Corporations Outline

Intro
Tuesday, September 3, 2019 10:42 AM
What is Corporate Law

• Hypo: Pharma
➢ Groups affected by the company's decisions
❖ Insurance companies
❖ Customers
❖ Competitors
❖ Suppliers
❖ Doctors/Hospitals
❖ Shareholders
❖ Banks/Debt holders/Other Creditors
❖ Employees
❖ Regulators/FDA
❖ Government
❖ NGOs
➢ How can these groups affect the corporations (tools)
❖ Insurance - contracts/pricing/insurance policy - whether the company will cover the drugs or not
❖ Customers - demand/preferences
❖ Competitors - buyout threat/antitrust concern/competitive landscape, comparative advantage
❖ Suppliers - cultivating long-term contractual relationship
❖ Doctors/Hospitals - market power/concerns can lead to torts
❖ Shareholders - Shareholder agreement, by-laws/shareholder activism
❖ Banks - whether to finance/contractual restrictions/bankruptcy law
❖ Employees - unionization/competitive labor market, mobile workers
❖ FDA - compliance, significant discretion
❖ Gov't - tax revenue, among other things
❖ NGOs - publicizing, providing a public voice to the other groups' concerns
Notes Page 1
Agency
Tuesday, September 3, 2019 11:36 AM
1. 5 major ways to demonstrate existence of P/A relationship
I. Actual express authority:

• Agency = fiduciary relationship resulting from
➢ The manifestation of consent by one person to another
➢ That the agent shall act on the principal's behalf (benefit)
➢ And subject to principal's control
➢ And consent by the agent so to act
• Principle & agent explicitly agree that A has power to act on P's behalf and subject to P's control
• Gorton v. Doty - volunteer the car but specify the driver
➢ no consideration necessary
➢ Ownership alone establishes a prima facie case against the owner for the reason that the presumption arises that the
driver is the agent of the owner
II. Actual implied authority
• Same four elements
• Qualification for the manifestation prong
➢ Jenson Farms v. Cargill - grain business; the focus is on the control
❖ When an agency relationship is to be proven by circumstantial evidence, the principal must be shown to have
consented to the agency
✓ Manifestation of consent - directing Warren to implement its recommendations
✓ Behalf - Warren procuring grain for Cargill as the part of its normal operations which were totally financed
by Cargill
✓ De facto control - Cargill's interference with the internal affairs of Warren
❖ Restatement - a security holder who merely exercises a veto power over the business acts of his debtor by
preventing purchases or sales over specified amounts does not thereby become a principal
✓ However, if he takes over the management of the debtor's business, and directs what contracts may or may
not be made, he becomes a principal
➢ Mill Street Church v. Hogan - hired to do painting work; nature of the job requires assistant, who's injured
❖ whether the agent reasonably believes because of present or past conduct of the principal that the principal wishes
him to act in a certain way or to have certain authority
✓ The nature of the task or job may be another factor
✓ The existence of prior similar practices is one of the most important factors
III. Apparent authority
• Manifestation from principal to third person (Restatement 8)
➢ Historically, the manifestation needed to be really specific, now more indirect, e.g. Ampex (salesperson handling the
transaction, but without authority to approve)
➢ Also, in limited situations, courts have even allowed other types of A's communications to the 3rd party to count as
manifestation
• Sufficient to create reasonable belief in 3rd party that authority existed
➢ Ampex - Absent knowledge on the part of third parties to the contrary, an agent has the apparent authority to do those
things which are usual and proper to the conduct of the business which he is employed to conduct
• (Some jurisdictions) And on which the 3rd party reasonably relies to her detriment
➢ Cal and Delaware do require a showing of actual detrimental reliance
➢ NY unclear
IV. Inherent agency power
• Watteau v. Fenwick - Version 1 - undisclosed principal
➢ Fact - beerhouse sold but remained as the manager
➢ Third party knows about neither the existence nor the identity of the principal
➢ (1) A was a general agent for an undisclosed P, and had AEA/AIA to conduct some types of transactions
➢ (2) The transactions in question were usual or necessary in such a business
➢ (3) A was acting on P's account (i.e., in P's interests)
➢ Limited by third restatement (not followed by most states), requiring principal's notice of agent's conduct and failure to
take reasonable steps to notify others
• Version 2 - disclosed principal
➢ Elements:
➢ (1) A acting as general agent
➢ (2) A's acts usually accompany or are incidental to transactions which this type of agent would usually be allowed to
conduct
Notes Page 2
conduct
➢ (3) Third party has reason to believe that agent is authorized and has no notice to the contrary
➢ Similar to apparent authority
V. Ratification
• Elements
➢ Existence - P must exist at time of initial contract formation
➢ Purported benefit - A must enter into K purportedly on P's behalf
❖ Botticello - In this case, the husband never purported to be acting on the wife's behalf, therefore no ratification
possible
➢ Affirmance - P must take subsequent manifestation with full knowledge of circumstances indicating a choice to treat
act as authorized
❖ Does not need to be communicated to purported agent or the third party
➢ Persistence - 3rd party can't withdraw claim before ratification
VI. Estoppel (only in some jurisdiction)
• Elements
➢ Principal negligently creates appearance of a purported agent's authority
➢ Third party reasonably believes authority to exist
➢ Third party changes her position in reliance on that belief
2. Agent's liability
• Note tort liability of agent remains whether or not respondent superior applies
• Contract liability of agent
➢ If principal is not liable, agent may be still liable herself to the third party on one of two bases
❖ Common law fraud/deceit
❖ Warranty of authority
➢ If principal is liable, agent's exposure is far more limited
❖ Fully disclosed P - A usually not
❖ Undisclosed/partially disclosed P - A liable as guarantor on the contract
✓ Atlantic Salmon - A person purporting to make a contract with another for a partially disclosed principal is a
party to the contract
○ If the other party has notice that the agent is or may be acting for a principal but has no notice of the
principal's identity, the principal for whom the agent is acting is a partially disclosed principal
○ To avoid personal liability, the agent has to disclose not only that he is acting in a representative
capacity, but also the identity of his principal
3. Distinguishing between employees and independent contractors

• One flavor of principle-agent: Employee-employer relationship (only these can pass torts liability)
➢ Agreed to work on behalf of the master, and
➢ Subject to the master's control or right to control the physical conduct of the servant
➢ Humble Oil - servant v. independent contractor
❖ The court found a master-servant relationship
✓ The business was the retail marketing of Humble's products
✓ Under a strict system of financial control and supervision by Humble, with little business discretion by IC
✓ Humble funished the location and equipment, advertising, the products and part of the operating costs
✓ Hours of operation controlled by Humble
✓ The agreement terminable at will by Humble
✓ The rents are remuneration as they are based on the sales
• Another - independent contractor (they can only pass on contract liability)
➢ Agreed to work on behalf of the principal
➢ Not subject to the principal's control over how the result is accomplished ("physical conduct")
➢ Sun Oil
❖ Found only IC relationship
✓ Although the station and the equipment were owned by Sun, the least subject to termination by both parties
✓ Although manager purchased products from Sun and borrowed equipment solely for Sun products
✓ Although large sings of Sun products, advertising under Sun heading and Sun uniforms for employees
✓ Although Sun's rep inspected the place and made suggestions
✓ The manager was under no obligation to follow the advice
✓ Manager independently determined his own hours of operation and the identity, pay scale and working
conditions of his employees; it was his name that was posted as proprietor
❖ Rule - whether the company has retained the right to control the details of the day-to-day operation of the service
station; control or influence over results alone being viewed as insufficient
➢ Holiday Inns
Notes Page 3
➢ Holiday Inns
❖ In determining whether a contract establishes an agency relationship, the critical test is the nature and extent of
the control agreed upon
✓ The court found in that case that the provisions did not give defendant control over the day-to-day operation
of the hotel
✓ e.g., current business expenditures, fix customer rates, demand a share of the profits, fire employees,
determining wages and working conditions, supervise work routine
• Outside of Principle-agent: "non-agent" independent contractor
➢ Operates independently and simply enters into arm's length transactions with others
4. Miller v. McDonalds - special rule for employment by apparent authority

• Needs justified reliance by the third party
5. Special rule finding Principal's tort liability for ICs

• Usually none
• Exceptions
➢ Non-delegable duties (as in the case of E/E acting outside scope)
❖ Traditionally certain antidiscrimination laws; antitrust laws; occupational health & safety regulations
➢ P retained A to perform inherently dangerous activities
❖ Majestic Realty v. Toti (1959)
✓ Facts - demolition of building damaged adjacent building
➢ P was negligent in selecting/instructing/overseeing IC
❖ §213
✓ §213(d) may be relevant if you select an agent with little financial resources
5. Limit - only liable if action is within scope

• Restatement 2nd §219
➢ M is subject to liability for the torts S committed while servants acting in the scope of their employment
➢ M is not subject to liability if outside the scope, unless
❖ M intended the conduct or the consequences
❖ Negligent or reckless
❖ S's conduct violated a non-delegable duty of M
❖ (apparent scope) S purported to act or to speak on behalf of the principal and there was reliance upon apparent
authority, or he was aided in accomplishing the tort by the existence of the agency relation
• Restatement 2nd §228 (defining scope)
➢ Not followed by every state
➢ ("Conjunctive" test) Conduct S is within the scope of employment if, but only if
❖ It is of the kind he is employed to perform
✓ Arguello v. Conoco (2000)
○ Facts - racial discrimination while purchasing gasoline
○ Elements
 Time, place, and purpose of the act
 Similarity to acts servants is authorized to perform
 Whether act is commonly performed by employees
 Extent of departure from normal methods
 Whether the master would reasonably expect such act would be performed
❖ It occurs substantially within the authorized time and space limits
❖ It is actuated, at least in part, by a purpose to serve M, and
✓ Bushey & Sons v. U.S.
○ Facts - drunk seaman got drunk and turned some wheels on the drydock wall, which sank as a result
○ Note alternative tests discussed by court for determining scope
 Traditional "purpose" test from §228
 Trial court: "least cost risk avoider/bearer" approach
 Judge Friendly approach (modified §228)
 Harm arises characteristically out of and in course of employment
 Harm is within the unique nexus/proximity of employment
 Harm is foreseeable (notwithstanding reasonable efforts by Employer to forestall it)
○ Which test seems to be the most defensible
 All three versions of this test are still around
✓ Third Restatement - an employee's act is not within the scope of employment when it occurs within an
independent course of conduct not intended by the employee to serve any purpose of the employer
❖ If force is intentionally used by the S against another, the use of force is not unexpectable by M
Notes Page 4
✓ consider decision in Manning v. Grimsley
○ Facts - MLS pitcher hounded by hecklers heaves baseball at them
○ Holding - what must be shown is that the employee's assault was in response to the plaintiff's conduct
which was presently interfering with the employee's ability to perform his duties successfully
○ Court also held that the action was expectable
✓ Third Restatement - an employee's intentionally criminal conduct may indicate a departure from conduct
within the scope of employment, not a simple escalation. The nature and magnitude of the conduct are
relevant to determining the employee's intention at the time
➢ Conduct of a servant is not within the scope of employment if it is different in kind from that authorized, far beyond
the authorized time or space limits, or too little actuated by a purpose to serve the master
6.Special rule finding Principal's tort liability for Ics

•Usually none
•Exceptions
•Non-delegable duties (as in the case of E/E acting outside scope)
➢ Traditionally certain antidiscrimination laws; antitrust laws; occupational health & safety regulations
• P retained A to perform inherently dangerous activities
➢ Majestic Realty v. Toti (1959)
❖ Facts - demolition of building damaged adjacent building
• P was negligent in selecting/instructing/overseeing IC
➢ §213
❖ §213(d) may be relevant if you select an agent with little financial resources
7. Statutory twist - Dynamex (CA) defining E/E relationship against IC

• For purpose of CA wage and hour law for transportation workers
➢ "employ" means to engage, suffer, or permit to work
➢ "employer" means any person who directly or indirectly, employs or exercises control over the wages, hours, or
working conditions of any person
• The Martinez case held that the wage order embodied three alternative definitions of "employ"
➢ To exercise control over the wages, hours or working conditions, or
➢ To suffer or permit to work, or
➢ To engage, thereby creating a common law employment relationship
• This court ruled on the "suffer or permit to work" test - the worker is IE for the purpose of wage order only if the hirer can
prove that
➢ The worker is free from the control and direction of the hirer in connection with the performance of the work, both
under the contract for the performance of such work and in fact
➢ The worker performs work that is outside the usual course of the hiring entity's business, and
➢ The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as
the work performed for the hiring entity
➢ These three elements are parts of the common law test, but note the burden-shifting
Gorton v. Doty (Idaho 1937) - actual express authority

• Facts
➢ Gorton, member of a high school football team
➢ Doty's car was driven by the coach to transport the team
➢ She volunteered her car
❖ Require the coach to drive it
❖ Not promised or received compensation
❖ The school district paid for the gasoline
• Holding - agency existed
➢ (Restatement) Agency - the manifestation of consent by one person to another that the other shall act on his behalf and
subject to his control, and consent by the other so to act
❖ Doesn't need to involve some matter of business
✓ Only that where one undertakes to transact some business or manage some affair for another by authority
and on account of the latter
❖ Ownership alone establishes a prima facie case against the owner for the reason that the presumption arises that
the driver is the agent of the owner
• Dissent - agency requires request, instruction or command, not just passive permission
• No consideration therefore no contract - but not necessary for agency
• Problem - this is tort liability so there should have been discussion of employer-employee relationship
➢ Reason maybe - cheapest cost bearer is the insurance company
Notes Page 5
➢ Reason maybe - cheapest cost bearer is the insurance company
• In this case
➢ Manifestation - check
➢ Control - the requirement of him driving
➢ Consent - check
➢ Behalf/benefit - unclear
A. Gay Jenson Farms Co. v. Cargill (Minn. 1981) - actual implied authority
• Facts
➢ Warren, a grain company sought financing from Cargill
➢ Cargill acted as a buyer and a financier
❖ As Cargill became more concerned about the financial situation, more strings got attached
✓ Right of first refusal on grain
✓ Right of entry to carry on checks and audits
✓ Recommendation and guidance
✓ Right to stop the funding
✓ An official sent to supervise the elevator
• Holding - the existence of the agency may be proved by circumstantial evidence which shows a course of dealing between
the two parties
➢ When an agency relationship is to be proven by circumstantial evidence, the principal must be shown to have
consented to the agency
❖ Manifestation of consent - directing Warren to implement its recommendations
❖ Behalf - Warren procuring grain for Cargill as the part of its normal operations which were totally financed by
Cargill
❖ De facto control - Cargill's interference with the internal affairs of Warren
➢ Restatement - a security holder who merely exercises a veto power over the business acts of his debtor by preventing
purchases or sales over specified amounts does not thereby become a principal
❖ However, if he takes over the management of the debtor's business, and directs what contracts may or may not be
made, he becomes a principal
✓ The line - when he assumes de facto control over the conduct of his debtor
• Cargill may avoid liability if it didn't meddle with the management and operation, but Warren's situation could go even
worse if Cargill didn't interfere, so accepting the responsibility may be wise - there are pros and cons
➢ another solution - subsidiary
❖ Counter - piercing the corporate veil??
Mill Street Church of Christ v. Hogan (Ky. 1990) - actual implied authority / apparent authority
• Facts
➢ Mill Street Church of Christ (“Mill Street”) hired a church member to paint its building, and during previous jobs, it
allowed the member to employ his brother, Samuel J. Hogan, to assist him.
➢ Hogan was injured on the first day at work, and Mill Street paid the church member for the hours worked by Hogan
prior to the injury.
• Holding - Bill Hogan had implied authority
➢ The focus of examining implied authority - whether the agent reasonably believes because of present or past conduct of
the principal that the principal wishes him to act in a certain way or to have certain authority
❖ The nature of the task or job may be another factor
❖ The existence of prior similar practices is one of the most important factors
➢ In this case yes
❖ Prior similar practices
❖ An assistance was needed to complete the job
➢ Sam Hogan believed that Bill Hogan had the authority to hire him as had been the practice in the past
❖ Same relied on Bill's representation
❖ This seems like apparent authority
• Practice Problem P. 16 - Paul owns an apartment building and has hired Ann to manage it
➢ Tell her to hire a company to cut the grass, Ann does it - yes
➢ Without express instructions, Ann hires a janitor to clean the building - express authority no; implied authority
probably, first Ann is the manager, a general agent that does a variety of things consistent with making the building
tidy and attractive; apparent authority probably as well
➢ Paul told Ann not to hire, but local custom gives managers the power to hire janitors - express authority no, implied
authority no; apparent authority probably yes
Three-Seventy Leasing Corporation v. Ampex Corporation (5th Cir. 1976) - apparent authority
• Facts
Notes Page 6
• Facts
➢ Joyce from 370, negotiated with Kays, a salesman of Ampex and Mueller, Kays' superior
➢ A written document submitted by Kays to Joyce at the direction of Mueller, not signed by anyone
❖ Executed by Joyce, not by Ampex
➢ Kays sent a letter to Joyce which confirmed the details of the transaction
• Holding - apparent authority
➢ When the principal acts in such a manner as would lead a reasonably prudent person to suppose that the agent had the
authority he purports to exercise
➢ Absent knowledge on the part of third parties to the contrary, an agent has the apparent authority to do those things
which are usual and proper to the conduct of the business which he is employed to conduct
➢ In this case
❖ Salesman, reasonable presumption of agency
✓ Ampex did nothing to dispel this reasonable inference
❖ Kays, directed by Mueller, submitted the document
✓ Nothing suggested that Kays could not sign it
❖ Joyce indicated that all communications to be channeled through Kays
• Apparent authority
➢ Manifestation from principal to third person (Restatement 8)
❖ Historically, the manifestation needed to be really specific, now more indirect, e.g. Ampex
❖ Also, in limited situations, courts have even allowed other types of A's communications to the 3rd party to count
as manifestation
➢ Sufficient to create reasonable belief in 3rd party that authority existed
➢ (Some jurisdictions) And on which the 3rd party reasonably relies to her detriment
❖ Cal and Delaware do require a showing of actual detrimental reliance
❖ NY unclear
• Hypo - if it's extension of credits like Cargill, then a salesman probably doesn't have the authority, the presumption less
reasonable
Watteau v. Fenwick (1892) - inherent agency power

• Facts
➢ Beerhouse owner sold the place, but remained as the manager
❖ His name still on the license and painted over the door
❖ Their agreement provided that the manager had no authority to buy any goods except bottled ales and mineral
waters
• The principal is liable for all the acts of the agent which are within the authority usually confided to an agent of that
character, notwithstanding limitations, as between the principal and the agent, put upon that authority
• This is IAP Version 1 - undisclosed principal
➢ Third party knows about neither the existence nor the identity of the principal
➢ (1) A was a general agent for an undisclosed P, and had AEA/AIA to conduct some types of transactions
➢ (2) The transactions in question were usual or necessary in such a business
➢ (3) A was acting on P's account (i.e., in P's interests)
➢ Limited by third restatement (not followed by most states), requiring principal's notice of agent's conduct and failure to
take reasonable steps to notify others
• IAP Version 2 - disclosed principal
➢ Elements:
➢ (1) A acting as general agent
➢ (2) A's acts usually accompany or are incidental to transactions which this type of agent would usually be allowed to
conduct
➢ (3) Third party has reason to believe that agent is authorized and has no notice to the contrary
➢ Similar to apparent authority
Botticello v. Stefanovicz (1979) - ratification

• Facts
➢ Sale of real property, husband only owned an undivided half interest
➢ The buyer didn't know and an agreement was reached
• Ratification - the affirmance by a person of a prior act which did not bind him but which was done or professedly done on
his account
➢ Requires acceptance of the results of the act with an intent to ratify, and with full knowledge of all the material
circumstances
➢ In this case, the husband never purported to be acting on the wife's behalf, therefore no ratification possible
• Elements
Notes Page 7
➢ Purported benefit - A must enter into K purportedly on P's behalf
➢ Affirmance - P must take subsequent manifestation with full knowledge of circumstances indicating a choice to treat
act as authorized
➢ Persistence - 3rd party can't withdraw claim before ratification
Hoddeson v. Koos Bros (N.J. 1957) - Estoppel

• Facts
➢ Somebody faked as staff at a furniture store
• Elements
➢ Principal negligently creates appearance of a purported agent's authority
➢ Third party reasonably believes authority to exist
➢ Third party changes her position in reliance on that belief
Atlantic Salmon v. Curran (1992) - Agent's liability on the contract

• Defendant dealt with the plaintiffs as a rep of a company that doesn't exist
➢ He later claimed that he acted on behalf of Marketing Designs, which was a real company
➢ Plaintiffs did not know of the existence of Marketing Designs
• A person purporting to make a contract with another for a partially disclosed principal is a party to the contract
➢ If the other party has notice that the agent is or may be acting for a principal but has no notice of the principal's
identity, the principal for whom the agent is acting is a partially disclosed principal
➢ To avoid personal liability, the agent has to disclose not only that he is acting in a representative capacity, but also the
identity of his principal
❖ Duty not on the plaintiff, but on the agent
• Note tort liability of agent remains whether or not respondent superior applies
• Contract liability of agent
➢ If principal is not liable, agent may be still liable herself to the third party on one of two bases
❖ Common law fraud/deceit
❖ Warranty of authority
➢ If principal is liable, agent's exposure is far more limited
❖ Fully disclosed P - A usually not
❖ Undisclosed/partially disclosed P - A liable as guarantor on the contract
Liability of principal to third party in torts

• Servant
➢ Agreed to work on behalf of the master, and
➢ Subject to the master's control or right to control the physical conduct of the servant
• Agent-type independent contractor
➢ Agreed to work on behalf of the principal
➢ Not subject to the principal's control over how the result is accomplished ("physical conduct")
• Non-agent type independent contractor
➢ Operates independently and simply enters into arm's length transactions with others
Humble Oil v. Martin (1949) - Servant v. Independent Contractor

• Facts
➢ Tort liability of a gas station, owned by Humble but operated by an independent contract
➢ They had a commission agency agreement
• The court found a master-servant relationship
➢ The business was the retail marketing of Humble's products
➢ Under a strict system of financial control and supervision by Humble, with little business discretion by IC
➢ Humble funished the location and equipment, advertising, the products and part of the operating costs
➢ Hours of operation controlled by Humble
➢ The agreement terminable at will by Humble
➢ The rents are remuneration as they are based on the sales
Hoover v. Sun Oil (1965)

• Found only IC relationship
➢ Although the station and the equipment were owned by Sun, the least subject to termination by both parties
➢ Although manager purchased products from Sun and borrowed equipment solely for Sun products
➢ Although large sings of Sun products, advertising under Sun heading and Sun uniforms for employees
➢ Although Sun's rep inspected the place and made suggestions
➢ The manager was under no obligation to follow the advice
Notes Page 8
➢ The manager was under no obligation to follow the advice
➢ Manager independently determined his own hours of operation and the identity, pay scale and working conditions of
his employees; it was his name that was posted as proprietor
• Rule - whether the company has retained the right to control the details of the day-to-day operation of the service station;
control or influence over results alone being viewed as insufficient
Murphy v. Holiday Inns (1975)

• Facts - personal injury while at the hotel
• If the license agreement is sufficient to establish an agency relationship, the disclaimer clause does not defeat it
• In determining whether a contract establishes an agency relationship, the critical test is the nature and extent of the
control agreed upon
➢ The court found in that case that the provisions did not give defendant control over the day-to-day operation of the
hotel
❖ e.g., current business expenditures, fix customer rates, demand a share of the profits, fire employees, determining
wages and working conditions, supervise work routine
Miller v. McDonald's Corp. (1997) - Tort Liability and Apparent Agency

• Actual agency relationship exists - the agreement required the restaurant to use the precise methods that defendant
established
➢ Defendant had the right to control the restaurant in the precise part of its business that allegedly resulted in the injury
• Regarding apparent agency - needs actual belief and reliance
➢ Actual disbelief = affirmative defense
Ira S. Bushey & Sons v. United States - scope of employment

• Facts
➢ Drunk Coast Guard turned some wheels on the drydock wall after returning from shore leave late at night
➢ Part of the drydock sank
• Restatement 2nd §219
➢ M is subject to liability for the torts S committed while servants acting in the scope of their employment
➢ M is not subject to liability if outside the scope, unless
❖ M intended the conduct or the consequences
❖ Negligent or reckless
❖ S's conduct violated a non-delegable duty of M
❖ (apparent scope) S purported to act or to speak on behalf of the principal and there was reliance upon apparent
authority, or he was aided in accomplishing the tort by the existence of the agency relation
• Restatement 2nd §228 (defining scope)
➢ Not followed by every state
➢ ("Conjunctive" test) Conduct S is within the scope of employment if, but only if
❖ It is of the kind he is employed to perform
✓ Arguello v. Conoco (2000)
○ Facts - racial discrimination while purchasing gasoline
○ Elements
 Time, place, and purpose of the act
 Similarity to acts servants is authorized to perform
 Whether act is commonly performed by employees
 Extent of departure from normal methods
 Whether the master would reasonably expect such act would be performed
❖ It occurs substantially within the authorized time and space limits
❖ It is actuated, at least in part, by a purpose to serve M, and
✓ Bushey & Sons v. US
○ Facts - drunk seaman got drunk and turned some wheels on the drydock wall, which sank as a result
○ Note alternative tests discussed by court for determining scope
 Traditional "purpose" test from §228
 Trial court: "least cost risk avoider/bearer" approach
 Judge Friendly approach (modified §228)
 Harm arises characteristically out of and in course of employment
 Harm is within the unique nexus/proximity of employment
 Harm is foreseeable (notwithstanding reasonable efforts by Employer to forestall it)
○ Which test seems to be the most defensible
 All three versions of this test are still around
✓ Third Restatement - an employee's act is not within the scope of employment when it occurs within an
Notes Page 9
✓ consider decision in Manning v. Grimsley
○ Facts - MLS pitcher hounded by hecklers heaves baseball at them
○ Holding - what must be shown is that the employee's assault was in response to the plaintiff's conduct
which was presently interfering with the employee's ability to perform his duties successfully
○ Court also held that the action was expectable
✓ Third Restatement - an employee's intentionally criminal conduct may indicate a departure from conduct
within the scope of employment, not a simple escalation. The nature and magnitude of the conduct are
relevant to determining the employee's intention at the time
➢ Conduct of a servant is not within the scope of employment if it is different in kind from that authorized, far beyond
the authorized time or space limits, or too little actuated by a purpose to serve the master
Principals' Liability for Torts of ICs

• Usually none
• Exceptions
➢ Non-delegable duties (as in the case of E/E acting outside scope)
❖ Traditionally certain antidiscrimination laws; antitrust laws; occupational health & safety regulations
➢ P retained A to perform inherently dangerous activities
❖ Majestic Realty v. Toti (1959)
✓ Facts - demolition of building damaged adjacent building
➢ P was negligent in selecting/instructing/overseeing IC
❖ §213
✓ §213(d) may be relevant if you select an agent with little financial resources
Dynamex v. Superior Court (2018) - statutory riffs on Er-Ee/IE

• For purpose of CA wage and hour law for transportation workers
➢ "employ" means to engage, suffer, or permit to work
➢ "employer" means any person who directly or indirectly, employs or exercises control over the wages, hours, or
working conditions of any person
• The Martinez case held that the wage order embodied three alternative definitions of "employ"
➢ To exercise control over the wages, hours or working conditions, or
➢ To suffer or permit to work, or
➢ To engage, thereby creating a common law employment relationship
• This court ruled on the "suffer or permit to work" test - the worker is IE for the purpose of wage order only if the hirer can
prove that
➢ The worker is free from the control and direction of the hirer in connection with the performance of the work, both
under the contract for the performance of such work and in fact
➢ The worker performs work that is outside the usual course of the hiring entity's business, and
➢ The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as
the work performed for the hiring entity
➢ These three elements are parts of the common law test, but note the burden-shifting
Notes Page 10
Corporate Formation Podcast
Monday, September 16, 2019 5:57 PM
Proprietorships Corporation
Limited Liability No, but partnership agreement can Yes, but creditors may seek guarantees
have indemnities
Free transfer No (default) Yes (default)
Continuity At will (default) Indefinite (default)
Fiduciary Duties Care/loyalty Care/loyalty
Management Decentralized (default) Centralized (default)
Flexibility of Excellent Sometimes awkward
default rule
Formation Informal Formalities required
Tax Pass-through Entity-level tax
• Flat 21% on taxable income
• Both state and federal tax
• For shareholders
➢ Ordinary income v. capital gains rate
➢ Taxed only when income is realized
Capitalizing costs to shield tax liabilities
• "Impairments" (depreciation/amortization)
• If a closely held structure, can just pay yourself salary or leasing intellectual
property rights of yours to your own company
• Debt holders - interest payments are deductible
• US v. Foreign incorporation
➢ Profit/tax base shifting to low tax jurisdictions
Personhood Aggregation of parts Separate legal entity
Sources of Law
• Highly "Statutized" area of law
➢ Significant role for statutory interpretation
• But also lots of background common law rules
➢ Especially regarding fiduciary duties
• Most corporate laws are default rules
➢ However, because of specificity of statutes, it can be costly to set aside default rules
• Focusing on the Delaware General Corporate Law (DGCL)
Corporate Formation (excel file)

• Promotional arrangements
➢ Checking trademarks, various forms of corporations, reservation of names
• Place of incorporation
➢ Delaware or the home state
• Drafting Charter / Articles of Incorporation (Item 2)
➢ DGCL §§ 101-103
➢ The Model Business Corporation Act
❖ Name
❖ Authorized shares
❖ Registered agent
❖ Incorporators
➢ Need to have a name
➢ registered office and registered agent in Delaware
➢ Stated purpose
➢ Capital stock - nonvoting stocks, preferred stocks, par value
❖ Danger of dual class structure - new investors have less incentives
❖ Blank check for preferred stocks - more difficult for other investors to gain control
➢ Incorporator
➢ Optional provisions
➢ Filed with secretary of state
➢ Amending articles of incorporation
❖ The board of directors must recommend the amendment to the shareholders
❖ Shareholders must approve the amendment
❖ The amendment must be filed with the secretary of state's office
• Drafting by-laws
➢ By-laws tend to be far more detailed than the articles of incorporation
Notes Page 11
➢ By-laws tend to be far more detailed than the articles of incorporation
❖ By-laws need not be filed with the state government, which means they are not part of the public record
❖ By-laws are more easily amended than articles of incorporation
❖ Officers and directors tend to be more familiar with by-laws than with the articles
• Organizational meeting
➢ Elect directors
➢ Adopt by-laws
➢ Issue stock
❖ Maybe SEC filings
➢ Appoint officers
➢ Ratify/execute contracts
➢ Tax Elections (IRC §83b)
❖ Tax law characterizing the moment of vesting of stock a taxable event
❖ §83(b) allows founders to opt to be taxed in full on value of unvested stock when initially issued
✓ Founders can plausibly claim that stock has $0 value at this time
Notes Page 12
Corporate Personhood and Internal Affairs Doctrine
Thursday, September 19, 2019 9:57 AM
Internal Affairs Doctrine

• State of incorporation determines the applicable legal framework to analyze inter se
(between shareholders, management, officers…) rights, duties, obligations, etc. of relevant
constituencies within a corporation
➢ Not necessarily including employees, creditors, suppliers, customers…
❖ e.g. employment law in the state of that employment
• Long arm statutes, e.g., CA Corps Code §2115
➢ Scope of application
❖ Privately-held corps
❖ Majority of voting shares held by California residents
❖ Majority of "economic activity" done in CA
✓ Property, payroll & sales factors
➢ Apply CA corporate law concurrently to numerous issues
• Newest trend - attempting to "Internal Affairs-ize" traditionally non-IA-related issues
➢ e.g. non-competes/non-solicitation terms for EEs
• Boilermakers - By-law providing that litigation relating to Chevron's internal affairs should
be conducted in Delaware
➢ have a "procedural, process-oriented nature"
❖ By-laws typically do not contain substantive mandates, but direct how the
corporation, the board, and its stockholders may take certain actions
➢ The forum selection by-laws fit this description
❖ They are process-oriented, because they regulate where stockholders may file
suit, not whether
❖ They govern where internal affairs cases governed by state corporate law may
be heard
❖ By contrast, the by-laws would be regulating external matters if the board adopt
a by-law that purported to bind a plaintiff, even a stockholder plaintiff, who
sought to bring a tort claim against the company based on a personal injury she
suffered that occurred on the company's premises or a contract claim based on a
commercial contract with the corporation
✓ The by-laws would not deal with the rights and powers of the plaintiff-
stockholder as a stockholder
➢ Codified in DGCL 115
• VantagePoint - DE internal affairs doctrine trumps CA long-arm statute
➢ The internal affairs doctrine is a long-standing choice of law principle which
recognizes that only one state should have the authority to regulate a corporation's
internal affairs - the state of incorporation
➢ Application of local internal affairs law to a foreign corporation is apt to produce
inequalities, intolerable confusion, and uncertainty, and intrude into the domain of
other states that have a superior claim to regulate the same subject matter
➢ Internal affairs doctrine is a major tenet of Delaware corporation law having
important federal constitutional underpinnings (CTS V. Dynamics)
➢ Choice of law doctrine - jurisdiction with "greatest relationship or interest"
Corporate Personhood
• Residency - Hertz
➢ Diversity Jurisdiction: 28 U.S.C. §1332(c)(1)
➢ State of incorporation and state where it has its principal place of business
➢ Holding - "principal place of business" best read as referring to the place where a
corporation's officers direct, control, and coordinate the corporation's activities.
Notes Page 13
➢ In practice it should normally be the place where the corporation maintains its
headquarters
➢ Another possible test - "economic activity" test in CA long-arm, especially with
decentralized corporation
• Rights
➢ Gradual but inconsistent extension of personal constitutional rights to corporations
➢ Contracts Clause
➢ Equal Protection & Due Process
➢ But no 5th right against self-incrimination
➢ First Amendment
➢ Distinctions between regulations on commercial versus political speech
❖ Restrictions on commercial speech receive intermediate scrutiny
❖ In order even to receive intermediate scrutiny, speech must pertain to
lawful material & not be misleading
➢ Political speech, and manner regulated
❖ Strict scrutiny
❖ Direct contribution limitations
✓ Various state and federal laws limit contributions to candidates; anti-
corruption rationale
✓ Still good law
❖ Non-coordinated expenditure limitations
✓ Invalidated in Citizens United
❖ Disclosure/disclaimer requirements
✓ Upheld in Citizens United
Boilermakers v. Chevron (Del. Ch. 2013) - by-laws

• Facts
➢ By-law providing that litigation relating to Chevron's internal affairs should be
conducted in Delaware
• DGCL §109(a)
➢ The power to adopt, amend, or repeal by-laws shall be in the stockholders entitled to
vote
➢ Any corporation may, in its certificate of incorporation, confer the power to adopt,
amend or repeal by-laws upon the directors
• DGCL §109(b)
➢ The by-laws may contain any provision, not inconsistent with law or with the
certificate of incorporation, relating to the business of the corporation, the conduct of
its affairs, and its rights or powers or the rights or powers of its stockholders,
directors, officers or employees
• The by-laws of Delaware corporations have a "procedural, process-oriented nature"
➢ By-laws typically do not contain substantive mandates, but direct how the
corporation, the board, and its stockholders may take certain actions
➢ §109(b) has long been understood to allow the corporation to set "self-imposed rules
and regulations that are deemed expedient for its convenient functioning."
➢ The forum selection by-laws fit this description
❖ They are process-oriented, because they regulate where stockholders may file
suit, not whether
❖ They govern where internal affairs cases governed by state corporate law may
be heard
❖ By contrast, the by-laws would be regulating external matters if the board adopt
a by-law that purported to bind a plaintiff, even a stockholder plaintiff, who
Notes Page 14
suffered that occurred on the company's premises or a contract claim based on a
commercial contract with the corporation
✓ The by-laws would not deal with the rights and powers of the plaintiff-
stockholder as a stockholder
• The plaintiff argued that a board-adopted forum selection by-law cannot be a contractual
forum selection clause because the stockholders do not vote in advance of its adoption to
approve it
➢ Rejected
➢ The by-laws constitute a binding part of the contract between a Delaware corporation
and its stockholders
❖ Stockholders are on notice
❖ Stockholders have asserted to a contractual framework established by the
DGCL and the certificates of incorporation that explicitly recognizes that
stockholders will be bound by by-laws adopted unilaterally by their boards
➢ There are protections for the shareholders
❖ They can still adopt and amend by-laws themselves
✓ Counter - shareholders meet once a year, the board meet much more often
○ But the board will not likely ignore shareholders, at least for PR
reasons
❖ DGCL gives stockholders an annual opportunity to elect directors
❖ There can also be shareholder lawsuits against the corporation in almost any
state for big corporations - based on the minimum contact doctrine of personal
jurisdiction
• Aftermath - legislature codified the decision in section 115, but also amended DGCL §
109(b) to ban so-called fee shifting by-laws - shifting all litigation expenses to a plaintiff in
intra-corporation litigation when the plaintiff doesn't fully win
Hertz Corp. v. Friend (2010) - Corporate Residency

• Facts
➢ Two California citizens sued Hertz in a Cal state court
➢ Hertz sought removal to a federal court
➢ Hertz operated facilities in 44 states, and a lot of activities in Cal (most of any state)
➢ Leadership and its domestic subsidiaries is located at the corporate headquarters in
New Jersey
• Diversity Jurisdiction: 28 U.S.C. §1332(c)(1)
➢ State of incorporation and state where it has its principal place of business
• Diversity jurisdiction's basic rationale - opening the federal courts' doors to those who
might otherwise suffer from local prejudice against out-of-state parties
• Holding - "principal place of business" best read as referring to the place where a
➢ In practice it should normally be the place where the corporation maintains its
headquarters, provided…
➢ First, the statute's language supports the approach
❖ "place" in the singular
❖ "place" is a place within a state, not the state itself
➢ Second, administrative simplicity
❖ Complex jurisdictional tests eat up time and money, produce appeals and
reversals
❖ Promote greater predictability
➢ Third, legislative history offers a simplicity-related interpretive benchmark
❖ Numerical test rejected for its complexity and practicality
• Decentralized Corporations that are managed vis Skype meetings from different states? -
unclear
Notes Page 15
unclear
➢ Maybe back to the economic activity test
➢ Insurance for "gaming the system" - the moving party bears burden of showing
diversity
VantagePoint v. Examen (Del. 2005) - Internal Affairs Doctrine and Long-arm statute
• Facts
➢ Examen incorporated in Delaware
➢ VantagePoint owns 83% of preferred stock of Examen
➢ VantagePoint wants to block a merger
➢ Delaware - voting as a single class, VantagePoint won't be able to block it
➢ Cal - vote by class, VantagePoint can block
• The internal affairs doctrine is a long-standing choice of law principle which recognizes
that only one state should have the authority to regulate a corporation's internal affairs - the
state of incorporation
• Application of local internal affairs law to a foreign corporation is apt to produce
inequalities, intolerable confusion, and uncertainty, and intrude into the domain of other
states that have a superior claim to regulate the same subject matter
• Internal affairs doctrine is a major tenet of Delaware corporation law having important
federal constitutional underpinnings (CTS V. Dynamics)
➢ "no principle of corporation law and practice is more firmly established than a state's
authority to regulate domestic corporations, including the authority to define the
voting rights of shareholders"
➢ Acknowledged that the internal affairs of a corporation are subjects that require one
uniform system of regulation
• Two rationales
➢ Choice of law doctrine - jurisdiction with "greatest relationship or interest"
❖ Counter - the factors may go all over the place, depending on the individual
cases
➢ Constitutionality under Federal Constitution - Commerce Clause and Due Process
• Potential counters from start-ups even under Cal
➢ Go public
➢ Bylaws
➢ "drag along" provision - stockholders required to vote their shares in favor of a
deemed liquidation event…
➢ "pay to play" provision - if you don't invest in recent rounds, you will lose your rights
Citizen United v. FEC (2010) - Corporate Personhood and 1st Amendment Right of Political
Speech
• Gradual but inconsistent extension of personal constitutional rights to corporations
➢ Contracts Clause
➢ Equal Protection & Due Process
➢ But no 5th right against self-incrimination
• First Amendment
➢ Extent to which 1st Amendment rights depend on corporate personhood
➢ Distinctions between regulations on commercial versus political speech
❖ Restrictions on commercial speech receive intermediate scrutiny
❖ In order even to receive intermediate scrutiny, speech must pertain to lawful
material & not be misleading
➢ Political speech, and manner regulated
❖ Strict scrutiny
❖ Direct contribution limitations
✓ Various state and federal laws limit contributions to candidates; anti-
Notes Page 16
✓ Still good law
❖ Non-coordinated expenditure limitations
✓ Invalidated in Citizens United
❖ Disclosure/disclaimer requirements
✓ Upheld
• Facts
➢ Citizens United is a nonprofit
➢ Released a film critical of Clinton
➢ The law: §441(b) - prohibits corporations and unions from using their general
treasury funds to make independent expenditures for speech defined as an
"electioneering communication" or for speech expressly advocating the election or
defeat of a candidate
• KENNEDY majority
➢ The law is an outright ban, backed by criminal sanctions
❖ The option to form PACs does not alleviate the First Amendment problems.
PACs are burdensome alternatives; they are expensive to administer and subject
to extensive regulations
❖ STEVENS dissent - the authority of legislatures to enact viewpoint-neutral
regulations based on content and identity is well settled
✓ e.g., campaign spending by foreign nationals, limitations on civil servants
➢ Standard of review - laws that burden political speech are subject to strict scrutiny
❖ Requires furthering of a compelling interest and narrow tailoring
➢ Political speech does not lose First Amendment protection simply because its source
is a corporation
❖ STEVENS dissent - corporations are not actually members of the society
✓ Corporate spending is furthest from the core of political expression since
it's derivative
✓ Lesser risk of invidious discrimination or political favoritism
✓ Founders didn't have corporations in mind for bills of rights - they were
quasi-public entities receiving close scrutiny at the time
➢ Rationales rejected
❖ Anti-distortion
✓ Wealthy corporations could still lobby elected officials although smaller
corporations may not have the resources
✓ And wealthy individuals and unincorporated associations can spend
unlimited amounts on independent expenditures
✓ STEVENS dissent
○ corps can amass and deploy financial resources on a scale few
natural persons can match
○ The interests of nonresident corporations may be fundamentally
adverse to the interests of local voters
○ The opinions of real people may be marginalized
○ Generate the impression that corporations dominate our democracy
❖ Corruption
✓ Buckley - the absence of prearrangement and coordination of an
expenditure with the candidate or his agent alleviates the danger
✓ The electorate won't lose faith
○ It shows that the people have the ultimate influence over elected
officials, the fact that a corporation is willing to spend money to
persuade voters
❖ Protecting dissenting shareholders
✓ Shareholders have procedures of corporate democracy
✓ STEVENS dissent - the rights are so limited, given the internal authority
Notes Page 17
✓ STEVENS dissent - the rights are so limited, given the internal authority
wielded by boards and managers and the expansive protections afforded
by the business judgment rule
○ Most American households own stock through mutual funds and
pension plans
○ Majority of individual investors make no trades during a given year
○ The injury to the shareholders will have already occurred
✓ What you can do as a minority shareholder?
○ Buy more shares
○ Requiring the company to disclose the political related expenditures
at the shareholder meeting
○ Counter - based on data, the political related proposals at SH
meetings are dropping recently, also they rarely get passed
 Probably SHs don't care or they don't want disadvantage for
only their firm
➢ Disclaimers and disclosure - upheld
❖ Prompt disclosure of expenditures can provide shareholders and citizens with
the information needed to hold corporations and elected officials accountable
for their positions and supporters
Notes Page 18
Piercing the Corporate Veil
Sunday, September 22, 2019 4:29 PM
Corporate Veil
• Walkovszky - Both vertical and horizontal piercing possible
• Test Part I - unity of interest and ownership (Sea-Land)
➢ Four factors
❖ The failure to maintain adequate corporate records or to comply with corporate
formalities
❖ The commingling of funds of assets
❖ Undercapitalization
❖ One corporation treating the assets of another corporation as its own
➢ Courts have also considered
❖ The holding out by one entity that it is liable for debts of the other
❖ Maintaining identical equitable ownership
❖ Use of the same offices and employees
➢ Note the policy discussion in the end, and think
❖ Is the industry one in which entrepreneurship is important
❖ Is co-ownership and ownership transferability important
❖ Is diversification of ownership valuable - more valuable for firms that tend to do
only one thing
❖ Are the plaintiffs more effective risk bearer or avoiders
❖ Is there huge underdeterrence or undercompensation risk
❖ Can lenders monitor the corporation
❖ Is the harming act of the corporation one that can be effectively "priced out" by
the plaintiffs (negotiation, guarantees)
❖ Has the corporation been sloppy about maintaining economic boundaries
✓ If not, then it has maintained the clarity and financial transparency
❖ Is the underlying legal claim one that is likely to give rise to large jury awards
• Test Part II - Adherence to the fiction of separate corporate existence would sanction a
fraud or promote injustice (Sea-Land)
➢ "promote injustice" prong
❖ Unsatisfied judgment not enough - every plaintiff will pass on that score
because why else would a plaintiff bring a veil-piercing action
❖ Case law - some "wrong" beyond a creditor's inability to collect would result
✓ The common sense rules of adverse possession would be undermined
✓ Former partners would be permitted to skirt the legal rules concerning
monetary obligations
✓ A party would be unjustly enriched
✓ A parent corporation that caused a sub's liabilities and its inability to pay
for them would escape these liabilities
✓ Or an intentional scheme to squirrel assets into a liability-free corporations
while heaping liabilities upon an asset-free corporation would be
successful.
➢ The key appears to be proof of some form of bad faith motivation underlying the
actions of the defendant
○ Inequitable results are more likely to be found in situations where the corporate
form is used to avoid the effect of a statute or regulation
○ Increasing receptiveness in tort cases rather than breach of contract, because of
the difficulty that tort victims have in "pricing out" risk
• Note - Most states allow reverse piercing, which get from SH/owner to that owner's other
assets
➢ subject to similar 2-part as ordinary piercing, plus assessment of harm to “innocent”
Notes Page 19
➢ subject to similar 2-part as ordinary piercing, plus assessment of harm to “innocent”
3rd party SHs in the pierced entity
• Union Properties - Minimal capitalization by itself does not justify a finding that the
limited partners incur general liability for their control of the corporate general partner
➢ "piercing the corporate veil" doctrine of corporation law
➢ Petitioner had notice - If petitioner had not wished to rely on the solvency of Union
Properties as the only general partner, it could have insisted that respondents
personally guarantee contractual performance
Walkovszky v. Carlton (N.Y. 1966)

• Facts
➢ The plaintiff was severely injured in NYC, run down by a taxicab
➢ The company was owned by the defendant, who also owned 10 other taxi companies,
each one having two cabs registered in its name, and buying only the minimum
insurance
❖ The sole assets of these corporations are the vehicles and they are apparently
subject to mortgages
➢ Plaintiff argued that the corporations were operated as a single entity and the structure
constitutes an unlawful attempt to defraud members of the general public
➢ Trial court granted the motion to dismiss (failure to state a cause of action), appellate
court reversed
• The law permits the incorporation of a business for the very purpose of enabling its
proprietors to escape personal liability
➢ Not without limits - pierce the corporate veil whenever necessary to prevent fraud or
to achieve equity
❖ Guided by the general rules of agency (respondeat superior)
✓ Whenever anyone uses control of the corporation to further his own rather
than the corporation's business, he will be liable for the corporation's acts
upon the principle of respondeat superior applicable even where the agent
is a natural person
➢ To treat the corporation as an agent and pierce the corporate veil
❖ First way (enterprise liability) - a corporation is a fragment of a larger
corporate combine which actually conducts the business
✓ Only the larger corporate entity would be held liable
❖ Second way (piercing) - individual stockholders carry on the business in their
personal capacities for purely personal rather than corporate ends
✓ The stockholder would be personally liable
✓ This is more like agency theory, which is too powerful as it's hard to
imagine corporation with sole ownership will not have identical interests
as the owner
➢ In this case
❖ No allegations that the defendant was conducting business in his individual
capacity
✓ Barren of any sufficiently particularized statements that the defendant is
actually doing business in his individual capacity, transferring the personal
funds in and out of the corporations without regard to formality and to suit
their immediate convenience
❖ The insurance fact not enough
✓ The remedy lies with the legislature
• KEATING dissent
➢ Undercapitalization - for the purpose of avoiding responsibility or acts which were
bound to arise
❖ All income was continually drained out of the corporations
➢ The policy of this state has always been to provide and facilitate recovery for those
Notes Page 20
➢ The policy of this state has always been to provide and facilitate recovery for those
injured through the negligence of others
❖ The great increase in the number of automobile accidents
❖ In the Vehicle and Traffic Law - the legislature determines that it is a matter of
grave concern that motorists shall be financially able to respond in damages for
their negligent acts
❖ Given the costs of hospital care and treatment and the nature of the injuries, it
would be unreasonable to assume that the legislature believed that the minimum
is sufficient for those with substantial assets
➢ Limited scope - a participating shareholder of a corporation vested with a public
interest, organized with capital insufficient to meet liabilities which are certain to
arise in the ordinary course of the corporation's business, may be held personally
responsible for such liabilities
Sea-Land v. Pepper Source (7th Cir. 1991)

• Facts
➢ Sea-Land, an ocean carrier shipped the peppers of the Pepper Source
❖ Didn't get paid
➢ PS had been dissolved for failure to pay franchise tax
➢ Sea-Land then sued Marchese and six business entities he owns
❖ Alleging both enterprise liability and piercing the corporate veil
❖ Five with sole ownership, Tie-Net 50% ownership
✓ Except for Tie-Net, none of the corporations ever held a single corporate
meeting.
✓ Marchese did not remember any of these corporations ever passing articles
of incorporation, bylaws, or other agreements.
✓ Marchese runs all of these corporations out of the same office, with the
same phone line and the same expense account.
✓ Marchese "borrows" substantial sums of money from these corporations;
the corporations also "borrow" from each other, which left PS completely
out of capital.
✓ Marchese used the bank accounts of these corporations to pay all kinds of
personal expenses; Marchese did not even have a personal bank account.
➢ Trail court granted Sea-Land's motion for summary judgment
• Illinois Law
➢ two requirements
❖ Such Unity of interest and ownership
✓ That the separate personalities of the corporation and the individual or
other corporation no longer exist
✓ Four factors
○ The failure to maintain adequate corporate records or to comply with
corporate formalities
○ The commingling of funds of assets
○ Undercapitalization
○ One corporation treating the assets of another corporation as its own
✓ Courts have also considered
○ The holding out by one entity that it is liable for debts of the other
○ Maintaining identical equitable ownership
○ Use of the same offices and employees
✓ Satisfied in this case
❖ Adherence to the fiction of separate corporate existence would sanction a fraud
or promote injustice
✓ Sea-Land argued "promote injustice"
○ Some element of unfairness, something akin to fraud or deception or
Notes Page 21
○ Some element of unfairness, something akin to fraud or deception or
the existence of a compelling public interest must be present in order
to disregard the corporate fiction.
○ Unsatisfied judgment not enough - every plaintiff will pass on that
score because why else would a plaintiff bring a veil-piercing action
○ Case law - some "wrong" beyond a creditor's inability to collect
would result
 The common sense rules of adverse possession would be
undermined
 Former partners would be permitted to skirt the legal rules
concerning monetary obligations
 A party would be unjustly enriched
 A parent corporation that caused a sub's liabilities and its
inability to pay for them would escape these liabilities
 Or an intentional scheme to squirrel assets into a liability-free
corporations while heaping liabilities upon an asset-free
corporation would be successful.
○ Not satisfied in this case
✓ Trial court found fraud on remand
○ Marchese had engaged in blatant tax fraud by treating his personal
expenses as deductible corporate business expenses, and had used
corporate funds for his own benefit while avoiding corporate debts
○ Marchese had assured a Sea-Land representative in a telephone
conversation that the bill would be paid, even though he knew at the
time that he would manipulate the corporate funds to insure there
would not be funds to pay the bills
✓ The key appears to be proof of some form of bad faith motivation
underlying the actions of the defendant
○ Inequitable results are more likely to be found in situations where the
corporate form is used to avoid the effect of a statute or regulation
○ Increasing receptiveness in tort cases rather than breach of contract,
because of the difficulty that tort victims have in "pricing out" risk
• Most states allow reverse piercing, subject to similar 2-part as ordinary piercing, plus
assessment of harm to “innocent” 3rd party SHs
• Relating to internal affairs doctrine
➢ Is it internal affair?
❖ Restatement says yes
➢ Many jurisdictions have a slightly more liberal
❖ NY - use law of state having greatest interest in the litigation
❖ DE - has used Delaware piercing doctrine if either the corporation or its
SH/corporate parent is from Delaware
❖ Cal - long arm statute 2115
Frigidaire Sales Corporation v. Union Properties (Wash. 1977) - Limited Partnership

• Limited partnership
➢ Tax advantage - "pass-through" losses: investors are able to claim their pro rata share
of the economically artificial losses
➢ Corporate advantage of limited liability
➢ Later people developed a variation: a limited partnership with a corporation as the
sole general partner
❖ With the use of this form, no individual was liable for the debts of the
partnership
• Facts
➢ Plaintiff entered into a contract with Commercial, a limited partnership with Union as
Notes Page 22
➢ Plaintiff entered into a contract with Commercial, a limited partnership with Union as
the general partner
• Minimal capitalization by itself does not justify a finding that the limited partners incur
general liability for their control of the corporate general partner
➢ "piercing the corporate veil" doctrine of corporation law
➢ Petitioner had notice - If petitioner had not wished to rely on the solvency of Union
Properties as the only general partner, it could have insisted that respondents
personally guarantee contractual performance
Policies of Limited Liability

• Cons
➢ Under-deterrence and under-compensation, leading the corporation to breach too
many contracts, commit too many torts, or engage in too many nuisances
• Pros
➢ Encouraging Entrepreneurship
❖ Risk-averse people are not willing to take "actuarially fair" bets
✓ Entrepreneurs face so many potential debts, obligations or lawsuits
❖ Limited liability limits the downside risk and facilitates a future transition into a
larger one enterprise
✓ Because otherwise the liability risk will blow up for bigger operation
❖ Also, some individuals are judgment proof either way, eliminating limited
liability will just reallocate the activities in the hands of those people
➢ Reallocating risks to better risk avoiders
❖ e.g. trade creditors, banks or other financial intermediaries
➢ Reallocating risks to better risk bearers
❖ Creditors are less adverse to risk than start-ups
❖ Also, avoiding over-deterrence - risk-averse individuals take too much care in
conducting their affairs
➢ Facilitating co-ownership and transferability
❖ shareholders don't have to monitor each other's financial position and don't have
to monitor management that eagerly
✓ Counter - might not be a good idea
○ But third parties like creditors will monitor the situation, and note
they are often better risk avoiders and bearers
➢ Facilitating diversification
❖ People can take many small gambles instead of a few large gambles
➢ Facilitating credit: asset partitioning
❖ Creditors can sue the company directly rather than having to sue all of the
company's owners jointly
❖ Partitioning of the company's assets away from the shareholder's assets
contributes to the financial transparency of the entity, thereby facilitating the
operation of capital markets
➢ Correcting legal error
❖ Juries award significantly higher damages when defendants are businesses
• So think
➢ Is the industry one in which entrepreneurship is important
➢ Is co-ownership and ownership transferability important
➢ Is diversification of ownership valuable - more valuable for firms that tend to do only
one thing
➢ Are the plaintiffs more effective risk bearer or avoiders
➢ Is there huge underdeterrence or undercompensation risk
➢ Can lenders monitor the corporation
➢ Is the harming act of the corporation one that can be effectively "priced out" by the
plaintiffs (negotiation, guarantees)
Notes Page 23
plaintiffs (negotiation, guarantees)
➢ Has the corporation been sloppy about maintaining economic boundaries
❖ If not, then it has maintained the clarity and financial transparency
➢ Is the underlying legal claim one that is likely to give rise to large jury awards
Notes Page 24
Corporate Debt
Monday, September 23, 2019 9:54 PM
Corporate Debt
• No fiduciary duties to bond holders
➢ Only two legal questions - interpretation of express terms of indenture; implied duty
of good faith and fair dealing
➢ The standard contractual tool - intent of parties for both questions
❖ Much harder in cases of bond indentures
❖ Because "true intent" of the parties is probably impossible to divine, courts
focus more on uniformity and predictability than accuracy, especially
boilerplate clauses
➢ Exception - Gheewalla re: insolvency
❖ Two alternative definitions of insolvency
✓ Balance sheet insolvency - a deficiency of assets below liability with no
reasonable prospect that the business can be successfully continued in the
face thereof
✓ Cash flow insolvency - an inability to meet maturing obligations in the
ordinary course of business
❖ The general rule - directors do not owe creditors duties beyond the relevant
contractual terms
❖ No direct claim for breach of fiduciary duties may be asserted by the creditors
of a solvent corporation that is operating in the zone of insolvency
✓ Creditors are protected by covenants, liens, good faith and fair dealing…
✓ The corporation in the zone of insolvency is one in most need of effective
and proactive leadership - as well as the ability to negotiate in good faith
with its creditors, which will be undermined
✓ Policy - clear signal beacons and brightly lined channel markers
✓ The court doesn't want "zone of insolvency" to become a litigation
machine, want clear rule
❖ However, the creditors of an insolvent corporation have standing to maintain
derivative claims against directors on behalf of the corporation for breaches of
fiduciary duties
❖ But the fact that the corporation has become insolvent does not turn derivative
claims into direct creditor claims
• Interpreting terms
➢ Sharon Steel - piecemeal selling the assets; assumption of debt only available when
"all or substantially all" are sold
❖ Successor obligor clauses are boilerplate provisions that must be given a
consistent, uniform interpretation
✓ For better and quicker understanding of these provisions
✓ Uniformity in interpretation is important to the efficiency of capital
markets
✓ Contract language is the starting point in the search for meaning
❖ The words "all or substantially all" are given meaning in light of the particular
context and evident purpose
✓ They leave the borrower free to merge, liquidate or to sell its assets
✓ They seem designed to protect lenders as well by assuring a degree of
continuity of assets
✓ (balancing test) Where contractual language seems designed to protect
the interests of both parties and where conflicting interpretations are
argued, an interpretation which sacrifices a major interest of one party
Notes Page 25
argued, an interpretation which sacrifices a major interest of one party
while furthering only a marginal interest of the other should be rejected
○ Sharon's position would severely impair the interests of lenders - a
borrowing corporation can engage in a piecemeal sale of assets
❖ The holding - boilerplate successor obligor clauses do not permit assignment of
the public debt to another party in the course of a liquidation unless "all or
substantially all" of the assets of the company at the time the plan of
liquidation is determined upon are transferred to a single purchaser
➢ Textualist - Nabisco
❖ Indentures are often not the product of face-to-face negotiations between the
ultimate holders and the issuing company
❖ The parol evidence rule bars plaintiffs from arguing that the speeches made by
company executives prove defendants agreed or acquiesced to a term that does
not appear in the indenture
✓ Under certain circumstances, courts will consider extrinsic evidence to
evaluate the scope of an implied covenant of good faith
○ However, not for the customary or boilerplate provisions of detailed
indentures used and relied upon throughout the securities market,
such as those at issue
• Good faith and fair dealing
➢ Nabisco
❖ About the implied covenant of good faith and fair dealing
✓ In contracts like bond indentures, an implied covenant derives its
substance directly from the language of the indenture, and cannot give the
holders of debentures any rights inconsistent with those set out in the
indenture
✓ The lender can usually expect only interest at the prescribed rate plus the
return of the principal
○ The plaintiffs in this case want this Court to create an additional
benefit for which they did not bargain
○ The sort of unbounded and one-sided elasticity urged by plaintiffs
would interfere with and destabilize the market
 The expectations of the market cannot be ignored
 The risk of LBO is already accounted for in the market
evaluations
➢ Katz
❖ Test - The test for obligation to act in good faith and to deal fairly - is it clear
from what was expressly agreed upon that the parties who negotiated the
express terms of the contract would have agreed to proscribe the act later
complained of as a breach of the implied covenant of good faith.
✓ In this case, nothing in the indenture provisions granting bondholders
power to veto proposed modifications
❖ Katz factors
✓ Value of exchange relative to prevailing market value of debt on the
secondary market
○ Less likely to be coercive if what's being offered is more valuable
than what's being given up
○ Counter - the company can manipulate the expectation of the market
to push the market price down
✓ Debt is widely-held rather than closely-held
○ Application of the Coase theorem - transaction costs/collective
action problems reduced with fewer owners of debts
✓ Exchange for greater rather than lesser priority claims
○ Collective action problems reduced if proposal is to move to the
backward in line rather than forward
Notes Page 26
○
backward in line rather than forward
✓ Marrying the exchange offer with consent vote
○ Decoupling allows debt holders to express their opinion without
incurring a possible cost
• Note - a lot of hardcore textualist cases, see cases for specific scenarios
Bond
• Debentures are long-term unsecured debts
• Bonds are long-term secured debts
• The rights of bondholders are largely governed by private contract.
➢ Most of the contractual terms are contained in a document called an indenture, which
includes various covenants
➢ Generally a corporate trustee is appointed to enforce the terms of the indenture
❖ Potential conflict of interest
• Choice of law overwhelmingly NY law
• No fiduciary duties to bond holders
➢ Only two legal questions - interpretation of express terms of indenture; implied duty
of good faith and fair dealing
➢ The standard contractual tool - intent of parties for both questions
❖ Much harder in cases of bond indentures
✓ Trustee, underwrite, credit rating agency…
• Because "true intent" of the parties is probably impossible to divine, courts focus more on
uniformity and predictability than accuracy, especially boilerplate clauses
• Trust Indenture Act of 1939 - prohibiting the alteration of "core" terms, including interest
payment, principal amount, and duration, without unanimous consent of the holders.
➢ However, TRA does not regulate the modification of financial covenants
➢ The procedure for altering or eliminating such covenants is specified in the indenture
❖ Many indentures allow alteration or elimination of non-core covenants with the
approval of a majority or, often, some higher percentage
Sharon Steel v. Chase Manhattan Bank (2d Cir. 1982) - Debtor's Sale of Substantially All its
Assets
• Facts
➢ UV had issued certain debentures.
❖ They are trading below face amount
❖ had successor obligor clauses - the company that got "all or substantially all" of
the property can assume the debts
➢ UV adopted a plan to liquidate all three lines of business
❖ Sold the metal mining and manufacturing business and cash to Sharon Steel, at
that point UV only had that line of business left
• Successor obligor clauses are boilerplate provisions that must be given a consistent,
uniform interpretation
➢ For better and quicker understanding of these provisions
➢ Uniformity in interpretation is important to the efficiency of capital markets
➢ Contract language is the starting point in the search for meaning
❖ The debt security holder can do nothing to protect himself against actions of the
borrower which jeopardize its ability to pay the debt unless he…establishes his
rights through contractual provisions set forth in the indenture
• The words "all or substantially all" are given meaning in light of the particular context and
evident purpose
➢ They leave the borrower free to merge, liquidate or to sell its assets
➢ They seem designed to protect lenders as well by assuring a degree of continuity of
Notes Page 27
➢ They seem designed to protect lenders as well by assuring a degree of continuity of
assets
➢ (balancing test) Where contractual language seems designed to protect the interests
of both parties and where conflicting interpretations are argued, an interpretation
which sacrifices a major interest of one party while furthering only a marginal interest
of the other should be rejected
❖ Sharon's position would severely impair the interests of lenders - a borrowing
corporation can engage in a piecemeal sale of assets
❖ The balancing test is more creditor-friendly than other tests
• The holding - boilerplate successor obligor clauses do not permit assignment of the public
debt to another party in the course of a liquidation unless "all or substantially all" of the
assets of the company at the time the plan of liquidation is determined upon are transferred
to a single purchaser
➢ In this case, at the time of the liquidation plan, only 51% of the book value is
involved in the Sharon transaction
➢ Therefore the clauses not applicable and the debentures are due and payable
• The cutoff seems to be 2/3
• Solution - the seller can sell the entire company to Sharon first, then Sharon liquidate parts
of the company
MetLife v. Nabisco (S.D.N.Y. 1989) - Incurrence of Additional Debt

• Facts
➢ KKR LBO of Nabisco
❖ LBO may transfer wealth from creditors to existing SHs
➢ Plaintiffs allege that Nabisco's actions have drastically impaired the value of bonds
previously issued to plaintiffs by misappropriating the value of those bonds to help
finance the LBO and to distribute an enormous windfall to the company's
shareholders
❖ Note - LBO will usually lower the bond rating
❖ Alleging a breach of implied covenant of good faith and fair dealing and "in
equity"
✓ Asserting that the company consistently reassured its bondholders that it
had a mandate from its Board to maintain the credit rating
• Indentures are often not the product of face-to-face negotiations between the ultimate
holders and the issuing company
➢ Underwriters ordinarily negotiate the terms - they negotiate in part with the interests
of the buyers in mind as they must then sell the bonds
➢ Sophisticated investors like plaintiffs are well aware of the indenture terms
➢ In this case
❖ One clause provided that Nabisco may consolidate, merge…so long as it
assumes the debt
❖ The express covenants that restrict the ability to incur precisely the sort of debt
involved in LBO were eliminated in renegotiations
❖ Also, MetLife's own documents were well aware of the LBO trend, how to
avoid that (covenants) and the resistance they would face to put those clauses in
❖ Investors as sophisticated as MetLife would be hard-pressed to plead ignorance
of these market risks
• The parol evidence rule bars plaintiffs from arguing that the speeches made by company
executives prove defendants agreed or acquiesced to a term that does not appear in the
indenture
➢ Under certain circumstances, courts will consider extrinsic evidence to evaluate the
scope of an implied covenant of good faith
❖ However, not for the customary or boilerplate provisions of detailed indentures
Notes Page 28
❖ However, not for the customary or boilerplate provisions of detailed indentures
used and relied upon throughout the securities market, such as those at issue
• About the implied covenant of good faith and fair dealing
➢ In contracts like bond indentures, an implied covenant derives its substance directly
from the language of the indenture, and cannot give the holders of debentures any
rights inconsistent with those set out in the indenture
➢ The lender can usually expect only interest at the prescribed rate plus the return of the
principal
❖ The plaintiffs in this case want this Court to create an additional benefit for
which they did not bargain
❖ The sort of unbounded and one-sided elasticity urged by plaintiffs would
interfere with and destabilize the market
✓ The expectations of the market cannot be ignored
✓ The risk of LBO is already accounted for in the market evaluations
• Aftermath - the fraud claims left standing were settled
➢ Alleging Rule 10b-5 violation (federal securities fraud)
• No balancing test, very textual
➢ Good faith and fair dealing very important for arm's length contracts but not for
standardized debt obligations
➢ Effectively letting capital markets to "price out" any creditor vulnerabilities
➢ Problem - creating lengthy contracts; also deterring innovative clauses, people don't
know what the interpretation will be
➢ Unclear how much the "sophisticated investor" part matters
❖ Geren v. Quantum (S.D.N.Y. 1993) - sophistication doesn't matter
• More appealing argument - the market price relied on the representation of CEO/CFO
Bank of New York Mellon v. Realogy (Del. Ch. 2008)

• Facts
➢ LBO of Realogy by Apollo issued a number of debts
❖ Lever I, more senior, secured by a first lien on all assets
✓ Allowing Realogy to issue additional debt obligations ("Other Term
Loans") to new lenders
❖ Level II, unsecured
❖ Level III
➢ Realogy got into financial trouble during the 08 crisis
❖ Noteholders are invited to participate as lenders under a new leading facility
✓ Secured by a second lien on all assets
✓ Participating noteholders would fund their obligations under the new term
loans with the delivery of existing notes
• Level II trustees sued, alleging violation of the Level I credit agreement
➢ Arguing the new leading facility cannot be loans under the credit agreement because
they are not funded in cash
• The fundamental feature of a loan is the advancement of some valuable property in
exchange for a promise to repay that advancement
• The transaction could be restructured by having the noteholders commit to paying cash for
the new term loans while at the same time having Realogy agree to buy the existing notes,
from the noteholders, for cash, at the proposed reduced price
• The Court granted judgment for the trustees through another provision
➢ "no Permitted Refinancing Indebtedness shall have different obligors, or greater
guarantees or security, than the Indebtedness being Refinanced."
• Note - negative pledge covenant
➢ Prohibiting a debtor from mortgaging specified assets to any lender without providing
"equal and ratable" mortgage protection to the obligations covered by the covenant
Notes Page 29
Katz v. Oak (Del. Ch. 1986) - exit exchange offer
• Exit exchange offer - a debt-restructuring maneuver designed to overcome "holdout"
problems among bondholders, who individually don't want to forgive ay of their claims on
the company
➢ Exchange - a proposal inviting individual bondholders to "tender" their securities
back to the firm
➢ Exit consent - the exchange offer is often tied to a consent solicitations, asking BHs to
consent to weakening/nullifying certain negative covenants
➢ Policies
❖ Avoiding bankruptcy
❖ Reducing agency costs - not forcing the managers to take on risky projects as
the equity cushion gets thin
❖ Problem - coercion of BHs
• Facts
➢ Oak in financial trouble, entering into acquisition and stock purchase agreement with
Allied-Signal
❖ Requiring 85% of the BHs to tender and accept the exchange offers
❖ Which is in turn conditioned on consent to amendments to the relevant
indentures - having the effect of removing significant negotiated protections to
BHs including the deletion of all financial covenants
• The terms agreed to define the corporation's obligation to its bondholders
• The test for obligation to act in good faith and to deal fairly - is it clear from what was
expressly agreed upon that the parties who negotiated the express terms of the contract
would have agreed to proscribe the act later complained of as a breach of the implied
covenant of good faith.
➢ In this case, nothing in the indenture provisions granting bondholders power to veto
proposed modifications
• Katz factors
➢ Value of exchange relative to prevailing market value of debt on the secondary
market
❖ Less likely to be coercive if what's being offered is more valuable than what's
being given up
❖ Counter - the company can manipulate the expectation of the market to push the
market price down
➢ Debt is widely-held rather than closely-held
❖ Application of the Coase theorem - transaction costs/collective action problems
reduced with fewer owners of debts
➢ Exchange for greater rather than lesser priority claims
❖ Collective action problems reduced if proposal is to move to the backward in
line rather than forward
➢ Marrying the exchange offer with consent vote
❖ Decoupling allows debt holders to express their opinion without incurring a
possible cost
Morgan Stanley v. ADM (S.D.N.Y. 1983) - redemption

• Facts
➢ In May, 1981, ADM issued debentures
❖ Subject to redemption
❖ Cannot redeem before 1991, if using proceeds from new debts with less than
16.08% interest rate
➢ ADM issued new debentures in 1982 and 1983
➢ ADM conducted two common stock offerings then redeemed the debt in 1983
❖ The direct source of funds was the two stock offerings
Notes Page 30
❖ The direct source of funds was the two stock offerings
• Franklin case from Illinois ruled that the redemption was lawful because the refunding was
accomplished solely from the proceeds of the common stock issue
➢ Adopting a rule that looked to the source of the proceeds for redemption
• Usual contract construction principles unhelpful
➢ First, no "plain meaning" suggested by the redemption language
➢ Cannot discern the intent of the parties
➢ Both parties are drafters
• Adopting Franklin
➢ Franklin preceded the drafting of the ADM indentures by several years - both parties
on notice
➢ Stressing the need of uniform interpretation for boilerplate clauses
• A different case would be before us if ADM, contemporaneously with the redemption,
issued new, lower-cost debt and used the proceeds of such debt to repurchase the stock
issued in the first instance to finance the original redemption. On those facts, the
redemption could arguably be said to have been indirectly funded through the proceeds of
anticipated lower-cost debt
• Show that you can't be too textualist
Wilmington Savings v. Cash America (S.D.N.Y. 2016)

• Facts
➢ Cash America issued indentures
❖ Providing that Cash America will not permit any of its subsidiaries to sell,
liquidate, merge…unless the book value of the properties disposed of does not
exceed 10%
❖ Wilmington can accelerate in the event of default
❖ Cash America can redeem with premium
➢ Cash America approved spin-off of Enova
• Plain language in the debenture provided that the book value shall be the book value of all
assets, no reference to net assets
• Remedy - where acceleration provisions of the indentures are explicitly permissive and not
exclusive of other remedies and the debtor does not find itself unable to make required
payments, there is no bar to the lender seeking specific performance of the redemption
provisions where the debtor causes the debentures to become due and payable by its
voluntary actions
➢ In such circumstances, the redemption premium must be paid
➢ The court's analysis turned on the distinction between defaults arising from
"voluntary" actions (e.g., liquidations or spinoffs) versus involuntary actions (e.g.,
bankruptcies)
Corporate Debt: Recap

• Conventional contract law doctrines
➢ GFFD; rule of interpretation/construction
➢ Parties intent is clearly a legal fiction, instead focus on predictability & reliability
❖ Winter's balancing test
❖ Most others use hard textualist approach
❖ Ultimate effect on size of indenture
NACEPF v. Gheewalla (Del. 2007) - Creditors and Insolvency

• Facts
➢ NACEPF entered into use and royalty agreement with Clearwire regarding radiowave
spectrum licenses
❖ Market collapsed
❖ Clearwire unable to obtain any further financing and effectively went out of
Notes Page 31
❖ Clearwire unable to obtain any further financing and effectively went out of
business
❖ In this case, NACEPF was creditor
➢ Defendants served as directors of Clearwire at the behest of Goldman Sachs
❖ NACEPF alleging that Clearwire was either insolvent or in the "zone of
insolvency," the Defendants owed fiduciary duties to NACEPF "as a substantial
creditor of Clearwire" for not preserving assets and holding on to NACEPF's
license rights to keep GS's investment in play
❖ A direct claim
• Two alternative definitions of insolvency
➢ Balance sheet insolvency - a deficiency of assets below liability with no reasonable
prospect that the business can be successfully continued in the face thereof
➢ Cash flow insolvency - an inability to meet maturing obligations in the ordinary
course of business
➢ In this case, the lower court found that a reasonable inference satisfied for both zone
of insolvency and insolvency for certain periods
• The general rule - directors do not owe creditors duties beyond the relevant contractual
terms
• No direct claim for breach of fiduciary duties may be asserted by the creditors of a solvent
corporation that is operating in the zone of insolvency
➢ Creditors are protected by covenants, liens, good faith and fair dealing…
➢ The corporation in the zone of insolvency is one in most need of effective and
proactive leadership - as well as the ability to negotiate in good faith with its
creditors, which will be undermined
➢ Policy - clear signal beacons and brightly lined channel markers
➢ The court doesn't want "zone of insolvency" to become a litigation machine, want
clear rule
• However, the creditors of an insolvent corporation have standing to maintain derivative
claims against directors on behalf of the corporation for breaches of fiduciary duties
• But the fact that the corporation has become insolvent does not turn derivative claims into
direct creditor claims
➢ At all times, claims of this kind belong to the corporation itself
➢ Injuring creditors only indirectly by diminishing the value of the firm and therefore
the assets from which the creditors may satisfy their claims
➢ Unless a marked degree of animus towards a particular creditor
➢ Policy - directors of insolvent corporations must retain the freedom to engage in
vigorous, good faith negotiations with individual creditors for the benefit of the
corporation
Notes Page 32
Shareholder Derivative Actions
Saturday, October 5, 2019 12:50 PM
1. In re Medtronic - Direct or derivative actions?

• Derivative claim - an individual shareholder may not asset a cause of action that belongs to
the corporation, but instead must sue in a representative capacity on behalf of the
corporation if asserting a claim alleging an injury to the corporate entity
• Direct claim - alleging an injury to the shareholder individually
• Different standard for different claims
➢ Derivative claim under Minn law - must allege with particularity the efforts made to
obtain the desired action from the directors and the failure of the corporation to take
such action
• Test - when shareholders are injured only indirectly, the action is derivative; when
shareholders show an injury that is not shared with the corporation, the action is
direct
• Certain courts also consider whether harm alleged by the SH is "special", i.e., not shared
pro rata with other SHs
➢ "special harm" held not necessary by Delaware court, but still legitimate factor
2. If derivative, then is demand excused?

• The following is the DE approach
• If board decision or action, Aronson test
➢ Permit suit by a stockholder who is able to articulate particularized facts showing that
there is a reasonable doubt either that
❖ A majority of the board is disinterested and independent for purposes of
responding to the demand, or
✓ What's interested or independent (Grime)
○ Naming all of the current board won't work
○ Claiming board members won't turn on one of their own won't work
○ Interested
 Substantive case against them is strong
 They have material financial interest in outcome
○ Non-independent
 They are closely connected to interested parties
 Dominated/controlled by other interested defendants
 Securities regulation guidance can sometimes be signpost of
disinterestedness and independence
 In re Oracle
• A plaintiff may establish that a director lacks
independence by alleging with particularity that the
director "is sufficiently loyal to, beholden to, or otherwise
influenced by an interested party to undermine the
director's ability to judge the matter on its merits"
➢ Allegations of mere personal friendship or a mere
outside business relationship, standing alone, are
insufficient to raise a reasonable doubt about a
director's independence
➢ Nevertheless, some professional or personal
friendships, which may border on or even exceed
familial loyalty and closeness, may raise a
reasonable doubt whether a director can
appropriately consider demand
❖ Must consider all facts in their totality
Notes Page 33
❖ Must consider all facts in their totality
 Sanchez - There arises a pleading stage inference that Jackson's
economic positions derive in large measure from his 50-year
close friendship with Sanchez, and that he is in these positions
because Sanchez trusts, cares for, and respects him
 Zimmerman - a careful analysis of why the directors, on an
individual basis, might need to curry favor with (or otherwise
consider their obligations to) the majority shareholder is
necessary
• For example, the court must consider what material
benefits or detriments the majority shareholder can
bestow or impose upon each of the directors, other than,
as a genera matter, the majority shareholder's capacity to
deny them their continuing status as directors
 Accordingly, courts tended to focus on economic relationships
between the defendant and the directors whose independence
was being questioned
❖ The underlying transaction is protected by the business judgment rule
• if "Non-Board" Decision or Action (inaction/action of prior board/action of board
delegee) - Rales test
➢ Harder than Aronson
➢ Essentially the Part One of Aronson test
• NY approach (Marx)
➢ No reasonable doubt; no action/non-action distinction
➢ A demand would be futile if a complaint alleges with particularity that
❖ A majority of the directors are interested in the transaction
✓ Director interest may either be self-interest in the transaction at issue
✓ Or a loss of independence because a director with no direct interest in a
transaction is controlled by a self-interested director
❖ Or the directors failed to inform themselves to a degree reasonably necessary
about the transaction
❖ Or the directors failed to exercise their business judgment in approving the
transaction
✓ The challenged transaction was so egregious on its face that it could not
have been the product of sound business judgment of the directors
3. If excused, if demand made?

• Grimes - then excusal presumed waived
4. If not excused and no demand made, then dead (Grime)
5. If demand made (whether or not excused)

• Did board or SLC recommend that?
➢ Yes - proceed
➢ No
❖ DE Grime - cannot proceed unless decision "wrongful" (Rales applied ex post)
❖ NY Auerbach - The special litigation committee comprised of substantive
decisions and procedures
✓ The substantive decision falls squarely within the embrace of the business
judgment doctrine
✓ As to the methodologies and procedures best suited to the conduct of an
investigation of facts and the determination of legal liability, the courts are
well equipped by long and continuing experience and practice to make
determinations
Notes Page 34
determinations
○ Expected to show that the areas and subjects to be examined are
reasonably complete and that there has been a good-faith pursuit of
inquiry into such areas and subjects
○ Proof, however, that the investigation has been so restricted in scope,
so shallow inexecution, or otherwise so pro forma or halfhearted as
to constitute a pretext of sham, consistent with the principles
underlying the application of the business judgment doctrine, would
raise questions of good faith or conceivably fraud
6. If excused and no demand made, is there SLC recommendation?

• Yes - proceed
• No - Zapata
➢ Two-part tests
❖ First, the independence and good faith of the committee
✓ The corporation should have the burden of proving independence, good
faith and a reasonable investigation
❖ Second, the court should determine, applying its own independent business
judgment, whether the motion should be granted
✓ The Court should carefully consider and weigh how compelling the
corporate interest in dismissal is when faced with a non-frivolous lawsuit,
giving special consideration to matters of law and public policy in addition
to the corporation's best interests
➢ Special committee checklist
❖ Independent composition
❖ Fully empowered in its charter
❖ Full access to records
❖ Defendants/other directors cannot interfere
❖ Separate outside counsel
❖ Adequate budget
In re Medtronic (Minn. 2017) - direct v. derivative actions

• Facts
➢ Medtronic, a Minn corporation, acquired Covidien, a Irish company
➢ Then Medtronic and Covidien became wholly owned subsidiaries of the Irish holding
company New Medtronic (Inversion), reducing Medtronic shareholders to 70% of the
new company
➢ Plaintiffs alleged that the 70% was to secure tax benefits under Irish law, but IRS
treats an inversion transaction as a taxable event for shareholders while officers and
directors who incurred an excise-tax liability on their stock-based compensation were
reimbursed by the company
• Derivative claim - an individual shareholder may not asset a cause of action that belongs to
the corporation, but instead must sue in a representative capacity on behalf of the
corporation if asserting a claim alleging an injury to the corporate entity
• Direct claim - alleging an injury to the shareholder individually
• Different standard for different claims
➢ Derivative claim under Minn law - must allege with particularity the efforts made to
obtain the desired action from the directors and the failure of the corporation to take
such action
• Test - when shareholders are injured only indirectly, the action is derivative; when
shareholders show an injury that is not shared with the corporation, the action is
direct
• First alleged harm - excise-tax reimbursement
Notes Page 35
• First alleged harm - excise-tax reimbursement
➢ Has to be derivative claim
❖ At bottom an alleged waste of corporate asset
❖ The recovery would go to the company
• Second - capital-gains tax
➢ Direct claim as the company itself did not incur the tax liability and any recovery
would go only to the shareholders
• Third - dilution of shareholders' interest in the corporation
➢ Unlike a derivative overpayment claim, in which the shareholders claim that their
shares have diminished in value by reason of the decrease in value of the
corporation's assets due to overpayment in a transaction, the plaintiff alleged that
class members' ownership interest and voting power were diluted by Medtronic to
provide adequate protection for the tax benefits it sought in the transaction with
Covidien
➢ An injury that falls only on shareholders and not on the corporation
• Certain courts also consider whether harm alleged by the SH is "special", i.e., not shared
pro rata with other SHs
➢ "special harm" held not necessary by Delaware court, but still legitimate factor
• For derivative actions, the company will pay attorney's fees for plaintiffs if they win or
settle
➢ For defendants, if a judgment for money damages is imposed, the company can't pay
the costs for the defendants
➢ So incentives for defendants to settle, both for defendants and for plaintiffs' attorneys
• Special procedural concerns with SH derivative actions
➢ The board is the general agent, but board may be conflicted in suing itself or
management
➢ Also, SHs are not authorized to make management decisions, but a single shareholder
isn't always the ideal representative of SHs as a whole
➢ Therefore special procedural impediments as a compromise
• Four Key Procedural Hurdles
➢ Bond-posting requirements (in some states)
❖ Effective 2-way fee shifting
❖ In around half of the states including NY, a derivative claimant with small
holdings must post security for corp's legal expenses
❖ But Delaware banned fee-shifting provisions
➢ Special pleading/standing requirements
❖ Delaware Chancery Court Rule 23.1
➢ Demand Requirements
❖ Grimes; Oracle
➢ Special Litigation Committees
❖ Auerbach; Zapata
Grimes v. Donald (Del. 1996) - Demand Requirement

• Facts
➢ The employment agreement between CEO and the company
❖ Very lucrative severance package
➢ Donald wrote to the Board and demanded that the Board abrogate the Agreements;
the Board refused the demand
• The due care, waste and excessive compensation claims asserted here are derivative; the
abdication claim is a direct claim
• Abdication claim fails
➢ Directors may not delegate duties which lie at the heart of the management of the
corporation
➢ However, an informed decision to delegate a task is as much as an exercise of
Notes Page 36
➢ However, an informed decision to delegate a task is as much as an exercise of
business judgement as any other
❖ Likewise, business decisions are not an abdication of directorial authority
merely because they limit a board's freedom of future action
➢ In this case, if an independent and informed board, acting in good faith, determines
that the services of a particular individual warrant large amounts of money, the board
has made a business judgment
❖ That judgment normally will receive the protection of the business judgement
rule unless the facts show that such amounts, compared with the services to be
received in exchange, constitute waste or could not otherwise be the product of
a valid exercise of business judgment
• Demand requirement of the derivative claim
➢ A stockholder filing a derivative suit must allege either that
❖ The board rejected his pre-suit demand that the board assert the corporation's
claim or
✓ If the stockholder cannot plead excusal using the "tools at hand"
○ A variety of public sources, including the media and the
governmental agencies such as the SEC
○ In addition, a stockholder who has met the procedural requirements
and has shown a specific proper purpose may use the summary
procedure embodied in 8 Del.C. section 220 (shareholder right to
inspect books and records) to investigate the possibility of corporate
wrongdoing
✓ If a demand is made and rejected, the board rejecting the demand is
entitled to the presumption of the business judgment rule unless the
stockholder can allege facts with particularity creating a reasonable doubt
that the board is entitled to the benefit of the presumption
❖ allege with particularity why the stockholder was justified in not having made
the effort to obtain board action
✓ The basis for claiming excusal would normally be that
○ A majority of the board has a material financial or familial interest
○ A majority of the board is incapable of acting independently for
some other reason such as domination or control
○ The underlying transaction is not the product of a valid exercise of
business judgment
✓ Depends on what the shareholder is challenging
○ Board Decision or Action - Aronson test in this case
○ "Non-Board" Decision or Action (inaction/action of prior
board/action of board delegee) - Rales test
 Harder than Aronson
 Essentially the Part One of Aronson test
✓ What's interested or independent
○ Naming all of the current board won't work
○ Claiming board members won't turn on one of their own won't work
○ Interested
 Substantive case against them is strong
 They have material financial interest in outcome
○ Non-independent
 They are closely connected to interested parties
 Dominated/controlled by other interested defendants
 Securities regulation guidance can sometimes be signpost of
disinterestedness and independence
➢ Salutary purpose
❖ Invokes a species of a alternative dispute resolution procedure
Notes Page 37
❖ Invokes a species of a alternative dispute resolution procedure
❖ If litigation is beneficial, the corporation can control the proceedings
❖ If demand is excused or wrongfully refused, the stockholder will normally
control the proceedings
❖ Counter - nobody gonna make a demand
➢ Balanced environment
❖ Deter costly, baseless suits by creating a screening mechanism
❖ (Aronson test) Permit suit by a stockholder who is able to articulate
particularized facts showing that there is a reasonable doubt either that
✓ A majority of the board is disinterested and independent for purposes of
responding to the demand, or
✓ The underlying transaction is protected by the business judgment rule
➢ In this case
❖ A shareholder who makes a demand can no longer argue that demand is excused
❖ The complaint fails to include particularized allegations which would raise a
reasonable doubt that the Board's decision to reject the demand was the product
of a valid business judgment
In re Oracle (Del. Ch. 2018) - Demand Requirement

• Facts
➢ "demand would be futile" case
➢ Ellison cofounded Oracle and was CEO until 2014, after that Chairman and CTO
❖ He exhibited total control of Oracle, including removing board and executive
members who disagreed
➢ He also founded NetSuite
❖ The company not doing well, direct competitor of Oracle
❖ Oracle later bought NetSuite
✓ Through a special board committee
❖ Plaintiff alleging overcompensation
• Where a derivative plaintiff attacks "a decision approved by a board committee consisting
of less than half of the directors who would have considered a demand", the Court applies
the Rales test
➢ See Grimes
➢ A board is disabled from considering a demand under Rales if at least half of its
members
❖ Are interested in the challenged transaction,
❖ Lack independence
❖ Or face a substantial likelihood of personal liability for the conduct described in
the complaint
➢ Demand is not excused simply by allegations of director liability, instead the plaintiff
must make a threshold showing that their claims have some merit
• Oracle's outside directors do not face a substantial likelihood of liability
➢ Charter exculpates its directors from monetary liability for breaches of the duty of
care
➢ The only way is duty of loyalty claim
• A majority of the Oracle board lacks independence
➢ A plaintiff may establish that a director lacks independence by alleging with
particularity that the director "is sufficiently loyal to, beholden to, or otherwise
influenced by an interested party to undermine the director's ability to judge the
matter on its merits"
❖ Allegations of mere personal friendship or a mere outside business relationship,
standing alone, are insufficient to raise a reasonable doubt about a director's
independence
❖ Nevertheless, some professional or personal friendships, which may border on
Notes Page 38
❖ Nevertheless, some professional or personal friendships, which may border on
or even exceed familial loyalty and closeness, may raise a reasonable doubt
whether a director can appropriately consider demand
✓ Must consider all facts in their totality
Marx v. Akers (N.Y. 1996) - Demand Requirement NY

• Facts
➢ Shareholder derivative action alleging self-dealing by the directors awarding
excessive compensation to the outside directors, also alleging violation of fiduciary
duties by voting for unreasonably high compensation for executives
• Rejects the Delaware approach and the universal demand approach
• NY approach
➢ No reasonable doubt; no action/non-action distinction
➢ A demand would be futile if a complaint alleges with particularity that
❖ A majority of the directors are interested in the transaction
✓ Director interest may either be self-interest in the transaction at issue
✓ Or a loss of independence because a director with no direct interest in a
transaction is controlled by a self-interested director
❖ Or the directors failed to inform themselves to a degree reasonably necessary
about the transaction
❖ Or the directors failed to exercise their business judgment in approving the
transaction
✓ The challenged transaction was so egregious on its face that it could not
have been the product of sound business judgment of the directors
• In this case
➢ Not interested in setting executive compensation as only three directors are
executives
➢ Interested regarding director compensation as the outside directors comprised a
majority of the board
❖ However, failed to state a cause of action regarding director compensation
Auerbach v. Bennett (N.Y. 1979) - NY Special Committees

• Facts
➢ The audit committee for General Telephone & Electronics Corporation found
evidence of bribes and kickbacks and some directors had been personally involved
➢ Shareholder sued
➢ Then the board adopted a resolution creating a special litigation committee, which
decided not to proceed with the claim
❖ Three disinterested directors who had joined the board after the challenged
transactions
❖ 15-members board, 4 sued, 8 had been on the board during the transaction, 3
joined after
• The business judgment rule does not foreclose inquiry by the courts into the disinterested
independence of those members of the board chosen by it to make the corporate decision
on its behalf
➢ In this case, there is nothing in this record to raise a triable issue of fact as to the
independence and disinterested status of these three directors
• Courts have consistently held that the business judgment rule applies where some directors
are charged with wrongdoing, so long as the remaining directors making the decision are
disinterested and independent
➢ The possible risk of hesitancy on the part of the members of any committee to
investigate fellow members is an inherent, inescapable, given aspect of the
corporation's predicament
• The special litigation committee comprised of substantive decisions and procedures
Notes Page 39
• The special litigation committee comprised of substantive decisions and procedures
➢ The substantive decision falls squarely within the embrace of the business judgment
doctrine
➢ As to the methodologies and procedures best suited to the conduct of an investigation
of facts and the determination of legal liability, the courts are well equipped by long
and continuing experience and practice to make determinations
❖ Expected to show that the areas and subjects to be examined are reasonably
complete and that there has been a good-faith pursuit of inquiry into such areas
and subjects
❖ Proof, however, that the investigation has been so restricted in scope, so shallow
inexecution, or otherwise so pro forma or halfhearted as to constitute a pretext
of sham, consistent with the principles underlying the application of the
business judgment doctrine, would raise questions of good faith or conceivably
fraud
Zapata v. Maldonado (Del. 1981) - Del Special Committee

• Facts
➢ Shareholder sued ten officers and/or directors alleging breaches of fiduciary duty
➢ The directors appointed two new outside directors to the board and created an
independent investigation committee composed of those two directors, which
dismissed the actions
• Note - this is for the demand excused cases, if demanded, then only wrongful refusal claims
• Rejecting business judgment rule
➢ Sufficient risks
❖ Excused demand case
❖ Creation of the committee four years later
❖ Directors are passing judgment on fellow directors
➢ Whether the Court of Chancery will be persuaded by the exercise of a committee
power should rest in the independent discretion of the Court of Chancery
❖ The final substantive judgment not beyond the judicial reach
• Two-part tests
➢ First, the independence and good faith of the committee
❖ The corporation should have the burden of proving independence, good faith
and a reasonable investigation
➢ Second, the court should determine, applying its own independent business judgment,
whether the motion should be granted
❖ The Court should carefully consider and weigh how compelling the corporate
interest in dismissal is when faced with a non-frivolous lawsuit, giving special
consideration to matters of law and public policy in addition to the corporation's
best interests
• Interesting fact: the special committee in the Oracle case decided to let the case proceed
• Special committee checklist
➢ Independent composition
➢ Fully empowered in its charter
➢ Full access to records
➢ Defendants/other directors cannot interfere
➢ Separate outside counsel
➢ Adequate budget
Delaware County Employees Retirement Fund v. Sanchez (Del. 2015) - Del Director
Independence
• Facts
➢ Independence of one single director Jackson for a demand excusal question
➢ Jackson and Chairman Sanchez have been close friends for more than five decades
Notes Page 40
➢ Jackson and Chairman Sanchez have been close friends for more than five decades
➢ Jackson's wealth is largely attributable to business interests over which Sanchez has
substantial influence
• We did not suggest that deeper human friendships could not exist that would have the
effect of compromising a director's independence
➢ There arises a pleading stage inference that Jackson's economic positions derive in
large measure from his 50-year close friendship with Sanchez, and that he is in these
positions because Sanchez trusts, cares for, and respects him
• Note
➢ Aronson - The plaintiff must demonstrate that through personal or other relationships
the directors are beholden to the controlling person
➢ Zimmerman - a careful analysis of why the directors, on an individual basis, might
need to curry favor with (or otherwise consider their obligations to) the majority
shareholder is necessary
❖ For example, the court must consider what material benefits or detriments the
majority shareholder can bestow or impose upon each of the directors, other
than, as a genera matter, the majority shareholder's capacity to deny them their
continuing status as directors
➢ Accordingly, courts tended to focus on economic relationships between the defendant
and the directors whose independence was being questioned
Notes Page 41
Purpose of Corporations
Tuesday, October 15, 2019 12:54 PM
A.P. Smith v. Barlow (N.J. 1953)

• Facts
➢ Donation to Princeton
➢ Rationale provided - good will, favorable environment, assuring free flow of property
trained personnel
• Modern conditions require that corporations acknowledge and discharge social as
well as private responsibilities as members of the communities within which they
operate
➢ Wealth transferred from individuals to corporations and the imposition of heavy
burdens of individual taxation
➢ Corporations to assume the modern obligations of good citizenship in the same
manner as humans do
• NJ statute in 1930 legalizing community funds and other charitable instrumentalities, as
long as the directors "deem expedient and as in their judgment will contribute to the
protection of the corporate interests"
• In this case, no suggestion that it was made indiscriminately or to a pet charity of the
corporate directors in furtherance of personal rather than corporate ends
➢ On the contrary, it was made to a preeminent institution of higher learning, was
modest in amount, voluntarily made in the reasonable belief that it would aid the
public welfare and advance the interests of the plaintiff as a private corporation and as
part of the community in which it operates
• Note - DGCL section 122
➢ Can be read merely as an authorization to make charitable contributions
➢ The courts have been extremely tolerant in accepting the business judgments,
including their business judgment about whether a charitable donation will be good
for the corporation in the long run
• Note - California, NY statutes stated that "regardless of specific corporate benefit"
• Note - Penn statute requiring directors to consider any or all groups affected by corporate
actions, including shareholders, employees, suppliers, customers and creditors of the
corporation, and upon communities where the corporation are located
➢ The directors shall not be required to consider one particular group as a dominant or
controlling interest or factor
Notes Page 42
Fiduciary Duties
Business Judgment Rule

• A legal presumption that a corporate fiduciary has endeavored in good faith to exercise
care in carrying out her duties in corporation's interest
• Places burden on party complaining of breached fiduciary duty to overcome it
• Note - duty of loyalty uses "entire fairness" doctrine
• Note - Gantler v. Stephens (Del 2009) confirmed that it also applies to officers
• Implicit statutory sources
➢ DGCL 141(a)
❖ Powers of the board to manage corporation
➢ DGCL 141(c)
❖ Powers of delegation to committees/experts/officers
➢ DGCL 141(e)
❖ Board members are fully protected in relying on opinions and information
generated by committees or others competent
• Rationale
➢ Core competencies of courts
❖ Not substantive business decisions (v.s. process)
➢ Incentives
❖ Not to limit productivity
❖ Encouraging risk-taking
➢ Balancing with other levers of deterrence for managers
❖ Direct governance
❖ Compensation/termination
❖ Public securities markets / takeover markets
• Cede - fiduciary duties - good faith, loyalty or due care
➢ If the business judgment rule is rebutted, the burden shifts to the defendant directors,
the proponents of the challenged transaction, to prove to the trier of fact the "entire
fairness" of the transaction to the shareholder plaintiff
➢ Entire fairness - fair dealing +fair price
❖ Fair dealing
✓ Timing of transaction
✓ Structure of transaction
✓ How it was initiated/negotiated, e.g. competitive bidding
✓ How it was disclosed to directors/shareholders
✓ How approval were obtained
❖ Fair price
✓ Value of consideration
✓ Market test
✓ Value of alternative transaction, including not doing the deal
✓ Other elements that reasonably affect the intrinsic or inherent value of the
transaction
Notes Page 43
The Duty Not To Waste
Sunday, October 20, 2019 2:24 PM
Duty not to waste

• BJR protected
• Very hard to win
• Barlow - charitable donation not contrary to corp purpose
• The courts have been extremely tolerant in accepting the business judgments, including
their business judgment about whether a charitable donation will be good for the
corporation in the long run
• Ford - not scrutinizing how to maximize profits, but whether you are trying to do it
• Shlensky - The director's judgment is accepted unless shown to be tainted with fraud
➢ The court will not interfere unless a showing of fraud, illegality or conflict of interest
• Note Musk case - much harder than DoL standard; cleansed by SH vote
The duty not to waste

• very hard to win with business judgment rule
• Modern descendant of the doctrine of Ultra Vires - actions undertaken that are contrary to
purpose of the corporation
• Boards disabled from wasting corporate assets: actions for which there is no rational basis
in light of the corporation's purpose
➢ SH Primacy: purpose of corporation = maximizing share value
A.P. Smith v. Barlow (N.J. 1953) - charitable donation not contrary to corp purpose
• Facts
➢ Donation to Princeton
➢ Rationale provided - good will, favorable environment, assuring free flow of property
trained personnel
• Modern conditions require that corporations acknowledge and discharge social as
well as private responsibilities as members of the communities within which they
operate
➢ Wealth transferred from individuals to corporations and the imposition of heavy
burdens of individual taxation
➢ Corporations to assume the modern obligations of good citizenship in the same
manner as humans do
• NJ statute in 1930 legalizing community funds and other charitable instrumentalities, as
long as the directors "deem expedient and as in their judgment will contribute to the
protection of the corporate interests"
➢ SH claimed that it did not apply as corp predated the statute
• In this case, no suggestion that it was made indiscriminately or to a pet charity of the
corporate directors in furtherance of personal rather than corporate ends
➢ On the contrary, it was made to a preeminent institution of higher learning, was
modest in amount, voluntarily made in the reasonable belief that it would aid the
public welfare and advance the interests of the plaintiff as a private corporation and as
part of the community in which it operates
• Courts willing to fall back on pretty much any claim, unless self-dealing or personal
benefits are clear
Notes Page 44
➢ Can be read merely as an authorization to make charitable contributions
➢ The courts have been extremely tolerant in accepting the business judgments,
including their business judgment about whether a charitable donation will be good
for the corporation in the long run
• Note - California, NY statutes stated that "regardless of specific corporate benefit"
➢ ALI also this approach - "reasonable amount of resources"
• Note - Penn statute requiring directors to consider any or all groups affected by corporate
actions, including shareholders, employees, suppliers, customers and creditors of the
corporation, and upon communities where the corporation are located
➢ The directors shall not be required to consider one particular group as a dominant or
controlling interest or factor
➢ This is called constituency statute, now followed by 20-ish states
Dodge v. Ford Motor (Mich. 1919)

• Facts
➢ Ford was doing really well, but decided no special dividends would be paid in the
future with all profits reinvested
➢ Ford's policy was to reduce the price and intended to be less profitable and to benefit
the public
• The directors alone have the power to declare a dividend of the earnings of the corporation
➢ The courts will not interfere unless fraud, misappropriation or refuse to declare a
dividend when the corporation has a surplus of net profits which it can, without
detriment to its business, divide among its stockholders, and when a refusal to do so
would amount to an abuse of discretion as would constitute a fraud, or breach of that
good faith towards the stockholders
• A business corporation is organized and carried on primarily for the profit of the
stockholders. The powers of the directors are to be employed for that end.
➢ Not within the lawful powers of a board of directors to shape and conduct the affairs
of a corporation for the merely incidental benefit of shareholders and for the primary
purpose of benefiting others
➢ The difference between an incidental humanitarian expenditure of corporate funds for
the benefit of the employees, like the building of a hospital for their use and the
employment of agencies for the betterment of their condition, and a general purpose
and plan to benefit mankind at the expense of others, is obvious
• Meanwhile not interfering with the proposed expansion of Ford
• Waste doctrine - not scrutinizing how to maximize profits, but whether you are trying to do
it
Shlensky v. Wrigley (Ill. 1968)

• Facts
➢ Cubs refused to install lights and have night games
➢ Experiencing huge losses
➢ Alleging that it's because of the owner's personal opinions that baseball is a daytime
sport and the installation of lights and night games will have a deteriorating effect
upon the surrounding neighborhood
• The director's judgment is accepted unless shown to be tainted with fraud
➢ The court will not interfere unless a showing of fraud, illegality or conflict of interest
• The effect on the surrounding neighborhood might well be considered by a director who
was considering the patrons who would or would not attend the games if the park were in a
poor neighborhood
➢ Furthermore, the long run interest of the corporation in its property value might
demand all efforts to keep the neighborhood from deteriorating
Notes Page 45
New Developments
• Delaware's Public Benefit Corporations
➢ Must balance interest
❖ SHs
❖ Best interests of those materially affected by its conduct (employees, creditors,
customers, suppliers)
❖ The specific public benefits identified in its certificate of incorporation
➢ A suit for failure to balance only needs to allege failure to pursue one of the three
interests or the trade-off not rational
➢ Unless they are receiving a personal benefit, directors protected by the exculpation
provisions are only liable for balancing decisions if they are interested
➢ The statute remains stockholder-centered in many respects - no new beneficiaries are
created, and only stockholders may bring lawsuits
➢ Statutory Business Judgment Rule (DGCL 365(b))
❖ For all disinterested balancing decisions, the directors are presumed to have
satisfied their fiduciary duties if
✓ The directors are informed and disinterested
✓ The balancing decision has a rational purpose
○ Meaning procedural rationality - son long as the process employed
was either rational or employed in a good faith effort to advance
corporate interests
➢ Supermajority vote to opt in, opt out or change purpose; also for M&A
❖ SHs have appraisal rights
• Business Roundtable - we share a fundamental commitment to all of our stakeholders
• Wachtell - the New Paradigm
• Warren - Accountable Capitalism Act
➢ Mandatory federal charter for large corporations - required to consider the interests of
all corporate stakeholders
Notes Page 46
Duty of Care
Sunday, October 20, 2019 2:25 PM
Duty of care
• Van Gorkom test
➢ Business Judgment Rule - a presumption that in making a business decision, the
directors of a corporation acted on an informed basis, in good faith and in the honest
belief that the action taken was in the best interests of the company
❖ (procedural challenges to BJR) determination of whether a business judgment
is an informed one turns on whether the directors have informed themselves
prior to making a business decision, of all material information reasonably
available to them
❖ Gross negligence is the proper standard
➢ The conducts following the vote may be informed, therefore rectify and cure the
Board's prior dereliction
➢ Legacies - Emergence of "fairness opinions", especially in the M&A context
❖ Directors can't blindly rely on opinion's conclusion; they must understand its
analysis
• Kamin - The neglect referred to in the statute is neglect of duties (i.e., malfeasance or
nonfeasance) and not misjudgment
➢ More than imprudence or mistaken judgment must be shown
• Francis - directors owed that degree of care that a businessman of ordinary prudence would
exercise in the management of his own affairs
➢ The nature and extent of reasonable care depended upon the type of corporation, its
size and financial resources
❖ Thus, a bank director was held to stricter accountability than the director of an
ordinary business
❖ More like ordinary negligence for banks, not gross negligence
➢ With certain corporations, directors are deemed to owe a duty to creditors and other
third parties even when the corporation is solvent
❖ e.g. banks
❖ Directors of nonbanking corporations may owe a similar duty when the
corporation holds funds of others in trust
• In re Cornerstone - need to make satisfactory pleading against each individual director
defendant
➢ a duty of loyalty claim against the interested fiduciaries does not relieve the plaintiff
of the responsibility to plead a non-exculpated claim against each director who moves
for dismissal
Kamin v. American Express Company (N.Y. 1976)

• Facts
➢ American Express acquired DLJ and subsequently DLJ's share took a dive
➢ American Express declared a special dividend to all stockholders to which the shares
of DLJ would be distributed in kind
➢ Plaintiffs alleged that AE could've sold the DLJ shares, get the capital loss to offset
capital gains and save taxes
➢ AE argued that decrease of net income from the sale would impact AE shares
• The question of whether or not a dividend is to be declared or a distribution of some kind
should be made is exclusively matter of business judgment for the Board
➢ The court would not interfere unless the directors have acted or are about to act in bad
faith and for a dishonest purpose
• The neglect referred to in the statute is neglect of duties (i.e., malfeasance or nonfeasance)
Notes Page 47
• The neglect referred to in the statute is neglect of duties (i.e., malfeasance or nonfeasance)
and not misjudgment
➢ More than imprudence or mistaken judgment must be shown
• In this case
➢ The defendants were fully aware that a sale might result in tax saving
➢ This is not a case in which directors totally overlooked facts called to their attention
❖ They gave them consideration, and attempted to view the total picture in
arriving at their decision
Smith v. Van Gorkom (Del. 1985)

• Facts
➢ The company, Trans Union, had difficulty in generating sufficient taxable income
❖ Van Gorkom is a CEO
➢ Van Gorkom met with a takeover specialist Pritzker and proposed a price of $55 per
share and a financing structure without consulting the Board of management except
the controller of the company
❖ No basis for $55
➢ In subsequent negotiations, Pritzker demanded to buy shares at market price as a price
to serve as "stalking horse" and drafted a merger agreement
➢ Then there's a 3-day ddl to agree set by Pritzker, Van Gorkom then called a special
meeting
❖ Management didn’t want it
❖ A procedurally defective meeting happened, and the board approved
✓ 20-minute oral presentation
✓ The merger agreement delivered too late
✓ Neither Van Gorkom nor any other director read the agreement
✓ Did not disclose the methodology to arrive at $55 or the fact that he
proposed the price
✓ The acceptance was conditioned on the right to accept any better offer
during the market test period and that the company could share its
proprietary information with bidders
○ The board did not reserve the right to actively solicit alternate offers
• Business Judgment Rule - a presumption that in making a business decision, the
directors of a corporation acted on an informed basis, in good faith and in the honest
belief that the action taken was in the best interests of the company
➢ (procedural challenges to BJR) determination of whether a business judgment is
an informed one turns on whether the directors have informed themselves prior
to making a business decision, of all material information reasonably available
to them
➢ Gross negligence is the proper standard
➢ In the merger context - the directors must act in an informed and deliberate manner in
determining whether to approve an agreement before submitting the proposal to the
stockholders
• The vote was not an informed business judgment
➢ Did not adequately inform themselves as to Van Gorkom's rules
➢ Uninformed as to the intrinsic value of the company
➢ Gross negligent upon two hours' consideration, without prior notice, and without the
exigency of a crisis or emergency
➢ DGCL 141(e) - directors are fully protected in relying in good faith on reports made
by officers
❖ "report" has been liberally construed to include reports of informal personal
investigations by corporate officers
❖ In this case, no evidence of any "report"
✓ Only Van Gorkom's oral presentation of his understanding of the terms of
Notes Page 48
✓ Only Van Gorkom's oral presentation of his understanding of the terms of
the proposed Merger Agreement, which he had not seen
❖ At a minimum for a report to enjoy the status conferred by 141(e), it must be
pertinent to the subject matter upon which a board is called to act, and otherwise
be entitled to good faith, not blind, reliance
➢ A substantial premium may provide one reason to recommend a merger, but in the
absence of other sound valuation information, the fact of a premium alone does not
provide an adequate basis upon which to assess the fairness of an offering price
❖ In this case - the Board knew the stocks were undervalued; had made no
evaluation of the company, had not ever considered selling the company or a
merger before; accepted without scrutiny of $55
➢ The market test component failed to prove reasonableness - did not give the Board
freedom to seek bidder and to share proprietary information
• The conducts following the vote was also uninformed and cannot rectify and cure the
Board's prior dereliction
➢ Didn't see the papers
➢ The market test period was effectively reduced
• Cede v. Technicolor (Del)
➢ Similar facts
➢ The court held that the transaction was entirely fair and therefore no cause of action
although the board breached its fiduciary duty
➢ Distinguishing Van Gorkom - in Van Gorkim, the board also violated the duty of
disclosure
❖ The compound breaches of the duties of care and disclosure could not withstand
an entire fairness analysis
➢ The test of entire fairness - the timing, initiation, negotiation, and the structure of the
transaction, the disclosure to and approval by the directors, and the disclosure to and
approval by the shareholders
❖ In that case, CEO negotiated hard, CEO was informed well, advisory firms were
the best in the country, the price was 100% premium, no indication that more
money was possible
• Legacies
➢ Emergence of "fairness opinions", especially in the M&A context
❖ Report authored by IB/financial advisor, addressed a corp's board of directors,
opining whether price terms are substantively fair
❖ Bargaining leverage against negotiating partner
❖ Sometimes required pursuant to debt covenants
❖ Normally a value range
❖ Directors can't blindly rely on opinion's conclusion; they must understand its
analysis
➢ Passage of DGCL 102(b)(7)
❖ As liability insurance rates purportedly increased and directors threatened to
quit or decline appointment after the decision
❖ Applies to both directors and officers
❖ Applies only to money damages
❖ Does not cover duty of loyalty or good faith violation
❖ Also see DGCL 122(17)
Francis v. United Jersey Bank (N.J. 1981) - Duty of Care & Nonfeasance
• Facts
➢ The mom had 48 percent of a reinsurance brokerage
❖ Not active in the business
❖ Knew nothing of its corporate affairs
❖ Made no effort to assure that the policies and practices of the corporation
Notes Page 49
❖ Made no effort to assure that the policies and practices of the corporation
➢ Her sons dominated the management and withdrew large sums of money from the
corporation in the forms of loans
➢ The loans were taken from funds that the corporation was holding in trust for its
clients and the company went bankrupt
➢ Now the mom's sued
• Duty of care - directors owed that degree of care that a businessman of ordinary prudence
would exercise in the management of his own affairs
➢ The nature and extent of reasonable care depended upon the type of corporation, its
size and financial resources
❖ Thus, a bank director was held to stricter accountability than the director of an
ordinary business
❖ More like ordinary negligence for banks, not gross negligence
➢ A director should acquire at least a rudimentary understanding of the business of the
corporation
➢ Also a continuing obligation to keep informed about the activities of the corporation
➢ A general monitoring of corporate affairs and policies
➢ Maintain familiarity with the financial status by a regular review of financial
statements
• With certain corporations, directors are deemed to owe a duty to creditors and other third
parties even when the corporation is solvent
➢ e.g. banks
➢ Directors of nonbanking corporations may owe a similar duty when the corporation
holds funds of others in trust
• Nonfeasance now characterized as duty of loyalty cases
In Re Cornerstone (Del. 2015) - 102(b)(7)

• Facts
➢ Merger with the controlling stockholder
➢ Did not follow the process of safe harbor for self-interested transaction
❖ Meaning if the merger is conditioned ab initio upon both the approval of an
independent, adequately-empowered Special Committee that fulfills its duty of
care; and the uncoerced, informed vote of a majority of the minority
stockholders
➢ Thus, the entire fairness standard presumptively applied
❖ The defendants must establish that the transaction was the product of both fair
dealing and fair price; the transaction itself must be objectively fair,
independent of the board's beliefs
➢ The defendant directors were insulated from liability for monetary damages for
breaches of the fiduciary duty of care by an exculpatory charter provision
➢ Despite that provision, the plaintiffs in each case not only sued the controlling
stockholders and their affiliated directors, but also sued the independent directors
• When a director is protected by an exculpatory charter provision, a plaintiff can survive a
motion to dismiss by that director defendant by pleading facts supporting a rational
inference that the director harbored self-interest adverse to the stockholders' interests, acted
to advance the self-interest of an interested party from whom they could not be presumed to
act independently, or acted in bad faith
➢ But a duty of loyalty claim against the interested fiduciaries does not relieve the
plaintiff of the responsibility to plead a non-exculpated claim against each director
who moves for dismissal
• To require otherwise would increase costs for disinterested directors, corporations, and
stockholders, without providing a corresponding benefit
➢ Each director has a right to be considered individually
➢ Create more harm than benefit for minority stockholders in practice
Notes Page 50
➢ Create more harm than benefit for minority stockholders in practice
❖ Creating incentives for independent directors to avoid serving as special
committee members, or to reject transactions
❖ The present rule does not create problem of undercompensation for minority
stockholders
✓ Interested fiduciaries, often the proverbial deep-pocketed stockholders,
will continue to be required to prove entire fairness
➢ The purpose of DCGL 102(b)(7) was to free up directors to take business risks
without worrying about negligence lawsuits
• Plaintiff seeking damages must plead that individual director violated non-exculpated
fiduciary duty
➢ Duty of loyalty
➢ Duty of good faith
➢ Waste
Notes Page 51
Duty of Loyalty
Duty of Loyalty
1. Is there a conflict of interest?
• Bayer - historical duty of loyalty
➢ Plead with particularity the existence of a conflict of interest that was
❖ Finance in nature
❖ Either direct or indirect
❖ Was material
2. If yes, then director or dominant shareholder
I. Director
3. Cleansed by 144(a)(1) or (a)(2)?

• Benihana
➢ DGCL 144(a)(1) approval
❖ Safe harbor for interested transactions
✓ If the interests are disclosed or are known to the board
✓ And the board in good faith authorizes the transaction by a majority of the
disinterested directors
• DGCL 144(a)(2) approval - informed vote of majority of disinterested SHs
➢ Gantler v. Stephens (2009): Ratifying SH vote can’t double dip: statutorily required
vote cannot simultaneously serve a dual purpose of cleansing (e.g., approving merger
/ sale / charter amendment).
• If not, go to entire fairness doctrine
4. Is there corporate opportunity implication?

• Broz/Guth test
➢ if there is presented to a corporate officer or director
❖ A business opportunity
✓ AngioScore on invention - needs to develop from idea to an opportunity
❖ Which the corporation is financially able to undertake,
❖ Is, from its nature, in the line of the corporation's business and is of practical
advantage to it
✓ In re eBay - eBay in the business of investing in securities
○ eBay consistently invested a portion of its cash on hand in
marketable securities
✓ AngioScore - This factor is to be broadly construed
❖ Is one in which the corporation has an interest or a reasonable expectancy
✓ Broz - the company didn't have as it was liquidating the licenses
❖ And, by embracing the opportunity, the self-interest of the officer or director
will be brought into conflict with that of the corporation
➢ The law will not permit him to seize the opportunity for himself
• Defense
➢ Cleansing with 144 (board or SH or fairness)
❖ Broz - presentation to the board as safe harbour
❖ Probably has to be formal
➢ Some jurisdictions have toyed with two types of affirmative defenses
❖ (AngioScore)Incapacity - corporation was practically unable to pursue the
opportunity
✓ Legal prohibitions, e.g. antitrust, bankruptcy constraints
Notes Page 52
✓ Legal prohibitions, e.g. antitrust, bankruptcy constraints
✓ Financial distress
✓ Offeror's refusal to deal with corp
❖ (Broz) Source - fiduciary approached in personal capacity unrelated to her role
at the corporation
✓ Broz - became aware of the opportunity in his individual and not his
corporate capacity
➢ Advanced waivers - DGCL 122 allows for partial carve-outs for corporate
opportunities
❖ (17) corporation can renounce in its charter or by action of its board, any
interest or expectancy in specified business opportunities or specified classes or
categories of business opportunities that are presented to the corporation or one
or more of its officers, directors or stockholders.
❖ This provision became increasingly popular in corporations' charters
II. Dominant shareholder
3. Is there a dominant shareholder?

• "de facto" dominant shareholder - even SHs with less than a 50% stake may constitute
DSHs if they exercise sway in voting and management
4. DoL issues
➢ Direct - decision/transaction resulting in a material, non-pro-rata distribution of corporate
property
➢ Indirect - decision/transaction that didn't result in a non-pro-rata distribution, but still
advanced the DSH's financial interests in a material, non-pro-rata manner
➢ Sinclair - non-enforcement of contract
➢ Hard cases - intra-SH conflicts such as Zahn and In re Trados
➢ Sinclair - Self-dealing occurs when the parent causes the subsidiary to act in such a way
that the parent receives something from the subsidiary to the exclusion of, and detriment to,
the minority stockholders of the subsidiary
5. Standard
• Default standard - entire fairness
• Lynch - the defendants may shift the burden of persuasion to the plaintiff if either
➢ Special committee of independent directors, or
❖ UOP - Interested directors cannot participate at all
✓ there were common Signal-UOP directors participating, at least to some
extent, in the UOP board's decision-making processes without full
disclosure of the conflicts they faced
✓ The result could have been entirely different if UOP had appointed an
independent negotiating committee of its outside directors to deal with
Signal at arm's length
➢ an informed vote of a majority of the minority stockholders
• Kahn - Business judgment rule if the merger is conditioned on both
➢ The business judgment standard if and only if
❖ The controller conditions on the approval of both
❖ The special committee is independent
❖ The special committee is empowered to freely select its own advisors and to say
no definitively
❖ The special committee meets its duty of care in negotiating a fair price
❖ The vote of the minority is informed
❖ There is no coercion of the minority
Notes Page 53
❖ There is no coercion of the minority
• Note - Gantler v. Stephens (2009): Ratifying SH vote can’t double dip: statutorily required
vote cannot simultaneously serve a dual purpose of cleansing (e.g., approving merger / sale
/ charter amendment).
III. Entire Fairness Test (Fair Dealing + Fair Price)

• Trados
➢ Fair dealing - embraces questions of when the transaction was timed, how it was
initiated, structured, negotiated, disclosed to the directors, and how the approval of
the directors and the stockholders were obtained
➢ Fair price - relates to the economic and financial considerations of the proposed
merger, including all relevant factors: assets, market value, earnings, future prospects,
and any other elements that affect the intrinsic or inherent value of a company's stock
❖ Utilization of market test
❖ Value of alternative transactions…
➢ The unitary determination of fairness - whether the minority stockholder shall receive
the substantial equivalent in value of what he had before
❖ Under the circumstances of this case, the fact that directors did not follow a fair
process does not constitute a separate breach of duty - an unfair process can
infect the price, result in a finding of breach, and warrant a potential remedy
• UOP
➢ Fair dealing
❖ Part of that is the duty of candor
❖ Moreover, one possessing superior knowledge may not mislead any stockholder
by use of corporate information to which the latter is not privy
IV. SH vote cleansing ineffective

• Gantler v. Stephens (2009): Ratifying SH vote can’t double dip: statutorily required vote
cannot simultaneously serve a dual purpose of cleansing (e.g., approving merger / sale /
charter amendment).
DGCL 144
• Designed to deal with Duty of Loyalty issues
• Only if "material" business interest
• Three venues for business judgment rule to apply to interested transactions
➢ Material facts known to the board
❖ Can't manipulate the voting process, e.g. coercion
➢ Material facts known to the shareholders
➢ Fair
❖ Burden on defendant
• Van Gorkom shows that Duty of Care suit may also reference DGCL 144
Bayer v. Beran (N.Y. 1944) - Directors and Managers

• Facts
➢ A radio advertising program for the company
➢ Alleging that the radio advertising was for the benefit of the wife of the company,
who was a singer
• The business judgment rule yields to the rule of undivided loyalty
➢ Including situation in which a trustee chooses to deal with another in such close
relation with the trustee that possible advantage to such other person might influence,
consciously or unconsciously, the judgment of the trustee
➢ Burden on the director to show the inherent fairness
• In this case, no breach of fiduciary duty
Notes Page 54
• In this case, no breach of fiduciary duty
➢ The other directors did not know until they had approved
➢ No evidence that the program was designed to foster or subsidize the career of the
wife
❖ That her participation in the program may have enhanced her prestige as a
singer is no ground for subjecting the directors to liability, as long as the
advertising served a legitimate and a useful corporate purpose and the company
received the full benefit thereof
➢ No suggestion of bad musical quality or competence of the singer
➢ No suggestion that the program was inefficient or that its cost is disproportionate
➢ No special treatment, professional setting
• Historical duty of loyalty
➢ Plead with particularity the existence of a conflict of interest that was
❖ Finance in nature
❖ Either direct or indirect
❖ Was material
✓ Does it depend on the income level?
Benihana of Tokyo v. Benihana, Inc. (Del. 2006) - safe harbor for interested transactions
• Facts
➢ Father owner established trust because of legal trouble
➢ Remarried and changed will for new wife
❖ Children pissed, wanted to dilute the voting power of the trust
➢ The company was also having problems
❖ The resulting construction and renovation plan anticipated huge costs
❖ Financial adviser advised issuing convertible preferred stock
➢ The director, also the director and VC of another company, represented that company
in negotiation to buy the preferred stock
• DGCL 144(a)(1) approval
➢ Safe harbor for interested transactions
❖ If the interests are disclosed or are known to the board
❖ And the board in good faith authorizes the transaction by a majority of the
disinterested directors
➢ The courts review the interested transaction under the business judgment rule
➢ In this case, it's clear that the board possessed that material information when it
approved the transaction
• Did not find breach of loyalty for that director
➢ Did not use any confidential information
➢ Did not set the terms, did not deceive the board, did not dominate or control the other
directors
Broz v. Cellular Information Systems, Inc. (Del. 1996) - Corporate Opportunities

• Facts
➢ Broz owner of RFBC
➢ Also a director of CIS, a competitor of RFBC
➢ Third company sought to sale a cellular license for Michigan-2
❖ The company listed RDBC, did not offer it to CIS in light of CIS's recent
financial difficulties
➢ Broz spoke with CEO and two other directors, all expressed no interest in the license
➢ PriCellular gained control of CIS, not executed before the whole incident
➢ PriCellular also began negotiation for that license
❖ Broz won the deal
• Guth - if there is presented to a corporate officer or director
➢ A business opportunity
Notes Page 55
➢ A business opportunity
➢ Which the corporation is financially able to undertake,
➢ Is, from its nature, in the line of the corporation's business and is of practical
advantage to it
➢ Is one in which the corporation has an interest or a reasonable expectancy
➢ And, by embracing the opportunity, the self-interest of the officer or director will be
brought into conflict with that of the corporation
➢ The law will not permit him to seize the opportunity for himself
• The court's factors
➢ Broz became aware of the opportunity in his individual and not his corporate capacity
❖ Concerns such as misappropriation of the corp's proprietary information not
here
❖ The burden for Broz is lessened to some extent
➢ CIS not financially capable
➢ While within the line of business, not clear that CIS had a cognizable interest or
expectancy in the license
❖ CIS in the process of divesting its license holdings
➢ No conflict in this case, as Broz sought only to compete with an outside entity
PriCellular
• Presentation to the board is not necessary, the director can just make an ex ante
determination
➢ Presentation provides a safe harbor
In re eBay (Del. 2004)

• Facts
➢ eBay retained Goldman Schas for IPO, secondary offering and acquisition of PayPal
❖ During these transactions, GS gave the directors thousands of IPO shares at the
initial offering price
• Corporate opportunity
➢ eBay financially able to exploit
➢ eBay in the business of investing in securities
❖ eBay consistently invested a portion of its cash on hand in marketable securities
➢ Investing was integral to eBay's cash management strategies and a significant part of
its business
➢ eBay was never given an opportunity to turn down the IPO allocations
• This was not an instance where a broker offered advice to a director about an investment in
marketable security
➢ A large investment bank that regularly did business with a company steering highly
lucrative IPO allocations to select insider directors and officers at that company,
allegedly both to reward them for past business and to induce them to direct future
business to that investment bank
• As a form of commercial rebate
➢ Clear conflict of interests
• An agent is under a duty to account for profits obtained personally in connection with
transactions related to his or her company
➢ Insider directors accepted a gratuity that rightfully belonged to eBay
➢ Even not corporate opportunity, still constitute a breach of the fiduciary duty of
loyalty
AngioScore v. TriReme (N.D. Cal. 2015)

• Facts
➢ 2 medical companies
➢ A director designed a direct competitor product for the other company
❖ Also tried to conceal it
Notes Page 56
❖ Also tried to conceal it
• Corporate Opportunity Doctrine under Del Law
➢ The elements
❖ Line of business
❖ Interest or expectancy
❖ Financially able
❖ In a position inimical to his duties by taking the opportunity
➢ Once shown, the burden shifts to the fiduciary to show either the corporation was
presented the opportunity or the corporation was not in a position to take the
opportunity
➢ A director or officer may take a corporate opportunity if
❖ In his individual not his corporate capacity
❖ Not essential to the corporation
❖ Holds no interest or expectancy
❖ Has not wrongfully employed the resources of the corporation
• Policy - invention v. fiduciary duty
➢ The rule - the duty requires he offering the opportunity to acquire the rights to the
invention
• Elements applied
➢ Opportunity - it had developed from a mere idea into a concrete opportunity
➢ Line of business - an activity as to which the corporation has fundamental knowledge,
practical experience and ability to pursue, which, logically and naturally, is adaptable
to its business having regard for its financial position, and is one that is consonant
with its reasonable needs and aspirations for expansion
❖ This factor is to be broadly construed
➢ Interest or expectancy - some tie between the property and the nature of the business
❖ Implicate many issues of the line of business analysis
❖ The court may decline to find an interest or expectancy even with line of
business if facts establish that a corporation is shifting away from its historical
line of business, where it disavows such interest, and where it lacks the capacity
to capitalize on the interest
➢ Financial capacity - this prong implicates broader policy concerns more favorable to
the corporation
❖ Stemming from the inherent conflict between a director who has control and
responsibility for the financial security of the corporation he serves and the
director's potential personal interest in ensuring that the company not have
secured financial footing so as to permit usurpation of what otherwise might be
a corporate opportunity
❖ Thus, once the plaintiff has made such a prima facie showing of financial
ability, a fiduciary faces a significant burden in establishing that a corporation
was financially unable to take advantage of a corporate opportunity
• Corporate opportunity once established -
➢ Fiduciary can't appropriate it without first seeking to cleanse her action under section
144(a)
❖ Disclosure and then approval by majority of disinterested directors
❖ Or disclosure and approval by majority of disinterested shareholders
❖ Or demonstrating entire fairness
✓ Pretty hard
➢ Full disclosure is necessary
❖ Probably has to be formal - informal 1-on-1 conversation with disinterested
board probably insufficient
• Some jurisdictions have toyed with two types of affirmative defenses
➢ Incapacity - corporation was practically unable to pursue the opportunity
❖ Legal prohibitions, e.g. antitrust, bankruptcy constraints
Notes Page 57
❖ Legal prohibitions, e.g. antitrust, bankruptcy constraints
❖ Financial distress
❖ Offeror's refusal to deal with corp
❖ Broz
➢ Source - fiduciary approached in personal capacity unrelated to her role at the
corporation
• Advanced waivers - DGCL 122 allows for partial carve-outs for corporate opportunities
➢ (17) corporation can renounce in its charter or by action of its board, any interest or
expectancy in specified business opportunities or specified classes or categories of
business opportunities that are presented to the corporation or one or more of its
officers, directors or stockholders.
➢ This provision became increasingly popular in corporations' charters
Sinclair Oil Corp. v. Levien (Del. 1971) - Dominant Shareholders

• Facts
➢ Sinclair in the business of exploring for oil and of producing and marketing crude oil
and oil products
❖ It owned about 97% of Sinven, a Venezuela subsidiary
➢ Sinclair dominates all members of Sinven's board of directors
❖ Almost all directors were officers, directors, or employees of corporations in the
Sinclair complex
➢ Plaintiff alleged that Sinclair caused Sinven to pay out such excessive dividends that
the industrial development of Sinven was effectively prevented
• When the situation involves a parent and a subsidiary, with the parent controlling the
transaction and fixing the terms, the test of intrinsic fairness [entire fairness], with its
resulting shifting of the burden of proof, is applied
➢ This standard will be applied only when the fiduciary duty is accompanied by self-
dealing--the situation when a parent is on both sides of a transaction with its
subsidiary
➢ Self-dealing occurs when the parent causes the subsidiary to act in such a way that the
parent receives something from the subsidiary to the exclusion of, and detriment to,
the minority stockholders of the subsidiary
• In this case
➢ Dividends were received by everybody
❖ Not self-dealing
➢ The plaintiff could point to no opportunities for Sinven
❖ Since Sinclair received nothing from Sinven, no self-dealing
➢ However, Sinclair contracted with Sinven
❖ Act of contracting with its dominated subsidiary was self-dealing
❖ Sinclair International breached as its payments lagged and didn't purchase the
contractual minimum
✓ If the contract was breached, then Sinclair received these products to the
detriment of Sinven's minority shareholders
❖ Under the intrinsic fairness standard, Sinclair must prove that its causing Sinven
not to enforce the contract was intrinsically fair to the minority shareholders of
Sinven
• "de facto" dominant shareholder - even SHs with less than a 50% stake may constitute
DSHs if they exercise sway in voting and management
• Key duty-of-loyalty issues involving DSHs
➢ Direct - decision/transaction resulting in a material, non-pro-rata distribution of
corporate property
➢ Indirect - decision/transaction that didn't result in a non-pro-rata distribution, but still
Notes Page 58
❖ Sinclair - non-enforcement of contract
❖ Hard cases - intra-SH conflicts such as Zahn and In re Trados
• Hypo - suppose that a third party was interested in acquiring either Sinven or Sinclair
➢ Zahn - must disclose the offer to the Sinven
➢ Thorpe - but can announce that Sinven will use all its voting power as a shareholder
of Sinven to ensure that the transaction goes to Sinclair & not Sinven
Zahn v. Transamerica Corporation (3d. Cir. 1947)

• Facts
➢ Axton-Fisher had Class A stock and Class B stock
❖ Upon liquidation, the Class A stock was entitled to share with Class B with
Class receiving twice per share
❖ Each Class A was convertible to Class B on one to one
❖ Each Class A was callable upon sixty days' notice
➢ Transamerica bought Axton-Fisher
❖ Owning 66% of Class A and 80% of Class B
❖ Dominated the board and had complete control of the company
➢ Transamerica knew of the tobacco inventory that AF possessed and tobacco's value
rose like insane
❖ Called Class A and later liquidated AF
• The directors of AF were the instruments of Transamerica
➢ The act of the board of directors in calling the Class A stock, an act which have been
legally consummated by a disinterested board of directors, was here effected at the
direction of the principal Class B stockholder in order to profit it
• Common law duty of candor - information fairness (must disclose material information to
all parties)
➢ Just an application of duty of loyalty
Fliegler v. Lawrence (Del. 1976) - ratification

• Facts
➢ Defendant Lawrence, president of Agau Mines, in his individual capacity, acquired
certain antimony properties, which were then "a raw prospect"
❖ Offered to Agau but the board decided against it because of corporation's legal
and financial position
➢ Thus, property transferred to USAC, a corporation formed just for this purpose and a
majority of stock owned by the defendant directors
❖ Capital necessary for development could be raised without risk to Agau
❖ Agau granted a long-term option to acquire USAC if the properties proved to be
of commercial value
➢ The option executed by Agau
❖ Agau was to deliver stocks for USAC stocks
❖ The action approved by majority vote of the shareholders
• Shareholder ratification of an interested transaction shifts the burden of proof to an
objecting shareholder to demonstrate that the terms are so unequal as to amount to a gift or
waste of corporate assets
➢ Where formal approval has been given by a majority of independent, fully informed
shareholders
• However, in this case, the safe habor failed as the majority of shares voted in favor of
exercising the opion were cast by defendants in their capacity as Agau shareholders
➢ Only about one-third of the disinterested shareholders voted, and we cannot assume
that such non-voting shareholders either approved or disapproved
In re Trados (Del. Ch. 2013)
Notes Page 59
In re Trados (Del. Ch. 2013)
• Trados
➢ Developed desktop software for translating documents
➢ Also entered the enterprise market
➢ Sought VC funding to spur its growth and help with IPO
• All players
➢ Hummel
❖ Founder and CTO, later designated by VC directors as president
❖ Owns common stock
❖ On the board
➢ Wachovia
❖ VC investment, getting Series A preferred stock
✓ Which has liquidation preference, cumulative dividend and participating
preferred (shared in any remaining distribution available for the common
stock)
✓ Had the right to veto charter amendment, issuance of shares, dividends,
change of control
✓ Right to vote with the common stock on an as-converted basis
❖ Designated Scanlan as director, who was also Wachovia partner
❖ Made follow-on investments in Series BB
✓ Same as Series A
➢ Hg
❖ VC investment and getting Series C preferred stock
✓ Same as Series A, only not participating preferred
❖ Reinvested and got Series D preferred stock
✓ Same as Series C
❖ Also own common stock
❖ Designated Stone as director, who was also Hg partner
❖ Made follow-on investments in Series BB
✓ Same as Series A
➢ Sequoia
❖ Received Series E via stock-for-stock merger with Uniscape
❖ Designated Gandhi, who was Sequoia director, and Prang, who had close
relationship with Sequoia
✓ Prang also received some Series C
➢ Invision
❖ VC investment, getting Series F
❖ Designated Laidig as director, who was not an Invision partner
❖ Reinvested and got Series FF
• Events
➢ Trado in trouble, not achieving synergy with Uniscape as two teams used different
codes
➢ New CFO Budge
➢ New CEO Campbell
❖ Sotck options
❖ Joined the board
➢ At this low point, JMP, an investment bank, provided a valuation range of $20.4
million ~ $169.8 million
➢ SDL made a $40 million offer with $10 million in cash, rejected
➢ Campbell secured venture debt and his strategy made business better and better
➢ Board passed the Management Incentive Plan
Notes Page 60
➢ Board passed the Management Incentive Plan
❖ An escalating percentage of sale proceeds depending on the valuation achieved
❖ To the extent MIP participants also received consideration as equity holders,
whether through common stock or options, their MIP payout would be reduced
by the amount of the consideration
➢ SDL still pursuing, with nobody else interested
❖ Invision demanded a price of $60 million, the board and the management did
not attempt for a penny more
❖ Campbell presented a stand-alone plan, but the board didn't consider it at all and
nobody was interested in funding it
➢ Merger agreed
❖ Campbell would become President and CSO of SDL, also joining the board
❖ Hummel got continued employment
❖ Out of 60M, 7.8M went to MIP, 52.2M went to VCs
✓ Without MIP, it would be 57.9M for VCs and 2.1M for common stock
holders
• Standard of Conduct - Duty of Loyalty
➢ A board does not owe fiduciary duties to preferred stockholders when considering
whether or not to take corporate action that might trigger or circumvent the preferred
stockholders' contractual rights
➢ Preferred stockholders are owed fiduciary duties only when they do not invoke their
special contractual rights and rely on a right shared equally with the common stock
➢ Generally it will be the duty of the board, where discretionary judgment is to be
exercised, to prefer the interests of the common stock-as the good faith judgment of
the board sees them to be-to the interests created by the special rights, preferences,
etc.…of preferred stock
• Three tiers of standard of review
➢ Uninterested and independent - business judgment rule
❖ Unless one of its elements is rebutted, the court merely looks to see whether the
business decision made was rational in the sense of being on logical approach to
advancing the corporation's objectives
➢ Enhanced scrutiny
❖ Requires that the defendant fiduciaries bear the burden of persuasion to show
that their motivations were proper and not selfish and that their actions were
reasonable in relation to their legitimate objective
❖ Applies where there are potential conflicts of interest
✓ The realities of the decision-making context can subtly undermine the
decisions of even independent and disinterested directors
✓ Unocal - directors resisting a hostile takeover
✓ Revlon - the sale of a corporation
○ Most traditionally, there is the danger that top corporate managers
will resist a sale that might cost them their managerial posts, or
prefer a sale to one industry rival rather than another for reasons
having more to do with personal ego than with what is best for
stockholders
➢ Entire fairness - when the board labors under actual conflicts of interest
❖ The plaintiff must prove that there were not enough independent and
disinterested individuals among the directors making the challenged decision to
comprise a board majority
• Analysis of directors
➢ Campbell and Hummel
❖ Rule - a director is interested in a transaction if
✓ he or she will receive a personal financial benefit from a transaction that is
not equally shared by the stockholders
Notes Page 61
not equally shared by the stockholders
✓ And the benefit is of a sufficiently material importance, in the context of
the director's economic circumstances
❖ Campbell
✓ The board position of SDL, standing alone, is not enough
✓ But the $2.34 M MIP represented 23% to 47% of his net worth
❖ Hummel
✓ $1 M of MIP was significant
✓ Post-transaction employment was also a material benefit
➢ VC directors
❖ Dual fiduciary obligations
❖ If the interests of the beneficiaries diverge, the fiduciary faces an inherent
conflict of interest
❖ The court mentioned the VC business model, that focus on returns and exits
➢ Outside director - Prang
❖ A long history with Sequoia
✓ Including investing in Sequoia funds and being CEO of a company backed
by Sequoia
❖ The relationships resulted in a sense of owing-ness that compromised his
independence
❖ The proceeds from merger were material too, representing 3.7%-5.5% of his net
worth
• Entire Fairness
➢ Fair dealing - embraces questions of when the transaction was timed, how it was
initiated, structured, negotiated, disclosed to the directors, and how the approval of
the directors and the stockholders were obtained
❖ Transaction initiation
✓ Did not evaluate Trados from the common stockholders' perspective
✓ Potential solution by the court - a drag-along right or change the charter
for fiduciaries' duty
❖ Transaction negotiation and structure
✓ The structure and operation of the MIP provide evidence of unfair dealing
towards the common stock - it converted the management team from
holders of equity interests aligned with the common stock to claimants
whose return profile and incentives closely resembled those of the
preferred
○ Once the deal price exceeded the liquidation preference, the MIP
took value away from the common
○ The MIP skewed the negotiation and structure of the Merger in a
manner adverse to the common stockholders
○ Without MIP, Cambell, Budge and Hummel would have received
nothing for their options, and Hummel would have received $0.5 M
for his common stock
 Their interests would have been aligned with the interests of
the common stockholders
❖ Director approval
✓ The defendants did not understand that their job was to maximize the
value of the corporation for the benefit of the common stockholders
✓ Did not consider the interests for common stockholders at all
✓ Safe harbor not used
○ did not consider forming a special committee to represent the
interests of the common stockholders
○ They also chose not to obtain a fairness opinion to analyze the
merger or evaluate other possibilities from the perspective of the
Notes Page 62
○
merger or evaluate other possibilities from the perspective of the
common stockholders
❖ Stockholder approval
✓ Safe harbor not used - never considered conditioning the merger on the
vote of a majority of disinterested common stockholder
✓ The failure to do so is not evidence of unfairness; it simply deprives the
defendants of otherwise helpful affirmative evidence of fairness
➢ Fair price - relates to the economic and financial considerations of the proposed
merger, including all relevant factors: assets, market value, earnings, future prospects,
and any other elements that affect the intrinsic or inherent value of a company's stock
❖ The court ultimately adopted defendant's expert testimony
✓ There were no real comparable companies
✓ DCF used
○ Rule - in steady state, it is typically assumed that future business
growth will approximate that of the overall economy
 7% used, often lower growth rate for Delaware decisions
✓ Plaintiff used exit multiple for DCF
○ But the court ruled that exit opportunity is far from certain and
therefore demanded higher discount rate
➢ The unitary determination of fairness - whether the minority stockholder shall receive
the substantial equivalent in value of what he had before
❖ Under the circumstances of this case, the fact that directors did not follow a fair
process does not constitute a separate breach of duty - an unfair process can
infect the price, result in a finding of breach, and warrant a potential remedy
Weinberger v. UOP (Del. 1983) - procedural cleansing in the DSH context

• Facts
➢ Signal purchased 50.5% of UOP because too much cash
❖ At $21, stock price at $14
➢ 13 directors, Signal nominated six
❖ Five were directors or employees of Signal
❖ The sixth, a partner of Lazard, had been one of Signal's rep in the negotiations
and bargaining with UOP
➢ CEO/President of UOP retired, Signal replaced him with Crawford, an employee of
Signal
➢ Two Signal director/employee ordered a feasibility study, then to Signal officers
performed the study --- they were also all UOP directors
❖ The result -- purchase 49.5% at any price up to $24 per share
❖ Ultimately Signal decided to propose $20-$21
➢ The executive committee of Signal met and Crawford invited
❖ Crawford said the price was "generous" and voiced no objection
➢ Crawford spoke with outside directors and retained Lehman to render a fairness
opinion
❖ A Lehman partner, Glanville, was also a director and financial adviser for UOP
❖ Glanville got a 3-person team and concluded the price was fair
➢ Signal board agreed to propose
❖ Contain procedural cleansing - requiring that the merger be approved by a
majority of UOP's outstanding minority shares
➢ Signal people abstained during UOP board meeting
➢ Board and shareholder voted yes
• Primary issue - preparation by two UOP directors of their feasibility study for the exclusive
use and benefit of Signal
➢ They did not share this report with their fellow directors of UOP
Notes Page 63
➢ They did not share this report with their fellow directors of UOP
➢ It was a matter of material significant to UOP - difference between $21 and $24 is
huge
➢ Problem - there were common Signal-UOP directors participating, at least to some
extent, in the UOP board's decision-making processes without full disclosure of the
conflicts they faced
❖ The result could have been entirely different if UOP had appointed an
independent negotiating committee of its outside directors to deal with
Signal at arm's length
➢ When directors are on both sides of a transaction - entire fairness
• Fair dealing
➢ Part of that is the duty of candor
❖ Moreover, one possessing superior knowledge may not mislead any stockholder
by use of corporate information to which the latter is not privy
❖ The feasibility study failed in this respect
➢ Signal initiated and structured the transaction
❖ The four business day time constraint was placed by Signal
❖ Crawford never negotiated the price with Signal
➢ Directors
❖ The outside UOP directors lacked one material piece of information generated
by two of their colleagues
❖ The fairness opinion was prepared in a hurry
✓ But the impression was given that a careful study had been made
➢ Stockholders
❖ Denied the critical information that Signal considered a price of $24 to be a
good investment
❖ Therefore the vote not an informed one
• Section 144 was for duty of loyalty issues involving directors/officers
➢ Courts have broadly embraced common law analogies to 144 in other settings
❖ e.g., duty of care involving directors in Van Gorkom
➢ For dominant shareholders
❖ Fliegler - only vote of disinterested SHs counts
❖ Still may be skeptical
✓ Dominant shareholders can really influence the directors
• Fair price - the monetary remedy confined to appraisal proceeding
➢ Additional remedy in cases of fraud, misrepresentation, self-dealing, deliberate waste
of corporate assets, or gross and palpable overreaching
➢ Note - Rabkin later effectively eliminated appraisal as the executive remedy for any
claim alleging breach of duty of entire fairness
• Remedy and type of unfairness
➢ Unfair dealing - court has the power to fashion an equitable remedy
❖ The court very reluctant to do that
➢ Unfair price - see Rabkin above
Kahn v. M&F Worldwide Corp. (Del. 2014)

• Facts
➢ M&F is a majority shareholder of MFW
❖ Three out of thirteen directors of MFW were officers of MFW and M&F,
Perelman, Schwartz, Bevins
➢ Perelman began to explore taking MFW private
❖ M&F engaged Moelis bank
➢ Schwartz sent a letter proposal to the MFW board
❖ Conditioned the merger on a special committee of independent directors and the
approval of a majority of minority shareholders
Notes Page 64
approval of a majority of minority shareholders
➢ M&F directors recused themselves from the board meeting
❖ The board decided to form the special committee
• Test for self-dealing by a controlling stockholder
➢ Default standard - entire fairness
➢ Lynch - the defendants may shift the burden of persuasion to the plaintiff if either
❖ Special committee of independent directors, or
❖ an informed vote of a majority of the minority stockholders
➢ Business judgment rule if the merger is conditioned on both
• Reasoning
➢ The undermining influence does not exist in every controlled merger setting
❖ Where the controller irrevocably and publicly disables itself from using its
control to dictate the outcome of the negotiations and the shareholder vote, the
controlled merger then acquires the shareholder-protective characteristics of
third-party, arm's-length mergers
➢ Optimally protects the minority stockholders in controller buyouts
❖ The controlling stockholder knows that it cannot bypass the special committee's
ability to say no
❖ The controlling stockholder knows it cannot dangle a majority-of-the-minority
vote before the special committee late in the process as a deal-closer
➢ Defers to the informed decisions of impartial directors, especially with shareholder
vote
❖ It will provide a strong incentive for controlling stockholders to accord minority
investors the dual protection structure
➢ The dual protection merger structure and the entire fairness standard converge at the
same critical point: price
• The business judgment standard if and only if
➢ The controller conditions on the approval of both
➢ The special committee is independent
➢ The special committee is empowered to freely select its own advisors and to say no
definitively
➢ The special committee meets its duty of care in negotiating a fair price
➢ The vote of the minority is informed
➢ There is no coercion of the minority
Tornella v. Musk (Del. 2019)

• Facts
➢ Shareholder alleging that the compensation plan for Musk was excessive and product
of breaches of fiduciary duty of the board
➢ Musk is Tesla's controlling stockholder
• Policy
➢ Delaware courts have long recognized the risks to sound corporate governance posed
by conflicted controllers
➢ However, a rule holding corporate fiduciaries personally accountable for all
transactions with conflicted controllers unless the fiduciaries demonstrate the
transaction is entirely fair will necessarily suppress at least some beneficial
transactions
• MFW rule
➢ Originally for a freeze-out merger
➢ The court has applied the MFW framework to controller transactions involving the
sale of a company to a third party and a stock reclassification
➢ The controlling stockholder's potentially coercive influence is no less present, and no
less consequential, in instances where the board is negotiating the controlling
stockholder's compensation than it is when the board is negotiating with the controller
Notes Page 65
stockholder's compensation than it is when the board is negotiating with the controller
to effect a transformational transaction
➢ Thus, entire fairness is the standard by which the compensation of controlling
stockholder must be reviewed, and MFW rule provides the cleansing
• About the shareholder vote
➢ DGCL 216(1) sets the default minimum for a quorum - majority
➢ DGCL 216(2) sets the default minimum for the affirmative voting threshold -
majority of shares present or represented at the meeting
➢ Ordinarily, a majority of disinterested shares present and a majority of those shares
voted in favor would justify business judgment (normal cleansing)
➢ However, in this case - needs MFW cleansing
• Waste claim
➢ The pleading burden on a plaintiff attacking a corporate transaction as wasteful is
necessarily higher than that of a plaintiff challenging a transaction as unfair
➢ This is especially so with respect to the award given that the majority of disinterested
stockholders voting at the special meeting approved the award, and our law
recognizes as axiomatic, even on the pleadings, that stockholders would be unlikely
to approve a transaction that is wasteful
Notes Page 66
Obligation of Good Faith
Friday, October 25, 2019 5:14 PM
Obligation of Good Faith

• Subsidiary to DoL
➢ Therefore not protected by exculpatory clauses
• Disney
➢ Three different categories of fiduciary behavior are candidates for the "bad faith"
pejorative label
❖ The first category - "subjective bad faith", fiduciary conduct motivated by an
actual intent to do harm
✓ The court determined that this constitutes class, quintessential bad faith
❖ The second category - fiduciary action taken solely by reason of gross
negligence and without any malevolent intent
✓ The court determined that gross negligence, without more, cannot
constitute bad faith
➢ The third category - intentional dereliction of duty, a conscious disregard for
one's responsibility
✓ Falls in between the first two categories
✓ The court determined that this is also bad faith
• Stone
➢ In Disney, we identified the following examples of conduct that would establish a
failure to act in good faith
❖ Where the fiduciary intentionally acts with a purpose other than that of
advancing the best interests of the corporation
❖ Where the fiduciary acts with the intent to violate applicable positive law
❖ Where the fiduciary intentionally fails to act in the face of a known duty to act,
demonstrating a conscious disregard for his duties
➢ In the oversight case, the necessary conditions (in the absence of red flags)
❖ The directors utterly failed to implement any reporting or information system or
controls, or
❖ Having implemented such a system or controls, consciously failed to monitor or
oversee its operations thus disabling themselves from being informed of risks or
problems requiring their attention
• A director's obligation to act in good faith traditionally was subsumed in a court's inquiry
into the director's satisfaction of her duties of care and loyalty.
• However, Cede - "the triads of their fiduciary duty - good faith, loyalty or due care"
• Several references to concept of good faith in DGCL
➢ 102(b)(7) - disallowing charter provisions exculpating directors for acts/omissions not
in good faith
➢ 141(e) - directors fully protected if they rely on reports/records of
committees/experts, if reliance is in good faith
➢ 144(a) - allows cleansing of conflict of interest by disinterested board and/or
shareholder vote if in good faith
➢ 145 - authorizing indemnification of directors/officers, but withholding authority for
actions not taken in good faith
In re the Walt Disney (Del. 2006) - Compensation

• Facts
➢ Ovitz was the leading partner at a talent agency
➢ He was lured to become president of Disney with great severance package
➢ He was later fired without cause and thus got a lucrative severance
Notes Page 67
➢ He was later fired without cause and thus got a lucrative severance
• Three different categories of fiduciary behavior are candidates for the "bad faith"
pejorative label
➢ The first category - "subjective bad faith", fiduciary conduct motivated by an actual
intent to do harm
❖ The court determined that this constitutes class, quintessential bad faith
➢ The second category - fiduciary action taken solely by reason of gross negligence and
without any malevolent intent
❖ The court determined that gross negligence, without more, cannot constitute bad
faith
✓ Gross negligence can establish the breach of duty of care
✓ Section 102(b)(7) authorizes exculpating the breach of duty of care
✓ If this second category is adopted, then the protections of 102(b)(7) would
be eviscerated as a violation of the duty of care would automatically
become an act or omission not in good faith
✓ Also look at DGCL 145
➢ The third category - intentional dereliction of duty, a conscious disregard for one's
responsibility
❖ Falls in between the first two categories
❖ The court determined that this is also bad faith
• Note - Brehm v. Eisner (Del. 2000)
➢ Due care in the decision-making context is process due care only
➢ Irrationality may be the functional equivalent of the waste test or it may tend to show
that the decision is not made in good faith
Stone v. Ritter (Del. 2006) - oversight

• Facts
➢ AmSouth bank got huge fines for failing to set up effective oversight mechanisms
such as "suspicious activity reports"(SARs)
• Caremark - only a sustained or systematic failure of the board to exercise oversight--such
as an utter failure to attempt to assure a reasonable information and reporting system
exists--will establish the lack of good faith that is a necessary condition to liability.
• So-called "oversight" liability draws heavily upon the concept of director failure to act in
good faith
➢ In Disney, we identified the following examples of conduct that would establish a
failure to act in good faith
❖ Where the fiduciary intentionally acts with a purpose other than that of
advancing the best interests of the corporation
❖ Where the fiduciary acts with the intent to violate applicable positive law
❖ Where the fiduciary intentionally fails to act in the face of a known duty to act,
demonstrating a conscious disregard for his duties
• The requirement to act in good faith is a subsidiary element of the duty of loyalty
• In the oversight case, the necessary conditions (in the absence of red flags)
➢ The directors utterly failed to implement any reporting or information system or
controls, or
➢ Having implemented such a system or controls, consciously failed to monitor or
oversee its operations thus disabling themselves from being informed of risks or
problems requiring their attention
• Marchand v. Blue Bell (Del. 2019)
➢ Caremark has a bottom-line requirement that is important: the board must make a
good faith effort---i.e., try---to put in place a reasonable board-level system of
monitoring and reporting
➢ When a plaintiff can plead an inference that a board has undertaken no efforts to
make sure it is informed of a compliance issue intrinsically critical to the company's
Notes Page 68
make sure it is informed of a compliance issue intrinsically critical to the company's
business operation, then that supports an inference that the board has not made the
good faith effort that Caremark requires
Notes Page 69
Insider Information
Tuesday, November 5, 2019 4:50 PM
Elements of an insider trading case of 10b-5 model

• Person must be in possession of information that is material (TSC v. Northway Standard)
➢ A fact to which a reasonable investor would attach importance in determining his
choice in the transaction in question
➢ Probability * Magnitude
• Information must be non-public
➢ Information that is not reasonably available to members of the general investing
public
❖ Tough case (Coates in Texas Gulf) - public information that has been released,
but has not been absorbed into the market
✓ Informed party must wait till she has not reasonable advantage
❖ Selective disclosures to favored parties largely fail this test
• Person must buy or sell securities on the basis of MNPI
➢ Presumed that person traded on basis of MNPI if person was aware of MNPI at time
of transaction
➢ Affirmative defenses
❖ Pre-existing plan to buy/sell
✓ Specific formula/algorithm, with no ability by informed party to influence
timing/manner of transactions
❖ Organizational defendants
✓ Natural person executing trades not aware of MNPI, and reasonable
policies/procedures in place to guard against insider trading
• Trading person must violate a duty of confidentiality ("disclose or abstain")
➢ Traditional theory - statutory/constructive insiders
❖ Duty owed to corporation
✓ Officer
✓ Director
✓ Block shareholders (>10%)
✓ Constructive insiders
○ Agents who, because of their position of trust and confidence, are
given access to information related to security's value that is
reasonably expected to be confidential
Notes Page 70
 See Dirks, footnote 14 - under certain circumstances, such as
where corporate information is revealed legitimately to an
underwriter, accountant, lawyer, or consultant working for the
corporation, these outsiders may become fiduciaries of the
shareholders
 The corp must expect the outsider to keep the disclosed
nonpublic information confidential
 Accountants, lawyers, shrinks
 This definition has been translated into regulatory rules (Rule
10b-5(2))
 Explicitly agreeing to maintain MNPI in confidence
 Implicit agreement, established through a history, pattern
or practice of sharing confidences
 Implicit agreement presumed if MNPI received by close
family member
○ Tippees (Dirks)
 a tippee assumes a fiduciary duty to the shareholders of a
corporation not to trade on material nonpublic information only
when
 the insider has breached his fiduciary duty to the
shareholders by disclosing the information to the tippee,
and
 Whether disclosure is a breach of duty depends on
large part on the purpose of the disclosure
 The test is whether the insider personally will
benefit, directly or indirectly, from his disclosure
• Salmon - Definition of "personal benefits"
➢ This personal benefit can often be
inferred from objective facts and
circumstances such as a relationship
between the insider and the recipient that
suggests a quid pro quo from the latter,
or an intention to benefit the particular
recipient
➢ The elements of fiduciary duty and
exploitation of nonpublic information
also exist when an insider makes a gift
of confidential information to a trading
relative or friend
 The tippee knows or should know that there has been a
breach
➢ Misappropriation theory - duty owed to 3rd party information generator
❖ Even if information generator could freely trade, party who learns information
Notes Page 71
❖ Even if information generator could freely trade, party who learns information
from information generator can't if it would violate a duty of trust/confidence
❖ O'Hagen - Misappropriation theory - in lieu of premising liability on a fiduciary
relationship between company insider and purchaser or seller of the company's
stock, the misappropriation theory premises liability on a fiduciary-turned-
trader's deception of those who entrusted him with access to confidential
information
➢ The misappropriation theory outlaws trading on the basis of nonpublic
information by a corporate "outsider" in breach of a duty owed not to a
trading party, but to the source of the information
➢ Deception through nondisclosure is central to the theory of liability for
which the government seeks recognition
❖ If the fiduciary discloses to the source that he plans to trade on the
nonpublic information, there is no "deceptive device" and thus no
section 10(b) violation - although the fiduciary-turned-trader may
remain liable under state law for breach of a duty of loyalty
❖ SEC Rule 10b5-2: providing a "non-exclusive list of three situations in which a
person has a duty of trust or confidence for purposes of the 'misappropriation'
theory…."
➢ First, whenever someone agrees to maintain information in confidence
➢ Second, between two people who have a pattern or practice of sharing
confidences such that the recipient of the information knows or reasonably
should know that the speaker expects the recipient to maintain the
information's confidentiality
➢ Third, when someone receives or obtains material nonpublic information
from a spouse, parent, child, or sibling
Policy Against
• Unfair – only insiders can make money in the market
• Uninformed investors will stay out of the market  Less deep / illiquid / inefficient
➢ “Too much” Information Trading can lead to market breakdown
• Insiders will over-invest in developing and keeping secret confidential information for
purpose of personal trading
➢ Might have incentive to throttle down arrival of new information even further
Policy For
• Can lead to faster price adjustments, and more accurate markets
• Can be a powerful form of compensation for employees
Notes Page 72
• Can be a powerful form of compensation for employees
➢ Companies could opt in/out by contract or charter provision
• Doctrinal tests often make unintuitive distinctions

➢ Traditional I-T treats buying/selling competitors’ shares different than own shares
(envelope auction)
• Hazy definitions can lead to unfairness

➢ “Personal benefits” test
• Enforcing insider trading laws is expensive
• Self-defeating -- the less I-T occurs, the greater $ incentive to do it.
• Now common law fraud or fiduciary duties claims preempted by federal securities law
Goodwin v. Agassiz (1933)

• Predates federal law, rely solely on fiduciary duty
• Facts - Defendants bought stocks before the mining discovery was disclosed to the public
• Where a director personally seeks a stockholder for the purpose of buying his shares
without making disclosure of material facts within his peculiar knowledge and not within
reach of the stockholder, the transaction will be closely scrutinized
• In that case, no violation
➢ The information was a theory, not certainty
➢ Transaction done on stock exchange, not face-to-face, the parties didn't know each
other's identity
SEC v. Texas Gulf (2d Cir. 1969)

• Facts
➢ Located a segment of land that looked especially promising
➢ Several employees bought stocks
• Rule - 1924 Exchange Act
➢ Relevant part - section 10(b)
➢ SEC corresponding rule - 10b-5
❖ Unlawful
✓ (1) to employ any device, scheme, or artifice to defraud
✓ (2) to make any untrue statement of a material fact or to omit to state a
material fact necessary in order to make the statements made, in the light
of the circumstances under which they were made, not misleading
✓ (3) to engage in any act, practice, or course of business which operates or
Notes Page 73
✓ (3) to engage in any act, practice, or course of business which operates or
would operate as a fraud or deceit upon any person,
❖ In connection with the purchase or sale of any security
➢ Elements of an insider trading case of 10b-5 model
❖ Person must be in possession of information that is material (TSC v. Northway
Standard)
✓ A fact to which a reasonable investor would attach importance in
determining his choice in the transaction in question
✓ Probability * Magnitude
❖ Information must be non-public
✓ Information that is not reasonably available to members of the general
investing public
○ Tough case (Coates in Texas Gulf) - public information that has been
released, but has not been absorbed into the market
◊ Informed party must wait till she has not reasonable advantage
○ Selective disclosures to favored parties largely fail this test
❖ Person must buy or sell securities on the basis of MNPI
✓ Presumed that person traded on basis of MNPI if person was aware of
MNPI at time of transaction
✓ Affirmative defenses
○ Pre-existing plan to buy/sell
 Specific formula/algorithm, with no ability by informed party
to influence timing/manner of transactions
○ Organizational defendants
 Natural person executing trades not aware of MNPI, and
reasonable policies/procedures in place to guard against insider
trading
❖ Trading person must violate a duty of confidentiality ("disclose or abstain")
✓ Traditional theory - statutory/constructive insiders
○ Duty owed to corporation
 Officer
 Director
 Block shareholders (>10%)
 Constructive insiders
 Agents who, because of their position of trust and
confidence, are given access to information related to
security's value that is reasonably expected to be
confidential
Notes Page 74
confidential
– See Dirks, footnote 14 - under certain
circumstances, such as where corporate information
is revealed legitimately to an underwriter,
accountant, lawyer, or consultant working for the
corporation, these outsiders may become fiduciaries
of the shareholders
 The corp must expect the outsider to keep the
disclosed nonpublic information confidential
– Accountants, lawyers, shrinks
– This definition has been translated into regulatory
rules (Rule 10b-5(2))
 Explicitly agreeing to maintain MNPI in
confidence
 Implicit agreement, established through a
history, pattern or practice of sharing
confidences
 Implicit agreement presumed if MNPI
received by close family member
 Tippees
– See Dirks
✓ Misappropriation theory - duty owed to 3rd party information generator
○ Even if information generator could freely trade, party who learns
information from information generator can't if it would violate a
duty of trust/confidence
• Policy of 10b-5: all investors trading on impersonal exchanges have relatively equal access
to material information
➢ Thus, anyone in possession of material inside information must either disclose it to
the investing public…or must abstain from trading in or recommending the securities
concerned
➢ Materiality - arises only in "those situations which are essentially extraordinary in
nature and which are reasonably certain to have a substantial effect on the market
price of the security if disclosed"
❖ The basic test is whether a reasonable man would attach importance…in
determining his choice of action in the transaction in question
❖ This encompasses any fact which in reasonable and objective contemplation
might affect the value of the corporation's stock or securities
❖ A balancing of both the indicated probability and the anticipated magnitude of
the event
• One particular holding - assuming that the contents of the official release could
instantaneously be acted upon, at the minimum defendant Coates should have waited until
the news could reasonably have been expected to appear over the media of widest
circulation
Notes Page 75
circulation
• One particular holding - a major factor in determining whether the discovery was a
material fact is the importance attached to the drilling results by those who knew about it
➢ The timing by those who knew of it of their stock purchases and their purchase of
short-term calls
Dirks v. SEC (1983)

• Facts
➢ Dirks, an officer of a NY broker-dealer
➢ Received information from a former officer of Equity Funding
❖ That it was vastly overstated as the result of fraudulent corporate practices
➢ Dirks discussed the information with a number of clients and investors
❖ The price fell
• Quoting Chiarella - a duty to disclose under 10(b) arises from the existence of a fiduciary
relationship
➢ Policy - imposing a duty to disclose or abstain solely because a person knowingly
receives material nonpublic information from an insider and trades on it could have
an inhibiting influence on the role of market analysts, which are necessary to the
preservation of a healthy market
➢ Thus, a tippee assumes a fiduciary duty to the shareholders of a corporation not
to trade on material nonpublic information only when
❖ the insider has breached his fiduciary duty to the shareholders by
disclosing the information to the tippee, and
✓ Whether disclosure is a breach of duty depends on large part on the
purpose of the disclosure
✓ The test is whether the insider personally will benefit, directly or
indirectly, from his disclosure
❖ The tippee knows or should know that there has been a breach
Salman v. United States (2016)

• Facts
➢ Maher, an investment banker, discussed companies that dealt with innovative cancer
treatment and pain management techniques with his brother Michael
➢ Michael started to trade on the information, and Maher ultimately began to assist him
➢ Without Maher's knowledge, Michael fed the information to Salman, Maher's brother
in law
• Definition of "personal benefits" - whether the insider receives direct or indirect personal
benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will
translate into future earning
Notes Page 76
translate into future earning
➢ This personal benefit can often be inferred from objective facts and circumstances
such as a relationship between the insider and the recipient that suggests a quid pro
quo from the latter, or an intention to benefit the particular recipient
➢ The elements of fiduciary duty and exploitation of nonpublic information also exist
when an insider makes a gift of confidential information to a trading relative or friend
U.S. v. O'Hagan (1997)

• Facts
➢ Defendant was a partner of a law firm
➢ The law firm was retained for a potential tender offer
❖ The partner bought a bunch of stocks for the target firm before the offer was
disclosed
• Misappropriation theory - in lieu of premising liability on a fiduciary relationship
between company insider and purchaser or seller of the company's stock, the
misappropriation theory premises liability on a fiduciary-turned-trader's deception of those
who entrusted him with access to confidential information
➢ The misappropriation theory outlaws trading on the basis of nonpublic information by
a corporate "outsider" in breach of a duty owed not to a trading party, but to the
source of the information
➢ Deception through nondisclosure is central to the theory of liability for which the
government seeks recognition
❖ If the fiduciary discloses to the source that he plans to trade on the nonpublic
information, there is no "deceptive device" and thus no section 10(b) violation -
although the fiduciary-turned-trader may remain liable under state law for
breach of a duty of loyalty
➢ Policy - an investor's informational disadvantage vis-a-vis a misappropriator with
material, nonpublic information stems from contrivance, not luck; it is a disadvantage
that cannot be overcome with research or skill
• Another rule - section 14(e) of the Exchange Act: about tender offer
➢ SEC Rule 14e-3(a)
❖ Unlawful for any other person who is in possession of material information
relating to such tender offer which information he knows or has reason to know
is nonpublic and which he knows or has reason to know has been acquired
directly or indirectly from
✓ The offering person
✓ The issuer of the securities sought or to be sought by such tender offer
✓ Any officer, director, partner or employee or any other person acting on
behalf of the offering person or such issuer,
❖ To purchase or sell…, unless within a reasonable time prior to any purchase or
sale such information and its source are publicly disclosed by press release or
otherwise
Notes Page 77
otherwise
➢ Violation in this case
• Note - SEC Rule 10b5-2: providing a "non-exclusive list of three situations in which a
person has a duty of trust or confidence for purposes of the 'misappropriation' theory…."
➢ First, whenever someone agrees to maintain information in confidence
➢ Second, between two people who have a pattern or practice of sharing confidences
such that the recipient of the information knows or reasonably should know that the
speaker expects the recipient to maintain the information's confidentiality
➢ Third, when someone receives or obtains material nonpublic information from a
spouse, parent, child, or sibling
Notes Page 78
Indemnification and Insurance
Thursday, November 7, 2019 8:59 AM
DGCL 145
• (a) - relating to suits by third parties, allowing indemnification in certain circumstances for
"expenses…, judgments, fines, and amount paid in settlement."
• (b) - relating to derivative suits, allowing indemnification in certain circumstances only for
expenses and, if the person seeking indemnification has been found liable to the
corporation, only with judicial approval
• (c) - expenses must be reimbursed if the defendant was successful on the merits or
otherwise
• (e) - advancement of expenses
• (f) - expressly contemplates agreements that provide greater protection than does the statute
itself
• (g) - insurance
Waltuch v. Conticommodity Services (2d. Cir. 1996)

• Facts
➢ Waltuch was officer for Conticommodity Services and traded silver for the firm's
clients
➢ The silver market crashed
❖ Angry silver speculators filed numerous lawsuits against Waltuch and
Conticommodity
✓ Conticommodity paid over $35 million for settlement
✓ Waltch's case dismissed with no settlement contribution
❖ CFTC also charged him, with Waltuch agreeing to a penalty that included fine
and six-month ban
• First claim - the indemnification clauses in the charter didn't have the good faith
requirement, as in DCGL 145
➢ Ruling - indemnification rights may be broader than those set out in the statute, but
they cannot be inconsistent with the scope of the corporation's power to indemnify
❖ e.g. Hibbert - as the 145(a) was not limited to suits in which directors were
defendants, the bylaw that did not draw an express distinction between plaintiff
directors and defendant directors was consistent with 145(a)
❖ In this case, getting rid of good faith requirement would be inconsistent
➢ Note - 145(g) explicitly allows a corporation to circumvent the "good faith" clause of
145(a) by purchasing a directors and officers liability insurance policy
❖ However, there are uninsurable claims, such as fines, penalties (Securities Fraud
fines or penalties reaching "final adjudication", which incentivizes settlement)
• Second claim - 145(c) affirmatively requires corporations to indemnify its officers and
directors for the successful defense of certain claims
➢ Ruling - Success under 145(c) does not mean moral exoneration. Escape from an
adverse judgment or other detriment, for whatever reason, is determinative
➢ In this case - the suit was dismissed without his having paid a settlement
Citadel Holding v. Roven (Del. 1992)

• Facts
➢ Director of Citadel
➢ An indemnity agreement - shall indemnify the agent against any expense or liability
incurred…
❖ 16(b) of the Exchange Act was listed as one specific exception
➢ Defendant also entitled to require Citadel to advance the costs of defending certain
lawsuits
Notes Page 79
lawsuits
• Holding - the language in no way renders the right to advances dependent upon the right to
indemnity
➢ Subjective to a reasonableness test - Citadel is not required to advance unreasonable
expenses
• Listen to the last 10 mins of Nov 7
Indemnification and Insurance

• Indemnification represents important protection
➢ A type of second-party insurance, therefore it may be cheaper
➢ Litigation is less likely since the shareholder plaintiff may realize the corporation is
footing the bill
• Insurance also important
➢ Most states' corporate laws specifically prohibit certain categories of indemnification,
yet no limitation for insurance
❖ e.g. for actions not in good faith
❖ e.g. when the director has been adjudged to be liable
➢ However, in practice, third party insurers often impose their own strings and
exceptions to policies
• Three points
➢ Not all claims are indemnifiable or insurable
❖ Rare for policy to insure against liability for clear duty of loyalty breaches or
fraud
➢ Providing some sort of insurance/indemnification may be necessary if a corporation is
to attract knowledgeable directors
➢ Depending on the circumstances, shareholders can sometimes exercise considerable
influence on the practices of boards regarding a corporation's take-up of
indemnification/insurance
Notes Page 80
Corporate Governance/SH Vote
What is Corporate Governance

• Descriptive definition - method by which corp. is directed, in light of overall goals of the
corp., laws and key constituencies
• Functional definition - the way that a company distributes internal decision-making
authorities
Four Basics
• Who gets to vote and how is voting power distributed
➢ Default - stockholders vote and one vote per share
➢ Opting out - DGCL 212(a) - multiple classes of stock with different voting power
❖ 221 - allows charter to give voting rights to bondholders
❖ 212 - SHs can designate a proxy to vote their shares
• When and on what do SHs vote?
➢ Shareholder meetings
❖ Special meetings 211(d), called by the board
➢ Decisions where a vote is required
❖ Election of board
❖ Removal of board
❖ Authorizing amendment to charter/bylaws
❖ Repealing majority-vote bylaws previously adopted by SHs
❖ Authorizing mergers and acquisitions
❖ Authorizing sales
❖ Authorizing dissolution of corporations
❖ SH proposals
❖ NYSE/Nasdaq - Share dilutions exceeding 20%
➢ Default rule - SHs are generally not allowed to decide (141(a))
❖ Ordinary business decisions
❖ Proposing charter amendments, mergers and dissolutions
❖ Nominating board candidates, absent proxy access bylaw
• How are SH votes counted
➢ Usual vote - ordinary voting
➢ Alternative - cumulative voting for director elections
• How does the voting proxy system work, and how is it regulated
➢ Heavily regulated by both state and federal laws
❖ State law
✓ How to pay and ground rules of administration
✓ Fiduciary duties on boards
❖ Federal law for public corporations
✓ Prohibits fraud in the conduct of a proxy solicitation (Rule 14a-9)
✓ Regulates process by which shareholders are allowed to pass their own
resolutions (Rule 14a-8)
➢ Note the broker/beneficial shareholders problem
❖ Matters on which brokers are prohibited from voting "uninstructed" shares
✓ Issues with contested proposals
✓ M&A proposal
✓ SH appraisal
✓ Matters altering terms of stock/debt
✓ Executive compensation
✓ 20% dilution
✓ Election of directors
Notes Page 81
✓ Election of directors
Stroh v. Blackhawk (Ill. 1971) - Shareholder voting control

• Facts
➢ Class A and Class B share
➢ Class B can vote, but without economic incidents of shares of stock
• The law does not require that a shareholder, in addition to the management aspect of
ownership, must also have an economic interest
Levin v. Metro-Goldwyn-Mayer (S.D.N.Y. 1967) - Strategic use of proxies

• Facts
➢ A proxy contest between two groups
➢ One group used MGM to pay for the services of attorneys, PRs and proxy soliciting
organizations, and used the offices and employees of MGM
• Competing policies
➢ Shareholders should be fully and truthfully informed as to the merits of the
contentions of those soliciting their proxy
➢ The court should not unnecessarily exercise its injunctive power in such matters lest
such judicial action operate to unduly influence a stockholder's decision
• The test - whether the management used illegal or unfair means of communication
➢ Not in this case
Financing Proxy Contests

1. Do proxy fight concern a matter of corporate policy or personal control
➢ Personal control - neither side can charge costs to corp.
➢ Corporate policy
2. Was incumbent or challenger victorious
✓ Incumbent - incumbent can charge, but only for reasonable and proper
expenses incurred (Levin)
✓ challenger
○ Rosenfeld v. Fairchild Engine (N.Y. 1955)
 Policies of allowing reimbursement for management -
otherwise the corp. may be at the mercy of the challengers with
ample funds
 Even there's no challenger, quorum is hard to get
 Rule - both incumbent and challenger can charge, but SHs
must ratify challenger compensation, subject to court scrutiny
of reasonableness and propriety
• Opting out - DGCL 113
➢ Bylaws may provide for reimbursement of expenses incurred by SH in soliciting
proxies
Recent developments in DE law regarding SH voting/governance

• DGCL 216 allows Plurality voting for board members
➢ Can't be repealed by board
• Proxy access
➢ DGCL 112 permits bylaws to extend nomination power to SHs subject to any lawful
condition
• Advance notice bylaws for proxy challenges
➢ Sets a deadline by which a SH must give notice to the company of its intention to
nominate director candidates & identify those nominees
➢ Saba v. Blackrock (2019)
❖ Facts
✓ Board election
Notes Page 82
✓ Board election
✓ Advance notice bylaws
✓ Permitted by bylaws to request that the shareholder supplement the notices
with additional information
○ A questionnaire comprising nearly one hundred questions over forty-
seven pages, due in five days
❖ Ruling - breach of contract (bylaw)
✓ A substantial number of questions unrelated to director qualifications, and
the strict deadline
✓ Overstepping their authority under the bylaw
✓ Rule of construction - if charter or bylaw provisions are unclear, we
resolve any doubt in favor of the stockholder's electoral rights
❖ Ruling - failing to show breach of fiduciary duties to ensure fair and reasonable
nominating and voting procedures in the election of directors
✓ No proof that defendants acted with the primary purpose of thwarting
Saba's nominees under Blasius, or otherwise acted inequitably under
Schnell
Blasius v. Atlas (Del. 1988) - effectiveness of a shareholder vote

• Facts
➢ Blasius, a shareholder, delivered to Atlas a shareholder consent that, if joined in by
holders of a majority, would have added 8 members to the 7-member board
➢ Atlas then added two new members, thereby precluding shareholders from placing a
majority of new directors on the board through Blasius' consent solicitation
• First - if there was no policy dispute but it was entrenchment for selfish reasons, there
would be a breach of duty
➢ Not found in this case
• Unocal rule - a board may take certain steps to defeat a threatened change in corporate
control, when in good faith pursuit of a corporate interest, and are reasonable in relation to
a threat to legitimate corporate interests posed by the proposed change in control
• However, that rule does not apply to action designed for the primary purpose of
interfering with the effectiveness of a stockholder vote
➢ Rationale - the shareholder franchise is the ideological underpinning upon which the
legitimacy of directorial power rests
➢ The test
❖ If plaintiff can demonstrate that board has acted for the primary purpose of
impeding the effectiveness of shareholder voting power
❖ Then board must bear the heavy burden of demonstrating a compelling
justification for the board's actions, otherwise breach of duty of loyalty
✓ Failed in this case
✓ Very hard to pass
○ Footnote 5 - e.g., two-tier tender offer with junk bonds for second-
step merger
✓ Mercier (2007) - board demonstrates compelling justification under
Blasius if their action
○ Serves, and is motivated by, a legitimate corporate objective, and
○ Is reasonable in relation to this legitimate objective and not
preclusive or coercive with respect to SH voting
○ So the ruling was diluted somehow, now similar to Unocal ruling,
and dormant
➢
Notes Page 83
Shareholder proposals
Rule 14a-8 - provides a means by which a SH can submit at the corporation's expense their own
proposal, including, but not limited to, bylaw proposals, for consideration at the SH meeting
• Stake/holding requirement
• Timing requirement
• Exceptions
➢ Rule 14a-8(i)(1): "proper subjects" - if the proposal is not a proper subject for action
by shareholders under the law of the jurisdiction of the company's organization
❖ Important role for state law here
➢ Rule 14a-8(i)(2): violates state law
➢ Rule 14a-8(i)(3): "false or misleading" - proposals that are too vague
➢ Rule 14a-8(i)(5): "substantially related" - the proposal relates to operations which
account for less than 5 percent of the company's total assets [and net earnings and
gross sales] at the end of the most recent fiscal year…, and is not otherwise
significantly related to the company's business
➢ Rule 14a-8(i)(7): "ordinary business" - a proposal that deals with a matter relating to
the company's ordinary business operations
➢ Rule 14a-8(i)(8): proposal relates to director elections
➢ Rule 14a-8(i)(9): proposal directly conflicts with one of company’s own proposals
Trinity Wall Street v. Wal-Mart Stores (3rd Cir. 2015) - "ordinary business" exception
• Facts
➢ Wal-Mart rejected Trinity's request to include its shareholder proposal in Wal-Mart's
proxy materials for shareholder consideration
➢ The proposal asked the board to develop and implement standards for management to
use in deciding whether to sell a product that endangers public safety/potential to
impair the reputation/offensive to community
• Test
➢ First - whether the subject matter relates to Wal-Mart's ordinary business operations
❖ The subject matter of the proposal is its ultimate consequence
✓ In this case a potential change in the way Wal-Mart decides which
products to sell
❖ A proposal need only relate to a company's ordinary business to be excludable.
It need not dictate any particular outcome.
➢ Second - whether Trinity's proposal raise a significant policy issue that transcends the
nuts and bolts of the retailer's business
❖ In this case, it raises policies but does not transcend
❖ Examples
✓ A proposal that asks a supermarket chain to evaluate its sale of sugary
sodas because of the effect on childhood obesity does not transcend
○ Too entwined with the fundamentals of the daily activities
✓ A proposal raising the impropriety of a supermarket's discriminatory
hiring or compensation practices transcends
○ Disengaged from the essence of the business
✓ Far more likely to transcend when the product is that of a manufacturer
with a narrow line
○ It would relate to the seller's very existence
• Note - SEC Staff Bulletin signals a change of policy from SEC (regarding no objection
letters), a wider public policy carve-out
➢ Even if the significant policy issues relates to the "nitty-gritty of its core business,"
the proposal may still transcend
Notes Page 84
the proposal may still transcend
Lovenheim v. Iriquois Brands (D.D.C. 1985) - "Substantially related" exception

• Facts
➢ Proposed resolution relates to the procedure used to force-feed geese for production
of foie gras
• Rule 14a-8(i)(5)
➢ Less than 5% of total assets and net earnings
➢ Isn't otherwise significantly related to issuer's business
❖ Ruling - the meaning of "significantly related" is not limited to economic
significance
✓ The ethical and social significance also count
AGSCME v. AIG (2d Cir. 2006) - "relates to an election"

• Facts
➢ The proposal would amend the bylaws to require the company to publish the names
of shareholder-nominated candidates for director positions together with any
candidates nominated by the board
• The court adhered to the previous SEC interpretation, not the current one
➢ The exclusion is limited to shareholder proposals used to oppose solicitations dealing
with an identified board seat in an upcoming election
• Aftermath
➢ DGCL 112 allows corporations to grant proxy access through bylaws (codifying the
case)
➢ In 2011, Amended Rule 14a-8(i)(8) conforms to AIG holding
❖ Bylaws that expand proxy access rights to a broader group of shareholders or
create alternative proxy access rights were expressly authorized
❖ A shareholder proposal to eliminate or restrict proxy access rights, was
impermissible
➢ Rule 14a-11 would require issues to grant SHs right to include nominees in proxy
materials
❖ Struck down by D.C. Circuit (Business Roundtable)
✓ Policies
○ A board often would have the duty to oppose shareholder nominees
○ Shareholder activism is not beneficial for corporate performance
○ Certain institutional investors would use proxy access as leverage to
extract private gains at the expense of other investors
CA v. AFSCME (Del. 2008)

• Facts
➢ SH bylaw proposal granting proxy challenge reimbursement rights for successful
"short slate" proxy challengers
• First question (Rule 14a-8(i)(1)): whether it's a "proper subject" for shareholder action
➢ The shareholders' statutory power to adopt, amend or repeal bylaws is not coextensive
with the board's concurrent power and is limited by the board's management
prerogatives under DGCL 141(a)
➢ A proper function of bylaws is to define the process and procedures by which those
decisions are made
➢ Whether or not a bylaw is a process-related must necessarily the determined in light
of its context and purpose
❖ Bylaws that requires the expenditure of corporate funds does not become
automatically deprived of its process-related character
❖ Context in this case - the process for electing directors
❖ Purpose in this case - to promote the integrity of that electoral process
Notes Page 85
❖ Purpose in this case - to promote the integrity of that electoral process
❖ So yes in this case
• Second question (Rule 14a-8(i)(2)): whether the Bylaw would violate state law
➢ In this case, yes - it limits the exercise of the board's fiduciary duties
❖ In some circumstances the duties may require them to deny reimbursement to a
dissident slate
➢ Note - DGCL 113 now permits bylaws to provide for reimbursement of proxy
challenge expenses
❖ Unclear whether this invalidates this case
Notes Page 86
Shareholder Inspection Rights
Thursday, November 28, 2019 2:22 PM
No federal proxy rules requiring the corporation to give out the shareholder list
• Depends on state laws
Crane v. Anaconda (N.Y. 1976)

• Facts
➢ Crane, a shareholder of Anaconda, announced a proposed offer to exchange debts for
Anaconda stocks
➢ Requested a copy of Anaconda's list of shareholders
• NY law - only subject to denial if the inspection is not desired for a purpose…other than
the business of the corporation
➢ A shareholder desiring to discuss a tender offer should be granted access to the
shareholder list unless it is sought for a purpose inimical to the corporation or its
stockholders
➢ The statute should be liberally construed in favor of the stockholder whose welfare as
a stockholder or the corporation's welfare may be affected
➢ Thus, this is not "a purpose other than the business of the corporation"
❖ Since the exchange offer may affect not only the future direction of the
company but the continued vitality of the shareholders' investment, inspection
should be allowed so that shareholders may independently evaluate the situation
Pillsbury v. Honeywell (Minn. 1971)

• Facts
➢ Shareholder purchased share to get other shareholders to alter the board and change
the policy of producing war weapons
➢ Requested shareholder ledger and corporate records
• Under Delaware law (DGCL 220), the shareholder must prove a proper purpose to inspect
corporate records other than the shareholder lists
➢ Note - for shareholder lists the burden of proof is on the corporation
❖ For Cal, SH with more than 5% voting shares have absolute rights
➢ In Cal and NY burden always on the corp
➢ Policy - in the context of the large firm, inspection can be more akin to a weapon in
corporate warfare
• In this case, no proper purpose
➢ Test - a purpose reasonably related to such person's interest as a stockholder
➢ The petitioner was not interested in even the long-term well-being of Honeywell or
the enhancement of the value of his shares
➢ His sole purpose was to persuade the company to adopt his social and political
concerns, irrespective of any economic benefit to himself or honeywell
• Wilkinson v. Schulman (Del. 2017) - not a proper purpose when it was the purpose of the
attorneys, not the shareholders
• Note - what is a purpose "reasonably related to interests as a SH"
➢ Assist SH in ascertaining value of her shares - yes
➢ Assist dissident SH in PR campaign connected with control contest - yes
❖ Crane
❖ Limitation - not permitted if it's about an ego boost or political campaign
➢ Help fill in particularized allegations connected with a SH lawsuit - yes
❖ Hoeller (Del. 2019) - SH must articulate a credible basis to suspect actionable
wrongs
➢ To call SHs' attention to a potentially troubling political/social activity of company -
depends
Notes Page 87
depends
❖ See Pillsbury
Sadler v. NCR Corporation (2d Cir. 1991) - NY long-arm

• Facts
➢ AT&T solicits NCR shareholders to replace the board so that the tender offer could
go through
➢ Sadler, a shareholder, acting at AT&T's request, sought NCR its stockholder list,
including CEDE list and NOBO list
• NY law permits NY resident to request the shareholder record of the foreign corporation
doing business in NY, if the resident has been a shareholder for six months
• NY law permits this agreement between AT&T and Sadler
➢ Liberally construing the statute and the meaning of "agent"
• Re: NOBO list
➢ Del - declined to order compilation of NOBO lists
❖ Rationale - takes longer to produce and not essential in proxy contests unlike
CEDE lists
➢ NY - allowed
❖ Rationale - to place shareholders on an equal footing with management in
obtaining access to shareholders
• Aftermath - NY law amended to provide that the corporation shall not be required to obtain
information about beneficial owners not in its possession
➢ Note - CEDE list under possession, NOBO list only available if the corporation
request that from brokers and other record holders in street name
➢ Same rule in Del., but Cal allows NOBO requests
• Note - SH inspection right is one of the few areas of corporate law that openly rejects the
strict internal affairs doctrine
➢ Test - substantial business in the forum state
• Notes
➢ SH lists
❖ Record SH (CEDE) ledger: always must be produced
❖ Beneficial SH (NOBO) list: depends on state
➢ Books and records
❖ Formal corporate record generally must be produced
✓ Charter, bylaw, annual report
✓ Board/committee minutes
✓ Accounting statements
✓ Formal correspondence
❖ Harder cases - informal deliberative communications
✓ KT4 v. Palantir (Del. 2019) - if the company conducts formal corporate
business largely through informal electronic communications, then those
communications are subject to 220 requests
Notes Page 88
M&A
Thursday, November 28, 2019 6:22 PM
Judicial ambivalence toward defensive measures

• Reasons to defer
➢ Boards are supposed to be fulcrum for planning long-term corporate strategy
❖ Including whether to sell the corporation
• Reasons to worry
➢ Poor management by boards often one reason for hostile takeovers
➢ Bad boards want to entrench themselves
Unocal v. Mesa (Del. 1985) - defensive tactics

• Facts
➢ Mesa launched a two-tier tender offer with junk bonds offered at the second step
➢ Unocal adopted a resolution that if Mesa acquired 50%, Unocal would buy the remaining shares using
debts, but excludes Mesa from the proposal
• The board has a large reservoir of authority upon which to draw; but when a board addresses a pending
takeover bid, there's the omnipresent specter that a board may be acting primarily in its own interests
• The test - directors must show that they had reasonable grounds for believing that a danger to corporate
policy and effectiveness existed because of another person's stock ownership (threat prong)
➢ They satisfy that burden by showing good faith and reasonable investigation
➢ Such proof is materially enhanced by the approval of a board comprised of a majority of outside
independent directors who have acted in accordance with the foregoing standards
➢ Restrictions on a selective stock repurchase
❖ The directors may not have acted solely or primarily out of a desire to perpetuate themselves in
office
➢ The board can argue long-term strategy in this prong
➢ In this prong, relevant constituencies to consider include
shareholders/employees/creditors/customers/trade creditors/community, only officers/directors are not a
permissible constituency under Unocal
➢ As a result, not that far from business judgment rule
➢ Can also consider the acquirer: whether coercive like two-tier tender offer, whether the acquirer is a
green-mailer or break up companies left and right
• A further aspect - balance
➢ The defensive measure must be reasonable in relation to the threat posed (proportionality prong)
• Aftermath - discriminatory self-tenders now prohibited by SEC (Rule 13e-4(f)(8))
➢ Poison pills are used instead - "Shareholder Rights Plan"
❖ The rights are attached to the stock and cannot be traded separately, priced so that exercise of the
option would be economically irrational
✓ The rights become exercisable and can be traded separately upon a distribution event (~20%
acquisition trigger)
❖ "flip-in" element - if triggered, entitles the holder, except the acquirer, to buy two shares of the
target issuer's common stock at half price
✓ Thereby dilute acquirer's stock
❖ "flip-over" element - if triggered (usually merger), entitles the holder to purchase stock of the
acquiring company at half price
❖ Redemption provision - the board may redeem the rights at a nominal price at any time prior to
the right being exercised
• Note
➢ Unitrin - a board's endeavor to resist a hostile acquirer cannot be coercive or preclusive
➢ The courts have also struck down measures that all but extinguished chances for a hostile bidder to
make attractive bid (Carmody; Quickturn)
Revlon v. MacAndrews & Forbes (Del. 1985)

• Facts
Notes Page 89
• Facts
➢ Pantry Pride tries to acquire Revlon
❖ Hostile tender offer
➢ Revlon adopted two defensive measures - stock repurchase and poison pills
❖ Pantry Pride still pursuing
➢ Revlon started to negotiate with other parties and reached an agreement with Forstmann (leveraged
buyout)
❖ Lock-up potion to purchase a division of Revlon
❖ No-shop provision
❖ Cancellation fee
❖ In return, Forstmann agreed to support the par value of the notes
• Unocal test
➢ The court considered the defensive measures reasonable
• However, as it became apparent that the break-up of the company was inevitable and the board authorizes
management to negotiate a merger or buyout with third parties
➢ The duty of the board had thus changed from the preservation of Revlon as a corporate entity to the
maximization of the company's value at a sale for the stockholder's benefit
❖ In this case, the board could not make the showing of good faith by preferring the noteholders and
ignoring the duty of loyalty to the shareholders
• Regarding noteholders
➢ The rights of them were fixed by contract and the noteholders required no further protection
➢ A board may have regard for various constituencies in discharging its responsibilities, provided there
are rationally related benefits accruing to the stockholders
❖ However, such concern for non-stockholder interest is inappropriate when an auction among
active bidders is in progress, and the object on longer is to protect or maintain the corporate
enterprise but to sell it to the highest bidder
❖ Also, no rationally related benefit accrued to the stockholders
• Lock-up and no-shop provisions, while not per se illegal, were struck down for ending an active auction and
foreclosing further bidding operate to the shareholders' detriment
➢ Paramount - these decisions need to be reasonable measures to maximize shore-term SH values
• The board also played favoritism for a white knight, which violated Unocal duties
• For Revlon test, basically only short-term benefits for shareholders can be considered, unlike Unocal
• Aftermath
➢ Time, Paramount - Revlon applies once it becomes inevitable that the firm will either be broken up or
will experience a change of control
❖ Change of control - control of firm shift from a fluid aggregation of unaffiliated SHs into the
hands of a single entity or unified group
➢ Rule of thumb - ask whether, should the board's strategy be implemented, the shareholder will lose the
ability to sell their shares for a control premium
❖ If yes, then Revlon scrutiny
➢ Corvin - cleansing Revlon duties by SH vote
❖ What counts as a SH-cleansing “vote”? (Less than you’d think)
✓ In Re Volcano (2016): If majority of disinterested SHs subscribe to friendly tender offer
(even if no actual vote per se), it “counts” as a Corwin vote.
❖ Requirement that SH vote be “fully informed” and “non-coerced”
✓ Morrison v. Berry (2018): Invalidated SH cleansing vote as not fully informed when proxy
disclosures made to SHs found materially incomplete as compared to details in books and
records from § 220 action
✓ In Re Saba Software (2017): Denied Corwin defense when SHs were asked to vote to
approve proposed merger or else face delisting of stock.
❖ When is a Corwin cleanse disallowed? “Entire Fairness” DoL cases
✓ D/O: DGCL § 144(a) already allows cleansing by SHs or directors
✓ DSH: cleansing by either SHs or Directors “flips burden” under Entire Fairness (per MFW,
a full BJR-triggering cleanse requires both).
Notes Page 90

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Intro

Tuesday, September 3, 2019 10:42 AM

What is Corporate Law

1. 5 major ways to demonstrate existence of P/A relationship

I. Actual express authority:

3. Distinguishing between employees and independent contractors

4. Miller v. McDonalds - special rule for employment by apparent authority

5. Special rule finding Principal's tort liability for ICs

5. Limit - only liable if action is within scope

6.Special rule finding Principal's tort liability for Ics

7. Statutory twist - Dynamex (CA) defining E/E relationship against IC

Gorton v. Doty (Idaho 1937) - actual express authority

Watteau v. Fenwick (1892) - inherent agency power

Botticello v. Stefanovicz (1979) - ratification

Hoddeson v. Koos Bros (N.J. 1957) - Estoppel

Atlantic Salmon v. Curran (1992) - Agent's liability on the contract

Liability of principal to third party in torts

Humble Oil v. Martin (1949) - Servant v. Independent Contractor

Hoover v. Sun Oil (1965)

Murphy v. Holiday Inns (1975)

Miller v. McDonald's Corp. (1997) - Tort Liability and Apparent Agency

Ira S. Bushey & Sons v. United States - scope of employment

Principals' Liability for Torts of ICs

Dynamex v. Superior Court (2018) - statutory riffs on Er-Ee/IE

Corporate Formation (excel file)

Internal Affairs Doctrine

Boilermakers v. Chevron (Del. Ch. 2013) - by-laws

Hertz Corp. v. Friend (2010) - Corporate Residency

Walkovszky v. Carlton (N.Y. 1966)

Sea-Land v. Pepper Source (7th Cir. 1991)

Frigidaire Sales Corporation v. Union Properties (Wash. 1977) - Limited Partnership

Policies of Limited Liability

MetLife v. Nabisco (S.D.N.Y. 1989) - Incurrence of Additional Debt

Bank of New York Mellon v. Realogy (Del. Ch. 2008)

Morgan Stanley v. ADM (S.D.N.Y. 1983) - redemption

Wilmington Savings v. Cash America (S.D.N.Y. 2016)

Corporate Debt: Recap

NACEPF v. Gheewalla (Del. 2007) - Creditors and Insolvency

1. In re Medtronic - Direct or derivative actions?

2. If derivative, then is demand excused?

3. If excused, if demand made?

4. If not excused and no demand made, then dead (Grime)

5. If demand made (whether or not excused)

6. If excused and no demand made, is there SLC recommendation?

In re Medtronic (Minn. 2017) - direct v. derivative actions

Grimes v. Donald (Del. 1996) - Demand Requirement

In re Oracle (Del. Ch. 2018) - Demand Requirement

Marx v. Akers (N.Y. 1996) - Demand Requirement NY

Auerbach v. Bennett (N.Y. 1979) - NY Special Committees

Zapata v. Maldonado (Del. 1981) - Del Special Committee

A.P. Smith v. Barlow (N.J. 1953)

Business Judgment Rule

Duty not to waste

The duty not to waste

Dodge v. Ford Motor (Mich. 1919)

Shlensky v. Wrigley (Ill. 1968)

Kamin v. American Express Company (N.Y. 1976)

Smith v. Van Gorkom (Del. 1985)

In Re Cornerstone (Del. 2015) - 102(b)(7)

2. If yes, then director or dominant shareholder

3. Cleansed by 144(a)(1) or (a)(2)?

4. Is there corporate opportunity implication?

II. Dominant shareholder

3. Is there a dominant shareholder?