors for the amount by which the
aggregate dividend paid exceeds the amount legally available for the payment of
dividends.
Exceptions:
DGCL 174(a) only directors that willfully or negligently violate the legal capital rule are
liable. 172 allows directors to rely on the determinations of the corporation’s accountants
when deciding whether the legal capital rule is met.
DGCL 174(c) any director held liable can, in turn, sue any stockholder who took the
dividend with knowledge that it was illegal.
NY Legal Capital Rule: 2 part test and both parts have to be satisfied.
1. Equity Insolvency Test: cannot pay dividends to stockholders if it is insolvent or if
paying dividends would render is insolvent.
• Insolvent: unable to pay its debts as they become due in the ordinary course of
business NYBCL 102(8)
2. Net Assets Test/ Balance Sheet Test: restricts distributions to the amount by which
corps assets exceeds the sum of its liabilities and “stated capital” NYBCL 510(b)
• TA – TL > stated capital
• “stated capital” amount set forth in the capital stock account on the balance sheet
Same as DE Capital = CSA + PSA
• In NY, max dividend allowed = (TA – TL) – stated capital so same as 1st prong of
DE surplus formula
• But remember in NY, must satisfy BOTH tests – you do not get to look at
previous year profits or current year profits
Ex. 1
c/s = 500,000 o/s sh
p.v. = $1 p/s
TA = $5.1 mil
CSA = $500,000
TL = $3.2 mil
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1. Solvency Test:
assume it is solvent $5.1 – $3.2 so liquidated amount is $1.9 mil
or you can say CA v. CL (common asset exceed current liability)
$1.9 > $500,000 so solvent
then
2. Net Asset Test:

TA – TL > SC (stated capital)
$5.1 mil – $3.2 mil > $500,000
So max dividend payable = $1.9mil - $500,000 = $1.4 mil aggregate (1.4/ 500k sh/ o/s) =
$2.80/ sh
Ex. 2
c/s = 500,000 o/s sh
p.v. = $1 p/s
TA = $3.6 mil
CSA = $500,000
TL = $3.2 mil
1. Solvency Test:
assume it is solvent $3.6 – $3.2 so liquidated amount is $400,000
or you can say CA v. CL (common asset exceed current liability)
$400,000 > $500,000 so insolvent – no dividend
Then Don’t even do the Net Asset Test once the Solvency Test Fails
NYBCL 719 (a)(i) and (d)(i) Liability for NY director is essentially the same as DE
Valid consideration for stock

Both NY and DE allow future services as valid consideration for stock
NYBCL 504(a)
DGCL 152
PREFERRED STOCK
Preferred stock: a hybrid security featuring characteristics of both debt and equity.
• Debt-like characteristics: high par value (like the face value of a bond), regular
defined dividends (like interest payments), ranking “senior” to CS holders
• PS dividends are payable at the discretion of the BOD. This is distinguishable
from debt in that a company with debt outstanding must make interest payments
“come hell or high water”
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• Equity-like characteristics: dividends payable at discretion of BOD and subject to
legal capital rules, limited fiduciary duties, “junior” ranking to creditors during
liquidation
• PS holders are contractual claimants (like creditors) – rights are delineated by K
(the corporate charter). Certificate of amendment/ designation filed w/ sec. of
state to determine the amount and attributes of that specific series of stock
• Privileges associated w/ series of stock may vary b/c the attributes of each series
are heavily dependant based on the market conditions @ the time issued
• The charter can specify that amount will be determined at a later time via a
charter amendment or black check preferred stock provision
• Blank check preferred stock provision: this provision grants the BOD the
authority to issue a new series of PS when the board believes doing so is
desirable. The CSholders will have had to approve a charted amendment
allowing this. DGCL 102(a)(4) and NYBCL 402 (a)(6)
• Certificate of designation: resolution that is filed to add preferred stock. DGCL
151(g) and NYBCL 502 (c) and (d)
1. Dividend preference: in the event dividends are paid, PS holders have priority over
CS holders (dividends are payable at discretion of BOD and must satisfy legal capital
rules first) DGCL 151(c)
• Annual dividend rate is stated as a fixed % of p.v. or as fixed annual dollar
amount (i.e. 10% Series A or $2 p/sh)
• Usually higher amount than debt security interest rate b/c its riskier
Cumulative and Noncumulative Preferred Stock

1. Cumulative: if the board chooses not to pay a dividend (does not want to or legal
capital rules not satisfied), it becomes an arrearage (missed preferred stock dividends that
have accumulated), and the board must pay the cumulative preferred stockholders’
arrearage and current quarterly dividends before common stockholders.
• Like rollover minutes
• Most are this type
• If BOD chooses not to pay cumulative preferred stock dividends for 6 consecutive
months then shareholders can elect 2 BOD members
2. Non-cumulative: if they pass on paying the quarterly stock dividend, that dividend is
gone forever, even if there is money later and the board wants to pay.
Why would someone want non-cumulative stock?

Venture capitalists will buy this kind of preferred stock b/c of its liquidation preference,
has value in the context of a young company.
• Noncumulative convertible preferred stock provides venture capitalists with the
downside protection of preferred stock and the upside potential of common stock
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2. Liquidation preference: in the event of any voluntary or involuntary liquidation,
dissolution, or winding up of the company, the company must pay preferred stockholders
their stated (i.e. contractual) liquidation preference prior to the distributing any assets to
common stock holders. Dollar amount in charter, typically the par value, until preferred
shareholders are paid their dividends then common stock holders get nothing.
• In the event that the company has insufficient funds to pay the preferred
stockholders their full liquidation preference, then the company will divide its
available assets among them on a pro rata basis.
Preferred stock contract: will specify whether a given series of preferred stock is
cumulative or noncumulative and will address the following negotiations between the
company and prospective preferred stockholders (or their agent).
• Preferred stock is a negotiated security: negotiated with investors or investment
bank
• Statutory voting rights: right of preferred and common stockholders, vote
together as a single class, in order to approve an amendment to corporate charter
DGCL 242(b)(1) and NYBCL 803(a)
o If the proposed amendment would affect or change, in an adverse
way, the powers, preferences, or other special rights of a series of
preferred stock, the holders of that series are entitled to vote as a separate
class DGCL 242(b)(2) and NYBCL 804(a)
• Contractual voting rights: the preferred stock contract typically provides
preferred stockholders with the right to elect a specified number of members
(typically 2) to the company’s BOD if company misses a specified number of
quarterly dividends (usually 6)
• Conversion rights: Preferred stock contract may grant conversion rights to
preferred stockholders. Those rights allow them to convert their shares of p.s. into
shares of the company’s common stock at a specified conversion price. Has the
downside protection of preferred stock and the upside potential of common stock.
• Participation rights: These rights entitle p.s. holders to receive, in addition to their
p.s. dividends, dividends payable on common stock as if each share of preferred
stock they held were a share of common stock.
• Redemption rights: Company can redeem some or all of the outstanding shares of
a given series of p.s. Would want to do this if interest rate drops. Negotiated by
company b/c it benefits company.
COMMON STOCK
Common stockholders: are equity owners (true owners). CS holders are residual
claimants – they are residual in nature b/c creditors and preferred stockholders are in line
before them
• In a liquidation context, they are entitled to any assets of the corporation that
remain after the corporation liquidates and pays creditors and preferred stock
holders
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Voting:
• CS holders elect BOD and vote on many fundamental corporate transactions (i.e.
mergers, dissolution, amendments to charter)
• Usually one vote per share. Can also issue non-voting shares but must also have
voting stock or else who would elect BOD? DGCL 212(a) and NYBCL 501(a)
• If corp issues non-voting stock the public stock exchanges don’t list it so a
company can create super-voting stock (i.e. 10 votes per share) then sell a
different class w/ only 1 vote per share
• The only difference between Class A, Class B, etc. is the voting rights. The
amount and dividend payout is the same across the board.
Dividends:
• Dividends are payable at the discretion of the BOD
• Subject to Legal Capital Rule
• Corp can pay dividend in cash or can distribute property, other securities, stock
dividends (or even whisky – Whiskey Dividend Case)
• Stock dividends consist of debentures and spin-off (a corporate divestiture in
which a division of a corporation becomes an independent company and stock of
the new company is distributed to the corporation's shareholders) DGCL
173/212(a) and NYBCL 510(a)
Voting Dilution and Preemptive Rights:

• Voting dilution: the reduction in the fractional ownership involved with a given
stockholder’s stock that results from the corp’s issuance of additional shares of
common stock and/or the conversion of convertible securities into shares of
common stock.
• Preemptive rights: stockholder’s right to subscribe to new stock issuance in
preference to persons who are not stockholders. The corp must first offer her a
fair and reasonable opportunity to purchase the portion of the newly-issued shares
necessary to maintain and preserve her current ownership interest in percentage
terms. DGCL 102(b)(3) and NYBCL 622: no preemptive rights exist by statute –
only if specified in charter
PART B: CORPORATE FORMATION AND LIABILITY ISSUES
Corporate governance is the set of processes, customs, policies, laws and institutions
affecting the way a corporation is directed, administered or controlled. Corporate
governance also includes the relationships among the many stakeholders involved and the
goals for which the corporation is governed. The principal stakeholders are the
shareholders, management and the board of directors
o A corporation’s internal affairs are governed by the law of the state of its
incorporation even if it does no business in that state (i.e. DE – DGCL; NY
NYBCL (variation of Model Act)
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Corporate Governance Documents:
• Certificate of incorporation/ charter
• By-laws
• BOD resolution: written statement of BOD resolve to take a particular action
(contained in minutes of BOD meetings)
**In hierarchal order
Corporate Charter
DGCL 102 and NYBCL 402: what must be in charter
NYBLC 301: Corporate name

301(a)(1): must contain corp., incorporated, lmtd., or some variation
301(a)(5): list of words that cannot be in name
301(a)(2)(ii): must be distinguished from names of domestic limited liability companies
(i.e. can’t be IBM Inc.)
NYBCL 402(a)(2): Business purpose

State specific or generic business purpose in charter. Usually a corp. will have both
“Purpose is to specific purpose and any lawful activity in the state of NY”
NYBCL 402(a)(4): Authorized # of shares

Aggregate # of shares which the corp shall have the authority to issue. Must list class w/
or w/out par value
NYBCL 402(a)(5): Share classes

If shares are divided into classes, the designation of each must state rights, preferences,
and limitation of the shares of each class.
NYBCL 402 (a)(6): Blank check provision

Grants the BOD the authority to issue a new series of preferred stock when the board
believes doing so is desirable.
NYBCL 402(a)(9): Duration

Corp is perpetual unless the charter states otherwise. Can be amended to change
NYBCL 402(b): Director’s personal liability

Limits directors personal liability for breach of certain fiduciary duty (duty of care)
Analogous to DGCL 102(b)(7)
NYBCL 402(c): Everything else in charter

Corp can add anything to the charter so long as it is legal
Amending Charter:
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• General NY rule: if stock has been issues then BOD and p.s. and c.s shareholders
must approve. If it would adversely effect one of them then they have veto power
• Once approved then file certificate of amendment
• NYBCL 803(a) and DGCL 242
Exceptions:
• If no shares have been issued, then sole incorporator can file certificate of
amendment and don’t need BOD approval b/c no BOD has been formed NYBCL
803(d) and DGCL 241
• Can fix typos w/out BOD approval (but NOT name)
By-laws
By-laws:
• Mechanics that govern meetings of BOD, shareholder meetings, #of BOD
members, how to fill BOD vacancies
• Describes titles and description of some positions
• Shareholders can amend by-laws at any given time. Most charters can allow
directors to amend by-laws w/out shareholder approval. NYBCL 601(a) and
DGCL 109(c)
• If there is a conflict w/ directors and shareholders in by-laws the shareholders
ALWAYS win
Board of Directors Resolutions
BOD Resolutions:
• Written statement of a BOD’s resolve to take action
• Often in minutes
• Rarely a conflict w/ other 2 documents
Class #4
Ultra Vires Doctrine
Classic ultra vires doctrine:

• “beyond the corporation’s power”
• The corporation is endowed with life and capacity only insofar as provided in its
charter
• Very narrowly construed
• Original purpose was to protect the public from unsanctioned activity
• Ashbury Railway v. Riche: Old English rule. Any K entered into by corp. that
was ultra vires was void, even if corp. amended its charter to encompass those
ultra vires activities it contracted to do.
• 3rd party couldn’t enforce the K; corp couldn’t enforce K
Today’s ultra vires doctrine:
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• NYBCL 202(a) and DGCL 122
• Much more broad – gives corporations a litany of implicit powers
• Certainty of commercial dealings trumps ultra vires
• Ultra vires acts are acts that go beyond specific corporation’s power – they are
legal acts but this corp does not have power to do. Illegal acts are illegal for
everyone. Unauthorized acts are w/in the scope of the corp but not authorized by
BOD - they are not ultra vires (i.e. K w/out BOD approval – enforceable but corp.
can in turn sue the officer that entered into K w/out authorization DGCL 124(2)
Goodman v. Ladd Estate (OR)

Pg. 125, CB
Facts:
• Westover consisted of Liles (sole shareholder), Wheatley (director), and Martin
(director)
• Wheatley took out a personal loan that was indirectly guaranteed by corp.
• Wheatley defaulted and Ladd brought suit against Westover on the guarantee but
Westover did not pay
• Goodman purchased Liles shares of Westover stock and brought action to enjoin
Ladd from enforcing the guarantee on ultra vires grounds
• Goodman states that Wheatley got benefit from loan, not corp, therefore, the
guarantee was ultra vires (all parties agree that guarantee was ultra vires)
• Ladd said that Goodman was aware of the guarantee when he bought the shares
and Liles approved it
Holding:
• Goodman gets no relief b/c they approved it indirectly through Liles
Reasoning:
• If a shareholder has participated in the ultra vires act, he cannot thereafter attack it
as ultra vires.
Law:
DGCL 124: Ultra Vires Doctrine
(1) Ultra vires may be asserted first in a proceeding by the shareholders for an ultra vires
act.
(2) If the proceeding is due to K, it may set aside the performance of K if equitable.
*disconnect between 1 and 2
(3) Attorney General can assert ultra vires in an act of dissolution of the corporation or to
enjoin unauthorized acts.
*policy of protecting public from unsanctioned corporate activity
Dodge v. Ford (MI)

Pg. 134, CB
Facts:
• The Dodge brothers, who held a minority interest in the Ford Motor Co.,
challenged the decisions by Henry Ford, who held a majority interest, to not issue
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a special dividend and to employ more men and spread the benefit of the
industrial system to the maximum number of people
• Ford wanted to make cars better and cheaper
Issue:
• To what extent may a corporation act in a manner that is not intended to
maximize corporate profits?
Holding:
• Supreme ct. upholds trial court ordering business to pay dividend of $19.2 million
Reasoning:
• Courts rarely compel corps to pay special dividends where there was no fraud or
breach of fiduciary duty by the directors
• This is b/c courts' more general deference to directors' and officers' business
decisions, however, this deference assumes that directors are acting in the
shareholders' interest. Here, Ford testified that he was looking out for the
interests of employees and car-buyers.
A.P. Smith v. Barlow (NJ)

Pg. 137, CB
Facts:
• Corporation in business of making valves gives $5k to Princeton – approved by
BOD
• Shareholders argue that it wasn’t in corp charter and bring suit
• In declaratory judgment action, the lower ct. finds that donation is sound so Δ
appeals
• Π brings in expert witnesses (CEO’s of other corps and CEO of Princeton) that
testify that donating $ is a sound investment b/c generates good will in
community and attracts smarter employees
• Δ argues that donation was self-serving for the CEO of corp to get on BOD at
Princeton.
• NJ statue allows for corporate gifts but statute enacted after corp was incorporated
so not grandfathered
• Common law: corporations giving charitable gifts is allowed as long as it
reasonable amount and benefits the corporation (direct or indirect)
• NJ statute: (1) reasonable amount is ok BUT can’t exceed 1% of capital and
surplus and must be authorized by shareholders and it cannot violate legal capital
rules or negatively impact the capital cushion. (2) donee cannot own more than
10% of stock of corp. giving gift
Notes:
• This case represents the evolution since Dodge v. Ford of the diminished scrutiny
on corporate gifts
• Biggest danger of corporate gifts is CEO’s giving to “pet charities” in return for
seats on BOD of gift recipient
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• Both NY and DE allow: NYBCL 202(a)(12): Corporation can add to its charter a
provision not allowing ANY charitable contributions DGCL 122(9): Corporate
charitable gifts - does not have NY provision
What is the ability of the BOD to consider constituencies other than the
stockholders?
NYBCL 717(b): constituency statute; when a Board takes action as to change in control.
Can consider employees, customers, creditors, long/short term interests of the corp.
DGCL: no constituency statute, only case law (Mills Acquisition) as to hostile takeovers.
Consider anyone you want, provided they bear some reasonable interest to money for the
s/holders.
Pre-Incorporation Transactions by Promoters
Promoter: a person who transforms an idea into a business by bringing together the
needed persons and assets, and superintending the various steps required to bring the new
business into existence.
• Generally they will run company or have equity position once incorporated
• Promoter often enters into K for the benefit of the corporation before it has been
formed.
• Liability of promoter (general rule): when a promoter makes a K for the benefit
of a contemplated corporation, he is personally liable on the K and remains liable
even after the corporation is formed.
o EXCEPTION: if the other party knew that the corp. did not exist yet
nevertheless looks solely at the corp. for performance, then promoter will not
be personally liable (Goodman)
o Promoter bears the burden of proof.
• Preincorporated services constitutes valid consideration for stock NYBCL 504(a)
and DGCL 152
Goodman v. Darden (WS)

Pg. 115, CB
Facts:
• Π in the process of forming corp while entered into K to renovate Δ’s apartment
building
• Π defaulted and Δ wants to hold him personally liable
• Π signed K “Building Design & Development Inc (In formation) John Goodman,
President”
• Checks were payable to corp and Goodman
Issue:
• Is Π, as a promoter, a party to the K?
Holding:
• Yes
31
Law:
• General rule: when a promoter makes a K for the benefit of a contemplated
corporation, he is personally liable on the K and remains liable even after the
corporation is formed.
o EXCEPTION: if the other party knew that the corp. did not exist yet
nevertheless looks solely at the corp. for performance, then promoter will not
be personally liable
o Promoter bears the burden of proof.
Reasoning:
• There was nothing explicit in the agreement that DDS relied on corporation
formation when they entered into K so Goodman not off the hook b/c he bears
burden of proof and offered nothing that DDS relied on corp. for performance
Once corp. formed, is it bound to K entered by a promoter?

• A corporation that is formed after a promoter has entered into a K on its behalf is
not bound by the K without more
• If corporation decides to take over K then must adopt formally or implied
(through performance by accepting benefits from K)
• Promoter on the hook until novation, unless, 3rd party refuses to let him off hook
• This is not Ratification: b/c ratification occurs when an unauthorized agent enters
into K on behalf of corp. Here, a pre-incorporated K cannot be ratified b/c
ratification requires principal and agent in existence AT THE TIME the K was
entered into. There is no principle and agent if has not been incorporated.
Restatement 2nd §326.
• Agency relationship not present if corp. not yet formed. Only applies to post-
incorporated Ks. Ratification is unrelated to promoter liability.
Adoption: agrees to adopt as its own a K that was formed before the corp. was created.
You don’t have to adopt a pre-incorporation K. If you don’t adopt, the promoter is left as
liable unless the exception applies. Even if K is adopted, promoter and corp are joint and
severally liable
• Implied adoption is ok: knowingly accepting the benefits and moving forward.
• Illinois Control v. Langham: a promoter is liable under a K under the law of
promoter’s liability, the fact that the corporation also becomes liable on the K, by
adopting it, does not relieve the promoter of liability. Promoter and corp. are joint
and severally liable
Novation: completely separate agreement; create a new K to release promoter;

corporation is substituted in the K for the promoter. K looks identical to previous K,
except the corp. is substituted for the promoter.
• This is the only way to get promoter off the hook
• 3rd parties are often reluctant to sign w/out some form of compensation
Consequences of Defective Incorporation
32
When, if ever, should a party receive benefit of limited liability when they make an error
during the incorporation process?
• Depends on whether the corporation exists de jure, de facto, or by estoppel
• A defective corp does not have limited liability (creditors would argue that
company has joint and several liability) but they can make defenses of de facto or
estoppel if they are not a de jure corporation.
De jure: a corporation organized in compliance w/ the requirements of the state of

incorporation – a legal corporation
De facto: insufficient compliance to constitute a de jure corporation so not recognized by

state, but steps taken were sufficient for 3rd party to treat enterprise as corporation
• Requirements: must execute the certificate of incorporation (must sign), bona fide
(good faith) effort to file, must actually exercise corporate power.
• If you are found to have a de facto corporation (even if you mess up), the
promoter will not be held personally liable for pre-incorporated Ks.
• What if everything is done but it’s lost in the mail? Promoter wins if he has
exercised corporate power.
• What if everything is done but you do not include a fee. No good faith intent and
no limited liability.
• Cantor v. Sunshine Grocery: exercise of corporate power is interpreted narrowly
(you don’t have to show a lot). Lease signing is enough to show corporate power.
If you go after the corp. first, that shows that you are looking to them for liability.
• In torts, de facto defense is valid
Estoppel: a party who has dealt w/ an enterprise on the basis that it is a corporation is
estopped from denying the enterprise’s corporate status. Less of a showing required for
estoppel.
• Difference from de facto corporation: the estoppel doctrine focuses on the 3rd
party’s mental state and actions; de facto corporation focuses on the promoter and
what he tried to do.
o If you thought of the
entity as a corporation and acted as if you dealt with a corporation you are
estopped from arguing that it is not a corporation.
o For de facto, all you
need is the three elements. You don’t need the 3rd party at all.
• Estoppel is a good defense if you can’t prove the de facto corporation defense.
• The best defense is a de jure corporation defense > de facto > estoppel.
• State can come after you even if you can prove de facto corporation defense
NYBCL 109(a)(2) and DGCL 329(b)
• Best way around using a de facto defense and estoppel defense: form a legal
corporation.
• Best way around pre-incorporation liability for promoters: incorporate first before
you do anything.
33
Class #5
Piercing the Corporate Veil (disregard the corporate entity)
Limited Liability:
• Shareholder’s are limited to their investment as the only risk of lose if the
corporation fails
• Shareholders are not liable for corporate obligations by statute
• Managers are not liable for corporate obligations b/c of principles (i.e. K or
vicarious liability)
Fletcher v. Atex
2nd circuit
Pg. 221, CB
Facts:
• Π: tort claim for injuries suffered by keyboard manufactured by Δ (Apex  805
Middlesex Corp)
• Δ: manufactured keyboard and is subsidiary of Kodak (sole shareholder)
Issue:
• Whether Atex was merely Kodak’s alter ego to constitute piercing the corporate
veil
Π:
• Alter ego theory: Argues that Kodak “dominated and controlled” Atex
DE Law:
• Under DE law, it is appropriate to pierce the corporate veil when you show fraud,
or when the subsidiary is being treated as the alter-ego or mere instrumentality of
the parent company. Here, second applies.
• Π has a high burden of proof
Alter-ego test: you must show the parent and subsidiary operated as a single economic
entity AND that there is an element of injustice or unfairness to the whole situation
which would make piercing the corp. veil fair.
1. To show the 2 operate as a single economic entity:
o Make sure there was adequate capitalization
o Corporate formalities (were corp. “housekeeping” formalities maintained and
observed).
o Siphoning of money – centralized cash management structure.
o Alter-ego as a façade of the parent
o Insolvency – but this is a given in most cases
2. To show injustice or unfairness: (in this case it wasn’t addressed at all). Conclusory
statements are not enough…you need proof!
Reasoning:
• Adequate capitalization not at issue here b/c that deals with capitalization at time
corp was formed – Kodak bought Atex so not a factor
34
• In this case there was insufficient evidence presented by Π to show that Atex did
not follow corporate formalities. On the contrary, Atex presented BOD minutes,
tax forms, etc.
• No siphoning of $ by Kodak from Atex. Kodak had Atex’s funds for interest
maximizing reasons, plus, Atex had full access to the funds at any time
• The façade argument was best Π put forward b/c Kodak literature called Atex a
division and not a subsidiary. A division is still part of same corporation. Court
still held it wasn’t enough to pierce the corporate veil.
• Even if Π did raise factual question about domination, they offered no
evidence of the 2nd prong
Walkovszky v. Carlton (NY)

Pg. 227, CB
*NY version of DE law – similar law, different language
Facts:
• Π ran over by cab owned by Δ
• Δ: stockholder of 10 corporations including one that owned cab
• Essentially a civil procedure case with dicta re: piercing the corporate veil
Issue:
• Whether these corporations operated as a single entity, unit and enterprise
Holding:
• Δ did not operate as single entity
Reasoning:
• “it is quite another to claim that the corporation is a “dummy” for its individual
stockholders who are in reality carrying on the business in their personal
capacities for purely personal rather than corporate ends” (same as DE alter ego)
• “commingling of funds” (same as DE siphoning of funds)
Avoiding getting your clients corporate veil pierced:

• Corporate housekeeping necessary for limited liability. Treat the corporation as a
separate and distinct entity; avoid alter ego assertion. (housekeeping is simple and
adhering to rules is small price to pay to avoid liability)
• Keep your corporate funds away from personal funds, no commingling: transfers
of money to you should be documented as a salary or dividend or loan; don’t pay
with personal checks.
• Provide minimal amount of capital customary for the business involved;
substance not just form.
Enterprise Theory
As scale of business enterprises enlarged, subsidiary corporations became more popular.
A single large-scale business is conducted by a constellation of corporations, controlled
by a central holding company, the various sectors being separately incorporated. This is
because it is better for tax and liability reasons
Minton v. Cavaney (CA)
35
Pg. 239, CB
Facts:
• Δ ran pool that Π’s daughter drowned in. Seminole was sued and Cavaney was
substituted as Δ
• Π won $10k but never collected so they argue that Cavaney is Seminole’s alter
ego in this new litigation
• Δ had no assets except lease for pool. They never issued stock after they were
incorporated.
• Cavaney – was temporary director, treasurer, secretary (as accommodation to
Seminole b/c they were his client and he was their attorney)
CA law, to piece the corp. veil:
• Director must treat the corporate assets as his own
• Must add or withdraw capital from the corp. at his will
• Must hold themselves out as being personally liable for the corp.’s
debts
• Must provide inadequate capitalization (“capital was trifling compared
with the business to be done and the risks of loss”)
• Must adequately participate in the corp.’s affairs (did not use the
language “shareholders” b/c Seminole had no shareholders
Policy of adequate capitalization:
• To protect involuntary creditors (3rd party tort victims)
Holding:
• Caveney was an equitable owner b/c he was to receive stock if/when stock was
issued for his services as secretary, treasurer, director – it didn’t matter that this
was temporary or an accommodation
Notes:
• Interesting case b/c corp. hadn’t issued any stock and Π argued that Δ was
personally personable b/c of his close relationship with corp. that didn’t respect
corporate form but Π can’t go after s/holders if there are none. Plus, he was going
to be issued stock in the future
• Ct. stated that capital was inadequate when it is “trifling” but 9 out of 10 business
fail so the argument can be made that all those businesses had inadequate
capitalization (Haas)
• Π won but b/c Cavaney was not party to original suit and statue of limitations ran
out, Π could not collect
Arnold v. Browne (CA)

Pg. 241, CB
• Inadequate capitalization alone is not dispositive to pierce corporate veil
Slottow Fidelity (CA)

Pg. 241, CB
• Inadequate capitalization could be dispositive
Truckweld v. Olson (WA)
36
Pg. 242, CB
• There is no law requiring a corporate stockholder to commit additional private
funds to an already faltering corporation
• Adequate capitalization is only required during corporation formation
Piercing the LLC’s Veil

Kaycee Land and Livestock v. Flahive (WY)
Pg. 499, CB
General rule: veil piercing can happen to LLC

• Ct said “we can discern no reason, in either law or policy, to treat LLC’s
differently than we treat corporations. If the members and officers of an LLC fail
to treat it as a separate entity as contemplated by the statute, they should not enjoy
immunity from individual liability for the LLC’s acts that cause damage to third
parties”
• WY started the LLC
• Uses same factors as NY, DE, CA: (1) commingling of funds; (2) inadequate
capitalization; and (3) use of corporation as mere shell (alter ego)
**don’t have to show fraud
**housekeeping not an issue b/c housekeeping requirements are much less stringent for
an LLC than they are for corp.
Equitable Subordination of Shareholder Claims

Equitable subordination: allows a court to punish inequitable conduct by reducing the
payment priority of an offending creditor to a lesser status than the payment priority of
non-offending creditors.
• “Deep Rock Doctrine from Taylor v. Standard
• Applies to controlling stockholder claims as creditors – as a stockholder you can
lend $ which makes you a creditor and shareholder at same time
• Limited doctrine and only applies to debt claims of controlling shareholders
• Where do the claims fit? Debt claims go below creditors including liquidation
preference of preferred shareholders  pushed down to common stock level
• Equitable subordination is less drastic than piercing of the corporate veil  ES
pushes your claim to the bottom while p.c.v. exposes your personal assets
• Purpose of the doctrine is to eliminate unfairness or injustice to innocent creditors
in a bankruptcy proceeding
• Bankruptcy Code §510(c): gives bankruptcy courts the authority to subordinate
claims
Benjamin v. Diamond: factors to consider whether to subordinate a claim: (1) The

claimant must have engaged in some inequitable conduct; (2) the misconduct must have
resulted in injury to the creditors of the debtor or conferred an unfair advantage on the
claimant; and (3) equitable insubordination of the claim must not be inconsistent with the
provisions of the Bankruptcy Code (b/c E.S. claims exist inside and outside bankruptcy)
37
• E.S. is not an all or nothing doctrine – if only one claim relates to inequitable
conduct then only that one will be subordinated
• Limited doctrine and only applies potentially to debt claims controlling
stockholders
Pepper v. Litton: where the claim is found to be inequitable, it may be set aside or
subordinate to the claims of other creditors
Costello v. Fazio
Pg. 24, SCM
**Vivid example of equitable subordination, s/holders in question didn’t engage in fraud
but nonetheless the action was inequitable
Facts:
• Partnership that incorporated and took out capital as a creditor
• Their initial financial sheet did not look good so they issued promissory notes to
make Fazio and Ambrose creditors (each partner was to receive $2k worth of
shares – same as their initial contribution)
• Corporation goes bankrupt 2 years later, complete turnover of creditors – at that
time had paid all of their creditors except promissory note payees – if they hadn’t
they’d be joint and severally liable
• Fazio and Ambrose’s claims were subordinated
• New capital found to be inadequate
Holding:
• The corporation was not adequately capitalized at the time of its incorporation
Reasoning:
• Fazio and Ambrose, serving in a fiduciary relationship to the corporation, acted
for their own benefit when they withdrew capital and it was to the detriment of
the corp. and its creditors (and future creditors)
• It should have been apparent that the undercapitalization would have lead to
business failure
• They took advantage of their fiduciary positions hoping to gain equality of
treatment w/ general creditors – therefore, their claim should be subordinated
Law:
• Pepper v. Litton: where the claim is found to be inequitable, it may be set aside
or subordinate to the claims of other creditors
• Taylor v. Standard Gas: question to be determined when the plan or transaction
which gives rise to the claim is challenged as inequitable is “whether, w/in the
bounds of reason and fairness, such a plan can be justified”
• Uniform Fraudulent Transfer Act §4(a)
Arnold v. Phillips: Arnold calls $75k loan to business is equity contribution so not a loan
that is equitably subordinated. Additional income after inception is a loan – adversity
later can necessitate corporate borrowing to meet its needs but must document loan as
necessary for housekeeping
38
Problem #5
SCM, pg. 4
A. Theory to recover from PK:

• Try to p.c.v. of PK/ Harmann – look at factors of single economic entity
• Does PK have its own BOD and corporate housekeeping to prove?
• Was there commingling and siphoning of funds?
• Common control over both?
• Harmann wearing creditor hat so go after b/c tort victim is involuntary creditor –
get rid of his claim by equitable subordination
PART C: CORPORATE STRUCTURE
Class #6: Distribution of Corporate Powers
Directors Power:
DGCL 141(a): Corporations are managed by or under the direction of the BOD, except
to the extent as may otherwise by provided in the charter.
NYBCL 701: Business of corporation should be managed by the BOD; each member
must be at least 18 (sorry Hanah Montana)
ALI-PCG 3.01: contrasts by saying that the management of a publicly held co. shall be
conducted by and under the supervision of the corp.’s principal senior executives (this
recognizes modern corporate governance)
Shareholder Power:
Voting: Each shareholder’s voting power is directly tied to amount of her capital
contribution, as votes are allocated on a per share basis. Can vote on amendments to
charter DGCL 242(b), fundamental transactions (mergers DBCL 251, dissolution DGCL
275, substantial sale of assets DGCL 271 ), elect (and in some cases remove BOD – but
don’t normally get to vote on replacement (DGCL 144)), amend by-laws (can share that
power w/ BOD by stating in charter DGCL 109(a))
Removing BOD Members:

NY 706(a): can remove with cause
NY 706(b): can remove w/out cause only if charter or by-laws allow. If removed then
shareholders elect replacement if removed without cause
DGCL 141(k): shareholders can remove directors w/ or w/out cause
Election for replacement:

For vacancies (generally): the remaining BOD members are usually allowed to appoint
someone to act as a board member for the remainder of the term
NYBCL 705(b): shareholders who oust can vote for a new director
Schnell v. Chris-Craft (DE)
39
Pg. 166, CB
*Amended by-laws to move up annual meeting is legal but inequitable
Facts:
• Δ sought to enjoin management to accelerate date of annual meeting to reduce
time for proxy contest to make it more difficult for sh/holders to wage a
successful proxy fight
• DGCL 109: corp. charter can give power to s/holders to amend by-laws but they
can share that power with BOD if charter allows
• In this case, s/holders gave directors power to amend by-laws so their action was
legal statutorily and according to the charter BUT under the circumstances their
actions were inequitable b/c they put their own needs ahead of s/holders
Holding:
• Δ breached fiduciary duty of loyalty so held for Π
Leveraged Recapitalization
Leveraged recapitalization: involves a company’s incurrence of large amount of debt.
The goal is to put a substantial amount of cash into the hands of the company’s common
stockholders by leveraging the company’s assets. To achieve this goal, the company will
borrow large amounts of debt and then distribute the proceeds to its stockholders in the
form of an extraordinary dividend.
• A stockholder vote is not required
• The company becomes highly leveraged, its assets are used to secure the new
debt, and its cash flow going forward services the new debt
• Shares become much less valuable – but has potential to enhance value of corp
b/c shareholders can reinvest
• Common s/holders have greatest interest in company going forward
• Creditors hate b/c c.s. holders have $$ and the leverages recap incurs high interest
making it harder for company to pay off and puts company at risk for insolvency
• But shareholders could care less b/c they have $$ and if corp goes under they are
ok and creditors aren’t ahead of them in line
• Often employed when confronted with a hostile takeover bid to put more $ in the
hands of s/holders than that being offered by a hostile party
Blasius v. Atlas (DE)

Pg. 167, CB
*Shareholders rather than management propose a leveraged recap
Facts:
• Π acquired 9.1% of Δ’s common stock making them the largest s/holders
• Π believed Δ was poorly managed and encouraged Δ to implement a leveraged
recap.
• Blasius’ leveraged recap called for: (1) payment to c.s/holders an aggregate
dividend of $35 mil + stock option proceeds and proceeds of sale of certain
operations; and (2) payment of non-cash dividend = $125 mil principal amount of
40
7% Secured Subordinated Gold-Index debentures (a debt security that is like an
I.O.U.)
• Δ reacted negatively to this so Π by-passes management w/ written consent
• DGCL 228: Action through written consent: any action that could be taken by
s/holders at a meeting, can be taken w/out a meeting w/out notice to s/holders if
they deliver to the company written consent telling the company to take action.
o You need the same number of votes you would need in a s/holder meeting
(s/holders of at least 51%)
o You have 60 days from the earliest date of consent to get all the remaining
consents in to have that action be effective NYBCL 615(a)
• Blasius’ written consent sought to (1) adoption by s/holders of a precatory
resolution (a request that is not mandatory) recommending the BOD develop and
implement a restructuring proposal; (2) amend Δ’s by-laws to expand BOD
members from 7 to 15 (max allowed in by-laws) and (3) elect the 8 new seats
which would give them a majority on the board
• Δ responded by voting to amend the by-laws to increase size of BOD from 7 to 9
then filled the 2 seats with Δ friendly appointees (which allowed them to keep
their majority control even if Π’s written consent passed)
Issue:
• Whether a board may validly act for the principal purpose of preventing a
company’s stockholders from electing a majority of new directors
• Can a board act for the principle purpose of preventing s/holders from electing a
majority of new directors?
Law:
• DGCL 141(a) Business Judgment Rule: a presumption that in making a business
decision, the directors of a corp. acted on an informed basis, in good faith and in
the honest belief that the action taken was in the best interest of the company
o Shareholder has burden of overcoming the presumption
o Policy: business decisions should be made in board room, not court room
w/ 20/20 hindsight – if BJR applies, you have to show court that the action
had NO RATIONAL business purpose, in order to have a court rule it
voidable
** Doesn’t apply in this case b/c this is clearly a corporate governance issue
(purpose of action was to impede s/holders and expanding the BOD does not have
to do with business judgment)
• Unocal rule: When taking defensive actions (which have as a byproduct
protecting your own jobs), there must be some sort of threat, and the action taken
must be proportional
**But defensive response here is to keep the status quo which is a conflict of
interest b/c not necessarily looking out for what’s best for corporation, instead
they were trying to protect their jobs
Holding:
• Compelling justification test: The board must have a compelling justification
for taking unilateral action, the primary purpose of which is to interfere with or
impede the exercise of the stockholders voting franchise
41
MM Companies v. Liquid Audio (DE)
Pg. 187, CB
*DE examines the Blasius Standard
Facts:
• MM (owns 7% of LA stock) sends letter to LA BOD discussing willingness to
acquire LA which includes proposal to change by-laws to add BOD members and
MM had nominees already
• LA responds by (1) announcing stock-for-stock merger w/ Alliance Corp.; (2)
postponed annual s/holder mtg. and held a special mtg. to vote for merger; (3)
proposed stock by back if merger vote passed – which would induce holders to
vote in favor of merger b/c s/holders would own stock in LA and Alliance; (4)
LA BOD amended by-laws to add 2 seats and filled them with 2 LA friendly seats
• BOD rationale for expanding the Board was that eh 2 nominees were really great
people and the company will benefit from the experience, and also, that if MM
was successful there could be acrimony in the board room
• Chancery court held for Δ directors claiming that the board proposed to expand
the board primarily b/c they wanted to diminish the influence of any nominees of
MM at least in numerical terms
• DE Sup. Ct. reviews the Chancery court’s decision and notes that the standard of
judicial review is dispositive of who has the burden
• The choices of review are:
• BJR (favors Δ- co and directors) – Π/ s/holder has burden of overcoming the
presumption of BJR. If they can’t prove then game over but not exactly game
over the board must show that it was a rational business purpose. So if burden
isn’t met
• Blasius compelling justification (favors Π –s/holders) – DE ct rarely applies –
focuses on struggle between s/holders and directors.
• Unocal (favors Δ-directors) - focus on defensive actions by BoD - Δ has burden
of proof. Defensive measure must be proportionate and reasonable in relation to
the threat posed. An action is not reasonable in relation to the threat posed if it is
Draconian (defensive response that precludes any possible takeover, despite what
the offer is, it wouldn’t be enough, or it would be coercive to their s/holders into
doing something they would prefer not doing. Anything in this range of
reasonableness is allowed by DE courts)
Holding:
• In this case, Δ’s action affected s/holders, so the compelling justification and
Unicol standard appeared to be triggered. Ct. said that Δ was impeding the
s/holder voting and there needs to be a justification and once that is satisfied then
you can satisfy the lower Unocal test (but no one ever passes the compelling
justification test)
• Δ/directors board expansion was invalid b/c they didn’t meet the compelling
justification test so Δ’s action was invalidated as an inequitable act
42
Williams v. Geier
Pg. 84, SCM
Facts:
• Facts giving rise to the dispute happened in ’85 (height of hostile takeover boom)
but wasn’t decided until ‘96
• Δ Milacron and Π minority s/holders
• Publicly traded company but Geier family owned or controlled in excess of 50%
stock, all the rest were held by s/holders in the marketplace.
• 10 directors, 3 of whom were inside (employed by corp and most likely a senior
executive that happens to sit on board) and the remaining 7 were outside
(independent, disinterested parties, no affiliation with corp other than the fact that
they sit on board)
• DE court gives a great deal of deference to decisions make by an independent
committee, the DE chancery court will bend over backwards to make sure those
decisions are respected by the board)
• Δ’s recap plan offended Π, the plan was to provide for a tenure voting plan which
involved Δ amending its charter so that c.s. holders would be deemed by fiat to
have 10 votes per share instead of 1, so new buyers would only be entitled to one
vote per share but after 3 years the buyers would be entitled to 10 votes per share.
New shares would be entitled to only 1 vote, until the buyer held the stock for 3
years and then it would convert
• Recap plan sought 2 objectives: (1) reduce the level of exposure to raiders (those
conducting hostile takeovers, feeding on corporate vulnerability based on hurting
business cycles- someone who wants to buy the company when the stock prices
are low); (2) provide the board with a corporate structure, which gives the board
the best opportunity to evaluate and negotiate in the best inters of s/holders, any
proposal to acquire the company (huge impediment in being taken over)
• How to achieve these objectives: (1) deterred a hostile party from providing a
hostile tender offer (sending offers to purchase directly to s/holders – company
can’t do it but it is still a self tender offer; (2) going private transaction is when
the company tries to buy back all shares it must comply with the Williams Act of
SEC – govt. got involved b/c people were messing w/ s/holders so govt.
involvement was necessary b/c s/holders didn’t want to be left out.
• Tender offer rules mandate a time period in which that offer must be open by law
20 days.
• Hostile tender offer: someone is doing it w/out that company’s BOD blessing
• Friendly tender offer: an offer made w/ BOD blessing w/ terms typically
negotiated in advance
• Any hostile party that acquired shares in a tender offer would see the votes go
from 10 – 1, so the acquiring corp would have to by significantly more than 50%,
Geier family owns more than 50% and they won’t sell w/out thinking it’s a good
deal so it becomes impossible to take control of the BOD via hostile takeover
• Π alleges Geier family want to sell some stock to get cash, yet they don’t want to
give up control of the company, so they did this scheme – families retained shares
43
have 10 votes and sold shares that have 1 vote – so Geier’s could sell 30% of
shares and still have control
Holding:
• The statements here are coercive b/c if the shareholders did not make the 2/3
majority vote, then their stock would be de-listed from the NYSE and would no
longer be able to be traded or sold. Coercion – shareholders vote on a particular
issue NOT ON THE MERITS. Here, compelling justification does not apply b/c
there is s/h approval of this amendment.
Notes from class:
• By modifying the votes p/sh – same implication as Blasius b/c reduces # of votes
and disenfranchises minority s/holders
• To modify the charter the BoD must approve then obtain s/holder approval then
file amendment to charter w/ Sec. of State. If s/holders have approved the BoD
can refuse to submit the amendment if they change their mind on the amendment
DGCL 242 (c): this right is only given if explicitly in the charter
• Π wanted Blasius standard b/c BoD plan impeded their right to vote for directors
of their choosing indirectly based on # of votes
Class #7 Authority in General
Agent: is a person who by mutual assent acts on behalf and subject to control of another
– the principal. 2 types of agents:
• General: authorized to conduct a series of transactions, covering a wide spectrum
of activities with some continuity of services (i.e. corporate officer)
• Special: authorized to conduct only a single transaction or only a series of
transactions not involving the continuity of service
Principal: person on whose behalf and subject to whose control an agent acts. 3 types of
principals:
• Disclosed: when an agent and a third party interact, the third party has notice that
the agent is acting for a principal and has notice of principal’s identity
• Partially disclosed: when an agent and a third party interact, the third party has
notice that the agent is acting for a principal but does not have notice of
principal’s identity
• Undisclosed: when an agent and a third party interact, the third party has no
notice that the agent is acting for a principal.
Authority:
• Actual: focus is on relationship between agent and principal, agent’s belief. The
principal’s words or conduct would make a reasonable person believe he was
authorized to act.
o Express or implied: if you have authorized someone to sell your house,
you impliedly authorized them to advertise for sale
o Incidental: ensures that the main purpose will be fulfilled
44
• Apparent: focus is on 3rd party. Words or conduct of the principal would make a
reasonable party in the 3rd party’s shoes believe that he principal’s agent was
authorized to act.
o Power of position: Actual and apparent authority typically go hand-in-
hand
 Ex. Reasonable for 3rd party to believe that the Treasurer can sign
checks
 Ex. If treasurer never given explicit authority to write checks,
instead, power given to comptroller of corp. Nevertheless, it is reasonable
for a 3rd party to believe that the treasurer could write checks so – corp is
bound
• Agency by estoppel: similar to, or subsumed within, apparent authority. An
alleged principal will be held liable for the actions of his purported agent if an
innocent 3rd party changes her position or:
o Principal takes actions to induce 3rd party to believe
o Alleged principal knew of the 3rd party’s belief, but did not take adequate
measures to remedy mistaken belief
o Similar to promissory estoppel in that there is no actual K
• Inherent: the authority of the agent to take action that a person in the principal’s
position should have reasonably foreseen that the agent would have taken even
though the agent is not authorized to do those specific actions.
• Ratification: after the fact approval. Principal with material knowledge of the
facts, either treats the conduct as authorized , or justifiable if he had such intention
o Express or implied: principal accepts benefits or approves it =
ratifications
o Principal and agent both must be in existence when agent does such action
 Ex. Overzealous corporate officer entering into a transaction and
when the board learns about it, the corp starts accepting benefits and
paying for it
Liability:
• Principal  3rd Party: principal liable if agent had any of the 5 types of authority
• 3rd Party to Principal: if principal is bound, 3rd party is bound to perform.
EXCEPTION: If undisclosed principal then 3rd party is not liable with the
transaction if the principal or agent knew that the 3rd party would not deal if the 3rd
party knew the identities of the principal or agent.
• Agent  3rd Party: if agent had authority, he is not bound to 3rd party unless
principal was undisclosed or partially undisclosed.
• Agent  Principal: if agent had actual authority, then agent not liable. If
apparent authority, then he is liable to principal for damages. Ratification
probably follows apparent authority. No settled law for inherent authority.
• Principal  Agent: if agent acts with actual authority, then no liability. Principal
must indemnify the agent for any damages paid, if the agent does things correctly
and is sued by 3rd parties
45
Reading v. Attorney General
Pg. 23, CB
**Agent must act solely for the benefit of the principal
Action by Directors -
Formalities Required for Action by the Board:
Models of Corporate Governance:

• Traditional – managed by BoD
• Modern – function of board is to monitor (watchdogs) the senior executives who
manage the corp ALI-PCG 3.01
Constraints on Directors:
• Time: meet only 6 – 12 times per year so 48 – 72 hours per year focusing on the
management of corp.
• Information: not unusual for directors to receive materials very shortly before a
meeting or at the meeting. There is no staff to help you look at the info and see if
it’s accurate so DE 141(e) - directors are entitled to rely on records prepared by
officers and opinions and reports by outside advisors. NYBCL 717(a) is the
same provision, must be done in good faith. Directors don’t ask for more info or
on a more timely basis, there is generally a grimaced look and it shows a level of
mistrust
• Composition of BoD: it is not uncommon to have individuals who are closely
tied to the top executives. Typical BoD members are current or past executives,
considered inside or independent directors.
o Distinction between contrary points and voting against CEO’s wishes 
higher tolerance for contrary statements, as opposed to voting no.
o Lawyers, accountants, investment bankers are on board, need a nexus.
They will usually not rock the boat w/ the CEO
o Friends of CEO considered outside independent directors
o Major stockholders – they usually are talking about their money and
nothing has a greater interest to them, most likely to rock the boat of the CEO
Board of Directors: Election
Staggered BoD: Members are broken up into typically 3 classes, Class 1 up for
reelection this year, 2 the next, etc. It is a rolling election process, only one class per year
is up for re-election
• A company would want this b/c at any given moment there is one class of director
who has been there and the new directors will benefit from the continuity
• Anyone who wants to take over the BoD in a hostile proxy fight would need to
win 2 annual elections to replace the majority on the BoD, so it takes a minimum
of 13 months – most companies would not want to wait around for 2 elections
46
• Companies w/ staggered boards and poison pills are almost impervious to
takeovers
• DGCL 141(d): board can be divided into 1,2 or 3 classes and board is up for
election in successive years. Provision can be in certificate of incorporation, or
initial bylaw by sole incorporator (adopts initial set of directors and bylaws) or
put in later on if s/holders adopt.
o Shareholders hate staggered boards b/c they stop takeovers – so best time
to add it in is right before you go public, s/holders will not buy the continuity
argument
• NYBCL 704(a): notes that you cannot mathematically divide directors into one
class. You can divide into as many as 4 classes. Differs from DE: requires that
directors be divided into classes as equally as possible.
o It can possibly take 3 years for a takeover.
Board of Directors: Approval of Actions

Action can only be taken in 1 of 2 ways:
• Unanimous written consent: any action that directors can have in a meeting can
do it outside of a meeting as long as unanimous consent by directors (issuing
stock, S election, relieving sole incorporator of liability, and appointing directors).
DGCL 141(f), NYBCL 708 (b)
• Regular and special meetings: Need quorum and appropriate vote (in person or
conference call)
o Quorum: minimum # of directors law requires to be present for legally
binding action. Default is majority of the entire authorized board.
o DGCL 141(b), NYBCL 707, 709(a)(1): Can change quorum threshold to
require greater than a majority but you cannot lower to a number less than 1/3.
• Appropriate vote: assuming a quorum, you need a majority vote of directors
present at the meeting. Default is majority.
o DGCL 141(b), NYBCL 708(d): Can require super majority.
o DGCL 141(b), NYBCL 709(a)(2): Cannot be lower than majority.
Shareholder voting:
o S/h can only vote for directors and fundamental transactions (mergers,
amendments to charter, dissolution)
o Plurality: only top vote-getter wins
Straight/traditional voting: You can vote the number of shares you own for each
nominee.
• Majority s/holder can elect ALL directors
• DGCL 216(iii): unless cert. of incorporation or by-laws, top vote-getters win
(plurality)
• NYBCL 614(a): plurality vote can only change in the cert. of incorporation NOT
by-laws.
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Cumulative voting: A s/holder can cast for any single candidate or for two or more
candidates, as chooses, a number of votes equal to number of shares she holds times the
number of directors to be elected
• Cumulative voting MUST BE IN CERT. OF INCORPORATION
• DGCL 214 and NYBCL 618: s/holders may cumulate their votes only if cert of
incorp. allows it
• Policy: helps minority s/holders ensure they get to elect at least one person to
BoD to represent them. It doesn’t guarantee it but gives them a chance.
• Best time to add cumulative voting provision in charter is at time of incorporation
otherwise majority s/holders will never vote to approve it
Formula to determine how many directors you can elect:
N = (X) x (D+1)
S
• D = # of directors to be elected (not number of nominees)

• N = # of directors you get to elect
• X = # of shares you own
• S = total # of shares to be voted assuming 1 vote/share.
• If you have 100 shares (X), 5 directors are to be elected (D), there are 1000 shares
outstanding (S).
• To determine the fewest number of shares you can own in order to elect 1 director
use the same formula but N=1 and solve for X (just work backwards). To
determine 2 directors N=2, and so on.
Shareholder Meeting:
In order to have a vote of stockholders to be legally binding, you need to have a quorum
of stockholders present and appropriate number of votes (same as directors)
Quorum:
• DGCL 216: the cert. of incorporation or by-laws can specify a quorum, but cannot
be less than 1/3 of the shares needed for a meeting. If you don’t have a quorum
specified, default provision is the majority of stockholders needed to vote.
• NYBCL 608(b): you can have less than a majority, but not less than 1/3. You can
have a higher quorum requirement, but only cert. of incorporation can provide for
it. DE does not allow this
• 608(c): quorum requirements are met at the BEGINNING of the meeting – so
people can leave during meeting and it won’t affect quorum.
Appropriate number of votes:
• In DE, the default rule is a majority vote present or by proxy.
• DGCL 216(ii) or by-laws can establish a threshold contrary to a majority.
• Assuming no tinkering of voting requirements, you need at least 26% of the
shares. Under the default rule, stockholders who own 26% of the shares can
control.
Abstentions:
48
NY and DE very different.
• DE: Abstentation equals a ‘no’ vote
• NY: Abstentation counts for quorum but not for votes
• NYBCL 614(b): an action is approved if a number of votes cast in favor
outnumber those against. Only applies to those who vote.
• Hypo: quorum is 500; 200 abstain; 175 vote against; 125 vote in favor. In NY it
is passed but in DE it does not pass – need 251 votes in favor
Proxy Voting:
NYBCL 609(a): every stockholder entitled to vote may authorize another person to act
for him by proxy.
In NY, under NYBCL 609(b), a proxy is effective for a period of time up to the date
specified. If no date is specified, a proxy can be effective no more than 11 months after
date of issuance (only lasts for 1 annual meeting).
Proxy holder must vote as s/holder instructed.
EXCEPTION: Irrevocable proxy: gives the proxy holder discretion as to how he wants
to vote.
Proxy must say on its face that it is irrevocable, and must be given to one of:
• NYBCL 609(f)(1): A pledgee: ex. pledging shares as return for a loan. During a
term of a loan, the bank allowed to vote.
• NYBCL 609(f)(2): Someone who has purchased or agreed to purchase the share
(record date problem). When you have shares of a publicly traded company, the
stockholder who holds shares at the record date gets to vote, even if they sell
afterwards.
• NYBCL 609(f)(5): A person designated under a valid stockholder’s agreement.
Ex. trading voting rights for cash.
• DGCL 212: pretty much the same as NY but some differences.
• DGCL 212(b): In DE, if you don’t put an expiration date, the proxy lasts for 3
years from date of issuance. But proxies are still revocable at the stockholder’s
will.
• Irrevocability: under DGCL 212(e), proxy must state on its face that it’s
irrevocable AND must be coupled with an interest.
• Coupled w/an interest: person receiving the proxy has some nexus with the shares
-essentially same as NY’s 609 (f) and (e)
PART D: CORPORATE FIDUCIARY DUTIES
DUTY OF CARE
Duty of Care: protection from harm to s/holders by sloppy/negligent decision making by

BoD. Duty of care analysis is an analysis of the decision making process, not the
decision itself.
• NYBCL 717(a) and RMBCA 8.30: A director shall perform in good faith, and
exercise that degree of care that person in a like position would exercise.
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• DGCL does not have duty of care provision
• Subjective – in like position as director in question (same skill set, i.e. lawyer,
accountant) and similar circumstances. Objective component – RPP
• 20/20 hindsight is not part of analysis.
• Duty to act and abstain - applies not only to actions that directors take
consciously, but also omissions.
Francis v. United Jersey Bank (NJ)

Pg. 515, CB
**With power comes responsibility
Facts:
• Δ is in the business of reinsurance brokerage.
• Partnership  corp. w/ 5 directors (2 bad sons and 1 old mother)
• Brothers engage in unscrupulous conduct – taking out “loans” and reporting them
as such on balance sheet but never paid interest or back to corp. account
(siphoning of funds); did not disclose the “loans” as personal, and comingled
funds of reinsurers and ceding companies with their own funds
• Mother does not participate in running of corp and has no idea that sons are doing
this
Issue:
• Whether Mrs. Pritchard was negligent in not noticing and trying to prevent he
misappropriation of funds held by the corporation in an implied trust? And if her
negligence was the proximate case of the plaintiff’s loss?
Law:
• General rule: a director should acquire at least a rudimentary understanding of
the business of the corporation. Not required are detailed inspections of books
but should regularly view financial statements.
• “Dummy director” is not protection – all directors are responsible for managing
the business and affairs of the corporation.
Holding:
• Δ had a duty and she breached that duty. Using the substantial factor test it was
found that her breach was the proximate cause of Π’s loss.
Reasoning:
• Negligence/ breach of duty: She had duty to monitor financial statements and she
did not, had she reviewed them she would have noticed something “fishy” going
on. She had a duty to object to illegal activity and if nothing was done about it,
then she had a duty to resign. She did not do any of these things
• Substantial factor test: the wrong that was committed must be a substantial factor
in producing the harm: (1) commingling of funds; (2) stealing by sons; and (3)
dereliction of duty by Δ – if she had spent anytime looking at records she could
have put an end to it.
In re Emerging Communications
Pg. 528, CB
Facts:
50
•Δ was financial expert in telecommunications sitting on the board of
telecommunications company
• Corp received merger offer that Δ knew was too low but did argue this when
Houlihan (outside financial firm) gave the valuation
Holding:
• Δ could not rely on financial advisors b/c he had superior knowledge, equal to or
greater than Houlihan’s (DGCL 141(e) n/a)
Reasoning:
• The reasonably prudent director in his position (investment advisor in
telecommunications) would have voted no on merger offer and his failure to vote
no was negligence
In re Caremark (DE)
Pg. 562, CB
Facts:
• Δ gives kickbacks to doctors illegally at lower level of corp. – fines and criminal
charges result
• Δ/ directors negligent for failing to be made aware of what was going on with
lower managers – failed to be active monitors (linked w/ duty of care)
Holding:
• Caremark standard: whether the corporation made a good faith judgment that the
corporation’s information and reporting system is in concept and design adequate
to assure the BoD that appropriate information will come to its attention in a
timely matter as a matter of ordinary operations.
• Caremark test/ evidence of good faith judgment: when there is a sustained or
systematic failure by the board to attempt to ensure that the system exists.
• Level of negligence needed to show breach of duty of care is gross negligence.
Notes from class:
• Despite Francis, the court gives great deference to BoD decisions b/c boardroom
is where decisions should be made – not courtroom w/ 20/20 hindsight
• Judicial developments that watered down duty of care:
o Level of negligence in DE is gross negligence (Aronson case)
o Business judgment rule: waters down level b/c it is presumed that
directors acted in good faith so Π has burden of overcoming it
Business Judgment Rule (Aronson)

Protects directors in their decision making b/c presumptions that they made an informed
judgment, in good faith (fulfilled their fiduciary duties).
Presumptions:
• Business decision
• Informed basis (duty of care)
• Good faith
• Made in best interest of corporation – put corp and s/h needs ahead of own (duty
of loyalty)
To overcome presumption Π needs to show:
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• Improper motive OR
• Dividend constituted corporate waste, OR
• Show that dividend cannot be based on any reasonable business objective
Smith v. VanGorkom (DE)

Pg. 544, CB
Facts:
• Δ is president of Trans Union arranged for leveraged buy out (LBO) to Pritzer and
had Romans (CFO) figure out how much required to satisfy debts but never the
fair price of the company and was not conclusive
• Δ looked into MBO to sell his shares at $55 p/s – Peterson (controller) came up
w/ this amount, which was 45% higher than current price (premium price), b/c
whomever buys those shares will have control of corp
• Δ decides against MBO b/c of conflict of interest but instructed Peterson to
calculate the feasibility of LBO at that price
• VG met w/ Pritzer and proposes the premium price at which he agrees
• VG wanted to be free to accept any better offer so Pritzer agreed but wanted to
secure shares at a certain price that he could sell to highest bidder if VG sold to 3rd
party
• Pritzer gives VG 3 days to make final decision so VG calls special meeting
Sept. 20th meeting:
• Directors called in but with no indication as to the subject of meeting
• Voted to approve after only 2 hours which consisted of an oral presentation by
VG and no materials were distributed
• Lawyer – Brennan – tells BoD that fairness option not required by law
• Roman states that the amount proposed was neither a fair price nor valuation of
corp. $55 p/s was low end of fair price
Post- Sept. 20th meeting:
• VG signs agreement at opera w/out reading it
• Proposed amendments that VG asked for actually constrain Trans Union more
than the original terms but b/c he didn’t read it he was bound
• 2 interested outside bidders – GE and KKR
• KKR – approached by Roman – offered $60 p/sh but VG rejects offer so KKR
withdraws offer
Issue:
• Did Δ make informed business decision at Sept. 20th meeting
• If they did not, whether directors actions taken subsequent to Sept. 20th were
adequate to cure any infirmary action on Sept. 20
Holding:
• Directors did not make informed business decision for three reasons:
1. Directors did not adequately inform themselves of VG’s role
2. DGCL 141(e) Good faith reliance. Meeting hastily called, directors did
not know what it was about, they had to make a decision in 3 days. Directors
had a duty to inquire further – they could not blindly rely on VG. Blind
reliance is NOT good faith.
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3. Directors were uninformed of intrinsic value of company – no valuation
made nor request of CFO or outside form to determine the fair price range
• Directors “collective experience” argument did not remedy the Sept. 20th
actions, it actually undermines their argument. Their unfounded reliance on
premium and market test as basis for accepting Pritzer proposal demonstrates that
they should not be deferred to (and will probably not be elected to another board
ever again).
• Board must not read every K or legal document, but, if it is to successfully
resolve itself, then there must be some credible contemporary evidence
demonstrating that the directors knew what they were doing and endured that their
purported action was given effect
Aftermath of Van Gorkom: duty of care is basically dead

So NY and DE pass exculpatory charter provision statutes
DGCL 102(b)(7): director relieved from his or her duty of care except for unlawful
dividends but exculpatory charter provisions CANNOT protect from:
• Breach of duty of loyalty
• Acts or omissions not taken in good faith
• Unlawful payments of dividends (can’t violate legal capital rules)
• A transaction from which a director derived an improper personal benefit
NYBCL 402(b): same exculpatory charter provision as DE
**If charter does not contain exculpatory provision then Van Gorkom still applies
Malpiede v. Townson (DE)

Pg, 580, CB
Facts:
• Δ “Fredrick’s of Hollywood” announced that it was looking for a buyer
• Knightsbridge offered to purchase outstanding shares so entered into merger
agreement for $6.14 p/sh
• MA had “no shop” provision that Δ could negotiate with other third parties for a
higher price but could not actively seek a higher bidder
• There were 2 other bidders – Milton and Veritas
• Milton dropped out
• Veritas offered $7.75 so Knightsbridge matched but added “no talk” provision
(which is illegal according to Haas b/c by not talking w/ 3rd party bidders, Δ
breached duty of loyalty b/c they are not maximizing s/h value), termination fee,
appointment of non-voting board members
• Veritas went all the way up to $9.00 but Δ rejected relying on Knightsbridge
stated intention to vote its shares against third party bids, the no talk provision,
and Veritas’ request for an option to dilute Knightsbridge interest
• Π s/h bring suit under Revlon which said that if you put company up for sale, as a
director your role changes from protector to salesman and it is your duty to get the
highest price for s/h
Issue #1:
53
• Whether Δ breached fiduciary obligation to maximize s/h value (duty of loyalty)
Holding #1:
• Π alleges that CEO had conflict of interest b/c he was acting for his own best
interest b/c he was on both BoD’s but court held that one director did not
dominate the others so merger was approved by majority of disinterested directors
Issue #2:
• Whether Δ was grossly negligent for failure to implement a defensive strategy
such as poison pill (duty of care)
Holding #2:
• Even if court had found a valid due care claim, the exculpatory charter provision
trumps that claim.
D&O Insurance
• Director and officer liability insurance that insures against liability and legal
expenses. Technically it is indemnification insurance because it does not require
the insurer to defend (although it does require the insurer to indemnify for losses,
including defense costs), and the insurer’s obligation do not accrue until the claim
is settled or adjudicated.
• 2 components: (1) corporate reimbursement, which insures the corporation
against potential liability to officers and directors under the latters’ right to
indemnification from the corporation; and (2) personal coverage, which insures
the directors and officers themselves against the losses based on claims against
them for wrongful conduct when they are not indemnified for the loss of the
corporation
• “claims made” basis: only coverage for events that arose during term of coverage
and claim brought during term of coverage. Once a director resigns, he usually
asks corp. to buy “tail” insurance that covers as long as the statute of limitations
allows to protect from claims that arose while he was on BOD
DUTY OF GOOD FAITH

Duty of good faith is tied in w/ duty of loyalty
In re Walt Disney Co. Derivative Litigation

Pg. 110, SCM
Facts:
• Ovitz concerned w/ early termination during OEA negotiations so he wanted a no-
fault termination option (NFT) which provided options to be exercised upon
termination
• Ovitz did not perform well as president b/c he did not have same freedom as he
did at CAA and he butted heads w/ Eisner
• Eisner did everything he could to go around NFT but Ovitz didn’t do anything
worthy of being fired w/cause so he had no choice but to terminate w/out cause
• Disney paid him $140 million in accord w/ NFT
Π s/holders allege:
54
1. Δ breached duty of care
2. Δ bad faith conduct
3. Δ wasted corporate assets
1. Duty of Care:
• Focus on decision making process – consideration and approval of
Ovitz fell short of corporate governance “best practices”
• Ct. said that “best practices” would have been all committee
members having access to a spreadsheet laying out all possible scenarios (Ovitz
terminated w/ and w/out cause for each year of employment K)
• Committee could have presented that to BOD before they voted for
Ovitz
• 9/26 mtg.: approved “term sheet” which summarized material
terms but did not lay out all scenarios, instead, it had figures and formulas that
allowed members to come to the “best practices” result on their own (piece of
puzzle, not whole puzzle)
• Holding: while it was not “best practices” it certainly wasn’t gross
negligence
2. Bad Faith Conduct/ breach of loyalty:
• Chancery ct. defines bad faith as “the intentional dereliction of duty, a conscious
disregard for one’s responsibilities…conduct that is clearly disloyal to the
corporation.”
• First time court considers intent in duty of care case and not negligence
• Π has burden of overcoming BJR presumptions – prong of good faith
• Π claims this definition is erroneous b/c it materially changed the 2003 definition
but DE Sup. Ct. said it correct.
• Π claims it is erroneous b/c it was not properly tied to BOD decision making
process under duty of care but court says that there are 3 potential categories of
bad faith but only 1st and 3rd hold up in judicial analysis: (1) subjective: intent to
do harm; breach of duty of care and good faith: Π contends that by being grossly
negligent directors breach both but ct. said no - duty of care and breach of good
faith cannot be synonymous. To merge them would nullify the congressional
intent of DGCL 102(b)(7) exculpatory provisions and DGCL 145 indemnification
statutes and (3) intentional dereliction of duty: which is more culpable than
grossly negligent conduct b/c does not involve traditional disloyalty b/c Δ did not
gain anything – Δ did not put their own needs ahead of corporation’s.
• Court says that Chancery court definition of bad faith is correct but falls short so
they create their own definitions
• Bad Faith: disloyalty w/out self-interest
• Breach of Loyalty: disloyalty w/ self-interest
• Holding: Directors certainly did not gain anything by firing Ovitz and thus did
not put their own needs ahead of the corporation’s
3. Waste of Corporate Assets:
• Π claims NFT was wasteful
55
• Very difficult for Π to prevail – must show that “the exchange was so one-sided
that no business person of ordinary, sound judgment could conclude that the
corporation has received adequate consideration”
• As a Π, if you didn’t overcome BJR presumptions then must show Δ irrationally
squandered corporate assets in order to prevail
• Holding: b/c Disney needed a high enough NFT to attract him from CAA and
they were contractually obligated to pay it was not a irrational
• Orvitz did not do anything to induce his termination b/c he had no control, plus,
he was fired w/out cause and did nothing egregiously bad.
DUTY OF LOYALTY
1. Self-dealing transactions: Director directly transacts w/ corp.
• Concern: if you are part of the deal and it’s affecting you personally, you
are liable to put your interest ahead of the corporation. The other directors have
to approve it.
2. Interlocking directorate: Transaction between two different corporations
w/ director on both boards (Kodak – Fletcher v. Atex)
• Concern: you might put the interests of one company and its s/h over another.
But, there are situations where you, as a director, may have a bigger financial
interest in one over another. (Lewis)
3. Usurpation of corporate opportunities: Where a director or officer learns
of a business opportunity and rather than offer it to the corporation, she usurps it
herself and uses it for her advantage.
• Concern: she is thinking about keeping the money for herself (Harris)
4. Entrenchment activities: Directors making decisions the result of which
secure their positions as directors. Entrenching themselves in office.
• Concern: directors who are doing things that ensure their jobs and job safety may
not be making the best decisions for the corporation or s/h.
5. Action that favors one class of s/h over another: Sometimes companies
have one class of stock outstanding, benefiting one s/h over another, and the one that
is not helped claims that it is owed money.
• Concern: duty of fairness in regards to the s/h.
Self-dealing Transactions
General rule of 1880: transactions voidable at option of s/h or BOD even if transaction
was fair.
• Policy: it is human nature not to be able to disenfranchise their self-interest from
interest of corp.
• Cumberland Coal & Iron: the disinterested directors are put in an uncomfortable
position b/c they have to scrutinize and check the transactions made by one of
their fellow board members
General rule of 1910: K valid if approved by disinterested majority of directors and not
found to be unfair or fraudulent by the court if challenged.
General rule today:
DGCL 144(a): Interested party statutes/ cleansing process
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No K or transactions btwn a corp and one or more of its directors OR a K or transaction
btwn a corporation and one or more entities (interlocking director problem) shall be
void or voidable even if the interested director is there and votes in the transaction if
one of three things occur (cleansing process):
(1) Full disclosure + disinterested director approval: if K is approved by a majority of
disinterested directors, it will be valid so long as the disinterested directors were told of
the director’s interest in the deal. True even if less than quorum of the board.
(2) Full disclosure + stockholder approval: if the conflict of interest is disclosed or
known by the s/h, and they approve in good faith, then the mere fact that there was a
conflict of interest cannot be challenged on duty of loyalty grounds.
(3) Objective fairness: if the K or transaction, as determined by the court, is objectively
fair to the corporation then ok.
**when challenged on grounds that disclosure made was inadequate then the conflict was
not fully understood.
DGCL 144(b): Interested directors count for quorum determination but do not count if
you are trying to cleanse.
NYBCL 713: 3 distinctions from DE

• For a transaction btwn a corp and 3rd party to fall w/in 713, there must either be
an interested director or the director must have a substantial interest in the other
corporation. In DE, not substantial but you can infer.
• NY imposes a tougher voting standard. 713 (a)(1) requires disinterested director
approval comply with 708(d). Approval by a majority of disinterested directors
present; if no quorum then must be unanimous. In DE, only majority of
disinterested required.
• 713 (b): if the procedure met and cleansed under the first two processes then the
transaction cannot be challenged in court. If the procedure is not met then the
burden of proving that K is fair and reasonable to the corporation is up to those
interested in transaction. In DE this is disjunctive – Π can still challenge in court
even if cleansed.
Hypothetical: cleansing by disinterested director voting

*NY is more stringent than DE
BOD meeting with 15 directors but only 13 shoe up. Default provision is a majority
present so a quorum is present.
Case 1: 4 interested, 9 disinterested
• NYBCL 713(a)(1): a self-interested transaction can be approved only if 1 of 2
things occur. If any of the disinterested voters vote ‘no’ then approval must
comply with 708(d). OR it can be approved if 7 of the 9 vote in favor of it.
Interested votes don’t’ count. Up to 2 people can vote ‘no’ to comply with 708(d)
(majority present)
Case 2: 5 interested, 8 disinterested and 2 vote ‘no’
• In DE, all you need is a majority of disinterested and since there are 8
disinterested, you only need 5 votes
• In NY, you need 7
Case 3: 9 interested, 4 disinterested
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• According to 708 you don’t have enough. If you don’t have enough and fall
bellow majority voting requirement, then all disinterested have to vote ‘yes’.
Other option is s/h approval
• In DE, you only need a majority vote so you only need 3 to vote ‘yes’, not 4
Self-Interested Transactions/Interlocking Directorate
Lewis v. SLE
Pg. 609, CB
Facts:
• LGT runs tire dealership and SLE owns land & building that LGT used
• 4 brothers – Donald (Π) and Alan, Leon, Richard (Δ)
• Interlocking directorate: Δ were directors and s/h of SLE and LGT. Π was only
s/h of LGT
• This structure created incentive for lopsided transactions b/c Δ would get all
gain and Π would get all the harm
• Δ treated SLE as a shell to protect LGT
• Δ leased land to Π pursuant to lease agreement that expired but no new lease
agreement was entered into and Π paid same amount
• The s/h agreement stated that each child not a s/h by 1972 had to their sell SLE
chares to LGT at book value
• Π claims that if Δ had charged market rate for rent after lease expired it would
have raised his book value to sell shares
• Π brings suit action Δ for wasting SLE assets by grossly undercharging for rent
Law:
• BJR not applicable b/c it presupposes no conflict of interest but here there is
an interlocking directorate (if you want to disable BJR then show conflict of
interest)
• Δ has burden of proving that transactions between SLE and LGT were fair and
reasonable 713(b)
Reasoning:
• SLE’s expert showed that rent should have been higher which disproves Δ’s
argument
• SLE says LGT could not afford higher rent but court held that they should have
kicked LGT out and found tenant that could pay market rate
Holding:
• Because Δ didn’t find a tenant that could pay the market rate they were
wasting corporate assets
Damages:
• Δ was found j&s liable for fair market value determined by accounting
Usurpation of Corporate Opportunities
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Northeast Harbor Golf Club v. Harris
Pg. 658, CB
Facts:
• Δ purchased two parcels of land surrounding golf course that she was president of
at time she purchased
• Both opportunities were presented to her in her capacity as president
• She did not disclose to the BOD until after she purchased them but told them that
she did not intend to develop at that time
• Trial court found in favor of Δ b/c Π was unable to prove the corp was in the
same line of business (buying real estate)
• Sup. Ct. used this opportunity to change the ME usurpation law
Law:
• Line of business test: If a business opportunity is presented to the officer or
director which the corporation is financially able to undertake and in the line of
business of the corporation, then officer or director cannot seize the opportunity
for himself. An opportunity is in the same line of business if it is so closely
related to the corporation that the director would be in competition with the corp.
if he took advantage of it. (Maine and Delaware)
o Problem with this test is that the line of business prong is too difficult to
determine and a corporation can usually find financing sources when good
opportunities open up to them.
• Fairness test: asks whether the director or officer is being fair and equitable to
corp in usurpation of opportunity (Massachusetts)
o Problem with this test is that there are no defined guidelines of what
“fairness” means
• Two-step test: same as line of business test
• ALI-PCG 5.05(a): General rule is that you cannot undertake a corporate
opportunity for yourself unless 3 things occur:
o You have to offer the opportunity to the corporation after fully disclosing
your conflict of interest and fully disclosing the opportunity itself
o The opportunity has to be rejected by the corporation
o Either one of 3 things has to occur:
 The taking of the opportunity was objectively fair to the
corporation
OR
 The opportunity was rejected in advance by disinterested directors
in accordance with the BJR
OR
 Rejected in advance or ratified after the fact by disinterested
shareholders
**Same as DGCL 144 just in reverse
**Cannot constitute waste if corp rejects it
*Financiability does not get discussed except in comments of statute so its
considered but not emphasized
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•ALI-PCG 5.05(b): Corporate opportunity defined:
o In connection with the performance of functions as a director or officer, or
under circumstances that should reasonably lead the director or officer to
believe that the person offering the opportunity expects it to be offered to the
corporation OR
o Through the use of corporate information or property, if the resulting
opportunity is one that the director should reasonably be expected to believe
would be of interest to the corporation OR
o Any opportunity to engage in a business activity of which an OFFICER
becomes aware and knows is closely related to a business in which the
corporation is engaged or expects to be engaged
• ALI-PCG 5.05(c): Burden of proof:
o If not properly rejected or ratified, then director or officer has the burden
of showing that the taking was fair. If rejected, the burden is on the other
side.
• Rooted in disclosure
Holding:
• ME adopts the ALI as law and remands case back to lower court
• Π wins but b/c statute of limitations ran out they were not entitled to judgment
Entrenchment Activities
Unocal v. Mesa
Pg. 1124, CB
Facts:
• Δ (T Boone Pickens/ takeover artist) initiates hostile takeover
• Mesa’s 2-tier “front end loaded” tender offer:
o 1st tier (front end): tender offer to buy 37% of shares at $54 p/s (already
own 13%)
o 2nd tier (back end): as majority s/h they need to get rid of minority so they
squeeze out w/ a merger
• Once own more than 50% - control of BOD of target corp. and to get
approval for merger they need s/h approval so Δ wanted to get rid of them so they
got merger consideration: $54 worth of IOU’s (not cash, like 1st tier). These
securities were highly subordinated (“junk bonds”)
• Ct holds this action was coercive b/c if minority didn’t tender their shares
at front end then left w/ back end so they are coerced into tendering at front end
even though the amount was low
• Π rejects the tender offer b/c Goldman Sachs determined offer was
inadequate through independent valuation (van Gorkom conducted no valuation
which was their problem)
Unocal’s defensive measures:
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• Conditional exchange offer: if 1st tier/front end was successful then Unocal offers
to buy rest of stock at $72 p/s of debt securities and all s/h can tender at $72 – all
s/h EXCEPT Mesa (“Mesa Exclusion”)
• Strategy is that Mesa does not want to buy a corp that has incurred a huge amount
of debt and it would leave them as sole s/h in a debt ridden corp.
• Unocal argues that Mesa Exclusion was to adequately compensate s/h @ backend
of Mesa’s proposal
• Δ argues that Π breaches their fiduciary duty with Mesa Exclusion b/c they are
being singled out from other s/h
• Π argues that they owe no duty of fairness to Δ and the Unocal BOD acted
reasonably and in good faith concluding that Mesa’s tender offer was coercive
and inadequate. Further, Π argues that exchange offer was made in good faith, on
an informed basis and in exercise of due care to protect s/h from Mesa’s harmful
tactics
Law:
• DGCL 160(a): allows corp to selectively repurchase from specific s/h as long as
it is not for the primary purpose to entrench in office (which would breach duty of
loyalty b/c for personal benefit, not corp.)
• BOD’s power to act derives from its fundamental duty and obligation to protect
the corp. from harm reasonably perceived, irrespective of its source
• UNOCAL STANDARD: any defensive action will be protected by BJR
presumption IF:
o REASONABLE GROUNDS: Directors have to show that they had
reasonable grounds for believing that a threat existed. Must conduct an
investigation in good faith (outside investigation by Goldman Sachs very good
for Π)
o PROPORTIONALITY: The defensive measures you implement have to
be reasonable to the threat posed. – Can’t kill a fly with a sledgehammer
Holding:
• Π’s decision to oppose tender offer was made in good faith belief that it was
inadequate
• Π entitled to BJR presumptions b/c had directorial power to oppose tender offer
and ok to undertake selective exchange b/c reasonable in relation to threat posed.
Today:
• State law still allows corp to select s/h from which to buy shares from (DGCL
160(a)
• But, Williams Act passed which prohibits exclusionary discriminatory tender
offers
Unitrin v. American General

Pg. 1135, CB
**Analyzes Unocal test and undermines it by defining draconian
Facts:
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• Π has super-majority voting provision as defense for hostile takeover (requires
75% to approve) and share repurchase program to purchase 10 million shares on
the open market at $50 3/8
• BOD held 23% collectively so to vote in favor of a merger would be virtually
impossible
• DE chancery ct. holds that super-majority is defense enough so refuses to allow Π
to also have the share repurchase program but supreme court reverses
Holding:
This is the proper Unocal Standard:
Any defensive action will be protected by BJR if 2 thing occur:
1. REASONABLE GROUNDS: Directors have to show that they had reasonable
grounds for believing that a threat existed. Conduct an investigation in good faith.
2. PROPORTIONALITY: The defensive measures you implement have to be
reasonable to the threat posed – cannot be draconian
• Draconian means coercive or preclusive
• Coercive would not allow s/h to vote against it (i.e. Williams v. Geier/ Unocal)
• Preclusive would make it impossible for 3rd party to ever purchase even if a great
price was offered. Disproportionate response smacks of entrenchment.
• Range of reasonableness: anything between preclusive and coercive.
Notes:
• DE ct. extremely management friendly
• Ct. bends over backward to make it work for Π and undermines Unocal so that
virtually every defensive strategy is ok
Revlon v. MacAndrews & Forbes

Pg. 1163, CB
Facts:
• Δ (Perlman/ Pantry Pride) tender offer for Π
• Π’s investment bank says Δ’s tender offer of $45 p/s is grossly inadequate (should
be in the mid-50’s range)
• Δ’s strategy was to acquire Π’s stock w/ junk bonds then “bust up” by selling
businesses separately b/c they are worth more separately than as a whole. This
would drive up price to $60/70 p/s
• Marty Lipton (WLRK) recommends that Π buy 5 million of their own shares
which would sell to their directors so that they are in “friendly hands” (ESOP –
employee stock ownership plan which is a trust for benefits of employees)
• Δ ups bid to $42 p/s conditioned upon receiving at least 90% o/s stock (lower on
face but essentially equal in view of completed exchange offer)
• Π responds by senior subordinated notes – notes w/ covenants that limited their
ability to incur additional debt, sell assets, or pay dividends unless otherwise
approved by independent members of BOD (there were only 4 of 14 directors that
were independent)
• Δ announces new tender offer of $42 cash which is more b/c Π is so highly
leveraged w/ all the debt securities
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• Π rejects Δ’s offer and authorizes management to negotiate w/ other parties in
acquiring them (Π’s fatal mistake)
• Π finds Fortsmann as their “white knight” and gives them financial information
(did not give to Δ)
• Π’s stock plummets b/c they are so highly leveraged so Fortsmann makes new
proposal – $ 57.25 p/s LBO w/ lock-up option to purchase Π’s most valuable
division is 3rd party bought more than 40% then they could buy at bargain
basement price (crown jewel), plus no-shop provision and cancellation fee.
Fortsmann would support the value of notes in the secondary market (buying
them as the price lowered)
• Δ ups tender offer to $58 p/s conditioned on nullification of the Rights Plan
(poison pill), waiver of the covenant, and injunction of Frontsmann’s lock-up
• Δ seeks injunctive relief and enjoined the lock-up, no-shop, and cancellation fee
provisions or agreement
Law:
• Re: injunction: Δ must demonstrate both a reasonable probability of success on
the merits and some irreparable harm which will occur absent an injunction
• Duty of loyalty comes into play here – “when BOD implements take-over
strategies there arises “omnipresent specter that a board may be acting in their
own interests, rather than the interests of the corp and s/h”
Holding:
• Poison pill and Exchange Offer: were reasonable responses to perceived threat
HOWEVER when they put themselves up for sale 2 things happened:
o Directors’ duties became that of an auctioneer (get the best price)
o Defensive strategies are moot
• Lock-up: did not encourage bidding so it ended auction
o Lock-up options and no-shop provisions are not illegal, but, they are only
permissible if they intensify bidding process
o Cancellation fee only ok if is part of overall plan to thwart Δ’s effort
• White knight: Π showed favoritism toward Frontsmann so it is not allowed b/c
this was an auction and not a take-over so not creating level playing field. You
are breaching duty of loyalty by not getting best price for s/h
• Don’t have to get price but should accept the bid offering the “highest price
reasonably available for the company” and can consider several factors:
o Adequacy and terms of the offer
o Offer’s fairness and feasibility
o Proposed and actual financing of the offer and consequences of the
financing
o Questions of illegality
o Impact of both the bid and the potential acquisition on other constituencies
(provided bears reasonable relationship to s/h interest)
o Risks of nonconsummation
o Basic s/h interests at stake
o Bidder’s identity, prior background, and other business venture
experiences
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o Bidder’s business plan for the corporation and their effects on s/h interest
Defensive Strategies:
• Charter provisions:
o Staggered BOD
o Super majority voting provisions
o Elimination of s/h ability to take action via written consent
o Limitations on ability to call special meetings
o Limitations on expanding size of BOD
o Tenure or time phased voting system: each sh receives multiple votes but
multiple votes disappear when the share is transferred or sold (Williams v.
Geier)
o Two- tier voting stock (Unocal)
• Poison pill: (shareholder rights plan) distribution of stock, stock rights, or other
securities that have special redemption or conversion properties that make it
unattractive for bidder to want to take over
o Negotiating chip to get target corp on level playing ground as bidder
• Asset-based defensive strategies:

o Lock-up most common is “crown jewel” where the target company
subjected to hostile takeover sells its most valuable asset to a third party at
bargain basement price making the takeover bidder lose interest
o Greenmail: target using its own cash to buy back shares of its own stock
from a hostile party at a premium price NYBCL 513(c)
o Golden parachute: Large severance package in employment K that a
target must make to senior managers upon the occurrence of a change in
control of target
o White squire: target issues a large amount of newly issued shares to a
friendly third party that agrees not to sell to hostile party in “standstill
agreement”
o White knight: when target knows that it cannot stave off hostile party it
will seek to sell to a friendly 3rd party buyer
o Pac Man: if hostile party initiates bid on target company, target company
will turn around and launch a hostile takeover bid for the hostile bidder
Action that favors one class of s/h over another:
Sinclair Oil v. Levien

Pg. 688, CB
Facts:
• Δ: Sinclair  holding company w/ 97% interest in Sinvin (Sinvin is a subsidiary
but not a wholly owned subsidiary) Π: other 3% s/h
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• Sinclair Int’l  wholly owned subsidiary of Δ
• Δ and Sinvin had interlocking directorate
• Δ dominated BOD – no independent directors
• Δ owed fiduciary duties to corp and minority s/h – the other 3%
Π alleged that Δ breached duty in 2 ways:
1. Paying excessive dividends and not growing corp internally
o Δ stunted Sinvin’s development which lead to de facto liquidation
o Π alleges that BOD paid dividends to fill their own pockets
o Dividends were paid in compliance w/ legal capital rule DGCL 170(a)
o Δ wants BJR (burden on Π to overcome presumptions)
o Π wants intrinsic fairness test (burden shifts to Δ)
INTRINSIC FAIRNESS TEST: directors or controlling s/h must show that the
deal was intrinsically fair to the corporation and minority s/h
o In parent-subsidiary relationship must show that controlling s/h used its
power to extract a benefit that is not available to minority
 To disable BJR, you have to show that no reasonable business
objective or improper motive.
 Improper motive – show that there were some opportunities that
could have been pursued, which Π did not
Holding for Δ:
• It was not self-dealing b/c every s/h received dividends – including Π so intrinsic
fairness test n/a
• BJR applies so Π must show improper motive to get dividends from Sinvin
• Π showed absolutely no business opportunities were even presented to Sinvin that
Sinclair usurped for their own benefit to the detriment of Sinvin
2. Π alleges Δ breached K between Sinclair and Int’l

o Int’l made late payments and amount purchased
o Π alleges Δ purposefully breached for their own benefit
Holding for Π:
• Intrinsic fairness test (burden on Δ) – benefit of breach was for Int’l (100% owned
by Δ) to detriment of Sinvin (97% owned by Δ)
• Δ had no argument so failed to meet burden – no legal reason for breaching K
Notes:
• In order to avoid owing fiduciary duties, Δ should obtain 3% shares (they couldn’t
here b/c of Venezuela law that allowed them to get oil) but if they wanted to they
could take action
• DGCL 253 short form merger provision: if you own more than 90% then no s/h
meeting or vote required, just file necessary paperwork
• DGCL 262: minority s/h in short form merger can get appraisal rights so if they
think they are getting too low of a price for s/h they can petition ct to compel
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majority for valuation to get fair value, but, burden is on Π/minority s/h to
challenge the price and pay for valuation
• Δ can also do reverse stock split
Jones v. Ahmanson (CA)

Pg. 711, CB
Facts:
• Minority s/h in this case are account holders of Δ: savings and loan (Association)
• Majority (85%) decided that instead of doing a reverse stock split, to establish
holding company and exchanged their stock for stock in the newly formed
company (UF) which was essentially a de facto 250-1 stock split
• During IPO the shares of UF were only offered to majority s/h
• UF was financed by debentures (debt securities) guaranteed by Association
• Eventually the funds dried up in Association rendering the minority’s shares
worthless while the UF shares skyrocketed
Holding:
• Δ did not pass intrinsic fairness test thereby breaching fiduciary duty owed to
Π b/c they used Association’s assets to guarantee UF’s debentures which
benefited majority s/h to the detriment of minority s/h
Reasoning:
• Δ could have created a stock split and created a marker for Assoc. stock or still
formed holding company but for Assoc. s/h and permit all s/h to exchange their
shares before offering holding company shares to the public
• Instead they used the holding company to maintain control while still selling
shares and earning $ (just like the tenure voting structure of Williams v. Geier
BOD)
Remedy:
• Π entitled to receive the appraised value of her shares on the date of exchange
with interest at 7% or sum equivalent to the FMV of a “derived block” of UF
stock
Stock Splits
1. Forward split: # of o/s increases while the p/s trading price increases which sells more
shares so demand goes up thus driving up price
• Ex: 2–for–1 double # of sh (pre-split sh x 2) divide of sh/2 (pre-split $/2)
• Stock split viewed by market as “bullish” – positive signal of managerial
confident that stock price will continue to rise
• Does not impact s/h economically but could potentially require s/h approval if you
don’t have enough authorized shares in charter
2. Reverse split: # of o/s decreases while the p/s trading price increases
• Ex: 1–for–2 divide # of sh (pre-split sh/2) double of sh (pre-split $ x 2)
• Reverse split viewed by the market as “bearish” – negative signal viewed as an
attempt to raise its p/s price through “smoke and mirrors” rather than by
increasing earnings and growing corp.
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• Can also be used to squeeze out minority s/h (what Sinclair could have done if
didn’t need Venezuelan s/h) – all other s/h end up owning a fraction of 1 share
and thus will receive cash compensation for their fractional share pursuant to the
terms of the reverse stock split
PART E: DERIVITIVE CLAIMS
Derivative Lawsuits:
Lawsuits brought by s/h of a corporation on behalf of corporation. Derivative in nature
b/c the s/h ability to bring the suit is derived by the corporation’s ability to bring the suit.
The corporation has a reason to bring the suit and chooses not to defend itself.
Corporation must be involved in the lawsuit as a nominal defendant (although it
ultimately receives the benefit) to get its name in the pleading.
Requirements: one share is enough. You must own shares when you bring suit and you
may have to continue to own during suit.
Can bondholders or preferred s/h bring a suit? No – no one other than common s/h can
bring a suit. Exception to that is insolvency or bankruptcy b/c bondholders have the
largest stake.
What if you own a bond convertible into common stock? Convertible bondholders
cannot bring suit until they convert.
NYBCL 626: (a) You don’t need to own any particular quantity of stock.
(b) You must plead that you own stock at the time the complaint was filed and that you
own stock at the time transaction you are complaining.
(c) Demand requirement plead w/ particularity what you have done to demand on BOD
to take action and if not, why.
Policy: BOD should be initiating suits, not s/h. BOD is first line of defense. If they
aren’t aware of problem then give them time to fix before filing suit.
Direct v. Derivative Suit:

Tooley v. Donaldson
Pg. 919, CB
Set forth test to determine whether direct or derivative suit:
1. Who suffered alleged harm? Corp. or s/h?
2. Who would receive benefit/ remedy? Corp or s/h?
Strike suits: the countervailing consideration is the potential of abuse through strike
suits. Corporate equivalent of ambulance chasers/ nuisances. Professional plaintiffs with
very few shares (financed by lawyers) will bring suits every time stock prices dip. The
real winners are the lawyers of Π b/c they get a lot of $ and cases normally don’t go to
trial
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• Part of settlement was Δ had to pay lawyer fees if the case goes to discovery so Π
just needs to get past motion to dismiss to get to “land of discovery”
• Corporation’s goal was to get motion to dismiss to send message to strike suit law
firms and professional Π’s
Private Securities Litigation Reform Act: (§ 27 of Securities Act of 1933 and § 21D of
Securities Exchange Act of 1934: 1934 Act governs secondary trading market and is
usually implicated with derivative suits.
1. Certification requirements:
• Π must certify that she read the complaint, that she did not buy
shares at the direction of legal counsel. Must list other strike suits that have
been implemented in the last 3 years. That she will not receive extra
compensation other than pro-rata portion.
• Court appoints lead Π believed to be most capable (normally the
largest s/h)and will appoint lead counsel
• No longer rush to get to courthouse
2. Pleading requirements:
• Π must specify the exact statements of Δ that are allegedly misleading and
why they think they are misleading. If Δ needs to act with a particular state of
mind (i.e. fraud, intent), you need to plead facts with particularity that give
rise to a strong inference of that state of mind. It must be in your complaint,
thus must be in there pre-discovery – very difficult to prove w/out discovery.
State law of derivative suits: general need for a s/h to make a demand on the BOD to
take action to protect corporation. Very often, the harm is not caused by 3rd party, but the
BOD themselves so if that is the case then demand is excused (demand futility)
Marx v. Akers
Pg. 950, CB
When should demand be excused?

1. DGCL 2-prong approach:
1. Conflict of interest – to make a complaint of demand futility, must please
facts that creates a reasonable doubt that directors were not disinterested or not
independent
• If you can indicate facts suggesting defendant directors are conflicted and
wouldn’t take action to protect corporation b/c personal involvement in
benefiting then demand excused, proceed to court
• Easier to prove
2. Not valid business judgment – the challenged transaction was not product
of valid exercise of business judgment
• “Smell test”: does the transaction itself reflect the spirit of director
disinteredness?
• More difficult to prove
2. Universal demand:
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Π must always make a demand no matter what. You can bring an action only if 90 days
have passed. Can bring earlier if BOD rejects demand or corporation would suffer
irreparable harm
3. NYBCL 626(c):
Reasonable doubt standard. Either on its face or decision itself calls into question their
interestedness. Complaint must set forth:
1. Similar to DE conflict of interest: majority of directors are interested in
challenged transaction. Either self-interest or lack of free will self-interest
(people exerting their influence) OR
2. Similar to smell test: directors did not fully inform themselves to extent
reasonably expected under circumstances, OR
3. Similar to smell test: challenged transaction is so egregious on its face
that it could not be the product of sound business judgment
PART F: SHAREHOLDER INFORMATION RIGHTS AND PROXY VOTING
Shareholder Inspection Rights

General standard: s/h needs “proper purpose” as to why you want to look at books and
records
• Easiest to see is the list of s/h so that you can communicate with them
• Can see financial statements but not process used to determine
• Record dates: BOD picks date for (1) dividend record date to determine which
s/h receive dividends; and (2) record date of s/h meeting to determine who gets to
vote in the meeting
Proxy Voting
Securities Exchange Act 14 a-8: s/h entitled to submit issues for consideration at s/h
meeting. The resolutions are not binding b/c BOD ultimately approves them.
Proposals that do not need to be included: social policy proposals, illegal activity,
fraudulent misstatements, personal grievances, immateriality, impossibilities, ordinary
business operations, relation to dividends.
PART G: CLOSELY-HELD CORPORATIONS
Closely-Held Corporations:
• Company whose stock is only held by very few s/h.
• Owner-managed who receive salaries instead of dividends
• Not publically traded b/c no secondary market
• Formal K restrictions influence corporate governance and ability to transfer shares
• Treated like a partnership but incorporated to protect from liability w/ flow-
through tax benefit
• No reporting requirements under SEC Act of 1934
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Donahue v. Rodd Electrotype
Pg. 327, CB
* Judicial response to closely-held corp problems
Facts:
• Δ retired and negotiates that corp buys back 80 shares for $800 p/s
• Π (minority s/h) wants his shares bought back for same price but Δ rejects
• Π alleges that Δ breached fiduciary duty to minority s/h by not allowing him same
opportunity to sell s/h @ price
• Δ says that he does not owe duty to Π b/c corp can selectively buy shares (DGCL
160)
Holding (only applies to closely-held):
• Relationship between s/h in a closely-held corp must be one of trust,
confidence and finest loyalty (Meinhard v. Salmon) for the enterprise to succeed
• No duty to include other minority s/h in the sale of your stock BUT when you
include the company as a party it is unfair
Notes:
• Oppressive tactics/ freeze-outs: corp refuses to pay dividends, drain corp’s
earnings in the form of exorbitant salaries and bonuses to the majority s/h, fire
minority and since there is no liquid secondary market, it is impossible to sell
• Applies only to actions in operations of the corp (like Sinclair and Amonson)
• If Δ had sold his shares to 3rd party then Π had no legal claim but since he
involved corp to the exclusion of minority
• In order to be w/in fiduciary duty the corp must offer each minority s/h the same
opportunity to sell a ratable # of shares to corp @ identical price
Remedy:
• Δ give up $ he got for shares or corp can buy same # shares from Π at $800 p/s
Statutory provisions to allow corps to act like partnerships:

NY has unified approach with defined shareholding characteristics
• Allows corp to realign internal corporate governance to resemble a partnership
• Only non-publicly traded can use
• Corp can always use – no need to opt-in
NYBCL 620:
(a) allows s/h to enter into agreements to govern how s/h are voted – no freedom of
voting
(b) Restricts management’s control or transfers all or part of management (resembles
member-managed LLC)
*must give public notice of quirky provisions
DE is a statutory close-corp
DGCL § 341-356: integrated set of statutory provisions. Statutory close corporation:
entity has to OPT-IN to a statutory scheme, as opposed to a close corp which may or may
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not have to be opted-in. In order to be a statutory close corporation, you must qualify
AND have an affirmative election
(a)(1): no more than 30 s/h. Stock must be subject to restrictions of §202 (s/h agrmt over
governance and transferability of shares). No public offering of stock (nod to S corp)
DGCL 343: election to have a statutory close corporation. You need to put in the title of
the corporation and underneath, you must state that you are a Statutory Close
Corporation. Certificate has to include any provisions under §342
DGCL 342(b): allows you to set forth qualifications that people must meet to be a s/h
(i.e. all s/h must be members of family). You usually become a statutory close
corporation when you file, but under §344, you cannot have one after the fact unless you
have a super-majority of s/h (66 2/3)
Contractual Responses: Control

1. Shareholder agreement: you can have provisions that commit contractually s/h to vote
in one way or another and it is completely valid
DGCL 218(c) and NYBCL 620(a): cannot buy votes, but contractually committing
people to vote with respect to a governance related issue.
Remedy is specific performance in the event that a given s/h does not vote in accordance
w/ agreement
2. Irrevocable proxy: one s/h gives to someone else to allow that person to vote as he
sees fit. Proxy can be irrevocable as long as it is stated that it is irrevocable and coupled
with an interest (i.e. bank-pledgee-to secure a loan) DGCL 212(e) and NYBCL 609(f)
Haft v. Haft: coupled w/ an interest if you have an interest in the corp that may support
the irrevocable proxy
3. Voting trust: separates the voting attributes of shares from the financial attributes.
You must deposit the shares in a trust and the trustee is told how to vote shares
DGCL 218(a): voting trust will last as long as you want (not infinite but up till a date
specified)
NYBCL 621(a): maximum of 10 years with a 10 year option available
Contractual Responses: Ownership

Because s/h of closely held corp desire to be in business together, s/h provisions prevent
shares from falling into the wrong hands by either placing restrictions on transferability
or forced resale provisions.
Restrictions on the transferability of shares:

1. Right of first refusal: 3rd party makes offer and that triggers. Must first offer the
shares to the corp or other existing s/h on the exact same terms. If the offer lapses or is
declined then can sell to 3rd party. Reasoning: seller should be indifferent since he is
getting the same amount regardless, but the shareholders are not indifferent. DGCL
202(c)(1)
2. Right of first offer: differs from right of first refusal b/c of timing and solicitation. If
you decide to sell you can’t go out and solicit from 3rd parties. You must offer your
shares to the corporation or its s/h first. The s/h agreement states what the price of the
shares will be or the pricing formula used.
71
• Usually a combination of the right of first refusal and right of first offer, both may
kick in. If the corporation declines the rights of first offer, you can go solicit
other bids, but you have to offer the stock again under the right of first refusal.
Only if the corporation or s/h decline again can you sell to a 3rd party
• If 3rd party purchases the shares he will be subject to the same restrictions as
original holder
3. Consent restraint: If there is a consent restraint there is usually not a right of first
refusal/offer provision. You cannot transfer your shares w/out prior written consent of
the corporation. The corp. can examine who you are selling to.
• Consent restraints are most likely to be struck down by courts b/c it is
unconstitutional to restrict rights to personal property
• DGCL 202(c)(3)
• NY no statute but case law, Rafe v. Hinden, valid as long as consent is not
withheld unreasonably
4. Group restriction: usually means that the other types do not exist. You can sell your
shares freely but only to people w/in the group (i.e. family restrictions)
**Transfer restrictions do not trump the operation of law (i.e. divorce settlement – stock
can be transferred regardless of transfer restrictions, or repayment of loans)
**Legend: statement on the certificate that alerts prospective transferees that what they
are about to buy is subject to transfer restrictions. Legend must be conspicuous and on
the face and state that the shares are subject to the provisions. If legend isn’t on the
certificate, then the buyer takes the stock and is not subject to provisions of which she is
not aware. If she knows about them, they apply. DGCL 202(a) and NYBCL 8-204
Forced Resale Provisions:

Requirements by K for a s/h to sell back her stock on the occurrence of a set of events,
regardless if she is willing and able to continue owning them.
• Events that trigger: termination of employment or death (the company receives
the funds necessary to repurchase the shares from the estate through proceeds of a
life insurance policy that the company took out on the deceased.
• Biggest issue is price. Usually BV which is a conservative valuation – great for
corp). BV = (TA-TL)/ # o/s.
•
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Choosing Entity Structure for Business: Sole Proprietorship vs Partnership

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Choosing Entity Structure for Business: Sole Proprietorship vs Partnership

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PART #A: CHOICE OF ENTITY

Factors in deciding choice of entity:

1) Sole Proprietorship (SP)

3. Transferability of ownership interest

6. Raising addition capital

2) General Partnership (GP)

3. Transferability of ownership interest

6. Raising addition capital

A, B, and C enter into a partnership.

3) Limited Partnership (LP)

Notes from class 5.29.08

Gateway Potato Sales v. GB Investments

4) Limited Liability Partnership (LLP)

5) Limited Liability Company (LLC)

3. Transferability of ownership interest

6. Raising addition capital

3. Transferability of ownership interest

Publicly Traded Private/ Closely Held

6. Raising addition capital

b. Preferred stock: *Dividend preference: until the current stock dividend to

Hierarchy of Repayment – “Food Chain”

Delaware is popular b/c:

Analysis of 6 factors to determine best form of business for Roberta

Analysis of 6 factors to determine best form of business for Lindsay

Analysis of 6 factors to determine best form of business for JS Smith

Recommendations for group: 1) Manager-managed LLC w/ operating agreement all but

Haas questions 6.3.08

Class #3: Capital Structure

Capital structure (capitalization): where did funds, assets come from?

Balance sheet: Financial statement that provides capital structure information.

1. Current Assets (CA) 1. Short Term (ST)

CSA = # of o/s shs of c/s

Retained Earnings or Deficit (RE/D)

Total Assets = Total Liabilities + Owners Equity

3. Intangible Assets: IP (trademarks, patents)

2. Long-term debt: things due in later than a year

Creditors – Contract Claimants

$5000 (50 sh x $100) CSA = $250 (50 sh x $5 pv)

Formula: S = (TA – TL) – capital

c/s = 100,000 o/s sh

S = (TA – TL) – capital

c/s = 100,000 o/s sh

S = (TA – TL) – capital

**The net profit test is an and/or test**

2. Net Asset Test:

Valid consideration for stock

Cumulative and Noncumulative Preferred Stock

Why would someone want non-cumulative stock?

Voting Dilution and Preemptive Rights:

PART B: CORPORATE FORMATION AND LIABILITY ISSUES

DGCL 102 and NYBCL 402: what must be in charter

NYBLC 301: Corporate name

NYBCL 402(a)(2): Business purpose

NYBCL 402(a)(4): Authorized # of shares

NYBCL 402(a)(5): Share classes

NYBCL 402 (a)(6): Blank check provision

NYBCL 402(a)(9): Duration

NYBCL 402(b): Director’s personal liability

NYBCL 402(c): Everything else in charter

Board of Directors Resolutions

Classic ultra vires doctrine:

Today’s ultra vires doctrine:

The net profit test is an and/or test