Business Associations Cheat Sheets

Definitions
1. Accredited investors: high wealth investors or banks/mutual funds, not counted in the 35 buyers limit under
Regulation D
2. Auction contest: competitive bidding contest in an open auction
3. Authorized but unissued shares: shares authorized by charter but which have not been sold by the firm
4. Authorized shares: articles must specify number of shares corporation is authorized to issue
5. Beneficial owner: owns at least 10% of shares
6. Conversion: right to trade in the preferred stock for some other form of consideration
7. Corporate opportunity doctrine: Directors, officers, and controlling shareholders must not take for themselves any
business opportunity that could benefit the corporation
8. Debenture: an unsecured loan certificate issued by a company, backed by general credit rather than by specified
assets
9. Debt instrument: Assets that require a fixed payment to the holder, usually with interest (ex. Bonds, mortgage)
10. Derivative action: Lawsuit brought by shareholders of a corporation on its behalf to enforce or defend a claim
11. Dividend: Sum of money paid regularly by a company to its shareholders out of its profits or reserves
12. Dominant shareholder: has at least 10% of the voting rights
13. Efficient market: share prices reflect all information
14. Equity instrument: Document that serves as a legally applicable evidence of ownership in a firm
15. Fraud on the market: stock prices are a function of all material information about the company and its business
16. Greenmail: purchase by a corporation of a potential acquirer's stock, at a premium over the market price, IRS
imposes 50% tax on gain
17. Intentional dereliction of duty: a conscious disregard for one’s responsibilities
18. Inversion: a corporate merger where a US based company merges with a foreign corporation to create a new
corporate entity that is incorporated outside the US
19. Junk bond: a high-yield, high-risk security, typically issued by a company seeking to raise capital quickly in order to
finance a takeover
20. Lack of due care: fiduciary actions taken sole reason of gross negligence and without any malevolent intent
21. Leveraged buyout: one company's acquisition of another company using borrowed money, assets are used as
collateral for the loans
22. Liquidation: right to receive a greater benefit upon the occurrence of some condition such as the merger of the
corporation
23. Lockup provision: prevents insiders from selling their shares for a specified period of time
24. Misappropriation theory: breach of duty owed to the source of the information
25. No shop provision: bars the seller from soliciting a purchase proposal from any other party
26. Option: agreement to purchase stock at certain price during a limited time
27. Outstanding shares: number of shares corporation has sold and not repurchased
28. Poison pill (pg. 802): allow existing shareholders the right to purchase additional shares at a discount, effectively
diluting the ownership interest of a new, hostile party
29. Put: the right but not the obligation to sell a stock at a specified price before the expiration date
30. Redemption: right to force the corporation to buy back the stock at a certain time or for a specified price
31. Residual claimants: equal right to participate in distributions of earnings and in event of liquidation, to share equally
in the firm’s assets remaining after all prior claims have been satisfied
32. Self dealing: parent acting in a way that excludes subsidiary and causes them a detriment
33. Stocking horse: a figure used to test a concept or mount a challenge on behalf of an anonymous third party. If the
idea proves viable or popular, the anonymous figure can then declare its interest and advance the concept with little
risk of failure
34. Subjective bad faith: fiduciary conduct motivated by actual intent to do harm
35. Sunken ship fallacy: when a person or company sticks with a decision because they've already put the money down
for it and want to make sure it isn't lost
36. Treasury shares: once issued and outstanding but repurchased by corporation
37. White knight: hostile takeover defense where a “friendly” individual or company that acquires a corporation at fair
consideration that is on the verge of being taken over by an unfriendly bidder
Rules
Securities Act Regulation D
• Private placement exemption
• Allows capital to be raised through
sale of equity or debt securities
without registering with SEC
• Rule 504 - If an issuer raises no more
than $1m through the securities, it
generally may sell them to an
unlimited number of buyers without
registering the securities.
• Rule 505 - If it raises no more than
$5m, it may sell the securities to 35
buyers but no more.
• Rule 506 - If it raises more than $5m, it
may sell to no more than 35 buyers,
and each buyer must pass various
tests of financial sophistication.
• Regulation D provides that issuers can
protect the exemption by using
reasonable care to make sure the
buyers are planning to hold the stock
themselves.
• Rule 144 - Allows buyers to resell stock
they acquire in a Regulation D offering
if they first hold it for one year and
then resell it in limited volumes.
SEA 16b – Prophylactic Rule
officers, directors, and 10%
shareholders must pay to the
corporation any profits they make,
within a six month period, from buying
and selling the firm's stock
if corp. fails to act, security holders can
sue the statutory insider to recover
profits from those trades
applies only to companies that register
their stock under 1934 Act
consider classes of stock separately
conventional vs. unconventional
o Whether the transaction is volitional
o Whether the transaction is one over
which the beneficial owner has any
influence
o Whether the beneficial owner had
access to confidential information
about the transaction or the issuer
10b-5
RULE: It shall be unlawful for any person, directly or indirectly, by the use of
any means or instrumentality of interstate commerce or of the mails, or of
any facility of any national securities exchange to use or employ, in
connection with the purchase or sale of any security registered on a national
securities exchange or any security not so registered, any manipulative or
deceptive device or contrivance in the contravention of such rules and
regulations as the Commission may prescribe as necessary or appropriate in
the public interest or for the protection of investors.
To recover damages, plaintiff must prove
o A material misrepresentation or omission by the defendant
o Scienter
o A connection between the misrepresentation or omission and the
purchase or sale of a security
o Reliance upon the misrepresentation or omission
o Economic loss
o Loss causation
1933 Securities Act
§2 what is a security?
§4(2) private placement exemption test
• Number of offerees and relationship to issuer
• Number of units offered
• Size of the offering
• Manner of offering
§5 requires that securities be registered
• Security may not be offered for sale through mails or by use of other
means of interstate commerce unless a registration statement has
been filed with SEC
• Securities cannot be sold until registration is effective
• Prospectus must be delivered to purchaser before sale
§11 can sue for damages when there is a material misstatement in the
registration statement
§12(a) rescission right (applies to super small securities not registered)
14a-8
• Rule: If any security holder of an issue notifies the issuer of his intention to
present a proposal for action at a forthcoming meeting of the issuer's security
holders, the issuer shall set forth the proposal in its proxy statement and
identify it in its form of proxy and provide means by which security holders
presenting a proposal may present in the proxy statement a statement of not
more than 200 words in support of the proposal
• EXCEPTION: If the proposal relates to operations which account for less than
5% of the issuer's total assets at the end of its most recent fiscal year, and for
less than 5% of its net earnings and gross sales for its most recent fiscal year,
and is not otherwise significantly related to the issuer's business, it may omit
a proposal and any statements in support thereof from its proxy statement
 Corporation – Basics Articles of Incorporation Closed Corporation
A business entity that allows its owner Existence begins when filed unless a 35 or fewer
(shareholders/stockholders) to invest money delay effective date is specified shareholders
into the business without incurring personal All persons purporting to act as or on Less corporate
liability for the business’s debts and behalf of corp. knowing there was no formalities
obligations incorporation are jointly & severally Owners have
Shareholders may become personally liable liable for all liabilities created while so expectation of
for their own acts or conduct acting management
Shareholders = owners Requirements Involuntary dissolution
Officers = day to day executives o Name of the corporation by court order = ok
Directors = supervisors or pace setters that o Name of registered agent No ready market for
establish goals and policies o Duration shares, salary instead
o Number of authorized shares
o Name and address of the directors S Corporation
Issuance of Stock/ Gaining Capital Corp. with 100 or less
o Name and address of the
Procure cash from management or owner’s
incorporators shareholders
personal funds through a loan
o Purpose of the corporation Taxed as a partnership
Seek small business loans or other types of
loans
Defective Incorporation Passes income directly,
De Facto Corporation: Not a legal LLC, avoids double taxation
Issuance of equity or debt through the
but parties treat it as such, 4 elements Shareholders report
corporation
o Proceeded in good faith income & losses on
Bonds and other debt securities consist of
o Under a valid statute individual tax returns
two distinct rights
o For an authorized purpose Shareholders must be
o Bondholder entitled to receive stream of
o Have executed & acknowledged individuals
payment in form of interest over period of
articles of association pursuant to
years
those people
o At end of bond’s prescribed term Primary vs. Secondary
Corporation by Estoppel: where one
(maturity) bondholder is entitled to the Markets
assumes to be a corp. and acts under a
return of the principals Primary: consists of
particular name, a 3rd party dealing with
it under such assumed name is issuers and investors
Common vs. Preferred Stock estopped to deny its corp. existence where a corporation, as
Common stock: entitles owner to vote on issuer, offers securities,
fundamental corporate changes, not entitled to either in the form of
receive a dividend Shareholder Rights equity or debt, to
Preferred stock: has rights not provided to Ability to vote on major issues purchase or investors
common stock, entitled to a dividend, has right Ownership of a portion of the assets who buy the security
to redemption, conversion, or liquidation Right to elect a board of directors with an eye toward
Right to inspect corporate books and investment and gain.
records Secondary: consists of
Duties Ability to sue the company for wrongful investors trading
Duty of Care: the responsibility that requires acts or abuse of power securities with other
board members to act on full information, in An entitlement to dividends if given investors with an
good faith, and to place the best interest of the Right to transfer ownership if desired expectation that market
corporation at the forefront of all business share price will increase
decisions
Duty of Loyalty: Board members and those with Corporation Charitable
a fiduciary duty to a corporation must avoid Enterprise Liability
Contributions Only larger corporate
self-dealing and instances where the board Reasonable or modest in amount (most
member or executive enriches themselves at entity would be held
states limit to 1-3% of market cap) financially responsible
the expense of the corporation and its Corporate nexus – must be in some way
shareholders Plaintiff has burden of
that the contribution benefits the proof
o Can be ratified – DGCL §144(a) corporation
Obligation to Act in Good Faith: requires No pet charity – can’t have a connection
corporate leaders to act if they are aware of a to the charity receiving the contribution
distinct obligation or responsibility to act rather (alma maters okay though)
than standing idly and refusing to engage in
required action
 Piercing Corporate Veil Business Judgment Rule
Tip off – single member or shareholder Forbids courts from second guessing the business judgment of
Unity of Interest test corporate executives, so long as those decisions are informed,
o Corporate formalities made in good faith, and in the best interest of the corporation
o Commingling of funds and shareholders.
o Undercapitalization Plaintiff burden to rebut BJR via breach
o One corporation treating assets of Illegality of a board decision does not deprive directors of BJR
another corporation as its own Plaintiff who fails to rebut BJR is not entitled to any remedy
Van Dorn requirements unless the transaction constitutes waste
o Strong alignment of interest between
the shareholders and the business
o Observing the corporate form would Duties of Directors Shareholder Duties
promote injustice or fraud Must have a rudimentary use best judgment and
Net jet factors understanding of the firm's act in good faith when
o If there is overall injustice or unfairness business and how it works, keep making decisions for
o The LLC is a mere instrumentality or informed about the firm's the company
alter ego of its owner activities, engage in a general Acting as shareholders
monitoring of corporate affairs, – no fiduciary duty to
attend board meetings regularly, other shareholders
Shareholder Approval and routinely review financial Controlling
Duty of care claims – extinguished by statements shareholders owe
informed vote, no BOD effect Sustained or systematic failure to duty to the minority
DOL vs. directors – fully informed vote shifts exercise oversight of employee
BOP to plaintiff to show waste, BOD misconduct will establish lack of
approval has same effect good faith
DOL vs. controlling shareholders – fully Directors
Entitled to rely on the honesty of
informed vote shifts burden of proof to Exculpation
their subordinates until something
plaintiff to show unfairness, no BOD effect No exercise of
occurs to put them on notice that
business judgement –
illegal conduct is taking place
yes
Proxy Fights & Shareholder Proposals Waste – yes
Shareholders may appoint an agent to attend Quorum Uninformed decision –
the meeting and vote on their behalf. Directors acting separately and not yes
That agent is the shareholder's proxyholder, collectively as a board cannot bind Fraud – if known, no
or proxy. the corp. Conflict of interest –
Proxy fights result when an insurgent group When there are personal no
tries to oust incumbent managers by transactions of directors with their Illegality – no
soliciting proxy cards and electing its own corporations – their dealings are Bad faith – no
representatives to the board. subjected to rigorous scrutiny,
Proxy fights are subject to the 1934 Securities burden on director
Exchange Act and to state corporate statutes After approval by disinterested Stock
Insurgent only gets reimbursed if they win, directors, court reviews the Characteristics
management can be reimbursed as long as it transaction according to the BJR Right to receive
is reasonable and the contest involves policy dividends
Shareholder proposal
Investment Contract Elements Negotiability
o Must own $2k of share value, and hold
Investment of money Ability to be
for more than 1 year
In a common enterprise pledged or
o Can be over social issues
Expectation of profits hypothecated
o Must relate to operations that account Conferring of voting
for more than 5% of company’s assets Passive investment – primarily
from the managerial efforts of rights in proportion
others to shares owned
Capacity to
appreciate in value
 Intrinsic Fairness Test
Test for determining the validity of conflicted
corporate transactions, which requires the
directors to show that the transactions were
objectively fair (to prove/disprove self-dealing)
Used if parent did exclude minority, if parent
did not exclude > BJR
SLC Independence Test (Zapata)
Inquire into the independence and good
faith of the committee, corporation has
burden of proving independence
o If not independent -> deny corporation’s
motion, ends here
Court applies their own independent
business judgment on whether the motion
should be granted
Doran Test (Private Placement)
Number of offerees and their relationship to
each other and the issuer (information
available)
Number of units
Size of the offering (how much money are
they raising?)
o Regulation D Rules 504-506 provides safe
harbors
Manner of the offering
Freeze Out Test
Recognizing punctilio of honor to each other
Must be a legitimate business purpose for its
action (standard: should have a large measure
of discretion)
Whether there was an alternate course of
action
Damages: reasonable expectancy in the
position
Other Shit
Pg. 83-85(CJ) Eli Whitey: beginning of
corporations
Santa Fe v. Green holding: A fraudulent
transaction under § 10(b) of the Securities
Exchange Act of 1934 must involve conduct
that is manipulative or deceptive
Disclose or abstain: if an insider has inside
information, must disclose or abstain from
using it
Tipper/Tippee (Dirks & Salman)
Tipper must breach a fiduciary duty
Tippee knows or should know the fiduciary
duty breach
Tipper must benefit from the trade
Futility Tests
Delaware (pg. 370)
o Familial or financial interest
o Domination or control
o No valid business judgment
New York (pg. 375) – a demand would be futile if a complaint
alleged with particularity that
o A majority of the directors are interested in the transaction or
o The directors failed to inform themselves to a degree reasonably
necessary about the transaction or
o The directors failed to exercise their business judgment in
approving the transaction
Mergers & Acquisitions
• Hostile takeover: the acquisition of one company (called the target
company) by another (called the acquirer) that is accomplished by
going directly to the company's shareholders or fighting to replace
management to get the acquisition approved.
• Tender offer: corporation seeks to purchase shares from outstanding
shareholders of the target corporation at a premium to the current
market price
• Friendly merger: acquisition of one company by another with full
knowledge & consent of BOD, usually requires approval of
shareholders
• Short form mergers: between parent company & its substantially
owned subsidiary
Unocal Defensive Measures Test
Board acted in good faith and in best interest of shareholders
Can’t act to perpetuate to be in office
Defensive measures must be reasonable to threat posed
Derivative vs. Direct Action
Derivative: claim asserts that the defendant harmed the
corporation
Direct: claim asserts that the defendant harmed the shareholders
Corp must reimburse director’s expenses if successful,
shareholders only reimbursed if win, any recovery goes to
corporate treasury
Timeline
• Determine if derivative or direct
o Who suffered an injury?
o Where does recovery go?
• Demand
o Must start with a demand on the BOD
o Excusal – when demand is futile, can go directly to court
o Must outline the waste or breach of duty
o Indicate why it should be excused
o Delaware vs. NY futility test
o If demand is made, no court, unless there is wrongful
excusal
• Special Litigation Committee
o Zapata independence test
• Derivative lawsuit proceeds