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Business Associations Charts Professor Joo Spring 2004

Partnership Form vs. Corporate Form.......................................................................................2 Formation....................................................................................................................................2 Overview of Shareholder Powers................................................................................................3 SEC Rule 14a-8...........................................................................................................................3 Voting and Appraisal in Mergers – Delaware Approach...........................................................4 Shareholders’..............................................................................................................................4 Exceptions to ..............................................................................................................................4 Conflict of Interest and Self-Dealing Compared.........................................................................5 Directors’ Fiduciary Duty and the Business Judgment Rule: Review & Summary Under Delaware Law.............................................................................................................................6 BREACHES OF FIDUCIARY DUTY..........................................................................................6 Demand Requirement Flowchart – Delaware.............................................................................7 Rule 10b-5 and Insider Trading..................................................................................................8 Overview: 10b-5 Private Cause of Action..................................................................................9 Rule 14a-3.................................................................................................................................10 Overview of Limited Liability Companies (LLCs).....................................................................10 Protecting Minority Owner from Majority Oppression............................................................11 “Piercing the Corporate Veil”..................................................................................................11

piercing the corporate veil is permitted Ownership is transferable and easier because you can sell your shares and there is an easily identifiable market for them Indefinite. default rules are changed through the charter or bylaws 2 . the partners can withdraw at will Partnership is done when the partners say it is done Today. bylaws Limited Shareholders get limited liability because they have less control All you lose is the extent of your investment in the corporation (shares may become worthless) In certain situations. perpetual existence unless limited in the charter (default rule is forever) • Liability • • Unlimited personal liability Traditional: Unlimited liability for each partner. charter. a partnership can continue beyond the partners No.Partnership Form vs. Corporate Form Partnership • Formation • Informal • • • • Corporation Formal. but that makes little sense In partnerships. unless agreed otherwise (each partner has equal power with all the other partners) Can agree to have an executive committee or a managing partner • Continuity • • • Centralized Management • • • Yes – CEO. personal assets at risk Partnership can buy insurance to insure partner against personal losses • • • Transferability of Ownership Interest • Ownership is not transferable. Board of Directors Definite managerial hierarchy Default Rules • Many • Many. A partner could contract around this. Secretary. CFO. file with the secretary of state Articles of Incorporation.

Relates t the election of Directors (8) o Not okay if it would tend to create contested elections Directly conflicts with a management proposal already on the ballot (9) • • • • 3 . so a shareholder proposal to stop the practice is permitted. Held: although it accounts for less than 5% of total assets. and is “not otherwise significantly related to business” (5) o Lovenheim: ¶ is small shareholder who wants to offer non-binding resolution for the corporation to stop engaging in practices that force feed geese (affects about 5% of business). in light of ethical/social concerns. ¶’s proposal may be “significantly related to business” Would be beyond management’s power (6) Relates to “ordinary business” (7) o Cracker Barrel: Practice of refusing to hire gay workers is related to ordinary business.Overview of Shareholder Powers (Keep in mind the general presumption that state corporation law sees shareholders having limited control in the company) • • • Electing / Removing Directors Approving Amendments to the Articles Approve Fundamental Changes o Amendment of Articles of Incorporation o Dissolution o Sale of All or Substantially All Assets o Merger/Consolidation Make Nonbinding Suggestions • SEC Rule 14a-8 Management can exclude a shareholder proposal from the corporation’s proxy if the proposal: • • • Is beyond shareholder power under state law (14a-8(i)(1)) Would cause the corporation to violate the law (2) Relates to operations that account for less than 5% of total assets or net earnings and gross sales.

because this is a fundamental change. • Substantial power because it is a check on management and such action can slow down the process of the merger HOWEVER.Voting and Appraisal in Mergers – Delaware Approach Shareholders of acquiror and target get to vote on statutory merger or consolidation. there is NO VOTE on other forms of corporate combination • This is an incentive for management to change form in another way Shareholders (of Acquiror or Target) who vote against merger that is approved can demand that the corporation repurchase their shares at “fair value” • Shareholders get fair value as determined by the court (even if less than the original merger price!) • Shareholders get NOTHING until the end of the proceeding. and may be assessed court costs if the fair value is less than the original merger price BUT note the “Market exception” (see below) – the right to dissent does not exist if there is a liquid market for the shares in question Acquiror Shareholder: NO Appraisal Rights if: • Dilution is minimal (less than or equal to 20%) • Acquiror shares were publicly traded at the time of the merger Exceptions to Appraisal Right Target Shareholder: NO Appraisal Rights if: • Target stock was publicly traded at the time of the merger AND consideration for the shares is either stock in the survivor or any publicly traded stock • Note that shareholders DO get appraisal if the consideration is in cash Shareholders’ Voting Right Dissenting Shareholders’ Appraisal Right 4 .

Why not? Minority shareholders got dividends too? Everbody benefited! With respect to the contract between Sinven and Sinclair’s subsidiary. Why? 5 . Shapiro Sinclair: Sinclair did NOT commit self-dealing by causing Sinven to pay dividends.Conflict of Interest and Self-Dealing Compared Conflict of Interest Self-Dealing “Controlling shareholder” influences directors to act for the corporation and stands to gain personally AND excludes other minority shareholders from gain The controlling shareholder pick up some of the Directors’ duty of loyalty when the controlling shareholder tells the Directors what actions to take! Description Director Acts for the corporation and stands to gain personally Burden of Proof Burden of establishing the fairness of the transaction is usually placed on the interested director However. the court finds selfdealing. a conflict alone does not void a transaction if: Sale of corporate property by/to the director or the director’s spouse Controlling shareholder must prove the transaction’s fairness Example Cases Globe Woolen.

§ 144(3)) (cf. plaintiffs must plead (and ultimately prove) that the directors breached their fiduciary duty (either duty of loyalty OR duty of care). The directors were either careless or disloyal.Directors’ Fiduciary Duty and the Business Judgment Rule: Review & Summary Under Delaware Law When shareholders sue directors based on a business decision.. (2)) Conflicting transaction without cleansing is subject to a fairness review (Del..g. but we do not have the facts to prove it either way. director may not take a “corporate opportunity” Corporate Opportunity is Defined by a Balancing Test: 1. corporate certificate can exculpate directors from personal liability for some breaches of care.g.g. Delaware DOES NOT recognize a duty of “substantive due care” Lack of Candor Waste Failure to Monitor Directors ultimately monitor officers and employees on Corporate assets given for behalf of the shareholders. § 144(1). Greenfield) Lack of good faith * Breaches of Duty of Care+ Lack of Procedural Care Extreme failure to take steps to become informed before action (e. or a breach of procedural due care. waste. Within the corporate line of business 3. Note: Waste is in the middle because in some sense. so ¶s must plead (and ultimately prove) facts were sufficient to rebut one of these presumptions. Smith v. BREACHES OF FIDUCIARY DUTY Breaches of Duty of Loyalty (BJR doesn’t apply) Usurpation of Corporate Opportunity Unless disclosed to and passed up by board. Shapiro v. it is insufficient to merely allege that the business decision turned out to be unsuccessful. the duty. Corporation has financial ability 2. Rather.. it is a kind of proxy. not spy on employees (e. Will put director in conflict with duty to corporation (e. 6 . Caremark) Waste is far worse than unfairness *These duties are sometimes characterized as involving both care and loyalty. According to the Business Judgment Rule. Van Gorkom) Failure to act/make a decision (failed to use your business judgment) Unlike some states. Cellular) Conflict of Interest Conflict alone is NOT a breach if cleansed by disclosure and approval/ratification by directors or shareholders (Del. especially in agreed. and sometimes as independent categories + In Delaware. the court will NOT second-guess the substance of the Director’s business decisions. Thus a complaint must allege conflict. Corporation has interest or expectancy 4. Remember that the Business Judgment Rule further presumes that the directors were loyal & careful. Globe Woolen. larger corporations is to establish monitoring procedures. Broz v. consideration so low no reasonable person would have Because directors must delegate.

suit will probably be dismissed because you’re basically admitting the board IS impartial) No – ALWAYS HAPPENS Board moves to dismiss. it is unlikely that the Board will bring suit.Demand Requirement Flowchart – Delaware Situation: Shareholder wants to sue Directors for violation of Fiduciary Duty 1. Does shareholder oppose dismissal? No End of analysis Yes Court applies the Zapata test to the SLC: 1. and if the shareholder sues the Director(s) anyway. The Board will likely DENY the request. Court applies its own business judgment No Board appoints a Special Litigation Committee (SLC). Suit can proceed. the Board will move to dismiss. 7 . Was the shareholder’s demand futile? (Apply the Aronson test: was there reasonable doubt regarding (a) the Board’s disinterestedness. 3. and the standard will be BJR review (i. Was the Special Litigation Committee independent? 2. SLC recommends dismissal Yes Demand is excused. Does the Board allow the suit to proceed? Yes End of analysis 4. Did shareholder demand that Board bring corporate suit against Director(s)? Yes – NEVER HAPPENS In this scenario. or (b) BJR?) No Demand is not excused.e. Suit is dismissed (Aronson). Go to #2 below 2..

The duty to dsclose must have some separate basis (e. duty to correct previous statements that are now misleading) “Tippees”: It’s not what you know.. and if so. However. and inside information on the other. are questions that are not completely settled. we deter the behavior Primary Arguments for Punishing Insider Trading Rule 10b-5 “It shall be unlawful to employ any device.e. whether a person who trades on the basis of such information is liable under rule 10b-5. scheme. artifice to defraud. or senior employees. We DO know that officers. is information that a noninsider wrongfully acquires. “misappropriates”. A tippee “inherits” fiduciary duty to the corporation (and thus the duty to disclose) IF: o Tipper is a corporate insider who violated fiduciary duty by giving corporate information to tippee  Violation of fiduciary duty = Benefit to insider  Benefit to insider includes tipping as “gift” to friend or relative o Tippee knew or should have known that tipper was violating fiduciary duty • Who Has a Duty to Disclose or Abstain Under 10b-5? Misappropriation and Rule 10b-5 Between the extremes of skillfully or innocently acquired nonpublic information on the one hand. but how you came to know it.Rule 10b-5 and Insider Trading We want people to think that the market is fair. the extent of liability. The misappropriation theory is most useful where ▲ had no independent fiduciary duty to the party with whom he traded. officers. directors or employees w/ FD directly to company involved in transaction with a potential for profit ARE “insiders”. the goal is to build trust in our markets • • We don’t want investors to pay too much By punishing insiders. Who Is An “Insider”? • Chiarella: “Duty to disclose under 10(b) does NOT arise from the mere possession of nonpublic market information.. i.g.” “Insider” is a term of uncertain scope that refers to persons having a relationship with a corporation. fiduciary duty to the other party. make any misstatement or material fact. 8 . or omit to engage in any act…that would operate as fraud in connection with the purchase or sale of any security. its directors.

a potential merger). a ¶ may be able to prove reliance on a misrepresentation by alleging she relied on the integrity of the market. You can rebut this presumption by showing:  That the Market Makers hear the lies and don’t fall for them  Information does not actually cause the price to change  All the information the ¶s claim they were deprived of actually did enter the market • • 9 . AND  Magnitude of the event Scienter o PSRLA re Scienter: The 10b-5 complaint must “state with particularity facts giving rise to a strong inference that the Defendant acted with the required state of mind. o Courts are split regarding 10b-5’s scienter requirement:  Deliberate (“intentional”) – cause of action  Reckless – possibly grounds for a cause of action (Novak)  [Negligent] – probably not grounds for a cause of action (Hochfelder) o The Second Circuit’s standard for scienter is as follows:  Facts showing motive and opportunity to defraud OR  Circumstantial evidence raising a “strong inference” of “conscious misbehavior or recklessness” Reliance/Causation o If you would have bought it anyway. the court must make a fact-specific inquiry considering:  Likelihood the event will occur.Overview: 10b-5 Private Cause of Action Threshold Issue: • Standing o Must be a purchaser or seller (Blue Chip) Elements of the Cause of Action • Material misrepresentation or omission o Materiality: Substantial likelihood that a reasonable shareholder would consider it important o For materiality of statements/omissions regarding a contingent event (e.g.. you’re not entitled to relief o “Fraud on the Market” Theory: Where securities are sold in a well-developed market (rather than in a face-to-face transaction).

or not to trade. Overview of Limited Liability Companies (LLCs) A new solution for close/small companies • • Limited Liability Flexible Governance o Member managed or manager-managed o Few mandatory terms Substantial Tax Benefits o Escape “double taxation” of corporations LLC Governance Terms • • • Statute o Mostly “enabling” Contract o Contract provides most of the terms (Elf Atochem) Fiduciary Duty o How much? (at the very least. not to the other members of the LLC (McGee) • • 10 . members of an LLC owe Fiduciary Duty to give notice – see VGS case) Exit & Liquidity o Fiduciary duty owed to LLC. If you have information about a tender offer. It does not matter how you obtained such information. This rule is broader because the SEC has broad authority to define what is “fraudulent” under the statute.Rule 14a-3 This rule requires disclosure of information pertaining to a tender offer. you have a duty to disclose it.

AND 3.Protecting Minority Owner from Majority Oppression • • Partnership: At-will withdrawal + dissolution (so majority must buy out the departing Partner) Public Corporation: At-will withdrawal through sale on liquid market How to protect the minority in closely held corporations. majority can avoid by buying out minority “Piercing the Corporate Veil” Alter Ego/Instrumentality Test: 1. minority can dissolve • • “Modern” Approach Minority has broader rights to ask court for dissolution If court orders dissolution. Did shareholder have complete domination and control AND 2. Did shareholder’s conduct cause actual harm to the plaintiff? 11 . Did shareholder use control of the corporate form in an unjust. CA) H&D Proposal • • Minority can demand buyout by majority If majority does not buy out. where there is no dissolution right and no liquid market? • Shareholders may contract ex ante (based on assumption & prediction) to sterilize Directors if certificate states corporation is a “Close Corp” (DE. fraudulent or wrongful way.