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NOTE: Entities don’t act because they are legal fictions; instead, employees of an entity act. Thus, don’t underestimate individualized incentives of employees to make certain decisions (don’t want to look bad).
I. AGENCY LAW
A. WHO IS AN AGENT? 1. Agency The label the law applies to a relationship in which: a. By mutual consent (formal or informal, express or implied) b. One person or entity (agent) c. Undertakes to act on behalf of another person or entity (principal) d. Subject to the principal’s control 2. Rest (Second) of Agency § 1 “Agency is the fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act.” 3. Agent one who has agreed with another person (principal) to act on his behalf and subject to his control. a. A Nonservant Agent is one who agrees to act on behalf of the principal but is not subject to the principal’s control over how the task is performed. b. Agents owe a fiduciary duty to their principal. 4. Creation of the Agency Relationship a. Restatement: Agency is the fiduciary relation which results from the manifestation of consent by the principal to the agent that the agent shall act on the principal’s behalf and subject to the principal’s control, and consent by the agent to so act. b. Creation of Agency necessarily requires two steps: (1) Manifestation by the Principal, and (2) Consent by the Agent. i. When the agent manifests consent to the principal’s request, the agency exists, even though the principal may initially be unaware of the manifestation. c. Objective Standard for Determining Consent The law looks not to subjective intent, but to objective manifestation of such consent by looking to words and conduct of agent and principal. d. If two parties manifest consent to the type of business or interpersonal relationship the law labels “agency,” then an agency relationship exists. The legal concept applies and the label attaches regardless of whether the parties had the legal concept in mind and regardless of whether the parties contemplated the consequences of having the label apply. i. Parties may expressly state their agreement does not constitute an agency (particularly in regards to franchise agreements) and courts may recognize such provisions; however, such clauses are not dispositive and will not be enforced if the parties actions are to the contrary. e. Agency is consensual, but not necessarily contractual; thus, an agency can exist even though the principal provides no consideration. i. Gorton v. Doty (1937)—D allowed the school football team to use her car in transporting the football team to a game, with a condition precedent that the football coach drive the car, but there was no consideration. P was in the car when it was in an accident and sued P on an agency theory. o HELD: The evidence sufficiently supported the finding that the relationship of principal and agent existed. P designated the driver,
making it a condition precedent to using the car; thus she consented that the coach should act for her and on her behalf in driving the car to and from the game. The coach consented to be an agent by driving the car. D’s request that the coach drive the car is the manifestation by the principal for the coach to act on her behalf by driving her car—because she volunteered the car Coach consented to be the agent by driving it. Coach is acting on her behalf in her wanting to do something nice for the team. o DISSENT: There is a total lack of evidence to support the allegation that D is the principal of the coach. More than “mere passive permission” is needed to create an agent. o How can you avoid Liability in this Case? Get automobile insurance that covers passengers. CONTROL: i. Consent and Control To create an agency, the reciprocal consents of principal and agent must include an understanding that the principal is in control of the relationship. The control need not be total or continuous and need not extend to the to the way the agent physically performs, but there must be some sense that the principal is in charge. ii. Control as a substitute for establishing agency status—When a creditor exercises extensive control over its debtor’s business, that control can establish an agency relationship. o A. Gay Jenson Farms Co. v. Cargill, Inc. (1981)—D was a creditor to Warren and the recipient of 90% of Warren’s grain (13 year long-term contractual relationship). D also exercised extensive control over Warren’s financial decisions and operations, and disbursement of funds. When Warren went bankrupt, 86 Ps, to whom Warren owed $2 million, sued D. ISSUE: Was there ACTUAL AUTHORITY between Cargill (principal) and Warren (agent)? HELD: D, by its control and influence over Warren, became a principal with liability for the transactions entered into by its agent, Warren. A creditor who assumes control of his debtor’s business may be liable as a principal for the acts of the debtor in connection with the business. This is determined by looking at the circumstances as a whole. By directing warren to implement its recommendations, Carill manifested its consent that Warren would be its agent. Warren acted on Cargill’s behalf in procuring grain for Cargill as part of its normal operations, which were totally financed by Cargill. Further, an agency relationship was established by Cargill’s interference with the internal affairs of Warren, which constituted de facto control. Rest. (sec.) Of Agency— • Safe Harbor Period—“A security holder who merely exercises a veto power over the business acts of his debtor of preventing purchases or sales above specified amounts does not thereby become principal.” Pt. before which the agency is created.
“However, if the creditor takes over management of the debtor’s business either in person or through an agent, and directs what contracts may or may not be made, he becomes a principal, liable as a principal for the obligation incurred thereafter in the normal course of business by the debtor who has now become his general agent. The point at which the creditor becomes a principal is that at which he assumes de facto control over the conduct of his debtor, whatever the terms of the formal contract with his debtor may be.” Danger in this Line of Reasoning: Bank loans to businesses—in Minn. Don’t renew the loan because if you go too far in trying to give advice, there might be an agency relationship. This situation is scary because there is no bright line test. What can one do to avoid such liability? Don’t get so involved. Create a partnership. What could the farmers have done? Want cash. Want payment before delivery of grain. Ask Cargill to write a check. This is the most extreme case you can find. o Lease Cost Avoider (LCA)—Should the responsible party be the person with the lowest cost of avoiding the loss? This is the question you should ask in each case in order to determine whether the outcome was the most economically efficient. o Going-Concern Value—Every business has some relationship with their customers and suppliers and bankruptcy dissolves this relationship. o Look at planning a problem on p. 13 (Make or Buy Question)— Note that Bankruptcy is the worst possible option—you want to avoid this! You could take over Warren (failing company) by increasing control or write the farmers to tell them that they were not liable for purchases made by Warren (problem because they have control). There is risk from either choice; in certain circumstances both could fail. iii. Control as an element of servant status—Whether the principal has a right to control the physical performance of the agent’s tasks determines whether the agent is a servant or non-servant. iv. Control has a consequence—As a consequence of agency status, the principal has the power to control the agent (even if the agent has not consented to give the principal limited control; however, the agent must manifest a recognition that serving the principal’s interest is the primary purpose of the relationship). g. Agency Contracts can change the rights and duties that exist between agent and principal, but they cannot abrogate the powers that agency status confers on each party to the relationship: i. Principal always has the power to control every detail of the agent’s performance. ii. Agent may have certain powers that bind the principal iii. Both principal and agent have the power to end the agency at any time.
5. SOLE PROPRIETOR SHIP a. Sole Proprietorship a business owned directly by one individual, called a sole proprietor, who has direct ownership of the assets used in the business. It is usually not thought of as an organization in the legal sense. b. Open Account (or trade account)—Personal obligation of sole proprietor (sp) to seller—regardless of how much SP owes, she personally owns any goods, even those that have not been sold to customers. c. Secured Creditor—One whose claim is secured by specific property, and who has first claim to the proceeds of the sale of such property. d. General Creditor—All other creditors. e. Nonrecourse loan—a way to avoid personal liability for business debts. The loan is secured by specific property and in the event of non-payment, the lender’s sole recourse would be to sell the property and apply it to the debt. i. A more convenient way to avoid personal liability may be to incorporate the business. f. In the event of bankruptcy no distinction is drawn between business and personal debts. g. The difference between the value of the business and the amount of the debt is her equity in the business. However, there may be a difference between the book value (more of a historical figure) and the market value. h. Leverage—the financial consequences of the use of debt and equity. The use of debt creates financial leverage for the equity. The greater the debt the greater the leverage. The greater the leverage the greater the potential gains and losses for the equity and the greater the risk of loss for the debt. i. Effects of leverage result from the fact that: o The debt holder (lender) has a fixed claim o The return on investment or business financed by the debt is uncertain o The equity holder (the borrower) has a residual claim (the right to whatever is left after the debt holder’s claim is satisfied) ii. If the rate of return on the total investment (before interest) turns out to be less than the rate of interest, leverage will work against the owner. iii. “Breakeven Point”—occurs where the return on total investment is the same rate as that paid on debt. There is no loss or gain from use of the borrowed funds. iv. Leverage creates risk and the greater the leverage, the greater the risk. o RULE: The degree of RISK will depend on the total value of the business as compared to the amount of debt. As the debt rises in relation to the value of the business, the risk to the general creditor rises. As the risk rises, the lender is likely to want increasing control or a higher interest rate (higher return). v. See p. 8 K&C for GREAT Example i. Employment agreements—Transaction Costs (COASE) are not always justified in negotiating individualized employment agreements because the default rules may be satisfactory. However, lawyers may be able to provide knowledge of the common law or statutory default rules and their view on its sufficiency or appropriate modifications necessary. i. There is a range of possibilities—Standard form to Taylor-made j. Divergent interests and mutual interest must come together in a business deal— Fairness and Integrity are very important. 6. Effects of Legal Right of Control over the Agent a. Generally, as duration of an employment contract increases, the importance of
control increases. b. There is an important relationship between incentives and power to control. For some employees, particularly those in higher-level management positions, incentives can be provided that tend to align the interests of an employee with those of the employer and to the extent that this happens the importance of control to the employer diminishes. c. Further, to the extent that specificity can be achieved, the importance of control diminishes. If it is difficult to specify the desired output or performance, or to observe or measure it, incentive compensation may not be feasible and control may be important. d. The extent to which the employer can find replacements affects control, incentives and specificity. e. Vicarious Liability 7. Organization within Firms and Across Markets—Can hire within a FIRM, meaning hire an employee or can hire across a MARKET, meaning hire an independent PERSON/COMPANY to work within your business. a. “Make or Buy Decision” Do we make something in house or do we buy something from an outside supplier? Every business deals with this decision. b. Ex. Car manufacturer— i. “In Firm”—build all part to a car and assemble the parts into the product ii. “Across Market”—buy all parts from outside suppliers, and company only assembles the final product. c. COASE—The Theory of the Firm—Why is everything in the world not owned by one giant company? If it is beneficial to vertically integrate your work, then why don’t that keep going? What determines where we stop? i. Answer—firms internally organize until it is cheaper to buy from outside than to produce internally. d. Relevant Variables in the Make or Buy Decision: risk, control, duration, incentives, availability of objective tests of success, opportunities for stealing and for cheating and shirking and other forms of self-dealing, and ability to predict the future. i. Cost/Benefit analysis of keeping an eye on monitoring costs of in firm v. across market 8. Owners and Managerial Employees a. Incentive-Based Compensation: i. The owner may want incentive based salary to increase the manager’s productivity ii. Likewise, the manager may want an incentive-based salary according to performance in order to receive greater compensation. iii. The Compensation package may consist of a salary (fixed claim) plus a bonus based on profits (residual claim). The presence of an element of incentive compensation like a bonus based on profit shifts some of the risk of the business to the manager. It aligns the manager’s objectives and interests with those of the owner, and thereby allows the owner to be less concerned with supervision, review and control. o The better you can align the incentives of the agent and the principal, the better business will be. iv. BUT as the manager rewards become increasingly tied to the business, he will become more concerned about control. v. The negotiations of these contracts, however, can be potentially antagonistic, and as a result, can be very costly. b. **“Hypothetical Bargain”**—To a considerable extent it will be necessary to leave
problems for resolution as they arise, relying on the proposition that by and large the outcomes prescribed by law (DEFAULT RULES), in the absence of explicit agreement, will be consistent with what the parties would have provided had they tried to anticipate and resolve all conceivable issues. i. Ex. Partnership voting—1 partner and 1 vote—Is this what your client would want (agree to) if they were to lay out the issue in the contract. ii. ESSAY ON EXAM—NO default rule and help client determine whether they would be happy with the default rule if it was needed. c. Employers may be reluctant to enter into long-term contracts with executives because 9. Irreducible divergences of interest: a. There is a divergency or conflict between the interests and goals of two employees. The resolution of that divergency or conflict can produce an interesting exercise in game theory or bargaining strategy. B. LIABILITY OF PRINCIPAL TO THIRD PARTIES IN CONTRACT 1. An agent’s power to bind the principal to third parties and to bind third parties to the principal is central to the agent’s ability to accomplish tasks on the principal’s behalf. Thus, principals and third parties are legally bound to contracts with each other as if the principal had directly acted—Attribution or Imputation a. Power the ability to produce a change in given legal relation (between principal and third parties) by doing or not doing a given act. b. Qui facit per alium facit per se 2. Agents have the power to bind a principal through any one (or more than one) of the following: (1) actual authority, (2) apparent authority, (3) inherent power , (4) estoppel, and (5) ratification. 3. Attribution or Imputation is transaction specific and time sensitive. With the exception of ratification, all attribution rules are applied exclusively as of the time that relevant transaction occurred. 4. AUTHORITY—A principal may be bound by the acts of an agent under any one of the following separate principles: b. Actual Authority Agent’s act was authorized. i. Two Kinds: o (1) Express and o (2) Implied Actual authority circumstantially proven which the principal actually intended the agent to possess and includes such powers as are practically necessary to carry out the duties actually delegated. This focuses upon the agent’s understanding of his authority—Whether the agent reasonably believes because of present or past conduct of the principal tat the principal wishes him to act in a certain way or to have certain authority. In most cases the principal does not think of, far less specifically direct, the series of acts necessary to accomplish his objects, and implied actual authority fills in the gaps. But express manifestations of the principal can negate implied authority. ii. Creation of actual authority involves: o An objective manifestation of the principal o Followed by the agent’s reasonable interpretation of that manifestation by the principal o Which leads the agent to believe that it is authorized to act for
14)—The elders of D hire Bill to paint the church building. what it is reasonable for him to infer that the principal desires him to do in the light of the principal’s manifestations and the facts as the agent knows or should know them at the time he acts. Silence can also indicate consent i. he is told that Petty is difficult to get in touch with. v. “Zone of Endeavor” iii. where the third party’s view is pivotal to the existence of such authority. Binding the Principal—If an agent acting with actual authority makes a contract on behalf of a principal. Bill hires Sam Hogan. o Special rules for contracts involving undisclosed principals— When the principal is undisclosed. Objective Standard of Reasonable Belief of the Agent The agent is authorized to do. The elders discuss using Petty to assist with the work. o This is the direct opposite of apparent authority. A manifestation that reaches the agent through intermediaries can still give rise to actual authority. In most circumstances. p. the principal may be breaching a contract with the agent. iv. who had helped him with church maintenance before. or • The agent fraudulently represents that the agent is not acting for the principal. Sam falls and is injured. vii. leaving him with the impression that he could hire whom ever. and the agent or undisclosed principal knows or should know that the third party would not have made the contract with the principal. but when Bill explains that he needs help to finish. but not who that other is Totally undisclosed—the third party does not know or have reason to know that the agent is acting as an agent. iv.the principal iii. Hogan (1990. Leading the agent to believe it is authorized to act for the principal ii. then the principal is bound to the contract as if the principal had directly entered into the contract. Mill Street Church of Christ v. vi. the third party is likewise bound. and to do only. But in this situation. Irrelevance of third party’s knowledge—An agent can have actual authority even though at the tie of the relevant occurrence the third party neither knows nor has reason to know the extent of the authority. The church claims 7 . Principal’s Control of Agent’s interpretation—A principal can always cut back or countermand previously granted authority simply by making a manifestation to the agent and seeing that the manifestation reaches the agent. the third party would not have entered into the contract knowing the principal was a party. the third party is sometimes entitled to: Insist on rendering performance to the Agent (especially when the contract involves personal services) Escape the contract entirely—Escape is possible if either: • The contract between the third party and the agent provides that it is inoperative if the agent is representing someone else. o The agent can have actual authority even though at the time of the binding act or omission the principal is Only partially disclosed—the third party knows or has reason to know that the agent is acting for another.
and the intermediary does not have to be an agent of the principal. c. o Authority by position within an organization based upon a 8 . the third party is not required to show it relied to its detriment on the appearance of authority. xiv. Sam believed Bill had the authority to hire him and to deny him coverage would have been unfair—This is apparent authority o TEST: What is REASONABLE for the Agent and/or Third Party to think that the principal wants him to do. However. Can also exist when no actual agency exists. UNLESS: The apparent agent is actually authorized to act for the principal. the statements of the apparent AGENT CANNOT give rise to apparent authority. accurately describes the extent of its authority. Apparent Authority if the principle engages in written or spoken conduct that leads a third party to reasonably to believe that the principal has allowed given the agent authority. and While actually authorized. For apparent authority to exist. o Authority By Position the position given to an agent may create apparent authority based upon business practices and local custom. this was never communicated to Bill. xii. and Bill was left with the reasonable impression to hire whomever Bill needed assistance to complete the job he was hired to do as an agent. Types of Manifestations: o A manifestation that reaches third party through intermediaries can still give rise to apparent authority. Reasons: In the past the church had allowed Bill to hire Sam or other persons whenever he needed assistance. not the right to bind. the third party must be able to point to at least some peppercorn of manifestation attributable to the apparent principal and this must form the basis of the third party’s reasonable belief that the apparent agent is actually authorized. Under the Restatement. However. The power to bind. o HELD: Bill Hogan had implied authority to hire Sam as his helper. This creates a contractual duty between the principal and the third party because the agent had apparent authority. many jurisdictions require detrimental reliance (agency by estoppel) xiii. x. Can co-exist with actual authority and can extend the actual agent’s power to bind the principal beyond the scope of the agent’s actual authority xi.there was neither express nor implied authority given to Bill to hire Sam. then apparent authority does not exist. viii. and o Which causes the third party to reasonably believe that the “apparent agent” is indeed authorized to act for the apparent principal. Reasonable person standard. Creation of apparent authority involves: o An objective manifestation from the “apparent principal” o Which somehow reaches a third party. if the third party knows that the agent has no authority to bind. ix. ii. o THUS. i. Even though the elders discussed hiring Petty.
even though the commission resulted in a higher salary that was received by his superior Kaufman. xvi. and It must be the apparent principal’s failure to contradict the assertions that causes the third party to reasonably believe that the apparent agent is authorized. o What could the Company Do to Avoid this Problem? Make it very well known what the policy is—put it in a handbook. which is determined by the same analysis as for actual authority given to an agent— Objective o Duty of inquiry on third party o Apparent agent’s conduct cannot affect this belief. Schenley Industries. o By inaction (silence)—Requires the following criteria to be met: Someone must assert that the apparent agent has actual authority (including the apparent agent) The apparent principal must be aware of those assertions and fail to do anything to contradict them The third party claimant must be aware of: (1) the assertions themselves. Third Party’s Interpretation—Reasonableness requirement o Mere belief is insufficient—must be reasonable. P got a letter stating that the company was working on an incentive-based plan. and shortly thereafter he was informed by Kaufman that he would get a title of district manage and later learns from Kaufman he would also get 1% commission on the sales of men under him. the court explains that there was no express authority because there was a statement in company policy that only the President to make salary and promotion decisions. xv. about compensation. An agent for an undisclosed principal can never have apparent authority xvii. (1960. The president of D told P to speak with the NY general manager. Kaufman. o Least Cost Avoidance Answer An Employer was in a better position to prevent this mistake than is an employee. Inc. After moving. There was sufficient evidence for a jry to find that D had given Kaufman apparent authority to offer P 1% commission of grass sales of the salemen under him and that P reasonably had relied upon Kaufman’s offer. and (3) the apparent principal’s failure to contradict the assertions. this is not at issue because P believed that Kaufman had authority.hierarchical structure and custom of certain titles. It is too time consuming the require employees to get confirmation from the top of the latter every time. talk about the 9 . o By acquiescing the agent’s conduct. ISSUE: Was there apparent authority? o HELD: D can be held accountable for Kaufman’s action on the basis of both inherent and apparent authority. Lind v. However. o What could Lind have done to avoid the problem? Get the person above Kaufman to confirm the promotion and salary increase. p.16)—P worked for D and was promoted to a new office. (2) the apparent principal’s knowledge of these assertions. P was never paid (4 years) and D claimed that Kaufman lacked the authority to offer P commission because only the president of the Co had this power.
o Note that this transaction involves two aspects. this contract is null an void. which confirmed the delivery dates for the memory units. . time. 10 . even if he is undisclosed. Does the company have the duty to disclose this custom to the customer. but the Kays’s superior at D sent an email to the office explaining that P was a new customer and that the Ks would go through Kays. . D never signed the document.” (Nogales) ii. b. who through Kays. Ampex Corp. expense. i. o Ampex could have had a statement on the contract be more clear.policy in a training session. p. but in violation of orders. xix. Ampex could have better employee training. (Second) of Agency § 8A (comment b) “Inherent Agency. Inherent Agency Power a general agent binds an undisclosed principal to contracts that are within the usual scope of authority of agents of the same type. . On November 17th. Kays had apparent authority to accept Joyce’s offer on behalf of D. the principal may become liable as a party to the transaction. that limitation will not bar a claim of apparent authority. and the Letter to Joyce confirmed the acceptance of the contract by D. signed a lease for 6 computer core memories. o HELD: In the light of the circumstances surrounding these negotiations. P subsequently signed a contract with EDS to lease the memories. Kays sent a letter to Joyce. . even where the agent had neither authority nor apparent authority. EXAM Questions: o What could the employer have done to protect itself against the problem in the case? o What could the employee have done to protect himself? o Cost Avoidance Question—who was in a better position to avoid the problem? Look to effort. REST. (Second) of Agency § 8A—“ Inherent Agency . Whether a sales rep. Rest. Maintain a policy that all arrangements must be in writing—no oral modifications of employment contracts.22)—P was solely owned by Joyce. There are three types of situations in which this type of power exists: o (1) General agent does something similar to what he is authorized to do. saying that without the signature of a contract manager. However. Three-Seventy Leasing Corporation v. (1976. is the power of an agent which is derived not from authority apparent authority or estoppel. Absent knowledge of such a limitation by third parties. etc. xviii. o P could have called and asked for confirmation. would have the authority to obligate the company on both agreements is a matter of industry custom. Here the power is based neither upon the consent of the principal nor upon his manifestations. his friend and a sales representative of D. o LEAST COST AVOIDANCE? We want people in Ampex’s position to do more to notify its customers of its acceptance procedures because it is less burdensome to the company to communicate than it is to put the burden on the customer to jump through hoops to get confirmation. but solely from the agency relationship exists for the protection of persons harmed by or dealing with a servant or other agent. In this case. They could better train their employees as to promotion procedures. On one hand there is the sale of the memories and on the other hand there is an extension of credit.
and as such D was bound to pay P because P was unaware of Humble’s lack of actual authority. which would be authorized if he were actuated by a proper motive. This is a catchall doctrine based on fairness. xiii. and are trusted and controlled by him.” o “But because agents are fiduciaries generally acting in the principal’s interests. xi.” iii. Then the act binds the principal regardless of whether the agent had actual authority and even if the principal had expressly forbidden the act. NOTE: Inherent agency with a disclosed principal is very similar to apparent agency. o HELD: Because of Humble’s position as manager. or o The agent is not acting in the principal’s interest. xii. and the fact that cigars would usually be supplied to such an establishment. P’s lack of knowledge at D’s ownership. Fenwick (1892. 11 . This is not really agency—Professor thinks it is wrong iv. it is fairer that the risk of loss caused by disobedience of agents should fall upon the principal rather than upon third persons. P sued to recover the price of cigars purchased. and o A true statement concerning the same subject would have been within the agents actual or apparent authority. o (2) Agent acts purely for his own purposes in entering into a transaction. the court found that D was liable to pay P. It holds the principal responsible for: o Certain unauthorized acts of an agent whom the principal has entrusted with ongoing responsibility. Inherent agency with an undisclosed principal is very different. the agent has caused mischief while acting counter to the principal’s wishes. In this situation. vii. but the third party is without blame. Watteau v. but Humble’s remained the manager and his name remained on the bar. D gave Humbe authority to order only bottled ales and mineral waters. D was the principal of Humble. o The agent is acting in the interests of the principal. and for o Certain false representations of an agent or apparent agent. vi. viii. o (3) Agent is authorized to dispose of goods and departs from the authorized method of disposal. v. P had no knowledge that Humble was not the owner or that D owned the beerhouse—D is an undisclosed principal. Rule for False Statements by an Agent—Agent’s false statements are attributable to the principal if: o The principal is disclosed or partially disclosed. Does NOT apply if either: o The third party knows the agent is acting without authority.A “general agent” is an agent authorized to conduct a series of transactions involving a continuity of service. x. ix. Enterprise Liability Places the loss on the enterprise that stands to benefit from the agency relationship. If the agent is a general agent—principal has authorized an agent to conduct a series of transactions involving a continuity of service—with actual authority to conduct transactions. p. and o The agent does an act usual or necessary with regard to the authorized transactions. and D was to purchase everything else needed.25)—Humble sold his beerhouse to D.
Inc. apply to partnerships.000 and (2) would give NSC a 1 cent per gallon discount on all diesel fuel. NSC defaulted on the note and ARCO foreclosed. and to the power of agents bind their principals. Edison.o The court also compares the agency situation to the law of partnerships. for partnership obligations. thus. ISSUE 2: There was no instruction to the jury as to inherent agency and there was no objection to that. to engage singers for musical recitals. o HELD: When an agent is selected. but did not give the fuel discount or make NSC competitive. which was unheard of in the circumstances. ARCO lent the money. therefore. gave no intimation to a singer dealing with him that D’s promise would be conditional upon so unusual a condition as that actually imposed. an unconditional engagement for a singing tour.28)—SKIPPED IN CLASS— D hired fuller as an agent to engage P to perform at recitals for the purpose of recording her voice and selling the recordings to dealers (new technology). xv. a marketing manager for ARCO told NSC that it must build a motel at its service station and that in exchange (1) it would lend NSC $100. This comparison is the opposite of what analysis normally occurs. they could not bring that issue up on appeal (not worried about the procedure) o HELD: The instructions given to the jury only covered actual authority. The mere fact that the purpose of the recitals was advertisement. xiv. Fuller was also told to execute a contract with P. ISSUE: Would it be normal for Tucker to not have this kind of authority. Tucker. Kidd v. they took the risk by dealing with the risky client. Partners are considered to be agents of the partnership. All partners are liable. Nogales Service Center v. and (3) make NSC competitive. Atlantic Richfield Company (1980. (1917. Inherent authority depends upon neither of these concepts since it may make the principal liable because of conduct. D is liable. the customary implication would seem to have been that his authority was without limitation of the kind here imposed. p. as principals. ARCO claims that Tucker was outside of his authority and that the statute of frauds barred any action on the alleged oral contract. as was the known custom. instead of entrance fees. p. Thomas A. The problems is that P understood. Thu. D planned to only have a recital when a dealer agreed to it. with the power to incur obligations on behalf of the partnership. o Professor has a problem with this because P is getting a windfall because they never knew they were dealing with D. a person who becomes a partner cannot escape liability for partner’s debts by concealing his or her membership in the partnership. Fuller was told to learn from the artists what fees they would expect and to tell them that D would pay the railway fairs. because a principal is responsible for the actions of his agent. and Fuller likely communicated.31)— NSC claims a breach of contract against ARCO. It is fairer to place the burden upon the agent’s principal than upon the third persons. 12 . which he did not desire or direct to persons who may or not have known of his existence or who did not rely upon anything which the principal said or did. as was Fuller. Since agency rules relating to undisclosed principals.
i. validating the original unauthorized act and production the same legal consequences as if the original act had been authorized. he can avoid the affect of the affirmance. Entitles the third party to the full benefit of the bargain and not just quantum meruit. The court also looks to the fact that while the agent was not acting with authority. Ordinarily. ii.” then the purported agent is not released from liability to the principal. and o At the time of the attempted ratification. or o Engaging in conduct that is justifiable only if the purported principal made such a choice This includes failing to repudiate the act. Whether or not ratification has occurred is a question of fact. 2 Necessary Requirements: i. Third party can avoid affirmance in two situations: o Changed circumstances that to materially hold the third party to the contract would be unfair o Conflicting arrangements: 13 . b. 2 Requirements: i. Rest—If at the time of the affirmance. Most courts treat the purported principal’s knowledge of the material information as a recondition to ratification. Affirmance—the act of ratification (occurs at the manifestation) o Making a manifestation that. EXCEPTION: IF the principal ratifies only to “cut his losses. viewed objectively. inherent agency will be applied when the agent was acting within the general scope of his business 5. e. but actions that indicate an affirmance. Ratification a. Preconditions: o The purported agent must have purported (expressly or impliedly) to act on behalf the purported agent in some transaction with a third party. Intent to Ratify ii. Full knowledge of material facts. the third party must not have indicated—either to the purported agent or to the purported principal —an intention to withdraw from the transaction. c. a purported principal’s affirmance binds not only the purported principal but also the third party. o The purported agent must have acted without either agency authority or agency power and estoppel must not apply o At the time of the act the purported principal must have existed and must have had capacity to originally authorize the act. Principal’s Ignorance: i. Ratification by implication No express affirmance. i. f. the purported principal is ignorant of material facts involved in the original transaction. and is unaware of his ignorance. indicates a choice to treat the unauthorized act as if it had been authorized. h. Includes accepting or retaining benefits while knowing that the benefits result from an unauthorized act g. ii. iii. In practice argue ratification in the alternative to authority d. Ratification releases the purported agent from any liability for having made an unauthorized contract. The principal’s ignorance ceased to be a factor if the third party has learned of and detrimentally relied on the principal’s affirmance. Ratification occurs when the principal affirms a previously unauthorized act. i.
RULE: Marital status cannot in and of itself prove the agency relationship. mary says that she will not sell for less than a certain price. Hoddeson v. Koos Bros. At no point does walter represent to P that he was an agent of his wife. If the original transaction was not purported to be done on account of the principal receives its proceeds does not make him a party to it. and D claims that the salesman must have been an imposter. and at no prior point in time had he acted as her agent. Imposes liability on a person for “a transaction purported to be done on his account . estoppel can apply even though the claimant can show no manifestation attributable to the asserted principal. i. and Makes substitute. Stefanovicz (1979. the court finds that where a proprietor of a place of business by his dereliction of duty enables one who is not his agent conspicuously to act as such and ostensibly to transact the proprietor’s business with a patron in the establishment. i. if: i. ii.36)—Mary and Walter acquired a farm as tenants in common. Estoppel (He thought this was too goofy to go over in class) a. p. conflicting arrangements or takes some other action ii. in such circumstances the law will not permit the proprietor 14 . She does not receive a receipt. P and her aunt are unable to identify the salesman who took the money. RULE: Status of jointly owning land does not make one the agent to the other. and the furniture is never delivered. Relies on the apparent lack of authority. Rest. as is essential to effective subsequent ratification. Botticello v. he did not take reasonable steps to notify them of the facts [that there was no authority]. And the facts do not support ratification. (a) he intentionally or carelessly caused such belief. which is to be delivered to her home at a later date. 6. Can arise from the asserted principal’s mere negligent failure to protect against misapprehension. Since Walter at no time purported to be acting on his wife’s behalf. In fact. ii.40)—P goes into a furniture store with her aunt.Third party learns that the purported agent acted without authority. constitute a delegation of power as an agent. Ratification. Adoption. (1957. the appearances being of such a character as to lead a person of ordinary prudence and circumspection to believe that the imposter was in truth the proprietor’s agent. ISSUE: Is an agreement for the sale of real property enforceable when the agreement has been executed by a person owning only an undivided half interest in property? i. HELD: There is no actual or apparent authority because there was no manifestation by the principal. however Mary never signs the contract and never agrees. HELD: This is an issue of Ratification by implication The fact that one spouse tends more to business matters than the other does not. . Unlike apparent authority. Walter then leases the farm to P with an option to sell. absent other evidence of agreement or authorization. Case law confuses this distinction c. (b) knowing of such belief and that others might change their position because of it. However. . b. and pays cash for a furniture set. and Novation j. or ii. to persons who have changed their positions because of their belief that the transaction was entered into by or for him. iii. p.
but not subject to the principal’s control over how the result is accomplished. 2 Forms: o Agent-type one who has agreed to act on behalf of another. otherwise. to determine the identity of D’s principal. A doctrine imposing strict. Independent Contractor a. but D claims he was acting as an agent of his sole proprietorship (Marketing Designs. the name printed on his business cards. 7. The duty rests upon the agent. Servant (Rest. HELD: Unless otherwise agreed (DEFAULT RULE). which was a dissolved entity at the time the debts incurred. To work on behalf of the master. o There is no hardship in this rule. p. It is not sufficient that the Ps had the means. Be subject to the master’s control or right to control the physical conduct of the servant. advertisements and checks. Respondeat Superior— a. it was D’s job to reveal it. LIABILITY OF PRINCIPAL TO THIRD PARTIES IN TORT 1. b. i. o Non-Agent-Type One who operates independently and simply 15 . C. ii. Curran (1992. The tortfeasor agent meets the criteria to be considered a “servant” of a principal. b. Atlantic Salmon A/S v. if he wants to avoid liability. RULE: It is the duty of the agent to disclose that he is acting in representative capacity and to provide the identify of his principal. and iii. iii. Applies to negligent and intentional torts 2. vicarious liability on a principal when: i. (MD)). Actual knowledge is the test. then the agents liability is released. to disclose his agency and not upon others to find it.43)—Ps seek to recover from D individually for unpaid contracts. Inc. o Partially Disclosed Principal DEFAULT Rule—A person purporting to make a contract with another on behalf of a partially disclosed principal is a party to the contract and is liable on the contract. An agent’s tort has caused physical injury to a person or property. Inc. Ps could have gotten a credit check to protect themselves. the agent is personally liable on a contract entered into by him on behalf of his principal. Agent’s liability on the Contract a. Servant v. o Fully Disclosed Principal Default Rule—If it is a fully disclosed principal. i. ii. a person purporting to make a contract with another for a partially disclosed principal is a party to the contract. It was not the plaintiff’s duty to seek out the identity of D’s principal. but thought he was operating on behalf of Boston Seafood Exchange. The tortuous conduct occurred within the servant’s “scope of employment. Also.defensively to avail himself of the impostor’s lack of authority and thus escape liability for the consequential loss thereby sustained by the customer. Ps were never told about MD. Independent Contractor A nonservant who provides services or undertakes tasks for others. through a search of Boston’s city clerk records. of Agency §§ 1 and 2) Master/Servant Relationship Exists where the servant has agreed: i. NOTE: One of the reasons to be incorporated is so that your personal assets don’t get snagged. This falls under a theory of agency by estoppel.” b. and ii.
enters into arm’s length transactions with others. 1) Firm—sell gas and oil through stations owned and operated through company employees ii. The car rolls off the property and hits the Martins in the back. Whether or not the work is part of the regular business of the employer ix. Whether or not the one employed is engaged in a distinct occupation or business iii. by the agreement. Organization Across Markets i. The skill required in the particular occupation v. Humble Oil and Refining Co. When personal injury to third parties results from the negligence of station personnel. as it did also the principal products there sold by Schneider under the so-called “Commission Agency Agreement” between him and Humble which was in evidence. Whether or not the parties believe they are creating the relation of master and servant x. The extent of control which. Point of next cases—There are a number of ways for a business to organize a business in order to sell its products. Companies make these decisions in the way that they believe is the most efficient and the most profitable. c. v. Major Issue: Oil companies often deal with Organization within the Firm v. Basically. the work is usually done under the direction of the employer or by a specialist without supervision iv. v. HELD: Humble is responsible for the operation of the station. nor the station employees considered Humble as an employer/master. tools.48)—Ms. The length of time for which the person is employed vii. 10 Factor Test: i. the court must determine whether the operator of the station was an employee (servant) or independent operator (independent contractor). FIXING THE PROBLEM TO TURN OUT LIKE SUN: One way to make this case turn out like SUN is to not require reports to the headquarters. Love drops her car off at a service station owned by Humble. Whether the principal is or is not in business d. i. the master may exercise over the details of work ii. Schneider. that the employees were paid and directed by Schneider individually as there boss and that a provision of the agreement expressly repudiates any authority of Humble over the employees. but 16 . the agreement required Schneider to do anything Humble might tell him to do. iii. with reference to whether. The method of payment. since there is other evidence bearing on the right or power of Humble to control the details of the station work as regards Schneider himself and the employees he would hire. 2) Markets—Sell gas and oil through independently owned stations. are not conclusive against the master-servant relationship. which admittedly it owned. whether by the time or by the job viii. Martin (1949. Whether the employer or the workman supplies the instrumentalities. Rest. The kind of occupation. iv. ii. and the place of work for the person doing the work vi. but run by Schneider. ISSUE: At what point will you allow the accident victim to sue the main business entity supplying goods to a store? Does the putative principal have enough control over the putative agent so that the putative principal should be liable for the putative agent’s tortuous actions? e. p. in the locality. Humble asserts that the service station was an independent contractor. The facts that neither Humble.
The station sold mostly Sun products and maintained mostly Sun equipment. Basically. but franchise contracts do not really fit normal agency law—the franchisee does act on behalf of the franchisee to some extent. or discipline and supervise employees. f. and optimum public good will. The relationship depends upon what is. Another way is to change the termination requirements Humble is the only one who may terminate at will. There close areas of contract only arose out of their mutual interest in the sale of Sun products and the success of Barone’s business. However. Each alone is fine. D was given no power to control daily maintenance o the premises and no power to control business expenses or demand a share of profits. p. and attend basic training. considered as a whole.instead may it less formal and more friendly by sending an agent to offer “suggestions” and to get information informally from the branch/store.53)—P was slipped and fell on a puddle of water at the Betsy-Len’s hotel. establishes an agency relationship. HELD: Barone was an independent contractor. i. ii. D was empowered to regulate the architectural style of the buildings and the type and style of furnishings and equipment. The service station. Policy Questions: i. iv. The lease is only that between landlord tenant and independent contractors because Sun had no control over the details of Barone’s day to day operations. all for the benefit of both contracting parties. TEST: Control over day-to-day operations of business. so provide this in the contract! Because going to court to determine who pays in INEFFICIENT! 17 . the Franchisor makes only $450 per Month for 100 rooms at a location. throughSu’s national and local advertising that it has Sun-quality service and products. the parties cannot effectively disclaim it by formal consent in a contract. NEED premises liability insurance. (1975. Sun Oil Company (1965. unlike retail outlets. but not to any great extent. Barone had extensive contact with Sun.500 a month in gross revenue. is a one-company outlet and represents to the public. ii. RULE: When an agreement. owned by Sun. Barone determined his own hours of operation and had the option of other products. but in SUN. i. HELD: The License agreement contains the principal features of a franchise contract with regulatory provisions that gave D no control or right to control the methods or details of doing the work. Murphy v. The name of the station also had Barone’s name. trademarks.50)—P is injured as a result of his car catching on fire while at Barone’s service station. The purpose of the provisions was to achieve system-wide standardization of business identity. Sun did not have control over the daily operations of Sun’s business. etc. Therefore. while the franchisor makes $30. operating under a franchise agreement with D. Holiday Inns. BELT AND SUSPENDERS—Don’t just depend on the law being in your favor. p. no principalagent or master-servant relationship was created. Hoover v. uniformity of commercial service. He was also had no reporting requirement to Sun. the termination right was mutual. Franchisor sells the brand name and quality control. Inc. The regulatory provisions did not give D control over day-to-day operations of Betsy-Len’s iii. g. and he had attended the Sun school. Why not just make the agent get an insurance policy that would indemnify the principal if sued for actions? h. Betsy-Len’s was also permitted to use the trade name. but you really need them both to protect yourself. also form a contract in your favor to cover yourself. However. i.
Scope of Employment 18 . 4. A jury could also find that the plaintiff believed that all McDonald’s restaurants were the same because she believed that one entity owned and operated all of them.—“One who represents that another is his servant or other agent and thereby causes a third person to justifiably rely upon the care or skill of such apparent agent is subject to liability to the third person for harm caused by the lack of care or skill of the one appearing to be a servant or other agent if he were such. the franchise agreement goes beyond the stage of setting standards. The third party suffers physical harm as a result b. Miller v. The person makes a misstatement of fact concerning the subject. §267 “One who represents that another is his servant or other agent and thereby causes a third person justifiably to rely upon the care or skill of such apparent agent is still subject to liability to the third person for harm caused by the lack of care or skill of the one appearing to be a servant or other agent as if he were such. and using only McDonald’s food. 3. and allocates to the franchisor the right to exercise control over the daily operations of the franchise. ii. i. exercised sufficient control that the standards she experienced at one would be the same as she experienced at the others. Look at problem on p. Tort Liability and Apparent Agency a. HELD: Summary judgment reversed because a jury could find that McDonald’s retained sufficient control over the franchise daily operations as to create an agency relationship.” iii. (1997. in practical effect. keeping certain booking records. and service policies and standards. “If. p. o Issues in regards to Franchisor/Franchisee: (1) Whether the putative principal held the third party out as an agent and (2) whether the plaintiff relied on that holding out. cooking methods.” This means that McDonalds has to hold out (do something to indicate) that the franchise restaurant is his agent. Trial Court granted Summary judgment for McDonalds because they did not own or operate the restaurant. McDonald’s Corp. wearing uniforms. How much freedom does the franchisee have to run the business? Quite a bit because it is an extreme remedy to revoke a franchise and it is difficult to develop a financial penalty that is equivalent to their violation. business practices. Failure to comply could result in termination of the franchise. iii. The licensing agreement signed with the franchise owner required that the location be operated in a manner consistent with the McDonald’s system—this included use of trade and service marks. The Apparent principal is liable to a third party if: i. d. or at least. an agency relationship exists. Rest. when she bits into a sapphire while eating a Big Mac at a franchise restaurant. A third party relies on that misstatement. o The centrally imposed uniformity is the fundamental basis for the court’s conclusion that there was an issue of fact whether the franchisors held the franchisee out as the franchisor’s agent. menus and paper items. no matter how many precautions you take. but expensive to draft. you can’t guarantee that a court will not find that there is an agency relationship.v. o A provision for arbitration could be helpful. and iv.” c.58)—P sues McDonalds Corp. Rest. 62—Like Best Westerns—Note. A person has actual or apparent authority to make statements concerning a particular subject ii.
Commuting—not normally SOE ii. The previous relations between master and servant iv. ii. The time. Whether or not the master has reason to expect that such an act will be done vii. Whether or not the act is one commonly done by such servants. v. however. e. c. has not been entrusted to any servant vi. One of the Coast Guards sailors. tortuous. the Court finds that the motive/incentive test is inadequate. It is actuated. Lane was not so unforeseeable as to make it unfair to charge the government with 19 . “Special errand exception and necessary travel —SOE iii. If force is intentionally used by the servant against another.S. i. (1968. at least in part. Rest. the use of force is not unexpected by the master. It is of the kind he is employed to perform ii. The extent departure from the normal method of accomplishing an authorized result. Traveling i. Master’s control over servant does not influence the SOE f. The Court admits that this scope has been expanded. and x. this court does not do this. turns the valves and floods and injures the dry-dock. etc? ii. Ultimately. U. which may fairly be said to be characteristic of its activities. Lane. place. “It is not at all clear that expansion of liability in the manner here suggested will lead to a more efficient allocation of resources.a. and purpose of the act iii. “Frolic and Detour”—not SOE g. Bushey & Sons. or constitutes a minor crime. if within the enterprise. Whether or not the instrumentality by which harm is done has been furnished by master to servant ix. coast guard Vessel was stored in a dry-dock owned by P. but only if it is actuated. Basically. and iv. It occurs substantially within the authorized time and space limits iii. §228 says that conduct of a servant is within the scope of employment if. Whether or not the act is seriously criminal d. Inc. at least in part.—A servants conduct is within the scope of his employment if: i. There is a deeply rooted sentiment that a business enterprise cannot justly disclaim responsibility for accidents. conduct must be of the same general nature as that actually authorized or incidental to the conduct authorized. by a purpose to serve the master. p. Factors to Consider: i.S. Can be within the SOE even if it was expressly forbidden by the principal. b. HELD for Foreseeability: BUT. A more efficient allocation can only be expected if there is some reason to believe that imposing a particular cost of the enterprise will lead it to consider whether steps should be taken to prevent a recurrence of the accident—Accident Avoidance (costs)—how do you avoid such accidents? What can you expect the future to look like depending upon whom you put the responsibility—Government or Dry-Dock owner? Can gov’t prevent drunken sailors asking questions or can the drydock owner get insurance. Rest. Ira S. by a purpose to serve the master. The similarity in quality of the act done with the act authorized viii. The extent to which the business of the master is apportioned between different servants v. RATIONALE against Using Motive Test of Employee: Rest. comes back drunk one night. Whether or not the act is outside the enterprise of the master or.62)—A U.
and (5) payroll taxes. b. an the employee Smith. acts out in a violent manner. The employer should be held to expect risks. Grimsley (1981. Moreover. summary judgment should not be granted. the jury could reasonably have found that Grimsley’s assault was not a mere retaliation for past annoyance. but a reasponse to continuing conduct. ISSUE: Can P sue the Orioles for damages as an agent? i. RULE: Where a plaintiff seeks to recover damages from an employer for injuries resulting from an employee’s assault what must be shown is that the employee’s assault was in response to the plaintiff’s conduct which was presently interfering with the employee’s ability to perform his duties. 6. The principal owed a duty to the injured party to have the agent’s task 20 . Servant concepts also influence the reach of statutes in: (1) Discrimination in employment. They sue under §1981 makes it a violation of law to disallow someone to make contracts. o NOTE: Many courts have rejected the foreseeability argument and kept the intent o the agent’s actions. p.68)—D plays for the Baltimore Orioles and throws a baseball at a heckling fan. ii. Liability for Torts of Independent Contractors a. According to some authorities. Here it was foreseeable that crew members crossing the dry-dock might do damage. Statutory Claims a. Thus. h. (3) worker’s compensation. (2) unemployment compensation. Manning v. 2000)—Ps are a group of African American and Hispanic customers of Conoco who were subjected to racial discrimination while purchasing gasoline and other services. HELD for Scope of Employment: The court rejects the presumption that because Smith behaved in an unacceptable manner that she was obviously outside the scope of her employment. Inc. (71. HELD: A jury could reasonably have found that such conduct had either the affirmative purpose to rattle or the effect of rattling the employee so that he could not perform his duties successfully. there is a company owned store. Conoco. 5. In one incident. (4) social security. Arguello v. which was presently interfering with his ability to pitch in the game if called upon to play. Smith’s position as a clerk and her authorization from Conoco to conduct sales allowed her to interact with Ps and put her in the position to commit the racially discriminatory acts. o RULE: In order to impose liability on a defendant under §1981 for the discriminatory actions of a third party. The principal intended or authorized the result or the manner of performance. or ii. negligently or intentionally. the principal is not liable for an independent contractor’s intentional torts. to the public also.responsibility. which arise out of and I the course of his employment of labor. All three instances occurred at stores that Conoco claimed were independent stores in Texas. the plaintiff must demonstrate that there is an agency relationship between the defendant and the third party. ii. i. HELD for Agency relationship between Conoco and Conoco Branded Stores: Court finds no agency relationship therefore they cannot be liable for damages to Ps. What is reasonably foreseeable in this context is quite a different thing from the foreseeably unreasonable risk of harm that spells negligence. UNLESS i.
then he is accountable for it to his master because the servant has unjustly enriched himself by virtue of his position (this is true even in the absence of a fiduciary relationship or actions within the scope of employment). however these are not essential causes of action. HELD: On exception to the general rule is that liability may be imposed on the landowner who engages an independent contractor to do work which he should recognize as necessarily requiring the creation during its progress of a condition involving a peculiar risk of harm to others. and that is sufficient to make him liable to hand it over to the crown.performed with care. iii. Professor thinks this is a good decision. i. He was violating his duty in doing so and the military took possession of the Money. p. escorted these lorries through Cairo. p. Meaning the assets he controls and his position plays the predominant part in his ability to obtain the money. while others assert that the principal ratified the wrongful act by not terminating the independent contractor c. D. (1959. However. Duty of LoyaltyAn employee is an agent of the principal. Becaue the current NY statute is that the razing of buildings in a busy. Inc. ii. Toti Contracting Co. a fiduciary relationship and P was not acting in the course of his employment. and while in uniform. The uniform of the Crown and the position of the plaintiff as a servant of the Crown were the only reasons why he was able to get this money. HELD: There was not. b. Under this fiduciary duty to the Principal. iii. D does not use proper procedures for demolishing the buildings. unless special precautions are taken. if the contractor is negligent in failing to take those precautions. and part of the demolished building falls on Ps’ building. and he got it because he was a sergeant in the British army. Duties During Agency a. v. i. The agent is also bound to act for 21 .75)—Ps own a building and the city hires D to tear down some buildings to build a parking deck. built up section of a city is inherently dangerous. or (c) where the activity contracted for constitutes nuisance per se. RULE: If a servant takes advantage of his services and violates his duty of honesty and good faith to make a profit for his services and violates his duty of honesty and good faith to make a profit for himself. Reading v. ii. FIDUCIARY OBLIGATION OF AGENTS: Duty of Loyalty and Duty of Care 1. Some cases that impose liability rest on a finding of control. EXCEPTIONS: (a) where the landowner retains control of the manner and means of doing the work which is the subject of the contract. he is not liable for the negligent acts of the contractor in the performance of the contract. in this case. Majestic Realty Associates. Such work may be said to be inherently dangerous. Regem (1948. to do work not in itself a nuisance. Therefore. b. GENERAL RULE: Ordinarily where a person engages a contractor who conducts an independent business by means of his own employees.80) (Professor Doesn’t Think this case is important—Didn’t go over)— D accompanied a lorry from one part of Cairo to another. It matters not that the master has not lost any profit or suffered any damage. the agent is bound to exercise the utmost good faith and loyalty so that the agent did not act adversely to the interests of the principal by securing or acquiring any private interests of his own. and as such owes a fiduciary duty to the principal. nor does it matter that the master could not have done the act himself. it fits the exception and makes the city liable. (b) where he engages an incompetent contractor. iv.
Singer (1963. principal may recover based on a theory of negligence or 22 . iv. Therefore. iii. In this case. he did not inform P of the customer’s orders and instead did the work and kept the profits. o HELD: As general manager. Negligent injury to Employer o Principal is entitled to recover from the agent because of the agent’s carelessness. Incompetent business decision o If the agent causes extreme loss by exercise of extremely bad judgment in the operation of the business. c.the furtherance and advancement of P’s interest. o If the injured third person sues the principal. o Disgorgement (REMEDY) DEFAULT RULE for Agent’s Breach of Fiduciary Duty of Loyalty If one’s fiduciary duty of loyalty to an employer is breached. by obtaining orders from a customer for his own account. o Insurance will not be available in this case because it is difficult to write policies about this rule. unless the agent made a reasonable decision that simply turned out badly. he must pay P the profits earned from his sideline business. Inaccurate information o Agent has a duty to supply principal with accurate information. If by virtue of agent’s carelessness this information is seriously inaccurate. Negligent injury to third person o Respondeat Superior—The principal is responsible for the agent’s actions—DEFAULT RULE –it is what most people would do o If the injured third person only sues the agent. the agent may be liable for his own dereliction. the agent must account to the principal for the profits made as a result of the breach. o This makes it difficult for the state to develop a good default rule. disclosure of the situation would have prevented the problem. p. the principal is entitled to reimbursement from the agent. agent may not be reimbursed by the principal. D gets a windfall because it was work that they could not have done in the first place. o Insurance can take care of the problem ii. o Disclosure (SOLUTION) In most situations where there is a breach of loyalty. however. which he owed to P and his fiduciary duty of general manager thereof during the existence of such employment by engaging in business activities directly competitive with P. i. Disgorgement is a harsh arrangement in order to deter breaching a duty of Loyalty. D claims P incapable of doing the work requested by these customers. D was P’s agent and owed a fiduciary duty to P. v.83)—P employed D as a skilled mechinist-consultant and manufacturer’s representative to be the general manager. Duty of Care Duty of Care required is basically a reasonable person standard. ISSUE: Whether D breached his contract of employment with P and violated the duty of loyalty. General Automotive Manufacturing Co. i. o Insurance can take care of the problem. D violated the fiduciary duty he owed to P by failing to disclose all the facts related to the other orders.
but leaves open the possibility that agent will be liable for what the principal regards as an outrageously stupid or careless action. leading to the adoption of conservative. o There is a trade-off between the agent’s over-reaction. then quit and formed own. the agreement may not be enforceable. It too P several years to gather their client list. personal and confidential. v. Self insurance by employer (damage to employer) o Self-insurer as to injuries arising from the business o May execute an Indemnity Agreement under which principal agrees to indemnify the agent for liabilities that he may occur. identical business. 2. and covering potential acts of grossly-careless behavior. Inc. CONTRACTS regarding such duties i. iv. Insurance for negligent injury to third persons o Insurance policy is likely to be taken out by the principal. ii. It would be different if these customers had been equally available to P and D. Town & Country House & Home Service. self-productive strategies that will educe the returns from the business. o It is likely that the agent will insist that principal by protection for him. Waiver of liability for Negligent injury to Employer o If principal wants to be a self-insurer. P brought an action to enjoin D from engaging in the same business at P and from soliciting its customers on a theory of unfair competition.87)—P owns a home cleaning company using mass production methods. P claims that because its business is “unique. Waiver of Liability for incompetent Business decisions o Suppose the principal agrees to relieve agent of liability for even seriously defective business decisions. however. HELD the Customer Lists are protectable and using them breaches the duty of loyalty: Although appellants did not solicit P’s cusomters until they were out of P’s employ.” D cannot engage in the business without breach of the confidential relationship in which they learned trade secrets and customer lists.” so this type of agreement is difficult to word. nevertheless P’s customers were the only ones they did solicit. o Paul Newman Story—Private Investigator & Rent Harper o When asking should the law enforce this agreement. then you should ask the question: What is the harm of enforcement? iii. o d. but these customers had been screened by P 23 . o Self-Dealing (a violation of the duty of loyalty) actions may lead the agent to provide inaccurate information. o Professor doesn’t see why this would not be enforceable. p. o If this happens there may be a backlash of the agent’s behavior. D worked for P for three years. Duties During and After Termination of Agency: Herein of “Grabbing and Leaving” a. or will insist on added compensation so that he can buy his own policy. costly. o This is the idea of respondeat superior (default rule)—if most people thought about this idea they would agree that the principal is in the better position to compensate through insurance. ii.lack of due care. Newbery (1958. i. principal may not want to insure “gross-negligence. ISSUE: Do you have a duty to not misappropriate trade secrets after you leave an employment. contacting same customers.
000 probability of being the winning ticket. the residual claim in any enterprise will have a higher expected rate of return than a fixed claim in the same enterprise. SPECULATION ON RELATIONSHIPS AMONG RISK. DURATION.560. . i. e. most businesses will make decisions as if they are risk neutral. “Control follows risk” b. They will only accept risk if they are paid to do so. Ex. o Economic Trade-Offs prevent promotion of competition iv. Attitudes towards Risk: i. E. AND SPECIFICITY 1. CONTROL.000. Risk Averse b. expected rate of return or required payment will rise.000 x $1. the party with the claim is impaired by such competition. or a business.000.000 v. people are willing to pay to achieve their desired safety and security. Whoever bears the risk calls the shots. 2. EV= 1. d. Payoff ii.000 c. i. Because people don’t like risk they buy insurance. RETURN. f. The payoff of wining the ticket will be $1. o Must take actions to maintain secrecy. i. however. iii. . is 10%. As a result.000. RULE for Trade Secrets: Even where a solicitor of business does not operate fraudulently under the banner of his former employer. If looking at businesses larger than those that are an extension of a person.25 0 0 iii. Expected Value (EV) of Any ticket = 1/1.000 1.000 iv. Probabilities must always add up to 1. Maximum Amount a person would pay for a ticket: o > $1—Risk Preferring (gambler)—will pay more than the expected value o $1—Risk Neutral—will pay expected value o < $1—Risk Aversion—not willing to pay the expected value. If the expected rate of return on a first mortgage investment in a piece of property. 24 .60 100. Lottery Example: Each lottery ticket has a 1/1.500. As risk rises.15 10. he still may not solicit the latter’s customers who are not openly engaged in business in advertised locations or whose availability as patrons cannot be readily ascertained but whose trade an patronage have been secured by hears of business effort and advertising and the expenditure of time and money. constituting part of the good will of a business which enterprise and foresight have build up.000 = $1 ii. Risk Preferring ii. without which their receptivity and willingness to do business with this kind of a service organization could not be known.000. NOTE: Unfair Competition claims are business torts Difficult because all benefit from competition (cheaper prices. better quality).000. Most people are risk averse in their major economic decisions—risk aversion.000 60. Prob. c. Risk Neutral iii. RISK AND RETURN a. the expected rate of return on the underlying equity in that enterprise will be several points higher. RISK AND CONTROL a. Thus.at considerable effort and expense. .000.
however. b. c. or some combination. d. DISTINGUISHING AGENCY FROM OTHER RELATIONSHIPS II. a. 4. Uniform Partnership Act (1914)—1/2 States 4. A creature of contract and of statute. F. or the fixed claim. such as efforts. RISK AND CONTROL—OWNERS AND EMPLOYEES Control Is associated with risk. Partnerships A. such a contract may make the employee’s fortunes dependent to some significant degree on the success or failure of the firm. though other risks may decrease. What is a Partnership and Who are Partners? 1. DURATION AND RISK a. Each of whom co-owns the business 25 . An unincorporated business. ideas. UPA § 9—Partnership—An association of two or more persons to carry on as coowners a business for profit. at some point the process must end. intended to make a profit. property. certain risks associated with that investment or relationship may increase. c. money. The rules established by common law and statute (DEFAULT RULES). Constraints on specificity may require generalized participation in control of the enterprise. Partnership: a. b. § 18 of UPA key language is “subject to any agreement between them” 6. at the same time. which can be by word or conduct 3. Each of whom brings something to the party. 3. which is in turn associated with ownership and ownership alone. as the employees skills become specific to the firm or as other barriers to relocation evolve. 6. Revised Uniform Partnership Act (1997)—1/2 States 5. A partnership arises when two or more persons manifest an intention. who may be either individuals or entities. Must consider value of transaction with the costs of negotiation of tailor-made provisions. b. 7. The holders of the equity (or residual) claim in a firm are more likely to be interested in and have control of the firm than are the holders of debt. DURATION AND SPECIFICITY a. e. Determining who is a partner is important because the rule of partnership law makes each partner potentially liable for all of the debts of the partnership. DURATION AND CONTROL a. may seem adequate. In a short-term relationship there may be relatively little need for elaborate rules specifying rights and obligations and the cost of supplying such rules may seem high in relation to their expected value. Long-term employment contract may reduce the employee’s risk of unemployment. c. COASE (above) 5. As the duration of an investment or relationship increases. b. There may be reasons to expect specificity (private rule elaboration) to increase with duration of employment. As duration of the relationship increases. the likelihood of changes in circumstances seriously affecting the relationship increases and the need for spelling out the consequences of those changes in circumstances may increase. 2. Which has two or more participants.d. though perhaps simple and basic. Equity investors will want to have the power to select the managers and to make certain fundamental decisions.
even if the amount of payment varies with eh profits of the business. P retained full control of the operations. Right to share in profits i. Each of whom has a right to co-manage the business. all obligation of loss. if warranted. etc. PARTNERS COMPARED WITH EMPLOYEES a. Community of power in administration f. UPA. Additionally. Will most likely take over partnerships eventually. Intent of the Parties b. . Rights of the parties on dissolution and appearance. . However.e. The agreement called their relationship a partnership and allowed her to receive 20% profit. Conduct of the parties toward third persons h. HELD: Under all these circumstances. a partnership has 26 . subject to any agreement between them. proceeds. § 18 “The rights and duties of the partners in relation to the partnership shall be determined. or rights to income. Not necessary to have actual profits ii. (e) All partners have equal rights in the management and conduct of the partnership business. § 31 “Dissolution is caused: (1) Without violation of the agreement between partners. the parties intent was only a pay increase. Limited Liability Companies are taking over as the primary form of small business organization. . but he following rules: . p. Language of the agreement g. courts have borrowed partnership laws in order to set the boundaries for LLCs. Element Considered when determining the existence of a partnership a.” e.” i. with a salary of $15 per week. . or designee of a deceased or retired person o Of interest or other charge on the loan. However. Each of whom shares in the profits of the business. and f. Chesire wanted a salary increase. giving due effect to the written agreement and bearing in mind that the burden of establishing a partnership is upon the one who alleges it to exist. unless the profits were received in payment: o Of a debt by installments or otherwise o For services as an independent contractor or of wages or other compensation of an employee o Of rent o Of an annuity or other retirement or health benefit to a beneficiary. Uniform Partnership Act. They instead treat it as a consequence of partnership d. Difference in profit sharing and revenue sharing iii. representative. c. or increase in value derived from the collateral. 8. (b) By the express will of any partner when no definite term or particular undertaking is specified. RUPA § 220(c)(3) A person who receives a share of the profits of a business is presumed to be a partner in the business. i. including a direct or indirect present of future ownership of the collateral. Ownership and control of the partnership property and business i. While this increases the co-management and co-ownership aspects of the relationship. or o For the sale of the goodwill of a business or other property by installments or otherwise. 9. Unemployment Compensation Commission (1945. and P offered to sign an agreement that he would pay her more money if the income of the shop warranted it. neither the UPA nor the RUPA mentions loss sharing as a prerequisite. Obligation to share in losses i. i.91)—P operated a beauty shop and employed Chesire as a cashier and receptionist. Fenwick v. .
but the return is only $500. she was not subject to losses. ISSUE: Are they coowners in the business for profit? i. Bad investment because investment costs $1 million. Government Sponsored Entities (GSEs)—Freddie Mac and Fannie may—Hold worthless mortgages ($5 trillion dollars) because they gave loans to people who couldn’t afford them. and that degree has not been reached. PARTNERS COMPARED WITH LENDERS a. note 2 i.000 to KN&K in liquid securities to use for collateral. Ds loaned $2.000. iv. as well as an option to join the firm. ii.000 iv. Martin v. o $1. ii. Basically. provided the trustees cannot initiate actions.000).000 or less than $100. NOTE: Hall was not their agent because they had no right to control Hall. by adding together a bunch of minor issues you get something important. p. but not determinative. c.96)—Important to Professor b/c Classic Case-Professor draws significant comparisons between Cargill and Marin —Hall. iii. no partnership existed. She had no authority or control in operating the business. 10.not been established because the essential element of co-ownership is lacking. Fannie may and Freddie mac were taking these long shot bets (as the one above) because the money was coming from the public. prohibiting loans to members (no “draws) are nothing but proper security for a loan when the firm may dissolve at any time. 27 . Indenture A mortgage of the collateral delivered by the debtor to the trustees to secure the performance of the agreement. ii. and she was not held out as a partner. In exchange. It is quite true that even if one or two or three like provisions contained in such a contract do not require this conclusion. Ds. MORAL: High Return. HELD: Looking at the three agreements as a whole. o Advising. made a trustee/lender agreement with friends. The question of degree is often the determining factor. $20 million in debt with only $12 million in assets. Offer to invest $1 million in order to have a 1/40 chance in getting $20 million in return. b. Expected value example on p. the court does not look at conduct of parties. EV = 1/40 x 20M/1m = $500. This case is almost the opposite of the Cargill case. yet it is also true that when taken together a point may come where stipulations immaterial separately cover so wide a field that we should hold a partnership to exist.500. Whereas in Cargill there was actual control. High Risk v. Peyton (1927. a partner in KN&K.000. The agreement between these parties was nothing more than one to provide a method of compensation for work performed. Because P only accuses Ds of an actual partnership. KN&K gave Ds KN&K securities (that were too speculative to give as collateral to banks) and 40% of the profits of the firm until the loan was paid off (not to exceed $500. and maintaining power to veto highly speculative or injurious business is a proper precaution to secure a loan. inspecting. o Assignment of interest in firm. iii.000 life insurance policy on Hall’s life belongs to the Trustees —this does not create a partnership and is not imply an unusual association because trustees knew only Hall and new firm had almost gone into bankruptcy due to unsafe speculation. 100. o Option is somewhat unusual.
calling themselves “sponsors and partners.101)—P’s predecessor in interest (SEM) and D entered into an Agreement in 1974. the requisite mutual intent to convert intangible intellectual properties into partnership assets may well depend much more importantly upon a clear contractual expression of mutual intention to form a partnership. RULE: Joint adventurers. Southex Exhibitions. B. D signs a 20 year lease with Gerry. P should receive damages as well as the right to the trade show. p. Rhode Island Builders Association. HELD: A partnership was not created because one must look at the totality of the circumstances. The Fiduciary Obligations of Partners 1. Then SEM took control. partnership never given a name. ii. but it helps!—This tips the scale in this case) o P did not conduct itself as belonging to a partnership—conducted business in own name. o Even though the UPA explicitly identifies profit sharing as a particularly probative indicium of partnership formation. Inc. Salmon (1928. for the Bristol Hotel property and independently agrees with P to obtain the necessary funds. This duty can be divided into 2 Categories: a. Issues relating to differences of interests between or among partners—less strict and less clear rules 2. but does not inform P of the offer or of the agreement. D accepts the offer on his own behalf. and never filed a partnership tax return o No ownership interest in tangible property “In the present circumstances (involving intangible intellectual property).” However. inc. In return. D will not use any other company. i. SEM’s President also expressed that he did not want ownership of the show. Gerry offers an 80 year lease to D. a. it does not necessarily follow that evidence of profit sharing compels a finding of partnership formation. like copartners. v. Issues relating to the conduct or interests of the partnership’s business— selfishness not allowed without consent of other partners b. they indicated a desire to terminate the contract or renegotiate its terms. Partners owe each other a fiduciary duty of loyalty. Meinhard v. but applicable to partnerships. P and D’s agreement provides that P will pay half the moneys required to reconstruct the property into retail stores. and in return P will receive 40% profits for the first five years and 50% of the profits for the remaining 15 years. p. Theory of the Case: D wrongfully dissolved the partnership and as a result. the duty of the finest loyalty.d.109)—MOST IMPORTANT CASE OF SEMESTER— Concerns a joint venture rather than a partnership. the agreement provides that SEM will produce home shows conducted at the providence civil center and pay and indemnify D for all the costs (P incurs 100% of losses). subject to mutual renewal. despite the legal labels assigned to an intended relationship. D simply entered into another production contract and D sued. while the enterprise continues. claiming a breach of the fiduciary duty owed to partners. 4 months prior to the end of the lease. Each party bore the losses equally. The follow are the factors used to determine the lack of a partnership: o No sharing of losses (not determinative. owe to one another. but D had the sole power of management. Many forms of conduct permissible in a workaday world for those acting at arm’s length are 28 . (2002. rather than that of the partnership. The two parties will split profits 55/45 for a fixed term of 5 years.
The trouble about his conduct is that he excluded his coadventurer from any chance to compete. Why Didn’t Meinhard ask in 1922 what was happening with the lease? 29 . i. even though D was not guilty of purposely trying to defraud P. Therefore. form any chance to enjoy the opportunity for benefit that had come to him alone by virtue of his agency. It is a question of degree.b. he breached his fiduciary duty and the price of denial is an extension of that trust at the option and for the benefit of the one whom he excluded. determining that the joint venture was the same as a partnership. P obtains 49% of the shares and D 51% of the shares. The court is trying to make it easier for D to by P out because the two obviously hate each other now. DISSENT (ANDREWS): If this were a partnership. placing a duty upon D to concede his knowledge to P. we do not need to say whether he would have been under a duty. The very fact that D was a in control with exclusive powers to direction charged him with even more with the duty of disclosure. or better yet. REMEDY: Because the parties intended for D to manage the operations. if successful in the competition. subject to fiduciary duties akin to those of partners (this sentence here is the key difference between the dissent and the majority—Cardozo decides the case in paragraph 3. i. c.” then D would not have a duty to disclose the information. therefore. e. pre-emptive opportunity. requiring a fiduciary duty) “The two were in it jointly. f. Punctilio every point is nailed down and as it should be ii. whereas Andrews believed that it was only the single lease). Questions: i.” ii. P and D were joint adventurers.” (What is it that they were in jointly? Cardozo sees it as extending beyond the original lease. an extra share should be added to D’s half. D appropriated to himself in secrecy and silence. then he would be agree with the majority outcome. A trustee is held to something stricter than the morals of the marketplace. that was thus an incident of the enterprise. However. The question is why doesn’t every plaintiff get an award when there is a breach of the duty of finest loyalty? HELD: The two were coadventurers. the number of shares to be allotted to P should be reduced to such an extent as may be necessary to preserve to D the expected measure of control and dominion. Andrews didn’t believe this was a partnership and therefore. NOTE: The reason this case did not discuss the existence of a partnership are that the Plaintiff did not give this line of argument. and thus prolong by indirection its responsibilities and duties. Thus. and not merely by half of some undivided part. P’s equitable interest is to be measured by the value of half of the entire lease. for better or for worse. but the punctilio of an honor the most sensitive. Because in this case. did not believe that these rules applied. and that either would be free to compete for the award. since only through disclosure could opportunity be equalized. is then the standard of behavior. IF he had done this. forbidden to those bound by fiduciary ties. Not honesty alone. If there is an opportunity “ lacking any nexus of relation between the business conducted by the manager and the opportunity brought him is an incident of management. the subject-matter of the new lease was an extension and enlargement of the subject matter of the old one. to hold the lease so acquired for the benefit of the venture then about to end. and these two parties would owe a duty to disclose the opportunity of a new lease. d. He might have warned P that the plan had been submitted. i. “Pre-emptive privilege.
to refrain from dealing with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership. the parties will be forced to engage in possibly costly efforts to shape a rule fitting their true intentions. Investors confronted with such a provision might be willing to accept it if. If they fail to do so through ignorance to do so. NOTE: Cited in over 1000 published state court opinions. Would this door swing both ways? Could Salmon have sued Meinhard if the venture had failed and he needed money? g. as has previously been suggested. (c) A partner’s duty of care to the partnership and the other partners in the conducting and winding up of the partnership business is limited to refraining from engaging in grossly negligent or reckless conduct. a. and only if. And greater precision may be impractical. h. i. OR should the case be decided based upon what most people would hypothetically agree to/ expect to be true. profit. c. ii. iii. (a) The only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care set forth in subsections (b) and (c) b. entirely legitimate economic considerations that require a restrictive rule on the obligation to share information or opportunities. or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property. HYPOTHETICAL BARGAIN / Parties Expectations had the parties wanted the agreement to extend past the twenty years of the lease. 5. (b) A partner’s duty of loyalty to the partnership and the other partners is limited to the following: i. the promoters reputation is good—only if the promoter has a good record. then the possibility of unfair outcomes arises. o Salmon’s strongest argument is that the plain language of the agreement would tell the court the true intentions of the parties. to refrain from competing witht eh partnership in the conduct of the partnership business before the dissolution of the partnership. RUPA § 404—General Standard of Partner’s Control a. to account to the partnership an hold as trustee for it any property. or a knowing violation of the law i. BIG QUESTION: Should you allow parties to contract out of fiduciary duties? If the rule supplied by law is inconsistent with what the parties would have wanted (as suggested by Cardozo) then. c. separate from the the individuals. 4. Cardozo’s strongest argument is that this rule what most parties would have contracted for at the outset. Business Judgment Rule (BJR) o See Bane below and determine whether it would fit into this rule?—It is a line drawing issue. b. There may be compelling. o How aggressive should courts be with the requirements of “gross 30 . 6. Should the case be decided based upon what the parties intended when they entered into the agreement. ii. including the appropriation of a partnership opportunity. ii. Sometimes the law reifies a corporation/partnership treats it as a single entity/unit. The vagueness of the rule of fiduciary obligation may require the adoption of express agreements that seem to go too far in denying any such obligation. intentional misconduct.3. then they would have provided for an extension in their lease. i. and iii. This case is full of good rhetoric.
There is no suggestion that the Ds failed to inform Bane of his rights. p. but in this case there is no breach of duty of care. HELD: Bane ceased to be a partner when he retired. but not of his former partners. b. NOTE: If there were fraud. Ferguson (1989. a closely related member of the partner’s family. Can’t do business with a partner himself.115)—ISSUE: Whether a retired partner in a law firm has either a common law or a statutory claim against the firm’s managing council for acts of negligence that. Rescinding the contract 9. The pension plan id not establish a trust and even if. a partner has an obligation to render on demand true and full information of all things affecting the partnership to any partner. GRABBING AND LEAVING a. A partner is prohibited from: a.negligence”? o Coco-Cola Example d. Competing with partnership b. 8. Taking business opportunities from which the partnership might have benefited or that the partnership might have benefited or that the partnership might have needed c. Bane v. the mismanagement was not of the plan but of the firm. the rights and obligations of the partners are the same as those of a person who is not a partner. NOTE: Bane is not a partner. terminate his retirement benefits? i. RULE: A partner is a fiduciary of his partners. by causing the firm to dissolve. Fiduciaries may plan to compete with the entity to which they owe allegiance. iii. AFTER DISSOLUTION a. subject to other applicable law. would it fit under this limitation on “gross negligence. but an individual with a contract. f. but merely negligent mismanagement. Disgorgement of profits gained through disloyal act. iv. the business judgment rule would yield them from liability for mere negligence in the operation of the firm.” ii. Using partnership property for personal gain d. for the withdrawal of a partner terminates the partnership as to him. REMEDIES for breach of Fiduciary Duty of Loyalty: a. Engaging in conflict-of-interest transactions i. 10. Business Judgment Rule (BJR)—And even if the Ds were fiduciaries of Bane. (f) A partner may lend money to and transact other business with the partnership. o The Business Judgment Rule is a line-drawing judgment—Looking to the RUPA above. provide that in the course of such arrangements they do not otherwise act in violation of their fiduciary duties. an organization in which the partner has a material financial interest. the plan’s managers were fiduciaries of its beneficiaries. and as to each loan or transaction. b. notwithstanding the absence of one. 7. Do not have to prove damages c. (e) A partner does not violate a duty or obligation under this Act or under the partnership agreement merely because the partner’s conduct furthers the partner’s own interest. then it would be a duty of care. 31 . (d) A partner shall discharge the duties to the partnership and the other partners under this act or under the partnership agreement and exercise any rights consistently with the obligation of good faith and fair dealing e. NOTE: It is incredible difficult for a plaintiff to win a Duty of Care Claim. or any other person whose interests are adverse to the partnership. However.
HELD: The logistical arrangements to establish a new firm were permissible.b. At the time of leaving. Courts will look to the ABA committee of Ethics and Professional Responsibility. and the substance and method of their communications with clients. the expelling partners act in “good faith” regardless of motivation if that act does not cause a wrongful withholding of money or property legally due to the expelled partner at the time he is expelled. In a cross-claim. NOTE: Ingenious provisions in the Partnership agreement “A voluntarily retiring partner. p. . i. Should be very objective and explain to them the options.1989)—Ps terminated their relationship with Ds to start their own firm. UPA § 31—“Dissolution is caused (1) Without a violation of the agreement between partners. Through their preparation for obtaining clients’ consent. stating that any notice explained to a client that he or she has the right to decide who will continue the representation. 11. ii. They recruit other members of the firm while still working and refuse to give names of the clients they were taking with them. to wit a fiduciary. MBC because they wanted more money for the work they were doing.8% of the firm’s interest. EXPULSION a. o Ambiguity—is it always obvious whether the client came to the firm through the attorney? What if he was one of several factors inducing the client to come? o What is “fair charge”? d. c. giving rise to an action for damage the affected partner has suffered as a result of his expulsion. obtained an unfair advantage over their former partners in breach of their fiduciary duties. Also. RULE: If the power to involuntarily expel partners granted by the partnership agreement is exercised in bad faith or for a predatory purpose. i. Shaughnessy (1989. for general guidelines as to what partners are expect from each other concerning their joint clients on the division of their practice. The fiduciary relationship between partners to which the terms bona fide and good faith relate concern the business aspects or property of the partnership and prohibit a partner. b. they breached their fiduciary duties by unfairly acquiring consent from clients to remove cases from Ds. the content of the letter sent to the clients was unfairly prejudicial to Ds because it was onesided. their secrecy concerning which clients they intended to take. subject to the right of the client to stay with the firm. c. however. Ps had 6% and 4. . Ds claimed Ps breached their duty of fiduciary duties. from taking any personal advantage touching those subjects. In sending the letter you should not recommend your own employment. RULE: Where the remaining partners in a firm deem it necessary to expel a partner under no cause expulsion clause in a partnership agreement freely negotiated and entered into. i. could remove any matter in which the partnership had been representing the client who came to the firm through the personal effort or connection of the retiring partner. 32 . Also. the sent onesided letters on firm letterhead to former clients and referring council requesting those individuals come with them. the partnership agreement is violated. Meehan v. (d) By the expulsion of any partner from the business bona fide in accordance with such power conferred by the agreement between the partners. upon the payment of a “fair charge”. The UPA default rules don’t work so well for law firms and other service businesses. breached the partnership agreement.
they discover that the old bookkeeper had been embezzling money. Wheat would be the position of P. 2. as a co-tenant in all partnership property. 2. b. At the time the partners negotiated the contract. PROFESSOR NOTE: 1913. I. Rights in specific partnership property i. The assets are thought of as a bundle rather than as specific separate items. What about Meinhardt? Mienhardt stretches in the opposite direction. E. b. NOTE: Would you agree to a no cause expulsion clause? Less trial. ii. An undivided interest. Putnam v. either to retain or convey. That interest is the partner’s pro-rata share of the net value or deficient of the partnership. Under UPA. Partnership tenancy possessory right of equal use or possession by partners for partnership purposes (like a joint tenancy). Shoaf (1981. had the company failed. the AIG loan from the Government (bailout) is not constitutional. which he follows. Art. Their intent was to provide a simple. practical.132)—P sells her ½ interest of her partnership interest to D. The Entity and Aggregate Concepts 1. The reification distinction has important legal consequences: a. c. C. D. Would she accept a partner’s share of the company’s liabilities? NO. She did not have a specific interest in any specific assets fo the company. Partnership Property 1. HELD: Mutual ignorance does not warrant a reformation of the contract for sale of the partnership interest. a. leaving a sizeable deficit. Lawlis v. The partnership acted in good faith. and above all. Nevertheless. or warrant a decree in favor of the transferor for a share of the value of the oil. The business is treated as something separate from its owners. and b. Knightlinger & Gray (1990. with another program outline. a speedy method of separating a partner from the firm if necessary. the firm signed an agreement with him to get him back on track. After this transfer. they believed in the “guillotine method” of involuntary severance as in the best interests of the partnership. P could only sell all of her interest in the partnership. For this reason a conveyance of partnership property held in the name of the partnership is made in the name of the partnership and not as a conveyance of the individual interest of the partners. as having an existence of its own. the partner vote 9 to 1 (P’s one vote as the 1) to expel him. Therefore. there is no breach of duty in his expulsion because he voluntarily agreed to the method. there is no breach of duty. P then had a relapse and he gets a second chance. P had agreed to the procedure used to expel him. p. therefore. ii.d. a partnership 3 Property Rights: a. and when he finally to the firm in which he was a senior partner. p. iii. but more efficient. and P wants to intervene to recover funds paid by the banks. i. § 8—According to Professor. This possessory right is incident to the partnership and the possessory right does not exist absent the partnership. Right to participate in Management. HELD: P was expelled in accordance with the partnership agreement.125)—P had an alcohol problem. There is a strong tendency to reify corporations—refer to the entity and the individuals who make up the corporation in the aggregate as one entity This is a less significant phenomenon in partnerships because there is more of a tendency to treat partnerships as entities separate and distinct from their owners. Interest in the partnership i. She could not sell a 33 . All she had was a partner’s interest in a share of the profits which she certainly intended to convey.
and Returns 1. they can sell it and get no money returned. Raising Additional Capital 1. UPA § 26—Nature of Partner’s Interest in the Partnership—“A partner’s interest in the partnership is his share of the profits and surplus. When partnership property is attached for a partnership debt the partners.” c. but he has no right to possess such property for any other purpose without the consent of his partners. (2) his interest in the partnership. G. o (b) A partner’s right in specific partnership property is not assignable except in connection with the assignment of rights of all the partners in the same property. has an equal right with his partners to possess specific partnership property for partnership purposes. The effect of deducting depreciation from gross revenues at the partnership level will be to allocate depreciation according to profit share—equally among all partners. a.” b. “Draw” Cash distributions to partners. ii. 3. The amount of the draw of each partner is determined by majority vote of the partners. depending upon the agreement. subject to the provisions of this act and to any agreement between the partners. 3. and shares of gain may differ from shares of loss. such as pro rata according to initial capital contribution.” 4. 2.000 and 40 partners invest the remaining $9 million.000. o (d) On the death of a partner his right in specific partnership property vests in the surviving partner or partners . #1 shows problem of Transaction Costs and Free-Riders--COASE. Also demonstrates the Prisoners’ Dilemma—Problems with cooperation and 34 . May not want the right to sell the ownership interest to be alienable because you are responsible for the other’s actions. 4. . (2) The incidents of this tenancy are such that: o (a) A partner.000 to complete the building. cannot claim any right under the homestead or exemption laws.specific interest in the lawsuit. A partner’s share of profit can be thought of as something he or she has earned and reinvested in the firm. and the same is personal property. UPA § 25—Nature of a Partner’s Right in Specific Partnership Property— i. Tenancy in partnership a. and (3) his right to participate in the management. might be wise to agree initially to allocate depreciation in accordance with some other formula for tax reasons.000. UPA § 24—Extent of Property Rights of a Partner—“The property rights of a partner are (1) his rights in specific partnership property. He puts in $1. o (c) A partner’s right in specific partnership property is not subject to attachment or execution. Must assume you are not acquainted with any of the other partners. and it may be more or less than the profit.000 to start a company. “Dilution” the process of adjusting ownership shares to take account of additional capital contributions and changes in the value of the business. but not remain a partner. He comes up short and needs another $500. . Contributions. This is part of the problem dealing with Externalities. except on a claim against the partnership. PROBLEM—Guy needs $10. Capital contribution does not necessarily control the sharing of gain and loss. There is no provision in the partnership agreement covering the need for additional capital. or any of them. (1) “A partner is co-owner with his partners of specific partnership property holding as a tenant in partnership. 3. However. 2. or the representatives of a deceased partner. But if they sell the building now. Accounts. F.
UPA § 18(e)—in the absence of an agreement to the contrary. and the act of every partner for apparently carrying on in the 35 . Rights of Partners in Management (CONTROL) 1. i. If you don’t cooperate and give more money. 341 (1983) 9. The loans might bear a larger interest rate with no distributions to be made to the partnership until the full amount of the loan and interest are paid. could require a 2/3rds vote. You can cooperate or defect. Ask partner to agree to be responsible for any shortfall. a.” o MAJORITY RULE= 1 partner. (1) Control i. o Professor says: Give all business decision power to the executive committee. 4. But if someone defects. the decision of the majority controls. 1 vote o ALTERNATIVE CONTRACTUAL AGREEMENTS—Could allocate voting power based upon initial capital contributions OR delegate decision making power to a small group.” o Thus. b. If a partnership of 5 or more. Can also require partners to make loans to the partnership pro-rata. 3 Basic Rules with Partnerships (absent contrary agreements): a. it may be impossible to reduce the percentage interest of a partner. The increase in th share of the profits and capital of a partner contributing additional capital is determined with reference to the current value of the business. if there are three partners and they disagree as to any ordinary matter. then it is difficult to make someone to cooperate. ii. could require unanimous vote for important decisions. “all partners have equal rights in the management and conduct of the partnership business. a. your percentage of interest will be diluted even more than in pro-rata.coordination. a. A commonly used provision permits the managing partner to issue a call for additional funds and provides that if any partner does not provide the funds called for her or his share is reduced. and there is an incentive to defect. Answer to question at bottom of 137—Correct price is $500 each for 1000 new points. LOOK TO K&C for more detail H. UPA § 18(h)—“Any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of partners. Joint. So. new points will be offered to the partners at a set price. when called upon to do so. 7. b. UPA § 9 Every partner is an agent of the partnership for purposes of its business. (2) Agency. a change in the partnership share is a fundamental change that requires consent. Penalty Dilution—The partnership agreement might provide that if the managing partner determines that additional funds are needed. Subject to abuse 8. Without prior agreement. 6. 17 U. o ALTERNATIVE CONTRACTUAL AGREEMENTS—Instead of looking making decisions based upon a majority of partners. especially when there is no penalty for failing to cooperate. b. maximizing outcome is for both people to cooperate. Pro-Rata Dilution—A provision addressing the issue of a possible need for capital. how do you draft an agreement to provide an incentive for investors to cooperate and provide extra capital. Davis Rev. according to existing formulas. Subject to abuse. Also look to page 87 in K&C 5.C.
Develop a Dissolution agreement BEFORE the partnership is created. p. a. HELD: There is no basis for fraud because P was not deprived of any legal right as a result of his reliance on his statement. to be paid and amount determined as if on the date of dissociation. p. Continuation Agreements—An agreement containing a provision specifying that the remaining partners will continue as partners under the existing agreement. Day v. For an amendment need 3/4 ths vote. Partnership Dissolution 1. (a) The assets of the partnership are: (I) The partnership property. UPA § 40—Rules for Distribution of Funds at Dissolution—“In settling accounts between the partners after dissolution. because in the very nature of things D was not. c. control. usual way the business of the partnership binds the partnership. However. in the absence of an agreement to the contrary. called up P and told him to continue delivering. etc. Admission. a misrepresentation regarding his chairmanship does not form the basis for a cause of action in fraud. b. a majority of partners. UPA § 15—joint and several liabilities in partnerships 2. since P had not right to remain chairman of the Washington Office. D lost his position and the firm moved the Washington office to the other firm’s location. Ultimately when there are problems you have to dissolve the partnership. but no limitation is effective against a person doing business with the firm unless it has been communicated to that person. Disolution of Contravention means wrongful dissolution. 5. which implicitly authorized the Executive committee to create. Therefore. a. and when the firm merged with another firm. for the purpose of its business and within its scope. freeman’s purchase of bread bound D. and could not be. the assets of the partnership were sold at a price equal to the greater of the liquidation value or the value based on a sale of the entire business as a going concern without the dissociated partner.140)—D advised P that he did not want anymore bread. c. Bromberg & Ribstein—The Treatise on Partnerships 3. Having read and signed the partnership agreements. ii. b. D’s partnership dissolves. 2. When there has been siddociation. You can require unanimous consent. for such was an ordinary matter connected with the partnership business. National Biscuit Company v. severence. i. Under RUPA it is called dissociation. however.I. (3) Liability. and participation are voted on by all partners and there must be a majority vote. the following rules shall be observed. ii. HELD: Freeman was a general partner to D with no restrictions on his authority to act within the scope of the partnership business. the partnership is technically dissolved when a partner leaves. 4. D could not restrict the power of Freeman to buy bread. (II) the 36 . which P did. D’s partner. the partnership continues as to the remaining partners and the dissociated partner is entitled. plus interest from the date of dissociation. or eliminate firm committees. Each partner may be held personally liable for the full amount of any partnership debt that is not satisfied from the partnership property. Stroud (1959. subject to any agreement to the contrary: a. Freeman. Sidley & Austin (p. agree that one party has overriding power. this rule has been modified in many states. Thus. 3.1977.146)—P was an underwriting partner in D’s Washington office. plaintiff could not have reasonably believed that the status of the Washington Office Committee was inviolate and beyond the scope and operation of the Partnership agreement. Can talk about it more clearly before a disagreement occurs. Under UPA. a. Agency can be limited by express terms of an agreement.
if available 4. (III) Those owing to partners in respect of capital. a partner may have reason to want to dissolve the partnership. as follows: i. o (c) A partner has been guilty of such conduct as tends to affect prejudicially the carrying on of the business. RIGHT TO DISSOLVE a. Owen v. so he was ruled against. he may seek a judicial dissolution. b. the court shall decree a dissolution whenever: o (a) a partner has been declared a lunatic in any judicial proceeding or is shown of unsound mind.152)-. the partner who is seeking to et out can not be sued by other partners. If a court dissolves the partnership. (I) Those owing to creditors other than partners. it will be deemed a wrongful dissolution.Owen. ii. A court may order the dissolution of a partnership where there are disagreements of such a nature and extent that all confidence and cooperation between the parties has been destroyed or where one of the parties by his behavior materially hinders a proper conduct of the partnership business. Term established in contract: In certain cases. This is a reason to take the route of judicial dissolution as opposed to merely dissociating and causing a wrongful dissolution—Like staying in a Bad Marriage b. iii. o (d) A partner willfully or persistently commits a breach of the particular agreement. one partner cannot constantly minimize and deprecate the importance of the other. o Partner gets back his original capital contribution o In the absence of an agreement to the contrary. Therefore. no partner will be entitled to interest on his/her capital account. but if he does so. i. a court should not issue a decree to dissolve a partnership. o Partner gets his percent of profits remaining. p. sought judicial dissolution of the partnership because the agreement did not expressly fix duration and the two were no longer able to get along. o GET IT IN WRITING! o Courts have a lot of discretion in determining dissolution o The reasoning of this case is similar to the “Doctrine of Unclean Hands”—Cohen was acting inappropriately. Cohen (1941. iv. On the other hand. (b) The liabilities of the partnership shall rank in order of payment. who had entered into an oral agreement with Cohen whereby they contracted to become partners in the operation of a bowling alley business. o HELD: Where there are only minor differences and grievances that involve no permanent mischief. (IV) Those owing to partners in respect of profits. ii. In that case. (II) Those owing to the partners other than for capital profits o Partner gets any loan money returned. o (b) A partner becomes in any other way incapable of performing his part of the partnership contract. partnership is dissolved. as in this case. or otherwise so conducts himself in 37 . without undermining the basic status upon which a successful partnership rests. If there is not enough money to repay the partner’s loan.contributions of the partners necessary or the payment of all the liabilities specified in clause (b) of this paragraph. UPA § 32—“On application by or for a partner. then the partners must contribute their pro-rata share of ownership (including the partner to be repaid) in order to create that amount.
i. it was not reasonably practicable to carry on the business o NOTE: Dissolution by judicial decree is rare. Lewis also agrees to give Collins a claim on his ownership (mortgage payable to bank on demand) until Collins is completely repaid for Lewis’ portion of the loan. Collins and the bank attempt to foreclose on the mortgage. by a judicial decree that: (i) the economic purpose of the partnership is likely to be reasonably frustrated. Lewis paid it out of earnings of the business during the first year of its operation. A partner who has not fully performed the obligations required by the partnership agreement may not obtain an order dissolving the partnership. This means that if either partner contravenes the partnership. Therefore. p. o HELD: There is no such things as an indissoluble partnership only in the sense that there always exists the power.155)—Lewis persuaded Collins to enter into a partnership for the operation of a cafeteria for a term of 30 years. o (f) Other circumstances render a dissolution equitable. allegedly because of Collins’ lack of cooperation. of dissolution. there would be a reasonable expectation of profit. he is not allowed to participate in good will and is liable to the other for damages. Even partners who are locked in an irreconcilable dispute usually manage to agree to some plan which enables one or all of them to exit gracefully. o NOTE: If this were a UPA case. might say that under § 32. as does the right to relief from the provisions of any legal contract. Lewis (1955. And Collins ensures Lewis that he will make sure it does not negatively affect Lewis. Collins demands Lewis to make the business profitable and he refuses to provide any more money to the venture. as opposed to the right. because whatever settlement the feuding partners can reach is likely to be more economical than court-ordered dissolution. this extra money was properly Collins’ obligation to provide. There is not a reasonable expectation of profit under Lewis’s continued management. o Collins right to foreclose on the mortgage depends upon whether or not Lewis has met his basic obligation of repayment at the rate agreed upon. (ii) another partner has engaged in conduct relating to the partnership business that makes it not reasonably practicable to carry on the business in partnership. a procedure which typically requires the partnership to dispose of the property for considerably less than its actual value. Upon his refusal to pay it. under these circumstances. or (iii) it is not otherwise reasonably practicable to carry on the partnership business in conformity with the partnership agreement. Collins v. Thus. Also. The venture failed to make money. but Lewis was found competent to manage and but for Collins’ conduct. 38 . iii. the court properly refused to allow Collins to foreclose. no dissolution may be granted.matters relating to the partnership business that it is not reasonably practicable to carry on the business in partnership with him. UPA § 801(5)— a partnership is dissolved “on application by a partner.” c. But legal right to dissolution rests in equity.” This provision is a safe harbor to prevent a party getting sued for wrongful dissolution because we don’t want to force people together who can’t get along. Under the basic agreement of the partners.
this power is held by a fiduciary and must be exercised in good faith. each of these brothers will get 50% of the partnership value after liabilities are repaid. however. o And although a partnership may dissolve at the express will of any partner (UPA § 31). provided the partners have not agreed to a definite period of time during which the partnership should continue—UPA § 31(1)(b) i. However. a partner’s relationship with other partners is terminable at the will of any partner. o A partner at will is not bound to remain in a partnership. Thus. • Freeze-Out Majority owners try to force co-partners to sell their interests at a price lower than the true price. • Book Value = Acquisition price . regardless of whether the business if profitable or unprofitable.depreciation. A profit may not. o What could the Brother do in order not to breach is fiduciary duty? Get a professional appraisal of the business/partnership. Additionally. A well written partnership agreement should include: i. e. ii. and so P had right to dissolve. the dissolution would be wrongful and the plaintiff would be liable under UPA. if P acted in bad faith and violated fiduciary duties by attempting to appropriate to his own use the new prosperity of the partnership without adequate compensation to his co-partner. Buyout Agreement (buy/sell agreement)— o 39 . Chances are. The understanding to which defendant testified was no more than a common hope that partnership earnings would pay for all the necessary expenses. Such a hope does not establish even by implication a definite term or particular undertaking as required. this number is an accounting artifact that has no connection to market value. is that the brother with more money will buy the partnership. Some courts have agreed with Traynor and others have not. d.160)—TRAYNOR— Business lost money for three years. Business Valuation Models many methods used by appraisers in order to place a monetary worth on a business in order to divvy up the proceeds at the time of dissolution. then it is not really at will. however. P wanted dissolution. according to Traynor. o HELD: There was no implied term as to the duration of the partnership (because there was no evidence of it). more financially stable partner will want to find a value of the business that is as low as possible without violating his fiduciary duty and creating a freeze out. Page v. Therefore. However. this right must be exercised in good faith. freeze out a co-partner and appropriate the business for his own use. Page (1961. If there is a good faith limit. In the absence of an agreement to the contrary. p. D tried to say there was an implied term of partnership to last long enough to pay the loan.Collins should have had a cap on how much money he would put into the venture. cannot freeze out. but is added by Traynor. If the partnership is dissolved. especially if there is not a realistic market value because there are no bidders. The good faith element is not in the UPA. and as it started to make profit.
One partner pays a percentage of the average of three appraisals o Ex. iii. Majority partners in a partnership-at-will may purchase the partnership assets at a judicially supervised sale. o This is one of the most important things to remember for your client! Buy/Sell agreements force people to think about what is fair before they are placed in that position. “I cut and you choose” approach make more accurate. this is a more attractive alternative. Difficulties include: o It may be difficult to find such a buyer because of the costs of communicating information about the business to people who are not familiar with it. 4 Primary Ways to “Wind Up” a partnership when dissolution/dissociation occurs: i. o Courts are sensitive and will carefully review fairness. Sheffel and a third partner filed for dissolution. as a going concern. Prentiss v. Sale to Minority The minority partner may find and wish to purchase the partnership.163)—After freezing Prentiss (15% owner) out of the partnership’s management and affairs. This destroys all good will. o HELD: Although Prentiss was excluded from management of the partnership. One of more popular ways. purchasing partnership assets at a judicially supervised sale. iv. either alone or with new partners. in their conflicting role as sellers to the non-continuing partner. Sale of Going Concern to Outsider Where good will is of significant value. Rather. i. “Going out of Business” Sale Shut down store and sell/liquidate all its assets.o Ex. Sheffel (1973. only to insiders. the participation of the majority partners in the sale 40 . ii. ii. Sale to Majority A purchase of the business. Moreover. the trial court found no indication that such exclusion was done for the wrongful purpose of obtaining the partnership assets in bad faith. p. 5. CONSEQUENCES OF DISSOLUTION a. o The purchasing partners will be in a position that puts heavy strain on the fiduciary obligation they owe. o Some of the values inherent in the business may exist only for its present owners. Set one price that he would be willing to take or to pay. from the partnership by the majority partners who wish to continue their investment is the same as the sale above. Continuation Agreement—should contain a minimum of 5 things: o Transfer of rights and obligations of dissolved partnership to successor partnership o Conversion of continuing partners’ rights in the dissolved partnership to rights in the successor partnership o Compensation of the dissociated partner for partner’s rights in the dissolved partnership o Indemnification or (if possible) the release of the dissociated partner for debts of dissolved partnership o Indemnification of the dissociated partner for debts of the successor partnership. it was the result of the inability of the partners to harmoniously function in a partnership relationship. b.
Disotell v. however. so should come up with a better manner of appraisal. or pay to any partner who has caused the dissolution wrongfully . may do so. they get around this through the agreement that they vote on percentages. The trial court gave D the option to buy P’s share at a precise figure (where did it come from?). the court should imply a term which comports with community standards of fairness and policy rather than analyze a hypothetical bargain. Profits allow for depreciation whereas cash flow does not. The right as against each partner who has caused the dissolution wrongfully.increased the final sales price. c. (b) The partners who have not caused the dissolution wrongfully. Stiltner (2004. such as this court. It seems less important in this case than it does in other cases. while others. but did not give P the option to buy D’s interest. HELD: Giving D option to buyout P is correct. o Partners will tend to be the highest bidder if the partnership is sold because they have greater knowledge of the business. less any damages recoverable under clause 2a II of this section. enhancing the worth of Prentiss’ interest. to permit a buyout finding the fair market value of the property. But should take into account the personal use of the hotel property. P argues that a partner who was not wrongfully dissolved can ask for liquidation (UPA § 37). and in like manner indemnify him against all present or 41 . Gap-Filling Where a term is missing within a written contract. but should not include the loan obligation. Disotell was to contribute to the project and those he actually contributed. i. provided they secure the payment by bound approved by the court. This court explains that a buyout would reduce the economic waste by avoiding the cost of appointing a receiver and conducting a sale. the court may search for a term that the parties would have agreed to had the question been brought to their attention. It is difficult to use tax appraisals to give value. based on admissible evidence. Where there is no agreement between the parties. iv. during the agreed terms for the partnership and for that purpose may possess the partnership property. ii. the court should determine what each partner contributed or took from the partnership assets and any differences between services. o NOTE on Freeze Outs: The UPA 18(e) says that all partners have the rights to control. but remanded to determine figure. iii. d. the value of his interest in the partnership at the dissolution. if they all desire to continue the business in the same name. It was error. NOTE on § 38—Some hold that the statute require liquidation. find that § 38 allows a buyout as a justifiable way of winding up a partnership. to damage for breach of the agreement ii. UPA § 38—“(2) When dissolution is caused in contravention of the partnership agreement the rights of the partners shall be as follows: i.166)—Real estate development went sour and D seems like the one with the money. p. NOTE: Buyout figure should be covered in the agreement. the superior court should consider the risks and obligations each party assumed. v. We see the term “freeze out” again in this case – this freeze out case law is somewhat vague. either by themselves or jointly with others. (a) Each partner who has not caused dissolution wrongfully shall have o II. In considering what term is reasonable. Because the act did not prohibit the buyout option it was not error to grant Stiltner the option ot buy out Disotell’s partnership interest. In remanding the case.
173)—Dale is inventor and Meersman is attorney that decided to form partnership. (2) Continue to Operate the Business o Four Consequences of this decision: If the firm’s creditors are informed of the withdrawal. less any damages caused to his copartners by the dissolution.” which are not used in partnership statutes. If the business is continued under paragraph 2b of the section the right as against his co-partners and all claiming through them in respect of their interests in the partnership. Additionally. iii. according to Professor wrongfully. that Dale’s 42 . the contravening partner is no long liable for any debts thereafter incurred. Agreement had some problems in the way it was drafted according to Professor. o The court concludes. don’t use the words “contemplated a permanent agreement” because this does not tell you anything. because taking them away would hinder running the business. using Dales’s patents. -Should use the terms consistently throughout the agreement. reduced by any damages for which he may be liable by virtue of his breach of the partnership agreement. and to be released from all existing liabilities of the partnership. (1) Wind up the business—Sell it as a going concern or liquidate its assets. or the payment secured by bond approved by the court. he could have gotten his stuff back because “expiration” does not have a UPA definition and “dissolution” does have a definition. but is responsible for those previously incurred. Continuing partners must post a bond to guarantee ultimate payment to contravening partner and to protect him from claims of creditors for pre-dissolution obligations. and will not get his patents back. Dale must write Vasso a check. (1986. Vasso Corp. v. but in ascertaining the value of the partner’s interest the value of the good will of business shall not be considered. to have the value of his interest in the partnership.: -The agreement used the words “expiration of the partnership. When a different term is used. Pav-Saver Corp. e. ascertained and paid to him in cash. Contravening partner is entitled to be paid the value of his interest. p. iii. Then distribute proceeds according to UPA § 40. Significant penalty for wrongful dissolution because you lose the good will in value of your share (difference between hard asset value of firm and market value). had Dale used “dissolution”. ii. Basics of § 38—2 Consequences of Withdrawal in Contravention of Agreement: i. He continuing partners may use the partnership property and need not pay the contravening partners the amount to which he is entitled until the end of the agreed upon term. and gets damages to partnership subtracted from that amount.” RUPA is not as severe. the reader assumes that a different meaning is intended. o HELD: Dale wrongfully dissolved the partnership (contravention).future partnership liabilities. (c) A partner who has caused the dissolution wrongfully shall have: o II. -Also.
Professor disagrees with this Default Rule. To Professor. Upon PSC’s notice of termination. “the wrongful termination necessarily invokes the provisions of the UPA so far as they concern the rights of the partners. the right to possess the partnership property and continue in business upon a wrongful termination must be derived from and is controlled by the statute. iii. ii. the one owed nothing must pay the partner who has a right to the return of his capital investment. according to the Court. if one partner is owed money and the other is not. RULE: In a joint venture where one party contributes funds and the other party contributes labor. Under the UPA and RUPA. p. meaning Dale should get his patents. the partnership is obligated to pay what is owed to the partnership in respect of capital. Kovaick agrees to put up the money for a remodeling project and Reed agrees to supply the labor (but no money up front). Professor believes this is much closer to the intentions of the parties. use “Dissolution” and RUPA use “Dissociation” 6.179)—In an oral partnership agreement. iv. disregarding how much they actually contributed. Therefore. Thus. i. the court finds that presumption only applies to cases in which each party contributed capital. The court here finds that Reed’s labor contribution was equal to Kovacik’s monetary contribution and therefore it is an even loss. Kovacik v. Therefore.” o DISSENT: The court should construe the contract as written. Reed refuses. b. despite the parties contractual direction that PSC’s patents would be returned to it upon the mutually approved expiration of the partnership. the liquidated damages clause provided for unilateral termination. neither partner is liable to the other for contribution for any loss sustained. Try to Draft a Better Contract for Dissolution to fix the problems with this agreement. It is difficult to value the services of the labor provider over the capital contributor. The provisions in the contract do not conflict with the statutory opinion to continue the business and even if there were a conflict the provisions of the contract should prevail. Reed (1957. REMEMBER § 40(b) Three payment (after paying creditors and loans made by partners).” i. However. iv. v. The partnership doesn’t pan out and loses money and Kovacik wants Reed to share equally in the losses. Here that was not the case. Kovacik would have been entitled to ½ of his capital returned. remember in what state you are drafting the K—UPA states. the 43 . v.unilateral termination was in contravention of the agreement. SHARING OF LOSSES a. NOTE: The RUPA adheres to the UPA’s default rule that every partner shares equally in the losses and specifically rejects the reasoning in this case. The general rule is that in the absence of an agreement to the contrary the law presumes partners and joint venturers intended to participate equally in profits and losses. Vasso decides to continue running the business (§ 38(2)(b)). UPA § 18(a): States that partners split profits AND losses…they will “share equally in the profits and surplus remaining after all liabilities…and must contribute towards the losses. HELD: Kovacik attempts to invoke UPA § 40(b) dealing with the schedule of payments upon dissolution. NOTE: In drafting. However.
o When the partner dies. i. where one partner contributes cash or property and the other contributes services. after deducting the interest on the loan and the amount of the salary. then the death of a partner would cause the dissolution and windup of the partnership. Trigger Events—what event can cause the buyout agreement to kick in o Death If there is not a buyout agreement. The agreement may set that each of these payments may be deferred. But. the partners do not know which side of the table they will sitting on.) c. chronic medical condition. c. o Will of any partner—retirement. a buyout agreement will be inherently fair because at the time of the agreement.agreement should identify how the services will be valued upon dissolution of the partnership so that he will not be liable to the capital contributor for half of his contribution. Typically. 7. Probably want to do this. Buyout Agreement Checklist i. if you don’t sell it on the open market. Explain what kind of disability is included. etc. Fair Market Value—the amount you would get if the business is sold. (They don’t know if they will be the departing or remaining partner. DRAFTING SOLUTION: In a two person partnership. ii. A buyout agreement is an agreement that allows a partner to end his relationship with the other partners and receive a cash payment or series of payments or some assets of the firm in return for his interest in the firm. other opportunity. the policy proceeds go to the family to buy out the partnership interest of the dead partner. the partners may want to agree that the contribution of cash or property is treated as a loan subject to a fair return and the contributor of services can be paid a salary. An over-arching question is where will the money come from for the buyout? o Most of the time. It is a way to contract around the UPA provisions which call for liquidation upon certain events occurring causing dissolution. Price o This is a very difficult thing to come up with. ii. Option to Buy—is there an obligation to buy or just an option to buy? o Firm—allow the firm buy you out o Other investors—do you want to include that other people can buy the interest and become partners in the business? o Consequences of refusal to buy If there is an obligation If there isn’t an obligation iii. VERY IMPORTANT TO PROFESSOR! b. Profits and losses would be calculated and allocated between the partners. then how do you determine the FMV? 44 . BUYOUT AGREEMENTS a. Obligation to Buy vs. etc. o Disability—injury. the firm will take out life insurance policies on the partners and pay premiums on the policy.
HELD: Since there is no partnership agreement. Shaughnessy (earlier portion of case above)—This firm had a written partnership agreement that provided for what would happen when a partner left the firm and what would happen with pending cases. ii. The four partners in the law firm mutually decided to dissolve the partnership and formed two new firms.” b. ii. Jewel v. since the partners may agree among themselves by contract as to their rights and liabilities. Rule: Absent a contrary agreement. Professor says that it is just stupid for a law firm not to have a written partnership agreement—“it is an invitation to litigation. Belman—This partnership has a buyout agreement that is triggered by death. resignation or retirement. iii. Boxer This case involves a law firm which had no written partnership agreement. Jewel and Leary filed suit stating that the judgment awarding post-dissolution income on active cases at the time of dissolution was in error. i. One of the partner’s cocaine use became such a problem that he was incapable of making rational business decisions. insanity. i. The court interprets the rule that “no partner is entitled to extra compensation for services rendered in completing unfinished business” to apply to those pending cases in the law firm that are part of the winding up process. The departing partners • 45 . Meehan v. G&S Investments v. the profit from those cases must be split among the original partners. The other partners sought a judicial dissolution and the right to carry on the business by buying out the partner’s interest. any income generated through the winding up of unfinished business should be allocated to former partners according to their respective interests in the partnership. The court states that “It is not the province of this court to act as a post-transaction guardian for either party. LAW PARTNERSHIP DISSOLUTIONS a. Method of Payment o Cash o Installments With interest? v.” Professor LOVES this statement. 8.You use other sources which are just substitutes and in most cases are not going to be the FMV o Substitutes for FMV Book value—an accounting number that is the original cost of the assets minus depreciation Appraisal Formula Set price each year Relation to duration iv. Rule: A partnership buyout agreement is valid and binding even if the purchase price is less than the value of the partner’s interest. HELD: Here. Therefore. the court merely enforces the parties’ agreement in the partnership agreement. Protection Against Debts of Partnership vi. Procedure for Offering Either to Buy or Sell o First mover sets price to buy or sell o First mover forces others to set price d. The buyout agreement deals with a value based on capital accounts—it is very straightforward. the UPA default rules apply.
4. Dissolution is caused by a member’s death. General Partners Personally liable for the debts of the firm and have the power to act on behalf of the firm and to control it. Has the corporate characteristic of limited liability. ISSUE: Whether the two limited partners became general partners through their exercise of control over the firm? a. Members may withdraw at will. the UPA default rules will apply. and b. even though different from those rules provided in the UPA. Uniform Limited Partnership Act (ULPA) and Revised Uniform Limited Partnership Act (RULPA) 3. the express rights provided by a partnership agreement control. but is treated as a partnership for purposes of federal income taxation. Absent such an agreement. In this case. and are not personally liable for the debts of the firm. The withdrawing partner is not subject to the same risks of liability to existing creditors as with a ordinary partnership. Limited partnership protection can be lost if there is participation or control exercised over the business by the limited partners. HELD: The UPA has provisions for what to do with a departing partner’s interest in the firm (liquidation. sales. i. 3. K. the partnership agreement minimized the impact of the dissolution process—Professor found it brilliantly smart contracting. 8. J. b. 7. which drastically limited the opportunities for partners to take advantage of losses and correspondingly reduced the use of limited partnerships for tax shelter investments. b. 4. Vary from state to state. bankruptcy. Limited Liability Partnerships 46 . ii. Limited Partnerships 1. 5. withdrawal. Limited Partners Do not participate in control. Benefit over limited partnerships because investors can participate in management L. (2) Avoidance of the double tax on corporate income. De Escamilla—Hacienda Farms was formed as a limited partnership with Russell and Andrews acting as limited partners. Consists of one or more general partners. Most appealing for favorable federal income tax features. plus one or more limited partners. Rules are governing LPs are essentially the same are those for ordinary partnerships. 2. the general partner was incorporated so there was no personal liability. the UPA is a set of DEFAULT rules. It specifically states that partners may design their own methods for dividing up assets and such an agreement will control. 6. Most common pay off rule provides for payment of the fair market value of the withdrawing member’s interest. iii. Tax Reform Act of 1986 added a new provision affecting passive activity losses. generally with 6 months notice. 2. etc). Bankruptcy was filed by the partnership. c. 5. This is a common thing.could pay a fee to the firm for taking a case and then the case would be gone. Rule: If a limited partner exercises control over the partnership business. Limited Liability Companies 1. a. (1) Limitation of the liability of investors to the amount invested in the firm. etc. the limited partner must not assume any active interest in the partnership affairs. Two objectives of an LLC: a. do not have the power to act for the firm. NOTE: In this case. 6. he becomes a general partner. Rule: Upon dissolution and division of assets. reduced by damages. Holzman v. To preserve personal liability immunity. However. This partnership agreement winds up the partnership immediately.
Chartering Business NJ and Delaware were in a battle “chartering business” for years. England a. the partnership structure becomes less effective and corporation structure becomes more effective. e. America a. This is because in order to function in the American economy at this time. Delaware takes the NJ statute and improves upon it. a second state to give full faith and credit to a legislature’s grant a corporation certificate to a company. it was nearly impossible to have that many partners. b. A quid pro quo—the King got something in exchange for granting you a corporation status a body with a separate legal identity. NOTE: As the minimum capital needed increases. However. f. Until mid-19th century. Virginia (p. This attached somewhat of a scandal because of quid pro quo with legislatures and grant of a corporation. To raise that much money. CORPORATIONS A. This is a STATE law topic. you didn’t need a big business. Consequently. Royal Charter Corporation was a Tool / Extension / Concession of Government b.” meaning “body” 2. Derives from “Corpus. 47 . o “A race to the top” Load up laws in favor of investors and not in favor of promoters. Investors have an advantage of promoters/managers. LLPs are general partnerships for which the liability of the general partners is restricted. Delaware won! States are in competition with one another to charter business. A partner in an LLP is not personally liable for partnership obligations arising from negligence. d. it was rare for a business to ask for corp status. i. wrongful acts. and as such a state could only preclude a foreign corp from engaging in transaction within its own borders if these transactions did not amount to interstate commerce. 3. was not a citizen entitled to the benefits and privileges and immunities clause of the Constitution. or similar misconduct unless the such actions were committed by the individual partner or a person operating under the partner’s direct supervision and control. Thrives on investor ignorance. History 1. III. i. the grant of incorporation fell within the field of interstate commerce. g. Partnerships worked fine because small business’ needs were served easily in this way because there wasn’t a large need for capital.1. The traditional idea of corporations changed with the development of Railroad companies because you needed a tremendous amount of capital. This decision is a transitional one because it first held that a corp. c.114 in K&C)—Facilitated the ability of a corporation incorporated in one state to do business in another. 1896—New Jersey’s General Incorporation Statute—invited companies to incorporate their companies. State competition for chartering Business is either (either good or bad for investors): o “A race to the bottom” or Load up laws in favor of promoters (or managers) of business and not laws that favor investors. Paul v. ii.
The shareholders elect a boards of directors. and certain rights with respect to creating a public market for the shares of selling its shares in the market. VC The money in such funds comes from wealthy individuals or from institutions such as pension funds and University endowments. and generally the people owning a substantial portion of the total shares will occupy the top managerial positions or will be involved in a meaningful way in the selection and monitoring of the people who do occupy those positions as well as in the formulation of the corporate strategies and policies. typically financed by a venture capital fund (VC). “manager controlled” “Closely Held Corporation” A corporation that has a small number of shareholders. H. “owner-controled” “Startup Corporations” Important intermediate type of corp. directors. 2. each with a relatively small investments. but the basic rules are much the same. 1. Fund will be managed by savvy people who invest the money in huge gains to make up fro the inevitable losers. Shareholders are likely to be members of the board of directors. generally operates on a modest economic scope. A corporation is a particular set of rules for the organization of economic entities. The officers and other employees act on behalf of the firm. G. non-public information. No or little separation between ownership and control 3. J. The shareholders in such corps do not expect to participate actively in the operation of the business. 2. h. Some federal regulations requiring disclosure of important facts relating to operation and financial performance. Equity ownership is reflected in shares of stock of relatively modest value (rarely more than $100). As a separate entity. that enters into contracts. C. D. it is the corporation. a. There are a large number of investors. I. They are passive investors. Shareholders have no powers to act on behalf of the corporation. Entity investors are called are called shareholders or stockholders and their ownership interests are reflected in shares of the common stock of the firm. 3. Assets separated from Shareholders 48 . Woodrow Wilson “REFORMED” NJ’s statute. not the shareholders. and employees on the basis of material. Also prohibitions on “insider-trading”—trading by corporate officers. thus. VC managers will bargain no only for a share of the gain if the venture is successful but also for participation in control and for various protections. and files or is the defendant in lawsuits. the aggregation of individual savings permits large-scale investment and large-scale operations by the corp. 1. 3. E. In 1913.B. VC is likely to insist on seats on the board of directors. 1. Separate Entity a. 3. “Public Corporations” Large firms with many shareholders and with active trading of shares. who in turn select the officers who run the business. subject to approval of the board of directors as to major decisions. F. Corporation codes vary from state to state. Characteristics (accounting for success in organizing economic activity on a large scale) 1. Divisible ownership a. Founders “incorporate” the corporation by filing certain documents with the appropriate state agency and may chose to do so in any of the 50 states. 2. a priority in case of liquidation. incurs debt. NY Stock exchange and NASDAQ also have regulations requiring minimum numbers of independent directors. This is the best idea because the promoter wants to sell stock in a new corp and to get good investors you need to promote a favorable environment for the investors to give their money. and destroyed it. 2.
Shareholders—elect Board of Directors—hires. Thus. K. v. The issue on which we will most closely focus b. Smith Mfg. d. b. fire hydrants. The shares of stock of public corps are freely transferable and may be bought or sold on established markets such as the NYSE. by voluntary liquidation upon recommendation of the board of directors approved by a vote of the majority of shareholders. monitors. Shareholders risk losing the amount of their investment. manufactures and sells valves. A. In the absence of such agreement.P.. limitations may be imposed on transfer. 6. by merger into another corp. Corps should not be studied in this fashion because there are many categories of people whose activities are coordinated within the firm. Transferable and Tradeable Shares and Debt Obligations a. Barlow (1953. the board and the professional managers have effective control. This means maximizing the corporation’s profits. 2. Co. Its board of directors adopted a resolution. This protects the corps stability and its creditors. but no more. In closely held corps. who in turn appoint the CEO and other officers. RULE: Shareholder Wealth Maximization is the Exclusive goal of Corporations a. Co. Shareholders cannot remove from the corp their pro rata share of the corp’s assets. etc.a. 99 /100 times. shares are freely transferable. Professor thinks there is nothing wrong with it. The shareholder power to elect directors may have little practical effect. or by judicial decree in extreme circumstances. b. e. The stockholders of the corporation questioned this action. Contractual obligations and debts incurred by employees of the corp are strictly obligations ad debts of the corp. OVERALL: According to Professor.500 be transferred to the university. It is just a feature of a corporation. Centralized Control and Separation of Ownership and Control a. The corp’s existence may be terminated as a result of insolvency. which set forth that it was in the corporation’s best interests to join with others in the 1951 Annual Giving to Princeton University and designated $1. p. by agreement among the shareholders. Lawyers and laypersons tend to speak instinctively of a corporation as an it—to reify it—as if it has an identity and an existence of its own. not of the shareholders (or the employees or directors). Berle and Means two men who wrote on and had problems with this separation of control and ownership. & disciplines if necessary Officers 8. Shareholders elect the members of the board of directors. L. Assets of a corporation are held by the corporation. Issue: Whether this donation by 49 . Limited Liability a. courts will defer to business judgment of the corporation. 4. b. Smith Mfg. Indefinite Duration a. The traditional view is that he objective of a corp is to maximize wealth of shareholders c. 7. There is a separation of share ownership and control. d.282)—The A.P. boards tend to be self-perpetuating. This means the shares are highly liquid—the can be turned in to cahs by a quick phone call or a few keystrokes on the internet. 5. c. Role and Purpose of Corporation 1. This is the basic premise or tenant on which the entire analysis of corporate governance by the law and economics movement is based. with new members often chosen by the professional managers.
i. d. This case is RICH with history i. Courts of equity will not interfere in the management of the directors unless it is clear that they are guilty of fraud or misappropriation. b. iii. Ford was really against the Rockefeller “big fat capitalists” and the “robberbarons” and so he would never say that he was out to maximize profits. the Dodge brothers are minority shareholders (Ford had 58% and Dodge Bros had 10%) and are creating their own car company—so Ford has an incentive NOT to pay them special dividends (they will invest the money in a competing company). ISSUE: Whether Ford is required to pay the special dividends to the shareholders or whether it can re-invest the profits in the company? a. courts are extremely tolerant in accepting the business judgment of the board of directors. or refuses to declare a dividend when the corporation has a surplus of net profits which it can. If they did so. p. § 122: “Every corporation created under this chapter shall have power to…9) make donation for public welfare or for charitable. Delaware General Corporate Law. He even states that Ford Motor Co. scientific. Ford Motor Co. ii. revise or repeal” the corporate charter at any time. Dodge v. Rule: A corporation’s primary purpose is to maximize the profits for its shareholders and the powers of the directors are to be employed to that end. this is a business decision and management is in the hands of the directors i. This case deals with two issues—the power of a corporation to designate funds to charities/philanthropic uses and the power of a statute to pass statutes that apply to corporations incorporated prior to the enactments. alter or repeal corporate charters at any time. Business Judgment Rule—the court found that such a donation was an implied power of the board of directors.288)—The Dodge brothers filed suit against Ford Motor Co. A corp. no one would incorporate there. 50 . Rule: A state has reserved powers which permit it to revise. b. New Jersey has passed a law allowing such donations by corporations e. after Ford decided not to pay any more special dividends and to instead reinvest the money in the business. charter is relatively meaningless now. (1919. so this rarely comes up. f. c.” c. Reserve Powers—states can “alter. Intra Vires—“within the scope” of the corporation’s powers (or the board of directors powers). HELD: Ford ultimately loses and the court orders him to pay the special dividends (which of course he got 50% of because he owned 50% of the shares).the corporation was intra vires? a. d. g. and to determine its amount. Most state incorporation laws include this sort of provision and are typically read as authorizing charitable contributions that aid in maximizing the corporation’s profits. 3. or educational purposes…” ii. However. i. HELD: Giving money to a University is within the scope of the corporation’s power because it was a modest amount given as an investment in the community and in the future of the company. should only make a “reasonable amount of profits. here. Normally it is the directors decision whether to declare a dividend of the earnings of the corporation. without detriment to its business and a refusal to doe so amounts to an abuse of discretion that breaches the duty of good faith. In this case. Ultra-Vires—“outside the scope” of the corp’s power.
The court does say that he can build the plant (he wanted to build a plant to expand the business). ii. The thing is “judges are not business experts” and we really don’t want the judge deciding these issues. e. NOTE: If Ford had said something like Barlow, then he would have won. f. QUESTION: Is there a difference between the company and the shareholders? To Professor, the company is the shareholders. g. NOTE: Professor doesn’t think the court should interfere into business judgment. 4. Shlensky v. Wrigley (1968, p.293)—Wrigley, the majority shareholder and operator of the Chicago Cubs, refused to install lights at Wrigley Field so that the club could hold night games. Shlensky, a minority shareholder, filed a derivative suit to compel the installation of lights (stating that the club was losing money by not having these night games). a. Rule: A shareholder’s derivative suit must be based on conduct of the directors which exhibits fraud, illegality or conflict of interest and not just on a disagreement over a business decision. b. HELD: Here, the court states that there is a lack of fraud, illegality or conflict of interest—the minority shareholder just doesn’t agree with the directors’ business decision. The court says, “We do not mean that we have decided that the decision of the directors was a correct one. That is beyond our jurisdiction and ability. We are merely saying that the decision is one properly before directors and the motives alleged in the amended complaint showed no fraud, illegality or conflict of interest in their making of that decision. c. The court finds that it is not its place to determine whether or not the lack of lights is a bad business decision absent those things. 5. Principles of Corporate Governance (American Law Institute), a. This turned into what the law should be and not what the law was; therefore, never called a restatement. Thus, this has not had much of an effect on corporate law. b. § 2.01 Profit Maximization and Alternatives. i. (a) A corporation should have as its objective the conduct of business activities with a view to enhancing corporate profit and shareholder gain. ii. (b) Even if corporate profit and shareholder gain are not thereby enhanced, the corporate, in the conduct of its business: o (1) Is obliged, to the same extent as a natural person, to act within the boundaries set by law; Ex. do you need to tell your driver to follow the speed limit no matter what? o (2) May take into account ethical considerations that are reasonably regarded as appropriate to the responsible conduct of business, and “may”—not required to consider ethical issues o (3) May devote a reasonable amount of resources to public welfare, humanitarian, educational, and philanthropic purposes. The board decides what is reasonable. M. Formation: 1. Central step in the incorporation process is the filing with a state official (secretary of state) of a document usually called the articles of incorporation or the charter. a. Includes a nominal fee, b. SOS issues a certificate of incorporation, evidencing the attached articles have been filed with him or her. c. Articles of Incorporation i. Usually brief, with its contents closely tracking the requirements of the incorporation statute of the jurisdiction of incorporation, which statute
usually sets forth in very specific terms necessary for minimal contents of these articles. ii. Delaware Code § 102 Name, Address, purpose of the business, name of incorporator, and specify classes of stock that can be issued and their rights. iii. Will often authorize the issuance of a maximum number of shares in each class, and the Board of Directors may from time to time issue up to the number specified for each class. The number of shares may be increased only by a vote from the shareholders. d. Corporation registration office is in the jurisdiction of incorporation. Bylaws adopted by the Board of Directors a. Cover number and qualifications of directors, committees of the board and their responsibilities, quorum and notice requirements for meetings of shareholders and directors, and titles and duties of the corporation’s officers. Filing is a matter of notice. a. Gives notice to the world of the corporation’s governance structure, and this can be important in some instances. b. Limited partnerships must also meet public notice requirements c. Important for security interest reasons. Concession Theory of the Incorporation State gives limited liability to shareholders. a. Not unfair because there are two kinds of creditors: i. (1) Contract Creditors and o Professor—The creditors choose to contract with the company, despite the limited liability set up. Therefore, limited liability is not unfair. ii. (2) Tort Creditors. o Limited liability may be unfair since these creditors don’t bargain to be a creditor. b. Therefore, a corporation’s limited liability is not must of a “Concession” by the state. Amendment a. Articles of Incorporation may be amended by a vote of the majority shareholders. b. Modern corporate law has abandoned the “vested right” doctrine and replaced it with procedural protection. Today, under most state statutes, proposed charter provisions that adversely affect the legal rights of a specific class of stock will require “class voting” the amendment must be adopted by both the majority of all shareholders and by a majority of the adversely affected class. Duration a. Corporations have a perpetual or unlimited life. b. May be dissolved upon a shareholder vote or, in extreme situations, by judicial or other governmental order. c. In the absence of an agreement to the contrary, or special circumstances justifying judicial intervention, a minority shareholder has no legal power to terminate the existence of the firm or to withdraw his or her capital. However, shareholders may be more readily able than partners to sell their interests. d. Shares of stock are freely transferable unless there is an express agreement to the contrary in the articles of incorporation or bylaws. e. A change in the identity of shareholders has no effect on the identity of the corp. f. “Right of First Refusal” Each party can grant a right of first refusal to the other, meaning if a party wishes to sell his or her shares to an outsider, the shares must first be offered to the other existing shareholders at the price the outsider is willing to pay.
g. Buy/sell Agreement—also applies to corporations and shareholders. 7. Choice of law a. Freely choose to form their corporations in any of the fifty states. b. Internal Affairs Law—Regardless of where the corporation operates or where its shareholders or assets are located, the laws of the state in which a corporation is incorporated will apply to question concerning internal corporate governance. c. Those states that allow participants in the venture to greatest freedom to shape the rules that will govern them are called “permissive.” N. Promoters and the Corporate entity 1. “Promoter”—term of art referring to a person who identifies a business opportunity and puts together a deal, forming a corporation as the vehicle for investment by other people. a. A promoter’s activities includes arranging necessary capital, acquiring any needed assets or personnel, and arranging for the actual incorporation of the business. 2. Fiduciary Duties a. Agent of a principal that is a corporation—Stockholders can’t sue for damage to the corporation. Therefore, the fiduciary duty is to the corporation and not to the officers, stockholders, etc. b. A promoter owes a fiduciary obligation to the corporation, like that of an agent and principle. (but obligations to the corp. do not come into existence until the corporation comes into existence.) c. Problem on Page 200 in Case book: i. Case 1: Demonstrates common law fraud. ii. Case 2: Disgorgement remedy causes faithless agents to drop their profits. Agent can satisfy his duty to his agent through full disclosure. iii. Case 3: The Corporation becomes the real party in interest. iv. Case 4: Sometimes the form of the transaction can prevail over the substance of it. “There is more than one way to skin a cat.” 3. Liability of the Promoter to Third Parties: If the corporation has already been formed and a promoter makes a contract in the corporation’s name, then there is normally no issue in regards to liability. The corporation is liable and the promoter is not. However, there are a number of situations when the promoter could be liable. EXCEPTIONS: a. Corporation not formed and not named in K If a promoter makes a contract in his own name without referring to a not-yet-formed corporation, the promoter will be personally liable, even if the promoter had the intent to assign the contract to the corporation. b. Contract in Corporation’s name without noting corporation has not yet been formed When a promoter makes a contract that purports to be in the corps name, but does not on its face disclose that the corporation has not yet been formed as of the contract date, and the other party is not aware that the corp does not exist, then the promoter will be personally liable on the contract, provided the promoter was aware that the corp was not yet formed. c. Promoter Believes Corp has been formed If the promoter believes the corporation has been formed, but due to some technical defect, which he is unaware of, the corp doesn’t exist at the time he signs the contract on the corp’s behalf, then the courts have generally found ways to rule sympathetically toward the promoter. i. De Jure Corporation—When the defect is trivial, the court will forgive it and treat the core as a de jure corp. ii. De Facto Corporation—when the defect is more serious, the court will apply the common law doctrine and treat the unincorporated business as 53
Piercing the Corporate Veil 1. Southern-Gulf relied upon the contract and secured financing. Southern-Gulf Marine Co. Inc. IF the corporation is actually formed. he will be liable for the corporation’s acts upon the principle of respondeat superior applicable even where the agent is a natural person. the promoter will also be held personally liable for the same reason. Solutions within Contract: i. No. Successor in interest provision for corp formed in a different jurisdiction iv. a. ii. The court will reason that the parties intended for SOMEONE to be liable and in the absence of a corporation. (1982. a. Put a minimum capital requirement on the K so that when the capital on the corp reaches a certain level. the promoter is likely to be held personally liable. 9. or. the court must interpret the parties intent: i. HELD: The record discloses nothing indicating that the substantial rights of the defendant were affected by Southern-Gulf’s de facto status. c. the promoter is must less likely to be held liable. Problem. does not exist. EXAM: How do you help a client avoid getting its veil pierced? 2. but it still depends on the intent of the parties.202)—Camcraft sought to get out of a contract with Southern-Gulf stating that Southern-Gulf had not been incorporated when the contract was signed (trying to get out of the contract by a technicality). “Alter Ego” Principle—100% owner is treating the corporation as an “alter ego”—similar to agency law 54 . The courts will disregard the corporate form. RULE: When a party has contracted with what he acknowledges to be and treats as a corporation and has incurred obligation in his favor. iii. Camcraft. “pierce the corporate veil. the Corp. Therefore. Inc. i. the individual is no longer liable on the K and the corp becomes liable. General Rule: The law permits the incorporation of a business for the very purpose of enabling its proprietors to escape personal liability. (can’t use contract technicality offensively) b. Contract indicates that a corporation is formed In this situation.” whenever necessary to prevent fraud or to achieve equity. Camcraft is estopped to deny the corporate existence of Southern-Gulf in this regard and the rule of construction which adapts an interpretation in accordance with justice and fair dealing with doubts resolved against the seller. iii. p. the promoter sets forth a contract that indicates to the other party that it is dealing with a corporation yet to be formed. it is the promoter. at the time the K is signed. 4. EXCEPTION: Whenever anyone uses control of the corporation to further his own rather than the corporation’s business. Try to specify what happened if corp is not formed an dif it is formed what happened if corp doesn’t adopted the K. d. ii. but which is intended to be formed. If the corp adopts the contract. but he signs as an individual and as president of the non-existent corp. b. that party is estopped from denying the existence or legal validity of such a corporation in order to escape those contractual obligations. O. Term allowing Camcraft to stop construction if the corporation is not formed.incorporated calling it a de facto corporation and extending protection of limited liability. to use accepted terminology. but the contract is never adopted. In this case. v. IF the corporation is never formed. Camcraft likewise relied on the contract and began construction of the vessel.
Such liability extends not only to the Corporation’s commercial dealings but to its negligent acts as well. P was seriously injured. The enterprise does not become either illicit or fraudulent merely because it consists of many corporations.ii. Three possible legal doctrines that a plaintiff might invoke in such situations: o Enterprise liability—can get to other assets of other corporate entities. In this case. o NOTE: you have to be licensed to run a cab o DISSENT: He argues that he doesn’t think that the Legislature intended to require a taxi corp to only have the minimum amount of insurance if they can afford more. If corporation is a “dummy” for its individual stockholders who are in reality carrying on the business in their personal capacity for purely personal rather than corporate ends. by one of D’s cabs. o One corporation treating the assets of another corporation as its own. o Clear Legislative Statement Rule the reading of the statute is so odd that we won’t read that meaning into the statute unless it is done clearly. o Disregard for the corporate entity (piercing the corporate veil) 3. then only the larger corporate entity will be held financially responsible iv. D owns many corporations and holds only the minimum insurance per cab. To Professor this is part of formalities don’t intermingle corporate and personal funds. o HELD: There is no valid cause of action. and if the insurance coverage required by statute is inadequate for the protection of the public. and i.207)—Common practice as a taxicab industry of vesting the ownership of a taxi fleet in may corporations. passing bylaws. Carlton (1966. the remedy lies not with the courts but with the legislature. (1) Such a unity of interest and ownership that the separate personalities of the corporation and the individual are or other corporation no longer exist (maintain corporate formalities). having board of director’s meeting. but not to the personal assets of the owner. iii. then the stockholder will be personally liable. The taxi owner-operators are entitled to form such corporations. Professor thinks this is ridiculous. each owning only one or two cabs. There are no allegations that D was conducting business in his individual capacity. 55 . o Respondeat superior (agency). If a corporation is a fragment of a larger corporate combine which actually conducts the business. p. o Undercapitalization—not enough capital to meet the normal predicable costs of doing business. o Commingling of funds or assets. vi. Factors: o Failure to maintain adequate corporate records or to comply with corporate formalities Follow formalities of having Certificate of incorporation. RULE: A corporate Entity will be disregarded and the veil of limited liability pierced when two requirements are Met: a. v. Walkovszky v. and He is so involved in the operations that we should hold him responsible under agency theory.
i. o Some wrong beyond a creditor’s inability to collect would result o Common sense rules of adverse possession would be undermined o Former partners would be permitted to skirt the legal rules concerning monetary obligations. ii.218)— Skipped 5. D has a judgment against one of his corporations that dissolved. However. is not liable for the debts of the subsidiary. commingling business funds from various corporations and his personal funds. 4. When a corporation is so controlled as to be the alter ego or mere instrumentality of its stockholders. Inc. o A party would be unjustly enriched o A parent corporation that caused a sub’s liabilities and its inability to pay for them would escape those liabilities o An intentional scheme to squirrel assets into a liability-free corporations while heaping liabilities upon an asset-free corporation. a. (2) Circumstances such that adherence to the fiction of separate corporate existence would sanction a fraud OR promote injustice (Corp. the corporate form may be disregarded in the interests of justice. On remand. p. b. There is no respondeat superior between subagents/subsidiaries The “alter ego” makes a parent liable for the actions of a subsidiary which it controls. The second is a “subsidiary” c. This is determination is based upon a totality of the circumstances. found P was defrauded. In Re Silicone Gel Breast Implants Products Liability Litigation (1995. 56 . P tries to get money from D personally and from his other corporations. o HELD: Clearly shared control/utility of interest and ownership. i. v. Sheffield (1971.212)—D is clearly not following corporate formalities. Sea-Land Services. p. may not be used to commit fraud). additional companies owned by the liable party may also be held accountable for the debts owned and they may have their veils pierced because of their relationship to the guilty party if the court orders the piercing by court order. Corporate shareholder must be aware of the danger that if it is not careful. “Promote injustice means something less than fraud. the creditors of the subsidiary may be able to pierce the corporate veil of the subsidiary. p. like any other shareholder. the court remands for a determination of whether not awarding damages would “promote injustice” in the manner shown above. o Enterprise Liability situation o “Reverse Piercing” when a person is found liable through veil piercing of the corporation they own. but it does not mean that where a parent controls several subsidiaries each subsidiary then becomes liable for the action of all other subsidiaries. Ex. Pepper Source (1991. so the parent. beyond those it decides to commit to the subsidiary. Someone sues b. so the parent can undertake an activity without putting at risk its own assets. Bristol also owns other subsidiaries. Must act as if the corporation is separate from you. Roman Catholic Archbishop of San Francisco v. and undercapitalizing the businesses. The first corporation is generally referred to as a “parent corporation” not liable for the debts of the subsidiary. A corporation owns all the shares of common stock of another corporation.222)—Bristol Beyers Squib is the parent corporation and owns 100% of MEC as a subsidiary. a.
The parent and the subsidiary have common directors or officers The parent and the subsidiary have common business departments The parent and the subsidiary file consolidated financial statements and tax returns The parent finances the subsidiary The parent caused the incorporation of the subsidiary o The subsidiary operates with grossly inadequate capital o The parent pays the salaries and other expenses of the subsidiary o The subsidiary receives no business except that given to it by the parent o The parent uses the subsidiary’s property as its own o The daily operations of the two corporations are not kept separate o The subsidiary does not observe the basic corporate formalities. a. It is often easier for a lawyer to form a corporation than for clients to respect the form and thereby make it effective. Presser is the authority on this issue. Can’t complete plan around the avoidance of liability—can conform to formalities to help. etc. Rs controlled the Union property and through their control of Union they exercised day to day control and management of Commercial. SO WHAT? How is this fraudulent? iii. Totality of Circumstances Factors: o The first 5 are not necessarily bad—Found in most subsidiary situations. Rs were also officers of Union. d. 2 of the 3 directors were the same. Rs were limited partners of Commercial. which is not possible for tax-shelter-type investments if the corporate veil is used. they filed consolidated federal income tax returns. Frigidaire Sales Corporation v. ii. 7.for a breast implant leaking and try to hold Bristol liable. For example.229)—P enters into a contract with Commercial. iv. such as keeping separate books and records and holding shareholder and board meetins. b. Professor kind of says. Union Properties. a limited partnership. c. used its own resources to loan money. Commercial breaches the contract. The tax advantage of the use of the limited partnership form of organization was that the investors were able to claim their pro rata share of the losses of the partnership on their individual tax returns. A variation on the basic limited partnership” a limited partnership with a corporation as the sole general partner. (1977. 57 . Delaware courts do not necessarily require a showing of fraud if a subsidiary is found to be the mere instrumentality or alter ego of the stockholder. o HELD: The court concludes that a jury could find that MEC was but the alter ego of Bristol based upon the totality of the circumstances. 6. This could be a case of Apparent Agency—Bristol Meyers was holding itself out as the source of the breast implants because name was on the product. p. Inc. “Tax Shelter” Investments ones that show losses for tax purposes even though they may be successful economically. No individual was liable for the debts of the partnership. the only general partner of Commercial.
Often better in these situations to pay off the plaintiff shareholder so that you can continue running the business. etc. If a corporate official violates any of the duties he or she owes to the corportation. a. In normal circumstances. 2. 208 i. directors. board of directors. Professor: This is the correct/fair outcome because to do otherwise would result in a windfall because P knew what they were bargaining for when entering into the contract. ii. a. b. exchanging low recovery for high attorney’s fee award. Tendency for meritorious actions to result in Collusive Settlements real party in interest tends to be the plaintiff’s attorney and this attorney has an economic incentive to strike a deal. This prevents the free rider problem that would otherwise exist. questions of litigation strategy are decided by the board of directors. Look p. 5. Sometimes even offer a non-monetary remedy (“put together an investigation committee”). b. DERIVATIVE LITIGATION 1. iii. In effect the law “taxes” all shareholders and thereby equitably apportions the costs of monitoring the defendant’s conduct. The lawsuit is the corporation’s right and any recovery from the action accrues to the corporation. i. Suit may be brought for its nuisance value because it is often more costly for the defendant to defend the action than it is for the plaintiff’s attorney to bring it. resulting in damage to the corporation. Thus. P was never led to believe that respondents were acting in any capacity other than in their corporate capacity. c. Necessary because of the separation between ownership and control 3. a. not shareholders 7. IF SUCCESSFUL Corp required to pay the plaintiff shareholder’s expenses because he has benefited the corp. Because Rs scrupulously separated their actions on behalf of the corporation from their personal actions. Typically involves a breach of the fiduciary duty of loyalty owed to the corporation. In this case the shareholders loose out and the shareholder plaintiff gets a greater benefit. b. or shareholders of the corporate general partner. petitioner never mistakenly assumed that Rs were general partners with general liability. This creates an agency problem because the shareholder plaintiff owes a duty as an agent to the stockholders. this indirectly affects the shareholders. American law recognizes the right of a shareholder to sue in the corps behalf to redress the injury. judicial approval of settlements reached in class and derivative actions is required in almost all jurisdictions. P. and the board of directors fails to take appropriate action. 6. Nuisance Action or Strike Suit a. “Damage” Corporation’s financial situation is worse than it otherwise would be and the price of the corporation’s stock is lower than it otherwise would be. IF UNSUCCESSFUL Attorney/plaintiff bears the cost of the suit. In reality suit typically brought by plaintiff’s attorney who owns a small amount of stock. HELD: Limited partners do not incur general liability for the limited partnership’s obligations simply because they are officers. 58 . This arises because both the Defendants and the nominal shareholder plaintiff can pass the real costs of litigation onto the corp.i. ii. True defendants are the individuals who have wronged the corporation—officers. To reduce the possibility of collusive settlements. 4.
P must allege that a majority of the board personally benefited from the challenged transaction or was otherwise subject to a legally disabling conflict of interest. i. d. applicable to pending actions. such a law is a substantive rule of decision. the plaintiff may still be barred from proceeding because of the special litigation committee. NJ passes a statute. o HELD: P is a self-chosen representative and a volunteer champion —Constitutional to require a bond to be posted. SLC would hire outside counsel and carry out a thorough investigation. Reputation. making Ps with a small interests with companies liable for posting a bond for the reasonable expenses of attorney’s fees of the Defense if he fails to make good his complaint. 9. thereby avoiding the need for the lawsuit o Bring the requested action o Permit the P to proceed in its place. Delaware Strict Demand Rule gives the BOD the opportunity to do one of several things. 8. b. Furthermore.0125% of the total shares). the making of demand concedes that a business judgment test applies to the board’s decision to reject demand. To deter frivolous action. ii. Only shareholder who owned shares contemporaneously to at the time of the wrong have standing to sue because subsequent shareholders not injured by the wrong. iii. P often required to post a bond for defendant’s attorneys fees to be paid if action is unsuccessful. i. o Take corrective actions or enter into a settlement with the D.232)—Cohen owned 100 shares in Beneficial at $90 a share (this is . or o Reject the requested action as not in the corp’s best interest. Problem because sometimes derivative litigation is a necessary monitoring mechanism by which to police the conduct. a plaintiff who wishes to commence a derivative action must either first make a demand on the board of directors to bring the action or demonstrate that demand was excused. Beneficial Industrial Loan Corp. In DE. o RULE: A federal court with diversity jurisdiction must apply a state statute providing security for costs if the state court would require the security in similar circumstances. P seldom makes demand. to Professor. p. Generally. demand excused distinction be dropped and that demand be required in virtually all cases.d. a. (1949. a. Excused Demand usually excused if the complaint alleged misconduct by ay of the board’s members. After Cohen initiates the suit. is more important to a person than the fear of litigation—if a reputation is bad then no one will wan to invest in the company. e. Procedurally. Cohen v. Business Judgment Rule—the corporation’s board of directors can successfully move to dismiss the action on the ground that it has reviewed the action and deems it contrary to the corporation’s best interest. c. Demand Rule strictly enforced. consisting of director who were not properly regarded as defendants. Preferring to argue excused because under Delaware Law. Cohen is complaining about mismanagement and fraud and brought a derivative action. but American Law Institute ha recommended that the demand required. 59 . o NOTE: There are remedies for these situations other than Litigation. Special Litigation Committee—Even if demand is excused.
10. demand will be deemed to be futile (and thus excused) if the board is accused of having participated in the wrongdoing. financial. HELD: P was had a personal cause of action. p.” In general. This case is here to show that it can be difficult to determine if a suit is a direct suit or a derivative suit. TEST: The question to ask is whether the injury is a direct injury to the people (shareholders) or an injury to the corporation (and only an indirect injury to the shareholders). b. and b. Business judgment rule: How much judicial review do you want in the internal organizations of a business? a. 11. officers. individually. RKO Case The officers loose a $100. Justifications frequently given are plausible. If a JUDGMENT for money damages is imposed on the Ds. Inc. the corporation or the stockholders individually. i.b. Court vary in their standard of review applied d. Flying Tiger Line. Delaware 2 prong standard to be used in determining whether a stockholder’s claim is derivative or direct: a. 13. not a derivative suit. 12. (1) Who suffered the alleged harm. e.000 attorneys fees awarded and a committee assigned to investigate. The requirements of demand on directors: Direct suits generally vindicate shareholders’ structural. ISSUE: Whether this suit is a derivative action or a class action direct law suit? a. The suit was brought as a class action suit. Eisenberg argued that the reorganization would unfairly diminish his voting power and the voting power of all other public stockholders by preventing them from directly influencing the affairs of the operating company.000 contract because of bad contact. c. on the other hand. b. NOTE: most important check on incompetent management if the risk of being taken over. (2) Who would receive the benefit of any recovery or other remedy. generally enforce fiduciary duties of directors. or controlling shareholders – duties owed to the corporation. See Grimes v. (Direct action when shareholder claimed directors’ abdicated statutory control to CEO under terms of employment agreement). These committees almost always decide not to proceed with litigation and to dismiss action. The derivative suit is an action in which the plaintiff represents the corporation. Show how willing courts are to approve settlements. b.236)—Eisenberg is a shareholder of Flying Tiger and filed suit against Flying Tiger to overturn a reorganization and merger. Rule: The class action suit is a representative action where the representative of the class represents the issues of the entire class. Demand excused: Demand on the board is excused where it would be “futile. liquidity. d. Derivative suits. Delaware view: In Delaware. the corp can pay the legal fees of the P and of the Ds. c. Eisenberg v. they will be required to pay those damages and may be required to bear the cost of their defense. d. and voting rights. If a action is settled BEFORE judgment. The difference lies in the representation by the plaintiff. c. the corporation or the suing stockholders. i. (1971. Settlements and Attorneys Fees a. When the derivative suit brought it is settled with $500. demand will not be excused unless P carries the burden of showing a reasonable doubt about whether the board either: 60 . EVERY state pushes these suits towards settlement. Professor thinks this is funny! e. Donald.
. a demand is considered to be futile and therefore excused if the complaint alleges with particularity that a majority of the directors are interested in the transaction. Also. acted rationally after reasonable investigation and without self-dealing). a breach of the duty of loyalty by the board must be alleged with specificity. ii. demand will be excused if (and only if) the complaint alleges “with particularity” any of the following: o “That a majority of the board is interested in the challenged transaction. or (2) was entitled to the protections of the INFORMED business judgment (i.” In other words. etc. Rule: In New York.) Issue: Whether the board’s rejection of the demand made by the shareholder was valid? i. o Difficult to get: But Delaware makes it very difficult for P to make either of these showings. usually. In New York. the board rejecting the demand is entitled to the presumption that the rejection was made in good faith unless the stockholder can allege sufficient facts to overcome the presumption.” c. o This case just reiterates that in Delaware. after termination. Grimes alleges that the agreement is a breach of the board’s fiduciary duties because it failed to exercise due care and committed waste. d. he must plead facts showing either (1) or (2) with great specificity. For instance. New York: New York follows roughly the same rules as Delaware about when demand will be excused. Donald—Plaintiff is a stockholder and finds that the employment contract that the company has with Donald is terrible. a director who merely “passively rubber stamp[s] the decisions of the active managers” does not thereby exempt herself from liability.e. Rule: If a shareholder makes a demand on the board of directors to take action and that demand is rejected.) o That the board “did not fully inform themselves about the challenged transaction to the extent reasonably appropriate under the circumstances. o Here Grimes made a pre-suit demand and his failure to plead particularized allegations which would raise doubt regarding the board’s decision to reject the demand meant that the board received the protection of the business judgment rule. ISSUE: Whether the plaintiff was required to make a demand upon the board before pursuing litigation? i. she has lost her independence by being “controlled” by a self-interested director. Marx v. the CEO. or because. Akers—Plaintiff brought derivative action against board of directors of IBM alleging a waste of corporate assets due to excessive compensation of IBM executives and outside directors. o That “the challenged transaction was so egregious on its face that it could not have been the product of sound business judgment of the directors. medical benefits. it is usually not sufficient that P is charging the board with a violation of the duty of due care for approving the transaction. Grimes v. and that the directors failed to exercise their business judgment in approving the 61 .(1) was disinterested and independent.” (A director can be “interested” either because she has a direct self-interest in the transaction. although she has no direct self-interest in the transaction. that the directors failed to inform themselves to a degree reasonably necessary about the transaction. typically a plaintiff will not bring a demand because the plaintiff will not want to waive the right to an excused demand and admit that the board can make a valid decision. (The employment contract involved continued payment to Donald.
g. The plaintiff is entitled to show that the members of the committee were not in fact independent (e. Minority / Delaware view: Delaware. a case in which the Delaware Supreme Court tried hard to reconcile the need for early termination of meritless actions with the need to make sure that the independent committee does not simply rubber-stamp 62 . to accept the assertions of the intervenor and to disqualify the entire board would be to render the corporation powerless to make an effective business judgment with respect to the prosecution of the derivative action. receive the protection of the business judgment doctrine. or did not conduct even a reasonably careful investigation. that they were dominated by the controlling shareholder who was accused of wrongdoing). if the court is convinced that the committee was independent and used appropriate procedures. a. by contrast. the court adopts a standard of futility for demands. Alternatives (Insoluble problem) Germany: Must require a union worker member to be on the board. v. e. But the much more interesting question is whether.256)—A shareholder of GTE challenged the decision by a board-appointed special litigation committee to terminate a shareholder’s lawsuit.. the costs of proceeding with the suit would be high. The court will NOT attempt to make an independent determination of whether the committee was correct in its conclusion that the probability of recovery was low. or that the committee did not use reasonable procedures in reaching its conclusion (e. The Role of Special Committees and Judicial review Courts do not simply rubber stamp and independent committee’s decision not to pursue the suit. This moves you towards a more political model versus a business model. the New York position and the Delaware position. 14. Additionally. but the court may not inquire into the substantive merits of the decision—such a decision is protected by the business judgment rule. the court may nonetheless us its independent judgment about whether P’s suit has merit. Thus. etc. courts vary widely. ISSUE: Whether further judicial inquiry is permitted after a special litigation committee recommends dismissal of the derivative suit? o HELD: A court may properly inquire as to the adequate independence of the special litigation committee members and the reasonable appropriateness of its investigation. o In New York.transaction. Majority / New York Rule: The New York approach makes it very difficult for the plaintiff to overcome the independent committee’s recommendation that the suit be terminated.. On this issue. Instead. the legislature had not adopted a “universal demand” policy so it is not the role of the court to enforce such a policy. i. its investigation was very shallow). and the board’s approval of that recommendation. Maldonado. a bank representative must be present on the board. b. Bennett (1979. The Delaware approach was articulated in the landmark case of Zapata Corp. the New York courts will not review the merits of the substantive recommendation that the suit be dismissed. For instance. if P can show that the committee was not really independent.g. will in some situations let its court review the substantive merits of the committee’s recommendation that the suit be dismissed. p. Auerbach v. the court is unlikely to dismiss P’s suit based on the committee recommendation. the committee’s substantive recommendation that the suit be dismissed. There seem to be two main positions. o Therefore. ii. But once the court is satisfied with the committee’s independence and procedures.
and will allow the suit to proceed. they are themselves accused of wrongdoing by the plaintiff). only the independence. Zapata Corp. For instance. will be reviewed by the court.” whether the suit should be dismissed. the court may determine. not the substantive merit of its decision. the court will apparently treat the case just as it would treat a case in which the main board rejects the plaintiff’s demand. If the answer to any of these questions is “no. in Delaware the committee’s recommendation that the suit be dismissed will not be given the protection of the business judgment doctrine. independent. Two-step test: Under Zapata. procedural correctness. o (2) Step 2: Even if the committee passes all the procedural hurdles of step one. Only in “demand excused” cases: Apparently. the court may allow the suit to go forward even though the committee (acting with procedural correctness. Maldonado did not make a demand stating futility. it is only in cases falling into the “demand excused” rather than “demand required” variety that the court will use the two-step test of Zapata.261)—Maldonado was a stockholder of Zapata and brought a derivative suit against ten officers and directors alleging breach of fiduciary duty. It is in this second step that the Delaware approach varies sharply from the New York approach: whereas the New York courts would never enter this second step at all (and would always dismiss the suit if the committee passed muster under step 1). If demand is required¸ and the corporation responds by appointing an independent committee that then recommends not continuing the suit. and good faith of the committee. if the committee members are shown to have been dominated by a controlling shareholder. and good faith) has recommended against continuation of the action. v. p. and would probably result in a substantial recovery for the corporation. In that situation. Maldonado (1981. ii.wrongdoing by insiders. iii.g. i.. If the court feels that the suit has merit. or if they conducted a shallow investigation. ISSUE: Whether the committee has the power to cause the present action to be dismissed? o HELD: A court can review the decision by an independent litigation committee to dismiss a derivative suit and should apply a two-step 63 . bye “applying its own independent business judgment. the court should use a two-step test to determine whether the committee’s recommendation of dismissal should be followed: o (1) Step 1: The court should determine whether the committee acted independently and in good faith¸ and whether the committee used reasonable procedures in conducting its investigation. the Delaware courts retain the freedom to allow the suit to continue even though the committee acted with procedural correctness. or to have been motivated by their own self-interest (e. the committee recommendation will be disregarded.” then the court will automatically disregard the committee’s dismissal recommendation. In other words.
vi. viii. 4. EXAM ISSUE: Statutory Construction and Legislative Intent or Silence B. The plaintiffs also allege bad faith. b. c. applying its own business judgment. ii. INTRODUCTION: 1. Allows somewhat more flexibility than the corp in developing rules for management and control. IV. HELD: Drawing on a general sense of human nature. To Professor. “Scienter” Intent iv. iii.” NOTE: Regime Uncertainty Gov’t is imposing itself into a formerly private business regime. Revenue “Guidance”—A pitch to a meeting of higher ups giving estimates of future profitability. Limited Liability Companies A. which stated that the SLC must establish its independence by a yardstick that must be “like Caesar’s wife— above reproach. In Re Oracle Corp. “Fetishize” v. LLC is an alternative form of business org. RULE: The burden of proving the independence of the special litigation committee is on the special litigation committee and the SLC must show that the committee members are capable of making a decision with only the best interests of the corporation in mind. and on shareholders. as in corporations. four members of the board sold Oracle stock prior to the release of news about the company and before the stock price fell. Rather it seems to undermine traditional understandings of Delaware law that give clear and precise legal rules. no doubt tax on co. Advantageous tax treatment— a. whether the substantive merits of the committee’s decision are valid. the court determines the SLC has not met its burden to show the absence of a material factual question about independence. that combines certain features of the corporate form with others more closely resembling general partnerships.269)—Plaintiffs brought a derivative action stating that the defendants breached their duty of loyalty by misappropriating inside information and using it as the basis for trading decisions. This judge is trying to get the Supreme Court to change the law. The company appointed a special litigation committee to determine whether the suit should be dismissed. I find this to be the case because the ties among the SLC. LLC may be managed by its members or by managers who may or may not be managers 5. This opinion notes the Martha Stuart Case. the problem with this view is that no one could ever pass the test because he sets forth such a demanding standard of independence. the court should determine. the trading defendants. First. Liability shield for its members. o This case doesn’t seem like it benefits the shareholder and the corporation. Investors called members 3. Investors in an LLC can take account on their individual tax returns of any losses of 64 . and Stanford are so substantial that they cause reasonable doubt about the SLC’s ability to impartially consider whether Trading Defendants should face suit. Basically. p. Only LLC Is taxed once on its profits. i. Derivative litigation (2003. vii.test. 2. the court should inquire into the independence and good faith of the committee and second.
Inc.I.I. The missing link between the limited disclosure made by D and the protection of the notice statute was the failure to state that P. d. Consider Least Cost Avoider D. however. i.I.II. 3. f.I. HELD: LLC’s notice provision was not intended to alter the partially disclosed principal doctrine. Must first disclose LLC status 2.I. LLC. When P. However.” He negotiates a K with Ps and only gives them his business card. since all statutes fix a problem.I. i. The county court. LLC. the failure to disclose the fact that the entity was a limited liability company would be irrelevant by virtue of the statute. b. Water.I.. FORMATION: 1. Cannons of Statutory Construction i. the agency theory of the undisclosed principal controls. doesn’t pay on the K. Waste. found that P did not identify themselves as agents of P.I. then these agency rules must yield in favor of the statute. 6. otherwise. they sue D individually. e. a. If D had told P’s rep that they were acting on behalf of P. however. OPERATING AGREEMENT 65 . the company. ii. unless a law is codifying common law. LLC. Greater freedom than corp in allocating profit and loss for tax purposes. LLC. Statute normally provides a notice provision stating that filing the LLC with the proper agency creates constructive notice to the world of the limited liability enjoyed by the owners. Therefore. it is in derogation of the law and should be narrowly construed. a. The OPPOSITE of ABOVE: “Remedial statutes are to be broadly construed so as to effectuate its purpose. p.I. “Plain Meaning”—One the face of the statute—strongest statutory argument you can make..I.” then you have to know that it is a limited liability company. c. & Land. ii. his business card only says “P. it is inferred that the agent is a party the contract and is liable for damages and can be sued on the K. NOTE: If the general assembly has altered the common law rules applicable to this case by adopting the LLC Act.I. the principles of agency law apply notwithstanding the LLC Act’s statutory notice rules. C.300)—D is a manager and member of P.I. The court implies legislative intent from the rule that the LLC must have LLC in its name.” o Remedial statute is one that fixes the problem. Lanham (1998.” o Well. the plain meaning could be that in order to have “notice that the limited liability company is a limited liability company. it must first be disclosed to a third party that they are dealing with an LLC.. all statutes are in derogation of the common law. RULE: The statutory notice provision applies only where a third party seeks to impose liability on an LLC’s members or managers simply due to their status as members of the LLC.the LLC as those losses are incurred c. they are remedial and should be broadly construed.I.I. v. but as P. In this case.. When a third party sues a manager or member of an LLC under an agency theory. Paperwork and filing with state agency. This is always the first step in an argument because if the court beliefs it you win. Agency Undisclosed Principal Where the principal is partially disclosed (the existence of a principal is known but not his identity.. “Statutes in derogation of the common law are to be strictly construed. stood for P. therefore.
More specifically. set forth any requirements for contribution. RULE: Only where the agreement is inconsistent with mandatory statutory provisions (contravene the act) will the members’ agreement be invalidated. p. Jaffari (1999. State LLC statutes will establish “default rules” that govern. and set forth the remedies for breach of the agreement. it seems highly likely that similar concepts will be applied to LLCs.305)—Member brought purported derivative suit against limited liability company and its manager. key point of LLC statutes is that they let people come up with their own rules 3. PIERCING THE VEIL OF AN LLC 1. Most LLC statutes incorporate a policy of freedom of contract.” iii. p. stating “It is the policy of this chapter to give maximum effect to the principle of freedom of contract and to the enforcement of limited liability company agreements. Such statutory provisions are likely to be those intended to protect third parties. Does the statute thus mean that the LLC’s veil can not be pierced? The court says. The statute doesn’t say anything about piercing the veil. E. b. define classes of members or managers. that document is not the most important document relative to the LLC. the Delaware statute clearly enunciates this policy. b. While some of the concepts applied to corporations are not readily transferable to LLCs. a. Inc. through its operating agreement. Freedom of Contract i. The Court of Chancery dismissed suit for lack of subject matter jurisdiction. According to Professor. and (2) contractual provisions directing that all disputes be resolved exclusively by arbitration or court proceedings in California were valid under Limited Liability Company Act. indications are that courts will “pierce” the veil of an LLC under doctrines analogous to those currently applied in corporate piercing cases. HELD: (1) limited liability company was bound by agreement defining its governance and operation. 312)—Wyoming’s LLC statute does not mention piercing the veil. provide for the dissolution and windup of the LLC. govern voting rights. i. The argument is that the MT statute says that neither the members nor the managers are liable for the debt or obligations of the LLC. Elf Atochem North America. For instance. 2. “No. Rule: In the absence of fraud. provide for the allocation of profits and losses as well as distribution. 2. but these cases indicate that veil piercing will likely be permitted with respect to LLCs. ISSUE: Does Legislative Silence provide for piercing the veil? a. alleging. Flahive (2002. ii. b. Regardless of whether the relevant state law requires a certificate of formation or articles of organization. Kaycee Land and Livestock v. Other states have adopted piercing provisions. There are few cases dealing with this topic. but only if there are no controlling provisions in the operating agreement. the operating agreement can establish the process for admission of new members. even though company did not itself execute agreement. Despite uncertainties surrounding the piercing doctrine as applied to corporations. ii. the LLC. v. b. a. is structures as flexibly as its members choose b. Essentially. Essentially. and Wyoming has done nothing---What do you argue from inaction or silence? Professor wants us 66 . a.1. a. a claim to pierce the veil of a limited liability company (LLC) is treated in the same manner as a court would pierce a corporate veil. breach of fiduciary duty. the operating agreement governs the internal operation of the LLC as well as the relationship between the members and the LLC itself.” iii.
Board of directors can only claim the Business Judgment Rule is they have satisfied the duty of care and duty of loyalty. In this case there must be gross negligence to overcome the presumption. If read literally. if the legislature meant to get rid of an important doctrine like veil piercing. then there is a presumption of a proper decision based upon the business judgment rule. Conflict of interest—duty of loyalty 2. This is based on a “no barking dog” analysis. American Express Company (1976. § 303(b) of Uniform LLC Act (a big departure from Corporations law)—“The failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business is to a ground for imposing personal liability on the members or managers for liabilities of the company. Hunt Sports Enterprises—Members of an LLC formed to explore the possibility of applying for a new NHL franchise sought a declaration for breach of contract against each other based on the exclusion of certain members’ ownership interests in the franchise. FIDUCIARY DUTIES IN LLCs 1. these statutes allow the LLC to set what will be its own fiduciary responsibilities for members and the operating agreement will control 2. or misfeasance. THE OBLIGATIONS OF CONTROL: DUTY OF CARE 1. More than imprudent or mistaken judgment must be shown. ISSUE: Whether the member breached his fiduciary duty to the LLC? a. ii. This case is important because the court found that the members could allow for competition with the LLC by placing a clause in the operating agreement giving members such right. i. Because they did not. b. It should be noted that over half of state LLC statutes contain provisions which allow the operating agreement to modify or define the fiduciary duties of members or managers without restriction. and Other Insiders A. C. At the present time. Directors. Minnesota has such a statute. p. 3. the value of the stock was $4 million and the directors of AmEx faced the choice of 67 . they did not mean to get rid of the doctrine. The Duties of Officers.323) V. New Horizons Supply Cooperative v. Haack (1999. The scope of fiduciary duties owed by members and mangers of LLCs is. at best. illegality. malfeasance. in an embryonic stage. a.328)— AmEx made an investment in a brokerage firm called DLJ for $30 million. Consider the interests they protect—duty of care B. Kamin v. Rule: A member of an LLC does not breach a fiduciary duty to the LLC by directly competing against it where the operating agreement expressly permits competition. DISSOLUTION OF LLC 1. Focus on PROCEDURE. G. Simply stated. p. c. If the Board follows the proper procedure. McConnell v.” F. 1. RULE: The question of whether a dividend is to be declared or distributed is a matter of business judgment for the board of directors and courts will not interfere in such a decision unless a plaintiff can show bad faith (fraud. not on substance of the decision making—did the board make a reasoned business judgment? 1. these statutes allow LLCs to operate free of any fiduciary duties. The court’s upholding of this clause indicates the strong desire of the court to permit the parties to freely contract. iv.to think about the different arguments… can go both ways. selfdealing). they would have discussed it. o Ex. a.
Van Gorkom goes to see Pritzker without consulting the board and offers him the company at $55 a share. Professor thinks that the Court acts too quickly in taking the board’s word for the fact that this not booking the loss was correct. i. 2. The directors stated that they were concerned with liquidating the stock and the adverse impact it could have on the company’s net income figures. Despite the Board’s decision. Smith v. self-dealing. Van Gorkom (`985. that other courses of action might have differing consequences. “Directors are entitled to exercise their honest business judgment on the information before them. iii. or that their action might benefit some shareholders more than others presents no superimposition of judicial judgment. o Therefore. p. so long as it appears that the directors have been acting in good faith. so he determines $55 would be best). This is merely a claim regarding the business judgment of the board. and to act within their corporate powers. ii. The board is afraid that if they display a loss then the stock price will decrease. The court explains that the board of directors are “experts” and its expertise/decision-making is protected by the business judgment rule. where an unadvised judgment has been made. The determination of whether a business judgment is an informed one turns on whether the directors have informed themselves prior to making a business decision. Whether a business judgment is an informed one turns on whether the directors have informed themselves prior to making a business decision or all material information reasonably available to them. it doesn’t matter what the accounting standard is because the value is already reflected in the price. of all material information reasonably available to them. Romans came up with a value of the company shares (and he determined that a loan of $60 a share would be too difficult to pay back and $50 would be easy. or bad faith. o Because of this rule. he wants to be able to accept them—Pritzker says that 68 . HELD: P failed to allege any fraud. Van Gorkom says that he wants to make sure that $55 is the best offer so the if other offers come through. iv. How much information has to be available.liquidating the bad stock investment (and taking a corporate tax deduction for the loss) or distributing the stock to shareholders as a special dividend (a taxable event for shareholders). “Publicly Available Information” there is no secret information—you can find everything. Professor thinks this decision is correct because it is not gross negligence. That they may be mistaken. Efficient Capital Market Hypothesis All publicly available information of a company is almost instantaneously reflected in stock price. the stock price already reflects this loss and the board’s idea is wrong. o Therefore.332)—Trans Union was not making enough money to take advantage of all of its tax benefits (those available during the 1980s) and so Van Gorkom began to think about the options for changing the nature of the company. Book the Loss Recognizes the loss on the books in order to get tax savings—In this case the board thinks it is better to take the loss in taxes than to report the loss. Information + Debate = Informed business Judgment iii. b. The board opted for the stock dividend and some shareholders brought a derivative action. i. He spoke to the CFO (Romans) and Romans did some research on a leveraged buyout. there is no business judgment protection for the board of directors.” ii.
you have just paid the highest price for the thing that you bought. you will take money and re-invest it elsewhere.5 million shares of stock outstanding in trans—$690. you need to be worried about “the winner’s curse. business-savvy individuals. but the procedure. o This goes with the phrase. v.” iv. rather than substance. people really didn’t think that plaintiffs could win a duty of care case. this is impossible based upon the Economics of Information (discussed below). This case sets a very aggressive bar for duty of care cases in favor of the shareholder and as such. vii. and (2) They failed to disclose to the stockholders all of the information as to how the price of the shares was arrived at. o If you own stock in a company that is buying up other companies. The increased price of D&O (Director & Officer) Liability Insurance. Pritzker was offering a “premium”—a premium price is the price offered that is higher than the current value of the corporation’s stock. “The Winner’s Curse” it is the idea that when you win an auction. o The court applied a theory of gross negligence to the decision making procedures of the board o Big Questions: Are the stock holders so uninformed that their vote doesn’t count for anything?? o Board must make a recommendation to the stockholders. The substance of the board’s decision is protected by the BJR. (A. the case raised a great outcry. you are the one paying the premium. o Concerns of the dissent included: The fear that director liability would be a deterrent to an outside person agreeing to serve as a director. if you own stock in the target company. DISSENT: The dissent stated that a court shouldn’t second-guess a director —plus. .000. iii. He wants a lock-up option (to purchase a vault of shares at the current price--$38--so that if the company stock price goes up. According to Professor.he doesn’t want to be the “stalking horse” bid. vi. The court finds that the directors breached their fiduciary duty of care because: (1) they failed to inform themselves of all information readily available to them and relevant to their decision to recommend the Pritzker merger. o A premium is always paid in a takeover. Pritzker wants to go through with the deal and a special meeting of Trans Union takes place on Saturday to discuss the deal—the board of directors is handed merger documents and accepts the merger. IF you own stock in the company purchasing the target company. Prior to this case.000 outstanding ii.W. Wallis was an outside director who was an economist and statistician at Yale and Chicago and under-secretary of state for Reagan). This is a Friendly Takeover They want to be taken over.HELD: The court in this case takes issue with PROCEDURE. 69 . With premiums. which was followed can be reviewed by the court. o This was the FIRST time in Delaware that a plaintiff had prevailed on a duty of care case. and based on their fiduciary duty they Board must gather “all information reasonably available. 12. these men were smart.” and the Court finds the Board did not do this. The ball is in your court to make it worth as much as you thought it would be. he can sell those shares for a profit). ISSUE: Did the BOD reach an informed decision regarding the merger i.
Typically. Stigler tried to figure out at what point people reached this conclusion and why. etc. They need to get all material information but how do they know that the information they have gotten is enough. that you could find a better deal. Can’t optimize because you don’t know the parameters of what you searching. LBOs involve a buyout by the management of the company. The board in Van Gorkom is faced with the same sort of decision. provided that such provisions shall not eliminate or limit the liability of a director: o (i) For any breach of the director’s duty of loyalty to the corporation or its stockholders. iii. the reasonably available standard from VanGorkum decision is illusory. o under § 174 of this title relating to payment of dividends. People search until they think they have searched enough to quit searching. who should decide whether the information is enough—the board or the court? Lock Up Option If you are going to have an auction of the selling company. (This is what is called taking a “public company private. Leveraged Buyout—a buyout of a company that involves a lot of debt—basically. And. Professor is VERY skeptical about the outcome of this case. reliance on experts. iii. Delaware General Corporation Law § 102(b)(7)—Opt-In Default Rule— MEMORIZE! i. viii. How much information do you gather before you decide you have gathered enough to make a decision. This is what boards are faced with when making a business decision—at some point you must decide that enough information has been gathered to make a decision. “A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director. then the company who began the efforts to buy wants the selling company to sell them treasury stock at market price (not at a premium). (It can be compared to buying a house with a mortgage. This is only successful if the group running the company will run it well enough to pay back the debt.c. a group of people go to a bank and borrow money to buy up all the stock of a company (typically a company with a small amount of equity and a large amount of debt). The fear that the decision would lead to super-cautious decision making by directors. At some point.” i. The company may then sell those treasury stock to whoever wins at the auction. or 70 . ii. There is always the possibility that if you kept searching. The group borrows money from the bank and then pays the bank a monthly note. ii. ii. a person has to say enough is enough.”) “Economics of Information”—George Stigler—a person doesn’t know whether the decision to get more information is a good one until after more information is gotten. Therefore. o (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law. the group owns the company.) i. g. A corporation can in its articles of incorporation have a clause that states: ii. d. f. e. At the end of the payment of the debt. Economics of informationPeople economize on “search costs. The fear that boards would start to second guess all recommendations from CEOs for fear of being accused of self-dealing. i.
vi.” Waste—an exchange so one-sided that no person of sound judgment could conclude that the corporation received adequate consideration. Cinerama v. In order to prevent the courts from becoming “super-directors. Inc. Cinerama was a shareholder of Technicolor and opposed the merger with Perelman’s company. Fiduciary duties of care and loyalty gives rise to the requirement that a “director disclose to shareholders all material facts bearing upon a merger vote. a. HELD: Technicolor and its board had met its burden of proving “the entire fairness” of the transaction—and such factors to be considered in determining fairness were: the timing. Inc. weigh o qualify director’s judgments. Technicolor.345)—DISNEY CASE—Eisner hires Ovitz to replace Katzenberg as president of Disney. although it was later found to be bad advice. Duty of Care: o PROCESS (reasonably informed business judgment) Delaware Corporate Code § 141(e)—reliance on an expert in good faith by the board provides “full protection” by the business judgment rule. Additionally. HELD: Based upon the facts presented. ii. A legislative reaction to a judicial decision—Who is in the better position to change the law—judiciary or legislature? 3. i.For any transaction from which the director derived an improper personal benefit. o SUBSTANTIVE (waste test)—“Courts do not measure. Van Gorkum. relied on a compensation expert. the disclosure to and approval by the directors and the disclosure to and approval by the shareholders. Only when there is complete lunacy or irrationality will the court look to the substantive aspects of the decision. initiation. Meaning Directors are not personally liable for breaching the duty of care. We do not even decide if they are reasonable in this context. There has been widespread adoption by states and adoption by the shareholders. b. a. the Court would NOT second-guess the consideration given for the employment contract because it was not an issue for the court to determine. iii. P alleges waste. Brehm v.342)—Perelman acquired Technicolor. if the corporation opts to include this provision. Eisner and Ovitz disagree and decide that Ovitz can leave the company on no-fault grounds (getting all the money in the employment contract). The board went through the proper procedures required by § 141(e) and considered the information reasonably available. p. • Bd. (Delaware SC—p. Vast majority of Fortune 500 are incorporated in DE and have adopted §102(b)(7).” mere disagreement cannot serve as the grounds for imposing liability on a board of directors for alleged breach of fiduciary duty of care and waste. and structure of the transaction. This amendment essentially voids Smith v. they were not particularized enough ot show a breach of fiduciary duty by the board. iv. they can agree for him to leave and he gets a huge salary package). Due care in the decisionmaking context is process due care only. negotiation. Ovitz receives a very nice employment contract with a very favorable term regarding no-fault termination (if there is no cause for firing. Eisner (2000. at a price of $23 per share (the pre-offer price was $11 per share). v. 4. o 71 .
b. . Pritchard for violating her duty of care as a director. alcoholic. BJR as an Absetntion Doctrine. To Professor. Pritchard was elderly. United Jersey Bank (1981. they probably would have done so. Pritchard) have misappropriated $12 million from trust accounts held by the company on behalf of others. Professor’s Delimma: Tighten up on the rules or allow for more risk taking under the guise of the business judgment? How does the role of reputation play into this debate? a. Treats the rule as having Substantive Content. She hardly ever attended board meetings. Pritchard done even so little as to read the corp’s financial statements at any time. Pritchard is a director of Pritchard & Baird. but there are outer limits . The rule’s presumption of good faith is also a presumption against judicial review of duty of care claims. Directors are not required to conduct a detailed inspection of day-to-day activities. never read or obtained any financial statements. and must keep informed in a general way about the corp’s activities. she would have noticed an item called loans to shareholders which dwarfed the company’s assets. Pritchard breached her duty of care to the corp. The court will abstain from reviewing the substantive merits of the directors’ conduct unless the P can rebut the business judgment rule’s presumption of good faith.. 6. liable if he does some or all of the following: i. and sons of Mrs. p. therefore. a reinsurance broker. P&B goes bankrupt. and its trustees in bankruptcy sue Mrs. Expected Value i. he must resign. the rule simply raises the liability bar from mere negligence to gross negligence or recklessness. had Mrs. The BJR comes into play as a standard of liability only after one has first determined that the directors satisfied some standard of conduct. But they must at least become familiar with the fundamentals of the business.356)—Mrs. Fails to learn anything of substance about the company’s business. Charles and William Pritchard (directors. Thus. etc. sole stockholders. or v. In effect. and which would have immediately put her on notice that her sons were effectively stealing trust funds. and depressed over the death of her husband. Francis v. Fails to read reports.Court says it is completely a matter of business judgment. Risk v. The most successful claims against directors have come where the director simply fails to do the basic thins that directors generally do. Otherwise neglects to go through the standard motions of diligent behavior. and asked her sons to stop. given to him by the corporation. a director might be found grossly negligent and. . The court basically says that the only substantive test is complete irrationality so there is really no substantive test. i. and is therefore liable for the losses caused by the misappropriation. Here. iv. financial statements. 5. knew nothing of the corporation’s affairs. Fails to obtain help when he sees or ought to see signals that things are going to seriously wrong with the business. They show that two officers of P&B. ii. 7. iii. During the years the misappropriation took place. Fails to attend meetings. these facts are pretty egregious. Had she noticed this. i. ii. Two Conceptions of Business Judgment Rule (BIG Policy Consideration) a. b. and if it is not corrected. Mrs. and in general did not pay any attention to her duties as a director or to the affairs of the corp. HELD: Mrs. Court notes that if he comes across illegal activity then he is under a duty to say something. 72 .
o Here. i. exists. Since the Ps would be unlikely to prevail on the merits. that does of care does require that reasonable control systems be pu in place to detect wrongdoing. the burden on a P who wants to establish a breach of this obligation is high—only a sustained or systematic failure of the board to exercise oversight—such as as an utter failure to attempt to assure a reasonable info. and then spends $250 million to settle various related civil claims against it. In deciding whether a settlement involving no financial recovery is reasonable. Passive Negligence—Circumstances exist that the Board arguably ought to notice and do something about. the Anti-Referral Payments law (ARLP). “one free bite” rule is not as relevant. . forbids firms such as caremark from paying doctors to refer Medicare and Medicaid patients to it. and failure to do so under some circumstances may render a director liable for losses caused by non-compliance with applicable legal standards. Derivative litigation (Delaware Case—1996. No senior officers or directors of the firm are charged with wrongdoing. which the board concludes is adequate. vi. claiming that the Board members failed to exercise their duty of care. which provides various forms of therapy to outpatients. settlement is reasonable. participates in various Medicare and Medicaid programs. settles these charges by pleading guilty so a single felony count. a. A lot flows from the criminalization of white color crimes and corporate illegal activity –high deterrent. no responsibility . The co.362)— Caremark is a medical services firm. However. At some point. Federal Prosecutors indict the co. therefore. b. The mere fact that the corp committed a criminal violation does not by itself establish such a failure of oversight by the board. but instead the board members do nothing—Failure to detect wrongdoing. . Court asked to approve settlement—It is a structural settlement. Allis-Chalmers. don’t take the job. The co. Caremark pays physicians fees for monitoring certain patients. A federal law. the monitoring costs outweigh the benefits of what you find out.iii. not evidence exists that the director Ds were guilty of such a sustained failure of oversight. the court must take into account the likelihood that the plaintiffs would have prevailed at trial. taking various steps to avoid the future violations. v. ii. against all members of the BOD. A directors obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system. . Graham v. . Inc. iii. even where the board has no prior reason to suspect that wrongdoing is occurring. without the Ds paying any money. Stockholders then bring a derivative suit on behalf of the co. While a board’s duty may not require it to install a system of espionage to ferret out wrongdoing. which required them to put control mechanisms that would have prevented such violations. p. “No Duty . including Medicare and Medicaid patients. RULE: If you can’t handle the job. In re Caremark Int’l. on the theory that the fees violate ARPL. Allis-Chalmers—GE and Westinghouse sold about 90% of electrical generating equipment and what happened was that top 73 . “Optimal Amount of Fraud” The company has to make a choice of how much money you put into the security system. but with the co. The parties propose to settle the suit. that are under the firm’s care. 8. and reporting system exists—will establish the lack of good faith that is a necessary condition to liability. and level of detail” iv. HELD: The settlement is approved. They are getting a kickback. on various felonies arising out of these monitoring fees.
o Rule: The Supreme Court of Delaware held that “absent cause for suspicion. If the transaction is so unfair that it amounts to waste or fraud against the Corp. ii.” It is the “one bite rule”—once someone does engage in activities causing suspicion. Courts generally look through the substance of the transaction to the substance of the director’s interest. loans to and from the company. Expected punishment = probability x fine/imprisonment c. DIRECTORS AND MANAGERS a. sound judgment could conclude that the corp has received adequate consideration. 74 . Substantive and Procedural Fairness Test i. the court will uphold it. Consider expected value b. c. the court will usually void it at the request of stockholders. including corp. The Substantive Test focuses on the Transaction’s terms and whether the interested director advanced his interests at the expense of the corporation. DUTY OF LOYALTY 1.managements decided that the two companies should just split the business and raise prices—pricing conspiracy (A price fixing conspiracy in violation of Sherman Anti-Trust Act). Ex. ii. The AG filed criminal proceedings and many people went to jail. Sales and purchase of property. 9. there is no duty upon directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists. The Key player has helped influence the corp’s decision to enter the transaction.. and iii. Corp. e. the board is on alert. Corporate transactions with director’s relatives. but then gives no indication of how it should be read. corporate transactions with interlocking directors. Ex. A key player (director or manager) and the corporation are on opposites sides of a transaction ii. Problem on p. The key player’s personal financial interests are at least potentially in conflict with the financial interests of the corporation. d. Indirect Self-Interest Self-dealing when the corporate transaction is with antoher person or entity in which the director has a strong personal or financial interest. Replaced the rule of voidability ii. furnishing of services by a non-management director. i. o In Caremark. If the Transaction is Fair. stock. trans with an entity in which the director has a significant financial interest. the court says not to read the Graham decision too broadly. In order to guarantee compliance. 372-373 a. Self-Dealing Transactions One in which 3 conditions are met: i. b. It says that boards have to do something with regards to compliance but the level of compliance is a BJR issue. Expected Punishment = Probability of being Punishment (caught and prosecuted) x cost of being caught (size/length of fine/imprisonment) i. o Standard for Wastean exchange that is so one sided that no business person of ordinary. the expected punishment cannot be less than cost of compliance must D. i. Direct Self-Interest Self-dealing occurs when the corporation and the director himself are the parties to the transaction. Courts approach fair dealing as follows: i.
especially the price. o ROLE OF INTERESTED DIRECTOR IN APPROVAL PROCESS— most modern states permit the interested director to negotiate. Court will scrutinize the terms of the transaction. o Widespread Acceptance. Burden of Proof i. However. Under the MBCA. once a challenger shows the existence of a director’s conflicting interest in a corporate transaction. however. i. A director is “disinterested” if he is not directly or indirectly interested in the transaction and he is not dominated by the interested director A director is “dominated” when he acts as requested without independent judgment. f. Beran (1944.374)—Directors of Celanese Corporation of America were charged with negligence and self-interest in commencing a radio advertising program because of the wife of the Celanese president was chosen to perform the radio ad. then the directors could vote to approve the transaction/contract/agreement without counting the interested directors in the vote. g. ii. if the judge concludes the transaction was in the corporation’s best interest. o Disclosure is the key. participate and vote upon the transaction without invalidating the transaction. Bayer v. the burden generally shifts to the party seeking to uphold it to provide the transactions validity.The Court accepts the fairness of self-dealing. o Problem: Requires judicial meddling in business matters. such participation might be evidence of domination o ***The bottom line is that there must be 1) disclosure and 2) knowing acceptance. iii. The Procedural Test focuses on the board’s decision making process and measures the independence of the disinterested directors. p. o OBJECTIVE TEST: The self-dealing transaction must replicate an arm’s length market transaction by falling into the range of reasonableness. o DISCLOSURE ABOUT THE TRANSACTION Whether full disclosure would have given the board a meaningful opportunity to review the proposed transaction and negotiate more favorable terms. o Process of Board Approval—Did the Board act independently? o If there was disclosure on the part of the directors or if the other directors knew about the issue. under the more process-oriented approaches. o APPROVAL OF DISINTERESTED BOARD—Some courts will uphold the transaction and others will merely shift the burden of of proving fairness to the plaintiff. o CORPORATE VALUE: The transaction must also be of value to the corporation with regards to its needs and scope of business. the challenger has the burden to prove the transaction’s validity when disinterested directors or shareholders have approved the transaction. Rule: Policies of business management are left solely to the discretion of o 75 .
(1980. KEY ELEMENTS: Must prove EITHER: o Disclosure and Acceptance (without vote of interested director). disclosure was key here—the directors KNEW about the wife’s involvement and such disclosure prevented wrongdoing. o HELD: This case shows a typical state statute. o This is an easy and best example of a duty of loyalty case! 2.L. ii. & E. and if there is any evidence of improvidence or oppression. to prop up the other corp. Basically a situation of being both a landlord and a tenant. when challenged. Then. The claim was that those directors were using the corp. iv. o NOTE: The burden of proof is on the defendant. p. HELD: Here.381. those directors lose the protection of the business judgment rule and must demonstrate that the transaction was fair and reasonable to the corporation at the time it was entered into. Fair and Reasonable Price ii. o Look at statute provided on p. Note: A court must first make a preliminary determination that the duty of care and duty of loyalty have not been violated. disproportionate in price. improper motive. b. RULE: When directors have personal interest in a transaction and there is no disclosure. Corporate Opportunity is a sub-set of the duty of loyalty. v. any indication of unfairness or undue advantage. are. or self-interest.379)—Professor Likes this Case—A group of siblings serve as directors/shareholders of two corps. or The point is to disclose the conflict of interest and let the disinterested directors or shareholders decide what to do. who is claiming fairness. The shareholders of one corp claimed that the directors had committed waste by undercharging a tenant. and some serve on both corps. o If no disclosure. unless the other party can show it was fair and reasonable. however. S. Liability may not. Inc. Also. or conducted for personal gain so there was no breach of loyalty. i.” o “The burden is on the director not only to prove the good faith of the transaction but also to show its inherent fairness from the viewpoint of the corporation and those interested therein. o Professor.the board of directors and may not be questioned absent a showing of fraud. the corp may void the contract. it can invoke the BJR h. CORPORATE OPPORTUNITIES a. there was no evidence that the ad program was inefficient. the transactions will be voided. examined with the most scrupulous care. 76 . D did not make full disclosure and did not prove that the price paid was fair and reasonable. Lewise v. be imposed on directors because they failed to approve the radio program by resolution at a board meeting.. That tenant was another corp in which three of the directors were heavily involved. directors acting separately and not collectively as a board cannot bind the corporation. Rule of Voidability “Such personal transactions of directors with their corps. A director or senior executive may not compete with the corporation where the competition is likely to harm the corp.” iii. better to have a meeting to be safe. such as transactions as may tend to produce a conflict of interest and fiduciary obligation. If there is no disclosure. Board Meetings Rule: Generally. which takes away the duty of loyalty issue where there is disclosure.
Corporate Expansion Corporation expects managers to devote themselves to expanding the corporation’s business in order to maximize profitability. but the key play must make full disclosure about the conflict and competition. the manager must obtain corporate consent before exploring it. Conduct that would otherwise be prohibited as disloyal competition may be validated by being approved by disinterested directors. is from its nature. i. d.Fairness Test—Substantive v. (2) it is ratified by shareholders after full disclosure. most corporations’ line of business is to do anything to make money. USE OF CORPORATE ASSETS The key player may not use corporate assets if this use either (1) harms the corporation or (2) gives the key player a financial benefit. the self-interest of the officer or director will be brought into conflict with that of the corporation. or by being ratified by shareholders. o If the corporation has an existing expectancy in a business opportunity. i. CORPORATE OPPORTUNITY DOCTRINE A director or senior executive may not usurp himself a business opportunity that is found to “belong” to the corporation. or (3) the Key Player pays the fair value for any benefit he has received. Procedural (see above). Tests: i. o PROBLEMS: Today. e. i. and by embracing the opportunity.c. and the corp may recover damages equal to the loss it has suffered or even the profits it would have made had it been given the chance to pursue the opportunity. Line of Business Test (Corporation’s Existing Business) o To measure the reach of a corporation’s expansion potential. g. i. the manager must seek corporate consent before taking the opportunity. Interest or expectancy(Existing Corporate Interest)—used to measure corporation’s expansion potential. is one in which the corporation has an interest or reasonable expectancy. the law will not permit him to seize the opportunity for himself. o If the new project is functionally related to the corps existing or anticipated business. with the purpose of forcing disclosure. Manager Entrepreneurialism Managers expect to have freedom to pursue their outside business interests in order to promote their entrepreneurial initiative. f. Preparation to compete is also a violation of the duty of loyalty. CONSENT and INCAPACITY 77 . o Courts compare the new business with the corporation’s existing operations. Loft (note in Broz)—most famous corporate opportunity doctrine statement in Delaware. h. EFFECT—If the key player is found to have taken a corporate opportunity. Use will not be a violation if it is (1) approved by disinterested directors after full disclosure. . o Guth v. he taking is per se wrongful to the corp. The corp need not have an existing interest or special need for the opportunity and the manager need not have learned of the opportunity in his corp capacity. setting forth the Line of Business test—“If there is presented to a corporate officer or director a business opportunity which the corporation is financially able to undertake. ii.” iii. in the line of the corporation’s business and is of practical advantage to it.
j. It is not the law of Delaware that presentation to the board is a necessary prerequisite to a finding that a corporate opportunity has not been usurped. Broz v.389)—eBay hired Goldman Sachs as its lead underwriter and Goldman. Goldman allowed two of the eBay directors to buy other companies’ IPOs at favorable prices. in consultation with eBay. instead of for CIS. PriCellular begins discussions of a tender with CIS and PriCellular feels P owed it to disclose. determined what they could sell the IPO for and raise the amount of money that eBay wanted. o IPO—Initial public offering. The opportunity was related more closely to the business conducted by P than by CIS. It is a takeover method that does not involve the BOD. CIS was aware that P potentially had conflicting duties with his wholly owned subsidiary. i.. In Re eBay.i. the manager has violated a duty of loyalty inherent in the corporate opportunity doctrine. Offer typically contingent on the offeror getting a specified number of shares sufficient to get control of the company. RULE: Where the opportunity engaged in by a manager is a line of business of the corporation. ii. The company offering the K did not offer it to CIS because CIS had just emerged from insolvency reorganization. Cellular Info. The shareholders bringing this suit argue that this is a corporate opportunity because eBay invests excess cash in marketable securities—it was eBay’s line of business. by buying the share away from the shareholder at a premium price. opportunity by voluntarily relinquishing it. i. Voluntary Consent A corp can voluntarily relinquish its interest in a corp. (1996. arose by virtue of the manager’s association with the corporation. Presentation to Board of Directors Presenting the opportunity to the board creates a kind of “safe harbor” for the director. P talks to a couple of the CIS board members about the offer. and CIS did not have the financial capacity to exploit the opportunity. The opportunity involved cellular telephone service contracts in rural Michigan. o Underwriter—a corporation doesn’t know how to price securities or 78 . p. k. Corporate Incapacity Many courts allow managers charged with usurping a corp opportunity to assert that the corp could not have taken the opportunity because it was financially incapable or otherwise unable to do so. which removes he specter of a post hoc judicial determination that the director or officer has improperly usurped a corporate opportunity. Shareholders Litigation (Did not go over in class—2004. Inc. and when the corporation is given no chance to reject the opportunity. and they were able to engage in this business. in order to keep eBay bringing them business. l. o HELD: P wins because the Court determines that the opportunity came to him in his individual capacity and not his corporate capacity. o Tender Offer—A mechanism for someone one the outside of a corporation to come in and take over the corp. Rule: The corporate opportunity doctrine us implicated only in cases where the fiduciary’s seizure of an opportunity results in a conflict between the fiduciary’s duties to the corporation and the self-interest of the director as actualized by the exploitation of the opportunity.384)—P is a member of board of CIS and utilized a business opportunity for his solely owned corporation. but does not make a formal presentation. p. it was expected. Sys. Inc.
Sinclair Oil v. and then met the statutory safe harbor standards. iii. b. o HELD: While P attempted to argue that its business transaction with Sinven should be governed by the business judgment rule. and not by the intrinsic fairness test. Exclusion of Minority o Many courts hold controlling shareholders to a higher standard when they use control in stock transactions to benefit themselves to the exclusion of minority shareholders. p. or do they need protection because maybe they inherited this share? ii. DOMINANT SHAREHOLDERS a. subject to careful judicial scrutiny. o Some courts have used this intrinsic fairness analysis to invalidate stock redemptions and conversions that prefer controlling shareholders. The intrinsic fairness standard will be applied only when the fiduciary duty is accompanied by selfdealing—when the parent is on both sides of a transaction with its subsidiary. c. Where a corporation is publicly held. A parent company owes a fiduciary duty to its subsidiary. disclosed the opportunity. Intrinsic Fairness Test When there is a fiduciary duty AND it is accompanied by self dealing. The fact that the controlling shareholder is generally allowed to sell his controlling interest at a premium is one illustration of this lack of any generally recognized fiduciary obligation.394)—P owns 97% of the subsidiary Sinven. i. etc. However. this alone will not invoke the intrinsic fairness test. had the board approve the actions. o HELD: Directors should have gone to the board. d. ii. The (sad) Plight of Minority ShareholdersMinority shareholders are at the mercy of the majority shareholder’s decisions. by virtue of its domination of its subsidiary. Is this a windfall for the minority shareholders who buy in knowing they are in the minority. the court disagreed. A parent does indeed owe a fiduciary duty to its subsidiary when there are parent subsidiary dealings. Self-dealing occurs when the parent. P breaches its K with Sinven and Sinven chooses not to remedy breach. Levien (1971. The minority shareholders in sinven take issue with the decision and accuse the directors of not being intrinsically fair. POLICY QUESTIONS: Should the law ride to the rescue of the minority shareholder? o The Law does come to the rescue. 3. Dominant shareholders owe a fiduciary duty to a minority shareholders. causes the subsidiary to act in such a way that the parent receives something from the 79 . P is a holding company of crude oil and Sinven produces petroleum in Venezuela. the courts have been less quick to impose on the controlling shareholder a fiduciary obligation with any real bite.market securities and so they will hire an underwriter (an investment bank) to price the security and market the security. i. P treats Sinven as an independent entity— entering into contracts with Sinven. there is BOTH a higher degree of fairness required and a shift in the burden of proof under which the parent must prove. that its transactions with the subsidiary were objectively fair.
Because the Class B shareholders did not act in good faith when the caused the board to redeem the Class A shares and concealed the information about the value of the inventory. RATIFICATION 80 .subsidiary to the exclusion of and detriment to the minority shareholders of the corp. and that the Class A stockholders would thereupon have exercised their privileges to convert their stock. ii. ii. It therefore decided to have the company sell its assets to a third party and liquidate. (2) simply liquidate without notice. p. voting shareholders with no right to. o Therefore. disclosing the intention to liquidate together with full information as to the appreciated value of the tobacco inventory. In bringing this about.” and became aware that the company’s tobacco inventory had become dramatically more valuable than shwn on the company’s books. (1947. When a controlling shareholder or group deals with the noncontrolling shareholders. When the parent controls the transaction and fixes the terms. share for share. the amount is the amount each class B was awarded. Zahn v. They chose option 3. Class B shareholders were “insider. Transamerica Corp. Ask for a vote of only the minority shareholders to ratify the decision. NOTE: 2 Things you could do to prevent suits and problems with minority shareholders: i. the board had three main choices of how to deal with class A stock: (1) give full notice. and the burden is on the stockholder not only to prove the food faith of the transaction but also to show its inherent fairness from the viewpoint of the corp and those interested therein. or (3) call A’s shares without disclosure. f. mostly public shareholders who got most of liquidation assets and right of co. into Class B stock and would thus have participated equally with the Class B stockholders in the proceeds of liquidation.399)—Axton-Fisher Tobacco Co. minus the money he was paid in buying out his Class A stock. (an entirely common law duty) i. to redeem stock. and Class B. whose dealings with the corp must be subjected to rigorous scrutiny. Therefore. mostly owned by Transamerica. it owes the latter a duty of complete disclosure with respect to the transaction. that when voting as a stockholder he may have the legal right to vote with a view of his own benefits and to represent himself only but when he votes as a director he represents all the stockholders in the capacity of a trustee for them and cannot use his office as a director for his personal benefit at the expense of the stockholders. Buy out the minority shareholders—it could be cheaper than walking on egg shells because there are minority owners. e. AFTERMATH: The Court found that a disinterested board of Directors would undoubtedly have exercised its power to call the Class A stock before liquidation. the Class B holders breached their fiduciary obligation to class A holders. o HELD for P: A dominating or controlling stockholder is a fiduciary. then liquidate. the test of intrinsic fairness applies and the burden of proof shifts. o “There is a radical difference when a stockholder is voting strictly as a stockholder and when voting as a director. then liquidate. had two kinds of “common stock”—Class A. 4. EXCEPTION: Some cases hold the controlling shareholder does have some kind of fiduciary obligation to avoid injuring the interests of the non-controlling shareholders.
The transaction constituted waste ii. § 144 of Delaware Statute—A properly ratified contract between a corporation and one of its directors is not void or voidable solely because of the conflict of interest. Lawrence (1976. The transaction was ultra vires (unauthorized) because of a limitation in the articles of incorporation. ii. RULE: Shareholder ratification of an interested transaction. iii. • Professor thinks this is a poor reading to the statute because the statute refers to “disinterested directors. shifts the burden of proof to an objecting shareholder to demonstrate that the terms are so unequal as to amount to a gift or waste of corporate assets. they pass the intrinsic fairness test. d. • The statute removes an “interested director” cloud when its terms are met and provides against invalidation of an agreement solely because such a director or officer is involved. or iv. must show: i. p. Ratification of an “interested transaction” by a majority of independent. The transaction was illegal. Van Gorkom and Wheelabrator Tech. Therefore. b. Instead. o Fliegler v. Only 1/3rd of the disinterested shareholders voted.” but only to “shareholders” without modifying it with disinterested.a. DUTY OF LOYALTY and RATIFICATION 81 . DUTY OF CARE and RATIFICATION shareholder vote approving a challenged merger agreement has the legal effect of curing any failure of the board to reach an informed business judgment in its approval of the merger. although less than unanimous. Some statutes do not count the shares of interested shareholders for the purpose of ratification. Interested Majority i. HELD: The purported ratification by the Agau shareholders would not affect the BOP in this case because the majority of shares voted in favor of exercising the option were cast by the defendants in their capacity as shareholders. c. However. even though the actions are still subject to judicial scrutiny. most courts do NOT require defendant to show fairness.405)—Shareholders of Agau brought suit against its officers and directors claiming that the officers and directors wrongfully usurped a corporate opportunity belonging to Agau and profited accordingly. there is not factual basis for applying the above rule. Nothing in it removes sanctions for unfairness or from judicial scrutiny. Courts remain suspicious of self-dealing transactions if shareholder ratification is by a majority of shareholders interested in the transaction. fully informed shareholders shifts the burden of proof to the objecting shareholder to demonstrate that the terms of the transaction are so unequal as to amount to a gift or a waste of corporate assets. i. The shareholders were uninformed iii. Where a majority of shares are cast by shareholders who neither have an interest in the transaction nor are dominated by those who do.
Securities Act of 1933 a. Standard of review is normally entire fairness. inc. 82 . “Blue Sky Law” in Kansas—First regulation of the primary market. and that the proxy’s were misleading. it is a breach of trust issue. in good faith. p. if the vote truly is fully informed. with BOP on directors. it would seem that the shareholders would already be protected. o HELD: There was no breach of duty of loyalty or of care. in which the issuer of Securities sells them to investors i. In Re Wheelabrator Tech.’s directors are also directors or have a financial interest. and Not voidable if it is approved. the standard of review remains entire fairness. while the duty of care claim is more procedurally based. and its controlling shareholder. ii. WTI held a meeting to discuss the merger and after positive results from lawyers and investment bankers. Primarily parent-subsidiary mergers that were conditioned upon receiving majority of the minority stockholder approval. The primary market. 2. But. and such approval is granted. 3. SECURITIES LAW: DISCLOSURE AND FAIRNESS 1. An initial public offering (IPO) by a corporation takes place in the primary market. o Rule stated above E. b. The rationale is that even an informed shareholder vote may not afford the minority shareholders sufficient judicial protection in a duty of loyalty claim. Nonetheless. BUT where the merger is conditioned upon approval by the majority of the minority stockholder vote. that they were not fully informed. but the BOP for demonstrating unfairness shifts to the plaintiff. the duty of loyalty claim is not necessarily extinguished because the court says it isn’t a business judgment issue.408)-Waste and WTI negotiated a merger in which Waste would own 55% of Waste stock. Principally concerned with primary market i. If the board is fully informed. Shareholders litigation (1995. o This case is different because there is no majority owner. in which investors trade securities among themselves without any significant participation by the original issuer. o (2) Cases involving a transaction between the corp. by a majority of disinterested shareholders Invokes the business judgment rule and limits judicial review to issues of gift or waste with the burden of proof upon the party attacking the transaction. then the claim of failure of duty of care is extinguished. the 7 WTI members approved the transaction.2 Kinds: o (1) “Interested” Transaction cases between corporation and its directors (or between the corp.. A group of shareholders filed suit alleging that the board of directors didn’t use due care. Exchange between stockholders. i. Also no breach of the duty of loyalty. The Secondary Market. 2 Types of Markets: a. The majority of the WTI shareholders voted to approve the transaction as well. and an entity in which the corp.
or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of a promoter or third party. security future.” c. ii. A list of rather specific instruments—“any note. i. an investment contract is a security. Definition of a Security a. Created the Securities and Exchange Commission (SEC) as the primary federal agency charged with administering the various securities laws. . ii. regulation of shareholder voting via proxy solicitations.” Congress asks the SEC to define fraud. confirmed by senate.b. ii. A list of general catchall phrases. treasury stock. Knowing whether a particular type of instrument or investment will be deemed to be a security is important for 2 reasons: i. c. Requirement of periodic disclosures by publicly held corporations. 5 Commissioners.” i. transaction. bond. Congress is delegating their Rule Making Power to the Commissioners d. i. ii. 2 Goals: i.” “investment contract. Staff has 3 primary functions: o It provides interpretative guidance to private parties raising questions about the application of the securities laws to a particular transaction. no more than three of whom can be from one political party. Principally concerned with the secondary market. Statutory Definition--§ 2—The terms in § 2 shall be defined in accordance with the various provisions of § 2. broad fraud statute—“necessary or appropriate . . To know whether you need to comply with its anti-fraud provisions. Deals with insider trading and other forms of securities fraud. “any interest or instrument known as a security. Questions to Ask: o Is it a profit-making venture? o Is the investor passive? ii. Complying with the Securities law is VERY Expensive! 6. b. and regulation of tender offers. Thus. o Commissioners have rule making power. such as “evidence of indebtedness. which are less demanding and easier to prove than normal fraud (with certain procedural advantages). debenture. Two broad categories: i. The Howey Test (most important SC case on this): “An investment contract is a contract. b. short-swing profits by corporate insiders. o It advises the Commission as to new rules or revisions of existing rules.” ii. To create a Transactional Disclosure Model—mandating disclosures by issuers in connection with primary market transactions. Vague Statute + Administrative Agency + Congressional Delegation of “Legislative Authority = American Government since 1933. Securities Exchange Act of 1934 (p. How Far can Congress Legislate? Pretty Far! iii. e. Broad. unless the context otherwise requires.” or in general. 5. Tells you whether registration is needed for your transaction. 83 . stock.263 of statutory book) a. and o It investigates and prosecutes violations of the securities laws. § 10b—Creates a vague. Mandating disclosure of material information to investors and prevention of fraud. 4.
to eliminate the word “solely. p. o Stock: Must be called “stock” and must have the characteristics of Stock.iii. This standard has been relaxed. as a result of the investment agreement or factual circumstances around it. o RULE: Economic Reality—The question is whether an investor as a result of the investment agreement itself or the factual circumstances that surround it. o HELD: This case deals with the definition of a security—and reiterates the fact that the definition of a security is so broad that in fact. Issue: Whether that being sold fell within the definition of a security? o Rule: The interests of an LLC do not constitute a “security” for purposes of the Securities Exchange Act. v. Robinson v. therefore. this was not a security. • The conferring of voting rights in proportion to the number of shares owned. The Registration Process a. is left unable to exercise meaningful control over his investment. o Why doesn’t everyone just register as a security to be safe? Very expensive—many fees associated with registration. a client might be selling a security and not even know it The key element is whether an investor. § 5—Imposes 3 Basic Rules prohibiting the sales of securities unless the company issuing the securities has “registered them with the SEC: i. Why is the plaintiff trying to sue under the securities laws? It is much better to be a securities plaintiff rather than a common law fraud plaintiff. Glynn (2003. iv. • Negotiability. is left unable to exercise meaningful control over his investment. • The ability to be pledged or hypothecated. Since Robinson was NOT a passive investor. 5 Characteristics of Common Stock • The right to receive dividends contingent upon an apportionment of profits. 7. A security may not be offered for sale through the mails or by use of other means of interstate commerce unless a registration statement has been filed with the SEC 84 . there was a partial interest in an orange orchard that was being sold and the farm had not registered the investment contract as a security. • The capacity to appreciate in value. Robinson filed suit claiming a violation of the federal securities laws.415)—There was an agreement (contract) between two parties for the sale and purchase of GeoPhone.” You don’t have to be solely dependent on another. Yet the securities laws do not extend to every person who lacks the specialized knowledge of his partners or colleagues. the plaintiff is trying to prove that the thing being sold is a security. In this case. Business venture often find their genesis in the different contributions of diverse individuals. So. without showing that this lack of knowledge prevents him from meaningful controlling his investment.
ii. The core of the registration statement is the “prospectus. ii. Instead. it does not ask whether the security would be a good investment. companies cannot sell the new securities. Securities may not be sold until the registration statement has become effective iii. This is the safest bet. o “Buy the Market”—buy into a fund (a mutual fund like Vanguard) that has a bunch of stock from a bunch of different companies. g. ii. Prima Facie Case for Securities Violations: i. Risk of loss shifted to investment bank. o Disproving Chartism was the first step toward the market failure doctrine. could you predict what his next step would be? NO! This is like stock prices. Exempt Transactions—one time exemptions. § 4—Exemptions to Registration: i. iii. Investment banking firm is the middle man identifying who will buy the stock. 2 Types of Exemptions: i. Must buy the market. ii. f. IMPORTANT: When the SEC reviews the registration statement. Market Failure i. or dealer ii. iv. BUT the market never works perfectly. ii. The underwriting firm will buy the entire issue at a discount off what they think they can sell it for. People who sell chart information and advice on stock prices. d.” the principal disclosure documents issuers are required by the Securities Act to give prospective buyers. Defendants sold or offered to sell these securities iii. b.” o 4 Factors for Determining Exemptions: Number of offerees and their relationship to each other and the issuer. can’t have perfect competition because you can’t have perfect information. it asks whether the registration statement contains the disclosures required by the statute and the SEC rules thereunder and whether that information appears to be accurate. The prospectus (a disclosure statement) must be delivered to the purchaser before a sale. (2) Transaction by an issuer not involving any public offering. ChartismGraph of stock movement over time. i. Information Failure— o REMEDY: The SEC requires public disclosure of information to help prevent market failure. No registration statement filed in connection with the defendants’ offering of securities. “(1) Transactions by any person other than an issuer. c. h. either when initially sold by the issuer or in any subsequent transaction. underwriter. Until he SEC has approved the disclosures made in the prospectus. There is Imperfect Competition. Number of units offered 85 . o Therefore. Doesn’t work! o Random Walk By watching a drunk walk down a street. Defendants used interstate transportation or communication in connection with the sale or offer of sale. e. etc. Can’t out perform the market by advice. It would be great if the market worked perfectly and perfectly allocated resources. Exempt Securities—need never be registered. NO DEFAULT RULES—all mandatory registration requirements.
The exemption turns on the knowledge of offerees. to offer to sell or offer to buy through the use or medium of any prospectus or otherwise any security. (b) It shall be unlawful for any person.Doran is approached about investing in a petroleum company in Wyoming and looks at drilling logs and technical maps and then decides to invest. j. no matter how sophisticated the investor is. . The size of the offering The manner of the offering o Purpose/Scope of “Private Offering” (not defined in statute) Purpose of act is to protect investors by promoting full disclosure of information thought necessary to informed investment decisions. iii. however. it shall be unlawful for any person. Therefore. §5 i. 86 .422)-. ii. specifying the required contents of a prospectus. i. o Generally exempt only the initial sale. (1977. the defendant has the burden of proving that the transaction was indeed a private offering. . Based on the four factors listed above. [interstate commerce stuff] . in a private offering the company should give the investor the same information that would be in a registration statement. Petroleum Management Corp. Regulation D Basically codifies the four factors listed above. . unless a registration statement has been filed as to such security. It is most nearly reflected in the first of the four factors (listed above)—The number of offerees and their relationship to each other and to the issuer. iii. He is a “savvy investor” and knows enough to look at this sort of information. . Doran is sued to follow through with his payment of the note. and provides safe harbors for issuers. (c) It shall be unlawful for any person . p. directly or indirectly? o (1) to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to carry or transmit any prospectus relating to any security with respect to which a registration statement has been filed under this title. Doran v. Other Exemptions i. this is a FACT based analysis o NOTE: Sophistication of the investor is not a substitute for access to the information that registration would disclose. o Rule: A private offering is an exempt transaction—meaning that it falls outside the registration requirement of the Securities Act. directly or indirectly: o (1) To make use of any means or instruments of transportation or communication in interstate commerce or through the mails to such security through the use or medium of any prospectus or otherwise . unless such prospectus meets the requirements of § 10. He co-signs a note and then the company defaults on it because the company is shut down by Wypoming state law (state law limiting the production of oil by oil producers). o HELD: Doran states a prima facie case of a violation of the federal securities law and then the defendant raises an affirmative defense (a private offering exemption) and has the burden of proving it. (a) Unless a registration statement is in effect as to a security.
or any o 87 . Securities Act § 11 o If there is a material misrepresentation or error on the registration statement. Rule 504. Congress wanted to impose civil liability as an important deterrent and therefore enacted various express private rights of action for private parties injured by securities laws violations. etc. it may sell to 35 buyers but no more. but they didn’t overrule the old cases. engineer. any person acquiring a such a security . or appraiser. ii. iii. . o Due diligence is a defense to misrepresentation and is the only viable defense to a § 11 claim. and each buyer must pass various tests of financial sophistication. Common Law fraud does not work with the way securities are set up—must show reasonable reliance. . . the Court has implied a private right of action (they have re-written the statutes). Rule 505. Due diligence is “reasonable investigation” which gives reasonable belief that the statements were true at the time given. o Limits on the numbers of buyers does not include accredited investors-banks. o The plaintiff does not have to prove scienter (intent). o Text of § 11. . Civil Liabilities—Securities Fraud i. . or necessary . so the Courts make one up. o “implied private right of action”—statute is silent about a private right of action. Congress must expressly say so. if Congress wants there to be private rights of action. o Must file with the SEC a notice of sale shortly after it issues the securities.. . contained an untrue statement of material fact or omitted to state a material fact required . iv. it may sell to no more than 35 buyers. If it raises more >$5 million. causation. Securities Act § 12(a)(1) o Strict liability on sellers of securities for offers or sales made in violation of § 5. o Failure to register is an example. If it raises < $5 million through securities. . scienter. o Cannot widely advertise. (a) In case any part of the registration statement . brokers. the issuer • Every accountant. k.Safe harbors: If an issuer raises < $1 million through securities. may sue? • Every person who signed the registration statement • Every person who was a director of . . o The remedy here is rescission. o Issuer must still give buyer some information. . Courts no longer do this because it was illegitimate. Rule 506. Today. o Others (not the issuer) are held to a negligence standard and must prove that they were NOT negligent through due diligence. v. then the issuer of the security is held strictly liable. Even where the Acts don’t explicitly state a private right of action. and injury. it may generally sell them to an unlimited number of buyers without registering the securities. .
. the fact that is falsely stated must be “material” o What is a Material Fact? Not defined by § 11 “Those matters as to which an average prudent investor ought reasonably to be informed before purchasing the security registered. shall be liable as provided therein who shall sustain the burden of proof: . Secured bonds on the bowling alleys were being sold. however. • (B) Purporting to be made upon his authority as an expert. other than the issuer. or (ii) such part of the registration statement did not fairly represent his statement as an expert or was not a fair copy of his exact report . vi. BarChris Construction Corp. he had reasonable grounds to believe.432)—Escott and other purchasers of debentures (secured bonds) sued BarChris for material false statements and material omissions on the registration statement of the debentures. . HELD: Here. (432. . p. reasonable ground to believe and did believe. . at the tiem such part of registration statement became effective.person whose profession give authority to the statement made by him. Rule: Due diligence is a defense to a claim under § 11. o Escott v. who has with his consent been named as having prepared or certified any part of the registration statement . This is NOT a binary (yes/no) question—it is more of a sliding scale based on the facts of the situation. he had. (i) he had after reasonable investigation. at the time such part of the registration statement therein were true and that there were no omissions . at the time such part of the registration statement became effective. . . • Every underwriter with respect to such security (b) Due Diligence Defense—No person. reasonable ground to believe and did believe. . that the statements therein were untrue or that there was an omission. informed decision about whether or not to buy the security. . . . . that the statements therein were true and that there was no omission . . after reasonable investigation. This case came out of the bowling craze in the 1950s and the fallout when this craze tanked. o Under § 11 of the Securities Act. . the Court finds one year to be material and 88 . the defendant must prove reasonable investigation and reasonable belief that the statements made were correct at the time. (3) that registration statements: • (A) Not purporting to be made on the authority of an expert. . Material facts are those that an investor needs to know before purchasing so that he can make an intelligent. • (C) Purporting to be made on the authority of an expert (other than himself) .” • “Average Prudent Investor” is the Standard by which the due diligence standard is judged. .
integrated disclosure system. He should have known that he required to make a reasonable investigation into the truth of all statements in the unexpertised portion of the document he signed. no matter how new he is. l. The SEC developed this system based on the efficient capital market hypothesis—the idea that all publicly available information is more or less instantaneously incorporated into the market price of its securities. which a prudent man would employ in the management of his own property.another year not to be material. Ignorance is no excuse if you sign the document. He is presumed to know his responsibility when he becomes a director. the company itself is not buying and selling its own shares— company is NOT a market participant in 10b-5 Rules. § 11 imposed liability in the first instance upon a director. b. The other individuals involved must prove due diligence to avoid liability. However. often called the Birnbaum Rule. directly or indirectly. Integrated Disclosure System i. He is not required to conduct an independent audit. The standing requirement. Professor really doesn’t think that these sorts of laws are such a good idea. Neither the lawyer for the company nor the lawyer for the underwriters is an expert within the meaning of § 11. Section 10(b)—Delegation of Congressional Power i. he should have known his obligations under the statute. Integrated disclosure starts with the reports that must be filed under the Exchange Act. o The Securities Act registers offerings. i. Rule 10b-5—Securities Fraud a. It shall be unlawful for any person. o The Exchange Act registers companies. The issuer of the security is strictly liable for a misrepresentation or false statement of material information. he did not have reasonable ground to believe that all these statements were true. but he is required to check matters readily verifiable. More is required of the director writing the registration statement. He can escape liability only by using that reasonable care to investigate the facts. Absent this federal law. iii. Having failed to make such an investigation. Due diligence is “reasonable investigation” To say that the entire registration statement is expertised because some lawyer prepared it would be an unreasonable construction of the statute. The lawyer made no investigation and relied on the others to get it right. by use of any means or instrumentality of interstate commerce or of the mails. or of any 89 . 8. there is no state cause of action for breach of the duty of loyalty. As a lawyer. avoids speculation about whether and how much a plaintiff might have traded. the SEC adopted a new modern. ii. There were originally two separate disclosure systems under the Securities Act and the Exchange Act. In these cases. Purchasers and Sellers: 10b-5 standing Only actual purchasers or sellers may recover damages in private 10b-5 action. c.
(b) To use or employ. or omitted a material fact that made his statement misleading or remained silent in the face of a fiduciary duty to disclose a material fact. g. f. in connection with he purchase or sale of any security. not misleading. but incomplete. Rule 10b-5 case law is a series of species of federal common law only loosely tied to the statutory text. IN 10b-5 cases of a duty to speak. by use of any means or instrumentality of interstate commerce. leading management to “simply 90 . Materiality—The SC has held that a fact is material for purposes of 10b-5 if there is a substantial likelihood that a reasonable investor would (NOT might) consider it important in deciding how to for or consider it as altering the “total mix” of information in deciding whether to buy or sell (Basic Inc. The plaintiff relied on the misrepresentation. . (a) To employ any device. 10b-5—Adopted Pursuant to General Rule-Making Authority—“It shall be unlawful for any person directly or indirectly. the Court does not want to require disclosure of an overabundance of information. each of which tests whether the supplier of misinformation should bear another’s investment losses: i. statement can be actionable if it omits material information that renders the statement misleading.facility of any national security exchange . in connection with the purchase or sale of any security registered on a national securities exchange or any security not registered . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. Punitive damages are not available. Fraud Elements of Private 10b-5 ActionThe plaintiff has the burden of showing the following elements. . Causation. or of the mails or of any facility of any national securities exchange. practice. Courts use various theories to measure damages under Rule 10b-5. or course of business which operates or would operate as a fraud or deceit upon any person. This creates a fear that companies will dump everything on the public record to the point where there is so much that no once could ever sift through the information. The plaintiff suffered actual losses as a result of his reliance. . d. courts will dispense with reliance if the undisclosed information was material. Material misinformation. The defendant affirmatively misrepresented a material fact. v. v. i. or (c) To engage in any act. courts will infer reliance from the dissemination of misinformation in the trading market. in light of the circumstances under which they were made. Levinson). Damages. or artifice to defraud (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made. e. ii. Material Deception 10b-5 prohibits false or misleading statements of material fact. Scienter. . This means a true. o Cascade Effect Justification for securities laws is forcing disclosure of (material) information to investors. The plaintiff suffered damages. iv. The defendant knew or was reckless in not knowing the misrepresentation and intended the plaintiff rely on the misinformation. Thus. Reliance. o “Manipulative or Deceptive Device of Contrivance”— iii. scheme. . In 10b-5 cases involving transactions on impersonal trading markets.
while relatively small trades by insiders can heave substantial effects. the information is material. gave material false information to his client about an upcoming merger. under which non-public information automatically affects prices. Additionally. this theory has almost completely been 91 .bury the shareholders in an avalanche of trivial information—a result that is hardly conducive to informed decision-making.” • Three levels of Efficient Capital Market Hypothesis o Strongest form: Even non-public information affects price o Intermediate: Publicly available information is impounded into the market price. ISSUE: Whether the action may proceed not on behalf of those who received Hoffman’s news in person but on behalf of everyone who bought Jefferson stock during the months when Hoffman was misbehaving. This case deals with private information that a stock broker distributed to private clients. “No one these days accepts the strongest version of the efficient capital market hypothesis. o West v. o Weakest Form: Can’t use past price movement to predict future prices Horizontal Demand Curve: “One fundamental attribute of efficient markets is that information. the latter trades convey information and the former do not.” • However. if Disclosure of the information would affect the price of the company’s stock. p. There is no proof that non-public information affects the market (accepting a weak version of the Efficient Capital Market Hypothesis). HELD: No causation in this class certification. It may shift up or down with new information but it is not sloped like the demand curve for physical products. (2002.” Basic o In general. A class action was certified on behalf of everyone who bought the touted stock during the period that the misinformation was being given. which could not happen if prices already incorporated the effect of non-public information. That version is empirically false: The public announcement of news (good and bad) has big effects on stock prices. a securities broker at Prudential. the misinformation never made it to institutional traders—the small investors to whom it was given do not have any tangible effect on the market price. RULE: A class action may not be brought on behalf of everyone who purchased stock during a period when a broker violated securities laws by not providing material non-public information. Because the record here does not demonstrate that non-public information affected the price of Jefferson Savings’ stock. a remand is unnecessary.463)—Hoffman. That is why institutional purchases do not elevate prices. There are so many substitutes for any one firm’s stock that the effective demand curve is horizontal. not demand in the abstract determines stock prices. Prudential securities Inc.
HELD: Unless the disclosure had been misleading (which Ps did not claim was the case) no liability could result. Duty to Speak—Normally. that are intended to mislead investors by artificially affecting market activity. o Basic suggests saying “no comment” iii. Green ( p)—A parent company merged with its majority owned subsidiary after giving minority shareholders notice of the merger and an information statement that explained their rights to a state appraisal remedy. matched orders. h. or rigged prices. An unfairly low price does not amount to fraud. • Whether the cause of action is one traditionally relegated to state law. except where federal law expressly requires certain responsibilities of directors with respect to stockholders. Corporate Mismanagement—Mismanagement by corporate officials can violate Rule 10b-5 if the mismanagement involves fraudulent securities transactions that can be said to injure the corporation. such as wash sales. • Manipulation Virtually a term of art when used in connection with securities markets. A claim of fraud and breach of fiduciary breach states a cause of action under 10b-5 only if the conduct alleged can be fairly viewed as “manipulative or deceptive” within the meaning of the statute. silence is not actionable under Rule 10b-5. ii. . it would lead Federal securities law towards taking over state corporations laws. RULE: Not every corporate fiduciary breach involving a securities transaction gives rise to a 10b-5 action. • Clear statement requirement—“Absent a clear indication of congressional intent. . o Santa Fe Industries v. state law will govern the internal affairs of the corporation. referring generally to practices. and investors commit their funds to corporate directors on the understanding that. we are reluctant to federalize the substantial portion of the law of corporations that deals with transactions in securities. Reliance The reliance requirement tests the link between the alleged 92 . • Professor thinks it is crazy to delegate to the court the power to make this kind of decision. Corporations are creatures of state law. particularly where established state policies of corporate regulation would be overridden. courts have imposed a duty to speak when defendants have a relationship of trust and confidence with the plaintiff.” NOTE: The problem was if this action succeeded. Nonetheless. Factors in determining Congressional intent to create a federal cause of action: • Fundamental purpose of act is full disclosure. an amount slightly higher than the valuation of the subsidiary by the parent’s investment banker.rejected by economists. The parent stated that a valuation of the subsidiary’s assets indicated a $640 per share value. . even though the parent was offering only $125 per share.
so market price was not affected by misstatements. o Could argue this protects the market. the inquiry into an investor’s reliance upon information is into the subjective pricing of that information by that investor. Levinson). ideally. ii.”—Basic. SAY ON EXAM: “All information is impounded into the market price. o Rebutting the Presumption: Any showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff. stockholder’s in their reliance on the market. Causation Courts have required that 10b-5 Plaintiffs show two kinds of causation to recover: i. Non-Disclosure—when the defendant fails in a duty to speak—whether in a face-to-face transaction or anonymous trading market—courts dispense of proof of reliance if the undisclosed facts were material. With the presence of a market. or his decisions to trade at a fair market price. Prove certain plaintiffs did not rely on misstatements when divesting themselves of their shares. Thus. Courts treat reliance as an element in all private 10b-5 cases. the market is interposed between seller and buyer and. the plaintiff would not have entered into the transaction or would have entered under different terms—a restated reliance requirement.” o People have sold based on misinformation in the market. but relax the requirements of proof in a number of circumstances: i. v. the market is performing a substantial part of the valuation process performed by the investor in a face-to-face transaction. the value of the stock is worth the market price. the efficient capital market hypothesis posits that market prices reflect all publicly available information about the company’s stock. In an open and developed stock market. transmits information to the investor in the processed form of a market price. Fraud on the Market (The Same Principle as the Efficient Capital Market Hypothesis Theory)—In cases of false or misleading representations on public trading market—so called fraud on the market—courts have created a rebuttable presumption of reliance (Basic Inc. This “fraud on the market” theory assumes that if the truth had been disclosed. The market is acting as the unpaid agent of the investor. EXAMPLES: Prove the market makers were privy to information on the truth of the mergers.misinformation and the plaintiff’s buy/sell decision—I weeds out claims where the misinformation had little to no impact on the plaintiff’s decision to enter the transaction. investors would not have trading at the prevailing nondisclosure price. and through it. o THEORY: Those who trade on public trading markets rely on the integrity of the stock’s market price. o BUT ask: Is this really necessary when we have state corporations laws to deal with these situations? i. will be sufficient to rebut the presumption of reliance. o “In face-to-face transactions. Prove news of the merger discussions interrupted the marketplace and dissipated the effects of the misstatements. 93 . informing him that given all the information available to it. Transaction Causation—Requires the plaintiff to show that “but for” the defendant’s fraud. Otherwise you have to show that the plaintiff heard the statement and specifically relied on it.
and investor’s reliance on the material. Damages Private 10b-5 plaintiffs have a full range of equitable and legal remedies. he does not necessarily disagree that the courts should not be making legislation. FRAUD-ON-THE MARKET RULE: Because most publicly available information is reflected in market price. p. k. Where the plain text does not resolve some aspect of the Rule 10b-5 cause of action. merely because agreement-in-principle as to the price and structure has not yet been reached y the parties or their representatives. iv. However. ISSUE: Was this information material? i. o Court Rejects the “Agreement-in-Principle” Theory. The Exchange Act imposes only two limitations. 94 . imply that the goal of liability is compensation and effectively precluding punitive damages. o There is not valid justification for artificially excluding from the definition of materiality information concerning merger discussions.” o While Professor likes the economic analysis of the majority. j. iii. reliance is no longer an issue because of the Fraud on the Market Rule. This deals with the secondary market. DISSENT: “Confusion and contradiction in court rulings are inevitable when traditional legal analysis is replaced with economic theorization by the federal courts. Levinson (1988.ii. not the people who bought the Basic stock. l. When the merger was finally publicly announced. v. Remedy: Amount you could have sold stock at and the amount at which the stock was actually sold. an investor’s reliance on any publicly available material misrepresentations. The scope of conduct prohibited by § 10(b) is controlled by the text of the statute. Levinson and other shareholders alleged that the company’s repeated denials of merger negotiations were material misrepresentations upon which they relied and sold Basic Stock. o COURT’S SOLUTION: Don’t answer questions concerning the mergers—ALWAYS say “no comment” ii. v. it was in negotiations with Combustion regarding a tender offer.450)—Basic made public statements that it was not in merger negotiations. courts must infer how the 1934 Congress would have addressed the issue had the 10b-5 action been included as an express provision of the act. public misrepresentations will be inferred under a fraud-on-the-market theory.. Where the information is material. Secondary Liability: There was no implied private right of action against those who aid and abet violations of Rule 10b-5. MATERIALITY RULE: Whether a company statement is material in the context of merger discussions requires a case-by-case analysis of the probability that the transaction will be consummated and the significance of the transaction to the issuer of the securities. § 28 states that the plaintiff’s recovery cannot exceed actual damages. This is a class action in which the shareholders are suing the Co. that there were no negotiations as to price and structure of the transaction has been reached between the would be merger partners. EFFECT: If shown to be material. Loss Causation—requires the plaintiff to show that the fraud produced the claimed loss to the plaintiff—a foreseeability or a proximate cause requirement. Difficulty is determining how much you could have sold it for. Basic Inc. which would otherwise be considered significant to the trading decision of a reasonable investor. may be presumed for purposes of a rule 10b-5 action.
o “Fiduciary obligations of directors ought not to be made so onerous that men of experience and ability will be deterred from accepting such office. Those insiders who obtain material information prior to its release have a duty to abstain from trading or to disclose the information and wait until the 95 . The plaintiff sells his stock to the buyers who are directors of the company but later sues stating that he would NOT have sold his stock if he had known about the geologist’s information. p. ii. iii. Federal Duty to “Disclose or Abstain” from Trading Overtime. would significantly dampen the enthusiasm for trading in the stock market. anyone in possession of material insider information must either abstain from trading or disclose to the investing public. b.” iv. The company employees were ordered to keep the drilling results a secret. i. HELD: Every element of actual fraud or misdoing by the defendant is negated by the findings. Agassiz is the president of a mining company and the company has surveys going on trying to figure out if there is material in Michigan to mine. federal courts have developed rules against insider trading based on implied fiduciary duties of confidentiality. it must be proved. given that any insider is always going to be in a better position with more information. as the facts afford no ground for inferring fraud or conspiracy and no facts placed upon them a duty to disclose the theory. RULE: Where a director personally seeks a stockholder for the purpose of buying his shares without making disclosure of material facts within his peculiar knowledge and not within reach of the stockholder. Big Question: What kind of rule do you want. obtained. p. to impose an abstain-or-disclose duty on everyone with nonpublic. The plaintiff in the case wanted to sell his stock and there was a buyer—but the two never met—it was not a face to face transaction.478)—This is a case brought in STATE court and signifies the majority view of state courts until the late 1930s. c. Rumors began to circulate about the drilling results and TSG issued press releases stating the rumors were exaggerated and unfounded. directors. Several TSG employees and their tipees then bought TSG stock and call options on the stock. the transaction will be closely scrutinized. Goodwin v. (1969.9. or employees within the corporation. One of the geologists studying the area has a theory about what is available in Michigan and Agassiz knows the information because he is president of the company. The theory was at most a hope and a possibility. RULE: Insiders are those who are officers. however. Application of Rule 10B-5 to Insider Trading a.482)—TSG began exploratory drilling in Canada and it looked like there was an extraordinary high mineral content in the area from the drilling. However. o SEC v. No statute or rule defines insider trading—its regulation remains largely a matter of federal common law. yet not preventing directors from buying and selling their own stock. material information. Early State Majority No Duty Rule—corporate insiders. having inside information do not have a duty not to trade with regards to the corporation of which they are a part based on that inside information. But Fraud cannot be presumed. Agassiz (1933. i. Early federal courts held that just as every securities trader is duty-bound not to lie about material facts. Texas Gulf Sulphur Co.
directors. Using his access to confidential takeover documents 96 . ii. An example of backdoor legislation. consultants.”—Professor disagrees—there is nothing in the Congressional statute of 10(b) to indicate equal access. and other temporary fidicuaries. Thus. not just directors. d. The existence of this legal prohibition. o This duty also applies to attorneys. Traditional Insider Trading Theory: § 10(b) and Rule 10b-5 are violated when a corporate insider trades in the securities of his corporation on the basis of material non-public information. directly or indirectly. and employees of an issuer who know of favorable information as a result of their position within the company.” • The court states that “it was the Congressional purpose [of 10b-5] that all investors should have equal access to the rewards of participation in securities transactions. to information intended to be available only for a corporate pupose and not for personal benefit of anyone. Congress should fix this.information is reasonably disseminated to the investing public before trading. even though state corporate law has largely refused to infer such a duty in impersonal trading markets. may not take advantage of such information knowing it is unavailable to those with whom he is dealing. the SC anchors federal regulation of classic insider trading on a presumed fiduciary duty of corporate insiders to the corporations shareholders. violate rule 10b-5 if they purchase shares or options before the information is released. o That relationship gives rise to a duty to disclose or abstain from trading because of the necessity of preventing a corporate insider from taking unfair advantage of uninformed stockholders. United States: Chiarella was employed in the composing room of a financial printer. This information qualifies as a “deceptive device” under § 10(b) because a relationship of trust and confidence exists between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position within the corp. accountants. which conveys a public impression of an unrigged game. as well as tippees who obtain material information before its release. ii. o Applied insider trading prohibition of § 16(b) to ALL transactions. is misleading. Chiarella and Dirks. an insider is not always prevented from investing in his own company just because he is familiar with the company’s operations—“essentially extraordinary circumstances require disclosure. Roberts & Co—Anyone who is trading for his own account in the securities of a corporation has access. • Furthermore. Fiduciary Duty of Confidentiality—In the early 1980s SC provided a framework for the abstain or disclose duty. HELD: Officers. • Matter of Cady. i. Chiarella v. A decade later the court brought “outsider trading” within its framework. iii. RULE applies to ANYONE. but Congress never does anything—The Agency keeps trying to broaden their own rule. O’Hagan.
then there would be no incentive for anyone to go out and determine whether there is fraud occurring. there has been no breach of duty to stockholders. he figured out the identity of certain takeover targets. Dirks passed on the information to his firm’s clients. p. Roberts duty. contrary to explicit advisories by his employer. They dumped their holdings before the scandal became public. The Tippee’s duty to disclose or abstain is derivative from that of the insider’s duty. a former company insider. “Imposing a duty to disclose or abstain solely because a person knowingly receives material 97 . and Dirks could not be liable for passing on the information to his firm’s clients.494)—Dirks was a securities analyst whose job was to follow the insurance industry. o HELD: Reversed Chiarella’s criminal conviction under Rule 10b-5 and held that Rule 10b-5 did not impose a “parity of information” requirement. And absent a breach by the insider. but rather because it has been made available to them improperly. the Court held. a tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only went the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach. could not trigger a duty to disclose or abstain. TEST for determining whether a disclosure is a breach of duty: Will the insider personally benefit. SEC (1983. o RULE: For an insider to have tipped improperly. the SC held that Dirks did not violate Rule 10b-5 because Scrist’s reason for revealing the Scandal to Dirks were not to obtain an advantage for him. He later sold at a profit when the raiders announced their bids. Dirks v. o HELD: On appeal from the SEC disciplinary sanctions for Dirk’s tipping of confidential information. • This not the case with insider’s disclosing information to analysts. A breach occurs when the insider gains some direct or direct personal gain or a reputational benefit that can be cashed in later. directly or indirectly. Thus. iv. Chiarella then bought stock in the targets. there has to be a fiduciary breach. Chiarella had not duty to the shareholders with whom he traded because he had no fiduciary relationship to the target companies or their shareholders. If the SEC rule were correct. And for Rule 10b-5 purposes. Some tippees must assume an insider’s duty to the shareholders not because they receive inside information. there is not derivative breach. o Misappropriation of Information is the plug in this loophole.that his firm printed for corporate raiders. the insider’s disclosure is improper only where it would violate the Cady. When he learned of an insurance company’s massive fraud and imminent financial collapse from Secrist. Merely trading on the basis of nonpublic material information. from his disclosure? Absent some personal gain. Secrist had exposed the fraud with no expectation of personal benefits.
o § 14(e) Expressly gives rulemaking authority to regulate tender offers. vi.” Citing to the legislative history of the exchange act and to SEC releases. but for the other firm. the Justice Department brought an indictment against O’Hagan. p. . alleging securities fraud. if the fiduciary discloses to the source that he plans to trade on the nonpublic information.” v. o DISTINCTION: In lieu of premising liability on a fiduciary relationship between the company insider and purchaser or seller of the company’s stock.nonpublic information from an insider and trades on it could have an inhibiting influence on the role of market analysts. Second the “fiduciary’s fraud is but when . he uses the information to purchase or sell securities.501)—O’Hagan was a partner in a law firm retained by a company planning to make a tender offer for a target company.” O’Hagan’s trading operated as fraud on the source in connection with securities trading. After an SEC investigation. U. in breach of a duty owed to the source of the information (not to the shareholders). Both the bidder and the law firm had taken precautions to protect the bid’s secrecy. a violation of Rule 10b-5. When the bid was announced. mail fraud. O’Hagan sold for profit of more than $4. and money laundering. defrauds the principal of the exclusive use of that information.3 million. o RULE: The unauthorized use of confidential information is (1) the use of a “deceptive device” under 10(b) and (2) “in connection with” securities trading. there is no deceptive device and thus. in breach of a duty of loyalty and confidentiality. O’Hagan (1997. and thereby violates § 10b and Rule 10b-5. . The 8th Circuit reversed the conviction on the grounds that misappropriation did not violate Rule 10b-5. no § 10(b) violation—although the fiduciary-turned-trader (outsider) may remain liable under state law for breach of a duty of loyalty. First. v. the court concluded that misappropriation liability would “insure the maintenance of fair and honest markets and thereby promote investor confidence. the misappropriator devices the source that entrusted to him the material. nonpublic information by not disclosing his evil intentions. the misappropriation theory premises liability on a fiduciary-turned-trader’s (“Outsider’s”) deception of those who entrust him with access to (source of) confidential information. Misappropriation theory of Insider-Trading: A person commits fraud in connection with a securities transaction. Because the deception essential to the misappropriation theory involves feigning fidelity to the source of the information. when he misappropriates confidential information for securities trading purposes. o A fiduciary’s undisclosed. o Full disclosure forecloses liability under the misappropriation theory. o HELD: Reversed and validated the misappropriation theory. self-serving use of the principal’s information to purchase or sell securities. He purchased common stock and call options on the target’s stock before the bid. He was convicted on all counts and sentenced to prison. NOTE: O’Hagan is not the attorney for the company in which he held stock.S. o Rule 14e-3(a)--“If any person has taken a substantial step or steps 98 . a violation of fiduciary duty.
o Agree Rule 14e-3(a) applies in this case. (2) The issuer of the securities sought or to be sought by such tender offer. Disgorging Short-Swing Profits a. meaning an insider might sell enough shares to bring his holdings below the 10% and later. The Court defers to the agencies interpretation. and 10% shareholders who make a profit in short-swing transactions within a six month period. This is Congress’s stab at trying to prevent insider trading. customers. This includes costs of defense 99 . yet they fail to cover abusive insider trading that occurs outside the six month window or by those who are not insiders specified under 16. Recovery is to the corporation. Numerous situations giving rise to liability—claim by third person or for injury to corporation or shareholders. 10. and the second disposed of the remainder. directors. (1972. deceptive or manipulative act or practice within the meaning of section 14(e) of the Exchange Act for any other person who is in possession of material information relating to such tender offer which information he knows or has reason to know is nonpublic and which he knows or has reason to know has been acquired directly or indirectly from: (1) the offering party. Reliance Electric Co. director. INDEMNIFICATION AND INSURANCE 1. partner. Risk of liability may be remote. it shall constitute a fraudulent. F. Most states have detailed statutory provisions covering the authority or obligation of a corporation to indemnify officers or directors for any damages they might incur in connection with their corporate activities and for the expenses of defending themselves. 511)—Did not go over in class— Emerson owned 13. b. but the amount of damages can be large in relation to the wealth of the director. a. their insider status must exist at both ends of the matching transactions. i. e. The rationale is that 10% shareholders are less likely to have access to inside information or to corporate control mechanisms than officers or directors. o NOTE: A purchase of stock falls within 16(b) where the purchaser becomes a 10% owner by virtue of the purchase. a tender offer. or claims by employees. p. The first sale reduced Emerson’s holdings to 9. or employee or any other person acting on behalf of the offering person or such issuer. Section 16(b) imposes automatic strict liability on qualifying officers. The mechanical short-swing profit rules are both overly broad and overly narrow. it is necessary that the person have held more than 10% immediately before both the purchase and sale to be matched. Short-Swing Algorithm: A two-part algorithm determines whether disgorgement is available: f. d. but still within the 6 months. Shareholder status (10%) “immediately before” BOTH transactions: For 10% shareholders.2% of Reliance stock and disposed of its entire holdings in two sales. both of them within six months of purchase. or has commenced. b. competitors. c. sell additional shares free of liability under the statute.to commence. or (3) Any officer. or government agencies.96%. v. Thus. ISSUE: Whether the profits derived from the second sale are recoverable by the corporation? o HELD: The statute clearly contemplates the requirement that a 10% owner be such both a the time the purchase and the sale of security involved. They broadly cover innocent short-swing trading that occurs without the use of inside information or any wrongful intent. Emerson Electric Co. and suit may be brought either by the corporation or by a shareholder in a derivative suit.
but they cannot be inconsistent with the scope of the corp’s power to indemnify. Thus. Indemnify expenses and attorneys’ fees if acting in good faith. officer. to any threatened. employee. or agent of a corporation has been successful on the merits or otherwise in a defense of any action . d. “If § 145(f) gave corporation unlimited power to indemnify directors and officers. Therefore.” iii. d. as delineated in the statute’s substantive provisions. “A corporation shall have power to indemnify any person who was or is a party . which may be of the utmost importance. including subsection (a). had no reasonable cause to believe his conduct was unlawful. not for derivative suits) a. not mandatory ii. employee or agent of the corporation . with respect to any criminal action or proceeding. . b. judgments. administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that he is or was a director. against expenses (including attorneys’ fees). . iii. (c) Expenses must be reimbursed if the officers and directors successfully defended claims.§ 145 (For suits by third parties. iii. fines. . (e) Advancement of expenses. and amounts paid in settlement. fines. This is so important because the biggest threat to directors and officers and securities violations. he shall be indemnified against expenses (including attorneys’ fees) actually and reasonably incurred by him in connection therein. and amounts paid in settlement actually and reasonably incurred by him in connection with such action. . 3. e. any such indemnification rights provided by a corporation contract must be consistent with the substantive provisions of § 145. BUT may have to give the money back if D loses. (b) Covers indemnification for suits by or in the right of the corporation—that is. Corporation may be able to purchase insurance. A discretionary indemnification power. (f) A corporation may provide indemnification rights that go beyond the rights provided by § 145(a) and the other substantive subsections of § 145.c. . Permissive ii. Exception: If the person seeking indemnification has been found liable to the corporation. ii. the final clause of subsection (g) would be unnecessary: that is its grant of power to purchase and maintain insurance is meaningful only because in some insurable situations. officer. (a) Provision relating to suits by third parties allowing indemnification in certain circumstances for expenses. indemnification rights may be broader than those set out in the statute. p. . judgments. Indemnification powers—“private arties may not circumvent the legislative will simply by agreeing to do so. c. Trying to expand what corporations can indemnify. i.”—Waltuch 100 . “To the extent that a director. . salaries would have to increase in order to by insurance for themselves. Affirmative/Mandatory requirement. whether civil. he corporation simply lacks the power to indemnify its directors and officers directly. if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation. . i. pending or completed action . . criminal. Contract may not exceed the scope of corps. i. 521 ii. . Delaware Law is typical . i. in derivative suits it allows indemnification only for expenses. HOWEVER. 2. i. only with judicial approval. Concern about the possibility of a hostile take-over. and. it is necessary to allow corporations to indemnify because otherwise.” Waltuch. .
o HELD: (1) The contract would require indemnification of Watuch even if he acted in bad faith. Inc. Thus. compelling the corporation to reimburse a partially successful director’s litigation expenses related to those claims or charges she defends successfully. then you can sell insurance. a. o Often have high deductible and have maximum amounts that they will pay. INDEMNIFICATION The corporation’s promise to reimburse the director for litigation expenses and personal liability if the director is sued because she is or was a director. 5. (2) Once Wltuch achieved his settlement gratis. iv. Success is sufficient to constitute vindication. o Drafting Issue: Employment Contract concerning indemnification should have addressed how settlements would be treated. then that reading is un-favored and wrong. (g) Insurance is authorized i. the corporation is obligated under all state statutes to indemnify the director for litigation expenses. he achieved success on the merits or otherwise. can buy insurance that covers directors’ actions not otherwise entitled to indemnification. 2 Issues with this defense: (1) When is a defense successful? and (2)Can their be mandatory indemnification for a partially successful defense. corporate statutes permit the corporation to indemnify directors and officers against liability arising from their corporate position. principally when a director is liable to the corporation in a derivative suit. INSURANCE Corporate statute permit the corporation to buy insurance for itself to fund its own indemnification obligations and for directors to fill the gaps in corporate indemnification. d. Explicitly allows a corporation to circumvent the “good faith” clause of subsection (a) by purchasing directors and officers liability insurance policy. after company (but not director) paid to settle private lawsuits brought by silver traders. and criminal behavior (anti-trust and certain securities laws). 4.521)—Applying a Delaware law to require indemnification of litigation expenses incurred by director charged with conspiring to corner silver market. c. b. Corp. • Whole Act Rule: Reading the statute in its entirety. o Important Exclusions—including Environmental Risks are not covered. i. f. Based on the idea that everything the legislature does is carefully considered and is there for a reason. a. ii. These policies are not easy to come buy—the problem is often evaluating the risk—if you can estimate risk. Waltuch v. To encourage qualified individuals to accept corporate positions and take goodfaith risks for the corporation. including attorney’s fees. General Rule: Mandatory Indemnification for Successful Defense If a director is sued because of her corporate position and she defends successfully. (1996. Some statutes require indemnification “to the extent” the director is successful. ContiCommodity Services. i. Indemnification rights continue even after one has left the corporation. NOTE: The indemnification agreement can be in the employment contract. 101 . which is inconsistent with § 145(a) and thus exceeds the scope of a Delaware corporation’s power to indemnify. Indemnification is a form of insurance provided by the corporation to its directors.o Surplusage—If you have two reading of a statute and any part is made useless by a certain reading. p. iii. his settlement vindicated him.
corporate directors have the right to make reasonable and proper expenditures. p. The court finds nothing excessive or unreasonable about the incumbent uses of corporate funds and resources and emphasized the right of the shareholders to be fully informed.535)—The plaintiffs own 11% of the company and seek to take over the company by putting up their slate of candidates for board positions and getting the shareholders to vote by proxy for their candidates. Citadel Holding Corp. 2. v. D’s claim for indemnification and reimbursement was prompted by a suit brought by P against him. and other agents. Levin v.529)—There were limitations on his ability to exercise his options. P alleged that D violated section 16(b) of the SE Act by purchasing certain options to buy stock while he was a director. Metro-Goldwyn-Mayer. Problems of Control A. HELD: The Agreement requires P to advance to D all reasonable costs incurred in defending the federal action. b. subject to court scrutiny. a. Roven (1992. or give away your proxie. therefore. The corporation can meet its indemnification obligations. HELD: P lose because of state law and business judgment rule. The provisions speak to Roven’s right to indemnification and not to advance. which will be used to vote the way the corporation’s Board of Directors thinks is best. (1967. As long as the incumbents can characterize what they are doing as reasonable and not excessive in order to “communicate with the shareholders” then the court is going to uphold the behavior. Inc. You can attend a yearly meeting. Shareholders are Rationally Ignorant and they Remain Passive As a shareholder. 3. i. Each group is soliciting proxies for a vote at the annual meeting. 537)—P brings a shareholders derivative suit to have the $261. The 102 . subject to the scrutiny of the courts when duly challenged. you are uninformed because it is not worth your time or energy to find out what the right answer should be (to get involved). Rosenfeld v. P claims they don’t have to pay you the things you are not obligated to indemnify (because you are never entitled to indemnification in a 16(b) action). p. not to indemnification. as compared to a purely power contest. The stockholders have the right to reimburse successful insurgents for the reasonable and bona fide expenses incurred in any such policy contest. p. they do not have to pay an advance. Strategic use of Proxies Incumbent directors (present management) may use the corporate funds and resources in a proxy contest if the sums are not excessive and the shareholders are fully informed. (1955. This determines the rights to advance. Fairchild Engine & Airplane Corp. Absurd Result Test If you were to read the statute in this manner. 6. PROXY FIGHTS 1. then there would be an absurd result. so this doesn’t fall under a 16(b).522 that was paid out of corporate treasury to reimburse both sides of a proxy fight returned to the corporation. nothing in the agreement compels the conclusion that D is not entitled to advance for the costs of defending federal action. statutory or extra-statutory. Therefore. 4. a. The O’Brien Group is the current management and the Levin Group is the insurgency.officers. and employees. from the corporate treasury for the purpose of soliciting shareholder proxy votes for policies that the directors believe in good faith are the best interests of the corporations. Reimbursement of Costs In a contest over policy. The plaintiff seeks an injunction to stop the incumbents from using corporate money in the solicitation and in addition seeks money damages. either by acting as a self insurer or by purchasing insurance from outside insurance companies. a. VI.
o HELD: Did not have to include it. RULE: Corporations may omit shareholder proposals from proxy materials only if the proposal falls within an exception in rule 14a-8. c. c. ii. Prohibits people from soliciting proxies in violation of the SEC rules. Most famous of these proposals was in the late 1960s and involves Ralph Nader who bought up GM stock and started something called “Project GM” which wanted to make GM socially responsible. Proper Proposals: Rule 14a-8 contains a dizzying list of 13 reasons for management to exclude a shareholder’s proposal: i. which won. Regulation of Proxy Fights--§ 14(a) of the Exchange Act a. Iroquois Brands. Proposals that interfere with management’s proxy solicitation---The rule has four exclusions for proposals that threaten to interfere with orderly proxy voting iii. Look to the federal register to determine what the SEC might have meant. b. (1985. or confused—Five of the exclusions are meant to prevent spurious or scandalous proposals. deceptive. v. i. then the management is not required to include the proposal on the proxy statement. or (2) give the group a copy of the shareholder’s list and let it distribute its own materials. 14(a)-7 states that management can either: (1) mail the insurgent group’s material to the shareholders directly and charge the group for the costs. The proposal must be in the form of a resolution (only one) that the shareholder intends to introduce at the shareholder’s meeting. Proposals that are illegal. It should be a policy contest and not a personality contest. ii. Proposals inconsistent with centralized management—Four of the exclusions aim at proposals that interfere with the traditional structure of corporate governance. It of course. Professor says not hard to prove policy and courts will rarely second guess reimbursement to a successful insurgent. absent some egregious waste. EXCEPTION: If a shareholder proposal relates to less than 5% of the total assets of the corporation and is not significantly related to the business. 6. got voted down d. which related to force feeding geese for pate. Dole Food Co. Ltd. Shareholder Proposals under 14a-8 The SEC shareholder proposal rule seeks to promote shareholder democracy by allowing shareholders to propose their own resolutions using the company financed Proxy machinery. p. b. thinks that these rules are a total waste of time. HELD: Right to reimbursement.000 worth of a public company’s shares for at least one year may submit a proposal—14a-8(b) (1). These rules require a proxy statement—a communication between the insurgency group to stockholders that must look a certain way and have certain information in it. 103 . and the original management paid for their side of the proxy fight and the new management voted to reimburse the insurgent group. and since it is ambiguous. Rule 14a-8 Procedures—Any shareholder who has owned 1% or $2. New York City’s Employees’ Retirement Sys. a. Professor. Lovenheim v. i. i. for their expenses. (1992.insurgent group actually won the proxy fight. the courts must determine what “significantly related” is supposed to mean. therefore. e.559)—Lovenheim sought an injunction barring Iroquois from excluding on its proxy statement a proposed resolution that he intended to offer at the upcoming shareholders meeting. o Professor find this Exception Totally Ambiguous. i. 5.
a. the court ordered Dole to include the proposal in the proxy statement. Consolidated Edison Co.568)— Shareholder sued to compel D to include a proposal in its proxy materials endorsing a change in the company’s pension policies. such as the Articles of incorporation. accounting records. are available as of right. Anaconda Co. 7. Thus. MBCA 16. Inspection of Corporate Books and Records—Corporate statutes codify shareholder’s common law rights to inspect corporate books and records. are available for inspection only upon a showing of a “proper purpose. Inc. b. unless it is sought for an objective adverse to the company or its stockholders. and shareholder lists. the burden rests on the corporation to demonstrate that the proposal does not relate to the ordinary business operations of the company. o Professor thinks decided correctly. Some statutes limit this right to record shareholders. a shareholder. wants to include a proposal on the Dole proxy statement. RULE: A shareholder wishing to inform others regarding a pending tender offer should be permitted to access the company’s shareholder list. ii. (1992. Narrowly Construed—A cannon of statutory interpretation that says that statutes in derogation of the common law should be narrowly construed.563)—A retirement fund. Other records. 104 . HELD: P not barred from access by liberally construing the statute in favor of shareholder. of NY. o HELD: Because Dole failed to prove the proposal fell within one of the exceptions. o HELD: The proposal relates to the redress of a personal claim or grievance against the company. MBCA 16. i. o Professor thinks this case is WRONG. Austin v.02.01(e). Thus. f. Dole’s argument to excluding the statement is that it has no power to effectuate he proposal—it is beyond its power to do anything about it and thus it is a waste of time and money. Information Rights To facilitate shareholder’s voting powers. bylaws.p. demanded access to D’s shareholder list for the purpose of informing other shareholders of a pending tender offer. Professor thinks this should have been narrowly construed.572)—Crane. p. such as board minutes. (1976.” o Courts have found such a purpose if the shareholder’s request for these records relates to the shareholder’s interest in his investment. which manages billions of dollars. corporate law gives shareholder the right to receive information from the corporation. management must provide a shareholder’s list to a shareholder planning to solicit proxies from fellow shareholders or internal financial records to a shareholder seeking to value her investment or uncover mismanagement. p. i. and minutes of shareholder’s meetings. But management need not provide records to a shareholder planning to give them to competitors or seeking to advance a political agenda unrelated to his investment. not one that relates to the conduct of ordinary business. i. Some records. v. D fulfills its burden in proving this. o Crane Co. RULE: In attempting to omit a shareholder proposal. not beneficial owners.
Minority stockholders have a right for the board to not be subject to contractual restraints on their discretion. his counterpart of the close corporation often has large total of his entire capital invested in the business and has no ready market for his shares should he desire to sell. (partners in all but name). detailed shareholder agreement securing the rights and obligations of all concerned. State ex rel. Closely Held Corporation One in which the stock is held in a few hands. c. ii. the minority shareholder is the victim. sound business judgment. McQuade v. insuring him a modicum of control. Gallar a. Professor tends to think that most people voluntarily enter into the situation o O’Neal is kind of a windfall to minority shareholders. Plight of the Minority Shareholder Subject to the will of the majority decision—“at mercy of an oppressive majority. Often the only sound basis for protection is afforded by a lengthy.Liberally construed is the opposite interpretation adopted here. The Ds argue that the K was void because contracts compelling someone to keep certain persons in office are illegal. Stoneham owns a majority of shares and McQuade and McGraw are minority shareholders. which eventually became Doonsbury.” BUT. Professor thinks that according to O’Neal. quite necessary for the protection of those financially interested in the close corporation. that owned the NY Giants baseball team agreed as shareholders to elect themselves as directors and as directors appoint themselves as officers at specified salaries. i. F. specifically enforceable by the courts. in his opinion. iv. b. Stoneham (1934. o RULE: In order for a shareholder to inspect shareholder lists and corporate documents. 2. or only rarely. as a practical consideration. Without a shareholder agreement. CONTROL IN CLOSELY HELD CORPORATIONS 1. P was upset with Honeywell’s contributions to the Vietnam ware effort and buys 100 shares of Honeywell stock and then seeks access to the shareholder list and corporate documents/records. o HELD: Denied inspection of shareholders’ list by shareholder seeking to communicate anti-war beliefs with other shareholders. but legislature has bought into it.606)—Three shareholders of the corp. Inc. iii. Eventually. ii. B. Hodge O’Neal Developed/Conceptualized the category of closely held corporations. the shareholder must demonstrate a proper purpose relating to an economic interest. Concern about minority shareholders—cannot dissolve a corporation like you can in a partnership. While the shareholder of a public-issue corporation may readily sell his shares on the open market should management fail to use. p. most minority shareholders buy into the situation. and wherein it is not at all. i. HELD: BY neutralizing the role of the board so much so that it did not have • 105 .—P is the great grandson of Pillsbury baker and was Doon in college. Pillsbury v. dealt in buying or selling. Old Rule: Restrictions on directorial Discretion are invalid as a matter of public policy. Honeywell. a large minority shareholder might find himself at the mercy of an oppressive or unknowledgeable majority. Shareholder agreements similar to that in question here are often. The board must be free from outside contractual decisions. a. or in a few families. McQuade is dropped as director and his claim is that the contract made between the three was not kept—he seeks specific performance.
have authorized such provision in the certificate of incorporation or an thereof. ii. may provide that in exercising any voting rights. And enter into a shareholders’ agreement regarding Clark’s continuation as manager and director. whether or not having voting power. 142—Officers shall be chosen in such manner and shall hold their officers for such terms as are prescribed by the by-laws or determined by the BODs or other governing body. Clark gave the formula to Dodge’s son. NOTE: In this case there are minority shareholders. b. a. 142 i. Clark v. iii. The Delaware statute permits a corporation to contract around the idea that the board of directors shall manage the business and affairs of every corporation and provides for more flexibility—141. EXAM! 2 Additional things Clark could have done to protect himself—this is how you get money out of a closely held corporation when you leave—Need BOTH: 106 . There are NO minority stockholders.611)—Clark and Dodge are the sole shareholders in two pharmaceutical cos. 3. shares are transferred or issued only to persons who had knowledge or notice thereof or consented in writing to such provision. the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such persons or persons as shall be provided in the certificate of incorporation. and (2) If. 141—if any such provision is made in the certificate of incorporation. but Dodge held the medicinal formulas. b. if in writing and signed by the parties thereto. After making the agreement that he would be kept as manager. ii. Clark owned 25% and Dodge owned 75% of the corps. Clark was fired and sued for breach of Contract. 4. no foul” Rule of Construction If the enforcement of a particular contract does not damage anyone.effective control over the corporation contradicted the statute stating that the board controlled the company. i. ISSUE: Whether the agreement for continuing manager position was valid? iii. then there is no reason for holding it to be illegal. Corporate Planning by use of Employment Contracts a. and the rule in this case is not the standard anymore. HELD: If a Corporation can get unanimous agreement among investors for the contract and there is notice to potential investors. The NY legislature changed the corporations law in the state to conform to this decision--§ 620 i. (a) An agreement between two or more shareholders. TODAY—Legislative willingness to view small corporations from large corporations a. or as determined in accordance with a procedure agreed upon by them. in small corporations these types of agreements are very common. p. an agreement for a continuing managing position is valid. The requirement of unanimity followed by notice is an attempt to soften the McQuade Rule. “No harm. subsequent to the adoption of such provision. or as they may agree. 5. ii. Dodge (1936. the shares held by them shall be voted as therei provided. provided there is unanimous agreement amongst investors and notice to potential investors. a contract between them to vote for specified persons to serve as directors is legal and not in contravention of public policy. NOTE: This is a close corporation without a “ready market” for stock. Clark acted as manager. ii. Evolution of Old Rule: Where the directors are also the sole shareholders of a corporation. However. (b) Shall nevertheless be valid: (1) if all the incorporators or holders of record of all outstanding shares.
i. Negotiate a buy-sell agreement o 182-183 Buyout Agreements—Cross Reference—Even though dealing with partnerships same problem. COMPETITION AND TRADE SECRETS v. but is necessary for closely held corporations because there is generally no one to sellt he stock to and no good way to value the shares. COMPENSATION o Salary o Adjustments (ex. i. vacation. Issues to Address in an Employment Contract: i. Agreements by which the shareholders simply commit to elect themselves. stock options. incapacity. c. etc. Modern View Reflected in Gallar—Such agreements are enforceable. b. etc. etc. Shareholder Agreements. o Not really necessary for large corporation. or their representative. for inflation) o Bonuses. and are now expressly validated in many jurisdictions. same solution. o Outside activities iv. Negotiate an employment contract. and Involuntary Dissolution: a. o Effect of illness. Would also like to have a Dividend Payout Contract if you can get it—Like you have in Gallar. are generally considered unobjectionable. Courts have more difficulty with shareholder agreements requiring the appointment of particular individuals as officers or employees of the corporation. o Benefits o Travel and other expenses o Perquisites iii. at least for closely held corporations. Voting Truss. as directors. DUTIES AND STATUS o Job Description and other duties o Amount of time. what would happen at the end of the term. since such agreements do deprive the directors of one of their most important functions. ii. which defines a term of employment. VOTING TRUST Shareholders who wish to act in concert turn their shares over 107 . etc. as long as they are signed by all shareholders. o This is the way to contract around the “plight of the minority shareholder” ii. PARTIES o Mergers. Statutory Close Corporations. DURATION o Number of years. They do not interfere with the obligations of the directors to exercise their sound judgment in managing the affairs of the corporation. o Guarantee by majority shareholder 6. CONSEQUENCES OF TERMINATION o Liquidation Damages – Important o Duty to mitigate vi. and “good cause” stated for firing. iii. b. and then what? o Termination for Cause—By whom? What is cause? Helpful to give some performance standard.
This may be member managed (like a partnership) or manager managed (like a corporation). Estrada (1992. o HELD: The Estrada’s breached the agreement by their written repudiation of it. i. the agreement placed a restriction on transfer and treated the shareholder’s noncompliance with the voting agreement as an election to sell the shares at market price minus a premium. Can create voting trusts and instruct the trustee to vote all the shares for directors. p. They signed an agreement in which they agreed to pay certain dividends each year and to pay. this would violate public policy. if in writing and signed by the parties thereto. p. Voting trusts generally must be made public. which was required in the agreement. the COASE Theorem may determine what happens post settlement. no injury to the public or to creditors. and on other matters submitted to shareholder vote. then an agreement between shareholders will be upheld. b. in the event either should die.” o Specific Performance creates a poisonous atmosphere. in accordance with decisions reached by the five members by majority vote. so long as they do not endanger other stockholders. This includes a salary continuation provision for 5 years.623)—Estrada violated a shareholder agreement by voting her shares in opposition to the majority. Galler v. i. The Court relies on F. Ben and Izzy. o STATUTE: “An agreement between two or more shareholders of a close corporation. o Shows the problems that state legislatures have attempted to remedy with special statutes. may provide that in exercising any voting rights the shares held by them shall be voted as provided by the agreement. each owned 47. Hodge O’Neal (who basically developed/categorized the category for closely held corporations) and determines that a court should not analyze these agreements with an eye towards voiding them because often the only sound basis for protection afforded by a lengthy detailed shareholder agreement securing rights of obligations of all concerned. Under McQuade. in accordance with instructions in the document establishing trust. reflected in a document. o “There is no reason why mature men should not be able to adapt to the statutory form to the structure they want. no fraud. Ramos v. or violate a clearly mandatory provisions of the corporation laws. and (3) it doesn’t violate any express statutory provision. drafted by or for the investors and called regulations or operating agreement. LIMITED LIABILITY COMPANIES Issues of control are generally left largely to individual choice. Ben dies and Izzy refused to carry out the agreement (Emma is ben’s widow). d.5% of the stock. and no statute is violated. HELD: The court orders specific performance of the agreement. Where there is no injury to a minority shareholder. or as the parties may 108 . Galler (1964. ii. ISSUE: Is the shareholder agreement valid? i. In addition.to a trustee. (2) it doesn’t injure creditors or the public. iii. Ramos sued because Estrada violated the voting agreement. 7. creditors. The trustee then votes all the shares. a. a pension to the remaining spouse. Voting Trusts are often used to maintain control of a corporation owned by a family or group. requiring them to repudiate. Modern Test: A shareholder agreement that substantially curtails the discretion of the Board of Directors will nonetheless be upheld if (1) it doesn’t injure any minority shareholder.618)—The two principal owners of a corporation. therefore. or the public.
b. These courts. An agreement between them narrowly defined the intended activities of the corp. and provided that no other activities could be engaged in without the minority shareholder’s consent.” ii. expediency.” o Professor—it is hard to tell people not to act out of self-interest because that is what people do. the Court decided shareholder agreement under Delaware law. i. as might be required in the case of a statutory close corporation. c. have held that a majority stockholder in a close corporation has a fiduciary obligation to minority shareholders and must behave towards him with good faith. not every action by the majority that is disadvantageous to the minority will be a breach of the fiduciary obligation. Violation of this obligation can be compensated by an award of damages. ABUSE OF CONTROL 1. the court cited Delaware provisions relating toe statutory close corporations. or self-interest. Donohue rule is similar to that of Mienhardt—Treat you close corporation shareholders with the utmost good faith an loyalty. Kurtz (1980. If a majority attempts a classic squeeze-out or freeze-out of a minority holder. but stated that the result would be the same under NY law. a. “Squeeze Outs” or “Freeze Outs”—The majority freezes out a minority shareholder a. 628)—Using choice of law rules. For instance. C. Zion v. “They may not act out of avarice. especially the Massachusetts courts. the “section shall not invalidate any voting or other agreement among shareholders which agreement is not otherwise illegal. Where a freeze out has occurred. d. b. i. There were essentially two shareholders with Kurtz holding the majority interest and Zion the minority. Fiduciary Obligation of Majority to Minority Some states have recently formulated a theory of fiduciary obligation to resolve close corporation duties. c. d.” This is intended to “preserve any agreements which would be upheld under court decisions even though they do not comply with one or more of the requirements of this section. 2. Strict good faith standard.agree or as determined in accordance with a procedure agreed upon by them. including voting agreements of corporations other than close corporations. HELD: In supporting its view that the agreement did not violate the public policy of Delaware. the majority of holder may be found to have violated his fiduciary obligation. the test is: 109 . This is the direction close corporation law is headed.” Even though this corporation is not a close corporation. “Stockholders in the close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another. this may be a violation of the majority fiduciary duty. This fiduciary obligation doctrine is important as a method of resolving disputes because it gives courts that apply it a method of rectifying the minority shareholder’s grievance without ordering dissolution. p. although the corporation involved in the case was not a statutory close corporation and the restriction in the agreement was not made part of the articles of incorporation. NOTE: Trying to protect the reasonable expectations of the minority shareholders. c. Two Step Wilkes Test Cutting back on the Donohue standard. if the majority refuses to pay dividends and refuses to employ the minority shareholder so that the minority has no way to participate in the fruits of ownership.
Springside (1976. but this is better than Donohue with no limit on the duty of good faith. Each shareholder participated in management and received an equal salary. Court is determining what the reasonable expectations of the minority shareholder. o DISSENT: Should have talked about Wilkes. Should have had an employment K and a buy/sell provision. should advise your client that if he is going to offer to buy out the minority’s stocks then it must be an adequate. or majority shareholders against at will discharge. acquires no right from the corp. p. P signs a written agreement. o You can define the terms of your own employment if you sign an employment contract and a buy/sell agreement. There is a right to selfish-ownership. P files suit stating that the fiduciary duty was owed to him so he cannot be fired. g. iii. likely market price. RULE: No duty of loyalty and good faith akin to that between partners arises among those operating a business in the corporate form who have only the rights. the court is attempting to re-write and create reasonably expectations from the sloppy expectations that these people have. but the court does not say how small the company must be. which allows D to buy back P’s stock if he ceases to be employed for any reason. e. duties. Additional evidence of a freeze-out is offering a low-ball offer to buyout the minority shareholder’s stock. (2) The minority shareholder must then show that there was another course of action that would have been less harmful to the minority shareholder and would have achieved the same business purposes. o HELD: A minority shareholder in a close corporation. Sugarman v. Basically.630)—P and three other shareholders each owned 25% of the corporation. who contractually agrees to repurchase his shares upon termination of his employment for any reason. Wilkes v. Relations between P and another shareholder deteriorated and the other shareholders caused the corporation to terminate P’s salary and drop him from the Board. HELD: The court attempts to redefine the Donohue Rule. Sugarman (1986. f. Later. NOTE: The court is trying to apply partnership law to close corporations.637)—P was employed as a manager and wanted to buy into the company and his first request was denied. This is why you should write your expectations in contracts. But there is no explicit employment agreement. Ingle v. (p. P filed suit. holding that there will be some cases where actions might be disadvantageous to a minority shareholder. he was permitted to buy in and after some time. ii. i. i. ii. i. and o Who decides what is a legitimate business purpose? This is a problem. Glamore Motor Sales.642)—Leonard is the majority and others are minority shareholders. but where there is no breach of a fiduciary duty. offer. Inc.i. P was eventually voted out and fired and D exercises its option and buys back the stock. Here the shareholders had violated their fiduciary duty by squeezing P out—stripping him of his ability to obtain his expected return on investment. p. Allegations arises that Leonard abused his 110 . The Defendants had no legitimate business purpose. (1) The Majority shareholders must demonstrate a legitimate business purpose for the action. Therefore. and obligations of shareholders an not those of partners.
3 Types: (1) Horizontal—between competitors. went so far as to hold that a minority shareholder has a fiduciary obligation to his co-shareholders. Obligation of Minority Stockholders a. 2. i. and obligations of the acquired company would have passed by law to the acquiring company. Acquisitions. the acquired company would have disappeared and all the property interests. 4. Nixon v. Statutory Merger—a merger accomplished pursuant to the procedures prescribed by state law.646)—Wolfson was one of four shareholders in a corporation that owns real estate and the corporate charter gives each shareholder an effective veto power over any corporate decision. (2) Vertical—between corporations that stand in supplier/customer relationship. 650)—A stockholder who bargains for stock in a closely held corporation can make a business judgment whether to buy into such a minority position and if so on what terms. Merger A transaction by which one corporation (acquiring firm) purchases the assets and liabilities of another corporation (acquired firm) in return for either its own securities or cash. 1. Atlantic Properties (p.fiduciary duties by engaging in self-dealing and paying himself an exorbitant salary (derivative) and then paying no dividends. o HELD: The court looks to the totality of circumstances and although in reality nothing really amounts to much. One lower court in Mass. 5. 1. Mergers. a. The other three would not agree to what Wolfson wanted to do and Wolfson would not agree to what they wanted. ISSUE: Whether Wolfson is liable for the loss of the IRS assessment? i. and (3) Conglomerate—catchall merger with no real connection. Permitting ad hoc court rulings would do violence to normal corporate practice and corporation law. Shows that the courts are not always good at applying the Wilkes/Donohue standard and therefore there should be contractual agreements so not relying on the courts. the court add up and find that the plaintiff wins. The tools of a good corporate practice are designed to give a purchasing minority stockholder the opportunity to bargain for protection before parting with consideration. HELD: Shareholders are not always treated equally for all purposes and the only issue is whether the corporation’s actions meet the standard of entire fairness. QUESTION: Who is better to make this decisions? Court or Legislature? VII. B. Blackwell (p. rights. which prescribes among other things. Terms spelled out in a merger agreement. Delaware Court has not adopted such a fiduciary duty. and Takeovers A. Upon the filing of the merger agreement with the appropriate state official. Smith v. HELD: Finds fault with Wolfson. the treatment of the shareholders of each corporation. Wolfson refused to all the corp to pay a dividend out of his surplus and the corp was assessed large penalties by the IRS for excessive accumulation of earnings. drafted by the parties. 111 . You can’t even tell if this is a direct or derivative suit. o RULE: Shows the point of contractual agreements between parties. ii. b. Three other shareholders sued against Wolfson. if the minority shareholder has been given veto power over corporate actions. Considerably flexibility is available. but all parties are guilty and fault lies in the veto agreement. This is a claim for waste and for personal recovery on the theory of a freeze-out. 3. Leonard offers to buy out the minority offering far less than what the stock is worth. or a combination of both.
d. An acquisition where the acquiring corporation acquires the assets of the acquired corporation for cash or for its securities. b. § 251—“Statutory Merger” Provisions. 4. a. The point is to benefit the minority shareholder and to encourage merger. Would deal with the company rather than with the shareholders. shareholders of each corporation who voted against the merger are entitled to demand from the courts that they be paid in cash the fair value of their shares. Anything traced to the merger or the prospect of the merger is not shared in by dissenters. Appraisal Right In addition. c. Therefore. HOWEVER. because they dissented.3. One advantage is that the acquiring corporation may be able to avoid succeeding to the liabilities of the acquired corporation. If you dissent from the merger. § 262(h) Shareholders who dissent from a merger and seek appraisal fights are entitled to seek cash payment equal to the fair value of the shares “exclusive of any element of value arising from the accomplishment of expectation of the merger. This decreases the number of acquisitions and it discourages tender offers. 4. Formally. Shows you the nature of mergers and different ways to achieve this effect. 2. f. he can ask the Court to appraise the value and award him what they think is sufficient. Consequences when the doctrine is accepted: a. C. but you must take what the shares were worth pre-acquisition. Approval by votes of the board of directors and the shareholders of each of the two corporations is required. the Federal Williams Act does require the highest price paid to any shareholder must be paid to all shareholders. 5. Acquiring corporation does not succeed to unforeseen liabilities of the acquired corporation as it would under a statutory merger. determined by agreement. 3. there is no transaction between the two corporation’s shareholders. Delaware Statute. then mergers wouldn’t happen—and we want mergers to happen because it increase the value of the firm. The selling shareholders who are disputing the merger get appraisal rights the most common result 112 . Practical Mergers 1. c. The De Facto Merger Doctrine is the theory that a transaction that is not literally a merger. 5. Delaware Corporations Law. you can attempt to perfect your appraisal rights. This makes sense because if it were publicly traded you could just trade your shares if you no longer wanted ownership. 2. but which is found to be the functional equivalent of a merger should be treated as if it were a merger for the purpose of appraisal rights and required shareholder votes. If this statute did permit dissenting shareholders to get the merger value of the shares. SHORT-FORM MERGER—Acquiring firm offers its shares to the shareholders of the acquired company in return for shares of the acquired firm. 1. e. Delaware Corporations Law § 262—Appraisal Right of Dissenting Shareholders. (b)(1)—only applies to companies that are not publicly traded. i. including appraisal rights. If a shareholder does not think the offer is sufficient.” a. you either take the market price or the price offered in the merger. or some of each. Not Used Very Often because there are delays and there is no guarantee that you will get any greater amount. d. D. ASSET ACQUISITION: Buy all the assets of another company for cash. Majority State Rule—controlling shareholders may receive a premium for their shares without sharing that premium with the majority. b. Known liabilities will be satisfied by the seller or assumed by the buyer and taken into account in the purchase price.
statute. a holding company. if there are two ways to skin a cat. HELD: It was substance over procedure. c. through the merger process. a corporation engaged in mining and manufacturing and placed three of its directors on the Glen board. i. o NOTE: the court says the book value goes down. courts will give strict scrutiny to the fairness of the 113 . but which is found to be the functional equivalent of a merger. and they have done so in special circumstances. that is. Farris v. and c. entitling him to appraisal rights. purchased 38. 6. 5. followed by a merger might happen to produce the same results as the merger statute alone would have produced is irrelevant to the issue of the shareholder’s appraisal rights. Nearly any freeze-out transaction requires the insiders to be on both sides of the transaction and therefore.715)—List. HELD: Delaware Court rejects the de facto merger doctrine. In other words. but here are important factors that have arisen: a. Occurs when a majority uses its control. i. which they might not otherwise have. and dissolving List. The fact that a sale of assets procedure. The two corporations entered into a reorganization agreement. D’s dissenting shareholders did not get appraisal rights and Hariton argues that this is a de facto merger. then it should be treated as if it were a merger for the purposes of appraisal rights and required shareholder votes. Equal Dignities Rule (Delaware Law and Majority Rule): The sale of assets statute and the merger statute are independent of each other. The selling (disputing) shareholders get the right to vote on the transaction. Freeze-Our Mergers 1. Only occasionally accepted—Minority view is acceptance of the de facto merger. but according to Professor. the parties may choose either way. therefore. p. 2. (1958. a. which is not literally a merger. which they might not have had otherwise. they are of equal dignity and the framers of a reorganization plan may resort to either type of corporate mechanics to achieve the desired end. to try and get the minority shareholders to sell their shares at an unfavorable price. Glen shareholders received notice and agreed to the reorganization. De Facto Merger (Minority Rule): The Court must look to the realities of the transaction (substance rather than form) and where a transaction. Farris. giving List shareholders stock in Glen.b. 3. which entitled Glen to purchase the assets of List and take over lists liabilities. Hariton v. ii. Creditors of the seller might have a claim against the buyer. No hard and fast rules.5% of the outstanding stock of Glen. Glen Alden Corp. a shareholder of Glen filed suit to enjoin the proceedings because it did not conform to the statutory requirements for mergers. (p. 4. Whether the target shareholders receive most of their consideration as shares in the acquiring company rater than as cash or bonds. E.722)—Loral Electronics and D agreed to a sale of assets which had the economic result as being exactly the same had D merged into Loral. Inc. should be treated as a merger. The corporation chose the sale of assets. book value means nothing. Whether the pooling method of accounting is used rather than the purchase method. But the Pennsylvania legislature saw it a different way and they amended the statute to abolish the theory of de facto mergers in Pennsylvania. Glen defended on grounds that this was a sale of assets. and not the merger. b. Whether the target corporation has transferred all its assets and then is dissolved. rather than a merger. It is the market value that is important. a. Arco Electronics.
we conclude that the burden entirely shifts to the plaintiff to show that the transaction was unfair to the minority.3 million shares bought by Signal.transaction. Two Aspects of Shareholders and if either is lacking. The court looks mostly to a two part fairness test: Substance—fair price. 4. The sale is contingent upon D stockholders responding to a tender offer of 4. or other items of misconduct to demonstrate the unfairness of the merger terms to the minority. 3. Over-Subscribed So many shareholders responded to sell their shares in the tender offer that the same percentage of shares had to be purchased from everyone. o Also. outside directors is appointed to negotiate the transaction. o Independent Committee to Negotiate: The court makes it clear that one of the best steps insiders can take to insulate the transaction from the subsequent attack is by making sure that a special committee of independent. HELD: there was a breach of fiduciary duty because no full disclosure. in a suit challenging a cash-out merger must allege specific acts of fraud. misrepresentation. p. Adequate disclosure to the outside minority shareholder concerning the transaction. do not have to use the Delaware Block Method: Elements of value were assigned a particular weight and the resulting amounts were added to determine the value per share. UOP. (1983. Signal elects its own-directors and makes a Signal man the CEO of D. which is going to sell new stock to Signal at $21 a share. RULE: Plaintiff. 114 . Inc. the court will likely find the transaction unfair and either enjoin it or award damages. ii. they are required to demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain. RULE: Where corporate action has been approved by an informed vote of a majority of the minority shareholders. Intrinsic Fairness Test Virtually all courts carefully scrutinize the transaction to make sure that it is intrinsically fair to the outsider/minority shareholders. and fair disclosure. The transaction did not meet the requirement of entire fairness because it lacked procedural fairness. Problem: There was not full disclosure from Signal-UOP directors as to conflicts—their own evaluation found they could have paid $21-$24.724)—Singnal is a big company that buys lots of other companies through conglomerate mergers—it buys. fairness of price. Weinberger v. iv. and ii. Signal buys a controlling interest in D. Signal then decides to purchase the minority shares of D. and uses money to buy again. no one owner of shares could sell all their stock so every D shareholder had accepted the tender offer had a purchase of their shares purchased. a. i. i. found the court may use whatever valuation method it wishes. a.” As the 51% majority shareholder. sells. The premium offer of $21 a share was so high that the tender offer was “over-subscribed. iii. Where directors of a Delaware corporation are on both sides of the transaction. Opens up the ability of Courts to look at any other accepted methods or techniques for accounting. but this was no disclosed to shareholders. thus creating a fair price. This is the road map noted in the footnote. and Procedural— fair dealing. o No requirement to articulate a “business purpose” for this type of transaction. Fair procedures under which the corporation’s board decided to approve the transaction.
the primary question is: What should be the role of the board of directors when shareholders seek to exercise control. Studies show that defensive tactics against takeovers do not result in better bids or more valuable corporations. The Entrenchment Motive—To perpetuate the power and prestige of control— suggests that the target board should not be allowed to use corporate resources to interpose obstacles. Thus. 2. Court goes against DE precedent and against increasing the value of the corporation by discouraging the use of two-step acquisitions. including all relevant factors: assets. 1. b. b. C. o IMPORTANT to Professor! We want the court to evaluate the procedure to keep them out of deciding substance. When the shareholders are presented with a tender offer that the management opposes. structured. Measured. market value. Hostile only from the point of public relations. Dilemma of Takeover Defense management of the corp and control of the corp’s governance machinery reside with the board of directors. and any other elements that affect the intrinsic or inherent value of the company’s stock. That is. Judicial Review the court has responded to the takeover dilemma in an ambivalent and inconsistent way. Professor—Bad because the corporation is the shareholder and the goal is to increase the value of the corp. defensive tactics can drive away weak or destructive bids. It draws into high relief the tension between the shareholder liquidity rights (attached to voting power) and management discretion. Actual Purpose Review Courts initially dealt with the takeover dilemma by a judicial slight of hand and to determine whether an entrenchment motive lurked behind a take-over 115 . FAIRNESS TEST (IMPORTANT): o (1) Fair Dealing (Procedural)—questions of when transaction was timed. therefore. There is an omnipresent conflict of interest—shareholders seeking a premium price while incumbent management has a self-interest in opposing any hostile bid 1. Assumption is that fair procedures lead to fair substance. The Court can come to a professional expert judgment over procedure. o (2) Fair Price (Procedural)—relates to the economic and financial considerations of the proposed merger. VIII. a hostile takeover exposes management to shareholder control. and how the approvals of the directors and the stockholders were obtained. the board can negotiate on behalf of the dispersed public shareholders. Activist Thesis a. c. how it was initiated. Passivity Thesis a. earnings. future prospects. Despite the potential conflict of interest. not to protect management’s jobs. E. 5. v. and otherwise assure fair treatment. More than any other corporation regulating device. buy time to find other bidders. d. the board is uniquely able to use corporate resources to further shareholder (and non-shareholder) interests.But the burden remains on those relying on the vote to show that they completely disclosed all material facts relevant to the transaction. induce better bids. the board should be passive. disclosed to the directors. Hostile Takeovers A. should the board be passive and not interfere or should it be activist and resist? A hostile bidder premises its bid on ousting incumbent management. D. B. Best Price rule a.
758)—Maremont is attempting to takeover Holland furnace Co. p. it entices others to try and do the same. Cheff v. The discussions between the two breakdown. v. it appears to be the business judgment rule and the duty of care—in the end the court ends up saying that “if there is danger to the status quo as a result of the takeover. Furthermore. courts adopted a process-oriented standard. Mathes (1964. c. iii. but Maremont keeps buying stock of Holland. TEST: “The question then presented is whether or not the defendant satisfied the burden of proof showing reasonable grounds to believe a danger to corporate policy and effectiveness existence by the presence of Maremont’s stock ownership. “Greenmail” the target company board agrees to buy the stock from the raider at a price above the market price to make the raider go away. The managers are worried about losing their jobs. But is this really a danger. so they are willing for the co. Maremont wanted to change the way Holland marketed its product. b. wanted to cut the retail division. The directors satisfy their burden by showing good faith and reasonable investigation. RULE: “Actual Purpose View”—If the board has acted solely or primarily because of the desire to perpetuate themselves in office. then the directors can defend themselves by saying that they are trying to maintain the status quo. the challenger bore the difficult burden of providing the board’s dominant motive was entrenchment. RESULT: Courts readily accepted almost any business justification for defensive tactics. ii. the premium paid to the first person depletes the resources of the company and makes it less attractive to other investors and entrenches the current board. o Sometimes liquidation is a good thing because the whole is not 116 . the directors will not be penalized for an honest mistake of judgment if the judgment appeared reasonable at the time the decision was made.” iv. HELD:the court explains that the Ds have proves reasonable grounds that danger to corporate policy and effectiveness existed by the presence of the Maremont stock owners. it virtually absolved takeover defenses from fiduciary review and insulated management incumbents from discipline of the market in corporate control. Good Faith and Reasonable Investigation the courts accepted defensive actions if the incumbent board could point to good faith and a reasonable investigation (preferably by outside directors) into a plausible business purpose for the defense.defense. Thus. and sell the furnaces wholesale. d. The board of Holland is going to pay “greenmail” to Maremont to go away. Once this was done. Professor Notes: o Professor doesn’t really think this is take over is bad—Maremont is going into the market. to take on a bunch of debt to purchase the stock from maremont. The shareholders bring a derivative suit stating that the board should not have used greenmail to buy the stock—they breached their fiduciary duty which is to increase the value of the corporation make the shareholder’s more money. o This is a problem because it should deal with shareholder interests. However. thus showing the absence of an entrenchment motive. i. then the use of corporate funds or defensive mechanisms against takeovers is improper. Maremont begins to buy up stock of Holland and then meets with Cheff regarding the feasibility of a merger. a. buying up stock and offering to sell it. o When a corporation pays greenmail.
o How do you determine true/primary motives? Most people have several motives in making a decision? 2. and o “When a board addresses a pending takeover bid it has an obligation to determine whether the offer is in the best interests of the corporation and its shareholders. ii. v.5 billion (a poison pill).greater than the sum of the parts—it may be better and more valuable to liquidate. those on the back end got $54 worth of junk bonds. Mesa Petroleum Co. ISSUE: Did the unocal board have the power and duty to oppose a takeover threat it reasonably believed harmful to the corporate enterprise. Unocol developed a plan to thwart the takeover in which the company would give money to the shareholders to decrease their shares. If the board starts taking things into account besides the welfare of the stock holders. . the goal/threat should deal with the value/price of the stock and should not concern yourself with constituencies. v. the court invalidates the defensive tactic as a violation of the board’s fiduciary duties. . Mesa Petroleum Co. certain caveats to a proper exercise of this function. (1985. meaning entitled to the business judgment rule? iii.— Preponderance of Evidence Standard. o To Professor. Because of the omnipresent pecter that a board may be acting primarily in its own interests rather than those of the corporation and the shareholders. he would get it with an additional $6. as the case notes. He makes a two-tired front loaded cash tender offer for a certain percentage of Unocal stock—those participating at the front end would receive $54 in cash. c. Two Prong Unicol Test: i.” ii.” o “In the face of inherent conflict directors must show that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed because of another’s ownership in stock. HELD: The problem here is that there is no idea what the court means by corporate enterprise. a. Unocal Corp. There are however. Boone Pickens’ idea was to buy up companies making bad investments and get them back on track.5 billion in debt. if Pickens actually succeeds in taking over the company.770)—T. there is an enhanced duty which calls for judicial examination at the threshold before the protections of the BJR may be conferred. b. but they state it is the best interests of the corporation and its shareholders. Boone Pickens is a man who went around buying up companies from their current managers in the oil industry. (1) The board must reasonably perceive the bidder’s action as a threat to corporate policy—a threshold dominant purpose inquiry into the board’s investigation. excluding Mesa and in order to do it would have to borrow $6. If the defensive tactic fails either prong of the test. but this is not the case. then there is no standard because it opens the door for any justification of a defensive mechanism 117 . Proportionality Review Delaware developed in Unocal Corp. its decision should be no less entitled to the respect they otherwise would be accorded in the realm of business judgment. The court goes on to say that the board must take into account the shareholders and the constituencies other than shareholders. The inside directors on the board are also officers. i. deterring him from the takeover. Thus. (2) Any defensive measure must be reasonable in relation to the threat posed—a proportionality test. p. T.
The second step of a two-step transaction is less desireable. Option #2: You don’t accept the first offer but the tender goes through and at the second step of the transaction. Option #1: You tender your stock to Pickens and the deal goes through— you receive $65 dollars for 51% of your stock and $55 for the rest. You have three options: i. F. The rights become exercisable upon appearance of bidder or takeover. Suppose that you. then your small percentage of stock isn’t going to be able to affect the outcome. a. o But. the SEC demonstrated its disapproval of discriminatory self-tenders by amending its rules to prohibit issuer tender offers other than those made to all shareholders. your entire stock is purchased for $55 a share—this is less than option 1. This offer coerces each shareholder into tendering and forecloses a more advantageous auction for the stock. if you can’t change the outcome. if the corporation is a large corporation. Option #3: If the transaction doesn’t go through and Pickens goes away and another bidder comes along and offers $70 for the stock. It is called “coercing” a two-tier tender offer. Code § 141(a)—The power of the board is to manage the corporation’s business and affairs.against a takeover. So. 1 is better than 2. Del. then you should go with Option #1. 1. o The truth is. o The securities laws require a “pro-rata” purchase so that each shareholder has the opportunity to sell a portion of their shares at the premium price. the shareholder. 3. 118 . known as Shareholders Rights Plans—it is adopted by the board without shareholder action in which a warrant grants the holder the option to purchase new shares of stock of the issuing corp. iii. o The small shareholders choice is between 1 and 2—3 will not really come into play. then there will be rival raiders which could bid the price of your stock up to $70. G. ii. Example: Pickens offers to buy 51% of the stock at $65 (the front end) and announces that he will then merge the company into his own firm in a transaction that pays $55 cash per share for the remaining 49% of the stock (the back end). self-tender offers are basically prohibited. o Everyone will act in their own self-interest hoping to get more money. Poison Pills—The rule did not prohibit poison pills. Development: Two-Tiered “Front-Loaded” Cash Tender Offer 1. This is a plan by which shareholders receive the right to be bought out by the corporation at a substantial premium on the occurrence of a stated triggering event. Flip-in element typically triggered by acquisition of 20% of issuers stock. They are highly complex plans. think that if Pickens’ bid fails. Thus. then you could possibly get more (but see discussion above). iv. 2. with a blended price of $60. SEC Reaction to Poison Pills After Unocal. o This is called “coercing a two-tier tender offer”—it forces the shareholders to sell.
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