Business Organizations Outline

AGENCY
 “Fiduciary relationship that arises when one person (the principal) manifests assent to another person
(“agent”)) that the agent shall act on the principal’s behalf and subject to the principal’s control, and the
agent manifests assent or otherwise consents so to act.”
o 1) mutual assent (must be both ways) 2) for agent to act on principal’s behalf and 3) subject to
principal’s control.
o Agent (A) can bind principal (P) to a third party (T)
o You don’t need a contract, you don’t need consideration…all you need is assent
 Features:
o Scope: special agent (just one transaction); general agent (series of transactions…“basically
anything”).
o Disclosure:
 Fully (third party knows that it is dealing with an agent and that there’s a principal
involved)
 Partially disclosed (third party knows it is dealing with an agent, but it does not know
who the agent is representing)
 Undisclosed (third party doesn’t know that the agent is an agent)
o Amount of control: employee/servant (control in detail); independent contractor (only controls
generally, but defers to skills/judgment)
 Formation: explicit or implicit (Jenson Farms v. Cargill)
o Liability in Contract:
 Actual Authority: what a reasonable person in the Agent’s position would infer from the
Principals conduct. Express if communication was explicit, implied (or incidental) if the
agent’s actions were reasonably calculated to discharge the principal’s explicit
instructions.
 Apparent Authority? what a reasonable third party would infer from conduct of
Principal. (White v. Thomas (Ark. App. 1991)). (Focus is on Principal)
 Inherent Authority? A general agent has the power to bind a principal, whether disclosed
or undisclosed, to an unauthorized contract as long as a general agent would ordinarily
have the power to enter such a contract and the third party does not know otherwise
(folded into estoppel in 3rd Restatements). (Gallant Ins. Co. v. Isaac) (focus is on
AGENT).
 By estoppel: failure to act when knowledge and an opportunity to act arise. Also need
reasonable change in position on part of 3rd party.
 Ratification: accepting benefits under an unauthorized contract.
o Liability in Tort:
 Generally: principals are liable for agents known as employees, but not for independent
contractors.
 Levels of control:
 Branch network: control over where stores are, benefits of workers,
micromanaging (Starbucks)
 Franchise System: People use name and then are allowed to run their own store
(McDonalds).
o Factors from Humble Oil and Sun Oil
 Who sets hours of operations?
 What products do they sell?
 Who holds title to goods?
 When is it terminable?
  How much risk is there?
 What is required?
 Overall: where does the risk/reward fall?
 Termination: at any time unless otherwise specified. Contractual claim for damages if principal
“revokes” or agent “renounces.”
 Governance of Agency
o 3 fiduciary duties of Agent and Principal to each other (pg. 36-39 in supplement)
 Obedience: to document relating to relationship (Rule 8.09)
 Loyalty: to exercise legal power over the subject of the relationship in a manner the
holder believes in good faith to advance the interests of the principal. (Rule 8.01-03)
(Tarnowski v. Resop)
 Can’t benefit yourself from the deal (material benefit arising out of position, Rule
8.02)
 Can’t be the agent of the adverse party and the agent of the principal (Rule 8.03)
 *All profits made by agent in course of agency belong to principal. (Tarnowski)
 Trustee’s Duty to Trust Beneficiaries: trustee may not deal in individual capacity
with the trust property (even with consent) (In re Gleeson)
 Care: duty to act in good faith. (Rule 8.08)
 8.06: conduct that would otherwise breach duty is not a breach if principal
consents w/ disclosure. Must still be acting in good faith, disclose material facts,
and deal fairly.
 8.08: good faith requirement.
o Trustee’s Duty to Trust Beneficiaries: trustee

Cases:
 Jenson Farms v. Cargill (Minn. 1981) (Formation of Relationship, Implicit Assent): Jenson sued
Cargil (food products conglomerate) and Warren (grain elevator) to recover losses when Warren
defaulted on contract. Warren is insolvent ($4 million in debt). Farmers are arguing that Cargill is a
principal for Warren, Cargill says that it has merely loaned Warren money. Issue: was there sufficient
relations to hold Cargil liable for Warren’s default? Holding: Yes: although there was no explicit
agreement, a jury could find an agency relationship b/c there were sufficient indicators of Cargill’s
control over Warren. 9 factors listed on page 12 of the book: Cargill made constant recommendations,
had first right of refusal on grain, Warren needed Cargill’s approval in order to enter into
mortgages/purchase stock/pay dividends, Cargill had a right of entry onto Warren’s premises to carry on
checks and audits, Cargill criticized Warren’s finances, officers’ salaries and inventory
(correspondence), Cargill claimed that Warren needed “strong paternal guidance”, Cargill financed
Warren’s purchases of grain and operating expenses, and Cargill had the power to discontinue the
financing of Warren’s operations. Actions can equal assent even if not explicitly given. The parties
conception of the relationship does not control…can prove that a principal/agent relationship exists by
the circumstantial evidence between two parties.
 White v. Thomas (Ark. App. 1991) (Apparent Authority): White employed Simpson part time for two
years, instructed Simpson to attend auction and bid up to 250K on a farm. She overbid, wound up
paying $327,500 and then negotiated to sell 45 acres of the property to Thomas in an attempt to make up
for her mistake….she signed the contract with Thomas as POA for White. White was unhappy and
repudiated the deal. Thomas sued White (as Simpson’s Principal) for specific performance. Court held
that there was no apparent authority b/c Thomas couldn’t have thought buying and selling were closely
related. Thomas knew Simpson had POA to buy, but it doesn’t mean he thought she had POA to sell.
Blank check showed apparent authority for buying, not selling…..Thomas could have followed up with
the principal but he didn’t.

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  Gallant Ins. Co. v. Isaac (Ind. App. 2000) (Inherent Authority): Gallant (principal) issued car insurance
to Isaac through Thompson Harris (independent agent). Thompson-Harris bound Gallant to new
insurance policies. Forms were changed by TH (without Gallant’s approval…application said that an
agent can’t change terms of the policy). Isaac got into accident during policy lapse. Court found that
there was no actual (implied/incidental) or apparent authority. Sua sponte addressed inherent authority.
TH was left unsupervised to develop this practice. Gallant knew it was going on and didn’t do anything
to stop it. How was Isaac supposed to know her insurance agent works with the overarching company?
Therefore, inherent authority existed……however, inherent agency power has fallen out of favor.
 Humble Oil v. Martin (1949 Tex.) (Employee v. Independent Contractor): Car parked at a gas station
rolls down a hill and injures Martin + kids. Martin sues the owner of the station (Humble Oil), the
station’s operator (Schneider) and the owner of the vehicle (Love). Schneider had commission agency
agreement with Humble. Martin attempted to make the case that Schneider was an agent of Humble Oil.
Court held a relationship existed b/c Humble established strict financial control and supervision over
Schneider: use of docs, humble owned everything, paid for most expenses, Schneider had to sell Humble
products, rent owed to Humble was based on the amount of products sold by Schneider….Schneider was
a “glorified store clerk”. Humble failed in its argument that Schenider should be considered an
independent contractor.
 Hoover v. Sun Oil (1965 Del.) (Employee v. Independent Contractor): Hoover sued Sun and station
operator for negligence b/c his car caught fire (gas station attendant was smoking while filling up the
car). Hoover argued that the operator should be viewed as an agent of Sun Oil….wore a Sun Oil
uniform, sold Sun Oil products, Sun Oil employees inspected the station. **P-A relationship did not
exist when an independent contractor controls day-to-day operations of entity that is responsible for
damages suffered by plaintiff. Independent contractor was in change of day to day operations, could sell
competing products, no documentation…had more control in comparison to Humble Oil. From a public
policy perspective, we want the people in control to be held liable…they’re in a better position to
monitor.
 Tarnowski v. Resop (Minn. 1952) (Profits to Principal): purchaser employed agent to
investigate/negotiate purchase of a business…perform due diligence on P’s investment (coin-operated
money machines). Agent did not follow the principal’s directions and accepted a secret commission
from the sellers. Purchaser sued to recover secret commission. **All profits made by agent in course of
agency belong to principal.
 In Re Gleeson (Ill. App. 1954) (Can’t self-deal as a trustee): Farm owner died, left land trust to
children. Trustee rented the land to himself…had his partnership farm the land because he didn’t want
to miss a farming season (wanted beneficiaries to get income). He even raised the rent the following
year. There was still a breach of loyalty (self-dealing) b/c trustee relationship is strict.

PARTNERSHIP
 General agent of partnership, each partner binds the partnership by contracting usual course of business.
o Features:
 All partners are owners-principals and general agents
 All general partners are jointly and severally liable for the debts of the business.
 All partners share equally in control (unless agreed otherwise).
 Agency Conflict Among Co-Owners: during enterprise there is a fiduciary duty of loyalty to the other
partners. (Meinhard v. Salamon)
 Formation of Partnership:
o UPA § 6(1): 2 or more persons who carry on as co-owners as a business for profit (consent)
 Don’t need to have money
 Normally an agreement, but not necessary
o Uniform Partnership Act § 7  rules for determining the existence of a partnership

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  7(4): receipt by a person of a share of the profits is prima facie evidence that he is a
partner. Lack of daily involvement is not per se indicative of absence of partnership.
o Vohland v. Sweet: The parties must have intent to form a partnership, but this means “an intent
to do those things which constitute a partnership,” rather than the specific intent to become
partners. Other factors for formation of partnership: level of control, intent to form a partnership,
investment of time, equity, sweat equity.
 Note* For a real commission, make it % of gross profit, not net profit.
o Partnership by Estoppel
 UPA §16: If a person represents herself as being a partner and third party reasonably
relies on representation and does business with enterprise, then the person who
represented as the partner is personally liable for transaction.
o Uniform Partnership Act § 18  No person can become a member of a partnership without the
consent of all the partners
 Relations with Third Parties
o Partnership Creditors’ Claims against Departing Partners
 Generally, withdrawing partner is liable for obligations incurred prior to departure.
 UPA § 36(2,3): (easier to dissolve) withdrawing partner is released if courts infer an
agreement between the continuing partners to release withdrawing.
 Creditors must agree (can be inferred) and material
 RUPA 703 (Identical to UPA 36(2,3)
 RUPA §306: partners are jointly and severally liable for torts, contract, and otherwise.
But (307(d)) must exhaust business assets before you go after personal assets.
o Third Party Claims Against Partnership Property (RUPA § 203 or UPA § 8)
 The property controlled by partnership should be separate from personal assets or else
they will be available to both business/personal creditors.
 Partners do not own the property in traditional sense, but they have a transferable interest
in profits of sale.
o Liability under Torts and Contracts
 UPA § 15: partners are jointly and severally liability on partnership torts. Jointly liable
on partnership contracts.
 RUPA § 305/306: Partnership is liable for acting in ordinary course of business. Timing:
jointly and severally liable for both! But must exhaust business assets before pursuing
personal assets (307(d)).
 Partnership Governance and Issues of Authority
o UPA
 9: every partner is an agent of partnership for purposes of business and can bind
partnership for ordinary business.
 18: differences among partners in ordinary matters of partnership can be decided by
majority of partners. No act in contravention of any agreement between partners may be
done rightfully without the consent of all of the partners.
 Analysis: (NaBisCo v. Straud (N.C. 1959))
 UPA: Is it in the ordinary course of business?
o No §9.2 (needs unanimous authority under 18h)
o Yes §9.1 (individual can bind the partnership if it is not disagreed upon)
 If there is a disagreement, then check §18(h)
 Need majority to do it if its part of business.
o RUPA: same analysis but under §401(j)
 Alt. solution for the unknown: 303 secretary of state can have a file with who has
authority for what.
 Termination (Dissolution or Disassociation)
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 o DEFAULT: check terms of agreement is it a partnership for term or for a specific purpose?
o UPA
 Formation (§§ 6,7) Dissolution (§29) Winding UP (§ 37, 38, 40) Termination
(§30). (Dissolution requires winding up under UPA (but not RUPA), unless it is a
wrongful dissolution (death or leaving wrongfully)
o RUPA
 Formation (§202) Disassociation (§§ 601, 602, 701) Dissolution (and winding up)
(§§ 801, 805, 807) possibly termination (§802)
 Disassociation: partner leaves but partnership continues as long as there is
consent. Leaving partner paid by § 701.
o Accounting for Partnership’s Financial Status and Performance (Adam v. Jarvis (Wis. 1964))
 Required documents: (1) Balance sheet, (2) income statement, (3) partnership capital.
 Statutory Dissolution of Partnership at Will (partner can withdraw without any
consequences)
 Unless K says otherwise… Residual value of P’ship (after paying creditors and
P’s loans and capital accounts) must be divided among P’s in accordance with
their ownership (equally if K does not say otherwise)
 Options:
o Physical division of assets (UPA and courts don’t allow this)
o Judicial auction (in tact or liquidated value)
o Appreciation of value to highest purchaser within the firm (UPA gives no
option for this).
 UPA §§ 38,40
o Figure out residual value (after payments to creditors, and amounts owned
to partners, capital accounts of partners)
o Divide equally
 RUPA § 701
o Residual value and must buy out leaving partner at high of
 Liquidation value (if you just sold it) or going concern value (what
is the value of the whole business)
o Duty of Loyalty and Opportunistic Dissolution (Page v. Page (Cal. 1961)).
 UPA §31(1)(b): partnership can be dissolved by express will by any partner when no
definite term or particular undertaking is specified. If there is a term or undertaking, it
can be terminated if both agree.
 *always have the power to terminate a partnership, but you don’t always have a
right (have to pay for the consequences through a breach of contract action)
 Forms of Partnership
o General Partnership: has generally been phased out. Didn’t need to be registered. Pass through
taxation (not taxed at the entity level…only at the individual level).
o Limited Partnership
 Allows limited liability (only liable for your investment in the partnership) and profit-
sharing for passive investors. Pass through taxation. Need at least one GP who incurs
unlimited personal liability, but it can be another LLC or corp. Limited partners do not
have control, just GP. Popular with private equity funds and hedge funds….people want
money to be managed by an asset manager…investors are getting a limited liability
partnership interest.
o Limited Liability Partnership:
 Needs to be registered, pass through taxation. GP in which partners retain limited liability
with respect to partnership liabilities arising from negligence, malpractice, wrongful act,
or misconduct of another partner or agent not under partners’ direct control (liability

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 shield). Still liable for the debts of the firm. Came into existence because people didn’t
want to be responsible for their partner’s malpractice.
o Limited Liability Company
 Limited liability, participation in control, pass through taxation (lose if publicly traded).
Varies by state. Management can be by directors or managers. Limited liability even
when they exercise direct? control.
o Modern corporation
 Investor-owned entity where the investors themselves have little control. Limited
liability, creditors only rely on business assets, legal personality, shareholders have
limited liability (never asked to pay for more than cost of shares), transferable shares,
centralized management + elected board.
o Note: two tier tax for publicly traded equity for LP and LLC
 (1) entity income and (2) as individuals when income is distributed.

Cases:
 Meinhard v. Solomon (NY 1928) (Duty of loyalty to co-owner): M and S entered into partnership for
hotel business. M was a passive investor and S ran everything. Did not work well together. When lease
was about to end, S and owner (Gerry) went into negotiations and made a new deal…M was left in the
dark. M sued because he believed it was his legal right to be involved in the new venture….demanded
lease be held in trust as an asset of venture. M wanted an option to renew (right of first refusal). Court
held that the relationship and duty of loyalty continue while the enterprise continues. S must inform M
of any new opportunity. No longer good law.
 Vohland v. Sweet (Ind. App. 1982) (Has a partnership been formed?): S worked for V’s father at
nursery. S’s status changed: V decided to give S a 20% share of net profits after all expenses….V
viewed S as an employee and thought this was a legit commission. S brought action for dissolution of
partnership (wants to wind-up) and won. V appealing. No partnership income taxes filed, V borrowed
money in his own name, S & V restocked nursery using part of net profits and therefore part of net
shares. Holding that there was a partnership created b/c prima facie case of profit sharing and
sweat/equity investment. The parties must have intent to form a partnership, but this means “an intent to
do those things which constitute a partnership,” rather than the specific intent to become partners. Look
at control, risks, stakes each person has in the business.
 Nabisco v. Straud (Need majority): Straud and Freeman entered G.P. to sell groceries. Straud told
Nabisco that they didn’t want any more bread. Freeman wanted to order more bread and Nabisco sold
the bread. The bill didn’t get paid and the partnership dissolved. Under UPA, S wanted to make a
decision in the ordinary course of business so he needed a majority vote (which he didn’t have)…Stroud
therefore did not have the authority to remove Freeman’s authority. The partnership was obligated to
pay for the bread.
 Adams v. Jarvis (Wis. 1964) (Can contract around UPA): GP of 3 doctors. One is leaving and says his
leaving constitutes dissolution and that the partnership must wind down. Other doctors do not want to
wind down. Trial court decided that plaintiff’s withdrawal was dissolution and assets would be
liquidated and divided according to UPA. Adams wanted to dissolve to get accounts receivable. But
partnership agreement was clear that partnership would continue even after withdrawal (“The
incapacity, withdrawal, or death of a partner shall not terminate this partnership”). Differing terms
between termination and dissolution shouldn’t default the agreement to the UPA standards. Agreement
outlined that partners have duty to get accounts receivable. Adams ended up getting 5/12 (leaving after 5
months) * 1/3 (3 partners) of the profits in the year of his withdrawal. Everything in the UPA can be
superseded by contract.
 Page v. Page (Cal 1961): oral partnership agreement, older Page (plaintiff) wanted to terminate after a
few years. Each contributed $43k. Loan for $47k by older Page that allowed him to make demand on
any time. Air force base came in and was more lucrative, older Page tried to dissolve. Younger Page

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 argued that they were in a partnership for a specific term…needed to repay debts…cited past
partnerships with the older Page that lasted for specific terms. Trial court ruled that it was a partnership
term: long enough for partnership to repay partnership profits. Appeal ruled that it was a partnership at
will b/c every partnership is for profit. However, the older Page still wasn’t allowed to dissolve the
partnership just b/c it would be more profitable solo. Dissolution must be done in good faith….need to
fairly pay out debts and assets.
 Pappas v. Tzolis (NY Ct. App. 2012): 3 partners pooled money together. Tzolis obstructed the other two
partners from leasing the building to someone else, goes on to negotiate a great deal behind the back of
the other two partners. Tzolis bought the other partners out  got the great deal, other two partners are
pissed. Partners alleged a breach of fiduciary duty. Lower court  there was no fiduciary duty…cited a
certificate signed by the partners during negotiation process (“we haven’t relied on anything”).
Appellate court reverses  Tzolis’s duty of disclosure was not extinguished by the certificate. Tzolis
has not proven that the agreement allowed him to secretly negotiate the sale of the company’s only asset.
Relationship is adverse. Highest Court (Court of Appeals reverses again)  the fraud/misrepresentation
claim is BS. The operating agreement specifically permitted members of the partnership to engage in
outside business, including competing business. LLCs are very flexible….can contract around common
law fiduciary duties….but the courts still get to say what’s good faith and what isn’t.

FORMATION AND STRUCTURE OF CORPORATIONS

Key Terms
 Public Corporations: more buyers, less restrictive
o Culture can change when a company goes public and liability changes….more risk-taking
behavior (think Goldman Sachs)
 Closely Held Corporations: privately held and incorporated for liability issues, non-capital-raising.
Shareholders are managers and directors.
 Controlled Corporations: single person or small group controls company
 “in the Market”: no individual controls the corporation.
Key Features:
 Reduce cost of contracting for credit.
 Indefinite “life”
 Corporations are citizens and entitled to some constitutional protections (Santa Clara v. Southern
Pacific)
o Citizens United: right of free speech is protected. If the shareholders are unhappy with the way
the entity is using that right, then they can remedy it.
Process of Incorporation
 RMBCA § 2.01-05 (pg. 258 of statutory supplement)
o Incorporator signs docs/pays fees, drafts certificate/articles of incorporation, secretary of state
issues corporation’s charter, election of directors, adoption of bylaws, and appointment of
officers.
 Articles of Incorporation/Charter must contain: voting stock, board of dir., shareholder voting for which
transactions, original incorporator, name, purpose (lawful business), capital structure (shares, classes,
terms of governance.
Limited Liability
 Pros: lowers cost of business (less due diligence), makes diversification and passivity more rational
strategy, reduces monitoring of managers and shareholders, gives incentives to act efficiently, easy to
measure value, investors can diversify, promotes optimal investments b/c less risk.
 Cons: people can declare bankruptcy and just be liable for investment (bad for creditors), allows for
moral hazard, shareholder apathy.

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  Benefits of transferable shares: permits takeovers, shareholders can exit w/o disrupting business, shares
are fungible (interchangeable)

PROTECTION OF CREDITORS

Generally
 Creditors benefit from normal creditor-debtor law and additional protections b/c limited liability
exacerbates normal problems (opportunities for misrepresentation, shifting assets out of corp.)
 Two ways to get money  equity or take out loans (debt)
o Debt is a more popular alternative because it is often cheaper than equity can deduct debt from
taxes, and there is not tax reduction for dividends
 Vocab:
o Equity owners, shareholders
 Investors pay for shares, corporation uses that money to pay debts, then whatever left
over goes to shareholders
o Shares:
 Par value: what the company says the share has (usually a nominal value)
 Dividends: BOD declares percentage of income into each share
 Market Value: the cost of share on the market
 Market Capitization: market value * number of shares
o Control Continuum
 Debt: gets paid before owners, but fixed upside (interest rate) and no voting.
 Preferred Stock: paid before common stock but after debt, set par value & dividend, no
voting
 Equity: residual interest. Paid last but gets more upside and voting.
Means of Creditor Protection
 Mandatory Disclosure: federal securities law imposes mandatory disclosure on public corporations but
not for closely held. Helps illuminate assets, liabilities, incomes, cash flow, etc. but it costs a lot of $ for
the corps
 Capital Regulations: laws requiring minimum investments or restricting the removal of capital or
minimum amount in bank before giving out dividends. Limits risk but ties up capital.
 Financial Statements: release of balance sheets to show assets, liabilities, and stockholder equity
(difference between assets and liabilities).
o State capital: portion of value transferred to the corp. at time of original sale.
o Capital Surplus: if stock is traded for more than original sale, money goes into surplus account.
 Distribution Restraints: limits the dividends a firm can pay out. Barely do anything and easy to
manipulate.
o DGCL §170(a): directors can pay dividends out of either surplus (assets- liabilities-state capital)
or, if no surplus, out of net profits in the current and/or preceding fiscal year.
 Assets include capital surplus and retained earnings. Can give dividends as long as the
company has profits.
o RMBCA §6.40: no dividends if as a result (a) they cannot pay debts or (b) assets are less than
liabilities plus the preferential claims of preferred shareholders. (but boards find different ways
to crunch he numbers)
o Conn. Gen Stat. § 38-687: can’t pay dividends today if you wont be able to pay debts tomorrow.
 Standards Based Duties (Fiduciary Duties)
o Director Liability: directors owe obligation to creditors not to render the firm unable to meet its
obligations to creditors by making distributions to shareholders or to others without receiving a
fair value in return.

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  Uniform Fraudulent Transfer Act: if debtor is about to be insolvent, any attempt to
transfer assets out of company to avoid paying debts shall be treated as fraud….meant to
prevent debtors from giving away their stuff right before other creditors come.
o Creditor Protection: Fraudulent Transfers (UFTA § 4)
 Imposes effective obligation on parties contracting with or insolvent to give fair value for
the cash or benefits they receive, or risk being forced to return those benefits. Statute
allows for voidance of any transfer made for delaying, hindering, or defrauding creditors.
 Can attack transaction if (1) there is intent to hinder or (2) if there are such little
assets that there is likely intent.
 If corporation that is nearing insolvency becomes insolvent, shareholders get nothing.
Incentives shift b/c shareholders have nothing to lose (riskier) and creditors still want to
recoup some investment. **Directors owe a duty to the corporation (not necessarily just
creditors or shareholders) (Lyonnais Bank). Creditors cannot sue by themselves, but they
could sue for breach of duty to the corporation. (N. Am. Cathloc Edu v. Gheewalla)
 Piercing the Corporate Veil: equitable device to set aside entity status of corporations and hold
shareholders liable directly on contracts/torts. Rare solution, really need everything to be
aligned/particularly egregious facts in order to invoke. If you keep up with corporate formalities odds
are it won’t be possible to pierce the corporate veil. Probably no piercing against public corporation,
passive shareholders, minority shareholder.
o Basic Equity Test: disregard the corp. form whenever recognition of it would extend the principle
of incorporation beyond its legitimate purposes and would produce injustice or inequitable
consequences.
 Factors: disregard for corporate formalities, thin capitalization, small number of
shareholders, active involvement in shareholder management.
o Lowendahl Test: plaintiffs must show existence of shareholder who completely dominates
corporate policy and uses her control to commit fraud or wrong that proximately causes
plaintiff’s injury. (usually includes failure to treat corporate form seriously)
o Van Dorn Test (from Sea Land Services v. Pepper Source (7th Cir. 1991)).
 1) there must be such a unity of interest and ownership that the separate personalities of
the corp. and the individual no longer exists.
 Failure to maintain adequate records, commingling of funds, under capitalization,
one-corporation treating assets of another corp. as their own.
 2) circumstances must be such that adherence to the fiction of separate corporate
existence would sanction (a) fraud OR (b) promote injustice (has to be compelling public
interest).
o Laya Test (applied in Kinney Shoe):
 1) unity of interest and ownership such that the separate personalities of the corporation
and the individual shareholder no longer exist;
 2) would an inequitable result occur if the acts were treated as those of the corporation
alone
 but if both prongs are satisfied, there is still a potential third prong: D might still
prevail by showing an assumption of risk.

Cases:
 Sea-Land Services v. Pepper Source (7th Cir. 1991) (Van Dorn Test): SL shipped peppers for PS. PS did
not pay SL a freight bill. SL filed suit for $, but PS was already dissolved for failure to pay state franchise
taxes. SL got a favorable judgment but since PS was dissolved it was looking to reverse-pierce the corporate
veil in order to get the money. SL brought suit against Marchese as an individual and the 5 other business
entities he owned. SL believed these corporations were alter egos for each other and Marchese created for
his personal use and shield from liability. First prong of Van Dorn test (above) was met (no meetings of the

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 corporations, no articles of incorporation or bylaws, Marchese ran everything from one location, companies
borrowed money from each other interest-free). Second prong not satisfied because SL did not argue that a
further injustice would occur other than just losing money. Injustice can’t just be that counterparty cant get
judgment, has to be something beyond the fact that P cant get money out of the corporation. Reversed and
Remanded to find if there was an injustice other than that the plaintiff could not fully recover. Examples of
what a further injustice would be: unjust enrichment, escaping rules or liabilities, common sense rules of
adverse possession, intentional scheme going on. Second prong was ultimately satisfied (fraud).
 Kinney Shoe Corp. v. Polan (4th Cir. 1991) (Laya Test): Cabel County (parent) Kinney Shoe (sub)
Industrial (Parent 2/lessee) Polan (Sub 2/sub- lesee). Kinney seeking to recover rent owed on a sublease
between Kinney and Industrial, and Polan is sole shareholder of Industrial. Industrial went bankrupt, so
Kinney went after Polan personally. Other than this sublease, Kinney had no assets or bank accounts.
Industrial only had income from a sublease to Polan. Court said undercapitalization of Industrial was not
enough, but ultimately found that the two prongs of the test were satisfied. Industrial did not observe
corporate formalities. Those who get to benefit from limited liability should be able to do the few things
required for creating and maintaining corp (“you didn’t even try”).
 Walkovsky v. Carlton (NY 1966) (Lowendahl Test): Taxi case…this is wise corporate structuring. P
injured when hit by a taxi in NYC. Cab owned by Carlton’s corporation. Carlton also owned 9 other
corporations with 2 cabs registered in their names. Corps. seemed independent but allegedly they operated
as a single entity. Carlton trying to limit his liability. Even though it could be argued that they were shell
companies or fragments of a larger company, the allegations themselves weren’t enough. Dissent  thinks
10 corps with no assets and minimal capitalization is funny enough to pierce.
 Credit Lyonnais Bank (Del. Chancery Court): held that when a corporation is in the vicinity of insolvency,
the directors, in making business decisions, should not consider shareholders’ welfare alone, but should also
consider the welfare of the community interests that constitute the corporations…include the creditors
 N. Am. Catholic Edu. v. Gheewalla (DE 2007): Creditors cannot assert a direct claim (alleging injury to
their own interests as creditors) but do have standing to assert a derivative claim (alleging injury to the
corporation) against an insolvent corporation.
o Directors in the zone of insolvency “must continue to discharge their fiduciary duties to the
corporation and its shareholders by exercising their business judgment in the best interests of the
corporation for the benefit of its shareholder owners.”

THE VOTING SYSTEM

Generally
 Good details in the other outline for this section…should probably review if you have time
 Shareholders: own equity, have voting rights, vote for board/changes in charter/bylaws, right to books
records.
 Management: determine policy, appoint CEO/CFO/others, elected by shareholders, annually/staggered
basis. Decides many aspects of the voting process: proposals, times/place, type of stock.
 Rules:
o Ways to Tally: first past the post (winner takes all), cumulative,
o Quorum: default is that a majority of shares entitled to vote has to be present for a valid vote
(DGCL §216; RMBCA § 7.25)
o Ways to Vote:
 Class voting: a majority of each class is needed to win.
 Duel Class Voting Rights: allows for multiple classes (multiple votes per share or no
votes per share). (Allowed in DGCL § 151(a) and NYBCA §613)
 Cumulative: each stock gets to vote X number of times for X positions. Minorities can
still claim percentage of positions.
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Electing and Removing Directors
 Common law required “for cause” removal.
 Directors are entitled to certain due process rights, but the extent is unclear (Campbell v. Loews)
 State law usually bars directors removing other directors absent express authority.
 For Cause or Without Cause Removal (DGCL §141(k); RMBCA § 8.08(a))
o If cumulative voting is in place, the only way to vote off a director is with the same number of
requisite votes needed to elect (need more votes to remove person than they would need to elect
that person).
o Staggered Boards (DGCL § 141)
 Methods for removing directors:
o Amend cert of incorporation: DGCL § 242
o Amend Bylaws: § 109 to increase (§233(a)(1)) or remove (§ 141k) board member
o Dissolve company and distribute assets (§ 275).
Shareholder Meetings and Alternatives
 Other needs for meeting include adopt/amend/repeal bylaws, resolutions, etc. Special meeting is the
only way shareholders can initiate the action. Shareholder Consent Solicitations: written consent in lieu
of a meeting.
Proxy Voting (DGCL § 212; RMBCA §7.22)
 Addresses the quorum requirement. Generally, proxies must record the designation of the proxy holder
by the shareholder and authenticate the grant of the proxy. Proxy holder is bound to exercise the proxy
as directed, but can exercise independent judgment.
 Financing Proxies: (Rosenfeld v. Fairchild Engine (NY 1955)) (Reimbursement after proxy contest):
management may look to corp. treasury for the reasonable expenses of soliciting proxies in good faith to
defend a position in a bona fide policy contest (not a personal power contest). Insurgents only get
reiumbrused if they win.
 Vote Buying (HP/Compaq case (2002)) (Vote Buying): it is illegal per se if the purpose is to defraud or
disenfranchise shareholders. If it is not to defraud, it is illegal if it is intrinsically unfair. Case: could
have been vote buying b/c they tried to shut polls after they got Duetche bank on board. Hewlett was
ultimately unable to prove that there was a defrauding of the shareholders even though there were
suspicious circumstances.
Shareholder Information Rights
 Stock List: discloses the identity, ownership interest, and address of each registered owner of company
stock. Delaware doesn’t need proper purpose. But RMBCA you do. Once “proper purpose” is shown,
the list is handed over. (RMBCA §16.02: burden is on shareholder).
 Inspection of Books/Records: allows shareholder to investigate the books and records, but may lead to
jeapordization of propriety or competitively sensitive info. (RMBCA and DGCL §220(c) burden is on
shareholder).
Separating Control from Cash Flow Rights
 Normally, good policy to award voting right to investors who claim corporation’s residual return. But
normally there is a prohibition against corporation voting shares owned by the corporation directly or
indirectly.
Voting Duties
 Chris-Craft Industries: although the action by the board (moving up the date of the vote to limit ability
of dissidents to gather proxy strength) was not illegal, the inequitable purposes could not stand b/c they
stripped shareholders of their valid exercise of voting right.

FEDERAL PROXY RULES

Securities Exchange Act of 1934

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  Main Features: disclosure requirement and mandatory vetting regime, regulation of the process of
soliciting proxies, “Town Meetings (14a-8)” that permits shareholders to gain access to proxy materials,
general anti-fraud provision (14a-9).
 §§ 14a-1 to 14a-7: makes it unlawful for any person to contravene against any rule the commission
adopts by “soliciting” “proxy” votes on registered “securities.”
o What are “proxy solicitations” 14a-1/14a-2 (exceptions)
 Broad definition except for (1) communication to less than 10 shareholders (2)
shareholders not seeking proxies but wishing to communicate (3) announcements of
intention to vote (even with reasons, its okay).
 But if you own more than $5M in corp. stock, you can make an exempt communication,
but you still have file notice of exemption with SEC (14a-6g).
o 14a-3: no once may be solicited for a proxy unless they are, have been, furnished with proxy
statement containing the info specified in schedule 14a (compensation, structure, transactions,).
o 14a-4 to 14a-5: form of proxy.
o 14a-6: formal filing requirements
o 14a-7: list-or-mail rule (disclosure of shareholder list or pay for proxy materials to be mailed.
o 14a-8: “Town Meeting Rule” allows shareholders to include certain proposals in company’s
proxy materials.
 Shareholder must show identity, number of proposals, length of docs, subject matter.
Also must (1) holder $2,000 or 1% of stock for a year, (2) must file w/ management 120
days before management plans to release proxy statements, (3) may not exceed 500
words, (4) must not run afoul subject matter restrictions.
 Grounds for rejecting: improper under state law, relates to ordinary business, relates to
matter < 5% of the business, conflicts with proposals, would disqualify a nominee who is
standing for election, would remove director from office before term expires, questions
competence/business judgment/or character of one nominees; seeks to include specific
company’s proxy materials for election; or otherwise would affect outcome of the
upcoming election of directors.
 Basically, if it has to do with the election, do it on your own.
o 14a-9: Antifraud Rule: there is an implied private right of action against companies for violating
the Act. (Virginia Bank Shares case)
 Test for Implied Right: (1) is plaintiff one of the class for whose special benefit the
statute was enacted? (2) Is there and indication of legislative intent (explicit, implicit)
either to create or deny a remedy. (3) is it traditionally regulated by state law?
 Elements
 (1) materiality: fraud must have “substantial likelihood that a reasonable
shareholder would consider it important for voting”
 (2) culpability: usually negligence.
 (3) causation and reliance: causation is presumed if misrep is material and was
“essential link” in accomplishment of transaction.
 (4) available relief: injunctive, recession, or monetary.
o Normal Types:
 Corporate social responsibility resolution
 Corporate governance resolution.

MANAGEMENT OBLIGATIONS

Fiduciary Duties
 Duty of Obedience (covered in agency law)

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  Duty of Loyalty: requires that corporate fiduciaries exercise their authority in a good-faith attempt to
advance the corporate purposes.
 Duty of Care: requires Corporate Directors or Officers to act
o 1) in good faith
o 2) in a manner that she reasonably believes to be in the best interest of the corporation
o 3) with care than an ordinarily prudent person would reasonably be expected to exercise in a like
position under like circumstances.
Techniques for Limiting Risk Exposure of D&O
 Statutory Indemnification: reimburse any agent, employee, officer, or director for reasonable expenses
for losses of any sort (attorneys fees, investigation fees, settlements, etc.) arising from actual or
threatened judicial proceedings. (DGCL §§ 145a, 145c 145(f))…good faith requirement?
o Waltuch v. ContiCommodity (2d Cir. 1996): DGCL 145a grants indemnification that can be
extended by corporate charter. 145c can be extended to civil claims too.
o Waiver of Obligation: DGCL 102(b)(7)
 Statutory Director/Officer Insurance: insulates officers/directors from liability (DGCL §145g/
RMBCA§8.57)
Business Judgment Rule
 BJR: where a director is independent and disinterested, there can be no liability for corporate loss, unless
the facts are such that no person could possibly authorize such a transaction if he or she was attempting
in good faith to meet their duty. (Similar definition from Gagliardi v. Trifoods (De. CH. 1996)). See
also RMBCA § 8.31
o Kamin v. Amex (NY 1976): Court will not interfere unless a clear case is made out of fraud,
oppression, arbitrary action or breach of trust.
 More about the decision making process than the actual decision
 General Rule: Courts should not second guess good faith decisions made by independent and
disinterested directors
 American Law Institute (ALI) BJR (pg. 341): a director or officer who makes business judgment in
good faith and fulfills the duty under this section if the director or officer
o 1) is not interested in the subject of the business judgment
o 2) is informed with respect to the subject of the business judgment to the extent that the
director/officer reasonably believes is appropriate under the circumstances; and
o 3) rationally believes that the business judgment is in the best interest of the corp.
 Court WILL look at business judgment
o 1) if there is violation of duty of care
o 2) if there is a violation of duty of loyalty
o 3) is made in judgment of good faith
o OR if no one could have possibly made that choice in good judgment.

DUTY OF CARE

 Duty of Care under ALI § 4.01(a)

o A director or officer has a duty to the corporation to perform…
 1) in good faith
 2) in a manner that he or she reasonably believes to be in the best interest of the
corporation; and
 3) with the care that an ordinarily prudent person would reasonably be expected to
exercise in a like position and under similar circumstances.
 General Claims for Duty of Care must show violation of:
o 1) financially disinterested directors of officers (like part of duty of loyalty)
o 2) is duly informed before exercising judgment
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 o 3) who exercise judgment in good faith effort to advance corp. interest.
 WAIVER (pg. 32 of LR outline): authorization for Charter Amendments Waiving Duty of Care
Liability (DGCL §102(b)(7)). Takes out duty of care requirement from Smith v. Van Gorkom.
o But can show “BAD FAITH” to get around it. Does not apply to duty of loyalty.
o No protection from the BJR when there is a violation of federal law (Miller v. AT&T)
 Sources of Information for Duty of Care: RMBCA §8.30(b):
o In discharging duties, director is entitled to rely on info, opinions, reports, etc. if prepared or
presented by
 1+ officers or employees if director reasonably believes them to be reasonable and
competent.
 Legal counsel, public accountant, or other people with professional expert competence.
 Committee of the board of which he is not a member if the director reasonably believes
the merits form the committee.
Duty to Monitor
 History of Passivity: courts look at what a reasonable person would have done.
o Smith v. Van Gorkom: personal liability for grossly negligent decision b/c of lack of informed
decision.
o Francis v. United Jersey Bank (NJ 1981) there is a duty to have a rudimentary knowledge of the
industry and workings of the business.
o Graham v. Allis Chamlers Mfg. (Del. 1963): duty to monitor a company is entitled to deference,
absent showing of “red flags”
 Caremark Claims (In re Caremark Derivative Litigation (Del Ch. 1996) and clarified in Stone v. Ritter
(Del. 2006)).
o Director Oversight Liability if
 1) director utterly fails to implement any reporting or information systems; or
 2) having implemented the systems, consciously failed to monitor or oversee the
operations, thus disabling themselves from being informed
o AND imposition of liability requires showing that directors knew they they were not discharging
fiduciary obligation. “Sustained and systematic failures.”
 Really must show gross negligence. The focus is on the systems that are in place and
how well they are monitored. It is not on how risky the business decision is. (In re
Citigroup Inc. Shareholder Derivative Suit)
o “Red Flags” if red flag come up in the warning system, if they are fraudulent/criminal and you
didn’t do anything about it, it is almost necessarily indicative that warning systems did not work.
But if the red flags are less than fraudulent, it doesn’t mean that Caremark claim was valid.
 Other tools for enforcing duty to Monitor
o Sentencing guidelines, DOJ Thompson Memo; Sarbanes-Oxly Act § 404.

Cases:
 Kamin v. Amex (NY 1976): BJR applied to decision by AmEx. Amex bought shares of DIJ and lost
$25M. Amex wanted to distribute shares to shareholders as dividends, Kamin wanted them to sell the
shares to offset tax savings. No claim of fraud or self dealing. Court ruled that there was no claim b/c
of BJR. Court will not interfere unless a clear case is made out of fraud, oppression, arbitrary action or
breach of trust. After Kamin and until Van Gorkom, it was a given that a corporation would be protected
by BJ rule.
 Smith v. Van Gorkom (Overcoming Business Judgment Rule): first time that court held financially
disinterested directors were personally liable for consequences of business decisions b/c they were
grossly negligent by not making informed business decision. (Rare that courts apply this nowadays).
Van Gorkom called a special meeting of the board but did not give them an agenda and board approves

14
 the merger after two hour meeting (20 min pres.). Meeting was egregiously sloppy, cannot agree to
merger without any analysis and examination of financials.
 Francis v. United Jersey Bank (NJ 1981) (Duty to Monitor): family owned reinsurance business. Sons
took “loans” for themselves. Ms. Pritchard, the other owner, was sued for passivity and held liable. BJ
rule did not apply because widow was not informed at all, she made no judgments when she could have
done something (stepped down, sued sons, stopped them). Directors must say something, get help, or
resign.
 In re Caremark Litigation (Del. Ch. 1996) (Duty to Monitor, Pipeline): DOJ found a bunch of crimes.
Civil suit including duty of care claims. Court was reviewing and said there was a low probability that
duty of care violation happened. Rule (see above). Court looked at the warning systems in place for
compliance (internal checkmarks, PWC investigation, ethics manual). No evidence that showed
evidence of violation. Caremark had always had an ethics guidebook, an internal audit plan, and a toll-
free confidential ethics hotline. A system was in place to monitor….a pipeline to know what employees
are doing
 Stone v Ritter (Del. 2006) (Reaffirming Caremark): new standard…see LR outline.
 Graham v. Allis Chalmer Mfg. (Del. 1963) (Duty to Monitor, Red Flags): AC was large decentralized
corp. that made electrical equipment. 1930’s was busted for price fixing and then in 1950. Defendant
directors said they had no knowledge of price fixing. Plaintiffs argued they should have known.
Holding: duty to monitor is entitled to deference, absent showing of red flags. Directors should be able
to rely on info from employees and compliance at face value
 In re Citigroup Shareholder Derivative Lit (Monitoring business risks): shareholders sued after
subprime issue under Caremark theory. Court held that BJR applied b/c there was no evidence of ill
informed decisions, just bad business decisions. Distinction between misconduct (Caremark) and
business risk.


DUTY OF LOYALTY

 Conflict transactions  interested in the transaction for some reason

 A corporate director, officer, or controlling shareholder must exercise her institutional power over corporate
process or property in a good faith effort to advance the interests of the company
o Fiduciary duty to disclose all material facts to the corporation’s disinterested representative and to
deal with the company on terms that are intrinsically fair in all respects
 Rationale for duty:
o Real people and communities invest their financial assets in companies
o There are enforcement problems in public corporations that can tend to be fragmented and
unorganized

A duty to whom?
 Old law was that duty is to the shareholders…shareholder primacy (Dodge v. Ford Motor Co.)
 Duty to Corporation: Constituency Statutes: many states have enacted statutes that say directors have
power (but not obligation) to balance interests of shareholder constituencies and interests of non-
shareholders in setting corp. policy (Penn. BCL § 1715(a) and Conn. Gen. Stat § 33-756(d)
o Question of loyalty arises when a board claims to advance a non-shareholder interest over
shareholders, i.e. Public Benefit
o A board may decide to use retained earnings to fund investments, price reductions, and increase
employee wages as a device to increase long-term corporate earning.
 eBay v. Newmark (craigslist): corporate form is not a vehicle for purely philanthropic ends: still
have some duty to shareholders. Having chosen a for-profit corporate form, the craigslist directors

15
 are bound by the fiduciary duties and standards that accompany that form. Those standards include
acting to promote the value of the corporation for the benefit of its stockholders.
 Delaware Benefit Corporation: allows corps to form a for-profit org. w/ intent to produce
public benefit.
o Charitable contribution (A.P. Smith v. Barlow) (Factors to consider in making a legitimate
charitable contribution)
 Made to legit institution, modest amount and within limitations imposed by statutes,
voluntarily made with reasonable belief that it would aid public welfare and advance the
interest of the corporation.

When does
Duty of
Loyalty
Come Up?
 Presumption that BJR applies P shows there is a conflict D, corporation, has to prove there was
procedural fairness (safe harbor rule) or substantive fairness (entire fairness test).
 Even if it is approved, if burden is shifted to P, P can show that it was fraudulent or in
violation of BJR b/c it was irrational or egregious.
o What constitutes a Breach/Conflict: (1) self dealing w/ direct financial interest of party in
transaction. (2) Interested transaction if director has indirect interest in transaction b/c he is not a
party but stands to benefit.
 Self Dealing: (Sinclair)
 1) controlling stockholder is on both sides of transaction and dictated its terms,
AND
 2) there is a special benefit to the controlling stockholder in which the minority
stockholders do not share.
o Entire Fairness Test (DGCL § 144(a); Weinberger): once plaintiff establishes that duty has been
breached, then director must establish fairness of transaction by showing
 1) Fair dealings: duty on corp. to completely disclose to the shareholders all relevant
info. when transaction was timed, initiated, structured, negotiated, what was disclosed
to directors, how approvals were obtained
 2) Fair price: requires that price being offered for outstanding price be equivalent to price
determined by an appraisal. Economic and financial consideration, how deal affected
intrinsic value of the assets.
 Use of Special Committees: (Weinberger)
o Use of an independent negotiating committee of outside directors to deal
with conflicting interest company at arm’s length. Fairness is likely met
b/c it shows that each contended party had in fact exerted its bargaining
power against the other at arm’s length, which is strong evidence that it
meets the fairness test.
o Safe Harbor Statutes: A director’s self dealing transaction is not voidable simply b/c he is
interested as long as it (DGCL §144; NYBCL §713, Cal. Corp. Code §310) (See also Cookies v.
Lakes)
 A) disclosure and authorization by disinterested directors OR

16
  B) disclosure and authorization by disinterested shareholders OR
 C) the Transaction is fair
 Note: states differ as to exactly what constitutes a “cleansing procedure.”
Types of Claims: An interested Director Transaction is voidable unless there was disclosure/approval (safe
harbor) or it was substantively fair)
 Procedural Claims: there was a violation of
o Disclosure: valid authorization of a conflicted transaction between director and her company
requires the interested director to make full disclosure of certain things prior to transacting.
Includes disclosure of potential benefit/interest and all material facts that she is aware of. (See
Hayes Oyster) OR
o Approval (ratification) by
 Disinterested directors
 Disinterested shareholders
 Need unanimous shareholder approval to ratify a conflicted transaction that
involves corporate waste (Lewis v. Vogelstein)
 Substantive Claims
o Substantial Fairness
o Waste (difficult): must prove that corp. entered into transaction and got so little of a
consideration that it was basically a gift (Lewi v. Voeglestein).

 Ratification by Shareholder: BJR applies if approved in good faith by a majority of disinterested SHs.
Can only be attacked for waste.

17
  Types of Transactions
o Interested transaction involving non-controlling shareholder is subject to BJR (In re
Wheelabrator)
o Interested transaction involving interested controlling shareholder:
 Non-self dealing transactions: BJR applies, burden on plaintiff to prove a violation.
 Self-dealing transaction with ratification from disinterested shareholders: BJR applies.
 Self-dealing if transaction favors controlling shareholder at the expense of the other
shareholders, entire fairness applies, burden is on the defendant to prove fairness of its
transactions (Sinclair)
 Self-dealing if transaction favors controlling shareholder at the expense of others but it
is approved by majority of disinterested shareholders must still meet entire fairness test
but burden is on plaintiff.
 Conditioned upon receiving a majority vote of the minority shareholders
(Weinberger)
 Ordinarily: duties apply to directors/officers, not shareholders, but if shareholder effectively controls a
corp. It has a duty of loyalty to the corp.
Corporate Opportunity Doctrine:
 Directors/officers/controlling must not take advantage of an opportunity that belongs to the corporation
for their own personal gain.
 Is it a corp. opportunity? (Factors)
o Financial capacity to undertake opportunity
o In corp.’s line of business
o Interest or expectancy in the opportunity
o Whether the opportunity would bring the insider into conflict w/ corp.
 Three Lines of Doctrine:
o Expectancy or Interest Test: expectancy or interest must grow out of an existing legal interest
and the appropriate of the opportunity will in some degree balk the corporation of its purpose.
o Line of Business Test: any opportunity which is reasonably determined to fall in company’s line
of business is corporate opportunity.
 How this matter came to attention?
 How far removed from core activities of corp?
 Whether corp. info is used in recognizing or exploiting opportunity?
o Fairness Test: how managers learned of disputed opportunity, whether he or she used corporate
assets in exploiting the opportunity.
 When can a fiduciary take opportunity?
o Whether the board has evaluated the question to accept in good faith and denied b/c of financial
position, incapacity, etc. must present opportunity to board for them to evaluate.
o DGCL §122(17): Bylaws can opt out of this restriction.

Cases:

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  Cookies v. Lakes (Self Dealing can be ok): Cookies Inc is formed to make BBQ sauce, Cookies enters
into distributship w/ minority shareholder (Herrig). Distributorship is successful and Herrig buys out
Cook, becomes controlling shareholder. He makes self-dealing contracts. Shareholders were pissed b/c
they couldn’t get dividends until loans were paid, loans wouldn’t be paid if he kept getting raise. Rule:
directors must establish they acted in good faith, honesty, and fairness in addition to requirements that
any such transactions must be fully disclosed and consented to the board of directors or shareholders.
Holding: even though it was self dealing, it was fine b/c he provided info and was consented.
 Hayes Oyster Co. v. Keypoint Oyster (Duty to disclose): Hayes is director, shareholder, and CEO of
Coast Oysters (public co). Hayes suggests to another Coast employee to form new corp. called
Keypoint. Coast faces cash flow problems and Hayes convinces board to sell two oyster beds to
Keypoint. Hayes Oysters also arranges to help Keypoint w/ financing in exchange for 50% equity.
Hayes Oysters getting 50% happens after Coast votes to sell but before Coast shareholders approve.
Coast’s new mangaement discovers what Hays did and brings suit. Holding: Hayes should have
disclosed his self interest before he voted for the sale. Violation of duty to disclose under duty of
loyalty. Disclose or abstain.
 Cooke v. Oolie (BJ rule is appropriate when disinterested directors vote same as interested): O and
S were directors and creditors of company, voted to pursue an acquisition proposal that best protected
their own interest instead of accepting proposals for shareholders. But since disinterested directors
voted to approve the deal, O/S did not breach duty of loyalty b/c BJR applied. Court used DGCL §
144(a)(1). Disinterested voter ratification cleanses the taint of interest. Their vote signals that the
interested transaction furthers the best interests of the corporation
 In re Wheelaborator Tech: WTI was bought in merger by WMI, which owned shares but not control.
Four WTI officers were WMI directors. WTI uninterested shareholders approved transaction. Other
shareholders claimed breach of duty under DGCL § 144. Rule: fully informed shareholder’s ratification
does not extinguish duty of loyalty claim, but serves to make BJR the applicable review and shift burden
to plaintiff to prove waste. Holding: since transaction did not involve controlling SH, BJR applies.
 Sinclair Oil Corp. v. Levin: SOC was major SH of Sinven and nominated all members of board and
controlled the company. Minority SH (Levin) alleges SOC caused Sinven to pay excessive dividends.
Rule: BJR applies b/c there is no self dealing in a situation where the benefit is not exclusive to the
majority shareholder (dividends were distributed proportionately). Holding: entire fairness applies.
 Weinberger v. UOP: Signal owns 50.5% of UOP and holds 7/13 seats of UOP board. Signal board
decides to buy remainder of UOP to invest. Two directs of UOP and S perform study and pass along
price of $24 as good investment. Price study was shared with Signal board but not with overlapping
UOP members. S offers $21 a share (55% control premium) conditioned on getting approval from
majority of minority UOP shareholders. UOP non-overlapping board approves. Suit for duty of loyalty
violation. Rule: apply fairness test. Holding: S failed to disclose non-overlapping UOP board their
study. Remand to determine price and other factors. One party had superior knowledge, negotiations
were done too quickly (3-4 days), the fairness reports were done in a hasty manner so minority
shareholder vote was not an informed one. A special committee could have solved this problem if there
was real deliberation.

DUTY OF INSIDERS: INSIDER TRADING

Short Swing Profits Prohibition: § 16 of 1934 Act.

 Covers directors, officers, and 10% liability (stock) holders.
 Requires: public report of any transaction in corporation’s securities w/in two days. Must give up
profits to company that they make within 6-month period. Official title of person doesn’t matter; it
matters what non-public info they have access to.
 Test: look at purchases and scale w/in short swing profit period. Ignore any transaction before statutes
applies.
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Exchange Act § 10(b) and Rule 10(b)-5.
 Rule 10b5: (pg. 373)
 its unlawful to
 (A) Employ any device, scheme or artifice to defraud;
 (B) To make any untrue statement of material fact or omit a statement of material fact
necessary in order to make the statement made, in the light of the circumstances
under which they are made, not misleading; OR
o Material: would a normal stock buyer want to know it?
o Check when right attaches below
 (C) To engage in any act, practice, or course of business which operates or would
operate as fraud or deceit on any person;
 In connection w/ purchase or sale of any security.
 Notes: Requisite reliance must be by a buyer or seller of stock AND misleading info
must be made in connection w/ purchase or sale of stock. Doesn’t extend to spouse or
dependent.
 Private right to action created (Kardon v. National Gypsum Co.) if there was contemperanous trading.
 THEORIES: 10b-5(B) attaches under one of these two theories individual liability as an insider,
tippee/tipper, or misapporpriator. Always requires a RETAC: if its to source of info= fiduciary duty
claim; if its to someone else= misappropriations theory.
 Fiduciary Duty: in order to establish an insider violated 10b-5 by breaching duty to disclose
or abstain to an uninformed trader, you have to show there was a specific, pre-existing
relationship of trust and confidence (RETAC) between insider and the counterparty
(Chiarella, Dirks)
 RETAC arises, among other circumstances whenever:
o A person agrees to maintain info in confidence;
o Two people have a history, pattern, or practice of sharing confidences such
that the recipient of material non-public info knows or reasonably should
know that the person communicating the info expect that the recipient will
maintain its confidentiality; OR
o A person receives or obtains material non-public info from a spouse, parent,
child, sibling, unless the recipient can demonstrate that, under the facts and
circumstances of the family relationship, no duty of trust or confidence
existed.
 Misappropriation: violation of 10b5 when he “misappropriates confidential info for securities
trading purposes, in breach of duty owed to source of the info.” (O’Hagan). Basically trader
breached RETAC in obtaining info and used that info for his benefit (Dirks, Chestman,
O’Hagan).
 Statutory Insiders: an individual with RETAC is held to this standard.
o Disclose or abstain rule: corporate insider must abstain from trading in the shares of his corp unless
he first disclosed all material inside info known to him.
 Tipper/Tippee Liability
o Tipper Liability
 Tipper had a duty (RETAC)
 Tipper intentionally (criminal) /recklessly (civil) breached the duty
 Tipper received personal benefit.
o Tippee Liability (Dirks) *(must have Tipper liability to have Tippee)
 Tippee knew (or had reason to know) about Tipper’s breached RETAC duty
 Tippee knew (or had reason to know) that Tipper improperly obtained information
 Tippee used the information for its benefit by trading or tipping.

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 Misappropriators: a person who has misappropriated nonpublic info has absolute duty to disclose that info
or refrain form trading. Reaches ppl who may not be insiders.
o Liability
 Breached any RETAC in obtaining info
 Used info for its benefit by trading or tipping.

Other Rules/Acts
Rule 14e-3: covers inside trading on tender offers
 Imposes duty on any person who obtains inside info about a tender offer that originates with either the
offeror or the target to disclose or abstain from trading. No fiduciary duty needed, must disclose or
abstain. Need to know that it was insider info.
o B) violation to communicate nonpublic material info under circumstances under which tipeee is
reason likely to trade on that info.
Insider Trading Acts (Amendments to 1934 Act)
 §20A: creates a private right of action for any trader opposite an insider trader, with damages limited to
profit gained or losses avoided.
 §21A(a)(2): allows civil penalties up to 3X profits gained or loses avoided
 §21(a)(1)(B): controlling person may be liable too, if controlling person know or recklessly disregarded
likelihood of insider trading
 §21A(e): bounty hunter provision gives 10% of recovered to whistleblower.

Cases:
 Texas Gulf Sulphur (Old Case law): any possession of relevant, material, nonpublic info gives duty to
disclose or abstain. 10b-5 claim brought against everyone involved in purchasing stock on rumors of
mineral deposit.
 Chiarella v. US (RETAC Required): required fiduciary duty (RETAC) to bring a claim. Financial
printer saw docs about buying stock of target company. He bought stock and made $30k. Printer had
no RETAC and thus no liability under 10b-5. Other laws were subsequently enacted.
 Dirks v. SEC (Tippee Liability): Dirks (tippee, investment advisor) got info from former director
(tipper) of corp. saying there was fraud in corp. Dirks does his own investigation. SEC brings charges
against Dirks for telling clients about alleged fraud. The tipper (former director) did not receive benefit.
Rule: see above. ** Need to have tipper liability to have tippee liability. Since there was no benefit for
the tipper there was no liability for tippee. Dirks didn’t violate. This was a rare case where it was found
the tipper did not personally benefit. He just wanted the fraud to be released. Court probably did not
want to make Dirks liable because he did do a service
 U.S. v. Chestman (Pre 10b-5): Waldbaums were selling A&P. Loeb is family member who finds out,
calls broker (Chestman). Chestman then buys stock in Waldbaums. Chestman tells Loeb to buy more.
Loeb did not have a liability under 10b-5 b/c he had no special duty. The info was gratuitously
communicated.
 U.S. v. O’Hagan (SCOTUS adopts misappropriation theory): O’Hagan was partner at firm working
on tender offer. He wasn’t’ involved in the deal, but when his firm stopped working on the deal, he
purchased stock in Pillsbury. He made huge money when it went public. Not liable under fiduciary
duty theory b/c he only owed duty to the acquirer, not Pillsbury. Court adopts misappropriation theory
and extends 10b-5. Just need a breach, and does not need to be to the corporation itself (can be to
acquirer or acquireree). O’Hagan breached duty to law firm, law firm had duty to one acquiring the
company.
 Santa Fe Ind. V. Green: don’t expand (w/o congressional intent) a federal law when the state law has a
remedy. Generally, corporate mismanagement is in the province of state law. No fraud, deceit, or
manipulation, no federal law. It might have been a breach of duty, but it was not insider trading.

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  Goldberg v. Meridor: but when there is deception, 10b-5 can be a remedy even if it was a state law
fiduciary duty.

SHAREHOLDER LAWSUITS

Types of Suits
 Direct Suits: injury alleged is to a personal interest, can be brought individually or as a class action, and
remedy is to recover damages lost.
 Derivative Suits: Plaintiff sues on behalf of corporation, typically alleging that directors failed to
vindicate its claim b/c they were the wrong doers, the injury alleged indirectly harms shareholders, and
the remedy is often injunction, damages to corp. and shareholders don’t necessarily receive anything.
 Comparing: (Tooley v. Donaldson)
o Who suffered the alleged hrm (Corp. or shareholder?)
o Who would receive the benefit? (corp. or shareholder).
Requirements to bring Derivative suit:
 Standing:
 P must be SH for duration of action and at time of alleged wrong action or omission.
o (1) fair and adequate representation of the class (FRCP 23.1 and Delaware)
o (2) contemporaneous ownership (FRCP 23.1 and Delaware, RMBCA 7.41, ALI 7.02).
 Demand on Board: complaint must have first tried to obtain action desired from D&O or have grounds
for not making the demand.
o Delaware: Aronson/Levine Demand Futility Test
 P must (1) establish that directors are interested or dominated; OR (2) create a
reasonable doubt, with particularized facts, that challenged transaction is protected by
the BJR.
 In a double derivative suit (brought by shareholder of sub), apply modified Aronson:
establish whether board is interested or independent (first prong only). (Rales v.
Blasband)
o RMBCA: plaintiff must make demand and waited 90 days unless irreparable injury (§7,42)
and then if demand is refused shareholder may continue by alleging with particularity that
board is not disinterested (§7.44(d)) or did not act in good faith (§7.44(a)).
o ALI: P must make demand unless irreparable injury (§7.03) and if demand is refused and
shareholder continues court will review board motions and dismiss derivative suits using
graduated standard.
 BJR for alleged duty of care violation (§7.10(a)(1))
 Reasonable belief in fairness for alleged duty of loyalty violations (§7.10(a)(2)).
 No dismissal if P alleges undisclosed self-dealings (§7.10(b)).

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Special Litigation Committees
o Formed after lit has begun and board needs to make decision. Independent directors are used to figure
out whether to litigate or not. SLC have fid. Duty to corp. and court will not allow dismissal if it would
breach duty.
o Zapata 2-step (to see review whether SLC breached fiduciary duty when dismissing suit)
o (1) Court should inquire into the independence and good faith of the committee and the basis
supporting its conclusion.
 Corp. has burden to prove independence, good faith, and reasonable investigation.
o (2) Court should determine, applying its own independent business judgment, whether the
motion should be granted. Court focuses on the decision whether to sue, not just on the
underlying litigation (Oracle).
Paying for Suit
o Common-Fund Doctrine: if there is a common fund that the attorney’s protected in the litigation, fees
can be paid out of that.
o Substantial Benefit Rule (Fletcher v. A.J. Industries (Cal. App. 1968)).
o P in derivative action may be awarded attorney fees against the corp., if the corp received
substantial befit from litigation. (Doesn’t require common-fund prior to lit).
o (1) Must be a financial benefit; (2) doesn’t matter if they arise from judgment or settlement.

Cases:
o Fletcher v. A.J. Industries (Substantial Benefit Rule): formation of substantial benefit test. Settlement
was made and attorneys were granted fees.
o Levine v. Smith (Del. 1991) (Need to make demand unless doing so would be futile): makes Aronson
Disjunctive (or instead of and) and Broader. GM buys EDS from Ross Perot in a stock transaction that
made Perot GMs largest SH. Perot is on board and criticizes GM. GM pays Perot $742M in exchange
for his stock, notes, and agreement not to wage proxy contest or criticize GM. Deal is approved by
subcommittee and then 22 other board members. Shareholders sue claiming breach of fiduciary duty.
Argue that demand is excused b/c it would have been futile. Court  management didn’t lack
independence…valid exercise of the board members’ business judgment…insufficient facts to support
the shareholders’ argument
o Oracle Derivative Litigation: inquiry to independence of SLC is highly individualized. Court ruled that
members of SLC couldn’t make independent choice b/c of school ties to Stanford. Members of the same
church having coffee together. Court looked at where they went to school, different community service
and foundations the members were involved in, where they all live and the potential for social
awkwardness as indicators of interest.
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CHANGES IN CONTROL AND STRUCTURE

Transactions in Control
o Acquisition can either be from (1) purchasing shares from numerous small holders (tender offer); or (2)
purchasing controlling block from an existing control holder (seller demands a control premium)
Acquisition of Control Block
 Premium is the added amount an investor is willing to pay for the privilege of directly influencing the
corporation’s affairs”
o Regulation of Control Premia: Market Rule (Zetlin v. Hanson Holdings (N.Y. 1979)) (It’s ok to sell at a
premium).
o Common Law: seller receives whatever market will bear for control premia, absent looting of
corp. assets, conversion of corp. opp., fraud, etc.
o When is Control Premia Subject to Disqualification (minority of courts)
o (1) Equal opportunity Rule (Rare): all shareholders are entitled to a part of the control premium.
Very rare! Only applied in situations like (Perlman v. Feldman) where unusually large premium
and for one’s self breaching fiduciary duty. Duty was breached because he sold goodwill. Meant
to deter looting, stealing corporate opportunities….but it can also deter transactions that would
be good.
o (2) controlling shareholder may use its shareholder right to vote based on its own interest and
private benefit, but it cannot force the corp. to give up certain protections it would have had
otherwise. (In re Digex)
o (3) Cannot violate contracts or covenants that preclude disparate consideration (good faith and
fair dealings) (In re Delphi)
Tender Offers
o A premium public offer at fixed price, open for set period.
o Regulated by William Act:
o (1) Early warning system (§13(d)): requires disclosure whenever anyone acquires more than 5%
of the stock.
 Must file w/in 20 days of acquiring. Qualified institutional investors and passive
investors are exempted.
o (2) General Disclosure: (§14(d)(1)): requires tender offeror to disclose identity and future plans,
including any subsequent going-private transactions.
o (3) Anti-Fraud Provision (§14(e)): prohibits any fraudulent, deciept, or manipulative practices in
connection with a tender offer.
o (4) Terms of Offer (§14(d)(4)-(7)): governs the substantive terms of tender offer must be open
for 20 business days, must be made to all holders and all have to get same deal, bidder cannot
buy outside the tender offer.
o Hart Scott Rodino Act: must wait 30 days before closing transaction so the gov’t has time to assess it,
must wait 15 days for cash tender offers. Can be extended.

Cases:
o Perlman v. Feldman (2d Cir. 1955) (Equal opportunity Rule (rare)): Korean war had steel shortage,
semi-official price freeze and rationing of steel. Feldman (Director and CEO) controlled 37% of
Newport Steel. Sells stake to Wilport for $20 a share when stock was trading at $12. Feldman resigns
and Wilport takes control of the board. Court says he breached fiduciary duty by selling the goodwill of
the company. Employs equal opportunity doctrine and disperses the premium b/c company would have
made money.
o In re Delphi (Del. Ch. 2012): Rosenkranz contributes 12% of capital and owns 49.9% of the votes o
Delphi. Equal opportunity rule for Class A and Class B for sale of company. Rosenkranz is adamant

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 about receiving control premium before voting for the sale to go through and gets amended charter to
allow for some control premium. Court thinks this is in violation of good faith and fair dealing b/c he
agreed to forego those rights at the time of purchase.

MERGERS AND ACQUISITIONS:

Vocab:
o Short Form: if you have 90% of corp. you can acquire the rest with resolution from board. (DGCL
§253).
o No subject to entire fairness review (Glassman v. Unicol) No need for a vote, just resolution of
the board. Minority SH still have appraisal rights.
o Long Form: if you can’t get 90%, you have to go through the normal statutory merging process.
o One-Step: negotiate and vote.
o Two step: tender offer. If 90% or more, short form, if not, then long form.
Forms
o Statutory Mergers
o Process (DGCL §251)
 (1) A & T board negotiate merger
 (2) Proxy materials are distributed to shareholders as needed
 (3) Shareholder Vote
 T shareholders always vote
 A shareholders vote if A’s outstanding stock will increase by more than 20%.
 (4) If majority approved, T’s assets merge into A, T shareholder get A stock, and
certificate of merger filed with sec. of state.
 Dissenting SH get appraisal right.

o Asset Acquisition: acquire all or essentially all of the assets. T may continue by name but will just be a
shell. Good when T has liability/bad reputation.
o *A does not need a vote (unless NYSE requires it)
o Process (DGCL §271)
 1: A & T board negotiate the merger
 2: Proxy Material and Vote for T shareholders only
 3: Transfer assets (title, physically, etc.)
 Result is higher transaction costs than merger
 4: T liquidates consideration received to shareholders

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 o Compulsory Share Exchange: forces shareholders to take shares of another stock. Same tax implication
of a tender offer w/o same time and minority shareholder issues.
o Process (RMBCA § 11.03)
 1: A and T boards negotiate tender offer
 2: Majority shareholders vote and it becomes mandatory for all shareholders
 3: A’s stock is distributed to T’s shareholders pro rata, while A becomes sole owner of all
of T’s stock.

o Two-Step Merger (for DE in lieu of Compulsory Share Exchange)

o Process: T & A board negotiate 2 linked transactions as one single package.
 (1) tender offer for most or all of T’s shares
 (2) Merger between T and a subsidiary of A which followed tender offer and removes
minority shareholders who failed to tender shares
 If it is a cash merger, then minorities are “cashed out”
o Triangular Mergers (forms of the 2-step)
o Start w/ 3 corporate entities (parent purchaser, subsidiary, target)
 If sub merges into T reverse triangular merger
 If T merges into Sub forward triangular merger
o Benefits: shields A from liability of T, keep goodwill and name of T, no shareholder vote for A
b/c parent is the stockholder.
Shareholder Voting & Appraisal Rights

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 *Shareholders don’t have to vote in a cash tender offer, only if there’s stock involved!
o Appraisal Rights (DGCL §262): dissenting shareholders can go to court and get pro rata share of value
of corp. as it was prior to merger. Cash=appraisal rights. Stock= no appraisal rights.
o Process:
 SH get notice of appraisal right at least 20 days before SH meeting (§262(d)(1)).
 SH submit written demand for appraisal before shareholder vote, and then votes against
(or at least refrains form voting for) the merger (§262(d)(1))
 If merger is approved, shareholder files petition in Chancery Court within 120 days after
merger becomes effective (§262(e))
 Court holds valuation proceeding to demine the shares’ faire value exclusive of any
elements of value arising from accomplishment or expectation of the merger (§262(h)).
 No class action device available, but chancery court can apportion fees among plaintiffs
as equity may require (§262(j)).
o Exception: Market Out Rule
 §262(b): get appraisal rights in a statutory merger.
 BUT (§262(b)(1)): NO appraisal rights if shares are:
 Market-traded (i.e. NYSE); OR
 Company has 2,000+ shareholders; OR
 Shareholders not required to vote on the merger.
 BUT (§262(b)(2): DO get appraisal rights if
 Your merger consideration is anything other than shares in surviving corporation
(i.e. cash); OR
 Shares in third company that is exchange traded or has 2,000 shareholders (with
de minimus exception for cash in lieu of fractional shares)
Duty of Loyalty in Controlled Mergers (Freeze-Out Mergers)
o Terms:
o Freeze-out tender offer: tender offer + short form merger
o Freeze-out/Cash-out Merger: existing controlling shareholder merges the companies together and
cashes out minority shareholders.
o Fiduciary Duty Claim
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 o Fairness Actions dominate b/c (1) appraisal right might not be available; (2) actions claiming
breach can be brought before merger is finished; (3) can be class actions.
o Wienberger Rule: if P alleges and shows transaction was between controller and the company,
fiduciary ahs burden to establish the transaction was fair in all respects to the corporation.
(Check M&F worldwide to prove dependency)
 Entire Fairness test: (1) shareholder ratification and (2) independent director approval.
 Can use Special Committee.
 If fiduciary can meet fairness test, P must show unfairness by questioning independant
judgment committee, unfair opinion, lack of real negotiation.
o NEW LAW:
o Use BJR in controller buyouts if and only if:
 (i) the controller conditions the procession of the transaction on the approval of both a
Special Committee and a majority of the minority stockholders;
 (ii) the Special Committee is independent;
 (iii) the Special Committee is empowered to freely select its own advisors and to say no
definitively;
 (iv) the Special Committee meets its duty of care in negotiating a fair price;
 (v) the vote of the minority is informed; and
 (vi) there is no coercion of the minority.
o If not, use entire fairness review.

Cases:
 Kahn v. Lynch Comm. (Del. 1994): shareholder owed fiduciary duty if owns majority interest or
exercises control over business affairs of corp. Alcatel owns 43.3% of Lynch Comm; Lynch wants to
buy Telco, but supermajority provision allows Alcatel to veto. Alcatel tells them to acquire Celwave
(owned by Alcatel) instead. Lycnh appoints special committee to negotaite with Celwave. Alcatel
threatens to hostile takeover if they don’t accept, special committee accepts. *Mere existence of spec.
comm. doesn’t shift burden. They must have real bargaining power and exercise it with majority
shareholder at arm’s length. Threat of hostile takeover meant no real choice.
 Kahn v. M &F Worldwide: defining independent v. controlling
o *To show that a director is dependent, a plaintiff must demonstrate that the director is beholden
to controlling party or so under [the controller’s] influence that [the director’s discretion would
be sterilized. Inquiry must be whether, subjectively, the ties were material in the sense that they
would affect the impartiality.
 In re Siliconix (Del. Ch. 2001): unilateral tender offer, followed by short form merger (aka freeze out
tender offer). Rule: freeze-outs executed via tender offer are not subject to entire fairness review.
 In re CNX Gas Crop. (Del. Ch. 2010): entire fairness applies to controlling shareholder tender offer that
lacks a special committee recommendation.

PUBLIC CONTROL CONTESTS

 Hostile Bid: no actual agreement between bidder and target, but there is a tender offer for control which
is indicative of backend long-form freeze out coming.
 Duties exist because of the potential threat
o Structural coercion: risk that disparate treatment of non-tendering shareholders might distort
shareholder’s tender decisions.
o Opportunity Loss: might deprive shareholders of opportunity to select a superior alternative
offered by management.
o Substantive Coercion.
Duties of Board Defending Against Takeover
 Enhanced Business Judgment Rule (Unocal)
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 o (1) Directors must show reasonable grounds for believing that a danger to corporate policy and
effectiveness existed, AND
o (2) the defensive measure is reasonable in relation to the threat posed (Unitrin)
 (a) was the defense tactic coercive (aka back end tender offer is so bad that there was a
rush to the front end) or preclusive (basically blocks any other person from offering).
 If yes: not okay.
 If no: go to (b)
 (b) can the defendant directors prove the defense tactic fell within range of
reasonableness?
 If tactic is not draconian and in the range of reasonableness, court should not use
its business judgment over the boards as long as there is good faith and not
grossly negligent than BJR.
Fiduciary Duties when Sale Become Inevitable
 Once sale/break up of company becomes inevitable, board transition from being defender of corporation
(Unocal duty) to auctioneers with duty to receive the best price possible for the company (Revlon
Duty)
 General Duties: (Barkan v. Amsted Industries (Del. 1989))
o (1) level playing field among bidders
o (2) Market Check required: must check to see what offers are out there. Except if directors have
reliable info that transaction is fair.
 Triggers of Revlon Duty
o (1) when corp. initiates an active bidding process
o (2) when response to a bidder’s offer, corp. abandons long-term strategy and alterative
transaction involving the break up of the company.
o (3) change or sale of control, or creation of controlling block (QVC)

Poison Pill
 PP was upheld under Unocal: (1) board ahs authority to adopt a poison pill under DGC 157 and 151g
and (2) adoption of a pill is a valid exercise of business judgment.
 Implementing Flip In PP:
o Step 1: Rights plan adopted by board vote. Shareholder vote not necessary as long as the
board has the requisite provision in the charter allowing it to issue blank check preferred
stock.
o Step 2: Rights are distributed by dividend and remain “embedded” in the shares.
o Step 3: Triggering event occurs (it never does) when prospective acquirer buys > 10% of
outstanding shares. Rights are no longer redeemable by the company and soon become
exercisable.
o Step 4: Rights are exercised. All rights holders are entitled to buy stock at half price – except
the acquirer, whose right cancelled.

Cases:
 Smith v. Van Gorkom: BJR did not apply b/c directors had been grossly negligent in failing to act
informed reasonable deliberation.
 Unocal v. Mesa: gave enhanced BJR. Threat was there (2 tier tender with threat of greenmail) and
proporation b/c Unocol responded with defensive recapitalization.
 Unitrin v. American General Corp. (Del. 195): focused on prong 2: if tactic is not draconian….

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