1

Corporations
Fall 2012
Exam-Spend have of the time on the multiple choice questions. Essay questions state what you
should not write about. Discuss any facts, assumptions, and look to determine if any facts discuss
a few factors/elements but leave out some.
1. Creation of Corporations
a. Governing Law
i. State Law(Corporate Law)
ii. Securities & Exchange Commission(SEC) Regulations
b. Formation
i. Most states organize their corporations in Delaware
ii. Doesn’t matter where you do business and headquarters
iii. Corporation can choose the law that will resolve disputes
1. The state you incorporate is the state law that will govern disputes
iv. Top states to organize a corporate
1. Delaware
2. New York
v. OK adopted Delaware corporate law; thus, Delaware Law=OK Law.
vi. Most state courts will follow Delaware judge-made rules.
c. Governing Documents
i. Articles of Incorporation, Charter, or Corporate Constitution
2. Corporate Players
a. Shareholders
i. Owners of the corporation, provide capital for the corporation and enjoy
capital appreciation.
ii. Maintain “bundles of rights”
1. Voting Rights
a. Elect board of directors. DGCL §216
b. Remove board of directors. DGCL § 141(k)
c. Approve or deny amendments to governing documents
(Fundamental Change). DGCL § 242
d. Approve or deny a merger with another company
(Fundamental Change) DGCL § 251
e. Approve or deny the sale or all or substantially all of the
company assets. (Fundamental Change) DGCL §271
f. Approve or deny dissolution (death) of corporation.
(Fundamental Change) DGCL §275 or 245
2. Economic Rights-Not entitled to any particular property owned by
corporation.
b. Board of Directors
i. General-DGCL §141(a-p)
ii. Oversee the direction of corporation. Spend maybe two days each year doing
operational work.
iii. Membership Composition
1. Usually executives of other corporations. Some could be employees.
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2. Two Types
a. Affiliated Director-Not an insider but has an economic
relationship with the firm (i.e. consultant, attorney).
b. Inside Director -Serves on both the board and is an employee
of the corporation. (i.e. Company CEO)
c. Outside Director
i. Not an employee of the corporation.
ii. Theory for Outside Directors
1. Would likely have the interest of the
shareholders and be willing to go against
management when necessary and be
independent.
iv. Select officers (managers) of corporation (i.e. CEO, CFO, etc).
c. Managers(Officers)
i. Actual employees of the corporation and manage the day-to-day operations.
ii. Performance Considerations
1. Might not act as the board or shareholders want them to.
2. Incentives to Performance
a. Compensation
b. Stock Options
c. Bonuses
3. Penalties
a. Reductions in compensation.
b. Termination.
4. Monitoring of Performance
a. Agency Problem
i. Are the agents(board of directors and managers) going
to do what the organization (stock holders) want?
b. Third Parties
i. Accountants
1. Audit financial statements.
ii. Investment Banks
1. Make recommendations as to what stock a
company should purchase.
c. Costs of Monitoring
i. Financial costs.
ii. Corporation could miss a profit generating opportunity.
d. Not necessarily perfect.
3. Purpose of Corporations
a. Corporate Social Responsibility
i. Corporations are allowed to give money to charitable organizations but does
not provide a limit as to how much. DGCL § 122
ii. Common Law Limits
1. 1-2% of profits.
2. Could be a lot of money.
b. Maximize Shareholder Value
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i. Not always true since they sometimes endorse behavior that doesn’t in that
end.
4. Types of Corporations
a. Corporation(Publicly Held)
b. General Partnership
c. Limited Partnership
d. Limited Liability Corporation (LLC)
e. Limited Liability Partnership (LLP)
f. Close Corporation(Not discussed at length)
5. Characteristics of Each Type
Characteristic Corporation Close LLC General Limited LLP
(Publicly Corporation Partnership Partnership
Held)
Recognized as Yes Yes Yes Yes Yes Yes
Legal Entity?
Limited Yes there is a Yes Yes No Gen. Partner: Yes
Liability to veil (*Pierce) No
Investors? but, DGCL Lim. Partner:
102(b)6 and Yes
contract
Perpetual Yes, but Yes Trending to No No No
Existence? DGCL 102.65 yes
Free Yes No Look to No Gen. Partner: Look to
Transferability But articles of No partnership
of Investment DGCL 202 formation Lim. Partner: agreement
Interest? No, but
Centralized Yes Look to Member- No (one Yes, General Look to
Mgmt? (shareholders articles of managed: No partner, one Partner partnership
don’t manage) incorporation vote) agreement
*“One share, or shareholder Manager-
one vote” agreement managed:
DGCL 141, Yes
142
Tax? Entity-level May qualify Taxed at Taxed at Taxed at Taxed at
tax and for pass- investor- investor-level; investor-level; investor-
investor-level through level; no no entity- no entity-level level; no
tax on treatment such entity-level level tax tax entity-level
distributions that there is tax tax
only an
investor-level
tax
Formalities to Yes Yes Yes No; only Yes Yes
Form Entity? DGCL 102 needs
agreement; no
“magic”
words needed.
Important:
Substance of
the argument.
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a. Publicly Held Corporations

i. Stocks open to the public?
1. No.
2. Can’t specify where investment goes.
ii. Formalities To Organization
1. Certification of Incorporation
a. Must go to state office and pay amount required.
iii. Investor Liability Limited To Investment?
1. Default Rule-Yes(Corporate Veil)
a. Example-Tylenol becomes dangerous. Stockholders may lose
what they spent on stock but personal assets can’t be touched.
2. Exceptions
a. Statutory-DGCL §102(b) (6)
i. Could impose liability through the certificate of
incorporation. Limit for liability must be specified.
b. Common Law (Piercing the Corporate Veil)
3. Benefits
a. Stockholders don’t lose anything besides purchase price.
b. Encourages people to invest who normally wouldn’t.
iv. Perpetual Existence?
1. Default Rule-Corporations have perpetual existence and live forever.
2. Exception-Corporation may limit duration. DGCL §102 (b)(5)
3. Corporation can limit duration of existence in charter.
4. Benefit
a. Facilitates long-term contracts.
v. May Freely Transfer Their Interests?
1. Default Rule-Yes. Shareholders don’t have to receive permission.
a. DGCL §202
2. Corporation can limit ability to freely transfer.
3. Reasons Corporations Would Limit Transferability
a. Transfers would trade down.
i. Example-Trading stocks to The Three Stooges.
ii. If limitation present, then corporation could require
their consent before shareholder transfers.
b. Prevent competitors from purchasing stock.
4. Benefit-Induce investment because they can get rid of stock whenever
they want. Would be willing to spend more on day one.
vi. Investors Centralize Management In The Hands Of The Few?
1. Default Rule-Yes.
a. DGCL §141 & §142
2. Board hires managers to manage the company.
3. Stockholders don’t manage the company.
4. Majority-Centralized management in the few.
a. Example-US government.
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5. Supports investor diversification since they don’t put all of their eggs
(finances) in one basic.
6. CEO will invest a lot in learning business.
a. Could be a negative if fired and can’t translate to another job.
b. If that happens then CEO and stockholders clash. CEO wants
to stay, stockholders that him to go and sell shares.
vii. Subject to Tax?
1. Yes.
2. Subject to two levels of taxation
a. Corporate Level
i. Business entity owned 50/50
ii. 30% -Corporation taxed for its own income
b. Individual/Investor
i. 30%-Taxed on dividends
b. General Partnerships
i. Definition-2 or more persons engaged in business as co-owners.
ii. Formalities to Organization?
1. No—formalities not required.
2. Look at substance.
a. Look at the intent to enter into a partnership.
b. “Must be borne in mind, that the intent to do those things
which constitute a partnership.”
c. Examples
i. Partnership
1. Sharing profits of a business EXCEPT profits
were a payment for: (1) Debit, (2) Wages of an
employee or rent to landlord, (3) Annuity to
widow, (4) Interest on a loan.
ii. No Partnership
1. Sharing property doesn’t constitute a
partnership even though they may receive
profits from the property.
iii. Investor Liability Limited To Investment?
1. No. Subject to unlimited liability.
2. Personal assets are at risk.
iv. Perpetual Existence?
1. Traditional Rule-No. Partnership is an aggregation of individuals and
if any pool of individuals change (i.e. partner dies) then it doesn’t
exist.
a. Problems With Traditional Rule
i. Inhibits contracts because changing in partnership could
mean they won’t ever be compensated.
2. Some jurisdictions have trended away from traditional rule.
v. Free Transferability of Shares?
1. No.
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2. Traditional Rule-Must receive consent from non-transferring partner to

transfer shares.
a. Reason For Traditional Rule
i. Personal liability of assets are in play.
vi. Centralized Management?
1. No. Default Rule-One partner, one vote. Doesn’t matter how much an
individual invested.
2. Decentralized management.
3. Every partner participates in the management of the business.
4. Partners can contract out of the default rule.
vii. Tax
1. No. Don’t pay taxes as a partnership.
2. Profits are equally distributed to partners.
3. Then investors pay individual tax.
4. Inputted Income
a. Doesn’t matter what partners take home, partners must still pay
individual income tax.
viii. Powers of Partners
1. Partners are agents of the partnership.
2. Can enter into contracts on behalf of the partnership.
a. Limitations
i. Nature of Business
1. Can only make contracts that involve nature of
the business.
a. Example-Real estate business. Partner
can purchase land. Can’t buy tiger in
China.
b. Exception
i. Partner has no authority to act for the partnership in the
particular issue and the person with whom he is dealing
has knowledge of the fact that he has no such authority.
c. Limited Partnerships
i. Formalities to Organization?
1. Yes. Must file certain documents.
2. Two different partners(Must have one of each)
a. General Partner
b. Limited Liability Partner
ii. Investor Liability Limited To Investment?
1. Yes/No
2. No—General Partner-Do not enjoy limited liability and subject to
unlimited liability.
3. Yes—Limited Partner-Enjoy limited liability (Take on role of
shareholders). Personal assets are not at risk.
iii. Perpetual Existence?
1. No. Must have general partner. If you lose general partner then it dies.
iv. Free Transfer of Shares?
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1. General-Not freely transferable.

2. Limited-Freely transferable.
v. Centralized Management?
1. Yes—just for general partner who manages daily operations.
vi. Tax
1. Single level taxation. Not entity level.
vii. Limits on Limited Partner
1. Consulting with and advising isn’t the same.
d. LLC-Limited Liability Corporation
i. Formalities to Organization
1. Yes. Must go through procedural hoops with the state.
ii. Investor Liability Limited to Investment?
1. Yes—Enjoy limited liability. Exception—piercing the corporate veil.
iii. Free Transfer of Shares?
1. No.
2. Default Rule-Shares aren’t freely transferable.
3. Other members must approve new member.
iv. Centralized Management?
1. Yes—members. Members manage the business.
2. All members participate in the management of the LLC
3. Default Rule-How members vote is in proportion to their percentage of
profits (can be changed if they provide otherwise).
4. Note-Common way to provide otherwise is to have Manager-managed.
5. Manager-managed-Manager is appointed by members to run the LLC.
v. Tax
1. Single Level
e. LLP-Limited Liability Partnership
i. Formalities to Organization
1. Yes.
2. Must file document with the state.
ii. Investor Liability Limited to Investment?
1. Yes/No
2. Person committing malpractice won’t lose their assets.
3. Must look at the state role.
iii. Centralized Management
1. Yes. General partner takes on the role of management.
iv. Perpetual Existence?
1. No
v. Tax
1. Single level taxation.
f. Close Corporations
i. Open to Public
ii. Formalities
iii. Investor Liability Limited to Investment?
1. Yes
iv. Perpetual Existence?
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1. Yes
v. Investors Freely Able to Transfer Their Interest?
1. No
vi. Centralized Management
1. Look to articles of incorporation or shareholder agreement.
vii. Tax
1. May qualify through treatment such that there is only an investor-level
tax.
viii. Problems
1. If an investor engages in risky behavior, then the court can remove
liability from investors and their personal assets.
2. Lenders will sometimes require personal collateral of the investors
(house, car, etc).

6. Board of Directors & Formalities

a. Majority of the states adopted some form of the Model Business Corporation Act
(MBCA)
b. Sometimes the statute won’t let you contract around the default rule.
c. Requirements for Board Meetings (Found at MBCA §8.20)
i. Notice-MBCA §8.22
1. Regular Meetings-Don’t require notice of date, time, place or purpose
of meeting. Something can’t go outside the normal scope of a regular
meeting (i.e. Making a large purchase).
2. Special Meetings-Must provide two days notice of time, date, and
place.
a. Default Rule-Purpose of the meeting doesn’t need to be in
notice.
i. Reasoning:
1. Don’t need purpose because you can always
postpone the decision for the future.
2. Protects confidentiality because notice could
pass through multiple channels before reaching
board member.
3. Waiver-MBCA §8.23
a. Director can waive notice by:
i. Writing-Must be signed by director entitled to notice
and filed with the minutes or corporate records. OR
ii. Attendance or Participation, UNLESS
1. Objects before or as soon as you arrive and
don’t vote for the action at the meeting. If you
object but then vote for the action then you
waive notice.
4. Quorum-MBCA §8.24
a. Default Rule-Quorum consists of:
i. (1) Majority of the fixed number of directors if
corporation has fixed a board size; OR
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ii. (2) Majority of the number of directors prescribed, or if

no number is prescribed the number in office
immediately before the meeting begins, if the
corporation has a variable-range size board.
b. Articles of incorporation or bylaws may set quorum to consist
of no fewer than 1/3 of the fixed or prescribed number of
directors.
c. Default Rule-If quorum is present when a vote is taken,
affirmative vote of a majority of directors present constitutes
the action of the board.
d. Corporations can get out of this rule by requiring a
supermajority vote for certain actions.
5. Communication/Location of Meeting-MBCA §8.20(b)
a. Default Rule-Anything is allowed so long as the other directors
can hear each other.
b. Email is discouraged since emails can be misconstrued.
6. Meetings Actions
a. Board member can act without having a meeting if all board
members unanimously sign a consent document describing the
action to be taken and delivers it to the corporation. See MBCA
§8.21(a)
b. A director’s consent may be withdrawn by a revocation signed
by the director and delivered to the corporation prior to
delivery to the corporation of unrevoked written consents
signed by all the directors. See MBCA §8.21(b)
7. Committees
a. All rules in sections §§8.20-8.24 apply to committee meetings
as well.
b. Default Rule-Board can authorize a committee to act on behalf
of the board. MBCA §8.25
i. Limitations to Authorization-MBCA §8.25(e)
1. Authorize or approve distributions
2. Approve or propose to shareholders action that
this Act requires be approved by shareholders.
3. Fill vacancies on the board of directors or any
committees.
4. Adopt, amend, or repeal bylaws.
c. Nominating Committee
i. Board members sit on the committee.
ii. Committee decides who should be nominated to serve
on the board of directors.
d. Model Business Corporation Act §8 – Directors and Officers (majority of the
states follow the MBCA – more detailed in some respects than DGCL)
i. §8.01 – Requirements for and duties of Board
ii. §8.02 – Qualifications of Directors
1. Prescribed by Articles of Incorporation
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iii. §8.03 – Number and election of directors

1. (a) – Must consist of one or more individuals
2. (b) – Number may be increased or decreased
3. (c) – Elected at the annual SHH meeting
iv. §8.04 – Election of directors by certain classes of SHH
v. §8.05 – Terms of directors generally
vi. §8.06 – Staggered terms for directors
vii. §8.07 – Resignation of directors
viii. §8.08 – Removal of directors by SHH
1. SHH may remove one or more with or without cause
2. Can only be done in a meeting for that purpose
ix. §8.09 – Removal of directors by judicial proceedings
x. §8.10 – Vacancy on board
xi. §8.11 – Compensation of directors
1. Fixed/set by board of directors
xii. §8.20 – Meetings
1. All participating directors must be able to simultaneously hear each
other
a. Teleconference and video conferences are ok
b. Email real time not ok (cannot hear)
xiii. §8.21 – Action without Meeting
1. (a) Each director must sign consent
2. (b) Consent can be revoked by a signed revocation sent prior to all
consents being received
xiv. §8.22 – Notice of meeting
1. (a) Regular Meeting – Okay without notice
a. Boards oversee these all the time so its regular and not
everyone needs to be there
2. (b) Special Meeting – 2 days notice (purpose not required in notice)
a. Doing something outside the norm so we need all directors
there to have an opportunity to participate
xv. §8.23 – Waiver of notice
1. (a) Waiver must be in writing and signed by director (filed with the
minutes)
xvi. §8.24 – Quorum and Voting
1. Quorum = majority
2. Articles of Incorporation can make a quorum = 1/3
xvii. §8.25 – Committees
1. (e)(2) – Committees cannot approve or make proposals to SHH that
have to be approved by SHH

7. Agency and Authority

a. Ways To Appoint Agents of Corporation
i. Bylaws
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1. Board designates an officer (i.e. Chief Executive Officer).

ii. Actual Authority
1. Must be written or spoken words or other conduct of principal (usually
board), reasonably interpreted by the agent, that agent can act for the
principal.
a. Examples
i. Written document.
ii. Spoken words.
iii. Conduct-Nodding heads.
2. Agent actions that are authorized by the board, subject the company to
liability of the agent’s actions.
iii. Apparent Authority
1. Written or spoken words or other conduct of principal reasonably
interpreted by third party, that the agent can act for principal.
2. Conduct must come from principal to third party.
a. i.e. Corporation tells third party that agent doesn’t have
authority.
3. Corporation is subject to liability.
iv. Inherent Authority (Powers of the Position)
1. Menard, Inc. v. Dage-MTI, Inc.
a. Facts-Corporate CEO made a deal with third-party to sell some
land but didn’t have authority.
b. Inherent authority used.
c. Principal is Liable for Actions of Agent If Three Elements Met:
i. (1) Customary authority of agent.
ii. (2) Third party reasonably believes that the agent is
authorized to do them.
1. Must look at subjective belief. If he doesn’t
actually believe the agent was authorized then
the sale won’t stand.
iii. (3) Third party has no notice that the agent is not
authorized to make the action.
d. Applying the elements.
i. CEO is the highest employee. Purchased real estate
before without board authority.
1. Counter-Company isn’t in the business of
buying real estate and is an extraordinary action.
2. Purchase alone doesn’t have the power to sale.
ii. No reason to question defendant because he’s the
president.
iii. President lied to plaintiff on authority. Didn’t interact
with board.
v. Estoppel Doctrine
1. No written or spoken assent.
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2. Basically the corporation just sits by knowing someone is acting for

the corporation when they shouldn’t but the corporation gives no
reason to think otherwise.
3. A person is subject to liability to a third-party who justifiably is
induced to make a detrimental change in position because the
transaction is believed to be on the person’s account, if: (1) the person
intentionally or carelessly cause such belief, or (2) having notice of
such belief and that it might induce others to change their positions,
the person did not take reasonable steps to notify them of the facts.
4. See RST §2.05 on page 148 in statutes book for more detail.
vi. Ratification
1. Principal can ratify actions of the agent by (1) manifesting assent or
(2) conduct that justifies a reasonable assumption that the person so
consents.
a. Example-Paying a bill or conduct.
2. See RST §4.01 on page 166 in statutes book for more detail.
vii. Theories
1. Corporation has the responsibility to watch employees.
2. Third-party should be on notice that an employee may not be
authorized to make a transaction and should conduct an investigation
into employee’s authorization.
8. Duty of Care
a. Inquiry looks to determine if the board of directors or corporate office in a way that
would harm the corporation.
b. Business Judgment Rule-Absent fraud, illegality, or self interest, courts defer to
decision of the board, presuming the board was informed and acted in good faith to
further the best interests of the corporation and shareholders.
c. Reasons for BJR
i. Shareholder knows corporation will take risks.
ii. No set method for making business judgments.
iii. Could allow board decisions to blow out of proportion if safeguard not
present.
d. Disinterested Conduct
i. Shlensky v. Wrigley
1. Facts-Shareholder wants lights installed on Wrigley Field. Board says
no.
2. Rule-BJR applies unless there has been no showing of fraud, illegality,
or conflict of interest.
ii. Miller v. American Telephone & Telegraph Co.
1. Facts-AT&T didn’t collect on million-dollar debt from DNC.
Shareholders claim it amounts to an illegal contribution.
2. Burden of Proof/Rule-Plaintiff must show there was no legitimate
business justification for decision.
3. Arguments in favor and against:
a. In Favor-Corps should make best judgment for themselves.
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b. Opposed-Legislature says this type of behavior is wrong and

corps shouldn’t be allowed to ignore the law.
e. Informed
i. In Re Walt Disney Co. Derivative Litigation(Cases Shows Board Informed)
1. Facts-Directors hired new Pres. Contract provision gave Pres large
severance if he left before contract ended. He left, got settlement.
Board did establish a compensation committee to review everything.
2. Take Aways
a. Board doesn’t have to follow “Best Practices.”
b. Courts look at process more than the decision.
c. Fair for board members to rely on each other.
d. 3 Categories of Bad Faith
i. Subjective Bad Faith-Intent to do harm.
ii. Lack of Due Care-Gross negligence without more.
iii. Conscious disregard for one’s duties.
3. Informed-Court looks at process not substance of the decision.
4. Standard of Care-Reasonableness
5. Standard of Liability-Gross negligence
6. Considered (in) action-Board made a business judgment, so courts
look straight to BJR.
7. There’s a presumption that the board was informed and plaintiff must
prove otherwise.
8. Holding-Court finds that gross negligence (2nd one) without more isn’t
enough to constitute bad faith.
ii. Smith v. Van Gorkom (Case shows board not informed)
1. Facts-Corp with net worth of $500 mil sold itself in a week. Board met
only once that week and set meeting with 2 hours notice. Board didn’t
read anything, didn’t have a 3rd party expert. One person had report but
didn’t read the contract he was discussing. CFO’s report did not
discuss the issue at hand.
2. Rule: The Corp does not have to have an expert but they need to be
informed somehow.
3. Result-Board wasn’t informed and could be subject to personal
liability. Remember DGCL §102(b)(7) “may be included in certificate
of incorporation” & DGCL §141(e).
f. Monitoring
i. Look to determine if the board failed to act and safeguard against harmful
inaction.
ii. Stone v. Ritter
1. Facts-Plaintiff claims that board didn’t monitor business which
resulted in $50million loss at hands of employees.
2. Note-Failure to gather reasonable information is not enough to create
liability. There must be utter failure to monitor or consciously
disregard output of the monitoring.
3. Good Faith
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a. Failure to act in good faith only results in liability when the

board has either (1) intent to harm or (2) conscious disregard of
a known duty to act.
4. Board didn’t consciously disregard duty because it told employees to
object federal laws and setup monitoring system.
5. Note-Corporation must consider what laws they must comply with and
what type of corporation they have.
iii. DGCL §102(b)(7)
1. Allows corporation to opt-in to restrict liability for the board for
monetary damages to the corporation/shareholders in the event of
gross negligence in failing to inform itself.
2. Even though it looks like duty of care, monitoring/oversight can fall
under duty of loyalty. Reasons below:
a. You can’t eliminate liability for breach of duty of loyalty
b. Can eliminate liability for an act or omission not in good faith.
iv. Francis Case
1. Facts-Wife told husband to beware her oldest son. She was unfamiliar
with business and corporation.
2. Rule-Directors don’t need to be directly involved in day-to-day
activities but they do need to be involved.
3. Note-If a director has special skills, then most people believe the
minimum should be raised.
v. Normal Procedure
1. Plaintiff bears burden to show board (1) wasn’t informed and (2) they
didn’t act in good faith. If plaintiff meets this burden then courts no
longer defer under BJR.
2. Burden shifts to defendant to show the transaction was fair.
vi. Defense
1. Defendant argues telling shareholders that they’re not informed
insulates the board from liability.
9. Duty of Loyalty
a. General
i. Usually involves some self-interested transaction. Focuses on what is self-
interest.
ii. Examples-Excessive salary, use of corporate employees for personal work
without compensation to corporation, stealing funds.
b. Contracts with Interested Directors
i. Cookies Food Products, Inc v. Warehouse Distributing, Inc.
1. Facts-Defendant owns one company (Warehouse Distributing),
purchased majority share in stock of a subsidiary company (Cookies),
and later took over the management of the company.
2. Burden of Proof
a. Plaintiff must first show self-interest on the part of the board.
b. Defendant director must prove that the transactions were done
in good faith and with honest and fairness toward the
subsidiary company.
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3. 3rd circumstance fits in for the defendant

4. Dissent
a. Defendant was paid more than he deserved.
b. Example-Start a corporation and we need to hire a janitor and a
computer programmer. If we hire Bill Gates to do something
that anyone can normally do then he wouldn’t get paid above
market value.
5. 3 Interested Contracts Allowed/DGCL §144-Interested Directors
Specifications
a. (1st Circumstance) Disclosure=authority by majority of
disinterested directors in good faith (even if less than quorum).
OR
b. (2nd Circumstance) Disclosure+approval by shareholders in
good faith. OR
c. (3rd Circumstance/Fairness Test) Fair when authorized,
approved, or ratified.
i. Ratification=No authorization but approved action after
the fact. Approval after the action has occurred.
1. Example-Cleveland and diet coke purchase.
2. Similar to DGCL §144 (a)(1). Looks to
information and distribution of info.
3. Note-Fairness is not a point, it’s a range.
d. If defendant met all of their burdens then the burden shifts back
to plaintiff to prove unfairness or waste.
e. Reasoning
i. 1st & 2nd-More likely to disclose since you have loyalty
to the directors or stockholders.
ii. Fairness-Board thinks it’s fair but the court determines
whether contract is indeed fair.
iii. Problem with 3rd is directors sometimes don’t know
what’s fair.
c. Special Problems of Parent-Subsidiary
i. Case v. New York Central R.R.
1. Facts-Plaintiffs-Minority shareholders in Mahoning. Mahoning-Rents
lines to New York Central Railroad. Mahoning and Central Railroad
consolidated taxes (way to save money). Both companies have the
same board of directors.
a. Tax Consolidation Plan
i. Year 1
1. Parent=$100 no profit.
2. Subsidiary=$100 profit.
3. Result=Pay both parties.
ii. Year 2
1. Parent=$100 loss
2. Subsidiary=$100 profit.
3. Result=Break even.
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2. If one shareholder is in control, then controlling shareholder can’t

disadvantage minority shareholders. Even though you don’t hold the
majority of shares, control matters.
3. Question to ask-Did majority benefit to the detriment of the minority?
We care about how much of a detriment. Here the minority received
enough profit to favor. Not the test though.
4. Things to look at
a. Did they exploit?
b. Who’s dictating authority?
c. Could be a majority shareholder who doesn’t really control.
5. Note controlling isn’t always the majority.
a. Remember grandma-70%, grandson-10%, other relative-20%
i. Grandson has control because grandma does whatever
he wants.
6. Holding-If both parent and subsidiary benefit, even if the benefit is
disproportionate, courts tend to allow this to stand UNLESS the
fairness is startling (i.e. Millions for parent and pennies for subsidiary)
7. Possible Remedies
a. Action Not Yet Consummated=Injunction
b. Action Already Taken Place=Damages

ii. Sinclair Oil Corp v. Levien

1. Facts-Sinclair controls Sinven.
2. Issue-Did the majority benefit to the detriment of the minority?
3. Holding-Court says business judgment rule prevails.
4. Example-If one class of stock went to the majority and another to the
minority and dividends were only paid to majority then detriment to
minority.
5. Best example of majority benefiting to the detriment of the minority is
the contract argument.
6. Review DGCL §144
d. Compensation of Managers
i. Salaries, Bonuses, Pensions
1. Adams v. Smith
a. Facts-Corporation made death benefit payments to the widows
of deceased officers. Nothing written in bylaws or charter
allowing such. Waste claim made.
b. Holding-Court doesn’t allow payments because there was no
written obligation. This falls outside the business judgment rule
because of substance.
c. Policy Reasoning-Allowing the corporation to do so would
result in widespread fraud.
d. Burden of Proof-Plaintiff maintains burden of proving that the
exchange was so one sided that no business person of ordinary,
sound judgment could conclude that the corporation has
received adequate consideration.
 17

e. What to look for-Did the board of directors irrationally

squander or give away corporate assets?
f. General contracted salary, benefits, and bonuses are okay.
g. Waste Test
i. If a disinterested board said allows additional
compensation beyond what they normally would if
there’s a contract. The idea is that no reasonable person
would accept it.
1. Exception-Not a crazy amount. See footnote 33
on pg 98.
h. Reasonableness is not an issue and should not be considered.
i. How to give a salary or benefits to a retired individual?
Adequate consideration is met.
i. Consult corporation after retirement.
ii. Work for a competing business.
2. Mlinarcik v. E.E. Wehrung Parking, Inc.
a. Facts-Father founded parking company. It was subleased to
another company. Robert(founder’s son), Marilyn(Rob’s wife),
and Shirley(founder’s daughter and Rob’s sister) own stock.
Rob owns the majority. Father dies and son takes over. Robert,
Marilyn, and Shirley are on the board. Rob also becomes
manager. Rob and Marilyn receive salaries for their roles.
b. Holding-BJR will be applied because plaintiff didn’t meet
burden of proof. Testimony wasn’t good enough.
c. Problem with decision is majority benefits to the detriment of
minority.
d. This is a general example of self-interest because Shirley, as a
board member, was excluded from benefiting.
e. Ohio statute uses “reasonable compensation” while Delaware
uses “suitable compensation.”
i. Reasoning-Delaware statute doesn’t allow courts to
determine if compensation is adequate.
ii. Also allows second-guessing without more proof.
f. See aspects to consider when determining compensation on pg
145.
g. Contrast between publicly traded corporation v. others
i. Publicly traded-Rarely see excessive compensation.
e. Stock Options
i. Right (“Exercise Right”) to acquire stock at a specified price after a specified
period of time and before a specified period of time.
1. Specified Price-Price is set and doesn’t change.
2. Vesting Period-After a specified period of time has passed, you can
purchase.
ii. Benefits
1. Don’t have to spend money to purchase stock immediately.
2. Insulated from possibly losing money.
 18

iii. Default Rule-Every corporation has the right to create stock options. Doesn’t
require stockholder approval. See DGCL §157.
iv. Why stockholder approval is use by boards of directors
1. Self-interested board.
2. (Non corporate law)Tax advantage.
3. (Non corporate law)Private rules (NYSE) might require stockholder
approval if options aren’t available to every employee.
v. If board grants themselves stock options then we’re taken out of BJR you go
to three questions to determine whether the option is alright. DGCL §144
1. i.e. Removing the self-interest tank.
vi. Eliasberg v. Standard Oil Co.
1. Facts-Board creates stock option plans. Plans limit the amount
available to the entire board, individual director, etc. Shareholders
approve plan. Plan documents were sent to shareholders before the
meeting. Vesting period present in stock options.
2. Standard of Review-Waste inquiry.
3. Holding-No self-interest when board grants options to third parties and
they are still in the BJR.
4. Four Possible Effect of Shareholder Ratification-pg 158
a. One might conclude that an effective shareholder ratification
acts as a complete defense to any charges of breach.
i. Won’t act as a complete defense for breach of duty of
loyalty.
b. Test goes from fairness to waste.
i. Test is more likely to be used and applied.
c. Shifts the burden of proof of unfairness to plaintiff, but leaves
the shareholder-protective test in place.
i. Plaintiff must show that it’s unfair.
ii. Reasoning-If really unfair, shareholders wouldn’t
approve thus it would be hard to prove.
iii. Hard for plaintiff to prove.
iv. Why would shareholders approve a transaction that
wasn’t fair?
1. Shareholders afraid to say no.
d. Shareholder ratification should be ignored.
i. Reasoning-Shareholders don’t actually read the
necessary documents for corporation and just follow
along.
ii. You don’t see this.
5. Note-Waste isn’t protected by BJR.
vii. Purpose of Vesting Period
1. If person doesn’t work hard then they will be fired and prevented from
purchasing stock.
2. Example-Cleveland granted stock options on Friday when he leaves
the office. Has the right to buy one million shares at $10 per stock
which is the market price. On Monday, Cleveland does nothing. Same
 19

day the market price goes up to $11. Cleveland quits after buying the
stock.
viii. Bear v. Elster
1. Facts-Disinterested directors granting options. Problem is there was no
vesting period. Plaintiff must show waste which is very hard.
2. Standard of Liability=Waste
3. Holding-Since they’re disinterested then BJR applies unless plaintiff
can prove waste. Since plaintiff couldn’t show waste then BJR applies.
4. Test
a. Tested against the requirement that they contain conditions or
surrounding circumstances are such that a corporation
reasonably may expect to receive expected benefit from
options.
b. Reasonable relationship between value of benefits to
corporation and value of options granted.
5. Policy Considerations
a. Who is really reasonable?
i. i.e. Years before Bob Stoops was coach the team had no
success. After he came the team got better. How
responsible is Bob Stoops?
b. Comparing Peers To Each Other
f. Corporate Opportunities
i. Has the director, officer, or other fiduciary taken a corporate opportunity that
belongs to the corporation?
ii. Irving Trust v. Deutsch
1. Facts-Company wanted to buy rights to another corporation. Company
didn’t have enough money so a few directors said they would buy the
stock and the company could get the rights. Director later say they
thought they were buying the shares because the company couldn’t
afford to purchase the shares.
a. People involved-3 Directors, Reynolds-Company Employee,
Stein
2. Issue-Whether a director or other person with a fiduciary responsibility
can engage in an opportunity because the corporation does not have
sufficient funds to engage in the opportunity?
3. Holding-
a. One who knowingly joins a fiduciary in an enterprise where the
personal interest of the latter is or may be antagonistic to his
trust becomes jointly and severally liable with him for the
profits of the enterprise.
b. A mere employee of a corporation does not ordinarily occupy a
position of trust or confidence toward his employer unless he is
also an agent in respect to the matter under consideration.
4. Way to Answer
a. Is there a duty?
i. Everyone else yes, Reynolds no.
 20

b. What is the opportunity?

c. Did the opportunity belong to the corporation?
i. If in “line of business” then yes.
1. Is this the type of business the corporation
usually engages in?
2. Examples
a. Yes-Texaco learns of drilling
opportunity.
b. No- Facebook learns of opportunity as
well.
3. Problem
a. Line of business is hard to determine for
big corporation.
d. Corporation did not have the finances to make the purchase.
i. Risk that the board of directors won’t pursue options to
acquire funds necessary for board approval. Board
usually must prove they tried to raise funds.
1. Reasons for skepticism in this case.
a. President owed money to corporation
that it could’ve used.
b. Corporation had relationship with a bank
that it could’ve acquired funds from.
ii. Policy-Courts are usually skeptical of this. If the offer is
that good, the corporation will usually find a way to
make the purchase.
iii. Rapistan Corp v. Michaels
1. Facts-Worked for a company and later left to join another company
that bought a smaller company
2. Capacity
a. Individual
b. Official
3. Capacity Arguments
a. Plaintiff-Person always in official capacity.
i. i.e. Mike Zuckerburg
b. Defendant-Free time when offer was made.
4. Court adds essential to the test.
a. Problem-Too up in the air.
iv. Possible Tests for Corporate Opportunity
1. Corporate opportunity
2. Capacity
3. Line of Business
4. Essential
a. Problem-Sets the bar too high.
5. Desirability
a. Problem-Bar is too low.
6. Plan
 21

a. Could be helpful. In the middle of essential and desirability.

b. Problem-How specific must the plan be?
7. Assets-Which were used?
a. Hard-Cash, facilities, and contracts.
b. Soft-Good will, working time, and corporate information use.
i. Example-Cleveland’s brother
c. Standard-A significant use of corporate assets by a fiduciary
must create a direct and substantial casual connection between
the assets and the pursuit and/or acquiring of corporation.
v. Burg v. Horn
1. Facts-Similar scenario
2. Holding-Defendants had pre-existing business that was setup to
purchase.
g. Questions to Ask
i. What are their fiduciary positions? Are they fiduciaries?
ii. Is this a corporate opportunity that is characterized for the company?
1. Line of business-What’s the market? (i.e. Books?)
iii. Whose assets helped develop the opportunity?
1. Corporation’s money or tools used to acquire?
iv. Full or part-time?
1. Burg v. Horn
v. Reasonable expectations of all involved? Could the plaintiffs reasonably
expect they would no longer engage in previous opportunities and give
majority to them?
1. Burg v. Horn
10. Accounting
a. 3 Types of Financial Statements
i. Balance Sheet
1. Equation: Assets=Liabilities + Owner’s Equity
a. Assets-Anything that can give rise to revenue.
i. Example-Apple has a warehouse of i-phones. I-phones
will soon bring in revenue.
b. Liability-Money borrowed.
c. Owner Equity-Residual account. Whatever is left over is what
the shareholders get.
d. Example-$10 Assets=$20 (liabilities)-$-10(Shareholder’s
Equity)
2. States the position of the corporation as of the moment in time.
3. If assets change (down) liabilities remain the same, owner’s equity
goes down.
ii. Income Statement
1. States the position of the corporation over a period of time (i.e. year,
quarter, six months).
2. Not solely based on cash, follows Accrual Method.
3. Accrual Method
a. Income earned as soon as job was finished.
 22

b. Don’t care about cash, just process.

c. i.e. Person performs a job on Monday but doesn’t receive
payment until the following Monday. That’s assumed to be
income.
iii. Statement of Cash Flow
1. Nothing misleading. Looks at everything over a period of time.
b. Principal purpose of the use of financial statements by third parties is valuing a
corporation. There is temptation to manipulate the numbers of a report or to phrase
words differently while conveying a different meaning.
c. 4 Ways to show Standing on a Report
i. Accelerate Depreciation/Amortization
1. Amortization: Intangible Assets, like a patent or copyright.
2. Depreciation: Tangible asset, like a truck.
3. Amortization or Depreciation is an Expense which reduces profit.
(Revenues-Expenses=Profit)
4. Spreading out depreciation (expenses) can make profits look better.
ii. Minimal use of Off-Balance Sheet Debt
1. Companies may try to hide their debt off-balance sheet.
iii. Conservative Assumptions for Pensions
1. The higher the interest rate, the less money that need be on hand today
to pay a future debt. The lower the interest, the more money that need
be on hand today to pay a future debt.
iv. Conservative Revenue Recognition
1. Don’t create false revenue.
2. Round trip trades=bad practice
a. Traders buy an amount of a commodity and simultaneously sell
the same amount at the same price.
b. False creation of trading volume and revenue.
11. Corporate Finance & Opportunism
a. Statutes
i. DGCL §102 (a) (4)-Specifies that a corporation may issue different types of
shares with different voting rights.
ii. DGCL §122 (13)-Allows corporation to borrow money.
iii. DGCL §151-Specifies classes of stock, redemption, and rights.
iv. DGCL §153-Discusses the consideration for stock.
v. DGCL §154-Defines capital, surplus, and net assets
vi. DGCL §170-Authorizes board of directors to pay dividends subject to some
limitations.
vii. DGCL §174-Discusses liability of directors for unlawful payment of
dividends or unlawful stock purchase or redemption.
viii. MBCA 6.21-Discusses issuance of shares.
ix. MBCA 6.40-Discusses dividends to shareholders.
b. Different Types of Securities
i. Common Stock
1. Control Voting
a. First in line to vote.
 23

b. Residual claim (whatever is left over).

c. DGCL 242-Amending charter
i. Must have board and shareholder approval.
d. DGCL 251-Merger or Sale of Substantial Access
i. Shareholder approval required.
e. DGCL 275-Dissolution
i. Shareholders must approve.
f. Policy Reasoning
i. They are more likely to elect individuals who will
properly manage the company so they can receive.
2. Distribution
a. Dividend/ Interest
i. No. Default Rule- Dividend payments are not required.
Board of directors can choose whether to pay
dividends.
1. DGCL 170
ii. If they sue then court will likely go with BJR.
b. Amount
i. Board chooses the amount of dividends.
ii. If they sue court will go to BJR.
c. Priority
i.
3. Dissolution
a. Last in line to receive benefits after dissolution of corporation.
4. Capital Appreciation
a. Yes—can enjoy appreciation.
b. Example-Borrow $1K to start business. Owe $1,050(including
interest). Business is now worth $100K. Bank would get
$1,050. Whatever is left over goes to the shareholders.
“Concept of Buy Low Sell High.”
5. Preferences
ii. Debt
1. Statute
a. DGCL 122(13)
2. Control Voting
a. Last in control.
b. Generally don’t have a vote.
c. Could allow a vote through the contract.
i. Options
1. Outright prohibition against spending the money
elsewhere.
2. Vote would specify how the money is used.
d. Policy Reason-They’ll get their money back regardless and is
least likely to make the best decision.
3. Distribution
a. Dividend/Interest
 24

i. Interest
1. Required?
a. Yes. Whatever the contract says.
2. Amount?
a. Yes. Whatever the contract says.
3. Priority?
a. Interest must be paid before dividends
paid to shareholders.
4. Dissolution
a. Priority
i. First
b. Amount
i. Whatever the contract says.
5. Capital Appreciation
a. No. They’ll get whatever the contract states.
iii. Preferred Stock
1. Statute
a. DCGL 102(a)(4)
b. DCGL 151
2. Control Voting
a. Second in control.
b. Contract oriented voting rights from governing documents.
c. Non-contracted voting rights.
i. DGCL 242(b)(2)
1. Even if voting rights aren’t contracted, statute
allows voting as a class(lump sum) IF:
a. The amendment to the certificate of
incorporation would change, substitute,
enlarge or diminish the nature of its
business or its corporate powers and
purpose.
ii. To make an amendment that would adversely affect the
class, you must receive approval from that class.
d. To determine whether preferred stockholders receive voting
rights, look to the certificate of incorporation.
e. Could receive voting rights according to distribution
information below.
3. Distribution
a. Dividend/Interest?
i. Dividends
1. Required-Yes/No.
a. Dividends are cumulative-Corporation
can defer paying for up to six quarters. If
accumulated dividends go unpaid then
preferred stockholders can vote and get
representation on the board.
 25

b. If this is invoked and dividends are later

paid, preferred stockholders loose voting
power.
2. Amount-2nd. Fixed by contract.
3. Priority-2nd.
4. Dissolution
a. Amount-Typically specified by contract.
b. Priority-2nd after debt holders, before shareholders.
5. Capital Appreciation
a. No. All contractual.
b. Exceptions
i. Convertibility-Could convert debt to common stock. If
traded then preferred stock is
ii. Participating Dividends-If corporations start paying
crazy dividends then they could want some of the
action.
iv. MM Relevancy/Theory
1. Irrelevant if financed through debt or stock.
2. Focuses on left side (credit) of balance sheet rather than right (debts).
c. Advantages
i. Taxes
1. Debt
a. If debt issued, then interest paid on debt is a deductible expense
to the corporation. Taxed only once (individual income). Tax
advantage.
2. Stock Dividends
a. Not tax deductible. Taxed twice (individual income and
corporate level). Tax disadvantage.
ii. Information Content of Capital Structure
1. Example-Good manager of corporation and tell investors future is
good. If dishonorable manager, you say future is good.
iii. Bankruptcy Costs
1. Corporation could suffer detriment through loss of reliability and
customers.
2. Example-You can trust the corporate manager when he says the future
is rosy c
3. Things that show future is good
a. Won’t share stock. Issue debt instead.
4. Things that show future isn’t good
a. Stock is being sold.
iv. Disciplinary Effect of Debt
1. Goes to the concept of interest must be paid on debt.
2. Positive-If you fund corporation by debt then it must be paid and
provides an incentive to management to do good things.
3. Negative-Don’t have the money needed to finance new projects.
d. Leverage(Not in case book)
 26

i. The aspect of making investments using borrowed money at a low interest rate
with an eventual higher rate of return on dividends.
e. Modes of Opportunistic Behavior Among Holders of Financial Assets(Ways
Shareholders Appropriate Wealth From Debtholders)
i. Increasing Riskiness of Corporation
1. Shareholders like risk. Debt holders don’t like risks since their return
is the same.
ii. Withdrawing Money From Corporation
1. Shareholders cause board to pay dividends. Debt holders suffer.
2. Limitations on Paying Dividends(DGCL 170 & 154, etc)
a. Default Rule-170
b. Surplus Definition-DGCL 154
i. Surplus=Net Assets(Owner’s Equity)-Capital
ii. Net Assets=Assets-Liabilities(Overall=Shareholder
Equity)
iii. Capital=Aggregate par value
1. Stocks can’t be sold for less than par value.
2. Par value found in certificate of incorporation.
3. Set by board. Lower par value results in higher
surplus and higher amount of dividends
available for board to pay.
3. Stock Buy Back-Economic equivalent of a dividend.
a. Statutory limitations to directors’ ability to retrieve buybacks.
f. Attempts to Avoid Opportunism
i. Legal Capital System (DGCL 170
1. Legislature limiting directors’ ability to pay dividends thinking this
might help protect debt holders from being exploited by shareholders.
2. Note-This doesn’t protect debt holders because there will always be a
surplus.
ii. Fraud
1. Money being fraudulently conveyed to the shareholder (disguised
dividend). Usually must prove intent which is difficult.
iii. Contract
1. Since legal capital may not protect debt holders, they may protect via
contract.
iv. Fiduciary Duty
1. Some think there is a fiduciary duty owed by the corporation to the
debt holders.
2. There is a common law obligation to shareholder
3. Generally assumed debt holders aren’t in the fiduciary duties of the
board. Once there is a contract there is a duty of good faith and fair
dealing with respect to debt holders.
4. Light Switch Theory-When liabilities exceed assets, directors do owe a
fiduciary duty to debt holders because all of the company’s future
earnings will go to debt holders.
5. Credit Lyonnais Bank Nederland v. Pathe Communications Corp.
 27

a. There should be a zone of insolvency when the directors can

take into account the creditors and debt holders’ position.
b. Supreme Court rejects this theory. Instead goes with light
switch theory.

Statute Control Distributio Dissolution Capital MM

Voting n Amount/Priorit Appreciatio Irrelevanc
Dividend/ y n e
Interest
Required?
Amount?
Priority?
Common DGCL 1st. Dividend Priority-3rd Yes-Can
Stock 102(a)4, DGCLs Required- and last. enjoy.
etc. 216, 242, Not Amount-
251, 271, required. Whatever is
275 Board’s left over.
Option to
pay.

DGCL 170
Amount-
Board
decides.
3rd
Preferre DGCL nd
2 . Dividends Amount- No**
d Stock 102(a)(4) DGCL Required- Contracted
, 151 242(b)(2 Yes/No Priority-2nd
) Amount-
Contracte
d
Priority-
2nd
Debt DGCL 3rd. No.* Interest 1st. No**
122(13) Required-
Whatever
K says. 1st
*Can contract out to allow voting rights but will usually have prohibition of certain activity
instead.
**Convertible to common stock.

12. Forming the Corporation

a. Selecting the State
i. DGCL §101
1. Allows any person or entity to form a corporation in Delaware,
regardless of where you are a citizen.
 28

ii. Every state tries to craft corporate law to encourage people to form
corporations in the state. Delaware leads other states.
iii. DGCL §131
1. Doesn’t require corporation to operate out of Delaware. Must keep a
registered office in Delaware.
2. Policy-Corporations get to choose the law that governs disputes
among, directors, shareholders, and managers.
iv. Inter Affairs Doctrine
1. State corporate law only applies when the nature of the dispute
involves the corporation.
2. Example-Person sues Sonic, Inc., about eating bad food. That state’s
law applies. Contrast-Shareholder sues because he was denied right to
vote. Delaware law governs.
3. Passes the muster of Dormant Commerce Clause
v. Benefits of Delaware
1. Large body of case law means more certainty of decisions.
2. Mature statutes
3. Specialized courts with specialized judges.
4. Highlight responsive legislature.
5. (Not really a factor) Everyone registers in Delaware. Over 80% of
corps.
vi. Examples
1. Miller v. American Telephone-pg 78
a. Because the corporation was organized in NY, then that state’s
law governs.
b. Compliance With State Requirements
i. Certificate of Incorporation
1. DGCL 102 Content Requirements
a. Name the corporation correctly with magic word (association,
corporation, etc).
b. Must be distinguishable from other corporations.
i. Name must be different.
ii. Example-Sonic Corp (First to file). Sonic, Corp won’t
work. It’s too similar to first Sonic.
c. Must have a registered agent in the state.
d. Nature of the business
i. What the business will do.
ii. Can say that the nature is to “engage in any lawful
activity.”
1. Suggested phrasing.
2. If this isn’t used then corporation could violate
constitution if the nature of the business is
changed. (i.e. First start as a bakery. Then start
selling coffee. Constitution says purpose is to
sell baked goods.)
 29

e. Set forth total number of shares to be authorized and the par

value. If different classes of stock (preferred stock) are
authorized then the number must be listed.
i. Maximum number of allowable stock must be set out in
articles. Should this not be included then the
corporation must amend COI. Usually will authorize
more shares then what they will sell.
f. Stock Terms
i. Authorized-Number shares authorized by COI.
ii. Issued & Outstanding-Shares in the hands of investors.
iii. Treasury Stock-Corporation might buy back stock
which are no longer issued and outstanding. The bought
back stock are called treasury stock.
2. Execution=Effective date of the COI.
3. DGCL §161=Issuance of additional stock.
4. DGCL §151=More than one class of stock.
5. DGCL §153-Par Value=Minimum amount that share can be sold.
Note-Most board set par value at 0.01
6. Optional Provisions
a. 102(b)
7. Steps to File- (1) Secretary of State, (2) Formalities met, (3)
Permissive options, (4) By-Laws(DGCL §109)
ii. Other Considerations
1. States now require corporations organized in one jurisdiction but
operate in another state to pay another fee just to do business.
a. Policy Considerations
i. Big Corporations-Won’t care about filing fees in other
states and will still organize in Delaware.
ii. Small Corporations-Would prefer to organize just in
one state.
iii. Defective Corporation
1. Two Consequences of Not Following Formalities
a. De Facto Corporation-If there has been a colorable or an
attempt in good faith to incorporate under the statute and some
exercise of corporate powers has occurred, a de factor
corporation results.
b. De Jure Corporation-If there has been substantial compliance
with the statute providing for incorporation (noncompliance is
slight), a de jure corporation results.
2. Thompson & Green Machinery Co v. Music Lumber Co
a. Facts-Plaintiff provides goods and services to a corporation.
Both plaintiff and defendant thought it was a corporation.
Corporation provides and IOU and doesn’t perform. Plaintiff
sues and realizes there is no corporation and thus no liability
and goes after the individual defendant because there’s no
“corporate veil.”
 30

b. Estoppel Doctrine(Common Law Rule) (Focuses on Plaintiff’s

Failures)
i. One that deals with “corporation” as if validly
organized cannot subsequently challenge the validity of
its organization.
ii. Policy-You should’ve checked before engaging in
business with them.
c. Plaintiff could’ve negotiated a personal guarantee.
d. Agency Rule(Focuses on Defendant’s Failures) (Statutory
Rule)
i. One that acts for corporation without authority is just as
liable for obligations flowing from those actions.
ii. Policy Reason-You should’ve filled out the documents.
e. Holding-Since the legislature adopted the agency rule then the
defendant is liable.
3. Don Swann Sales Corp v. Echols
a. Facts-Similar facts in Georgia. Both of the above rules are
statutes in Georgia.
b. Holding-Doctrine of estoppel wasn’t allowed.
4. Sulphur Export Corp v. Caribbean Clipper Lines, Inc.
a. Facts-Appropriate paperwork filed but corporation didn’t
contribute $1,000 capital. Corporation didn’t perform for
contract.
b. Failure To Raise Capital-If a corporation transacts business
without the initial required capital and all directors who
participated and didn’t dissent are personally liable for any
debt of corporations.
c. Policy
i. Idea is to protect plaintiffs but it doesn’t since the
“filing capital” isn’t in place.
d. Holding-Defendant non-dissenting directors are liable.
5. DGCL §329-Prevents individuals from arguing defective corporation
as a legal defense.
6. DGCL §242-Discusses the process to amend the certificate of
incorporation after payment for stock has been issued.
7. DGCL §109-Discusses process to amend the by-laws.
13. Piercing the Corporate Veil (Usually applies to Close Corporations)
a. General Question: Should the defendant be held personally liable?
b. Piercing is usually an issue when just one person is control.
i. Shareholder is sole shareholder and director.
c. Perpetual Real Estate Services, Inc v. Michaelson Properties, Inc.
i. Facts-Shareholder forms corporation.  entered into a partnership with  to
share liability.  didn’t have money and instead wanted Michaelson
(shareholder) to be personally liable for obligations of corporation.
ii. Requirements (Factors) to Pierce Veil-Mention on exam that courts look for
an equitable remedy to grant relief and a legal wrong.
 31

1. (1) Corporation was a dummy entity(Below are elements for this factor
a. Domination/Control-
i. Person exercised “undue dominion and control” over
corporation.
b. Corporate Formalities-Are you behaving like a corporation?
i. Meetings held?
ii. Directors elected?
iii. Documentation of events (minutes of meetings)?
c. Siphoning-Distributing money
i. Reasons why it’s not an issue
1. Michaelson was the sole shareholder and it’s
assumed that he would distribute to himself.
2.  &  both reviewed the information
d. Alter Ego(Comingling)
i. Theory-Eliminating the line between business and
corporation.
ii. Using corporate treasury to finance personal endeavors.
iii. Using personal funds to pay for corporate expenses.
e. Underlying Claim
i. Contract-You had the opportunity to contract out of the
problem. Veil is likely to not be pierced.
ii. Tort- Veil is likely to be pierced.
f. Legal Wrong
i. Siphoning-See above.
g. Undercapitalization
i. Purposely don’t capitalize corporation so they don’t
have any assets to cover anything substantially.
2. (2) Corporation used to commit fraud, disguise wrongs, or conceal
crime.
a. Easy to prove and won’t be on exam but mention anyway.
3. Note-See Kinney (few cases down) for additional factors to consider.
iii. Policy Considerations
1. Contract Cases-Court is not likely to pierce because both parties freely
contracted agreement.
2. Tort Cases-Courts are likely to pierce the veil. No agreement present.
3. Individual v. Another Corporation
a. Individual-Veil likely not to be pierced because an individual’s
personal assets would be on the line.
b. Another corporation.-Veil likely to be pierced.
d. Kinney Shoe Corp v. Polan
i. Facts-Person had a corporation but didn’t do anything formally (have
meetings, elect officers, etc).
ii. More Factors To Pierce Corporate Veil
1. Credit Check (Permissive Factor)
a. Factors to Conduct Credit Investigation
i. On whose should we place the burden?
 32

1. Creditor?
2. Person who has zero dollars? Require them to
disclose.
2. Maintain & Adhere to Simple Formalities of a Corporation
3. Adequate Capitalization
iii. (No Capitalization + No Formalities) + Unfairness=Veil pierced
e. Walkovsky v. Carlton (Veil between affiliated companies)
i. Facts-Taxi cabs. They have minimum insurance required by the state.
ii. Veil Factors Discussed
1. Capitalization
a. Could be money or insurance.
i. i.e. Insurance company would cover liability.
iii. Holding
1. Majority thinks capitalization is enough because it meets the statutory
requirements.
14. Liability & Pre-Formation Transactions/Successor Liability
a. Successor Liability
i. Before
1. Acquiring-Company that’s purchasing another company.
2. Target-Company that will be bought by other company.
ii. Three Ways to Acquire A Company
1. Stock Purchase
a. Acquiring company owns all the stock in the target company.
b. Acquiring company will not be liable.
c. Shareholders not liable.
2. Merger
a. Must comply with formalities. DGCL §251 & 259 (Merger
Statute)
b. Target corporation ceases to exist.
c. Acquiring company assumes target’s assets and liabilities.
d. Pending Litigation-If target company was a plaintiff then
acquiring company becomes a plaintiff. Same if target was a
defendant.
e. Stockholders get stock in the surviving entity.
3. Asset Purchase
a. You can segregate assets and liabilities.
b. Person purchases assets and leaves liability with target.
c. Reasons you wouldn’t segregate
i. Don’t have enough cash to pay in full.
ii. Stockholders get stock from purchasing company.
iii. General Rule: A purchaser of assets is not subject to the seller’s liabilities
unless(EXCEPTIONS to Successor Liability)
1. (1st) Fraud
2. (2nd) Express/Implied Assumption
a. Voluntarily assumed liabilities when purchasing assets.
3. (3rd) De Facto Merger
 33

a. Not a merger in compliance with the statute.

b. Looks like a merger but legally isn’t.
c. Courts will treat the case like a merger and the purchaser
assumes liabilities.
d. Factors
i. Continuing ownership in the assets (similar to merger).
Same ownership before and after corporation?
ii. Did two corporations form one without liabilities?
e. If two companies are still in existence then the exception
doesn’t apply.
th
4. (4 ) Mere Continuity of Seller/Business
a. Continuing the seller’s business.
iv. Tift v. Forage King Industries, Inc.
1. Facts-Defendant was first a sole proprietor then became corporation.
Plaintiff injured by defendant’s project.
2. General Rule-Corporation which purchases the assets of another
corporation does not succeed to the liabilities of the selling
corporation.
v. Anderson Lumber v. Myers
1. Facts-Defendant lost a suit and formed another company.
2. Holding-4th exception didn’t apply.
3. Factors for 4th Exception
a. Who are the owners?
i. Exact or separate?
b. Same officers or employees?-
c. Same assets?
d. Time?
i. Takes place closely to imposition of liabilities.
e. Same name?
f. Same product?
b. Promoter’s Contracts
i. All parties know corporation isn’t in existence.
ii. Reasons to Contract Before Formation
1. Acquire office space
2. Hire employers
iii. Three Possibilities
1. Promoter signed the paperwork and is liable.
2. The corporation should be on the hook since they’ll benefit.
3. 3rd party was foolish because it entered into an agreement with a
corporation that wasn’t into existence.
iv. Liability of Corporations
1. Kridelbaugh v. Aldrehn Theaters Co.
a. Facts-Attorney hired by promoters (who later become officers
and directors) to find state to incorporate and then file
paperwork. Attorney didn’t get paid.
b. Possible Theories
 34

i. Agency Theory- Won’t work because the corporation

wasn’t formed at the time it was contracted.
ii. Birthing Theory-Corporation didn’t choose to be born
and couldn’t choose.
iii. Voluntarily Acknowledgement –Pay for previous and
current actions.
c. Rule
i. Corporation is not liable for acts taken before it is
formed.
v. Liability of Promoters
1. Sherwood & Roberts v. Alexander
a. Facts-Plaintiff gets loans for people. Defendant signs contract
on behalf of a non-existent corporation.
b. Statutory Rule
i. One that acts for a corporation without authority is
liable for debts arising from those actions.
c. Burden of Proof-Promoter bears the burden of proof.
d. Common Law Rule
i. A promoter who acts on behalf of a projected
corporation & not for himself will be personally liable,
UNLESS the other party agreed to look to some other
person or fund for payment.
1. Questions to Ask to Determine If Exception is
Met
a. Did promoter refuse to sign as an
individual?
b. Did the creditor prepare contract for
signature of individual promoter?
c. Creditor insisted that the contract show a
corporation as the obligor, even though
they knew there was no corporation?
d. Did the creditor make any attempt to
hold the promoter individually liable?
e. Holding
i. Statutory rule doesn’t apply. Common Law Applies
1. Rule geared toward getting rid of de facto
corporation theory.
ii. Plaintiff’s actions show he wanted corporation to be
bound and didn’t look to individual defendant to
guarantee.
1. Wanted name of corporation of document.
2. All documents had spaces for defendant to sign
individually except the note.
3. Plaintiff wanted defendant to show certificate of
incorporation before proceeding.
2. How & Associates v. Boss
 35

a. Facts-Plaintiff agreed to draw plans for defendant (new

corporation). Defendant signed as “Agent for Corporation to be
formed, who will be obligor.” First corporation never formed
and defendant pays plaintiff from another corporation (not
party to contract).
b. Language is ambiguous
i. Contract seems to show defendant meant for
corporation to be the obligor in the future.
1. Defendant could’ve had agreement designate
him as not being the obligor.
c. Take Away
i. Payments from 3rd parties isn’t enough.
3. Stewart Realty Co v. Keller
a. Facts-Defendant signed for a corporation not formed and
plaintiff knew it wasn’t in existence. Plaintiff leased real estate
to defendant.
b. Common law rule applies because plaintiff let defendant sign
as a non-existent corporation.
c. MBCA 2.04-Discusses liability for pre-incorporation transfers
15. Shareholder Voting Rights & Influencing Shareholder Votes
a. DGCL §216-Quorum and voting rights
b. DGCL §141(d)-Classes of stock
c. Individual vote may be largely irrelevant.
d. Aggregate
i. Vote can be critical if all votes are brought together.
e. Single Vote Aspects
i. Usually irrelevant because shareholders must seek out information to be
informed.
ii. Also costly
f. Choosing Directors
i. General Rule-Usually don’t have a choice. Generally there is one nominee for
each seat.
ii. DGCL §216-Quorum and voting rights
iii. DGCL§ 271-Sale, lease or exchange of assets, and procedure
iv. General Rules
1. Quorum=Majority of shares entitled to vote. Not majority of
shareholders. Can’t be less than 1/3 of shares.
2. In all matters, other than election of board members, a majority of
votes present and voting is sufficient.
3. Allows election of board by plurality. If no alternative, all you need is
one vote.
4. Three different standards
a. Board of Directors
b. Anything else/Misc
c. Fundamental Change
 36

v. DGCL §271(Fundamental Change)-Applies for sale of substantially all of the

assets. Requires majority of outstanding shares.
vi. Campaigning Against Corporation
1. Current board members can campaign using the corporation’s money.
2. Person trying to run against slate of nominees has to spend their own
money.
a. Usually won’t work.
g. Who Votes
i. Shareholders-Yes. Usually going to allocate vote risk.
ii. Preferred-Probably not (protected by contract).
iii. Debt holders-No unless by contract.
h. When to vote
i. Significant matters
1. Mergers
2. Fundamental Change
3. Board elections
i. Shareholder Initiative To Vote
i. Generally don’t have power to initiate change
1. Reasoning(Remember Brady Bunch Example)
a. Too much voting without outcome.
b. Wouldn’t have a result.
ii. Board of Directors step forward and make a proposal, shareholders vote yes or
no.
j. Timing
i. Delay
1. Hilton Hotels Corp. v. ITT Corp
a. Facts-Hilton wants to force ITT to have an annual meeting.
Hilton said annual means every year. Expert says meaning of
annual is different than a special or regular meeting. State law
requires 18 months for annual meeting. Delaware says 13
months. ITT’s actions are statutory but inconsistent with
common law.
b. Consistent with statute, possibly not consistent with fiduciary
duty.
c. Problem with moving up meeting would hinder other
individuals from attending the election.
d. Advancing a meeting date when everyone is preparing for a
later date and board amends bylaws to allow such, this can be
problematic.
e. Holding
i. When the board starts messing with shareholders’
rights, courts will be highly skeptical.
ii. IF the board acts with the primary purpose to impede
effective shareholder franchise, then the board must
establish compelling justification for its.
ii. Evasion of Voting Requirement
 37

1. Hilton Part II
a. Facts-ITT comes up with a re-organization that staggers terms
for board of directors. ITT also tried to sell assets to subsidiary.
Statute allows. Problem is the timing of actions.
b. Actions were consistent with statute but not fiduciary duty.
c. DGCL §141(d)
d. Two Tests
Blasius Unocal
If the board acts with the When a board takes defensive action, burden on
primary purpose to impede board of directors to establish:
effective shareholder 1. Reasonable investigation & good faith reasonably
franchise, then the board must perceived threat to (1) corporation, (2) significant
establish compelling corp policy, or (3) shareholders.
justification for its actions. 2. Defensive response must be
reasonable/proportional to the threat. It’s not
preclusive or coercive.
e. Unocal Steps
i. Plaintiff shows board took defensive actions.
ii. Burden shifts to defendants (board) to prove first part of
Unocal Test.
iii. Then board must show the response was proportional to
the threat.
iv. Courts will give more credence to outside board of
director’s perception.
v. Note
1. Recognized Threats
a. Inadequate purchase amount.
b. People who have bankrupted other
companies (corporate policy).
2. Not Proportional
a. Not preclusive
b. Not coercive
f. Applying Unocal
i. 1st Part
1. Defendants didn’t meet with the plaintiff to see
what their intentions were.
2. Amount offered by plaintiff to purchase was
sufficient.
3. Defendants didn’t show plaintiff couldn’t run
the company.
nd
ii. 2 Part
1. Defendant’s actions were preclusive because
defendant’s shareholders can’t exercise their
right to determine board membership.
g. Applying Blasius
i. Purpose—look for circumstantial evidence
 38

1. Timing(Before, during, or after big step)

a. Defendant tried to implement the new
plan before the next shareholder vote.
b. Example-If law school tried to remove
itself from the main campus then it
wouldn’t take two months.
2. Entrenchment
a. Board would get more terms and group
3. ITT’s Stated Purpose (Good or bad reason?)
a. Bad reason for not seeking shareholder
approval of plan.
4. Benefits of Plan
a. No economic benefits can remedy board
entrenchment and denying voting rights.
5. Effect of Classified Board
a. Plan prevents shareholders from electing
a majority of shareholders.
ii. Compelling Justification
h. Trigger Situations to Apply Either Test
i. Quick decisions
ii. Moving up a meeting
iii. Helping a board become entrenched.
16. Supervoting/Vote Buying
a. General Rule-1 share=1 vote
b. Supervoting
i. Allows certain people to have shares that equal more than one vote.
ii. Corporations generally aren’t allowed to change the rules after for their
benefit.
1. Lacos Land Co v. Arden Group Inc.
a. Facts-Corporation wants to recapitalize company to setup two
classes of stock. CEO would receive “Class B” stock which is
better than Class A. Plaintiff wants to prevent the transaction
because it was a threat. CEO says he will not allow favorable
transactions for the company unless the new plan is put in
place.
b. Court considers what “hat” CEO was wearing when making
the threat.
i. Shareholder-Free to make threats if they chose. Might
treat controlling shareholders differently though.
1. Applying-Court doesn’t know if he was acting
as shareholder.
ii. Directors-Fiduciary duty to act with complete loyalty.
1. Directors can’t threaten shareholders.
2. Corporation Can’t (DGCL §151)
a. Cap voting at a certain number of shares OR
b. Take away voting power from purchaser or initial shareholder.
 39

3. Corporation can issue non-voting stock.

4. Rule: Issuance of supervoting stock will be void if garnered through
fraud or is seeking to disenfranchise shareholders.
c. Vote Buying
i. Schreiber v. Carney
1. Facts-Jet Capital will prevent merger of company (Texas International)
that it has 35% voting rights unless it has money to exercise its
warrants.
2. Warrant-Right to acquire a security within a specified period for a
certain amount of time. Used to attract investors.
3. Things to consider
a. Does the minority or majority want to engage in the activity?
i. Here—65% wanted to engage in the merger.
b. Disclosure?
i. Here—yes. .
4. Difference from this and Lacos
a. Concentration of power that could negatively affect
shareholders tomorrow. i.e. Giving CEO all the power through
different class of shares.
5. Test
a. Don’t like vote buying if one of these is present:
i. Fraud?
ii. Disenfranchisement?
iii. Concentration of power (Common Law).
6. Holding
a. If fraud or disenfranchisement, then vote buying is illegal.
7. Delaware Approach
a. Delaware doesn’t care about vote buying. Each action should
be looked at in light of its purpose.
8. Note-Consider whether the purpose has good intentions.
17. Voting Procedure
a. Record Date
i. Definition-Who’s entitled to notice of meeting and who’s eligible to vote.
ii. Person who is listed as the owner on the record date is entitled to vote unless
he sells the stock and gives a proxy to the seller.
1. Problem with the rule-Because most negotiating isn’t face to face, the
person purchasing the shares might not be able to vote since he doesn’t
communicate with the seller.
iii. Limits on Dates (DGCL §213)
1. Can’t be more than 60 days nor less than 10 days before the date of the
shareholders meeting.
a. Example-Record date on October 1. Means the meeting can
take place on October 11-November 30 or anytime in between.
b. Proxy
i. Usually on a card.
ii. Reasons for proxy
 40

1. Helps board meet a quorum.

iii. General Rule-Revocable
1. How to revoke
a. Deliver a later dated proxy.
b. Designate someone else.
c. Show up and vote.
iv. Irrevocable Proxy
1. Can be given to
a. Person who has purchased or agreed to purchase shares.
v. Proxy Contest
1. Different groups competing for proxies.
2. Each group tries to be first because they’ll likely be the first to
influence a shareholder.
3. Also want to be last to solicit in case the shareholder votes each time
and you’ll get the vote that matters since it’s the last date.
vi. Proxy Contest Expenses
1. Rosenfeld v. Fairchild Engine & Airplane Corp.
a. Facts-Old board spent money defending proxy contest. They
lost and new board compensated old board for expenses used to
campaign. New group was reimbursed for their expenses and
later ratified by shareholder vote.
b. Old Board Expenses Alright?
i. Concerns of legitimate policy.
ii. No suggestion that the expenses were unreasonable.
c. Cons of Not Reimbursing Directors for Proxy Expenses
i. Would defer board from actually defending.
d. Reimbursing Dissident Shareholders(Person who launched the
contest)
i. No duty but when the shareholders approve then court
won’t scrutinize.
ii. Sends a signal to next dissident shareholder that the
corporation will cover the costs because they want
better management.
e. Idea is to tax all shareholders when they might benefit.
f. DGCL §113 Proxy Expense Reimbursement
i. Bylaws can provide for reimbursement of expenses
incurred by shareholder soliciting proxies. Limits can
include(more limits in book)
1. Eligibility—how many people you’re trying to
get on the board?
a. 1 or 2 might be alright. All of the board
is a different matter.
2. Previously sought reimbursements—don’t want
the same shareholder always asking for
reimbursement.
g. DGCL §112 Access to Proxy Expenses
 41

i. Specifics as to who can obtain expenses.

ii. Limitations
1. Must have been a shareholder for a certain
amount of time.
2. Minimum number of shares.
c. Shareholder of Record
i. Corporation has a book that identifies shareholders.
ii. Usually banks or brokers are the shareholder of record.
iii. Reason
1. Helps simplify bookkeeping.
2. Too many shareholders to keep up with.
iv. Direct how votes are cast.
v. Dividends paid to them.
d. Cumulative Voting
i. Allocating votes to multiple individuals.
ii. Default Rule-Corporations can opt into cumulative voting.
iii. Limitations
1. Must grant the ability to have cumulative voting in the certificate of
incorporation, not by-laws.
iv. Ways to get around cumulative voting
1. Shrink the size of the board.
2. Staggered terms.
v. Benefits
1. Minority shareholders receives more influence.
vi. Formula

# of shares required to  # of shares

ensure election of 1 # of director vacancies +1
director (Symbol=more than)
Steps to Determine
1. Take number of shares and divide by the number of vacancies + 1.
2. Add one to the number that you got in step 1.
3. The number that you calculated in step 2 is the number of shares
needed.

e. Removal of Board Members

i. Default Rule-May remove board members with or without cause by the
holders of majority of shares.
ii. Cause
1. Conviction of a felony
2. Bankruptcy
3. Insanity
4. Harassment of employees
iii. If classified or staggered board
1. Default Rule-If don’t contract otherwise, you may only remove
staggered board through cause.
 42

iv. Cumulative Voting

1. Exception to the default rule(DGCL 141(k))3
a. If we’re removing all the board then that’s fine,
b. If removing only one there must be cause.
c. If votes cast against removal would be sufficient to
cumulatively elect the director to be removed during an
election when the entire board was up for election through
cumulative voting.
18. Judicial Supervision of Elections/Director Vacancies
a. Schnell v. Chris-Craft Industries, Inc.
i. Facts-Board amended the by-laws to move up the annual meeting. Certificate
of incorporation allowed board to amend the by-laws. Minority shareholders
are trying to have a proxy contest.
ii. Moving the meeting issues
1. Legally board can amend the board meeting.
2. Goes against their fiduciary duty.
iii. Rule
1. Absent fraud or inequitable conduct, the date for a stockholders’
meeting, established under the by-laws, won’t be extended by the
courts at the request of dissident shareholders solely because of the
circumstances of a proxy contest.
b. MM Companies, Inc. v. Liquid Audio, Inc. (Good for Blasius Analysis)
i. Facts-Two vacancies Shareholders wanted a special meeting to amend
certificate of incorporation to enlarge board. Nothing in the statute or articles
of incorporation allows shareholders to call special meetings. Board expanded
seats by two and filled the vacancies. Shareholders want to take over Liquid
Audio.
ii. Shareholders may amend by-laws as well as the board.
iii. Compelling purpose not found.
iv. Default Rule-Vacancies resulting from the increase of the board membership
can be filed by the majority of the board regardless of a quorum or by a sole
remaining director. Board can always fill vacancies.
1. DGCL §223
2. Test-Did you act to impede shareholder exercise? (Dealing with
Blasius and Unocal) Not did you affect control.
v. Policy Considerations
1. Delaware courts have pushed back against Blasius and just make
Unocal do the work. Reason-if primary purpose (Blasius) is to impede
shareholder franchise then hard to prove Unocal.
2. Blasius is also rarely applied
vi. Example of Court Finding Compelling Interest
1. Target Corp 1 and Acquirer 1 negotiating for price. Acquirer 2 offers
more money but they don’t really want to acquire target. They want to
harm Acquire 1.
2. Shareholders say no to Acquire 1 because Acquire 2 doesn’t have the
money.
 43

3. Acquire 1 wants to delay shareholders meeting to allow Acquire 2 to

get the money which they won’t.
4. Court said Acquire 1 did seek to impede shareholder franchise but
there was compelling justification.
vii. Quote This Language From The Case!!!!
1. “When the primary purpose of a board of directors’ defensive measure
is to interfere with or impede the effective exercise of the shareholder
franchise in a contest election for directors, the board must first
demonstrate a compelling justification for such action as a condition
precedent to any judicial consideration of reasonableness and
proportionality.”
viii. How to mention on an exam
1. Won’t get to proportionality without first proving compelling
justification. State both tests are implicated. Thus first do compelling
justification (Blasius) then move to Unocal test.
2. Note-Arguments go both ways whether to integrate or apply serially.
ix. Exam Strategies for Blasius and Unocal Test.
1. Argue both sides.
2. Plaintiff-Wants just Blasius.
3. Defendant (Board)-Blasius doesn’t apply. Board will say they have a
compelling interest. Shareholders still retain
4. Assuming plaintiff wins, apply compelling justification.
5. Assuming defendant wins, Blasius is out of play.
6. Then, did the board take defensive actions (apply Unocal).
7. Plaintiff-Board was grossly negligent in informing themselves.
8. Board’s arguments in compelling justification will likely be the same
that they would in proportional/reasonable in Unocal.
9. Board will also argue BJR in the first part of Unocal.
19. Close Corporations
a. General
i. As the number of shareholders get smaller, they can enter into contracts to
restrict certain thing.
ii. Similar to the tv show “Survivor.”
1. Limited number of people on island.
2. Competing teams.
3. Alliances & impact of alliances on the few.
b. Characteristics
i. (1) Small number of shareholders, (2) Form alliances, (3) High overlap, (4)
Customized, (5) No liquid assets
c. Reasons to go to court for relief
i. Example 1-Minority doesn’t get a voice. Court may protect the minority
against majority.
ii. Example 2-Ties at the shareholder level.
d. Statutes (DGCL §341-356)
i. DGCL §341 applies to all close corporations if they opt in.
1. Might be subject to additional requirements and benefits.
 44

ii. DGCL §342 Requirements To Opt In Close Corporations Sub-chapter

1. Requirements
a. Charter
b. Have stock certificates
i. Reason
1. Subject to some restrictions.
c. Cap on the number of shareholders (no more than 30).
d. No public offerings
i. Can’t make public sales.
ii. Can only raise money through private individuals
(people they have a connection to).
iii. DGCL §344 Election to Become Close Corporation
1. Requirements
a. Amend certificate of incorporation to include information in
i. Vote must approved by at least 2/3 of the shares of each
class of outstanding stock.
b. Shares subject to restriction
iv. DGCL §346 How To Get Out of Close Corporation
1. Charter may require a greater vote.
2. 2/3 is the general requirement.
3. Must change articles of incorporation.
v. DGCL §202 Restrictions on Transfer and Ownership of Securities
1. Requires notice of restriction unless you have actual notice.
2. Imposing Restrictions
a. Charter
b. By-Laws
c. No ex post facto restrictions
i. Unless holders are parties to the agreement and voted in
favor
3. Obligates shareholder to offer to corporation and opportunity to buy
within a reasonable amount of time.
a. Note-Statute doesn’t contain any mention of reasonable price.
Only a reasonable amount of time. Price can be anything as
long as there are not
4. Shareholder Put Right-Obligates shareholders to purchase shares.
a. Shareholder can put shares to corporation and they have to
purchase.
5. Requires consent of holder to transfer or sell shares.
6. Might obligate corporation to buy back shares which could prevent a
majority shareholder.
7. Can restrict sell or transfer to any person or group so long as it isn’t
unreasonable.
e. Restriction of Transfers of Shares
i. Reasons for Restrictions: (1) Know identity of purchaser and (2) Prevent
competitors from getting a share.
ii. Allen v. Biltmore Tissue Corp (Authorized Restriction)
 45

1. Facts-Shareholder dies and his estate doesn’t want to sell back shares.
2. Holding
a. If a shareholder dies or desires to sell shares, then the
corporation has the opportunity to repurchase the shares at cost
for 90 days, and if the corporation does not exercise its option
to repurchase, then shareholder or his estate may sell to anyone
at any price.
b. Can restrict if restriction is reasonable.
3. Problems of Holding
a. Identify of the person
i. Requiring a sells to a particular residents.
1. Example- Shareholder in Hawaii but limited to
selling to individuals in Oklahoma.
b. Could be incompetent.
i. i.e. Hannibal Lecter
c. Time period
i. Want to allow shareholders to cash out, may not have
money on hand thus need time to sell assets we’re not
using or find another investor to take over the share.
1. Example-Two investors buy a machine with
2,000(half from each investor). Investor wants
to get out and wants $1,000 next day.
d. Cost
i. Shareholder could lose capital appreciation if
corporation will only purchase at low price.
ii. Shareholder could also lose capital appreciation if the
share isn’t worth enough.
iii. Overall, shareholders won’t enjoy capital appreciation.
Instead, they’ll get a return through salaries as a
manager and director.
iii. Unauthorized Restrictions
1. Required Consent as Restriction on Transfer
2. Rule: Restrictions which give an individual arbitrary power to forbid
the transfer of the shares of another will not be upheld and will be
struck down as unreasonable and against public policy as an
annihilation of property (Rafe v. Hindin)
3. DGCL §202(c)(3) – No language saying that consent may not be
unreasonably withheld but court in Rafe seems to read one in
4. DGCL §349 – Corporate Option Where Restriction is Held Invalid
a. Corporation has option for 30 days after judgment holding
restriction invalid to acquire restricted security at a price
agreed upon by the parties
b. If no price agreed upon, Court shall determine the fair value
(can hire appraiser)
iv. Note
1. Disparity in price is ruthlessly criticized by the courts.
 46

2. Fair market value somewhere between a certain range.

3. How to determine fair market value of stock
a. Expert-Will determine market value but there will likely
be biasness.
b. Two experts will agree on a third expert who will
determine fair market value. Both parties will split the
cost of the expert.
c.
Cost Fair Market Value

DGCL §218
Voting Trusts Voting Agreements
Transfers to trustee for term of
Title to Shares Title remains with SHH
the trust. New shares to trust
Right to Vote To Trust Stays with SHH
Discretion Regarding Vote – Before K determines how vote is SHH agreement about vote
Event affected affected before
Discretion Regarding Vote – After Power to affect vote lost after SHH agreement about vote
Event transfer affected after
SHH enjoys all beneficial SHH enjoys all beneficial
Dividends / Rights on Dissolution
rights except for vote rights
Public Disclosure Required Not Required
DE: No Cap; Generally: 10
Cap on Term No Cap
yrs.

f. Special Agreements Allocating Authority

i. Ways to Allocate Authority
1. Cumulative Voting
2. Issue Different Classes of Stock
a. One class gets equal voting powers.
b. Allocate rights as the corporation sees fit.
3. Require Supermajority Vote
a. Deviate from default rule by including in the charter a
requirement for a certain high percentage of votes (80%) for
certain actions.
b. DGCL §242(b)(4) Amending Certificate
i. Amendments must be approved by supermajority that’s
specified by COI.
4. Voting Agreements
a. Ringling v. Ringling Bros
i. Facts-Shareholders entered into an agreement on voting
that required arbitrator to resolve disputes. Parties had a
dispute during voting. After the arbitrator resolved the
 47

dispute, he directed each of the shareholders to cast

their votes a certain way pursuant to his agreement.
ii. Lower Court Decision
1. Arguments against voting agreements(Outdated
Arguments)
a. It’s an agreement to agree.
b. Against Public Policy
c. Shareholders own an obligation to act in
best interest of corporation and duty to
other shareholders. Transferring vote
doesn’t allow shareholder to
2. Default Rule-Shareholders have no duty to other
shareholders.
a. Exception-If you own majority vote then
you can’t force something on other
shareholders that would result in a loss.
3. Remedies: Legal relief isn’t available. Equitable
relief is the next available remedy.
iii. Appellate Court Decision
1. Contract Is A Voting Agreement Not Trust.
a. Reasons
i. Not filed publicly.
ii. Title hasn’t been transferred to
an agent.
iii. No irrevocable proxy.
2. Secretive contract is valid.
3. Remedies: Court considers the harm to non-
parties.
b. Voting Agreements Are Allowed If: (Buck Case)
i. Benefit the Corporation
ii. No Fraud
iii. Doesn’t Violate Public Policy
5. Voting Trust
a. Specifications for Voting Trust
i. Trustee must be party to the agreement.
ii. Be filed publicly.
iii. Title must be transferred to an agent.
iv. No irrevocable proxy.
v. DGCL §218 Voting Trusts Specifications
1. No secret voting trust.
2. Corporation receives copy of agreement.
3. Certificates show transfer of shares to trust from
shareholder.
4. Voting trustee has the right to vote.
 48

5. Trust is the shareholder. Usually agreement

requires dividends to be disbursed from Trust to
shareholder.
a. Separation of voting rights and
economic rights.
6. Agreement can only make general provisions
about voting.
a. Example-“Trustee shall vote to
maximize shareholder value.”
7. Shareholders might not get the vote that they
want if Trust votes opposite of what
shareholders get. Practically, it’s expected that
the Trust would consult the shareholder.
8. If agreement doesn’t specify how to vote then
the Trust makes a determination as to how they
vote.
b. Abercrombie v. Davies
i. Facts-Agreement between shareholders to prevent
takeover by Phillips. Agreement named several agents
to act on their behalf for 10 years. Arbitrator would
work out any disagreements between trustees/agents.
ii. Court says Voting Trust isn’t valid
iii. Reasoning
1. Agreement not filed with the corporate
headquarters in Delaware.
iv. How to determine if there is a voting agreement(Look
to the substance of the agreement
1. Severing of the right to vote and economic
interest?
2. Irrevocable proxy?
a. Yes=Not a real voting rights and there
isn’t a trust because shareholder can
always revoke the power of proxy to
vote on shareholders behalf.
3. Voting Control?
4. Formal transfer of shares?
a. Have document from corporation
actually showing a transfer.
v. Holding-There is a trust; however, formalities didn’t
take place.
6. Agreements Respecting Actions of Directors
a. McQuade v. Stoneham
i. Facts-Agreement between parties keeps multiple parties
as managers of the corporation. They also owned stock
options. Individuals refused to keep their word and
removed plaintiff as shareholder.
 49

ii. McQuade is “frozen out” because they are left with

very little ability to be involved
iii. Sterilization—Shareholders have entered into an
agreement while wearing their board hats and
contracted away discretion. Court doesn’t allow this.
iv. Rule
1. A contract is illegal should it contract the
board’s discretion away that would preclude the
board from authority over the business.
2. Exceptions:
a. When the agreement’s infringement is
slight and negligible (Clark v. Dodge)
b. When all SHH are represented in the
agreement, no prohibition on enforcing
the agreement to limit director discretion
(Clark v. Dodge)
b. Clark v. Dodge
i. Facts-Plaintiff and defendant (only two shareholders)
made an agreement that plaintiff would always be
director and general manager and plaintiff would show
defendant’s son recipe for corporation.
ii. Exceptions are present here and not in McQuade.
7. Agreements Implied by Majority’s Fiduciary Duty (Money/Salaries &
Close Corporations)
a. Wilkes v. Springside Nursing Home, Inc.
i. Facts-Plaintiff contracted with defendants to require
equal pay for working with the nursing home they
founded. Defendants didn’t give Plaintiff a raise like
they did themselves and later had him fired as an officer
and removed him as director.
ii. Distinguishing Theory-Majority is ganging up on the
minority.
iii. Distinguished from other cases because on a per share
basis, everyone is treating everyone the same. Instead,
majority is disadvantaging an employee of the
corporation.
iv. Rule/Test
1. (Step 1)Board must show legitimate business
purpose
a. Personal reasons aren’t valid.
b. Paying less to just one person isn’t valid.
c. If board meets this burden then go to
step 2.
2. (Step 2)Burden shifts back to person making the
charge to demonstrate that the same legitimate
objective could have been achieved through an
 50

alternative course of action less harmful to that

individual(minority)’s interest.
a. Think is the action narrowly tailored?
v. Note-Many jurisdictions haven’t adopted this rule.
b. DGCL § 354 Operating Corporation as Partnership
i. Allows you to operate corporation as a partnership and
impose an obligation to a shareholder and require every
person to be paid fairly.
ii. Don’t worry about common law.
c. DGCL §350 Agreements Restricting Discretion of Directors
i. Allows restriction of board of directors discretion.
ii. If shareholders take away discretion of directors, then
for those purposes we’ll treat shareholders like directors
d. DGCL §351
i. If you opt in to close corporation chapter then you don’t
have to have a certificate of incorporation.
e. Zidell v. Zidell
i. Facts-Plaintiff claims defendant breached corporate
opportunity to purchase stock because defendant
purchased shares after plaintiff told him that he would
purchase for corporation.
ii. Not a corporate opportunity because corporation
doesn’t usually purchase.
iii. Rule
1. Having a majority shareholder isn’t a bad thing.
Could’ve dealt with this in by-laws.
2. Only deals with acquisition of control not abuse
of control.
8. Directors’ Delegation of Management Authority
a. Board can delegate authority but not all authority.
b. Kennerson v. Burbank Amusement-Note case
i. Facts-Amusement park. Board delegated all of its
discretion to CEO.
ii. Holding
1. Corporation wasn’t being managed under its
discretion or direction.
iii. Policy Reasons for Holding
1. Example-Could go from Disney on Ice to OKC
Frontier City.
2. Would result in fundamental change which
needs board approval.
3. Way to fix this would be to delegate authority
“subject to the board’s approval.”
iv. Board can’t sterilize decision making power. DGCL
§141 (a)
c. Pioneer Specialties, Inc. v. Nelson
 51

i. Facts-By-laws state President can serve for one year

and can be re-elected. Board elected him to one-year
term but contracted to two-year term.
ii. Rule
1. Contractual employment rights can be created
when they’re not prohibited by the by-laws.
iii. Holding
1. Only a part of the contract is invalid—two year
agreement.
iv. How to avoid problem
1. Make sure long-term contract is consistent with
statute and by-laws.
v. Hierarchy of Authority: (1) Statute, (2) COI, (3) By-
Laws
g. Deadlock and Dissolution
i. Ways to Resolve Disputes
1. Arbitration
a. Benefits: (1) Prompt, (2) Confidential, (3) Workable Solutions
2. Receivers/Custodians
a. Giuricich v. Emtrol Corporation
b. DGCL § 226(a)
i. Any shareholder can apply to a court for a
custodian/receiver when:
1. Shareholder deadlock prevents election of
directors.
2. Director deadlock and business is
suffering/threatened with irreparable injury.
3. Corporation abandoned its business and failed
within a reasonable time to take steps to
dissolve, liquidate, or distribute its assets.
c. Receiver Power-DGCL 226
i. Controls the business and has the power to liquidate
assets.
d. Custodian Power-DGCL 226
i. All powers of the receiver put can’t liquidate.
e. Custodian for Close Corporation-DGCL 352
f. Provisional Director for Close Corporation-DGCL 353
i. Only has power that the court gives them. Most
commonly used
g. Hierarchy of Receivers/Custodians
i. Receivers
ii. Custodian
iii. Professional Director
h. How to Dissolve Any Corporation
i. Nelkin v. H.J.R. Realty Corp
 52

1. Facts-Case about people who bought building, paid low rent, and two
left and later complained that those who stayed should’ve paid more.
2. Issue-Question is whether the plaintiffs’ behavior changed?
3. Rule-Court won’t punish a majority who is abiding by the agreement
that the plaintiffs (minority) agreed to. Minority’s behavior changed
here.
4. See factors required for the plaintiff to obtain relief under expectation
analysis on page 789.
5. Note-Even if someone has the right to dissolution, you usually don’t
see if happen:
a. Cohse Theorem: It doesn’t matter who has the legal right to
dissolution, because you’ll always end up where you should
end up. All that changes is who gets a bigger slice of the pie.
ii. DGCL §275 How To Dissolve A Publicly Held Corporation
1. (Option 1) Initiated by the board of directors after adopting a
resolution putting it to shareholder vote. Shareholder vote must occur
and requires majority of outstanding shares.
2. (Option 2) Dissolve without action of board of directors if all
shareholders unanimously consent.
iii. DGCL §355 Dissolve Close Corporation
1. May include provision granting shareholder the right to cause
dissolution of corporation at will or upon a specified event taking
place.
20. Mergers and Acquisitions
a. General Info
i. Threat of an acquisition could motivate the board by encouraging them to
disregard any self-interest.
b. 3 Ways to Change Corporate Capital: (1) Merger, (2) Sale of assets, (3) Purchase of
stock.
c. Means to Acquire
i. Merger
1. Must be initiated by board of directors on both sides of the transaction
(both target company’s and acquiring company’s board).
2. Shareholder approval required.
a. Serves as a check on the board.
3. Can’t be unfriendly merger.
4. All shareholders are told is what the consideration will be.
ii. Sale of Assets(All or substantial amount)
1. Must be initiated by board of directors on both sides of the transaction
(both target company’s and acquiring company’s board).
2. Shareholder approval required
a. Serves as a check on the board.
iii. Stock Acquisition
1. Board of directors approval isn’t required.
2. Implies shareholder approval.
iv. Proxy Contests
 53

1. Usually paired with something else which is really about a merger or

sale of assets.

Must be initiated by Shareholder Approval?

both boards of
directors?
Merger Yes Yes
Sale of Assets(All or Yes Yes
substantial amount)
Stock Acquiring No Implied
d. Merger Mechanics
i. DGCL §251 (b)(5) Mergers of Corporations
1. Shares of target company can be
a. Converted into shares of the survivor
b. Cancel shares
c. Converted into securities
d.
e. Hostile Transactions
i. Cheff v. Mathes
1. Facts-Company #1 has a method to distribute products. Company #2
thinks it can do this better and wants to buy Company #1. Company #1
rejects purchase offer and Company #2 purchases large amount of
Company #1’s stock.
2. Unocal issue is present because Company #1 is acting defensively.
a. Board conducted reasonable investigation.
b. Reasonably perceived threats present—Company #2 would do
away with good method of sales.
3. Only the first part of Unocal is present. This is not the entire test.
4. DGCL §160-3 Limitations to Corporation’s Power to Repurchase Its
Own Shares
a. Corporation can’t purchase shares that would impair capital of
corporation.
b. May have, by charter, reserved the right to redeem them at the
corporation’s will at certain amount. Charter presents you from
going over this amount.
c. Can’t force people to sell shares back to you unless you reserve
the right to redeem, which would be in the charter.
ii. Defensive Measures to Deter Mergers(See handout)
1. Poison Pill
a. Can generally be adopted by the board of directors.
b. Discriminates upon board of directors but may be okay (See
above case).
c. Dilutes potential or current shares less attractive.
2. Fair Price Provisions
a. Makes the shares that acquirer would purchase more
expensive.
 54

3. Supermajority Vote Requirements

a. Makes receiving the necessary approval for a merger
increasingly higher.
b. Could be deterred from achieving step 2.
4. Classified Board of Directors
5. Time
a. Delay meetings to allow board of directors to act.
b. Able to reorganize corporation.
6. Eliminate Ability of Shareholders to Act by Written Consent
a. Could require unanimous consent to act by written consent.
b. Prevents acquirer from taking action until a shareholder
meeting is held.
7. Limit Who Can Call Shareholder Meeting
a. Chairman of the Board, CEO
b. In organizational documents, ability to call shareholder
meetings is limited to individuals who are likely to be hostile to
acquiring company.
8. Defensive Audit
iii. Two Step Process
1. Step 1
a. (Tender Offer) Acquirer offers to buy Target shareholders
stock.
2. Step 2
a. Force merger on target.
f. Proportionality(Unocal)
i. Unocal Corp. v. Mesa Petroleum
1. Facts-Mesa wants to purchase Unocal. Made a cash tender offer and
wants to issue junk bonds (worst credit rating) as consideration to
minority shareholders. Realized amount will be less because it’s likely
that they won’t be paid. Unocal Board rejects the offer so Mesa tries to
purchase shares to force merger on Unocal. Experts for Unocal say
Mesa’s above market price offer is inadequate.
2. Control of a company is worth more than the market price (premium)
than what shareholders will realize.
3. Unocal Test
a. If board takes defensive actions against hostile acquirer, then
board bears the burden
i. Reasonable investigation (informing itself) and good
faith reasonably perceived threat to corporation,
shareholders, significant corporate policy.
1. Investigation
a. Looks at the process of deliberation.
b. More meetings show more investigation
to inform itself.
2. Reasonably perceived threat to corporation,
shareholders, significant corporate policy.
 55

a. Shareholders
b. Trying to protect them from any
coerciveness from the result of an offer.
Basically coerces them into saying yes to
something that is ultimately a bad offer.
ii. Defensive response is proportional to the threat (within
range of reason)
1. Proportional
2. Not preclusive
3. Not coercive
b. If board passes Unocal then we’re back to BJR.
c. If board doesn’t pass Unocal then threat.
4. Court holds Unocal’s actions were reasonable and proportionate to
Mesa’s tender offer.
5. Criticism of Case (Cleveland Dicta)
a. Defensive response is discriminatory.
6. Examples of Threats
a. Inadequately of offer
i. Found in above case.
b. Nature and timing of offer
i. Nature=Coercive?
ii. Timing=Example-Share value magically goes down
and acquiring company.
c. Impact on constituencies other than shareholders
i. i.e. People leaving the corporation who help benefit of
corporation.
d. Risk of non consummation
i. As acquirer attaches more conditions to offer, it
becomes less likely that the transaction will actually
take place.
e. Quality of Securities Being Offer
i. Nature of consideration (cash, types of bonds, etc).
ii. Paramount Communications v. Time Inc
1. Facts-Time wanted to purchase a movie company and looked at
several corporations including Warner and Paramount. This would
originally be a “stock for stock merger.” Time’s subsidiary is trying to
purchase Warner. Paramount made an offer to purchase Warner. Time
made a tender offer to purchase Warner shares. Doing this eliminated
the need to go to shareholders for a vote because Time’s shareholders
didn’t have to approve the tender offer to Warner for their shares.
Note-Only source that gave shareholders right to vote was the NYSE
because Time was issuing shares but this won’t apply because less
than 20% of the shares are issued by Time.
2. Benefit of the Triangular Structure (Subsidiary merging and not parent
company directly merging with the target company.
a. Subsidiary can avoid having shareholders vote on the merger.
 56

b. Since shareholders have limited liabilities, Time’s assets are

shielded from Warner’s liabilities.
3. Not a Business Judgment Rule case because board took a defensive
action.
4. How defensive—restructured Time/Warner agreement.
5. Skeptical because we don’t know if board acted according to BJR or
Fairness.
6. Unocal Analysis Applied (Not Found)
a. Board conducted reasonable investigation
i. Consulted financial advisors.
ii. Agreement could be a danger to Time’s corporate
culture (could be a weak argument in other cases but
valid here) because Time has never considered selling
its corporation. Paramount’s idea would result in Time
being the target corporation rather than Time being in
control as the acquiring company. Could also loose
“journalistic integrity.”
b. Reasonably perceived threat
i. Time’s loss of journalistic integrity.
c. Board’s action was proportional to the threat
7. Criticisms(Dissent)
a. Could be self-interest motivated rather than being a reasonably
perceived threat.
b. Transaction precludes Paramount because it only wants a little
of Warner when it only wants a little chunk of Time.
c. Management has crammed a transaction down the throats of
Time because they only went with Warner and not Paramount.
i. Court response-Board can make its own choices. Target
company is not trying to sell itself. Only had to come
up with a new transaction after Paramount made their
other offer.
d. No coercion because the same consideration is given in
second-step merger because it’s is the same offer of cash.
iii. Paramount Case—Part 2
1. Board met its burden on steps one and two of Unocal.
2. Rule
a. If board meets it burden under Unocal then business judgment
rule applies.
b. If board doesn’t meet its burden under Unocal then fairness
scrutiny is applied by the court.
3. Policy Notes
a. If board meets burden, it would be hard for plaintiff to argue on
business judgment rule.
b. If board doesn’t meet its burden, it would be hard to the board
to meet the heightened scrutiny of fairness.
g. Fairness
 57

i. If the majority is forcing a transaction on the minority, then the plaintiffs can
take the case outside the business judgment rule and into test of fairness.
ii. Two aspects-Review pg 1097(section C)
1. Fair dealing
a. Embraces questions of when the transaction was time,
transacted, disclosed to directors.
b. How approval of shareholders or board was received?
c. When disclosed to directors?
2. Fair price
a. Deals with financial considerations.
b. Consulted outside advisors?
c. Don’t want controlling shareholder dictating terms.
d. Might not care about price that much unless t
iii. Common law inquiry looks like DGCL §141 but may not apply because it’s a
merger between corporation and shareholders.
iv. Weinberger Case(Note Case)
1. Case shows there was no fairness.
2. Rule
a. If you’ve established an Independent Committee, then going to
fairness is easier.
3. Reasons
a. Tight time constraints
b. Approved in a short period of time.
c. No negotiations.
d. Expert opinion is helpful but the opinion wasn’t diligent.
v. Independent negotiating committee of outside directors would help show
fairness.
vi. Controlling shareholders can try to make a merger happen when they are an
officer in one corporation and shareholder in another. Wilkes.
vii. Rule-Shareholders don’t have a fiduciary duty to each other. Keep in mind
majority shareholder can do something to hurt minority.
viii. Kahn v. Lynch Communication Systems
1. Facts-Board composition of Lynch included Alcatel. For certain
transactions, statutory requirement is 80% supermajority vote. Thus,
Alcatel can veto everything Lynch wants. Lynch wants to acquire a
company. Instead, Alcatel tells Lynch to get another company, which
is a subsidiary of Alcatel. Independent committee formed that doesn’t
include Alcatel people. Board unanimously approves the plan.
2. Problem
a. Independent Committee felt pressured by Alcatel.
b. Concern that Alcatel is
3. Case is outside the business judgment rule
4. Fairness Test
a. Fairness Components
i. Fair dealing
ii. Fair price
 58

b. Initial Burden: Plaintiff carries the initial burden.

c. Burden 2: Controlling shareholder must show fair dealing and
fair price. If they can do that then it’s over.
i. How to show fair dealing
1. Independent Board
a. Court looks for something else besides
just establishing an independent
committee.
b. Questions to ask about committee
i. Is the committee just saying yes
to what the controlling
shareholder wants?
ii. Do they actually posses
independent negotiating power?
c. If both present, then burden shifts to
plaintiff.
d. Above information applied
i. (Question 1 & 2) No alternatives
for other options. Court says
committee should just say no.
Although hostile takeover might
be launched, but corporation can
take defensive actions.
2. Approval by the non-controlling
shareholders(“majority of the minority”)
d. Burden 3: Burden shifts back to the plaintiff to show that the
transaction was unfair.
i. Note-Why unfairness rather than business judgment
rule? Possible that shareholders approved out of fear
because the transaction may not proceed. Could anger
the controllers of the company. This allows
shareholders to prove the transaction was unfair.
e. Note-If fair dealing is shown then we’re less suspicious
regarding fair dealing.
5. Rule
a. If a person wields controlling share, even though not majority
shareholder, Court must determine if they were in fact
controlling certain aspects of the transaction.
6. Evidence Showing Control
a. Alcatel could block Lynch’s actions.
b. 6/11 board members wanted to hire certain managers. Alcatel’s
5 board members said no.
c. Lynch forced to consider other company because they were
forced to by Alcatel.
21. Derivative Causes of Action
a. Means by which shareholders can sue.
 59

b. Direct Cause of Action

i. Not the corporation that has been harmed, you’ve been harmed.
ii. Example-Board will not allow shareholder to inspect books and records.
Shareholder may sue to get right to inspect the books. Statutory right to
shareholder (see below)
iii. DGCL §220
1. Every shareholder has the rights to inspect the books of the
corporation.
c. Derivative Cause of Action
i. Breach of Fiduciary Duty
1. Corporation is harmed.
2. Shareholders harmed derived from the harm to the corporation.
d. Procedural Hurdles
i. Is it actually a direct or derivative cause of action?
1. See above to distinguish.
ii. Federal Rules of Civil Procedure 23.1 Derivative Actions by Shareholders
1. Harm must be contemporaneous harm. Plaintiff must be a shareholder
at the time of the harm.
2. Action shall not be dismissed without approval of the court and notice
to the shareholders.
a. Policy for this—Prevents shareholder from being bought off to
stop the suit.
3. (Demand Rule) Complaint must allege, with particularity, the efforts
made by plaintiff to obtain the action the plaintiff desires from the
directors and the reasons for the plaintiff’s failure to obtain the action
or for not making the effort.
e. Procedural Summary
i. When launching a derivative suit, plaintiff either
1. (1) Runs to the court without making demand on the board OR
2. (2) Make demand on board.
f. How to review a derivative action question
i. Is this a direct cause of action or derivative? Derivative-Corporation, in
theory, is harmed by actions of a party. If no then not a derivative suit.
ii. Assuming yes, determine which the plaintiff did (see procedural summary
above).
iii. Should court grant motion to dismiss case?
g. Exhaustion of Internal Remedies
i. Demand on Directors
1. Marx v. Akers
a. Facts-Plaintiff claims board gave itself excess compensation.
Plaintiff didn’t make demand before suit.
b. Universal Demand
i. Always make a demand and give board 3 months to
determine if they want to proceed and launch the cause
of action.
 60

ii. If irreparable injury can be shown, then 3 months

requirement is waived.
c. Policy for Universal Demand
i. (Pros) Brightline rule.
ii. (Cons) Plaintiff will probably try to circumvent the rule
by alleging irreparable injury. This would increase
cases because there would be more suits to determine if
the board properly didn’t hear demand.
d. General Purpose of Demand Rule
i. Board should make decisions on behalf of the
corporation, not shareholder. Allows board to fix
problems without the aspects of a trial.
ii. Protects board from harassment by litigation (strike
suits). Rosenfeld v. Fairchild Engine & Airplane Corp
is an example.
iii. Might be better to resolve things without litigation.
e. Situations Where Demand Isn’t Required
f. Delaware Demand Test (Similar to NY Test) (When
shareholder never makes demand, would demand be futile?)
i. Complaint must plead facts with particularity (general
terms) giving reason to doubt that
1. (1) Majority of the board is disinterested and
independent (Plaintiff is trying to show board
isn’t disinterested and independent) OR
2. (2) Challenging decision was not valid exercise
of business judgment.
g. If found plaintiff didn’t make proper demand, then the court
will dismiss the case for failure to state a claim.
h. Note-Court might have other reasons to dismiss the claim.
2. Beam v. Stewart, et al.
a. Facts-Beam (Plaintiff) sued Stewart (Defendant) and other
board members claiming Stewart breached her fiduciary duties.
b. Board Members
i. Martinez-Friend of Stewarts
ii. Moore-Friend and at the same wedding
iii. Seligman-On a publishing board that published a book
that expressed concern of Martha Stewart’s company.
c. Court discusses each prong of Demand Test
i. Disinterested & Independent
1. Is the nature of the friendship such that it would
produce a bias? Looking for some sort of detail
or particularity that would give reason to doubt.
a. Martinez
i. Board member has a good
reputation since he’s been on
other cases. Also spent a lot of
 61

time building up his reputation.

Formerly sold Stewart’s products
but doesn’t currently.
b. Moore
i. It was probably a big wedding.
Also seems to be a circle of
friends.
c. Seligman
i. Actions could be perfectly
consistent as a board member for
Stewart’s company. Not
d. Plaintiff should’ve looked at the board meeting minutes to try
and find some reference to friendship.
e. Holding-Demand was necessary and case dismissed.
ii. Board’s Authority to Refuse Demand & Terminate the Suit
1. Levine v. Smith
a. Facts- Stockholder wanted management to buy him out. Board
didn’t
b. Question to ask-Was the shareholder’s demand on board of
directors wrongly refused?
c. Test to Determine Wrongfulness of Board’s Decision to Refuse
Demand
i. Does complaint plead facts with particularity giving
reason to doubt:
1. Board of directors decision was not a valid
exercise of business judgment.
ii. Note-Once you make demand on directors, you can’t
later claim that they’re not disinterested or independent.
d. Plaintiff’s Claim
i. Wanted his lawyer to make presentation to board
decision.
ii. Board should’ve consulted more.
e. Court Response
i. Board was already informed on day one.
ii. Lawyers and other requests don’t do anything more.
f. Holding-Valid refusal of demand.
2. Zapata Corp v. Maldonad
a. Facts-Plaintiff didn’t make demand because all of the original
defendants weren’t independent and were defendants. Later,
four of the defendant-directors are no longer on the board and
two outside directors are appointed. Board created an
Independent Investigation Committee, composed of the two
new outside directors, to review plaintiff’s claim to determine
if the committee should continue.
b. Issue-Can the committee move to dismiss?
 62

c. Test to Determine Whether Board Committee Can Properly

Dismiss A Case (Use when majority of the board is interested,
not independent, and
i. Burden on committee(defendants), on behalf of the
board, of the corporation, to show it’s
1. Independent
2. Acted in good faith
3. Conducted reasonable investigation before
concluding that the cause of action should be
dismissed.
ii. If committee carries that burden, then court should
exercise its own business judgment and may dismiss the
cause of action. Court has discretion to dismiss or not to
dismiss.
iii. If committee can’t carry its burden then the motion to
dismiss is denied.
d. Policy Reasons for Allowing Court to Exercise Its Own
Business Judgment
i. Falls within court’s domain since courts often make
decisions regarding the merits of the case.
ii. Defendants have selected independent committee.
Could result in bias.
3. Example
a. Monday there’s a wrong. Shareholder wants to sue but doesn’t
have any reason to think majority of the board isn’t
disinterested. Make demand on board.
b. Tuesday-Person hears board has refused demand. Shareholder
can only say it wasn’t a valid business judgment.
c. Wednesday-Information shows majority of the board is
interested. Did shareholder loose opportunity to demand.
Shareholder may have ability to ex post claim wrongful refusal.

Demand Excused Demand Refused Zapata

Plead facts with Burden on committee to
particularity giving prove: (1) Independent,
reason to doubt: (2) Good faith, and (3)
Reasonable investigation
(1) Majority of the board X
is disinterested and
independent.
(2) Challenged decision If committee carries
was a valid exercise of burden then court
business judgment. exercises its own business
judgment and may
 63

dismiss/grant summary
judgment.
Demand Review

iii. Demand on Shareholders

1. Delaware doesn’t require demand on shareholders.
2. OK and federal government requires derivative plaintiff to make
demand on shareholders before commencing the suit.
3. Mayer v. Adams
a. Facts
b. General Rule
i. In situations of fraud, a shareholder doesn’t have to
make demand.
c. Reasons for Not Having Shareholder Demand Rule With Fraud
i. You can’t ratify fraud over the objection of a single
shareholder. Same applies with illegality.
d. Reasons for Having Shareholder Demand Rule
i. Self-interest-Should make a demand
h. Qualifications of Plaintiff Shareholder
i. Courtland Manor, Inc. v. Leeds
1. Facts-Plaintiff claims defendant’s lease was unfair to the corporation
(which defendant is a director) and unfairly benefited general
partnership (which defendant is a partner and controls).
2. Contemporaneous Rule
a. Plaintiff must have been a shareholder at the time of the
alleged wrong doing in order to file a derivative action.
3. General Rule
a. A shareholder may not complain of acts of corporate
mismanagement if he acquired his shares from those who
participated or acquiesced in the wrongful transaction or pursue
derivative action.
4. Exception to the Contemporaneous Rule
a. Material facts weren’t publicly disclosed at the time the person
acquired the shares.
b. Note-This only applies if the buyer didn’t purchase from a
person who participated in the wrongful acts.
5. Fraud to rule
6. Hypo 1
a. Corporation worth $100. One 50% shareholder. Lone director
owns 50% of corporation too. Director says he needs money
and takes money from corporation. Shareholder sells shares to
another person who pays $25. Person who buys doesn’t have a
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cause of action. Buyer is getting what he paid for once the

amount of the share goes back to $50.00. Selling shareholder
can’t sue because he’s no longer a shareholder. “See
Contemporaneous Rule.”
7. Hypo 2
a. Same scenario except director steals the money and no one
knows. Shareholder sells to buyer for $50. Buyer has a cause of
action because director’s information was secret. Selling
shareholder doesn’t have a claim either. “See exception to
Contemporaneous Rule.”
8. Hypo 3
a. Same scenario as 2. Director sells to someone else. Buyer
wouldn’t have a derivative cause of action but instead a direct
cause of action. See “General Rule.”
22. Settlement & Judicial Approval
a. Notice
b. General Rule: Court’s must approve derivative suit settlements.
c. General Methods of Oversight
i. Monitoring
1. Ongoing
a. i.e. Mom has a nanny to monitor kids.
2. Outcome
a. i.e. Mom wanted kids to do the homework.
b. Not necessarily perfect because the outcome might not be
perfect.
3. Comments
a. Are shareholders actually going to monitor?
4.
ii. Bonding
1. Combining your interests with the other person’s.
2. Reputation (i.e. Martha Stewart case)
iii. Incentives
1. Compensation
d. Problems with Oversight and Derivative Suits
i. Monitoring
1. Ongoing
a. Non-experts can’t monitor experts. Not sufficient.
2. Outcome
a. Win or lose the lawsuit. Not sufficient because good lawyers
can lose cases whereas bad ones can win.
ii. Bonding
1. Bonding your interests to clients’
a. Bond your interests to the client’s interest. If you don’t serve
the client’s interests then you can get kicked out of the
organization.
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b. Might not sufficiently bond the lawyer’s interest because it

would be harder for the lawyer to be kicked out of the bar.
Hard for the bar to determine if the attorney is acting
appropriately.
2. Reputation
a.
iii. Incentives
1. Compensation
a. If lawyers get a part of the settlement then the lawyer will work
harder for a nice settlement.
b. Not necessarily good because a lawyer might keep the case
going to collect more attorneys’ fees. Generally lawyers will
want to settle early for a lower amount even though the
plaintiffs could collect more damages later.
e. Court Review
i. Judges tend to be happy to see corporate lawsuit settled.
f. Attorneys Fees (2 Methods to Calculate. Courts have discretion)
i. Lodestar Calculation-Hourly calculation for attorneys fees
1. Delaware doesn’t like this method.
2. Argument Against-Lawyer may keep litigating.
3. Percentage-Certain percentage of funds received by winners will go to
attorneys.
4. Pro
a. Lawyers were instrumental in getting the fund and should get a
part of the funds.
5. Cons
a. Lawyer’s role or risk may be minimal. Could’ve done nothing
with the case.
b. Higher the amount at stake, then the general thought is lawyers
should get a smaller percent.
23. Derivative v. Direct
a. Derivative Cases
i. Normal Cases
1. Breach of duty of loyalty, duty of care, excessive compensation
ii. Shareholders Benefit
1. Damages go to the corporation which then could be distributed
through dividends.
b. Direct Cases
i. Normal Cases
1. Failure to be allowed to inspect the corporate books.
2. Abdication
c. Derivative or Direct?
i. Grimes v. Donald
1. Facts-Defendant CEO has a contract with the board of directors.
Plaintiff claims this provision is unlawful and wants a provision in the
contract invalidated. Also claims no due care and waste.
 66

2. Direct Cause of Action Test

a. Nature of the Relief (Does the corporation get the benefit of
relief?)
i. Plaintiff seeking an injunction or damages?
1. Damages=Derivative
a. Reason-Run the risk of multiple suits.
2. Injunctive=Direct
a. Reason-Helps all shareholders. Less
concerned about other reasons why we
have demand rule for derivative suits.
b. Nature of the Harm/Wrong
i. Individual v. Corporation
1. Individual-Only one shareholder
2. Corporation-Corporation as a whole suffers.
3. Example
a. Failure to call a meeting is a statutory right that supports it
being a direct cause of action. DGCL 211
4. Excessive Compensation=Derivative
a. Corporation suffers harm. Shares could be worth less
5. Breach of Duty of Loyalty=Derivative/Direct
a. Derivative-Corporation suffers harm.
b. Direct-Individual simultaneously harmed directly. Minority’s
stake has gone down because of majority shareholder’s actions.
d. Special Circumstances in Derivative Suits
i. Barth v. Barth
1. Facts-Plaintiff sues for excessive compensation and using corporate
employees for personal work (duty of loyalty).
2. Rule
a. Shareholders of a corporation may not maintain suits in their
own names to redress an injury to the corporation.
3. Exception
a. Rule doesn’t apply to close corporation.
4. Reasons for Close Corporation Exception
a. Shareholder may have a fiduciary relationship with each other
individually.
b. Very difficult for a shareholder in a close-corporation to recoup
his investment.
5. Reasons Against
a. Debt obligations. If corporation isn’t in good condition, this
might result in creditors not being paid.
b. Treats one shareholder differently than others.
6.
a. Look at the other shareholders impact.
b. Also consider if the plaintiff could be made whole in a derivate
action suit.
24. Indemnification of Defendants
 67

a. Policy Reasons
i. Might have trouble recruiting directors
b. Three Legged Stool
i. Provision in COI (DGCL §102 (b) 7)
ii. Purchase and/or maintain insurance on behalf of anyone who is a director or
employee. (DGCL §145)
iii. Indemnify to the full extent of the law.
1. May apply to current and past employees.
2. DGCL 145 (a) doesn’t apply to derivative suits. Must have acted in
good faith.
3. DGCL 145 (b) can indemnify person who was or is a party or
threatened to be a party.
4. DGCL 145( a) Can indemnify directors against (see below) is
reasonable and with good faith.
a. Expenses including attorney’s fees
b. Judgments
c. Fines
d. Amounts paid in settlement
5. DGCL 145 (b)
a. Expenses including attorney’s fees.
c. Statute-DGCL 145
i. 145 (a)
1. Voluntary
ii. DGCL §145 (b)
1. Voluntary
2. Deals with derivative suits.
iii. DGCL 145 (c)
1. Director shall be indemnified if he was successful on the merits.
Corporation shall cover expenses including attorney fees.
iv. DGCL 145 (d)
1. Who can make decision to indemnify if not made mandatory
a. Majority vote of the board who isn’t a party to the suit (quorum
doesn’t matter)
b. Committee designated by majority vote of above directors
c. If no directors or then independent legal counsel
d. Stockholders
v. DGCL 145 (e)
1. Expenses paid may be paid in advanced but person might have to pay
the money back if the director is ultimately not entitled to the fees.
vi. DGCL 145 (f)
1. Can provide indemnification through by-laws, etc.
vii. 145 (k)
d. Waltuch v. Conticommodity Services
i. Facts-Two cases. First-Waltuch was dismissed from the suit. Second-Waltuch
was settled and paid a fine.
ii. Argument against court’s statutory interpretation-DGCL 145 (a)
 68

1. Look to ambiguous terms to argue it’s not clear.

2. Attorneys’ fees are ambiguous since you don’t know who they would
go to.
iii. Good faith at issue because the statute requires good faith.
iv. 145 (c)
1. Settlement means you’re successful.
v. 145 (f)
1. Corporation makes it mandatory
vi. Successful on the merits or otherwise
1. Doesn’t care about morals.
vii. Holding
1. 145 (f) can grant additional indemnification but it must be consistent
with other sections including good faith.
e. Baker v. Health Management Systems (Fees on Fees)
i. Facts-Plaintiff, who is an officer for the corporation, was joined to a suit after
it started. He then got his own attorney. Plaintiff asks for indemnification for
fees for first case and for this case as well.
ii. Rule- Fees on fees not allowed.
iii. Plaintiff Arguments
1. Must use a “but for” test. But for the first case I wouldn’t have
incurred the costs.
iv. Contrast/Court’s Argument
1. Legislative history doesn’t support this.
v. Holding
1. Person won’t get indemnification
vi. Dissent/Another contrast
1. How else can you enforce indemnification if you can’t sue?
2. If we don’t allow parties to have his own lawyers, then he’ll have to
raise common defense.
f. Ridder v. CityFed Financial Corp.
i. Facts-Corporate by-laws state it will pay legal fees in advance of litigation but
the director might have to pay them back. Director is sued by receiver and
wants fees paid in advance.
1. Receiver argues because they’re suing, they shouldn’t have to pay
advance legal fees.
ii. Rule-You can’t change the rules after the litigation has begun. If the by-
laws/charter say corporation will advance fees then you must do so. Advance
fees are okay.
25. Federal Securities
a. Elements
i. (1) Standing, (2) Materiality, (3) Causation-reliance, link between lie and
damages, (4) Scienter, and (5) Damages.
b. Insider Trading
i. Possible breach of fiduciary duty.