AGENCY

EXAM APPROACH—Questions to ask:

• 1.) Is there a Principal-Agent relationship/and what type?

• 2.) If so, does the issue involve a TORT or CONTRACT?

Agency:
• An agency is a fiduciary relationship that arises when one person (a
principal) manifests assent to another person (an agent) that the
agent shall act on the principal’s behalf and subject to the principals
control.

o There are three parts:

1.) Manifestation of consent by the principal that

the agent act on the principal’s behalf; AND

2.) subject to the principal’s CONTROL; AND

3.) the agent manifests CONSENT

Three players in agency Questions:

• 1.) The Principal

• 2.) The Agent
• 3.) The Third Party

Agency Problems Involving Contract: When facing a fact pattern where

a contract is involved the question is whether the principal is not whether
the principal is liable, but whether the principal is bound by the agent’s
actions.
• General rule: An agent has the ability to bind a principal to an
agreement, provided that the agent has some form of authority.

• Types of Authority: 1.) actual authority, 2.) apparent authority,

3.) ratification, and 4.) agency by estoppel.

o 1.) Actual Authority (Express and Implied):

Actual authority exists when P communicates to A about
the activities in which the agent may engage and the
obligations the agent may undertake. This
communication may be spoken Or written (express
actual authority). It may be through silence or implied
by the job (implied actual authority).

Actual Express Authority—

Involves examining the principal’s explicit
instructions.

Actual Implied Authority—

Involves examining P’s explicit instructions and
asking what else might be reasonably included in
those instructions (i.e. implied) to accomplish the
job.

Implied authority includes actions that are

necessary to accomplish the principal’s original
instructions to the agent; it also includes those
actions that the agent reasonably believes the
principal wishes him to do, based on the agent’s
reasonable understanding of the authority granted
by the principal.

o 2.) Apparent Authority

 Apparent authority is created when a person (principal
or apparent principal) does or says something or
creates a reasonable impression/manifestation that
another person (the apparent agent) has the authority
to act on behalf of that apparent principal.

It is about what a third party reasonably believes the

principal has authorized the agent to do.

o 3.) Ratification—―Authority given after the fact‖:

Ratification is the authority granted after the contract

has been made. It involves situations in which an agent
enters into an agreement on behalf of the principal
without any authority (actual or apparent).

P’s affirmation may be express or implied (i.e. implied

by accepting the benefits of the transaction).

Once agreement or transaction has been ratified the law

treats it as if it were originally done by the agent with
actual authority. Thus, binding both parties to the
agreement (i.e. principal and third-party).

To be VALID, P must know or have reason to know, at

the time of the alleged ratification, the material facts
relating to the transaction.

P MAY NOT PARTIALLY RATIFY a transaction. P must

ratify the whole transaction. Its all or nothing.

Limitations on Ratification:
 If a third party manifests an intention to withdraw
from the transaction, prior to ratification, the
principal may not ratify the agreement.

Ratification will be denied when necessary to

protect the rights of innocent third parties.
Ex. Annie (agent) enters into an agreement
with Ted (third-party) to sell Pat’s
(Principal) house on day one. On day two,
P’s house burns down. P cannot ratify on
day three and say ―Ok, I accept the
agreement.‖ (P. 22)

Ratification might also be denied if the passage of

time affects the rights and liability of a third
party.

o Questions to ask to determine whether there is a valid

ratification:
A.) Did P through word or deed manifest his
assent to affirm the agreement?
B.) Will the law give effect to that assent?

o 4.) Agency by Estoppel: (P.23)

Estoppel is not really a form of authority. Estoppel is an

equitable doctrine which prevents the principal from
denying that an agency relationship exists.

Estoppel generally arises in agency situations in which

the principal has done something improper.

As used in agency, estoppel involves:

 1.) Acts or omissions (generally wrongful) by the
principal, either intentional or negligent, which
creates an appearance of authority in the
purported agent.

2.) The third party reasonably, and in good faith,

acts in reliance on the appearance of authority.

3.) The third party changes her position in

reliance upon that appearance of authority.

Difference between between ESTOPPEL and

APPARENT Authority:

1.) Estoppel requires that the third party

alter his or her position in reliance on the
purported authority.
There is no such requirement for apparent
authority.

2.) Apparent authority requires a

manifestation by the principal (directly or
indirectly) to the principal.

• No such manifestation is required for

estoppel, merely some culpable act or
omission by the principal.

• Estoppel might arise when the principal

takes some improper action. Yet, the
improper action is not sufficient to amount
to a manifestation to the third party.

o Inherent Agency power:

 This is a term used by the restatement of Agency to
indicate the power of an agent which is derived not
from authority, apparent authority or estoppel, but
solely from the agency relation and exists for the
protection of persons harmed by or dealing with a
servant or other agent. (Statute bk, 2)

Agent’s Liability for Contracts

Liability of--Undisclosed Principal: (P.22/29)

o Definition--A principal is undisclosed when the principal

authorizes an agent to act on the principal’s behalf with
respect to third parties, but the principal is undisclosed and
the third party is unaware that the principal exists.

Agent acts with authority:

If the agent acts with the principal’s actual, express
or implied, authority, then the principal is
bound.

There can be no apparent authority with an

undisclosed principal, because an undisclosed
principal by definition cannot have made a
manifestation to the third party.

These situations are covered under the concept of

liability of an undisclosed principal (was formerly
known as ―inherent agency‖).

• Under this concept the law will sometimes hold an

undisclosed principal liable for certain unauthorized
transactions of his agent when a third party has made a
detrimental change in position, if the principal had
 notice of the agent’s conduct and that it might induce
third parties to change their positions, and the principal
did not take reasonable steps to notify the third parties
of the facts. (Third Restatement
Agency § 2.06)—P.23

• Liability of Partially Principal for Contract:

o A partially disclosed principal exists when an agent tells a
third party that the agent is acting on behalf of a principal, but
the identity of the principal is not disclosed. (P.30)

Liability of Agent for Contract:

o General Rule-- An agent is not liable as a party to the

contracts that the agent enters into on behalf of a disclosed
principal.

o There are two situations when an agent will be treated

as a party to a contract:

1.) Agent is acting on behalf of an undisclosed

principal; OR

2.) Agent is action on behalf of a partially disclosed

principal (i.e. unidentified principal).

o In both instances, the agent is bound by the agreement

at the election of the third party. The third party may
choose to sue the authorized agent OR principal.

UNLESS the parties specifically agree that the agent will

not be bound OR the original agreement provides that,
upon identification of the principal, the agent will no
longer be bound.
 o However, in most situations in which the agent would be
found liable under an agreement the agent would have
a claim for indemnification provided that the agent acted
with P’s authority and did not cause the breach of the
agreement. (P.30)

EXAM APPROACH (Questions to Ask): (P. 28-29)

• 1.) Did Principal give Actual Authority to the Agent (*either express
or implied)?

• 2.) Did the principal make some manifestation to the third party
creating Apparent Authority?

• 3.) Was the Principal undisclosed, creating liability of an undisclosed

principal (formerly Inherent Agency Power (IAP))?

• 4.) Did the Principal ratify the contract?

• 5.) Is Estoppel an issue?

o Did P do something wrong or fail to do something, that

created an impression with the third party?

o Did the third party rely and alter his or her position to his or
her detriment?

Agency Problems Involving Torts:

1.) First determine whether an employee/employer

relationship existed.
o Asses whether the principal had the right to exert control
over the manner and the means by which the agent
performed his duty.

It is not just the actual exercise of control that is

critical. It is also the right to exercise control that is
evaluated.

Factors involved in assessing P’s right to exert control

over A:
1.) Extent of control that the agent and principal
have agreed the principal may exercise over the
details of the work.
2.) Whether A is engaged in a distinct occupation
or business
3.) Whether type of work done by agent is
customarily done under P’s direction or without
P’s supervision.
4.) The skill required in A’s occupation
5.) Who supplies the tools or instrumentalities
required for work and place to perform work?
6.) Length of time A is engaged by P
7.) Whether A is paid by the job or by time
worked
8.) Whether P and A believe they are creating an
employment relationship; AND
9.) Whether the principal is or is not in business.

Employee vs. Independent Contractor: Under the

doctrine of Respondeat Superior, P is responsible for the
torts committed by its employee within the course and
scope of employee’s employment. Generally, P is not
responsible for the torts of their independent
contractors.
Non-Employee Agents and independent
contractors: It is possible to have an agency
relationship in which the agent is not an employee.
The Third Restatement refers to some individuals as
non-employee agents. Other sources still use the term
independent contractors

Rule:
• When a fact pattern involves an
independent contractor OR a non-employee
agent, if the tort occurs over an area which
the principal exercises some control, the
principal might still be liable. (SEE Fiona
example on p. 15)

EXCEPTIONS to independent contractor rule:

There are certain situations in which a principal is
still liable for the torts of an agent who Is not an
employee and over whom the principal exercises
no control. Those situations are:

• 1.) Inherently dangerous activities—any

activity likely to cause harm or damage
unless some precautions are taken.

• 2.) Non-delegable duties—a duty that a

person may not avoid by the mere
delegation of the task to another person.
The hiring of the agent to perform the task
will not discharge or transfer the principal’s
responsibility or liability.

• 3.)Negligent hiring—this is not about

vicarious liability. Rather, it is direct
negligence. Liability is based on the
 principal’s negligence in hiring the
independent contractor, not on attributing
responsibility for the tortuous act to an
independent contractor or to an innocent
principal.

• 2.) Was Agent/employee acting within

Scope of employment?:

o Intentional Torts:
Principals/employers are not liable for the intentional
torts of their agents/employees.

Exception:
However, when the employer’s job is such
that some part of the intentional tort might
be characterized as being done with the
intent of serving the employer P will be
liable.
o Ex. Club bouncer who ejects patron from the club.

o Frolic & Detour:

1.) Frolic—when an agent leaves employment to do

something for personal reasons.

2.) Detour—If an employee is still engaged in

employment but strays only slightly from the direct
assignment, that is known as a mere ―detour.‖

Ex. An agent who is driving to the bank to deposit

money for the store which employs him and takes
a longer route so he can drive by the new
sculpture in the park is on a detour.
 • If he gets in an accident while driving by the sculpture,
the employer will still be liable.

• 3.) Apparent Agency: (P.16-19) o Apparent agency

arises in situations in which the person committing the
tort is not an employee , or perhaps not even the
agent, of the principal.

Under the traditional agency analysis, P would not be

liable for the alleged agent’s tort. However, if there are
circumstances which led the injured third-party to
reasonably believe that an employment or agency
relationship existed between the P and alleged A and
those circumstances existed because of some action or
inaction on the part of P, then P might still be liable
under the theory of apparent agency.

Many courts (but not all) require proof that if the

alleged agent was under the control of P, then P
would or could have exercised control to avoid the
tort which took place.

• REMEMBER: o The Agent is always liable for his own negligence.

o Also, the principal always responsible for his or her own

negligence (in such an situation the doctrine of respondeat
superior does not ably).

EXAM APPROACH—TORT (Questions to ask):

• 1.) Is there an Employee—Employer relationship?

 • 2.) If the agent is an employee, did the tort occur within the scope
of the employment or was it clearly outside the scope (frolic or
detour)?

• 3.) Even if there is NO Employee/Employer relationship—is there

sufficient control to create a ―non-employee agent,‖ and if so, did
the tort occur within the scope of that control?

• 4.) Even if there is no control exercised over agent, does the event
fall into an exception such as an: i.) inherently dangerous activity,
ii.) a non-delegable duty, OR iii.) negligent hiring?

• 5.) If there is no liability for the Principal under a control analysis, is

there a claim for Apparent Agency because the third party
reasonably relied on the appearance of the agency and was harmed
as a result of the reliance?

Rights and Responsibilities: (P.32-33)

• Agent—The agent has certain duties and obligations to P. The

agent’s knowledge is imputed to P.

o 1.) Duty of care, competence, and diligence o 2.) Duty of

loyalty o 3.) Duty not to acquire material benefits arising out
of the agency
o 4.) Duty not to act as (or on behalf of) an adverse party o
5.) Duty not to Compete o 6.) Duty not to use the principal’s
property o 7.) Duty not to use confidential information o 8.)
Duty of good conduct o 9.) Duty to provide information

• NOTE:
o While some of these duties may be waived by the
principal, such a waiver requires that the principal ne fully
 informed and that the agent still act in good faith and still
deal fairly with the principal. (P.33)

• Principal—The principal has certain duties and obligations to the

agent. (P.34)

o 1.) Duty to indemnify o 2.) Duty of good faith and fair

dealing
Partnership
Background:
• Partnerships are generally governed by state law. Most states have
adopted some version of the Uniform Partnership Act (1997)
(RUPA—which stands for the ―revised Uniform Partnership Act‖).
The codified versions of RUPA are known as the default rules,
because the apply if the partnership is not governed by an
agreement or if the partnership agreement does not cover a
particular area. Although most provisions of RUPA can be modified
by an agreement there are some that cannot.(See P. 41)

• NOTE—No formal partnership agreement is needed, but it is

recommended.

Types of Partnership

• 1.) General Partnership (Outline based on general partnerships)

• 2.) Limited Liability Partnerships

• 3.) Limited Liability Companies

Partnership

• A partnership is :

o 1.) An association of two or more persons o

2.) To carry on as co-owners of a business o
3.) For profit.

Attributes Associated with a Partnership:

 • 1.) Each partner is jointly and severally liable for the debts of the
partnership

• 2.) Each partner has the ability to participate in the control and
management of the partnership.
o Under the Uniform Partnership Act (1997) (RUPA)—Each
partner is entitled to at least one vote regardless of how much
capital he or she contributed.

• 3.) In a partnership profits are shared equally. So, when a

partnership is dissolved, the money is divided up among the
partners.

• 4.) TAX—Partnerships are not taxed on their income.

• 5.) Partners owe each others owe each other the highest level of
fiduciary duty.

Partnership by Estoppel

• There are instances, even if someone is not a partner in a

partnership, where he or she might still be responsible for the debts
of the partnership.

o Ex.
In a partnership by estoppel, if A, B, and C are partners,
and X Is not a partner, X still can be held liable as a
partner IF X allows the partners to act in a way that
third parties reasonably believe X to be a partner.
(P.41)

To be liable under this theory, X must make some

manifestation which creates an impression,
allowing others outside the partnership to
 reasonably believe that X is a partner; AND the
third party claiming partnership by estoppel must
rely on that impression to his or her detriment.
(P.42)

• Partnership by Estoppel requires: (P.42)

o 1.) Actual reliance—

o 2.) Reliance must be
reasonable—

o 3.) Some manifestation (by the alleged partner)—

• Difference between Partnership by Estoppel and Apparent

Authority:
o

Fiduciary Obligations of Partners –(―The punctilio of an honor most

sensitive‖):
• 1.) Partnership Duty of Loyalty:
• 2.) o
CORPORATIONS
CORPORATIONS

Background:
Corporations are a method of doing business. It enables promoters to do
business through them. The corporation is the one doing the business. The
law treats corporations as legal persons as opposed to natural persons.

There are articles of corporation filed with the secretary of state (the
date they are filed that is the corps birth date)

By-Laws: There are set of rules for running the corp.

When the corporation wants to conduct business, natural persons

that are in charge of its affairs natural persons have to conduct
meetings.

A record of those meetings are called MINUTES.

The agreements (resolutions) made in the meetings are called RESOLUTION.

A Corp. can own shares in another corp.

Shareholders—are the owners of the corporation. They provide the capital

to the corp. and receive corps. Residual net profits (after creditors are paid).

The shares are evidenced by stock certificates. You keep a certified copy in
the corporate notebook and the original in a safety deposit box.

Shareholders are required to meet once a year. In that meeting one of their
primary functions is to elect a board of directors and consent to any changes
to any organizational fundamental issues (i.e. changes in articles of
incorporation)
Board of directors (highest level of fiduciary duty to the corp.)—is a high
position of power in corp. They have the exclusive power to manage the
corporations business. They determine if and when dividends are paid.
They are not required to contribute any money to corp. or share in losses.
They are the guardians of the corporation.
They do not get to share in the profits of the crop. as a member of the board
of directors. However, they can be compensated or not as part of the board
of directors.
Note: A shareholder could also be on the board of directors.

Board of directors elect the officers of the corporation. The officers work
day to day in the corporation. Its their job. They are responsible for
carrying in day to day business (9 to 5 job) Example:
President, VP, secretary, CEO, CFO,
They are fiduciaries of the corporation

Dejure corportaion—A straightforward corp. formed by filing articles of

incorp. With secretary of state.

Corp. by Estoppel
Third party seeking to avoid a contract.

Elements:
1.)The court treats a firm that is not incorporated as if it were
2.)if a third person regarded them as such
3.)and third person would gain a windfall if they court now failed to
recognize the firm as a corp.

Benefits:
Allows individuals to take risks shielding them from personal liability (or
limited liability). This is the hallmark of doing business as a corporation.
Allows individuals to take risks in commerce. Allows more people to take
risks and develop business.
Defacto Corp Elements:
1.) Promoters tried to incorporate in good faith
2.) had legal right to do so
3.) AND acted as a corporation.

Southern-Gulf Marine Co. No. 9, Inc. v. Camcraft, Inc.

Corporation by Estoppel

Facts:
Plaintiff, Southern-Gulf Marine Co. No. 9, Inc., contracted with Defendant,
Camcraft, Inc., to buy a supply vessel from Defendant. Defendant refused to
comply with the agreement, arguing that the contract was invalid because
Plaintiff was not incorporated in Texas as the initial agreement stated.

Enterprise Liability involves a bunch of different corporation. The plaintiff

wants to include all of the assets of each of the separate corporation that
are operating in a single enterprise. The plaintiff wants to pool the assets of
the corporation in order to pay for damages suffered.

Walkovszky v. Carlton

Piercing the Corporate Veil

Sea-Land Services, Inc. v. Pepper Source

Piercing the Corporate Veil:

• General Rule:
 o Generally, the owners of a corporation, as well as the
directors and officers can not be held personally liable
for the obligations of the corporation.

• Exception:
o However, in some circumstances, even though a
corporation has been validly formed, the courts will
hold the shareholders, officers, or directors personally
liable for the corporations obligations to avoid fraud
or in justice.

• Van Dorn test—2 PRONG TEST (for Piercing the

Corporate vail) (P. 213-14)

o A corporate entity will be disregarded and the veil of

the limited liability pierced when two requirements
are met:

PRONG (1.) there must be such unity of interest and

ownership that the separate personalities of the
corporation and the individual [or other corporation] no
longer exist;

Four Factors—to determine whether a corporation

is controlled by another to justify disregarding
their separate identities:

• i. the failure to maintain adequate corporate records or to

comply with corporate formalities;

• ii. The comingling of funds or assets;

• Iii. Undercapitalization; AND

 • Iv. One corporation treating the assets of another
corporation as its own.

PRONG (2.) circumstances must be such that adherence

to the fiction of separate corporate existence would
sanction a fraud or promote injustice.

Board of Directors (Control):

• The Board of Directors are in charge of managing the corporation.

• The Board of Directors hold office until the next annual meeting
unless the Articles of Incorporation states otherwise.
• They can delegate duties relating to management to Officers who
are employees of the corporation.
• The Board of Directors is vicariously liable for the actions of the
officers.
• The Board of Directors selects the employee/officers and
determines how much salary they will make.
• If a shareholder is not an employee, then the shareholder will only
receive money through dividends.
• The Board of Directors determines how much, if any dividends will
be paid.
• There decisions are limited by fiduciary duties, but they their
decisions are also protected by the business judgment rule.

Shareholder Control-- Voting Rights: (Acing 141-143)

• Shareholders control the corporation indirectly to some extent by

their voting rights.
• The right to vote is held by the shareholder of record on the stock
transfer book as of the day the book is closed on record day. (Flem.
10)

o Shareholders have the right to vote:

1.) for the election and removal of directors (with or
without cause at anytime)
2.)to adopt, amend or appeal laws
3.) shareholders must approve ―fundamental corporate
changes.‖ (Flem. 10/Barbri 20)

• Shareholders may vote in their own self-interest whereas directors

are bound by their fiduciary duties and must act based upon their
good faith determination of what is best for the corporation and all
the shareholders.

• Voting Trusts

o A device whereby two or more shareholders place their shares

in trust. The trust has a trustee who is responsible for voting
the shares.

o The trust is typically governed by a trust agreement, which

determines how long the trust will last and how many shares
will be voted.

Typically voting trust are limited to 10 years in most

states.

o Benefits:

There is little question about enforcement , since

trustee holds and votes the shares.
 They avoid problems of deadlocks among shareholders.

o Disadvantages:

Shareholders might be uncomfortable with turning over

possession of their shares to a trustee and the loss of
control that accompanies relinquishing possession.

• Vote Pooling Agreement o An agreement between or among, two

or more shareholders which states that the parties’ shares will be
voted in a certain way, based upon some criteria.

Vote pooling agreements are very flexible. They can

be used in a variety of situations, for example:

It may cover all shareholder votes or only certain

votes such as the election of directors;

It may be for an unlimited period of time or a

defined period;

It may cover a portion of a shareholder’s shares

or all of their shares (e.g. John will vote 60% of
his shares pursuant to a Vote pooling Agreement
with Sally, but he may vote the other 40% as he
chooses); and

It may delegate control to an individual who has a

relatively small ownership percentage.

• There is no requirement that the person who controls the shares

under a Vote Pooling Agreement and that person’s relative
percentage of ownership in the corporation correlate.

• Shareholder Agreements
 o Shareholder Agreements deal with a wide variety of matters.
(See Acing 143)

• Limitation on Shareholder Voting Agreements:

o General Rule

Shareholders may agree on how they will act as

shareholders (i.e. they may agree that they will elect
each other onto the board of Directors),

But they MAY NOT:

agree on how the directors they elect will act

(because directors have fiduciary duties);
OR

agree that once they are on the Board of

Directors they will elect each other as
officers. (Acing 145)

o Exceptions:

Shareholders can agree on how they will vote as

directors IF:

1.) the agreement is signed by ALL the

shareholders (shareholder unanimity exception)

OR

2.) In some states, even if the all the share-

holders are not parties to the agreement, the
agreement is still enforceable provided that:

• a.) the shares of the corporation are closely held;

 • b.) the minority shareholders (i.e. they were not a party to the
agreement) do not object (or cannot object); AND

• c.) the agreement is reasonable.

Proxies: (Acing Biz Org--P.126--138)

• A shareholder may vote his shares either in person OR by proxy

executed in writing by the shareholder OR his attorney in fact.

o A proxy is valid for only 11 months UNLESS it provides

otherwise. (Barbri, 22)

Proxies are subject to federal control under the Securities Exchange

Act of 1934. (Barbri, 22)

A. Proxy
Often a shareholder is not able to attend a meeting but would still
like to vote on a matter. In these instances, the shareholder may
give a proxy to someone else to vote that shareholder’s shares.

o A proxy is a written (or electronic) document which is given to

someone else, allowing them to vote on a person’s behalf.
(Acing, 126)

It is a power of attorney given by the shareholder to

someone else to exercise the voting rights attached to
his shares. (Flem. 11)
o Proxies may give the holder discretion or no
discretion in that they may provide specific instructions on how
the shares are
 to be voted, or they may leave the discretion of how to vote
to the proxy holder.

• Importance of Proxies:
o Proxies are often important because in order to have a meeting
of the shareholders of the corporation a quorum is required.
A quorum is a minimum number of people, voters, or
votes (in this case shareholders), who must be present
at a meeting in order to make the meeting valid.
Without the use of proxies a corp’s shareholders would
be unable to vote because the quorum requirements
would not be met.

[quorum requirements are usually established by

statute, but may be modified subject to statutory
limitations).]

A typical quorum requirement for shareholder vote

would be 50% of votes, plus one. Because shareholders
vote based upon percentages, it is the number of shares
that is relevant and not the number of shareholders.

Ex.
• If a corporation has $5,000 shares issued and an outstanding,
2,502 shares would be required to be represented at a meeting in
order to have a quorum.

• Revocability of Proxy: (Barbri, 23)

o An appointment of a proxy generally is REVOCABLE by a

shareholder and may be revoked in a number of ways.

Ex.
In writing
By the shareholder showing up to vote himself,
 OR
By later appointment of another proxy.

o A proxy will be IRREVOCABLE only if:

the appointment form CONSPICIOUSLY states that it is

irrevocable; AND

the appointment is coupled with an interest

Ex.
• A pledgee;

• A person who purchased OR agreed to

purchase the shares;

• A creditor of the corporation who extended

credit to the corp. under terms requiring
appointment;

• An employee of the corp. whose

employment contract requires the
appointment; OR

• A party to a voting agreement.

o The proxy may be ―irrevocable‖ for as long as the interest

lasts. (Acing 144)

o Death or Incapacity of Shareholder—appointing a proxy

does not affect the right of the corporation to accept the
authority of the proxy holder

UNLESS:
 the corporate officer authorized to tabulate votes
receives written notice of the death or incapacity
prior to the time proxy holder exercises her
authority under the appointment. (Barbri, 23)

B. Proxy Holder
• The person who is give the authority is called the proxy holder and
he becomes the shareholder’s agent to vote the shares in question.
(Flem. 11)

C. Solicitation of Proxies

• Several rules in Regulation 14A, adopted under the SEC Act of 1934
govern the entire proxy process, regulating the manner and means
by which proxies may be obtained or solicited.

• Prior to the time that any person makes a ―solicitation,‖ the

person being solicited must 1st receive or/ have received a ―Proxy
statement.‖ (SEC Rule 14a-3).

o Solicitation includes: (Acing 127)

Any request for a proxy

Any request to execute OR not to execute, OR to revoke

a proxy; and

Furnishing of a form or proxy or other communication,

reasonably calculated to result in the procurement,
withholding, or revocation of a proxy (See. Long Island
Lighting Co. v. Barbash)

Solicitation does not include: (Acing 128)

 Public statements or speeches or advertisements
stating how a shareholder intends to vote AND
the reasoning behind the vote;

Solicitations by someone (other than an affiliate

of the corporation OR a party in interest) who
does not intend to act on another’s behalf;

Any solicitation made to 10 or fewer persons,

provided it is not made by the corporation; AND

Advice to any person with whom the person

furnishing the advice has a business relationship.

D. Proxy Fights

• A proxy fight—is a battle to obtain control of a corporation through

a vote of the shareholders.

o Insurgent group—the group who wants to gain control and

oust existing management.

They attempt to gain control by soliciting proxies from a

large enough number of shareholders to elect its own
representatives to the Board of Directors.

Access to shareholders--Rule 14a-7 (SEC Act 1934)

provides that when an insurgent group wants to contact
shareholders and provide materials related to the
contested vote, EITHER:

1.) management may mail the insurgent group’s

material to the shareholders directly and charge
the group for cost;
 OR

2.) management can give the insurgent group a

copy of the shareholder list and let the insurgent
group distribute its own materials (this option is
generally disfavored by management. (Acing 129)

o Incumbent group—the existing management

E. Reimbursement for Costs Associated with Obtaining Proxies:

• Once the proxy battle is over and one side has won and the other
has lost, the parties often turns to the issue of reimbursement.

• Incumbent directors/management can use corporate funds

to defend corporate policy (i.e. by waging proxy campaigns)
as long the expenses are not excessive or illegal AND the
shareholders are fully informed.

o The rules of reimbursement are the following:

1.) The corporation MAY NOT reimburse either

party, UNLESS the dispute involves a question of
corporate policy.

The dispute cannot be personal—i.e. an

argument that one group is better than the other.

NOTE—because of this rule most proxy

battles are presented as matters involving
―policy disputes.‖

2.) The corporation may ONLY reimburse

reasonable and proper expenses.
 3.) The corporation may reimburse the
incumbents whether; AND

4.) The corporation may reimburse insurgents

only if they win AND the corporation’s
shareholders ratify the reimbursement, after full
disclosure.

Shareholder Proposals—(Shareholders’ rights to include their proposals in

Proxy statements)—(SEC Rule 14a-8):

• Issue—The biggest question that arises in this area is

o What needs to be satisfied in order for a shareholder proposal

to ―qualify‖ to be included in the proxy statement? (Acing
130)

• The proposals must relate to certain areas over which the

shareholders have control.

o In order to satisfy the requirement that a proposal be within

an area which is a proper subject for action by the
shareholders, most proposals are worded as
recommendations, rather than mandates and are nonbinding
in nature.

• Shareholder proposals have both procedural and substantive

requirements they must meet.

o Procedural requirements (to be eligible to submit a

proposal):

A shareholder must hold $2,000 in market value of the

company’s stock, and have held it continuously, for the
 12 months preceding the proposal;

A shareholder may not submit more than one proposal

for each shareholder’s meeting;

A proposal may not exceed 500 words

Most proposals must be submitted to the company at

least 120 days before the company’s proxy statement is
released; AND

Either the shareholder or shareholder’s ―qualified

representative‖ must attend the meeting at which the
proposal is to be considered.

o Substantive Requirements (if these requirements are

not met the proposal will be EXCLUDED):

The topic must be the proper subject for actions by

shareholders under state law;

The proposal may not cause the company to violate any

law;

The proposal may not address personal grievance or

special interest which is not applicable to other
shareholders;

If the proposal relates to the company’s operations,

those operations must involve at least 5% of the
company’s assets, net earnings or gross sales OR the
operations must otherwise be significantly related to the
company’s business;
 Proxy can not violate proxy rules by including material
misleading statements;

The proposal may not be beyond the company’s power

to implement;

The proposal may not address management functions

such as the company’s ordinary business operations;

The proposal may not relate to specific amounts of cash

or stock dividends; and

The proposal may not directly conflict with one of the

company’s own proposals, being submitted at the same
meeting.

In addition, the proposal can be excluded by company if

it was previously submitted within the last 5yrs and did
not receive the require percentage of votes. (Acing,
132)

Shareholder Inspection Rights

Right to shareholder lists:

o Shareholders have an unqualified right to obtain a list of other

shareholders and their addresses.

• Right to inspection of corporate records:

o Shareholders have a right to inspect corporate books and

records IF Shareholder has a proper (or legitimate)
business purpose.

Ex—Proper purpose:
 Shareholder wants to solicit support (consistent
with proxy rules) for a shareholder proposal.

Effort to gain control of corporation an effort to

gain a shareholder list for someone else trying to
gain control of the corporation

Effort to investigate alleged corporate

mismanagement or malfeasance

Effort to gather information to asses the value of

one’s shares; and

An effort to communicate with other shareholders

in connection with a proxy fight or a shareholder
proposal. (Acing P.133-1334)

Improper purpose:
Finding potential customers for a personal
business venture;

Persuading the corporation to adopt one’s social

or political concerns, (irrespective of any
economic benefit to the shareholders of the
corporation)—See State Ex Rel. Pillsbury v.
Honeywell, inc.

To institute a suit without substantive basis

Seeking proprietary information (i.e. trade secrets

or other intellectual property); and

Seeking information to aid a competitor of the

corporation.
Closely Held Corporation & Public Company

• Public company

o In a public company the stock is often owned by

thousands of shareholders, most of whom do not know
each other.

o The stock of the corporation (or at least one class of

stock) has been registered with the SEC and may be
bought or sold on one of the public exchanges (i.e. the
New York Stock Exchange or NASDQ).

o Battles for control—In public companies battles for control

can take the form of proxy fights or tender offers.

• Closely held Corporation

o A closely held corporation’s stock is typically held by a

relative few number of shareholders.

o Its shares are not publically traded and sales of stock

take place in private transactions, typically requiring an
exemption from the registration requirements of the 1933
Act.

o Closely held corporations are often also called ―private

companies and often have shareholders who also serve
on the Board of Directors and hold positions as officers
as well.
 o Battles for control—the struggle for control often focuses on
a shareholder’s ability to control votes, often through
agreements or structure of the business.

FREEZE-OUTS: (Acing 110/148-155)—

Ask Prof about the Delaware (Majority rule) and Massachusettes rule
(Minority rule)

• A freeze out involves a situation in which a minority shareholder is

blocked from holding a paid position with the corporation (i.e.
position as an officer or employee), by the majority.

o It is not just the actions or circumstances that are relevant in

evaluating a ―freeze out,‖ but also the intent behind the
actions and the circumstances.

o Freeze outs are not always actionable—A shareholder who

owns a minority position in a corporation must know that
being frozen out is a possibility--based on the mathematical
realities of the situations.

o Ex. Of an unlawful freeze out:

Dominant shareholder pays herself a salary well in

excess of a reasonable salary leaving no funds to
distribute to the minority shareholders.

• Dominant shareholder (Acing 110-115,120)

o Generally, shareholders do not owe each other fiduciary

duties to other shareholders.

o However, because a dominant shareholder has more influence

over the corporation and over the Board of Directors, there
 are certain instances when dominant shareholders are bound
by certain fiduciary duties. In these instances only certain
―duty of loyalty‖ transactions are implicated.

In the instance of a dominant shareholder the board is

not allowed to ―cleanse‖ the transaction and ratification
by disinterested shareholders just shifts the burden of
proof to PL. (Acing 111).
o Determining whether a shareholder is
dominant?

Question to ask—whether the holdings of a particular

shareholder is enough to exert control, over the
corporation.
Ex. If one shareholder has 25% of corp. stock and
all other shareholders each hold 1% (or less),
then the shareholder with 25% might very well be
dominant. (Acing 112)

NOTE—A group of shareholders acting together , might

also be considered to be a dominant shareholder.

o ―Freeze-Outs‖--Partnership Like Analysis (Wilkes

case)—(Acing 152)
Shareholders in closely held corporations owe each
other a duty of good faith.
In a freeze out, the majority, or controlling group must
have a ―legitimate business purpose‖ for its action,
and,
even if there is a legitimate business purpose, the
minority shareholder will still have the opportunity to
show that the ―same legitimate objective could have
been achieved through an alternative course of action
less harmful to the minority interest.
RULE 10b-5

• This rule makes it illegal for anybody to directly or indirectly use any
measure to defraud, make false statements, omit relevant
information, or otherwise conduct business operations that would
deceive another person in the process of conducting transactions
involving stock and other securities
• Who can use it?
o Rule 10b-5 can be used by the SEC and by private
individuals in pursuing fraud claims.

• Purpose of the Rule:

o It creates liability for anyone who makes misleading

representations or omission that is connected to the purchase
and sale of a security.

o Rule 10b-5 is also used to restrict insider trading. In fact the

rule’s greatest impact is to prohibit instances of trading
securities on the basis of inside information.

o The rule is not about correcting every wrong, it is about full

disclosure. Once full and fair disclosure is made, the fairness
of the transaction is not an issue under federal law.

• Rule statement:

o Under rule 10b-5, it is unlawful for any person, directly or

indirectly, by the use of any means or instrumentality of
interstate commerce or the mails , or of any facility of any
national securities exchange in connection with the purchase
of any security to:

1.) employ any device , scheme, or artifice to

defraud;
 2.) Make any untrue statement of a material fact
or omit to state a material fact necessary in order
to make the statements made, in light of the
circumstances under which they were made not
misleading; OR

3.) Engage in any cat, practice, or course of business

that operates or would operate as a fraud or deceit
upon any person,

o in connection with the purchase of any security. A

violation of the rule can result in a private suit for damages,
an SEC suit for injunctive relief , or criminal prosecution.

• If Plaintiff is a Private Person: To recover damages under rule

10b-5 a private plaintive must show: (Barbri 60-62)

o 1.) Fraudulent conduct:

PL must show DF engaged in some fraudulent conduct

by either:

making a material misstatement OR

making a material omission

o 2.)Materiality:

A statement will be considered material if there is a

substantial likelihood that a reasonable investor would
consider it important in making her investment decision.
No bright line test exists, but a plaintiff need not
prove that the information us statistically
significant or valid.
o 3.) Scienter:

The conduct complained of must have been undertaken

with an intent to deceive, manipulate, or defraud.
The Supreme Court has held that statements
made knowingly suffice, but negligence alone
does not suffice. However, some courts have
held that ―deliberate recklessness‖ does suffice.

o 4.) in connection with Plaintiff’s Purchase or Sale of a

Security:

The fraudulent conduct must be in connection with the

purchase or sale of a security by the plaintiff.

The term ―in connection‖ is interpreted broadly.

• The term INCLUDES transactions such as

exchanges of stock assets, mergers,
contracts to sell, etc.

• It EXCLUDES potential purchasers who did

not buy (because of the fraud) and people
who already own shares and refrain from
selling (because of the fraud).

Rule 10b-5 applies to ANY security, in both a

public corporation and closely held corporation.
(Acing 175)

The focus is on a sale or purchase by the plaintiff.

The defendant need not have purchased or sold
any securities.
 • E.g. A nontrading DF, such as a company
that intentionally publishes a misleading
press release, can be held liable to a person
who purchased or sold securities on the
market on the basis of the press release.

NOTE—Distinction between private PL and

Gov.:

• A private plaintiff can not bring an action

based on DF’s status as an ―aider and
abettor‖ of other defendants’ fraud.

• However, the government may base an

action on aiding and abetting.

o 5.) Interstate commerce:

The fraudulent conduct must involve some means of
interstate commerce.
E.g. Use of a telephone OR mail will suffice.

o 6.) Reliance:
If a plaintiff brings a private action, there must be a
showing that he or she actually AND justifiably relied on
the defendant’s misrepresentation.

OMMISSIONS: In the case of an omission reliance is

presumed.

There are some cases in which a company or an

officer of the company has a duty to speak but do
not, in such cases, the company’s failure to speak
is considered an omission.

• Rationale:
o Given the duty to disclose, a person is entitled to rely that
appropriate disclosures will be made. In effect, they can rely
that on silence as a statement that there are no material
information that the company is required to disclose , which
has not been disclosed. (Acing 180)

FRAUD ON THE MAKET THEORY: Under the fraud

on the market theory, in a misrepresentation
action on securities sold in a well defined market
(e.g. the national stock exchange), reliance on
any public misrepresentations may be presumed.
(Barbri, 62)

• This theory is generally applied in instances

involving a misrepresentation (usually
involving a large group of people), which
involve an affirmative statement (NOT an
omission), in which plaintiff cannot show
that they each relied on the statement.
(Acing 180)

o The fraud on the market theory was

developed as a way to show how a
large group of people could have
relied on a misstatement.

The fraud on the market theory creates a

rebuttable presumption that, even if the plaintiff
did not hear the misstatement, there was still
reliance. (Acing 180)

• The theory creates a presumption that the

investor relied on the integrity of the
market price and so the investor does not
even need to have seen or heard the
 misrepresentation to satisfy the reliance
element.

If DF wanted to avoid liability, DF would need to

rebut the theory by showing that the
misrepresentation: 1.) did NOT affect the market
price; 2.) DF issued corrective statements which
were also priced into the market; 3.) PLs would
have bought OR sold anyway, even with full
disclosure; OR 4.) DF did not rely on the integrity
of the market.

Fraud on the ONLY works when there is an

efficient market, It does NOT apply in private
transactions.

o 7.) Causation:

The plaintiff has to show that statement caused the

loss.
It is not enough to show that the misrepresentation
caused the transaction.

The plaintiff needs to show that the

misrepresentation caused the lass itself.
(Acing 181)

o 8.) Damages:

Plaintiff must be able to show injury/damages.

Damages in a 10b-5 may take the form of:

Actual damages:
 o Difference between the price actually paid/or received AND
the price that should have been paid without the 10b-5
violation.

• consequential damages

• Punitive damages (in extreme cases)

• Note—Private plaintiffs have to prove two additional

elements (Reliance & damages)—ASK PROF!!!

• INSIDER TRADING--Rule 10(b)(5)-1 (“the plan”)

o Rule 10b5-1 permits major holders to sell a predetermined

number of shares at a predetermined time to avoid insider
trading claims
o Insider trading falls into two categories Traditional insider
Trading and Misappropriation. (Acing 192).
o 10b5-1 plan: Any person executing pre‐planned transactions pursuant to a
Rule 10b5‐1 plan that was established in good faith at a time when that person
was unaware of material non‐public information has an affirmative defense
against accusations of insider trading, even if actual trades made pursuant to
the plan are executed at a time when the individual may be aware of material,
non‐public information that would otherwise subject that person to liability
under Section 10(b) of the Exchange Act or Rule 10b5‐1

Two different types of people can be liable for

insider trading—the insiders who have access to
the inside information and the people who give
and receive tips based on the inside information
(tippers and tippees).

Tippers:
 Tippers are individuals who give tips of inside
information to someone else who trades on the
basis of such information.

Tippees:
A tippee is the individual that receives the inside
information from the tipper.

o Insiders:
D/O or shareholder w/ > 10% or anyone who

Ex. of Insiders: directors, officers, controlling

shareholders, and employees of the issuer, etc.

Ex. Constructive insider: (also owe duty of trust and

confidence):
A securities issuer’s CPA, attorneys, accountant,
underwriter, consultant bankers performing
services for the issuer, etc.

Tipper-Tippee Liability (Traditional Analysis—Prior to

O’Hagan case)

o IMPORTANT--The above analysis involves a typical;

situation in which an insider actually trades on that
information. However, individuals might also share inside
information with others.

o The insider trading rules limit the dissemination of material,

non-public information (“tipping”) by someone in possession
of information (“tipper”) and prohibit the use of that
information by the recipient (“the tippee”). Also, tipper/tippee
liability must also be based upon tipper’s breach of duty AND,
tippee’s knowledge of that breach of duty.
 An insider is only liable for tipping if they violated a
fiduciary duty by providing the tip.

In this analysis, the law is only interested in the duty of

loyalty.

o Tipper Liability:
A tipper is liable if they:

1.) Disclose material, non-public information

to others; AND

2.) that disclosure is made in breach of the

fiduciary duty of loyalty (OR in the case of a
tippee turned tipper with the knowledge that the
information was obtained as a result of breach of
a fiduciary duty of loyalty); AND

The existence of a breach is measured by

whether the tipper personally benefitted,
directly or indirectly, from the disclosure.

o A personal benefit is broadly defined.

It can include any consideration,

such as a monetary benefit, a tip in
exchange for a tip, an enhanced
reputation, or even a gift. o A personal
benefit is not the desire to do public
good.

3.) Someone trades on that information.

o A tipper is liable if anyone along the chain of information
dissemination trades on the information, not just the tipper’s
direct tippee.

NOTE---The tipper is not liable if there’s no

personal benefit received OR if no one trades on
the information.

o Tippee’s Liability:

A tippee’s liability is based completely on the tipper’s

liability. If there is no breach of duty by the tipper,
there can be no liability. If the tipper has no liability,
then the tippee can not have liability.

The tippee can ―inherit the tipper’s fiduciary

duty to the shareholders of the corporation not to
trade on material non-public, information ONLY
when:

• 1.) tippee receives material, non-public

information which was disclosed in
breach of a fiduciary duty by an insider
for the insider’s personal benefit at the
company who’s stock is being traded;
AND

• 2.) the tippee knows OR should know,

that the tip was a breach of the tipper’s
duty; o Ex. If insider provides a tip in
exchange for money , the tippee only needs
to know that the insider tipped for money,
not that tipping for money constitutes a
breach of fiduciary duty.
 • 3.) the tippee trades on that
information;

OR

• Provides the information to others (i.e.

tips and becomes a tipper), receives a
personal benefit for the tip and
someone trades on that information.

o NOTE—A person can be liable both as a tipper and a

tippee:

Any tippee who knowingly receives material, non-

public information, arising out of an insider’s
breach of duty, can also be liable as a tipper if
that individual passes that information along to
others in exchange for a personal benefit.

o If by overhearing the inside information, the person realizes

(or should realize) they are overhearing a breach of duty,
then they may not trade on the information.

o A tipper may protect its tippees from liability by not telling

the tippee the source of the information.

If the tippee does not know the source of the

information, the tippee can not know or have reason to
know of the breach.

Also, if the tippee truly did not know the source of the
information, the information might not be material.
 MISAPPROPRIATION THEORY (10b5-2) (Post—United States
v. O’Hagan)

o Background:
Prior to the O’Hagan case, insider was only liable if
there was a breach of duty in the trading of material,
non-public information

o The misappropriation theory broadens liability to

extend to those who breach a fiduciary duty of trust
and confidence to the source of the information.

o COMPLETE –RULE:

A person commits fraud in a securities transaction

when they misappropriate material, nonpublic
information in breach of a fiduciary duty of trust
and confidence owed to the source of the
information, AND does not disclose their intent to
trade on that information.

This is a way to hold the outsiders liable b/c

outsiders don’t have a fiduciary duty to the corp

o In evaluating whether there might be

misappropriation liability, one needs
to ask if anyone along the chain of
disseminated information breached a
fiduciary duty of trust and confidence.
(Acing 190)

• Since Rule 10b-5 requires some fraud or

deception under the misappropriation
theory, the fraud or deception occurs when
the misappropriator deceives the source of
 the information by letting the source believe
the information will be treated as
confidential.

• As in the traditional insider trading, tippees

who do not trade, do not become liable,
UNLESS they become a ―tipper‖ and
acquire tipper liability. (Acing 204)

o Short Exam Rule statement (for Misappropriation):

Under 10(b)(5)—2, a person can be prosecuted by

the government for trading on market information
in breach of a duty of trust and confidence owed
to the source of the information. Under a
misappropriation theory, the duty need not be to
the shareholder.

o List of Circumstances under Rule 10(b)-5 under which

people will be deemed to owe a duty of trust and
confidence in a misappropriation case: (Non-exhaustive)

1.) when a person agrees to maintain information in

confidence

2.) the parties have a history of sharing confidences

3.) When the person receives the information from a

spouse, child, parent or sibling (unless person can prove
they had no reason to know the information was
confidential). (Acing 201)

• RULE 14e—3 and Insider Trading Relating to Tender

offers:(Acing 205-207)
• SECTION 16(b)—SHORT SWING PROFITS (This is a rigid
rule-it either applies or does not)

o requires company insiders to return any profits made from the

purchase and sale of company stock if both transactions occur
within a six-month period.
o The purpose of section 16(b) is to prevent unfair use of inside
information and internal manipulation of price. This is
accomplished by imposing strict liability for covered
transactions whether or not there is any material fact that
should or could have been disclosed –NO PROOF OF USE OF
INSIDE INFORMATION IS REQUIRED. (Barbri, 64)

o This rule DOES NOT APPLY to closely held corporations.

o This rule APPLIES TO publicly held corporations whose

shares are traded on a national exchange OR that have at
least 500 shareholders in any outstanding class and more
than $10 million in assets.

o RULE:

Section 16(b) of the Securities Exchange Act of

1934 provides that any profit realized by a
director, officer, or shareholder owning more
than 10% of the outstanding shares of the
corporation from any purchase and sale, or sale
and purchase, of any equity security of the
corporation within a period of less than six
months must be returned to the corporation.
(Barbri, 64)

o Elements:
1.) Purchase and Sale or Sale and purchase within
six months;

2.) Equity Security;

 An equity security, is a security other than a pure
debt instrument, including options, warrants,
preferred stock, common stock, etc.

3.) Officer, Director, or More than Ten Percent

Shareholder;

Deputization of Director:

A person may deputize another person to act

as his representative on the board. In these
cases, securities transactions of the
principal will come within section 16(b).

4.) Profits realized

Includes not only traditional profits, but also losses
avoided.

• SARBANES-OXLEY ACT of 2002 (―SOA‖)

o The Act was an effort to increase disclosure by, and oversight

of, publicly traded companies in the wake of the Enron
scandal.

o Some of the requirements of the Act are:

1.) A publicly traded company’s president or CEO as

well as its Chief Financial Officer (aka Treasurer) must
sign its financial statements, verifying these officers
have each reviewed the statements, the statements are
accurate, and that the signatory takes responsibility for
what is in the statements.
 2.) Public companies may not make personal loans to
their officers or directors and must adopt a ―code of
ethics‖ for their respective CEOs and various financial
officers.

3.) SOA requires that attorneys who represent publicly

held companies report evidence of material violation of
the securities laws OR breach of fiduciary duty OR
similar violation by the company or any agent thereof…
to the company chief legal officer or CEO.

If proper action is not taken in response to such a

report, the attorney is then required to refer the
matter to a higher authority within the company.

For more information see--Acing 186/Barbri 66

• MERGERS & ACQUISITIONS

o Merger:
A merger occurs when two companies come together to
form one company.
If one of the two original companies survives then the
process is called merger.
The term is used to describe any combination of firms.

o Consolidation:
If the combination results in a new company, then the
process is called a consolidation.

o There are three basic ways companies may combine:

 1.) Statutory merger:

A statutory merger involves a combination in

accordance with applicable state law.

In traditional mergers the two companies negotiate

the percentage ownership that each respective
company’s shareholders will have in the new firm.
• In a merger/consolidation the consideration passes to the Target
shareholders.

Transaction must be approved by the shareholders

of both companies
Shareholders who do not approve the
transaction are typically entitled to
appraisal rights, UNLESS both companies
are publically traded.

2.) Sale of Assets:

Occurs when one company purchases the assets
of another.

In a sale of assets the Acquirer corporation gives

the Target corporation either stock or cash (or
some combination of cash and stock) in exchange
for the Target corporation’s assets.
Following the sale the Target corporation
usually has few or no assets, other than the
consideration paid to the Acquirer.

In a sale of assets, the Target must usually make

its creditors aware of the sale so that creditors
may make a claim against the consideration being
paid for the Target’s assets.
Once the Target’s creditors have been paid and
the Target has received the balance of the
consideration paid by the Acquirer, the Target
may then, issue a liquidating dividend to its
shareholders.

If the target has a substantial number of assets,

the sale of assets can be a more complicated
process than a statutory merger because, among
other requirements, a sale of assets will require
the transfer of ownership of each of the specific
asset of the Target corp.

In a sale of assets the shareholders of the Target

corp. are entitled to vote on a sale of all or
substantially all of the assets.

In Delaware the shareholders of the Acquirer

corp. are not entitled to vote, but some other
states do allow shareholders in the Acquirer corp.
to vote on transactions involving the sale of
assets.

In Delaware, dissenting shareholders in the

Target corp. are NOT entitled to appraisal rights,
BUT some states so allow the Target company
shareholders in a sale of asset transaction
appraisal rights.

Dissenting shareholders in the Acquirer corp. are

NOT entitled to appraisal rights.
 The acquiring corporation will obtain the Target
corp’s assets, BUT NOT its liabilities (Acing 223-
24)

3.) Sale of Stock:

A stock sale involves the purchase of the stock of

one company by another.
Since the Target company provides stock
instead of assets, the Target corporation
winds up as a subsidiary of the Acquirer
corp. As a result, there are two surviving
corporations instead of one.

Since the Target corporation survives, its liabilities

also survive.

o NOTE—Technically the first process is a merger or a

consolidation and a sale of stock or assets is an acquisition.

o In most basic of mergers one company is identified as the

―acquirer‖ while the other is identified as the ―Target.‖

• De Facto Merger Doctrine:

o The Defacto Merger Doctrine is applied when a company

manipulates the form of a transaction to avoid a result which
would have applied had the transaction been accomplished in
a more traditional manner. (Acing 227)

Rationale: When a shareholder is faced with a

transaction that so fundamentally changes the
 corporate character of a corporation and the interest of
the plaintiff as a shareholder therein, to refuse him the
rights and remedies of a dissenting shareholder would
in reality force him to give up his stock in one
corporation and against his will accept shares in
another. (Farris v. Glen Allen Corp.—this case is in
the new casebook)

o Under the de facto merger doctrine, if the transaction has the

substantive effect of a merger, then the shareholders of the
companies involved in the transaction are entitled to the
same statutory protections they would have received had
there been a merger. (Acing 227)

o Delaware and a majority of jurisdictions do not recognize the

de facto merger doctrine,

because the courts have reasoned that states have

different processes to achieve the same results and, as
long as the process is legal, courts should not recast
the transactions which would only increase uncertainty
and litigation (See Hariton v. Arco Electronics).
(Acing 227)

• FREEZE OUT MERGERS:

o Freeze out mergers (aka ―cash out mergers‖) are a process

by which, in some states, a majority shareholder may force
the minority shareholders to sell their stock in a merger with
(or acquisition by) an entity owned by the majority
shareholder(s), enabling the majority shareholder(s) to
acquire 100% control of the company.
o These transactions involve a conflict of interest.

The standards for reviewing transactions involving a

controlling shareholder and a conflict of interest and a
merger is ―entire fairness.‖ (Acing 228)—Cross
check with class notes!!!

The entire fairness standard requires that the

transaction be accomplished by both 1) a fair
process (i.e. fair dealing) and 2.) fair price.--
 THIS IS DIFFERENT FROM WHAT IS IN YOUR
NOTES!!! (See Week 12)

• As long as the majority shareholder effectuates the freeze out

merger at a fair price and by a fair process, then the merger may
proceed.

o Different states have different requirements for cash out

mergers:

California & Delaware—Short Form Merger

(―Freeze out‖/‖cash out‖):
California will only allow a majority shareholder to
―cash out‖ the minority in a ―short form
merger‖ in which the majority own at least 90%
of the corporation and the transaction must be
approved by the California Commissioner of
Corporations.
(Acing 229)

Statutory Short Form Mergers:

Short form mergers are often used following tender
offers to eliminate any remaining minority
shareholders. (Acing 229)

HOSTILE ACQUISITIONS:

• Unlike ―Freeze Out Mergers‖ (and statutory short form mergers)

were both firms’ Board of Directors must agree in order for the
transaction to proceed, there are situations in which one firm or
individual wants to acquire another, and the Board of Directors of
the Target firm does not want to be acquired or does not want to be
acquired by that particular person or firm. (Acing 230)

o The process of excluding the Board from an effort to

acquire control of a company is generally referred to as
―hostile.‖

o There are three main approaches that might be used to

circumvent the Target’s Board of Directors: (Acing 230)

Tender offers—are a public offer, usually made to all

the shareholders of the Target corporation wherein the
Offeror offers to buy all of the Target’s shares at a
specific price. (Acing 230)

NOTE:
Any person who commences a tender offer in
an effort to acquire more than 5% of a
company must comply with the extensive
rules and regulations arising under sections
14(d) and 14(e) of the 1934 Act. --(Acing
231)

Direct Share Purchases—involve direct purchases of

stock by the potential acquirer in the public market or
privately negotiated transactions with limited number of
shareholders.

Proxy Contest—is a battle for control of the Target’s

Board of Directors through the shareholder voting
process.
• TAKEOVERS: (Acing 230-31)

o Hostile Takeovers—
A hostile takeover involves an effort to acquire sufficient
shares to control the board of Directors, and then
replacing the board of Directors with the Acquirer’s own
slate of directors.

This process is often followed by some form of

statutory merger of the acquired Target entity
into an entity controlled by the Acquirer and may
or may not involve cashing out the remaining
shareholders.

• Defense Tactics: (Acing 232) o Below are some of the tactics

companies use to resist hostile takeovers:

1.) Greenmail:
Greenmail involves a payment made to a potential
acquirer to incentivize them to leave the company
alone.

• It usually occurs when…..

2.) White knight:

3.) Poison pill:
4.) Share Repurchases:
5.) Staggered Board:
6.) Shark repellent:
7.) Golden Parachutes:
8.) Pac-man Defense:

• Fiduciary Duties in Takeover Defenses: (Acing 234) o

• DISSOLUTION & LIQUIDATION